1                              MEETING
             2                               of the
             3                     MARKET STRUCTURE HEARINGS
             4                        New York University
             5                             Tisch Hall
             6                           New York, N.Y.
             7                         November 12, 2002
             8                             9:00 a.m.
             9            ANNETTE L. NAZARETH, Chairperson, Presiding
            10                DIVERSIFIED REPORTING COMPANY, INC.,
            11                        1025 Vermont Avenue,
            12                       Washington, D.C. 20005
            13                           (202) 296-9626
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            24                Diversified Reporting Services, Inc.
            25                           (202) 467-9200
             1                       P-R-O-C-E-E-D-I-N-G-S
             2             COMMISSIONER GLASSMAN:  Good morning.  I'm
             3   Commissioner Cynthia Glassman, and on behalf of my
             4   colleagues, Chairman Pitt, Commissioners Goldschmid, Atkins
             5   and Campos, who will be here in a second, I'd like to welcome
             6   all of you today to our market structure hearing, and thank
             7   you all for your participation.
             8             Our first interactive session in Washington, on
             9   October 29th, was very informative, and I know I speak for
            10   all of my colleagues when I say that we have been looking
            11   forward to the second session today.
            12             As I said at the last session, the purpose of
            13   today's session is to educate the Commission on issues
            14   relating to the structure of the U.S. equities markets, with
            15   emphasis on how the public interest and protection of
            16   investors can best be served.
            17             A key subtheme is whether our well-intended rules
            18   to protect the public have unintended consequences.  We want
            19   the benefits of your views on the topics we've chosen for
            20   discussion today.  Even more useful to us, will be the
            21   opportunity to listen to you, the panelists, discuss and
            22   debate this array of issues.
            23             In my ten months as Commissioner, I've had meetings
            24   with representatives of many different markets and market
            25   participants, and each meeting has been useful.  But what I
             1   really wanted to do was to get all of the differing
             2   viewpoints on a particular topic represented in the same
             3   room, and let the people advocating one position respond to
             4   those advocating a contrary position.  No holds barred.
             5             We had some lively discussion last time, and this
             6   is what we hope will happen today.
             7             As far as our expectations, it's obvious that two
             8   days of hearings, no matter how productive they are, are not
             9   going to answer all the questions.  But today's discussion
            10   will enhance our understanding of current market structure
            11   policy concerns, as well as possible tradeoffs that we may
            12   have to make as we attempt to resolve the important issues
            13   before us.
            14             Before we get started, I'd like to again thank the
            15   key members of our market structure working group.  Annette
            16   Nazareth, Bob Colby and Alden Atkins and their staff in
            17   market reg.  Larry Harris, our chief economist and his
            18   colleagues; Giovano Presioso, and Meridith Mitchell, who are
            19   not here today, but from our general counsel's office.  Steve
            20   Jung on the Chairman's staff and last but not least, Mary
            21   Head and Brian Stern on my staff.
            22             Now, let's get started.  I'll turn this over to
            23   Annette.  Thanks.
            24             MS. NAZARETH:  Thank you, Commissioner Glassman.
            25   I, too, would like to welcome the Commission, our
             1   distinguished panelists and members of the public to this
             2   second market structure hearing.  Today the Commission
             3   continues its more than thirty-year tradition of critically
             4   examining issues relating to the structure of our equity
             5   markets.  Prior Commissions have faced many complex and novel
             6   issues in this particularly challenging area of securities
             7   regulation, both before and after the Securities Act
             8   Amendments of 1975 that gave the Commission a mandate to
             9   build a better national market system.
            10             To its credit, the Commission took actions that
            11   have resulted in a vibrant, healthy and efficient
            12   marketplace, a marketplace indeed that is the envy of the
            13   world.  As technology continues to transform our lives and
            14   the way we do business, once again we stand at a crossroads
            15   with respect to various market structure issues, and the
            16   solutions we arrive at will have far-reaching consequences,
            17   especially in this highly competitive marketplace.
            18             We hope that these hearings will achieve several
            19   important objectives.  First, as Commissioner Glassman
            20   mentioned, we hope that these hearings will provide a
            21   comprehensive picture of the structure of the U.S. equities
            22   markets.  Our marketplace consists of a sweeping variety of
            23   market centers and trading methods that cater to different
            24   types of securities and different categories of investors.
            25   Some markets are centralized, others are decentralized.  Some
             1   markets are driven by the interaction of customer orders,
             2   others are propelled by the willingness of designated market
             3   intermediaries to committed capital.  Some markets are
             4   grounded in the physical trading floor where bids and
             5   offerings meet face-to-face.  Others float in the anonymous
             6   realm of cyberspace.
             7             Another goal of these hearings is to discuss the
             8   complex tradeoffs that we have to make in regulating market
             9   structure.  How should we reconcile the investor's need to
            10   obtain current information about market activity with each
            11   market center's desire to exploit the commercial value of the
            12   data that it generates?  How should we reconcile the
            13   investor's desire to have access to the best prices with the
            14   right of individual market participants to employ the
            15   business model of their choice?
            16             When should a market be required to act in the
            17   public interest, rather than in the interest of its members
            18   or shareholders?
            19             These questions do not have simple answers, and
            20   there are many difficult decisions to be made.  We are
            21   nevertheless committed to resolving these competing interests
            22   in the fairest and most balanced manner possible.
            23             A third goal of these hearings is to use what we
            24   learn to maintain consistent policy positions on the key
            25   issues facing the Commission.  In recent years, the
             1   Commission has undertaken a number of market structure
             2   initiatives.  Just to name a few, the Commission adopted
             3   order handling rules for market makers and ECNs in 1996,
             4   Regulation ATS governing alternative trading systems in 1998,
             5   and order execution and order routing quality disclosure
             6   obligations for market centers and retail brokers in the year
             7   2000.
             8             While some may differ, most would say that these
             9   rules have significantly improved the transparency and
            10   accessibility of our markets.
            11             The Commission has also solicited comment on a
            12   number of specific areas of market regulation.  Among others,
            13   the Commission has issued concept releases on the regulation
            14   of market data fees and revenues, the fragmentation of the
            15   U.S. securities markets, and the regulation of exchanges.
            16   The Commission also convened an advisory committee in 2000,
            17   chaired by Dean Joel Seligman, to consider issues related to
            18   the collection and dissemination of market information.
            19             These efforts to develop sound policies for market
            20   regulation must continue if we are to make our markets
            21   fairer, more efficient, and more transparent.  To this end
            22   the Commission seeks to ensure that the decisions it makes in
            23   the coming months and years will benefit from the wise
            24   counsel of the industry, the academic community, and the
            25   public.
             1             Now, before I introduce our participants today,
             2   I'll briefly mention just a few housekeeping matters.  This
             3   morning we will have two sessions.  In the opening session,
             4   we'll touch on the overarching principles of market structure
             5   and discuss whether there is a consensus on those guiding
             6   principles.  This session will last only an hour, and will be
             7   followed by a fifteen-minute break from approximately 10:30
             8   to 10:45.  We may run a little bit late.
             9             We will then follow with our first major session on
            10   market data to be moderated by Bob Colby of the Division of
            11   Market Regulation.  At 12:15 we'll break for lunch for one
            12   hour and then reconvene at 1:15 for our afternoon program.
            13             As to the general groundrules, in order to keep the
            14   dialogue moving and to afford everyone an opportunity to
            15   speak, and I am very optimistic, I'm told we have a group of
            16   good chatters here, I'd like to ask each of you to attempt to
            17   limit your responses to two or three minutes, and given the
            18   limitations on time, we also ask that you not pipe in just to
            19   repeat a point that's already been made.
            20             The next groundrules are just as tough.  Try to
            21   leave your ego at the door, your own personal business
            22   perspectives and biases, and keep in mind that the
            23   Commission's ultimate goal is the protection of investors;
            24   that this is a policy discussion after all.  And I'd also
            25   like to note that just outside this room, we have a black
             1   box, which you can put note cards with questions that you may
             2   have for the panel that, time permitting, we will attempt to
             3   address later in this program.
             4             So with that underway, I'd like to introduce each
             5   of the participants briefly and then circle back and give
             6   everyone the opportunity, if you wish, to make a brief
             7   statement, although it's not required, but you're certainly
             8   welcome to.
             9             Before I do that, I would like to introduce our
            10   Commission which is present today.  We have Chairman Pitt,
            11   Commissioners Goldschmid, Atkins and Campos and of course
            12   Commissioner Glassman.  I'd especially like to thank Chairman
            13   Pitt for calling for these hearings and Commissioner Glassman
            14   for her very substantial efforts in putting this program
            15   together.
            16             We also have at the table Bob Colby, who is the
            17   Deputy Director of Market Regulation, and Larry Harris, who
            18   is our chief economist.
            19             Going around the table, in order, we have Robert
            20   Murphy, who is here from LaBranche.  We have Commissioner
            21   Campos.  We have Albert Kyle, who is a professor from Duke
            22   University; Minder Cheng, who is with Barclay Global
            23   Investors, Ian Domowitz, with Investment Technology Group;
            24   Janet Angstadt with Archipelago; Matt DeSalvo with Morgan
            25   Stanley; Scott DeSano from Fidelity Management and Research,
             1   I think the staff is pulling a stunt on me, DeSalvo and
             2   DeSano next to each other.  Larry Harris, Chairman Pitt, Bob
             3   Colby, Commissioner Glassman, we have Tom Peterffy from
             4   Interactive Brokers Group, Tom Gardner, who you may not
             5   recognize without his hat, here from Motley Fool, Paul
             6   O'Kelly from the Chicago Stock Exchange, Robert Steel from
             7   Goldman Sachs, Gunner Burckhart with Deutsche Asset
             8   Management; Commissioner Goldschmid, Commissioner Atkins and
             9   Rubin Lee from Oxford Financial Group.
            10             I'd like again to give each of you the opportunity
            11   to make a brief statement.  We could start, Bob, with you, if
            12   you'd like to.
            13             MR. MURPHY:  Be happy to.  Good morning, I am Bob
            14   Murphy, New York Stock Exchange specialist with LaBranche &
            15   Company as well as New York Stock Exchange Director and Vice
            16   Chairman of the board.  I wish to thank the Commission for
            17   affording us this opportunity to exchange views on issues
            18   relating to the structure of our security markets.
            19             Our markets can only benefit from these hearings.
            20   Specialists on the New York Stock Exchange are accountable to
            21   the investing public, for the quality of NYSE markets and
            22   their specialty stocks.  This means that the specialist is
            23   responsible for fostering and maintaining liquidity and
            24   continuing two-sided auction markets on the NYSE floor.  The
            25   specialist plays a pivotal role in insuring that investor
             1   orders receive the best possible execution.  To accomplish
             2   this, specialists act both as agent and principal in their
             3   specialty stocks, to help insure that markets for those
             4   stocks are fair and orderly, and that they operate
             5   efficiently in the public interest.
             6             The NYSE specialist is the focal point of the
             7   auction price discovery process.  The specialist's primary
             8   job is to bring buyers and sellers together in an efficient
             9   and orderly manner to provide transparency and liquidity and
            10   to maximize the opportunity for public buy and sell orders to
            11   interact without getting between them.
            12             The NYSE specialist has an affirmative obligation
            13   to step in and step up when no one else wants to.  The
            14   specialist buys or sells as principal when necessary to
            15   minimize short-term imbalances between supply and demand.
            16             In this way, the specialist provides depth and
            17   price continuity, minimizes volume at this time in the
            18   auction market.  In addition, the specialist has a negative
            19   obligation.  The specialist may not trade for a proprietary
            20   account unless reasonably necessary to maintain a fair and
            21   orderly market.
            22             The NYSE specialist places customers on both sides
            23   of the market first.  In my view, all of us in the industry;
            24   brokers, dealers, market makers and specialists, should
            25   adhere to that fundamental principle.
             1             The industry has changed quite a bit since I first
             2   came to Wall Street and not all for the better.  I am
             3   concerned about a number of anticustomer practices that I see
             4   in the industry today.  Dealers in other markets cherry pick
             5   the easiest orders of the least informed customers and
             6   execute those orders at prices discovered at the NYSE while
             7   NYSE specialists stand ready to accept all orders of all
             8   customers, including the offsetting orders of the cherry
             9   pickers.
            10             Agents for customers receive payment for their
            11   customer orders.  Agents for customers trade against orders
            12   for their customers, without giving those orders a chance to
            13   interact with other orders of public customers.  Dealers in
            14   other markets disseminate non-competitive quotes, thereby
            15   shunning the responsibility to make markets for all, while
            16   still guaranteeing significant order flow.  An exchange buys
            17   reports of off-exchange trades from OTC dealers and ECNs and
            18   fraudulently prints those off exchange trades as though they
            19   have actually taken place on that exchange.  An ECN hides
            20   quotes and its participants ignore better priced orders on
            21   other markets.
            22             Regaining investor confidence is crucial to the
            23   continued preeminence of our secondary markets, yet we have
            24   allowed to creep into our markets practices in which dealers
            25   and even agents put their own interests ahead of the
             1   interests of their customers.
             2             The NYSE trading model precludes these
             3   anti-investor practices by the very way that it has evolved.
             4   We integrate the trading of institutional and retail orders
             5   into a single auction and we apply automation to the extent
             6   consistent with that integration.  This provides investors
             7   with optimal price discovery and maximum flexibility.  Other
             8   markets take different approaches, but whatever model a
             9   market may choose, the Commission should not permit it to
            10   embody those anti-investor practices -- and that requires the
            11   Commission to attack the root causes of those practices.
            12             Finally we believe Congress got it right in 1975
            13   when it determined that transparency was the heart of
            14   effective inter-market competition and when it bounded
            15   intermarket competition by the principle that dealers should
            16   only intervene as a last resort, thus, we support all markets
            17   disseminating as much as is possible, trading interests
            18   disclosed at the point of sale.  We support maximizing the
            19   opportunities for customer orders to interact directly within
            20   a market so that the particular participants to a trade
            21   receive best execution and all market participants receive
            22   the benefits of optimal price discovery.
            23             Let's place the customer first.  I thank you for
            24   this opportunity to present my views.
            25             MS. NAZARETH:  Thank you, Bob.  Pete?
             1             PROFESSOR KYLE:  Thank you.  I just want to make a
             2   couple of points.  Three points.  First, computers have
             3   become very commonplace in trading and we need to think about
             4   what the role of computers is.  On the one hand, computers
             5   allow us to implement very complicated trading strategies and
             6   keep track of very large amounts of information.  On the
             7   other hand, computers are very honest.  If they do something
             8   wrong you can generally catch them and they generally do
             9   whatever you tell them to do and we shouldn't lose sight of
            10   the fact that computers will allow us to have a better audit
            11   trail and more continuity in the markets.
            12             Second of all, I want to make a few points of
            13   organized exchanges.  Organized exchanges have sophisticated
            14   members and sophisticated customers.  They  also have
            15   unsophisticated customers who are usually retail type people.
            16   The value of an organized exchange's franchise largely lies
            17   with its reputation among the least sophisticated customers.
            18   And the ability of an exchange to build this reputation
            19   largely consists of how transparent the exchange is, so the
            20   idea of building transparency is very important for organized
            21   exchanges to maintain their reputation, which is their
            22   capital, with the least sophisticated customers.
            23             The third point I want to make, we have with the
            24   national market system a ticker, and that ticker could easily
            25   be augmented to have added to it various pieces of
             1   information that would make the market transparent and also
             2   make it easier to audit what's going on in the market.  Among
             3   other things, you could have a unique identifier attached to
             4   a ticker that would allow it to be traced back to a
             5   customer's trade so a customer can easily identify his trade
             6   on the ticker.  Whether you're a large customer or a small
             7   customer, that type of information would be very valuable and
             8   would not be all that costly to implement.
             9             Thanks.
            10             MS. NAZARETH:  Thank you.  Minder?
            11             MR. CHENG:  Good morning.  I also would like to
            12   thank the Commission for giving us the opportunity to comment
            13   on these important issues that will be important not only to
            14   us, but also to the market and to the investors.
            15             Let me just start by saying I think that trading,
            16   especially on the buy side for the large institutional asset
            17   managers has evolved from pure execution to an element of --
            18   a cost element of the investment return to now account for a
            19   large portion of the additional return we can provide to our
            20   investors.
            21             Now, with the technology and with regulatory
            22   environment changes, it has opened the way for buy side
            23   traders to directly access market liquidity, but what it also
            24   has introduced is it created an environment where it becomes
            25   a challenge for the buy side institution to find a way to
             1   additional return, minimize transaction cost, but then
             2   without really going through some of the hurdles that
             3   certainly did not exist before.
             4             And I would just highlight one major challenge, I
             5   think, which I think will be discussed later, for a buy side
             6   trading operation, generally speaking, the most difficulty
             7   challenge is to move large blocks of orders through the
             8   market over multiple days.  So we're going to get into a
             9   discussion of fairness and transparency in the market.  From
            10   our point of view, meaning for at least for a buy side shop,
            11   transparency generally is a good thing, but may not be too
            12   good a thing, given what we're trying to do.
            13             In other words, this may certainly introduce some
            14   bit of a controversy, so I was hoping to see an environment
            15   where there's enough transparency, enough fairness, but
            16   without compromising buy side trading's capability to get our
            17   trades done without paying excessive market impact cost.
            18   Thank you.
            19             MR. DOMOWITZ:  Thank you for inviting me here
            20   today.  I join with everyone else in the most interesting
            21   times in market structure and possibly all history.
            22             I'm the managing director of products at an
            23   institutional agency brokerage, and as overseer of three
            24   alternative trading systems, I obviously believe that ATS
            25   systems provide value and contribute to best execution for
             1   our clients.  Our own system is non-price discovery in
             2   nature, attests to a deep interest in a market structure that
             3   promotes meaningful price discovery in the national market.
             4             Now, as such, I therefore promote consolidation,
             5   but I don't believe that it ought to be mandated or
             6   necessarily all encompassing, and in thinking about market
             7   driven solutions, I think that we all must also recognize
             8   that exchanges now compete with brokers along with a variety
             9   of dimensions.  This complication has implications which I
            10   believe should be acknowledged and I'm sure will come up here
            11   today.
            12             Now, as I say, ITG is an agency brokerage and we do
            13   not commit capital.  Nevertheless, such commitment is very
            14   important and should be fostered in a competitive
            15   marketplace.  In today's environment, however, I don't
            16   believe that capital provision need be tied to any particular
            17   form of market microstructure.  In other words, if immediacy
            18   is indeed demanded, it will be supplied at some price under a
            19   variety of conditions.
            20             Finally, I view best execution which I believe is a
            21   topic that will come up today, not just as a set of reporting
            22   requirements, but as a process.  And these are broker
            23   responsibilities, by and large, and they include measurement
            24   analysis and control of transaction costs on the part of
            25   clients.
             1             I believe in development of market structure that
             2   contributes to and perhaps more importantly, may depend on
             3   best execution obligations, and I hope that some of our
             4   discussion focuses on that today.
             5             Thank you again.
             6             MS. NAZARETH:  Janet.
             7             MS. ANGSTADT:  Good morning, I'm Janet Angstadt
             8   here for Jerry Putnam.  I am with Archipelago Holdings and I
             9   think we're uniquely positioned to talk about market
            10   structure from the ECN and the market exchange perspective.
            11   We've been an ECN for five years now and an exchange since
            12   March, and we've really benefited from, a lot of innovative
            13   mechanisms that the SEC put in place; the order handling
            14   rules that got us to the  quote, the Reg ATS that gave us
            15   some certainty as to our status as an ATS and also invited us
            16   to become an exchange.
            17             I think from our perspective, we found that in fact
            18   the state of the union is very good.  We've seen a lot of
            19   good initiatives from the Commission, again the order
            20   handling rules, Reg ATS, decimals 1-5.  There are just a
            21   couple of areas that we should see some attention should be
            22   given, and in fact those things are happening now.  I think
            23   with respect to access among markets and making sure that
            24   access between these competing markets is fair.  If that's in
            25   the ATS arena, let's make sure that access fees are in fact
             1   fair between these competing markets, and with respect to
             2   linkage, between the reform that the Commission has urged
             3   with the ITS linkage we think that's a good area for these
             4   market areas to really push to bring some innovation and some
             5   technology, so we would ask the Commission to watch closely
             6   what the ITS operating committee is doing there and make sure
             7   there's enough momentum for that group to continue, but we're
             8   pleased to be part of the debate this morning.
             9             MS. NAZARETH:  Matt DeSalvo?
            10             MR. DeSALVO:  Matt DeSalvo, Morgan Stanley.  I come
            11   here as a broker-dealer that represents order flow that
            12   originates from both the retail and institutional side on
            13   both an agency and principal basis; that transact in the
            14   public marketplace on both the auction, electronic and ATS
            15   level in both cash and derivatives.
            16             One of the biggest structural issues facing the
            17   market today is relevant inaccessibility of prices in the
            18   system often driving the NBBO.  The concept of fairness is
            19   paramount in our mind also.  We need to end up with either an
            20   access standard for all markets that require quick execution
            21   against split interests.  We offer a flexible approach to
            22   best execution, recognizing the fact that there are actual
            23   and opportunity costs associated with trying to reach prices
            24   in non-automated and unlinked markets.  Whatever the SEC does
            25   in terms of market structure at the end of the day, its
             1   paramount objective should be levelling the playing field.
             2   That means eliminating or rationalizing access fees.  In
             3   other words, this issue right now where market makers and
             4   ECNs have one ability to charge and one not to charge needs
             5   to be addressed.  That means answering the question as to why
             6   broker-dealers have to pay exorbitant rates to the monopoly
             7   for market data that it needs to satisfy, -- to meet best
             8   execution requirements.  That means access standards and best
             9   execution obligations that could be fairly and realistically
            10   administered.
            11             MS. NAZARETH:  Scott.
            12             MR. DeSANO:  Good morning, thanks for the
            13   opportunity to be here today.  I'm Scott DeSano from Fidelity
            14   Investments.  Fidelity along with the fund industry generally
            15   serves individual investors.  Mutual funds as a whole have
            16   over 6 trillion in assets under management, which it
            17   reinvests for over 90 million individuals.  As of October,
            18   Fidelity had over 400 billion in equity assets in over 200
            19   equity funds domestically.
            20             We approach market structure issues with only one
            21   purpose in mind and that's to better the returns for our
            22   funds and in turn for the individual investors who invest in
            23   our funds.  For this reason, distinctions between retail
            24   investors and institutional investors may not always be the
            25   most useful.  Through full and fair competition, investors
             1   are more likely to achieve best execution for their trades,
             2   but best execution is in the eye of the beholder.
             3             The goal of best execution is not limited to
             4   obtaining the best price.  As important, if not more
             5   important, is the speed and certainty of execution.  This is
             6   especially the case for trading the large blocks of stock
             7   given the volatility of the markets and the demands of
             8   liquidity involved in trading large blocks of stock.
             9   Liquidity is very key.
            10             Market centers should disclose their entire limit
            11   order book.  The securities markets have begun to make
            12   improvements in this area with Super Montage and the New
            13   York's Open Book, but these steps fall short of full and
            14   timely transparency.  Disclosing the size and price levels of
            15   orders on the limit order book will lead to greater liquidity
            16   and depth of trading.
            17             Mutual funds and other institutional investors will
            18   add to liquidity by placing their orders on the limit order
            19   books if strict time and price priority are given to those
            20   orders over orders entered later on the book or made in the
            21   trading platform.  The lack of strict time and price
            22   priorities effectively deters institutional investors
            23   including Fidelity from placing limit orders on the
            24   specialist books.  This contributes to fragmentation and a
            25   lack of transparency in the market and detracts from the
             1   depths and liquidity in the trading of stocks.  The lack of
             2   strict time and price of trading of orders has undermined the
             3   appeal of the New York institutional express system for the
             4   trading of large blocks of securities.  The practice of being
             5   pennied by traders on the Floor adds to the disincentives
             6   against placing limit orders on the specialist books.
             7             Decimalization was intended to foster better
             8   execution for customer trades by narrowing spreads and adding
             9   liquidity to the markets.  The unintended consequence of
            10   decimalization has in fact made best execution problematic
            11   for investors.  Traders and specialists are now able to jump
            12   ahead of earlier entered customer orders with much less
            13   downside risk.  They can offer minimal price improvement of
            14   one cent to the ordering sides of the trade with the
            15   knowledge that if the market turns against them they are
            16   likely to lay up their position with little loss while able
            17   to capture far greater upside gain.  This forced us as an
            18   institution to trade predominantly upstairs or through ECNs.
            19   It is open to serious question whether on balance investors
            20   obtain better execution within an environment that provides
            21   floor traders with heightened trading advantages over
            22   customer limit orders.
            23             Thank you.
            24             MS. NAZARETH:  Tom Peterffy.
            25             MR. PETERFFY:  I'm Tom Peterffy, Chairman of
             1   Interact Group.  We are an electronic broker-dealer who
             2   provide liquidity and market makers and execute for our
             3   direct access profession accounts.  We do this fully
             4   electronically in Asia and Europe and to the extent possible
             5   in the United States.
             6             We appreciate this opportunity to tell you our
             7   views.  We think that broker-dealers should be able to
             8   interact with electronically accessible limit orders.  We
             9   should provide strong economic incentives to traditional
            10   exchanges throughout the world.  Approximately 100 of our
            11   employees work as market makers on the floors of the four
            12   traditional option exchanges and two oversee our market
            13   making activities on the fully electronic ISE option
            14   exchange.  These two people transact more volume every day
            15   than the other 100 combined.  We need electronically
            16   accessible limit order books with automated matching to
            17   efficiently fulfill our duty of best execution and provide
            18   access to the markets.  Thank you.
            19             MR. GARDNER:  I'm Tom Gardner, co-founder of Motley
            20   Fool.  I'd like to thank the Commission for including me and
            21   the Fool today in the proceedings.
            22             We are an organization that reaches more than 20
            23   million investors each month through our on line service,
            24   newspaper column and our radio program on NPR.  I am not
            25   someone who works at a firm that handles orders and we are
             1   not an organization that speaks to active traders that are
             2   using many of the trading systems that we'll speak of today,
             3   so I am largely irrelevant to today's proceedings and in the
             4   interests of full disclosure I want to get that out there.
             5             I can speak about general philosophy, and that is
             6   that we believe that healthy markets, a rise in liquidity, in
             7   trading activity rely on equal access to material information
             8   and presently available prices in the national market system
             9   for all investors, regardless of the size of their account
            10   and regardless of the size of their order.  We do not believe
            11   that distinctions between retail institutional investors are
            12   useful or should be relevant to the work, those regulating
            13   the marketplace.  However, we should not lose sight of the
            14   fact that our markets in large part because of the SEC over
            15   the last decade are increasingly transparent, efficient, more
            16   competitive and more accessible to all investors, but
            17   progress requires vigilance.  At this point, henceforth,
            18   today I am the quintessential proxy for Dr. Kyle's least
            19   sophisticated customer.
            20             MS. NAZARETH:  And proud of it.  Paul.
            21             MR. O'KELLY:  Thank you, Annette.  First of all,
            22   I'd like to commend the SEC for undertaking this review of
            23   market structure and thank them for allowing the Chicago
            24   Stock Exchange to participate today.
            25             More than 25 years ago, Congress directed the SEC
             1   to facilitate the creation of a national market system.  When
             2   it met the objectives that Congress identified as important
             3   for protection of public investors, one built on a set of
             4   principles that Congress also identified in the 1975 Act
             5   amendments.  To those who listened to the market structure
             6   hearings in Washington a couple of weeks back, you heard
             7   Annette ask the various participants whether those principles
             8   continue to be relevant today when determining how to
             9   structure a market.  It was one of the few areas where there
            10   was a consensus among the participants.
            11             I mention this fact, because when the Commission
            12   market participants back in 1975 built the national market
            13   structure system, it contained two principal attributes.  One
            14   was the consolidated mandatory display of quote and trade
            15   information to promote market transparency, and the other was
            16   intermarket access to prices which promote the best execution
            17   of orders.  I think that if the Commission again examines
            18   market structure in light of these principles, it will reach
            19   the same conclusion, and the market will look as it does
            20   today at the current national market structure.  The
            21   challenge for the Commission is not to find an alternative
            22   market structure, the challenge for the Commission is going
            23   to be to try to bring new participants with new trading
            24   models into the existing market structure in a manner which
            25   both promotes competition, promotes investor confidence in
             1   the market and is fair to the other market participants.
             2             MS. NAZARETH:  Thank you, Paul.  Bob?
             3             MR. STEEL:  My name is Bob Steel of Goldman Sachs
             4   and I thank the Commission for the opportunity to be here
             5   today and I assure Tom he's not the only one who feels
             6   foolish on a regular occasion.  I think a lot of what I was
             7   going to say by introduction has been said so maybe I can
             8   shorten the comments and say from our perspective at our firm
             9   we see the equities marketplaces through multiple lenses and
            10   from multiple perspectives.  We act as a traditional
            11   brokerage firm handling orders for clients.  We are a major
            12   block trading firm often using our own capital to provide
            13   liquidity to institutions and issuers.  We make markets in
            14   over 5,000 over the counter stocks.  One of our affiliates is
            15   the second largest specialist on the floor of the New York
            16   Stock Exchange.  Another affiliate provides sophisticated
            17   electronic order technology to institutions and broker-
            18   dealers.  We are among the largest options market makers and
            19   we also own a substantial minority interest in Archipelago,
            20   an alternative trading system.
