U.S. GOVERNMENT PRINTING OFFICE

65–803CC WASHINGTON : 2000

DECIMALS 2000—WILL THE EXCHANGES

CONVERT?

HEARING

BEFORE THE

SUBCOMMITTEE ON

FINANCE AND HAZARDOUS MATERIALS

OF THE

COMMITTEE ON COMMERCE

HOUSE OF REPRESENTATIVES

ONE HUNDRED SIXTH CONGRESS

SECOND SESSION

JUNE 13, 2000

Serial No. 106–107

Printed for the use of the Committee on Commerce

(

(II)

COMMITTEE ON COMMERCE

TOM BLILEY, Virginia, Chairman

W.J. ‘‘BILLY’’ TAUZIN, Louisiana

MICHAEL G. OXLEY, Ohio

MICHAEL BILIRAKIS, Florida

JOE BARTON, Texas

FRED UPTON, Michigan

CLIFF STEARNS, Florida

PAUL E. GILLMOR, Ohio

Vice Chairman

JAMES C. GREENWOOD, Pennsylvania

CHRISTOPHER COX, California

NATHAN DEAL, Georgia

STEVE LARGENT, Oklahoma

RICHARD BURR, North Carolina

BRIAN P. BILBRAY, California

ED WHITFIELD, Kentucky

GREG GANSKE, Iowa

CHARLIE NORWOOD, Georgia

TOM A. COBURN, Oklahoma

RICK LAZIO, New York

BARBARA CUBIN, Wyoming

JAMES E. ROGAN, California

JOHN SHIMKUS, Illinois

HEATHER WILSON, New Mexico

JOHN B. SHADEGG, Arizona

CHARLES W. ‘‘CHIP’’ PICKERING,

Mississippi

VITO FOSSELLA, New York

ROY BLUNT, Missouri

ED BRYANT, Tennessee

ROBERT L. EHRLICH, Jr., Maryland

JOHN D. DINGELL, Michigan

HENRY A. WAXMAN, California

EDWARD J. MARKEY, Massachusetts

RALPH M. HALL, Texas

RICK BOUCHER, Virginia

EDOLPHUS TOWNS, New York

FRANK PALLONE, Jr., New Jersey

SHERROD BROWN, Ohio

BART GORDON, Tennessee

PETER DEUTSCH, Florida

BOBBY L. RUSH, Illinois

ANNA G. ESHOO, California

RON KLINK, Pennsylvania

BART STUPAK, Michigan

ELIOT L. ENGEL, New York

TOM SAWYER, Ohio

ALBERT R. WYNN, Maryland

GENE GREEN, Texas

KAREN MCCARTHY, Missouri

TED STRICKLAND, Ohio

DIANA DEGETTE, Colorado

THOMAS M. BARRETT, Wisconsin

BILL LUTHER, Minnesota

LOIS CAPPS, California

JAMES E. DERDERIAN, Chief of Staff

JAMES D. BARNETTE, General Counsel

REID P.F. STUNTZ, Minority Staff Director and Chief Counsel

SUBCOMMITTEE ON FINANCE AND HAZARDOUS MATERIALS

MICHAEL G. OXLEY, Ohio, Chairman

W.J. ‘‘BILLY’’ TAUZIN, Louisiana

Vice Chairman

PAUL E. GILLMOR, Ohio

JAMES C. GREENWOOD, Pennsylvania

CHRISTOPHER COX, California

STEVE LARGENT, Oklahoma

BRIAN P. BILBRAY, California

GREG GANSKE, Iowa

RICK LAZIO, New York

JOHN SHIMKUS, Illinois

HEATHER WILSON, New Mexico

JOHN B. SHADEGG, Arizona

VITO FOSSELLA, New York

ROY BLUNT, Missouri

ROBERT L. EHRLICH, Jr., Maryland

TOM BLILEY, Virginia,

(Ex Officio)

EDOLPHUS TOWNS, New York

PETER DEUTSCH, Florida

BART STUPAK, Michigan

ELIOT L. ENGEL, New York

DIANA DEGETTE, Colorado

THOMAS M. BARRETT, Wisconsin

BILL LUTHER, Minnesota

LOIS CAPPS, California

EDWARD J. MARKEY, Massachusetts

RALPH M. HALL, Texas

FRANK PALLONE, Jr., New Jersey

BOBBY L. RUSH, Illinois

JOHN D. DINGELL, Michigan,

(Ex Officio)

3

C O N T E N T S

Page

Testimony of:

Grasso, Richard A., Chairman and CEO, New York Stock Exchange,

Inc .................................................................................................................. 11

Levitt, Hon. Arthur, Chairman, Securities and Exchange Commission ...... 6

Zarb, Frank G., Chairman and CEO, National Association of Securities

Dealers, Inc ................................................................................................... 16

Material submitted for the record by:

Grasso, Richard A., Chairman and CEO, New York Stock Exchange,

Inc., letter dated July 17, 2000, enclosing response for the record .......... 27

Levitt, Hon. Arthur, Chairman, Securities and Exchange Commission,

letter dated July 25, 2000, enclosing response for the record ................... 39

Zarb, Frank G., Chairman and CEO, National Association of Securities

Dealers, Inc., letter dated July 14, 2000, enclosing response for the

record ............................................................................................................. 34

(III)

(1)

DECIMALS 2000—WILL THE EXCHANGES

CONVERT?

TUESDAY, JUNE 13, 2000

HOUSE OF REPRESENTATIVES, COMMITTEE ON COMMERCE, SUBCOMMITTEE ON FINANCE AND HAZARDOUS MATERIALS, Washington, DC.

The subcommittee met, pursuant to notice, at 2:35 p.m., in room

2123, Rayburn House Office Building, Hon. Michael G. Oxley

(chairman) presiding.

Members present: Representatives Oxley, Shimkus, Wilson,

Fossella, Towns, Engel, and Luther.

Staff present: David Cavicke, majority counsel; Linda Rich, majority counsel; Robert Simison, legislative clerk; Shannon

Vildostigvi; professional staff; Brian McCullough, professional staff;

and Consuela Washington, minority counsel.

Mr. OXLEY. The subcommittee will come to order. The Chair

would recognize himself for an opening statement.

Three years ago I introduced a bill, along with Ed Markey and

Tom Bliley, the Common Sense Stock Pricing Act to convert the

U.S. securities markets to decimals. Some folks thought I was behaving like a Democrat telling industry what to do. I supported

decimals for three reasons: One, competition in spreads; two, ease

of understanding; and three, international competitiveness. Three

years later, we have a date when our securities markets will make

the switch from trading in fractions to trading in decimals. Given

the deadlines that have come and gone along the way, I am reminded of the words of the great philosopher, Ringo Starr, ‘‘you

know it don’t come easy.’’

We have a firm commitment from the SEC, the exchanges, and

the industry for conversion to decimals beginning this September.

The patience Congress has shown should not be mistaken for anything other than our steadfast desire to protect investors through

competition.

Decimals is a classic case of a concentrated benefit to some with

a cost spread widely and invisibly. Chairman Bliley, Congressman

Markey and I took the lead to protect the public when others

failed.

Conversion to decimals is a win for our markets. Investors will

be able to pay a fair and accurate price for securities. No longer

will they be forced to quote and trade in the SEC-mandated increments of a 16th, or before that, an 8th. They will quote and trade

securities in prices set by competitive forces. When competition establishes trade increments, whether it be a spread of a nickel, a

2

penny, or less, a fair price will be paid. The SEC should not meddle

with the competitive process. Competition alone should set the

quoting and trade increments.

The study on minimum increments requested by the SEC should

not become an excuse for collusion. Competitive spreads in decimals will save investors money, as much as $3 million a day, according to the GAO. Although that may not seem like a lot of

money to Wall Street, it is to the American investor.

Over the years, the SEC has stood by while fractions have transferred investor money to Wall Street. Today we take a step closer

to allowing the market to put that money back in their pockets,

and as a result of the leadership of Chairman Levitt, we are getting there.

I am pleased that Island ECN will begin trading in decimals on

July 3. I want to salute them for their leadership in the market.

They were able to recognize the need and visualize the benefits of

decimal conversion. For doing so they will get a jump on the rest

of the competition. I also would be disappointed to see SEC rules

or industry plans that inhibit the ability of any competitor to compete on price.

The challenge is for the rest of the market to stick to the conversion schedule to which they have agreed. The SEC needs to monitor the market participants to ensure that all parties are ready to

convert to decimals by the new implementation deadline. The GAO

will continue its work auditing both the SEC and industry to see

that this is completed. Soon investors will receive the benefits of

H.R. 1053, the Common Sense Stock Pricing Act of 1997 by trading

in a decimalized market, a victory we all can be proud of. Decimals

in 2000, the time has come.

At the dawn of the 21st century, our markets will no longer trade

in the increment of the 18th century. I want to specifically thank

our panelists today for their leadership and hard work on this

issue, Chairman Levitt, for your continued guidance and leadership, Chairman Grasso and Chairman Zarb, for your active participation in this. This is a team effort where we have come, and I

can’t thank you enough. With that, let me turn to my good friend,

the ranking member from New York, Mr. Towns, for an opening

statement.

[The prepared statement of Hon. Michael G. Oxley follows:]

PREPARED STATEMENT OF HON. MIKE OXLEY, CHAIRMAN, SUBCOMMITTEE ON

FINANCE AND HAZARDOUS MATERIALS

Three years ago I introduced a bill, the Common Cents Stock Pricing Act, to convert the U.S. securities markets to decimals. Some folks thought I was behaving like

a Democrat—telling industry what to do. I supported decimals for three reasons: (1)

competition in spreads; (2) ease of understanding; and (3) international competitiveness.

Three years later we have a date when our securities markets will make the

switch from trading in fractions to trading in decimals. Given the deadlines that

have come and gone along the way, I am reminded of the words of the philosopher

Ringo Starr—‘‘you know it don’t come easy.’’

We have a firm commitment from the SEC, the exchanges, and the industry for

conversion to decimals beginning this September. The patience Congress has shown

should not be mistaken for anything other than our steadfast desire to protect investors though competition. Decimals is a classic case of a concentrated benefit to some

with the cost spread widely and invisibly. Chairman Bliley, Congressman Markey,

and I took the lead to protect the public when others failed.

3

Conversion to decimals is a win for our markets. Investors will be able to pay a

fair and accurate price for securities. No longer will they be forced to quote and

trade in the SEC mandated increments of a 1⁄16th. They will quote and trade securities in prices set by competitive forces. When competition establishes trade increments, whether it be a spread of a nickel, a penny, or less, a fair price will be paid.

The SEC should not meddle with the competitive process. Competition alone should

set the quoting and trade increments. The study on minimum increments requested

by the SEC should not become an excuse for collusion.

