U.S. GOVERNMENT PUBLISHING OFFICE

WASHINGTON : 

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

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

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

99–832 PDF 2016

S. HRG. 114–238

REGULATORY REFORMS TO IMPROVE EQUITY

MARKET STRUCTURE

HEARING

BEFORE THE

SUBCOMMITTEE ON 

SECURITIES, INSURANCE, AND INVESTMENT

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE

ONE HUNDRED FOURTEENTH CONGRESS

SECOND SESSION

ON

EXAMINING RECENT EFFORTS BY THE SEC AND FINRA IN AIDING THE 

FUNCTIONING AND STABILITY OF THE EQUITY MARKETS, AND IDENTIFYING KEY ISSUES UNDER CONSIDERATION TO REDUCE MARKET 

COMPLEXITY, INCREASE OPERATIONAL STABILITY, AND PROMOTE

EFFICIENCY, COMPETITION, AND CAPITAL FORMATION

MARCH 3, 2016

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

(

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


BANKI-41578DSA with DISTILLER
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

RICHARD C. SHELBY, Alabama, Chairman

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

DEAN HELLER, Nevada 

TIM SCOTT, South Carolina 

BEN SASSE, Nebraska 

TOM COTTON, Arkansas 

MIKE ROUNDS, South Dakota 

JERRY MORAN, Kansas 

SHERROD BROWN, Ohio 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

JON TESTER, Montana 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

JOE DONNELLY, Indiana

WILLIAM D. DUHNKE III, Staff Director and Counsel 

MARK POWDEN, Democratic Staff Director

DAWN RATLIFF, Chief Clerk 

TROY CORNELL, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor

SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT

MIKE CRAPO, Idaho, Chairman 

MARK R. WARNER, Virginia, Ranking Democratic Member 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

TIM SCOTT, South Carolina 

BEN SASSE, Nebraska 

JERRY MORAN, Kansas 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

JON TESTER, Montana 

ELIZABETH WARREN, Massachusetts 

JOE DONNELLY, Indiana

GREGG RICHARD, Subcommittee Staff Director

MILAN DALAL, Democratic Subcommittee Staff Director

(II)


BANKI-41578DSA with DISTILLER
CONTENTS

THURSDAY, MARCH 3, 2016

Page

Opening statement of Chairman Crapo ................................................................. 1

Prepared statement .......................................................................................... 26

Opening statements, comments, or prepared statements of: 

Senator Warner ................................................................................................ 2

WITNESSES 

Stephen Luparello, Director, Division of Trading and Markets, Securities 

and Exchange Commission .................................................................................. 4

Prepared statement .......................................................................................... 26

Richard G. Ketchum, Chairman and CEO, Financial Industry Regulatory 

Authority ............................................................................................................... 6

Prepared statement .......................................................................................... 37

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Letter to Committee from Mary Jo White, Chair, Securities and Exchange 

Commission ........................................................................................................... 43

(III)


BANKI-41578DSA with DISTILLER

BANKI-41578DSA with DISTILLER
(1)

REGULATORY REFORMS TO IMPROVE EQUITY 

MARKET STRUCTURE 

THURSDAY, MARCH 3, 2016

U.S. SENATE, SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Subcommittee convened at 10 a.m., in room 538, Dirksen 

Senate Office Building, Hon. Mike Crapo, Chairman of the Subcommittee, presiding. 

OPENING STATEMENT OF CHAIRMAN MIKE CRAPO 

Chairman CRAPO. The Committee will come to order. 

This is a hearing of the Subcommittee on Securities, Insurance, 

and Investment relating to market structure. I think we will have 

a very good hearing today and I appreciate everyone’s attendance. 

The landscape of stock markets and trading today is substantially different than it was 20, 10, or even 5 years ago. Regulations 

and technological innovation have moved stock trading from the 

floors of exchanges to virtually all trading now being conducted 

electronically on automated markets. Technology and innovation 

has benefited investors by leading to tighter spreads, lower costs, 

and more efficient markets. 

However, the expansion of trading venues, speed, and mandated 

interconnectedness of exchange and market participants has raised 

questions regarding market complexity and resiliency. For the past 

several years, the Securities and Exchange Commission and the Financial Industry Regulatory Authority have been working to better 

understand whether their market structure rules have kept pace 

with the changes in trading technology and practices. 

In 2014, the Banking Committee held a hearing with a broad 

mix of market participants to examine the role of regulation in 

shaping today’s markets as well as whether these markets are as 

resilient and as stable as they should be. Several witnesses at the 

hearing argued that Regulation NMS, a set of SEC market structure rules that passed by a three-two vote over 10 years ago, needed to be reexamined. 

Later in the year, SEC Chair White provided an update to her 

market structure agenda in a response to a letter Senator Johnson 

and I sent and highlighted three fundamental policy questions that 

the Commission would be focusing on. 

First, the trade-through restrictions in Rule 611 of Regulation 

NMS and whether they should be rescinded or modified. 


BANKI-41578DSA with DISTILLER
2

Second, the current regulatory model for exchanges and other 

trading venues and whether it makes sense for today’s markets. 

And, third, the maker-taker fee structure, including the related 

issue of restrictions on locking and crossing quotations in Rule 610 

of Regulation NMS. 

These are complicated issues and I appreciate the data-driven 

approach by the SEC and FINRA and the extensive comments from 

market participants, investors, and academics. It will be helpful to 

understand from our witnesses what progress has been made in 

identifying and prioritizing the key concerns with our equity market structure and what options are being explored to address them. 

After all, the 2010 Flash Crash is still fresh in many of our minds 

and additional market events have raised concerns about market 

integrity and resiliency. 

In fact, the SEC’s Equity Market Structure Advisory Committee 

met to diagnose and discuss one of the latest market disruptions, 

namely, what went wrong last August 24 when dramatic price 

moves triggered more than 1,000 trading halts in hundreds of 

stocks and exchange-traded funds. 

Today, this Committee hopes to hear from our witnesses about 

what lessons were learned from recent market disruptions and 

what steps need to be taken to strengthen the operation of the 

markets. The U.S. capital markets are vital to the growth of our 

economy and we need to take the necessary steps to make sure 

that the U.S. financial system and markets remain the preferred 

destination for investors throughout the world. 

I do look forward to the testimony of our witnesses, who I will 

introduce in just a moment, but let me turn first to my colleague, 

Senator Warner. 

STATEMENT OF SENATOR MARK R. WARNER 

Senator WARNER. Well, thank you, Chairman Crapo, and thank 

you for holding this hearing on this very important topic. 

I was going to remark that, knowing how it is a little complicated, I was happy to see that at least one of our colleagues was 

here, but already our comments have driven him out of the room, 

so——

[Laughter.] 

Senator WARNER.——but we are glad to see him——

Chairman CRAPO. I am sure he is listening on his iPhone. 

Senator WARNER. Over the past few decades, we have seen remarkable technological progress and innovation in our security 

markets, coupled with substantial regulatory reform. Some of these 

advances and reforms, including decimalization, have brought considerable rewards for individual investors by narrowing spreads 

and increasing liquidity. Most trades today can happen within fractions of a second, providing good prices and counterparties for 

those seeking to buy equities around the world. 

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

periodic dislocations. In recent years, as the Chairman mentioned, 

we have seen a market-wide Flash Crash, a series of mini-Flash 

Crashes in individual equities in Blue Chip stocks, a Flash Freeze 

at NASDAQ in 2013, problems with high-profile IPOs like 

Facebook and BATS, a glitch at the New York Stock Exchange in 


BANKI-41578DSA with DISTILLER
3

July 2015 that halted trading for hours, an ETF meltdown in 2015, 

and numerous allegations of and settlements for misbehaviors by 

dark pool operators. 

It is clear much work around market structure remains. So, 

where do policymakers go from here? Let me make four quick 

points. 

First, in the era of microsecond trading, we need to reevaluate 

the way our stock markets function. Chair White has made the 

right call by asking the Commission to conduct a holistic market 

structure review. We need data to be able to rationally analyze the 

market so appropriate investor protections can ultimately be implemented. 

Second, I believe strongly we should explore additional pilots. It 

has been nearly 2 years since Chair White announced her holistic 

review. Some have argued against conducting pilots in the interim 

as inconsistent with this review, but I do not think this is necessarily the case. As long as pilots are carefully crafted and done 

in a timely fashion, they can produce valuable data. 

Last week, I saw a stunning graphic from RBC Capital Markets 

that charted 839 different fee schedules that are composed of 3,729 

separate fee variables. When one examines these variables in detail, it appears that certain exchanges are using their fee engineers 

to put together bespoke pricing terms for one or a small handful 

of customers in order to attract and retain order flow. Given this 

incredible complexity, it is likely very difficult for market participants to know whether they are getting best execution and the benefit of a fair and orderly market. 

To address this, there is a proposal pending before the SEC that 

would, for a 6-month period, eliminate rebates or comparable inducements for a random sample of 50 of the 100 most actively traded stocks. I strongly endorse this maker-taker pilot to help detect 

conflicts of interest, promote price transparency, and reduce inefficiencies. 

Third, we should examine the role dark pools play in market 

structure, particularly in light of recent settlements with the SEC 

and the New York Attorney General. The original rationale for alternative trading venues—executing block sales, large block sales—

appears to have diminished, with only an average trading size of 

187 shares at the five largest dark pools, according to a recent 

FINRA study in 2014. I would love to hear more on that subject. 

The SEC has made recent studies in both enforcement and regulation of this space, recent strides, and I hope it continues. 

Fourth and finally, we must have the regulatory tools necessary 

to conduct adequate market oversight. This means establishing the 

Consolidated Audit Trail (CAT) so the SEC can have real-time insight into the mechanics of the stock market. It is beyond frustrating that nearly 6 years after the Flash Crash we still have not 

built the CAT. Both of our witnesses today have a critical role in 

its approval, so I look forward to hearing their explanations on its 

timely completion. 

Thank you, Mr. Chairman, and I look forward to our witnesses’ 

testimony. 

Chairman CRAPO. Thank you very much, Senator Warner. 


BANKI-41578DSA with DISTILLER
4

I saw the same graphic you did, and it is remarkable to see the 

kind of analysis that can show the complexity of the markets that 

we are now dealing with. 

And, again, I appreciate the work that both the SEC and FINRA 

are doing. We want to both, I think, encourage that that work proceed quickly and that we address these critical issues and get the 

advice and counsel of those who regulate these markets. 

And, in that context, our witnesses for today’s hearing on Regulatory Reforms to Improve Market Structure are Mr. Stephen 

Luparello, Director of the Division of Trading and Markets at the 

U.S. Securities and Exchange Commission, and Mr. Richard 

Ketchum, Chairman and CEO of Financial Industry Regulatory 

Authority. 

As many of you may know, Rick Ketchum has announced that 

he is going to be retiring later this year, and I know that I will 

miss you, Rick. All of us will. Thank you for your service and for 

your dedication to improving our markets. We appreciate it very 

much. 

Mr. KETCHUM. Thank you very much for those words. 

Chairman CRAPO. Gentlemen, I think you know the rules very 

well. We have allocated 5 minutes to each of you, and we will have 

you go in the order I introduced you. And at that point, then, we 

will have an opportunity for some questions and dialogue. 

Mr. Luparello. 

STATEMENT OF STEPHEN LUPARELLO, DIRECTOR, DIVISION 

OF TRADING AND MARKETS, SECURITIES AND EXCHANGE 

COMMISSION 

Mr. LUPARELLO. Chairman Crapo, Ranking Member Warner, 

Members of the Subcommittee, thank you for inviting me to testify 

regarding equity market structure. I welcome this opportunity to 

discuss a topic of such importance to investors, public companies, 

our securities markets, and capital formation. 

Enhancing U.S. equity market structure continues to be a primary focus of the SEC. It was a primary focus in 2015 and will 

continue to be in 2016. My written testimony lays out the full 

range of the SEC initiatives. 

In 2015, for example, the SEC published a proposal to enhance 

the operational transparency of alternative trading systems, proposed amendments to a rule that would require broker-dealers who 

engaged in proprietary trading in off-exchange venues to become 

members of a national securities association, and approved a pilot 

program to assess the effect of tick sizes on market quality for 

smaller issuers. 

Before I touch briefly on a few upcoming initiatives, I want to 

give an overview of the Commission’s program for equity market 

structure to help illuminate how particular initiatives fit into the 

program as a whole. 

Today’s equity markets, as you know, are dominated by computer 

algorithms. These algorithms are capable of generating, routing, 

and executing orders with enormous sophistication, volume, and 

speed. They have enabled types of market mechanisms and trading 

practices that were not possible in the days of manual markets. 


BANKI-41578DSA with DISTILLER
5

Our regulatory regime must keep pace with and adjust appropriately in response to these market changes. But doing so requires 

thorough study and an appreciation of the workings of the full market. Market structure issues typically are complex and highly interrelated. Even when a particular problem is identified, efforts to develop a response must reflect the full consideration of the risk of 

unintended consequence. 

To meet this challenge, our ongoing equity market structure review is based on three key elements. First, it is data driven. A vital 

first step in dealing with market structure questions is to marshal 

relevant data. Although data analysis alone cannot dictate particular outcomes, it is extremely valuable to help narrow the range 

of viable regulatory responses. 

Accordingly, the SEC has made a concerted effort in recent years 

to strengthen its capabilities for data collection and analysis. These 

efforts include capturing a wider range of data sources, deploying 

more sophisticated technology tools and analyzing data, and employing additional personnel with the necessary quantitative skill 

sets. 

Second, our review of equity market structure is open to a wide 

range of views. Many market structure issues arise in the context 

of proposed SEC rules, national market system plans, and exchange rules. These procedural contexts provide an extensive opportunity for public comment. But given the complexity of market 

structure issues, the SEC has taken an extra step of seeking out 

a wide range of views in contexts other than specific proposals and 

adoptions. These have included concept release, public roundtables, 

a request for comment on particular topics, and the establishment 

of the Equity Market Structure Advisory Committee. 

Finally, our equity market structure review is comprehensive in 

scope. Properly assessing market structure issues requires full appreciation of the extent to which market participants, the tools 

they employ, and the trading venues they use are interrelated. 

Rarely, if ever, does a material change in one aspect of market 

structure not have important effects on other aspects of market 

structure. 

Accordingly, the SEC does not address issues in isolation. Rather, as outlined in my written testimony, the SEC has advanced initiatives that encompass market stability, high frequency trading, 

fragmentation, broker conflicts, and the quality of markets for 

smaller companies. Focus on this wide range of substantive issues 

is intended to help address particular areas of concern while still 

providing an opportunity to assess the extent to which these issues 

and initiatives across different categories are interrelated. 

I will finish by briefly mentioning four particular initiatives that 

should see important developments in the coming months. One, as 

mentioned already, is the Consolidated Audit Trail, or CAT, which 

would represent a major step forward in oversight of the equities 

markets. We have approved certain exemptions and approved the 

CAT project manager, clearing the way for the staff to be in a position soon to make a recommendation to the Commission for publishing the CAT plan for notice and comment. 

Another noteworthy new rulemaking initiative involves institutional order routing transparency, which would expand investors’ 


BANKI-41578DSA with DISTILLER
6

understanding of the brokers’ routing decisions—of their brokers’ 

routing decisions—by mandating standardized order routing disclosures. I anticipate that the staff will make a recommendation on 

this initiative in 2016. 

Another noteworthy new initiative is an anti-disruptive trading 

rule. Staff is developing a recommendation that would be narrowly 

tailored to address aggressive destabilizing strategies in conditions 

where they have the most possible impact to exacerbate price volatility. 

And, finally, a fourth initiative is the potential for a pilot program, as discussed, on maker-taker fee structures. A subcommittee 

of the SEC’s Equity Market Structure Advisory Committee is assessing this issue and I anticipate that it will have a recommendation ready to discuss by the full committee at its next meeting in 

April. 

Thank you for inviting me to testify to discuss these issues and 

I look forward to answering your questions. 

Chairman CRAPO. Thank you very much, Mr. Luparello. 

Mr. Ketchum. 

STATEMENT OF RICHARD G. KETCHUM, CHAIRMAN AND CEO, 

FINANCIAL INDUSTRY REGULATORY AUTHORITY 

Mr. KETCHUM. Chairman Crapo, Ranking Member Warner, and 

Members of the Subcommittee, I also want to thank you for the opportunity to testify today. 

In recent years, there has been an increased debate about the 

structure of capital markets. Once the domain of regulators, market operators, and large sophisticated investors, market structure 

is now a topic for much broader public discourse. This discourse 

often, appropriately, includes questions about whether or not the 

markets are fair and whether they provide a level playing field for 

all investors. 