            21             In summary, from our vantage point decimalization,
            22   technological advances in order handling execution and the
            23   conversions of roles of various market participants have
            24   exposed frictions in the cash and derivative markets that
            25   should be addressed.  Examples that have been subject to
             1   recent debate include ECN access fees, the use and submission
             2   of market data revenues and the effectiveness of market
             3   linkages particularly the connection between auction and
             4   electronic markets.  Although extensive Commission
             5   involvement in structured markets is often unnecessary and
             6   potentially harmful due to the swift and dynamic nature of
             7   change, we believe in this case it is incumbent upon the
             8   Commission not only to remedy some of the existing ailments
             9   in the U.S.  equity markets, but also put a forward looking
            10   framework in place that enables the rules and macro
            11   structures of markets to evolve as the underlying
            12   participants both compete and develop.  Thank you.
            13             MS. NAZARETH:  Gunner?
            14             MR. BURKHART:  My name is Gunner Burkhart.  I'm the
            15   global head of trading at Deutsche Asset Management based in
            16   London.  We are an 11th hour addition to this gathering and
            17   we appreciate being invited to it.  We manage about $800
            18   billion in assets in all the asset classes around the world
            19   and our constituents are retail investors, be they in the
            20   United States, Asia, Europe, as well as corporate pension
            21   funds, institutional funds, et cetera.  We think the timing
            22   of these discussions, both in October and today and hopefully
            23   the ongoing discussions, is highly relevant.  We are
            24   currently engaged in similar discussions with stock exchange
            25   or Bourses, as they're known in Europe, and also in Europe
             1   with regulators in Europe and Asia as well -- Given the
             2   turbulence in our industry collectively as well as in the
             3   world, there's certainly been no better any time my twenty-
             4   year career to sit down with the main and major participants
             5   and constituents in our industry to discuss these topics.
             6             Our concerns around the world and certainly very
             7   relevant here in the United States boil down into three main
             8   categories and I echo some of my competitors Scott and Minder
             9   this respect.  They are liquidity, efficiency and
            10   transparency, and I hope and I am sure that throughout the
            11   remainder of the day we will enter into fairly lively
            12   discussion about how we attain and regulate all three of
            13   these, not just for the institutional asset managers in the
            14   world, but for the investor on the street.  That's not just
            15   Main Street, USA but also Main Street, Frankfurt or Main
            16   Street, Taipei, for that matter, who are also very large
            17   investors in the United States.
            18             Thank you for allowing us to participate.
            19             MR. LEE:  Good morning, my name is Ruben Lee and
            20   I'm founder and managing director of the Oxford Finance
            21   Group.  May I echo everybody's previous statements that it's
            22   a pleasure and honor to be here and thank you very much, and
            23   may I also say that I think that these issues are very, very
            24   important, notwithstanding the fact that some other issues in
            25   the private markets seem to be dominating the newspapers, I
             1   think these are very important and should not be eclipsed by
             2   them.
             3             The Oxford Finance Group is a research, consulting
             4   and implementation firm and I do all of three of those
             5   things.  I have clients in special financial organizations,
             6   government regulators, exchanges; a whole series of
             7   commercial activities.  I'm also an advisor to the European
             8   Parliament on financial services.
             9             Notwithstanding all of that, I view my role here
            10   today to be to propose to the Commission to further its own
            11   goals, namely, to look at the American securities markets, to
            12   look at those issues which are most important, to find
            13   optimal answers and most relevantly, to find answers that are
            14   not so radical that they can't be considered, but yet are
            15   still not so conservative that they should not be considered.
            16   So in particular, I'm interested in the feasibility of
            17   different types of questions, and by that I mean, the extent
            18   to which different sorts of solutions may be feasible within
            19   the current legal structure, so I don't think we should seek
            20   to change the current legal structure, but I think that there
            21   is much that is open to interpretation, that many people do
            22   not yet appreciate.
            23             I also am interested in the feasibility of
            24   solutions, that is to say, the political feasibility, within
            25   the market and I'm also interested in the extent to which
             1   current regulatory structures are, in my view, in the
             2   American context, captured by a range of different political
             3   interests, which restrict change.  We will be looking at a
             4   whole series of issues to do with transparency, best
             5   executions, exchange regulations, and I would be happy to
             6   participate in that.  Thank you again.
             7             MS. NAZARETH:  I think it's clear from these
             8   participants we have an incredibly knowledgeable group and
             9   clearly everyone comes with their own perspective, but that's
            10   exactly why you're here.  We're interested in carrying forth
            11   with these concepts and you'll see that well over the course
            12   of the day.
            13             As Paul O'Kelly mentioned, we're going to briefly,
            14   as we did in the last market structure hearing, discuss the
            15   basic principles of the national market system and see
            16   whether, again, although no one should feel compelled,
            17   whether again we have a broad consensus that those core
            18   principles that characterize our national market system
            19   remain valid today.
            20             Let me go over again briefly what they are.  The
            21   first is transparency of information.  That is, the
            22   availability to brokers, dealers and investors of information
            23   with respect to quotes and trades.  The next is economically
            24   efficient execution of securities transactions; ease of
            25   obtaining best execution; fair competition among markets and
             1   intermediaries within marks and lastly, the opportunity
             2   consistent with the aforementioned goals for investor orders
             3   to be executed without the participation of a dealer.
             4             So again I'd like to ask the group before we do go
             5   on, because it's important to know whether we're all working
             6   off the same principles, whether these are the right
             7   precepts, and where there's conflicts, how those conflicts
             8   should be resolved.  It would be helpful to establish, again,
             9   before we go ahead, whether there's consensus on these
            10   principles.
            11             This is somewhat theoretical, although obviously it
            12   has very pragmatic implications for our discussion today, but
            13   since it's a somewhat academic excise to begin, I thought I'd
            14   begin by calling on one of our academics, it's sort of like
            15   getting back at some of these academics like Professor
            16   Goldschmid who called on us in Columbia, but I thought I
            17   would ask Professor Kyle if you have a view that these are
            18   the correct goals.
            19             PROFESSOR KYLE:  I think they're the correct goals,
            20   except I want to think a little bit about what we mean by
            21   "fair competition."  To some people, fair competition means
            22   if the other guy is more efficient than I am, then the other
            23   guy should be punished so he and I have equal market share
            24   and equal equilibrium.  To others fair competition means the
            25   rules of the game should be the same for everybody so the
             1   person who provides the most efficient service captures the
             2   greater market share.  To  me it means the latter, that is
             3   the more efficient should capture the larger market share.
             4             MS. NAZARETH:  Tom?  What do you think?
             5             MR. PETERFFY:  Well, legally, these are the correct
             6   principles and we have made a lot of progress towards them in
             7   the last three or four years, especially decimalization was a
             8   very large step.  These objectives are completely within our
             9   reach, if only we could just get along.
            10             With technology and sufficient economic incentives,
            11   I think that the participants and the Commission can achieve
            12   them in a very short period of time.
            13             MS. NAZARETH:  Bob Steel?
            14             MR. STEEL:  I was just laughing.  I'm sure "get
            15   along" in Tom's vocabulary means we do it his way.
            16             MR. PETERFFY:  Or yours.
            17             MR. STEEL:  I've got lots of ways.
            18             You know, Annette, I think that it's probably
            19   pretty easy to pledge allegiance to these ideals, but really
            20   the challenge is the nuance at the edges and we heard a
            21   dichotomy, I think on this side of the table, about
            22   transparency is a good ideal, but at some point too much
            23   transparency carries with it a burden that people who are
            24   representing large numbers of individuals with a larger order
            25   feel disadvantaged and so I think the real issue is threading
             1   the needle on these three or four issues with greater
             2   specificity and we can all kind of, as I said, pledge
             3   allegiance to the ideals, but then it gets down to really
             4   determining how you get down to this dynamic of Bob's
             5   complete transparency and Scott and Minder's idea of
             6   transparency which has a different idea and cost.  I think
             7   this is the tricky part, especially in the area of
             8   transparency.
             9             MS. NAZARETH:  You alluded to this also, Ruben that
            10   to some extent it's in the eye of the beholder and people's
            11   obviously own business models or political inclinations can
            12   factor into this.  Do you have more comments on this?
            13             MR. LEE:  I have a couple of comments; one on
            14   transparency, one on fair competition.  On transparency, I
            15   would make three comments.  The first is that what you're
            16   getting now is not what you think you're getting, so you
            17   think that you're getting the best bid and offer, but you're
            18   not actually getting that, but most people don't appreciate
            19   that, I think in the American context retail.  The second is
            20   that I very much agree and I think there's a fair amount of
            21   academic evidence to support Minder's viewpoint that optimal
            22   transparency is not full transparency.  There are a range of
            23   different tradeoffs, but in my mind, I'm very much on that
            24   point, and we can go into the subtleties of that.
            25             The third is and this is going back to the '75
             1   amendments which is very important, is that, Pete alluded to
             2   this, which is that market structures of many different types
             3   have strong incentives to provide transparency, number one.
             4             The second is that even where there are no mandated
             5   links between markets, one can point to Europe, we have seen
             6   consolidators of information, so the idea that we need to
             7   have some sort of institutional consolidator of information
             8   here in the U.S. I think is much less relevant than it was
             9   when it was initiated and in part because it's so much
            10   cheaper to do that.  So I think one needs to be careful about
            11   requiring a need for mandatory transparency when there's so
            12   much private incentive to produce appropriate levels.
            13             Of course there are exceptions to that, where
            14   transparency must be structured and mandated in some way, but
            15   I view that to be an exception.
            16             Let me now make a comment on the fair competition.
            17   In my view, in most contexts, there are very strong
            18   incentives for orders to centralize on particular trading
            19   systems and in fact what we see here in America is actually
            20   very unusual, that we have such an abundance of trading
            21   systems, notwithstanding the fact that they are shrinking in
            22   number and in part I think that abundance does arise as a
            23   result of various SEC rules which allowed the continuation of
            24   a range of different systems which in fact are being
            25   subsidized in various ways by these rules.
             1             I think there's a counter balance to that, which is
             2   if you think as I do that orders may tend to consolidate that
             3   where you have institutions such as the New York Stock
             4   Exchange where they do consolidate, I think there are very
             5   good grounds for examining the actions of such monopolistic
             6   providers very, very carefully and a whole range of different
             7   aspects and while in many contexts it is appropriate to say,
             8   yes, leave people to decide what sort of market structure
             9   they want to adopt and I agree with that, once we start
            10   approaching the monopolistic provider, I think there we need
            11   to be much more careful.
            12             MS. GLASSMAN:  I have a question for anybody.
            13   Given, there seems to be general agreement on what the ideals
            14   are, perhaps not the specifics, can we meet all of these
            15   ideals simultaneously, are there tradeoffs we have to make
            16   among them?
            17             MR. CHENG:  Maybe can I start?  I think the
            18   question, maybe if I can rephrase it, is from the
            19   Commission's point of view, are you in a position to design
            20   or promote a market structure that basically is one size fits
            21   all.  The question we have here is the market is full of
            22   retail and institutional investors.  Going back I think to
            23   the five principles behind the NMS, the third being the ease
            24   of obtaining best execution, we already heard earlier that
            25   best execution means different things to different people.
             1             To the retail investors it may mean the best price,
             2   but for institutional investors, it may not mean the best
             3   price at the moment of trade, because again, going back to
             4   the fact that we often trade large blocks over time, so the
             5   question is, how do we create the right balance between the
             6   two?  And back to the transparency.  I think we can achieve
             7   it, although the question in our current market, I think
             8   Scott mentioned as well, that transparency cannot be achieved
             9   without protection, because if there's no protection, in
            10   other words, there's no, say, price, time, size priority,
            11   then I think the market participants will not be incentivized
            12   to really show their hands so they could get picked up.
            13             So I think on the one hand we are basically dealing
            14   with competing goals here.  The five elements are all good on
            15   paper.  The question is, can we somehow find a way to piece
            16   them together without conflict.  Thank you.
            17             MR. DeSANO:  I just wanted to add, I don't believe
            18   there's a perfect market structure, period.  And that we need
            19   to think about that as we think about all these things.
            20   There's a little give-up on everybody's part because of all
            21   the constituencies.  Competition and fairness lends itself to
            22   continuous improvement in the market structures, but we'll
            23   never get to a perfect structure.
            24             MR. DeSALVO:  I think what would help some of these
            25   issues that we're talking about, would be from our point of
             1   view a clear definition of best execution.  Fragmentation and
             2   competition has drawn away the retail orders into shades of
             3   gray with regards to best execution away from price.  Market
             4   accessibility between, where we have auto ex in certain
             5   marketplaces and not other marketplaces have led even retail
             6   order flow to be subject to shades of gray when it should
             7   clearly be price subject to best execution at a certain
             8   level.  We don't even have that in this case and what we
             9   would like to see coming out of this is a clear definition of
            10   best execution with getting back to price and the only way
            11   that you can get back to price with regards to best execution
            12   is markets that efficiently transact between each other as
            13   opposed to the current market structure where there is
            14   inefficient linkages and inefficient ways that markets access
            15   each other.
            16             MR. DOMOWITZ:  Getting at the original question,
            17   which is whether or not you can satisfy all these at once, I
            18   mean, there's a small preamble to that.  We can all agree,
            19   I'm with Bob, it's easy to pledge allegiance.  This is like
            20   motherhood.  Frankly, it's easy to agree.  Following up on
            21   Ruben, if we didn't agree, we'd have to change legislation.
            22   This is not something we can actually agree on at this table
            23   by ourselves in some sense, but it's worth saying, first of
            24   all, market structure is a term used by a variety of people
            25   to support a variety of positions.  It is essentially in my
             1   view, the rules and institutions that contribute to
             2   competition in the marketplace for transaction services.
             3             Now, viewed that way, what's feasible now, all
             4   right, again, following up on something Ruben said, is indeed
             5   I think the reconciliation of these five points.  Should we
             6   indeed get a little bit deeper to these rules that are
             7   promoting competition in the first place and to me that is
             8   the right place to start.
             9             Absent that, were I to go back to the legislation,
            10   I would actually turn to this point about best execution and
            11   I would say let us create best execution obligations and the
            12   rest will follow.
            13             MS. NAZARETH:  Janet?
            14             MS. ANGSTADT:  I was going to say, I think all
            15   these questions go to best execution.  I would urge that we
            16   not try to define best execution any more than we have. I
            17   think the 1-5 rules have really offered the disclosure that's
            18   necessary for people to make their choices.  Again, too, I
            19   think it was Minder's point that best execution to an
            20   institution may be very different than a retail investor and
            21   perhaps some of the suitability rules that we have are
            22   already in place to help protect retail investors and I think
            23   the diversity that we have in the market structure today,
            24   really allows people to choose speed over price if that's
            25   what's important, so I think actually these principles help
             1   lead us to that kind of a best execution very strongly.
             2             MR. DeSALVO:  I hate to go back and repeat this,
             3   but again, we don't even have a situation right now where we
             4   have an agreement on smaller, for the retail institutions, of
             5   what is best execution, because they're opposing views of
             6   speed or price.  I think if the Commission can come out and
             7   say what is the definitive goal, at least that would allow
             8   all of us to be on the same playing field rather than the
             9   current shade of gray.
            10             MS. NAZARETH:  Well, I think, as you know, Matt,
            11   that the analysis is so colored by other principal/agency
            12   conflicts, like payment for order flow and the like, that
            13   it's not as simple as just speed or price.  But we'll get
            14   into that later.
            15             Does anybody else have any points before we take a
            16   break?  Yes, Paul.
            17             MR. O'KELLY:  I'd like to make one point.  While
            18   these principles are very noble, if they suffer from
            19   anything, they suffer from a little vagueness.  But if we
            20   look at the '75 Act amendments where these principles were
            21   articulated, you'll see in the very next section where
            22   Congress makes the point that markets that are linked
            23   together can promote these five principles.  Now, how we
            24   interact with each other is a very difficult issue to
            25   address, but it seems clear to me that Congress back in 1975
             1   didn't like the idea of market fragmentation, didn't think
             2   that it would promote these five principles and I have no
             3   reason to believe that that's changed in the subsequent 27
             4   years.
             5             MS. NAZARETH:  Thank you.  Yes?
             6             MR. MURPHY:  I'd just like to, a couple of points.
             7   As far as best execution, I think as long as the ultimate
             8   customer is at the forefront and his outlook is what's
             9   paramount, the markets in general will acquiesce and should
            10   be encouraged to just keep the ultimate customer primary,
            11   primary concern.
            12             When it basically gets to a point where best
            13   execution is defined by economic terms or being able to take
            14   advantage of a situation, that's where we get to that gray
            15   area that Matt talked about, and right now, the 1-5 data that
            16   we've seen so far I think is pretty skewed and it's not
            17   talking about apples and oranges.  I think we can do a lot
            18   better or maybe get some more independent input on best
            19   execution statistics, so you know, I basically agree with all
            20   these principles, but giving the customer choices, because
            21   definitely, there are different venues that benefit the
            22   different participants in the markets, so as long as there
            23   are choices and they're transparent choices, we will do okay.
            24             MS. NAZARETH:  Yes?
            25             MR. LEE:  Yes, I've got one more point.  To be very
             1   explicit, I think that there are tradeoffs between these five
             2   different goals, and I think that the choices that the
             3   Commission has made have implicitly showed their choices for
             4   these different goals.  So in particular, if you look at the
             5   fifth one, which is investor access, subject to the first
             6   four, one could debate whether that one has been promoted
             7   given membership structures of exchanges and so on and so
             8   forth, and in fact one could strongly argue that it has not
             9   been promoted, so these goals have not been equal in the eyes
            10   of the Commission historically.
            11             MS. NAZARETH:  It sounds like yet again we have
            12   violent agreement on the principles, and we'll spend the rest
            13   of the day arguing over the details.
            14             We'll take a fifteen-minute break and reconvene at
            15   five of eleven.
            16             (Brief recess.)
            17             MR. COLBY:  Welcome back, everyone.  We're going to
            18   turn to the issue of market data as one of the fundamental
            19   building blocks.  I want to make sure everybody talks into
            20   the mike, because the audience has had trouble hearing.
            21             We also have two players replace people who were
            22   injured in the prior panel.  Duncan Neiderauer is replacing
            23   Bob Steel.  Actually, he wanted to do it, but Duncan pushed
            24   him out of the way.
            25             U.S. investors today have access to a consolidated
             1   real-time stream of market information for each of the
             2   thousands of stocks traded in the U.S. markets.  This price
             3   transparency is a cornerstone of the U.S. national market
             4   system.  It facilitates the best execution of customer
             5   orders, promotes investor protection and mitigates the
             6   fragmentation of buying and selling interest among different
             7   market centers.  The most basic form of market information is
             8   the best quotation and last sale data with respect to a
             9   particular security at a given time.  The best quotation is
            10   the highest bid and lowest offer price for a security
            11   currently made available by self-regulatory organization and
            12   is commonly referred to as a national best bid and offer or
            13   the NBBO.  Last sale data generally identifies the price at
            14   which the most recent trade in a particular security
            15   occurred, the size of that trade, and the market in which the
            16   trade took place.
            17             Price transparency in the United States, as we
            18   discussed earlier, was mandated by Congress in 1975.
            19   Congress directed the SEC to use its new authority to adopt
            20   rules to integrate the market through the collection and
            21   consolidation of market information.  Under these Commission
            22   rules, quotes, trade price and volumes are collected by the
            23   stock exchanges and NASD for all exchange listed and NASDAQ
            24   stocks within seconds of the quote or the trade taking place.
            25   The current NBBO quotation, as well as individual market
             1   center, over the counter market maker and ECN quotes and
             2   reports of all trades are disseminated for each stock on a
             3   nearly real-time basis.  Vendors and brokers that make this
             4   market information available from--vendors that make it
             5   available from any individual market are required by
             6   Commission rules to make equally available consolidated
             7   information from all participating markets.
             8             Furthermore, to implement this quote collection and
             9   trade reporting mechanism, the SRO's, the self-regulatory
            10   organizations, have acted jointly under several national
            11   market system plans to disseminate consolidated market
            12   information.  These plans govern all aspects of the
            13   arrangements for collecting and distributing market
            14   information.  Among other things, they require the individual
            15   SRO's to transmit market information to a central processor,
            16   which then consolidates the information into a single stream
            17   for dissemination of vendors and some large end users.  In
            18   turn, the vendors, brokers, and large end users may
            19   disseminate the information to the public.
            20             These plans also establish fees for market data.
            21   The resulting net revenues are divided among the
            22   self-regulatory organizations that provide the data and
            23   represent a significant percentage of the SRO's revenue.  The
            24   plans also establish non-fee standards such as reporting
            25   obligations, hours of operation and regulatory halt
             1   procedures.
             2             The implementation of decimal pricing and point
             3   increments in 2001 has increased the demand for deeper or
             4   different levels of market information, as was touched on
             5   earlier in the discussion.  For example, the New York Stock
             6   Exchange recently began to provide real-time semi-dynamically
             7   updated view of the limit order books for all New York Stock
             8   Exchange traded issues.  NASDAQ Super Montage, which began to
             9   operate on October 14th, provides NASDAQ stand alone
            10   quotation and ordering system by a means of aggregating
            11   quotes at a multiple of price levels to create an integrated
            12   trading system.  Some ECNs such as Island and Archipelago
            13   make their limit order books available on their websites at
            14   no charge and some Internet portals also make this
            15   information available for free for just users on the web.
            16             Nonetheless, despite these steps taken by the
            17   markets, the impact of decimalization led some market
            18   participants, as was evidenced earlier in the discussion, to
            19   believe that more limit order information is needed in
            20   standard formats that can be integrated.  There have also
            21   been repeated questions raised regarding the market data fees
            22   that are charged by the consolidated systems disseminators.
            23   In particular, the fact that market centers are rebating or
            24   seeking to rebate a significant percentage of these market
            25   data revenues to their members, has led some to suggest the
             1   market data fees are too high, and could be reduced
             2   substantially.
             3             In light of the wide range of views and comments
             4   that are received on a concept release that was put out by
             5   the Commission on market data revenues, the SEC formed an
             6   advisory committee in August, 2000, to assist it in
             7   evaluating issues relating to market value data available.
             8   In a final report in September of 2001, the committee
             9   reaffirmed the importance of price transparency and
            10   consolidated information, the importance of these for the
            11   health and vitality of the securities markets and then it
            12   recommended with varying degrees of consensus a number of
            13   measures to increase flexibility in market centers and data
            14   vendors to make data available to the public.
            15             It also suggested that technological and
            16   competitive developments may have lessened the need for
            17   market centers to act jointly to consolidate data under
            18   existing national market system plans.
            19             So the purpose of this session is to consider the
            20   ways that market data, in particular real-time market data,
            21   is collected, processed, and made available and the many
            22   questions that have arisen regarding this data.
            23             These include the utility of the data for
            24   investors, and we need to talk about for which investors, the
            25   way that the data is made available, the fees that are
             1   charged and inherent in talking about the fees that are
             2   charged, I think is the topic of how self-regulatory
             3   organizations get funded, even though that's a major issue
             4   that comes up later in the day.
             5             So, with that information and introduction, let's
             6   start in on the questions.  I wanted to start first in
             7   talking about the information that's available, is it useful,
             8   what is its nature, is it useful, then go to should other
             9   information be available and then after we have talked about
            10   that, start talking about fees, if that's all right with the
            11   panel.  Fees are going to be an interesting topic in and of
            12   itself.  Let's start with the national best bid or offer.
            13   The national best bid or offer is in a sense a product built
            14   and maintained for retail investors, and so I think, first
            15   question should be how useful is it?  How important is it to
            16   have some sort of a measure of the existing quote and how
            17   good a measure is the NBBO?  Anyone want to address this from
            18   a retail investor standpoint?  Ruben, you expressed some
            19   views about the nature and utility of the NBBO.  Do you want
            20   to start?
            21             MR. LEE:  I think several points.  The first is, I
            22   agree with Pete's point, that if you are relatively
            23   uninformed, that as much needs to be done, that should be a
            24   focus of the Commission and it clearly is not, given your
            25   historical mandate to investors out there.  So retail
             1   investors should be a primary concern.
             2             The best bid and offer does play a very, very
             3   important role in showing what may be available, but I think
             4   that it's, as I indicated beforehand, it doesn't show the
             5   full bids and offers that are available throughout the
             6   market, and there's a question in my mind, both as to whether
             7   it could do that or whether it should do that.  That's the
             8   first point I'd like to make.
             9             The second is that, and this comes to the issue of
            10   competition between different markets, and both as trading
            11   institutions and in terms of their ability to gain revenues
            12   from data.
            13             If you considered the value of data from competing
            14   markets, you would probably say that the New York Stock
            15   Exchange data is much, much more valuable than anybody
            16   else's, and on that basis--
            17             MR. COLBY:  You're speaking about quotes or trades
            18   as well?
            19             MR. LEE:  Let's talk about quotes initially.
            20             On that basis, there's a question as to whether the
            21   SEC's rule, which says that if you carry any particular data,
            22   you need to carry all data, okay, is necessarily appropriate,
            23   indeed, whether it follows from the Act, that's to say, you
            24   might choose, even if you decided you accepted that
            25   transparency was an appropriate goal because you're mandated
             1   to, whether you needed the rule to deliver that goal, and I
             2   think there are questions about that, which lead to questions
             3   specifically about the options market, where, and I know that
             4   you're familiar with this, where there's an excess of data
             5   with all these different dates and so on and so forth.  There
             6   the vendors are complaining that you may mandate it because
             7   you have a regulatory interest in getting that data, but
             8   actually the cost of getting all that piping needs to be
             9   borne in mind.
            10             MR. COLBY:  Several issues raised and they're all
            11   important.  Pete, did you want to address this NBBO issue?
            12             PROFESSOR KYLE:  If you go back to the five points
            13   from the previous session; transparency, economic access to
            14   the market, best execution, fair competition and facilitating
            15   investors order crossing, it seems like having a national
            16   best bid best offer is necessary to achieve at least four of
            17   those, because the basic idea is that you want a small
            18   investor who closes an order with one securities firm to buy
            19   at 4, another investor places an order in another securities
            20   firm to sell at 3, or sell three or four.  A transaction
            21   ought to occur and at a very minimum in order to achieve four
            22   of those objectives, you need some mechanism for keeping
            23   track of the fact that a transaction ought to be occurring,
            24   and that requires having national best bid/best offer.
            25             Now, if you want it to be set up in such a way that
             1   an economically relevant sized transaction can also be
             2   monitored, then you want to show a certain amount of depth to
             3   transactions, because it's possible the best bid might be for
             4   a tiny quantity.  Even for a retail investor it might be
             5   relatively smaller than his order so you want to show at
             6   least enough depth to show a reasonable sized quantity, be
             7   able to be monitored with respect to the prices offered in
             8   the market.  So it seems to be a requirement that that be the
             9   case and probably a requirement that it be augmented enough
            10   to have relevant sized quantities in it.
            11             MR. COLBY:  Bob, would you like to talk about what
            12   the New York Stock Exchange is doing to respond to that?
            13             MR. MURPHY:  Sure, just how I feel about it, and
            14   again, there is a little bit of a split at the stock
            15   exchange, but I do feel that there is a need for the NBBO,
            16   and it's -- definitely in a decimal environment it's been
            17   diminished, but, you know, the issue of not needing it any
            18   more, it's almost we're going too far the other way.  We
            19   would be taking transparency out of the market at the expense
            20   of the little guy, so I think we definitely need it.
            21             But depth, as the Professor said, is paramount. Now
            22   because of decimals and we have our Open Book, that's been
            23   very well received as a data product.  I think we have over
            24   7500 subscribers now since it's been launched, and we also
            25   have, I believe before the Commission, Dual Quote, which will
             1   include NBBO, include the Open Book, and will also force the
             2   specialist to put up a size held market that all participants
             3   can interact with as need be.  So--
             4             MR. COLBY:  Meaning that it's a market that's below
             5   the NBBO or above the NBBO where there's a greater size
             6   available?
             7             MR. MURPHY:  Absolutely, and should and must be
             8   disseminated to all participants.  So you know, that's our
             9   answer to the lack of transparency in a decimal environment
            10   and I think the more--that also, it includes the crowd, it
            11   includes all orders entrusted to the specialist and the
            12   specialist's interests as well, to give institutions a better
            13   look at what kind of liquidity is down there.
            14             MR. COLBY:  Matt, you have trading prices and a
            15   large retail brokerage operation.  What role does the NBBO
            16   play?
