U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

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

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

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

76–108 PDF 2013

MARKET STRUCTURE: ENSURING ORDERLY, 

EFFICIENT, INNOVATIVE, AND COMPETITIVE 

MARKETS FOR ISSUERS AND INVESTORS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON CAPITAL MARKETS AND 

GOVERNMENT SPONSORED ENTERPRISES 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

JUNE 20, 2012 

Printed for the use of the Committee on Financial Services 

Serial No. 112–137 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

SPENCER BACHUS, Alabama, Chairman 

JEB HENSARLING, Texas, Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

THADDEUS G. McCOTTER, Michigan 

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 

NAN A. S. HAYWORTH, New York 

JAMES B. RENACCI, Ohio 

ROBERT HURT, Virginia 

ROBERT J. DOLD, Illinois 

DAVID SCHWEIKERT, Arizona 

MICHAEL G. GRIMM, New York 

FRANCISCO ‘‘QUICO’’ CANSECO, Texas 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

BARNEY FRANK, Massachusetts, Ranking 

Member 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

JAMES H. CLINGER, Staff Director and Chief Counsel 

(III) 

SUBCOMMITTEE ON CAPITAL MARKETS AND GOVERNMENT SPONSORED ENTERPRISES

SCOTT GARRETT, New Jersey, Chairman 

DAVID SCHWEIKERT, Arizona, Vice 

Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

DONALD A. MANZULLO, Illinois 

JUDY BIGGERT, Illinois 

JEB HENSARLING, Texas 

RANDY NEUGEBAUER, Texas 

JOHN CAMPBELL, California 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

NAN A. S. HAYWORTH, New York 

ROBERT HURT, Virginia 

MICHAEL G. GRIMM, New York 

STEVE STIVERS, Ohio 

ROBERT J. DOLD, Illinois 

MAXINE WATERS, California, Ranking 

Member 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

RUBE ́ N HINOJOSA, Texas 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

CAROLYN B. MALONEY, New York 

GWEN MOORE, Wisconsin 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

AL GREEN, Texas 

KEITH ELLISON, Minnesota 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

June 20, 2012 .................................................................................................... 1 

Appendix: 

June 20, 2012 .................................................................................................... 55 

WITNESSES 

WEDNESDAY, JUNE 20, 2012 

Coleman, Daniel, Chief Executive Officer, GETCO .............................................. 3 

Cronin, Kevin, Global Head of Equity Trading, Invesco, on behalf of the 

Investment Company Institute (ICI) .................................................................. 5 

Gawronski, Joseph C., President and Chief Operating Officer, Rosenblatt 

Securities .............................................................................................................. 6 

Joyce, Thomas M., Chairman and Chief Executive Officer, Knight Capital 

Group, Inc. ............................................................................................................ 9 

Mathisson, Daniel, Head of U.S. Equity Trading, Credit Suisse ......................... 37 

Niederauer, Duncan, Chief Executive Officer, NYSE Euronext .......................... 11 

O’Brien, William, Chief Executive Officer, Direct Edge ....................................... 38 

Smith, Cameron, President, Quantlab Financial .................................................. 14 

Solomon, Jeffrey M., Chief Executive Officer, Cowen and Company .................. 40 

Toes, Jim, President and Chief Executive Officer, Security Traders Association (STA) .............................................................................................................. 42 

Weild, David, Senior Advisor, Capital Markets Group, Grant Thornton LLP ... 45 

APPENDIX 

Prepared statements: 

Coleman, Daniel ............................................................................................... 56 

Cronin, Kevin .................................................................................................... 70 

Gawronski, Joseph C. ....................................................................................... 82 

Joyce, Thomas M. ............................................................................................. 91 

Mathisson, Daniel ............................................................................................. 112 

Niederauer, Duncan ......................................................................................... 125 

O’Brien, William ............................................................................................... 136 

Smith, Cameron ................................................................................................ 148 

Solomon, Jeffrey M. .......................................................................................... 163 

Toes, Jim ........................................................................................................... 174 

Weild, David ...................................................................................................... 178 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Garrett, Hon. Scott: 

SIFMA concept release letter, dated April 29, 2010 ...................................... 196 

SIFMA letter dated June 25, 2010 .................................................................. 220 

SIFMA paper on liquidity, dated August 31, 2009 ........................................ 232 

(1) 

MARKET STRUCTURE: ENSURING ORDERLY, 

EFFICIENT, INNOVATIVE, AND COMPETITIVE 

MARKETS FOR ISSUERS AND INVESTORS 

Wednesday, June 20, 2012 

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 9:06 a.m., in room 

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

Members present: Representatives Garrett, Schweikert, Royce, 

Manzullo, Biggert, Neugebauer, Campbell, Pearce, Posey, 

Hayworth, Hurt, Grimm, Stivers, Dold; Waters, Miller of North 

Carolina, Maloney, Moore, and Green. 

Also present: Representative McHenry. 

Chairman GARRETT. Good morning. Today’s hearing of the Subcommittee on Capital Markets and Government Sponsored Enterprises, entitled, ‘‘Market Structure: Ensuring Orderly, Efficient, Innovative, and Competitive Markets for Issuers and Investors,’’ is 

called to order. 

We welcome the panel before us, and look forward to an interesting hearing this morning on this, as someone was just saying to 

me in the audience, very timely matter. Before we get to our panelists, we will have an opportunity for opening statements, and with 

that, I will recognize myself for 3 minutes. 

And as I say, today’s hearing has a fairly long title, ‘‘Market 

Structure: Ensuring Orderly, Efficient, Innovative, and Competitive 

Markets for Issuers and Investors.’’ 

I believe that when examining the state of our equity markets, 

we must first look at the data, and the data tells us something, 

that by any traditional measuring stick, the United States equity 

markets are the best in the world, whether it is at execution of 

speed, liquidity, or pricing, both retail and institutional investors 

are recognizing the direct benefits of this very evolving marketplace. 

So what I am hopeful to learn about from our two esteemed panels that we have today are ways that Congress, the regulators, and 

the market participants can continue to ensure that our markets 

remain the envy of the world. Specifically, I look forward to learning and hearing some ideas from all of you on: first, promoting improved competition between the market participants; second, inVerDate Nov 24 2008 18:30 Feb 21, 2013 Jkt 076108 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\76108.TXT TERRI
2 

creasing innovation in the marketplace; and third, facilitating additional capital formation for small businesses. 

First, I believe that improved competition in the wake of implementation of Regulation National Market System (Reg NMS) has 

been a major contributor to the improved data seen in our equity 

markets. Narrower spreads, faster execution, and increased liquidity have all been direct results of additional competition in the 

marketplace. And so promoting improved competition should be 

achieved by lowering barriers to entry and establishing a more efficient process to bring new technology to bear, not by saddling market participants with additional burdens and raising transaction 

costs eventually to the investors. 

Second, increased innovation in the marketplace must be a priority. Technological innovations in our marketplace over the last 

decade have really been amazing. Markets have become more automated, and I believe this automation has yielded significant 

positives for all the investors. While there have been isolated cases 

out there we have read about in the paper—things like flash crash 

and the recent Facebook IPO—we must look at the empirical data 

as a whole because if you focus simply on a couple of isolated anecdotal evidence or events, I think that takes away from the truly extraordinary strides that have been made in large part because of 

the technological innovations in the marketplace. 

And finally, on the heels of the successful and bipartisan JOBS 

Act, I look forward to examining ways to facilitate additional capital formation for small businesses. While the JOBS Act will help 

small businesses go public, I am also interested in further discussing ways to help increase liquidity and trading once they do. 

So there are two proposals out there. One, Mr. McHenry has a 

draft legislation to implement a market quality incentive program, 

and Mr. Schweikert over here has a proposal to allow for increased 

tick sizes for smaller companies. These could be ways to provide 

much needed support for small businesses. As I say, I believe that 

Reg NMS has achieved many benefits for the large cap firms. I am 

not certain that the current one-size-fits-all is in its best interests. 

So, in conclusion, as a piece of advice to the regulatory community, I quote my good friend, Mr. Hensarling, who is not here, who 

often says, ‘‘First, do not harm.’’ I guess that was not Mr. 

Hensarling; Hippocrates actually said that originally, but anyway, 

any change to the rules of the equity markets should be a thoughtful, empirical data analysis and benefits of any potential change. 

Ensuring we maintain the deepest, most liquid, and most efficient 

equity markets in the world is a top priority of this subcommittee, 

and I do look forward to a robust discussion today on these important issues and examining whether there are better ways to facilitate investment, capital formation so American businesses can 

grow and create jobs. 

And with that, I look to our next speaker, and neither one are 

here. Does the vice chair have—no? 

Mr. SCHWEIKERT. Mr. Chairman, I can do the other side if you 

want. 

Chairman GARRETT. Mr. Schweikert will speak for the other side 

of the aisle for 10 minutes. No, I guess not. 

3 

With that, since the other two gentlemen on our side of the aisle 

have not arrived yet, we will then go to why we are really here, 

not to hear from us, but to hear from the panel. 

So we look to the members of the panel to make your presentation. First, will be Mr. Coleman. 

And, of course, for those of who you have been here before, you 

know your complete written statement will be made a part of the 

record, and so you can summarize your statement in 5 minutes. 

I think I say this every single day to people, make sure you push 

your microphone on and make sure, most importantly, that you 

pull the microphone as close as you can because someone will say 

that to you during the course of your remarks. 

So, good morning, Mr. Coleman, and you are recognized for 5 

minutes. 

STATEMENT OF DANIEL COLEMAN, CHIEF EXECUTIVE 

OFFICER, GETCO 

Mr. COLEMAN. Good morning, Chairman Garrett, and members 

of the subcommittee. My name is Daniel Coleman, and I am the 

chief executive officer of GETCO. GETCO is a global trading firm 

providing multi-asset class market-making and trade execution 

services for institutional clients, broker-dealers, and investors. 

GETCO participates in the market both as a liquidity provider, 

through our market-making services, and as an agency broker executing customer orders. 

As a firm, we say we are market-driven, that is, our business is 

predicated on the integrity and soundness of the global capital 

markets. For this reason, I am honored to be here today with my 

distinguished fellow panelists. 

Today’s hearing offers the opportunity for a comprehensive discussion about the quality of our markets and the reforms policymakers should be considering. Specifically, my remarks will touch 

upon the need for a more concerted focus on policy measures designed to increase stability and foster confidence; the challenges institutional investors face in sourcing liquidity and understanding 

whether their trades are, in fact, receiving best execution; and finally, the benefits and risks posed by a more automated marketplace. 

Past policy initiatives have promoted competition and innovation. 

This, in turn, has leveled the playing field for new entrants. The 

‘‘old boy’s club’’ that existed on many of the trading floors is gone. 

In keeping with the best qualities of capitalism, ability above all 

else is now the most critical determinant of success. As with any 

highly competitive marketplace, firms that are unable or unwilling 

to meet changing markets will struggle. The global market demands change, and companies adapt or they disappear. That is the 

power of competition. 

When it comes to market structure, however, the power of competition without the stability and confidence to attract investors 

and issuers leads to highly efficient markets that serve no purpose. 

The markets need confidence above all else. 

Today, investor confidence has been shaken by a series of highprofile events that paint a picture of an overly complex, fundamentally fragile market system. Individual investors are skeptical of 

4 

our markets in part because of the prolonged economic downturn 

and in part because of a host of new and nefarious sounding terms 

that seem unnecessarily complex and opaque. And yet, the individual investor’s cost of execution is unquestionably better than 

ever before. If it were not for these high-profile, confidence-shaking 

events, I believe the individual investor would have few qualms 

with their overall experience. 

The institutional investor, on the other hand, does have justifiable issues with how the market structure has changed their dayto-day business. Executing larger orders throughout the day, institutional trading desks face the issue of lack of transparency due to 

speed and fragmentation. This leads to a sense, I would say, of a 

loss of control. 

As a former trader, I know how disconcerting it can be to place 

an order and not have confidence in how it is being executed. Back 

in the day, when I was a trader, I could hit up time and sales on 

my market data system. I could see my order, and I would know 

when it traded. Today, it is impossible to tell which trade is yours. 

It is this loss of control that causes many critics to long for the 

markets of old. While highly inefficient, they were far simpler to 

understand and to navigate, but attempting to roll back the clock 

is shortsighted, if not impossible. 

So what should be done to holistically address these concerns? It 

is our belief that policymakers must place the same emphasis on 

fostering market stability that they once placed on increasing market efficiency and competition. As part of this focus, we urge regulators: first, to consider modernizing market-maker obligations; second, to make a concerted effort to provide more stringent standards 

around what constitutes best execution for institutional investors; 

third, provide greater flexibility for exchanges to compete; and, finally, to emphasize the thoughtful testing and deployment of new 

trading technology to minimize risks posed by errors or bugs. 

In conclusion, all of our lives have become increasingly complex 

as a result of the immediacy, access, and optionality technology 

presents. Understanding how to harness these benefits while minimizing their concurrent risks is not a phenomenon unique to financial services. Regulators should move swiftly to implement sensible 

reforms and to put stability on the same footing with efficiency and 

competition. We should look to minimize disruptions from new 

technologies and strive to return a measure of control to the institutional investor. All of these steps are necessary if we are to retain public confidence in the overall health and integrity of our 

global capital markets. Thank you. 

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

56 of the appendix.] 

Chairman GARRETT. And I thank you, Mr. Coleman. 

Good morning, Mr. Cronin. We welcome you here, and you are 

now recognized for 5 minutes. 

5 

STATEMENT OF KEVIN CRONIN, GLOBAL HEAD OF EQUITY 

TRADING, INVESCO, ON BEHALF OF THE INVESTMENT COMPANY INSTITUTE (ICI) 

Mr. CRONIN. Good morning. Thank you for having me today, 

Chairman Garrett and members of the subcommittee, and thank 

you for the opportunity to speak here today. 

My name is Kevin Cronin, and I am global head of equity trading 

for Invesco. Invesco is an independent global asset management 

firm with operations in more than 20 countries and assets under 

management of $632 billion. Our responsibilities including managing the equity, equity derivatives, and FX trading activities of 

the 45 traders Invesco employs on 9 trading desks in 7 countries. 

I am pleased to participate today on behalf of the Investment 

Company Institute at this hearing, examining the structure of the 

U.S. securities markets. ICI is the national association of U.S. investment companies, including mutual funds, closed-end funds, 

ETFs, and unit investment trusts. The structure of the securities 

market has a significant impact on ICI members, who are investors 

of over $13 trillion in assets and who held 29 percent of the value 

of publicly traded U.S. equity outstanding at the end of 2011. ICI 

members are institutional investors but invest on behalf of over 90 

million individual shareholders. 

We are encouraged by the benefits that advancements in market 

structure have brought to funds and other investors. In general we 

believe investors, both retail and institutional, are better off now 

than they were just a few years ago. The costs of trading have been 

reduced. More trading tools are available to investors with which 

to execute trades. And technology has increased the efficiency of 

trading overall. 

Nevertheless, there are a number of steps which I will outline in 

a moment that we believe can be taken to further enhance the 

quality of U.S. markets, securities markets. 

One of the fundamental elements of an efficient market also is 

active participation of long-term investors. It is therefore important 

that operation of securities markets fosters the confidence of investors. Unfortunately, long-term investor confidence has recently 

been challenged by a series of scandals, financial crises, and technological mishaps affecting trading venues. To further improve the 

quality of the securities markets and to ensure long-term investor 

confidence, we believe it is time for regulators and market participants alike to address and to take action on many of the difficult 

and complex issues impacting investors today. These include conflicts of interest that exist in the markets, including those surrounding so-called liquidity rebates and the increased number and 

complexity of the types of orders utilized by market participants. 

In order to gather data to examine the impact of liquidity rebates 

on the markets, ICI recommends that a pilot program be established where a set of securities would be prohibited from being subject to liquidity rebates. We also recommend that regulators vigorously examine any conflicts of interest raised by order types and 

ensure sufficient and readily available information on the details of 

order types are available to all investors. 

Issues surrounding automated trading and high frequency trading also may impact investor confidence. While ICI believes autoVerDate Nov 24 2008 18:30 Feb 21, 2013 Jkt 076108 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 K:\DOCS\76108.TXT TERRI
6 

mated trading and certain high frequency trading strategies arguably bring several benefits to the securities markets, regulators 

and market participants must act to address several issues of concern to investors, including, for example, the number of order cancellations in the securities markets, and consider truly meaningful 

fees or other deterrents that would adequately address this behavior. In addition, the need for enhanced surveillance capabilities to 

detect potentially abusive and manipulative trading practices cannot be ignored. 

Participation by and confidence of long-term investors in the 

market also is critical to the capital formation process. Difficulties 

surrounding capital formation, particularly for small companies 

that want to come to market, have been well-documented. ICI 

strongly supports the need to stimulate capital formation. We 

therefore recommend that a pilot program be established to examine whether changes to the current penny spread should be implemented. 

Finally, issues associated with undisplayed liquidity must be examined. For ICI members like myself who frequently execute large 

block orders, venues that provide undisplayed liquidity, such as the 

so-called dark pools, are critical to lessen the cost of implementing 

trading ideas and mitigate the risk of information leakage. We 

would be concerned if any regulatory reforms impeded funds as 

they trade securities in such venues. 

Broker-dealer internalization, however, is a form of undisplayed 

liquidity that does raise concerns for investors. Internalization may 

increase market fragmentation and degrade the price discovery 

process because it can result in customer orders not being publicly 

exposed to the markets. In addition, it may risk conflicts of interest 

between broker-dealers and their customers. We, therefore, recommend that any internalized orders should be provided with significant price improvement. 

ICI looks forward to working with other market participants to 

tackle these complex issues to ensure the securities markets remain highly competitive, transparent, and efficient, and that the 

regulatory structure that governs the securities markets encourages rather than impedes liquidity, transparency, and price discovery. Thank you, and I look forward to answering any questions 

you may have. 

[The prepared statement of Mr. Cronin can be found on page 70 

of the appendix.] 

Chairman GARRETT. And I thank you. 

Good morning, Mr. Gawronski, and welcome to the panel. You 

are recognized for 5 minutes. 

STATEMENT OF JOSEPH C. GAWRONSKI, PRESIDENT AND 

CHIEF OPERATING OFFICER, ROSENBLATT SECURITIES 

Mr. GAWRONSKI. Good morning. 

Chairman Garrett, Ranking Member Waters, and members of 

the subcommittee, thank you for convening today’s hearing on equity market structure and inviting us to share our views. My name 

is Joe Gawronski, and I am the president and chief operating officer of Rosenblatt Securities. Rosenblatt is an agency broker serving 

7 

institutional investors in the U.S. equities markets and an authority on market structure. 

Traders, investors, exchanges, and governments all around the 

world rely upon our independent granular analysis of the rules, 

regulations, competitive dynamics, and behavior of participants in 

equity and derivative markets globally. We have studied extensively the massive changes to U.S. equity market structure that 

have occurred since 1996. We have also lived through them as brokers representing institutional orders in the market. We believe 

there are two major points regarding market structure that must 

be understood above all others by the subcommittee. 

First, today’s market structure is a Rube Goldberg creation of 

sorts. It is the product of a gradual 15-year evolution during which 

government repeatedly acted in big ways and market forces repeatedly reacted accordingly. The result of this to and fro is that today’s profoundly complex patchwork market structure is certainly 

not what one would have designed if starting with a blank slate. 

But it generally results in better outcomes for both retail and institutional investors than what it replaced. This is a second major 

point. 

With apologies to Sir Winston Churchill, what we have today is 

the worst market structure possible except for all the others that 

have been tried. This does not mean that things are perfect. There 

are a few critical problematic gaps in today’s structure that merit 

exploration by regulators and legislators. Among these are the 

rules regarding off-exchange trading, safeguards against systemic 

risk, and the quality of markets for shares of smaller companies, 

and best execution obligations of brokers need to be enforced given 

the conflicts today’s market structure engender. 

In our written testimony, we have elaborated to some extent on 

how we got to where we are today with this cycle of government 

action and market reaction, with the order handling rules, Reg 

ATS, decimalization, and finally Reg NMS being the highlights. 

But to provide a thorough count here would require more of your 

time and patience than we have today. Importantly, the result of 

all of it is that both explicit costs such as exchange fees and brokerage fees, as well as the implicit costs such as bid-ask spreads and 

market impact have come down dramatically during this period. Investors who once paid 25 cents per share in spread alone when 

buying and selling stocks like Intel and Microsoft now pay no more 

than a penny or two. Exchanges that once extracted monopoly 

rents from trading customers now compete vigorously to offer the 

lowest fees. 

But there are corners of the market that either have not shared 

in the benefits of this transformation or have largely failed to 

transform in ways that result in the best possible outcomes for investors. One such cause for concern is the explosion in off-exchange 

trading in recent years. According to our analysis of public data, 

16.4 percent of U.S. equity volume was executed away from markets that display price quotes in January of 2008. By January 

2012, nondisplayed trading had more than doubled to an all-time 

high of 34.2 percent. 

According to nonpublic data that we collect directly from the various brokers and ATSs, about 14 to 15 percentage points of this offVerDate Nov 24 2008 18:30 Feb 21, 2013 Jkt 076108 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 K:\DOCS\76108.TXT TERRI
8 

exchange trading is done in so-called dark pools. Most of these 

trades are executed at the midpoint of the national best bid-offer 

spread, so both customers receive significant price improvement, 

but a significant fraction of off-exchange trades do not result in materially better outcomes and therefore do not seem justified in receiving special rule protection. A minority of trades in the aforementioned dark pool simply match the NBBO or offer de minimis 

price improvement over the best prices quoted on the exchanges. 

Additionally, we estimate that approximately 10 percentage 

points of off-exchange market share is retail orders that are executed as principal by wholesale market makers. In the vast majority of cases, these wholesalers either match the NBBO or offer de 

minimis price improvement, about 10 percent of the spread. Typically, the wholesalers also offer cash payments to the retail brokers 

of roughly 10 to 15 cents per hundred shares. The end customer 

benefits from any price improvement if offered but does not see any 

of the payment for order flow, which is kept by the retail broker. 

In a few cases, big online brokers serving retail customers have 

contracted to execute either 100 percent or substantial portions of 

marketable customer order flow with certain wholesalers. 

The vast majority of liquidity-seeking retail orders in the United 

States never interact with the bulk of the country’s available trading interests in the exchange environment. This is important because trading markets exist to ensure that companies can raise 

capital and that the prices of the securities they sell are as accurate as possible. This, in turn, enables the efficient allocation of 

capital in the U.S. economy. 

It is axiomatic that the more trading interests interaction in the 

centralized market or at least the market that is virtually centralized using technology, the more accurate prices will be. Historically, certain brokers have argued that internalization without significant price or size improvement is necessary to counter the immense market power of exchanges. Today, however, there are 13 

exchanges scratching and clawing for market share, and no one exchange carries more than 20 percent market share. Exchanges can 

and would adopt pricing and rule structures that would be economically attractive to retail brokers and customers without 

lopping this important segment off from the wider market. 

The SEC in early 2010 floated the idea of a Trade-At Rule, which 

would prohibit internalization without significant size or price improvement. We believe the United States should consider this seriously and other mechanisms that would maximize the interaction 

of orders in the secondary markets with the goal of optimizing 

price discovery and efficient capital allocation. 

Another area that merits continued regulatory scrutiny is the reality that today’s automated fragmented markets, although they 

deliver better outcomes for investors under normal circumstances, 

do not perform as well under stress as the more manual consolidated markets that preceded them. 

In general, we think the SEC’s focus on systemic risk issues in 

the fast-moving, highly automated, highly fragmented markets we 

now have has been well-placed, and the back burnering of issues 

like internalization were appropriate steps at the time. However, 

9 

I think perhaps we have a little more time to examine some of 

these issues now. 

Finally, of particular interest to this subcommittee is the quality 

of markets for small companies. We and other market participants 

have observed a divide in outcomes for large cap actively traded 

stocks and smaller issues. Small company shares may not be experiencing the efficiency and cost benefits that have accrued to bigger, more liquid stocks as a result of the 15-year market structure 

transformation I have discussed. We support experimentation by 

regulators and legislators to provide new incentives for making 

markets in the shares of smaller companies. The provision of the 

recently adopted JOBS Act requiring the SEC to study whether 

minimum price increments would improve market quality for 

emerging growth companies is one example of such measures. 

Chairman GARRETT. I am going to ask you to wrap up there. 

Mr. GAWRONSKI. Sure. In closing, I would like to reiterate that 

modern U.S. equity market structure is the creation of 15 years of 

back and forth between government regulation and market reaction to that regulation. It is far from perfect, and there are several 

aspects of it that merit further investigation and potential reforms, 

but it serves the investing public better than what preceded it. As 

a result, fundamental reforms like the ones that triggered the great 

market structure transformation back in 1997 should be considered 

only with the greatest of care. While market participants have 

proved quite adaptable, the market structure is, nevertheless, an 

ecosystem that functions well overall and changes need to be carefully considered, backed up by empirical data, and in most cases 

should be explored with pilot programs. Thank you. 

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

82 of the appendix.] 

Chairman GARRETT. Thank you. 

Good morning, Mr. Joyce. You are recognized. 

STATEMENT OF THOMAS M. JOYCE, CHAIRMAN AND CHIEF 

EXECUTIVE OFFICER, KNIGHT CAPITAL GROUP, INC. 

Mr. JOYCE. Good morning, Mr. Chairman. Chairman Garrett, 

Ranking Member Waters, and members of the subcommittee, 

thank you for the opportunity to offer my testimony in connection 

with this very important hearing. Knight Capital Group opened for 

business in 1995. Built on the idea that the self-directed retail investor would desire a better, faster, and more reliable way to access the market, Knight began offering execution services to discount brokers. Today, Knight services some of the world’s largest 

institution and financial services firms, providing superior trade 

executions in a cost-effective way for a wide spectrum of clients in 

multiple asset classes, including equities, fixed income, derivatives 

and currencies. In 2011, Knight executed more than 900 million 

trades and 1 trillion shares for more than $6.4 trillion in notional 

value. The majority of the trades we execute today are on behalf 

of retail investors. We count amongst our clients some of the largest retail brokerage firms in the United States, including Scottrade, 

Ameritrade, and Fidelity. In addition, we service some of the largest institutional investors in the industry. 

10 

We have spent the last 17 years evolving our technology infrastructure so that we can process millions of trades a day on behalf 

of investors in a fast, reliable, cost-effective manner, while providing superior execution quality and service. This is all brought to 

bear in our endeavor to secure best execution on behalf of our customers. Importantly, access to this sophisticated gateway is available to nearly every investor in the country. We appreciate the opportunity to comment on the market structure issues which are the 

focus of the hearing, all of which revolve around the notions of execution quality, liquidity, fair access, and responsible rulemaking 

through rigorous cost-benefit analysis. 

Make no mistake, the U.S. equity market is the best functioning 

and fairest market in the world. This has been achieved through 

fact-based decisions, prudent rulemaking, structural transparency, 

and timely and efficient disclosure, all of which are products of a 

competitive and fair market structure that allows choice and fosters innovation. Frankly, there has never been a better time to be 

an investor, large or small, in U.S. equities. Execution quality is at 

historically high levels while transaction costs are at historically 

low levels. 

In 2010, we sponsored an academic study authored by three of 

the Nation’s leading academic scholars: Jim Angel from Georgetown; Larry Harris of USC; and Chester Spatt from Carnegie Mellon. The study concluded that, ‘‘virtually every dimension of U.S. 

equity market quality is now better than ever: execution speeds 

have fallen; retail commissions have fallen substantially and continue to fall; bid-ask spreads have fallen substantially and remain 

low; market depth has marched steadily upward; and institutional 

transaction costs continue to be the lowest in the world.’’ And the 

slides in our written testimony present evidence that these same 

metrics hold true today. 

Investors have seen substantial improvement in execution quality over the last 5 to 7 years. In point of fact, one of the more notable things is price improvement. Over the last 2 years, over half 

a billion dollars of price improvement has been credited towards 

the retail investor, and that money flows into their pocketbooks 

and back into the economy. The facts show that investors have benefited greatly over the years as a direct result of the developments 

in market technologies. High-speed computers, dark pools, et 

cetera, are not the problem. Indeed, they are the culmination of our 

free market system, competition. This competition is what keeps 

the U.S. capital markets great. Market venues spend hundreds of 

millions of dollars a year in technology. We all look for new and 

improved ways to source and access liquidity in a most efficient 

fashion. 

Access to all this liquidity and the gateway to the marketplace 

is available to the retail investor at no additional charge. We fully 

support this subcommittee’s initiative to review the broad range of 

market developments which have helped shape our equity markets 

in recent years. Today, the equity markets offer more benefits to 

investors than at any time in history. Regulatory fine-tuning is 

necessary in a market as dynamic as the U.S. equities. However, 

as the renowned statistician William Edwards Deming once said, 

‘‘In God we trust; all others must bring data.’’ 

11 

Now, I would like to spend 1 minute talking about the so-called 

trade at proposal, which seems to raise its head every few years. 

For the last 25 years, the SEC has consistently rejected these proposals, noting that a competitive choice-driven market is far better 

for investors. Internalization is one such benefit for investors. Internalization is arguably the one great defense for the retail investor against the professional traders in the marketplace. We believe 

a Trade-At Rule would stifle innovation and set the U.S. equity 

markets back more than a decade. 

We have some suggestions as to how we think the markets could 

evolve, not so much that they are not working properly, but perhaps for the benefit, if you will, for investor confidence. I would like 

to touch on a couple of them. 

Access fees: They have been at the core of almost every debate 

that has taken place around the market structure in almost the 

last 2 decades. The so-called maker-taker model is an exchange 

that provides makers with a fee and takers pay a fee. We believe 

this has encouraged a large group of traders to trade with the only 

goal to collect those fees as opposed to true investing or intermediating. Therefore, we recommend the SEC take a hard look at that. 

Second, we support the proposal to widen spreads for certain 

tiers of securities, including higher-priced stocks as well as less-liquid stocks. In that regard, Knight fully supports the tick size study 

recommended by Representative Schweikert that was included in 

Title 1, Section 106(b) of the JOBS Act. 

Knight has previously proposed to the SEC that it consider 

adopting additional market-maker obligations. We believe market 

makers should be required to keep their quotes live for at least one 

second. In our view, this will restore a good deal of credibility to 

the posted quotes in the market and eliminate a lot of trading behavior that does not contribute meaningfully to the liquidity in the 

market. 

So, in conclusion, Knight appreciates the constructive roles this 

committee and subcommittee have played in the oversight of the 

markets in the rulemaking process. Your oversight helps ensure 

that U.S. capital markets remain competitive and innovative, thus 

benefiting all investors. Competition and innovation spurred by insightful rule changes fostered by the SEC have resulted in dramatic improvement in market technologies and execution quality 

for the benefit of public investors. The U.S. equity markets are the 

most liquid and efficient in the world and have all performed exceedingly well over the last decade. Thank you for your interest in 

these issues and the opportunity to contribute to this debate. 

[The prepared statement of Mr. Joyce can be found on page 91 

of the appendix.] 

Chairman GARRETT. Thank you, Mr. Joyce. 

You are also welcome to the panel this morning, and you are recognized for 5 minutes. Good morning. 

STATEMENT OF DUNCAN NIEDERAUER, CHIEF EXECUTIVE 

OFFICER, NYSE EURONEXT 

Mr. NIEDERAUER. Thank you, sir. 

Chairman Garrett, Ranking Member Waters, and members of 

the subcommittee, I want to thank you for inviting me today. U.S. 

12 

equity market structure is an issue of the utmost importance to reinstilling confidence in markets, and we applaud you for holding today’s hearing. 

NYSE Euronext is a global exchange operator of several equities 

and derivatives exchanges in the United States and in Europe. 

This provides us with a unique vantage point from which to compare global securities markets and to learn from the experiences 

we accumulate by operating in these various jurisdictions. In most 

developed markets, there is one national stock exchange and a 

handful of competing platforms. However, in the United States 

there are hundreds of competing trading venues which include exchanges, dark pools, electronic communication networks, and 

broker-dealer-owned liquidity pools. On one hand, this competition 

has spurred tremendous innovation in the form of increased automation and speed of trading, greater reliability of trading systems, 

improved functionality, and lower transaction costs. Most importantly, the combination of regulatory change and competition has 

benefited at least some investors. However, these reforms have also 

had unintended negative consequences. The reforms created lower 

barriers to entry for new trading venues, some of which lacked 

price transparency. These alternative venues also operate under a 

less rigorous regulatory framework, and the result has been a dramatic rise in off-exchange trading. 

Today, one-third of all equity trading takes place off exchange, 

and over 1,200 listed securities have more than 50 percent of their 

volume traded off exchange, an increase of nearly 150 percent in 

less than 2 years. As a result, we are rapidly approaching a bifurcated market structure in the United States. On one tier, regulated 

exchanges, such as the NYSE, serve as price makers. Price makers 

are critical to the price discovery process since they show the best 

available prices with associated share sizes for all securities. These 

quotes referred to as the national best bid and offer, or NBBO, are 

constantly changing with activity in the markets and are what established a reference price for nonexchanges and all other liquidity 

pools. 

On the other tier, alternative trading venues are price matchers. 

They match willing buyers and sellers that participate in their 

venues but do not contribute to price discovery by displaying quotes 

to be included in the NBBO. That is, the off-exchange trading centers provide so-called undisplayed liquidity. Undisplayed liquidity 

can serve an important function for investors seeking to trade large 

blocks of securities. However, today the average trade size is similar in both exchange and nonexchange venues. Moreover, 

undisplayed trading currently accounts for a substantial volume of 

overall equity trading. We believe now is the time for policymakers 

to consider at what level does price discovery materially suffer. 

A common argument made in support of the growth in off-exchange trading is that spreads have decreased as a result of heightened competition. However, the data clearly shows us that spread 

compression actually is the result of the move to decimalization in 

2000, and since 2006, spreads actually are wider by nearly three 

basis points. That doesn’t sound like much, but on an average price 

stock, that is a doubling of the spread since 2006. This tells us 

there has been a dilution of market quality to the detriment of inVerDate Nov 24 2008 18:30 Feb 21, 2013 Jkt 076108 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 K:\DOCS\76108.TXT TERRI
13 

vestors, so do not be misled by charts that show you the trend 

since 2000. Dark pools had little volume in 2006. The markets were 

working fluidly, displayed liquidity was a more significant part of 

the market, and the spreads had already been tightened due to 

decimalization. 

Thus, we believe there is good reason for Congress and the SEC 

to be concerned that without action, we risk greater loss of investor 

confidence and decreased market stability. To address the issue, we 

recommend that policymakers focus on establishing fairer and 

more transparent equity markets as well as a more level regulatory 

playing field among trading centers. 

So, with that, I would respectfully recommend a number of solutions. First, promote public price discovery by requiring that internalizing firms simultaneously display a protected and accessible 

quote at the NBBO or provide meaningful price or size improvement versus the NBBO if not quoting. As I am sure the committee 

is aware, this was the primary recommendation of the joint committee that was passed to study the aftermath of the flash crash 

in 2010, yet this recommendation has not even been reviewed or 

considered. 

Second, create an audit mechanism that can adequately surveil 

the consolidated market. This could be assigned to FINRA or to the 

SEC. 

Third, enhance transparency by restoring dark pools to their 

original envisioned function of facilitating block transactions, i.e. 

have minimum trade sizes. 

Fourth, level the competitive playing field between exchanges 

and nonexchanges by ensuring that we all must comply with the 

same standards concerning SEC filings, fair access, and market 

surveillance. In other words, make our rule proposals effective on 

filing or subject our competitors to our elongated approval processes. 

Fifth, fairly distribute the cost of regulation across all exchanges 

and other liquidity pools. Our cost of regulation as a percentage of 

the cost of regulating the markets is exponentially greater than our 

market share. 

Sixth, consider rule changes or pilot programs that would ease 

the burdens on smaller publicly traded companies and enhance 

their liquidity. These might include increasing the minimum price 

variation or tick size for smaller companies, perhaps letting each 

company choose their own, increasing the market cap threshold for 

Sarbanes-Oxley compliance from $75 million to $250 million, and 

allowing companies and exchanges to collaborate to develop and 

fund liquidity provision programs. 

In closing, let me reiterate that while the U.S. capital markets 

are the best in the world, there is room for improvement which 

would benefit investors and market participants. Public confidence 

in the markets stems at least in part from leadership, and we need 

this leadership to come from Congress, the Administration, market 

participants, and exchanges working together to achieve a better 

market structure, restore investor confidence, and as Chairman 

Garrett said, make sure our markets remain the envy of the world. 

Thank you for allowing me to testify, and I look forward to your 

questions. 

14 

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

125 of the appendix.] 

Chairman GARRETT. Thank you very much. 

Mr. Smith, you are now recognized. 

STATEMENT OF CAMERON SMITH, PRESIDENT, QUANTLAB 

FINANCIAL 

Mr. SMITH. Good morning, Chairman Garrett, Ranking Member 

Waters, and members of the subcommittee. Thank you for inviting 

me to participate in today’s hearing. 

My name is Cameron Smith, and I am the president of Quantlab 

Financial, a Houston-based quantitative trading firm. Quantlab 

was founded in 1998, and we now employ more than 100 people. 

Our company operates in the United States and around the world. 

As you know, in recent years computer technology has shifted the 

marketplace to an open, competitive electronic environment. I 

would like to briefly discuss the current state of the U.S. equity 

market, the role we play, and then share a few suggestions for policymakers to consider. 

In any discussion on market quality, perspective is needed. The 

United States has the world’s leading equity market, and empirical 

studies show that investors have never enjoyed lower transaction 

costs. The United States has achieved this position by adhering to 

certain core values: fairness; transparency; and open competition. 

So what does this all mean for investors? As Gus Sauter, who is 

the chief investment officer of Vanguard says, ‘‘Vanguard investors 

have enjoyed a 50 percent reduction in trading costs over the last 

decade.’’ This means an investor saving for retirement over 30 

years could see their balances in their account increase by 30 percent. So, this is real savings. 

While the general trend of improving market quality is clear, 

there still remains a great deal of misunderstanding around the 

role of modern professional traders, sometimes referred to as high 

frequency traders. Markets have always had professional traders 

that bridge the temporary gaps between supply and demand, and 

today that role is both automated and highly competitive. It is no 

coincidence that as market quality has improved—the bid market 

quality has improved with these developments. 

Empirical studies show that high frequency trading improves 

price discovery, reduces short-term volatility, and lowers investor 

transaction costs. However, we are here today because market 

quality can always be improved, and I would like to quickly provide 

four substantive ideas on that. 

First, regulators should have easier access to all the data they 

need to oversee our markets and to ensure they operate with the 

highest integrity. In this regard, we support initiatives such as consolidated audit trails and large trader reporting. Further, we have 

encouraged the formation of industry working groups to offer technical assistance to regulators to fully utilize the richness of the 

data that electronic markets provide. 

Second, we must continue to enhance broker-dealer risk management practices and market safeguards like circuit breakers or limit 

up/limit down protections. While the SEC and the exchanges have 

already implemented some of these protections, they need to be 

15 

calibrated and refined in response to experience in a variety of 

market conditions. 

Third, policymakers and the industry must continue to monitor 

and consider ways to address the issue of market fragmentation. 

The challenge has long been to balance the benefits of competition 

against the complexities from fragmenting the market among too 

many trading venues. We must therefore ensure that regulations 

don’t inadvertently contribute to fragmentation by hindering the 

ability of a public market to compete with the private markets, 

such as dark pools and internalization venues. In this regard, we 

support two relatively incremental initiatives. One would just be 

amending Reg NMS to allow markets with zero bid-ask spreads to 

be displayed. The second would be to allow exchanges to experiment with smaller tick sizes that will drive volumes and price discovery back to public markets. 

Finally, I am sure that we all agree that policies must be shaped 

by facts established through rigorous data analysis rather than 

anecdotes, rumors or unsupported assertions. It is imperative that 

policymakers and industry together develop and specify common 

metrics that we can all refer to for accessing the current health of 

our markets, and we need to make these measures available 

through a publicly available dashboard, perhaps on a Web site so 

that anyone can track them. 

Mr. Chairman, thank you for the opportunity to appear today, 

and I look forward to answering any of your questions. 

[The prepared statement of Mr. Smith can be found on page 148 

of the appendix.] 

Chairman GARRETT. Thank you. And I thank the entire panel. 

So, moving to questioning, I will first recognize myself for 5 minutes. 

Just an observation from the six people on the panel is that one 

of the common themes is the benefits of competition and the necessity to try to achieve any regulatory reform to encourage additional 

competition in the marketplace. Another, a second take-away, and 

a couple of you made this point; Mr. Smith just did, and you had 

the comment earlier with regard to information and data. What 

was the statement? In God we trust; all others must provide data. 

So that was the other take-away that I took is that whatever we 

do here and also whatever the regulators eventually come up with 

as well should be data and factual driven and empirically driven 

as opposed to anecdotally driven or politically driven or otherwise. 

It should not be moved by simply just recent cases in the headlines 

and that sort of thing. So that is all good. 

Let’s take a look at a couple of things then, first, with regard to 

competition. In order to do that, the rule process that is currently 

in place for the lit exchanges, as we have heard, is time-consuming 

in certain cases. Cumbersome is another way to describe it. Now, 

that was supposed to be addressed, it was my understanding, in 

Dodd-Frank. That was supposed to be addressed with Section 915, 

I believe, of that law, to set what is sort of like a time limit on the 

rule process approval process, but now I understand that the way 

it is actually being implemented is that before the proverbial clock 

starts ticking, they ask for drafts and what have you, and that can 

take a long period of time. Does anyone want to comment on what 

16 

the existing process is, whether you are involved with it or not, and 

what we need to be doing in that area? 

Mr. NIEDERAUER. Sure. Looking down the panel, I guess that one 

is mine. So as we have said before, I think we were optimistic, Mr. 

Chairman, that when the streamlining proposals that you are referring to were talked about and hopefully implemented, that they 

would work in practice the way they were written up. Regrettably, 

they have not worked in practice the way they were designed. So 

our frustration stems from the fact that we are all in favor of competition. We did not appear at the hearing today to talk about mitigating or eliminating competition. We would just like the opportunity to compete, too. And we feel that at the stage we are at as 

an exchange, we are able to innovate at the pace that many of our 

competitors are able to innovate, but we have one hurdle in our 

way that doesn’t appear to be in the way of many with whom we 

compete, and that hurdle is because of our history, we are required 

to file a rule change every time we would like to implement one 

of these innovations, and many of the venues with whom we compete are not under a similar burden. So we would simply like that 

playing field leveled, and I think we would prefer to see it leveled 

by letting us innovate at their pace rather than slowing everyone 

else’s pace of innovation down to our rulemaking process. 

Chairman GARRETT. Let me just interpose and let the other 

members of the panel discuss that, and also when you discuss that, 

let’s just also maybe throw in another aspect, the regulatory nature 

that we have of lit exchanges of the SRO model and that these are 

now for-profit entities and what have you, whether that changes 

anything from where we used to be, if you want to morph that into 

your answer. I see, Mr. Joyce, you were wanting to chime in? 

Mr. JOYCE. Yes, Mr. Chairman. Obviously, we certainly respect 

the work the New York Stock Exchange has done, but I think when 

we talk about a level playing field, we need to keep in mind that 

an exchange is an exchange, and a broker-dealer is a broker-dealer. 

Exchanges have a certain rule set: They have to treat clients, for 

example, all the same; they don’t commit capital. Broker-dealers 

can commit capital. We can commit capital at various degrees to 

various clients. We can preference some clients. We cannot do business with other clients. So I think we need to be careful when we 

talk about leveling the playing field. This is apples and oranges, 

dogs and cats. Similar but different. An exchange has certain responsibilities that are decidedly different than the responsibilities 

broker-dealers have. Just to point out one, for example, we have 

best execution responsibilities. When we take an order on behalf of 

a retail client, we have a certain fiduciary responsibility that is 

mandated by the SEC; an exchange does not have best execution 

responsibilities. So I completely agree that they should be allowed 

to compete in a more facile fashion. Having said that, let’s not confuse the fact that an exchange is an exchange, and broker-dealers 

are broker-dealers. 

Chairman GARRETT. Does anybody else want to chime in? 

Mr. GAWRONSKI. We don’t operate an exchange or a dark pool, 

so we are users of both of these systems, both of their products, in 

fact, and they are both good products. But I guess I tend to agree 

with Duncan on this one in that I don’t think it is a level playing 

17 

field. When the Reg ATS and other rules were adopted, there 

wasn’t competition in the markets, so that has brought on meaningful competition. It is cutthroat competition at this point, and I 

do feel that what ends up happening is that we end up with the 

sort of other side of the coin of competition is fragmentation, and 

we should limit that in some instances or at least make it so that 

if people are competing on a level playing field, I think you will 

probably see a little decrease in that fragmentation, and the SEC 

framed it pretty well at one point. They said their job with respect 

to market structure, at least one aspect of it, is to balance the competition among exchanges and market centers versus the competition among orders, and I think the competition among orders is 

suffering a little bit. We have gone, the pendulum maybe has 

swung a little bit too far and maybe we just need to—I don’t think 

we need to make massive wholesale changes, I just think we need 

to look at leveling the playing field. 

Mr. JOYCE. I would love to comment just a little bit more on the 

issue around the quality of the quote, the quality of the issues of 

fragmentation. I just think we should tread carefully. Again, there 

is not a scintilla of data to indicate that fragmentation is hurting 

investors. I think we have just heard six people say the markets 

have never been better. If we are going to address things like offexchange trading, which, P.S., the reasons there are venues to 

trade off-exchange was to solve problems. Dark pools were originally set up to help institutional traders resolve the issue around 

accessing large pools, large orders, without displaying their issues 

into the marketplace, and if you will, a large institutional trader 

displays what they do in the marketplace, it can move a price. Very 

dangerous. Retail investors utilize internalization because they get 

instant prices, generally better than the NBBO, and they don’t 

have to worry about issues like co-location, competing with professional traders, and market data issues. These things have been set 

up, and they have been solving problems and solving them well. 

Chairman GARRETT. I thank you. I am over my time, Mr. Smith, 

so I will recognize the gentlelady from California. 

Ms. WATERS. Thank you very much, Mr. Chairman. I did come 

in a little late, but there seems to be an overriding theme in the 

testimony that we are hearing today. Everybody agrees that we 

have the world’s leading equity market: it is healthy; and the SEC 

is doing a great job. Is that what I heard? Let me go on to the 

questions. 

Let me go to Mr. Joe Gawronski. You discuss how the Canadian 

government has already adapted a so-called Trade-At Rule requiring significant price improvement if a trade is going to be executed 

off an exchange. You said that Australia and Europe are considering adopting similar rules. Should the United States pursue such 

a rule? If so, why? And are broker-dealer conflicts of interest a 

problem when it comes to internalization? 

Mr. GAWRONSKI. Sure. Thank you for the question. Yes, we do 

think the United States should consider a similar rule to what the 

Canadians have adopted. Of course, that is not live yet; I think it 

goes live in October. So I do sympathize or agree with a lot of the 

participants here that we need to be careful about big changes. 

18 

Just to be clear, and I think this has been mischaracterized in 

the press quite a bit actually, we are big users of dark pools, and 

we are not suggesting that all dark trading be eliminated. Off-exchange trading can be valuable. I tend to think, though, when the 

off-exchange trading looks very similar to on-exchange trading, 

meaning similar order size or similar pricing, I am not quite sure 

why it is allowed and we shouldn’t push it into the publicly displayed markets. 

So I think we should consider something. The Canadians have 

adopted this. I think the Australians probably will follow. Obviously, the genie is a little bit out of the bottle here so it is a little 

more difficult because it does affect people’s business models. But 

I think if we do it in a way that is requiring significant size and/ 

or price improvement, I think you will not see off-exchange trading 

go away. I just think you will limit it and reverse it a bit. 

In terms of broker conflicts, yes, they are rampant. I am a 

broker, and I am embarrassed by what some of the people in my 

industry do. They put the rebate that they will receive or the lower 

cost fee ahead of best execution for the customer. So even though 

it will mean more regulation for me in terms of proving to the SEC 

or FINRA when they come in that we have done the best job for 

our customers, I welcome it because I know how we treat our customers. And I don’t see that same type of resolve or commitment 

by the vast majority of the broker-dealers. 

Ms. WATERS. Let me hear what Mr. Joyce and Mr. Cronin have 

to say about that. 

Mr. CRONIN. Thank you. As an institutional investor and again 

representing ICI, we do have concerns about hidden liquidity in 

terms of internalization, and part of that is centering around the 

fact that these orders don’t ever hit the lit markets, so the price 

discovery mechanism, that is where buyers and sellers interact, 

that not taking place could be detrimental. We recognize that there 

could be benefits to investors by price improvement that happens 

with internalization. Our point is that if the price improvement is 

a tenth of a cent, which is about 10 cents on 100 shares, we are 

not sure that the benefit outweighs the cost, which could be that 

those orders, if seen in the lit market, could do appreciably better 

or help the price formation process. 

Of course, the other point is that as we look at this issue, there 

are complications around the Trade-At Rule. Most specifically, that 

the Trade-At Rule is unclear to us whether or not there would have 

to be a move to subpenny increments to really appropriately reflect 

bids and offers that have access fees within them. As an institution, I can promise you that we believe that moving to subpennies 

would be exceptionally disruptive for institutional investors. The 

minimum risk increment, as we described, at a penny is wonderful 

for some population of securities, the top hundred, two hundred 

names certainly, but there is a population of traders of stocks of 

issues that that penny increment doesn’t seem to make a whole lot 

of sense, that is that the price formation, the process of trading the 

efficiency breaks down, so we would be very, very careful specifically about a trade issue. 

Ms. WATERS. Mr. Joyce, how about you get a word in here before 

the time expires? 

19 

Mr. JOYCE. Thank you very much. With all due respect to our 

friends in Canada and Australia, there are more retail investors in 

the United States than there are people in those countries. So I 

think we have to make sure that we take pride in the fact that the 

United States has the best markets in the world, and we certainly 

want to follow best practices, but I think the lead on these issues 

should come from here, with the data-driven decisions and not be 

looking at smaller countries to lead the way for us. 

Ms. WATERS. Thank you very much. 

I yield back, Mr. Chairman. 

Chairman GARRETT. Mr. Campbell from California. 

Mr. CAMPBELL. Thank you, Mr. Chairman. 

I heard you all talk a lot about trading costs, how they are down, 

and liquidity and how it is up and institutional investors and so 

forth. I would like to suggest that those are trees within the forest 

and not looking at the forest. And in spite of what you just indicated, Mr. Joyce, the forest to me is a couple of things. 

First of all, that the public increasingly does not trust Wall 

Street and therefore does not trust you. And whether that is due 

to flash crash, dark pools, high frequency trading, MF Global, all 

of these things put together, that the public increasingly believes 

that there are a lot of big people doing funny things behind closed 

doors that they don’t understand and can’t control and that, therefore, they can’t participate equitably in this game because it is not 

a fair or level playing field. That, to me, is not good. It is not good 

for the markets, and it is not good for America that we are disconnecting the public from public markets. 

Second of all—and this is my own little metric—I always thought 

there were kind of four participants in markets and that there is 

investment, there is trading, there is speculating, and there is gambling, and that those things all go on. The gambling, speculation, 

and trading have been on a dramatic increase of late and that investment is almost disappearing. And that is not good for markets, 

for America, or, in my view, for capital formation. 

Because if you are on the other end of this and you have a company—and we talk about IPOs and all that sort of stuff, you want 

investors. You really don’t want traders, you really don’t want speculators, and you don’t want gamblers. But there are lots of them 

out there. They are moving the markets, moving them around, and 

fewer investors. 

That is my perspective, and that is what I think we should be 

talking and focusing more on. And if that means, in my view, that 

the cost of trades go up a bit, I will exchange that all day long for 

a market that has more investment and more connection with the 

public and less domination by a very few people behind closed 

doors and so forth. 

In the remaining time, I would love to hear your reaction; and 

if any of you think I am completely full of garbage, feel free to say 

so. People up here on the panel have no problem doing that. 

Chairman GARRETT. We will give you extra time. 

Mr. CAMPBELL. The chairman is particularly adept at that. So 

feel free to do so or to give comments. 

Mr. NIEDERAUER. I would love to start. Thank you for your comment, Congressman. Because I don’t know what your colleagues 

20 

think of you, but that is my first impression of you, and that is why 

I think we are actually all here today, right? 

We can still be proud of what we have in the equity markets, and 

you heard a lot of positive comments about some innovations that 

have helped a lot in the last decade. But, ultimately, whatever we 

have done, to sit up here and say, oh, it is all fine, let’s not tamper 

with it because it is working great—the public has never been more 

disconnected, the public has never had less confidence in the underlying mechanism, and that is why in my closing remarks I 

talked about the need for all of us to work together. Because that 

is the root issue, right? 

We are not going to be able to be the group that prevents crises 

from happening. They have happened throughout the country’s history, right? But at the end of the day, the citizenry has lost trust 

and confidence in the underlying mechanism, and it is for some of 

the reasons you talked about. What used to be an investor’s market 

is now thought of as a trader’s market, and I think we have convinced ourselves along the way that speed is synonymous with 

market quality. In some cases, it might be; and in other cases, it 

clearly isn’t. 

So I think your comment speaks at the heart of why we are here. 

Because to say we should just leave it alone because it is working 

great, when people have never had less confidence in what is going 

on, I think is a call to action. So I appreciate your comment. 

Mr. CAMPBELL. Thank you. 

Let me just on that, whichever one of you said we ought to hold 

the price for a second—yes, Mr. Joyce—when you talk to people out 

there who want to invest 5 years, 10 years, whatever, invest, and 

you say you have to hold prices for a second because most of the 

time people trade in and out in 30 milliseconds, understandably, 

they have absolutely no faith in this thing. 

So, Mr. Cronin, he had his hand up first. I am sorry. It appears 

I am out of time. But go ahead. 

Mr. CRONIN. I appreciate the opportunity to quickly say that we 

understand entirely your point. As I suggested, in representing ICI, 

we have $13 billion in assets and 90 million of those investors 

whom you reference. Our interest is clearly that investor confidence is well-placed in this market. And while we recognize there 

are some benefits that recent developments have made, there is 

clearly still work to be done, including things, as we discussed, 

around regulatory capabilities to ensure that any activity that is 

nefarious or improper or manipulative is able to be seen, spotted, 

and prosecuted. 

Mr. CAMPBELL. Mr. Chairman, my time is up, so I will defer to 

you on what happens now. 

Chairman GARRETT. The gentleman yields back. 

Mr. CAMPBELL. Then, I will yield back. 

Chairman GARRETT. The gentlelady from New York. 

Mrs. MALONEY. Thank you, Mr. Chairman, for having this hearing, and I thank all the panelists for being here. 

I would like to focus on the growing percentage of the market of 

these dark pools, which seems to be the exact opposite of what we 

are trying to achieve in Dodd-Frank: making our markets more 

transparent, putting them on exchanges, letting everyone know 

21 

what is going on. And this seems to be growing. So I would like 

to know what percentage exactly of the market are these dark 

pools and why are they growing? Why are they making up more 

and more of the market? I would like to understand more of it. I 

would like to start at this end and go down, if people would like 

to comment on it. Mr. Smith? 

And then, I would like to know what is the impact that they are 

having of not really being transparent or on exchanges and why is 

this segment of the market growing and what is the impact it is 

having on competitiveness of our markets? 

Mr. SMITH. Okay. That is a good question. It is definitely something we should be focused on. 

I, too, am concerned about the fragmentation and support a goal 

of trying to reduce it and try to consolidate the markets. The markets have splintered over the last decade or so. They have gone 

from a couple of centralized markets that had the majority of the 

market share to, as we heard today, dozens of markets where the 

trading volume is spread all out. 

Mrs. MALONEY. Do you have a sense of how much of the market 

it is? 

Mr. SMITH. I will have to defer to Duncan on that, who has a 

staff who probably looks at that. 

Mr. GAWRONSKI. I am known as the dark pool boy in this world, 

so I will do the data. 

About 14 to 15 percent of the market is what we would characterize as dark pools, but you actually have to about double that figure to almost a third of the market when you include things other 

people would call internalization or wholesaling activity. So about 

two-thirds of the market is on exchange, and about one-third of the 

market is off exchange. 

Mrs. MALONEY. How would you define a dark pool? Not being on 

the market? 

Mr. GAWRONSKI. There is no quote displayed. Like when you see 

a bid and offer on the New York Stock Exchange or NASDAQ, you 

would not see a quote. As Duncan talked about— 

Mrs. MALONEY. Are they regulated by the CFTC? 

Mr. GAWRONSKI. No, by the SEC. 

Mrs. MALONEY. By the SEC. 

Mr. GAWRONSKI. Yes, although there is this different rule book 

in the sense that some of them are broker-dealers and not ATSs, 

and so therefore FINRA could also be the primary regulatory body. 

Mrs. MALONEY. Why is it growing as a percentage of the market? 

Mr. GAWRONSKI. I think there are a couple of reasons. One is the 

fee differentials that exist between some of the dark pool markets 

and the displayed markets. Another reason is some of the things 

that you were talking about in terms of the sort of fast world we 

live in. There is some arbitrage activity between the displayed market pricing and what is happening in the dark pools. Someone can 

maybe buy at the midpoint in a dark pool and sell in a displayed 

market, capturing that differential in time. So I think a lot of it 

is driven by those types of things. 

And I think institutional investors do seek refuge in dark pools 

in terms of doing blocks. But the reality is most of the activity in 

dark pools is not blocks anymore. That is my problem with it, is 

22 

that I would like to reserve it to situations where either blocks are 

getting done or significant price improvement is being achieved. 

Mrs. MALONEY. See, I don’t understand how they do not have to 

do a quote display and be more visible. Because that was the total 

goal, to put people on exchanges in Dodd-Frank. How is this happening that they are being excluded from the effort to put quotes 

out there, increase competition. Any answer? 

Mr. JOYCE. Yes, Congresswoman. First of all, I think they started 

because they saw the problem in the marketplace where there were 

institutions trying to access liquidity or retail investors trying to 

get protection. But, fundamentally, they were to protect investors. 

And you shouldn’t think that the prices are—it is some kind of 

Wild West. The prices are dictated by the NBBO. They cannot 

trade away from the stated price. So they basically fundamentally 

solve problems that investors had. That is why they were created. 

Somebody came up with an idea to deal with an issue, and a dark 

pool was created, and they enhanced competition. 

Mrs. MALONEY. How are they increasing competition? You say 

they are or they are not? 

Mr. JOYCE. They are increasing competition because people are 

competing. They come up with new, clever ideas that serve investors’ needs. 

Mrs. MALONEY. Why have the spreads decreased in recent years? 

Dark pools have suggested that the tightening of bid-ask spreads 

is at least partially a function of the emergence of new dark liquidity venues. Could you comment on that? 

Mr. JOYCE. I think the fact that the spreads are tighter, tighter 

spreads make it cheaper to trade. So that is a net benefit. 

Mrs. MALONEY. My time is up. Thank you. 

Chairman GARRETT. And I see Mr. Hurt as joined us. He is recognized for 5 minutes. 

Mr. HURT. My question is for Mr. Joyce and Mr. Niederauer. 

As the trading rules and regulations deal with or have affected 

small and mid-cap companies, perhaps in a disproportionate way, 

I was wondering if you could each talk just generally about what 

the solution is or how it is that we can increase the—make it easier 

for the smaller and mid-cap companies to access capital in the current structure? 

Maybe Mr. Joyce, or whoever wants to go first. 

Mr. JOYCE. I think the small and mid-cap companies by definition trade differently because there is just simply less of a flow. 

They have fewer investors. So they just behave differently, if you 

will, because of the structure of how they have been set up. 

I think in order to introduce more interest in the area, you have 

seen over the years a diminution of research coverage on the small 

and mid-cap names because of certain rule sets that have been introduced to the marketplace. I think any of the policies that have 

been pursued, including the JOBS Act where we can encourage 

more research, would be a wonderful thing. We also think the opportunity to widen spreads so that liquidity aggregates in places 

that people can more visibly see, as opposed to having to trade in 

penny spreads all the time in some cases, is probably another net 

benefit. 

23 

So I believe that more sunlight in the form of research, the ability, if you will, for market makers to sponsor some of these small 

and mid-cap names. For example, we have about 80 percent market share in the bulletin board and pink sheet names, which is the 

real, if you will, micro-cap names. We don’t have that market share 

because we wanted it. We have that because people, other competitors, backed away from it. So any way you can incent people in the 

form of even sponsoring market-making opportunities in these 

names would be helpful. 

Mr. HURT. Thank you. 

Mr. NIEDERAUER. And I would echo some of that, Congressman. 

I think the JOBS Act was a great start, and I think our next challenge now collectively should be how do we reconcile some of the 

opportunities that the JOBS Act promised us to deliver to small 

companies that are not yet in the capital markets with the SMEs 

that already are, who as you probably heard us say before we think 

are overly burdened by some earlier regulations. And I think 

whether we try things like Mr. Joyce just recommended or that ICI 

recommended, we would be very much in favor of experimenting 

with allowing companies to select their own tick size. Ultimately, 

you could argue that could be their decision. 

We have studied internally what we think it would take for us 

to implement something like that. I don’t think the implementation 

process would be long, although, obviously, all the industry participants would have to code their systems accordingly as well. 

And I think we are very much in favor of what Congressman 

Schweikert and others have recommended in terms of experimenting with some kind of liquidity provision program. Because I 

think if we don’t do that combination of things, we do run a risk 

that, even though we don’t intend for that to be the outcome, the 

good news is we get a lot of small companies to market and they 

access the growth capital that creates the jobs we desperately need. 

The other news is, once they get there, they run the risk of being 

orphaned from a research coverage and liquidity provision point of 

view. 

So I think we would be very, very interested in working with the 

industry and with all of you to figure out ways we can improve the 

situation for some of these SMEs that are already on the public 

markets. Because we think that is the future of the country in 

terms of job creation. 

Mr. HURT. With respect to the JOBS Act, at what point do you 

think we will have concrete results that we can say are a consequence of the action that we have taken here in Washington? At 

what point will we be able to really judge the effectiveness of that 

Act? 

Mr. NIEDERAUER. Assuming that it gets implemented by the regulatory authorities in the time which you have asked them to implement it, I would be very optimistic that we would be able to 

share results with you as early as next year. I can tell you that we 

are in conversations with—just our exchange is already in active 

conversations with 50 to 100 companies by my estimate, and I can 

honestly tell you I don’t think we would be having the conversation 

with them about accessing the capital markets if it were not for the 

24 

JOBS Act. So I think the early returns are already very, very positive. 

