1

           1           BEFORE THE SECURITIES AND EXCHANGE COMMISSION

           2   -----------------------------------x

           3   HEARING RE:                             REVISED: 5/03/04

           4         PROPOSED REGULATION NMS           File No. S7-10-04

           5   -----------------------------------x

           6             InterContinental The Barclay New York

           7             111 East 48th Street

           8             New York, New York

           9             April 21, 2004

          10             9:01 a.m.

          11   COMMISSIONERS:

          12        WILLIAM H. DONALDSON, Chairman

          13        PAUL ATKINS

          14        CYNTHIA A. GLASSMAN

          15        HARVEY GOLDSCHMID

          16        ROEL CAMPOS

          17   ANNETTE L. NAZARETH, Director

          18        Division of Market Regulation

          19   ROBERT L.D. COLBY, Deputy Director

          20        Division of Market Regulation

          21   JONATHAN G. KATZ, Secretary

          22

          23

          24               Diversified Reporting Services, Inc.

          25                          (202) 467-9200

                                                                           2

           1                       P-R-O-C-E-E-D-I-N-G-S

           2             MR. DONALDSON:  Good morning.  There's a ring to

           3   that "good morning," everyone.  We are missing Commissioner

           4   Campos so we'll wait for just a second while we're waiting

           5   for him to arrive.  Let me just introduce my fellow

           6   commissioners, on my right, Commissioner Glassman, on my

           7   left, Commissioner Goldschmid, Commissioner Atkins, and

           8   Commissioner Campos hopefully to arrive momentarily.

           9             Let me begin by saying, on behalf of the Securities

          10   and Exchange Commission, I'd like to welcome our panelists

          11   and I particularly want to thank you all in advance for your

          12   participation at today's hearing on Regulation NMS.  Reg NMS

          13   was proposed by the Commission for comment in February and

          14   the aim is to modernize the regulatory framework of the

          15   National Market System.

          16             I also want to welcome members of the public and

          17   other interested parties to today's hearing.  Although the

          18   format of the hearing restricts participation and discussion

          19   to the panelists, it is our hope that the proceedings will

          20   inform and stimulate observation and questions by all who are

          21   attending today.  We hope, too, we'll have the full benefit

          22   of your thoughts via written submissions during the formal

          23   comment period and through ongoing discussions and

          24   consultations.

          25             The National Market System was mandated, as many of

                                                                           3

           1   you know, by Congress in 1975 and laid the foundation for

           2   competition among markets trading the same securities, while

           3   preserving wherever possible and practical the benefits of

           4   orderly interaction and price competition.  The National

           5   Market System relies on, one, public display of firm

           6   accessible quotations in a consistent format; two, the

           7   immediate display of orders to trade at or better than a

           8   specified price, commonly known as a limit order; three,

           9   consolidated publication of market quotation and trade data

          10   in a form that is both reliable and widely available; four,

          11   linkages between markets trading the same securities in order

          12   to foster efficiency and competition; and, five, in the

          13   exchange markets, rules that are designed to ensure that the

          14   best quote is honored before trades are executed at inferior

          15   prices.

          16             In general, our system of multiple competing

          17   markets has worked remarkably well.  Our markets are among

          18   the world's most competitive and efficient.  Competition

          19   among markets has fostered technological innovation and the

          20   creation of trading platforms and order routing systems that

          21   address the needs of all types of investors, regardless of

          22   size and sophistication.  Investor participation in the

          23   markets has exploded in the last decade.

          24             Over the past decade, however, there have been

          25   significant developments in our markets that threaten to

                                                                           4

           1   erode the efficient functioning of our National Market System

           2   regulatory structure.  Advances in technology and trading

           3   have led to the development of new alternative trading

           4   venues, particularly ECNs.  Their instantaneous electronic

           5   capabilities often do not interact seamlessly with

           6   floor-based exchanges and vice-versa.

           7             The number of trading venues has increased, and it

           8   has become more and more complicated and costly to access

           9   them, as some market centers charge fees to access liquidity. 

          10   These fees not only raise trading costs, but also cause

          11   identical published quotations to reflect significantly

          12   different true prices.

          13             Revenue from the dissemination of market data has

          14   become a significant funding source for SROs, giving them

          15   powerful incentives to maximize reported trade volume.  In

          16   turn, the structure of these incentives has produced

          17   problematic practices, such as so-called "wash trades" and

          18   "shredding," as ways to generate more "tape prints" and thus

          19   more market data revenue.

          20             The growth in subpenny trading has increased the

          21   risk that trivial quote increments will be used to step ahead

          22   of limit orders.  Limit orders have already been discouraged

          23   by decimalization, and the opportunities to "step ahead" of

          24   the trade increase geometrically in a subpenny environment.

          25             Regulation NMS as currently proposed grew out of

                                                                           5

           1   considerable preliminary fact-finding efforts and extensive

           2   discussions with industry participants and represents the

           3   critical next step toward the resolution of these issues.  In

           4   brief, the regulation in its current form is designed to

           5   encourage honoring the best price between markets by

           6   establishing a uniform trade-through rule for both exchange

           7   and NASDAQ listed securities, with proposed exceptions for

           8   slow markets and informed investor opt-outs.  It seeks to

           9   address the issues of efficient access between markets and

          10   inconsistent quote prices by establishing a uniform market

          11   center access rule with a de minimis fee standard.  It

          12   proposes to ban the display of subpenny quotes in most

          13   stocks.  And it would alter the rules concerning how market

          14   data is disseminated and priced.

          15             Regulation NMS was intended to advance the

          16   discussion by setting forth concrete proposals and then

          17   subjecting them to wide-ranging questions and critique. 

          18   While its publication was a critical step, focusing public

          19   comments on these critical market structures, I want to

          20   emphasize that the Commission has in no way reached any final

          21   decision on any of the proposals' provisions.  We are fully

          22   aware that these rules are complex and may have consequences

          23   not contemplated by the drafters of the proposals.

          24             The purpose of this hearing is to broaden the

          25   dialogue with respect to our proposals.  We intend to use

                                                                           6

           1   this opportunity to probe your responses and ensure that we

           2   understand the informed, analytical and factual underpinnings

           3   of your observation.  We will use this hearing, the written

           4   comments that we have already received, the comments we will

           5   receive subsequent to the hearing, and the results of a

           6   continuing process of consultation, to obtain insights to

           7   help us determine whether to adopt or modify the Regulation

           8   NMS proposal.

           9             To say that market structure issues are complex and

          10   controversial is an understatement, to say the least.  So the

          11   perspectives of the market participants here today and those

          12   who submit comments to the Commission are vital to assess the

          13   impact of the choices implicit in these proposals.  The

          14   efficient functioning of our capital markets has intense

          15   public policy aspects.  For example, the advantage obtained

          16   by some market participants at the expense of another subset

          17   of participants must be balanced against public policy

          18   mandates of fairness to all and not just those directly

          19   involved in a particular transaction.

          20             So I would ask that you put on your public policy

          21   hats for today's hearing.  You can help the Commission by

          22   putting yourself in our shoes.  You can help us by

          23   identifying public policy goods that can be achieved by

          24   enacting the right and appropriate market structure rule

          25   proposal.

                                                                           7

           1             With the reminder that there will be plenty of

           2   opportunity during the comment period to assess the fairness

           3   of the economic impact of these proposals on certain industry

           4   participants, I would ask that in your responses today, you

           5   try to put aside your institutional interests, your biases,

           6   and even your current business models.  I would ask that you

           7   set time-worn and all-too-familiar rhetoric to the side and,

           8   instead, give us the benefit of your frank and succinct

           9   insights about how the proposals and the alternatives to the

          10   proposals would serve our capital markets and the investing

          11   public from a public policy perspective.

          12             With that opening plea or prayer, I believe the

          13   time for considering market structure issues is now, and I

          14   very much look forward to delving deeply into the issues

          15   during today's hearing.

          16             Commissioner Campos has arrived.  Welcome.  So why

          17   don't we begin.

          18             Annette Nazareth, who heads our Division of Market

          19   Regulation, will have a few words to say.

          20             MS. NAZARETH:  Thank you, Bill.  I would like to

          21   thank all of our panelists, who so generously agreed to

          22   participate today in these proceedings.  As you know, we have

          23   a very ambitious agenda.  We have seven panels and we expect

          24   to go to about five-thirty.  Each panel is designed to

          25   address a specific element of proposed Regulation NMS.

                                                                           8

           1             The first two panels will address the trade-through

           2   proposal which, as you undoubtedly know, has engendered

           3   perhaps the greatest amount of controversy of the proposals. 

           4   We look forward to a very constructive dialogue on those

           5   issues.

           6             I thought I'd very briefly summarize the proposal

           7   for you and then introduce our panel.  The trade-through

           8   proposal would require any market center that executes orders

           9   to establish policies and procedures reasonably designed to

          10   prevent a trade-through, which is the execution of any

          11   incoming order for a security at a price that is inferior to

          12   the best price displayed in another market.  The

          13   trade-through proposal would apply to both exchange listed

          14   and NASDAQ securities.

          15             At the same time, the proposal would include two

          16   important exceptions that are designed to accommodate market

          17   centers with different market structures.  First, a customer,

          18   or a broker/dealer acting for its own account, would be able

          19   to consent on an order-by-order basis to having its order

          20   executed in one market, without regard to the prices in

          21   another market.  This exception is designed to provide

          22   greater flexibility to informed traders while preserving the

          23   average customer's expectation of having his or her orders

          24   executed at the best price.

          25             Second, an automated market, one that provides for

                                                                           9

           1   an immediate automated response to incoming orders for up to

           2   the full size of the best displayed bid or offer without

           3   restriction, will be able to trade through a better displayed

           4   price on a non-automated market up to a certain amount that

           5   would reflect to the greatest extent possible the cost of

           6   attempting to access the other market.

           7             This exception was designed to reflect the

           8   comparative difficulty of accessing market quotes from

           9   non-automated markets and to enhance the ability of

          10   individual markets to compete fairly with each other.

          11             Overall, the proposal is designed to be a practical

          12   response to the current criticisms and changes in the

          13   marketplace while still maintaining and indeed enhancing the

          14   important customer and market integrity goals of best

          15   execution and the protection of limit orders.

          16             So with that brief introduction, I would like to

          17   introduce our panel.  I can assure you that they look much

          18   better from this angle than the angle that you all are

          19   seeing.

          20             First on my far left is John Thain, who is the

          21   chief executive officer of the New York Stock Exchange; next

          22   to John is Bob Greifeld, who is president and CEO of The

          23   NASDAQ Stock Market.  Next, we have Scott DeSano, who is the

          24   head of the equity trading department at Fidelity

          25   Investments, then Ed Nicoll, the CEO of Instinet Group; next

                                                                          10

           1   Bob Steel, the vice-chairman of Goldman Sachs and who serves

           2   as co-chair of the market structure committee of SIA and we

           3   have Ivan Freeman, who is the chief operating officer,

           4   institutional equities of Morgan Stanley and, last but not

           5   least, Gus Sauter, who is chief investment officer of

           6   Vanguard Group.

           7             We've agreed prior to these proceedings that in the

           8   interests of time, we were not -- we were going to dispense

           9   with prepared statements.  If any of the panelists have

          10   prepared statements that they would like to introduce in the

          11   record, we would be happy to do that but we do want to get

          12   right on with the debate.

          13             Generally, the discussion of the trade-through rule

          14   and the questions that we want to address will fall into

          15   three general categories, the first being, is there really a

          16   need for a trade-through rule; the second being, is there a

          17   need for an opt-out and the third, would you need an opt-out

          18   if all markets were sufficiently -- provided for automated

          19   execution.

          20             So I wanted to start with the first group of

          21   questions that go to the need for the trade-through rule, and

          22   we'll go in order.  Again, in the interests of time, I guess

          23   if we could limit our initial remarks to two or three

          24   minutes, that would be very helpful.

          25             So the first questions are, are there any benefits

                                                                          11

           1   from an intermarket trade-through rule beyond those that are

           2   produced by the duty of best execution and investor interest,

           3   would an intermarket trade-through rule encourage the display

           4   of limit orders and would it make it more likely that such

           5   orders receive the best price?  And we'll start with John

           6   Thain.

           7             MR. THAIN:  Thank you.  Good morning.  Mr.

           8   Chairman, Commissioners, Annette, Bob, and other members of

           9   the Commission.  Thank you for the opportunity to be here

          10   today.

          11             The New York Stock Exchange is the largest and most

          12   liquid equity market in the world.  And one of its

          13   fundamental tenets is that orders are executed at the best

          14   price.  A trade-through rule ensures that all investors,

          15   minnows or sharks, get that best price.  And investors who

          16   provide liquidity to the market by entering limit orders are

          17   protected from their orders not being ignored.

          18             Individual investors, who unfortunately are not

          19   represented here today, overwhelmingly view price as the most

          20   important factor when they are executing trades in the

          21   marketplace.  The trade-through rule encourages markets to

          22   compete by offering the best prices.

          23             Weakening the trade-through rule, particularly

          24   allowing certain investors to opt out of the trade-through

          25   rule, will undermine investor confidence and reduce liquidity

                                                                          12

           1   in the marketplace.  The investor who provides liquidity to

           2   the market by entering the best bid or best offer is not

           3   being asked if he or she wants to opt out, and that's the

           4   person who the trade-through rule was originally designed to

           5   protect.  The prices at which trades are reported if the

           6   trade-through rule was weakened or people were allowed to opt

           7   out, would not reflect the true best prices available in the

           8   marketplace, undermining confidence in the reported prices. 

           9   And allowing trade-throughs will increase internalization of

          10   order flow and fragmentation of the marketplace.

          11             I believe, Mr. Chairman, as you said, that the

          12   interests of America's investing public must come first

          13   before the interests of certain large institutional investors

          14   or certain proprietary trading venues.  Weakening the

          15   trade-through rule, particularly the opt-out provision, is

          16   not in the best interests of U.S. and global investors, be

          17   they minnows or sharks.  Thank you.

          18             MS. NAZARETH:  Thank you.  Bob Greifeld?

          19             MR. GREIFELD:  This trade-through proposal has

          20   certainly received more publicity and created more

          21   self-appointed experts than those of us who work in the

          22   industry could reasonably imagine.  But if we attempt to

          23   reduce this issue to its essence, we realize that the heart

          24   of the matter is, what is the best protection for investors? 

          25   The best protection for investors is best execution.

                                                                          13

           1             I remember reading in 1993 the Commission's

           2   payment-for-order-flow release that defined best execution in

           3   terms in addition to price.  The Commission specified that

           4   liquidity, cost, price impact, accessibility and certainty

           5   were other important factors in determining best execution.

           6             At that time, I was attempting to build a business

           7   with a trade order management system called Brass.  And I

           8   recognized that incorporating best execution features into

           9   that trade order management system was a good business

          10   opportunity.  It was good for my business, but it was most

          11   importantly good for investors.

          12             Now, NASDAQ has operated without a trade-through

          13   rule for its entire history.  The NASDAQ Stock Market is

          14   governed by the principle of best execution.

          15             If we look at The NASDAQ Stock Market in its two

          16   hundred most actively traded stocks, we have a spread of one

          17   cent.  Our minimum price variation is one cent.  We cannot do

          18   any better.  These narrow spreads mean that we have vigorous

          19   limit order competition in our market.  The market orders in

          20   The NASDAQ Stock Market are the beneficiaries of this

          21   vigorous limit order competition.

          22             Reg NMS represents a bold step forward by the

          23   Commission and as we contemplate the impact, we should be

          24   guided by the principles that first, we should not fix what

          25   is not broken, and two, let's ensure that we do no harm.  We

                                                                          14

           1   understand the desirability for uniformity in the U.S. equity

           2   market and we support the Commission's effort with respect to

           3   Reg NMS.  We believe that careful implementation of a fast

           4   market definition with an opt-out provision will enable the

           5   NASDAQ market to suffer no harm.  We do state, however, that

           6   the failure of this Commission to adopt the opt-out rule is a

           7   denial of the full benefits of best execution as the

           8   governing force in our markets.

           9             We believe that the government should only be

          10   involved where the government must be involved.  The

          11   definition of a fast market by the Commission should be a

          12   two-paragraph description that mandates automated response

          13   and automated update.  The investors should determine the

          14   finer points of fast.  How do we allow the investors to

          15   determine the finer points of fast and how do we allow the

          16   investors to achieve best execution according to their

          17   investment objectives?

          18             The opt-out clause allows investors to opt in, to

          19   choose which attributes of best execution are important to

          20   them for that transaction.  The opt-out clause allows

          21   investors to opt in to their definition of fast.

          22             Without the opt-out clause, best execution is

          23   reduced to a single dimension of a concept of price.  Our

          24   industry's concept of best execution is derived from common

          25   law agency principles and fiduciary obligations.  Best

                                                                          15

           1   execution is truly a flexible concept that meets the needs of

           2   customers under diverse circumstances.  Reg NMS is about

           3   modernizing our equity markets.  Reg NMS is not about rolling

           4   back carefully evolved principles that govern many diverse

           5   industries in our country.  I urge the Commission not to put

           6   the concept of best execution in a straitjacket.  Thank you.

           7             MS. NAZARETH:  Scott?

           8             MR. DeSANO:  It's better to be called a shark than

           9   an eight-hundred-pound gorilla.

          10             Well, our view on trade-through is a very simple

          11   one, I think, and I would contend that we don't have an

          12   effective trade-through rule today and would echo a lot of

          13   the things that Bob just mentioned with respect to the fact,

          14   how NASDAQ has worked without a trade-through rule for all

          15   time.

          16             There's concern about limit orders out there if we

          17   don't have trade-through rules.  And I will assure you that

          18   we as an institution are more apt to put limit orders on

          19   NASDAQ than we are on other exchanges and we are not

          20   concerned whatsoever with there not being a trade-through

          21   rule.  We're a fiduciary and we are charged with doing the

          22   best job possible for our shareholders each and every day.

          23             That is the best all-in price that we can achieve

          24   for our shareholders, not the best individual price.  Walking

          25   a stock up or down is a painful process, trying to achieve

                                                                          16

           1   execution of large orders.  If we have the opportunity to see

           2   and capture liquidity at a price two, three, four cents away,

           3   but it completes our order, that's a much more effective way

           4   for us to do our transacting.

           5             Our fiduciary responsibility should allow us to

           6   have the ability to make decisions to go where we want, when

           7   we want, how we choose to.  Investors act in their own

           8   economic self-interest all the time.  They don't need to be

           9   instructed to do so.  We were going to get to the opt-out on

          10   the next go-around, but the simple fact is we don't see the

          11   need for a trade-through rule, we think that it works just

          12   fine without one on NASDAQ now and we're about choice.

          13             MS. NAZARETH:  Ed?

          14             MR. NICOLL:  In trying to answer the question

          15   without referring to our other rhetoric, I think the -- one

          16   of the things that I think the Commissioners have to be very

          17   cognizant of is that the trade-through rule is not -- does

          18   not give people priority for their limit orders, in the sense

          19   that it allows -- the trade-through rule allows

          20   internalization by all parties cap the limit order.

          21             So if the New York Stock Exchange, for instance, an

          22   order goes down there and establishes -- a limit order is

          23   displayed on the New York Stock Exchange, the rule is that

          24   people can trade through it.  The rule is not that people

          25   have to hit that limit order, because there's no time

                                                                          17

           1   priority.  There's price priority but not intermarket time

           2   priority.

           3             So what we are allowing is parasitic behavior at

           4   the price.  We are allowing competition at the price.  But

           5   somehow, we're concerned about the very few exceptions where

           6   one market center might want to trade through another by a

           7   few pennies.  And it seems to me that the notion that some

           8   put forth in which they conflate the duty of best execution

           9   with the trade-through rule, that somehow, supporting the

          10   trade-through rule is about protecting people's limit orders,

          11   is disingenuous unless they take the view, which very few

          12   people do, that those limit orders have to be respected both

          13   from a time-priority basis and a price-priority basis.

          14             And there's, I think, as far as I know, only one

          15   person on this panel who actually advocates that, at least

          16   it's a consistent, in my view, philosophical point of view. 

          17   If you are concerned -- the real issue here, and some imply

          18   that what the trade-through rule protects is the person who

          19   placed the limit order, then we ought not allow people to

          20   match that limit order in competing venues.  Yet we do all

          21   the time, and we allow that kind of internalization to take

          22   place between competing venues.

          23             In our view, you get very little benefit from the

          24   trade-through rule and yet you get a lot of harm.  You are

          25   disincentivizing competition.  You are allowing markets that

                                                                          18

           1   can manipulate their best advertised price to effectively

           2   freeze out other markets that are pure agency marketplaces. 

           3   There's a lot of cost to the trade-through rule, and we

           4   believe there's extremely little benefit.

           5             And for those who advocate the rhetoric that the

           6   trade-through rule is about protecting limit orders, let them

           7   totally protect limit orders and advocate a time priority as

           8   well as price priority.  Yet they don't do that.

           9             I think that, you know, our view is that the

          10   opt-out is a reasonable compromise between the two views. 

          11   It's a moderate and very modest exception to the

          12   trade-through rule.  We've seen this kind of modest proposal

          13   work in the past with respect to the three cent de minimis

          14   exception for the ETFs that has been very successful.  Of

          15   course, I think it's well known that we would favor total

          16   competition between market venues and let investors and

          17   traders choose how to execute their orders.

          18             But given where we come from and the market

          19   structure, we think that the opt out is an important but

          20   modest improvement to the current regulatory environment.

          21             MS. NAZARETH:  Bob?

          22             MR. STEEL:  Thank you, and it's a pleasure to be

          23   here.  I speak to you today on behalf of the Securities

          24   Industry Association so, as I've tried to develop a

          25   perspective that represents all 600 members of the SIA, I

                                                                          19

           1   have some sympathy for the task that you've assigned yourself

           2   to developing a single view.

           3             I think in reality, though, while I certainly will

           4   disappoint some members of the SIA, that the consensus is in

           5   favor of a trade-through rule for the reasons that have been

           6   articulated by the far right of my panel here today; that

           7   basically, and we'll get into this in the next question, that

           8   there should be some exceptions for choosing a different

           9   alternative or opting out, that in general the SIA favors

          10   that the trade-through rule protect the book as it is.

          11             MS. NAZARETH:  Ivan?

          12             MR. FREEMAN:  Thank you.  Thanks for having us

          13   here.  We operate as a broker/dealer in the U.S. equity

          14   markets and as a broker, we represent both individual and

          15   institutional investors and as a dealer, we can do capital

          16   trading in virtually every market in the U.S. and in every

          17   instrument.

          18             So against that backdrop, and really in the spirit

          19   of what Chairman Donaldson asked us to do, we put on both a

          20   public policy hat and in our interest in evaluating efforts

          21   to enhance the efficiency and fairness of the U.S. equity

          22   markets.  And we approached this without a bias toward a

          23   particular exchange or market center.  Instead, we really

          24   tried to evaluate what is the impact on the market itself,

          25   and on the ability for investors to accomplish what they want

                                                                          20

           1   to accomplish in the marketplace.

           2             Short of forcing interaction of orders to a single

           3   venue, we believe that a National Market System in which

           4   participants are economically induced to compete vigorously

           5   for market share on a level playing field is an attractive

           6   objective.  I think the overarching objective of an enhanced

           7   national market still should be to leverage these

           8   state-of-the-art meetings that we have at our disposal today

           9   to put in higher standards of best execution, so the National

          10   Market System should ensure that there is immediate

          11   accessibility of better prices on an away market.  But that

          12   also requires that we recognize that speed is an important

          13   element in obtaining the best execution.

          14             Ultimately, the informed customer's freedom of

          15   choice needs to be respected, and I'll defer the comments

          16   with respect to the opt-out in specifics to the next question

          17   round.  But I think that it is clear that from our

          18   perspective, the proposed Regulation NMS does move us closer

          19   to a National Market System objective that is attractive.

          20             A certain level of trade-through protection should

          21   be available to those placing market and marketable limit

          22   orders so long as you have clear standards of accessibility

          23   and that those standards are strictly enforced.

          24             We think that, as we read the rule, we don't view

          25   this as a safe harbor.  We don't view it as a substitute for

                                                                          21

           1   best execution.  It doesn't alleviate the burden on somebody

           2   handling an order on behalf of a customer to meet its best

           3   execution requirements.  So we think that standard is still

           4   going to hold.  But in the context of the question that's

           5   asked relative to whether the intermarket trade-through rule

           6   would produce benefits beyond those that due to the best

           7   execution and investor self-interest already do, we would say

           8   it does.  It quantifies something that creates a minimum

           9   standard and creates competitive behavior among market

          10   centers that allows market orders to be obtained in a manner

          11   in which they may not have been in the absence of the rule.

          12             MR. SAUTER:  I'd like to thank for you having me

          13   here today.  When Ed Nicoll referred to one person in the

          14   crowd who believed in price/time priority, I hope he was

          15   referring to me.  We have been consistent supporters of the

          16   concept of price/time priority.  In fact, we have been

          17   consistent supporters to the idea of a central limit order

          18   book; but I have no delusion that we're going to be able to

          19   argue that one today so I'll leave that one alone.

          20             Quite naturally, all investors want to minimize

          21   transaction costs and how do we do that?  By having the most

          22   liquid market possible.  So our view is, try to create a

          23   marketplace that is -- that does provide the maximum

          24   liquidity; in other words, provide the incentive to put limit

          25   orders on the book.  Price/time priority does create that

                                                                          22

           1   incentive.  At the same time, we think that a trade-through

           2   rule is necessary to preserve price/time priority.

           3             I would note that there's a natural tendency for

           4   investors to not place limit orders.  Who wants to convey

           5   that much information to the marketplace?  It's like playing

           6   a poker game where you're revealing your hand.  At the same

           7   time, you're also providing a free option to the marketplace. 

           8   You're willing to allow someone to put an order to you.  If

           9   they want to exercise against you, they have that right. 

          10   You're standing there always willing to be traded against.

          11             So that there is a natural tendency not to place

          12   limit orders, a natural tendency not to create liquidity in

          13   the marketplace which is, I think we all agree the optimal

          14   benefit to investors is to have a totally liquid market.

          15             Therefore, we think that we need to create some

          16   sort of incentive to place limit orders to get around that

          17   natural tendency to not placing orders.  We need to have some

          18   form of price priority, time priority ideally as well.  But

          19   we think a trade-through rule is necessary to ensure that the

          20   markets are not totally fragmented, to ensure that an

          21   investor that does place the best limit offer or bid is

          22   executed first.  We think it would be a tremendous

          23   disincentive to place limit orders if in fact other orders

          24   can be executed around you.

          25             We think that frequently the new entrant into the

                                                                          23

           1   marketplace, the entrant who is taking liquidity out of the

           2   market, is favored.  We think that the entrant that puts

           3   liquidity into the market, that places a limit order, should

           4   be favored.  So while we would say that there are many times

           5   where we would like to access all of the liquidity, say,

           6   perhaps away from the NBBO, we believe that would be

           7   detrimental to the marketplace.  We might be best served at

           8   that instant in time taking a price away from the NBBO by

           9   being able to fill a hundred-thousand-share order or

          10   half-a-million-share order.  But we think in the long run

          11   we're creating a disservice to ourselves if we do skip the

          12   NBBO and hit the maximum liquidity provided at a different

          13   price, an inferior price.

          14             We've created a disincentive to put limit orders on

          15   the books.  If the person who established the NBBO is

          16   ignored, they won't come back.  They won't continue to place

          17   limit orders.

          18             What we -- we, ourselves, place fewer limit orders

          19   than we used to because of some of the recent changes in the

          20   marketplace which we actually view as being positive, that

          21   being decimalization; but at the same time, it showed many of

          22   the problems in the marketplace.  So we do place fewer limit

          23   orders now than we used to.

          24             I would note some of the comments about limit

          25   orders not needing a trade-through rule in the NASDAQ

                                                                          24

           1   marketplace.  I would point out that in fact, NASDAQ market

           2   makers have a best-execution requirement.  And I believe if

           3   you ask most of them, they think that means that they have to

           4   honor the NBBO.  So in effect, you do have a quasi limit

           5   order requirement in the NASDAQ marketplace.

           6             And I would also note that ECNs are designed to

           7   honor price-time priority; at least price-time priority is in

           8   their own system but they also seek best price outside of

           9   their system.  So I don't think that comparing the NASDAQ

          10   marketplace, that, quote-unquote, does not have a limit

          11   order -- I'm sorry, a trade-through requirement, with the

          12   listed markets, and saying, "Well, one market functions fine

          13   without trade-through rule, therefore, the other market

          14   doesn't require it as well," I think that in effect, there is

          15   a quasi trade-through rule being honored in the NASDAQ

          16   marketplace.

          17             So again, we think that limit orders should be

          18   encouraged and we think the best way to encourage them is to

          19   make sure that they are protected and given price priority if

          20   not time priority as well.

          21             MR. DONALDSON:  I'm sure that my fellow

          22   Commissioners have got questions they would like to ask.  I

          23   suspect maybe all of you have got questions you'd like to ask

          24   of each other.  Let's start and see if the Commissioners have

          25   anything.

                                                                          25

           1             MS. GLASSMAN:  Yes, I have a couple of questions. 

           2   First, on our proposal to except the trade-through rule for a

           3   slow market so the trade-through would only be for fast

           4   markets, what is fast enough?  What does "fast" mean?

           5             MR. NICOLL:  If I could jump in, I think that's one

           6   of the problems.  At Instinet, we've worked to reduce our

           7   response time from milliseconds to microseconds.  We now have

           8   total turnaround times under a millisecond.  For those

           9   uninformed a millisecond is a thousandth of a second.

          10             We're not -- we're not, you know, we're leery of a

          11   rigid definition of what is and what is not a fast

          12   marketplace.  We think, for instance, if you were to say that

          13   a fast marketplace is one that responds within seconds, that

          14   would create not a, you know, not a ceiling, but in effect a

          15   floor.  And, you know, and you would have all markets

          16   basically responding to a second, because there would be, you

          17   know, it would give everybody the ability to be part of this

          18   large trade-through regime and yet have the slowest

          19   marketplace.  This is essentially the problem.  You are

          20   looking at one simple criteria of competition, which is

          21   price.

          22             Now, without -- without, you know, preaching, I

          23   mean, I think it is -- I agree with the New York Stock

          24   Exchange.  At the end of the day, it's all about price. 

          25   Customers want to get the best price.

                                                                          26

           1             The question is, how do they achieve that?  Do they

           2   achieve that simply by chasing the best advertised price or

           3   by interacting in the marketplace according to various

           4   criteria that they believe will get them the best net price

           5   in terms of executing their orders?  And if we are to simply

           6   reduce competition to the best advertised price, as we do in

           7   the trade-through rule, then we have a -- we have a set of --

           8   of perverse incentives to actually go to the slowest, to

           9   create the slowest market within the rules.

          10             So whatever you define as -- as an automated market

          11   is effectively going to be the floor and it's going to, in my

          12   view, it's going to stop innovation from people trying to

          13   offer better, faster, different kinds of marketplaces.  And

          14   this is the -- my worry about the trade-through agreement.

          15             MR. DONALDSON:  If I could just jump in on part of

          16   your question, that is, a one-second market, two-second

          17   market, what's the need for a micro or millisecond execution

          18   capability?  How much of the marketplace is affected by that?

          19             MR. NICOLL:  Let me just answer that and then I'll

          20   let others answer.  We are working on microseconds because we

          21   want our system to be completely responsive and real-time, in

          22   the most contentious environment --

          23             MR. DONALDSON:  My question is, responsive to whom?

          24             MR. NICOLL:  Everybody.

          25             MR. DONALDSON:  How much of the overall market is

                                                                          27

           1   interested in micro or millisecond trading?

           2             MR. NICOLL:  I think it's important to everybody

           3   because when you reduce response times, and you have massive

           4   spikes in demand into the system, those reduced response

           5   times give everybody what amounts to a seamless interaction

           6   into the marketplace, even in the fastest time.

           7             You're right, a trader right now cannot even tell

           8   the difference between twenty milliseconds where we used to

           9   be, and three hundred microseconds where we are now.

          10             But when the Fed chairman has something to say, and

          11   everybody wants to enter the market at the same time,

          12   reducing response times to microseconds is important to

          13   eliminating latencies in the system due to overall demand

          14   into the system.

          15             MR. DONALDSON:  Do you have any idea how much of

          16   the marketplace is affected by that?  That's my only

          17   question.

          18             MR. NICOLL:  I think it's most important at the

          19   time when the most amount of people want to access the market

          20   immediately.  And I don't know -- I don't know.  I don't know

          21   if we are actually getting a bang for a buck in terms of

          22   trying to reduce the response time as much as we have.  I do

          23   believe that we ought to be able to try give kinds of systems

          24   and compete on different criterias of value and let

          25   traders -- I'm trying to get Scott's business.  I'm not quite

                                                                          28

           1   sure what it is that I've got to do to get Scott's business,

           2   but I think you ought to let competition play out and let

           3   Scott and Gus -- let us know what it is that we have to do to

           4   meet the demands.  And the demands of the Ameritrades and the

           5   customers around the world.

           6             Just one last thing.  I made a lot of money

           7   offering a system that guaranteed retail investors 60-second

           8   response times.  Last, I think, two weeks ago, the

           9   competition in terms of response time is now down to two

          10   seconds.  One of the on-line brokers is guaranteeing a

          11   two-second execution.  Those people are responding to the

          12   needs of individual investors and the demands for speed by

          13   individual investors.  I don't know how well it's going to

          14   go, Mr. Chairman, I honestly don't.

          15             MR. FREEMAN:  I think this question actually goes

          16   to the heart of one of the question that outlines the opt-out

          17   issue.  Because the concept of fast or the concept of

          18   autoexecution is to some degree in the eyes of the beholder. 

          19   What does that constitute?  And we could be talking about the

          20   turn-around time from the time an order actually hits a

          21   market center, is processed and turned around, but from an

          22   investor's perspective, you probably also have to consider

          23   the trip from the investor's point of decision to the market

          24   center.  So really you need to look at the time between, and

          25   understand where the access can accommodate peak volume or

                                                                          29

           1   whether or not in fact there's some latency as a result of

           2   that.

           3             And I think to a large degree different investors

           4   will have different priorities in terms of how they look at

           5   what is fast and in particular, how fast impacts their

           6   meeting their overall objective of what they would consider

           7   best execution to be in the context of their overall rules in

           8   the marketplace.

           9             MR. SAUTER:  Our view of fast is immediate.  It's

          10   faster than humans can do.  It's an automated process.  We

          11   would like to be able to access all of the liquidity of the

          12   marketplace to fill an order.  That might mean that we would

          13   have to jump from venue to venue and perhaps hit ten

          14   different venues in order to get our entire order filled.  In

          15   a volatile marketplace, if there's a second delay or even a

          16   half a second delay, at a given exchange, that may mean that

          17   our order goes unexecuted.  We believe that best execution

          18   has two components.  I mentioned earlier best price and

          19   certainty.

          20             And with speed, you get certainty.  We can look and

          21   see what the national book, quote-unquote "national book"

          22   looks like at this instant in time.  If we had linkages in

          23   place, we could hit every -- every offer out there at a very

          24   instant in time.

          25             That is, for us, an ideal.  So a fast market is an

                                                                          30

           1   instantaneous market to us.

           2             MS. GLASSMAN:  I have a lot of questions but I know

           3   we have limited time so I will just ask just one that follows

           4   up on what George just said.

           5             The debate in some sense has been characterized as

           6   speed vs. price, speed vs. best price.  But isn't it really,

           7   speed is certainty, certainty now, vs. uncertainty later, and

           8   so the slower market means less certainty that you'll

           9   actually get that advertised price?  Isn't that the issue?

          10             MR. SAUTER:  Yes, it is, in our view.

          11             MR. DeSANO:  Let me also add one more component to

          12   that.  Speed, certainty and volume.  Your buying a couple of

          13   hundred shares here and there is not a lot of use to a lot of

          14   institutional investors.  So we look at it in three

          15   components; the all-in price, and buying is a very key

          16   component.  Speed and certainty are equivalent.

          17             MR. GREIFELD:  I think the global issue is again

          18   about choice.  But we believe the best execution allows the

          19   investor to have choice of what's important for them.

          20             I tie back to Gus' comment.  He said that in the

          21   NASDAQ market, we essentially operated with a trade-through

          22   rule in place, even though none exists.  And that is a direct

          23   result of the fact that we're governed by best execution.  So

          24   we talk about standards of best execution, we ourselves

          25   include price as first among equals.  It's not the only one,

                                                                          31

           1   the only standard.  But it's first among equals, and that's

           2   how the NASDAQ market operates today without a trade-through

           3   rule.

           4             In the rules contemplated here with Reg NMS, to get

           5   us back to the competitive dynamic that exists, we think we

           6   need to have the opt-out.  The opt-out represents the opt-in

           7   opportunity for investors to choose; choose based upon

           8   various criteria that are outlined under best execution that

           9   have been supported by this Commission for a long period of

          10   time.

          11             MR. DONALDSON:  Anyone else?

          12             MS. NAZARETH:  Why don't we --

          13             MR. GOLDSCHMID:  Annette, let me lead you into

          14   where I think we've got to go.  On the opt-out, will it

          15   fragment the market, will it give too much advantage to,

          16   whether you want to call them sharks or whales, gorillas,

          17   pick your own.  But tell me what's really going to happen.

          18             MR. THAIN:  Commissioner Goldschmid, let me add on

          19   to some of the prior panelists and get your answer to the

          20   question.  First of all, price is not the only criteria, and

          21   one of the reasons why we support the Commission's position

          22   on fast market/slow market is that we understand that if

          23   there is a dramatically different execution time, that

          24   markets do move very quickly.  And so speed does make a

          25   difference to people.

                                                                          32

           1             And I also agree, though, that price should be

           2   first among equals.  So the fast market/slow market

           3   definition, and the differentiation between those markets,

           4   and I do think there's issues about exactly how you define

           5   automatic fast markets, I think the simplest way is that they

           6   provide automatic execution, which basically means

           7   computer-to-computer execution, and I frankly don't think it

           8   makes very much difference whether we argue about

           9   milliseconds or microseconds or anything like that, as long

          10   as you get a direct computer-to-computer execution which, by

          11   the way, also gives you the certainty.

          12             But once you have fast markets, once you have

          13   computer-to-computer certain automatic execution, there is no

          14   reason why you shouldn't go to where the best price is.  And

          15   if you allow people to opt out after you get comparably fast

          16   markets and comparable certainty, and by the way, the other

          17   thing the NASDAQ would like, which I'm sure he'll say

          18   eventually, is anonymity, which he also gets with an

          19   electronic execution, a computer-to-computer execution.  Once

          20   you get to that stage, there is no good reason and no good

          21   public policy reason why you should not execute at the best

          22   price.

          23             And the ability for institutions or "informed

          24   investors" to opt out after they have that same execution

          25   capability will lead to internalization of order flow, which

                                                                          33

           1   is bad for the market, it will not protect the limit orders,

           2   which you've heard from a number of people, is a very

           3   important thing, and ultimately, will lead to fragmentation

           4   in our marketplace.

