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HOW ROADBLOCKS IN PUBLIC MARKETS PREVENT

JOB CREATION ON MAIN STREET

HEARING

BEFORE THE

SUBCOMMITTEE ON TARP, FINANCIAL SERVICES

AND BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS

OF THE

COMMITTEE ON OVERSIGHT

AND GOVERNMENT REFORM

HOUSE OF REPRESENTATIVES

ONE HUNDRED TWELFTH CONGRESS

FIRST SESSION

NOVEMBER 15, 2011

Serial No. 112–121

Printed for the use of the Committee on Oversight and Government Reform

(

Available via the World Wide Web: http://www.fdsys.gov

http://www.house.gov/reform
(II)

COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM

DARRELL E. ISSA, California, Chairman

DAN BURTON, Indiana

JOHN L. MICA, Florida

TODD RUSSELL PLATTS, Pennsylvania

MICHAEL R. TURNER, Ohio

PATRICK T. MCHENRY, North Carolina

JIM JORDAN, Ohio

JASON CHAFFETZ, Utah

CONNIE MACK, Florida

TIM WALBERG, Michigan

JAMES LANKFORD, Oklahoma

JUSTIN AMASH, Michigan

ANN MARIE BUERKLE, New York

PAUL A. GOSAR, Arizona

RAU ́ L R. LABRADOR, Idaho

PATRICK MEEHAN, Pennsylvania

SCOTT DESJARLAIS, Tennessee

JOE WALSH, Illinois

TREY GOWDY, South Carolina

DENNIS A. ROSS, Florida

FRANK C. GUINTA, New Hampshire

BLAKE FARENTHOLD, Texas

MIKE KELLY, Pennsylvania

ELIJAH E. CUMMINGS, Maryland, Ranking

Minority Member

EDOLPHUS TOWNS, New York

CAROLYN B. MALONEY, New York

ELEANOR HOLMES NORTON, District of

Columbia

DENNIS J. KUCINICH, Ohio

JOHN F. TIERNEY, Massachusetts

WM. LACY CLAY, Missouri

STEPHEN F. LYNCH, Massachusetts

JIM COOPER, Tennessee

GERALD E. CONNOLLY, Virginia

MIKE QUIGLEY, Illinois

DANNY K. DAVIS, Illinois

BRUCE L. BRALEY, Iowa

PETER WELCH, Vermont

JOHN A. YARMUTH, Kentucky

CHRISTOPHER S. MURPHY, Connecticut

JACKIE SPEIER, California

LAWRENCE J. BRADY, Staff Director

JOHN D. CUADERES, Deputy Staff Director

ROBERT BORDEN, General Counsel

LINDA A. GOOD, Chief Clerk

DAVID RAPALLO, Minority Staff Director

SUBCOMMITTEE ON TARP, FINANCIAL SERVICES AND BAILOUTS OF PUBLIC AND

PRIVATE PROGRAMS

PATRICK T. MCHENRY, North Carolina, Chairman

FRANK C. GUINTA, New Hampshire, Vice

Chairman

ANN MARIE BUERKLE, New York

JUSTIN AMASH, Michigan

PATRICK MEEHAN, Pennsylvania

JOE WALSH, Illinois

TREY GOWDY, South Carolina

DENNIS A. ROSS, Florida

MIKE QUIGLEY, Illinois, Ranking Minority

Member

CAROLYN B. MALONEY, New York

PETER WELCH, Vermont

JOHN A. YARMUTH, Kentucky

JACKIE SPEIER, California

JIM COOPER, Tennessee
(III)

C O N T E N T S

Page

Hearing held on November 15, 2011 ...................................................................... 1

Statement of:

Noll, Eric W., executive vice president of NTS Management, NASDAQ

OMX Group, Inc.; and Joseph Mecane, executive vice president and

chief administrative officer for U.S. Markets, on behalf of NYSE

Euronext ........................................................................................................ 8

Mecane, Joseph .......................................................................................... 18

Noll, Eric W. .............................................................................................. 8

Letters, statements, etc., submitted for the record by:

Mecane, Joseph, executive vice president and chief administrative officer

for U.S. Markets, on behalf of NYSE Euronext, prepared statement

of ..................................................................................................................... 20

Noll, Eric W., executive vice president of NTS Management, NASDAQ

OMX Group, Inc., prepared statement of .................................................... 10

Quigley, Hon. Mike, a Representative in Congress from the State of

Illinois, prepared statement of ..................................................................... 5

(1)

HOW ROADBLOCKS IN PUBLIC MARKETS

PREVENT JOB CREATION ON MAIN STREET

TUESDAY, NOVEMBER 15, 2011

HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON TARP, FINANCIAL SERVICES AND

BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS,

COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM,

Washington, DC.

The subcommittee met, pursuant to notice, at 9:48 a.m., in room

2203, Rayburn House Office Building, Hon. Patrick T. McHenry

(chairman of the subcommittee) presiding.

Present: Representatives McHenry, Guinta, Gowdy, and Quigley.

Staff present: Drew Colliatie, staff assistant; Gwen D’Luzansky,

assistant clerk; Linda Good, chief clerk; Peter Haller, senior counsel; Christopher Hixon, deputy chief counsel, oversight; Devon Hill,

minority staff assistant; Jennifer Hoffman, minority press secretary; Brian Quinn, minority counsel; and Steven Rangel, minority

senior counsel.

Mr. MCHENRY. The committee will come to order. This is the

Subcommittee on TARP, Financial Services and Bailouts of Public

and Private Programs. Our hearing is entitled, ‘‘How Roadblocks

and Public Markets Prevent Job Creation on Main Street.’’

It is the tradition of this subcommittee to begin with the reading

of the Oversight and Government Reform Committee’s mission

statement.

Oversight Committee Mission Statement: We exist to secure two

fundamental principles: First, Americans have a right to know that

the money Washington takes from them is well spent; and, second,

Americans deserve an efficient, effective government that works for

them. Our duty on the Oversight and Government Reform Committee is to protect these rights. Our solemn responsibility is to

hold government accountable to taxpayers because taxpayers have

a right to know what they get from their government. We will work

tirelessly in partnership with citizen watchdogs to deliver the facts

to the American people and bring genuine reform to the Federal

bureaucracy. This is the mission statement of the Oversight and

Government Reform Committee.

With that, I will recognize myself for 5 minutes for an opening

statement.

Over 2 years into our economic recovery, America’s labor and

capital markets continue to face unprecedented challenges. Tens of

millions of Americans remain unemployed or underemployed, economic growth is anemic, and small business continues to struggle
2

to access capital, all of which exists despite an endless number of

government initiatives.

Recently, our subcommittee examined barriers to small business

capital formation, particularly focusing on the pre-IPO market. We

heard from market participants and experts who explained the repercussions that outdated SEC regulations have on the formation

of startup companies. I am proud to say that earlier this month the

House passed with broad bipartisan support—which is often rare

in Washington and right now exceedingly rare—we passed several

pieces of legislation to roll back these out-of-date and burdensome

regulations. Now the next move goes to the U.S. Senate, where we

hope that they will take positive action.

Today’s subcommittee hearing takes the next step of examining

the life of small- or medium-sized businesses, this time in the postIPO world. While some might associate the IPO market with people becoming overnight billionaires or ringing the bell at the New

York Stock Exchange, or the bell at NASDAQ, the reality is that

the health of our Nation’s IPO market is a signal of its economic

growth, innovation, and job creation. Businesses use the capital

that they raise through an IPO to grow and expand, which means

investing and hiring. In fact, over 90 percent of jobs created by a

company are done after it goes public. That is important to note.

This is not about the founders putting money in their pockets. It

is about giving the company the capital it needs to grow and expand and innovate.

Recognizing today’s dismal unemployment rate and job numbers,

it is no surprise that America’s IPO market is suffering. Experts

point to market structure and liquidity issues for small- and medium-sized companies as a primary reason. For one, the rapid increase in high-frequency trading has directed money toward the established liquidity of the higher cap companies. This trend has discouraged the kind of attention startup companies used to garner

from investors who used to target them and other small businesses

that showed promise of hidden value. Another mentioned item is

the abrupt reduction in equity research. Even if investors are intent on finding a diamond in the rough, the lack of information discourages this effort.

These market realities and others are why we have invited two

of the world’s major stock exchanges, the New York Stock Exchange and NASDAQ, to explain the importance of liquidity for

small-cap companies and what can be done to strengthen the U.S.

IPO market.

