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88–529 PDF 2014

EQUITY MARKET STRUCTURE: A REVIEW 

OF SEC REGULATION NMS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON CAPITAL MARKETS AND 

GOVERNMENT SPONSORED ENTERPRISES 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRTEENTH CONGRESS 

SECOND SESSION 

FEBRUARY 28, 2014 

Printed for the use of the Committee on Financial Services 

Serial No. 113–67 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

GARY G. MILLER, California, Vice Chairman 

SPENCER BACHUS, Alabama, Chairman 

Emeritus 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

ROBERT HURT, Virginia 

MICHAEL G. GRIMM, New York 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

MARLIN A. STUTZMAN, Indiana 

MICK MULVANEY, South Carolina 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

TOM COTTON, Arkansas 

KEITH J. ROTHFUS, Pennsylvania 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

PATRICK MURPHY, Florida 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

SHANNON MCGAHN, Staff Director 

JAMES H. CLINGER, Chief Counsel 

(III) 

SUBCOMMITTEE ON CAPITAL MARKETS AND GOVERNMENT SPONSORED ENTERPRISES

SCOTT GARRETT, New Jersey, Chairman 

ROBERT HURT, Virginia, Vice Chairman 

SPENCER BACHUS, Alabama 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RANDY NEUGEBAUER, Texas 

MICHELE BACHMANN, Minnesota 

KEVIN McCARTHY, California 

LYNN A. WESTMORELAND, Georgia 

BILL HUIZENGA, Michigan 

MICHAEL G. GRIMM, New York 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

MICK MULVANEY, South Carolina 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ANN WAGNER, Missouri 

CAROLYN B. MALONEY, New York, 

Ranking Member 

BRAD SHERMAN, California 

RUBE ́ N HINOJOSA, Texas 

STEPHEN F. LYNCH, Massachusetts 

GWEN MOORE, Wisconsin 

ED PERLMUTTER, Colorado 

DAVID SCOTT, Georgia 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

KEITH ELLISON, Minnesota 

MELVIN L. WATT, North Carolina 

BILL FOSTER, Illinois 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

DANIEL T. KILDEE, Michigan 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

February 28, 2014 ............................................................................................ 1 

Appendix: 

February 28, 2014 ............................................................................................ 31 

WITNESSES 

FRIDAY, FEBRUARY 28, 2014 

Campos, Hon. Roel C., Partner, Locke Lord LLP; and former SEC Commissioner (2002–2007) ............................................................................................... 7 

Lofchie, Steven, Partner, Cadwalader, Wickersham & Taft LLP ........................ 8 

Sirri, Erik R., Professor of Finance, Babson College; former SEC Chief Economist (1996–1999); and former Director of the SEC Division of Trading 

and Markets (2006–2009) .................................................................................... 10 

Spatt, Chester, Pamela R. and Kenneth B. Dunn Professor of Finance, Tepper 

School of Business, Carnegie Mellon University; and former SEC Chief 

Economist (2004–2007) ........................................................................................ 11 

APPENDIX 

Prepared statements: 

Campos, Hon. Roel C. ....................................................................................... 32 

Lofchie, Steven .................................................................................................. 36 

Sirri, Erik R. ..................................................................................................... 60 

Spatt, Chester ................................................................................................... 65 

(1) 

EQUITY MARKET STRUCTURE: A REVIEW 

OF SEC REGULATION NMS 

Friday, February 28, 2014 

U.S. HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON CAPITAL MARKETS AND

GOVERNMENT SPONSORED ENTERPRISES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The subcommittee met, pursuant to notice, at 9:30 a.m., in room 

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

Members present: Representatives Garrett, Hurt, Royce, Neugebauer, Huizenga, Stivers, Fincher, Mulvaney, Hultgren, Ross; 

Maloney, Hinojosa, Lynch, Scott, Himes, Peters, Foster, Carney, 

and Kildee. 

Ex officio present: Representative Hensarling. 

Chairman GARRETT. Greetings. The Subcommittee on Capital 

Markets and Government Sponsored Enterprises is hereby called to 

order. Today’s hearing is entitled, ‘‘Equity Market Structure: A Review of SEC Regulation NMS.’’ Let me thank all the members of 

the panel for being with us here today. We will begin in regular 

order with our Members’ opening statements and then proceed to 

the panel after that. 

I now yield myself 8 minutes for an opening statement. Today’s 

hearing will focus on the structure of our Nation’s equity markets—in other words, the stock market—and will provide a retrospective review of Regulation National Market System (Reg NMS) 

which was adopted by the SEC in 2005. I do want to thank our esteemed panel for joining us here today to provide their expert testimony on a very important topic. I also want to thank the ranking 

member for her attention to these important issues and the constructive bipartisan job that she has done to promote strong capital 

markets here in the United States. 

Mrs. Maloney, along with Mr. Hurt and Mr. Grimm and Mr. 

King, as well as Commissioner Dan Gallagher, joined me at a 

roundtable on market structure up in New York back in May. That 

was a great opportunity to hear from some of the foremost experts 

on the history and evolution of the equity markets and the regulatory regime governing those markets. While modern equity markets trace their origin back to an agreement signed under the 

buttonwood tree on Wall Street in 1792, over time these markets 

have become essential to Main Street as well. 

Companies all around the country need robust equity markets to 

raise capital to grow their business and create jobs. Likewise, inVerDate Nov 24 2008 17:43 Sep 03, 2014 Jkt 088529 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\88529.TXT TERRI
2 

vestors require fair, efficient, and competitive equity markets so 

that they can do things like invest for their retirement, buy a 

home, or pay for a child’s education. And so, I commend Chair 

White and her fellow Commissioners for their commitment to 

prioritize a review of equity markets and the rules that govern 

them. 

A comprehensive review hasn’t been conducted by the SEC since 

1994, yet the structure of these markets and the rules, including 

NMS, look much different today. Another review is long overdue, 

and the unanimous agreement of the SEC on this point, which 

seems rare these days, speaks volumes to the significance of this 

issue. 

Before Congress and the SEC can take another hard look at the 

U.S. equity market, however, I believe it is important to set a baseline to suggest a few basic parameters for this review. First, U.S. 

equity markets are among the deepest, most liquid, and lowest cost 

markets in the world. This does not mean that these markets are 

perfect, that there is no room for improvement. There is. It simply 

means that when we review the market structure and explore making future changes, we must keep in mind the axiom, ‘‘First, do no 

harm.’’ 

Second, a review of the equity market structure must be based 

on a deep set of objective data rather than anecdotes or politically 

convenient arguments. It follows that we should avoid, at the outset, buying into a sensational narrative in the media that portrays 

fast markets that rely on computer technology as inherently fragile 

or bad for investors before we even have a chance to collect and 

analyze all the data on it. 

I know that the very capable staff at the SEC’s Division of Trading and Markets is in the process of gathering and examining quality data with their new Market Information Data Analytics System 

(MIDAS). I also look forward to the arrival of the Division’s new 

Director, Stephen Luparello, who has shown an impressive grasp 

of these complex issues. I am pleased that the SEC appears to recognize the importance of making any future decisions on equity 

market structure based on empirical economic data that has been 

peer-reviewed and formally commented on by the public and by 

market participants. 

Third, a quality review must put everything on the table. In 

other words, it should be truly comprehensive. We simply will not 

be able to form a complete picture of how our equity markets work, 

and develop smart reforms to improve these markets, if we are not 

prepared to ask all the tough questions and reassess every aspect 

of market structure. This includes reevaluating the objectives and 

impacts of Reg NMS, and other regulations concerning equity markets, as well as congressional mandates such as the Security Acts 

Amendment of 1975. 

Last but not least, we must resist all calls to impose additional 

layers of complex regulations on individual market participants in 

order to control or influence their behavior before we understand 

the underlying drivers of those behaviors. While I agree that we 

must take a close look at high-frequency trading, broker-dealer internalization, the proliferation of order types, the maker-taker 

model, and trading in so-called ‘‘dark pools,’’ the first steps should 

3 

be to determine how and why these behaviors and business models 

developed. 

To the extent that the regulatory regime played a role, I question 

whether adding another layer of new rules onto an already complex 

structure will do anything to actually improve this structure or protect investors. 

This brings us back to the subject of today’s hearing. Recently, 

Reg NMS has been identified as a potential source of problems occurring in the U.S. equity markets. A central part of the SEC’s review of the equity market structure, therefore, should be to determine whether regulations, including NMS, are driving market complexity and dislocation and incentivizing suboptimal behavior by 

market participants. 

For example, by linking all market venues together through technology, prioritizing price and speed in executing orders, and protecting only automated quotations, has Reg NMS been the primary 

contributor to what we may now lament as needlessly complex and 

fragmented equity markets? Have these efforts to link markets together to promote a national market system also led to the many 

recent disruptions which originate at one location and then seem 

to ripple throughout the system? 

Recent data also suggests a rise in volatility in the market postReg NMS. Is this because Reg NMS led to an increase in the 

amount of high-speed algorithmic trading in the markets? Is it related to the so-called end-of-market sweep exception of Reg NMS 

or the protection rule? 

So in addition, there are literally hundreds of different complex 

order types that exist in today’s equity markets, and these unique 

order types develop as strategies to get around the market protection of top-of-the-book quotes in NMS or exploit other market participants. These are just some of the questions about Reg NMS that 

need to be explored. 

At this point, I don’t believe anyone has a definitive answer to 

any of these questions, but they leave the door open to the possibility that the government’s own rules might be at the center of the 

problem. That is precisely why any serious review of equity market 

structure must include an examination of these complex issues and 

ask the difficult questions. 