            17             MR. DeSALVO:  I think the NBBO has been diluted
            18   with the introduction of decimals.  It had much more
            19   importance at the steep level than it does at the penny
            20   level.  The introduction of Super Montage and Dual Quotes and
            21   Open Book I think are representations that the marketplace
            22   recognizes that the NBBO needs to add some depth, so you've
            23   had exchanges respond to it.  I think the important thing
            24   from our point of view is that the NBBO is the basis point
            25   with which you start making some of your decisions, but
             1   accessing the NBBO I think is where we come out on whether it
             2   is important or not.
             3             In other words, an NBBO that is represented by a
             4   market that is easily and fairly accessible is meaningful.
             5   An NBBO that is representative of underlying markets that are
             6   difficult to get to, slow in response time, et cetera, where
             7   you start to grade away from an auto-ex environment, leads to
             8   NBBO's that are different.  An NBBO in one stock versus an
             9   NBBO in another stock with equal one penny bid offer spreads
            10   can have entirely different meanings with regards to response
            11   time and accessibility, so I think that a marketplace that
            12   has an NBBO as a minimum requirement for market data
            13   dissemination you have to also step back, the NBBO goes up in
            14   importance if there's equal accessibility between markets.
            15             MR. COLBY:  So the accessibility is a key question
            16   with the NBBO.  We're going to leave actual detailed
            17   questions about access to the later session.  But I note the
            18   point if you have an NBBO, and it can't be accessed, it's a
            19   very difficult question.
            20             MR. COLBY:  Could I ask Minder what role does the
            21   NBBO play and what do you look at, I'm going to ask Gunner to
            22   address the same thing.
            23             MR. BURKHART:  I think we probably have the same
            24   answer, I wouldn't want to speak for Minder, but the NBBO to
            25   us is nothing more than a guideline or an indication.  Matt's
             1   point is well taken, in that it's the depth and the
             2   accessibility that's the real issue for institutional
             3   investors.  You have to have an NBBO I think for the retail
             4   world out there, and even for us to have a guideline that
             5   says that even if it's a hundred share market on the bid and
             6   the offer, that's the best bid and best offer out there.
             7   It's really the depth beyond that and the accessibility,
             8   whether it's a hundred share market or the hundred thousand
             9   share market which Bob is referring to, the capital
            10   commitment market outside of that, the specialist is now
            11   willing to put up, it's of more interest to us.
            12             Yes, the NBBO is an essential item.  However, it's
            13   largely irrelevant for an institutional investor.  Sorry,
            14   Minder, I didn't want to speak for you.
            15             MR. CHENG:  I think we're in competition across the
            16   table but I think our views pretty often are similar so no
            17   further comment.
            18             MR. LEE:  Could I make one comment about the NBBO?
            19   I'm wondering what is the incentive for markets not to
            20   provide their quotes.  If there are incentives not to provide
            21   their quotes, to what extent do you guys need to be involved?
            22   That's what I'm wondering.  Not to put the questions to the
            23   listeners today, but--
            24             MR. COLBY:  I would just say that we went through
            25   an era where we needed to mandate quotes to be made available
             1   because there are mixed incentives from different trading
             2   systems.  It's worth, can I pick up on one of your--unless
             3   someone wants to rise to that, could I pick up on one of the
             4   questions that you posed, Ruben, which is that we currently
             5   have at SEC a rule which says that if vendors or brokers give
             6   information about one individual market to customers, they
             7   must provide equally the information from all markets that
             8   are participants in the NBBO.  There were a number of
             9   historical reasons for that.  You posed the question whether
            10   it's still necessary.  Recognizing that some markets have the
            11   larger percentage of the best quote than others.
            12             Does anyone, Paul, is this something you would be
            13   interested in talking about?
            14             MR. O'KELLY:  Well, the requirement for the Vendor
            15   Display Rule is one that I think it's important from public
            16   investor protection reasons, because if you do not require
            17   all folks to be part of a consolidated quote and vendor
            18   display rule, some market participants will only buy a New
            19   York quote or only buy the NASDAQ quote.  And that's going to
            20   have a spiraling effect over time. If fewer people buy other
            21   market competitors quotes, market competitors are going to be
            22   less able to provide markets that compete with the markets
            23   who are selling their quotes and eventually you're going to
            24   lead to one, a single market selling its quotes and there
            25   will be no alternatives.
             1             If you do not allow other markets to display their
             2   quotes, even a consolidated quote, to give customers the
             3   opportunity to choose among them, you're going eventually
             4   lead to a single both on the listed side and NASDAQ side.  I
             5   don't believe people are anxious to have that.
             6             MR. COLBY:  So there's a limited ability to get
             7   your quotes disseminated.  I'm done.
             8             MR. O'KELLY:  You earlier talked about tradeoffs in
             9   these principles that Annette articulated and in this NBBO
            10   area, I think this is one of the areas where a trade-off
            11   occurs, is that you have the NBBO where people have to act
            12   jointly, because we believe price transparency is a good
            13   thing, it will make everyone join together to provide
            14   transparency to everyone for the NBBO.  Beyond the NBBO there
            15   can be a relaxation of that requirement and allow markets to
            16   compete with each other.  If the New York Stock Exchange
            17   wants to provide its open order book to its customers because
            18   they believe it will give them a competitive edge, they
            19   should be free to do so.  If NASDAQ wants the Super Montage
            20   to show the market three quotes deep, they should be free to
            21   do so.
            22             This is an area where I think the Commission has
            23   acted responsibly in allowing the goals of transparency and
            24   competition to co-exist, requiring vendor display,
            25   consolidated NBBO, on the other hand, allowing markets to act
             1   on their own competitively to sell products beyond the NBBO.
             2             MR. LEE:  Can I take issue with that, in the
             3   following sense, that if I'm an investor, clearly I want to
             4   know where I can execute my trades.  Because I want to know,
             5   someone's going to fulfill that demand for me.  A vendor is
             6   going to package together exchange X, exchange Y and exchange
             7   Z.  Suppose that the vendor decides that, or rather, even the
             8   investor decides that actually exchange Z is not really worth
             9   knowing about because I'm not going to undertake much
            10   business on that.  Nobody's saying that they should not be
            11   allowed to package the data together, but the question is
            12   should any be required to package the data together and
            13   indeed if they are required to package the data together,
            14   does that have implications of supporting inefficient trading
            15   systems.  That's where I think you might want to think about
            16   it.
            17             MR. GOLDSCHMID:  I want to get a question in. The
            18   problem of entry barrier in your analysis.
            19             MR. LEE:  Entry barrier is a real problem in which
            20   there are market externalities, no question and it may be
            21   that you want to effectively subsidize entry barrier, which
            22   is what is going on here, but on the other hand, by doing
            23   that, it's important to recognize that you are subsidizing
            24   it, and that's what I'm saying it.
            25             MR. COLBY:  To what extent also is there an
             1   agency-principal problem, because, it sounds like what you're
             2   setting out is a model for sophisticated investors choice of
             3   information, but to the extent this is as, people said a bare
             4   minimum that's used for retail investors, to what extent do
             5   you think that the choice would be in the hands of the
             6   investor as opposed to the purveyor of the information to the
             7   investor?
             8             MR. LEE:  People go to Tom Gardner and he says he's
             9   a fool, but he's not a fool, right?  And they go to him
            10   because he's built up a reputation, and the issue is, if I'm
            11   a vendor and I'm going to be offering something which retail
            12   investors who know that they're relatively unsophisticated,
            13   but can trust him, that is something that I would want to
            14   invest in, so it doesn't seem to me, there's still a private
            15   incentive to be promoting.
            16             MR. COLBY:  Let's turn to another issue that was a
            17   very big part of the advisory committee consideration of
            18   market data.  Let me just put it out, whether it's of any
            19   interest to the people in this room, and that is the question
            20   of how the data gets pulled together.  Is it important to
            21   have a central consolidator that pulls the data together, or
            22   is it sufficient to require information to be made available
            23   and either leave it open to people to pull it together or to
            24   say it needs to be consolidated without a central
            25   consolidator?  My first question, is that of anything that's
             1   of any real interest to anyone at this table and if so, what
             2   are your views on it?
             3             It's a real interest to many market participants,
             4   Ruben, I'm going to hold you for a minute, because we see all
             5   these things are of interest to you.  Anyone else?
             6             MR. DeSALVO:  I would say with regard to SIP's
             7   work, whether it's one SIP or multiple SIPs competing--
             8             MR. COLBY:  By SIP you mean a central processor?
             9             MR. DeSALVO:  Yes. The actual process of
            10   consolidating disseminating is not broken.  What is broken
            11   and we hope that you get to it, is the cost that we pay for
            12   it.
            13             PROFESSOR KYLE:  I have some views on this.
            14             MR. COLBY:  Pull the mike up.
            15             PROFESSOR KYLE:  I think that having consolidated
            16   data going out through one feed has potential advantages,
            17   especially if you augment it to put more audit trail type
            18   data in it, because then you automatically get a fair time
            19   sequence, assuming all the different endings that are feeding
            20   data into it are feeding data into it in approximately the
            21   same way and what comes out at the end is going to have a
            22   certain kind of time sequence that's very integral to
            23   monitoring whether customer orders that are sitting there in
            24   the market are respected or not respected, there's a one-
            25   second difference in execution time.
             1             MR. BURKHART:  I would say also that in respect to
             2   the principle or ideal of fairness, if you like, in
             3   transparency, if you have a consolidated data source at least
             4   you know or you could feel somewhat comfortable that all the
             5   participants, be they retail, institutional or otherwise,
             6   with brokerage are receiving the same level of data, and what
             7   they do with it and how they handle it, or how they repackage
             8   it and analyze it to their customers or internally is really
             9   where their efficiencies or competitive advantages should be
            10   borne, as opposed to who receives what.
            11             If we all received the same data from a single
            12   source -- if Matt at Morgan Stanley gets the same data as
            13   Duncan at Goldman Sachs, what they do with it will determine
            14   their competitive edge over one another.  Ditto if Minder and
            15   I received or Scott and I received the same data.  How we
            16   analyze it, restructure it, retool it for our own purposes
            17   really should be the different shading factor amongst us, not
            18   multiple data feeds that we have to pay different amounts
            19   for.
            20             MS. ANGSTADT:  It seems, too, that it becomes such
            21   a tool of the regulators to, in the examination for best
            22   execution and it's really been a measurement of best
            23   execution that, even if somebody wants to buy unconsolidated
            24   data, they really do need for regulatory purposes the
            25   benchmark of the NBBO just to measure where they are.  I
             1   think one aspect of the Vendor Display Rule that I don't know
             2   if we'll get into is the display of the last sale data, what
             3   evil will befall us if we're able to display on a real-time
             4   basis and unconsolidated basis the last sale as opposed to
             5   just the NBBO.
             6             MR. COLBY:  What evil will befall us?
             7             MS. ANGSTADT:  I don't know that any will.  Is
             8   there a reason that we should not, you know, revisit the
             9   Vendor Display Rule and relax some of those requirements so
            10   that while we've been able to provide real-time limit order
            11   books and again on an unconsolidated basis so people can take
            12   a look at this information, what about providing the last
            13   sale as well, if that's something that a marketplace chooses
            14   to do.
            15             MR. COLBY:  Since not everyone has memorized the
            16   display rule, what it requires is that if you make the quotes
            17   from any one market available, you have to make the quotes
            18   for all markets, and if you make the last sale for any one
            19   market available, you have to make the last sale for all on
            20   an equally accessible manner, but it doesn't require that you
            21   make available the quotes of any market, it doesn't link the
            22   two, the quotes and the trades together.  So, Ruben, I know
            23   you want to talk on these two issues.
            24             MR. LEE:  A couple of points.  The first is, to use
            25   an example in Europe, we have competing markets and private
             1   market participants, either vendors have consolidated without
             2   any mandatory requirement to do so.  That's the first.  The
             3   second is I would take issue with two things which Gunner
             4   said as follows:  I think that his notion that if we have it
             5   all together in a single consolidated fee, we all work from
             6   the same information base, is wrong.  I think that in fact,
             7   market participants do work from very, very different
             8   information bases.  They see all different sorts of order
             9   flows.  In fact, not only is it wrong, but it gives the wrong
            10   impression in that having a BB, a best bid and offer makes it
            11   seem as though we all have the same information, but in fact
            12   we do not.
            13             And the second point I would make, which is a
            14   classic economist dilemma, thank goodness I'm no longer an
            15   economist, which is by requiring everyone to use the same
            16   structure you destroy incentives to provide better and faster
            17   structures and in fact, that is part of what makes and
            18   enhances the market, so I think that it gives the wrong
            19   incentive structure.
            20             MR. BURKHART:  Perhaps our disagreement on this
            21   point is founded over our definition of the data that's
            22   provided.  I was referring really to the basic standard trade
            23   data that should be available in a consolidated fashion to
            24   all participants.  Obviously, each of the participants,
            25   whether it's at the brokerage end or at our end, have lots of
             1   different internal information that we have gathered from our
             2   own proprietary sources which may or may not give us an
             3   advantage, and I wouldn't want to imply that we should either
             4   make that data wholly available to everybody, thereby giving
             5   up our proprietary advantage, or in fact that would be of
             6   interest to anybody other than ourselves.  I think our point
             7   perhaps differs on the data itself more than anything else.
             8             MR. COLBY:  Maybe we should talk--a number of the
             9   panel participants said that after decimals, that there was a
            10   crying need for more and different information for trading
            11   purposes.  It would be worth talking, and I know that Gunner
            12   and Minder took it to another level in terms of what the
            13   terms on which it should be available would be, but what is
            14   needed, sort of public information at this stage.  Tom, you
            15   represent some very active trading.  What are your thoughts
            16   on this?
            17             MR. PETERFFY:  We pull the data together ourselves.
            18   If we did not do that, we couldn't provide best execution.
            19   Our problem is that that data means different things to
            20   different people, because some of it is electronically
            21   accessible and some of it is not.  Now, what do you do when
            22   you see a quote that is a penny apart, and the one that's a
            23   penny better is not accessible.  This is the problem.  So I
            24   think that the market data question basically depends on
            25   market structure.  Once we have a market where all quotes are
             1   electronically accessible, the best solution automatically
             2   falls out.
             3             MR. DOMOWITZ:  I think the market data question is
             4   not just a question of market structure, it's a question
             5   from, let's say, my perspective of also quality service.
             6   Now, in the same way as Tom mentioned, we also pull the data
             7   together.  I find it very interesting a discussion of what
             8   you might call size adjusted quotes, okay, size adjusted
             9   spreads, you like to know what's there at a penny, what's
            10   there at a nickel.  When we talk like that, what we're really
            11   just saying is we'd like to see some notion of an order book,
            12   that's all that really is, that's basically saying there's a
            13   certain amount of shares available at certain prices as you
            14   step down the price panel.  Now, we put that type of data
            15   together ourselves for the benefit of our clients.  In other
            16   words, we pull data from a variety of sources, we use a
            17   variety of vendors to do that, and, frankly, we don't even
            18   find that in and of itself completely sufficient to meet what
            19   we believe are the needs for execution.
            20             We also need, if you like, scorecards for how well
            21   the markets are doing.  So when we talk about what do you
            22   actually need to get the job done, it's actually not even
            23   restricted to prices and clients, we actually need a lot of
            24   things.  But we can do it, we're pretty happy that the market
            25   does it, we happen to think that the market does it rather
             1   widely right now.  It's not a question of having to mandate
             2   the notion for this quasi order book for this information
             3   that's provided to all participants, the market is basically
             4   providing this and with means to access, although I would
             5   agree with some of the comments around that access is often a
             6   trifle difficult.
             7             MR. COLBY:  The limit order book display, other
             8   than the top, is a voluntary market driven system and some
             9   systems like Archipelago and Island makes its entire book,
            10   New York is making its book available, NASDAQ is working
            11   towards.  Is this producing what the market traders need and
            12   is it having a negative effect on reducing people's
            13   willingness to put information on the book, and Scott, maybe
            14   I can, you said I think earlier that post pennies that you're
            15   doing a lot more trading upstairs and on ECNs.  Is that
            16   trading visible or is it less visible than it was before or
            17   what's the thinking behind that?
            18             MR. DeSANO:  The reason we go upstairs is to take
            19   some of the problems of market structure off of our plate and
            20   put it on the Street, to be honest.  It's an unpleasant thing
            21   for them.  It's more motivated by splitting trades on the
            22   Floor that we don't want to split.  It has nothing to do with
            23   really what we're talking about here.
            24             MR. COLBY:  Minder?
            25             MR. CHENG:  I think just one more comment.  I think
             1   taking a step back, what is the reason for NBBO?  Before even
             2   getting to that, I think Gunner mentioned, for the buy side,
             3   it used to be, when the buy side didn't really have much
             4   direct access to the market, when we traded just about
             5   everything through the broker-dealers, so which means that
             6   even if I could see there was a better quote on this exchange
             7   as opposed to the other exchange, the relevance was very
             8   little, because we still traded through a broker-dealer, so
             9   we basically imposed that responsibility on the broker-
            10   dealers.  Not these days.  These days with this ongoing
            11   intermediation from the sell side and also with the
            12   technology that offers the sell side the ability to directly
            13   access the market.
            14             Now, here comes the question that I raised earlier.
            15   If we put, what we are trying to do is basically trying to
            16   figure out the order book or supply/demand.  But post decimal
            17   I think lack of protection, as Scott put it, basically, it
            18   has forced the buy side in a way to trade more upstairs and
            19   that is indeed true.  And, so, in other words, there's an
            20   order book, there's an NBBO and we can even address the
            21   depths, but there's also that liquidity that are not showing.
            22   We often go through ATSs and ECNs and we place our order
            23   through the reserve book.  We don't show the sizes of the
            24   market because, again, because of the lack of protection by
            25   showing it we will get picked off, most likely.  So I think,
             1   again, going back to Ian's point, the data structure or
             2   whether we want to create the right data that, again, that
             3   would sort of fit the retail need and the institutional need
             4   for them, meanwhile, there's no protection that has been
             5   offered to guarantee that whoever is providing that
             6   transparency to the market can be protected and rewarded.
             7             So I think that as long as we can't, I mean, to the
             8   extent that we cannot resolve that issue, how much do you
             9   want to provide through NBBO, how much depth, I think will be
            10   ongoing.
            11             MR. COLBY:  Can we follow this up?  Earlier I think
            12   Minder and Gunner both said they need to be rewarded for
            13   putting limit orders on the book with some kind of a price-
            14   time.
            15             MR. BURKHART:  I don't know if I would use the word
            16   "rewarded " in front of the regulators.  I certainly am not
            17   looking for any financial reward.
            18             MR. COLBY:  Incentive?  Well, you're probably the
            19   only person.  Incentive for putting the orders.  Could we
            20   proceed on this for just a while?  How much price/time
            21   priority would it require to encourage institutions to put,
            22   and ultimately, is there any amount that's going to encourage
            23   you to put the full size of a major order on the book or is
            24   that something that has to be worked, that ultimately has to
            25   be worked upstairs?
             1             MR. DeSANO:  It's not just price/time priority,
             2   it's I don't want to be improved.  If in order for me to put
             3   an order on the book, I want to reach two or three cents and
             4   take that stock from that person who's provided that
             5   liquidity on the book, I don't want to be improved.  I don't
             6   want somebody to step ahead and sell it to me a penny
             7   cheaper, I don't want it.  If I get that, I'm not putting an
             8   order on the book myself, all I'm providing is a way to get
             9   picked off.  So it's beyond price/time priority.  Does that
            10   make sense to you?
            11             MR. COLBY:  Are you saying when there's an order in
            12   the market you want to be able to access it?
            13             MR. DeSANO:  I want to be able to access it, okay,
            14   but in order to make it work, in order to get that limit
            15   order there so you have size on the book, you have to protect
            16   the person who has provided the liquidity and if I want to
            17   reach through and grab that liquidity by definition I should
            18   say I forego wanting price improvement, I have made the
            19   decision I want to buy that stock.  I don't want somebody to
            20   step ahead of that and free ride that person's order so.  By
            21   definition I don't want them to sell it to me cheaper and I
            22   don't want them to go along with that purchase or I won't put
            23   an order down there myself.
            24             MR. BURKHART:  I agree with Scott and to invert the
            25   perspective, what we would, we, being the institutional asset
             1   management community, would be used for when we put our large
             2   and show large size orders on the limit order book is a free
             3   option.  It's a free option for the specialist in the New
             4   York Stock Exchange, it's a free option for the floor
             5   brokers, it's a free option for anybody that wants to step in
             6   front of us for a penny or a smaller increment if we ever get
             7   to that, to trade ineffectively and to dilute or shut us out
             8   effectively.  It's one reason why Scott is trading upstairs
             9   and why we do and Minder does more today than perhaps in the
            10   days of old, is we don't want to give that free option to all
            11   the market participants.  That's a structure issue.  I'd be
            12   more than happy to put 100,000 shares of ABC stock down on
            13   the order book.  I don't want to show it and I want to know
            14   that I've got price/time priority with that order down there.
            15             MR. DeSANO:  I just want to add, the concept of
            16   price improvement in a market environment in the past was
            17   widespread I think made more sense today with decimals, I go
            18   back to best execution is in the eye of the beholder.  We
            19   need liquidity, we need access, too.  I think price
            20   improvements should go to those who have orders out loud.  If
            21   somebody's on the book at 20.03, 20.04 and there's a block
            22   out at 20.05, I want to reach out to 20.05, I'll pay the
            23   person at 2, 3 and 4 cents at 20.05 and I want that liquidity
            24   on the book.  That's actual price improvement, not what we
            25   have today.
             1             MR. COLBY:  Gunner, if I heard you correctly, you
             2   said you'd be perfectly happy to put a 100,000 share order on
             3   the book, but you don't want it to be shown, and you want
             4   price/time priority.
             5             MR. BURKHART:  Does that sound contradictory?  Is
             6   that what you're asking me?
             7             MR. COLBY:  It's what everybody wants, to have your
             8   cake and eat it, too.  The question I'd ask is right now, we
             9   have individual markets set their own price/time priority,
            10   and forgive me if I'm encroaching on your panel here, Larry,
            11   but there's no market price/time priority, and even within
            12   markets the amount of price/time priorities vary.  So my
            13   question to you is how much payback would there be if there
            14   was greater price/time priority within a market, and someone
            15   mentioned the penny versus the larger increment, and also
            16   there's a question that even within a market you might have
            17   price/time priority but not across a market.  Janet runs I
            18   think a pure price/time priority system and that's been a
            19   selling point of yours.
            20             MS. ANGSTADT:  Yes, it has been.  But we certainly
            21   have people who want to be able to access quotes with the
            22   price/time priority.  We have some order types that help
            23   reach out to people who are very fast if we don't have
            24   liquidity on the system, but it is a strict price/time
            25   priority system within Archipelago.
             1             MR. NIEDERAUER:  I think what Scott and Gunner and
             2   Minder are all saying, would be, I think the genie is out of
             3   the bottle on this one a little bit.  I think now you're in a
             4   decimalized environment, we might aspire to have a pure
             5   price/time environment, but under these conditions there's no
             6   such thing as a pure price/time environment now.
             7             When you listen to Scott's depiction of what a
             8   larger institution would like to do, that's what I think the
             9   NYSE Institutional Express order was designed to do, and we
            10   could argue in practice whether it has or hasn't worked.  I
            11   think what you're seeing from our seat is competition is
            12   kicking in.  I think six months or a year ago we would say
            13   let's mandate that since the NBBO is becoming less relevant,
            14   but it's still important, let's just mandate that people have
            15   to show more than one level.  Well, it turns out you really
            16   didn't have to mandate that, because everybody is showing
            17   multiple levels.  Folks like us are consolidating everything
            18   that people are contributing and putting in front of
            19   institutions like Minder, Scott and Gunner represent.  On top
            20   of that the competition kicks in with these various order
            21   types.  It may sound like these guys want to have their cake
            22   and eat it too, I'm not sure in a decimalized environment
            23   what else we're to do, other than to display a small quantity
            24   display, have a lot on research and count on the competitive
            25   forces again to take over where intelligent order routers
             1   begin to understand there are certain pools of liquidity that
             2   there's more than meets the eye behind there.  I'm not sure
             3   how we can solve that.
             4             I think short of turning the clock back to a
             5   smaller minimum price variation, I think these are natural
             6   outgrowths of a competitive market structure that maybe
             7   aren't as dysfunctional as we think they are.
             8             MR. MURPHY:  Could I weigh in a little bit, another
             9   observation with Gunner and Scott in a decimal environment.
            10   I still think price improvement is a valid option.  In the
            11   opening statement, Scott, when you said that shareholder
            12   value for your fund holders is your primary concern, why
            13   wouldn't you, if it was offered to you, want price
            14   improvement?  That liquidity is still there, the perception
            15   is that someone jumped ahead of that published bid or
            16   offerings whatever it is, for liquidity.  One misnomer and I
            17   know NYSE staff can back this up.  The specialist as far as
            18   pennying is extremely insignificant, almost nil, as far as
            19   penny jumping.  Really where the pennying comes in on the
            20   Floor is agents that represent the institutions, who like
            21   Minder said earlier, you know, the transparency is a double-
            22   edged sword.  A lot of people that have some size to do are
            23   careful about what they divulge and advertise on the national
            24   best bid or best offer, but if a large institution has a
            25   further interest, and gets price improved on a block of stock
             1   while that advertised, say up a penny or two, is still there,
             2   if he has a further interest, it's still available to him.
             3   So why not take advantage of that price improvement, even if
             4   it is a penny or two?  I don't think that's a bad thing.
             5             MR. COLBY:  Let's now shift directions and talk
             6   about market data revenues.  Currently, the public market
             7   data system is very closely linked to self-regulation.  SRO's
             8   collect the quotes, the trade information from their members,
             9   and they make this information publicly available, and
            10   historically the SRO's have charged for this information.  So
            11   let me start with what was our Chairman's question at the
            12   last hearing which is, is market data a public good that
            13   should be available for free to investors and market
            14   participants?  Start with that one.
            15             PROFESSOR KYLE:  I'll answer that.
            16             MR. DeSALVO:  I don't have a problem with that.
            17             PROFESSOR KYLE:  There are a lot of externalities
            18   that exist with respect to markets, and if you think about
            19   market data, market data is providing a positive externality
            20   to the people who use it.  It has characteristics of a public
            21   good in that once it's out of the bag it's a little hard to
            22   prevent it from circulating around, but it can be prevented.
            23   If you think of market data as providing an externality and
            24   if you thinking about providing a limit order as hanging
            25   yourself out there to get picked off, that's providing an
             1   externality.  That suggests that market data should be
             2   expensive because the people who are benefiting from it as a
             3   positive externality should in some sense maybe pay for it,
             4   like a little tax on them having to pay for it I think is
             5   probably reasonable.  If you think about an efficient funding
             6   for exchanges, market data fees, that is payments for a
             7   positive externality that they're creating for everybody else
             8   should be a large component of their revenues and that's kind
             9   of an efficient way of creating that positive externality.
            10             COMMISSIONER PITT:  Now, let me follow up with
            11   that, because there are different types of market data and
            12   maybe the problem of coming up with an answer to the question
            13   exists when you try to conflate the different types of data.
            14             Let's just deal with transactions and stated bids
            15   and offers.  If you assume the best execution, whatever it
            16   means, is a legal obligation and if you assume that the only
            17   way you can fulfill that obligation is to be able to have
            18   sufficient data to note where best execution will take place,
            19   again, whatever best execution is, then if you just limit
            20   market data to that kind of information, people who are
            21   willing to have limit orders on the books in size, et cetera,
            22   why isn't that akin to IBM's results of operations, for which
            23   we do not charge; that's available to investors for free,
            24   because it's thought to be relevant information about making
            25   a judgment.  Why isn't that equally true of market data about
             1   bids and offers and actual transactions?
             2             PROFESSOR KYLE:  I think because in the case of IBM
             3   providing set financial information, the shareholders of IBM
             4   can be located as the individuals who ultimately will benefit
             5   from having that information provided, and it's fair enough
             6   to make them pay for it, so in some sense, maybe it's IBM
             7   that bears the cost of creating its own financial information
             8   and that's a reasonable way to finance the provision of that
             9   information.  But when you're talking about a trading system,
            10   there are going to be people out there who would like to
            11   benefit from the price information that is created by the
            12   trading system, and the people that are benefiting from the
            13   price information created by the trading system are not
            14   necessarily using the trading system, they could be offshore
            15   or maybe trading outside the United States.  Those persons,
            16   it seems to me it would be fair to ask them to pay for that
            17   information because they're actually benefiting from it in
            18   realtime.
            19             MR. HARRIS:  Who is creating the price information?
            20             PROFESSOR KYLE:  The exchanges.
            21             MR. HARRIS:  Is it the exchanges or the traders
            22   that act at the exchanges, and if it's the traders who act at
            23   the exchanges what mechanism takes the data from the market
            24   revenue back to the people who are actually producing the
            25   information, which is what's necessary for best execution.
