COMMODITY FUTURES TRADING COMMISSION

 SECURITIES AND EXCHANGE COMMISSION

 JOINT ADVISORY COMMITTEE MEETING

 ON EMERGING REGULATORY ISSUES

 Washington, D.C.

 Friday, November 5, 2010
 2 

 1 PARTICIPANTS:

 2 GARY GENSLER

 2 Chairman, Commodity Futures Trading Commission

 3 

 3 MARY SCHAPIRO

 4 Chairman, Securities and Exchange Commission

 4 

 5 JIM MOSER

 5 Commodity Futures Trading Commission

 6 

 6 GREG BERMAN

 7 Securities and Exchange Commission

 7 

 8 BART CHILTON

 8 Commodity Futures Trading Commission

 9 

 9 MICHAEL DUNN

 10 Commodity Futures Trading Commission

 10

 11 Advisory Committee Members:

 12 BROOKSLEY BORN

 13 JACK BRENNAN

 14 RICK KETCHUM

 15 MAUREEN O'HARA

 16 SUSAN PHILLIPS

 17 DAVID RUDER

 18 JOE STIGLITZ

 19 Other Participants:

 20 ROBERT COOK

 21 DAN GRAY

 22 ANDRE KIRILENKO
 3 

 1 PARTICIPANTS (CONT'D):

 2 SCOTT O'MALIA

 3 STEVE SHERROD

 4 DAVID SHILLMAN

 5 ELSIE WALTER

 6 

 7 

 8 * * * * *

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 12

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 4 

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

 2 (9:05 a.m.)

 3 CHAIRMAN GENSLER: I want to welcome

 4 everybody. Good morning. And call this, the 4th

 5 Meeting of the Joint Advisory Committee on

 6 Emerging Regulatory Issues, to order. The date is

 7 November 5, 2010. This meeting is held in

 8 accordance with the Government in Sunshine Act.

 9 We're joined by the distinguished members of the

 10 Advisory Committee. I think here with us today,

 11 Susan Phillips, David Ruder, Maureen O'Hara, Jack

 12 Brennan, Brooksley Born, and Rich Ketchum. What I

 13 don't know is, do we have some committee members

 14 on the phone?

 15 MR. STIGLITZ: Yes, this is Joe

 16 Stiglitz.

 17 COMMISSIONER CHILTON: Mr. Chairman,

 18 Bart Chilton, too.

 19 CHAIRMAN GENSLER: All right, I know

 20 that we have some commissioners on the phone as

 21 well, Bart Chilton, but do we have any committee

 22 members on the phone? Robert Engel was maybe
 5 

 1 going to be joining us as well.

 2 MR. STIGLITZ: Joe Stiglitz.

 3 CHAIRMAN GENSLER: Oh, Joe Stiglitz is

 4 on the phone. Thank you. Good to hear you, Joe.

 5 And -- oh, I see, actually Rob Engel is out of the

 6 country and unfortunately unable to join us. And

 7 as we've done at our prior meetings of this

 8 committee, my co-chair, Chairman Shapiro, and I

 9 will share the presiding officer duties today.

 10 First I'd like to offer Chairman Shapiro

 11 the opportunity to make some opening remarks.

 12 Chairman Shapiro.

 13 CHAIRMAN SHAPIRO: Thanks, Gary. Let me

 14 offer my thanks to all the committee members as

 15 well for being with us today and express our

 16 really tremendous appreciation for all you're

 17 doing to help us on these issues.

 18 When we last met, the staffs provided

 19 you with a briefing and an update on their

 20 investigation into the events of May 6th, and then

 21 last month, as you all well know, the staff

 22 completed their final report and presented it to
 6 

 1 the two subcommittees for which it was prepared.

 2 As you know, the report was not intended to

 3 provide policy recommendations. Rather we asked

 4 that the staffs provide a detailed account of the

 5 events of May 6th, both to identify what happened

 6 that day and to really inform ongoing policy

 7 discussions. That report has been widely

 8 recognized as providing the authoritative

 9 analysis, and as I hope the committee will discuss

 10 today, a lot of additional food for thought as we

 11 move forward.

 12 Now that you all have had time to review

 13 the staff findings, I very much look forward to

 14 hearing your views and what areas of focus you

 15 think deserve the most attention from all of us.

 16 I want to be sure that we're doing

 17 everything we can to reduce the likelihood of

 18 another May 6th. Already this past summer the SEC

 19 approved a pilot program by the National Exchanges

 20 and FINRA to pause trading in a security when its

 21 price moves more than 10 percent in 5 minutes.

 22 Initially limited to stocks in the S&P 500, these
 7 

 1 circuit breakers were expanded to include Russell

 2 1000 stocks and several hundred exchange traded

 3 funds in September.

 4 The SEC also approved market making

 5 rules providing clarity when erroneous -- clearly

 6 erroneous trades will be broken, and the staff

 7 will be shortly approving rules regarding the use

 8 of stub quotes as well as considering revising the

 9 parameters for market wide circuit breakers. And

 10 the staff continues active discussion with the

 11 exchanges about modifying the single stock circuit

 12 breakers to incorporate a limit up/limit down

 13 banding mechanism.

 14 All of these rules are interconnected,

 15 both within the equities markets and across

 16 equities and futures markets. This

 17 interconnectedness lies at the foundation of many

 18 of our other market structure initiatives at the

 19 SEC as well and so I'm particularly interested in

 20 your thoughts on these important topics.

 21 Thank you, and I'll turn it back to

 22 Chairman Gensler.
 8 

 1 CHAIRMAN GENSLER: Thank you, Chairman

 2 Shapiro for those remarks. I'll make a few

 3 remarks myself and then turn it over to the

 4 presenters and the committee.

 5 I'm pleased to join Chairman Shapiro in

 6 welcoming the members of the Joint Committee. I

 7 would also like to thank Chairman Shapiro and her

 8 fellow commissioners and all of the staff of the

 9 SEC on their ongoing work with regard to May 6th,

 10 but not only that, but also on the strong

 11 collaboration that we have with regard to

 12 Dodd-Frank and all that our two sets of

 13 commissioners and staffs are doing together.

 14 I'd also like to thank the staff at the

 15 CFTC for all their hard work and planning this

 16 meeting and furthermore I'd like to thank and

 17 introduce -- I know that Commissioner O'Malia is

 18 here. I think either Commissioner Summers and

 19 Commissioner Dunn will be joining us and I know

 20 that Commissioner Chilton is on the phone because

 21 we heard that earlier. Is that right still?

 22 COMMISSIONER CHILTON: Yeah, I'm here,
 9 

 1 Mr. Chairman.

 2 CHAIRMAN GENSLER: Terrific. And I know

 3 this is a busy week for all of us, so it's

 4 possible that Jill and Mike are unable to join us

 5 just given all our rule writing and the FIA expo

 6 still going on in Chicago.

 7 Since the Joint Advisory Committee last

 8 met, the CFTC and SEC staff did release this

 9 supplementary report, I think it was October 1st,

 10 and as outlined in the joint report there were at

 11 least three chapters to the event, first, the very

 12 fragile market environment that came into that

 13 day, mostly out of Europe and the news events.

 14 Secondly, the liquidity crisis in the E-Mini

 15 futures contract and related index securities.

 16 And then thirdly, the liquidity crisis in the

 17 individual securities, sort of the breakage after

 18 that.

 19 Today's meeting is primarily for the

 20 committee to hear of the work of its two

 21 subcommittees and have an opportunity, as a full

 22 group, to have an open discussion about May 6th
 10

 1 and their thoughts on what changes should be made

 2 to ensure the markets work best for the investing

 3 and hedging public.

 4 Before we hear from the subcommittees we

 5 will receive a brief update from the staff, not

 6 only on the supplementary report, but also on some

 7 of the recent rule proposals of each of our

 8 commissions.

 9 Some of the ideas that I look forward to

 10 hearing from this expert panel is, foremost, I'm

 11 interested in what the committee's views are on

 12 how we protect the market integrity, both in light

 13 of May 6th, but also in light of the changing

 14 technology of the marketplace.

 15 Secondly, and maybe more specifically,

 16 what, if any, additional risk protection should we

 17 consider with regard to the use of algorithmic and

 18 high-frequency trading. And I do say, what, if

 19 any, but I would like to have your thoughts.

 20 Third, should we require exchanges in

 21 executing brokers to update risk mechanisms? They

 22 have many risk mechanisms in place now, but should
 11

 1 we ask them to update them and rules particularly

 2 for market pauses? We have market pauses, of

 3 course, in the futures marketplace, but should

 4 they be updated in any way in the pilot program

 5 that the SEC has?

 6 And then lastly, what are the

 7 committee's views on just the variety of actions

 8 that we've taken recently whether it's the

 9 Advanced Notice of Proposed Rulemaking that we've

 10 put out on disruptive trading practices, or of

 11 course your views on the pilot program, or any of

 12 the actions that we've taken recently.

 13 Today's discussion will be open and

 14 candid. I know the committee has not formed its

 15 final recommendations. This is part of a

 16 deliberation process but I would hope that your

 17 deliberations continue abreast and promptly and we

 18 could get your thoughts soon.

 19 So, with that, again, I want to thank

 20 Chairman Shapiro and the SEC, my fellow CFTC

 21 commissioners and staff, and so forth. I think I

 22 turn it back?
 12

 1 CHAIRMAN SHAPIRO: Yes, thank you.

 2 Thanks, Gary. Today we are pleased also to be

 3 joined by SEC Commissioner Elise Walter, who I

 4 will add is a former general counsel of the CFTC

 5 and so back on familiar territory, and of course

 6 by the staff of the CFTC and the SEC who worked

 7 tirelessly on the report issued back in May, but

 8 also the one issued most recently on October 1st,

 9 and did, I think, a really outstanding job, and

 10 you have all of our tremendous appreciation for

 11 that effort.

 12 In addition to a brief discussion of the

 13 response to the report, they're going to provide

 14 us with information concerning the most recent

 15 actions by the two agencies regarding the matters

 16 raised in the report, and then in addition, we'll

 17 also hear reports from both the subcommittees, as

 18 Gary said, on cross-market linkages and on

 19 pre-trade risk management and then the full

 20 committee will have the opportunity to discuss

 21 potential recommendations and how we might move

 22 forward.
 13

 1 So, with that, let me introduce Gregg

 2 Berman of SEC and Andre Kirilenko of the SFTC to

 3 walk us through current initiatives.

 4 MR. KIRILENKO: Thank you, Chairman

 5 Shapiro, Chairman Gensler, members of the Joint

 6 Advisory Committee, and commissioners of the CFTC

 7 and the SEC. Thank you very much for the

 8 opportunity to be here.

 9 The purpose of my presentation today is

 10 not to describe for the public -- already had a

 11 good chance to absorb about the report, but to

 12 touch on some of the broad themes and clarify some

 13 of the issues that might be useful for the

 14 subsequent discussions of the Joint Advisory

 15 Committee.

 16 As Chairman Gensler said, and as the

 17 report has laid out, the events of May 6th can be

 18 grouped into three broad themes, one is the

 19 overall market uncertainty, the second is a large

 20 cell program event in E-Mini, and the third is the

 21 propagation of volatility to other markets and

 22 securities.
 14

 1 I will specifically focus on the

 2 liquidity event in the E-Mini. As a reminder, the

 3 joint staff report stated that a large fundamental

 4 trader chose to execute a cell program of 75,000

 5 E-Mini contracts via an automated execution

 6 algorithm, that was programmed to feed orders into

 7 the E-Mini market to target an execution rate of 9

 8 percent of the trading volume calculated over a

 9 period of time but without regard to price for a

 10 time.