This all-encompassing review should also assess the regulatory 

regime that governs various intermediaries in the market, ways to 

improve disclosure of post-trading pricing and routing decisions to 

investors, and additional ideas to ensure that intermediaries are 

acting in the best interest of their customers. 

I know this will not be an easy task, but I am hopeful that Chair 

White, the other four Commissioners, the SEC staff, and this subcommittee will devote the necessary time, energy, and effort to 

study these important issues. We owe it to the investors and the 

issuers who depend on these markets to facilitate the appropriate 

flow of capital. 

Finally, in a recent speech on the need to review market structure, current SEC Commissioner Michael Piwowar recently succinctly noted, ‘‘In order to move forward, we must look back.’’ I sincerely agree with the Commissioner, and I look forward to beginning this through a look back on Reg NMS with today’s panel. 

4 

And with that, I yield back, and at this point I recognize the 

gentlelady from New York, the ranking member of the subcommittee, Mrs. Maloney, who has taken a lead interest in all of 

these issues, for 5 minutes. 

Mrs. MALONEY. I want to thank the chairman for calling this 

hearing, and for your very informative conference that we had earlier in New York on market issues. And I thank all of the distinguished panel members, including the former head of the SEC. We 

welcome your comments today. 

This is a very important hearing, and I would like to thank you 

for your leadership and for the willingness to tackle this in a nonpartisan way. The United States has the deepest, most liquid, and 

most effective capital markets in the world. The U.S. stock market 

is 13 times larger than the British stock market and 14 times larger than Germany’s stock market. The strength of our markets is a 

key contributor to our country’s overall economic strength. We need 

to continually work to make sure that our markets are safe, competitive, innovative, and fair to all investors. 

The sheer size of our stock market is attractive for investors because they know they will be able to sell their investment quickly 

if they need to. Investors also know that they will get the best price 

available to them when they do decide to sell their stocks, which 

increases the attractiveness of trading in our markets. 

The purpose of this hearing is to review the foundation of our 

successful market structure, and particularly Regulation NMS, the 

National Market System. When the SEC passed Regulation NMS 

in 2005, the goals were to promote price competition, protect investors, and enhance market efficiency. Now, nearly 9 years later, it 

makes sense for Congress to take a step back, review the changes 

that have taken place, and ask what we did get right in Regulation 

NMS, what we did get wrong, and what can we improve? 

Price competition has undoubtedly increased as the number of 

different trading venues available to investors has exploded. Some 

in the markets argue that the price competition has come at the 

expense of market efficiency. However, as the large number of trading venues has led to fragmented markets, there is obviously a fine 

line between too many trading venues and too few trading venues, 

and whether we have the right balance is one of the issues I hope 

we will explore today. 

But if we have learned anything from Regulation NMS, it is that 

even small changes in market structure regulations can have large 

consequences. That is why I think the best changes in market 

structure will be grounded in data and empirical evidence. I am 

pleased that the SEC is already developing a tick-size pilot program to test whether tick sizes for stock trading really will enhance 

liquidity, and this one pilot program will look at raising it from a 

penny to 5 cents. 

And as we explore other potential changes to our market structure, we should also keep in mind that our equity markets are undoubtedly better today than they were a decade ago. Today’s retail 

investors have better access to the markets and at lower costs than 

ever before. It is important not to lose sight of these benefits. 

I look forward to a robust, informative discussion from our distinguished panel, and I yield back the balance of my time. 

5 

Chairman GARRETT. The gentlelady yields back. 

The vice chairman of the subcommittee is recognized for 2 minutes. 

Mr. HURT. Thank you, Mr. Chairman. Mr. Chairman, thank you 

for holding today’s hearing. And I want to thank our witnesses for 

joining us today to examine Reg NMS and our Nation’s equity market structure. 

Last Congress, this subcommittee led the charge to pass the 

JOBS Act to decrease burdensome regulations and provide incentives for emerging growth companies to access capital and public 

markets. While we continue to see successes of the JOBS Act, it is 

essential that we also ensure that our equity markets themselves 

are functioning as efficiently and effectively as possible. Our markets and the technology underpinning them have continued to advance quickly in the year since Reg NMS was implemented. I believe this hearing is an important opportunity to allow Members to 

explore how it is that our equity markets have evolved since that 

time and potentially where they are headed in the future. 

I agree with others who have called for a wholistic review of the 

Nation’s market structure. This issue is too important and too complex for a disjointed review that could lead to unintended consequences. It is imperative that we get this right, not only for the 

markets but for retail investors, pensioners, emerging growth companies, and all market participants. 

I am encouraged that Chair White and all of the SEC Commissioners have publicly supported the idea of this review of our equity market structure. I look forward to moving this process forward so we can ensure that the United States continues to have 

the most efficient, competitive, and liquid markets the world has 

ever known. I would like to thank our witnesses again for their appearance. I look forward to your testimony. 

Mr. Chairman, I yield back my time. 

Chairman GARRETT. The gentleman yields back. 

Mr. Lynch for 2 minutes. 

Mr. LYNCH. Thank you very much, Chairman Garrett and Ranking Member Maloney, for holding this hearing. And I want to 

thank the panelists for coming forward and for your willingness to 

help the subcommittee with its work. This hearing on equity market structure is long overdue. It is an important issue that we need 

to be addressing. 

The U.S. equity markets are often described as the deepest and 

most transparent in the world, and I guess that is probably true. 

And it is true because the vast majority of the trading in the 

United States, about 63 percent this past January, is conducted on 

open and transparent exchanges with robust pre- and post-trade 

transparency. An open market obviously reduces spreads, decreases 

volatility, and creates a safer environment for investors. 

However, over the past 5 years there has been a marked increase 

in the volume of trades that are being conducted in dark pools or 

opaque alternative markets, and that is a real problem. Off-exchange trading has expanded by some accounts from 15 percent to 

40 percent over recent years. 

There are some legitimate reasons for the use of dark pools. I 

know that institutional investors execute large volume trades 

6 

which can’t necessarily be performed well on open markets because 

of the likelihood that there may be some actors out there trying to 

game those trades. However, we are seeing a trend where trading 

that should normally be able to be conducted on open exchanges, 

public exchanges, is going off exchange, and that is a problem. We 

should be fostering policies which ensure that all trading can be 

done on open and public exchanges to the extent possible, and we 

should ensure that for off-exchange trading, when necessary, we 

still have a window to observe that trade is being done in the most 

transparent manner possible. 

I look forward to the testimony. I have some questions for you 

that I hope you can help us with. And again, I want to thank the 

witnesses for their willingness to come forward and help the subcommittee. 

I yield back the balance of my time. 

Chairman GARRETT. The gentleman yields back. 

Mr. Scott, for 3 minutes, please. 

Mr. SCOTT. Thank you very much, Mr. Chairman. And this is indeed a very, very important hearing, a critical hearing to be able 

to really examine the equity market structure. Specifically, though, 

I think we need to really gear in on the SEC’s regulations of the 

National Market System, which is commonly referred to as Reg 

NMS. 

There are two principles that are outlined in Reg NMS: the first 

one is competition among markets and competition among orders; 

and the second one is serving the interest of long-term investors’ 

listed companies. The point is that while Reg NMS appears to have 

been a success in increasing competition among markets, given the 

significant growth of what is referred to as dark trading, this dark 

trading volume, which is now 40 percent of average daily volume 

in this country, is in the dark, and an increase in liquidity fragmentation, 13 equity exchanges, around 45 dark pools, and many 

more broker-dealer internalizers. NMS appears to have resulted in 

not more competition, but less competition among orders. 

And in addition, many large institutional investors who act on 

behalf of long-term investors have raised concerns about the extreme fragmentation of liquidity and a lack of disclosure coming 

from dark trading venues. 

So the ultimate question I think we have to answer today is, has 

order competition decreased, and what should the SEC do about 

this? Shouldn’t the SEC be looking for ways to rebalance this? I 

think this is the overreaching, overarching issue in question that 

we have to answer today because many investors are concerned 

with these dark pools, and that process is not increasing competition but lessening competition, and we must do something to address that. And it would be good to examine what steps must be 

taken to make sure there is adequate competition. 

Thank you, Mr. Chairman. I yield back. 

Chairman GARRETT. The gentleman yields back. 

We now turn to our panel. And again, I thank every member of 

our panel for being with us today. For those of you who have not 

testified before, I always do the admonition to make sure that you 

pull the microphone close to you because sometimes I can’t hear up 

here. You all will be recognized for 5 minutes. And without objecVerDate Nov 24 2008 17:43 Sep 03, 2014 Jkt 088529 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 K:\DOCS\88529.TXT TERRI
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tion, your complete written statements will be made a part of the 

record, so we ask you to summarize your testimony right now in 

5 minutes. We will start, as we always do, from left to right. 

Former SEC Commissioner Campos, good morning, and welcome 

to the panel. 

STATEMENT OF THE HONORABLE ROEL C. CAMPOS, PARTNER, 

LOCKE LORD LLP; AND FORMER SEC COMMISSIONER (2002– 

2007) 

Mr. CAMPOS. Chairman Garrett, Ranking Member Maloney, and 

members of the subcommittee, thank you very much for inviting 

me here today. It is a privilege to be here with you. And I agree 

that the Reg NMS and the U.S. capital market structure is a very 

worthy subject of your consideration. I appreciate that you are 

working very closely with the Securities and Exchange Commission, my old agency. 