Our focus is not to reverse market expansion or efficiencies. Instead, our aim is to understand why small- to medium-sized companies have second thoughts about going public and the influence

that hesitation has on our economy and job creation. With small

companies out to fend for themselves in the public market, experts

and academics have suggested the formation of agreements between companies and brokers or even exchanges to create a market

in the issuer’s security. Such agreements would allow small companies the ability to produce an orderly liquid market for their stocks

that is observed for many household brands. As the saying goes, liquidity begets liquidity. Research has shown that these agree-
3

ments, already permitted overseas, have led to a positive influence

on liquidity for small public companies.

However, like most new ideas, such a direct agreement requires

a change in regulation, this time by both FINRA and the SEC.

Today is an opportunity to learn the purpose and effects of these

regulations and where there is room for improvement. Orderly

markets are one of our Nation’s greatest strengths. Providing capital, access to businesses, and choice to investors is obviously at the

heart of this. In the midst of our slow recovery, it is imperative

that we continue to improve our markets to spur innovation and

job creation.

I am interested to hear from both our witnesses and both exchanges today about the challenges our small, public companies

face and what can be done to fortify our post-IPO world. I appreciate their attendance and I look forward to their testimony.

With that, I recognize the ranking member, Mr. Quigley of Illinois for 5 minutes.

Mr. QUIGLEY. Thank you, Mr. Chairman.

Today’s hearing will examine how roadblocks in public markets

prevent job creation on Main Street. It will focus on how newer and

smaller publicly traded companies encounter problems accessing

capital from U.S. equity markets. The stock of smaller publicly

traded companies often suffers lower trading liquidity. This means

that small companies often cannot offer enough shares at prices

that are acceptable to buyers or that companies cannot sell their

shares quickly enough. Small publicly traded companies do not

have brand name recognition and often have difficulties attracting

investors. Some suggest that the U.S. market structure itself is a

roadblock for small companies.

In a statement prepared for a joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues meeting, David Weild, a

former vice chairman of NASDAQ, stated, ‘‘The stock market structure today is disastrous for the vast majority of small capitalization

stocks with asymmetrical order books. Who is there to create liquidity for the small capitalization stocks? The answer is often no

one.’’

I think it is important that our examination seeks to answer why

no one is there to create liquidity for small capitalization stock. I

also believe we should be innovative in finding ways to create liquidity for small-cap stock in the United States to ensure equity

markets are competitive and attractive for both issuers and investors. Improving small publicly traded companies’ access to capital

will contribute to the growth of these companies and their ability

to create jobs.

Any solutions we explore today must also permit our U.S. markets to function effectively and help ensure investor confidence in

U.S. markets. However, while I favor bold action in bringing capital to American businesses, we must not sacrifice investor protection. Only a couple years ago in 2008, we witnessed how inadequate financial oversight led to fraud, recklessness, unscrupulous

behavior, and manipulation in the market which caused the greatest financial crisis since the Great Depression. That is precisely

why Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, to reform the U.S. financial regulatory sys-
4

tem and to address the lack of accountability for Wall Street firms

that caused the crisis or helped cause the crisis.

Mr. Chairman, I thank you for holding this important hearing

and I look forward to the testimony of our two witnesses. I yield

back.

Mr. MCHENRY. I thank the ranking member.

[The prepared statement of Hon. Mike Quigley follows:]
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Mr. MCHENRY. The full committee chairman has joined us and

has requested 2 minutes, and the chairman is recognized for 2 minutes.

Mr. ISSA. I thank you chairman, and I thank you for holding this

important hearing. Your leadership in this area has been essential,

whether it is public companies reforming the mistakes made under

Dodd-Frank, including the DATA Act and other essential reforms

that were never included in that act. As we all know, Bernie

Madoff succeeded in the largest Ponzi scheme in American history

because of an absence of transparency that could have easily made

not just a few smart people who pushed the SEC on behalf of the

investors, but the entire public very aware that he was trading in

nothing. So I know that the work you are doing there, along with

crowd funding, is essential.

I join with Mr. Quigley on the need to have small capital funds

not become orphans. But at the same time it is very clear that a

great many companies should be allowed to have a broad group of

sophisticated investors without the need for full public scrutiny and

full public access. Often institutional investors, knowledgeable and

with their own resources, given an audited financial statement, will

make a wiser, more informed, and larger contribution. So there are

many ways in which we can help reform the capital markets.

I share with Mr. Quigley the need to make sure we never again

have a meltdown, and that is where the work that you and others

on the committee have done to try to get at Fannie and Freddie,

very much the causes of moneys not being traceable or accountable

had a root in that collapse that we all suffer from to this day.

So, Mr. Chairman, thank you for the continued work. I might

note the presence of the House Chaplain who has seen fit to begin

looking at the work of our committee, and perhaps that is the best

sign of all. I yield back.

Mr. MCHENRY. Thank you, Mr. Chairman.

Father, we ask for your prayers.

Members will have 7 days to submit opening statements for the

record. We will now recognize the panel of witnesses.

We have Mr. Eric Noll, who is the executive vice president of

NASDAQ OMX Group. We have Mr. Joseph Mecane, executive vice

president and co-head of U.S. Listings in Cash Execution and is

testifying on behalf of NYSE Euronext.

It is the policy of this committee that all witnesses be sworn in

before they testify. If you will please rise and raise your right

hands.

[Witnesses sworn.]

Mr. MCHENRY. Let the record reflect the witnesses answered in

the affirmative. Thank you. You may be seated.

With that, we will recognize you each for a period of 5 minutes

to summarize your opening statements. We have a simple light system. It is a traditional light system. Green means go; yellow means

whoa up and sort of wrap it up; and red, go as fast as you can,

says Mr. Quigley. So at the yellow light that means you have 30

seconds to wrap it up.

We will now begin with Mr. Noll.
8

STATEMENTS OF ERIC W. NOLL, EXECUTIVE VICE PRESIDENT

OF NTS MANAGEMENT, NASDAQ OMX GROUP, INC.; AND JOSEPH MECANE, EXECUTIVE VICE PRESIDENT AND CHIEF ADMINISTRATIVE OFFICE FOR U.S. MARKETS, ON BEHALF OF

NYSE EURONEXT

STATEMENT OF ERIC W. NOLL

Mr. NOLL. Thank you, Chairman McHenry and Ranking Member

Quigley. At NASDAQ OMX we believe the challenges that we face

in today’s equity markets around liquidity and capital formation

can be addressed by actions in four areas: one, addressing market

structure weaknesses and their concurrent effect on price discovery; two, changing the lack of regulatory focus on rules and

trading venues that would assist in the development of vibrant

small company growth; three, removing regulatory barriers to

small- and mid-cap companies that impede the IPO process and

raise the cost of being public for those companies; and, finally, not

directly related to liquidity and capital formation, but to assist

companies in building their business, the development of an H1B

and other immigration reforms to assist those companies in their

internal hiring and growth plans. We believe that addressing these

issues is critical for generating job creation and growth in the U.S.

economy.

Today’s U.S. markets, the engine of economic growth, are increasingly fragmented and volatile. Liquidity in U.S. stocks is disbursed across 13 exchanges and over 40 other execution venues.

Nearly one-third of public company stocks trade 40 to 50 percent

of their volume away from the organized exchanges. In the past 2

years the percentage of U.S. market share traded in those systems

that do not post their bids and offers rose from 20 percent to over

30 percent. Many retail and core investor orders are executed away

from those primary exchanges.

While we identify market fragmentation as the source of some of

the issues in regard to capital formation in the United States, there

have been many benefits of that fragmentation. They have reduced

investor costs and improved execution qualities in already listed securities. However, the unintended consequences of that market

fragmentation have been a lack of liquidity and price discovery in

listed securities outside of the top 100 traded names and a disturbing absence of market attention paid to small-growth companies by all market participants, including exchanges.

Although recent market volatility has led to a slight movement

toward exchange markets, trading in shares of public companies on

these private trading systems accounts for more volume than on

NASDAQ and the NYSE combined. Price discovery and available

transparent liquidity are essential parts of vibrant market systems.

Just as our markets continue to evolve and adapt, so must the

regulatory structure of our markets. We support the development

of a consolidated audit trail with real-time market surveillance and

new regulatory tools to help regulators keep pace with technology

advances and other changes in the markets.

Between 2003 and 2007, the amount of capital raised by private

equity funds increased by 300 percent. Issuing private equity allows companies to avoid disclosure and governance obligations cre-
9

ated to protect investors. 2008 and 2009 were the worst years for

IPOs since at least 1980. In 2009, there were just 12 venturebacked IPO’s, raising $1.6 billion, and 270 acquisitions with disclosed deals totaling $14.1 billion.

U.S. stock listings are on the decline. In 1995, there were around

8,000 U.S. listings. Today, there are around 5,000. Meanwhile, the

number of listing on non-U.S. exchanges has increased from around

23,000 in 1995 to over 40,000 today.

