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OVERSIGHT OF THE SEC’S DIVISION 

OF TRADING AND MARKETS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON CAPITAL MARKETS AND 

GOVERNMENT SPONSORED ENTERPRISES 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRTEENTH CONGRESS 

SECOND SESSION 

JUNE 26, 2014 

Printed for the use of the Committee on Financial Services 

Serial No. 113–88 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

GARY G. MILLER, California, Vice Chairman 

SPENCER BACHUS, Alabama, Chairman 

Emeritus 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

ROBERT HURT, Virginia 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

MARLIN A. STUTZMAN, Indiana 

MICK MULVANEY, South Carolina 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

TOM COTTON, Arkansas 

KEITH J. ROTHFUS, Pennsylvania 

LUKE MESSER, Indiana 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

PATRICK MURPHY, Florida 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

STEVEN HORSFORD, Nevada 

SHANNON MCGAHN, Staff Director 

JAMES H. CLINGER, Chief Counsel 

(III) 

SUBCOMMITTEE ON CAPITAL MARKETS AND GOVERNMENT SPONSORED ENTERPRISES

SCOTT GARRETT, New Jersey, Chairman 

ROBERT HURT, Virginia, Vice Chairman 

SPENCER BACHUS, Alabama 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RANDY NEUGEBAUER, Texas 

MICHELE BACHMANN, Minnesota 

KEVIN McCARTHY, California 

LYNN A. WESTMORELAND, Georgia 

BILL HUIZENGA, Michigan 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

MICK MULVANEY, South Carolina 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ANN WAGNER, Missouri 

LUKE MESSER, Indiana 

CAROLYN B. MALONEY, New York, 

Ranking Member 

BRAD SHERMAN, California 

RUBE ́ N HINOJOSA, Texas 

STEPHEN F. LYNCH, Massachusetts 

GWEN MOORE, Wisconsin 

ED PERLMUTTER, Colorado 

DAVID SCOTT, Georgia 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

KEITH ELLISON, Minnesota 

BILL FOSTER, Illinois 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

DANIEL T. KILDEE, Michigan 

PATRICK MURPHY, Florida 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

June 26, 2014 .................................................................................................... 1 

Appendix: 

June 26, 2014 .................................................................................................... 35 

WITNESSES 

THURSDAY, JUNE 26, 2014 

Luparello, Hon. Stephen, Director, Division of Trading and Markets, U.S. 

Securities and Exchange Commission ................................................................ 8 

APPENDIX 

Prepared statements: 

Luparello, Hon. Stephen .................................................................................. 36 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Luparello, Hon. Stephen: 

Written responses to questions for the record submitted by Representative Messer .................................................................................................... 47 

Written responses to questions for the record submitted by Representative Fincher ................................................................................................... 50 

Written responses to questions for the record submitted by Representative Stivers .................................................................................................... 56 

(1) 

OVERSIGHT OF THE SEC’S DIVISION 

OF TRADING AND MARKETS 

Thursday, June 26, 2014 

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON CAPITAL MARKETS AND

GOVERNMENT SPONSORED ENTERPRISES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to notice, at 9:19 a.m., in room 

2128, Rayburn House Office Building, Hon. Scott Garrett [chairman of the subcommittee] presiding. 

Members present: Representatives Garrett, Hurt, Neugebauer, 

Huizenga, Mulvaney, Ross, Wagner, Messer; Maloney, Lynch, Perlmutter, Scott, Himes, Foster, Carney, and Sewell. 

Ex officio present: Representative Waters. 

Chairman GARRETT. Good morning. 

Today’s hearing of the Capital Markets and Government Sponsored Enterprises Subcommittee is hereby called to order. Today’s 

hearing is entitled, ‘‘Oversight of the SEC’s Division of Trading and 

Markets.’’ And I welcome the panel. After looking yesterday where 

it was an elongated two-panel hearing, I welcome our one witness, 

Mr. Luparello, to the Capital Markets Subcommittee hearing today, 

and I look forward to your testimony. 

We will begin with opening statements. And I recognize myself 

for 6 minutes. 

Today’s hearing will focus on the activities of the Division of 

Trading and Markets of the Securities and Exchange Commission. 

Director Luparello, welcome, and thank you for your testimony 

that you provided in writing and the testimony that you are going 

to present today. 

The Division of Trading and Markets at the SEC, as you know, 

has a broad swath of responsibility and authority over activities 

that represent some of the core functions of the U.S. capital markets. 

Specifically, the Division sits at the epicenter, if you will, of our 

Nation’s equity, fixed-income, and derivatives marketplaces. 

The SEC is reforming or considering reforms of all three of those 

markets. These changes will dramatically change the way that investors invest, issuers raise capital, and businesses hedge their 

risk. 

First, let’s look at the equity markets. Let me thank you again 

for participating in the roundtable that we held, I guess a little 

over a year ago up in New York City. 

2 

The roundtable, as you know, served as a substantive starting 

point for Members and other attendees to learn about the evolution 

of the rules governing equity markets today. 

I think it was a very informative discussion we had there and 

provided a solid foundation from which to better comprehend the 

current challenges faced by the various market participants as well 

as the potential impact rule changes could have. 

And to that end, by the way, Chair White gave a speech recently 

where she outlined a number of prospective changes to various 

market practices in an attempt to address some of the issues most 

frequently highlighted as concerns. 

And so, when she did that, I applauded her, and I continue to 

applaud her for her continued focus on our Nation’s equity markets. 

But I caution that moving too quickly or in an ad hoc manner 

without thinking through all of the possible consequences could, as 

I say, do more harm than good. 

It is so critical, then, that besides just addressing specific narrow 

issues being faced by market participants, that the Commission 

conduct a fundamental review and challenge many of the central 

assumptions regarding the rationale of its overall regulatory regime. 

Let me provide perhaps two specifics areas where I would like 

to see more attention from the Commission. 

First, the world is vastly different, we all agree, from 1975, when 

Congress amended the Exchange Act in response to one dominant 

equities exchange at the time. 

We live in a world of demutualized exchanges where all market 

centers are for-profit, providing similar functions, yet they are competing under very different regulatory umbrellas. 

The SEC should take the time, therefore, to thoroughly analyze 

the situation and eventually make changes that put these varying 

market participants on, as I always say, a more level playing field. 

Second, Reg NMS, as the order protection rule, is a very heavyhanded rule dictating explicitly how venues and orders are supposed to interact with each other in the marketplace. 

Now, this has been highlighted by a number of the commentators, including some of our previous panelists here, as one of the 

significant factors underlining market practices and, also, behavior. 

So I look forward to discussing these issues, as well as Chair 

White’s recent proposals, during the questioning period that we 

will have after the testimony. 

Next, in regard to fixed income, many argue that this is often a 

part of the marketplace that is overlooked compared to the equity 

markets. 

Our corporate and municipal bond markets have literally trillions of dollars of outstanding issuances, and they provide investment opportunities for millions of investors, but these markets are 

very different than our equity markets. 

Chair White gave a speech on Friday outlining some proposals 

seeking additional practices and price transparency for investors in 

these less liquid markets than the equity markets. 

So I believe increasing transparency and competition for the benefit of the investors is appropriate, and I’m interested to see more 

3 

specifics on how these new proposals that she is talking about will 

actually work. 

All that said, I do worry that the Commission’s reform potentially robs from Peter to pay Paul, as they say. Specifically, how 

do we help investors in the corporate bond market if we improve 

pricing transparency, on the one hand, but if we reduce liquidity 

through the Volcker Rule, on the other hand? 

Requiring additional transparency for markets that the Commission made less liquid and where investors have to pay wider 

spreads is not a net win for the investors at the end of the day. 

A greater investor protection in this market would be to ensure 

greater liquidity and better ways for investors to get in and out of 

the positions. That is what liquidity is about. 

The SEC then needs to closely examine on an ongoing basis the 

impact of the Volcker Rule on the liquidity in the corporate bond 

market and keep policymakers well-informed of this important information. 

Finally, regarding derivatives, the Commission took a very important step yesterday in finalizing rules that specify how market 

participants that have affiliates overseas will be impacted under 

the SEC’s Title VII regime. 

So I applaud the rigorous and thoughtful process that the Commission undertook when finalizing those rules, and I am also hopeful that the new leadership over at the CFTC, some of which we 

just swore in the other day, will allow this process to go forward 

and to follow suit and formalize their guidance which they have 

had in the past under a rule now so that the force of law will not 

be in question. 

Finally, another issue that has continued to be one of much debate is the proper regulatory approach for broker-dealers. 

Recently, one of the Commissioners gave a speech essentially 

saying that the SEC is now a systemic risk regulator, and that 

statement caught us by surprise. 

It is my understanding that Congress created the SEC as a markets regulator with three-part function of: protecting the investors; 

maintaining fair, orderly, and efficient markets; and facilitating 

capital formation. 

I served on the Dodd-Frank Act conference committee, and nowhere in that do I recall the mission of the SEC actually changing 

to a systemic risk regulator. 

So I am very concerned that the Division of Trading and Markets 

actually might be losing one of its primary responsibilities, which 

is oversight of broker-dealers. 

It appears that the Federal Reserve—without any proper authority whatsoever from Congress, what they are trying to spread is a 

regulatory and bailout net over even the broader marketplace and 

over the broker-dealer community as well. 

So we must stop enlarging the government’s safety net and, instead, remove moral hazard and reinstate market discipline. 

The Division of Trading and Markets has many important tasks 

at hand. Other issues that I have not gone into in detail, but are 

nonetheless important, are: regulating clearing agencies and transfer agents; overseeing FINRA and other SROs; determining whether or not to change the duty of care for broker-dealers; and conVerDate Nov 24 2008 17:25 Dec 18, 2014 Jkt 091152 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 K:\DOCS\91152.TXT TERRI
4 

ducting oversight of the out-of-control and anti-investor Security 

Investor Protection Corporation. 

So, Director, thank you for taking on this very difficult assignment and also for being here today. This subcommittee wants to 

make sure we work closely with you in the future and also with 

Chair White and the rest of the Commission as well as you carry 

out your important duties. 

With that, I now recognize the ranking member of the subcommittee, the gentlelady from New York, Mrs. Maloney, for 5 

minutes. 