As you know, I served as a Commissioner of the Securities and 

Exchange Commission from 2002 to 2007. During my service, I was 

part of the Commission that implemented Sarbanes-Oxley, and 

part of the Commission that, with the work of the SEC staff, adopted Regulation NMS. I was there when all of the considerations, all 

of the battles, all of the presentations, and all of the arguments 

about market structure, about different business models were debated, considered, and presented. 

I will be brief. My testimony and written portions of it will be 

a part of the record. 

First, I agree with the comments that have been made by the 

Members. Today’s U.S. markets are the envy of the world. When 

I was a Commissioner at the SEC, I had the privilege of representing the agency internationally, and what I discovered internationally was that the largest investors of various countries invest 

in the United States. And I remember distinctly a manager of a 

sovereign wealth fund that invested billions of dollars in the 

United States said to me, ‘‘I invest in the United States because 

I know, first of all, that my investments there are safe. If something wrong happens, I can get redress in your courts. And secondly, I can get good prices and a fast reaction.’’ 

This feature, that the U.S. markets bring foreign capital into the 

United States, is a huge benefit and a huge feature of our particular markets. I agree that nothing is perfect. Any system needs 

to be revisited. And our National Market System, I am sure, could 

be improved. However, as my father used to say, and as all of you 

have noted, we shouldn’t be fixing what isn’t broken. 

So let me just very briefly tell you about what we thought about 

with the staff and the Commissioners that I was a part of when 

we looked at NMS. We saw a system that was not working very 

well. We saw traditional exchanges that gave opportunities to flow 

brokers to trade ahead, to give them many seconds of advantage 

in being able to work trades. We heard that individual investors 

and institutional investors were not getting fair executions and fair 

prices, and we heard that the markets overall were not working 

well. 

So, our first and foremost objective was to create a system in 

which investors were treated fairly and were treated safely. And as 

8 

has been noted, the 1975 Congress actually gave the SEC the direction to establish the National Market System, and it gave the Commission the guidelines which were to be the areas that it was supposed to concentrate on: efficient execution; fair competition; transparency; market access; and dealer disintermediation. 

One of the things we wanted to do was to accommodate the 

unique features of the American system, which is that we have 

many different trading centers. We wanted the markets to make 

the choices as to which of the different trading centers and market 

models would survive the markets. So our system essentially had 

another concept, and that is that it was a system, not a building, 

not a buttonwood tree, but a system of many centers that needed 

to be electronically connected. 

So today, when people talk about fragmentation, be careful. If we 

have a system that is connected, you may have liquidity from different sources, but it doesn’t mean that it is necessarily fragmented. It doesn’t mean that investors today are not getting the 

best price. And I assure you that today, the prices and the executions investors receive are far better than they were in 2002, when 

I ended up voting to approve the NMS. 

Clearly, the markets need some regulation. Our history is clear 

that bad things happen when there isn’t any regulation. So the 

question is not whether there will be regulation, but how much, 

and what is the right balance. Also, technology is the big issue of 

the day. 

[The prepared statement of Mr. Campos can be found on page 32 

of the appendix.] 

Mr. HURT [presiding]. Mr. Campos, thank you very much. 

The Chair now recognizes Mr. Steven Lofchie. 

Thank you for being here. You are recognized for a period of 5 

minutes. 

STATEMENT OF STEVEN LOFCHIE, PARTNER, CADWALADER, 

WICKERSHAM & TAFT LLP 

Mr. LOFCHIE. Thank you very much for having me, Chairman 

Garrett and Ranking Member Maloney. My name is Steven 

Lofchie, and I am head of the financial regulation practice at 

Cadwalader, Wickersham & Taft. In addition to practicing law in 

the area of financial regulation for the past 20 years, I have also 

written a number of books on the topic including, ‘‘The Guide to 

Broker-Dealer Regulation,’’ which is commonly regarded as the 

standard text in the area. 

I have prepared written testimony that I have submitted for the 

record. Again, I am very appreciative of the opportunity to testify 

to the subcommittee on the rules governing the equity markets. 

Since 1975, the operation of these markets has been governed by 

the principles that Congress established in Section 11A of the Securities Exchange Act of 1934, that there should be efficient trade 

execution and fair competition, and that market data should be 

made widely available. But while the principles established in 1975 

still hold true today, today’s problems are not the same problems 

that existed in 1975. 

Then, the problems of the equity markets were the problems of 

the near monopoly of the NYSE at the time which stifled innovaVerDate Nov 24 2008 17:43 Sep 03, 2014 Jkt 088529 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 K:\DOCS\88529.TXT TERRI
9 

tion, the snail’s pace of trade execution, and that the exchanges 

were largely private clubs at which admission was limited by members. Those problems of 1975 have been remarkably well-addressed 

thanks to the regulatory efforts of the SEC and the technological 

innovation and the competitiveness of market participants. Unlike 

in 1975, trades are executed in milliseconds, bid and ask spreads 

are at a penny, numerous exchanges and alternative trading systems compete, and trade information is real time. 

But today’s markets present different problems. Today’s problems, in fact, are so different from those which existed in 1975 that 

they are almost the mirror of them. Instead of trading being too 

slow, perhaps it is too fast. Instead of too much reliance on an individual specialist, perhaps we are too vulnerable to technology failures. Instead of exchanges being private clubs where members 

have an interest in the support of the organization and vice versa, 

today the exchanges have become business organizations with distinct interests from their members. Instead of trading on a monopoly market, trading is fragmented or dispersed, depending upon 

your choice of words. 

This means that if the SEC assumes it can address the problems 

of today’s market using the same tools and the same rules that it 

did in 1975, there is a danger it will worsen problems rather than 

resolving them. Forty years after Section 11A was adopted, as you 

have all noted, it is time for the SEC to take a ground up look, and 

it must study not only the front page matters, such as market volatility and technology vulnerability, it must also look at behind-thescenes issues such as market data feeds and how those impact 

market trading incentives. 

The SEC must also conduct a self-examination as to its own assumptions of how markets work. The markets, as they exist today, 

and as they existed in 1975, are not simply the the result of interaction between buyers and sellers. They are also very much a creature of market regulation. The NYSE was able to dominate trading 

for so long not because it had a better market, but because rules 

permitted it to disadvantage competition. When the current set of 

market rules were adopted, the dissenting Commissioners worried 

that these rules would increase fragmentation and volatility. Those 

concerns have proved justified. 

In addition, it makes sense to look at regulatory structure. Does 

it make sense for the exchanges to regulate their competitors? And 

finally, I want to talk about the issue of technology failure. How 

do we deal with the technology failure that is such a front page 

issue? One of the things I have suggested in my written testimony 

is that we look at other models of regulation, such as the airline 

industry, where the focus is more on gathering information as to 

how a problem occurs. 

Thank you very much for inviting me to the hearing, and I look 

forward to questions. 

[The prepared statement of Mr. Lofchie can be found on page 36 

of the appendix.] 

Mr. HURT. Thank you, Mr. Lofchie. 

The next witness is Mr. Erik Sirri, former Director of the SEC 

Division of Trading and Markets. 

10 

Thank you for being here, and the Chair recognizes you for 5 

minutes. 

STATEMENT OF ERIK R. SIRRI, PROFESSOR OF FINANCE, BABSON COLLEGE; FORMER SEC CHIEF ECONOMIST (1996–1999); 

AND FORMER DIRECTOR OF THE SEC DIVISION OF TRADING 

AND MARKETS (2006–2009) 

Mr. SIRRI. Chairman Garrett, Ranking Member Maloney, and 

members of the subcommittee, thank you for having me here today 

to testify. 

U.S. equity markets consist of more than a dozen registered exchanges and more than 60 market centers. Their efficiency is remarkable. Today, a modern electronic market maker that trades as 

much as 15 percent of a large-cap NASDAQ stock may earn as little as 1 or 2 hundredths of a penny for every share it trades. The 

old worries about a dominant market maker being a monopolist 

have been replaced by new issues concerning fair access, 

connectivity, computerized trading, and the robustness of systems. 

Reg NMS today is almost 9 years old, and still, it remains a rule 

with both proponents and detractors. It highlights the fact that 

market structure regulation is necessarily a difficult exercise. For 

example, traders value confidentiality for their orders because unnoticed trading results in better prices for traders’ ultimate customers. Any regulatory desire to increase market transparency is 

constrained by a trader’s desire for secrecy. Traders forced into a 

transparent market against their wishes will elect not to submit 

their orders into the market and will hold them upstairs until they 

are ready to trade. There is thus a limit on how much transparency 

can be brought to any marketplace. 

As a second example, not even the strictest regulations can force 

liquidity providers or market makers to provide liquidity to a marketplace if it is not profitable for them to do so. They will simply 

exit the market. This principle contributed to the demise of traditional market makers and specialists on physical exchanges like 

the NYSE. 

U.S. equity markets are generally very efficient. Changes of fees 

of as little as one-tenth of a cent per share will clause flow to move 

from one venue and cause it to be rerouted to another market center as brokers attempt to lower trading costs or earn higher rebates 

from their customer flow. This is both a testament to the quality 

and efficiency of our markets and a cautionary tale to regulators. 

It demonstrates how sensitive market participants’ business models 

are to very small changes in costs and how quickly trading platforms, brokers, and investors react to changes in the competitive 

landscape. We should expect that any meaningful changes in equity market regulations will have large consequences in the routing 

and execution of orders and the business model of market participants. 