Exchange listings help companies raise capital, both directly and

indirectly. In addition to selling shares, exchange trading establishes a fair transparent price for a company. A company that has

a clear price and many potential buyers will attract further investors and lenders to help them fund growth.

It is well recognized that companies that do not trade on exchanging are valued at a discount. Financial experts, the U.S. IRS,

the SEC and courts, recognize that discounts for lack of marketability range from 30 percent to as high as 75 percent. A company

valued 30 percent or more below its true value will not be able to

invest, grow, or create jobs as quickly. Plainly stated, the higher

the number of bidders for an asset, the higher the sales price.

Academic research has estimated that between 2000 and 2005,

a $50 billion drop in foreign IPOs on U.S. markets cost the U.S.

$3.3 billion in lost annual trading-related revenues for U.S. brokers. These revenue losses mean jobs in financial services and related industries, and are moving from the United States to foreign

markets.

In any free market society, the number one source of job creation

is entrepreneurship. Canada, the United Kingdom, and Sweden

have successful venture markets with significant numbers of listed

companies and substantial capital-raising success. These markets

list hundreds of small companies that create jobs at a fast rate.

Venture market companies regularly grow and then graduate to

the main markets in those countries.

The United States has no equivalent U.S.-supported and U.S.-organized venture market. NASDAQ OMX has received approval to

create such a market on the former Boston Stock Exchange. The

companies listed on BX will be smaller companies and the availability of the BX market will facilitate their ability to raise capital

to continue and expand their business, creating jobs and supporting the U.S. economy.

In conclusion, we would also like to quickly address the regulator

barriers for IPOs. We ask the SEC be open to market-based solutions to create competitive solutions to market problems. We also

think that Sarbanes-Oxley reform is critical as we go forward to

help small companies go public and remove some of the impediments to their ability to go public.

Thank you for inviting me to testify. I look forward to responding

to your questions.

[The prepared statement of Mr. Noll follows:]
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Mr. MCHENRY. Mr. Mecane.

STATEMENT OF JOSEPH MECANE

Mr. MECANE. Chairman McHenry, Ranking Member Quigley and

members of the subcommittee, I want to thank you for inviting

NYSE Euronext to discuss whether new and smaller public companies suffer from liquidity issues as a result of our current market

structure and whether the current structure contributes to a lower

level of IPOs.

I intend to focus my attention on three main topics. First, I will

focus on the importance of liquidity for companies with small market capitalizations and a proposal we believe may help small-cap

issuers. Second, I will discuss liquidity fragmentation in the marketplace. And last, I will address the subcommittee’s question regarding liquidity payments to market makers.

Before I jump into the points previously outlined, I would like to

give some background about smaller issuers and why it is important to focus on this segment of the market. Small- and mediumsized enterprises, so-called SMEs, are the backbone of the American economy, and in previous economic downturns entrepreneurs

and small businesses have been the main source of job creation. In

fact, 18 of the 30 Dow Jones Industrial Average companies were

founded during economic downturns.

However, in order to enable SMEs to reach their full potential,

capital must be easily accessible. In that effort, NYSE Euronext

has been vocal in its support for Congress to adopt legislation to

increase the threshold for Regulation A offerings as well as to

adopt a larger exemption for SMEs from Sarbanes-Oxley, section

44-B. Each of these and other efforts are with a keen eye toward

not only capital formation, but also job creation, which increases

significantly as companies move through the capital formation

process. To echo some of the remarks by Chairman McHenry at the

beginning, over 90 percent of jobs in a company are created after

a company goes public.

There is one reason that liquidity is so vital for new and smaller

issuers. Companies with small capitalizations consistently raise

two concerns about going public as it relates to market structure.

First, whether there will be sufficient liquidity in my stock; and

second, will I have sufficient analyst coverage?

As the Securities and Exchange Commission recognized in its

2010 concept release on equity market structure, small-cap stocks

can and often do trade differently than large-cap stocks. In particular, we have observed less liquidity at the national best bid and

offer for small-cap stocks which we believe may be hampered by too

narrow of a spread increment of a penny. While narrower spreads

are generally a very positive result for investors, we believe that

a penny minimum tick size may counterintuitively reduce the

amount of liquidity at the best price, thus resulting in smaller

quoted sizes and thinner markets.

Accordingly, NYSE Euronext has advocated that a market-wide

pilot with wider spread increments for less liquid securities could

be a worthwhile exercise. During the pilot period, market participants and the Commission can review data to determine whether

the impact is providing added investor benefits to less liquid securi-
19

ties. This could help increase the appetite for research coverage

which declined after the global research settlement, and should be

combined with a separate review of the restrictions around IPO

communications.

Liquidity concerns for emerging growth companies transcend the

public markets with volumes fragmented across multiple exchange

and non-exchange venues. While we believe that competition has

been a positive factor for the marketplace, we have noted that the

level of off-exchange participation in less liquid stocks is frequently

above average. However, price discovery is dependent on interaction among a diverse set of market participants.

In this vein, we have recently filed for approval of our newly created Retail Liquidity Program. This program will allow for superior

execution prices for retail investors and encourage additional price

competition for retail orders from liquidity providers, and we believe this program could help consolidate and potentially increase

the liquidity in less liquid securities.

Finally, the committee requested comment regarding what if any

additional incentives could be adopted to incent market makers to

post liquidity in less liquid stocks, including the allowance of

issuers to pay market makers to provide liquidity directly. The

committee has discussed the creation of a program where small-cap

companies could enter into agreements directly with broker-dealers. NYSE Euronext believes the idea discussed warrants further

review from both FINRA and the SEC and it is a topic that we

have been separately pursuing. We would note, to echo Chairman

McHenry’s comments, that this is a process that exists in Europe

and has shown beneficial effects on the liquidity of smaller issuers.

In closing, NYSE Euronext believes that Congress and the appropriate regulatory authorities should work together with the industry to identify appropriate steps that can be taken to increase the

level of liquidity for smaller public companies. Even if only on a

pilot basis, trying new things will allow the market to determine

which approaches could have the greatest impact on increasing the

level of liquidity in illiquid stocks.

Jobs are the number one issue facing our Nation, and although

only part of a broader solution, we believe that adopting some of

the approaches previously outlined will have a positive impact in

reversing some of the negative trends we have recently seen.

Thank you for the opportunity to present.

[The prepared statement of Mr. Mecane follows:]
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Mr. MCHENRY. I certainly appreciate your testimony. This is

very helpful and instructive.

I want to begin this way. There is a lot of discussion about what

our public markets actually do and it is missed on a lot of individual Americans what the public markets are really all about. So

I want to ask you, what net benefit do you provide to society

through your exchange, through the public markets? I will just

begin there. Mr. Noll?

Mr. NOLL. I think we provide several. The first one is what I will

call the ability to discover prices for assets. So if a key tool for investors of all types, retail and institutional, is to understand the

real value of an asset that they are investing in and the willingness to risk their own capital by investing in that, understanding

the true price of that underlying asset is critical. So the ability of

exchanges to discover that price for all investors on a fair and

transparent way where everyone has access to that same price is

critical for the determination of the underlying value of those assets.

Linked to that price discovery formation is what I will call liquidity discovery. So just as important as discovering the price, is the

size at which I can transact at. So exchanges perform a valuable

function in gathering together all of the available buying and selling interest that is out there so that investors not only can discover

price, but they can discover the size in which they can transact at,

at that price.

Ultimately that price discovery and that liquidity discovery enables companies not yet public to help themselves determine how

they will be valued when they become public and provide a framework and a platform in which they can in fact bring their asset forward, attract investor interest, and see the liquidity in that investor interest develop and therefore raise prices to create jobs and

grow their own businesses.

So if I were to summarize, those are the big three that I think

add value from the exchange side.

Mr. MCHENRY. Mr. Mecane?

Mr. MECANE. I will echo Mr. Noll’s comments. I will also add

that one of the primary purposes of an exchange are to match companies who are looking to raise capital in a public venue with potential investors who may look to invest in that company, help it

grow and expand.

Clearly companies that do want to go public or want to raise capital have a number of different options that they can pursue in

order to do that. They can look to private investors and do a private capital raise. They can look to be acquired, either through a

traditional M&A transaction or through a private equity or venture

capital-type transaction, or they can choose to raise capital in a

public format.

Obviously the theme of this panel is talking about why companies may choose to go one of those other routes instead of going the

public company route, and that is obviously a complex question,

but I would view that last piece as being the primary responsibility

of a public market.

Mr. MCHENRY. With IPOs, it is about accessing capital in order

to grow your business and it is a choice that you described, Mr.
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Mecane, between the various options. Many small businesses put

it on a credit card to get started or get a loan. Probably not right

now. They probably put it on their credit card more so. And then

once they grow, they can get to the stature by which they can go

to the public markets to access capital to more fully grow their

business and take leaps and bounds. It also provides investors, individual small mom-and-pop investors, the average American, to

access this type of equity-side upside benefit of companies going

public.