Mrs. MALONEY. Thank you, Chairman Garrett, for holding this 

very important and timely hearing. 

And welcome, Mr. Luparello. 

Mr. Luparello also participated in your meeting on trading and 

markets that you held in New York earlier, which was tremendously informative and a fine experience for all of us who were fortunate enough to attend. 

The SEC has a critical role in our economy because it is responsible for overseeing and regulating the Nation’s capital markets. 

Without vibrant capital markets, companies would have a difficult time raising money to expand their businesses and create 

jobs, and our economy would be stalled. 

The SEC’s mission is to simultaneously protect investors, encourage capital formation by businesses that are seeking to grow, and 

maintain fair, orderly, and efficient markets. 

Balancing these overlapping objectives is a difficult job, but I believe the SEC has performed admirably under Chair White, who, 

incidentally, is from the great City of New York. 

And I look forward to hearing your testimony as well. 

There is, however, one common theme that runs through each of 

the SEC’s three missions. In order to accomplish any of the SEC’s 

three missions, investors have to feel confident in the fairness and 

integrity of our capital markets. 

If they are not confident that they will get a fair shake, they will 

not put their money at risk in our capital markets and they will 

not invest in U.S. companies. 

I have always said that markets run more on confidence than on 

capital, and I believe that is particularly important right now. 

Over the past decade, the incredible advances in technology, 

along with major overhauls of the regulatory framework for trading 

stocks, has fundamentally changed our equity market structure. 

Some market participants have seen some huge benefits from 

these changes, particularly retail investors. They have seen their 

trading costs fall to some of the lowest levels on record. 

And other market participants have not fared as well. The lower 

trading costs for retail investors has come at the expense of certain 

brokers and intermediaries. This is all to be expected. 

Any fundamental overhaul of our market structures has winners 

and losers, but these changes in our market structure have at the 

very least caused many market participants to take a step back 

and question whether they are still getting a fair shake. 

That is why I think confidence is so important right now. If there 

are problems, we need to fix them, because investors’ confidence 

can disappear in the blink of an eye. 

5 

I was pleased to hear Chair White say in our April hearing in 

response, really, to the chairman’s question that the U.S. stock 

market is not, in fact, rigged, as some have claimed. 

And I will say that almost all of the market participants that I 

speak to have expressed tremendous appreciation for the SEC’s 

careful, data-driven approach to market structure issues. 

I was also pleased to see that just last night, the SEC announced 

a pilot program that will test whether wider tick sizes will increase 

capital formation for smaller companies. 

This committee passed unanimously a bill last November that required the SEC to conduct such a pilot program, and that passed 

the House overwhelmingly. 

So I am pleased to see that the SEC has shown a willingness to 

work with this committee on these important and other very complex market structure issues. 

I look forward to working with our witness, Mr. Luparello, who 

recently took over as the Director of the SEC’s Division of Trading 

and Markets. 

Even though he has only been on the job for a few short months, 

his Division has already announced several major initiatives, and 

I look forward to hearing from him today. 

Thank you very much. And I yield back the balance of my time. 

Chairman GARRETT. The gentlelady yields back. Thank you very 

much. 

We now turn to the vice chairman of the subcommittee, Mr. 

Hurt, for 2 minutes. 

Mr. HURT. Thank you, Mr. Chairman. And thank you for holding 

today’s hearing to conduct oversight over the SEC’s Division of 

Trading and Markets. 

While the SEC’s Division of Trading and Markets has a number 

of consequential initiatives on its agenda, including the review of 

our equity market structure, I am particularly interested in hearing about issues related to the self-regulatory organizations. 

I am encouraged by SEC Chair White’s recent comments that the 

Commission’s review of equity market structure will include an examination of the nature of our self-regulatory model. 

However, some, including SEC Commissioner Gallagher, suggested that over time SROs have changed dramatically from selfregulatory to quasi-governmental and now operate more like an additional branch of government. 

Congress delegated specific responsibilities to these entities, and 

they should not be immune from our scrutiny. It is important for 

this subcommittee to look closely at the current structure of the 

SROs, their role in our financial regulatory system, whether their 

operations are sufficiently transparent and accountable, and finally, if changes are necessary to ensure that they meet the standards and responsibilities imposed by Congress. 

I am pleased to see several of the SROs implementing more robust processes for economic analysis in their rulemaking. 

It is incumbent upon the SEC and Congress to ensure that these 

cost-benefit standards are rigorously applied. Congress and the 

SEC should also promote similar policies for the remaining SROs, 

instead of a reliance on ad hoc measures. 

6 

I look forward to working with my colleagues on this subcommittee to critically examine the SROs in our framework of selfregulation in financial markets today. 

I want to thank Mr. Luparello for appearing before our subcommittee. I look forward to your testimony. 

And thank you, Mr. Chairman. I yield back the balance of my 

time. 

Chairman GARRETT. I thank the gentleman. And the gentleman 

yields back. 

We will go to Mr. Lynch now for 2 minutes. 

Mr. LYNCH. Thank you, Mr. Chairman. 

And thank you, Ranking Member Maloney. 

And welcome, Director Luparello. 

Mr. Luparello, you are at the helm of the Securities and Exchange Commission’s Division of Trading and Markets at a time of 

great importance. 

Currently, our capital markets face many challenges, including, 

most importantly, I think, high-frequency trading, a subset of algorithmic trading, and you have mentioned that extensively in your 

written remarks. 

The rise of algorithmic trading, whereby computer algorithms 

make trading decisions, creates both new opportunities and challenges for U.S. investors and regulators. 

As highlighted in Michael Lewis’ book, ‘‘Flash Boys,’’ advancements in the speed of information are allowing high-frequency 

traders to front-run trades and exploit market fragmentation for 

profit without providing socially useful intermediation between investment capital and the companies who can put that capital to 

use. 

Now, I am not sure if using the term ‘‘rigged’’ is proper, that our 

markets are rigged, but I do know that there are two firms: Virtu 

Financial, which traded heavily in the market for 5 years without 

a losing day, which is incredible; and Tradebot, which traded for 

over 4 years without a losing day in the market. 

So maybe ‘‘rigged’’ isn’t the proper term, but let’s just say the 

current structure of the market favors high-frequency traders over 

average investors. And maybe that is why we are seeing a lot of 

investors walk away from the market, because they believe it is 

rigged. 

I, along with many of my colleagues in Congress, am particularly 

concerned about abuses in the markets caused by this practice. 

Both the Senate Banking Committee and the Senate Permanent 

Subcommittee on Investigations recently held hearings to examine 

disruptions in the market caused by high-frequency trading. And I 

think this committee could do the same. 

In a recent speech, SEC Chair Mary Jo White addressed the 

public’s growing concern about high-frequency trading and proposed recommendations for new rules. 

I would like to hear your thoughts today about how that might 

be accomplished. 

Thank you for the time, Mr. Chairman, and your indulgence. I 

yield back. 

Chairman GARRETT. The gentleman yields back. 

Mr. Foster is recognized for 3 minutes. 

7 

Mr. FOSTER. Thank you, Chairman Garrett. I appreciate your 

holding this hearing. 

Mr. Luparello, I appreciate your appearing before this committee 

to discuss the complex and important issues around market structure. 

I believe it is easy to make the case that technology has largely 

benefited retail investors who have seen spreads between bid and 

ask prices narrow to historically low levels. 

Ironically, one of the main challenges in market structure is protecting the interests of large institutional investors who are sophisticated participants and are normally thought of as being fully capable of taking care of themselves. 

One analogy that I like to use when thinking about high-frequency trading and dark pools is the example of Disney World. 

Forty years ago, Disney Corporation bought up large blocks of 

swampland in central Florida using anonymous shell corporations 

and paying the current market price. Was that fair? 

If Disney had attempted this in a State where the prices and 

beneficial owners behind real estate transactions were immediately 

made public, then land speculators would have jumped in, buying 

up parcels of land nearby with the intent of selling them back to 

Disney at a profit. Would that have been fair? 

The point I am trying to illustrate is that while dark pools sound 

bad to the public because of the implication of opacity, forcing 

every transaction into the open would create winners and losers. 

I agree with Chair White that our equities markets are not 

rigged. But it is clear that, with 11 exchanges and 40 alternative 

trading systems, the market is overly fractured and there is a lack 

of transparency in many respects. 

This competition helps keep trading fees low for investors, but it 

also incentivizes routing two exchanges that pay the most for their 

orders. 

It is also clear that many of the current market regulations were 

developed in a world before the equity markets were dominated by 

computer algorithms. 

And, yet, it is absolutely clear that not enough information is 

provided to market participants to know about how their trades are 

routed and executed. 

Additional measures should be taken to ensure that alternative 

trading systems disclose harmonized digestible information about 

how they operate and whether or not they are really offering price 

improvements from the lit market. 

So as you embark on a comprehensive review of our equity market structure, including issues like order times and consolidated 

data feeds, I urge you to use a data-driven approach to bring about 

more transparency. Market forces and transparencies are often the 

best disinfectant. 

Thank you. I yield back. 

Chairman GARRETT. Thank you. 

And the gentleman yields back. 

We will now turn to our witness. Mr. Stephen Luparello is the 

Director of the Division of Trading and Markets at the U.S. Securities and Exchange Commission. Mr. Luparello, we can now turn to 

you, finally, and hear your testimony. 

8 

There are two things I always say: one is to make sure you bring 

the microphone close enough to you because we can’t hear otherwise; and, of course, your entire written testimony will be made a 

part of the record. 

You are now recognized for 5 minutes, Mr. Luparello, and thank 

you for being with us. 

STATEMENT OF THE HONORABLE STEPHEN LUPARELLO, DIRECTOR, DIVISION OF TRADING AND MARKETS, U.S. SECURITIES AND EXCHANGE COMMISSION 

Mr. LUPARELLO. Chairman Garrett, Ranking Member Maloney, 

and members of the subcommittee, thank you for inviting me to 

testify on behalf of the U.S. Securities and Exchange Commission 

regarding the Division of Trading and Markets’ activities and responsibilities. 

The mission of the Division is to support the Commission’s mandate by fostering investor protection and establishing and maintaining standards for fair, orderly, and efficient markets. 

To this end, the Division is responsible for the rules that apply 

to many of the major participants in the U.S. securities markets. 