SEC Commissioners have been calling for a broad review of our 

market structure. These market structure questions are eminently 

amenable to empirical analysis, and any revisions to our trading 

rules should be preceded by meaningful and objective analysis of 

economic data. I believe that an encompassing, data-driven, empirVerDate Nov 24 2008 17:43 Sep 03, 2014 Jkt 088529 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 K:\DOCS\88529.TXT TERRI
11 

ical study is an important step to complete before implementing 

any substantive change to market structure regulation. 

I would like to offer two final thoughts. First, I would be remiss 

if I didn’t highlight the need for improvements in the structure of 

our fixed income markets. The fixed income markets are larger 

than our equity markets. Investors in corporate and municipal 

bonds trade using an opaque network of OTC dealers, and retail 

investors can price spreads of as much as 5 percent. All this happens at the same time that these investors trade in equities, in percentage spread measured in tenths, and in submillisecond timeframes. I hope that in the near future, regulators will turn their 

focus to the trading structure of these vital markets. 

And second, I think it is important that any review of equity 

market structure include a focus on the best execution duties of 

brokers that handle customer orders. Existing interpretations of 

best execution have not kept pace with the changes in market 

structure and with automated trading. Examples of potential concerns include the effective access fees and liquidity rebates on 

broker routing decisions and the routing of nonmarketable customer limit orders to exchanges rather than to other venues more 

advantageous to the limit order. 

The Commission should, as part of its review of market structure, revisit their guidance on best execution and consider whether 

another approach, such as one based on policies and procedures, 

would be useful in augmenting any change to market structure 

under consideration. 

Thank you for your time this morning. 

[The prepared statement of Mr. Sirri can be found on page 60 of 

the appendix.] 

Mr. HURT. Thank you, Mr. Sirri. 

Our final witness is Mr. Chester Spatt, former SEC Chief Economist. 

Thank you for being here, and you are recognized for 5 minutes. 

STATEMENT OF CHESTER SPATT, PAMELA R. AND KENNETH B. 

DUNN PROFESSOR OF FINANCE, TEPPER SCHOOL OF BUSINESS, CARNEGIE MELLON UNIVERSITY; AND FORMER SEC 

CHIEF ECONOMIST (2004–2007) 

Mr. SPATT. I would like to thank Chairman Garrett, Ranking 

Member Maloney, and the members of the subcommittee. I am 

pleased and honored to have the opportunity to present my views 

at today’s important hearing. I served as Chief Economist at the 

SEC from 2004 to 2007, and I am currently still involved in regulatory issues. I am a member of the Shadow Financial Regulatory 

Committee and the Federal Reserve’s Model Validation Council, 

among other activities. 

There have been dramatic changes in the structure of our equity 

markets over the last 2 decades, reflecting changes in technology 

and changes in regulation. Prior to NMS, there was decimalization, 

which had big impacts on our markets. NMS led to a series of 

changes focusing on much greater automation in the trading process by its emphasis on fast markets, and partially as a byproduct 

of NMS and other considerations, there has been a dramatic 

change in fragmentation. For example, the New York Stock ExVerDate Nov 24 2008 17:43 Sep 03, 2014 Jkt 088529 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 K:\DOCS\88529.TXT TERRI
12 

change share of trading in its own listings has fallen from 80 percent to 20 percent. 

I am pleased that the subcommittee has organized today’s hearing to focus on NMS because more generally, I believe that financial regulators should undertake serious retrospective reviews of 

the consequences of their actions and that, at least in the past, this 

has not been so much of a focus. I am pleased that going forward, 

there is more orientation toward that, that the SEC, for example, 

is signaling its interest in undertaking an experimental pilot analysis with respect to decimalization, although I think my own views 

are rather doubtful that wider ticks will necessarily meaningfully 

impact IPO decisions. 

One thing that NMS did do is it had the effect of resolving some 

open issues in its day, which I think provided some clarity to the 

trading community, and at least some of the big changes that occurred in the aftermath of NMS just simply reflected that there 

were some rules of the game that were specified, whatever those 

rules were, and then various platforms felt comfortable to enter. 

In the aftermath of NMS as well, New York Stock Exchange specialists no longer retained potentially a 30-second option to send orders to other platforms through the ITS system. So NMS led to, I 

think, a variety of important changes. 

One of the most striking aspects of NMS is the structure of its 

order protection rule. Orders were protected, but the only orders 

that were protected were at the top of the book, and I think that 

is an important point to highlight. So in a way, NMS is a bit schizophrenic, that NMS basically says that orders at the top of the 

book are deserving of protection, but other orders are not. And certainly, I would not favor providing protection down the book. That 

would be, I think, even more prescriptive and would add to the 

technological burden of the rule, but I think it points to a lack of 

coherence within the structure of NMS, because the protection that 

is provided is only for orders at the top of the book. 

Indeed, I think that points to one of the contributors to fragmentation directly in the rule, because if you have distinct platforms as opposed to a consolidated platform, you get more protection out of NMS, because every top of the book is protected; whereas, if platforms are not separated, they have less protection. 

An additional important aspect of NMS is how it integrates the 

markets. Brokers, of course, have had longstanding best execution 

responsibility. NMS also has the effect of routing orders to the platforms that potentially would provide the best execution at the top 

of the book. But in a sense, then, NMS is providing a substitute 

for best execution, and I think one metric to look to, which has 

really not been focused on, is whether NMS in fact reduces somewhat the extent of abuse of best execution responsibilities. If NMS 

were successful, you should now see less abuses of best execution 

than previously. 

An important set of distortions, in my view, with respect to the 

trading is the ‘‘make or take’’ features of the market, which NMS 

provides some structure around. There are incentives to collect liquidity rebates and avoid fees for taking liquidities. But I think 

there are real conflict of interest issues that are raised, and in fact, 

13 

I think some interference with best execution, because orders 

would be isolated where they don’t fill most quickly. 

Thank you very much very much for the opportunity to speak. 

[The prepared statement of Mr. Spatt can be found on page 65 

of the appendix.] 

Mr. HURT. Thank you, Mr. Spatt. 

Now, we will turn our attention to questions from the Members, 

and I will first recognize myself for 5 minutes. 

It seems like everyone agrees that this is an important endeavor 

that we are undertaking, but I guess the question is, is how is the 

best way to do that and what information do we need, what information does the SEC need to be able to navigate through this? And 

I guess my question, and I would like to start with Mr. Campos 

and then just go down the line, is what data does the SEC currently have that is needed to be able to do this, and what data do 

they perhaps not have that they need to have to be able to make 

the right decisions regarding strengthening our equity markets? 

Mr. CAMPOS. That obviously is an excellent question. And there 

is, first of all, a lot of data. My colleagues who are economists and 

researchers deal with that daily. But essentially, a study of whether investors are getting best execution, as was just discussed, studies as to whether the pricing tends to reflect the best price in the 

markets, all of that data is there. Are orders being routed from 

market and trading centers to reflect the best top of the book price? 

Again, all of those things are data that is available. 

And what we don’t know, I suppose, are things about whether liquidity is being held back, about whether there are things going on 

in internalization models. I would argue that the enforcement 

mechanisms and the examinations have been very robust. But 

nonetheless, that could be looked at. 

Mr. HURT. Okay. Thank you. 

Mr. Lofchie? 

Mr. LOFCHIE. Thanks very much. I think there is a lot of quantitative data. What I think there needs to be is more focus on qualitative data, an understanding of the motivations of market participants. I think we need to understand why do mutual funds and institutional investors prefer going to alternative trading systems 

rather than to trade on the exchanges? It is not enough just to look 

at the numbers. It is important to understand why they find one 

venue preferable to another, and that will help us understand how 

rules changes that we will make in the future will affect their incentive scheme. 

Mr. HURT. Mr. Sirri? 

Mr. SIRRI. I think we all talked about how tricky it is to trade 

with computers, but one of the good things about that is that you 

have the data. It is in electronic form to begin with. That is not 

how it was 20 years ago. So, the SEC has the access to a chunk 

of that, not all of it. 

I think partners in this revision have to come from industry. The 

street, the broker dealers, the users, they also have data in electronic form. Hopefully, as part of the process that this committee 

is envisioning, they will cooperate, they will do their own analysis, 

and they will contribute that data to the public, to the Commission, 

14 

so that its analysis can be fruitful and you get a better answer to 

these questions. 

Mr. HURT. Thank you, Mr. Sirri. 

Mr. Spatt? 

Mr. SPATT. I think much of the data is potentially available because of the electronic structure of our markets. Historically, the 

SEC was not in a good position to integrate the data from various 

platforms, given the large number of platforms and the importance 

of the fine time stamping, and I don’t know whether those are still 

issues going forward. 

It seems to me the types of things that one would want to analyze in a serious way are to try to understand, especially the routing decision. It seems to me the routing decision is at the core of 

the issues. My comments earlier about the ‘‘make or take’’ decision 

are illustrative of that, but you can think of the routing decision 

more broadly. I think that is an absolutely essential feature that 

it is important to try to drill down on. It is also related to issues 

involving how orders at a higher level are packaged. How does the 

institutional investor piece out his order? And it is a bit related to 

best execution, but I think in some ways it is broader. 

Now, that would be data that I think typically the SEC wouldn’t 

currently have. That would be data that would be available in the 

brokerage community or in the asset management community, in 

effect, how do they put in orders, and then what are the paths by 

which they execute over time. And I think understanding that 

would be incredibly helpful. 

Mr. HURT. Thank you, Mr. Spatt. My time has expired. 

I now recognize the ranking member, Mrs. Maloney, for 5 minutes. 

Mrs. MALONEY. Thank you very much. 

Professor Sirri, you noted in your testimony that one of the 

SEC’s goals in passing Reg NMS was to promote price competition. 