           5             MR. DONALDSON:  I'd like to ask just a general

           6   question of, Scott, you and Bob have talked about, I think

           7   your words were, "Executing an order in terms of what's

           8   important for that order."  And I guess my question is, is

           9   there an obligation, a fiduciary obligation if you want to

          10   call it that, an obligation for a marketplace itself to look

          11   beyond your interests in a particular transaction toward the

          12   interests of the marketplace itself?

          13             In other words, is there any obligation to think

          14   that this may be best for me at this particular moment to opt

          15   out and hit the best execution, and in so doing, perhaps I

          16   damage other parts of the market that aren't involved in my

          17   transaction to get a limit order that gets passed?

          18             MR. GREIFELD:  A very good question.  I think the

          19   question results from the concept of an existing limit order

          20   that gets opted out.  And the thought seems to originate from

          21   the fact that an existing limit order that's opted out is

          22   frozen in time and is not, in itself, portable.

          23             The way I look at this discussion is, we have

          24   competing self-interest.  And the competing self-interest is

          25   governed by best execution.  So that limit order that is sent

                                                                          34

           1   to a market is sent by a broker who has an obligation of best

           2   execution for that order.  And that broker has to evaluate,

           3   dash 5, dash 6 status, to make sure he's sending it to the

           4   proper market center.  And I think the fundamental fear of

           5   the New York Stock Exchange and others is that an existing

           6   limit order will choose the best outcome for itself and has

           7   the ability to move in the new world.

           8             So you have the order that can be opted out, and

           9   you have the new order coming in.  But they both have their

          10   self-interest under best execution, and they both will come

          11   to arrive at what's best for that order.  So the fact is, if

          12   I send an order to an exchange and I'm not getting a fill, I

          13   have the ability to move that order.  And I was going to move

          14   that, I was going to say picoseconds, which is billionths of

          15   a second, but we're not there yet, but I can move that very

          16   quickly.  So that order that is there is portable and can

          17   move the milliseconds and get to the place where you want to

          18   go.

          19             MS. NAZARETH:  Bob, you could answer Commissioner

          20   Goldschmid's questions, maybe everybody can answer both sets

          21   of questions, and I think John, if you want to jump in on the

          22   last part --

          23             MR. GREIFELD:  Make sure I answered it properly.  I

          24   wanted to make sure I got the full benefit.

          25             MR. GOLDSCHMID:  Fundamentally, Bob, it goes to the

                                                                          35

           1   heart of what opt-out is going to be, will it fragment, will

           2   it help out the big guy and not the small guy, what's really

           3   effected?

           4             MR. GREIFELD:  I think opt-out will be used less

           5   and less in time as the market centers learn to compete, and

           6   we saw this happen in the NASDAQ marketplace after Reg ATS. 

           7   Certain ECNs were actually faster to respond.  And we had to

           8   learn that customers were measuring milliseconds and making

           9   intelligent routing decisions.  And there was a big gap of

          10   performance.  Ed mentioned 22 milliseconds.  They might --

          11   somebody's at 22 milliseconds, everybody else was at, you

          12   know, a hundred, 150.

          13             Within twelve months, it wasn't days and it wasn't

          14   weeks, but within twelve months all the competitors were in

          15   around 22 milliseconds and at a point it doesn't matter, the

          16   speed difference, and I would say once you're into

          17   milliseconds, the difference between 20, 25 and 30 really

          18   doesn't matter to very many investors at all.  So what you

          19   saw is investors responded to what the customer wanted and

          20   what they did is improve their systems.  And the incidence of

          21   opt-out in the NASDAQ marketplace declined as competitors had

          22   to respond to the market forces.

          23             We're saying what the opt-out is, is the market

          24   forces will be released to make sure that we all have to

          25   compete and compete effectively.

                                                                          36

           1             MR. GOLDSCHMID:  You say it as basically a

           2   corrective to keep flexibility and pressure on, if I

           3   understand.

           4             MR. GREIFELD:  The way I look at it is, right now

           5   you can define a fast market literally in two paragraphs.  If

           6   you don't do it that way, if you don't have an opt-out, you

           7   have to write a book.  You have to write a book of rules, and

           8   writing a book of rules is difficult but it can be done.  But

           9   the really insurmountable task is to follow and track who is

          10   following that rulebook, and you have to follow that not in

          11   an audit once a week, once a month.  You have to follow it

          12   every second of every single trading day.  And Ed points out

          13   that there are certain points in the trading day where the

          14   volume just explodes.  You have to have a whole set of rules

          15   and a whole set of tracking for that.  The opt-out will let

          16   the market determine who is actually providing the fast

          17   market.

          18             MR. GOLDSCHMID:  After yesterday, you think there

          19   can be an explosion?

          20             MR. DeSANO:  I would add in on the fast market

          21   notion that we would like to be able to access multiple

          22   levels of the book, in order to be considered a fast market. 

          23   Also with respect to where this fragment, I mean,

          24   SuperMontage has about 18 percent market share and Mr. Thain

          25   has a much higher market share and we see very little

                                                                          37

           1   difference in our day with respect to trying to get done what

           2   we need to get done given that disparate market share

           3   difference.

           4             What else do we have?

           5             MS. NAZARETH:  Opt-out.  What does the opt-out do?

           6             MR. DeSANO:  Well, the opt-out, there are different

           7   constituencies who obviously have different purposes and

           8   needs.  And you spoke to, you know, if we need to do

           9   something, do we worry about hurting other people.  That

          10   would be really difficult for me to go in to our board of

          11   trustees and say, "I really didn't take care of our

          12   shareholders because I was afraid I was going to damage the

          13   marketplace."

          14             That's an unacceptable explanation from me to the

          15   board of trustees.  And that's why we get involved in this

          16   process, to try to worry about those issues in this kind of

          17   setting so that we work in a viable market structure that's

          18   good for all.

          19             But the opt-out is about choice.  And it's about

          20   having informed investors go where they want to go, when they

          21   want to go, in a manner that suits their needs.

          22             To have this dictated to me precludes you from

          23   being able to achieve best execution.  Best execution is best

          24   all-in price to us.  That's what it is.  And if I have to do

          25   a hundred trades at the best price at that moment to get a

                                                                          38

           1   certain order done as opposed to ten trades, I guarantee it's

           2   going to cost a lot more money for our shareholders.  And so

           3   we need to be able to exercise our judgement to go where we

           4   want and when we want using our fiduciary responsibility and

           5   our understanding of best execution.  And that's why I

           6   believe the opt-out is absolutely necessary in this process.

           7             MR. DONALDSON:  Let me just push on that now.  You

           8   know, in terms of your trustees.  Assume for a minute what --

           9   an extension of what you're saying is, we ought to be able to

          10   trade anywhere, any time that suits your particular purposes

          11   at that moment.

          12             Supposing that the result of that was people's

          13   unwillingness to place limit orders, and supposing the day

          14   after tomorrow, one of your trustees asks you, "What's

          15   happened to the marketplace?  There's no limit order, there's

          16   no market that I can refer to; has your doing anything you

          17   want for a period of time done this to our market?"

          18             MR. DeSANO:  Essentially that's where we are now. 

          19   We don't place limit orders because there's no real

          20   protection out there.  We're going through this in the hopes

          21   that by having each venue have to compete, you know, head to

          22   head, just pure competition, that we get to a world where he

          23   will be comfortable placing limit orders.  The situation is

          24   not a comfortable one now and I think this is a means. 

          25   Allowing the opt-out is a means to create and foster

                                                                          39

           1   competition between venues to get order flow and in the end,

           2   I think that you'll see far more limit orders show up.

           3             MR. DONALDSON:  What change, now, would make you

           4   more comfortable placing limit orders?

           5             MR. DeSANO:  Everybody gets to trade by the same

           6   rules.  You don't have a geographic advantage.  Our orders

           7   don't get broken up.  We don't get price improved.  There's a

           8   lot of --

           9             MR. DONALDSON:  You're talking about access?

          10             MR. DeSANO:  Access.  I think time priority by

          11   venue is important.  But not across venues.

          12             MR. NICOLL:  Can I try and really touch on your

          13   concern?  Really, what you're talking about is that if we

          14   allow people to trade through limit orders, that people will

          15   stop placing limit orders.  And while it might be in the --

          16   in an individual's interest to trade through an order, that

          17   the -- at the Commission, there's a public policy issue here

          18   that we want to protect the incentives market-wide to

          19   place -- limit orders, getting people -- I mean, placing

          20   limit orders is getting people to reveal their reference

          21   points, you know?  I mean, that's what really market

          22   structure ought to encourage, it's getting people to openly

          23   say what they want to try and sell.  And we need to create a

          24   set of policies to the greatest extent possible that

          25   incentivizes people to reveal their reference price in the

                                                                          40

           1   marketplace, to, in effect, place limit orders.

           2             And you're worried that an opt-out provision to the

           3   trade-through rule will create disincentives for people to

           4   place limit orders and yet, what we're really talking about

           5   here now, okay, is a world in which stocks are trading in

           6   increments of a penny, okay?  Not eighths and quarters and

           7   when the trade-through rule was passed thirty years ago, but

           8   a penny.

           9             We are allowing people, and there's no talk, other

          10   than Gus, there's no talk of a CLOB anymore, there's no talk

          11   of time priority.  So although the New York Stock Exchange

          12   talks about protecting limit orders, they are quite happy to

          13   compete with the Chicago Stock Exchange by matching the

          14   Chicago Stock Exchange's limit orders and not sending their

          15   order to the Chicago Stock Exchange.  So really what you're

          16   saying -- so we don't have that now, largely.  We have an

          17   occasional -- an occasional trade-through and there are

          18   literally hundreds of traders on the streets now, as we've

          19   reduced the cost of trading, who will arb markets for a

          20   penny.

          21             So do we want to create this structure with all the

          22   disincentives for competition to worry about that, the rare

          23   occurrence when markets trade through each other, while at

          24   the same time we allow them to ignore each others' limit

          25   orders simply by matching them?  One of the reasons why

                                                                          41

           1   people don't place limit orders now in particular venues,

           2   because another venue can simply match those orders and

           3   internalize against that.

           4             So the fact of the matter is, we don't have a lot

           5   of protection for limit orders.  We have a situation in which

           6   venues are competing.  The people who place limit orders are

           7   the people who are the power.  They are -- they are the

           8   people that venues compete for.  And I think the best from a

           9   public policy position is, you ought not to worry about the

          10   occasional trade-through for a penny.  What you ought to

          11   worry about is incentivizing these various venues to compete

          12   with each other so that you know, we -- the competition

          13   settles in on that venue which meets the needs of most

          14   investors.

          15             There's -- this is not a world in which people are

          16   trading through each other for twelve-and-a-half cents

          17   anymore and I submit to you that there's rare -- we rarely

          18   see trade-throughs that -- that the Commission would need to

          19   be concerned about in the NASDAQ marketplace, where there is

          20   no trade-through rule

          21             MR. STEEL:  I think there are two questions.  Let

          22   me try to address them specifically.  One, I think from

          23   Commissioner Goldschmid was, the issue, would you end up with

          24   a fractured marketplace, and I think it's that consternation

          25   that the SIA interprets that we should have a narrowly

                                                                          42

           1   available opt-out provision and we should do this in a more

           2   patient way as opposed to an opening where there's more, a

           3   greater degree of flexibility with regard to opting out.  So

           4   I think that addresses that issue and I think that is a

           5   consternation, and so the fast-slow is our first step in

           6   trying to think about that, and so that I think is a public

           7   policy issue.

           8             I think the second issue that the Chairman raises

           9   is one that really has to be the -- the big issue for all of

          10   us, and that is that it's quite imaginable to me that some of

          11   us are going to have to have a reduction in our ambition

          12   because it's for the public policy good.  And I think that to

          13   the extent that you help proscribe that and say that these

          14   are the rules of the road that are required for the benefit

          15   of the marketplace, it will be helpful to all because Scott

          16   does have a fiduciary duty.  And to have him be unclear as to

          17   how to do that is a little bit unfair to him, and I think the

          18   dialog with his trustees is a challenging one for him to

          19   have.  And so I think the conclusion would be that a

          20   relatively proscribed opt-out, and then with clarity about it

          21   so then people can begin to play within the defined rules

          22   would be I think a policy perspective that addresses both of

          23   your questions, I think.

          24             MR. FREEMAN:  I think the point that was made about

          25   freedom of choice is an important one and that we support the

                                                                          43

           1   view that --

           2             MR. DONALDSON:  Get closer to your microphone.

           3             MR. FREEMAN:  I'm sorry.  That the customer should

           4   be a final arbiter of what constitutes best execution for him

           5   or her in the context of the markets and to resolve the issue

           6   of how fast is fast, et cetera.  But I think we should also

           7   look at the existence of antitrade-through rules or

           8   trade-through protection and the behavior modification that

           9   that engenders on the same aspect of behavior modification

          10   with respect to the placement of limit orders, and I'll

          11   elaborate on -- for those who aren't familiar, that means

          12   that they -- they move around in time and space and price and

          13   react to the market as well.

          14             They are moving.  And you have to presume that the

          15   impact of a trade-through rule on the execution of market

          16   orders, and marketable limit orders, is also going to have an

          17   impact on the behavior of how limit orders get routed, and

          18   that this concept that there's a best execution obligation

          19   for how to route limit orders is quite valid, that if

          20   somebody is getting traded through routinely because maybe

          21   that was perceived as a slower venue, there will be a

          22   decision to be made, is that the right place to place limit

          23   orders.  So I think we have to be cognizant of both the

          24   interaction of the two as well as the dynamics of limit

          25   orders.

                                                                          44

           1             One other point that I would make is that we should

           2   also recognize that even in the absence of an opt-out rule,

           3   just the dynamics of the marketplace are going to lead to

           4   things that will be trade-throughs on the tape.  There's lots

           5   of market dynamics today including capital commitments if you

           6   traded intraday and need to get put up on the tape because we

           7   want to see all trades that take place when they get

           8   reported -- by the way, there's a 90-second requirement for

           9   posting trades if the first place, so you can see latency in

          10   trades that are not as late, but could look to the limit

          11   order placement as trade-throughs.

          12             And there's also lots of activities that take place

          13   in the cash markets that is reflective of activity that was

          14   going on in the derivative market.  So you can see that

          15   executions are taking place where they are at the market, but

          16   they are against, not cash, but against derivative

          17   transactions, and may not look like they are meeting a best

          18   execution standard from the perspective of a trade-through

          19   rule but are quite valid trades and may be perceived by a

          20   limit order placer as a trade-through.

          21             So I think we need to tolerate that even in the

          22   absence of any opt-out protection, or even in the other

          23   exemptions, and given the other exemptions that are in the

          24   rule with respect to contemporaneously trading, there will be

          25   appearances of trade-throughs.  And that's a factor in the

                                                                          45

           1   market today and you'll see that continues as the

           2   trade-through rule change goes through as proposed.

           3             MR. SAUTER:  To answer Chairman Donaldson's

           4   question first about fiduciary obligation and the requirement

           5   to minimize transaction cost, we would -- we believe there's

           6   a very different set of circumstances in the short run vs.

           7   the long run.  If you try to minimize your transaction costs

           8   on one trade, you can do that by perhaps opting out and

           9   leapfrogging the NBBO.

          10             We think that that perhaps does not minimize -- we

          11   believe strongly it does not minimize transaction costs in

          12   the long run and our goal is to minimize our total

          13   transaction costs.  So we do worry that the opt-out rule

          14   really does lead to fragmentation in the marketplace as well. 

          15   We would like to see a marketplace that ultimately is

          16   somewhat of an integrated National Market System that would

          17   enable investors to literally ping back and forth across the

          18   National Market System hitting limit orders as they go on

          19   their way to getting complete execution.

          20             If you had that instantaneous type of system set

          21   up, there would be no logical need for an opt-out rule.  Who

          22   would chose to opt-out if you could take everything on the

          23   way up?

          24             So we strongly oppose an opt-out rule because we

          25   believe that in the long run, that does disincent limit

                                                                          46

           1   orders, even though it might enable us to get a better fill

           2   in the very short run.

           3             We would support the de minimis exception in the

           4   short run because we believe that actually sunsets on itself. 

           5   The de minimis exception really would ultimately require all

           6   markets to become automatic, fast, if you will, and once that

           7   happens, it does create a national market book, if you will,

           8   and therefore, would sunset on itself.

           9             MR. THAIN:  May I just add one thing?  Mr.

          10   Chairman, there are markets that don't have these kinds of

          11   rules.  Many of the fixed income markets don't have these

          12   kinds of rules.  And those markets are characterized by lack

          13   of transparency, by much wider bid-ask spreads, by no

          14   centralized source of liquidity, and frankly, by

          15   broker/dealers being able to make a lot of money in them.

          16             And so I think that there are examples of what

          17   happens when you don't have these types of rules but I don't

          18   think that's good for the U.S. equity markets and I don't

          19   think that's good public policy.

          20             MR. CAMPOS:  Can I ask what the status is of this

          21   ideal world of interconnectivity, is that something that can

          22   be accomplished relatively soon, are we -- I mean, I keep

          23   hearing about this pinging back and forth from market to

          24   market.  But yet, when we get down to details, it doesn't

          25   seem to really be there.

                                                                          47

           1             MR. SAUTER:  It's pretty well there in the

           2   ECN/NASDAQ marketplace.

           3             MR. THAIN:  I think, Commissioner, probably -- I

           4   don't -- there aren't many things probably all of us would

           5   agree with, but hopefully this is one, and we'll see.

           6             I think most of us will agree that ITS in its

           7   current construct doesn't work.  And so it needs to be fixed

           8   so that you do in fact get good interconnections between the

           9   marketplaces.

          10             MR. ATKINS:  Well, actually that was one question I

          11   wanted to give back because I have a lot of questions about a

          12   lot of this.  But to get to a practical question, with

          13   respect to what is it right now, and we're talking about the

          14   trade-through rule, that at least when we were looking at

          15   this with respect to the ETFs last year, year-and-a-half ago,

          16   whenever it was, and then what was seen through some of our

          17   enforcement actions, I really wonder what does exist right

          18   now with respect to the trade-through rule and with respect

          19   to ITS, you know, a lot of people say that ITS was meant from

          20   the beginning to not work.  And so we're sort of seeing that

          21   now.

          22             So I'm wondering what, as far as each of your

          23   perspectives go, whether or not the trade-through rule is

          24   effective right now in the markets.

          25             MR. NICOLL:  I think it's ironic, I agree with --

                                                                          48

           1   this is where I just have to say how ironic it is, with my

           2   good friend Gus, we're saying that we had an effective

           3   national market system in NASDAQ where there is no

           4   trade-through rule, which has created competition where there

           5   are mechanisms in which we are accessing each other's markets

           6   at lightning speed and an effective de facto CLOB as a result

           7   of that and I would argue, Gus, and I would argue to the

           8   Commission, that that's because of competition that is played

           9   out without the rigid hand of regulation requiring people to

          10   go to one venue vs. another.

          11             And I don't think, I think there are thousands and

          12   thousands of trade-throughs within the listed -- between the

          13   markets, I mean, I think, you know, there are -- there are

          14   trade-throughs in the ETFs all day long and the markets are

          15   apparently locked all day long, yet they shouldn't occur

          16   because things -- because when you trade a hundred million

          17   shares a day, which is what the QQQs trade, every day,

          18   whether we like it or not, it's trading a hundred million

          19   shares a day, it's so fast that it's almost impossible to

          20   have an orderly National Market System where everybody goes

          21   in absolute order, even with computers, even with a

          22   trade-through rule overlying it.

          23             And really what we have is a kind of chaos of

          24   activity which has in fact, you know, lowered transaction

          25   costs.  The QQQs, since we created a de minimis exception in

                                                                          49

           1   the QQQs, we've seen the spread go from an average of six

           2   cents where, today on Inet, the spread is three tenths of a

           3   penny.  That is effectively trading with no -- with no cost

           4   between the bid and the offer.  And that kind of -- of

           5   competition and the interplay of technology --

           6             MS. NAZARETH:  Ed, I have to add I have no

           7   recollection of the spread on that --

           8             MR. NICOLL:  Well, I --

           9             MS. NAZARETH:  -- I hadn't finished -- extremely

          10   narrow all along and the three cent de minimis with a market

          11   that normally trades at a tenth of a cent is enormous.  So --

          12             MR. NICOLL:  Well, I can go back and we can

          13   question the statistics that were given to me and we can go

          14   through that.  Clearly, the spread is narrowed and the spread

          15   today is three tenths of a penny and we can certainly

          16   demonstrate that that's the case.  And it's not around a

          17   penny increment.  It's a true subpenny spread.  But we -- but

          18   there are lots of trade-throughs.  There always have been

          19   lots of trade-throughs, and certainly it's very difficult to

          20   keep an orderly marketplace of, you know, when stocks trade

          21   with that kind of velocity and that kind of volume.

          22             MR. DONALDSON:  Well, there's a flashing signal

          23   over here that we're coming to the end of this allotted

          24   period.  I want to say, we're going to see some of this panel

          25   back on a couple of the other panels.  I'm sure that there

                                                                          50

           1   are just thousands of questions sitting behind this table and

           2   over there, so this is just a beginning.  I hope we're going

           3   to have a chance to talk to you all in a different forum.  I

           4   do want to thank you for coming here and -- thank you.

           5             MR. NICOLL:  Thank you, Chairman.  Annette, my

           6   notes -- I misspoke.  It was -- our records show that it was

           7   four cents when we traded on the American, not six cents.  I

           8   apologize.

           9             MR. DONALDSON:  Okay.  We're going to take a little

          10   break here, a ten-minute break and then we're back at 10:30.

          11             (Recess taken.)

          12             MR. DONALDSON:  Okay.  Why don't we get going here. 

          13   Welcome to our second panel.  Since you have your backs to

          14   the audience, maybe you would all, starting with you John,

          15   say who you are and who you represent so the people can hear

          16   you.

          17             MR. WHEELER:  I'm John Wheeler with American

          18   Century Investments and I'm here representing the Investment

          19   Company Institute, the trade group for the mutual fund

          20   industry.

          21             MR. HERRON:  Dave Herron, Chicago Stock Exchange.

          22             MR. FAGENSON:  Robert Fagenson, VDM Specialists on

          23   the New York Stock Exchange, and Stock Exchange Specialists

          24   Association.

          25             MR. MADOFF:  Bernard Madoff of Madoff Securities.

                                                                          51

           1             MR. CRONIN:  Kevin Cronin from AIM Management,

           2   actually now AIM Investments.  Under the Act of full

           3   disclosure, I'm also the chairman of the New York Stock

           4   Exchange Institutional Creditors Advisory Committee.

           5             MR. PETERFFY:  Thomas Peterffy, Interactive

           6   Brokers.

           7             MR. PUTNAM:  I'm Gerry Putnam, CEO of Archipelago.

           8             MS. NAZARETH:  Since this group has a little unfair

           9   advantage, it's like having a quiz after having seen somebody

          10   just ahead of you take it.  Perhaps we'll even be able to get

          11   into some more in-depth questions because we do have some

          12   sense of what's going to be discussed.  But I thought maybe

          13   we could start with the same basic questions, which are, you

          14   know, are there benefits to the trade-through rule beyond

          15   best execution and investor -- beyond the duty of best

          16   execution and you do have views on that, Gerry?

          17             MR. PUTNAM:  Thanks for having me.  I think, Mr.

          18   Chairman, you mentioned in your opening remarks that this was

          19   a complex rule, and we agree with you, and in many ways, we

          20   think it's actually too complex, which would make it

          21   difficult to actually enforce in the context of a

          22   trade-through situation.  Today, we do have a trade-through

          23   rule for New York listed stocks, and that rule is routinely

          24   violated.  It's a very simple rule.  It just says, "Don't

          25   trade through."

                                                                          52

           1             The rule that's proposed here obviously has more

           2   components to it with exceptions and opt-outs and all of

           3   that.

           4             I had one of our folks take a look yesterday at --

           5   in light of doing this today, what's going on right now on

           6   our trade-through situation, and we actually automated the

           7   process of dealing with trade-throughs, complaining about

           8   them and trying to get them resolved.  And yesterday, in one

           9   four-minute period between 1:52 and 1:56 in the afternoon, we

          10   actually had 37 outstanding complaints with no resolution --

          11   again, a simple rule, just don't do it -- in 32 different

          12   stocks.

          13             Not surprisingly, 70 percent of them were with the

          14   New York Stock Exchange, and they do have the largest market

          15   share so that's where you would expect it would happen the

          16   most often.  But our concern is that the rule is too complex

          17   to enforce when you consider the rule today, which is very,

          18   very simple.

          19             I also have concern with, we've come up with this

          20   new definition of fast vs. slow markets.  And I think that's

          21   going to be difficult to define, and I think it's dangerous

          22   to go in that direction.

          23             There's another standard that we've worked with in

          24   the over-the-counter marketplace, which is really the issue

          25   of firm quotes vs. soft or what we like to call "maybe"

                                                                          53

           1   quotes.

           2             And we think that's really where the distinction

           3   should lie and that's where investors are asking for a

           4   choice.  In the case of what you'd call or the analogy would

           5   be a slow market, we would say that is a market that has

           6   "maybe" quotes or indications.

           7             At times, investors would like to choose to avoid

           8   the "maybe" market, in exchange for trading with a certain

           9   market or a market that had a firm quote, one that they knew

          10   would not be manually interfered with.

          11             I think that's where you'll find the -- if you look

          12   back to what happened in the NASDAQ world, and Bob Greifeld

          13   mentioned it earlier, NASDAQ had a different structure than

          14   the ECNs did when they came in.  ECNs came in with firm

          15   quotes.  Today all quotes for the most part are firm in

          16   NASDAQ and we don't have a trade-through problem.

          17             I think finally, just touch on NASDAQ, another

          18   thing that you mentioned was the possibility of unintended

          19   consequences.  And I think there are serious unintended

          20   consequences for the NASDAQ world if we impose a

          21   trade-through rule.

          22             Today, through competition, a large number of very

          23   sophisticated routing systems have been made available to the

          24   marketplace.  And the way they operate is, they operate on

          25   the basis that all quotes in NASDAQ are firm, and I'll just

                                                                          54

           1   make a quick example, say we have a quote on Instinet at five

           2   cents, one in NASDAQ at six and one in ours at seven.  One of

           3   these smart order routers will say, take the five, take the

           4   six, take the seven, all at the same time, so they have

           5   imposed a trade-through always seeking best price.  But if we

           6   put a trade-through rule in the NASDAQ world, a quote coming

           7   into your system, to take the seven stock, the seven cent

           8   stock, we'd either have to hold it up and not display a

           9   customer limit order, which is exactly the opposite of what

          10   we're trying to get at here today, which is to display

          11   customer limit orders, or we'd have to send that order back

          12   to that participant saying, "It's going to trade through, we

          13   can't handle it," at which point we interfere with time

          14   priority within our own system.  So --

          15             MR. COLBY:  Before you stop, could I ask the other

          16   panelists, could you address the fundamental question that

          17   the prior panel was addressing, which was, they all said that

          18   we need to protect limit orders in order to encourage price

          19   discovery.  Do we need a trade-through rule to help protect

          20   limit orders?

          21             MR. PUTNAM:  In the NASDAQ world we don't have one,

          22   and all protected competition has done it.  The ultimate

          23   reward, by giving people a choice, if you place your order,

          24   if you make the distinction between firm quotes and soft

          25   quotes, and then give customers the opportunity to opt out of

                                                                          55

           1   trading with the soft ones, what's going to happen is, you're

           2   going to get rewarded for making a firm quote.

           3             At that point, Scott's got what he wants.  He puts

           4   an order out there, it will be interacted with.  It's exactly

           5   what happened in the NASDAQ world as it went from being

           6   semiautomatic with market makers and totally automated with

           7   ECNs to one that is a totally automated marketplace today.  I

           8   think it will -- it's self policing, best execution, Gus

           9   mentioned best execution.  It applies in both the listed

          10   world and the NASDAQ world.  Leave it there.

          11             Let the markets compete and they will automate like

          12   they did in the OTC world and I think we'll get to our best

          13   result that way, but you do have to give customers the

          14   opt-out, I mean, the opt-out being the choice between trading

          15   with the best quote, which is just the best price, and being

          16   able to say, "On this particular order, I want to override

          17   the system.  I don't want to trade with the 'maybe' quotes. 

          18   I only want to interact with the ones that are firm."

          19             MR. DONALDSON:  How do you define a firm quote?

          20             MR. PUTNAM:  It's --

          21             MR. DONALDSON:  Is there a time that it's firm?

          22             MR. PUTNAM:  The fast flow thing, because that it's

          23   a question of time.  So you say, "Well, one second, geez,

          24   that's really fast, but not necessarily firm."  Firm means

          25   the order is available on the touch.  If another order comes

                                                                          56

           1   in, it will execute against that order without any human

           2   intervention.  The order doesn't stop for someone to look at

           3   it and think about what they might do with -- they might do

           4   that really quickly.

           5             MR. DONALDSON:  How long does it have to remain

           6   firm?

           7             MR. PUTNAM:  It just has to be firm to begin with. 

           8   Today's world, in electronic marketplace, all of our quotes

           9   are firm, if they are displayed and if an order comes in and

          10   that order still exists, it will execute.  In the listed

          11   world, where, if you look at the competing -- competing

          12   models like the floor-based specialist model on New York,

          13   those quotes aren't necessarily firm.  You can see it.

          14             And Scott says, you know, in the interests of his

          15   shareholders, he wants to take that quote?  Well, he gets

          16   there to find out that that ten thousand shares at a nickel

          17   isn't really there.  There's ten thousand shares at a nickel

          18   but there are 17 other people that are going to take that

          19   order.  So to him, that's not firm.  Or there's some price

          20   improvement that takes place, or it traded ahead because

          21   there's other people standing there.  So they are not -- the

          22   distinction needs to be made between quotes that are

          23   interfered with or could be, and quotes that are purely

          24   sitting will with an electronic trigger on them that says,

          25   "If you touch it and you're the first one in line, you get

                                                                          57

           1   it."  And that's where the market wants, I believe would like

           2   to be able to make a choice.

           3             MR. PETERFFY:  Well, we enthusiastically support

           4   the Commission's proposed trade-through with some

           5   modification.  We believe that instead of focusing on whether

           6   market center is automated, we should focus on whether any

           7   particular quote disseminated by that market center is

           8   automated.

           9             We propose that automated quotes be followed by one

          10   corrector symbol that signifies that the quote is

          11   automatically traded when a matching order meets. 

          12   Automatically executed quotes, whether they are on the top of

          13   the book or up and down the book, should be protected by the

          14   trade-through rule, and manual quotes should not be.  This is

          15   a simple and technically easy idea to implement, focusing on

          16   whether a particular disseminated quote by market center is

          17   electronically executable, on a hybrid market such as the New

          18   York Stock Exchange, to get the benefit of the trade-through

          19   rule protection for those quotes that deserve it, and would

          20   provide these market centers with the flexibility to evolve

          21   towards a more automated system in any way they see fit.

          22             In addition, this approach would deal with the

          23   question of whether quotes away from the NBBO should be

          24   protected or not, and how those trades should be done.

          25             Accordingly, a rule should allow automated markets

                                                                          58

           1   to trade through manual markets by any amount.  Limiting the

           2   trade-through, trading through of manual markets to the de

           3   minimis requirements would merely entice manual exchanges to

           4   adjust the quotes lower so as to be off the market by more

           5   than the trade-through requirement and thereby force orders

           6   to come to them and to continue to take advantage of these

           7   three options.

           8             Conversely, we see no justification not to give

           9   best execution against automatically available quotes.  We do

          10   not see an up tick as a valid option and we do not believe

          11   that we should go along with that.  Lastly, there was a

          12   proposal that brokers should disclose to their customers the

          13   amount by which they trade through manual quotes.  We do not

          14   believe that you should require this because this would

          15   merely create a false impression that those prices were

          16   actually attainable where we all know that most of the time

          17   they are not.

          18             MS. NAZARETH:  Thomas, can you address whether you

          19   think there are benefits to protecting the best price limit

          20   order in the market, at least not --

          21             MR. PETERFFY:  There certainly are benefits to

          22   liquidity providers.  If you like our firm is a large

          23   liquidity provider.  If we were told that anybody can trade

          24   through our quotes, we would stop providing such quotes.

          25             MR. GOLDSCHMID:  I just want to ask a question.  I

                                                                          59

           1   want to make sure if I understand both of you.  Instead of

           2   using "fast" terminology, you're using automated quotes that

           3   can be taken as --

           4             MR. PUTNAM:  That's correct.

           5             MR. PETERFFY:  And by the way, we also think that

           6   there should be a clear standard as to what an automated

           7   quote is.  And in today's market, most internally tradable

           8   orders by ECNs are executed in less than a tenth of a second. 

           9   So we believe that an automated quote should be one that

          10   either executes or books or declines or routes an order to a

          11   better market in less than a quarter of a second, at least 98

          12   percent of the time.

          13             MR. GOLDSCHMID:  Gerry, do you agree with that?

          14             MR. PUTNAM:  I think that it could actually be, and

          15   that's sort of where the marketplace is today, that's the

          16   standard for it, it could be simpler than that.  It is simply

          17   what we all do today in the electronic world is, there is no

          18   manual intervention in that quote.  Tom's point is well

          19   taken.  If we sat there with a two-second quote, it took us

          20   to automatically fill an order in two seconds, we'd have no

          21   customers.  So the marketplace takes care of -- takes care of

          22   that.

          23             MR. PETERFFY:  But that's not true for other

          24   dominant market centers, right?  If you give them two

          25   seconds, they will take two seconds.

                                                                          60

           1             MR. CRONIN:  Thank you for giving me the

           2   opportunity to today present our views on the proposed Reg

           3   NMS.  As we look at the proposal, I think it's clear in that

           4   general concept, this proposal promotes some of the most

           5   valuable tenets we think of what will ultimately forge the

           6   most efficient capital market structure in the world and that

           7   clearly is innovation, transparency, speed and efficiency,

           8   and ultimately we believe that this proposal would provide us

           9   as institutions, and investors in general, the competition

          10   that's necessary with the investor protections that are

          11   necessary and ultimately with the choice that's necessary for

          12   us to pursue best execution.

          13             You hear a lot of talk about these terms,

          14   competition and choice and protection.  And it's unfortunate

          15   in the earlier panel that protection, it didn't seem to me,

          16   it was dismissed as rhetoric.  I don't believe that

          17   protection of limit orders is rhetoric.  If you look at the

          18   absence of protection today, I think many of us have come to

          19   the conclusion that the marketplace isn't nearly as efficient

          20   as it should be or could be.  And part of our process here

          21   today should be to collectively figure out what will lead to

          22   a greater benefit for investors.  What will lead to greater

          23   incentives for investors to post their limit orders?

          24             And I think clearly the trade-through proposal and

          25   uniform application of it is part of that protection.  If

                                                                          61

           1   necessary, I know that there might be some unintended

           2   consequences I believe that Gerry specifies that are

           3   tangible.  But I also believe that the technological

           4   advancements that are made and the capabilities that many of

           5   these systems provide will overcome that problem.

           6             In theory, it's hard for us to imagine any concept,

           7   public policy that would not advance the protection of the

           8   limit orders.  So again, in theory, I support Reg NMS's

           9   proposal for the uniform application of the trade-through

          10   rule.

          11             Opt-out is a vexing issue for institutions. 

          12   Opt-out would allow us in theory to trade at, quote-unquote,

          13   inferior prices and I think Scott did a good job earlier of

          14   describing how his institutions' displayed prices aren't

          15   necessarily either certain or the best prices and are pursued

          16   in terms of best execution.

          17             And yet it is troubling to advance any policy that

          18   would promote our ability to pursue these inferior prices at

          19   basically the exception of those who are willing to display

          20   their limit orders.

          21             In the end, I think opt-out does give investors

          22   needed flexibility and I do believe that it creates an amount

          23   of competition that's necessary to facilitate the advancement

          24   of the marketplace, but I'm not sure that the end justifies

          25   the means.  And that is to say, I believe that competition

                                                                          62

           1   will ultimately get us to where we need to be in terms of

           2   efficiencies, in terms of automatic execution capabilities

           3   that many of us want.  But it's very hard to establish a

           4   public doctrine that, in order to facilitate that end,

           5   basically takes away some of the protections that we feel are

           6   very important to this whole process.

           7             I will probably bring my comments to a close there

           8   in the interests of letting others speak, but the issue is a

           9   very difficult one for institutions, as I know it is for the

          10   Commission.  I believe that if we properly define what fast

          11   markets are, and I think you have to very specifically define

          12   what a fast market is, and I believe it's under a second. 

          13   I'm not going to get into picoseconds or whatever that term

          14   was earlier for billionths of seconds.  I think that's

          15   nonsensical to most investors, Mr. Chairman.

          16             However, I think it is clearly in the best

          17   interests of investors in general that that time frame be

          18   very specific, that it be flexible over the course of time,

          19   because our fear is that the lowest common denominators would

          20   be all that we would get.

          21             But it's critically important to define that, to

          22   define the standards of linkage, and I know others will

          23   advance that all levels of the book need to be electronically

          24   accessible for it to be deemed automatic or fast.  I don't

          25   view that as appropriate.  I think it infringes on the form

                                                                          63

           1   of structure.  I think it's asking for example an option

           2   market to be something more than it is.

           3             I think it is reasonable for the top of the book

           4   initially.  I think competitive forces will ultimately lead

           5   us to a better sweeping capability at the exchanges, for

           6   example, and I think the advancement, again, is by and large

           7   to make sure that we all understand what a fast market is, to

           8   make sure that competitive forces are there, to make sure all

           9   the market centers have the ability to get to that point, and

          10   do get to that point, and in the absence of that, I think

          11   unfortunately, an opt-out may be necessary.

          12             MR. MADOFF:  Our firm has made a, you know, fairly

          13   decent living as a fast market competing with a slow market,

          14   so I'm not sure that it's in our own best interests to have

          15   everyone on a fast market but, since our good Chairman has

          16   asked us all to take off our selfish hats and speak for the

          17   public good, I'm going to try to do that.

          18             I agree a little bit with what everybody has said

          19   here.  And I think that really this debate comes down to fast

          20   markets vs. slow markets.  If you were in a situation just

          21   looking at the NASDAQ world today, which is operating without

          22   a trade-through rule, which is a fast market, I don't think

          23   this discussion would be taking place for the most part.

          24             I think what's triggered it is that you now have a

          25   lot of fast markets represented primarily by ECNs that are

                                                                          64

           1   trying to compete with what is a slow market.  We have

           2   accomplished that by putting our own capital at risk and

           3   being willing to protect limit orders and trade-throughs from

           4   taking place because we do operate in an environment that has

           5   a trade-through rule.  In the NASDAQ market, we don't have

           6   that issue.

           7             But the ECNs who don't really have their own

           8   capital that they can put into play, they are just

           9   representing customer orders, they cannot make capital

          10   commitments and therefore, do not protect orders in a

          11   marketplace, and that's why it makes it very difficult for

          12   them to compete in an area where there's a trade-through

          13   rule.