We also oversee the rulemaking activities of the exchanges, clearing agencies, and FINRA in their capacity as self-regulatory organizations; monitor risks at large broker-dealers and clearing agencies; and assist the Commission with major international regulatory coordination efforts. 

Under the Dodd-Frank and JOBS Acts, the Division has primary 

responsibility for more than 30 separate mandatory rulemaking 

initiatives and studies under the two statutes, as well as the ongoing oversight and the implementation they require. 

These new responsibilities include the creation of a regulatory 

structure for securities-based swaps, the regulation and monitoring 

of clearing agencies designated as systemically important, the prohibition of proprietary trading by insured depository institutions 

and their affiliates as part of the Volcker Rule, and the development of rules for intermediaries engaged in crowdfunding. 

Although the Division’s day-to-day and long-term focus cover a 

wider set of initiatives and mandates, I want to highlight a few of 

the key areas of responsibility and summarize our current efforts 

in each. 

First, the Division is playing a lead role in the comprehensive review of equity market structure recently described by Chair White 

to ensure that the U.S. equities markets remain the strongest in 

the world. 

This initiative includes a review of the evolution of market practices over the last decade and the role of Commission rules, including Regulation NMS, in that evolution and the need for any adjustments to that structure. 

Chair White has directed the Division to take a number of specific actions related to high-frequency trading, market transparency, and order handling, and has recommended that the Commission create a Market Structure Advisory Committee to review 

specific initiatives and rule proposals. 

Beyond this, the Division is working with FINRA and the exchanges to advance several initiatives, including efforts to miniVerDate Nov 24 2008 17:25 Dec 18, 2014 Jkt 091152 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 K:\DOCS\91152.TXT TERRI
9 

mize consolidated data latency and enhanced transparency and the 

extent to which such latency exists, clarify how exchanges themselves use data feeds for regulatory and routing purposes, and review order types offered by the exchanges to clarify their operation. 

Another important part of the review is developing recommendations to improve the market for smaller issuers, as a core guiding 

principle of our review is the recognition that, when considering 

market structure, one size certainly does not fit all. 

To this end, the Commission is continuing its evaluation of 

decimalization rules, including its consideration of a tick-size pilot 

that would widen the quoting and trading increment for certain 

smaller company securities and exploring other competitive market 

structure alternatives for smaller cap issuers. 

In addition, last year, at Chair White’s request, each of the exchanges, FINRA, and the clearing agencies prepared action plans 

to strengthen critical market infrastructure. 

These entities currently are working to implement these plans, 

including through several important measures that should be completed in the very near future. 

Additionally, in March 2013, the Commission proposed Reg SCI 

to improve the Commission’s oversight of market infrastructure. 

As proposed, the rule would require exchanges, clearing agencies, 

and other critical market participants to have in place policies and 

procedures reasonably designed to help ensure that their systems 

are robust, secure, and compliant. 

Beyond the many important market initiatives, the Division is 

working to fulfill the Dodd-Frank Act Title VII mandate to establish a new regulatory regime for security-based swaps, which historically have traded over-the-counter. 

These rules are intended to achieve a number of goals, including 

facilitating the centralized clearing of swaps with the intent of reducing counterparty risk, increasing transparency for regulators 

and market participants, and addressing capital and margin requirements for security-based swap dealers and major securitybased swap participants. 

To date, the Commission has proposed all of the rules required 

by Title VII, adopted a number of final rules and interpretations, 

and provided a road map for the further implementation of its Title 

VII rulemaking, and has taken other actions to provide legal certainty to market participants during the implementation process. 

Just yesterday, the Commission adopted rules regarding the application of Title VII to cross-border activity. Division staff continues to work to develop recommendations for final rules required 

by Title VII and has been actively engaged in discussions with domestic and foreign regulators regarding the direction and coordination of international derivatives regulation. 

The Division is also continuing its efforts to establish rules pursuant to Title VIII of the Dodd-Frank Act, which requires the Commission to increase regulation of financial market utilities and financial institutions engaged in payment clearing and settlement 

activities that are designated as systemically important. 

Finally, the Division and other SEC staff are considering how to 

recommend the Commission use its authority under the DoddFrank Act to adopt rules establishing a uniform fiduciary standard 

10 

for conduct for broker-dealers and investment advisors when providing personalized investment advice about securities to retail 

customers. 

To more fully inform the Commission’s decision on this issue, 

Chair White has directed the Division to work with its colleagues 

in DERA and the Division of Investment Management to evaluate 

potential options in light of the information available for the Commission’s consideration. 

Thank you again for inviting me to discuss the Division’s activities and responsibilities, and I look forward to answering your 

questions. 

[The prepared statement of Mr. Luparello can be found on page 

36 of the appendix.] 

Chairman GARRETT. Thank you very much. We appreciate your 

testimony. 

I now recognize myself for 5 minutes for questions. 

I am going to begin with the same question that I asked Chair 

White: Director, are the markets rigged? 

Mr. LUPARELLO. That is an easy question to start with. 

No. The markets are not rigged. There are clearly things about 

the markets that require further attention and perhaps some regulatory response or enhanced transparency, and the Commission 

and the Division are focused on that. But fundamentally, the markets are fair for investors. 

Chairman GARRETT. So when the issue of investor confidence is 

raised, should investors have confidence in the markets? 

Mr. LUPARELLO. I think it is fair to worry about investor confidence, even if you think the markets are not rigged. 

The extent to which there is a perception that it is rigged is 

maybe—it is not as important as whether the markets are actually 

rigged, but it is obviously a very important thing for the Commission. 

So one of the things we have to do in our policymaking is do 

things that reassure participants in the market that the markets 

are fundamentally fair to them. 

Chairman GARRETT. Okay. This may be a segue; I don’t know. 

Chair White, just recently, in her speech the other day, touched 

on some of the proposals that you—one of the proposals was the 

creation of a market advisory committee. And I presume such an 

advisory committee is supposed to serve as a resource, if you will, 

of information from stakeholders and the like. 

And I assume that the purpose of it is to provide that information as you go forward—you and the entire SEC goes forward with 

the other recommendations that she and you are considering. Is 

that correct? 

Mr. LUPARELLO. That is correct. 

Chairman GARRETT. And she didn’t really elaborate. She just 

spoke one or two sentences in her speech. 

So is this advisory committee being put together by her or is this 

being put together by the entire Commission? How does that work? 

Maybe you could flesh it out, if you will, a little bit. 

Mr. LUPARELLO. I will flesh it out to the extent I can. 

Chairman GARRETT. Okay. 

11 

Mr. LUPARELLO. The committee will be a committee that will be 

consistent with the obligations of the Federal Advisory Committee 

Act. 

Chairman GARRETT. Okay. 

Mr. LUPARELLO. At this point, the staff is presenting a recommendation to the entire Commission, which will include the 

mandate, the charter, and the proposed participants. 

Chairman GARRETT. Okay. 

Mr. LUPARELLO. And, to that point, the entire Commission will 

have an opportunity to vote on the— 

Chairman GARRETT. So, where do the people come from? Who 

makes the recommendations to serve on this? Is that from Chair 

White or is it from the whole Commission? 

Mr. LUPARELLO. The recommendations in the first instance will 

be made by staff— 

Chairman GARRETT. By staff. 

Mr. LUPARELLO. —on Trading and Markets and others. But, obviously, the Commission will have input into that. 

Chairman GARRETT. The Commission. 

Mr. LUPARELLO. Yes. 

Chairman GARRETT. Okay. 

A whole slew of issues are being run through here today. 

Other people have raised, and we have talked about in this committee previously, Reg 611, also known as the trade-through rule, 

as an area some people say needs extensive, thorough review, and 

other people push away and say not. 

One of the people who says that it does need further review is 

Andy Kessler, in a recent Wall Street Journal piece—I remember 

reading that the other day—and across the Chamber, Senator John 

McCain. In his opening statement at the Permanent Subcommittee 

on Investigation hearing on market structure, he also said it does. 

What is your take on this? Is this an area that is going to be one 

of the primary focuses of the SEC for review? 

Mr. LUPARELLO. The Chair, in her speech, laid out what I think 

you can basically categorize as short-term initiatives and longerterm initiatives. 

Chairman GARRETT. Okay. 

Mr. LUPARELLO. Clearly, the study of Reg NMS, broadly, but specifically the issue of the trade-through rule is one that is very much 

on our agenda. 

Unlike the shorter-term issues, I think the staff tends to think 

that there is more study and more discussion that needs to go on. 

There are obviously some benefits that have come with Reg 611 in 

terms of competition. 

Obviously, there is also a substantial amount of fragmentation 

that has come with it. That is a very difficult issue to balance. 

Chairman GARRETT. Yes. 

Mr. LUPARELLO. It is very much on our agenda, but at this point 

I don’t think we have reached a conclusion. 

Chairman GARRETT. Okay. So one other question. I have 50 seconds here to go. 

There is an issue about dealing with best execution and whether 

you are enforcing and modernizing that whole system. Right? 

12 

And also tied to that is the issue of disclosure requirements on 

that. So there is an issue there as far—as you do that, whether 

that has a conflict of interest as far as the broker is concerned. 

So, in 26 seconds: first, address that; and second, if you are going 

to be addressing those couple of issues there and that point, the 

other issue is: Are you getting into the weeds too much on these 

specific issues before you do a more holistic analysis of the overall 

market structure before getting down into trying to fix those pieces 

of it? 

Mr. LUPARELLO. You touched on it perfectly, which is that so 

many of these issues are fundamentally interrelated. 

Chairman GARRETT. Right. 

Mr. LUPARELLO. And to try to look at them in a stovepipe means 

you are probably going to have as many unintended consequences 

as intended consequences. 

Chairman GARRETT. Exactly. 

Mr. LUPARELLO. There is a very important sort of overarching 

analysis of how much best execution drives a variety of things, 

whether it is the need for the trade-through rule or further disclosure on payment for order flow or things like maker-taker pricing. 

All of those issues, I think we will look at together. 

Again, I think it is important for confidence and, because of a variety of smaller fixes, that we move quickly on the shorter-term initiatives. 

But we will, on the longer-term initiatives, look at all these 

things together and not attempt to sort of pick them apart in ways 

that are artificial. 

Chairman GARRETT. Good luck. I appreciate that. 

The gentlelady from New York is now recognized for 5 minutes. 