Questions of market structure can be broad and complex and it 

can be difficult to pinpoint what really needs to be addressed. I believe there are three key aspects of the markets that securities 

market participants and regulators should always be working to 

strengthen: market fairness, market transparency, and market liquidity. 

Investors must have confidence that they can access current, accurate market prices that reflect true investor supply and demand. 

That means that market structure must foster and promote accurate prices and low trading costs for retail investors. Having been 

in this business for a long time, I have seen many significant market structure changes that have benefited investors, but some of 

these changes have also led to a more complex and fragmented 

market. 

FINRA has responsibility to oversee and regulate over-thecounter trading of exchange listed and non-exchange listed securities as well as trading in many fixed income instruments. In addition, FINRA provides automated surveillance and other regulatory 

services to U.S. equity and options exchanges, conducting surveillance for approximately 99 percent of the listed equity market and 

approximately 70 percent of the listed options market. 


BANKI-41578DSA with DISTILLER
7

As a result, while the markets have become increasingly fragmented, we have been able to aggregate trading data across the 

markets to conduct comprehensive cross-market surveillance. This 

is important because we have found many instances where market 

participants have consciously dispersed their trading activity across 

multiple markets in an effort to avoid detection. 

In addition, FINRA’s cross-market surveillance program enables 

us to detect those market participants who are acting in concert to 

engage in market manipulation schemes. Our innovative program 

allows us to run dozens of surveillance patterns and threat scenarios across the data we gather to look for manipulation and front 

running as well as layering, spoofing, algorithmic gaming, and 

other abusive conduct. This sophisticated surveillance allows us to 

detect activities that we were not able to see before. We are also 

starting to design surveillance programs that will span equities 

and options markets together to detect potential cross-product manipulative conduct. 

Transparency is another market feature of paramount importance to investors, and FINRA recently proposed a series of initiatives designed to increase the scope of trading information we receive and provide more transparency into trading activities to market participants and investors. In general terms, these efforts include a call for alternative trading systems to provide more indepth order information for regulatory surveillance, greater transparency of volume executed away from stock exchanges, more 

granular audit trail information, and tighter restrictions around allowable clock drift to better ensure proper sequencing of events. 

These FINRA initiatives align with broader market structure 

changes implemented by the SEC and other market participants. 

Since the May 2010 Flash Crash, the SEC, FINRA, and the U.S. 

stock exchanges have implemented a variety of initiatives to minimize the impact of extreme volatility. Among the changes, regulators adjusted the market-wide trading pause, which gives market 

participants an opportunity to assess their positions, valuation 

models, and operation capabilities when extreme periods of volatility occur. In addition, FINRA and the exchanges implemented a 

limit up-limit down initiative which addresses the type of sudden 

price movements that the market experienced during the Flash 

Crash. 

We had an excellent opportunity to evaluate the effectiveness of 

these changes last August 24. The events of that day illustrated 

both the value of having appropriate controls in place and areas 

where those controls might be enhanced, and I look forward to discussing this in greater detail with the committee. 

Many of these issues are being considered by the SEC’s Equity 

Market Structure Advisory Committee, of which I am a member. 

Among other things, the committee is reviewing the current regulatory model for exchanges and other trading venues as well as the 

current state and impacts of Regulation NMS, and in particular, 

the EMSAC is considering whether rules on limiting trade 

throughs, capping access fees, and preventing locked and crossed 

markets continue to serve their intended purposes. 

I appreciate the opportunity to testify today and would be happy 

to answer any questions you may have. Thank you. 


BANKI-41578DSA with DISTILLER
8

Chairman CRAPO. Thank you very much. And, again, I appreciate the effort that both of you and your organizations have been 

involved in on this. And, to start with, I would note that, as Senator Warner indicated, Chair White 2 1⁄2 years ago now embarked 

on the holistic approach and we had been looking at these issues 

even for a couple of years before that. I am in the mode of wanting 

to find out how soon we will get to go on some of the answers. 

Each of you in your testimony have identified some specific areas 

and proposals that you think are—I assume you think are ready 

to move forward. So, what I would like to ask you to do, both of 

you to do right now for the remainder of the time I have in my 

questioning in this round is to pick maybe the top two proposals 

or actions that you think need to be made, and I am talking about 

in terms of what we can get to as quickly as we can, or how quickly 

we can get to some proposals on the table so we can start moving 

and then give me a little bit of a timeframe idea of what you think 

that we are looking at in terms of getting to these proposals. Mr. 

Luparello. 

Mr. LUPARELLO. So, it is a fortunate coincidence that I think my 

top two are the ones that are next up in terms of us getting proposals out, both of which I alluded to in my oral statement, but 

specifically the Consolidated Audit Trail and our institutional order 

routing disclosure rule, which in shorthand, we call Institutional 

606. 

Chairman CRAPO. And I heard you say ‘‘soon’’ on the Consolidated Audit Trail and during 2016 on the other, so how about—can 

you specify that a little bit? 

Mr. LUPARELLO. Well, you know, I generally get in trouble when 

I put specific dates on things——

[Laughter.] 

Mr. LUPARELLO.——but I will at least reference that the Chair 

recently said that it is her desire to have the Consolidated Audit 

Trail approved and the plan processor selected in 2016, and if you 

back out some of the hard dates that go into that, that would require us to get the plan out for notice and comment in the coming 

few weeks. 

Institutional 606 is something we are working hard to get out in 

somewhat a similar timeframe. One of the reasons why I think it 

is both an important rule and an important rule to get out soon is 

it works nicely in complement with our Reg ATS proposal that we 

put out. Both of those rules stand on their own as very good, important disclosure-based rulemakings. But, in a way, they work 

even better together. 

Chairman CRAPO. All right. Thank you. 

Mr. Ketchum. 

Mr. KETCHUM. Well, let me start and agree with Steve on both 

of his pieces, without counting them as my two, but I will just 

briefly——

[Laughter.] 

Chairman CRAPO. We will grant you that. 

Mr. KETCHUM. But, I will briefly mention on the Consolidated 

Audit Trail, FINRA obviously does a substantial percentage of the 

market surveillance tasks where audit trail information is so critical and CAT is a huge step forward. The ability to move from a 


BANKI-41578DSA with DISTILLER
9

two-step process of identifying the firms that are executing and 

clearing trades where they may be problematic to an ability to 

identify customers as opposed to having to go out to firms to get 

that information dramatically reduces false positives, dramatically 

improves our ability to identify problematic activity, and I could 

not be more supportive of the SEC’s efforts there. 

I would just note, it is a complex task, and I know, Chairman 

Crapo, that you have always been interested in balance and ensuring that this is done the right way, as well. I think the SEC’s exemptive order, which I compliment Steve on for getting out yesterday, was a great example from what was submitted by the exchanges and FINRA of the type of efforts to both move CAT forward but also move it forward in a way that is operationally the 

most efficient and effective, and I look forward to the publication 

of the plan and moving it as quickly as possible. 

Two other things I will mention. It is the right time to address 

and manage and look closely at the maker-taker issue. I compliment the SEC for moving forward on a pilot, working with the 

exchanges and FINRA, and I think there were a variety of excellent reasons to set the maker-taker pricing and access fee provisions where it was at the time the SEC did. The markets, as both, 

Chairman Crapo, you and Ranking Member Warner indicated, 

have changed dramatically since then. The arbitrage issues around 

maker-taker pricing today raise real questions from the standpoint 

of efficiency and investor confidence. It is the right time to look at 

it. 

And, the last piece is, we collectively, both the SEC, the exchanges, and FINRA, all need to respond to the areas where there 

is still more to be done showing up from the standpoint of trading 

on August 24. Fundamentally, the markets and the steps that were 

put in place worked and operated well to reduce the type of volatility that we had seen earlier at the Flash Crash. But, there are 

a range of issues, as I indicated in my testimony, that deserve to 

be looked at closely, and I think that also, from an investor confidence standpoint, is something we ought to get to. 

Chairman CRAPO. Well, thank you very much, and you both kept 

me right on time. 

Senator Warner. 

Senator WARNER. I appreciate the Chairman’s questions. 

I am going to come at it maybe with a little more edge. I think 

it is great, what you have—and I say this—I know you guys are 

both trying to get us where we need to be, but, you know, it is 6 

years on the CAT, and I hope you will take back, Steve, the notion 

to the Commission that at least this Senator’s patience is wearing 

very thin. I also wonder, on the Consolidated Audit Trail, since the 

SEC does not have jurisdiction over the futures markets, obviously, 

that is CFTC, but as we saw with the Flash Crash, if you have 

something happen on the futures side, it can also affect the equities side. 

So, I am going to get out at least two of my questions and I am 

going to ask you to both answer quickly, because I have got three 

or four more. How do we deal with that jurisdictional issue, recognizing that you have committed that we are going to get this 

project—the CAT finished in 2016, point number one. 


BANKI-41578DSA with DISTILLER
10

Point number two, to where, Mr. Ketchum, you were at, I think 

the maker-taker pilot is really, really important. I do not know if—

Senator Crapo and I both saw it. I do not know if Senator Warren 

saw the RBC chart that showed—again, I just say to say again—

839 different fee models and over 3,700 different kind of fee structures, a level of complexity that even for Wall Street is over the 

top, that clearly is driving commissions, fees, and rebates in a way 

that is not transparent, that does not guarantee best markets, that 

under the guise of bespoke products, I think, is creating a real disservice, and my understanding, at least, in terms of a maker-taker 

pilot, if you decide to move forward, this would not require months 

and months of preparation. You could simply pick an arbitrary 100 

equities, put 50 in the control batch and 50 in the noncontrol batch 

and flick a switch and we could start that pilot. 

So, I would like you on the first round, briefly, because I have 

got, again, a few others to whack at—to hit on—how hard around 

the CAT without the jurisdiction on futures, and can we be assured 

that we are going to move forward on maker-taker in a timely 

manner, in either order. 

Mr. LUPARELLO. I will be happy to start. CAT could not be a 

higher priority for us, and getting a recommendation to the Commission——

Senator WARNER. Six years is a long time. 

Mr. LUPARELLO. I—I appreciate that, and I have lived that for—

I have lived in that space for all of it, including some time living 

with access to inadequate information. So, we—like I said, it could 

not be a higher priority for the Commission, for the Chair, and especially for me and my staff, and we expect to have something 

very, very soon. 

I think the issue of other products, it cannot be overstated. There 

are some jurisdictional issues. I know the CAT plan participants, 

and Rick is more close to this than I am, have been identifying 

those potential expansions into other products, because August 24 

proved what I think we already knew, which is that the futures 

markets and the cash markets are inextricably linked, and if we do 

not have a good vision into those, we are still—we are going to be 

seeing a much more complete picture on a day in, day out basis, 

but during times of extreme market stress, we are going to be 

missing an important part of the picture if we do not have futures 

there. 

I agree, I think maker-taker is a pilot that, unlike some other pilots, where I think we are concerned that we are adding even more 

complexity when you put a pilot into place, that maker-taker is one 

that can be done very simply. We look forward to the recommendation from the Equity Market Structure Advisory Committee. I 

think it will be something we will be able to act on very quickly. 

Senator WARNER. When? 

Mr. LUPARELLO. The subcommittee is supposed to make a recommendation to the full committee at the next full committee 

meeting, which is late April. And, so, that full committee will 

then——

Senator WARNER. Do you think there will be a recommendation, 

either go or no go? 


BANKI-41578DSA with DISTILLER
11

Mr. LUPARELLO. I think the Subcommittee will be ready to make 

a recommendation to the full committee. Given the conversations 

that the full committee has had, I obviously cannot commit the full 

committee. I would expect that they would probably have some 

questions about the construction of a pilot, but I think there is 

broad-based support, which is, obviously, very important because it 

is a committee with a number of different market participants and 

constituents, that I think there will be broad-based support for a 

pilot. Obviously, the details of how you construct the pilot are to 

be determined. 

Senator WARNER. Rick. 

Mr. KETCHUM. As the operator of most of the market surveillance 

activity going on in the markets today, nothing could be more important to us than moving to CAT. We are fortunate now that we 

can look across markets and across products, but the Consolidated 

Audit Trail dramatically enhances the effectiveness of our job. 

You are right, Senator Warner, that there is no question that including futures and, frankly, on the way, credit default swaps 

would be a huge step forward with respect to the Consolidated 

Audit Trail and efforts should be made to move across jurisdictional lines. We have worked closely with the MERC with respect 

to investigations for years and they have been tremendously cooperative. But, the only way to effectively identify or recreate markets is to have it all in one single database, and your point is absolutely correct. 

Senator WARNER. Can you quickly address, since my time is out 

and I want to come back next round on tick size and bond market 

transparency, just very quickly on maker-taker. 

Mr. KETCHUM. Maker-taker, I absolutely support a broader pilot. 

It is something that should be done from the standpoint of data. 

There are a lot of interesting questions around it. But, to me, sitting as just one member of the Equity Advisory Committee of the 

Commission, I think this is absolutely the right time to look and 

make changes to the maker-taker pricing. 

Chairman CRAPO. Thank you, Senator Warner. 

And, Senator Warren. Senator Warren has to leave to another 

Committee meeting, and so she is going to get a few extra minutes 

on this one instead of waiting for the second round, if that is all 

right with you, Mr. Warner. 

Senator WARREN. Thank you. 

Senator WARNER. Sure. 

Senator WARREN. Thank you very much Mr. Chairman. I really 

appreciate your cooperation so I can cover two hearings, and also 

appreciate your calling this hearing. This business about market 

structure is just powerfully important. That makes this hearing 

very important. 

I want to focus on the self-regulatory aspect of this market. 

FINRA is not a Government agency. It is instead an independent 

nonprofit organization that is responsible for regulating parts of 

the securities industry. So, I looked on your Web site and the Web 

site for FINRA says that it is dedicated to investor protection and 

works everyday to ensure that every investor receives the basic 

protections they deserve. I want to explore whether this industry 

self-regulation really works. 


BANKI-41578DSA with DISTILLER
12

This week, three economists from the University of Chicago’s 

Booth School of Business released a study that looked at records 

on 1.2 million registered financial advisors and brokers from 2000 

to 2015, and they found that 1 in 13 had a documented record of 

criminal, civil, or regulatory misconduct. Amazingly, only about 

half of them had been fired by their firms because of this misconduct, and of the half that were fired, 44 percent got a job at another advisory firm within a year. 

Now, the study also finds that certain advisory firms hire a huge 

number of advisors with a history of misconduct and those firms 

tend to, quote, ‘‘cater to unsophisticated consumers, particularly 

the elderly and those with less education.’’ For example, a customer 

walking into an Oppenheimer and Company retail location looking 

for financial advice has a one in five chance that the advisor will 

have a documented history of misconduct. 

Mr. Ketchum, as the head of FINRA, what are you doing to make 

sure that the elderly and people who can least afford bad financial 

advice do not fall into the net of someone who has already got a 

documented history of misconduct? 

Mr. KETCHUM. Senator Warren, I am glad you asked that question. First, I read that study, as well, with great interest, and I do 

find it dismaying that firms do hire in many circumstances persons 

with those type of records. Those are exactly the factors we look at 

from the standpoint of where we focus our exams and where we 

focus our enforcement investigations. It is exactly those type of factors which result in us barring or suspending up to a thousand persons a year, bringing action with respect to a wide range of firms 

and more than a thousand actions a year. And we care very much 

about the issues from the standpoint of recidivism and the potential impact with respect to investors. 

Senator WARREN. Well, I appreciate, Mr. Ketchum, that you care 

about this, but these are the data about what is going on right 

now. I want to know what you plan to do about it. You know, we 

have got FINRA-registered companies where 15 to 20 percent of 

the FINRA-registered advisors have a history of misconduct. What 

is going on here? 

Mr. KETCHUM. Well, first up, and let us go back to the definition 

of misconduct, which is, among other things, that the firm settled 

an arbitration or a complaint for some amount of money without 

admission one way or another with respect to the investor. 

Senator WARREN. But——

Mr. KETCHUM. These are absolutely incidents of exactly the type 

of thing we look at from an exam standpoint——

Senator WARREN. Well, I am glad you are looking at it——

Mr. KETCHUM.——but we do actually have to find somebody——

Senator WARREN.——but you are not taking them off the street. 

And let us be——

Mr. KETCHUM. We do when they violate the rule. Yes, we do. We 

bar——

Senator WARREN. Then how can it be so——

Mr. KETCHUM. We bar hundreds of——

Senator WARREN. How can there be so many? How can it be that 

you could walk into an Oppenheimer and Company and have a one 

in five chance of encountering someone who has prior—recorded 


BANKI-41578DSA with DISTILLER
13

prior misconduct? And, let us keep in mind, this does not—these 

are not trivial. 