             1             PROFESSOR KYLE:  That was your question for the
             2   session this afternoon, I think.
             3             MR. HARRIS:  There is the issue that the incentives
             4   for passing along the information is too great or too small.
             5   So if traders can shop around for exchanges and exchanges are
             6   charging for data in some manner that's proportionate to the
             7   amount of business they do, then exchanges are going to
             8   rebate the fees they get from traders ultimately to the
             9   traders, and traders shopping around for exchanges are going
            10   to ultimately play one exchange off the other.  How far that
            11   can go is an issue.
            12             MR. NIEDERAUER:  I don't think it's the same today
            13   and I think the Chairman's question was at the first hearing,
            14   think about what the exchange's product is, and I think we'd
            15   all agree that it's fairly non-controversial that it's fair
            16   that an exchange charges a transactional fee for bringing
            17   together a buyer and seller to transact with one another.
            18   That's their product, their core competency, they're
            19   delighted to provide that facility and I think we're in all
            20   within reason willing to pay.  I think where it becomes more
            21   confusing for us is, think about what we've been talking
            22   about in this session so far the provision of market data to
            23   help you decide where to trade.  One could argue it's nothing
            24   more than the exchange facility trying to attract liquidity
            25   to come to it's place so it could charge that transaction
             1   fee.  I think as we thought about this, we felt the same way
             2   about the reporting of the trades that took place.  That's at
             3   best a byproduct of what we've already paid for on the Floor.
             4             To Larry's question, one could argue that you could
             5   trace its ownership back to the sell side or the buy side,
             6   not the exchange, so I think we all feel like we've paid for
             7   the exchange's key product, which is bringing buyer and
             8   seller together and the provision of data to help us make the
             9   decision before and after that transaction challenges whether
            10   we should be paying for that.
            11             MR. DOMOWITZ:  There are a couple of things, here.
            12   I actually don't completely disagree, but the first point is
            13   that I think it's misleading to say that IBM provides its
            14   corporate data for free.  The shareholders  pay that cost.
            15   The army of accountants, lawyers, technology systems and
            16   whatnot that's required to produce that data impacts the
            17   bottom line of IBM.
            18             MR. PITT:  I think that's right.
            19             MR. DOMOWITZ:  The provision of data impacts the
            20   bottom line of the exchange.
            21             MR. PITT:  But they provide it to the public, the
            22   investing public for free.  That's the distinction.  I
            23   certainly agree with you that there is a cost for the
            24   provision of that data and somebody is paying for it.
            25             MR. DOMOWITZ:  Someone is paying for it.  So the
             1   issue is perhaps also how much, right, which is something
             2   they could come to, I'm sure, something which I disagree a
             3   little bit, with Duncan, we haven't raised yet what the
             4   monies are really used to pay for.  In other words, if I am
             5   an ATS and I provide share transaction services, and I charge
             6   for that, no question, if I'm an exchange, I also charge for
             7   that.
             8             If I'm an exchange, I have to at least under the
             9   current system fund regulatory oversight.  In fact, that
            10   exchange may even oversee my ATS, as things are, these days.
            11   So there is a question--
            12             MR. COLBY:  Hope they do.
            13             MR. DOMOWITZ: --of who is going to pay for that.
            14   We could say, you could make an argument, that the share
            15   transaction charge should pay for the regulation, but this is
            16   basically talking about cross-subsidization across different
            17   areas of the business.  There's a data area of the business,
            18   there's an execution area of the business, they do complement
            19   each other, where the monies come from and what are they
            20   paying.
            21             MR. NIEDERAUER:  I think that's fair.  I think I
            22   actually do agree with you.  I think the corollary to that is
            23   there are some cross-subsidies that this creates and I think
            24   one our guidelines for this session was to just keep it
            25   simple.  I think it's gotten overly confusing and I know
             1   we're going to get into probably market data rebates at some
             2   point, which I think is an additional distortion.  Nobody
             3   wants to go to a place to trade that is underfunding its
             4   regulation.  I think our view is make the cost of that
             5   regulation more transparent.  We'll decide collectively
             6   whether we think that's fair or adequate, because we don't
             7   want anyone taking shortcuts there, but don't confuse the
             8   issue by saying we're going use this other source of revenue
             9   to fund this regulatory cost.  Just put it out there.
            10             MR. DOMOWITZ:  I'm a hundred percent for that.
            11   When I was thinking about my own opening remarks, the one
            12   that I really wanted to come out with -- perhaps now is the
            13   right time -- is that the morass of both implicit and
            14   explicit rules and the cross-subsidies that are created is
            15   more complicated than the U.S. Tax Code.  If I stacked all
            16   the books summarizing the U.S. Tax Code on the podium I
            17   guarantee given the rickety nature of it, this podium would
            18   just collapse.  The thing, is we don't even have all these
            19   market structure intricacies written down.  They are
            20   byproducts of how we said we are going to operate the
            21   markets.  I think Duncan's point was extraordinarily correct
            22   -- if we're able to clear away some of that, we can get a
            23   better view of the underlying economics of the issue.
            24             MR. COLBY:  As the lone registrant at the table,
            25   Paul, do you want to respond to this?
             1             MR. O'KELLY:  Nothing is free.  The notion we
             2   should put out market data for free is often said by people
             3   who don't have to put together exchange operating budgets for
             4   the coming year.  This is simply an allocation of the cost of
             5   running the exchange.  Who is going to bear what costs.
             6   Exchanges go through these exercises regularly.  The exchange
             7   has to adequately fund itself, the SRO's responsibilities,
             8   they have to get the money from some source, try to allocate
             9   those reasonably across all the people who use their markets.
            10   We're not here today to debate the cost of annual membership
            11   dues, we're not debating the cost of transaction fees, we're
            12   not debating the cost of clearing fees, we're not debating
            13   the cost of listing fees.  These are all fees an exchange
            14   assesses so it can fund itself as a marketplace, as a
            15   self-regulatory organization.  There is nothing special,
            16   nothing magic about market data fees.  They are one of the
            17   sources of income for the exchanges to fund themselves and we
            18   should not lose sight of the fact that exchanges are mutual
            19   organizations run by the broker-dealers providing those
            20   orders and if they believe that the allocations of the costs
            21   across the various lines of business in the exchange are
            22   unfairly discriminating against one segment, they have the
            23   opportunity within those organizational structures to make
            24   those points and get changes made.
            25             MR. DeSALVO:  Could I just weigh in?  I think it
             1   would be helpful for a minimum standard -- yes, they'll sit
             2   on a monopoly of the market data and as such they have their
             3   privilege to disseminate that information that we end up
             4   receiving.  There should be a minimum standard that allows us
             5   to trade that we get.  Could it be NBBO plus three, last
             6   sale, and size, at which point the pricing of that minimum
             7   data be at one level and then any of the other data that the
             8   SRO decides to put out on a competitive market basis they
             9   should be able to get whatever they want.
            10             But we pay in excess of a hundred million dollars a
            11   year for market data.  We are not getting a hundred million
            12   dollars plus worth of best execution analysis on that data,
            13   and there's no way that the current market structure is going
            14   to allow that to change.  A strong end minimum low-priced
            15   NBBO should be priced at one level, anything else should be
            16   reflected into what the competitive market prices should
            17   bear.
            18             MR. COLBY:  Some folks mentioned that recently
            19   there was a development where some folks rebate market data
            20   revenues back to people that report trades or sometimes
            21   submit limit orders and that raises a number of questions.
            22   One, is this an appropriate use of market data revenues?  Is
            23   it somehow undercutting, some folks have said there's a
            24   self-regulatory function and is this rebate or rebates by
            25   some undercutting the self-regulatory function?  Does it
             1   suggest the rates are too high or is this an appropriate way
             2   to allocate out the value of market data revenues to the
             3   people that are producing it?  Anyone have views on that?
             4             MR. O'KELLY:  May I respond?
             5             MR. COLBY:  Paul would like to respond.
             6             MR. O'KELLY:  To me this is a classic case of
             7   damned if you do, damned if you don't.  You have half of your
             8   members saying market data fees are too high.  So you say,
             9   okay, let me look and see how I can run my exchange
            10   efficiently and use the market data fees that are beyond
            11   those required to run the exchange, try to incent my members
            12   to try to make better markets.  I use those monies, return
            13   them to the members rather than keeping them.  I advocated
            14   internally a long time market data fees shouldn't be
            15   returned, they should go to officer's bonuses, but we passed
            16   that over many times.
            17             (Laughter.)
            18             MR. O'KELLY:  So we rebate them to members and we
            19   give them to members who demonstrate they can increase their
            20   market share, provide better markets.  We think that's the
            21   most competition among markets and it's a valid use of market
            22   data fees.  The alternative would be to keep the market data
            23   fees.  My bonus would go up.  We don't think that's the right
            24   thing to do.  We see nothing wrong with rebating market fees.
            25   The issue isn't rebating, it's to make sure that whatever
             1   rebate program you put in place is not one that's susceptible
             2   to manipulation or misuse to the people to whom you give the
             3   money.
             4             MR. DeSALVO:  That assumes that the current level
             5   of market data fees is correct and we're saying it's
             6   incorrect, let alone whether you should keep it for your
             7   officers or send it out to attract order flow as a form of
             8   payment for order flow.  What we're saying is that the
             9   general notion for market data fees is too high and we should
            10   not have to pay the same for the general, to place an order
            11   on a trade, the minimum level strong man that I talked about,
            12   that level fees is too high.
            13             MR. O'KELLY:  Not all exchanges rebate the fees, so
            14   for those exchanges who are not rebating any fees to the
            15   members, perhaps they could answer for them they need all
            16   that market data to run their exchange.  Perhaps because
            17   there are revenues from other sources, not sufficient to run
            18   the rest of the responsibilities or perhaps they run their
            19   SRO responsibilities and other mechanisms in a more robust
            20   fashion.
            21             MR. DeSALVO:  Why should we pay market data fees
            22   for best execution purposes for you to rebate to your
            23   participants to attract order flow to your exchange.  I don't
            24   follow that logic.
            25             MR. COLBY:  Bob, as vice chair of the New York
             1   Stock Exchange, I think you would have some insights to this.
             2             MR. MURPHY:  Remarkably, in doing my homework to
             3   get ready for the panel I realized nearly 70 years market
             4   data fees have stayed constant as about 17 percent of the New
             5   York Stock Exchange's revenue stream.
             6             The other point I would like to make, as far as the
             7   Board goes, in our structure, we have nearly half our board
             8   is made up of industry leaders, and they get, I think it's
             9   twelve out of 27 board members sit on the board, and they get
            10   a look at the budgets and the data pricing schedules, and I
            11   think that the challenge is to keep it fair and to keep it
            12   reasonable, but I agree with Paul on one point, that there is
            13   some heavy lifting in, especially as far as the New York is
            14   concerned, because there are so many moving parts and we have
            15   to put it all together and then the product is produced.  We
            16   have the floor brokers, the specialists, we have the trades
            17   and the quoting and there's some heavy lifting there.
            18             Where I totally disagree, and where Paul and I
            19   disconnect is the data rebates for buying tape prints.  That
            20   I think is maybe an indication that market data fees could be
            21   a little on the high side, because I think it's fictitious
            22   data anyway, because these are internalized trades, there's
            23   no opportunity for any interaction by any other market
            24   participants, and as far as this consortium goes, it's almost
            25   like we're subsidizing, and I have to agree with Ruben on
             1   this, we're subsidizing a lot of what's going on, because
             2   they piggyback the consolidated tape and consolidated quote
             3   consortium.  It's a tough issue, but it's one that should be
             4   dealt with.
             5             MR. PITT:  Bob, let me just ask one question.
             6   Which way does it cut if you've been able to maintain market
             7   data fees at a set percentage for 70 years?  What conclusion
             8   should we draw from that?
             9             MR. MURPHY:  I think it's right now, in this
            10   environment, we need every penny we can get, but it funds a
            11   lot of things that go on there, and 17 percent of our revenue
            12   stream I don't think is exorbitant, but again, I want to
            13   point out that our board, made up of twelve industry leaders,
            14   can react if they feel at the table that these are, we are
            15   overcharged, and I think we're okay as long as we're not
            16   maximizing profits, but just making it sufficient to fund
            17   what we have to do as an SRO.
            18             MR. PITT:  I guess one model of pricing tends to be
            19   what's your cost for the production of either the product or
            20   the service, and then what's a reasonable return.
            21   Presumptively, if the costs were being set that way, it would
            22   be highly unusual if it came out to be 17 percent of total
            23   self-regulatory costs over 70 years, which suggest that the
            24   costs are being set some other way, which then leads to the
            25   question that I think some of the people who pay the fees are
             1   asking, which is how are the costs set, it's not just a
             2   question of what they're funding, but how are they set and
             3   why is it appropriate to pay that amount of money and
             4   potentially, as was raised earlier, are there other costs of
             5   regulation which are obviously critical, can be recovered
             6   without tying into market data.
             7             MR. MURPHY:  Chairman, I don't know, I think it's a
             8   really stretch to know if you can identify exactly what the
             9   expenses are of putting all the data together to form one
            10   product or to come up with our tape and our quote line, but
            11   you know, I don't have the answer for you.  I think that's
            12   something staff could work on and maybe have an answer to,
            13   but it's a good question.  No doubt about it.  But right now,
            14   I think it's fair.
            15             MR. DeSALVO:  I think the cost of processing data
            16   has not been reflected in the cost of disseminating the fees
            17   to the buyers of that data.  That Moore's law has not been
            18   implemented into our bills that we receive every month with
            19   regards to data.  That the cost of producing a billion and a
            20   half shares worth of data is not is cheaper than it was ten
            21   years ago when it was a billion shares of data.  That's not
            22   being reflected in the market.
            23             MR. COLBY:  Did you want to speak to this?
            24             MR. LEE:  I had a couple of points.  One is
            25   practical, two is conceptual.  The practical point is to
             1   agree with the stock exchange down there, which is saying if
             2   you actually look at the different sources of revenues of the
             3   different exchanges, in fact almost all those sources are
             4   under threat, apart from market data, so actually, I predict
             5   that we will see market data fees going up, much to the
             6   chagrin of the  Morgan Stanley friends over there, that's the
             7   first point I would make.
             8             The second point is a conceptual point and here,
             9   while I very much agree with Duncan in his statement that we
            10   need to identify clearly what the costs of self regulation
            11   are, and have a debate appropriately about how to fund them,
            12   I think that's absolutely vital, I agree with Ian.  What I
            13   disagree with him, which is a general conception, is that an
            14   exchange is a trading system and a byproduct of that is data.
            15   To the contrary, a completely appropriate view of an exchange
            16   could be it's a media company and what it produces is data,
            17   and I think what you're saying is exchanges and other forms
            18   of trading systems are reducing their trading costs to get
            19   them closer and closer to zero, so it doesn't surprise me
            20   that data fees are going up, and I think that's the wrong
            21   model in which to decide what is appropriate.
            22             I want to do a couple of more conceptual points
            23   which Ian raises and follow them up about the appropriate
            24   price for data.  If something is a public good does not mean
            25   that it's the appropriate cost, the appropriate cost for it
             1   should be zero, and in fact, again, as a very ex-economist,
             2   one would normally talk about that the appropriate cost
             3   should be its marginal cost.  In this context, the marginal
             4   cost of producing and disseminating data is actually falling
             5   very, very close to zero, okay, and what I would argue is
             6   that that modern economic model for deciding what is an
             7   appropriate cost for data is actually inappropriate and then
             8   we can go into the details of that subsequently.
             9             MR. NIEDERAUER:  I think I'll try to have a
            10   practical one and a conceptual one, too.  I think the first
            11   thing I would say you may just be having a conversation about
            12   different kinds of business models.  The sell side's business
            13   model, for example, tends to be a bundled matter.  If we
            14   trade with BGI, Fidelity or Deutsche Asset, I think the
            15   equivalent we're talking about the exchange is doing, is
            16   every time I send Gunner an indication, I send him a bill
            17   with that indication because here's my attempt to say I've
            18   got some stuff going on, here's what I'm competitively
            19   putting in front of you to express a willingness to transact
            20   with me and I would charge him for that.  I would charge him
            21   to transact with me, I would then report the trade and then
            22   charge him for that also.  We think that our transaction fee
            23   is certainly fair, it's negotiated with our customers every
            24   time, it may be as simple as a difference between a bundled
            25   pricing model and an unbundled pricing model, it may be that
             1   simple.
             2             I think to get back to the rebate question, I think
             3   the way Paul explained it, it sounds great.  It sounds if
             4   that's how everybody administered it, maybe we wouldn't have
             5   a problem with it, I think it's easier to just reduce the
             6   fees instead of talking about charging here and rebate it.
             7   One of the buzz words for today is unintended consequences.
             8   I think one of you mentioned that in your opening remarks.  I
             9   think one of the unintended consequences of these market data
            10   rebates, it led to strange behavior.  It led to people
            11   trading in one place, but then printing the trade somewhere
            12   that just was going to write them the biggest check.  I think
            13   with all the themes we're trying to discuss today, that's
            14   just terribly distorting and disappointing, because it
            15   misleads the very people that we're trying to put better
            16   information in front of.  Suggesting that some exchange
            17   simply because they pay the most money is a real venue for
            18   liquidity, it's just terribly misleading if that's what we're
            19   trying to avoid.
            20             MR. COLBY:  Unless the Commissioners, if any
            21   Commissioners have any specific questions, then I think we're
            22   going to call a halt for this one.  I just say, from a
            23   practical standpoint of we are going to look at the costs of
            24   production and then setting the fees from that, we're very
            25   glad that we have a very able chief economist.
             1             (Whereupon, at 12:15 p.m., a luncheon recess was
             2   taken.)
             3                 A-F-T-E-R-N-O-O-N   S-E-S-S-I-O-N
             4                            (1:25 p.m.)
             5             MR. HARRIS:  Welcome back from lunch.
             6             My name is Larry Harris, I am Chief Economist at
             7   the SEC.  We are now going to start the session on best
             8   execution.
             9             Viewed broadly, obtaining the best possible
            10   execution of orders is the reason we are all together here in
            11   this room.  For some of us, it is the reason why we are in
            12   this business.  High quality executions encourage investor
            13   participation in the securities markets and thereby reduce
            14   the cost of raising capital.
            15             Best execution is a concept ground in the agency of
            16   fiduciary law.  The legal obligation of best execution owed
            17   by a broker-dealer to its customer requires that the
            18   broker-dealer obtain the most favorable terms for a
            19   customer's transaction available under the circumstances.
            20   When a security is traded in only one market and all orders
            21   meet and are executed within that market, best execution is
            22   relatively simple.  Broker-dealers merely have to determine
            23   how best to present each order to the market.
            24             The competition among orders produces the best
            25   prices available for those orders at that time.  The
             1   simplicity of such fully consolidated markets is attractive
             2   to many people.  Many securities, however, trade in multiple
             3   markets.  The competition for order flow among market centers
             4   encourage the development of cheaper and more innovative
             5   trading services.
             6             For this reason,  Congress and the Commission long
             7   encourage competition among market centers.  Unfortunately,
             8   assuring best execution may be quite difficult when competing
             9   market centers trade the same security.  Investors,
            10   especially small ones, often cannot easily monitor and
            11   enforce best execution.  The amount at stake is often small
            12   and detecting, much less proving, the availability of a
            13   better execution is difficult.
            14             Brokers, therefore, have relatively little risk of
            15   liability from investors complaining of poor execution.  In
            16   these markets, some brokers may not aggressively seek the
            17   most optimal execution for their customer orders either to
            18   avoid the search costs involved or to profit from trading
            19   with those orders.  They may trade directly with customer
            20   orders as a dealer or route their orders to another dealer in
            21   exchange for payments for order flow.
            22             When multiple market centers compete for order
            23   flow, broker-dealers who seek to provide best execution must
            24   identify the location of the best available prices and access
            25   those prices routinely and efficiently.  If they do not have
             1   facilities to accomplish these tasks, investor orders may not
             2   interact at the best available prices and efficient price
             3   discovery across the marketplace may be impaired.
             4             One of Congress's principal goals in enacting the
             5   75 Act Amendments was to address pure customer executions
             6   resulting from trading securities in separate unconnected
             7   markets.  In addition to establishing national market system
             8   mechanisms for collecting and disseminating market data,
             9   Congress envisioned the framework in which broker-dealers
            10   have access to all markets, competing markets would be linked
            11   together in a way to produce efficient executions at the best
            12   available prices.
            13             The Commission has striven to remove discriminatory
            14   barriers to direct access directed by exchanges and the NASD.
            15   The Commission has also sought to integrate new trading
            16   systems, such as ECNs, alternative trading systems and other
            17   routing services into intermarket mechanisms.  The
            18   Commission's Regulation ATSs requires display of customer
            19   orders of certain high volume ATSs be integrated into the
            20   public flow, and the major ATSs provide fair access on
            21   neutral nondiscriminatory terms.
            22             The Commission has also encouraged sufficient
            23   linkages between market centers.  These linkages provide a
            24   back-stop mechanism to help assure that orders routed to one
            25   market benefit when better prices are available in a
             1   competing market.  These linkages may also help smaller and
             2   newer market centers compete with the dominant markets by
             3   reducing the need for each broker-dealer to build separate
             4   links to each competing market.
             5             These linkages and the anti-trade through
             6   regulations that often accompany them, have been quite
             7   controversial.  Slow linkages favor slow markets; fast
             8   linkages favor fast markets; and no linkages favor
             9   well-established markets in arbitrage orders.  Not
            10   surprisingly, the SEC has heard every possible preference
            11   expressed.  I expect we will hear that again today.
            12             Best execution involves more than just the
            13   execution of individual orders between the given market
            14   structure.  Market structure affects the incentives to quote
            15   vigorously and offer aggressive limit orders.  Aggressive
            16   quotes and limit order prices produce the best prices for all
            17   orders.  Many people believe that the national market system
            18   should be structured to award market participants for
            19   contributing to price discovery.
            20             The existence of multiple market centers competing
            21   for order flow can reduce opportunities for order interaction
            22   and, thus, discourage vigorous quote and limit order
            23   competition.  This problem arises because most markets
            24   encourage competition among orders within their markets but
            25   not across markets, and because dealers trading with their
             1   customers can freely ask superior prices displayed in other
             2   market centers.
             3             In this session on best execution, we will now
             4   consider these questions, among many others:
             5             Should markets be linked?
             6             What does best execution mean?
             7             If the markets are linked, how fast should the
             8   linkages be?
             9             Do we still need trade-through rules to assure best
            10   execution?
            11             How should trade-through rules be applied?
            12             How should we assure the best representation of
            13   limit orders?
            14             Should market centers be allowed to charge access
            15   fees for market orders?
            16             Should market centers be free to offer liquidity
            17   rebates for limit orders?
            18             Should brokers be allowed to take such rebates?
            19             And should brokers be allowed to take payments for
            20   order flow?
            21             Anyone of these questions is a question that could
            22   easily occupy us for the two hours that we have in front of
            23   us.  We will try to try cover as many of these as we can, and
            24   other questions of interest, as we debate the market
            25   structuring.  I will note very quickly before we start that
             1   one thing that I found fascinating at the SEC in this market
             2   structure area, nobody ever comes to us saying that they are
             3   in favor of less competition.  Everybody is in favor of more
             4   competition, but there are two types of competition that they
             5   speak for, usually not carefully identifying the fact that
             6   there is another type out there.
             7             They either speak for best competition or
             8   competition for best price.  That's the traders competing
             9   with each other for best price.  And that competition, of
            10   course, works best when everybody comes together in one
            11   place.  Or they speak for competition among market centers,
            12   which is wonderful for producing low-cost execution services
            13   and innovative services, but it is fundamentally at odds with
            14   the first type of competitions.
            15             So we have two competitions that are, in some
            16   sense, at odds with each other.  I venture to say that just
            17   about everybody in this room is, indeed, in favor of
            18   competition and we usually hear arguments for one side or the
            19   other.  The difficulty that the SEC faces is trying to trade
            20   off between those two types of competition.
            21             So let's start off with just a question that we
            22   have touched upon a few times this morning already:  What
            23   does best execution mean?  Who is responsible for assuring
            24   best execution?  Should it be the broker who handles the
            25   order, or should it be the national market system that
             1   insures that orders get routed to the best prices?
             2             Why don't we start with Pete; do you want to offer
             3   an opinion about that?
             4             PROFESSOR KYLE:  I don't know if I want to offer an
             5   opinion on what best execution means exactly, but I want to
             6   offer something that's related to that.  And that is that the
             7   key ingredient is allowing the customer limit orders to meet
             8   each other in the marketplace.  That is for having a
             9   mechanism in place for if I place a limit order to buy and
            10   you place a limit order to sell, they can meet.
            11             The second ingredient is tick size.  If tick size
            12   is really large, there is a good chance that we will not meet
            13   even if we are at the same price or some area in between.  If
            14   tick size is very small and we have the opportunity to meet,
            15   then we probably will meet.  To think about the consequences
            16   of having a larger tick size limit order not meeting, you
            17   just have to go back and figure out the way NASDAQ worked
            18   five years ago.  When the tick size of NASDAQ was reduced, it
            19   simultaneously allowed customer limit orders to meet each
            20   other more efficiently, my understanding is there was a
            21   dramatic drop in trading costs for the small customers on
            22   NASDAQ.
            23             So I think those two ingredients, customer limits
            24   orders meeting each other and small tick size, kind of solve
            25   most of the problem regardless of how the rest of
             1   institutions with margins work.
             2             MR. HARRIS:  So how would you have customer orders
             3   meet each other in the national market system?  How would you
             4   interpret the national market system?
             5             PROFESSOR KYLE:  I would interpret it that there is
             6   a mechanism where a customer can place an order with a
             7   broker, that order gets displayed nationally, and there is a
             8   mechanism where if I place a limit order with your broker,
             9   automatically the mechanism can find me.
            10             MR. HARRIS:  And the broker would be responsible
            11   for insuring that that automatically happens or would you
            12   have some consolidated mechanisms to do that?
            13             PROFESSOR KYLE:  Then it gets down to details, but
            14   the basic detail is that if you tell your broker, I would
            15   like to get the best price in the market, the broker has an
            16   obligation to find me if I am also advertised on the national
            17   market system, which I would be.
            18             How that gets implemented is kind of details,
            19   important details, but the big picture is that mechanism is
            20   in place.
            21             MR. HARRIS:  I neglected to mention that Chris
            22   Quick from Fleet Securities has now joined our panel
            23   representing himself, of course, but more broadly, I presume
            24   NYSE Specialists.
            25             Chris, what does best execution mean to you?
             1             MR. QUICK:  I think best execution is when the
             2   broker looks after the customer's best interests, regardless
             3   of his own interest.  We have to, again, think about who is
             4   driving this market?  It is the customers.  It is not the
             5   other end of the spectrum.  It is not the dealer, it is
             6   always the customer first.  And I think that's why the New
             7   York Stock Exchange has in its history put in the forefront
             8   its long tradition of serving investors first.
             9             MR. HARRIS:  Chris, is the customer well served by
            10   having an ITS system?
            11             MR. QUICK:  The customer is served by, again,
            12   getting the best price for that, regardless of where it comes
            13   from.  If it comes from ITS, if I have a customer order that
            14   gets delivered here on the floor to me, I have an obligation
            15   to go to that ITS marketplace where that best price is,
            16   whether it is a penny, whether it is two cents, whatever it
            17   is, it is the best price.
            18             MR. HARRIS:  Is it your opinion that the ITS
            19   systems insures and helps produce the best price?
            20             MR. QUICK:  I think when you set out in 1975, that
            21   it did probably accomplish that.  I am not sure today that
            22   ITS is the vehicle to continue on in the future.
            23             MR. PETERFFY:  I would like to say something about
            24   ITS.
            25             The ITS rules practically stated prohibit any
             1   market to trade through the quotes of any other market.  This
             2   would make sense if all the quotes would be electronically
             3   instantaneously reachable.  But they are not.
             4             These rules provide traditional exchanges to have
             5   somewhere between 30 and 90 seconds to decide whether they
             6   want to trade with an order or not.  This is a free option
             7   which is very expensive to the order provider.  The
             8   Commission should examine whether the exchanges and ECNs with
             9   electronically accessible venues would be cut free from the
            10   ITS quotes.
            11             If the answer to the question would be affirmative,
            12   these electronically accessible venues would form their own
            13   ITS rules, and there are a sufficient number of them now that
            14   if there would be a no trade through -- a trade through
            15   prohibition among them -- they would certainly come up with a
            16   fair price.
            17             MR. HARRIS:  Thank you, Tom.
            18             We will undoubtedly return to ITS and the question
            19   of speed of linkages a number of times today, but I want to
            20   stay just a little further on best execution and return to
            21   that question very quickly.  Though, I am sorely tempted to
            22   jump in.  We will be in interesting territory very quickly
            23   with best execution also.
            24             Gunner, let me ask you, for institutional size,
            25   does the Commission have any business worrying about best
             1   execution or is this really just a retail issue?