Competitive spreads decimals will bring will save investors money—as much as

$3 million a day—according to the GAO. Although that may not seem like a lot of

money to Wall Street, it is to the American investor. Over the years the SEC has

stood by while fractions have transferred investor money to Wall Street. Today, we

take a step closer to allowing the market to put that money back in their pockets.

I am pleased that Island ECN will begin trading in decimals on July 3rd. I want

to salute them for their leadership in the market. They were able to recognize the

need and visualize the benefits of decimal conversion, and for doing so will get a

jump on the rest of the competition. I also would be disappointed to see SEC rules,

or industry plans, that inhibit the ability of any competitor to compete on price.

Now the challenge is for the rest of the market to stick to the conversion schedule

to which they have agreed. The SEC needs to monitor the market participants to

ensure all parties are ready to convert to decimals by the new implementation deadline. The GAO will continue its work auditing both the SEC and industry to see

that this gets done.

Soon investors will receive the benefits of H.R. 1053, the Common Sense Stock

Pricing Act of 1997 by trading in a decimalized market—a victory we can all be

proud of.

Decimals in 2000—the time has come. At the dawn of the 21st century our markets will no longer trade in the increment of the 18th century.

I yield back.

Mr. TOWNS. Thank you very much, Mr. Chairman. I want to

thank you for holding this hearing. I also want to thank you for

behaving like a Democrat and for your long-standing commitment

to decimal trading in the U.S. equity markets.

U.S. securities markets are very, very important to the economy

of New York City. Therefore, I am committed to making sure that

these markets are competitive internationally. Decimal trading is

an important part of keeping the U.S. equity market internationally competitive, because all of the world’s other equity markets already trade in decimals. I am especially pleased with my good

friend, one of the witnesses here today, Dick Grasso, the chairman

of the New York Stock Exchange. Dick is a visionary, and it is good

to see you here. He has successfully positioned the New York Stock

Exchange to compete in the 21st century, and we congratulate you

for that.

Decimal trading has benefits for investors, too. Trading in pennies or nickels will certainly make it easier for retail investors to

track price movements in their stocks. Trading in pennies will also

result in narrower spreads in many stocks providing significant

savings to investors.

The impact of decimal trading will reach far beyond this. In fact,

I don’t believe that anyone yet fully understands how far-reaching

these changes will be. Decimal trading will affect message traffic

and is likely to have an impact on quote debt and incentives to engage in payments for order flow.

The challenges in starting decimal trading are great and we will

not underestimate that. For this reason, I think it is very prudent

to begin decimal trading with a pilot program before fully implementing decimal trading in all stocks. Again, Mr. Chairman, I

thank you for calling this hearing and I look forward to the testiVerDate 11-MAY-2000 08:10 Oct 30, 2000 Jkt 066288 PO 00000 Frm 00007 Fmt 6633 Sfmt 6602 E:\HEARINGS\65803 pfrm02 PsN: 65803
4

mony coming from the various witnesses, and on that note, I will

yield back.

Mr. OXLEY. I thank the gentleman for his contribution. I now

recognize the gentleman from Staten Island, Mr. Fossella.

Mr. FOSSELLA. Thank you, Mr. Chairman. And welcome to the

panel, distinguished as they may be. Let me commend you as well,

and Chairman Bliley, my good colleague, Ed Towns for pursuing

this as well as Ed Markey, who is not here.

As I said earlier today, this is a common sense measure that I

think is long overdue, and one of the things that was stated earlier,

I think it was Mr. Zarb had talked about one of the wonders of the

last several years has been the growth and participation by ordinary Americans who, decades ago, probably would not have participated in the enhancement of wealth in this country, and it is a

great thing.

I think 1 day every family should own a share of corporate America and will be better off for it. But this is a measure that I think

goes beyond those who just failed math who may not understand

fractions. It is something whose time has come. Over the last couple of years, while the industry, mind you, there were folks who

were in the trenches trying to make this conversion happen, they

deserve a lot of credit too for doing so in an appropriate way and

to the degree that we were able to work and interface with the industry.

I always found them to be honest and people of integrity as those

you see before us, Chairman Levitt, and especially Dick Grasso as

well on the New York Stock Exchange. Not only is it important in

the envy of the world in terms of the capital markets that we

should be very proud of, and these gentlemen and all of whom they

represent, but it is also important to the people I represent. New

York City, as Ed Towns said, is really so closely related to the financial service industry and the markets, and we should never lose

that, but also because people that live in Ed Towns’ district and

people that live in my district work every day for the New York

Stock Exchange and for Nasdaq. So for that, I am grateful. Let’s

get on with the hearing.

[Additional statements submitted for the record follow:]

PREPARED STATEMENT OF HON. TOM BLILEY, CHAIRMAN, COMMITTEE ON COMMERCE

Mr. Chairman, three years ago I joined you and Ed Markey to move our stock

markets to decimals. Decimals are important for two reasons. The first is that investors will save money—a lot of it—by ending SEC mandated minimum spreads. According to the GAO investors will save $2 billion per year. The second reason is that

decimals are easier to understand. Nobody knows how much 13⁄16ths is, but everybody knows how much eighty-one cents is.

After we marked up the Common Cents Stock Pricing Act of 1997, our witnesses

before us today committed to get it done. We have waited patiently for three years,

and through a number of excuses, for conversion to take place. Today, I understand

our witnesses will commit to begin conversion in September and complete it by April

9 of next year.

This is not one minute too soon. Each day you wait, investors lose $3 million to

Wall Street. I expect you will keep your commitment and make this change happen.

When we began this process, we were opposed by much of Wall Street and the SEC.

Now, the continuation of trading in fractions is widely considered an embarrassment. The SEC and the industry need to make this their number one priority.

I would like to applaud those market participants who are ready to make the conversion to decimals sooner. The Island, ECN has announced that it will begin offering decimal trading on July 3. Island should be commended for their efforts to bring

5

greater transparency to the market and American investors. Competition is the best

protector of investors. We should be sure that no barriers are placed in the way of

those who want to offer better prices to the public.

I also repeat my insistence that there be no mandated minimum increments for

quoting or trading. Those practices are illegal under the antitrust laws. Competition’, not collusion, should set prices. I trust that the study of minimum increments

called for by the SEC will not be a vehicle for continued obstruction of market

forces.

Mr. Chairman, I would like to congratulate you on your hard work to bring decimals to our markets. Your tireless advance of this issue is letting American investors see the light at the end of the tunnel. Soon they will also be seeing a more

competitive market where the market decides the price of stocks and not the government. We in Congress led, and the public is the better for it.

I yield back.

PREPARED STATEMENT OF HON. ELIOT L. ENGEL, A REPRESENTATIVE IN CONGRESS

FROM THE STATE OF NEW YORK

Mr. Chairman, I first want to thank you and the distinguished members of this

Subcommittee for having this hearing today. I am equally pleased that Chairmen

Levitt, Grasso, and Zarb taking time to appear before this Subcommittee to discuss

the issue of decimalization.

As you know, Mr. Chairman converting to decimal trading has been one of my

concerns since 1997. All market participants, whether individual investors or professionals, would be affected in some way by a conversion to decimal pricing.

While at times progress toward decimal trading has not been as fast as it could

be, I also want to be sure that Exchanges and market participants have taken measures to prudently implement a transition.

I understand that NYSE is prepared to move forward with decimalization and applaud its efforts bringing NYSE and the U.S. financial market in line with our

International counterparts. However, like a symphony orchestra, unless all market

participants do their parts the financial market may experience unintended consequences. I am aware that NASD may not be fully prepared to move toward

decimalization and look forward to asking questions related to this topic.

Once again, I thank the Chairman and Subcommittee for holding a hearing on

this important matter.

PREPARED STATEMENT OF HON. JOHN D. DINGELL, A REPRESENTATIVE IN CONGRESS

FROM THE STATE OF MICHIGAN

Mr. Chairman, I commend you for holding this hearing and I welcome the panel

of distinguished witnesses.

I believe that an orderly transition to decimal pricing in the United States securities markets will benefit the markets and investors. It will make stock prices more

understandable to the average investor. It also will narrow the quotation spreads

in many stocks, thus providing significant savings to investors. While there is not

a big difference between a nickel and the current 1⁄16th (6.25 cents), there is if the

variation drops to a penny. A penny spread may not prove economical for market

makers, in which case bid and ask prices will widen, and the market, and not the

securities industry, will decide how narrow or wide spreads will be.

The Securities and Exchange Commission (SEC) issued an order on June 8 calling

for a phased-in decimal conversion schedule and full systems testing. The order directs the exchanges and Nasdaq to submit a plan that would phase in decimal pricing for listed stocks and certain options starting no later than September 5, 2000,

and phase in decimal pricing for Nasdaq securities beginning no later than March

12, 2001. All securities must be priced in decimals no later than April 9, 2001. I

believe that this plan is reasonable and responsible, and I will support it.

I do want to raise one concern that I hope will be addressed during the implementation of the SEC’s order. The conversion to decimal pricing for listed securities allows for up to three months of testing, while the testing for Nasdaq securities appears to be only three weeks. Given the proposed NASD timetable, which I understand to be two weeks of self-testing from February 26, 2001 to March 12, 2001,

I am not satisfied that the industry will have sufficient time to test systems in conjunction with the Nasdaq’s new computer system and be ready for full conversion

by March 31, 2001. I urge the SEC, Nasdaq, and the industry to work together to

resolve this shortcoming within the parameters of the SEC order.

6

Mr. OXLEY. I thank the gentleman. We now turn to our distinguished panel and the aforementioned individual. Let me begin

with Chairman Levitt, chairman of the Securities And Exchange

Commission, the longest serving chairman of the Securities And

Exchange Commission in our Nation’s history. Again, we thank you

for your leadership and vision on this issue, Arthur.

STATEMENTS OF HON. ARTHUR LEVITT, CHAIRMAN, SECURITIES AND EXCHANGE COMMISSION; RICHARD A. GRASSO,

CHAIRMAN AND CEO, NEW YORK STOCK EXCHANGE, INC.;

AND FRANK G. ZARB, CHAIRMAN AND CEO, NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.

Mr. LEVITT. Chairman Oxley and members of the subcommittee,

I appreciate the opportunity to address you concerning the transition to decimal pricing in both our securities and options markets.

Your leadership, along with Chairman Bliley, Congressman Markey and other Members of Congress, has paved the way for our Nation’s securities markets to begin making this truly watershed

change this year. The significance of the transformation to decimals is likely to be enormous. Many seasoned market veterans disagree in their predictions of exactly what decimal pricing will mean

for our markets. Most agree, however, that, in the end, investors

will clearly benefit, particularly small investors using market orders. As prices are quoted in smaller and smaller increments, it

will be easier and cheaper for dealers and investors to improve the

bid or offer on a given security; but the imperative to embrace decimal pricing goes beyond the quality of our domestic markets.

