U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

91–299 PDF 2014

S. HRG. 113–477 

HIGH FREQUENCY TRADING’S IMPACT ON THE 

ECONOMY 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

SECURITIES, INSURANCE, AND INVESTMENT 

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED THIRTEENTH CONGRESS 

SECOND SESSION 

ON 

EXAMINING THE VALUE, BENEFITS, RISKS, BURDENS, AND CONCERNS 

HIGH FREQUENCY TRADING CREATES FOR THE ECONOMY AND THE 

MARKETPLACE 

JUNE 18, 2014 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.fdsys.gov/ 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

KAY HAGAN, North Carolina 

JOE MANCHIN III, West Virginia 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

MIKE CRAPO, Idaho 

RICHARD C. SHELBY, Alabama 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

TOM COBURN, Oklahoma 

DEAN HELLER, Nevada 

CHARLES YI, Staff Director 

GREGG RICHARD, Republican Staff Director 

DAWN RATLIFF, Chief Clerk 

TAYLOR REED, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT

MARK R. WARNER, Virginia, Chairman 

MIKE JOHANNS, Nebraska, Ranking Republican Member 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

JON TESTER, Montana 

KAY HAGAN, North Carolina 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

BOB CORKER, Tennessee 

RICHARD C. SHELBY, Alabama 

DAVID VITTER, Louisiana 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

TOM COBURN, Oklahoma 

MILAN DALAL, Subcommittee Staff Director 

BRYAN BLOM, Republican Subcommittee Staff Directorr 

(II)

C O N T E N T S 

WEDNESDAY, JUNE 18, 2014 

Page 

Opening statement of Chairman Warner .............................................................. 1 

Opening statements, comments, or prepared statements of: 

Senator Johanns ............................................................................................... 3 

WITNESSES 

Hal S. Scott, Nomura Professor and Director, Program on International Financial Systems, Harvard Law School ............................................................... 5 

Prepared statement .......................................................................................... 30 

Jeffrey M. Solomon, Chief Executive Officer, Cowen and Company, LLC, 

and Cochair, Equity Capital Formation Task Force ......................................... 7 

Prepared statement .......................................................................................... 36 

Andrew M. Brooks, Vice President and Head of U.S. Equity Trading, T. 

Rowe Price Associates, Inc. ................................................................................. 9 

Prepared statement .......................................................................................... 69 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Illustrations of miniflash crashes from May 13, 2014, submitted by Chairman 

Warner .................................................................................................................. 72 

Statement submitted by Greg Mills, Head of Global Equities Division, RBC 

Capital Markets ................................................................................................... 75 

(III)

(1) 

HIGH FREQUENCY TRADING’S IMPACT ON 

THE ECONOMY 

WEDNESDAY, JUNE 18, 2014 

U.S. SENATE, SUBCOMMITTEE ON SECURITIES, INSURANCE, AND

INVESTMENT, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Subcommittee met at 10:01 a.m., in room 538, Dirksen Senate Office Building, Hon. Mark R. Warner, Chairman of the Subcommittee, presiding. 

OPENING STATEMENT OF CHAIRMAN MARK R. WARNER 

Chairman WARNER. This hearing will come to order. 

I want to thank Senator Johanns’ staff for working with our office today in putting together today’s hearings. I want to thank our 

witnesses, who I will come to introduce in a couple of moments. 

I do feel, as I was mentioning a little bit yesterday, this is not 

the first hearing or even the first hearing this week on this subject. 

We perhaps were front-run a little bit yesterday by Senator Levin’s 

activities, but we think we can build upon his good work as the 

Senate takes a look at this very important issue. 

Yesterday, Senator Levin’s hearing really focused on potential 

conflicts of interest between brokers and investors. Our hope will 

be that this hearing will take a larger, macro view of the effects 

of high frequency trading on the economy and the marketplace. 

Over the past few decades, we have seen remarkable technological progress and innovation in our securities markets coupled 

with substantial regulatory reform. Now, some of these advances 

and reforms, including decimalization, have brought considerable 

rewards for individual investors by narrowing spreads and increasing liquidity. Most trades today can happen within fractions of a 

second, providing good prices and counterparties for those seeking 

to buy equities around the world. 

But, at the same time, we have seen increased volatility and 

periodic dislocation. I think we all remember the flash crash a 

while back, but perhaps what did not get as much attention is that 

this—that was not the only incident. Just last month, on May 13, 

we had a series of mini flash crashes in a series of individual 

stocks. Such events do little to engender confidence and, indeed, 

may hinder investment in the stock market, adversely affecting the 

broader economy, particularly as it affects small cap stocks. 

Gains in liquidity, I know, for most folks on the street are seen 

as the holy grail, but we have to ask ourselves at some point, at 

2 

what price this increased liquidity, and does sometimes simply 

progress and technological innovation bear other costs that need to 

be examined? 

Some critics of current U.S. market structure place the blame on 

high frequency trading. For purposes of today’s hearing, we are 

going to define high frequency trading to include computerized algorithmic trading of a number of varieties to essentially address 

when a computer is making a decision based on a program as opposed to a human. 

In recent months, I know there has been a lot of renewed attention on this subject given to the publication of Michael Lewis’s 

book, Flash Boys. And, I know many of my colleagues and I have 

growing concerns with what is happening in our markets that is 

leading to this erosion of confidence. 

There are a few reforms that I would like to see the SEC implement to help strengthen confidence in the economy. First, and I 

think Senator Johanns will speak to this, as well, conducting a tick 

size pilot. As a former venture capitalist, I have concerns over 

front-running that impairs the ability of small companies to find 

adequate liquidity for their shares in the marketplace. This activity 

can adversely affect underwriting decisions or even the choice to go 

public, which obviously harms capital formation in its beginning. 

Chairman White recently announced that the Commission is trying to finalize details of a potential pilot. I believe it should be for 

an adequate length of time, preferably more than a year, to capture 

enough data. It should also cover all of the trading venues, lit and 

dark, to ensure collection of accurate data. 

Second, the SEC must expedite the implementation of a consolidated audit trail. Way back in May of 2010, a day after the infamous flash crash, then-Senator Ted Kaufman took to the floor. He 

talked about that challenge, and he and I both went to then-Senator Chris Dodd, who was Chair of this Committee, to require the 

SEC to report to Congress on the need for a consolidated audit 

trail, better order screening, and the risk posed by high frequency 

trading. 

Unfortunately, more than 4 years later, we have seen little 

progress on our request, especially on the issue of the consolidated 

audit trail. The SEC has issued two extensions to the SROs and 

FINRA, delaying a proposal until September 30 of this year at the 

earliest. However, having this in place will help regulators decipher 

what is happening in the market, so we need to implement this 

ASAP, and I hope the SEC is listening. 

Chairman White recently posed some reforms to enhance transparency in the market, and I thank her for moving on that, and 

it is clear that the SEC and the CFDC have a monumental task 

in policing our markets and they need full funding. I will continue 

to advocate for that as long as I am in this position. 

Again, I look forward to hearing from our witnesses. I am going 

to move to Senator Johanns for his statement, and then, with the 

willingness of my colleagues, go ahead and introduce the panel and 

get to the testimony. 

Senator Johanns. 

3 

STATEMENT OF SENATOR MIKE JOHANNS 

Senator JOHANNS. Mr. Chairman, let me start out and say to the 

witnesses, thanks for being here. We appreciate it. I look forward 

to this hearing. 

I also want to thank the Chairman for holding this hearing on 

high frequency trading. No doubt about it, it is getting attention 

these days, if not a lot of noise. 

One thing that I probably need to be reminded about, as I think 

about my last months in the U.S. Senate, is if I have the capacity 

to write a book and get on ‘‘60 Minutes’’, I will probably get a lot 

of Congressional attention and I will be back here, sitting where 

you are sitting. 

[Laughter.] 

Senator JOHANNS. Maybe I can even convince Mr. Lewis to write 

a book about the need for housing finance reform or the overreach 

of EPA regulations. Both of those need attention. 

Now, the spotlight is shining brighter. We all acknowledge that. 

The issue of high frequency trading, though, is not a new concept. 

So, as I said, I look forward to the witnesses talking about the 

impact of high frequency trading on our economy, asking and answering questions, does the practice help or does it hurt investors? 

Now, it does seem to me that retail investors really have never 

had it better. Costs are low. There seems to be ample competition. 

Market access is very easy these days. I definitely do not think the 

markets are rigged, as some have suggested. 

However, I also believe that we cannot simply ignore certain 

market structure issues. We should always be encouraging liquidity. After all, why have a market if liquidity is not a part of it? We 

should be encouraging fairness. We should be encouraging transparency in the marketplace. We need to ensure that the U.S. remains the envy of the world when it comes to capital markets. I 

would just put out there, I do not think anyone does it better. 

I also want to associate myself with comments made by Chairman Mary Jo White, who I have a lot of confidence in. She recently, in a public speech, said this, and I am quoting, ‘‘We should 

not roll back the technology clock or prohibit algorithmic trading, 

but should assess the extent to which computer-driven trading may 

be working against investors rather than for them.’’ There is a lot 

said in that quote. 

America has always encouraged innovation. We want fastest. We 

want strongest. We want most powerful. I can relate to this. Growing up on a dairy farm in Northern Iowa in the 1950s and then 

becoming Secretary of Agriculture, I have seen a lot of change in 

that arena. The equipment and technology now is so much faster. 

It is so much smarter. The combines are so far advanced over what 

we were doing. It is unbelievable, what has happened in that 

arena. Who benefits from that? The consumer benefits from that, 

because they have a supply of food that is just unparalleled in the 

world and pay less of their disposable income. Technology is a good 

thing. Our financial trading systems have, obviously, gone through 

a remarkable, if not similar, evolution. 

I think everyone here today is concerned with investor confidence. So, from the witnesses today, I would like to hear how 

4 

small investors and small companies are affected in today’s trading 

world. How do they fare? 

As I said earlier, it seems that technology developments over the 

last several years have benefited retail investors by making the equity markets more accessible and affordable for the moms and the 

pops in Nebraska. But, investors are also, understandably, concerned when news stories suggest that the deck is somehow 

stacked, that the stock market has become an insider’s game, that 

it cannot be trusted. So, I hope that we can talk about these real 

or perceived problems today. 

Also, I am concerned with investor confidence in the small cap 

company space. The goal for every stock is liquidity. Can you market that stock? While the market seems to work fine for a large, 

if not blue chip, stock, the smaller public companies have not fared 

as well. 

I know there has been discussion about widening tick sizes for 

smaller emerging growth companies. There was legislation on the 

House side that directs the SEC to issue a pilot program to test 

whether wider trading increments will promote more active trading 

and boost liquidity for smaller companies. Interestingly enough, 

this House bill passed 412 to four. I do believe that is part of what 

spurred the SEC to act. A House vote of 412 to four on a complex 

piece of legislation is almost unheard of, a remarkable result. 

So, I would like to get the panel’s thoughts on the pilot program 

and also hear about any other special market structure reform 

ideas that will benefit the small investor, the Main Street companies, those folks who are trying to find their place in this market. 

Mr. Chairman, a great hearing today. I compliment you for calling it. Some very, very important issues that can have significant 

economic consequences to our States and to our country. Thank you 

very much. 

Chairman WARNER. Thank you, Senator Johanns. 

We have been joined by Senator Reed, who was longtime Chair 

of this Subcommittee, and Senator Warren, who brings, obviously, 

a wealth of knowledge to this subject. And, with their discretion, 

I am going to go ahead and introduce the witnesses and we can get 

started. 

First, Mr. Hal Scott is the Nomura Professor at Harvard Law 

School, where he has taught since 1975, and Director ofthe Committee on Capital Markets Regulation. Professor Scott teaches 

courses on capital market regulation, international finance and securities regulation. He is currently Director of Lazard and a member of the Bretton Woods Committee and a past Governor of the 

American Stock Exchange. It is my understanding, as well, is he 

taught Senator Reed—— 

Senator REED. He did, without any effect. 

[Laughter.] 

Chairman WARNER. ——and has worked with, obviously, a colleague of Senator Warren’s. When I was there, I did not have a 

chance to take one of his courses, but I look forward to his testimony. 

Mr. Jeffrey Solomon is Chief Executive Officer of Cowen and 

Company and a Director of the Cowen Group. Mr. Solomon is responsible for overseeing all of Cowen and Company’s business, inVerDate Nov 24 2008 11:30 Dec 19, 2014 Jkt 046629 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 L:\HEARINGS 2014\06-18 HIGH FREQUENCY TRADING S IMPACT ON THE ECONOMY\H
5 

cluding investment banking, capital market sales, and trading and 

research. Mr. Solomon is also amember of the Committee on Capital Markets Regulation as well as the Cochair of the Equity Capital Formation Task Force, a group of professionals from across 

America’s start-up and small cap company ecosystems. Thank you 

and welcome, Mr. Solomon. 

And, Mr. Andrew Brooks is Vice President of T. Rowe Price, 

where he is head of U.S. Equity Trading. He joined the firm in 

1980 as an equity trader and assumed his current role in 1992. Mr. 

Brooks is currently a member of the Investment Company Institute 

Equity Markets Advisory Committee—that is a mouthful—and is 

on the board of the National Organization of Investment Professionals. Welcome, Mr. Brooks. 

So, we will get to the testimony. Professor Scott. 

STATEMENT OF HAL S. SCOTT, NOMURA PROFESSOR AND DIRECTOR, PROGRAM ON INTERNATIONAL FINANCIAL SYSTEMS, HARVARD LAW SCHOOL 

Mr. SCOTT. Thank you, Chairman Warner, Ranking Member 

Johanns, and Members of the Subcommittee, for permitting me to 

testify before you today on the impact of high frequency trading on 

investor confidence and capital formation in U.S. equity markets. 

I am testifying in my own capacity and do not purport to represent 

the view of any organizations with which I am affiliated. 

High frequency trading, or HFT, is a topic that has generated 

significant attention in recent years, intensifying more recently 

with the publication of Michael Lewis’s book, Flash Boys. It is my 

intention to provide a thoughtful response to a debate that has 

sometimes been fraught with frenzied emotion. 

Let me be clear at the outset. The emergence of high frequency 

trading activity in and of itself has not negatively affected our secondary markets. Our secondary markets remain strong, with 

roughly 50 percent of global exchange trading occurring on U.S. exchanges. With roughly half of this volume generated by HFT firms, 

the increased liquidity provided by HFTs lead to decreased costs of 

stock issuance, thus improving capital formation. And, of course, 

improved capital formation for our businesses leads to higher 

growth in the real economy. 

Transaction costs for retail and institutional investors have also 

been in continual decline over the past 10 years, as evidenced by 

current bid-ask spreads, and have fallen by 50 percent since 2006 

and brokerage commissions that are at historic lows. Retail investors can now trade for less than $10 a trade. 

