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S. HRG. 112–756 

COMPUTERIZED TRADING VENUES: WHAT SHOULD 

THE RULES OF THE ROAD BE? 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

SECURITIES, INSURANCE, AND INVESTMENT 

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

ON 

EXAMINING COMPUTERIZED TRADING VENUES 

DECEMBER 18, 2012 

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

( 

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

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

KAY HAGAN, North Carolina 

RICHARD C. SHELBY, Alabama 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

ROGER F. WICKER, Mississippi 

DWIGHT FETTIG, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director 

DAWN RATLIFF, Chief Clerk 

RIKER VERMILYE, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT

JACK REED, Rhode Island, Chairman 

MIKE CRAPO, Idaho, Ranking Republican Member 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

KAY HAGAN, North Carolina 

TIM JOHNSON, South Dakota 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

JERRY MORAN, Kansas 

ROGER F. WICKER, Mississippi 

KARA STEIN, Subcommittee Staff Director 

GREGG RICHARD, Republican Subcommittee Staff Director 

CATHERINE TOPPING, FDIC Detailee 

(II)

C O N T E N T S 

TUESDAY, DECEMBER 18, 2012 

Page 

Opening statement of Chairman Reed ................................................................... 1 

Opening statements, comments, or prepared statements of: 

Senator Crapo ................................................................................................... 2 

WITNESSES 

Joseph Mecane, Executive Vice President and Head of U.S. Equities, NYSE 

Euronext ............................................................................................................... 4 

Prepared statement .......................................................................................... 27 

Responses to written questions of: 

Senator Reed .............................................................................................. 51 

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

LLC ........................................................................................................................ 6 

Prepared statement .......................................................................................... 29 

Responses to written questions of: 

Senator Reed .............................................................................................. 65 

Eric Noll, Executive Vice President and Head, Nasdaq OMX Transaction 

Services ................................................................................................................. 7 

Prepared statement .......................................................................................... 35 

Responses to written questions of: 

Senator Reed .............................................................................................. 68 

Robert C. Gasser, Chief Executive Officer and President, ITG ........................... 9 

Prepared statement .......................................................................................... 40 

Responses to written questions of: 

Senator Reed .............................................................................................. 74 

(III)

(1) 

COMPUTERIZED TRADING VENUES: WHAT 

SHOULD THE RULES OF THE ROAD BE? 

TUESDAY, DECEMBER 18, 2012 

U.S. SENATE, 

SUBCOMMITTEE ON SECURITIES, INSURANCE, AND

INVESTMENT, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Subcommittee met at 9:31 a.m., in room SD–538, Dirksen 

Senate Office Building, Hon. Jack Reed, Chairman of the Subcommittee, presiding. 

OPENING STATEMENT OF CHAIRMAN JACK REED 

Chairman REED. Let me call the hearing to order, and let me 

welcome our witnesses. I thank my colleague, the Ranking Member, Senator Crapo, for joining us this morning. 

This hearing will be focused on how computers, market regulation, and competition have dramatically changed equity markets in 

the United States. In recent decades, the United States equity markets have experienced tremendous technological innovation and intensified competition between an expanding set of trading venues, 

some of which have been driven by regulatory changes. 

As of December 2012, there are 13 official stock exchanges registered with the Securities and Exchange Commission. In addition, 

there are nearly 40 ATSs, alternative trading systems, through 

which broker-dealers can access the market. Included among the 

ATSs are the so-called dark pools that do not publicly display 

quotes or prices. There are also more than 200 broker-dealers that 

execute orders in-house in a process known as ‘‘internalization.’’ In 

short, liquidity has fragmented over numerous trading venues as 

competition has intensified. 

Two SEC regulations dramatically changed or accelerated 

changes in the structure of our financial markets. In 1998, the Securities and Exchange Commission adopted Regulation ATS to encourage the development of innovative new market centers. Regulation ATS exempted these alternative trading systems from having 

to register as exchanges. And in 2005, the SEC adopted Regulation 

National Market System, or Regulation NMS, a series of rules and 

regulations designed to modernize and strengthen the national 

market system for equities. Implemented in 2007, Regulation NMS 

is credited by some to have caused the biggest change of the two 

by requiring that orders be sent to the trading platform with the 

best price. 

2 

The adoption of Regulation ATS and Regulation NMS led to a 

proliferation of new trading platforms. It also put a premium on 

speed, giving an advantage to firms that could place orders first 

and take advantage of minuscule price differentials between the 

trading venues. Such high-frequency, computer-based training has 

grown in recent years, representing about 50 percent of equity 

trading in the United States. High-frequency trades employ many 

different automatic strategies with rapid orders and short-term 

holding periods. High-frequency trading, advanced computer technology, and trading strategies have led to changes in the marketplace that minimize latency or the time it takes to send and execute a trade. 

In response to the demand for faster execution, exchanges are allowing trading firms to place or collocate their service in the exchanges’ data centers. Some trading venues also allow direct access 

through which certain trading firms access the exchanges’ matching engine directly. Exchanges also offer direct data feeds on a proprietary basis to their customers. These feeds cost more, but the 

data arrives sooner. It has been reported that some exchanges and 

trading firms have developed an ultra-fast micro wavelength to 

provide even faster speeds. 

The growth of new trading venues and the increasing use of automation and advanced computing technology have raised questions about the effect that these changes have had on the stability, 

fairness, and integrity of our marketplaces. Flash Crash, the BATS 

and Facebook IPOs, and Knight’s trading debacle all bring into 

question the very rules that govern our market structure. 

Do market rules reflect the realities of today’s market structure? 

Are the markets fair and transparent? Is the marketplace too complex or to fragmented? Should all markets have the same rules? Is 

there a great potential for systemic risk propagation as a result of 

the interconnection of highly computerized markets? Or, essentially, the ultimate question, do the rules of the road need to be 

changed? 

I look forward to our witnesses’ testimony and a robust discussion of these issues. 

I will now turn to my colleague Senator Crapo and thank him 

for his indulgence for my long opening statement. Thank you. 

STATEMENT OF SENATOR MIKE CRAPO 

Senator CRAPO. Thank you very much, Mr. Chairman. I appreciate you holding this important hearing today. It is our second in 

a series of hearings on computerized trading. 

At our last hearing, we heard from witnesses representing the 

buy side: high-frequency traders and the research and advisory 

firms. Today we are going to hear from witnesses representing exchanges and alternative trading venues. 

Because there have been too many market disruptions caused by 

software errors since the Flash Crash of 2010, there has been a lot 

of discussion on how to fortify our markets during times of market 

stress. 

In October, the Securities and Exchange Commission held a 

Technology Roundtable on how to minimize trading errors and 

market malfunctions as well as how to respond to them in real 

3 

time. The use of kill switches, automated switches that would turn 

off trading at securities firms when their volume exceeded preset 

maximums, appears to be the first choice of many market participants. Our market infrastructure should be able to handle a trading error or technology failure in an appropriate way to minimize 

disruptions. 

I am interested in learning more about how effective kill switches can be and what their effectiveness is with regard to other safeguards. 

I also look forward to hearing from our witnesses about how the 

industry, working with the SEC, has made progress in implementing kill switches since the Technology Roundtable. In addition, 

I look forward to a discussion about the changing landscape of our 

securities markets and how different trading venues impact investor protection, market integrity, and capital formation. 

Our witnesses today provide a deep expertise on these and other 

issues, and I appreciate them being here and bringing us their expertise and their thoughtfulness in addressing these questions. 

Again, Mr. Chairman, I appreciate you, not only our working relationship but holding this hearing, and I look forward to working 

on this and other issues with you as we move forward. 

Chairman REED. Thank you very much, and I also look forward 

to working with you, Senator Crapo. 

Senator Corker, do you have a statement? 

Senator CORKER. No. 

Chairman REED. Thank you very much, Senator Corker. 

Let me introduce our witnesses now and then ask them to 

present their testimony. 

Our first witness is Mr. Joe Mecane. Mr. Mecane is an executive 

vice president with NYSE Euronext and oversees strategy, business development, and operations for the company’s U.S. equities 

platforms. Prior to joining the company, Mr. Mecane was managing 

director in the Equities Division of the UBS Investment Bank. 

Thank you, for joining us. 

Mr. Dan Mathisson is the head of Advanced Execution Services 

at Credit Suisse. AES is a full-service suite of algorithms, strategies, tools, and analytics for trading securities throughout the 

world. He is on the board of directors of BATS trading, the Credit 

Suisse Global Equities Operating Committee, and is a member of 

the New York Stock Exchange Electronic Traders Advisory Committee. Thank you, Mr. Mathisson. 

Mr. Eric Noll is executive vice president, Transaction Services, of 

the Nasdaq OMX Group, Inc., the world’s largest exchange. Mr. 

Noll oversees the trading operations of all U.S. transaction services 

businesses. Mr. Noll joined Nasdaq OMX from Susquehanna International Group. Thank you very much, Mr. Noll. 

And our final witness is Mr. Robert Gasser. Mr. Gasser is chief 

executive officer and president of Investment Technology Group, 

Inc., ITG. Before joining this organization, Mr. Gasser was head of 

U.S. equity trading a JPMorgan. Thank you very much. 

Gentlemen, all of your testimony will be made part of the record. 

We ask you to summarize within the 5 minutes allocated to you, 

and we will begin with Mr. Mecane. Thank you, Mr. Mecane. 

4 

STATEMENT OF JOSEPH MECANE, EXECUTIVE VICE 

PRESIDENT AND HEAD OF U.S. EQUITIES, NYSE EURONEXT 

Mr. MECANE. Chairman Reed, Ranking Member Crapo, and 

Members of the Subcommittee, my name is Joe Mecane, and I am 

EVP and head of U.S. Equities at NYSE Euronext—a leading global operator of financial markets and provider of trading technologies. 

While the U.S. continues to have the most liquid markets in the 

world and remains at the forefront of innovative technology used 

to conduct electronic trading, the infrastructure used to operate the 

markets each day has grown so sophisticated that few fully appreciate how well our markets actually operate in a highly competitive 

and complex environment. 

This has made it difficult for market participants, regulators, 

and Congress to determine if the growth in the number of trading 

venues and use of automated trading is beneficial. 

However, in light of the market events that have occurred in recent years, I would like to focus on how technology and our market 

structure have created both unnecessary complexity and mistrust 

of markets; and, relatedly, what we believe the industry, regulators, and Congress should be doing to address it. 

Electronic trading has added tremendous benefits to the capital 

markets, including lower costs of trading, faster speed of execution, 

and in some cases greater transparency. However, there were several regulatory changes that drove the market to become more electronic. One significant factor was decimalization of the markets in 

2001, which had an effect of decreasing average spreads by roughly 

38 percent, directly benefiting end investors. The narrowing of 

spreads led to a huge expansion of electronic trading because 

human traders could no longer effectively make markets in this environment and because institutions and brokers began relying more 

on algorithmic trading to access the markets and reduce their costs 

of trading. This process started before Regulation NMS. In fact, almost all reductions in spreads occurred during the pre-Regulation 

NMS period. 

In 2007, just as the technology was becoming more sophisticated, 

the SEC adopted Regulation NMS through which exchanges began 

to compete by establishing the NBBO, and speed became the competitive differentiator based on one market’s ability to set the national best bid or offer faster than a competing market. 

Regulation NMS also established the Order Protection Rule to 

protect visible orders and encourage displaying quotes, yet today 

over 3,000 securities have 40 percent of their volume occurring offexchange. This level of off-exchange activity erodes the incentive 

for market makers to continue to trade the less active securities 

and threatens to further decrease the incentives for companies to 

go public. 

Today, there are 60 execution venues in the U.S. markets. Exchanges find themselves competing more directly with other venues 

that are able to employ different practices than exchanges with less 

oversight and disclosure. As a result of these advantages, brokerdealers continue to move more order flow into their own trading 

venues before routing to the public markets. 

5 

As you can see, the technology and the rules that govern the U.S. 

equity markets have resulted in the creation of a trading infrastructure primarily focused on speed and complexity through which 

traders can identify and access liquidity. To accomplish this, exchanges, brokers, and vendors have had to build expensive networks with robust capacity, as well as learn how to interact in a 

very complex ecosystem. 

In response to this new flow of orders, exchanges have developed 

new order types and evolved their market structures. Regardless of 

the reason for the specific order type, most are premised on the 

goal of attracting liquidity to the public markets, and all must be 

reviewed by the SEC and published for public comment, something 

unique to national securities exchanges. 

The bottom line is that our market structure incentivizes these 

various levels of increased complexity. Our main message today is 

that if we want to reduce the complexity of technology and the related framework of our markets, we should simplify the overall 

market structure. 

NYX believes that the SEC is best suited to propose meaningful 

market structure changes, and regulators in other global markets, 

including Canada, Australia, and Europe, are already taking action. With congressional oversight, the SEC should continue with 

the holistic review it began in 2010 with the Concept Release on 

Equity Market Structure by proposing changes that will promote 

transparency, fairness, and long-term capital formation. 

We believe that changes to be considered should include a review 

of market maker obligations, the Sub-Penny Rule, the Order Protection Rule, tick sizes for illiquid securities, and addressing the 

conflicts and overlap between broker-dealers and exchanges, including the obligations and responsibilities of each when providing 

like services. 

The Consolidated Audit Trail, proposed by the SEC, also is a 

vital component to ensuring effective surveillance in a highly fragmented marketplace. 

NYX also believes that, in light of the existing complexity of the 

markets and the trading glitches that have occurred this year, all 

trading venues should ensure a robust set of policies and procedures around their systems development life cycle. Although testing may not be the most exciting part of the industry’s initiatives, 

the hyper-competition that exists in the securities markets lends 

itself to excessive levels of change to remain competitive and compliant with new regulatory requirements. 

In closing, I want to reiterate our belief that although our capital 

markets are the best in the world, there remains room for improvement. Our recommendations for change have a simple premise: implement market structure changes that enhance transparency for 

investors and level the playing field for trading venues. 

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

questions. 

Chairman REED. Thank you very much. 

Mr. Mathisson, please. 

6 

STATEMENT OF DANIEL MATHISSON, HEAD OF U.S. EQUITY 

TRADING, CREDIT SUISSE SECURITIES LLC 

Mr. MATHISSON. Thank you, Chairman Reed, Ranking Member 

Crapo, and Members of the Subcommittee. My name is Dan 

Mathisson, and I am the head of U.S. Equity Trading for Credit 

Suisse. Credit Suisse’s U.S. broker-dealer unit, formerly called 

First Boston, has been in operation in the U.S. since 1932, and 

today Credit Suisse employs 9,200 people in the United States. We 

are one of the largest U.S. broker-dealers, having executed 12.4 

percent of total volume in 2012, and we own and operate two alternative trading systems: Crossfinder, which has been the largest 

ATS in the U.S. since 2009, and Light Pool, a newer ATS that publicly displays bids and offers. 

I have been working in the equity markets for over 20 years, and 

it is a privilege to have the opportunity to speak here today. 

Credit Suisse believes that the U.S. equity markets are better 

than they have ever been and remain the envy of the world. We 

recently published a broad survey of market quality where we 

found that the markets have improved in almost every measurable 

way. We believe that Regulation ATS, decimalization, and Regulation NMS were successful at making the U.S. markets more efficient, fair, and equitable. However, while they are good, the markets are not perfect, and we have seen several market disruptions 

that became big news stories in the past few years. But we believe 

that the SEC has moved aggressively and thoughtfully to fix these 

issues, and Credit Suisse fully supports the pending Limit Up/ 

Limit Down rule, the consolidated audit trail, the market access 

rule, the tighter marketwide circuit breakers, and the creation of 

the SEC’s new Office of Analytics and Research. We applaud the 

SEC for these actions and believe they will serve to significantly 

reduce the risks of disruptions in the future. 

In addition to those SEC actions, we have a further suggestion 

that we believe will decrease the likelihood of disruptions. We recommend that the SRO status of the exchanges be examined. The 

trading errors that occurred on the day of the Facebook IPO last 

May served to highlight a peculiar quirk of the U.S. market structure: that exchanges do not have material liability for their failures. As SROs, exchanges have long been considered by courts to 

be quasi-governmental entities and are therefore entitled to the 

common law doctrine of sovereign immunity, which protects Government entities from liability judgments. 

Yet exchanges today are clearly not governmental entities. They 

are for-profit private companies that are not particularly different 

from broker-dealers. While they still have a few vestigial regulatory functions, the majority of their regulatory responsibilities 

are typically outsourced to FINRA. We believe that exchanges 

should not have been allowed to retain their SRO status when they 

converted to for-profit entities 6 years ago. Businesses or individuals are inherently more cautious when they have the potential to 

be found liable for their actions. It is time for policy makers to correct this mistake. 

Our second suggestion is that it is time for the regulators to do 

a comprehensive review and overhaul of the market data revenue 

plans. The Consolidated Tape Association has a legal monopoly on 

7 

providing a stream of real-time data from our Nation’s stock markets. The CTA is the only source of this data, and it sells it at a 

high cost to the investing public. After all of its operational and administrative costs, the CTA makes a profit of approximately $400 

million a year, which is then rebated to the exchanges based on a 

complex formula. 

Historically, the SEC has justified granting exchanges this exclusive right to sell market data as a form of user tax to fund the exchanges’ regulatory expenses. However, based on what we can 

glean from earnings reports and SEC filings, the amounts earned 

by the exchanges today far exceed the regulatory expenses, and 

tape revenue acts as a major profit center for the exchanges. It appears that somewhere along the way market data revenue became 

a Government-granted windfall at the expense of the investing 

public. The current market data system was passed in November 

1972. After 40 years, we believe it is time to give it a fresh look. 

In summary, removing immunity from exchanges would increase 

reliability over the long term and, therefore, reduce market disruptions, and overhauling the tape revenue system would reduce costs 

for the investing public. 

Thank you for the opportunity to appear here today, and I will 

be happy to answer any questions that you may have. 

Chairman REED. Thank you very much, Mr. Mathisson. 

Mr. Noll, please. 

STATEMENT OF ERIC NOLL, EXECUTIVE VICE PRESIDENT AND 

HEAD, NASDAQ OMX TRANSACTION SERVICES 

Mr. NOLL. Good morning. Thank you, Chairman Reed and Ranking Member Crapo, for the opportunity to testify today on computerized trading. My name is Eric Noll. I am the executive vice president of Nasdaq Transaction Services for Nasdaq OMX. 

Computerized trading is a fact of life and the default method for 

billions of trades over the past several years—billions of trades 

that happen without any concern or problem in the market every 

day. While there are issues, computerized trading has a proven 

track record of delivering benefits for investors, equalizing the information advantage that was the staple of manual markets, lowering trading costs, and allowing the market to handle trade traffic 

that would freeze otherwise manual markets. 

In light of recent events, do not forget the unique role exchanges 

continue to play in the U.S. equity markets. All that your constituents associate with ‘‘the market’’ starts with an exchange. The 

iconic public companies—Apple, Google, eBay, and Amazon—must 

satisfy exchanges listing standards and regulations against corporate fraud and abuse. Only equity exchanges carry the important 

responsibility to support that growth and wealth creation from 

those companies. 

Exchanges have heavy responsibilities to create a safe market for 

investors, characterized by fair access, transparency, and efficiency. 

No other market participant is charged with or even permitted to 

undertake that burden. One need only look at the list of SRO responsibilities that registration triggers to understand why so few of 

our lightly regulated competitors voluntarily take that step. 

8 

All of the buying and selling and active trading in the markets 

is not a grand game of speculators. It has real job creators and investors relying on the market’s best information to make rational 

business and investing decisions. Price discovery, the best bid and 

offer, and visible liquidity are very important to public companies 

seeking activities like secondary offerings for expansion and to use 

their stock as a currency in the marketplace to achieve strategic 

goals like acquisitions. 

Exchanges are not in the business just to see trading for 

trading’s sake. We are in the business to produce transparent 

quoting and trading that helps price discovery, helps add liquidity, 

tightens spreads, and benefits the continuous market, ultimately 

helping job creation and economic growth. 

U.S. markets are complex, fragmented, and interconnected. We 

are working tirelessly to ensure that markets are strong and fair, 

and that as the pace of trading accelerates, so too does the pace 

of regulation and investor protection. 

For example, after May 6th, the SEC and the exchanges worked 

quickly and cooperatively to devise new protections and reform 

rules for breaking trades, instituted single stock circuit breakers, 

and will implement updated marketwide circuit breakers and the 

Limit Up/Limit Down mechanism in the first quarter next year. 

Nasdaq also fully supports and is helping to lead and define the 

implementation of Peak Net Notional Exposure levels, or what is 

commonly known as ‘‘kill switches.’’ 

On the issue of high-frequency trading, many vilify HFT as a 

business model. We urge caution against that sweeping criticism. 

It seems the tenor of the debate about HFT has become too broadly 

negative toward it as a business model. Academic evidence, like the 

British Beddington study, suggests that HFT trading tightens 

spreads and adds valuable liquidity—certainly positives for the 

market. 

It is not enough simply to vilify fast trading. Regulators and exchanges are working to identify and address specific bad actors and 

specific bad outcomes such as false, misleading, or deceptive practices. 

To improve our own regulatory program and the regulatory programs of exchanges around the world, in 2010 Nasdaq acquired 

The SMARTS Group, the leading provider of automated surveillance for post-trade high-speed trading. 

As you have heard, our markets are complex: 13 exchanges and 

40-plus alternative venues. Each venue has its own systems and 

competes for orders. Each has its own order types and is continually developing new ones with input from investors. 

While some order types have come under scrutiny, let me be 

clear: Nasdaq OMX order types do not provide advantages to certain users allowing them to jump ahead in line at a given price 

level. We believe that order types should be designed to make our 

markets better, improve transparency, and improve price discovery. 

We go through a rigorous process to get our order types approved 

and to expose our innovative ideas to the market through the notice and comment period at the SEC, often allowing competitors to 

mimic our ideas and beat us to the market. That is part of our SRO 

burden. To help members understand our order types, we recently 

9 

posted on our Web site a plain-language list and a description of 

Nasdaq’s order types. 

We are passionate about the critical role we play in capital formation, and while it presents challenges to everyone, ultimately we 

believe technology is an important part of that solution. We appreciate the opportunity to testify. I look forward to your questions. 

Chairman REED. Thank you very much, Mr. Noll. 

Mr. Gasser, please. 

STATEMENT OF ROBERT C. GASSER, CHIEF EXECUTIVE 

OFFICER AND PRESIDENT, ITG 

Mr. GASSER. Chairman Reed, Ranking Member Crapo, and other 

Members of the Subcommittee, thank you for the opportunity to 

testify this morning on the topic of rules of the road for computerized trading venues. On behalf of a leading agency broker, my goal 

is to offer an unbiased, fact-based view on the current state of U.S. 

equity market structure. 

ITG is a New York Stock Exchange-listed company with 17 offices across 10 countries and nearly 1,100 employees. As an agency 

broker, ITG provides trading services, technology, analytics, and research to a wide array of leading asset managers. Throughout our 

25-year history, we have worked in partnership with major mutual 

funds, pension funds, and other institutional investors, innovating 

to improve trading and investment performance. In my testimony 

today I would like to offer a brief overview of current market structure, discuss some recent events which have impacted investor confidence, and look at some ways to restore this confidence. This 

morning we hope we can infuse some data and analysis into the 

debate. 