As securities markets become more global with many stocks traded in multiple jurisdictions, U.S. markets must adopt the international convention of decimal pricing to remain competitive. I

firmly believe the time is now to make this important move to decimals. The changeover, however, must proceed in a prudent manner. Vigilance on all of our parts and a sharp focus on the maintenance of orderly markets have never been more important.

We have issued an order directing the exchanges and Nasdaq to

submit a plan that would phase in decimal pricing for listed stocks

and certain options starting no later than this coming September,

and for Nasdaq securities no later than March 12, 2001. At least

some securities must begin quoting in pennies in September, and

all securities must be priced in decimals no later than April 9,

2001. But we have afforded markets the flexibility to set a more

aggressive phase-in schedule provided that they can satisfy themselves that there will be minimal disruptions to the markets. I expect that this plan will move our markets appropriately and prudently toward decimal pricing, the goal all of us share, a goal that

was moved constructively and aggressively by this committee and

by a number of members of your staffs. I realize that many of you

have been frustrated with the pace of the market’s conversion to

decimals. I share these frustrations. Earlier this year I was surprised to learn of the NASD’s inability to meet the July 3 conversion deadline.

I do appreciate, however, that unprecedented volume spikes and

unexpected test results contributed to that delay. The experience

reaffirms my judgment that technology must remain second to

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1The Canadian exchanges implemented decimal pricing on April 15, 1996. This change reduced the minimum tick size on the primary Canadian exchange, the Toronto Stock Exchange

(‘‘TSE’’), from 12.5 cents to 5 cents for stocks trading above $5. For stocks trading between $3

and $5, the minimum tick size was reduced from 5 cents to 1 cent. The minimum tick size for

stocks trading under $3 was unchanged. According to a 1997 study, spreads for stocks listed

solely on the TSE narrowed by 20.18%. This study also indicated that investors save 139 million

Canadian dollars per year as a result of the narrowing of the spread (or 102 million U.S. dollars). Because the value of shares traded annually in the U.S. is approximately 30 times that

on the Canadian markets, the potential cost savings for U.S. investors that trade at the spread

using market orders could be significant. See Jeffery M. Bacidore, The Impact of Decimalization

on Market Quality: An Empirical Investigation of the Toronto Stock Exchange, 6 Journal of Financial Intermediation 92, 100-115 (1997). 2See Securities Exchange Act Release No. 42914 (June 8, 2000).

none among the priorities of each of our markets, and that close

Commission oversight is critical. Since March, we have received

numerous briefings by the NASD’s technology group, and we have

scheduled weekly conference calls between the NASD, the Commission, and private technology consultants selected by us. I believe

that the Nasdaq is taking the formidable challenges it faces extremely seriously, and I am completely optimistic that they will

meet this schedule on time.

I look forward to the cooperation and collective effort of all market participants as we move closer to bringing decimal pricing to

our markets. It is a profound and a positive step both for America’s

investors and for America’s competitive edge in the coming global

marketplace.

Thank you.

[The prepared statement of Hon. Arthur Levitt follows:]

PREPARED STATEMENT OF HON. ARTHUR LEVITT, CHAIRMAN, SECURITIES AND

EXCHANGE COMMISSION

Chairman Oxley and Members of the Subcommittee: I would like to thank Chairman Oxley and the members of the Subcommittee for the opportunity to testify on

behalf of the U.S. Securities and Exchange Commission concerning the implementation of decimal pricing. Your leadership has paved the way for our nation’s securities markets to begin making this truly revolutionary change this year.

I. EXECUTIVE SUMMARY

The convention of quoting stock prices in fractions dates back more than two hundred years. Currently, the United States securities markets are the only major markets not to price stocks in decimals. As the securities markets become more global,

with many stocks traded in multiple jurisdictions, the U.S. securities markets need

to adopt the international convention of decimal pricing to remain competitive. And

the overall benefits of decimal pricing are likely to be significant. Investors may

benefit from lower transaction costs due to narrower spreads.1 Moreover, the markets will be easier to understand for the average investor, who is used to dealing

in dollars and cents for every-day transactions. It is time for the U.S. securities

markets to make this change.

The Commission recognizes the efforts of Chairman Oxley, Chairman Bliley, Congressman Markey, and other members of Congress in spearheading the conversion

to decimal pricing. We want to assure you that the Commission is also committed

to implementing decimal pricing as soon as possible. That is why the Commission

issued an order directing the exchanges and Nasdaq to submit a plan that would

phase in decimal pricing for listed stocks and certain options starting no later than

September 5, 2000, and phase in decimal pricing for Nasdaq securities beginning

no later than March 12, 2001.2 Under the order, all securities must be priced in

decimals no later than April 9, 2001—shortly after the end of the quarter.

I realize that many of you are frustrated with the pace of the U.S. markets’ conversion to decimals. I share some of these frustrations. The Commission has been

working with the securities industry to implement decimal pricing since 1997. Like

Congress, we believe the time is right for the securities industry to convert to decimal pricing.

8

3Testimony of Thomas J. McCool, Director, Financial Institutions and Markets Issues, GAO,

before the Subcommittee on Finance and Hazardous Materials, Committee on Commerce, U.S.

House of Representatives on May 8, 1998. The GAO also recommended that the Commission,

in directing the securities industry’s move to decimal pricing, assess: (1) the potential impact

of decimal trading on the industry’s processing and communication capacity; and (2) the impact

on market regulations and exchange rules. 4 As joint discussions regarding the implementation of decimal pricing became more detailed,

the exchanges and NASD began voicing concerns regarding antitrust liability. See, e.g., letter

from Colleen P. Mahoney to Harvey J. Goldschmid, General Counsel, Commission, dated October 14, 1999. 5See Securities Exchange Act Release 42360 (Jan. 28, 2000), 65 FR 5004 (Feb. 2, 2000) (‘‘Decimals Order’’).

Nevertheless, it is critical that this conversion take place in a safe and orderly

manner. The Commission has serious concerns about a full-scale conversion to decimal pricing in listed securities without an orderly phase-in. In particular, based on

our discussions with the industry, we are concerned that making an immediate leap

to decimal pricing could jeopardize systems capacity and capabilities. Without adequate time for planning and systems testing, an immediate full-scale conversion has

the potential to create widespread operational problems, which in turn could adversely affect investors.

Of course, some of the planning and testing has already been completed. Most of

these prior efforts, however, assumed that Nasdaq stocks would be converted to

decimals at the same time as listed stocks. Any different plan to trade listed stocks

in decimals, Nasdaq stocks in fractions, and some options in both, raises issues that

must be addressed. For these reasons, we believe that the prudent approach is to

phase-in decimals starting in September 2000 to ensure that the markets continue

to operate in a fair and orderly manner, and that investors are fully apprised of the

changes ahead. Nevertheless, we have left the markets and the securities industry

the flexibility to set a more aggressive phase-in schedule, provided that they can

satisfy themselves that there will be mimimal disruptions to the markets.

I will now briefly discuss the chronology of events leading up to this point, including the recent Commission order.

II. BACKGROUND

Throughout the mid and late 1990s, the Commission engaged the securities industry and the public in a discussion regarding the need for decimal pricing in the U.S.

securities markets. On March 13, 1997, this debate moved to the legislative arena

when Congressman Oxley introduced a bill in the U.S. House of Representatives

that would have directed the Commission to adopt a rule requiring quotations in

dollars and cents for transactions in equity securities. Subsequently, the New York

Stock Exchange announced that it would implement decimal pricing by January

2000. Other markets soon followed suit. In light of this activity, the bill was not

taken to full markup in the House Commerce Committee.

On May 8, 1998, the General Accounting Office (‘‘GAO’’) determined that

‘‘[e]nsuring that securities industry systems are ready for the Year 2000 is too important to the continued functioning of the industry to risk failure by attempting

to implement decimal trading before the Year 2000 effort is completed.’’ 3 I concurred in this assessment, but I also noted the importance of setting a date certain

by which the markets must move to decimal pricing. At that time, I believed that

the industry should strive to implement decimal pricing by June 30, 2000.

On August 25, 1998, Commission staff requested that the exchanges and the National Association of Securities Dealers, Inc. (‘‘NASD’’) provide information regarding the status of rule and systems changes that would need to be adopted to implement decimal pricing. Their responses indicated that a range of rules and systems

would require modification to accommodate decimal pricing. Because of the impact

of decimal pricing on the securities industry as a whole, virtually all the market

participants, and the Commission, believed that a coordinated approach to implementation was necessary. To expedite the conversion to decimal pricing and to alleviate the industry’s antitrust concerns, 4 on January 28, 2000, the Commission ordered the exchanges and NASD to begin implementing decimals on July 3, 2000,

and to complete implementation for all equities and options within six months after

the July 3rd date.5

The January 28th order also required the markets to submit, by March 13, 2000,

a joint plan detailing specifically how decimal pricing would be implemented. To

mitigate the potential strain on the computer capacity of the industry and to minimize the potential for systems errors, the order permitted the markets to phase-in

decimals over several months and permitted trading to begin in nickel increments

for equities and greater increments for options.

9

6See Securities Exchange Act Release No. 42516 (March 10, 2000), 65 FR 14637 (March 17,

2000). 7 After receiving responses from the markets regarding these questions, the Commission, on

April 13, 2000, issued an order suspending the current deadlines for the implementation of decimal pricing. See Securities Exchange Act Release 42685 (April 13, 2000), 65 FR 21046 (April

19, 2000) (‘‘April Order’’). 8 Id.

Prior to issuing the January 28th order, the Commission staff surveyed the exchanges and NASD regarding their preparation for decimal pricing. I understand

that Nasdaq officials informed the staff that Nasdaq would be ready for a decimal

pilot by July 3rd. In late February, Nasdaq reaffirmed its readiness in its formal

response to the survey, but indicated that it was continuing testing to confirm its

readiness. As I understand it, the testing revealed unexpected capacity problems

stemming, in part, from unprecedented volume surges. On March 6, 2000, the

NASD announced that it would not have sufficient capacity to meet the target dates

for implementation.

The NASD also expressed concerns regarding overall industry readiness and requested that the Commission work with the industry and the markets to determine

an appropriate time frame that would not impose unnecessary risks on investors.

Moreover, the NASD said that it was not able to determine when it would be ready

to implement decimal pricing. As a result, on March 10, 2000, the Commission

issued an order delaying the March deadlines for approximately one month.6 In addition to the March 10th order, I sent a letter to each of the markets requesting

their opinions regarding issues central to the implementation of decimal pricing.