          14             And if you look at the fact that they were able to

          15   successfully compete in the NASDAQ market where there isn't a

          16   trade-through rule and it's fast market against fast market,

          17   you're now asking them to compete with a slow market that has

          18   a trade-through that doesn't allow that to take place.  So

          19   the ECNs, you had to give them the de minimis exception to

          20   enable them to function there.

          21             If you want a clear example of the difficulty of

          22   having a fast market compete with a slow market and not

          23   having chaos with a rule that says they can't trade through

          24   it, you just have to look at the AMEX trading of ETFs with

          25   the NASDAQ marketplace.  When it first happened, and I can

                                                                          65

           1   tell you as a very active player in the ETF world, it was

           2   sheer chaos the first few days when you allowed trading of

           3   ETFs on both the AMEX and in the NASDAQ marketplace where you

           4   had a clear example of a slow market competing with a fast

           5   market.

           6             In reality, if you made all markets become fast

           7   markets and -- up to certain share size, this issue goes

           8   away.  I know of no reason why slow markets today, and let's

           9   talk about the New York because that's basically what we're

          10   here to talk about, if they automated their marketplace,

          11   which they certainly have the capability to do, and probably

          12   will do, then, and you -- you said that there was a

          13   trade-through rule that you could not, fast markets could not

          14   trade through other fast markets, we would support that.  I

          15   can see no justification for one fast market trading through

          16   another fast market.

          17             You asked for a definition of a fast market, Mr.

          18   Chairman.  My definition would be, which other people I think

          19   have already echoed, is that an immediately accessible or an

          20   automatically accessible market.  It doesn't have to be under

          21   a second.  Our average execution speed is clearly under one

          22   second for almost 99 percent of our executions.  I don't need

          23   to go down to milliseconds, picoseconds and so on.  I just

          24   want to know that when I see a quote, that that quote is

          25   immediately accessible and the only way that that quote will

                                                                          66

           1   not be accessible to me would be if another automatic

           2   execution takes place before mine.

           3             If I'm going to send an order to a marketplace and

           4   someone is going to be able to take that order, hold it up

           5   for 30 seconds or even five seconds, show it to other orders

           6   that are in the crowd who are going to get a second look,

           7   that's not fair.

           8             If you want to encourage people to put orders into

           9   quotes, which is really what this is all about, you cannot

          10   allow them to get a second look at an order.

          11             I'm not going to get into the data of CLOB because

          12   that's not why we're here, and I don't think that's

          13   necessary.  In any event, I think competition levels that

          14   playing field.  But you cannot have an order go down to a

          15   marketplace in an automatic fashion and then once it arrives

          16   at that marketplace, manual intervention takes that order and

          17   then delays the execution of that order because, while that

          18   process is going on, even if it might afford a better price

          19   to the order that is currently shown in that marketplace as a

          20   quote, I may very likely and probably will miss executing

          21   that order, and then the order that is below that price will

          22   no longer be there because those orders come and go, you

          23   know, literally before you can blink your eye.

          24             So the way to solve this issue is force all market

          25   centers up to a certain share size to become automated. 

                                                                          67

           1   Otherwise, you can opt out of that market.

           2             Now, to deal with the opt-out issue, I believe that

           3   there should be an unfettered opt-out of a slow marketplace

           4   because, as a practitioner in the marketplace, it's very

           5   important for me to have a rule that I can comply with.  I

           6   don't want a rule that I cannot properly comply with.  And I

           7   cannot comply with a rule unless there are linkages in place,

           8   whether those markets are accessible, and they are accessible

           9   at a fair price which I guess we'll discuss at the next --

          10   the next panel.

          11             So as far as opting out is concerned, you cannot

          12   force fast markets, you know, to not be able to opt out of a

          13   slow market.  And the opt-out has to be unfettered because I

          14   have concerns that even with this one, two and three cents

          15   ban that you are proposing, because in a marketplace that

          16   takes place today, these prices flicker and I don't know

          17   whether a spread that is three cents, when I decide to opt

          18   out, may be two cents, you know, by the time I press that

          19   button.

          20             So it sounds simple to -- and I'm not sure how much

          21   compliance there is, even with the three cent de minimis ban,

          22   and -- I mean, somebody here, I guess Bob Greifeld, said the

          23   problem is going to be how do you surveil, you know, all of

          24   these -- all of these issues.  That's a very difficult

          25   situation and I genuinely believe that most practitioners in

                                                                          68

           1   the marketplace want to comply with the rules.  They are not

           2   trying to disadvantage anybody.

           3             I would like to start with the premise that most of

           4   the practitioners in our industry come in to their firms in

           5   the morning saying they want to comply with the rules, they

           6   want to do what is best for their client.  I don't think

           7   anybody is trying to opt out of an execution that they think

           8   they could really get.

           9             So those are the issues that I think are important

          10   to dealing with in any rule proposal that you may make. 

          11   Thank you.

          12             MR. FAGENSON:  Mr. Chairman, Commissioners,

          13   Annette, Bob, and Jonathan Katz, I finally get to see the man

          14   who is behind all those letters.

          15             In many ways, at certain times, today, it sounded

          16   like a Congressional hearing.  Some of the panelists find no

          17   need to get a clear question that's asked, but simply get

          18   their comments into the record.  And I will try and adopt the

          19   Chairman's opening comment that we should try and keep a

          20   public policy hat firmly on our heads, because that's really

          21   what we're here to talk about.

          22             The good news is that because we have the deepest,

          23   most liquid markets in the world, and are in fact the envy of

          24   the world, we're not talking about something that's damaged

          25   or broken, we're simply talking about something that's

                                                                          69

           1   terrific and trying to make it better.  That makes our job

           2   easier but also more challenging because we have to be

           3   certain not to upset that which has built over so many years

           4   and served us and the people of this country and the world so

           5   well.

           6             So the question is, a trade-through rule, is it

           7   necessary?  Is it going to incent people to put limit orders

           8   in the book?  And my answer to that is, absolutely yes.

           9             If we turn the clock back to the confusion that

          10   existed in the old NASDAQ pricing model where people would

          11   enter a limited buy order at 15 and see the stock trading

          12   that was at 14 and seven eighths and not understand why they

          13   didn't buy that stock at 15 and the broker would calmly take

          14   their hand and say, "We can't buy it at 15 unless it's

          15   offered at 15," and it can be trading at 14 and seven eighths

          16   or 14 and three quarters forever.  And unless it's offered at

          17   15, you cannot get it.

          18             That was extremely confusing and I think some of

          19   the elements of what we're talking about, if it's not

          20   perfectly clear in terms of absolute limit order protection,

          21   will be extremely confusing and will disincentivize investors

          22   large and small to enter their limit orders if they don't

          23   feel that those limit orders are going to be afforded price

          24   protection.

          25             Now, I testified to the Common Sense Pricing Act,

                                                                          70

           1   which made it very clear from what was stated at the time,

           2   that every penny saved investors over a year would be a

           3   billion dollars in their pockets.  We have to be careful, if

           4   we eliminated a trade-through rule, and have a de minimis

           5   exemption or an opt-out, we're talking about three cents. 

           6   Well, it may not be every share.

           7             But if we do the multiplication, if the Common

           8   Sense Pricing Act put five billion dollars in investors'

           9   pockets, this has the potential to take nine billion out of

          10   their pockets because if everyone were pure and all motives

          11   were perfect, and as one of the earlier panelists said, it

          12   only happened occasionally, and people didn't set up systems

          13   to take advantage of what the system offers, then everything

          14   would be fine.  But I think history has proven that not to be

          15   the case.

          16             Where an exemption exists, people are going to find

          17   a way, I think, to take intermarket/intramarket advantage of

          18   it.  And that poses a tremendous danger because the opt-out,

          19   as well-intentioned as it may be, creates to a certain extent

          20   an elitist two-tiered market, two classes of citizens, and I

          21   can't find anything within that that speaks of good public

          22   policy.

          23             I think we have to be careful as we take a look at

          24   the benefits that the trade-through rule provides to

          25   investors that we don't start designing a system for

                                                                          71

           1   practitioners and forget about the customers.

           2             Now, I heard it's no longer politically correct to

           3   talk about the eight-hundred-pound gorillas, they have been

           4   on the Atkins diet, no pun intended.  So now they are five

           5   hundred pound gorillas.  Pretend they are not sitting in the

           6   corner of the anteroom and that large institutional investor

           7   does not have a certain weight in the marketplace.  It would

           8   be disingenuous at the very least.

           9             In fact, what we haven't talked about today is the

          10   medium sized institution, the small Midwest bank, the

          11   individual investors, and what the effect on public

          12   confidence will be if we do away with the trade-through rule. 

          13   And that is a huge danger here.  In some ways, before talking

          14   about the SEC, I feel like I'm in front of FAA or should be,

          15   because if it's not price, then it would be safety, and

          16   certainly there are other issues that are important.  And

          17   whether it's the food quality, or on-time performance, if you

          18   don't get there, nothing else really matters much.

          19             In this case, the best price and the ability to

          20   have confidence that you're going to be protected are the key

          21   elements to what makes our markets the deepest and most

          22   liquid in the world.  The liquidity provider has to be

          23   rewarded and has to be protected, and I'll get back to what

          24   the Chairman's question was before.

          25             Just because you can do it doesn't mean you ought

                                                                          72

           1   to.  And just as we have systems that can trade in

           2   nanoseconds, microseconds, or whatever the phrase of the day

           3   is, doesn't mean that that is relevant to the most -- to most

           4   investors who we seek to protect.

           5             Intermarket competition by making markets fast and

           6   making quotes automated and automatic and accessible is the

           7   key, and it's rare over our careers that I have agreed with

           8   so much of what Bernie Madoff has said, but in fact, the man

           9   did build a business competing with me, and he has to be

          10   congratulated.  And he didn't come here to whine his way into

          11   rules changes or Congressional mandates to do it.  He did it

          12   by offering a better price or a better execution system and

          13   built a business on that.  And that's to be applauded and

          14   rewarded.

          15             On the other hand, as I see the Commission moving

          16   towards protecting customers and investors by giving more

          17   disclosure and better disclosure and better protection of

          18   mutual funds, I would hate to see us do away with the

          19   trade-through rule and take a tremendous step backwards in

          20   the markets.

          21             MS. NAZARETH:  Mr. Herron?

          22             MR. HERRON:  Thank you for the opportunity to talk

          23   today.  At this point, I will no doubt be echoing many of the

          24   thoughts that have come before.  In one sense, it's a little

          25   bit like Phil Nicholas in the lineup as -- on the 18th of the

                                                                          73

           1   Masters, but we will be repeating some things.

           2             One thing that has not been stated is really that

           3   the -- the trade-through rule of the last 25 years has acted

           4   as a cornerstone that I feel has unified the markets.  I did

           5   trade in the markets prior to the trade-through rule, and

           6   believe me, we did not have liquidity, we did not have the

           7   depth, we did not have the tightness and spreads that have

           8   come to exist over the last 25 years.

           9             The -- even the proponents of doing away with the

          10   trade-through rule have benefitted from the price discovery

          11   process that limit orders have put into the marketplace and

          12   without the trade-through rule, many of those limit orders,

          13   much of the incentive to place those limit orders by

          14   professionals, by dealers and by customers might not have

          15   occurred.

          16             The -- any action to weaken the trade-through rule

          17   will only serve to take away investor trust in the

          18   marketplace.  And this industry has not done much to earn

          19   that trust lately.  I think extending the trade-through rule

          20   to other markets, especially as the markets become more

          21   linked together and look more alike, will only serve to win

          22   back the trust of those investors that is so key to the

          23   marketplace.

          24             We believe that the Commission has a framework to

          25   adopt a trade-through rule with requirement for automatic

                                                                          74

           1   execution at all venues that will necessitate the need for

           2   an -- that will eliminate the need for an opt-out provision

           3   completely.  If markets are truly automatically accessible

           4   and no one has to wait for exposure to an auction to receive

           5   their answer if they choose to not expose that order to the

           6   auction, there is no reason to pick a price worse than the

           7   one displayed in the marketplace.

           8             In reality, for 25-odd years, we have had

           9   trade-throughs occurring in the marketplace but those

          10   trade-throughs have occurred with a requirement that the

          11   offending party satisfy the traded-through party.

          12             So even though there have been trade-throughs, the

          13   investor at other exchanges, in the third market, has been

          14   protected, if not in direct interaction, by the offending

          15   party coming out to satisfy that quote, by that dealer's

          16   ability to protect that order and satisfy that -- satisfy the

          17   order that's been traded through, knowing that there is some

          18   protection that exists for him or her.

          19             As far as an opt-out provision, we get a little

          20   ahead of ourselves, but we believe firmly, as I said, that

          21   the opt-out is not needed and indeed, that the opt-out is

          22   offered to the wrong party.  The person posting the limit

          23   order should be rewarded and the professional trader or the

          24   large institutional trader should not be allowed to ignore

          25   that price to trade for their -- to speed up their execution

                                                                          75

           1   or simply to fill an order more quickly.  Thank you.

           2             MR. WHEELER:  Good morning.  On behalf of the

           3   Investment Company Institute, I'd like to thank the Chairman

           4   and the Commissioners and the directors for giving us this

           5   opportunity to speak before you today.

           6             Again, I'm with American Century Investments and

           7   I'll take Kevin's lead in the interests of full disclosure,

           8   American Century does have a very small minority stake in

           9   Gerry Putnam's technology, the Archipelago Stock Exchange. 

          10   But again, I'm here speaking on behalf of the Investment

          11   Company Institute this morning.

          12             I think first of all, on this distinction between

          13   fast and slow markets, the Institute would agree that

          14   investors need to be provided choice.  And to me this is all

          15   about choice.  For far too long, I think our equity markets

          16   have been structured and regulated in a way that rewards

          17   passive behavior in price discovery in the transparency of

          18   our markets.  Whether it's floor brokers who stand in a crowd

          19   and price-improve an incoming order, or specialists who have

          20   the discretion of their capital to inject into the

          21   marketplace at their own discretion.

          22             I think we have a unique opportunity in front of us

          23   with Reg NMS, and the N representing national, we have an

          24   opportunity for all market centers within that National

          25   Market System to compete on a level playing field and allow

                                                                          76

           1   investors the option to place their orders wherever they deem

           2   fit.

           3             And whether we as institutions choose to operate

           4   electronically and anonymously on a system like Gerry

           5   Putnam's or if we choose to have a manual floor-broker-based

           6   system like Bob Fagenson's, we should be afforded that

           7   choice.  We have a responsibility to our shareholders, but

           8   the Institute does feel like there is a bigger common

           9   responsibility and that responsibility is to protect any

          10   investor within the National Market System who chooses to

          11   display their limit order.

          12             In our view, limit orders are the building blocks

          13   that provide the foundation for an efficient market, and

          14   again, I think Reg NMS provides us with a unique opportunity

          15   to put the faults of the structures of the marketplaces in

          16   the past where they belong, in the past, and allow the

          17   injection of technology that's been developed by the private

          18   sector, for the most part, over the past couple of decades,

          19   to give investors every opportunity to reduce their

          20   frictional trading costs and enjoy automatic execution trade

          21   if they -- if they so choose.

          22             So the Institute is in favor of this distinction

          23   between fast and slow or maybe vs. firm, you know; however,

          24   we want to label these market centers but again, our focus is

          25   going to be on protecting that limit order.  And as many of

                                                                          77

           1   the panelists before me have kind of kicked around this idea

           2   of, let's focus on the people that opt in, and put them ahead

           3   of the people who choose to opt out, force the people who

           4   want to opt out and circumvent display of limit orders to

           5   honor all those people who have opted in.

           6             And I've made this argument to Bob and Annette in

           7   the past.  The limit order has a value to it.  Whether it's

           8   the ability to buy a stock $20 higher than where it's

           9   currently trading, if you open up The Wall Street Journal you

          10   will see a whole list of options that are out of the market,

          11   that are out of the money if you will, but they will have a

          12   price attached to them.  And in my view, what our markets

          13   have done as -- is the intermediaries in our market have

          14   extracted that option value from those limit orders and it

          15   goes right into their pockets.

          16             Trade-through will put that trade through back in

          17   the option money of the investors who display those limit

          18   orders.  So again, there may be trades that we all, the

          19   Institute and all of our various mutual fund accounts, feel

          20   like on a given trade we may be better suited to trade up a

          21   dime and get a block of stock done, we feel a common

          22   responsibility to each other within the industry, with a

          23   feeling that if we honor everybody's limit order along the

          24   way, the markets will be more transparent, more robust, and

          25   all investors, small, large, whales, gorillas, minnows,

                                                                          78

           1   whatever you want to call them, will all have lower

           2   frictional trading costs along the way.  Thank you.

           3             MS. NAZARETH:  John, could I ask you, if we could

           4   start with you and move this way, it was implicit in what you

           5   said, but do you think that we can sufficiently define the

           6   terms of what a fast market is such that we can mandate that

           7   everybody be a fast market, so that an opt-out is unnecessary

           8   to the rule?  Is that what you suggest?  And I think some of

           9   the folks on the panel I think earlier addressed this

          10   question, but not everyone, so that --

          11             MR. WHEELER:  Absolutely.  I think Gerry brought up

          12   a point, if he wants to be autoex and he gets a seven-cent

          13   offer coming at him but there's a five- or six-cent offer

          14   coming ahead of that bid, he's kind of stuck as to what to do

          15   with that order, give it back, hold onto it, whatever the

          16   case may be.

          17             I guess in my view the liability in that situation

          18   resides in the person disseminating that order.  And if you

          19   all lay out regulation that requires our exchanges to code

          20   into their order distribution process that they, at the time,

          21   nanosecond, whatever it may be, that that order hits the

          22   system, that it just reads what's there and ships Gerry his

          23   order at seven cents, Gerry should be free to trade that with

          24   the understanding that whoever sent him that has the

          25   responsibility of meeting those orders along the way so that

                                                                          79

           1   that five-hundred-share offering at five cents that may be,

           2   you know, Gerry or Bernie Madoff, or the six cent offering

           3   that may be one of you on a home PC, you know, interacting

           4   through a discount broker and sitting on the New York Stock

           5   Exchange, whatever the case may be, the responsibility I

           6   think lies on who's disseminating that order and then we all

           7   as participants would, I guess, in my view, compete on where

           8   that order resides.

           9             We will -- there's always going to be, unless

          10   everything matches up perfectly, there's always going to be a

          11   residual behind that offer, if there's a ten-thousand-share

          12   offer, four or five cents in a bid for twenty thousand

          13   shares, you're going to kind of step up and take all of those

          14   limit orders along the way but then there's still going to be

          15   a residual and it's going to reside wherever I choose to let

          16   it reside, whether it's the New York Stock Exchange,

          17   Archipelago, Chicago Stock Exchange or wherever.

          18             So yes, to answer your question, we can operate I

          19   think without a trade-through and I think you, we get a peek

          20   of it with the ETFs but I think again, we have a bigger

          21   responsibility to come back to the trade-through and protect

          22   all those putting up orders and I think we can do that

          23   technologically.

          24             At least, I think at this point, with NMS, I think

          25   we have to identify that as the ultimate goal rather than

                                                                          80

           1   dilute this down to say, "Gee, the technology just doesn't

           2   really allow us to do what we wanted to do."  We need to set

           3   that out, even if it's further down the road, as the ultimate

           4   goal of what we decide here, that protection of limit orders

           5   is crucial.  They are the building blocks for an efficient

           6   marketplace, and as technology develops, to get better and

           7   better along the way.  We need to do that.

           8             MS. GLASSMAN:  I'd like to ask a question about the

           9   opt-out.  I don't think it's been raised before.  Assuming

          10   that we adopt an opt-out proposal as a rule, is the proposal

          11   that we put out for comment practical, is it too complex,

          12   what are your views on that?

          13             MR. WHEELER:  I'll speak if nobody else does.  In

          14   our view you should only opt out to circumvent a manual

          15   marketplace, and let the marketplaces determine whether they

          16   want to be autoex, whether they want to be autoex at their

          17   displayed price or all through their order book and let the

          18   competitive forces determine who wins this.

          19             And as investors, we're agnostic.  We don't really

          20   care who wins this, whether New York wins this or Gerry

          21   Putnam wins this.  Our only goal is to save our investors as

          22   much money as we possibly can and to protect the people that

          23   display those limit orders along the way.  I think there will

          24   be unintended consequences of an opt-out.  We didn't know

          25   what SOES would do twenty years ago.  We didn't know what

                                                                          81

           1   Direct Plus -- I think Bob, maybe he didn't know what Direct

           2   Plus would do to the New York Stock Exchange.  Not then.

           3             These are all well intended, you know, innovations

           4   in the marketplace with some very negative unintended

           5   consequences, and I view opt-out as the same way.  Who is

           6   going to step in to a trade that opted out and determine

           7   whether the person who made the determination was truly

           8   acting in a best execution interest or if they were paying a

           9   bill with that particular trade?

          10             And, you know, again, have mentioned, we haven't

          11   done great job in this business of late.  Let's close some of

          12   these loopholes and focus back on what's really paramount to

          13   an effective market and that's protecting the people who

          14   display limit orders.

          15             MR. GOLDSCHMID:  Want to leave room for me to trade

          16   on an auction market if I want to.

          17             MR. WHEELER:  Absolutely.  When I think to this, in

          18   discussions that we've had, you know, the views in no way can

          19   put the auction market out of business.  I think there's

          20   still a place for the New York Stock Exchange to transact

          21   their business here.  But in my view, I guess those blocks of

          22   stock are going to get priced in more of a relative manner

          23   than an absolute manner.  It's not going to be, hey, there's

          24   a twenty cent offering and an order comes in, I'll pay

          25   twenty, turn to the guy, 19 cents, offered at twenty, oh,

                                                                          82

           1   trading at twenty, somebody else got the stock benefit.

           2             It's going to be, I think a floor broker that's a

           3   seller meeting a floor broker and a buyer and these markets

           4   moving really fast, a penny comes back -- they just say,

           5   "Hey, in the middle of the spread," when they walk over to

           6   the specialist when they push the button, in the middle of

           7   that spread, "I'll meet you and we'll trade a hundred

           8   thousand shares."  So whether it's 18 cents, 19 cents, twenty

           9   cents, we don't care, as investors, about, you know, the

          10   incremental movement of that midpoint, if you will, which

          11   does get into subpennies.  We really feel like that's the

          12   only use for the subpenny.  But, you know, if the floor

          13   brokers meet and they agree on a relative price and they walk

          14   over and push the button and it trades, and you're not again

          15   compromising anybody's display order in the process, I have

          16   no problem with that whatsoever.

          17             MR. CRONIN:  Commissioner, I'd like to come in on

          18   your question as it pertains to how onerous the process is or

          19   should be relative to opting out.  If it's the Commission's

          20   objective to offer an opt-out provision, and again, I think

          21   I'm on record as saying I don't believe that's necessarily in

          22   the best interests of all investors, but if it is the course

          23   of direction that you take, I would hope that you would make

          24   it a very onerous process to undertake for investors.  An

          25   opt-out should only occur in very specific instances.

                                                                          83

           1             We shouldn't say that particular investors opt out

           2   25 percent of the time.  It should not be done on a global

           3   basis.  I think those are the kinds of things, if there is an

           4   opt-out, and again, there are some, I think competitive

           5   advantages to having an opt-out, but if it is offered, it

           6   should be very definitely offered on the pretext of having it

           7   happen very rarely as opposed to a commonplace occurrence.

           8             MS. GLASSMAN:  Bernie, did you have anything to

           9   say?

          10             MR. MADOFF:  Yes.  If the question is the opt-out

          11   provision, is it -- is it too onerous to comply with, I would

          12   say absolutely yes.  Based upon conversations that we have

          13   had with our clients, both broker/dealer clients as well as

          14   institutional clients, have all said that they would not be

          15   able to effectively opt out based upon provisions that you

          16   have.

          17             And what would happen, they claim, is for the most

          18   part, they would not opt out.  Therefore, I think their

          19   clients would be suffering.  So if you put brokerage firms in

          20   a position where this, in order for them to opt out, they

          21   have to comply with it as you people have laid out, they will

          22   choose not to opt out and that will probably be to the

          23   detriment of their customer.  And I know that that's not what

          24   you're really trying to accomplish.

          25             So if you have to on an order by order basis, and

                                                                          84

           1   then provide the information that you would be required to

           2   provide them so that the investor could make the choice,

           3   which I know is what you're trying to do, you're trying to

           4   have the investor make the choice, not the broker make the

           5   choice.

           6             The problem is that most investors are willing to

           7   let their broker make the choice and if they find that their

           8   broker is not making the choice, you know, in their best

           9   interests, they are going to move their account to another

          10   broker that will do that.

          11             Again, you start -- have to start with, and I know

          12   this -- the modern times today does not support, you know,

          13   this amount of good faith in your brokerage firm.  But you

          14   really have to start with the assumption that most of us in

          15   this industry really have their clients' interests, you know,

          16   coming first.  Not necessarily the firm's self-interest.

          17             So if you're going to have an opt-out provision,

          18   which I believe you have to have in certain instances, then

          19   it has to be an opt-out that people will use.  Otherwise,

          20   you're not accomplishing anything.  And again, I go back to

          21   that, our position is that an automated market should not,

          22   you know, be able to opt out of another automated market.  If

          23   I know that I'm going to send the order to that marketplace

          24   and that I have every reason to believe it's going to be

          25   executed without any manual interaction delaying that order,

                                                                          85

           1   then I have no interest in opting out of a price that I see.

           2             MR. FAGENSON:  Following on on Bernie's comment, if

           3   you have an all fast market, an opt-out becomes irrelevant

           4   from our perspective.  To think that opt-out is actually

           5   going to reach through to the individual investor and be

           6   something where they are going to issue informed consent,

           7   what they are doing is almost as if thinking that payment for

           8   order flow was sanitized by printing some disclaimer on a

           9   customer form.  And most customers tend to expect that their

          10   brokers are going to act in their interest and the brokers

          11   then have to live up to that.  I don't think there's any

          12   accountability with letting an individual investor know.

          13             An opt-out in an automated computer-to-computer

          14   marketplace, fast market, I think is absolutely unnecessary,

          15   and the next question is, can we do it?  Absolutely.  I think

          16   that it is viable and the later panels will discuss how this

          17   integrates with the auction market principles.  But NYSE is

          18   committed to it and if we're the ones that everyone is

          19   looking at as the benchmark of anything from recidivism to

          20   activism, depending on your perspective, we will get it done.

          21             MR. PETERFFY:  So we all seem to be in agreement

          22   here.  I would like to -- everyone is up -- now, I would like

          23   to address the issue of time and why it is important.  If you

          24   imagine a five-minute period, you see that in the five-minute

          25   period, the stock price wanders up and down and the bids and

                                                                          86

           1   offers wander up and down.

           2             If you give somebody five minutes to execute the

           3   trade, he can within that period of time, among the various

           4   prices that occur, he can pick the one he wants, right?  This

           5   is also true for a second.  There are less changes in price,

           6   but we do know that there are changes in price on active

           7   stocks within a second.

           8             This is why I'm suggesting that we go with the time

           9   that is technologically feasible that works today, and that's

          10   why I'm suggesting that we should stick to a quarter of a

          11   second, because otherwise, if we do not have a limited amount

          12   of time, then everything else we say, up dot, not up dot, et

          13   cetera, doesn't mean anything.

          14             MR. PUTNAM:  Our belief is that the opt-out is too

          15   complex.  Simple automated markets vs. non-automated markets

          16   is where the distinction should be made.  To the extent that

          17   a manual market has value, people will use it and they will

          18   use it.  Problem is, you don't have a choice today under the

          19   current rule not to use it.  If the -- the thing is, we

          20   wouldn't even be sitting here talking about this today if

          21   people felt that the dominant manual market that we all deal

          22   with was the best choice one hundred percent of the time.  We

          23   wouldn't even be having the debate.

          24             The fact is, the marketplace wants a choice when it

          25   doesn't want to be in manual mode, and I think that's why we

                                                                          87

           1   do need the option, but it has to be something that's

           2   enforceable because it's clearly defined.

           3             MR. ATKINS:  Well, I guess I'm going to follow up

           4   on all this, especially with respect to the specialist

           5   system, because I was intrigued by the comments as to the

           6   executability of the quotes, and I was wondering, is that

           7   concept inimicable to a specialist system?  We talk about

           8   fast and slow, if we were to go down that road, and I was

           9   just wondering how we would structure that in an auction

          10   system, or is that impossible?

          11             MR. FAGENSON:  Well, it's definitely possible and I

          12   note the next panel is going to deal with that in depth so I

          13   won't try to take too much time.  But I think what John said

          14   earlier is true, that negotiated transactions, wholesale

          15   large transactions will take place and, so long as there is a

          16   trade-through rule in the context of the quote, limit orders

          17   are protected.  This is a matter of negotiating price and

          18   quantity, and is not going to be unduly influenced by small

          19   transactions that are taking place at the same time.  So the

          20   integration is possible.

          21             I think starting back with the issue of fast

          22   markets having autoexecution capability improves investor

          23   choice, improves market execution, improves price protection,

          24   and how we ultimately integrate the auction market principles

          25   and protect the ability of people to use judgement in

                                                                          88

           1   achieving prices in transactions that are not executable in

           2   the context of the posted inside market is a challenge that

           3   we're going to have to rise to.  But I think it's certainly

           4   something that we can and will do.  I think to a certain

           5   extent it's going on now.  Just, the system is somewhat

           6   arcane from point of view of ITS and the times that people

           7   have that it creates a tremendous amount of animus.

           8             We have to get that out of the market.  We have to

           9   have all people feel good about how their orders are

          10   executed, how their orders are treated and how they

          11   understand the system and make it as simple as possible.  And

          12   protecting and not having the Commission come out in favor of

          13   one market system vs. another, and I think that's absolutely

          14   possible.

          15             MR. DONALDSON:  We've reached the witching hour of

          16   11:30, sadly.  We've -- we'll take just a couple of minutes

          17   here for everybody to stand up and turn around in their seat

          18   and we'll bring the next panel in.  Two minutes.  Thank you

          19   very much.

          20             (Recess taken.)

          21             MR. DONALDSON:  I want to ask the panel to identify

          22   themselves for the benefit of those who are sitting behind

          23   you, just starting with you, Bob, if you will.

          24             MR. FAGENSON:  Robert Fagenson, same person,

          25   different seat, vice-chairman, Van Der Moolen Specialists,

                                                                          89

           1   member of American Stock Exchange and also a member of the

           2   New York Stock Exchange Specialist Association.

           3             MS. WILLIAMS:  I'm Jennifer Williams, I'm with the

           4   Griswold Company.  I'm also a member of the New York Stock

           5   Exchange and an active executing floor broker on that

           6   exchange.

           7             MR. LaBRANCHE:  Good morning, Michael LaBranche,

           8   CEO of LaBranche & Company.  We're a specialist firm on the

           9   New York Stock Exchange.

          10             MR. TILLY:  I'm Ed Tilly.  I'm vice-chairman of the

          11   Chicago Board Options Exchange and serve as a market maker

          12   and specialist.

          13             MR. BRODSKY:  I'm Bill Brodsky.  I'm chairman and

          14   CEO of the Chicago Board Options Exchange.

          15             MR. SODANO:  Good morning, I'm Sal Sodano, Chairman

          16   and CEO of the American Stock Exchange and vice-chairman of

          17   the NASD.

          18             MR. THAIN:  And I'm John Thain, I'm the chief

          19   executive officer of the New York Stock Exchange.

          20             MS. NAZARETH:  This panel was teed up very well by

          21   Commissioner Atkins, who asked the exact correct question as

          22   to what will the challenge be of combining a traditional

          23   trading floor with an automatic execution facility of the

          24   type we've been talking about being required by the

          25   trade-through rule.

                                                                          90

           1             So the question that we'd like you to address, and

           2   we can start with John Thain, who no doubt has done a great

           3   deal of thinking about this question in the recent past is,

           4   how feasible is it for a market to combine an active trading

           5   floor with an automatic execution facility?  Is it possible

           6   to achieve the twin goals of preserving the trading floor's

           7   potential for improved prices and liquidity beyond the

           8   market's displayed quotes and also operating an automatic

           9   execution facility that provides fast and efficient access to

          10   the market's displayed quotes?

          11             So undoubtedly, many folks here are very interested

          12   in hearing about what the New York's thinking is on this and

          13   we'll start with John Thain.

          14             MR. THAIN:  Thank you, Annette.  First of all, I'm

          15   happy to have on the panel someone who has actually done

          16   this.  And so there's proof that it can be done.  But it

          17   certainly is one of our challenges.

          18             I am committed to making the New York Stock

          19   Exchange a fast market.  Full stop, we're going to do that. 

          20   I'm committed to do that primarily because it's what an

          21   important part of our customer base wants.  And if we don't

          22   offer our customer base the ability to trade electronically,

          23   quickly, with certainty, and with anonymity, they are going

          24   to move their order flow away from the exchange, and that's

          25   bad for our business.  So our fundamental motivation is, a

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           1   subset of our customer base wants to be able to trade this

           2   way so we will give them the capability to do that.

           3             But I'm also committed to maintaining the

           4   advantages of the continuous auction system that goes on on

           5   the floor of the exchange.

           6             It's clear to me that the auction model with the

           7   specialists and the floor brokers has advantages in certain

           8   circumstances over a purely electronic market.  The most

           9   important advantage is reduced volatility.  And there's a lot

          10   of ways and a lot of ways to look at this, but the easiest

          11   way to look at it is, over the last two years, 48 companies,

          12   so the exact same companies, moved from the NASDAQ, a totally

          13   electronic market, to the New York Stock Exchange.  And the

          14   intraday volatility of those 48 companies on average fell by

          15   50 percent.  Not by a little bit, by a lot.

          16             So it's clear that the value of the auction process

          17   and the specialists and the floor brokers does dramatically

          18   reduce the intraday volatility and ultimately the cost of

          19   capital to companies who trade in that marketplace.

          20             The auction process also provides better opens and

          21   closes, is better able to deal with order imbalances, it's

          22   better able to deal with unusual events like earnings

          23   surprises, either positive or negative, or corporate

          24   takeovers, and it also provides ultimately better prices,

          25   because the New York Stock Exchange does have the best price

                                                                          92

           1   in its security 90-plus percent of the time, and lower

           2   transaction cost.

           3             So the key here, the key challenge is to marry the

           4   best of both worlds.  Now, I understand that there's a

           5   question about, will the Stock Exchange actually get this

           6   done, will they offer the customers the ability to trade

           7   electronically, and in particular, there's been this question

           8   raised about, will the execution be automatic.

           9             And the answer is yes, it will.  We will allow --

          10   and as a matter of fact, Direct Plus, which is our version of

          11   this, already exists.  We will allow customers to trade

          12   against the best bid or the best offer.  They will be able to

          13   trade electronically.  It will be a computer-to-computer

          14   link, and, you know, subject to the -- to the constraints of

          15   the speed of electrons, it will basically allow very fast

          16   execution against the inside market.

          17             We, though, we still, though, want to keep very

          18   much the benefits of the auction process.  We want to be able

          19   to deal with order imbalances.  And this I think is a very

          20   important thing.  We do not want the trading in New York

          21   listed stocks to turn out to have the same kind of volatility

          22   that you've seen in the electronic marketplace.  So that

          23   benefit of moving from NASDAQ to the New York Stock Exchange,

          24   we don't want that to go away.

          25             So we have to make sure that, as we provide people

                                                                          93

           1   with the ability to trade electronically, that if there are

           2   significant order imbalances, we can deal with those in a way

           3   that doesn't cause dramatic ups and downs in the prices.

           4             We also have to make sure we don't in any way upset

           5   the value of the closings and if you've seen that S&P has

           6   decided to use the American Stock Exchange closes in certain

           7   of its stocks that are traded on NASDAQ and its index,

           8   because of the better process of getting closes done through

           9   an auction process on the quoted exchange.

          10             So we have to keep the good things about the

          11   auction process and marry them with the fast execution

          12   capabilities that some of our customers had asked to have.

          13             It's also important to us, and I'm sure some of my

          14   fellow panelists will voice this, that the members on the

          15   floor are able to interact with the electronic market.  And I

          16   made this comment, I was actually at one of the other

          17   marketplaces that also is electronic and manual, and there,

          18   the floor, inside the pits they are actually able to interact

          19   and trade electronically as well as on the floor, and we very

          20   much want to make sure that we give our floor brokers and our

          21   specialists the ability to interact with the electronic

          22   marketplace.  So we're not going to run this as two separate

          23   markets.  We want to integrate the markets, allow customers

          24   the choice to be able to trade electronically if that's what

          25   they want to do, but also to be able to keep all the benefits

                                                                          94

           1   of the floor and ultimately, you know, assuming we get this

           2   to work properly, which I am confident we will do, we'll have

           3   to best of both worlds.

           4             So there are issues, there are concerns, there are

           5   challenges, but I'm very much committed to making this work.

           6             MR. SODANO:  Thank you.  Good morning.  The AMEX

           7   would like to thank the Commission for allowing us to express

           8   our views this morning.  Combining the traditional auction

           9   trading floor with that of automatic autoexecution is clearly

          10   something we know we need to do, even from our own

          11   perspective being able to be more nimble in dealing with the

          12   ECN environment, which basically was built primarily for

          13   speed.

          14             But rather than go through a lot of the points that

          15   John just went through with which I agree, one of the points

          16   I do want to raise here is, we want to make sure that the

          17   auction marketplace roll, as it pertains to innovative

          18   securities, such as the types of securities that we bring to

          19   market at the AMEX, new things to market, in the smaller and

          20   mid cap marketplace, act differently than they do in the

          21   larger markets.  And it's very clear what benefits the

          22   traditional auction marketplace provides for those types of

          23   securities.

          24             Let me say up front, the AMEX is clearly committed

          25   to moving forward and quickly and deliberately to provide an

                                                                          95

           1   automatic execution functionality for the products listed and

           2   traded on the exchange.  We have rule filings pending before

           3   the Commission.  And we expect to, hopefully, get our autoex

           4   capability in place and not too far down the track for the

           5   exchange traded fund products such as the larger traded QQQ

           6   ETF, SPDR, and DIA products that in and of themselves create

           7   their own liquidity, we want to get that done as soon as we

           8   can.

           9             And as John mentioned before our NASDAQ UTP

          10   program, where S&P did come to us and ask us on a prior

          11   program to try to create some more stability on a test basis

          12   for closing prices in NASDAQ, get an automatic execution

          13   program in place as soon as we can for the NASDAQ UTP problem

          14   products as well.

          15             The difficult challenge remains in terms of how do

          16   we effectively and responsively integrate the autoex

          17   functionality into our auction model while continuing to

          18   maintain the unique benefits that our market provides to

          19   investors, listed companies, and as I just mentioned a second

          20   ago, the innovative products that we come up with at the

          21   American Stock Exchange.  As John just mentioned, I think it

          22   is very clear that a specialist environment does present some

          23   very clear improvements to the marketplace as opposed to a

          24   NASDAQ environment.

          25             Issuers choose the American Stock Exchange just as

                                                                          96

           1   they would the New York Stock Exchange, for the decreased

           2   volatility.  Particularly, again, I want to underscore the

           3   differentiation we'd like to make in the types of securities,

           4   rather than focusing on just a fast market/slow market, the

           5   types of products that are being traded.  Companies that

           6   trade less volume can use, clearly, the advantages that an

           7   auction marketplace provides.