I think it is important to begin there, because a lot of discussion

about financial service products right now isn’t related right back

to what their net benefit is. It isn’t a benefit as a product, it is a

benefit of price discovery and accessing capital to grow a business.

So I wanted to begin there. I would hope that we can come back

for other rounds of questions. But with that, I would like to recognize Mr. Quigley for 5 minutes.

Mr. QUIGLEY. Thank you, Mr. Chairman. It is interesting the

chairman brought this up to the 30,000-foot level. Sometimes we

have questions that are more specific. I guess I would like to ask

a specific question, but then get back to a larger 30,000-foot perspective.

My initial question had to do with Mr. Mecane. In your written

testimony I think the quote is, ‘‘Although the FINRA Rules adopted

in 1997 prohibit any direct or indirect payment by an issuer to a

market maker, NYSE Euronext believes the idea discussed may

warrant review by both FINRA and the SEC and it is a topic we

have been pursuing.’’ Obvious concerns are because the rule in the

first place dealt with manipulation, it dealt with the potential that

executives of a company are incentivized to have their stock valued

very high so it creates an opportunity for inappropriate activities.

That question, and I would like you to both address it, really gets

to the core of the issue here with what we try to do here. Put yourself in our place. What we are really dealing with for yourselves

and for ourselves is faith and trust both with the American public

and with potential investors. Investors have to have faith that

there won’t be a manipulation, but also the larger issue of giving

you the opportunities to do what needs to happen to create jobs

when the American public still has a gaping hole in faith and trust.

Can you address that as a larger issue?

Mr. MECANE. Sure. It is a very good point, and we echo your concerns about ensuring that investors have full faith and confidence

in our public markets. Part of why my words were chosen carefully

is because I don’t think it is a very straightforward topic, and there

are different sides to the same equation.

The reason the restriction was originally put in place was to

avoid exactly the point that the Congressman raised, that there is

a conflict inherent in a situation where a company itself is paying

a liquidity provider to make a market in the stock. So it is part

of why, while we believe it may be a worthwhile discussion and experiment to try, it would need to be done in a way where there was

sufficient disclosure and discussion around the conflict itself and

whether it could be addressed.

When I specifically stated that it is an avenue that we have been

pursuing separately, part of our thought—and where we have been
26

looking at this as an opportunity—is specifically in the ETF market. While that is not a topic of this committee, it is relevant because with ETF products, which are generally linked back to the

underlying securities, there is less opportunity for manipulation because there is an arbitrage between the ETF price and the stock

price.

My point is that one avenue to try is an experiment specifically

with ETFs with this type of a program to see if it actually helps

with liquidity in those names, and that could then give more support and documentation as to whether it would be worth trying in

the public markets also. So it could be done in a two-step process

to try and minimize the conflict that you raised, Congressman.

Mr. NOLL. Thank you, Congressman. Like the New York Stock

Exchange, this has been an issue that we have been paying attention to for a while. NASDAQ OMX in Stockholm operates a market

called True North which is a venture market in which market makers do receive payments from issuers, and we have seen some great

success in that platform in developing liquidity in the Nordic markets.

Here in the United States, I think our concerns are echoed by

you and by the New York Stock Exchange that the ability to create

conflict or have conflicts in this area is something that we have to

be very careful about. We are proposing, not unlike the New York

Stock Exchange, to come forward with our own set of rules around

this kind of process. One would be for our BX venture market in

which we would create a structure by which the exchange in an

open and transparent way would collect payments from issuers and

then use them to provide to market makers to provide liquidity. So

we are preparing a rule filing now to submit to the SEC that would

allow us to do that.

I think it brings two very good benefits to us by doing that, not

only to us but to the marketplaces. One is that it is a rule set that

would be transparently argued, debated, and approved by the SEC,

and therefore monitored by them on an ongoing basis and the rules

would be available and open to everyone to see and to participate

in.

Then I think it would address a problem that this committee has

identified, which is that there is a lack of liquidity in these smallcap stocks. And I think it is fair to say and important to say that

market makers will respond to economic incentives, so passing a

rule that says that market makers need to make markets in smallcap stocks won’t add any more liquidity. What will add liquidity to

them is creating economic incentives to them to benefit by providing liquidity, and we think that this program will do that.

Likewise, on the ETF side, NASDAQ is preparing a rule filing to

do the same thing as well, which is to stimulate market maker interest in less active, less interesting ETFs, or not less interesting,

but less followed ETFs to help stimulate liquidity in those as well.

And I agree with Mr. Mecane that in both cases I think that these

are valuable experiments for the Commission to try.

Mr. QUIGLEY. Thank you.

Mr. MCHENRY. Mr. Guinta, the vice chair of the committee, is

now recognized for 5 minutes.
27

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

both for coming here today.

In a series of subcommittee hearings that we have been having

over the last several weeks, we have been focusing a lot on how to

create access to a stronger job market in this country. Obviously,

the country is concerned about that primarily, and it has a dramatic effect on just about everything we do nationally and internationally.

My focus is more narrow in scope, and I want to talk a little bit

about the IPO market, I want to talk a little bit about the decline

of IPOs that we have seen recently in this country, and I want to

ask you both to focus a little bit on, number one, why you think

we have had a decline in IPOs, where those IPOs are being listed,

and what the negative effect of that is in terms of job creation here

in America.

Mr. Mecane, if you want to begin.

Mr. MECANE. Sure. Thank you for the question. I will borrow

from a report that was recently issued which the committee may

or may not have seen, but it is a series of recommendations from

the IPO task force which tried to tackle this issue and did, I think,

do a good job of generating some data to support the issues that

were being discussed.

What seems to be the prevailing trend around the decline in

IPOs is specifically concentrated in the smaller part of the market,

so the sub-$50-million-type companies, and it does not appear that

those companies are not being created or that they are actually

going public on other venues. What appears to be the trend is that

they are choosing to, when they get to a size where they are at a

decision point about what the next step is for them to proceed, they

are choosing increasingly to go through a private M&A-type transaction, either being acquired by a larger firm or a private equitytype firm, instead of going the route of the public market.

I would say that has been the very broad trend over the last 20

years, where the first decade of the last 20 years was marked by

a very high level of capital issuance by those smaller companies

and the last decade of the last 20 years has been marked by more

of these private M&A transactions.

Obviously, it is an important question from a job creation standpoint, because as we noted earlier, much of the job creation that

does happen in a company’s life cycle occurs after they go public

when they do have access to all these additional funds to expand

their business and to hire and to go into new business lines.

So the question as to why companies are choosing that private

route instead of the public route is an important one. It is also, I

believe, a complex one with a number of different dynamics occurring simultaneously.

To paint one side of the equation, clearly the private equity and

private capital part of the market has become a lot stronger in the

last decade, and so some of what we are seeing could just be the

evolution of that part of the market and an increasing ability to

have another option other than going public. But at the same time,

I think it is hard for us to ignore the fact that the cost of going

public and the oversight of being a public company, especially for
28

a smaller $50-million to $100-million-type company, has been increased significantly over the course of the last few years.

Obviously it is a balancing act post-Sarbanes-Oxley and other

types of reforms to make sure that there is confidence in our companies and willingness of investors to know that the company that

they would be putting money into is safe. But at the same time it

does call into question whether there are things that we can do to

make it easier, less costly, especially for the first few years of a

company being public, to be able to go public more easily.

Mr. GUINTA. I want to get to Mr. Noll, but just one final question. Would you agree with the statement that an M&A transaction, rather than an IPO, is missing an opportunity for job creation?

Mr. MECANE. I don’t want to over-generalize too much, but I

would agree in a lot of M&A transactions the focus tends to be on

synergy opportunities as opposed to expansion opportunities, and

that is an over-generalization. It is not always true, but I do generally agree.

Mr. GUINTA. Generally speaking, yes.

Mr. Noll, can you just maybe add to what Mr. Mecane said?

Mr. NOLL. Sure. Following up on Mr. Mecane’s comments about

M&A, which I generally would agree with, I think one of the issues

that we are facing as an exchange and as an economy is that when

that becomes increasingly the only avenue, it creates limitations on

the way companies can grow their business, the way they can ask

for capital, and the way they can use that capital to grow their

businesses.

So it isn’t so much that M&A represents a bad way for companies to grow their business or private equity is a bad way for companies to grow. Quite to the contrary, those are all valid and very

good ways to grow businesses. But as the IPO window for those

businesses has closed, it removes some of the optionalities for what

companies can do in a way that is most ideal for them, so that we

become very worried about that and making sure we are developing that market for that small-cap company.