Mr. HURT. Thank you. I yield back my time. 

Chairman GARRETT. Thank you. The gentleman yields back. 

Mr. Green? 

Mr. GREEN. Thank you, Mr. Chairman, and I thank the witnesses for appearing. 

I want to speak to you very briefly about a couple of things. Let’s 

start with the ability to arbitrage. Do you agree that this is a good 

or a bad thing, the ability to arbitrage in the marketplace? Who 

would like to respond? 

Mr. JOYCE. I am happy to do it, Congressman. 

I think it is a good thing. Because I think for a really healthy 

marketplace, you need a variety—sometimes a wide variety—of 

market participants. You need the retail investor, the long-term investor, the institutional investor, the intermediaries, the 

arbitrageurs. I think if you want to have a healthy, vibrant market, 

you need a broad spectrum of participants. And arbitrageurs, while 

they take up a niche in the market, they do benefit the marketplace. 

Mr. GREEN. Is there anyone who differs? 

Talk to me for just a moment about hedging. As you know, this 

has been in the news lately. And I don’t want to get you involved 

in somebody else’s debate, but I think it is a great opportunity for 

me to hear from some other folks about hedging and how it benefits the market. I would like to hear your pros and cons, if you 

would, on hedging. 

Who would like to be the first? 

Mr. CRONIN. I guess what I would say, as it pertains to the ICI, 

is we are not here to testify on behalf of what the banks are doing 

on their balance sheets and that sort of thing. But in the world of 

trading, risk management is an important component, so the ability for our contemporaries and counterparts, Morgan Stanley, Merrill Lynch, et al, to hedge risk, is an important feature of us finding 

liquidity. If we wanted to sell a large position of stock to them, they 

would take it in their inventory with their own capital and try to 

hedge the risk of that position using a number of different derivative contracts. 

So in the context of, at least for us, finding liquidity in the markets, hedging and the ability for our counterparts to hedge risk is 

an important notion. 

Mr. GREEN. Because time is of the essence, I will go next to my 

final point, which is, given that we appreciate hedging and we appreciate the ability to arbitrage, some contend that there is a thin 

line of distinction between these two and a highly technical term 

known as gambling. Can someone give me an opinion as to when 

you cross that line and you no longer are hedging but you are now 

moving into another arena? 

I don’t mean to make you uncomfortable. I am reading body language. If this is something you don’t feel comfortable talking about, 

I suppose I will understand, but since you are experts, maybe 

someone can help me understand. When is it that you cross the 

line and it becomes Las Vegas in the investment market? 

25 

Mr. COLEMAN. I think, generally speaking, hedging is meant to 

decrease your risk and gambling is often to increase your risk. 

Mr. GREEN. Is it possible for the structure of the actual product 

that you produce to become more of a gamble than a risk? 

Mr. COLEMAN. I would say, not in our business line. 

Mr. GREEN. Not in yours. 

Let’s not talk about anybody individually. What I am trying to 

speak for will be people who invest in these markets. So don’t let 

this become personal, please. 

But just help me to understand, do we have this thing called 

gambling taking place? And, if so, I would like for somebody to address it. 

Mr. JOYCE. If I could, I will take a shot at it, Congressman. 

I don’t know if you can ever quantify a term like gambling that 

you have used, and this is probably not a very official answer or 

a very concise answer, but I think it is kind of in the eye of the 

beholder. Your view or somebody’s view of gambling might be 

somebody else’s view of a healthy intermediary doing his job or her 

job. So I hate to have—I don’t want to sound like I am vacillating, 

but I believe applying the term ‘‘gambling’’ to components of the investment world basically defaults back to, it is in the eye of the beholder. 

Mr. GREEN. Okay. Let me just give you a quick example of something. I don’t know that I can do it in 25 seconds, but, some time 

ago, there was something known as the numbers racket. You may 

not have heard of it. But in the numbers racket, when one runner 

had a big hit on a given number, usually 7 or 11—for some reason 

these are popular numbers—he would go to another number runner and say, ‘‘Look, I have a big run on 7. I will give you $10,000 

if you will cover all of my losses above a certain amount if 7 hits.’’ 

And if 7 hits, then that person would cover. 

As it turns out, that was kind of a credit default swap. Now, 

those people who were doing that went to jail. But if you can go 

to one of our Ivy League institutions and get a great amount of 

credibility, you can go into the stock market and bring these innovations, and these innovations are embraced, and they become a 

good way to do business. 

So I am just trying to get a better sense of when is it that these 

innovations that at one time were not received warmly became so 

enthusiastically embraced? What happens so that you can cross 

that line with these things and have this kind of circumstance? 

My time is up. Thank you very much. You have been wonderful. 

Thank you, Mr. Chairman. 

Chairman GARRETT. Okay. It looks like everyone wanted to answer that question, but time is up. 

The gentleman from Texas is recognized. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. I think this is a 

very important hearing, and I think the fact we have a very diverse 

panel here is healthy. 

I think one of the things—I heard Mr. Campbell make his comments earlier about how the little guy probably feels a little bit 

disenfranchised sometimes, that he sees other people making 

money by investing and he is maybe not doing so well. And I think 

as policymakers, one of the things we have to be careful about here 

26 

is that I have seen since I have been in Congress that sometimes 

Congress is trying to make markets where nobody ever loses any 

money, and that is not the role of Congress. 

The role of Congress is for transparency and integrity of the markets. That is our goal. 

One of the things that we have seen is with technology is a lot 

of innovation in almost every area of business and finance, and 

particularly in the finance area, which has created some new opportunities and some new efficiencies in the market. 

So when I was kind of listening to Mr. Niederauer—you would 

think somebody with the name ‘‘Neugebauer’’ would be able to say 

that. So how about if I just call you ‘‘Duncan’’ and you call me 

‘‘Randy?’’ 

But I think the question is—I heard you say the competition is 

healthy, the efficiency that is created by the technology and all of 

that—hopefully, everybody is invested, whether you are a small investor or big investor. It is how we manage this new competition, 

these new outlets, and are we doing it in a proper way. Would you 

kind of expand on that just a little bit? 

Mr. NIEDERAUER. So, with your permission, I will call you 

‘‘Randy,’’ rather than ‘‘Congressman,’’ and we will call it even. 

Mr. NEUGEBAUER. That is great. 

Mr. NIEDERAUER. Thanks, Randy. 

So it goes back to what several of your peers on the committee 

have talked about, in my opinion. So it goes back to Congressman 

Campbell’s comment about the little guy feels disenfranchised, 

whether we are proud of the market structure or not. So if the customer is always right, that is the customer, that is who we are supposed to be serving. 

It goes back to Congresswoman Maloney’s comment about the increasing opacity in the U.S. equity market is hard to reconcile with 

what we think we have learned in the crisis, that the products that 

got us in trouble were pretty opaque, right? It wasn’t the transparent markets that got us in trouble. It was the opaque markets. 

So I think competition is a good thing, and let’s start with figuring 

out how to try to measure its impact. 

I will help the committee with one thing. We can all bring you 

mountains of data. I guarantee you the data will be inconclusive. 

We can prove one thing. Mr. Joyce can prove another thing. Mr. 

Cronin can prove another. We can all prove different things from 

the data. It will be inconclusive. 

So at the end of the day, we are obliged to figure out if we think 

we have a policy or a confidence issue or we don’t, because the 

data—we are going to take a lot of time gathering data, and I am 

not sure—we were going to draw very different conclusions from it. 

I want to be very clear. My statements earlier—we don’t think 

there is anything nefarious going on in the equity markets. The 

broker-dealers are simply executing in a way that is consistent 

with the rules they are given. And in fairness to them, if internalizing is better economics for them, less regulation, why wouldn’t 

they execute there, right? Why not? 

Now, I do disagree with one thing my friend, Mr. Joyce, said. If 

it were as simple as a broker-dealer were a broker-dealer and an 

exchange were an exchange, we are all for that. That is okay with 

27 

us. That is how it was, historically. What has changed in the last 

5 to 10 years is broker-dealers can own things that look a heck of 

a lot like an exchange; and we certainly can’t own anything, nor 

are we asking to, that looks a heck of a lot like a broker-dealer. 

So that is point number one. 

My final point, point number two, is I want to be very, very 

clear, if the size that is getting executed in a dark pool is much bigger than we can provide in the public market, or if the price is better, we don’t have a leg to stand on. That is called competition. 

But if you think about what the dark pools were envisioned to 

do, where it was about institutional customers like Mr. Cronin 

needing to find an alternative to the public market because the 

public market was not serving them properly, that was fine if the 

average order size was still large in the dark pools. The data that 

I have is, for the top five dark pools, the average execution size is 

half of what we typically display in the public market. I don’t get 

how that is serving anybody. That is just making the markets more 

opaque, with no benefit to the end customer. 

Thank you, sir. 

I left you 12 seconds. Oh, I went over 12 seconds. Sorry. 

Mr. NEUGEBAUER. With the chairman’s indulgence, to be fair 

here, Mr. Joyce, if I am a little investor and I am trying to move 

100 shares and there is an institutional investor out there that 

needs liquidity or something and they are trying to move 200,000 

or 500,000 shares, does the dark area provide me some protection 

in—one of the things, I guess, do I want to be in front of that trade 

or on the back of that trade in a normal exchange trade? 

Mr. JOYCE. We believe firmly that internalization is a huge benefit for the retail investor because we give instant execution at the 

price quoted, generally at a better price quoted. 

If I could just add one more thing in regard to the 

disenfranchised little guy, I think we need to understand again 

that there are many, many different people participating, many different types of investors in the market. A retail investor should not 

and I think cannot, worry about a 15-second time horizon in their 

investment; and if they get upset if they miss by a penny—and, of 

course, all the market data says they are doing better than that— 

but if they get upset and they miss by a penny and they run away 

from the market, they have missed the opportunity to—in the last 

24 hours, I think Hershey has hit an all-time high, Costco has hit 

an all-time high, McDonald’s is near an all-time high. These are 

household names. 

So we need to work on the education component of this, too. 

There are different people with different time horizons. If you are 

in there for the long term and you are not getting frustrated, which 

can happen, there are plenty of opportunities out there to build 

wealth. 

Mr. NEUGEBAUER. Thank you. 

Chairman GARRETT. Thank you. 

And Mr. Stivers is here and is recognized for 5 minutes. 

Mr. STIVERS. Thank you, Mr. Chairman. 

My first question is for Mr. Niederauer. The purpose or the benefit of an exchange to the entire system is to provide price transVerDate Nov 24 2008 18:30 Feb 21, 2013 Jkt 076108 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 K:\DOCS\76108.TXT TERRI
28 

parency to the entire market, is that correct? That is one of the 

benefits. 

Mr. NIEDERAUER. That is what we aspire to do, yes, sir. 

Mr. STIVERS. And even if shares are traded in dark markets, the 

exchanges provide sort of goalposts or left and right limits for people throughout the markets to know what the alternative price 

would have been, is that correct? 

Mr. NIEDERAUER. The public market quote that I referenced in 

my opening—in my oral remarks, the so-called NBBO, is typically 

used as a reference price for those opaque markets, yes, sir. 

Mr. STIVERS. So I guess the beginning point here is that, even 

though there is some opacity on the part of the markets, the exchanges are there to help everybody understand what the alternative price would be, and so it is very publicly known what the 

alternative would be. Is that correct or incorrect? 

Mr. NIEDERAUER. Yes. We actually have an obligation to publish 

that bid and offer at all times with an associated size. So, yes, sir, 

that is correct. And we think that if the customer experience was 

better in the dark pools, as I alluded to a minute ago, then there 

is no argument, from our point of view. When it is clearly better 

for the executing broker but it is less clear that it is better for the 

customer, that is the only issue we have, really. 

Mr. STIVERS. Can you help me understand, from your perspective 

on the New York Stock Exchange, what have your volumes been 

over the last couple of years? Has this rise in dark markets been 

at your expense in volumes? I thought your volumes were continuing to go up. 

Mr. NIEDERAUER. Until the last 6 months of the markets—or 

really the first 6 months of this year, when we all see for all of us 

in the business the volumes are lower, which I think gets to the 

confidence issue, potentially, volumes in the overall market have 

gone up. That was a pretty steady increase after decimalization; 

and with the advent of some of the technologically enabled trading 

strategies, volume has generally increased. 

If you want to measure it by market share, the market share has 

gone down in the transparent exchanges at the expense of the 

opaque venues the last couple of years. And in the last 6 months, 

I think volume is down for everybody relative to the last few years. 

Mr. STIVERS. But is there anybody on the panel—and you can 

just raise your hand on this one if you disagree with this—who believes that the dark markets have actually done anything to reduce 

the efficiency of the marketplace or reduce liquidity in the marketplace? They have increased liquidity for sure, right? 

Mr. NIEDERAUER. Yes, I think competition generally increases liquidity. I think we focus more to the first part of your question 

about how much of that is displayed. Because the regulations that 

we put in place—let’s put decimalization aside. That was for a different reason, and that was really why spreads went lower and volume went up. It was the advent of NMS 6 or 7 years ago that was 

designed and hoped to encourage the display of liquidity, in addition to fostering competition. I think it certainly fostered competition. I am not sure it led to more display of liquidity. 

Mr. CRONIN. Can I just comment from an institutional perspective on that as we talk? 

29 

Mr. STIVERS. Go ahead. 

Mr. CRONIN. Institutions obviously represent retail investors; and 

whether it is the self-directed guy who is buying 100 shares with 

Tom’s firm or somebody who invests in a mutual fund, they both 

deserve the same positive outcome. 

So from an institutional perspective, when we have a big order— 

maybe it is 500,000 shares, maybe it is 5 million shares—there has 

to be a recognition that when we take that order to the market, 

there are a number of participants, probably including some on this 

panel, who would like to know about that order and could take advantage of it. So we need to be able to protect those orders. 

Dark pools, as originally conceived, were ways that we could go 

into the dark, interact with other large intermediaries and get bigsized trades done. 

Now, clearly, the market— 

Mr. STIVERS. I do need to get to one more question. I hate to cut 

you off. I really apologize, but I am limited on time. 

The other thing I would like to quickly discuss is, I worked in 

a broker-dealer a long time ago and the whole rise of market makers—and a lot of this was for the small issuers. So I do want to 

talk about the impact on small issuers of the rise of dark markets. 

And I know on a lot of the exchanges, including the New York 

Stock Exchange, you have to meet certain qualifications to get listed. 

I am out of time, but maybe there will be a second round of questions where we can talk about the impact. I know it has come up 

a little bit on small issuers. 

Thanks, Mr. Chairman. I yield back. Hopefully, there will be a 

second round. 

Chairman GARRETT. Thank you. The gentleman yields back. 

The gentleman from Arizona is recognized. 

Mr. SCHWEIKERT. Thank you, Mr. Chairman. 

Sorry to run out on that. We had something that affected Arizona— 

Forgive me if you have now gone into this in great depth, but, 

first off, tell me the pros and cons, and if you would even have a 

brilliant mechanical way you would do it of smaller capped companies, thinly traded. Would you allow them to choose or participate 

in choosing their tick size? 

Let’s start from one end, and tell me good or bad. 

Mr. COLEMAN. I think our preference would be the exchange to 

decide or something along those lines. We would be flexible to 

changing tick size and seeing what impact we have, so we are not 

opposed to it. But I think an exchange is probably better situated 

to get the tick size right for everybody involved. 

Mr. CRONIN. I don’t know that we would be too prescriptive on 

who exactly should set those. The only thing I would say is it 

seems like the exchanges and even investors would be in a better 

position than necessarily the issuing companies to determine what 

that tick size should be. 

Mr. GAWRONSKI. I agree with Kevin. 

Mr. SCHWEIKERT. Oh, that makes it easy. 

Mr. JOYCE. I am not sure how much time management of these 

smaller companies think about tick size, but I am all for choice, 

30 

and if they think it would be beneficial to the way their company 

trades with the data that they collect, then I am all for choice. 

Mr. NIEDERAUER. We did touch on some of this while you had to 

step out, and I think there was general consensus that that is directionally correct. It is consistent with all the things we have 

talked about in the past of what can we do generally for the SMEs 

that are already listed to enhance their liquidity. 

We talked about liquidity provider programs. We talked about 

choosing their tick sizes. I mentioned in some of my earlier remarks that I think it would be—we shouldn’t have so many different ones that it confuses the marketplace. But I think they are 

fairly easy to implement. We could do it with the companies. We 

would report it to the market participants. I think it is a pretty 

easy job for everybody to change their underlying systems to deal 

with different tick sizes. 

So we talked about a range of things, all targeted to enhance liquidity for the small companies. 

Mr. SMITH. I think investors, since they are the ones who own 

the securities, have the most interest in having the appropriate 

tick size. So I don’t think that having issuers select them on behalf 

of somebody who owns that stock makes a lot of sense. 

In terms of tick sizes in general, I think we need to calibrate 

them. So there is no reason, for instance, that Berkshire Hathaway 

should have the tick size as some $5, very actively traded stock. 

And I think in Europe, for instance, they have different tick sizes 

based on the value of the stock; and optimally you probably would 

like to do it with the value and the liquidity of the stock taken into 

consideration. 

So I think there is some calibration that could be done on that, 

both reducing tick sizes because of a lower investor transaction cost 

and potentially even increasing them in the appropriate circumstance as well. 

Mr. SCHWEIKERT. We end up in the discussion about increasing 

the tick size, particularly for the very thinly traded stocks. But 

many of us—and we have had this testimony here—is the crisis, 

as you may see, since Sarbanes-Oxley, we have almost one-third 

fewer publicly traded companies today. Does monkeying with something of this nature make it more possible with the new Reg A and 

some of the other mechanics out there to have the next sort of generation of publicly traded companies come to market, does it work? 

Are we talking about something that actually would provide liquidity? 

Mr. Smith, are we—and this is for not companies that are already listed, but for the next generation, particularly the small 

players. Would this help bring them? 

Mr. SMITH. Certainly, I tend to favor the calibrated tick size approach, but, at the same time, I always favor innovation. So to the 

extent that one of the exchanges wants to experiment with having 

even a bigger tick size for some small cap companies or some upand-coming companies and they want to have a pilot to do that, I 

would be supportive of that as well. 

Mr. NIEDERAUER. I strongly agree with your statement. 

If you think about what the root of the work on the JOBS Act 

and Reg A was all about, it was to open the door for that next wave 

31 

of entrepreneurial companies to find their way to the growth capital that the capital markets provide, Congressman. And I think 

what we have been talking about today is what else can we do for 

them as they are arriving or when they get there. 

Mr. SCHWEIKERT. I know we are up against time, but that is 

what we are in many ways hungry for, is what else should we be 

doing to get those companies out there. 

Mr. NIEDERAUER. Right. And I think the on-ramp is a great 

start. I think we talked earlier about reconciling that for the already listed companies. We talked about liquidity provision programs, which I know you have championed, and incentives for a research provision as well. So we are going to keep brainstorming on 

that, and I think tick size is just one of many things we can do to 

try to make sure we encourage that next round of entrepreneurial 

companies to come to the market. 

Mr. SCHWEIKERT. I am now out of time, but please give us your 

ideas. 

Thank you, Mr. Chairman. 

Chairman GARRETT. And I thank you. 

The gentlelady from New York is recognized. 

Dr. HAYWORTH. Thank you, Mr. Chairman. 

It was just mentioned again, the support for a pilot project to see 

how we can enable liquidity of small cap stocks to access capital 

more effectively and get investors more easily into that mix as well. 

Maybe we could just talk about some parameters for a pilot project, 

if we were to do them, so that we can get some guidance here on 

the committee. 

I am getting the sense that there could be a lot of flexibility, I 

presume facilitated by technology, to experiment with flexibility for 

tick sizes. Is there broad support for that being an element of a 

pilot project? 

Mr. Niederauer? 

Mr. NIEDERAUER. I think it probably would be. We can follow up 

as panelists with other people in the industry. I think if you listen 

to the different recommendations that are being made, one approach is to tie it more to basis points and just have it naturally 

be a function of the price of the underlying stock. 

I think that is going to be inadequate from the standpoint of a 

lot of the small companies, because their concern is less about their 

spread but the underlying liquidity in their stock. So I think just 

doing the same spread for every stock that trades at $25, I am not 

sure that is going to get at the answer. 

I do think that with all the technology that has been brought to 

bear that you have heard a lot about today on the panel, it is pretty trivial for a lot of us to figure out how to put a pilot program 

in place and to be able to study it. And before we get too nervous 

about it, it is an unfortunate but true fact that Congressman 

Schweikert shared. There are only a few thousand publicly traded 

companies in the United States, and this is an issue that is probably relevant to a fraction of those few thousand. 

So I think if you can let us go to work and work together and 

figure out where we don’t make it too complex but we get at the 

right answer, I think that is a great follow-up that we can all work 

on together. 

32 

Mr. JOYCE. If I can just add one thing, I think we need to be 

careful we don’t get too caught up in the technicalities of how they 

trade. Let’s face it. If you are a small company, you want to build 

momentum. You want to build enthusiasm for what are doing. You 

want to get your story out in the marketplace. 

So, as such, I think you should investigate things like allowing 

companies to sponsor market makers to actually make markets in 

their stock. As I said earlier, we have like 80 percent market share 

in the bulletin board and pink sheet names. Not because we wanted it—we are happy to have it—but because a lot of our competitors faded and walked away from it because it wasn’t profitable 

enough. 

We also need to get the research story out there. You need to 

think about ways where you can publish research in a professional 

fashion and have the research analyst still work with the investment banker as they bring the company out. 

So I think we certainly have to look at the technicalities of trading, but let’s make sure we give these companies a chance to tell 

their story. 

Dr. HAYWORTH. Mr. McHenry can obviously nod assent or not, 

but I think what you are talking about, Mr. Joyce, sits right in 

with the legislation you have introduced, does it not, Mr. McHenry? 

That is exactly what we are talking about. 

Mr. JOYCE. Yes, we are in violent agreement. 

Dr. HAYWORTH. Right. It sounds like common sense. Because, as 

I understand it, the regret that people have expressed about 

switching to decimalization is that the markets providing for that 

kind of dissemination of research and the investment of time into 

that research was severely compromised by changing the tick size. 

Who should be—which entities should be the ones to be most 

heavily involved in a pilot project? Who should provide the overarching supervision? I don’t know, Mr. Niederauer, if you have a— 

Mr. NIEDERAUER. I was hoping that the other panelists would 

volunteer us, because it is always easier to be volunteered than to 

volunteer. 

I think we would have to take the lead on it with the other exchanges, and I would like to start by working closely with the 

issuers. So I think that would be step one. 

But I think we have to dampen the issuers’ enthusiasm a bit. Because as Tom and Kevin and Cameron have all said, the investor 

should have some say in this, too. We don’t want to just hit the 

target on one thing and create another problem for ourselves somewhere else. 

But I think we could take responsibility for starting and beginning by working with the issuers whom we know care deeply about 

this, see if we can get as far as implementing some rules that let 

them choose it and calibrate it properly, and then make sure before 

we launch it that the investors are okay with it as well. 

I think you have heard Mr. Cronin express from ICI’s point of 

view, that you guys would be okay with the pilot, subject to the details, right? 

Mr. CRONIN. Yes, we would definitely support a pilot program. 

And if I can just give you some perspective, as investors, one of 

the things that we look at when we invest in companies clearly beVerDate Nov 24 2008 18:30 Feb 21, 2013 Jkt 076108 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 K:\DOCS\76108.TXT TERRI
33 

yond growth opportunities and the industry they are in and that 

sort of thing is the liquidity. So the more things that we can do to 

enhance the liquidity and participation, the better. 

We quite clearly are supportive from an ICI perspective of trying 

this pilot program with traditional tick sizes being moved from a 

penny to—if it is 5 cents, if it is more than that, we are completely 

open. But we certainly would have all kinds of interest—Duncan, 

thank you for offering—of being very involved in that process. Because at the end of the day, it is our investors’ money that you are 

looking to really get more engaged in this. And one of the prices 

for admission for that is just more transparency, better liquidity; 

and I think the pilot program can help get us to a better place for 

that. 

Dr. HAYWORTH. I appreciate that. Thank you. 

My time is up. I yield back. 

Chairman GARRETT. And we move from the gentlelady from New 

York to the gentleman from New York. 

Mr. GRIMM. Thank you, Mr. Chairman. 

Good afternoon to everyone on the panel. I appreciate your input 

today. 

Being a New Yorker, I am very interested in how our exchanges 

are working. I think that, overall, we have had an explosion in 

spreads tightening and better executions over the last several 

years. 

But I want to go back to something Mr. Niederauer said before. 

You were mentioning when my colleague from New York, Ms. 

Hayworth, talked about the company being concerned about—they 

are less concerned about the spread and they are more concerned 

about liquidity. But when there is a larger spread, doesn’t that always mean that for the market makers, there is more opportunity 

for them to make money? Therefore, more market makers and possibly more liquidity? Is there something to be said about that, that 

there is a correlation between the spread and liquidity? 

Mr. JOYCE. Yes. If you don’t mind, Congressman, I would like to 

jump in on that one. 

At Knight Capital Group, we make markets in 19,000 companies. 

We make markets in every single publicly traded company in the 

United States. Of course, about 6,000 or 7,000 are listed on exchanges, and the rest of them are actually too small to actually 

warrant a listing on an exchange. And that is where we have ended 

up with outsized market share, because that business of making 

markets for small companies has become very tough and a lot of 

market participants walked away from the opportunity that we 

stayed with. 

So I agree with you completely that if spreads widened, market 

makers might have an opportunity to have more of a profitable 

business, that it might attract more sponsorship for more companies. I think that is something that is a likely outcome if spreads 

widened in an appropriate fashion. 

Mr. GRIMM. Is it true to assume that if that is the case, more 

market makers making markets, they are more likely to do at least 

some research? And then these companies, it is hard for them to 

get their research coverage, it is hard for investors to find anything 

on these companies, that would help the process along as well? 

34 

Mr. JOYCE. Yes, sir. Back when I worked at Merrill Lynch, back 

in the old days when my hair was a whole lot darker, we only 

made markets in names that we had research coverage. So there 

are a lot of firms out there that will tie research coverage to market making. 

Mr. GRIMM. If I could go back to Mr. Niederauer, exchanges are 

very heavily regulated under the 1934 Act, but ATSs, including 

dark pools, are regulated as DDs under Reg ATS. So I would concede, I guess, that ATSs are not as heavily regulated as exchanges. 

So if I am understanding—I read your testimony, your suggestions 

correctly, and I just want to make sure I have it correct—it seems 

to me that NYSE is advocating for its competitors really to be saddled with the same regulatory burdens as exchanges that they are 

subject to. Is that correct? 

Mr. NIEDERAUER. I think it is a tale of two cities. I think what 

we are saying is if the playing field is uneven and the ATSs are 

looking more like exchanges than broker-dealers, then there are 

two ways to level the playing field. You can make it easier for us 

to compete, or you can burden some of the ATSs that collectively 

are an important part of the market now with some exchange-like 

regulation. So I think what we are trying to say is we could go in 

either direction, but what is clear to us is that the competitive 

landscape has changed. 

As I said in one of my earlier remarks, the bright line between 

where a broker-dealer’s business begins and ends, and where an 

exchange’s business begins and ends, is a lot blurrier than it used 

to be, but it seems to be only blurry in one direction. We are certainly in no position, because of the 1934 Act and other things, to 

be in the broker-dealer business. Yet, many of the broker-dealers 

are able to be owners of venues that look an awful lot like an exchange, but are not subjected to nearly the regulatory burdens that 

we are subjected to. 

It also comes down to the cost of regulation, if I can just add 

that. So if we thought about consolidating the ability for FINRA or 

the SEC to regulate the market, and then we thought about what 

that should cost to regulate the market, an important part of investor confidence, I think we would be delighted to pay a share of the 

regulatory cost of regulating the markets that was consistent with 

our market share. Right now, the cost that we bear is exponentially 

greater compared to our market share. 

Mr. GRIMM. What are you doing now to try to compete in the 

meantime? 

Mr. NIEDERAUER. I think we do some of the things that we have 

talked about on the panel today. We have tried to keep up with the 

pace of innovation by innovating ourselves. 

I think the challenge we have there, to go back to the core of 

your question, is that we are subjected to an elongated rule-filing 

process where all of our competitors can comment against us, yet 

we are never given the opportunity to comment on any innovation 

they might like to install in their less-regulated pool because they 

don’t have a rule-filing process. 

Mr. GRIMM. My time has expired. Thank you very much. I yield 

back. 

Chairman GARRETT. The gentleman yields back. 

35 

Mr. McHenry is recognized. 

Mr. MCHENRY. Thank you, Mr. Chairman; and I thank you for 

allowing me to sit in on this hearing and ask a question. 

As the panel knows, I have a bill. The committee staff has presented you with a draft. Many of you have made comments on it. 

The point is, we have small companies that maybe at the time— 

whether it is Whole Foods or Apple, Microsoft or Dell—started life 

as small companies that eventually moved to prominence. My 

thought process here is to incentivize small companies to seek our 

exchanges, to seek the public markets. It is good not only for the 

institution but great for small investors and those that are concerned about retirement savings and the like. 

But, with the advent of high frequency trading and markets 

being what they are, liquidity begets liquidity. So how do you help 

those that are on the edges? 

The comment made just a few minutes ago is we are not talking 

about a large percentage of the market, whether in cap or the 

amount of trading, but an important segment so that we can have 

folks get onto the public markets, so the idea being that you have 

some liquidity support. So with market fragmentation, high frequency trading, those top names get enormous focus. They get lots 

of liquidity as well. 

So, Mr. Niederauer and Mr. Joyce, you have mentioned this, but 

could you describe what you would expect to be included in a liquidity support agreement if my legislation were to pass. 

Mr. JOYCE. Your point is well made. I think the data has proven 

that most jobs are created post-IPO, so we certainly want to encourage as much of this as possible, getting companies into the 

public markets. 

I would say that we have talked about three main things, tick 

sizes being one. And under the heading of tick sizes, if they are 

wider, they may encourage more market makers to participate, 

more market makers to sponsor the stocks, the companies in question, more market makers to perhaps pick up research of these 

stocks and companies in question. 

I also think you need to make sure that you are comfortable with 

the relationship between the investment banking entity that is arguably bringing the company public and their own in-house research department. It is not always nefarious. It is not always 

what it has been portrayed as in the press. Usually, they work 

well, hand-in-glove, and it is a very beneficial relationship to have 

research support a new company. 

So, again, I would allow issuers to pay for market-making support, if that is the way they want to proceed. It doesn’t have to be 

a whole lot of money, but it would be something that would be an 

incentive. Make sure you allow research to articulate the story so 

that the general public will be interested in it, and think about 

why you need tick size to encourage market makers to participate 

more frequently than they currently do. 

Mr. NIEDERAUER. We have done things like this in other product 

areas already, so we think it is very applicable. In the markets we 

operate in Europe, this is already much more the rule than the exception. So we know there are some long-standing rules here that 

we hope your legislation will give us an opportunity to revisit, 

36 

right? We know that it has historically has been thought of as, 

well, we are not going to allow such a thing as a company incenting 

someone to provide liquidity in their security. We think your legislation opens the door, and we would be happy to work with you to 

do that. 

We also hope that the profit opportunity by widening out the 

spread for the dealers will make it easy for those markets to stay 

transparent. 

Ideally, from our point of view—I realize it is talking our own 

book—stay on exchange, which we think would be healthier. And 

we hope that one of the outcomes of this would not be that it gives 

a perverse incentive for people to make the markets more opaque, 

but I think we would be willing to take that chance. 

Because I think your first point is the right one. This is not only 

good for these small companies, investors; it is good for the country, right? Because this is where job creation comes from. This is 

the backbone of America. We need to get back to where we are facilitating their entry to the capital markets, which is the only 

growth capital they can get their hands on, to help them be great 

companies some day, and we have to give them their start. 

Mr. MCHENRY. So what protections are required in Europe to 

allow this basic liquidity support to be provided by broker-dealers? 

What does that look like? 

Mr. NIEDERAUER. Yes, I think the good news is there are not 

many protections required. Because it is just simply a pragmatic 

approach to saying that a lot of the benefits of market innovation, 

as you pointed out, Congressman, have helped the big companies. 

They really haven’t helped the SMEs. And that is not just in the 

United States. That is all around the world. 

So there is not a huge set of rules around this. It is just simply 

a pragmatic approach, kind of like the JOBS Act and the approach 

we took on Reg A was, where it didn’t require a huge amount of 

infrastructure around it. It is just common sense that says we need 

to create incentives for people to support these companies when 

they are in the public market. So we can share that with your staff, 

but it is not complicated in the slightest. 

Mr. MCHENRY. Thank you. 

Thank you, Mr. Chairman. 

Chairman GARRETT. I thank you, Mr. McHenry, and I thank the 

panel as well. I believe that concludes all the Members who are 

here for the first panel, so I thank the witnesses very much for 

your time. Your testimony was fascinating. 

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 30 days 

for Members to submit written questions to these witnesses and to 

place their responses in the record. 

With that, you are excused, and thanked as well. 

As you make your way out, we then look forward to our second 

panel. We just note that sometime today we will have votes, and 

I know there is another committee coming in after votes, so that 

is why we are moving on expeditiously to the second panel. 

Greetings to the second panel, and welcome as well. We welcome 

you here, and we look forward to your testimony, and the admoniVerDate Nov 24 2008 18:30 Feb 21, 2013 Jkt 076108 PO 00000 Frm 00042 Fmt 6633 Sfmt 6633 K:\DOCS\76108.TXT TERRI
37 

tion I will give to this panel as I always do, for those who have not 

been here before, is to make sure you bring your microphone close 

and try to abide by the little red, yellow, and green lights in front 

of you as far as your 5-minute timeframe. 

We will begin with Mr. Mathisson. Thank you for being with us, 

and you are recognized for 5 minutes. 

STATEMENT OF DANIEL MATHISSON, HEAD OF U.S. EQUITY 

TRADING, CREDIT SUISSE 

Mr. MATHISSON. Thank you. 

Good morning, my name is Dan Mathisson, and I am the head 

of U.S. equity trading for Credit Suisse. Credit Suisse is a U.S. 

broker-dealer unit formerly called First Boston, which has been in 

operation in the United States since 1932, and today Credit Suisse 

employs 9,400 people in the United States. I have been working in 

the equity markets for the past 20 years, and I appreciate the 

chance to appear here today and give my opinions on the markets. 

Credit Suisse believes that overall, the U.S. markets are very 

good and remain the envy of the world. We recently published a 

broad survey of market quality where we found that bid-ask 

spreads in the United States are the tightest in the world, intraday 

market volatility has been decreasing since 2005, and the total 

number of market disruptions has been decreasing over the past 

decade. After looking at these, plus a broad number of other indicators, we believe that Reg ATS, decimalization, and Reg NMS were 

all successful at making the U.S. markets more efficient, fair, and 

equitable. 

However, markets can always be made better, and so today we 

suggest three improvements. First, the trading errors that occurred 

on the day of the recent Facebook IPO served to highlight a peculiar quirk of the U.S. market structure that needs to be addressed, 

namely, that exchanges do not have material liability for their 

technology failures. Dating back to the days when exchanges were 

not-for-profit, member-owned organizations, exchanges have SRO 

status, and therefore, they have been considered by courts to be 

quasi-governmental entities. This quasi-governmental status means 

that they have historically fallen under the absolute immunity doctrine, which protects them from liability judgments even in cases 

of gross negligence or willful misconduct. 

Yet, exchanges today are not particularly different from brokerdealers. While they still have a few vestigial regulatory functions, 

the vast majority of their broker-dealer regulatory responsibilities 

are now outsourced to FINRA. Both exchanges and ATSs accept 

buy and sell orders and match them electronically; both exchanges 

and ATSs offer undisplayed orders, typically called dark orders; 

both exchanges and ATSs offer displayed orders; and both are forprofit enterprises. 

Although, practically speaking, they are very similar, they have 

very different legal status. ATSs may be held liable for their actions like almost all U.S. businesses, while exchanges may not. We 

believe that considering exchanges to be quasi-governmental entities no longer makes sense and that restoring exchanges’ moral 

hazard would be an important step towards creating a more reliable marketplace. 

38 

Exchanges should not have been allowed to convert to for-profit 

entities 6 years ago while still retaining their SRO status. You 

should not be able to be a for-profit and a not-for-profit at the same 

time. It is time for policymakers to correct this mistake by removing exchanges’ SRO status. 

Our second policy suggestion is that it is time to eliminate the 

restriction on broker-dealers owning more than 20 percent of an exchange. This would allow broker-owned ATSs to be become exchanges. Historically, the 20 percent restriction was put in place to 

ensure that broker-dealers could not control a regulator and regulate themselves. Yet now that exchanges are also for-profit enterprises just like broker-dealers, and now that they outsource most 

of their regulatory function to FINRA, we believe this ownership 

cap is obsolete. 

Exchanges have four very significant economic advantages over 

ATSs, which is why two ATSs, BATS and Direct Edge, worked very 

hard over the last few years to successfully convert from being 

ATSs to being exchanges. Allowing ATSs to convert to exchanges 

would effectively level the playing field, allowing regulators to have 

one set of rules for everyone. 

Lastly, we suggest it is time for the regulators to do a comprehensive review of the consolidated tape plans. The Consolidated 

Tape Association has a legal monopoly on providing a consolidated 

stream of real-time data from our Nation’s stock markets. The CTA 

sells this data and makes a profit of approximately $400 million 

per year, which is then rebated to the exchanges based on a complex formula. The revenue that exchanges receive from these rebates is significant. For example, in their annual report, NASDAQ 

reported receiving $116 million in tape rebates in 2011. These 

plans were set up in November of 1972. After 40 years, we believe 

the current tape revenue model is obsolete and rife with problems, 

and we recommend a full review of the tape revenue system. 

Thank you for the opportunity to appear today, and I will be 

happy to answer any questions that you may have. 

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

112 of the appendix.] 

Chairman GARRETT. Thank you. 

Mr. O’Brien, welcome, and you are recognized for 5 minutes. 

STATEMENT OF WILLIAM O’BRIEN, CHIEF EXECUTIVE 

OFFICER, DIRECT EDGE 

Mr. O’BRIEN. Thank you. 

Chairman Garrett, members of the subcommittee, I would like to 

thank you for opportunity to testify today on behalf of Direct Edge. 

With over 10 percent of all U.S. equity volume trading on our exchanges every day, we are one of the largest stock market operators, stock exchange operators not only in the United States but in 

the world. 

We have talked about the theme of confidence, and I think it is 

the right one. Investor and issuer confidence is perhaps at a low 

point. You can question the merits of those concerns, but those concerns exist, and I think you have to acknowledge them. I think 

there are some simple steps that we can take that are intellectually 

39 

consistent and operationally feasible to start the process of helping 

to restore that confidence. 

I don’t think monopolies are the answer; more efficient competition is. I think some people will argue that confidence is undermined by the number of choices that investors have and the complexity of navigating it. I just don’t believe that. I don’t think investors think the soap market is unfair because there are 500 different 

kinds of soap, and I don’t think they think the stock market is unfair because there are 50 places to execute your trade. 

I think, at the same time, we have to create more efficient mechanisms for those markets to communicate with one another in 

times of market stress. The flash crash, the recent IPO troubles 

were not caused or even made worse by fragmentation. They were 

made worse by the lack of efficient and effective communication 

among market participants in those situations. In the IPO situation, there were absolute monopolies, and there was very little visibility into what was happening there, and I think that was the biggest problem. 

Thankfully, I think we can easily improve this, and we have already started to do that. The limit up/limit down mechanism the 

SEC just approved can help all market participants deal with sudden and sharp changes in stock prices in a cohesive manner. I 

think more work can be done so that in crisis situations, all market 

participants can quickly come together to make sure these problems don’t cascade and investors are protected. 

I think rather than restricting off-exchange trading, exchanges 

should have greater flexibility to make their markets a better place 

for institutional and for retail order flow. I kind of reject the notion 

of an unlevel playing field. I don’t like that term. Somebody has it 

better, we have it worse, we need to fix it. I just want to make my 

exchange a better place for retail and institutional orders and for 

all our customers, quite frankly. 

I think sometimes we are hamstrung by the current application 

of the principle of fair access under Federal securities regulation, 

the notion that if you can’t make it available to everyone, you can’t 

make it available to anyone. I think we need to lay down a clear 

mandate, whether it is through provision of the Federal securities 

laws or other means, to make it clear that exchanges can roll out 

programs that are targeted toward long-term investors. 

I think we also need to highlight SEC oversight of market participant technology. The SEC is already doing this very rigorously. I 

don’t think a lot of people know it. There is the automation review 

policy and the related inspection programs the SEC undertakes 

which are very vigorous. That program, however, is still technically 

voluntary. I think it should be formally made a Commission rule, 

and I think that would send a powerful message to investors that 

the glitches that investors perceive to have occurred are being overseen from a regulatory perspective, and we are working to further 

mitigate these issues from a risk management perspective. 

I think with respect to technology, we have to incentivize the 

proper use of technology rather than trying to turn back the clock. 

It is going to be unique to the stock market that people view technology as the problem rather than the solution, but you can’t deny 

that it is a source of angst how automated our markets have beVerDate Nov 24 2008 18:30 Feb 21, 2013 Jkt 076108 PO 00000 Frm 00045 Fmt 6633 Sfmt 6633 K:\DOCS\76108.TXT TERRI
40 

come. At the same time, I think taking steps to making trading 

slower not only wouldn’t work; they wouldn’t improve investor confidence in the short term or the long term. I think it is about providing the right incentives in a framework of shared responsibility. 

Direct Edge was the first stock exchange to roll out a program that 

requires members to examine the amount of orders they send to 

our system relative to trades and imposed economic consequences 

if that ratio was too high. I think that is the type of framework 

that we should be pursuing rather than artificially impeding the 

evolution of technology in our markets. 

I think, in addition, investors need some more transparency regarding where their orders are routed in addition to where they are 

executed. A basic question that investors need to answer to feel 

confident, to trust but verify, is what happened to my order? There 

is a lot of information out there right now about where your order 

is executed, but I think investors want to know where it was routed in the course of trying to be executed as well. We could expand 

SEC Rule 606 for individual investors. We can actually implement 

this on an order-by-order basis technically quite easily for institutional investors, and we need to explore that. 

I do agree with the theme in the earlier panel that regulation 

should be made more flexible to enhance the trading of smaller cap 

companies. The one-size-fits-all model doesn’t work. The stock that 

trades 10,000 shares a day effectively trades under the same market structure as Bank of America that trades over 2,000 or 3,000 

times that amount. I think the legislative proposal put forth by 

Congressman McHenry and Vice Chairman Schweikert would be 

good first steps there. 

I think from an informational perspective, there is a concern that 

there is not adequate information for all investors. We need to create a national depth of book feed, not only to give investors easy 

access to the best price in the market at any one point in time, but 

all those prices, we can leverage the existing infrastructure and I 

think do that quite easily. 

Finally, I think the consolidated audit trail needs to be approved, 

implemented, and funded. Investors want to know that cops on the 

beat have the information and the tools available to do their jobs. 

Again, I think this will send a powerful message that we are making sure that happens. I thank you for the opportunity to testify, 

and I look forward to answering your questions. 

[The prepared statement of Mr. O’Brien can be found on page 

136 of the appendix.] 

Chairman GARRETT. Thank you, Mr. O’Brien. 

Mr. Solomon, welcome, and you are now recognized. 

STATEMENT OF JEFFREY M. SOLOMON, CHIEF EXECUTIVE 

OFFICER, COWEN AND COMPANY 

Mr. SOLOMON. Thank you, Chairman Garrett, and members of 

the subcommittee for inviting me to speak today. My name is Jeff 

Solomon, and I am the chief executive officer of Cowen and Company, an emerging growth investment bank that is focused on servicing growth-oriented companies in sectors such as health care, 

technology, telecommunications, media, aerospace and defense, and 

retail. Our clients are some of the best and most motivated entreVerDate Nov 24 2008 18:30 Feb 21, 2013 Jkt 076108 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 K:\DOCS\76108.TXT TERRI
41 

preneurs in the country. They seek to develop products and services that create positive change for whole sections of our economy 

and generate substantial long-term private sector jobs. These entrepreneurs need access to capital to fund their growth, but their 

choices to raise capital in the public markets are impacted by a 

lack of trading liquidity in small cap stocks. 

So when we talk about market structure, my perspective is guided by the belief that fostering trade liquidity in small cap stocks 

will increase access to capital for emerging companies and help 

generate job growth in the private sector. For the record, I just 

want to tell you a little about me. I was born and raised in Pittsburgh; I do not come from a long line of Wall Street executives. My 

father owns a small manufacturing business, and his father actually worked as a machine operator for Westinghouse Electric for 35 

years. Most of my 24-year career on Wall Street was on the buy 

side, where I was buying and selling public securities and private 

securities with a lot of Wall Street firms. 

So now, as the CEO of Cowen, I am advising companies on how 

to access the capital markets, and we also produce high-quality research on these companies. My comments focus specifically around 

small cap companies because I really think that is the area we 

should focus on as we talk about market structure. 

I would like to commend Congress on the recent passage of the 

JOBS Act, which will help, certainly help new issuers, but there is 

still a lot of work to be done around market structure to facilitate 

capital formation. The last decade has shown a significant decrease 

in trading liquidity for most small cap issuers. Mutual funds and 

exchange traded funds are now the dominant market participants, 

and a lack of trading liquidity in any small cap stock makes it difficult for these institutional investors to accumulate positions. 

Moreover, portfolio managers carefully assess liquidity when determining position size and price as they know it will be hard to 

exit an investment when their price targets are reached or should 

they need to sell to generate liquidity to meet investor redemptions. This dynamic has severely narrowed the investment universe 

for small cap companies that might be looking to do an IPO, and 

therefore makes it difficult for them to raise capital to expand. Indeed, the number of IPOs raising less than $60 million has fallen 

precipitously over the past decade. One of the reasons for the lack 

of trading in small cap stocks can directly be attributed to the advent of decimalization or penny increments. As a direct result of reduced trading spreads, professional market makers and specialists 

whose job it was to provide liquidity for their clientele were forced 

to overhaul, sell or dissolve their businesses in order to contend 

with much lower revenues. 

This, in turn, gave rise to two forces affecting market structure, 

which would be electronic trading and reduced research coverage 

for small cap stocks. In order to reduce costs, many firms developed 

electronic market makers to replace human market makers and 

specialists, which caused a severe reduction in price discovery between buyers and sellers of small cap stocks. 

While some of the effects of electronic trading are hidden in the 

larger names, it has become uneconomic for many sell-side firms to 

make markets in small cap stocks. In my opinion, we need to find 

42 

a way to bring back the human element that is so critical to fostering orderly liquid markets in small cap stocks. Wider spreads 

would certainly help to pay for that. To be clear, I am not calling 

for the wholesale repeal of decimalization, but like many people 

here, as we have heard on the panels today, decimalization is not 

a one-size-fits-all proposition. From what I see, decimalization has 

principally benefited institutional investors who trade stocks with 

market caps of $2 billion or greater, where the markets always 

exist to trade these stocks, but the benefits of trading small cap 

stocks in penny increments are far less clear to me when weighed 

against the effects of the obvious decline in trading liquidity that 

has occurred. As such, I am suggesting that Congress and the regulators consider increasing the tick increment from emerging growth 

companies or allow a company to determine their own increment 

size. Indeed, I recognize the SEC has undertaken a report on the 

impact of the decimalization on small companies as required by the 

JOBS Act, and I look forward to reading their findings. Some of the 

pilot programs proposed here today are also wonderful ideas as 

well. 

What I hear from private companies and small cap issuers is 

that it is essential to have published research from Wall Street 

firms following an offering. They understand that secondary market liquidity is critical to further capital formation needed to fund 

their growth, and with the support of revenue for market-making 

activities, Cowen would absolutely dedicate more resources to research and trading and support for these companies in the markets. 

To be fair, over the past decade a number of Wall Street firms 

have done things to damage their relationship with the American 

people and the investing public, but the vast majority of people on 

Wall Street, especially those at growth banks like my firm, had 

nothing to do with the mortgage mess or the financial crisis. 

By pursuing modifications to existing legislation and regulations 

around decimalization that bring back market makers for small cap 

stocks, Congress and the regulators will be telling Wall Street executives how they can allocate their resources to profitably meet 

the needs of their clients while fostering job growth in America. We 

can still be the leader in funding successful innovation in the 

United States, but in order to thrive, once again, we must make 

it more economically viable for small companies to access capital 

markets to fund their growth, create new industries, and provide 

Americans with the job growth from the private sector we so dearly 

want and need. Thank you. 

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

163 of the appendix.] 

Chairman GARRETT. Thank you, Mr. Solomon, I appreciate that. 

Mr. Toes, you are recognized now for 5 minutes. Welcome to the 

panel. 

STATEMENT OF JIM TOES, PRESIDENT AND CHIEF EXECUTIVE 

OFFICER, SECURITY TRADERS ASSOCIATION (STA) 

Mr. TOES. Thank you, Chairman Garrett, Ranking Member Waters, and members of the subcommittee. The STA welcomes the opportunity to present comments before the Subcommittee on Capital 

43 

Markets and Government Sponsored Enterprises on market structure. The STA was formed in 1934. We are an organization of individuals who are involved in the trading of financial securities. Our 

membership is diverse, both geographically and in the roles we fulfill in the marketplace. Much of our testimony today will reference 

years of comment letters STA has written on market structure, letters which were the culmination of input received from a wide 

range of market participants. The testimony of STA over the years 

has accurately informed and alerted Congress and the SEC to the 

possible consequences, both intended and unintended, of proposed 

changes to market structure. We are pleased to have the opportunity to do so today. 

Our testimony will focus on three areas of concern STA has with 

today’s market structure: investor confidence; capital formation; 

and the quality of regulation. We will also identify specific areas 

which we, as practitioners, believe are the primary forces causing 

our concerns: operational capability; decimalization; and the rulemaking process for both SROs and the SEC. 

Investor confidence is influenced by several factors, none more 

than the operational capability of the markets. Failures of that capability, even as a rare or limited occurrence, destroy investor confidence much more so than any regulatory or market structure minutia. Fostering greater operational capabilities should be the foremost consideration of any regulatory or legislative entity that has 

oversight or influence on our financial markets. It is imperative 

that such entities ensure no demands are made on the operational 

capacity of the industry that results in its being unable to deliver 

the services it purports to offer. Furthermore, behavior which 

stresses the operational capability of our markets should be identified and reviewed by the proper regulatory agency. Our markets 

need to be open to serve a wide range of market participants with 

varying business models. Therefore, it is critical that behavior 

which is deemed harmfully, potentially harmful to the overall operational capability of our markets not be allowed to exist 

unimpeded. 

Today, rules governing the securities markets are introduced to 

the marketplace by SEC initiatives in the form of rule proposals or 

the rule filings of SROs submitted to the SEC for approval. SEC 

approval of SRO rules and SRO rules in certain cases that are effective upon filing present unique problems. While there are similarities in these processes, they are distinct and vary primarily in 

the level of due diligence required of the Commission. There are efficiencies within both processes that when applied properly, serve 

the competitive nature of our markets and investor confidence. Our 

concerns at the STA reside in the lack of criteria that are used in 

deciding which process better serves investor confidence when rules 

are proposed. 

The Commission should consider alternative approaches to the 

approval of important SRO rules that have material market-wide 

implications on the structure of our marketplace. Rather than picking and choosing between the proposals or, in the alternative, approving all of them in cases where multiple rule filings are made 

that are identical or very closely related or where the SRO rule filings have material market-wide implications, the Commission 

44 

should consider substituting a proposal for a uniform market-wide 

SEC rule in lieu of those of the SROs. STA does not suggest that 

changes to fee structures or other SRO proposals that attempt to 

differentiate themselves would merit a uniform SEC approach. Instead, the Commissioners should propose uniform, market-wide 

rules when there are significant market-wide implications. 

STA believes that in addition to the review of specifics of SEC 

and SRO rule proposals, the quality of regulation would be improved and investor protection better served if the SEC addressed 

the increased need for industry input on technology and back office 

operations in the rulemaking process. The existing rule review and 

approval process is increasingly ill-suited to obtaining this information. We submit that the SEC needs to take formal action on regulations and particularly before adopting those imposing significant 

technological or operational burdens on the markets, to create advisory or implementation committees as permitted by law to ensure 

it receives input from the trading community including experts in 

trading systems and products and develops an understanding of 

the operational demands of the proposed rules. We are encouraged 

that in the adoption of the limit up/limit down pilot program, the 

SROs responded to the STA’s recommendation to establish an advisory committee which is to be composed of a broad cross-section of 

market participants who may submit views on the matters relating 

to the limit up/ limit down plan. 

Decimalization: There is perhaps no single market structure or 

event that has yielded more benefit to retail investors who transact 

directly with the marketplace to buy or sell securities than the introduction of decimal prices. The benefits for this class of investor 

are witnessed every day in the narrow bid-ask spreads in securities 

in which they trade. The data which shows implicit savings to 

these investors brought on by narrow spreads becomes even more 

impressive when it shows that even during moments of volatility, 

spreads remain tight. 

This benefit, which was immediate and long-lasting, however, 

has come with the cost of the secondary market’s ability to perform 

their capital formation function. In its letter to the Commission 

dated May 14, 2003, the STA wrote, ‘‘The raising of equity capital 

by corporations is the cornerstone of our economy. However, given 

the recent regulatory events surrounding research and investment 

banking and market structure changes affecting trading, the raising of capital has become exceedingly more difficult. That, in turn, 

is impacting the U.S. economy and its ability to create jobs. Action 

must be taken soon to remedy what could be soon a capital formation crisis. A reexamination of decimalization is a good place to 

start.’’ Members of the panel, we reiterate that this letter was written in May of 2003. 

The unintended consequences of decimalization have been dramatic, most notably in a decline in the quantity of liquidity provided in some stocks in the small- and medium-sized companies. 

Shareholders benefit from the presence of liquidity providers. They 

dampen market volatility. STA recommends an examination of the 

impact of decimalization on electronic and traditional market making as well as other liquidity providers, considering the costs of 

45 

maintaining trading operation in a decimalization regime and the 

balance of market maker obligations with the benefits. 

One way to conduct an examination is through a Commission-initiated pilot program utilizing a statistically significant number of 

small and mid-sized companies to study the impact of the secondary markets on quoting and trading securities in pricing increments greater than a penny. Thank you, and I look forward to answering your questions. 

[The prepared statement of Mr. Toes can be found on page 174 

of the appendix.] 

Chairman GARRETT. And I thank you very much. 

Mr. Weild, welcome to the committee. You are recognized for 5 

minutes. 

STATEMENT OF DAVID WEILD, SENIOR ADVISOR, CAPITAL 

MARKETS GROUP, GRANT THORNTON 

Mr. WEILD. Thank you. Chairman Garrett and members of the 

subcommittee, thank you for inviting me today to speak about an 

issue of great importance to many Americans: how to structure 

stock markets to better support the U.S. economy, job growth, and 

investors. 

My name is David Weild. I oversee the Capital Markets Group 

of Grant Thornton, one of the six global audit, tax, and advisory 

organizations, and I was formerly vice chairman of the NASDAQ 

stock market with responsibility for all of its listed companies. I 

also ran the equity new issues business of a major investment bank 

for many years. 

The IPO problem is, in reality, an after-market support problem. 

The current U.S. market structure failed to support the needs of 

small and mid-sized companies that were absolutely essential to 

U.S. economic success. My written testimony demonstrates four 

key structural challenges that the U.S. public stock markets must 

confront in order to foster the growth of small companies and in 

turn the economy. 

First, inadequate tick sizes, the smallest increment by which a 

stock can be bought or sold, have eroded the economic infrastructure required to support small cap stocks. This is to the forest issue 

that Mr. Campbell raised. This infrastructure includes equity research, sales, and capital essential to the visibility and liquidity 

that small public companies need. Think of tick sizes as the tolls 

required to maintain the bridges, roads, and tunnels of the stock 

market. In fact, our stock market today only covers the cost of 

trade execution services. Lack of after-market support for small cap 

companies means that fewer and fewer companies are doing IPOs, 

and fewer IPOs means fewer U.S. jobs. 

Second, inadequate tick sizes have undermined Wall Street’s fundamental ability to properly execute IPOs, and the evidence is 

clear. Companies going public today are more mature than they 

were in the 1990s, and yet their IPOs are failing at increasingly 

higher rates. More deals are being withdrawn, more are being 

priced below their initial filing range, and more are trading below 

their initial IPO price, including Facebook. 

Third, U.S. stock market structure is optimized, clearly optimized for trading big brand and large cap stocks. The structure enVerDate Nov 24 2008 18:30 Feb 21, 2013 Jkt 076108 PO 00000 Frm 00051 Fmt 6633 Sfmt 6633 K:\DOCS\76108.TXT TERRI
46 

courages computerized trading and speculation at the expense of 

fundamental investment, yet small cap companies under $2 billion 

in market value represent 81 percent of all listed companies but 

only 6.6 percent of market value. 

And finally, today’s one-size-fits-all stock market, which we believe is attributable to the order handling rules, regulation ATS, 

decimalization and regulation NMS, has the United States averaging only 128 IPOs per year instead of the 500 to 1,000 that we 

project in our written testimony. This has drastically reduced the 

number of U.S.-listed companies and has cost America, in our view, 

as many as 10 million jobs. 

There is ample rationale for treating small company stocks differently. You have heard much of it on this panel. We specifically 

recommend that small company issuers be allowed to choose their 

own tick size within a certain range, preferably 1 to 25 cents per 

share, to encourage research sales and trading support for their 

stock. Providing better economic incentives to support small cap 

stocks will lead to increased IPOs and in turn higher rates of capital formation and job growth by both public and private companies. 

We commend Congress for passing the JOBS Act. It is a good 

first step, but even while passing the Act, Congress recognized the 

need to review U.S. market structure by requiring the United 

States to study the impact of decimalization on the number of IPOs 

and small cap securities. Following the study, the SEC is allowed 

to set a minimum trading increment of 1 to 10 cents for emerging 

growth companies. We recommend that Congress encourage the 

SEC to go a step further and initiate a pilot program that allows 

all small cap companies to choose their own tick sizes ranging from 

1 to 25 cents within some tolerances. 

Back in 1971, there was a technology company that was unprofitable on an operating basis. It was only 3 years old when it went 

public and raised only $8 million. It created a revolutionary product, the first commercially available microprocessor chip. After it 

went public, it actually missed its product delivery date, and investors cut its stock price in half. Talk about risk. That kind of company would never make it to the IPO stage in today’s unforgiving 

market. The name of that company? Intel Corporation. 

How many Intels have been needlessly lost to the U.S. economy 

by today’s market structure? Congress has the power to help reverse our current situation and bring back the stock market that 

once was the envy of economies throughout the world. We recommend that Congress support an SEC pilot program that allows 

all small cap companies to choose their own tick sizes. Thank you 

for the opportunity to speak today. 

[The prepared statement of Mr. Weild can be found on page 178 

of the appendix.] 

Chairman GARRETT. I thank you, and I thank the entire panel. 

I will yield myself the first 5 minutes. Going in reverse order, 

Mr. Weild, on that point, so I think along the lines of some things 

that Mr. Campbell was raising, which were good points, the forest 

through the trees analysis, so we have heard, in the second panel, 

the second panel is a little bit different from the first panel, we 

have gotten into some more detailed recommendations on it. Mr. 

47 

Weild, you are saying, a couple of points you are making; one is 

that the one-size-fits-all is not appropriate, right? Let me just drill 

down on that on a couple points, and I will open this up to the 

whole panel. One-size-fits-all with regard to the regulatory nature 

of it? At the other end of the panel, Mr. Mathisson was talking 

about that aspect of it. Would you like to chime in on that, maybe 

either refute or support what Mr. Mathisson was talking about as 

far as the advantages and disadvantages that you have now where 

you don’t have a one-size-fits-all, where you have an exchange-regulated SRO situation out there and the cumbersome process that 

we have, they have with regard to changing of the processes on the 

platform as opposed to the ATS? 

Mr. WEILD. Chairman Garrett, I think it is a question of perspective. From the perspective of issuers, markets have been totally homogenized with decimalization and Reg NMS and Reg ATS, and as 

a consequence, markets trade identically, it really doesn’t matter 

any longer if you list on the New York Stock Exchange or the 

NASDAQ stock market for that matter. 

I think there is a separate issue, which is the regulation of those 

environments, and there is some diversity there, if you will, and I 

would take issue with Mr. Mathisson in the sense that I think it 

would be very unwise to create open-ended liability. We have two 

listed stock exchanges left in the United States, and if one of them 

had a catastrophic failure and were liable and were put out of business, that would just irrevocably harm investor confidence in the 

United States. These are two different issues. 

But for us to give issuers a seat back at the table, what happened with Reg ATS is that we opened up markets to lots of trading centric enterprises that don’t list companies, so the representation of issuers has been undermined. So if you give them choice 

over tick size, it puts them into a discussion with their institutional 

investors and with their value providers, the investment banks, 

about what are the optimum number, and it actually gives them 

a seat back at the table, which I think is one of the things that 

has been lost. 

Chairman GARRETT. Mr. Mathisson, do you want to chime in? 

Mr. MATHISSON. To respond to that, we don’t have 2 exchanges 

in this country, we have 13 exchanges in this country, and all of 

them do have the right to list stocks, and some of those inevitably 

will become successful at listing stocks. And if the regulators eliminated the 20 percent restriction on broker-dealer ownership of exchanges, we would likely have another 6 or 7 more, so we could 

have an environment where we would have 20 exchanges. If we 

had 20 exchanges, and one of them went down due to their own 

errors and had such a big trading incident that it brought their entire system down and they went bankrupt, you would have at 

least—in today’s world, we would have 12 others; you could have 

19 or 20 others if the restrictions on exchange ownership were removed. 

As for tick sizes, we would have no problem with an experiment 

to allow corporates to choose their own tick size. I think that it 

would not make a significant difference in the IPO markets or in 

the ability to raise capital. However, I do think it meets the chairman’s criteria that you mentioned in the first panel of, first do no 

48 

harm. I do not think it would do any harm to the markets, although I don’t expect it would significantly help, either. 