Since many retail investors access the equity markets indirectly 

through institutional funds or advisors, like mutual funds, institutional costs are highly relevant to retail investors, as well. Leading 

financial economists find that the average transaction costs for institutional orders are also at an all-time low. 

Investor confidence in our markets also remains strong. Since the 2010 Flash Crash, there has been a net inflow of more than $50 

billion in holdings of U.S.-listed companies and a total net inflow 

of nearly $500 billion in all exchange-traded products. Clearly, investors are not fleeing from our equity markets due to perceived 

threats of high frequency trading. 

6 

Moreover, experts have found that high frequency trading has 

not caused an increase in stock market volatility, although I think 

we will go around a little bit on that. And, the SEC has also largely 

addressed future Flash Crash concerns by implementing single 

stock circuit breakers and revising marketwide circuit breakers 

that will temporarily halt trading if price movements become too 

volatile. 

Critics of HFT have questioned the fairness of allowing certain 

traders to benefit from their physical proximity to an exchange, 

known as colocation, and have access to faster data feeds. However, 

the SEC requires exchanges to offer such access to all market participants at the same cost, and remember, a large number of retail 

investors trade through these institutions who have such access. 

Over 90 percent of market participants have access to such services, including retail investors indirectly. 

Thus, it is hard to argue that the U.S. equity market is broken 

as a result of the emergence of high frequency trading. Nonetheless, there is always room for targeted improvement of the current 

regulatory structure, and I would now like to present a few specific 

proposals. 

First, regulators should consider mandating and harmonizing exchange-level so-called kill switched. A kill switch is a mechanism 

that would halt a particular firm’s trading activity when a 

preestablished exposure threshold has been breached, thus stopping erroneous orders and preventing any further uncontrolled accumulation of positions. This would act against a single firm. 

Second, they might consider addressing the volume of order message traffic generally, which can create market instability, by establishing order-to-trade ratios, and regulators should consider 

charging fees for extreme message traffic in particular circumstances. 

Third, regulators should consider abolishing immunity that exchanges have from liabilities for losses from market disruptions 

based on their SRO status, which might better align the exchanges’ 

incentives to limit potentially risky trading that could pose widespread operational risk. 

And, I also endorse the idea, and I think it is quite important, 

of a much better audit trail, the CAT effort that the SEC is underway with, and I agree with Senator Warner that they should act 

sooner rather than later on that, because knowing what happens 

is the key to all of our understanding, and that audit trail will help 

give us knowledge that we currently do not have about how trading 

is actually being conducted. 

In concluding my remarks, I wish to reiterate that the strength 

of U.S. equity markets has positively affected capital formation, 

and by extension, promoted job creation. Any changes in HFT regulation should be based on a factually careful assessment of abuses 

and regulation to fix them without harming the overall performance of our markets. 

Thank you, and I look forward to your questions. 

Chairman WARNER. Thank you, Professor Scott. 

Mr. Solomon. 

7 

STATEMENT OF JEFFREY M. SOLOMON, CHIEF EXECUTIVE OFFICER, COWEN AND COMPANY, LLC, AND COCHAIR, EQUITY 

CAPITAL FORMATION TASK FORCE 

Mr. SOLOMON. Good morning, Chairman Warner, Ranking Member Johanns, and the Members of the Subcommittee. Thank you for 

inviting me to speak today regarding high frequency trading’s impact on the economy. 

My name is Jeffrey Solomon and I am the Chief Executive Officer at Cowen and Company, an emerging growth investment bank 

focused on servicing growth-oriented companies in key sectors of 

our economy. Along with Scott Cooper, the Chief Operating Officer 

of Andreessen Horowitz, I am also the Cochair of the Equity Capital Formation Task Force. And, interestingly, I have spent most of 

my career as an institutional investor in equities, so I understand 

this issue from many sides. 

Over the past year, there has been significant debate about the 

economic impact of HFT, high frequency trading, on the equity capital markets in the United States and how the rise in their trading 

activity has introduced increased market risk and volatility. We 

would argue that the debate surrounding HFT is actually symptomatic of a more complex market structure that encourages potentially counterproductive trading behavior, behavior that limits true 

market depth and trading volume in many stocks and hinders investors’ ability to buy and sell those stocks in small cap companies, 

in particular. 

This has resulted in reduced availability of capital for small public companies to expand their businesses and create valuable private sector jobs. As such, any debate about the pros and cons of 

HFT really needs to address the structure of the equity market 

that has given rise to its existence. 

The rise in electronic trading and the regulations that followed 

resulted in new market structure for equities that was intended to 

benefit investors, and today, our market’s structure is marked by 

speed of execution, lower transaction costs, and sub-penny increments, a dynamic which works well enough in highly liquid large 

cap stocks, but fosters opacity and liquidity in small cap stocks. For 

investors in small cap stocks, true price discovery is far more important than speed of execution. 

As a result, it has become more costly and difficult for institutional investors, who are the primary providers of growth capital 

to emerging companies, to invest, trade, and make markets in 

small caps. Companies with market caps of $750 million and below 

represent only 2 percent of the daily trading volume in the United 

States, and, on average, are only 30 percent held by institutions. 

Without meaningful institutional ownership, capital formation for 

small companies has declined to levels well below historic levels 

and has impeded price appreciation for many individual investors, 

as well. 

While the JOBS Act had made it easier for emerging growth 

companies to go public—the number of IPOs has increased since its 

passage—little has been done to improve the quality of secondary 

market trading in small stocks. And, to address these concerns, the 

Equity Capital Formation Task Force presented its findings and 

8 

recommendations to the United States Treasury in a report which 

sets out two areas for consideration. 

One is to encourage increased liquidity in small cap stocks by 

fostering a simpler, more orderly market structure for small cap 

stocks, and to expand capital for small cap and micro cap companies by completing regulatory changes outlined in the JOBS Act in 

accordance with Reg A Plus. These recommendations are designed 

to enhance capital formation for small companies while balancing 

the needs of investor protection and preserving many of the important improvements made to market structure that investors have 

enjoyed since the advent of decimalization. 

In order to improve market structure, we have recommended 

that the SEC implement a well designed pilot program that allows 

for a true empirical test on the effects of both wider spreads and 

limited trading increments in small caps, which we believe will encourage fundamental buyers and sellers to meaningfully engage 

with each other. By designing a pilot that requires all market participants to cluster their bids and offers at fewer discrete increments, and by limiting the ability of certain market participants to, 

quote-unquote, ‘‘price improve’’ in sub-penny increments, we will be 

able to observe whether or not the volume and depth necessary to 

enhance liquidity in small caps will improve. Improved trading liquidity begets cheaper and more efficient access to capital for these 

companies, and improved access to capital translates into increased 

job creation in the private sector. 

One of the most important aspects of designing a successful pilot 

program is ensuring that such a pilot program is allowed to operate 

for a long enough period for time to gather meaningful data around 

whether or not the changes to the market structure are having desired effects. We strongly believe that market participants, especially those that use algorithms and trade frequently, will need 

time to adjust their trading practices and/or business models in 

order to adopt to the new market structure. However, just as they 

adopted to decimalization and other market structure changes over 

the past 15 years, we are confident that they will adapt to these 

proposed market changes in the small cap market, as well. 

It appears as if the SEC, under the leadership of Chairwoman 

White, has made a strong commitment to enhancing overall liquidity of the capital markets in general and for small companies, more 

importantly. The Task Force supports the data-driven results oriented approach that the Commission has espoused publicly over 

the last 9 months. Our members continue to advocate that a onesize-fits-all market structure does not meet the needs of any market participants. 

We praise Congress on the passage of the JOBS Act, which demonstrated that a well-drafted legislation and regulation can meet 

the dual needs of fostering increased formation for capital while 

maintaining investor protection. Now is the time to create momentum, or to capitalize on the momentum created by the JOBS Act 

to take additional steps to further the growth of America’s most 

promising private and public growth companies. We owe it to those 

Americans seeking jobs and those companies creating those jobs to 

try and adjust a small part of the market structure in order to improve access to capital. 

9 

I thank you for this time and I welcome your questions and dialogue. 

Chairman WARNER. Thank you, Mr. Solomon. 

Mr. Brooks. 

STATEMENT OF ANDREW M. BROOKS, VICE PRESIDENT AND 

HEAD OF U.S. EQUITY TRADING, T. ROWE PRICE ASSOCIATES, INC. 

Mr. BROOKS. Good morning. Chairman Warner, Ranking Member 

Johanns, and distinguished Members of the Senate Subcommittee 

on Securities, Insurance, and Investment, thank you for the opportunity to testify today on behalf of T. Rowe Price regarding the impact of high frequency trading on the economy. 

My name is Andy Brooks. I am a Vice President and Head of 

U.S. Equity Trading at T. Rowe Price. This is my 34th year on the 

trading desk at T. Rowe Price. T. Rowe Price was founded in 1937 

and is a Baltimore-based advisor, serving more than 10 million individual and institutional investor accounts. 

Since I last testified before this Committee in September of 2012, 

we have seen considerable turnover in Congress, this Committee, 

and at the U.S. Securities and Exchange Commission. However, 

there has been little change in addressing the issues discussed 21 

months ago, although we do applaud the SEC’s efforts in implementing limit up, limit down controls and developing the consolidated audit trail. Additionally, we are encouraged by Chair Mary 

Jo White’s recent comments suggesting a heightened focus on improving market structure. And, we appreciate this Committee’s 

continued interest in improving our markets. 

However, order routing practices, payment for order flow, maker/ 

taker pricing, market data arbitrage, and the myopic quest for 

speed are all issues that remain unaddressed. In addition, we have 

grown increasingly concerned about the growth of dark pools and 

the challenges of the direct fast feed operating alongside the slow 

security information processor feed. 

Although this hearing is focused on HFT, we believe HFT is 

merely symptomatic of larger market structure problems. We are 

cautious not to lump all electronic trading into the class of HFT, 

and, further, we do not believe that all HFT is detrimental to the 

market. We are supportive of genuine market making. However, 

we acknowledge there are predatory strategies in the marketplace 

that have been enabled by our overly complex and fragmented 

trading markets. Those parties utilizing such strategies are exploiting market structure issues to their benefit and to the overall market’s and individual investors’ detriment. 

We question whether the functional roles of an exchange and a 

broker-dealer have become blurred over the years, creating inherent conflicts of interest that may warrant regulatory action. It 

seems clear that since the exchanges have migrated to for-profit 

models, a conflict has arisen between the pursuit of volume and resulting revenue and the obligation to assure an orderly marketplace for all investors. The fact that 11 exchanges and over 50 dark 

pools operate on a given day seems to create a model that is susceptible to manipulative practices. 

10 

If a market participant’s sole function is to interposition themselves between buyers and sellers, we question the value of such 

a role and believe it puts an unneeded strain on the system. It begs 

the question as to whether investors were better served when the 

exchanges functioned more akin to a public utility. Should exchanges with de minimis market share enjoy the regulatory protection that is offered by their status as exchanges or should they be 

ignored? 

Additionally, innovations in technology and competition, including HFT, have increased market complexity and fragmentation and 

have diluted an investor’s ability to gauge best execution. For example, in the race to increase market share, exchanges in alternative trading venues continue to offer various order types to compete for investor order flow. Many of these types facilitate strategies that can benefit certain market participants at the expense of 

long-term investors, and while seemingly appropriate, often, such 

order types are used in connection with predatory trading strategies. We are supportive of incremental efforts, such as recent initiatives by the New York Stock Exchange to eliminate 12 order types 

from their offerings. 

We also believe that increased intraday volatility over the past 

year is just symptomatic of an overly complex market. Though commission rates and spreads have been reduced, volatility continues 

to be alarmingly high. It was refreshing to see a recent report from 

RBC Capital Markets examining the impact of intraday volatility 

and exposing the high cost to investors. Most academics only look 

at close to close market volatility. 

Increased market complexity results in a lack of investor confidence. A recent Gallup Poll noted that American household ownership of stocks continues to trend well below historic norms. One 

can never be sure what drives investor behavior, but it seems clear 

to us that we need to do a better job of earning investors’ confidence in our markets. Those investors who have stayed on the 

sidelines in recent years, for whatever reason, have missed out on 

significant equity returns. We worry that the erosion of investor 

confidence can undermine our capital markets, which are so important to the economy, job growth, and global competitiveness. 

Over the past two decades, the markets have benefited from innovations in technology and competition. Generally, markets open 

at 9:30, they close at 4, and trades settle efficiently and seamlessly. 

Vibrant and robust markets function best when there are varied 

investment opinions, styles, and approaches. However, given the 

myriad of ways to engage in the markets, we feel that investors 

would benefit from an increased focus on market structure, particularly features that enable predatory and manipulative practices. 

Disruptive HFT strategies are akin to a tax loophole that has been 

exploited and needs to be closed. Market participants utilizing such 

strategies are essentially making a riskless bet on the market, like 

a gambler who places a bet on a race that has already been won 

and for which he knows the outcome. 

In the spirit of advancing the interests of all investors, we might 

make the following suggestions. We envision a pilot program where 

all payments for order flow, maker/taker fees, and other inducements for order flow routing are eliminated. We also envision a 

11 

pilot that incorporates wider minimum spreads and some version 

of a ‘‘trade at’’ rule, which we believe would lead to genuine price 

improvement. These programs should include a spectrum of stocks 

across market caps, average trading volumes, among other factors. 

Additionally, we would advocate for a pilot program that would 

mandate minimum trade sizes for dark pools. Dark pools were 

originally constructed to encourage larger trading interests, and it 

seems perverse that many venues on the lit markets, or exchanges, 

have a larger average trade size than dark pools. 

HFT and market structure issues were recently brought into the 

public spotlight by Michael Lewis and his book, Flash Boys. Sometimes, it takes a storyteller like Mr. Lewis to bring attention needed to an issue, and we hope that all parties involved will come together and seize this opportunity to improve our markets. Again, 

we would advocate for pilot programs to test and ultimately implement measured, yet significant, changes. 

On behalf of T. Rowe Price, our clients, and shareholders, I want 

to thank the Committee for this opportunity to share our views on 

how we can together make our markets as good as they can be. 

Chairman WARNER. Thank you, gentlemen. Very good testimony. 

I am going to ask you to put 5 minutes on the clock for each of 

us. I will try to be brief. I would ask you to be fairly brief in your 

responses, so I am going to try to get as many questions as I can 

in my time. 

I have a particular bias, as a former venture capitalist, on the 

notion of small cap stocks, and would point out to my colleagues 

that data by the Kauffman Foundation has pointed out that literally, I think, 80 percent of all net new jobs that have been created in the last 30 years in America have come from startup enterprises. So, how we accelerate that is, I think, a policy focus that 

we would all share. 

Professor Scott and Mr. Brooks, do you share Mr. Solomon’s belief that there should be some level of differentiation between small 

cap and larger caps and pilots like the tick size pilot moving forward? Other suggestions? Professor Scott. 

Mr. SCOTT. Well, I am a member of Jeff’s Task Force and I do 

agree with—— 

Chairman WARNER. Press your microphone button. 

