COMMODITY FUTURES TRADING COMMISSION

 SECURITIES AND EXCHANGE COMMISSION

 JOINT ADVISORY COMMITTEE MEETING

 Washington, D.C.

 Wednesday, August 11, 2010

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 2 

 1 PARTICIPANTS:

 2 GARY GENSLER

 Chairman, Commodity Futures Trading Commission

 3 

 MARY SCHAPIRO

 4 Chairman, Securities and Exchange Commission

 5 MICHAEL MENDELSON

 Principal AQR Capital Management

 6 

 NOEL ARCHARD

 7 Head, U.S. Products Blackrock

 8 CHARLES ROTBLUT

 Vice President and Editor

 9 American Association of Individual Investors

 10 KEVIN CRONIN

 Director, Global Equity Trading Invesco

 11

 CHRIS NAGY

 12 Managing Director, Order Routing Sales and

 Strategy, TD Ameritrade

 13

 PAMELA CRAIG

 14 Chief Financial Officer, Accenture

 15 JIM MOSER

 Commodity Futures Trading Commission

 16

 GREG BERMAN

 17 Securities and Exchange Commission

 18

 19 * * * * *

 20

 21

 22

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 1 P R O C E E D I N G S

 2 (9:06 a.m.)

 3 CHAIRMAN GENSLER: Welcome and good

 4 morning. I'll call to order this third meeting of

 5 the Joint CFTC-SEC Advisory Committee on Emerging

 6 Regulatory Issues. The date is August 11, 2010.

 7 This meeting is held in accordance with the

 8 government's Sunshine Act and we're joined by all

 9 of the members of the advisory committee I think

 10 except for Brooksley Born and Susan Phillips.

 11 Susan Phillips may be joining by phone and maybe

 12 Brooksley.

 13 As we have done in our prior meetings of

 14 the committee, my co-chair Mary Schapiro and I

 15 will share the presiding officer's duties, but

 16 first I'd like to offer Chairman Schapiro the

 17 opportunity to make some opening remarks.

 18 CHAIRMAN SCHAPIRO: Thank you very much,

 19 Gary. I also want to join Chairman Gensler in

 20 welcoming all of our committee members and again

 21 thank you for the time and effort that you've

 22 invested over the past few months as we continue

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 1 our review of the May 6 events.

 2 As part of the SEC and CFTC review of

 3 market events on May 6, we're pursuing two related

 4 courses of inquiry. The first is empirical and

 5 data driven. SEC staff have been reviewing raw

 6 transaction and order data, order book snapshots,

 7 trade summaries, information about broken trades

 8 and information related to the initiation of LRPs

 9 and self-help.

 10 The second area of inquiry is focused on

 11 extensive interviews with market participants,

 12 their first- hand accounts of what happened on May

 13 6 and their responses to those events throughout

 14 the course of the day. These efforts will

 15 culminate in a SEC-CFTC joint report that will be

 16 presented to this committee for its consideration

 17 next month and of course we will share with the

 18 public as well.

 19 As part of our review, we have sought

 20 input from institutions and individuals who can

 21 help us build an understanding of what happened,

 22 how it affected market participants and how we

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 1 might best avoid future events of this type. At

 2 our last joint advisory market meeting,

 3 representatives of the various exchanges discussed

 4 their experiences and their observations of the

 5 markets on that day. Significant market

 6 participants also shared their views and

 7 observations regarding liquidity, trading and the

 8 apparent breakdown of an orderly market. Today

 9 the committee will hear panelists describe the

 10 impact of May 6 from the perspective of investors

 11 both large and small and we think the investor

 12 perspective is crucial to understanding these

 13 events and to fostering stronger capital markets.

 14 As you know, following May 6 the SEC has

 15 undertaken two immediate policy responses. The

 16 first was to work with the exchanges and FINRA to

 17 develop new stock- by-stock circuit breaker rules.

 18 These rules which were approved by the SEC on June

 19 10 require the exchanges and FINRA to pause

 20 trading in S&P 500 stocks when they experience a

 21 10 percent change in price over a 5-minute period.

 22 This pause which is currently applied on a pilot

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 1 basis gives the markets the opportunity to attract

 2 new trading interest in an affect stock, establish

 3 a reasonable market price and resume trading in a

 4 fair and orderly fashion. In June we published

 5 for comment proposals by the exchanges and FINRA

 6 to expand this program to include all the stocks

 7 in the Russell 1000 index as well as 344 specified

 8 exchange-traded funds, and we're currently

 9 reviewing the comments received on those proposals

 10 and I hope we'll have Commission approval of this

 11 phase of circuit breakers very soon.

 12 The second policy response was to work

 13 with the exchanges and FINRA on amending their

 14 rules for breaking clearly erroneous trades. As

 15 the committee heard previously, after May 6 the

 16 exchanges exercised their existing authority to

 17 break clearly erroneous trades that were effected

 18 that day at prices 60 percent or more away from

 19 the pre-declined prices. The process that was

 20 used to draw that line however was neither clear

 21 nor transparent to market participants and we've

 22 received reports that the lack of clear guidelines

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 1 for dealing with clearly erroneous transactions

 2 and the lack of transparency surrounding the

 3 decision to break trades but not others created

 4 uncertainty for investors and others about how

 5 such transactions would be handled in the future.

 6 The proposed rule changes are designed to address

 7 these concerns by setting clearer standards for

 8 breaking trades and curtailing the discretion of

 9 the exchanges and FINRA. These proposed rules

 10 were published for comment in June and we're now

 11 reviewing the comments received.

 12 We're considering as well whether other

 13 steps are appropriate to reduce the risk of sudden

 14 disruptions and clearly erroneous trades including

 15 deterring or prohibiting the use of stub quotes by

 16 market makers, and we're studying the impact of

 17 trading protocols on individual exchanges

 18 including the use of trading pauses, price callers

 19 and self-help rules. Finally, we're looking

 20 closely at other mechanisms that may contribute to

 21 a more stable market such as instituting

 22 limit-up/limit-down mechanisms. As we continue to

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 1 examine these and other issues and to consider

 2 actions that may further protect investors and

 3 stabilize financial markets, it is critical for us

 4 to continue to hear a variety of informed views.

 5 Today's guests and of course our committee members

 6 will I'm sure not only shed more light on May 6

 7 but provide some of those knowledgeable

 8 perspectives that we need. I want to thank again

 9 all of our guests who are speaking as well as our

 10 committee members for being here today. Thank

 11 you, Gary.

 12 CHAIRMAN GENSLER: Thank you, Mary.

 13 Today we'll continue our examination of market

 14 events that took place on May 6. I want to thank

 15 you for co-chairing this meeting and I look

 16 forward to our continuing work together on these

 17 issues. But also with regard to the Dodd-Frank

 18 bill, this right here my friend, are two sets of

 19 Commissioners in a moment, our Commissioners.

 20 We're going to be working together very closely.

 21 The Dodd-Frank Act for the first time brings the

 22 other-the-counter market on comprehensive

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 1 regulation and I know when you chaired the CFTC

 2 you nosed up to that, you tried, but now Congress

 3 has actually given the SEC and the CFTC the

 4 necessary authority. So I really do look forward,

 5 and I can report to the public our meetings today

 6 and the last month have been remarkable. We set

 7 up 30 teams. The SEC set up a different set of

 8 teams. You have more work than we do because you

 9 have credit- rating agencies and a lot of other

 10 investor-protection issues. Some of these teams

 11 have met five and six times already, the exchange

 12 emails, and it's really been a cooperative effort.

 13 We won't always agree, but I think that we're

 14 going to agree on most and where we disagree

 15 hopefully we'll disagree agreeably. So I wanted

 16 to thank you for that off-script.

 17 The agencies of course are also working

 18 together on this issue around May 6 and this

 19 Advisory Committee on Emerging Issues and the

 20 expert panelists we're going to hear from today

 21 are critical with regard to this review. I want

 22 to thank the CFTC and SEC staff for all of their

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 1 hard work in planning this meeting and of course

 2 everything they're doing around May 6. I want to

 3 thank my fellow Commissioners Mike Dunn, Jill

 4 Sommers and Bart Chilton who were able to attend

 5 today. I know that Scott was unable to attend,

 6 but I want to thank all of you as well.

 7 The market events of May 6 require

 8 continued review. The staffs of the joint

 9 agencies put out a report I guess it was May 18

 10 which was only 12 days after which I guess with

 11 the rule writing we'll have to do some deadlines

 12 similar. Today's meeting will be part of that

 13 ongoing process building upon those staff reports.

 14 I think we're shooting as Chairman Schapiro said

 15 for September, maybe even early September that the

 16 staff will deliver the follow-up report concerning

 17 May 6 based on the research over the last 3

 18 months. Then we look forward to this expert

 19 committee to come back and we're hopefully going

 20 to set short deadlines that too with your

 21 recommendations, whether you're able to do that as

 22 soon as the following month, but we're hopeful to

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 1 get your thoughts on this as well. I look forward

 2 to the informative dialogue with the panelists and

 3 with the committee members and I want to thank

 4 again the CFTC and SEC staffs. With that I think

 5 I'm supposed to introduce some of our panelists

 6 and then we can get going.

 7 We're pleased to be joined by the panel

 8 of witnesses today. This panel will focus on the

 9 investor perspectives of those events. We're

 10 joined by representatives of exchange trading

 11 funds on ETFs, a pension fund, individual

 12 investors, retail investors and representatives of

 13 asset management and mutual funds. We look

 14 forward to hearing their experiences and comments

 15 on May 6.

 16 We're honored to be joined in person by

 17 six of our committee members, Richard Ketchum who

 18 runs FINRA; David Ruder who once had Mary's role

 19 at the SEC; Maureen O'Hara, Joe Stiglitz and Bob

 20 Engle who are three enormously distinguished

 21 economists and professors in finance. I'm

 22 blurring finance and economics. I'm just a

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 1 washed-up finance guy. And Mr. Brennan who used

 2 to run I think the largest mutual fund complex but

 3 maybe you're second some days. We're deeply

 4 honored by the six of you joining us and I said I

 5 think that we might have Susan Phillips of this

 6 agency and obviously a Board of Governors

 7 director.

 8 Our witnesses today including Mike

 9 Mendelson, principal, AQR Capital Management; Noel

 10 Archard, head, U.S. Products for Blackrock.

 11 Blackrock probably might be now the largest asset

 12 manager. It depends how you count. Charles

 13 Rotblut, vice president and editor of the American

 14 Association of Individual Investors. Chris Nagy,

 15 managing director, Order Routing Sales and

 16 Strategy, TD Ameritrade, probably first in

 17 something depending on how you count. Kevin

 18 Cronin, director, Global Equity Trading at

 19 Invesco. Pamela Craig, chief financial officer,

 20 Accenture. We will now hear from our panelists'

 21 opening remarks and begin from the left, so I'm

 22 going to start over here.

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 1 MR. MENDELSON: Chairman Schapiro,

 2 Chairman Gensler, members of the joint committee,

 3 my name is Michael Mendelson. I'm a principal at

 4 AQR Capital Management, an investment management

 5 firm that for the last 12 years has managed assets

 6 for pension funds, endowments and foundations and

 7 now also manages public mutual funds. Thank you

 8 for inviting me today to discuss our experience of

 9 the events of May 6. The flash crash highlights a

 10 risk in an otherwise well-functioning U.S. market. 

 11 While AQR and the great majority of other

 12 investors managed to avoid damage from this event,

 13 unfortunately not everyone did. We can reduce the

 14 likelihood of a repeat flash crash and the work of

 15 this committee and the extensive efforts of the

 16 staffs of the SEC and CFTC may be the

 17 most-important steps in that effort.

 18 AQR employs quantitative methods in most

 19 of its investment strategies. We invest in a wide

 20 variety of instruments including U.S. equities.

 21 Our holding periods are typically months to years.

 22 Some of our investment strategies turn over every

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 1 few days but none would be considered high

 2 frequency, we are liquidity seekers though we

 3 don't use market orders and rely on liquidity

 4 providers to perform their essential functions.

 5 In many of the markets in which we trade which as

 6 fixed income, liquidity is provided by dealer

 7 firms whose ability to provide liquidity rises and

 8 falls with the health of the financial system.

 9 But in the U.S. equities market, liquidity is

 10 provided by a broad base of participants. This

 11 was a great benefit to all investors during the

 12 most difficult weeks of the financial crisis. Our

 13 exchange-traded markets performed admirably and

 14 those responsible for that from little small

 15 electronic market makers to the regulators who led

 16 us to a competitive broadly democratized market

 17 structure should be proud of this achievement.

 18 At AQR we built safeguards into our

 19 trading processes and have human oversight of

 20 them, important steps for protecting client

 21 assets. On May 6 our trading staff noticed early

 22 on that the market was potentially disrupted and

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 1 shut down our equity trading. We suffered no

 2 busted trades, we avoided trading at dislocated

 3 prices and we were able to complete the

 4 overwhelming share of portfolio transactions

 5 planned for that day. Nevertheless, May 6

 6 revealed risks in the trading ecosystem that need

 7 to be managed. I'd like to highlight three

 8 issues.

 9 First, questions remain about the cause

 10 of the flash crash. We know there was significant

 11 negative macroeconomic news, very heavy trading

 12 volume, substantial liquidity demand from market

 13 sellers, trade reports that appeared to be

 14 erroneous and a delinking of our trading centers.

 15 With liquidity providers experiencing large

 16 profit-and-loss moves while fearing they were

 17 flying blind with reliable market data, it is easy

 18 to understand why they would have compelled to

 19 withdraw their limit orders. Meanwhile, liquidity

 20 demanders continued to send market orders unaware

 21 that the typically deep-limit order book wasn't.

 22 I want to emphasize the importance of unaware. 

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 1 Second, had some of the weak links been

 2 stronger, what alternative course could events

 3 have taken that day? Perhaps the evaporation of

 4 the limit order book was actually our good fortune

 5 as the subsequent shocking trade reports screamed

 6 out to market sellers to stop. Without that loud

 7 blast, selling may have continued unabated causing

 8 a real crash from which it would have taken far

 9 longer than 15 minutes to recover. The clearing

 10 of the limit order book may have acted much like a

 11 circuit breaker, albeit a very sloppy one. Better

 12 market data, better exchange coordination and

 13 additional rules might have prevented the flash

 14 crash but might have enabled a real one. I don't

 15 know. Careful analysis of market data may yield

 16 an answer and I encourage the committee to work

 17 with industry participants to explore this. We

 18 need to understand what role demanders of

 19 liquidity had on May 6 and perhaps consider steps

 20 to better inform those participants of the live

 21 aggregate supply of liquidity.

 22 Third, the complexities of our trading

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 1 environment should give us pause and at least

 2 drive us to seeking light-weight and simple

 3 solutions. Toward that end, the current

 4 circuit-breaker pilot program may be a good start,

 5 but modifications may be needed. We have seen as

 6 recently as last Thursday that erroneous trade

 7 reports can halt a stock. With broad access to

 8 the trade reporting facility, there is too much

 9 potential for substantial abuse. Perhaps

 10 consideration should be given to a limit offer

 11 rule. Another proposed solution is to impose

 12 market- making obligations. This will increase

 13 costs for investors every second of every normal

 14 trading day by reducing the availability of

 15 liquidity-providing capital and increasing its

 16 risk. Adding insult to injury, on those rare

 17 occasions when markets are severely disrupted

 18 market-making obligations will accomplish nothing.

 19 After all, the function of a market maker is not

 20 to buy stock at the wrong price as a market is

 21 crashing. Market-maker obligations come with

 22 special privileges and some markets may need this

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 1 to encourage liquidity providers in the ordinary

 2 course of business, but instead here the

 3 suggestion is that privileges will encourage

 4 liquidity provision in extraordinary times. They

 5 won't.

 6 Thank you.

 7 CHAIRMAN GENSLER: Thank you. Noel?

 8 MR. ARCHARD: Thanks very much. Good

 9 morning. My name is Noel Archard. I'm the

 10 Managing Director at Blackrock and I head the

 11 product team for the U.S. Exchange-traded fund

 12 business. I greatly appreciate the opportunity to

 13 speak with you today about the impact of the May 6

 14 flash crash on investors and what steps we can

 15 take to prevent such market disruptions in the

 16 future.

 17 As the members of this committee know

 18 well, ETFs have become widely accepted investment

 19 vehicles for both institutional and retail

 20 investors. There are currently 985

 21 exchange-traded products available in the U.S.

 22 market with over $790 billion in assets invested.

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 1 They represent 30 percent of the total volume

 2 traded on national exchanges and they have become

 3 indispensable tools for a range of investment

 4 strategies. Institutional investors use them for

 5 a number of sophisticated strategies such as cash

 6 equitization or as a low-cost hedging tool. For

 7 their part, retail investors also use them in a

 8 wide variety of ways, to build an asset allocation

 9 as part of a core satellite approach or tactical

 10 investing among sectors to make a few.

 11 With their low cost, transparency and

 12 easy access to a wide range of asset classes, ETFs

 13 have significant advantages that have benefited

 14 millions of investors. For example, many

 15 investors both retail and institutional have found

 16 enormous value in able to observe the price of the

 17 ETF during the day and to use trade-type orders

 18 such as stop loss or limit orders in an attempt to

 19 control the price at which they transact.

 20 Against this backdrop, several market

 21 issues converged on May 6 to effect prices for

 22 U.S. equities in general and ETFs holding U.S.

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 1 equities specifically for a period of

 2 approximately half an hour during afternoon

 3 trading. We note that ETFs holding U.S.

 4 fixed-income securities and non-U.S. equities were

 5 largely unaffected and generally traded at prices

 6 within normal ranges of underlying asset values.

 7 Many ETFs holding U.S. equities however did not.

 8 In our view, four different factors simultaneous

 9 contributed to market prices for some ETFs

 10 diverging from underlying asset value.

 11 First, there was the sudden market

 12 freefall in U.S. equity prices which preceded the

 13 fall in ETF prices and caused market makers in

 14 ETFs that seek to track benchmarks heavy in the

 15 falling stocks to have difficulty valuing the

 16 ETFs' underlying assets. Second, anxiety over

 17 potential trade cancellations caused liquidity

 18 providers to fear that normal ETF hedging

 19 strategies would be interrupted which caused them

 20 to pull back from bidding for ETFs. Third, there

 21 was market fragmentation where exchange protocols

 22 and order routing rules increased selling

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 1 pressure. Finally, there was unintended selling

 2 because of the stop-loss orders that were

 3 triggered which increased the volume of sell

 4 orders on ETFs. These stop-loss orders which

 5 turned into orders to sell at market prices were

 6 executed significantly below trigger points due to

 7 the speed of price freefall.

 8 While we believe the final impact on

 9 investors was relatively limited to widespread

 10 trade cancellations, there was nonetheless an

 11 impact. To better understand exactly the effect

 12 on financial advisers, we at Blackrock's iShares

 13 ETF business recently commissioned a survey of

 14 retail financial advisers in late June. We

 15 commissioned the Flash Crash Perception Study to

 16 learn from financial advisers, one of the largest

 17 groups of ETF users, what they think about the

 18 market event that affected individual securities

 19 and ETFs as a category. The survey revealed that

 20 the majority of advisers were minimally impacted

 21 by the market disruption and they believed that

 22 market structure issues such as an overreliance on

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 1 computer systems and some types of high-frequency

 2 trading were the primary drivers of the crash.

 3 Stop-loss orders, market makers and

 4 exchange-routing issues were seen as secondary

 5 issues.

 6 As it relates to the macroeconomic

 7 environment, the majority of advisers surveyed

 8 expect current market volatility will either

 9 increase or remain at today's level over the next

 10 6 months. Furthermore, and perhaps

 11 disappointingly, those surveyed anticipate an

 12 event similar to May 6 will likely occur again no

 13 matter what solutions are adopted. The survey 

 14 also indicated that most advisers' accounts were

 15 not impacted by the events of May 6. Of those

 16 accounts touched by the volatile trading on that

 17 day, the most common cause was a stop-loss order

 18 triggered by the flash crash and executed at a

 19 significantly reduced value which happened to

 20 about a quarter of the advisers surveyed.

 21 Regardless of the cause of volatility,

 22 economic or structural like the flash crash,

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 1 advisers identified ETFs as the best investment

 2 vehicles to navigate a volatile market environment

 3 followed by bonds and mutual funds. The survey's

 4 findings underscore for us at iShares the

 5 importance of strong market structural reforms to

 6 help prevent future market disruptions some of

 7 which we've already spoke about this morning. We

 8 believe those reforms should include uniform 

 9 circuit breakers for stocks and ETFs across all

 10 exchanges, making exchange-trade error

 11 cancellation rules less arbitrary and more

 12 transparent in a manner that does not discourage

 13 liquidity providers from providing liquidity at

 14 times of market stress. Clearer guidelines for

 15 intermarket order writing rules. Replacing

 16 stop-loss orders with stop-loss limit orders to

 17 specify a limited price for a caller, and

 18 expanding the role of lead market makers to ensure

 19 orderly market functioning particularly at times

 20 of market reopening. We believe these reforms

 21 would represent a strong step toward preventing

 22 market disruptions like the one of May 6 in the

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 1 future. We at Blackrock looking forward to

 2 working together with members of this committee

 3 and the staffs of the SEC and the CFTC on this

 4 important issue.