Chairman GARRETT. Moving down, Mr. O’Brien, you heard some 

of my questioning on the first panel, and I just wonder if you could 

chime in here, and also with regard to how the exchanges are 

treated under Dodd-Frank Section 915 and the like, in your opinion? 

Mr. O’BRIEN. Sure, and let me also add a couple of remarks on 

your other questions. I think we are somewhere in the middle. You 

remember Direct Edge’s history; we started as a broker-dealer-run 

ATS, and we volunteered for exchange regulation and classifications. It is not an accident of history or anything. We wanted to 

become an exchange. We took on that mantle willingly. I think, 

with some limited exceptions, the process works but could be improved, and I think thematically, just the approach of how exchanges are viewed as having to make everything available to everybody; we can’t create more targeted opportunities within the 

framework of a common network. 

Dodd-Frank was supposed to make the process better. It really 

hasn’t. I am not going to say it has made it worse. It has made it 

different in the sense that now these deadlines are hit, and the opportunities to extend review periods are taken, many more exchange rule filings are disapproved now or at least the proceeding 

to start disapproval begins. The SEC used to pocket veto effectively 

exchange rule filings they didn’t like. They can’t do that anymore. 

So rather than do that, they will just start the disapproval process, 

and that starts another clock. So the intent of what Dodd-Frank 

was meant to do is not being implemented in reality. 

Chairman GARRETT. In 3 seconds, any buyer’s remorse as far as 

going into the exchange format with all the restrictions you have 

now because of that? 

Mr. O’BRIEN. No, not at all, because it has been better for our 

customers. 

Chairman GARRETT. Thank you. The gentleman from Arizona. 

Mr. SCHWEIKERT. Thank you, Mr. Chairman. I always hate buyer’s remorse, don’t you? Okay, so much for some humor. 

Chairman GARRETT. That is right, so much for— 

Mr. SCHWEIKERT. Yes, I know. One of the things, and forgive me 

for being somewhat fixated on this, but the discussion of tick size, 

particularly someone who truly wants to see that next generation 

of small companies come to market. Does it really make a difference? Because we heard in the previous panel of technology, that 

is simple, they can deal with it. So now the question is, the SEC 

does its study. Should we go—should it be 1 to 25 cents, should it 

be 1 to 10 cents? First, does it make a difference? What should it 

be? Should the company be able to choose it itself or should there 

be some metric from the exchange choosing it? Mr. Weild? 

Mr. WEILD. I think that there is such an incredible difference in 

terms of the market values and the float values, micro nano cap 

stocks are under $100 million, stocks that trade 10,000 shares a 

day, and then the behemoths that trade in the millions of shares 

a day, that the one-size-fits-all tick size doesn’t allow people to actually create liquidity. Academic literature clearly shows that proVerDate Nov 24 2008 18:30 Feb 21, 2013 Jkt 076108 PO 00000 Frm 00054 Fmt 6633 Sfmt 6633 K:\DOCS\76108.TXT TERRI
49 

liferating ticks, small tick sizes actually increase liquidity in large 

cap stocks, but they are harmful to liquidity in micro cap stocks. 

So to answer your question, absolutely undoubtedly if you want 

to commit capital, buy a block of stock and get, as we used to say 

on the trading desk, long and loud to go find a buyer, you need a 

way to get compensated for that risk. So for a tiny little nano cap 

stock, under a $100 million, the right answer might be something 

close to a quarter point. 

Mr. SCHWEIKERT. Is that going to be necessary to get that stock 

covered by research? 

Mr. SOLOMON. Yes. Sorry, David, can I just— 

Mr. WEILD. Go ahead. 

Mr. SOLOMON. Maybe I am—I think I am probably one of the 

only people on the panel who actually has a company that writes 

research on this, and what I would say to you is unequivocally— 

Mr. SCHWEIKERT. It is your fault then, right? 

Mr. SOLOMON. We do it. I think what is incredibly important is 

exactly what David said here, the after-market support is really 

critical to funding companies going forward. I will give you an example with our own company. We are a small cap publicly traded 

company, we trade about 300,000 shares a day. If you take a penny 

increment, that is $3,000 a day if you own 100 percent of the market share in trading our stock on a daily basis. If I want to get 

more research coverage as an issuer today, I don’t—who is going 

to do that? Where is the value in somebody writing research on me 

to generate interest when they really don’t have a lot of economic 

incentive to do so? And I think that is a big issue. That is a very 

big issue. 

Mr. SCHWEIKERT. This is a one-off, but it is one we were just actually sitting here talking about a moment ago. For small companies, would you allow a company to provide a blind compensation 

for research? What would you do there? 

Mr. SOLOMON. I am not in favor of paid-for research. I think the 

research independence rules are good. I actually think the integrity 

of research should be held sacrosanct and different from anything 

that has to do with issuers and what they want research people to 

do for them to be clear. I actually think if you could set your tick 

increment much wider than the marketplace will react, and if you 

set it wide enough and there is enough profit incentive for middlemen to come in and start to make markets, then those middlemen 

will have an economic incentive to write research on your— 

Mr. SCHWEIKERT. So your view is the tick size is ultimately the 

solution to get covered and get someone willing to carry you? 

Mr. SOLOMON. Yes, I do believe that is true. 

Mr. SCHWEIKERT. Do I have a consensus there? And then what 

should it be? Should it be the 1 to 25 or should it be the exchange? 

Who else makes the decision? 

Mr. O’BRIEN. I think it is part of the solution. When you think 

about what a company looking to access the capital markets needs, 

they are really thinking about two things. One, can I access the 

capital markets in a way that doesn’t overly disrupt my ability to 

run my business day to day, and there are things that are totally 

unrelated to equity market structure; the application of SarbanesVerDate Nov 24 2008 18:30 Feb 21, 2013 Jkt 076108 PO 00000 Frm 00055 Fmt 6633 Sfmt 6633 K:\DOCS\76108.TXT TERRI
50 

Oxley, for example, would be an example of that. So there is work 

to do there. 

The second thing is, I don’t want to be creating a new problem 

for myself as a CEO by creating a group of new investors who feel 

like orphans who can’t sell what they bought, who can’t understand 

what is going on in the company. So, in that vein, the potential 

widening of tick sizes can definitely help. It can increase the liquidity at the bid and ask, so if I am an investor and I want to buy 

500 shares, I feel like I am going to be able to sell that, even if 

the stock only trades 10,000 shares a day because I see 500 shares 

posted at the best bid or best offer at any one point in time, and 

I think in terms of how you decide what those tick ranges should 

be, issuers were ultimately going to look to their advisers. I am not 

sure how much merit there is in empowering the issuer to pick 

stock by stock, and I think you also want ease of use for the individual investor, the person looking at the Scottrade or E*TRADE 

screen, they want to know what the minimum increment is, so they 

want some standardization. 

Mr. SCHWEIKERT. In the 3 seconds I don’t have, back to also part 

of the original question, does changing the tick size bring us new 

IPOs in the micro categories or the $100 million and less categories? 

Mr. TOES. Yes, and I think one area that hasn’t been touched on 

as far as a benefit of a wider tick increment than the pennies to 

cost savings. When you think about the cost to maintain the trading center today, a large portion of those costs are really based on 

transactions. So when you have multiple price points, when you 

need to clear a trade, when you need to capture a quote, store that 

quote, those are all transactional type costs that you are incurring. 

Whether you are clearing a trade of 100 shares or 1 million shares, 

the cost on that is the same because it is based on a transactional—on a transaction. So when you take the number of price 

points and you reduce it from a 100 down to 20 on a dollar, you 

are, in fact, decreasing the amount of transactional costs you have 

on market data and also clearing fees. So there is a cost savings 

to be had. 

Mr. SCHWEIKERT. Thank you for your tolerance, Mr. Chairman. 

Chairman GARRETT. Thank you. The gentleman from California. 

Mr. CAMPBELL. Thank you, Mr. Chairman, and so as the cleanup hitter, it would appear, up here, I am pleased to hear, I think, 

unanimity both up here and down there that we want to reengage 

small- and medium-sized businesses in public markets again, 

which they have disengaged, and that we want to reengage the 

public at large in public markets again, which they have disengaged. I hear pretty much agreement with Mr. Weild’s points on 

the tick sizes, with which I agree as well. 

Let me talk again about a couple of other broader things, and 

then elicit comments from the group. It appears that we have—we, 

the broad we, Congress, Wall Street—focused on increasing liquidity, increasing speed, and reducing bid-ask spreads at the expense 

of public confidence, and I say public confidence as opposed to investor confidence because we really need public confidence because 

everyone in the public is potentially an investor and ought to be, 

and as opposed to investment over speculation, gambling, and tradVerDate Nov 24 2008 18:30 Feb 21, 2013 Jkt 076108 PO 00000 Frm 00056 Fmt 6633 Sfmt 6633 K:\DOCS\76108.TXT TERRI
51 

ing, and transparency, that we have sacrificed those things for the 

speed, the spreads, and the liquidity, and that is not a good thing, 

and we need to turn the tables the other way. 

And then when we talk about why people don’t IPO, I have 

talked to a number of different owners, CEOs, CFOs, et cetera, of 

companies who have either gone private, chosen not to take an 

IPO, or who are now in one of these nonpublic entities that has 

hundreds or thousands of investors, and why don’t they go public? 

I hear cost; that is a lot of it. We all know that, and we are trying 

to address that, and we have more to deal with, and that certainly 

is a lot of it. But I hear a lot of other things, too, that they really 

don’t want the value of their company determined by people whose 

investment—I will use that term loosely this time—horizon is between milliseconds and months. And particularly if you talk to 

some of the people who have the large privately traded multiple 

stockholder companies, they want investors; they don’t want traders determining the value of their company, and that that is something that my question would be, how do we get more of that? 

And another thing is, and it seems that a lot of what we talk, 

there are people on Manhattan island talking to other people on 

Manhattan island about how to keep people on Manhattan island 

happy with the possible exception of a few people in Boston, who 

manage some funds, and I have had a couple—and it is amazing, 

I have heard this from several different people, and they said, I 

just didn’t—I went into, I was in a red—doing close to a red herring on a road show, and I realized that the entire value of my 

company was being determined by some 25-year-old Harvard MBA, 

who graduated 3 months ago, who is with a fund that will determine the entire value of this company and will tell me, and I am 

going to use my industry in order to keep the innocent here, but 

who is going to tell me, who spent 35 years in the car business, 

whether I am running my car business well or not, and by the way, 

that 25-year-old Harvard MBA doesn’t own or drive a car. And I 

am not going to allow my company’s value and subject it to that 

kind of ridiculous oversight. 

So I burned up all but a minute. But how are we going to solve 

those problems? Because I am not making this stuff up, and these 

are not single individuals who are telling me this. They are multiple individuals, and they are not in the public markets— 

Mr. SOLOMON. —road shows in Pittsburgh, I am for that. 

Mr. CAMPBELL. Okay, fair enough. I should say Washington to 

Boston, that little thing right along there. Anyway. Yes? 

Mr. TOES. There are a couple of topics that you hit on there that 

speed for some reason has gotten a nasty connotation next to it. 

Speed actually helps investor confidence. People who sit at home 

and they look at the—they are trading from their, they are trading 

directly with the marketplace, investors, traders, they want to 

know when they look at the price on the screen from their computer that the price is what the price is at that moment in time, 

not— 

Mr. CAMPBELL. Millisecond speed? 

Mr. TOES. Hold on a second, hold on a second. Let me finish. And 

they want to know that the price they are looking at is where the 

stock is trading at that time, and when they hit the button to buy 

52 

or sell, when they make the decision to buy or sell, that the price 

they get is the price they are seeing on the screen. You are correct. 

Mr. CAMPBELL. If they hit the button fast enough. I would make 

exactly the opposite argument. You cannot hit the button fast 

enough today. People don’t—that isn’t quick enough. 

Mr. SOLOMON. I think there are different kinds of investors. So 

speed is one attribute that is desirable, but you have to ask yourself the question of whether or not there could be balance. I certainly think that for a lot of the issuers we talk to, absolutely what 

you said resonates. They want long-term investors. If you buy it at 

a penny lower or a penny higher, it shouldn’t matter if you are a 

long-term investor. There used to be a saying on the Street, ‘‘Don’t 

miss the trade for a quarter.’’ I watch people every day miss the 

trade for a penny or half a penny, and I wonder to myself, if you 

really have some long-term view on whether you think the stock 

is going to trade higher or lower, what does it matter to you? 

To some people, it does, and I think we need to be able to offer 

that, so you don’t want to take that away, and speed has helped 

with execution, no question about it, but you have to ask yourself 

at what expense, and I certainly think that if we can create, again, 

a fundamental marketplace where there is an opportunity for middlemen to stand and really take risk positions with the advent of 

creating liquidity, that is really what I think Wall Street is probably supposed to be doing, really taking risk positions and finding 

buyers and sellers and crossing trades and really moving product 

as opposed to storing product. That is really what is at the cornerstone of creating that ecosystem that is so vital for new issuance. 

And speed plays into that, but I don’t care if the market is fast or 

the market is slow as long as there are people congregating at a 

common point that will allow for there to be more trading liquidity 

on a daily basis. 

Mr. WEILD. Larger tick sizes throughout the market favor investors over traders and computer strategies. 

Mr. CAMPBELL. Okay. If there are no other comments from you, 

then I will yield back, Mr. Chairman. 

Chairman GARRETT. The gentleman yields back. The gentlelady 

from New York, where all these trades are happening, and where 

25-year-olds are doing these nefarious things. 

Dr. HAYWORTH. I am 52; don’t blame me. Thank you, Mr. Chairman. 

Mr. Weild, you just referred to tick size, and I did have the opportunity to ask members of the antecedent panel about how we 

might, how you might provide guidance from your industry perspective toward a pilot project, and I know Mr. Schweikert has 

been working, I think, with the SEC on studying the implications 

of tick size for the liquid small cap marketplace, but there certainly 

has been support for a pilot project. What elements would you like 

to see in terms of flexibility of setting the tick size? How would you 

base that? What kind of parameters would you use for that kind 

of flexibility? Who should be managing or participating in that kind 

of pilot project? And, I open it to the panel. 

Mr. Toes, maybe you would like to start? 

Mr. TOES. We do have some suggestions for the Commission on 

what criteria to use. We realize that it is a core function of the Act 

53 

that marketplaces are supposed to allow for customer-to-customer 

activity and have that activity go on unimpeded by middle people, 

but the criteria that we would use is that the role of the market 

maker obviously is to offset imbalances, when there are no customer-to-customer, when there are no buyers and sellers in the 

marketplace. So we feel the best way to measure that occurrence 

is to really look at the dollar volume of these particular stocks. So 

we would probably look for a criteria that is based less on the price 

of security, less on this actual market cap of the security, but more 

to do with the dollar volume of what the stock trades because we 

feel that is probably the best indicator for what, how much customer natural flow resides in the particular stock. 

Dr. HAYWORTH. Where the marketplace is of the stock’s viability, 

if you will, how vigorously it is trading. 

Yes, sir? 

Mr. O’BRIEN. I think that there are two principles we should adhere to when trying to implement any kind of experiment or pilot 

program with tick sizes. First, it has to be easy to assess the impact of it, right? That is why I am not necessarily in favor of each 

issuer choosing. The process of them choosing is going to take some 

time, and it may be isolated. 

Dr. HAYWORTH. Too many variables? 

Mr. O’BRIEN. Too many variables. You want to address those 

things out. The second is that you want it to be easy for investors 

to understand. Again, we may think it is good, but if the average 

person in your district thinks, here is another aspect of the stock 

market where the analyst knows what each tick size is and I don’t, 

it could cause some disengagement, and I am not in favor of that. 

I would agree with Mr. Toes; the two variables I think are the 

size of the company in terms of its market capitalization and its 

trading volume on a dollar volume or perhaps even a share volume 

basis, and take a subset of all securities that meet certain criteria 

along those matrix and implement it for a period of time. That will 

give you not only the data, but it is something that even people 

who aren’t lifelong Manhattan residents can understand what we 

are doing, why we are doing it and can understand whether or not 

it worked or not. 

Dr. HAYWORTH. Got it. And I appreciate those thoughts very 

much. 

Mr. Weild, any thoughts about where such a pilot should be 

based or how it should be administered, so to speak? 

Mr. WEILD. Sure. I think that you need a critical mass number 

of stocks to get the data to do the direct comparisons the micro 

market economists will want to look at. I think you are going to 

need on the order of 500 stocks over the course of 2 to 3 years, and 

I think if it is proven to be successful and adequate representation 

based on the market value, flow values, and volumes. 

And again, I do think that allowing issuers, not independently, 

but in conversation with their institutional investors and with their 

value providers, like Cowen and Company, to have a discussion 

with them to make recommendations about what their tick sizes 

should be and then have the board make a decision, I think would 

tell the market an awful lot about what the real, what the right 

value is. There is a big difference. Capital Research, with nearly 

54 

a trillion dollars under management, is investing in very different 

stocks, for example, than Wasatch Advisors in Salt Lake City that 

is a growth company investor, and so I think that from having that 

direct input, I think people are largely rational within a tolerance, 

they will come up with a better answer, market forces will cause 

a better answer than we will. 

Dr. HAYWORTH. Right. 

Mr. SOLOMON. I also think simple is better. I totally agree with 

you; keep it simple. I also believe investors like round numbers. 

Round numbers are good. When you meet somebody, you tell them 

you are going to meet them at the corner of something and something, you don’t tell them you are going to meet them in between 

the corner of something and something. It is the human condition, 

right? So I actually think if you put it in increments that are relatively straightforward that we all understand—nickels, dimes, 

quarters—are good things for people to really get their heads 

around, and it makes it a lot easier for people to understand exactly how this is going to work. 

I do think, like Mr. Weild said, it needs some time because I will 

have to make some investments in order to bring this back. It 

won’t just turn on all of a sudden. I will be looking at adding new 

research analysts. I will be making some up-front investment to 

see how we can sponsor companies more. So it will take time for 

it to work through the system. And of course, I am going to want 

to know that there is a commitment to this pilot program for some 

period of time because I am going to be making an upfront investment to see if I can get it to work for me as a CEO. 

Dr. HAYWORTH. That makes a lot of sense. I thank you, sir, and 

I yield back. 

Chairman GARRETT. The gentlelady yields back, and that brings 

us to the conclusion of the second panel, and the conclusion of today’s hearing. Again, I thank you all very much for the illumination that you brought to this topic. And I very much thank you all 

for being here. 

Without objection, I will be putting into the record three items, 

all of which are from SIFMA: a paper on displayed and nondisplayed liquidity, dated August 31st; a June 25, 2010, letter on market structure roundtable; and an April 29th of the same year concept release on equity market structure, which will all be part of 

the record, without objection. 

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 30 days 

for Members to submit written questions to these witnesses and to 

place their responses in the record. 

And with that, this hearing is adjourned. Thank you, gentlemen. 

[Whereupon, at 11:55 a.m., the hearing was adjourned.] 

(55) 

A P P E N D I X 

June 20, 2012 

56 


76108.001

Written Statement of Daniel Coleman 

Chief Executive Officer, GETCO 

Before the 

House Financial Services Subcommittee on Capital Markets and 

Government Sponsored Enterprises 

Market Structure: Ensuring Orderly, Efficient, Innovative and 

Competitive Markets for Issuers and Investors 

June 20, 2012 

Chairman Garrett, Ranking Member Waters, and members of the Subcommittee: 

1. Introduction 

My name is Daniel Coleman and I am the Chief Executive Officer of GET CO, a leading global 

electronic market maker. I appreciate the opportunity to provide testimony regarding equity 

market structure. 

The regular review of our capital markets, and the regulatory framework that applies to it, is 

critical to the continuing vibrancy of those markets. This review is more vital now than ever 

before because, over the last decade, investor confidence in our markets has slowly deteriorated, 

as nearly every facet of our financial and banking systems have in one way or another led 

investors to question the effectiveness, transparency, stability, fairness and overalllcgitimacy of 

how our markets manage risk, promote capital formation, allocate capital and operate fairly. 
57 


76108.002

It started with the bursting of the Internet technology bubble in 2000, followed by accounting 

and investment banking scandals in 2001 and 2002, the mutual fund late trading and market 

timing disgraces of2004, and culminated in the events of the last tour years: 0) the credit 

bubble that initiated the 2008 financial crisis that nearly destroyed our financial and banking 

system; (2) the heart stopping May 6th 2010 "flash crash" that caused investors to doubt the 

operational stability of our national market system, and; (3) the recent events ofthis year that 

raise legitimate concerns about the role of technology in the capital fornlation process. 

And, while critics of our current market strncture pinpoint the lack of investor confidence solely 

on the shortcomings of our national market system, the last decade has also brought 

transformational and positive changes in how capital is allocated and investors access liquidity. 

These changes reflect why the u.s. markets are still the most dynamic, efficient and trusted 

markets in the world. 

GETCO has witnessed first-hand these positive developments and we believe that if certain 

regulatory and operational changes to our current markct structure are adopted that adhere to 

core principles-promoting competition, price discovery, efficiency, transparency, stability and 

fairness-investors will once again believe in the soundness of our financial, banking, and 

capital market systcms and trust the financial community with their hard earned investing 

dollars. We look forward to participating and contributing to this discussion. 

II. Background on GETCO 

GETCO was founded in 1999 by two Chicago floor traders from the Chicago Board Options 

Exchange and the Chicago Mercantile Exchange who saw that their bnsiness of market making 

or "risk transfer" was at the begimling of a transformational shift trom analog to digital--or in 

trading parlance from the "pit" to the "screen." This transformation has occurrcd in nearly all 

asset classes and products-from stocks, like GM and GE that arc listed on the New York Stock 

Exchange, to futures contracts tied to agricultural products, likc com and soybeans that trade on 

the CME. As a result, in the last 13 years GETCO has grown to trade on over 50 exchanges and 

trading venues around the world in cash and futures products across four asset elasses - equities, 

fixed income, currencies and commodities. The firm currently has over 400 Associates located in 

Chicago, Ncw York, Palo Alto, London, Singapore and Hong Kong. 

2 
58 


76108.003

GETCO's primary business is as an electronic market maker--which is akin to a floor trader or 

"specialist" of the last century--posting two-sided markets on exchanges around the world to 

help investors efficiently transfer thc risk associated with holding a particular asset The service 

GETCO provides allows investors to immediately access publicly available liquidity, while 

saving money on trading costs_ In the llS_, GETCO is a registered market maker in over 4000 

securities on various equity and options exchanges J and is the second largest Designated Market 

Maker on the New York Stock Exchange. 

In 2008, GETCO expanded its core market making business by establishing GETCO Execution 

Services ("GES")-a client services business that executes orders on behalf of other brokerdealers and institutional clients. Through GES, GETCO operates three distinct businesses that 

leverage the technology and expertise of a global market maker. These services-GETMatched, 

GETAlpha and GETRouted- are designed to meet new demands by clients for better execution, 

routing and algorithmic serviees_ In 20 I 0, we began expanding these offerings to European 

markets. 

GETCO's Role as a Market Maker 

Market makers such as GETCO have existed for hundreds of years and their role has stayed 

constant: to bridge the gap in time between when natural buyers and sellers enter the market 

GETCO fundamentally believes that one of the primary purposes of a financial market is to 

allocate risk to those persons or entities best able to bear it. As natural counterparties do not 

necessarily meet in time, place, and size, market makers such as GETCO commit their own 

capital and assume a variety of financial risks until a natural counterparty can be found. 

In performing this intermediation role, market makers do not take directional positions or make 

"bets" on the long tcrm price of an asset. Instead, by providing continuous two-sided quotations, 

market makers allow consumers ofliquidity (i.e., natural buyers and sellers) to immediately trade 

Registered Equity Market Maker: BATS; Direct Liquidity Provider: Nasdaq; Lead Market 

Maker: NYSE Arca, Designated Market Maker and Supplemental Liquidity Provider: NYSE; and 

Registered Option Market Maker: BATS Options, C2, Chicago Board Options Exchange, 

International Securities Exchanges, Nasdaq Options Market, NYSE Amex Options, and NYSE 

Arca Options. 

3 
59 


76108.004

Market Makers Provide Multiple Benefits to the Markets: 

Lower trading costs by reducing the costs associated with finding someone with whom 

to trade. 

Reduce market volatility by buying when others want to sell and sclling when others 

want to buy. 

• Add liquidity and facilitate price discovery by posting quotations against whieh other 

market participants can use to value their portfolios or trade. 

Promote competition among markct centers and liquidity providers so that individual 

and institutional invcstors benefit from lower costs and access to diverse liquidity pools. 

In cxchangc for these services, markct makers generate revenue from the "Bid! Ask" sprcad, the 

difference between the buying price and selling price of a security. Numerous studies show that 

this spread has dramatically fallen over the last 20 years. This narrower spread is a direct cost 

savings to investors. 

Automation is used by today's electronic market makers to manage their risks by controlling 

how and whcn orders are placed and modified. By using technology to better control their risks, 

markct makcrs can offer better prices and reduce trading costs to investors. Electronic market 

makers provide the same benefits to market participants as traditional market makers but on a 

greater scale: 

• Dampcn markct volatility 

Reduce tradi ng costs 

Provide liquidity 

• Facilitate pricc discovery 

Provide safe and efficient method of risk transfcr 

4 
60 


76108.005

GlnCO's Client Services BusincS'; 

GETCO's client services business otfers three high-tech trading solutions that help investors 

solve their execution nceds: 

GETAlpha: An execution algorithm for U.S. equities that uses the same high-tech 

trading tools as a dedicated electronic market maker. By leveraging GETCO's 

proprietary trading systems and expertise, GET Alpha allows institutional investors to 

place trades with minimal market impact and protects against infornlation leakage or 

detection. 

GETRouted: A smart order routing solution for U.S. equities that provides institutional 

investors with the ability to completely customize their order execution strategy. 

• GETMatched: An Alternative Trading System registered with the SEC that provides 

access to the dedicated liquidity of GET CO's electronic market maker. GETMatched is 

the 5th largest OTC platform or "dark pool" by volume and executes trades only when 

there is a match at the National Best Bid and Offer (NBBO) or better. 

All client offerings are fully optimized for interaction with each other. 

III. U.S. Equity Market Structure 

Over the last 15 years, technology advancements and regulatory changes have created a U.S. 

equity market that is open, efficient, stable, transparent, competitive, and innovative. From the 

standpoint of choice, access, and cost, investors are better off than ever before in today's 

markets. Execution speeds have improved, trading costs are lower, and liquidity has increased, as 

measured by tighter bid-ask spreads and larger size in the consolidated market order book. And 

despite such dramatic improvements in how our markets function, investor confidence is as 

brokcn as it has ever been. It has been shakcn by a series of high-profile events that paint a 

picture of an overly complex, fundamentally fragile market-system. In spite of many advances, 

investors-both individual and institutional-- feel out-gunned, over-whelmed and out-of-touch. 

5 
61 


76108.006

A. Post-May 6th Refonns 

The market events of May 6, 2010 revealed flaws in the U.S. equity market structure. GETCO is 

very supportive oCthe SEC's and CFTC's well-reasoned retornls since then, which limit the 

potential for another, similar event. Within the first few months, the SEC led the exchanges and 

FINRA in implementing single stock circuit breakers, eliminating stub quotes, and establishing 

clearer rules for breaking trades that are clearly erroneous. This quiek action went a long way to 

restoring confIdence in the markets. 

In addition, the SEC and CFTC established a Joint Advisory Committee on Emerging Regulatory 

Issues composed of industry leaders and investor representatives. This Committee made wellreasoned recommendations for further regulatory refonns, J some of which the SEC has already 

adopted. 

For cxample, a few wecks ago, the SEC approved the securities exchanges' and FINRA's 

Volatility Plan (thc "Plan")-- a market-wide limit up-limit down mechanism to address 

extraordinary market volatility, GETCO supported this new Plan, which is intended to replace 

the single-stock circuit breaker pilot that was put in place beginning in June 2010. This new Plan 

improves upon the single-stock circuit breaker pilot by preventing trades in NMS stocks at prices 

outside of appropriate pre-set limits. The Plan also retains the concept of trading pauses when 

more fundamental price movcs occur. 

In addition, in Novcmber 2011, the SEC adopted a ban on naked sponsored access and required 

broker-dealers that provide access to trading on an exchange or alternative trading system to 

implement prudent risk management controls. GETCO supports these requirements1 and many 

other jurisdictions have, or are considering, similar measures. In its market making business, 

GETCO trades its own capital so risk management is an essential component of our operations. 

Accordingly, GETCO supported the market access rules because any market participant with the 

Recommendations Regarding Regulatory Rcsponses to the Market Events of May 6, 20 I 0, 

Summary Report of the Joint CFTC·SEC Advisory Committee on Emerging Regulatory Issues 

(February 18,20 II). 

Letter to Elizabeth Murphy, Secretary, SEC from John McCarthy, General Counsel, GETCO, 

dated April 1,2010 (commenting on the SEC's proposed Risk Management Controls for Brokers 

or Dealers with Market Access). 

6 
62 


76108.007

ability to directly enter orders onto a market should be subject to the same pre-trade risk 

management and supervisory procedures as registered broker-dealers. 

Finally. GETCO supports the creation ofa Consolidated Audit Traile! to provide the SEC and the 

SROs with efficient access to a robust and effective cross-market order and execution tracking 

system. We do not, however, believe that a "real time" audit trail is necessary to achieve this 

objective and would impose significant costs on both regulators and the industry. Instead, audit 

trail information received on a delayed basis would provide the same benefits as real-time 

information, at a substantially lesser cost. 

B. Roles. Obligations and Incentives for Market Makers 

Despite the worldwide financial tUTIl10il of the last several years, U.S. markets arc still the most 

liquid and efficient in the world. GETCO believes strongly that a significant reason for the high 

quality of U.S. markets is the liquidity provided by market makers. 

While all market participants contribute to efficient and liquid markets. a market maker's 

primary activity is to facilitate trades by buyers and sellers either on an exchange or in the OTC 

markets. Market makers come in different shapes and sizes, but they perform many similar 

functions. In general, a core principle of market making is the immediate provision of liquidity 

to buyers and sellers - either directly to a market maker's customers or indirectly through the 

public markets. Market makers create a steady and continuous stream ofliquidity - buying when 

investors and other market participants are selling and selling when they are buying. By 

providing liquidity on a continuous basis, market makers facilitate the efficient transfer of risk. 

In response to the evcnts of May 6, 2010, the SEC-CFTC Joint Advisory Committee on 

Emerging Regulatory Issues recommended that the SEC evaluate whether incentives or 

regulations can be developed to encourage persons who engage in market making strategies to 

regularly provide buy and sell quotations that are "reasonably related to the market." 

GETCO supports this recommendation and believes that fair questions have been raised about 

current market rules that impose no real quoting or trading requirements on market makers, nor 

4 Letter to Elizabeth Murphy, Secretary, SEC from John McCarthy, General Counsel, GETCO, 

dated August 10,2010 (commenting on the SEC's proposed Consolidated Audit Trail). 

7 
63 


76108.008

provide adequate incentives. As articulated in our letter, to the SEC staff in July of2010.;; we, 

along with Virtu Financial and Knight Securities, believe the obligations associated with market 

making need to be modernized to reflect the current electronic markets that evolved over the last 

10 years. By encouraging market participants to undertake clear and mcaninglul obligations, we 

believe the likelihood of instances of price dislocations like the one that occurred on May 6th 

20 I 0 would be substantially reduced. 

C. Undisplayed Liquidity 

As the SEC noted in its Concept Release on Equity Market Structure,!! undisplayed liquidity is 

not a new phenomenon. Dark liquidity in the equity markets takes the fom1 of undisplayed orders 

carried by floor brokers and block orders held upstairs, as well as over-the-counter market 

makers that trade with retail customer orders. These non-displayed pools of liquidity are 

beneficial and serve numerous legitimate tunctions, including improving fill prices, reducing 

market impact and information leakage, lowering transaction fees, and fostering innovation. 

The impact ofundisplayed liquidity on the quality of public price discovery is an area of inquiry 

by policymakers in many jurisdictions around the world. Publicly disseminated prices serve an 

important role in price discovery and the challenge for regulators is to strike the right balance in 

protecting the important role that public markets play in fostcring price discovery, while also 

recognizing the interests served by undisplayed pools ofliquidity. This inquiry requires 

policymakers to balance the public good that is associated with encouraging market participants 

to publicly display orders with the interests of each individual retail and institutional customer to 

get the best execution for its order. 

GETCO believes that there are incremental market-based changes that the SEC could make that 

would promote priee discovery, without reducing the choices that investors have regarding 

where to trade and prescrving the ability of new market centers to innovate, develop, and 

compete. As discussed in more detail below, GETCO believes that the SEC could adjust tick 

sizes for certain high and low priced securities, treat actionable indications of interest (lOIs) as 

Letter to Robert Cook, Director, Division of Trading and Markets, SEC dated July 9, 20 I 0 from 

John A. McCarthy, General Counsel, GETCO, LLC, Christopher R. Concannon, Partner, Virtu 

Financial, LLC, and Leonard 1. Amoruso, General Counsel, Knight Capital Group, Inc. 

Securities Exchange Act Release No. 61358 (Jan. 14,20 I 0),75 FR 3594 (Jan. 21, 2010). 

8 
64 


76108.009

quotations, and lower the threshold for requiring display into the public quote stream ofIOIs and 

other quotations. 

J. Tick Sizes 

GETCO believes that there are optimal tick sizes for securities, which are not always the same as 

the narrowest tick size. Optimal tick size is important to fostering price discovery in the public 

market and promoting efficient markets. The optimal tick size depends on the liquidity of a 

stock, its price and volatility. 

SEC rules currently establish minimum tick sizes at 1 cent for securities priced above $1.00. This 

current minimum tick size requirement crcates inefficiencies and has detrimentally affected the 

price discovery process. As stock prices decline, the tick sizc becomes a greater percentage of 

the price of the stock - incenting internalization and hidden liquidity in certain low priced 

securities. By contrast, in Europe, in the absence of regulation around tick size, the exchanges 

mutually agreed on a tick size for a range of prices. As the stock price decreases, so does the tick 

size. 1 GETCO believes that all orders in the U.S., especially retail orders, would routinely 

receive better-priced executions if the minimum tick size were correlated to the share priee of the 

security. 

An example of this can be seen in Citigroup, which until its reverse split - was a low prieed, but 

highly liquid stock. A firm's profit from trading against its client orders in Citigroup - a $5 stock 

with a I cent! 20 basis point spread - was significantly higher than the profit made from 

internalizing a client's order in Microsoft - a $30 stock with a I cent! 3 basis point spread. As a 

result of an inappropriately large tick size, the Citigroup orders - as with other low priced, high 

volume securities - were less likely to be traded on the public transparent markets. 

To illustrate, in the U.S., all stocks under $10.00 have a tick size that is greater than 0.1 % of the stock 

price. By contrast, in Europe, the tick size is never more than 0.1 % of the stock price. Also, in the U.S .. 

all stocks above $50.00 have a tick size that is less than 0.02%, of the price. III Europe. by contrast, the 

tick size ofa stock is never less than 0.02% of the price. 

9 
65 


76108.010

2. Actionable Indications of Interest 

GETCO supports transparency and its role in the public price discovery process. We support the 

SEC's proposal to treat actionable lOIs as quotations, subject to the same obligations as explicit 

finn quotes under SEC rules. Actionable lOIs convey infonnation that there is actionable trading 

interest in a security, which is tbe same as the infonnation conveyed by a finn "bid" or "offer.·' 

GETCO's alternative trading system. GETMatched, does not display orders to any users oftbe 

trading system. Moreover, GETMatched docs not intcract with lOIs from other trading venues. 

We believe that when participants in exchanges or ATSs have access to infonnation about 

potential trades that other market participants do not have, it creates a two-tiered market that is 

inconsistent with an dlicient market structure. 

3. Lowering the Threshold for Order Displav and Execution Access 

GETCO supports the SEC's proposal to lower the threshold at which A TSs must display the best 

priced orders in the public quotation stream. Currently, if an A TS displays orders to more than 

one person, its best-priced orders must be publicly disseminated when the ATS accounts for 5% 

or more of the average daily volume tllr a stock. The A TS must also provide broker-dealers the 

ability to trade with the displayed order. The SEC proposed to lower the threshold to 0.25% from 

5%. GETCO agrees with the Commission that lowering this threshold would reduce the potential 

for a two-tiered market and improve the quality or publicly available quotation data. 

D. Liquidity Rebates 

Markets have always rewarded or incentivized market participants to provide liquidity. The 

practice by some trading venues of offering rebates to participants that provide passive liquidity 

leveled the playing field by opening up liquidity provision to competition. Rebates allow market 

makers to post better prices on public markets, which directly improve the executions of liquidity 

takers. In the absence of rebates, effective sprcads would be wider, and wider spreads are a cost 

borne by liquidity demanders in the same way as explicit fees. 

Rebates allow market makers on public trading venues to post competitive prices, with the result 

of reducing transaction costs and increasing liquidity. Because ofthe ability of liquidity 

providers to post better quotes, average investors, whose orders are frequently internalized at the 

10 
66 


76108.011

prices displayed in the public market, also have lower transaction costs as a result of these 

rebates. 

The rebates paid to liquidity providers are generally funded through explicit fees paid by 

liquidity takers. However, when this explicit fee is paid by investors to trade with a better priced 

quote, the investor receives a bettcr net execution price. A liquidity taker that trades on a market 

with the best quoted price and transparent "taker" fees that are less than the minimum trading 

increment will always be receiving the best net price. For this reason, it is important that 

policymakers consider all costs implicit and explicit - in comparing the costs to liquidity 

demanders associated with maker-taker models and other pricing models. 

GETCO does not employ unique trading strategies that are designed solely to earn a rebate. The 

firm is a market maker on exchanges that otler a rebate for posting passive liquidity and we arc 

market makers on exchanges that do not - such as the NYSE. Rebates, when offered, are 

incorporated into detelmining the price at which we are able (0 quote a security. On markets on 

which we earn a rebate, we arc able to post much tighter markets. GETCO makes markets on 

trading venues that employ the maker-taker pricing modeL as well as on those that do not. 

Nevertheless, rebates can create a conflict for brokers responsible for making routing decisions 

for their customers. This is particularly (he case when trading venues offer rebates to brokers for 

taking liquidity. These rebates are akin to payment for order flow and broker preferencing 

an'angements that have long existed in the equity markets. It is important that regulators examine 

all these conflicts in detennining how to best ensure that customers' interests are placed above 

their brokers. 

Finally, the controversy regarding rebates offered by trading venues indicates that institutional 

investors arc not confident about where or how their order is being executed. The SEC has 

historically championed the rights of the retail investor, but generally felt institutional investors 

were sophisticated enough to manage on their own. In fact, there is a growing digital divide even 

amongst professional participants. 

To help institutional investors navigate this divide, there needs to be greater clarity around order 

execution quality for professional participants. Furthennore, institutional investors need to 

understand the trade-otIs and financial incentives involved in routing decisions by their brokers. 

11 
67 


76108.012

Additional transparency and better order execution analysis would help to alleviate concerns 

around gaming, manipulation and information leakage; and return a level of control and 

confidence to institutional participants. 

E. Co-Location and Data Feeds 

Today's professional traders use co-location and proprietary data feeds offered by market 

centers. The securities laws require exchanges to provide fair access to these tools to all market 

participants and represent market responses allowed by advances in communications and 

broadband technology. 

1. Co-Location 

Co-location is the modem day trading floor. Co-location is where a trading platform offers space 

in its data center for members to locate their own computer hardware to reduce the time it takes 

to reccive information and place orders on the market. 

Historically, market makers and other professional market participants have wanted to be as 

close as possible to the center of price discovery. Market makers need to manage the risk 

associated with making markets and speed; certainty of execution and proximity allow better risk 

management. Before the advent of electronic trading, this meant buying a "seat" or membership 

on an exchange. Exchange floors have now largely been replaced with computer "matching 

engines" and today's market makers need to be as closc to the center of price discovery in the 

exchange's matching engine as possible. 

We believe that co-location is a positive development because it equalizes access for participants 

who wish to be near the center of price discovery. Any market participant that determines that 

speed is an essential component to its trading strategy or risk management can invest in 

co-location. Most brokers are either co-located themselves or access markets through member 

firms that are co-located. 

2. Data Feeds 

As the SEC noted in its Equity Market Concept Release, the information in individual market 

center data feeds generally reaches market participants faster than the same information in the 

12 
68 


76108.013

consolidated data feeds. The slower speed of the consolidated data feed is attributable in large 

part to the extra step required for data to be consolidated and redistributed. As a market maker, 

GETCO subscribes to data feeds directly from the exchanges. Having the most up-to-date 

information on market prices allows GETCO to better manage its risks, which in turn allows the 

firm to post better priced quotations. 

GETCO also notes that, jf proprietary data feeds were prohibited or delayed, large market 

participants would have an informational advantage over small participants. Large participants 

would have immediate access to their own trading activity, while other market participants 

would have to wait until they received the consolidated data feed or delayed exchange data feed. 

IV. Dodd-Frank Act, Title VII 

The Financial Crisis of2008 prompted widespread realization among regulators, legislators and 

the general public that the derivatives markets were opaque, lightly regulated and ultimately 

backstopped by individual taxpayers when governments were forced to concede that certain 

institutions were simply "too big to fail." The Dodd-Frank Act attempts to address these issues 

by: 

• limiting the risk government-backed institutions can take making proprietary trades; 

• increasing transparency around derivative exposure through the mandated clearing of 

standardized products; and 

• facilitating the entrance of new participants to create a more competitive, diverse market 

place. 

Clearing in the swaps market is the critical first step in this process. There's little disagreement 

about the systemic benefits of clearing the most standardized and liquid swaps. By substituting 

the clearing house as the eounterparty in a swaps transaction, it reduces counterparty credit risk 

by mutualizing exposure. A clearing house also provides an objective and robust process for 

monitoring and managing risk and requires clearing members to contribute margin or collateral 

to insure that the clearing house can withstand the default of members. 

13 
69 


76108.014

In addition to these direct risk mitigation benefits that clearing houses provide, a cleared swaps 

market has the potential to allow a much wider array of participants to provide liquidity. Nonbank liquidity providers, such as GETCO, who do not enjoy a federal guarantee, are ready, 

willing and able to provide liquidity in the swaps market as soon as central clearing is 

established. For this reason, broad access to clearing houses - together with robust measures to 

ensure the safety and soundness of clearing houses is critical to achieving the goal of reducing 

systemic risk. 

The ability of a greater diversity of market participants to act as dealers in a cleared swaps 

market, would reduce the systemic risk we face today with a few "too big to fail" banks as the 

sole counterparties in these swaps markets. This diversification is precisely what was intended 

when the laws were envisioned and will ultimately increase the overall integrity and resiliency of 

the swaps markets by decreasing the risk of systemic failure. 

Thank you. 

14 
70 


76108.015

Testimony of Kevin Cronin, Global Head of Equity Trading, Invesco 

on Behalf of the Investment Company Institute 

"Market Structure: Ensuring Orderly, Efficient, Innovative and Competitive 

Markets for Issuers and Investors" 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

June 20, 2012 

Thank you Chairman Garrett, Ranking Member Waters and members ofthe 

Subcommittee for the opportunity to speak here today. My name is Kevin Cronin; 

I am Global Head of Equity Trading for Invesco. Invesco is a leading independent 

global asset management firm with operations in more than 20 countries and 

assets under management of over $632, billion. 

I am pleased to participate on behalf of the Investment Company Institute 

at this hearing examining the structure of the U.s. securities markets. ICI is the 

national association of U.S. investment companies, including mutual funds, 

closed-end funds, exchange-traded funds ("ETFs"), and unit investment trusts 

("UITs"). The structure of the securities markets has a significant impact on ICI 

members, who arc investors of over $13 trillion of assets and who held 29 percent 

of the value of publicly traded u.s, equity outstanding at the end of 2011. lCI 

members are institutional investors, but invest on behalf of over 90 million 

individual shareholders.! 

Funds and their shareholders therefore have a strong interest in ensuring 

that the securities markets are highly competitive, transparent and efficient, and 

that the regulatory structure that governs the securities markets encourages, 

rather than impedes, liquidity, transparency, and price discovery. Consistent with 

these goals, ICI has strongly supported efforts to address issues that may impact 

the fair and orderly operation of the securities markets and investor confidence in 

those markets and has long advocatcd for regulatory changes that would result in 

'Households are the largest group ofinvestors in mutual funds. Altogether, 52.3 million 

households, or 44 percent of all U.S. households, owned mutual funds as of 2011. Mutual funds also 

managed 55 percent of the assets in 401(k) and other defined contribution retirement plans and 45 

percent of the assets in IRAs at the end of 20n. For more information on the U.S. fund industry. see 

2012 Investment Company Institute Fact Book at www.icifactbookorg. 
71 


76108.016

more efficient markets for investors.' We commend the Subcommittee for 

holding this hearing to examine these critical issues.' 

As the title of the hearing suggests, orderly, efficient, innovative and 

competitive securities markets are essential for both issuers and investors. 

Achieving such markets requires fundamental elements such as: robust price 

discovery; transparency and fairness; sensible regulation with diligent oversight 

and enforcement; competition which fosters innovation and efficiencies; broadbased and diverse participation; and most critically, the participation of long-term 

investors. Long-term investors are the cornerstone of the capital formation 

process and their participation in the primary markets and secondary trading 

markets is fundamental to well-functioning securities markets overall. As such, it 

is critically important that the markets operate in the best interests, and foster the 

confidence, oflong-term investors. 

Unfortunately, over the past several years, long-term investor confidence 

has been challenged by a series of scandals, financial crises, and technological 

mishaps affecting the operations of exchanges, broker-dealers and automated 

trading systems -- including, most recently, the problems surrounding the 

Facebook IPG. 

To ensure long-term investor confidence, it is incumbent upon regulators 

to address issues raised by developments in the structure and operation of the 

securities markets and the impact of those developments on investors. ICI 

believes that regulators have fallen short of this important objective, most likely 

because the implementation of the Dodd-Frank Act has diverted SEC resources to 

mandated rulemaking. Significantly, numerous issues raised by the SEC's concept 

release examining the structure of the U.S. securities markets have not been 

addressed, including issues surrounding high frequency trading and undisplayed 

liquidity, as well as the adequacy of information provided to investors about their 

orders.4 

2 For a comprehensive list of, and links to, ICl's key comment letters on trading and market 

structure issues, see Appendix. 

3 While our statement focuses on the impact of market structure changes in the equity markets, lCl 

members also are active participants in the derivatives and fixed-income markets. Ongoing 

changes to the structure of those markets will have an impact on the manner in which funds 

execute trades and interact with other market participants. We therefore strongly support a robust 

examination of the current market structure in the non-equity markets. 

4 See Letter from Karrie McMillan, General Counsel, Investment Company Institute, to Elizabeth M. 

Murphy, Secretary, Securities and Exchange Commission, dated April 21, 2010; available at 

httll:llwww.ici.org/pdfI24266.pdf. 

2 
72 


76108.017

In addition, the events of May 6,2010 brought to the forefront several 

inefficiencies in the current market structure. Several ofthese issues have been 

addressed by regulators; nevertheless, issues relating to the role of market makers 

and high frequency traders during the "flash crash" remain unresolved. 

As discussed further below, ICI believes it is time for regulators and market 

participants alike to address, and take action on, many of the difficult and complex 

issues that have concerned investors for several years, including: 

• Issues surrounding automated trading and high frequency trading, 

including the number of cancelled orders in the markets; 

• The need for enhanced surveillance capabilities to detect potentially 

abusive and manipulative trading practices; 

• Conflicts of interest that exist in the markets, particularly those 

surrounding liquidity rebates and the creation of new and complex order 

types; 

• The need for increased transparency of order routing and execution 

practices; 

• Difficulties surrounding capital formation, particularly for small and midsized companies, and the need to examine the implementation of higher 

minimum quote variations (i.e., greater than $.01) for certain securities; and 

• Issues associated with undisplayed liquidity, particularly those related to 

broker-dealer internalization. 

Regulators state that they have been reluctant to act on many of these 

issues, citing the insufficiency of data to ensure that any new or revised regulations 

will not adversely impact the securities markets. In our judgment, if the data 

currently available is insufficient to make these determinations, steps should be 

taken to obtain such data. As discussed further below, this might be done by 

instituting pilot programs to generate data, such as in the areas ofliquidity rebates 

and minimum spreads. 5 

Impact of Automated Trading and High Frequency Trading on Funds 

One of the primary drivers of changes to the structure of the securities 

markets over the past several years has been the rapid evolution oftechnologies 

for generating, routing and executing orders and related improvements to the 

5 Pilot programs allow regulators to gather the data necessary to take a measured approach to 

reforms. If regulations are too restrictive, they may unintentionally limit the use of evolving 

market practices and technological developments and thus impede funds' use of new and 

innovative trading tools and trading venues. If regulations are too onerous or costly for some 

market palticipants, those participants may decide not to offer certain products or services to 

investors. 

3 
73 


76108.018

speed, capacity and sophistication ofthe trading functions available to investors. 

Funds rely heavily on technology for the efficient execution of their trades. 

To be clear, we believe that investors, both retail and institutional, are in 

many respects better off now than they were just a few years ago. Investors have 

much greater control over how their trades are executed. The increased number 

and variety oftrading tools also has resulted in less dependence on "high touch" 

trading and has contributed to lower overall trading costs and improved efficiency, 

certainly for the most liquid securities. On the other hand, the rise of automated 

trading and high frequency trading has forced funds and other institutional 

investors to modify the manner in which they trade to protect their proprietary 

trading strategies. Funds also have become more diligent in choosing their 

counterparties and in understanding where their orders are routed and the 

consequences ofthose routing decisions. 

Clearly, high frequency trading has dominated the debate over the virtues 

of automated trading. ICI believes certain high frequency trading strategies 

arguably bring several benefits to the securities markets and to investors, including 

providing liquidity and tightening spreads in certain types of stocks. At the same 

time, several practices that have become associated with high frequency trading 

have created concerns, as discussed below. 

Cancelled Orders 

We believe that regulators and market participants must act to address the 

increasing number of order cancellations in the securities markets, particularly 

those that are cancelled shortly after submission. While order cancellations 

related to making markets is one thing, orders sent to the market with no 

intention of being executed before cancellation is quite another. These orders tax 

the markets' technological infrastructure, and under the right circumstances, 

could interrupt the ability to process trades in an orderly fashion. In addition, ICI 

members report that certain of the practices and strategies surrounding 

cancellations often are designed to detect fund trading oflarge blocks of securities 

and to trade with or ahead of those blocks to the detriment of investors. 

We have recommended on several occasions that regulators examine 

whether a fee should be imposed on cancelled orders above a certain ratio of 

orders to executed transactions, designed to discourage the current risk free use of 

certain types of orders and to protect the integrity of the markets' infrastructure. 

While several exchanges have recently proposed such fees, we believe those 

proposals will be ineffectual; they will impact only the most extreme outliers, and 

the fee associated with the proposals is so small that it would not act as a 

deterrent. We therefore urge regulators and market participants to address 

4 
74 


76108.019

concerns regarding cancelled orders and consider truly meaningful fees or other 

deterrents that would adequately address this behavior. 

Addressing Market Manipulation and Abuse 

Recent technological advances in trading have allowed practices that are 

improper or manipulative in nature to be employed more easily and cheaply. This, 

in turn, has made trading more challenging for funds. The varied and complex 

trading practices used by market participants today also often makes it difficult to 

distinguish between legitimate and disruptive trading practices in a number of 

situations. We support action by regulators to clearly define practices involving 

automated trading strategies and high frequency trading strategies that may 

constitute market manipulation. In addition, we strongly support regulators 

having access to accurate, timely and detailed information about market 

participants and trades that are executed and the establishment of a more robust 

transaction reporting regime to enable regulators to monitor the activities of firms, 

ensure compliance with regulations, and monitor for market abuses. 6 

Addressing Potential Conflicts of Interest 

Liquidity Rebates 

The benefits and drawbacks of so-called "liquidity rebates" must be 

examined. 7 Brokers are incentivized to make routing decisions based on the 

availability and amount ofliquidity rebates offered by an exchange. Further, 

liquidity rebates subsidize certain of the high frequency trading strategies 

discussed above. At the same time, the benefits ofliquidity rebates to investors 

are doubtful-- investors do not receive these rebates directly and arguably also do 

not receive the benefits of rebates indirectly. 

We firmly believe that more must be learned about the effects of this 

practice on investors and the markets. We therefore recommend that the SEC 

work with the exchanges and other market participants to establish a pilot 

program where a certain set of securities would be prohibited from being subject 

6 ICI provided recommendations on certain aspects of the SEC's proposal to develop, implement, 

and maintain a consolidated audit trail ("CAT") and a central repository for the CAT data regarding 

the trading of listed equities and options. See Letter from Karrie McMillan, General Counsel, 

Investment Company Institute, to Elizabeth M. Murphy, Secretary, Securities and Exchange 

Commission, dated August 9, 2010; available at http://www.ici.orglpdf~]2df 

7 The practice of providing liquidity rebates is associated with what is often referred to as the 

"maker/taker" model. In the maker/taker model, trading venues typically charge fees to market 

participants who "take" liquidity and pay rebates to market participants who "make" liquidity by 

placing orders. 

5 
75 


76108.020

to liquidity rebates. In this manner, the SEC can examine the data generated 

about liquidity rebate practices and determine whether rulemaking is necessary to 

address concerns in this area. 

ICI does not believe that prohibiting liquidity rebates would negatively 

impact competition between markets. All trading venues should compete first on 

the basis of innovation, differentiation of services and ultimately, on the value 

their model of trading presents to investors; not on the amount of money rebated 

to market participants. 

Order Types 

In the race for increased market share, exchanges and alternative trading 

venues continue to create various types of orders to cater to market participants 

who create strategies and desire a vehicle through which to implement those 

strategies. Many of these order types facilitate strategies that can benefit market 

participants at the expense oflong-term investors or that are potentially abusive or 

manipulative. In addition, ICI members report that the transparency surrounding 

these order types is severely lacking. We therefore recommend that regulators 

vigorously examine the specific order types that exchanges and other trading 

venues offer and any conflicts of interest raised by the use of these order types. 

Sufficient transparency of the details of order types offered by exchanges and other 

trading venues also must be ensured and such information must be readily and 

easily available to investors. 

Transparency of Order Routing and Execution Practices 

More transparency is needed regarding the order routing and execution 

practices of market participants. In many cases, our members are in a position to 

obtain the necessary routing and execution data from broker-dealers and trading 

venues. We are concerned, however, that many investors are not privy to this level 

of transparency. 

At a minimum, we recommend that brokers, upon request from a customer, 

be required to provide certain standardized information about an execution 

including the type of execution venue used (i.e., an exchange or an alternative 

trading venue), the capacity in which the trade was executed (i.e., agency vs. 

principal), and each destination to which an order was routed (whether an 

execution was received or not). Increased information regarding payments and 

other incentives provided or received to direct order flow to particular trading 

venues also would be valuable. Such increased transparency should assist in better 

understanding conflicts of interest that exist and would allow investors to make 

better informed investment decisions. 

6 
76 


76108.021

Tick Sizes and Minimum Quote Variations 

The difficulties for small companies coming to market in the United States 

have been well documented over the last several years. Various proposals have 

been set forth to stimulate capital formation and to provide support for small 

companies that desire to come to market. One ofthese proposals is to widen 

spreads (i.e., minimum quote variations), particularly for less liquid stocks. 

Since penny spreads were implemented, the average trade size has been 

significantly reduced, making it more difficult for funds to trade large blocks of 

securities, particularly in small-cap and less liquid stocks. We therefore believe it 

is necessary to examine ways to increase market liquidity and the depth of markets 

in securities that have not benefited from the move to penny spreads. Specifically, 

we recommend that a pilot program be established to examine wider spreads in 

certain stocks. 8 We believe this pilot should be wide ranging, with different 

minimum spreads established for different types of stocks. A pilot program would 

generate valuable data on the impact on liquidity in these stocks, allowing the SEC 

to determine whether changes to the minimum quoting variation should be 

implemented. 

Undisplayed Liquidity 

While technological developments have resulted in improvements for 

investors, these changes also have shifted the dynamics of trading for funds, 

driving more fund orders away from the "lit" markets, such as the traditional 

exchanges, towards the use of undisplayed liquidity. 

Funds have long been significant users of un displayed liquidity. For ICI 

members that frequently execute large orders, undisplayed liquidity, and the 

venues that provide such liquidity (i.e., dark pools), lessen the cost of 

implementing trading ideas and mitigate the risk of information leakage. 

Protecting orders from information leakage is a primary component ofa fund's 

day-to-day trading responsibilities; dark pools allow institutional investors, to 

avoid transacting with market participants who seek to profit from the impact of 

the public display oflarge orders to the detriment of funds and their shareholders. 

We recognize that while the use of undisplayed liquidity brings certain 

benefits to funds, there are concerns about its impact on the price discovery 

process. Ideally, funds would like as many orders as possible to be executed in the 

8 The recent JOBS Act requires the SEC to conduct a study regarding the impact that quoting in 

penny increments has had on the securities markets, including on liquidity for the securities of 

small and mid-cap issuers and on market makers in those securities. The JOBS Act also gives the 

SEC authority, hased upon the results of its study, to implement rules that would increase the 

minimum trading increment for securities of "emerging growth companies." 

7 
77 


76108.022

lit markets. ICI therefore has strongly supported efforts to provide incentives for 

market participants to use transparent orders. Until we create a more efficient 

market structure for the execution of institutional sized orders, however, it is 

imperative that venues providing undisplayed liquidity remain available to funds 

and that the regulations overseeing these venues facilitate their continued use. 

Broker-Dealer Internalization 

Broker-dealer internalization (i.e., where a broker internally executes 

against its own customer orders, taking the other side of trade) accounts for a 

significant percentage of the total share volume of stocks, and therefore 

undisplayed liquidity more than the share volume attributed to dark pools as a 

whole. Internalized order flow also represents liquidity that funds do not have an 

opportunity, for the most part, to trade against. 

Internalization raises a variety of concerns. For example, internalization 

may increase market fragmentation because it can result in customer orders not 

being publicly exposed to the market. In addition, it may raise conflicts of interest 

between broker-dealers and their customers because broker-dealers may execute 

customer orders at the displayed quotations, foregoing the opportunity for price 

improvement in order to maximize their profits. 

We recommend that the SEC take action to ensure that internalized orders 

receive best execution. Specifically, any internalized order should be provided 

with "significant" price improvement. 9 This requirement could result in more 

customer orders being exposed to the market if the amount of internalized orders 

is reduced, thus furthering public display of orders and potentially improving price 

discovery. 

* * 

Thank you and I look forward to answering any questions. 

9 We question whether providing price improvement to internalized orders in, for example, 

increments of hundredths of a penny is providing meaningful price improvement. 

8 
78 


76108.023

Appendix 

Key ICI Comment Letters and Statements on Market Structure Issues 

Order Execution Obligations: Letter from Craig S. Tyle, Senior Counsel, 

Investment Company Institute, to Jonathan G. Katz, Secretary, Securities and 

Exchange Commission, dated January 16, 1996; available at 

http://www.ici.org/pdfb561 pdf 

Regulation of Exchanges and Alternative Trading Systems: Letter from Craig 

S. Tyle, General Counsel, Investment Company Institute, to Jonathan G. Katz, 

Secretary, Securities and Exchange Commission, dated July 28, 1998; available at 

http://www.ici.org/pdf/comment98 reg exch ats.pdf 

Market Fragmentation Concept Release: Letter from Craig S. Tyle, General 

Counsel, Investment Company Institute, to Jonathan G. Katz, Secretary, Securities 

and Exchange Commission, dated May 12, 2000; available at 

http://www.ici.org/pdf/11894·pdf 

Subpenny Concept Release: Letter from Craig S. Tyle, General Counsel, 

Investment Company Institute, to Jonathan G. Katz, Secretary, Securities and 

Exchange Commission, dated November 20, 2001; available at 

http://www.ici.org/policy/comments/Ol SEC SUB PENNY COM 

Regulation NMS: Letter from Ari Burstein, Associate Counsel, Investment 

Company Institute, to Jonathan G. Katz, Secretary, Securities and Exchange 

Commission, dated June 30, 2004; available at 

http://www.ici.org/policy/markets/domestic/04 sec nms com 

Disclosure of Short Sales and Short Positions: Letter from Ari Burstein, Senior 

Counsel, Investment Company Institute, to Florence Harmon, Acting Secretary, 

Securities and Exchange Commission, dated December 16, 2008; available at 

http://www.ici.org/pdf123128.pdf 

Amendments to Regulation SHO (Short Selling): Letter from Karrie McMillan, 

General Counsel, Investment Company Institute, to Elizabeth M. Murphy, 

Secretary, Securities and Exchange Commission, dated June 19, 2009; available at 

http://www.ici.org/policy/comments/cov comment/09 sec short sale com 

U.S. Senate Market Structure Hearing: Statement of the Investment Company 

Institute, Hearing on "Dark Pools, Flash Orders, High Frequency Trading, and 

Other Market Structure Issues," Securities, Insurance, and Investment 

Subcommittee, Committee on Banking, Housing & Urban Affairs, U.S. Senate, 

October 28, 2009; available at http://www.ici.org/pdf123925.pdf 

A-I 
79 


76108.024

Flash Orders: Letter from Karrie McMillan, General Counsel, Investment 

Company Institute, to Elizabeth M. Murphy, Secretary, Securities and Exchange 

Commission, dated November 23, 2009; available at 

http://www.ici.org/pdf/23973-pdf 

Non-Public Trading Interest: Letter from Karrie McMillan, General Counsel, 

Investment Company Institute, to Elizabeth M. Murphy, Secretary, Securities and 

Exchange Commission, dated February 22, 2010; available at 

http://v.'Ww.ici.org/pdfh4142.pdf 

Market Access: Letter from Ari Burstein, Senior Counsel, Investment Company 

Institute, to Elizabeth M. Murphy, Secretary, Securities and Exchange 

Commission, dated March 29, 2010; available at http://www.ici.org/pdfh421O.pdf 

SEC Concept Release on Equity Market Structure: Letter from Karrie 

McMillan, General Counsel, Investment Company Institute, to Elizabeth M. 