Mrs. MALONEY. Thank you very much. 

The chairman started with his first question to Chair White. I 

am going to begin with mine. 

I asked, ‘‘Are the markets rigged?’’ And Chair White said, ‘‘Absolutely not.’’ And I said, ‘‘Some of my constituents think they are.’’ 

So, that goes to the confidence issue. And they think they are because of books that have been written alleging it, statements by 

people alleging it, and basically, that some people have access to 

information before other people and that gives them an unfair advantage. 

I truly do believe that confidence is an important part of markets, and if people don’t have confidence that it’s fair and that they 

have a fair shot, the same shot that anyone else has, it will hurt 

our markets. 

So I am wondering, what could we do to address this concern 

that some people have? I am sure your office is getting the—my office is getting it. You have to be getting these allegations. 

Mr. LUPARELLO. We do. And we obviously take them very seriously. And we are borderline inundated on it. But that is our job. 

I think the answer to that is going to be different for different 

segments of the marketplace. Clearly, at the retail end, there is a 

lot that is good and works well for the market. 

By all available metrics, retail investors are doing better now 

than they have ever done in the past. That is mostly driven, obviously, by technology. 

13 

But there are certain things that lead to confidence concerns. 

One of those is stories around the different access to information. 

We are working with the exchanges and the SIPs to make sure 

that everything is being done to deal with the issue of SIP data latency, for example. 

And we are doing things around order types— 

Mrs. MALONEY. Dealing with—pardon me—what? Entry? 

Mr. LUPARELLO. I’m sorry. Data latency. 

Mrs. MALONEY. Data latency. I see. 

Mr. LUPARELLO. So doing a variety of things that reinforce fundamental fairness of the market is going to be our first step. 

Institutions have different issues and concerns around whether 

the market works well for them, and part of that is around some 

level of transparency of what happens in dark pools. 

And we are going to pursue an initiative that deals with greater 

transparency of routing of institutional orders. That exists on the 

retail side. 

It is also worth looking at this time whether that rule, which has 

been in place for 10 or 12 years, could use some modernization. 

But there are a variety of things we can do to bring transparency 

to the market and attempt to communicate well to retail investors 

about the fundamental fairness in the market. 

Mrs. MALONEY. In Chair White’s speech earlier this month, she 

said she was directing the staff to develop an ‘‘anti-disruptive trading rule.’’ 

And the purpose of this rule, according to her statement that 

day, is to limit the use of ‘‘aggressive destabilizing trading strategies in vulnerable market conditions.’’ 

Can you walk us through what you would consider to be an ‘‘aggressive short-term trading strategy?’’ 

Mr. LUPARELLO. I can at a high level. The specifics of that rule 

are still a topic of conversation and in development. 

But, as is generally thought, there are three types of strategies 

that together form what people think of as high-frequency trading, 

and there is a lot of gray area around those margins. So, I don’t 

like to get too invested in it. 

Mrs. MALONEY. What is an aggressive short-term trading strategy that she is talking about? 

Mr. LUPARELLO. One of the strategies is when a trader, based on 

a signal, aggressively takes liquidity on the same side of the market at multiple times and it is—as compared to a market-making 

strategy, where you are more passive and providing liquidity on 

both sides. This is a strategy that sees weakness on either the bid 

side or the offer side and takes liquidity in sequence. 

What the Chair was talking about was developing a rule where, 

whether or not that’s illegal now—and I think, in most cases, we 

would all agree that it is not illegal—whether there are times when 

the market is vulnerable and subject to volatility that you restrict 

a subset of traders from executing strategies like that during short 

periods of time. 

That writ large is what the anti-disruptive trading rule would 

look like. 

Mrs. MALONEY. How would you distinguish between an aggressive trading strategy and the more legitimate trading strategies 

14 

that major institutional investors and retailers follow? Do you differentiate based on the type of investor or based on the market 

conditions? How do you differentiate? 

Mr. LUPARELLO. Those are very important details. 

In our early thinking, I think it is based on a strategy in a very 

short period of time that is liquidity taking on one side of the market when the market itself is somewhat fragile, all those terms still 

to be defined. 

Mrs. MALONEY. My time has expired. 

Chairman GARRETT. Thank you. Good question. 

The vice chairman of the subcommittee, the gentleman from Virginia, Mr. Hurt, is recognized for 5 minutes. 

Mr. HURT. Thank you, Mr. Chairman. 

And, again, I thank Mr. Luparello for appearing today. 

As we undertake a review of the equity market structure in this 

country, I wanted to talk a little bit about the self-regulatory organizations generally. Obviously, they play an important role, a rulemaking role. 

I am a member of the Virginia State Bar and, as an attorney, 

as a member of a State regulatory organization charged with the 

creation of rules as well as the enforcement of those rules, I certainly understand the virtues of SROs generally. 

But I want to talk to you about your view on the evolution of 

SROs. Are they making good rules? Are they going through rigorous analysis to reach those rules? And what about transparency 

and accountability? 

Clearly, those are issues that I think promote the—certainly the 

response—promote the things that the SEC should be worried 

about: transparency; capital formation; and investor protection. 

And so, they play a critical role there. 

Can you talk a little bit about that evolution and where they are 

now and where you could see room for improvement? 

Mr. LUPARELLO. Absolutely. And when talking about SROs, 

clearly there are—the exchanges are also self-regulatory organizations. 

It is a very important issue, one that we are looking at more 

long-term. Your question is, I think, more specifically pointed at 

the broader rulemaking SROs, specifically FINRA and the Municipal Securities Rulemaking Board (MSRB). 

I think all of those points are extraordinarily important both in 

terms of the ability to have input into the rulemaking process as 

well as ensuring a level of confidence about that rulemaking process. 

Both FINRA and the MSRB, on significant rulemakings over the 

past few years, have added layers of opportunities for comment. 

So, as a general matter, when they are doing rules, first they 

subject them to their own internal notice and comment process. 

And then, after that, if there are major tweaks, they sometimes 

repeat that process and then eventually come to the Commission, 

where it goes through a separate notice-and-comment process. 

So we are comfortable with that level. One of the things is there 

is no specific obligation on the SROs to have that internal noticeand-comment process. 

15 

I think they tend to think it improves the quality of their product 

and so are committed to it. But that is one of the things that I 

think we would like to stay vigilant on and make sure they stay 

committed to that. 

They have also—and this is a fairly recent development—embraced more careful, more specific cost-benefit analysis in their 

rulemaking. I think that is something that, backsliding, I think we 

would think would be a very bad idea. 

I think, having spent a decent amount of time at FINRA, I always feel the need a little bit to defend the quality of the rulemaking process. 

And that early round of communications through notice and comment, as well as going through the committee process, often had 

a very, very strong cost-benefit component. 

And so, I would like to think that most of the rulemaking, even 

without an explicit cost-benefit obligation, had gone through some 

fairly careful cost-benefit analysis. That said, making that routinized and making that obligatory is, I think, a fundamentally good 

idea. 

When we at the Commission get rule filings from MSRB and 

FINRA, the two most important things were, obviously, we want to 

make sure it is good public policy, but we also want to make sure 

it is consistent with their statutory obligations and it does pass 

cost-benefit muster. 

Mr. HURT. Talk a little about the role of the SEC. 

Do you think the SEC conducts robust oversight over these agencies? And is there room for improvement there? 

Mr. LUPARELLO. The oversight of the SROs is the responsibility 

of our Office of Compliance Inspections and Examinations (OCIE). 

So I am a little bit more comfortable talking about being the 

overseen as opposed to the overseer. But there are substantial resources that are committed to overseeing the SROs. 

One of the things that came out of the Dodd-Frank Act was an 

obligation on the Commission to have a more routine oversight 

structure with the securities associations, of which FINRA is the 

only one I know that exists and is robust. 

And, look, especially FINRA has a very broad mandate, a very 

complicated program, and increasing the touch points and paying 

attention to it is something that you have to do basically all the 

time because there are just so many different moving parts. 

But I know both the Commission, again through the OCIE Staff, 

as well as the folks at FINRA, are very committed to that ongoing 

relationship. 

Mr. HURT. I see my time is about to expire, so I will yield back 

the balance of it. 

Thank you, sir. 

Chairman GARRETT. The gentleman yields back 7 seconds. 

And I now recognize the gentlelady from California. 

Ms. WATERS. Thank you very much, Mr. Chairman, and Ranking 

Member Maloney. I appreciate the opportunity to join with you 

today on the issues that you have identified dealing with the SEC. 

I have an issue that is very important to me that I have been 

trying to advance. I have a bill, H.R. 1627, the Investment Adviser 

Examination Improvement Act, which would authorize the SEC to 

16 

levy user fees to cover the costs of an increase in the frequency of 

examinations of investment advisers. 

The Investment Advisory Committee of the Commission has endorsed this legislation, which is one of the recommendations that 

SEC staff originally provided in the study required in Section 914 

of Dodd-Frank. 

From your perspective, do user fees represent a scaleable and 

workable way for the Commission to improve investor protection? 

Mr. LUPARELLO. I think, at a high level, the Chair and the Commission, as well as the staff, remain very concerned about the coverage of investment advisors from an examination standpoint, especially as compared to broker-dealers, and those statistics are 

well-known. 

We continue to be supportive of any solution that allows for a 

greater coverage of investment investors that is, frankly, consistent 

with the statute. 

Ms. WATERS. Section 911 of the Dodd-Frank Act provides that 

each time the Investor Advisory Committee submits a finding or 

recommendation to the Commission, the SEC shall promptly issue 

a public statement assessing the finding or recommendation of the 

committee and disclosing the action, if any, it intends to take with 

respect to the recommendation. 

Does the Commission plan on responding to this recommendation 

from the Investor Advisory Commission? 

Mr. LUPARELLO. Congresswoman, I am afraid that is an area of 

the Commission’s responsibility, specifically the Division of Investment Management, that is outside my scope, and I can’t speak to 

it. I’m sorry. I can find out the answer, though. 

Ms. WATERS. All right. Let me just wrap this up, Mr. Chairman, 

by saying that the examinations are done for the investor advisors 

once every 12 years. 

That is all they can expect to have to respond to in terms of an 

examination, which means only 8 percent of the exams are being 

done. 