These issues included:

• whether or not it would be feasible or advisable to implement decimal pricing in

exchange-listed securities while Nasdaq securities continued to trade in fractions;

• whether or not it would be feasible to trade the same securities in decimals on

an exchange and in fractions on Nasdaq; and

• what the impact of trading the same securities in fractions and decimals would

be on the options markets.7

In response, the exchanges indicated that their individual systems are capable of

converting to decimal pricing by July 3, 2000, though many of them expressed concerns about the readiness of the securities industry as a whole. The NASD asserted

that Nasdaq has sufficient capacity to implement decimal pricing for market makers

trading exchange-listed securities (i.e., the third market) by September 4, 2000, with

full implementation of decimal pricing by March 31, 2001. Two electronic communications networks stated that they are prepared for decimals, and that trading exchange-listed securities in decimals should not be delayed because of Nasdaq’s inability to meet the July 3rd target date.

The vast majority of the markets and securities firms, however, believed that it

would be difficult and confusing to implement widespread trading of exchange-listed

securities in decimals while trading of Nasdaq securities remains in fractions. Many

responses indicated that bifurcating the implementation of decimal pricing for different markets on other than a pilot basis raised serious concerns. For example,

some responses indicated that trading of Nasdaq stocks in fractions and exchangelisted securities in decimals over an extended period of time could prove costly to

markets, broker-dealers, and vendors. In addition, the Financial Industry Forum

(‘‘FIF’’) pointed out that systems would have to be adapted to perform price format

checking for each and every security traded in a different format. Without this format checking, and considering the investor confusion caused by mixed pricing, the

FIF believed that error rates and corresponding order rejection rates could sharply

increase. Moreover, the Securities Industry Association’s (‘‘SIA’’) Testing and Implementation Subcommittee warned that piecemeal testing of systems would be inefficient. The SIA’s experts found that any testing that was conducted at a point in

time that was distant from the implementation date would not provide an accurate

determination of readiness.

III. DECIMALS PHASE-IN PLAN

In view of these comments, on April 13, 2000, the Commission stayed the deadlines in the original Decimals Order and solicited public comment on two alternative

proposals for decimal implementation.8 In the first alternative, the Commission requested comment on the advisability of pricing all exchange-listed securities in decimals (in nickel or penny increments) by September 4, 2000 (‘‘Dual Pricing’’). In the

second alternative, the Commission requested comment on the advisability of phasVerDate 11-MAY-2000 08:10 Oct 30, 2000 Jkt 066288 PO 00000 Frm 00013 Fmt 6633 Sfmt 6621 E:\HEARINGS\65803 pfrm02 PsN: 65803
10

9See supra note 2.

ing in decimal pricing in certain exchange-listed securities on a pilot basis (‘‘Decimals Pilot’’).

The Commission received 36 comment letters on these decimal implementation alternatives. Some commenters urged the Commission to delay decimalization until

all markets are prepared for decimals. Others supported full decimalization for both

exchange-listed and Nasdaq securities either immediately or no later than the July

3, 2000 start-up date proposed in the Commission’s Decimals Order. The largest

number of commenters, consisting of broker-dealers, exchanges, clearing organizations, the NASD, and the SIA, believed that some form of phased-in dual pricing

starting on or about September 5 would be both feasible and advisable.

The commenters who preferred a phased-in approach varied on the optimal method for achieving this approach. Most of these commenters advocated an extended

pilot of only a small number of listed securities (along the lines of the Decimals Pilot

alternative proposed for comment in the April Order), with most listed securities

moving to decimals at the same time as Nasdaq securities. For example, the SIA

believed that a pilot was more feasible than Dual Pricing because Dual Pricing

would create major difficulties for the securities industry in creating and maintaining separate processes, systems, and programs to trade large number of securities

in decimals while many others trade in fractions. The SIA also believed that a pilot

would simplify educational efforts designed to inform the investing public of the way

in which specific securities would be priced. Other commenters, however, thought

it possible to phase-in decimal pricing in all exchange-listed securities more quickly.

The New York Stock Exchange, for example, favored commencing decimal pricing

in a limited number of NYSE-listed securities, advancing to a full pilot of perhaps

50 NYSE-listed securities during an initial phase-in period of one month or less. The

New York Stock Exchange indicated that an expansion to all of its listed securities

could prudently occur after approximately 60 days of trading in all pilot stocks. All

of the commenters stressed the need for careful planning and systems testing to

avoid potential market disruptions and to minimize investor confusion.

The Commission carefully considered the comments, particularly the request of

Congressmen Oxley, Bliley, and Markey to implement decimal pricing in all exchange-listed securities by September 4, 2000. In view of the concerns raised by

commenters and our own discussions with industry participants, the Commission

came to the conclusion that an immediate full-scale introduction of decimalization

in listed stocks, without adequate planning and systems testing, had the potential

to create widespread operational problems in the markets and the securities industry, which in turn could adversely affect investors.

The Commission therefore ordered the exchanges and Nasdaq to submit a plan

that would phase in decimal pricing for listed stocks and certain options starting

no later than September 5, 2000, and phase in decimal pricing for Nasdaq securities

beginning no later than March 12, 2001.9 Under the order, all securities must be

priced in decimals no later than April 9, 2001—shortly after the end of the quarter.

A phase-in period should give the industry time to finalize testing, to adjust their

systems to correct errors as they phase in particular stocks in decimals, to educate

investors, and to monitor changes in trading behavior. In particular, trading in decimals, especially in penny increments, may affect the use and display of customer

limit orders, the liquidity of certain stocks, and the ability to sell short. A phasein period, even a short one, will allow the Commission and the markets to monitor

the impact of decimalization on trading behavior and to determine if trading rules

need to be adjusted.

The Commission did not mandate widespread Dual Pricing ahead of Nasdaq’s projected decimal date because of the potentially serious systems and capacity problems

raised by market participants. In view of the New York Stock Exchange’s position

and other comments on a more rapid move to full Dual Pricing, the Commission did

not want to foreclose the possibility that the problems could be addressed and

broader decimal trading begin in listed stocks before April 9. Therefore, the Commission’s order gives industry participants the flexibility to begin broader Dual Pricing between September of this year and April of next year. If operational issues can

be addressed and investor confusion can be minimized through educational efforts

within a shorter time frame—such as the one suggested by the NYSE—the order

allows the industry to move to full decimalization well before April 9, 2001.

As for quoting increments, there was little agreement among the commenters regarding a minimum increment during the phase-in period—suggestions ranged from

a dime to a penny. Accordingly, in its order, the Commission allowed the exchanges

and NASD to fix the minimum quoting increment during the phase-in period, provided that the minimum increment is no greater than five cents and no less than

11

one cent for any equity security, and that at least some equity securities are quoted

in one-cent minimum increments. We fully expect that the pilot in listed stocks

under consideration will trade in penny increments.

Finally, the Commission directed the exchanges and NASD to submit (either individually or jointly) a study to the Commission on June 9, 2001, that evaluates the

impact of decimals on trading patterns and capacity and that makes a recommendation regarding a minimum increment, if any. Further, the order directed the exchanges and NASD to submit rule change proposals to the Commission thirty days

after submitting the study that would establish their individual choice of minimum

increments by which equities or options are quoted on their respective markets

IV. NASDAQ CAPACITY

Before I conclude, I would like to briefly address Nasdaq’s technology and planning. As I indicated above, the unprecedented growth in volume and quote traffic

is presenting the Nasdaq market with formidable challenges, and I am committed

to ensuring that Nasdaq faces them squarely. Last August and September, my staff

reviewed Nasdaq’s computer operations and identified to Nasdaq staff concerns

about Nasdaq’s capacity planning. In January of this year, the staff issued a report

to Nasdaq identifying systems capacity as a key concern and recommending that

Nasdaq obtain an independent assessment of its infrastructure capacity and its capacity planning process.

In response to Nasdaq’s announcement that it would not be decimal ready by July

3rd, we prompted Nasdaq to accelerate its process for hiring an independent consultant to evaluate Nasdaq systems capacity and capacity planning. That review is

nearing completion. Since that time, we also have closely monitored Nasdaq’s

progress with decimal implementation, including weekly conference calls with

Nasdaq’s Chief Information Officer. Last week, I personally met with Nasdaq management, including its Chief Information Officer, to discuss its readiness for decimals and broader capacity issues. We believe that Nasdaq is taking seriously the

challenges presented by the conversion to decimals, as well as other capacity issues.

Our goal is to see to it that Nasdaq remains on schedule for decimalization in

Spring of next year.

V. CONCLUSION

In conclusion, because of your leadership, decimalization will become a reality this

year, and investors will soon reap the benefits of trading in decimal increments. The

Commission remains committed to implementing decimal pricing in a safe and orderly manner, with minimal disruptions to the markets. We appreciate your leadership on this issue and hope to work closely with you in the months ahead.

Mr. OXLEY. Thank you, Mr. Chairman. Our next witness is the

Chairman and CEO of the New York Stock Exchange, Dick Grasso.

Mr. Grasso, welcome.

STATEMENT OF RICHARD A. GRASSO

Mr. GRASSO. Thank you, Mr. Chairman. Good afternoon. Mr.

Chairman, Mr. Towns, members of the subcommittee, I am pleased

to be here today to discuss the New York Stock Exchange’s conversion to a decimal pricing table. The legislation approved by this

subcommittee in early 1997 was the single most important catalyst

to the decimal conversion process. Chairman Bliley, Chairman

Oxley, Representative Markey, and all members of the subcommittee are to be commended and congratulated. I am particularly grateful for the support of the delegation members from New

York, Mr. Towns, Mr. Fossella, Mr. Engel, who have supported and

indeed encouraged the New York Stock Exchange to take this bold

conversion move.

I am pleased, Mr. Chairman, to be able to answer the question

posed by the title of today’s hearing by saying simply yes, the

NYSE will convert. Consistent with the timetables set by the SEC

order, the NYSE will begin the conversion to decimal pricing in

September. We expect to introduce a pilot for some 50 securities

12

which will trade both on the New York Stock Exchange and in the

Nasdaq third market quoted and traded on a penny-denominated

basis. The NYSE was the first market to approve conversion to decimal pricing when our board, with the encouragement of this committee, considered it at its meeting in June 1997.

The NYSE sees conversion to decimals as a win-win-win proposition. That is, it will benefit investors, the companies they invest

in, and all those in the industry who serve our consumers. Decimals will ultimately make prices more easily understood by individuals particularly. Spreads and highly liquid stocks should tighten appreciably. This should provide significant cost savings for investors, particularly given the minimum price variation being reduced to one cent. By bringing the United States into conformity

with international practices, decimalization should improve the

competitiveness of U.S. markets on a truly global scale. Decimal

trading will ultimately increase the number of possible trading increments within a single dollar from the current level of 16 to 100.