You had asked earlier as well where a company is going. So the

small companies are clearly going to the private markets. Foreign

issuers, who traditionally had come to the United States to raise

capital, are choosing not to list here, and a lot of that is compliance

with our Sarbanes-Oxley rules, which may create additional costs

for them that they would not like to face. I think the costs of market fragmentation are expensive for them.

It is an interesting day when Manchester United, a very large

U.K. sports team, chooses to list its stock on Singapore, and, quite

frankly, never considered a U.S. listing. Twenty years ago, they

would have come to the United States almost by default. So how

we think about those issues I think is important as we go forward.

So I think it is critical that we try to clear up the IPO calendar

and the IPO structure for those small-cap companies and those foreign issuers.

Mr. GUINTA. I see my time has expired. I appreciate the chairman’s indulgence.

Mr. MCHENRY. All right. Thank you. Now we will begin a second

round.
29

So the bid-ask spreads have tightened, but out of that order

flows have gone way up. I mean, the volume has gone way up. That

is correct, right? So what does that do for exchange revenue? Does

that mean exchange revenue goes up with the order flow? Mr.

Mecane?

Mr. MECANE. Sure. I would make two points. One is that there

has been two separate dynamics going on in the industry. One is

that clearly as bid-ask spreads have compressed, we have seen an

increase in volume. But I would also highlight the point that in

that same period of time, part of why those two trends happened

is because there has been increasingly aggressive competition in

the space, and the prices that exchanges and other venues have

charged has also declined commensurate or even in excess of the

spread decline. So I will just highlight that. Even though there is

higher volume, because of those trends we are actually, frankly,

making less money than we were in the prior periods.

But it also leads to a second point, which is more specific to the

small- and mid-cap part of the market. A lot of the spread compression and increased competition that we have seen has been in the

very large liquid stocks where you have seen a lot of algorithmictype trading, high-frequency-type trading, which tends to narrow

the spread and make it very cheap and efficient and fast for the

large-cap stocks to trade.

The unfortunate reality is those same trends haven’t occurred in

the small- and mid-cap part of the market. Those stocks don’t have

sufficient liquidity for the high-frequency-type automated traders

to traffic in those names, and as a result, you have not seen a commensurate level of volume or liquidity or spread compression that

you have seen in some of the large-cap names. And that is part of

why we have suggested the experiment with perhaps wider

spreads, as counterintuitive as that is, for those names.

Mr. MCHENRY. Okay. So there is less revenue of a new listing

based on competition.

Mr. MECANE. Correct.

Mr. MCHENRY. Okay. But order flow has gone way up, the volume has gone way up. So part of that is with the spreads compression but with the order flow going up. In those terms, spread compression, order flow going up, have they offset each other roughly?

Mr. MECANE. I think probably, roughly.

Mr. MCHENRY. Roughly. Is that how you see it with NASDAQ?

Mr. NOLL. I do, although I would note that volumes have actually come down in the last year, year and a half. And while I think

there is a great deal of truth to the statement that tighter spreads

and lower costs have driven volumes up, I think one of the things

to remember about volumes and participation in the marketplace,

it is ultimately about confidence in the market and it is market

structure, and it is also about the ability of investors to transact

in an effective way. So we have seen some of that confidence impaired.

Quite frankly, we have seen volumes come down. And some of

that confidence isn’t necessarily in exchanges or exchange systems,

but in the strength of the U.S. economy. So we have seen much

higher volume days 2 or 3 years ago than we have in the last year.

So while there certainly is a link between low costs and higher vol-
30

umes, it isn’t the only driver for volumes. So I think that is an important thing to know.

Mr. MCHENRY. So order flow is more important than new listings

though; is that fair to say, as a business concern?

Mr. NOLL. Well, I think two things about new listings that are

critical for us and why we are starting to pay a lot of attention to

this sector. One is this is where the new companies are going to

come from, and we as exchanges, and particularly at NASDAQ, if

we can’t get those companies to be public and listed on one of our

platforms for trading as they grow up to be big companies and very

important companies in the U.S. economy, we won’t be performing

our function in the way that we hope to be performing it.

Mr. MCHENRY. So therefore your investment on what used to be

the Boston exchange.

Mr. NOLL. Right. So the creation of the BX venture market, try

to look at market maker structures to try to provide liquidity there,

which for us is a long-term investment in the development of new

companies, because ultimately we think that is where the future

growth is going to come from and we need to participate in that.

Mr. MCHENRY. Okay. So you get an IPO. Immediately, because

of fragmentation, the market fragmentation, liquidity fragmentation, you have a substantial amount of your order flow off your exchange, right? Am I correct?

Mr. MECANE. Yes.

Mr. NOLL. Yes.

Mr. MCHENRY. Okay. So what you do to incentivize liquidity instantly benefits these folks. It doesn’t benefit you. It benefits this

order flow off your exchanges; is that correct?

Mr. MECANE. Yes.

Mr. MCHENRY. So this is part of the challenge, is what that incentive is for you, actually benefits not your companies.

Mr. MECANE. Yes.

Mr. MCHENRY. To be clear, I mean you have both accessed the

public markets in a very unique way as an exchange, so you do

have to be concerned about your revenue. So as a policymaker I

look at this and am trying to figure out how to incentivize you. But

instantly, how much of the order flow after an IPO goes off your

exchange? Mr. Mecane?

Mr. MECANE. It is roughly—in a given name we will have roughly 30 percent of the market share across our different venues, 30–

35 percent of the market share on our exchange, and then the rest

will be fragmented across other exchanges and non-exchange

venues.

To your point, a lot of the focus, and clearly we are self-interested in that argument also, but a lot of the focus is in—it is twofold. One is attracting as much liquidity to our market as possible;

and, second, it is creating as much liquidity in general from that

name. Clearly that benefits us from a revenue standpoint, but I

think the more important point is to really take a particular company or their stock to the next level, it needs to be a name that

institutional investors and long-term investors are comfortable investing in. And unless there is enough liquidity available, they are

not going to be comfortable putting their funds into that particular

company.
31

Mr. MCHENRY. Mr. Noll? And then I will pass off to Mr. Quigley.

I have gone over my time.

Mr. NOLL. Thank you, Chairman.

So I think the competition between marketplaces has actually

been very healthy. It has been very healthy for us as an institution.

I think it has been healthy in many ways for the marketplace. And

I agree with Mr. Mecane that when we take a company public, we

retain post-IPO about 30–35 percent of the volume in that name

on an ongoing basis.

But the competition between markets has actually helped us to

innovate. In many ways it created the success of NASDAQ over the

long term. And so as we go forward and we start to think about

what we need to do for small cap companies, it is not the competition with other venues that I worry about, it is the ultimate market

structure that we put in place that will enhance the development

of getting those companies to be public.

I think the competition between venues is a very healthy one. It

inspires us to do better. It inspires us to work harder. And I think

for us to compete for volume and for us to compete for success in

this marketplace is not a bad thing. I think that is going to spur

us to do a better job of it going forward, and we would fully expect

to win more than our fair share of that business back in that kind

of competitive environment.

So I am less worried about that kind of functionality than I am

in the overarching market structure that would enhance small

companies being able to go public.

Mr. MCHENRY. Thank you.

Mr. Quigley.

Mr. QUIGLEY. Thank you, Mr. Chairman. So we want to help. We

recognize that this is about striking a balance, to protect investors

and the public and creating jobs.

Mr. Noll, you started off on a bit of a pessimistic note, which I

appreciate and respect. But give me a little glimmer here. I am

reading quotes from Renaissance Capital about 2010 being not so

bad, that it was the first year since 2007 where the number of

IPOs was back in the triple digit range. Obviously, it is not just

the number that matters, but their performance. But they also

quote and say IPOs didn’t have just a good year in terms of numbers; their performance was strong, too. The average U.S. IPO rose

25 percent, the best returns for IPOs since 2006.

Do you agree with those numbers, see a trend or some hope

along the future?

Mr. NOLL. Well, I think clearly there has been a lot of successes

in this past year. On NASDAQ, of course, we look at Groupon and

Zillow that have recently listed on our marketplace and done very

well for investors, and in many ways those are both household

names that many investors are very familiar with. So we have seen

some repair in the IPO market from the depths of the financial crisis in 2008 and 2009.

I think what concerns us less is whether the household names

go public, right, who have grown, they are big, they have significant revenues, they have a share of mind in the investing public

because of their success off exchange. What concerns us much more

than that is we are not seeing support either for going public or
32

to, in the after-market for small companies who may not be as big

as Groupon or may not be as big as Zillow, to go public. So small

biotech companies, small green-energy companies who need to access capital and are struggling to find ways to do so.