           8             I'll be specific.  Based on the statistics that are

           9   available to us, at least we see at the AMEX, over 60 percent

          10   of the equities right now on all the markets trade under a

          11   hundred thousand shares a day.  So when you go through the

          12   statistics in looking at how is volatility effected in the

          13   dealer market vs. an auction market, I would agree with John

          14   and we see the same statistics, even more so at the AMEX,

          15   concerning middle market companies are the core of our equity

          16   business.  We believe the marketplace and therefore,

          17   investors, clearly receive a benefit by utilizing and having

          18   available to it the traditional auction marketplace.

          19             So our job is to come up with a model whereby we

          20   can provide autoex functionality for products that are -- a

          21   product that should be in that type of an environment as

          22   opposed to just a straight autoex marketplace or being

          23   defined as a fast market or a slow market.  We're looking at

          24   an environment where we should look at the products

          25   themselves rather than just the overall marketplace.

                                                                          97

           1             When determining the appropriate balance between

           2   speedy execution through autoex and liquidity, stability and

           3   potential for price improvement offered by the auction

           4   marketplace, we clearly believe one size does not fit all.

           5             The balance for the most liquid securities may not

           6   be the appropriate balance for the less liquid securities or

           7   any innovative securities that the AMEX has been known for. 

           8   Simply said, securities that lack natural liquidity can and

           9   do get the help of a marketplace that's afforded in a place

          10   like the American Stock Exchange.  I do believe there is a

          11   solution or business model that works.  We are working to

          12   implement a new order type that will allow autoex executions

          13   to take place, or simply be cancelled with immediate advice

          14   back to the customer if that's what happens.

          15             In addition, we will continue to work with our

          16   traditional auction marketplace as we have, and continue to

          17   put improvements into that traditional system such as

          18   increasing speed of access through the systems as we've

          19   traditionally offered.

          20             So in summary, what we're saying at the AMEX is

          21   clearly, we will look to, at some point, an automatic

          22   execution for all the securities that trade on the AMEX but

          23   we believe, in view of the debate that you've been hearing

          24   today, the Commission should not lose sight of the fact that

          25   it's not really a fast market or a slow market.  It's really

                                                                          98

           1   the types of products that are being traded.

           2             When you look at the AMEX in particular, things

           3   that are new to the market, there is not a natural source of

           4   liquidity.  When you look at very mature products like,

           5   whether it's Microsoft that trades on NASDAQ, or GE on the

           6   New York Stock Exchange, or QQQs, they provide their own

           7   liquidity.  When something is new, it needs help.  That's

           8   what we do.  We don't think there should be a mandate that

           9   those types of securities get automatically executed, but

          10   over time we will develop a system that does both.

          11             MR. GOLDSCHMID:  A question for you and John, a

          12   balance between simplifying it, customers on auction floor on

          13   setting up these new markets, should it be me as the customer

          14   that says, I want the floor or I want --

          15             MR. SODANO:  The system that we're working on on

          16   the AMEX is we want to create a new order type -- I guess the

          17   old term would be fill or kill.  I guess that's the closest

          18   analogy that I could make where an order would be sent to the

          19   AMEX for automatic execution, either it will be filled or it

          20   won't, immediately, and there should be immediate advice back

          21   to the customer that that order was either executed or not. 

          22   And then the customer will have to determine where that order

          23   goes from there.  So we believe that is very possible.

          24             MR. GOLDSCHMID:  And why wouldn't it be executed?

          25             MR. SODANO:  I'm not prepared to say why it would

                                                                          99

           1   not.  There's a lot, -- well, it gets into debate on, when

           2   should an automatic execution take priority over a price

           3   improvement order?  Should it be that clear?  Steadfast in a

           4   rule, should there be other opportunities where that may not

           5   be the case, and quite frankly, internally we're still

           6   looking at what the appropriate answers to those --

           7             MR. GOLDSCHMID:  John, can you address that?

           8             MR. THAIN:  Yes.  It's a little bit complicated

           9   because it depends on the order type and it depends whether

          10   or not it's a -- whether it's a market order or whether it's

          11   a marketable limit order.

          12             But the basic answer will be customers first of all

          13   will be able to choose so they will be able to send an order

          14   in via Super Dot, which they can today, or they will be able

          15   to sent an order in through Direct Plus, which is give the

          16   automatic execution.

          17             But we will probably also automate market orders

          18   and/or marketable limit orders to allow what, in essence,

          19   happens today to happen automatically where the specialist is

          20   pairing off the trades.

          21             So if you think about it, if you have five hundred

          22   shares bid at a quarter and you have a market order come in

          23   to sell that same security, that trade can be paired off. 

          24   And even if it came in as a Dot order, will probably still

          25   autopair it off as opposed to have anyone interact with it

                                                                         100

           1   because in essence, that's what happens today.

           2             MR. COLBY:  I think one of the questions we were

           3   interested in hearing from this panel is, how can it actually

           4   be done?  How can you retain a floor presence with the price

           5   improvement features and also have these electronic orders

           6   going off?  And we heard you say that you want to do it and

           7   that you're working on it.

           8             Bill and Ed from the CBOE, you've been struggling

           9   with this, which is why we're very interested in you, but the

          10   rest of the panelists, if you can talk about what can be

          11   preserved and what will be lost if you have this, that will

          12   be very helpful.

          13             MR. BRODSKY:  I guess that's my segue in.  I'm Bill

          14   Brodsky, chairman of the CBOE.  The CBOE applauds the

          15   Commission for Reg NMS and for holding this hearing today. 

          16   Many of the issues that are discussed here ultimately will

          17   affect the options markets which, as you know, are intensely

          18   competitive.  CBOE is not only the largest options exchange

          19   but also in terms of floor brokers and market makers is the

          20   largest securities exchange in the country with vigorous

          21   intramarket competition as well.  Options specialists, DPMs

          22   and market makers are all considered specialists under the

          23   Act, represent a significant amount of stock trading in the

          24   equity markets.

          25             All the markets that you heard from today are

                                                                         101

           1   places where our market makers, specialists and DPMs send

           2   their order flow for hedging the option orders that they do

           3   on our exchanges.

           4             Often, that represents hundreds of millions of

           5   shares a day in the equity markets.  Therefore, we not only

           6   have an interest in today's hearing, we have a vital stake in

           7   the outcome.

           8             We also wish to compliment the Commission and the

           9   staff overseeing the implementation over a year ago of a

          10   state-of-the-art electronic linkage system among the options

          11   exchanges.

          12             Sitting next to me is Ed Tilly, who is not only

          13   vice-chairman of our exchange, but was the person from our

          14   membership who chaired the committee that helped develop the

          15   system that we're talking about, a system that doesn't throw

          16   out the baby with the bath water, as John says, is the best

          17   of both worlds, and we think we have gotten to a point where

          18   we're now reaching the benefits of that, of achieving a

          19   combination of instantaneous execution along with retaining

          20   the benefit of price discovery of the trading floor.

          21             I'll just touch on the high points of the hybrid

          22   system and Ed will go into some of the specifics for you.

          23             Up until several years ago, CBOE employed a

          24   traditional trading floor-based auction system.  Last June,

          25   we introduced a new trading system that we named the Hybrid,

                                                                         102

           1   which combines the feature of open outcry with electronic

           2   competing dealer model.  The hybrid platform enables market

           3   makers and designated primary market makers, which is our

           4   equivalent of specialists, to electronically stream their

           5   individual quotes and for floor brokers to submit their

           6   customer orders into an electronic system.  Ed will go into

           7   the mechanics of the system.  But let me give you some

           8   statistics.

           9             We have reduced our average quote width in half

          10   while tripling the average size quoted.  Our quotes now are

          11   on the NBBO about 70 percent of the time while the

          12   floor-based exchanges that have not done what we have done

          13   have quotes on the NBBO about a third of the time.  And we

          14   were not much better than that.  So the difference is, when

          15   we imposed the electronics with firm quotes, our quotes

          16   narrowed and the size got bigger and I expect that to

          17   increase over time.

          18             Statistically, about 83 percent of our orders come

          19   in on the Hybrid system and 70 percent is done on the trading

          20   floor.  So we see the larger amount of orders being done

          21   electronically, as opposed to open outcry, but there is still

          22   a substantial amount of volume being done in open outcry. 

          23   For those market participants who desire an immediate

          24   execution against display quotes or size, the Hybrid trading

          25   system provides such an electronic means to access the best

                                                                         103

           1   quotes of competing market makers on the exchange.

           2             For those participants who have orders such as

           3   complex or large orders, they can benefit from the trading

           4   crowd information and interaction.  The exchange maintains

           5   and continues to maintain this trading floor with numerous

           6   competing market makers where such orders can be worked.

           7             And our floor brokers, by the way, add value in

           8   working those orders and getting price improvement.  Our

           9   exchange is unique in that we have many competing market

          10   makers, both on the electronic system and on the trading

          11   floor, along with an integrated limit order book between the

          12   two.

          13             We're now in the process of obtaining SEC approval

          14   for an enhanced Hybrid system which we call Hybrid 2.0.  The

          15   enhanced Hybrid would create competing and for the first time

          16   remote electronic DPMs or specialists and competing remote

          17   market makers who would stream quotes into the exchange's

          18   Hybrid system.  Up until this point, by the way, if you

          19   wanted to be a market maker or specialist DPM, you had to be

          20   physically on the floor.  So this is a marked departure from

          21   our 31-year history.

          22             In-crowd market makers would be able to submit

          23   quotes on the Hybrid system as well, so they could be in the

          24   crowd in an open outcry fashion or at the same time, submit

          25   electronically.

                                                                         104

           1             We've had a tremendous response from firms desiring

           2   to be electronic DPMs and market makers including firms that

           3   have never acted as market makers on the floor.  We hope with

           4   SEC approval to begin Hybrid 2.0 next month.

           5             Although we are very proud of our Hybrid system, we

           6   still see great value in offering trading floor liquidity. 

           7   Part of the genius of our securities markets is the ability

           8   to offer true liquidity on a trading floor.  While we suggest

           9   that the SEC try to accommodate the needs of automated and

          10   manual markets, we implore the Commission not to force

          11   markets into a completely electronic model.  Let the

          12   customers decide large and small what form of price discovery

          13   they want.  Thank you.

          14             MR. TILLY:  Hi, I'm Ed Tilly, vice-chairman of the

          15   CBOE, and I'll start by answering your question yes, hybrid,

          16   or a hybrid system can be done or can be implemented.  And

          17   before I touch on a few of the key aspects of our current

          18   hybrid trading platform, I'd say that this was a very complex

          19   process, and the encouragement we received from the

          20   Commission's department of regulation was extremely valuable

          21   in coming to our launch of the Hybrid platform.

          22             Let me focus on four key aspects of our hybrid

          23   platform, what we've done and the obstacles that we've had to

          24   overcome.

          25             We've eliminated the disincentive on our floor to

                                                                         105

           1   competitively quote and actually provided ample incentive for

           2   our market makers to competitively quote by rewarding those

           3   that are providing liquidity on the NBBO.  We promoted

           4   greater access to our markets, which enables greater order

           5   interaction.  It's very important to us to open up access to

           6   our marketplace while we're adding this technology.

           7             We're disseminating a real time firm quote

           8   comprised of customers, firms, broker/dealers and our

           9   on-floor liquidity providers who stream in electronic quotes. 

          10   We are maintaining an open outcry trading pit where price

          11   discovery added liquidity beyond disseminated electronic size

          12   with trade.  And we provide a competitive environment where

          13   complex orders can be handled.

          14             Mr. Thain and Mr. Sodano are correct.  When we find

          15   high volatility days, our transactions come off of the Hybrid

          16   trading system are represented by either the customers'

          17   choice or their order handler's choice, their broker's

          18   choice, and into the open outcry environment more and more as

          19   volatility increases.

          20             We've had the luxury in kicking off this system at

          21   the same time our industry was embracing the intramarket

          22   linkage plan.  It was very important to us that we're able to

          23   protect our customers and the customers of other exchanges

          24   through trade-through's in these fast markets.  So all these

          25   things together for us came together at the right time.  So

                                                                         106

           1   we had an intermarket linkage plan being kicked off, we were

           2   able to protect our customers, we're incenting our market

           3   makers to competitively quote, all while maintaining the

           4   benefit of open outcry when customers or their

           5   representatives choose to route their order that way.

           6             We don't get into the business of choosing how to

           7   route an order.  The customer does that or his representative

           8   does that.

           9             MR. DONALDSON:  What's happened to the economics of

          10   the open outcry portion that's now getting only 30 percent of

          11   the volume?

          12             MR. TILLY:  Well, let's be very clear, it's 30

          13   percent of the volume but about fifty percent of -- I'm

          14   sorry, 30 percent of the orders but fifty percent of the

          15   volume.  That's very distinctive point.  Complex orders,

          16   spreads, rolls for us, on expiration, in particular, are

          17   still handled in open outcry.  The majority of small retail

          18   paper is routed electronically --

          19             MR. DONALDSON:  What about the economics of the

          20   people involved in --

          21             MR. TILLY:  It's interesting that the economics

          22   haven't changed because the electronic NBBO, which we've held

          23   ourselves to for quite sometime prior to hybrid, the

          24   effective electronic bid/ask, see, we've had a no

          25   trade-through policy for sometime.  It came before linkage,

                                                                         107

           1   it came before our Hybrid platform.  The effect of NBBO is

           2   really unchanged.  We're just finding it on our own exchange

           3   now.

           4             So rather than having to reroute orders to the AMEX

           5   or to the Philly, we keep them in house and actually reading

           6   electronically on the NBBO as found on the CBOE.  So the

           7   effective market nationally hasn't changed.  It's only

           8   changed on our floor.  It's a big distinction.  The economics

           9   are truly unchanged because the bid/ask is unchanged.  It's

          10   all on our trading floor.  So the opportunity is increasing

          11   to trade on the CBOE for our members, but the economics are

          12   really unchanged.

          13             MR. BRODSKY:  Mr. Chairman, one other aspect to

          14   this is that the economics in our business have changed in

          15   the macro.  And that is that the competition that has been

          16   fostered by the electronics, by intermarket linkage and all

          17   the things that have happened over the last three or four

          18   years have been nothing less than breathtaking and the spread

          19   and the margins have narrowed.  As the margins have narrowed,

          20   volume has increased quite dramatically.

          21             The option industry is now trading around five

          22   million contracts a day.  That's equivalent of about a half

          23   billion shares a day.  But it's on a per trade basis less

          24   profit annually than it was before.

          25             MR. TILLY:  Certainly, but not to imply that the

                                                                         108

           1   electronics at home or the Hybrid system was --

           2             MR. SODANO:  Chairman Donaldson, I think that's a

           3   really important point that you bring up.  It's one of the

           4   points that we are grappling with at the AMEX as we do bring

           5   in an automatic system.

           6             Clearly, the people who risk their capital every

           7   day are going to have less opportunity to get return on that

           8   capital that they employ every day.  But we need to, and

           9   marketplace is going to have to come up with some way of

          10   incentivization to that capital to stay on the trading

          11   floors.  So it's a very important point that we need to come

          12   to grips with and come up with a solution.

          13             MS. GLASSMAN:  I just want to clarify what you mean

          14   by, when the customers are choosing the open outcry system

          15   over the autoex system, is that essentially an opt-in?  Is

          16   that what they are doing?

          17             MR. TILLY:  I can speak to how the routing

          18   parameters are set up.  Each firm is able to customize their

          19   routing parameters, how their orders will be handled on the

          20   floor of the CBOE once they hit our front door.  Some firms

          21   route to open outcry or broker interaction based on size of

          22   the order, based on a day's, maybe volatility in a stock. 

          23   They want a broker handling their order.  We allow them to

          24   choose.  They are not really opting in or out, meaning we're

          25   still protected by NBBO.

                                                                         109

           1             We're forced through intramarket linkage to honor

           2   all of the other options exchanges' markets.  So they are not

           3   opting out of any price protection.  They are choosing how to

           4   represent their orders once that order has hit the floor of

           5   the CBOE, whether it remains electronic and is autoexed or is

           6   handled by one of their representatives on open outcry.

           7             MR. BRODSKY:  One specific example of is that,

           8   Commissioner, would be, a customer wants to do five thousand

           9   contracts and the aggregate offer on the exchanges is two

          10   thousand contracts.  They may automatically execute the two

          11   thousand by literally pressing one button on the system that

          12   we've introduced but then they will go to the floor to do the

          13   balance.  So it's not even an either/or.  You can choose

          14   either order by order, or you can have a large order be part

          15   of it electronically because that's what the offering allows

          16   and then go down to the floor to negotiate the balance.

          17             MS. NAZARETH:  You have an integrated book.  Nobody

          18   is --

          19             MR. BRODSKY:  Yes, this is not parallel systems,

          20   and to Ed's credit and the credit of his practitioners that

          21   designed this with our computer people, what they did is,

          22   they said, we don't want two separate markets, we don't want

          23   to know what tracks market for ID and options and an open

          24   outcry market.  We have one integrated book.  If you're on

          25   the book, you're on the book and doesn't matter whether it

                                                                         110

           1   was put in by a broker from the crowd or from the firm from

           2   upstairs or a broker in the booth.  Once it's on the book

           3   it's protected.

           4             MR. TILLY:  If you can envision, it's one giant

           5   catcher's mitt.  It takes nice uniform quotes, a customer's

           6   resting order, a firm or a fellow professional's order and

           7   holds them all together in one giant book.

           8             MR. ATKINS:  So you're relying more on an NBBO

           9   concept rather than a trade-through, sounds like a post hypo

          10   than a -- an analysis, is that what you're saying?

          11             MR. TILLY:  I'm sorry?

          12             MR. COLBY:  Can you explain how -- there is an

          13   intermarket trade-through rule.  Can you explain how that

          14   fits into this picture?

          15             MR. TILLY:  As part of the interactive linkage

          16   program, we are -- no system, no floor-based or electronic or

          17   screen-based options system exchange can trade through

          18   electronically any other existing exchange.  So the national

          19   best bid/best offer, is sacred for electronic execution.

          20             On the floor-based exchange, those orders are

          21   kicked out for linkage and we will automatically link an

          22   order to another exchange where the customer can receive the

          23   NBBO price.  And the screen based -- the one screen based

          24   trading -- we're up to two now -- options exchanges, automate

          25   that process and send them to either the CBOE or the AMEX or

                                                                         111

           1   another options floor.

           2             MS. NAZARETH:  I think the question is also how

           3   does this work.  It's because through the linkage, each

           4   participant in the linkage is offering automatic --

           5             MR. TILLY:  Absolutely.

           6             MS. NAZARETH:  Everybody is essentially a fast

           7   market, offering orders up to the book size through the

           8   linkage.

           9             MS. GLASSMAN:  Everything is firm --

          10             MR. TILLY:  Firm.

          11             MR. DONALDSON:  Let's move to the other half of

          12   table.  Do you want to go?

          13             MR. LaBRANCHE:  Good morning, afternoon, actually. 

          14   One of the points I'd like to make is the auction in my mind

          15   is really the most important thing that the New York Stock

          16   Exchange represents to the public.  In my opinion, the

          17   auction functions like a bill of rights for investors,

          18   because it means that all participants in the marketplace,

          19   whether they have a hundred-share order or an eight-share

          20   order, get to interact in the market in a fair way.  No one

          21   gets a special advantage because they have a larger order and

          22   an individual that chooses the New York Stock Exchange as a

          23   destination gets included in that auction at all times.

          24             So the other thing about our market is, we have a

          25   continuous auction, which means that there's price discovery

                                                                         112

           1   occurring at all times during the trading day.

           2             Take, for example, some commodities markets which

           3   have limit up or limit down.  When markets are limit down,

           4   there's price discovery because the markets simply stop

           5   trading.  Our markets don't do that.  They trade all the

           6   time.  So I think what we need to do is see how we can

           7   integrate an automated system when we have displayed

           8   liquidity because when displayed liquidity is there, price

           9   discovery is not occurring.

          10             So what we're finding, and this gets back to the

          11   question that Mr. Colby asked earlier, how do we have both

          12   markets simultaneously?  And what, in my mind, is a practical

          13   way to look at it is, when there is displayed liquidity, then

          14   you can add speed and certainty of execution in those

          15   situations but when an order enters a marketplace that's

          16   bigger than what's seen as displayed liquidity, then price

          17   discovery starts to occur.

          18             Let's say, for example, there's five thousand

          19   shares offered at a certain price and fifty thousand comes in

          20   a bind.  We know that five thousand will trade at that price. 

          21   The question is, what happens to the other 45,000?  The

          22   specialist's job is to correct imbalances in that situation,

          23   provide price discovery.  And what I think the practical way

          24   to do it is to have an automatic execution for that five

          25   thousand so people will know, if it's there, they can press a

                                                                         113

           1   button and get it with certainty.

           2             Now, our job would be to find the right price for

           3   that other 45,000 in a way that makes the market efficient,

           4   and that's what we want to do.  So we have we want to have

           5   that capability for our customers, that's what we hear.  We

           6   hear that they want this and we want to offer that but we

           7   also still want to preserve the auction, the price discovery

           8   process in a way that gives the customer the best price.

           9             One of the great things about our market is that

          10   people have an inherent confidence that their orders are

          11   going to be handled in a good way, that makes our capital

          12   market in the United States better than any other capital

          13   markets in the world such as (unintelligible), which means

          14   that the 45,000 shares that were looking for the right price,

          15   they get the right price.

          16             So there's going to be a moment when we're finding

          17   that price discovery new price for the stock and it won't be

          18   automated.  But as soon as we find that new price discovery,

          19   then we go back to an automation.  That's how I see it

          20   happening.

          21             MS. WILLIAMS:  Hi, I'm Jennifer Williams.  I'm a

          22   member of the New York Stock Exchange and I work with the

          23   Griswold Company.  I'm also an active broker on the floor of

          24   that exchange.

          25             I'm going to take a bold step here and say

                                                                         114

           1   something outright that none of my colleagues have said thus

           2   far, is that the New York Stock Exchange has already begun

           3   its transformation to a hybrid market and I think that's

           4   important to understand.  And many of the investing public

           5   are not aware of that.

           6             Through the Direct Plus system, orders, small

           7   retail orders as well as large institutional orders have the

           8   option of bypassing a floor broker and going straight to

           9   automatic execution to the best bid or offer displayed on the

          10   screen so that an investor who values their speed of

          11   execution over the efficiency of the price discovery model of

          12   the auction market has the option to do so.

          13             Obviously, the system is not perfect.  If it were,

          14   we would not be sitting here today.  But I know that the New

          15   York Stock Exchange is working tirelessly to perfect that

          16   system so that we can create a truly hybrid market.  I

          17   suspect over the next few months, we'll really be able to

          18   fine-tune the details of the linkages.

          19             I'm hoping to explain to you what my role in all of

          20   this is.  I'm not a specialist, I'm not the chairman of the

          21   firm.  I'm just a floor broker but I value that title, and it

          22   means a lot to me and I'm not here to talk to you because I'm

          23   hoping to have a job in five years.  I'm here to talk to you

          24   because I do what I do because I believe in what I do and I

          25   believe that we have the best market pricing model in all the

                                                                         115

           1   world.

           2             I am a broker, meaning that I am an agent.  I do

           3   not at any time effect proprietary transactions, so that my

           4   incentive to go into a trading crowd is solely my fiduciary

           5   responsibility on behalf of my customers and it is to get

           6   them the best price.  As I said before, those customers that

           7   are more interested in their speed of execution can go autoex

           8   through the system and by-pass me.

           9             My fiduciary responsibility is to achieve the most

          10   efficient execution possible.  I would like to make the point

          11   that I believe efficiency used in this term is not synonymous

          12   or exclusive to speed.  And efficiency of execution must also

          13   take into account the cost of transaction and the price of

          14   transaction as well as the investment objectives of the

          15   particular customer.

          16             That's my job.  Somebody calls down and wants to

          17   buy fifty thousand shares of IBM, it's my job using my

          18   professional judgement with the market indices and the

          19   current market conditions at my disposal, to use my

          20   professional judgement to get that customer the best price.

          21             The Griswold Company represents customers that are

          22   some of the largest mutual funds and pension funds in the

          23   country.  And I've heard a lot of market buzzwords thrown

          24   around at this table this morning.  I'm going to bring it

          25   down a notch.  I'm talking about your pension funds.  I'm

                                                                         116

           1   talking about your parents' retirement accounts.  I'm talking

           2   about your children's college education funds.

           3             As the former panel mentioned about the

           4   trade-through truly that every penny that is saved by virtue

           5   of an auction market pricing system on an average of a

           6   one-and-a-half billion share trading day times 250 days a

           7   year, is $3.75 billion in savings every year to the investor,

           8   all over a penny.  That's a lot of college educations.

           9             So I think it's important to remember that while we

          10   can offer automatic execution and, like I said, the New York

          11   Stock Exchange is working nonstop to really perfect the

          12   system so that we can get instant executions for all size

          13   orders if that is what the customer so pleases, that the

          14   auction model is still the proven, most effective pricing

          15   mechanism and, after all, we're here because of the investing

          16   public.

          17             Any market that favors solely speed over the

          18   pricing mechanism that we offer invariably favors the market

          19   practitioners and not the market investors, and we should be

          20   here representing the interests of those investors and how we

          21   can best make the market work for them.

          22             MR. FAGENSON:  An efficient market is one that

          23   advocates liquidity and brings buyers and sellers together

          24   and the challenge of how we integrate that in terms of an

          25   electronic autoex environment with the use of judgement in

                                                                         117

           1   terms of how to get the best price, what velocity, what price

           2   points to enter and exit the market and how do you achieve

           3   that best execution and the customer's objectives is clearly

           4   something that's going to present the greatest challenge as

           5   we move ahead.

           6             Jennifer is right, we've got experience with this

           7   now, and have for some time, the integration of our own

           8   internal NYSE Direct Order type which allows an autoex at the

           9   inside quote albeit only up to 1,099 shares for limited

          10   orders now, has allowed us to see how an autoex environment

          11   can cohabitate the same trading as an auction marketplace. 

          12   And nuances that will have to be brought to bear in terms of

          13   expanding this order type so it can be without limit to size,

          14   without limit to order type, is going to be where we're going

          15   to have to focus.

          16             But in terms of taking the judgement that people

          17   want to exercise in their order, and the speed that they want

          18   to achieve, and eliminating some of the volatility we've seen

          19   in very unusual situations in other markets that don't have

          20   that judgement I think is something that we have to make sure

          21   that we focus on.

          22             Now, clearly there have been some examples.  One

          23   stock I think was very much in the news as we saw the price

          24   move 40 percent, $19 whatever it was, in a short period of

          25   time, and then rebound.  Clearly, this is not the stuff of

                                                                         118

           1   which customer confidence is built.

           2             So how do we prevent a situation that looked more

           3   like a day care center where no adults showed up that day

           4   from being the prevailing market system, and yet integrate

           5   the ability to autoex into a marketplace that has always had

           6   as its benchmark customer protection and the ability to

           7   exercise from the information one gets in the marketplace,

           8   one's judgement in how to achieve the customers' goals.

           9             New York Stock Exchange operates at its finest when

          10   there are imbalances.  Otherwise, things tend to happen very

          11   much automatically.  When suddenly the half a million for

          12   sale or the 800,000 to buy shows up in a stock as average

          13   daily volume is the same as the order with which one is

          14   faced, that is where you have to rise to the challenge.

          15             Now, years and years ago, reaction was simple.  You

          16   halted your trading.  But in these days, we want to enhance

          17   and protect the essence of free markets, how to we make sure

          18   that doesn't happen?  What Michael described before was that

          19   short period of time when customers are brought together,

          20   buyers and sellers, to achieve a fair, reasonable and

          21   accurate best price as close to the last sale as possible is

          22   where the essence of our auction and the integration into an

          23   autoex environment is going to really create the greatest

          24   challenge but also one that inevitably and in my mind

          25   absolutely we are going to be able to achieve.

                                                                         119

           1             The key here is not to destroy the essence of all

           2   that is good in trying to back us into a model that may

           3   appear on its face to be more efficient but in fact, has

           4   tremendous weaknesses.  We can marry the two.  We're doing it

           5   now.  We will expand the capabilities of autoex and we'll

           6   integrate it with the issues of judgement and auction

           7   pricing.  And I -- I, as everyone else at the exchange, are

           8   committed to that, and we know we can get it done.

           9             MR. DONALDSON:  Can I just ask you, Bob, or John,

          10   how long it will take to autoex all the way?  What are the

          11   innovations in terms of time?

          12             MR. THAIN:  Well, let me start.  First of all, we

          13   need to refile with the Commission which we would hope to do

          14   in the next three or four weeks.  And we've had discussion

          15   with Annette and Bob about what the nature of the refiling

          16   would be, so I think there's an understanding of where we're

          17   going.

          18             We are, as you've heard, I think in a very good

          19   position in that Direct Plus exists, and if Direct Plus

          20   didn't exist, this would take a lot longer.  So most of the

          21   changes we have to do are relatively straightforward,

          22   relatively easy.  So we need to remove the 1,099 share

          23   restriction, we need to remove the 30-second restriction.  We

          24   have to remove a few other things that were coded into how

          25   Direct Plus works, for instance, the hundred-share order

                                                                         120

           1   turns it off on either side.  So we're going to take that out

           2   as well.

           3             And I think that inside of the review period, that

           4   we would expect from the exchange, you know, we can be up and

           5   operating, you know, within the next several months, whatever

           6   the review process, whatever time the review process actually

           7   takes.

           8             The technicality of getting this to work I think

           9   can be done inside the normal SEC review process.  We're

          10   already in the process of putting the change into the floor

          11   brokers' wireless handhelds so that they can also interact

          12   with the electronic market and that is already being

          13   implemented as we speak.

          14             MR. DONALDSON:  The technology is there?

          15             MR. THAIN:  Yes, so technology is not going to be

          16   the hangup.

          17             MS. GLASSMAN:  Can I just, on that question the

          18   Chairman asked on how long it would take you to go autoex all

          19   the way, are you planning to be autoex all the way, or is

          20   there the other floor component?

          21             MR. THAIN:  No, we absolutely intend to run a

          22   hybrid, so no, we do not intend to be autoex all the way in

          23   terms of not having all of the benefits of the floor.  So we

          24   absolutely intend to run a hybrid market and to have the

          25   markets integrate with each other.

                                                                         121

           1             MR. ATKINS:  Are you contemplating something like

           2   in Chicago with the CBOE, which almost sounds like an opt-in,

           3   like Commissioner Glassman stated, an opt-in to the manual

           4   side, or is there a bifurcation there?

           5             MR. THAIN:  No, it is, I think, similar to what the

           6   CBOE has done.  I don't really think it's an opt-in.  It's a

           7   choice, a customer choice, and so a customer can choose, and

           8   you guys correct me if I don't say this properly, but a

           9   customer can choose to enter an order such that it goes to

          10   the floor and it gets the benefit of price improvement or

          11   they can choose to enter an order that gets automatically

          12   executed, so the customer is deciding which way they want to

          13   trade.  And by the way, the same thing is true when they give

          14   an order to a floor broker.

          15             So a customer can give an order to a floor broker. 

          16   The floor broker can also decide whether to interact with the

          17   floor and put the order in as the counterside comes available

          18   with the specialist in the auction process, or the floor

          19   broker can choose to electronically execute it in the

          20   electronic market and they can do that with pieces of it.

          21             So as you heard before, they can choose to

          22   electronically execute a piece of it, they can choose to work

          23   the auction process for a piece of it, they can decide how to

          24   do that and frankly, that is in fact how they represent their

          25   customers, figuring out what's the best way to do that.

                                                                         122

           1             MR. ATKINS:  May I ask another question here?  I

           2   guess one thing that was brought up with respect to CBOE as

           3   well, the chairman asked about the economics of the

           4   situation.  We've seen obviously, with respect to New York, a

           5   huge consolidation the last number of years of the specialist

           6   firms.  And then we've also, with respect to decimalization,

           7   and other strains on the system, you know, we've seen some

           8   other things that should not have happened that, you know,

           9   we've obviously taken action with respect to.

          10             So I'm just wondering, hypothetically, you know,

          11   trying to get over to this sort of system obviously is very

          12   important in order to achieve something new.  How is that

          13   figuring into your rearranging of your business model, have

          14   you contemplated this yet?  Obviously with Direct Plus, there

          15   are a lot of things that you hadn't contemplated, but I was

          16   wondering how it is getting into your rejiggering of the

          17   system.

          18             MR. FAGENSON:  Value added specialist systems not

          19   executing transactions that can be manually paired off.  It's

          20   integrating that capital to reduce volatility an maintain

          21   public confidence, those instances are still going to be

          22   there.  The issue is these -- I think earlier, it was asked

          23   what happens, the challenge is, what happens to an order that

          24   reaches an execution point and doesn't get executed, and the

          25   question is why.

                                                                         123

           1             Well, if someone executed ahead and liquidity was

           2   no longer there, what does that order convert to, does it

           3   become a limit order on the book, does it seek the next best

           4   price, how do you reset in an auction hybrid with an autoex,

           5   how does the next price get set, is autoex immediately

           6   available.  Those are going to be the keys.  But the

           7   specialist's real value in terms of helping to bring buyers

           8   and sellers together is not pairing off a hundred shares at a

           9   price that's almost automatically set by rote.

          10             John has said, and obviously we will make that even

          11   more efficient than it is today.  The issue is how do we then

          12   fairly price that imbalance and do that efficiently and

          13   effectively without interrupting an autoex capability.  And

          14   that's going to be the nuance that's going to take the

          15   greatest work.  But the technology is there.  The desire to

          16   do its is clearly there.  As Michael said, the customer is

          17   demanding it and we have no choice but to do it and we will.

          18             MR. DONALDSON:  How long does it take to resolve

          19   that?  I mean, can you give us a feel for it?

          20             MR. FAGENSON:  In terms of some time --

          21             MR. DONALDSON:  I understand what you're saying,

          22   the technology is there, and now it's the nuance of writing

          23   internal rules, if you will, how this works, right?

          24             MR. GOLDSCHMID:  When do we see plans?

          25             MR. FAGENSON:  I think the give-and-take between

                                                                         124

           1   the Commission and the exchange has been ongoing already.  I

           2   think they are far past the first chapter.  I am not the one

           3   who determines the timing of this.  It's not as if we're

           4   starting from square one.  I think it will happen sooner than

           5   later.  I'd rather John, Annette and Bob spoke to that since

           6   I'm sort of on the outside looking in.

           7             MR. COLBY:  We're certainly not going to speak to

           8   it.

           9             MR. THAIN:  Mr. Chairman, I think it is -- it is a

          10   matter of months.  I think it's not a matter of weeks, but I

          11   think it's a matter of months.

          12             MR. COLBY:  Many of you have said that you think

          13   the floor's finest hour is when there's a large influx coming

          14   down.  Do you anticipate that you'll need to shut off the

          15   automatic execution capability at times to handle those large

          16   imbalances?

          17             MR. LaBRANCHE:  Can I answer that question? 

          18   Because there's a very important point here.  You wouldn't be

          19   able to add value if it's necessary; in other words, you talk

          20   about -- delays and that's an automated market.  If every

          21   quote was automated, and the quote you saw was twenty

          22   dollars, it would go down twenty dollars.  That's the thing

          23   that we do that is different in our market.

          24             So trying to answer your question, I think, and

          25   it's an important question, what we envision is a matter of

                                                                         125

           1   seconds with pricing the stock and then when a displayed

           2   liquidity is available, when a bid is there, then you go to

           3   an autoex capability.  But you can't autoex something that's

           4   not there, and if there is no bid or offer in the market, and

           5   there's a bid/sell imbalance or buy imbalance, that's where

           6   we come in, and then as soon as there is displayed liquidity

           7   and we give our customers the ability to access that

           8   displayed liquidity with greater speed and certainty, and

           9   that's really what we want to do here.

          10             MR. GOLDSCHMID:  Sal, how about your timing?

          11             MR. SODANO:  We're also working with the Commission

          12   staff in terms of the rule filings.  We were working on

          13   providing a new autoex technology.  Our time frame is the

          14   latter part of this summer, early part of the fourth quarter.

          15             MR. DONALDSON:  Okay.

          16             MR. CAMPOS:  Assuming that this hybrid model is

          17   something that's beneficial, how does the proposal we have

          18   right now with the variations of the opt-out play into this,

          19   does that impede it, does it allow it to work within our

          20   proposal, need adjustment?

          21             MR. SODANO:  I listened to some of the earlier

          22   panels.  The view of the AMEX, my view is, we do not believe

          23   an opt-out solution is a good thing.  For someone who elects

          24   to opt out means someone is involuntarily being opted out,

          25   and we don't believe it's a good thing.  Limit order

                                                                         126

           1   protection we think is still a good thing in the marketplace

           2   so we don't think the opt-out provision is something we'd

           3   like to see.

           4             MR. DONALDSON:  We're at 12:30.  We will adjourn

           5   and resume at 1:30.

           6             (Luncheon recess:  12:30 p.m.)

                                                                         127

           1                 A-F-T-E-R-N-O-O-N   S-E-S-S-I-O-N

           2             (12:34 p.m.)

           3             MR. DONALDSON:  Okay, if we could get started, if

           4   we could close the doors and --

           5             Good afternoon, everyone.  Once again, I'm going to

           6   ask the panel to identify themselves, John would you raise

           7   your hand and say who you are, so we don't have to figure out

           8   who is talking.

           9             MR. GIESEA:  My name is John Giesea, president and

          10   CEO of the Security Traders Association, and I'm pleased and

          11   proud to be able to participate in this process and commend

          12   the Commission for both the proposal and the process by which

          13   you intend to move forward and I can assure you that the

          14   Security Traders Association is aggressively working today

          15   towards a document that will add to the commentary as you

          16   make decisions fulfilling the promise of the National Market

          17   System.

          18             We were proud and pleased to have created our white

          19   paper in August of last year, in which we had three points

          20   that we made that made it into your proposal --

          21             MR. DONALDSON:  I'm going to let you come back to

          22   your statement.  I just wanted you to say who --

          23             MR. GIESEA:  I am John.

          24             MR. DONALDSON:  I'll give you a chance --

          25             MR. GIESEA:  No problem.

                                                                         128

           1             MR. LEIBOWITZ:  Larry Leibowitz, executive vice

           2   president, Schwab Capital Markets.

           3             MR. FREEMAN:  I'm Ivan Freeman, back again, last I

           4   checked I'm still the chief operating officer for

           5   institutional equities at Morgan Stanley.

           6             MR. MADOFF:  Bernie Madoff of Madoff Securities.

           7             MR. PETERFFY:  Thomas Peterffy, the chairman of

           8   Interactive Brokers Group.

           9             MR. CONCANNON:  I'm Chris Concannon, vice-president

          10   of NASDAQ.  I'm not Robert Greifeld.  If I misstate anything,

          11   you can attribute it to Robert Greifeld.

          12             MS. NAZARETH:  I thought I'd tee up the issue and

          13   then pose the questions.