Murphy, Secretary, Securities and Exchange Commission, dated April 21, 2010; 

available at http://www.ici.org/pdf/24266.pdf 

SEC Market Structure Roundtahles: Letters from Karrie McMillan, General 

Counsel, Investment Company Institute, to Elizabeth M. Murphy, Secretary, 

Securities and Exchange Commission, dated June 1, 2010 and June 23, 2010; 

available at http://www.ici.org/pdfh4361.pdf and 

http://www.ici.org/pdfh4384·pdf 

Circuit Breakers: Letters from Karrie McMillan, General Counsel, Investment 

Company Institute, to Elizabeth M. Murphy, Secretary, Securities and Exchange 

Commission, dated June 3, 2010 and July 19, 2010; available at 

http://www.ici.org/pdfh4364.pdf and http://www.ici.org/pdfh4438.pdf 

Large Trader Reporting System: Letter from Karrie McMillan, General Counsel, 

Investment Company Institute, to Elizabeth M. Murphy, Secretary, Securities and 

Exchange Commission, dated June 22, 2010; available at 

http://www.ici.org/pdfh438Lpdf 

Clearly Erroneous Executions: Letter from Karrie McMillan, General Counsel, 

Investment Company Institute, to Elizabeth M. Murphy, Secretary, Securities and 

Exchange Commission, dated July 19, 2010; available at 

http://www.ici.org/pdfh4437·pdf 

Consolidated Audit Trail: Letter from Karrie McMillan, General Counsel, 

Investment Company Institute, to Elizabeth M. Murphy, Secretary, Securities and 

A-2 
80 


76108.025

Exchange Commission, dated August 9, 2010; available at 

http://www.ici.org/pdf/24477-pdf 

European Commission Review of MiFID: Letter from Karrie McMillan, General 

Counsel, Investment Company Institute, to Directorate General, European 

Commission, dated February 2, 2011; available at http://www.ici.org/pdf/24946 . .P.df 

IDSCD Consultation on Dark Liquidity: Letter from Karrie McMillan, General 

Counsel, Investment Company Institute, to Werner Bijkerk, Senior Policy Advisor, 

IOSCO, dated February ll, 2011; available at http://www.icLorg/pdfh4968.pdf 

Limit Up-Limit Down System: Letter from Karrie McMillan, General Counsel, 

Investment Company Institute, to Elizabeth M. Murphy, Secretary, Securities and 

Exchange Commission, dated June 22, 2011; available at 

http://www.ici.org/pdf/2529S·pdf 

Dodd-Frank Act Short Sale Reporting Study: Letter from Karrie McMillan, 

General Counsel, Investment Company Institute, to Elizabeth M. Murphy, 

Secretary, Securities and Exchange Commission, dated June 23, 2011; available at 

http://www.ici.org/pdfh5297·pdf 

IDSCD Consultation on Issues Raised by the Impact of Technological 

Changes on Market Integrity and Efficiency: Letter from Karrie McMillan, 

General Counsel, Investment Company Institute, to Werner Bijkerk, Senior Policy 

Advisor, IOSCO, dated August 12, 2GIl; available at 

lillp:llwww.ici.org/pdf/2S408.pdf 

Regulatory Action on Short Selling in the European Union: Letter from Karrie 

McMillan, General Counsel, Investment Company Institute, to Steven Maijoor, 

Chair, European Securities and Markets Authority, dated August 17, 20n; available 

at http://wwwjci.org/pdfh5428.pdf 

ESMA Consultation on Guidelines on Systems and Controls in a Highly 

Automated Trading Environment: Letter from Karrie McMillan, General 

Counsel, Investment Company Institute, to Steven Maijoor, Chair, European 

Securities and Markets Authority, dated October 3, 20n; available at 

http://www.ici.org/pdfhS546.pdf 

NASDAQ Market Quality Program: Letter from Ari Burstein, Senior Counsel, 

Investment Company Institute, to Elizabeth M. Murphy, Secretary, Securities and 

Exchange Commission, dated May 3, 2012; available at 

http://www.ici.org/pdf/26142.pdf 
81 


76108.026

NYSE Arca Fixed Incentive Program: Letter from Ari Burstein, Senior Counsel, 

Investment Company Institute, to Elizabeth M. Murphy, SecretaIY, Securities and 

Exchange Commission, dated June 7, 2012; available at 

http://www.ici.org/pdf/26227·pdf 
82 


76108.027

TestimQJIYJ)f Ios~l!h~GawLonski 

Pr~sideIlt& CQJU{osenbl<!!tSecurities 

Before the 

United States House of Representatives, Committee on Financial Services 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

"Market Structure: Ensuring Orderly, Efficient, Innovative and Competitive 

Markets for Issuers and Investors" 

June 20,2012 

Chairman Garrett, Ranking Member Waters and members ofthe subcommittee, 

thank you for convening today's hearing on equity market structure. I am pleased to 

offer the views of Rosenblatt Securities about this topic. 

My name is Joe Gawronski, and 1 am Rosenblatt's president and chief operating 

officer. Rosenblatt is an agency broker serving institutional investors in the US 

equity market. We are pure agents, who seek to execute trades on the best possible 

terms for our clients. We do not engage in proprietary or prinCipal trading, or own 

or operate any exchanges or dark pools. Rosenblatt is also a leading global authority 

on market structure. Traders, investors, exchanges and governments all around the 

world rely upon our independent, granular analysis of the rules, regulations, 

competitive dynamics and behavior of participants in equity and derivatives 

markets globally. 

We have studied extensively the massive changes to US equity market structure that 

have occurred since the US Department of Justice alIQgeq widespread price-fixing 

among dealers on the Nasdaq Stock Market in 1996. We've also lived through them, 

as brokers representing institutional orders in the market. 

We believe that there are two major points regarding market structure that must 

be understood above all others by the Subcommittee: 

First, today's market structure is a Rube Goldberg of sorts. It is the product of 

a gradual, 1S-year evolution, during which government repeatedly acted in 

big ways and market forces repeatedly reacted accordingly. Each time the 

industry changed its behavior in response to a new regulatory, legislative or judicial 

mandate, practices and structures sprung up that upended decades, even centuries 

of established practice. And these consequences, some of them unintended, 

triggered the government to revert with yet another round of fresh rules addressing 

the new order. The result? Today's profoundly complex, patchwork market 

structure is certainly not what one would design if starting with a blank slate. 

But despite its complexity and the largely ad hoc way in which it was created, 

modern market structure generally results in better outcomes, for both retail 

and institutional investors, than what it replaced. This is the second major point 

we believe the Subcommittee must understand above all others. With apologies to 
83 


76108.028

Sir Winston Churchill, what we have today is the worst market structure possible -

except for all the others that have been tried. 

Importantly, this does not mean that things are perfect. Indeed, there are a few 

critical, problematic gaps in today's structure that merit exploration by regulators 

and legislators for potential fixes. Among these are the rules regarding off-exchange 

trading, safeguards against systemic risk and the quality of markets for shares of 

smaller companies. 

Now I'd like to elaborate a bit on the first point - that today's market structure is 

the product of a lS-year cycle of government action and market reaction. This began 

in 1997, with the imposition of new "order-handling" rules following the price-fixing 

settlement between the Justice Department and the Nasdaq dealers I mentioned 

earlier. Dealers were required to display to the market customer limit orders that 

were priced better than their own, proprietary quotes. Rather than narrow their 

own quotes on the Nasdaq system, the firms did this mostly by shipping these 

orders to electronic limit-order books known as ECNs. The ECNs soon multiplied, 

dreamed up new and creative ways of attracting orders from other market 

participants and by the end of 1999 had captured one-third ofthe volume in 

Nasdaq-listed stocks. 

In that same year, 1999, the SEC responded to the new (and mostly unexpected) 

popularity of ECNs by passing Regulation ATS. This new rule allowed ECNs and 

other alternative execution venues to operate under a lighter set of regulatory 

requirements than those applied to exchanges. One ofthese ECNs, Island, developed 

a new way to lure customers into posting limit orders on its book - pay them a 

rebate every time another customer accessed one of those quotes. This was the 

beginning of the so-called maker-taker system under which most stocks in the US 

and, increasingly, other parts of the world, trade. Also in 1999, GETCO and Tradebot, 

two of what are today the world's biggest automated market-making firms -often 

referred to as high-frequency traders - were founded. Firms such as these often 

gravitated to the new ATSs, which generally were more innovative, tech-savvy and 

responsive to customer needs than the incumbent exchanges. 

Traditional dealers were marginalized by these new rules and the market's reaction 

to them. The final nail in their collective coffin came two years later, in 2001, when 

the markets finally implemented Congress' mandate to move from quoting prices in 

fractions of a dollar to using decimal pricing. With the minimum price variation now 

just one penny, down from 12.S cents\ (1/8 of a dollar) in the old order, and new 

types of firms able to compete with traditional dealers by quoting narrower markets, 

the "spread" between the best bid and best offer prices available for investors to 

access shrunk dramatically. Traditional dealers could no longer earn suitable profits 

from these spreads, and changed their business models as a result. By 2003 firms 

1 Technically speaking the minimum increment had narrowed to 1/16 or a dollar starting in 1997, when 

Bernard 1. Madorr Investment Securities began making markets in 1/16 increments. Regional exchanges, 

Nasdaq and the NYSE later followed. 

2 
84 


76108.029

such as Goldman Sachs, Morgan Stanley, Merrill Lynch and Credit Suisse First 

Boston were abandoning principal trading in favor of charging agency commissions 

for Nasdaq-listed stocks. They laid off hundreds of equity trading floor personnel 

and replaced them with computerized algorithms, which chopped big institutional 

trades into small pieces to be executed over time. 

At the same time, HFT firms such as GETCO and Tradebot were beginning to fill the 

market-making niche left vacant by the Nasdaq dealers. With the minimum tick just 

one penny, instead of a de facto 25 cents in the pre-Justice Department days, these 

new market makers earned far less per share than did their predecessors. As a 

result, they had to trade more frequently to amass sufficient profits. The average 

trade size in the market came down, and trading volumes began to rise. By 2005-

2006, HFT and HFT-related firms like Wedbush Morgan 2, Citadel and Automated 

Trading Desk became firmly entrenched in the ranks ofthe top liquidity providers 

for Nasdaq-listed stocks.3 

Institutional investors, who had become accustomed to an average trade size of 

2,000 shares or more in the old era, and plentiful block liquidity for even larger 

trades, were confronted with a completely new market structure and needed to 

interact with this new type of liquidity using different tools and tactics. Institutions 

began using the algorithms offered by the big investment banks that had once 

committed capital en masse to facilitate asset-manager orders. This only made the 

ground more fertile for the automated lIFT firms that today account for at least half 

of US equity volume. 

Then, starting in 2007, the SEC began implementing a sweeping set of equitymarket-structure reforms known as Regulation NMS. These were designed to better 

knit together markets that had become increasingly fragmented as a result of the 

Iimit-order-display rule and Reg ATS, and to bring to NYSE-Iisted trading the moreautomated style and structure that grew to dominate the Nasdaq market in the 

years following the Justice Department settlement. The most important element of 

Reg NMS was the dictum that manual, or "slow," markets would not enjoy protection 

against traders executing orders on other exchanges or ATSs at inferior prices. This 

effectively forced the NYSE to move from a manual to an auto-ex structure, making it 

possible for the first time for institutions and HFTs using algorithms to trade NYSElisted shares on the same electronic exchanges and ATSs that they'd been turning to 

for several years already in the Nasdaq-listed world. 

This is not a comprehensive account by any means - to provide that would require 

more of your time, and patience, than is available in this setting. But it is essentially 

how we got to where we are today. As you can see, the current market structure has 

been patched together over many years, with the industry reacting to significant 

government reforms in ways that often prompted further regulatory adjustments 

and further cycles of unintended consequences and even more new rules. 

2 Wedbush is a well-known clearing firm for large HFT firms. 

3 Source: Nasdaq OMX Group - Top Nasdaq Liquidity Providers, November 2006 

3 
85 


76108.030

This action-and-reaction cycle has, oddly enough, taken us to a better place with 

respect to investor outcomes than where we were in the mid-1990s, before the 

transformation began. Both explicit costs - such as exchange fees and brokerage 

commissions- as well as implicit costs like bid-ask spreads, the price impact of big 

orders and the "slippage" from the "arrival" prices of institutional orders to the 

average prices at which they are actually executed - have come down dramatically 

during this period. Instead of just one anointed "specialist" per NYSE-Iisted stock, or 

a cartel of upstairs dealers keeping spreads artificially wide for Nasdaq-listed shares, 

dozens of liquidity providers compete to make the tightest possible markets in the 

most actively traded US equities.4 Investors who once paid 25 cents per share in 

spread alone when buying and selling large-cap, actively traded stocks like Intel and 

Microsoft now pay no more than a penny or two. Exchanges that once extracted 

monopoly or duopoly rents from trading customers now compete vigorously to 

offer the most attractive fees and rule sets for various client segments, allowing 

those firms to charge lower commissions to their customers. Executions are largely 

instantaneous, and algorithms can be programmed to mask an asset manager's 

intent, limiting market impact and other implicit costs. 

To be sure, today's is a much more complex market structure, with no shortage of 

conflicts of interest between intermediaries and end investors, which requires more 

effort on the part of institutional investors to understand.s But those who invest the 

time and relatively small amounts of money necessary to gain such understanding 

reap much bigger benefits from greater efficiency and lower transaction costs. 

But there are a few corners of the market that either have not shared in the benefits 

of this transformation or have largely failed to transform in ways that would result 

in the best possible outcomes for investors. 

One such cause for concern is the explosion in off-exchange trading in recent years. 

According to our analysis of public data, 16.4% of US equity volume was executed 

away from markets that display price quotes" in January 2008. By January 2012 

non-displayed trading had more than doubled, to an all-time high of 34.2%. In May, 

31.2% of US equity trades were executed off-board. 

According to non-public data we collect directly from various brokers and ATSs, 

about 14-15 percentage points of this off-exchange trading is done in so-called dark 

pools - automated platforms, most of them registered ATSs, that match customer 

4 Additionally, the advantages that such market makers can obtain, such as low-latency internal trading systems 

or co-location with exchange matching engines. are available to all market participants who wish to invest in 

such technology, whereas the advantages that accrued to specialists and dealers were typically awarded only to 

them and not available to others. 

5 At the root of most of these conflicts is the incentive for brokers to route orders to venues that pay them 

rebates or charge the lowest possible fees, rather than to the venues that will provide the best execution. 

However, we believe that enforcement of current best-execution rules, rather than additional regulations or 

reforms, would best address this problem. 

6 These figures include all transactions executed away from registered exchanges, excluding major ECNs, such 

as those operated by BATS Global Markets and Direct Edge, which operated exchange-like limit-order books. 

4 
86 


76108.031

buy and sell orders without displaying price quotes. Based on our understanding of 

how these platforms work, we believe that the majority of trades executed in dark 

pools receive significantly better outcomes than would be readily available on 

exchanges. Most of the volume is executed at the midpoint of the National Best 

Bid/Offer spread, meaning that both customers are receiving significant price 

improvement. And at least a small portion of dark-pool executions also delivers 

substantially larger size than is available on exchanges. 

But a significant fraction of off-exchange trades do not result in materially better 

outcomes than would be readily available on exchanges. A minority of trades in the 

aforementioned dark pools simply matches the NBBO or offers de minimis 

improvement over the best prices quoted on exchanges. Additionally, we estimate 

that approximately 10 percentage points of the off-exchange market share is retail 

orders that are executed as principal by wholesale market makers. In the vast 

majority of cases, these wholesalers either match the NBBO or offer de minimis price 

improvement - about 10% of the spread. Typically the wholesalers also offer cash 

payments to the retail brokers of roughly 10-15 cents per 100 shares. The end 

customer benefits from any price improvement, if offered, but does not see any of 

the payment for order flow, which is kept by the retail broker. In a few cases, big, 

brand-name online brokers serving retail customers have contracted to execute 

either 100% or substantial portions of marketable customer order flow with certain 

wholesalers. Regardless of whether such contractual arrangements are in place, the 

vast majority of liquidity-seeking retail orders? in the United States never interact 

with the bulk of the country's available trading interest in the exchange 

environment. 

This is important because our trading markets exist to support primary markets -

to ensure that companies can raise capita!, and that the prices of the securities they 

sell to raise capital are as accurate as possible. This, in turn, enables the efficient 

allocation of capital in the US economy. And it is axiomatic that the more trading 

interest interacts in a centralized market - or at least a market that is virtually 

centralized using technology - the more accurate prices will be. 

However, our modern market structure encourages full-throated competition 

among market centers, but not among all individual orders. Retail orders that are 

hived off from the rest of the markets and executed by a handful of wholesalers -

again, approximately 10% oftotal US equity volume - are not doing worse, per se, 

than they would if they were sent to exchanges. In many cases they are doing better, 

owing to the de minimis price improvement I mentioned earlier. And they are 

certainly receiving better outcomes than they did in the pre-1996 era, when spreads 

were much wider. But they are largely divorced from the price-discovery process. 

And it's possible that they not only could receive better outcomes on exchanges, 

where midpoint liquidity is often resident in the form of so-called hidden order 

types, but that prices would be more accurate and capital allocation more efficient if 

7 Market orders and marketable limit orders 

5 
87 


76108.032

exchanges were permitted to compete with wholesalers for this order flow on a 

level playing field. 

Current prohibitions on sub-penny quoting by exchanges, as well as rules that 

permit de minimis price improvement and no size improvement for internalized 

trades, mean that the field of play is currently tilted away from exchanges and 

toward brokers. This results in attempts by exchange groups to come up with new, 

creative order types and rules in efforts to compete with the off-exchange market, 

such as the NYSE's proposed Retail Liquidity Program, which would add yet another 

layer of complexity to the Rube Goldberg contraption. 

Historically, certain brokers have argued that internalization without significant 

price or size improvement is necessary to counter the immense market power of 

exchanges, which once boasted near-monopoly market shares as well as in-house 

regulatory arms that wielded considerable influence over member firms. Today, 

however, there are 13 exchanges scratching and clawing for market share, with 

potentially more on the way. And no one exchange enjoys anything close to a 

majority ofthe market share in either consolidated volume or, in the case of listing 

markets, the activity in their own listed companies. Exchanges can, and would, 

adopt pricing and rule structures that would be economically attractive to retail 

brokers and their customers - without lopping this important segment off from the 

wider market, and without the threat that brokers would face insufficient 

competitive options for their customer orders. Exchanges also have ceded most of 

their member-firm regulatory activities to the Financial Industry Regulatory 

Association, or FINRA. So their ability to use regulatory authority as a competitive 

weapon is significantly diminished in today's market structure. 

The Canadian government recently took action to prohibit off-exchange trading 

without significant price or size improvement, with significant price improvement 

defined as at least one tick - or the bid-ask midpoint if the spread is one penny. 

Regulators in Australia may also be moving toward such a regime, and authorities in 

Europe are considering similar rules as part of a revamp of legislation that opened 

its markets to greater competition five years ago. The SEC in early 2010 floated the 

idea of a "trade-at" rule, which would prohibit internalization without significant 

size or price improvement. We believe the US should consider seriously this and 

other mechanisms that would maximize the interaction of orders in the secondary 

markets, with the goal of optimizing price discovery and efficient capital allocation. 

Another area that merits continued regulatory scrutiny is the reality that today's 

automated, fragmented markets, although they deliver better outcomes for 

investors under normal circumstances, do not perform as well under stress as the 

more manual, consolidated markets that preceded them. 

The most glaring and obvious manifestation of this, of course, occurred on May 6, 

2010. In what has become known as the flash crash, major equity indexes lost and 

then recovered approximately 9% of their value in the space of just a few minutes. 

One big reason why some stocks traded that day at absurd prices - as low as one 

6 
88 


76108.033

cent for some large-cap issues - is that brokers under Regulation NMS are allowed 

to bypass so-called slow markets. The NYSE's mechanisms for slowing down trading 

in times of stress to ensure accurate price discovery - the so-called Liquidity 

Replenishment Points - were activated in many of the affected stocks during the 

flash crash. But rather than wait for the LRPs, which depend on human intervention, 

to run their course and stabilize the stocks, many brokers simply routed around the 

NYSE, to fully automated exchanges whose order books were overwhelmed by 

rapid-fire selling. 

The lack of coordinated mechanisms to slow down trading and allow for human 

intervention during times of stress was an unforeseen hole in the market structure 

that evolved in piecemeal fashion since the late 1990s. The SEC and the exchanges 

have attempted to patch that hole, first with coordinated circuit breakers on 

individual securities and more recently with a so-called Iimit-up/limit-down system. 

The latter mechanism essentially prevents securities from trading at prices that are 

outside of pre-determined bands, based on movements away from the previous 

day's closing price. Such a system may prevent flash-crash-Iike dislocations that 

result from technological glitches or mistakes. But we worry that they may also 

inhibit price discovery for stocks that are affected by significant news - including 

earnings and other corporate events - that legitimately affects their prices. Of 

greatest concern is that traders who want to act upon such news will not wait when 

a stock is "limit-up" or "limit-down" in the US markets and simply go elsewhere to 

effect their transactions. 

Finally, of particular interest to this subcommittee is the quality of markets for small 

companies. We and other market participants have observed a divide in outcomes 

for large-capitalization, actively traded stocks and smaller issues. Small-company 

shares may not be experiencing the efficiency and cost benefits that have accrued to 

bigger, more liquid stocks as a result of the is-year market-structure 

transformation I've discussed here. A 2009 NYSE study of bid-ask spreads, for 

example, showed that at higher volatility levels, spreads for smaller stocks widened 

in the years following Reg NMS while spreads for the top 200 issues by market 

capitalization narrowed significantly. 

This alone is certainly not proof positive that market structure is harming market 

quality for small caps. Surely the dramatic spike in volatility that accompanied the 

height of the financial crisis in 2008 and 2009 contributed to spreads widening. But 

it is consistent with much anecdotal evidence. As brokers, we hear from our 

institutional clients quite often that small and mid cap stocks have never been more 

difficult to trade. And this also squares with what we know about the new 

generation of HFT liquidity providers, who largely concentrate on shares that 

already have a critical mass of volume and liquidity, because they need to trade in 

very large quantities to make their tiny per-share profits add up to something 

substantial. In short, it appears to us that the change from wide spreads and little 

competition among market makers to ultra-thin profit margins and intense 

7 
89 


76108.034

competition has removed many of the incentives that used to exist for firms to 

systematically provide liquidity in small-cap names. 

For these reasons, we support experimentation by regulators and legislators to 

provide new incentives for making markets in the shares of smaller companies. The 

provision of the recently adopted JOBS Act requiring the SEC to study whether 

wider minimum price increments would improve market quality for emerginggrowth companies is one example of measures that could address this issue. 

The subcommittee is also considering the notion of allowing issuers to pay market 

makers. Although we don't know what form such programs would take, we have 

reservations about this idea, whether these payments are made directly or funneled 

through exchanges. 

As I mentioned earlier, exchanges and market makers already offer payments to 

brokers in exchange for order flow. These rebates are part of an often-Byzantine set 

of fee schedules and rules that create significant conflicts of interest between 

investors and the brokers who execute their orders. Brokers have a strong incentive 

to route orders to the venues that will pay them the best rebates, thereby padding 

their profit margins, rather than to the venues that would provide the best possible 

executions for customers. These payments for order flow can also provide benefits, 

such as allowing market makers to quote tighter markets. And it would be difficult 

to eliminate them after having encouraged fragmentation and competition among 

trading venues, because fee schedules are one of the biggest competitive 

differentia tors in the exchange business. But they surely are one aspect of our 

market structure that one would not build in if designing the system today from 

scratch. 

We fear that introducing another set of economic inducements would create more 

conflicts that could harm investors. It is commonly known within some circles in the 

trading community that listed companies sometimes have pressed market makers 

to "support" their stocks. One well-documented case of such behavior involved the 

former CEO of American International Group, Hank Greenberg, who reportedly had 

badgered former NYSE CEO Dick Grasso and the specialist in AIG constantly for 

better priCing ofthe company's shares.s 

Exchanges derive substantial revenues from company listings, and don't want to 

lose them to competitors. That's a tough enough conflict for exchanges and investors 

to navigate. Issuers who pay market makers, directly or indirectly, may be even 

more emboldened to push those market makers to artifiCially prop up their share 

prices in the face of any number of legitimate market forces - such as unflattering 

news or short selling - or, simply, if management believes the market is not 

recognizing the company's true value. 

8 This episode is laid out in great detail in "King of the Club," the 2008 biography of Grasso by former Wall Street 

Journal reporter Charles Gasparino 

8 
90 


76108.035

In closing, I'd like to reiterate that modern US equity market structure is the 

creation of 15 years of back-and-forth between government regulation and market 

reaction to that regulation. It is far from perfect, and there are several aspects of it 

that merit further investigation and potential reforms. But it serves the investing 

public better than what preceded it. As a result, fundamental reforms, like the ones 

that triggered the great market-structure transformation back in 1997, should be 

considered only with the greatest of care. 

Thank you once again for the opportunity to share the views of Rosenblatt 

Securities. I will be happy to answer your questions. 

9 
91 


76108.036

Knight 

Testimony of 

Mr. Thomas M. Joyce 

Chainnan and Chief Executive Officer 

Knight Capital Group, Inc. 

Submitted before the 

The Committee on Financial Services 

Subcommittee on Capital Markets and Government Sponsored Entcrprises 

Unitcd States House of Representatives 

Hearing on: 

Market Structure: Ensuring Orderly, Efficient, Innovative and 

Competitive Markets for Issuers and Investors 

Wednesday, June 20, 2012 

Chairman Garrett, Ranking Member Waters, and Members of the Subcommittee thank 

you for the opportunity to submit written testimony in connection with this very important 

hearing regarding key market structure issues. 

I. Brief history of Knight 

Knight Capital Group, Inc. (Knight) opened for business in 1995. 1 Built on the idea that 

the self-directed retail investor would desire a better, faster and more reliable way to access the 

market, Knight began offering execution services to discount brokers. Today, Knight services 

some of the world's largest institutions and financial services firn1s, providing superior trade 

executions in a cost effective way for a wide spectrum of clients in multiple asset classes, 

including: equities (domestic and foreign securities), fixed income securities, derivatives, and 

currencies. Today, Knight through its affiliates, makes markets in equity securities listed on the 

I Knight Capital Group, Inc., through its subsidiaries, is a major liquidity center for foreign and domestic equities, 

options, futures, fixed income securities) and currencies. On active days, Knight can execute in excess of 10 million 

trades, with volume exceeding 20 billion shares. With offices in the U.S., Europe and Asia. Knight's clients include 

more than 5,000 broker-dealers and institutional clients. Currently, Knight employs more than 1,500 people 

worldwide. For more information, please visit: www.knight.com. 
92 


76108.037

New York Stock Exchange (NYSE), Nasdaq, NYSE Amcx, the OTC Bullctin Board, and OTC 

Markets. Knight typically exccutes approximately 4 million tradcs pcr day. In 2011, Knight: 

Made markets in (or tradcd) approximately 19,000 securities. 

Executed more than one trillion sharcs (approximately 4 billion per day) in U.S. equities. 

Executed more than 900 million equity trades (approximately 4 million pcr day). 

Tradcd more than $6.4 trillion in notional valuc (over $24 billion per day). 

The majority ofthc trades we execute today are on behalf of retail investors. Although 

retail customers do not come to us directly, their brokers do. We count amongst our clients some 

orthe largest retail brokerage firms in the U.S., including: Scottrade, TD Amcritradc, Fidelity, 

Raymond James, E*Trade, Pershing, Vanguard and Wells Fargo. In addition, we service some 

of the largest institutions in the country. These institutional clients send us orders on bchalf of 

mutual funds and pcnsion plans, whose ultimate clients are, of course, small investors. 

Knight has spent the last 17 years evolving our technology infrastructure so that it can 

process millions of trades a day on behalf of the retail investor - in a fast, reliable, cost effective 

manner, while providing superior execution quality and service. Our data centers are some of 

the largest and most reliable in the industry. We spend tens of millions of dollars cvery year 

making our teclmology platform better, faster and more reliable. Today, we have the capacity to 

process 20 million trades per day. We have connectivity to nearly evcry source of liquidity in 

the equities market, and our trade response times are measured in milliseconds. Our years of 

research and development, technology platform enhancements, and connectivity to liquidity 

whercver it resides is all brought to bear in our endeavor to secure best execution on behalf of 

our customers (and, in tum, their customer the retail investor). Importantly, access to this 

sophisticated gateway is available to nearly every investor in the country. 

As a result, we believe that Knight is uniquely qualified to comment on the market 

structure issues which are the focus of this hearing - " ... /0 examine equity market quality, 

Page 2 
93 


76108.038

innovation, competition and the impact that market structure has on smaller issuers. " At their 

core, these issues revolve around notions of execution quality, liquidity, fair access and 

responsible rule making through rigorous cost-benefit analysis - all of which form the foundation 

for our capital markets. As we have noted previously, and as you will undoubtedly see upon the 

careful analysis of all of the relevant data, the U.S. equity market is the best functioning and 

fairest market globally. This has been achieved through fact-based decisions, prudent 

rulemaking, structural transparency and timely and efticient disclosure, all of which are products 

of a competitive and fair market structure that allows choice and fosters innovation. 

2. There has never been a better time to be an investor 

There has never been a better time to be an investor (large or small) in U.S. equities. 

Execution quality (speed, price, and liquidity) are at historically high levels, while transaction 

costs (explicit and implicit) are at historically low levels. 

Virtually every dimension of U.S. equity market quality is now 

better than ever. Execution speeds have fallen, which greatly 

facilitates monitoring execution quality by retail investors. Retail 

commissions have fallen substantially and continue to fall. Bid-ask 

spreads have fallen substantially and remain low, although they 

spiked upward during the financial crisis as volatility increased. 

Market depth has marched steadily upward. Studies of institutional 

transactions costs continue to find U.S. costs among the lowest in 

the world. 

Equity Trading in the 21" Century. James J. Angel. Lawrence E. 

Harris, and Chester S. Spatt (February 23, 2010). 

The U.S. equity markets are the fairest, most transparent and most liquid markets in the 

entire world. Remember that during the course of the last few years, with the exception of two 

notable exceptions, the equity markets worked flawlessly. As will be discussed in more detail 

below, the two exceptions were May 6, 2010 the so called, "flash crash" and, more recently, 

Page 3 
94 


76108.039

Nasdaq's handling of the initial public offering (IPO) of Facebook Inc. on May 18,2012. The 

SEC has taken a number of measured and reasonable steps to address the issues associated with 

the flash crash. Currently, Nasdaq is preparing a rule filing to address the damages sustained by 

market participants and investors as a result of its technology and operational failures in 

connection with the Facebook IPO. The industry anxiously awaits the outcome, and hopes that 

the rcmedial measures taken by Nasdaq will fully address the entire scope of damages sustaincd 

by market participants. Aside from these two unfortunate days, the equities markets havc 

performed extremely well. One may not have liked the direction prices went at times but all 

investors could act on their investment decisions swiftly and with surety -- distinguishing 

themselves in their reliability and robustness. 

An extraordinarily important fact, however, continues to be overlooked -- investors have 

seen substantial improvements in execution quality over the last 5-7 years. 

For example: 

a. The amount of times investors receive a price better than the national best bid or 

offer (NBBO) has risen significantly over the years. 

-April2012 

,,, 70% 

" ;; 'J); 

i 

, 

~ 

, 

, 

}! "" 

Or!< 

'" 21ll' 2l1l5 200b 2m7 21llS 2009 2010 2011 2012 

_lndLdryAtorllctter(~) 

Calculations are/or held market orders of order size.\' J()O~J999 shares. Data Source; lhomson Transaction Ana{ylic.~. 

Page 4 
95 


76108.040

,lhl' 

up 

J I II 
96 


76108.041

The facts show that investors have benefited greatly over the years as a direct result of the 

developments in market technologies. In fact, in speaking before the STA's Annual Meeting on 

October 4,2007 after the adoption of Regulation NMS, formcr SEC Commissioner Annette L. 

Nazareth stated that, 

Today, the landscape has changed dramatically. In August of this 

year [2007], for example, NYSE's market share in NYSE-listed 

equities was approximately 45.8%. For the tirst time, A TSs and 

ECNs are now competing head-on with the listed markcts ... What a 

difference true competition makes! (emphasis supplied) 

High speed computers, dark pools, ctc. are not the problem; indeed, they are the 

culmination of our free-market system competition. Competition has led to better executions 

(both speed and price) for investors. We should not look to impede competition; rather we 

should always look for ways to enhance it. That is what keeps the U.S. capital markets great. 

Formcr SEC Chairman Arthur Levitt got it right when he said, 

Investors large and small have always been served well by those 

looking to build the deepest possible pool of potential buyers and 

sellers, maker trades at a better price, and all as quickly as 

possible ... Morc liquidity, better pricing and faster speeds are the 

building blocks of healthy, transparent markets, and we must 

always affirm those goals. 

Wall Street Journal-- August 17,2009. 

3. Trading Technologies 

Retail invcstors are able to harness the connectively and lightning-fast technology made 

available to them by their brokers and the execution venues that handle their order flow. From a 

speed and access point of view, investors are able to access some of thc best trading technology 

available today - at little or no cost. 

Market venues spend hundreds of millions of dollars every year on technology, including 

data centers, communication lines and infrastructure. They look for new and improved ways to 

Page 6 
97 


76108.042

sourcc and access liquidity, in the most effective and efficient manner (including, dark pools, colocation, and countless order types). The investor community is provided access to many of 

these tools and technologies without charge (other than, of course, the small commission they 

pay their broker). That's right -- investors get access to nearly all liquidity pools and they can 

harness some oCthe fastest and most sophisticated technologies in the world. For example, as 

noted above, Knight is connected to all key liquidity pools. We deploy some of the fastest, most 

sophisticated trading technology in the world, all of which is brought to bear for the purpose of 

executing our clients' orders. Simply put, if a retail investor gives a market order to buy 500 

shares of Starbucks to his broker and that broker routes the order to Knight (or, many other 

execution venues), that order willlikcly be executed at the NBBO, or better, in a fraction of a 

second. The cost to the investor is simply the commission paid to their broker (typically, less 

than $10). Knight, as well as most other non-exchange execution venues, provides access to all 

of its technology. liquidity, and gateway to the marketplace at no charge to the retail investor. 

These different forms of market structure arc needed for different participants. The retail 

investor truly benefits from this vigorous competition and resulting choices provided. These 

market processes arc designed to facilitate the sourcing ofliquidity and enhancing execution 

quality. Remember, the retail investor is not operating alone. Retail investors place their orders 

with sophisticated executing brokers who have access to the various liquidity pools in the 

market. Additionally, brokers often tum to executing venues (like, Knight and others) to gain 

further access to the markets. Taken together (the broker and the execution venue), these robust 

resources are brought to bear for the benefit of retail investors providing them with a vibrant 

gateway into the marketplace and unprecedented access and liquidity. 

Page 7 
98 


76108.043

4. !:pmpetition and Innovation 

We fully support this Subcommittee's initiative to review the broad range of market 

developments which have helped shape our equity markets in recent years. Competition and 

innovation have led to advancements in trading technologies over the last several years. In fact, 

Regulation NMS hclped pave the way for competition to thrive among market participants. In 

addressing the STA at its Annual Meeting on October 13,2006, SEC Commissioner Nazareth 

stated, 

Two of the Commission's primary goals for Reg NMS are to 

promote vigorous competition among markets and to remove any 

competitive advantages that the old rules may have given manual 

markets. All evidence to date indicates that these goals are well on 

their way to being met. 

Those advancements have resulted in more liquidity, more price improvement and faster 

executions. Investors of all shapes and sizes (from small retail investors to large institutions) are 

reaping the fruits ofthose endeavors. As fonner SEC Commissioner Kathleen L. Casey noted on 

October 21,2009, 

Competition has transfonned the equity markets. We have moved 

light years from the slow manual trading that once characterized 

the New York Stock Exchange. We have moved well beyond the 

NYSElNasdaq duopoly. Today, the U.S. equity markets offer more 

benefits to more investors than at anytime in history. Over the past 

decade, advances in technology, coupled with paradigm-shifting 

regulatory actions such as Regulation A TS, have lowered barriers 

to entry. The resulting vigorous competition for customer order 

flow among numerous trading venues including so-called "dark 

pools" -.- has led to more choices of trading centers, greater speed 

and liquidity, financial innovation, tighter spreads, and lower 

execution costs. Investors, particularly individual investors, have 

reaped the benefits of the fierce competition that has developed in 

this area. Therefore, it is imperative that we not take any regulatory 

actions that would impede or unintentionally reverse this 

considerable progress. 

Pagc 8 
99 


76108.044

5. Sensible rule-making 

Regulatory fine tuning is necessary in a market as dynamic as U.S. equities. Given tbe 

many market structure changes that have taken place in recent years, a holistic cxamination of 

the U.S. equity market structure is timely, relevant and necessary. We believe it is especially 

important to craft effectivc trading rules. As the renowned statistician W. Edwards Deming once 

said, "In God We Trust; all others must bring data." The best rulemaking is bascd on a careful 

analysis of all relevant facts. Wc urge the SEC to look closcly at the statistical evidence of how 

cHicientIy tbc equities markets currently operate; to assess how much value the current system 

brings to all investors; and, to insure that any rulemaking withstands a rigorous cost-benefit 

analysis. 

Knight has advocated repcatedly that compctition, rathcr than mandated and prescribed paths 

to trading, benefits market participants and all invcstors. For example, the SEC's Rule 605 is an 

cxcellent example of regulation that increascs competition by promoting transparency and 

comparability. The rule rcquires market participants to post their execution statistics in accordance 

with standardizcd rcporting metrics, thus enabling order routing firms to make morc informed routing 

decisions to meet their clients' needs. This has incrcased competition and pressured markct 

participants to continuously strive to improve their execution capabilities for customer orders, while 

resulting in dramatically reduced costs for investors. We believe the dramatic dccrease in brokerage 

commissions and the split-sccond executions for most marketable orders in reccnt years is a direct 

result of these competitive forces; it was not driven by regulatory fiat. Additionally, SEC Rule 606 

requires brokers to disclose on a quartcrly basis the vcnues to which it routed order flow, as well as 

any payment for order flow arrangement. The adopting release to Rule 606 states, in part: 

The purposc of requiring disclosurc concerning the relationships bctween a 

broker-dealer and the venues to which it routes orders is to alert customers to 

potential conflicts of interest that may influence the broker-dealer's order-routing 

Page 9 
100 


76108.045

practices. Currently, Rule lOb-IO(a)(2)(i)(C) requires a broker-dealer, when 

acting as agent for the customer, to disclose on the confirmation of a transaction 

whether payment for order flow was received and that the source and nature of the 

compensation for the transaction will be furnished on written request. In addition, 

Exchange Act Rule lIAcl-3(a) requires broker-dealers to disclose in new and 

annual account statements its policies on the receipt of payment for order flow 

and its policies for routing orders that are subject to payment for order tlow. The 

Commission believes that disclosure of potential conflicts of interest in 

conjunction with a quantitative description of where all non-directed orders are 

routed may provide customers with a clearer understanding of a broker-dealer's 

order routing practices than is provided under current rules. (emphasis supplied) 

Regardless of any payments received, the SEC and self·regulatory organizations (SROs), like FlNRA 

and the NYSE, have made it very clear, that the broker's first obligation is to seek best exeeution. 

The SEC has stated: 

The Commission anticipates that improved disclosure of order routing practices 

will result in better-informcd investors, will provide broker-dealers with more 

incentives to obtain superior executions for their customer orders, and will 

thereby increase competition between market centers to provide superior 

executions. Currently, the decision about where to route a customer order is 

frequently made by the broker-dcaler, and broker-dealers may make that decision, 

at least in part, on the basis of faetors that are unknown to their customers. The 

Rule's disclosure requirements will provide investors with a clearer picture of the 

overall routing practices of different broker-dealers. The Commission 

contemplates that this will lead to greater investor involvement in order routing 

decisions and, ultimately, will result in improved exeeution practices. Because of 

the disclosure requirements, broker-dealers may be more inclined (or investors 

may direct their broker-dealers) to route orders to market centers providing 

superior executions. Broker-dealers who fail to do so may lose customers to otber 

broker-dealers who will do so. In addition, the improved visibility eould sbift 

order flow to tho~e market centers that consistently generate the best prices for 

investors. This inereased investor knowledge and involvement could ultimatelv 

have the effect of increasing competition between market centers to provide 

superior execution. (emphasis supplied) 

See, SEC Release No. 34-43590 (November 17, 2000). 

This is precisely the type of transparency which has led to tierce competition among 

market centers. That healthy competition has resulted in the extraordinary levels of execution 

quality retail investors enjoy today. In addition, many of the measures taken subsequent to the 

Page 10 
101 


76108.046

flash crash, also demonstrate the careful, measured approach thc SEC has taken whcn adopting 

new marketplace regulations addressing systemic risk while not trying to micro-manage the 

markets. Those measures included: stock-by-stock circuit breakers, clarifying thc erroneous 

trade rules, sponsored access rules. and the recently adopted limit-up/limit-down rules. 

Trade At 

We urge the SEC and other regulators to neverlose sight of the importance of costbcncfit analysis. For example, various iterations of the "trade at" rule continuc to be proposed by 

certain market participants. For the last 25 years, the SEC has consistcntly rejected these 

proposals, noting that a competitive, choice-driven market is far better for investors. 

Internalization is one such benefit for investors. Internalization offers retail and institutional 

investors a cheap, fast and safe method for executing their orders. Internalization exists because 

of client demand for best execution. It is an execution choice that enables investors to get the 

best possible priee (often better than what is displayed in the market), along with low transaction 

costs and minimal information leakage. As noted previously, one of the many quantifiable 

benefits of internalization include price improvement which is money directly back into the 

pockets of investors. That is, investors can receive prices that are better than what are displayed 

in the market. Internalization is available for all investor types and access has been significantly 

demoeratizcd by the extremely networked lattice structure of venues. To move away from this 

networked venue system, with its lit and dark venues that offer more execution flexibility would 

be a step backward. From the point of view of smaller market participants, such as retail 

investors, the market has never been so inclusive and efficient. The readily available access to 

numerous venues has allowed small investors to reap the benefits of internalization via price 

improvement, enhanced liquidity, and improved spreads. Furthermore, we have seen no 

Page II 
102 


76108.047

quantitmi\T 'Illali!a!i\c steps to Chclllf:!t..' or sl()\\ 

intc-rnuli/atlon. 

rcgll11t", or moYCs to limit Internalization. would add custs tu 

and institutional implicitly hy 111inimizing competition and (omrKtillYC- innllvatiolL 

c~plicilly bj many or to,,"cr cost ui1crnnttyc venuC's pay accc~s It would 

minimize the opportunities j"l' price improwment (alll! diminatc snb''Pcnny imprownwnl) 

to retail orders they would trade at the NBBO. It \\ould reduce liquidity jlrovilkd by 

market makers as increased costs \\ould ou!\vcigh their liquidih' pwv'ision ahilit) in most 

Itw0111d increase quok m,--~ssagc traffic and quote nickering as !inns would he forced to 

be allhe NBBO (likelv the Itmesl permissihle quantity) I(l scnice their ,'n",c,m,'" It could 

place rl..~lail inn~swr:) at In high llnns (I It "\yould 

significantly diminish the 

displayed \Tlmes (which typicall\ do not place orders into the displayed markets) to 

hcmdJc their sensitive order now. fhe requirement that such a n~llue either offer price 

improvement aticast in the amount of the minimum increment in order 10 execute at the NBBO 

would he diflicul! gi\ en that many slocks in penn: Consider 

Ass,m,e Ih" markel in ABCD: 

10,00 (l00 sh.) 

9.99 (lOO) 

9,9& (100) 

\).96 ( 00) 

( 100) 

HUn (lOO) 

(20m 

10.1)6 t lOf)) 

An investor \\:1l11s to buy ·lOO 

iflhe market makcr internalizes that order. it c()ulcl pnwide up 

10 .JOO share's ", $10.0 I (and many time'S it will price improve 

to SJ(J.(I09). 

a 

market The order could be executed at an 

rmd fcc "I' up to ~OJ)03!sharc could be 

In example. under a at" rule. the inycstor could I'll) 

2. ge more per (or an Gtra S ll.('()) on the exact same 

ordeL 1$10.0.<) T SOJJO:l $!O.03X SJ(U)()9 $(IJ)29I. 

Conseqnently, im'cstors could hundreds pf millions of 

dollars more for trades in ae regime 

Page 
103 


76108.048

In short, "trade-at" would stifle innovation and set the U.S. equity market back more than 

a decade as many of the new business models that have been introduced would no longer exist. 

The detrimcntal consequences of such a radical move far outweigh any possible benefit. 

NYSE Retail Liquidity Program 

In October 2011, the NYSE submitted a rule proposal to the SEC in which it seeks to 

establish a liquidity program to attract retail order flow to the NYSE through the provision of 

price improvement from non-displayed sub-penny orders posted by professional Retail Liquidity 

Providers ("RLPs") on the NYSE book. Although not yet tiled with the SEC, it is our 

understanding that Nasdaq and possibly othcr exchanges are considering something similar. We 

have filed comment letters with the SEC in which we have urged the SEC to carcfully study and 

analyze the sweeping implications of this proposed rule filing, especially the impact on 

Regulation NMS and the move to sub-penny quoting/ranking, prior to making a final decision on 

the rule. Rule 612 of Regulation NMS (i.e., the "sub-penny rule") specifically prohibits: 

" ... market participanfsji-rml displaying. ranking, or accepting 

quotations in NMS stocks- that are priced in an increment of less 

than $0. OJ, unless the price ()fthe quotation is less than $J.OO." 

Regulation NMS Adopting Release, SEC Release No. 34-51808. (June 9, 2005). 

As one of the more actively debated components of Regulation NMS, Rule 612 was the subject 

of numerous comment letters. Thus, material changes to this rule, like those contemplated by the 

NYSE proposal require careful consideration. The NYSE contends that the pilot period would 

reveal all potential problems and issues. The dispositive tlaw in this argument is that the "pilot" 

will consist of securities traded on only one market venue. The NYSE fails to recognize that if 

approved, the proverbial slippery slope will be that many market participants will seek similar 

relief, thereby thrusting the U.S. equities markets into a sub-penny quoting/ranking environment 

without adequate study and analysis. A pilot program that allows only one venue to receive an 

Page 13 
104 


76108.049

exemption from Regulation NMS is not a realistic test scenario and is unlikely to reveal any 

useful data. 

Accordingly, in determining whether to approve or adopt new rules (e.g., trade at, RLP, 

etc.), we have urged the SEC to evaluate carefully all available empirical evidence, consider 

thoroughly the potential for unintended consequences, and insure that the benefits associated 

with any such proposal far exceed the costs. 

6. The displayed markets are valid and robust 

Some have argued that the value of the displayed markets is somehow eroded when 

trading occurs off an exchange. We disagree. We believe the displayed or "lit" markets are 

robust, execute the majority of trading volume in U.S. equities and, thus, the NBBO is a fair and 

accurate representation of the best prices available in the marketplace. As a result, trades 

executed 0[[ of an exchange predominately occur at the NBBO (or better) which is completely 

consistent with both the letter and spirit of Regulation NMS. Nevertheless, as noted, the 

majority of trading volume today continues to take place on an exchange. In fact, the lit markets 

(NYSE, Nasdaq, Direct Edge, BATS and the regional exchanges) account for approximately 

70% of overall market volume. Regulation A TS and Regulation NMS helped to break the 

monopoly the exchanges had on market share. In fact, one of thc "darkest pools" was the old 

specialist system on the floor of the NYSE. For years the specialists controlled trading 

information and access to data. Barriers to entry were lowered and competition was able to 

flourish, forcing the NYSE and Nasdaq to compete for market share, rather than simply demand 

it as a birth right. Former SEC Commissioner Casey properly noted: 

This trading volume migration from the incumbent exchanges to other 

venues that publicly display trading interest demonstrates the robust 

competition among trading centers for customer order flow. It also 

Page 14 
105 


76108.050

demonstrates that non-displayed liquidity has not materially reduccd 

the quantity of publicly disseminated trade information. Therefore, it 

appears that an obsessive focus on the rise of dark ATSs is misplaced. 

Quoting venues in the aggregate are doing just finc, and the 

competition among them is a good thing, not something we need to 

"correct." 

SEC Open Meeting, Commissioner Kathleen L. Casey (October 21,2009) 

Market participants of all shapes and sizes actively trade both in dispJaycd and undisplayed 

venues. If the prices in the displayed venues are not valid, trading firms quickly enter the 

displayed vcnues with orders and trades until the pricing is corrected. If this did not occur, those 

price dislocations would cause all venues (dark and lit) to be irrational. Thus, any suggestion 

that undisplayed venues do not contribute to price discovery is illogical. Market participants 

tradc in both venues, insuring that pricing is rational and bonafide. 

7. Suggested rule-making 

Knight firmly believes that the U.S. equity markets are the fairest most efficient markets 

in the world. However, we recognize that ongoing, incremental regulatory changes arc crucial to 

keep pace with a highly innovative equity market. We believe that the following rule changes are 

worthy of serious consideration and may help to restore investor confidence. 

a. Representative Patrick McHenry proposal. 

b. A consolidated audit trail. 

c. A review of access fees, including the elimination ofthc maker/taker model. 

d. Widcr spreads for certain tiers of securities; e.g., high-priccd stocks, Jess liquid stocks, ctc. 

e. Market maker obligations. including a time in force for market maker quotations. 

a. McHenry Proposal 

Representative Patrick McHenry has drafied a legislative proposal, the "Liquidity 

Enhancement for Small Public Companies Act," to ensure that adequate liquidity exists for 

smaller issuers. Knight fully supports this proposal. The bill seeks to promote the development 

Page 15 
106 


76108.051

of market quality incentive programs by pelmitting issuers, exchanges, or any other company 

approved by the SEC or an exchange to provide financial incentivcs to market makers that 

adhere to standards of market quality established by an exchange. Nasdaq had proposed 

somcthing similar on April 6, 2012 (SEC Release No. 34-66765). In its filing, Nasdaq seeks to: 

... add new Rule 5950 (Market Quality Program) to enable market 

makers that voluntarily commit to and do in fact enhance thc 

market quality (qnoted spread and liquidity) of certain securities 

listed on the Exchange to qualify for a fee credit pursuant to the 

Exchange's Market Quality Program, and to exempt the Market 

Quality Program from Rule 2460 (Payment for Market Making). 

As a leading market maker of U.S. equities, Knight supports initiatives designed to improve the 

liquidity and transparency of the equities markets. Market makers playa critical role in helping 

to insure the equities markets are vibrant and robust this is particularly important in less active 

securities. We believe that the McHenry and Nasdaq proposals will benefit all market 

participants including, issuers, investors (institutional and retail), liquidity providers, and the 

overall U.S. economy by encouraging smaller companies to go public. 

b. Consolidated Audit Trail (CAT) 

Knight supports the SEC's stated goal of creating a more robust and effective crossmarket order and execution tracking system. Knight believes thal the U.S. markets today are 

well regulated and this is undcrscored by considerable volumes of data collected by regulators, 

such as OATS, ACT, OTS, COATS, Blue Sheets and other SRO audit trails. Knight supports 

market transparency and a thoughtful regulatory reporting structure that allows trading 

information to be made available to SROs and the SEC in a timely and consistent manner. In 

determining whether to adopt CAT, we have urged the SEC to evaluate and leverage all existing 

regulatory systems. 

Page 16 
107 


76108.052

Access fees have been at the core of nearly every debate that has taken place around 

market structure for almost two decades - taking hold after the SEC Order Handling Rules were 

adopted in 1996 (SEC Release No. 34-37619A, footnote 272. September 6, 1996). The so-called 

"maker-taker" model is an exchange or trading platform pricing system that gives a transaction 

rebate to market makers providing liquidity (the makers); and charges a transaction fee to 

customers who take liquidity out of the market (the takers). Firms that "make" a trade post 

buy/sell ofTers and are paid a fee, typically between about 20 cents and 30 cents for every 100 

shares traded. Firms that "take" those shares are charged a fee (the majority of retail investors are 

"takers" of liquidity). It was certainly not anticipated at that time, when spreads were multiples 

of what they are now, that this "communications charge" would become such a large component 

of the cost associated with a trade, or a profit center which had become the basis for routing and 

trading practices. As spreads have narrowed over the years, a $0.003/share access fee has 

become a significant cost associated with the trade. Indeed, in a one penny spread environnlent, 

access fees have the effect of increasing the economic spread by 60% (assuming $0.003 on each 

side of the quote). We therefore suggest that the SEC re-evaluate access fees in connection 

with its review of equity market structure, and consider eliminating the maker/taker model to 

insure we properly align market incentives with bonafide trading activities. 

d. Wider spreac!s for certain securities 

Knight fully supports the proposal to widen spreads for certain tiers of securities, 

including higher priced stocks, less liquid stocks, etc. In a one-penny spread environment it is 

very often dit1icult to aggregate meaningful volume at the one-penny increments for certain 

securities. As a result, it is difficult for investors to transact in these stocks, and makes it more 

challenging for smaller companies to go public. 

Page 17 
108 


76108.053

In that regard, on AprilS, 2012, the Jumpstart Our Business Startups Act (the "JOBS 

Act") was signed into law. The stated goal of the JOBS Act is to promote job grov.1h hy easing 

the capital raising process for small and mid-sized companies. Many of the reforms included in 

this bill aim to reduce thc regulatory burdens and cost of raising capital associated with previous 

public and private offering rules. Knight fully support the "tick-size" study offered by 

Representative David Schwcikert that was included in Title I, Section 106(b) of the JOBS Act. 

Under this section, the SEC is directed to conduct a study examining: 

the transition to trading and quoting securities in one penny increments, also known 

as decimalization; 

the impact that decimalization has had on the number of initial public offerings 

since its implementation relative to the period before its implementation; 

the impact that this change has had on liquidity for small and middle capitalization 

company securities and whether there is sufficient economic incentive to support 

trading operations in these securities in penny increments. 

We look forward to the SEC's study and believe the results will indeed show that the 

securities of emerging growth companies should be quoted and traded using a minimum 

increment of greater than $0.01 - for example, $0.05. 

e. Market Maker Obligations 

Knight has previously proposed to the SEC that it consider adopting additional market 

maker obligations. Historically, market maker rules were designed to require market makers to 

maintain two-sided markets to ensure that investors can buy or sell a security any time and at a 

competitive price. In fact, during the recent Facebook IPO, many market making firms did just 

that. They processed hundreds of millions of shares of investor orders despite the technology 

issues experienced by Nasdaq. As a result of these extraordinary efforts to service investor 

needs during a highly dysfunctional IPO opening, media reports have estimated that market 

making firms lost more than $450 million. As we have noted above, our sincere hope is that 

Nasdaq takes the necessary measures to address the full scope of thc industry losses. 

Page 18 
109 


76108.054

Over the years, as the market structure changed, market maker obligations have evolved 

into the current rule sct. Although there have been some changes adopted post-May 6, 2010 

(e.g., the elimination of stub-quotes), now is an opportune time to update rules and establish 

clarity around what qualifications and obligations market makers should be expected to meet in 

return for any benefits they receive. 

While there are important specific elements that must be considered when adopting any 

new market maker rules, as a policy matter we support rules that would impose even stronger 

obligations on market makers. For example: 

• Based on the price and average daily volume (ADV) of the stock, market makers 

should be required to quote "at the inside" at various tier levels (5-10% of the time 

during market hours), with minimum size requirements (200, 500, 1000 shares). 

• Market makers should face higher capital requirements. Due to the risk associated 

with increased market maker obligations, capital requirements for market makers 

should be based on their quoting obligations in addition to the existing position based 

capital requirement. 

• Market makers should be required to keep their quotes "live" for at least one second. 

In today's world of hyper-speed trading, it is sometimes difficult to access quotations 

which appear in the market because they are cancelled in fractions of a second after 

being posted. Although many may view this recommendation as too aggressive, we 

firmly believe market maker quotes should not be pCImitted to be cancelled for a 

minimum of one second to enable other maker participants to access that quote. In 

our view, this will restore a good deal of eredibility to the posted quotations in the 

market, and will eliminate a good deal of trading behavior which does not contribute 

meaningful liquidity to the market. 

We believe these proposals represent meaningful reform that will make our markets 

better and more resilient, particularly in times of high volatility and priee dislocation. 

Conclusion 

Knight appreciates the constructive roles this Committee and Subcommittee have played 

in the oversight of the markets and the rulemaking process. Your oversight helps to ensure that 

the U.S. capital markets remain competitive and innovative, thus benefiting all investors. 

Page 19 
110 


76108.055

Wc also fully support this Subcommittee's and SEC's initiatives to review the broad 

range of market developments which have helped shape our equity markets in recent years. 

Competition and innovation, spurred by insightful rule changes fostered by the SEC, have 

resulted in dramatic improvements in market technologies and execution quality for the benefit 

of public investors large and smaIL The U.S equity markets are the most liquid and efficient in 

the entire world, and have pcrfonned exceedingly well over the last decade. From an execution 

quality perspective, we believe that there has never been a better time to be an investor in U.S. 

equities. The advantages are considerable, including: speed and stability, priee improvement, 

and a significant reduction in transaction costs. The empirical and statistical evidence available 

show tremendous investor benefits under the current trading and regulatory market structure. 

We echo the comments of many of the members of Congress, the SEC Chainnan and 

SEC Commissioners thaI these imporlant issues must be driven by the careful analysis of 

empirical data, and not be driven by emotion or politics. Indeed, fonner SEC Commissioner 

Casey stated quite pointedly, 

[I] think it is necessary for the Commission to first develop a 

deeper understanding of the whole range of U.S. equity market 

structure issues before we consider adopting these amendments. In 

my view, it is important that regulators act with humility. 

Sometimes we don't know what we don't know, and if we rush to 

regulate without a complete understanding of the extent to which 

complex and dynanlic activities may be interrelated, the specter of 

unintended consequences looms large. The regulatory process for 

rethinking market structure, like short selling, needs to be driven 

by data, not politics or unfounded assumptions. 

SEC Open Meeting, Commissioner Kathleen L. Casey (October 21, 2009) 

We are confident that an independent SEC will be careful and thoughtful in its work - and 

not be swayed by any market participant's self-interest. We urge the Committee, Subcommittee, 

and the SEC to look closely at the statistical evidence of how efficiently the equities markets 

Page 20 
111 


76108.056

currently operate; to assess how much value the cun'ent system brings to all investors; and to 

insure that any rulemaking withstands a rigorous cost-benefit analysis. Rules that are approved 

without statistical analysis, and simply under the auspices of a pilot, can have significant 

unanticipated consequences to the marketplace and investing pUblic. In short, we must insure 

that any proposed new rules do not do more harm than good. 

Thank you for your interest in these issues and for the opportunity to contribute to this 

important dialogue. 

Page 21 
112 


76108.057

m 

Government 
113 


76108.058

Witness Background Statement 

Dan Mathisson is the Head of U.S. Equity Trading for Credit Suisse. He is 

responsible for block trading, program trading, and electronic trading at Credit Suisse. 

Mr. Mathisson joined Credit Suisse in 2000 as a trader, shortly after which he 

founded the Advanced Execution Services (AES) group, which grew to be the leading 

electronic trading franchise on the Street. Prior to joining Credit Suisse, he was the 

head equity trader at D.E. Shaw Securities. 

Mr. Mathisson writes a regular column about trading and markets for Traders 

Magazine. In 2011 he was named one of the "Top Ten Innovators of the Decade" by 

Advanced Trading magazine, which cited him for creating the modern algorithmic 

trading desk. Mr. Mathisson received a BA in Economics from the University of 

Michigan, and he is a Chartered Financial Analyst. 

Introduction 

Good morning and thank you for giving me the opportunity to share my views on 

the best structure for our nation's stock markets. My name is Dan Mathisson, and I am 

the Head of U.S. Equity Trading for Credit Suisse 1. 

The U.S. broker-dealer subsidiary of Credit Suisse Group has been operating 

continuously in the United States since 1932, when the First Boston Corporation was 

1 Credit Suisse provides its clients with private banking, investment banking and asset management services worldwide. Credit 

Suisse offers advisory services. comprehensive solutions and innovative products to companies, institutional clients and hjgh-net~ 

worth private clients globally, as weI! as retail clients in Switzerland, Credit Suisse is active in over 50 countries and employs 

approximately 48,700 people. Credit Suisse ;s comprised of a number of legal entities around the world and is headquartered in 

Zurich. The registered shares (CSGN) of Credit Suisse's parent company, Credit Suisse Group AG, are listed in Switzerland and, in 

the form of American Depositary Shares (CS), in New York_ Further information about Credit Suisse can be found at W\o\I"I.V.credjt~ 

sUlsse.com. 
114 


76108.059

founded. Today, Credit Suisse is the highest volume broker-dealer in the U.S2 , and 

Credit Suisse owns and operates Crossfinder, which has been the largest Alternative 

Trading System (ATS) in the U.S. every month since May of 20093 

I have been working in the U.S. equity markets for 20 years, the last 12 of which 

have been at Credit Suisse. I appreciate the chance to appear here today. 

Summary 

Credit Suisse believes that equity market quality has improved markedly over the 

past two decades, but there is still room for improvement. We suggest four policy 

changes, each of which is designed to make markets more reliable than they are today, 

or to reduce costs for investors. 

Are the U.S. markets working effectively? 

Credit Suisse believes that the market structure changes of the past 20 years 

have been successful in their goal of creating equity markets that are more fair, orderly, 

and efficient than in the prior era. The empirical evidence shows that Regulation ATS, 

decimalization, and Regulation NMS have led to an increase in liquidity and a decrease 

in the total number of market disruptions. We have found this holds true for both large 

and small issuers. 

Credit Suisse recently completed a broad survey of market quality in the U.S. 

equity market, and found that in every empirical measure, the U.S. markets are 

functioning better than ever4 The study found: 

2 Bloomberg RANK, Credit Suisse was #1 in volume in S&P500 stocks for fun year 2011. 

3 Rosenblatt Surveys, May 2009 - April 2012 

2 
115 


76108.060

Positives: 

Overnight market volatility in 2012 is at a 15-year low. 

Intraday market volatility has been steadily decreasing since 2005. 

• Bid-Ask spreads in the U.S. are the tightest in the developed world. 

• Bid-Ask spreads have been clearly and steadily declining since Reg NMS 

was introduced, controlling for volatility. 

• Average size of bids and offers has increased since 2004. 

The number of market disruptions, a.k.a. "mini flash crashes", has been 

decreasing since 2000. 