Competition amongst market centers and broker-dealers 

spawned by the passage of Regulation ATS in December 1998 has 

led to intense competition for liquidity and ultimately to fragmentation. This fragmentation has undoubtedly introduced complexity into our marketplace but has been a positive force in reducing execution costs. 

Technology has provided market participants, including retail investors and mutual funds, with the tools necessary to aggregate liquidity and derive the full benefit of free market competition for 

order flow. 

Global asset managers, as fiduciaries, have an obligation to 

achieve best execution. The global market standard requires all 

asset managers of size to measure the quality of their execution 

and its effect on the investment process. ITG is the world’s largest 

provider of TCA, or transaction cost analysis. We measure millions 

of trades executed on behalf of hundreds of global asset managers. 

Our TCA data clearly demonstrates that institutional investors 

have benefited greatly from the evolution of U.S. market structure. 

Over the past 12 years, there has been a 70-percent decrease in average total equity trading costs in the U.S. As the data indicates, 

market structure is not broken. The current ecosystem of displayed 

and dark markets has resulted in significantly reduced costs that 

in almost all cases have been distributed back to investors. There 

is no evidence to suggest that competition and fragmentation have 

damaged price discovery or harmed capital formation. 

10 

ITG is not a market maker, and we do not take on proprietary 

positions. In other words, we do not have ‘‘skin in the game’’ when 

it comes to the debates around broker internalization, as our system provides ‘‘meaningful price improvement’’ to buy-side investors 

as described in Regulation NMS. 

Based on our data, we would conclude that broker-dealer 

internalizers, or ‘‘broker-dealer dark pools,’’ as they are sometimes 

known, provide a useful permeable layer between the client and 

the displayed markets. Brokers have a fiduciary responsibility to 

their clients while exchanges do not, and these liquidity pools 

would not exist unless benefit was derived by the customer. 

Most recently, Australia and Canada have imposed regulations 

around internalization that will provide us with data sets to examine when considering the implications of potentially taking similar 

action here in the U.S. Early returns do not look promising in 

terms of the effects on liquidity and trading costs. Regressing to an 

oligopoly of exchanges is clearly not the answer. 

Unfortunately, the evidence also suggests that the investing public has become disenchanted with equities. According to the Investment Company Institute, over half a trillion dollars has been 

pulled from U.S. equity mutual funds since the start of 2008. 

Much of this can be attributed to the reduced risk appetite of 

baby boomers and the relative safety of bonds supported by easy 

monetary policy. 

The May 2010 Flash Crash, the Facebook IPO, and Knight Capital’s trading debacle this past summer provide little comfort that 

U.S. equity markets are a safe place to trade or invest. Add in the 

suspicions that the investing public has about high-frequency trading and its perceived impact on the quality of markets, and you 

have a recipe for anecdote and conjecture overcoming facts and reason. 

In our opinion, we can focus on five tangible initiatives to accomplish restoring confidence: 

The SEC’s Consolidated Audit Trail, if implemented properly and 

cost effectively, will give investors confidence that regulators can 

police bad actors and predatory strategies. 

The consistent application of the market wide circuit breakers 

and the Limit Up/Limit Down Plan to all market centers would 

likely prevent a market disruption of Flash Crash proportions. 

Costs should be borne by market participants who create excessive quote traffic without executing order flow. 

Market data should be distributed to all market participants 

equally. 

Marketwide risk should be monitored at a central clearinghouse 

that would have the ability to terminate a broker-dealer’s 

connectivity to the national market system in the event of a rogue 

program released to the market. 

These five measures would give the investing public the protections they need to confidently invest in the world’s strongest and 

most resilient market while still deriving all of the cost savings and 

liquidity benefits which have been achieved over the past decade. 

Last, as the regulations called for by the Dodd-Frank Act begin 

to take hold across other asset classes, the lessons we have learned 

in equities will be applied to those markets. Price discovery, central 

11 

clearing, transaction cost analysis, and pre- and post-trade transparency will become as deeply integrated into foreign exchange and 

fixed-income markets as they are in equity markets. And innovation will come more quickly to those markets because of the lessons 

learned. For this reason, our equity market structure is all the 

more important to our broader financial system. 

Thank you again for the opportunity to share our views on these 

important questions. I would be happy to answer any questions at 

the appropriate time. 

Chairman REED. Thank you very much, gentlemen, for your excellent testimony. One of the major driving forces of this discussion 

is technology, and one of the things about technology, it tends to 

make good things better and bad things worse. So when it comes 

to markets, there has been, I think, evidence showing a decrease 

in spreads and savings to investors, but I think our job is to applaud those good things, but also look very seriously about what 

the costs might be because of this new technology and new markets. And it raises a threshold question about—and you all alluded 

to it, but let me start with Mr. Gasser—the complexity of markets. 

I think the dark pools, internalization, in fact, I think every one 

of the exchanges—and correct me, Mr. Noll and Mr. Mecane—has 

their own dark pools. Is that accurate? 

Mr. NOLL. We do not have—— 

Chairman REED. You do not have a dark pool? Do you? 

Mr. MECANE. We have a small investment in an ATS. 

Chairman REED. But the trend is that the proliferation of dark 

pools, the internalization, and it goes to the issues which—your 

question about investor confidence, investor enthusiasm. Price discovery, is that—even if you are saving prices, in the dark pools is 

price discovery for the average investor being compromised or complicated? What about capital formation for new companies? A lot of 

this trading is being done in a very small range of stocks, not all 

the stocks that are listed. So can you talk, again, accepting the 

benefits, what are the costs, the complexity, and what things might 

we do—and I would like everyone to respond—to make it a little 

simpler and a little more easy to bear? 

Mr. GASSER. Thank you, Senator. I think as we think about complexity, as I alluded to earlier, I think we need to retain the benefits that we have derived from current market structure while 

making the markets less opaque to retail investors. There is no evidence to suggest that the market share of internalization or trades 

that are executed away from the exchanges is harming price discovery. There has been a lot of academic focus on that. So we tend 

to go back to transaction costs and how they affect the institutional 

investor, which is our core constituency. 

But, clearly, the complexity, it has given rise to this view that 

there is a certain opacity to our marketplace. I would say that, you 

know, the IPO market in the U.S. has actually been leading the 

globe in terms of capital formation. It is not a great number this 

year, but I would submit to you that it is a function of the economy, of Sarbox, of some of the things that have been certainly imposed on growth companies that make it difficult for them to think 

about the critical mass they need in terms of market capitalization, 

to really think about the public equity markets as opposed to a priVerDate Nov 24 2008 16:26 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\12-18 COMPUTERIZED TRADING VENUES -- WHAT SHOULD THE RU
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vate equity market or a recapitalization somewhere else on their 

balance sheet. 

So at the end of the day, I think there is a lot of market forces, 

a lot of macroeconomic forces that come to bear as well on that 

equation. But I think in terms of speed and latency, we have gotten 

to a place now where it is a law of diminishing returns. Do we need 

to trade in micro seconds? I do not think so. That might be heretical for someone who has spent almost their entire professional career trying to improve markets through technology at delivery. But 

at this stage of the game, micro seconds are, I think, a vast overachievement, if you will, technologically in terms of the benefits 

that people derive from it, and it just creates more and more suspicion that the market is controlled by dark forces sitting in a data 

center and deploying more and more servers and software to attack 

a business motive. 

So I think at this stage of the game, there are some very clear 

things—consolidated audit trail, clearly. If folks have confidence 

that the SEC can enforce and regulate—and I think by their own 

admission it has been very difficult to do that given the complexity 

of the market—I think it will restore quite a bit of investor confidence. So I think the CAT, as it is commonly referred to, is very, 

very important. 

Chairman REED. Let me ask Mr. Noll and the whole panel to respond to this question. Then I will ask Senator Crapo for his questions, and then we will do a second round. 

Mr. Noll, the same issue, the general issue of complexity, and 

also I think when you talk about the SEC, there are two issues: 

one is the authority and one is the resources. So we have to make 

sure that if they get authority, they also have resources, but that 

is an aside. 

Mr. Noll, please, your comments. 

Mr. NOLL. Thank you, Chairman. A couple of comments around 

this. 

First of all, I do think the markets are incredibly complex. I disagree with Mr. Gasser, respectfully, that the increase in off-exchange trading is not harming price discovery. We have started to 

see some evidences of that. I want to be clear, though, however, in 

responding to that. We do think there is an important role for offexchange trading. We think there is an important role for ATSs. 

We think there is an important role for dark trading. 

Our concern is really about the primacy of price discovery and 

price formation. And to the extent that those are being negatively 

impacted by current market structure, we think that those issues 

should be revisited as we move forward. 

Other issues, you know, clearly to address more directly your 

question about the SEC, I do believe that they have the regulatory 

authority here. I do think that they are incredibly interested in this 

topic, concerned, and working very hard to address some of these 

issues. Some of the steps that we have taken as an industry, like 

the adoption of CAT, will give them some of the tools that they 

need in order to correctly assess what is going on in the marketplace as we move forward. 

Clearly, they are also deeply embedded in some of the other 

issues that we are debating and rolling out and implementing. CirVerDate Nov 24 2008 16:26 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\12-18 COMPUTERIZED TRADING VENUES -- WHAT SHOULD THE RU
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cuit breakers were the first of many. They are intimately involved 

with the Limit Up/Limit Down scenario currently being worked on 

by the industry as we roll that forward, and we have to address 

Senator Crapo’s earlier comment. The exchanges, working with the 

industry, are working with the SEC to adopt a format of kill 

switches that will prevent runaway algorithms from damaging the 

marketplace. 

So I do think that they certainly have the regulatory authority, 

they certainly have the commitment to be involved in this space. 

And to finalize my answer here, I think one of the important things 

to look at is complexity in and of itself is not a bad thing. Technology in and of itself is not a bad thing. What we should be doing 

around market structure is making sure that we can recover from 

incidents and that we do not create scenarios whereby incidents 

are much more likely to happen. 

And so much of the efforts that we are working on at Nasdaq 

and with the industry and our fellow exchanges are designed really 

to either recover from incidents or prevent new incidents from occurring. But the competition around the development and innovation around new market structure, new developments in the marketplace, is important. I think it adds value, and I think it brings 

real benefits to investors. 

Chairman REED. Thank you. 

Mr. Mathisson, please, and then Mr. Mecane. 

Mr. MATHISSON. Thank you. Mr. Noll just commented on the 

move to off-exchange trading, and I would actually dispute the data 

that there has been a move to off-exchange trading. In October of 

2012, 33 percent of the volume was traded on what is called the 

TRF, the Trade Reporting Facility, which is the trading that is 

done off-exchanges. If you go back 5 years to October of 2007, 30 

percent of the volume was traded on the TRF or off-exchange. We 

have seen a fluctuation between 25 and 35 percent of the volume 

done off-exchange every month for the last 5 years, with no exceptions. There is no trend if you look at the long term of flow actually 

moving off the exchange. You have to get pretty creative in how 

you cut the data to come up with a trend that the flow actually is 

moving off. So, you know, I think that there has not been an increase in off-exchange trading. That is important to acknowledge. 

Now, I concur with Mr. Gasser that we do not want to lose the 

benefits of competition, and we have seen many of them, as every 

panelist acknowledged in their testimony. At Credit Suisse, we are 

not in favor of setting any type of a speed limit or doing anything 

drastic. We would not be in favor of setting a 55-mile-per-hour 

speed limit across the board. We think the solution is to put proper 

safety mechanisms in place, to put seat belts and air bags in the 

cars, but not necessarily to say that people are not allowed to drive 

at the speed that they want to drive. 

We believe that some of the things that the SEC has already 

done—the Limit Up/Limit Down rule, marketwide circuit breakers, 

market access rules, and the discussion of kill switches—are the 

right solutions and do put the right safety mechanisms in place to 

allow the markets to continue to enjoy the benefits of competition. 

Chairman REED. Thank you. 

Mr. Mecane, please, and then I will recognize Senator Crapo. 

14 

Mr. MECANE. Thank you. While I think we would all agree on 

this panel that markets for the most part have improved significantly, we are concerned about the direction of some of the evolution of our markets. And I think it is also important to acknowledge that while we have had a lot of practices evolve over the period that markets have improved, not all the practices that existed 

necessarily contributed positively to some of the changes that we 

have had in the marketplace. 

And, while we are supportive of competition, some of the evolution that has happened has been a little bit unintended, and the 

two things that we have highlighted in a lot of our testimony and 

statements is around ensuring that from a public policy standpoint 

we have the right incentives in place for people to display orders 

publicly in the public markets, and ensuring that we have similar 

levels of rules and oversight for activities that occur on different 

venues. 

You know, I would respectfully disagree with some of Mr. 

Mathisson’s statements about the level of off-exchange trading, and 

it gets into a little bit of micro structure complexity around the 

ECNs that did publicly quote back in the early periods, and we are 

happy to address that offline. But, I think what it highlights is our 

markets have become extremely complex. I think the SEC and the 

industry have done a good job of responding to some of the crises 

that we have seen over the last few years, but clearly there is more 

that can be done. 

One of the things that we would encourage is because the markets are so complex and because when you do try to address one 

issue in isolation, it raises a host of other questions and issues. We 

have suggested that a holistic review of market structure, as the 

SEC had intended back in 2010 with the Concept Release on Equity Market Structure, is probably the best way to try and address 

all the issues that are being raised on this panel because it is difficult to address any of these issues in isolation. 

We would also suggest that perhaps one area that is discussed 

but not fully addressed yet is having testing standards in the industry. I think we need to be careful not to be too heavy-handed 

with that type of approach. But certainly having some best practices, some requirement for firms, trading firms, trading venues to 

have policies and procedures that address their testing standards, 

how they roll out new code, and setting that as a standard in the 

industry could certainly be very helpful. And as Mr. Noll highlighted, all of the Members of this Committee are involved in the 

industry discussions around potential kill switches that Senator 

Crapo mentioned before and working with the SEC about ways to 

potentially implement safeguards along those lines. 

Chairman REED. Thank you very much. 

Senator Crapo. 

Senator CRAPO. Thank you, Mr. Chairman. 

Let me follow up on the kill switch question. I guess I will start 

with you, Mr. Mecane. What progress is being made right now in 

implementing the idea of the kill switches since the SEC Roundtable? 

Mr. MECANE. Sure. It is a good question, and there is a very active dialog around the kill switch concept. As you know, all the 

15 

SROs and a number of industry firms, including the firms on this 

panel, were involved in discussions leading up to the roundtable 

about a possible framework for a kill switch. And subsequent to the 

roundtable, we have all engaged in a much more detailed assessment of how a kill switch could work. We have been working with 

DTCC, and, you know, as they say, the devil is in the details. It 

gets very complex once you start designing it and outlining it, and 

I believe we are getting close to a possible framework as we iterate 

through the different possible ways to implement something like 

that in the industry, you know, what parts should be mandatory, 

what parts should be optional, whether it should be at the clearing 

level, whether it should be at the SRO level. All these types of 

issues are under discussion, but I think we are hopeful to have 

something to report in the first quarter next year. 

Senator CRAPO. Thank you. 

Let me turn to you, Mr. Gasser. You indicated that you felt it 

would be very helpful for a central clearinghouse to monitor market risk. Could you explain that a little better? 

Mr. GASSER. Yes, Senator. You know, all of us have a substantial 

amount of capital committed to the business of clearing client 

trades, and they are held within the national clearinghouse, and 

there is a central clearing facility here in the U.S. which is actually 

very effective and much different in terms of global market structure. So it is very efficient, very effective. We have quite a bit of 

capital on deposit to support all of our trading activities there. 

One issue, I think, that is a relatively scary one for the industry 

is that Knight gave us some interesting lessons in terms of a potential for a firm to blow through their capital and for an unprecedented call on other firms’ capital at one stage or another to fill the 

gap. So that event I think had some interesting implications for not 

only the national market system, but for individual broker-dealers 

and their participation within the central clearinghouse. 

So when I alluded to that—and I know that Joe and Eric and 

others, and Dan and our firms, have been involved in this dialog. 

One of the things I think folks keep coming back to is that notional 

limitation that we should all be held accountable to. When you 

blow through that, then you are now at a place where you may 

substantially affect other firms and their capital on deposit. 

Senator CRAPO. Well, thank you. 

Mr. Noll, I will ask you this question—well, actually, I think Mr. 

Mecane and Mr. Noll both in their testimony indicated that you 

support a pilot program for an increased tick for the smaller capitalized companies, so I suppose the question would be for Mr. Gasser or Mr. Mathisson. Do you agree with that approach as well? 

Mr. MATHISSON. We would support a pilot program to test it out. 

We think it would be a significant change to the market structure, 

and as such, it should be done cautiously. But we would definitely 

support a pilot program if explicit metrics and goals were set out 

ahead of time to define success. 

Senator CRAPO. Thank you. 

Mr. Gasser. 

Mr. GASSER. We would also support that, Senator, and think that 

from the perspective of capital formation it has potentially positive 

or could have positive effects. 

16 

Senator CRAPO. Thank you. And I guess this question is to everyone but Mr. Mathisson since I am going to ask about his recommendation that the immunity of SROs be addressed in this system. Do you all agree with Mr. Mathisson’s recommendation? Mr. 

Mecane. 

Mr. MECANE. Sure. The concept of being an SRO is founded on 

or historically based on the idea of having obligations to the market 

and getting certain benefits for meeting that obligation. Some of 

the obligations include the rule-filing process, the oversight that we 

have, the regulatory obligations that we have, and some of the benefits that we accrue are economic in nature. And we would encourage a review—which, again, I think falls into the SEC’s holistic review of market structure—of the benefits and obligations of an 

SRO and what an SRO means. 

I think it is important to note that SROs by their nature do not 

have blanket immunity. SROs have immunity when performing 

certain of their regulatory functions. And beyond that—and most of 

those regulatory functions are around our function as a listing market. And when you expand beyond our regulatory responsibilities, 

we have immunity that is set contractually with our members. 

We would encourage, again, a holistic review of all the costs and 

benefits of being an SRO. Most of the items Mr. Mathisson raised 

are focused on reducing the economics for exchanges and transferring a lot of that benefit back to the investment banks. Again, I 

think that should be part of the holistic review that would potentially be done. 

Senator CRAPO. Mr. Noll. 

Mr. NOLL. Not unsurprisingly, I disagree with Mr. Mathisson on 

this. You know, I do think that there are several things about the 

exchange SRO model that are important to recognize as we talk 

about our immunities and our limitational liabilities, not the least 

of which is our obligation to provide fair access to all investors 

under all circumstances. So exchanges by their very definition exist 

to perform the price discovery function by gathering trading interest from all participants who want to participate and conduct that 

activity in a fair, transparent, accessible manner for all market 

participants. 

Under current market models, no other market participant has 

those same obligations, and that also performs what I think is a 

very critical role in the marketplace of establishing price discovery, 

providing liquidity, and providing information to not only investors 

and traders but issuing companies about how capital should be 

formed, how it should be allocated, and the risks in the marketplace. And I think because of the value of that function in the marketplace, the immunities are well established and should be enforced. 

Senator CRAPO. Mr. Gasser. 

Mr. GASSER. Yes, I would agree with the examination as part of 

a holistic examination of U.S. market structure. We were actually, 

I think, very close to that—obviously, this issue was not on the 

table. It was pre-Facebook, back in 2010. But we were very close 

to what I thought was the end of a long comment process, industry 

engagement, exchange engagement, and that was obviously a 

pushback as a result of the Flash Crash. I think bringing that back 

17 

on board and engaging the same way with the Commission 

amongst all market participants I think would be a good thing. 

In terms of immunity, I mean, I think we are all—as a broker, 

as an agency broker, I think we are all feeling the same thing. I 

do not want to speak for all brokers, but we are all feeling the 

same thing. There has got to be consequence for a system-wide failure of the type that we have experienced in the Facebook circumstance. Our clients suffered. Other broker-dealers suffered. 

Clearly, there were some decisions made that were, with all due respect, the wrong ones in terms of opening that stock. That is a 

very, very sharp contrast to the BATS failed IPO where actually 

they walked away when they realized that the software was not 

performing properly. 

That does not mean that electronic markets cannot open IPOs. 

I mean, they have done so successfully. Archipelago, which Joe’s 

firm acquired many years ago, did basically an electronic auction 

and was very successful. 

So the devil is in the details in terms of the technology that we 

all operate today and its effect on the outcome, but if the outcome 

is significantly negative and folks are harmed, there has got to be 

some consequence felt. We certainly would feel that consequence if 

we had a failure within our system and it was attributed to our 

technology and acting as a fiduciary on behalf of a client. 

Senator CRAPO. Thank you. 

Chairman REED. Thank you, Senator Crapo. 

Senator Hagan, please. 

Senator HAGAN. Thank you, Mr. Chairman, and thank you for 

holding this hearing. I think it is very interesting and timely. 

I just wanted to ask a couple of questions, one having to do with 

the dark pools. Mr. Mathisson, this question is, first of all, for this 

part directed to you. I have got definitions of dark pools, but I 

would like to have you give me your definition of a dark pool. 

Mr. MATHISSON. Sure. A dark pool is a trading system that is organized under Regulation ATS that does not show bids or offers. 

So it is a computerized trading system where people enter a bid or 

an offer, say a buy of 100,000 shares of IBM, that would not be displayed publicly. It just sits within the computer. If somebody happens to come in with a sell order of 100,000 IBM, then the two 

cross. But the difference between a dark pool and a displayed ATS 

or a displayed order on an exchange is that the displayed order 

gets shown to the world, so everybody sees there is a 100,000-share 

bid for IBM. In the dark pool, it just sits in the hope that somebody 

might bump into it. 

Senator HAGAN. How much of the trading is done on dark pools 

now, percent-wise? 

Mr. MATHISSON. The best numbers out there are considered to be 

Rosenblatt survey numbers, and Rosenblatt puts it at about 14.5 

percent of volume. 

Senator HAGAN. And has that been growing since they have been 

introduced after 1998, or however long? 

Mr. MATHISSON. That is right. It was probably—— 

Senator HAGAN. Has it been growing in the last—— 

Mr. MATHISSON. It has been growing, yes. It has picked up a lot 

of volume at the expense of the TRF, the Trade Reporting Facility. 

18 

Broker internalization is down from about 26 percent to 15 percent, 

and that 11 percent of the market moved to dark pools. So we have 

seen broker internalization go down. We have seen dark pool volume go up from approximately 4 percent 5 years ago to 14 percent 

today. 

Senator HAGAN. And what is typically the average trade in a 

dark pool? 

Mr. MATHISSON. The average trade sizes are small. I mean, they 

vary for different pools. Some pools are specifically aimed at crossing blocks. Mr. Gasser runs a pool that has a fairly high average 

crossing size. Some pools are as low as 200 shares, their average 

crossing size, which is comparable to exchange average size crosses. 