Mr. SCOTT. I am a member of Jeff’s Task Force and endorse the 

recommendations for a pilot study on increasing the tick size for 

small caps. I think the result will be to show that with more trading and more liquidity, you know, we will encourage small caps. 

But, I think it is important to do a pilot study. There is a lot of 

controversy around this question as to whether increasing the tick 

size will really increase trading and we need to find out. So, I am 

certainly in favor of the pilot program. 

Chairman WARNER. Do you believe that the basic premise that 

HFTs potentially could disadvantage small cap stocks at this point? 

Do you think—I guess, obviously, you are on that Committee, but 

I took that as—— 

Mr. SCOTT. I am not sure I see a connection between HFT per 

se and disadvantaging small caps. I think what we need to do is 

increase the tick size and see what results, even with high frequency traders as they might adjust to trading in such an environVerDate Nov 24 2008 11:30 Dec 19, 2014 Jkt 046629 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 L:\HEARINGS 2014\06-18 HIGH FREQUENCY TRADING S IMPACT ON THE ECONOMY\H
12 

ment. Maybe they will trade less, OK, with a bigger tick differential. But, that will be their adjustment to an increased tick size. 

Chairman WARNER. Mr. Brooks, and then we will let Mr. Solomon have a—— 

Mr. BROOKS. Senator, my sense is that this pilot program is way 

overdue. We have been talking about it for a long time. I think 

there is vigorous debate about whether—what will happen as an 

outcome, and I think it is time to try. You know, we are very interested in increasing displayed liquidity, especially in small cap 

stocks, and I think a larger tick size, the cost—the barrier to entry 

for someone who is trying to interposition themselves there will 

grow and perhaps they will be discouraged from playing in that 

sandbox. Greater displayed liquidity, I think, would be good for investors and would attract, perhaps, more interest, investor interest 

in those names. 

You know, at the heart of the issue is trying to figure out a 

mechanism to allow someone to tell the story of small companies, 

to promote small stocks, promote in a good way, to tell the story 

about the growth and the potential. We have removed so many incentives for brokers and others, financial advisors, to tell the story 

of a stock that it has made it hard for people to figure out why they 

should care about small companies. 

Mr. SOLOMON. Listen, we have written extensively about it and 

I totally agree. I think one thing, to augment what Professor Scott 

said, is it is not just wider spreads. It is wider spreads and limited 

trading increments, and this is really important. There are a lot of 

small cap stocks that trade at wider than a penny. What we have 

talked about here is having a minimum bid and offer. 

So, when a stock trades wide and all of a sudden there is interest 

or displayed liquidity, all of a sudden, it rushes to a penny, and 

that precludes institutional investors like Andy, who make up a 

significant portion of the net worth of American households invested in stocks. They cannot get access to the small companies 

that exhibit the best growth, because by the time he shows up to 

buy a meaningful stake, it is reduced to a penny and they are just 

waiting for him to sit there and indicate size so they can pick him 

off. 

And, so, what we have said is, if you forced people to cluster at 

bids and offers, fewer of them, at five-cent increments, there are 

only 20 places where you can cluster in between each dollar. And, 

you limit the trading at the bid, at the offer, or one price in the 

middle. That should be ample for any fundamental buyer and seller 

to do price discovery and it limits this game or casino type behavior 

we have seen with sub-penny price improvement. 

Chairman WARNER. Let me get one last question in, and I am 

going to take as a quick nod, yes, that we ought to move forward 

and keep the pressure on the SEC to move on their consolidated 

audit trail efforts. 

Mr. SOLOMON. Yes. 

Mr. BROOKS. Yes. 

Chairman WARNER. Let me try to get Mr. Solomon and Professor 

Scott’s comments. Mr. Brooks has got a fairly aggressive outline of 

reforms, including, for example, the pilot of getting rid of some of 

the, what appears to be inherent conflicts on the maker/taker cirVerDate Nov 24 2008 11:30 Dec 19, 2014 Jkt 046629 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 L:\HEARINGS 2014\06-18 HIGH FREQUENCY TRADING S IMPACT ON THE ECONOMY\H
13 

cumstances that we all discussed. You have got some general 

agreement. Would each of you go as far as Mr. Brooks has gone, 

Professor Scott and then Mr. Solomon. 

Mr. SOLOMON. Go ahead. You are up. 

Mr. SCOTT. He wants to defer to me. I am not—I do not think 

so. I am not ready for pilot studies yet on these issues. I think the 

first step is that we should get the SEC study done and see what 

they come up with on these issues, and we should hope that they 

act expeditiously. I might say in their defense that they have had 

a lot on their plate for the last several years and they have gotten 

around a market structure now and I think they are going full bore 

on it. So, I think we need to get a lot more information about the 

problems, focus in on what the abuses are. 

I also think we have to be careful about pilot studies. While I endorse Jeff’s pilot study, we can confuse the market a lot with a lot 

of pilot studies going on at the same time, where different stocks 

trade in different ways. And, so, we have to be very careful, it 

seems to me, about—and, then, when you design a pilot study, you 

have to have a control. So, some people are not going to be trading 

under the pilot. Other people will. We do not know exactly how the 

SEC will devise their pilot, but if you do not have that, then you 

do not have a controlled experiment. So, it—and it all depends on 

how you design this pilot, OK. 

So, I am not ready for pilots on this issue. I think on tick size, 

we have had a lot of discussion over several years. A lot of work 

has been done on it. SEC has studied it intensively, and I think 

we are ready for a pilot. I do not think we are ready for pilots on 

these other issues. 

Mr. SOLOMON. So, I think we designed our proposals here to engage in—within the context of the existing maker/taker regime. So, 

we have said that this only is 2 percent of the daily average trading volume, so the people that are making a fair amount of money 

trading large volumes should not be impacted by a small cap stock 

because it is not a significant portion of their revenue. 

On the issue of maker/taker, it is not—if you were setting up a 

market structure from scratch, I think we can acknowledge that it 

is not the most ideal economic way to incent behavior. But, it is 

what it is, in part because we got here through regulation. And, if 

we are going to undo maker/taker, we had better have a pretty 

good idea of how we are going to incent buyers and sellers to meet 

and how that is going to occur before we pull that plug or we will 

see a material drop in liquidity, simply because people will have to 

adjust their business models. 

Chairman WARNER. I would simply say, I concur with Professor 

Scott, the SEC has got a lot on their plate, one of the reasons why 

I support full funding, but we also have to see the kind of—we 

need to see the action from them. 

Senator Johanns. 

Senator JOHANNS. Thank you, Mr. Chairman. 

Every one of you presented fascinating testimony, interesting testimony, and I think it raised so many complicated issues. So, let 

me, if I might, take a step back here and ask you about your preference in terms of how we approach this, because if we just spent 

the next hour writing down the significant issues, I will bet you we 

14 

could not get it done in that hour. And, I am trying to figure out 

process-wise what is the best approach here, because the one thing 

we do not want to do is mess up a system that has done some awfully good things. Now, there may be some issues, and I do not 

want to necessarily debate that. 

Process-wise—Professor, I will start with you—would it be your 

preference that we look to the Chairman of the SEC, the SEC 

itself, to start working through these issues, identify approaches, 

and use its regulatory powers to deal with these issues, or would 

you rather have Congress try to—you know how we are functioning 

these days—would you rather have Congress grab a hold of this 

issue and see what we can do here? And, we have broad shoulders. 

You can tell us what you think and we will not be offended, I promise you. 

Mr. SCOTT. Senator, I have dealt with a lot of complexity in my 

life. This is one of the most complex areas you will ever encounter. 

When you go through particular questions of this trade or that 

trade and who is getting an advantage and how it works, it is very 

complicated. 

Senator JOHANNS. Yes. 

Mr. SCOTT. And, I think that says caution to legislation before 

we have the experts, OK, do their best job to formulate what the 

problems are and what the solutions are. And, I think your role for 

the time being is to make sure that the SEC goes forward on this. 

And, by the way, I am one that thinks the SEC should be adequately funded to do these kinds of jobs. I think it is totally unfair 

to the SEC to put a lot on their plate and not give them the money 

to do it. 

Senator JOHANNS. OK. 

Mr. SCOTT. So, I think, you know, let us have the SEC do it. You 

keep the pressure on for them to do it and you review their findings. 

Senator JOHANNS. Mr. Solomon. 

Mr. SOLOMON. I think it is a very complex issue, but I think 

there is actually a relatively few number of changes you can make, 

and I think, well within an hour, you could have it laid out. It is 

actually pretty straightforward if you start with some basic 

premise, which is simpler—simpler markets. Simpler markets foster better behavior from fundamental buyers and sellers. We have 

just got a market structure that basically has gotten away from, do 

you want to own this at this price? Do you want to sell this at this 

price? And—— 

Senator JOHANNS. But, let me ask you about that. You talked 

about sub-penny price improvement. Tell me, just as straightforward as you can, does Mr. Brooks win with that? 

Mr. SOLOMON. No. 

Senator JOHANNS. Who is the winner and who is the loser when 

you do that? 

Mr. SOLOMON. So, sub-penny price improvement is what enables 

electronic market makers to aggregate retail order flow and give 

them the execution inside the national best bid and offer. So, if the 

regime requires you to give a retail order or individual order an 

execution at the best bid and offer when it hits the floor, or when 

15 

it actually gets displayed, the best way to ensure you do that is to 

crawl inside whatever bid and offer there is by a tenth of a penny. 

Andy and his compatriots on the institutional side do not benefit 

from that because they are not individual orders. So, his ability to 

get an—he can stand there at the bid, and sit or stand there on 

the offer, and a lot of shares can trade at the bid and the offer and 

he does not get a fill. That is a problem, because a lot of folks, or 

a lot of other intermediaries are aggregating positions or selling positions in the hopes of being able to sell to him at a price higher 

or buy it from him at a price lower—— 

Senator JOHANNS. And—— 

Mr. SOLOMON. ——and that is what is happening with sub—that 

is where sub-pennying becomes a very difficult market issue. 

Senator JOHANNS. Right. As an individual investor, then, do I 

benefit? 

Mr. SOLOMON. So, you benefit in a couple of ways. So, you certainly benefit by having five-dollar commissions. This is the maker/ 

taker regime is what underpins cheap execution. 

Senator JOHANNS. Yes. 

Mr. SOLOMON. We question whether or not you actually benefit, 

because if you buy individual—most individuals are owning stocks 

that are in the growth range. We have seen what the disparity is 

in terms of individual ownership. Seventy percent—if you go to 

sub-$250 million companies, it is, like, 85 percent owned by individuals. The only reason to own those stocks is because you think 

they are going to go higher and because—and, what makes them 

go higher? Institutional involvement. So, there is—now, the market 

is biased against getting people like Andy involved in small cap 

stocks. So, while you may have gotten a five-dollar execution, did 

you—and, you may have actually given up the opportunity for price 

improvement. 

Senator JOHANNS. But, I may want the five-dollar execution. 

Mr. SOLOMON. Mm-hmm. 

Senator JOHANNS. You know, I remember the good old days when 

this did not exist and I had a few stocks and I called a broker and 

they charged me an arm and a leg and said, ‘‘I will settle up with 

you in 7 days,’’ and I am kind of going, wait a second. I think I 

lost on that deal. 

Mr. SOLOMON. So, there is a middle ground. 

Senator JOHANNS. And, the fact that you are telling me, ‘‘But, 

Mike, your stock might have gone up,’’ is not very reassuring to 

me. I want a five-dollar trade. What is wrong with that? 

Mr. SOLOMON. There is nothing wrong with wanting five-dollar 

trades, and we think there is enough competition in the marketplace that people will compete on commission. Listen, we should 

not be competing on commissions as a way to drive revenues. We 

should be competing on investment ideas. So, go to your broker 

that gives you—that shows you over a period of time that they can 

consistently make you money. Then commission dollars actually do 

not matter that much, and we—but we should not have—— 

Senator JOHANNS. What if I am a rugged individualist, and quite 

honestly, I do not want to deal with a broker. 

Mr. SOLOMON. OK. 

16 

Senator JOHANNS. I want to go someplace. I want to pay my five 

dollars for a trade. I want to give—I want to get access to all of 

the information they can give me. I want to dig into it. I want to 

study it. And, I am not alone. And, I am using me as a hypothetical 

here because I do not buy and sell or trade. I do not trade stocks. 

But, having said that, millions of Americans have warmed up to 

this idea and they like it. 

Mr. SOLOMON. Which is fine. There will still be people that offer 

cheap execution because we have got a lot of benefits. So, I think 

it is fine. There will still be cheap execution. 

What is missing in this, though, is a little bit of balance, because 

Andy manages a bunch of money in your 401(k) or in your pension, 

I mean, all these other areas, all these other ways that you access 

the market, and he is being precluded from participating in growth 

in a vital part of the American economy because the current market structure is overly focused on cheap execution or cheap commissions. 

And, I think there is a balance here, which is why we have said 

there is a different regime, potentially, that could go on for the 

smaller companies. There is not a one-size-fits-all answer here. 

Five-dollar executions are great. I use them. I love them. But, you 

do not have to give that up and still foster capital formation and 

encourage price discovery. 

Senator JOHANNS. I have exhausted my time, but I do have one 

question. What percentage of trades on a given day or a given 

month would be the five-dollar execution versus the Andys of the 

world? 

Mr. SOLOMON. I do not think I have that information. I think one 

of the challenges that the exchanges and the SEC is determining 

is what actually constitutes a retail order flow. 

Senator JOHANNS. OK. 

Mr. SOLOMON. That is a hotly debated discussion point, because 

there is—I think people feel like if we are really, truly protecting 

individual investors, everybody is on board with that. But, there 

are people who masquerade around as individual investors who are 

really high frequency or professional traders who are accessing 

their five-dollar trading accounts, and that does not quite seem like 

it is right. And so it is very difficult, actually, to know. I cannot 

tell—and, by the way, everything trades in hundred lots today, so 

it is really hard to be able to discern between an institutional order 

and a retail order. There is no real way to capture that data, to 

the best of my knowledge. 

Senator JOHANNS. Thank you, Mr. Chairman. 

Chairman WARNER. I think you raised a good point, Senator 

Johanns. The question I would have, and I am going to let Senator 

Warren get an extra couple minutes, is just that would that rugged 

individualist who gets the five-dollar trade be offended if somebody 

in that tiny spread is making perhaps inappropriate profits because you have got the incentives misaligned? But, I imagine 

maybe Senator Warren might go down that direction. 

Senator Warren. 

Senator WARREN. So, thank you, Mr. Chairman, and thank you 

all for being here. 

17 

And, I do. I want to pick up on that line. The question for me 

is not so much about the cost savings from all electronic trading, 

it is the question about the so-called high frequency traders. And, 

for me, the term ‘‘high frequency trading’’ seems wrong. You know, 

this is not trading. Traders have good days and bad days. Some 

days, they make good trades and they make lots of money, and 

some days, they have bad trades and they lose a lot of money. 