The other thing that the study found was that advisors who have 

engaged in prior misconduct are five times more likely to engage 

in future misconduct when compared with the average advisor. So, 

we are talking about real risk here. 

Mr. KETCHUM. And that is exactly the risk we look at with respect to our exams and enforcement investigations, and that is why 

many of those people get barred every year. 

Senator WARREN. Well, all I can say, Mr. Ketchum, is you obviously are not getting them out of the industry. They are still there. 

They are there in big numbers. And they are concentrated in places 

where they are most likely to encounter unsophisticated consumers 

and I think that is a real problem that we have got. 

So, let me look at another aspect of the industry self-regulation. 

Almost every advisory contract these days includes a forced arbitration award, and that means that if investors think they have 

been cheated, they cannot go to court, and if a bunch of them get 

cheated by the same broker in the same scheme, they cannot combine their claims into a class action. They have to come to you, to 

FINRA, for arbitration. 

Now, it turns out that investors do not win very often in arbitration and that even if they do manage to win, they do not get paid. 

A recent report from the Public Investors Arbitration Bar Association found that over $60 million in arbitration awards to investors 

in just 1 year, 2013, are still unpaid. And just to put that in context, that means of the people who finally made it all the way 

through the arbitration process and managed to actually win 

against their broker or advisor, about a quarter of them still have 

not gotten the money that they won in the arbitration award. 

Now, the same issue—main issue here seems to be that these security firms do not have the money on hand to pay these awards. 

They stay in business, but they do not have the money. So, what 

is FINRA planning to do to ensure that these firms and brokers actually have the money to pay an arbitration award when they 

cheat people? 

Mr. KETCHUM. OK. Three sets of responses to your very valid 

question. 

First, with respect to any firm that continues to do business in 

the securities industry, unless they leave and become an investment advisor, we will bar them if they do not pay their awards, 

plain and simple as that. No one can stay in as a FINRA member 

and not pay their arbitration awards. And we do that——

Senator WARREN. So, you are telling me—I just want to make 

sure I understand what that means. You are saying of the $60 million in arbitration awards from 2013, all of those people are now 

barred? They are not part of FINRA anymore? 

Mr. KETCHUM. If I can get through my three answers——

Senator WARREN. OK. 

Mr. KETCHUM.——I will try to address each part. If they continue to have money, if they continue to do business as a FINRA 

member and they do not pay their arbitration awards, we will bar 

them. 


BANKI-41578DSA with DISTILLER
14

Now, you are right, and one of the things that we have is that 

firms become insolvent, leave FINRA, and in those situations, we 

lose our jurisdiction from that standpoint and investors—from the 

standpoint of barring them, they are already gone—just as, by the 

way, they do if they are an investment advisor bringing an action 

against the firm and that firm goes insolvent with respect to enforcing a court decision, they have to go to court to enforce it, and 

that is a big problem from the standpoint of the number of people 

that are not paid. 

You raised exactly the right questions. The question as to whether the capital requirements are at the right level are fair questions. 

They are things we will look at at FINRA, although I will note capital requirements are essentially something that the SEC has 

taken responsibility for. Now, most of the time, we want to get 

these people out of the industry if they are doing bad things to investors. 

But, whether there should be jumps before firms leave to ensure 

that they have left capital to meet their arbitration obligations that 

may come forward is something we are looking at. Whether, one 

way or another, there should be a fund to try to at least address 

this with respect to small investors that are terribly harmed by 

that. I could not agree more that each of those issues ought to be 

looked at. 

Senator WARREN. OK. So, what I am hearing you tell me, and 

I just want to make sure I have this right, is that you believe that 

there ought to be more regulation so there is money available when 

people get cheated. And, second, you are telling me that all of the 

people who were cheated in 2013 who got arbitration awards who 

have not paid out, that all of those dealers and brokers are now 

out of the business and out of your jurisdiction. Is that right? 

Mr. KETCHUM. I am not—I am saying that those that have not 

paid out will either be in a short period of time barred or are already out. 

Senator WARREN. This is now 3 years. 

Mr. KETCHUM. Well, but with respect to those, they are gone. 

Those are firms that have left FINRA. 

Senator WARREN. All of them from 2013 are gone. 

Mr. KETCHUM. Those—yes. 

Senator WARREN. OK. 

Mr. KETCHUM. Those are firms that have left FINRA and the collection issues are exactly the same collection issues you have when 

a firm goes insolvent with respect to court. 

Senator WARREN. Well, I just want——

Mr. KETCHUM. But something should be done about it, and I 

want to repeat what you just said. I do believe this is an issue we 

want to be part of, we want to work with the SEC on, and it is 

a real concern. 

Senator WARREN. Well, I just want to say on both of these, I 

think something should be done about brokers and dealers who put 

customers at risk. Brokers and dealers have arbitration awards 

against them and cannot even pay when there is an award against 

them. They are serious issues. They affect ordinary investors. 

FINRA is supposed to be looking out for these folks, not for the advisory firms, and I hope you will address these issues quickly. 


BANKI-41578DSA with DISTILLER
15

Thank you, Mr. Chairman. Thank you for your indulgence in giving me the extra time. 

Chairman CRAPO. Thank you, Senator Warren. 

Senator Donnelly. 

Senator DONNELLY. Thank you, Mr. Chairman. 

I appreciate the efforts of the SEC and Chair White in recent 

years to review and improve the structure of our equity markets. 

They are significantly more complicated, and in recent decades, we 

have moved from a single dominant stock exchange to a marketplace now featuring 12 exchanges, 40 dark pools, and hundreds of 

broker-dealers. Additionally, trading is electronic and highly automated. 

And, Mr. Ketchum, you spent 14 years with the SEC before 

working for the exchanges and on Wall Street. Can you describe 

the significant changes in market complexity you have witnessed 

and the effect. 

Mr. KETCHUM. Well, I will try to, Senator Donnelly, and you are 

right. The changes are dramatic. I think over a period of years, 

with a combination of technological advances and the SEC’s focused effort to reduce barriers to entry and encourage competition, 

the markets have changed dramatically. We have moved from an 

environment where the New York Stock Exchange and NASDAQ 

stock market accounted for virtually all trading that occurred, 

where they operated with respect to either a single specialist system or a constrained market-maker system from the standpoint of 

providing liquidity to the environment that Mr. Luparello described 

earlier in his statement where liquidity is essentially provided 

through a range of algorithmic active traders, some of whom have 

requirements and obligations built into their exchange registrations and some of whom do not. 

The markets are also dramatically fragmented across large numbers of exchanges and automated trading systems, and that has 

changed the environment and raised issues from the standpoint of 

transparency, disclosure as to how orders are handled, issues from 

the standpoint of best execution, and, obviously, as has been discussed before, maker-taker pricing. This is an area that continues 

to deserve great——

Senator DONNELLY. Let me ask both of you, do you think the regulators have the tools to keep pace with the technology development and the efforts that are being put forward to try to constantly 

move the ball? You know, we have seen time after time some of 

these flash situations and others where the regulators are on this 

effort and the ball has already moved to this point. 

Mr. LUPARELLO. So, jurisdictionally, clearly, we have the tools we 

need. From the ability to both gather and analyze data, we have 

improved dramatically over the past few years, but there is still 

some way to go. So, in all of these issues, we always try to start 

first by analyzing the data we have available. I think, as you can 

see with the work we have done after the August 24 event, that 

is still a process that is a little more burdensome, a little more 

cumbersome than we would like. As we make progress on that, I 

think the ability to analyze data in a more nimble way, use both 

the expertise and the jurisdiction we have, and work with the


BANKI-41578DSA with DISTILLER
16

variety of market participants, will give us the ability to react in 

a timely fashion to market events. 

Mr. KETCHUM. I will agree with Steve that between us, and particularly the SEC has the regulatory tools necessary to address this 

and also analyze the markets. I will stick on the market surveillance side, where FINRA takes a primary responsibility. We have 

dramatically better capabilities now than we ever had before 

through our contracts across exchanges, both stock and options, to 

look across markets and identify manipulative activity that does 

not define the most active traders, but with respect to those aberrant ones. But, we can do better. A key tool is the Consolidated 

Audit Trail and I look forward to——

Senator DONNELLY. What concerns both of you the most about 

the current structure of the equity markets? Where, when you look, 

you go, here is a hole that somebody is about ready to exploit, here 

is a problem that we are—you know, and it is a hard question to 

answer. What are the problems you are missing that almost you do 

not know you are missing at this point? 

Mr. LUPARELLO. Well, all right, the answer is what you do not 

know. I think we are less—we are always attentive to the issues 

of the robustness of the structure, but, again, I think the pattern 

over the past few years has demonstrated that a number of the 

steps that the Commission has asked for and the markets have put 

into place have made the market broadly a more robust place. I 

think you look at the events in July, where one of the major markets was out for an extended period of time, fortunately the middle 

of the day, neither the beginning nor the end of the day, and the 

markets were able to trade pretty efficiently without that one primary market being in the marketplace. 

I think in terms of what we worry about, we worry about what 

everybody else worries about, which is cyber and those kinds of 

issues and whether the rules we have put into place, which are significant, are right, rightly tailored, and being adhered to to ensure 

that we are doing everything we can from that standpoint to make 

the market robust. 

Senator DONNELLY. Mr. Ketchum. 

Mr. KETCHUM. The market has dramatically improved from a resiliency standpoint in addressing some of the excess volatility 

issues when you look back to the Flash Crash, where I think the 

markets, as a result of the changes, were truly unsafe at any 

spade. We still need to step back, look at events like August 24, 

and identify the additional steps needed to address and ensure that 

those protections against unnecessary volatility continue to be improved. And we still need to enhance our audit trail to ensure we 

are identifying those small numbers of serious manipulative activities and creative activities in the most effective way possible. 

Senator DONNELLY. If I could ask just one more question, and 

this is—you may consider this a little bit offbeat, but when you 

look and you saw that there was a whole system set up to try to 

race ahead of trades, to try to gather the information and race 

ahead of trades that were being made to make more money, and 

part of it was putting locations and buildings right next door to 

buildings next door to buildings, when you look, is there anybody 

in your organizations that look for unusual activities, where you go, 


BANKI-41578DSA with DISTILLER
17

why are seven firms going into this building right next to this 

building, for instance? Do you look for things that, for want of a 

better way to put it, seem to have no real reason other than something may be going on? 

Mr. LUPARELLO. So, there is a very important question about 

whether the race for speed reaches a point of diminishing returns 

and whether we should do things in the market that enable market 

participants of different speeds and different capabilities to have as 

good an experience as possible. 

I think in the context of co-location, that is, in fact, a regulated 

function, that these are functions that the exchanges provide to 

their members. They must provide them on equal terms to all of 

their members. So, there is that aspect, at least, issues around 

speed and latency are highly regulated. It is a very important separate question about whether people are taking those speed advantages and using them for improper purposes. I think that is something that both we and FINRA—and again, FINRA is the front-line 

regulator—spend a lot of time both thinking about and looking at. 

Mr. KETCHUM. Certainly, our primary focus of our surveillance is 

looking at the outcomes, the trading and whether that trading is, 

in one way or another, taking advantage of other investors. And, 

I think, there, we are far more sophisticated in identifying patterns 

that suggest those problems than we have ever been before. 

Senator DONNELLY. Thank you, Mr. Chairman. 

Chairman CRAPO. Thank you, Senator Donnelly. 

We will have a second round of questions, and I will start it out 

with you, Mr. Ketchum. In fact, this is an issue that I think I am 

really sort of teeing up for Senator Warner here, but I wanted to 

get my bite at it first. 

FINRA and the Municipal Securities Rulemaking Board are expected to finalize rules to increase the disclosure of broker fees for 

retail trades and bonds. How will that work, and do you expect retail investors to get better pricing? 

Mr. KETCHUM. Thank you for that question, Chairman Crapo, 

and I think it shows—and both of you have demonstrated over time 

through your recognition that while there are many important 

issues to look at with respect to the equity market, there are also 

significant issues with respect to the evolving fixed income market. 

Yes, when I look at the present environment with respect to fixed 

income securities and look at the range of trade prices that exist 

with respect to similar bonds, we see a pattern in which firms, although they are not engaging in illegal activity from the standpoint 

of the markets, they charge meaningfully significant, as in multiple 

times of the amount of markup. That is precisely the type of situation where additional disclosure to investors that can—will, I 

think, encourage a more efficient market. 

We saw that happen with respect to TRACE when we began, and 

on the municipal security side, where trade reporting began and 

that resulted in more efficient pricing. I think this will, as well. It 

is not a cure all. And, in addition, we need to look very closely at 

the operational cost, which is what we will certainly continue to follow as we file these proposals with the SEC through that comment 

period. 

Chairman CRAPO. All right. Thank you very much. 


BANKI-41578DSA with DISTILLER
18

I am going to let Senator Warner dig deeper into that one, if he 

chooses to. I want to use the rest of my time in this questioning 

period with you, Mr. Luparello. Well, actually, this could be for 

both of you, too, so you will have to listen in, Mr. Ketchum. 

The SEC Equity Market Structure Advisory Committee has four 

different subcommittees, and this kind of follows on my first line 

of questioning. I am trying to pull out of you just where we are on 

all of this and what we can expect to see and how soon. But, those 

four subcommittees are subcommittees on Reg NMS, on trading 

venue regulation, on retail customer issues, and on market quality. 

And, I realize that is a pretty broad swatch, but I am curious to 

hear from you just, basically, what are the main options that we 

are seeing develop in these subcommittees and what more decisions 

need to be made before we get some proposals. 

Mr. LUPARELLO. So, the Equity Market Structure Advisory Committee—and it is true that Rick is on at least two of those subcommittees, so he has got a vantage point in terms of the operations of the subcommittees that I do not have—the committee 

itself has been in place for about a year or so. It is relatively new. 

The creation of the subcommittees is even newer than that. And, 

so, to a certain extent, how they are going to define their jurisdiction, what they are going to choose to focus on is something that 

they are still considering. 

We talked about asking one of—we directed one of—requested 

that one of the subcommittees focus immediately on constructing a 

maker-taker pilot. I think that is an important first tangible deliverable that a subcommittee will deliver and it is absolutely the 

right priority. 

There are a number of other things in play. I think one of the 

other ones we continue to think is a good area for a subcommittee 

to focus on and to make recommendations to us about is around 

issues of plan governance. 

So, in some ways, the work of the committees is still fairly

nascent and what they are going to choose to focus on is something 

that they are trying to figure out at this point. But, again, progress 

on an access fee pilot and progress on advice around plan governance are two very important things, and if they deliver those to the 

committee in the near term, they will be really delivering some valuable benefit. 

Chairman CRAPO. Thank you. 

Do you want to add something to that, Mr. Ketchum? 

Mr. KETCHUM. Well, as Mr. Luparello indicated correctly, I am 

on two—lucky enough to be on two of those subcommittees, one of 

which is focusing on best execution and customer order routing information, the other of which is looking at venue issues from the 

standpoint of the operation of plans and the appropriate regulatory 

treatment of exchanges and automated trading systems. 

The great advantage of the subcommittees, the Commission has 

set up these meetings so that we get input from a wide variety of 

persons with regard to the committee as a whole. The subcommittee allows us to also bring in a variety of experts and have 

more open two-way conversation to discuss potential actions, and 

that is what we are really trying to look through there with respect 

to both of my subcommittees. 


BANKI-41578DSA with DISTILLER
19

I expect that this will result in very concrete recommendations 

for improvements with respect to the type of information that is 

now provided with regard to executions by both the market-making 

firms and the order routing firms, and also responses with respect 

to the appropriate environment for exchange and ATS regulation. 

So, I think the subcommittees help with that. 

My impression is the focus now is that the—I expect in each of 

the areas that Steve discussed there will be concrete recommendations coming out, Mr. Chairman. 

Chairman CRAPO. Well, thank you. 

And, again with regard to both of you, quickly—I have got 2 minutes, basically, here—what issues in the fixed income markets, do 

you think, need to have some heightened attention? 

Mr. LUPARELLO. I would start by complimenting Mr. Ketchum on 

the work that FINRA has done in preparing to get a rule filing to 

us as well as MSRB in the area of retail order execution transparency. I think that is an enormous step forward. It is a long time 

coming. For Rick and I, it is an especially long time coming. So, 

we are looking forward to that. 

I think the other thing we are spending a lot of time on is that 

there has been a real development, again, mostly in the retail 

space, of the creation of transparency venues that basically look 

like ATSs that are bringing pre-trade transparency to the fixed income markets where it really has not existed before. 

I think one of the things we spend, like I said, a lot of time 

thinking about is are there ways we can encourage and push that 

forward without, as the regulator, perhaps interfering with what 

would otherwise be positive natural developments. So, we are in 

conversations with many of the platforms that provide these liquidity venues and trying to figure out what we can do to make sure 

that that development, which is a very positive development for investors, continues to move forward. 