And so, this is a very important issue, and I am hopeful that everything possible can be done to continue to advance it. 

And if user fees probably are the only way that we can get the 

resources to do the examinations, of course, I am hoping that everyone will support the idea of user fees. 

Mr. LUPARELLO. I couldn’t agree more with your observation. 

Ms. WATERS. Thank you. I yield back the balance of my time. 

Chairman GARRETT. Thank you. 

The gentleman from Texas is recognized for 5 minutes. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. And thank you for 

having this important hearing. 

Mr. Luparello, in a recent speech Commissioner Gallagher had 

an interesting observation. He stated that when people ask him 

how the SEC should respond to Michael Lewis’ ‘‘Flash Boys,’’ which 

focuses, as you know, on striking, tells about the high-frequency 

trading in equities, his response is, we still need to respond to 

Lewis’ 1989 classic, ‘‘Liar’s Poker,’’ which is a vivid description of 

the bond market structure issues that are still present today. 

I agree with him. That scenario is one we haven’t really looked 

at in the past. 

17 

And when I look at the allocation of resources at the SEC, you 

have hundreds of staffers in your division that are devoted to oversight of the equity and options market. 

And I believe there are six employees in the Office of Municipal 

Securities and, amazingly, no staffers focused on the corporate 

bond market. 

Given that debt financing is nearly $15 trillion of the market, 

why has the SEC allocated such a small amount of its resources 

to those markets? 

Mr. LUPARELLO. Overall, I entirely share your concern and support Commissioner Gallagher’s observation. Let me just correct you 

every so slightly. 

While Trading and Markets does not have a subsection that is 

solely focused on the fixed-income market, specifically, the corporate fixed-income market, there are a number of people for whom 

that is their responsibility. 

But overall, I couldn’t agree more. Obviously, we have a lot of 

work to do on equity market structure. We also have a lot of work 

to do creating a market structure for over-the-counter derivatives. 

But fixed-income, especially given how investing appetites are 

going to change going forward, is only going to become more and 

more of a retail market and more and more worthy of our interest 

and investigation. 

The Chair did give a speech within the past few days where she 

outlined at least some preliminary thoughts on how to address 

market structure in the fixed-income space. That work is going to 

come out of my division, and it is something we take very seriously. 

Mr. NEUGEBAUER. I think I have heard people say that there is 

probably less efficiency in the bond markets than in the equity 

markets. 

Would you agree with that statement? 

Mr. LUPARELLO. Yes, 100 percent. 

Mr. NEUGEBAUER. Yes. 

So somebody is paying for inefficiency? 

Mr. LUPARELLO. Part of that inefficiency comes with the fact that 

it is just fundamentally a less liquid market. But there is certainly 

some transparency that we would like to explore bringing to that 

market. 

Mr. NEUGEBAUER. Turning to the Volcker Rule, in, I think, October of 2011 and January of 2012, the agencies received nearly 

18,000 comments voicing opinions on a rule and, at the prodding 

of the White House and the Treasury Department, the rule was 

completed at the end of last year. 

Now, a lot of us felt like the initial rule that was put out was 

pretty vague, which prompted a lot of questions about it. 

And then, when the rule came back out, a lot of us were hoping 

that it would be re-proposed and be opened back up for comment, 

but that was not the case. 

And so, I think the industry felt like they were left with a lot 

of unanswered questions, and there continues to be, as I’m am sure 

you are aware, a growing number of concerns about the enforcement and how the rule is going to be interpreted. 

So tell me kind of, what the game plan is here. You have the 

Volcker Rule working group. But how are people going to have the 

18 

opportunity to respond to those in a timely manner? And have you 

worked out who makes the final decision where you have a multiagency Commission here looking over that process? 

Mr. LUPARELLO. Obviously, coordination is important. And the 

working group, which has representatives from the five regulatory 

agencies, meets constantly and is committed to consistency. 

One would hope that commitment to consistency doesn’t come 

with a cost of being slow in terms of getting guidance out, and my 

observation in my short time there is that has not been the case. 

So, as I said, the agencies are committed to doing these things 

completely consistently. 

We have started putting out responses to frequently asked questions. Three additional ones went up within the past couple of 

weeks. I think there are six now. Our view obviously is that is a 

living document that we will continue to try to populate to the 

greatest extent possible. 

Also, in our examination programs we are reaching out and having those conversations to try to get additional questions from entities that will be covered by the Volcker Rule so we can give them 

as much guidance as we possibly can. The extension of the conformance date also gives us a little bit more of a window to get that 

done. 

Mr. NEUGEBAUER. So are these interpretations—are they being 

made public so that everybody gets a look at them? 

Mr. LUPARELLO. Absolutely. 

Mr. NEUGEBAUER. And what about the minutes of the working 

group and how they are making those decisions and how they are 

coming to those conclusions? Any transparency there? 

Mr. LUPARELLO. Complete transparency on the FAQs that are on 

our Web site and the Web sites of the other four agencies. I am 

afraid I don’t know the answer to your question. 

Chairman GARRETT. The gentleman’s time has expired. 

We will give a little leeway to the gentleman from Massachusetts, Mr. Lynch. 

Mr. LYNCH. Thank you, Mr. Chairman. 

Mr. Luparello, I want to go back to the speech that Chair Mary 

Jo White gave back at Sandler O’Neill on June 5, 2014. 

She mentioned that the SEC is assessing the extent to which 

specific elements of the high-frequency trading environment may 

be working against investors rather than for them. This was about 

a month ago. 

Have we made any progress on that? 

Mr. LUPARELLO. The Enforcement Division obviously has a number of— 

Mr. LYNCH. Could you pull that microphone closer? My hearing 

is not good. 

Mr. LUPARELLO. Neither is mine. So I apologize. And I could hear 

you perfectly. I apologize for the microphone being too far away. 

Obviously, if the Commission’s staff in the Enforcement Division 

believes that there are market participants who are violating existing rules, that is subject to very careful investigation and enforcement. There have been a small number of cases, but I think, to be 

perfectly frank, the vast majority of high-frequency trading activity 

exists inside what is currently considered legal trading. 

19 

The Chair brought forward a number of initiatives, all of which 

are in development, including the one we had spoken about just 

briefly on the anti-disruptive trading rule being one that is very 

much directed at the conduct you are looking at. 

That is something that is a very high priority for the Division to 

come up with a recommendation to the Commission in the very 

near future, but we have not presented that to the Commission yet. 

Mr. LYNCH. All right. Thank you. 

Let me ask you—she also raised the issue of eliminating the exception right now from FINRA registration for dealers that trade 

in off-exchange venues. 

Are we making any progress on that? 

Mr. LUPARELLO. That is actually—that is half of two pieces, the 

other of which is to clarify that certain market participants that 

trade at a certain level need to register as broker-dealers. 

Then, having clarified that obligation to register as broker-dealers, if they participate in the over-the-counter markets, which 

clearly most high-frequency traders do because that is where dark 

pool volume gets reported, they would need to register as FINRA 

members. 

Those proposals are in development. Again, I think we are hoping to get them to the Commission soon. 

Mr. LYNCH. She also talked about the volume of trading being 

done in dark pools versus on lit exchanges and mentioned that 

there might be some way to put a little bit more light on some of 

these dark pools. 

Are there any concrete steps in that direction? 

Mr. LUPARELLO. Specifically, those proposals would call for enhanced transparency in terms of the business operations of ATSs. 

It is not so much changing the mix of lit quotes versus dark 

quotes, but basically the business operations, how they execute orders, how their fees work— 

Mr. LYNCH. A lot of dark pools are not ATSs, though. 

Mr. LUPARELLO. No. They are ATSs. 

Mr. LYNCH. Are you doing anything in that regard? 

Mr. LUPARELLO. Yes. 

I’m sorry. They are ATSs. 

So it would basically be looking back at our ATS rulemaking of 

10 or 12 years ago and modernizing it, enhancing the level of disclosure about the business operations of ATSs, including, importantly, the mix of participants in the ATSs and then making that 

information publicly available. 

Again, I feel like I am repeating myself, but that one is also in 

development. 

Mr. LYNCH. No. I understand. 

And it sort of leads to—the last question I have is, in her speech 

the Chair actually brought up a couple of enforcement cases where 

broker conflicts—because of the maker-taker fee structure, where 

some brokers were getting enhanced fees if they sent their trades 

in a certain direction. 

There was a conflict there with the general duty to place the best 

trade for an investor. She had a couple of fraud enforcement actions that she mentioned. 

20 

What are we doing in that area to try to manage those conflicts 

for the brokers? 

Mr. LUPARELLO. Maker-taker is a very important issue. It is a 

very complex issue, one that we have been studying for a while, 

and will continue to study. 

I will say, however, that if a broker is routing his customer orders based only on the desire to obtain rebates or avoid fees without making sure that he is meeting his overarching obligation of 

best execution, I think that would clearly violate our existing rule 

set. 

Mr. LYNCH. Thank you. 

I have exhausted my time. I yield back. 

Chairman GARRETT. Thank you. 

The gentleman’s time has expired. 

Mr. Ross is recognized for 5 minutes. 

Mr. ROSS. Thank you, Mr. Chairman. 

Mr. Luparello, in reviewing your opening statement, you talk 

about providing technical assistance to the Department of Labor 

with regard to their definition of ‘‘fiduciary’’ and specifically as to 

the practical application of making sure investors have proper 

guidance with regard to ERISA. 

I have some grave concerns over that. 

First of all, it gives rise to a new cause of action. As a lawyer, 

that is great. As a litigator, it is even better. But I think that it 

directly and adversely impacts the investors. 

Because I think, once you put that standard in there and you 

have an exodus of broker-dealers from the market, you still have 

a demand for that advice, and I think you create a more volatile 

investment market because of it. 

And my concerns are: What technical assistance are you providing? And do you feel that there should be a fiduciary definition 

with regard to investments with ERISA for broker-dealers? 

Mr. LUPARELLO. The Chair has asked the staff of Trading and 

Markets, as well as the staff of Investment Management, to come 

up with some proposals on that very issue, the standard of care, 

whether you can continue to have separate standards of care for 

different distribution venues or whether you need a single standard 

of care and whether that single standard of care is— 

Mr. ROSS. And I think that is appropriate. 