 5 Thank you again for the opportunity to

 6 speak today.

 7 CHAIRMAN GENSLER: Thank you, Noel. I

 8 wanted to ask and I apologize. If have all of

 9 your written reports electronically it facilitates

 10 putting it up on the web and I don't know if we

 11 do, so that the public can see what your comments

 12 are too. Charles?

 13 MR. ROTBLUT: Chairman Schapiro and

 14 Chairman Gensler, thank you for having me. I'm

 15 Charles Rotblut and I'm vice president with the

 16 American Association of Individual Investors and

 17 editor of the AAII Journal. We represent 150,000

 18 individual investors and we are a nonprofit

 19 organization focused on giving individual

 20 investors education and information about

 21 investing. Our members typically have an

 22 intermediate-level knowledge of investing, they

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 1 typically hold either a college degree or an

 2 advanced degree and the majority of them trade

 3 online through discount brokers and most of whom

 4 do follow a long- term strategy though we do have 

 5 some who trade a little bit more actively.

 6 Many individual investors continue to

 7 have questions concerning the May 6 flash crash.

 8 They are unsure about the procedures that caused

 9 stock prices to become so volatile. They are

 10 worried that solutions have not been established

 11 to prevent similar events from occurring in the

 12 future. They wonder about how much control over

 13 the movement of stock prices has been ceded to

 14 complex software programs that trade within

 15 milliseconds. They don't understand how market

 16 makers could have allowed some highly liquid

 17 stocks to fall to a penny per share. Most

 18 importantly, they are asking where the protections

 19 are for the individual investor.

 20 The biggest impact of the flash crash

 21 and the events of May 6 from the standpoint of the

 22 individual investor was not the effect it had on

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 1 their brokerage account balances but, rather, the

 2 effect it had on their confidence. They are

 3 concerned that unusual volatility such as the

 4 large price swings that transpired could occur

 5 again. They are also worried about the

 6 possibility of a buy or sell order, especially a

 7 stop order, not being executed in an orderly

 8 fashion.

 9 CHAIRMAN GENSLER: Thank you very much.

 10 Kevin?

 11 MR. CRONIN: Thank you, Chairman

 12 Schapiro and Chairman Gensler and members of the

 13 advisory committee for the opportunity to speak

 14 here today. My name is Kevin Cronin. I'm head,

 15 Global Equity Trading for Invesco, and I

 16 appreciate the opportunity to speak to you today

 17 about the events of May 6.

 18 Invesco is a leading global asset

 19 management firm operating in 20 countries with

 20 assets under management of approximately $560

 21 billion. I'll try to be brief in my statement. I

 22 have however posted a more-detailed statement for

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 1 the record.

 2 I'll spare any of the drama. We believe

 3 that the crash that happened on May 6 was in large

 4 measure the result of flaws and inefficiencies in

 5 the current U.S. Market structure. Specifically,

 6 the flash crash the need for updated market-wide

 7 and stock-by-stock circuit breakers, effective and

 8 transparent procedures for resolving clearly

 9 erroneous trades, a review of the risks and

 10 effectiveness of market orders, alignment of the

 11 inconsistent practices and procedures used by

 12 various exchanges to address major price

 13 movements, an examination of the responsibilities

 14 and obligations of registered and unregistered

 15 market markers and better coordination across all

 16 types of markets.

 17 Removing all instability and volatility

 18 from the equity markets is neither possible nor

 19 appropriate. However, establishing mechanisms to

 20 address extreme price moves in the markets and the

 21 volatility related to inefficient market

 22 structures will be critical in preventing a repeat

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 1 of the May 6 flash crash. As such, Invesco

 2 supported the single-stock circuit-breaker

 3 proposals as a means to mitigate the impact of

 4 sudden market volatility. Similarly, we strongly

 5 supported amendments to the rules relating to

 6 clearly erroneous executions, to clarify the

 7 process for breaking erroneous trades and to

 8 provide uniform treatment across exchanges for

 9 clearly erroneous execution reviews. However, we

 10 believe the whole notion of taking trades off the

 11 tape is generally detrimental to investor

 12 confidence. We would propose that exchanges

 13 clearly define and articulate the parameters that

 14 constitute erroneous trades and then program their

 15 systems to detect and reject trades outside of 

 16 those parameters. We believe uncertainty

 17 surrounding clearly erroneous trades and the risk

 18 associated with entering orders during a drop in

 19 stock prices very likely contributed to the rapid

 20 and dramatic market decline on May 6.

 21 As was clearly illustrated by the events

 22 of May 6, there was also a vacuum of liquidity and

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 1 in this vacuum of liquidity small market orders

 2 can have an outsized impact on the prices of

 3 securities. This vacuum was created when a

 4 massive wave of sell orders hit the markets

 5 triggering liquidity replenishment points, LRPs,

 6 on the New York Stock Exchange. These LRPs or

 7 speed bumps resulted in the NYSE going into slow

 8 mode. Subsequently, NASDAQ and the other

 9 exchanges declared self-help against NYSE Arca.

 10 This declaration of self-help allowed the other

 11 exchanges to essentially ignore the quotes on NYSE

 12 Arca. Thus as various exchanges where determining

 13 where to route their orders to fulfill their reg

 14 NMS obligations, they could do so without

 15 consideration to NYSE Arca. At the same time

 16 market makers and liquidity providers were

 17 widening their quotes or getting out altogether as

 18 the quotes they were receiving became less

 19 reliable. As a result, small market orders and

 20 stop-loss orders which were triggered became

 21 market orders and left to execute against the very

 22 limited amounts of liquidity that was posted on

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 1 other exchanges or market centers. In some cases,

 2 the only available quotes left were the so-called

 3 stub quotes of some of the market markers.

 4 As an institution we have long

 5 understood the significant risk of using market

 6 orders particularly as the market has become more

 7 fragmented, and as such we have not used them for

 8 some time. In light of the events of May 6 and

 9 the continuing issues small market orders have had

 10 in the market, obviously recently with the

 11 triggering of circuit breakers in stocks like

 12 Cisco and Citigroup and others, Invesco recommends

 13 that exchanges and broker dealers only accept

 14 market orders which have collars on them. A

 15 collared market order would only execution of the

 16 order within a certain percentage of the

 17 referenced price, for example, 3 percent of the

 18 last sale. We would also recommend similar

 19 treatment for stop-loss orders. This would give

 20 investors some level of protection from the impact

 21 of market orders that market orders can have in

 22 the current environment and would likely reduce or

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 1 altogether eliminate the issue of small share

 2 amounts triggering circuit breakers.

 3 We believe that the self-help provision

 4 under reg NMS needs to be reviewed. This

 5 provision was put in place many years ago to

 6 prevent manual markets from unnecessarily slowing

 7 down trading. It was also conceived at a time

 8 when there were very few high-frequency trading

 9 firms and fast executions were defined in seconds

 10 and not milliseconds. The events of May 6 also

 11 illustrate the interdependency of equity, options

 12 and futures markets, particularly the connection

 13 between price discovery for the broader stock

 14 market and activity in the futures markets.

 15 Invesco strongly supports a more robust discussion

 16 and examination of the linkages and

 17 interdependency of the equity, options and futures

 18 markets and whether rules need to be made more

 19 consistent across types of markets.

 20 The role of traditional liquidity

 21 providers such as market makers has taken on more

 22 significance given the events of May 6 as the

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 1 sudden absence of liquidity in the markets played

 2 a critical role in the severe price declines.

 3 Several ideas have been put forward to improve the

 4 operation of market makers that are worthy of

 5 further consideration including obligations

 6 surround best price, depth of market and maximum

 7 quoted spread obligations. In addition to

 8 traditional market makers, an examination of other

 9 liquidity providers particularly high-frequency

 10 traders is warranted. While Invesco believes

 11 there any beneficial high-frequency trading

 12 strategies and participants which provide valuable

 13 liquidity and efficiencies to the markets, we also

 14 believe there are some strategies that could be

 15 considered as improper or manipulative activity.

 16 This highlights the need for the industry to

 17 better understand high-frequency traders and the

 18 practices of high-frequency trading firms. While

 19 it is important for the advisory committee to 

 20 study the impact of market orders, LRPs, the

 21 declaration of self-help by exchanges, market

 22 makers and other issues we've mentioned, we

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 1 believe that more fundamental consideration is

 2 warranted, and this is whether the current

 3 structure has become too focused on the speed of

 4 execution over all other factors. At some point

 5 we believe that speed and price discovery have an

 6 inverse relationship and this dynamic needs to be

 7 well understood.

 8 I thank you for allowing me to

 9 participate and I look forward to answering any

 10 questions you might have.

 11 CHAIRMAN GENSLER: Thank you, Kevin, for

 12 those provocative remarks. Chris?

 13 MR. NAGY: Thank you. Chairman

 14 Schapiro, Chairman Gensler and members of the

 15 Joint Advisory Committee, thank you for the

 16 opportunity to participate on this panel

 17 concerning the May 6 market event.

 18 I'm Chris Nagy, managing director, Order

 19 Routing Strategy, TD Ameritrade. TD Ameritrade

 20 based in Omaha, Nebraska, was founded in 1975 and

 21 was one of the first firms to offer negotiated

 22 commissions to investors following the passage of

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 1 the 1975 amendments. Over the course of the next

 2 three decades, TD Ameritrade pioneered

 3 technological changes such as touch-tone trading

 4 and internet investing to make market access by

 5 individual investors more affordable and

 6 transparent. While TD Ameritrade clients

 7 predominantly trade equities and options, recently

 8 we've begun offering clients the ability to trade

 9 futures and Forex through our Think-or-Swim

 10 Division. TD Ameritrade has long advocated for

 11 market structures that create transparent, promote

 12 competition and reduce trading costs for

 13 individual investors.

 14 As technology rapidly advances, it's

 15 ever more important that regulators complete a

 16 comprehensive review that they are now undertaking

 17 to ensure our U.S. market structure remains among

 18 the greatest in the world. It's our intent to

 19 present these comments on behalf of our 7 million

 20 clients based upon the views they regularly

 21 expressed and our experiences in providing

 22 services to them.

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 1 While the U.S. financial markets have

 2 experienced precipitous market declines during a

 3 single day including the most famous 1987 market

 4 crash when the Dow Jones dropped 508 points, the

 5 May 6 market event in many ways unique first in

 6 the speed of the decline. The market whipsawed

 7 1,000 points in just 10 minutes. Second, the

 8 market decline was somewhat random and uneven

 9 causing over 90 percent temporary declines in some

 10 stocks while others were relatively unchanged.

 11 Third and perhaps most importantly it appears that

 12 the very nature of how the U.S. Markets are

 13 structured was a contributing factor to the

 14 precipitous decline. Although the causes may

 15 never be completely identified or understood, they

 16 appear partially lie in the dispersed structure of

 17 the U.S. markets and the markets' increasing

 18 dependence on liquidity providers who have no

 19 affirmative obligations to maintain two-sided

 20 quotes.

 21 Regardless of the exact cause, it's

 22 clear that the May 6 market event has had an

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 1 impact on investor psychology and their trust in

 2 the markets. How do you explain to an investor

 3 that a company with a market capitalization of $26

 4 billion that trades at $40 per share and seconds

 5 later trades at a stub quote of a penny?

 6 Obviously investors on the receiving end of

 7 executions filled against those stub quotes are

 8 going to question the fairness of the markets.

 9 Similarly, misgivings were voiced by investors who

 10 add executions that were less than 60 percent away

 11 from the market. Again, how do you explain to

 12 investors that a trade 61 percent away from the

 13 market was deemed erroneous but orders filled

 14 anywhere up to 59 percent away were not? And how

 15 do you explain to investors that some trades even

 16 though they were more than 60 percent away were

 17 busted while others were not?

 18 From our perspective, the answers for

 19 these clients will lie in the actions we as an

 20 industry and the regulators now undertake.

 21 Specifically, we may need to adjust the way in

 22 which the U.S. markets are currently structured so

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 1 that investors can trust that the price displayed

 2 to them is valid, so that they have the confidence

 3 in the liquidity available and so that they do not

 4 believe the markets are somehow rigged against

 5 them. The May 6 event was a wake-up call and one

 6 that requires a comprehensive response. Today's

 7 panel is just a small part of the appropriate

 8 response. It's a response that requires looking

 9 across equities, options and futures markets and

 10 approaching regulation holistically. It requires

 11 addressing not only the imposition of circuit

 12 breakers but also must include a review of dark

 13 pools, flash orders, access fees, high-frequency

 14 trading and naked access.

 15 For investors we think the right

 16 approach is a combination of the following.

 17 First, we agree with the adoption of the circuit

 18 breakers as a first good step. The regulators

 19 correctly identified an issue and took quick

 20 action to ensure trading took a pause during

 21 extreme market movements. But as everyone who has

 22 had to fumble around in the darkness of their

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 1 basement searching to reset a circuit breaker

 2 knows, circuit breakers are fail safe and do

 3 little to address the underlying cause of the

 4 problem.

 5 Second, TD Ameritrade believes that the

 6 regulators need to find a way to incentivize

 7 market centers to stay in the market, maintain

 8 two-sided quotes and most important to post size

 9 regardless of the market environment. The firm

 10 has noted previously that the May 6 market event

 11 demonstrated that today's markets contain many

 12 players who use their liquidity opportunistically,

 13 applying it when it's in their favor but pulling

 14 it during times of market duress.

 15 Third and particularly in the equities

 16 and options markets, the SEC should proceed with

 17 all due speed to move its concept release on

 18 market structure to a proposing stage while at the

 19 same time addressing issues like collocation,

 20 access fees, flash and naked access. Finally, as

 21 to the specific allegation that retail market

 22 orders and stop orders contributed to the

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 1 downturn, I can tell you from TD Ameritrade's

 2 perspective such orders are important to our

 3 clients and in looking at our own data we do not

 4 believe that there is any factual basis to assert

 5 that these types of orders contributed to the

 6 problem. In fact, TD Ameritrade's clients' market

 7 and stop orders were within average daily volumes

 8 on a percentage basis. Prohibiting market and

 9 stop orders would be a significant adverse,

 10 misguided and unnecessary overreaction to the

 11 underlying cause of the May 6 market event which

 12 would unduly deny retail investors the access to

 13 the markets they enjoy today.

 14 I look forward to answering any

 15 questions you may have. Thank you.

 16 CHAIRMAN GENSLER: Chris, thank you very

 17 much. Pamela?

 18 MS. CRAIG: Good morning. My name is

 19 Pamela Craig and I am the CFO of Accenture.

 20 Chairman Schapiro, Chairman Gensler, Commissioners

 21 and members of the Advisory Committee, Accenture

 22 appreciates the opportunity to share our

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 1 perspective on how the trading events of May 6

 2 impacted Accenture and our investors.

 3 Accenture is a global company with $22

 4 billion in annual revenue. We have 190,000

 5 employees, 32,000 of them in the United States and

 6 our market cap is $29 billion. Over 70 percent of

 7 our stocks are held by institutional investors

 8 based in the United States and just over 20

 9 percent are owned by current and former employees.

 10 Of our current employees, 25,000 are shareholders,

 11 62 percent of whom are in the U.S.

 12 We recognize that there is still not

 13 total clarity about what happened on May 6. We do

 14 understand that there was seemingly a perfect

 15 storm of economic news around the globe, a

 16 reduction of liquidity in many securities, unusual

 17 trading volumes and some technology challenges.

 18 Based on what we've all witnessed in the markets

 19 that day and since then, there is every reason to

 20 expect that this will happen again. We strongly

 21 believe that in times of market stress, all

 22 markets should operate under the same

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 1 circuit-breaker rules in order to promote orderly

 2 markets and investor as well as business

 3 confidence.

 4 We have a unique perspective on the

 5 trading events of May 6. Between 2:40 and 3:00

 6 p.m., the price of Accenture stock went from

 7 $41.01 to 1 cent and back again, and then closed

 8 that day at $41.09. Between 2:40 and 2:46 p.m., 

 9 Accenture shares fell from $41.01 to $38 as

 10 liquidity evaporated in the equity markets. This

 11 triggered an Accenture-specific circuit breaker at

 12 the NYSE, the LRP. At that point the NYSE stopped

 13 its own electronic trading in our stock briefly to

 14 go into slow mode so that market makers on the

 15 NYSE floor could then line up in orderly matching

 16 of trades. During this transition of about a

 17 minute, trading in our stock was temporarily

 18 halted on the NYSE while orders had the option to

 19 execute on other exchanges. A few small sell it

 20 market orders totaling just 10,000 shares

 21 altogether and all in a 10-second window were

 22 directed to other exchanges. These exchanges were

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 1 not coordinated with the NYSE and expected market

 2 making did not occur. These orders included 19

 3 trades of 100 shares each trading at a penny.

 4 Trades below $16.40 were subsequently busted.

 5 None of the cancelled trades were on the NYSE

 6 where the low trade for the day was in fact

 7 $38.75.

 8 This erratic trading rattled overall

 9 investor confidence in the market, but

 10 specifically affected our investor base including

 11 thousands of our employees. Accenture employees

 12 are granted equity compensation and participate in

 13 our employee stock purchase plan which provides

 14 them with a way to invest for their future and

 15 participate in the success of our company.

 16 Fifty-one percent of our 32,000 U.S. employees

 17 participate in the plan. After May 6 many

 18 employee shareholders were concerned about why our

 19 stock was affected versus other large cap

 20 companies. We believe this sentiment is

 21 consistent with the concerns of retail investors.

 22 The Joint CFTC-SEC Staff Report on the

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 1 market events of May 6 also highlighted

 2 Accenture's trading on that day and this brought

 3 further attention to the company. In addition,

 4 the partial trade cancellations have had an

 5 ongoing adverse effect on historical trading

 6 records. After May 6, the exchanges and FINRA

 7 cancelled trades in stocks between 2:40 and 3:00

 8 that were more than 60 percent away from the last

 9 trade at 2:40 p.m. This arbitrary pricing

 10 threshold caused the 52-week low for these stocks

 11 to be misleading to investors. It is

 12 disappointing that the 25-week low for Accenture's

 13 stock is currently $17.74 which obviously reflects

 14 the malfunction of the market- making process on

 15 not the true 52-week low. The low point on the

 16 New York Stock Exchange on May 6 was $38.75. We

 17 commend the SEC, the exchanges and FINRA for

 18 proposing new rules for cancelling clearly

 19 erroneous trades.

 20 We support efficient and fair markets

 21 and we also understand that the markets need to be

 22 governed by some rules. Increased competition

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 1 with more and better technology all the time has

 2 been good for the markets and has driven down the

 3 cost of trading. Nine years ago a substantial

 4 majority of our trades occurred on our primary

 5 exchange and today that's only about 45 percent.

 6 The rules need to be updated, modernized, if you

 7 will, so that they adapt to how the markets are

 8 evolving and continue to work as intended. If we

 9 expect today's markets to function well and keep

 10 up with increasingly sophisticated trading

 11 technology, then the rules need to be clear,

 12 coordinated and consistently implemented. If

 13 something similar to the May 6 events happened

 14 again, investors could be deterred from investing

 15 in our company even though it would have nothing

 16 to do with the strength of our underlying

 17 business, but instead would be due to a market

 18 glitch. We therefore urge the SEC to adopt the

 19 exchanges' and FINRA's proposed rules to expand

 20 the circuit-breaker pilot beyond the S&P 500.

 21 Expansion of the pilot to include companies in the

 22 Russell 1000 would provide protection for

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 1 investors and companies such as Accenture that

 2 experienced severely erratic trading on May 6 as

 3 well as provide regulators with a broader sample.

 4 In the end, while we understand it's

 5 good to pilot something with a smaller sample, it

 6 does not make sense to perpetuate different rules

 7 for different issuers. We firmly believe that

 8 changes are needed to limit the impact breakdown

 9 on issuers, their shareholders, their employees

 10 and business and investor confidence generally.

 11 As noted above, investors in many other companies

 12 remain unprotected by circuit breakers and we urge

 13 you to promptly expand the pilot to protect these

 14 investors and increase confidence in the U.S.

 15 equity trading markets.

 16 Thank you for inviting me to participate

 17 today and I welcome any questions you may have.

 18 CHAIRMAN GENSLER: Thank you, Pam.

 19 Thank you to all the panelists. Now I'm going to

 20 turn to our committee members who are going to do

 21 this in an informal way. Does someone want to

 22 start with a question?

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 1 CHAIRMAN SCHAPIRO: I'd like to address

 2 this question to Mr. Cronin. You talked in your

 3 discussion about the need for collared orders, in

 4 particular collared market orders and collared

 5 stop-loss orders. How exactly would a collared

 6 stop-loss order work however? I'm trying to

 7 understand the logistics of guaranteeing an

 8 execution. If it would through the collar it

 9 would simply be voided? Is that the argument that

 10 you would like to put forth?

 11 MR. CRONIN: Yes. I think as hopefully

 12 I was able to describe, a market order today given

 13 the fragmented nature of the market has to be

 14 understood in the context of what a market really

 15 means. So much of the liquidity that's available

 16 today is either hidden or available in places that

 17 some orders don't have access to. Our concern is,

 18 and I suspect Pam shares the same concern, that

 19 small orders if not carefully governed market

 20 orders can have a big impact. What we would

 21 propose is that we have market orders that are

 22 allowed to continue in through the system, it is

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 1 easy to hit the market button and I suspect quite

 2 a bit more difficult to put a limit price in.