 11 This statement is based both on the

 12 analysis of audit trail data and on several

 13 detailed conversations with the executor and

 14 broker of the large-scale program. As background

 15 I'd like to remind you that the extraordinary

 16 detailed information that -- about business

 17 transactions and positions of market participants

 18 that was included in the report, was included to

 19 the request of Congress. Congress explicitly

 20 requested the staffs of the two agencies to

 21 include in their report sufficient information and

 22 detail to the extent and only to the extent that
 15

 1 such information is necessary to provide an

 2 accurate and complete description of the May 6th

 3 events and their causes.

 4 For clarification purposes, however, it

 5 might be appropriate to say that the statement

 6 without regard to price or time should not be

 7 interpreted as a (inaudible) to saying that the

 8 automated execution algorithm did not use

 9 information about transaction prices or times when

 10 it submitted or modified sequences of orders. The

 11 automated execution algorithm is designed to feed

 12 limit orders, a limit order must specify price.

 13 The algorithm is also designed to calculate and

 14 recalculate limit order prices and quantities over

 15 specified periods of time. With the statement

 16 "without regard to price or time" means is that

 17 the trader did not use an effective overall price

 18 or time limit for the execution of the sell

 19 program.

 20 While automated execution algorithms may

 21 permit traders to use such features, this trader

 22 elected not to use a price limit and also did not
 16

 1 establish a minimum time period for the execution

 2 of the order.

 3 This automated execution algorithm

 4 executed orders against other market participants.

 5 The staffs have collected significant quantitative

 6 and qualitative information about the activity of

 7 market participants who were active on May 6th,

 8 including high-frequency traders, market makers,

 9 fundamental traders, and cross-market arbitrages.

 10 The staffs participated in a number of

 11 conversations with high-frequency traders and

 12 other market participants and has the data and

 13 analytics to exactly describe who and how provided

 14 and took liquidity in the E-Mini market.

 15 The larger trader and other market

 16 participants traded on the CME's Globex, an

 17 electronic limit order market. The staffs had a

 18 number of conversations with the CME and other

 19 exchanges regarding the details of the risk

 20 management functionality designed to deal with

 21 extreme price movements. Examples of such

 22 functionality include trading pauses and price
 17

 1 quantity bans on the orders that are allowed to be

 2 submitted.

 3 As a result, the staffs have a very good

 4 understanding how the price impact of a large sell

 5 of them cascaded to other markets and individual

 6 securities and the large role liquidity providers

 7 and liquidity takers played in that process.

 8 I will now turn the floor to my

 9 colleague, Gregg Berman, from the SEC.

 10 COMMISSIONER BERMAN: Thank you, Andre.

 11 For the equity side of the markets I'd like to

 12 spend a few minutes highlighting some of the

 13 larger themes that came out of our report and

 14 relating those themes to some of the actions,

 15 either recently taken by the SEC or that are

 16 currently underway.

 17 The first big theme comes of course from

 18 the linkages between the futures and the equity

 19 markets. As we know both from data and from

 20 interviews, as the E-Mini declined on May 6th --

 21 on the afternoon of May 6th, market participants

 22 were buying E-Mini and selling equivalent
 18

 1 exposure, either through ETFs or through

 2 individual baskets, of stocks.

 3 Those linkages kept the two markets in

 4 sync and as one declined, so did the other.

 5 Market pauses or market wide circuit breakers were

 6 not triggered on that day and one would imagine

 7 that under times of severe stress that's exactly

 8 when we would need such triggers. So, one of the

 9 first actions that we've been taking is working

 10 both with market participants throughout the staff

 11 of the SEC and the staff of the CFTC on revisiting

 12 market wide circuit breakers.

 13 Some of the ideas that we are

 14 considering include changing the levels at which

 15 the circuit breakers are triggered, changing the

 16 time parameters that caused the circuit breakers

 17 to trigger, and even considering possible changes

 18 to the index that triggered the circuit breaker

 19 themselves. I know that the Joint Advisory

 20 Committee has also spent a lot of time thinking

 21 about this and we very much look forward to their

 22 thoughts on this matter.
 19

 1 The second big theme that came out of

 2 the report was that liquidity providers and market

 3 makers, internalizers in the equity markets, all

 4 pulled back. Some of the reasons that were given

 5 for their pull back were quite varied, included

 6 the fact that there were rapid price moves that

 7 caused automated stops in systems. The ability to

 8 trade securities under very volatile circumstances

 9 was a concern, so market makers pulled back

 10 because of that. The ability to trade ETFs and

 11 tie the price of an ETF to the price of the

 12 underlying stocks was also a concern during times

 13 of volatile movements. Becoming too long as

 14 market prices fell and in certain securities as

 15 market prices rose, becoming too short, was also a

 16 concern. We use the phrase catching the

 17 proverbial knife or standing in front of a moving

 18 train caused market makers to pull back. Rapidly

 19 changing PNLs, intra-day PNLs caused them to

 20 pause. Concerns about broken trades caused them

 21 to pause, and a number of market participants said

 22 that they had feared some unknown cataclysm that
 20

 1 was causing prices to move so fast and just chose

 2 to basically sit out the rest of the afternoon.

 3 All of those different themes might lead

 4 to different policy in order to address those, but

 5 the one thing that we do know is that when trading

 6 occurs under circumstances where the market makers

 7 pull back, you get very disorderly prices. So one

 8 of the first things that we've done at the SEC is

 9 put in individual market circuit breakers,

 10 individual stock circuit breakers. As the

 11 chairman has mentioned, those circuit breakers

 12 have been rolled out to not just the S&P 500

 13 stocks, but to the stocks in the Russell 1000 as

 14 well as to a bunch of underlying ETFs.

 15 Clearly erroneous trades were also a

 16 factor on that day, both the trades that were

 17 broken and the concerns about market participants

 18 that trades would be broken, and uncertainty in

 19 what those levels would be, would the trades be

 20 broken, would the trades not be broken. Market

 21 participants do not like to trade if there is a

 22 potential that the trade itself will be broken
 21

 1 because they're trading both sides of the market

 2 at the same time.

 3 So, from those themes come both the

 4 rules on clearly erroneous trades and rules on

 5 circuit breakers.

 6 The third theme that came out was that

 7 trades were certainly executed -- some trades, at

 8 least -- at very absurd prices of a penny or a

 9 tenth of a penny or even one- one hundredth of a

 10 penny. The big issue there is the use of stub

 11 quotes which are automated quotes that are

 12 provided by either the exchanges or the market

 13 makers when they pull back.

 14 We have forthcoming rules from the

 15 exchanges and FINRA to address just this -- just

 16 this case of stub quotes. The rules basically

 17 describe parameters by which stub quotes, or which

 18 quoting bans can be used in order to prevent

 19 prices from falling as rapidly as they did, and

 20 those rules, I think, we will see in the upcoming

 21 weeks.

 22 The fourth large theme has to do with
 22

 1 high- frequency traders. The report that we

 2 provided was not a discourse on high-frequency

 3 trading or on mechanisms of market structure, but

 4 we did highlight, at least on May 6th, some of the

 5 behavior of high-frequency traders. High

 6 frequency trading has been a highlight, certainly,

 7 in the press and in fact there was a piece on

 8 high-frequency trading on 60 Minutes a few weeks

 9 ago.

 10 There are lots of different views about

 11 high- frequency trading in the market but what we

 12 have found, at least on May 6th, is that the

 13 situation is perhaps a little more complex and

 14 nuanced than we might have thought. During the

 15 afternoon of May 6th, high-frequency traders were

 16 both providing significant amounts of liquidity,

 17 but also taking significant amounts of liquidity

 18 and on a volume basis, approximately half of their

 19 orders take liquidity and half of their orders

 20 provide liquidity.

 21 We do not have evidence that suggests

 22 that they had triggered or they had caused or
 23

 1 created a wave of selling, but we also do not have

 2 evidence that they have prevented the wave of

 3 selling from continuing or stabilized prices.

 4 They basically traded. They traded on the way

 5 down, they traded on the way up, and they traded

 6 along with the rest of the market. They traded

 7 with a high frequency, hence the term

 8 high-frequency traders.

 9 After the market declined and on the way

 10 back up, some of the high-frequency traders sat

 11 the rest of the afternoon out or withdrew some of

 12 their liquidity, others actually increased the

 13 amount of trading that they did. So, again, it's

 14 a very nuanced circumstance and I don't think we

 15 can classify all HFTs as either being in one

 16 bucket or a second bucket.

 17 We spent a lot of time rebuilding the

 18 order books. It took many months to rebuild the

 19 order books in the equities markets. That meant

 20 going through each exchange as well as the fees

 21 from FINRA looking at all the buy orders, the sell

 22 orders, and putting together a comprehensive view
 24

 1 of what the market looked like. Overall we did

 2 not see a liquidity crisis in the stock market

 3 that somehow proceeded or started that morning.

 4 It was really -- the liquidity crisis was a result

 5 of market participants who were pulling back that

 6 afternoon.

 7 The most important thing, I think, that

 8 we actually learned from rebuilding the order

 9 books was just how hard it is to rebuild order

 10 books in the equity markets and why it actually

 11 took so long in order to do that. To try to

 12 address some of those issues in the future and to

 13 allow us to have a much quicker response and a

 14 better handle, perhaps even in real time, there

 15 are a number of forthcoming rules, such as the

 16 consolidated order trail and large trader

 17 reporting that will allow the SEC to gather

 18 information in or at near real time in order to

 19 make these types of tasks a lot easier.

 20 In addition, we have recently gone to

 21 the market with an RFI or request for information,

 22 for venders who provide tools that allow the
 25

 1 aggregation of order books, in real time, to come

 2 into the SEC, make some presentations so that we

 3 can get a sense of what tools are available with

 4 the possibility of procuring such tools in the

 5 future.

 6 We also spent a significant amount of

 7 time in the report -- both in the preliminary

 8 report and the final report -- on some of the

 9 disparate nature of trading at different venues.

 10 In particular we spent time on understanding

 11 exactly how the New York Stock Exchange use of

 12 liquidity replenishment points work, so-called

 13 LRPs. LRPs are bans that are designed to pause

 14 trading in individual stocks if the price moves

 15 beyond certain pre- specified limits.

 16 In general, I think we had mixed

 17 reactions from different participants. Most of

 18 the participants that we spoke to said they had no

 19 problems with routing around New York Stock

 20 Exchange as the stocks themselves and the quotes

 21 went slow. However, the fact that there were so

 22 many LRPs triggering that afternoon certainly
 26

 1 contributed to the fact that people really got a

 2 sense of -- the market participants got a sense of

 3 just how volatile their circumstances were.

 4 For the majority of stocks that have

 5 broken trades, LRPs were not an issue because

 6 those are not traded on the New York Stock

 7 Exchange, not listed on the New York Stock

 8 Exchange. But for those trades -- for those

 9 securities that had broken trades, we had found

 10 that most of the securities did not have

 11 sufficient liquidity on the New York Stock

 12 Exchange to have absorbed the trading that

 13 ultimately lead to stub quotes. But some did, so

 14 it's not 100 percent that there was no effect.

 15 There was most likely a small effect for at least

 16 some of the stocks.

 17 Perhaps more importantly in thinking

 18 about LRPs was not what happened on May 6th, but

 19 how do we generalize LRPs, perhaps to things that

 20 we might do in the future? Specifically, we have

 21 learned a lot about how circuit breakers work and

 22 operate during the pilot program that we've had
 27

 1 over the summer by carefully examining every one

 2 of the circuit breakers, the circumstances that

 3 lead up to any of the circuit breakers that have

 4 triggered. I believe about a dozen circuit

 5 breakers have been triggered since the pilot

 6 program went into effect.