I think there also should be a cost-benefit analysis because I 

think you are going to see, again, an exodus in the market of the 

broker-dealers. And, I think there are standards of care. There are 

standards of care just by way of common law. 

There is misfeasance, malfeasance, and negligence. And there are 

errors and omissions policies out there that cover that for some of 

these professional broker-dealers. 

So I am just very concerned that moving in this direction is going 

to do more harm to the investment market of those who want to 

engage in it than it will do as a benefit. 

Mr. LUPARELLO. I completely agree. 

And in developing our recommendations, cost clearly is an issue. 

We also worry about investor choice. 

As for the guidance, the technical assistance we are giving the 

Department of Labor, that is mostly in terms of providing them our 

21 

understanding of how the market operates. Obviously, their decision-making process is one over which we don’t have any control. 

Mr. ROSS. Thank you. 

Turning to the Volcker Rule again, the Volcker Rule will take 

place about the same time as the Basel III capital requirements are 

going to be imposed—what may very well be—when they may very 

well be imposed. 

My concern—and I want to know if it is a concern of yours—is 

whether there is going to be an impact on interest rates for corporate borrowers because of Basel III and the Volcker Rule. 

Mr. LUPARELLO. Obviously, we are concerned about and carefully 

look at liquidity in the marketplace. Even if we didn’t, the Chair 

has asked us to provide information on a quarterly basis, I believe, 

of— 

Mr. ROSS. Because that could impact our markets pretty significantly. It might be— 

Mr. LUPARELLO. Absolutely. We have— 

Mr. ROSS. —a little bit more regulation than we might need 

there. 

With regard to the Volcker Rule and the exemption for municipal 

and State debt as well as sovereign debt, because these types of investments, these types of debt, if you will, may fluctuate in the 

market, do you think that there is more advantage to the larger 

banks to take riskier investments because they will be protected as 

being exempted from the Volcker Rule? 

Mr. LUPARELLO. I will be honest with you, Congressman. It is not 

an area that I have spent enough time studying to provide an insightful point of view. 

Mr. ROSS. But I guess Congress exempted certain debt of State 

and municipal debt, but then the regulatory environment added 

sovereign debt. 

And that has me concerned because I think that those are gambles that—I don’t know how many people want to invest in the City 

of Detroit right now, but that is an exempted debt under the 

Volcker Rule. 

Let’s see. Lastly, the United States remains the only developed 

country to implement a restriction on proprietary trading. 

Will U.S. corporations face higher borrowing costs and be placed 

at a competitive disadvantage with regard to their foreign counterparts? 

Mr. LUPARELLO. Clearly, that is something we plan on studying 

and plan on continuing to communicate about with this subcommittee. 

Mr. ROSS. I appreciate your insight on that. 

And I will yield back the balance of my time. 

Chairman GARRETT. Thank you. 

The gentleman yields back the remainder of his time. 

Mr. Perlmutter is recognized for 5 minutes. 

Mr. PERLMUTTER. I thank the kinder and gentler chairman for 

my 5 minutes. 

Mr. Luparello, thank you for being here today. I just have kind 

of a series of questions about different kinds of rules that are out 

there. 

22 

In the lead-up to the crash of 2008, there were a couple of rules 

that were not in place that I think ultimately were then put back 

into place, and I would like to know what their status is. 

What is the status of naked short sales and the uptick rule? Do 

those exist or exist in some form or another? 

Mr. LUPARELLO. I will look for my staff folks over my shoulder 

to tap me on the shoulder if I am wrong. 

But I understand that the—to the best of my recollection, the 

short sale rule exists, but it exists only during certain times of 

market stress. So, the short-sale tick-test rule exists only in narrow 

instances. 

Mr. PERLMUTTER. In sort of times of— 

Mr. LUPARELLO. Right. 

Mr. PERLMUTTER. —where the market is diving, in effect? 

Mr. LUPARELLO. When the market is already directionally 

going—when it is already directionally going down. 

Mr. PERLMUTTER. Okay. Thanks. 

Talk to me about—and explain to the committee, if you would, 

because—this exchange-traded funds and leveraged exchange-traded funds and how those might have an effect on the overall market 

if things were to go sour. 

Mr. LUPARELLO. I think we talk about market structure for equities and we talk about market structure for fixed income and derivatives. 

But exchange-traded funds is an enormously important part of 

the market. It is something that my staff spends a lot of time on, 

as well as the Division of Investment Management, studying 

whether there are aspects of that from a market structure standpoint that we need to look at. 

There is also obviously— 

Mr. PERLMUTTER. So what is an exchange-traded fund? 

Mr. LUPARELLO. It is any number of products that either represent a basket of securities or some other reference asset that you 

can trade intraday. It is basically like a mutual fund except that 

there is pricing during the day. 

There is not always perfect transparency around the components 

of it. And so, the arbitrage between the components and the ETF 

are very, very important. 

Mr. PERLMUTTER. So in the SEC’s sort of overview of these funds 

and the trading of these funds, what are you seeing today? 

Because I have seen kind of an increase in articles about potential problems, one part of the market saying, ‘‘No. There is no problem here,’’ others saying, ‘‘Well, we had better watch this.’’ 

Mr. LUPARELLO. I think, from a market structure standpoint, it 

is certainly worthy of further attention. 

I think we are also always worried about whether some of these 

products are complex and being sold to investors who don’t actually 

understand the complexity and that they create separate sales 

practice issues. 

That is another part of it to which we need to pay very close attention. 

Mr. PERLMUTTER. Can you tell us what the—a couple of years 

ago, Mr. McHenry sponsored a bill on crowdfunding for small purchasers, small investors. 

23 

And there are fears about—part of your job, obviously, is being 

a policeman, making sure that people aren’t taken advantage of, 

there isn’t fraud in the marketplace. 

So, you have been tasked with some rulemaking on 

crowdfunding. What is the status of that? 

Mr. LUPARELLO. The proposed rules were published in October of 

last year, I believe, and we received a number of very thoughtful 

comments. The staff is working on it. 

There are issuer obligations that are embedded in the rulemaking that are the responsibility of the Division of Corporation 

Finance. 

The intermediary obligations, whether that is broker-dealer obligations or funding portal obligations, are our responsibility. 

We are working through it to the best of our ability and hope to 

get a recommendation to the Commission very soon. 

Mr. PERLMUTTER. All right. Thank you, Mr. Chairman. I yield 

back. 

Chairman GARRETT. Thank you. 

Mrs. Wagner is recognized for 5 minutes. 

Mrs. WAGNER. Thank you, Mr. Chairman. 

And I thank Director Luparello for being here. 

I want to continue the discussion on the fiduciary standard of 

conduct and, in your own words, consider whether and, if so—I underscore ‘‘if so’’—you will adopt rules establishing a uniform standard. 

To me, the most critical issue raised by the potential fiduciary 

rulemaking is whether the new rules will, in fact, hurt low- and 

moderate- and middle-income individuals’ access and affordable financial advice. 

And I appreciated your statement to Congressman Ross about 

the concerns of cost and choice in that investor market. 

Dodd-Frank required the SEC, I know, to study whether to subject broker-dealers to a fiduciary standard. However, the SEC’s 

2011 study ‘‘failed to identify whether retail investors are systemically being harmed or disadvantaged under one regulatory regime 

as compared to the other.’’ This was, of course, according to Commissioners Paredes and Casey. 

Without investor harm, Director Luparello, is there any basis to 

conclude that a uniform standard would, in fact, enhance investor 

protection? 

Mr. LUPARELLO. I think clearly, one needs to identify a benefit 

to stand up against the cost. The Commission before my time, but 

in the recent past, put out a request for further information around 

a variety of these issues. It is something that we continue to study 

very carefully. 

But I think it is a fair question that you need to identify a real 

benefit before you start to analyze the costs and benefits of these 

things. 

Obviously, there are certain aspects of the fiduciary standard 

which provide enhanced investor protection. But again, cost and 

choice are things that have to be balanced against that. 

Mrs. WAGNER. And I appreciate that. 

Following up on that 2011 study, Chair White, I know, told the 

committee in 2013 that she would do that request for information 

24 

to better inform the rulemaking. What were the results of that request for information? 

Mr. LUPARELLO. I think, to a certain extent, the level of information that flowed in was less than the staff thought it was going to 

be. 

And so, one of the questions we have is: If we are going to come 

up with recommendations, will there be a need for a new round of 

information-gathering? 

Mrs. WAGNER. And that was my understanding, that there really 

was not much feedback there. And I continue to be concerned 

about, again, this being a solution in search of a problem. 

Has any of the information helped inform your thoughts on 

how—thoughts on this potential rulemaking? And how that would 

be played out? 

Mr. LUPARELLO. Clearly, all input we get is important input. But 

it is all part of a multifaceted analysis that includes multiple divisions of the Commission. 

So, again, any input we can get is going to be helpful input. 

What the final recommendation is and how much that input is 

going to drive that is still something that is being— 

Mrs. WAGNER. I know that the SEC found in 2008 that investors 

were somewhat confused about whether they were dealing with 

broker-dealers or investment advisers. However, they did not identify any specific harm. 

Is the only solution to impose a fiduciary standard of care on 

broker-dealers or could any issues be fixed by, let’s say, amending 

existing FINRA rules? 

Mr. LUPARELLO. One of the questions is whether there are enhancements to existing rules for broker-dealers and—as well as 

recognition of some of the existing rules on broker-dealers that deal 

specifically with conflicts. That is always an option that I think has 

to be considered. 

Mrs. WAGNER. Good. 

One source of confusion for investors might be the variety of titles that brokers and investment advisors use. 

Would a simple way to fix the problem be to clarify which titles 

they can use, sir? 

Mr. LUPARELLO. I don’t know if that would entirely solve investor 

confusion. 

I can say that years ago, I was involved in a project where there 

were a variety of titles that were being used, especially around advice to senior citizens, that were, basically, fundamentally baseless. 

And so FINRA has in the past attempted, as well as other regulators, to crack down on the misleading use of titles. Whether you 

get to specificity around the words that can be used and that solves 

investor confusion is certainly worthy of additional consideration— 

Mrs. WAGNER. In my limited time, Chair White recently said the 

rulemaking was a high priority and she wanted to make a decision 

this year. So, she asked the staff for options. 

What other options have the staff suggested to the Commission? 