Negatives: 

• Quote flickering has increased, with the number of daily changes in the 

NBBO (National Best Bid Offer) per million shares traded at an alf-tirne 

high in 2011. 

Overall the study failed to find any empirical evidence of negative market 

performance other than the increased cost of message traffic. However, two events 

over the previous 26 months do appear to have caused outflows from equity funds, 

signaling a loss in investor confidence. These two events were the "Flash Crash" of 

May 2010, and the chaotic Facebook IPO of May 2012. 

Reduce the likelihood of another Flash Crash: eliminate market orders. 

The Flash Crash revealed a serious flaw in our market structure - on May 6, 

2010, there were no mechanisms in the market to stop panicked investors from selling 

4 Ana Avramovic, "Who Let the Bots OutT Credit Suisse Trading Strategy, May 2012. Also see 

"June 2012 Chartbook", Credit Suisse Trading Strategy. 

3 
116 


76108.061

stocks all the way down to zero. Credit Suisse believes that the new Limit Up I Limit 

Down rule and the new market-wide circuit breakers, recently passed by the SEC and 

scheduled to go live in February 2013, will be effective at preventing another flash crash, 

and we enthusiastically support these new rules. 

In addition to these new rules, we recommend going a step further to prevent 

disruptions, by eliminating the market order. An order to sell "at the market" is 

inherently dangerous, being a limit order with a price of zero. A buy market order is 

even more frightening, being a buy order with a limit of infinity. The order type is based 

on faith that the other side will materialize at a reasonable price, which is unlike how 

people buy or sell almost everything else. Yet the majority of orders in the equities 

market from mom and pop investors are sent at the market. If liquidity dries up, as 

happened on the day of the Flash Crash, the constant flow of retail market orders 

guarantees that stocks will trade at prices that are disconnected from their fundamental 

valuation. 

We believe that eliminating the market order would reduce disruptions and aid in 

the goal of achieving a fair and orderly market. Germany, Brazil, Hong Kong, and many 

other major markets already require investors to enter a price limit on every order. We 

recommend that the U.S. follow these marketsS 

Reduce the likelihood of another Facebook IPO situation: restore moral hazard to 

exchanges. 

5 For more on this topic, see "Market Madness", by Dan Mathisson, Traders Magazine, May 19, 

2010. http://www.tradersmagazine.com/newslflash-crash-opinion-mathisson-I 05736-I.html 

4 
117 


76108.062

The Facebook IPO on May 18, 2012 revealed that an exchange technology 

breakdown can cause significant chaos in the markets and undermine investor 

confidence. We believe the best way to reduce the chances of similar technology 

problems from occurring in the future is to remove protections which grant exchanges 

"absolute immunity" from liability. As Self-Regulatory Organizations (SROs), 

exchanges have been considered by courts to be quasi-governmental units. This 

afforded them immunity from liability judgments in situations where the exchange was at 

fault. Absolute immunity may have made sense when exchanges were not-for-profit, 

member-owned regulatory organizations. But today, the NYSE and all exchanges are 

for-profit enterprises that are not particularly different from broker-dealers. While they 

still have a few vestigial regulatory functions, the vast majority of their regulatory 

responsibilities is outsourced to FINRA. 

Exchanges now function as broker-dealers in many ways. For example, Nasdaq 

recently announced they would compete with broker-dealers by selling execution 

algorithms, which involve significantly more complex technology than simply crossing 

stock like the Facebook IPO.6 Complex trading technology like algorithms should go 

through rigorous QA (Quality Assurance) testing, and maximum caution should be 

exercised when rolling out new programs. We believe that providers of trading 

technology will naturally exercise greater caution if they have material liability when their 

6 "Nasdaq to Offer Algorithms, Competing with Brokers", by Nina Mehta, Bloomberg News, 

May 14,2012. Article quotes Professor Bruce Weber saying, "Before electronic trading really 

took off, it was clear where the exchange function ended and the brokerage function began. That 

line is getting blurred." 

5 
118 


76108.063

technology fails. Restoring exchanges' moral hazard would be an important step 

towards creating a more reliable marketplace. 

This is especially important since Regulation NMS does not allow broker-dealers 

to ignore an exchange's bids or offers, essentially compelling brokers to trade with 

every exchange, whether or not they find an exchange's technology to be reliable, and 

whether or not they find the exchange's liability policy to be fair and equitable. Policymakers should examine whether it still makes sense for exchanges to be considered 

governmental entities, given that they are no longer member-owned, no longer not-forprofit, and no longer have much of a direct regulatory function. 

Are exchanges and dark pools on a level playing field? 

Regulation ATS was specifically passed to allow broker-dealers to create 

electronic crossing networks that automated their traditional job of crossing client orders. 

ATS's, a subset of which are known as "dark pools", therefore operate under a different 

regulatory structure than exchanges. Dark pools are estimated today to execute 

approximately 14% of the volume in the U.S. market. Nasdaq and NYSE have claimed 

that regulators need to ensure that exchanges and dark pools are on a "level playing 

field" to protect the for-profit exchanges from losing further market share7 However, the 

"level the playing field" argument has the situation backwards, because there is a clear 

and massive economic advantage to being an exchange. Within the past five years, two 

major ATS's, BATS and DirectEdge, both voluntarily chose to become exchanges, 

spending millions of dollars and devoting years of effort to make the switch. They 

7 See "U.S. Market Structure Overview: BriefIng for House Staff', Nasdaq I NYSE, June 12, 

2012 

6 
119 


76108.064

became exchanges because they wanted to benefit from the four big advantages that 

exchanges have over crossing venues organized under Reg ATS: 

The 4 big economic advantages exchanges have over ATS's: 

1) Exchanges have absolute immunity on errors, having historically been 

considered quasi-governmental entitiesB Courts have typically ruled that 

exchange immunity holds even in cases of gross negligence or willful 

misconduct. ATS's are regular businesses that have liability for their actions. 

2) Exchanges receive "tape revenue". The CTA (Consolidated Tape Association) 

has a legal monopoly on providing a consolidated stream of real-time data 

from our nation's stock markets. The CTA makes a profit of approximately 

$400 million per year, which is then rebated to its participant exchanges 

based on a complex formula. The revenue that exchanges receive from 

these rebates is significant - for example, Nasdaq reported receiving $116 

million in rebates in 2011 from the CTA. ATS's do not receive tape revenue. 

3) Exchanges pay no clearing fees. An ATS is a party to both sides of each 

transaction that passes through it, while an exchange merely facilitates the 

transaction. Therefore ATS's pay tens of millions of dollars in clearing fees 

annually, whereas exchanges pay no clearing fees. 

4) Exchanges have no net capital requirements. Because they are not a party to 

the transactions that occur on their systems, exchanges do not need to hold 

capital to stand behind their trades. 

8 "Nasdaq Exchange Immunity May Limit Losses From Faccbook Claims", by Nina Mehta, 

Bloomberg News, June 13,2012. 

7 
120 


76108.065

So with exchanges having four significant economic advantages, why haven't all the 

ATS's followed BATS's and DirectEdge's lead and become exchanges? The primary 

reason is that most of the remaining large ATS's are owned by a single broker-dealer, 

and current regulatory restrictions makes it impossible for a broker-dealer to own more 

than 20% of an exchange. Therefore broker-dealers would have to spin off 80% of their 

ATS's to become exchanges. 

We agree with the exchanges that the regulators should "level the playing field" 

between dark pools and exchanges, and we suggest that the best way to do this would 

be to eliminate the 20% maximum on broker-dealer exchange ownership. We believe 

that if this restriction was lifted, most of the major ATS's would choose to become 

exchanges, after which the playing field would be level. 

Why do some investors choose to use dark pools? 

Dark pools help long-term investors by giving them an avenue to trade without 

revealing sensitive trading intentions to short-term traders. No one is compelled to use 

a dark pool - we believe that the 14% market share that dark pools have collectively 

achieved is a sign that investors have found they are beneficial. We believe that much 

of the debate over dark pools is misguided and is fueled by a desire of the old-school 

exchanges to avoid healthy competition. 

The irony of the exchanges' frustration at the success of dark pools is that the 

exchanges themselves are likely responsible for much of the growth of dark pools, due 

to their own policies that may scare away long-term investors from posting bids or offers 

on exchanges. Exchanges create significant revenue selling high-speed data feeds that 

8 
121 


76108.066

deliver information faster than the consolidated tape9

, and which contain data fields that 

are not available on the consolidated tape. Large investors may choose to use dark 

pools to avoid this dissemination of additional information that occurs when they use 

exchanges. 

Additional dissemination of information scares institutional traders away, because 

big institutions and the brokers who trade on their behalf expend a great deal of effort 

figuring out ways to buy and sell large amounts of stock while minimizing signaling to 

the marketplace that a large investor is buying or selling. Traders use a variety of 

techniques to reduce trading signals. There are four main types of signals that can 

reveal a trader's intentions to others: traditional phone calls, electronic messages like 

"lOis" (Indications of Interest), patterns within the "tape", and displayed bids and offers. 

Of these four types of signals, displayed bids and offers are the most obvious and 

therefore the most dangerous for investors. Therefore, the decision to display a bid or 

an offer is not made lightly by an institutional trader. 

Before computerized "dark pools" existed, traders often chose to keep their bids 

and offers undisplayed, to avoid sending a signal of their trading intentions to the 

marketplace. This was accomplished by giving a "not-held" order to the floor brokers on 

the exchange who would then keep sensitive orders "in their pocket". The broker would 

literally drop the order ticket in his pocket, without displaying it to the world, while 

keeping his eyes and ears open for the other side of the trade. This process also 

occurred at the specialist post on the exchanges, and in the "upstairs" market, where 

brokers would hold client orders while looking for the other side. 

9 In 2011, Nasdaq OMX reported generating $334 million in total market data revenues; NYSE 

Euronext reported $371 million. 

9 
122 


76108.067

A "dark pool" automates this age-old process. Traders drop orders into the 

computer's "pocket" The computer, just like the floor broker of old, does not tell anyone 

about the order in its pool. If the other side of the trade happens to also drop into the 

pool, the computer matches the two orders, and a trade occurs, 

Computerized dark pools have been around since 1987. They exist because 

they fill a need: the need for an institutional investor to be able to trade without telling 

the entire world that a new buyer or seller has entered the marketplace. Since 

decimalization, the number of shares required to be considered potentially "marketmoving" has decreased, as the average trade size dropped from over 1400 shares in 

1999, to under 300 in 2009. In a decimalized environment of constant small trades, 

even very small orders can benefit from dark pools. 

Questions have been raised about whether dark pools contribute to "price 

discovery." Dark pools must report all trades to the consolidated tape immediately, and 

their prints are a valuable source of "last trade" data. When buying a house, buyers 

determine the appropriate price based on the prices at which similar houses actually 

sold in the neighborhood. Asking prices are interesting, but actual home sales are far 

more important To assert that "last trade" data from dark pools does not contribute to 

price discovery is disingenuous. 

Conclusion 

Credit Suisse suggests four policy changes, each of which is designed to make 

markets more reliable than they are today, reduce investor cost, or increase fairness for 

investors: 

]0 
123 


76108.068

1) Repeal the rules that give for-profit exchanges immunity from liability. 

Restoring moral hazard to the exchanges will increase exchange 

management's level of caution on new technology rollouts and QA (Quality 

Assurance) procedures, and reduce the odds of future situations like the 

chaos that hit the market on the day of the Facebook IPO. 

2) Eliminate the market order. A sell "at the market" is an order to sell with a 

price of zero. A buy "at the market" is an order to buy with a price of infinity. 

An easy way to reduce the chances of large gaps in prices is to force 

investors to enter a limit price on every order. 

3) Perform a review of the pricing and rebate system operated by the 

consolidated tape plans. The CTA plans collect approximately $400 million 

a year from the investing public, which then get rebated to the for-profit 

exchanges that collectively run the plans. These plans were set up in 

November 1972, when the SEC adopted Rule 17a-15. After 40 years, we 

believe the current tape revenue model is obsolete and rife with problems, 

and we recommend a full review of the tape revenue system. 

4) Lift the restrictions that limit broker-dealers to 20% ownership in 

exchanges. Now that most exchanges outsource most of their regulatory 

functions to FINRA, we believe that this restriction is obsolete. Exchanges 

and ATS's are both for-profit, technology-intensive firms performing mostly 

the same tasks. We suggest repealing this rule and allowing ATS's to 

become exchanges and therefore compete on a level playing field. 

11 
124 


76108.069

Thank you for the opportunity to appear today and I will be happy to answer any 

questions that you may have. 

12 

Dan Mathisson 

June 20, 2012 
125 


76108.070

Testimony of Duncan Niederauer 

Chief Executive Officer, NYSE Euronext 

HFSC Subcommittee on Capital Markets and Government Sponsored Enterprises 

"Market Structure: Ensuring Orderly, Efficient, Innovative and 

Competitive Markets for Issuers and Investors" 

Wednesday, June 20th 

Washington, DC 

Introduction 

Chainnan Garrett, Ranking Member Waters and members of the Subcommittee, I want to 

thank you for inviting NYSE Euronext (NYX) to discuss the current status of the U.S. equity 

market structure. We believe this is an issue of utmost importance to ensuring investors' 

confidence in markets and believe it is prudent for both the Congress and the SEC to move 

forward with some of the recommendations I highlight in my testimony. 

NYX is a global exchange operator of 7 equities exchanges (3 in the U.S. and 4 in 

Europe) and 8 derivatives exchanges (3 in the U.S. and 5 in Europe). Although market structure 

rules in each country have their own nuances, NYX has a unique vantage point from which to 

compare each country's markets and learn from the experiences of our European colleagues and 

market participants. 

In accordance with the invitation we received from the Subcommittee, we will focus our 

attention on (i) the current equity market structure, (ii) items we believe deserve the attention and 

review of the Congress and the SEC, and finally (iii) possible solutions we believe will assist in 

both leveling the competitive landscape for the trading of securities and increase investors' 

confidence in U.S. markets. 

Market structure refonn raises a number of highly complex competitive and regulatory 

issues. Market microstructure changes implemented over the past few years, coupled with the 

continued automation of securities markets, have led to an explosion in both innovation and 

operational chalJenges. In assessing whether further refornl is needed, it is important to highlight 

that our markets typically function seamlessly and without interruption. Many of the practices 

that I am going to speak about today are indeed beneficial to the individual parties to such 

transactions. However, the regulatory framework governing our market structure must take 

account of the aggregate impact of these individual practices on the quality of our markets as a 

whole, as well as whether the existing market structure and regulatory regime are fair to all 

market participants. Is it fair, for example, that a small number of participants in private markets 

receive the highest quality orders. with no benefit to the public markets? Should different 

markets that perfonn identical functions be subject to different regulatory requirements, with 

certain orthose markets under a much lighter regulatory burden? Docs it make sense that one-
126 


76108.071

third of the market does not provide public quotations of the prices at which securities may be 

bought and sold, or that certain venues have to provide fair access to their markets, but others do 

not? Why has the volumc of securitics trading in dark pools tripled over the past few years, 

despite thc intcnt of Regulation NMS to incent the public display of securities orders? The 

complexity of our markets and cacophony of self-interested arguments seems to have led to 

paralysis on important matters of market structure refonn. We should not wait for another May 

6th to address these logical questions. 

Fair Competition among our markets should produce confidence among investors 

Even as our securitics markets have evolvcd through competitive and regulatory 

innovation, regulators and many market participants have remained focused on certain core 

principles: fair and stahle markets and capital fonnation. A 1975 Senate report on the national 

market system stated that "one of the 'paramount' objectives for the [system) is 'the maintenance 

of stable and orderly markets with maximum capacity for absorbing trading imbalances without 

unduc pricc movements. ",I The SEC specifically referenecd this objectivc in 2005 again when 

adopting Regulation NMS. In moving to implement the market structure refonns of Regulation 

NMS, the SEC also affinned its "finn belicfthat one of the most important goals of the equity 

markets is to minimize the transactions costs of long-tenn investors and thereby reduce the cost 

of capital for listed companies."z In its 2010 Concept Release on Equity Markct Structure, the 

SEC also noted Congrcss' focus on providing for fair competition among broker-dealers, 

exchange markets and non-exchange markets. 3 Another important core objcctive of the SEC is 

to facilitate the availability to brokers, dealers, and investors of reliable infonnation regarding 

quotations and transactions in securities. 

In most developed markets, there is one "national" stock exchange. However in the 

United States, there arc upwards of250 competing trading venues, which include exchanges, 

dark pools, electronic communication networks. and broker-dealers. 

This competition has spurred tremendous innovation in the fonn of increased automation 

and speed of trading, greater reliability of trading systems, and improved functionality. Most 

importantly, the combination of regulatory changes has benefited investors. Refonns such as 

decimalization in 2000 and competition among trading venues have resulted in a reduction in 

quoted spreads (that is, the difference between the price at which sellers sell and buyers buy). 

This decrease in quoted spreads reduecs transactions costs and thus increases returns to investors, 

a positive development for investors. 

Despite the positive effects of competition for investors, many investors nevertheless lack 

confidence in our securities markets. A number offactors have contributed to this lack of 

investor confidence, including some aspects of the structure of our equity markets. While some 

market participants consider volatility to be in their interest, long-tenn investors look to markct 

'Regulalion NMS. Exchange Act Release No. 51808. 70 Fed. Reg. 37496, 37500 (June 29. 2005) ("NMS Release'"). 

2 NMS Release at 37499. 

'Concept Release on Equity Market Structure, Exchange Act Release No. 61358, 75 Fed. Reg. 3594,3596 (Jan. 21, 

2010) ("Concept Release"). 
127 


76108.072

stability as the basis for confidence to commit capital. Market stability also gives companies 

seeking to grow their businesses the confidence that capital will be available to them when 

needed to invest in job-creating expansions of their businesses. 

Not surprisingly, significant negative events in the equity markets adversely impact 

investors' confidence in the markets. As the Joint CFTC-SEC Advisory COimnittee on 

Emerging Regulatory Issues noted, "[wJhilc many factors led to the market events of May 6, 

2010, and different observers place different weights on the impact of each factor, the net effect 

of that day was a challenge to investors' confidence in the markets.,,4 

Capital flows in the equity markets over the past several years underscore a lack of 

investor confidence in the securities markets. For example, data on investments in equity mutual 

funds suggest that investor confidence in the equity markets is at risk. The data show that over 

the last scveral years, investors, particularly small investors, have withdrawn billions of dollars 

from domestic equity funds. As with investor confidence generally, significant negative market 

events scem to affect negatively invcstors' participation in the equity markets. For example, the 

equity markets experienced increased capital outHows after the market evcnts of May 6th. 

Perhaps more significantly, howevcr, investor withdrawals in recent years have continued evcn 

in the absence of significant events and even during periods of increascs in the US stock prices. 

This behavior is inconsistent with historical patterns that show that investors typically invest in 

the equity markets during times of rising prices. 

Increased market competition has also led to unintended negative consequences 

During the past decade, and particularly since 2006, the exchanges operated by NYX 

have embraced, and been fundamentally transformed by, competition among the various 

securities markets. One of the driving forccs behind NYX's transformation, as the SEC has 

noted5

, has been the SEC's effort to modernize and strengthen the national market system for 

equity securities, particularly through Regulation NMS, which it adopted in 2005. 

In March 2006, the SEC approved the beginning of the Ncw York Stock Exchange's 

(NYSE) historic shift from a Hoor-based auction market with limited automated order interaction 

to a more automated market with limited Hoor-based auction market availability. With the 

approval of the "Hybrid Market," the NYSE began the substantial expansion of automatic 

execution of orders to buy and scll sccurities, and the ability of its Hoor members to participate in 

its automated market electronically. At the time of approval, automatic executions on the NYSE 

represented approximately II % of its market share volume, and the bulk of executions occurred 

manually in its Hoor-based auction. The average speed of execution was over tcn seconds and 

NYSE's share of consolidated vohune in NYSE-listed securities for the year preceding the 

approval of the Hybrid Market was about 75%. 

4 Recommendations Regarding Regulatory Responses to the Market Events of May 6, 2010: Summary Report of 

the Joint CFIC-SEC Advisory Committee on Emerging Regulatory Issues. Ihe recommendations are available at 

http://www .sec.!wv/spotlighlisec-cftcjointcommittee/021811-report.pdf. 

5 Concept Release at 3494-3495. 
128 


76108.073

Roughly two years latcr, the NYSE proposed further and substantial structural reforms 

with the introduction of its New Market Model. Foremost in significance were: (1) the phasing 

out of the specialist system and the concurrent creation of the Designated Market Maker, referred 

to as a "DMM"; (2) the alteration of the NYSE's longstanding priority and parity rules to allow 

DMMs to freely trade on equal footing with other market participants where the specialist 

prcviously had been obligated to yield to public customer orders in the book; and (3) the 

elimination of the advance electronic "look" at incoming orders that had been a historical feature 

of the specialist system. In 2009, the year following the adoption of the New Market Model, 

NYSE's share of consolidated volume in NYSE-listed securities had fallen from to 25%. By 

2009, the average speed of execution had fallen from about 10 seconds to less than a second. 

And between 2005 and 2009, thc average trade size in NYSE-listed securities fell from 708 to 

344 shares. These structural reforms and the highly competitive market conditions undcr which 

they occurred were nothing short of transfornJative. 

The NYSE has undertaken these reforms to meet the needs of market participants while 

maintaining certain manual market functions. Moreover, the NYSE has maintained these manual 

clements in the face of tremendous regulatory and competitive pressure to become fully 

automated. We believe that the tlexibility to intervene in markets manually is necessary to 

maintain orderly markets, as the efficacy of manual intervention during the events of May 6, 

20 I 0 demonstrated. 

Although structural reforms of securities markets have led to increased competition, those 

reforms have also had unintended negative consequences. The reforms created lower barriers to 

entry for new trading venues -some of which lack price transparency with respect to the 

securities transactions that arc executed through them. These alternative venues also operate 

under a less rigorous regulatory framework. Both of these have led to a dramatic rise in offexchange trading. 

Consolidated, transparent prices fonn the core of our market system. We believe that 

investors are more likely to have confidence in the securities markets if they believe that they are 

rcceiving fair prices when they buy and sell securities. As trading volume has shiftcd to new 

trading centers that operate with less transparency and fewcr regulatory requirements, more and 

more information is outside of public view and excluded from the price discovery process. With 

incomplete public information concerning the full extent of market activity, combined with everincreasing complexity regarding routing practices and sometimes limited transparency, it can be 

difficult to assess whether a customer is getting best order execution. The SEC noted in the 

release adopting Regulation NMS that "[i]mpaired price discovery could cause market prices to 

deviate from fundamental values, reduce markct depth and liquidity, and create excessive shortterm volatility that is hamlful to long-term investors and listed companies. ,,6 

Regulated exchanges, such as the NYSE, serve as price-makers. Price makers are critical 

to the price discovery proeess as they show the best available quotes for securities on both sides 

of the market (the lowest priccs at which sellers are willing to sell and the highest prices at which 

buyers are willing to buy). These best available quotes, referred to as the national best bid and 

"NMS Release at 37499. 
129 


76108.074

otTer (NBBO), are constantly changing with activity in the markets. Price makers show the 

NBBO at any given point in time. 

Alternative trading venues, by contrast, arc price matchers: they match willing buyers 

and sellers that participate in their venues, but do not contribute to price discovery by displaying 

quotes to be included in the NBRO. That is, the off-exchange trading centers provide so-called 

"undisplayed liquidity". We recognize that undisplayed liquidity has played a role in equity 

market structurc, in one form or another, for many years. For example, it can serve an impOliant 

function for investors seeking to trade large blocks of securities. With thc dcvelopment of nonexchange trading venues and new trading practices, however, undisplayed trading now accounts 

for a substantial volume of ovcrall cquity trading. But we need to ask ourselves at what level 

does pricc discovery materially suffer from gains in the market share by price matchers? 

Protecting investors requires listening carefully for cautionary signals 

Investors' confidence in a price discovery mechanism greatly contributes to thcir 

willingness to continue to invest their money, whether through a broker-dealer or through mutual 

and pension funds (whcre most Americans keep their life savings). However, there are several 

cautionary signals regarding the vibrancy ofthc national market system as a pricing mechanism. 

The primary factor contributing to the loss of vibrancy in the pricing mechanism is the 

increasingly bifurcated equity market structure. As discussed, an ever-increasing volume of 

trading in equities occurs in dark markets. Today one-third of all equity trading takes place off 

exchangc and over 1200 securities have more than 50% of their volume traded off-exchange, an 

increase of 143% in less than 2 years. 7 While NYX fully recognizes the legitimate functions 

served by otT-exchange trading models, there is a point at which the aggregate amount of offexchange trading is detrimental to price discovery and investor confidence. 

Order execution has always started with an investor and the investor's broker-dcaler. 

Once an order is submitted, the brokcr-dealer has had the option o[internalizing that order, 

meaning it can trade against the customer itself, or routing the order to an exchange where that 

ordcr is included in establishing the best price. Since the implementation of Regulation NMS, 

broker-dealers now have at least 4 options: internalizing the order, routing it to one of over 200 

other broker-dealers, routing it to anyone o[more than 40 dark pools, or routing it to an 

exchange where thc order will likely contribute to establishing the best price. These options 

bave increased because technology has enabled and the SEC has permitted non-exchange trading 

centers to create a very sophisticated web of connectivity whieh allows them to give select 

groups of traders and clients access to those orders before anyone else - each with its own level 

of conflicted interest. It is only after select customers have detelmincd they do not want to 

cxecute the order that thc order finds its way into the public markets, and only then does the 

order have the opportunity to contribnte to the price diseovery process. It is also important to 

note the increased industry conflict that has grown alongside these market strueture evolutions. 

As I previously noted, exchanges have demutualized, but at the same time most of the nonexchange activity occurs on venues that are owned by brokers who frequently have an agency 

7 NYSE Trades and Quotes (TAQ) 
130 


76108.075

responsibility, but also a profit motive, for the orders that they handle. This lack of 

independence and objectivity, alongside the lack of transparency, clearly influences decisionmaking and the philosophies of industry participants more than in the past. 

Intuitively, as this bifurcation grows and more volume moves toward non-exchange 

trading centers, the price discovery mechanism deteriorates. However, there is also data that 

reinforces this intuition and it is this data, in large part, which has NYX, NASDAQ OMX and 

BA TS exchanges concerned. A recent report issued by Rosenblatt Securities shows that dark 

pool market share is traditionally inversely proportional with volatility. 8 This means that traders 

retreat to the public markets (exchanges) when markets are stressed. The market events of May 

6th• 2010 are the best evidcnce of the retreat to public markets during times of volatility. As the 

CFTC-SEC Advisory Committee stated in its tinal report on the events of May 6t

\ so-called 

internalizers, such as OTC market makers and block positioners, decreased their internalizations 

during these market events. That is, they decreased the volume of their customers' orders that 

they executed on a principal or riskless principal basis. In some instances, when they tried to 

route these orders to other internalizcrs or to dark pools, the orders were rebuffed. In such 

instances, "[iJnternalizers instead routed orders to the exchanges, putting further pressure on the 

liquidity that remained in thosc venues.',9 

A study by Professor Daniel Weaver of Rutgers Business School provides evidence of a 

causal link between dark trading and market quality. Professor Weaver found empirical 

evidence that higher off-exchange trading is associated with a reduction in market quality, and in 

particular with wider spreads, increased price impact, and volatility from less available exchange 

depth. \0 

A common argument made in support of the growth in off-exchange trading is that 

spreads have decreased dramatically as a result of the increased level of competition to 

exchanges through the adoption of Regulation NMS. However, since 2006, in percentage terms, 

spreads are actually wider by 2.9 basis points.!! Again, what this tells us is that there is a 

dilution of market quality to the detriment of investors. 

Finally, as evidenced in SEC Rule 605 data, it appears that higher quality order flows are 

being routed to dark markets. As a result, orders sent to exchanges and incorporated into the 

public quote the only price discovery function - is the more toxic order flow. For example, in 

March 2012, NYSE-realized spreads were 0.3 basis points versus 3.9 basis points for executions 

reported to the TRF. This means that execution prices in off-exchange venues move 3.9 basis 

points over a five minute period whereas they only move 0.3 basis points when executed on 

NYSE. This data suggests that sophisticated market participants executing against order flow in 

8 Rosenblatt Securities, Inc., Market Structure Analysis and Trading Strategy: Let There be Light, Justin Schack and 

Alex Kemmsies. May 31. 2012. 

9 findings Regarding the Market Events of May 6, 20J 0: Report of the Staffs of the CfTC and SEC to the Joint 

Advisory Committee on Emerging Regulatory Issues (Sept. 30, 20 I 0) at 58. The report is available at 

http://www .sec.gov Inews/stud ics/20 1 O/markctcvents-report. pdf. 

10 Daniel G. Weaver Study available at: http://www.see.gov/comments/s7-02-10/s70210-127.pdf. 

11 NYSE, CQS, UQDf 
131 


76108.076

off-exchange venues are more likely to capture revenue from that trade than if the samc 

execution were done on an exchange, highlighting the desire for sophisticated investors to 

conduct more off-exchange trading despite the policy questions about best execution and priee 

discovery. 

The focus of securities regulatory policy should be on improving public confidence 

Each of these data points suggest there is reason for Congress and the SEC to be 

concerned that without action, we leave ourselves open to a greater loss of investor confidence 

and market stability. To solve the problem, policymakers should focus on establishing fairer and 

more transparent equity markets, as well as a more level playing field among trading centers and 

investors. 

I am certain that you will hear argumcnts from industry participants that the equity 

market structure is as good as it's ever been. We agree. However, while we recognize that 

things are better than they were 15 years ago, better does not mean there aren't practices to be 

improved, or that every practice that has evolved has had a positive effect on investors. 

Additionally. we believe the cost to the market from activities that may be good for a small 

group of individuals has overtaken the benefits, and we need to find a way to maintain a better 

balance for the public good. 

The time has come for policymakers to bring perspective to the public. We fear that as a 

result of too much focus on market microstructurc incrementalism, there has been too little 

public discourse on the fonnidable reliability and resilience of the equity markets during crises 

and overall fairness to investors. Public confidence stems in part from policy leadership and we 

need this policy leadership to come from inside the Congress, the Administration and industry in 

order to achieve a better market structure and to restore confidence to investors for the 

bettennent of our public markets and companies who need long-term capital to grow and 

produce more jobs. 

While not all of the solutions we're putting forth today are going to be popular with our 

own customer base, we believe putting all the options on the table, regardless of their popularity, 

is necessary if we're going to have an intellectually-honest discussion. Obviously all market 

participants. including us, have self interest in any outcome, but the current market structure 

yields an unlevel playing field not just for interested parties but also for investors, which has an 

adverse impact on public confidence in markets - something that hurts us all. 

We believe the items outlined below would have the greatest positive impact if 

implemented in whole or in part. 

Promote public price discovery 

As previously discussed, we believe that investor confidence in markets is of utmost 

importance and that a deterioration of price discovery is not only bad for exchanges and markets, 

but also contributes to a lack of investor confidence. As discussed in our comment letter to the 

SEC's Concept Release we believe internalization should be permitted, provided the 
132 


76108.077

internalizing firm simultaneously displays a protected quote at the NBBO or provides 

meaningful price improvement over the NBBO. The exchange believes this approach 

accomplishes several goals. First, requiring a contribution to the NBBO will result in a greater 

number of orders included in the price discovery process and therefore assist in establishing an 

NBBO that better reflects tbe "true" market. Additionally, if an internalizing firnl does not want 

to contribute to the NBBO. investors' orders that are internalized will need to receive meaningful 

price improvement over the NBBO. 

Create a consolidated audit trail that can adequately surveil the market 

NYX believes that a consolidated audit trail is necessary to appropriately surveil the U.S. 

capital markets. Neither the SEC nor private industry has the resources to surveil markets in 

real-time. This is why NYX and FINRAjointly supported the SEC adopting a rule two years 

ago that would have advanced the project by using existing infrastructure to create an audit trail 

with end-of-day reporting. It is unfortunate that a consolidated audit trail has still not been 

adopted but we are optimistic that the SEC will seek adoption of a proposal in the near term. 

Move forward with outstanding rulemaking proposals 

We believe that the SEC should move forward with its proposals to include actionable 

indications of interest within the definition of bids and offers; to reduce the threshold for display 

of dark liquidity; and to establish post-trade transparency for dark pool executions as was 

proposed in its 2009 proposal. Regulation of Non-Public Trading Interest. 12 

Level the competitive playing field 

Regulation NMS brought competition to the exchange space and broke down the duopoly 

of the NYSE and NASDAQ. As a result there are currently 13 equities exchanges. However, 

despite the increased competition in public exchanges, advances in technology and connectivity 

among Alternative Trading Systems and broker-dealers have led (0 one-third of all trading taking 

place off-exchange not all of which is positive for U.S. capital markets or investors. Because of 

these issues, we believe that cbanging the following items would create a fairer, more level 

playing field between excbanges and non-exchanges. 

SEC Filings. Registered exchanges are required to make public rule filings concerning 

various changes to their businesses. The regulatory process often includes a substantive review 

and takes considerable time and effort to complete. Tbe cUlTent rules also require exchanges to 

make public disclosures regarding business strategies and fee structures. In contrast, A TSs are 

required to make only limited notice filings on FOITll ATS twenty days prior to implementing any 

material changes. This regulatory inequality allows A TSs to illllovate quickly without SEC 

approval, while exchanges must undergo a rigorous and lengthy regulatory review process to 

initiate change. 

12 SEC Release No. 34-60997; Regulation of Non-Public Trading Interest 
133 


76108.078

By way of example, NYX {lied a proposal with the SEC alter over 9 months of 

negotiations with staff. The innovative proposal, which would guarantee retail customers price 

improvement, is the first of its kind to allow exchanges to segment retail order flow from other 

order flow. The proposal received opposition from several dark markets due to the program's 

guarantee of price improvement and the likely outcome that it may attract valuable order flow 

away from the dark trading venues. First filed publicly with the SEC in November 2011, the 

SEC has still not taken action over 220 days later. During that time, non-Exchanges have had thc 

opportunity to object to the proposal and our exchange competition has had the opportunity to 

develop their own similar programs to propose. We believe that the costs associated with going 

through this process do not outweigh the benefit of the SEC's review process. However, it is the 

competitive advantage that non-cxchanges have over exchangcs that troubles us most. The lack 

of regulatory scrutiny of non-exchanges also can lead to the proliferation of unfair trading 

practices such as the flash order structure and actionable indications of interest privately 

transmitted by non-exchanges to only select market participants. 

Fair Access. Registered exchanges are required to have mcmbership rules and procedures 

specifically designed to ensure access to exchange facilities is granted in a fair and impartial 

manner. The fair access requirements applicable to ATSs are far nalTower. A TSs must comply 

with general fair access requirements only if a five pcrcent trading volume threshold in an 

individual security is exceeded, and certain exceptions apply. The narrower fair access 

requirements have resulted in extreme levels of discrimination by ATSs against their customers. 

For example, dark markets oftcn segment certain customers from others, giving one customer a 

iirst look at the order flow the AI'S receives before showing it to other customers. In fact, it is 

common practice for orders to flow through many non-exchange trading centers before being 

executed. Although certain retail customers benefit from this process, pension funds and mutual 

funds that represent the majority of retail investors in the markets are often not allowed access 

since they too have more sophisticated trading strategies. Accordingly, NYX believes 

comparable fair access requirements should be applicable to all venues. 

Market Surveillance. Under the current market structure, registered cxchanges have selfregulatory responsibilities and must either maintain an extensive regulatory organization to 

conduct market surveillance or cnter into a regulatory services agreement with another selfregulatory organization, either of which involve significant time and resources. Non-exchange 

trading venues are not subject to the same rules and are free from any self-regulatory 

requirements. NYX estimates that it will spend nearly $85 million for U.S. equity market 

surveillance in 2012; however our exchanges only accountcd for 24.7 percent share of U.S. 

equity trading in May 2012. We believe all market centers should share the same responsibilities 

and contribute to the cost of market surveillance based on their respective market shares. In 

addition, NYX believes consideration should be given to the establishment of one selt~regulatory 

organization with responsibility for surveillance across the entire marketplace. 

These general issues of client segmentation, fair access and market surveillance also 

highlight the excessive level of focus on the "trees" rather than thc "forest." While there 

continues to be increasing levels of compliance focus on Exchanges' rules and prohibitions. the 

level of activity that is not subject to any of these requirements continues to grow unfettered. 
134 


76108.079

Addressing market structure for SMEs 

As another NYX executive testified last ycar before the House Oversight and 

Government Refonn Committee's Subcommittee on TARP, Financial Services and Bailouts of 

Public and Private Programs, companies with small capitalizations consistently raise two marketstructure conccrns in connection with their initial public otlerings: will there be sufficient 

interest in the company's stock will there be sufficient analyst coverage of the stock to attract 

long-tenn investors. These two concerns highlight the reason both short-tenn liquidity providers 

and long-tcnn investors arc necessary to provide Small and Medium Enterprises with the capital 

they need to grow their companies, while maintaining an investor's confidence that they will 

have the ability to exit their positions when desired. 

As the SEC recognized in the Concept Release, small cap stocks can and often do 

trade differently from large cap stocks. One area of concern is whether the current market 

structure itself, which treats all stocks similarly, impacts small cap stocks in an adverse manner. 

In particular, we have observed less liquidity at thc NBBO for small cap stocks and less 

exchange activity in less-liquid securities, which we believe may be the result of too-narrow 

minimum tick size. While narrower spreads are gcncrally a positive result for investors, 

especially in more liquid securities, we believe a $0.0 I minimum tick size for low-cap stocks 

may counter-intuitively create a disincentive to provide liquidity at the best price, resulting in 

smaller quoted sizes and thinner markets. In addition. it is also likely that deeper liquidity in 

smaller cap stocks as a result of wider spreads may lead to additional volume and with additional 

volume there may come increased analyst coverage. 

Accordingly, NYX has advocated that a market-wide pilot program requiring wider 

spread increments for less liquid securities could be a worthwhile experiment. During the pilot 

period, market participants and the SEC could review data to detennine whether the impact is 

providing added investor benefits to less-liquid securities. A pilot program would also provide 

the SEC with additional data that can be utilized in a cost-benctit analysis should it decide to 

make the pilot pennanent. 

With regard to Chainnan McHenry's draft legislation, we believe the creation of a 

program in which exchanges could provide incentives to market makers for meeting liquidity 

requirements is a worthwhile endeavor. In fact, NYX currently has a proposal out for comment 

with the SEC that would allow a similar pilot program for exchange-traded products. 13 Today, 

market makers receive more favorable economics for meeting our market maker liquidity and 

quoting requirements as their primary incentive from the exchange to provide liquidity. Although 

FINRA rules adopted in 1997 prohibit any direct or indirect payment by an issuer to a market 

maker, NYX believes Chainnan McHenry'S legislation may warrant further review by both 

FINRA and the SEC, and is a topic that we have been pursuing. We would also note that this is a 

process allowed in Europe and academic research has shown beneficial effects on the liquidity of 

smaller issuers.14 

13 NYSE Arca Lead Market Maker Issuer Incentive Program; SEC Release No. 34-66966. 

14 lohannes A Skjeltorp and Bernt Arne Odegaard (2011). "Why do listed firms pay for market making in their own 

stocks?" 
135 


76108.080

The JOBS Act and NYSE Big StartUp 

Finally, I want to provide a few comments on the the JOBS Act that this Committee and 

others in Congress were instrumental in passing. The struggling U.S. economy received a 

welcome boost when the JOBS Act survived our divided Congress and received President 

Barack Obama's signature. The passage of this ncw law signals that leaders in both parties 

understand that providing targeted, temporary rcliefto small busincsses seeking to access capital 

is critical to the recovery. 

Small businesses account for 99 percent of all U.S. companies, make up half of private 

sector cmployment, and have accounted for almost all net job growth in the U.S. over the last 

three decades. Yet today, many entrepreneurs with the ability to turn innovative ideas into 

successful, job-creating businesses do not have adequate access to capital. By phasing in certain 

rcgulations on small firms, the JOBS Act will help open new sources of capital [or growing 

companies at a critical stage in their dcvelopment. 

We believe exchanges have a responsibility to help small companies grow by providing 

entrepreneurs with a source of capital. In the best of times, exchanges may facilitate a hundred or 

more companies executing an IPO each year. However, given the scale of our current jobs 

challcnge, exchanges must look beyond the IPO and offer new avenues to allow small businesses 

access capital markets. 

Last month, NYX joined with other organizations to launch an initiative aimed at 

accelerating growth for small businesses. Our idea, "The NYSE Big StartUp", is aimed at 

encouraging big companies to help small companies. It's a pathway for corporate America to 

provide banking services, financial training, accounting services, legal services, marketing and 

logistics support, website construction, and other essential tools to enable small companies which 

lack those resources to get to the next level. The program also offers training, mentoring and 

education programs for startups and entrepreneurs, as well as a fund to belp ensure that capital is 

available to those least able to access it from traditional sources. 

Getting America's entrepreneurial engine firing on all cylinders requires cooperation 

between the public and private sectors. Good public policy, such as the JOBS Act, ensures that 

cntrepreneurs and small businesses have access to the capitaJ they need to expand and thrive. 

American corporations want to and must be part of the solution as well. Small businesses and 

entrepreneurs are our neighbors, our customers, and our futures. It is time to unleash the 

unparalleled innovation and creativity of American business to find solutions even more 

powerful than the economic challenges we face. 

Conclusion 

In closing, T want to reiterate our belief that although our capital markets are the best in 

the world, the data we've discussed suggests there remains room for improvement. Our 

arguments for change are simple: promote market structure changes that enhance transparency 

and level the playing field for both trading venues and investors. 

Thank you for allowing me to testifY and I look forward to your questions. 
136 


76108.081

Testimony Concerning 

"Market Structure: Ensuring Orderly, Efficient, 

Innovative and Competitive Markets for Issuers 

and Investors" 

by 

William O'Brien 

Chief Executive Officer 

Direct Edge 

Before the House Committee on Financial Services 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

June 20, 2012 

Chairman Garrett, Ranking Member Waters, Vice Chairman Schweikert 

and Members of the Subcommittee, I would like to thank you for the opportunity 

to testify today on behalf of Direct Edge, the operator of the one of the largest 

stock markets in the nation and the world. Over the past five years Direct Edge's 

market share of U.S. stock trading has risen to approximately 10 percent 

because we have innovated in response to changing market structure to provide 

new solutions for brokers and their customers. This innovation is possible only in 

an atmosphere of continued investor and issuer confidence in our nation's 

markets and how they are regulated. As discussed in our remarks, we believe 

this confidence to be at a low point, and that we are in need of targeted efforts to 

improve it. In this regard, the work of the Subcommittee in conducting this 

hearing is timely and valuable. 

Direct Edge believes that through careful examination, appropriate steps 

can be taken to improve investor confidence in a fair and orderly market without 

restricting innovation, competition or efficiency. To this end, Direct Edge offers 

the attached Statement of Market Structure principles that we believe should 

guide any reforms, in order to focus the current dialogue on what really matters 

improving our stock market for the benefit of the nation's investors. 
137 


76108.082

Statement of Market Structure Principles 

Direct Edge 

"Restoring Confidence" 

June 20, 2012 
138 


76108.083

Introduction 

Investor confidence in U.S. equity market structure is perhaps at its lowest 

point since the Great Depression. A 2010 Associated Press/CNBC poll showed 

that 86% of respondents believed that the stock market was "not generally fair" to 

small investors. Since that time, several high-profile incidents have led the 

investing public to seriously questions whether the stock market is on a sound 

operational footing. You can question the merit of such concerns - but you 

cannot deny they exist. 

An intellectually consistent and operationally feasible plan is needed to 

start the process of restoring that confidence. This is essential to return the stock 

market to its rightful place - for investors and entrepreneurs alike as a pivotal 

tool for achieving the American dream. Small investors will have great difficulty 

reaching their financial goals if they are driven to primarily invest in "risk free" 

assets due to confidence-related concerns. Small companies will find their 

access to equity capital markets limited without a vibrant secondary trading 

markets for equities, inhibiting corporate growth and the job creation that comes 

with it. Collectively, a healthy stock market is a critical element of building an 

ownership-based society where Americans are increasingly united in the 

common goal of furthering prosperity. A healing process needs to occur, and 

actions will speak louder than words. Direct Edge remains hopeful, because we 

believe that there are relatively simply and tangible steps that can be taken to 

start the work of restoring investor confidence. 

In this vein, Direct Edge offers this statement of the principles, and related 

actions, it believes will help restore investor confidence and provide a better 

environment for the trading of small and large-company stocks alike. In doing so, 

we hope that like-minded market participants will proffer their support, in 

whatever means they find advisable, in order to focus the current dialogue on 

what really matters - restoring faith in our nation's stock market for the benefit of 

all. Whether you agree in whole, in part, or not at all, we hope you find in these 

principles a healthy construct in which to discuss the issues and chart a path 

forward. 
139 


76108.084

1. Monopolies are not the answer - more efficient competition is 

Some argue that confidence is undermined by the choices that investors 

have or the alleged complexity of navigating them. Often this coincides with 

claims that efforts should be made to re-consolidate trading into a smaller 

number of venues, pleas to "level the playing field" by severely restricting certain 

business models, or giving regulators or issuers the ability to create new market 

monopolies. Retail order handling, "dark pools" and other trading alternatives 

often bear the brunt of these criticisms. This is the wrong path to pursue. 

Direct Edge does not believe investors will have more confidence in the 

stock market by reducing the number of choices that investors and their brokers 

have. People don't think the soap market is unfair because there are 500 

different kinds of soap. And they don't think the stock market is unfair because 

there are 50 places to execute their trade. The proliferation of trading 

alternatives has only served to lower costs, improve technology and give each 

investor a solution that is better tailored to their trading and investing needs. 

At the same time, cooperation among competing venues does need to be 

improved. The May 6,2010 "flash crash" and recent IPO troubles were not 

caused or made worse by fragmentation, but by insufficient communication and 

coordination between exchanges to deal with these situations. During the recent 

IPO-related issues, the relevant listing exchange had a total monopoly, and were 

"single points of failure" that in fact, failed. This was exacerbated by the lack of 

sufficient market-wide communication while events unfolded. At Direct Edge, we 

had no greater visibility into what was occurring than the average retail investor. 

No hotline, no market-wide escalation procedures, no nothing. 

We can easily improve this, and the work has already started. The 

market-wide single stock circuit breakers and recent SEC approval of a "limit 

upllimit down" mechanism help assure that all trading venues will deal with sharp 

and sudden changes in stock prices in a cohesive manner. More work can be 

done to ensure that in key market events especially when things go wrong - all 

the exchanges can quickly and effectively work together to prevent problems 

from cascading and protect investors. 
140 


76108.085

2. Rather than restrict off-exchange trading. exchanges should have 

greater freedom to make their markets more appealing to retail 

and institutional order flow 

Even though Direct Edge is one of the world's largest stock exchange 

operators, we do not believe that exchanges have some divine right to execute 

every trade. To start with the premise that there is an "unlevel playing field" is 

unfairly accusatory and alarmist, and does nothing to restore investor confidence. 

While it is true that exchanges and non-exchange venues have different 

responsibilities and privileges, the focus should be on ensuring that exchanges 

can consistently provide great results for a broad spectrum of investors. Direct 

Edge believes we are better as both a country and a company when exchanges 

have to earn their business, and have a robust capability to do so. 

Exchanges are at times hamstrung, however, because of the current 

application of the principles of "fair access" under federal securities regulation. 

Exchange efforts to provide a better experience for retail and institutional orders 

are often reviewed under the principle "if it isn't made available to everyone, it 

can't be made available to anyone". As a result, exchanges can be constrained 

in their efforts to provide a better environment for retail and institutional investors. 

This can lead the firms who manage this order flow to seek off-exchange 

executions. There is nothing nefarious about this, in fact it is consistent with the 

duty of best execution. If exchanges don't offer the best trading experience, 

trading volume should and will go elsewhere. 

Section 6 of the Securities Exchange Act of 1934 should be modified to 

clarify that exchanges have the freedom to provide tailored solutions for 

institutional and retail orders. Stock exchanges function best when diverse 

participants all believe they are getting a near-optimal outcome. This gives them 

the confidence to submit their order into a trading venue with maximum 

transparency, price discovery and liquidity. Rather than criticize the increase in 

off-exchange trading, empower exchanges to offer a better product and 

experience to long-term investors. Not only would this help restore investor 

confidence, it would prospectively improve trading outcomes. 
141 


76108.086

3. Enhance SEC Oversight of Exchange Technology 

Exchanges playa special role in our capital markets with respect to both 

investor confidence and capital formation. In the minds of most American 

investors, it is assumed that exchange operations are rock-solid. That 

assumption has been seriously undermined by recent events. No exchange, 

Direct Edge included, has been immune to this. 

The rise of for-profit exchanges, the dynamic nature of our business, and 

some exchanges' continued push into related technology businesses has created 

the potential for conflict between exchanges' risk-management practices and 

their profit motive. While this tension between short-term rewards and longerterm risks exists in almost all businesses, the role of exchanges in preserving 

investor confidence makes proper balancing of these needs particularly acute. 

Regulators have been vigorous in their efforts to oversee exchange technology 

practices, but their mandate should be strengthened further in this area. 

The priority and primacy of these efforts can be augmented by formally 

proposing and adopting the SEC's Automation Review Policy CARP") as official 

regulation under the federal securities laws. The risk-management practices 

currently reviewed as part of ARP inspections are comprehensive, covering 

several areas that have been recent sources of investor concern: information 

security, quality assurance testing, and incident management to name just a few. 

Direct Edge has made considerable investments of time, talent and technology in 

response to feedback provided by ARP examiners. The ARP program, however, 

is still technically voluntary for most trading v~nues. This allows exchanges and 

other impacted market participants considerable leeway in negotiating with 

regulators about what risks should be addressed and when. 

Proposing and adopting ARP as an official rule of the Commission would 

provide even greater authority to ensure that complex trading technology and 

infrastructure is managed prudently and with the ongoing stability of our stock 

market as a principal objective. It would send a powerful message to investors 

that regulators recognize the impact of the series of "glitches" our markets have 

suffered, and are working to further mitigate these risks. 
142 


76108.087

4. Incentivize and ensure the responsible use of technology rather 

than seeking to turn back the clock 

The debate over the fairness of the stock market has been unique in its 

criticism of the technological advancement that has swept every aspect of 

American life. By almost any measure, the transition from manual to electronic 

trading has lowered costs, improved execution quality and access to liquidity for 

retail investors. Automation has also significantly improved market consistency, 

made the "paper trail" easier for regulators to follow, and allowed for the quick 

and effective implementation of solutions like the post-UFlash Crash" single-stock 

circuit breakers. Thus the increasing automation of the stock market should be 

viewed as something that works to greatly improve investor confidence. But yet 

it remains a significant source of angst. 

Efforts to make trading slower generally, or restrict the technological 

capabilities of certain players are both unfeasible and undesirable. They would 

not make our markets safer, sounder or stronger. And there would be no rational 

argument that investors should feel more confident in investing in equities as a 

result. More likely outcomes are that: (i) significant implementation issues would 

prevent these measures from working as planned; and Oi) technologicallyadvanced trading would migrate off-shore. Either would work to further 

undermine investor confidence in both the short and long term. 

Efforts can be made to encourage and monitor how trading technologies 

are used so the benefits automation brings are not overshadowed by aberrant or 

inefficient behavior. Direct Edge was the first U.S. stock exchange to announce 

and implement a program intended to impose economic penalties on trading 

firms that had excessively high message-to-trade ratios. Our Message Efficiency 

Incentive Program prompts trading firms to examine their behavior and suffer the 

consequences if they choose to flood our market with orders that seldom or 

rarely result in trades. This gives our members the freedom to use technology as 

they see fit but at the same time the responsibility to use this technology 

efficiently. This notion of shared responsibility should be the foundation of any 

effort to ensure that market technology is used prudently. 
143 


76108.088

5. Investors should have transparency regarding where their orders 

are routed, in addition to where they are executed 

It is difficult to have confidence in a process when you have limited 

visibility. When it comes to the trading of stocks, there are countless ways for an 

order to be managed in light of the facets of execution quality - such as 

immediacy, explicit fees and market impact - and the preferences of the relevant 

investor. Most investors want to delegate the responsibility to manage these 

aspects of execution to their chosen broker, while still having the order-handling 

information necessary to hold them accountable. When you don't know what is 

going on behind the scenes, it is hard to have absolute faith that your interests 

are being fully served. Trust, but verify. 

One of the consequences of greater investor choice and increasing 

market technology is that it can be hard for an investor to answer the basic 

question - "what happened to my order?" Investors can be left wondering if they 

have complete information and brokers are more susceptible to allegations -

substantiated or not - of order mishandling. Where information can be efficiently 

used to allay these concerns, it can help restore confidence not only in an 

investor's ability to choose a broker, but in the market itself. 

There are multiple ways to efficiently achieve this objective both on a 

holistic and an order-by-order basis. The order-routing disclosures of SEC Rule 

606 could be expanded to list not just exchanges and other market centers 

where investor orders are executed, but where they are routed (whether 

executed or not) as well. For institutional and other savvy investors, 

standardized market identification codes can be implemented to provide this 

information on an order-by-order basis. Measures like this will "pull back the 

curtain" from the order-management process, and rather than revealing general 

malfeasance, show what is true thousands of professionals hard at work to give 

investors great execution outcomes every day. And any sub-optimal orderhandling practices will be much easier for investors and regulators to spot and 

hold the relevant parties accountable. 
144 


76108.089

6. Regulation should be made more flexible to enhance the trading 

experience for smaller companies 

Just as all investors are not created equal, each listed company has a 

variety of unique attributes and needs. From the international consumer 

conglomerate to the start-up bio-tech company to the white-hot social media 

juggernaut, the reasons for utilizing the equity capital markets vary greatly, as do 

their needs regarding secondary-market trading. 

An unintended consequence of Regulation NMS is the tendency to impose 

a "one size fits all" version of market structure on issuers, regardless of their 

characteristics and needs. The small cap stock with a trading volume of 10,000 

shares per day is traded within the same market structure as Bank of America, 

with a daily volume of 25,000 times that amount. While the reasons companies 

decide if and when to go public extend far beyond market structure concerns, the 

trading environment presents challenges for smaller companies. As a result of 

all these factors, potential public companies may remain private for longer 

periods. This in essence lures investors interested in these companies into 

trading on private markets which require less financial disclosure, have increased 

trading cost and reduced transparency. Work needs to be done to get the next 

generation of great American companies listed and trading on the public markets. 

The legislative proposal put forth by Representative McHenry would be an 

important first step in making exchange markets a more hospitable place for 

small public companies. The proposal, which would allow exchanges to create 

and administer incentives to ensure the provision of liquidity for their stocks, 

would give companies more meaningful choices. The ability to realize the 

benefits of the public markets without concern that you would be "orphaning" 

your new investors in a market with little liquidity would increase the confidence 

of both CEOs and fund managers alike to encourage the pursuit of the IPO 

alternative. There are many ways to raise capital, but an exchange IPO is a 

uniquely important event in the growth cycle of a good company. All reasonable 

ideas in furtherance of making this alternative as accessible as possible should 

be considered and pursued with vigor. 
145 


76108.090

7. A national "Depth of Book" data feed should be created to allay 

concerns about informational advantages 

Renewed efforts should be made to broaden the availability and lower the 

price of depth-of-book market data to investors. Changes in market structure 

since decimalization have dramatically increased the need for this information. 

Investors and intermediaries often use exchange depth information to better 

understand the market-wide liquidity in the stocks they trade. 

The process for acquiring and using this data is currently cumbersome 

and expensive, and can lead to the "rationing" of this important information. 

Market participants must compile this data from multiple exchanges across 

several data centers. This entails significant fixed costs even before any explicit 

exchange market data fees are paid, with total costs for retail firms of upwards of 

$1 million or more per month. This leads to such information being restricted to 

investors, creating the perception of "haves" and "have nots". Rightly or wrongly, 

the mere existence of such a perception dictates the need to provide more 

efficient ways of getting depth quote and trade data to more investors. 

A potential solution, recently discussed in a research paper authored by 

the research firm the TABB Group, is to create a nation-wide depth-of-book data 

feed through the existing infrastructure that exists for top-of-book data. Doing so 

would eliminate significant costs and produce material market efficiencies. 

Market participants are already connected to this infrastructure for the receipt of 

market data, and can leverage existing connectivity and infrastructure to receive 

depth data should they so choose. Some investment in the existing network may 

be required, and governance safeguards may be necessary to ensure 

appropriate service levels and fees. These measures, however, can be effected 

at a cost that is insignificant when measured against the potential savings to the 

entire industry and the improved perception of equal information. Retail investors 

would no longer have, as one commentator once put it, "little choice ... to obtain 

multiple proprietary exchange feeds - or [have] a view of the market that is 

increasingly incomplete." It would be good for business and good for confidence 

at the same time. 
146 


76108.091

8. The Consolidated Audit Trail should be approved, built and 

funded 

People have confidence when they believe the "cops on the beat" have 

the tools they need to do their job, and the stock market is no different. While 

had to prove, it is easy to state that the technology and diversification of modern 

markets make it impossible for regulators to deter, detect and punish 

inappropriate conduct. For the average investor, it is all too easy to think "if the 

experts don't understand what's going on, how can I?" Clearly demonstrating 

that regulators have appropriate information is thus essential to making sure that 

investors remain confident in how are markets our working. 

Direct Edge urges prompt SEC approval of the proposal to create a 

consolidated audit trail ("CAr) as a means not only to detect inappropriate 

activity, but to serve as the "gold standard" for regulators, academics, exchanges 

and others to truly understand how our markets are operating. Once approved, 

the process for creating the CAT should be one of maximum transparency, 

inclusive input and access and the funding to match the importance of its role in 

improving investor confidence. Building the CAT the right way will take some 

time, but if market participants feel they have a voice and a role in the process, 

patience will be rewarded with a system built the right way the first time. And 

most importantly, no matter how many "bad guys" are truly out there, it will give 

investors comfort that the regulators are one step ahead of them. 

9. The securities industry needs to better educate the investing 

public as to how modern markets operate to their benefit 

At times it seems like no industry likes to scare customers away like the 

securities industry. Many business models appear to have as a core sales tactic 

the argument that every market participant is looking to take advantage of longterm investors. Like when your plumber tells you that every other plumber 

(except him, of course) is out to rip you off. It is hard for investors to have 

confidence in markets when the overwhelming volume of "analysis" tells you to 

run for the hills. 
147 


76108.092

Exchanges and other industry-wide organizations need to make significant 

investment in basic investor education and communication to counter these 

allegations with facts and supporting information, so even competing market 

participants feel like partners in demonstrating that our nation's stock market is 

the best in the world. Direct Edge stands ready to contribute its time, talent and 

treasure to industry-wide, market-neutral efforts to give investors a real-world, 

plain-English way of understanding how stocks trade, how technology is used for 

their benefit, and providing answers as needed to "what happened?" when 

difficulties occur. 

Conclusion 

It is easy to talk about the lack of investor confidence in the abstract, but it 

has enormous financial consequences for American investors. Investors who 

move money from stocks to "less risky" assets risk low rates of retum and less 

transparent fees that could severely hinder their ability to retire, pay for college, 

and achieve other financial goals. Some things that impact investor confidence 

we can't control for - such as where asset prices will head over time. But other 

confidence-building measures are well within our reach. The time to act is now. 

This statement of principles is only part of Direct Edge's efforts to drive the 

market structure debate in a healthy and productive direction. We will continue 

to engage in partnered dialogue with our Members and evidence-based 

discussions with policy-makers, regulators and other thought leaders, and will 

offer comments and suggested policies in an appropriate and constructive 

manner. We look forward to a level of communication that will enhance our 

perspective, improve our markets and help restore investor confidence. 
148 


76108.093

Testimony of 

Cameron Smith 

Before the 

House Financial Services Subcommittee on 

Capital Markets and Government Sponsored Enterprises 

"Market Structure: Ensuring Orderly, Efficient, Innovative and 

Competitive Markets for Issuers and Investors" 

President 

Quantlab Financial 

Houston, Texas 

June 20, 2012 
149 


76108.094

Introduction 

TestimollY of Cameroll Smith 

Presidellt, Quallt1ab Fillallcial 

HoustOll, Texas 

Before the 

House Fillallcial Services Subcommittee 011 

Capital Markets alld Governmellt Spollsored Ellterprises 

"Market Structure: Ellsurillg Orderly, Efficiellt, Illllovative alld 

Competitive Markets for L~suers alld Illvestors" 

JUlle 20, 2012 

Thank you Chairman Garrett, Ranking Member Waters, and Members of the Subcommittee for 

providing me this opportunity to participate in today's hearing. My name is Cameron Smith. 1 am 

President of Quantlab Financial, a Houston, Texas-based quantitative trading firm. 

QuantIab was founded in 1998 and now employs more than 100 people. Our company does 

bminess in multiple markets around the world not just in equities but other asset classes such as 

futures, options, treasuries and foreign currencies. In addition, I have worked at the Securities 

Exchange Commission (SEC), an exchange, and a broker that serves institutions before arriving at 

QuantIab five years ago. 

I am proud of the role QuantIab plays in the market and how our trading activities, in competition 

with otI,er likeminded firms, lead to better prices for investors. 'Inc fact that a relatively small firm 

from Houston, Texas, is represented here today underscores the truly competitive, fair, and 

transparent nature of our equity markets. 

~fr. Chairman, we trust and hope that this hearing reflects a commitment by all concerned with the 

quality of our financial markets to a comprehensive assessment of the strengths and weaknesses of 

our markets. 

Modem Electronic Markets and Automated Trading Have Benefited U,S. Investors 

In recent years, computer technology advancements have shifted the marketplace from an exclusive 

market, centered around the privileged few with scats on an exchange floor to an open, competitive 

electronic cnvironn1ent where orders are routed to exchanges and prices are communicated to the 

public in real-tinle through tele-communication lines. Virtually all trading is automated in some 

fashion. The result of these advancements is that professional trading can take place nearly 

anywhere in the country and across the globe. 

Along with the technological advances, the updating of regulations over the last fifteen years has 

helped promote transparency and fair competition, leveling the playing field for all market 

participants. 
150 


76108.095

£\s these changes have dramatically increased the efficiency of the markets, the role of traditional 

manual market making and specialist fLttlls has been reduced and replaced by today's automated 

professional trading intermediaries. Many are calling these newer market participants "high 

frequency traders" or "HFTs." That is a vague label that means different things to many different 

people. 