It is in the interest of all market participants to ensure that the

markets can handle the increased message traffic which

decimalization will produce.

Today, the NYSE has significant capability to handle 1,000 messages per second. Stated in volume terms, some 5-plus billion

shares in a single trading session. By the end of this year, that capacity will double to 2,000 messages per second producing a capability of some 10 billion shares of capacity in a single trading session.

The NYSE takes its commitment to decimalization seriously, and

we have built and will continue to buildupon our technology infrastructure. This is a conclusion which we share by the GAO in its

report to this committee this past spring.

Later this year, the Exchange will begin the implementation of

what we call network NYSE, a platform for customer choice. The

new products that we will offer under the umbrella NYSE network

include NYSE direct plus, institutional express, and a virtual 3-D

trading floor, all of which will support decimal pricing tables as

they are brought on-line.

Testing between the exchange and the member firm community

began in mid January of this year, industry wide testing in listed

securities in April, and we are almost 90 percent complete. The Exchange is taking steps to make sure our member firms are prepared for decimal trading. At its meeting earlier this month, the

Exchange’s board of directors approved a rule which mandates each

member organization must participate in industry testing. This

rule will be filed with the commission. We have also sent out a

decimalization preparedness survey to our member organizations

and expect to complete our evaluation by the mid- to late part of

July.

The New York Stock Exchange has committed, Mr. Chairman,

significant resources and personnel at the highest levels to implement the wishes of this committee consistent with the timetable

embraced by Chairman Levitt and the Securities And Exchange

Commission. We remain committed to working with the Congress,

the Commission, and the industry, to ensure that decimalization

13

conversion is done on an expedited timetable without any risk to

consumers.

I thank you again, Mr. Chairman, for the opportunity to testify

today. I ask permission to submit my written statement for the

record and would be pleased to answer any questions after my colleague has testified. Thank you.

[The prepared statement of Richard A. Grasso follows:]

PREPARED STATEMENT OF RICHARD A. GRASSO, CHAIRMAN AND CHIEF EXECUTIVE

OFFICER, NEW YORK STOCK EXCHANGE

Mr. Chairman, Mr. Towns, and Members of the Subcommittee: I am pleased to

be here today to discuss the New York Stock Exchange’s progress in converting to

decimal pricing. I know that decimalization of U.S. securities markets has been a

high priority for this Subcommittee for several years. The legislation considered and

approved by the Subcommittee in early 1997 was the single most important catalyst

for the U.S. securities markets to commit to decimal conversion.

For this reason, I am pleased to be able to answer the question posed by today’s

hearing with an unequivocal ‘‘YES.’’ Consistent with the timetable to be set by the

SEC order, the NYSE will begin the conversion to decimal pricing in September,

with conversion fully completed by next spring. The Exchange has committed significant resources to ensure successful implementation of decimal pricing this year.

Moving to decimal trading has been a major focus at the New York Stock Exchange for the last three years. We first began these efforts as early as 1995 with

discussions of trading foreign shares in local currencies.

Our Board approved conversion to decimal pricing on June 5, 1997. We were the

first U.S. securities market to take that step. As we stated at that time, decimals

will ultimately make prices more easily understood by individual investors. Spreads

in highly liquid stocks should tighten appreciably. By bringing the United States

into conformity with international practices, decimalization should improve the competitiveness of the U.S. markets on a global basis.

To begin the move toward decimalization, the Exchange created a committee of

senior operations executives to assist in the preparation and implementation of industry efforts. This Operations Advisory Committee began meeting in September

1997. Subcommittees dedicated to specific subjects began meeting in November of

that year. At the suggestion of the SEC, the Exchange convened a small working

group of equity and options markets, which met in February 1998 to propose a plan

for the securities industry’s conversion to decimal trading. The input from the Operations Advisory Committee served as the basis for discussion among the markets

at that meeting. The proposed plan was endorsed by the Securities Industry Association, which also agreed to act as the industry focal point for implementation.

At the NYSE, a Decimalization Project Team was formalized in early 1999. In

order to optimize the efficiency of the conversion process, the Team worked in concert with the Year 2000 Project Planning Team. Participants in the Decimalization

Project Team included representation from the following NYSE offices: Systems

Planning, Trading Services, Market Operations, Market Surveillance, Market Data

Vendor Relations, Listing Systems, Research Systems, Communications Systems

and Media, Capacity Planning, Contingency Planning and Securities Industry Automation Corporation (SIAC).

Decimal conversion impacts every NYSE system, from trading systems to surveillance and financial systems. Imagine that all of the information travelling to and

from the New York Stock Exchange is contained in one large pipeline. Currently

that pipeline receives and transmits information, such as orders, quotations, lastsale data and administrative messages from the Exchange to and from, among others, broker-dealers, broadcasters, and financial information vendors. The conversion

to decimals implicates: the capacity of that pipeline; the ability of switches within

the pipeline to recognize where the data should go; and the interface between the

NYSE pipeline and other systems outside of the NYSE.

Decimal trading will ultimately increase the number of possible trading increments within a dollar from 16 to 100. Largely due to this, we believe that decimal

conversion is going to increase the volume of information in the pipeline. It is in

the interests of all market participants to ensure that this information pipeline can

handle the increased volume. Today, the NYSE’s ‘‘pipeline’’ has sufficient capacity

to handle 1000 messages per second, or, stated otherwise, 5 billion shares per day.

By the end of this year, the pipeline will handle 2000 messages per second or 10

billion shares per day.

14

Typically an order sent to our Trading Floor electronically, through the NYSE’s

SuperDot system, is executed and confirmed to the originating broker in less than

20 seconds. (When NYSE Direct+ is introduced later this year, this turnaround time

will be nine seconds for customers choosing this service.) The processing of an order

involves a number of different steps and implicates several systems. The order is

recognized, validated, routed to the trading post, appears on the display book, is exposed to the auction, may receive price improvement, and is executed and returned

to the originating broker.

The NYSE cannot tolerate system slowdown due to increased message traffic. All

of the NYSE’s new products, including NYSE Direct+, Institutional Xpress, and the

virtual 3D Trading Floor, will support decimal pricing as they are brought online

later this year.

Additionally, the Broker Booth Support System (BBSS) must be able to transmit

and receive decimal orders. (The BBSS provides electronic support to the NYSE

floor broker; it receives orders from member firms, transmits orders to the trading

post, researches stock trends and market data, and provides access to other broker

support services.) All components of the trading post, including the specialist display

book, the overhead display and the auxiliary display monitor, which provides market data and financial news to the Trading Floor, must support a decimal environment, i.e., must be able to recognize and display decimals. The NYSE’s regulatory

surveillance systems must be able to recognize decimal trading in order to properly

alert surveillance personnel to trading irregularities.

The NYSE employs a highly dependable network of systems. During the last 12

years, the NYSE has experienced a total of two hours of system downtime during

the trading day. The conversion to decimals is another challenge to ensure that the

NYSE’s systems operate as efficiently as possible. Currently all NYSE systems—including our switching and order processing systems, market data systems, surveillance systems, listed company and financial systems, common shared services systems, after-hours and comparison systems—are decimal-ready, and we will be ready

to implement consistent with the timetable established by the SEC order.

The NYSE is committed to providing its clientele with the fastest, most accurate

service possible. Most of the NYSE’s decimal conversion costs were incurred simultaneously with our Year 2000 system conversion. This simultaneous systemic conversion upgrade cost approximately $30 million.

With the advent of decimal trading, the Exchange is well-positioned to handle the

increased traffic across all of our systems. This, of course, is not enough. If investors

are to obtain the benefits of decimalization, market participants, from the regional

stock exchanges, to the broker-dealer community, to financial information providers,

to clearing organizations, should have the capacity and the ability to transmit and

accept data priced in decimals. With this in mind, an industry-wide effort to coordinate the decimalization process was put in place.

In July 1998, a Decimalization Steering Committee was formed, led by SIA and

composed of representatives of the equity and options markets and member firms.

The Committee engaged SRI Consulting to conduct a study designed to develop capacity planning assumptions for the industry’s order execution, market data, and

clearing systems. The SRI study, released in early May 1999, forecast increases in

quote messages per second for stocks of approximately 50%, using a minimum price

variation of a nickel, and well over 200% using a minimum price variation of a

penny.

At an industry-wide Decimalization Conference in September 1999, a proposed

implementation schedule was announced by the Decimalization Steering Committee.

It included three phases:

• Phase One, to be conducted from July 3-August 4, 2000, with a limited number

of securities trading in increments of a nickel. This phase was scheduled to last

five weeks and would involve 30-40 securities selected by the markets and the

Committee.

• Phase Two, to be conducted from August 7-September 29, 2000, when all securities would begin trading in nickel increments. This phase was scheduled to last

eight weeks.

15

• Phase Three, to begin October 2, 2000, when all securities would trade in increments determined by market forces.

On January 28 of this year, the SEC issued a release on decimal pricing, directing

the exchanges and NASD to submit a decimalization implementation plan. This action provided the industry with guidelines for conversion and cleared the way for

the industry-wide cooperation necessary for the successful conversion to decimal

pricing. The SEC specified that the plan should provide that decimal pricing of at

least some equities and options on those equities should begin no later than July

3, 2000, and that decimal pricing of all equities and options should be completed

within six months of that date. The SEC also stated that the plan may fix a minimum increment no greater than five cents during the phase-in period.

The NYSE moved early to convert our systems to decimal-readiness. A major test

conducted in mid-December 1999 found that 99% of our trading systems were ready

to operate in decimals. The remaining work was completed and the Exchange was

100% decimal-ready by April 30, 2000. On June 3, we conducted a full-blown decimal production test on the Trading Floor, which revealed no problems, and we have

now completed all internal testing.

Testing between the Exchange and some member firms began in mid-January of

this year. Industry-wide testing began in April. In order to maintain momentum,

industry-wide testing in listed securities has continued and is now 85% complete.

On April 13, the SEC issued an order staying the deadlines for decimal implementation and requesting comment on a revised schedule for implementation of decimal

pricing. The SEC solicited public comment on two alternative proposals:

(1) beginning trading in all exchange-listed securities in decimals, in nickel or penny

increments, by September 4, 2000; or

(2) phasing in decimal pricing in certain exchange-listed securities on a pilot basis,

to begin by September 4, 2000. Trading would be in penny increments. The pilot

would expand to all listed stocks on March 31, 2001. Selected Nasdaq stocks

would be added if feasible, and the SEC would expect all Nasdaq stocks to be

trading in decimals by March 31.

In response to the SEC’s latest request for comment on a timetable for implementing decimal pricing, the Exchange has stated that we are prepared to begin

decimal pricing this year whenever the Commission deems it appropriate.