But, high frequency traders have only good days. In its recent 

IPO filing, the high frequency trading firm Virtu reported that it 

had been trading for 1,238 days and it had made money on 1,237 

of those days. Now, I do not know what happened on the one bad 

day, but I assume a computer somewhere got fired. 

The question is that high frequency trading firms are not making 

money by taking on risks. They are making money by charging a 

very small fee to investors, and the question is whether they are 

charging that fee in return for providing a valuable service, or they 

are charging that fee by just skimming a little money off the top 

of every trade. 

So, let me start there. Mr. Brooks, the defenders of high frequency trading often claim that they provide liquidity to the market. There is always someone willing to buy whatever it is that investor is selling. What is your view on that? 

Mr. BROOKS. That is a great question, Senator. I think our view 

is that is a convenient answer by them. You know, the markets 

functioned pretty well prior to high frequency trading strategies 

being adopted. You know, if 95 out of 100 times that you have said 

you want to buy 100 shares of GE you canceled that trade, that expression of trading interest before anybody can get to you, I sort 

of question the true intent of what you are doing. 

Now, I think it is important to be clear, some high frequency 

trading strategies are legitimate. They are market making. They 

are statistical arbitrage. They are buying stocks in a basket against 

an index or something like that. But, a lot of these strategies really, our understanding—and by the way, I agree with both Mr. Solomon and Professor Scott, this market subject is incredibly complex—but, so much of what a high frequency trading strategy 

might be is to act, to draw a reaction, and then to profit from your 

reaction. So, they flank you. They pivot around you. They really 

have no intention of trading. They just sort of want to see what you 

are going to do, and once they know what you are going to do, they 

can step in front of you. 

Senator WARREN. Right. So, you would argue this is not adding 

liquidity to the marketplace—— 

Mr. BROOKS. We think there is a huge difference between liquidity and volume. They trump the liquidity side and we are, like, 

wow. Before you guys came along, we seemed to be fine, or seemed 

to be better, in some respects. 

And, I do think it is important here to identify that retail investors declare victory. You are in great shape. The five-dollar trade, 

instant access, awesome. But, a big part of your portfolio, of your 

nest egg, might be invested with people like us. And, in that part 

of the market, it is not such a good trade because you have people 

that are taking advantage of your being in a market for a longer 

period of time. When you are buying 100 shares, you are there for 

18 

2 seconds and you are done. You declare victory. You go home. It 

is great. 

But, let us say you have a million shares to buy. I might be there 

all day, and all day, those other interlopers, if you will, have an 

opportunity to step in front of, take advantage of, sniff out our 

order, all those kinds of things. And, that is troubling to the market. That is where we could be better. 

Mr. SOLOMON. I also think, by the way, that there are—the liquidity providers are there when it is convenient for them to be 

there. So, I would ask the question, are they really providing liquidity, because I know if I am an individual investor and I want 

to sell and I am in a line with everybody else, they have no obligation to be there. In fact, arguably, when that starts to happen in 

the market, the thing that concerns me most is all a lot of these 

algorithms look and tradeoff the same trends. So, if we start to get 

one-sided in the market in the other direction, they will widen 

their bids and offers and then we no longer have a market that is— 

has a responsibility to provide liquidity, a buyer of last resort. 

Senator WARREN. So, if I am following you, Mr. Solomon, you are 

saying that they are really adding volatility to the market, volume 

to the market, without adding true liquidity to the market. 

Mr. SOLOMON. It can be true liquidity. It is just not true liquidity 

when you might actually need to get true liquidity, because there 

is no obligation. So, they will trade as long as there is liquidity, 

and we have seen in small caps, for example, when there is no activity, they do not trade until there is activity. Then, they trade. 

And, so, that is not really providing that liquidity. That is, like, 

moths to the flame. There is a flame. Let us fly there. 

And, so, that is not real adding—it looks to the casual observer 

as if there is a lot of volume, but is there real fundamental buyers 

and sellers or is it just a bunch of people crawling in there when 

they think there are real buyers and sellers around and creating 

activity that really does not add to the ability for Andy to aggregate a position or sell a position when he actually needs to do it. 

And, I worry about the stability of the marketplace because when 

there is going to be—there will be, it is a matter of when—when 

there is selling, I wonder who is going to be there to actually buy 

it, because in the old days, we may not have liked the New York 

Stock Exchange and the things that they did and the money they 

made, but they stood there and bought stocks in 1987, down big, 

but they bought them and the market opened the next day. 

And here, I am a little bit concerned, particularly around the 

Flash Crash. What happened there? You do not really need to do 

a lot of studying. A lot of algorithms said, oh, my God, this is unusual. I am going to widen my bids and offers because I do not understand what is happening. And then everybody did it. And, so, 

we are no better today in that regard than we were in 2010. 

And, I think, that is actually the challenge in market structure, 

as opposed to whether HFT is good or bad. It is the market structure we live in, and HFT, sometimes it helps, sometimes it does 

not, but we are not in a good place market structure-wise. 

Senator WARREN. All right. So, thank you, and—good. Actually, 

if I can just answer it, because the other argument you often hear 

is one about speed, that it speeds up the transactions. Mr. Brooks. 

19 

Mr. BROOKS. So, our view on speed is, you know, if your request 

for speed is singularly focused, I think it is reckless. And, what we 

have been led to understand about market structure and the quest 

for speed is when you are interested in speed, you remove safeguards and you remove some of the infrastructure and the 

underpinnings of the market. And, so, fortunately, we put in—the 

SEC put in the limit up, limit down, and some marketwide circuit 

breakers and that has been great. But, both the Flash Crash and 

Knight Capital situation were maybe driven by speed, and if that 

is the case, that is not good for anybody. 

As investors, it is rare—it is rare that speed is important to us. 

Our average holding period is, like, 3 years. Why do I really care 

what is going to happen in a nanosecond? 

Senator WARREN. Well, I was going to say—— 

Mr. BROOKS. I do not. 

Senator WARREN. ——I take it the speed difference we are talking about is measured is milliseconds—— 

Mr. BROOKS. You cannot even blink—— 

Senator WARREN. ——not in 7 days. 

Mr. BROOKS. It is milliseconds, is right. 

Senator WARREN. Yes. 

Mr. BROOKS. It is nanoseconds. And, that advantage, that speed 

advantage, if it destabilizes, it seems to us that that is wrong. That 

is not right, and we ought to push back on that. Our view is, we 

really ought to just slow down, not walk away from technology, but 

let us take a deep breath here and really look at what we have, 

and I appreciate Professor Scott’s admonition about the complexity 

of the market. But, we have got to make some progress. 

You know, my boss says to me, ‘‘I do not really care how fast you 

are moving toward the goal, but please move in the right direction, 

will you?’’ If I am not moving in the right direction, I am in trouble. 

We have not been moving in the right direction. Oh, my God, we 

have got Dodd-Frank, we have got Volcker, we have got blah, blah, 

blah, all these things out there. They are always there. There is always a reason why you cannot do it today. 

You know, we used to have a fellow that worked for us who used 

to talk about the phrase, ‘‘Today is the hardest day to invest.’’ 

There is always something that might preclude you from doing 

something. Today is the hardest day to go after difficult market 

problems, because, gee whiz, I have got something else I have got 

to worry about. 

Can we just start to make some progress? Please. We do not 

have the answers. Pilot programs give you the opportunity to generate data. Let the academics run wild, try and figure it out. Move 

in very incremental, careful ways. It is right, you have to have a 

control. You have got to know what you are trying to study and 

measure for. But, we can do that, and I think we can do that in 

a constructive way. 

Senator WARREN. Well, I want to say, thank you very much, Mr. 

Chairman, on this. You know, high frequency trading reminds me 

a little of the scam in office space. You know, you take just a little 

bit of money from every trade in the hope that no one will complain. But, taking a little bit of money from zillions of trades adds 

up to billions of dollars in profits for these high frequency traders, 

20 

and billions of dollars in losses for our retirement funds and our 

mutual funds and everybody else in the marketplace. It also means 

a tilt in the playing field for those who do not have the information 

or do not have the access to the speed, or who are not big enough 

to play in this game. 

So, I want to see the SEC, the State agencies push forward in 

their investigations, and I think we should continue to do the 

same. 

Thank you, Mr. Chairman. 

Chairman WARNER. Thank you, Senator. 

We will actually get another—let us each take another question. 

I have got another question, if you want to take another quick shot 

at this. 

I just—I was in the technology business for a long time. The last 

thing you want to appear, particularly sitting in a chairman’s seat, 

is like a Luddite. But, I do kind of—do feel at times there may 

have been some—and I want Professor Scott to give a rebuttal to 

this a little bit—that technology for the sake of technology, when 

speed becomes so quintessentially important, when the opportunity 

to colocate becomes an advantage that clearly larger firms have 

over smaller, and the ability to get your—where you locate your exchange becomes such a—the real estate decision becomes such a 

critical question. 

And, I know that, Professor Scott, you said that the volatility has 

not increased. I actually thought that the intraday—again, volatility has gone up 5x since 1996. I want you to kind of mention 

that. 

And, I do, and I do not know if any of you cited this study, but 

the study that shows the millennials are investing in the market 

at a lower percentage than anyone else. Now, is that a question of 

just financial uncertainty or is there—you would think, from the 

generation that would be more technology competent, there would 

be more willingness to accept this, but there seems to be perhaps 

a wariness amongst young folks that perhaps the system is being 

gamed. 

Comments? Thoughts? 

Mr. SCOTT. I would like to say at the outset that when we talk 

about the market, we are talking about lots of different trading 

systems in that market. And, one of the stories of Flash Boys was 

the attempt to design a better market, IEX. So, there is maker/ 

taker, there is taker/maker out there. So, part of what we have to 

think about when we look at this is what are people gravitating to? 

If you give them taker/maker, are they using that system, or do 

they find something else that is wrong with it? So, the market is 

not just one thing that is working in the same direction, a lot of 

different trading systems, a lot of different ways to trade. 

All right. Now, let me address your question, Senator, on volatility. There are many ways to measure it, OK. You can do it 

intraday, in which it is going up. You can do it day to day, week 

to week. I would say long-term investors who are key to the capital 

formation of our country are less interested in the amount of 

intraday volatility, you know, except for those people who are out 

sitting there on E*TRADE just trying to make a profit in 1 day. 

21 

We are talking about long-term investors, and it seems to me that 

their horizon on volatility is shorter than intraday. 

The second thing I would say on volatility is that the CBOE Volatility Index, so-called VIX, has fallen to its lowest levels since 

2007. What they measure is the 30-day expected volatility of the 

S&P 500. So, there is still a different measure that shows very low 

volatility. 

Whatever the volatility is, or is not, it remains to be seen what 

high frequency trading’s impact is on that volatility, because volatility—and this comes back to a question you asked—is driven by 

a lot of factors, only part of which, and maybe even a small part 

of which, may be trading system. We have been, since 2008, in a 

state of high uncertainty as to the future of our economy, OK, and 

that in and of itself—OK, every day, oh, I think we are OK, no, we 

are not OK, we have got this data, we have got that data—that 

kind of environment, where you are not certain of where we are 

going, produces volatility. And, so, I think the question, is the volatility coming from high frequency trading or it is coming from 

something else. 

On all of these issues, we need more understanding, more transparency, more information, OK, which is, hopefully, the SEC is 

going to provide. 

Now, in terms of the millennials issue, so, you know, the question is, are younger people in this country increasingly sort of 

afraid to invest in the market? When those people were questioned, 

only 5 percent of them actually said that they had an aggressive 

risk tolerance. So, what these people are saying is that we are very 

conservative. We have a risk aversion. That 5 percent is a pretty 

low number. And, so, you have to then ask, well, why are they risk 

averse? Is it because there are high frequency traders operating out 

there? I do not think so. It is because of the nature of what we 

have seen in the market and great uncertainty about our economic 

future. And, I think, that is what is preventing people from investing. 

Now, that being said, Japan has had a longstanding problem of 

not getting people into their markets, and I think some people 

might analyze the reason for that as that the people do not trust 

the fairness of that market. So, we should not neglect fairness as 

a possible explanation, but there are powerful economic fundamentals here, in my view, that have been driving volatility and been 

driving less investor confidence. 

Chairman WARNER. Thank you. We will go to Senator Reed and 

then back to Senator Johanns. 

Senator REED. Well, thank you very much, Mr. Chairman, and 

thank you, gentlemen, for your testimony. I apologize. I had to be 

down at the Defense Appropriations hearing with Secretary Hagel 

and the Chairman of the Joint Chiefs of Staff. 

But, Mr. Brooks, in 2012, you were here before and testifying 

and—— 

Mr. BROOKS. Nice to see you again, Senator. 

Senator REED. Yes, sir, and it’sgood to see Professor Scott. As I 

said, previously, he led me to great intellectual waters, but I did 

not understand how to drink, so thank you. 

22 

But, in 2012, before the publication of Mr. Lewis’s book, you 

mentioned that there were many investors that were sort of turned 

off by the casino-type environment that they sensed, rightly or 

wrongly, and your clients, has that distrust, mistrust, or cynicism 

grown in the last 2 years? 

Mr. BROOKS. I do not know whether it has grown, but I also do 

not think it has abated. So, you know, we talked about the percentage of the households in this country that have exposure to the 

stocks at sort of 16-year lows and the millennials. I do not know 

what draws people to a market or away from investing, but that 

is not a good thing. You cannot save for your retirement if you do 

not generate some sort of return. So, we are pretty concerned about 

this whole issue. 

The job of trying to affirm a market’s reasonableness, its fairness, its transparency, seems to us to be ongoing, and we have sort 

of—we are not doing a good enough job there collectively as an industry and everybody to try and affirm the reasonableness and 

fairness of our market. So, we continue to be concerned about that 

issue. 

Senator REED. I think everyone has commented that high frequency trading has provided some significant advantages to marketplace liquidity, and in some cases probably narrowing price 

spreads, et cetera, but, again, going to particularly this popular 

perception argument that some of it seems to be algorithms that 

are cleverly designed to essentially not make economic investments, but to exploit sort of timing gaps in the system and other 

gaps in the system. You know, one of the things that is referred 

to is the sort of algorithms that will send out a huge number of 

bids and then cancel the bids, not because of the market activity, 

just simply because that is how they think they can move a price 

just a few basis points and then make the right move. That seems 

to me to be behavior that does not add to the economic value of the 

country, but it certainly makes some people very wealthy. 

Mr. BROOKS. We would agree with that, and sort of following up 

on what Professor Scott was talking about, intraday volatility, institutional investors who are really aggregated retail—it is everybody together, because that is who we represent—we do care about 

intraday volatility because it is in that environment that we are 

trading. It is in that environment that we are making our investment to hold something for 5 years. And, if a trading strategy—if 

someone has been able to exacerbate that volatility between 9:30 

and 4, I would argue it is causing longer-term investors a higher 

cost. 