By whatever name, however, the market needs professional intermediaries to bridge gaps in supply 

and demand between investors. Historically, this function was provided by pri,'ileged intermediaries 

known as specialists, market makers, dealers, floor traders, or locals. Today, this function is 

provided by diverse, highly competitive firms that rely on technology. 

It is this intense competition that has played a prominent role in reducing transaction costs for all 

investors, both retail and institutionaL By virtually every common measure of market quality, our 

markets have nev'er been healthier. This has been demonstrated in numerous empirical academic 

studies that show that transaction costs have come down dramatically, price discovery has improved, 

and short-term volatility has been reduced. I have attached a copy of a recent review of the 

academic literature on the topic for the record (Appendix A). The intensely competitive market is 

also why the u.s. equity market is the largest and most efficient equity market in the world. 

While the general trend of improving market quality is clear, there still remains a great deal of 

misunderstanding around the role of professional trading, and so~called high frequency trading in 

particular. 'W'hile different firms will describe their trading approach in different ways, high 

frequency traders generally collect and analyze publicly available data, and determine their view of 

the instantaneous "fair value" of whatever they are trading. Different traders use their view of fair 

valuc in different ways and at different times. Some make markets by posting prices around their 

idea of fair value. Others will wait until their idea of fair value allows them to trade immediately 

based on prices in the market. Regardless of their approach, the fierce competition between scores 

of professional intermediaries provides investors with the ability to buy or sell with low transaction 

costs. It is no coincidence that investor transaction costs dropped duting the recent period of 

increasing competition and automation. 

Further, the general approach of competitivc traders identifying and trading towards fair value 

cxplains why studies that have compared high frequency trading to thc rest of the market End that it 

tends to llnprovc price discovery and Io\ver, not increase, short term volatility .in the 111arket. 

Recently, in a working paper titled "High Frequency Trading and Price Discovery," Professor 

Terrence Hendershott at the University of California~Berkeley and Professor Ryan Riordan at the 

Karlsruhe Institute of Technology in Germany concluded that traders "playa positive role in price 

efficiency by trading in the direction of permanent price changes and in the opposite direction of 

transitory pricing etrors on average days and the highest volatility days." 

In sum, regulatory changes and technology advancements have led to a higher quality market that 

has benefitted all classes of investors, including retail and institutional, in the form of lower 

transaction costs, dampened volatility, and prices that better reflect all information. 

2 
151 


76108.096

Additional Refonns Have Potential to Further Improve Market Quality 

While market quality has improved and investors have benefitted over the past decade Of SO, there 

are aspects of the market that might benefit from certain regulatory initiatives. 

One policy that must be implemented in the short term is a reporting regime that ensures that 

regulators have access to all the data they need to adetluatdy surveil our markets and continue to 

ensure they operate with the highest inte,,'!ity. In this regard, we have consistently supported 

initiatives such as consolidated audit trails and the large trader reporting system. Further, we have 

encouraged the formation of industry working groups to offer technical assistance to regulators that 

must learn to analyze the richness of data that exists in electronic audit trails. 

As regulators develop more robust market surveillance tools, however, it would be a mistake to 

focus attention solely on one group of market participants, as now seems to be the case with efforts 

by some to define "high frequency trading." Instead, the programs should surveil the activities of all 

market participants, and tllen focus on specific unusual activity, regardless of their perceived str·ategy 

or usc of automation. 

A second area for in1provement is one that the SEC is already ill the process of addressing. Those 

are the related areas of risk management and circuit breakers or limit up/limit down protections. 

Many of the concerns expressed by critics of automated trading are really concerns, not about a 

specific trading style, but related to the threat of computer errors that undermine market illtegrity. 

\Xlhile automation has illlproved market quality dramatically, there is no question we must vigilantly 

protect against: its unique risks. Effective risk management by broker dealers, coupled with another 

line of defense at the exchanges through circuit breakers or lunit up/limit down protections, are 

important to protect our markets from the effects of computer errors, software bugs or unintended 

interactions. The SEC's proposals ill these areas arc right on the mark and should greatly reduce the 

potential in1pacts of errors while preserving the tremendous benefits of automation for investors. 

A third area that policymakers must continue to monitor and perhaps make some incremental 

changes involves the issue of fragmentation. This is a longstanding issue in the world of U.S. equity 

market structure. The challenge has long been to balance the benefits of cornpetition against 

complexities from fragmenting the market between too many trading venues. 

The best price discovery occurs when orders from market participants with different objectives, rime 

horizons, and perspectives interact in open and transparent markets. It is worthwhile to e>..-plore 

whether, for example, different types of order flow being executed away from the public, 

transparent markets, such as in dark pools or in other order flow arrangements, could lead to a 

degradation of market quality. We must, therefore, ensure that the current regulations don't 

inadvertently contribute to fragmentation by hindering the ability of public markets to compete with 

private markets. 

In trus regard, two adjustments to the current regulatory scheme are worth considering. First, 

consider allowing "locked" markets - that is, permitting quotes to be displayed when the "bid" price 

and the "ask" price are the same. While Regulation NMS banned locked markets, one in1pact of the 

ban is to widen the quoted spread of the public market, thereby facilitating internalization and dark 

pool activity. 

3 
152 


76108.097

Second, policymakers should create categories of stocks with different quote increments. While 

decimalization and penny increments have saved investors hundreds of billions dollars, a one size 

fits all approach regardless of whether a stock trades at $5 or $500 does not make sense. Increments 

that are too wide reduce the efficiency of the public exchange markets relative to the private 

markets. For example, when Citigroup stock was trading under $5 per share, just that one stock 

constituted more than 30 percent of the off private market volume. When the public markets 

cannot arrive at efficient prices due to tick increment constraints, it is relatively easier for offexchange venues to siphon away order flow, contributing to fragmentation. 

IV!y final suggestion involves impro\'ing our overall approach to how we monitor and evaluate 

market performance. Specifically, I believe it is imperative for the equity market community to 

develop commonly accepted measures of market quality that are monitored consistently over time 

and provide a common-ground for market structure discussions. Our capital markets arc far too 

important to allow policymaking decisions to be driven by opinion and anecdote as to the current 

state of our markets. Certainly, discussions about market structure, including high frequency 

trading, could benefit from rigorous statistical analysis and greater awareness of empirical evidence 

on the topic. There are already many established metrics and methodologies for examining market 

quality, including measures of liquidity, price efficiency, market impact, \'olatility and cost. It should 

be a priority of the policymakers to develop and specify the proper metrics before taking any 

significant steps toward altering the current market struchlre that has generally served investors well. 

Conclusion 

In summaty, I congratulate d,e Subcommittee for holding this hearing and fostering discussion as to 

the health of our equity markets. Despite a lot of criticism from some sectors, we must not lose 

sight of the fact that we do have the world's leading equity market and that the empirical evidence 

shows they have never been healthier. The U.S. has achieved this position by adhering to certain 

core values: transparency, open competition and the best interests of the investing public. 

Accordingly, when considering any future actions we must tread carefully and make sure that any 

actions are consistent with these values. This can be done by ensuring that any policy decisions are 

firmly grounded in empirically driven understanding of the markets. While there arc areas in need of 

improvement, we have a lot to be proud of. 

I thank you for the opportunity to appear today. I look forward to answering any questions. 

4 
153 


76108.098

Appendix A: 

Literature Review 

5 
154 


76108.099

High Frequency Trading Literature Review 

June 2012 

This brief literature review presents a summary of recent empirical studies related to 

automated or "high frequency trading" (HFT) and its impact on various markets. Each study 

takes a unique approach, yet all paint a consistent picture of markets being improved by 

competition and automation. 

Author(s) / Title Dataset Findings 

Angel, Harris, Spatt U.S. equities, 1993 - 2009 Trading costs have declined, bid-ask spreads 

"Equity trading in the 21st have narrowed and available liquidity has 

century", February 2010 increased 

RGM Advisors U.S. equities, 2006-2011 Bid-ask spreads have narrowed, available 

"Market Efficiency and liquidity has increased and price efficiency 

Microstructure Evolution in has improved 

US Equity Markets: A High 

Frequency Perspective", 

October 2010 

March 2012 (Update) 

Credit Suisse U.S. equities, 2003-2010 Bid-ask spreads have narrowed, available 

"Sizing Up US Equity liquidity has increased and short-term 

Microstructure", April 2010 volatility (normalized by longer term 

"Who Let the Bots Out? U.S. equities, 2004-2011 volatility) has declined, and the incidence of 

Market Quality in a High "mini" crashes has not increased 

Frequency World", March 

2012 

Hasbrouck, Saar U.S. equities, full NASDAQ Low latency automated trading was 

"Low-Latency Trading", May order book associated with lower quoted and effective 

2011 June 2007 and October spreads, lower volatility and greater 

2008 liqUidity 

Hendershott, Riordan Automated vs. other Automated trades made prices more 

"Algorithmic Trading and trades. efficient and did not contribute to higher 

Information", August 2009 Deutsche 80rse equities, volatility 

January 2008 

Chaboud, Hjalmarsson, Vega Automated vs. other Automated trades increased liquidity and 

and Chiquoine trades. may have lowered volatility 

"Rise of the Machines: EBS forex market, 2006-

Algorithmic Trading in the 2007 

Foreign Exchange Market", 

October 2009 

Markets Committee, Bank for Various FX venues, HFT is found to be beneficial during normal 

International Settlements notably Reuters and EBS, market periods, with similar behavior to 

(BlS] and various dates, traditional market participants during high 

"High-fl'equency trading in notably May 6, 2010 and volatility periods 

the foreign exchange March 17,2011 

market", September 2011 
155 


76108.100

Brogaard HFT vs. other trades. U.S. HFT helped to narrow bid-ask spreads, 

"High frequency trading and equities on NASDAQ and improved price discovery and may have 

its impact on market quality", BATS, various periods in reduced volatility 

August 2010 2008-2010 

Brogaard HFT vs. other trades. U.S. HFT activity tends to decrease idiosyncratic 

"High Frequency Trading and equities on NASDAQ and and intraday volatility. 

Volatility", October 2011 BATS, various periods in 

2008 - 2010 

Hendershott, Riordan HFT vs. other trades. U.S. HFT trades were positively correlated with 

"High Frequency Trading and equities on NASDAQ, permanent price changes and negatively 

Price Discovery" (working various periods in 2008 - correlated with transitory price changes, 

paper) 2010 suggesting that HFT improves price 

discovery 

Hirschey, Nicholas HFT vs. other trades. U.S. HFT trades were positively correlated with 

"Do High-Frequency Traders equities on NASDAQ and non-HFT trading, corroborating 

Anticipate Buying and Selling BATS, various periods in Hendershott and Riordan results 

Pressure?" 2008-2010 

O'Hara, Yao, Ye HFT vs. other trades. U.S. Odd-lots and trades of 1 00 shares drive the 

What's Not There: The Odd- equities on NASDAQ, majority of price discovery; BFT is more 

Lot Bias in TAQ Data various periods in 2008 - likely to trade with odd-lots 

2010 

Jamecic, Snape HFT vs. other trades. HFT improved liquidity and was unlikely to 

"An analysis of trades by high LSE equities, April - June, have increased volatility 

frequency participants on the 2009 

London Stock Exchange", 

June2010 

CME Group Automated vs. other Automated trading was associated with 

"Algorithmic trading and trades. im proved liquidity and reduced volatility 

market dynamics", July 2010 CME futures, May 2008-

May 2010 

Kirilenko, Kyle, Samadi and CME ES S&P-500 HFT traders did not change their behavior 

Tuzun eqUities index futures during the flash crash; HFT was net buyer 

"The Flash Crash: The contract, during the crash, net seller during the 

Impact of High Frequency May 3 - May 6, 2010 recovery; 11FT trading may have induced 

Trading on an Electronic more trading during the crash 

Market", May 2011 

Eurex AG, "Why high- Eurex FDAX: DAX During "FDAX flash crash", HFT acted "in a 

frequency trading is a good equities index futures way that protects the market by placing a 

thing", 2011 contract rapid succession of small, non-directional 

August 25, 2011 buy and sell orders, thus preventing abrupt 

price movements", improving market 

quality during a period of high stress 

Mellkveld Dutch equities traded on A single high frequency trader played an 

"High Frequency Trading and Chi-X and Euronext, 2007 important role in the development of a 

the New-Market Makers", competitive market center, resulting in 

April 2011 better liqUidity and lower trading costs 

2 
156 


76108.101

Lepone HFT vs. other trades. HFT has become a major provider of 

"The Impact of High Singapore Exchange liquidity, particularly during periods of 

Frequency Trading (HFT): (SGX), Australia market uncertainty 

International Evidence", Securities Exchange 

Septemher 2011 (ASX), NASDAQ and 

London Stock Exchange 

Hendershott, Jones, Automated quoting Automated trading narrowed bid-ask 

Menkveld facility, NYSE equities, spreads, lowered trading costs, and 

"Does Algorithmic Trading 2003 improved price efficiency 

Improve Liquidity?", 

February 2011 

Riordan, Storkenmairm Xetra high-speed trading Higher system speeds led to increased 

"Latency, Liquidity and Price system, Deutsche Borse, liquidity and improved price discovery 

Discovery", 2009 2007 

Hendershott, Moulton NYSE TAQ database plus Introduction of automation via the NYSE 

"Automation, Speed and others, June 1, 2006 - hybrid system improved price discovery and 

Stock Market Quality: The May 31, 2007 made prices more efficient 

NYSE's Hybrid", February 

2010 

Gomher, Arndt, Lutat, Uhle Various Survey paper that highlights beneficial 

"High-Frequency Trading", aspects of HFT, while noting that perceived 

March 2011 problems are largely a result of U.S. market 

structure 

Various Various European Generally stable or improving market 

B1S Foresight Project equities data sets quality over the past decade 

This following studies measured improvements in overall market quality: 

Angel, Harris and Spatt (February 2010) examined many measures of market quality and 

how they have changed over time and in response to regulatory and structural changes in the 

U.S. equity markets.' Drawing from a diverse set of data sources, they show that there has 

been significant improvement in virtually all aspects of market quality. They stated that 

"execution speeds have fallen, which greatly facilitates monitoring execution quality by retail 

investors. Retail commissions have fallen substantially and continue to fall. Bid-ask spreads 

have fallen substantially and remain low, although they spiked upward during the financial 

crisis as volatility increased. Market depth has marched steadily upward. Studies of 

institutional transactions costs continue to find U.s. costs among the lowest in the world." 

1 Angel, J., Harris, L. and Spatt, c., "Equity trading in the 21st century", 

l!.tm;L/.Jlapers.ssrn.com 15013 Ipapers.crm ?abstract id=1584026. 

3 
157 


76108.102

RGM Advisors, LLC (October 2010, Updated March 2012) studied recent data from the U.S. 

equity markets.' The authors examined trends in a number of U.s. equity market quality 

metrics over the period from January 2006 through June 2010 and how these metrics differed 

by market capitalization and by listing venue. They presented data that confirmed that over 

this period quoted bid-ask spreads declined, quoted market depth increased and short-term 

measures of market efficiency significantly improved. The updated Research Note examined 

the same metrics through the end of 2011, a period that included significant macro-volatility 

surrounding the European debt crisis and U.S. credit downgrade. The data demonstrated that 

trends toward improving market quality continued in recent periods, despite the macroeconomic shocks. 

Credit Suisse (April 2010, March 2012) released a report on related topics and showed that 

in recent years, bid-ask spreads declined, depth at the inside quote increased and intra-day 

volatility normalized by longer-term volatility declined substantially.' The authors concluded 

on this last point that "[t]his seems to be confirmation that the new market participants are 

successfully finding and removing mispricings, as well as dampening volatility that might 

otherwise be created by large institutional orders filled during the day." Credit Suisse (March 

2012) released a follow-up report on the impact of HFT on market quality and found that bidask spreads declined and depth at the inside quote increased. They also looked at historical 

long-term and short-term (intraday) volatility and found that long-term volatility has 

remained within historical norms while short-term volatility has declined over recent years. 

They concluded that, with regard to high frequency traders, "markets are not worse for their 

presence". 

Hasbrouck and Saar (October 2010) explored the nature and impact of low-latency 

(algorithmic) trading on the NASDAQ exchange during June 2007, a 'nominal' market period, 

and October 2008, a volatile, uncertain period:' They identified periods of high market 

activity due to algorithms and relate these to longer-term market quality metrics such as 

spread, effective spread and depth of liquidity. They observe in both periods "that higher lowlatency activity implies lower posted and effective spreads, greater depth, and lower shortterm volatility." 

2 Castura, j., Litzenberger, R., Gorelick, R., and Dwivedi, Y., 2010: "Market Efficiency and Microstructure 

Evolution in US Equity Markets: A High Frequency Perspective", 

h ltp: Ilwww.rgmadvisors.com/d ocs/M a rke tEfficiencyStudyO et20 1 O.pdf 

Castura, J., Litzenberger, R., Gorelick, R. 2012: "Market Efficiency and Microstructure Evolution in US Equity 

Markets: A High Frequency Perspective: Update March 2012", 

http://www.rgmadvisors.com/d Des 1M arketOualilyStu dyM arch2 0 12 .pdf 

3 Credit Suisse, 2010: "Sizing Up US Equity Microstructure", 

https: Iltradeview.csfh.com/edge IPublic/BulletinIServefile.aspx?Filel D-143 77 &m;133 7 4349 5 3 

Credit Suisse, 2012: "Who Let the Bots Out? Market Quality in a High Frequency World", htlps:fleuge.creditsuisse. com ledge IPuhlicfBulletin(Servetlle.aspx?Filei D;2135 2&m -21 0022272 5 

4 Hasbrouck, j. and Saar, G, "Low-Latency Trading", 

http://papers.ssrn.com(sol3/papers.dm?abstract id -1695460 

4 
158 


76108.103

The following studies examined market data sets that distinguished between automated 

trades and other trades: 

Hendershott and Riordan (August 2009) reported on the impact of automated trading on 

the Deutsche Horse's Xetra market, an equity market where automated trading activity could 

be distinguished.' The paper found that automated trading accounted for about half of the 

total volume in the top 30 volume stocks, and that automated trading was better than nonautomated trading at driving prices toward efficiency. The authors also showed that 

automated trading "contributes more to the discovery of the efficient price than human 

trading." Furthermore, they find there is "no evidence of [automated trading] behavior that 

would contribute to volatility beyond making prices more efficient." 

Similarly, in the foreign exchange market, Chaboud, Hjalmarsson, Vega and Chiquoine 

(October 2009) used a dataset that separately identified computer generated trades from 

human generated trades and showed that an increase in automated trading may be associated 

with less market volatility, and that automated traders tend to increase liquidity provision 

after exogenous market events such as macroeconomic data announcements." 

The Bank for International Settlements (September 2011) released a related study on the 

impact that growing HFT participation has had on the foreign exchange market. ' The authors 

based their findings on observations made from several banks and other foreign exchange 

markets, in addition to using historical data from Reuters and EBS, two of the largest FX 

trading platforms. They cited a general consensus that HFT benefits the markets under 

normal conditions, and therefore focused on two significant FX shocks: May 6, 2010 and 

March 17, 2011. In both cases, they found evidence suggesting that HFT did not withdraw 

from trading during the shocks, and that they may have been quicker to resume normal 

trading as the shocks stabilized than traditional market participants. 

Brogaard (August 2010) investigated the impact of "high frequency trading" or "HFT" on US 

equity trading on the NASDAQ and BATS exchanges.8 Using a data set provided by the 

exchanges that labeled all activity as either 'HFT' or 'everything else', Brogaard examined the 

exact impact that HFT participants have on the market. His analysis used a well-known 

regression framework to isolate various factors in the market and how HFT impacts each of 

these. In particular, he shows that HFT activity contributes more to price discovery than other 

activity, that HFT quotes are at the best bid or best ask price about 50% of the time, that 11FT 

reduces price impact (an important component of trading costs) for other partiCipants, and 

that HFT activity reduces volatility. 

5 Hendershott, T. and Riordan, R., 2009: "Algorithmic Trading and Information", 

http://papers.ssrn.com/soI3/papers.cfm?abstract id-1472050 

6 Chaboud, Alain, Hjalmarsson, Erik, Vega, Clara and Chiquoine, Ben, "Rise of the Machines: Algorithmic 

Trading in the Foreign Exchange Market" (October 2009). Federal Reserve Board International Finance 

Discussion Paper No. 980, http://ssrn.com!abstract-1501135 

, Bank for International Settlements, "High·frequency trading in the foreign exchange market" 

(September, 2011), http://www.bis.org!publlmklcOS.pdf 

8 Brogaard, J., "High frequency trading and its impact on market quality", 

www.futuresindustry.org/ptg/downloads!HFT Trading,rujI 

5 
159 


76108.104

Brogaard (October 2011) used the same data set to investigate the impact of HFT on 

volatility. 9 He performed a series of measurements in an attempt to determine the causal 

nature of the relationship between HFT activity and volatility. He found evidence that 11FT 

liquidity provision increases during times of short-term volatility, but decreases during 

periods of long-term volatility. Using the 2008 short-sale ban as an exogenous control 

variable of HFT activity levels, Brogaard found that restrictions that reduced HFT 

participation lead to higher volatility. 

Hendershott and Riordan (2011) examined the impact of HFT on the price discovery 

process using the same NASDAQ dataset used in Brogaard (2010).10 Overall they found that 

HFT trades are positively correlated with permanent price changes and are negatively 

correlated with temporary pricing errors, thereby improving the price discovery process. By 

distinguishing trades initiated by HFT, the authors found that marketable high frequency 

trades actively drive prices towards fair value. 

Hirschey (2011) used the same HFT-Iabeled NASDAQ dataset of Hendershott and Riordan 

(2011) to investigate how HFT used marketable orders." He found that HFT traded with 

marketable orders in the direction of previous, contemporaneous and future non-HFT orders. 

This corroborates the Hendershott and Riordan results, shOWing that HFT trades in the 

direction of permanent price impact. 

O'Hara, Yao and Ye (2011) used the same HFT-Iabeled dataset of Hendershott and Riordan 

(2011) to investigate the use of odd-lots in trading.12 They found that that odd-lots contribute 

to 30% of the price discovery process, and that such trading can represent a significant 

fraction of all trades, particularly for higher priced stocks. They showed that HFT was more 

likely to trade with odd-lots. Finally, they raised the concern that the consolidated pricing 

feed does not account for odd-lots, and as such may not be as useful as it was intended. 

A similar study done by Jarnecic and Snape (June 2010) used data provided by the London 

Stock Exchange (LSE).lJ Like the NASDAQ data set, this set label ed all activity by participant 

type; HFT, investment bank, retail, etc., providing a finer granularity of participation rates and 

behaviors. The authors used a similar regression framework as Brogaard in order to isolate 

the impact of HFT on various market metrics. They found that HFT participants tend to 

provide liquidity when spreads are wide, demand liquidity when spreads are narrow, that 

they are more likely to "smooth out liquidity over time and are unlikely to exacerbate stock 

price volatility". 

'J Brogaard, j., "High frequency trading and volatility", 

http://papers.ssrn.com Iso 13/papers.cfrn 'abstract id= 1641387 

10 Hendershott, T. and Riordan, R., 2011: "High Frequency Trading and Price Discovery", 

http://faculty.haas.t>erkeley.edu Ihcnder IHFT -PD.pdf 

11 Hirschey, N. "Do High-Frequency Traders Anticipate Buying and Selling Pressure?", 

https:llwww2.bc.edu/~taillard/Serninar spring 2012 filesiHirschey.pdf 

12 O'Hara, M. Yao, C. and Ye, M. "What's not there: The odd-lot bias in TAQ data", 

lillJl;lill'lpers.ssrn.com/sol~.cfrn?abstract id=1892972 

13 Jarnecic, E. and Snape, M., "An analysis of trades hy high frequency participants on the London Stock 

Exchange", http://rnfs.rutgcrs.edu IMFClMFC17/MS/MC10~44 7 Snape Iarnecic.pdf 

6 
160 


76108.105

The CME Group (July 2010) released a report on automated trading activity on the CME 

futures exchange." They labeled all participants as either "ATS" (automated trading system) 

or "non-ATS." They compared trade volume and messaging rates for each participant against 

market measures such as liquidity and volatility. ATS's impact on these measures varies by 

futures contract, but as a whole, they concluded that ATS-based "volume and message traffic 

tend to be associated with enhanced liquidity and reduced volatility". 

Kirilenko, Kyle, Samadi and Tuzun (May 2011) investigated the role that HFT played in the 

flash crash on May 6, 2010.15 With access to all trades and accounts for the S&P 500 e-mini 

futures contract that trades on the CME, they classified all participants by activity patterns, 

including a group of participants that they characterized as "HFT". They found that these 

participants accounted for a large portion of trading and that they did not change their trading 

behavior before or during the flash crash. 11FT participants were net buyers during the crash 

and net sellers during the recovery. The authors suggest that HFT trading during a brief 

period of the crash may have induced other participants into thinking there was more 

liquidity than was truly available. 

Backes (2011), representing the Eurex futures group, performed a similar investigation 

around the flash crash of the FDAX futures contract on August 25, 2011, which shared many 

characteristics of the May 6, 2010 flash crash in the U.S. 1G Analysis of the trading behavior of 

HFT during this time found that HFT played an important role in maintaining and providing 

liquidity during the sharp drop in the FDAX contract. The author stated that HFT acted "in a 

way that protects the market by placing a rapid succession of small, non-directional buy and 

sell orders, thus preventing abrupt price movements". 

Menkveld (April 2011) studied the development of the Chi-X European stock MTF in 2007 

and the simultaneous entry of a large high frequency trading participant on Chi-X." He found 

that this new participant was largely responsible for the increase in market share of Chi-X and 

ultimately led to reduced spreads for the stocks that it traded. 

Lepone (2011) summarized the results of a series of research conducted by the Australian 

organization Capital Markets Cooperative Research Centre (CMCRCVs These papers 

examined the impact of HFT on market quality for exchanges based in Singapore, Australia, 

the U.S., and the United Kingdom. Their data allowed them to identify trading participants 

and classify them into HFT and non-HFT groups. Following a methodology similar to 

Brogaard (2010), each of these papers measured the impact of HFT on market quality metrics. 

The findings showed a consistent pattern of improved market quality coinciding with growing 

14 The CME Group, "Algorithmic trading and market dynamics", 

http://wvvw.cmegroup.com!educationlfilesIAlgo and HFT Trading 0610.pdf 

Kirilenko et aI., "The Flash Crash: The Impact of High Frequency Trading on an Electronic Market", 

http://papers.ssrn.com/so13/papers.cfm ?abstract ido 16860.94&reco1 &srcabs02013 789 

16 Backes, "High-frequency trading in volatile markets ~ an examination", 

http://www.eurexchange.com/d ownloa dId ocum ents Ipu b lica tions Ifactsheet hi ghfreg u ency.pdf 

1" MenkveId, A., 2011: "High Frequency Trading and the New-Market Makers", 

http://papers.ssrn.comlsol3/papers.cfm7ahstract id-1722924 

18 Lepone, A., 2011: "The Impact of High Frequency Trading (HFT): International Evidence", 

http://wvvw.cmcrc.com 

7 
161 


76108.106

HFT participation. They also demonstrated that HI;! is active during all volatility conditions 

and "become the primary providers of liquidity" in periods of high uncertainty. 

These event studies investigated the impact o/improvements to a market center's trading 

technology: 

Hendershott, Jones and Menkveld (2007) examined the impact on the NYSE of their autoquoting facility introduced in 2003.19 This study showed that for all stocks, and particularly 

large-cap stocks, automated trading increased liquidity. It also demonstrated that the 

increase in automated trading caused a reduction in effective spreads, thereby reducing costs 

to investors. 

Similarly, Riordan and Storkenmairm (2009) reported on how a 2007 upgrade to the 

Deutsche Borse's Xetra trading system focused solely on latency reduction, positively affected 

market quality.'" After latency reductions in the exchange's trading systems, liquidity 

increased across market capitalization and trade sizes, and adverse selection and permanent 

price impact were dramatically reduced. 

Hendershott and Moulton (February 2010) studied the introduction of the NYSE hybrid 

system in 2006, which moved the NYSE to a faster and more automated matching system. 21 

They found that prices became more efficient due to faster price discovery and reduced noise 

in prices. 

These papers provided an overview 0/ "high frequency trading" and related market 

structure issues: 

Gomber et al. (March 2011) presented background information on HFT. Their paper 

analyzed HFT and "certain proposed regulatory measures."" They claimed that HFT is a 

technology rather than a strategy, and is a natural evolution in the market place. They 

highlighted the beneficial aspects that HFT can provide, and noted that perceived problems 

with HFT are largely a result of U.S. market structure rather than anything inherent in HFT 

itself. They provided several recommendations for policy makers that would maintain the 

beneficial aspects of HFT while providing markets with additional safety. 

1') Hendershott, T., Jones, C.M. and Menkveld, A.I.,: "Does Algorithmic Trading Improve Liquidity?", 

Journal of Finance, Volume LXVI, No.1, February 2011 

2U Riordan, R. and Storkenmairm, A., 2009: "Latency, Liquidity and Price Discovery", 

http://papers.ssrn.com Iso 13 Ipapers.cfm?a bstract id -12 47482 

21 Hendershott, T. and Moulton, P., February 2010: "Automation, Speed, and Stock Market Quality: The 

NYSE's Hybrid", http://www.hotelschool.comell.edu/research/facullybiQsjresearchpapers I docu m en ts IA utomationS peed Hybrid a ccepted.pdf 

22 Gomber, P., Arndt, B., Lutat, M., and Uhle, T., March 2011: "High-Frequency Trading", 

http://www.frankfurt-main-finance.com/en I cia ta -fa cts Istudy /H igh-Freq uency-Tra ding.pdf 

8 
162 


76108.107

The Foresight Project by the IllS was a study intended to "explore how computer generated 

trading in financial markets might evolve in the next ten years or more", with a particular 

emphasis on stability, integrity, competition, efficiency and costs." Most of the supporting 

papers were policy driven and speculative in the sense that they were not data-driven. One 

paper examined the changes in broad market quality in U.K. equities over the past decade and 

found that there are few trends of statistical significance. Volatility appeared to have peaked 

in 2008/2009, but had no discernable long-term trend. Liquidity and efficiency metrics 

appeared to have no significant trends, and there may be a positive link between competition 

and market quality. 

B I S F oresigh t P roj ect: jH];ll;Jj.\\'-\YlJl~bjs.'CQY2lkLforcsigh t (ou r-work I Dro je cts.L£.u rrc n tprojects (computer~trJ.din.g 

9 

76108.108

Written 

Solomon 

Chief Executive Cowen and llC 

Cowen 

House Committee Financial Services 

Subcommittee on Markets and Government 

Hearing entitled "Market Structure: 

"" •. ",rnw Clnd Comoetitive issuers and Investors" 

June 20, 2012 

76108.109

COW

Thank you for inviting me to speak with you today regarding market structure and fostering innovative and competitive cap

markets in the United States. My name is Jeff Solomon and I am the Chief Executive Officer of Cowen and Company, an em

growth investment bank focused on servicing growth-oriented companies in sectors such as healthcare, technology, 

telecommunications, media, aerospace and defense, and retail. 

Our clients represent some of the brightest and most motivated entrepreneurs in the country. They are actively seeking to 

products and services that can change, enhance or positively disrupt whole sections of our economy and, while they deploy 

vision, in more cases than not, they are significant creators of long-term private sector jobs. In order to continue to grow th

companies, these visionaries need access to the capital formation provided by the equity markets. 

I am very proud of the growth our country has achieved by fostering the greatest capital markets structure the world has ev

over the past century. To be fair, the system isn't always perfect and I fully support regulation to ensure the system functio

properly. Market oversight is a significant task and I know this committee, the SEC and other oversight bodies have been w

diligently to address a multitude of issues. But I do believe that we need to be extremely careful to examine how regulatio

imposed over the past decade have adversely impacted the equity markets and damaged capital formation at the very time 

most needed. 

The last decade has shown a significant decrease in the trading liquidity for most small cap issuers. At the same time, retail 

are less relevant than institutional investors in individual stocks as evidenced by the popularity of mutual funds and Exchan

Funds, who are now the dominant market participants. A lack of liquidity in any small cap stock makes it difficult for invest

accumulate a position. Moreover, portfolio managers carefully assess liquidity when determining position size and price as 

know it may be hard to get out of the stock when their price targets are reached or should they need to sell to generate liqmeet investor redemptions. This dynamic has severely narrowed the investor universe for small cap companies thereby ma

difficult for them to raise capital to expand. Indeed the number of IPOs raising less than $60 million has fallen precipitously 

past decade. 

One of the principal reasons for the lack of liquidity in small cap stocks can be directly attributed to the advent of decimaliz

meaning trading in penny increments. As a direct result of reduced trading spreads, professional market makers and specia

whose job was to provide liquidity for their clientele, were forced to overhaul, sell or dissolve their businesses to contend w

76108.110

COW

lower revenues. This, in turn, gave rise to two market forces affecting market structure - electronic trading and reduced res

coverage of small cap stocks. 

The following pages and figures are provided as detailed information to support my oral testimony and are intended to high

some key trends taking place with regard to market structure in the U.S., including: 

The undercoverage of small cap stocks by sell-side research analysts; 

The decline in "SmaIiIPOs", or IPO transactions raising $60 million in proceeds or less; 

The decline in companies listed on u.s. exchanges and u.s. exchanges' global competitiveness; and 

The relationship between employment and IPO activity. 

We have the opportunity to re-examine current market trading structures to further support the positive initiatives created 

JOBS Act. By pursuing modifications to existing legislation and regulations around decimalization that bring back market m

small cap stocks, Congress and the regulators will be telling Wall Street executives how they can allocate their resources to 

profitably meet the needs of their clients while fostering job growth in America. We can still be the leader in funding succes

innovation in the U.S. But in order to thrive once again, we must make it more economically viable for small companies to a

capital markets to fund their growth, create new industries and provide Americans with the job growth from the private sec

so dearly want. 

76108.111

COW

I. Sell-Side Research Coverage of Small-Cap Companies 

Reduced trading spreads forced professional market makers and specialists, whose job was to provide liquidity f

clientele, to overhaul, sell or dissolve their businesses to contend with much lower revenues. This, in turn, gave 

two market forces affecting market structure - electronic trading and reduced research coverage of small cap sto

regards to the latter, a significant portion of small cap stocks today are either undercovered by sell-side analysts 

covered at all. The chart below shows research coverage by market capitalization for companies traded on NASD

(Stocks traded on NASDAQ with No Analyst Coverage) 

60% 55% 

40 

50 

-

30 

20 

10 • • 7% .. 

Quintile 2 3 

Market Cap Range (MM) $0 - 41 $41 - 119 $119 - 301 Median Mkt Cap (MM) $21 $72 $189 Median # of Analysts 0 

4% -. 4 

$301 - 926 

$526 

6 

1% 

$926+ 

$2,150 

14 

Source: Keating Investments. "The JOBS Act: Shifting into Gear and Accelerating Up the iPQ On-Ramp" by Timothy J. Keating, May 2012. 

Note: Information as of December 31, 2011. 

4 

76108.112

COW

II. Decline in "SmaIlIPOs" on U.S. Exchanges 

Over the past fifteen years, there has been a dramatic decline in "SmaIIIPOs", or IPO transactions raising less tha

million in proceeds, in the U.S. From 1980 to 2000, these transactions accounted for 74% of total U.S. IPO activit

included financings for many technology sector pioneers like Microsoft and Cisco. Over the past five years, these 

transactions accounted for only 24% of U.S. IPO activity. 

To give you an example, I would like to turn back to 1986 when a company called Cellular Communications, Inc. 

public. Cellular Communications, Inc. was a company with a strong belief that cellular technology would grow an

provide a better way for people to connect and communicate with one another. This was far from mainstream t

at the time. Founded by my friend and now colleague, George Blumenthal of Cleveland Ohio, Cellular Communic

Inc. needed capital in order to stay afloat and explore growth. Through their IPO, the company raised only $25 m

But over the years, Cellular Communications, Inc. grew as a public company with the explosion in the use of cellu

technology and created a number of jobs along the way. They funded their growth primarily by way of the publ

markets with clear support from market makers and research firms that helped them tell their story to investors

no firm will do a $25 million IPO as it will likely only lead to another illiquid small cap stock. 

The chart on the following page shows U.S. IPO activity over the past three decades and the significant decline th

occurred in "SmaIiIPOs". 
168 


76108.113

I 

I lOa, 

II 

III 

966T 

am lii&i 

II 

. J i I 

iUI 

Ii 

II1II 

Ii 0861 
169 


76108.114

76108.115

IV, Number of Companies listed by Exchange Country 

Whiie the United States' exchanges have lost nearly 30% of its listings twenty years, exchanges acr

rest of the world have seen steady increase listing activity, This the for both exchanges located in em

markets, such uS Hong Kong, as well as exchanges located in more developed regions, including London and Toky

1991 2011 1997 2011 

United States 6,943 4,988 (28%) 8,823 4,988 (43

Borsa Itaiiana 267 328 23% 239 328 

Hong Kong 299 1,413 373% 583 1,413 1

Tokyo 1,764 2,291 30% 1,865 2,291 

76108.116

V, The U,S.'s share of GiobailPOs 

U,S< share of Global IPOs; or IPOs completed by foreign outside the!r home country, 

dramatically over the fifteen !n 22 fOfoign issuers listed on exchanges, 11% 

Global !POs, years ago, U5, captured a 45% shaf(? of these listings. 

IPO$) 

70"% 

60% 

50°/0 

40% 

30% 

20% 

100/0 

00;0 

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 
172 


76108.117
173 


76108.118

..... 

<: 

OJ 

E 

>-

0 

"i'l. 

E 

OJ 

<: 

:;) 

"0 

OJ 

'" ro 

:::: 

v 

.5 

0 

.... 

III 

OJ 

"" " € 

.... 

l:: 

0 

U 

"" III 

"'" Im 

:a: 

0 

!:!:: 

"0 

<!I 

'" <II 

ill 

'-0. 

III 

0 

<t 

"' 

.c '" 

co 

o 

C) 

" o 

m 

:J 

§ 

<i 

I 

if> 

0 

e. 

ttl " 0' M a 
174 


76108.119

Testimony of 

,Jim Toes 

President and CEO 

Security Traders Association 

Before the Capital Markets and Government Sponsored Enterprises Subcommittee 

Committee on Financial Services 

U.S. House of Representatives 

June 20, 2012 

Chairman Garrett, Ranking Member Waters and Members of the Subcommittee: 

The Security Traders Association (STA) welcomes the opportunity to present comments before tbe Subcommittee 

on Capital Markets and Government Sponsored Enterprises on: "Market Structure: Ensuring Orderly, Efficient, 

Innovative and Competitive Markets for Issuers and Investors". 

The STA was formed in 1934. We are an organization of individuals who are involved in the trading of financial 

securities. Our membership is diverse, both geographically and in the roles we fulfill in the market place. Much of 

our testimony today will reference years of comment letters STA has written on market structure; letters which were 

the culmination of input received from a wide range of market participants. The testimony of the STA over the years 

bas accurately informed and alerted Congress and the Securities and Exchange Commission (SEC) to the possible 

consequences, both intended and unintended, of proposed changes to market structure. We arc pleased to have the 

opportunity to do so today. 

Our testimony will focus on three areas of concern STA has with today's market structure: investor confidence; 

capital formation; and the quality of regulation. We will also identify specific areas which we, as practitioners, view 

are the primary forces causing our concerns: operational capability; decimalization; and the rule making process for 

both Self-Regulatory Organizations (SROs) and the SEC. 

Investor Confidence; Operational Capability 

Investor confidence is influenced by several factors, none more than the operational capability of the markets. 

Failures of that capability, even as a rare or limited occurrence, destroy investor confidence, much more so than any 

other regulatory or market structure minutia. Fostering greater operational capability should be the foremost 

consideration of any regulatory or legislative entity that has oversight or influence on our financial markets. It is 

imperative that such entities ensure no demands are made on the operational capacity of the industry that result in its 

being unable to deliver the services it purports to offer. Furthennore, behavior which stresses the operational 

capability of our markets should be identified and reviewed by the proper regulatory agency. Our markets need to be 

open to serve a wide range of market participants with varying business models. Therefore, it is critical that behavior 

which is deemed potentially harmful to the overall operational capability of onr markets not be allowed to exist 

unimpeded. 

Quality of Regulation and the Rulemaking Process for SROs and SEC 

Today, rules governing the securities markets arc introduced to tbe marketplace hy SEC initiatives in the fonn of 

rule proposals, or the rule filings of the Self-Regulatory Organizations submitted to the SEC for approval. SEC 

approval of SRO ruies, and SRO rules in certain cases that are effective upon filing, presents unique prohlems. 

While there are similarities in these processes, they arc distinct and vary primarily in tbe level of due diligence 

required of the Commission. There are efficiencies within both processes that when applied properly serve the 
175 


76108.120

competitive nature of our mmkcts and investor confidence. Our concerns reside in the lack of criteria that are used 

in deciding which process better serves investor confidence when rules are proposed. 

As stated in our letter to the Commission on June 8, 2012: 

STA acknowledges that the right of exchanges to compete is often exercised through the SRO rule filing 

proccss. While STA sees certain efficiencies and benefits which accrue to investors in this process. we have 

become concemed that the pattern of one SRO rule approval is often followed by similar. but different Rule 

filings by competing SROs. This trend has the potential to affect overall market structure and investor 

confidence. We strongly urge the Commission that \vhcn considering the impact to market structure with a 

single SRO Rule Proposal, it docs so under the assumption that competing SROs will file similar proposals. 

The Commission should consider altemative approaches to the approval of important SRO rule proposals that have 

material market-wide implications on the structure ofthe market Rather than picking and choosing between the 

proposals or in the alternative, approving all of them, in cases where multiple rule filings are made that are identical 

or very closely related or where the SRO rule filings have material market-wide implications, the Commission 

should consider substituting a proposal for a unifOlID, market-wide SEC rule in lieu of those of the SROs. STA does 

not suggest that changes to fee structures or other SRO proposals that attempt to differentiate themselves would 

merit a unifonn SEC approach. Instead, the Commission should propose uniform, market-wide rules when there are 

significant market-wide implications. 

For example, the NYSE Retail Liquidity Program (RLP) proposal would, among other things, allow sub-penny 

quoting, and if approved, other exchanges have suggested they would submit similar filings. This would lead to a 

significant market structure event one that includes sub-penny quoting and its implications on increased message 

traffic and market data charges, which would lead to increased technology and market data costs, as well as potential 

confusion by investors. Rather than an SRO rule, a sub-penny quoting proposal should be an SEC initiative due to 

its market-wide implications. Adopted pursuant to the requirements of the Administrative Procedures Act that insure 

the public has adequate notice and an opportunity to comment on the proposal, the resultant efficiency of a single 

proposal should produce a greater volume of focused expert analysis and input as to any difficulties in complying 

with the proposal, the costs of doing so, and the likely impact on the overall evolution of market structure. 

Competing SROs will undoubtedly comment on the proposed SEC rule, suggesting changes that reflect what was 

originally proposed in their individual rule filing. The SEC may adopt or reject these suggestions but importantly, 

experience has shown that minor modifications adopted in individual rule filings have not increased competition 

among the marketplaces that justifies the significant complexity they add to the compliance burdens and demands on 

the operational capacity of industry users. 

STA believes that in addition to the review of the specifics of SEC and SRO rule proposals, the quality of regulation 

would be improved and investor protection served if the SEC addressed the increased need for industry input on 

technology and back office operations in its rule approval process. The existing rule review and approval process is 

increasingly ill-suited to obtaining this information. For example, in its comments on the Consolidated Audit Trail 

proposal, the STA stated: 

In order for CAT to effectively meet its objectives, STA believes that extensive business analysis 

is needed that will require expertise in order, trade and post-trade systems and processes. Such an 

analysis will require many detailed discussions between SEC staff, the SROs and industry 

participant teams. 

We submit that the SEC needs to take formal action on regulations, and particularly before adopting those imposing 

signiticant technological or operational burdens on the markets, to create advisory or implementation committees as 

pem1itted by law to ensure it receives input from the trading community, including experts in trading systems and 

products, and develops an understanding of the operational demands of the proposed rules. We are encouraged that 

2 
176 


76108.121

in the adoption of the limit up-limit down pilot program, the SROs responded to STA's recommendation to establish 

an Advisory Committee, which is to be composed of a broad cross-section of market participants who may submit 

views on matters relating to the limit up-limit down plan. 

In today1s exceedingly high tech equity and derivative markets, where massive amounts of data are created and 

utilized by market participants and investors, every rule proposal by the Commission represents a complex 

administrative and compliance project for the industry. The STA is concerned that consideration and approval of 

these rules often takes place without adequate input to, and consideration by, the Commission concerning the 

technical difficulties, costs, and cost-beneiit analysis associated with them. This problem is exacerbated, in the case 

of an SRO rule filing, by the fact that SEC approval of the rule will often result in multiple filings by competitor 

SROs with similar but perhaps not identical proposals. It is necessary, therefore, for the SEC to not only consider 

these proposals on their own merits, but to include in its analysis the likely multiplication of complexity, 

technological demands, and costs and benefits on a market wide basis. 

Finally, Commission rule review and approval would be improved ifmore attention was paid to possible 

"unintended consequences" in connection with the approval of a rule. No one can predict the future, but experts can 

often demonstrate the most likely outcomes of some changes, and traditionally the SEC has not given much weight 

to such testimony, preferring instead to approve a rule and allow competition to decide whether it will work 

efficiently or not 

Decimalization; Capital Formation; and Investor Confidence 

There is perhaps no single market structure event that has yielded more benefit to retail investors who transact 

directly with the market to buy or sell securities than the introduction of decimal prices. The benefits for this class of 

investor are witnessed every day in the narrow bid to ask spreads in the securities in which they trade. The data 

which shows the implicit savings to investors brought about by narrow spreads becomes even more impressive when 

it shows that even durmg moments of volatile markets, spreads remain tight. 

This benefit, which was immediate and long lasting, however, has come with a cost to the secondary markets ability 

to perform their capital formation function. In its letter to the Commission on May 14,2003, STA wrote: 

The raising of equity capital by corporations is the cornerstone of our economy. However, given the recent 

regulatory events surrounding research and investment banking and market structure changes affecting 

trading. the raising of capital has become exceedingly more difficult That, in tum, is impacting the U.S. 

~conomy and its ability to crcate jobs. 

Action must be taken soon to remedy ",,'hat could be soon a capital fonnation crisis. A re-examination of 

decimalization is a good place to start. 

Members of this panel, we reiterate, this letter was written, May 2003. 

The unintended consequences of decimalization have been dramatic, most noticeably, in the significant decline in 

the quantity of liquidity providers in the stocks of smaller and medium sized companies and those with less than 

active trading markets. Shareholders benefit from the presence ofliquidity providers. They dampen market volatility 

to the beneiit of the marketplace and investor coniidence. Regulations should be reviewed to remove disincentives 

to the commitment of capital by trading operations with market making, both electronic and traditional, and block 

trading. STA is encouraged that the Jumpstart Our Business Startups (JOBS) Act included a requirement for the 

SEC to examine the impact decimalization has had on IPOs and on liquidity for small and mid- cap company 

securities. STA recommends an examination of the impact of decimalization on eJectronic and traditional market 

making, as well as on other liquidity providers, considering: the costs of maintaining a tTading operation in a 
177 


76108.122

decimalization regime; and the balance of market maker obligations with the benefits they may receive from that 

status. 

Onc way to conduct such an examination is through a Commission initiated pilot program utilizing a statistically 

significant number of small and middle capitalization company securities to study the impact on the secondary 

markets of quoting and trading securities in pricing increments of greater than Olle penny. Should the Commission 

move ahead with such a pilot program, a key data point that should be measured is whether private investors 

recognize and are willing to accept additional incremental costs in return for the opportunity to obtain the potential 

for greater growth characteristic of successful small- and mid-size companies. 

Thank you and I look forward to answering any of your questions. 

4 
178 


76108.123

t 

Statement of David Weild, Advisor Grant 

before US, House of Representatives Financial Services Committee 

Markets and Government Sponsored Subcommittee 

20, 2012 
179 


76108.124

Hearing on market structum: Ensuring orderly, efficient, innovative and competitive 

markets for issuers and investors 

Contents 

Introduction 

Summary 

The trouble with tiny ticks 

Aftermarket support: biggest obstacle to resurgence in the IPO market 

ConClusion: IPOs lead to job growth 

Additional materials 

About David Weild 

About Grant Thornton LLP 

(02012 Grant Thornton lLP. AU fights reserved. 

Page 

2 

3 

4 

8 

11 

13 

14 

16 
180 


76108.125

Hearing on market structure: Ensuring orderly, efficient, innovative and competitive 

markets for issuers and investors 

Introduction 

Chairman Garrett, Ranking l'vlember \vaters and members of the Subcommittee, thank you for inviting 

Ine to speak today about an issue of great importance to nlany Americans: how to structure stock 

markets to better support the U.S. economy and job growth. 

My name is David \veiJd. I oversee the Capital Markets Group of Grant Thornton J .LP, one of the six 

global audit, tax and advisory organizations. I was formerly vice chairman of The NASD£\Q Stock 

Market with responsibility for all of its listed companies, and I ran the equity new issues business of a 

rnajor investolcnt bank for tnany years. 

Grant Thornton's Capital Markets Group provides support to companies accessing today's global 

capital markets. These companies run the gamut from private companies and entrepreneurs to venture 

capital and private eqnity-backed companies - both small and large. 

e) 2012 Grant Thornton LlP. AU rights reSGrV()(t 
181 


76108.126

Hearing on market structure: Ensuring orderly, efficient, Innovative and competitive 

markets for issuers and investors 

Summary 

The current U.S. market structure fails to support the needs of small and mid-sized companies that are 

critical to U.S. econonuc Sllccess. The information I present today demonstrates the following key 

structural challenges that the U.S. public stock markcts must confront in order to foster the growth of 

small companies and, thus, the economy: 

1. Inadequate tick sizes (the smallest increment by which a stock can be bought or sold) have eroded 

the economic infrastructure required to support small cap stocks. Inadequate tick sizes leave 

insufficient revenue to pay for needed visibility (research and sales) and liquidity (capital 

commitment) that snpport investment in small capitalization stocks once they are public. Fewer 

[POs means fewer U.S. jobs. We now have a stock market that covers the cost of trade-execution 

senrices only. 

2. We estimate that had the Order Handling Rnles, Regulation ATS, Decimalization and Regulation 

NMS not been applied unilaterally to companies of all sizes: 

a. instead of averaging 128 [POs per year in the U.S. since the year 2000, we would be averaging 

between 500 and 1,000 lPOs per year; 

b. instead of shrinking the number of listed companies on our stock markets, we would be 

growing OUf stock tnarkets significantly; and 

c. the United States would have created millions - possibly over 10 million - new jobs. 

3. \'le also believe that inadequate tick sizes have undermined \'lall Street's fundamental ability to 

properly execute IPOs. The evidence is that while companies that go public today arc much more 

mature than they were in the 19905, [POs fail at increasingly higher rates. More deals are being 

withdrawn, more deals are being priced below their initial filing range, and more deals are trading 

below their IPO price. 

4. Finally, U.S. stock market structure is clearly optimized for trading big brand and large cap stocks. 

This structure encourages computerized trading and speculation at the expense of fundamental 

investment. It docs not create essential visibility for small cap companies and those companies that 

lack natural brand-driven visibility. There is ample rationale for treating small company stocks 

differently and allowing issuers to choose their own tick size within a certain range - say, 1 cent to 

25 cents per share to encourage support for their stock. Providing better economic incentives to 

support small cap stocks will lead to increased IPOs and, in turn, higher rates of capital formation 

and job growth at both already-public companies and private companies. 

~) 2012 Gr,'wt Thornton LLP. AI! rights re-s1O>ry"d 
182 


76108.127

Not so ago, during the of the: 'ROs and (90s.~ ,\nlL'rica>'s stock nurkcls \vcrc envied 

economics across The globe for tbeir abilhy to birth entire BC\\ industl1c~ _ .. such as the .:;.en1iconduciof, 

biOTechnology and the pC'[sonal cotnputcr industries - and propel "\mCftcan leadership and 

economic g-ro\\~th in those 

Since 1907, l'.S. stock has suffered it deyastating decline the numbers of srnail initial 

public offerings, fe.suit of-SFC-impktncntcd regulations that put 111 1l1otl0n decade ·long erosion of 

the l:.S. capital fonnation and support infrastructure on which sl11all cOl11panies relied. (Notably, the 

draslic drop small comprmy IPOs occurred befi>re 2002's :;arbancs-Oxky ,\ct.) \,'hilc they \\"('rc 

meant reduce costs for their unintended [cpCrcu;,:;s10IlS significant: decreasing nmnbers 

of slnall~c01npany IP()s, increased rnanagclllent burden of being public cornpany shiftillg 

lnanagcmcnt's foclls frntTI running business to trying to nlnrkct their stock, and onc·,slzc 

1 ~.S. srock \vhcrc big brands call sustain adcyuatc Ylsibi1iry with invcsror;.:;. 

Order Handling Rules (1997), Regulation ATS (Alternative Trading Systems) (1993), 

Decimalization (2001), and Regulation IIIMS (National Market System) (2005) caused 

a collapse in effective tick sizes 

T raflsact'!O!'lS raiSing 

SPACs 
183 


76108.128

StAkeholders: 

Roads - Trade execntlon venues, .as NYSE, NASDAQ, 

Direct Edge, Liqtlidn0t 

>t OrHamps ~" .. Investment banks 

$ Bridges -,. Market makers ready to buyJseH stocks 

committing 

tt Tunnels ,--, Ana!yst and broker support to investors 

Economic incentives: 

-- Tick sizes and cornmissiDIlS 

market's operations and upkeep 

investment banks (acting as bookrunner} 

Small company IPOs 

167 (1994) 39 (2006) "71% 

2,990 (1991"1991) 233 (2001,,2007) 
184 


76108.129

Ccmtil1uous decrease in 11'0 listings 

nurnbcr of listed enn",,,,,;,", year, and 

companies. ()ur markets \vill continue to shrink unless \v(-' 

llw ;]11f'r1cmrK,'f. 

we belicH', likely elevated 

const'tllH:'llce~ :::incc: 1997 

has now lo~!' -i3.5() () of an listed 

the tnccnttycs 10 support mmr);H1WS 

Indexed value of selected global <)xchange listings {1997 " 01 

capacity to gencrate f1C\\~ listings is also well below rcplacenlent n('l~ds to support economic 

and job rf{:at1on, In since 2002 it takes an ascrage of :"HO listings just to replace \vhar is being 

lost c\¥cry through the cornbinalloH of rncrgcrs ,"md and reguLHory (lelistings 

the L' .S. has not had 3·+0 ur 1110rt' listings an\' noe year the 199{)S. 

IPes 73 207 188 189 213 35 61 153 119 131 

559 500 302 284 379 267 354 237 340 

Source: Capita! Markets Advisory Partners LLC 

Inadequate tick sizes have undermined Wall Street's fundamental ability to properly 

e"ecute IPOs 

structure failing all not just :-;nlall businesses. C0111pan1cs rh,lt 

arc in nUlnbcr and 1111..1< .. 'h 1nOlT nlatufc than they in {hI' 
185 


76108.130

IPOs 
186 


76108.131

~farkcts ;mc.1 ::;null cOlnpanil'.s need to tTleet three to Any market' lackiug 

thre(' 'will not 11yc up to potential: 

Standard disclosure: Docs markd proY1dc transparency and standard di::;dosUfC? 

Reasonable cost: ;\ rc the cost;; be'll" to access be this 

,1, Adequat{:,: aftcnnarkct incentiv{~s: 

and 

there adcclmnc aftt'rtllarkt't 1nccnt1\'('s to support 

Standard disclosure 

< H<R< i'93r)lc!0\',\'ltun,drngl 

Adequate 

aftermarket 

incentives 

of 

aboyc chart nlaps Titles I through VI of the JOBS .. Act to our understanding of ho\.\' cach of these 

Tilles \vil1 improve capital fonnation. ,\f'tcrrnarkl't' ;;uppon is the biggest obstacle blocbng 

the t:,S, IP() Today's public Hurkers arc overly complex and do not hcha\'c in a 111anncr 

the :l\'Crage retail in\TSIOr underStands. \\'id1out J(kt.p.tate ecollornlc incent-i\'t'~, i1\yt>stnwm batl.ks 

C3nnot afford to compensate the traders and research analysts \vho Clt1 provide 

!r;1.nSparcflcy to il1YCSWrS regarding ;.;n\all c01npallY stocks. loslead of :'iupporting an C()tnp;lny ;;.tZCS~ l' 

markct optimized tr:l.<ling (not investing) pt11n:-uily S&P SOU of the 
187 


76108.132

"\\:inn('r;;-' n'~:;ulting illl..' nj()n::menth)ned chnngcs, ()ur conclll!'izm 1:' lll;lt nl\)ft' t() 

be done addition to li1eJOB:' ,\ct to impny\T aftcnnarkct ~llpporL which \y(' helicn' i:; (based the 

1 ()9o dn1p--()ff in tick ;;1;;(';;) by the bip;gcsl ob::;taclc tn 111 the IP() alld rcsull::"1111 

Job 

Hedge funds 

~ Day 

<$> Electronic trading 

<li' Vo!atWty 

Tn an ccotlo:my the 

... Big company acquirers 

Entrepreneurs 

investment 

banks 

• Venture 

'4 Market-makers 

@> Stockbrokers (advice) 

II> Uquidity small cap stocks 

'I> Transparency in small 

stocks 

'4 Long-term investors 

U,S, econon1Y and jobs 

" all should be offered choice 11o\v die markz'l 

lr:H_k;; lhcir ;:;tock. BCC1U;;\,; of Rcgl1Lttlon j~'\jS. 

complltcflz('{l high-frequency. dark pool 

issuer':" stock traded in only (}1'l(' "\\";1)' the 

Tick size choice for issuers 

Congrc;:;:; i1s hipflni;;an~hip in passing tile J( H~S ,\ct and the for 

ilupn)"\'cd capital formation. It a good first step, but ('''''en Congress n."cognit:et1 the need 

insip:-ht and analysis of .S. 1.11;lrket struc1urc, specifically instructing the Sl-:C to study the ilnpact 

dccin18JizarioH on (1) the number TPOs, and (2) li<1uidity small and middle cap.itahza!lon conlpan~ 

Folky\ying the study, the allowed 10 set a 'mjnitnUll1 tTading inCfC!11Cnl 

if it i::-; determincd growth rOll1panlcs'" should traded and <jlloted at 

lh<'111 1 cent. 

1Tcotnnwnd th<H the SI a pilot progran1 TO rn1Crging gro\yth ::1nd other smidl rap 

preferabJy bt:t\yeen 1 cent and ccnls (although the 

the ;;prcad undermine the intent to p:ty for necded s(lks, 

resenrch ,1l1d capital comn'ttUHCt1l). fnllowing paLU1'l('-tefs detennined by lht' SEC, \\"e bclicy(' that 

rnarngCtnn11S ;1lld their b():1fd~~ rnn~t ha\'c ::::tructurc ;lJH..! the impact on :-oharcholdcfs, 

and equal \"nice 

ls:-;uer:-; control 

h:tlancc that p[ the trading ("OtTHllHnily. \\'hat bctter "\va\' to do {his than to giyc 

(ilelr ()\vn 

the !.2;·alhcr yaluable research and data to the debatt' 

OIl how to best the to support capital form~Hion and job gH}\\<th. The 

SEC could evaluate the impact of different tick sizes OIl the pricing and trading patterns of 

clncrging gro\-vth and sman cap c(unpanics, and track variances across- specific industries 

COl.upany sizes. :111101tg other of study, \\~ou1d help define optimu1Tl tick to keep 

costs low in'iTstors and the necessary infra;-;'1rUctllfc support. :\brkt::t forces would then 

Since 

,lfl{'rtll;]rkc[ 

~trucrurt'. 

and ~:;maJl compan!cs \\'ol.dd nn longer he affcctf'-ct 1)\- it 

money supporting tnosi I P()s In lhe aflernlarkct. increasing 

fud in'i-T'stHWt11S in equity d.i:;;1Tibutloll, sale::; and aftermarket 
188 


76108.133

:-:upporr I~H' :-:n1:1l1 puhlic 

~lork markets and their choic(';;. I\i;ukcls would also realign ,HId refocus distribntion on investor=" 

:1nd impron.' the of IPC) sharc~ itl1d iavestor returns ~:1.H while laying ;1 

foundation 1 P( )s, economic gn}"\\"th ,111d job 

Small-, companies represent only 6.6 Q

A) of cUlnulativc market 

publicly listed companies, Thus, public matteL 

(1jjjCj'cnm' and allowing to choose lw 

",sub.s2 bililon companies represent less 7% ortolal public company market value 
189 


76108.134

An opportunity cost of 

economy 

A 

of jobs and untappod economic growth for the U.S. 
190 


76108.135

Hearing on market structure: Ensuring orderly, efficient. innovative and competitive 

markets for issuers and investors 

12 

Back in 1971, there was a sl11all technology company that was unprofitable 011 an operating basis. It 'vas 

only three years old when it went public, raising roughly $8 million - approximately $44 million in 

today's dollars. It created a revolutionary product: the first commercially available microprocessor chip. 

After it went puhlic, it actually missed its ftrst delivery date and investors cut its stock price in half. Talk 

about risk! That kind of company wouldn't even make it to the IPO stage in today's unforgiving 

market. 

The name of that company? Intel. How many Intels have been needlessly lost to the U.S. economy by 

today>s market structure? 

Congress has the power to help reverse our current situation and bring back the stock market that was 

once the envy of economics throughout the world for its ability to foster U.S. economic leadership. We 

recommend that Congress support an SEC pilot program that allows emerging growth companies and 

other already-public, small capit'dlization companies to customize their tick sizes. 

Thank you for the opportunity to present information on such an important topic. I am pleased to 

answer any of your questions. 

is:' 2012 Grant Thornton LLP. All rights reserved. 
191 


76108.136

Hearing on market structure: Ensuring orderly, efficient, innovative and competitive 

markets for issuers and investors 

Additional materials 

June 8,2012, presentation to SEC's Advisory Committee on Small and Emerging Companies 

Why arc IPOs in the leU? 