Chairman CRAPO. Thank you. 

Mr. Ketchum. 

Mr. KETCHUM. I would completely agree with the two issues 

Steve identified. I will mention one in a slightly different area, and 

that is Treasury securities. The agencies responsible, including Mr. 

Luparello with respect to the SEC, put out, I think, an excellent 

study that demonstrated the lack of transparency and also the dramatic changes with respect to how Treasury securities are trading 

now versus just a few years ago, and the time to move forward on 

that, and there has been a request for comment coming out of the 

Treasury Department that I thought was really very well done, 

time to move forward to ensure first, at a minimum, that there is 

full regulatory reporting of all transactions involved in the Treasury market and looking closely at the question of greater transparency. This is one of the most important markets of the world, 

but it distinguishes itself from all other fixed income markets in 

the United States from the lack of transparency. 

Chairman CRAPO. Well, thank you very much. 

Senator Warner, the floor is yours. 

Senator WARNER. Well, thank you, Mr. Chairman, and really, 

again, very much appreciate the fact that you have called this 

hearing. 


BANKI-41578DSA with DISTILLER
20

And, I just want to make an editorial comment before I get to—

I have got a whole series of additional questions and buckets we 

have not even gotten into yet. But, I think it is really important 

that you hear us that the public’s faith in the markets and the 

transparency and is it going to be treated fairly, I think we are not 

out of the woods on that. I think Senator Warren’s comments about 

arbitration and the failure to get paid, you know, that came up late 

February in the Wall Street Journal, I think we do need action and 

we need prompt, quick action from FINRA, Mr. Ketchum, so that 

there is, whether it is a reserve fund or some action, but not an 

action that is studied for years. 

You know, on the Consolidated Audit Trail, it is complicated. I 

understand that, appreciate that. But, it is 6 years, 6 years since 

the Flash Crash. You know, on the maker-taker pilot, I have not 

done all the research, but just common sense says if you have got 

839 different fee schedules and over 3,700 different fee variables all 

trying to create bespoke products that push fees and rebates to individual brokers, that is not on the up and up. And, I appreciate 

the idea that the subcommittee is going to recommend something 

in April, but we really do need to know when the full committee 

is going to act and when is this pilot going to take place. 

Let me get out a couple more before I even start on my next 

round. You know, the bond market transparency that Senator 

Crapo raised, Senator Coburn and I raised this issue in legislative 

form 2 years ago, and yet we still do not have a full-fledged answer, and there are mark-ups and mark-downs and selling bonds. 

I mean, the bond markets ought to be the most transparent of our 

markets. 

So, do either one of you want to respond on that, on the generic, 

and I have got three or four more things on specific I want to question you on. You might tell me that the subcommittee is going to 

act in April and the full committee is going to act by July or something. 

Mr. LUPARELLO. No, I think the subcommittee will make the recommendation to the full committee in April. I expect to get the full 

committee’s reaction to that at their meeting in April, and so——

Senator WARNER. Do you think they will actually act? 

Mr. LUPARELLO. I—that is—that is our—I cannot speak for the 

committee, since it is an independent committee, but I would assume that a number of these—first of all——

Senator WARNER. So, it is not unrealistic to think that we might 

have a maker-taker pilot at least started or close to started this 

summer? 

Mr. LUPARELLO. No. Unfortunately, a committee recommendation 

is just a recommendation to the staff. Again, I think you find 

that—that recommendation will find a very ready audience with 

the staff, but the staff still needs to make a recommendation to the 

Commission. Then the Commission would need to put it out for notice and comment. So, a Commission-mandated maker-taker pilot 

would take a few months after that. 

Senator WARNER. Mr. Ketchum, do you want to comment on——

Mr. KETCHUM. Well, on that, I just——

Senator WARNER.——either that or on market transparency? 


BANKI-41578DSA with DISTILLER
21

Mr. KETCHUM.——speak as one member of the committee and 

recognize in the end this will be a Commission decision, as Steve 

indicates. But, I certainly support a pilot. I look forward to see exactly what the subcommittee recommends, but I am pretty confident we will be supportive of it. 

I just want to take a second on fixed income. You are right. This 

is an area that has dramatically changed. It has become more and 

more an area where retail investors are participating both directly 

and indirectly through bond funds. I think the steps we have proposed with respect to mark-up disclosure and what I expect will 

come out of the MSRB is critically important and there is nothing 

that is more important to me than to see that go forward. 

And, as far as the points you made, Senator Warner, on arbitration, since I am retiring this year, I am not thinking in multiple 

years. This is a year that is terribly important to me as to what 

we do and this is something that is very important to me to make 

progress on. 

Senator WARNER. Done this year, in terms of some level of reserve or some ability for firms not to exit and leave people holding 

the bag? 

Mr. KETCHUM. I need to have that conversation with my board 

and there needs to be specific proposals, but yes, I hope so. 

Senator WARNER. Mr. Chairman, can I take a couple more? 

One of the areas that, Mr. Chairman, you raised at an earlier 

hearing and we both focused on terms of trying to provide more liquidity for small stocks, or smaller traded stocks, we talked about 

a tick size pilot. Again, agreement. Again, hope and expectation 

that that tick size pilot was going to take place this year. We saw 

it was supposed to take place and move forward in May. That date 

slipped to October. Arguably, some of the exchanges seem to have 

put forward proposals that seem to be more focused on preserving 

their own commercial interests than actually trying to provide a legitimate experiment. 

Are we going to hit October? I know there were three proposals. 

Where does it stand? 

Mr. LUPARELLO. We are——

Senator WARNER. How do we actually get this one on the ‘‘done’’ 

list? 

Mr. LUPARELLO. You have identified exactly the right issues that 

have caused the delay, but we are going to get it done by October. 

We have now filings in from——

Senator WARNER. That is for the record, October, no further 

delay? 

Mr. LUPARELLO. That is. That is from the standpoint of what we 

can deliver. So, we now have—we now have filings in from two of 

the markets that define some of the provisions, I think, in a manner more consistent than we—more consistent than had originally 

and more in line with what we were expecting. We assume the 

other markets will find that to be consistent with what their expectations of what a trade act component would look like. We are 

ready to move forward on all of them. I think we now have that 

level of consistency. We have the data gathering part of the

rulemaking done, and so I think we are in very good shape to move 


BANKI-41578DSA with DISTILLER
22

forward in a way perhaps we had not been in good shape up until 

these past few weeks. 

Senator WARNER. But, it is a fair critique, not of you all, but 

some of the exchanges, that their first round of proposals were 

more about preserving their own commercial interest than actually 

trying to figure out how we can bring more trading frequency and 

liquidity to smaller cap stocks. 

Mr. LUPARELLO. I guess I would say that for certain markets, the 

definition of trade, that is in the eye of the beholder. There was 

certainly differences of opinion on how that should be scoped. 

Senator WARNER. One of the things that we have, when I think 

anyone questions, whether it is HFTs or other aspects of the market, the ever more technologically driven market, I feel at times 

that you get kind of a dismissive response of, well, gosh, the god 

of liquidity trumps everything. So, that is the answer to any question that any nonperson from the market gets. You guys just do not 

understand because it is all about liquidity. 

Well, part of liquidity is, you know, the ability also for market 

making, and yet we do not have any kind of standardized definition 

of what a market-maker would end up looking like. Does it make 

sense to think about standardizing a definition around market 

maker? You know, should there be something that says you have 

got to have 99.9 percent of the time the ability to make a market? 

You do question some of these folks who say they are market makers, but at the end of the day have a closed out, completely closedout position. It seems just—again, I am not as sophisticated as 

some, but that seems inherently contradictory of the notion that 

you are making a market if you have closed out your position at 

the end of the day. 

We all know since 1987 to the Flash Crash and others market 

making is great when it is going up, but nobody wants to catch the 

knife when it is falling. So, thoughts on the whole question about 

some level of standardization around market making. 

Mr. LUPARELLO. It is a very important issue and I think it was 

part of Rick’s response to Senator Donnelly in terms of the dramatic changes in the market over the past couple of decades. It is 

fair to say that the obligations of being a market maker are considerably less than they used to be. The benefits of being a market 

maker are also less. So, the idea of potentially giving market makers some advantages that they do not have now in exchange for 

certain obligations that they do not have now is one that is a very 

important question and one that touches on a variety of different 

areas in the overall analysis of market structure. 

I think it is something where, again, the expertise of the committee is something we look to rely upon, but not exclusively. But, 

it is a very complex question. 

Mr. KETCHUM. I agree with Steve. With respect to my first SEC 

advisory committee, I was associated with the recommendation 

that this be looked at. I do think that greater definition of marketmaking obligations and market-making incentives is something 

that should be focused on. I entirely support the SEC looking at it. 

Senator WARNER. But, I hope we would actually move forward, 

because I think, again, whether it is liquidity or market making, 

there are lots of broad-based rationales given that, when the stuff 


BANKI-41578DSA with DISTILLER
23

hits the fan, sometimes if they are not there, then this value disappears. 

Let me get even a little more out there. One of the tools that 

SEC has, FINRA has, the FTC has, as the markets move more and 

more into algorithmic computer-driven trading, we know you all 

have the ability in certain instances to actually go in and look at 

the underlying code. Now, understanding that many of these firms 

believe that that underlying code is their proprietary secret sauce, 

I understand that as somebody who used to be in the tech world. 

But, I wonder, does it make sense to actually tag some of those 

codes so that in an event of a market meltdown or enormous turmoil, in kind of a post-action report, you could have tagged that 

code to see which of these secret sauces may have actually contributed to market meltdowns? And is anybody thinking through that? 

Mr. LUPARELLO. Yes, but I need to point out that there are a couple of assumptions that are in that that need to be validated or 

acted upon, one of which is that active proprietary traders are 

broker-dealers. I think that is something where, while most of 

them are now, it is important for the Commission to clarify that. 

It is something we are working on. And also that the code that is 

embedded in some of the algorithmic programs are, in fact, books 

and records of the broker-dealer. 

So, I think, as a general matter, like I said, most active traders, 

most HFTs are broker-dealers. I think they generally think of those 

things as books and records. When push comes to shove, I would 

hope they continue to hold those positions. Those are very important things for the Commission to clarify and are on our list of 

things to do in the coming months. 

But, absolutely, a better understanding of how algorithms are developed, how they are deployed, what their purposes are, and what 

order flow came from what algorithms is a very important piece of 

information that we need to have when we reconstruct markets, especially during volatile——

Senator WARNER. Right, I understand the proprietary nature and 

that needs to be protected, but the ability to go in after the fact 

and see the results—Mr. Ketchum, do you want to——

Mr. KETCHUM. I will just add two supplemental things from that 

standpoint. I completely agree that both being better able to identify problems with respect to an algorithm and in particular to create greater accountability from the standpoint of the supervisory 

obligations of the broker-dealer that is essentially providing the 

route to execute those orders is absolutely critical. 

In the present environment where we are trying to do that, recognizing that these are very clever folks who now send their strategies when they are manipulative over multiple broker-dealers, as 

I indicated before, to numerous markets, we are starting to throw 

report cards back to the firms that are executing when we see algorithms repeating again and again, manipulative activity using multiple broker-dealers, so those firms, even if they do not see the 

whole activity, can recognize their accountability from a supervision standpoint to, frankly, shut that algorithm off. 

Separately, as we move to a Consolidated Audit Trail, I know I 

am just—this is throwing a red flag at you——

Senator WARNER. Adding fire——


BANKI-41578DSA with DISTILLER
24

Mr. KETCHUM.——but as we move to a Consolidated Audit 

Trail——

Senator WARNER.——fuel to the fire here. 

Mr. KETCHUM.——we will then have exactly the ability to pinpoint with greater granularity the specific algorithm activities. 

And, I could not agree more that both the accountability of supervision and getting to that point where we can pinpoint the algorithm activity is really important. 

Mr. LUPARELLO. And, I guess the one thing I would add is while 

we absolutely have access—need to have access to the information 

to be able to understand the markets, we are not insensitive to the 

issue of the secret sauce. The number of times you would need to 

ask for code, the protections around asking for information of that 

sensitive and proprietary a nature is something that we would 

need to be very careful of. 

Senator WARNER. I would just say, and I do not want to state the 

Chairman’s position, but the Chairman and I want the markets to 

work. We are generally supportive of, you know, some of the advantages that have come out of the technological developments over 

the last 20 years. But, we also know, and we both went through 

kind of a litany in our opening statements of all of the glitches and 

challenges that the markets have seen even post-2008. 

And, at least from this Senator, I would take as a real deep concern that the things that we need to do to keep investor trust, and 

not just nonsophisticated investors, all the way up the food chain, 

and recognizing—I think one of you mentioned—there is so much 

money to be made, we are always going to be chasing wherever the 

markets and the advances move forward. 

But, when we look at the CAT taking 6 years, when we look at 

transparency in the bond markets, talking about it now for twoplus years, when we have been looking at questions like the tick 

size pilot being continued to be pushed off, when we are—I appreciate, Steve, your comments about maker-taker, but trying to get 

to a point of, all right, when is it going to actually happen, and this 

one, at least if I understand, at least, you may have to write a—

put out a Notice of Proposed Rulemaking, but the ability to actually turn on—we are talking about a 100-size pilot of which 50 

would be in the control and 50 would be in the noncontrol—it is 

not that complicated, and you cannot not look at the RBC data and 

not say something funky is going on here. That is a technical term. 

I would just encourage us that we act with as much speed as possible, and I would appreciate your—let me add to what Senator 

Crapo has said—appreciate your service. But, I can think of no—

nothing better in terms of part of your legacy than to say, at least 

on this issue of arbitration, people who rightfully have an ability 

to collect from malfeasance, that simply being able to escape the 

marketplace or go out of business where there needs to be some financial obligation, that would be a great legacy coming out of your 

tenure. 

Thank you, Mr. Chairman. 

Chairman CRAPO. Thank you, Senator. And, you and the others 

have all helped us get into a number of very critical issues here 

today. 


BANKI-41578DSA with DISTILLER
25

I cannot help but say that, when you talked about the god of liquidity in terms of being the answer to so many of the questions, 

I wonder if the power behind the curtain is order flow as opposed 

to liquidity in some of these contexts. 

But, that being said, I want to really thank you, Senator Warner, 

for really providing the exclamation point to the reason this hearing was called, which is that we want to—you know, we want to 

see things studied. We appreciate the importance of getting the appropriate data. We want to get it right. 

But, there is an increasing level of frustration in terms of getting 

around the board and back to go again and starting to implement 

some of the needed reforms for our market structure. I do not think 

there is any disagreement, if much at all anywhere, about the fact 

that we need to have some movement in terms of having our regulatory system keep up with our market structure and with the dynamics that we are dealing with. 

So, I appreciate both of you, our witnesses, being here and being 

willing to come up and be grilled in front of a Committee. But even 

more than that, I appreciate the work you are doing and your commitment that you have given us here today to help us get some of 

these issues over the goal line and help us start to move on some 

of these critical processes and reforms. 

Unless you have anything else, Senator Warner, we will adjourn 

the hearing. Thank you. 

[Whereupon, at 11:15 a.m., the hearing was adjourned.] 

[Prepared statements and additional material supplied for the 

record follow:] 


BANKI-41578DSA with DISTILLER
26

PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO 

The landscape of stock markets and trading today is substantially different than 

it was 20, 10, or even 5 years ago. 

Regulations and technological innovation have moved stock trading from the 

floors of exchanges to virtually all trading being conducted electronically on automated markets. Technology and innovation has benefited investors by leading to 

tighter spreads, lower costs, and more efficient markets. 

However, the expansion of trading venues, speed, and mandated interconnectedness of exchange and market participants has raised questions regarding market 

complexity and resiliency. 

For the past several years the Securities Exchange Commission and the Financial 

Industry Regulatory Authority have been working to better understand whether 

their market structure rules have kept pace with changes in trading technology and 

practices. 

In 2014, the Banking Committee held a hearing with a broad mix of market participants to examine the role of regulation in shaping today’s markets as well as 

whether these markets are as resilient and stable as they should be. 

Several witnesses at the hearing argued that Regulation NMS, a set of SEC market structure rules that passed by a 3–2 vote over 10 years ago, needed to be reexamined. 

Later in the year, SEC Chair White provided an update to her market structure 

agenda in a response to a letter Senator Johnson and I sent and highlighted three 

fundamental policy questions the Commission would be focusing on: 

The trade-through restrictions in Rule 611 of Regulation NMS and whether they 

should be rescinded or modified. 

The current regulatory model for exchanges and other trading venues and whether it makes sense for today’s markets. 