             2             MR. BURKHART:  First of all, I found it rather
             3   curious that when you asked initially did the responsibility
             4   for best execution rest with the market structure and
             5   exchange or did it rest with the broker-dealer, that, in
             6   fact, I think that the responsibility for best execution most
             7   squarely falls on the shoulders of the institutional asset
             8   manager.  And that's where the responsibility, I think, lies
             9   today.
            10             And the fact, as I see it, the plain truth of the
            11   matter is, the current market structure in the United States
            12   is in direct conflict with our fiduciary responsibility of
            13   best execution.  And that makes it very difficult for us.
            14             MR. HARRIS:  Your institution, undoubtedly, has a
            15   very large buy side desk and you refer to the responsibility
            16   of the trader that you employ to obtain best execution for
            17   the firm?
            18             MR. BURKHART:  Correct.
            19             MR. HARRIS:  What about smaller institutions that
            20   don't have buy side desks?  Should they have them or can they
            21   contract for that by going through a broker?
            22             MR. BURKHART:  Whether you have a centralized
            23   trading desk or dealing desk or not, somebody at your end is
            24   responsible for the execution of the order, whether it is the
            25   portfolio manager or some type of administrative person,
             1   somebody obviously licensed by the authorities.
             2             By and large over history, most buy side firms have
             3   outsourced the responsibility of execution to the
             4   broker-dealer.  I think that at least today, and the trend
             5   going forward, the responsibility for and the control of the
             6   execution and, therefore, by and by best execution however
             7   you define it, is going to come firmly into the lap of the
             8   buy side house.  Whether it is with a centralized trading
             9   desk or portfolio manager, I think the shift of the
            10   responsibility is very apparent.
            11             MR. HARRIS:  Tom Gardner?
            12             MR. PETERFFY:  He is not here.
            13             MR. HARRIS:  I'm sorry, I can't see that way.  I am
            14   sure he will be returning shortly.
            15             Minder?
            16             MR. CHENG:  Yes, I think I would just add to
            17   Gunner's point.  In terms of where the responsibilities
            18   reside, the responsibilities associated with best execution,
            19   there are some residing with the institutional trader, there
            20   are some residing with the broker-dealers, and there are also
            21   some residing with the exchanges.
            22             I think that when there is a better quote that is
            23   away from the NYSE, it is up to ITS, which I know we are
            24   going to get into, I think perhaps up to the specialist or to
            25   the broker-dealer at least to make sure that you do route
             1   your order up to a certain size to a market where it has the
             2   best quote.  But buy side doesn't have control over that
             3   unless we have direct access to the market, which we do in
             4   some other countries, but not in the U.S.
             5             I think the other point I would make is in terms of
             6   incentives you can regulate.  Among the three layers here, I
             7   think you can regulate the stock exchanges and the
             8   broker-dealer to do best execution, getting the best price,
             9   but you can regulate that, but the incentive, though, is
            10   mostly on the buy side because every penny we overpay for
            11   what we have to pay normally for that order, it will end up
            12   costing us performance, and it will end up really coming back
            13   and biting us on performance.
            14             So I think our incentive is perfectly aligned, with
            15   or without regulations, we are going to do our best because
            16   otherwise we are going to lose our investors.  Any costs we
            17   have to pay, we end up paying more, that will come back and
            18   bite us.  And the second point -- and I think if you don't
            19   get the incentives to carry out best execution, I think it is
            20   more natural on the buy side than probably more so than on
            21   the sell side with the stock exchanges.  Not that they won't
            22   do it, I think that they will do it, but suppose you don't
            23   get the price best price on an agency basis on the sell side.
            24   At least you just pass the cost on to the buy side.  Again,
            25   not that that's the case, but I think that if you look at the
             1   design of the game, it is much more in line with the buy side
             2   interest.
             3             The second point is the difference between retail
             4   investors versus institutional traders, it is the size,
             5   again, we talked about this morning.  Getting the best
             6   execution for the buy side entity, it means getting the best
             7   price for the overall basket, for a million shares as opposed
             8   to getting that for a hundred shares at that moment.  So we
             9   are happy to -- Scott mentioned it earlier, Gunner, too --
            10   that we are happy to give up price improvement so that we can
            11   actually get a large size done.  To us, that's more important
            12   than getting best execution for that hundred or two hundred
            13   shares.
            14             Coming down to it, if you look at the makeup of the
            15   transaction cost we end up paying, for retail investors,
            16   typically the spread, which is why it tends to help retail
            17   investors more than to us.  Because a large part of our key
            18   cost comes from market impact, which cannot be really
            19   displayed through the NBBO, so I think that's the difference
            20   I would highlight.
            21             MR. HARRIS:  Paul, the Chicago Stock Exchange, if I
            22   am correct, represents a fair amount of the retail order
            23   flow.  Listening to Gunner and Minder it sounds like they
            24   would, at least for the institutions, place a fair amount of
            25   responsibility for best execution in the hands of the buy
             1   side.
             2             Is the retail able to handle that and should they?
             3             MR. HERRON:  Dave Herron sitting in for Paul in
             4   this session.
             5             MR. HARRIS:  Sorry.
             6             MR. HERRON:  That's okay.
             7             Certainly Chicago, like New York is a blend of
             8   institutional and retail flow.  We do represent and provide a
             9   lot of liquidity for a lot of internet brokers and a lot of
            10   smaller customers.
            11             I think from the point of view of best execution, a
            12   broker-dealer has to be responsible for best execution for
            13   the customer's order.  Best execution can be different things
            14   to different people.  It's a combination of facets including
            15   speed, effect and spread, price improvement, liquidity and
            16   cost of execution.
            17             And I think as each broker-dealer fills their
            18   business model and chooses which markets to go to, they are
            19   able to compete for that customer business and the customers
            20   will vote with their commission dollars as to what is the
            21   best model for them.
            22             The exchanges also are required, I think, to
            23   provide for best execution, making sure that the specialist
            24   community and the broker community are, indeed, looking out
            25   for the best interest of their customers.  I would agree with
             1   Chris, that the marketplaces have to be designed to put those
             2   customer orders together.  And if they don't, the system
             3   breaks down.
             4             MR. HARRIS:  Janet, your Archipelago has an
             5   extraordinary rich set of linkages.
             6             Can you describe to us the importance of those
             7   linkages in terms of how they assure best execution, the role
             8   that they play?
             9             MS. ANGSTADT:  Sure.
            10             I think one of the  most important aspects of our
            11   linkage is that it is choice.  There is a way to reach just
            12   our book with an IOC or a P&P order time, so if you do wish
            13   to reach outside of Archipelago, you can do so.  We will
            14   forego an execution on our system to get you a better price
            15   outside our system.
            16             I think one of the points from this morning was
            17   that we talked about how important the NBBO was, and access
            18   to that NBBO is often a difficult thing.  One thing we have
            19   tried to build into our system is direct access through
            20   direct phone lines, if possible, to avoid those things that
            21   create delays.
            22             MR. HARRIS:  Should all brokers have the same sort
            23   of linkages that you have to everybody?  Or is that necessary
            24   or perhaps maybe not surprising that you think it is
            25   sufficient that they come to you?
             1             MS. ANGSTADT:  Absolutely.  Very good point, Larry.
             2             MR. HARRIS:  I didn't think through my question.
             3             There are a couple of ways to do linkages.  Go
             4   ahead, Matt.
             5             MR. DeSALVO:  I think the simplistic way to go is
             6   not as simplistic as it seems when you have markets that have
             7   different access standards and, in addition, within those
             8   markets you have certain ATSs that have access fee changes,
             9   you can look at a $10 bid and because it may take 30 seconds
            10   to respond versus less than a second, or there is an embedded
            11   access cost to that $10 bid.
            12             So when we have unequal playing fields with regards
            13   to the access standards and access fees, you cannot determine
            14   price as being a standard for best execution.  And I think
            15   what a lot of us are trying to say is that if we are going to
            16   fall back and answer the question of best execution if we
            17   don't even address equal access standards and $10 means $10
            18   to everybody, than you cannot get to a determination of price
            19   as a standard for best execution.
            20             MR. HARRIS:  Should price be a standard for best
            21   execution?  For what sort of customer should it be?
            22             MR. DeSALVO:  Price at NBBO can be one standard for
            23   one type of order.  But, again, we don't have agreement.  You
            24   know, a million share order at best execution at an inside
            25   market looses its meaning, but if we can't even determine
             1   that $10 in one marketplace is equal to $10 in another
             2   marketplace, it is very difficult to even go beyond the
             3   meaning of best execution at that point.
             4             MR. HARRIS:  Let's suppose that we are talking only
             5   about small orders.
             6             How would you construct the market system so that
             7   price would be meaningful across exchanges or across centers?
             8             MR. DeSALVO:  I would say that at a minimum, a
             9   price in one market should be equal to a price in another
            10   market and for participants price should be the same.  When I
            11   access a $10 bid, it should be $10 to me, not $10 plus an
            12   access fee.  And that should be true for all participants
            13   whether it is direct access on the buy side or the sell side.
            14             In addition, there should be a minimum level of
            15   access standards between markets.  That if the minimum is
            16   less than two seconds or less than five seconds for some
            17   level, that is equal and measurable between markets, that
            18   there is equal access on price and equal access on turn
            19   around response times.  At that point, at least you have a
            20   skeleton in which to draw markets.
            21             MR. HARRIS:  Specifically, what plumbing would you
            22   install to do that?  Would you require high speed linkages to
            23   market centers?
            24             MR. DeSALVO:  I would allow the market participants
            25   that they can either do it directly themselves or if they
             1   want to go through an ATS or if they want to build a network
             2   themselves.
             3             We are indifferent as to which approach, but the
             4   standard when you get there, should be the same.  How you get
             5   there I don't worry about.
             6             MR. COLBY:  Morgan Stanley retail customer orders,
             7   are you bringing them out to other markets or are you
             8   typically trading against them as principal and matching the
             9   prices?
            10             MR. DeSALVO:  Both.
            11             MR. COLBY:  Pete?
            12             PROFESSOR KYLE:  I want to say that this issue has
            13   already been kind of dealt with in a way that I suppose has
            14   been partially successful.  After the 1987 stock market crash
            15   remember that NASDAQ was totally criticized because of the
            16   bids and offers that they were posting.
            17             It turned out it appeared to be completely
            18   meaningless, so the SOES system was introduced after that.
            19   And the SOES system is a type of system which is your bid and
            20   your offer has to mean something and there is also a
            21   mechanism in place where somebody can punch a button and the
            22   person who punches the button first actually gets an
            23   execution with a reasonably quick turn around time.  Those
            24   bids and offers actually makes them equal.
            25             And if you have a ticker that has different numbers
             1   displayed on it that aren't meaningful, you are just opening
             2   yourself up for the same types of criticism that NASDAQ got
             3   after the '87 crash.
             4             MR. HARRIS:  So you would have high speed linkages,
             5   then?
             6             PROFESSOR KYLE:  Yes, basically, a high speed
             7   linkage.  It doesn't have to be -- we are talking about a
             8   hundredth of a second, a tenth of a second or one second.
             9   Those are the kinds of time frames I am talking about.  But
            10   one minute on the stock market is far, far too slow.
            11             It basically is something where you punch a button,
            12   it is waiting for the next person to punch the button and
            13   then you have execution and very prompt confirmation that I
            14   punched the button first and you punched it about the same
            15   time.
            16             MR. DELLA ROSA:  When the question of best
            17   execution came up, the definition of best execution, there is
            18   always a tendency when talking about best execution to try to
            19   have a simplistic view of how to think about it.  We all
            20   strive toward that.
            21             It is obviously a very complex issue, but in the
            22   small orders, the orders that are low in size that are
            23   displayed in the marketplace within the NBBO, that there is a
            24   place where if you become the closest to the black line is
            25   what is best execution.  However you go to where the market
             1   looks today and you go to where the functionality of the NBBO
             2   is, there are two perspectives.
             3             Number one, a standard of connectivity; access, if
             4   you will.  Number two, is equivalency of price.  Is the price
             5   that is displayed the actual price that one would see.  If a
             6   person in small orders could actually have a definition by
             7   what is posted and how quickly you try to achieve that within
             8   the NBBO, then you need to have those two things in place.
             9             Equivalency in price where you can actually see
            10   what exists is number one.  And number two, is access equal
            11   at the price that is shown?  If it is not, then you sacrifice
            12   that.  So on the small orders, orders below the sizes that
            13   are actually displayed on the NBBO, we need to accomplish
            14   that.
            15             MR. HARRIS:  So, Joe, once again, what would the
            16   plumbing look like?  How do you guarantee access and how do
            17   you guarantee price?
            18             Would it be high speed linkages again?
            19             MR. DELLA ROSA:  It is certainly high speed
            20   linkages.  The question is who provides them or what is the
            21   process for their provision?
            22             And if, in fact, the NBBO is that black line
            23   standard for execution; if, in fact, it is that, because if
            24   it doesn't have those two ingredients, again, it doesn't
            25   deserve to be that.  But if that's what our goal is for a
             1   standard, I think that the NBBO is really important to have
             2   reference in the marketplace.  So that if, in fact, we hold
             3   to that standard on the small orders, and I think that those
             4   who post in that are required to post in that, there has to
             5   be a level of standard of access that is equal so the prices
             6   that are displayed in that are equal also.
             7             MR. HARRIS:  Chris, so there have been a couple of
             8   arguments for high speed linkages.  We don't have to accept
             9   those arguments, but let's assume that we were to go to that,
            10   what would we sacrifice at the New York Stock Exchange by
            11   imposing high speed auto-ex response on the New York Stock
            12   Exchange?
            13             MR. QUICK:  I think with respect to the NBBO, the
            14   exchange will Dual Quote, we are going to automatically NBBO
            15   going forward after the Commission decides on whether or not
            16   the Dual Quote will exist.
            17             So the inside quote will be automatic, will be
            18   accessible to everyone.  The outside quote will be a binding
            19   quote for the specialists who all have interests aggregated
            20   on the price point on the NBBO to that point where you are
            21   bidding on depth.
            22             In terms of linkage, linkage in the exchange, you
            23   can come through the front door of the New York Stock
            24   Exchange right now for about $2 million as a member.  But you
            25   can come through a lot of other ways to the New York
             1   Exchange, as a clearing agent, as a clearing customer of the
             2   numerous people who offer clearing.  And we do all know how
             3   easy access is.
             4             You talk about direct access to the floor of the
             5   exchange not being a member of the exchange, so linkage is
             6   not a problem getting into the New York Stock Exchange.
             7             MR. HARRIS:  Assuming that the current linkages,
             8   which for the listed side is primarily ITS, assuming that
             9   that's not changed, how vigorously should the Commission
            10   pursue enforcing trade through rules in the decimal
            11   environment?
            12             Any opinions about that?
            13             MR. DeSALVO:  I think you answered it already by
            14   allowing the trade through option.
            15             MR. COLBY:  The nine month ticker, right?
            16             MR. HARRIS:  In any event, everything at these
            17   hearings is on a blank piece of paper, so did the Commission
            18   make a mistake when they did that?
            19             MR. DeSALVO:  Yes.
            20             MR. HARRIS:  What was the mistake?
            21             MR. PETERFFY:  Twofold.
            22             MR. HARRIS:  Tom?
            23             MR. PETERFFY:  I understand that somebody made a
            24   study as to how much the free option would cost, but the fact
            25   of the matter is that listed stocks have much higher trade
             1   through than ATSs.  So if you made a similar study for listed
             2   stocks of the free option, you would find a higher number.
             3             MR. HARRIS:  So we should, if we are going to grant
             4   -- you would suggest that we grant -- if we maintain the
             5   existing ITS system, you would suggest that we grant a larger
             6   de minimis exemption for listed stocks as opposed to ETFs?
             7             I want to make sure I understand what you are
             8   saying.
             9             MR. PETERFFY:  I do not think there should be any
            10   exemption among ECNs or electronically accessible markets.
            11   In other words, you should not allow any trade through
            12   whatsoever in a market that provides immediate electronic
            13   executions and immediate access.
            14             The problem is that the manual markets change the
            15   electronic markets into a situation where they simply come to
            16   a grinding halt when they want to trade through and the
            17   traditional market has its quote in the way.
            18             MR. DELLA ROSA:  I don't know how you can address
            19   trade throughs until you get to price equivalency and equal
            20   access.  I don't know how you address trade throughs before
            21   that.
            22             MS. ANGSTADT:  How do you have equal access when
            23   you have floor-based models and electronic models, and I
            24   think that one of the issues that the ITS is struggling with
            25   right now is bridging the gap between the two.
             1             One of the proposals that they have is to allow the
             2   automated market to trade through the manual markets.  And
             3   with respect to the ECN electronic markets, the trade through
             4   rule will still stand, although probably with an exemption
             5   that it be sized for that particular stock.
             6             So I think part of it is it is not just the
             7   linkage.  What is access, and when you are an automated
             8   market and you are trying to access some manual market, what
             9   does that mean?
            10             MR. DELLA ROSA:  I am not disagreeing with that,
            11   actually.
            12             MS. ANGSTADT:  But I think that's a good next step
            13   in terms of linkage.  And then the  next step is access, what
            14   does access mean for each individual market?
            15             MR. COLBY:  In the earlier discussion, Gunner and
            16   Minder said that as a precondition for them putting up limit
            17   orders there would have to be some sort of protection, some
            18   sort of price and time protection.  And there is, obviously,
            19   price -- I mean, time protection, and now we are talking
            20   about whether there should be price protection.
            21             So what would be the consequences for the people
            22   that are displaying a limit order in one market if other
            23   markets can freely or semi-freely trade through that price,
            24   trade through an inferior price to the limit order that they
            25   are displaying?
             1             MR. QUICK:  Does that go back to a problem we had a
             2   few years ago with the NASDAQ market?
             3             MR. COLBY:  Well, which of the many?
             4             MR. QUICK:  Trade throughs.
             5             You are, again, putting the dealer in front of the
             6   customer.  And, you know, in another life I was part of Quick
             7   & Reilly Group, which is a large retail complex.  We never
             8   had a customer who would call us and say they didn't care
             9   about the best price.
            10             You are, again, putting the dealer in front of the
            11   customer with de minimis ETFs exception, and it is to the
            12   advantage of the dealer.
            13             MR. DELLA ROSA:  Trade through at what level?
            14             Trade through at the level of the New York Stock
            15   Exchange or the NBBO?  Is it's at the level of the NBBO, then
            16   that's where -- what level are we talking about?
            17             If it is the NBBO, then these other pieces have to
            18   be in place at the level of the NBBO?
            19             MR. LEE:  Can I interrupt?
            20             This problem seems to me, accepting the price is
            21   the key criteria for what determines best execution and then
            22   ensuring that price is the price, whether it is an access fee
            23   or whether it is accessibility to it.
            24             And I want to step back a little and question
            25   whether the price should be the sole criteria.  And if it is
             1   not, then I want to know how should brokers be held liable
             2   for their actions, to what benchmark?
             3             And one way for it, and this hasn't been addressed
             4   properly, but I think the Commission may want to think about
             5   this, is to have it much more contractual.  Maybe I, as a
             6   client, I go to my broker and I say, "I want speed," so then
             7   that broker will be held accountable to speed.  Whereas I,
             8   another client, go to my broker and say, "I want price."  So
             9   that is very different from the current situation where you
            10   have really a single benchmark.
            11             And I am wondering what people feel about that,
            12   because I certainly feel that there is no single criteria for
            13   best execution.
            14             MR. HARRIS:  For a small trader, is there any
            15   reason that the small market order trader couldn't have both?
            16             That's the issue we are debating here I think, can
            17   a small market order trader have both speed and price?
            18             MR. LEE:  It depends upon the market structure.  I
            19   can envision a situation where I might want to sacrifice
            20   speed for price.
            21             MR. HARRIS:  And, hence, these hearings.  The
            22   question is, what do we trade off in doing that?
            23             MR. HERRON:  I think in the current market
            24   environment the small customer does have both.  They do have
            25   speed, prices and executions with price improvement being
             1   offered at many venues.
             2             So a manual market doesn't necessarily mean a
             3   slower execution for any manual market at the table  or any
             4   industry, so the customer does get speed and they do get best
             5   price.
             6             MS. GLASSMAN:  From a practical perspective, if the
             7   customer had a choice and it was contractual, how would one
             8   monitor that, that they were complying with that?
             9             MR. LEE:  That's your problem.
            10             (Laughter.)
            11             MR. LEE:  But my point being that if you want a
            12   simple answer, as you currently have now, then you don't
            13   allow for multiple criteria.
            14             And by not answering that question, you are
            15   answering it.  You are not allowing multiple criteria.  You
            16   can't say best execution is only one at a time.
            17             MR. DeSALVO:  Ruben, you haven't been on the other
            18   end of the phone of someone who selected speed and didn't get
            19   price.  So when they choose speed, they still mean price.
            20             MR. PETERFFY:  I think that there must be some
            21   confusion here speaking about speed and price.  The only
            22   reason we go on speed is because they worry that the price
            23   will move away from them, so it is price they are into; only
            24   price, not speed.
            25             Best execution certainly means the best aggregate
             1   price for the order.  There are small orders, and it is easy
             2   to see that it matters for small orders, yes.  Large orders
             3   are basically hedged by the dealer.  The dealer makes the
             4   large deal and then assembles the other side of that trade
             5   from many small orders.  And he can only do that efficiently
             6   if he has electronically accessible venues to do it.
             7             MR. HARRIS:  Tom, I wanted to follow-up with a
             8   comment you made earlier when you said that you believe it
             9   would be sensible to enforce a trade through rule on all
            10   systems that have high speed access.
            11             Would you extend that to require that all market
            12   centers have high speed access?
            13             MR. PETERFFY:  I think market centers should be
            14   free to have any access they wish to provide.
            15             MR. HARRIS:  Does anybody else want to comment now
            16   on the question of speed with best execution as it relates to
            17   the market orders?
            18             We can return to this later.
            19             MR. HERRON:  Just to point out that any attempt to
            20   weaken the trade through prohibitions would seriously weaken
            21   the national market system.  I think the ability of the
            22   customer or dealer to display an order in one marketplace and
            23   know that another marketplace is obligated to come to that
            24   order or match that order is key to a strong national market
            25   system.
             1             MR. HARRIS:  What are the strengths of the current
             2   market system that you are afraid that would weaken?
             3             MR. HERRON:  The ability of various participants in
             4   the national market system now to continue to compete in that
             5   environment.
             6             The national market system is a combination, I
             7   think the listed side is a combination of the best of the
             8   auction and dealer markets in that price discovery is
             9   permitted; yet, there is also the competition provided by
            10   multiple dealers.
            11             MR. HARRIS:  How does the trade through rule
            12   support your position?
            13             MR. HERRON:  If a trader in our marketplace is not
            14   confident that by displaying his bid or offer, or if the
            15   customer is not confident that by coming to our marketplace
            16   that our bid or offer didn't have some price priority, you
            17   might see all that, it would weaken the ability of the
            18   competing market.  It would weaken our ability to attract
            19   order flow if they thought that displaying in our marketplace
            20   would not allow them to get an execution.
            21             MR. HARRIS:  In order to preserve the trade through
            22   rule, what linkages do you need?
            23             MR. HERRON:  I think we are in a position where we
            24   have to take a look at the rules of the ITS trading system.
            25   I think the trading system itself is very dynamic, it works
             1   very well.  I think the rules perhaps allow for too much time
             2   to go by before execution have to be addressed.
             3             I am not sure we can get immediately to where we
             4   need to go, but perhaps the idea of auto execution, for
             5   markets to provide auto execution is as far as it goes.
             6             MR. DeSALVO:  Larry, I think in general we ask a
             7   lot of questions with regards to linkages, and I think what
             8   we are trying to attempt to say is don't worry about
             9   linkages, but worry about standards and let us worry about
            10   the linkages.  Standards are more important than linkages.
            11             MR. HARRIS:  So what standards should we be looking
            12   for?
            13             MR. DeSALVO:  We addressed it before when I think I
            14   said and Joe said, and we have beaten it around a lot, price
            15   is price and turn around times have at least a minimum
            16   threshold with which to participate to warrant your price
            17   being presented in the NBBO.
            18             If I am a market center and it takes two minutes to
            19   get to me and back, my market center bid or offer should  not
            20   be represented as the NBBO.  If you want your bid or offer to
            21   be represented in the NBBO, you should be subject to a
            22   minimum standard, access standard, and not worry about
            23   linkages required to get there.
            24             MR. HARRIS:  Chris, when Matt speaks about an
            25   access standard here, and we are certainly not talking about
             1   membership at the New York Stock Exchange, he is saying I
             2   have an order, I see your quote, I want it and I want it now.
             3             How quickly should he be -- I mean, if he goes to
             4   you, is he going to get it?
             5             MR. QUICK:  We have a lot of venues for access and
             6   quote.  You have institutional express, which you can debate
             7   whether it is a success or not, but, unfortunately, the
             8   participants don't know when their quote becomes accessible
             9   because the vendors have not pointed that out on their
            10   screens.  So, yes, the quote is accessible right now only if
            11   they go back and find it accessible.
            12             MR. DeSANO:  That's after what time frame?
            13             MR. QUICK:  That's after 15 seconds, Scott?
            14             MR. DeSANO:  That's right.
            15             MR. HARRIS:  Let me follow up.
            16             How do traders find if a market is displayed
            17   because it is not there quite often?
            18             MR. DeSANO:  I understand the concept of the
            19   institutional express, but there has been 15 trades in it, I
            20   think, this year.  And that's the reality of it, and I know
            21   that there have been problems with respect to that, but I
            22   don't even know why we talk about it.
            23             But very often we do try to go after quotes.  You
            24   can see them but you can't touch them, it is very
            25   frustrating.
             1             MR. HARRIS:  Gunner, you have something to add?
             2             MR. BURKHART:  Absolutely.
             3             And I find the discussion interesting from a lot of
             4   angles but I think the primary angle is that we are talking
             5   about linkages.  We are talking about the justification, if
             6   you like, of the NBBO.  We are talking about access; yet, we
             7   are doing so in the context of trying to justify the existing
             8   very fragmented market structure.
             9             I think we have fairly unanimous opinions of buy
            10   side participants, large and small, that what we need is a
            11   single marketplace where you know what the best bid and best
            12   offer is that you can access immediately.  Trying to link 43
            13   different platforms around the United States and trying to
            14   figure out who should pay for that and how do I access that
            15   best bid and offer, is that actually going to be there when I
            16   finally find that ultimate player is not the real issue.
            17             It is the issue if we are accepting that the
            18   current market structure is the correct one.  In other parts
            19   of the world, the different market structures apply and they
            20   are far more efficient and you get a single point of
            21   liquidity for all the players, single and institutional
            22   investors as well as retail players, but that's a far more
            23   profound discussion than I think you are willing to have
            24   today.
            25             MR. HARRIS:  I think we are willing to discuss
             1   anything today, and I would like to pursue that possibility.
             2   Clearly, the history of that proposal is not good.  We won't
             3   spend a lot of time on it, but I would like to ask one
             4   further question.
             5             Is it your expectation that Archipelago would
             6   survive in that sort of environment or how would you get from
             7   here to there?  I know what you just described would either
             8   put Archipelago or the New York Stock Exchange out of
             9   business or both of them, and the question is would that be
            10   desirable, and, if so, how would it be done?
            11             MR. BURKHART:  First of all, I am not looking to
            12   put anybody out of business.  I am looking to help construct
            13   or aid in the construction of the most efficient marketplace
            14   for the preeminent economy in the world.
            15             And I think what we have right now is far from
            16   that.  There are a lot of, I would say, highly incumbent,
            17   very politically strong structures currently in place which
            18   are not necessarily for the benefit of the end user, either
            19   the retail investor or the institutional investor.  And I
            20   think we need to seriously consider whose interests are we
            21   really looking after in this respect.
            22             When we talk about all these different angles in
            23   the discussion, let's get back to the primary principles and
            24   the five ideals we laid out initially.  And I would say this
            25   again, getting back to my earlier point, the current market
             1   structure in the United States is in conflict with trying to
             2   obtain these five ideals or principles.  It is not about
             3   putting somebody in or out of business; it is developing a
             4   common goal.
             5             It might mean changes to the Archipelago model, to
             6   the New York Stock Exchange model, to the NASDAQ model.
             7             MS. ANGSTADT:  I think our model is just a response
             8   to what makes life easier for people who are trying to seek
             9   that best execution.  Whether or not it is Archipelago
            10   providing a routing platform or we could simply be a limit
            11   order book and just be one destination, so I think you can
            12   either be a member or a subscriber to all of the pools of
            13   liquidity or you can go to one marketplace or a couple of
            14   marketplaces that are reaching out for that liquidity,
            15   because I think the alternative is you are building that
            16   order routing system to actually get to those places that
            17   have better prices.