With at least 58 different trading venues today, we certainly have 

increased competition. Some people say it is too much. As you 

know, many in the markets, including the exchanges, believe that 

we now have too many trading venues and that the markets have 

become too fragmented. What is your opinion? Have we reached the 

point where fragmentation of markets is a bigger problem than 

competition? Or do you think the markets are fragmented? 

Mr. SIRRI. I think if you talked about fragmentation as being 

anyone’s stock can trade in 50, 60, 70 places, yes, they are fragmented. But if you talk about fragmentation being they are insufficiently connected or other people are not able to get the best price 

across these markets, that is a tougher question to answer. 

The computerized trading, the private linkages help integrate 

those markets together, but the linch pin of it all in the end is the 

person who sends the order, who has the order to begin with and 

picks where am I going to trade it. That person has to be smart, 

that person has to use technology, and they have to figure out, in 

their routing decision, how to link. So I think while the markets 

are somewhat dispersed, there exists technology and smarts to 

bring them together. 

Mrs. MALONEY. Okay. So you support NMS? You think it has 

brought the improvements? 

15 

Mr. SIRRI. I wouldn’t say I support or don’t support NMS. Like 

all regulation, it has its problems and it can be improved, and I 

think probably that is why a lot of us are here today. 

I think dispersion of market centers was going on before NMS 

came up. We had separated market centers. NMS created a platform where more of it could happen and it at the same time allowed them to be more connected. I think the empirical studies 

that you all are calling for will help answer the question you are 

asking, which is, is it too much? 

Mrs. MALONEY. And Mr. Campos, as the SEC Commissioner who 

voted for Reg NMS, I would like to ask you one simple question. 

Is the current market structure what you envisioned when you 

passed it? And if not, what has surprised you? 

Mr. CAMPOS. None of us—just like we have 20/20 hindsight, we 

don’t have 20/20 foresight. We were worried initially about whether 

the connectivity was going to be sufficient and whether it would 

work. 

As Erik Sirri, Professor Sirri has just said, there were many 

markets already existing at the time that we adopted it. It would 

be a very arrogant regulator to believe that they can control or 

should control what the markets will look like in the future. So, the 

effort here again was to create a situation in which the technology 

connected and we had a market system. None of us had any idea 

of how many that would be, whether it would be 20, it would be 

30, or maybe it would be 10. But we expected that business models 

providing service and value to investors would be what would determine how many existed. 

I think it is a unique feature of the American system to have 

competition among markets. And recall that some of these markets 

produce very positive results. There is price improvement in some 

of these markets where there is an execution at the midpoint. I will 

just leave you with that. 

Mrs. MALONEY. Thank you. 

We certainly have the data elements out there, but they are not 

really in a way we can use them. And we created in Dodd-Frank 

the Office of Financial Research, and they have been in existence 

now for a number of years, and all they have done is proceed to 

give an LEI, which is an identification to every broker and person 

in the business, and that seems to me like a waste of time. I think 

the best data element is the trade itself, and that trade itself is 

identified with a broker and a firm. Am I not correct? I will just 

ask Mr. Campos or anybody? 

Mr. CAMPOS. Yes. I think getting an execution at a decent price, 

being able to access the best price, and that can be tested, I think 

is ultimately the best test of the situation. 

Mrs. MALONEY. My time is almost up, and I don’t think I have 

time for you to answer, but I would like back in writing from you, 

if we were to look at this, and we have the data elements, what 

would be the best way to look at it? You have much more expertise 

than any of us because you have lived through it and you have 

been part of the markets, you study it every day. I think that 

would be very helpful to us as we look at this. 

My time has expired. Thank you. 

16 

Mr. CAMPOS. I would be very pleased to do that. I am sure all 

the other members would, too, on the panel. 

Mr. HURT. Thank you, Mrs. Maloney. 

The Chair now recognizes the gentleman from South Carolina, 

Mr. Mulvaney, for 5 minutes. 

Mr. MULVANEY. I do have a couple of different types of questions. 

Mr. Sirri, I want to follow up on a question. I don’t know if I understood the answer to Mrs. Maloney’s question, so I will put it to 

the entire panel. Has Reg NMS led to too much fragmentation 

within the markets? I think Mr. Sirri said no, but I wonder if that 

is unanimous amongst the panel? 

Mr. Spatt? 

Mr. SPATT. I am not so concerned that it has led to too much 

fragmentation, although it may have led to too much fragmentation 

in particular ways. It certainly creates some incentives toward 

fragmentation by the focus on the top of the book in particular, but 

it is not so much of a concern to me on the broad issue because 

spreads are substantially down. Before you had a situation where 

a lot of the market making was occurring in a very noncompetitive 

way. So it is not a huge concern to me, but this is obviously a first 

order issue to consider. 

Mr. MULVANEY. Mr. Lofchie? Mr. Campos? 

Mr. LOFCHIE. I think what I am hearing from all of the panel is 

that fragmentation per se is not an issue, and that remarkably 

trades can be executed across markets much faster today than they 

could be in 1975 or pre-NMS. 

I think the real issue is why we have so many markets. Is it because it is serving the interests of market participants or is it because rules incent people to move customer orders in ways that 

may be inefficient in order to take fees rather than to serve their 

customers. And I think if we have rules that incent brokers and institutional investors to act in the best interests of their customers, 

then the market will decide how many exchanges and how many 

alternative trading systems survive. 

Mr. MULVANEY. Does your analysis change if we start talking 

about the lit versus unlit of these dark pool markets? Do we need 

to update the regulatory environment to allow them to compete on 

a more even playing field? Mr. Lofchie? 

Mr. LOFCHIE. One of the things that I think we need to look at, 

again, is the motivation of traders. There is clearly a tremendous 

incentive of traders, as Professor Sirri said, not to show their 

quotes on the exchange markets. And I think, given the increase 

of trading in these alternative trading systems, we need to understand why they provide benefits. Clearly, they do provide a benefit. 

And I am anxious as to any system that would force the person at 

the point of trade, the institutional investor, the mutual fund, the 

pension plan, not to trade in a way that he sees as serving the interests of his investors. 

Mr. CAMPOS. Could I serve a caution? 

Mr. MULVANEY. Please. 

Mr. CAMPOS. The term ‘‘dark pools’’ is used often, and it has sort 

of a sinister connotation. After all, it is dark. But the reality is that 

the rules regarding dark pools are very clear. They have to at least 

reflect the last best price. And often what they reflect is a negotiaVerDate Nov 24 2008 17:43 Sep 03, 2014 Jkt 088529 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 K:\DOCS\88529.TXT TERRI
17 

tion, and there is price improvement because they tend—or at least 

one particular system that I am very familiar with executes at the 

midpoint, which is a positive for both, and then it is reported to 

the tape. 

So the actual execution and the price that they agree upon is not 

kept from the market. It is not a secret. And it offers something 

that is very important to many large institutional investors, which 

is that they have large block trades to execute, and if they put 

them in through regular execution situations they have to be 

shredded or so-called, split up into small. It is very expensive to do 

that. And so, there is a reason why many of these markets exist. 

They provide a service that is necessary 

Mr. MULVANEY. There is an efficiency that comes from that. 

Mr. Campos, I am going to do something unusual. I am going to 

go off topic, but since we have you here today, I want to ask you 

about something that just became public this week. It deals with 

the SEC, it doesn’t deal with you individually, but I am curious to 

know your opinion of it. There was a fairly widely reported paper, 

I think published by the University of Virginia by two professors 

out of Georgia, regarding insider trading by SEC employees. Specifically, how they are able to apparently pick better times to sell 

stocks than the ordinary public and that they apparently, I guess 

the allegation is, they use information that is inside the SEC on 

upcoming investigations. 

How should we best approach the issue going forward as a committee as we want to focus on possible wrongdoing by the employees at the SEC? 

Mr. HURT. Mr. Campos, because we are running up against the 

votes, is it possible for you to please respond in writing? 

Mr. MULVANEY. I would appreciate it. I wasn’t aware of the 

votes. Thank you, Mr. Chairman. Yes, sir. 

Mr. HURT. Yes. 

Mr. CAMPOS. Certainly 

Mr. HURT. And so, if you would please respond in writing, that 

would be very helpful. 

Mr. HURT. The Chair now recognizes Mr. Lynch for 5 minutes for 

questions. 

Mr. LYNCH. Thank you, Mr. Chairman. I would be interested in 

having the response to the earlier question as well. 

This is a great discussion, and the problem at the root of this 

sometimes—and I know that Congress has been late in responding 

to this. I think the SEC agreed to take up a study of market structure back in 2010, and that has not happened yet. One of the problems that we have is the pace at which technology changes and the 

pace at which government changes. We would still have powdered 

wigs, if we looked good in powdered wigs still. 

Meanwhile, technology changes at a breakneck speed. And so in 

a way, we find ourselves in a reactionary mode in government. We 

are trying to, in this case, with market structure, respond to the 

plumbing of these super fast trading platforms and things like 

that. Oftentimes, we find ourselves trying to catch up, and that has 

been a real struggle. So maybe there is a way we can, if the SEC 

gets serious about that, together we can envision a platform that 

might be able to address all of the concerns that we have. 

18 

But let me get to my question. Not only has the volume of dark 

pools, of trading in dark pools has increased, but also we are seeing 

some individual stocks where over 50 percent of the trading in individual stocks is going to dark pools, and that is a different issue 

than people having large trades, trying to move those institutionally without being gamed by some of these other traders. 