The maker-taker fee structure, including the related issue of restrictions on locking and crossing quotations in Rule 610 of Regulation NMS. 

These are complicated issues and I appreciate the data driven approach by the 

SEC and FINRA and the extensive comments from market participants, investors, 

and academics. 

It will be helpful to understand from our witnesses what progress has been made 

in identifying and prioritizing the key concerns with our equity market structure 

and what options are being explored to address them. 

After all, the 2010 Flash Crash is still fresh in many of our minds and additional 

market events have raised concerns about market integrity and resiliency. 

In fact, the SEC’s Equity Market Structure Advisory Committee met to diagnose 

and discuss one of the latest market disruptions, namely what went wrong last August 24 when dramatic price moves triggered more than 1,000 trading halts in hundreds of stocks and exchange-traded funds. 

Today, this Committee hopes to hear from our witnesses about what lessons were 

learned from recent market disruptions and what steps need to be taken to 

strengthen the operation of the markets? 

The U.S. capital markets are vital to the growth of our economy and we need to 

take the necessary steps to make sure the U.S. financial system and markets remain the preferred destination for investors throughout the world. 

PREPARED STATEMENT OF STEPHEN LUPARELLO

DIRECTOR, DIVISION OF TRADING AND MARKETS

SECURITIES AND EXCHANGE COMMISSION

MARCH 3, 2016

Chairman Crapo, Ranking Member Warner, and Members of the Subcommittee:

Thank you for inviting me to testify on behalf of the U.S. Securities and Exchange 

Commission (SEC or Commission) regarding equity market structure. I welcome 

this opportunity to discuss with you a topic of such importance to investors, public 

companies, our securities markets, and capital formation. 

The securities markets are ever-evolving and technology has been the primary 

driver of the changes. The ongoing challenge for regulators is to ensure that regulatory regimes are appropriately updated to respond to evolving market mechanisms 

and trading practices. 

Today, I will update you on the SEC’s efforts for meeting this challenge with respect to the U.S. equity markets. Enhancing equity market structure continued to 

be a primary focus of SEC efforts in 2015, as it will be in 2016. Among other things, 


BANKI-41578DSA with DISTILLER
27

1See http://www.sec.gov/marketstructure/.

2 Concept Release on Equity Market Structure, Securities Exchange Act Release No. 61358, 

75 FR 3594 (January 21, 2010) (File No. S7–02–10), available at http://www.sec.gov/rules/concept/2010/34-61358fr.pdf. 3 A roundtable on decimalization was held at the SEC on February 5, 2013, and a roundtable 

on market structure was held at the SEC on June 2, 2010. 4 Request for Comment on Exchange-Traded Products, Securities Exchange Act Release No. 

75165, 80 FR 34729 (June 17, 2015), available at https://www.gpo.gov/fdsys/pkg/FR-2015-06-

17/pdf/2015-14890.pdf.

the SEC published a proposal to enhance the operational transparency of alternative 

trading systems (ATSs), proposed amendments to a rule that would require brokerdealers engaging in proprietary trading at off-exchange venues to become members 

of a national securities association, and approved a pilot program to assess the effect 

of tick sizes on market quality for smaller companies. We plan to continue to make 

important strides in 2016. 

I. Overview of the SEC’s Program for Equity Market Structure 

Today’s equity markets, as you know, are dominated by computer algorithms. 

These algorithms are capable of generating, routing, and executing orders with 

enormous sophistication, volume, and speed. They have introduced types of market 

mechanisms and trading practices that were not possible in the days of manual 

markets. 

Our regulatory regime must keep pace with and adjust appropriately in response 

to these market changes. But doing so requires thorough study and an appreciation 

of the workings of the full market. Market structure issues typically are complex 

and highly interrelated. Even when a particular problem is identified, efforts to develop a response must reflect a full consideration of the risk of unintended consequences. 

To meet this challenge, the SEC is engaging in an ongoing equity market review 

that is based on three key elements—it is data-driven, open to considering a wide 

range of views on all issues, and comprehensive in scope. 

Data-Driven Analyses 

A vital first step in dealing with market structure questions is to marshal relevant data. Although data analyses alone cannot dictate particular outcomes, they 

are extremely valuable in helping to narrow the range of differences in perspectives 

and of viable regulatory responses. Accordingly, the SEC has made concerted efforts 

in recent years to strengthen its capabilities for data collection and analysis. These 

efforts include capturing a wider range of data sources, deploying more sophisticated 

technology tools for analyzing data, and employing additional personnel with the 

necessary quantitative skill sets to use these tools. 

The SEC is committed to bringing data analysis fully to bear on equity market 

structure issues. Many of the results of these efforts can be found on an SEC Web 

page that is devoted to helping inform the public debate on equity market structure.1 The Web page includes a series of research papers, underlying data highlights, and literature reviews prepared by SEC staff that address issues such as the 

speed of trading, trading in off-exchange venues, high frequency trading, market 

fragmentation, and market quality for small capitalization companies. Most recently, staff-prepared papers were added that address two notable market events 

that occurred in 2015—the New York Stock Exchange (NYSE) trading suspension 

on July 8th and the August 24th market volatility—both of which are discussed further below. 

Open to Wide Range of Views 

Many market structure issues arise in the context of proposed SEC rules, national 

market system (NMS) plans, and exchange rules. These procedural contexts provide 

an opportunity for public comment. Given the complexity of market structure issues, 

however, the SEC has taken the extra step of seeking out a wide range of views 

in contexts other than specific proposals and adoptions. These have included a concept release,2 public roundtables,3 and a request for comment on particular topics.4

The SEC also has approved over 40 exchange-level active pilots, as well as two market structure-related pilots initiated by the Commission and implemented in the 

form of NMS plans submitted by the exchanges and FINRA. 

To further provide an opportunity for a wide range of views and inputs, the SEC 

established the Equity Market Structure Advisory Committee (EMSAC), which held 

its first meetings in 2015. The 17 members of EMSAC bring an enormous range of 

expertise, experience, and perspectives to their deliberations on equity market structure. EMSAC brings in an even wider range of perspectives by inviting nonmembers 


BANKI-41578DSA with DISTILLER
28

5See http://www.sec.gov/spotlight/equity-market-structure-advisory-committee.shtml.

6 Chair White’s June 5, 2014 speech, entitled ‘‘Enhancing Our Equity Market Structure,’’ is 

available at https://www.sec.gov/News/Speech/Detail/Speech/1370542004312. 7See www.nyse.com/market-status/history for a description of the events leading up to the 

trading suspension at NYSE on July 8, 2015. 8The data highlight is available at http://www.sec.gov/marketstructure/research/highlight2016-01.html.

to make presentations on key issues at each EMSAC meeting. EMSAC also has 

formed four subcommittees to affirmatively seek out additional viewpoints and conduct detailed evaluations of market structure issues for EMSAC’s consideration. As 

discussed further below, EMSAC’s public proceedings already have shed a great deal 

of light on key market structure issues,5 and I anticipate this will continue in 2016. 

To date, the EMSAC has not provided the Commission with any recommendations. 

Comprehensive in Scope 

The U.S. equity market is a complex ecosystem in which different types of market 

participants employ a range of tools and strategies to trade on 12 registered exchanges, more than 40 ATSs, and more than 200 non-ATS broker-dealers. Properly 

assessing market structure issues requires a full appreciation of the extent to which 

these market participants, tools, and trading venues are interrelated. Rarely, if 

ever, does a material change in one aspect of market structure not have important 

effects in other aspects of market structure. 

Accordingly, the SEC’s equity market structure program does not attempt to address issues in isolation, but rather is comprehensive in scope. As laid out in Chair 

White’s market structure remarks in June 2014,6 the SEC has advanced initiatives 

that address five broad categories of issues: market stability, high frequency trading, fragmentation, broker conflicts, and quality of markets for smaller companies. 

Focus on these substantive issues is intended to help address particular areas of 

concern, while still providing an opportunity to assess the extent to which issues 

and initiatives across different categories are interconnected. 

II. Equity Market Structure Developments and Initiatives 

A. Market Events in 2015

There were two notable market structure events that occurred in 2015—the 

NYSE’s suspension of trading on that exchange for more than 3 hours on July 8, 

2015, and the unusual level of price volatility on August 24, 2015. While the markets generally responded well, each event brought to light certain issues and provided a useful opportunity for focused empirical analysis by SEC staff. 

NYSE Trading Suspension on July 8, 2015

On July 8, 2015, the NYSE, because of a systems issue, suspended trading in all 

symbols on the exchange at 11:32 a.m. and reopened at 3:10 p.m.7 To help assess 

the effect of this suspension on trading, on February 3, 2016, SEC staff in the Office 

of Analytics and Research (OAR) within the Division of Trading and Markets published a Data Highlight on the SEC’s equity market structure Web site. The Data 

Highlight examines trading volume, quoted spreads, and quoted depth before, during, and after the suspension.8

Total trading volume in NYSE-listed corporate stocks on July 8 was well within 

the range of observed trading volume in the first 7 months of 2015. While the 

NYSE’s share of trading volume declined, other market centers—especially other exchanges—experienced corresponding large increases in trading volume in NYSE-listed stocks on July 8. The Data Highlight observed, however, that NYSE-listed stocks 

experienced substantial increases in spreads and substantial decreases in depths. 

Not all NYSE-listed stocks were equally affected by the NYSE trading suspension. 

Large cap NYSE-listed stocks experienced the biggest declines in depth, while small 

cap NYSE-listed stocks experienced the biggest increases in spreads. 

The observations in the Data Highlight reflect the resilience of the U.S. equity 

market structure to the sudden withdrawal of even a large exchange, but also suggest that such a withdrawal is not without effects on market quality. In this respect, 

the event demonstrates the need for continued emphasis on systems reliance and 

integrity that has been a focus of the SEC’s efforts in recent years and is discussed 

below. 

In addition, although the NYSE was able to resume trading on July 8 prior to 

its closing auction, the potential that it would not be able to do so highlighted the 

need to address a ‘‘single point of failure’’ in equity market structure at the close. 

This type of vulnerability has been targeted by the critical market infrastructure 

initiative of the SEC and self-regulatory organizations (SROs). The opening and 


BANKI-41578DSA with DISTILLER
29

9The Research Note is available at https://www.sec.gov/marketstructure/research/equitylmarketlvolatility.pdf. 10Such initiatives include the revision of market-wide circuit breakers that apply across the 

securities and futures markets and the National Market System Plan to Address Extraordinary 

Market Volatility (commonly known as the Limit Up-Limit Down, or LULD, Plan). 11The report of the staffs of the CFTC and SEC on the May 6, 2010, Flash Crash is available 

at https://www.sec.gov/news/studies/2010/marketevents-report.pdf.

closing auctions on primary listing exchanges are integral aspects of a normal trading day and continue to be dominated by the primary listing markets. As discussed 

below, NASDAQ and NYSE are working to achieve redundancy in these auctions. 

Price Volatility on August 24, 2015

On Monday, August 24, 2015, the U.S. equity markets and equity-related futures 

markets experienced unusual price volatility, particularly during the period surrounding the 9:30 a.m. opening of regular trading hours at the start of a new trading week. To help assess the operation of the U.S. equity markets under stressed 

conditions, SEC staff in OAR published a Research Note on the August 24 event 

on the SEC’s equity market structure Web site.9 In recent years, the SEC and SROs 

have implemented several regulatory initiatives to address severe short-term price 

volatility.10The events of August 24 provided a useful opportunity to evaluate the 

practical operation of these initiatives under stressed market conditions. The Research Note provides empirical data and other information to help assess trading 

on August 24, including several issues that have been debated among market participants and observers. These issues include the opening process at primary listing 

exchanges, the triggering of trading pauses under the National Market System Plan 

to Address Extraordinary Market Volatility (commonly known as the ‘‘Limit UpLimit Down,’’ or ‘‘LULD Plan’’), and the effects of market volatility on trading in 

exchange-traded products (ETPs). 

The empirical data in the Research Note suggests that, in contrast to the Flash 

Crash on May 6, 2010,11 broad market prices did not ‘‘flash crash’’—defined as a 

sudden and extreme price decline that is unexplained by the arrival of new information and is soon reversed. On August 24, broad market prices already had declined 

by 5 percent in pre-9:30 trading. At 9:30, the equity markets opened for regular 

trading hours at broad market price levels that were consistent with the pre-9:30 

trading. The broad market then absorbed a surge in price-insensitive selling (with 

volume as much as 4 to 8 times higher than normal in many securities) with a relatively small price decline of 2 percent and soon recovered. Also, unlike the 2010 

Flash Crash, equity market infrastructure and trading systems held up without serious incident to the high trading volume and message traffic of August 24. 

However, the empirical data in the Research Note also suggests certain issues 

that arose on August 24 that generally fall within three broad categories and require attention. 

First, in the opening minutes of trading on August 24, a significant minority of 

ETPs experienced what could be described as a breakdown in arbitrage—specifically, they traded at substantial discounts to the underlying indexes they were designed to track. 

Second, many of these ETPs that experienced high volatility triggered trading 

pauses under the LULD Plan. These trading pauses helped prevent the irrational 

prices that occurred during the 2010 Flash Crash (such as one penny prices). The 

ETPs, however, did not resume trading in an orderly fashion, but traded erratically 

in ways that triggered additional LULD pauses. More than 80 percent of LULD 

pauses on August 24 occurred in ETPs, and most of these were repeat pauses in 

the same symbols and occurred when prices were recovering upward. Notably, although a significant minority of ETPs experienced severe volatility and multiple 

LULD pauses on August 24, a majority of ETPs experienced levels of volatility consistent with broad market prices, and 80 percent of ETPs did not experience a single 

LULD pause. 

The third category of issues on August 24 related to corporate stocks. Unlike for 

the market broadly, prices for a relatively small number of individual corporate 

stocks experienced flash crashes—extreme price declines followed by quick recoveries. These included six corporate stocks with very large capitalizations. In addition, 4.7 percent of the more than 4,000 corporate stocks analyzed in the Research 

Note declined by 20 percent or more from the previous Friday’s close price, while 

19.2 percent of the more than 1,400 ETPs analyzed in the Research Note declined 

by 20 percent or more. 

The unusual volatility on August 24 warrants continued close evaluation to consider whether regulatory responses may be appropriate. As noted below, the SRO 

participants in the LULD Plan are considering potential modifications, and


BANKI-41578DSA with DISTILLER
30

12 Request for Comment on Exchange-Traded Products, Securities Exchange Act Release No. 

75165, 80 FR 34729, 34740–34741 (June 17, 2015), available at https://www.gpo.gov/fdsys/

pkg/FR-2015-06-17/pdf/2015-14890.pdf. The Comment period closed in August 2015, and the 

SEC has received 40 comment letters, which are available at https://www.sec.gov/comments/

s7-11-15/s71115.shtml. 13 Chair White’s November 19, 2014, statement is available at https://www.sec.gov/News/

PublicStmt/Detail/PublicStmt/1370543489640.

individual exchanges also are assessing their opening and reopening processes. And 

prior to August 24, the Commission broadly requested comment on ETPs, including 

the extent to which arbitrage mechanisms are effective in aligning ETP prices with 

their underlying indexes.12

SEC staff continues to examine a broad spectrum of issues related to trading on 

August 24. These include, among other things:

(1) factors that may have been associated with volatility in ETPs and other securities, including the nature of selling pressure, sources of liquidity provision, 

and, for ETPs, create and redemption activity;

(2) the effect of Regulation SHO short-sale restrictions;

(3) the opening process on primary listing exchanges, including the nature of 

trading prior to and immediately after the opening auction on the primary 

listing exchange;

(4) the reopening process following LULD pauses, including the nature of participants in the reopening auctions on primary listing exchanges and the rules 

and practices employed by exchanges in connection with reopenings;

(5) the operation of the LULD Plan, particularly as it applies in the period following the opening of regular trading hours and to reopenings following LULD 

pauses; and

(6) the operation of market-wide circuit breakers, particularly as they apply in 

the period following the opening of regular trading hours. 

B. Regulatory Initiatives 

The Commission advanced a series of key regulatory initiatives relating to equity 

market structure in 2015, and more are on the SEC’s agenda for 2016. 

1. Preventing Market Instability 

One of the most serious concerns about highly electronic markets is the risk of 

instability and disruption. Sophisticated technology tools can enhance efficiency, but 

they also can facilitate the rapid onset of a trading disruption. These disruptions 

can arise when systems that drive algorithmic trading fail or malfunction, and also 

when high-speed trading leads to sudden gaps between liquidity demand and supply 

that can cause extreme price volatility. Addressing the risk of instability and disruption from these two sources has been a high priority of the SEC in recent years and 

will continue to be a focus in 2016. 