Senator Warren sort of talked about a tax. That is sort of a tax 

on the system. All the money that the high frequency crowd is taking out—they are not taking risk overnight, they are flat every day, 

they never lose money—all the profits they are making are coming 

from someone else. That might be the longer-term investors, everybody in their 401(k)s, their 529 plans, et cetera. 

So, we are very concerned about intraday volatility and that is 

why we would like to see some pilot programs to examine, can we 

constrain that a little bit? Can we make the markets a little deeper, a little more transparent to bring that intraday volatility in, 

narrow it? We do not have the answer until we try. 

23 

Mr. SOLOMON. We agree with that—— 

Senator REED. Let me go to Mr. Solomon, and then I will ask 

Professor Scott just to comment on the general sort of discussion 

that we have initiated with Mr. Brooks. Mr. Solomon. 

Mr. SOLOMON. Yes, Senator. We agree completely. Actually, we 

are very much on the same side here. The intraday volatility in 

single stocks has actually, in some instances, never been higher. 

When a buyer shows up, the stock lifts inexplicably, and when a 

seller shows up, the stock drops inexplicably. So, I do not really 

think there are a lot of good measures for single stock volatility. 

I think, with all due respect to the Professor, I do not think the 

VIX has anything to do with this. The VIX is an irrelevant—it just 

looks at overall market volatility and all it says is that, you know, 

generally speaking, people are, you know, sanguine about the overall market, in general, macroeconomically, even with all the worries. They are generally sanguine. When they are not sanguine, the 

VIX will be 40. But, it does not impact what happens in single 

stocks. 

There are some definite issues here that are exacerbated by the 

market structure, and high frequency—some high frequency traders that do engage in flash trading behavior, in particular, are 

harmful, I mean, and I do not think there is anybody that can 

argue about that. 

But, if you look at the reason why people flash, it is because a 

lot of the trading goes on in the dark. So, dark pools are, by their 

definition, not transparent. So, if you want to trade in a dark pool, 

well, you need a way to light that dark pool, and one of the ways 

you can light that dark pool is by flash trading and seeing where 

the bids and offers are. And, the question is whether or not dark 

pool operators encourage that kind of behavior or discourage that 

kind of behavior. 

At Cowen, we do not run a dark pool and we are not interested 

in running a dark pool. We have access to a lot of different liquidity providers and we have developed algorithms to help folks like 

Andy access pockets of liquidity and combat that kind of behavior. 

So, there are some market clearing mechanisms that allow you to 

deal with that. But, in general, if you do not have the kind of algorithms we have to combat that kind of behavior, you are at a significant disadvantage. 

I would also say, when people talk about speed, there are plenty 

of analogies we could use about speed and what it does. We can 

all say that the National Highway System increased the productivity of this country in ways that even President Eisenhower could 

not imagine. But, we have speed limits. Every car on the highway 

can go faster than it is allowed to go. So, it is OK for regulators 

and legislators to say, we know you can go faster. We know you 

can make improvements in efficiencies of your engines. But, we 

think that this is the right speed to encourage the right kind of economic behavior and protect investors. 

So, I do not think you are actually being a Luddite at all by asking the question, just because we can go faster, should we go faster, 

and there are plenty of examples like that one that suggest we 

might not be better. 

24 

Senator REED. Thank you. Thank you very much. Just a last 

word, if I may prevail upon my colleagues. 

Senator JOHANNS. Sure. Go ahead. 

Senator REED. Thank you, Mike. 

Professor, please. And, welcome. Good to see you. 

Mr. SCOTT. Thank you, Senator. I think we need to keep our eye 

on the ball. The ball is, you know, what is best for people who are 

trading in this market and what do they care about, and in turn, 

what is best for our economy? So, we talked about three different 

elements in the market. We talked about volatility. We talked 

about liquidity. We talked about transaction costs. OK. 

So, on volatility, I have already said, people disagree on this. It 

depends how you measure volatility, OK. I still am of the view 

where maybe traders get rewarded for a little less volatility during 

the day. Does a long-term investor really care about intraday volatility? The people who are trading for them may care because they 

get compensated on basically how they do. But, for the long-term 

investor, I have to say, I am in TIAA–CREF and I could care less 

about intraday market volatility. 

Now, the second part of it is liquidity, OK. People are obviously 

interested in being able to trade in and out of their stock positions 

when they want to. This is retail and institutional. And, here 

again, we have a lot of data, all right, an economist that says, liquidity overall in this market is an all-time best. And, yet, Jeff, 

OK, when he deals with small cap stocks, he does not see that because we are measuring the overall market, which is dominated by 

large cap stocks. So, if we have a liquidity problem, I think it is 

targeted—should be targeted, and I think Jeff would agree with 

this, at trying to get more liquidity in small cap stocks. We do not 

have that liquidity. Therefore, people do not want to invest in 

them. Therefore, we do not have capital formation. 

And, the third thing is transaction costs, and this goes back to 

Senator Johanns’ questions or observations. You know, retail costs, 

I think everybody would agree, are at an all-time low. Nobody here, 

I think, has said that is not the case. On the institutional side, we 

have studies by financial economists—there was just a recent study 

by Angel, Harris, Chester Spatt, they are all pretty well recognized 

financial economists, who say the average transaction cost for an 

institutional order of one million shares for a $30 stock is at a historic low of 40 basis points, OK. So, we have to reconcile that conclusion with what Mr. Brooks is observing. I am not saying Mr. 

Brooks is not observing higher transaction costs, but here is a pretty well respected group of financial economists who are saying it 

is at an all-time low. 

So, I come back to Senator Johanns’ process question, really. 

There are a lot of differences of opinions on these issues, OK, and 

it is, in my view, the SEC’s first role to sort this out, write a good 

report for our country, including for this Committee or for the 

greater Senate Committee and the House, and then we will have 

something, OK, to look at and react to. 

So, I think, again, we should not be legislating now on these 

issues. We should be fact finding and the primary fact finder 

should be the SEC. And, by the way, Senator Reed, when you were 

25 

out of the room, I am very much in favor of the SEC having adequate funding to do this and other things. 

Senator REED. Thank you very much. Thank you, gentlemen. 

Senator JOHANNS. Go ahead. 

Mr. BROOKS. Could I possibly respond to—— 

Senator JOHANNS. Mr. Brooks, you wanted to—— 

Mr. BROOKS. So, there are lots of studies out there talking about 

transaction costs, and you can pretty much find a study to match 

any opinion you want to espouse. There is an RBC study out saying 

that intraday volatility costs are now perhaps higher than ever, 

and we are seeing that in our trading. And, I know Professor Angel 

and he is a good guy and he does good work, but it depends what 

you are examining, and so that is a very complicated subject, too, 

talking about transaction costs. 

Two other things we have all sort of talked about here today are 

conflicts of interest and complexity, and we could be better if we 

could eliminate conflicts of interest and reduce complexity, and I 

want to just tell you a quick story, a trading story. 

So, one day a few years ago, T. Rowe Price, we had 2.5 million 

shares to trade in a number of different stocks and we picked a 

broker and they were about our number 7th broker on the day in 

terms of the business we did. That 2.5 million shares got represented out to the marketplace as 750 million shares of interest, 

300-to-one. So, we had 2.5 million shares to buy. It got displayed 

in different times, different ways, as 750 million shares, simply to 

get 2.5 million shares executed. 

Now, was that a great trading strategy? The numbers looked 

pretty good. The reality is, we have 11 exchanges and 50-plus dark 

pools. That complexity, that myriad of—that spider web out there 

of where you have to go to trade today has created all kinds of 

challenges for every investor, and it is that issue that we need to 

try and focus on. How crazy is it that you have to go to so many 

different places to say, anybody there? Anybody want to trade? 

Anybody care today? We are really—we are obfuscating things, and 

people have been able to figure out ways to profit from that that 

really cause them to take no risk. 

Mr. SOLOMON. I am willing to bet that that was a large capitalization stock, too. 

Mr. BROOKS. They were across the spectrum, actually. 

Mr. SOLOMON. Right. And, so, if you look at what happens in 

small cap stocks—sometimes, you know, it is like—we call it the 

Hotel California. If you own a small cap stock, you can check out 

any time you like, but you can never leave. And, that is a problem 

when it comes to capital formation. 

And, we talk—prior to the JOBS Act, which was to get companies to think about going public, private companies, we seem to 

have established a really good regime in the Congress where we 

can do good legislation that balances investor protections and creates a forum for capital formation. But, once these companies are 

public, who is actually sponsoring them and how is that trading occurring? 

And, we are in a period now where we have a number of new 

companies, and we would love to give them the right kind of experience to encourage further investment in capital-intensive busiVerDate Nov 24 2008 11:30 Dec 19, 2014 Jkt 046629 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 L:\HEARINGS 2014\06-18 HIGH FREQUENCY TRADING S IMPACT ON THE ECONOMY\H
26 

nesses from your venture capital friends who right now, if you look 

at the last 10 years of venture capital investment in this country, 

it is disproportionately in companies that do not hire lots of people, 

or are not capital intensive. We do not back semiconductor manufacturing companies in this country anymore. That is a problem. 

And, so, if you need access to capital beyond the venture spectrum, you have to find it in the public markets, and this is what 

we are talking about. There needs to be that liquidity. 

Chairman WARNER. Senator Johanns gets his question. 

Senator JOHANNS. Maybe more of an observation than a question, and here would be my observation. I came to this hearing 

today wondering about the process question—that is why I asked 

it first out of the box—just simply because we, years and years ago, 

created an SEC. We gave them authorities. We have looked at that 

from time to time. We have broadened their authority and we have 

said to them, we want you to be the experts. We want you to understand this marketplace and report to us on what is working and 

what is not working. 

And, I leave this hearing today more and more convinced that if 

there is direction from Congress, it should be direction to the SEC 

to go out there and find the facts, report back, do the pilot program—which, incidentally, I have no problem with. 

The second observation is this. What traders are doing is not illegal. If they are out there buying and selling and doing what they 

are doing within the laws that are currently on the books, they 

have a right to do that. And, it occurs to me, Mr. Brooks, that they 

have kind of outsmarted you, not because you are less intelligent 

than they are, but they watch you like a hawk and all of a sudden 

they are starting to figure some things out and they are just a second ahead of you and it is profitable. 

Now, I would not be smart enough to do that. I guess if I were 

that smart, I would be doing that instead of what I am doing now, 

right? 

Chairman WARNER. You are not running for reelection, though, 

right? 

Senator JOHANNS. Yes. 

[Laughter.] 

Senator JOHANNS. I will not be doing that in my next life. 

All I am saying to you is before we head out there in a free marketplace and start defining behavior to be illegal, we should be 

darn sure about what we are doing, because it could have some 

economic consequences. 

Now, I want you to go out and give me the very best deal, and 

I do not think I am invested in your company whatsoever, but I 

do have a retirement program here that I have got some money in, 

and I tell you what, I look at the statement and I say, way to go. 

Good job. You are making more money for me. I want you to do 

that. 

But, having said that, again, I think we need to be very thoughtful about when we proclaim behavior to be illegal in a free market 

system, and that one, I must admit, I want more information on. 

I want more fact finding. I want to understand who wins, who 

loses, what is the consequences. And, I do not think we are anywhere near there at this point. 

27 

Like I said, I leave this hearing with somewhat the same impression I came to the hearing with, and that is we need the SEC out 

there to lead this effort. We need to encourage them, fund them, 

do those things. And then a future Congress—this will happen 

after I am gone—needs to be careful and thoughtful about how 

they are going to figure this out, because just because they are 

making money does not warrant us jumping in and saying, that behavior is illegal. You are making money. That has got to be illegal 

behavior. 

Mr. BROOKS. Senator, I think that is a—your point is well made. 

I do not think we are saying this behavior is illegal, but it might 

not be fair. It might not be right. It might not be ethical. So, if 

someone gets an information advantage about my trade and they 

get it—they get knowledge of a trade that is going to happen, and 

it happens and they are able to profit from that knowledge before 

the rest of the market can, when it is really marketwide knowledge 

that should be shared, I am not sure that advantage is right. 

I have no problem with people making money. I mean, we are 

a for-profit enterprise. This is America. We believe in that. But, 

when you take an unfair advantage or you found an unfair advantage and you have exploited that, I think that maybe the SEC 

needs to gut-check that and come back and say, maybe we can 

tweak things, because that is not fair. 

That is why I think the tax loophole analogy is a good one. You 

know, we respect people that found ways to avoid paying taxes, but 

if it is a loophole, it often needs to be closed. And, we think that 

some of these predatory practices are, in fact, not fair and not right 

and they should not be allowed to go on. It is not that they are illegal, but they have an unfair advantage. 

You know, my mother used to say to me, ‘‘Just because you can 

do it does not mean it is right,’’ and I think that is important. 

Senator JOHANNS. You know, and I got the same lesson. 

Mr. BROOKS. Yes, sir. 

Senator JOHANNS. I got the same lesson, and I do not agree with 

the philosophy you espouse, and I hope I live by that philosophy. 

But, again, highly technical, critical that we get good information 

from the SEC, critical that we understand what the consequences 

of our actions might be, because at the end of the day, there will 

be consequences. And what we stop here may open something up 

over here that we do not like any better. Like I said, I just think 

we need to be very careful, very thoughtful. 

I have not read the book. I am sure it is a great read. Mr. Lewis 

is a fascinating author. But, having said that, this is very serious 

business, and if there is anything I take from this hearing and 

three outstanding panelists, in my judgment, is we need to be 

thoughtful about where we head from here. 

Mr. SOLOMON. This is why we have advocated for pilots. I think 

if there is one consensus, we have all said that there should be pilots and we should observe those pilots and make changes based 

on the information we gather from that. 

I will just say, there is a little bit of a difference at the SEC now 

than there was when the JOBS Act was passed. Chairwoman 

White has really made this a priority. She is data-driven. She is 

going to do a lot of analytics. And, she has been very consistent in 

28 

her commentary, as have the other Commissioners. So, I do think 

that we can maybe get some answers from them. 

But, I will say that the first thing that came out that was required—the JOBS Act required the SEC to look at market structure, and I would encourage you to read that report and see if you 

learned anything from that. And, I would say, part of the reason 

why we formed the Equity Capital Formation Task Force is we 

looked at that report and said, it did not tell us anything. So, we 

have to advocate for them to actually tell us something that is 

helpful. 

And, I am hopeful that under this leadership of Chairwoman 

White that we will get a different outcome, but I think it is Congress’ responsibility to ensure that we get that output, and that is 

part of the reason why I am here, at least. 

Chairman WARNER. Let me—and, again, I appreciate everybody’s 

comments and, I think, the very good questions. And, I think, Senator Johanns and I have worked on a lot of things together. We get 

the conflict. We have got the value-add to the economy of the retail 

investor being able to get that cheaper price. 