          14             The -- what we're talking about in this panel is

          15   the linkage portion of the market access proposal.  The

          16   market access proposal would address intermarket access to

          17   quotes and order executions in the equity markets of the

          18   National Market System.  A market center such as an exchange

          19   that offers execution functionality will be considered a

          20   "quoting market center," while a market participant that

          21   enters quotations -- solely on a quotation facility that does

          22   not offer order execution functionality such as the NASD's

          23   ADF, will be considered a "quoting market participant."

          24             The market access proposal seeks to ensure access

          25   not through government imposed linkages but rather, through

                                                                         129

           1   linkages established by the marketplace.  At its core, the

           2   proposal would prohibit a quoting market center or quoting

           3   market participant from imposing unfairly discriminatory

           4   terms that prevent or inhibit any person from accessing its

           5   quotes indirectly through a member, customer or a subscriber.

           6             The standard is intended to ensure that a member,

           7   customer or subscriber of a quoting market center or quoting

           8   market participant can sponsor access to quotes and order

           9   execution without receiving disparate treatment in the

          10   handling of that order with respect to fees, speed or other

          11   terms.  Thus, the quoting market center or quoting market

          12   participant would not be permitted to treat orders from

          13   non-members, non-customers or non-subscribers that are

          14   communicated indirectly through a member, customer or

          15   subscriber any differently than from the way it treats the

          16   orders of that member, customer or subscriber.

          17             Consequently, securities market participants would

          18   not need to establish direct relationships with every quoting

          19   market center or quoting market participant in order to

          20   access the quotes in all markets.  Rather, these participants

          21   would need only have relationships with a member to obtain

          22   effective access to these quotes.  The proposed rule also

          23   would require each quoting market participant to make its

          24   quotations available for the purpose of order execution for

          25   all quoting market centers and all other quoting market

                                                                         130

           1   participants on terms as favorable as those it grants to the

           2   most preferred customer, member or subscriber.

           3             So to tee up sort of what the fundamental questions

           4   are with this linkage proposal, is access to markets through

           5   the members of an SRO or through customers or subscribers of

           6   ECNs or market makers sufficient to assure fair and effective

           7   access to displayed quotations?  And then, are there barriers

           8   to access that must be removed for this indirect access to be

           9   feasible?

          10             Now, I guess we could start with John Giesea.

          11             MR. GIESEA:  Part 2?

          12             MS. NAZARETH:  Part 2.

          13             MR. GIESEA:  I was about to make reference to our

          14   submission last August where we talked about three primary

          15   concerns; one being linkage and access for the purposes of

          16   this conversation; two being regulation, common regulation,

          17   and I would just single out in this particular context what

          18   you've proposed for locked and crossed markets.  We certainly

          19   endorse the elimination of those types of markets.

          20             And thirdly, we have been -- long been a proponent

          21   of the elimination of access fees and the unfairness of one

          22   segment being able to access and another not.

          23             So we're pleased with the progress in terms of the

          24   de minimis cap that's embodied in your proposal of one mil,

          25   and the fact that all participants are able to make that

                                                                         131

           1   charge, and we would still prefer that to be zero, but we

           2   recognize the fairness issue as having been addressed as well

           3   as the de minimis fee which is not totally unreasonable.

           4             With respect to the current access proposal that

           5   we're discussing today, my opinion on the first part of the

           6   question is, yes, those linkages are sufficient, and then the

           7   second part relative to barriers, we have a concern in the

           8   trading community where we have been 15 years involved with

           9   fighting rogues, so to speak, that have a purpose of

          10   disrupting the market rather than helping the market, so that

          11   preventing the unintended here, in the access portion, we

          12   believe access is the absolute cornerstone to the National

          13   Market System.

          14             And that any misuse of that access or quoting,

          15   putting quotes in that you cannot access, that breakdown of

          16   the system, is the unintended consequence, we would like to

          17   see avoided.  Thank you.

          18             MR. LEIBOWITZ:  I think that we would say that the

          19   principle of open and equal access to all markets is

          20   absolutely critical to the functioning of the markets.  I

          21   think a fair level playing field is exactly what the market

          22   needs.  The problem as we see it is that this is necessary

          23   but not sufficient to gaining these -- to having these

          24   markets function properly.

          25             The problem in market access isn't a technology

                                                                         132

           1   problem and it really isn't even a fragmentation problem. 

           2   Even the much maligned ITS system is a failure not because of

           3   technical limitations but because of the lack of automated

           4   execution and because of a monopolistic governing system

           5   where a single vote can prevent innovation in markets that

           6   have opened it up and become more active.  Brokers and venues

           7   have built a highly efficient network, practicing markets,

           8   and third party linkage providers such as Lava and other

           9   vendors have thrived by providing these services for people

          10   who choose not to provide it themselves or can't afford to.

          11             So this principle in the marketplace has worked

          12   very efficiently.  The other pieces towards making the

          13   markets efficient, we believe that the Commission is working

          14   towards addressing; that is this access fee roulette where

          15   basically rogue trading locks markets and trades solely for

          16   the purposes of rebates and -- and creates market distortions

          17   and unautomated markets which again, lock markets and prevent

          18   the fair distribution of quotes and access to trading venues.

          19             We believe that if the markets are open and fair in

          20   the quotations, that the automated execution is implemented,

          21   and that access fees are taken care of, then a lot of

          22   problems that we see in today's markets will go away by

          23   competition.  Thank you.

          24             MR. FREEMAN:  I'm going to give you a trading desk,

          25   institutional trading desk perspective on this topic, and I

                                                                         133

           1   also think that this is a topic, while it's isolated for

           2   purposes of this panel discussion really does have a lot of

           3   overlap with some of discussions that have either taken place

           4   or will take place later today.

           5             As we look at the entire rule, and in particular,

           6   the linkage concept, we like the approach the Commission has

           7   taken with respect to establishing a trade-through rule and

           8   the recognition that if you're going to comply, you need to

           9   have access in order to comply, and we agree with the notion

          10   of having direct access or nondiscriminatory indirect access

          11   to a member and customer.

          12             But one of the things that we would focus on is

          13   that we need to look at access to quotes as a package; that

          14   is to say, if you're going to have autoex, you really need to

          15   look at end-to-end connectivity, so it really is everything

          16   from making sure that you have access to efficiently deliver

          17   an order, and that it is processed, and that's really dealing

          18   with the speed issues that we're talking about, in real time,

          19   and that the response from the execution or the non-execution

          20   on that order is also sent back to the original sender of

          21   that order in real time.

          22             The whole package is what really hangs together and

          23   what we are talking about, nondiscriminatory access or direct

          24   access, we think all of those end-to-end from sort of my door

          25   to the market center's door and back, really have to be

                                                                         134

           1   included in that.

           2             Moreover, as we look at providing access to the

           3   quotes, we also think about having access to the information

           4   about the quotes being a very necessary component to a market

           5   participant that wants to play, say, with the trade-through

           6   rule.  So one of the things that we would ask to spend more

           7   time looking at is, what is the actual minimum data

           8   requirement with respect to being able to comply with the

           9   rule, in addition to the actual access to the quote itself?

          10             So what's the -- you need to know where to go, not

          11   just what the inside market is, you need to know what is the

          12   venue that's going to get me that quote and have access to

          13   the data at a reasonable price in order to do that, but I

          14   know there's a market data discussion later in the day that's

          15   focused on a different aspect of this but we can look at

          16   access to the data in tandem with access to actually

          17   actionable quotes.

          18             MS. NAZARETH:  Bernie?

          19             MR. MADOFF:  I think that we can support the

          20   Commission's proposal on this second piece, the access.  It

          21   seems to be very well thought out.  You've addressed the --

          22   the issues that we were concerned about to bring it down to a

          23   minimum -- a minimum amount of a fee.  I think it's something

          24   that we probably can all -- we can all live with.

          25             As to the connectivity and the linkages, that is

                                                                         135

           1   something that, on the face of it, looks fine.  I guess the

           2   only concern that we have is that anybody that is a quoting

           3   market center, and whose quote that we cannot trade through,

           4   that we have to honor and that we want to honor, they must be

           5   available -- those quotes must be accessible.  We don't --

           6   there's some concern in the industry that someone who does

           7   not have a significant amount of market share and that

           8   doesn't have a linkage in place or has the cost of that

           9   linkage would be something that would be -- make no sense to

          10   acquire unless we could get to that.

          11             Now, that shows up to a very small degree in the

          12   marketplace today.  But, you know, that doesn't mean that it

          13   cannot become a real problem in the future, and I think

          14   that's very easy to address and just to make sure that the

          15   quotes that we're going to honor are going to be accessible

          16   and that they will either go through an SRO that we'll have

          17   to -- that those quotes have to be posted on an SRO or a

          18   universal hub that's acceptable to everyone, or that we'll be

          19   able to ignore that quote.

          20             So I think that all of that is very doable.  But

          21   that's the caveat that I would mention.

          22             MR. PETERFFY:  I think that what Bernie said would

          23   also go for market centers that do have significant market

          24   share.

          25             MR. COLBY:  Feel like expanding on that, Tom?

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           1             MR. PETERFFY:  Obviously, we are in favor of

           2   efficient access because who would not be?  But open and

           3   efficient access does not really matter when quotes are not

           4   automatically trading.  As we heard from the previous panel,

           5   they are working on a hybrid system but they will turn off

           6   the automated market when the book is traded away.  What will

           7   at that time be the price that we cannot trade through? 

           8   Whatever it will be, it will not be automated and we'll be

           9   paralyzed, as we are today.

          10             This is the reason we need an exception to be able

          11   to trade through the non-automated quotes and we need it as

          12   soon as possible.  If we do not get this, there is no

          13   incentive for open outcry markets to proceed with automation. 

          14   They have all the financial incentive to drag their feet.

          15             You must approve the exception for automated

          16   markets to trade through non-automated quotes if you want

          17   serious action on the part of open outcry exchanges.

          18             MR. CONCANNON:  The NASDAQ actually supports the

          19   Commission's approach here to what I would call soft

          20   linkages.  We believe that, given the trade-through proposal

          21   in Reg NMS, this topic of standards, while none is exciting

          22   as the trade-through debate, it's critically linked to the

          23   trade-through debate and you clearly point that out in your

          24   proposal.  Obviously, a market center that is obligated to

          25   provide order interaction with other market centers under the

                                                                         137

           1   trade-through proposal has to be able to efficiently access

           2   quotes of those other market centers.

           3             We do agree with the approach used where access can

           4   be done through a member or subscriber of the other market

           5   center as opposed to a hard linkage, or an ITS version.

           6             NASDAQ today does not have a hard linkage.  It in

           7   fact -- members are free to link, markets are free to link. 

           8   And we do have some linkages in place.  I will tell you,

           9   bilateral linkages between two markets are very difficult to

          10   negotiate and to complete, given the competitive interests on

          11   both sides.  The approach that the Commission is using is

          12   actually a very good approach where market centers can use

          13   other members of the other market center to access the quotes

          14   of that market center.

          15             We will ask for further clarification on how you

          16   actually achieve that.  There is a market center,

          17   Archipelago, that has an affiliate or a sub that is a

          18   broker/dealer that accesses similar to the proposal or the

          19   model contemplated by the proposal.  When market centers

          20   actually own broker/dealers or contract with broker/dealers

          21   to access other market centers, there are questions about

          22   whether it's a facility of that market center, what are the

          23   boundaries of the broker/dealer that is working with the

          24   market center to interact with the different market centers.

          25             So we agree with the approach.  We'd ask for

                                                                         138

           1   further clarification of how you actually effect that.  They

           2   are clearly complex, when a market center owns a

           3   broker/dealer, what are the boundaries around those

           4   complexities?  And I do agree with Bernie's point about new

           5   entrants.

           6             What the trade-through rule will potentially create

           7   is an incentive to put up a quote, knowing that I will always

           8   have someone to interact with my quote, without having

           9   customers that are subscribers of my entity.  So I confirm an

          10   ECN and have one customer posting bids and offers, knowing

          11   that the trade-through rule guarantees that interaction, yet

          12   I am a market share participant that's less than one percent.

          13             Will the industry incur major costs of linking to

          14   that one market center because of the guaranteed execution

          15   they get from the trade-through rule?  That is an issue that

          16   does have to be dealt with.  We do support the Commission's

          17   approach with respect to changing from 20 percent to 5

          18   percent the ATS requirements for fair access.  I think five

          19   percent is a very reasonable number.  If you've achieved five

          20   percent of market share, you have to meet certain standards

          21   of fair access.  You are clearly a market center, and you're

          22   obligated to interact like a market center.

          23             MS. NAZARETH:  You and Bernie both raised the

          24   interesting issue of what you do with a smaller market

          25   center.  You've used the one percent number.  Is it fair to

                                                                         139

           1   require that smaller market, and what would that definition

           2   be, basically, to make their quotes accessible to an SRO

           3   automated execution facility because of the costs involved in

           4   expecting the industry to connect to smaller players?

           5             MR. CONCANNON:  Yes, I think that would be a fair

           6   approach to force them into an SRO execution facility,

           7   clearly biased in my answer.  But I do think it does

           8   alleviate this cost burden to the members on how they achieve

           9   best execution when there's truly a cost in communicating

          10   with that sole destination despite its size.  So I do agree

          11   that one approach is to force them to use an SRO structure.

          12             MS. NAZARETH:  Bernie?

          13             MR. MADOFF:  Yes, I think that's fair.  Look, I

          14   spent most of my business life being forced into different

          15   venues in order to compete with that venue.  And somehow or

          16   other, we were able to figure it out.  I think that you, as

          17   Chairman and Commissioners have said, there is a certain

          18   amount of thinking that has to be done for the public good. 

          19   So while you would like to allow everybody to be able to

          20   compete, no matter how small they are, and I, better than

          21   most, can appreciate that philosophy, that being said, you

          22   cannot disrupt the market.

          23             So there's nothing wrong with forcing someone that

          24   has not -- not significant enough to make the amount of order

          25   flow or volume to -- you can't force people into his game but

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           1   you can allow them to play in that game by putting them into

           2   an independent marketplace like a NASDAQ, or, as we did, into

           3   ITS.

           4             So I think there's no problem with setting some

           5   sort of a limit and saying that somebody has to have a

           6   certain percent of market share before they will be required

           7   to go to -- through their linkage.  It's not a great

           8   imposition to go through an SRO's linkage.

           9             You know, I just want to explain one thing about

          10   ITS, now, maybe because 25 years ago, I was -- I was on the

          11   committee to put ITS together, so I feel I have to defend

          12   that to a certain extent.  And everyone, when you speak about

          13   ITS, people seem to feel, "Well, it doesn't work, it was

          14   designed not to work."  And I was a -- that's true and not

          15   true.

          16             Number one, it was designed not to work by certain

          17   interested parties, unfortunately.  But there is nothing

          18   technologically wrong with the ITS system.

          19             I use it all the time.  You can deliver an order to

          20   another exchange electronically, as fast as I certainly want

          21   to trade, and we trade as fast as pretty much everyone.

          22             It's what happens when that order arrives at that

          23   marketplace, which is what Tom was addressing.  So having an

          24   automated delivery into a marketplace is only part of the

          25   question.  There has to be an automatic response in order for

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           1   it to truly be an automatic market.  And since I have the

           2   microphone, I just want to address one other issue that came

           3   up this morning, but is relevant as it comes to access.

           4             Don't believe for a minute that the displayed size

           5   that you see in an electronic marketplace is the total size. 

           6   That is only the tip of the iceberg.  Below the quote, the

           7   displayed size that appears in most electronic markets, is

           8   what we call in the industry a reserve size.

           9             Once that displayed quote is exhausted

          10   electronically, almost instantly, more size shows up, you

          11   know, to replace that size.  There is no single specialist on

          12   any floor of an exchange, nor any upstairs market maker that

          13   themselves today in this environment can provide enough

          14   liquidity to offset an imbalance.  Imbalances are offset by

          15   customer orders interacting into that marketplace.  It is not

          16   the specialist, it is not the market maker like myself that

          17   can stand there and provide the liquidity, particularly

          18   during extreme moments.

          19             The best way to provide that liquidity is to allow

          20   customer orders to get into the marketplace as soon as

          21   possible.  The easiest way to do that, and certainly the most

          22   efficient way to do that is through some sort of an

          23   electronic capability to them to do that.

          24             MS. GLASSMAN:  Can I just jump in with a request

          25   which a number of you have already done on this panel.  But

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           1   as we get through this panel and the others later today,

           2   you're talking about different components of the rule.  If

           3   you would just address briefly how important -- how dependent

           4   whatever component you're talking about is relative to the

           5   other components of the rule, because ultimately we will

           6   probably be dealing with them individually in some sense, so

           7   it will be important for me to understand how linked they are

           8   or are not.

           9             MR. PETERFFY:  I think the ultimate issue is

          10   automate it.  As long as automated orders are executable, we

          11   are fine.  Once we allow manual orders to hold up the

          12   process, we are all paralyzed.  So I think, unless we agree

          13   on trading through manual markets, this entire conversation

          14   is meaningless.

          15             MR. GOLDSCHMID:  That is to say, where there's a

          16   hybrid system, the minute they break from automatic, they

          17   ought to be able to be traded through --

          18             MR. PETERFFY:  Right.  And that is why I'm

          19   proposing that ultimately tradable limit orders be followed

          20   by a character, a unique character that indicates that the

          21   matching order that's accessing the system to trade with that

          22   quote will be automatically executed.  That's a simple

          23   matter.

          24             MR. MADOFF:  I don't think that anybody is

          25   suggesting elimination of an auction marketplace.  I think

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           1   that we all understand the importance of that type of a

           2   marketplace, the role that it plays, and that there is no

           3   reason that it can't exist side by side with an electronic

           4   marketplace.  And I think you heard in the first panel, and

           5   will probably continue to hear that there is a role for both

           6   to play and they both can complement each other.

           7             So it is, what we're focusing in on now is that

           8   automated orders must be delivered automatically and

           9   responded to automatically.  If that displayed interest does

          10   not appear, and you then have to rely upon a crowd, and some

          11   people may decide they want to go into the crowd initially,

          12   and I think as what you heard this morning was that the

          13   challenge of the exchanges is going to be, how do they allow

          14   that to happen, how do you bring the two of them together?

          15             I don't doubt for a minute that the technology is

          16   there to do that.  But there are plenty of orders that

          17   deserve to be handled by a specialist or by a market maker in

          18   a manual mode.  That's not the problem.

          19             The problem is, do not take someone who wants to

          20   trade in an automatic mode and have his order taken out of

          21   the automatic mode and put into a manual mode, you know, when

          22   it's not his choice to do that.

          23             MR. COLBY:  Could I just talk on that?  Tom's

          24   suggestion was that it's all right to connect the floor with

          25   the automatic by designating when a quote was automatically

                                                                         144

           1   executable and when it wasn't.  Is that a condition that the

           2   rest of the market participants could live with, that they

           3   could identify on a quote-by-quote basis when something is

           4   tradable through --

           5             MR. PETERFFY:  They currently do.  Whenever we get

           6   a quote, we read where it is coming from.  So that when we

           7   or -- because each quote is accompanied by a letter that

           8   signifies what exchange it is coming from.  So when we are

           9   going to trade with that quote, we are going to send the

          10   order to that exchange.

          11             So all we are asking for is an additional letter

          12   for each of the manual exchanges so that we could tell them

          13   that -- whether we are sending this order to trade with the

          14   manual part of the exchange or the automated system of the

          15   exchange.

          16             MR. COLBY:  You're on a very high end of the

          17   automated world.  Can some of the other participants address

          18   what worked for them?

          19             MR. FREEMAN:  Well, I think that one of the issues

          20   here, and I that I we can link this to Commissioner

          21   Glassman's question about what other parts are implicated

          22   here, I'm talking about the market data implication before,

          23   but I think that in a practical sense, there is a concept

          24   that in some ways, to comply with the trade-through rule, at

          25   least one market participant and probably many need to have

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           1   the network of connectivity to all the market centers.

           2             And if you think about the actual mechanics of

           3   executing a trade where you see shares are offered at two

           4   cents, three cents and four cents in three different venues

           5   and you want to take that liquidity from the street, the most

           6   efficient way to do that may well be to go and send orders to

           7   the two-cent venue, the three-cent venue and the four-cent

           8   venue.

           9             An issue could arise where each of those market

          10   centers themselves having obligations under the trade-through

          11   rule to receive the order, say the three-cent order comes to

          12   the three-cent venue, looks at the marketplace and says, "Oh,

          13   wait a minute, I can't execute this order," something I

          14   discussed before, "I either have to ship it to the two cent

          15   place or send it back."

          16             And I think one of the things we need to think

          17   about in addition to this concept that a quote might go from

          18   automatically executable to not automatically executable on

          19   the same -- at the same venue, we'd also have to think about,

          20   can an order placer send an order to a venue and say, "I'm

          21   taking, in effect, I'm taking care of the trade-through rule

          22   on the two cents, please execute in your book."

          23             We need to be able to have this distinction made so

          24   that the trade-through rule doesn't work to your detriment

          25   because everybody's trying to comply with it.  So there's a

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           1   concept of a new order type that's not an opt-out, but it's,

           2   I'm complying, you can trade at three cents, you --

           3             MR. COLBY:  I'll just point out, that's half there

           4   in the rule.  The concept right now is that if the other

           5   orders have been accessed during the process of being

           6   accessed, the -- the rule doesn't currently have a concept of

           7   you telling the --

           8             MR. FREEMAN:  That's sort of my point.  In other

           9   words, know there's an exception that you can

          10   contemporaneously do a trade-through if I'm taking out the

          11   top of book in the other centers.  But what I'm saying is

          12   what is the behavior of the other centers?  I mean they're

          13   not -- they don't know unless I've told them I've taken out

          14   the top of the book.  Trading through would not be a

          15   violation of the trade-through rule.

          16             MR. GOLDSCHMID:  But you want to take

          17   responsibility for that, too.  I take it --

          18             MR. FREEMAN:  Well, what I'm saying is that if I'm

          19   executing an order and I'm trying to comply with best

          20   execution and trade-through requirements, and I think it's

          21   better for me, instead of going serially, to go

          22   simultaneously.  I want to ensure that the venues I'm sending

          23   the order to don't concern themselves with the compliance

          24   because I've taken on that responsibility.

          25             MR. GOLDSCHMID:  Yes.  That's what I'm -- but you

                                                                         147

           1   have taken on the responsibility.

           2             MR. FREEMAN:  They need to know that I have.

           3             MR. DONALDSON:  In the instance of an order that's

           4   in the automatic -- let's say that you've exhausted the bid,

           5   and let's say there is no big reserve there, and there's

           6   going to be a gap.  How do you handle the timing of filling

           7   that gap?

           8             In other words, how do you gather together

           9   liquidity if it's not there immediately in order to take care

          10   of a big block that's unexecuted that threatens to drop the

          11   market in an unacceptable way?

          12             MR. FREEMAN:  Well, to some degree, I'll take a

          13   shot at that, I think that one needs to be concerned that if

          14   you have a large order, that is satisfied in part ahead of

          15   you, and that you have an overage, that you need -- you need

          16   an ability to have an immediate cancel.  I'll take out the

          17   top of the book.  If it doesn't fit in, it's gone by the time

          18   I get there, or it can only be partially filled, I'd like to

          19   get my order --

          20             MR. DONALDSON:  Let's say it's a market order not

          21   held.  You get part of it executed and there's nothing there

          22   immediately, and -- in the -- in the manual market?  How much

          23   time -- how do you handle that?  How much time should be

          24   allowed to put together some sort of a bid or some sort of a

          25   price that's closer to the last sale as opposed to going back

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           1   into the automatic market and dropping the price by an

           2   unacceptable amount?

           3             MR. MADOFF:  We deal with that all day long today. 

           4   Now, but the people that deal with that, that's a competitive

           5   issue.  So if someone is trying to attract market share into

           6   their -- into their marketplace, then they are going to have

           7   to put up their capital to complete that order after they

           8   have exhausted, you know, whatever is available in other

           9   marketplaces.

          10             So most firms like ours for sure have what they

          11   call smart rallies.  So we can instantaneously take out every

          12   bid or offer that is displayed and then clean up the balance

          13   of that order by providing liquidity ourselves.

          14             If we choose not to do that, then we will just keep

          15   on exhausting all of the order flow, all of the bids that

          16   reappear.  That's a competitive issue that you're dealing

          17   with today in the NASDAQ marketplace.  But people, as I --

          18   it's important to deal with what I had just brought up, that

          19   the person that's controlling the order has to have the

          20   ability -- has to be an -- to say, listen, once that order --

          21   and it exists today for the most part -- it's a -- it's an

          22   immediate or cancel order, or fill or kill order.  You put

          23   the order into the marketplace.  If it doesn't get executed,

          24   it comes back.  Then it's up to the person who is controlling

          25   the order, certainly if it's a not-held order, to decide

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           1   where do I route that order, do I provide liquidity myself,

           2   do I send it to another venue?  That happens.

           3             And that what you will see, for the most part,

           4   there will be extensions in some inactive stocks, but for the

           5   most part, you will see liquidity develop because the way, if

           6   you look at the way the NASDAQ market operates today, there

           7   is tremendous reserve size.  So people don't want to show

           8   their total hand by displaying all of their order at one time

           9   because they are afraid that people will disadvantage them if

          10   they do that.

          11             The way we accommodated that in the NASDAQ

          12   marketplace is giving people the ability to put reserve size. 

          13   That automatically rises, once the displayed size disappears. 

          14   So I do not think that's a real problem.

          15             That does not mean that there will be instances

          16   where the order will have to be held manually, and that's

          17   when the specialists on the exchanges will take their role

          18   and that's when market makers like myself will fulfill their

          19   role.  And that happens pretty much today.

          20             MR. LEIBOWITZ:  I'd like to echo what Bernie sees. 

          21   I think if you look -- the question was, what happens if we

          22   blow through the book?  And through a sort of trial and error

          23   of what's the right amount of time to wait and seek the

          24   reserve in there, there's much more liquidity than people

          25   ever expected.  And then brokers, through, as a service for

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           1   their customers, start to provide capital to make sure that

           2   stocks don't move too much, and all of that is really

           3   reflected in our execution quality statistics so that our

           4   customers can say, "Oh, you're doing a good job executing

           5   large orders for us," or if we were constantly blowing

           6   through orders, that would show up relatively quickly.

           7             MR. PETERFFY:  There is always -- there is always a

           8   block that is so large that it cannot just be dropped into

           9   the market.  So this is where the broker/dealers execution

          10   comes in to play.  But what is important for the broker,

          11   after he has dealt with the block or reverses the block, that

          12   he is able to go to the various market centers and get

          13   automated executions for the pieces in which he is digesting

          14   the block.

          15             MR. ATKINS:  To make this -- maybe to make this

          16   even more like a college exam question or something like

          17   that, I'll throw a couple of variables in like Commissioner

          18   Glassman was saying, when we're talking about access, if we

          19   adopt adequate access, and there is in the rule, we might

          20   talk about that, there are two other provisions that we're

          21   talking about extending to NASDAQ that I wonder, with respect

          22   to all of the discussion that we had earlier on the

          23   importance of limit orders and encouraging that, I wonder

          24   what you think is going to be the effect of that, and that is

          25   the provision of locked and crossed markets.  We have no

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           1   rule.  And then also the extension of the trade-through rules

           2   to NASDAQ.

           3             The combination of these factors, what does that

           4   point to do to the marketplace, and is there something with

           5   respect to access that might obviate those two provisions of

           6   our rule?

           7             MR. PETERFFY:  We see nothing wrong with locked

           8   markets.  A locked market is as tight as a market can get,

           9   namely, it's as tight as the Commission -- the problem with

          10   locked markets is that some market centers have programs to

          11   turn off their automated system and they do not work.  So you

          12   should ask these market centers to change their programs and

          13   let the locked markets live and let customers have the tight

          14   market.

          15             MR. GIESEA:  The STA opposed locked and crossed

          16   markets for a number of reasons.  The basic principle is that

          17   if you accept an order, the terms under which it could be met

          18   in the marketplace, it seems like a rational thing to do, to

          19   seek out the bid or the offer the customer has obtained, that

          20   he desires to have an execution, as opposed to entering a

          21   locking or a crossing quotation, essentially, to collect

          22   liquidity rebate, perhaps, as opposed to serving the

          23   customer, and also giving the existing bid or offer its

          24   rightful execution.

          25             MR. PETERFFY:  You are correct when you're talking

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           1   about customer orders but not when you're talking about

           2   market maker orders.

           3             MR. LEIBOWITZ:  I don't see a useful purpose to

           4   locked and crossed markets.  I think a lot of proposals in

           5   other areas of regulation actually will solve most of this

           6   problem, will be access fee problems, and the automated

           7   execution.

           8             I think a lot of this will go away.  But -- but I

           9   think it's disingenuous to say that if somebody is showing an

          10   indication they want to trade, a bottom line is, that's an

          11   inefficient use of the market when there is actual indication

          12   on the other side.

          13             MR. PETERFFY:  Well, as long as the market is

          14   automated, and I'm quoting eleven of eleven in the hopes of

          15   getting then to within one hundredths of a cent of rebate,

          16   I'm doing a public service and I'm doing it all by myself.

          17             MR. ATKINS:  I guess that's what I was hoping to

          18   get in discussion, because if you do iron out these

          19   extraneous impediments like access fees or whatever, then do

          20   we really need it and then are we going to create unintended

          21   consequences through an artificial prohibition, I believe, so

          22   that's the response --

          23             MR. CONCANNON:  Yes, I agree with Larry that some

          24   of the other components of the proposal could actually

          25   alleviate something like locked and crossed markets.  The

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           1   access fee is an issue.  People do lock and cross to obtain a

           2   rebate.  That is a trading strategy today.

           3             Changing the pricing of access could actually

           4   change the incentives of lock and cross.  Access terms are

           5   another issue, why there are locks and crosses.  People that

           6   don't provide automated execution or linkages, whether

           7   bilateral or customer electronic linkage, are going to lock

           8   the market.  They have stale quotes.  They aren't being

           9   updated, aren't being accessed.

          10             So you will have a situation where a broker has a

          11   valid reason to post a quote against a slow market quote, so

          12   if you can trade through that quote, arguably, you should be

          13   able to lock it.

          14             There are similar issues in both decisions.  But I

          15   do think locks and crosses do provide confusion for investing

          16   public.  What is the true market when it's locked?  More so

          17   when it's crossed?  So I think discouraging locks and

          18   crosses, providing other parts of the rule so that it

          19   actually provides enhancements that avoid the incidents of

          20   locks and crosses, is actually a very good approach.

          21             Your question on trade-through and NASDAQ, I know

          22   this is access standards, but I did want to try and address

          23   it.  When we look at, we've had this discussion about what

          24   will happen and what will happen with an opt-out.

          25             NASDAQ is the test case.  The market is an opt-out. 

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           1   It's governed by best execution, and in fact, limit order

           2   display is happening every day and it's very aggressive limit

           3   order display.  Our quotes, our spreads are extremely narrow,

           4   and they are more narrow in these stocks than the market that

           5   has a trade-through rule in it today.

           6             So I would argue that the opt-out, while we support

           7   Reg NMS and the trade-through component of it, we do believe

           8   the opt-out allows for this aggressive limit order display. 

           9   It won't discourage it.  It's actually the access portion of

          10   it, the automated features will encourage the use of limit

          11   orders and that's what happened on NASDAQ.  As you introduced

          12   more automation, and first it was ECNs, and NASDAQ responded

          13   to that competition, people are using limit orders on NASDAQ. 

          14   And I think we heard that from the prior panels, especially

          15   from the buy side, that they do like trading in the NASDAQ

          16   market as opposed to the market that has the trade-through

          17   rule.

          18             MR. LEIBOWITZ:  I was just going to say, it seems

          19   hard to argue with the principle of not being able to trade

          20   through an automated market.  Just in principle, that seems

          21   to make sense, whether it's NASDAQ or anywhere else.  But

          22   what it's really going to come done to at the end of the game

          23   is, what's the practicality of enforcing it?  Some of the

          24   examples that Ivan gave of, you know, sort of ending up in a

          25   circle where orders get shipped from place to place because

                                                                         155

           1   limit orders keep getting cancelled or changed, and so that

           2   you never really know where the market is.

           3             The question is in the electronic world, how will

           4   we enforce that in real time, whereas if it becomes something

           5   that's part of an auditable thing, because right now, when

           6   there's a trade-through, the trade-through rule is, call the

           7   New York Stock Exchange and complain to professionals.

           8             Well, that can't happen in an electronic market. 

           9   You can't get satisfaction that way.  So how will we actually

          10   do it?

          11             MR. COLBY:  Given the interest in moving towards

          12   automatic markets, should we be going farther than just

          13   having a trade-through rule with a fast market exception,

          14   should we be mandating automatic execution or saying that

          15   non-automated quotes are not part of the best bid and offer?

          16             MR. CONCANNON:  Well, if I could address that, I do

          17   think the fast or slow market approach could have a dramatic

          18   effect.  Markets -- and we're hearing it today -- markets are

          19   committing to being fast for fear of being deemed slow.  It

          20   will dramatically affect a broker's decision of where to

          21   place his limit orders.  So there is this race before you

          22   even actually approve the rule, to be fast.

          23             I am concerned that there is this option of slow

          24   out there.  And that under the trade-through rule, you have

          25   the de minimis standards of -- even though they are slow, you

                                                                         156

           1   still have to respect that quote.  I do believe at some point

           2   there is a business model in being deemed a slow market.  In

           3   fact, by sitting out on a quote, you obtain tremendous amount

           4   of information, trading information because people are

           5   required to try and hit you that there could be a business

           6   model in being deemed a slow market or participating in a

           7   slow quote.

           8             And I was a little bit concerned about Tom's

           9   proposal to just deem a quote slow or fast, in real time. 

          10   There are times, I like the concept where you better be fast

          11   or else no one's going to put a limit order on you.  That's a

          12   very good competitive environment.

          13             MR. PETERFFY:  I think you absolutely must have

          14   standards.  Otherwise, everybody will go to the lowest common

          15   denominator, namely, we'll take as long as possible.  If you

          16   give me two seconds, then I can wait for two seconds and see

          17   what is the lowest bid that has occurred during those two

          18   seconds, and that's where I'm going to buy my customer's

          19   order.  So I don't think that's fair.  If you do that, you

          20   will create a circumstance in which the bad guys will make

          21   all the money and the good guys will go out of business.

          22             MR. MADOFF:  I have a hard time, you know,

          23   addressing the issue as to what's a fast market or a slow

          24   market.  And certainly, I don't think that we have to get --

          25   we don't have to -- do not have to define it down to the

                                                                         157

           1   nanoseconds or whatever we were talking about this morning.

           2             You're going to have to -- first of all, I think

           3   that it's going to be very difficult for the Commission to

           4   say everyone has to be fast or that everyone has to be

           5   automated.  I do not think that's the direction we want to

           6   go.  I think that letting the competitive forces work will

           7   accomplish what you really want to accomplish anyhow and I

           8   think that if you say that automatic execution involves order

           9   delivery, and automatic response, and what you want to say

          10   that's one second, whatever, everyone will be able to live

          11   with that, I think in the real -- in the real world.

          12             I do not -- I do not see a problem with the access

          13   fee issue as you've addressed it, as I said earlier.  I think

          14   that whether or not you need a trade-through rule is a

          15   different issue.  I think that if you have the linkages, you

          16   deal with the access issues.  People are not going to trade

          17   through markets.  And clearly, they are not going to trade

          18   through automated markets.

          19             So you know, I don't think we have to deal with, do

          20   we force everyone to be automated or not.  I think what

          21   you've witnessed this morning was the so-called slow markets

          22   are going to become fast markets because of the competitive

          23   reasons that exist in this marketplace.

          24             So, and to answer the question, I guess, that Bob

          25   asked before, can markets read an identifier, which is an

                                                                         158

           1   important issue to those that operate in an automated market,

           2   the answer is yes.  Our system -- an automated system is an

           3   automated system.  So everyone's automated system will be

           4   able to read whether they're sending an order to a

           5   non-automated system market or not.  And I think that

           6   clearly, that's what you want to happen.

           7             I want to know that the order is going to an

           8   automated market, and that that may not be executed

           9   automatically.  That happens all the time in today's world. 

          10   I can send orders to other automated markets.  I do not get

          11   an execution if in fact, you know, there's a limit on that --

          12   on that order.  And that's fine.  As long as I get -- I get

          13   it back immediately and I know that I didn't get that

          14   execution, that's as much as I can ask you.

          15             MR. FREEMAN:  Bob, I'd like to address your

          16   question by expanding it a bit, which is to say, are there

          17   other things that we should be mandating in terms of the

          18   operation of a market participant when we're having all these

          19   linkages, and I'd like to raise two things:

          20             Maybe we should be thinking about uniformity across

          21   the market centers and trading halts and how to trade those. 

          22   And a potentially systemic issue also is the disparity of

          23   different market centers and how they handle erroneous

          24   trades.  And as market participants go and dispute through

          25   various means, end up in places they may not know where they

                                                                         159

           1   are actually ending up, if they are not looking at a uniform

           2   set of erroneous trade procedures, it might pose some sort of

           3   risk to the system.

           4             MR. DONALDSON:  I think we're --

           5             MR. GOLDSCHMID:  One last quick one, or maybe not

           6   quick.  What will this do to ITS, and does it matter if we

           7   take this route, Bernie, you --

           8             MR. MADOFF:  I don't think it matters.  I think

           9   that ITS, there's going to have to be some sort of a linkage. 

          10   The problem with ITS, which was, you know, discussed this

          11   morning, is a governance issue.  It's not a technology issue. 

          12   It's the fact that in order to make enhancements to ITS, you

          13   have to have a unanimous vote, which anyone who has

          14   involvement with this industry knows is impossible.  And the

          15   problem is that people confuse that ITS is an automatic

          16   linkage.  It isn't.  I deliver my orders automatically, then

          17   they turn into manual orders down at the exchanges.

          18             Now, that also, if you just -- if the New York

          19   becomes a fast market, my guess would be, you could use ITS

          20   as it presently exists with no problem at all.  Now, maybe

          21   somebody wants to build a better technology platform than

          22   exists in the pipe.  But I have to tell you I'm as large a

          23   user of ITS as exists today, and we probably do ten percent

          24   of the transactions in New York Stock Exchange issues.  I

          25   have no problem with ITS as a technology platform.

                                                                         160

           1             I have a problem with it once it gets to the

           2   ultimate destination.

           3             MR. FREEMAN:  I think one of the things we also

           4   need to consider with respect to any hard linkage is, to the

           5   extent that it becomes a market standard, should we be

           6   concerned about single point of failure.  If everyone is

           7   grabbing onto it because -- maybe we have to think about that

           8   as well.

           9             MR. LEIBOWITZ:  I think you have a perfect example

          10   of that in NASDAQ, where there was a time where people really

          11   felt that NASDAQ couldn't handle the stress of the system and

          12   what ended up happening is, ECNs created direct connections,

          13   brokers created -- so this sort of third party network sprang

          14   up around NASDAQ because it wasn't capable of handling it and

          15   I think that's all happened here.

          16             MR. COLBY:  ITS gives a guaranteed way to get into

          17   an exchange.  Now, the execution process when you get there

          18   may not be as good.  If it's not there, are the other routes

          19   into these exchanges adequate?