Senator HAGAN. OK. Thank you. 

Mr. Gasser, ITG has observed in the past that the traders in 

these dark pools will often experience adverse selection, and a trader will see a stock move in his or her favor immediately after he 

or she executes a block trade in a dark pool. The question is: Can 

you discuss why the adverse selection is occurring in dark pools? 

And how does the lack of transparency in these venues contribute 

to adverse selection? 

Mr. GASSER. Yes, Senator. Actually, ‘‘dark’’ is probably an unfortunate, nefarious term. 

Senator HAGAN. I agree with that. 

Mr. GASSER. But I—— 

Senator HAGAN. Why do we call it ‘‘dark’’? 

Mr. GASSER. Because these are orders and executions that are 

not exposed to the lit market, so basically a quote that you can find 

on the screen. So I think that was basically the origin of ‘‘dark.’’ 

ITG has been operating a dark pool for 25 years, and that is 

POSIT. POSIT is the granddaddy of dark pools, if you will. It is 

a system that brings together institutional investors, allows them 

to interact with one another directly and anonymously, so they do 

not know size, they do not know who their counterparty is, and we 

improve price. So, in other words, we trade at the midpoint, and 

then we report—and this is very important. We report that trade 

immediately to the TRF. So there is complete transparency in 

terms of the trade having been done and now reported to the tape. 

As Dan alluded to, our average execution size in our block trading system is 29,000 shares, so it is significantly in excess of the 

average size cross, and this is because it is an institutional constituency. 

I think over time what has happened over that 25-year period 

that brings us to today is that internalization pools have become 

more multiconstituent, if you will; in other words, folks are not 

only crossing institutional flow, they are crossing retail flow. They 

are acting as market maker. There is high-frequency folks or, you 

know, strategies that are sitting within those pools and interacting, 

and they look much more like exchanges. So I think that has been 

a very steady evolution over time. 

To get to your point about adverse selection, one of the things 

that we find is that, given the opportunity for institutions to interact with one another directly, that is the highest—and I think Dan 

would acknowledge that as well. That is the highest-quality execution that one can achieve. 

19 

Now, one order may be larger than the other. That is unavoidable in terms of negative selection. In other words, if you are a 

buyer and the seller is ten times your size, ultimately the price is 

going to go down if you extinguish that order. But that is what I 

would describe as organic to the environment we operate in. 

What is much more difficult to control is that once you are forced 

into the lit market and you are forced into other trading venues, 

you now have less control over who you are interacting with. And 

so adverse selection can come from dark pools. It can come from 

lit pools. It can come from a variety of different places. And there 

are predatory strategies that we find every day, folks that are trying to, you know, basically probe liquidity pools and find the size 

of your order, the limit of your order, and are trying to trade 

against that order. 

Senator HAGAN. Do you think that occurs in transparent pools 

versus the dark pools? Where is it most likely to occur? 

Mr. GASSER. I think they are interchangeable. I think they come 

in and out of those markets, you know, looking for—you know, it 

is—— 

Senator HAGAN. Do the rest of you all agree with that? 

Mr. NOLL. I have a slightly different view of that. I think, you 

know, Mr. Gasser said something I thought was illustrative, which 

he said dark pools look a lot like exchanges, except I would make 

some real distinctions around that. You know, one is they do not 

have to display prices that are accessible by outside investors. They 

are not required to take all investors on an equal and fair basis. 

The rules are not public. Their order types are not filed for a public 

notice and comment. So there are some significant differences, and 

I think that is where our concerns as exchange operators come in, 

which is to avoid the negative externalities of off-exchange or dark 

trading, which I will reiterate has real value for investors, and 

POSIT is one of the real benefits for institutional investors in the 

marketplace. It does what it is intended to do, which is allow buyside investors to find liquidity in an efficient, information-less way. 

But I do think that our concerns are really about asymmetrical 

information leakage, fair access, and nondiscriminatory activities. 

Mr. GASSER. Just for clarity, when I said some dark pools look 

like exchanges, I was actually alluding to the average execution 

size, so other dark pools that are outside the POSIT system. 

Senator HAGAN. Mr. Noll, let me ask you a question having to 

do with the minimum price variation. In the U.S., the MPV for all 

stocks of a dollar is one penny, and in Europe, their minimum price 

variations are less uniform. How do MPVs impact high-speed trading? And particularly I am looking at like a stock—at Google at 

$670 a share versus B of A at $9.50 a share. 

Mr. NOLL. I think one of the things that we have noticed in the 

marketplace is that actively traded securities, not necessarily limited to stock price, so that certainly is a factor to consider here, but 

actively traded securities trade extraordinarily well in our national 

market system today. There is price discovery, there is liquidity, 

there is activity. 

I think where we become very concerned is outside of those actively traded names, and European markets, as you alluded to, 

Senator, use what they call an ‘‘intelligent tick size regime’’ to deVerDate Nov 24 2008 16:26 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\12-18 COMPUTERIZED TRADING VENUES -- WHAT SHOULD THE RU
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termine what the appropriate tick size is based on a variety of 

characteristics for the underlying security, a lot of which have to 

do with liquidity in addition to price amount, available float, size 

of the bid-offer spread. And so where we are interested in looking 

at this as a pilot—and I agree with the rest of the panel here that 

a pilot is a good thing for us to do here, particularly if set up well— 

is to uncover ways in which we can get better liquidity in less actively traded names and smaller cap securities. And I think minimum price variation will help us do that. I think a pilot will help 

us address that as we go forward. 

Senator HAGAN. Thank you. 

Thank you, Mr. Chairman. 

Chairman REED. Well, thank you very much, Senator Hagan, for 

your excellent questions. 

Let me just begin another round, and if Senator Crapo returns, 

obviously, I would invite him to join, too. 

I think we all recognize that the interrelationships of these different issues are such that requires across-the-board, marketwide 

approach, holistic in Mr. Mecane’s terms, but I think we also have 

to look at some sort of specific issues and, therefore, we have been 

talking about dark pools and ATSs, et cetera. 

Just with respect to stepping back, the national market system, 

my sense, the motivating force was to make sure that orders sent 

to the trading platform were the best price, regardless of where the 

orders originate. And with these dark pools in particular, that does 

not seem to be the case. Is that a fair—since to be a member of 

a dark pool, that is not something that is—anyone can do or—let 

me use that as a prelude to ask Mr. Gasser to comment and others 

to comment. 

Mr. GASSER. I keep coming back to the notion of a broker being 

a fiduciary on behalf of the client order. So we have very, very— 

the U.S. has very prescriptive regulations about how we report our 

execution quality, how we relate that back to customers. Obviously 

transaction cost analysis is core to what we do as a firm. So, you 

know, the highest priority is not to internalize order flow within 

POSIT for us. It is to find the best price. So that could exist in the 

lit market, other dark markets, or our system. 

Now, fortunately for us, I think we can demonstrate a long history of very, very substantial cost savings, trading cost savings 

within our dark pool. But that is part of an ecosystem that we are 

forced to aggregate with technology every day, and we do not aggregate it based on being able to internalize it. We aggregate it 

based on the ability to find the best price, and we know that we 

are all—as brokers, we are going to be measured by the customer 

at the end of the day, and the customer votes typically with their 

feet in terms of quality of execution. 

Chairman REED. Mr. Mecane, do you have a comment. Then Mr. 

Mathisson, because this is—— 

Mr. MECANE. Sure. Just to your question, Senator, I think it is 

a slightly different issue, at least from our perspective. As far as 

I know, most executions, dark pools, wherever, do happen at what 

the best price is in the public markets. From our standpoint, there 

is a slightly different issue that we think should get addressed, 

which is whether the person who is setting that best price in the 

21 

public markets is properly incentivized, meaning the person who is 

creating that best bid or offer price very frequently, roughly onethird of the time, will see trading happening at the price that he 

is displaying. And while the executions that are happening away 

from the public market are at that best price, the concern that we 

have from a broader public policy standpoint is whether there is diminished incentive for people to display their orders publicly if a 

significant amount of activity happens in front of their displayed 

price. And so when we have talked about incentives for people to 

display liquidity, whether the right balance is in place to ensure 

that the person who sets the best price, and Regulation NMS in its 

main mission set out properly incentivizing the public display of orders as its objective, we would just highlight that we should probably step back and review whether we think the balance that has 

evolved is the right one. 

Chairman REED. Mr. Mathisson? And then I have another question. I will change the topic slightly. 

Mr. MATHISSON. Yes, when traders decide whether to put out a 

bid order on an exchange or on a displayed ATS or put one into 

the dark, on a dark pool, they are making a tradeoff decision. If 

you show it publicly, then you get what is called NMS protection, 

meaning that nobody can trade through your price. So, in other 

words, if I show a bid at 27.50 into the national market and I 

choose to display it, then a trade cannot occur at 27.49 or lower 

anywhere. It cannot occur in a dark pool, it cannot occur anywhere. 

So I have what is called protection. Now, that is the plus side. 

The negative side of doing it is that I show this bid which might 

scare the price up, and that is a tradeoff that traders decide to 

make, and they are constantly weighing whether it is better to display it and get protection and potentially attract a seller or whether it is better to put it in a dark pool, take on a lower fill rate, but 

have less chance of scaring the price. And that is essentially what 

trading is. It is a tradeoff between what we call signaling risk and 

fill rate. And that is what trading algorithms do. That is what people, traders, are deciding. And so the system allows traders to 

make that choice. 

Now, Regulation NMS does ban the trade outside of the trade 

price. Once you put that price up, trading cannot occur in a dark 

pool at a different price, and the dark pool trades are reported to 

the tape immediately, so the whole world does know about them 

after the fact, and they do occur at or within the national best bid 

or offer. 

Chairman REED. Thank you. This testimony and the questions 

have been very thought-provoking, so you can anticipate additional 

questions in writing, in fact, some detailed questions, and I know 

you will respond. 

Let me change, again, quickly from my last set of questions, and 

then I will recognize Senator Crapo again. 

We do understand this is a systemic approach—we should take 

a systemic approach, but issues crop up. One of them is the order 

type issue, which is getting a lot of attention. The proliferation of 

order types adds to the complexity, raises lots of questions, and it 

goes back to sort of the public perception of markets, too. Are these 

orders being written to induce people to come into your market to 

22 

give them tailored, bespoke approaches to the market which other 

particularly retail investors do not have? Are there too many of 

these? Should there be a standard set of order types that every 

market alternative as well as exchanges follow? And this general 

question of order types I think is important, at least to broach at 

this point. So let me start quickly—and, again, because I want to 

recognize as briefly as possible Mr. Mecane and then we will go 

down the panel. 

Mr. MECANE. Sure. It is a good question, very topical. I think 

there are two main points that I would draw out. One is that it 

is important to recognize why a lot of these order types have 

evolved. Some of them are to comply with Regulation NMS; some 

of them are to guarantee economic results; some of them are to 

compete with some of the practices, customer segmentation, et 

cetera, that happens off-exchange. So I will go back to one of my 

earlier points, that the order type evolution is largely because the 

market structure that we have creates the need or the demand for 

different order types to replicate certain behaviors, some of which 

used to happen nonelectronically. But, again, my first point is if we 

want to review the order type issue or simplify the markets, we 

should simplify the market structure that they operate in, and 

there will be less need for these order types. 

The second point I would just make is that it is important to recognize that all exchange order types are publicly filed, reviewed by 

the SEC, put out for public comment, disclosed, and can be utilized 

by any member of an exchange. Now, if there are any order types 

that are not adequately disclosed or not described accurately in the 

filings, that I think is a separate issue that needs to be addressed. 

But at least in terms of the intent of the process, all the rule filings 

should describe order types and order type behaviors, which, again, 

is something that is very distinct from how nonexchanges operate. 

Dan’s and Bob’s firms have algorithms. There are probably more 

algorithms for institutional customers in the industry than there 

are order types for broker-dealers to use. So I think it is just the 

evolution of our complex market structure. 

Chairman REED. Mr. Mathisson, just for clarification, is there a 

requirement for ATS to submit order types or algorithms for review? 

Mr. MATHISSON. No. I mean, they do get filed in what is known 

as a Form ATS, but it is not reviewed and subject to approval. You 

just tell the SEC what you are doing. So that is correct. 

Chairman REED. All right. The order type issue. 

Mr. MATHISSON. I agree with Mr. Mecane that complex orders— 

that the line between algorithms that broker-dealers do and the 

line between complex order types that exchanges offer is blurry, 

and there are a lot of similarities between the two. But I think that 

the broker-dealer is the right place to have that complexity, and 

the reason is because the broker-dealer is a fiduciary to the client. 

The broker-dealer has an error account, and the broker-dealer has 

liability. And complex order types are more likely to fail than simple matches. I would be in support of a market system where ATSs 

and exchanges only offer very simple order types, just buy-and-sell 

matches, market on close, market on open, just the traditional, 

most simple order types, and put that complexity within a strucVerDate Nov 24 2008 16:26 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\12-18 COMPUTERIZED TRADING VENUES -- WHAT SHOULD THE RU
23 

ture where there is an error account, there is a fiduciary responsibility, and there is liability if things go wrong. The more complicated an order type gets and the more complicated an algorithm 

gets, the more likely it is to fail, and so the question becomes who 

eats the error when that fails. With an exchange, the answer is— 

you know, the exchange does not eat the error. The error gets 

borne by the broker-dealer who used the order type. 

Now, finally, the order types, while they are reviewed—all the 

exchange order types are reviewed by the SEC. The Wall Street 

Journal put out a piece that said every single order type that has 

ever been submitted by the exchange has been approved. There has 

never been one that has been rejected. You know, so I would question how thorough and meaningful a review that actually is. 

Chairman REED. Thank you. 

Mr. Noll? And then again, to allow Senator Crapo, your brief 

comments. 

Mr. NOLL. Well, factually what Mr. Mathisson says about order 

types, from my own experience around the SEC review of order 

types and order type introduction, we have withdrawn many more 

order types at the suggestion of the SEC than we have had approved. So while the public notice and comment period does, in 

fact, exist and so I do think historically order types have been improved, many, many order types, many variations on order types 

have, in fact, been asked—we have been asked by the SEC to withdraw them for a variety of reasons, having to do with their view 

of what is the appropriate market structure. So they do not go 

unreviewed I guess is the point I would try to make. 

I agree with Mr. Mecane on most of what he said. I think order 

types have evolved in various ways, some due to regulatory reasons, Regulation NMS being the primary one; but also because in 

an electronic market—and make no mistake about it, our markets 

are electronic today—order types fill the function and allow the 

function of what used to be done manually to be done electronically 

and with technology. And order types are a tool to do that. And I 

think it is important to recognize that they need to be applied fairly, they need to be made available to everyone, and they have to 

be used so that they are not favoring one type of party over another 

in an unfair way. And I think we have strived to achieve that, and 

I think for the most part we have been successful with that. 

Chairman REED. Mr. Gasser, your comment, quickly. 

Mr. GASSER. Senator, you heard in your first hearing, I think 

there is a significant cross-section of the institutional investor community that has become frustrated with the permutation of these 

order types. At the end of the day, I think our view is—as Dan alluded to, as a fiduciary, it is our job to make sure that their orders 

are properly represented and that we are taking advantage of all 

the technology available to use, and it is all in the public domain. 

So I think it is—from the perspective of preventing competition and 

further innovation, I would be hesitant to say that we need to prevent further innovation there on that front. 

Chairman REED. Thank you very much. 

Senator Crapo. 

Senator CRAPO. Thank you, Mr. Chairman. I just had one final 

issue to get into. 

24 

Mr. Mathisson, in your written testimony, you indicate that socalled quote flickering has increased with decimalization. And, 

similarly, Mr. Gasser, you indicated in your testimony that you recommend that market participants who create excessive quote traffic without executing order flow should bear the costs of this activity. 

How does quote flickering work? And what is its impact to the 

system? Mr. Mathisson first. 

Mr. MATHISSON. Well, quote flickering is when somebody shows 

a bid or an offer for a very short amount of time and then keeps 

changing it repeatedly. Now, the cost of it on the system—I mean, 

the reason it is done is it would be typically done by high-frequency 

trading systems that are just making decisions very rapidly and 

they are deciding they want to buy something and the price of 

something else moves and they decide, you know, a thousandth of 

a second later to pull the bid or the offer. And so the result is that 

they can get quote flickering. It is empirical fact that quote flickering has increased. The number of quotes per day is up dramatically versus what it was about 5 years ago, and it is up, you know, 

something like 100 times from what it was 10 years ago. 

Now, the cost of quote flickering is primarily in technology infrastructure. When you have a lot of quoting going on, people need to 

build networks and computer systems that are capable of digesting 

hundreds of millions of quotes a day. And so it is an expense, essentially, on everybody. All trading systems by broker-dealers and 

typically by mutual funds and pension funds and other investors 

read all these quotes and respond to them, and so they all have to 

spend a great deal more money on technology than they otherwise 

would. 

Senator CRAPO. Thank you. 

Mr. Gasser. 

Mr. GASSER. Yes, in 2010, we gave a speech to an industry trade 

group and recommended, you know, some type of tax on what is— 

you know, there is no benefit to the broader national market system of having folks come in and basically flicker on the bid or the 

offer, as Dan alluded to. We spend a tremendous amount of money 

on infrastructure to support that, as I said, with no discernible 

benefit to investors or anyone else in the ecosystem. 

While equity volumes have steadily declined, the duress or the 

stress that it places on our infrastructure has increased 

logarithmically, so we are getting less liquidity, less volume, and 

we are being forced to support this activity in terms of our own investments in our business. 

Senator CRAPO. Thank you. 

Mr. Noll and Mr. Mecane, do you want to comment. 

Mr. NOLL. Sure. I agree that quote stability is an important goal 

for exchanges and for the marketplace. You know, we at Nasdaq 

have tried to take some steps on our own to bring more quote stability to the marketplace. So, you know, the first thing we have 

done is introduce an order type called the minimum life order type 

that creates economic incentives to have an extended quote as opposed to a short quote. We have also introduced and I believe we 

are the only exchange today that has an excessive messaging fee 

25 

for rapid quote changes without trades and without taking on discernible obligations in the marketplace. 

And then, last, we introduced a new market model called PSX, 

which is a price six exchange, which was designed really to get 

away from being at the top of the book because you were there first 

in terms of your quote ability, but being there in size as the incentive for the market participants. I wish I could say that that has 

had more success in the marketplace in developing as a real alternative to some of the other market models. That has yet to do that. 

But I do think that there is room for innovation here. I do think 

achieving quote stability is an important goal in the marketplace. 

I think it makes the markets better for everyone. 

Senator CRAPO. Thank you. 

Mr. Mecane. 

Mr. MECANE. I would just add two quick points. I think we would 

all agree that message traffic in general is a high cost for the industry and for all of us. The two points I would make, the first is 

just a recognition, again, that some of that message traffic or a lot 

of that message traffic arises not only because of Regulation NMS 

but because there are 50 venues out there for people to trade on. 

So in a lot of cases, traders will put their quotes in a subset of that 

many venues. They get executed on one venue, and then they pull 

their quotes from everyone else. And so some of the market complexity does contribute to the amount of message traffic. So, again, 

that points back to the holistic review of market structure. 

The second is while the consolidated audit trail is still very much 

a development in process, one of the discussions is around whether 

there is a mechanism through the consolidated audit trail to potentially align some of the costs of surveillance and producing the consolidated audit trail records back to the person who has created the 

quotation. And so there is potentially another mechanism down the 

road to help address message traffic. 

Senator CRAPO. Thank you very much. I really appreciate the 

testimony of these witnesses. It has been very helpful. 

Chairman REED. It has been very, very helpful, and Senator 

Crapo’s question has raised a question in my mind, a real question 

not a rhetorical one, and I will just see if anyone would like to respond to it. Is this flickering phenomenon related to entities that 

do not have market-making responsibilities so that they can come 

in and just ping the system without any responsibility to actually 

follow through? Is that related and we should be thinking about 

that? 

Mr. GASSER. Yes, I would not say that I know for certain, but I 

think it stands to reason that it is probably—and I certainly do not 

want to tar the HFT community with a brush here, but it is probably a high-frequency strategy, as Joe alluded, that has been deployed into every market center liquidity pool. We have seen, you 

know, some pretty significant anomalies from time to time, and, 

you know, 10 o’clock in the morning, 10:30 in the morning, where 

you have got these just huge spikes. They tend to be focused on 

large cap liquid names, and to get back to the point of investor perception, if folks had, you know, more insight into this, I cannot see 

that it would be a positive from that perspective. In fact, it would 

probably be perceived as just another example of a participant that 

26 

had the ability to affect other participants in orders of magnitude 

larger than the capital they have deployed or their desire to actually execute trades. 

Chairman REED. So I think that unless someone objects, this 

issue of—one of the categories we have to look at in market formulation is the responsibilities of market makers, who should be a 

market maker and what rights, what responsibilities they have, 

and that is an open question now given the new technology. I assume that that would be a point of agreement by the panel. 

I want to thank you all again. Senator Crapo was absolutely correct. Your testimony has been both thoughtful and thought-provoking, so expect lots of written questions. 

We appreciate the time that you have made. The preparation 

that you have undertaken has been obvious in this testimony. 

I will ask my colleagues, all the colleagues on the Subcommittee, 

if they have additional questions or written statements, please get 

them to us by December 28th, and then we will get them to you 

as quickly as possible and ask for your prompt response. 

The only thing, as we have been going back and forth about 

these dark pools, and I think you, Mr. Gasser, made the point that 

it is probably not the best term, I think there might be a rule of 

thumb that anything that could be used as a title for a Batman 

movie is probably not something that is good in the financial markets. But that is just a quip. 

With no further questions, I will adjourn the hearing. Thank you, 

gentlemen. 

[Whereupon, at 10:51 a.m., the hearing was adjourned.] 

[Prepared statements and responses to written questions supplied for the record follow:] 

27 

1Data is calculated based on decrease in dollar value of spreads between 2001 and 2007, 

when the next major market structure changes were implemented through Reg. NMS. Consolidated Tape Association and NYX. 2Tabb Group: U.S. Long-Only Institutional Average Commission Rates, 2005–2012. 

3 Reg. NMS: http://www.sec.gov/rules/final/34-51808.pdf. 4 Consolidated Tape Association. 

PREPARED STATEMENT OF JOSEPH MECANE 

EXECUTIVE VICE PRESIDENT AND HEAD OF U.S. EQUITIES, NYSE EURONEXT

DECEMBER 18, 2012 

Introduction 

Chairman Reed, Ranking Member Crapo, and Members of the Subcommittee, my 

name is Joe Mecane and I am EVP and Head of U.S. Equities at NYSE Euronext 

(NYX)—a leading global operator of financial markets and provider of trading technologies. NYX’s exchanges in Europe and the U.S. trade equities, futures, options, 

fixed-income, and exchange-traded products. In the U.S., we operate three equities 

exchanges, two options exchanges, one futures exchange, and a technology business 

that provides comprehensive commercial technology, connectivity, and market data 

products and services. 