But, I do think the notion, and I am a proud free market advocate and proud of my experience longer in business than I have 

been in politics, but there is this notion in the market, you take 

risks and you take your lumps and you take your wins. Something 

that is inherently—a track record that says if 99.9 percent of the 

days in a trading exchange you make money—and it is not just an 

HFT, I recall some of the large cap banks who had those same 

records—it creates at least something that is echoing what you 

have said. We need more data. 

And, I come back to the fact, May 13, not May 13 in 2010, but 

May 13 in 2014, Xerox and Lorillard, this was the—we had a 

miniflash crash. And, if we were to have another one of these incidents, the tendency would be, as you know, Senator, we might 

overreact too quickly. So, the fact that we are 4 years after the first 

Flash Crash—and I remember the previous Chair of the SEC, asking her what happened, and months and months later, they were 

still trying to find out—the fact that we do not have that consolidated audit trail information done—I mean, I am for adequate 

funding for the SEC, as well, but at some point, the priority—this 

needs to be a higher priority. And, I do think we have a role to 

nudge the SEC to act, to make this a higher priority, to urge our 

colleagues on both sides of the aisle to get the SEC the resources 

they need to do their job, number one. 

I think, at least, I, and I think you have concurred on the tick 

size, the pilot, the notion of small caps. We want to try to accelerate that. 

But, there are—I think Mr. Brooks has raised some fundamental 

questions about this notion of fairness here that we do not have all 

the appropriate data to kind of make that judgment. And, my concern will be, if we do not have that data soon, another incident will 

happen, and, my gosh, because of the complexity, Congress trying 

to line-by-line legislate this would not be a pretty activity. 

All right, Professor Scott. Briefly, because we are about to bring 

the hearing to an end. 

29 

Mr. SCOTT. I just want to put in a plug. Our committee has got 

a full-scale project to examine all these market structure issues 

and we will be doing so over the next 9 months. So, I want to say, 

the SEC is not the only organization out there that is going to be 

studying market structure. Our committee is doing it. I am sure 

there will be others for you to look at and sort of weigh those other 

studies against whatever the SEC—— 

Chairman WARNER. And, I would say this. One of the things I 

think this Subcommittee needs to do, since we have this as our jurisdiction, and Senator Levin had some of the folks yesterday, but, 

you know, we need to have some folks—back to Mr. Brooks’ point 

about how many exchanges there are out there competing, it 

should be very, very small. You would have to search out these 

very, very small exchanges. On the other hand, in the notion of a 

market, they need to have their say in this Committee, as well. 

I want to thank all the witnesses for very focused answers and 

appreciate your contribution. Senator Johanns, thanks for your 

contribution, as well. 

The hearing is adjourned. 

[Whereupon, at 11:29 a.m., the hearing was adjourned.] 

[Prepared statements and additional material supplied for the 

record follow:] 

30 

1 Comm. On Capital Mkts. Reg., Interim Report of the Committee on Capital Markets Regulation (Nov. 30, 2006), http://www.capmktsreg.org/pdfs/ 

11.30CommitteelInterimlReportREV2pdf. 2 Comm. on Capital Mkts. Reg., Competitiveness Measures, http://www.capmktsreg.org/ 

educationresearch/competitiveness-measures/ 3 Id. 

4Mary Blume, ‘‘The Hallowed History of the Carrier Pigeon’’, New York Times, Jan. 30, 2004. 5See Letter from Hal S. Scott to Joseph Dear, Chairman, Inv. Adv. Comm., U.S. Sec. and 

Exch. Comm. (Jan. 23, 2014), available at http://www.equitycapitalformationtaskforce.com/ 

files/H%20Scott%20IAC%20letter%202014%2001%2023.pdf. 

PREPARED STATEMENT OF HAL S. SCOTT 

NOMURA PROFESSOR AND DIRECTOR, PROGRAM ON INTERNATIONAL FINANCIAL

SYSTEMS, HARVARD LAW SCHOOL

JUNE 18, 2014 

Thank you, Chairman Warner, Ranking Member Johanns, and Members of the 

Subcommittee for permitting me to testify before you today on the impact of high 

frequency trading on investor confidence and capital formation in U.S. equity markets. I am testifying in my own capacity and do not purport to represent the views 

of any organizations with which I am affiliated, although some of my testimony is 

based on the work of the Committee on Capital Markets Regulation (CCMR). On 

the whole, high frequency-trading increases liquidity in our equity capital markets. 

The increased liquidity leads to decreased costs of stock issuance, thus improving 

capital formation. And of course, improved capital formation for our businesses 

leads to higher growth in the real economy. 

The Committee was formed in 2005 to address the issue of competitiveness in our 

primary public equity capital markets and issued a report in 2006 detailing the 

threats to our primary markets and suggestions for improvement. 1 Just as regulatory changes can lead to competitiveness concerns in our primary markets, the 

same is true of our secondary markets. Therefore, any changes in our secondary 

market trading must be assessed for their competitive implications, particularly 

given the current relative competitive strength of our secondary markets vis-a-vis 

those abroad. 

The CCMR tracks, on a quarterly basis, 13 measures of the competitiveness of the 

U.S. public equity market. 2 We have found that while the competitiveness of our 

primary markets has suffered over the past 6 years, our secondary markets remain 

strong with roughly 50 percent of global exchange trading occurring on U.S. exchanges. 3 The CCMR is currently undertaking a review of market structure issues 

with a focus on dark pools, internalization, decimalization, exchange backup systems, and the subject of today’s hearings, high frequency trading. 

‘‘High frequency trading’’ or ‘‘HFT’’ is a topic that has generated significant attention in recent years and increasingly in the last few months. The widespread public 

interest in this topic was intensified following the 2010 ‘‘flash crash’’ and more recently, with the publication of Michael Lewis’ book Flash Boys, which has ignited 

a general attack on HFT’s place in the U.S. capital markets. But policy cannot be 

made on the basis of a journalistic tale that makes for a best seller—rather it must 

be informed by verifiable facts. This is largely why we are here today and my intention is to provide a thoughtful response to a debate that has been at times fraught 

with frenzied emotion. 

Let me be clear at the outset, that I believe the net effect of HFT activity in our 

equity markets has been positive. Transaction costs are at historic lows, liquidity 

is at historic highs, and volatility has stabilized. These features of today’s market 

not only benefit both retail and institutional investors, but also positively affect capital formation, and by extension, promote job creation. The fact that HFT is the subject of a best-selling book and has generated vocal opposition both within the financial industry and across the American public more broadly, does not, in itself, justify 

drastic regulatory change. There is nothing new about the advantages of speed to 

traders. You may recall that the Rothschilds used carrier pigeons to bring them 

news of the outcome of battles in the Napoleonic wars. 4 While the speed with which 

they obtained this information gave the Rothschilds an advantage, the markets generally benefited from the speed by which the new information got into the market, 

even if those who actually traded with the Rothschilds were at a disadvantage. 

My primary concern is that the recent frenzy over HFTs draws attention away 

from other important market structure issues. For example, as a member of the Equity Capital Formation Task Force, along with my fellow panelist Mr. Solomon, I 

have been highly supportive of a tick-size pilot program for small cap stocks and 

have been encouraged by the SEC’s recent commitment to conduct such a program. 5

31 

6 Justin Schack, ‘‘HFT Is Not Driving Investors From the Stock Market’’, Fin. Times, May 10, 

2013. 7 Id. 

8 Id. 

9See James J. Angel, Lawrence E. Harris, and Chester S. Spatt, ‘‘Equity Trading in the 21st 

Century: An Update’’, June 21, 2013. 10 Id. 11See ‘‘The Citadel Conversation’’, Q1 2013, available at https://www.citadelsecurities.com/ 

lfiles/uploads/sites/2/2013/06/The-Citadel-Conversation-with-Larry-Tabb-and-JamilNazarali.pdf. 12 Rosenblatt Securities estimate. 13 B. Friedman, ‘‘Economic Implications of Changing Share Ownership’’, Journal of Portfolio 

Management 22 (Spring 1996). 14 Board of Governors of the Federal Reserve System, Flow-of-Funds Accounts (2013). 15 Investment Company Institute, 2013 Factbook. 16 Id. 17 Rosenblatt Securities estimate. 18See James J. Angel, Lawrence E. Harris, and Chester S. Spatt, ‘‘Equity Trading in the 21st 

Century: An Update’’, June 21, 2013. 

That being said, to the extent that public concern over HFTs reduces investor confidence, our capital markets will suffer. But in my opinion, any reduction in confidence would not be based on the facts. Given the recent volumes in trading, there 

is little evidence that people have lost confidence in our markets. Critics of HFT point to the $261 billion that retail investors have pulled from equity mutual funds since the 2010 ‘‘flash crash’’ as evidence that investors have lost 

confidence in our equity markets. 6 However, retail investors have simply moved 

their investments to exchange traded products, which of course trade in U.S. equity 

markets. The net effect is investor inflows of almost $500 billion since the 2010 

flash crash. 7 In 2012 alone, there were net inflows of $57 billion in securities trading in U.S. equity markets. 8 If investors were indeed overly concerned by HFT then 

they wouldn’t have added such substantial amounts to their capital at risk in our 

equity markets. 

Another common misconception regarding HFT and our current equity market 

structure is that HFTs have somehow caused an increase in transaction costs for 

individual retail investors. In fact, transaction costs for retail investors are at historic lows, as evidenced by current bid-ask spreads and retail brokerage commissions. Since 2006, the average effective bid-ask spread on NYSE-listed stocks has 

dropped in half, from over 3 cents to roughly 1.5. 9 Retail brokerage commissions 

are also at all-time lows; the average commission charged by the three major retail 

brokers is approximately $10 per trade. 10 Given the reduction in spreads and commissions, the net cost of a given trade has dropped dramatically for retail investors. 

According to the Tabb Group, 7 years ago retail investors’ effective payments on executed trades were roughly 130 percent of the NBBO spread (the difference between 

the national best bid and offer). Since then they have dropped to less than 100 percent, so the average retail investor receives a better price on a trade than the best 

price available on an exchange. 11 In short, it is a great time to be a retail investor. 

However, bear in mind that retail investors only directly account for approximately 15–20 percent of daily stock market volume. 12 Since many retail investors 

access the equity markets indirectly through institutional funds or advisors (such 

as mutual funds, pension funds, or private wealth advisors), institutional cost reduction is highly relevant to retail investors as well. In 1950, over 90 percent of U.S. 

equities were held directly by households. 13 That number has dropped to less than 

40 percent in 2013 14 and this is primarily high-net worth individuals. Household 

ownership of mutual funds has risen from 5.7 percent in 1980 to 46.3 percent in 

2013 constituting 90 percent of mutual fund assets. 15 Collectively mutual funds own 

30 percent of the U.S. stock market capitalization. 16 Clearly, what is good for institutional investors is also beneficial for the small investor. 

The institutional investors that primarily trade on behalf of the small investor 

constitute roughly 25–35 percent of average daily stock trading volume in the U.S. 17

And today institutional trading costs are historically low. Based on institutional 

trade data compiled by leading finance academics, the average transaction cost for 

an institutional order of 1 million shares for a $30 stock is at a historic low of 40 

basis points. 18 This includes additional costs associated with price movement from 

information leakage. The costs of trading these large orders can exceed bid/ask 

spreads if there is information leakage that a large order is being placed and the 

price of the trade subsequently moves against the buyer. To prevent this, institutional traders split large orders into small orders for execution to avoid tipping off 

other market participants that a large order has entered the market. Neither retail 

nor institutional investors appear to have suffered from the increase in HFT trading 

32 

19 Id. 20Mary Jo White, Chair, U.S. Sec. and Exch. Comm., ‘‘Enhancing Our Equity Market Structure’’, Speech at Sandler O’Neill & Partners, L.P. Global Exchange and Brokerage Conference 

(Jun. 5, 2014). 21 Id. 22See NYSE Circuit Breakers, available at https://usequities.nyx.com/markets/nyse-equities/ 

circuitbreakers. 

activity. If anything, market participants are experiencing the best trading conditions ever seen. 

In addition to transaction costs, market volatility and more importantly severe 

market dislocations are also a primary concern for all investors. Critics of HFT contend that HFT strategies have led to a significant increase in stock market volatility 

caused merely by HFT trading activity, rather than changes to the fundamentals 

of stocks. However, respected market structure experts continue to believe that volatility is largely driven by macroeconomic concerns and not HFT activity. Stock market volatility, as proxied by the CBOE Volatility Index (VIX), understandably rose 

during the heart of the financial crisis, but has since fallen to its lowest levels in 

seven years. Intraday volatility of individual stocks also remains low. Professor 

Larry Harris has found that there is no clear pattern that stock market volatility 

or the intraday volatility of individual stocks has accompanied the rise of HFT. 19

And while the extreme volatility experienced during the flash crash in 2010 was a 

significant market disruption that should not be repeated, the SEC has largely addressed this concern by implementing single-stock circuit breakers and revising 

marketwide circuit breakers that will temporarily halt trading if price movements 

become too volatile. 

Thus, it is hard to argue that the U.S. equity market is ‘‘broken’’ as a result of 

the emergence of HFT activity. Nonetheless, there is always room for targeted improvement of the current regulatory structure, including with respect to certain 

practices of HFT traders. But we should proceed cautiously and thoughtfully so as 

not to chill legitimate market functions. There are risks to implementing any 

changes which must be assessed—for example, bid/offer spreads could widen or exchange volumes (and with it liquidity) could drop. 

As a first step, we must precisely identify what practices warrant further regulatory scrutiny. Defining high frequency trading is far from straightforward. For example, many institutional traders place relatively small trades with high frequency, 

but whether this is a unique and potentially abusive investment strategy or whether 

this is simply an optimal trading strategy that has evolved with automated trading 

(e.g., to execute a large block trade without exposing the size of the order), is a baseline question. Technological advances mean that modern trading is done electronically with orders no longer being given to a broker on an exchange floor. And trading is getting faster every year. We can’t put the genie back in the bottle; Mary Jo 

White recently acknowledged that ‘‘the SEC should not roll back the technology 

clock.’’ 20

At the same time, there are certainly many general risks that come with automated and faster trading. We need to make sure our rules keep up with industry 

technology. Regulation has not kept pace with technological advances. As Mary Jo 

White acknowledged, ‘‘many market structure rules and industry practices were developed with manual markets in mind.’’ 21 We have seen other significant changes 

in response to modern technology before—for example, following the October ’87 

crash, when the NYSE implemented marketwide circuit breakers in response to the 

recommendations of a presidential task force. 22

Market instability is something everyone agrees we need to avoid, to the extent 

possible. In our fast-paced world, our markets are particularly susceptible both to 

fat finger mistakes and errors, as well as intentional, manipulative behavior by certain market participants. The incredible speed at which we now trade can exacerbate errors, and quickly. 