Regulation Systems Compliance and Integrity (SCI) 

The Commission adopted Regulation SCI in November 2014 to strengthen the 

technology infrastructure of the U.S. securities markets. Regulation SCI imposes requirements on key market participants intended to reduce the occurrence of systems 

issues, improve resiliency when systems problems do occur, and enhance the Commission’s oversight and enforcement. Subject to a few exceptions, SCI entities were 

required to start complying with the requirements of Regulation SCI on November 

3, 2015. The Technology Controls Program in the SEC’s Office of Compliance Inspections and Examinations is now examining SCI entities for compliance with Regulation SCI. 

A CyberWatch team has also been established that is responsible for triaging all 

system events reported to the SEC under Regulation SCI. This team currently monitors all the filings required by Regulation SCI that are submitted by SCI entities 

to the SEC. When a major SCI event is reported, they maintain constant communication with the SCI entity until the event is deemed resolved. Since Regulation 

SCI went live on November 3, 2015, CyberWatch has received 326 filing submissions, including Non-De Minimis Event Notifications & Filings, Quarterly De Minimis and System Change Reports, and Annual Review Reports. 

The Commission staff, in response to Chair White’s directive, is preparing recommendations for the Commission’s consideration as to whether an SCI-like framework should be developed for other key market participants, such as certain brokerdealers and transfer agents, whose operations can have a significant market impact 

if they are disrupted.13


BANKI-41578DSA with DISTILLER
31

14See Securities Exchange Act Release No. 67091, 77 FR 33498 (June 6, 2012) (File No. 4–

631), available at https://www.sec.gov/rules/sro/nms/2012/34-67091.pdf. 15See Angel, James J., ‘‘Limit Up-Limit Down: National Market System Plan Assessment To 

Address Extraordinary Market Volatility’’ (May 28, 2015), available at http://www.sec.gov/comments/4-631/4631-39.pdf. 16See 81 FR 10315 (Feb. 29, 2016). The comment period for the proposal ends on March 21, 

2016. 

Critical Market Infrastructure 

Since 2013, SEC staff has been working with the SROs, including clearing agencies, on a range of market structure and infrastructure initiatives. One of these initiatives involved improving the resiliency of systems that constitute potential single 

points of failure, including the securities information processors for consolidated 

market data feeds (SIPs). In June 2014, the SIPs implemented enhancements to 

their disaster recovery sites and systems to establish a ‘‘hot/warm’’ backup process 

to provide for a 10-minute fail over from the primary to the backup sites. In addition, the equity exchanges have amended their clearly erroneous rules and the options exchanges have amended and harmonized their obvious error rules to provide 

greater clarity to market participants regarding trade breaks. The equity and options exchanges also have been enhancing their risk mitigation mechanisms. Most 

recently, the NYSE and NASDAQ have progressed on an initiative to serve as each 

other’s backups if they are unable to fail over to their backup sites in time to run 

their respective closing auctions. These efforts compliment the new requirements of 

Regulation SCI, which are applicable to critical market infrastructure. 

LULD Plan 

Initially approved on a pilot basis in 2012,14 the LULD Plan establishes a marketwide mechanism that is intended to moderate extraordinary price volatility in individual securities and reduce the incidence of erroneous trades. In particular, the 

LULD Plan requires trading centers to have policies and procedures reasonably designed to prevent trades from occurring outside specified price bands. If the national 

best offer (bid) reaches the lower (upper) price band, a limit state is initiated. If 

such national best bid or offer does not recover to inside the price bands within 15 

seconds, a 5-minute trading pause is triggered to accommodate more fundamental 

price moves (as opposed to erroneous trades or momentary gaps in liquidity). The 

LULD mechanism is intended to reduce the negative impacts of sudden, unanticipated price movements in securities, thereby protecting investors and promoting a 

fair and orderly market. In particular, the LULD Plan is designed to address the 

type of extreme short-term price volatility that occurred during the 2010 Flash 

Crash. 

The LULD Plan continues to operate on a pilot basis. Consistent with the SEC’s 

data-driven approach to market structure issues, the SROs were required to provide 

an assessment of the LULD Plan. The SROs engaged a third-party consultant to 

provide an empirical assessment of the Plan’s operation, which was submitted to the 

SEC in May 2015.15 The consultant found that the LULD Plan generally had succeeded in preventing erroneous trades in large cap stocks during regular trading 

hours, and that the vast majority of limit states resolved themselves without triggering a trading pause. The consultant observed, however, that many LULD limit 

states and trading pauses occurred in small, low volume stocks, and that most were 

unnecessary and related more to difficulty in determining the opening reference 

price when the opening auction on the primary listing exchange did not produce a 

trade rather than to excess volatility. 

The Commission recently published the SROs’ proposal to extend the LULD Plan 

for another year until April 2017.16 As noted by the SROs, extension of the pilot 

period will enable the SROs and the Commission to further evaluate the LULD 

Plan’s operation. The SROs also have proposed to amend the LULD Plan to modify 

the identification of the first reference price of the day for those securities that do 

not have an opening auction trade. The first reference price for these securities 

would be the closing price of the security on the primary listing exchange on the 

previous trading day, or if no such closing price exists, the last sale on the primary 

listing exchange reported by the SIP. The Commission will consider whether to approve or disapprove the proposed amendment to the LULD Plan after the notice and 

comment process. 

The SROs are continuing to evaluate additional issues regarding the operation of 

the LULD Plan, including those that may have been revealed by the events of August 24, 2015. On August 24, for example, trading centers resumed trading following a LULD pause but before new price bands were disseminated by the SIP. 

Many of these trades were executed at prices outside the new price bands. I


BANKI-41578DSA with DISTILLER
32

17See Letter from Stephen Luparello, Director, Division of Trading and Markets, SEC, to Mr. 

Paul Roland, Chairman of the LULD Plan Operating Committee, dated February 10, 2016 (Re: 

Limit Up-Limit Down Plan to Address Extraordinary Market Volatility). 18The ISC oversees the Industry Working Group and Sub-Working Groups. All these groups 

are responsible for assessing the scope, requirements, and changes needed to facilitate the implementation of T+2. 19PricewaterhouseCoopers LLP, Shortening the Settlement Cycle: The Move to T+2 (2015), 

available at http://www.ust2.com/pdfs/ssc.pdf. 20Letter from the Hon. Mary Jo White, Chair, U.S. Securities and Exchange Commission to 

the ICI and SIFMA (September 16, 2015), available at: http://src.bna.com/i7; Statement Regarding Proposals to Shorten the Trade Settlement Cycle, Commissioner Michael S. Piwowar 

and Commissioner Kara M. Stein (June 29, 2015), available at https://www.sec.gov/news/statement/statement-on-proposals-to-shorten-the-trade-settlement-cycle.html. 21See Transfer Agent Regulations, Securities Exchange Act Release No. 34–76743 (Dec. 22, 

2015), available at http://www.sec.gov/rules/proposed/2015/34-76474.pdf. 22See Chair Mary Jo White, U.S. Securities and Exchange Commission, Beyond Disclosure at 

the SEC in 2016 (Feb. 19, 2016), available at http://www.sec.gov/news/speech/white-speech-beyond-disclosure-at-the-sec-in-2016-021916.html; see also Commissioners Michael Piwowar and 

Kara Stein Statement of Support for the Need to Modernize the Commission’s Transfer Agent 

Rules (June 11, 2015), available at http://www.sec.gov/news/statement/statement-of-supportmodernize-sec-transfer-agent-rules.html.

understand that the SROs are working quickly to enhance their procedures to ensure they do not resume trading following a LULD pause without an effective price 

band in place, either by waiting for the message from the SIP or by temporarily calculating the new price bands internally. Given the potential for this problem to undermine the effectiveness of the LULD Plan when securities reopen following a trading pause, I have asked that each SRO enhance its procedures as soon as possible, 

but no later than April 1, 2016.17

I also understand that the SROs intend to propose a LULD Plan amendment to 

refine the operation of the LULD mechanism to eliminate the need for clearly erroneous execution rules, except in very limited objective circumstances. I expect that 

such an amendment will be filed for Commission consideration during the course 

of the next pilot period, should the Commission approve the proposed extension. 

Finally, I understand that there are a number of other issues that the SROs are 

analyzing with a view toward possible further amendments to the LULD Plan, including: (i) a review of ETPs to determine whether adjustments should be made to 

the Plan to account for the particular trading characteristics of ETPs; (ii) the impact 

of double-wide price bands during the opening period, (iii) the advisability of coordinated reopening procedures; and (iv) potential enhancements to the categorization 

of securities into different tiers. 

Shortening the Settlement Cycle 

Currently, most securities transactions in equity and debt settle 3 days after the 

trade has been executed, which is referred to as ‘‘trade date plus three’’ (T+3). Last 

spring, the Industry Steering Committee (ISC),18 established by the Depository 

Trust Clearing Corporation and co-chaired by Securities Industry and Financial 

Markets Association (SIFMA) and the Investment Company Institute (ICI), published a white paper that addresses certain procedural steps it believes are necessary to achieve the move to T+2.19 The white paper also includes an implementation timeline that targets the transition to T+2 by the end of the third quarter of 

2017. 

Chair White and the Commissioners have expressed their support for the industry 

T+2 initiative,20 and Chair White has asked the staff to develop a proposal to 

amend Rule 15c6–1. The staff is currently working on a proposal for the Commission’s consideration, and is actively engaged in discussions with the ISC regarding 

industry planning and preparation for the prospective migration to T+2. 

Transfer Agent Regulation 

On December 22, 2015, the Commission issued an advanced notice of proposed 

rulemaking concerning a range of potential new requirements for transfer agents.21

This marked the first significant action by the Commission in this area in over 40 

years.22 The staff will consider comments received as it develops further recommendations to the Commission for transfer agent reform. 

2. Addressing High Frequency Trading 

As algorithmic trading has increasingly dominated equity market volume, concerns have been raised about the speed and fairness of the equity markets. Algorithmic trading encompasses the high frequency trading strategies employed by proprietary trading firms, as well as much of the trading by brokers acting on behalf 

of institutional investors. Algorithmic traders use a variety of low-latency tools. 


BANKI-41578DSA with DISTILLER
33

23 Exemption for Certain Exchange Members, Securities Exchange Act Release No. 74581, 80 

FR 18036 (April 2, 2015), available at https://www.gpo.gov/fdsys/pkg/FR-2015-04-02/pdf/

2015-07293.pdf. The Commission has received 21 comment letters on the proposal, available at 

https://www.sec.gov/comments/s7-05-15/s70515.shtml.

These include co-located services in the data facilities of trading venues and direct 

data feeds from these venues rather than consolidated data feeds, which are on average less than 1 millisecond slower than the direct data feeds due to the time needed for consolidation of data at the SIPs. While rolling back the technology clock is 

neither feasible nor appropriate, the SEC must assess the extent to which specific 

elements of an algorithmic trading environment may not optimally serve the interests of investors, as well the effectiveness of its regulatory oversight of high-speed 

and high-volume trading. 

Additional Timestamps for Consolidated Data Feeds and Data Feed Usage 

In response to Chair White’s request to enhance the ability of market participants 

to monitor market data latencies, the SROs added additional timestamps to the consolidated data feeds in 2015 that reflect, for each order or execution processed by 

an exchange, the event processing timestamp included on the exchanges’ direct data 

feeds. The exchanges also enhanced their procedures for clock synchronization. With 

a common event time reflected in both the consolidated and direct data feeds, market participants can now more readily assess the absolute and relative latencies of 

each, and determine which data feed best meets their trading or other business 

needs. In 2014, the exchanges, again in response to a request from Chair White, 

disclosed in their rules how they use the consolidated and direct market data feeds 

in their operations, thereby enhancing the opportunity for public understanding of 

today’s equity markets. 

Membership Requirements for Dealers Trading in Off-Exchange Venues 

In March 2015, the SEC proposed amendments to Exchange Act Rule 15b9–1 that 

would require broker-dealers engaging in proprietary trading at off-exchange venues 

to become members of a national securities association.23 SEC staff is reviewing 

comments on the proposal and is working to prepare a recommendation for the 

Commission to consider in 2016. 

Enhanced SEC Recordkeeping Requirements for Trading Algorithms 

SEC staff is developing a rulemaking recommendation for the Commission to consider that would strengthen recordkeeping requirements for algorithmic trading. 

Such requirements may encompass key elements of the algorithm itself, as well as 

a record of the orders generated by the algorithm. Such records would provide greater transparency for regulators into algorithmic trading. 

Status of Unregistered Broker-Dealers 

SEC staff is developing a recommendation for the Commission to consider in 2016 

that would clarify the status of active proprietary traders that are not registered 

as broker-dealers and subject certain of them to the SEC and SRO regulatory regime for broker-dealers. 

Anti-Disruptive Trading Rule 

SEC staff is developing a recommendation for the Commission to consider that 

would address the use of aggressive, destabilizing trading strategies in conditions 

when they could most seriously exacerbate price volatility. Such a rule will need to 

be carefully tailored to apply to active proprietary traders in short time periods 

when liquidity is most vulnerable and the risk of price disruption caused by aggressive short-term trading strategies is highest. 

EMSAC Discussions 

EMSAC has formed a Market Quality subcommittee that will consider the impact 

of technology on the efficiency of the markets and systemic risks. Among other 

things, the subcommittee will consider market-maker obligations and high frequency trading strategies that may exacerbate volatility. Any advice or recommendations of the subcommittee (and other subcommittees mentioned below) 

would be presented to the full advisory committee for its consideration. 

3. Consolidated Audit Trail 

In July 2012, the SEC adopted Rule 613 under Regulation NMS requiring the 

SROs to submit an NMS plan to create, implement, and maintain a Consolidated 

Audit Trail (CAT). The CAT would capture customer and order event information 

for orders in NMS securities, across all markets, from the time of order inception 

through routing, cancellation, modification, or execution. CAT would represent a sigVerDate 0ct 09 2002 16:12 Dec 22, 2016 Jkt 000000 PO 00000 Frm 00037 Fmt 6621 Sfmt 6621 S:\DOCS\99832.TXT SHERYL

BANKI-41578DSA with DISTILLER
34

24See Letter from the SROs, to Brent J. Fields, Secretary, Commission, dated February 27, 

2015. 25See Letters from the SROs to Brent J. Fields, Secretary, Commission, dated December 23, 

2015, and February 8, 2016. 26See Order Granting Exemptions from Certain Provisions of Rule 613 Pursuant to Section 

36(a)(1) of the Securities Exchange Act of 1934, Securities Exchange Act Release No. 34–77265 

(March 1, 2016). 27 Regulation of NMS Stock Alternative Trading Systems, Securities Exchange Act Release No. 

76474, 80 FR 80998 (December 28, 2015), available at https://www.gpo.gov/fdsys/pkg/FR2015-12-28/pdf/2015-29890.pdf. The comment period closed on February 26, 2016, and comments are available at http://www.sec.gov/comments/s7-23-15/s72315.shtml.

nificant step forward in regulatory capabilities for oversight of the equity markets. 

In 2015, the SEC and SROs continued to make substantial progress toward a CAT. 

First, the SROs filed amendments to the CAT plan in 2015 that contained additional information than the original plan necessary to the consideration of an operational plan. On February 27, 2015, the SRO’s filed an Amended and Restated CAT 

NMS Plan.24 On December 24, 2015, and February 9, 2016, the SROs filed an 

amendment to the Amended and Restated CAT NMS Plan.25

Second, the SEC approved an amendment to the CAT plan processor selection 

plan in June 2015 allowing the SROs to move forward with selecting the plan processor, which would build and operate the CAT. The CAT plan processor selection 

plan, which is separate and distinct from the CAT plan, governs the SROs’ governance and selection of the CAT processor. The SEC also approved an amendment providing for recusal of plan participants in circumstances that might present conflicts 

of interest. In accordance with these amendments, the SROs narrowed the bids for 

CAT plan processor from six bidders to a shortlist of three bidders in November 

2015. 

Third, in anticipation of the SROs’ completion of the CAT plan, we appointed a 

CAT project manager in November 2015. This person will be the technological point 

person for the development and usage of the CAT at the SEC, as well as the SEC’s 

liaison with the SROs and the CAT plan processor. The CAT manager will maintain 

an open line of communication with the SROs and market participants. 

Fourth, on March 1, 2016, the Commission approved exemption requests submitted by the SROs to provide the SROs the flexibility to include, in the CAT plan 

for notice and comment, alternative approaches to those described in Rule 613.26

Fifth, SEC staff is reviewing the Amended and Restated CAT NMS Plan to provide a recommendation to the Commission regarding publication of the plan for notice and comment. Although I cannot provide exact timing, I hope the staff will be 

in a position to submit a recommendation to the Commission soon to publish the 

CAT plan for public notice and comment. 