Because we are always careful to implement new systems after full testing, we

suggest that the first phase of implementation be a pilot program in which decimal

trading in pennies would begin in a limited number of NYSE-listed securities. This

initial program would ultimately include about 50 NYSE-listed securities, with a

range of trading volumes and other trading characteristics, during an initial phasein period of one month or less. Such a measured approach would provide the opportunity to assess the impact of decimal trading on an inter-systemic basis. Of particular concern is the expected increase in message traffic associated with decimal

pricing. We believe that expansion of the pilot program to all NYSE-listed securities

could occur after approximately 60 days of trading, subject to evaluation of the pilot

program results.

The Exchange is taking steps to enhance the preparedness of our member firms

for decimal trading. At its meeting earlier this month, our Board approved a rule

mandating that each member organization participate in industry testing. This rule

is being filed with the SEC.

We have also developed, and are conducting this month, a decimalization preparedness survey. The survey, which was sent out on June 9, asks whether member

organizations:

• are currently ready to handle decimal pricing;

• have tested their systems;

• have implemented the requisite capacity for penny increments;

• have assessed third party vendors’ preparedness; and

• have addressed the pending changes with both retail and institutional customers.

We expect to complete evaluation of the responses by the end of July.

The New York Stock Exchange has committed significant resources and personnel

at the highest levels to implement decimal pricing. We continue to believe that decimal pricing will enhance our global position. More importantly, decimalization will

make stock prices more easily understood by individual investors, and will result

in narrower quotation spreads in many stocks. This will provide significant savings

to investors, particularly if the minimum price variation is reduced to a penny. We

remain committed to working with the SEC, Congress, and the securities industry

to achieve decimalization of U.S. securities markets as soon as practicable.

16

Thank you again for the opportunity to testify today. I would be pleased to answer

any questions you may have.

Mr. OXLEY. The Chair would ask unanimous consent that all

written statements will be made part of the record including the

members’ opening statements as well.

We now recognize the Chairman and CEO of Nasdaq, our good

friend, Frank Zarb.

STATEMENT OF FRANK G. ZARB

Mr. ZARB. Thank you, Mr. Chairman, members of the committee.

Thank you for this hearing and thank you for your leadership.

I am with the opening comments of Chairman Levitt and the following comments by Chairman Grasso. I think they have covered

a good part of where we stand, and we certainly associate ourselves

with both the spirit and the substance of what has been outlined

here this afternoon. So I am going to make my opening statement

very, very brief so we can get to your questions.

I did want to say, however, the significance of what we are doing

is more meaningful than simply a rearrangement of market structure. It does follow the way the world is turning with respect to

Mr. and Mrs. average middle class, participating in the wealth of

the securities markets. The world will have within 5 years about

500 million Internet users. That is 500 million Internet users

worldwide. A good many of them are going to be able to trade online as we see now, even in places like Japan, where 50 brokerages

are offering on-line trading.

All of this means that average people, especially here in the

United States, are going to want to have an opportunity to share

in the wealth of the securities markets. This step toward

decimalization moves the country in that direction in a meaningful

way. In my opinion, this is the most significant and meaningful aspect of what we are about to do here. It clearly will have advantages in terms of spreads and economics to the investor, but more

meaningfully than that, it has both a society and a cultural dimension that we should not overlook.

With respect to commitment, the NASD and Nasdaq are committed to decimals. We will follow the same general outline that

has been articulated here earlier. We will be prepared in September to move in unison with my good friend Dick Grasso, and

the New York Stock Exchange in order to open a test and we will

do it in pennies. By the March date articulated by the chairman,

we will be ready to start to move into Nasdaq securities and have

it completed on schedule.

There are obviously questions that have been raised with respect

to capacity. We have moved to ensure those capacity issues are resolved. I would just remind you that in the first 6 months of last

year, we averaged about 900 million shares a day on the Nasdaq

stock market. This year to date so far we have averaged 1.7 billion

shares per day on the Nasdaq stock market. That is an example

of the changes in capacity that we have had to provide for. Having

said all of that and given those numbers, we are prepared to move

on schedule, and we will hopefully be moving in a parallel way that

is a quality-of-market dimension and not one which is a competitive aspect. This is not a structure that should be used as a comVerDate 11-MAY-2000 08:10 Oct 30, 2000 Jkt 066288 PO 00000 Frm 00020 Fmt 6633 Sfmt 6602 E:\HEARINGS\65803 pfrm02 PsN: 65803
17

petitive tool where you run the risk of confusion and worst to investors.

There is a question that still needs to be addressed hopefully

during the pilot stage, the impact on options. I have read a lot of

studies and they don’t always all agree with each other. I am sure

you have seen some of the statement studies as to the volume aspect of options trading in decimals. We are going to have to look

at those numbers very carefully during the pilot period and make

sure we make the appropriate judgments going forward.

Mr. Chairman, members of the committee, we are, at Nasdaq,

completely supportive of this goal and we will be there on time

with a performance that has been outlined to the benefit of the

marketplace.

[The prepared statement of Frank G. Zarb follows:]

PREPARED STATEMENT OF FRANK G. ZARB, CHAIRMAN AND CHIEF EXECUTIVE

OFFICER, NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.

I am Frank Zarb, Chairman and CEO of the National Association of Securities

Dealers, Inc. I thank Chairman Oxley and this Committee for this opportunity to

testify on the NASD’s preparedness for decimalization and our schedule of implementation for conversion to decimal pricing.

By way of summary, the NASD remains a strong proponent of decimalization. We

are prepared to implement decimal pricing, as the SEC finds to be in the public interest in maintaining fair and orderly markets and to protect investors. We are thus

prepared to implement decimal pricing for listed securities on September 4 of this

year on a pilot or full basis, in nickels or pennies. We are also prepared to implement decimal pricing in Nasdaq securities by March 31, 2001, on either a pilot or

full basis, in nickels or pennies. Because conversion to decimals requires the efforts

of all market participants to be successful, we will continue to work with the SEC,

Securities Industry Association, and our membership to ensure that decimalization

occurs in a timely and non-disruptive manner.

THE NASD

Let me briefly outline the role of the NASD in the regulation and operation of

our securities markets. Established under authority granted by the 1938 Maloney

Act Amendments to the Securities Exchange Act of 1934, the NASD is the largest

self-regulatory organization (SRO) for the securities industry in the world. Virtually

every broker-dealer in the U.S. that conducts a securities business with the public

is required by law to be a member of the NASD. The NASD’s membership comprises

5,500 securities firms that operate in excess of 80,000 branch offices and employ

more than 638,000 registered securities professionals.

The NASD is the parent company of The Nasdaq Stock Market, Inc., the American Stock Exchange, and NASD Regulation, Inc. (NASDR). These wholly owned

subsidiaries operate under the authority of the parent, which retains overall responsibility for ensuring that the organization’s statutory and self-regulatory functions

and obligations are fulfilled.

NASD Regulation is responsible for the registration, education, testing, and examination of member firms and their employees. In addition, it oversees and regulates

our members’ market-making activities and trading practices in securities, including

those that are listed on The Nasdaq Stock Market and those that are not listed on

any exchange.

The American Stock Exchange is the nation’s second largest floor-based securities

exchange, and is the only U.S. securities exchange that is both a primary market

for listed equity securities as well as a market for equity options, index options, and

equity derivatives.

The Nasdaq Stock Market is the largest electronic, screen-based securities market

in the world. Founded in 1971 as the world’s first all electronic stock exchange, it

is the original on-line market, and the pioneer in e-commerce. Nasdaq today accounts for more than one-half of all equity shares traded in the nation and, since

January of last year, is also the largest stock market in the world in terms of dollar

value of shares traded. Nasdaq lists the securities of 4,854 domestic and foreign

companies, more than all other U.S. stock markets combined. There are over 70 million investors in Nasdaq companies.

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Nasdaq ended 1999 with its fifth consecutive year of record gains. That year produced 136 trading days where volume exceeded one billion shares traded on Nasdaq.

Annual share volume reached 265.6 billion, up from 201.5 billion in 1998—a 32 percent increase for the year. The market value of the more than 4,800 companies listed on Nasdaq ended the year at $5.2 trillion, up over 100 percent from year-end

1998. It is not hard to see, with such explosive growth, how estimates of 1999 and

2000 market volume made several years ago were too low.

NASDAQ DECIMALIZATION

The NASD welcomes this opportunity to describe our preparedness and implementation schedule for decimals, and applauds Chairman Oxley and the Subcommittee

on the leadership they have shown in ensuring that our markets decimalize as soon

as possible. This constant attention contributes to the speed with which the markets

and the industry are converting to decimal trading.

Like the Subcommittee and the SEC, the NASD remains committed to implementing decimal pricing as expeditiously as possible. However, we too are concerned

that decimals be implemented in a way that does not negatively impact order routing, trading, and settlement systems of the markets and the securities industry, and

that does not result in investor confusion.

The NASD’s commitment to decimals was early and strong. As you are aware, the

NASD was the first US market to support decimal pricing, beginning with our testimony before this Subcommittee on April 16, 1997. The NASD Board on August 7,

1997 voted to begin operating Nasdaq systems using decimals. In a May 7, 1998 letter to Congressmen Bliley, Oxley, and Markey we underscored our commitment to

decimal pricing, but cautioned that the implementation date should be set for September 2000 to allow time to deal with the Year 2000 problem.

We would also point out that Nasdaq is the first and only US market whose systems support trading of decimals today. While we do not yet provide decimal

quotation services, Nasdaq’s trade reporting systems support decimals and allow

participants to trade and report trades for comparison and clearing in decimals now.

Our position on converting our markets to decimals has not changed. We remain

a strong proponent of the shift to decimals because they will make the markets even

more accessible to investors and can potentially reduce transaction costs. We want

to reemphasize to the Subcommittee that we will commit whatever capital and personal resources are necessary to implement decimalization on a timely basis.

As you are aware, in 1999 and early 2000 Nasdaq experienced a doubling of share

volume, accompanied by an even greater increase in quote and trade message traffic. As a result, Nasdaq encountered problems with previous decimalization schedules because of systems capacity problems stemming from the unprecedented, explosive growth of Nasdaq trading since the last quarter of last year. We have addressed

those problems and are confident that we will fully comply with the revised schedules.

Nasdaq will not be an impediment to decimalization of the exchange-listed market, on either a full or pilot basis in September 2000. From a technical standpoint,

it appears possible for exchange-listed securities to be traded in decimals while

Nasdaq trades in fractions. This transition will not pose the system problems that

full Nasdaq implementation of decimals would entail, because the exchange listed

securities are a small fraction of Nasdaq volume and exchange volume is growing

much slower than Nasdaq. For example, NASD exchange listed trade volumes in the

Consolidated Quotation System are only 6% of Nasdaq’s 2.2 million trades per day.