Market structure is causing the IPO crisis - and more 

A wake-up call for America 

Wall Street Journal OpEd entitled, "How to revive small-cap IPOs," October 27, 2011 

if) 2012 Grant Thomton LLP, All rlghts r~served, 
192 


76108.137

Hearing on market structure: Ensuring orderly, efficient, innovative and competitive 

markets for issuers and investors 

About David Weild 

David \\feild is a Senior Advisor to Grant Thornton LLP's Capital Markets Group, which provides 

strategies and insights into todais global capital nnrkets. 

Experience 

14 

David is the Chairman & CEO of Capital Markets i\dvisory Partnets and the former vice-·chairman and 

executive vice-president of 111e NASDL\Q Stock Market, with oversight of the more than 4,000 listed 

companies. Prior to NASDAQ, he spent 14 years at Prudential Securities in a number of senior 

management roles, including president of eCommerce, head of corporate finance, head of technology 

investment banking and head of equity capital markets in New York, London and Tokyo. He worked 

on mote than 1,000 IPOs, follow-on offerings and convertible transactions and was an innovator of 

new issue systems and securities underwriting structures~ including the use of Form S-3s to mitigate risk 

for small capitalization companies raising equity and convertible debt capital, He created the Market 

Intelligence Desk - or "MID" - while at NASDAQ to support issuers in their quest to belter 

understand what was impacting trading in their stocks. 

Education 

David holds an MB,', [rom the Stern School of Business and a BA from \vesleyan University_ He has 

studied on exchange at The Sorbonne, Ecole des Haute Etudes Commerciales and The Stockholm 

School of Economics. 

Industry participation 

David has participated in the l\j'{SE's and National Venture Capital Association's Blue Ribbon 

Regional Task Force to explore ways to help restore a vibrant 11'0 market and keep innovation 

flourishing in the United States, and is Chairman of the International Stock Exchange Executives 

Emeriti (ISEEE) Small Business Financing Crisis Task Force. He served as Director of the National 

Investor Relations Institute's New York chapter and Helium.com (sold to RR Donnelly) and currently 

serves as a Director of Hanley & "\ssociatcs and as Chairman of the Board of Tuesday's Children, the 

non-profit that serves 9/11 families, first responders and their families. Da\'id testified before the 

CFTC-SEC Joint Panel on Emerging Regulatory Issues in the wake of the May 2010 "flash crash," and 

before the SEC i\dvisory Committee on Small and Emerging Companies on June 8, 2012. David is 

often in terviewed by the financial news media. 

@2012GrantThornton lLP. Ali rights r>1served. 
193 


76108.138

Hearing on market structure: Ensuring Qrderly, efficient, innovative and competitive 

markets for issuers and investors 

Publications 

Da"id and Edward Kim have co-authored a number of Grant Thornton studies, including Why "re fPO ... 

illlhe feU? in 2008, Released in the fall of 2009, Market ,rtrudlln! i,r call,ring the 11'0 aisi,f (updated by 

A1cu-ket Jtrnc/ure is ",iJNSina the fPc) airir - and more in 2010) and ~4 }J!ake~/~r Ltdl/or A1Jlni({l have been 

entered into the Congressional Record and the Federal Register, They also authored the chapter, Killi'Zg 

the Stock ,Market That l.L1id the Golden Eggs in the recent book on high frequency and predatory practices 

entitled, Brokm Markets, by Sal J\rnuk & Joseph Saluzzi, published in May 2012 by FT Press (Financial 

Times), 

@1012 G~nt Thornton LLP, All rights fe-served, 
194 


76108.139

on market structure: Ensuring orderty, efficient, innovative and competitive 

for issuers and investors 

About Grant Thornton LLP 

16 

Grant Thornton has an instinct for growth, and every day we help dynamic organizations unlock their 

potential for growth. Our clients are the entrepreneurial private businesses and public companies that 

will generate new jobs. And serving them includes bringing our best thinking to Congress - because 

we believe members should know all the options in order to make informed policy decisions that foster 

econolnic growth. 

The people in the independent firms of Grant Thornton International Ltd provide personalized 

attention and the highest quality service to public and private clients in more than 100 countries. Grant 

Thornton LLP is the U.S. member fum of Grant Thornton International Ltd, one of the six global 

audit, tax and advisory organizations. Grant Thornton International Ltd and its member firms arc not a 

worldwide partnership, as each memher fum is a separate and distinct legal entity. 

Grant Thornton LLP offices 

Alaska Illinois New Jersey Rhode Island 

~\nchorage Chicago Edison Providence 

Oakbrook Terrace Arizona NcwYotk South Carolina Schaumburg Phoenix .:\lbany Columbia 

Kansas Downtown California Texas \-Vicruta t\lidtown Irvine Long Island -Austin 

Los Angeles Maryland Dallas 

Sacramento Baltin'1ore North Carolina I Iouston 

San Diego Massachusetts Charlotte San ~\ntonio 

San Francisco Raleigh 

San Jose Boston-N Station Utah 

Boston-Fin Dist Ohio Salt Lake City 

Colorado \Xlcstborough Clncinn<lti Virginia Den .... er Cle>'eland 

Michigan ~ \.1exandria 

Connecticut Detroit Oklahoma ;'IeLean 

Gla:::tollbury Minnesota Oklahoma City Washington Tulsa Florida ;\finncapolis Seattle 

Fort Lauderdale Oregon 

?\fiami Missouri Portland Washington, D.C. 

Orlando Kansas City Washington, D.C. 

Tampa St.Louis Pennsylvania Wisconsin 

Nevada Harrisburg ,\ppleton Georgia Philadelphia 

~\tlanta Reno ;\Iadison 

l\lilwauk:cc 

f) 2012 Grant Thornton LlP. AU fights mserved, 
195 


76108.140

1.ld 
196 


76108.141

By Electronic Mail (rule-comments@scc.gov) 

Ms. Elizabeth M. Murphy 

Secretary 

Securities and Exchange Commission 

100 F Street, NE 

Washington, DC 20549-1090 

April 29, 2010 

Rc: Concept Release on Equity Market Structure: Release No. 34-61358: 

File No. S7-02-10 

Dear Ms. Murphy: 

The Securities Industry and Financial Markets Association ("SIFMA") I welcomes the 

opportnnity to comment on the Securities and Exchange Commission's ("SEC' or 

"Commission") concept release ("Concept Release") on equity market structure? We appreciate 

the timeliness of the Commission's review, and we are pleased to comment on the range of 

issues discussed in the Concept Release. including, among others, the performance of the equity 

markets, high frequency trading ("HFT") and undisplayed liquidity. It has been ten years since 

the Commission's last general review of the equity markets,3 and much has changed during that 

time. For example, there have been significant developments in the over-the-counter ("OTC') 

I The Securities Industry and Financial Markets Association ("SIFMA") brings together the shared interests of 

hundreds of securities firms, banks and asset managers. SIFMA!s mission is to support a stTong financial industry, 

Investor opportunity, capital fom13tion,job creation and economic grovvth, while building trust and confidence in the financial markets. SJFMA, with offices in New York and Washington, D.C., is the u.s. regional member of the 

Global Financial Markets Association (""GFMA"). For more information. visit www.sifma.org. 

2 Exchange Act ReI. No. 6lJ58 (Jan. 14,2010), 75 Fed. Reg. 3594 (Jan. 21.2010) ("Concept Release"). In addition 

to the Concept Release, the Commission has issued a number of proposals and adopted mles related to equity market 

structure during the pa,t months. See. e.g, Exchange Act ReI. No. 61595 (Feb. 26.2010), 75 Fed. Reg. 11232 (Mar. 

10,2(10) (adopting a short sale price test and other amendments to Regulation SHO); Exchange Act ReI. No. 61379 

(Jan. 19,20 I 0), 75 Fed. Reg. 4007 (Jan. 26. 20 I 0) (proposing risk management controls for broker-dealers with 

market access) ('"Market Access Release"); Exchange Act ReI. No. 60997 (Nov. 13.2009),74 Fed. Reg. 61208 

(Nov. 23. 20(9) (proposing rules regarding non-public trading interest); Exchange Act ReI. No. 60684 (Sept. 18, 

2009),74 Fed. Reg. 48632 (Sept. 23, 2009) (proposing a ban on flash orders); Exchange Aet ReI. No. 60388 (Jul. 

27,2009),74 Fed. Reg. 38266 (Jul. 31, 2009) (adopting various amendments imposing the so-called "close-out" 

requirement in Interim Temporary Final Rule 2041' of Regulation SHO). 

Sce Exchange Act Rei. No. 42450 (Feb. 23,2000),65 Fed. Reg. 10577 (Feb. 28, 2000) (requesting comment on 

issues relating to market fragmentation) ("Market Fragmt.:!ntation Release") . 

• p 
197 


76108.142

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 2 

market, including the registration of Nasdaq as a national securities exchange. There also have 

been dramatic improvements in information processing and communications technology, 

facilitating the development of new trading strategies, such as HFT. The growth of trading on 

un displayed liquidity venues, increased competition among trading centers and the resulting 

dispersion of order flow, Regulation NMS, and regulatory consolidation (e.g., the creation of the 

Financial Industry Regulatory Authority ("FINRA,,)4) all have contributed to a market that 

differs in numerous ways from that reviewed ten years ago. 

Notwithstanding generalizations to the contrary, SIFMA believes that the market structure 

changes discussed in the Concept Release cannot be universally characterized as favorable or 

unfavorable market developments. They are more complex in that they represent advancements 

for investors and the markets in some sense, yet they may also present issues in terms of certain 

national market system ("NMS") goals. The challenge is to recognize and realize the benefits 

offered by these developments while working to carefully address any associated, valid 

rcgulatory concerns. We believe the Commission should evaluate each of the issues presented in 

the Concept Release in light of its ability to promote key and distinct NMS goals: (1) eflicient 

pricing and best execution; (2) market liquidity; (3) market transparency; (4) fair and orderly 

markets; and (5) competition among markets and investor choice. 

Section I of this letter discusses SIFMA's views regarding thc current performance of our equity 

markets. Section II offers our comments on a number of market structure issues raised in the 

Concept Release, including HFT and undisplayed liquidity, among others. In addition to 

evaluating current equity market structure and the issues in the Concept Release, we believe it is 

important to take a longer-term look at the direction of the equity markets. Section III therefore 

sets forth suggested equity market goals and regulatory initiatives that market participants and 

regulators should work toward in the near future, including the need for additional market data 

reform to protect the interests of retail investors. We look forward to discussing our comments 

and any other issues with the Commission as it continues its market structure review. 

I. Equity Market Structure: Governing Principles and Current Performance 

A. Governing Principles 

Section IIA of the Securities Exchange Act of 1934 ("Exchange Act") sets out the principles of 

the NMS, all of which Congress deemed were to be achieved through a system of competing 

markets linked through technologyS These principles include: 

economically efficient execution of securities transactions; 

fair competition among brokers and dealers and between markets; 

4 FINRA was fonned by a consolidation ofthe enforcement ann of the New York Stock Exchange ("NYSE"), 

NYSE Regulation, Inc., and the National Association of Securities Dealers ("NASD") in 2007. See Exchange Act 

ReI. No. 56145 (Jul. 26, 2007), 72 Fed. Reg. 42169 (Aug. 1,2007). 

5 See H.R. Rep. 94-123, 94'h Cong., I" Sess. 50 (1975). 
198 


76108.143

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 3 

availability of quotation and transaction information; 

practicability of executing investors' orders in the best market; and 

an opportunity, consistent with economically efficient execution and the practicability 

of executing investors' orders in the best market, for invcstors' orders to be executed 

without the participation of a dealer. 6 

As the Commission has acknowledged, the various NMS goals may be difficult to reconcile at 

times. 7 For example, intermarket competition implies a greater dispersion of ordcr flow than 

might otherwise be the case in a centralized equity market and this, in turn, requires greater 

efforts by broker-dealers to achieve best execution. Similarly, the Concept Release raises 

questions regarding the aligned or contrasting interests of long-term investors and professional 

traders- the resolution of which may have policy implications in assessing how best to advance 

the NMS in any particular instance. 8 Notwithstanding these and other tensions, NMS goals 

clearly remain the touchstone in evaluating current market structurc. Restating them somewhat, 

SIFMA believes these NMS principles equate to ensuring that Commission regulations promote 

efficient pricing and best execution; facilitate market liquidity; promote market transparency; 

maintain fair and orderly markets; and preserve competition among markets so as to provide 

investors alternatives for meeting their financial objectives. 

In particular, SIFMA believes that robust competition and innovation are hallmarks of the US 

equity markets, and that regulation that unnecessarily limits competition dampens thc incentive 

to innovate. Instead, regulation should encourage fair competition among broker-dealers and 

among markets because such competition inevitably leads to greater choices for investors, which 

facilitates efficient pricing and best execution. As discussed below, we are concerned that 

regulation that functionally rewards market participants that have not kept pace with market 

developments by easing competitive pressures to perform efficiently and effectively in the 

marketplace will hinder further market development, stifle innovation, and disadvantage our 

markets and US investors in the global marketplace. 

B. Curreut Equity Market Structure 

Our current equity markets are characterized by efficient and effective linkages and healthy 

competition among markets and market participants. This is demonstrated not only by statistics 

cited in the Concept Release and other studies, described below, but also through the practical 

observation of the markets. For example, during the 2008 financial crisis, trading in the equity 

markets continued without a significant hitch, permitting investors to find liquidity even during 

this volatile period. This is in contrast to the liquidity freezes and instability tJ1at were evident in 

other markets (i.e., the credit markets) during that time. 

6 Exchange Act Section II A(a)(1 )(C), 15 USC § 78k-1 (a)(1 )(C). 

7 Concept Release at 3597. 

8 ld. at 3596. 
199 


76108.144

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 4 

The Concept Release discusses various trends that, in our view, affinn the strength of the equity 

markets. For example, the SEC notes a significant amount of order flow dispersion among 

various market centers, focusing on the dispersion of order flow of NYSE-Iisted companies in 

particular. 9 We view such order flow dispersion as a sign of healthy intennarket competition. 10 

The Commission also notes that execution speeds have improved significantly. This too, we 

believe, is a benefit to our markets as increased transaction speed is important to obtaining best 

execution in increasingly automated markets. In fact, among the more important outcomes of 

Regulation NMS were the elimination of the antiquated Intermarket Trading System ("ITS") 

rules and the enhancement of quote accessibility/firmness brought about by mandating that only 

automated quotes may receive trade-through protection. 

Other researchers have noted similar advancements in the equity markets. One study points out 

an increase in average daily traded volume ("ADTV") from three billion shares in 2003 to ten 

billion shares in 2009. 1 

J Average trade sizes have shrunk, perha~s due to the rise in algorithmic 

trading; however, bid-offer spreads are tighter than ever before. J Commissions also remain at 

low levels. Intennarket trade-through protection (the Order Protection Rule ("OPR"), Rule 611 

of Regulation NMS) has facilitated increasingly etlicient private linkages between trading 

centers - replacing the less etlicient ITS linkage. We also note that the Commission and FINRA 

are engaged in rulemaking that should provide additional enhancements to market 

transparency. JJ 

Although SIFMA believes today's markets are strong, there are areas which merit improvement. 

Market transparency continues to increase for institutional market participants, but SIFMA 

remains concerned about the disparate level of transparency afforded retail investors. While 

decimalization has reduced spreads to the benefit of all investors, it has, not surprisingly, led to 

decreased size at the national best bid and offer ("NBBO"). Institutional investors are more apt 

to have technology that allows them to aggregate size at a rapidly changing NBBO or to access 

" See, e.g., id at 3600; see also O'Hara, Maureen and Mao Ye, 1s Market Fragmentation Harming Market Quality? 

(Mar. 2009), 3-4, available at http://ssm.com/abstract~ 1356839 (discussing findings that market fragmentation does 

not appear to hann market quality). 

10 NYSE executed approximately 79.1 percent of the consolidated share volume in its listed stocks in January 2005, 

comparcd to 25.1 pcrcent in October 2009. Concept Release at 3595. 

1 I Angel, James J., Lawrence E. Harris. Chester S. Spatt, The Economics oJTrading in the 2 J sl Century (Feb. 23. 2010). 

5. available at http://www.knight.com/newsRoom/pdfs/EquityTradinginthe21stCentury.pdf. 

12 See O'Hara at 19, supra note 9; Concept Release at 360S, m. 60. 

!3 Additional information about the trading activity of alternative trading systems ("A TS"), if adopted, will add to 

the strength and efficiency of our equity markets. See Exchange Aet ReI. No. 60997 (Nov. 13,2009), 74 Fed. Reg. 

61208 (Nov. 23. 2009) (proposing regulation regarding non-public trading interest). However, as noted in our 

comment letter on that proposal. we believe the Commission can achieve its A TS transparency goals without risking 

harmful disclosure of confidential customer information through delayed, rather than real-time. reporting of ATS 

identity on trade reports. See Letter from Ann Vlcek. Managing Director and Associate General Counsel, SIFMA, 

to Elizabeth Murphy. Secretary, SEC, Feb. 18,20 I 0 (advocating delayed A TS trade reports to avoid harmful 

disclosure of confidential investor trading interest). The SEC has approved new FlNRA reporting requirements that 

reduce OTe trade reporting time from 90 to 30 seconds, which should improve market transparency in the near 

term. See Exchange Act ReI. No. 61819 (Mar. 31,2010); 75 Fed. Reg. 17806 (Apr. 7, 2010). 
200 


76108.145

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 5 

individual market data feeds that show depth beyond the NUBO, but these tools and private data 

feeds are available to retail investors to a much lesser extent. This is especially problematic as 

US investors increasingly arc managing their own portfolios, including investments for their 

retirement or their children's educational needs. Thereforc, it is becoming more important that 

all investors have access to quality market data at reasonable prices. In addition, as exchanges 

have become for-profit entities, it becomes critical that the Commission take steps to support 

technology benefits for all investors, particularly with respect to access to enhanced market data. 

We discuss market data issues in greater detail in Section lIl.D of this letter. 

As noted, SIFMA generally believes that our cquity markets are effective and robust. However, 

in addition to the concerns expressed immediately above, we recognize that certain markct 

practices have raised market efficacy or fairness concerns that nced to be evaluated and, based on 

the results of that evaluation, perhaps addressed. We discuss certain of these issues below. 

II. Current Market Structure Issues 

A. High Frequency Trading and Related Issues 

HFT is an cxample of technological and financial innovation that has generated both praise and 

strong criticism. We note that a variety of market participants employ HFT, ranging from those 

cngaged solely in proprietary trading (whether as a proprietary trading firm that mayor may not 

be a registered broker-dealer, a proprietary trading desk of a multiservice broker-dealer, or a 

hedge fund) 14 to broker-dealers that handle customer ordcrs. HFT is a type of trading, not a type 

of trader a distinction important to keep in mind when considering the various trading 

practices and tools often utilizcd in HFT. Not all market participants within a particular category 

(i.e., hedge funds, proprietary trading broker-dealers, etc.) engage in HFT, and therefore any 

regulatory initiatives designed to address issues raised by HFT should be targeted to the type of 

activity, rather than to the market participant, in order to achieve their objectives without 

unintended consequences. 

HFT provides significant liquidity to investors, including long-term investors. Passive marketmaking trading strategies of HFT traders, for example, generally involve the submission of 

nonmarketable resting orders that provide liquidity at specified prices. IS As the Commission 

notes, IIFT traders largely have rcplaced more traditional types of liquidity providers in the 

equity markets, such as exchange specialists and OTC market makers. 16 To the extent that HFT 

orders a significant portion of the overall number of orders in the market establish or 

supplemcnt the NBBO, they not only facilitate the trading objectives ofHFT traders, but also 

serve as a reference point for executions by other market participants. Moreover, certain 

strategies associated with BFT, such as arbitrage strategies, help bring such prices in line by 

identifying and capitalizing on disparities between related financial instruments in ditTerent 

14 Concept Release a13606. 

15 fd. at 3607. 

'" fd. 
201 


76108.146

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 6 

markets ~~ thereby facilitating pricing efficiency. More generally, HFT is representative of 

technological advancements and broader changes in the provision of liquidity in the market for 

instance, the migration from the single specialist system to the use of automated Designated 

Market Makers and Supplemental Liquidity Providers on the NYSE in recent years changes 

that, in our view, have improved the equity markets. 17 HFT also has enhanced competition 

among markets. US exchanges and market participants - as well as foreign exchanges have 

recognized these benefits and modified their trading infrastructures to accommodate HFT.18 

However, as HFT has increased, issues have arisen regarding the fairness ofHFT and whether 

such trading imposes an unreasonable amount of systemic risk on the equity markets. As 

discussed below, SIFMA believes there is a need for more disclosure about HFT and related 

issues. Such disclosure not only would provide market participants with more information 

related to an important market practice, but also would facilitate the Commission's efforts to 

appropriately regulate the markets. Similarly, we support the Commission's goal of enhancing 

risk controls related to market access, including HFT, although, as discussed bclow, significant 

issues need to be addressed with respect to proposed Rule 15c3~5. 

1. Co-Location, Individual Data Feeds, and BFT Trading Strategies 

a) Co-Location Arrangements 

Co-location arrangements involve the hosting of servers by an exchange, trading center, or third 

party in close proximity to the matching engine of the exchange or trading center with the goal of 

minimizing network latencies in the transmission and execution of orders. Market participants 

that are confident in the efficiency of communication technologies and execution facilities are 

likely to be more comfortable, from a market risk perspective, with submitting greater numbers 

of orders, in larger size and over a larger universe of stocks, than they might under less optimal 

conditions. To this extent, co-location arrangements benefit all investors. However, concerns 

have been raised that the ability of some firms to utilize co-location arrangements is 

fundamentally unfair to other market participants. Questions also have been posed regarding 

whether firms using co-location arrangements ought to be subject to regulatory obligations 

similar to those formerly attendant on specialists and market makers. Related issues include 

whether the speed at which participants are pennitted to access the markets should be controlled 

in a manner that provides more unifonnity among market participants. 

As an initial matter, SIFMA notes and agrees with statements in the Concept Release that 

exchange co-location arrangement~ arc and should be subject to the rule filing requirements of 

17 See Exchange Act ReI. No. 58184 (luI. 17,2008),73 Fed. Reg. 42853 (luI. 23, 2008) (creating the NYSE's New 

Market Model, including the creation of Designated Market Makers and the phasing out of the NYSE specialist); 

Exchange Act ReI. No. 58877 (Oct. 29, 2008), 73 Fed. Reg. 65904 (Nov. 5, 2008) (establishing the NYSE 

Supplemental Liquidity Provider Pilot). 

!8 See, e.g., Nina Mehta, High~Freqllency Trading Is a Tough Game, Traders Magazine Online News, Nov. 24, 

2009; see also, LSE Changes Tariffs for High Frequency Trading to Boost Volumes, Bloomberg Network (Apr. 22, 

20 I 0) (LSE noting that the changes arc" .... designed to encourage tighter spreads, greater depth of liquidity and 

improved execution likelihood on the order book to the benefit of all participants."). 
202 


76108.147

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 7 

Section 19(b) of the Exchange Act, including the requirement that such proposed arrangements 

must be determined by the Commission to be consistent with the Exchange Act before being 

approved. 19 Provided that co-location facilities are made available to exchange members and 

other persons using those facilities on fair and reasonable terms, including physical location 

within a facility, and pursuant to fees that are equitably allocated among members and other 

persons using those facilities, we do not view co-location arrangements as conferring an "unfair 

advantage" to firms that use them or as creating a "two-tiered" market. 20 Exchange members 

that have the capability and desire to enter into co-location arrangements pursuant to exchange 

rules that have been reviewed and approved by the SEC under the Exchange Act should be 

permitted to do so. 

We do, however, believe that added disclosure about co-location and other market access 

arrangements would be beneficial to market participants. Such disclosure might describe 

standard, high speed, co-location, or other means by which members may access an exchange or 

A TS, and provide market participants with details regarding the categories of market participants 

that use each means of access, the data capacity associated with each arrangement, and the 

quotation and transaction volume attributable to each arrangement. For example, the 

Commission could create greater transparency surrounding co-location arrangements by 

requiring exchanges that offer co-location services to disclose the number of market participants 

using co-location, the percentage of the exchange's orders, quotes, or executed transactions 

associated with co-location, and a general description of the activity of co-location users (i.e., 

number of messages per second, percentage of time at the NBBO, and activity in various tiers of 

securities). 

We do not believe, however, that firms engaging in co-location arrangements should have 

affirmative or negative obligations solely as a result of such arrangements. Co-location 

arrangements are unlike exchange specialist status (where, as the SEC remarks, specialists 

enjoyed unique time and space advantages on exchange floors 21 ) because they should be 

available to any firm willing to devote resources to entering into such an arrangement. Thus, we 

do not believe that participants in these arrangements should be required to accept affirmative or 

negative trading obligations. 

b) Direct Data Feeds and the Processing of Market Data 

Concerns also have been raised regarding whether it is fair that some market participants are able 

to use individual or direct market data feeds. Related questions include whether there should be 

"batch processing" or other measures to throttle the transmission of data in the markets in an 

attempt to level the playing field for data consumers, or whether data feeds should continue to 

disseminate as much information as is currently available. 

19 See Concept Release at 3610. 

20 Exchange Act Section 6(a)( 4), 15 USC § 78f(a)(4). 

21 Concept Relea,e at 361 I. 
203 


76108.148

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 8 

Restrictions on the availability of market data or the content and transmission speed of such data 

would be a significant step back for our markets, As recently as the adoption of Regulation 

NMS, the Commission acknowledged the utility that direct market data feeds provide to firms 

and investors in terms of providing prompt and, in many instances, more fulsome information 

about potential trading liquidity in a given market. 22 SIFMA believes that firms should continue 

to be able to use these direct market data feeds without any mandated delay to permit 

consolidated data to reach all users at the same time. Such a delay would slow the market to the 

transmission capabilities of a single plan processor and thereby reduce incentives for 

technological development, rather than encourage plan processors to update their systems to 

remain competitive in the market.~, Batch processing of orders would exacerbate this problem by 

basing data transmission speed on the capabilities of an even larger universe of market 

participants. 23 Slowing the flow of market information would impede price discovery and 

reduce the pricing efficiencies that we currently enjoy among markets. We believe slower 

markets also would present greater opportunities for gaming. Rather than considering an 

approach that would slow technology or progress, the Commission should consider approaches 

that make direct market data feeds available to a broader nniversc of market participants, 

including retail investors, on fair and reasonable terms, and that enhance the speed and content of 

consolidated market data. We discuss our views on this issue in Section IILD of this letter. 

It may, however, be appropriate for the Commission to give greater consideration to the manner 

in which direct market data feeds may be used by market participants. As noted, direct market 

data often is faster and more detailed than consolidated data. Also, direct data feed recipients 

generally are able to more easily trace orders they submit to an exchange or electronic 

communications network ("ECN") using such feeds facilitating, for exanlple, their ability to 

analyzc the implications of a particular trading strategy. But some SIFMA members believe that 

direct market data feeds may be used by third parties to generate more implicit information about 

the markets. For example, member firms state that direct market transaction information may be 

linked to particular displayed quotations and, in some instances, direct market data may be used 

to help discern the presence of reserve orders. As discussed below, SIFMA does not believe that 

the use of trading strategies uscd to identify potential liquidity in various markets, whether 

displayed or undisplayed, necessarily requires a regulatory response. However, it might be 

beneficial for market palticipants to have a better understanding of the ways in which their 

market data, if provided to a trading center publishing direct market data, might be used by other 

22 See Exchange Act ReI. No. 51808 (Jun. 9, 2005), 70 Fed. Reg. 37496, 37566-67 (Jun. 29. 2005) (authorizing the 

independent distribution of market data outside of what is required by the joint industry market data plans). 

2) Ironically, the Concept Release itself presents a compelling argument against restraints on communications 

technology. According to the release. the average speed of execution for small, marketable orders on the NYSE was 

10.1 seconds in 2005, compared to 0.7 seconds in October 2009. Concept Release at 3595-96. Had the Commission 

adopted an approach similar to the batch processing idea discussed in the Concept Release, execution speeds on the 

NYSE not only would have been less likely to have decreased, but also other markets presumably would have seen 

their execution speeds constrained based on the capabilities of the NYSE or other markets. It is difficult to 

understand the incentive any market would have to improve on such speeds under such an approach. 
204 


76108.149

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 9 

market participants. We urge the Commission to give further thought to this issue, inclnding 

whether it merits an empirical review. 

c) Trading Strategies 

The SEC raises a number of questions regarding HFT trading strategies, including whether the 

implementation ofparticnlar strategies bencfits or harms long-term investors and, if so, whethcr 

regnlatory initiatives are necessary to address such strategies. for example, the Commission 

asks whcthcr it should imposc a minimum requiremcnt on the duration of orders (such as one 

second) before they can be cancelled, either generally, in particular contexts, or when used by 

particular types oftraders, or whether the use of "pinging" orders by all or some traders to assess 

undisplayed liquidity should be prohibited or restricted in all or somc contexts. 24 We think any 

such attempts are ill-advised. 

We caution the Commission against hastening to categorize trading strategies as "bcneticial" or 

"harmful." In the tirst instance, absent clear fraud or manipulation, we believe that engaging in 

such line drawing on a broad basis is fraught with difficulties. For example, market participants 

have long been astutc to the possibility of other orders in the market that, if executcd, could have 

a serious impact on the value oftheir portfolios. Thus, strategies designed to anticipate the 

trading of other market participants are not novel concepts, and the ability to identifY buyers and 

sellers in the market absent fraud, manipulation, or a breach of duty - should not result in 

prohibitions on a strategy that aims to make such determinations. In addition, existing trading 

strategies, whether for IIFT or otherwise, will evolve in ways that inevitably will outpace 

regulatory efforts to categorize thcm, and entirely new trading strategies similarly will develop at 

a rapid pace. 

Rather than taking a path that will require it to engage in such line drawing, the Commission 

would better serve investors by: (I) relying on its general antifraud authority to address discrete 

situations in which market participants engage in fraudulent or manipulative activity, and (2) 

adopting rules that would facilitate the provision of more information about HFT strategies to the 

Commission. The Commission would, of course, have to consider the extent to which such 

disclosure might lead to information leakage or otherwise disadvantage market participants, and 

take appropriate steps to avoid such adverse consequences (such as rcquiring the disclosure for 

regulatory and not public consumption, or publishing information in aggregated rather than 

disaggrcgated form). In this regard, SIfMA looks forward to reviewing and commenting 

separately on the Commission's proposal for large trader reporting. 25 

SIFMA is leery of regulatory efforts that may overemphasize real or perceived distinctions 

between the interests of "long-term investors" and "short-term professional traders." 

Admittedly, investors have different time horizons in terms of their investment objectives. For 

" Concept Release at 3607. 

25 See Exchange Act ReI. No. 61908 (Apr. 14,2010),75 Fed. Reg. 21456 (Apr. 23, 2010)("Large Trader Reporting 

Release"). 
205 


76108.150

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 10 

example, an investor with a long time horizon generally is likely to be less concerned with shortternl volatility in a stock, whereas an investor with a short time horizon is apt to be more 

concerned about short-term price movements than the long-term performance of that stock. 

However, we believe that the interests of long-term investors and professional traders are, in fact, 

aligned more often than might be assumed and, where they differ, as described above, the nature 

of each investor's trading interest is not necessarily incompatible with the other. For example, 

the ability of a long-term investor to purchase or sell a security is dependent on available market 

liquidity, whether provided by long-ternl or short-term investors. As noted by the Commission 

itself, much of the liquidity in today's market - available to professional traders and long-term 

investors alike - is attributable to professional traders. 

2. Risk Management - Market Access 

SIFMA recognizes that the volume and rate of message traffic associated with HFT may pose 

enhanced financial, regulatory, and other risks to broker-dealers and trading markets. Therefore, 

as a general matter, we support the use of pre- and post-trade controls on market access, and the 

general principle underlying the SEC's proposed Rule 15c3-5 that such controls and procedures 

are appropriate in market access arrangements. However, if proposed Rule 15c3-5 is to be 

effective, certain significant, complex issues regarding market access must be addressed before 

the SEC adopts the rule. 

As discussed in greater detail in SIFMA's separate comment letter regarding the proposed rule,26 

we believe that proposed Rule 15c3-5 does not appropriately distinguish market access 

arrangements involving multiple broker-dealers, each of which undertakes a different role in a 

transaction. In certain circumstances, the broker-dealer providing market access may not be in 

the best position to control financial and regulatory risks associated with the relevant 

transactions, or financial and regulatory controls may already be assumed by other brokerdealers involved in the transaction. For example, an introducing broker-dealer may route its 

customer orders to an exchange through a broker-dealer that provides it access, and may clear 

those orders through a separate clearing broker. The SEC also should clarify that nothing in 

proposed Rule 15c3-5 precludes the continued application of self-regulatory organization 

("SRO") guidance that requires broker-dealers to apply risk controls and procedures to orders 

that are sent to non-exchange and non-ATS trading venues or to internal ATS venues. 

In addition, because many broker-dealers rely on third-party risk management technology, the 

SEC should clarify that a third-party vendor may control the underlying software of such risk 

management technology, so long as the broker-dealer is able to control the software's applied 

26 See Letter from Ann Vlcek, Managing Director and Associate General Counsel, SIFMA, to Elizabeth M. Murphy, 

Secretary, SEC (Apr. 16,2010) (regarding risk management controls for broker-dealers with market access). 

SIFMA's comment letter also asks the SEC to clarify certain issues regarding capital and credit thresholds required 

under the proposed rule, how broker-dealers can comply with the proposed CEO certification requirement, and that 

the SEC and SROs should examine finms with a view to improving procedures rather than treating any trading error 

as a violation of the rule per se, as well as to recognize in any adopting release the difficulty of and limits involved 

in monitoring for duplicate orders. 
206 


76108.151

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 11 

parameters and thresholds. Thc SEC also should clarifY that such permitted third-party software 

includes that provided by exchanges and ATSs,27 given that market centers currently do and 

should continue to playa significant role in monitoring risk management compliance. Market 

centers are particularly well suited to apply certain pre-trade controls to order flow, such as 

trading halts, clearly erroneous orders, and orders not reasonably related to the market. 

SIFMA also is concerned that the rule as proposed could be interpreted to require a firn1 

providing market access to have access controls and procedures reasonably designed to prevent 

the entry of orders that are manipulative or based on inside infonnation. The SEC should clarify 

that broker-dealers providing market access would not be liablc for regulatory requiremcnts only 

tangentially related to market access, such as margin, or violative behavior such as manipulative 

trading, insider trading, or other fraudulent activity. 

B. Undisplayed Liquidity 

Thc terms "undisplaycd" or "non-displaycd" liquidity are uscd to encompass a wide variety of 

trading interest. Non-displayed trading interest includes some exchange and ECN orders 

(including exchanges and ECNs that permit members or subscribers to limit the display of some 

or all of the quantity of an order), AI'S orders (ATSs accept orders that are not displayed to 

subscribers or non-subscribers), working orders of buy side or institutional investors, and 

working orders and capital commitment trades of broker-dealers. Displayed liquidity, on the 

other hand, includes the consolidated quote and the NBBO, quotes on the Alternative Display 

Facility ("ADF"), and depth of book data offered by certain market data vendors or exchanges 

and ECNs that shows all ofa market center's bids and otlers.28 As the SEC is aware, nondisplayed liquidity venues often arc used by market participants seeking to avoid adverse market 

impact when executing their trades. 

SIFMA does not believe the evidence demonstrates that the availability of non-displayed 

liquidity venues has, in tact, impaired priee discovery or execution quality. To the contrary, as 

described above, display markets remain healthy. We note, for instance, the prevalence of very 

narrow spreads in NMS stocks, indicating that effective and efficient price discovery is occurring 

in the public markets. 29 In addition, by protecting the top of book of trading centers, the OPR is 

an effective supplement to the duty of best execution in policing cxecution quality. Such studies 

also indicate there have been improvements in dcpth of book display beyond the NBBO.30 

27 For example, the NYSE's Risk Management Gateway, at 

http://wv.w.nyse.comitechnologies/tradingsolutions/I22787066970I.html. 

28 Sec SlfMA paper on Displayed and Non-Displayed Liquidity, Aug. 3 1,2009, at wv.w.sifma.org. 

29 See O'Hara at 19, supra note 9 ("In the post-Reg NMS world, effective spreads are extremely low, with average 

spreads in the 3-4 cent range. Turning to our specific hypothesis, the data show that effective spreads are lower in 

the fragmented sample on average by .29 cents with median spreads lower by .11 cents."). 

30 Sec Angel at 15, supra note II. Notwithstanding these research findings, as discussed herein, SIFMA believes 

that steps ean and shonld be taken to extend the benefits of enhanced market data to retail investors at a reasonable 

cost, 
207 


76108.152

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 12 

These trends have occurred conCUlTent with the growth of A TSs - which have olTered significant 

opportunities for price improvement to their end users, including firms representing retail 

investors - as a percentage of all non-displaying liquidity venues. We note that some market 

participants have identified recent empirical evidence suggesting a possible migration trend in 

execution volumes from displayed to non-displayed markets,3! but that the most recent studies 

we have seen do not discuss any adverse market impact resulting from this trend. We note also 

that, given the changes in the markets as a result of non-displayed liquidity, there is no CUlTent 

evidence to suggest that non-displayed liquidity would become displayed liquidity should the use 

of non-displaying trading venues be restricted. Nevertheless, we encourage the SEC to conduct 

its own study on whether these obscrvations are representative of longer telTll material changes, 

and, if so, whether thcy have a dctrimental impact on market quality. 

C. Trade-At Proposal 

The Concept Release asks whether, if commenters believe that the quality of public price 

discovery has been harmed by non-displayed liquidity, the Commission should considcr a "tradeat" rule. Such a rule would prohibit any trading ccnter from executing a trade at the NBBO 

unless the trading center was displaying that pricc at the time it received the incoming contraside order. The trade-at rule would require a trading center not displaying at the NBBO at the 

time it received an incoming marketable order either to execute the order with significant price 

improvement (e.g., the minimum allowable quoting increment), or route intermarket sweep 

orders ("ISOs") to the ful~ dis~layed size ofNBBO quotations and then execute the balance of 

the order at the NBBO pnce. 3 

SIFMA strongly opposes the concept of a trade-at rule. Initially, and in response to the 

Commission's threshold question, such a rule is not walTanted given the health of our markets 

(described above) and, importantly, the absence of compelling evidence that non-displaying 

trading venues are impairing public price discovery. A trade-at rule would likely lead to a 

deluge of additional message traffic and increased incidence of flickering quotcs. The added 

costs to trading centcrs and broker-dealers would likely be significant and it is not clear that the 

anticipated benefits of additional quotes at the insidc would outweigh them. 

We also believe that a trade-at rule would have significant adverse consequences for investors, 

and retail investors in particular. Competition with respect to other best execution factors - such 

as market depth, reliability, and liquidity guarantees would fall largely by the wayside under a 

trade-at rule that effectively dictates the manner in which broker-dealers must trade. For 

liSee, e.g., Rosenblatt Securities Inc., Trading Talk: Market Structure Analysis & Trading Strategy - LeI There Be 

Light (Apr. 27, 2010) (indicating that non-displayed trading volume has increased while displayed trading volume 

has decreased during February and March, 2010); compare Erik SiITi, Keynote Speech at SIFMA 2008 Dark Pools 

Symposium (Fcb. 1.2008), at http://www.sec.gov/news/spceehl2008/spch020108ers.htm 

("The bottom line is that the volume percentage of dark pools of liquidity operated by dark A TSs and broker-dealer 

intemalizers has remained [the same] ... "), 

32 Concept Release at 3613. 
208 


76108.153

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 13 

example, broker-dealers executing orders internally currently may provide a customer with laster 

executions along with opportunities for price improvement. By contrast, a trade-at rule might 

instead require that same order to be routed out, both slowing the execution of the customer's 

order and, potentially, causing the customer to miss the market and lose the opportunity for price 

improvement. In addition, a broker-dealer routing an order to an away trading center may well 

incur additional costs in the form of fees for accessing the liquidity of the away market. These 

fees, ultimately, may be passed on to customers. Price competition among trading centers would 

be significantly hindered by a trade-at rule. A trade-at rule would require certain quotes to be hit 

in various trading centers, which in turn would reduce the incentive for trading centers to provide 

lower cost executions by, for example, lowering access fees. 

More fundamentally, a trade-at rule would stifle innovation, making it less feasible for new 

business models that have been introduced into the markets during the last decade to exist, to the 

detriment of all investors. For example, the rule would significantly impact the ability of 

investors, including long-term investors, to use non-displaying trading venues to handle sensitive 

order flow. The requirement that such a trading venue offer price improvement at least in the 

amount of the minimum increment to execute orders when the operator of the venue is not 

quoting at the NBBO would be difficult to meet given that many stocks trade in penny 

increments. Alternatively, the routing ofISOs to the full displayed size ofNBBO quotations 

would subject such venues to access fees in away markets and significantly reduce the ability of 

non-displaying venues to offset customer orders. 

Routing under a trade-at rule also might increase the chance of information leakage, signaling to 

other market participants the possibility of additional order flow at the non-displaying trading 

venue, thereby disrupting attempts of institutional investors to reduce implicit costs associated 

with large orders. While order routing is required in some circumstances under the OPR, the risk 

of information leakage is ameliorated somewhat by the promotion of the regulatory policy of not 

allowing a better priced limit order to be bypassed, and thus the fact that the routed order 

receives a better price as a result of the routing. In addition, investors who prefer not to have 

their orders displayed or routed could miss execution opportunities should potential contra-side 

liquidity have to be rouled away to comply with a trade-at rule. 

In sum, a trade-at rule would have detrimental effects on the speed and cost of executions, the 

liquidity currently available in the market, and the ability of investors to control their trading 

interests. It would undercut best execution by dictating a particular manner of trading, which we 

think is wmecessary given the recent performance of the equity markets. In doing so, the rule 

would extend well beyond even the OPR in its clear preference of investors who display orders 

over investors who decide it is in their best interest not to display some or any of their orders -

even if they may be willing to execute at the same price as the displayed markets. In this respect, 

a trade-at rule comes very close to a consolidated limit order book or "CLOB." Both would 

negate the competitive benefits of dispersed order t10w and unnecessarily impede investor 
209 


76108.154

Ms. Elizabeth M. Murphy 

April 29. 2010 

Page 14 

choice. We note that the SEC has considered a trade-at rule or CLOB in the past and determined 

that such restrictive trading measures were unnecessary 33 

D. Potential for Sub-Penny Pricing 

Noting that a penny spread on a low-priced stock provides a greater incentive for internalization, 

the Commission asks whether it should consider reducing the minimum trading increment under 

Rule 612 for low-priced stocks. Currently, Rule 612 precludes exchanges, associations, ATSs, 

and broker-dealers from displaying, ranking, or accepting bids, offers, or orders in NMS stocks 

in prices less than a penny if the bid, offer, or order is priced equal to or greater than one dollar 

per share. Conversely. market participants may display, rank, or accept bids, offers, or orders 

priced less than one dollar per share in increments as small as $0.000 1. 

SIFMA continucs to believe that quoting in sub-penny increments would not contribute to the 

maintcnancc of orderly markets. Sub-penny pricing would encourage market participants to 

"step ahead" of competing limit ordcrs by submitting an order with an economically insignificant 

price enhancement to gain execution priority. Currently, in order to step ahead of a competing 

limit order, a market participant needs to post an order for 100 shares at a full penny better than 

the existing order. This offers a full dollar of price improvement to the putative liquidity taker of 

a round lot and provides meaningful economic value in order to achieve price priority for 

incoming market orders. If sub-penny quoting wcre pennitted, for example, such that an order 

could step ahead bascd on a price only .001 higher than a competing order, the resulting price 

improvement would be only ten cents. SIFMA believes that attaining priority for such a low 

amount would reduce the incentive for liquidity providers to publish limit orders. It also would 

negatively impact the utility of order priority rules such as the OPR. Increasing the number of 

pricing points at which market participants may trade and, as a related matter, reducing the costs 

associated with gaining price priority to a level that is not meaningful predictably will lead to 

even greater amounts of orders and flickering quotes in today's automated trading environn1ent. 

Sub-penny pricing also would decrease the depth available at the best displayed prices, rendering 

the NBBO less effective in reflecting true trading interest. Decreased depth at each price in turn 

would require multiple transactions at multiple prices to complete an order, which would 

increase tl1e cost and difficulty of completing a trade. 

In addition, sub-penny pricing would pose both operational risks and technological challenges. 

The ability of finns to enter prices to three or more decimal places increases thc likelihood of 

human error with very little pricing advantage gained, creating additional operational risk. We 

also assume that sub-penny pricing would be pennitted, if at all. for a subset of securitics 

detennined by price, volume, available liquidity, or other factors. Pennitting a greater degree of 

sub-penny quotations for such a subset of securities and taking into account tl1ese various and 

potentially variable factors would require significant systems recoding, increasing both 

operational risk and cost for all market participants without providing conunensurate significant 

price improvement. The proliferation of quotes also would create systems capacity problems 

for instance, it would be difficult to view and keep track of quotes if the number of quotes 

See Market Fragmentation Release at 10587-88. 
210 


76108.155

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 15 

available in a given stock increased by a factor often. SIFMA notes that, in the options markets, 

for example, the data rates increased so significantly in the options penny pilot that options 

exchanges needed to dcvelop quote mitigation strategies to limit thc amount of data generated. 34 

Sub-penny pricing also has implications in light of the existing "maker-taker" fee structures of 

various markets, discussed below. Sub-peJll1Y pricing would be particularly problematic in the 

event market participants were to cam maker-taker rcbatcs in excess of the spread for a stock. 

Such a fee structure could incentivizc market participants to aggressively place ordcrs in 

expectation of collecting a rebate without regard to the quality of the execution received. Thus, 

should the Commission consider sub-penny pricing for stocks priced higher than onc dollar, it 

also nccds to cousider access fees and maker-taker rebate incentives and their potential effect on 

rebate arbitrage and execution quality. 

E. Maker-Taker Pricing/Rebates, Access Fees, and Liquidity Fees 

Some SIFMA members have expressed concern that market pricing models and rebates have had 

a significant impact on market structure and should be studied further by the Commission. For 

example. concerns have been raised that "makcr-taker" pricing subsidizes professional traders 

using co-location and direct data feeds at the expense of retail and long-term investors. It 

appears that the bulk of the maker-taker rebates for addinli liquidity are paid to firms engaged in 

HFT. A high rebate often implies a higher taker charge,3. which is in tum paid by long-term 

investors either directly, or indirectly through increased costs on their executing broker-dealers 

that. ultimately, are passed through to them. Maker-taker pricing also has been said to distort 

economic spreads. For instance, for stocks trading in penny increments, a taker fee can represent 

up to a 50-60 percent mark-up from displayed prices. As a result, broker-dealers increasingly 

spend signiticant resources analyzing the impact of taker fees on execution quality. In order to 

allow for an objective assessment of this and related issues, SIFMA believes the Commission 

should conduct a study regarding the impact of maker-taker pricing on order routing, execution 

practices, and market quality. 36 

The Concept Release notes that retail order flow typically is sent to OTC market makers 

pursuant to payment for order flow ("PFOF") arrangements. 37 SIFMA does not believe that 

PFOF arrangcments are the primary drivers of routing decisions; instead, we believe that routing 

34 See. e.g., Max Bowie, Is Sub-Penny Pricing Just Common Cents? (Feb. 1,20 1 0). See also Exchange Act ReI. No. 

55162 (Jan. 24,2007),72 Fed. Reg. 4738 (Feb. 1,2007) (approving proposed changes to AMEX rules regarding the 

option penny pilot, including a quote mitigation proposal); Exchange Act ReI. No. 55156 (Jan. 23, 2007), 72 Fed. 

Reg. 4759 (Feb. 1,2007) (approving proposed changes to NYSE Arca rules regarding the option penny pilot, 

including a quote mitigation proposal). 

35 However, as the Commission notes, a trading center may have an inverted pricing structure, paying a liquidity 

rebate that is higher than its access fee. Concept Release at 3599. 

36 As part of this study, the Commission might consider a pilot program that would consist of stocks across varying 

price levels that could be traded only without the provision of rebates to determine the impact liquidity rebates may 

have on order routing, execution practices, and market quality. 

37 Concept Release at 3606. 
211 


76108.156

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 16 

decisions morc oftcn are based on thc OPR and othcr factors associated with particular trading 

venues, such as rcbatcs and access fees. We also note that OTe market makers often are able to 

otler price improvement to small orders. That said, SIFMA recognizes that the total amount of 

PFOF paid to firms per ycar is not immaterial, and that it may make sense for thc Commission to 

study whether such arrangcments have had an impact on exccution quality for investors. 

F. Market Quality and Order Routing Data: Rules 605 and 606 

The Commission has asked whether Rules 605 and 606 continue to provide useful information 

regarding thc quality of order execution by market centers38 and the routing of customer orders 

by broker-dealers, or whether these Rules need to be modified given changes in the markets 

since their adoption. More specifically, the Commission asks whether individual investors 

understand and pay attcntion to Rule 605 and Rule 606 statisticsJ9 SIFMA believes that, in their 

current form, neither of these rules provides useful and meaningful comparative information to 

market participants, particularly individual investors, or regulators, and that the rules should be 

either modified or rescinded in light of market developments. 

Rule 605 was adopted to improve public disclosure of thc quality of executions afforded to 

orders by market centers 4D The Rule requires monthly reports by market centers that include 

information about a market center's quality of executions on a stock-by-stoek basis, including, 

among other statistics, how market orders of various sizes are executed relative to the public 

quotes, as well as information about effective spreads (the spreads actually paid by investors 

whose orders are routed to a particular market center). The Rule also requires market centers to 

disclose the extent to which they provide cxecutions at prices better and worse than the NBBO to 

investors using limit orders. 

One clement of Rule 605 that should be amended is the timeframe by which execution quality is 

measured. Currently, Rule 605 reports require disclosure of execution time in tranches measured 

in whole seconds. In the current equity markets, in which executions occur in milliseconds if not 

microseconds, whole second execution quality measurcs do not provide useful information 

regarding execution speed. For instance, we understand that the Rule 605 reports of some 

market centers list their execution speed as "zero seconds" while others list execution speed at 

one second due to rounding for purposes of the Rule. Therefore, Rule 605 should be amended to 

take into account today's sub-second execution speeds in ordcr to provide useful execution 

quality information. 

Similarly, benchmarking w1der Rule 605 has become more complicated in recent years. Industry 

vendors conducting Rule 605 analyses typically basc their benchmark on consolidated market 

38 Exchangc Act Rule 600(b )(38) defines a market center as an exchange market maker, aTC market maker, A TS, 

national securities exchange, or national securities association. 17 C.F.R. §240.603(c). 

39 Concept Release at 3605-06. 

40 See Exchange Act ReI. No. 43590 (Nov. 17,2000),65 Fed. Reg. 75414 (Dec. 1,2000) ("605 and 606 Adopting 

Release") (adopting Rules llAc1-S and 11 AcI-6, renumbered pursuant to Regulation NMS as Rules 605 and 606, 

respectively). 
212 


76108.157

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 17 

("SIP") data, whereas broker-dealers submitting execution data, including time, often use dircct 

market data that does not have the same latency as the SIP data. The Rule 605 vendors thcn 

compare the data provided by broker-dealers with the SIP data, resulting in information likely to 

bc inconsistent. As a result, Rule 605 should have data parameters in placc to ensure more 

uniform benchmarking and analyses. 

In addition, SIFMA is concerned about the possible disparate treatment of marketable orders in 

displaying and non-displaying trading venues for Rule 605 purposes. We recognize that the 

Commission has issued guidance regarding what constitutes a "covered order" for purposes of 

Rule 605 reporting, and with respect to the exclusion from Rule 605 of special handling orders, 

in particular. 41 However, we think there may be some confusion among broker-dealers regarding 

whether or not resting orders routed to non-displaying trading venues must be included in Rule 

605 reports. 42 As a result, Rule 605 data may not reflect consistency in the treatment of covered 

orders. The Commission should consider providing additional guidance on what constitutes a 

covered order that takes into account changes in trading practices to promote more consistent 

Rule 605 data. 

Similarly, there appears to be confusion among market participants about how certain types of 

orders should be treated for Rule 605 purposes -- for instance, whether all orders in securities in 

which a broker-dealer makes a market should be reported (regardless of whether the brokcrdealer acted as a market maker in the specific transaction reported), whether both proprietary and 

customer orders should be reported, or whether, for large size orders, only "parent" or both 

"parent" and "child" orders should be reported. Therefore, Rule 605 should be modified to 

clarify the types of orders that are within its ambit to ensure that Rule 605 requirements are clear 

to market participants and that Rule 605 data is consistent and useful to routing broker-dealers 

and investors. Also, as noted above, market access fees have become a significant focus in order 

routing determinations. SIFMA believes that statistics regarding access fees and liquidity 

rebates would be useful as part of Rule 605 disclosures. 

To the extent the SEC believes Rule 605 data, as modified to address the issues noted above, 

provides useful information regarding order execution quality, the data might be presented in a 

form that is more meaningful to investors. While we are cognizant that a primary purpose of 

Rule 605 data is to facilitate order routing determinations by broker-dealers, investors 

incrcasingly have more input into routing decisions whether via sponsored access arrangements 

or otherwise. A more "user friendly" format for execution quality statistics would be helpful not 

4l See, e.g., 605 and 606 Adopting Release at 75421-22; SEC Division of Market Regulation: StaffLegalllullelin 

No. 12R (Revised): "Frequently Asked Questions About Rule I I Acl-5," FAQ 5, available at 

htlp:llwww.sec.gov/intetps/legallslbimI2a.htm (explaining that "[t]he definition of covered order in paragraph (a)(8) 

oftbe Rule does not specifically identify every type of order that may fall within the "special handling" exclusion. 

In general, any market or limit order for which the customer requests a type of handling that may preclude the order 

from being executed promptly at the current market price at the time of order receipt (subject only to a limit price) 

would qualifY for the special handling exclusion and not be covered by the Rule."). 

n For instance, depending on the availability of contra-side orders in a non-displaying trading venue, marketable 

orders in such trading venues may not be executed for significant periods of time. Some firms have expressed 

uncertainty aboul whether such orders fall within the special handling exclusion. 
213 


76108.158

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 18 

only for institutional investors, but also would aid retail investors seeking to bettcr understand 

the routing decisions of their broker-dealers. 

Rule 606 was adopted to im~rove public disclosure of broker-dealer practices with respect to thc 

routing of customer orders. 4 Rule 606 requires brokcr-dealers that route customer orders in 

equity and option securities to make publicly available quarterly reports that, among other things, 

identify the trading venues to which customer orders are routed for execution. In addition, 

broker-dealers are required to disclose to customers, on request, the venues to which their 

particular orders were routed. Finally, the rule requires broker-dealers to disclose the material 

aspects oftheir relationships with each executing venue, including any PFOF or profit-sharing 

arrangements. 

As with Rule 605, SIFMA is concerned that Rule 606 statistics no longer providc meaningful 

information to investors about order routing decisions. The primary reason is that order routing 

practices now are largely driven by the OPR and the rcquirement to fill protected quotations. In 

addition, and unlike when Rule 606 was first adopted, there is now a significant amount of 

"pinging" activity using immcdiate-or-cancel ("IOC") orders. The practice of pinging makes it 

difficult for customers to discern when a broker-dealer has routed IOC orders to find potential 

liquidity from when customer limit orders are routed to post liquidity in a trading center. 

Although, as noted elsewhere in this letter, we do not believe pinging is detrimental to thc 

markets, thc changes in market routing practices renders Rule 606 inadequate t(lr providing 

information to investors about actual order routing decisions. We do believe that therc is value 

in disclosing broker-dealers' potential conflicts of interest regarding order routing, but such 

disclosure could be provided by means other than Rule 606 reports, such as through other 

disclosure on broker-dealer websites. 

III. Suggested Regulatorv Initiatives 

SIFMA believes that, going forward, the equity markets should be characterized by the same 

underlying principles that have led to the development ofthe current NMS: the existence of 

multiple, competing markets; efficient and effective linkages; the availability of varying forms of 

market data; and continued technological and financial innovation. We note, however, that 

certain specific improvements to the current market structure will be necessary to maintain 

strong, efficient, and effective equity markets. 

A. Consolidated Audit Trail and Large Trader Reporting 

SIFMA understands that the Commission currently is considering the utility of a consolidated 

audit trail, and we respectfully urge the Commission to make this a regulatory priority in the near 

future. A consolidated audit trail would be a significant step in improving oversight of the 

markets. Although FINRA's Order Audit Trail System ("OATS"), the NYSE's Order Tracking 

System ("OTS"), and the ability ofthc Commission to seek Electronic Blue Sheets ("EBS") 

provide useful audit trail information. they do not provide regulators the benefits of a 

41 See 605 and 606 Adopting Release. 
214 


76108.159

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 19 

consolidated audit trail. An efficient, harmonized, and market-wide regulatory audit trail would 

eliminate redundancy among the various SRO audit trail and surveillance requirements and 

systems. It also would allow better oversight ofthe markets as a whole, thereby helping to 

reduce overall market risk. 

In order to be effective, a consolidated audit trail should have a single system administrator and 

permit market participants to report order and transaction information once, which viOuld 

improve reporting efficiency and provide the administrator a holistic view of market activity. 

This would allow regulators to better monitor market activity and address discrete regulatory 

issues. An effective consolidated audit trail would entail uniform reporting rules among SROs 

and mandatory information sharing among SROs to provide consistency and reporting 

efficiency,4.\ 

SIFMA intends to submit a separate comment letter on the SEC's large trader reporting 

proposal,45 but believes that the proposal raises many of the issues discussed above regarding a 

consolidated audit trail and that these are worth raising, albeit briefly, in this letter. While 

SIFMA supports the concept of large trader reporting, we believe that the Commission's large 

trader reporting proposal should be part of the process of creating a consolidated audit trail, 

rather than a separate and preceding process that will shift regulatory focus and market 

participant resources away [i'om a consolidated audit trail process. For example, we do not think 

it is productive to devote industry time and resources to what SIFMA believes will be a 

complicated and lengthy process of enhancing the EBS system and current EBS reporting to 

accommodate the proposed rule. Instead of undertaking this task, we believe it would be much 

more beneficial for the Commission and the industry to work toward the more critical goal of 

establishing the consolidated audit trail. 

If the Commission believes that large trader reporting should be a near-term regulatory objective, 

SIFMA recommends alternative means of accomplishing that goal that will require less time and 

resource commitment and allow regulators and market participants to focus on the larger and 

more significant goal of developing a consolidated audit trail. For example, one option would be 

to require large traders to self-report currently, obtaining MPIDs or other identifYing numbers in 

order to do so, which would provide the SEC with the information it needs without requiring the 

expensive and time-consuming enhancement of EBS. SIFMA continues to review the large 

trader reporting proposal and looks forward to providing more comments to the Commission in 

the near future. 

B. Increased Harmonization of Disparate Regulation and Compliance 

Oversight 

SIFMA believes that the current regulatory structure entails many conflicting or duplicative rules 

and regulations, regulatory initiatives, and systems programming demands. This places 

." For example, we expect that such a consolidated audit trail would incorporate relevant Trade Reporting Facility 

("TRF") reporting rules as well as the most effective elements ofthe OATS and OTS systems and the PBS system. 

45 See Large Trader Reporting Release. 
215 


76108.160

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 20 

unnecessary burdens on regulators and market participants alike, and poses a significant risk to 

market efficiency as well as meaningful investor protection. We recommend that the SEC, 

SROs, and other market participants undertake a comprehensive review of existing market 

structure and trading rules to identifY conflicting or duplicative requirements that could be 

hmIDonized or eliminated. 46 Although we commend FINRA and the NYSE for their work on a 

consolidated rulebook for the past few years, we believe that there are several trading rules that 

could be harmonized to provide better market efficiency without compromising investor 

protection. For example, the harmonization ofNYSE Rule 92 and FINRA's Manning Rule has 

been ongoing for several years, and SIFMA believes that a single rule in this area would be most 

effective and efficient. More generally, SIFMA believes that a single set of trading rules would 

be sufficient. 

In addition, the Commission, SROs, and firms must find ways to better coordinate and 

strcamline system programming demands associated with regulatory changes. For example, 

current programming demands facing market participmlts include FINRA's Related Market 

Center identifier, Nasdaq's sponsored access rule (as well as any other market access rules that 

are approved),47 short sale regulation requirements, including the newly-adopted price test,48 

FINRA's OTC consolidated quote facility,49 symbology changes, 50 and busincss-related 

progrmnming requirements such as the DirectEdge exchanges, the Nasdaq OMX PSX exchange, 

and the BATS exchange, all ofwhieh are scheduled currently to go livc in 2010. Systems 

changes have become increasingly complex, costly, and time consuming. Coordination among 

regulators and market participants with respect to technical specifications, implementation, and 

testing time periods would be a more rational and efficient approach to this urgent issue. Making 

coordination a higher priority would provide the Commission with a bctter sense of the 

capabilities of market participant systems and the sorts of programming changes feasible within 

reasonable time frames, which would enable it to better assess the programming demmlds of 

proposed SEC and SRO rulcmaking. We emphasize that the primary concerns regarding such 

programming issues arc capacity and the dedication of personnel necessary to systems 

46 See Letter from Ira D. Hammerman, Senior Managing Director and General Counsel, SIFMA, to Christopher Cox, 

Chairman, SEC, Nov. 25, 2008 (regarding SEC guidance concerning proposed rule changes filed by SROs); Letter 

from Marc E. Lackritz, President, SIFMA, to Jonathan G. Katz, Secretary, SEC, Mar. 9, 2005 (regarding the SEC's 

SRO governance and transparency proposal and self-regulation concept release) (together, the "SRO Letters"). 

47 Exchange Act ReI. No. 61345 (Jan. 13,2010),75 Fed. Reg. 3263 (Jan. 20, 2010). 

48 See fn. 2. 

49 Exchange Act ReI. No. 60999 (Nov. 13,2009), 74 Fed. Reg. 61183 (Nov. 23, 2009). 

50 See, e.g., Options Clearing Corporation Information Memo #26905 (Jan. 25, 2010) (describing changes to option 

contract adjustment methodology and symbol conventions to become effective with the implementation of the 

Options Symbology Initiative); NYSE/Euronext Information Memo (Nov. 4, 2009) (annouucing NYSE AMEX's 

commencement of Nasdaq symbol trading and testing schedule); Nasdaq OMX Equity Trader Alert #2010·' (Jan. 