 7 If we couple the information that we

 8 learned from that with what we learned about

 9 different trading practices at markets about

 10 banding and about LRPs leads us to formulate some

 11 next generation circuit breakers that are focused

 12 more on limit up/limit down, how do we prevent a

 13 stock from going into a circuit breaker mode

 14 before the price moves instead of after the price

 15 moves. So, limit up and limit down is something

 16 that we've been considering both at the SEC as

 17 well as with a number of industry participants and

 18 as a bonus, limit up/limit down also should

 19 directly address things like stub quotes and

 20 clearly erroneous trades.

 21 The last large theme, I think, that

 22 comes out of the report is the use and the high
 28

 1 bars that people have around data. What we have

 2 -- what we did observe was that there were delays

 3 on the public feeds, the consolidate quotes and

 4 the consolidated tape feeds, on May 6th and while

 5 that may have affected users directly of those

 6 feeds, we also found that many of the market

 7 participants who are providing liquidity choose to

 8 use the direct feeds from the exchanges

 9 themselves, the so-called proprietary feeds.

 10 Nevertheless, folks who use, and market

 11 participants who use the CQS and CTS have to know

 12 that those feeds themselves are extremely reliable

 13 and that there are no delays.

 14 We worked very carefully with the

 15 exchanges on trying to understand the source of

 16 the delays that occurred on that day and we do not

 17 have any data or evidence at this point to suggest

 18 that one or more parties purposely flooded the

 19 market with quotes for the express purpose of

 20 trying to delay. We believe that the delays were

 21 caused by servers that were not yet upgraded and

 22 general very high volumes of traffic as people
 29

 1 were trying to trade during very, very disruptive

 2 market conditions.

 3 Nevertheless, over the summer and

 4 continuing, we have worked with the exchanges in

 5 trying to not only revisit May 6th, but also look

 6 at other days of very high quote traffic to try to

 7 ensure that the exchanges and the SROs have the

 8 capacity, to make sure that they can handle any of

 9 the quote traffic that comes out there, as well as

 10 looking at any potential quoting practices that

 11 might be manipulative.

 12 In order to address some of those

 13 issues, we have thought about not only the RFI

 14 that we have so that we can see the data in real

 15 time in things like consolidated audit trail and

 16 large trade reporting that will help us examine

 17 what parties are doing what, but as recent as

 18 yesterday, I think, or two days ago, the SEC

 19 passed rules regarding sponsor access by which

 20 algorithmic trading can occur through a broker in

 21 a form that is no longer completely naked, where

 22 the trades go in directly but that the broker
 30

 1 would actually have some responsibilities and

 2 oversight about ensuring certain risk management

 3 and other procedures to have some oversight about

 4 those algorithms themselves.

 5 Thank you.

 6 CHAIRMAN GENSLER: Steve?

 7 MR. SHERROD: Thanks, Greg. I'm going

 8 to briefly summarize two actions taken by the CFTC

 9 last week. In the first action the CFTC approved

 10 a proposed rule that would expand the prohibition

 11 of market manipulation of swaps. Generally the

 12 proposed rule makes it unlawful for any person to

 13 defraud another in connection with any swap.

 14 Further, the proposed rule makes it unlawful for

 15 any person to manipulate or attempt to manipulate

 16 the price of any swap.

 17 In the second action, the CFTC approved

 18 an advanced notice of proposed rulemaking on

 19 disruptive trading practices. Congress amended

 20 the Commodity Exchange Act to expressly prohibit

 21 certain trading practices that Congress determined

 22 were disruptive of fair and equitable trading.
 31

 1 The amendments make it unlawful for any person to

 2 engage in any trading practice or conduct on or

 3 subject to the rules of a registered entity that,

 4 one, violates bids or offers; two, demonstrates

 5 intentional or reckless disregard for the orderly

 6 execution of transactions during the closing

 7 period; or three, is of the character of, or is

 8 commonly known in the trade as spoofing, that is,

 9 bidding or offering with the intent to cancel the

 10 bid or offer before execution.

 11 Congress also granted the Commission

 12 authority to promulgate such rules and regulations

 13 as, in the judgment of the Commission, are

 14 reasonably necessary to prohibit any other trading

 15 practice that is disruptive of fair and equitable

 16 trading. The notice encourages the commoners to

 17 address a number of specific questions, I'll

 18 provide you two: Should the Commission specify an

 19 additional disruptive trading practice concerning

 20 the disorderly execution of particularly large

 21 orders during periods other than the closing

 22 period? And second, should the Commission
 32

 1 promulgate additional rules specifically

 2 applicable to the use of algorithmic trading

 3 methodologies and programs that are reasonably

 4 necessary to prevent the algorithmic trading

 5 systems from disrupting fair and equitable

 6 trading?

 7 That concludes my summary.

 8 CHAIRMAN GENSLER: And I think that

 9 concludes the panel. And so I want to thank Gregg

 10 and Andre and Steve and it was really -- as an

 11 opportunity, I just wanted to give our committee

 12 members an opportunity to ask questions and have a

 13 discussion with our staff and then after that

 14 we'll go to the subcommittees.

 15 Susan?

 16 MS. PHILLIPS: I didn't quite follow the

 17 point you were making about the fees. What was it

 18 you were -- the point you were trying to make with

 19 the fees?

 20 COMMISSIONER BERMAN: Sure, so this

 21 refers to the pricing feeds for trades and for

 22 quotes that are accessible by the public directly,
 33

 1 the so-called consolidated tape. The consolidated

 2 tape, trades on that tape were delayed for certain

 3 symbols on the New York Stock Exchange on May 6th.

 4 CHAIRMAN SHAPIRO: Gregg, I think --

 5 Susan, I think Greg said feeds, F-E-E-D-S, not

 6 fees.

 7 COMMISSIONER BERMAN: Oh, I'm sorry.

 8 Oh, feeds as opposed to fees.

 9 CHAIRMAN SHAPIRO: I think that's the

 10 source of the confusion.

 11 MS. PHILLIPS: I could not get the

 12 connection.

 13 CHAIRMAN SHAPIRO: I can see why.

 14 CHAIRMAN GENSLER: Maureen?

 15 MS. O'HARA: Andre, I just wanted to

 16 follow up on the role that the large trade played

 17 in precipitating the crash. As I read your

 18 report, it seemed as if the report was saying that

 19 perhaps this is the straw that broke the camel's

 20 back, that there were already liquidity issues in

 21 the markets that day and this large trade came

 22 along and obviously we can't replay history and
 34

 1 said, if that trade never happened, we would --

 2 may have not had a crash, but is it the case that

 3 that interpretation is correct or is it the case

 4 that your view is that that trade is in fact the

 5 cause of the crash or just more correlating with

 6 the beginning of the crash?

 7 MR. KIRILENKO: Thank you, Maureen.

 8 There were 15,000 trading accounts trading on that

 9 day in the E-Mini. One trading account, as we say

 10 in the report, conducted the largest change in

 11 that position of the year up to that point in a

 12 matter of 20 minutes, which happened to coincide

 13 with the onset of the extreme move in volatility.

 14 We did examine the execution profiles of pretty

 15 much all trading accounts -- all of them -- all

 16 thousands of them -- and we grouped them into

 17 categories, because some of them behaved very

 18 similarly and, therefore, it was justified to put

 19 them into categories, and then we looked at how

 20 they interacted.

 21 The way that, as you know, these markets

 22 work, and the way that this particular trade was
 35

 1 done, as the report states, was done through an

 2 automated execution program. An automated

 3 execution program is designed, they're generally

 4 designed not to be disruptive. However, under

 5 some circumstances -- or generally this automated

 6 execution programs are also designed to take the

 7 market as given so they assume that the market is

 8 moving where it's moving and by doing what they're

 9 doing, they're going to have an impact, but not

 10 necessarily move the market.

 11 However, in some cases it might be that

 12 what the -- an automated execution program is

 13 doing is actually causing the movement in the

 14 market to which it then starts to react. And this

 15 is what we were trying to uncover and we found

 16 some evidence that this is what might have

 17 happened.

 18 CHAIRMAN GENSLER: But can I just ask,

 19 Andre, to stretch the analogy a little bit, but

 20 this camel, was it thirsty and parched before the

 21 weight of one trade was put on it? I think that's

 22 Maureen's question because the report does say
 36

 1 that the order book and the E-Mini was about -- I 

 2 can't recall the exact numbers -- about half or so

 3 was already dissipated. The volatility index is

 4 measured either in the VIX index or elsewhere. It

 5 was quite high. You had currency movements and

 6 other movements in other markets that were pretty

 7 significant before 2:30. So, how parched was the

 8 camel before the extra weight was put on the back?

 9 MS. O'HARA: I like that.

 10 MR. KIRILENKO: The camel was pretty

 11 parched. The camel was -- the camel may not have

 12 been necessarily dying of thirst, but it was

 13 pretty thirsty.

 14 MS. O'HARA: It's a came problem,

 15 clearly.

 16 MR. KETCHUM: Gregg and Robert, perhaps

 17 a follow up question. Starting with the

 18 compliments with respect to both staffs and both

 19 commissions because I think each of the actions,

 20 as you'll see from the various buckets we see of

 21 issues, I think, go directly to a variety of the

 22 realities and frailties of our existing electronic
 37

 1 market and I think both commissions have raised

 2 and gone to precisely the right type of issues,

 3 but you mentioned briefly your view that it may

 4 well be appropriate to go beyond the initial

 5 triage of market pauses with the clear benefits

 6 they provide but some of the limitations from the

 7 standpoint of slowing trading in times when it

 8 turns out there really isn't serious imbalances

 9 and also not controlling an error trade occurring

 10 substantially away from the market. Since the

 11 error trade only triggers the pause, it is not

 12 stopped in itself, and you talked about variety of

 13 modernized limit approaches that, if I understood,

 14 would be in some way or another time-based and

 15 time-based, volatility-based in a short timeframe.

 16 I think the Commission has been right to

 17 focus on pauses first, which is both

 18 technologically easier to put in place, and from a

 19 term-wise, far easier to both understand from a

 20 market standpoint and to implement. Some of the

 21 challenges -- I also agree that the Commission is

 22 right to be pushing towards a more flexible and
 38

 1 more complete approach for the reasons I

 2 mentioned, but the challenges of limits are both

 3 being able to properly identify reference prices,

 4 identifying how the market restarts in situations

 5 where there are serious imbalances as opposed to

 6 where it balances, and how to avoid simply a

 7 cascading of limit on limit on limit and creating

 8 in a slightly longer, but still very short time,

 9 the similar volatility that we experienced on May

 10 6th.

 11 I can't pretend not to know -- I know

 12 you've had conversations with the exchanges and

 13 FINRA about some of those issues. Are you in a

 14 position to elaborate anymore of your thoughts

 15 about how those type of issues can be addressed

 16 with respect to limits? Or is that still a matter

 17 of, sort of, consideration and you're not to the

 18 point of being able to discuss it?

 19 MR. COOK: Well, Rick, I think you've

 20 teed up a lot of the issues that we're working

 21 through in connection with this discussion. There

 22 are a number of complicating factors that you just
 39

 1 identified -- how do you measure the reference

 2 price, when do you decide to trigger the limit,

 3 and when do you decide that it's actually -- the

 4 limit is no longer really the right way to go, you

 5 have to pause the market to reopen because the

 6 trading interest has moved so far outside whatever

 7 band you set for the limit, that there really

 8 needs to be a reopening procedure. And,

 9 importantly, how do you do this in a way that is

 10 going to work as a practical matter and that

 11 people will understand? Because you can get very

 12 complicated here very quickly and we have a market

 13 with all different types of participants, and we'd

 14 like to have something that people will understand

 15 how it works, can plan for how it will work.