We need to ensure the safety and soundness of our markets. Fortunately, as I 

have previously mentioned, the SEC and securities industry have already taken a 

number of steps to address this topic. For example, in addition to circuit breakers, 

the SEC has issued requirements for market participants to address technology 

risks through the Market Access Rule and proposed Regulation SCI. The Consolidated Audit Trail is expected to be operational in 2016 and will provide the SEC 

comprehensive data regarding the routing and execution of orders, allowing regulators to better prevent, identify and respond to any firms engaged in harmful practices. 

Critics of HFT contend that HFT firms have access to proprietary data feeds from 

the exchanges that provide them with information before other traders, allowing 

33 

23 Rosenblatt Securities estimate. 24TABB Forum, ‘‘No, Michael Lewis, the U.S. Equities Market Is Not Rigged’’, http:// 

tabforum.com/opinions/no-michael-lewis-the-us-equities-market-is-not-rigged. 25See Larry Harris, ‘‘Maker-Taker Pricing Effects on Market Quotations’’, Aug. 30, 2013. 26 Id. 27 James J. Angel, Lawrence E. Harris, and Chester S. Spatt, ‘‘Equity Trading in the 21st 

Century: An Update’’, June 21, 2013. 

them to ‘‘front run’’ the market. However, it is important to be clear that trading 

on information that is publicly available is different than a broker trading ahead 

of a customer, which is patently illegal. Michael Lewis points out examples in which 

he claims that HFT traders obtain an advantage in the market when brokers trade 

only a small portion of a larger customer order with the HFT to gain a rebate on 

that small portion. The HFT then uses the information from the small order to 

trade ahead of the remainder of the customer’s order, thus resulting in the broker’s 

customer receiving an inferior price for the remainder of the order. However, the 

flaw in these examples is that brokers actually route customer orders in a manner 

that ensures that their customers’ orders arrive at various trading platforms at the 

exact same time, so customers receive the best price for their full order. Such routing practices are consistent with brokers’ legal requirement to seek the best execution reasonably available for their customers’ orders. Specific examples are described in the appendix. 

Additionally, there is growing public interest in a practice called ‘‘colocation,’’ 

which refers to traders locating their data servers in the same physical space as exchanges to facilitate faster trading and profits, which along with proprietary data 

feeds gave rise to latency arbitrage. In general, latency arbitrage entails the ability 

of HFTs to synthesize quotes from all exchanges faster than other market participants, thus enabling HFTs to trade on those quotes at a profit. One could argue 

that this activity closes the gap between divergent prices in similar ways as other 

forms of arbitrage. While critics question the ‘‘fairness’’ of allowing certain traders 

to benefit from their physical proximity to an exchange or access to proprietary data 

feeds, proponents of the practice point out that the SEC does not allow exchanges 

to discriminate in offering these services. If an exchange offers proprietary data 

feeds or colocation to any traders, it is required to offer access to all other market 

participants, both HFT firms and non-HFT firms, at the same cost. Under this system, every market participant has an opportunity to colocate. If the exchanges no 

longer offered this access to anyone, either by choice or prohibition, a race would 

ensue to acquire the real estate adjacent to the exchange, which could actually limit 

access to many market participants. One might even view colocation as the modern 

incarnation of market makers vying for position on an exchange floor. Furthermore, 

90 percent of all trades are now executed by colocated traders with access to proprietary data feeds, which includes institutional investors acting on behalf of retail investors. 23

Another issue to consider is the increasing technology ‘‘arms race’’ occurring 

among HFTs. To beat out competitors, HFTs invest more heavily in powerful and 

expensive technology to gain an edge over the competition. But increased competition among HFTs may further reduce costs for the rest of the market as HFT margins decline. The TABB Group estimates that HFT revenues in the U.S. have 

dropped from $7.2 billion in 2009 to $1.3 billion in 2014. 24

Much discussion recently has also revolved around the ‘‘maker-taker’’ pricing system that developed roughly 17 years ago, well before the rise of HFTs. 25 On a trading platform with ‘‘maker-taker’’ pricing, the liquidity taker pays a fee and the liquidity provider receives a rebate. The first venue to introduce maker-taker pricing 

was Island ECN in 1997. 26 While some have introduced various criticisms of makertaker pricing, this is neither a system nor a problem created by HFTs. The makertaker pricing system can exist in low frequency trading environments and HFT environments alike. 

Finally, I note that certain critics of HFTs are also highly critical of the ‘‘dark 

pools’’ where these traders, along with other institutional investors, increasingly 

trade. It is estimated that 15 percent of stocks are now executed in dark pools, 

where information about orders is not publicly displayed. 27 Critics suggest that 

dark trading inhibits the pricing function of secondary markets, and also question 

their opacity more generally. It is important to note, however, that neither dark 

pools nor market fragmentation more generally are ‘‘problems’’ that arose because 

of HFT. The automation of equity trading following the SEC’s adoption of Regulation National Market System (Reg NMS) in 2005 led to a fragmentation of execution 

venues, including SEC registered exchanges as well as alternative trading venues 

like dark pools. Thus dark pools and fragmentation were partly the result of regulaVerDate Nov 24 2008 11:30 Dec 19, 2014 Jkt 046629 PO 00000 Frm 00037 Fmt 6621 Sfmt 6621 L:\HEARINGS 2014\06-18 HIGH FREQUENCY TRADING S IMPACT ON THE ECONOMY\H
34 

28See Gary Cohn, Op-Ed, ‘‘The Responsible Way To Rein in Super-Fast Trading’’, Wall Street 

Journal, Mar. 20, 2014; and James J. Angel, Lawrence E. Harris, and Chester S. Spatt, ‘‘Equity 

Trading in the 21st Century: An Update’’, June 21, 2013. 29See Mary Jo White, Chair, U.S. Sec. and Exch. Comm., ‘‘Enhancing Our Equity Market 

Structure’’, Speech at Sandler O’Neill & Partners, L.P. Global Exchange and Brokerage Conference (Jun. 5, 2014). 

tion. In addition though, there were general market forces at work. Buy-side traders 

who questioned whether their trades were being front-run on traditional exchanges 

turned to dark pools because of the protection that dark trading brings from potential front-running. One key benefit to dark pools is that orders are not displayed, 

thus it is difficult to front-run them or to know when large blocks are being bid and 

offered. Furthermore, it is important to remember that a Reg NMS stock can only 

be traded in the dark if it is executed at a price that is equal to or better than the 

best publicly available price on an exchange. In addition, dark pools are required 

to offer post-trade transparency, as executed stocks are publicly reported in real 

time. While proposals to further reform dark pools, for example, by requiring disclosure of trading practices or fee structures or imposing antidiscrimination rules, may 

warrant further attention, such reforms are unrelated to HFT and outside the scope 

of my testimony today. 

I would now like to present a few specific proposals that I believe could be helpful 

in ensuring the safety and security of our automated world. 

First, regulators should consider mandating and harmonizing exchange-level kill 

switches. A kill switch is a mechanism that would halt a firm’s trading activity 

when a preestablished exposure threshold has been breached, thus stopping erroneous orders and preventing any further uncontrolled accumulation of positions. For 

example, if a trading firm typically only holds $1,000,000 in shares of NASDAQtraded stock during any point in the trading day, it could be required to implement 

a kill switch at 5 times that exposure-level, or $5,000,000 in shares of NASDAQtraded stocks. If the threshold is breached, further trading would be prevented and 

the firm’s open orders on NASDAQ would be halted. It is important that such kill 

switches be mandatory at the exchange level. This would serve to further mitigate 

volatility related to errant algorithms or ‘‘fat finger’’ errors. 

Second, we might consider addressing the volume of order message traffic, which 

can create market instability, by establishing order-to-trade ratios. Electronic order 

instructions are used to direct the placement, cancellation and correction of orders. 

Since 2005, order flow has increased by 1,000 percent while trade volume has increased by only 20 percent. 28 As was experienced during the 2010 flash crash, a 

spike in orders and cancellations can exacerbate market volatility and overwhelm 

the exchanges’ infrastructure. The current market structure only places costs on 

trade executions, thereby allowing market participants to generate excessive ordermessage traffic without internalizing the costs of the negative externalities just described. Regulators should assess why order volumes have increased and consider 

charging fees for extreme message traffic, keeping in mind that any order-to-trade 

ratios should depend on the liquidity of the stock. 

Third, regulators should consider abolishing immunity that exchanges have from 

liabilities for losses from market disruptions based on their SRO status. For example, NASDAQ received immunity from liability for half-a-billion dollars of losses incurred by brokers from the Facebook trading glitch because it claimed it was acting 

in its SRO, and not its for-profit, capacity. If immunity does not apply to activities 

related to smart routing and other technology offerings, this might better align the 

exchanges’ incentives to limit potentially risky trading activity that could pose widespread operational risk. 

In addition to the proposals discussed above, I wanted to address two recent suggestions by Mary Jo White. First, the SEC staff is working to develop a recommendation for an antidisruptive trading rule. 29 In theory, such a rule has potential as a targeted solution aimed at aggressive short-term traders. However, ‘‘the 

devil is in the details.’’ While such a rule would be aimed at active proprietary traders during specific, short time periods when the markets are most vulnerable, basic 

questions will need to be addressed, such as which traders should be restricted, during which time periods, and for which activities. There may be some clear-cut cases, 

where for instance it would be easy to craft a rule that says: ‘‘don’t short further 

during a period where stock’s value has declined by x.’’ But it is perhaps not as 

clear-cut as to whether we should impose an affirmative market-making obligation 

during periods of stress. None of this is to say an antidisruptive trading rule is undesirable; however, it would need to be formulated carefully. 

35 

30 Id. 31 A trade-at rule requires brokers and dark pools to route trades to public exchanges, unless 

they can execute the trades at a meaningfully better price than available in a public market. 

It is unclear how the SEC would define a meaningfully better price. 

White has also asked her staff to propose a recommendation that would subject 

unregistered active proprietary traders to the SEC’s rule as dealers. 30 Again, such 

a rule could potentially be an effective tool in monitoring and regulating the behavior of harmful trading practices. But it may be difficult to identify which ‘‘unregistered active proprietary traders’’ should be subject to broker-dealer requirements. 

We have seen similar difficulties in the new practice of designating ‘‘swap dealers’’ 

under Dodd-Frank. Furthermore, a number of these entities may be subject to oversight already. The SEC should ensure that any registration requirements are 

streamlined and coordinated. 

Finally, I’d like to address the topic of decimalization. As I mentioned up front, 

I eagerly await the specifics of the SEC’s pilot program on tick sizes. I would hope 

that the SEC pays particular attention when applying different metrics to different 

types of securities covered by the program, so as not to introduce additional operational risk through increasingly complex trading rules for these stocks. For example, I understand the SEC is considering dividing the pilot into three groups of 

stocks, which trade at different increments and may or may not be subject to the 

‘‘trade at’’ rule. 31 I encourage the SEC to keep in mind the safety and soundness 

of our equity markets when finalizing the design for this pilot. 

Thank you and I look forward to your questions. 

APPENDIX 

The following are specific examples of allegedly predatory trading behavior by 

HFTs from Flash Boys. I follow with a response to the perceived problem posed by 

the example. 

Example 1: On pages 74–75, the example has a customer wishing to purchase 100,000 shares of XYZ Company at $25 per share. In this example, 100 shares are 

offered on BATS for $25 and 10,000 shares are offered by other sellers on each of 

ten more exchanges. Lewis suggests that the broker’s router will send the buy order 

to BATS first to receive a rebate offered by BATS, even though BATS is only offering 100 shares. However, the problem then arises that once the BATS trade is executed, the other 100,000 shares available may disappear before they can be purchased. 

This example fails to recognize how brokers actually route customer trades in 

order to satisfy their ‘‘best execution’’ requirement, which precedes Reg NMS. In 

practice, brokers will send orders to acquire the 100 shares on BATS and 10,000 

shares on the ten other exchanges at the same time. In fact, brokers have flexibility 

to actually send the order for 100,000 shares of XYZ Company to the other exchanges slightly before they send the 100 share order to BATS, if the broker reasonably believes this will achieve a lower fill price for the customer’s complete order 

for XYZ Company. 

Example 2: On pages 137–138, the example has a customer wishing to purchase 

shares of IBM through a broker (Goldman Sachs in this example). In this example, 

the broker is required to purchase 100 shares on BATS for $19.99 before purchasing 

500 shares on the NYSE for $20.00 due to Reg NMS. As a result, the same problem 

then arises that once the BATS trade is executed, the other 500 shares available 

may disappear before they can be purchased. 

Again, the broker would route the 600 IBM share order to both exchanges simultaneously. The broker even has the flexibility to route the 500 share order to the 

NYSE before the 100 share order to BATS, if the broker reasonably believes this 

would achieve a lower fill price for the customer’s order for IBM. 

Example 3: On page 222–223, the example has a customer wishing to purchase 

100,000 shares of P&G through a broker (Bank of America in this example). The 

customer is willing to pay up to $82.97. The broker first pings IEX looking to buy 

100 shares, but then fails to send a larger order subsequently. In this example, 

Lewis suggests that a seller of 100,000 shares at $82.96 could have existed at IEX, 

which the broker missed. Instead the broker pings IEX with multiple 100 share orders, thus ‘‘goos[ing] up the price.’’ 

The flaw with this example is that the broker does not know that there is really 

a ‘‘seller waiting on it’’ for 100,000 shares. Furthermore, if the entire 100,000 share 

order had been sent, and only 1,000 was executed (since the example states that 

there are only 1,000 shares listed), the broker would have revealed the entire size 

of the order, thus dramatically ‘‘goosing’’ up the stock much more than the 100 

share pings. 

36 

PREPARED STATEMENT OF JEFFREY M. SOLOMON 

CHIEF EXECUTIVE OFFICER, COWEN AND COMPANY, LLC, AND COCHAIR, EQUITY

CAPITAL FORMATION TASK FORCE

JUNE 18, 2014 

Over the past few years, there has been significant debate about the economic impact of High Frequency Trading (HFT) on the Equity Capital Markets in the United 

States. Much of this discussion focuses on the specific activities of these market participants and how the rise in their trading activity has introduced increased risk 

and volatility—even within the inner workings of equity market function. In other 

words, memories of the May 2010 ‘‘Flash Crash’’ are still fresh in the minds of market participants and fears of a repeat event are prevalent. 

However, HFT, in and of itself, is not the root cause of increased market risk. Indeed, we would argue that the challenges surrounding HFT are actually a symptom 

of a more complex market structure that promotes and encourages potentially counterproductive trading behavior—behavior that reduces the availability of capital for 

smaller capitalization companies to expand their business and reduces liquidity for 

investors. As such, any debate about the pros and cons of HFT really needs to address the structure of the equity market that has given rise to its existence. 

Today’s market structure has evolved over the past decade and half as a result 

of several regulatory changes regarding trading increments, fair access and order 

routing changes just to name a few. To be clear, each of these changes was well 

intended and has had positive effects on market participants. Yet there are a significant number of market participants who have grown increasingly skeptical that the 

sum total of these changes has actually resulted in a market that is holistically better or worse. 