          20             MR. CONCANNON:  I would say yes.  People have built

          21   these linkages as need --

          22             MR. COLBY:  But Chris, they haven't built them

          23   in -- we're assuming they would build --

          24             MR. PETERFFY:  That will be applicable to the

          25   listed stocks as soon as the listed stocks trade somewhere

                                                                         161

           1   where it's worthwhile to access it.

           2             MR. CONCANNON:  And actually today building around

           3   ITS because of the speed and the response time issues, so

           4   people do have -- brokers have hard wires into multiple, you

           5   know, regional exchanges of trade listed and they do sweep

           6   through the listed markets.  And avoid ITS for the reasons

           7   like Bernie mentioned, not because of the technology, but

           8   because of the response time.

           9             But there is a big issue on ITS and it's the hard

          10   linkage issue.  It's a free access into the markets.  It

          11   devalues the -- the value of membership.  Why should I become

          12   a member of an exchange or an SRO when I can be a member of

          13   one SRO and just access all the other SROs?  So the approach

          14   that he -- has used is actually a very good approach using

          15   the member to access the market.  The value of the seats on

          16   New York will dramatically fall when ITS is enhanced and give

          17   automated execution.

          18             That same rule applies to NASDAQ.  Why would anyone

          19   be a member of NASDAQ if they can go through a hard linkage

          20   and be a member of an exchange that has lower standards and

          21   less regulatory issues for them?  Those --

          22             MR. LEIBOWITZ:  Of course what that would say is

          23   that ITS should really go to work on access speed methodology

          24   more like what applies in the rest of the access speed

          25   portion and that might make the whole problem wash out.

                                                                         162

           1             MR. CONCANNON:  Yes, potentially that could be one

           2   way to do it.  I do like the approach that the Commission set

           3   forth the membership approach.

           4             MR. PETERFFY:  I would like to correct myself if I

           5   may.  About the DOT routing system being terrific and

           6   obviously, it works very well.  All we would like to see is

           7   that being extended.

           8             MR. DONALDSON:  Thank you all very much.

           9             (Recess taken.)

          10             MR. DONALDSON:  All right, we'll ask this panel to

          11   do a hand up in the air so people in the back of the room

          12   know who you are.  Bob?

          13             MR. BRITZ:  Bob Britz, I'm president of the New

          14   York Stock Exchange.

          15             MR. PUTNAM:  Gerry Putnam, CEO of Archipelago.

          16             MR. O'BRIEN:  I'm Bill O'Brien, chief operating

          17   officer for Brut ECN.

          18             MR. NICOLL:  Ed Nicoll, CEO of Instinet Group.

          19             MR. LAVICKA:  Matt Lavicka, managing director at

          20   Goldman, Sachs.

          21             MR. JOYCE:  Tom Joyce, CEO of Knight Trading Group.

          22             MS. NAZARETH:  Likewise, we're going to continue

          23   our discussion of the market access proposal, but this panel

          24   will be focused on the access fee portion of the proposal. 

          25   As you know, the market access proposal would also establish

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           1   a de minimis standard for access fees.  It would assure

           2   access to public quotes for a fee that could not accumulate

           3   to more than two tenths of a cent per share in any

           4   transaction.

           5             The application of the fee standard to different

           6   entities would depend on how a quote was accessed by an order

           7   router.  Such access can be divided into three categories:

           8             First, quotes could be accessed through an SRO

           9   order execution facility defined in the proposal as a quoting

          10   market center, which would be authorized to charge a fee of

          11   no more than one tenth of a cent per share.

          12             In addition, if a quote was attributable to a

          13   particular broker/dealer, the broker/dealer would also be

          14   authorized to charge a fee of no more than a tenth of a cent

          15   per share.

          16             Second, quotes could be accessed through a

          17   broker/dealer whose quotes were not accessible in any SRO

          18   order execution facility.  Such a broker/dealer is defined in

          19   the proposal as a quoting market participant and he's

          20   authorized to charge a fee of no more than a tenth of a cent

          21   per share.

          22             And third, quotes could be accessed directly

          23   through a broker/dealer whose quotes were also accessible

          24   through an SRO execution facility.  Except for the

          25   accumulated fee cap of two tenths of a cent per share, this

                                                                         164

           1   type of direct access is not specifically covered by the

           2   proposal and would continue to be subject to the existing

           3   rules with respect to access fees.

           4             The market access proposal also would require every

           5   SRO to establish and enforce rules requiring its members to

           6   avoid locking and crossing quotations and enabling market

           7   participants to reconcile locked and crossed quotations

           8   before effecting a trade.  The SRO rules also would prohibit

           9   members from initiating a pattern or practice of locking and

          10   crossing quotations.

          11             I guess we'll start with the basic questions which

          12   are, at what level do fees associated with access to a

          13   market's quotes become a problem that hampers the fair and

          14   efficient access to quotes and are competitive forces alone

          15   sufficient to address the level of access fees.  We'll start

          16   with Tom.

          17             MR. JOYCE:  I don't think competitive forces alone

          18   are enough to control access fees.  In point of fact, a

          19   little history, access fees were introduced in the Order

          20   Handling Rules that the SEC endorsed in 1996.  ECNs at the

          21   time, ATSs in general, were given the ability to charge a fee

          22   to members, other broker/dealers, who were forced because of

          23   the best execution rules to go to that ECN.  So even though

          24   you were a non-subscriber, you were forced to go there and

          25   ATSs were then given the right and no other broker/dealer had

                                                                         165

           1   that right to assess a fee to you.

           2             So this was introduced by regulatory fiat in 1996. 

           3   While it was clearly not a level playing field, which was to

           4   say no other broker/dealers had the right to do that, this

           5   was established and got credence in the market and the next

           6   thing you knew there were ten ECNs or ATSs, or both.  So

           7   clearly, with the proliferation of ECNs, the proliferation of

           8   ATSs, all the broker/dealers that were out there on the other

           9   side of the equation, competition did not do almost anything

          10   to knock down access fees.

          11             In point of fact, ATSs assumed as their given right

          12   to charge access fees while the rest of the market

          13   participants could not.  So I believe that they were

          14   artificially imposed on the market and they should be

          15   eliminated entirely.  I don't know if there is a minimum

          16   amount of an access fee that is appropriate vs. not

          17   appropriate.

          18             Another bit of history, one of the reasons access

          19   fees were introduced in 1996 was because it was the view of

          20   some people at the Commission that market makers have the

          21   ability to capture spread and as a result, ATSs were, quote

          22   unquote, disadvantaged.

          23             Well, over the competitive environment that's

          24   occurred since then, the -- because of decimalization, and

          25   now, again, another regulation seems to be coming our way,

                                                                         166

           1   the ability to capture spread that supposedly market makers

           2   had has been virtually eliminated yet access fees are still

           3   here.

           4             So I am of the firm belief that competitive forces

           5   have done very little to eliminate access fees, that access

           6   fees were artificially introduced into the markets, and

           7   frankly, the only good access fee is zero.

           8             MR. LAVICKA:  We believe that markets should be

           9   fair, open and transparent.  However this transparency can

          10   only be achieved if quotes comprising SEC mandated national

          11   best bid and offer reflect a true and complete value of the

          12   transaction.  Best execution obligations, the 11Ac1-5 rule,

          13   and the proposed trade-through rule, have elevated NBBO to a

          14   key role as the benchmark for measuring price and execution

          15   quality in the equity markets and for this reason, when it

          16   comes to the NBBO, we believe that what you see should be

          17   what you get.  Access fees that hide behind a quote means

          18   that the quote is not what it says it is.  If we're going to

          19   continue to use the NBBO as a benchmark for price discovery

          20   and best execution, then the SEC must ensure that the NBBO

          21   quote is an accurate representation of price.

          22             Apart from these transparency concerns, we also

          23   believe that, for a quote to be part of the NBBO, it should

          24   be possible to execute against that quote in an efficient

          25   manner.  In other words, in addition to being what it says it

                                                                         167

           1   is, the NBBO should be available for immediate execution. 

           2   Subjecting the quote to this requirement will help ensure the

           3   validity of using the NBBO as benchmark.

           4             Also, it should be noted that access fees may

           5   create an alternative way of quoting in subpennies, something

           6   that Regulation NMS proposes to eliminate.  And for this

           7   reason as well as the transparency and accessibility reasons

           8   already mentioned, it is imperative that the SEC ensure that

           9   access fees do not distort the quote.

          10             We believe that our markets are robust precisely

          11   due to the extent of the lively competition that exists. 

          12   However, we think that competition should be based on the

          13   value of services provided to clients sending orders to a

          14   particular venue, services such as providing capital, deeper

          15   liquidity, flexible and sophisticated order types, and smart

          16   order routing and handling.  It should not be based on hidden

          17   fees or burdens on intermarket access to a venue's published

          18   quote in the NBBO.

          19             In summary, if the NBBO is based on transparent and

          20   accessible prices, then broker/dealers like Goldman Sachs

          21   will be able to fulfill their duty to seek best execution for

          22   their customers' orders and market participants will be

          23   assured of an accurate, meaningful and reliable benchmark. 

          24   Thank you.

          25             MR. NICOLL:  I'll try and answer your question.  I

                                                                         168

           1   don't know -- I don't know where there -- whether anybody has

           2   done a study or a credible analysis on where access fees

           3   begin to disincentivize people from entering the marketplace. 

           4   I don't know where that is.  That's why I think it should be

           5   established by competition between market venues.  Just like

           6   I don't think anybody knows what the right price of many

           7   things are, except as it's established by forces of supply

           8   and demand.

           9             Let me be absolutely clear.  For agency markets to

          10   exist, they have to charge agency fees.  Instinet, by the

          11   way, has been from the very beginning and still is prepared

          12   to represent its access fees within the quote itself, but

          13   that would require quoting in pennies.  So I hardly think

          14   that they are hidden.  They are published, they are uniform,

          15   because we are a fair access ECN, everybody knows what they

          16   are.

          17             And they are necessary to create an agency market. 

          18   Otherwise, we will have dealer marketplaces.  Can't have it

          19   both ways.  So the question is not should there be agency

          20   fees.  The question is, is there a need for the Commission to

          21   cap them and to take a position about what the appropriate

          22   level of agency fees is for agency marketplaces.

          23             MR. O'BRIEN:  Thanks for the opportunity to speak

          24   to you all today.  I think in deference and in partial

          25   apology for speakers on this panel that represent large

                                                                         169

           1   customers of Brut, I'm going to, in answering your question,

           2   I think counterpoint to some of the statements they have

           3   already made today.

           4             It was interesting.  At the end of the last panel,

           5   it talked about the problem of ITSs and zero cost structure

           6   devaluing the member, the value of exchange membership. 

           7   ECNs, prior to the Order Handling Rules, really, Instinet was

           8   the only one, did charge access fees at their locations going

           9   back to their start in 1969.  I think to kind of balance the

          10   interests of getting their order prices into the public quote

          11   and to improve market transparency, they allowed, they didn't

          12   impose by fiat, but they allowed continuation of charging for

          13   access to those quotations via the public quote system,

          14   notwithstanding the fact that a firm had not entered into a

          15   contractual relationship with the ATS operator, and I think

          16   it was kind of validating, an example of the value of

          17   maintaining the value of membership on a customer basis, does

          18   make sense.  Has competition driven those fees down? 

          19   Absolutely.

          20             Before 1996, the average fee captured by an ATS was

          21   three cents a share.  Remember, Instinet at the time charged

          22   liquidity provider and charged liquidity taker.  Today net

          23   fees for ECNs are under a tenth of a cent.  Talking about a

          24   95 percent reduction of those fees on that basis.  So it's

          25   competition by and large is working to keep those fees as a

                                                                         170

           1   reasonable level, and as Ed pointed out, there is a reason

           2   for those fees.  We talked a lot earlier today about how

           3   limit orders have value and promoting them, encouraging their

           4   display, rewarding the people that display them is something

           5   that needs to be furthered by a market structure.

           6             Current market center fee structures do just that,

           7   and you need to be able to preserve that.  And you know, in

           8   the previous panel, a couple of speakers, talked about rogue

           9   traders, that people providing limit orders are some way, you

          10   know, not worthy of our respect.  It's a good economic

          11   outcome, it's a good public policy outcome.

          12             On the way to decimalization, there has been a

          13   significant, you know, influx of liquidity into the market by

          14   non-traditional firms providing net liquidity to the

          15   marketplace, taking advantage of the economic model that

          16   agency markets offer.  You disregard liquidity and the value

          17   of those net liquidity to the average investor really at your

          18   peril.

          19             So it is a valuable fee structuring, and

          20   competition by and large is driving it down.  The problems

          21   that some of the panel has talked about, distortions, I just

          22   flatly don't agree with it.  And the idea of NBBO somehow

          23   being distorted is just not true.  The average investor that

          24   places an order on an on-line platform at Schwab or

          25   Ameritrade or Fidelity, sees price.  They have no knowledge

                                                                         171

           1   of these fees, it's netted out to them in the form of the

           2   commissions that they pay.  In terms of intermediaries, they

           3   are very highly aware of these fees.  They are driving these

           4   fees down to historically low levels.  And they can -- they

           5   can operate their business model successfully in ignoring

           6   them.

           7             So I think by and large, competition is working to

           8   keep these fees at reasonable levels.  I think where

           9   competition may fail is the instance that was spoken about in

          10   the last panel, kind of a de minimis market center that has a

          11   right to put an order into the public quotation and cause a

          12   lot of disruption with a very small amount of order flow that

          13   can attempt to, you know, extort rates that are not

          14   consistent with, you know, a disciplined market with market

          15   rates, and that creates a tension for Matt and for Tom, given

          16   their duty of best execution to, A, build the linkage and pay

          17   for it, whether it's on their own or through a third party

          18   vendor that is inefficient relative to the liquidity that

          19   market destination may have; and two, accept fee structures

          20   that are just not competitive.

          21             So some of the ideas that were bandied about a

          22   little earlier about making de minimis markets participate

          23   through SROs or execution facilities really would do two

          24   things:  One, it provides efficient linkages, and two, it

          25   subjects those markets to the rule sets of SROs like NASDAQ

                                                                         172

           1   has today to keep their rate structures at what the market

           2   views as reasonable levels.

           3             MR. PUTNAM:  We strongly support the

           4   nondiscrimination policy that is part of the section of Reg

           5   NMS.  ArcaEx has been over the years a strong proponent of

           6   best execution, always finding the best price regardless of

           7   where it traded.  We actually pioneered that aspect of the

           8   business.  And as a result, we've also been on the leading

           9   edge of the unfair access fee issue.

          10             We've actually gone through a period of time where

          11   we had competitors who came up with rates specific to us, a

          12   competitor rate, and it was two to five times what they

          13   charged everybody else.

          14             When we fought it, and refused to pay in some

          15   cases, as a way of fighting those fees, our access was

          16   threatened.  So threats of, "We'll pull your wires out of the

          17   wall if you don't pay this extortion fee because we know your

          18   model's best ex, and there we can take advantage of you."

          19             That said, we are entirely against the idea of the

          20   government setting rates for us.  Access fees have dropped

          21   dramatically and you heard earlier from Tom, and when it

          22   started, it was a relatively high fee.  Fees have gone almost

          23   to zero at this point.  It's been the result of

          24   hypercompetition.  There is no problem in the marketplace. 

          25   Market makers in NASDAQ today are actually paid for access to

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           1   their quotes.  NASDAQ pays a two tenths of a cent per share

           2   rebate to them when someone accesses their quote.

           3             I would say if you're going to go down this path, I

           4   mean why stop at market access?  And many of you know, we

           5   filed an S-1 to go public.  And as a result we have to use an

           6   investment banker.  And I know there's been a lot of debate

           7   over the fact that investment bankers tend to charge a

           8   relatively high, very similar fee.  So why not go to the next

           9   step and lower the fee that they can charge us for doing our

          10   investment banking business?

          11             And then there's the matter of my on-line broker. 

          12   They all tend to charge the same fee today, so why not take a

          13   whack at them?

          14             I think that some of what we're heard earlier from

          15   the CBOE, I don't know that it was Bill Brodsky or Ed Tilly,

          16   they are talking about how they are getting people into their

          17   electronic quotes and the comment was, "We reward

          18   participants for adding liquidity."

          19             Well, we reward participants for adding liquidity

          20   and I think John Wheeler earlier mentioned that you look up

          21   in the option pages and you see those option prices, well,

          22   there is option value in those limit orders.  And the takers

          23   of liquidity are willing to pay a fee for unfettered access

          24   to those quotes.  So the market has set a fair rate.

          25             Those who provide or are willing to stick their

                                                                         174

           1   neck out and provide quotes get paid in exchange for letting

           2   people access them.  We've talked a lot about protecting

           3   limit orders and the value of limit orders here.  You take

           4   the reward away for displaying limit orders, all of a sudden

           5   we're back at some policy that's going to threaten limit

           6   orders again.  So again, I think that is exactly the wrong

           7   place to go.

           8             We do not like the idea of somebody telling us what

           9   we can charge for our service.  That's the issue which Bill

          10   brought up about a few ECNs that set up these toll booths in

          11   the middle of the execution highway and charge exorbitant

          12   fees.  Well, it's over with.  That's done in the marketplace. 

          13   We, they have been there.  They are not there today.  NASDAQ

          14   solved its problem by passing a rule, which is where we think

          15   this should be addressed.  SROs passed rules like NASDAQ did

          16   that said, "We're going to limit what you can charge in our

          17   marketplace.  If you don't like it, go someplace else."

          18             We can choose to do the same thing, so let the SROs

          19   determine price, let competition deal with the issue of

          20   getting price gouged like you all liked to do with us,

          21   because we did get gouged for years.  We suffered through it. 

          22   The marketplace determined access to the best price was the

          23   best thing.  So now those guys that were gouging us all do

          24   what we used to do, which is seek the best price regardless

          25   of where it is, and that took care of the price tabs problem,

                                                                         175

           1   as they obviously don't want it done back to them.

           2             MS. GLASSMAN:  Your putting the fee in the quote,

           3   even though it would involve some fees?

           4             MR. PUTNAM:  Another way to do it would be to put

           5   the fee in the quote.  Everybody charges the same thing

           6   today, so we all know what the fee is anyway.  So, you know,

           7   I mean, a hundred percent of the marketplace is charging

           8   roughly the same price.  So everyone can do the math.  It's

           9   sub one penny.  It's sub a half a penny.  It's actually

          10   closer to a quarter of a cent or three tenths of a cent per

          11   share.  Everyone can do that math.

          12             MR. O'BRIEN:  I would just ask the question, what

          13   would the value of doing that be to the individual investor,

          14   would the commission rate charged by an Ameritrade or Goldman

          15   Sachs or Knight go down because they explicitly absorbed

          16   these fees in the price of transaction?  Why not do that with

          17   SEC fees or the NASD's trading activity fee or clearance and

          18   settlement fees?

          19             Those fees don't necessarily need to be transparent

          20   to the end user provided that they are transparent to their

          21   intermediaries and there's competition among participants

          22   regarding them.

          23             MR. PUTNAM:  What if you chase off the really

          24   efficient modern market maker, the one who comes in and views

          25   that two tenths of a cent that they receive for providing

                                                                         176

           1   liquidity or displaying limit orders in the system, it's part

           2   of their -- a big part, in many cases a big part of their

           3   economics.  They are so nimble and so quick, but enormous

           4   liquidity providers, if you take that away and they just

           5   disappear, what to we do with limit orders?  We just shrunk

           6   the supply of limit orders in the marketplace.  Spreads are

           7   widened if they go away.  We had a lot wider spreads before

           8   those folks showed up than we do today.

           9             MR. BRITZ:  I think I'm probably going to end this

          10   particular rotation where T.J. began it, but I'd like to

          11   start by saying, while I'm aware that this has been a hotly

          12   debated issue in the over-the-counter market for quite some

          13   number of years now, it's not been an issue in the listed

          14   market.

          15             So I think we come to this issue in a somewhat

          16   different way than many of the other people around this table

          17   who have been living and breathing this issue for X number of

          18   years.  If nothing else, we've come to it with fair, fresh

          19   eyes.  In fact, very fresh eyes.  It wasn't until the

          20   publication of Reg NMS that we realized maybe this really was

          21   an NYSE listed issue.  In fact, even after the publication,

          22   and having read Reg NMS, we respectfully disagree that this

          23   actually does border on to the NYSE domain.

          24             And the simple reason is, the NYSE has never

          25   induced anyone to send it an order via a cash payment.  And

                                                                         177

           1   so we have never had any need for access fees to fund those

           2   kinds of schemes.

           3             But Reg NMS does something that did get our

           4   attention and it says, SRO, or where it suggests that SRO

           5   transaction charges ought to be categorized in the same way

           6   as access fees, and it says that notwithstanding that ECN

           7   access fees are in addition to SRO transaction charges and no

           8   such additional fee exists at the New York Stock Exchange.

           9             ECN X's fees are true variable costs and are not

          10   transparent in real time whereas NYSE transaction charges are

          11   completely transparent, known before the trade, and because

          12   of the very structure of those transaction charges, they act

          13   much more like the fixed charge and a variable cost that can

          14   be tagged to any particular trade.

          15             And lastly, the NYSE levied these transaction

          16   charges on its members, its customers, and those members, and

          17   not incidentally, the SEC, approved those charges.  ECNs levy

          18   access fees on non-customers.  There was no privity.  Those

          19   customers have not agreed to the charge and indeed, at the

          20   time of the trade, may not know that they are going to get a

          21   bill from an ECN on behalf of the counterparty to that trade.

          22             So I want to be on record first and foremost saying

          23   we don't see the comparability yet between ECN access fees

          24   and SRO transaction charges.

          25             I'll take a shot at answering straightforwardly

                                                                         178

           1   some of the questions, and here's why I said I think I'm

           2   going to end up where T.J. began.  Having said all of that,

           3   bids and offers that have access fees attached should always

           4   be differentiated from those that don't.  There should be no

           5   de minimis exceptions, de minimis exceptions or an attempt to

           6   rationalize that there is no difference between an offer that

           7   has a two mil access fee tagged to it and an offer that has

           8   no access fee.  Well, they are fundamentally different and no

           9   amount of rationalization is going to change that.

          10             So first point is that there always ought to be

          11   differentiation, and so the question as to whether or not the

          12   market forces and competition would work.  I'm not sure I

          13   have the definitive answer to that, but I know they can't

          14   work unless there's full transparency and for differentiation

          15   of those orders that have a tag and an access fee and those

          16   that do not.

          17             As far as its form, differentiation can take any

          18   number of forms.  I suspect probably we'd have a unanimous

          19   vote in this room that I'm the last person that you'll want

          20   to architect the format here.  And there's nothing new.  It

          21   can yield, an order that has an access fee can yield to those

          22   that do not in terms of priority.  You can round up or round

          23   down, an order that's got an access fee to the nearest penny,

          24   and probably lots of different other schemes that can get you

          25   to the same result.

                                                                         179

           1             There was another question as to whether or not

           2   allowing everyone to charge access fees is somehow a remedy

           3   to this problem.  And I'll just give you one man's reaction

           4   to that.

           5             I think allowing everyone to charge access fees to

           6   validate the practice of the few that today do charge access

           7   fees smacks of regressing to the lowest common denominator

           8   and I haven't seen any analysis that the Commission has done

           9   in this regard, but I would be concerned that it would add to

          10   trading costs rather than diminish trading costs.

          11             There was another question about locked markets,

          12   and I heard a little bit of the discussion on the prior

          13   panel.  I can't get my mind around those who think that

          14   locking markets is somehow a public service.  That may just

          15   be me.

          16             Locked markets are, without a question, a system of

          17   an inefficient market.  If somebody wants to buy for fifty

          18   bucks and somebody wants to sell for fifty bucks in an

          19   efficient market, they trade, they don't lock.  I think they

          20   should be dealt with in terms of regulatory action.  I

          21   would -- you haven't asked for my advice, but I'll give it to

          22   you.  If you ban the practice of requiring liquidity rebates,

          23   you get rid of contrived locked markets very, very quickly. 

          24   And liquidity rebates are payment for order flow by a more

          25   delicate name.  So I think that would be a good place to

                                                                         180

           1   start.

           2             And I guess I'd wrap up by saying, I think the

           3   current proposal, A, pretends that access fee orders and

           4   non-access fee orders are the same thing when they are not,

           5   gets the Commission into the rate making business and I

           6   always understood you were loathe to do that.  It's an

           7   indirect and likely an ineffective way of dealing with locked

           8   markets and it imposes a solution on markets where the

           9   problem doesn't exist.  Thank you.

          10             MR. COLBY:  We've had a very sharp difference of

          11   opinion, I can say here.  But in the middle they've talking

          12   about rogues and outliers and how much they exist, and the

          13   problem there is that there have been some, maybe, smaller

          14   ATSs that charge considerably more than other ATSs, all

          15   right?  So there's been some consolidation of rates down to

          16   the three tenth of a cent level, but then there have been

          17   outliers.  And that's been in the non-trade-through rule,

          18   best execution environment.  Yet somehow they've managed to

          19   survive at that.

          20             If you have a trade-through rule, what happens in

          21   that context?  Can you operate this partial access fee,

          22   partial non-access fee, different rates, does everyone then

          23   have an incentive to cut an outlier if you've got a

          24   requirement to go to a quote but you can attach a fee to it?

          25             MR. JOYCE:  I guess I'm starting.  Just as a point

                                                                         181

           1   of clarity, though, I just want the Commission to understand

           2   that in some way with all due respect, disingenuous to

           3   compare commissions attached to working an order as a

           4   subscriber on behalf as an agent, and an access fee which is

           5   charged without debate to a non-subscriber.

           6             So to say that Instinet, and there was only one ECN

           7   before 1996, saying Instinet's commission charges that we at

           8   Merrill Lynch -- at the time I was at Merrill Lynch, paid

           9   happily to access liquidity, as a subscriber, as a willing

          10   client of Instinet, to compare that with an access fee which

          11   we are forced to pay whether we want to or not as a

          12   non-subscriber is frankly two completely different things and

          13   should not, probably be permitted.

          14             MR. PUTNAM:  Tom, you and Bob will have to go back

          15   and read this, because this isn't just nonmember access fees. 

          16   This is a fee that we can charge a subscriber.  So the

          17   specialist on the New York Stock Exchange changes his

          18   business model to become more electronic, he may want to

          19   decide to change on how he charges for access to his

          20   liquidity, because you can't enter position trades anymore,

          21   you can't take advantage of things that you took advantage of

          22   in the past, as a way of making money.

          23             You may decide to charge an access fee for access

          24   to this brilliant marketplace.  This is a limit on that fee. 

          25   It is not just non-member access.

                                                                         182

           1             MR. JOYCE:  I'm not saying it is, with all due

           2   respect, Gerry.  I'm saying comparing the commissions that we

           3   paid to Instinet before 1996 and access fee today, whether a

           4   subscriber or non-subscriber, they are not the same thing. 

           5   They are just fundamentally not the same thing, having

           6   written checks for both kinds of bills.

           7             MR. PUTNAM:  That's over with now.

           8             MR. JOYCE:  I agree, but --

           9             MR. PUTNAM:  It's over with now.  We're trying to

          10   solve a problem that doesn't exist anymore with government

          11   mandated rate making.

          12             MR. LAVICKA:  It's not over yet.  You still have

          13   the fact that the SEC has created this NBBO.  It's holding us

          14   to it because of best execution, 11Ac1-5.  I think you have

          15   the trade-through rule, you're just giving that much more

          16   weight to what the NBBO that we're going to have to go and

          17   access.  So you've already mandated that, you're already in

          18   the game, so it's a public good that needs to be protected. 

          19   We need to access it, and I don't know how you can avoid

          20   having to regulate the fees for accessing that.

          21             MR. O'BRIEN:  I would agree with Matt that a

          22   trade-through rule could exacerbate the problem that exists

          23   today because there are some firms with the courage that

          24   despite the duty of best execution can stand up and make a

          25   decision that a high-rate inaccessible market can be avoided

                                                                         183

           1   consistent with the duty of best execution.  Not all firms

           2   have the courage to make that decision.  So the trade-through

           3   rule exists, and a market says I'm accessible on an automated

           4   base, provided you put a direct line to me in for a thousand

           5   or two thousand dollars a month, despite if that is correct

           6   that I have a thousand shares of liquidity a day on my

           7   system, it's going to create a real problem, but I think to

           8   reconcile that with Gerry's point is that to the extent that

           9   clearly identifiable problems exist in the current access

          10   structure, the way to deal with them is direct regulation of

          11   them, not a broad-ranging effort to fix prices across the

          12   industry for subscriber and non-subscriber access.

          13             So with respect to the outliers that the trade rule

          14   might further encourage, I think the idea of requiring them

          15   to responsibly participate in the public quote through an

          16   order execution facility of an SRO and subject them to the

          17   wide usage of that SRO linkage and the discipline of an SRO

          18   rule set would address that problem and then with respect to

          19   locking and crossing markets, and I think -- I think

          20   competing public policy concerns lead me personally to a

          21   tipping point that they are on a net basis not good for the

          22   industry and the individual investor.

          23             But the way to deal with that is not through

          24   killing a bee with a bazooka.  It's prohibiting the conduct,

          25   not prohibiting or trying to prohibit the alleged underlying

                                                                         184

           1   motivation, because there are several motivations for locked

           2   and crossed markets, not just fees.

           3             All the reasons why someone would argue that they

           4   would want to trade through a price of an inaccessible market

           5   would justify wanting to lock or cross the quote of an

           6   inaccessible market.  So you need to understand that fees are

           7   not the only motivation for wanting to lock and cross

           8   markets.  That being said, they may be a problem but the way

           9   to deal with it is prohibition of the conduct, not indirect

          10   regulation of potential underlying motivation.

          11             MR. JOYCE:  Locked and crossed markets actually

          12   exploded after the introduction of the alternative display

          13   facility, which was another little bit of history, which was

          14   created because the SuperMontage proposal that NASDAQ had was

          15   viewed by many people to disadvantage the current ECNs, that

          16   so they wanted a different place to execute in which, you

          17   know, whether you argue that point or not, they did get a

          18   different place to execute.  It was called the alternative

          19   site.  It started sort of in full form, I guess in early

          20   December of '02, and locked and crossed markets went from a

          21   nuisance to over 500,000 of them a week, and that was pure

          22   fee gamesmanship because you could lock the ADF and wait till

          23   I, I have to go to you for my best execution

          24   responsibilities, would then route to the ADF, take your

          25   offer and then pay the two mils that you were waiting to

                                                                         185

           1   collect.

           2             So the fees that have been embedded in this market

           3   have in fact created an enormous amount of locked and crossed

           4   markets and you can directly trace them back to the

           5   introduction of the ADF.  So there is germane data that point

           6   directly to people using fees and creating locked and crossed

           7   markets which, and I completely agree with Bob Britz, locked

           8   and crossed markets are trading already and they do not in

           9   any -- there is no benefit to the market to have a locked and

          10   crossed market out there.

          11             MR. COLBY:  So I heard several people say that the

          12   trade-through rule exacerbates, and Bill said you can deal

          13   with it by making sure outliers are part of an SRO that

          14   charges, puts limits on the fees.  I think there are four

          15   SROs that accept quotes from ECNs of which one has a limit on

          16   the fees and that's very recent, so it's not a no-brainer

          17   that SROs are going to limit the fee sets.  But if I go back

          18   to this price/time rule, if you have a trade-through rule,

          19   another way to deal with it would be to say that quotes that

          20   have fees or that have substantial fees can be traded

          21   through.  Like non-automated quotes, they can be traded

          22   through.  What do you think about that possibility?

          23             MR. PUTNAM:  We've considered that and we think

          24   it's a great way to address the problem.  Each SRO files its

          25   rules.  And we feel a trade-through rule that says if we deem

                                                                         186

           1   another market to charge an excessive fee, then we'll choose

           2   not the trade with it, and we can name that marketplace.  It

           3   is certainly one way to deal with it.  I would say though,

           4   this is going on, and then you could look at it and say, you

           5   know what, that's not an unreasonable fee.  The better way to

           6   deal with it, though, is to let the marketplaces, like we've

           7   seen happen in NASDAQ, where they have limited what a -- what

           8   a participant in their marketplace can -- can charge.

           9             This problem has been solved.  I mean, we've talked

          10   about it for a really long time and while we've talked about

          11   it, there's a couple -- and there's not even a couple of

          12   little anything left anymore.  I don't think there's a single

          13   ECN out there any longer that we consider to be a price

          14   gouger.  They've all come into line because of competition. 

          15   The small ones have to fall inside of an SRO.  They won't be

          16   their own, so they can't -- you're not going to let someone

          17   create an exchange and say, "Okay, we're an exchange, our fee

          18   is three cents a share."  We'll just say no.  You guys can

          19   dictate that.  Today, this is a problem that is gone.  And

          20   again, no one suffered more than we did.  I mean, tens of

          21   millions of dollars in price gouges.

          22             So we should be the first one here that way say,

          23   "Hey, guys, that's it, please don't let them do this to us

          24   anymore."  We're completely against.  We've had a couple of

          25   people on this panel that have suggested that you should not

                                                                         187

           1   allow us to charge for our service.  I don't know how those

           2   two hundred people that come to work every day are going to

           3   get paid if you decide I can't charge anything unless you

           4   decided that the service we're providing to the marketplace

           5   is worthless, and you want to ban us from the industry.

           6             But if you don't let me charge for my service, then

           7   it's going to be very difficult to -- for us to exist.

           8             MS. GLASSMAN:  Can I just jump in a minute?  What

           9   difference does it make if the SROs impose the cap or the

          10   exchanges impose a cap or we impose a cap?  And

          11   alternatively, if they impose a cap, why do we need to impose

          12   a cap?  So it's kind of two sides of the same question.

          13             MR. PUTNAM:  That's what I would say, if they

          14   impose a cap, in fact you do not need to, and the SROs are

          15   not going to settle up, I don't believe that an SRO would

          16   ever get through this Commission whose business model was to

          17   set up a toll booth in the middle of the best execution

          18   highway that says, "If you want to pass through here, you've

          19   got to give me three bucks."  I mean, it's just not going to

          20   happen.  And we actually had that environment since 1997 for

          21   a period of time, and it competed itself out of the

          22   marketplace.

          23             And when we did fight, and the Commission did step

          24   in at times when someone told us, "We're going to pull the

          25   wire out of the wall as a means of forcing you to pay this

                                                                         188

           1   exorbitant fee," the Commission gave us help.  So the

           2   Commission gives guidance and gives help to the marketplace

           3   when it sees something unfair.

           4             That said, leave it to the SROs to determine what

           5   they want to charge.  If someone, you know, it's a real

           6   business, and has a real market share, and throws a massive

           7   fee out there, they are going to lose all their customers. 

           8   That will take care of it.  The problem is when you have

           9   these little ones, when I will tell you the problem with the

          10   small market centers is nonexistent today.

          11             MR. O'BRIEN:  I think the reason is that this goes

          12   back to the prior panel on linkage.  That not all market

          13   centers necessarily need to provide access to an SRO order

          14   execution facility.  So to the extent that they require minor

          15   market centers to be accessible via an SRO but allow major

          16   market centers is to utilize private direct linkages, SRO

          17   regulation kind of provides more flexibility to the industry

          18   over all than, say, an SRO-by-SRO rate structure.

          19             In terms of also why the SRO is better to act, it's

          20   a general belief from a public policy perspective on the

          21   value of a self-regulatory system, that SROs are closer to

          22   their membership than the Commission as a whole, on an

          23   ongoing, sustainable basis, and to provide that type of

          24   service to their membership of access to minor market

          25   centers, they are best equipment to -- to cap rate structures

                                                                         189

           1   for access to minor markets.

           2             MR. COLBY:  May I just add to this debate two

           3   points.  One is that fortunately in Gerry Putnam's situation

           4   where there was this gouged rate, the entity that was

           5   involved in charging the rate was at a level that they were

           6   subject to fair access requirements, and so there was a fair

           7   access consideration.  I think we probably should point out,

           8   that at least two of the major ECNs are quoting to SROs where

           9   they constitute the vast, vast predominance of the SRO's

          10   business in that market.  So to expect that SRO to then curb

          11   the fees of the entity that's providing them almost all it's

          12   business is perhaps not as realistic --

          13             MR. O'BRIEN:  But those SROs are sufficiently large

          14   enough that competitive market forces are going to help --

          15             MR. COLBY:  Maybe you can explain that because it's

          16   not clear to me why the market is not disciplining the rate

          17   structure generally, why they would --

          18             MR. O'BRIEN:  I will explain it, because Ed is the

          19   CEO of a public company, Gerry is about to become CEO of a

          20   public company.  They are in a hypercompetitive market.  They

          21   cannot, consistent with the duties to their current or

          22   ultimate investors in their company, try to impose

          23   significant rate hikes in that type of environment without

          24   jeopardizing their business franchise.  That's not true for

          25   Bill O'Brien starting his own ECN that has no duty and just

                                                                         190

           1   is able to acquire order flow from one provider, and has a

           2   right to voluntarily provide that to the public quotation

           3   system and then dictate access to that system, A, privately

           4   and B, whatever other rate structure I feel like charging.

           5             MR. LAVICKA:  I just want to agree with Bob.  The

           6   SROs have had plenty of time to limit fees and the only

           7   reason the one that did it did it was because of Reg NMS

           8   coming out with the input that it was going to cap the fees. 

           9   That's if only reason you got any action.

          10             MR. O'BRIEN:  I would disagree.  I think the

          11   existence of alternatives, whether by ADF or by regional

          12   exchanges entering the market from a competitive perspective

          13   to provide quote services, gave NASDAQ what they felt was the

          14   flexibility to cap fees whereas a historical monopoly

          15   provider quote display service felt like they couldn't.

          16             MR. NICOLL:  Can I make one other point here, I

          17   think we all have to, again, focus on -- I think it's curious

          18   that we call these things access fees.  These are agency fees

          19   being charged by an agency marketplace.  And --

          20             MS. GLASSMAN:  Could I ask it, who are you the

          21   agent for, isn't that the question?

          22             MR. NICOLL:  We create a set of services whereby we

          23   allow -- we create a network in which broker/dealers come in

          24   to our market in accordance with Reg ATS and they display

          25   their bids and offers and other people access those bids and

                                                                         191

           1   offers.  If I can't charge a fee for that service, I can't be

           2   in business.

           3             The New York Stock Exchange has a curious set of

           4   fees in which you can access the fees initially because

           5   the -- the brokers on the floor, if you come in in the first

           6   five minutes you access to quote, it's free, but if you put

           7   up your orders on the floor of the New York Stock Exchange,

           8   and your orders sit down there for over five minutes, then

           9   you get charged.  You get charged a lot.  In fact, you're

          10   not -- to me, the distinction between the agency fees charged

          11   by ECNs and the agency fees charged by in cooperative effort

          12   between the specialists in the New York Stock Exchange are a

          13   distinction without a difference.

          14             And yet we, you know, we are a huge router of order

          15   flow down to the floor of the New York Stock Exchange.  We

          16   get charged down there, we get charged on average .8 cents. 