 16 But to go to your specific question, I

 17 think it's a little premature now to try to frame

 18 out some of the possible approaches here that

 19 we're considering. We're in active dialogue,

 20 though, and I think -- you know, I think one thing

 21 that would be good to emphasize is that there's

 22 strong support and consensus, I think, among all
 40

 1 the exchanges and all the relevant market

 2 participants we've been talking to to do this, so

 3 we're very optimistic that we'll find the right

 4 approach. What we need to do and what we're

 5 spending the time doing is to make sure that

 6 whatever specific parameters we choose are the

 7 right ones and can be implemented without too much

 8 disruption. So, we're hoping to be bringing

 9 something forward with the participation of the

 10 exchanges in the relatively near future for people

 11 to react to.

 12 MR. KETCHUM: Thank you.

 13 CHAIRMAN GENSLER: David?

 14 MR. RUDER: Gregg, you talked about

 15 market data and the proprietary feeds as opposed

 16 to CQS. I heard from your discussion somehow or

 17 other that you thought that there was some way to

 18 bring these two feeds together, that there was

 19 some way that CQS could catch up with the

 20 proprietary feeds so that all the information came

 21 to the market in the same place?

 22 It's my understanding that that -- that
 41

 1 given collocation proprietary feeds, that's not a

 2 very likely result. Could you comment on that?

 3 CHAIRMAN GENSLER: And Gregg, and just

 4 as you -- could you explain what CQS, for the

 5 public -- listening public, just if you could give

 6 a -- thank you to former Chairman Ruder, but the

 7 public might not know.

 8 COMMISSIONER BERMAN: Sure. So, the

 9 exchanges have systems that are producing quotes

 10 and trades and those are internal, they come out

 11 of their matching engine when quotes are compared

 12 and trades are produced. In addition to the

 13 internal systems, the exchanges have feeds. Some

 14 of those feeds only have exchange information.

 15 So, on the New York Stock Exchange, on NASDAQ,

 16 they have the quotes and the trades that are only

 17 on that exchange. Those are what we would call

 18 the proprietary feeds.

 19 In addition, every exchange in the SROs

 20 are required to send trades that are occurring on

 21 their exchange as well as quotes, but not all the

 22 quotes, just the best quote, the best bid, and the
 42

 1 best offer, to a central system that aggregates

 2 the quotes and the trades from all of the

 3 exchanges and FINRA at the same time. Those two

 4 feeds are called the CQS and the CTS, for

 5 consolidated quote system and consolidated trade

 6 system, actually two separate feeds that are going

 7 out to the market.

 8 As a market participant, you can

 9 subscribe to the proprietary feeds from every one

 10 of the exchanges and you can see the depth of

 11 books, you can see all the quotes, or you can gain

 12 access to the CQS and the CTS, which contains the

 13 same data except across all markets at the same

 14 time, but in limited scope, you don't see the

 15 depth of the market itself.

 16 Regulation NMS basically provides

 17 requirements that says every exchange, every SRO,

 18 must make available data to the SIP, the plans

 19 that support the CQS and CTS feeds at the same

 20 time that they make data available to other market

 21 participants.

 22 So, there should be no delay between the
 43

 1 information that goes out from an exchange on the

 2 proprietary feeds and those that that can be

 3 obtained from the CQS and CTS.

 4 Now, there are some technology delays

 5 that are on the order of milliseconds, but what we

 6 saw on May 6th was that the delays were on the

 7 order of seconds and sometimes many seconds, and

 8 that -- those are technology issues that can be

 9 resolved.

 10 MR. RUDER: That's not quite my

 11 question. As I understand it the CQS has to bring

 12 together all of the proprietary feeds in order to

 13 get a common quote that -- NBBO quote that it

 14 could put out to the market and that takes

 15 sometimes up to two seconds, as I understand it,

 16 whereas the proprietary feeds can take place in

 17 milliseconds, and what I'm asking is whether

 18 you're suggesting that there was some way to

 19 bridge that gap, technologically or in other ways.

 20 It seems to me that as I look at it, that that's

 21 probably a fact of life that has to be accepted,

 22 that there will be a difference in the speed of
 44

 1 those and we need to deal with that as a problem

 2 rather than assuming that these can somewhat be

 3 brought together.

 4 COMMISSIONER BERMAN: That's exactly

 5 right. There will always be a delay because what

 6 happens on the CQS and the CTS is an aggregation.

 7 That takes time. However, the timing on that is

 8 on the order of milliseconds, so the delays are

 9 measured in fives and sixes and tens of

 10 milliseconds, not seconds, so at a minimum we want

 11 to make sure that the delay is at the level that

 12 is technologically possible today, so there should

 13 be no excuse for a two second or a three second

 14 delay, but nevertheless, there will always be some

 15 delay, but again that delay will be measured in

 16 milliseconds.

 17 CHAIRMAN SHAPIRO: Could I actually

 18 follow up on that? So, even if you had -- could

 19 somehow guaranty dissemination to the public,

 20 because it's the receipt of the information, I

 21 think, is sort of the operative issue here, not

 22 when the information gets to the SIP or gets
 45

 1 disseminated, but it's when it's received by

 2 either subscribers or market participants. Can

 3 you -- is there anything you would do to ensure

 4 that everybody received the information at the

 5 same time and then could act on it and respond to

 6 it quickly? Or because of things like

 7 collocation, even if you had a rule that said that

 8 information can't be disseminated until exactly

 9 the same moment, whether it's from a proprietary

 10 feed or a consolidated feed, collocation is still

 11 going to give some entities a time advantage

 12 because they'll receive the information a

 13 microsecond faster?

 14 MR. GRAY: It would be possible and this

 15 was an issue that the Commission talked about in

 16 its concept release on market structure that it

 17 issued back in January. Right now, as Gregg said,

 18 the rule is, exchanges can't provide the

 19 information to their proprietary customers any

 20 sooner than they provide it to the consolidator,

 21 and the issue that the Commission asked for

 22 comment about in the concept release was, should
 46

 1 the exchanges be told, delay releasing the

 2 information to your proprietary customers until

 3 it's clear that the information has had time to go

 4 through the consolidator and get to the

 5 individuals? And a lot of people commented on

 6 that in various ways.

 7 MR. BRENNAN: Would -- isn't an even

 8 simpler answer to say, eliminate proprietary --

 9 eliminate the proprietary feed? Was that one you

 10 looked at? Is that seen as anti-competitive or

 11 anti-free market? But that would certainly solve

 12 the problem of differentiated access, right?

 13 CHAIRMAN GENSLER: But the proprietary

 14 feed has greater depth of --

 15 MR. BRENNAN: I understand. I

 16 understand.

 17 MR. RUDER: That's still another

 18 question, the depth of book question. If --

 19 whether we're talking here about the best quote

 20 being disseminated to the public and the public

 21 now does not get, as I understand it, the depth of

 22 book feed that goes under the proprietary feeds.
 47

 1 MR. COOK: I think part of the question

 2 here is what we're trying to solve for because I

 3 think all this is correct, and you could say

 4 theoretically that you can't distribute

 5 proprietary feeds at all. You could try to put

 6 some time delays and then people will try to game

 7 around that and so if, for example, you say, well,

 8 you can't collocate in the same building, people

 9 will try to collocate a mile away or two miles

 10 away, whatever, just outside whatever band you

 11 put. I mean, I think most of the very active

 12 traders in the markets and many of the traders who

 13 are trading on behalf of customers who need the

 14 speed, actually subscribe to these proprietary

 15 feeds, so they have it.

 16 The delay, while it can be relevant in

 17 some circumstances, often is non consequential to

 18 people who are not basing their trading strategy

 19 on, you know, that -- it doesn't depend on

 20 milliseconds, so it really depends on your

 21 strategy. If you're able to trade on your

 22 strategy based on the consolidated feeds, it may
 48

 1 not be worth it to you to pay some more for the

 2 proprietary feeds but on the other hand some

 3 people find it useful to get those feeds to put

 4 together the depth of order book. And so I think

 5 there are competitive issues here at play. There

 6 are commercial issues for the exchanges, in this

 7 role, venders of data that are important to their

 8 commercial strategy, and I think -- and it is

 9 important, though, to recognize that for many

 10 people this delay -- many people maybe -- many

 11 people who may be trading, this delay really isn't

 12 that significant, doesn't really impact their

 13 trading strategy.

 14 CHAIRMAN GENSLER: Maureen?

 15 MS. O'HARA: Can I just follow up a

 16 moment on this? So, one could think about the

 17 fact that there is a vector of information here,

 18 some of which, the price for example, is something

 19 that would be relevant for every trader, some of

 20 which orders of magnitude of the book are not

 21 relevant for every trader. How difficult -- or is

 22 it infeasible -- to sort of make rules that say
 49

 1 that the price per se, the execution prices, all

 2 have to be available at the same time but the

 3 other information could be disseminated more

 4 quickly?

 5 I'm just trying to think about the fact

 6 that not all information has value but some does,

 7 and is there any way -- have you considered, sort

 8 of, breaking this problem down into pieces and

 9 saying the price data has to be all the same but

 10 the quotes and other depth data could be allowed

 11 to coexist?

 12 CHAIRMAN GENSLER: Maureen, can I ask --

 13 when you say price data --

 14 MS. O'HARA: Trades, the executed

 15 trades.

 16 CHAIRMAN GENSLER: The executed trades,

 17 what's called the transaction data rather than the

 18 quote data.

 19 MS. O'HARA: The transaction data,

 20 right.

 21 COMMISSIONER BERMAN: From a technology

 22 standpoint, it's certainly possible and in fact
 50

 1 there are two separate feeds, one of the trades

 2 and one of the quotes. In fact, one of the

 3 challenges that we had in the analysis of May 6th

 4 is actually tying those together. To the extent

 5 that participants are relying on the price to

 6 determine what quotes they want to put in, they

 7 will also be relying on quotes on the other side

 8 of the market, so if we do have delays between

 9 those two, we would have to think about what are

 10 the implications for people who are making markets

 11 to be able to determine, what quote do I want to

 12 place if they're seeing prices of actual

 13 transactions that have been delayed?

 14 MR. KETCHUM: Just to follow up on that,

 15 Maureen. It seems to me, if I understand the

 16 question -- I may not -- that their fundamental

 17 complexity gets very hard. If you segregated out

 18 the top of book feed for every marketplace and

 19 every trading system that had a quoting obligation

 20 and you just provided the back book feed, the

 21 remaining information as proprietary information,

 22 the trouble is that the order that is identified
 51

 1 as the best quote, given the latency issues, is

 2 going to be different, so you're going to have

 3 best bid information and best offer information

 4 that's not consistent with the depth of book that

 5 you're showing at the same time because it's going

 6 to be nanoseconds to a second delay depending on

 7 volume and the rest, so it's sort of hard, I would

 8 think, to detach the top of the book from the rest

 9 of the book if you're really getting -- because

 10 otherwise you're not going to get the actual feel

 11 at that instant as to what the book composition

 12 is.

 13 CHAIRMAN GENSLER: Brooksley?

 14 MS. BORN: Well, let me just raise a

 15 slightly different topic. I was interested in

 16 what the report had to say about the algorithm

 17 that was used by the trader that seems to have

 18 triggered or acted as a stimulus for the flash

 19 crash and I wondered if the staff knows whether

 20 that algorithm that has neither price limits nor

 21 time limits is commonly used, widely used in the

 22 marketplace or whether it's proprietary to just a
 52

 1 few traders or executing brokers, and whether

 2 there has, in the past, been any study of

 3 algorithms and whether or not they can be limited

 4 to assure orderly trading.