While the U.S. continues to have the most liquid markets in the world and remains at the forefront of innovative technology used to conduct electronic trading, 

the infrastructure used to operate the markets each day has grown so sophisticated 

that few fully appreciate how well our markets actually operate in a highly competitive, fragmented, and complex environment. This has made it difficult for market 

participants, regulators, and Congress to determine the extent to which the growth 

in the number of trading venues, the speed at which trading platforms operate, and 

use of automated trading are beneficial. 

However, in light of the market events that have occurred in recent years, I’d like 

to focus on how technology and our market structure have created unnecessary complexity and mistrust of markets; and, relatedly, what NYX believes the industry, 

regulators, and Congress should be doing to address it. 

Market Structure Drivers Toward Computerized Trading 

Decimalization. Electronic trading has added tremendous benefit to the capital 

markets, including lower costs of execution, faster speed of execution and, in some 

cases, greater transparency. However, the trend toward computerized trading was 

accelerated and fostered by several significant regulatory changes that drove the 

market to become more electronic. One important factor was decimalization of the 

markets in 2001, which had an effect of decreasing average spreads by roughly 38 

percent in NYSE- and NASDAQ-listed securities, directly benefiting end investors. 1

At the same time institutional commissions, borne directly by end investors, were 

declining and decreased 33 percent 2 in the years leading up to Regulation NMS 

(Reg. NMS) implementation. In fact, almost all reductions in spreads and commissions occurred prior to the implementation of Reg. NMS and led to a huge expansion 

of electronic trading because human traders could no longer effectively make markets in this environment, and because institutions and brokers began relying more 

on algorithmic trading to access the market and reduce their costs of trading. This 

began a steady progression to have the most sophisticated algorithms and technology, since the smartest, the fastest, and the first prevailed—well before the implementation of Reg. NMS in 2007. 

Regulation NMS. In 2007, just as the technology among the trading community 

was becoming more sophisticated, the Securities and Exchange Commission (SEC) 

adopted Reg. NMS. This regulation gave brokers the freedom to trade around markets such as the New York Stock Exchange (NYSE) when the NYSE was in ‘‘slow’’ 

mode, 3 and at the same time forced participants to access the national best bid or 

offer (NBBO) in the market. Because exchanges competed by establishing the 

NBBO, speed among markets became the competitive differentiator based on one exchange’s ability to set the NBBO faster than a competing market. While Reg. NMS 

also established the Order Protection Rule to protect visible orders and encourage 

displaying quotes, today more than 3,000 securities have over 40 percent 4 of their 

volume occurring off-exchange in dark markets. In the NYSE MKT listed market, 

which represents 709 securities, off-exchange trading accounted for 42 percent of the 

volume in November. This level of off-exchange activity erodes the incentive for 

market makers to continue to trade the less active securities, has a negative effect 

28 

5 CFA Institute: ‘‘Dark Pools, Internalization and Equity Market Quality’’, October 2012, Weaver: ‘‘Off Exchange Trading and Market Quality in a Fragmented Market’’ (May 2011), Tabb 

Group: ‘‘A Spotlight in the Dark: An Inevitable Debate’’, November 2012. 6http://www.sec.gov/rules/concept/2010/34-61358.pdf 

on price discovery 5 and threatens to further decrease the incentives for companies 

to go public. 

ATSs and internalization. Today, there are around 63 execution venues in the 

U.S. markets, including 13 exchanges and 50 dark pools. Exchanges find themselves 

competing more directly with Alternative Trading Systems (ATSs or dark pools) and 

broker internalization, which are able to employ different practices than exchanges 

with far less oversight and disclosure. Some of this competition is through cost, 

some through order handling practices, and much of it is through client segmentation whereby nonexchange venues are able to incentivize their own or third party 

liquidity provisions based on the nature of the person they are trading against. As 

a result of this advantage, large broker-dealers continue to move more order flow 

into their own private trading venues for a ‘‘first look’’ before routing on to the lit 

public markets. Since the implementation of Reg. NMS, we’ve seen two markets 

evolve—the lit public, regulated and accessible market versus the dark, selective 

and private nontransparent market. 

As you can see, technology and the rules that govern the U.S. equity markets 

have resulted in the creation of a trading infrastructure primarily focused on speed 

and resulting complexity through which professional traders can identify and access 

liquidity—too often at the expense of retail investors and market integrity. To accomplish this, exchanges, brokers, and vendors have had to build expensive networks with the capacity to keep up with the growth of messages delivered each day 

to market participants seeking liquidity, as well as learn how to interact in a very 

complex ecosystem. 

In response to this new flow of orders, exchanges have developed new order types. 

Order types have different purposes, such as giving cost certainty or competing with 

the client segmentation that exists off-exchange. Regardless of the reason for the 

specific order type, most are premised on the goal of attracting liquidity back to the 

public markets for the purpose of enhancing transparency and price discovery. 

Moreover, all order types must be pre-approved by the SEC and published for public 

comment, something that is unique to exchanges and which does not exist for ATSs 

or brokers who internalize. 

Recommendations 

The bottom line is that our market structure incentivized these various levels of 

increased complexity. Our main message is that if we want to reduce the complexity 

of technology and our markets, we should simplify the overall market structure. 

Doing so would certainly prove beneficial for the future of our national market system, for investors and issuers, and to the growth and well-being of our economy— 

including efficient access to capital to fund innovation, new business and job creation. 

In this regard, key questions include determining who should lead the change 

process, and what should be done to correct course while ensuring that we continue 

to have the most transparent and liquid markets in the world. 

NYX believes that the SEC is best suited to propose meaningful market structure 

changes—and, in fact, regulators in other global markets, including Canada, Australia, and Europe, are already taking action. With Congressional oversight, the 

SEC should continue with the holistic review it began in 2010 with the Concept Release on Equity Market Structure 6 by proposing changes that will promote additional transparency, fairness, and long-term capital formation. This unfinished initiative needs to be completed and made a 2013 priority. 

We believe that changes to be considered should include a review of market 

maker obligations, the Sub-Penny Rule, the Order Protection Rule, tick sizes for illiquid securities, and addressing the conflicts and overlap between broker-dealers 

and exchanges, including the obligations and responsibilities of each when providing 

like services. 

The Consolidated Audit Trail, proposed by the SEC, also is a vital component to 

ensuring effective surveillance in a highly fragmented marketplace. Such surveillance should include better identification and reporting on high frequency trading, 

similar to that being discussed by the Commodity Futures Trading Commission, to 

increase the transparency of this practice. 

NYX also believes that, in light of the existing complexity of the markets and the 

technology and trading glitches that have occurred this year, all trading venues 

should ensure a robust set of policies and procedures around their systems developVerDate Nov 24 2008 16:26 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00032 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\12-18 COMPUTERIZED TRADING VENUES -- WHAT SHOULD THE RU
29 

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 high-net-worth private clients globally, as well as retail clients in Switzerland. Credit Suisse is active in over 50 countries and 

employs approximately 48,400 people. Credit Suisse is 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 www.credit-suisse.com. 

ment life cycle. Although testing may not be the most exciting part of our markets, 

the hyper-competition that exists in this industry lends itself to excessive levels of 

change rates just to remain competitive and compliant with new regulatory requirements. The industry has been faced with implementing new back stops such as single-stock circuit breakers, market-wide circuit breakers, limit up-limit down, and 

possibly kill switches. These regulatory mechanisms have cost the industry tens of 

millions of dollars to implement over the past several years and have been developed in response to some of the negative effects of highly complex markets, in an 

effort to protect against those inevitable situations when the unforeseen occurs. 

Conclusion 

In closing, I want to reiterate our belief that although our capital markets are 

the best in the world, there remains room for improvement. Technology and innovation should not be the cause of crisis and fear in our markets. Under the right conditions and structure, they are assets and produce opportunity for all market participants. Our recommendations have a simple premise: implement market structure 

changes that enhance transparency, fairness and price discovery for investors and 

level the playing field for trading venues. 

Thank you for inviting me to testify and I look forward to your questions. 

PREPARED STATEMENT OF DANIEL MATHISSON 

HEAD OF U.S. EQUITY TRADING, CREDIT SUISSE SECURITIES LLC 

DECEMBER 18, 2012 

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 

founded. Today, Credit Suisse employs approximately 9,200 people in the United 

States, and 48,400 people globally. We are one of the largest U.S broker-dealers, 

executing 12.4 percent of all U.S. equity volume in 2012. Most of that volume derives from our 1,600 institutional clients, which include the largest mutual funds 

and pension funds in America, representing the savings of tens of millions of Americans. 

I have been working in the U.S. equity markets for more than 20 years, the last 

12 of which have been at Credit Suisse in New York. This is the second time I have 

been given the privilege of appearing before this Committee, and I appreciate the 

chance to appear here today. 

Summary 

Credit Suisse believes that equity market quality has improved markedly over the 

past two decades, and that the competition spurred by the adoption of Regulation 

ATS and Regulation NMS has benefited the average investor. However, there is still 

plenty of room for improvement in the market structure. Within the past decade, 

our Nation’s exchanges have transitioned to a for-profit model, after more than 200 

years as not-for-profit, member-owned organizations. Despite their new for-profit 

status, exchanges have retained quasi-governmental status as SROs (Self-Regulatory Organizations), and exchanges still receive significant public funding through 

the market data revenue plans. We believe that this new model for the markets has 

proven itself to be costly to investors, unfair to broker-dealers, and rife with conflicts 

for the exchanges themselves. We suggest that ending exchanges’ status as SROs 

and transferring those regulatory responsibilities to FINRA or the SEC would put 

all market players on a level playing field and would benefit the average investor 

by creating markets that would be simpler, less vulnerable to disruptions, and less 

expensive to operate. 

30 

2 Ana Avramovic, ‘‘Who Let the Bots Out?’’ Credit Suisse Trading Strategy, May 2012. Also 

see ‘‘June 2012 Chartbook’’, Credit Suisse Trading Strategy. 3See, Cheng Gao and Bruce Mizrach, Rutgers University, ‘‘Market Quality Breakdowns in Equities’’, Sept. 2012. 4 James Angel, Lawrence Harris, Chester Spratt, ‘‘Equity Trading in the 21st Century’’, Feb. 

23, 2010. 

1. Are the U.S. markets working effectively? 

Although the markets are not perfect, 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 better than in the prior era. The empirical evidence shows 

that Regulation ATS 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 ever. 2 The study found: 

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 all-time high in 2011. 

Overall the study concluded there was no empirical evidence of negative market 

performance other than the increased cost of message traffic. Many other academic 

studies have found similarly positive results. A Rutgers University study released 

in September 2012 that examined data back to 1993 concluded that market quality 

breakdowns are 41 percent less frequent post-Reg NMS than prior to the rule. 3 A 

Feb. 2010 broad review of the equities markets by three well-respected professors 

concluded, ‘‘Virtually every dimension of U.S. equity market quality is now better 

than ever.’’ 4

2. Have liquidity and price discovery been impacted by the flow of stock trading volume to off-exchange venues? 

Implicit in this question is a statement that volume has been moving to off-exchange venues, which is factually incorrect. Over the past 5 years, volume has not 

shifted to off-exchange venues. Figure 1 shows the percentage of U.S. volume executed on exchanges from January 2008 through November 2012. As can be seen, the 

percentage of volume executed off-exchange has been remarkably constant over the 

past 5 years. 

31 

32 

5 Ashley Lau, ‘‘Nasdaq Defends Facebook Compensation Plan-Letter to SEC’’, Reuters, Sep. 

19, 2012, available at http://www.reuters.com/article/2012/09/19/us-nasdaq-facebook-letteridUSBRE88I18V20120919. 6See, Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Notice of Filing of 

Proposed Rule Change to Amend Rule 4626—Limitation of Liability, Exchange Act Release No. 

67507 at 4 (July 26, 2012). 7See, e.g., Barbara v. NYSE, 99 F.3d 49 (2d Cir. 1996); DL Capital Group, LLC v. Nasdaq 

Stock Market, Inc., 409 F.3d 93 (2d Cir. 2005). 8See, e.g., D’Alessio v. NYSE, 258 F.3d 93 (2d Cir. 2001). 9 Id. at 28. 10See, e.g., Scott Patterson, ‘‘SEC Nixed Knight’s Plea for a Do-Over’’, Wall St. J., Aug. 6, 

2012, available at http://online.wsj.com/article/ 

SB10000872396390444246904577571113923528168.html. 

While the level of on-exchange vs. off-exchange volume has stayed remarkably 

constant, there has been a shift in volume from NYSE and Nasdaq to two new exchanges: BATS and DirectEdge. As seen in Figure 2, from October 2007 to October 

2012, Nasdaq and the NYSE floor lost a combined 24.6 points of market share. New 

exchanges BATS and DirectEdge gained 22.4 points over that same period. Virtually 

all of the loss in the traditional exchanges’ market share is explained by the rise 

of these two well-managed and efficient exchange competitors. 

3. How does the current market structure impact market integrity or investor confidence? 

Credit Suisse believes that the current market structure is not optimal for investor protection and market integrity. The aftermath of the Facebook IPO on May 18, 

2012, revealed a significant flaw in the existing market structure. As has been widely reported, the Nasdaq exchange experienced extensive system failures during the 

initial public offering of Facebook Inc., causing others to suffer losses estimated to 

exceed $500 million. 5 Nonetheless, Nasdaq has only offered a $62 million settlement 

to those that suffered losses due to Nasdaq’s failures, an offer it views as an ‘‘accommodation,’’ given its view that it is legally immune from liability. 6

Because the Exchange Act of 1934 vests the exchanges with self-regulatory authority, courts have traditionally afforded exchanges ‘‘absolute immunity’’ from civil 

liability for damages arising in connection with their regulatory operations. 7 The 

basis for this is the common law doctrine of sovereign immunity, under which a 

Government entity may not be held liable for acts taken in its official capacity. Because an exchange is empowered to perform a ‘‘quasi-governmental’’ regulatory function, courts have found that exchanges ‘‘stand in the shoes’’ of the SEC, and they 

receive the same immunity that the SEC would be granted. 8

It is a dangerous situation when a for-profit enterprise can cause half a billion 

dollars of losses for others, and not have the risk of being held legally liable. Instead 

of bearing the cost of its own failures, Nasdaq believes that ‘‘the risks associated 

with system malfunctions should be allocated among all exchange members, rather 

than being borne solely by the exchange.’’ 9 In other words, Nasdaq asserts that the 

costs should be borne by the shareholders of the for-profit broker-dealers that suffered the harm, rather than the shareholders of the for-profit exchange that caused 

the harm. 

The contrast to recent events involving Knight Capital Group is striking. On August 1, 2012, a system error caused a Knight Capital Group broker-dealer subsidiary to send a slew of erroneous orders, resulting in $440 million in losses. Since 

Knight is not an exchange, and therefore does not benefit from sovereign immunity, 

rather than externalizing these costs on the market as a whole, Knight’s shareholders suffered the losses. 10

A fundamental principle of the law is that if a private enterprise wrongfully 

causes harm to others, it may be held liable to pay for the financial damages that 

ensue. In conducting its operations and implementing new systems, a broker-dealer 

must consider the risks and potential costs of potential liability and act accordingly. 

An exchange, on the other hand, may operate in a reckless manner. 

Sovereign immunity may have made sense when exchanges were not-for-profit, 

member-owned regulatory organizations that existed for the good of their members. 

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, they outsource the vast majority of their regulatory responsibilities 

to FINRA. 

Exchanges now function as broker-dealers in many ways. For example, Nasdaq 

announced in May of 2012 they would compete with broker-dealers by selling execution algorithms, which involve significantly more complex technology than simply 

33 

11 ‘‘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.’’ 12See, Regulation NMS Rule 611(a). 13See, ‘‘U.S. Market Structure Overview: Briefing for House Staff’’, Nasdaq/NYSE, June 12, 

2012. 14See, In re the Applications of EDGX Exchange, Inc., and EDGA Exchange, Inc. for Registration as National Securities Exchanges, Exchange Act Release No. 61698 (Mar. 12, 2010); In the 

Application of BATS Exchange, Inc. for Registration as a National Securities Exchange, Exchange Act Release No. 58375 (Aug. 18, 2008) [hereinafter BATS Exchange Registration Order]. 15See, Amendment No. 5 to Form S-1, BATS Global Markets, Inc. (Mar. 21, 2012) at 2, available at http://sec.gov/Archives/edgar/data/1519917/000119312512125661/d179347ds1a.htm 

[hereinafter BATS Form S-1]. 16See, e.g., ‘‘SEC Special Study: Electronic Communication Networks and After-Hours Trading’’, at n. 27 (referring to the applications of Island ECN, NextTrade, and Archipelago), available at http://www.sec.gov/news/studies/ecnafter.htm. 17 ‘‘Nasdaq Exchange Immunity May Limit Losses From Facebook Claims’’, by Nina Mehta, 

Bloomberg News, June 13, 2012. 

crossing stock like the Facebook IPO. 11 Complex trading technology like algorithms 

should go through rigorous quality assurance testing, and maximum caution should 

be exercised when rolling out these types of programs. We believe that providers of 

trading technology will naturally exercise greater caution if they have material liability when their technology fails. 

Repairing this problem in the current market structure 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. 12 Policy makers should examine whether it still makes sense for exchanges to be considered quasi-governmental entities, given that they are no longer member-owned, no longer not-for-profit, and no longer have much of a direct regulatory function. 

4. 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. 

ATSs, a subset of which are known as ‘‘dark pools’’, operate under a very different 

regulatory structure than exchanges. 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 share. 13 However, 

their ‘‘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 5 years, two major ATSs, BATS, and DirectEdge, both voluntarily 

chose to become exchanges, 14 spending millions of dollars and devoting years of effort to make the switch. In describing its history, the parent company of BATS Exchange explained that it converted from an ATS to an exchange in order ‘‘to participate in and earn market data fees from the U.S. tape plans [and] reduce our clearing costs . . . .’’ 15 While many ATSs have applied to the SEC to convert to exchange 

status, and all were willing to accept exchange responsibilities, 16 we are not aware 

of a single exchange that has tried to convert to ATS status. While exchange status 

does come with some burdens, clearly market participants are happy to accept those 

costs in return for the five significant advantages of being an exchange. 

The 5 big advantages exchanges have over ATSs: 

1. Exchanges have absolute immunity on errors, having historically been considered quasi-governmental entities. 17 Courts have typically ruled that exchange 

immunity holds even in cases of gross negligence or willful misconduct. An 

ATS is a regular business that has liability for its 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 distributed to its participant exchanges based 

on a complex formula. ATSs 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 ATSs pay significant clearing fees, whereas exchanges pay no 

clearing fees. 

4. Exchanges have no net capital requirements. An ATS operator must meet 

stringent net capital requirements. Exchanges face no such requirement. 

34 

18FINRA hosts an ‘‘Alternate Display Facility’’ to allow ATSs to display their bids and offers, 

but due to outdated technology, this service is not operational as of December 2012. 19 NASDAQ OMX Group, Inc., 2011 Form 10-K at 57, available at http://sec.gov/Archives/ 

edgar/data/1120193/000119312512077518/d259668d10k.htm. 20 NYSE Euronext, 2011 Form 10-K at 60, available at http://sec.gov/Archives/edgar/data/ 

1368007/000119312512086538/d275617d10k.htm [hereinafter NYSE 2011 Form 10-K]. 21See, BATS Form S-1, supra note 15 at 18, 39. 22See, ‘‘Concept Release: Regulation of Market Information Fees and Revenue, Exchange Act 

Release No. 42208’’ (Dec. 9, 1999) [hereinafter SEC 1999 Market Data Concept Release]. 23 2012 Market Structure Hearings, supra note Error! Bookmark not defined. (statement of 

Duncan Niederauer, CEO, NYSE Euronext), available at http://financialservices.house.gov/ 

uploadedfiles/hhrg-112-ba16-wstate-dniederauer-20120620.pdf. 24 NYSE Euronext, 2011 Form 10-K at 60, available at http://sec.gov/Archives/edgar/data/ 

1368007/000119312512086538/d275617d10k.htm [hereinafter NYSE 2011 Form 10-K]. 25See, BATS Form S-1, supra note 15 at 73–74. 

5. Exchanges can display bids and offers directly into the National Market System. An ATS cannot display a bid or offer directly into the National Market 

System. Instead, an ATS must pay an exchange to display bids and offers on 

their behalf. 18

5. How has the operating model of exchanges been influenced by their change from 

not-for-profit organizations to for-profit companies? 

Since becoming for-profit companies, exchanges have a fiduciary responsibility to 

their shareholders to maximize profits. A major source of revenue and profit for the 

exchanges comes from the sale of market data. 

The exchanges, together with FINRA, have a Government-granted monopoly over 

the sale of market data to the public—including the fees from market data generated by off-exchange trading. The Consolidated Tape Association (the ‘‘CTA’’), 

which administers the consolidated tape on behalf of the exchanges and FINRA, 

charges high fees to the investing public for real-time market data. While there is 

no systematic transparency into the CTA’s finances, some information can be 

gleaned from the exchanges’ parent companies’ public financial disclosures: 

• NASDAQ: The NASDAQ OMX Group, Inc. reported earning $115 million of net 

U.S. tape revenue from the CTA during 2011. 19 This amount is separate from, and in addition to, the $135 million NASDAQ earned from the sale of proprietary U.S. market data products. 

• NYSE: NYSE Euronext earned $193 million from market data relating to U.S. 

equity trading in 2011, although it is not entirely clear from their disclosure 

whether this includes revenue unrelated to the U.S. consolidated tape plans. 20

• BATS: BATS Global Markets, Inc. earned $55.4 million from its share of revenue from the U.S. tape plans in 2011. 21

The estimated $400 million in market data revenues that the CTA distributes to 

the exchanges are after operational and administrative expenses have been paid. 

Given that real-time data is a Government-granted monopoly, and market data 

prices are not set by the market and are not subject to competition, the investing 

public is arguably being overcharged for market data by approximately $400 million 

a year. 

Historically, the SEC has justified granting exchanges the exclusive right to sell 

market data as a form of user tax to fund the exchanges’ regulatory expenses. In 

1999, the SEC stated that exchanges are entitled to market data revenues to offset 

the cost of regulating their markets. 22 However, the amounts earned by the exchanges today far exceed their regulatory expenses and act as a major profit center 

for exchanges. 

In Congressional testimony, the CEO of NYSE Euronext estimated that it would 

‘‘spend nearly $85 million for U.S. equity market surveillance in 2012.’’ 23 This is 

far outpaced by the market data revenue NYSE Euronext earns, which appears to 

have totaled $193 million in 2011 from market data relating to U.S. equities trading. 24 NASDAQ OMX Group earned $115 million of net U.S. tape revenue during 

2011, but spent only $35 million on regulatory expenses across the entire holding 

company—apparently even including regulatory expenses relating to their non-U.S. 

exchanges. BATS Global Markets, Inc. earned $55.4 million from its share of the 

U.S. tape plans in 2011. But it spent only one tenth of this amount on regulatory 

expenses of $5.5 million in 2011, including costs under its outsourcing agreements 

for regulatory services to be provided by other SROs. 25

The enormous revenues from market data are way out of proportion with the 

costs of exchanges’ self-regulatory responsibilities. Market data revenue has simply 

become a Government-granted windfall at the expense of the investing public. 