          17   Some specialists charge us more than a penny a share to leave

          18   orders down in their books.  They need to do that or they

          19   need to trade on a principal basis to make a living.  It's

          20   the same kind of fee structure.  And we are in the business

          21   of being an agency market.  We don't take positions, we don't

          22   trade on our own account.  We never act as a dealer and our

          23   customers value that position in the marketplace and we must

          24   charge some kind of agency fee above and beyond the quotes

          25   that you see in order to exist.

                                                                         192

           1             MR. JOYCE:  You know, I think it's interesting that

           2   a couple of individuals today have talked about, well, if we

           3   can't charge the fee, we can't be in business.  Of course,

           4   the fees are mandated courtesy of the SEC.  But I thought our

           5   business model was supposed to add value to the market.

           6             And if my business model is, I pay for an order, I

           7   pay two mils for an order, and then I charge somebody else

           8   three mils for an order, and that's my reason to exist,

           9   that's an interesting business model.  I will say for sure

          10   that before the NASDAQ market introduced, and actually,

          11   Instinet effectively introduced the central limit order

          12   board, it was a pure example of commission 101.

          13             There was a need in the NASDAQ market for a central

          14   limit order book and Instinet very cleverly filled it.  But

          15   now, that need doesn't nearly exist to the extent it did

          16   before if it exists at all, and if my entire business model

          17   is to pay you something and charge you, who has to come here,

          18   you don't get a vote, you have to come here, more, well,

          19   that's just an interesting business model.  And I personally

          20   believe if, without that, that access fee that is imposed

          21   upon people who don't subscribe to your system, if that goes

          22   away, the business model goes away with it, then really what

          23   kind of business model was it in the first place?

          24             MR. NICOLL:  Let me respond if I could.  I'd be

          25   happy -- it's interesting -- it's interesting that you're

                                                                         193

           1   our -- questioning our business model given the fact that

           2   your business model is simply is to internalize a lot of

           3   other people's quotes and pay people for order flow to come

           4   in to your -- in order to -- in order to free-ride off of

           5   publicly created quotes.

           6             So I mean, we can sit here and we can spit over

           7   each other's business models.  But we are not internalizers,

           8   we are not dealers, we are pure agents.  We are not, you

           9   know, we think actually rebates make sense because they came

          10   about as a result of market competition.

          11             We'd love to be able to go back to a time when

          12   Instinet was able to charge for both posting and taking

          13   liquidity, but it was market forces that forced Instinet to

          14   pay rebates, and just -- and I -- and let's not forget that

          15   the trade-off that Instinet made at the time when it went

          16   from being a voluntary central limit order book for NASDAQ

          17   dealers to one where it incorporated into the quote, into the

          18   Order Handling Rules, that it no longer had a choice of who

          19   could and couldn't access its quote.

          20             Instinet then could cherry pick who it wanted to do

          21   business with.  After it -- after the Order Handling Rules,

          22   it no longer could.  It was a fair access ECN.  And I

          23   think -- and I think that a perfect example of what the

          24   Chairman asked when we started out, it was not in Instinet's

          25   interest to do that.  Instinet has seen a price decline of

                                                                         194

           1   over 90 percent in terms of its revenue capture for a hundred

           2   shares since that happened.

           3             But the Commission was right, the SEC was right. 

           4   Fair access is absolutely fundamental to the market structure

           5   system and if I have to put on my public policy hat, I agree

           6   that that was a fair tradeoff for the Commission to demand of

           7   ECNs.

           8             But I think it's quite unfair, then, to turn around

           9   and say that ECNs are not -- should not be able to charge an

          10   agency fee for their services.

          11             MR. JOYCE:  Just to clarify.  We don't internalize

          12   if we don't have order flow.  People choose a route that's

          13   their -- I understand internalization well.  We did it at

          14   Merrill Lynch, it may or may not be an issue, but just to

          15   clarify, we do not internalize because we don't have any

          16   capital.  People choose to send us their order flow for

          17   execution.

          18             MR. ATKINS:  As a follow-up to that, just about

          19   value added of the ECNs, I'm assuming that because you do

          20   send some of your orders there, that trades there, that there

          21   is value added.  But I was -- I was wondering if you sort of

          22   implied that perhaps you were only doing it because of your

          23   best execution obligation.

          24             MR. LAVICKA:  Absolutely, and I think you have to

          25   distinguish between when we see a quote from Archipelago or

                                                                         195

           1   Instinet, and that's the best bid or offer in the country,

           2   and as a market center we want to access that quote, so we

           3   can -- we can fill fulfill our best execution obligation, I

           4   think that's different than when we want to take advantage of

           5   the facilities and the service that an Instinet or

           6   Archipelago provide, namely, anonymity, smart order handling,

           7   there's a lot of unique order types or discretionary order

           8   types that they have, and these are all value added services

           9   that they can charge fees to, and I think if the rule doesn't

          10   have it, it should make a distinction between those two types

          11   of fees.

          12             MR. JOYCE:  Agree.  We do subscribe to several of

          13   them because we do think in many cases they are value added. 

          14   It's the issue around where we are forced to go to some of

          15   them because the best execution requirements that the

          16   subscriber or non-subscriber, commission vs. access fee

          17   assessed gets blurred.  Subscriber route is clear.

          18             MR. O'BRIEN:  In fairness to the broker, I think

          19   that's a conundrum that many brokers face, that -- Bob had

          20   asked the point, if there's a trade-through exception, would

          21   that alleviate the problem, and really, there's no

          22   trade-through rule in NASDAQ today and brokers are still

          23   struggling with the problem, making clear that to the extent

          24   a market center is charging nonmarket or excessive

          25   transaction costs, that that may be a order routing

                                                                         196

           1   determination as part of their best execution decision.  I

           2   think it would give brokers a lot more comfort in making the

           3   decision about what market centers add value and which ones

           4   do not.

           5             MR. COLBY:  One of the proposals in the release is

           6   to reduce the fair access standard which currently apply to

           7   ATS above twenty percent market share level to five percent,

           8   but there's a question in the release about what are fair

           9   access requirements -- and this is a question of who can

          10   become a subscriber and on what terms, the gouge rate, the

          11   other issue, whether this should apply to any ATS that has a

          12   quote published in the NBBO.

          13             MR. PUTNAM:  Easily apply it to any model

          14   whatever -- you want to be in the marketplace, you have to

          15   allow access to your market.

          16             MR. O'BRIEN:  Well, I mean, yes and no.  Brut is in

          17   that five to twenty percent category today and I think we de

          18   facto comply with fair access requirements to our publicly

          19   displayed quotations.  The problem is even if you apply that

          20   to all ATSs, they can still decide, I'm going to charge nine

          21   tenths of a cent for access for --

          22             MR. PUTNAM:  That's not the question, though.  The

          23   question is whether they can deny access or they can provide

          24   access on special terms to competitors and what I think Bob

          25   is suggesting or what I'm suggesting is, no, you can't do

                                                                         197

           1   that.  You can't single someone out and say, "We don't like

           2   you, so you can't trade with us," or, you can't single

           3   someone out and say, "We don't like you but if you want to

           4   trade here, you can pay extortion rates for trading here," so

           5   that would not be allowed.

           6             MR. O'BRIEN:  I would agree with that.  I'm just

           7   saying it wouldn't solve a problem that Matt and Tom struggle

           8   with that for an ECN that is universally charging a

           9   non-market rate to all of its customers even on -- albeit on

          10   a nondiscriminatory basis and struggling with how to, you

          11   know, link to that center for the best execution respect.

          12             MS. NAZARETH:  But it does sound like you think it

          13   would help in situations where you think there have been

          14   discriminatory rates charged to competitors in the way --

          15             MR. PUTNAM:  But it's not saying we're going to

          16   force you to connect to a marketplace that charges an unfair

          17   rate.  What it's saying is, if you choose to connect to a

          18   marketplace, you have the freedom to connect to it.  I mean,

          19   I can think of an outlier on the ADF where we might not want

          20   to be a subscriber of that system.  That said, we should be

          21   allowed to be a subscriber of that system but if we don't

          22   want to be a subscriber to that system and there's no public

          23   linkage to it, there's an outlier and it solves itself

          24   because they find out and people don't trade with them,

          25   because they charge a gouge rate.

                                                                         198

           1             And this quote's no longer accessible through the

           2   NASDAQ linkage, so you can't use the SuperSOES get in the way

           3   of the method of charging this fee.  So guess where are they

           4   now.  They're out on the ADF and they charge the same like

           5   everybody else does.  It solved itself without any help.

           6             MR. LAVICKA:  It has solved itself, I think once

           7   they cross that line of putting a quote in the NBBO, we need

           8   to protect the integrity of if NBBO, and what that means.  I

           9   don't think you just void it.  I don't think that's enough. 

          10   I think this you have to regulate and make sure there's fair

          11   access to that quote.

          12             MS. NAZARETH:  I think we're done.

          13             MR. ATKINS:  I guess I can ask another one.  I have

          14   a lot on the subject I could ask.  But I mean, Bob, you were

          15   talking about, you know, with respect to some of the other,

          16   comparisons with transaction fees or regulatory fees and

          17   things like that.  And I don't know if other people have

          18   this, but certainly, I'm not one to defend government trying

          19   to come in and regulate, but with respect to compare the

          20   access fee issue here, to, say, the market data area, which,

          21   you know, as things change in the next few years, I think

          22   things will get more comparable as far as some of these

          23   issues go, but we don't -- we basically provide, they will

          24   tell, just rubber-stamp the fees that are charged by various

          25   marketplaces.  So I was wondering what implications are from

                                                                         199

           1   that to this discussion here.

           2             MR. BRITZ:  My experience in the market data space

           3   is very different than the SEC rubber stamping CTA and NYSE

           4   market data filings.  But I do take your point.  Listen, I

           5   think it's a slippery slope when the government gets involved

           6   in rate making.  We're going to have a panel here on market

           7   data in the not too distant future.

           8             I think it's a slippery slope when the government

           9   designs formulas for revenue allocations.  The way this has

          10   been expressed to me in terms of why access fees have somehow

          11   migrated into the listed space and sort of grabbed ahold of

          12   the transaction charges is that in one way or another, they

          13   are all involved in reaching a quote in a particular market.

          14             But to your point, some are market data fees, some

          15   are membership fees, some are real estate fees on our trading

          16   floor and lots of fees that others charge as well.  So why

          17   the Commission would zero in on transaction charges, I agree

          18   completely with what Matt said and with what T.J.  said.  If

          19   ECNs add value to their customers, they ought to be able to

          20   charge subscriber fees, which I, roughly, I guess, are akin

          21   to the NYSE transaction charges.

          22             I would not argue one way or another that those

          23   fees ought to be capped and on balance, I would argue that

          24   they ought not to be capped.  To the extent that Gerry's firm

          25   provides valuable order types, he ought to get what the

                                                                         200

           1   market thinks the value of that is.

           2             Access fees are in a very different bucket than

           3   those kinds of fees and SRO transaction fees.  And I think

           4   your point, once you go down this road, I don't know how you

           5   distinguish the various other fees that are used to fund

           6   marketplaces or ECNs from transaction charges or access fees.

           7             MR. GOLDSCHMID:  I have a question.  We'll think

           8   hard about what we've heard from this panel.  But assume we

           9   stay on course with what you propose.  What would the world

          10   look like in three years?

          11             MR. NICOLL:  Just in this particular area?

          12             MR. GOLDSCHMID:  Just in this area.

          13             MR. NICOLL:  I didn't -- you know, I think one of

          14   the -- I mean, I think one of the unfortunate, or one of the

          15   possible unfortunate side effects of this proposal might be

          16   that it would discourage new entrants, and so I think it

          17   might actually benefit the larger players in the space,

          18   because there's not, certainly going to need enormous scale

          19   in order to make a buck and you're not going to have any new

          20   entrants coming in, and that may, you know, and there would

          21   be less pressure from innovation and less competition.

          22             So I think what's likely to happen is consolidation

          23   in the space and no new entrants in the space.  I -- I'm sure

          24   there will be other things.  I'm just not smart enough to

          25   figure it out.

                                                                         201

           1             MR. BRITZ:  I think the staff at the SEC that

           2   handle investor complaints will grow exponentially.  People

           3   will be getting bills from counterparties they do not

           4   recognize after the trade has taken place.

           5             MR. DONALDSON:  Why don't we draw this panel to a

           6   close and reconvene in ten minutes.

           7             (Recess taken.)

           8             MR. DONALDSON:  I won't make you introduce

           9   yourselves since everybody knows the back of your heads by

          10   now, except for you, Dan.  Why don't we get Annette, you want

          11   to start us off?

          12             MS. NAZARETH:  Sure.  I think the substance of the

          13   subpenny quoting proposal is pretty clear.  The proposal

          14   would prohibit market participants from accepting, ranking or

          15   displaying orders, quotes or indications of interest in

          16   subpennies.  The proposal would not, however, prohibit a

          17   trade from being printed in a subpenny increment, so that

          18   firms could continue to offer average price trades and

          19   subpenny price improvement.  So I think we should launch

          20   right into a discussion of whether the people think this

          21   proposal has merit, are competitive forces alone sufficient

          22   to address the problems discussed in Reg NMS with respect to

          23   subpenny quoting or do you support the subpenny quoting

          24   proposal?  Bob?

          25             MR. GREIFELD:  Thank you, Annette.  With permission

                                                                         202

           1   of Commission I'd just like to back up one second to a panel

           2   that I was on earlier today in response to a point, and I say

           3   that in light of the fact that I have very few words to say

           4   about subpenny, so I'll be under my allotment.  There was a

           5   quote made with respect to volatility in NASDAQ stocks and a

           6   study was referenced, and what I want to say is, the NASDAQ

           7   market has a trade reporting responsibility of 90 seconds. 

           8   So we do not receive trades in sequence.  And I think Mr.

           9   Peterffy referenced within a given time frame, it can -- he

          10   talked about seconds versus volatility.  So as we do our

          11   studies of volatility in The NASDAQ Stock Market, we realize

          12   that trade reporting is not the way to look at volatility

          13   studies in that the trades are routinely out of consequence. 

          14   We think the best way to look at volatility across all

          15   markets, especially a market with a trade-through rule, is

          16   with quoted spreads.  The quoted spreads reflects where

          17   stocks can trade at each instant of time.  And when you take

          18   that study of the 40 some-odd stocks, and you quote spreads,

          19   you actually find that the volatility stayed roughly the

          20   same, and the largest stocks that were referenced in that

          21   study of volatility actually increased on a marginal basis,

          22   and on the smaller stocks they decreased.

          23             And the basic theory that we supported at NASDAQ

          24   and supported by a lot of economists is that volatility is

          25   almost exclusively company-specific, it's not

                                                                         203

           1   market-specific.  And we'd like to ask permission from the

           2   Commission to commit to the record a more detailed study on

           3   volatility on the NASDAQ market.  Thank you.

           4             With respect to subpenny quoting, it just -- a

           5   thought just hit my mind and I think it's a quote from Yogi

           6   Berra, "I feel it's deja vu all over again."  We leave that

           7   limited order display and before limit order display we had a

           8   bifurcated market where retail investors were treated

           9   differently than professional investors.  And we solved that

          10   problem.  But the problem reared its ugly head through the

          11   form of subpenny quoting.  Retail investors in this country

          12   today cannot see or trade with subpennies.  Professional

          13   investors can.  This has to stop.  It has to change.  It is

          14   not right for these investors.

          15             I don't think there's anything else you can say

          16   about it.  We also believe this proposal is fairly

          17   straightforward and should be put on a different review track

          18   than the other proposals of Reg NMS.  I think it's incumbent

          19   upon all the people at this panel and in this room to make

          20   sure we get this approved sooner rather than later.  Thank

          21   you.

          22             MR. JOYCE:  I believe that -- I also believe, and

          23   we at Knight firmly believe that there is no benefit to the

          24   market to have subpenny trading.  It is my humble opinion a

          25   race to the bottom.  Just because we can trade in subpennies

                                                                         204

           1   doesn't meet we trade.  We can trade in sub-subpennies.  We

           2   can do a lot of things.  It's certainly hard to find a retail

           3   product in any part of the economy short of gasoline, and I

           4   think that line nine in gasoline prices never actually moved

           5   very much.  It's hard to find anything that you trades in

           6   subpennies.

           7             I completely endorse what Mr. Greifeld said about

           8   the fact that the retail investor has been excluded from the

           9   user group of people who are very adept and have audit

          10   computing power.  I don't think there's one thing wrong with

          11   the U.S. market having certain standards of excellence and I

          12   think a penny minimum trade quote is one standard that we

          13   should adhere to so I firmly endorse the abolition of

          14   subpenny trading.

          15             MR. NICOLL:  I think just think markets should be

          16   allowed to go to equilibrium.  I think once again, we

          17   recently moved from subpennies to pennies because our

          18   competitors who were trading in pennies were actually taking

          19   market share away from us.  Our customers really prefer that

          20   we trade stocks in pennies.  So we went from trading in

          21   pennies to all stocks down to a dollar, with the exception,

          22   as I mentioned before, of the QQQs and the ETFs.  There's an

          23   active, a very active market in the ETFs in subpennies.  Much

          24   of that is arbiting against the derivative marketplaces.  And

          25   as I mentioned before, the average spread in, for instance in

                                                                         205

           1   QQQs on Inet is 4.3 cents.  It trades on average a hundred

           2   million shares a day.  If, you know, if that were the spread

           3   to the entire marketplace and we were to enforce that to a

           4   penny, we would be imposing additional transaction costs of

           5   close to two hundred million dollars a year on people buying

           6   and selling QQQs and I just don't see why that is.

           7             I understand that there is a cost/benefit trade-off

           8   here, that, you know, we have to think about the cost of

           9   vendors, in terms of delivering all the various price points,

          10   and I think that's a reasonable concern.  I do have some

          11   experience in serving retail investors and the last company

          12   that I had a significant role in creating delivered subpenny

          13   pricing to its investors over the web.  And there's no reason

          14   why others can't.

          15             But you know, this seems to be, again, almost all

          16   the ECNs that traded in subpennies have now gone to pennies

          17   because the vast majority of clients want to trade in

          18   pennies.  One exception I think is Brut, which trades in

          19   subpennies under five dollars.  We only trade in under a

          20   dollar.  And, you know, this is just, again, to me, I just

          21   don't think that this is a -- a problem that needs to be

          22   solved by regulation, and I think the markets have actually

          23   already solved the problem for the most part.

          24             PROF. WEAVER:  I testified before Congress in

          25   support of decimalizing stock prices.  It was contrary.  At

                                                                         206

           1   that time, markets were allowed to choose the pick signs they

           2   wanted.  They chose a penny.  That was a mistake.  Liquidity

           3   dried up.  Limit orders are shock absorbers for liquidity

           4   events.  We need depth at prices.  I believe that now is not

           5   the time to allow markets to set the tick.  I think now is

           6   the time for regulatory intervention.  I support the

           7   Commission's proposal but I don't think it goes far enough. 

           8   I think not only should subpenny quoting be banned, I think

           9   subpenny trading should be banned.  In fact, I urged the

          10   Commission to consider going to a nickel tick for some higher

          11   priced stocks.

          12             MR. COLBY:  Is this where we're supposed to cheer?

          13             MR. GIESEA:  I just have a few comments.  Since

          14   2001, the Security Traders Association has opposed subpenny

          15   quoting.  And I would like to make sure we distinguish

          16   between quoting and trading and my comments are specific to

          17   quoting.  Because there are some valid uses for subpenny

          18   transactions to be reported via average pricing across the

          19   network for fee block kinds of transactions.

          20             With regard to quoting and with regard to the

          21   question are competitive forces enough, I think competitive

          22   forces as it relates to the field of athletics brings to mind

          23   that in each sport, there are rules, and in this case, rules

          24   are better -- the proposal here by the Commission is better

          25   than allowing competitive forces to allow to come to its own

                                                                         207

           1   decision.

           2             So we clearly and unanimously support the one penny

           3   increment.

           4             MR. DONALDSON:  I don't assume you have too much

           5   support for subpenny pricing.

           6             MR. JOYCE:  The only thing I'd add, and it may not

           7   surprise anybody here that Ed and i slightly disagree on

           8   this, too, is that I think if you go from subpenny pricing of

           9   QQQs, I assume the entire market is not a carve up for some

          10   of the ETFs.  I think -- I personally believe that it's

          11   overstated that we did a transaction opposite to the market,

          12   because largely, as pointed out earlier, the trading that

          13   takes place in many, many cases, in really liquid ETFs like

          14   the QQQs, are largely agency trades.  It's not mom and pop

          15   buying from a dealer.  It's mom buying from pop.

          16             So if a lot of transactions are taking place at 1.3

          17   cents, and I am a buyer, and it's a penny market, and it's

          18   bid one offered at two, instead of paying two, I pay 1.3

          19   cents.  Well, I did a little better.  But the seller did a

          20   little worse.

          21             So in my opinion, in an agency situation like that,

          22   it's simply a zero sum game where mom might do better

          23   sometime but pop doesn't do as well, i.e., mom buys it better

          24   but pop sells it worse.  So I think in an agency market, I

          25   think you run the risk of overstating the -- the added cost

                                                                         208

           1   of widening the spread in an instrument like the QQQs that I

           2   just don't think it's there.  Again, I think it's a zero sum

           3   game in a transactional -- added transactional costs are

           4   probably overstated.

           5             MR. DONALDSON:  Professor Weaver, since you brought

           6   it up, have you got any empirical work done or that you know

           7   of that leads you to conclude that we put to put it at a

           8   nickel rather than a penny?

           9             PROF. WEAVER:  Well, spreads have gone down quite a

          10   bit.  And so has debt.  And I think that the short answer is,

          11   I don't think there's anything out there that shows that we

          12   should go to a nickel.  It's my personal opinion that by

          13   going to a nickel, we would bring more depth back to the

          14   marketplace, and we seem to be focused way too much on

          15   narrowing the spreads.  But the other part of that is depth

          16   in the market.  Another very important measure of market

          17   quality.

          18             MR. ATKINS:  Can I ask a question, I mean, as far

          19   as depth goes, isn't the depth still there, it's just spread

          20   out over more price points and does that have to do, like the

          21   stock exchanges' liquidity quote product that they've been

          22   talking about, I mean, doesn't that sort of get back at what

          23   you're talking about with respect to --

          24             MR. WEAVER:  I think that a lot of limit order

          25   traders have switched to being market order traders and just

                                                                         209

           1   monitoring the market more rather than putting limit orders

           2   in there.  Limit orders are smaller sizes now.  And I've seen

           3   some studies, it's not conclusive whether or not they -- if

           4   add up all the depth between certain price levels, you'll get

           5   the same depth you had before.

           6             So, no, I don't think that's the case.  I think

           7   that a lot of limit traders have switched to being market

           8   order traders.  And I'm worried about that.  Liquidity

           9   belongs in the place where shocks are going to occur, not

          10   away from the market.  And I believe in rules that will

          11   encourage as much liquidity at the source of shocks as

          12   possible.

          13             MR. ATKINS:  So basically what you're saying is,

          14   you sort of talked about that before with one of the other

          15   panels about adding another context on the floor of an

          16   exchange, where there has to be a return of capital, and a

          17   lot of this for decimalization was built into the spreads,

          18   the vigorish there in what market participants were able to

          19   wring out of the system.  So basically what you're arguing is

          20   we went too far, we need to go back and restore some of that

          21   non-transparency --

          22             MR. WEAVER:  Yes.  Yes.  Now, transparency in all

          23   areas of trading is not a good idea.  And there are some

          24   areas, for example, it was a mistake opening up the limit

          25   order book to the public.  I think was a mistake.

                                                                         210

           1             MR. COLBY:  Can I bring up the question of the QQQs

           2   or other ETFs, I heard Tom address it, but are there some

           3   instruments that should be traded possibly would benefit to

           4   trade in subpennies, other than ones that are very low

           5   priced, because of their derivative price nature and the

           6   like?

           7             MR. NICOLL:  Let me just, it's interesting because

           8   we've had -- we're interested in cascades, because we went

           9   from subpennies to pennies over the last six months.  I'm not

          10   quite sure -- I should know this, I don't know exactly when

          11   it happened, but I should think it was about three months

          12   ago.  And we gained overall, we gained market share as a

          13   result of doing it.  We did lose significant market share in

          14   one stock under five dollars, which went to -- which

          15   essentially went to -- is continuing to trade in subpennies

          16   and for the life of us we can't figure out why.  It's a

          17   particularly volatile stock but there are a lot of these four

          18   or five dollar stocks that are volatile, and it's not clear

          19   to us why the market seems to prefer to trade that stock in

          20   subpennies.

          21             We're talking about Brut having like a sixty

          22   percent market share in all of the trading in that particular

          23   stock.  So we're a little bit scratching our heads about it,

          24   and we -- this is what we do all the time, and this is what

          25   we -- we think we ought to know why these kinds of effects

                                                                         211

           1   are occurring, and quite honestly we don't.

           2             I do think in ETFs that there is a tremendous

           3   amount -- there is a good reason to have subpennies because

           4   of the arb between the futures.  I think if we go to one, the

           5   spreads will lose activity to other markets, and there's a

           6   good reason to have as finally priced marketplace in these

           7   ETFs as we can.  Other than that, I can't make an argument

           8   for what the spread should be in a particular equity, where

           9   there is no other derivative price involved.

          10             MR. COLBY:  If you give us the name of the stock

          11   we'll have our crack market surveillance team look at it.

          12             MR. ATKINS:  I guess that's what I wanted to go

          13   back to them to help goad Ed along here on this question.

          14             But -- and get back to what Bob was saying with

          15   respect to subpennies.  I mean, maybe it's fine and well to

          16   say that we shouldn't have subpennies on anything except ETFs

          17   now, today, in, you know, April 2004.  But just like we

          18   couldn't predict what went on with respect to SPDRs and QQQs

          19   and all that ten years ago, looking from here on out, how can

          20   we predict what's going to be going on at some other product

          21   and if we limit things artificially to a penny now, how will

          22   we -- how will that market ever be able to figure out what

          23   was needed later on?

          24             MR. GREIFELD:  Well, certainly from our

          25   perspective, the Commission has a continuing right to change

                                                                         212

           1   the market when they see the need to do so.  So to the extent

           2   that we ban subpenny trading today, and some time in the

           3   distant or not to distant future, that is looked upon as a

           4   correction that is no longer proper, then we address, you

           5   know, tomorrow's problems tomorrow.  I they we have to deal

           6   with what exists today.

           7             MR. ATKINS:  It's taken ten years to get NMS --

           8             MR. GREIFELD:  To the extent we're going with

           9   subpennies at some time in the future, that the proper way to

          10   hold it out is to give the retail distribution mechanism time

          11   to implement the support of subpennies.  So we went from

          12   fractions to decimals and decimals to subpennies very quickly

          13   and nowhere in the process was there a comment period and a

          14   period of adjustment for the retail distribution network in

          15   this country.

          16             So today, retail investors are not able to trade in

          17   subpennies and professional investors are.  And every day

          18   that goes by, that's not a proper situation for any of us in

          19   this room.

          20             MR. NICOLL:  Since we have a little bit of time,

          21   Chairman, if we can just make one other comment, because you

          22   asked me about speed, and I just want to point out something

          23   that might be a little counterintuitive.  Which is that the

          24   bigger you make, you know, the increment and the more

          25   chunkier you are, the more you're rewarding the first party

                                                                         213

           1   to get at that wider increment.  And the more -- and the more

           2   benefit accrues to very, very fast, sophisticated traders who

           3   specialize in getting to the market before anybody else.  If

           4   I'm a super -- and lots of these guys out there, electronic

           5   market maker now, and I have -- and I'm running models, I

           6   make more money like Tom makes money as a market maker, and

           7   he should because he provides capital to the marketplace -- I

           8   make more money with spreads if I can get to the head of the

           9   line at that penny increment or, if we were to go to five

          10   cents, there would be that much more important to get there

          11   really, really fast.

          12             So time priority as we widen the spreads become

          13   even more important, and remember, even with trade-through,

          14   we are -- nobody here is proposing intermarket time priority. 

          15   So the wider the spread, the more you have people line up at

          16   each individual increment, the more important time priority

          17   becomes and the more that we reward really sophisticated

          18   investors who can get to the front of the line quicker.

          19             The absolute, you know, best example of that are

          20   the guys down on the floor who can see, who can get there

          21   faster than anybody else on a floor based market.  On a

          22   market like mine, that would be a very, very sophisticated

          23   investor who is investing an enormous amount in throughput

          24   down to the matching entry.  And it just is a factor.  So I

          25   mean when we talk about this dichotomy between very

                                                                         214

           1   sophisticated traders and non-sophisticated traders just

           2   realize that when we widen the increment, we are getting a

           3   benefit to people who can get to the head of the line first.

           4             MR. JOYCE:  What I'd like to add is that it is

           5   happening now in the subpenny world and again it's

           6   sophisticated traders because they will look at that quote

           7   and they will sniff the quote.  You of course can't see a

           8   subpenny quote.  It's a computer quote that is sort of a

           9   private closed user group.  And they'll sniff the quote, then

          10   see it's not 1.2, it's 1 and 1 to 1.9 so then they

          11   immediately offer 1.8.  The only people doing that are people

          12   with a lot of computer power and professional traders.  It's

          13   definite my folks who have quickness --

          14             MR. NICOLL:  I don't disagree with that.  I don't

          15   disagree with that.  I'm just saying that there are

          16   countervailing issues the other way also, is all that I'm

          17   saying.  It's not one or the other.

          18             MR. ATKINS:  Well, are there any stocks now that

          19   are really being traded in subpennies, because I thought Brut

          20   has changed over --

          21             MR. NICOLL:  Well, anything under a dollar anywhere

          22   is still trading under subpennies, and as I said, Brut is

          23   still trading five dollars stocks and under.  So -- not on

          24   any of the major ECNs other than Brut is any subpenny trading

          25   occurring over a dollar.

                                                                         215

           1             MR. ATKINS:  So that's --

           2             MR. JOYCE:  And a lot of --

           3             MR. ATKINS:  So your points at the market -- okay.

           4             MR. DONALDSON:  If there are no objections from

           5   either side of the table, we'll steal a few minutes from the

           6   subpenny panel and donate them to the next panel.

           7             MR. NICOLL:  I'm sorry --

           8             MR. DONALDSON:  Unless there are other comments

           9   that people want to make.  Thank you all very much.  And why

          10   don't we get our last panel.

          11             (Recess taken.)

          12             MR. DONALDSON:  Starting on my right, will you just

          13   raise your hand and just tell the people in back of the room

          14   who you are?

          15             MR. LYNCH:  I'm Phil Lynch, I'm the CEO of Reuters

          16   America.

          17             MR. McBLAIN:  I'm Leo McBlain, chairman of the

          18   Financial Information Forum.

          19             MR. HALVORSON:  Kurt Halvorson, chief

          20   administrative officer for Ameritrade Holding Corporation.

          21             MR. BROWN:  Jeff Brown, general counsel of Schwab

          22   Capital Markets.

          23             MR. COLKER:  David Colker, CEO and President of the

          24   National Stock Exchange.

          25             MR. GREIFELD:  Bob Greifeld of The NASDAQ Stock Market.

                                                                         216

           1             MR. BRITZ:  Bob Britz.  I'm President of the Stock

           2   Exchange.

           3             MR. DONALDSON:  Okay.  Annette --

           4             MS. NAZARETH:  Sure, I think I'll give this one in

           5   particular an introduction because it's one of the more

           6   complicated proposals.  The market data proposal sets forth

           7   four subproposals that would be, one, update the formulas for

           8   allocating more than four hundred million dollars in market

           9   data revenues to the SROs; two, broaden participation in the

          10   governance of the joint SRO plans to help assure that

          11   interested parties other than SROs have an opportunity to be

          12   heard.

          13             Three, authorize individual market centers to

          14   disseminate their own data independently in addition to the

          15   consolidated data that is disseminated through the joint SRO

          16   plans; and four, rewrite current Rule 11Ac1-2, which requires

          17   the consolidated display of data to streamline its

          18   requirements and to ease its burden of compliance.

          19             The proposed market data formulas are very complex

          20   and I'm sure we'll give that to everyone here, but in

          21   essence, they would divide market data revenues equally

          22   between trading and quoting activity.

          23             With respect to quoting, markets would be

          24   compensated both for quoting at the NBBO and improving the

          25   NBBO.  Modifying the net income allocation formulas would not

                                                                         217

           1   alter the total fees charged by the three existing data

           2   Networks but would address the most pressing and serious

           3   problem with current market data rules, namely the economic

           4   and regulatory distortions caused by the other formulas.  The

           5   other three subproposals set forth in the market data

           6   proposals was recommendations of the Commission's Advisory

           7   Committee on Market Information including permitting market

           8   centers to distribute additional information such as depth of

           9   book, independently from the jointly administered plans,

          10   broadening governance of the plans to a non-voting advisory

          11   committee and finally, generally easing the burden of

          12   compliance with market data rules.

          13             MR. COLBY:  In addition to the exact proposal, the

          14   release tried to give fair treatment to a number of other

          15   proposals and ideas that have been routed by the Commission's

          16   Advisory Committee on market data and other areas and we set

          17   them out with criticisms of them, but I know that members of

          18   the -- have views, so I'd like to just mention them and get

          19   them on the table here.  One was the deconsolidation model

          20   which would say that brokers and vendors no longer have to

          21   provide consolidated data, they can choose whose data to make

          22   available.  And so there wouldn't obviously need to be any

          23   consolidation of -- the overall data could be disseminated

          24   separately.

          25             The second model was one that was called the

                                                                         218

           1   multiple consolidators model which would be, each market

           2   would put out its data, then there would still need to be

           3   consolidation by the brokers and the vendors, but the vendors

           4   could pull it together and make it available.  And the third

           5   was a hybrid model which would say, we could deregulate

           6   trades that could be put out on an individual market basis,

           7   deregulate the full quote stream.  Quote stream could be put

           8   out by each individual market, but there would still be a

           9   consolidated national best bid and offer which would be sold

          10   at a much substantially reduced rate.  It would be considered

          11   public good.

          12             That's what would be provided to the customers as

          13   their baseline trading unit and it would be sold at a very,

          14   very substantially reduced rate, perhaps at cost-plus.

          15             And so there would be a similar variety of

          16   consolidation models.  So I wanted to get those out so in

          17   case you wanted to stray beyond the pure formula that was set

          18   out.

          19             MS. NAZARETH:  Bob?

          20             MR. BRITZ:  I think I'd start by agreeing that the

          21   SEC is right to look to address some of the, my term,

          22   objectionable practices that have crept into the marketplace

          23   in the last five or ten years, whether they be payment for

          24   order flow, or wash sales or shredded tape prints to the

          25   highest bidder and a variety of others.  They are at best

                                                                         219

           1   inconsistent with investors' need for transparency and

           2   credibility in the market data space in a well functioning

           3   national market.  And secondly, they have the potential to

           4   compromise the broker's fiduciary obligation to the client.

           5             We believe, rather than deal with these issues

           6   indirectly through market data revenue allocations, the SEC

           7   should either enforce existing rules that deal with these

           8   practices, or to the extent you think you need to promulgate

           9   new rules to ban them, we think you ought to do that.

          10             What's striking to me in this whole discussion is

          11   that there is no natural link between the practices that you

          12   cite in your questions and market data revenues.  The actions

          13   of a couple of markets and ECNs have caused them to be linked

          14   by those markets' paying for orders on the one hand, or, as I

          15   believe even worse yet, finished tape prints.

          16             On the other hand, and doing so, even though money

          17   mingles, doing so extensively out of market data revenues. 

          18   Through Reg NMS, the Commission proposes to deal with these

          19   issues, but not by banning them, but by modifying the market

          20   data revenue allocation formula.

          21             The problem is that the practices you cite don't

          22   spring from the market data formula or any particular

          23   formula, but they drop out of the joint action on the part of

          24   market participants in either CTA in the listed space or the

          25   OTC/UTP plan in the over-the-counter market.  So I know the

                                                                         220

           1   question that you put before the house is, do you need

           2   additional regulatory tools to deal with these issues, and if

           3   you'll allow me a little poetic license, I would suggest you

           4   need a deregulatory tool by abolishing the consortia that

           5   give rise to the cross-subsidies that in turn give rise to

           6   what you characterize as the distortive incentives.

           7             They don't drop out of any particular formula, and

           8   I want to be clear, New York is neither wed to the existing

           9   allocation formula nor is it at this point, we're still

          10   trying to figure it out, for or against the proposed formula. 

          11   We simply think you're missing the markets if on the one hand

          12   you're trying to get at the source of money that gives rise

          13   to these objectionable practices.  It's not any particular

          14   formula.  It's the joint action in general and particularly

          15   the joint pricing action on the part of what are otherwise

          16   natural competitors.

          17             We all know that some today have figured out a way

          18   to make the current trade-based formula work to their

          19   financial advantage without necessarily adding any value into

          20   NMS price discovery.  And so my question would be, is there

          21   anyone who thinks that, by modifying the formula, and as best

          22   I can tell, it continues to cling, roughly half, to the

          23   existing formula, by adding a few more metrics and not

          24   incidentally, a great deal of complexity, does anyone think

          25   that the new formula will not be exploited in the same way

                                                                         221

           1   that the existing formula is currently exploited?

           2             So I think what -- I repeat, I think you're missing

           3   the market.  I'm neither for nor against any particular

           4   formula.  I do think that the stated objectives are A, to see

           5   if you can sort of cut off the oxygen -- these are my words,

           6   not yours -- cut off the oxygen for some of these

           7   objectionable practices, I don't think you're going to get it

           8   because I don't think the formula is the issue, and B,

           9   implicitly, it seems as though you're trying to encourage

          10   better quotations, improving the NBBO and so on.  And I will

          11   tell you, having modelled this as best we have been able to

          12   do at New York, I think it's indisputable that New York

          13   quotes better than any other market in the listed space.

          14             Intuitively, you would think we would do somewhat

          15   better under a formula that rewards quoting.  In point of

          16   fact, we do somewhat worse, as best we can tell.

          17             I don't mean to make an individual point of that,

          18   only to suggest the law of unintended consequences.  If you

          19   think that the current formula is instilling incentives for

          20   better quotations, we have an opinion that maybe it isn't.

          21             The other thing I would say is that failing to

          22   listen to me, and the Commission has a wonderful track record

          23   of doing that, probably rightfully so, if you are determined

          24   to try and cure this via tinkering with the formula, I would

          25   just ask you to do two things.  Put it through what I'd call

                                                                         222

           1   an exploitability filter and then do your best to satisfy

           2   that it will not be damned in the same way that the current

           3   formula is damned.  And the other thing I would mention is

           4   try to put it through a cost/benefit analysis, and I think

           5   that's part of your process anyway, so I apologize for being

           6   redundant.  But I'll give you an example.

           7             Dropping out of the middle of -- what I call the

           8   middle bucket, there's the trades, there is the -- if there

           9   are three markets that each display the NBBO for 20 seconds

          10   and the cumulative size is ten thousand shares, that results,

          11   as we understand it, in total quote credits for this minute

          12   event of 20 million quote credits for that one single event. 