 3 So if we were all in agreement, what

 4 would happen is any market order would have a

 5 reference price as soon as it came in and

 6 depending on what would be a reasonable percent, I

 7 think 3 percent, it would not executive if it was

 8 unable to find a price within that price band.

 9 This is something that has worked in various forms

 10 and fashions in other exchanges particularly the

 11 CME and I think has been very, very beneficial.

 12 I do believe also it would have the

 13 knock-on effect of getting rid of this nefarious

 14 problem that has erupted here the last couple of

 15 weeks which is small trades causing

 16 circuit-breaker elections and halts in stocks like

 17 Cisco, Citi and others that really have no

 18 business being halted for such small share

 19 amounts.

 20 CHAIRMAN SCHAPIRO: Could I say one

 21 thing with respect to that? This is an issue I'm

 22 really interested in pursuing so if the committee

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 1 would particularly devote some thinking to this

 2 alternative, circuit breakers were the thing we

 3 could do fast and get in place and have a calming

 4 effect on the market. And while we have had a

 5 number of triggers, I'd be interested to know if

 6 anyone thinks they caused any harm to the

 7 marketplace. It's not my perception that they

 8 have. But to get some thoughts from the committee

 9 on this issue in particular over the next couple

 10 of weeks I think would be really helpful to us.

 11 CHAIRMAN GENSLER: Staying with that, I

 12 notice that I think Chris probably, though you're

 13 sitting next to Kevin, might be miles away in

 14 terms of this issue so I'm curious, do you think

 15 that collared market orders whether it's up and

 16 down 3 percent or 4 trading or any number would

 17 work for retail investors?

 18 MR. NAGY: Let me take both of those

 19 because we're talking about stop orders and we're

 20 talking about market orders. So let me take the

 21 stop-order issue first and talk a little bit about

 22 that. At our firm TD Ameritrade we do offer a

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 1 sort of collared type of order through our

 2 technology. It's what we call a trade trigger.

 3 Effectively what that allows the investor to do is

 4 just set a stop-loss limit price, however that

 5 limit price is going to track the underlying price

 6 of the security. Once the trigger event hits then

 7 that order goes into the market as a stop order.

 8 The problem that you have with collars,

 9 and I think it's a very intriguing idea. Don't

 10 get me wrong on that. I actually leaned over to

 11 Kevin and told him I like a lot of the aspects of

 12 the CME limit up and limit down program. The

 13 problem with some of the stops and some of the

 14 market orders by just eliminating those in the

 15 totality of the marketplace would have an adverse

 16 impact on retail investors for the following

 17 reasons. Here's why. Retail investors, and I

 18 said this on June 2 and I think we put it in a

 19 couple of comment letters, really invest in the

 20 market at two points in time. One is in the

 21 morning right when the markets opens. Ironically

 22 the circuit breakers don't start until 9:45. Why

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 1 do retail investors invest right in the morning?

 2 It's because they work all day. They go home,

 3 they eat dinner, feed the kids, then they sit down

 4 and they get to their investment portfolio and

 5 redo their investments. We see an awful lot of

 6 that. At my firm we see 10 to 15 percent of our

 7 trading day occurs at 9:30 in the morning even

 8 though the circuit breakers don't go into effect

 9 until 9:45.

 10 Stop orders likewise are important to

 11 retail investors for a lot of the same reasons.

 12 They want to protect the downside of their

 13 security. In a very precipitously declining

 14 market with a lot of volatility, if there are

 15 collars in place and it happens to miss that

 16 collar event, there's not going to be a very happy

 17 retail investor at all whether they're off on

 18 their family vacation which is typically when

 19 things like that would occur. That's the problem

 20 that you have.

 21 I think what we need to look at is

 22 addressing the structure of the markets more. Had

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 1 the markets not dropped 900 points in 10 minutes,

 2 I don't think we'd be sitting here today, but

 3 there was a complete evaporation of liquidity in

 4 the marketplace and I think that itself is more

 5 concerning to investors rather than missing their

 6 stock price by a dollar or two.

 7 MR. CRONIN: The thing I would say,

 8 Chris, is that the two are very interconnected.

 9 Liquidity providers are generally watching things

 10 happen and making decisions based on that so that

 11 as bad quotes start to get into the system, as

 12 clearly erroneous trades get into the system,

 13 their ability or interest in making markets goes

 14 away with it. What I would propose is I get how

 15 investors might have an interest in times of

 16 heightened dislocation in the market, but is that

 17 particular instance of all the times that they 

 18 invest which I would suspect is a relatively

 19 smaller percentage, the volatility we had maybe a

 20 year-and- a-half ago, but it seems like to me that

 21 the protection that they would get generally from

 22 a collared order would certainly exceed any

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 1 material consequence of not being able to sell at

 2 the market in worse times.

 3 I would also offer that this doesn't

 4 preclude anybody from putting a limit order in

 5 that's well below the market. I suspect that an

 6 investor who got the penny, Pam clearly was

 7 irritated and I suspect that the guy who sold it

 8 at a penny was irritated too. There are basic

 9 procedures that could have been put in place that

 10 would have precluded that event for not only that

 11 seller of the penny but also for Accenture as well

 12 and I think it's a sensible thing to do.

 13 MR. NAGY: The one thing I'd say about

 14 the aggressive limit stocks, and Mr. Ketchum will

 15 know this, there are actually FINRA rules that

 16 prevent hyperaggressive price limit orders into

 17 the market so that we've got to have certain 

 18 parameters within our system to prevent a lot of

 19 that. I think that would need to be restructured

 20 if we were going to go down that road. The one

 21 problem that you have with that though is that

 22 what happens if the investor misses that collar?

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 1 That's the quandary and that's where I think we

 2 really need to take a look at the structure of the

 3 market, the liquidity in the marketplace during

 4 times of duress like we saw on May 6, like we saw

 5 in 1987, like we saw with that Friday the 13th

 6 crash in 1988 or 1989, they're very similar in

 7 that the market went down but they need to go down

 8 in an orderly fashion. In 2008, when the market

 9 started to decline into 2009, that was pretty

 10 ordered. People were writing market and stop

 11 orders and things worked very, very well. That

 12 happened on May 6 was unique and it was different

 13 and that's the problem that we need to fix.

 14 MR. ARCHARD: I think I'd like to build

 15 on that if I could from an adviser's perspective

 16 because I do agree that clearly it would be nice

 17 to get something in place from the perspective of

 18 the collars or something else. But when we did

 19 our survey just a little over a month ago, over 60

 20 percent of advisers said they would continue to

 21 use stop-loss orders and over 75 percent said they

 22 would continue to use market orders.

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 1 To use an anecdote, I was in front of a

 2 group of advisers about 3 weeks after the crash

 3 and we talked about do you think it's a good idea

 4 to use market orders and already at that point

 5 there was the consideration do we get rid of

 6 stop-loss orders. The sentiment from this group

 7 of 50 advisers was be careful of fighting

 8 yesterday's battle. If this had been a day that

 9 truly was going down 1,000 points in the market or

 10 more which some of the models were saying because

 11 there had been a true market event, they would

 12 have been pretty upset if they had had stop-loss

 13 orders in place that got blown through the collar,

 14 that they didn't executed because the market was

 15 moving so quickly so that a defensive strategy

 16 that they wanted in place as investment

 17 professionals that are monitoring the account,

 18 they wouldn't have access to that. So I don't

 19 think it's something that we should ignore.

 20 Clearly the issues that we saw of small

 21 market orders pushing through the order books was

 22 an issue but it's part of that larger issue of all

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 1 these interlinked events that came together so

 2 that we should be careful of trying to solve the

 3 bigger problem and not just solve the May 6 issue.

 4 MR. KETCHUM: To that point, Mr. Archard 

 5 I think you suggested what arguably could be an

 6 alternative to collars which is to shifting the

 7 existing pilot with regard to pauses to rolling

 8 limit ups and limit downs which has arguably two

 9 benefits. One, as Chairman Schapiro noted, if you

 10 are concerned with respect to a single trade

 11 stripping beyond the pause level since a single

 12 trade can do that, a limit up addresses that by

 13 not allowing trades in any market below the limit.

 14 Secondly, it doesn't require a pause for 5 minutes

 15 if there's buy interest or the futures reacts and

 16 bounces so that you don't hold the market up in

 17 those circumstances. Yet to do build in

 18 essentially on an organized basis across all

 19 markets an assurance that stop- loss orders don't

 20 strip past the limit or at least provide a firm

 21 for a period of time a chance to react to those

 22 stop losses before they trade again.

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 1 Maybe I can address to anybody, but

 2 certainly to Noel, Kevin and Chris, the downside

 3 of limits in a terribly fragmented environment

 4 like the U.S. securities markets is that they are

 5 only uniform in some ways. They're uniform in

 6 ensuring that trades don't go below them, they're

 7 not uniform as to when the marketplace starts up

 8 and there's always the potential you can have a

 9 single random bounced trade but still have serious

 10 sell pressure and you lose the opportunity to have

 11 the auction that the pause provides from the

 12 standpoint of trying to pull together buy and sell

 13 activity, and you also result in one market

 14 starting up at a different time albeit not

 15 probably significantly different than the other

 16 markets since that market will know when its order

 17 hits.

 18 I question would be is that a fair

 19 reflection of the ups and downs and given the pros

 20 and cons of it, do you think that's a better

 21 solution where we sit with respect to pauses and a

 22 possible collar?

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 1 CHAIRMAN GENSLER: In answering the

 2 questions, the public might not know what a

 3 rolling limit is.

 4 MR. KETCHUM: Who knows what I said?

 5 You know far more about limits than I do.

 6 CHAIRMAN GENSLER: In your answer for

 7 the public try to say briefly what was suggested.

 8 MR. CRONIN: First you were very

 9 articulate which is excellent.

 10 MR. KETCHUM: Which is always a miracle.

 11 MR. CRONIN: That aside, I think that

 12 there has to be a bifurcation, you have circuit

 13 breakers and a collar type arrangement or you go

 14 to this limit up/down, and what that would mean is

 15 that a stock at any point in time would have a

 16 percentage that it would be allowed to trade up or

 17 down and it reached that limit, if it were a sell

 18 for example, it could only trade down to that

 19 limit price and no further, say for 10 minutes on

 20 CME it would trade down at that limit price. It

 21 has the opportunity to trade above that, but it

 22 can't below it. If after the 10 minutes it were

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 1 to continue to trade at that price, there would be

 2 a 2-minute halt again using the CME as the model

 3 where all investors hopefully would take into

 4 consideration exactly what had happened, the

 5 2-minute halt would end and then the stock would

 6 be free to trade below that first limit price.

 7 You might find that there would be a second limit

 8 price that would be appropriate and you would go

 9 through the same machinations again.

 10 CHAIRMAN SCHAPIRO: Kevin, after the

 11 halt would you have the listed market reopen the

 12 stock or would all markets simultaneously try to

 13 reopen the stock?

 14 MR. CRONIN: I think the devil is in the

 15 details and that was what Rick was alluding to. I

 16 would personally prefer that it would be a

 17 coordinated event like the NASDAQ open where you

 18 have multiple players putting indications in and

 19 you have an open. That to me makes more sense.

 20 You get all buyers and sellers together and you

 21 don't get these dislocations in one exchange

 22 versus the other. To me this fundamentally gets

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 1 to the issue of some of the problems we have

 2 today. Markets are not aligned. People are doing

 3 their own thing and when you get to that, even if

 4 you come up with sensible solutions, to the extent

 5 that things are not all linked together, the

 6 beneficial outcome which we think could happen

 7 won't if they're not linked appropriately.

 8 MR. BRENNAN: Kevin, let me follow-up

 9 for one second. The cynics say there are 40

 10 trading menus for a guy like you, not for somebody

 11 who trades through TD Ameritrade and doesn't know

 12 necessarily where it happens. Do you think that

 13 coordination can occur for dark pools and other

 14 trading venues to make the net effect that you

 15 want out of that type of limit up/limit down?

 16 That's been one of big reactions, it's easy to do

 17 in one exchange in Chicago, it's tough to do in

 18 the equity market. What's your sense of that?

 19 MR. CRONIN: It would be tough to do for

 20 sure, but I think most institutions, clearly

 21 Invesco and I'm certain Vanguard and Blackrock and

 22 others, would take the opportunity to make sure

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 1 that they were in the right venue to ensure that

 2 they are protected as that stock reopened or to

 3 source the liquidity wherever it was appropriately

 4 sourced at that time. Clearly it keeps getting

 5 back to this root issue that we have a very

 6 fragmented market, different market centers in

 7 large measures who are doing their own thing, and

 8 to the extent that that's not better coordinated,

 9 this is going to be a very, very difficult thing

 10 to fix.

 11 I think generally, and I don't mean to

 12 speak for our peers, we would be very supportive

 13 as an industry to try to get to a better location

 14 where things are linked better where we wouldn't

 15 have to for example hide so much of our order

 16 flow, where we would have more incentive to post

 17 liquidity and some of these dislocations perhaps

 18 wouldn't happen, certainly not to the magnitude

 19 that they have recently.

 20 CHAIRMAN GENSLER: Chris?

 21 MR. NAGY: Just a note on the circuit

 22 breakers. We as a firm are fans of this trading

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 1 band idea that the CME has been running for a long

 2 time. It's been in place for I think 20 years.

 3 It seems that it's worked very effectively with

 4 the limit-down strategy. Halting and stopping

 5 trading is always a bad idea because of the devil

 6 in the details of the opening process. I said

 7 this in my speech that circuit-breaker rules don't

 8 kick in until 9:45 and here we're going to talk

 9 about trading in milliseconds today yet the

 10 markets open at 9:30, all stocks aren't usually

 11 open until 9:31 or 9:32. It's an ironic situation

 12 to be in. We've also noticed that with the

 13 circuit breakers the problems that we've had with

 14 those have been in the reopening process.

 15 If you look at Citigroup, for example,

 16 it was triggered on an erroneous trade. The

 17 opening process that occurred after that wasn't

 18 equal among all the exchanges. One exchange

 19 opened before. Genzyme, which was about a week

 20 ago, same exact thing there. That was triggered

 21 off of another erroneous trade but then it was an

 22 erroneous price for the opening price that

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 1 triggered it go into a halt again. Then Hewlett

 2 Packard, which we had just the other day, was a

 3 manual issue from one of the exchanges that caused

 4 that to go into a regular trading session when it

 5 should have been extended hours. So a lot of the 

 6 reopening processes on these tend to be very

 7 difficult.

 8 I'd also add, and I think this goes to

 9 some of Pam's comments, that there's not a lot of

 10 transparency when you see a halt. If you're a

 11 retail investor looking at quotes be it on TD

 12 Ameritrade, Google or Yahoo or one of the quote

 13 providers out there, it doesn't clearly say that

 14 this stock is in a halt type condition and that's

 15 a confusing environment for the investor. I think

 16 when you get into some of the trading band issues,

 17 then when you start harmonizing across the

 18 different products and agencies be it the minis

 19 versus inequity, but then you can also tie that I

 20 think into a lot of the ETF products which had a

 21 lot of the erroneous issues. Those are my

 22 thoughts on the direction that we'd like to see

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 1 the overall circuit- breaker system go.

 2 MR. ARCHARD: One topic leads to another

 3 here. I would say that from our perspective as

 4 we've looked at it we're deeply concerned about

 5 the reopening of the securities. Closing them is

 6 only half the story. Getting a logical restart if

 7 there's a 10-car pileup you really need the state

 8 trooper to get traffic moving in the right way

 9 again. When we think about the role of lead

 10 market makers and we think about even the role of

 11 the specialists going back many, many years, it

 12 feels like many years, 5 to 6 years now, in this

 13 rapid environment you can't go back in time, but

 14 there was a benefit to having some there that

 15 regulated the activity that was happening on the

 16 exchanges. And we do think as we look to balance

 17 obligations with incentives to some of these types

 18 of players in the marketplace, looking at things

 19 such as making the lead market maker responsible

 20 for the orderly reopening of the markets if there

 21 is a stop, there could be a type of incentive that

 22 then is the other side of the obligations that

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 1 they might have to step up into to be lead market

 2 makers on the securities. So looking at the

 3 interlinking of those issues at the time of

 4 reopening of securities we think is pretty

 5 important.

 6 MR. KETCHUM: Maybe to that point and

 7 the broader issues since there were differences of

 8 opinions suggested by a number of panelists on

 9 market-maker obligations, I'll start on one side.

 10 Mr. Mendelson you indicated you thought that

 11 market-maker obligations of any sort will never

 12 solve anything, and certainly you're right that no

 13 one has ever seen a market-maker obligation that

 14 encourages somebody to go off a cliff in a steep

 15 downturn, although I'd note that I think if you go

 16 back and look at most of the studies it would show

 17 on the days when there were more incentives to

 18 market making, those people ended up net long in

 19 those days and certainly net long during the

 20 timeframe in which markets were going down.

 21 I guess the question would be there are

 22 two pieces of market obligations. One is another

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 1 piece of addressing Accenture and Ms. Craig's

 2 concerns and that is addressing stub quotes and at

 3 least requiring a market maker to not have a

 4 two-sided quote outside of the pause level. Would

 5 you think even that so skews the incentives that

 6 you wouldn't be in favor of it?

 7 MR. MENDELSON: No. I think that's a

 8 probably a little bit different type of story.

 9 Right now some people are obligated to provide

 10 stub quotes and I don't think that's very helpful.

 11 I think it's almost better if there were no quote.

 12 So I don't think a penny bid in Accenture stock --

 13 I don't see what economic function that serves.

 14 MR. KETCHUM: Maybe on the other side,

 15 Mr. Archard, to your point, and Kevin and Chris, I

 16 know you both suggested you favored some increased

 17 incentives and increased obligations from a

 18 market-making standpoint at least I guess for lead

 19 market-maker types. My question there would be

 20 incentives as in what? Obviously we have a very

 21 fragmented commoditized set of exchanges that have

 22 relatively little pricing power and relatively

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 1 little ability to attract. One market competes on

 2 market-making obligations and provides a

 3 significant incentives of parity and that would be

 4 the New York Stock Exchange. The other markets

 5 choose not to provide that significant incentive.

 6 But if there were a view of something more than

 7 just getting out of the stub quote problem and

 8 having narrow quotes requirements to generally be

 9 around the best bid and offer and then

 10 requirements to layer the book on both sides which

 11 is what I see that would not create miracles in

 12 bad times but probably would avoid having single

 13 relatively small orders stripped through the book.

 14 That does change the cost-benefit issues to

 15 market-makers. What incentives do you think would

 16 make sense to you as non-market-making

 17 participants to encourage that?

 18 MR. NAGY: I will tell you that market

 19 makers as a whole are very, very important to us

 20 at TD Ameritrade because what they do is they

 21 provide the retail investor consistency in the

 22 marketplace so that if there is not necessarily

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 1 liquidity available at the inside, that market

 2 maker will generally step up and fill the entirety

 3 of the order at the inside so that client got the

 4 price they saw when they entered the order.

 5 In terms of incentives I don't think you

 6 can just -- and there's been a lot of talk about

 7 let's create rules where we'll get rid of stub

 8 quotes by forcing market makers to quote right

 9 inside of the 10 percent threshold and that should

 10 do it. The problem I think there is, and we've

 11 seen this over the past decade, market makers are

 12 fewer and fewer and fewer in number and a lot of

 13 the growth in overall liquidity providing has been

 14 in more opportunistic liquidity, albeit there is a

 15 fair-weather trader, but if turns dark and gloomy

 16 I'm out of here. I read about it in the journal

 17 every day.

 18 So I think in order to counter that and

 19 in order to get incentives in the markets I think

 20 there are a couple of things. One I don't

 21 unfortunately this committee has the power to do

 22 but I think it would be a very good one which

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 1 would be tax incentives to liquidity providers in

 2 the markets. I think that would very powerful

 3 similar to how in some products on the CBOE for

 4 example where you've got 60-40 tax -- on

 5 particular products. I think that's very

 6 appealing.

 7 The second thing that I think this

 8 committee does have the power to do is when you

 9 take a look at market data, the overall

 10 infrastructure of market data and what can be done

 11 with market data incentives in the marketplace.

 12 We begin addressing this issue in a very large

 13 fashion there appears to be a very large

 14 dislocation in the cost of that data, in getting

 15 that data by some firms versus other firms and we

 16 don't see a real fair allocation of the overall

 17 infrastructure of the data and I think that's a

 18 very good resource to take a look at to see what

 19 opportunities can be created in the marketplace.

 20 Finally, I'll say that in our markets

 21 today we incentivize the quote and not the depth.

 22 So if you look at all the market structures that

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 1 are out there, all the different ECNs, all the 

 2 different exchanges that are out there, we provide

 3 a lot of incentives to post a limit order but not

 4 for size and there are ways that you could change

 5 that structure so that you're incentivizing size

 6 rather than just the limit. I will say I think

 7 reg NMS did a wonderful job of making the markets

 8 more electronic during that time but I do think

 9 the overall notion of access fees in the markets

 10 should be looked at as well, too.