35 

26 Ana Avramovic, ‘‘Who Let the Bots Out?’’ Credit Suisse Trading Strategy, May 2012. 27The SEC adopted Rule 17a-15 in November 1972, establishing the current tape plans. 

Furthermore, the current tape revenue system potentially encourages odd distortions in the markets. Because the CTA allocates revenue to the exchanges based on 

a complex formula involving variables such as each exchange’s number of 

quotations, for-profit exchanges try to set policies and services that will increase the 

level of quoting activity. We believe this is a major factor in why quote flickering 

has markedly increased, with the number of daily changes in the NBBO (National 

Best Bid Offer) per million shares traded recently climbing to an all-time high. 26

It is logical to assume that if the tape revenue system were reformed, quote flickering would be seen as a wasteful expense rather than a lucrative source of revenue. 

6. What regulatory or legislative changes should be considered by regulators or Congress? 

Credit Suisse suggests three policy changes, each of which is designed to make 

markets more reliable than they are today or reduce investor cost: 

1. Remove the SRO status of the for-profit exchanges. For-profit entities should 

not be shielded from liability for damages that arise as a result of their own 

actions. For-profit entities should not be able to audit and regulate their competitors. Exchanges have already transferred most of their regulatory tasks to 

FINRA. It is time for Congress to revoke their special quasi-governmental status and Government privileges. 

2. Perform a review of the pricing and rebate system operated by the consolidated tape plans. The CTA plans collect over $400 million a year from the investing 

public, most of which then gets rebated to the for-profit exchanges that collectively run the plans. Forty years after these plans were established, 27 we believe the tape revenue model is obsolete. In the current system, the investing 

public overpays for market data, and the exchanges receive a Governmentgranted windfall. 

3. Lift the restrictions that limit broker-dealers to 20 percent ownership in exchanges. Although there is no rule or law limiting broker-dealer ownership in 

exchanges, there is a precedent set by the regulators to cap broker-dealer ownership of an exchange at 20 percent. Allowing broker-owned ATSs to follow in 

the footsteps of BATS and DirectEdge and become exchanges would level the 

playing field between exchanges and ATSs, ultimately resulting in lower costs 

for investors. 

Thank you for the opportunity to appear today and I will be happy to answer any 

questions that you may have. 

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 in the Index Arbitrage 

department, shortly after which he founded the Advanced Execution Services (AES) 

group, which executes trades on behalf of institutional clients using algorithmic 

techniques. Prior to joining Credit Suisse, he was the head equity trader at D.E. 

Shaw Securities, where he worked from 1992–2000. 

Mr. Mathisson writes a 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 B.A. in Economics from the University of Michigan, 

and he is a Chartered Financial Analyst. 

PREPARED STATEMENT OF ERIC NOLL 

EXECUTIVE VICE PRESIDENT AND HEAD, NASDAQ OMX TRANSACTION SERVICES

DECEMBER 18, 2012 

Thank you Chairman Reed and Ranking Member Crapo for the opportunity to testify today on computer trading in U.S. securities markets. 

Computer trading is a fact of life and has been the default method of trading for 

billions of trades over the past several years—Billions of trades that happen on our 

market and others without any concern or problem. While there are issues to review, computer trading has a proven track record of delivering benefits for investors 

and market participants that includes bringing new investors to the markets, equalVerDate Nov 24 2008 16:26 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00039 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\12-18 COMPUTERIZED TRADING VENUES -- WHAT SHOULD THE RU
36 

izing the information advantage that used to be the staple of manual markets, lowering trading costs and giving the market expanded abilities to handle trade and 

message traffic growth that would freeze manual markets. As we saw during the 

financial crisis of 2008, the U.S. equities markets did not freeze-up and billions of 

trades that investors needed were handled by our computers. And of course, this 

was done without any contribution from the equity asset class to the list of problems 

that had to be managed. So, while we have experienced some trading anomalies like 

the Flash Crash of May 6, 2010, and a number of computer-trading events. I believe 

these are isolated technology incidents and not symptoms of deeper market structure concerns. At NASDAQ OMX we are laser-focused, every day, on how do we improve our market and make it more resilient and robust? 

This question is critical because a well-functioning equity market is needed for efficient capital formation, innovative competition, and job creation. Companies like 

Microsoft, Cisco, and Intel, used capital raised from listing on NASDAQ to make 

cutting edge products that have transformed our lives. Along the way, these companies created millions of jobs and strengthened many communities. Innovative highgrowth companies attract new talent and that talent pool then demands new goods 

and services. This virtuous cycle has played out in dozens of venture zones, from 

Silicon Valley to the Northern Virginia high tech corridor. And they have created 

enormous wealth opportunities, allowing millions of average investors to share in 

that wealth—enabling them to buy homes, put children through college, and retire 

with financial security. 

In light of recent events, some may forget the unique and central role exchanges 

have played and continue to play in U.S. equities markets. All that your average 

constituent associates with ‘‘the market’’ starts with an exchange. The iconic public 

companies they recognize—Apple, Google, eBay, and Amazon—must satisfy exchanges listing standards, and they remain subject to exchange regulations against 

corporate fraud and abuse. The exchange listing process and regulatory program 

culminate in the IPO process that provides entrepreneurs with efficient platforms 

for capital formation and job creation. Only equities exchanges such as NASDAQ 

are entrusted with the important responsibility to be a catalyst for growth and 

wealth creation. 

After the IPO, exchanges have a unique and continuing duty to foster price discovery and transparency. Exchanges like NASDAQ create and disseminate the ticker symbols and prices that your constituents see on television stations like CNBC, 

in newspapers like the Wall Street Journal, and at Internet portals like Yahoo Finance. Exchange quotes then create the reference price for all other trading, not 

only in equities but in other asset classes as well. Dark pools and other competitors 

use exchange quotes as a reference price for trading equities. Markets, such as the 

Chicago Mercantile Exchange and the Chicago Board Options Exchange, use equities exchange quotes to trade options, futures, and other derivatives. Vanguard, Fidelity, and Schwab use exchange prices for mutual funds, ETFs, and other instruments. Those ticker symbols are a byproduct of the rules and sophisticated regulatory systems that equities exchanges develop and enforce to protect investors and 

to provide orderly markets. They are the result of a system that is by law fully 

transparent, and that publicly discloses all rules and prices to all customers and 

treats all customers equally. 

Only exchanges have the authority and responsibility to oversee broker-dealers as 

they interact with the market. That authority is the result of a rigorous public process of qualifying to be an exchange conducted by the SEC—in the case of NASDAQ 

it took 6 years. Exchanges alone adopt member and market regulation rules, develop automated surveillance systems to detect rule violations, and discipline 

broker-dealers that violate rules and harm investors. Congress recognized that enforcing rules in U.S. securities markets is so important that two regulators rather 

than one are needed to enforce them. Congress codified the authority of exchanges 

to act as self-regulatory organizations (SROs), to set and enforce trading rules and 

to halt trading during extraordinary national or international events. SROs supply 

the SEC and other regulators vital information about the trends and performance 

of U.S. capital markets. The SEC is our partner in protecting investors. 

In fact, exchanges have heavy responsibilities to create a safe market for investors, characterized by fair access, transparency, and efficiency. No other market participant is charged with or even permitted to undertake this burden. Alternative 

trading systems (ATSs) are not entrusted to regulate and discipline their users in 

this manner. An ATS can choose to regulate its users, but it must then register as 

an exchange and accept SRO responsibilities. Today, virtually every ATS has the 

option to register as an exchange. One need only look at the list of SRO responsibilities and obligations that registration triggers to understand why so few ATSs voluntarily take that step. 

37 

While we often discuss the importance of capital formation, our regulatory responsibilities and the IPO process, let me add another important, but sometimes overlooked branch of our role in the markets—our role in the daily trading dynamics 

of the market. Trading and trading behaviors like price discovery, best bid and best 

offer and visible liquidity are very important to companies as they might seek secondary offering cash injections to their businesses and use their stock as currency 

in the market to achieve strategic goals like acquisitions. Price discovery and transparent liquidity are also very important to investors as they make informed decisions about which stocks to buy and at what price and when to sell. All the buying 

and selling and active trading in the equities market is not a grand game of speculators—it has real job creators and investors looking for the market’s best information to make rational business and investing decisions. Exchanges maximize transparency, strive for fairness and support that price discovery engine and it is our 

unique market role to perform that function. We are not in business just to see trading for trading’s sake. NASDAQ OMX is an exchange to produce transparent 

quoting and trading that helps price discovery, helps add liquidity, tightens spreads 

and benefits the continuous market is what we strive to support. 

Cooperation 

The role of exchanges is more important than ever in today’s challenging environment. U.S. markets are complex, fragmented, and interconnected. Markets and traders leverage new technologies to trade near the speed of light. We at NASDAQ are 

working tirelessly to ensure that markets are strong and fair, and that as the pace 

of trading accelerates, so too does the pace of regulation and investor protection. 

When computerized trading appears as a threat to investors, the SEC naturally 

turns first to exchanges for assistance. Regardless of where the problems began, regardless of where the damage was felt, the exchanges are always on the front lines 

partnering with the SEC and we work closely with the SEC to fix and improve the 

equities markets. In the aftermath of May 6th, the SEC and the exchanges worked 

quickly and cooperatively to devise new protections to keep computer trading errors 

from spreading too rapidly or inflicting unacceptable harm on the overall market. 

The exchanges reformed their rules for breaking trades, instituted single stock circuit breakers, updated market-wide circuit breakers, and we will implement the 

Limit Up/Limit Down mechanism in February. NASDAQ has also developed tools 

to help broker-dealers manage their obligations under the Market Access Rule. 

In the wake of several highly publicized computer malfunctions, the exchanges 

are again leading the industry in a collaborative working group. A key and challenging initiative being discussed by this Industry Working Group, and one that 

NASDAQ fully supports and is helping to lead and define, is the implementation 

of ‘‘Peak Net Notional Exposure’’ levels, or ‘‘kill switches,’’ that would automatically 

trigger a cessation of trading when an individual firm exceeds predetermined risk 

thresholds. The Industry Working Group is considering various approaches to both 

the SRO-level and broker-dealer level requirements, as well as a means for coordinating cross-market checks to create the market-wide check needed to combat the 

effects of market fragmentation and interconnectedness. 

Testing 

One important area of focus is testing and industry preparedness. NASDAQ is 

partnering with Carnegie Mellon University to form the Carnegie Mellon Software 

Engineering Institute dedicated to help bring the industry together to improve the 

resilience of financial services technology. We hope to form and lead a group of market participants, regulators, technology providers, and academic institutions with 

the goal of driving resilience in the large scale software engineering and technology 

arena and being recognized globally as a leader in helping the financial markets become more resilient and robust. 

The industry has learned through experience that it must change the way we test. 

In the past, industry-wide system changes have utilized a testing methodology that 

tested for system design integrity. For example we might test a software update by 

having our members send us test orders to ensure the software does what we are 

asking it to do. Or, we might ask members to challenge our systems with high volumes. Instead, we should be testing each other’s systems to try to break them. A 

more robust testing environment would assume breakdowns by all testing participants to visualize the impact on a system’s integrity. Such ‘‘destructive’’ testing will 

spot troubles that the kinder-gentler testing of the past would not uncover. 

High Frequency Traders (HFT) firms have attracted much media attention, but 

they are not the only ‘‘fast’’ players in the marketplace. Exchanges, dark pools and 

broker systems are all connected and all use sophisticated technology. These systems communicate in slices of time that approach the speed of light. This is a great 

38 

achievement, but it means that previously minor events now represent profound 

risks that can tangibly affect investor confidence. NASDAQ OMX is not immune to 

this issue, and we are committed to answering this challenge. 

High Frequency Trading 

NASDAQ believes that technological developments must be implemented in a 

manner that ensures all investors a ‘‘fair deal.’’ Average investors must not be 

placed at a disadvantage to professional traders by rules that permit selective disclosure of information, preferential access to trading interest, or the appearance of 

a two-tiered market. All markets that trade the same securities should be equally 

transparent about their operations, including the rules governing their trading systems, the criteria for admission and the prices of comparable services. The Commission must regularly examine whether the application of new technologies contribute 

to regulatory arbitrage. 

For example, exchanges and regulators around the world are analyzing the pros 

and cons and overall impact on markets of HFT. The International Foresight Project 

was commissioned by the British Government’s Department for Business, Innovation, and Skills (BIS) to investigate the effects of HFT. This definitive and independent study, led by Sir John Beddington, Chief Science Officer for the British 

Government, found that HFT is likely positive for markets. Similarly, the Swedish 

Financial Services Agency released its own report finding that HFT in that country 

also had a positive impact on liquidity, and that regulators and exchanges continue 

to refine their tools for ensuring proper surveillance. 

Many in the public arena vilify HFT as a business model issue. It is our view to 

always caution against such sweeping criticism. When, like the Beddington study, 

HFT is studied in depth, you find benefits to several metrics from the broad participation in our markets by firms that we consider to be high frequency traders. Like 

the British and other studies, we find that HFT trading tightens spreads and adds 

very valuable liquidity—certainly positive for our markets. We know that everyone 

in the markets has a profit motive and that generally incentivizes innovation and 

competition among participants. What we know from experience is that our industry, no matter the business model, will always attract individual players who cross 

the line and NASDAQ OMX, the other exchanges, FINRA (the Financial Industry 

Regulatory Authority) and the SEC work to expose those individual bad actors. It 

seems the tenor of the debate about HFT has become too broadly negative towards 

the business model. The academic evidence about HFT supports the fact that they 

generally add value to the market. 

It is not enough simply to vilify fast trading. Regulators and exchanges are working to identify and address specific bad actors and specific bad outcomes such as 

false, misleading or deceptive practices. NASDAQ has worked diligently to ensure 

that the pace of its regulation matches the pace of trading. NASDAQ has partnered 

with FINRA to develop special HFT inspections. For example, in December of 2010, 

NASDAQ OMX retained outside experts to assist in assessing and improving our 

internal training program on HFT strategies. Through focus and effort, NASDAQ’s 

Market Watch staff has developed 11 new alerts (algorithms specifically designed 

to spot certain trading behaviors) in addition to the 21 surveillances FINRA utilized 

for HFT related reviews. 

To improve our own regulatory program and the regulatory programs of exchanges around the world, NASDAQ invested in state-of-the-art technology. In 2010, 

NASDAQ acquired The SMARTS Group, the world’s leading provider of software for 

automated surveillance for exchanges, regulators, and brokers. With SMARTS, 

NASDAQ literally can deploy high speed surveillance to match high speed and any 

other kind of trading. We have held demonstrations for many Members and staff 

of this Committee to demonstrate the power of the SMARTS system. The feedback 

from those demonstrations has been positive. 

These efforts have paid off. NASDAQ surveillance and referrals to FINRA and the 

SEC have improved compliance. While we cannot go into great detail, we have a 

full plate of pending Investigations on issues related to High Order/Low Execution 

Ratios, Wash Trading, Layering, Manipulation of the closing auction, Manipulation 

through master-sub relationship, Supervision, Order Entry controls. NASDAQ has 

detected violations by high frequency traders resulting in fines as high as $3.5 million and in the expulsion of firms and individuals from the securities industry. 

NASDAQ is protecting investors from people that use technology to prey on them. 

Our goal is always to constantly evaluate and improve our market to make it as 

robust and fair as possible using technology and the wisdom and experience of our 

industry-best employees. 

39 

Complexity 

Any evaluation of the health of our markets and the ecosystem of computer trading must include a discussion of complexity. There are 13 registered exchanges active in the U.S. equities markets. The SEC also allows trading on 40+ venues in 

the U.S. where a broker can send one or more of their orders. Each of these venues 

has its own systems and procedures and each competes for orders from brokers and 

ultimately investors. Each venue has its own order types and each is continually 

talking to investors to develop new order types that satisfy their needs. The result 

is dozens or even hundreds of different order types for members to understand and 

program. Is the explosion of order types helpful or harmful for the market? 

While some order types have come under intense media and regulatory scrutiny, 

let me be clear, NASDAQ OMX order types do not provide advantages to certain 

users allowing them to jump ahead in line at a given price level. NASDAQ believes 

that each order type it creates should be designed to make our markets better, and 

to improve transparency and price discovery. Fairness and equal access are key 

SRO responsibilities and we will always adhere to those principles. NASDAQ goes 

through a rigorous process to get order types approved by the SEC. As an exchange 

we have to expose innovative ideas to the market through the notice and comment 

process, often allowing our competitors time to mimic our idea and beat us to market. That is part of our SRO burden. For the sake of transparency and to help members understand our order types, we recently posted on our Web site a list and a 

plain-language description of NASDAQ’s order types. 

Computer trading and some of the concerns that have been outlined to Congress 

are in many respects the direct result of market structure decisions. Many problems 

with our markets stem from well-intentioned regulations like Regulation ATS and 

Regulation NMS, which sought to promote competition and to resolve tensions between electronic and floor-based trading. Regulation NMS has led to an increase in 

dark trading, which denies market participants a clear view of trading interest in 

a given stock. Dark trading is a concern in many countries; Canada recently modified its market structure to limit dark trading and to maximize price discovery. The 

Commission has similar market structure proposals pending since 2009. 

Market-Based Approaches 

In addition to regulatory enhancements, NASDAQ has also developed several 

market-based approaches to improve the trading experience, and help reestablish 

the prominence of the public company model. For example, NASDAQ launched the 

first ‘‘price/size’’ market to create incentives for quotes that offer deep liquidity rather for quotes that are fast. Also, NASDAQ voluntarily eliminated flash orders from 

its equity markets. NASDAQ also introduced the ‘‘MinLife’’ order to incentivize a 

longer quote life. Finally, NASDAQ is the only exchange to recently institute a 

charge for excessive messages to discourage a trading technique used primarily by 

high frequency traders. 

NASDAQ OMX is also working to improve the market structure for small public 

companies that are job creation dynamos when given a supportive ecosystem. This 

past year, the JOBs Act recognized the importance of special rules for these emerging companies. However, Congress did not go far enough and consider how these 

companies were treated once they actually go public. Regulation NMS subjects these 

smaller stocks to a one-size-fits-all market structure. Apple, Microsoft, GE, and 

other large cap stocks trade relatively well, despite a highly fragmented marketplace. Small companies however are not best suited for a fragmented liquidity pool 

and dark trading. Smaller stocks do not perform well in the fragmented marketplace 

no matter their listing venue. This can compromise the momentum for smaller public companies and capital formation within this class of stocks. There are innovative 

ideas to empower small companies to help their stocks trade more often and more 

efficiently: 

• Tick Size Pilot Program: Allows smaller companies to opt-in for a wider tick size 

for their stock to allow more spread for market-makers to be incentivized. Multiple tick size regimes are already used already in numerous other countries 

successfully. 

• Market-Maker Support Pilot Programs: Allows the company to opt-in to a program to provide economic support for more aggressive quoting and trading in 

their stocks. These programs, common around the world, allow the exchange to 

stand between the broker and the listed company to improve the trading of a 

stock. 

40 

Conclusion 

NASDAQ OMX is passionate about the critical role we play in capital formation, 

investor protection and job creation. While it presents challenges to everyone, ultimately we believe that technology is an important part of the solution for ensuring 

orderly and fair markets. We view efforts to slow-down our markets as counterproductive. Building robust and dependable markets requires legislators, regulators 

and market participants to continue to come together to drive positive evolution. 

NASDAQ OMX is committed to working with Congress, the SEC, our fellow exchanges and all market participants to make the U.S. equity market the best in the 

world. NASDAQ OMX appreciates the opportunity to testify. I look forward to your 

questions. 

PREPARED STATEMENT OF ROBERT C. GASSER 

CHIEF EXECUTIVE OFFICER AND PRESIDENT, ITG 

DECEMBER 18, 2012 

Introduction 

Chairman Reed, Ranking Member Crapo, and other Members of the Subcommittee, thank you for the opportunity to testify this morning on the topic of 

‘‘rules of the road’’ for computerized trading venues. On behalf of a leading agency 

broker, my goal is to offer an unbiased, fact-based view on the current state of U.S. 

equity market structure. ITG is a NYSE-listed company with 17 offices across 10 

countries and nearly 1,100 employees. As an agency broker, ITG provides trading 

services, technology, analytics and research to a wide array of leading asset managers. Throughout our 25-year history, we have worked in partnership with major 

mutual funds, pension funds and other institutional investors, innovating to improve trading and investment performance. In my testimony today I would like to 

offer a brief overview of current market structure, discuss some recent events which 

have impacted investor confidence and look at some ways to restore this confidence. 

There has been much written of late about the quality of our equity markets. This 

morning we hope we can infuse some data and analysis into the debate. 

Market Structure 

Competition amongst market centers and broker dealers spawned by the passage 

of Regulation ATS in December 1998 has led to intense competition for liquidity and 

ultimately to fragmentation. This fragmentation has undoubtedly introduced complexity into our marketplace but has been a positive force in reducing execution 

costs. Technology has provided market participants, including retail investors and 

mutual funds, competition for order flow. 

Global asset managers, as fiduciaries, have an obligation to achieve best execution. The global market standard requires all asset managers of size to measure the 

quality of their execution and its effect on the investment process. ITG is the world’s 

largest provider of TCA, or Transaction Cost Analysis. We measure millions of 

trades executed on behalf of hundreds of global asset managers. Our TCA data 

clearly demonstrates that institutional investors have benefited greatly from the 

evolution of U.S. market structure. Over the past 12 years, there has been a 70 percent decrease in average total equity trading costs in the U.S. As the data indicates, 

U.S. market structure is not broken. The current ecosystem of displayed and dark 

markets has resulted in significantly reduced costs that in almost all cases have 

been distributed back to investors. There is no evidence to suggest that competition 

and fragmentation have damaged price discovery or harmed capital formation. 

ITG is not a market maker, and we do not take on proprietary positions. In other 

words, we do not have ‘‘skin in the game’’ when it comes to the debates around 

broker internalization, as our system provides ‘‘meaningful price improvement’’ to 

buyside investors as described in Regulation NMS. Based on our data, we would 

conclude that Broker-Dealer internalizers, or broker-dealer dark pools as they are 

sometimes known, provide a useful permeable layer between the client and the displayed markets. Brokers have a fiduciary responsibility to their clients while exchanges do not, and these liquidity pools would not exist unless benefit was derived 

by the customer. Most recently, Australia and Canada have imposed regulations 

around internalization that will provide similar action here in the U.S. Early returns do not look promising in terms of the effects on liquidity and trading costs. 

Regressing to an oligopoly of U.S. exchanges is clearly not the answer. 

41 

Investor Confidence 

Unfortunately, the evidence also suggests that the investing public has become 

disenchanted with equities. According to the Investment Company Institute, over 

half a trillion dollars has been pulled from U.S. equity mutual funds since the start 

of 2008. Much of this can be attributed to the reduced risk appetite of baby boomers 

and the relative safety of bonds supported by easy monetary policy. 