          13   Our folks have estimated that the total quote credits only

          14   for 2003 on a pro forma historical basis would have been 1.3

          15   quadrillion quote credits.  I don't know what a quadrillion

          16   is but I know it's a very large number.

          17             And so I ask you to think about, and I tell you, as

          18   we have run the numbers, we lose a little bit but not a whole

          19   lot worth mentioning but I guess my point would be we largely

          20   come out at the same place from this, now, I can't speak for

          21   others, from this complex formula, and in what we end up

          22   doing on account of having a formula that is so difficult to

          23   administer and the law of large numbers kicking in here, if

          24   this ends up being a transfer of wealth from the market

          25   centers to the data processing vendors and the data storage

                                                                         223

           1   vendors, I think we will have not accomplished what we're

           2   trying to accomplish.  So it's a roundabout way of saying, I

           3   think -- I would question whether or not you're actually

           4   going to meet what I think are your objectives, because I

           5   don't think you're going to the heart of the problem

           6   practices and I don't think at the end of the day we've got a

           7   formula just yet that's going to incent better quotation. 

           8   Thank you.

           9             MS. NAZARETH:  Bob?

          10             MR. GREIFELD:  I think I agree with a lot of what

          11   Bob said.  So that's hardly specializing.  But our context is

          12   a little different and I think our recommendations probably

          13   go a little further.  First, we recognize it's in the public

          14   interest to have a basic amount of market data available to

          15   investors.  We believe that market data is the NBBO and

          16   nothing more.  If this market data is a part of the public

          17   good, then a government mandated utility is a natural

          18   consequence.

          19             But we believe the government should only be

          20   involved where the government must be involved.  So we must

          21   limit the monopoly to the data that is part of the public

          22   good, and provide it at a low cost.  Currently that cost for

          23   professional investors is around $20.  That cost in a NASDAQ

          24   market was established by NASDAQ over 20 years ago.  It was

          25   about $17 twenty years ago.  There was no great wisdom in

                                                                         224

           1   that number, and we look at the number today, that number is

           2   too high.

           3             We agree with that concept.  The number probably

           4   should be somewhere around five to seven dollars.  And that's

           5   after some thoughtful analysis on our side, and trying to

           6   imply a rough cost-plus basis to the analysis.

           7             With the current structure, then, data is not

           8   provided at a low enough cost and it does create, as Bob

           9   mentions, unintended results and distortions in our market. 

          10   The market centers today are the beneficiaries of that

          11   excessive rent and are utilizing this money to buy prints

          12   independent of market center value.

          13             If the utility rate was five to seven dollars, then

          14   the market centers would have a very difficult time buying

          15   prints.  And I think that is the problem we're trying to

          16   solve.

          17             Now, understand that NASDAQ can sit here with great

          18   credibility and say we want to endorse this, because we also

          19   are a beneficiary of that $20 price range, and I have to

          20   admit I get nervous advancing this proposal because what it

          21   means is, I have to go to the competitive market and develop

          22   data products that provide value beyond the monopoly product.

          23             So with this approach, what changes is, first and

          24   foremost, investors will win.  They will have lower cost for

          25   basic market data.  In addition, they will have a choice to

                                                                         225

           1   buy additional data products from people like NASDAQ.

           2             The brokerage firms also will win.  Their customers

           3   will trade at a lower cost, lower net effective cost, and the

           4   brokerage firms now control customers' order and trade

           5   information and they will be in a position to be a value

           6   added consolidator to an organization such as NASDAQ.

           7             So the dynamic changes from the market center to

           8   the brokerage firm that has retail CLOB.  The retail

           9   exchanges, they certainly will lose in this proposal.  NASDAQ

          10   starts out losing, we go from $20 to five or seven.  We take

          11   our risk that we come up with products that bridge the gap

          12   and maybe do better in time.  Where we win is, we remove some

          13   aspects of regulatory arbitrage.  What's unresolved is the

          14   concept of market data funding regulation.  This concept, if

          15   we go with the $5 rate will be revealed as false.

          16             Money is fungible.  I run NASDAQ under this basic

          17   truth.  I don't assign individual dollars to regulation.  But

          18   where is the money for regulation going to come from?

          19             If we've learned anything today, it is, there is

          20   intensifying competition between markets.  Regulation cannot

          21   be a victim of that competition.  Regulation is the

          22   cornerstone of the quality of our markets.  Regulation

          23   requires its own direct and completely attributable and

          24   secure source of funding.

          25             I've had such a good time here today, as a panelist

                                                                         226

           1   and a spectator, that I look forward to coming before this

           2   Commission and testifying on the future of the regulatory

           3   function.  Thank you.

           4             MR. COLKER:  First of all, I'd like to thank you

           5   for the opportunity to participate today.  I'd like to

           6   challenge the assumption that the current market data revenue

           7   distribution methodology needs to be changed and I'd also

           8   like to caution the Commission against making a change which

           9   could prove to be far worse than any problem that exists

          10   today.

          11             I think it's important to put the market data issue

          12   in historical perspective.  In the last 25 years, the trade

          13   was quoting methodology.  That system has been in place over

          14   25 years and for most of that time it's been perceived to be

          15   fair and effective and easy to administer.  It really was

          16   only first questioned a couple of years ago and that was

          17   because, and it was brought up by NASDAQ, because of the

          18   National Stock Exchange's success in attracting a lot of

          19   order flow from NASDAQ.

          20             What we did in brief was combine our old electronic

          21   model with a commitment to operate like a utility which

          22   allowed us to meet the brokerage community's longstanding

          23   need and request for lower market data costs by sharing that

          24   data with our members just like any mutual company would do. 

          25   And what's happened is, the other exchanges in order to

                                                                         227

           1   compete with us have provided similar programs and what

           2   that's done is, we estimate it's now saving the brokerage

           3   community about $65 million a year.

           4             So I think if the SEC is not going to address the

           5   explicit cost of market data, which Reg NMS implies it's not

           6   going to do, it's very important that you preserve a

           7   competitive environment so that the exchanges, through

           8   competition, can indirectly continue to push down the cost of

           9   market data.

          10             Very quickly also, we believe in the premise that a

          11   trade-based formula and trade allocation -- applies to

          12   behavior has not been sufficiently proven to justify the

          13   formula that's being proposed.  We also think the formula is

          14   unnecessarily complex and while well meaning, it's -- price

          15   discovery value junk.  Seems to be flawed and very expensive

          16   to administer.  Just to -- if you understand that today,

          17   the -- the rate markets are generating 18 million NBBO

          18   changes, and imagine administering cost of trying to

          19   determine annually how many thousands of quote credits each

          20   quote is due for each of the 23,400 seconds in every trading

          21   day.

          22             I certainly respect the Commission's desire to try

          23   and incorporate -- try and encourage quote competition but I

          24   think the benefit to doing so under this proposed formula

          25   don't come close to outweighing the formula's administrative

                                                                         228

           1   costs.
           2             Finally, I'd like to say that whatever action the

           3   Commission ultimately takes, I think it's important to

           4   combine such action with changes that require the NBBO and

           5   trade reports to become real time.  In an electronic world,

           6   that means automatic executions, automatic quote updating and

           7   automatic trade reporting.  So I would offer that maybe no

           8   quotes or trades should be given credit for market data

           9   revenue unless they are going to go past unrelated markets. 

          10   Thank you.

          11             MR. BROWN:  Thank you Annette.  I want to applaud

          12   the Commission for it's creativity in coming up with a

          13   formula for allocation.  I don't remember the last time I

          14   really tried to think about square roots and things like

          15   that.  So it really got me, you know, to refresh a lot of my

          16   old mathematics.

          17             But the point that Schwab believes in is that the

          18   market data reform proposal you put forth simply misses the

          19   point, and that point is is that market data revenue is too

          20   expensive.  And I'm really pleased to hear today for the

          21   first time that, you know, NASDAQ, you know, seems to have

          22   recognized that fact.  We at Schwab have been arguing and

          23   advocating market data reform for many years and we've heard

          24   all the stories and all the rationale about why the market

          25   data rates are what they are and frankly, we don't believe

                                                                         229

           1   them.

           2             You know, last year, the market data cartels took

           3   in $424 million in revenue and had expenses of $38 million. 

           4   Well, that's a profit margin of over a thousand percent and I

           5   mean, we at Schwab wish we had that profit margin, but we

           6   think it really reflects that there's too much revenue

           7   washing around in this system.

           8             And clearly, that excess revenue manifests itself

           9   in the types of practices that you're concerned with, you

          10   know, tape shredding, market data rebates, excessive pay to

          11   executives.  And there's clearly a link to, between market

          12   data revenue and these practices.  We don't think you can

          13   ignore that.

          14             So we would advocate that, before you have us, you

          15   know, or the exchanges buy Cray computers to start figuring

          16   out what their market data revenue share is, we deal with the

          17   problem; reduce the cost of market data because it's the

          18   investors who pay that cost and Commissioner Atkins, you

          19   raised it in -- a good point, I thought, in the last, or the

          20   panel before the last, where you asked about, you were, the

          21   relationship between capping access fees for brokers and

          22   capping or not capping the market data revenue structure that

          23   we have today.

          24             And we certainly think that's a real telling point,

          25   that, you know, the Commission is willing to get into rate

                                                                         230

           1   making or proposed rate making for private businesses because

           2   you see a harm, but you haven't proposed a rate making -- any

           3   action for monopoly priced data that we pay for and investors

           4   pay for.

           5             So we would strongly advocate that you review this

           6   proposal and work with NASDAQ to reduce the cost of market

           7   data to investors.  Thank you.

           8             MR. HALVORSON:  Thank you, and again, I appreciate

           9   the opportunity to participate this afternoon on behalf of

          10   Ameritrade, and the retail investor, we think that we bring a

          11   unique perspective to this panel and to the proposed Reg NMS

          12   and we're pleased to comment on that.

          13             I want to start with the premise that market data

          14   is really the fuel, I think, that runs the market.  And four

          15   years have passed since the Commission issued its concept

          16   release concerning market data structure.  Ameritrade in this

          17   regard is disappointed in a couple of things; one, that Reg

          18   NMS does not address market data and related revenues in a

          19   comprehensive fashion, and two, that the Commission has not

          20   taken the step of requiring transparency by requiring SROs

          21   and SIPs to publicly disclose the costs, true costs of

          22   providing market data to the public.  By comparison, recent

          23   Rules 11Ac1-5 and -6 have contributed greatly to the

          24   transparency and competition and in the order flow arena. 

          25   Similar market data transparency would increase competition

                                                                         231

           1   and potentially reduce costs for all users.

           2             Accordingly, Ameritrade is not today interested in

           3   necessarily debating the merits of the proposed allocation

           4   model as we're not a SIP, as we're not an SRO, and we're not

           5   interested in debating the merits of necessarily the hybrid

           6   model.  What we are interested in gaining an understanding of

           7   the costs associated with providing the data and determining

           8   the appropriate structure to allow for either return of these

           9   excess revenues back to investors, or a model in which market

          10   data revenues simply equal the costs of providing such data

          11   to the investing public.

          12             Market participants like Ameritrade are forced to

          13   pay the costs of the very data they provide.  Any broker or

          14   vendor, as those before me have indicated, can conduct

          15   business in the current environment, will tell that you the

          16   process is overly costly, complicated and burdensome.

          17             SROs require a tremendous amount of detailed

          18   information about how a firm like Ameritrade may use market

          19   data, the type of services that we provide, our use of

          20   technology and how we monitor the users of the information. 

          21   Ultimately, brokers like Ameritrade must share confidential

          22   and competitively sensitive material with the SROs and SIPs. 

          23   Further, the SROs require individual investors to consent to

          24   an agreement which requires the payment of sometimes

          25   discriminatory fees, and is a contract replete with legalese

                                                                         232

           1   and confusing terms or conditions which many retail investors

           2   don't understand.

           3             We spend an inordinate amount of time and money

           4   simply complying with the administrative burdens of tracking

           5   market data used by our customers in maintaining two separate

           6   systems, one for real time data and one for delayed data. 

           7   The current proposal we believe does not address these

           8   issues.

           9             Again, to Jeff's point, we believe that the SROs

          10   and SIPs are really granted monopoly powers in terms of the

          11   fees charged and the control over the dissemination of that

          12   data.  We believe market data fees are imposed in a

          13   discriminatory fashion.  For example, investors accessing

          14   realtime quotes through an account executive by phone, for

          15   example, or from media distributors, do not incur market data

          16   fees.  That same investor who is accessing quotes on-line are

          17   charged a market data fee each time a realtime quote is

          18   accessed, and whether it's charged directly to the end

          19   investor or the retail customer, or to the firm, ultimately,

          20   that customer is ending up paying higher costs for the use of

          21   that data.

          22             The current definitions around professional and

          23   unprofessional users are inconsistent and costly to the

          24   retail public as well.  As Jeff pointed out, the release

          25   notes that out of the $424 million in revenue derived from

                                                                         233

           1   market data fees, we'll take a little bit different look at

           2   this.  386 million or the corollary is distributed back to

           3   SRO participants.  The Commission previously has said, "The

           4   total amount of market information revenues should remain

           5   reasonably related to the cost of market information."  And

           6   we believe there is no transparency to determine whether it

           7   actually costs anywhere near 386 million in order to provide

           8   data back to investors.

           9             So we submit that the way to determine whether

          10   there has been an equitable and reasonable allocation of

          11   costs is to require the SRO or the SIP to have publicly

          12   audited financials regarding the true cost of providing

          13   market data to the end users, including the retail investing

          14   public.

          15             Ameritrade recommends these financial statements

          16   similar to the disclosures under 11Ac1-5 and -6 be made

          17   available to the public through the SEC's website.  Given

          18   that investors ultimately pay these fees, either directly or

          19   indirectly, we clearly believe that requiring the

          20   transparency of such information is in the public's best

          21   interest and only then can the true cost of such data be

          22   analyzed and act as the basis and direction for what we

          23   believe should be future market data reform, both in terms of

          24   pricing and ultimately the distribution of these revenues.

          25             Thank you.

                                                                         234

           1             MR. McBLAIN:  I should explain that the Financial

           2   Information Forum is an organization that focuses on the

           3   industry's information systems.  Our participants come from

           4   the markets, from broker/dealers, and from the vendors who

           5   provide these services to the community, the market data

           6   vendors, service brokers, so when we look at any of these

           7   issues, we typically do it from the perspective, can the

           8   information systems handle it, and how might it impact the

           9   systems.

          10             We've heard this morning and all day today, of

          11   course, the NBBO, really has changed over the years.  When

          12   the National Market System rules were first promulgated, it

          13   was pretty much a system of people acting with systems

          14   linking them.  We've heard today that today, it's very

          15   difficult for people to be taking the trading actions and

          16   monitoring the information.  The NBBO doesn't have a duration

          17   of several seconds.  It's down to milliseconds.  And so the

          18   character of the market to a great degree is changing to

          19   where it is computer black boxes interacting.

          20             And so the duration of the NBBO is much shorter and

          21   I do think that the proposed regulations are good in that it

          22   has reduced the requirements for the display of consolidated

          23   information.  Data vendors today are required to maintain a

          24   montage of quotes for all markets and that looks like that

          25   would not be under the proposed information regulation.  So I

                                                                         235

           1   think it is good that the -- we have to realize now that much

           2   as we had real time information and delayed information in

           3   the past, as a basis of segregating market data, to some

           4   degree, there is now a different tiering of the information,

           5   and that the information as it is used by the black boxes vs. 

           6   the information that is displayed an a terminal and watched

           7   by the human eyes.

           8             And in many cases, on these fast market conditions

           9   that we're talking about, we can really see that it's very

          10   difficult for a person to be analyzing what they see on a

          11   screen and taking action with the same degree that the

          12   trading systems do.

          13             I'd also like to point out for clarification, I

          14   know we're talking about the formula, but I think it's hard

          15   to answer that question without addressing some of these

          16   other areas.

          17             I would not walk away with the idea that technology

          18   is not a problem.  I think we have heard that from the

          19   participants in these panels, but remember, again, they are

          20   representing large organizations where computer power

          21   comes -- they have the dollars to do that.

          22             We might believe as we look at the Internet and

          23   information today to get the impression that things are real

          24   time but the fact of the matter is that there still are

          25   communications systems and there are propagation delay times

                                                                         236

           1   and there are processing cycles.  And when you look and try

           2   to draw up a page on the website, for example, there truly is

           3   a perceivable display at some time.

           4             So I guess the question, the formula is, the first

           5   question that we had is, who would do this calculation? 

           6   Since the whole matter of who might be the consolidator has

           7   been put up for question, that gives rise, now, then

           8   presumably whoever it is that calculates the NBBO would also

           9   be the calculator of the allocation of these revenues.

          10             And we've heard the previous speakers say, it is

          11   very complex.  When the NBBO, the components that go into the

          12   NBBO are changing in milliseconds to somehow capture that and

          13   put that data together is a significant burden, perhaps it's

          14   a burden that the party that might be interested in being a

          15   consolidator may not, given the fact that he becomes a part

          16   of the task.

          17             So that's basically, as I say, as we look at it, we

          18   don't make a judgement as to what this does to the markets

          19   but what we view here is that it indeed seems to be something

          20   that's going to require much greater capacity in the

          21   distribution, the downstream people who do not necessarily

          22   have the dollars to spend on high powered computers.

          23             So that is our concern as we look into it, is that

          24   the formula appears to be very complex, probably adding a

          25   cost burden, and then finally what I would look at is to say,

                                                                         237

           1   if in fact investors do realize that it takes a black box to

           2   really get the best price, will they perceive that the data

           3   that they see on the screen now has less value if it is not

           4   data that they can act upon for their own investment

           5   decisions.

           6             So thank you.

           7             MR. LYNCH:  On behalf of Reuters, I appreciate the

           8   opportunity to share our views on the proposed Regulation

           9   NMS.  They are not really focused on the -- on the structure,

          10   but the effects of the ultimately formulated approach as to

          11   how the fees are distributed.  Although Reuters is best known

          12   as the worlds largest news agency more than 90 percent of our

          13   revenue actually derives from our financial services

          14   business, providing professionals in equities, fixed income,

          15   foreign exchanges, et cetera, with services.

          16             Our open technology, which is based on industry

          17   standards, enables our customers to integrate our information

          18   with content from other sources, and we provide institutions

          19   with the ability to reduce risks, distribute and manage an

          20   ever increasing volume of market data.

          21             We think that as a general principle, we support

          22   that the -- the introduction of greater competition and

          23   flexibility into the consolidation and distribution of the

          24   U.S. securities information.  We believe that investors

          25   should have greater freedom to decide which information they

                                                                         238

           1   need to conduct their business and make investment decisions. 

           2   It is our view that market forces should play an even greater

           3   role determining the value of information and sharing that is

           4   provided for investors.

           5             Turning to the specific proposals, we will be

           6   filing a more detailed comment but I wanted to offer a couple

           7   of things.  One is that we are encouraged by the proposal to

           8   eliminate the montage portion of the consolidated display

           9   requirements.  We think the Commission has correctly

          10   identified the data which is most important to investors;

          11   namely, price, size and the market center of the NBBO.

          12             We agree that market forces and investor choices

          13   rather than regulatory requirements should determine what

          14   additional data should be displayed.  We also see merit in

          15   the proposal to require consolidated display only in the

          16   context in which a trading or order decision could be

          17   limited.  The language of the proposed rule needs to be

          18   studied more carefully.  We think the proposal would promote

          19   the availability of more information at a lower cost, while

          20   ensuring that investment decisions are made upon the basis of

          21   complete and accurate information.  Being the last speaker,

          22   on the last panel, I wanted to keep my remarks brief.  I

          23   appreciate the opportunity.

          24             MR. GOLDSCHMID:  We do, too.  I do have a question

          25   or two, I'm not trying to hold everybody.  You suggested the

                                                                         239

           1   Commission identified the right data.  And Bob, I take it you

           2   were saying the same thing.

           3             Is there anyone who doubts, one, that that data is

           4   important, and two, that someone at the Commission has got to

           5   take a role in making sure it gets out, without worrying

           6   about the price or allocation of it?

           7             Did I hear everybody in effect saying the

           8   Commission's got to do this if we're going to have a national

           9   market system, with a kind of sensible transparency?  That's

          10   fair?

          11             MR. LYNCH:  We think it should be available on

          12   similar commercial terms to everybody, so it should be

          13   available equally.

          14             MR. GOLDSCHMID:  And then I take it the second

          15   basic question is, what kind of price should be involved in

          16   it?  How much cost?  And I think fairly, people have said, if

          17   I understand it correctly, it's four hundred some-odd million

          18   dollars involved and we're not sure why it's that number, or

          19   whether it ought to stay, with Bob and several others saying

          20   it's got to be way too high; is that what I'm hearing?

          21             MR. GREIFELD:  Yes.

          22             MR. BROWN:  Yes, sir.

          23             MS. NAZARETH:  Bob, I'm sure, had a view on this. 

          24   I heard a bunch of different things.  I heard cost, whatever

          25   that is, and it sounded like the cost for -- technology cost,

                                                                         240

           1   putting it together, I heard something less than $20, and

           2   then I heard let the market -- let market forces determine

           3   it.  So I think we heard many different formulations.

           4             MR. GOLDSCHMID:  Well, Annette, once you conclude

           5   that someone -- there has to be one central source of it,

           6   then you're not talking about the market doing it.

           7             MS. NAZARETH:  I agree.

           8             MR. GOLDSCHMID:  Bob, where are you on --

           9             MR. BRITZ:  Commissioner, there are different

          10   economics depending upon which securities we're talking

          11   about.  I'll give you but one example.  The last time I

          12   looked, the priciest market data, at least in the equities

          13   space, on a per print basis of all markets was American Stock

          14   Exchange data by a significant factor vs. New York. 

          15   NASDAQ's, I don't know them in a granular way, but I'm

          16   guessing their economics are very different than New York,

          17   and National is very different as well.

          18             I would share with you a couple of data points,

          19   because I think if I may say so, I think there was a little

          20   bit of fun with numbers taking place a short while ago. 

          21   There was a number about $28 million in market data cost. 

          22   The Commissioners should understand, those are the marginal

          23   distribution-only costs.  They are not the costs to actually

          24   produce the data.  There is no distribution and therefore no

          25   distribution cost if there is no production of the data.  So

                                                                         241

           1   you should just understand the space that that number refers

           2   to.

           3             In the New York's case, and I only have visibility

           4   obviously into the New York's cost structure, I understand

           5   the CTA overall revenue structure, in New York's case, it

           6   costs us $488 million last year to produce market data.

           7             Now, let me bring a little clarity to that number

           8   because people like Commissioner Glassman would suggest that

           9   when we execute a trade, we're doing two things.  There's

          10   essentially a joint product there.  Within one hand, we're

          11   executing two or more investors' orders, so that's the sort

          12   of transaction processing piece of the puzzle, on the other

          13   hand, we're manufacturing market data.  And people like me

          14   come down on the side that at the end of the day, transaction

          15   charges are -- and the agency execution fees are about as

          16   interesting to the counterparties to the trade, the price of

          17   the data that dances across the tape, or the actual price

          18   itself, is interesting to millions of people around the

          19   world, and so you get into interesting allocations of cost as

          20   between what are you doing, executing a trade or producing

          21   market data.

          22             I'm a little rusty in my cost accounting skills,

          23   but the good news is, you don't actually have to go there. 

          24   In the New York's case, against $488 million of cost to

          25   produce the data, 172 -- 488 -- excuse me.  $178 million

                                                                         242

           1   in -- $172 million in market data revenue, including twelve

           2   from proprietary data, so 160 from the consolidated regulated

           3   data and $151 million in terms of transaction revenues.

           4             So you don't even have to make the distinction.  If

           5   you combine the 151 in transaction revenues and the 160 or,

           6   depending upon your point of view, the 172 in market data

           7   revenues, you get $323 million worth of revenues against $488

           8   million worth of costs.

           9             I've been on the other side of the Schwab debate

          10   for about ten years now, and in the very first meeting, with

          11   Mr. Brown's predecessors, I said that if Schwab could get the

          12   New York to the point where it could recover its costs of

          13   market data, I would pay their legal bills for the campaign. 

          14   So I emphasize and I throw those numbers at you because I

          15   think each market has a cost structure that's very different

          16   and the economics of market data are very different as well.

          17             MR. GOLDSCHMID:  Go ahead.

          18             MR. BROWN:  Well, as one of Schwab's lawyers, I

          19   particularly appreciate the thought that someone else may pay

          20   some money to us to raise our salaries.  But the issue, then,

          21   becomes, everything that goes into manufacturing and

          22   execution and disseminating and apparently adding up to this

          23   488 million.  We would question that.  First of all, we don't

          24   know, because the -- there's no real accounting to anyone

          25   about this.

                                                                         243

           1             Secondly --

           2             MR. BRITZ:  On the contrary, those numbers are

           3   published in the New York Stock Exchange's annual report.

           4             MR. BROWN:  Yes, but it's hard to understand

           5   exactly what relates to the production of market data. 

           6   Second, and more importantly, in my mind, there is a

           7   distinction about, you know, the order flow that comes in

           8   isn't necessarily their product.  You know, that the formula

           9   you've come up with and the basis for it that you talked

          10   about was rewording SROs for price discovery.

          11             Well, in my mind, SROs don't discover prices.  It's

          12   the order flow within those SROs that discover prices, and

          13   the fact has to be that that order flow is what creates the

          14   market data.  And it's customer orders doing that.  So to say

          15   that, you know, it's all a cost to the New York Stock

          16   Exchange to produce that data is not quite true.  Brokers

          17   have their own expenses to produce that information, to

          18   transport it from the customer to the execution venues. 

          19   Well, all of that has to go into the calculation.  But what's

          20   coming out is the investors are paying for the entire panoply

          21   of cost that relate to market data.

          22             MR. GREIFELD:  We've spent a lot of time in the

          23   eleven months since I've been at NASDAQ understanding our

          24   cost structure.  And we are saying to this commission today

          25   that, at a five to seven dollar rate for basic data, we have

                                                                         244

           1   the ability to provide a decent return to our shareholders.

           2             So I don't sit here today saying we have the lowest

           3   cost structure in the world and we're certainly working to

           4   reduce our cost base, but it is inconceivable to me as

           5   someone now who is responsible for the SIP in the NASDAQ

           6   world, who has the technology background, to figure out any

           7   way to spend anywhere near the $488 million, and certainly,

           8   we would welcome the opportunity to take a contract from New

           9   York Stock Exchange to maybe run it a little more

          10   efficiently.  But, you know, investors have to be the

          11   beneficiary here.  There is just too much money in the

          12   system.  It's been allowed to become inefficient and we're

          13   saying that at five to seven dollars we can make a decent

          14   return on that.  And I think that's the right answer for

          15   investors.

          16             MR. HALVORSON:  I can't speak to Mr. Britz' numbers

          17   from the NYSE.  I know that in doing the mental math when

          18   Jeff was speaking, he and I used the same basis of numbers in

          19   the marketplace that the Commission has provided.  And I

          20   would simply suggest that if the costs are indeed real, then

          21   let's just open the books and take a look at them and give a

          22   true line-by-line display of what it actually costs to

          23   produce and distribute the data.

          24             To Jeff's point, from a retail inventory

          25   standpoint, and really the retail order flow, it's the

                                                                         245

           1   institutional order flow that's feeding the quotes that are

           2   displayed.  Nobody's making them up.  They are based upon

           3   real orders coming to the marketplace from the end investors. 

           4   So they are the ones that really own the data that's being

           5   produced.  And that's why we simply make the statement and

           6   have the position that those market data revenues, whatever

           7   is in excess of costs, if it's not a revenue equal cost

           8   model, should come back to the individual investor.  Those

           9   that ultimately provide the quotes.

          10             MR. GOLDSCHMID:  Now, let's say we did that, would

          11   you be concerned at all about any other data being the

          12   product of the SRO?

          13             MR. HALVORSON:  I think that that does raise some

          14   interesting questions.  There is a lot of other data that's

          15   provided and within the proposal, there's questions about how

          16   we segregate that, do we put that into this thought of an

          17   independent model vs. consolidated model, and I think there

          18   is other market data that perhaps has a different pricing

          19   scheme or a different model to it.

          20             MR. BROWN:  To your point, sir, obviously in

          21   today's environment, depth of book data is becoming more and

          22   more important to everyone.  And we thought that permitting

          23   SROs to sell that data independently of the monopoly system

          24   is a good thing.  Let's see how it works, and I think there

          25   are entities today, we've heard them, ECNs say, that put

                                                                         246

           1   their data out on websites for free, their full book.  So

           2   there are going to be cost pressures to on -- on the entire

           3   system to drive down and provide competition for data.  So

           4   that might work.

           5             But we're also concerned at Schwab about creating a

           6   two-tiered system of data where the investor will only

           7   receive the NBBO and institutional investors and those who

           8   can afford it will be seeing the full book and really be able

           9   to judge where the market may be going or where is the best

          10   trading opportunities.

          11             That concerns us and we really would encourage the

          12   Commission to review that and think carefully about whether

          13   the NBBO is sufficient for making trading decisions by a

          14   retail investor.

          15             MR. COLBY:  Can you explain why, if you're

          16   concerned -- what you're concerned about whether the NBBO

          17   prices are -- what's the market pressure going to be on the

          18   depth of the book and that's going to keep those prices low? 

          19   Because depth of book currently for market makers is in the

          20   hands of NASDAQ, the limit order display is a separate

          21   product and the -- and New York has the entire New York book,

          22   nobody else has it.  So where is the market pressure to --

          23             MR. BROWN:  Well, one, I guess I'd look at what's

          24   going on currently.  The full book, and I'm not sure of the

          25   actual names that the markets have for them, but they are

                                                                         247

           1   available now and they are not, people aren't rushing to buy

           2   them.  They are expensive, but the -- the institutions are

           3   buying, but I think that if we can permit competitive forces

           4   to, I mean, you're right, the one concern is, if you're the

           5   sole -- if you're 90 percent of the volume, and you have 90

           6   percent of the order flow, what does anyone else have to show

           7   to compete?  I mean, that's a fair point.

           8             But if, like in the NASDAQ market, where there is a

           9   greater diversity of centers of orders, then there can be

          10   competition for that information.

          11             MR. GREIFELD:  I think that two competitive

          12   disciplines will keep the price in check and I think the

          13   basic question is if you have 80 percent basic market share

          14   beyond the NBBO, can you charge anything.  One is, the rules

          15   contemplated with Reg NMS, you will not see an 80 percent

          16   market share player.  That tends not to be a natural outcome

          17   of competitive markets.  So you have that one factor.

          18             But the second factor is the contributors to this

          19   flow have the ability to form their own consortium and

          20   develop their own product.  So I look at it as NASDAQ in the

          21   world that we would advocate, you could have Merrill, Morgan,

          22   Goldman get their information together and come up with a

          23   trade theme.  They are perfectly able to do that.

          24             So you will have the ability for alliances to shift

          25   based upon, you know, deals that are offered, and that's the

                                                                         248

           1   competitive market that we want to have.  You don't have that

           2   ability today when the market centers are long.  So to the

           3   extent we put it towards the retail investors, close to the

           4   retail investor, one, they benefit, and two, it should create

           5   competitive dynamics in terms of how it's going to work.

           6             MR. ATKINS:  I, as far as I'm glad we have both

           7   Schwab and Ameritrade here.  I was wondering from your

           8   perspective what do your customers, your retail customers

           9   want as far as services via the order execution, the

          10   information that they are not able to get or that they don't

          11   receive at a reasonable fee?

          12             MR. HALVORSON:  Well, from the Ameritrade client

          13   perspective, they basically want, you know, some fairly

          14   simple things.  They want a tradable quote, right, they want

          15   to be able to get the price they see or better, as quickly as

          16   possible.  And whether it's a -- whether it's an active

          17   trader or whether it's a longer-term investor, they both seek

          18   the same things.

          19             And we've actually got written -- written comments

          20   on the rest of the proposal which we will be pleased to

          21   submit to the Commission that addresses our viewpoints on the

          22   trade-through aspects and the other aspects as well.  But

          23   Commissioner Atkins, it really is pretty simple in terms of

          24   what our clients want.  And they want the quote that they see

          25   to be executable in a very quick time frame.

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           1             MR. BROWN:  And we shouldn't really forget the

           2   other piece that is really very important, too.  Trade people

           3   who are trading or contemplating a trade, and that is the

           4   series of previous trades.  Having access to the stream of

           5   trades gives you an idea of where the next trade is going to

           6   be.  So that's a service that we do provide and they will

           7   want.

           8             I think one of the -- and Kurt raised a very good

           9   point earlier, about what our customers don't want is when

          10   they want data, they get sent a ten-page contract that they

          11   have to sign as an individual and they can't even begin to

          12   understand what's in that document.  And they call us and we

          13   have to work them through it and try to help them understand

          14   before they sign.

          15             That process, this onerous administrative process

          16   that we have three networks to deal with, has to change.  I

          17   mean, it's become so time-consuming for the brokerage

          18   community, the man-hours that applies to this has to -- has

          19   to change.

          20             MR. HALVORSON:  I also just to follow on -- with

          21   Jeff's comment, I would also just suggest that when we look

          22   at the costs associated with market data fees, we really

          23   aren't including costs that broker/dealers are incurring to

          24   manage the process that Jeff and I just alluded to, that

          25   process of organizing and tracking and distributing these

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           1   agreements to our clients and also assisting them in

           2   understanding what's required of them before they can gain

           3   access to the very data that we believe they are providing.

           4             MR. BRITZ:  I speak only for New York.  It's on the

           5   Internet.  It's a one-page agreement.  It's click on, so I

           6   don't know what it is Ameritrade and Schwab are organizing

           7   and distributing to their customers, and there are lots of

           8   other market data vendors and agreements out there, so

           9   perhaps they are, but it's not the New York.

          10             MR. HALVORSON:  And, Mr. Britz, I would suggest

          11   that you're right, ours is a click through, it's an

          12   electronic document, and there are a number of different

          13   agreements out there.  And there, you know, the complexity of

          14   those is what we have stated.  They are written largely in

          15   legalese and they are difficult for a retail investor, even a

          16   sophisticated investor, to understand.

          17             MR. CAMPOS:  Given that -- if we can go back a few

          18   steps, we need a requirement in government to make sure that

          19   this data is available, begin there, and then you know, we

          20   can see that there's some debate about what's the right

          21   price, and it's clearly, you know, some are saying it's too

          22   expensive to achieve, or the more you look into it, the more

          23   discussion there is about really whether the price is right

          24   or not.  So that's a key point.

          25             And given that there's clear distortion today given

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           1   the way the formula is allocated, given what's going on, why

           2   not try to do something like what the proposal puts out which

           3   is essentially a, you know, we don't know totally what the

           4   right numbers are, but let's allocate it fairly and let's try

           5   to promote it even if it's imperfect, you know, quotes and

           6   being the NBBO price, how bad is that if we go forward with

           7   the proposal?

           8             MR. BRITZ:  Commissioner, can I suggest the

           9   construct to your first point, which is not quite sure

          10   whether -- whether it's the right price, and --

          11             MR. CAMPOS:  I'm just reflecting what I'm hearing.

          12             MR. BRITZ:  And I'd just like to offer a comment on

          13   that and perhaps one way to think about it, as proposed to

          14   the Commission having to grapple with providing investors

          15   access to this information, they can hardly avoid it.  It's

          16   on television, it's on the Internet, it's in airports, in

          17   train stations.  It's in restaurants and bars.  And I would

          18   offer the suggestion that the very pervasiveness of this data

          19   is suggestive that the cost is absolutely at the margin.  One

          20   way to think about it.

          21             MR. COLKER:  I would question whether distortions

          22   existed.  I would take exception to that.  I think the

          23   exchanges today are competing very strongly for order flow;

          24   we're doing it through a combination of costs, technology and

          25   service innovations and our success is measured in terms of

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           1   the number of trades we're able to record, and that, I think,

           2   that's appropriate.  And the competition, at least on the

           3   NASDAQ and AMEX side has successfully pushed down the cost of

           4   the data to the tune of 65 million a year on a NASDAQ side,

           5   about fifty million on the AMEX side, and if the one

           6   remaining barrier to competition on the New York side, which

           7   is trading -- that comes down, I think we'll see enormous

           8   pressure on market data on the other side, if not through

           9   market forces.  So I would argue strenuously to let the

          10   market do its thing.  You're going to see, in order for the

          11   exchanges to respond to the major retailers, you're going to

          12   see the cost of market data come down significantly, it

          13   already has.

          14             MR. CAMPOS:  You're just saying leave it alone?

          15             MR. COLKER:  I think it's working pretty well.

          16             MR. GREIFELD:  I would disagree with that, but I

          17   think the current proposal trying -- we think it's just a

          18   second opportunity for gamesmanship and we've already

          19   conceived different ways that people can develop programs

          20   that can basically arbitrage that and we don't think it

          21   solves the issue.

          22             With respect to the allocation beyond trades and

          23   quotes, we think that proper allocation should be about

          24   shares.  It seems the easy way to go and less subject to

          25   gaming.  But again, our overall point is, those reallocation

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           1   formulas do not get at the heart of the issue.  And the heart

           2   of the issue is that the investors need an NBBO.  It should

           3   be at a very low cost, and vendors such as ourselves should

           4   be able to sell above and beyond that on true value.

           5             MR. CAMPOS:  So you want us to set ceilings? 

           6   What --

           7             MR. GREIFELD:  We believe when you agree with the

           8   concept, you've got certain data that's required by all

           9   investors, that's part of the public good, then the natural

          10   corollary to that is that the government should set the rate

          11   for that data.  And it does pain me to say that but it's the

          12   right answer.  They are tied to together.  And we are

          13   revealing our hand.  Twenty dollars is too high by any sane

          14   measure of the costs associated with it.

          15             MR. BROWN:  And, you know, it's the government that

          16   has mandated that everyone purchase this data.  So you've

          17   gone that step.  You've created a monopoly price for this

          18   data.  So now it's in your hands to regulate that price.

          19             MR. GREIFELD:  And that monopoly price has not been

          20   thought of for a very long time.  NASDAQ itself set that

          21   price twenty years ago.  So we have a monopoly price that was

          22   set almost twenty years ago without any active review of how

          23   that relates.  And any time you're dealing with a monopoly

          24   price, then the participants have the right to understand how

          25   that price is derived.

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           1             MR. BRITZ:  In case I was too subtle earlier on,

           2   there another way to get at so called monopoly price and that

           3   is to bust up the consortium.

           4             MR. DONALDSON:  Okay, I think we're coming to a

           5   close.  I want to first of all thank this panel, I want to

           6   thank those members of the other panels who are still here. 

           7   I also want for say to all of you who are sitting behind this

           8   desk, I fear that you have been sitting on your hands and

           9   biting your tongue and not saying things.  I hope we'll hear

          10   from you one way or another by e-mail or by direct visitation

          11   to the SEC or by carrier pigeon or any way, help us with your

          12   thoughts and arguments.  Thanks to the staff for the work in

          13   putting this together, and thank you for bearing with us all

          14   day long.

          15             (Time noted:  5:09 p.m.)

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