I know that in the international literature there has been a couple of studies by Australia and our friends in Canada that have 

looked at the U.S. markets, and they have had real concerns about 

price discovery and whether our markets are as efficient as they 

once were. And it is interesting because both of those countries, 

after studying the United States, are implementing measures to 

preserve their price discovery process. Both are implementing 

‘‘trade at’’ rules to try to preserve the ability of large trades to be 

done in the dark but also requires most other trades to be routed 

to the best price on the transparent markets. 

What do you think that our next step should be in terms of moving towards markets that move trades back onto these lit markets, 

lit exchanges, public exchanges, what do you think that the greatest incentives we could give to move some of these trades back 

onto, again, lit markets, public markets, NASDAQ, the New York 

Stock Exchange, so that the risk of—well, the risk of something 

happening in the opaque markets is reduced? 

Mr. CAMPOS. Is that directed to me? 

Mr. LYNCH. Yes. 

Mr. CAMPOS. Thank you for the question; it is very thoughtful. 

First of all, I think you need to ask yourself, and the whole committee does, is it really a worthwhile goal to want to increase the 

volume on the exchanges per se, is that a real and a worthy goal? 

I submit to you that if orders are being routed correctly, if the 

connectivity is working and investors are getting the best price at 

that particular instant, that in itself is a worthy result. And the 

fact that volume is now dissipated may or may not be a negative. 

Mr. LYNCH. Just to interject here. 

Mr. CAMPOS. Sure. 

Mr. LYNCH. With the rebate system, I am not sure I can tell 

whether the customer—in the dark pool situation. So I don’t know, 

I don’t really have a window into that, or government doesn’t have 

a window into that to determine, with the speed of these trades, 

with the offering of rebates and other considerations, whether the 

customer is getting the best available price. I know that is the idea. 

Mr. CAMPOS. Right. 

Mr.LYNCH. But we have seen in other situations where there 

have been opaque markets, that whatever advantage a trader can 

get, they will take. That is just the way it works. 

Mr. CAMPOS. I know there is a time issue, so I will make it very 

brief. 

Mr. LYNCH. Yes. 

Mr. CAMPOS. Again, it is a great question. One should look at it. 

I believe that many so-called dark pools and ATS’s, if they offer 

price improvement, that is what has been used in Australia and 

other places to allow sort of a license to be in that particular— 

Mr. HURT. Thank you, Mr. Campos. 

Mr. LYNCH. I yield back. 

19 

Mr. HURT. And I apologize to the witnesses for this time constraint. 

What I would like to do, if there is no objection, I think we probably have time to squeeze in two more questions, one from Mr. 

Ross and then one from Mr. Scott, and then we can adjourn temporarily to vote and then we will come back. And I apologize to the 

witnesses and to the audience for that and to the Members. 

But the Chair now recognizes Mr. Ross for 5 minutes. 

Mr. ROSS. Thank you, Mr. Chairman. 

Commissioner Campos, do you feel that Reg NMS is the reason 

we have so many trading centers? 

Mr. CAMPOS. Not per se. I think it accommodated it. Remember, 

Reg NMS was intended when we did it to allow the markets to 

work in the manner that markets work. 

Mr. ROSS. So they have naturally evolved, in other words, irrespective. 

Mr. CAMPOS. Exactly. And there were already many, many centers when NMS was— 

Mr. ROSS. And that is not a bad thing, is it? 

Mr. CAMPOS. I don’t think it is a bad thing at all. 

Mr. ROSS. Mr. Lofchie, you spoke earlier in your opening statement about the monopoly of the NYSE back in 1975, and I think 

that some would say that back then we had two dominant exchanges, the NASDAQ and the NYSE, and they had high barriers 

to entry. Back then, some would argue, it was simpler and safer. 

Do you think that is something that we should consider going back 

to? Is it even possible? 

Mr. LOFCHIE. It is certainly not possible. It was clearly simpler. 

I don’t know that it was safer. 

Look, there is no question that today’s markets, as disbursed as 

they are, in fact, I think provide investors much better protection, 

that all of these various markets work together more quickly than 

the NYSE did back then. So I think we have to deal with the markets that we have and the technology that we have. There is no 

turning back. 

Mr. ROSS. And technology has been good, but retail investors 

have been a little bit hesitant, have they not, because of technology, when you look at how technology has permeated so many 

areas of our world, whether it be medicine or transportation or 

anything. And so when you have a flash crash occurring, would you 

say that technology has been somewhat of an impediment, although a benefit? 

Mr. LOFCHIE. I think overall, it has been an extremely large benefit. Again, I think our ability to track information, to know whether investors are getting the best price, to link markets, if you compare the markets of today to the markets of 1975 or of pre-NMS, 

there is no question they are far better. On the other hand, when 

something goes wrong, it goes wrong big, and I think that is something that needs to be focused on. I think the SEC, with some of 

the moves to start markets, has made moves in that direction. 

Mr. ROSS. In your opening statement, I very much enjoyed your 

discussion semantically about dark pools and protective coves 

versus naked bazaars. Is this more of an issue of semantics? We 

have probably the deepest and most transparent equity markets of 

20 

anybody. And we look at dark pools, and is the first problem that 

we have one of semantics? 

Mr. LOFCHIE. I think there is a risk that we judge markets by 

their name rather than by the service that they provide. And it 

does worry me that when mutual funds and institutional investors 

are electing to trade on what we are calling a dark pool, that we 

are saying, oh, that is not good, because we don’t like the name of 

it. 

Mr. ROSS. The dark pool. But it does help retail. It helps the 

markets. It is a necessary tool, wouldn’t you agree? 

Mr. LOFCHIE. Clearly, the way that retail investors for the most 

part trade in the market or participate in the market are through 

these institutional entities like mutual funds and like pension 

plans, which very much avail themselves of dark pools. 

Mr. ROSS. Mr. Sirri, with regard to market data, and I think Mr. 

Lofchie’s earlier testimony about more qualitative analysis of the 

data as opposed to just a collection of quantitative collection of 

data, do you feel that the SEC is doing that now and using it effectively? Are they doing more quantitative collection as opposed to 

qualitative? 

Mr. SIRRI. I think relative to, say, 5 or 10 years ago, the SEC 

has improved on both fronts. Their quantitative data use is better 

than it has been, they have tooled up in that area, they have expanded the group that does such analysis, it has many more people 

in it now and it has more skilled people than it used to. That has 

improved. 

As to your question about qualitative data, I am not as well informed about that. I would expect they have. That necessarily involves outreach, that involves talking to people and understanding 

that. 

Mr. ROSS. Right. It is more than just collection. 

Mr. SIRRI. Absolutely. And I will tell you from having been there, 

there is usually no shortage of people who want to walk in the door 

and explain their views to you. So unless that has changed in the 

last few years, I expect they are hearing their views. 

Mr. ROSS. One quick question, and, Mr. Spatt, I will give this to 

you. A recent Wall Street Journal article states that many Wall 

Street executives point to extreme complexity created by Reg NMS 

as the cause for technical glitches. Has the combination of technical 

complexity and more exchanges created an environment where 

glitches are more likely to occur? 

Mr. SPATT. There seem to be more glitches in recent years. Inherently, to the extent that the platforms need to interface with 

each other, that is maybe part of the source of a glitch. But I think 

one also has to assess the glitches from a broad perspective in 

terms of the everyday performance of the market. 

Mr. ROSS. Higher volume, higher frequency may lead to more 

glitches. 

Mr. HURT. Thank you. 

Mr. ROSS. Thank you. 

Mr. HURT. Thank you, Mr. Spatt. 

Mr. ROSS. I yield back. 

Mr. HURT. The gentleman’s time has expired. 

The Chair now recognizes Mr. Scott from Georgia. 

21 

Mr. SCOTT. Thank you very much. 

I want to go back to this issue of the dark pools, because I think 

we need to understand my point and the concerns about the fair 

competition. We, in Congress, amended the Securities Exchange 

Act to add Section 11A, which was to foster fair competition. 

Now, it is important for us to understand what these dark pools 

are. I am not casting a bad light on them. But what these dark 

pools are, they provide institutional, large institutional investors 

with anonymity in the equities market with the option to execute 

these large orders without identifying either themselves or the location of trade to the consolidated market data, and such secrecy 

allows market participants to prevent other traders from pricing in 

that arena. Therefore, this concern is certainly a legitimate concern, especially now that 40 percent of the average daily volume is 

in the dark. And with the increase in liquidity fragmentation—13 

equity exchanges, 45 dark pools—many, many of our investors are 

raising concerns. 

So my question is, don’t each of you agree that order competition 

as a result of this has decreased and that the SEC should be looking for ways to rebalance this? Please, each of you. 

Mr. SPATT. I don’t agree. I agree that the issue of transparency 

is an important one, but I also feel that the institutional investors, 

how they manage their orders to some extent is part of their intellectual property. If we were to, for example, declare that we would 

not allow the dark pools to operate, to some extent they are going 

to follow very different tactics. They are going to presumably then 

shred their orders to a much greater degree. There is a balancing 

act. 

Mr. SCOTT. That is what I am asking for. I am not asking that 

we do away with the dark pools. I am just simply saying that there 

should be an examination for a more fair competition within that. 

Mr. SPATT. I am very comfortable with the idea of studying the 

issues, but I think it is important to keep in mind that there is a 

bunch of balancing, and that to some extent, if the rules were to 

change, institutional investors will change how they respond to 

those rules, and I think it is important to keep that in mind. And 

I also think it is important to keep in mind that even for dark 

pools, there is post-trade price reporting, for example, that is required of the dark pools as well. 