 5 MR. KIRILENKO: Thank you very much for

 6 this very important and thoughtful question. We

 7 have been engaged in discussions with market

 8 participants who provide automated execution

 9 services. We've looked at this specific algorithm

 10 and we've also looked at other automated execution

 11 algorithms and the -- each one of these algorithms

 12 consists of a number of moving parts and some of

 13 these moving parts are set in motion by the

 14 customers who set parameters so that as these

 15 parts start moving, some of these moving parts are

 16 preset within the box that is part of the

 17 algorithm.

 18 What we were trying to discern in our

 19 understanding of the automated execution

 20 algorithms is whether or not there is capacity for

 21 an algorithm -- automated execution algorithm

 22 specifically, that is, just for background,
 53

 1 automated execution algorithms are designed

 2 typically to take a trade, typically a large

 3 trade, and split it into a sequence of smaller

 4 trades so as to minimize market impact.

 5 So, it could do it, depending -- these

 6 algorithms could do it by taking into account the

 7 actual prices at which they execute, they could

 8 also try to target a proportion of market

 9 activity, for example, volume. They also could

 10 look at depth. They look at -- they often

 11 randomize times at which they submit orders so as

 12 not to be detected by other market participants.

 13 What we were specifically looking for is

 14 whether or not there is capacity -- or still are

 15 looking for, whether or not there is capacity was

 16 in automated execution programs to cascade and

 17 that is a very active area of inquiry, and this is

 18 the area of inquiry that feeds into our -- some of

 19 the issues that, hopefully, the Joint Advisory

 20 Committee would also consider, which is what is

 21 the role of the executing brokers in provision of

 22 automated execution services.
 54

 1 CHAIRMAN GENSLER: Andre, maybe if I can

 2 -- this may be the question that -- how common is

 3 the use of automated execution algorithms that

 4 don't limit price or time? I mean, other than the

 5 -- of course they always look at the price of the

 6 last trade, but don't have an overall price band

 7 or time band? I think that was --

 8 MR. KIRILENKO: We looked at the large

 9 trades in the E-Mini. Large, and by large I mean

 10 that trades of the same size or larger, that

 11 occurred in the previous 12 months, and as the

 12 report states, that was the only time when an

 13 algorithm that did not take into account, did not

 14 set an overall price limit or time limit, was

 15 used.

 16 MS. BORN: For these very large trades?

 17 MR. KIRILENKO: For large trades.

 18 MS. BORN: So, you haven't studied

 19 whether it's used for smaller trades?

 20 MR. KIRILENKO: We have conducted

 21 conversations, we've had numerous conversations

 22 with executing -- this particular executing
 55

 1 broker, and this type of algorithm, they did not

 2 provide specific statistics, but it is not widely

 3 used.

 4 MR. COOK: I think the broader question

 5 of understanding algorithms and the whole process

 6 by which -- this is obviously so important in the

 7 markets now because almost any trade being entered

 8 into a high speed market like this needs to be

 9 done through some form of algorithm if it's of --

 10 especially if it's of any size, because the whole

 11 purpose of the algorithm is to be able to execute

 12 the trade without influencing the market price,

 13 and I think understanding -- the areas that we

 14 would like to continue to understand better

 15 include the whole process for the design/creation

 16 of an algorithm, the way that it's made available

 17 to customers, what kind of controls are around

 18 that, what type of testing occurs, what kind of

 19 disclosure occurs around the provision of

 20 algorithms to customers so that they know. I

 21 think these are useful areas for further inquiry.

 22 They are somewhat picked up in the sponsored
 56

 1 access proposal that the SEC approved on Wednesday

 2 with -- in a sense that there are obligations now

 3 for firms who have market access or who provide

 4 market access to somebody else, to make sure they

 5 have reasonable policies and procedures to deal

 6 with the issues such as error trades or trades

 7 that exceed preset limits of some type.

 8 But it is an issue, I think, where we

 9 have been studying it, we actually have a

 10 taskforce at the SEC that was cross-divisional and

 11 formed before May 6th to begin to look at some of

 12 these issues and go out and meet with some of

 13 these firms and talk to them about the trading

 14 strategies they're using and the algorithms

 15 they're using, and I know Dan and David have been

 16 part of this. I don't know if you want to comment

 17 on, more specifically to your question about how

 18 prevalent some of these types of algos are, at

 19 least as much as we've been able to learn to date

 20 through our interviews with market participants.

 21 MR. GRAY: Well, it's hard to say

 22 exactly how often a particular type of algo is
 57

 1 used, but this participation algorithm, which is

 2 just based on volume, is not unusual. It can be

 3 often part of a suite, though I guess I would --

 4 it's understood that you should be careful how you

 5 use an algorithm that doesn't have all of the

 6 throttles that some of the other ones do.

 7 CHAIRMAN GENSLER: That's really --

 8 staff will bail me out here, please, but as I

 9 understand, it's that many of the execution

 10 algorithms, a client has a choice to pick from a

 11 suite of what is -- that Dan said is a throttle.

 12 What is the limit? It's almost like doing a pull

 13 down menu. I don't know if it was literally a

 14 pull down menu, but so the client has a choice.

 15 Do they want to set price? Do they want to set

 16 time? Do they say, all right, I want to do 10,000

 17 contracts over the course of the next three hours

 18 randomized? Do I want to do it within 3 percent

 19 or 6 percent or -- you know. So they have a

 20 choice. The algorithm might have a number of

 21 things programmed in and as I understand it, the

 22 executing broker here didn't see specifically the
 58

 1 choices the customer made, and as we understand

 2 it, that is quite usual that the executing

 3 broker's algorithm is -- the customer is using

 4 that algorithm, it wants anonymity, so the

 5 executing broker doesn't know which choices they

 6 made, which throttles their limits. 

 7 MR. KIRILENKO: Right. I would like to

 8 --

 9 CHAIRMAN GENSLER: Did I get that about

 10 right?

 11 MR. KIRILENKO: That's right, and I

 12 would like to perhaps clarify a little bit that

 13 the use of an algorithm versus the parameters,

 14 which is what I was trying to say before -- versus

 15 the parameters specified by the customer, so the

 16 -- you know, it's often said that this particular

 17 algorithm -- basically, many algorithms can be set

 18 with certain parameters to do very similar things

 19 even though the algorithms are very different.

 20 So, an algorithm that takes --

 21 explicitly takes price into account, you can set

 22 the prices so wide that it will not. The
 59

 1 algorithm that takes time into account, you can

 2 set the time to a month and it will not. So, the

 3 customer has a choice to set the parameters and so

 4 the -- on May 6th, it was both the parameters that

 5 were set and the algorithm that was used that are

 6 important, and from that extent we're trying to

 7 understand better what are the parameters and how

 8 the particular combination of parameters, not just

 9 the algorithms, that customers need to know about.

 10 CHAIRMAN GENSLER: I'm sorry, Brooksley

 11 and then Susan.

 12 MS. BORN: So, currently, at least with

 13 respect to this particular executing broker, there

 14 is no kind of oversight of the customer's choices.

 15 There isn't a review at any point of whether this

 16 has been an appropriate use of an algorithm that

 17 will not be disruptive to the market. Is that

 18 right?

 19 MR. KIRILENKO: I cannot speak on behalf

 20 of the executing broker. Our limited

 21 understanding is there are certainly risk

 22 parameters in place prior to any of the customers
 60

 1 could place any order or use any of the pipeline

 2 used by the executing broker. These particular

 3 customers must have accounts with executing

 4 brokers, they also have limits on how much they

 5 execute over what periods of time and what

 6 executing brokers could do for them.

 7 Within those agreements there might be

 8 very specific requests that customers may give to

 9 executing brokers not to oversee their trades or

 10 not to see how the trade has been executed. And

 11 part of it, it could be easy to understand, is

 12 that the customer may not necessarily feel like

 13 disclosing its trading activity to an executing

 14 broker in order not to be, for example, affected

 15 by some other activity -- executing trading

 16 activity that this executing broker may undertake.

 17 Therefore, a customer wants to protect

 18 what it wants to do in executing its large order,

 19 for example.

 20 CHAIRMAN GENSLER: Susan?

 21 MS. PHILLIPS: I understand that you're

 22 looking further into whether or not there should
 61

 1 be some kind of constraints, constraints on these

 2 algorithms. I guess what I'm wondering is, are

 3 there in existence now any best practices that --

 4 informal best practices -- that broker- dealers

 5 should be following?

 6 COMMISSIONER BERMAN: At a recent

 7 conference given by SIFMA, we actually heard a

 8 panel on exactly that topic and I think today it's

 9 quite varied. You'll have some brokers who

 10 actually have throttles, they will override in

 11 real time trading as it happens. You have others

 12 who don't have those throttles, so I don't know to

 13 the extent that there are best practices. From

 14 what we've heard from some of those providing

 15 algorithms, it is a competitive market and many

 16 parties will use multiple algorithms by different

 17 executing brokers, and as with all things, if they

 18 find that there are throttles preventing them from

 19 doing what they would like at one party, they may

 20 go to a different party.

 21 Within that, one thing I'd like to

 22 highlight and come back to something that Andre
 62

 1 said before, when we think about executing

 2 algorithms, we normally think about feeding in

 3 prices slowly so that you don't move the market,

 4 but there is an added complication that has to do

 5 with the other side of algorithms, namely

 6 algorithms by parties who are not trying to

 7 execute but are trying to respond to what the

 8 market is doing, namely those that are generally

 9 run by high-frequency traders. In addition to

 10 feeding in information slowly so you don't disrupt

 11 the market, you have to feed it in a way that

 12 doesn't give you away, to show that there is an

 13 algorithm. So, there's quite a bit of a feedback

 14 going on that if someone can detect that there is

 15 an algorithm on the other side, then the person

 16 who is detecting the algorithmic trade can in turn

 17 have an algorithm that plays off of that. That's

 18 a recently new phenomenon, so it's obvious that

 19 you want to feed something in slowly, not to

 20 disrupt the market, but you also want to do that

 21 in a way that doesn't cause the market to change

 22 because of that algorithm itself.
 63

 1 CHAIRMAN GENSLER: I was just curious,

 2 Robert or Gregg, the rule that was just adopted, I

 3 guess two days ago, about sponsored access, does

 4 that require the executing broker to filter the

 5 choices, or is it like what we have currently in

 6 the futures marketplace where there are many risk

 7 filters, like our executing brokers have to make

 8 sure you have the margin and the financial

 9 resources, but in the futures market at least

 10 currently the executing broker does not limit the

 11 choices, these choices you're talking about? So,

 12 that's my question, what did the SEC do in that

 13 regard?

 14 MR. COOK: Well, it does require that

 15 the firm with market access, so the one who has

 16 the pipes into an exchange and is using those

 17 pipes for its own trading or to offer a pipeline

 18 for someone else to come through, have in place a

 19 set of policies and procedures and supervisory

 20 controls around providing that access to address a

 21 range of issues including financial risk, risk of

 22 error trades, that sort of thing. It doesn't get
 64

 1 -- the rule is not very prescriptive about saying

 2 you can do this, you can't do that, but it does

 3 require that all firms establish a baseline for

 4 making sure that they have some reasonable

 5 controls around error trades, for example, but it

 6 doesn't limit the choices that a firm can provide

 7 in terms of algorithms made available to its

 8 customers.