            18             MR. CHENG:  I think -- just one more point here --
            19   Gunner and Scott and myself, we all have one thing in common.
            20   We all look after trading globally.  And one observation that
            21   has been shared, although not explicitly and not officially,
            22   but by a lot of us in the market on the buy side, from just
            23   looking at how each market has really been structured, one
            24   observation we can make about the United States is that it
            25   has very good liquidity, but the market structure does not
             1   let that liquidity somehow find its way to interact with one
             2   another.
             3             And the thing about -- and I think Ruben's and
             4   Gunner's comments were based in London -- with European
             5   markets, or the London market and the European, they have
             6   perhaps better market structure, although liquidity may not
             7   be as good as in the U.S. market.  So there you have it.
             8             I think you need the liquidity to drive the market
             9   structure, but also you need market structure to give you the
            10   way to have liquidity with one another.  Whether the NYSE or
            11   Archipelago or other ECNs will survive, we don't know.  But I
            12   think what was clear from this morning and the previous
            13   points, I think that if there is a way to somehow have a
            14   centralized book that retail investors and the institutional
            15   investors can access, I think that that appears to be a
            16   better structure.
            17             Whether it is going to be through one ECN or one
            18   stock exchange, I think that that's probably secondary.
            19             MR. HERRON:  Isn't it possible that liquidity is
            20   driven by the market structure we have and that by changing
            21   that market structure, we take that liquidity out?
            22             MR. DOMOWITZ:  No, I think a variety of studies
            23   have shown that across various market structures, the
            24   liquidity doesn't really change, all things equal.
            25             When you get right down to it, investors provide
             1   liquidity; markets do not provide liquidity.  That's a core
             2   concept.  Now, getting back and linking that to what Gunner
             3   and Minder and I think others are talking about, on the one
             4   hand it is corporate dictum, you can't manage or you can't
             5   control, and everybody here is talking about gaining control
             6   one way or another.  The issue is control for whom, all
             7   right, and on what basis.
             8             With that in mind, I want to echo I think what Matt
             9   said, first of all, as a policy prescription, talking about
            10   the precise linkages, even talking about the notion of
            11   complete consolidation as though that's where you should
            12   actually set policy, I think that that's incorrect.
            13               I think that the issue is standards.  I buy 100
            14   percent into Joseph's comments about what are two equivalent
            15   prices.  We are talking about access in terms of time and we
            16   may be talking about access in terms of money.  We may find
            17   that competition, okay, amongst the market centers basically
            18   gets rid of this issue about a price is a price depending on
            19   the access.  That may or may not be true, but timing can be
            20   helped by setting standards.
            21             Now, I know that in the end we all operate
            22   according to a set of standards.  Starting with the SEC, I
            23   know when, viewing Gunner as a client, viewing Minder as a
            24   client, when they outsource to ITG as a broker, they are
            25   setting a particular standard, and basically, they will come
             1   back and ask us to analyze ourselves if they don't do it for
             2   us.  In fact, we are asked to provide the tools to analyze
             3   ourselves with respect to performance.  And since they have
             4   access to the tools, we can't exactly give them the rigged
             5   deck.
             6             So it is the standards that are important here.  I
             7   am not trying to avoid the devil in the details, and I think
             8   that is the wrong way to respond to this, but getting too far
             9   down so you are actually talking about individual elements of
            10   market structure is not the way.  The market has actually
            11   been very good in certain respects.  When we talk about trade
            12   through rules, you know, the speed within the electronic
            13   marketplace actually has been fast enough, leaving the manual
            14   markets aside for a second, they have done pretty well.
            15             People are actually, you know, it is not even
            16   distinctive anymore to claim you have a so-called smart order
            17   router that figures out where the price is, where the
            18   liquidity is and how to get there.  That's just taken as
            19   given.  I mean, if you are a decent broker, that's what
            20   you've got.  So the market solves these problems.  At that
            21   level, the market solves the problems.
            22             Will the market actually produce complete
            23   consolidation?  If it doesn't, it will probably get close
            24   enough to satisfy you if, indeed, the standards are set and
            25   we operate accordingly.  Because given those, Gunner will set
             1   his, I will set mine and the retail investor will have a say
             2   as well.
             3             MR. HARRIS:  The complete consolidation model has
             4   been proposed by a couple here and whether it has a political
             5   future or not is perhaps a different issue, but I do want to
             6   give Chris an opportunity to tell us what is happening in
             7   front of him on the floor of New York Stock Exchange that is
             8   valuable.
             9             And the reason I raise the issue is because that
            10   complete consolidation model isn't inconsistent with your
            11   market structure.  If your market structure is to be
            12   preserved, it's probably because it has some value and I
            13   would like you to tell us what it is.
            14             MR. QUICK:  I agree with Ian that customers want
            15   liquidity, and especially when you put customers trading with
            16   customers.  That creates liquidity.
            17             On the New York Stock Exchange we put customers to
            18   customers 85 percent of the time, no dealer intervention.
            19   That's what creates frictionless trading on the New York
            20   Stock Exchange, no displacements, volatility profiles are
            21   lower than other markets, This is what we have been selling
            22   all these years, continues -- it continues with innovation,
            23   it continues with technology wrapped around it, but the New
            24   York Stock Exchange is no different than any trading room on
            25   Wall Street.
             1             The four biggest trading rooms on Wall Street are
             2   the New York Stock Exchange, Goldman, Merrill Lynch and
             3   Solomon Smith Barney.  Everybody is behind that technology.
             4   But the New York Stock Exchange, by not only being
             5   responsible for both sides of the transaction, the sell side
             6   and the buy side; not just adhering to one side of the
             7   transaction while discrediting the other side of the
             8   transaction.
             9             So this customer to customer, the constant flow is
            10   begetting liquidity, and that's why we do 84 percent of the
            11   volume listed trades.
            12             MR. HARRIS:  I would like to now change the
            13   direction of our discussion just slightly, still --
            14   everything we are doing, of course, is very highly integral.
            15             When we talk about best execution, implicitly we
            16   seem to always assume that we are talking about the execution
            17   of market orders and people want to trade and the speed and
            18   so forth, and we frequently give, at best, lip service to the
            19   execution of limit orders.  I would like us to give far more
            20   attention now to the question of execution of limit orders.
            21             First of all, I would ask, is it important that
            22   public investors have an opportunity to offer liquidity
            23   through limit orders?
            24             And then secondly, if they do, what are the
            25   implications of that value for the construction of our
             1   markets?  So is it important that public traders, whether
             2   they be institutional or retail, have an opportunity to offer
             3   liquidity to limit orders?
             4             I know Gunner's answer, so...
             5             MR. BURKHART:  I will expand upon it, okay.
             6             I think it is very important, I think it is
             7   important to everybody involved in the markets that
             8   institutional players, as well as retail players, feel
             9   comfortable and, therefore, place limit orders on the market.
            10   I mean, you want to have that liquidity present there,
            11   whether it is fully transparent, what type of priority or not
            12   that those limit orders --  you get into rebates and things
            13   like that, that's a different discussion -- are given is a
            14   different issue.
            15             But, yes, we certainly want to be able to do that
            16   because it benefits all of us.
            17             MR. HARRIS:  So the opportunity to offer liquidity
            18   is a value that probably everybody agrees with.
            19             The question is:  Will people offer liquidity if
            20   there isn't a meaningful opportunity to get hit?  I assume
            21   that everybody at the table recognizes that offering
            22   liquidity without an opportunity to trade is a foolish thing.
            23   So then the difficult question is:  If we want people to
            24   offer liquidity, or allow them to, and if they are to offer
            25   it in a meaningful way, what mechanism should there be, if
             1   any, to ensure that their orders somehow get filled?
             2             Anybody willing to take that?
             3             MR. CHENG:  I am afraid to say, as I mentioned
             4   briefly in the morning, with the current structure I think
             5   that it would make it pretty difficult for the buy side, at
             6   least, for the buy side to place large size limit orders,
             7   although we very much like to.
             8             And, again, the point really comes down to the lack
             9   of protection or the opportunity of being picked off by
            10   placing a large size limit order, even though by doing so we
            11   are supposed to provide liquidity and reduce our transaction
            12   costs for both us and the other side, but I think the lack of
            13   protection is really hindering us from doing that.  Hence,
            14   again, not just using up fair trading a lot more, but also I
            15   think I mentioned reserve book.
            16             We use quite a few ECNs.  I think Gunner and Scott
            17   may be doing something similar.  The way we place our limit
            18   orders is through the reserve book.  It is out there but it
            19   is not going to be seen by everyone.  It will only be seen by
            20   servers who apply, so, in other words, we are providing
            21   hidden liquidity that only will be tapped into by the others
            22   like us.
            23             MR. HARRIS:  And the reward to providing that
            24   liquidity is that somebody will somehow discover you, right?
            25             MR. CHENG:  Yes, discover but without the negative
             1   consequences.
             2             MR. HARRIS:  Exactly.
             3             MR. BURKHART:  We are not asking for special
             4   dispensation or rewards or incentives.  We want to put
             5   liquidity on the order book, whatever form the order book
             6   might take.  But we also have to have fairly iron-clad
             7   guarantees that we are not being used for free option, which
             8   is exactly what is happening today.
             9             MR. DeSALVO:  I think there is an additional point
            10   with regard to this, when a broker-dealer presents a limit
            11   order, whether it is from an institutional or retail client,
            12   and our market is accessed, there is no access fee to access
            13   that market.
            14             When a limit order from the same client is
            15   presented to an ATS, there is access fee.  I think that
            16   disparity between the two representatives is wrong.  We
            17   should either both be allowed to charge or neither should be
            18   allowed to charge.  But to have the same client give the same
            19   limit order to participant A and Participant B, and one gets
            20   the charge and one doesn't get the charge, that bifurcation
            21   in the marketplace is unfair.
            22             MR. DELLA ROSA:  I think one level of incentive is
            23   price-time priority.  In other words, if you are there you
            24   get priority just by exposing that order.
            25             At the same time, I don't think it is the behavior
             1   of traders in the marketplace or investors trying to execute.
             2   If you display an order and behavior will still stay in place
             3   even if the time price priority was in place, that one would
             4   not display an order under the circumstances because market
             5   information would be out there.
             6             MR. HARRIS:  So price priority ensures that
             7   displayed limit orders will get executed no later than when
             8   they've gone completely stale.  Time precedence actually
             9   gives them some incentive, to enforce time precedence across
            10   exchange systems, you will have a routing range and we are
            11   back to linkages again.  I know where Gunner stands.
            12             How does the Commission resolve these issues?  Is
            13   it sufficient -- we are going to get to access fees, but
            14   let's go on the back road to access fees.
            15             Presently a number of ECNs pay brokers in the
            16   following ways; rebates on limits orders to execute.  ECNs, I
            17   know that Archipelago does it, NASDAQ is doing it now,
            18   basically everybody is doing it.  These payments are, in a
            19   sense, very much like the payments for market orders.  The
            20   question is: Who should hold, say, a retail broker
            21   accountable for their limit order routing decisions in an
            22   environment where the retail broker is being paid for the
            23   limit order?
            24             Pete, how about you?
            25             PROFESSOR KYLE:  I didn't want to answer that
             1   question directly other than to say that what is displayed in
             2   a national NBBO should be net of the fees so that you know
             3   what it is.
             4             MR. HARRIS:  We will talk about access fees for
             5   sure.  That's kind of a different issue.
             6             I want to talk about the agency problems that are
             7   associated with payments for order flow.  Now we are talking
             8   about payments for limit orders.
             9             MR. DELLA ROSA:  Doesn't this go hand in hand, if
            10   you got the ability to charge, then you get a rebate.  But if
            11   you take that out of the quote, then it no longer exists in
            12   the marketplace.
            13             MR. DOMOWITZ:  That is part of an overall agency
            14   business model.
            15             MR. HARRIS:  I understand you can't pick it apart.
            16   One of my difficulties --
            17             MR. DeSALVO:  I think the agency business model can
            18   be changed.  The toll is collected now at the time of the
            19   access to the market.  It should be reversed so that the toll
            20   is collected up front for the person placing liquidity on it,
            21   then you could have equal access standards.
            22             MR. HARRIS:  We will talk about access fees and we
            23   will do it in the next five minutes.  But I want an answer to
            24   this question:  Who is responsible for best execution, or in
            25   this case, best representation of limit orders?
             1             Is it sufficient for a broker, a retail broker to
             2   route their limit order, or its limit orders, to the ECN that
             3   offers the highest rebate?
             4             MR. QUICK:  No, it is in direct competition with
             5   what the customer wants.  You are again putting the dealer
             6   ahead of the customer.
             7             Can we talk about the customer here?  The
             8   broker-dealer is responsible for achieving the best price for
             9   his customer, ex-internalization, ex-payment for order flow,
            10   ex-rebates from a broad data base.
            11             MR. HARRIS:  So how would this then be enforced on
            12   a practical basis in the present system?  Is IIAc1-5 and 6
            13   sufficient to deal with the best representation issue
            14   associated with limit orders?
            15             MR. HERRON:  They don't actually deal with
            16   representation of limit orders.  The broker-dealer is
            17   responsible not only for trying to lower their cost by
            18   getting perhaps the rebate from an order, but also routing
            19   the order to a venue that can expect execution.
            20             And if that venue is an ECN, depends upon another
            21   ECN customer coming in, without any price protection against
            22   other exchanges, that may not happen.  But, again, the
            23   customers can vote with their business.
            24             MR. HARRIS:  Dave, how do you get limit orders?
            25             MR. HERRON:  We get limit orders directly and from
             1   various brokerage firms.
             2             MR. HARRIS:  Are those linkages, the order flows
             3   associated, are there payments or liquidity rebates or
             4   anything like that?
             5             MR. DAVIS:  There occasionally are.  The payment
             6   for it goes up to the specialist community, and we give our
             7   specialist community a rebate based on share of market date
             8   revenue.
             9             MR. HARRIS:  Which is an issue we have already been
            10   through.  I want to focus on access fees and liquidity
            11   rebates.
            12             MR. COLBY:  Just to follow up, Dave, you get limit
            13   orders from your customers, about 84 percent or some odd
            14   percent of the volume in those stocks that are going off on
            15   the New York Stock Exchange.  So what do you do to help
            16   assure your broker customers or their customers, if anything,
            17   that sending a limit order when the buy is mostly taking
            18   place elsewhere is a safe thing to do?
            19             MR. HERRON:  In order to compete for that business,
            20   our specialist community guarantees to the customer that they
            21   will receive an execution in our venue.  So we don't rely on
            22   simply displaying the order and getting filled.
            23             It does require that oftentimes our community must
            24   interact and go out aggressively to other communities to make
            25   sure they that don't get caught behind the eight ball when
             1   they fill those orders, but our community, it is much as the
             2   New York Stock Exchange, when we interact with our customer
             3   orders it is a matter of risk and reward, and oftentimes we
             4   are interacting with our customers with prices and at times
             5   we don't particularly want to, but we need to do that to keep
             6   our customer base happy.
             7             MR. HARRIS:  I intend to keep my promises --
             8             MR. BURKHART:  Before we get into that, can I just
             9   ask a question.
            10             Why do we allow payment for order flow?
            11             MR. DOMOWITZ:  Before we answer that, can I just
            12   sort out whether we are talking about the payment for order
            13   flow in the sense that once upon a time we used to talk about
            14   it, which is really payment for market orders, or whether we
            15   are talking about limit order, you know, driving the about
            16   quote rebate.
            17             Which one are we talking about?
            18             MR. BURKHART:  When we answer that question, the
            19   follow-up question, who actually gets the money?
            20             MR. DOMOWITZ:  Can I answer that question?
            21             MR. BURKHART:  Hypothetically, if I have an account
            22   with Charles Schwab, let's say, and the Chicago Stock
            23   Exchange is paying me to give them limit orders, is that
            24   rebate somehow coming back to me in the form of a rebated
            25   commission?
             1             MR. HARRIS:  As I understand it, presently it is
             2   going to Schwab and Schwab, presumably, is giving you better
             3   service for lower commissions as a consequence.
             4             MR. BURKHART:  Isn't that a very curious motivator?
             5             MR. PETERFFY:  Indirectly, it does go back to you
             6   because brokers all have to compete, yes, all have to compete
             7   on price --
             8             MR. BURKHART:  Competing on price is one thing,
             9   competing on how much rebate is different.
            10             MR. PETERFFY:  To the extent we receive a rebate,
            11   we can provide a lower commission.
            12             MR. COLBY:  If there was equal visibility for every
            13   element, that would probably work out fine.  The concern, of
            14   course, is that it is much more difficult for a normal
            15   customer to observe whether they get a good execution than it
            16   is to figure out the commission.
            17             MR. HERRON:  I think the customers are much more
            18   sophisticated than you think.
            19             MR. COLBY:  Well, I hope they are.
            20             MR. HERRON:  Based on my experience at Charles
            21   Schwab and in the regional exchange community, they are very
            22   sophisticated.  They know exactly what they are getting.
            23             MR. COLBY:  Here, here.
            24             MS. ANGSTADT:  One of the things I wanted to
            25   mention about the ECN rebates is that the distinction is
             1   pretty clear between the payment for order flow and the
             2   rebate in that when people are paying for orders it is
             3   because they believe they can make a lot of money on that
             4   order flow, I presume.  And with our rebates, one of the
             5   reasons we are happy to give someone their money back on the
             6   transaction fee is because we have actually saved by being
             7   able to cross those orders internally.
             8             So our costs for writing out are much higher and we
             9   have to charge for that.  But, obviously, when we can match
            10   internally, it is a cost savings to us and we want to pass
            11   that along to people as opposed to just make more money on
            12   those orders.
            13             MR. BURKHART:  The net result is the same, though?
            14             MS. ANGSTADT:  It is, and I think the difference
            15   is, though, if I sent my order as fiduciary -- if I sent my
            16   order to an execution point that doesn't charge very much,
            17   like an ECN, as opposed to calling somebody who may work the
            18   order for me at whatever the desk prices are, who is getting
            19   the cost savings for going to the electronic venue and the
            20   prices are lower.  So it is a difference in the cost.
            21             MR. HARRIS:  Gunner asks some great questions and
            22   even in asking questions is making points -- his points.
            23             MR. BURKHART:  I go back to London tomorrow, don't
            24   worry.
            25             MR. DeSALVO:  I would take exception to the ECNs
             1   not charging much.  Our bills, we pay tens of millions of
             2   dollars in ECN fees annually.  They may not be large on a per
             3   transaction basis, but like everything else, they add up.
             4             MR. QUICK:  I have to question whether the better
             5   price is on electronic venue.
             6             You know, that's a statements that is fairly -- the
             7   better price on electronic venue, I disagree with, and the
             8   stock exchange takes exception to that.
             9             MR. HARRIS:  Let's talk a little about access --
            10             MR. GOLDSCHMID:  Larry, let me follow that up a
            11   second.
            12             What are the data out there now in terms of the
            13   price packages of fast exchanges at the New York Stock
            14   Exchange?
            15             MR. QUICK:  What, I'm sorry?
            16             MR. GOLDSCHMID:  In terms of execution.
            17             MR. QUICK:  In terms of execution, we have a
            18   product right now if the customer wants speed, it is called
            19   NX.  They can access either side of the NBBO with an
            20   automatic execution that doesn't get exposed to the auction
            21   process.
            22             But in terms of the auction process, 57 percent of
            23   the orders that do come through the New York Stock Exchange
            24   do get price improvement, 37 percent of which get the price
            25   improvement more than half of the spread of the quote.
             1             MR. PETERFFY:  The problem with NX is that it
             2   basically limits you to a thousand shares.
             3             MR. QUICK:  Because it is a product designed for
             4   the retail customer, not professionals, Tom.
             5             MR. PETERFFY:  When do professionals get best
             6   execution?
             7             MR. QUICK:  You need to come to the auction through
             8   the front door.
             9             MR. PETERFFY:  Easy to say.
            10             MR. BURKHART:  For $2 million, Tom, you, too, can
            11   play.
            12             (Laughter.)
            13             MR. HARRIS:  Access fees, okay, so that everybody
            14   knows what we are talking about,  Some market systems like
            15   NASDAQ, ECNs, charge a fee for market orders that are
            16   executed.  Many of these systems are also rebate fees in the
            17   form of a liquidity rebate.
            18             So the question is:  Is this sensible?  What I will
            19   do is paint a very quick picture and then ask our panelists
            20   to respond to this picture.  Is there anything wrong with the
            21   following story: I am an ECN, unnamed, limit orders provide
            22   liquidity.  My job is to aggregate the liquidity.  I will pay
            23   people for aggregating -- for coming and offering their limit
            24   orders.  That's the liquidity rebate.  And in doing so, I
            25   will create a liquid market that benefits everybody.
             1             But, of course, I can't pay people if I can't
             2   recover my expenses; therefore, I have to charge an access
             3   fee.  I have aggregated the liquidity, I have paid for it,
             4   anybody who wants to use it has to pay an access fee.
             5             We will talk later about comparing prices.  I just
             6   want to know is there anybody uncomfortable with this
             7   argument?
             8             MR. DOMOWITZ:  Yes, the first one is you left
             9   something out, which is it doesn't have to be an access fee.
            10   We certainly pay ECN fees for hitting a bid.  In other words,
            11   if we come in and we take the liquidity, we pay a fee.
            12             MR. HARRIS:  Right.
            13             MR. DOMOWITZ:  So we don't need to differentiate
            14   the types of fees.
            15             Did you mean the access fee just to include any
            16   liquidity?
            17             MR. HARRIS:  Yes, any liquidity for taking access.
            18             PROFESSOR KYLE:  I just want to say if a ticker is
            19   meaningful, you can't have too much flexibility in the fees
            20   and commissions that are kind of built into the ticker.
            21             If the best bid and best offer are 4 bid at 5, and
            22   I want to put a price through at 7,  I can just have a
            23   negative commission paid by one party and a higher commission
            24   paid by the other party and basically cheat the system by
            25   having a lot of flexibility in the fees that I charge.  So it
             1   seems to me, for the ticker to have some integrity, there has
             2   to be some kind of assumptions made about the nature of the
             3   fees and the commissions positive and negative that went into
             4   the tick and out of the system.
             5             And the same is true with the bids and ask.  If I
             6   am posting a bid or an offer, they should be posted in some
             7   standardized way to kind of pence out fees that are not
             8   common to everybody posting a bid or an offer in the system.
             9   That being said, you usually eliminate the incentive for
            10   people to cheat on the ticker by using fees to distort
            11   prices.
            12             On the other hand, you want to look at what
            13   actually goes on on the exchange floor with the current
            14   trading rules.  That is kind of another thing, if they want
            15   to, let's say, make market orders pay transactions fees and
            16   let the limit orders not pay the fees, that may be a good way
            17   to create liquidity.  Liquidity reflected on the ticker
            18   should be uniform and standardized.
            19             MR. HARRIS:  So you would have the SEC set a
            20   standard that the industry can't rule itself?
            21             PROFESSOR KYLE:  Well, the ticker should mean
            22   something, so if I look and see the ticker went out at
            23   $75.43, I don't want it to wind up being the case that maybe
            24   someone is paying a minus $1 commission and somebody else is
            25   paying plus $1.10.
             1             MR. HARRIS:  Which would require somebody saying,
             2   "This is the way we price things.  You determine what the
             3   prices are, but this is the way we do it"?
             4             MR. DeSALVO:  Well, you start off by painting a
             5   picture of an unnamed ECN being able to withdraw liquidity,
             6   post an order and recoup some of the cost by adding an access
             7   fee.  That sounds remarkably familiar to what we do every
             8   day.  And we also have to track order flow, we also post
             9   limit orders, but we don't have that luxury.  And we also
            10   post principal bids and offerings similar to what other
            11   people do around here, and we don't have that.
            12             So why is there an unlevel playing field for doing
            13   the exact same business model?
            14             MR. DELLA ROSA:  That also takes us back to the
            15   equivalent pricing question.  Whereas, in the marketplace you
            16   have 1 to 10 bid, 1 to 10, and one offers a liquidity bid.
            17   Actually, that is a 10 net bid.
            18             Why isn't that a better bid in the marketplace?
            19   Why isn't that displayed as a better bid in the marketplace?
            20             MS. ANGSTADT:  I don't understand why you are
            21   making a distinction between transaction fees and access
            22   fees.  If, as a service, I am providing liquidity and I am
            23   able to charge a transaction fee, why should I have to give
            24   that cost away if somebody wants to reach in who is not a
            25   subscriber?
             1             It is the argument that New York has about
             2   nonmember access, which, as I said before, I don't really
             3   understand why you have to give it away.
             4             MR. DeSALVO:  I agree with you.  Why do we give it
             5   away, though?
             6             If you access, if you go outbound for your client
             7   because you are linked in NASDAQ to us or any of the other
             8   broker-dealers here, and you access our limit order, do you
             9   pay an access fee on our bid or offer?
            10             The answer is no.  But when I access your limit
            11   order, the same limit order potentially from the same client,
            12   potentially in the same stock, I pay you an access fee.  So
            13   what you are saying is that because you are an agency model
            14   you can charge a fee, but somebody that represents both
            15   principal and agent cannot.  And I find that hard to
            16   understand, how you can charge and I cannot.
            17             MS. ANGSTADT:  I am not suggesting that you
            18   shouldn't be able to charge an access fee.
            19             MR. DeSALVO:  Thank you.
            20             MS. ANGSTADT:  I am just saying that access should
            21   not have to be given away for free.  What has happened in the
            22   NASDAQ market is a blending of the agency and dealer markets
            23   and the way we make money is different.  And I think that
            24   cannot be reconciled just by saying one group cannot charge
            25   an access fee.
             1             MR. DELLA ROSA:  I think that from the point of an
             2   equal playing field, and I think that you just stated that
             3   you thought it should be equal, but I think from the
             4   standpoint of equal prices in the marketplace, that's the
             5   second question, as to what is actually displayed in the
             6   marketplace and are they equivalent?
             7             And in that case, they would not be equivalent, so
             8   it is either you take that fee outside of the displayed price
             9   in the marketplace --
            10             MS. ANGSTADT:  I think the Super Montage has come
            11   up with a great a way of handling this, and that is you have
            12   two different algorithms.
            13             MR. HARRIS:  We will talk about that also --
            14             MR. PETERFFY:  Ultimately, liquidity takers must
            15   pay liquidity providers for the liquidity.  Now, it is either
            16   done by paying a spread or it can be done by creating good
            17   competition by rebates for limit orders.  The question is,
            18   which is cheaper for the end customer?
            19             And if you look at what is happening at the ECNs
            20   and market order, lately you see that spreads are extremely
            21   tight, so it is probably a good deal for the customer.
            22             MR. HARRIS:  How would that be the case?  The
            23   market order trader -- is it a good deal on net or just a
            24   good deal on gross?
            25             MR. PETERFFY:  It is a good deal net.
             1             MR. HARRIS:  I don't see why that's the case.
             2   Perhaps I am missing something.  The market order trader
             3   faces a very tight spread, which is a good deal, but has to
             4   pay the access fee.
             5             MR. PETERFFY:  Right, but just to turn the issue
             6   around, it is the broker that pays the access fee.
             7             MR. HARRIS:  Not if the broker pays  the access
             8   fee.
             9             MR. PETERFFY:  So when we execute for a penny on a
            10   market order, then we have to pay 3/10th of a penny to the
            11   ECN.  On the other hand, we route a limit order, we get
            12   2/10th of a penny back.
            13             Now, where do we route the limit order?  Do we
            14   route the limit order to the ECN which provides the quickest
            15   way to cancel, because we think that that is part of best
            16   execution, to allow the customer to cancel when he wants.
            17             MR. BURKHART:  Maybe I just don't understand it
            18   properly, but aren't the access fees passed along, directly
            19   or indirectly, to the ultimate investor; yet, the rebates
            20   seem to stop short of being passed along to the ultimate
            21   investors.
            22             MR. PETERFFY:  No, they are not.  We charge a penny
            23   a share.  That's it.
            24             MR. HARRIS:  Here is my problem with the entire
            25   system, and perhaps, Janet, you can explain this to me.  It
             1   is unclear to me what determines the liquidity fee in the
             2   end.
             3             So we have four ECNs or exchanges trading the same
             4   securities, each one feeling that they can get more order
             5   flow by offering larger liquidity rebate, and each one offers
             6   a larger liquidity rebate and they end up playing a game of
             7   leap frog.  Where does it end?
             8             MS. ANGSTADT:  I don't know.  I think it is largely
             9   being driven by competition.
            10             I think, again, for us to have orders crossed in
            11   our system is very efficient for us cost-wise, so that's why
            12   the rebates are available.  And that's something we are
            13   always striving to do is to increase that cross trade so that
            14   we work to increase that rebate, so I don't know where it
            15   ends.
            16             MR. HARRIS:  Was the Super Montage set up right in
            17   the following sense:  You have a situation where you have
            18   dealers who offer liquidity, and you have ECNs that have
            19   customers who offer liquidity.  ECNs charge access fees, and
            20   so the issue is, what is the price?  And issue that seems to
            21   keep reoccurring over and over again.