Mr. SCOTT. Mr. Sirri? 

Mr. SIRRI. I think if you wanted to create an environment where 

there was more transparency in dark pools, Congress could do that 

and the SEC could do that, incrementally if they chose. For example, you could cause the dark pool to report when a trade occurred 

in that particular dark pool. That is not done today. A dark pool 

is not identified as such. 

But as to what Mr. Spatt said, I would agree with it, which is 

if you choose to do that then traders, as they use that particular 

dark pool, will change. They will do something different. Net-net, 

is that better or worse? I can’t tell. But I think part of what gets 

at the answer to your question and to Mr. Lynch’s question will be 

a comparison of how well did a particular trade do on an exchange 

that was lit and how well did that same trade or an equivalent 

trade do on a dark pool that was dark? 

22 

Mr. SCOTT. Good. 

Mr. Lofchie? 

Mr. LOFCHIE. I think one of the issues that you implicitly identified, Representative Scott, is the fact that large traders may move 

the market. And I think the concern that all of us have, and I 

think likely share with you, is that when mutual funds and pension plans trade in large volume, if they are going to do that in a 

fully exposed manner, are they going to move the markets against 

them and will that end up hurting retail investors indirectly. 

Mr. SCOTT. Thanks. 

Mr. Campos? 

Mr. CAMPOS. Representative Scott, thank you. That is a very 

thoughtful question. 

The issue here really is, can you stop human nature? People 

since time immemorial have made deals outside any market system. If you own stock and I own stock, we can trade it without any 

market. And so what you are hearing is essentially that there is 

a need for large investors to do their trades cheaply, which helps 

pensioners, which helps retirees, and they need to save money on 

executions and they need to get the best price. So these dark pools 

serve that purpose very well. 

Mr. HURT. Thank you, Mr. Campos. 

Mr. SCOTT. Thank you, sir. 

Mr. HURT. And I think, unless there is any objection, Mr. 

Huizenga from Michigan has asked to be recognized for 5 minutes. 

I think we can work him in before we have to run to votes, so I 

am going to recognize him for 5 minutes. 

Mr. HUIZENGA. Thank you, Mr. Chairman. I promise to try to 

fold time and space here and make it as fast as possible so we can 

get to votes. 

I was going to start by asking, and I think we have explored this 

quite a bit, how the rules and regulations may have pushed, not 

forced, but maybe pushed some of these trades off of the exchanges 

and into these dark pools. I think it has been explored quite a bit, 

and Mr. Lofchie I think asked a key question: Why are they going 

to these alternatives? 

And I am going to go to another dark and ominous place, high 

frequency trading, or I think as some of my friends in New York 

call it, automated trading, much less ominous than the high frequency sounding. 

But, Mr. Sirri, talking about mandating a focus on price and 

speed in executing trades, I am curious about your take on how 

Reg NMS has impacted equity markets and the investors who participate in these markets, and has it led to some of these high frequency tradings, HFTs, or is that separate in your mind? 

Mr. SIRRI. I think certain provisions of Reg NMS certainly contributed to that, most specifically the ones that required private 

market linkages. Before Reg NMS, the linkages between our exchange markets was very primitive. An exchange like the New 

York could hold an order for 10, 20, 30 seconds and not interact 

with that. 

Today, the exchanges have to be automated, those automated exchanges are protected, and they route orders between each other on 

high-speed computer networks. This has gone on to the point where 

23 

if you are serious about trading in these markets, you need to collocate your computers, you need to trade physically close to your 

market center, because like travel time, as fast as that is, that is 

an important determiner. 

Mr. HUIZENGA. I know there was a story not that long ago about 

the use of some of the military technology on communication with 

lasers now being utilized. I am trying to get my head wrapped 

around fractions of nanoseconds and the amount of information, 

the multiple terabytes that are being exchanged sometimes. 

But does anybody have a concern with the speed, what has occurred? Mr. Spatt? 

Mr. SPATT. Well, not necessarily a strong concern. It is surprising, though. I share your at least implicit surprise. I think 

what it is pointing out is that the various intermediaries must feel 

that these are profitable investments, and that despite incurring 

the costs for these investments, they are still able to make money 

as intermediaries, and I think that is important to keep in mind. 

Mr. HUIZENGA. Does anybody care to address what equity markets in Europe or Asia have rules equivalent to Reg NMS, how do 

these markets perform compared to the United States, and are 

there any differences in performance in part attributable to Reg 

NMS? I would love to hear about Canada as well. As Chair of the 

Inter-Parliamentary Group on Canada, we are working on a trip up 

there, and would love to have this conversation with my Canadian 

friends. 

Mr. SIRRI. I am not sure I can speak to Canada, but I can talk 

generally about, for instance, Europe. 

Mr. HUIZENGA. All you have to do is add an ‘‘eh’’ on the end of 

the sentence and you are good. 

Mr. SIRRI. There you go. 

Our markets are quite integrated relative to, say, the European 

markets generally. So, for example, as primitive as it sounds, they 

won’t have an integrated quote across all their pan-European market centers. They won’t even have a synchronous clock across those 

centers. We take for granted that all our market centers know 

what time it is down to a millisecond. That is not necessarily true 

in a pan— 

Mr. HUIZENGA. Meaning the DAX and the CAC and everybody 

else aren’t necessarily on the same page? 

Mr. SIRRI. That is not necessarily integrated in that same way. 

So in that sense, we have a much higher degree of integration in 

our markets. 

Mr. HUIZENGA. Do you see them going in that direction? 

Mr. SIRRI. I think there are different issues there. They have different incentives and they have different governing principles. 

They have MiFID and certain other things that govern that. I am 

not sure I am up-to-speed enough to tell you, but I don’t think I 

have seen big movements. 

Mr. HUIZENGA. Have they not done that because there is a fear 

that it may put them at a disadvantage? I’m sorry, Mr. Campos, 

I think you were— 

Mr. CAMPOS. No. I was just going to add that if you are interested, I believe in Europe there is more of a protection of their particular market. It is viewed as a national asset. As we know, their 

24 

governments protect major industries, major businesses. Germany 

has a big interest in the Deutsche Borse, and the U.K. in the LSE. 

But in addition to the difference that Professor Sirri just mentioned, clearing and settlements in Europe is a private matter. It 

is not a utility like it is here in the United States essentially. So 

you have additional costs to trade. This is why the U.S. markets 

are—one of the reasons, among many, that they are much cheaper. 

So, there is a big difference in that world. 

Mr. HURT. Thank you, Mr. Campos. 

The subcommittee will now stand in recess, and we will get 

started again as soon as we can. Thank you. 

[recess]. 

Mr. HURT. I am going to call the subcommittee to order. Without 

objection, the Chair is authorized to declare a recess of the subcommittee at any time. Would the witnesses please return to the 

table? 

I want to again thank you all for your appearance today. I think 

the ranking member is here. I don’t think she has any other questions. I might just kind of wind up with a final question and ask 

for each of you to sort of comment on it. As you know, SEC Chair 

White and her fellow Commissioners recently supported the need 

to review equity market structure. What ultimately, from their 

standpoint and from ours, should the goal of that review be? And 

if you wanted to just kind of wrap up with your thoughts on that 

question, Mr. Campos. 

Mr. CAMPOS. I appreciate the question. Thank you for the question. 

I think that, as we began, and in your remarks as well, the caution is not to throw the baby out with the bathwater, if I can use 

a common phrase. I think technology is an issue. Technology has 

moved faster, quicker, in ways that no one has foreseen. And I 

think the discussion about speed in trading is a legitimate issue to 

discuss. That shouldn’t be confused with structure and whether we 

have competition appropriately among markets and among the orders. And I think the issues that technology has brought, the flash 

crash and other instances like that, may have to do with plumbing 

and may have to do with better connections and that sort of thing, 

and that is a separate review. 

Mr. HURT. Mr. Lofchie? 

Mr. LOFCHIE. One of the interesting issues, I think, for the regulators is determining whether we need a more rules-based system 

or a more policy-based system. And I think one of the issues that 

has been raised is the difficulty of regulation keeping up with technological advancement. I think the more that we have a rulesbased system, really the more difficult it is for the law to keep up 

with technology. And I think Professor Sirri has raised the possibility of going to a more policy-based system, and that might be one 

that in fact proves more flexible in keeping up with technology. 

Mr. HURT. Thank you. 

Mr. Sirri? 

Mr. SIRRI. Your question was about the goal of searching for 

these. I think the goal would be to learn as much as you can from 

all sectors and synthesize it before you make your decision. Sectors 

here are investors, they are brokers, they are market centers. You 

25 

learn quantitative things, you learn qualitative things, you look at 

data. Then you put it together in a way that in fact many other 

people can’t, because there are a lot of people who see pieces, but 

few people see it all. The SEC has the potential to see much more 

than anyone else. Synthesize it and then use that to inform your 

regulatory choices after you have synthesized. 

Mr. HURT. Great. Thank you. 

Mr. Spatt? 

Mr. SPATT. I think the review in part should try to assess what 

have been the impacts of the major regulations from the past, including NMS and decimalization, what have been the broad impacts of these, and to what extent do the regulators feel that there 

are distortions in the routing process. Especially in an environment 

where there are as many platforms as there are, the routing decision is absolutely central to the competitive process. And I think 

trying to drill down on that in a variety of ways has implications 

for understanding some of the detailed rules, like the rules about 

maker-taker, it has implications for the interface between NMS 

and best execution. 