The May 2010 Flash Crash, the Facebook IPO, and Knight Capital’s trading debacle this past summer provide little comfort that U.S. equity markets are a safe place 

to trade or invest. Add in the suspicions that the investing public has about high 

frequency trading and its perceived impact on the quality of markets, and you have 

a recipe for anecdote and conjecture overcoming facts and reason. 

Where speed is concerned, it is clear that the law of diminishing returns must 

be applied to further dramatic shifts in the foundations of our equity marketplace. 

Microseconds versus milliseconds do not matter to the wider, more important, audience. We need to restore investor confidence, but not at the cost of disturbing the 

progress that has been made. 

Recommendations 

• The SEC’s Consolidated Audit Trail, if implemented properly and cost effectively, will give investors confidence that regulators can police bad actors and 

predatory strategies. 

• The consistent application of the Market Wide Circuit Breakers and the LimitUp Limit-Down Plan to all market centers would likely prevent a market disruption of ‘‘Flash Crash’’ proportions. 

• Costs should be borne by market participants who create excessive quote traffic 

without executing order flow. 

• Market data should be distributed to all market participants equally. 

• Marketwide risk should be monitored at a central clearing house that would 

have the ability to terminate a broker-dealer’s connectivity to the national market system in the event of a rogue program released to the market. 

Conclusion 

These five measures would give the investing public the protections they need to 

confidently invest in the world’s strongest and most resilient market while still deriving all of the cost savings and liquidity benefits which have been achieved over 

the past decade. Lastly, as the regulations called for by the Dodd-Frank Act begin 

to take hold across other asset classes, the lessons we have learned in equities will 

be applied to those markets. 

Price discovery, central clearing, transaction cost analysis, and pre- and post-trade 

transparency will become as deeply integrated into foreign exchange and fixed income markets as they are in equity markets. And innovation will come more quickly 

to those markets because of the lessons learned in equities. For this reason, our equity market structure is all the more important to our broader financial system. 

Thank you again for the opportunity to share our views on these important questions. I would be happy to answer any questions at the appropriate time. 

42 

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45 

46 

47 

48 

49 

50 

51 

1 After significant analysis and industry commentary, the Investment Industry Regulatory Organization of Canada (IIROC) and the Canadian Securities Administrators (CSA) took the position that limiting the use of off-exchange trading was critical to maintaining the quality of the 

price discovery process and adopted new rules which went into effect on October 15, 2012. 

http://www.bcsc.bc.ca/uploadedFiles/securitieslaw/policy2/23- 

405%20Dark%20Liquidity%20in%20the%20Canadian%20Market.pdf. Rosenblatt Securities indicated the portion of Canadian equity trading done by dark pools was 2.06 percent in November 

2012, down from 5.67 percent in September 2012. Rosenblatt Securities, ‘‘Let There Be Light’’, 

December 19, 2012. 2Off-exchange dark trading grew from 19.5 percent in October 2007 to a record level of 36.6 

percent as of January 2013, including 38.5 percent in Nasdaq-listed securities. Off-exchange 

trading has increased 300 basis points in only two months since October 2012. Moreover, as of 

January 2013, approximately 3800 securities (49 percent of total securities) have over 40 percent 

of volume traded off-exchange (CTA). 

RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN REED 

FROM JOSEPH MECANE 

Q.1. There was testimony that ‘‘dark trading’’ is a concern in many 

countries and that Canada recently modified its market structure 

to limit dark trading and to maximize price discovery. Canadian 

regulators have imposed a new framework governing how dark 

pools and undisplayed orders are allowed to operate including priority of lit over dark flow and a minimum price improvement requirement for dark orders. What is your view of these reform proposals? Would these measures make the U.S. markets more or less 

fair and transparent? Please explain. Would these measures be feasible in the U.S. markets? Why or why not? 

A.1. To be clear, we are not adverse to the concepts of internalization or dark pools. We believe they are a valuable part of the market in terms of facilitating the execution of institutional block orders and providing significant amounts of liquidity to retail orders. 

However, there is a balance that must be struck between internalization and public price discovery in order to maintain a healthy 

public market. We believe the new Canadian rules—which are designed to encourage transparency, support the price discovery process, reward displayed orders with increased execution opportunities, and increase liquidity for all—can be incorporated into the 

U.S. markets to help achieve this difficult balance. Additionally, 

the Canadian rules recognize the value that dark trading can offer 

to minimize the market impact of trading blocks and provide meaningful price improvement—again, useful paradigms for preserving 

the value of internalization while creating mechanisms to facilitate 

publicly displayed liquidity. 

A key objective of the Canadian rules was to encourage the posting of visible orders and expose liquidity to the widest variety of 

participants by ensuring that visible orders execute before dark orders at the same price across the entire market. 1 In stark contrast 

to Canada, in the U.S., market participants who take an added risk 

by displaying their orders are being traded ahead of, normally at 

the same price, on dark markets. This has the effect of reducing 

the execution experience on ‘‘lit’’ markets and further encourages liquidity providers to move into the dark markets. We believe this 

effect is borne out by the statistics we noted in our testimony that 

show that U.S. market structure has led to widespread and rapid 

growth in dark trading. 2

We are concerned about the aggregate effect of dark or internalized activity on the overall U.S. marketplace, mainly the effect on 

spreads and volatility, as noted in recent research by the CFA InVerDate Nov 24 2008 16:26 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00055 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\12-18 COMPUTERIZED TRADING VENUES -- WHAT SHOULD THE RU
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3http://www.cfapubs.org/doi/abs/10.2469/ccb.v2012.n5.1; http://papers.ssrn.com/sol3/papers.cfm?abstractlid=1846470 4 In a summary report on Recommendations Regarding Regulatory Responses the Market 

Events of May 6, 2010, the Joint CFTC–SEC Advisory Committee noted that ‘‘the impact of the 

substantial growth of internalizing and preferencing activity on the incentives to submit priced 

order flow to public exchange limit order books deserves further examination’’ and recommended 

the SEC review whether to ‘‘adopt its rule proposal requiring that internalized or preferenced 

orders only be executed at a price materially superior (e.g., 50 mils for most securities) to the 

quoted best bid or offer. http://www.sec.gov/spotlight/sec-cftcjointcommittee/021811-report.pdf 5 In the rule the Commission stated: ‘‘The Commission agrees that strengthened protection 

of displayed limit orders would help reward market participants for displaying their trading interest and thereby promote fairer and more vigorous competition among orders seeking to supply liquidity.’’ http://www.sec.gov/rules/final/34-51808.pdf 

stitute and Professor Daniel Weavers of Rutgers Business 

School 3—especially in the thousands of less actively traded securities, as well as the selection bias in orders that do make it to public 

markets. Moreover, the Joint CFTC–SEC Advisory Committee 

urged the SEC to review the issue of internalization/dark trading 

in 2010. 4 Changes such as these are also in line with a key objective of Regulation NMS (Reg. NMS), namely displayed order protection. 5

Q.2. What is an example of an order type that the NYSE has created to make our markets better, and improve transparency and 

price discovery? How does this order type provide equal access? 

Does the NYSE allow dark or undisplayed orders or provide dark 

execution? Why or why not? 

A.2. The number and characteristics of order types offered by exchanges has been of recent discussion in the press and within the 

industry. It is important to note the overarching market structure 

context within which new order types are created, not the least of 

which is the competitive and complex dynamic among Exchanges 

and non-Exchange participants that is fostered by inequitable regulation. Among other things, we develop order types to allow clients 

to control how their orders interact with others in a complicated 

market environment. Many order types are developed to help participants comply with requirements of Reg. NMS, while others enable a participant to control their execution costs. More recently 

and significantly, Exchanges have developed order types to attempt 

to compete with practices that are allowed by non-Exchange 

venues, some of which are undisplayed. One of these order types, 

and perhaps the newest and most innovative in our suite of order 

types, is the RLP order. 

The Retail Liquidity Program (RLP), which was approved in July 

2012, gives retail investors the ability to receive price improvement 

at a sub-penny increment of at least $0.001 in an exchange environment. In comparison, off-exchange venues have been permitted 

to segment customer order flow, and trade in sub-penny increments, without limits since the inception of Reg. ATS. Approval of 

this relatively simple and beneficial order type took several months 

to develop and discuss with the SEC before the 240 day public 

process that took place once we publicly filed the proposal with the 

Commission. Prior to the existence of RLP, exchanges were not permitted to target specific customer segments, even where there 

could be significant benefits to the retail investing public. While arguments can be made about whether sub-penny executions and 

segmentation are the ‘‘right’’ market structure, in general we firmly 

53 

6 NYSE Euronext operates three equity exchanges in the U.S., NYSE, NYSE MKT (MKT), 

and NYSE Arca (Arca), each of which publicly discloses all order types in SEC-approved rule 

filings and on our publicly available Web site. http://usequities.nyx.com/markets/nyse-equities/ 

order-types; http://usequities.nyx.com/markets/nyse-arca-equities/order-types 

believe that exchanges should be able to compete on equal footing 

with other venues when the investing public can benefit from price 

improvement in a competitive, liquid price discovery process. 

The development, testing, and approval process for a new exchange order type is extensive and lengthy—sometimes taking a 

year or more to receive SEC approval. Exchange orders types are 

required to be available to members on a fair and reasonable basis 

and are detailed in SEC rule filings which are published for public 

comment and subject to the scrutiny of our direct competitors. 6 By 

contrast, ATSs and brokers offering ‘‘dark’’ or internalized trade 

execution services do not publicly disclose details about how their 

trading functionality works, including order ranking and execution 

rules, and the algorithms and order types offered to clients are not 

subject to prior public comment, SEC approval, or even SEC review. These participants use their regulatory advantage as a competitive edge to develop order functionality and this often drives client demands for Exchange order types. 

Overall, to the extent an initiative develops to ‘‘streamline’’ the 

number of order types, the most effective way to accomplish this 

would be through a simplification across all market venues of the 

underlying market structure that gave rise to the proliferation of 

order types. 

Q.3. Rule 612 of Regulation NMS prevents sub-penny quoting. 

However, under an exemption in Rule 612 the SEC actually allows 

broker-dealers to execute orders in sub-penny increments. Because 

there are no quoting obligations for broker-dealer internalization, 

broker-dealers can provide price improvement to their customers in 

the form of sub-penny executions. What are advantages or disadvantages of sub-penny quoting? Is special pricing good for retail 

investors? Why or why not? 

A.3. Sub-penny quoting and trading raise two separate but interrelated issues. First is the ability for certain venues to trade in 

sub-penny increments. The second is whether quoting should similarly be allowed down to the sub-penny level. 

Our primary viewpoint is that the rules applying to sub-penny 

trading and quoting should be consistent across venues, regardless 

of the market participant utilizing it. From a public policy perspective, if sub-penny trading is allowed in non-Exchange venues, we 

believe similar conventions should be allowed in Exchange venues 

also. On a related note, as we’ve highlighted elsewhere, we worry 

about the rising level of activity that trades in front of visible, displayed liquidity and would suggest that a minimum amount of 

price improvement be required for this convention. Until the RLP 

program, Exchanges were only permitted to offer midpoint executions to its members. However, in August 2012, under the RLP program, for the first time an Exchange was allowed on a pilot basis 

to permit the execution of retail orders in sub-penny increments at 

a minimum of $.001 to mirror some of what occurs in internalizaVerDate Nov 24 2008 16:26 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00057 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\12-18 COMPUTERIZED TRADING VENUES -- WHAT SHOULD THE RU
54 

7SEC Release No. 34-67347: http://www.sec.gov/rules/sro/nyse/2012/34-67347.pdf. 

tion. 7 However, the RLP program remains far more restrictive 

than broker internalization, and is currently limited to a small segment of the marketplace. Despite the positive impact it may have 

on the retail investor, the RLP program only accounted for 0.14 

percent of consolidated volume in December 2012. 

The related question is whether sub-penny quoting should be allowed alongside sub-penny trading. This is also the topic of an upcoming SEC Roundtable, and should also be considered in the context of our previous point. However our basic view is that to the 

extent sub-penny trading continues to be allowed, then a more fair 

market structure would be to similarly provide for sub-penny 

quoting. While we agree with many of the negative implications of 

sub-penny quoting—such as investor confusion, a noneconomic denomination, quote traffic implications—we believe the current 

structure puts the public markets are at a significant competitive 

disadvantage that should be addressed. 

The chart below shows sub-penny trading (excluding mid-point 

executions) in securities priced above $1 rose from 2.7 percent in 

January 2006 to 10.5 percent of volume in January 2013. In securities priced between $1 to $5, sub-penny trading (excluding midpoint executions) rose from 3.3 percent in January 2006 to 14.0 

percent in January 2013. Nearly all sub-penny trading (excluding 

mid-point executions) occurs off-exchange. 

Q.4. Does the larger percentage spread in low-price stocks lead to 

greater internalization by OTC market makers or more trading volume in dark pools? If so, why? Should the Commission consider reducing the minimum pricing increment in Rule 612 for lower priced 

stocks? 

55 

8http://www.sec.gov/spotlight/regnms/jointnmsexemptionrequest043010.pdf 

A.4. We believe the current penny quoting requirement has created 

artificially wide spreads in many liquid low-priced stocks where 

there is significant internalization. 8 There are two primary ways 

to potentially alter this dynamic—one by decreasing the minimum 

tick increment, and the other by incentivizing displayed public liquidity over that traded privately, as we have highlighted in our 

previous answers. Reducing the minimum pricing increment in liquid low-priced securities would lower investor trading costs and improve market transparency. In contrast to the ‘‘one size fits all’’ approach of the U.S., many countries have adopted tiered tick sizes 

based on the price level of a stock, with tick increments less than 

a penny. 

The decision to internalize a trade is influenced by the trade-off 

of profit opportunity versus ‘‘risk’’ assumed. In general, the wider 

the spread in a lower-priced stock, the more profit opportunity and 

incentive to internalize. This incentive is further distorted to the 

extent there are differing increment rules on different types of 

venues, and also to the extent venues are allowed to trade in front 

of displayed liquidity in sub-penny increments. 

The other contributing factor to greater internalization in low- price stocks is the uniform access-fee cap of $.0030 per share that 

applies across all stocks as defined in Regulation NMS. Some 

thought should be given to reducing the access-fee cap in these 

stocks commensurate with either price or spread. 

Q.5. Some commentators have suggested that the Securities and 

Exchange Commission (SEC) should lift the ban on locked markets. 

Locked markets occur when a trader attempts to place a bid on one 

exchange at the same price as an offer on a different exchange. 

They argue that bids and offers at the same price but different 

venues should be forced to interact, and this could reduce fragmentation in the marketplace and perhaps reduce the prevalence 

of trading in dark pools and internalization venues. What is your 

view of this proposal? 

A.5. Prior to Reg. NMS market centers were allowed to display 

quotes that locked or crossed other markets for NASDAQ-listed securities. Commenters at that time noted that locked/crossed markets could cause investor confusion and detract from market efficiency and were prohibited within Regulation NMS. Recently, some 

market participants have suggested that locked markets should potentially be allowed as a way to reduce fragmentation and internalization. 

We agree that the current market structure has incentivized too 

much fragmentation and executions purely based on the public 

market quotes. There are several ways to potentially address this 

issue, some of which have been addressed in our previous responses. Locked markets are another way to potentially reduce the 

fragmentation incentive by decreasing the potential profit opportunity from internalizing, and/or reducing the need for a similar 

number of protected quotes. 

As with any proposed changes, it is important to evaluate both 

the positives and negatives of any changes. On the positive side, 

locked markets would make transparent more trading interest— 

56 

nondisplayed buy and sell orders on market centers that are executable but not currently eligible for display. Locked markets 

would also reduce trading costs by eliminating the spread and 

would potentially simplify some order types that were developed to 

comply with Reg. NMS rules. 

However, on the negative side, we specifically worry that locked 

markets would become common in many active securities that continually quote at a penny spread today, potentially creating investor confusion. 

The benefits and concerns resulting from locked markets need to 

be carefully considered as part of a holistic review of U.S. equity 

market structure. Other potential alternatives to allowing locked 

markets exist and should be considered. These include depth-ofbook protection as well as other suggestions highlighted in other 

responses such as incentivizing displayed liquidity and/or introducing consistent trade and quote increments in the industry. 

Q.6. Internalizing broker-dealers often pay retail brokers to direct 

customer orders to their trading venues. Does this practice advantage or disadvantage retail investors? Why or why not? Why is retail flow valuable to trade against? 

A.6. Trading with retail flow is regarded as advantageous for two 

reasons—on average, the ‘‘informational’’ content tends to be lower 

than other types of order flow encountered in the market, and secondly, retail flow tends to be smaller and have less liquidity impact 

in a given stock. When a small order is sent by an institutional client, it is often a part of a larger order, and the counterpart interacting with the first order does not know that there will be significantly more stock behind it. 

Payment for order flow is an issue that has been widely debated 

in the industry and also warrants further ongoing review due to 

the inherent conflicts that exist when the payment is not directly 

accruing to the end investor. It is also important that payment for 

flow not be viewed in isolation. Payment for order flow, price improvement, and access fees are interrelated topics that should be 

dealt with concurrently. 

The traditional retail internalization model that exists today is 

primarily done through the interaction of retail market orders with 

a single wholesaler. Internalization is beneficial to the individual 

retail counterparty to the trade if the execution results in meaningful price improvement. However, internalization deprives both retail and institutional limit orders displayed on exchanges from 

interacting with those orders. The markets and price discovery optimally function through interactions with multiple, diverse market 

participants. When there is a proper mix of market participants, 

there is a greater incentive for market makers to quote more aggressively than a single participant. This incentive affords investors an opportunity to receive a superior fill on an exchange, one 

of the primary drivers behind the development of our RLP program. The Exchange environment brings competition from multiple 

liquidity providers, which offers retail investors greater price improvement potential, while also continuing to protect displayed 

quotes, which is fundamental to preserving market quality for all 

investors. 

57 

9http://financialservices.house.gov/uploadedfiles/hhrg-112-ba16-wstate-kcronin-20120620.pdf 

10 2013 Regulatory and Examination Priorities Letter: http://www.finra.org/web/groups/industry/@ip/@reg/@guide/documents/industry/p197649.pdf. 11Tabb Group, ‘‘A Spotlight in the Dark: An Inevitable Debate’’, p. 8, Exhibit 4, November 

2012; http://www.cfapubs.org/doi/abs/10.2469/ccb.v2012.n5.1. 

Q.7. Broker-dealers that operate their own dark pools can get a fee 

advantage when they route customer orders through their own 

dark pools rather than through a lit exchange. Does this create a 

conflict of interest between investors, who want to buy or sell 

stocks at the best prices, and brokers, who want to avoid exchange 

fees? Why or why not? 

A.7. There are two related topics that this question raises. The first 

is one of best execution and whether the interests of the customer 

are being put first. The second is a broader question about the cumulative impact of these practices on overall market quality. 

There are 13 equity exchanges offering a wide variety of fee 

choices for customers. Some exchanges offer high rebates to encourage liquidity providing and charge corresponding fees to remove liquidity. Under this model, investors who take additional risk by 

posting liquidity and showing their investment interest may be rewarded as price makers through a rebate. Investors who do not 

want to set prices but rather only act as takers of liquidity are 

charged a fee. This model was created by exchanges as a way to 

incentivize market participants to make public markets and assist 

in the price discovery process. This mechanism has become increasingly depended upon by exchanges as the more highly desired order 

flow from retail and institutional investors is executed in dark 

trading venues. Several exchanges also offer low take fees or even 

rebates to remove liquidity—minimizing the incentive for brokers 

to avoid exchanges simply because of fees. 

As noted in the previous response, investors trading through a 

single private broker venue may not be optimizing their execution 

if the reason is to avoid exchange take fees or to maximize business 

in the broker-dealer owned dark pool. In an exchange environment, 

however, the order would be exposed to competitive participants 

within a transparent environment with a real chance for execution 

optimization. 

As was expressed by Invesco’s Chief Investment Officer during 

the June 2012 House Financial Services Committee’s hearing, internalization whereby the broker-dealers garner information advantages creates a conflict of interest that they believe does not advantage the investor. 9 Similar conflict and disclosure issues were 

also recently raised by FINRA. 10

More significantly, however, is the effect this aggregate activity 

has on overall market quality. As outlined in recent research by 

Tabb Group and the CFA Institute, 11 the incentive to segment 

markets and reduce transparency jeopardizes the price discovery 

process and can adversely impact costs for all investors. Contrary 

to the stated goals of Reg. NMS, today’s market structure incentives result in increasingly higher levels of dark trading in broker 

owned venues, resulting in increased conflicts between investors 

and their executing brokers. 

Q.8. The U.S. exchanges are required to submit data to a centralized network where it is aggregated before being disseminated to 

58 

the public. However, the Consolidated Tape Association/Securities 

Information Processor or SIP now lags behind direct proprietary 

market data feeds. As a result, high frequency trading firms and 

other market participants now usually colocate their computer 

servers at every exchange and subscribe to proprietary data feeds 

offered by the exchanges in order to capitalize on latency arbitrage 

opportunities. Why should anyone receive market data flow from 

other than the consolidated tape? Should market data be distributed to all market participants equally? How do you think this can 

best be accomplished? 

A.8. The consolidated tape data feeds include the best-priced 

quotations of all exchanges and all reported trades, as well as the 

calculation of the NBBO, short sales restriction indications, single 

stock circuit breaker indicators, and other data. Proprietary data 

feeds of individual exchanges include those exchanges’ own bestpriced quotations and trades as well as other information not available through the consolidated tape, such as depth-of-book prices, 

which are required for trading larger or more sophisticated orders, 

particularly in a Regulation NMS environment. Because of these 

differences, market participants may choose to take market data 

from the consolidated tape and/or directly from exchanges or other 

vendors, depending on their individual needs. In any event, the 

SEC has to approve exchanges’ proprietary data products before 

they are sold to the public, and one of the general requirements for 

approval is that the data is indeed fairly and equally accessible to 

those that want to subscribe to the data feeds. Moreover, speed differences from a user perspective are not unfair or unusual. Because 

the data that exchanges send to the securities information processors (SIPs) is consolidated by the SIPs and then redistributed, 

the information in the proprietary data feeds of exchanges is permitted to reach market participants faster than the information 

sent from the SIP to the same market participants. Indeed, this 

was expressly contemplated in Regulation NMS where the SEC 

noted: 

Commenters were concerned about the statement in the 

Proposing Release that the distribution standards would 

prohibit a market from distributing its data independently 

on a more timely basis than it makes available the ‘‘core 

data’’ that is required to be disseminated through a Network processor. Instinet, for example, requested that the 

Commission clarify that the proposal would not require a 

market center to artificially slow the independent delivery 

of its data in order to synchronize its delivery with the 

data disseminated by the Network. Adopted Rule 603(a) 

will not require a market center to synchronize the delivery of its data to end-users with delivery of data by a Network processor to end-users. Rather, independently distributed data could not be made available on a more timely 

basis than core data is made available to a Network processor. Stated another way, adopted Rule 603(a) prohibits 

an SRO or broker-dealer from transmitting data to a venVerDate Nov 24 2008 16:26 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00062 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\12-18 COMPUTERIZED TRADING VENUES -- WHAT SHOULD THE RU
59 

12See, SEC Release No. 34-51808; File No. S7-10-04 at p. 271 (August 29, 2005). 

dor or user any sooner than it transmits the data to a Network processor. 12

Further, in the SEC’s 2010 Concept Release on Equity Market 

Structure, the Commission commented the average latency for the 

consolidated data feeds was generally less than 10 milliseconds at 

that time. This latency captures the difference in time between receipt of data by the SIP from the exchanges and distribution of the 

data by the SIP to the public. Since that time, continued improvements have been made to the SIP’s processing and today the average quote latency is less than 1 millisecond for Tape A&B securities and less than 2 milliseconds for Tape C securities (such data 

is made publicly available on a quarterly basis). [http:// 

www.nyxdata.com/CTA] We would note that the amount of data 

sent via proprietary feeds is far greater than on the consolidated 

feed, so the cost of telecommunications and the time to process this 

data when received is higher as well. Given these differences, we 

believe the provision of consolidated and proprietary data is largely 

about choice for customers. 