13,2010) (notifYing market participants of required changes to specifications regarding equity symbology in 

response to the NYSE's announced intention to begin listing and trading companies using 5-character root 

symbols.). 
216 


76108.161

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 21 

development and quality assurance to ensure that programming changes do not strain the 

capacity or functionality of the overall market structurc. 

SIFMA also believes the SEC should pursue greater global regulatory coordination. Given the 

vast array of regulatory and legislative initiatives in the US and other countries, it is critical that 

the collective impact of global economic growth be carefully considered, notwithstanding the 

merit of any individual measure. As SIFMA has previously stated, we are concerned about 

potential barriers to market entry, distortions to competition, and regulatory arbitrage that could 

result from the accelerated pace of regulatory and legislative reforms that are not considered 

together as part of a well-balanced and well-coordinated regulatory framework. 5 I 

C. Reliance on Empirical Data 

SIFMA believes that investors, market participants, and the Commission would benefit from 

greater efforts to ensure that regulatory proposals are sufticiently grounded in supporting 

empirical data. This is particularly the case to the extent proposed regulations would reduce 

investor flexibility. Such data should be made publicly available so that market participants 

including broker-dealers, investors, academics, and other interested parties have the 

opportunity to review it and provide more fully informed responses to proposed regulations. 

Basing regulatory proposals on such data will help engender market confidence in any resulting 

final rules among market participants and investors alike. For example, before proposing 

significant changes to the manner of trading available in displayed and non-displayed markets, 

the SEC should offer empirical data evidencing the underlying bases for key regulatory concerns 

- namcly, that public markets have been hanned by trading in non-displayed markets and that 

such harm outweighs the benefits offered to investors by non-displaying markets. 52 

As technology continues to evolve and impact market structure, increased use of empirical data 

will be critical to developing sound regulatory policymaking. In particular, the Commission's 

increased attention to the potentially diffcrent interests of long- and short-tenn investors requires 

greater clarity and evidence regarding where and how such interests, in fact, diverge. Where the 

Commission proposes to take regulatory action based on such differences, whether they be 

varying time horizons for investment gains or concerns about competitive advantages in the 

marketplace, such proposals should be rootcd in data regarding a measurable difference that 

exists to the detriment of long-term investors, and balancing that interest against competing 

market interests. 

Of coursc, we appreciate that the Commission typically solicits data from market participants 

and other commenters in the course of its rule proposals. However, the limited comment period 

associated with many of the Commission's proposed rules often is insufficient to assemble, 

assess, and provide data in timely comments. And, although empirical data provided in 

51 See SIFMA Press Release, SIFMA, AFME, and ASIFMA Support G20 Work to Take Stock and Assess Global 

Reforms, Prevent Regulatory Fragmentation, Increase FSB Transparency (Nov. 6, 2009), at www.sifma.org. 

" As discussed above, SIFMA does not believe there is sufficient empirical data regarding any negative market 

impact of non-displayed liquidity. 
217 


76108.162

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 22 

comments on the Commission's proposed rulemaking is useful, we think rulemaking would be 

more eiTective if the Commission were to conduct and publish more of its own empirical 

analysis before proposing rules. SIFMA notes that the Commission in the past has provided data 

to support its rule proposals, such as for Regulation NMS. 53 When such empirical analysis is 

conducted and data is made available by the Commission in support of its rulemaking, the 

subsequent discussion and analysis of the proposed rulemaking is more efficient and productive. 

D. Market Data Issues 

As a preliminary matter, SIFMA notes that retail investors, either acting in a self-directed 

manner or with the assistance of a financial adviser, must rely largely on consolidated market 

data when making investment decisions. This is not because retail investors do not want to see 

meaningful liquidity rather, it is because depth of book market data pricing generally is too 

expensive for the majority of retail investors. As a result, we believe it is vital that the 

consolidated market data currently available in the markets be significantly enhanced both in 

terms of the speed at which data is updated and transmitted, and in terms of the amount of data 

currently available. As discussed elsewhere in this letter, SIFMA does not believe that slowing 

the rest of the market and direct data feeds to the pace of consolidated data is an appropriate 

solution to disparities between retail and institutional investors' access to market data. Rather, 

the Commission should take steps to require or incentivize improvement in consolidated market 

data speed and depth without sacrificing the improvements made regarding the speed and depth 

of direct market data. 

In addition, SIFMA believes that there should be a reasonable relation between the costs 

associated with producing market data and the fees charged for that market data. We remain 

concerned about the lack of transparency in how such fees are detern1ined. 54 We note, for 

example, that the Concept Release data indicates the consolidated tape revenue is 32 times 

greater than expenses, and that expenses appear to be static or decreasing. 55 With faster and 

improved technology, market data fees should be trending downwards, rather than upwards. We 

believe cost-based market data fees subject to a transparent fee-setting process would result in 

lower market data fees. Such a fee-setting process should involve market participants and permit 

real challenge to the market data fees being proposed. In addition, we do not believe that market 

data fee rule changes should be permitted to be effective upon filing, and should instead be 

subject to a full notice and comment process. 

The Commission has stated in the past that it agrees that the level of market data fees should be 

reviewed and that, in particular, greater transparency concerning the costs of market data and the 

53 Concept Release at 3604, fu. 55. 

54 See Letter from Marc K Lackritz, President, SJA to Jonathan G. Katz, Secretary, SEC, Feb. 1,2005 (regarding 

Regulation NMS); SRO Letters, supra note 46. 

"Concept Release at 3601. 
218 


76108.163

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 23 

fee-setting process is needed. 56 Becausc these costs arc passed on to the end-user investor in one 

form or another, it is the investor who stands to benefit from such increascd transparency. We 

believe the Commission needs to address this issuc in the ncar future in order to bring market 

data fees in line with the true costs of providing market data. 

In order to achieve the market data goals discussed above, SIFMA believes that the SEC should 

facilitate greater competition regarding market data. One approach would be to establish a 

competing consolidator model for market data. Such a model would, for example, allow the 

individual SIPs to handle all symbols, and then permit each of them to compete on price and 

markct data performance aceording to defined metrics established to ensure market data quality. 

A competing consolidator model would incentivize SIPs to provide public market data in the 

most cost effective way, and ensure market data quality by requiring SIPs to compete for market 

share. It might even encourage the entrance of a new SIP not controlled by the exchanges. 

Alternatively, the Commission could amend the so-called display rule that requires SIPs and 

broker-dealers to Rurchase and provide consolidated market data to their customcrs at the point 

of trade decision,)7 and instead, or as an alternative, pern1it individual broker-dealers to purchase 

direct data feeds from exchanges and consolidatc the data themselves. Either approach would 

remove, in part, the government-mandated monopoly that each SIP enjoys today. putting 

pressure on the SIPs to improve their service, contain their costs, and begin to compete on price. 

Should the SEC not establish a competing consolidator model or amend the display rule as noted 

above, at a minimum, it should require a more harmonized approach on market data rules and a 

single unifonn agreement among tape associations to create a more efficient means of accessing 

public market data. Currcntly, the SIPs have differing regulatory and operational infrastructures 

that unnecessarily complicate market participants' access to their market data. For example, 

there is not a uniform market data agreement, so market data subscribers must use multiple and 

often differing agreements with market data providers. Such agreements may have multiple 

standards and definitions (e.g., what constitutes a "professional"), making coordination and 

compliance with the various standards difficult and time consuming in terms of persol1l1el and 

back otliee support. This effort could be significantly streamlined with more uniforn1ity among 

SIP requirements. 

* * * * * 

56 Exchange Act ReI. No. 50870 (Dec. 16,2004),69 Fed. Reg. 77424. 77461 (Dec. 27, 2004) (proposing Regulation 

NMS). 

"Exchange Act Rule 603(c), 17 C.F.R. §240.603(c). 
219 


76108.164

Ms. Elizabeth M. Murphy 

April 29, 2010 

Page 24 

SIFMA appreciates this opportunity to comment on the issues raised in the Concept Release, as 

well as to offer its thoughts on other market issues and market structure principles. We look 

forward to further discussions about specific regulatory initiatives and equity market structure 

more generally with the Commission and its staff. If you have any comments or questions, 

please do not hesitate to contact me at 202.962.7300. 

cc: Mary L. Schapiro, Chairman 

Luis A. Aguilar, Commissioner 

Kathleen L. Casey, Commissioner 

Troy A. Paredes, Commissioner 

Elisse B. Walter, Commissioner 

Sincerely, 

Ann Vlcek 

Managing Director and Associate General 

Counsel 

SIFMA 

Robcrt W. Cook, Director, Division of Trading and Markets 

James Brigagliano, Deputy Director, Division of Trading and Markets 

David Shillman, Associate Director, Division of Trading and Markets 

Daniel Gray, Market Structure Counsel, Division of Trading and Markets 
220 


76108.165

June 25, 2010 

By Elech'onic Mail (rule-commcnts(a;scc-gov) 

Ms. Elizabeth M. Murphy 

Secretary 

Sec uri tics and Exchange Commission 

100 F Street. NE 

Washington, DC 20549-1090 

Rc: Market SlIucture Roundtable: File No. 4-602 

Dear Ms. Murphy: 

The Securities Industry and Financial Markets Association ("SIFMA,,)i welcomes the 

opportunity to comment on the range of issues raised during the Securities and Exchange 

Commission's ("SEC" or "Commission") Market Structure Roundtable. The following 

comments add to and complemcnt the comments SIFMA has submitted on the SEC's recent 

market structure Concept Release" as wel! as the SEC's various market structure rule proposals. 

including those related to market aceess,3 non-public trading interest,4 consolidated audit trail,S 

and large trader rcporting6 We appreciate the Commission's commitment to improving the 

national market system, and look Jorward to a continued dialogue with the Commission as it 

examines the equity markets and their regulation. 

The Securities fnduslIy and Financial Markets Association ("SIFMA') brings together the shared interests 

of hundreds of securities finns, banks and asset managers. SIFMA's mission is to support a strong financial 

industry, investor creation and economic while building trust and 

the offices in New York and D.C., is the regional 

("fiFMA"). For more visit. 

Securities 14. (Jan. 21. 2010); Letter 

Ann Vlcek. SlFMA, to M. Murphy, rc: Market Structure (Apr. 2010) 

("SIFMA Concept Release Letler"). 

Securities Exchange Act ReI. No. 61379 19.2010),75 Fed. Reg. 4007 (Sept. 23, 

Ann Vlcek, SIFMA. to Elizabeth M. Murphy, re: Risk Management Controls for Brokers or 

Market Access (Apr. 16. lOIO) ("SIFMA Market Access Letler·'). 

Securities 

Ann Vlcek, SIFMA, to 

Securities 

Release"); SIFMA Letter at 

13.2009).74 Fed. Reg. 61208 (Jan. 23, 2009); Lettcr fi'om 

Regulation of Non-Public Trading Interest (Feb" 18,20 I 0). 

26,2010).75 Fed. Reg. 32556 (June 8, 2010) ("CAT 

14.20 I 0).75 Fed. Reg. 21456 (Apr. 23. 2010) 

M. Murphy, SEC fe: The Large Trader 

Letter"). 
221 


76108.166

2 

A. Preventing Price Gaps and Erroneous Trades 

The market disruption of May 6th highlighted the need to prevent price gaps and 

erroneous trades. The preliminary report CReport") of the Commission and the Commodity 

Futures Trading Commission ("CFTC") regarding the events of May 6th points to a variety of 

often inter-related potential causes for the "temporary. breakdown in the market's price setting 

function when a number of stocks and ETFs were executed at clearly irrational prices.,,7 We 

encourage the Commission to clarify the responsibility of trading venues to prevent price gaps 

and erroneous trades from occurring, thus reducing the need for declaring halts. 

1. Stock-by-Stock Circuit Breaker Rules 

The events of May 6th also highlighted inconsistencies regarding the circumstances in 

which trading may be paused in the various markets. The SEC responded quickly by approving 

stock-by-stock circuit breakers that pause trading in S&P 500 stocks across all U.S. equity 

markets for a five-minute period in the event that the stock experiences a 10 percent change in 

price over the preceding five minutes. 8 SIFMA supports these rules as a first step in addressing 

the structural issues highlighted on May 6th• However, we would encourage the SEC to ensure 

that all trading pause rules are the same across all markets going forward. 

a. Expansion of Stock-by-Stock Circuit Breaker Rules 

As noted, the stoek-by-stock circuit breaker rules are limited in scope, as they only apply 

to the stocks in the S&P 500. We encourage the SEC to act expeditiously - and in advance of 

the conclusion ofthe 6-month pilot period to expand the scope of the rules to other securities, 

particularly ETFs.9 In this regard. we note that ETFs experienced significant volatility on May 

6th and also would benefit [rom uniform pauses in trading. to We arc also concerned that, as the 

pilot is expanded to more symbols, the current circuit breaker parameters will not be appropriate 

for low priced securities. We therefore suggest that securities priced below $5.00 be excluded 

from coverage under the pilot. Finally. we support further analyses of the linkages between the 

various financial markets; specifically, the SEC should continue to work with industry 

participants to explore how circuit breaker trading pauses should be treated across related 

markets, including the options and futures markets. 

SEC Approves New Stock-by-S(ock Circuit Breaker Rules, SEC Press Release 20 I 0-98 (June 10,20 I 0) 

("Circuit Breaker Press Release'). 

Sec Securities Exchange Act ReI. No. 62251 (June 10,2010),75 Fed. Reg. 34183 (June 16,2010) 

(approval of FINRA single stock circuit breaker); Securities Exchange Act ReI. No. 62252 (June 10,20 10),75 Fed. 

Reg. 34186 (June 16,20 I 0) (approval of equity exchanges' single stock circuit breaker rules). 

See Circuit Breaker Press Release (stating SEC's intention to expand the circuit breaker rules to other 

securities). 

10 Preliminary Findings regarding tbe Market Events of May 6ili 2010, Report ofthe Staffs of the CFTC and 

SEC to the Joint Advisory Committee on Emerging Regulatory Issues (May 18,2010) ("May 6th Rep0l1") at 5-6. 
222 


76108.167

3 

b. Single Uniform Intermarkct Trading Pause Rule 

Various exehanges and FlNRA have or are contemplating their own unique volatility 

rules that would permit those markets to halt trading in their markets under circumstances other 

than those set forth in the recently adopted stock-by-stoek circuit breakcr rules. For example, the 

NYSE's trading system incorporates liquidity refreshment points ("LRI's"), which, when one is 

triggered, pauses trading for a time to permit additional liquidity to enter the market. 11 Similarly, 

Nasda~ has proposed expanding its Volatility Guard rules which arc similar to the NYSE 

LRPs. L SlFMA is concerned that, as noted in the SEC's preliminary report on the May 6th 

events, the imposition of disparate volatility rules may have the eflect of exacerbating, rather 

than dampening, price volatility since orders may bc routed to othcr, less liquid venues for 

immediate execution rather than waiting out the pause in trading. 13 In light ofthese concerns 

and the gcneral need for regulatory consistency, SIFMA believes that a single, uniform 

intermarket rule should govern such stock-by-stock trading pauses and that any market-specific 

volatility rules should be eliminated. 

2. Other Methods for Preventing Price Gaps and Erroneous Trades 

SIFMA encourages the SEC to cvaluate whether methods other than, or in addition to, 

trading halts would better serve the markets in limiting price gaps and erroneous trades. In 

particular, SIFMA believes that the tollowing approaches arc worth further consideration. These 

approaches would virtually eliminate the need to halt a security due to aberrant trading. 

a. Limit UplDown Approach 

The SEC should consider the benefits of a "limit up/down" approach to controlling 

trading during volatile markets, similar to that utilized in the futurcs markets. In the futures 

markets, certain instruments may only trade within established price bands that are based on the 

prior day's close, known as limit up and limit down. Applying this concept to the securities 

context, once a designated stoek price threshold is reached, trading could still continue but only 

within appropriate pre-set limits. Such an approach would largely eliminate erroneous trades and 

minimize the costs associated with interrupting continuous trading and denying market 

participants access to a continuous flow of market data during critical periods of time while still 

ensuring orderly market conditions. The key to the proper functioning of a limit up/down 

approach, of course, is the adoption of the correct trading band for various securities. We 

encourage consideration being given to establishing thresholds based upon market irequency 

(similar to the current single stock circuit breaker triggers) as opposed to using a static prior 

night's close. SIFMA encourages the Commission to compare the relative merits of this limit 

up/down approach with those associated with the use of circuit breakers. 14 

II 

12 

13 

See NYSE Rule 1000. 

See SR-NASDAQ-2010-0066. 

May 6th Report at 4. 

We note that, if implemented etfectively, the limit up/down approach would eliminate the possible need for 

market collars and the need to regulate stub quotes, as discussed below. 
223 


76108.168

4 

b. Collars on Market Orders 

As the SEC described in its Report, some of the most inexplicable executions on May 6th 

resulted from the use of markct orders during thc period of extreme volatility. IS As we saw, an 

unusually large influx of such orders can quickly usc up all available liquidity across all markets, 

resulting in orders breaking through many price levels in an effort to obtain an execution at any 

price. SIFMA does not believe that the SEC should prohibit the use of market orders; such 

orders remain a valuable tool for investors seeking immediate liquidity, notwithstanding the risks 

associated with their usc during volatile trading periods. However, the SEC should consider 

ways to minimize the risks related to the usc of market orders, including their potential to 

contribute to sudden price moves. In this regard, SIFMA encourages the SEC to pursue 

initiatives to educate investors about the risks of market orders. In addition, the SEC should 

consider whether the imposition of collars on market orders would provide benefits to investors, 

or would detract from the trading flexibility that investors currently enjoy. We note that, like the 

limit up/down approach, the efficacy of market order collars would depend on the ability to 

establish the correct benchmark for the collar. 

c. Stub Quotes 

Stub quote executions were another source of erroneous trades on May 6th• As nominal 

quotes entered by market makers to meet their two-sided quote requirements, stub quotes are not 

intended to indicate actual trading interest. As a result, SIFMA recommends the elimination of 

stub quotes. Instead, we would encouralfe the SEC to consider other auto-quoting mechanisms, 

including establishing collars on quotes, 6 or material incentives for market makers to maintain 

their quotes. 

B. Market-Wide Circuit Breakers 

None of the existing market-wide circuit breakers, which apply across all equity trading 

venues and futures markets, were triggercd by the events of May 6th We support the SEC staffs 

efforts to evaluate how the market-wide circuit breakers should be recalibrated to be effective in 

today's fast paced electronic trading envirorunent. In particular, the SEC should analyze how 

often the triggers have been hit, how often they should have been hit, and whether limitations on 

trading short of a trading pause may be beneficial under certain circumstances, and then 

introduce a reasonable proposal based on that data. Any modifications, however, should be 

coordinated between the securities and futures markets. 

15 W. at 75. 

16 In considering such measures, the SEC should evaluate the potential impact on message traffic in the 

marketplace to mitigate inefficiencies. 
224 


76108.169

5 

C. Market Center Obligations 

1. Accurate and Accessible Market Data 

SIFMA believes that it is critical for market centers to ensurc that their markct data is 

both accurate and accessible. Market centers should establish mechanisms for checking, 

verifying and reporting their market data. In doing so, they should have the means to handle 

their order flow so as to avoid rednndant prices and extraneous prints. Moreover, rules applying 

any clearly erroneous policy should be very limited; permitting tradcs at an inappropriate price 

causcd by preventable market data issues and addressing this problem by later breaking the trade 

should not be permitted. This is particularly troubling in light of the fact that, in many instances, 

trades do not occur in isolation. For example, broker-dealers may enter hedging or other 

oi1setting transactions based on another trade in both the equities and derivatives markets. Thus, 

breaking one aspect of such related transactions as clearly erroneous but not the other may have 

significant consequences for fimls. Finally, the market center's market data procedures should 

require the market center to pull its quote, or group of affected quotes when applicable (M., a 

given letter range), if the data becomes delayed, inaccessible or otherwise inaccurate. 

2. Clearly Erroneous Policies 

SIFMA supports the SEC's recent efforts to clarify the equity exchanges' and FINRA's 

processes for breaking erroneous trades.17 We applaud the decision to curtail the markets' 

discretion in breaking erroneous trades and to impose unifonn rules for breaking such trades. 

We urge the SEC, the exchanges and FINRA, however, to continue to work to ensure uniformity 

and consistency in the application of their clearly erroneous policies. In addition, we believc that 

the options exchanges should handle erroneous trades in a manner consistent with the equity 

markets. SIFMA looks forward to reviewing the SROs' recently proposed clearing erroneous 

trade rules. 

3. Invocation of Self-Help 

The SEC has identified the self-help remedy as another potential contributor to the May 

6th market disruption. 18 Exchanges are entitled to exercise the self-help remedy under the Order 

Protection Rule when another exchange repeatedly fails to respond within one second. A 

declaration of self-help frees the declaring exchange from its obligation to route orders to the 

affected exchange. The self-help remedy was invoked against NYSE Arca during the disruption, 

thereby further limiting the available liquidity (although the provision of liquidity may have been 

17 See Securities Exchange Act ReI. No. 62333 (June 21, 2010) (NYSE proposal); Securities Exchange Act 

ReI. No. 62331 (June 21, 2010) (NSX proposal); Securities Exchange Act ReI. No. 62336 (June 21, 2010) (CHX 

proposal); Securities Exchange Act ReI. No. 62337 (CBSX proposal); Securities Exchange Act ReI. No 62341 (June 

21,2010) (FINRA proposal); Securities Exchange Act ReI. No. 62334 (June 21. 2010) (NASDAQ Proposal); 

Securities Exchange Act ReI. No. 62330 (June 21, 2010) (ISE proposal); Securities Exchange Act ReI. 62340 (June 

21,2010) (BATS proposal); Securities Exchange Act ReI. No. 62338 (June 21, 2010) (EDGA proposal); Securities 

Exchange Act ReI. No. 62339 (June 21, 2010) (EDGX proposal); Securities Exchange Act ReI. No. 62342 (June 21, 

2010) (NASDAQ OMX BX proposal); Securities Exchange Act ReI. No. 62332 (June 21,2010) (NYSE Amex 

proposal). See also SEC to Publish for Public Comment Proposed Rules for Clearly Erroneous Trades, Press 

Release 2010-104 (June 17,2010). 

" May 6th Report at 5. 
225 


76108.170

6 

impaired in any event in light of apparent systcm issues at NYSE Arca). In light of the 

significant effect of declaring self-help - that is, thc loss of liquidity of an entire market, SIFMA 

encouragcs the SEC to carefully analyze how it could tighten the self-help process by imposing 

unifonn standards on when and how self-help may be utilized. For example, we would advocate 

more specific and unifonn standards for when a market may invoke self-help on its own behalf 

as well as when one market may declare self-help against another market. Additional procedures 

should govern, at a minimum, how long the self-help period will last, how markets should be 

contacted, how market participants should be alerted to self-help being invoked, and how the 

self-help period will end. Indeed, the SEC may wish to consider the value of independent 

evaluations of the accessibility of the exchanges' quotes, both in real-time as well as in 

connection with self-help dcclarations. 

4. Additional Market Center Disclosure 

SIFMA believes that market participants would benefit from additional disclosures from 

market centers about their trading arrangements and practices. Such information would provide 

valuable infonnation to market participants seeking to obtain best execution. 19 

5. A TS vs. Exchange Issues 

More reccntly, there have been discussions about the extent to which alternative trading 

systems ("ATSs") may have more flexibility to engage in various practices than national 

securities exchanges. SIFMA believes the SEC should consider this issue, as well as others 

involving the relative costs and benefits of exchange vs. A TS designation, and whether the 

balance between these market centers is appropriate or needs to be adjustcd. In doing so, the 

SEC should take into account differences between A TSs that operate as electronic 

communication networks, and those that operate as non-display trading venues. Moreovcr, any 

such assessment needs to be balanced and should not focus solely on benefits accruing to ATSs. 

We note, for example, that national securities exchanges receive significant bencfits not available 

to A TSs, including benefits related to the use and sale of market data, lower clearing costs and 

no net capital requirements. 

D. Market Maker Obligations 

1. Definition of Market Maker 

With the rise of high frequency trading, some have questioned whether the definition of a 

market maker should be expanded to include certain high frequency traders in light of some of 

the possible advantages such traders enjoy. As discussed in our comment letter on the SEC's 

Concept Release, SIFMA does not believe that there is a need to redefine a "market maker" at 

this time or to impose market maker obligations on high frequency traders. 20 It may, however, 

be useful for the Commission to consider how to better promote market liquidity by incentivizing 

market makers. 

19 For a more detailed discussion, see SIFMA Concept Release Letter at 7. 

20 See SIFMA Concept Release Letter at 7. 
226 


76108.171

7 

2. Market Maker Obligations 

As the events of May 6tl1 highlighted, the current market maker obligations do not operate 

to ensure liquidity, particularly in volatile markets. SIFMA encourages the SEC to consider how 

best to enhance liquidity in those moments when it is most needed. The SEC should work with 

the exchanges to improve market maker auto-quoting mechanisms to better provide liquidity in 

times of duress (M., imposing collars on quotes). In addition, thc SEC and the self-regulatory 

organizations should ensure that market makers are making appropriate use of their market 

making privileges (M., relying on their short sale exemption only if they are providing 

liquidity). The SEC also should consider more generally ways to ensure that liquidity docs not 

flee the market, as discussed above, rather than looking to market makers to hold back the 

floodgates during volatile trading. 

E. High Frequency Trading, High Speed Trading and Related Issues 

SIFMA recognizes the value of high frequency trading in today's markets, particularly 

the significant liquidity provided to the market by such trading. However, as high frequency 

trading has increased, questions have arisen regarding the fairness of high frequency trading as 

well as the degree to which such trading exposes the equity markets to an unreasonable amount 

of systemic risk. As discussed in our comment letter on the equity markets Concept Release, 

SIFMA believes that the market would benefit from more disclosure about high frequency 

trading practices and how they affect the markets2 ! 

1. Direct Market Data Feeds vs. Consolidated Data Feeds 

SIFMA believes that it would be a significant step backward for the SEC to impose 

restrictions on the availability of market data or the content and transmission speed of such data. 

Rather than considering an approach that would slow technology or progress, the SEC should 

consider how to make direct market data feeds available to a broader universe of market 

participants, including retail investors, on fair and reasonable terms, and how to enhance the 

speed and content of consolidated market data. For example, the SEC might consider requiring 

market centers that sell their direct market data feeds to invest more heavily in ensuring that 

market data generated by the Consolidated Quotation System, Consolidated Tape Association 

ar:d Nasdaq securities information,processors is distributed efficiently, in a timely manner and 

With appropnately useful eontent.-

21 For a more detailed discussion, see SIFMA Concept Release Letter at 5-11. 

For a more detailed discussion, sec SIFMA Concept Release Letter at 8. 
227 


76108.172

8 

2. Ensuring Appropriate Use of Direct Market Data Feeds 

Direct market data feeds, which generally are faster and more detailed than the 

consolidated data fecds, provide markct participants with valuable information. SIFMA notes, 

however, that such feeds may be used by third parties to attempt to derive more information 

about the markets than the providers of the data realize or intend to permit. For example, 

membcr firms state that direct market transaction infornlation may be linked to particular 

displayed quotations and, in some instances, direct markct data may be used to help discern the 

presence ofreserve orders. SIFMA urges the SEC to consider whether it would be beneficial for 

market participants to have a better understanding of the ways in which their market data, if 

provided to a trading center publishing direct market data, might be used by other market 

participants. Better disclosure of these practices would facilitate the ability of market 

participants to opt-in or opt-out of the use of their data in this manner. 23 The SEC also should 

consider whether the level ofimplicit information provided by various market centers in direct 

market data feeds rises to a level akin to that of providing a quote or actionable indications of 

interest to the recipients of the data feed and, if so, what the implications of providing such data 

are under the SEC's Quote Rule. 

3. Co-Location 

SIFMA does not believe that firms participating in co-location arrangements, including 

the use of specialized data, lower latency data, or higher band with consumption, should have 

aftirmative or negative obligations solely as a result of such arrangements. As noted in our 

Concept Release comment letter, we view co-location arrangements as sufficiently distinct from 

exchange specialist status that such obligations are not warranted.24 

4. Minimum Duration for Quotes/Orders 

In response to concerns about trading interest that is available for only very brief pcriods 

of time, some commenters have suggested imposing a minimum duration for quotes and orders. 

SIFMA opposes any such minimum duration requirements and, instead, encourages the SEC and 

the markets to explore other ways to incentivize longer display periods.25 

F. Internalization and Undisplayed Liquidity 

SIFMA believes that undisplayed liquidity, including internalization practices of brokerdealers, provides genuine benefits to the markets and their participants without detracting from 

the overall vibrancy of the displayed markets. As the SEC is aware, non-displayed liquidity 

often is used by market participants sceking to avoid adverse market impact when executing their 

trades. In addition, internalized executions by broker-dealers, in particular, provide investors 

often retail investors - with speedy executions and, frequently, price improvement, mainly 

24 

25 

For a more detailed discussion, see SIFMA Concept Release Letter at 8. 

For a more detailed discussion, see SIFMA Concept Release Letter at 7. 

For a more detailed discussion, see SIFMA Concept Release Letter at 9. 
228 


76108.173

9 

bccause broker-dealers retain control over the order execution process. Moreover, internalized 

orders that are not executed immediately are subject to display obligations where appropriate, 

thereby furtbering the national quotation system. We note also that there is no current evidence 

to suggest that non-displayed liquidity would becomc displayed liquidity should the use of nondisplaying trading venues be restricted.26 In fact, it is possible that restricting the use of nondisplayed trading venues would reduce the overall amount of available liquidity in the 

marketplace at any given time. 

Indeed, the most recent studies we have seen - including a study concluded subsequent to 

the close of the Concept Release comment period - demonstrate that the availability of nondisplayed liquidity venues have not, in fact, adversely impacted the displayed markets by 

impairing price discovery or execution quality. To the contrary, displayed markets remain 

healthy. For example, a very recent working paper on the impact of dark pools on market quality 

concludes that "a higher amount of dark pool activity is associated with lower quoted and 

effective sprcads, lower price impacts, and lower short-term volatility. In other words, more 

dark pool activity is generally associated with higher market quality.",27 

G. Trade-At Rule 

SIFMA strongly opposes the adoption of a trade-at rule. A trade-at rule would prohibit 

any trading center from executing a trade at the NBBO unless the trading center was displaying 

that price at the time it received the incoming contra-side order. Under such a rule, even reserve 

orders on exchanges would be required to protect away quotes before receiving an execution. As 

discussed in more detail in our comment letter on the Concept Release, 28 a trade-at rule would 

have detrimental effects on the speed and cost of execution, the liquidity currently available in 

the market, and the ability of investors to control their trading interests. Indeed, a trade-at rule 

comes very close to a consolidated limit order book or "CLOB" - a concept that has been 

repeatedly rejected by the SEC and market participants for many years as a threat to competition 

and itlliovation in our markets. 29 Given the absence of compelling evidence that non-displaying 

trading venues are impairing public price discovery - indeed, as discussed above, recent research 

suggcsts that more dark pool activity is generally associated with higher market quality, SIFMA 

does not believe that such a significant change in market structure is warranted. Moreover, while 

proponents of this idea view it as a way to stimulate greater display of limit orders, it is not at all 

clear that trading interest that an investor or broker-dealer has deemed is best represented on a 

non-displayed basis will, in fact, be sent for display in a trade-at environment. We note that 

there are already incentives for displaying liquidity, such as rebates, trade-through protection and 

minimum price variations. 

26 For a more detailed discussion, see SIFMA Concept Release Letter at 11-12. 

27 Sabrina Buti, Barbara Rindi and Ingrid M. Werner, Diving into Dark Pools, Fisher College of Business 

Working Paper (available at http://fisheLosu.eduifinifacuity/wemer/workingpapers.htm). 

28 SIFMA Concept Release Letter at 12-14. 

See, M .. Securities Exchange Act ReI. No. 51808 (June 9, 2005); 70 Fed. Reg. 3 7496(June 29,2005). 
229 


76108.174

10 

H. Access Fees and Sub-Penny Quoting 

SIFMA continues to believe that quoting in sub-penny increments would not contribute 

to the maintenance of orderly markets. Sub-penny quoting would encourage market participants 

to "step ahead" of competing limit orders by submitting an order with an economically 

insignificant price enhancement to gain execution priority. Sub-penny quoting also poses both 

operational and technological challenges. Moreover, sub-penny quoting has implications in light 

of the existing "maker-taker" fee structures of various markets. For example, sub-penny quoting 

would be particularly problematic in the event market participants were to charge fees in excess 

of the spread for a stock. Thus, SIFMA believes that the SEC should study access fees and 

maker-taker rebate incentives and their potential effect on rebate arbitrage and execution 

quality.JO 

I. Market Data 

As we have discussed on numerous occasions, SIFMA believcs that the lack of 

competition with respect to the availability of market data continues to be a pressing concern for 

retail and institutional investors. We urge the SEC to study ways in which the content of market 

data may be enhanced and bc made available to all investors on fair and reasonable terms. 31 

J. Risk Management Market Access 

As SIFMA discussed in greater detail in its comment letter on proposed Rule 15c3-5. 32 

SIFMA. as a general matter. supports the use of pre- and post-trade controls on market access, 

and the general principle underlying the SEC's proposed Rule 15c3-5 that such controls and 

procedures are appropriate in market access arrangements. If. however, proposed Rule 15c3-5 is 

to be effectivc, certain significant, complex issues regarding market access and related credit risk 

must be addressed before the SEC adopts a final rule. For example, proposed Rule 15c3-5 does 

not appropriately distinguish markct access arrangements involving multiple broker-dealers, each 

of which undcrtakes a different role in a transaction. Similarly, because many broker-dealers 

rely on third-party risk management technology, the SEC should clarify that a third-party vendor 

may control the underlying software of such risk management teclmology, so long as the brokerdealer is able to control the software's applied parameters and thresholds. 

K. Regulatory Consistency 

The current regulatory structure is beset by many conflicting or duplicative rules and 

regulations, regulatory initiatives and systems programming demands. This places unnecessary 

burdens on regulators and market participants alike, and poses significant risks to market 

efficiency and meaningful investor protection. As a result, we recommend that the SEC. SROs 

and other market participants undertake a comprehensive review of existing markct structure and 

32 

For a more detailed discussion, see SIFMA Concept Release Letter at 14-16. 

For a more detailed discussion, see SIFMA Concept Release Letter at 22-23. 

See SIFMA Market Access Letter. Sce also SIFMA Concept Release Letter at 10-11. 
230 


76108.175

11 

trading rules to identifY confEcting or duplicative requirements that could be harmonized or 

eliminated. In addition, the regulators and firms must find ways to better coordinate and 

streamline system programming demands associated with regulatory changes. Moreover, in 

recognition of enhanced global connections of financial partici~ants, SIFMA also believes that 

the SEC should pursue greater global regulatory coordination.3

. 

L. Consolidated Audit Trail and Large Trader Reporting 

SIFMA believcs that an efficient, harmonized and market-wide regulatory consolidated 

audit trail would be a significant step in improving oversight of the markets and, therefore, 

supports the concept of a consolidated audit trail proposaL34 For similar reasons, SIFMA 

supports the concept of large trader reportingJ ) However, we believe that thc SEC's largc trader 

reporting proposal should be part of the process of creating a consolidated audit trail, rather than 

a distinct process, in order to ensure that any large trader reporting regime implemented before 

the consolidated audit trail would be folded into the consolidated audit trail, once it is 

operationaL36 SIFMA recently filed a comment letter on thc large trader reporting proposal, and 

looks forward to commenting on the consolidated audit trail proposal later this sununer. 

M. Rules 60S and 606: Market Quality and Order Routing Data 

As discussed more fully in our Concept Release comment letter, we believe that Rules 

605 and 606 could be improved upon in light of market developments in favor of more 

informative tools. For example, we believe that there is value in disclosing broker-dealers' 

potential conflicts of interest regarding order routing, as rcquired by Rule 606; however, such 

disclosures could be provided by means other than Rule 606 reports, such as through brokerdealer websiles37 

* * * * * 

For greater detail on regulatory consistency issues, see SIFMA Concept Release Letter at 20-21. 

34 CAT Release. 

35 Large Trader Release. 

36 For a more detailed discussion ofthe consolidated audit trail and large trader reporting proposals, see 

SIFMA Large Tradcr Rcporting Letter. 

For a more detailed discussion of Rules 605 and 606, see SIFMA Concept Release Letter at 16-18. 
231 


76108.176

12 

SIFMA appreciates the opportunity to comment on the issues raised at the Market 

Structure Roundtable. We look forward to further discussions about specific regulatory 

initiatives and equity market structure more generally with the Commission and its staff. If you 

have any comments or questions, please do not hesitate to contact me at 202-962-7300 or 

alvcek@sifma.org. 

Sincerc1y, 

Ann 1. Vlcek 

Managing Director and 

Associated General Counsel 

SIFMA 

cc: Mary 1. Schapiro, Chairman 

liS1DOCS 7581669",3 

Luis A. Aguilar, Commissioner 

Kathleen 1. Casey, Commissioner 

Troy A Paredes, Commissioner 

Elisse B. Walter, Commissioner 

Robert W. Cook, Director, Division of Trading and Markets 

James Brigagliano, Deputy Director, Division of Trading and Markets 

David Shillman, Associate Director, Division of Trading and Markets 

Daniel Gray, Market Structure Counsel, Division of Trading and Markets 
232 


76108.177

August 31, 2009 

SIFMA Paller on Displayed and Non-Displayed Liqnidity 

I. iNTROlllJCTlON 

Concerns have been raised, particularly in the last several months, by regulators, members of 

Congress and the press regarding dark pools, Hash quotes, and high frequency trading. It is clear 

from recent public commentary that these and related terms arc often misunderstood, or used 

variably to cover a large variety of trading centers, trading interests, and trading mechanisms or 

strategies. 

SIFMA I member firms, which serve both institutional and retail investors, believe that it is in 

their clients' aue! our markets' interests to study these trading concepts and to work with market 

participants. regulators and Congress to ensure that our markets remain fair, honest and efficient 

/()r all investors, To facilitate an informed review of the issues at hand, SIFMA prepared this 

paper to clarity the definition orman), terms and rednce the confusion surrounding them 2 

II, TER~IS WITH NO CLEAR MEANING OR WITI! M!lLTlI'LE MEANINGS 

As an inilialmatter, there are certain terms critical to the current debate that are not defined in the 

law and lack uniformity of meaning. They may, in fact, have vcry different meanings and 

purposes depending on the context in "hich they are used, SIFMA has identified several of those 

terms below. 

o DARK POOL, DARK LIQUIDITY OR DARK MARKKr: These terms have been used to refer to a 

wide variety of either trading centers or services offered by traditionaL well-known trading 

centers, including exchanges, 1 AlSs (alternative trading systems)" ECNs (electronic 

The Securities Industry and Financial J\/1arkets Association shared interests of more than 

600 securities finns, b~anks and asset SIFMA's promote policies and practices that 

\\'ork to expand and perfect markets, development of new products and services. and create 

efficiencies for member firms, \:vhile preserving and enhancing the public's trust and confidence in the 

markets and the industry. SIFMA works to represent its members' interests locally and globally. It has 

offices in Nc\v York. Washington and London and its associated flm1, tbe Asia Securities Industry 

and financial Markets Association, is in I long Kong. SIFMA '5 \vebsitc is yvww.sifma.on:r. 

This pnper focuses on these issues as they relate the equity markets. [t should not be used as 

legal guidance or viewed as a document SIFMA member consensus vicVI's (as is generally 

the case with SIFl\1A comment letters filed securities rcgulators)~ this paper is intended to 

convey the general understanding of these lemlS among SIFMA firms. ror some readers, this lllay 

not be ns comprehensive as they would wish while, for other readers, we recognize that it may 

"technical" in its usc of industry terms We note for these readers that each of the major 

markets provides on their website definitions order types llsed in their markets as well as of many 

other lrading tem1S and strategies. Although we may usc such tenns and refer to stich strategies in this 

document, we do not define many of them here for the sake of brevity. 

The term "exchange" means that brings together the orders for securities of multiple 

buyers and sellers and uses non-discretionary methods (whether by providing a trading facility 

or by setting rules) under which such interact \\'ith each other. and the buyers and sellers entering 

such orders agree to the terms of a trade. An organization that meets this definition can either \\'ith 

the SEC as a national securities exchange or register as a broker-dealer and comply with A TS. 
233 


76108.178

2 

communications networks),' and broker-dealers. Depending all the context, the terms "dark 

pool," "dark liquidity," and "dark market" have been used, for example, to refer to the following 

types of trading centers or services: (a) an ATS tbat does not display quotes publicly; (b) 

internalization practices ofa broker-dealer (see below); (c) services at an exchange or ECN that 

allow for some or all of the quantity of an order to not be displayed publicly;6 and/or (d) a trading 

center whosc reported volume is not separately identified when it is reported to the Consolidated 

Tape (or Ticker).' 

o INTERNALIZA nON: This term is used to refer to a number of different trading practices, such as: 

(a) orders that are "preferenced" for execution at the trading center to which they were sent 

(including at an exchange); (b) market making firms that execute customer orders against their 

published quotes; (c) broker-dealers that seek to fill customer orders by crossing them against 

proprietary trading interest within the finn; (d) broker-dealers crossing incoming client orders 

against other existing client orders; or (e) broker-dealers engaging in riskless principal trades. 

o HIGH FREQUENCY TRADING: There is no standard industry definition of the term "high 

frequency trading" (HFT); instead, there are several possible variations. HFT can refer to firms 

that generate multiple proprietary bids and offers and trade in a high-speed, automated manner, 

often taking advantage of short-term pricing inefficiencies while providing liquidity to the 

broader marketplace. In other cases, HFT is used more generally to describe any trading activity 

involving multiple, short duration (i.e., millisecond), computer-driven orders that often use 

algorithms and low-latency market data. Overall, trading strategies and systems in today's 

electronic marketplace have become increasingly automated and are functioning at much higher 

speeds for broker-dealers, institutions, and retail investors. 

III. TERMS COMMONLY USED TO CLASSIFY LIQUIDITY 

Given the current debate regarding "dark pools" and "flash quotes," SIFMA believes that it 

would be helpful to describe the different types of liquidity available in U.S. markets today. 

A. TYPES OF NON-DISPLAYED LIQUIDITY 

Since the beginning of our securities markets, both investors and broker-dealers have chosen at 

times not to display the full extent of their trading interest for fear of moving the market in an 

adverse direction. Thus, market participants always have maintained pockets of non-displayed 

liquidity such as those discussed below. 

The tcnn "ATS" refers to a trading center that, white meeting the statutory definition of an "exchange," is 

eligible to be regulated in accordance with the provisions of Regulation ATS. Many ATSs do not display 

quotes; instead. they match orders between their subscribers. A TSs are not new; indeed, they existed well 

before the adoption of Regulation A TS in 1998. 

The term "ECN" refers to a subset of A TSs that widely disseminates quotations to third parties. 

We note that exchange reserve ("iceberg") orders are sometimes referred to a<; fldark," but are really 

partially displayed orders. They are discussed further in a later section ofthis document. 

Each exchange and FINRA, in its capacity as operator ofthe Altemative Display Facility ("ADF"), is 

required to provide transaction reports for completed transactions in its market within 90 seconds to a 

central consolidator known as the "Consolidated Tape." Such transaction reports include the relevant stock 

symbol, size, and price of the transaction as well as the symbol identifYing the market of execution. Each 

of the exchanges directly reports the volume of transactions executed on their respective markets to the 

Consolidated Tape. Non-exchange trading centers (e.g., ATSs and broker-dealers) report their trades 

executed in the over-the-counter market to a FINRA Trade Reporting Facility ("TRF"). FINRA in tum 

reports the volume of such transactions to the Consolidated Tape, but the information does not identify the 

individual non-exchange trading center or distinguish between the ATS volume and other broker-dealer 

volume. 
234 


76108.179

3 

J. WORKING ORDERS OF BUY SIDE/INSTITUTIONAL INVESTORS (E. G., MUTUAL FVNDS): 

The greatest source of non-display cd liquidity residcs at the invcstor leveL Typically, 

investment managers have extensive trading interest residing in their order management 

systems that has not yet been sent to any trading ccnter or broker-dcaler. Buysidc trading 

desks have tools that enable them to access such non-displayed liquidity in order to negotiate 

trades without committing trading intcrest to the marketplace. 

2. WORKING ORDERS AND CAPITAL COMMITMENT TRADES OF BROKER-DEALERS: Brokerdealers often have not held ordcrs' from clients and/or their own internal trading interest that 

are not displayed at any venue. The cxtent ofa brokcr-dealer's interest in a capital 

commitmcnt tradc is not displayed as it represents a bid or offer that could be made to a 

customer. 

3. EXCHANGE AND ECN ORDERS: Exchanges and ECNs pcrmit a trader to display all, somc or 

none of the quantity of an ordcr. While displayed and partially displayed orders of exchanges 

and ECNs will be discussed in thc sections below, we note here at least certain types of 

partially displayed order types as well as non-displayed order types currcntly bcing used: 

hidden, reserve, discretionary and mid-point peg order types. 

4. ATS ORDERS: Most ATSs accept orders that are visible only to their intcrnal matching 

engines and are not part ofthe public quote stream. A TS structures and the functions an ATS 

perfonns vary considerably, and include: (a) single broker-dealer owned vs. consortium 

owned; (b) dissemination of indications of interest (lOIs) vs. no dissemination of 1015 (grey 

vs. dark); (c) routing capability vs. crossing only; (d) one single liquidity provider vs. 

mUltiplc liquidity providers; (e) block crossing size restrictions vs. any size order; (f) 

dissemination of quotcs vs. no dissemination of quotes; (g) centcr limited to certain market 

participants vs. onc that is opcn; (h) dcrivatively priced vs. actively priced; (i) continuous 

trading vs. periodic crosses (point in time); and OJ automated matching vs. negotiated 

crossing. 

B. TYPES OF TRADITIONAL DISPLA YED LIQUIDITY 

The SEC's order display rulc sets standards for the public display of quotes. A public quote 

includes the "side" (buy or sell), size (number ofsharcs), stock symbol and price, and is shown to 

a public audience. Such a quote is thereforc referred to as "fully displayed liquidity." Public 

quotes for bids or offers are collected by various trading ccnters, and then displayed to investors 

through a public data feed. A market center or market data vendor also may sell or otherwise 

providc more detailed information on the bids or offers it has received to markct participants via 

direct data feeds. These direct data feeds, as dcscribed more fully bclow, often emphasize speed, 

content or both, and contain information that goes beyond the SEC's ordcr display requirements. 

1. CONSOLIDATED QUOTES AND NBBO. Under the national market system plans approved by 

thc SEC, each national securities exchange, as well as each ECN and market maker, must 

supply to a central consolidator (i.e., securities information processor, or "SIP") their best bid 

and offcr (also known as their "top of book"). The best bid and best offer from all of the 

collectcd data is known as the National Best Bid or Otfer ("NBBO"). This consolidated 

infonnation is then made available to vendors, which disseminate the information to brokerdealers, investors and othcr persons for a fee. 

For those who are not familiar with this tenn, we note that broker-dealers have discretion with not held 

orders but no discretion with held orders, which are usually retail orders. 
235 


76108.180

10 

11 

12 

4 

2. ADF QUOTES: The Alternative Display Facility, commonly known as the ADF, provides 

market participants (e.g., ADF-registered market makers or ECNs) an alternative mechanism 

for posting quotes other than on an exchange. 

3. DEPTH OF BOOK: "Depth of book" data, available from certain market data vendors or 

directly from exchanges and ECNs, shows all of a market center's bids and offers, including 

top of book and any bids or offers at prices away from the top of book. This infonnation 

provides market participants with a more in-depth view of the available liquidity in a 

particular stock. Some trading centers offer depth of book data for a fcc, while others freely 

disseminate it. 

C. TYPES OF PARTIALLY DISPLA YED LIQUIDITY 

Certain types of liquidity do not fit neatly within the definition of a public quote and are often 

referred to as "partially displayed liquidity." They often may be missing one of the basic quote 

elements, may be part of an order that is related to a public quote, or may be directed to a limited 

audience of investors (or a combination of these). 

1. INDICATIONS OF INTEREST AND ACTIONABLE lOIs: lOis are generally expressions of 

trading interest in a security where the price, side, or number of shares is not always specified 

by the sending party. An 101 is not considered a finn quote and cannot be executed without 

further interaction with the 10l's sender.' If the trading interest always or nearly always 

results in an execution without further interaction with the 10l's sender, then the 101 may be 

characterized as a quote. lOIs can be communicated verbally or electronically disseminated 

through a direct data feed. 'o In essence, lOis can be viewed as an automated means of 

seeking contra-side trading interest from one or more trading partners, a practice formerly 

done through a manual or verbal process. Sometimes, the term "actionable 101" is used to 

describe, among other things, any 101 or quote message sent to a designated private network 

of market participants that are alerted to a trading opportunity that exists if responded to in a 

timely manner. II 

2. EXCHANGE FLOOR TRADERS: Exchange floor traders maintain a pool of non-displayed 

liquidity that may be accessed manually or electronically by sending an order to the 

exchange, either to the broker directly or to the exchange book. Such "working orders" are 

shared with other floor brokers through verbal negotiation andlor the posting of a bid or an 

offer. This source of non-displayed liquidity deriving from exchange trading floors has long 

been a characteristic of the auction system. 

3. FLASH QUOTES: The term "flash quote" refers to immediately executable quotes that 

exchanges disseminate (i.e., "flash") for a very short period of time (e.g., less than 112 

second) to their direct data feed subscribers. 12 Flash quotes have an extremely short duration 

and are not included in the public consolidated quotation data. 

4. DIRECT DATA FEEDS: Typically, flash quotes, lOis, and depth of book data are 

disseminated via direct data feeds to interested market participants. The information is 

http://v.ww.see.gov/rules/finall34-40760.txt 

Exchanges also may disseminate in a direct data feed imbalance information for open/close aggregated 

orders. 

There is also an "SOl," or "Solicitation ofln!eres!." which is similar (0 an lor and has been approved by 

the SEC for the International Securities Exchange. 

Flash quotes are, or have been, offered by several market centers. These market centers view (or viewed) 

flash quotes as a means for seeking additional liquidity for the execution of an order within their trading center before the unexecuted portion of the order is routed away or cancelled. 
236 


76108.181

5 

alTered either for a fee or through some kind of mutual arrangement. Such direct data feeds 

usually emphasize speed or targeted content, or both. 

a. Faster Speed: Somc direct data feeds enable recipients to receive information faster 

than the public SIr feed (reduced latency), sometimes even up to a full second fastcr. 

Exchanges and ECNs, for example, will usually disseminate their detailed quote 

infonnation to whichever market participants can afford to build the infrastructure and 

pay for the high speed feed. 

b. Content: Some direct data feeds may include marc detailed content, such as depth of 

hook or partially displayed information (i.e., lOIs, negotiation messages, and certain flash 

quotes). 

5, RESERVE/IcEBERG ORDERS: Most exchanges and ECNs offer order types that allow market 

participants to indicate that a portion of their order should he continually displayed in the 

puhlie quote stream with a residual portion of their order left in reserve and kept from the 

public quote stream. These "reserve" orders are known as "icebergs" in Europe because the 

displayed component is usually only the tip of the iceberg, with the bulk of the order hidden 

(underwater), 

IV, RECENTLY RAISED QUESTIONS 

13 

A, PRICE DISCOVERY AND NON-DISPLA YED LIQUIDITY 

Issue: Whether the use of dark pools impairs price discovery and provides disincentives to 

publicly display quotations. 13 

Response: The concerns about price discovery appear to be based on the assumption that the use 

of non-displayed liquidity diverts order flow away from the public quoting markets, thereby 

adversely affecting the execution quality for those market participants that display their orders in 

the puhlic markets. SIFMA believes these fears are unfounded, based on history and practice. 

First of all, there is no economic incentive for all (or most) liquidity to go dark. Trading 

professionals, particularly those with large orders that are likely to have a significant impact on 

the market (e.g., orders for money managers that oversee collective pools of assets contrihuted by 

individuals), always have a dual focus when seeking best execution of their orders: displaying a 

quote to achieve a more certain execution (with the risk of moving the market adversely) versus 

not displaying a quote in an attempt to reduce market impact and potentially obtain price and/or 

size improvement. This natural "give and take" between certainty of execution (and eliminating 

"opportunity cost risk") and managing market impact (with attempted price/size improvement) 

works to maintain equilibrium between non-displayed and displayed liquidity. 

Indeed, such equilibrium generally has been maintained over the years, even as non-displayed 

liquidity has evolved from a manual process to more automated solutions, For example, since the 

early years of the NYSE, there have been floor brokers who worked large orders discreetly in 

For some of the issues discussed in this section, we note certain instances in footnotes where these issues 

were raised recently, For this issue, see Chairman Mary L. Schapiro, SEC, Testimony Concerning SEC 

Oversight: Current State and Agenda, Before the United States House of Representatives Committee on Financial Services, Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises 

(July 14,2009) ("Schapiro July 14 Testimony"); Speech by Chairman Mary L. Schapiro, SEC, New York 

Financial Writers' Association Annual Awards Dinner, New York, NY (June 18,2009) eSchapiro June 18 

Speech"); Speech by James A. Brigagliano, Co-Acting Director, Division of Trading and Markets, SEC, 

2009 SIfMA Market Structure Conference, New York, NY (May 20, 2009) ("Brigagliano May 20 

Speech"). 
237 


76108.182

14 

15 

6 

order to obtain the best possible price for investors. In the over-the-counter markets, traders held 

their trading interest on their desks and used the telephone to call trusted partners to inquire about 

possible matchcs. As markets have evolved, new ways of managing this trading process and the 

risks associated with displaying large trading interest have developed. The growth in the number 

of A TSs, for example, can be viewed as a necessary electronic manifestation of an age-old 

process, rather than a new trading concept. 

In addition, we note that non-displayed orders and relatcd trading activity are part of the price 

discovery process. Market participants that use non-displayed orders constantly monitor and 

respond to displayed bids and otTers as well as to last sale and volume traded information (which 

originates from both displayed and undisplayed order types and markets). Market participants 

using non-displayed order types display orders when market conditions compel them to shift from 

passive to more aggressive interaction with the marketplace. For example, when the market price 

ofa security changes or a certain amount of volume is reported to the tape (again, whether 

executed at a displayed market or dark pool), such activity can cause trading behavior to change 

from passive (i.e., use of un displayed or partially displayed orders) to active, whcre a trader will 

"take" or display liquidity. 

Our markets and trading tcchnologies have evolved considerably over time. While the process 

has become more sophisticated and complex, most of the basic principles remain unchanged. 

Dark pools and undisplayed orders (like the trading interest in a floor broker's book) play an 

important role in the investmcnt trading process, in ensuring market efficiency, and in price 

formation. 14 As sueh, the use of non-displayed orders, when properly regulated, will continue to 

be beneficial to investors of all types. SIFMA supports periodic reviews of new trading 

developments to ascertain their effect on market efficieney and the price discovery function and 

to determine whether new or different regulation is needed. 

B. POST TRADE TRANSPARENCY 

Issue: Whether the use of dark pools undcnnines the quality and quantity of publicly 

disseminated trade information. !5 

Response: "Post-trade transparency" (reporting to thc Consolidated Tape) differs from "pretrade transparency" (price discovery). Non-displayed orders, which have no pre-trade 

transparency, QQ have post-trade transparency in that transactions resulting from non-displayed 

trading interest are publicly reported to the Consolidated Tape. The current transaction reporting 

rules, however, do not call for identification of the individual non-exchange trading center or 

distinguish between the A TS volume and other broker-dealer volume. SIFMA believes that a 

review should be undertaken to detennine whether and how to enhance post-trade reporting 

transparency. For example, one recommendation may be that all ATSs should follow unifo011 

reporting practices in order to provide reliable public information on their trading activity. 

SIFMA looks forward to any such review ofthe type and timing of post-trade transparency with 

market participants. 

As the former Director of the SEC's Division ofTmding and Markets, Erik Sirri, said, " ... dark pools of 

liquidity have been around for a long, long time. The single largest dark pool in the world for many 

decades could be found on the trading floor of the New York Stock Exchange. The floor traders there 

manually represented a pool of un displayed liquidity that could be accessed only by sending an order to the floor to probe buying and selling interest. ... Dark pools are solutions to a perennial trading dilemma for 

anyone that needs to trade in substantial size, particularly institutional investors. They provide a mechanism for such transactions to interact without displaying the full scale of their trading interest. 

Today, nearly every equity trading venue in the U.S. offers some sort of dark liquidity." Speech by Erik 

Sirri at SIFMA 2008 Dark Pools Symposium, February 1,2008 ("Sirri February 1 Speech"). 

Schapiro July 14 Testimony; I3rigagliano May 20 Speech. 
238 


76108.183

16 

17 

7 

C. INDICATIONS OF INTEREST VS. ORDERS/QUOTES 

Issue: How lOIs as opposed to orders/quotes should be treated from a regulatory perspective to 

avoid undermining the fundamental goals ofthe national market system. 16 

Response: Ihe SEC has previously differentiated lOIs and orders by describing lOIs as interest 

to buy or sell a security where the price. side or number of shares is not always specified, unless 

the price or size is implied. In other words and as previously mentioned, an TOI is trading interest 

that cannot be executed without tilliher interaction between the market participants. SIFMA 

supporL, the SEC's continued reliance upon this previously articulated definition of an lOT. 

SIFMA, though, urges the SEC to clarifY and then appropriately enforce the application of this 

definition to new types of trading interests as they appear. 

D. INFORMATION ACCESS 

Issue: Whether high speed data feeds, lOis, etc. lead to the development of significant private 

markets to which public investors have no access. 

Response: As discussed earlier, there are many types of market data feeds today that offer 

various levels of information to market participants and at different speeds. Institutional and 

retail investors, as well as trading professionals, often value and therefore seek unique levels of 

information that are important to them, and at the speed they want. SIFMA believes it would be a 

step backwards in market structure evolution if we forced all data recipients to receive market 

data at the same speed, as this could reduce the market to the lowest common denominator and 

will inhibit innovation in new technologies and processes. The different levels of speed and 

information are available to all investors and market professionals if they believe it necessary and 

assuming it can be obtained at reasonable cost. The option to access different levels of 

information and speed does not raise fairness concerns as long as this option is available to all 

market participants and investors and at reasonable cost. 

E. TRADING ACCESS 

Issue: Whether Regulation A IS's fair access rule sufficiently protects investors. 17 

Response: Ihe SEC adopted the fair access rules under Regulation A IS to ensure that market 

participants have adequate access to the many advantageous services provided by significant 

A ISs, including any non-displayed liquidity, which may not otherwise be available. Ihe fair 

access rules of Regulation A IS require ATSs with at least 5% of the trading volume in a security 

to establish objective, fair standards for access to its system (e.g., a standard based on credit 

requirements or disciplinary history). The SEC set the threshold at 5% in order to balance the 

competing interests of (i) ensuring appropriate access to those ATSs with a significant percentage 

of trading volume with (ii) allowing start-up and other small AISs to enter the business and offer 

competition without incurring undue costs associated with the fair access requirements. SIFMA 

believes that this threshold to date has appropriately balanced the competing interests, while 

ensuring adequate access to significant sources of liquidity. 

It also is worth noting that many exchanges and broker-dealers have established execution 

relationships with dark pools, and that many markets have order types to facilitate accessing dark 

liquidity if their investors so desire. Sophisticated tcchnology and linkages therefore enable 

investors to access dark liquidity if they wish. However, in light of the continuing changes in our 

Schapiro June 18 Spcech; Brigagliano May 20 Speech, 

Schapiro July 14 Testimony; Schapiro June 18 Speech; Sirri February I Specch. 
239 


76108.184

18 

19 

8 

markets, SIFMA supports reviewing Regulation A TS to determine whether its fair access 

provisions and, in particular, any exceptions to them remain appropriate for today's markels. 

F. FRAGMENTATION 

Issue: Whether A TSs should be linked somehow to avoid an overly fragmented market," 

Response: n,e existing national market system, which provides for inter-market linkages and 

public display of consolidated quotation and last sale information, and the adoption ofthe Order 

Protection Rule under Regulation NMS ensure that market participants arc able to obtain access 

to market in[onnation as well as maintain the practical ability to access the displayed and nondisplayed markets. Because many market centers have trading relationships with dark pools, 

retail investors therefore have an opportunity to interact with the liquidity in dark pools by 

sending orders to broker-dealers and exchanges to utilize their services. Fragmentation, and the 

competition that it encouraged, has thereby benefitted our markets and investors and should 

continue to do so, as long as the appropriate parameters for access to market information (such as 

reasonable cost) and to dark pools (such as standard access requireme"ts) arc in place. 

It is important to note that the industl), went through the same analysis regarding fragmentation 

and price discovery issues. including concerns with A TSs possibly siphoning liquidity, in J 999-

2000.'9 At that time, the concept of consolidating liquidity in a centralized limit order book, or 

CLOB, was thoroughly debated and rightfully discarded. SIFMA believes that, with the 

combination of private linkages and the Regulation NMS trade-through protection, having 

multiple markets (i.e .. fragmentation) is less of a market structure or best execution concern. 

Accordingly, SIFMA believes that there is no need to mandate any additional linkages at this 

time. 

* * 

SIFMA and its member firms stand ready to assist further in ensuring that the market structure 

issues and trading concepts and terms in this paper are fully understood, and that revisions to 

existing regulations or new regulations are instituted where necessary to ensure that the U.S. 

markets remain vibrant and efficient and that investors' interests remain protected. 

In this regard, please contact the following SIFMA staff members if further information or 

assistance from SIFMA or its member firms would be helpful: 

For press inquiries, please contact Andrew DeSouza (adesollza01sifma.org) or Travis Larson 

(tlarson01sitina.org ). 

For Congressional inquiries, please contact Scott DeFife (sdefife@sifma.org) or Margaret 

Simmons (msimmolls@sifma.&[g). 

For inquiries from securities regulators, please contact Ann Vlcek (av!cek@sifma.OI:g). 

Brigagliano May 20 Speech. 

http://www.sec.gov/rules/sro/ny9948n.htm 

o