If the Commission approves publication of the plan, there would likely be a 60-

day comment period during which interested parties may submit comments to the 

Commission on the plan as noticed. SEC staff will consider comments received and 

evaluate what recommendations to make to the Commission, including potential 

modifications to the plan. Upon Commission approval of a CAT plan, Rule 613 provides that a plan processor shall be selected within 2 months of the effective date 

of the plan. SROs begin reporting data within 1 year of effectiveness; SRO members, 

except those that qualify as small broker-dealers, begin reporting data within 2 

years of effectiveness; and SRO members that qualify as small broker-dealers begin 

reporting with 3 years of effectiveness. 

4. Enhancing Market Transparency and Examining Trading Venue Regulation 

As noted earlier, equity trading volume now is divided among 12 exchanges, more 

than 40 ATSs, and more than 200 non-ATS broker-dealers. The competition for 

order flow among these venues benefits investors by encouraging services that meet 

particular trading needs and by keeping trading fees low. As noted above in connection with the NYSE suspension of trading on July 8, multiple trading venues also 

can help avoid disruptions if one venue, even a major exchange, experiences a systems problem. Fragmented markets, however, also can raise questions regarding the 

rules that govern their operations and intermarket trading, including the extent to 

which their operations are transparent to investors and whether the rules establish 

a fair and level playing field for competition. 

Proposal To Enhance ATS Operational Transparency 

In November 2015,27 the SEC proposed to amend Regulation ATS to require ATSs 

that facilitate transactions in NMS stocks to make public disclosures on Form ATS–

N about: (1) the activities of the broker-dealer that operates the ATS, and its


BANKI-41578DSA with DISTILLER
35

28The paper is available at https://www.sec.gov/spotlight/emsac/memo-rule-611-regulationnms.pdf. 29The paper is available at http://www.sec.gov/spotlight/emsac/memo-regulatory-model-fortrading-venues.pdf.

affiliates, that relate to the ATS; and (2) the manner in which the ATS operates, 

including disclosures about types of subscribers, order types, execution procedures, 

and use of market data. These proposed rules are designed to provide greater transparency around the operations of ATSs so market participants can better evaluate 

ATSs as potential trading venues and make more informed routing decisions. 

The Commission also proposed rules to provide a process for the Commission to 

determine whether an ATS qualifies for the exemption under which it operates and 

declare an NMS Stock ATS’s initial Form ATS–N either effective or, after notice and 

opportunity for hearing, ineffective. The proposal includes a process for an ATS to 

file, and the Commission to review, amendments to Form ATS–N. The Commission 

also proposed rules to provide a process for the Commission to suspend, limit, or 

revoke the exemption after providing notice and opportunity for hearing. Finally, 

the Commission proposed that all ATSs’ safeguards and procedures to protect subscribers’ confidential trading information be written. These proposed rules are designed to facilitate the Commission’s oversight of ATSs and thus, better protect investors. 

The comment period on the ATS proposal closed on February 26, 2016. SEC staff 

is reviewing comments on the proposal and preparing a recommendation for the 

Commission to consider in 2016. 

SEC Staff Papers and EMSAC Discussions regarding Rule 611 of Regulation NMS 

and Trading Venue Regulation 

In April 2015, SEC staff prepared a briefing paper on Rule 611 of Regulation 

NMS, which restricts the execution of trades at prices that are inferior to quoted 

prices.28 The paper first notes Rule 611’s place in the U.S. regulatory regime for equity market structure and then summarizes the Rule’s requirements and the SEC’s 

objectives for the Rule when adopted. It then addresses changes in equity market 

structure that have occurred since Rule 611 was adopted in 2005, supported by a 

series of data tables. The tables provide data on changes in the market shares of 

trading venues, visible and dark fragmentation, trading volume, average trade size, 

and trade-through rates. 

EMSAC considered issues raised by the Rule 611 paper at a meeting in May 2015. 

It also has formed a Regulation NMS Subcommittee that will consider, among other 

things, the impact of Regulation NMS, including Rule 611, and whether it should 

be modified to reflect changes in trading technology and practices, and competition. 

In October 2015, SEC staff prepared a briefing paper on the current regulatory 

model for trading venues and for market data dissemination.29 It contrasted the regulatory model applicable to national securities exchanges, which are SROs, with 

that applicable to ATSs, which are registered as broker-dealers. The paper also was 

intended to facilitate a discussion of the SROs’ role in the collection, processing, and 

dissemination of market data and the treatment of associated fees. 

EMSAC considered issues raised in the trading venue papers at a meeting in October 2015. It also created a Trading Venues Regulation subcommittee to consider 

the current regulatory model for trading venues and whether it is optimally serving 

all market participants and the market as a whole. 

5. Mitigating Broker Conflicts 

Another area of focus in equity market structure is broker conflicts and how they 

are exacerbated or mitigated by the availability of many different trading venues. 

These venues offer a plethora of order types and other trading services, as well as 

various fees and payments related to these services. Most investors rely on their 

brokers to navigate market complexities of fragmented markets on their behalf, but 

monitoring execution quality can be difficult for even sophisticated investors. 

Institutional Order Routing Transparency 

SEC staff is developing a recommendation for the Commission to consider in 2016 

that would expand investors’ understanding of their brokers’ routing decisions. 

Among other things, the staff’s recommendation would enhance the information provided to institutional customers through standardized order routing disclosures. Requiring standardized disclosures, in combination with the recently proposed enhanced ATS operational transparency rulemaking, would be intended to provide sufficient baseline information to institutional investors to bolster their ability to: (1) 

assess the potential for harmful information leakage concerning their orders; (2) assess the conflicts of interest their broker-dealers may face in handling their orders; 


BANKI-41578DSA with DISTILLER
36

30The paper is available at https://www.sec.gov/spotlight/emsac/memo-maker-taker-fees-onequities-exchanges.pdf. 31The paper is available at http://www.sec.gov/spotlight/equity-market-structure/issues-affecting-customers-emsac-012616.pdf. 32Securities Exchange Act Release No. 74892, 80 FR 27513 (May 13, 2015), available at http:/

/www.sec.gov/rules/sro/nms/2015/34-74892.pdf. 33Securities Exchange Act Release No. 76382, 80 FR 70284 (November 13, 2015), available 

at http://www.sec.gov/rules/exorders/2015/34-76382.pdf. The Tick Size Pilot was scheduled to 

begin in May 2016. However, in order to give the SROs and their members sufficient time to 

implement the Tick Size Pilot, the Commission issued the exemption to the Participants. 

(3) assess the performance of a broker-dealer in handling their orders and achieving 

best execution; and (4) compare the services of their routing broker-dealers. 

Exchange Order Type Transparency 

As another means of increasing transparency in the markets, Chair White asked 

the exchanges in 2014 to conduct a comprehensive review of their order types and 

how they operate in practice. 

The exchanges also were asked to consider appropriate rule changes to help clarify the nature of their order types and how they interact with each other (including 

a clear description of all material aspects of the operation of their order types). As 

a result, all of the exchanges reviewed their order types and related rules, and submitted proposed rule changes that provide substantial additional detail on their operation. 

SEC Staff Papers and EMSAC Discussions regarding Maker-Taker Fee Structure 

and Customer Issues 

In October 2015, SEC staff prepared a briefing paper on the maker-taker fee 

structure offered by many exchanges.30 The purpose of the paper was to facilitate 

an objective assessment of maker-taker fees in the U.S. equity markets by outlining 

the development of the maker-taker fee model, summarizing the current public debate about its impact on equity market structure, and presenting both the asserted 

advantages and disadvantages of maker-taker fee structures. EMSAC also discussed 

maker-taker fee issues at multiple meetings in 2015, and its Regulation NMS subcommittee will consider approaches to a potential access fee pilot. 

In January 2016, SEC staff prepared a briefing paper that was intended to facilitate consideration of certain issues affecting customers—particularly retail customers—in the current equity market structure, namely: (1) the risks of using certain order types; (2) the potential conflicts presented by payment-for-order-flow arrangements; and (3) the development of more meaningful execution quality reports.31 EMSAC discussed these customer issues at its February 2016 meeting and 

also has created a Customer Issues subcommittee to consider initiatives to protect 

investor interests and promote investor confidence. 

6. Building Quality Markets for Smaller Companies 

Smaller public companies face market structure challenges that are not the same 

as those of larger companies. These include the need for a sufficiently liquid market 

that provides their investors with a reasonably efficient means to establish and liquidate positions. A single market structure may not fit all companies, and the SEC 

has sought to focus concretely on how to enhance the equity market structure for 

smaller companies. 

Tick Size Pilot 

One initiative designed to address concerns about improving liquidity in the secondary market for smaller companies is the development of a pilot program that 

would allow smaller companies to trade at wider tick sizes. In June 2014, the SEC 

directed the equity exchanges and FINRA to act jointly in developing and filing a 

national market system plan to implement a tick pilot program. The Commission 

noted particularly that a pilot program could facilitate studies of the effect of tick 

size on liquidity, execution quality for investors, volatility, market-maker profitability, competition, transparency, and institutional ownership in the stocks of 

small-capitalization companies. 

In May 2015, the Commission approved a plan filed by the equity exchanges and 

FINRA (Participants) to implement a tick size pilot program (Tick Size Pilot).32 In 

November 2015, the Commission issued an exemption to the Participants from implementing the Plan until October 3, 2016.33

The Tick Size Pilot will have a 2-year duration (Pilot Period), and will include exchange-listed common stocks that have the following characteristics: (1) a market 

capitalization of less than $3 billion; (2) a closing price of at least $2 per share on 

the last day of the measurement period (and a closing price of not less than $1.50 


BANKI-41578DSA with DISTILLER
37

34See, e.g., Securities Exchange Act Release No. 76552 (December 3, 2015) (File No. SR–

BATS–2015–108), available at http://www.sec.gov/rules/sro/bats/2015/34-76552.pdf; Securities Exchange Act Release No. 76229 (October 22, 2015) (File No. SR–NYSE–2015–46), available 

at http://www.sec.gov/rules/sro/nyse/2015/34-76229.pdf. 35Securities Exchange Act Release No. 77105 (February 10, 2016)(order approving BATS’ 

rules to implement the data collection requirements of the Tick Size Pilot), available at http:/

/www.sec.gov/rules/sro/bats/2016/34-77105.pdf; Securities Exchange Act Release No. 77164 

(February 17, 2016) (order approving FINRA’s rules to implement the data collection requirements of the Tick Size Pilot), available at http://www.sec.gov/rules/sro/finra/2016/34-

77164.pdf; Securities Exchange Act Release No. 77218 (February 23, 2016) (order approving 

FINRA’s rules to implement the quoting and trading requirements of the Tick Size Pilot), available at http://www.sec.gov/rules/sro/finra/2016/34-77218.pdf. 36 A copy of that testimony is available at http://www.sec.gov/news/testimony/testimony-venture-exchanges.html.

per share during the measurement period); (3) a consolidated average daily volume 

of one million shares or less; and (4) a volume-weighted average price of at least 

$2 per share (Pilot Securities). 

Pursuant to the Tick Size Pilot, Participants will collect data reflecting a variety 

of market quality metrics with respect to the Pilot Securities and transmit such 

data to the Commission. The collected data will be publicly available in an aggregated form. In addition, the Participants are required to conduct, and provide the 

Commission with, a publicly available impact assessment. The Participants are 

scheduled to begin collecting Tick Size Pilot data in April 2016, which is 6 months 

prior to the start of the Pilot Period. 

The Participants have submitted to the Commission proposed rule changes to implement the quoting and trading requirements and the data collection requirements.34 The Commission has approved the proposed rules to implement the data 

collection requirements that have been submitted, as well as one of the proposals 

to implement the quoting and trading proposals that have been submitted.35

Venture Exchanges 

On March 4, 2015, the SEC’s Advisory Committee on Small and Emerging Companies held a meeting at which it considered venture exchanges and other means 

to increase secondary market liquidity for investors in smaller companies. Previously in 2013, this Advisory Committee had recommended the development of a 

separate U.S. equity market that would facilitate trading in the securities of small 

and emerging companies. 

On March 10, 2015, the Commission submitted testimony to this Subcommittee 

for its hearing on venture exchanges and small capitalization companies.36 The 

Commission stated that it was considering innovative approaches that appropriately 

balance the needs of smaller companies for efficient secondary markets and the interests of investors in smaller companies. It noted that venture exchanges potentially could achieve such a balance by providing investors a transparent and wellregulated environment for trading the stocks of smaller companies that offers both 

enhanced liquidity and strong investor protections. The Commission observed that 

it had previously approved a proposal for a venture exchange, but the exchange had 

never been launched. It emphasized, however, that, as it did with the BX Venture 

Market, it would carefully consider any efforts of exchanges that were particularly 

designed to meet the needs of smaller companies and their investors. 

The Commission continues to be receptive to efforts that would appropriately balance the needs of smaller companies and the interests of their investors. 

III. Conclusion 

Thank you again for inviting me to discuss the SEC’s efforts to strengthen the 

U.S. equity market structure. As is evident from the many initiatives noted above, 

the SEC’s program for optimizing equity market structure is actively moving forward. I look forward to answering your questions. 

PREPARED STATEMENT OF RICHARD G. KETCHUM

CHAIRMAN AND CEO, FINANCIAL INDUSTRY REGULATORY AUTHORITY

MARCH 3, 2016

Chairman Crapo, Ranking Member Warner and Members of the Subcommittee:

On behalf of the Financial Industry Regulatory Authority, or FINRA, I would like 

to thank you for the opportunity to testify today about current issues and potential 

regulatory changes that could improve equity market structure. 


BANKI-41578DSA with DISTILLER
38

In recent years, there has been increased debate about the structure of capital 

markets. Once the domain of regulators, market operators and large, sophisticated 

investors, market structure is now a topic for much broader public discourse. This 

discourse often includes questions about whether or not the markets are fair and 

whether they provide a level playing field for all investors. 

Partly this concern is a reaction to volatility. For example, last August the Dow 

Jones Industrial Average plummeted more than 1,000 points within the first 10 

minutes of trading, with message traffic nearly doubling. And the Chicago Board 

Options Exchange Volatility Index—the U.S. market’s so-called ‘‘fear gauge’’—

surged 45 percent to its highest level in nearly 4 years. While the gauge has cooled 

since then, it remains elevated, recently hovering around 22, which is nearly double 

last year’s low mark of just under 12. 

While I can’t fully diagnose what may at times be ailing the equity markets, this 

tumult exemplifies the importance of the structure of markets for financial instruments. All of us here know today that questions of market structure can be broad 

and complex, and it can be difficult to home in on what really needs to be addressed. 

I believe there are three key aspects of the markets that securities market participants and regulators should always be working to strengthen: market fairness, market transparency and market liquidity. 

SEC Chair Mary Jo White has set out a road map for potential future changes 

in the equity and fixed income markets, which specifically includes an important, 

ongoing role for FINRA and other SROs. A number of changes have already been 

made or are in progress; many remain under discussion and analysis. As all such 

changes are contemplated, it is important to consider how proposals might enhance 

market fairness, transparency and liquidity. 

FINRA 

Before I address specific market structure issues and initiatives, I’d like to provide a brief overview of FINRA and its regulatory programs. FINRA provides the 

first line of oversight for broker-dealers and the U.S. securities markets, and 

through its comprehensive regulatory programs, regulates the firms and brokers 

that sell securities in the United States. FINRA oversees nearly 4,000 brokerage 

firms and over 600,000 registered brokers. FINRA touches virtually every aspect of 

the broker-dealer business—from registering individuals to examining securities 

firms; writing rules and enforcing those rules and the Federal securities laws; informing and educating the investing public; providing trade reporting and other industry utilities; and administering the largest dispute resolution forum for investors, brokerage firms and individual brokers. 

We also work behind the scenes to detect and fight fraud. In addition to our own 

enforcement efforts, each year we refer hundreds of fraud and insider trading cases 

to the Securities and Exchange Commission (SEC) and other agencies. FINRA regularly shares information with other regulators, leading to important actions that can 

prevent further harm to investors. 

More than 10 years ago, FINRA established the FINRA Investor Education Foundation to support innovative research and educational projects aimed at improving 

the financial capability of all Americans. Together with the Foundation, FINRA is 

committed to providing investors with information and tools they need to better understand the markets and basic principles of investing—and to help them protect 

themselves. 

In addition, FINRA operates and regulates OTC market transparency facilities 

that provide the public and professionals with timely quote and trade information 

of publicly traded equity and debt securities. They are the primary source for regulatory data on these transactions, and provide FINRA-registered firms with tools to 

comply with reporting obligations in secondary-market activity in fixed income and 

equity securities. In this role, we are continually evaluating and identifying areas 

where enhanced transparency can benefit investors and the markets. 