 11 MR. CRONIN: Rick, I guess there are two

 12 ways to look at this. First, it's easy to say

 13 that the market- making function failed at this

 14 particular point in time. It had issues to be

 15 sure. But I do think that as you look at

 16 different types of markets that are being made for

 17 example in ETFs, the mechanism works very well.

 18 The incentives are in place. If you're able to

 19 understand what the value of the underlying

 20 securities in a basket are and at the same time

 21 understanding what you could see the ETF for for

 22 example, you have this ability to make a

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 1 reasonable market and there is risk that's assumed

 2 and you have the ability to make money. That

 3 works. It doesn't work when they get bad

 4 information and they have to pull away as we

 5 clearly saw, but I think that mechanism generally

 6 is in place and works well today. We want to be

 7 very careful that that is not upset as we proceed.

 8 That said, I think if you look

 9 traditionally at the market-making function,

 10 market makers have been given some level of

 11 advantage and with that advantage there is an

 12 expectation that there was a commensurate amount

 13 of obligation. As we look at market making today,

 14 there are some firms that clearly are designated

 15 market makers, broker dealers registered as market

 16 makers, but as we went to pennies, the spread

 17 mechanism that used to incent market-making

 18 activity went away and as we had this influx of

 19 new participants, i.e., high-frequency traders,

 20 the ability for traditional market makers to

 21 participate and/or compete has been severely

 22 compromised.

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 1 What we have today I think is a group of

 2 investors, gosh here he goes again, with

 3 high-frequency traders who have an advantage and

 4 they don't have a commensurate amount of

 5 responsibility. So I ask is it fair that they

 6 have direct access to exchanges where the rest of

 7 us are looking at CQS? Is it fair that they have

 8 collocation and have maybe a 100- or

 9 200-millisecond advantage? Maybe the answer is

 10 yes. Maybe people can intellectually argue the

 11 point away. I happen to believe that there are

 12 real advantages that are conferred and as such

 13 there should be real obligation. If not, everyone

 14 should have the same quote access which would be

 15 CQS and collocation would go away.

 16 MR. MENDELSON: May I comment on that?

 17 CHAIRMAN GENSLER: Yes, because I also

 18 want to let our panelists ask questions. Why

 19 don't you go and then Rob is going to ask some.

 20 MR. MENDELSON: At our firm we track our

 21 transaction costs and we have for the history of

 22 this over a very long time and our transaction

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 1 costs have gone down steadily. In the old days

 2 when there were market makers and many years ago I

 3 used to next to a very large group of market

 4 makers, there was a group of participants with

 5 very significant advantages. The result was that

 6 investors paid significantly every minute of every

 7 single trading day and when there was a

 8 market-disruptive event, it didn't help us. In

 9 1997, I think it was October 27, we had a crash.

 10 It wasn't like the 1987 crash but I think we were

 11 down about 7-1/2 percent on the S&P 500 or

 12 something like that. Market makers weren't there

 13 to buy your stock at a bad price and they're not

 14 going to be now. So what we have is we're hoping

 15 that by providing special incentives or

 16 obligations or preferences for market makers, that

 17 they're going to do something that they simply

 18 aren't going to do. They are not going to stand

 19 there and buy stock at the wrong price.

 20 On the other hand, on an ordinary basis

 21 the system today allows us to trade more cheaply

 22 in more stocks than ever before. While the

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 1 market-making function today as Chris just

 2 described as opportunistic, I don't think it is

 3 opportunistic. They're always there. On a

 4 previous panel before this committee one

 5 participant suggested that obligations have to be

 6 there 97 percent of the time. I would say with no

 7 requirement for obligation, certainly electronic

 8 market makers have been present this year, which

 9 we would call a bad year I think, 99.975 percent

 10 of the time. So in the 150 trading days so far

 11 this year there have probably been 20 minutes

 12 where some of them weren't there. I don't think

 13 that an obligation where 97-percent of the time

 14 you have to be there is in the slightest bit

 15 helpful. It won't change a thing.

 16 CHAIRMAN GENSLER: Rob just had a

 17 question.

 18 MR. ENGLE: I was wondering when we talk

 19 about incentives for market makers, does it make

 20 any sense to think about these as being time

 21 varying? In other words, there are some times

 22 when you would especially like to incent market

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 1 makers to stay in the market, and so the question

 2 is I suppose partly would such time-varying

 3 incentives which could be quite substantial

 4 because they would only be for a small amount of

 5 time have an effect in a temporary market

 6 disruption? Obviously it's not going to stop the

 7 prices falling off the cliff if that's what we're

 8 talking about, but it would stabilize an event

 9 potentially like the flash crash.

 10 MR. MENDELSON: Professor Engle, I think

 11 that if you had a large enough incentive that

 12 might work, but at the time of let's say a flash

 13 crash time, you're facing enormous risks so if you

 14 have an enormous edge you are going to be more

 15 likely to participate but it may have to big. I

 16 don't know. I may have to be a very big

 17 incentive.

 18 MR. CRONIN: I would add that nobody

 19 would expect any person in any vocation to catch

 20 falling knives. That's probably not good for your

 21 health. On the other hand, market making is part

 22 of what the market structure is. Hopefully

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 1 they're there making fair and efficient markets

 2 and that facilitates people's interest and

 3 hopefully confidence in the marketplace. What

 4 we're talking about is a particular instance where

 5 stocks are falling precipitously and, again, I

 6 wouldn't subscribe or prescribe the notion that

 7 market makers necessarily should step in and

 8 absorb a half-a-trillion-dollars' worth of what

 9 would otherwise be market losses. It's

 10 impossible. On the other hand, that's why you

 11 have things like limit down or circuit breakers.

 12 At least getting to that point of hitting the

 13 circuit breaker or the limit down would be fair

 14 and orderly. Walking away from it as we saw

 15 clearly does nothing. Nothing good comes out of

 16 that. So I do think that we're not talking about

 17 this particular market event for market makers

 18 standing up and taking one for the team, it really

 19 is an overall effort to ensure that all of these

 20 pieces are appropriately in place so we don't get

 21 an event like May 6.

 22 Bad markets are going to happen. We've

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 1 had more than our share of bad markets over the

 2 past 2-1/2 years. What happened on May 6 was

 3 different because not only did we have events a la

 4 Lehman or Barclays and what was happening with

 5 Greece, but we had a market that's evolved to the

 6 point where it's become so electronic and there is

 7 so little communication between the different

 8 exchanges that this is invariably going to happen.

 9 It wasn't right. You had a huge price point drop

 10 and it rebounded back. That clearly tells you

 11 that something is wrong systemically. It wasn't

 12 the event. It wasn't the shock to the system that

 13 caused a semipermanent erosion in the value of

 14 stocks. This is what we're talking about. We're

 15 trying to address the everyday lives of investors

 16 and as best we can prepare for these events making

 17 sure that we're not causing them by not paying

 18 attention to some of the details we need to pay

 19 attention to.

 20 MR. ARCHARD: Most of the market makers

 21 who we spoke to after this event, from an

 22 incentive perspective they felt there was the

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 1 right level of incentive per risk in the

 2 marketplace and that's why they were in there

 3 today in most cases as Michael pointed out. The 

 4 trouble is again no regulation or no amount of

 5 obligation or anything else is going to -- someone

 6 is not going to put their firm out of business

 7 over the course of the afternoon or in 20 minutes.

 8 But trying to look at the positives of this and

 9 not to state the obvious, but I will, this was

 10 really a remarkable event. Twenty-five percent of

 11 the Russell 1000 securities dropped over 10

 12 percent in about 90 seconds. We were talking to

 13 the market makers through the afternoon and they

 14 were saying that their models were showing -- they

 15 were anticipating a 5,000-point decline by the end

 16 of the day. They thought a bomb had gone off

 17 somewhere and that they were the last persons to

 18 hear about it and they were frankly very

 19 concerned.

 20 I think the point that Kevin is making,

 21 that when we look at circuit breakers, if we look

 22 at market makers, are there to help with the

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 1 orderly flow of traffic in the market but they

 2 need orderly markets to operate in in those

 3 situations so that thinking about circuit breakers

 4 and thinking about orderly restarts and how all

 5 that works, it gives them the confidence, the

 6 clearly erroneous trade rule, a really critical

 7 juncture when they're doing trades in the market,

 8 they're hedging. No market maker wants to go into

 9 the overnight holding a long or a short position.

 10 They want to be neutral to the market. If they're

 11 not sure what the parameters are for a cancel,

 12 they're going to step away. Even if there's a

 13 bright shiny line that says at 20 percent if

 14 anything moves from here we're going to stop

 15 markets and everything below that could be

 16 cancelled, they'll still probably not too incented

 17 to take trades up to that 20-percent line in the

 18 case that they're going to be lopsided, negatively

 19 biased in their hedge. So there are concerns

 20 there that that raises other issues around should

 21 it be straight cancels on clearly erroneous or

 22 should we be rebooking at some other values

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 1 similar to what the futures markets do. Again,

 2 this all comes around to what do we facilitate to

 3 make the participants in the market be there

 4 through thick and thin from a structural

 5 perspective rather than from a compensation

 6 perspective because if the structure is right, the

 7 business model is there for them to participate.

 8 MR. NAGY: I think your idea is very

 9 intriguing and it's one that I'd certainly like to

 10 give further thought as to the implications

 11 because I will tell you that the retail investor,

 12 I already mentioned that we get about 10 to 15

 13 percent of our orders overnight because they go

 14 home, the other time that the retail investor is

 15 in the market is during times of market duress.

 16 That's when they're at work and all of a sudden

 17 their coworker leans over and says, Do you see the

 18 market? It's down 600 points. My nest egg, my

 19 401(k). I'd better take a look at them. In fact,

 20 during that time I think we had 127 orders in

 21 Accenture down to 88 cents which we ended up

 22 correcting. The reality is that 2 percent to 3

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 1 percent of the time that we really need to

 2 consider in the marketplace that we need to put

 3 productions in.

 4 In 1987, we did have something that

 5 actually worked and the market rebounded after

 6 that. The market halted and it stopped. The fear

 7 was subsided and the market started to I believe

 8 rebound after the second halt during that

 9 particular instance. It's been a while. I think

 10 the combination of those incentives and some of

 11 the halts, the structures that we're putting in,

 12 do go a long way to sooth confidence and fear.

 13 CHAIRMAN GENSLER: We've talked about

 14 market orders versus collared markets, stop-loss

 15 orders, pauses and rolling limits, and now we've

 16 spent a lot of time on market-making obligations

 17 and we've also talked about the challenges of the

 18 reopen. I've listed what I thought but I don't

 19 know where Joe is going to take us.

 20 MR. STIGLITZ: I wanted to pursue a

 21 question that you proposed, how do you incentivize

 22 greater depth in the market? You talked about

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 1 taxes. Within the structure of the market, the

 2 rules, are there some that you think would do that

 3 better?

 4 MR. NAGY: Honestly, I think when Mary

 5 Schapiro and the Commission put forward the

 6 concept release on market structure, it is has a

 7 lot of noble thoughts on how to change market

 8 structure for the better. Again, I said this in

 9 my opening statement, I think that there are a lot

 10 of things that we can do to ultimately change that

 11 structure, one of those being how we incentivize

 12 the quote today. I really think that needs to be

 13 looked at. We've focused so much at the quote but

 14 we've not focused anything on the size at all in

 15 the marketplace. 

 16 MR. STIGLITZ: I was trying to ask you

 17 to be a little bit more specific on how you would

 18 answer that.

 19 MR. NAGY: How I would get liquidity

 20 into the marketplace?

 21 MR. STIGLITZ: Yes.

 22 MR. NAGY: What I said earlier is I

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 1 think ways that you can start getting liquidity

 2 into the marketplace are through tax incentives,

 3 market data incentives, or changing the structure

 4 of how you provide rebates to limit orders today.

 5 I think that those are a couple of important steps

 6 that you could take to do that.

 7 In today's markets it seems to be

 8 difficult to trade in the visible market, and

 9 Kevin and these guys know this a little bit better

 10 than my smaller retail orders, but the minute you

 11 expose your hand in the visible marketplace, the

 12 liquidity is gone. It evaporates. If there are

 13 processes like that that can help bring that

 14 liquidity into the visible marketplace I think is

 15 important. There I'd specifically say some of the

 16 dark pool changes that we're looking at and how

 17 dark pools operate I think are very important

 18 measures that we can take to help bring liquidity

 19 back into the markets.

 20 Again, I won't say there is a

 21 silver-bullet solution to any of this. I think

 22 it's a much more comprehensive process that needs

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 1 to be undertaken fundamentally with the entire

 2 market structure which a lot of it I think is

 3 contained in the concept release.

 4 CHAIRMAN SCHAPIRO: Could I follow-up on

 5 that quickly and on Joe's question? I don't want

 6 to suggest that we're headed in this direction at

 7 all, but if, for example, and it's been proposed

 8 that orders have to have a minimum lifespan but

 9 you could incentivize market makers to continue to

 10 make markets by not having that rule apply to

 11 them, if we can think a little bit differently

 12 about not just the market structure as it is and

 13 what kinds of incentives can we layer over it but,

 14 rather, the market structure as we would like it

 15 to be and what kinds of incentives might exist.

 16 One that pops into mind is whether there would be

 17 limitations placed on the way trading is done

 18 today and then some of those limitations might not

 19 apply to market makers as a way to incent them to

 20 be there in size.

 21 MR. NAGY: Interestingly again, I

 22 believe the CME has a process in place where they

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 1 charge for cancellations on a number of orders.

 2 In our market structure today we've got a profound

 3 amount of orders. If you take a look at any quote

 4 be it Accenture or any stock, you see 70 to 90

 5 quote updates in a single second and a lot of

 6 these are almost like flickering quotations.

 7 Those are actually orders followed by an immediate

 8 cancellation. The irony of that is that's taxing

 9 and utilizing the infrastructure of our nation's

 10 pipes to get that data out to the retail client.

 11 Yes, I do think there are things that can be done

 12 so that everyone has to pay their fair share to

 13 utilize the infrastructure of the bandwidth that

 14 we have. Our firm is one of the largest payers of

 15 market data in the industry yet we don't use the

 16 largest pieces of the pipes. That seems a little

 17 unfair. So I think things like that, taxing

 18 cancellations on a certain basis and forcing

 19 people if you're going to put up a quote, maybe

 20 that quote needs to be there, the market data plan

 21 requires that the quote is visible for a certain

 22 amount of time.

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 1 CHAIRMAN GENSLER: I'm going to turn to

 2 Maureen. One of the things, and I'm looking at

 3 this panel and not this panel, I'm interested in

 4 is as trading velocity is increased or one might

 5 say that trading times have gone down into

 6 microseconds and nanoseconds and order size has

 7 come down, the e-mini on that day, I think on most

 8 days, the average trade is five or six contracts

 9 and that's about 250- to 300,000 notional amount

 10 of stock. Market makers, and we've studied this

 11 and you all will get this data by early September,

 12 they really are there. There are dozens and

 13 dozens of market makers in the e-mini but they're

 14 staying relatively flat. Their whole economic

 15 model is they're not putting a couple of billion

 16 dollars on the line. They just simply aren't. So

 17 how in an environment where average trade size has

 18 come way down, average trade time has come down,

 19 70 to 80 orders in Accenture in a second, and yet

 20 as it was said earlier, in normal times,

 21 99-percent of the time the cost to transact in the

 22 futures and securities markets have come way down?

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 1 The bid offer spreads have narrowed and there are

 2 enormous benefits to the American investor in most

 3 times. But then what happens?

 4 So that's just a question. I'm just

 5 framing. Not that there's an answer, but Maureen

 6 has a question.

 7 MS. O'HARA: I wanted to follow-up on

 8 the idea of the incentivizing of size. Obviously

 9 one direct way to do it would be to change

 10 priority rules to go from price time size to price

 11 size time. That would incentivize size but yet at

 12 the same time your retail traders now would step

 13 behind size. As we think about these priority

 14 rules, how do we sort through this? Are you in

 15 favor of a change in priority rules?

 16 MR. NAGY: I think that's something that

 17 should be looked at. When you look at the retail

 18 investor the beauty of dealing with a lot of

 19 market makers out there is they understand the

 20 importance of taking care of the investing public

 21 so that there are things that you can do in that

 22 particular instance. In fact, there are a lot of

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 1 things that were done back in the early days.

 2 When New York traded a lot of securities and they

 3 had a very deep book, one of the ways that some of

 4 the other markets could incentivize orders on that

 5 is they would match the liquidity available so

 6 they kind of mark you where you're at in line on

 7 your limit order so that when that order became

 8 available on New York you were then executed for

 9 retail limit orders and it was a way for the

 10 retail client to almost get double protection on

 11 their limit order. Again if you incentivize a

 12 market maker I think things like that could be

 13 created in the secondary market. I think that's a

 14 very intriguing idea to bring size back to the

 15 marketplace.

 16 MR. CRONIN: May I suggest that the

 17 bigger problem is that institutions have no

 18 incentive to post real liquidity in these markets.

 19 Nothing could be clearer than to watch IBM trade

 20 down in a vacuum and some of the other big-cap

 21 names that ordinarily would have had significant

 22 levels of interest on that book, but because of

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 1 the predatory nature of some of the participants

 2 today we have no incentive to post large amounts

 3 of liquidity. I submit to you that transaction

 4 costs have come down, but could they be lower of

 5 the markets were more efficient? Are there

 6 dimensions of cost that we can't understand today

 7 because we're not even sure what the value of a

 8 quote is? There are 40 places where stocks are 

 9 transacted at any given point in time. None of us

 10 have clarity on what the real supply and demand is

 11 in most issues. These are fundamental issues of

 12 what the value of a securities market is. So I

 13 submit that a more important effort would be to

 14 try to help institutions come to a better

 15 understanding of how we're incentivized to send

 16 more of our orders directly to the market and to

 17 post them so people can see them.

 18 Priority is an important point. A lot

 19 of people now are talking about whether or not

 20 there should be a trade at rule. A trade at rule

 21 would say not only is there a top of book

 22 protection, but the first one in gets executed.

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 1 That's reasonable. Some others would say don't

 2 just do one top or one part of the book, do the

 3 whole book, why shouldn't there be time and price

 4 priority at each level and not just at the quoted

 5 level? I'm not prepared to go there just yet but

 6 I do believe that we have that in our arsenal

 7 ultimately if we're not finding the right mix.

 8 But make no mistake about it, if institutions had

 9 higher incentives to post limit orders, if there

 10 weren't these nefarious participants jumping in

 11 front of us, they had no interest in a stock until

 12 we had an interest, we show it and they jump in

 13 front of us, we hide in dark pools now. That's

 14 how we accomplish now. That's how we accomplish

 15 our orders. We worry about their infiltration

 16 into dark pools.

 17 It's not 70 quotes a second, Chris, it's

 18 5,000 quotes in a second in some of these names.

 19 This is the new phenomenon called quote stuffing.

 20 So what happens is they send in a particular issue

 21 5,000 quotes within a second. What in the world

 22 is the value of that enterprise? So let's

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 1 concentrate on some of these things and really get

 2 back more to the fundamentals which is really

 3 creating a market where transparency and posting

 4 liquidity is not only incentivized but creates

 5 efficiency and effectiveness for all participants.

 6 CHAIRMAN GENSLER: There is one issue

 7 that we need to get to still which is ETFs.

 8 MR. STIGLITZ: Following-up on this a

 9 little bit, the one time where these issues become

 10 very relevant is if you had rules about the rate

 11 of decline of stocks. You have clearly a

 12 statement of an excess demand or supply that's

 13 being manifested and you're restricting the

 14 market. At that point who gets the priority of

 15 fulfillment is a big deal and one might argue

 16 going back to Rob's point about being sensitive to

 17 the time, this is an automatic way where the

 18 greater the market imbalance, the greater the

 19 value of the prioritization rule would then have

 20 in a way an automatic way of giving more return to

 21 people who are putting in greater depth.

 22 MR. MENDELSON: May I make a comment?

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 1 These things that we're talking about right now

 2 seem to be more about how the market functions day

 3 in, day out all the time and not so much about the

 4 flash crash or something like that, although there

 5 is clearly a relationship such as how

 6 market-making activity is done is going to effect

 7 crashes or flash crashes so that we don't even

 8 know I don't think in this case whether the flash

 9 crash was an alternative that day to a real crash.

 10 It was a bad day. We don't know.

 11 We shouldn't confuse these things. When

 12 we talk about things like Invesco not having

 13 incentive to post size, I think that's true. But

 14 as you've also said transaction costs are much

 15 lower because trading is a little bit like a

 16 repeated gain where you have to adjust. You have

 17 to adjust to what other participants are doing.

 18 Other participants are showing smaller size and

 19 trading in smaller lots more frequently. Other

 20 participants have to adjust. If you don't adjust

 21 you're disadvantaged. The market has adjusted by

 22 offering dark pools but there is only so far it

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 1 can go. Other participants have to adjust and

 2 change their trading size and if they don't want

 3 to change their trading size they will in fact be

 4 disadvantaged, but it's not clear at all that that

 5 has a lot to do with the flash crash.

 6 MR. CRONIN: I totally disagree.

 7 Liquidity is the issue in the flash crash. If

 8 people had been there and had more incentive to be

 9 there, and by the way, we came rushing in to buy a

 10 number of securities that were dislocated so we

 11 would have been there, others would have been so I

 12 think it's exactly related to what happened here.