Moreover, listed market average daily trade volume, although roughly equal to

Nasdaq at the end of 1998, is now substantially lower than Nasdaq volume, as

shown in the following chart.

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US Equities Average Daily Trade Volume

We are prepared to implement either of the alternatives suggested in the SEC’s

recent release seeking comment on revised decimal implementation schedules. We

are thus prepared to implement either full dual pricing or a pilot of dual pricing,

in listed stocks in nickels or pennies, by September 4, 2000, as the SEC finds to

be in the public interest in maintaining fair and orderly markets and to protect investors. We will also be ready to initiate decimal pricing in Nasdaq securities on

March 31, 2001, in nickels or pennies, on a pilot or full market basis. In this connection, we note that Nasdaq has never had and does not support a government mandated minimum trade price variation for equities.

OPTIONS DECIMALIZATION

The largest challenge of decimalization relates to options trading. Because each

option trades both puts and calls in multiple series, a single quotation change in

its underlying equity can trigger a large amount of quote activity for that option.

The demands currently placed on the systems that disseminate options quote and

trade data are already substantial due to highly volatile equity markets and a rapidly changing competitive landscape. In addition, a recent industry study projected

that the transition to decimal pricing will increase the demands placed on these systems to levels well beyond their anticipated capacities. The exchanges continue to

work with each other and the SEC on a solution to this complicated and challenging

problem.

CONCLUSION

We applaud the work that the SEC, the Securities Industry Association’s

Decimalization Steering Committee, and the Decimal Exchange Committee are

doing to ensure that the industry will be prepared for decimals as soon as possible.

We recommend that you consult with them on their plans and schedules, which are

a major component of the decimalization process, to gain a more complete view of

how all market participants will convert to decimal pricing. Because conversion to

decimals requires the efforts of all market participants to be successful, we will continue to work with the SEC, the industry, and our membership to ensure that

decimalization occurs in a timely and non-disruptive manner.

Thank you for the opportunity to testify on this important issue. We look forward

to working with the Subcommittee, the SEC, and all market participants to implement decimals as soon and as safely as possible. I will be happy to answer any questions that you may have.

Mr. OXLEY. Thank you, Mr. Zarb. Thanks to all of you. Let me

begin the round of questioning with a general question. It seems

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the first issue that comes up when we are talking about this conversion, which will begin in September, is what factors will be considered in the number of stocks in the pilot program initially, and

what will be the minimum increment? In other words, the order,

as I understand it, Chairman Levitt, does not specify these issues.

Could you give us some kind of an idea, and I would like to ask

the other two CEOs exactly what they have in mind. Under your

orders, I understand you can have as few as one stock or as many

as several thousands. Where are we in terms of that number?

Mr. LEVITT. We don’t require nickel increments, and we allow the

markets to determine, subject to Commission approval, the scope

and the pace of the phase-in. We do set a minimum increment of

a penny during the phase-in period, which lasts until April 9, 2001.

After that period of time, market forces will prevail and any increment can be implemented at that point, subject to Commission approval.

Mr. OXLEY. Now, when you testified in 1997, that seemed to be

the implication in that regard. Is it also true you will have a market study that will track that in terms of trying to come up with

a minimum increment or not coming up with a minimum increment?

Mr. LEVITT. In 1997, the question was pennies, nickels, or dimes?

Today, the question really is whether the system is capable of handling hundredths, and we are going to watch very closely what

happens during this pilot period, but, certainly, our inclination in

terms of formulating this program is to allow market forces to determine the scope of the program, the number of securities that are

phased in, and eventually after April 2001, the level of what the

increment will be. Obviously, if during this pilot period we see systemic risks, we are going to work very closely with the exchanges

and with the committee to address that, but we will work very,

very closely and watch it closely.

Mr. OXLEY. Mr. Chairman, would you envision or would you indicate to the committee that perhaps as much as a minimum of 50

stocks would be a rather valid and effective number of stocks in the

initial pilot program of listed stocks?

Mr. LEVITT. I think that 50 would certainly be a minimum expectation, and Chairman Grasso has indicated already that that is his

intention, to select 50 stocks to be part of the pilot.

Mr. OXLEY. Is that the magic number, Mr. Grasso, or is that just

an example?

Mr. GRASSO. It is, Mr. Chairman. What we seek to do in the pilot

is create a representative sample of the most active, the least active, the mid caps, and more importantly, from a capacity standpoint, to recognize that there can be securities that don’t necessarily appear in the most actively traded tables each day that

have an enormous velocity of consumer activity built into them. So

what we are going to do, Mr. Chairman, is build a sample of 50

securities that really cover the landscape NYSE.

It would be our intent to both quote and trade those securities

with penny increments, and this is going to be very important that

I underscore that, Mr. Chairman, because we are going to coordinate a pilot with the NASD’s third market, the Nasdaq intermarket. We would have to be on the same pricing platform, and we

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would have to both quote and trade in the same minimum variations. I think the simplest approach is to do that in pennies from

day one. There are some, Mr. Chairman, who would say quote in

nickels and trade in pennies. I think that would be a terrible mistake for consumers because four price points would be missed for

the public to see. I believe, as Chairman Levitt has said and Chairman Zarb agrees, that there is enormous benefit to consumers in

conversion to decimal pricing.

I think that ultimately the marketplace will decide the minimum

price variation, but we should engineer to permit the penny to be

the platform of both quotation and, if you will, minimum price variation. It would be our goal, Mr. Chairman, to open up on 5 September with just a few number of stocks. By the mid part of September, we would have our 50 pilot in place. We would run that

pilot for 2 months in partnership with the NASD, and then in close

coordination with the Commission, evaluate the results, and following, I would have to believe, Mr. Chairman, the first of the year

we would be in a position to expand it to all listed securities.

Mr. OXLEY. Mr. Zarb, I would like to have you comment on the

two issues that were addressed by the gentleman on your left, and

also ask you specifically if Nasdaq will quote in pennies. Will you

also execute in pennies?

Mr. ZARB. We will on the intermarket during the September period for listed securities and, yes, the answer to your question is

yes. The pilot should really be a learning process and a measuring

process, so we should make sure that we work closely with the New

York Stock Exchange and with the Commission to make sure the

basket of securities are the right ones selected, and that the measurements, every step of the way, are the right measurements so we

can learn.

As we learn, that will speed up the process of the entire rollout.

So we certainly support the notion of 50 in the September period.

Mr. OXLEY. This will be my last question. It occurred to me that,

and I would be interested in all of our answers, the Island ECN

has already announced that they will be quoting and trading in

decimals on July 3. What effect, if any, would you see that having

in terms of the pilot program and in terms of long-term conversion

to decimals? Not only from a competitive standpoint for you two

gentleman, but also for Mr. Levitt, how is that going to affect the

overall markets? I know it is a little bit of a crystal ball, but I am

curious as to what reaction you might have with that.

Mr. Levitt?

Mr. LEVITT. I think the ECN’s use of lower than pennies represents a very small portion of the market, and I am not concerned

with that. As I suggested, I think the pilot period will give us an

opportunity to phase in the use of decimals without running any

kind of systemic risk and making sure we are protecting investors.

I think once we pass the phase-in period in April of next year, obviously, the ECNs and any other competitors at that point will be out

there; and if the markets say that we should go to hundredths or

thousandths or whatever, that is where the markets will take us;

but I am not motivated to do otherwise, to run the risk of a systemic disruption by virtue of the fact that one relatively small part

of our overall market will be trading at less than pennies.

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Mr. OXLEY. Mr. Grasso?

Mr. GRASSO. Historically, Mr. Chairman, the ECN’s business has

primarily been confined to Nasdaq securities, so I am not certain

that there is going to be profound impact. I commend Island for initiating their pilot on the 3rd of July. In reality, I think it will not

be until we see unlisted securities in a decimal format that we can

make any conclusions as to the effectiveness of splitting the penny.

You will recall, Mr. Chairman, when we were discussing the legislation back 3 years ago, that we shared with this committee, the

fact that our engineering has the capacity to handle fractions of 1/

4,096, if anything can create a massive strain upon the investor eyesight community of this world, it would be to split the penny into

4,096 increments.

To Chairman Levitt’s observation, I believe competition will drive

the pricing table. We are prepared to split the penny if that is what

the consumer wants. We are prepared to split the fraction. We

have got the ability to do that today. I think in the final analysis,

though, the market is going to be the judge, and certainly, at least

historically, ECNs have not had significant market shares in listed

securities, although I would encourage the Island and those who

will pilot in decimals beginning in July to consider not only the traditional bridge through the system of the NASD, but through the

opportunity to become electronic access members at the New York

Stock Exchange for a very modest fee.

Mr. ZARB. I thought advertising wasn’t allowed, Mr. Chairman.

Mr. OXLEY. Mr. Zarb, you can do some advertising of your own

if you would like.

Mr. ZARB. Whatever Island wants to do, Island moves its trading

through the Nasdaq system as do the other ECNs. Whatever they

do, we can handle. We will just convert it as it moves to the

Nasdaq system until we are on a full decimalized platform. I think

it is good to have pieces of the industry leading in various areas.

I am a little concerned with too many moving in different directions at different denominations. In order to think in terms of a

competitive leg up, I don’t think that is correct at all, and I would

hope that the markets will move, generally speaking, with us in

September, and then by the early part of next year.

Mr. OXLEY. Thank you. My time has long expired. Let me now

recognize my good friend from New York, Mr. Towns.

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

Let me begin with you, Mr. Levitt, Chairman Levitt. Given the

Nasdaq proposed timetable, which I understand to be 2 weeks of

self-testing from February 26, 2001, to March 12, 2001, are you

satisfied that the industry will have sufficient time to test the system in conjunction with the Nasdaq’s new computer system and all

the other things, and be ready for full conversion by March 31,

2001?

Mr. LEVITT. I am. I believe that, the way this phase-in has been

devised, the markets themselves will determine the level of acceptance of trading in decimals and the level of phase-in. I think by the

time we reach 2001, I am satisfied, on the basis of our analysis of

Nasdaq’s capabilities, on the basis of our weekly discussions with

the technical people at Nasdaq, on the basis of the assurances that

Nasdaq executives have given to us and to the markets, and on the

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basis of the kinds of competitive pressures which will develop during this period to prove the excellence of the system, that Nasdaq

will be well equipped to meet the timetable they have committed

to.

Mr. TOWNS. Why would 3 months be allowed for industry testing

on the conversion for listed securities and less than 2 weeks for

testing for Nasdaq securities?

Mr. LEVITT. I am not sure that I understand that question.

Nasdaq will have the ability to test their systems all during the

rest of this year. They just are unable to have their systems online in sufficient time period to be able to begin the phase-in of

Nasdaq securities in September.

Mr. TOWNS. The industry, I am sorry. I misled you, I think.