I think understanding the decision process by which firms route 

orders seems to me an absolutely central issue, and it seems to me 

potentially at the heart of the overarching theme. I think the regulators want to try to learn as much as they can. There is a wealth 

of data. And I think by putting the right lenses on, there is the potential to learn. 

And I think the regulators also ought to step back, and following 

on the theme of some of the prior witnesses, the regulators should 

step back and try to identify what are the objectives and goals and 

try to lay those out and potentially maybe try to consider pulling 

back from as prescriptive a set of rules as we currently have. 

Mr. HURT. Great. Thank you. 

And with that, I will yield back my time. And I am pleased to 

recognize the gentleman from California, Mr. Royce, for a period of 

5 minutes. 

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

I wanted to ask Mr. Sirri and maybe Mr. Lofchie on order protection, can you give us your best guess on what the market would 

look like without an order protection rule? Would markets be less 

connected, and would there be fewer or would there be more trading venues? What would be the evolution? 

Mr. SIRRI. Those are the hardest kind of questions to answer, you 

change one thing and then what does the world look like? And the 

reason why they are hard to answer is because I have to tell you 

what the banks, what the brokerages would do next with that. It 

is hard to predict. 

I think if the world were to come to pass as you suggest, you put 

a lot more weight on the brokers’ obligations. For example, since 

there is not an automated way to protect certain quotes, then brokers are going to have to do that on their own. Certain things 

might speed up, you might get even faster trading in some ways. 

But I think to the extent that you are thinking about a world 

where that might actually happen, you would probably have to 

make some other changes to go along with it, because that is, of 

26 

course, just one piece of what NMS provided. So I wish I had a better crystal ball, but it is just a tough question. 

Mr. Royce. Mr. Lofchie? 

Mr. LOFCHIE. I am going to be bolder than Erik, but I feel comforted that he said this was a hard question. My guess would be 

that there would be fewer markets and that you would— 

Mr. ROYCE. There would be fewer exchanges. Instead of 15 exchanges, there might be— 

Mr. LOFCHIE. I think the order protection rule provides some incentive to split orders among markets rather than concentrating 

them. 

Mr. ROYCE. Yes. 

Mr. LOFCHIE. I appreciate Professor Sirri’s remark that you really are guessing at the motivations of participants, but I think that 

is the challenge that the SEC faces, is to anticipate— 

Mr. ROYCE. So this is propping up some of the smaller exchanges, presumably the existing structure that otherwise, given 

the efficiencies, might be collapsed. Is that your— 

Mr. LOFCHIE. I think that would be my hypothesis. 

Mr. ROYCE. Yes. 

Mr. LOFCHIE. And, again, I think it is really about anticipating 

how rule changes would affect the markets. 

Mr. ROYCE. And that takes me maybe to the next question. As 

we look at the issue from 30,000 feet, you have investors seeking 

to purchase a product in a market. Required in every one of those 

transactions is an intermediary, a broker has to be involved in that 

transaction. 

So, Mr. Sirri, your testimony notes that it is important to have 

this factor of the responsibilities of brokers that handle customer 

orders and their best execution duties, and what does that best 

execution mean for the end investor? That is who we are focused 

on here. And what should the Commission look at in this space 

when considering the responsibility of brokers and ensuring the 

end investor receives the best experience? 

Mr. SIRRI. The reason why that duty, the best execution duty, is 

important in securities markets is because individual investors in 

particular can’t tell how well they are being treated. Mom and pop, 

when they place an order on their screen, they don’t know whether 

they should be trading at 20, 20.01, 20.02 or 20.03. They just don’t 

know. They don’t have the information. 

That duty confers upon the broker the obligation to act in the interest of the customer whose order they are handling. Hence, it becomes more important the less sophisticated the investor is. So the 

Commission has always used the duty of best execution to help foster the interests of individual investors when they can’t monitor 

things for themselves. I think it continues to be as important as it 

ever was, if not more important today. 

Mr. ROYCE. So my last question would be, then, what is so complex about the current system, other than there being so many 

trading venues, other than there being so many exchanges, and 

how does this complexity actually affect the average investor? 

Mr. SPATT. The complexity, I think, comes from many sources. 

There are a whole range of different types of investors with different business models, intermediaries trying to have their own 

27 

business models that accommodate the needs of different types of 

investors. And obviously, we put those together. At a high level you 

see this about exchanges and platforms without exchange obligations, you see this with respect to dark pools, you see a whole 

range of types, and then they are interacting. 

And I do think that NMS has made this trading environment 

more complex because of the obligation to hunt for liquidity across 

the tops of all of these vehicles. 

Mr. ROYCE. Let me, if the chairman would indulge me, I know 

Commissioner Campos wrote about this at one point. If I could just 

finish up with your observations, Commissioner? 

Mr. CAMPOS. Thank you. If we are talking complexity, as has 

been said, complexity comes from many sources. And it is almost 

like fighting the wind. It is going to keep coming, because you have 

many different types of consumers, let’s just think of it in another 

context, and you have a lot of different people who want to sell consumers. 

So I would caution that reducing complexity in and of itself 

should not be the goal. Instead, fairness is the goal. Is the average 

small investor, for example, getting almost all the time the best 

price at that particular instant? If you let things like that guide 

you—and I know you have a great staff and you think about these 

things deeply—but if you let principles like that guide you, you will 

get through this complexity and you will be able to essentially do 

the proper analysis, which I know you are going to do. 

Mr. ROYCE. Thanks, Commissioner, and thanks, panel, very 

much. 

Mr. HURT. The gentleman’s time has expired. 

The Chair now recognizes Ranking Member Maloney for a period 

of 5 minutes. 

Mrs. MALONEY. I would like to hear your comments on what you 

think caused the flash crash and the 3-hour stall in NASDAQ and 

what you can do to correct that. 

And one of you mentioned the churning of selling stocks all over 

the place in order to generate fees. I think that was you. Mr. 

Lofchie, in your statement, the fear of churning or moving stocks 

around just to get fees? One of you talked about that. 

Mr. LOFCHIE. I think I expressed a concern, Representative 

Maloney. 

Mrs. MALONEY. Yes. And I would like to hear more about that. 

And lastly, in reading one of these news articles, they looked at 

a $2.5 million transaction for stocks, and the broker, they tracked 

it, the broker offered to buy 750 million shares of stock in order to 

hide the fact he was buying 2.5 million, and the author questions 

how that is going to distort the market, trying to hide what they 

are doing. 

So, any comments from any of you on those four questions? 

Thank you very much. It was very insightful and it was wonderful 

to have so many well-informed people speak to us today. Thank 

you. 

Mr. SPATT. I will try to take on some of the questions, but not 

all of the questions. 

On the issue of why we have these glitches, I think there are a 

range of reasons. To some degree, the so-called fat finger where one 

28 

trader makes—one trading firm makes a big error, like being off 

by a zero or maybe two zeros, this has been at the root of some 

situations, and then as it transmits through, then the market participants, they think that it is real information and then so people 

react to that in a major way. This has been at the root of some of 

the glitches. 

I think to some degree, even in the flash crash, this was there. 

In the case of the Knight fiasco, I think the problem was they were 

responding to what they perceived to be a change in the rules on 

the NYSE, and on the first day that those changes in rules got 

rolled out, they started running their modified procedure against 

that, but without having the opportunity to pretest it, and then 

further reinforced by they didn’t have a kill switch to stop things. 

So I think the stories for the glitches differ across situations. I 

do think that when you have many different platforms, a problem 

at one can feed into the others. In the NASDAQ case, it was actually in the key information channel, the SIP, and ultimately that 

is kind of a unique thing, but that kind of brought much of it down. 

With respect to your final question about the firm wanting to 

trade a couple million shares but then scales it up to a couple hundred million shares to try to hide its intent, this is actually a question I have thought about a lot in recent weeks. I think it is a difficult question, because the party that has a couple million shares 

to trade does seem to me to have a legitimate interest in not wanting the markets to immediately figure out what it is they are up 

to and have their investors squeezed by the other side of the market. So it tries to create what in my discipline we sometimes might 

call more of a randomized or mixed strategy. But I was struck in 

this example by how off the charts, then, the scaling up was, but 

it does seem to me it started from an investor trying to solve a legitimate business problem, but then clearly they pushed the envelope on it. But it seems not obvious to me where I would ultimately 

want to come down on that. 

Mr. SIRRI. I think the one thing I would say to that last point, 

Congresswoman Maloney, is that as technology changes, the form 

of manipulation can change, and so your interpretation of what you 

call manipulation has to change along with it. You pointed to something that you probably couldn’t have done 10 or 15 years ago. You 

can do it today, and I think the way you track manipulation, the 

regulator tracks manipulation has to change. 

Mrs. MALONEY. And what about the churning for fees? 

Mr. LOFCHIE. I think the regulators need to look at not only the 

high profile issues, such as high frequency and algo, they need to 

look at more subtle issues like market data fees and to ask whether those kinds of fees are altering the way investors trade to alter 

the order routing decisions, as Professor Spatt has said. 

Mrs. MALONEY. Thank you. My time is up. 

Mr. HURT. I would like to thank today’s witnesses for your testimony. 

The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to these witnesses and to place their responses in the record. Also, without obVerDate Nov 24 2008 17:43 Sep 03, 2014 Jkt 088529 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 K:\DOCS\88529.TXT TERRI
29 

jection, Members will have 5 legislative days to submit extraneous 

materials to the Chair for inclusion in the record. 

With that, this hearing is adjourned. Thank you. 

[Whereupon, at 11:57 a.m., the hearing was adjourned.] 

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