 13 Confidence in the markets is everything whether

 14 it's on the institutional side or individual side,

 15 whether it's the issuers or participants who are

 16 just watching who have interest in 401(k)s or

 17 whatever. It's everything and until and unless we

 18 get greater confidence in the market and better

 19 ability for all participants to make sure that

 20 it's a level and fair playing field, we are going

 21 to have these kinds of problems.

 22 MR. RUDER: As I listen to this, I agree

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 1 that we're not really addressing the flash crash

 2 problems which exist in my mind because of some

 3 problems that have existed in the high-frequency

 4 trading market. We have computer trading going on

 5 with the retail investor severely disadvantaged by

 6 the others who are able to trade in an automated

 7 way. We have programs which are established and

 8 are not subject to human intervention so that

 9 we're talking about how to do with a whole series

 10 of traders who are programming their computers to

 11 trade based on events that they can imagine and if

 12 they don't imagine a really serious loss of

 13 liquidity in a way that is realistic, we're going

 14 to continue to have these kinds of events. I

 15 don't know what it is we can do to avoid this kind

 16 of computer- generated loss of confidence.

 17 MR. MENDELSON: I think we have to

 18 understand first what actually did happen and I'm

 19 not sure we really do understand that. I know

 20 you're all working on that but there are a few

 21 things that we may have to look at like there's

 22 also the other side of the equation with the

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 1 liquidity demanders. I think there's been much

 2 less focus on that. I think we have a reasonable

 3 understanding of what happened with the liquidity

 4 providers, that they more or less went way

 5 eventually and we have some reason to understand

 6 why they did because their market data appeared to

 7 be corrupted although it may have been correct

 8 prints that looked bad, but things went off the

 9 rails from there. But there was no connection

 10 between the information that the liquidity

 11 provider has whether it's a person or whether it's

 12 an electronic system that says this is scary and

 13 at the same time the liquidity demander whether

 14 it's a TV client or an institutional client who's

 15 sending orders who isn't really in touch with what

 16 a market maker is thinking at that point and you

 17 have this disconnect between what the liquidity

 18 providers are thinking, all of a sudden they're

 19 saying I got to go away, and the liquidity

 20 demanders they just keep going on their merry way

 21 sending orders. That's where the imbalance is.

 22 It takes two sides to have an imbalance and we

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 1 haven't focused a lot on the other side of the

 2 equation and maybe we ought to.

 3 To respond to your point about what the

 4 computers are doing and disadvantaging retail,

 5 retail has been a very significant winner in this

 6 whole thing because their trading costs are lower

 7 by far, their commissions are lower, and I'm sure

 8 that TD's data would bear that out. On the

 9 machines being like unguided, they're not. There

 10 are people sitting in front of those machines and

 11 those are the ones who turned them off so that

 12 there are people sitting there just like in the

 13 old world of market makers there were people there

 14 to not pick up the phone which is what happened.

 15 MR. ARCHARD: I'm going to be cautions.

 16 I'm a little bit in between these two groups as

 17 far as wanting to be sure we don't throw out the

 18 good with the bad. If I use something like the

 19 exchange traded fund where it's difficult to say

 20 are you getting the right price for IBM or even

 21 for Accenture, we have a range but it's again it's

 22 trading in a lot of different places. We can look

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 1 at the ETF at the underlying securities in the

 2 ETF, the cost of acquiring that basket for a large

 3 institution and for the largest, heaviest traded

 4 ETFs, the cost of the spread acquiring that in the

 5 market for the average investor is inside of that

 6 because of the activity of all the trading that's

 7 going on in the market. So for many days out of

 8 the year, many hours out of the year, I would say

 9 that there is a benefit there.

 10 But I'll go back to this whole

 11 interlinked situation, how you define a

 12 high-frequency trader, I haven't heard anyone who

 13 has come up with any one solution. I don't know

 14 much about quote stuffing intuitively. That

 15 doesn't sound like a good thing, but I'll admit I

 16 don't know in that situation. But I do think we

 17 have to be cognizant that even long-term investor

 18 at some point do want to sell their securities and

 19 you're not going to naturally find another

 20 long-term investor to sell it to all the time.

 21 There is a benefit to this trading that's going on

 22 in the marketplace.

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 1 What we have to be aware of is what are

 2 the behaviors that we want to link here. If

 3 collocation of server farms with the data source

 4 is important in today's model, then maybe that's a

 5 privilege you do give to a lead market maker and

 6 not someone else who's just going to throw trades

 7 in front of the lead market makers and for doing

 8 that collocation maybe you have to say there are

 9 three levels of orders with size underneath

 10 because anyone can come up 97 percent of the time

 11 and throw out a best bid and offer and only show

 12 100 shares. That's the way I think we have to be

 13 thinking about the behavior in the marketplace to

 14 try and negate 20 bad minutes.

 15 CHAIRMAN GENSLER: You mentioned ETFs,

 16 may I shift for a moment because I think between

 17 at least two firms, I know you're not over there,

 18 and one other firm, it's probably 80 percent of

 19 the ETF providers. You said something in your

 20 opening remarks that I don't think bears out with

 21 some of the facts that we've been looking at. You

 22 said that ETFs are followed. You used different

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 1 words. In fact, I thought that at the critical

 2 minutes not just dozens but it got to the point of

 3 hundreds of ETFs were breaking down early, and

 4 they weren't just small ones. One of them was one

 5 of largest Vanguard ones, I can't remember the

 6 name of it. What do you think it was why 5, 6 to

 7 7 minutes before the dive there were so many ETFs

 8 that were significantly down in more than the

 9 market?

 10 MR. ARCHARD: I'd like to see that data

 11 because I would not agree with that statement.

 12 From what we've looked at from time and quotes of

 13 the individual securities of the underlying

 14 baskets and where the ETFs were --

 15 CHAIRMAN GENSLER: It's a very different

 16 question. I'm not saying whether the ETFs

 17 reflected the time, but there were a lot of ETFs

 18 in the 5, 6 or 7 minutes before the dive that were

 19 already significantly down and a high percentage

 20 that hit this busted trade rule, the 60 percent

 21 rule and so forth. What is it in ETF land that

 22 you think has a high proportion of busted trades,

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 1 that there was a group of them, not the broad

 2 market ones but more of them that were 5 to 10 

 3 minutes early?

 4 MR. ARCHARD: Again I would still assert

 5 that I did not see, and I'd be happy to look at

 6 any data that you have, that would show that ETFs

 7 were leading the charge on this. Every ETF for

 8 those of you who might be familiar with it, an

 9 exchange traded fund generally follows the market

 10 value follows the value of the underlying

 11 securities. That pricing that's put out by the

 12 market makers is determined by calculating the

 13 weighted value of the securities that make up that

 14 ETF. As it became more difficult to come to that

 15 value as these individual securities were rapidly

 16 dropping, you can almost think of it as a

 17 contagion in the basket, as bad prints were going

 18 off in multiple different locations showing

 19 pricing all over the boards, the confidence level

 20 in the derived price of the ETF was very unclear

 21 and the confidence level was falling rapidly and

 22 that's where you started to see the step back from

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 1 the pricing.

 2 The closer the ETF and the securities

 3 that make up the ETF got to that 10 percent

 4 threshold, that's the point in some situations

 5 where you saw a really rapid acceleration of the

 6 disconnect between the price of the ETF and the

 7 individual securities, or in some cases there

 8 might have been a leveling off and it continued to

 9 send the ETF until the pullback several minutes

 10 later. There are a number of reasons for that.

 11 One of them is understanding how they calculate

 12 the price of the ETF based on the underlying

 13 security. You also have the situation that some

 14 of these people who we've talked about, some of

 15 the electronic market makers, are not calculating

 16 the price of the underlying securities, they're

 17 looking at what the lead market maker is doing in

 18 the market. As those market makers were unable to

 19 calculate a price and stepped away, then the

 20 opportunistic traders or the people who are in

 21 there sort atop a book also went away.

 22 You raised the point of ETFs being a

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 1 disproportionate number of the cancels. As I

 2 mentioned in my statement, ETFs make up about 30

 3 percent of the trades on any given day. They were

 4 about 60 percent of the cancels. The reason that

 5 we see for that, and I've seen some data recently

 6 come out I think from the ICI that also supports

 7 this from time and quote data that came from the

 8 New York Exchange, what we saw was once the

 9 self-help provisions kicked in, over 90 percent of

 10 the exchange traded funds in the U.S., their

 11 primary listing is on the New York Stock

 12 Exchange's Arca platform and about 30 to 40

 13 percent of the trades usually execute I think is a

 14 ballpark number each day. For the lower average

 15 daily volume ETFs, over 60 percent of the daily

 16 executions occur on NYSE Arca. So at the most

 17 critical juncture of the day or of that 20 minutes

 18 when liquidity was most important and where most

 19 of the trades would go off toward NYSE Arca, some

 20 of that got lost in the closed loop where again

 21 there are more sellers than buyers and as the

 22 people normally making quotes in these went away

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 1 you had that. So that's an argument why you saw a

 2 disproportionate amount of ETF cancels versus

 3 individual securities.

 4 CHAIRMAN GENSLER: Rick, help me out

 5 here.

 6 MR. KETCHUM: I agree with your

 7 questions. I thought from exactly the direction

 8 you said with respect to self-help. Certainly

 9 anytime the primary market and any listed security

 10 goes out, there's a tendency for that to be the

 11 deepest book and I would suspect you're waiting

 12 for the analysis for the SEC and CFTC that that's

 13 one reason why ETFs were a substantial percentage

 14 of the cancels. A couple of you suggested there

 15 should be changes in reviews from the standpoint

 16 of self-help. Self-help today is essentially

 17 driven by SEC's fairly specific standards from the

 18 standpoint of what an exchange or a firm must see

 19 with respect to response time on the orders before

 20 calling for self-help. It sounds like you think

 21 that some of the calls were too quick or something

 22 else should happen. My question would be how

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 1 would you change the self-help requirements or

 2 would you look at self-help with respect to a

 3 primary market as perhaps another reason to have a

 4 brief pause or something else. We can agree that

 5 self-help didn't work terribly well that day.

 6 What would be the change that would make sense?

 7 MR. BRENNAN: Gary, could I just add on

 8 to Rick's question?

 9 CHAIRMAN GENSLER: Please.

 10 MR. BRENNAN: And do you think it's

 11 beneficial to have something like LRPs in

 12 existence on one major market but not the others

 13 not to steal your whole question?

 14 MR. KETCHUM: I think you've added an

 15 additional question.

 16 MR. BRENNAN: No, there's a semi-colon

 17 in between. It's still the same question. Is it

 18 beneficial to have different rules or should they

 19 be common if you guys could rewrite the rules?

 20 CHAIRMAN GENSLER: Self-help in LRPs,

 21 but we don't have 2 hours.

 22 MR. NAGY: I'll say a couple of things.

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 1 I have one point that I wanted to make on ETFs and

 2 I'll go really quickly here. The one theory that

 3 I have is certainly exchange traded funds are

 4 very, very important to retail investors and

 5 advisers. We see quite a bit of that business at

 6 the firm. I'll submit to you that the IPOV

 7 calculations for those aren't always readily

 8 disseminated to the entire marketplace.

 9 CHAIRMAN GENSLER: Do you want to say

 10 what that is for the public? What does IPOV stand

 11 for?

 12 MR. NAGY: My feeble understanding of

 13 this would be the mechanism that allows you to

 14 calculate what the value of the ETF itself is.

 15 CHAIRMAN GENSLER: That's good enough I

 16 think for now. So that's not transparent.

 17 MR. NAGY: That's not transparent. It's

 18 not readily disseminated in the price feed or it's

 19 not really disseminated by the underwriter of the

 20 specific ETF. We saw that in one of our products

 21 so that I would say that probably is partially

 22 responsible for it.

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 1 Getting to the issue of clearly

 2 erroneous, I think similar to the circuit breakers

 3 that we just installed, the self-help rules have

 4 an itchy trigger finger available to them so that

 5 there are no clear-cut guidelines when that was

 6 implemented to reg NMS on exactly when or how you

 7 would implement the self-help rules. It's not

 8 standardized I'd say across the exchanges. It's

 9 not consistent. I think that's the exact same

 10 issue with the LRPs. LRPs are not on every

 11 exchange and that created on May 6 a real

 12 dichotomy in trading in that was that a real

 13 price? Was it a self-help? There were some

 14 self-help rules that were called against the NYSE

 15 at that particular time. I think in order to fix

 16 that the rules across the exchanges need to

 17 absolutely consistent and that's one thing that we

 18 don't have not even with the circuit-breaker rules

 19 today that we just installed, they're not

 20 consistent across the exchanges, hence why we've

 21 seen issues with Genzyme and Citigroup and Hewlett

 22 Packard as of late. I think that's the most

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 1 important thing that could happen with the

 2 self-help change.

 3 MR. ARCHARD: From a competitive markets

 4 perspective, I think you want to have self-help

 5 provisions. You want to have something that's

 6 there that says if there's a problem at exchange

 7 A, the whole system doesn't grind to a halt. But

 8 I think that has to be in conjunction with if

 9 there are security-specific issues that that

 10 approach then is uniform across the exchanges and

 11 that you don't have a situation again where you're

 12 turning it off in one place, having it flow at

 13 another where there might be loss of liquidity.

 14 To clarify something that Chris said,

 15 the IIVs or IOPVs, they go by different names,

 16 again indicative values, this is a calculation of

 17 the underlying securities of the ETFs. It's

 18 usually calculated by the exchange or by a third

 19 party and it has a ticker assigned to it and you

 20 can pull it up and look at it. It is again just

 21 an indicative value. We've seen plenty of times

 22 where the value of the ETF is really the price

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 1 discovery mechanism because the ways that the IIVs

 2 are calculated are different. If you think about

 3 a domestic equity ETF versus an international ETF,

 4 IIV calcs a little bit more clean during market

 5 hours of the domestic equity that's trading. For

 6 an international security where the underlying

 7 securities and not trading and you have to do

 8 currency overlays to get to the value of an IIV,

 9 not as clean linkage, so that I want to be clear

 10 on the benefits, pros and cons of the IIV as a

 11 mechanism. It's something that's there as a

 12 reference point. It is not used by market makers

 13 as a means of getting to a price of an ETF.

 14 MR. MENDELSON: May I add on on

 15 self-help? Remember, Rick, you were involved very

 16 heavily in these discussions. The whole notion at

 17 some level with NMS was to really facilitate

 18 competition among marketplaces. At that time the

 19 New York Stock Exchange had a 65 to 70 percent

 20 market share and many of us were concerned that

 21 our orders had to be subjected the continuous

 22 option market process which we didn't want.

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 1 Sending orders to the exchanges were really

 2 indications of interest. They weren't executable

 3 orders. So we wanted that change, and part of

 4 that was that you create this self-help mechanism 

 5 that would encourage or perhaps discourage certain

 6 manual exchanges from trying to always have this

 7 mechanism where they would try to commandeer all

 8 the order flow. So self- help was a way that you

 9 could avoid a market that was trying to get their

 10 own market share up by always being in slow mode.

 11 There is an inherent conflict of

 12 interest between the exchanges and self-help. If

 13 you ignore one market, presumably you get more

 14 market share and now all exchanges basically are

 15 for-profit enterprises and that's a big difference

 16 from when this rule was put together and some of

 17 the tenets behind it were formulated.

 18 I do think, Jack, to your question, LRPs

 19 are a reasonable pursuit. I don't think that they

 20 necessarily should be pushed on all markets, but I

 21 do think if we've learned anything in this

 22 enterprise is that taking time and making sure we

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 1 understand exactly what's going, whether that's in

 2 seconds or minutes certainly could be debated,

 3 isn't a bad thing. If we could get to a market

 4 that among all the exchanges supported this

 5 ability to take inventory of things after you get

 6 down to a certain price dislocation, I think that

 7 would be a very workable and efficient thing for

 8 the markets.

 9 MR. ARCHARD: And I'd add on the

 10 self-help that I'd be interested or we'd be

 11 interested in seeing something as simple as if

 12 you're going to declare it to go back to what are

 13 the reasons for it? Do you have to go back to

 14 your regulatory body and say we've brought in

 15 self-help, this is why, this is the proof point

 16 behind it, end of story so that there's a clear

 17 trail as to why it was called and was it for a

 18 good cause?

 19 CHAIRMAN GENSLER: There are hundreds of

 20 days. I don't want to speak for the SEC.

 21 MR. KETCHUM: Let me try to speak

 22 slightly for the SEC. There is a record-keeping

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 1 requirement and a justification requirement with

 2 respect to self-help and I think actually there

 3 are some fairly specific standards with respect to

 4 the delays and return of orders before an exchange

 5 or market can --

 6 CHAIRMAN GENSLER: On self-help I think

 7 there was a provision as I understand it that if

 8 it's longer than a second that you don't have

 9 connectivity or you can judge what connectivity

 10 is, then they can go on to self-help. Jack and

 11 Rob. We're running a little late.

 12 MR. BENNAN: I want to ask about

 13 specifically, you keep trying to get back to ETFs

 14 and it gets hijacked away, so I want to go back

 15 and ask Noel a specific question. He had a

 16 definitive recommendation on circuit breakers, and

 17 the treatment of ETFs in a circuit-breaker mode

 18 Pam recommended an expansion of circuit breakers.

 19 What did you mean by having circuit breakers be

 20 the same for ETFs as for stocks, if I captured it

 21 right?

 22 MR. ARCHARD: Yes. Our view is we were

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 1 concerned early on when the pilot first rolled out

 2 of having stocks in a circuit-breaker mode and not

 3 the ETFs that might have those in the basket

 4 because if there were a system-wide error or a

 5 systemic issue I should say, something that was

 6 larger, on every given day one or two stocks might

 7 stop trading during the day for a variety of

 8 reasons. And this goes back to what I was saying

 9 earlier that market makers are calculating the

 10 value of the ETF based on those underlying

 11 securities. And if one or two stocks stop trading

 12 and it's for a known reason, news just came out

 13 they can quantify, they can get their heads around

 14 it, that's not going to disrupt their ability to

 15 price their basket or their confidence in that

 16 pricing level. But if a lot of stocks are going

 17 and then they all stop but the ETF is still

 18 trading, you're in price discovery mode. And

 19 maybe that works for the short-term, but for the

 20 long-term it feels like there should be a

 21 synchronization between what's happening in

 22 stopping the ETFs versus the underlying

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 1 securities.

 2 MR. KETCHUM: May I press that to make

 3 sure I understand the point? Obviously as the

 4 pilot moves to a second phase, a large number of

 5 ETFs will be pulled into it. Are you saying

 6 beyond being subject to the pause as that pilot

 7 gets expanded you also think an ETF should stop if

 8 a certain percentage of the stocks in the ETF have

 9 paused or what would be your thinking?

 10 MR. ARCHARD: Yes, I think that would be

 11 extremely difficult to put together. I think it

 12 just more came down to we wouldn't want broad

 13 swaths of the individual securities to stop

 14 trading when the ETFs aren't there so I think the

 15 ETF still has to be plugged to its value where it

 16 started the day or whatever intraday view that

 17 we're looking at but that there should be the

 18 safety net beneath the ETF just like there is

 19 beneath the individual securities that make it up.

 20 CHAIRMAN GENSLER: One thing, Jack and

 21 Rick and this group here that I think that the SEC

 22 and we're going to be looking for are your

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 1 thoughts in that there are the broad market

 2 circuit breakers which we know we're going to get

 3 advice from you on in a timely way. Right? We'll

 4 get that on a board market which currently include

 5 these 10 and 20 markets. The ETF land starts to

 6 blur into that because if you put in 5-minute

 7 pauses on ETFs, for instance if the SPDR 500 went

 8 into the 5-minute pause, what does that mean for

 9 the overall market, what does it mean to the

 10 e-mini, so that it's a continuum from individual

 11 stocks to small- basket ETFs to broad-market ETFs

 12 to the overall markets. I raise that as a

 13 question for this panel that I think we're all

 14 going to want to get your advice on.

 15 MR. ENGLE: One of the things that many

 16 of you brought up today we haven't actually

 17 discussed at all and perhaps that just as well,

 18 but it's the question of what are the rules for

 19 breaking trades. It seems that we talked about

 20 collars as ways of breaking trades before they get

 21 entered, but the difference between breaking

 22 trades afterwards is that you know more by the

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 1 time you're deciding whether to break a trade than

 2 you do at ex ante, at the moment when the trade is

 3 being entered. Do you really think that rules

 4 should be set up so that you would know ex ante

 5 whether a trade was going to be broken and if so

 6 maybe this is just the same as the collars that

 7 we're talking about?

 8 MR. NAGY: Yes, absolutely. One of the

 9 major issues of May 6 was that no one knew until

 10 the wee hours of the night exactly what the

 11 percentage was going to be and there was a lot of

 12 discussion. In fact, it's in the joint report

 13 regarding the "arbitrary" almost decision whereby

 14 the 60 trading was reached. I believe that any

 15 rules, which I think clearly erroneous is a very

 16 good idea. It's one of the unique things I think

 17 that we have in our capital market structure that

 18 some of the other structures around the world

 19 don't necessarily have and I think it's worked

 20 well. It's never an enjoyable process for either

 21 party at all, but in the particular case the rules

 22 need to be clear, concise and expeditious so that

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 1 we're not at 8 o'clock at night on May 6 saying 60

 2 percent away, those trades are going to be busted

 3 and then going in and finding those trades. I

 4 think it's got to be a much more clear process and

 5 coordinated across the exchanges and it wasn't at

 6 all.