            22             And as NASDAQ is set up, they allow the customer to
            23   choose whether they want to have their marketable orders
            24   allocated according to price-time priority or price -- let's
            25   see, the fee price-time, the access fee.  The problem being
             1   that the traders who submit marketable orders do not want to
             2   be in a situation where they were going after best price but
             3   had to pay a large access fee?
             4             Was that done correctly?
             5             MR. DeSALVO:  I think that the premise of being
             6   able to execute against those that don't charge an access fee
             7   is wonderful, but you have to remember, you only get to
             8   exhaust the liquidity from noncharging access members at some
             9   point if you look to change the price one penny.  You are
            10   going to eventually have to go through access fee charging
            11   ECNs that are there.
            12             So that Super Montage algorithm works wonderfully
            13   provided that there is not an access fee charging liquidity
            14   in the marketplace.  And by the way, you have to change price
            15   point, then you have to pay the fee at some point.
            16             MR. HARRIS:  Let's explore some other standards.
            17   One other possibility would be that you simply do everything
            18   on a net pricing basis.  And to do that we would have to
            19   break the penny and go down presumably to hundredths or
            20   something like that.
            21             Another possibility would be to pass through all of
            22   these fees and rebates to the customer so that the customer
            23   saw everything.  What are the pros and cons associated with
            24   these alternatives?
            25             Does anybody want to take a bite out of that?
             1             MR. DeSALVO:  I would vote against sub penny.
             2             MR. PETERFFY:  I don't think you can break the
             3   penny, but you also cannot pass it on to the customer because
             4   it is extremely confusing.  I think we just have to live with
             5   what we got.
             6             MR. HARRIS:  Well, we live with what we got, what
             7   we've got right now are large access fees which seem to be
             8   generating a fair amount of controversy, and liquidity
             9   rebates that are roughly commensurate.
            10             We have had several people speak for standards.  I
            11   presume the standard here would be something to the effect
            12   that if you are a broker -- and ECN is acting as an exchange
            13   facilitator, or whether you are an exchange, either way, that
            14   your intermediation fee -- which essentially  presently is
            15   the difference the between access fee and the liquidity
            16   rebate -- that the intermediation fee can only be collected
            17   on an equal basis between buy and sell, or only on the sell
            18   side, or only this way or that way, but not as the difference
            19   between an access fee and liquidity.
            20             So you might say there is zero liquidity, equal fee
            21   on either side.  Is that the standard?  We have a lot of
            22   request for standards today, the question is, is that the
            23   standard that you envision?
            24             MR. BURKHART:  I don't see why we are complicating
            25   the issue with all these fees.  Why don't we do away with the
             1   fees and you can charge a commission for trading?
             2             If ECN ABC has the most efficient platform, great,
             3   they have the best price, we will go there.  If the New York
             4   Stock Exchange does, great, we will go there.  If it is a
             5   consolidated platform one day, even better, we will go there.
             6   But to allow for rebates to effectively buy order flow
             7   because it understandably higher margin/lower cost business
             8   for you, but then because you are paying for that order flow,
             9   you then need to charge an access fee to offset it, you are
            10   really confusing the client.
            11             Again, the retail guy, the institutional guy, just
            12   let them display prices. If you want order flow on the basis
            13   of efficiency of your platform, wonderful, charge people a
            14   commission to buy and sell from you.
            15             MS. ANGSTADT:  Just to be clear, the access fee is
            16   not to offset the rebates that we are offering.  It is when
            17   people access us, there is more money there too and it is
            18   maintaining routes into us, so our routing out and having
            19   people access us is a higher cost to us as opposed to just
            20   internalizing order flow.
            21             MR. BURKHART:  Maybe Minder, Scott and I should
            22   charge Morgan Stanley and Goldman Sachs for our order flow.
            23             MR. DOMOWITZ:  Yes, one has to be a little careful
            24   about how these charges are stated.  I haven't seen any
            25   documents for order flow, or I should say financial records,
             1   but I have taken a peek at some others, and I can tell you
             2   that to set up a radianz network solution to bring people in,
             3   it is about 5,000 a month.
             4             This is not exactly a back-breaking proposition
             5   given that the client does pay $200 to get hooked up.  So
             6   there is a point at which this can't be pushed too far.
             7             MR. HARRIS:  Dave, if the Commission set a standard
             8   setting practice, not a rate setting practice, but a standard
             9   setting practice that said that you are to -- you, as an
            10   exchange intermediary, an exchange facilitating intermediary
            11   -- as an exchange, cannot offer rebates for people who offer
            12   liquidity, and we say the same to everybody else as well.
            13   Where does that leave you?
            14             Same question to Janet, if we say that there simply
            15   will be no liquidity rebates, but we say that also to all
            16   your competitors, are you worse off or better off?
            17             MR. HERRON:  On our part, I think the restructuring
            18   fees -- the customer and the exchange have to pay
            19   restructuring fees, and of course, right now the fees, as
            20   structured, have set proper behavior from our dealer
            21   community.
            22             They are not going to effect order flow if they do
            23   a bad job once they get it.  I would be worrying about the
            24   ability of our community to continue to compete unless we can
            25   structure the fees so that incented to do what is good in the
             1   marketplace.
             2             MS. ANGSTADT:  Yes, I don't know that I have an
             3   opinion on that.  I guess I do think that the ECN issue
             4   should also be thought of in the context of member and
             5   nonmember access to exchanges.
             6             We talked a lot about linkages, and I think with
             7   ITS we assume that there is a cost to ITS in that you get
             8   what you pay for, it is free and it has been slow.  So the
             9   speed at which you can access the market, and people going to
            10   charge for that, it does seem that we should able to charge
            11   for the value that we are providing.  It just seems that that
            12   is what all of the exchange markets have done.
            13             MR. COLBY:  I hate to say anything about the ITS
            14   system, but the electronic moves at the same speed as the ITS
            15   wire and everybody else.  It's when you get to market, that
            16   execution --
            17             MS. ANGSTADT:  Fair point.
            18             MR. HARRIS:  One last question, not last question,
            19   really, another question on this issue, what do you expect is
            20   happening to limit orders traders as their living
            21   increasingly in environments where they are paid to offer
            22   liquidity?
            23             Do you expect that their limit orders should become
            24   more aggressive or that this has had no effect upon them?
            25             MR. DeSALVO:  I think the limit order traders are
             1   shopping for the best rebate.
             2             MR. HARRIS:  Are the limit order traders shopping
             3   for the best rebate or are the brokers representing the limit
             4   order trader shopping for the best rebate?
             5             MR. DeSALVO:  Both.
             6             MR. HARRIS:  And do you think that --
             7             MR. DeSALVO:  What I would prefer is that you
             8   eliminate access fees, you come down to the most efficient
             9   and you don't have to worry about rebates.
            10             MR. HARRIS:  Which would be the better standard, to
            11   eliminate access fees or rebates?
            12             MR. DeSALVO:  Access fees, because if I represent
            13   different ten bids, when I access Joe's ten bids, it is ten
            14   bids, when I access Chris on the floor, it is ten bids.  When
            15   I access Archipelago, it is ten plus the access fee.  So the
            16   access fees get eliminated first.
            17             MR. HARRIS:  If we eliminate the access fees, what
            18   is the expectation, what happens to the limit order rebates?
            19             MR. DeSANO:  I think it just goes away naturally.
            20             MR. DELLA ROSA:  The benefit of limit orders in the
            21   marketplace is it should be incentivized by some rebate given
            22   to the marketplace by some unlevel playing field that's
            23   really a benefit is why that is incentivized that way.  The
            24   benefit of the marketplace should be price-time priority,
            25   that's why you put in the limit order in the first place.
             1             MR. HARRIS:  I am a clever guy here, if you
             2   eliminate the access fee, what happens, and you don't control
             3   the limit order rebate, wouldn't we just see the transaction
             4   fee rise very quickly?
             5             PROFESSOR KYLE:  But it might be paid not by limit
             6   orders but by market orders, you place an order to buy four
             7   and I place an order to sell four.  The criteria are we ought
             8   to be able to actually meet in the market.
             9             MR. DeSALVO:  Gunner explained it quite well, if
            10   Gunner gives Morgan Stanley a limit order and he pays me a
            11   commission for getting the limit order done, I don't get to
            12   charge an access fee so I collect on that side and collect on
            13   his sides; otherwise, I should be paying. It works the other
            14   way around on the ECN model.
            15             MR. HARRIS:  Let's change the topic for a moment
            16   and talk about internalization.  Internalization is when a
            17   broker-dealer routes an agency order to that same
            18   broker-dealer, usually in a separate unit of the firm, for
            19   execution and, generally, at the best bid or offer.
            20             Let's first ask a blank-sheet question: Should
            21   internalization be allowed?
            22             MR. HERRON:  Yes.
            23             MR. HARRIS:  Why?
            24             MR. HERRON:  I think internalization or payment for
            25   order flow, I think that is an incentive to order flow that
             1   has not proven in any way to be bad for the customer.  As a
             2   matter of fact, I think that many studies have shown that
             3   people subject to those practices are taking their best
             4   execution obligation very seriously and making sure that the
             5   customers receive very good execution.
             6             MR. HARRIS:  Taken as given what you said, and I am
             7   sure that many disagree with that, but let's take as given
             8   what you said, that the customer would be no worse off with
             9   payment for order flow or internalization, might it still be
            10   the case, though, that if there weren't such things that the
            11   customer might be better off.
            12             So what you have said is that the customer is no
            13   worse off, in a world in which there is internalization, the
            14   customer is no worse off having the order go to the
            15   internalizing dealer versus going to a market.  The question
            16   is:  If there were no internalization, might the customer be
            17   better off because they would have a better chance reaching
            18   their limit order?
            19             MR. COLBY:  Or to put it another way, is there
            20   another customer order that would be better off?
            21             MR. HARRIS:  Yes, that's the easier way to say it.
            22             MR. HERRON:  I will deal with the reality, that the
            23   evidence points to the customers are well served, and let the
            24   economists deal with the hypothetical.
            25             MR. COLBY:  That knocks Ruben out.
             1             MR. QUICK:  I think it has been proven that when
             2   customers meet customers, a better price is achieved by the
             3   customer.
             4             And by having time priority, the customer, again,
             5   is served best because he is shown that liquidity gets
             6   interacted with.
             7             MR. COLBY:  In most internalized models, customers
             8   are also meeting customers as well.  It is an opportunity
             9   where broker-dealers do take full advantage of their own
            10   order flow to have their own customers meet their own
            11   customers as well as best execution when necessary.
            12             MR. HARRIS:  When a trader offers a limit order and
            13   it is the first order in the market at that price, is it fair
            14   that dealers can be trading at that same price subsequently
            15   for the dealers own account?
            16             Fairness is one of our objectives, of course, so we
            17   have somebody who has offered to --
            18             MR. QUICK:  So you are acting as an agent and you
            19   are acting as a dealer?  You are acting as an agent for the
            20   customer's order --
            21             MR. HARRIS:  Let it be somebody else's order.
            22             MR. QUICK:  You are disadvantaging somebody who is
            23   shown time priority at that price, and you are self-dealing
            24   ahead of the customer.  You are, again, making the markets to
            25   the advantage of the participants rather than the customer.
             1             MR. HARRIS:  So now let me ask you a question:  I
             2   offered that order in Dave's market, Chicago, it was the
             3   better price.  And the question is:  Should traders at the
             4   New York Stock Exchange be allowed to trade at that price
             5   before he fills his orders?
             6             MR. QUICK:  The rules do permit that right now in
             7   our present model.  But if he is trading as a dealer, my
             8   initial point was if he is acting as a dealer and an agent,
             9   he should not be able to trade next to his customer's order.
            10             MR. HARRIS:  I understand.
            11             But the principal you just articulated, though,
            12   would suggest in a different world with linkages that the New
            13   York Stock Exchange would go to Chicago because they have
            14   time precedence.
            15             MR. QUICK:  The customer's preference is to where
            16   they send an order.  If they are sending an order to the New
            17   York Stock Exchange, if I am acting as an agent for an order
            18   at the New York Stock Exchange, I am disadvantaging somebody
            19   who is delivering an order to my venue at that same price.
            20             MR. HARRIS:  And in a world in which there are,
            21   say, very high speed connections, why would the customer care
            22   whether he got the same price from you or the same price from
            23   somebody else?
            24             MR. QUICK:  The order, if it was interacting with
            25   us, is on our market, not on the Chicago market.
             1             MR. HARRIS:  So let's go back to the question of
             2   national fairness, then.  If somebody went to the Chicago
             3   Exchange for whatever reason and displayed in the national
             4   market that he was the first person willing to trade at that
             5   price, should he get the trade?
             6             MR. QUICK:  Not in the present rules, no.
             7             MR. HARRIS:  That's not in the present rules.  I
             8   didn't ask what the rules were.  I asked what should happen,
             9   what's fair?
            10             MR. QUICK:  I think if somebody is willing to trade
            11   at the same price on the New York Stock Exchange, they should
            12   trade.
            13             MR. HARRIS:  How is that different --
            14             MR. QUICK:  I am acting as a dealer and as an
            15   agent.  I step aside when an order comes in at that price.  I
            16   don't trade as a dealer at that price until the customer is
            17   satisfied.
            18             MR. DELLA ROSA:  On the national market system, the
            19   price that is displayed takes precedence wherever it is
            20   displayed.  In a perfect world, in the national market
            21   system, the order that is displayed in the book should take
            22   precedence.
            23             PROFESSOR KYLE:  In a perfect world, the tick size
            24   would be even less than a penny.  I think the issue that you
            25   are talking about when you go to eighths of pennies, it
             1   becomes twelve- and-a-half times less important because when
             2   you have pennies, the ability to trade exactly that price
             3   with a one penny difference is not worth that much.
             4             So I think that needs to be recognized, along with
             5   the fact that in pennies traders who want to trade size
             6   should place scaled limit orders covering every single penny
             7   so that it is actually quite difficult to front run them or
             8   to violate some kind of price priority or time priority in
             9   the national market system environment.
            10             MR. DeSALVO:  I think you have IIAc1-6 rules to
            11   determine whether the internal version models are correct or
            12   not, so you also have, as regulators, the last vote to
            13   determine whether the broker-dealer made a wise choice or
            14   not.
            15             But I think when you talk about internalization,
            16   you also ought to speak about some of the benefits.  Some of
            17   the benefits are liquidity, including enhancement, providing
            18   liquidity that is outside what the published NBBO outside
            19   bears is a benefit to the client.
            20             In addition to liquidity enhancement, speed of
            21   execution and turn around time is something that clients
            22   enjoy.  So they enjoy the outside NBBO executions and they
            23   also enjoy rapid turn around times.  Those two benefits of
            24   internalization sometimes get lost in the menu.  In addition
            25   to that, if a broker-dealer, as I said, missteps on
             1   internalization, the IIAc1-6 numbers are on public notice and
             2   you can determine there whether they are making good or bad
             3   decisions.
             4             MR. HERRON:  Within the national market system,
             5   each participant has various levels for the most part of
             6   strict price-time priority within their venue.  I think if
             7   you talk about trying to provide strict time price priority
             8   between all the venues, you start to walk down a path towards
             9   very noncompetitive central limit order environment, which I
            10   think takes away choice for the customer.  It takes away the
            11   competition that has made our market so strong.
            12             MR. HARRIS:  Once again, you are speaking in favor
            13   of competition among market centers, and other people arguing
            14   the opposite point speaking in favor of competition on price.
            15             I want to explore one last issue as we approach our
            16   time of closing, and that is the imperfect world in which we
            17   live.  We have been talking about in a perfect world, blah,
            18   blah, blah.  In a perfect world, everybody is completely
            19   honest and the best execution happens because people take a
            20   lot of care to make sure that it does.  But in a very
            21   important respect that in some sense explains why the SEC
            22   exists, we live in a world where not everybody is honest and
            23   not everybody works as hard as we would like them to work to
            24   obtain best execution for their clients.  And many of the
            25   clients, undoubtedly, the vast majority of the retail clients
             1   are not in a position to adequately evaluate best execution.
             2             The question is:  How expensive are the regulatory
             3   efforts -- and by "regulatory" doesn't mean SEC only, but the
             4   brokers, the exchanges and so forth  -- how expensive are the
             5   efforts to ensure that we eliminate all the dark places where
             6   bad things can happen?
             7             So, for instance, internalization is maybe a good
             8   thing, but it also raises the possibility that it can be a
             9   dark place where somebody is misrepresented and nobody
            10   discovers it.  So what I would like to have is a very short
            11   discussion on the expenses of ferreting out dishonest people
            12   and perhaps some comments, if interested, on alternatives for
            13   doing that.
            14             We will start with Dave.  Dave, what do you guys
            15   spend to ensure that the market is operating fairly, if
            16   anything?  I want to get you to respond quickly.
            17             MR. HERRON:  I have been up and down for six days,
            18   I might have to defer to Paul on the actual number of what we
            19   spend.
            20             Speaking for the broker-dealer community in my past
            21   incarnation, there is a great deal of money being spent on
            22   monitoring for best execution, there was a great deal of
            23   money being spent before the requirement for IIAc1-5 and
            24   IIAc1-6 data.  I think the general sense that disclosure is
            25   very important has solved a need.
             1             I think customers are much -- are very savvy.
             2   Customers know the execution costs, they know where they are
             3   getting executed, they know what the NBBO was, they know what
             4   trades are on either side of their execution, and I think
             5   what the industry has done at the SRO level and the
             6   broker-dealer level in providing data and looking at
             7   execution has been extensive and is really fulfilling the
             8   purpose of disclosure.
             9             MR. HARRIS:  Joe, can you give us a sense of the
            10   money that is spent by Goldman to ensure best execution for a
            11   client?
            12             MR. DELLA ROSA:  To quantify the exact dollars
            13   would be difficult to do off the top of my head, but I can
            14   tell you that from the standpoint of the technology systems
            15   that are in place to monitor anything from limit order rules
            16   and things associated with that to inside code and best
            17   execution are significant.
            18             From the standpoint of our institutional clients
            19   and our own internal research groups that we have simply a
            20   setup for examining best execution and discussion of it,
            21   because, as I mentioned before, the bigger it gets, the
            22   argument becomes much more complex.  Understanding that, we
            23   have spent a significant amount of money as relates to that.
            24   So I think that it has been, quite frankly, meaningful
            25   dollars that have been spent.
             1             MR. HARRIS:  Gunner, you have spoken for a
             2   consolidated system.  That may be pie in the sky, but just
             3   for amusement now, the two previous folks, Dave and Joe, have
             4   spoken to the expenses that their organizations spend on best
             5   execution, or in Dave's case, past experience with
             6   broker-dealers.
             7             In a consolidated world, how much would they have
             8   to spend?
             9             MR. BURKHART:  I think in a consolidated world they
            10   would have to spend much less, and I think we, institutional
            11   investors, would have to spend much less as well.
            12             We currently spend a great deal of money increasing
            13   and great deals of money on assessing our transactions, both
            14   best execution obligations and responsibilities.  We also
            15   spend a lot of money on trying to figure out and access a
            16   more perfect marketplace and new alternative providers that
            17   get people like Scott, Minder and me together to trade where
            18   we reduce our market impact.
            19             So there is an auxiliary cost, unfortunately, to us
            20   and, therefore, to the investor on the street due to the
            21   structure of the marketplace.  But I have no doubt that if
            22   the pie in sky model were to come to the United States, I
            23   would think that costs for all participants would be lower.
            24             MR. DeSALVO:  I don't necessarily think that a
            25   consolidated model would represent the cheapest cost because
             1   when you look across between Europe and the United States,
             2   the more expensive place to trade is in Europe because the
             3   competition with one exchange leads to the highest trade cost
             4   and post-trade cost.  It is clear they are more expensive in
             5   a noncompetitive environment than it is here in the United
             6   States where you have competitive miles between NASDAQ and
             7   New York which leads to low transaction costs and then, most
             8   likely, lead to lower post-transaction costs.
             9             So the cheapest model is the fragmented model where
            10   there is competition, the total pre-trade, trade and
            11   post-trade costs here, not in the consolidated model.
            12             What is interesting, you asked the other gentlemen
            13   to quantify cost.  I would say that we spend over $200
            14   million in market data alone at our firm, some of which is
            15   going to regulatory policy in addition to, as Joe said, our
            16   internal IT costs, legal and compliance.  So you are talking
            17   about hundreds of millions of dollars that are going into
            18   this effort.
            19             MR. LEE:  I think the data about European and USA
            20   costs are much more conflicted than you are indicating.  I
            21   don't think they are as simple as that.
            22             MR. GOLSCHMID:  Isn't most of the cost here the
            23   cost of different platforms as opposed to a regulatory cost?
            24   I think those two things may be getting confused.
            25             If you have multiple platforms, you are going to
             1   look the best and you are going to spend to do that.  And it
             2   is not the regulatory costs that's driving that, it seems to
             3   me.
             4             MR. BURKHART:  In fact, the regulatory cost goes up
             5   because regulators have to look at more and more platforms.
             6             MR. HARRIS:  I am in an unpleasant position in
             7   several respects today.  I presently have to cut off the
             8   discussion, but I am sure many of these topics, including
             9   Commissioner Goldschmid's topic, will be discussed at our
            10   next discussion.  I also, as many of you probably recognize,
            11   have been in the unpleasant position of only asking questions
            12   and not being able to answer them.
            13             MR. GOLDSCHMID:  Larry, we will give you a minute.
            14             MR. HARRIS:  If you give me a minute, I will offer
            15   just one perspective.  It is completely off the topic of what
            16   we were discussing.
            17             I believe that theoreticians and purists in market
            18   structure have pretty firmly established the single most
            19   important determinant of liquidity is asymmetric information.
            20   That is to say, the extent to which some people know more
            21   than others do.  And I would like to connect that to the
            22   importance of the SEC.
            23             The SEC, through its extraordinarily broad
            24   disclosure programs, primarily organized through the Division
            25   of Corporation Finance, have done a tremendous job of
             1   leveling the field in the United States, so that information
             2   is very broadly available to market participants of all
             3   different stripes.  And to the extent that the U.S. markets
             4   are very liquid, and perhaps much more so than most other
             5   markets, it has probably more to do with the disclosure
             6   programs in corporate finance than it may have to do with the
             7   specific market structures that we have.
             8             But in any event, I thank everybody for their
             9   questions, for their responses, for their patience and for
            10   their interest.
            11             MS. NAZARETH:  We will take a break and reconvene
            12   in 15 minutes.
            13             (Brief Recess.)
            14             MS. NAZARETH:  We are ready for the final stretch.
            15   This last segment is on exchange registration and the
            16   self-regulatory system.
            17             Recent discussions of the current self-regulatory
            18   model, and there has been much discussion, has focused on
            19   several issues.  First, the growth of ATSs and ECNs, and
            20   electronic trading by SROs have heightened the competition
            21   between traditional SROs and their members who sponsor
            22   electronic trading systems.
            23             Demutualization plans may further aggravate these
            24   conflicts as SROs compete against their members as for-profit
            25   entities.  Some market participants that advocate the single
             1   independent SRO model are doing it as a separate SRO that is
             2   independent of any particular market or market participants
             3   can lead to fewer conflicts and greater economic and
             4   regulatory efficiency.
             5             Others have argued in favor of a hybrid model in
             6   which the regulation of member activity is conducted by a
             7   single independent SRO, but the oversight of trading remains
             8   in each individual market center.  We will discuss the SRO
             9   model a bit later in this segment.
            10             As to the issue of what is an exchange, the current
            11   definition focuses on the bringing together of orders for
            12   execution under a common set of trading rules.  Under this
            13   definition, traditional floor-based auctions, newer ATSs that
            14   provide systemwide price and time priority, options exchanges
            15   that allow the dealers to trade on parity with customers, and
            16   even an organized over-the- counter like NASDAQ that does not
            17   provide systemwide price and time priority would be
            18   exchanges.
            19             The threshold question that is presented by the
            20   NASDAQ exchange application is whether a market that allows
            21   the dealers to trade against their own orders, away from a
            22   voluntary central order interaction facility, and that does
            23   not, therefore, provide systemwide price and time priority or
            24   customer order priority over dealer trading, should be
            25   allowed to register as an exchange.
             1             What would be the ramifications for our existing
             2   exchanges in such a marketplace that changed its designation.
             3   Would the national market system potentially become a synergy
             4   of fragmented internalized marketplaces?
             5             So that's where we are now.  I think we can start
             6   by discussing where I just ended with the question of
             7   exchange registration.  The first question is:  Should the
             8   Commission permit NASDAQ to register as an exchange if it
             9   does not require interaction between orders but provides
            10   systemwide price priority?
            11             And isn't the analysis further complicated if
            12   NASDAQ becomes even more profit driven, will this lead both
            13   to more internalization by existing exchanges and to the
            14   dilution of regulatory efforts?  So this obviously brings
            15   together a number of things we discussed earlier.  While I
            16   can't promise, I think this will still be a lively
            17   discussion.  I can't promise the blood and guts that we had
            18   in Washington, the discussion was between Rich Bernard and
            19   Rick Ketchum, but we do, nevertheless, have people here, I am
            20   sure, who have strong views.
            21             Should I start with a New York participant who may
            22   have some views on this.
            23             MR. QUICK:  Rich, want to help me out on this?
            24             (Laughter.)
            25             MS. NAZARETH:  He had his shot.
             1             MR. QUICK:  I think in any exchange, I think we
             2   famously talk about becoming an entity, a public entity.  I
             3   think in terms of what you build, we have an infrastructure
             4   that has a capacity of 10 billion shares.  With our interest
             5   in maintaining that, we do like two billion shares or 1.6
             6   billion shares a day.
             7             Are our interests in the same interests as the
             8   owners of the exchange?  I think there is a lot of competing.
             9   Do you become slaves to your shareholders, do you become
            10   slaves to your market participants?  It is a question that I
            11   think is up in the air.
            12             I think Rich probably has a lot more opinions of it
            13   than I do.
            14             MS. NAZARETH:  Ruben, you have written about
            15   exchanges.  Obviously, we are talking about here in the
            16   context of our regulatory structure, but do you think that
            17   there is a requisite level of order interaction that should
            18   be required in the U.S. for you to be defined as an exchange?
            19             If not, what are the ramifications.
            20             MR. LEE:  No, I don't.
            21             I think that the most complex trading systems have
            22   the best incentive to determine their own what I would call
            23   market structure that is order execution nondriven.  And I
            24   think there is no need for the SEC to require price-time
            25   priority, which is not to say that price-time priority is not
             1   the best, but if it is the best, they will discover it.  They
             2   have exactly the right incentive to discover it.
             3             So I don't think that price-time priority should be
             4   a criterion by which to assess whether NASDAQ should be an
             5   exchange or not.  In this context, in considering -- as your
             6   brief is to consider the American securities markets, I
             7   think, and I am bound to say this, I think that you should
             8   consider, given that you trade a wide range of non-U.S.
             9   stocks here in America, I think it would be beneficial for
            10   U.S. investors to have greater access to European exchanges.
            11   And this is not an argument for Europe.  This is an argument
            12   if I am sitting in your chair promoting the American
            13   securities market.
            14             I think that there are a range of different ways
            15   which would be harmful or insufficient by Europeans
            16   exchanges, which would benefit your brief, that is to say,
            17   U.S. investors.  But in answer to your question about
            18   price-time priority, I think that's relatively simple.
            19             There is a whole range of other issues to do with
            20   governance, and I think that one point I make about that is
            21   that I am less convinced of the economic distinctions between
            22   for-profit and not-for-profit institutions than other people
            23   may be.  In fact, I think non-profit institutions can, in
            24   fact, obtain a monopoly in very much the same way as
            25   for-profit institutions.  So I don't think that the
             1   demutualization should be necessarily be a criterion either.
             2             I am sure we will be coming to conflicts of
             3   interest, and maybe now is not the time, but I have a couple
             4   of points about that as well.  In particular, I am not
             5   worried about the existence of conflicts of interest and I am
             6   much more concerned about how those conflicts are managed.  I
             7   think the SEC has a long and fine history of managing in
             8   terms of disclosures, due process, representation, and so on
             9   and so forth.  And I think those types of remedies would --
            10   can be continued in the future in terms of for-profit
            11   institutions.
            12             In fact, I think that the characterization of
            13   for-profit exchanges is being more conflicted than
            14   not-for-profit exchanges is simply wrong.  But in terms of
            15   the practical considerations, from the Commission's point of
            16   view, I think there are two big ones, from my point of view.
            17             One is to -- and I don't know that it fully
            18   addresses the NASDAQ application, but not to determine on
            19   price-time priority.  And the second is for the benefit of
            20   U.S. investors to allow greater access by European exchanges
            21   in an appropriate manner.  And there are a wide range of
            22   manners which could lead regulators or mutual recognition as
            23   we widely discussed and has been signaled by Harvey, and I
            24   don't know how that's going.
            25             MR. COLBY:  Let me just say for the record, we
             1   welcome the registration of any European exchange.