Rather than debate that point, we are encouraging lawmakers and regulators to 

explore and implement modifications to the current market structure to further improve equity market function. In doing so, our aim should be to accomplish objectives that further enhance the capital markets in the United States, which are still 

the best in the world, but are increasingly under siege as other global marketplaces 

evolve. These goals should be clearly defined in their objectives, observable in their 

outcomes, and easily modified as additional data around market performance is 

gathered. 

To be clear, if we remain stagnant in our approach to equity market structure in 

this country, we are increasingly putting our economic growth and private sector job 

creation at risk. Conversely, improvements to the equity market function will not 

only improve the market experience for all participants, but it will continue to foster 

the kind of economic activity that has been the hallmark of the American Experience since the outset of the Industrial Revolution. Later in this testimony, we will 

lay out specific observations around market structure that we strongly believe are 

inhibiting capital formation in industries that are vital to the continued economic 

growth of the United States. 

In making assessments about market structure, we have encouraged regulators 

and legislators to be balanced and thoughtful in their approach, while attempting 

to implement change. With just about any market-developed convention, there are 

both positive and negative aspects to the presence of electronically driven trading 

firms that utilize algorithmic-based programs to identify profit opportunities and 

execute upon them. One such positive is that many market participants who engage 

in High Frequency Trading are able to generate profits at very thin trading spreads. 

This attribute has led to a significant reduction in transaction processing and execution costs which has translated into lower commissions paid by all market participants. 

However, in the quest to accomplish this goal, we have created a highly fragmented marketplace that is quite hostile to the vital functions necessary to promote 

the capital formation that leads to private sector job growth. Not only has there 

been a substantial decline in small company IPOs over the past decade-and-a-half 

(transactions raising $60 million or less), but many small-cap public companies have 

also suffered from a lack of capital formation which has inhibited their ability to 

raise capital efficiently leading to limited job creation, innovation, and investment 

opportunities stemming from startups and small companies. 

For this reason, a group of market participants representing a cross section of the 

startup and small-cap company ecosystem formed the Equity Capital Formation 

(ECF) Task Force to examine the challenges that America’s startups and small-cap 

companies face in raising equity capital in the current public market environment 

and develop recommendations for policy makers that will help such companies gain 

greater access to the capital they need to grow their businesses, create new indusVerDate Nov 24 2008 11:30 Dec 19, 2014 Jkt 046629 PO 00000 Frm 00040 Fmt 6621 Sfmt 6621 L:\HEARINGS 2014\06-18 HIGH FREQUENCY TRADING S IMPACT ON THE ECONOMY\H
37 

tries, provide increased competition to the markets, and ultimately create private 

sector job growth. 

The attached report from the ECF Task Force, ‘‘From the On-ramp to the Freeway: Refueling Job Creation and Growth by Reconnecting Investors With Small-Cap 

Companies’’, was presented to the United States Treasury in November, 2013, and 

sets out two areas for consideration: (1) the implementation of a pilot program 

aimed at increasing liquidity in small-cap stocks by fostering a simpler, more orderly market structure for trading small-cap stocks and (2) the expansion of access 

to capital for small startups and micro-cap companies by completing the regulatory 

changes outlined in the JOBS Act relative to Regulation A+ and resolve conflicts 

with state laws. These recommendations are designed to enhance capital formation 

for small companies while balancing the needs of investor protection and preserving 

many of the important improvements made to the market structure to which we 

have become accustomed. 

The United States’ one-size-fits-all capital markets ecosystem makes capital formation for small-cap companies challenging. Today’s market structure is marked by 

speed of execution, lower transaction costs and sub-penny increments, which favors 

liquid, large-cap stocks and inadvertently fosters illiquidity in small-cap stocks 

where the benefits of High Frequency Trading are less obvious. As we discuss in 

the attached report, for many small-cap investors, true price discovery and market 

depth are of greater importance than speed of execution. Indeed, the current market 

structure which favors speed over price discovery is highlighted as a key reason why 

institutional investors, who are the primary providers of capital for small companies, have remained on the sidelines—forgoing investment in this critical ecosystem 

because the risk of position illiquidity is too great. 

A well-designed pilot trading program that allows for a true empirical test of the 

effects of wider spreads and limited increments in small-cap stocks will encourage 

fundamental buyers and sellers to meaningfully engage with each other, bringing 

the volume and depth necessary to enhance liquidity in the small-cap market. These 

proposed recommendations would extend to approximately 2 percent of the average 

daily market volume and would certainly be worth the upside of greatly expanded 

economic activity. Importantly, long-term market structure changes in the small-cap 

market will cause other market participants to adjust their trading practices and/ 

or business models accordingly. 

The health of the U.S. capital markets system is critical to driving private sector 

job growth and by extension, America’s future prosperity. As stewards of this system 

and the public interest, policymakers and market participants have a duty to ensure 

that our markets remain fair and orderly, and that their benefits reach the largest 

number of Americans possible. 

We have the opportunity to reexamine the current market structure as it relates 

to small companies and address some of the remaining barriers to accessing growth 

capital to further support the momentum generated by the success of the JOBS Act. 

We can support the growth of America’s most promising private and public growth 

companies by allowing them to access the capital markets to fund their growth, create new industries and provide increased competition to the markets. We owe it to 

those seeking jobs and those small companies creating opportunities to try to adjust 

a small part of the market in order to bring job opportunities to those hard working 

individuals. And we can do it without sacrificing many of the benefits that many 

investors enjoy that were brought about by the advent of the current electronically 

driven market structure. 

38 

39 

40 

41 

42 

43 

44 

45 

46 

47 

48 

49 

50 

51 

52 

53 

54 

55 

56 

57 

58 

59 

60 

61 

62 

63 

64 

65 

66 

67 

68 

69 

1T. Rowe Price Associates, Inc., a wholly owned subsidiary of T. Rowe Price Group, Inc., together with its advisory affiliates (collectively, ‘‘T. Rowe Price’’), had $711.4 billion of assets 

under management as of March 31, 2014. T. Rowe Price has a diverse, global client base, including institutional separate accounts; T. Rowe Price sponsored and sub-advised mutual funds, and 

high net worth individuals. The T. Rowe Price group of advisers includes T. Rowe Price Associates, Inc., T. Rowe Price International Ltd, T. Rowe Price Hong Kong Limited, T. Rowe Price 

Singapore Ltd., T. Rowe Price (Canada), Inc., and T. Rowe Price Advisory Services, Inc. 

PREPARED STATEMENT OF ANDREW M. BROOKS 

VICE PRESIDENT AND HEAD OF U.S. EQUITY TRADING, T. ROWE PRICE ASSOCIATES, 

INC. 

JUNE 18, 2014 

Introduction 

Chairman Warner, Ranking Member Johanns, and distinguished Members of the 

Senate Subcommittee on Securities, Insurance, and Investment, thank you for the 

opportunity to testify today on behalf of T. Rowe Price 1 regarding the impact of high 

frequency trading (HFT) on the economy. My name is Andrew (Andy) M. Brooks. 

I am Vice President and Head of U.S. Equity Trading of T. Rowe Price Associates, 

Inc. I joined the firm in 1980 as an equity trader and assumed my current role in 

1992. This is my 34th year on the T. Rowe Price trading desk. 

T. Rowe Price, founded in 1937, is a Baltimore-based global adviser with $711.4 

billion in assets under management as of March 31, 2014 and serving more than 

10 million individual and institutional investor accounts. 

We welcome the opportunity for discussion regarding the industry and market 

practices. 

Since I last testified before this Committee in September 2012, we have seen considerable turnover in Congress, this Committee, and at the U.S. Securities and Exchange Commission (‘‘SEC’’, or the ‘‘Commission’’); however, there has been little 

change in addressing the issues discussed 21 months ago, although we do applaud 

the SEC’s efforts in implementing limit up and limit down controls and developing 

the Consolidated Audit Trail. Additionally, we are encouraged by Chair Mary Jo 

White’s recent comments suggesting a heightened focus on improving market structure and we appreciate this Committee’s continued interest in improving our markets. However, order routing practices, payment for order flow, maker/taker pricing, 

market data arbitrage, and the myopic quest for speed are all issues that remain 

unaddressed. In addition, we have grown increasingly concerned about the growth 

of dark pools and the challenges of the direct ‘‘fast’’ feed operating alongside the 

‘‘slow’’ Securities Information Processor (SIP) feed. We recognize that change in 

Washington is constant, but would like to emphasize the fact that the fundamental 

market structure issues we face as an industry are ever evolving and are incapable 

of being resolved without regulatory intervention. 

Although this hearing is focused on HFT, we believe HFT is merely symptomatic 

of larger market structure problems. We are cautious not to lump all electronic trading into the class of HFT and further, we do not believe that all HFT is detrimental 

to the market. We are supportive of genuine market making; however, we acknowledge that there are predatory strategies in the marketplace that have been enabled 

by our overly complex and fragmented trading markets. Those parties utilizing such 

strategies are exploiting market structure issues to their benefit and to the overall 

market’s and individual investor’s detriment. 

We question whether the functional roles of an exchange and a broker-dealer have 

become blurred over the years creating inherent conflicts of interest that may warrant regulatory action. It seems clear that since the exchanges have migrated to 

‘‘for-profit’’ models, a conflict has arisen between the pursuit of volume (and the resulting revenue) and the obligation to assure an orderly marketplace for all investors. The fact that 11 exchanges and over 50 dark pools operate on a given day 

seems to create a model that is susceptible to manipulative behaviors. If a market 

participant’s sole function is to interposition themselves between buyers and sellers 

we question the value of such a role and believe that it puts an unneeded strain 

on the system. It begs the question as to whether investors were better served when 

exchanges functioned more akin to a public utility. Should exchanges with de minimus market share enjoy the regulatory protection that is offered by their status as 

exchanges, or should they be ignored? 

Additionally, innovations in technology and competition, including HFT, have increased market complexity and fragmentation and have diluted an investor’s ability 

to gauge best execution. For example, in the race for increased market share, exchanges and alternative trading venues continue to offer various types of orders to 

70 

2 Bain, S., Mudassir, S., Hadiaris, J., and Liscombe, M. (2014). RBC Capital Markets, ‘‘The 

Impact of Intraday Volatility on Investor Costs: Insights Into the Evolution of Market Structure’’, RBC Capital Markets. 3 ‘‘U.S. Stock Ownership Stays at Record Low’’. (n.d.). ‘‘U.S. Stock Ownership Stays at Record 

Low’’. Retrieved June 17, 2014, from http://www.gallup.com/poll/162353/stock-ownershipstays-record-low.aspx. 4Lewis, M. (2014). Flash Boys: A Wall Street Revolt. New York: W.W. Norton & Company, 

Inc. 

compete for investor order flow. Many of these order types facilitate strategies that 

can benefit certain market participants at the expense of long-term investors and, 

while seemingly appropriate, often such order types are used in connection with 

predatory trading strategies. We are supportive of incremental efforts, such as a recent initiative by the New York Stock Exchange to eliminate 12 order types from 

their offerings. 

We also believe that increased intraday volatility over the past few years is symptomatic of an overly complex market. Though commission rates and spreads have 

been reduced, intraday volatility continues to be alarmingly high. It was refreshing 

to see a recent report from RBC Capital Markets 2 examining the impact of intraday 

volatility and exposing the high costs to investors. Most academics only look at close 

to close market volatility. 

Increased market complexity results in a lack of investor confidence. Our firm is 

particularly focused on the interests of long-term investors although we appreciate 

the role other types of investors can have in creating a dynamic marketplace. A recent Gallup poll noted that American household ownership of stocks continues to 

trend well below historic norms. 3 One can never be sure what drives investor behavior, but it seems clear to us that we need to do a better job of earning investor’s 

confidence in the market. Those investors who have stayed on the sidelines in recent 

years, for whatever reason, have missed out on significant equity returns. We worry 

that the erosion of investor confidence can undermine our capital markets, which 

are so important to the economy, job growth, and global competitiveness. Re-affirming a strongly rooted commitment to fairness and stability of the market’s infrastructure is critically important. 

Over the past two decades the markets have benefited from innovations in technology and competition. Generally, markets open at 9:30 a.m., close at 4:00 p.m., 

and trades settle efficiently and seamlessly. The markets function in an orderly 

fashion, but if one were designing a market from scratch we doubt that we would 

end up with the overly complex structure we have today. 

Vibrant and robust markets function best when there are varied investment opinions, styles, and approaches. However, given the myriad of ways to engage in the 

markets, we feel that investors would benefit from an increased focus on market 

structure, particularly features that enable predatory and manipulative practices. 

We applaud looking into an enhanced oversight of HFT and other high frequency 

strategies and conflicts of interest in our current market structure. Disruptive HFT 

strategies are akin to a tax loophole that has been exploited and needs to be closed. 

Market participants utilizing such strategies are essentially making a riskless bet 

on the market, like a gambler who places a bet on a race that’s already been run 

and for which he knows the outcome. 

Suggestions 

In the spirit of advancing the interests of all investors we might make the following suggestions: 

A good first step might be to experiment with a number of pilot programs to examine different structural and rule modifications. We envision a pilot program 

where all payments for order flow, maker-taker fees, and other inducements for 

order flow routing are eliminated. We also envision a pilot that incorporates wider 

minimum spreads and some version of a ‘‘trade at’’ rule, which we believe would 

lead to genuine price improvement. These programs should include a spectrum of 

stocks across market caps and average trading volumes, among other factors. Additionally, we would advocate for a pilot program that would mandate minimum trade 

sizes for ‘‘dark pools.’’ ‘‘Dark pools’’ were originally constructed to encourage larger 

trading interests and it seems perverse that many venues on the ‘‘lit’’ markets or 

exchanges have a larger average trade size than ‘‘dark pools’’. 

HFT and market structure issues were recently brought into the public spotlight 

by Michael Lewis and his book Flash Boys. 4 Sometimes it takes a storyteller like 

Mr. Lewis to bring the attention needed to an issue, and we hope that all parties 

involved will come together and seize this opportunity to improve our markets. 

Again, we would advocate for pilot programs to test and ultimately implement 

measured yet significant changes. At the end of the day we are here because of our 

71 

firm commitment to all investors to ensure that the capital markets perform the 

functions for which they were designed-capital formation for companies and investment opportunities for both institutions and individuals. 

On behalf of T. Rowe Price, our clients, and shareholders, I want to thank the 

Committee for the opportunity to share our views on how we can, together, make 

our markets as good as they can be. 

72 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

ILLUSTRATIONS OF MINIFLASH CRASHES FROM MAY 13, 2014, 

SUBMITTED BY CHAIRMAN WARNER 

73 

74 

75 

STATEMENT SUBMITTED BY GREG MILLS, HEAD OF GLOBAL EQUITIES 

DIVISION, RBC CAPITAL MARKETS 

76 

77 

78 

79 

80 

81 

82