 9 CHAIRMAN GENSLER: So, it sounds like,

 10 though -- I mean, I'm sure that there are things

 11 we can learn in our world, and we'll take a close

 12 look at, particularly as we look at Dodd-Frank,

 13 but it sounds like it's about financial resources,

 14 or as in our world, margining and capability to do

 15 margining, error trades, using the pipeline as

 16 contrasted to a choice as to whether you limit a

 17 large order by time or price.

 18 MR. COOK: Yes, but, you know, part of

 19 having reasonable controls would be making sure

 20 that you're not offering an algorithm that could

 21 reasonably be foreseen as having a negative impact

 22 on the participant or the market, so I don't want
 65

 1 to make it sound like it's just about --

 2 CHAIRMAN GENSLER: So, it could cover --

 3 it could cover the other area?

 4 MR. COOK: Oh, yeah.

 5 CHAIRMAN SHAPIRO: And it clearly is

 6 about more than just financial and credit risk

 7 issues.

 8 MR. KETCHUM: If I could just add,

 9 before the SEC's action this week, the exchanges

 10 in FINRA had general supervisory rules that went

 11 to this point, although not with the depth and

 12 direction that the SEC rule will now put in place

 13 and it certainly does look to control with respect

 14 to error trades. It certainly looks to control

 15 from the standpoint of risk standpoint. It looks

 16 at the very edges with respect to controls on

 17 things that could be viewed as disruptive although

 18 generally at most focusing on that activity added

 19 around a close or some unique event. As you note,

 20 Chairman Gensler, the challenge of going beyond

 21 that to directing with respect to individualized

 22 choices as to when you use particularly algorithms
 66

 1 and what controls you build in with respect to

 2 stops and limits and a variety of other things, no

 3 one has tried to implement that far other than

 4 expecting careful supervision from the standpoint

 5 of broker-dealers. So, it remains an area of

 6 focus in our side as well as in your side.

 7 MR. COOK: Just to give you an example,

 8 and to pick up on Rick's point that, you know, it

 9 was mentioned that we've had triggers of the

 10 single stock circuit breakers and some of them

 11 have happened because very large orders come in

 12 and they are executed too quickly in a way that in

 13 retrospect you'd say, well, that was kind of

 14 foreseeable that we're going -- for example, if

 15 you put in an order too quickly in an amount

 16 that's many times the average daily trading volume

 17 for a security and you try to execute within a

 18 couple seconds amounts that typically are executed

 19 over a couple days, that sort of control against

 20 that type of algorithm or order entry, whether

 21 it's by algorithm or otherwise, are the sort of

 22 controls that we're talking about requiring a firm
 67

 1 that has access to a market to have in place to be

 2 able to filter out those sorts of trading

 3 activities.

 4 MR. KIRILENKO: May I just -- just very

 5 shortly to some of the question that you ask. I

 6 think that there has been a quite genuine desire

 7 expressed to us by some of the executing brokers

 8 for certainty, for some greater certainty in

 9 parameters that they'd like us to consider. And

 10 they say, well look, these are algorithms. Just

 11 tell us what to program, we'll program it in. We

 12 just need to know what to put into the box. Just

 13 tell us.

 14 CHAIRMAN GENSLER: Maureen and then I

 15 think what I'll do is -- you're going to stay at

 16 the table, I think, but have the subcommittee's

 17 report and then we'll continue the dialogue, but I

 18 think based on the subcommittee, so it would be

 19 helpful. But Maureen?

 20 MS. O'HARA: I'd just like to return to

 21 a point that Gregg raised about the obligations

 22 for executing brokers in general, and in the case
 68

 1 of an algorithm where a customer has made a choice

 2 of parameters, that seems like one issue, but

 3 something that seemed troubling in the crash was

 4 the routing decisions of brokers to apparently

 5 send orders to venues that had nothing in their

 6 books. And so the question of what is the best

 7 execution obligations in worlds where brokers sort

 8 of just route around venues to go to other venues

 9 without sort of checking that at all? Do you have

 10 any comments and feedback on that?

 11 I mean, one of the issues that did seem

 12 to leap out at this is that, you know, many of the

 13 internalizers, for example, seem to have stopped

 14 internalizing and just routed away, and it raises,

 15 I think, very interesting questions about best

 16 execution and what are the obligations.

 17 MR. COOK: There are certainly

 18 obligations from a best execution standpoint and

 19 we spoke to a number of the internalizers about

 20 their decision and how they thought through the

 21 process. The way that it was described to us was

 22 that they have algorithms themselves that are
 69

 1 taking incoming orders and based on their own

 2 internal risk limits are going to process their

 3 orders to the best that they can possibly do. The

 4 best that they can possibly do when you get a

 5 market order that says you must sell immediately

 6 at this price, is to look out -- well, first, look

 7 internally, would you like to buy the other side,

 8 and if the answer is no, then to look out at the

 9 different venues.

 10 So, they were cognizant of the fact that

 11 they were taking a market order and they saw that

 12 there was a price for 13 cents for a stock and

 13 they would say, sell that stock for 13 cents. And

 14 we asked about that, we said, well, why would you

 15 do that, and I think they had a fair answer which 

 16 was, how can we not do that if we were instructed

 17 to sell that immediately? We had programmed our

 18 algorithms to do that already so there was no way

 19 of stopping that from happening in real time. If

 20 they wanted to have -- to get together and say,

 21 should we really be selling something at 13 cents,

 22 it would have been too late by that point.
 70

 1 The analogy that they gave us or the way

 2 that they viewed this was, imagine the stock is at

 3 $40 and it suddenly plummets to $20 and the

 4 customer says sell at any price and we decide that

 5 $20 is -- it's a ridiculously low price, but the

 6 market goes down to $5 and stabilizes. Then the

 7 market was at $5, the customer now has a stock

 8 that's worth $5 even though he could have had it

 9 for $20, so part of the issue here was not that

 10 the market went down, but that the market went

 11 down and then it went back up at the same time and

 12 people got caught in that whip saw.

 13 So, it's a tricky problem, but it

 14 certainly does speak directly to the best

 15 execution responsibilities of broker-dealers.

 16 CHAIRMAN GENSLER: I don't know if

 17 Professor Stiglitz is on the phone and we haven't

 18 heard or paused, but just before we go to the

 19 subcommittees just to see if Joe has any

 20 questions?

 21 MR. STIGLITZ: I just have one question,

 22 which is in terms of that rule. Why don't you use
 71

 1 price incentives to charge brokers for, say,

 2 erroneous trades so that they have incentives to

 3 make sure that anything going through their

 4 brokerage isn't erroneous?

 5 MR. COOK: Well, it is something we

 6 could consider doing. I mean, part of the problem

 7 with the erroneous trade world is defining what is

 8 erroneous under the circumstances. But there

 9 certainly are incentives that we could take into

 10 account including either charging them for it, and

 11 frankly sometimes they are charged by their

 12 customers who seek to be made whole. I think that

 13 often happens. You could also not have a trade

 14 rate process.

 15 MR. STIGLITZ: Yeah.

 16 MR. COOK: Sorry, go ahead, Professor.

 17 MR. STIGLITZ: Oh, no, I understand.

 18 It's just that what we're concerned here more is

 19 the systemic effects on others, so it's not just

 20 the effect on -- with the particular party, and in

 21 fact was that on May 6th you did break a lot of

 22 trades because you thought it was important for
 72

 1 the systemic -- for the system, and, therefore,

 2 the fact that they hadn't designed systems that

 3 would avoid that is indicative that the system

 4 isn't working well when it's on the magnitude of

 5 what occurred.

 6 CHAIRMAN SHAPIRO: I would just add, I

 7 think, that with this new rule, I mean, the 

 8 ultimate paying the penalty is an enforcement case

 9 and if reasonable risk management controls are

 10 utilized and orders pass through those first,

 11 there's always the option it takes a while and

 12 it's a cumbersome process in some ways, but there

 13 is the option for enforcement action against the

 14 broker-dealer with the market access.

 15 MR. COOK: Yes, absolutely. The market

 16 access rule is intended to raise the bar and give

 17 us a standard against which we can hold brokers.

 18 One of the issues with trying to come up with a

 19 more particularized fee or charge is, who do you

 20 charge and who and under what circumstances and

 21 how much, because some people might argue that

 22 this was not -- some events around May 6th were
 73

 1 not necessarily particular actors doing something

 2 wrong, but they were responding to the signals

 3 they were getting and it's really the system as a

 4 whole that needs to be thought through, and I

 5 think part of what our approach has been in terms

 6 of the circuit breakers, moving to limit up/limit

 7 down, the new proposal that we hope to approve

 8 soon banning the posting of stub quotes, is to

 9 narrow or eliminate the circumstances in which

 10 you'd have erroneous trades, because that seems to

 11 be the real policy objective in the first place.

 12 CHAIRMAN GENSLER: I want to thank the

 13 staff, but please stay.

 14 As I think we noted at our last meeting,

 15 we have two subcommittees of this group and it's

 16 important that the public understand what those

 17 groups have been doing and the transparency of the

 18 subcommittees to report. We have a cross-market

 19 linkages subcommittee, which I think Brooksley

 20 Born, Jack Brennan, David Ruder, and Professor

 21 Stiglitz, Joe Stiglitz on the phone, are on and

 22 then we have a pre- trade risk management
 74

 1 subcommittee with Robert Engel, Rick Ketchum,

 2 Maureen O'Hara and Susan Phillips. And Jack

 3 Brennan and Rick Ketchum, in a remarkable show of

 4 volunteerism, and an inability to step back when

 5 others stepped back faster, are each leading each

 6 of these subcommittees. I don't know if we'd go

 7 so far as to say chair, but if you want the

 8 titles, you can have them.

 9 MR. KETCHUM: We don't want the titles.

 10 CHAIRMAN GENSLER: But the leads of each

 11 of these are going to report. They've had, I

 12 think, numerous conference calls, but each of the

 13 committees, consistent with Federal Advisory

 14 Committee Act or what is known as FACA and the

 15 Government In Sunshine Act will now report back to

 16 this full committee, as they will in the future as

 17 well.

 18 I think Rick was going to go first, and

 19 then Jack. Is that how it is? Rick?

 20 MR. KETCHUM: Thank you, Chairman

 21 Gensler. And you've accurately described what has

 22 occurred. Our subcommittee has had a number of
 75

 1 phone conversations. Our purposes, again, as you

 2 know, were limited. They were first to focus in

 3 particular in attempting to clarify for our own

 4 view, the market environment that existed on May

 5 6th and exists today across the securities and

 6 derivative markets. Secondly, to attempt to

 7 identify issues. We both -- I think both

 8 subcommittees attempted to start identifying

 9 issues in its preordained area, but given the

 10 nature and capabilities of the persons involved

 11 and the interconnection to the issues, we

 12 identified issues that crossed across the

 13 boundaries of both subcommittees. So, in fact,

 14 Jack and I are going to hand it back and forth in

 15 looking at those issue identifications because in

 16 both cases each committee identified in each of

 17 the various, what I would say, buckets of issues,

 18 similar issues.

 19 Let me take, just for a minute, to give

 20 you our perception from our subcommittee of the

 21 market environment, pass on to Jack for some of

 22 his --
 76

 1 CHAIRMAN GENSLER: What's the name of

 2 yours?

 3 MR. KETCHUM: Ours is the pre-trading

 4 issue subcommittee.

 5 CHAIRMAN GENSLER: Okay, pre-trading

 6 issue subcommittee report.