             2             MR. LEE:  But then the issue is, is that necessary?
             3   Are you imposing undue costs which will in the end be borne
             4   by U.S. investors by requiring such registration.  And the
             5   question is:  To what extent should you be happy with
             6   non-U.S. regulation of exchanges?
             7             And I would contend that -- and once again, I am
             8   not intending to be an advocate of Europe here.  What I am
             9   trying to be is an advocate of exactly your constituency, the
            10   investors in America, what would be best for them.  And in my
            11   view, I think that one should look carefully at the extent to
            12   which the regulatory environment of exchanges in Europe is
            13   beneficial, and, of course, to the many contexts that I think
            14   that it is not only beneficial, but equivalent to the U.S.,
            15   so requiring double regulation does not achieve anything.
            16             MS. NAZARETH:  So we got in the foreign market
            17   access point, which is not on our agenda, but it is on the
            18   Commission's agenda, but it is not on the agenda today.
            19             Pete Kyle, earlier in our discussions this morning,
            20   you mentioned that something to the effect of retail
            21   investors may, in fact, have certain expectations about what
            22   they get on an exchange and it may involve more than simply
            23   transparency.
            24             Do you think that retail investors or market
            25   participants in general have an expectation about what it
             1   means to have a transaction executed on an exchange that is
             2   different from their expectations of transactions in the
             3   over-the-counter market?
             4             PROFESSOR KYLE:  Certainly, I think that
             5   historically until the last five years or so, retail
             6   investors have gotten a better deal on organized exchanges
             7   than they have in pure dealer markets.  If you try to make a
             8   transaction called a small market order on NASDAQ versus the
             9   New York Stock Exchange, the New York Stock Exchange
            10   historically has looked very good until the last few years
            11   when NASDAQ started functioning more like an organized
            12   exchange itself.
            13             And, largely, the reputation of an exchange with
            14   its retail investors is its capital or a large part of its
            15   capital.  A point that goes along with that is that the
            16   governance structure has changed.  It has a lot to do with
            17   what objective they can maximize on.  And the exchange that
            18   is likely to be most friendly to retail investors dealing
            19   with an exchange that is governed by smaller customers.
            20             But the fact is exchanges are kind of owned and
            21   controlled by a mixture of organizations with different types
            22   of interest, including the kind of local floor traders on the
            23   exchange and the larger securities firms whose interests
            24   sometimes conflict and sometimes go hand in hand.  And I
            25   think that it is very important to think about the government
             1   structure of exchanges influencing the incentive that the
             2   exchanges have to represent the interests of retail investors
             3   or any other group.
             4             There is also, looking at commodity exchanges which
             5   historically have had different government structures,
             6   different ones in New York and Chicago, there are a whole
             7   bunch of them.  They have had different government structures
             8   over the years and they have also behaved differently with
             9   respect to the rules, so you can see that in the commodity
            10   markets as well.
            11             MS. NAZARETH:  Tony?
            12             MR. LEITNER:  I guess the question would be why
            13   not, because if we look at the convergence in the
            14   marketplace, we see that, number one, the old dealer market
            15   that NASDAQ was is certainly not only a different market
            16   today, that is to say, many NASDAQ dealers, including
            17   ourselves, are more and more representing customer orders
            18   essentially as agents in that marketplace.
            19             The prime member system within NASDAQ is an attempt
            20   to create an auction style marketplace within the context of
            21   the NASDAQ market.
            22             Number three, you would eliminate from a policy
            23   perspective and finally draw closure to the issue NASD and
            24   NASDAQ by forcing NASDAQ to, in fact, become its own SRO,
            25   although the thought of another rule book on my shelf is
             1   itself almost a sufficient negative against that, but we
             2   could get to what that structure should do later.  So it
             3   seems to me if one looks at those kinds of things, you would
             4   say that these other issues are sort of red herring issues.
             5   That what happens is the Commission then, from a policy
             6   perspective, really gets an ability to force that marketplace
             7   to, in fact, be governed having a majority of outside
             8   directors.
             9             That is not true of ATSs today.  They can be
            10   totally privately owned or publicly owned or whatever, have
            11   their own board of directors with no requirement for any
            12   public representation and so forth.  So I think the real
            13   issue is not NASDAQ becoming an exchange but what do you do
            14   with ATSs that become primary markets.
            15             MS. NAZARETH:  That is a very good question.  That
            16   was actually going to be my next question, as matter of fact.
            17             MR. DeSALVO:  With regard to the NASDAQ exchange
            18   status, NASDAQ and New York each make each other better.
            19   There are elements about NASDAQ that we like and there are
            20   things about New York that we clearly like, but the existence
            21   of the two marketplaces, clearly, clearly, although they may
            22   not admit it, at the end of the day, they do make each other
            23   better.
            24             And it is hard for us to see a marketplace that has
            25   the most volume on a day-to-day basis not being granted
             1   exchange status.  And for you to worry about whether they are
             2   a model for internalization is worrisome.  You are imposing
             3   something that the client base seems to be voting with their
             4   feet, currently that they are okay with it.
             5             MS. NAZARETH:  I guess the question is are the
             6   clients voting for or against?
             7             MR. DeSALVO:  I think at the end of the day, the
             8   Ac1-6 number will ferret out and also that the listings and
             9   the volume will be the economic result of where it goes.  But
            10   we clearly enjoy the benefits of a robust New York and a
            11   robust NASDAQ.  And we have the benefits and our  clients
            12   have the benefits of the best of New York  and the best of
            13   NASDAQ.  But to have one now not be an exchange, and with the
            14   volume here, it doesn't make any sense to us.
            15             MS. NAZARETH:  Tony was talking about Reg ATS and
            16   the question is, do the principles in there still work?
            17   Obviously, what Reg ATS did was take a very expansive view of
            18   what was an exchange and, arguably, did not specifically have
            19   these other conditions that we are discussing, and would
            20   leave it to the Commission to determine whether marketwide
            21   principle should be applied virtually regardless of whether
            22   you were an exchange or an ATS.
            23             You may have noticed in connection with our first
            24   market structure hearing, that AMEX presented a paper that
            25   basically said that they thought Reg ATS had failed and that
             1   all entities, technically defined as exchanges including
             2   ATSs, should be subject to the full exchange registration and
             3   regulation.
             4             I would imagine, Janet, you might have a view on
             5   that?
             6             MS. ANGSTADT:  Actually, I think we are a good
             7   example, we grew up with Reg ATS.  What I thought was a
             8   positive with Reg ATS was that you got the choice between
             9   either being a member of NASDAQ, somebody who is competing
            10   with us and trying to deal in our market structure and our
            11   market structure choices, or being able to go off on our own.
            12   And it is, really, that choice that is very important and
            13   taking on the responsibilities that come with that choice.
            14             MR. LEE:  I am not fully conversant with U.S. law
            15   and regulations, perhaps my ignorance will become evident
            16   here, but I have one comment which is as follows:  My
            17   understanding is that effectively there is an encumbrance
            18   being an exchange and being an SRO.  That's effectively the
            19   same thing.
            20             And there I have a potential problem that trading
            21   systems, all ATSs, should become SROs, precisely because --
            22   and this is a point that Pete alluded to -- if you have a
            23   government structure which is required by law to have
            24   representation and so on and so forth, and then it will find
            25   it very difficult to establish a trading system which
             1   disintermediates the people who were put into your government
             2   structure.
             3             So that if, for example, you are an ATS and you
             4   want to have direct access by institutions, that may become
             5   harder with a mandated government structure that says we need
             6   financial intermediaries to be on our board.  And if that's
             7   the case, then I would worry about requiring all ATSs to
             8   become exchanges.
             9             MS. NAZARETH:  But I do think the Commission has
            10   addressed that by trying to balance the issues and determine
            11   that there will be some representation of the members who are
            12   U.S. traders but not the large majority.  You are right,
            13   though, otherwise it would be a conflict.
            14             I guess another issue raised by the NASDAQ exchange
            15   application is:  What are the outer limits?  Is any trade
            16   that's printed on the exchange an exchange trade?  Does that
            17   potentially lead to the buying of prints?  Obviously, we have
            18   seen a lot of that lately, we have talked about the rebates.
            19             And what are the implications of having one
            20   potentially become print facilities?  Are there problems with
            21   having transactions that on their face appear to be an
            22   indication of liquidity in a certain marketplace, where
            23   actually those transactions were not effected anywhere near
            24   that venue?
            25             MR. LEITNER:  But you have to deal with that
             1   anyway, right?  That's what the first two panels were about.
             2             What does that have to do with whether NASDAQ
             3   becomes an exchange?
             4             MR. O'KELLY:  I will take a slightly different
             5   view.  I think you have to deal with that question, in that
             6   if NASDAQ becomes an exchange and they are allowed to avoid
             7   intramarket price-time priority, it won't take a day, it
             8   won't take 24 hours for some other exchange to come in and
             9   ask for similar relief.
            10             As a matter of fact, I think I have already seen
            11   some of those requests for similar relief, not from us, but
            12   from others, and you are going to have to deal with that
            13   question.  And I think it is a very important question for
            14   the marketplace.  I think we have seen at least one model of
            15   the market already where it seems to be the member is the dog
            16   and the exchange is the tail.  I don't know that that's the
            17   kind of market structure that you want to incent us to
            18   develop.
            19             MS. NAZARETH:  Tony, I certainly agree with your
            20   point, they are there already and one can't bifurcate that
            21   question from the question of exchange registration.
            22             Taking the question separately, though, apart from
            23   the NASDAQ context, do you think it is problem?  Do you think
            24   it is something that the Commission need to address?
            25             MR. LEITNER:  Which issue?
             1             MS. NAZARETH:  The issue of trade and print
             2   facilities.
             3             MR. LEITNER:  Yes, but I think we would say that
             4   that's an issue across all of the markets.  Even in New York,
             5   people trade upstairs and bring their crosses to the floor
             6   and they are printed there, so whether or not it is still an
             7   issue because they are exposed, that you can say there is
             8   some legitimacy to the execution, I think the point that was
             9   made in the earlier panel was, are you misleading the public
            10   by the degree to which you permit these practices to occur,
            11   or is it clear by the nature of the reporting what is
            12   happening on the market and what is happening off the market?
            13             Technology would today would potentially allow you
            14   to make those distinctions, so there is may be more than one
            15   way to deal with the policy issue but you have to define
            16   what's the problem first.
            17             MS. NAZARETH:  Well, I guess that's the question:
            18   Is there a reason for us, from a regulatory standpoint, to
            19   make that distinction?
            20             Obviously, to make that quite simple, would there
            21   be a benefit to the marketplace of having an indicator of
            22   when a transaction was effected either on an exchange or
            23   through an exchange system versus when it was effected
            24   separate and apart from that internalized setting?
            25             MS. ANGSTADT:  I think that one of the questions
             1   that we talked about this morning, too, in the national
             2   market system, that there was this principle of the
             3   opportunity for a transaction to be effected without the
             4   intervention of a dealer.
             5             Obviously, NASDAQ has done quite well in the dealer
             6   market.  I don't know if in an exchange application, you have
             7   to consider that objective of the national market system in
             8   considering their application for exchange status.
             9             MR. LEITNER:  Certainly in regard to
            10   internalization of members of NASDAQ and their ability to
            11   print on NASDAQ, as they do today, I don't see why you would
            12   force those prints to go into the ADF if it is done by a
            13   member.  That's sort of internalization, and that, I assume,
            14   is the question you are asking, is that internal cost,
            15   because they print right now, they just print to ACT.
            16             MR. COLBY:  Let me just --
            17             MR. DeSALVO:  The concept of internalization.  You
            18   speak of it as if it was a majority of the order flow
            19   involved.  It is not.  It is a minority of the order flow.
            20   So you seem to be hung up on this concept of internalization,
            21   which would make sense if it was lion's share of the volume.
            22   It is not, it is clearly the minority.
            23             MR. COLBY:  The reason that we are talking this
            24   issue out is if you move from an exchange where there is some
            25   sort of notion of a centralized trading system where the
             1   orders are interacting and broadening out to a system where
             2   there are rules governing how trades are done, but they don't
             3   actually internalize, the question is: Is there any sort of a
             4   lingering notion that when you have bulk trades reporting,
             5   that those are all interacting?
             6             If that's not really not how people think about it,
             7   then trying to differentiate between trades that were done at
             8   an interacting location and nexus, it probably is not worth
             9   the effort.  But if there is some lingering idea by looking
            10   at the volume done by the Chicago Stock Exchange that tells
            11   about how many orders are interacted in the Chicago Stock
            12   Exchange environment, then knowing that they were printing
            13   orders by somebody that was just internalizing in their --
            14   upstairs in an office and was just printing them there, that
            15   could be viewed as inflating and misleading.
            16             But if that's not the way people view it, then
            17   trying to differentiate it may not be important.
            18             Does anybody have any thoughts about that?
            19             MR. QUICK:  I think you are creating false
            20   liquidity if you are printing NASDAQ trades in Cincinnati,
            21   you are creating a sense of false liquidity in a market that
            22   really doesn't have liquidity if the trades are taking place
            23   somewhere in a closet and they are just getting printed on
            24   that marketplace to generate tape revenue.  But, again, it is
            25   not transparent, customers are not interacting with each
             1   other, prearranged trades.
             2             MS. NAZARETH:  Pete, do you have a view on this?
             3   Obviously, one of the reasons we focus on this is because we
             4   have a concern about the price setting mechanism and insuring
             5   that it is as efficient and effective as possible.  I think
             6   today we obviously have a system, particularly with respect
             7   to listed stocks, where there is so much activity in this
             8   venue, that there is a tremendous amount of order
             9   interaction.  And the fact that you have a number of other
            10   market centers that may mimic those prices really may not
            11   have a serious negative impact on the price setting
            12   mechanism.
            13             I guess the question is, eventually, in a worst
            14   case scenario, if we move to a totally fragmented market
            15   without a significant marketplace where orders interacted,
            16   will we have the same efficiency as we have today?
            17             PROFESSOR KYLE:  I am a strong believer in a
            18   mechanism where if Larry places his bid at four and I place
            19   my offer at four, we meet each other.  And I don't know --
            20   NASDAQ is set up kind of the way it is now, but as an
            21   exchange, would it deliver as well as the New York Stock
            22   Exchange delivers it or as well as an exchange that has kind
            23   of normal centralized marketplace rules will deliver it.
            24             MR. LEITNER:  Just look at it from one perspective,
            25   and that is intermediary perspective and the costs associated
             1   with it.
             2             Right now a broker-dealer that executes a
             3   transaction in the NASDAQ marketplace reports to ACT.  If
             4   NASDAQ becomes an exchange, to the extent that we have to
             5   change the technology and reporting system and the audit
             6   trail to bifurcate between where we execute orders on the
             7   same stock, it drives a whole bunch of things.
             8             It drives, for example, how exchange fees or
             9   Section 31 fees are assessed and paid.  It is a whole bunch
            10   of stuff, and one thing I can tell you with almost a
            11   certainty is that right now is not the time to ask
            12   intermediaries with the pressure we are under to accept a
            13   whole bunch of additional costs.  So I would urge the
            14   Commission in considering this issue not to think of it in a
            15   one dimensional frame work.
            16             MR. LEE:  I have a couple of points, which are as
            17   follows:  The first is that calling NASDAQ an exchange or not
            18   calling it an exchange is not going to change its market
            19   structure.  And so that if you think that price-time priority
            20   is better for market structure, then mandate it anyway.
            21   Don't use the exchange ticker, if you will, to mask that
            22   decision.
            23             Second, my view is that it may well be that
            24   price-time priority does deliver better markets.  But then,
            25   that's fine, let me go ahead and do that and set it up, and
             1   anybody who does that to compete with NASDAQ will win.
             2             My third point is I actually think that this is --
             3   to come back to Matt's point in a different way to focus on
             4   what is the key problem at the moment.  And the problem is
             5   not fragmentation.  The problem is to the contrary, it is
             6   centralization of a very, very big exchange and managing that
             7   big exchange that will now be associated with that.  So in
             8   some sense, I think you are looking at a problem which has
             9   arisen because of an application, and you need to resolve
            10   that problem, but that doesn't mean that you should take your
            11   eye off the other market structures which may be more
            12   important.
            13             MS. NAZARETH:  I would like to return for a few
            14   minutes to the SRO structure.  I know that some of you may
            15   have views on that as well.
            16             As I mentioned earlier, one of the debates about
            17   SRO structure is whether having multiple, competing SRO's is
            18   inefficient in and of itself, adds cost to the system, and
            19   whether we should go with a single SRO model or a hybrid
            20   model in which member regulation is under the purview of a
            21   single SRO market regulation, regulation of the trades and
            22   transactions in the marketplace being done by each of the
            23   individual markets.
            24             Some of you here have spent some time thinking
            25   about that.  Paul?
             1             MR. O'KELLY:  We talked about that issue internally
             2   in our exchange.  I think there are some trade offs here to
             3   having a single regulatory body.  There are a good number of
             4   efficiencies that can come from that, expertise created by
             5   that, regulators that they are now doing that across all
             6   markets so it is more likely to have uniformity of regulation
             7   across markets, which you don't have to worry about being an
             8   NASD member or becoming a member of the New York Stock
             9   Exchange, so having a single regulator can solve lots of
            10   those issues.
            11             There is a trade off, though, and the trade off is
            12   that to the extent that a regulator needs to understand its
            13   market and what is going on with its market participants so
            14   it can effectively do its job, is going to be lost if that
            15   single regulator stands away from a particular market.  I
            16   know the Commission spends a great deal of time itself not
            17   only regulating U.S. securities markets but trying to figure
            18   out what is going on in the U.S. securities markets so it can
            19   regulate it correctly.
            20             That same kind of phenomena is going to occur if
            21   you have a single regulator.  That is not to say that it is a
            22   bad idea, there are just trade offs and you should understand
            23   what those trade offs are before we opt to do that.
            24             MR. LEE:  I think, unfortunately, I am going to
            25   take the NYSE position here, which is, I think, that firstly,
             1   exchanges have a very strong incentive to provide a strong
             2   regulatory environment.  And this is what the NYSE sells as
             3   its banner, and I think that is good of them.  I think that
             4   demonstrative of something that we face in Europe where it is
             5   very, very important to not be confused by the terminology.
             6             In my mind, regulatory arbitrage is something
             7   widely to be welcomed.  Here in the states, it is often
             8   thought that it would lead to a race to the bottom, all
             9   right, in many contexts.  It would lead to people seeking to
            10   obey particular rules and so forth.  And in my mind, should a
            11   country where we have seen competition in regulatory
            12   structures where it is not a race to the bottom, so I think
            13   that that is, in as much as competition between market
            14   centers as trading systems is beneficial, I think competition
            15   between market centers as SROs is beneficial.
            16             And I think the down side of it, notwithstanding
            17   Dave Wilken's comments last time, I think the down side to
            18   having a single central regulator as exactly as one might
            19   expect, it will be much more slower, it will have to be much
            20   more politicized and so forth.  So I would be strongly in
            21   favor of competition between SRO's.
            22             MS. NAZARETH:  Tony?
            23             MR. LEITNER:  I guess the mantra here would be cost
            24   competency and consistency as themes.
            25             First of all, we don't know how much -- let's
             1   understand what the structure is today.  The SEC has primary
             2   responsibility for regulating exchanges, and there is the
             3   whole issue, of course, of whether ATSs should boost
             4   themselves up into exchange status.  Certainly something that
             5   ought to be given a look for those -- you know, at what level
             6   you increase the scrutiny of the exchanges and the direct
             7   regulation of ATSs.
             8             But with regard to the intermediary regulation,
             9   right now we have, certainly for large firms who are members
            10   of multiple venues, cross subsidization and indirect costs
            11   that are not quantifiable.  These structures being proposed
            12   that potentially levy a tax at the intermediary level on all
            13   of the business of intermediary, even that is not necessarily
            14   associated with the trading in that particular venue.  So
            15   from a cost point of view, firms like ours on whom all these
            16   burdens you have discussed like best execution and the like
            17   are being placed and the costs associated with them after we
            18   have sorted out how much it costs us to be regulated and to
            19   pay our regulators, whether or not they are the designated
            20   examining authority.
            21             Competency.  Competency is extremely important.  We
            22   absolutely benefit by rigorous, rigorous surveillance and
            23   regulation.  Firms that are compliance conscious will always
            24   benefit from having regulators who understand our business
            25   and come in and make sure we are doing it right.
             1             Consistency.  It is imperative that the rules that
             2   affect members, that is, the people who participate in the
             3   markets and their structure is such.  For example, the margin
             4   regulations, how much credit you can extend to customers.
             5   There is no reason that they should differ from marketplace
             6   to marketplace.  They ought to be the same, in my opinion.
             7             The examination for exchange of SEC rules such as
             8   the customer protection rules done by exchange staff, why do
             9   they need to be done by the exchange staffs of every SRO?  So
            10   when these issues -- and this is aside from the broader
            11   question of conflicts of interest that have been raised by
            12   marketplaces potentially regulating competitors and the
            13   possibility for inconsistent performance.  And that may or
            14   may not have been an issue anticipated by bifurcation of
            15   NASDAQ and the NASD.
            16             When the GAO looked at this a year ago, their
            17   report urged the Commission to take a careful look at this.
            18   I don't have a view about what the right answer is, but I
            19   think that the themes that I suggested, cost competency,
            20   consistency across markets, and looking functionally at what
            21   is the appropriate role for, say, a regulator other than the
            22   SEC to perform, because putting more burdens on you in this
            23   environment doesn't seem to be a great idea.
            24             On the other hand, combining the best of what the
            25   SROs currently do, into an area where you can create
             1   efficiencies, and let the marketplaces regulate their market
             2   rule.  It is in the area of market rules, the integrity of
             3   the marketplace, that exchanges know best and where their
             4   surveillance systems can be set up appropriately to deal
             5   fundamentally with their rules.  So they should do that.
             6             And the real question is whether all of the
             7   exchanges should do all of the other stuff.  And where you
             8   have a staff that has to deal with 196-4 filings for every
             9   rule approval that comes down the pike eight or ten times.
            10   It doesn't seem to be a great use of the Commission's
            11   resources.
            12             MS. NAZARETH:  That sounds, like you said the devil
            13   is in the definitely details, to combine member regulation
            14   from market regulation, that you are generally in favor of
            15   the hybrid approach.
            16             Is that fair?
            17             MR. LEITNER:  Yes.
            18             MS. NAZARETH:  Anyone else have any comments?
            19             MR. DOMOWITZ:  I find it interesting that on the
            20   one hand, the position that Reg ATS has backfired is
            21   basically a restatement of the fact that exchanges are
            22   worried about competitive pressure, all right, and are
            23   saying, well the competition doesn't have to pay the cost for
            24   that.
            25             On the other hand, the other side of the coin is
             1   that someone says, well, but the exchanges enjoy all this
             2   special status and they can earn money in different ways,
             3   and, by the way, we have to be members, therefore, we have
             4   our competition regulating us.  We have also spoken today
             5   about the interrelation between the market data fees and
             6   regulation, self-regulation in particular, and the potential
             7   conflicts there.
             8             Leaving aside the details of how you do it, if you
             9   really wanted to establish a level playing field that
            10   everybody talks about between exchanges, ECN, ATS, and
            11   whatever we want to call it these days, and leaving the issue
            12   of NASDAQ aside, you simply divorce the SRO function.  You
            13   get it out, figure out how to fund it.  There are lots of
            14   ways to do it.
            15             Once upon a time when there might have been a
            16   hundred people on the floor and you really had to know
            17   everybody else to figure out how the trading went on, and it
            18   was so complicated you really needed those guys to regulate
            19   themselves, I would have agreed you really need self-
            20   regulation in the sense it was once proposed.
            21             We are talking about going back to the New Deal
            22   here.  What was good policy is still good policy, even since
            23   1934.  But the way we carry it out is not necessarily even
            24   feasible any more.  I can see a resolution of a variety of
            25   problems, even if you introduce some new challenges in just
             1   divorcing the SRO function from the exchange, at which point
             2   you get execution centers that may or may not have listing
             3   functions because, frankly, someone might decide to get into
             4   the listing business.  But we would be done with it.
             5             MR. COLBY:  I would just like to point out that the
             6   Congressional budgeting process has not passed New Deal
             7   procedures.
             8             MR. O'KELLY:  May I respond to that?
             9             MS. NAZARETH:  Yes.
            10             MR. O'KELLY:  I think when we are talking about the
            11   SRO function, we need to divide it into two different
            12   buckets.  One of them is the SRO's ability to pass trading
            13   rules and enforce those trading rules across their members.
            14             Another more commonly thought of self-regulatory
            15   function is the surveillance function that makes sure that
            16   people abide by our rules.  If we were to have a single SRO
            17   divorced from all the market centers that performed those two
            18   functions, that single SRO would be adopting the rules that
            19   apply to all the different market centers.  Guess what would
            20   happened in a very short period of time?  With ease of
            21   regulation, all the markets would look exactly alike with the
            22   exact same trading.
            23             I don't think that's what we want to happen.
            24             MR. DOMOWITZ:  I actually disagree with that.
            25             I think that within the same set of standards,
             1   going back to standards, the competitive environment will
             2   dictate the issues for various execution centers to play in.
             3   In other words, the people that support NASDAQ today may,
             4   indeed, support NASDAQ tomorrow in that model.  The people
             5   that support New York today may, indeed support New York in
             6   that model tomorrow.
             7             They do so because they believe it is better for
             8   how they trade and what they trade.  The fact that you have a
             9   uniform set of standards does not mean that you have the same
            10   market structure.
            11             MR. LEITNER:  See, that is where the devil is in
            12   the details.  The New York Stock Exchange has rules unique to
            13   its floor model that have to do with the handling of customer
            14   orders and what our obligations are, and whether we can trade
            15   alone or against trading ahead, regulating block trading, so
            16   there is no need necessarily for the same type of rules on
            17   the NASDAQ marketplace, so I don't know what you mean by
            18   standards.
            19             It absolutely fits in the New York model.  They
            20   believe in them.  We believe in them.  We follow them.  But
            21   the NASDAQ market is different.  We go back to Matt's point,
            22   which is, these markets essentially are different models.
            23   And they have over time, I think, there has been some
            24   convergence and maybe even some of the New York rules will
            25   move in the NASDAQ marketplace as they evolve.
             1             MR. DOMOWITZ:  Yes, but the counter-example is very
             2   simple, an ECN, when that started, for example, it was a very
             3   different model than NASDAQ.  It was extraordinarily
             4   different model.  It thrived, it grew, and the limit order
             5   book market existed and actually was profitable.  It operated
             6   under NASD rules, it operated under the same rules as the
             7   market-makers.
             8             Although your point is well taken that the nature
             9   of the rules also determines the nature of the surveillance
            10   of associated practices.  We have clear counter-examples of
            11   the same regulatory regime can still breed different markets.
            12             MR. LEITNER:  But the era when the SEC could make a
            13   thousand flowers bloom with a no action letter, I think, are
            14   gone.  And that's the issue we are dealing with.
            15             MR. DOMOWITZ:  I will agree with that, too.
            16             MS. NAZARETH:  Matt?
            17             MR. DeSALVO:  We would be more of an advocate of
            18   separation of member regulation and market regulation.
            19             Member regulation involving such things as common
            20   sales practices and books and records and registration and
            21   finance standards.  But the market regulation side, we are
            22   comfortable with keeping it at the site of the transaction.
            23   So it is a differentiation between member and market.
            24             MS. NAZARETH:  Does anybody want to have the last
            25   word before we wrap up?
             1             MR. DeSANO:  It would just be interesting to us,
             2   every time we call down to ask a question to New York, we
             3   never walk away feeling like justice has been served, ever.
             4   And it may be that maybe there are just some things we don't
             5   understand.  But there is no place for us to go, and there is
             6   no appeals process.  There is nothing that is separate to say
             7   this is true, because there is no teeth in it for us because
             8   of the standing right now.
             9             It would be interesting to us to have a separate
            10   independent appeals process to add some justice to it for the
            11   little people.
            12             MS. NAZARETH:  One last final word, or would you
            13   prefer to end on that note.
            14             MR. QUICK:  I would not rather end on that note,
            15   but there are answers but there are other orders that
            16   interact other institutional orders at some time at the point
            17   of sale in the auction process.  And there is time priority.
            18   There are things that missed down there, but sometimes they
            19   just fall on deaf ears because they doesn't like the rules.
            20             But the rules are the rules, that's why the NYSE
            21   has been so successful because of the standards and rules
            22   that our SRO and our market surveillance staff and
            23   enforcement division carry out.  The exchange is not run by
            24   the members.  The exchange is run by a board comprised of
            25   twelve industry people, twelve outside directors that
             1   +represent industries, and we have three management directors
             2   on the board.
             3             MS. NAZARETH:  It has been a long day, but I think
             4   it was an extremely productive one.  I want to thank everyone
             5   for your participation on behalf of the staff and the
             6   Commission as well.
             7             (Whereupon, at 4:30 p.m., the meeting was
             8   adjourned.)
             9                             * * * * *
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