So while there has certainly been a very positive change from the

depths of the financial crisis to today in terms of IPOs, I still think

that there are issues around those smallest capital companies and

their ability to access capital.

Mr. QUIGLEY. Mr. Mecane?

Mr. MECANE. I would echo that comment. There has been a fairly

robust IPO market in 2011. We have had a number of very large

companies go public with us this year, Kinder Morgan, Linked-In,

Pandora. The issue, as Mr. Noll said, is we are seeing much of that

IPO activity concentrated with the large-cap stocks and not with

some of the small- and mid-cap stocks that we have seen historically.

Mr. QUIGLEY. You alluded earlier to rules and concerns and

issues. I look forward to the continued discussion. The devil is in

the details. So on an ongoing basis we would encourage and appreciate your participation. Thank you.

I yield back.

Mr. MCHENRY. The vice chair, Mr. Guinta, for 5 minutes.

Mr. GUINTA. Thank you, Mr. Chairman.

Mr. Noll, I want to touch a little bit on what the chairman was

talking about and relate it to market structure. I guess I wonder,

there is obviously competition between the New York Stock Exchange and NASDAQ. But I guess I would start to ask the question

this way: Who do you really see as your competition? I mean, I

have great concern about market structure, I have great concern

about the willingness of an IPO to occur on an exchange here in

America. And I see a lot of these either M&As or listing overseas,

I see that as a fundamental long-term problem economically, not

just for job creation but for the potential and future investor.

So we are talking about the benefits that one exchange would

have over the other, but I worry that we are focusing too much on

you—not you, but NASDAQ focusing too much on the New York exchange or the New York Stock Exchange focusing on NASDAQ and

the benefits that one would get from services provided by the other,

when I think the longer term and the larger problem is a different

competitor.

So how do you see it? Do you see the person sitting next to you

as the competitor or do you see some other exchange as the real

competitor?

Mr. NOLL. Clearly, Mr. Mecane and I are colleagues and respect

one another’s ability tremendously. And, yes, the New York Stock

Exchange is a competitor of ours. But I think in fairness to where

we really view competition is not just the New York Stock Exchange. In many ways it is a global competition, so we compete

with other marketplaces, other venues around the world.

We also compete domestically, not necessarily against the New

York Stock Exchange, but alternatives for capital raising. And

what I mean by that is when a company is looking to raise capital

or grow its business, who are we competing with for that capital
33

raise? Oftentimes it is with a private equity firm or some other alternative for raising capital.

So, yes, there is a vigorous competition for listings between the

New York Stock Exchange and NASDAQ in the United States on

a daily basis, but our competition is much broader than that on the

listing side.

On the trading side, it is even more robust than that. So clearly

the New York Stock Exchange is one of our key competitors on providing a transaction platform, but we compete with transaction

platforms among 13 other exchanges in the United States and 40-

plus other trading venues, plus broker-dealers, plus foreign trading

there. So we view our competition on the trading side in a much

more robust way as well. And essentially what we are hoping to

do in responding to that competition is with innovation, things like

the BX Venture Market and other things that we have done that

will help us gain trading volume and share by doing a better job.

So our competition is very broad competition, not a very specific

one.

Mr. GUINTA. So how much are you concerned about the services

that you provide benefiting a competitor?

Mr. NOLL. I am much less concerned about the services we provide benefiting the New York Stock Exchange or, quite frankly, any

of our other exchanges. I view that as state of being. We have a

competitive environment out there and we have to respond to it by

being better at our jobs.

I do think, though, that one of the critical things that we are

going to have to think about in terms of going forward is how do

we provide liquidity, whether it is on NASDAQ, whether it in the

marketplace as a whole for these small-cap companies. So ultimately the market structure that has to be put into place is one

that identifies that, not necessarily benefiting one market over another market.

Mr. GUINTA. What about off-exchange equity trading venues?

Mr. NOLL. They exist. They provide value in many ways. So I

think it is important that off-exchange trading venues continue to

exist where they can do things that we can’t do or they do things

for customers that we have been unable do. One of those is provide

price improvement. One of those is to retain the ability to not have

a large institutional order exposed to the marketplace; in other

words, solve the information leakage problem. And, ultimately, if

they are contributing to price discovery, you know, we have less

issues with those things.

I think where we do have issues is when we as an exchange are

barred or otherwise restricted in our ability to compete in that

marketplace because of SEC rules or other strictures that allow us

or prevent us from competing effectively and where those off-exchange venues are not contributing to a fair transparent market

and to price discovery.

Mr. GUINTA. So liquidity is dispersed, you say, over 13 different

exchanges. Are you suggesting that that is part of the liquidity

problem?

Mr. NOLL. No, it is a fact. What I am noting is in those largecap names, liquidity is scattered across 13 venues and 40-plus

more off-exchange. Those venues aren’t trading small-cap stocks
34

though. All of that liquidity, all of that trading is taking place in

what are essentially 100 very large names.

Mr. GUINTA. Okay. So if we want to grow the IPO market, should

we be focusing on a small-cap——

Mr. NOLL. I think large companies to a large extent take care of

themselves. Where we need help is in that small- and mid-cap sector, and I think that is where we should focus on our market structure rules, is how do we help those companies get liquidity, get research analyst coverage and access the public markets.

Mr. GUINTA. That is where I think we ought to be focusing as

well. So through either a further line of questioning or additional

future testimony, I would be very interested to know what you feel

the two or three or four things that we can be doing to enhance

that and augment that are. Because I think that is the direct nexus

to job creation, whether it is in my home State of New Hampshire

or anywhere in the country, but that is going to greatly benefit the

local economy and I think the national economy.

Thank you, again, Mr. Chairman, for allowing me to extend my

remarks.

Mr. MCHENRY. I certainly appreciate it. With the panel’s indulgence, I would like to go for another round, if that is all right.

To be honest with you, at this point I started with the broad concept, why do the public markets matter, right? I mean, to the point

where most—your hardworking American looks at the public markets and thinks it doesn’t have relevance to them. But it does, because it brings in capital to the United States, lowers the cost of

capital in a competitive marketplace, makes capital more available

and cheaper. That is sort of the ideal here.

It also means that as opposed to private equity, that the hardworking American can put their money, whether it is $500 or

$5,000 or $5 million, into the public markets and actually have

proper price discovery and at the same time, hopefully, over a period of decades, get a nice return. But we are also talking about

this challenge with small cap companies.

So one of the challenges is liquidity. So to discuss this, we begin

with liquidity. What can you do as an exchange legally now to provide these small cap companies a measure of liquidity? Mr.

Mecane?

Mr. MECANE. Sure. The primary mechanism that we as an exchange can use to incentivize liquidity is we have various market

maker programs on our exchange where we incentivize those liquidity providers to meet certain liquidity and quoting obligations.

In exchange for that, we share a portion of the economics that we

obtained through our transaction services.

We have actually skewed some of those payments to the point

where in some of the small cap names we are actually sharing almost more, or all or more of the revenue that we are able to get

in the transaction part of the business just to try and incentivize

further liquidity creation.

Mr. MCHENRY. The transaction part of the business, meaning the

IPO, or is that the——

Mr. MECANE. Meaning the trading piece. So we’re able to use

some of the revenue that we generate from the trading part of the
35

business, and we use that to subsidize the market making community.

One of the circular issues is that there’s, in some of these names,

not—we’re paying out all the revenue that we generate and it’s not

necessarily enough to help get the liquidity to where we would like

it to be.

Mr. MCHENRY. Uh-huh.

Mr. MECANE. That’s part of the reason for why we think the experiment of also letting issuers compensate market makers could

help, because in some circumstances, we’re already paying all the

revenue we have because most of that is on a per-transaction basis

and these issues don’t trade very frequently. It doesn’t generate

enough revenue to necessarily incentivize the liquidity providers.

Mr. MCHENRY. Okay, so the company goes through the whole

process of going to the public markets. When they go to the public

markets oftentimes what their broker dealer will say, well, we

want to have price support for the first month or 6 months or year,

whatever that may be, right? So the broker dealer provides price

support.

Mr. MECANE. Correct. That’s generally very specific around the

IPO time when there is Reg M exemptions and permitted activities

that broker-dealers can use too. But there isn’t necessarily an economic relationship going forward after that specific IPO event.

Mr. MCHENRY. Okay, sure. The reason why I bring that up is

structurally there is a level of support that currently exists in the

marketplace legally.

Mr. MECANE. Correct.

Mr. MCHENRY. So what are the possible solutions? Let’s just talk

about some of the solutions?

Mr. MECANE. On the liquidity side, again, there’s the idea of creating a different spread environment for small- and mid-cap stocks.