 7 MR. KETCHUM: Exactly. So, as a table

 8 setting -- and then to pass on to Jack for the

 9 first sets of issues -- we looked, and I think the

 10 Commission staff's excellent summary today as well

 11 as, again, a further compliment for both the

 12 preliminary report and the final report for the

 13 care, detail, and thoughtfulness of it. I guess

 14 we see a few things with respect to the character

 15 of the market that is that we site neither

 16 positively or negatively but we think reflects the

 17 marketplace and strongly argues for the

 18 consideration and attention that the two

 19 commissions have been clearly giving it.

 20 Those in first reflect as a result,

 21 starting from the equity market, which I love so

 22 much, conscious decisions of the Commission over a
 77

 1 period of time to encourage for very socially

 2 useful reasons, both increased competition in the

 3 marketplace for trading environments, quoting, and

 4 orders, increased transparency of those orders,

 5 and lower -- quite low barriers to entry that are

 6 both reflected in the Commission's flexibility and

 7 encouraging automated trading systems and

 8 encouraging competition across exchanges and the

 9 registration of new exchanges.

 10 The result of that has been, on the

 11 equity side, significant fragmentation that's

 12 characterized with a variety of factors. First,

 13 that fragmentation has included, as a result of

 14 conscious initiatives of the Commission, a degree

 15 of the market that reflects -- that is generally

 16 referred to in one way or another of dark pools,

 17 but I think while it reflects some independent

 18 trading, predominantly reflects dealer trading and

 19 proprietary trading through either matching

 20 systems or just interacting with customer order

 21 flow of that firm or other firms, and that

 22 percentage, which has always, in way or another,
 78

 1 existed in U.S. markets, has grown now to various

 2 different calculations but certainly as described

 3 in the report in some ways, to about 30 percent of

 4 the transactions and perhaps more of the orders,

 5 and as it was reflected earlier, the participation

 6 of those dealers may vary and appears to from the

 7 report, drops off considerably and leads to

 8 routing into the organized transparent

 9 marketplaces in time of pressure and volatility.

 10 That fragmentation also results in a

 11 commoditization of markets from a leverage

 12 standpoint, from the standpoint that both markets

 13 are quite constrained as to how they price their

 14 services, how they encourage particular liquidity

 15 providers to leave orders in their marketplaces,

 16 and with that, the degree in which they have

 17 flexibility to encourage market maker obligations

 18 or any regular requirements for continuous quoting

 19 at or around the marketplace because, again, the

 20 substantial reduction of leverage that has

 21 occurred in the electronic market environment.

 22 That environment is also encouraged,
 79

 1 both because of the fragmentation and because of

 2 the flexibility the commissions provide, and

 3 similarly on the futures side, the flexibility

 4 that the CFTC's provided for an environment, to a

 5 high degree levels of high-frequency trading and

 6 electronic trading and that electronic trading,

 7 again, providing a great deal of liquidity on many

 8 occasions during normal times does have impacts

 9 with respect to market operations. It creates

 10 levels of message traffic that can result in

 11 delays as was discussed here, particularly delays

 12 at different times with respect to an inconsistent

 13 issue with respect to the dissemination of

 14 consolidated data as opposed to the individual

 15 feeds of each particular market.

 16 In addition, that market structure is

 17 characterized by -- again as been noted by the

 18 staff and action's been taken by both commissions

 19 to look at, a proliferation of algorithms driving

 20 that electronic train, and that proliferation has

 21 evolved from algorithms that were effectively

 22 controlled by a limited number of large firms
 80

 1 shifting over time to a variety of vendors

 2 providing those services shifting over time to,

 3 for lack of a better word, the type of naked

 4 access that exists across both broker-dealers and

 5 non-broker-dealers directly collocating, and wide

 6 varieties of separate algorithm, both development

 7 and maintenance and control, exactly Chairman

 8 Gensler, the point that you raised.

 9 None of that is described and intended

 10 to describe from our subcommittee either from a

 11 positive or negative position, but only a

 12 reflection of the market that was sitting there on

 13 May 6th or arguably for a period of years before,

 14 and we believe that the conclusion out of that,

 15 certainly that market structure or probably any

 16 market structure that provides effective and easy

 17 access to electronic trading, is that liquidity

 18 problems are inherent difficulties in that

 19 high-frequency world that do deserve the attention

 20 of the commissions, not with any particular action

 21 suggested in that way, but certainly a recognition

 22 that in that type of world there will be a regular
 81

 1 challenge from the standpoint of liquidity

 2 problems that can result in very significant

 3 market volatility and for reasons described in the

 4 report.

 5 In addition, we think again, not

 6 surprising and consistent with, I think, what

 7 Gregg Berman said today, because of the speed of

 8 trading, uncertainty becomes a major factor in

 9 influencing the behavior of the market and that

 10 the questions and risks of that, responses to that

 11 uncertainty, are quite substantial because of the

 12 ability to immediately either drive substantial

 13 opportunistic trading into the market or remove

 14 substantial buy or sell liquidity in an extremely

 15 quick period of time that exists from an

 16 electronic trading environment.

 17 And finally, that very fragmentation and

 18 the reality of that electronic trading and the

 19 fact that the interrelation between the futures

 20 markets, options markets, and securities markets

 21 have always been significant in the U.S.

 22 environment. That electronic trading has made
 82

 1 that interrelation even greater and the importance

 2 and issues of coordination across the agencies and

 3 across the marketplace is even greater as well as

 4 a recognition that electronic trading has allowed

 5 efficient access to a wider variety of markets and

 6 a wider variety of trading relationships so that

 7 not only is it important to recognize that there

 8 is interconnection across directly related markets

 9 such as the E-Minis on the futures side, ETF

 10 options on the S&P Future and the equity markets,

 11 but also the relation in a less direct way as one

 12 sees from the trading on May 6th across a wide

 13 variety of asset classes from foreign currencies

 14 and dollar relationships to gold, silver, and a

 15 wide variety of other assets that in one way or

 16 another trade in a direct or indirect relationship

 17 with respect to equity markets.

 18 All of that, we think, justifies the

 19 existence of the committee and the attention of

 20 the SEC and CFTC and raises a series of issues

 21 that we've tried to order from the standpoint of,

 22 although they're interconnected in a variety of
 83

 1 ways, and with that, for the first couple buckets,

 2 I'll pass it to Jack Brennan.

 3 CHAIRMAN GENSLER: Thank you, Rick, for

 4 the committee report or at least part of it

 5 because I gather we're going to go back, but Jack,

 6 I gather you're probably the post-trade committee

 7 then --

 8 MR. BRENNAN: We're cross-market

 9 linkages and we do want to reiterate, one, the

 10 thanks to the staff for terrific work. The sprint

 11 from basics to the first report and then the

 12 subsequent report with your final findings. It's

 13 very impressive work, and congratulate the

 14 commissions on the fast action, you know, the list

 15 of actions that was presented this morning is very

 16 impressive and not comprehensive and not final,

 17 but really impressive, and so we think it's very

 18 important to get at one of the key themes that our

 19 committee has focused on -- our subcommittee has

 20 focused on -- which is investor confidence, and a

 21 lot of what we hear in all of this, you know, in

 22 our deliberations, the issue of investor
 84

 1 confidence is very important as is -- and because

 2 we started out at cross-market issues, sort of

 3 regulatory mechanisms that I will spend a little

 4 time on, too, today.

 5 Rick mentioned the third theme that sort

 6 of colored our conversations which is, you know,

 7 the interdependency, the automation, and the

 8 highly connectedness among the markets that is,

 9 you know, part of our lives today and we're not

 10 going to go back to a different environment nor

 11 necessarily would anybody want that, but it does

 12 color the next two themes that I would expose from

 13 our group, but they're really shared themes, as

 14 Rick said. Much as you tried to herd us into

 15 camel bins, we apparently had good springs and we

 16 jumped out without that last straw on our backs. 

 17 MR. KETCHUM: Though jumped out entirely

 18 independently and separately.

 19 MR. BRENNAN: Yeah, thank you, Rick.

 20 You're the regular, I'm not.

 21 So, the first area that we'd like to

 22 comment on, and it will seem a tad redundant, but
 85

 1 I would call it reemphasis on some of the areas

 2 you're already working on, and that is trading

 3 halts and market pauses.

 4 Again, if you think of anything that

 5 gets right at interconnectedness, and more so

 6 today than ever and the most obvious place being

 7 the spider, the E-Mini options markets, the

 8 interconnectedness is very much there.

 9 So, again, you've addressed some of

 10 these but we want to just share it where we went

 11 at this -- the committee members went at this

 12 independently, certainly, the issue of market

 13 halts and cross-market halts. Robert, you were

 14 just talking about it, but it's so important to

 15 look forward, not back, from our standpoint with

 16 respect to what are the metrics. Is the S&P 500

 17 correct? Should it be the, you know, a far

 18 broader index? And at what level does it get

 19 triggered, how long, et cetera? And then, in a

 20 sense, a more -- a broader question which is do

 21 they make sense? Are cross-market halts the right

 22 mechanism? Which leads to the second issue, which
 86

 1 is thematic, and again has been addressed here,

 2 but very important from our standpoint, and that

 3 is the whole issue of pauses versus halts and we

 4 think as you look at the results of your work, the

 5 staff work, and this came up in our first meetings

 6 and it's come up continually, you know, is that

 7 the new world? Are pauses -- particularly as it

 8 relates to the stock markets -- the new world?

 9 But is it implementable in an area where there are

 10 40 trading menus for stocks? We think it deserves

 11 an awful lot of attention because the

 12 differentiated behavior of different markets

 13 during May 6th, but symptomatic of where we are

 14 today, makes it incumbent on us to look at a

 15 different mechanism, much as we looked at a

 16 different mechanism back in '87 and put the halts

 17 in place. So, that's a critical issue that we

 18 would like to see addressed further, we know you

 19 will, in addition the whole cross-market issue, do

 20 they make sense, and how.

 21 The third issue, it gets more to the

 22 mechanics of specifically the stock exchanges and
 87

 1 that is LRP's self help. Again, I'll speak for

 2 myself, not totally clear whether they were

 3 beneficial, deleterious, didn't get as much play

 4 in the second report as in the first report, but,

 5 you know, simple question of they're recognizing

 6 there are huge implementation challenges, but does

 7 May 6th and what we learned from there raise

 8 questions at the exchange level itself?

 9 And then the final -- a final, not the

 10 final -- we wouldn't assert that all of this is

 11 comprehensive, but -- question specific to a

 12 product type, which is ETFs. Very new and just

 13 the question being asked which I know you've

 14 asked, are there special rules needed or related

 15 to broad market ETFs? Because their functional

 16 characteristics are so similar to a product

 17 regulated in other venue, obviously the futures

 18 market, and again a market, as we've spoken about

 19 in these committee meetings so far, that has

 20 become very large and ubiquitous.

 21 The last item, we obliviously, and we

 22 know you will, and Robert you already alluded to
 88

 1 it a bit, was the single stock futures -- single

 2 stock circuit breakers. Terrific -- terrific

 3 idea, both spiritually and actually when you

 4 implemented them. The FINRA board would like to

 5 take credit for making you do it, but that

 6 wouldn't be quite legitimate, but we'd like to

 7 think it -- since it went well, we'd like to take

 8 credit for it, the governors of FINRA, but we

 9 should, as you already said, are they working

 10 right? Why? You know, are we fat finger

 11 susceptible and other things? But an innovation,

 12 in an instant in some ways, but sometimes they're

 13 great innovations, so as a specific takeaway we'd

 14 like to see that looked at.