 7 MR. KETCHUM: I want to follow-up

 8 quickly on that. Did I hear you right in your

 9 initial statement that you're satisfied with the

 10 new proposed rules of the exchanges and FINRA with

 11 respect to this type of event?

 12 MR. NAGY: I would say yes, that starts

 13 to go down the road of consistency and coupled

 14 with stock-by- stock halts, yes.

 15 CHAIRMAN GENSLER: Pam, did you have a

 16 view on that?

 17 MS. CRAIG: I do. I agree and I support

 18 what you're doing in that area because that was

 19 very disheartening for us at all. At the end of

 20 the day we didn't know what the heck was going on

 21 and that's obviously not good at all to have that

 22 kind of disruption.

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 1 MR. ROTBLUT: I want to add that I think

 2 those rules need to be communicated. We heard

 3 from one investor that probably had a stock drop

 4 about 45 percent that wasn't broken and he

 5 actually called us up about a week after May 6,

 6 wanting to know what he could do and I think it

 7 needs to be clear to the investors that these are

 8 the rules that will cause a trade to be broken so

 9 that they know going in what to expect, but I

 10 think it needs to be combined with other measures

 11 to prevent illiquid trading which might cause an

 12 artificial large price swing as well, so I don't

 13 think you can have one without the other. I think

 14 there needs to be clarity for all individual

 15 investors going into the trade.

 16 CHAIRMAN GENSLER: We still need to hear

 17 from staff on the subcommittee report and I want

 18 to see if there are more subjects.

 19 MR. STIGLITZ: I wanted to pursue the

 20 question about restarting that was raised. I

 21 guess there are two questions. One is what are

 22 the consequences? You said that it was upsetting

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 1 that it wasn't done in an orderly way, but who

 2 looses and how significant is this? Obviously it

 3 would be better if it weren't, but is this a very

 4 significant thing and suggestions about how that

 5 might be done.

 6 CHAIRMAN GENSLER: This is the reopening

 7 after there's a 5-minute pause or any such

 8 circuit-breaker pause.

 9 MR. NAGY: I will submit that I believe

 10 that the opening processes are some of the most

 11 difficult processes in our market structure today

 12 when you've got a multitude of different market

 13 centers. It's something that's very

 14 uncoordinated. For example, in the listed markets

 15 we have two different openings. NASDAQ has a 

 16 listed opening and New York has a different listed

 17 opening. Those are at very different prices and

 18 very confusing for investors. At the same time,

 19 adding more opening processes into that when we

 20 can't open at 9:30 in the morning in this day and

 21 age when we're trading in milliseconds I think is

 22 something that seriously needs to be looked at and

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 1 considered. That's why it gives me great concern

 2 when we're halting stocks and then starting a

 3 reopening process because you get a lot of

 4 confusion out of it, and with the issues that

 5 we've had of the halted stocks and the new

 6 program, almost every one of those have literally

 7 been attributed to how the stock reopened again

 8 once it was closed, Hewlett Packard and Genzyme,

 9 for example.

 10 MR. CRONIN: Yet there is a tradeoff.

 11 No one is here to suggest that this process would

 12 be easy, but what's the consequence of not doing

 13 it, and I think we've seen some evidence of what

 14 the consequence is and I submit that that's worse

 15 than what could be the preventative maintenance to

 16 prevent it from happening again.

 17 MR. STIGLITZ: What happens when you

 18 place an order and there are these different

 19 prices at the beginning?

 20 MR. NAGY: It's not an easy process, I

 21 can tell you that much. We try to educate our

 22 clients a lot about the differences in the various

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 1 openings across various markets and in this day

 2 and age even the options exchanges, we have eight

 3 options exchanges now with eight different opening

 4 prices that go off and it tends to be very

 5 difficult. We try to use technology quite a bit

 6 so that if one exchange happens to open before

 7 another one, we try to pull those orders back and

 8 send them to the other exchange. There is no easy

 9 process and it makes it difficult to a big degree.

 10 Actually it's the subject of a lot of client

 11 complaints on a daily basis from not understanding

 12 the differences in the market openings that exist.

 13 And I think for issuers for as well, too, seeing

 14 different opening prices and how those print in

 15 the paper each day tends to be very confusing.

 16 MR. KETCHUM: The pause itself operates

 17 differently. Right? The pause itself requires a

 18 trade in other than very exceptional circumstances

 19 such as when the market is having technology

 20 problems that essentially requires a trade from

 21 the listing market before anybody else trades.

 22 Are you troubled by that or do you think that

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 1 makes sense?

 2 MR. NAGY: No, I think that makes sense

 3 but I think it's still a little confusing. And

 4 don't get me wrong. Kevin brought up a really

 5 good point which is what's the alternative.

 6 Right? And the alternative if we were not to have

 7 that looks worse. Again with stock-by- stock

 8 halts, I would not like to see that as the

 9 ultimate end solution to where we are. Earlier in

 10 this conversation we were talking about trading

 11 bands and limits up and limits down. I think the

 12 CME has run a very good program for 20-plus years

 13 with that and I think that's something that this

 14 advisory committee should look at maybe changing

 15 the stock-by-stock halts to something more like

 16 that.

 17 MR. CRONIN: Rick, as you know there are

 18 indications that investors get when these things

 19 are about to reopen. It's not like they happen in

 20 a vacuum and you have no idea of what the

 21 indication is. From an institutional perspective

 22 that's probably much easier to source than the

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 1 retail investor and if that's more problematic

 2 than I understand it to be it probably needs to be

 3 addressed.

 4 CHAIRMAN GENSLER: I want to thank you

 5 all, but I want to bring it back to Pam, it could

 6 have been a story of an investor, but to me the

 7 most riveting testimony with all respect. It

 8 reminds me that we're fortunate to have

 9 Commissioner Dunn today, but 10 to 14 days he's on

 10 the highway, and not anything to his fault, I feel

 11 the same way about Accenture, a car comes out and

 12 there's a massive pileup and fortunately he's here

 13 and more than a little bruised and battered. I

 14 thank God Mike is here and thank God Accenture's

 15 stock got back to the right levels. But in the

 16 same way for 10 seconds, a split moment, somebody

 17 sped through a stop sign is what happened to Mike,

 18 and for some 10 seconds, 10,000 shares which is

 19 nothing took your stock from $38 to a penny. We

 20 can't have that. So that's the direction I'm

 21 giving probably for my co-chair to the advisory

 22 committee. To me that was the most riveting and

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 1 it could have been a personal investor as well.

 2 Something doesn't feel right that in 10 seconds,

 3 10,000 shares takes you from $38. Your market cap

 4 at $38 was how many billion?

 5 MS. CRAIG: Less than $29 billion.

 6 CHAIRMAN GENSLER: So the consequential

 7 $35 to $30 billion of market capitalization at

 8 least on paper in 10 seconds was less than $10

 9 million.

 10 MS. CRAIG: Stunning.

 11 CHAIRMAN GENSLER: Stunning. Less than

 12 $10 million. Obviously that wasn't a true

 13 reflection of supply and demand and the valuation

 14 that investors placed on the long-term prospects

 15 of your company. So that's where we're looking

 16 for good advice. Thankfully both of you are here.

 17 I want to thank each of you because this

 18 has just been tremendous, and if there are not any

 19 further questions we will I think take a few

 20 moments before we hear from staff. We need to

 21 hear from staff. We have two subcommittees that

 22 we set up and officially they need to report. We

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 1 could do it if we had chairs of the subcommittees,

 2 if you want to pick chairs of these two

 3 subcommittees then you could report, but we need

 4 for the public to have some staff report on his

 5 subcommittee. We're going to take 2 minutes.

 6 We're going to thank our panelists and staff is

 7 going to give us a quick review.

 8 (Recess)

 9 CHAIRMAN GENSLER: I'm going to try to

 10 bring this back together. I thank you all. I

 11 hope I gave a long enough break. Again I want to

 12 thank the panelists because that was a very, very

 13 helpful discussion. I can tell from the 10-minute

 14 break that to be the case.

 15 The next item on our agenda is an update

 16 from our two subcommittees. As we had mentioned

 17 at our last meeting, we believe that it's

 18 important to provide the public with as much

 19 transparency about what these subcommittees are

 20 doing, their goals, priorities and deliberations.

 21 As a result, we'll have reports from the

 22 subcommittees as a standing on our committee

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 1 agendas. As I mentioned, I know you've only met a

 2 couple of times, but if the two committees appoint

 3 committee chairs among yourselves, I know you are

 4 thinking in your busy schedules who wants to be a

 5 committee chair, but then you get to report. That

 6 would be helpful. In the meantime, we're asking

 7 staff to report.

 8 The first subcommittee is the

 9 Cross-Market Linkages Subcommittee which focuses

 10 on topics related to the futures markets. This

 11 subcommittee addresses topics including the

 12 analysis of orders and trading and the broad- 

 13 based e-mini 500 contract, liquidity and the

 14 selling pressure that we've seen on May 6; trading

 15 practices and roles that can affect both futures

 16 and equity markets and some of the cross-market

 17 mechanisms and arbitrage. That subcommittee is

 18 Brooksley Born, Jack Brennan, David Ruder and Joe

 19 Stiglitz. Brooksley is not here so we can make

 20 her chair. I see by a vote of three and one

 21 abstention. Jim Moser from the CFTC will provide

 22 an update on this subcommittee. I'm going to

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 1 introduce the second, too, and then, Jim, I'll

 2 hand it over to you.

 3 The second subcommittee is the Pre-Trade

 4 Risk Management Subcommittee and focuses on topics

 5 related to equities, ETFs and equity index

 6 options, though I would note pretrade risk

 7 management also happens in the futures markets and

 8 I know you're talking about that too. This

 9 subcommittee will provide an analysis of the

 10 liquidity and selling pressures on May 6, provide

 11 an in-depth look at the order and trading of

 12 select dislocated securities and the trade

 13 practices and rules around that and implications

 14 for May 6. Additionally, this subcommittee will

 15 provide a review of the latency issues, that's how

 16 long things get to the consolidated tape. Members

 17 of the pretrade group are the other four members,

 18 Rob Engle, Rick Ketchum, Maureen and Susan. I

 19 guess I know who the three of you are appointing

 20 as chair, but that's not fair to Susan. I thought

 21 I had Robert, but Greg is going to do it.

 22 MS. PHILLIPS: This is Susan. I'm on.

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 1 CHAIRMAN GENSLER: Susan, I apologize

 2 because we should have allowed you time to ask

 3 questions and I didn't give you that chance on the

 4 earlier panel. I see that you're speaking up to

 5 make sure that you're represented not to be chair.

 6 Greg Berman is going to report for us for the SEC.

 7 Jim and Greg, take it away.

 8 MR. MOSER: Good morning Chairs Schapiro

 9 and Gensler and the advisory group. I'll be

 10 summarizing the cross-market presentations that

 11 were given by staff at the two conference calls

 12 that were held since the last public meeting.

 13 First, on the July 6 call there were two

 14 presentations made. The first was an analysis of

 15 the e-mini S&P 500 futures trading volume, and

 16 then there was an analysis of the e-mini order

 17 book. On the analysis of the e-mini trading

 18 volume and price, we found that trading activity

 19 exceeded 50,000 contracts per minute at two points

 20 on May 6, at the point when prices declined

 21 precipitously and then about an hour later or 10

 22 minutes before the close. Trading activity was

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 1 classified into two groups. The first group

 2 paired aggressive selling to passing buying and

 3 the second group paired aggressive buying to

 4 passive selling.

 5 Comparing these two price changes we

 6 found no clear pattern emerging. However, at the

 7 price trough, passive buy volume much exceeded

 8 aggressive buying. In a plot of differences

 9 between aggressive buy and sell activity,

 10 aggressive selling turned out to be more prevalent

 11 than aggressive buying with that difference

 12 increasing throughout the afternoon and then

 13 reaching a minimum at the time of the sharp price

 14 decline. A rebound in the aggressive buy/sell

 15 difference also coincided with the price rebound.

 16 As for the analysis of the e-mini order

 17 book using CME supplied Globex message data, staff

 18 reconstructed the limit order book for the e-mini

 19 futures contract on May 6. Plotting the near

 20 inside order book depth, this would be the best

 21 five bids and best five offers, the order book

 22 appears to have been well balanced with the number

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 1 of buy orders generally close to the number of

 2 sell orders. At about 2:30 Eastern Time there was

 3 a sharp drop-off on both sides of the near inside

 4 order book with the drop-off in orders to buy

 5 slightly leading, then matching orders to sell.

 6 Just prior to about 3:00 p.m., orders to sell

 7 spiked followed by a recovery period as the order

 8 book filled approaching its previous levels. It

 9 didn't quite get there but approaching those.

 10 These data closely matched the Globex data that

 11 was provided by the CME and plotted in the May 16

 12 preliminary report so that we felt that we had

 13 closely replicated the process that the CME was

 14 using.

 15 Staff then used the reconstructed Globex

 16 order book to construct an analysis of all

 17 standing bids and offers. The pattern from that

 18 analysis differs in that the depth of the order

 19 book can be seen to have been declining throughout

 20 the day. Staff noticed stale sell orders can be

 21 expected to accumulate over a period of declining

 22 prices so that we're not entirely comfortable with

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 1 analyzing that portion of the order book. What we

 2 can say is that the buy side of the order book was

 3 declining throughout the day.

 4 Staff has recently obtained order book

 5 data from some other days as was recommended by

 6 the advisory group. These are being used to

 7 compare the May 6 order book analysis to that of

 8 other days, both critical days and so- called

 9 normal days.

 10 On July 29 we had a second call where

 11 one presentation was made in that case, trader

 12 classification and trader behavior in the June

 13 2010 e-mini futures contract. In this case the

 14 data were grouped into a pre- event period, that

 15 would be May 3, 4 and 5, and then an event data

 16 group of May 6. Trading activity patterns

 17 observed during the pre-event period are analyzed

 18 in order to classify accounts as one of the

 19 following, market makers, high-frequency traders,

 20 buys/sellers, opportunistic traders and noise

 21 traders. Comparing the pre-event period to May 6

 22 on the basis of both percentage of volume and

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 1 percentage of trades, activity levels were similar

 2 for those of the assigned categories. The largest

 3 differences were for the seller and the

 4 opportunistic seller categories. Seller activity

 5 as a percentage of trades decreased from 10.10

 6 percent in the pre-event period, to 6.95 in the

 7 event period. Opportunistic trader activity

 8 increased from 33.34 percent in the pre-event

 9 period, to 40.13 percent in the event period. We

 10 also noted that the noise trader activity albeit

 11 it small in both periods did drop by half and went

 12 from 2.2 percent of trades in the pre-event

 13 period, to 1.04 percent during the event period.

 14 The next step in this analysis will

 15 apply the relationship of trader categories to

 16 volatility normalized price changes determined in

 17 the pre-event period and apply those into the

 18 event period. This will obtain some estimates of

 19 predictive price impacts from changes in the

 20 trading activity of any single group.

 21 Let me wind this up by thanking the

 22 advisory group for their insights and guidance.

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 1 It's been an interesting summer. It reminds of

 2 when I was a university professor and we used to

 3 do all of our research in the summer, so it's been

 4 fun.

 5 CHAIRMAN GENSLER: This may not be yet

 6 on our website for the public. I think these

 7 documents whatever Jim just went through will be

 8 on our website related to this committee. Are

 9 there questions from the full committee either to

 10 Jim or to other members of the committee who are

 11 on the subcommittee? Susan, did you have any

 12 questions on this one?

 13 MS. PHILLIPS: No, I'm fine. Thanks

 14 very much.

 15 CHAIRMAN GENSLER: Greg?

 16 MR. BERMAN: Since the latest full

 17 meeting of the Joint Advisory Committee on June 22

 18 we've held two conference calls with members of

 19 the Pre-Trade Risk Management Subcommittee. As

 20 you know, our investigation into the events of May

 21 6 is based on a two-pronged approach combining

 22 objective data analysis with direct insights from

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 1 market participants concerning their actions and

 2 decisions on the afternoon on May 6.

 3 In our first subcommittee call held on

 4 July 7, we discussed preliminary observations of

 5 our interviews to date with market participants.

 6 At that time we had already held a series of

 7 extensive interviews with market makers in

 8 equities and exchange traded funds from which an

 9 emerging theme had developed. We reported that

 10 most of the firms we interviewed significantly

 11 curtailed or completely halted their market-maker

 12 activities during and immediately after the rapid

 13 downturn in prices at or around 2:40 of the

 14 afternoon of May 6. Many market-making firms use

 15 a combination of automated algorithms and human

 16 traders to oversee their operations. As such,

 17 data integrity was cited by the firms as their

 18 number one concern. To protect against trading on

 19 erroneous data, every market maker implements

 20 automated stops that trigger when any questionable

 21 data is received. One way of identifying

 22 potential bad data is to look for large, rapid

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 1 price moves which were unfortunately in

 2 significant abundance on May 6.

 3 For example, the rapid decline in prices

 4 of the e-mini contract at around 2:40 triggered

 5 data integrity pauses in trading across a number

 6 of automated market- making algorithms even though

 7 these price declines were of course accurate.

 8 Rapid declines in individual securities also

 9 contributed to data integrity concerns and

 10 triggered likewise pauses.

 11 Some market makers also reported that

 12 trading volume overwhelmed their internal systems

 13 causing latencies in their ability to monitor the

 14 markets and confirm orders. Others found delays

 15 in the market feeds themselves and questioned

 16 their own ability to track prices accurately and

 17 in real time. Many were concerned that trades

 18 were going to be broken and that they would be

 19 inadvertently left long or short -- the market.

 20 If is fair to say that most market participants

 21 felt a certain sense of real-time confusion as to

 22 what was actually occurring as many securities

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 1 began to dislocate.

 2 We further noted that since exchange

 3 traded funds are based on baskets of securities,

 4 any data issues whether real or perceived with the

 5 pricing of an individual security can trigger data

 6 integrity pauses in the trading of ETFs that hold

 7 those securities, hence there is a knock- on

 8 effect. This is one of the reasons ETFs may have

 9 been disproportionately affected on May 6.

 10 As automated trading systems paused,

 11 some market makers withdrew completely from the

 12 markets and relied on autogenerated stub quotes to

 13 fulfill their market-maker obligations. Others

 14 fell back to manual trading but had to limit their

 15 focus to only a subset of securities and were not

 16 able to keep up with the unprecedented volumes

 17 that were ever more concentrated as yet other

 18 market makers continued to withdraw. In our

 19 interview process we were actually able to trace

 20 back a significant number of trades that were

 21 executed at stub quotes and were subsequent deemed

 22 erroneous and broken by the exchanges later that

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 1 evening.

 2 Our interviews with market makers were

 3 only a first step in a planned series of extensive

 4 interviews and conversations with a wide variety

 5 of market participants. At this time we are

 6 pleased to report that in addition to equity and

 7 ETF market makers, we have now completed many

 8 dozens of detailed interviews with option market

 9 makers, internalizers, dark pools, high-frequency

 10 traders and cross-market arbitrageurs. The noted

 11 behavior of almost all market participants

 12 remained consistent with a general theme of a

 13 rapid withdrawal of liquidity, but the specifics

 14 for each participant differ materially based on

 15 the type of participant. A detailed summary of

 16 these findings will be presented in our upcoming

 17 September report.

 18 In our subcommittee call held on July

 19 29, we covered three individual but related

 20 topics. These topics were chosen because they

 21 both completed and subtle in nature, have lots of

 22 technicalities that afforded lots of questions and

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 1 not necessarily because we believed that they

 2 presented any problems on May 6. A number of

 3 those topics were actually discussed today, and as

 4 demonstrated there are lots of opinions on these

 5 different topics.

 6 We began with our Division of Investment

 7 Management giving a detailed presentation about

 8 the ETF market itself. Exchange traded funds are

 9 a specific type of exchange traded product

 10 registered under the Investment Company Act of

 11 1940. Today ETFs represent about $700 billion in

 12 assets. Like mutual funds, ETFs hold a portfolio

 13 of securities and are often designed to track a

 14 given index or sector. However, unlike mutual

 15 funds, ETFs are not individually redeemable at a

 16 net asset value but instead are traded in a

 17 secondary market alongside individual equities.

 18 Only authorized participants can directly engage

 19 in transactions with ETFs to create or redeem

 20 large blocks of ETFs known as creation units.

 21 These transactions are executed at the end of the

 22 trading day through an exchange of creation units

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 1 for a predefined basket of securities or cash

 2 equivalents. In this fashion, the prices of ETFs

 3 and the prices of the securities that underlie the

 4 ETFs are linked through a detailed arbitrage

 5 relationship. Understanding how these

 6 relationships function provides the context to and

 7 some color on the behavior of ETF market

 8 participants on May 6.