Q.9. The October closure of the markets for 2 days due to Hurricane Sandy raised questions about the financial sector’s preparedness for the next natural or man-made disaster. What challenges 

did the markets face in reopening after Hurricane Sandy? What 

should have been done differently after Hurricane Sandy to keep 

providing trading services to customers and maintain market integrity? What can the stock exchanges do to prepare the market for 

another disaster? What changes need to be made by market participants and regulators? 

A.9. The effects of Hurricane Sandy on the northeast were devastating. Lives were lost and thousands of families were displaced. 

The markets faced several challenges leading up to and during 

Hurricane Sandy. Reports called for a severe storm with massive 

flooding, widespread power outages, the shutdown of major transportation methods and dangerous travel conditions. In retrospect, 

all of these reports came true. Further, many of the largest financial service companies, exchanges, the securities clearinghouse 

(DTCC), and countless related smaller firms are headquartered in 

areas that expected a severe impact. The storm was forecast to affect such a wide area that many firms had both their primary and 

backup facilities within the affected region. 

NYSE senior management was in contact with the SEC, industry 

trade associations, member firms, and other exchanges throughout 

the weekend of October 27th and October 28th to consider the challenges posed by the forecasted hurricane. In the end, this group collectively decided that the risk/reward of opening the market while 

all industry participants with a local footprint would operate in 

contingency seemed inconsistent with providing a stable, liquid 

market. 

Following the hurricane, the challenges faced by the markets 

were primarily borne by industry personnel. While the markets reopened on October 31st, industry personnel faced significant obstacles common to all residents of the surrounding area. Power and 

60 

communication outages hampered people’s ability to work remotely. 

Access and transportation to certain areas like lower Manhattan 

were severely restricted. Basic necessities in these areas like lodging and food presented some challenges initially. There was significant damage to communications around lower Manhattan and surrounding areas. While there were many challenges to overcome, we 

note that the markets re-opened without incident on October 31st. 

There are several lessons to be learned from this event. At a 

minimum, businesses learned the importance of a well-prepared 

and tested business continuity plan. At NYSE Euronext, we are actively considering changes to our current disaster recovery model 

for NYSE and NYSE MKT. The exchanges can take steps to both 

review BCPs and regularly test backup trading locations. Regular 

testing should both include a test of connectivity with exchange 

backup facilities and cause minimal disruption to the financial 

markets or its’ participants. The industry should consider whether 

to make these tests mandatory for all participants. Industry conversations are underway to assess lessons learned and prepare for 

similar events. 

Q.10. It has recently been reported that the SEC’s Interim Inspector General found that some staff in the SEC’s Trading and Markets Division did not encrypt computers containing confidential 

data from the exchanges and clearing agencies they were overseeing. What measures are being taken now or should be taken by 

market participants and regulators to better secure data in today’s 

high tech markets? 

NYSE Euronext is committed to providing our customers with a 

secure network delivering the highest levels of reliability in the industry. The reliability and availability of NYSE Euronext’s Secure 

Financial Transaction Infrastructure (SFTI) is dependent upon 

many dynamics including the prevention of security breaches and 

cyber attacks. The security problems uncovered through the SEC’s 

Inspector General Report were unfortunate and deeply concerning 

to NYSE Euronext, however we believe the important outcome is 

that the SEC appears to be taking steps to prevent a similar situation from occurring again the future. We also support a more targeted approach to regulator accumulation of entity data to ensure 

that any security issues have more limited impact. 

As witnessed by several high profile cyber security breaches during the past several years, the Federal Government has developed 

a notification process that includes a number of agencies including 

the SEC, CIA, FBI, and DHS. NYSE Euronext is supportive of 

these coordinated efforts by Federal agencies and will continue to 

be partner with them in securing our financial markets. 

As offered during the hearing, we would also like to take the opportunity to clarify the record on some of the representations and 

data provided by the Credit Suisse witness. We believe the below 

clarifications will provide a more accurate depiction of the facts. 

Point 1—Levels of ‘‘Off-Exchange’’ Trading 

Mr. Daniel Mathisson of Credit Suisse offered in his testimony 

that the ‘‘statement that volume has been moving to off-exchange 

61 

13Written Testimony of Daniel Mathisson of behalf of Credit Suisse, Before the Senate Banking Committee Subcommittee on Securities, Insurance, and Investment ‘‘Computerized Trading 

Venues: What Should the Rules of the Road Be?’’, December 18, 2012. 14 BATS became a national securities exchange in October 2008 and Direct Edge spun off the 

EDGA/EDGX exchanges in July 2010. 15Tabb Group, ‘‘A Spotlight in the Dark: An Inevitable Debate’’, p. 8, Exhibit 4, November 

2012; Rosenblatt Securities, U.S. Securities Volume: Year-In-Review, January 4, 2013. 16Other internalization generally includes trades matched internally by broker-dealers based 

on the public quote. While these market-makers maintain various quoting and pricing obligations to their own client’s orders, the desk may step in front of exchange-displayed orders by 

simply matching the displayed price. This can occur either on their client’s behalf or for their 

own account (Tabb Group, ‘‘A Spotlight in the Dark: An Inevitable Debate’’, November 2012). 

venues . . . is factually incorrect. Over the past 5 years, volume 

has not shifted to off-Exchange venues.’’ 13 We strongly disagree. 

Credit Suisse’s conclusions rely on data that incorporates a misleading and narrowly focused definition of ‘‘off-exchange’’ and ‘‘onexchange’’ trading: literally, whether a market was registered as an 

exchange or not during the relevant time frame. In particular, Mr. 

Mathisson includes BATS and Direct Edge, which were ‘‘Electronic 

Communication Networks’’ or ECNs in the ‘‘off-Exchange’’ category. 

These ECNs displayed public quotes and participated in price discovery in a way that was very similar to exchanges, and subsequently became registered exchanges. 14

Under a more accurate and accepted measurement methodology 

for ‘‘off-Exchange’’ trading, such ‘‘off-Exchange’’ activity would not 

include ECNs such as BATS and Direct Edge. When measured correctly, ‘‘off-Exchange’’ trading, which would only include dark pools 

and internalization desks, rose from 19.5 percent in October 2007 

to 35 percent in December 2012 and 37 percent in January 2013, 

as shown in Figures 1 and 2. Similar classifications were highlighted in recent reports by Tabb Group and Rosenblatt Securities. 15

Mr. Mathisson also commented that dark pool activity has increased, but ‘‘other internalization’’ 16 has declined. This statement 

also is misleading. Dark pool activity has indeed tripled from 4 percent to 13 percent of total volume over the cited period. However, 

what Mr. Mathisson refers to as ‘‘other internalization’’ has risen 

from 12 percent to 21 percent of total U.S. trading activity from between January 2008 and December 2012, as shown in Figure 2. 

62 

63 

17Written Testimony of Daniel Mathisson of behalf of Credit Suisse, Before the Senate Banking Committee Subcommittee on Securities, Insurance, and Investment ‘‘Computerized Trading 

Venues: What Should the Rules of the Road Be?’’, December 18, 2012. 

Source: Rosenblatt Securities, Consolidated Tape Association. Note: Total Off-Exchange Trading excludes BATS and DirectEdge as they operated as ECNs at that 

time. 

Point 2—SRO Immunity 

In his written testimony, Mr. Mathisson stated that (1) ‘‘courts 

have traditionally afforded exchanges ‘absolute immunity’ from 

civil liability for damages arising in connection with their regulatory operations’’; (2) ‘‘It is a dangerous situation when a for-profit 

enterprise can cause half a billion dollars of losses for others, and 

not have the risk of being held legally liable’’; and (3) that ‘‘Exchanges have absolute immunity on errors . . . ’’ [emphasis 

added]. 17

These statements are flatly inaccurate and warrant clarification. 

Exchanges do have immunity from private lawsuits for damages 

when engaging in conduct consistent with the quasi-governmental 

powers delegated to them pursuant to the Exchange Act, and we 

believe that this well-developed doctrine is critical to ensuring that 

exchanges are protected when fulfilling those statutorily delegated 

powers. However, exchanges still answer to the SEC for their conduct, and can and have been fined by their primary regulator. This 

is true regardless of whether immunity applies in particular cases. 

Separately, we have commercial limits of liability in place with 

our members, which are governed by rules and membership agreements approved by the SEC. These rules and agreements enable 

members to be reimbursed for certain types of errors made by the 

exchange. Moreover, these rules are submitted to the normal notice-and-comment process required by the Exchange Act, which 

64 

18Written Testimony of Daniel Mathisson of behalf of Credit Suisse, Before the Senate Banking Committee Subcommittee on Securities, Insurance, and Investment ‘‘Computerized Trading 

Venues: What Should the Rules of the Road Be?’’, December 18, 2012. 19Written Testimony of Daniel Mathisson of behalf of Credit Suisse, Before the Senate Banking Committee Subcommittee on Securities, Insurance, and Investment ‘‘Computerized Trading 

Venues: What Should the Rules of the Road Be?’’, December 18, 2012. 

gives the public—including our members—the opportunity to voice 

concerns about the exchange’s rules. 

Point 3—Tape Revenue for Consolidated Market Data 

In his written and oral testimony, Mr. Mathisson/Credit Suisse 

asserts that, ‘‘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 $400m per year which is then distributed to its participant 

exchanges based on a complex formula. ATSs do not receive tape 

revenue’’ [emphasis added]. 18 Mr. Mathisson later alleges that ‘‘ 

. . . the exchanges are entitled to market data revenues to offset 

the costs of regulating their markets . . . [and] revenues from market data are way out of proportion with the costs of exchanges’ selfregulatory responsibilities.’’ The citation for this statement is the 

SEC’s 1999 Concept Release: Regulation of Market Information 

Fees and Revenue, Exchange Act Release No. 42208 [hereinafter 

SEC 1999 Market Data Concept Release]. Finally Mr. Mathisson/ 

Credit Suisse alleges that ‘‘[b]ecause the CTA allocated revenue to 

the exchanges is based on a complex formula involving variables 

such as each exchange’s number of quotations, for-profit exchanges 

try to set policies and services that will increase the level of 

quoting activity.’’ 19 Mr. Mathisson/Credit Suisse claims that a byproduct of these alleged policies is quote flickering. These claims 

require clarification: 

1. While the CTA plan does not directly pass tape revenue to 

non-Exchange participants, the two FINRA TRFs rebate an 

estimated $50 to $60 million in tape revenue annually back 

to brokers, including ATSs and broker-dealer internalizers. 

2. The SEC 1999 Market Data Concept Release was not a rulemaking or adjudication by the SEC—it was an invitation for 

comment on matters the SEC was considering, and it did not 

result in rulemaking. In addition, the SEC 1999 Market Data 

Concept Release repeatedly refers to the market data pool as 

being used to fund ‘‘the market’s operation and regulation’’ 

[emphasis added]. As such, it is not accurate to represent that 

the SEC expressed a view, even in the context of the SEC 

1999 Market Data Concept Release, that market data fees are 

exclusively meant to fund regulation. 

3. The market data allocation formula is not based on an ‘‘exchange’s number of quotations,’’ but instead is partly based on 

dollar size and the amount of time at the NBBO (i.e., quoting 

share), which accounts for 50 percent of the allocation formula. The other 50 percent allocation is based on trading 

share. This allocation formula was established by the SEC in 

Reg NMS to incentivize both price discovery and market quality. Importantly, the formula requires that a quotation must 

be displayed for a minimum of one full second to earn quote 

65 

20http://www.sec.gov/rules/final/34-51808.pdf 21http://www.sec.gov/rules/final/34-51808.pdf, p. 264. 

credits. 20 This minimum time period was put in place by the 

SEC specifically to prevent quote flickering. In this regard, 

the SEC stated in its explanation to commenters that opposed 

the need for a market data plan formula, ‘‘ . . . the Commission’s primary objective is to correct an existing flaw in the 

current formulas by allocating revenues to those SROs that, 

even now, benefit investors by contributing useful quotations 

to the consolidated data stream.’’ 21 As such, we believe it is 

incorrect to assert that the SEC market data allocation formula incentivizes quote flickering. 

More broadly, as noted in our oral testimony, registered exchanges operate under a regime of obligations and benefits. These 

obligations are significant, and include: rule filing obligations, restrictions on business operations, the inability to transact with 

public customers, member ownership limitations, fair access and 

self-regulatory obligations. Mr. Mathisson and Credit Suisse seem 

to argue that any economic incentives associated with the fulfillment of these important obligations should be allocated to the 

broker-dealers and investment banks and not to the exchanges that 

bear these significant regulatory obligations that benefit the industry and subsequently, the public. 

As stated in our testimony, we would welcome a holistic review 

of our current U.S. market structure, including the benefits and obligations of registered exchanges and broker-dealers; however we 

would caution that the investment banks’ and broker-dealers’ economic self-interests should not be the linchpin upon which investor 

protection rests. 

Thank you again for the opportunity to testify and provide our 

thoughts. We would be happy to answer any additional questions 

that you may have. 

RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN REED 

FROM DANIEL MATHISSON 

Q.1. There was testimony that ‘‘dark trading’’ is a concern in many 

countries and that Canada recently modified its market structure 

to limit dark trading and to maximize price discovery. Canadian 

regulators have imposed a new framework governing how dark 

pools and undisplayed orders are allowed to operate including priority of lit over dark flow and a minimum price improvement requirement for dark orders. What is your view of these reform proposals? Would these measures make the U.S. markets more or less 

fair and transparent? Please explain. Would these measures be feasible in the U.S. markets? Why or why not? 

A.1. Canada rolled out new rules in October of 2012 that were intended to limit broker-dealer crossing platforms. The new rules 

forced several market participants to either exit Canadian markets 

(e.g., Goldman Sachs Sigma X) or drastically alter their business 

models (e.g., TSX Alpha Intraspread). According to the Rosenblatt 

Report released on December 19th 2012, combined dark volumes in 

Canada fell significantly to 2.06 percent in November, from 3.54 

66 

percent in October and an original 5.67 percent of equity trading 

volume in September before the new framework went into effect. 

While it appears the new rules have skewed the competitive environment, hurting Canadian ATS operators and helping exchanges, 

we have seen no empirical evidence that this change has been beneficial for investors. 

We believe that the U.S. regulators should carefully review any 

future academic studies that demonstrate how the Canadian 

change has impacted liquidity, price stability, bid/ask spreads, and 

other empirical measures of market health. In the absence of evidence that the rule change has helped investors, it would not make 

sense for the U.S. to blindly follow Canada’s lead. We believe that 

a rule change like this would have a major impact on the existing 

market structure, and this should only be considered as part of a 

comprehensive market reform that reviews the entire competitive 

landscape of the for-profit exchanges and broker-dealers. 

Q.2. Rule 612 of Regulation NMS prevents sub-penny quoting. 

However, under an exemption in Rule 612 the SEC actually allows 

broker-dealers to execute orders in sub-penny increments. Because 

there are no quoting obligations for broker-dealer internalization, 

broker-dealers can provide price improvement to their customers in 

the form of sub-penny executions. What are advantages or disadvantages of sub-penny quoting? Is special pricing good for retail 

investors? Why or why not? 

A.2. We believe that sub-penny trading is net beneficial for retail 

clients, as well as for institutional clients. In the current market 

structure, retail clients typically receive an immediate fill at a price 

slightly better than the bid or offer. For example, if Ford Motors 

is showing a 13.83 offer, a retail client buying 2,000 shares would 

often receive a fill of, say, 13.829, saving a small amount of money 

on the transaction vs. the offer price. Known as ‘‘price improvement,’’ those small amounts can add up to significant sums over a 

lifetime of investing. 

The SEC has recently relaxed Rule 612, by approving pilot programs by the NYSE and BATS Exchange which offer price improvement and allow sub-penny trading (‘‘Retail Liquidity Program’’ approved in July 2012). Since exchanges are now permitted 

to accept and rank orders in sub-penny increments in the RLP program, we believe broker-dealer operated Alternative Trading Systems should be able to do so as well. 

Q.3. Some commentators have suggested that the Securities and 

Exchange Commission (SEC) should lift the ban on locked markets. 

Locked markets occur when a trader attempts to place a bid on one 

exchange at the same price as an offer on a different exchange. 

They argue that bids and offers at the same price but different 

venues should be forced to interact, and this could reduce fragmentation in the marketplace and perhaps reduce the prevalence 

of trading in dark pools and internalization venues. What is your 

view of this proposal? 

A.3. While the rationale for banning locked markets under Rule 

611 of Regulation NMS Rule is to prevent trading at inferior prices, 

one of the unintended effects of Rule 611 has been the proliferation 

of exchange order types with the sole purpose of allowing sophistiVerDate Nov 24 2008 16:26 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00070 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\12-18 COMPUTERIZED TRADING VENUES -- WHAT SHOULD THE RU
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cated users to unfairly gain queue priority over simple limit orders. 

These order types have contributed to an increase in pinging and 

cancellation rates. We believe that lifting the ban on locked markets would greatly simplify the U.S. equity markets and possibly 

lead to better execution results for investors. We recommend that 

the SEC implement a pilot program lifting the ban on locked markets in several NMS symbols to conduct analysis and gather empirical data to measure the effects and impact to the markets. 

Q.4. Internalizing broker-dealers often pay retail brokers to direct 

customer orders to their trading venues. Does this practice advantage or disadvantage retail investors? Why or why not? Why is retail flow valuable to trade against? 

A.4. Retail investors are advantaged by the current system, where 

brokers are allowed to engage in market-making. Market-makers 

typically pay rebates to retail brokers for order flow, which allows 

the retail brokers to charge very low commissions to the end customer. Market-makers typically provide better quality of execution 

than exchanges, as execution quality statistics are made public 

under SEC Rule 605, resulting in savings for the investor. 

Retail flow is considered valuable to market-makers because it 

typically consists of a steady stream of small market orders. A market-maker will try to buy near the bid from client A and sell near 

the offer to client B, capturing a spread in the process. Marketmakers prize small orders because they are less risky than large 

institutional orders. 

Q.5. Broker-dealers that operate their own dark pools can get a fee 

advantage when they route customer orders through their own 

dark pools rather than through a lit exchange. Does this create a 

conflict of interest between investors, who want to buy or sell 

stocks at the best prices, and brokers, who want to avoid exchange 

fees? Why or why not? 

A.5. This practice does not create a conflict of interest. Under Regulation NMS, orders in the U.S. may not ‘‘trade through’’ the National Best Bid Offer (NBBO), meaning that if a stock is offered at 

18.50 on an exchange, a broker-dealer may not route a buy order 

to a venue where the order would be filled at 18.51 or higher. The 

client is guaranteed to do no worse than the best current price on 

the national market system. Within that significant constraint, as 

part of their best execution obligations, broker-dealers take into account multiple factors when deciding where to route client orders. 

These factors include the potential for price improvement, the 

speed of execution, and the likelihood that an order will be filled. 

Q.6. The U.S. exchanges are required to submit data to a centralized network where it is aggregated before being disseminated to 

the public. However, the Consolidated Tape Association/Securities 

Information Processor or SIP now lags behind direct proprietary 

market data feeds. As a result, high frequency trading firms and 

other market participants now usually colocate their computer 

servers at every exchange and subscribe to proprietary data feeds 

offered by the exchanges in order to capitalize on latency arbitrage 

opportunities. Why should anyone receive market data flow from 

other than the consolidated tape? Should market data be distribVerDate Nov 24 2008 16:26 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00071 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\12-18 COMPUTERIZED TRADING VENUES -- WHAT SHOULD THE RU
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uted to all market participants equally? How do you think this can 

best be accomplished? 

A.6. In an ideal system, we believe that all intraday market data 

would be supplied by the SIP. However, we recognize that this 

would create a significant disruption to the existing business models of the for-profit exchanges as well as many trading firms, and 

therefore regulators should carefully analyze and review the costs 

and benefits prior to changing the current data distribution model. 

Q.7. The October closure of the markets for 2 days due to Hurricane Sandy raised questions about the financial sector’s preparedness for the next natural or man-made disaster. What challenges 

did the markets face in reopening after Hurricane Sandy? What 

should have been done differently after Hurricane Sandy to keep 

providing trading services to customers and maintain market integrity? What can the stock exchanges do to prepare the market for 

another disaster? What changes need to be made by market participants and regulators? 

A.7. The decision to close the U.S. equities markets on October 

29th and October 30th was made after serious consideration and 

with industry-wide consensus on Sunday, October 28th, as Hurricane Sandy was bearing down on East Coast. Several contingency 

plans were discussed, but the primary concern was the safety of 

employees. All contingency plans involved a number of key employees having to commute and work in areas in immediate danger of 

being flooded or destroyed. 

Most U.S. financial institutions, including Credit Suisse, have 

backup power generators and disaster recovery sites to maintain 

uninterrupted trading and customer service during fire, flooding, or 

any other event impacting the firms’ primary location. However, 

given the rarity of events as severe as Hurricane Sandy, it would 

be impractical and tremendously costly for the entire industry to 

maintain fully operational, fully staffed alternative sites and facilities in various locations throughout the country. According to our 

research, during the past 100 years, the U.S. markets have been 

closed due to inclement weather only five times, including the two 

days of Hurricane Sandy. We agree that a continued focus on disaster recovery is prudent and necessary, but believe it is acceptable 

for the markets to close during extreme region-wide weather 

events, since these occur so rarely. 

RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN REED 

FROM ERIC NOLL 

Q.1. There was testimony that ‘‘dark trading’’ is a concern in many 

countries and that Canada recently modified its market structure 

to limit dark trading and to maximize price discovery. Canadian 

regulators have imposed a new framework governing how dark 

pools and undisplayed orders are allowed to operate including priority of lit over dark flow and a minimum price improvement requirement for dark orders. What is your view of these reform proposals? Would these measures make the U.S. markets more or less 

fair and transparent? Please explain. Would these measures be feasible in the U.S. markets? Why or why not? 