It’s hard to know in a perfect world whether that would actually

work or not, that’s why we’ve advocated perhaps a controlled experiment. But one of the dynamics of a penny spread environment,

which, again, has been very beneficial in the large-cap stocks, is

that when you have stocks that will trade with a wider spread of

a nickel or a dime, something along those lines, but there’s the

ability for another market participant to come into the marketplace

and better whatever prices are there by just a penny, so not significantly narrowing the spread, but just narrowing it by a small increment.

We think that by actually holding wider spreads in discrete intervals of a nickel or a dime, it could actually incentivize people to

put more liquidity into the market because they will be more confident that someone won’t step in front of their bid or their offer

with a de minimis amount. Again, it wouldn’t be the only fix to the

issue that we’re talking about. I think anything we do has to be

part of a comprehensive package.

Mr. MCHENRY. So that actually—on its face, that increase is

then efficiency.

Mr. MECANE. That’s why it is very counterintuitive. In a way, we

think it could actually improve efficiency. And that’s why we are

not saying it should be nickels or dimes with the very liquid stocks

where a penny works very well. If the natural spread for a stock
36

is a penny, then it makes sense that the stock should trade at a

penny. What we are more targeting is where the natural spread for

a stock looks like it’s more in the $0.05 or $0.10 range, but you’re

still allowing very small increments to be quoted in the marketplace and whether that’s actually efficient, even though it appears

inefficient.

Mr. MCHENRY. So is that spread differential based purely on volume?

Mr. MECANE. I think there are a number of factors, and it would

be need to be debated by the industry and the SEC what the right

framework would be. But I think it would be some combination of

volume, market cap, perhaps the price of the stock. I think there

are a number of factors that would go into determining the right

intervals.

Mr. MCHENRY. And so could you create—I mean, conceptually,

could you create a system by which the competition would determine what that spread is? So as the volume goes up and the market cap goes up, the spread could tighten?

Mr. MECANE. Correct. And I think it would need to be a collaborative industry solution. Part of why we haven’t done something

like this on our own and why we can’t on our own is because if

we’re the only ones quoting in different increments but everyone

else is quoting in penny increments, it just doesn’t work. It needs

to be an industrywide solution. When the SEC put their concept release out in early 2010, this was one of the items that they raised.

We, in our comment letter, indicated that this would be a good

market-wide experiment to help the trading and small- to mid-cap

stocks, but it would be an industry wide solution.

Mr. MCHENRY. Mr. Noll, would you like to touch on some of

these areas?

Mr. NOLL. Sure. You know, I think I go back to an earlier statement I made, which is what’s critical here is that market makers

have to be incented in the right way to provide liquidity. So they

will not do so at the risk of their own capital where it’s not economically viable for them. What’s important is to create that viable

platform for us to be able to incent market makers. Some of that

may be tick sizes in making the spread more viable for them to

provide liquidity there. Some of it may come from liquidity payments directly from issuers or through exchanges. And some, quite

frankly, is what I would call a time and place advantage, which is

under our current market construct, you know, every market

maker starts out evenly, and it’s best price that wins and oftentimes the first at that best price of what we call price time allocation system.

So for smaller cap stocks what might be more important is creating a time and place advantage for market makers rewarding

them by providing liquidity at that—in those small-cap companies.

So by ensuring that they get a larger piece of the trade, not necessarily because they were there first. So within that mix of ideas,

I think there are many things that exchanges can do to provide liquidity in these small-cap companies.

Mr. MCHENRY. So you both mention the benefits—well, you mention the positive nature of market fragmentation. What if you took
37

these small-cap companies and there was—and you were only to

market, there was no market fragmentation, walk me through that.

Mr. NOLL. Well, if there was no market allocation——

Mr. MCHENRY. Is that objectionable to you or positive to you

or——

Mr. NOLL. I think the critical thing would—to make sure that

that would not be permanent. I think there is a certain benefit for

what I would call a runway period of time. So if you had a smallcap listing on your venue and you had a runway to establish liquidity, incent market makers to create that liquidity and build a marketplace there, I think that could have some very positive effects.

I think where it starts to become dangerous is if that looks like

it could be a permanent state of being. And so where I think we

would want to see the market go is if that was a market structure

and a mission it was developed to help concentrate liquidity and

IPOs and small-cap companies, we would want to make some very

clearly delineated lines around that whereby other advantages

could start to compete for that business as well, because ultimately,

I think that competition is necessary.

So if you want to give companies runways, I think that’s an interesting idea and one that we’d be certainly willing to explore, but

I’d want to see an end date for that.

Mr. MCHENRY. Mr. Mecane, do you want to touch on that? I’m

not trying to create a bunch of controversy, but we’re throwing out

concepts to—on this problem and——

Mr. MECANE. It is a very good question, and it’s one that does

get a significant amount of debate in the industry, obviously given

that there isn’t a clear-cut solution. There is obviously a balancing

act between concentrated liquidity and the whole liquidity begets

liquidity argument, about, you know, having as much robust price

discovery, having it in one place versus the benefits of competition,

and having diverse competing venues also trying to generate liquidity and market share, etc. And the question is, where’s the tipping

point between the healthy level of fragmentation and, you know,

when, if any, does it go too far?

One of the factors that we highlighted is that while there’s an

average level of activity that happens away from the primary market or away from exchanges, it tends to be much, much higher in

the small and mid-cap stocks. There’s a lot of reasons for that, it

is not necessarily clear, but one reason is because the spreads are

wider, so there’s an increased incentive to trade those names

proprietarily if firms can. Some of it is because a lot of those names

tend to have a higher proportion of retail investors in them, so they

tend to get traded away from the exchanges.

One of the things that we’ve done, as I mentioned, is we’ve

launched a program recently which isn’t in effect yet but it’s out

for comment, to try and attract retail orders specifically to exchanges where we think in mid- and small-cap stocks, it will be

beneficial.

Again, the theory there being that perhaps if we concentrate

more liquidity together, especially in those small- and mid-cap

names, perhaps there could be a feedback loop in terms of also generating additional liquidity. It is unclear what the result will be,

but again, we are just trying different things to get at the problem.
38

Mr. MCHENRY. Sir, you mentioned in your opening remarks the

ability to purchase liquidity support. Explain to us how that functions?

Mr. MECANE. Sure. So right now in many European markets, including the ones we operate, private companies have the ability to

contract with brokers to offer a certain amount of liquidity support

for their stocks. In general, the academic research has shown that

it is beneficial, and it helps improve the spread in liquidity in the

name. The one distinction is that those programs do exist in a very

different market structure where—than the one we exist in, especially the periods of time that have been studied in those academic

studies tended to focus on more monopolistic-type environments

and——

Mr. MCHENRY. Less fragmented.

Mr. MECANE. Less fragmented. And so the only point I’m raising

is that I am hesitant to draw a direct analogy, but think it’s worth

an experiment.

Mr. MCHENRY. Worth——

Mr. MECANE. Trying.

Mr. MCHENRY. Seeing if it works.

Mr. MECANE. Right.

Mr. MCHENRY. Thank you for your indulgence. And I now recognize the vice chair, Mr. Guinta.

Mr. GUINTA. Thank you, Mr. Chairman. I want to go back a little

bit to the competitive issue, and how ultimately we ought to be providing flexibility and options for small-cap companies. I guess I

should be a little more specific in my line of questioning.

The first question I would have is the services that you provide—

I will ask Mr. Mecane first, the services that you provide, would

you say that they help a competitor once a company’s listed?

Mr. MECANE. I do think there is a certain level of that because

of the nature of our industry where it is a very competitive market,

and anything that we create can be generally replicated or copied

by other venues. I don’t think it is necessarily a bad thing in that

the—there is a benefit to first mover advantage, but clearly, it

could be—you know, there’s a certain negative result when everyone else ends up doing the same thing.

Where I do think, though—but generally, the competition that

we’re talking about, whether it is price competition or new product

competition, even though it might not be as beneficial for us as

venues, ultimately the consumer benefits from that. It generally

will result in more product choice, or it will result in lower prices.

Where I do think that competition becomes unhealthy or a problem

is where it becomes regulatory competition to use a different

phrase. One of the things that we advocated for is that all participants in the marketplace were performing similar functions should

be subject to similar regulation. I think that also fits into surveillance and oversight theme. One of the initiatives that the SEC has

advocated is this creation of a consolidated audit trail, and what

that will do is aggregate together all the activity in the marketplace and give a consolidated view of all the trading and all the activity that’s happening, not just on exchanges, but on other venues.

And I think that type of consolidation is very important, especially

as it relates to people’s confidence in the public markets.
39

Mr. GUINTA. What about the idea, or the notion of a new issuer

paying for their own services or designating some of their funds for

that—for that specific service. I know earlier you said that you utilize the revenue that you gained for that to provide that service,

but you also—I don’t know if you said it, but I will assume it that

you don’t have enough revenue. Therefore, should we be exploring

the opportunity of allowing a new issuer?