 9 We then turned to a presentation given

 10 by the New York Stock Exchange on the use of

 11 liquidity replenishment points or LRPs. LRPs

 12 essentially represent price bands within which an

 13 individual security can trade in an automated

 14 fashion. When the best bid for an individual

 15 security moves above the upper LRP limit or when

 16 the best offer moves below the lower LRP limit,

 17 fully automated executions on that side of the

 18 book are suspended and quotes on that side are

 19 marked as slow under Rule 611 of regulation of

 20 NMS. During an LRP, NYSE continues to accept

 21 orders and most LRPs are automatically resolved as

 22 additional buy or sell orders are received within

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 1 the price bands. However, if an LRP does not

 2 self-resolve in a short period of time, it is

 3 converted to a floor auction and the security can

 4 be repriced outside of the band. When an LRP is

 5 in effect at NYSE, other exchanges are allowed to

 6 trade through any quotes NYSE marks as slow,

 7 though NYSE cannot trade through the protected

 8 quotes at other exchanges.

 9 Also noted was that trading participants

 10 may cancel resting orders at any time during the

 11 LRP and reroute without any manual intervention.

 12 The presentation by NYSE closed with a variety of

 13 statistics related to LRPs throughout the last

 14 year. In our September report we will be

 15 providing more details on LRPs in the context of

 16 liquidity and market participant behavior related

 17 to the events of May 6.

 18 We then concluded the July 29

 19 subcommittee meeting with a presentation by our

 20 Division of Trading in Markets on what is known as

 21 the self-help exception, 206.11 of Regulation NMS,

 22 something also discussed by the panelists. This

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 1 rule generally requires trading centers to

 2 implement reasonable policies and procedures to

 3 prevent trade-throughs of protected quotations at

 4 other markets. Self-help permits a trading center

 5 to bypass the protected quotations of another

 6 market that is experiencing system problems. It

 7 was noted that the declarations of self-help by

 8 one market center against another are not uncommon

 9 as system arise from time to time. As with LRPs,

 10 our September report will provide more details on

 11 self-help in the context of liquidity and market

 12 participant behavior related to the events of May

 13 6.

 14 Thank you.

 15 CHAIRMAN GENSLER: Thank you, Greg. Are

 16 there questions? Jack?

 17 MR. BRENNAN: I don't want to ask you to

 18 play psychologist, but what was it that the market

 19 makers told you that prompted them to fear broken

 20 trades as much as the clearly erroneous trade

 21 rule? Why on May 6? There are lots of times when

 22 the market is volatile and could can have that

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 1 same sense. Was there some confluence of events

 2 that caused it because we hear it a lot in various

 3 aspects of this investigation.

 4 MR. BERMAN: There is not necessarily a

 5 rule but a bit of an unwritten convention

 6 regarding rapid price moves of more than 10

 7 percent and the exchanges can declare trades that

 8 fall over 10 percent very quickly as erroneous.

 9 This was not a matter of uncertainty in whether

 10 the trades were going to be declared erroneous,

 11 even if there were complete certainty and the

 12 market makers knew ahead of time what would be

 13 declared erroneous, as soon as you get into an

 14 area where something can be declared erroneous, a

 15 market maker does not want to be caught with half

 16 a buck so they will choose to not participate in

 17 the market at all and then risk having one side of

 18 the trade be broken.

 19 MR. STIGLITZ: Can you explain a little

 20 bit, if at the end of the day a market were still

 21 closed or maybe this hasn't happened, how would

 22 the ETFs get priced? Is there a clear rule?

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 1 MR. BERMAN: I think I understand the

 2 question. During the day ETFs are priced like any

 3 stock. It's technical. It depends on the

 4 buy-and-sell pressure of the ETF and the

 5 negotiated prices. There is a separate mechanism

 6 by which creation and redemptions occur and that's

 7 where an ETF looks more like a mutual fund where

 8 that is tied to the NAV of underlying securities.

 9 What happens is that at the beginning of each say

 10 I believe a basket of securities is identified as

 11 what will be tradable for creation units or will

 12 be redeemable if you're going to redeem some

 13 shares. Again, individual investors don't do

 14 this. This is only authorized participants in

 15 very large blocks. Even of the markets are

 16 closed, the securities can still be exchanged and

 17 redeemed. There are circumstances where you have

 18 ETFs on international markets where the end of the

 19 days don't coincide and in that case I believe

 20 that there are lags between the time that the

 21 actual settlement happens and then the transfer

 22 occurs.

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 1 CHAIRMAN GENSLER: Joe, did that answer

 2 your question?

 3 MR. ENGLE: I was going to say I don't

 4 know how you would take the closing price of an

 5 individual stock that was closed, but I assume

 6 it's still going to be the last trade and I would

 7 think with an ETF you would also record the

 8 end-of-the-day price as being the last trade. I'm

 9 not sure whether there is any provision that would

 10 be different from that. You're talking about if

 11 there is a circuit breaker at the end of the day?

 12 MR. STIGLITZ: That was the question.

 13 It's not like delivering wheat where you actually

 14 deliver the wheat. I believe there is a cash

 15 settlement of some kind.

 16 MR. ENGLE: I don't think there's any

 17 special end-of-day role that the ETF price plays,

 18 unlike a mutual fund.

 19 MR. BERMAN: You actually can deliver

 20 the securities so that the securities go back and

 21 forth. This would only affect the case where in

 22 lieu of transferring securities you wanted to

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 1 transfer the cash equivalent of those securities

 2 in which case you would need to have accurate

 3 pricing for the underlying securities.

 4 MR. STIGLITZ: That was the question.

 5 Maybe the question when you actually do the

 6 settlement --

 7 MR. BRENNAN: It's one of the things

 8 that keeps them close. It eliminates the discount

 9 on a traditional closed-end fund so that you can

 10 settle in cash or you can settle in securities.

 11 The preference is not to do securities because

 12 there are transaction costs but you can do it.

 13 MR. STIGLITZ: If something is missing

 14 what do you do?

 15 MR. BRENNAN: I don't know what happens.

 16 I'm not sure we've been through a period where the

 17 market closed at the end. I'm sure it happened

 18 with the SPDR on October 27, 1997, but I'm not how

 19 many other days the stocks markets weren't closed

 20 at the end of the day.

 21 CHAIRMAN GENSLER: Jack isn't it correct

 22 that like the wheat market, we're going through a

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 1 lot of wheat convergence issues right now in

 2 Kansas City and Chicago, exchange traded funds you

 3 can literally deliver the securities like you

 4 could deliver the wheat at least in theory in

 5 Kansas City and in practice hopefully, but you

 6 have to be one of these authorized participants

 7 and it can only be done by large blocks.

 8 MR. BRENNAN: That's right.

 9 CHAIRMAN GENSLER: They hopefully don't

 10 have what we have, this convergence issue, but I

 11 guess they could deliver a stock even it's not

 12 trading. Is that right, Greg?

 13 MR. BERMAN: I believe so. The question

 14 about what happens if you want to deliver a cash

 15 equivalent and the stock was closed is more

 16 general. How do you come up with what the end

 17 price for a stock is so that there are lots of

 18 ramifications about margins on a stock. The

 19 exchanges would need to come up with an official

 20 closing price and I assume that whatever price was

 21 picked would be the one that would be relevant for

 22 the transfer of ETFs.

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 1 CHAIRMAN GENSLER: Rick, did you have a

 2 question?

 3 MR. KETCHUM: To follow-up on the data

 4 integrity parts of your report of the minutes

 5 which again was echoed this morning, do you have a

 6 better feel with respect to exactly what those

 7 conclusions of data integrity was based on? Was

 8 it that they were seeing trades out of line with

 9 quotes or trades that would have trade-throughs or

 10 were they trying to execute trades against quotes

 11 in which they were continually unsuccessful? What

 12 were they telling you? And do you conclude that

 13 there really was significant data integrity issues

 14 across the board or whether they were spotty?

 15 MR. BERMAN: Most of the market

 16 participants explained that they put automatic

 17 triggers into the systems to look for anything

 18 that has the potential to be erroneous data and

 19 the first thing that they put in is any rapid

 20 price move. While there were true data integrity

 21 issues that we are focusing on in various

 22 different platforms and there also internal system

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 1 issues with some of the participants, it was

 2 actuate changes in prices that I believe triggered

 3 most of these alarms. As soon as you have a rapid

 4 change in price even if that's real, someone has

 5 to look at see maybe that's not correct and that

 6 then causes this huge cascade.

 7 When lots of securities have rapid

 8 changes in prices at the same time, then folks

 9 can't necessarily respond very quickly because

 10 each one of those securities need to be looked at

 11 individually to make sure that the prices are

 12 right and if you are collectively looking at a

 13 whole bunch of securities and finding

 14 dislocations, your assumptions are either that

 15 there is something greatly wrong with the feeds

 16 themselves because we're seeing this everywhere

 17 which would cause you to pause, or the feeds are

 18 completely correct and there's something

 19 fundamental going on in which case that would

 20 cause you to pause. Regardless of whether or not

 21 the prices themselves are correct, any perception

 22 of that is going to trigger these types of pauses

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 1 and we think that that was the majority of the

 2 issues.

 3 MR. STIGLITZ: I wanted to follow-up on

 4 that. I understand why people would not want to

 5 trade with market volatility but they were using

 6 the vocabulary of erroneous data and you would

 7 have thought that there would be some mechanism

 8 for separating out these two kinds of problems.

 9 So far what you've described is that they don't

 10 really separate the two and one of the concerns is

 11 in breaking the trades again in terms of the

 12 erroneous data, erroneous trades, it's

 13 understandable why you would want to break

 14 erroneous trades, but it seems as if there's

 15 another principle which is trades that were not

 16 erroneous but at were at prices that were larger

 17 deviations from what people had thought. Again,

 18 it seems to me that those are two concepts that

 19 are really quite different concepts that are being

 20 mixed together and one would have thought that

 21 there are ways of distinguishing between these

 22 two.

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 1 MR. BERMAN: I think the clearly

 2 erroneous trades and erroneous data, you're

 3 exactly right, those are completely separate

 4 concepts. The clearly erroneous trades and the

 5 cancellation of trades was one process that the

 6 exchanges got together and we fully described in

 7 the preliminary report how that process worked and

 8 we heard lots of feedback from the panelists on

 9 how they perceived that process. Completely

 10 separate from that is trading on erroneous data,

 11 erroneous market data or trading when you think

 12 you're placing an order and you don't necessarily

 13 get the confirm back immediately so there might be

 14 systems issues. That's a completely separate

 15 path.

 16 Sometimes I can imagine a situation

 17 where a trade is erroneously placed because of

 18 erroneous data and one might want to claim,

 19 therefore, that that trade was clearly erroneous.

 20 I don't think that's really what played into the

 21 afternoon of May 6. Those are two separate

 22 processes.

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 1 MR. RUDER: Could you describe the

 2 process for choosing the 60 percent figure for

 3 declaring those trades, which ones to be broken or

 4 not? First of all, was it across all of the

 5 trading centers? Secondly, why 60 percent? Why

 6 not 55? Why not 65? Why not 35? What was the

 7 thought process?

 8 CHAIRMAN GENSLER: Three questions. The

 9 process, was it across all markets and then the

 10 thought that went into the number. But the first

 11 thing I see is Rick shaking his head. Greg?

 12 MR. BERMAN: I think I might defer to

 13 Rick on those particular question.

 14 MR. KETCHUM: I'm glad you're answering

 15 it, Greg.

 16 MR. BERMAN: The exchanges did get

 17 together after and I know that they agreed on

 18 that. I don't know if I can comment on the

 19 details of the why and how.

 20 MR. RUDER: You said the exchanges.

 21 What about the other markets?

 22 MR. BERMAN: I believe that clearly

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 1 erroneous trades are within the domain of the

 2 exchanges. Rick?

 3 MR. KETCHUM: I can try to help but

 4 trying to explain the process may be beyond me.

 5 Each of the registered exchanges or trading in a

 6 security or who had trades in the security plus

 7 FINRA which through the TRF, whatever it stands

 8 for, facility, which represents essentially the

 9 internalized trades of the firms and some of the

 10 dark trade volume, worked together to have a

 11 single decision with respect to erroneous trades.

 12 Erroneous trades are relatively predictable from

 13 the standpoint of how those decisions work, and

 14 they're set out and the SEC worked with the

 15 exchanges for some time for that when it involves

 16 a single erroneous trade or a machine-gun-like

 17 number of errors going in the same security.

 18 There is much more flexibility and difficulty

 19 working it, when instead it stems from a market

 20 reaction and then flows like a waterfall from that

 21 in large numbers of securities. In that situation

 22 there is much less guidance. There were some

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 1 similar situations in September and October during

 2 the credit crisis but not quite like this.

 3 So in those circumstances the exchanges

 4 had more flexibility and on the other less

 5 guidance in how to work in a situation where in

 6 simple terms there was no clarity that there were

 7 any error trades, in fact there weren't. What

 8 there was was a massive market panic reaction that

 9 from a market structure standpoint resulted in

 10 trades that simply couldn't be justifiable. In

 11 that situation, obviously the last one was an

 12 opinion and not otherwise, the exchanges with

 13 FINRA were -- about only breaking the most extreme

 14 trades because as been mentioned several times

 15 here, these positions don't stand alone, they are

 16 traded out of, they are part of hedge positions

 17 and part of a variety of combinations or positions

 18 so that the breaking of trades particularly when

 19 it's not terribly predictable always has

 20 consequences.

 21 I think it's fair to say there's nothing

 22 specifically justifiable, about 60 percent is the

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 1 number rather than 50 or 70, it was an effort

 2 given the unique nature of this in the absence of

 3 any evidence of a particular area of trade to only

 4 knock out trades that would appear to be by at

 5 least standard undoubtedly for persons involved

 6 with it not normal and not real and for better or

 7 worse 60 percent was the point that the exchanges

 8 landed on.

 9 MR. RUDER: What did you do, put a bunch

 10 of pieces of paper in a hat and pick out one?

 11 MR. KETCHUM: I wasn't there so I won't

 12 testify how it happened.

 13 MR. STIGLITZ: Do you have any

 14 information about who the market participants

 15 whose trades were broken?

 16 MR. BERMAN: We're still working on the

 17 exact details of that and in our upcoming report

 18 in September I think we'll go into more detail,

 19 but our initial inclination was to follow the

 20 retail path and we believe that quite a number of

 21 those trades were actually retail trades. Most of

 22 the professionals got out of the market as soon as

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 1 the decline started happening so certainly the

 2 market makers began to pull out, your

 3 institutional asset managers would have pulled

 4 out, so many of those trades we believe were

 5 originally retail trades.

 6 CHAIRMAN GENSLER: Greg, what do you

 7 think, and this is a question probably for

 8 SEC/FINRA, that the September information will

 9 show? I know the May 18 said how many trades, but

 10 you're asking who was behind them and you think

 11 that you will be able to summarize that for the

 12 public?

 13 MR. BERMAN: Yes.

 14 MR. RUDER: To follow-up from your

 15 comments, that seems to say that the last part of

 16 the declines down to the stub quotes was almost

 17 all due to retail trades and it was the retail

 18 traders who were really causing this dramatic

 19 decline?

 20 MR. STIGLITZ: The question is who was

 21 getting stuck with the bad side of that trade and

 22 that could be because the way they structure their

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 1 offers.

 2 MR. RUDER: I take it that a group of

 3 stop-loss orders from the retail traders or market

 4 orders from retail traders, since you say that all

 5 the professionals were out of the market, so now

 6 we have the last part of the flash crash

 7 determined by retail trades rather than

 8 professionals?

 9 MR. BERMAN: I don't want to get too

 10 ahead of the final results in September, but what

 11 we are seeing is that most of the professionals

 12 had exited the market but many of the retail

 13 investors, some of them, were stop-loss orders so

 14 they were triggered automatically. Others were

 15 market orders that folks put in right there and

 16 then as they saw the decline going down. It was

 17 less around they got stuck with the bad trades;

 18 they were the only ones trading at that particular

 19 time. So you went to stub quotes and again those

 20 trades were later cancelled for those obvious 

 21 reasons.

 22 MR. RUDER: Then to go one more step

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 1 with it, at what point from 60 trading up toward

 2 40 and 30 were the professionals out and the

 3 retailers still in? Do you know that?

 4 MR. BERMAN: I don't think we have

 5 details at that level. What I can tell you is

 6 that there were about 20,000 broken trades and if

 7 you plot the numbers of securities and the trades

 8 and what the lowest point was, you will find that

 9 it's a barbell. Quite a number of the trades fell

 10 10, 11 to 12 percent and then a huge number fell

 11 90 trading or more. The area between 20 percent

 12 and 90 percent is very, very sparsely populated.

 13 Either you went all the way down or you stated at

 14 the 10 percent to 12 percent level. So the

 15 difference between 50 percent, 60 percent and 55

 16 percent, we're literally talking handfuls of

 17 trades in those regions so that we didn't see too

 18 many stocks fall 48.3 percent, either you went all

 19 the way down to a stub quote or close to it or you

 20 went down a nominal amount and then came back.

 21 MR. BRENNAN: Were they mostly

 22 low-volume, small- lot sizes, too?

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 1 MR. BERMAN: That's something that I

 2 think we will have some cross-sectional analysis

 3 on in the final report. I think the answer is

 4 yes, but that's not necessarily saying anything

 5 about the broken trades. Most trades are

 6 small-lot sizes today.

 7 MS. PHILLIPS: Were the broken trades

 8 spread across all markets?

 9 MR. BERMAN: I believe in the

 10 preliminary report we have a table that

 11 illustrates for the 20,000 or so broken trades

 12 different markets had different percentages

 13 obviously. The New York Stock Exchange did not

 14 have any broken trades because of their LRPs.

 15 Others had fewer broken trades because they have

 16 collars on their orders so that they do not accept

 17 market orders, and when they accept a market order

 18 they'll actually turn that into a limit order.

 19 And others execute the market orders directly.

 20 One thing that I'd like to note is

 21 market orders are often converted to limit orders

 22 before they get to the exchanges themselves so

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 1 that there is a limit to what the exchanges can do

 2 in terms of treating a market order. If they

 3 receive a limit order for 1 penny then that's a

 4 limit order for 1 penny. The situation is

 5 actually a little more complicated than just

 6 sending the retail orders straight to the market

 7 centers themselves.

 8 MR. STIGLITZ: Earlier we were talking

 9 about a large fraction of the broken trades being

 10 ETFs. Can you answer some of these same questions

 11 about the ETFs? Were there a lot of retail trades

 12 in the ETF that were broken?

 13 MR. BERMAN: My comments really for all

 14 broke trades and the majority of the 60-some-odd

 15 percent, et cetera, or more of the broken trades

 16 were ETFs. So, yes, everything applies to the

 17 ETFs themselves.

 18 CHAIRMAN GENSLER: Susan, and it was my

 19 fault that I didn't recognize you earlier, did you

 20 have either questions for this or even if you just

 21 wanted to share because there were five or six

 22 really important topics about market orders and

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 1 limits, all the six or seven topics that we talked

 2 about earlier that you wanted to share with the

 3 other members of the committee?

 4 MS. PHILLIPS: I remembered that it was

 5 ETFs that were predominantly the broken trades,

 6 but then I didn't remember about whether the

 7 futures markets had many broken trades.

 8 CHAIRMAN GENSLER: Jim can answer that.

 9 MR. MOSER: It did not have any broken

 10 trades.

 11 MS. PHILLIPS: Thank you.

 12 CHAIRMAN GENSLER: We're going to stay

 13 in our seats but I think Greg and Steve Sherrod

 14 from our side, are you going to do anything? No?

 15 That makes it easier for me because maybe it's

 16 already been done.

 17 I wanted to thank Greg Berman and Jim

 18 with regard to what they've done. As said, in

 19 early September the staff will deliver a follow-up

 20 report so that we'll have May 18 and then we'll

 21 have this follow-up report to the Joint Advisory

 22 Committee based on the research they've conducted

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 1 these last 3 months. Then once this committee has

 2 received the report, the next step would be to

 3 link the staff report back to the broader mandate

 4 of this Joint Advisory Committee. To that end we

 5 would subsequently ask this committee to prepare a

 6 document, maybe it's a shorter document than the

 7 staff or it can be as long as you want it to be,

 8 to be delivered to the Commissions ideally by

 9 early October -- we know that you're busy but

 10 we're trying to move this along -- that would

 11 address the following points, any specific

 12 recommendations that you may have regarding

 13 cross-market policies directed and related to the

 14 issues of May 6, cross-issues, or all of the six,

 15 seven to eight items discussed earlier. Chairman

 16 Schapiro had to leave but she particularly said

 17 some of those items earlier that were identified

 18 around collared market orders and so forth, the

 19 pilot program, all of the things that we talked

 20 about earlier, the pauses and the limits and so

 21 forth, those topics, but certainly included in

 22 that is the cross-market policy, circuit breakers

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 1 across the markets.

 2 Secondly, general areas of further

 3 consideration for the CFTC and SEC policies based

 4 on any broader cross- market themes. Some of

 5 cross-market themes again were talked about

 6 earlier today, cross-market themes about the

 7 fragmentation in the markets and so forth which

 8 were debated this morning and there were obviously

 9 a lot of things that were raised by members here,

 10 priority rules, and whatever the committee wants

 11 to advise us on. The two main areas are the

 12 cross-market issues related to May 6 and broader

 13 advice that you have. This committee doesn't go

 14 away with that report by the way. It goes further

 15 so that you're not off the hooks yet.