69 

A.1. NASDAQ OMX does not oppose all dark trading, but rather 

focuses on the need to make our markets as efficiently transparent 

as possible to ensure that the price discovery process is robust and 

that capital formation is maximized. 

NASDAQ OMX recognizes that large institutional trades between natural buyers and sellers should be able to occur at prevailing market prices outside the confines of an exchange or ECN 

in order to minimize disruption to the market. In executing all 

other types of transactions the emphasis should be on open, efficient, and transparent order interaction in order to ensure that the 

price discovery process is robust, broker-client conflicts of interest 

are minimized, and investor confidence and capital formation are 

maximized. These nonblock transactions can occur on exchanges or 

on ECNs. The Canadian policy decision to limit the use of closed 

alternative systems shows that regulators increasingly view it as 

important that open order interaction be strongly encouraged. We 

support innovative solutions like the Canadian Reforms and would 

like to see the SEC fully explore like-minded reforms here in the 

United States. Although the U.S. and Canadian markets are very 

different in scale there are common economic issues underlying the 

trading process in both markets. We view the SEC as appropriately 

positioned to weigh and balance the ramifications of investor protection, competition, liquidity, and regulatory complexity and look 

forward to working with them to understand the U.S. capital market’s needs in this area. 

Q.2. What is an example of an order type that the NYSE has created to make our markets better, and improve transparency and 

price discovery? How does this order type provide equal access? 

Does the NYSE allow dark or undisplayed orders or provide dark 

execution? Why or why not? 

A.2. In comparison with some markets, NASDAQ adheres to a 

principle of maintaining relative simplicity in its roster of order 

types, and ensuring that the operation of all of its order types is 

well understood by market participants. To that end, NASDAQ recently posted a webinar describing its order types, freely available 

to market participants and other members of the public at http:// 

www.brainshark.com/nasdaqomx/vu?pi=zF7zJ6aUZzoG0z0. Further descriptions of order type operation are available at http:// 

www.nasdaqomxtrader.com/content/ProductsServices/Trading/ 

Workstation/rash—strategy.pdf. Notably, NASDAQ does not offer 

any order types that allow an order to jump ahead of previously 

posted orders in execution priority. All order types are available to 

members on equal terms. 

NASDAQ believes that it is necessary to offer market participants the option of posting nondisplayed orders to enable NASDAQ 

to compete with the multiplicity of exchanges and alternative trading venues that offer this option, and because market participants 

representing large orders may have a legitimate need to use nondisplayed orders as a means to guard against adverse price movements. Moreover, nondisplayed orders that are designed to price at 

the midpoint between the national best bid and offer provide a 

means for market participants to offer price improvement to their 

counterparties. 

70 

Of course NASDAQ believes that its exchange should be the preferred venue for price discovery of the securities that it lists and 

trades. To that end, our schedule of fees and rebates for order execution offers a rebate for liquidity provided through displayed orders that is higher, and in many instances significantly higher, 

than the rebate for liquidity provided through nondisplayed orders. 

The effect of these financial incentives is borne out through actual 

patterns of trading, with approximately 90 percent of executions on 

NASDAQ based on the use of displayed orders. In addition, order 

types that NASDAQ offers that are designed to reprice aggressively 

to increase the order’s chances for execution are generally required, 

by their terms, to be displayed orders. 

Q.3. Rule 612 of Regulation NMS prevents sub-penny quoting. 

However, under an exemption in Rule 612 the SEC actually allows 

broker-dealers to execute orders in sub-penny increments. Because 

there are no quoting obligations for broker-dealer internalization, 

broker-dealers can provide price improvement to their customers in 

the form of sub-penny executions. What are advantages or disadvantages of sub-penny quoting? Is special pricing good for retail 

investors? Why or why not? 

A.3. NASDAQ believes that quoting increments must be uniform 

across all trading venues and market participants, including overthe-counter trading and broker-dealer internalization. Additionally, 

a one-size-fits-all increment regime is inefficient and ineffective; increments must be flexible and tailored to the characteristics of 

varying classes of securities. In fact, NASDAQ has several times 

urged the Commission to add tick increments both larger and 

smaller than those set forth in SEC Rule 612, most recently in its 

April 2010 joint letter with the NYSE and other exchanges seeking 

an SEC exemption from Rule 612 for certain actively traded securities. No action has been taken on that request for exemptive relief. 

These two principles dictate a reversal of the above-referenced 

exemption from Rule 612. That exemption has contributed significantly to the migration of trading away from lit markets and into 

the dark markets. While broker-dealers claim to provide price improvement to retail orders executed in the dark, that price improvement may be financially immaterial and outweighed by the 

negative impact of dark trading on price formation and market 

fairness. 

Q.4. Some commentators have suggested that the Securities and 

Exchange Commission (SEC) should lift the ban on locked markets. 

Locked markets occur when a trader attempts to place a bid on one 

exchange at the same price as an offer on a different exchange. 

They argue that bids and offers at the same price but different 

venues should be forced to interact, and this could reduce fragmentation in the marketplace and perhaps reduce the prevalence 

of trading in dark pools and internalization venues. What is your 

view of this proposal? 

A.4. This is an interesting theoretical concept that we think should 

be considered along with other approaches as the SEC evaluates 

U.S. market structure. The spread between bid and offer historically existed to compensate providers of liquidity, typically trading 

professionals, for the risk and expense associated with posting orVerDate Nov 24 2008 16:26 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00074 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\12-18 COMPUTERIZED TRADING VENUES -- WHAT SHOULD THE RU
71 

ders to buy and sell. In a series of well-conceived reforms, the SEC 

has opened the process of posting orders to buy and sell to all investors. As investors are motivated to trade for reasons other than 

short term trading profits motivating the professional there is no 

ex ante reason that a positive bid and offer spread should exist in 

situations where investors are separated by their preferred locus of 

trading. Should such locked markets occur, as they do frequently 

under Regulation NMS today, we expect that these locked markets 

would quickly clear as brokers and traders act to buy or sell at a 

price more favorable than would otherwise exist. We recognize that 

the SEC’s position on locked markets was driven in part by the 

market access fees charged by certain trading platforms during the 

time Regulation NMS was under consideration and that a review 

of the SEC’s ban on locked markets might reasonably also include 

a review of the market access fee caps created by Regulation NMS. 

Q.5. Internalizing broker-dealers often pay retail brokers to direct 

customer orders to their trading venues. Does this practice advantage or disadvantage retail investors? Why or why not? Why is retail flow valuable to trade against? 

A.5. NASDAQ believes that the public would view negatively the 

practice of retail brokers ‘‘shopping’’ their orders to the highest bidder, particularly where it results almost exclusively in their orders 

being routed to and executed in dark markets. Notably, the overwhelming majority of retail investors’ orders, whether entered by 

individuals, mutual funds, or pensions, are handled by sophisticated trading firms that are obligated to deliver best execution to 

such orders and to disclose payment arrangements. The question 

becomes whether those duties place sufficient constraints on potential conflicts of interest to overcome the negative perception of payment for order flow practices. 

Q.6. Broker-dealers that operate their own dark pools can get a fee 

advantage when they route customer orders through their own 

dark pools rather than through a lit exchange. Does this create a 

conflict of interest between investors, who want to buy or sell 

stocks at the best prices, and brokers, who want to avoid exchange 

fees? Why or why not? 

A.6. Fragmentation and darkness are eroding the quality and perceived fairness of U.S. markets. NASDAQ supported the Commission’s November 2009 proposal to modify the regulation of nonpublic trading interest. That proposal would have attempted to address the problem of so-called ‘‘dark’’ pools that use indications of 

interest to, effectively, display quotes to only a small subset of the 

national market system. It also would have begun to address the 

proliferation of dark pools that has fostered the two-tiered market 

which is anathema to the public interest. 

Q.7. The U.S. exchanges are required to submit data to a centralized network where it is aggregated before being disseminated to 

the public. However, the Consolidated Tape Association/Securities 

Information Processor or SIP now lags behind direct proprietary 

market data feeds. As a result, high frequency trading firms and 

other market participants now usually colocate their computer 

servers at every exchange and subscribe to proprietary data feeds 

72 

offered by the exchanges in order to capitalize on latency arbitrage 

opportunities. Why should anyone receive market data flow from 

other than the consolidated tape? Should market data be distributed to all market participants equally? How do you think this can 

best be accomplished? 

A.7. The U.S. national market system creates the fastest, deepest, 

most transparent and most reliable market data of any jurisdiction. 

No other market system creates aggregate data capturing a dollar 

or share volume of trading from as large a number of trading 

venues as the United States. In addition to aggregate data from 

the network processors, the flexibility granted by the Commission 

in Regulation NMS has sparked innovation and competition by exchanges, ATSs, and broker-dealers to create a previously 

unimagined variety of optional data products. This broad range of 

options supports an equally broad range of competing business 

models that require different amounts, types, and speeds of data. 

The coexistence of multiple competing business models, supported 

by a variety of data products, contributes positively to price formation and liquidity. In NASDAQ’s view, eliminating proprietary data 

products that support competing business models would harm the 

U.S. market and investors with little or no off-setting benefit. Additionally, it is worth noting that market participants that collocate 

in exchange facilities serve a wide variety of business models, including many highly sophisticated firms that serve retail investors. 

Q.8. The October closure of the markets for 2 days due to Hurricane Sandy raised questions about the financial sector’s preparedness for the next natural or man-made disaster. What challenges 

did the markets face in reopening after Hurricane Sandy? What 

should have been done differently after Hurricane Sandy to keep 

providing trading services to customers and maintain market integrity? What can the stock exchanges do to prepare the market for 

another disaster? What changes need to be made by market participants and regulators? 

A.8. Hurricane Sandy was a devastating storm that hit at both the 

physical assets and human resource center of our industry. It was 

the first time since 1885 that two trading days were lost to weather-related issues. We prepare for emergencies such as Sandy and 

other unexpected market events in several ways. With respect to 

physical infrastructure, NASDAQ OMX and most of our partners 

in the trading community maintain geographic and systems diversity that would have allowed contingency trading and regulation of 

our markets in the aftermath of Hurricane Sandy. 

NASDAQ OMX implemented our own emergency plans before, 

during and after Sandy made landfall. Our key employees and systems were in place and ready to operate. From a legal perspective, 

the SEC granted our board of directors and persons designated by 

the board the authority, memorialized in our by-laws, to take ‘‘any 

action’’ regarding the operation of our market or the trading of any 

and all securities in the event of an emergency or extraordinary 

market conditions. This gives us the ability to adapt to unexpected 

events to protect the integrity of the market, to protect investors 

and the public interest, and otherwise to ensure that we are fulfilling our mandates under the Securities Exchange Act of 1934. 

73 

Market integrity was clearly threatened by the moral dilemma 

presented by the prospect of operating the markets during Hurricane Sandy. Operating the market would have demanded that professionals from across our industry venture out into dangerous conditions, potentially imposing additional burdens on already 

stressed public safety personnel. Owing to the risks to human life 

in New York and New Jersey and for employees of the markets, 

our customers and regulators, the markets made the best decision 

under the circumstances. NASDAQ supported this collective decision, and exercised its emergency authority to close its market. 

The industry learned valuable lessons from the experience. We 

have already looked at how our contingency plans worked in a reallife situation. We are pleased that, without hesitation, we can say 

that NASDAQ’s testing and readiness plans, thanks to our dedicated employees, had our market ready to operate and trade all of 

our listed stocks in a normal and uninterrupted manner. 

Q.9. It has recently been reported that the SEC’s Interim Inspector 

General found that some staff in the SEC’s Trading and Markets 

Division did not encrypt computers containing confidential data 

from the exchanges and clearing agencies they were overseeing. 

What measures are being taken now or should be taken by market 

participants and regulators to better secure data in today’s high 

tech markets? 

A.9. NASDAQ is fully cognizant that attaining perfection in the operation and implementation of technology is impossible, even when 

it is developed and monitored by the most diligent personnel and 

rigorous systems. At the SEC’s own October 2, 2012, Technology 

and Trading Roundtable the SEC’s academic expert stated as 

much. Dr. Nancy Leveson, Professor of Aeronautics and Astronautics and Engineering Systems, at the Massachusetts Institute of 

Technology, describing her 47 years in computer science, at IBM, 

MIT, and in her own business stated: 

Let me tell you a little bit of what I’ve learned in the last 47 

years. The first lesson is that all software contains errors. I have 

not in all of that time ever come across any software that was nontrivial in which no errors were found during operations. The errors 

may not surface for a long time but they are lurking there and 

waiting for just the right conditions to occur. There are also some 

myths about certain industries being able to create perfect software 

but unfortunately this is patently untrue. No industry creates perfect software. 

NASDAQ fully agrees with this statement and, as such, understands the difficulty that all organizations, including the SEC, experience in implementing technology in a secure, effective manner. 

Moreover, the SEC Inspector General findings with respect to 

computer security at the SEC are another reminder that security 

is a shared responsibility between the markets, participants, and 

Government. The SEC seems fully committed to resolving the 

issues highlighted in the IG report, which raised concerns about 

one isolated area of the SEC that can be addressed appropriately 

through training and understanding about security protocols and 

best practices for the treatment of all sensitive information. 

NASDAQ OMX would welcome the opportunity to work with the 

74 

1See, Ian Domowitz, ITG, ‘‘Are We Missing the Evidence in the Global Dark Pool Debate?’’, 

December 2010 http://is.gd/qpumXJ. See also: Haoxiang Zhu, MIT, ‘‘Do Dark Pools Harm Price 

Discovery?’’, November 2012. http://www.mit.edu/zhuh/Zhuldarkpool.pdf 

SEC to ensure that the data we share with them is communicated 

in a secure manner and protected from unauthorized disclosure in 

the future. NASDAQ OMX is investing heavily to mitigate risks in 

the computer security area—we have hired nationally respected experts, upgraded our own systems, are in the process of enhancing 

our systems integrity testing and are demanding similar actions by 

those with whom we interact. NASDAQ OMX supports Congressional action to foster information sharing between national infrastructure operators and Government agencies that have access to 

information about cyber security threats, technology best practices 

and other resources that can help us protect vital infrastructures 

like our security markets. 

RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN REED 

FROM ROBERT C. GASSER 

Q.1. There was testimony that ‘‘dark trading’’ is a concern in many 

countries and that Canada recently modified its market structure 

to limit dark trading and to maximize price discovery. Canadian 

regulators have imposed a new framework governing how dark 

pools and undisplayed orders are allowed to operate including priority of lit over dark flow and a minimum price improvement requirement for dark orders. What is your view of these reform proposals? Would these measures make the U.S. markets more or less 

fair and transparent? Please explain. Would these measures be feasible in the U.S. markets? Why or why not? 

A.1. The Canadian regulators have clearly stated they made these 

changes despite a total lack of evidence that dark trading was negatively impacting Canadian market quality. Most academic evidence suggests that not only does dark not harm price discovery, 

it generally improves it. 1 ITG’s own analysis of the Canadian markets has shown a continued decline in institutional trading costs as 

dark pools have gained acceptance and grown in that market. 

While it is too early to fully discern the impact of the October 2012 

rule change, there is certainly no glaring evidence these rules have 

improved the marketplace or added to the availability of displayed 

liquidity. Early indications in the Canadian equity markets are 

that there has been a decline in order flow at the dark venues and 

an increase in trading flow posted as dark order types on the displayed markets. 

The U.S. equity market is much larger and more complex than 

the Canadian market. With 13 exchanges and over 40 dark pools, 

there is healthy competition for order flow, which has resulted in 

a dramatic decrease in both implicit and explicit trading costs over 

the past decade. It is a generally accepted principle in the U.S. that 

regulators should not make changes that simply favor one set of 

competitors over another without a resultant improvement in overall market structure. In our assessment, imposing rules similar to 

the Canadian measures in the U.S. would neither be feasible nor 

advisable, as they would not result in improved liquidity or better 

outcomes for institutional or retail investors. 

75 

Q.2. Rule 612 of Regulation NMS prevents sub-penny quoting. 

However, under an exemption in Rule 612 the SEC actually allows 

broker-dealers to execute orders in sub-penny increments. Because 

there are no quoting obligations for broker-dealer internalization, 

broker-dealers can provide price improvement to their customers in 

the form of sub-penny executions. What are advantages or disadvantages of sub-penny quoting? Is special pricing good for retail 

investors? Why or why not? 

A.2. There is clear value in price improvement through sub-penny 

executions, but sub-penny quoting is unnecessarily complex and of 

dubious benefit to investors. Sub-penny executions, in the aggregate, have lowered execution costs for retail investors by millions 

of dollars. It is appropriate for retail investors to receive this type 

of special pricing because retail order flow carries little risk of adverse selection; specifically, interaction with retail order flow does 

not involve many of the concerns that arise when interacting with 

orders from certain high frequency trading strategies, such as information leakage and price deterioration. In contrast, sub-penny 

quoting does not offer a clear benefit. It would add to the already 

onerous burden of rapidly growing message traffic and would impede market making, as market makers would not be able to offer 

meaningful price improvement. Sub-penny price quotes would 

make stock auctions difficult, if not impossible, eroding overall liquidity in the marketplace. 

Q.3. Some commentators have suggested that the Securities and 

Exchange Commission (SEC) should lift the ban on locked markets. 

Locked markets occur when a trader attempts to place a bid on one 

exchange at the same price as an offer on a different exchange. 

They argue that bids and offers at the same price but different 

venues should be forced to interact, and this could reduce fragmentation in the marketplace and perhaps reduce the prevalence 

of trading in dark pools and internalization venues. What is your 

view of this proposal? 

A.3. We believe the ban on locked markets causes more problems 

than it solves, and as such it should be lifted. There is much unnecessary complexity in current equity market structure stemming 

from efforts to prevent locking and crossing of markets. Locked 

markets are not that difficult to address from a market structure 

perspective. Market participants are capable of providing best execution in locked market situations when handling customer orders 

on an agency or riskless principal basis. Accordingly, we would support efforts to lift the ban. 

Q.4. Internalizing broker-dealers often pay retail brokers to direct 

customer orders to their trading venues. Does this practice advantage or disadvantage retail investors? Why or why not? Why is retail flow valuable to trade against? 

A.4. As discussed earlier, retail order flow is valuable because it is 

not informationally ‘‘heavy’’ and interacting with it does not involve 

significant information leakage. As a result, broker dealers are 

often willing to pay for this order flow, which yields clear benefits 

to retail investors in the form of lower trading commissions. We 

would argue that the practice of online brokers offering trading to 

retail customers for less than $10 per execution would not be posVerDate Nov 24 2008 16:26 Apr 26, 2013 Jkt 048080 PO 00000 Frm 00079 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\12-18 COMPUTERIZED TRADING VENUES -- WHAT SHOULD THE RU
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sible without trading rebates or payment for order flows. In general, we do not believe that this practice disadvantages retail investors because broker-dealers have fiduciary responsibilities to their 

clients to achieve best execution. It should also be noted that 

broker-dealers that receive payment for order flow are required to 

disclose such arrangements to the public pursuant to Rule 611 of 

Regulation NMS, and to their customers in confirmations required 

under Rule 10b-10 of the Securities and Exchange Act of 1934. 

Q.5. Broker-dealers that operate their own dark pools can get a fee 

advantage when they route customer orders through their own 

dark pools rather than through a lit exchange. Does this create a 

conflict of interest between investors, who want to buy or sell 

stocks at the best prices, and brokers, who want to avoid exchange 

fees? Why or why not? 

A.5. While the routing of customer orders through internal dark 

pools creates the potential for a conflict of interest, we believe it 

is a manageable conflict. Broker-dealers have a fiduciary duty to 

provide best execution when handling client orders. This duty 

should be the controlling factor when making order routing decisions Fulfillment of this duty can, and in most cases is, accomplished through the use of detailed transaction cost analysis and 

extensive evaluations of execution quality, (e.g., opportunities for 

price improvement, speed of execution, number of venues checked, 

character and volatility of the market, etc.). Such reviews and analyses can demonstrate whether internal crossing provides equivalent or better execution costs and superior transaction prices compared with routing orders to an external market center. In most 

cases, using an internal dark pool yields three clear advantages 

over exchanges: a lack of information leakage, lower latency and 

potential opportunities for price improvement. 

We would also note that there is much less of a conflict of interest with an agency dark pool as opposed to a pool which contains 

broker-dealer principal or proprietary order flow. In the case of an 

agency pool such as ITG’s POSIT, the broker-dealer is generally 

unconflicted as it does not have a vested interest in terms of profiting from one side of the trade. In addition, internal crossing also 

protects clients from incurring costs for lost opportunities. For example, a dark pool operator could forego an internal crossing opportunity by routing a client order to an exchange for the purpose of 

avoiding a potential conflict of interest. However, by the time the 

order arrives at the exchange, the targeted liquidity may no longer 

be accessible. In such a situation, the client would have been deprived of an opportunity to execute at the same displayed price (or 

even better) in the dark pool. 

Q.6. The U.S. exchanges are required to submit data to a centralized network where it is aggregated before being disseminated to 

the public. However, the Consolidated Tape Association/Securities 

Information Processor or SIP now lags behind direct proprietary 

market data feeds. As a result, high frequency trading firms and 

other market participants now usually colocate their computer 

servers at every exchange and subscribe to proprietary data feeds 

offered by the exchanges in order to capitalize on latency arbitrage 

opportunities. Why should anyone receive market data flow from 

77 

other than the consolidated tape? Should market data be distributed to all market participants equally? How do you think this can 

best be accomplished? 

A.6. We strongly believe that there should be equal opportunities 

for accessing market data. All market participants should have the 

same access to market data feeds, either through the SIP or direct 

proprietary feeds. As a matter of practice not all participants will 

elect to invest in the technology, subscription fees, and/or colocation 

costs to be able to take advantage of all proprietary data feeds. 

While we believe it is important to ensure equality of market data 

access, it would not be appropriate to attempt to ensure equality 

of outcomes through regulatory means. 

Q.7. The October closure of the markets for 2 days due to Hurricane Sandy raised questions about the financial sector’s preparedness for the next natural or man-made disaster. What challenges 

did the markets face in reopening after Hurricane Sandy? What 

should have been done differently after Hurricane Sandy to keep 

providing trading services to customers and maintain market integrity? What can the stock exchanges do to prepare the market for 

another disaster? What changes need to be made by market participants and regulators? 

A.7. We believe the decision to shut the market for 2 days in the 

wake of Hurricane Sandy was the correct one. The damage to lower 

Manhattan and the loss of life in affected areas supports this contention. The 2-day hiatus ensured the safety of broker dealer and 

exchange staff and enabled market participants to test and fully 

activate their business continuity programs. When markets reopened they did so in an orderly and efficient manner. In hindsight, better coordination between exchanges and market participants would have resulted in a smoother re-opening process. Of 

note, the decision to shut the equity markets on the Monday after 

Sandy hit did not come down until late Sunday night. There was 

some concern among broker-dealers that the exchanges’ disaster recovery plans had not been sufficiently vetted. The lessons for preparation for future disasters are to increase communication among 

all market participants and to increase awareness regarding the 

specifics of exchange disaster recovery plans.