Mr. MECANE. Yes. To link all those things together, everything

you said is correct. We do share the revenue that we generate in

incentivizing liquidity providers. One of the challenges with small

and mid cap stocks is that in a lot of cases, we’re paying everything

that we make. And so supplementing that with a direct payment

from the issuer is, we think, a worthwhile experiment. Clearly,

there’s issues that need to be tackled.

Mr. GUINTA. Sure.

Mr. MECANE. One of the things I said earlier is there is a conflict

inherent in that relationship. And one of the things that we’ve explored and been pushing is that the ETF market, where you don’t

have that same conflict, but you still have some of the liquidity

concerns with newly created products could be an area to conduct

an experiment and see whether you get beneficial liquidity in some

of the less liquid ETFs as a result of this type of program. And

then assuming we can document positive results, we can then try

a second experiment with some stocks and see if it has the same

effect.

Mr. GUINTA. There are a number of ways we could meet that objective that ensure the conflict of interest is mitigated.

Mr. MECANE. Correct.

Mr. GUINTA. Talk to me a little bit about, you mention the regulatory concerns. What are some of the regulatory issues that we

should try to address?

Mr. MECANE. One just general topic that has been discussed, and

is a frequent topic of the SEC’s agenda and one of the things that

they are working on is around the level of disclosure for different

activities and filings that have to be made. Clearly exchanges have

a very high level of public disclosure about our activities and how

we handle orders and our pricing. And one of the topics is whether

that level of disclosure should be applicable to all market participants. And there is valid reasons on both sides of the argument,

but clearly from our standpoint, we think that a similar level of

disclosure is warranted.

Mr. GUINTA. Okay. Thank you, Mr. Chairman.

Mr. MCHENRY. Thank you. Thank you, the discussions about the

consequences or potential negative consequences of this liquidity

support. So walk me through this, if liquidity support agreement

required these following couple of things, four things, the agreement is publicly disclosed, the liquidity provider does not provide

hedging service to third parties, the liquidity provider does not

trade on a proprietary basis of the issuer’s security, and the liquidity provider does not reveal its trading strategy or the plan transactions to the issuer. Do you think that would be sufficient to

counter the possible negative consequences?

Mr. MECANE. I think that’s definitely a good place to start.

Mr. MCHENRY. Are there additional things you would require?
40

Mr. MECANE. There could be a public disclosure of the terms of

the arrangement. We could, through the exchange or SEC, there

could be a mechanism to, you know, disclose exactly what’s being

done. There might be confidentiality concerns around that. So we

could debate at what level, but I think perhaps some additional

public disclosure of certain terms could be helpful.

Mr. MCHENRY. And duration.

Mr. MECANE. What the obligations are, what the payment structure is.

Mr. MCHENRY. Okay. Mr. Noll.

Mr. NOLL. I agree with Mr. Mecane, those are very good places

to start. A couple areas perhaps to pay a little more attention to,

when you talk about proprietary trading, clearly as a market

maker, the market maker is going to be taking positions in the security, that’s one of the things that providing liquidity means——

Mr. MCHENRY. Yes.

Mr. NOLL [continuing]. So delineating what is a market maker

position and what is market maker behavior from what is a speculative proprietary position.

Mr. MCHENRY. That can’t be too complicated, how many pages

is the simple Volcker rule? It adds what, 300 pages?

Mr. NOLL. I think you could burn a lot of brain cells trying to

find that line. Those are the areas that I think we would have to

spend some attention on.

One possible area to look at, I think as an addition is what is

the definition of market called that you’re looking for, and having

that be a transparent part of this proposal which is, this is our expectation as a company for what we expect to see, from supporting

this kind of market maker support system, spreads of X percent

and depth of Y securities. As part of that overall process, I think

maybe a healthy area as well.

Mr. MCHENRY. Okay, okay, interesting. This has been very helpful. I know we’ve touched on a number of things here, you know,

global competition is certainly a concern, obviously you both

touched on that to some degree, and the importance of really bringing capital to the United States. I mean, that’s really what our capital markets are about, it is sort of being a sponge to bring in capital. Are there any things you want to add additionally, just in this

broad concept we’re talking about? Ideas, solutions problems we

haven’t touched on in this hearing? Mr. Noll.

Mr. NOLL. We have touched on almost everything, but I do want

to emphasize I think the problem here is not just about liquidity

and not just about market structure. There is clearly regulatory

impediments for companies going public. You could group them

most largely in what I will call Sarbanes-Oxley, but there are more

than those. I think addressing those I think is also going to be critical to making the success if we are going to improve the IPO market for small——

Mr. MCHENRY. Do you want to talk about anything in particular

with Sarbanes-Oxley?

Mr. NOLL. Well, clearly the 404 restrictions and allowing that

market to have companies that are exempt from that to be higher

than it is today.

Mr. MCHENRY. Uh-huh.
41

Mr. NOLL. We agree with the billion dollar mark that we’ve seen

out there. And we think that that’s something that would be very

useful for companies as they go forward. You know, implementing

perhaps a time or a grace period for companies after they go public

may also be very beneficial.

And then we are very concerned about the new PCAOB requirement that companies change auditors as we go forward, because it

feels to us, in many ways, like an unnecessary expense. One of the

benefits of working with an auditor over time is that they know the

company and they become very familiar with the way the company

works. And so the cost of the audit actually goes down. To hit the

switch, auditors on a frequent basis to bring new auditors in creates a very expensive proposition for companies, and yet another

reason why a company may not want to go public. So I think it’s

important that we think about those in this context as well.

Mr. MCHENRY. Mr. Mecane.

Mr. MECANE. I will echo what Mr. Noll said and the point I made

earlier which is that any type of reform that we do needs to be part

of a broader package, I don’t think any market structure fixes, in

and of themselves, are going to necessarily fix the problem. I point

again to the IPO task force report which I thought did a very good

job of coming up with very discrete, concrete recommendations that

are reasonably implementable as a path forward for increasing potentially research coverage, making it easier for companies to go

public, and perhaps palatable, regulatory relief that could help

loosen up some of the trends that we’ve been seeing.

Mr. MCHENRY. What about securities class action lawsuit reform?

Mr. MECANE. As a non lawyer——

Mr. MCHENRY. I like the stare off here.

Mr. MECANE. It is something we can certainly get back to you on.

Mr. MCHENRY. That is a creative answer. Let me ask this in a

different way, because that wasn’t even—it was an open-ended

statement really. Do security class action lawsuits and the structure and form and the payment and expense, do they disincentivize

the public markets?

Mr. MECANE. What I would say very broadly is that I believe

that when companies are evaluating their different future options

that there’s a perception of a cost of being public, some of that

being the oversight of quarterly earnings, and complying with the

different rules. Some of it is, to your point, chairman, subjecting

yourself to potential lawsuits from investors, etc. I think that goes

into the evaluation and the equation whether conscious or subconscious about whether people’s best path forward is a public or

a private one. I think anything that potentially increases the cost

of going public is negative.

Mr. MCHENRY. Mr. Noll.

Mr. NOLL. I would agree with Mr. Mecane there. We would have

to also get back to you with our opinion about securities litigation

reform. I do want to emphasize that one of critical things that exchange markets do do by being transparent markets is create a set

of rules by which all companies have to abide by, both in their listing standards and in the trading of those rules. And so keeping investor protection in the front of our minds is also important. So to
42

the extent that anything that supports investor protection in this

process is something that we wouldn’t want to give up as we go forward.

Mr. MCHENRY. Okay, well on that area of agreement you’ll both

get back to us. I certainly appreciate your willingness to have the

conversation here this morning. This is the roadblocks to public

markets and the impact that has on job creation. I mean, this is

not something we touched on, but obviously, when companies are

able to go to the public markets, access capital, they are able to

greatly expand their work force and what their able to do in terms

of offering a product or their service.

And so having a vibrant public market goes right along with vibrant labor markets and modern societies around the world historically, but I appreciate your willingness to have the conversation

about these ideas, about these concerns, potential solutions, but

also the current struggles that we’re facing right now.

I appreciate your ability to have that conversation and sort of engage in a broader range of subject matters this morning. We very

much appreciate it. And as policymakers here, those watching from

their offices and those of us that are trying to craft legislation to

free up capital formation in this country, this is very helpful.

Thank you for your time. With that, you’ll have—you’ll each have—

I’ve got my final script here, you’ll have 7 days to add additional

comments to the record, as do Members. With that, this meeting

stands adjourned. Thank you.

[Whereupon, at 11:18 a.m., the subcommittee was adjourned.]

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