Mr. LEVITT. The firms actually will have been trading in decimals for at least 6 months before the Nasdaq phase-in.

Mr. TOWNS. Thank you.

Mr. Zarb, by what date will the Nasdaq be prepared to have the

industry begin testing on your new computer system?

Mr. ZARB. We will be testing almost right away. We are running

tests now. We will be running, in answer to your former question,

we will be testing with the industry months and months before the

actual startup next year so that there will be live testing with the

industry going on throughout this period, and we will be ready to

follow the listed security pilot and to be up and running on our system in September, by September 5, along with the New York Stock

Exchange, and then by the early part of next year in March on

Nasdaq securities.

Mr. TOWNS. Thank you. Let me say this, Mr. Chairman. We don’t

get a hearing like this too often where we get an agreement across

the board. I want you to know that this is a historic hearing that

you put together here. I want you to know that I am delighted to

be part of it. Thank you. I yield back.

Mr. OXLEY. Thank you for your help in this matter as well. I

know the gentleman from New York, the other gentleman from

New York, and the other gentleman from New York have unique

constituencies with regard to the securities markets, the financial

markets in New York, and we have always respected that and appreciated their input.

The gentleman from Illinois, Mr. Shimkus.

Mr. SHIMKUS. Thank you, Mr. Chairman. It is great to be here

and also applaud the work that you have all done, Mr. Levitt and

the Exchanges and Chairman Oxley. I know this is something that

has been near and dear to his heart and the ranking member for

a long time, and I see the benefits of simplification from my constituents to have a better understanding of perhaps what many

folks feel is a very complicated issue. I am very excited about it,

and I think it is a win-win for everybody.

Projections of the increase in transactions, have you run any

analysis of how the simplification might sell to the consumers and

the possibility of increased traffic and use? And could you give us

a positive, or based upon your analysis which all businesses do,

what do you project the benefits to be of moving to a decimal system?

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Mr. GRASSO. If I might, Congressman, it is certainly from an investor’s standpoint make pricing far easier understood. From a volume standpoint, I have seen estimates that range from a 50 percent increment to over a 300 percent increment in the core equity

business, and that, I think, is in large part based on a simulation

of experience from the conversion from 8ths to 16ths, which occurred some 3 years ago. I think it is important to recognize that

the reason we are going to coordinate a phase-in is that a lot of

the analytical work done is purely that, theoretical analytical work.

I think as both Chairman Levitt and Chairman Zarb pointed out,

it is not just a matter for the equity markets to be concerned about.

The equity markets are woven into the derivative markets and the

vendors of financial information who must push the data into the

consumer world. It is fair to say that the traffic on systems is going

to increase geometrically to the level of usage today, just simple

mathematics.

In the core equity product, you are moving from 16 price changes

to 100 price changes per dollar. When you multiply that or, if you

will, magnify it in almost a fast breeder effect into the options and

futures markets, it causes all of us to want to actually have handson experience as we will from September 5 through the balance of

this year in evaluating, not just the impact from an equity market

standpoint, but from an options market, a futures market, a vendor

community, and all of those interrelated systems in the comparison

clearance and settlement process, which is why we believe with the

leadership of this committee, and certainly the leadership of the

Commission, that we are approaching it with the proper amount of

speed and the proper amount of care to make certain consumers

benefit, and there is no unforeseen harm out there in this conversion activity.

Mr. SHIMKUS. If I may follow up, Mr. Grasso, with the pilot program and this transition, how have you gone about deciding which

stocks to initially include?

Mr. GRASSO. What we will attempt to do, we are in the process

of segmenting our list right now. If you were to look at our business today, of the 3,100 issuers whom we are privileged to trade,

the first 500 produce almost 80 percent of our daily activity, daily

activity being an average daily volume of just slightly in excess of

a billion shares. My colleague to my right likes to probably point

out that his good friend, Dick Grasso, runs the second most active

exchange in the world.

Mr. ZARB. I don’t usually say ‘‘good friend,’’ though.

Mr. GRASSO. Close friend, except during market hours. If you

were to look at our daily activity, 80 percent is concentrated in the

first 500 issues. We would select a sampling from the most active,

from the least active from the high priced, from the low priced and

then a bit more esoteric to the credibility of the experiment, we will

look at those securities that aren’t necessarily the most actively

traded from a volume standpoint but are the most, if you will, populated by large numbers of small orders.

So we have a truly representative sampling of the experience we

can expect when we flip the switch and thus can have an absolute

total confidence that we are not going to flip the switch and disappoint investors.

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Mr. ZARB. Let me just add to the answer to your first question

briefly. There are two forces working here, one is truly the democratization of the marketplace. We have enormous additions of retail

transactions on our system this year over last year, a very substantial measurable number of individual people that are entering the

securities markets. It is not only true here; it is true worldwide.

That is going to happen with or without decimals. Decimals then

come along, make it easier for that to happen, make it a more

friendly market. That will have an increasing propelling effect on

the expansion of volumes.

Mr. LEVITT. I might also add to that, amidst the euphoria about

this action which all of us share, this testing period is absolutely

essential. We have talked thus far about the possibility of systemic

risk, and I believe that the plans that have been formulated obviate the likelihood of that. But we don’t know yet what kinds of rule

changes will have to be implemented to account for a very different

world that we are about to enter. We don’t really know what impact decimalization is going to have upon liquidity. These are very,

very important considerations, and I think the coming months will

be critical in terms of making judgments and decisions and reactions to all three of these elements.

Mr. SHIMKUS. Thank you very much, Mr. Chairman. I yield back.

Mr. OXLEY. The gentleman yields back. Before I recognize the

other gentleman from New York, the chairman hit on a very important point. There is so much we can learn beginning September 5

through the rest of this year and into the next quarter next year,

that frankly I hadn’t considered. Until you mentioned that in terms

of volume, in terms of the capacity, all of the different issues that

are there, which obviously makes your decision very critical in

terms of setting up this pilot program to the point where it can

really reflect what we can expect from the full blown conversion to

decimals in the next year. So that is something worthy of thinking

about. Maybe even at some point, worthy of another hearing so we

can sort that out and have the major players here, as you are

today, telling us where we are, and perhaps what we might need

to do, or what the SEC might need to do to facilitate that change.

This committee, as you know, is dominated by New Yorkers, and

I now recognize another gentleman from New York, Mr. Engel.

Mr. ENGEL. Thank you, Mr. Chairman. You should consider yourself blessed that there are so many New Yorkers here. You know

Ohio is just a little bit away.

Mr. OXLEY. We are growing, though.

Mr. ENGEL. Let me welcome all three gentlemen. As Mr. Towns

said, it is very rare that everyone agrees. It is almost difficult to

ask questions. I remember back in 1997 when we were talking

about decimalization, and one of the questions I asked during one

of the hearings was well, why should government impose

decimalization, why don’t we just let the market kind of naturally

change, and I decided I sounded too much like a Republican, and

I decided to pull the question.

Let me ask Mr. Zarb first. I read in your testimony, you talk

about options trading in your submitted testimony, and you say because each option trades both puts and calls in multiple series, a

single quotation change in its underlying equity can trigger a large

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amount of quote activity for that option. And then you add, a recent industry study projected that the transition to decimal pricing

will increase the demands placed on these systems to levels well

beyond their anticipated capacities. And you say the exchanges

continue to work with each other and the SEC on a solution to this

complicated and challenging problem. I wonder if you can elaborate.

Mr. ZARB. Obviously, the options market is different from the underlying securities market in that you do have—especially in a

volatile period, you have both puts and calls being written against

the same security at different levels of pricing. So both the quote

traffic and the execution traffic is a geometric dimension of what

it is for the underlying securities and what it is today. We are

going to get our first good look at that in the September pilot, and

as we begin the process of testing with our own members.

To the extent that that volume is what has been predicted,

frankly I have got to be convinced that the projections that have

been raised are correct. I have seen a good many of them. They

have come from all over the lot. Some of them are scare stories. I

know that the SEC is working with the major options markets and

are going to be watching this very, very carefully.

Mr. ENGEL. When you say the Exchanges are working with each

other and the SEC on a solution, how——

Mr. ZARB. To be able to determine what the volume increases are

going to be, and what capacity is going to be required to accommodate it. This is not a question of ‘‘if,’’ it is a question of ‘‘when,’’ and

making sure that there are no hiccups along the way. We just don’t

know enough of how the options market is going to react here. The

projections are that they are going to have a substantial increase

in volume. They will, and it has to be managed.

Mr. LEVITT. They are increasing their capacity, but they may

have to reduce their quotation volume to handle the increases

caused by decimals.

Mr. ENGEL. Mr. Zarb, I am told—please correct me if I am

wrong—that the NASD’s new computers won’t be on-line until end

of February in 2001, and that you won’t test your own system until

March 12. Isn’t that a problem?

Mr. ZARB. If that were correct, it would really be a problem because we already committed to go live, the capacity is being added

all the time and the necessary programming is being built, and we

are fairly confident of that. We will be testing with the industry

with our members and our market makers months before we go

live in March.

Mr. ENGEL. With regard to the third market, are you also going

to quote your prices in pennies and execute orders in pennies?

Mr. ZARB. We dutifully follow our senior exchange on the listed

side of the House, and whatever they do, we do, yes, sir.

Mr. ENGEL. Mr. Grasso, that leads me right to you.

Mr. GRASSO. Does that put me back in the category of good

friend?

Mr. ZARB. My good friend, Mr. Grasso.

Mr. ENGEL. He is my good friend too. That is what counts.

I guess that is all the questions I have. I just wanted to ask Mr.

Grasso, first of all, I wanted to compliment him because the decVerDate 11-MAY-2000 08:10 Oct 30, 2000 Jkt 066288 PO 00000 Frm 00030 Fmt 6633 Sfmt 6602 E:\HEARINGS\65803 pfrm02 PsN: 65803
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imal trading, those of us in New York have really been focusing on

this issue a great deal, and at the beginning there seemed to be

some resistance in some corners, and I think the New York Stock

Exchange has really took the resistance and really grabbed the bull

by the horns and decided not only to go with the flow, but really

to implement it and really be a leader in it. I think it is something

that we need to take notice and mention, because I think it really

was due to your leadership. As you mentioned, this committee had

been prodding for a long time, and it was really good to work together to do that. I want to thank all of you.

Mr. OXLEY. Thank you. And I understand the gentlelady from

New Mexico has no questions; is that correct?

Thank you for being here. There is a very historic hearing and

one that I think all of us will look back on with a great deal of

pride and satisfaction of where we have come and where we are

going, and we couldn’t have done it literally without all three of

your gentlemen’s leadership and friendship. We thank you so

much, and the subcommittee stands adjourned.

[Whereupon, at 3:30 p.m., the subcommittee was adjourned.]

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