Finally, and of particular relevance to today’s hearing, FINRA, directly and 

through our regulatory service agreements with exchanges, monitors approximately 

99 percent of all trading in U.S. listed equities markets and 70 percent of the options markets. In fact, FINRA’s market surveillance systems process approximately 

42 billion market events each day to closely monitor trading activity in equity, options and fixed income markets in the United States. 

Evolution of Market Structure 

Any sound evaluation of equity market structure should begin with an understanding of where things stand now, and how we got here. In the past 20 or so 

years, the equity markets have changed in many fundamental ways. Perhaps the 

most significant development has been the shift from human-intermediated markets 


BANKI-41578DSA with DISTILLER
39

to electronic intermediation. While some observers have noted that high frequency 

trading (HFT) activity may be declining since its peak around 2009, it is nevertheless clear from various estimates that automated trading has become the predominant force in equities markets. We have seen many of the traditional floor-based 

brokers and market-maker specialists of previous years replaced by firms commonly 

characterized as HFT. 

Market structure arrived at its current state because of several interrelated factors. Technological advancements have most obviously allowed for the rise of highly 

automated, low-latency trading systems capable of digitally ingesting orders, trades 

and news and making advanced trading decisions. Many also point to the impact 

of regulatory action, including Regulation ATS, decimalization, and Regulation 

NMS, all of which have the underlying goals of promoting competition, lowering 

trading costs, and enhancing best execution. 

However, as SEC staff has observed recently in a number of detailed, thoughtful 

papers, there are no easy explanations. For example, while Regulation NMS is commonly cited as a cause of market fragmentation and the proliferation of HFT, even 

prior to Regulation NMS, Nasdaq had undergone a major transformation from a traditional dealer model to a new, electronic market structure. Similarly, some believe 

HFT owes its existence to the increase in the number of trading venues, yet HFT 

is also a significant force in the E–Mini futures contract, which trades in a highly 

centralized market. 

The fact that market structure developments cannot always be easily explained 

does not prevent regulatory improvement. It simply underscores the need for careful 

data analysis. For example, the SEC’s MIDAS project has been providing greatly enhanced insight into the functioning of markets and has helped provide a foundation 

for market structure refinements. Similarly, FINRA, through it Order Audit Trail 

System called OATS, collects and processes billions of order-related events each day 

that also helps shed light on some of the fundamental market structure policy questions. 

There is undoubtedly more work to be done. The rise of automation has delivered 

many benefits to investors, who are now able to trade much more quickly and 

cheaply than ever before. But there are potential inefficiencies in today’s market 

structure that we must continually evaluate to make sure markets are fair, transparent and liquid. 

Market Fairness 

Investors must have confidence that they can access current, accurate, bona fide 

market prices that reflect true investor supply and demand. That means that the 

market structure established, including the regulatory framework supporting it, 

must foster and promote accurate prices and low trading costs for retail investors. 

Having been in this business for a long time, I’ve been part of many significant regulatory changes that have benefited investors. However, competition and regulatory 

changes have also led to a more complex, fragmented market. In today’s increasingly fragmented market, bad actors can consciously disperse their trading activity 

across markets, asset classes and broker-dealers in an attempt to hide their footprints and avoid detection. It is part of our job at FINRA to monitor what’s happening in the market and ensure that the markets operate fairly. 

FINRA has responsibility to oversee and regulate over-the-counter (OTC) trading 

of exchange-listed and non-exchange-listed securities, as well as trading in corporate 

and municipal debt instruments and other fixed income instruments. FINRA also 

conducts examinations of market making and trading firms to assess compliance 

with FINRA trading rules and the Federal securities laws. In addition, FINRA provides automated surveillance and other regulatory services to U.S. equity and options exchanges. FINRA has regulatory service agreements (‘‘RSAs’’) in place with 

10 of the 12 U.S. equity exchanges and all U.S. options exchanges. By virtue of 

these agreements, FINRA conducts market surveillance for approximately 99 percent of the listed equity market and approximately 70 percent of the listed options 

market. As a result, while the markets have become increasingly fragmented, 

through our contracts with exchange clients, FINRA has been able to aggregate 

trading data across the markets to conduct comprehensive, cross market surveillance. This is important because FINRA has found many instances where market 

participants have consciously dispersed their trading activity across multiple markets in an effort to avoid detection. In addition, FINRA’s cross market surveillance 

enables us to detect those market participants who are acting in concert to engage 

in market manipulation schemes. We have found that such activity accounts for a 

significant percentage of our cross market surveillance alerts. 

We developed an innovative cross-market surveillance program that allows us to 

run dozens of surveillance patterns and threat scenarios across the data we gather 


BANKI-41578DSA with DISTILLER
40

to look for manipulation and frontrunning, as well as layering, spoofing, algorithmic 

gaming, and other abusive conduct. This sophisticated surveillance allows us to detect activities that we were not able to see before. For example, 51 percent of our 

cross-market alerts identify potential manipulative activity by two or more market 

participants acting in concert. And 57 percent of our cross-market alerts identify potential manipulation by a market participant on multiple markets. FINRA also is 

starting to design surveillance programs that will span equities and options markets 

together to detect potential cross-product manipulative conduct. 

In addition to SEC and FINRA oversight, firms themselves have a fundamental 

obligation to supervise their own trading activity to ensure that the activity does 

not violate any applicable SEC or FINRA rules. A number of existing SEC and 

FINRA rules specifically govern firms’ trading activities including the SEC’s Market 

Access Rule, which requires firms with market access to have a system of effective 

risk management controls and supervisory procedures. Although a reasonable supervision and control program may not foresee every potential failure or prevent every 

undesirable consequence, it is an additional protective measure in today’s regulatory 

structure that promotes and supports market fairness. 

And as you know, in July 2012, the SEC adopted Exchange Act Rule 613 requiring 19 SROs—FINRA and the 18 national securities exchanges—to work together 

to jointly file a NMS plan to govern the creation, implementation, and maintenance 

of a Consolidated Audit Trail, or CAT, which will collect information on virtually 

every order and trade in equity securities and options in the United States. The 

CAT will be the world’s largest repository of securities data, processing approximately 58 billion records on a daily basis. 

FINRA strongly supports the SEC’s action to require the development of the CAT, 

an important initiative that will even further enhance regulators’ ability to conduct 

surveillance of trading activity across multiple markets and perform market reconstruction and analysis. Comprehensive intermarket surveillance is essential to ensuring the overall integrity of the U.S. securities markets and maintaining the confidence of investors in those markets. 

Market Transparency 

Transparency is of paramount importance to the equity markets. The SEC said 

recently, and I agree, that transparency is a primary tool by which investors protect 

their own interests. To this end, the FINRA Board of Governors formed a Working 

Group to assess FINRA’s rules and regulatory programs related to HFT, which resulted in a series of initiatives designed to increase the scope of trading information 

FINRA receives and provide more transparency into trading activities to market 

participants and investors. 

In general terms, these efforts include a call for alternative trading systems 

(ATSs) to provide more in-depth order information for regulatory surveillance, greater transparency of volume executed away from stock exchanges, more granular 

audit trail information and tighter restrictions around allowable clock drift to better 

ensure proper sequencing of events. 

These initiatives build on an earlier initiative from 2014, when FINRA began publishing on its Web site weekly volume information regarding transactions in equity 

securities executed within ATSs. Since that time, FINRA has been considering additional data that may be useful to market participants and investors and is expanding this initiative to provide more insight into larger-sized, or ‘‘block,’’ trades. Later 

this year, FINRA will begin publishing monthly aggregate ATS block trading statistics, which will provide interested parties with more detailed information on ATS 

trading activities, thus further enhancing transparency in the over-the-counter market. In addition, FINRA will be further expanding its transparency initiative by 

publishing the remaining equity volume executed over-the-counter by FINRA member firms, including the trading activity of non-ATS electronic trading systems and 

internalized trades. The ATS and non-ATS volume data on FINRA’s Web site will 

be free of charge to all users. 

Data from FINRA’s ATS transparency initiative helped inform the SEC’s recent 

proposal to significantly revise the disclosure regime for NMS Stock ATSs. The 

SEC’s proposal would, among other things, require greater public disclosure concerning the operation of business dealings of NMS Stock ATSs and would provide 

for enhanced oversight of these ATSs’ filings. As it stated in its recent comment letter on the proposal, FINRA fully supports the proposal’s objective of enhancing market transparency. 

Market Liquidity and Volatility 

Since the May 2010 Flash Crash, the SEC, FINRA and U.S. stock exchanges have 

implemented a variety of initiatives to minimize the impact of extreme volatility, 


BANKI-41578DSA with DISTILLER
41

the causes of which can vary from market forces to technological malfunctions. 

These initiatives have created a multi-faceted safety net for the markets and are 

designed to promote investor confidence. Among the changes, regulators adjusted 

the market-wide trading pause, which gives market participants an opportunity to 

assess their positions, valuation models and operational capabilities when extreme 

periods of volatility occur. 

On top of that, FINRA and the exchanges implemented a limit up/limit down initiative, which addresses the type of sudden price movements that the market experienced during the Flash Crash. Under the plan, a limit up and limit down mechanism prevents trades in NMS stocks from occurring at prices outside of certain 

ranges. And if the changes in price are more significant and prolonged, the limit 

up/limit down plan would trigger a trading pause in that security. 

We had an excellent opportunity to evaluate the effectiveness of these changes 

last August 24th, when the Dow plummeted more than 1,000 points within the first 

10 minutes of trading. The events of that day illustrated not a market out of control, 

but the value of having appropriate controls in place. Were it not for the limit up/

limit down procedures, the market fluctuations last August would have been more 

dramatic. There were over 1,200 trading pauses that day, with over 1,000 occurring 

in exchange-traded products (ETPs), many which were repeats in the same ETP. 

Clearly, the August events showed these processes are serving a crucial function, 

but also showed that additional refinements are necessary. One of the issues that 

day was the big gaps between the value of underlying indexes and the exchangetraded funds (ETFs) that track them. ETFs combine aspects of mutual funds and 

conventional stocks. They operate like a mutual fund by offering an investor an interest in a professionally managed, diversified portfolio of investments. Unlike mutual funds, however, ETF shares trade like stocks on exchanges and can be bought 

or sold throughout the trading day at fluctuating prices, whereas mutual funds are 

priced just once at the end of the trading day. On August 24th, unusual trading affected many of the major ETFs as well as many less liquid ones. While trading volume surged, public display of trading interest—or liquidity—dropped. And we saw 

pricing volatility in ETFs because of the conflicts between halts on the underlying 

stocks within the indices and the pricing of the index. 

The volatility and the issues we saw with ETFs offers up a great opportunity for 

regulators to take another look at the effectiveness of the initiatives put in place 

after the 2010 Flash Crash, as well as our market structure generally. Among the 

issues ripe for review are the opening processes on primary listing exchanges; the 

operation of the limit up/limit down at the opening of trading, at re-openings after 

a trading pause and where the price is rebounding; the use of single market prices 

rather than consolidated prices for index calculations at times when the primary 

market opens outside its normal process; the use of stop orders, which become market orders when triggered and can execute at a price substantially worse than anticipated by the investor, particularly in volatile markets; and whether marketmaker quoting obligations are stringent enough to promote market stability. 

Liquidity in the U.S. markets has thrived because of confidence in the markets. 

Investors need to be sure that markets will operate predictably. And it’s important 

for us as regulators to implement programs that minimize the impact of market volatility and to limit market disruption while also promoting an efficient price discovery that encourages the provision of liquidity. 

Work of the SEC’s Equity Market Structure Advisory Committee 

As noted in the Subcommittee’s invitation to testify, the questions enumerated 

above as well as a number of other market structure issues are also being considered by the SEC’s Equity Market Structure Advisory Committee (EMSAC), of which 

I am a member. In addition, given the number and broad ranging issues to address, 

the EMSAC created four subcommittees to focus on specific equity market structure 

areas: Regulation NMS, Trading Venues Regulation, Customer Issues and Market 

Quality. These subcommittees have met several times between full EMSAC meetings. Both the SEC staff and EMSAC members have dedicated significant time and 

effort with good progress being made, and I look forward to seeing where the process takes us. 

EMSAC discussions have ranged from more broad, thematic topics such as increased coordination between the equities and futures markets to more specific regulatory and market-based improvements, like retail investors’ use of certain order 

types. For example, discussions have included efforts to update the SEC’s rules on 

the public disclosure of execution-quality statistics and order-routing practices. 

These rules brought much needed transparency to the markets when they first were 

adopted, but market structure has been largely transformed since then and they are 

in need of updating to better reflect the current market structure. 


BANKI-41578DSA with DISTILLER
42

In addition, the committee is reviewing the current regulatory model for exchanges and other trading venues, as well as the current state and impacts of Regulation NMS. In particular, the EMSAC and its subcommittees are considering 

whether the Regulation NMS rules on limiting trade throughs, capping access fees, 

and preventing locked or crossed markets continue to serve their intended purpose. 

These rules were generally intended to bolster investor protection when they were 

adopted, but some market observers have questioned whether they might also have 

contributed to market fragmentation and rebate arbitrage. 

The EMSAC also is actively considering many of the questions about market volatility highlighted above, including the operation of limit up/limit down and whether 

firms could better educate their customers about the risks of market and stop orders. This issue is one example of a place where FINRA believes it can work in parallel to complement EMSAC efforts. Guided by the recent EMSAC discussion, and 

based on FINRA’s own regulatory analysis, FINRA is currently considering providing additional guidance to firms to underscore the importance of investor education in this area. The EMSAC has heard a variety of views on these important 

market structure questions, which is why, as I noted above, I believe it is critical 

to use data as the guide forward as we evaluate how any potential changes may 

impact market fairness, transparency and liquidity. I look forward to continuing to 

offer my and FINRA’s experience and expertise as the EMSAC moves forward with 

its work. 

Small Company Issues 

Issues related to small company issues deserve careful consideration as well. 

FINRA has been involved in several projects focused on this segment of the market. 

Tick Size Pilot Program 

On May 6, 2015, the SEC approved an NMS Plan submitted by the SRO Participants to implement a Tick Size Pilot Program. The Order approved the NMS Plan 

for a 2-year period, which is to commence on October 3, 2016. The Plan is designed 

to allow the Commission, market participants, and the public to assess the impact 

of increment conventions (commonly referred to as tick sizes) on the liquidity and 

trading of the common stock of small-capitalization companies. The Tick Size Pilot 

is a data-driven test and will evaluate whether or not widening the tick size for securities of smaller capitalization companies would impact trading, liquidity and 

market quality of those securities. The pilot will consist of a control group and three 

test groups, with each test group having approximately 400 securities. Each SRO 

Participant, including FINRA, is required to comply, and to enforce compliance by 

its member organizations, as applicable, with the provisions of the Plan. The SROs 

have filed rule changes in furtherance of the Pilot and have been working closely 

with the industry on implementation issues, including the data reporting requirements necessary to allow for effective data and impact analysis of the different test 

groups. 

JOBS Act Implementation 

In order to fulfill our mandate under the JOBS Act crowdfunding provisions, we 

filed proposed rules and forms with the SEC for SEC-registered funding portals that 

become FINRA members. FINRA streamlined the rules to reflect the limited scope 

of activity that Congress permitted to funding portals while also maintaining investor protection. The SEC approved FINRA’s Funding Portal Rules, which became effective on January 29, 2016. FINRA’s systems were ready as of that date to begin 

receiving applications from prospective funding portals. FINRA’s regulatory program 

is fully prepared for the May 16, 2016, effective date of the SEC’s Regulation 

Crowdfunding. 

Conclusion 

FINRA appreciates this opportunity to discuss these important market structure 

issues and its programs with the subcommittee. We remain committed to working 

closely with the SEC, other regulators, this subcommittee and the full committee 

as we continue to work toward our dual mission of protecting investors and safeguarding market integrity.


BANKI-41578DSA with DISTILLER
43

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD


BANKI-41578DSA with DISTILLER99832001.eps
44


BANKI-41578DSA with DISTILLER99832002.eps
45


BANKI-41578DSA with DISTILLER99832003.eps
46


BANKI-41578DSA with DISTILLER99832004.eps
47


BANKI-41578DSA with DISTILLER99832005.eps
48


BANKI-41578DSA with DISTILLER99832006.eps
49


BANKI-41578DSA with DISTILLER99832007.eps
50


BANKI-41578DSA with DISTILLER99832008.eps
51


BANKI-41578DSA with DISTILLER99832009.eps
52


BANKI-41578DSA with DISTILLER99832010.eps
53


BANKI-41578DSA with DISTILLER99832011.eps
54


BANKI-41578DSA with DISTILLER99832012.eps