Mr. LUPARELLO. The development of those options is still in process, but I think you have touched on what the variety of choices 

could be. 

25 

Mrs. WAGNER. And will you be able to report back to us some of 

those options at some point in time, sir? 

Mr. LUPARELLO. I believe I need to report to my Chair, first. But, 

yes, absolutely. 

Mrs. WAGNER. Wonderful. Thank you. I appreciate it. 

I yield back, Mr. Chairman. 

Chairman GARRETT. The gentlelady yields back. 

Mr. Scott is now recognized. 

Mr. SCOTT. Thank you very much, Mr. Chairman. 

Mr. Luparello, when Securities and Exchange Commission Chair 

White appeared before our committee, I expressed some concerns 

about what is referred to as the lack of order competition and I 

asked her what her plans are to deal with market structure. 

And I want to make a note that I am somewhat encouraged by 

the recent announcements of the items that you intend to take action on before the end of the year. However, it appears that much 

of this is low-hanging fruit and does not directly address my concerns that I addressed to her about order competition. 

So let me ask you: What is your plan to address some of the bigger market structure issues such as the increased level of dark 

trading that even the SEC has recognized as having a negative impact on price discovery? 

Mr. LUPARELLO. I think your characterization of the Chair’s plan 

is fair and, frankly, what she would articulate as well, that there 

are a variety of initiatives that the staff is ready to move on quickly and that there are others that deserve, frankly, a little bit more 

study, a little bit more interaction— 

Mr. SCOTT. What would be some of those you want to move on 

quickly? 

Mr. LUPARELLO. The ones we would want to move on quickly are 

an anti-disruptive trading rule, the registration of all high-frequency traders as broker-dealers, the requirement that those that 

trade over the counter become FINRA members, enhanced disclosures on the business operations of ATSs and enhanced disclosures 

on the routing of institutional orders. 

The issue you touch on is an extraordinarily important one— 

right?—that there is an extraordinary amount of fragmentation in 

the marketplace these days, some of which leads to positive competition and lower costs, but some of it clearly can lead to degraded 

opportunities for lit quoting and for order interaction. 

That is a very important balance and one that we desire to get— 

Mr. SCOTT. But are you all assessing point by point the negative 

impacts on price discovery? 

Mr. LUPARELLO. Absolutely. So as we study NMS—and, again, I 

don’t want to refer to it as a long-term study—what—our next plan 

is to put out a series of White Papers, work very closely with a variety of participants, including our Market Structure Advisory 

Committee, once it is stood up and operational, to look at these 

issues. 

I tend to like to think of that one in the context of the tradethrough rule, that a lot of these things come with the fragmentation of those venues. 

And so we will look at—we are very much going to look at that. 

That is one of our most important longer-term issues. 

26 

Mr. SCOTT. Okay. Let me share very quickly, this is a rather 

startling observation. But today, only 63 percent of trades are conducted in what is referred to as lit markets, where we can see 

them. Now, that means 37 percent are in dark pools. It means that 

investors are not seeing the true depth of the liquidity behind the 

stocks. 

So while high-frequency traders will, what you refer to, ping the 

market by sending out a bid to see if there is a response from the 

dark pools, this is not possible for all investors. 

How does this affect an investor’s ability to even price a stock? 

And is this a significant advantage for some participants over others? 

Mr. LUPARELLO. It is certainly worthy of study. And I completely 

agree with the importance of those statistics. 

That said, it is probably worth noting that, of that 37 percent, 

a significant portion are actually retail investors getting good-quality executions very quickly done. That doesn’t at all touch on the 

issue of whether we have quote degradation that we need to worry 

about. 

But one of the things we need to do as we study is to make sure 

that some of the better features of the markets, including how retail investors experience both high-quality and rapid executions, 

doesn’t get degraded or, frankly, if it does get degraded, it is a decision we are making with our eyes wide open. 

So, yes, it is, I think, just sort of troubling on its face that such 

a large percentage of activity happens off of lit markets and there 

are more headwinds than there are encouragements to quote in lit 

markets. But, to a certain extent, that has come to the benefit of 

certain retail investor-type trades. 

It is a very complex issue, one that we plan on studying very 

carefully. 

Mr. SCOTT. Thank you very much. 

The lack of order competition is a very, very serious issue. 

Mr. LUPARELLO. I could not agree more. 

Mr. SCOTT. Thank you, Mr. Chairman. I yield back. 

Chairman GARRETT. Thank you. The gentleman yields back. 

The remaining gentleman on our side, Mr. Mulvaney, is now recognized. 

Mr. MULVANEY. Thank you, Mr. Chairman. 

Mr. Luparello, let’s talk a little bit about litigation and liability, 

which I used to know something about in a previous life. 

One of the things that Dodd-Frank did—I think it was Section 

921(a)—is give the SEC the ability, but not the obligation, to limit 

the use of arbitration in securities litigation. 

I used to do a little of that. I have been on the plaintiffs’ side 

of that, and I have been on the defendants’ side of that. And while 

it was certainly different than going through the court system—the 

ordinary court system, I have to tell you that I liked parts of it. 

It was a lot quicker. It was a lot easier. And for both sides, it was 

usually a lot cheaper. 

I recognize the fact, again, that it was different than going 

through ordinary litigation. There were certain tools that were not 

available to me, for example, as a plaintiffs’ lawyer, that would be 

27 

in the courts. But, conversely, it was a trade-off there of having it 

be easier, quicker, to do. 

So, I guess, now that you have this ability to limit—or to possibly 

limit the use of arbitration, I have to ask you: What’s wrong with 

arbitration? What is the SEC’s stance on arbitration within financial securities litigation? 

Mr. LUPARELLO. I can’t help but sort of flash back a little bit to 

my extended tenure at FINRA, where we ran the dispute resolution forum and worked very hard to make sure that it worked as 

efficiently as possible, but felt a certain need to defend the arbitration program as a viable alternative. 

Obviously, the statute provides the Commission the authority, 

but not the obligation, to act. As a general matter, in its oversight 

capacity, the Commission spends a substantial amount of time with 

FINRA making sure that forum is run as carefully and fairly and 

transparently as it possibly can be. 

Obviously, there have been a lot of enhancements made to that 

forum, I think very much to the benefit, over the past few years. 

The Commission hasn’t particularly—hasn’t taken a position on 

Section 921 at this point, to the best of my knowledge. And while 

I am relatively new and have had a variety of conversations with 

the Chair, that is one that I still haven’t had. 

Mr. MULVANEY. And just to clarify one thing—because I understand a little bit of the history of how it ended up in Dodd-Frank— 

is it the opinion of the SEC that arbitration contributed to the financial crisis? 

Mr. LUPARELLO. Not to my knowledge. 

Mr. MULVANEY. Okay. Thank you very much. 

Let’s talk about a different, but somewhat related, topic, which 

is the liability of exchanges. 

My understanding is that exchanges, when they perform their 

regulatory functions, have certain immunities from liability; when 

they perform their commercial functions, they don’t. 

I think this has become relevant in the last couple of weeks and 

months as NASDAQ has sought to assert its immunity vis-a-vis the 

Facebook IPO and that what we might be seeing, is an attempt by 

certain exchanges to sort of blur the lines, to make that which is 

commercial appear regulatory in order to avail oneself of immunity 

from liability. 

Has the SEC looked at this issue? I don’t think you have expressed any opinions on it yet. Do you expect to do so in the near 

future? 

Mr. LUPARELLO. SRO immunity is a creature of case law and, 

like any good litigator, one tries to expand that protection based on 

the facts. 

The SRO status of exchanges—and you described the issue perfectly—is the difference between the commercial and the regulatory, and it is certainly on our agenda to do. 

I think, when we think about the SRO status of exchanges, we 

are thinking about two different issues, one of which is the competitive playing field between exchanges and other venues that do 

things that look an awful lot like exchanges. 

But part of it is analyzing the SRO obligations and protections 

that go with being an SRO that the exchanges currently enjoy. 

28 

So that is an issue we are going to continue to look at. 

Specifically on the Facebook litigation, to my knowledge, I don’t 

know that we have been asked to opine and I don’t know that we— 

Mr. MULVANEY. I am not asking you to opine—I used that only 

as an example. 

So I guess my last question is this: Can we expect the SEC to 

provide some guidance in the near future and say, ‘‘This is regulatory and this is commercial?’’ 

Mr. LUPARELLO. Perhaps in the context of studying the SRO 

issue more broadly, which is one of our longer-term initiatives, that 

will be something that we opine on. 

At this point, I think giving specific guidance is probably not in 

the near—is not going to happen in the near future. 

Mr. MULVANEY. Thank you, Mr. Luparello. 

I yield back. 

Chairman GARRETT. Thank you. The gentleman yields back. 

Mr. Foster is recognized for 5 minutes. 

Mr. FOSTER. Thank you, Mr. Chairman. 

One example of the current system for not incentivizing maybe 

the best behavior is the proliferation of order types that are designed to capture rebates from the exchanges. Reg NMS put in 

place a uniform, one-size-fits-all, 30-mils fee cap for all stocks. 

And this rebate model has arguably increased liquidity for active 

named stocks, but some would say that it actually made those 

stocks more costly for institutional investors. It also has perhaps 

pushed transactions to off-exchange venues as investors try to 

avoid these fees. 

My question is: Is the Commission contemplating—or should it 

contemplate a pilot program to reduce the market fee access cap, 

perhaps alongside the tick-size pilot, particularly for very liquid 

stocks? And specifically, what would you think of tiered access fees 

based on the liquidity? 

Mr. LUPARELLO. I think those are all—first of all, I completely 

agree with the observations. 

Maker-taker in certain areas of the market is definitely tied inextricably to the growth of complex order types. In the short term, 

we have asked the exchanges to go back and do an inventory of 

their order types, make sure they understand how all their order 

types work and how those order types—whether or not those order 

types are consistent with how they were described to us in the first 

instance. 

We have given them a deadline of November to come back with 

that study, which, given the complexity in the growth and order 

types, is a challenge. 

Maker-taker and the issue of potential broker conflicts married, 

of course, to the fact that does, I think, pretty clearly drive a substantial amount of volume from on exchange to off exchange is 

something that we are going to consider. 