 16 That's to aid you in the process. We're

 17 happy to have staff members of the SEC and CFTC

 18 work with the Joint Advisory Committee collect

 19 your individual thoughts on each of he points,

 20 aggregate, synthesize the information, help

 21 organize the final document. Greg Berman and

 22 Robert Cook are here from the SEC who runs the

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 1 Division of Trading and Markets. We have

 2 different names over here and maybe we need to

 3 harmonize that too. We have Jim Moser and Andre

 4 Kirilenko who you've met who are from our chief

 5 economists side, and Steve Sherrod, Rick Shilts

 6 and others from our Division of Market Oversight

 7 are all available to help out as well.

 8 I want to turn to my fellow

 9 Commissioners, Mike Dunn, Jill Sommers and Bart

 10 Chilton, I think each have some thoughts too.

 11 COMMISSIONER DUNN: Thank you very much,

 12 Mr. Chairman. And first and foremost, I'd really

 13 like to build upon what you were just saying in

 14 recognizing the importance of this advisory

 15 committee. To ensure that we have an orderly

 16 working marketplace, a lot falls on your shoulder

 17 and I appreciate you, Mr. Chairman and Chairman

 18 Schapiro for getting such a distinguished panel

 19 here. I've just finished reading Joe Stiglitz's

 20 book, Freefall, and I'd highly recommend it to

 21 everybody. Since we're not paying them we can

 22 plug them. I'll plug the Stern School of Business

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 1 and Northwestern as well as great institutions.

 2 One thing really struck me today and

 3 that was hearing from the panel members that we

 4 had, not the advisory committee, who indicated

 5 that what happened on May 6 can happen again. In

 6 fact, they expect it to happen again.

 7 Mr. Chairman you made an analogy of the

 8 terrible auto accident that I was involved in

 9 which happened in a very quick time and what

 10 happened to stocks at Accenture, but there was a

 11 big difference. In my case, somebody broke a

 12 rule. Somebody went through a stop sign. We

 13 don't have a rule here that was broken that caused

 14 this. What we're looking for in this advisory

 15 committee are the rules of the road to ensure that

 16 these accidents don't happen in the future and

 17 certainly don't happen in the magnitude that they

 18 happened.

 19 I want to build on something that the

 20 Chairman did when he started and that was talking

 21 about the Frank- Dodd bill. It has mandated that

 22 the CFTC and SEC work together. The two Chairs

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 1 have started these meetings that have been

 2 mandated, staffs are going through those, and I

 3 hope, Mr. Chairman, that we would follow-up in a

 4 similar format that we have here, where we have an

 5 open public meeting where everyone is privy to the

 6 types of recommendations that we were mandated to

 7 take a look at and what our staffs are going to be

 8 recommending to us. To that extent, there are

 9 regulatory bodies that I still feel we ought to be

 10 working with as well to ensure that we get that

 11 out there.

 12 I'd really like to thank the staffs of

 13 both the CFTC and the SEC for the work they've

 14 done for us as the Commission, but also for this

 15 advisory committee. Since we're not paying you we

 16 don't expect you to shoulder all the burden of

 17 that and we stay in the agricultural area, work

 18 them like a rented mule. Get as much out of them

 19 as you can.

 20 CHAIRMAN GENSLER: I don't know what to

 21 do with that last statement. The one thing I want

 22 to say is that Commissioner Dunn is absolutely

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 1 right that the SEC and CFTC are working tirelessly

 2 together and we are on the Dodd- Frank bill going

 3 to have a number of staff roundtables. I can't

 4 remember how these are called. Some of them may

 5 even start later this month, and between the SEC

 6 and CFTC I think they've identified four or five

 7 topics. They will be open to the public, I don't

 8 think we'll have as many cameras here, but they'll

 9 go through a number of topics related to data,

 10 related I think to governance, related possibly to

 11 these new swap execution facilities and so forth,

 12 and will jointly hear from the public on very

 13 critical issues and the SEC Commissioners and the

 14 CFTC Commissioners will be allowed to go, but

 15 staff is going to run them which saves Mary and me

 16 from running these things too probably.

 17 Commissioner Sommers?

 18 COMMISSIONER SOMMERS: Thank you, Mr.

 19 Chairman. I think following-up on all of that, I

 20 want to say how much I appreciate the panelists

 21 being here today and all of the committee members.

 22 It's extremely important for us to look at this

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 1 coordination across markets, the equity markets,

 2 the security options and the futures and how to

 3 appropriately impose the two rules that we have on

 4 all of those markets like circuit breakers. I

 5 think that as the markets have evolved and

 6 products like ETFs and equity index futures have

 7 increased the interconnectedness of our markets

 8 and the markets that we each regulate have also

 9 increased, yet we have completely different market

 10 structures and completely different rules on

 11 either side.

 12 Some of the issues that we talked about,

 13 high- frequency trading, collocation and general

 14 structure issues are before both of our agencies

 15 so I can't really stress enough how forums like

 16 this to increase the dialogue and cooperation

 17 between the two agencies is extremely helpful to

 18 me and I think to us all as regulators. Thank you

 19 all for being here.

 20 CHAIRMAN GENSLER: Commissioner Chilton?

 21 We're bound to get sound bite here I know.

 22 COMMISSIONER CHILTON: Thanks, Mr.

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 1 Chairman, and thanks to everybody's staffs in

 2 particular. I know you guys have already been

 3 working like rented rules, and thanks to the

 4 advisory committee.

 5 People are going to say it's going to

 6 happen again like Commissioner Dunn said and the

 7 answer it is could. I think it's less likely that

 8 it would today with some of the changes that are

 9 being incorporated, and as we move further down

 10 the road it'll be even less likely, but you can't

 11 give certitudes.

 12 As we were talking about all of these

 13 issues and it was fascinating all of the

 14 suggestions that the panel have, people come up

 15 with sorts of phrases about what happened on May

 16 6, they say it was a perfect storm or it was a

 17 collection of culprits, and I think sometimes it's

 18 too easy for us to rely on that when we don't know

 19 what specifically it was. It was a bunch of

 20 things. I'm not saying that it wasn't a bunch of

 21 things, but by the same token, I think that the

 22 panel and the staff should still be looking for a

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 1 smoking gun. One of the areas, and I'm not saying

 2 that this is a smoking gun, that was not discussed

 3 a whole lot today is this gap between the

 4 consolidated tape and the premium tape on the New

 5 York Stock Exchange. At times there was more than

 6 a 20-second delay. What I think we need to do is

 7 make sure that there wasn't any price trading,

 8 these algorithmic trades that could have gone in

 9 and simultaneously bought on the real-time feed,

 10 the real- time feed from the New York Stock

 11 Exchange, and then sold on the delayed feed, the

 12 consolidated feed, right away hundreds of time and

 13 taken just a minute advantage individually but

 14 collectively it could have been a larger amount.

 15 When I started thinking about this we

 16 have a Technology Advisory Committee that

 17 Commissioner O'Malia convened a couple of weeks

 18 ago and I asked these sorts of questions then to

 19 make sure that I wasn't a conspiratorial person

 20 thinking this is crazy, and four of the folks who 

 21 are on this panel, eminent experts, thought I was

 22 crazy to ask. Of course that could be going on.

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 1 So I don't feel as nutty about asking the question

 2 and maybe there is nothing to this Greg or Jim,

 3 but that gap of 20 seconds might not be a lot in

 4 our lifetimes, it might not be a lot for a lot of

 5 folks, in a basketball game it could be something,

 6 in these markets it could be huge. So I hope that

 7 we make sure that these algorithmic price pirates

 8 aren't seeking false prophets, that they aren't

 9 trying to go after something they shouldn't have

 10 gone after.

 11 Thank you again for everything.

 12 CHAIRMAN GENSLER: Thank you. Rick or

 13 Greg? Joe?

 14 MR. STIGLITZ: Two questions. One is

 15 we've been talking about the U.S. market. I

 16 gather that there have been similar spikes in a

 17 couple of other markets. Has your staff looked at

 18 any other markets where anomalies of this kind

 19 have occurred, that because we've been talking

 20 about different rules and the impact, it might be

 21 of some interest to see whether they've gone

 22 through a similar kind of exercise?

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 1 MR. BERMAN: We are aware of the

 2 different structures that exist in different

 3 international jurisdictions and other types of

 4 markets. There is something that is unique around

 5 the U.S. equity market in that it is fragmented.

 6 There are different market centers, there are at

 7 least 9 to 12 depending on how you count the ones

 8 that are visible, and as we've heard from a number

 9 of panelists, people like to use the 40 as the

 10 total number of venues that are actually out

 11 there. Forty times 40 is 1,600 different

 12 combinations. So while there are certainly things

 13 that we can learn from observing these types of

 14 patterns in other markets, a lot of this is within

 15 the U.S. That we'll have to study.

 16 MR. STIGLITZ: The particular question I

 17 was concerned with is if there are these kinds of

 18 spikes occurring even without this complexity,

 19 ours may be more prone because of the complexity,

 20 but it would remind us that even without that we

 21 have something to sorry about.

 22 MR. BERMAN: Agree.

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 1 MR. MOSER: We're also looking at as I

 2 mentioned the order book activity on other days.

 3 Two of the days as I recall were in the third

 4 quarter of 2008 when there were sharp breaks as

 5 well, so what we want to do is analyze and see in

 6 what ways was May 6 different than those sharp

 7 breaks and how did the order book evolve on those

 8 days.

 9 MR. STIGLITZ: I think Australia had a

 10 big spike, it was an upper one, and in their case

 11 it was a wrong order. Somebody pushed the wrong

 12 button. The reason I mention that is it shows the

 13 fragility of the system to a mistake, so that's at

 14 least one thing that one wants to worry about and

 15 if that's the case then obviously with all the

 16 kinds of fragmentation that we have, the problems

 17 could be much worse.

 18 MR. MOSER: We have some outstanding

 19 research from other error trades than in the

 20 United States. There aren't too many to analyze,

 21 but what we've found is that in general the market

 22 does come back very quickly recognizing that it is

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 1 an error and it just bypasses it. I'd be glad to

 2 send the advisory group that paper if you'd like.

 3 MR. STIGLITZ: Just one more question I

 4 wanted to ask, and that to do with the Dodd-Frank

 5 bill. Are there particular regulatory issues that

 6 they raise that you think interact with what we

 7 should be doing?

 8 CHAIRMAN GENSLER: I can't speak for the

 9 SEC, and as you know the CFTC largely swims in the

 10 lane of derivatives, foreign-exchange derivatives

 11 which we call futures now, and these newly

 12 regulated over-the-counter derivatives. I do

 13 think market structure issues here are going to

 14 play a tremendous role because, as you know,

 15 Congress enacted a bill that says all standardized

 16 derivatives that can be clearing platform have to

 17 come to a clearing house. And there are various

 18 estimates, but that seems that would be a majority

 19 of the over-the-counter derivatives marketplace by

 20 far, and that those have to then be exposed to

 21 transparent trading venues and these transparent

 22 trading venues can be swap execution facilities.

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 1 So from the world of the futures market,

 2 which, as people have pointed out, has been less

 3 fragmented than the securities market, this

 4 over-the-counter derivatives marketplace may will

 5 have multiple trading platforms. In fact, there

 6 could be dozens. The bill actually fosters

 7 competition among these trading platforms so that

 8 I think it will be helpful as you're thinking

 9 about fragmentation and market structure issues.

 10 Congress has dealt with the broad

 11 policy. There will be swap execution facilities

 12 that are supposed to be open to multiple

 13 participants making bids and offers to multiple

 14 participants. It's what people call many to many.

 15 There is pretrade transparency. But how they all

 16 will work in combination to enhance market

 17 liquidity, enhance transparency, enhance

 18 efficiency of markets, which is part of the goal

 19 of the statute, I think that will be helpful to

 20 get your advice on. Not that you might not have

 21 advice on clearing houses and other things, but I

 22 think it's probably more around the trading venues

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 1 that very similar types of issues might arise.

 2 MR. STIGLITZ: One in particular was

 3 raised this morning, which is the bill encourages

 4 as you say trading on exchanges and clearing

 5 houses but also allows for over-the- counter. And

 6 in some of the issues we've talking about, dark

 7 pools versus transparency, raise the concern that

 8 how you organize the transparent part can affect

 9 the magnitude of the trading that goes into the

 10 dark pools so it seems to me that that's one of

 11 the things --

 12 CHAIRMAN GENSLER: Absolutely. I think

 13 Congress addressed part of that in that they said

 14 even on the bilateral transactions, those that are

 15 not on the trading, have to be reported in a

 16 real-time basis as well, so there's post-trade

 17 transparency we have to sort through the SEC and

 18 we have to sort through how to do that. In terms

 19 of what's on the swap execution facilities,

 20 Congress also addressed it by saying it's

 21 multiparty to multiparty. Some of the dark pools

 22 currently in the equity markets, the darkest of

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 1 them, are proprietary platforms if I understand

 2 and it appears at least to this reader, I'm can't

 3 speak for my fellow Commissioners, that Congress

 4 addressed that and said, no, it has to be

 5 multiparty to multiparty. It might be addressed

 6 right there in the statute in a sense, but those

 7 will be subject to interpretation obviously.

 8 MR. ENGLE: I'm wondering what we could

 9 do that would be useful, and perhaps maybe the

 10 question is what's actually feasible in terms of

 11 the various incentives for public liquidity

 12 display that were talked about today, things like

 13 treating cancellations differently from just 

 14 having them freely available, changing priorities,

 15 changing access fees or rebate structures and so

 16 forth which are to some extent under regulatory

 17 supervision and to some extent are exchange set.

 18 What's the scope that we can think about here?

 19 CHAIRMAN GENSLER: I would hope that you

 20 would help the two Commissions on things that are

 21 within our authority and jurisdiction. Though you

 22 could take up I think it was one of the earlier

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 1 panelist's thoughts where they had a

 2 recommendation about the tax situation, the SEC

 3 and the CFTC don't have those authorities. I

 4 think what would be best if you recommended things

 5 that are either within our authority or if you

 6 think there needs to be a change in law related to

 7 our specific authorities.

 8 MR. ENGLE: When I used the word tax I

 9 guess I meant charge for cancellations.

 10 CHAIRMAN GENSLER: I think the wonderful

 11 thing about advisory committees, and this one is

 12 an esteemed group, is that we're not looking to

 13 limit you. If you have a good recommendation and

 14 there's a consensus we want to hear that. The

 15 immediate thing are the events of May 6 and the

 16 cross-market issues there and then obviously some

 17 general market structure issues, and since the

 18 panel doesn't go away we're hopeful that there

 19 will be lots of other advice along the way, too.

 20 What's feasible is also what is doable in a timely

 21 way as the first report from the eight advisers.

 22 Susan?

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 1 MS. PHILLIPS: I was wondering after the

 2 September report and if there are recommendations

 3 that come out of that relating to circuit breakers

 4 or different types of orders, some of the market

 5 rules of trading kind of stuff, what other kinds

 6 of issues are the two Commissions interested in

 7 having the committee look at?

 8 CHAIRMAN GENSLER: You're asking what

 9 might be the agenda for this advisory committee

 10 beyond this. That's an excellent question, but

 11 why don't you allow Chairman Schapiro and myself

 12 working with our fellow Commissioners to come back

 13 to you as we sort through this first. I think I

 14 understood your question but maybe I didn't.

 15 MS. PHILLIPS: Yes.

 16 CHAIRMAN GENSLER: Commissioner Dunn?

 17 COMMISSIONER DUNN: It would be good to

 18 hear from the advisory group what types of things

 19 they think they ought to look at. That would be

 20 very helpful.

 21 CHAIRMAN GENSLER: This group was set up

 22 immediately after the May 6 event and Chairman

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 1 Schapiro have been talking about it since the

 2 presidential transition, then Acting Chairman Dunn

 3 had suggested we have this too, and we worked with

 4 Congress to get this authorized. Believe it or

 5 not we had to have this committee authorized

 6 because we couldn't spend money on behalf of the

 7 SEC and they couldn't spend money on behalf of us

 8 and you had to change an appropriations law to do

 9 a joint advisory committee. It's a great country.

 10 We did that with the support of many members of

 11 Congress, so we really do look for this to be a

 12 committee that goes on to talk about emerging

 13 risks, that one of the things that came out of the

 14 crisis of 2008 is to have an outside group of

 15 experts advising these two market regulators. It

 16 brings some harmony among them, but beyond the

 17 harmony is to say what are the emerging issues?

 18 What is the next thing that's on the horizon? You

 19 got commissioned into service with the specific

 20 task of May 6 but it's much broader than that.

 21 It's what do you see on the horizon and what other

 22 things do you think the nation's two market

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 1 regulators should be thinking about, but that's

 2 past October.

 3 MR. STIGLITZ: May I give a comment

 4 related to the discussion we had earlier this

 5 morning in which it was very clear that there have

 6 been very big changes in the structure and the

 7 performance of these markets in very recent years

 8 which affect both the liquidity of the markets and

 9 incentives for various market participants to

 10 gather information such as previously when you

 11 talked about the incentives for those who are

 12 doing fundamental research, their ability to

 13 extract returns for those investments. In some

 14 ways it seems to me that one of the questions is

 15 not only the question of stability but also even

 16 the efficiency of these markets with respect to

 17 the issues these fundamental roles that these

 18 markets play in making the real economy work

 19 better. I think that should be an important

 20 focus.

 21 CHAIRMAN GENSLER: Maureen?

 22 MS. O'HARA: The SEC's concept release

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 1 is also is all about that and so I think to some

 2 extent we want to make sure that we're not

 3 duplicating what they're doing but actually moving

 4 beyond that as well. Certainly those issues are

 5 there and the SEC has that and that's been out now

 6 for 3 months or 4 months, something like that. So

 7 hopefully we'll be able to add to that as well.

 8 MR. RUDER: Could I make a comment about

 9 staffing? We don't have an identifiable staff

 10 that reports to us. I presume that the SEC and

 11 CFTC staffs are available to us. I would hope

 12 that we would receive from the joint staffs a

 13 summary of the various suggestions that have been

 14 made so that we wouldn't be starting from scratch

 15 in September when we receive a document from you.

 16 CHAIRMAN GENSLER: David, I think that's

 17 an excellent suggestion. Technically speaking

 18 now, you don't need to speak, but Jim and Tim,

 19 aren't you officially the committee's staff? Jim

 20 Burns and Tim Karpoff just got outed. Can you

 21 follow-up with what are the things that outside

 22 market experts or the panelists have suggested?

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 1 That's what you're saying?

 2 MR. RUDER: Yes, so that we can consider

 3 those in the timeframe between now and the time

 4 that we receive the report so that the report then

 5 has some relevance for us in terms of the kinds of

 6 suggestions we might make, and that would give us

 7 also an opportunity collectively to make other

 8 suggestions that any of us might have. I would

 9 hope that we could have some procedure for

 10 circulating papers without having a public meeting

 11 about what we might think.

 12 CHAIRMAN GENSLER: All in compliance

 13 with the Federal Advisory Committee Act.

 14 MR. RUDER: Yes, I understand that.

 15 You've given over the past some documents that

 16 have been helpful, some sets of testimony, but I

 17 would also urge the staff to give to us if it's

 18 available to them any written papers and documents

 19 that may be helpful to us in making decisions and

 20 evaluating suggestions. This is as you know

 21 extremely difficult subject matter and very

 22 technical and we need all the help we can get.

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 1 CHAIRMAN GENSLER: Those are both

 2 excellent suggestions. This is the administrative

 3 side, we need to discuss and approve the minutes

 4 of the June 22 meeting of the committee. Let me

 5 ask whether there is any discussion of the

 6 minutes. They're in your binders. Do I hear a

 7 motion?

 8 MR. KETCHUM: So moved.

 9 CHAIRMAN GENSLER: Do I hear a second?

 10 MR. ENGLE: Second.

 11 CHAIRMAN GENSLER: All in favor?

 12 GROUP: Aye.

 13 CHAIRMAN GENSLER: Any opposed? Looks

 14 like the ayes have it.

 15 I want to thank everybody. I want to

 16 thank my fellow Commissioners, all the panelists

 17 and the committee members. I think this has been

 18 a terrific dialogue today. So I would ask is

 19 there any other committee business?

 20 Not hearing of any other committee

 21 business, I can declare this meeting adjourned. I

 22 might have to entertain a motion. It's a FACA

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 1 committee.

 2 MR. KETCHUM: So moved.

 3 CHAIRMAN GENSLER: Is there a second?

 4 MR. ENGLE: Second.

 5 CHAIRMAN GENSLER: All in favor?

 6 GROUP: Aye.

 7 CHAIRMAN GENSLER: The committee is

 8 adjourned.

 9 (Whereupon, at 12:36 p.m., the

 10 PROCEEDINGS were adjourned.)

 11 * * * * *

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 1 CERTIFICATE OF NOTARY PUBLIC

 2 I, Carleton J. Anderson, III do hereby

 3 certify that the forgoing electronic file when

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 5 direction; that said transcript is a true record

 6 of the proceedings therein referenced; that I am

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 8 any of the parties to the action in which these

 9 proceedings were taken; and, furthermore, that I

 10 am neither a relative or employee of any attorney

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 12 financially or otherwise interested in the outcome

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 14 /s/Carleton J. Anderson, III

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 17 Notary Public in and for the 

 18 Commonwealth of Virginia

 19 Commission No. 351998

 20 Expires: November 30, 2012

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