I don’t know at the end of the day that we will decide to go with 

a pilot, but I think certainly a pilot is one of the options. And, 

again, I think the way you articulated it that—and sort of consistent with our notion of one size not fitting all, clearly makertaker has a different impact at the more liquid end of the market 

than it does at the less liquid end of the market. 

29 

So, I can’t say we have reached any conclusions yet. There is a 

lot of work to do there. But I think the issues that you have articulated are ones that are both very much at top of the book for us, 

but also somewhat consistent with how we are thinking about it. 

Mr. FOSTER. Are there alternatives you are considering in addition to pilot programs? You could obviously just adopt something 

market-wide, but it seems like it mitigates the risk if it starts with 

a pilot program. 

Mr. LUPARELLO. It is certainly too early to tell in terms of our 

thinking. And so I will just cite what others have cited, which I 

think are worthy of further analysis. 

Obviously, a maker-taker pilot with trade at the most liquid end 

of the market. 

The other thing is looking at perhaps quoting in subpennies 

versus quoting in pennies, which would have a natural compression 

aspect on maker-taker, as well as just considering the consequences 

of banning it outright. 

I think these are all things that we are going to think about over 

the next few months. 

Mr. FOSTER. Are you thinking of changes to the attribution 

rules? 

Basically, it is my understanding that when a trade is made public, the venue is not made public in most or maybe all instances, 

whereas other countries, in fact, do it differently, where the venue 

is also made public. 

This may allow third parties or the participants themselves a 

better view of whether you are actually getting the best deals on 

which venues. 

Mr. LUPARELLO. I think that is especially true with dark pools. 

There still is a fair amount of opacity whether an over-the-counter 

trade was a dark pool trade versus just an internalized trade of a 

broker-dealer. 

FINRA has made some steps going forward on that to enhance 

transparency. So you now have a requirement that transactions 

that are reported by a broker-dealer that sponsors an ATS clarifies 

whether it is a broker-dealer or whether it is the ATS. That is an 

important first step. 

They are also publishing transaction volume information. It is an 

important next step. 

But one of the interesting things about the over-the-counter market is there is sort of an assumption that the 30-something percent 

that makes up the over-the-counter market is entirely dark pools. 

The reality is, it is only about a third in dark pools. 

And so, we are going to have conversations with FINRA to continue to try to develop greater transparency in that space, just how 

much of the over-the-counter activity is happening inside of ATSs 

versus happening broker-broker versus happening internalized. 

And I think one of the next steps off of that is looking at whether 

attribution of location, hitting the tape as opposed to just hitting 

the regulatory tape, is something worth pursuing. 

Mr. FOSTER. Okay. And, quickly—I guess I have about 15 seconds—do retail investors today have relatively simple tools to get 

some idea of whether their trades are being executed well or not? 

30 

They can see their fees actually, but what about the other part of 

it? 

Mr. LUPARELLO. The information is made available to them 

through existing Rules 605 and 606, which are Commission rules. 

Just how usable they are for retail investors is a very good question. 

Obviously, they also get disclosures through their confirms. I suspect most investors, if they are trading with their broker, have 

ready access to what is the inside market at the time and they can 

evaluate how well they are doing with the inside market. That 

clearly doesn’t tell the entirety of the story, but it does tell some 

of the story. 

We would also hope that broker-dealers in their responsibility to 

their customers both look out for their customers, but, also, communicate well the quality of those executions. Their ability on a 

trade-by-trade basis to say, ‘‘Is this broker versus this broker going 

to give me a better deal?’’ is a very complex analysis. 

Mr. FOSTER. Thank you. 

I yield back. 

Chairman GARRETT. Thank you. 

And now, for the last word. 

Mr. CARNEY. That must be me, Mr. Chairman. 

Chairman GARRETT. The gentleman is recognized. 

Mr. CARNEY. Thank you very much, Mr. Chairman. And thank 

you for having this hearing today. It is very interesting, if not a 

little bit complex and esoteric, for sure. 

I just have a few questions on some of the issues that I have 

been thinking about and working on over the past couple of years. 

Mr. Luparello, I appreciate you coming in today and having this 

conversation with us. 

You had some conversation a little bit about the tick-size pilot. 

I have been working with my colleague on the other side of the 

aisle, Mr. Duffy, for over a year on that, and we actually passed 

a bill out of this committee and on to the Floor as well. So, I was 

happy to see that the SEC is moving forward on that program. 

What do you expect to or hope to achieve out of the pilot and the 

framework that you have come up with? 

Mr. LUPARELLO. I, too, am happy that it is out the door. Obviously, there are a couple of procedural— 

Mr. CARNEY. By the way, I thought it was very well done. Not 

that I am an expert at all, but we were really just—our effort was 

to try to encourage the SEC to do something, and we were pleased 

with what you did. 

Mr. LUPARELLO. I appreciate that. 

And in the short term, the issues we want to study most carefully. So there will be a substantial amount of data that the SROs 

need to push to us to help in our analysis. 

But, fundamentally, what we want to see is whether there is 

more depth at the quotes based on the wider tick size, whether 

there is greater market-maker participation and, therefore, greater 

market-maker support. 

Obviously, at the same time, we want to see whether the wider 

tick size causes—certainly, in some cases, it may actually raise inVerDate Nov 24 2008 17:25 Dec 18, 2014 Jkt 091152 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 K:\DOCS\91152.TXT TERRI
31 

vestor costs, especially retail investor costs, a little bit. That is an 

issue we need to pay careful attention to and evaluate. 

I will say, while this is an important step forward and something 

that gives us a real vision into whether there are solutions for a 

segment of the market that work really well, I would like to think 

this is not the only thing we plan to do in the lower capitalization 

area. 

Mr. CARNEY. So talk about some of those other things that you 

think you would like to do. I think some of them were part of what 

you were just discussing. 

But what are some of those things? 

Mr. LUPARELLO. A little bit. 

But one of our longer—as I have talked about the Chair’s speech 

and the Chair’s vision on market structure, there are the shorterterm steps, which are our concrete actions to take, and there are 

longer-term things to think about. 

And in that longer term is just specifically the market structure 

for lower-cap, lower-volume stocks. And I think—one of the ideas 

that has been thrown around, one that has garnered a lot of conversation, is things like venture exchanges. 

And I think we are very open to the idea of competitive solutions. 

That is based—and we will continue to work with a variety of market participants. 

Mr. CARNEY. Sounds good. I am glad to hear that. I know my colleague on the other side of the aisle, Mr. Duffy, would be as well. 

Moving on to cross-border swaps, another kind of esoteric area, 

but an area on which I have worked with the Chair of this committee to try to get harmonization, we have taken a lot of heat 

from our approach. You came out with a rule just yesterday, I 

think. 

Could you talk about that? And in particular, your piece of the 

market is small, security-based swaps, I guess. What kind of coordination went into it with the CFTC? 

Mr. LUPARELLO. Careful coordination with both the CFTC and 

the other regulators. The vast majority of what we did yesterday 

is very consistent with the CFTC approach. 

There are clearly a couple of areas where we come up with a 

slightly different answer. Some of that is driven by our understanding of the workability of our markets. Some of it is driven by 

slight differences in the statute and potentially different authority 

questions. 

But literally all we did yesterday was clarify, given that the 

swaps market is fundamentally a cross-border market, some very 

substantial percentage of trades are between a U.S. person and a 

non-U.S. person—clarifying what transactions gave—would give 

rise to registration— 

Mr. CARNEY. Would you agree that the objective is to get harmonization of regulations across market venues around the world? 

Mr. LUPARELLO. Absolutely. And so, part of this is it is not just 

coordinating with the domestic regulators, but coordinating with 

the international regulators. 

Mr. CARNEY. What do you think is the biggest challenge there? 

What do we need to be concerned about? 

32 

There was some reporting about—and I know the ranking member has expressed some concern about non-guaranteed entities or 

something. 

Could you comment on that briefly? 

Mr. LUPARELLO. Yes. One of the big issues that we dealt with 

yesterday was the question of when you have a non-U.S. person 

that—you know, a subsidiary of a U.S. bank that is located in London, for example, and they do a transaction with another non-U.S. 

person. If that transaction is guaranteed by the U.S. bank. If there 

is an explicit recourse guarantee. 

It is really—the economic reality of that transaction is that the 

German hedge fund is actually doing business with the New York 

bank. So requiring that transaction to be counted for jurisdictional 

purposes made sense to us. 

When those guarantees become softer, there are some questions 

about whether we can reach what is essentially a transaction between one non-U.S. entity and another non-U.S. entity. 

And so part of this is—those are very difficult nuanced questions 

that do have the color of what our authority is over transactions 

that involve two non-U.S. persons, one of the difficult issues we try 

to navigate. 

Mr. CARNEY. My time is up. I would encourage you to keep working on that. It is, we believe, a very important issue. I work with 

the Chair on it and also encourage your cooperation and work with 

Department of Labor on fiduciary as well. 

Mr. LUPARELLO. I appreciate it. 

Mr. CARNEY. Thank you. 

Chairman GARRETT. I thank the gentleman. 

And I thank the Director. 

Before I let you go, Vice Chairman Hurt and I wrote a letter to 

Chair White several weeks back with regard to venture exchanges 

and the work that is being done there. 

Do you know when we will be receiving a response? Or do you 

want to just comment on that topic in general? 

Mr. LUPARELLO. I will find out when the response is coming. 

And, as I said, I think we are open to a variety of potential solutions and look to flexibility at different segments of the market. 

Conversations I have had with market participants and experts 

before I started at the Commission around venture exchanges create many sort of, I think, interesting opportunities. 

Chairman GARRETT. Opportunities. Yes. 

Mr. LUPARELLO. As is always the case, there are occasionally authority questions that go along with that, which need to be navigated. But we continue to think that this is an idea worthy of further conversation. 

Chairman GARRETT. Great. I appreciate your answer. 

That brings the hearing to a close. 

The Chair notes that some Members may have additional questions for this witness, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to this witness 

and to place his responses in the record. Also, without objection, 

Members will have 5 legislative days to submit extraneous materials to the Chair for inclusion in the record. 

33 

And with that, the hearing is adjourned. And thank you again. 

Mr. LUPARELLO. Thank you, Mr. Chairman. 

[Whereupon, at 10:52 a.m., the hearing was adjourned.] 

(35) 

A P P E N D I X 

June 26, 2014 

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