 15 That's the first, Chairman, theme that

 16 I'd like to address on behalf, really, of both

 17 committees independently. Thank you, Rick. The

 18 second one is -- and we've, again, addressed this

 19 at a -- in your reporting out, and that is the

 20 whole issue of market access and transparency, you

 21 know, the theme of fair and equal access and how

 22 do we think that plays out today in this highly
 89

 1 interconnected market. You've already discussed

 2 some of them and frankly as we were having our

 3 last meeting, you were issuing a rule around

 4 sponsored access and direct access. The questions

 5 -- and this is, again, a question that will come

 6 up in many areas -- that we think get highlighted

 7 in this episode and in your work, is about

 8 responsibilities that come with privileges and

 9 it's not just with respect to this specific issue

 10 of sponsored access and direct access, but I know

 11 in our subcommittee's conversations it kept coming

 12 up again and again and again. If you get a right

 13 or you have a right or you're granted a privilege,

 14 what are the responsibilities that come with it?

 15 And have our sense of, what are the

 16 responsibilities, kept up with the evolution of

 17 the privileges that have been granted? And,

 18 again, a similar theme comes up in collocation.

 19 You know, I think it's safe to say we don't expect

 20 anybody to roll back the clock and, you know,

 21 Robert, you mentioned, so it's a mile -- you want

 22 to be a mile away, if we say you have to be a mile
 90

 1 away. I said jokingly, I want to be in the real

 2 estate business near -- near the data. Forget

 3 about being in the markets, the better business is

 4 being in the real estate business right near the

 5 exchanges, but, again, are there responsibilities

 6 that come with collocation?

 7 And do we think collocation has an

 8 effect beyond that which we believe is fair? You

 9 know, the whole theme of high-frequency trading

 10 when we were sort of -- when we were thinking

 11 about both committees' reports, you could have had

 12 a whole theme on -- a whole separate section -- we

 13 could have had a high-frequency trading subgroup

 14 if we wanted to because it runs throughout this,

 15 but clearly the market access and transparency,

 16 because it gets to practices and it was already

 17 asked about, Professor Stiglitz asked about, you

 18 know, should there be prices -- should there be

 19 incentives around behavior, and one of the big

 20 questions from a market access and transparency

 21 standpoint has to do with quotes that are pulled.

 22 And, you know, we look and we say, are withdrawn
 91

 1 orders in this environment at the speed at which

 2 markets work problematic to -- and come back to

 3 the macro theme from our subgroup -- which is

 4 investor confidence, and is it false liquidity?

 5 Does it look like there's much more there than

 6 there is? Market book depth, obviously, is a

 7 whole other subject matter, but when it comes to

 8 specifically high-frequency trading, it's a

 9 question of whether that practice benefits from

 10 the good markets and can accentuate problems in

 11 bad.

 12 Gregg, you said it looks like they're

 13 buying and selling, they're on May 6th, but it's a

 14 bigger question than that as to whether there's --

 15 there are appearances and behaviors that run

 16 throughout -- through the normal markets, that

 17 should raise concern. We ask the question, we ask

 18 it without prejudice, but we think it's a theme

 19 that is very much live.

 20 So, those two themes, we think, are

 21 vitally important for additional work. You're

 22 already doing a lot in that regard, but critically
 92

 1 important, and I'll flip it back to Rick for our

 2 next one.

 3 CHAIRMAN GENSLER: Thanks, Jack. Rick?

 4 MR. KETCHUM: Again, building on it,

 5 Jack has at least -- and I'll state again -- these

 6 really are purposes of both issue spotting for the

 7 commissions and to begin a conversation with

 8 members of the advisory board. They don't reflect

 9 conclusions of the subcommittee, nor are they

 10 going to reflect everything that even my

 11 subcommittee members may think, and so I look

 12 forward to the conversation after this.

 13 Jack ably raised a lot of questions that

 14 our subcommittee would put under the question of,

 15 what do you do with empty books? You're in an

 16 environment where there's risk of empty books, how

 17 do you react to them? The second set of questions

 18 or group of issues that we think the Commission

 19 should continue to focus on is the question, again

 20 without suggesting that there are miraculous

 21 answers, how do you keep the book from becoming as

 22 empty? How are there ways to, in way or another,
 93

 1 encourage liquidity in a high-frequency world or

 2 at least avoid discouraging liquidity in a

 3 high-frequency world?

 4 The issues we would suggest that the

 5 Commission should at least continue to attend to,

 6 recognizing that you have taken steps already, I

 7 would briefly tick off as these: First,

 8 recognizing, as Jack just discussed and was

 9 discussed by the staff of the normal behavior that

 10 will occur with respect to any trader not subject

 11 to particular obligations in periods of volatile

 12 time, which is there will be a liquidity provider

 13 for a while and they'll sell for a while. The 

 14 question as to whether there is value in creating

 15 increased differentiation with respect to market

 16 makers and not recognizing -- or market maker-like

 17 activity as identified by the economists and not

 18 recognizing that for anything affected to occur,

 19 particularly on the equity side because of the

 20 fragmentation and lack of leverage of the

 21 exchanges, it would have to be a Commission

 22 initiative that went across all exchanges for it
 94

 1 to occur.

 2 We believe there are a variety of

 3 questions on market maker differentiation that

 4 could be addressed with just saying it's not

 5 right. We recognize that market makers are not a

 6 panacea in any way or that particular designs of

 7 market making can also discourage competition, and

 8 so we don't suggest that there are simple answers,

 9 but we do believe that questions as to whether

 10 differentiation of at least liquidity provider

 11 behavior and expectations of that occurring in

 12 volatile times, whether it be from the standpoint

 13 of regulatory requirements, fees, oversight in one

 14 way or another, are worth further evaluation.

 15 Second, given the timing issues, as

 16 again identified by the staff, we think further

 17 analysis and effort to try to reduce -- to

 18 increase transparency and reduce differences from

 19 a timing situation from the standpoint of data

 20 access and data feeds are a wise issue for the

 21 commissions to be focused on and deserve continued

 22 focus.
 95

 1 CHAIRMAN GENSLER: In that case was it

 2 fees or feeds?

 3 MR. KETCHUM: Feeds, sorry. F-E-E-D-S.

 4 I apologize. We think, indeed, it may be -- we

 5 think that includes the question as to whether

 6 greater book information and possibly additional

 7 analytical information from the standpoint of

 8 imbalances in the book and findings ways to have

 9 that information more effectively get out to the

 10 public and the participants in the market are

 11 worth evaluating.

 12 In addition, again recognizing the

 13 benefits behind the policy, we believe it is

 14 appropriate for the Commission to reevaluate the

 15 terms and the evolution of internalized business

 16 and business from the standpoint of operating

 17 outside of exchanges with quoting and transparency

 18 obligations. We don't start that with an

 19 assumption one way or another with regard to the

 20 lack of benefit from a competition and choice

 21 standpoint, that internalized business provides,

 22 but we recognize that there's been substantial
 96

 1 growth and we think the factual indications of how

 2 that business flew back to the organized markets

 3 during May 6th is instructive and worth at least

 4 further analysis and probably interconnected with

 5 the question of differentiation with regard to

 6 quoting obligations or obligations during periods

 7 of volatility.

 8 Finally, we think that beyond the

 9 questions of how perhaps steps can be taken to

 10 make the books somewhat less empty during volatile

 11 times, it is a good thing for the Commission to

 12 review -- the commissions to review best execution

 13 requirements as a little bit discussed earlier,

 14 and that while regulation NMS sets up a very

 15 specific, very rigid set of requirements with

 16 respect to honoring the best bids wherever they

 17 exist, the lack of specificity with regard to the

 18 care in interacting with orders across all limit

 19 order books, the lack of specificity with respect

 20 to the use of orders that may not reflect the

 21 risks of high volatility in short periods of time

 22 to some of the questions raised by Chairman
 97

 1 Gensler, we believe, deserve to be re-reviewed,

 2 and while that doesn't suggest that we think that

 3 it's not appropriate for individual markets to

 4 experiment with different ways of providing that

 5 liquidity, we do think that the overall question

 6 and the issues of guidance from a standpoint of

 7 best execution would be important to return to the

 8 agenda of the Commissions and we would recommend

 9 that be reviewed as well.

 10 And with that, I think the last piece,

 11 which better for not a self regulator to talk

 12 about, is the question of regulatory oversight and

 13 I'll pass that back to Jack and we promise we'll

 14 shut up.

 15 CHAIRMAN GENSLER: That's all right, so,

 16 Rick, I thank you for -- you've completed your

 17 subcommittee report.

 18 MR. KETCHUM: I may not have done it

 19 ably, but I'm done talking with respect to our

 20 subcommittee report.

 21 MR. BRENNAN: And I will shortly follow

 22 him. But the last theme and the last issue that,
 98

 1 actually, again has permeated the whole work here

 2 and is the question of actually your, and broadly,

 3 the Commission's access to information, and,

 4 again, listening to the staff this morning, I 

 5 think it was reiterated in some ways about how

 6 much we've learned in this process already, but at

 7 a high level, a couple of specific issues that we

 8 thought were worth, at least, examining and the

 9 first one is specifically why it's not appropriate

 10 for Rick to be presenting this part, and that is,

 11 the whole question, as we've discussed, of a

 12 consolidated audit trail on the stock markets.

 13 And the how, the why, at what cost, real time

 14 versus after the fact, and, you know, clearly a

 15 major issue for the SEC and one that we believe

 16 this event and the diagnostics around this event

 17 highlighted.

 18 Secondly, as Rick just talked about, the

 19 whole -- in both markets -- the whole transparency

 20 of order books and how that helps you do your jobs

 21 most effectively, both from a prophylactic

 22 standpoint and on an ongoing oversight standpoint.
 99

 1 The third, and this is -- it actually

 2 was alluded to again with regard to the

 3 information flow, and it's the whole question of

 4 understanding the exchange's business models

 5 today, because as we know, business models have 

 6 changed drastically and does that have an impact

 7 on behavior? We know incentives create behavior

 8 -- are there to incent behavior and will create

 9 different ways of doing business and it's a very

 10 high level question, but we think it's one worth

 11 contemplating and how does it -- how has it

 12 changed the way each of the commissions needs to

 13 think about their relationships and, importantly,

 14 again, the behaviors of those exchanges both with

 15 customers and then competitively with each other.

 16 A big question.

 17 And then the last issue with regard to

 18 the whole information access for you all, it was

 19 already addressed, but I think we would

 20 reemphasize it strongly is the understanding the

 21 algorithm, the effect, and the nature and the

 22 utilization of algorithms. You know, for some of
 100

 1 us it's kind of old news, but it's always new news

 2 in that old news and you realize just how vital it

 3 has been to this specific episode and your

 4 opportunity to get deep and knowledgeable about

 5 those in all of the markets again and

 6 understanding how firms like mine use them, but

 7 what their ramifications are.

 8 So, Chairman Gensler, that concludes our

 9 subcommittee's report. Our hope is that now that

 10 we've stopped talking, I know there's lots of

 11 insights and opinions on the part of the committee

 12 members and there's much more depth below these

 13 high level oversights, so I hope we can engage in

 14 a conversation.

 15 CHAIRMAN GENSLER: Absolutely. I think

 16 -- I don't know whether I officially accept the

 17 reports, but I'm going to turn to Chairman

 18 Shapiro.

 19 CHAIRMAN SHAPIRO: Thanks, Gary. First

 20 of all, thanks to the subcommittees, in particular

 21 to Jack and Rick. I thought this was extremely

 22 helpful. You raised incredibly thoughtful points
 101

 1 and have laid out for us, I think, a lot of work

 2 that we need to continue to do to address what I

 3 believe are the right issues that you've raised.

 4 I wanted to go back to one thing Rick

 5 said, internalization is an issue we've been

 6 particularly interested in for a long time, not

 7 just because of the events of May 6th when we saw

 8 what had been internalized order flow going back

 9 into the markets, but as you can imagine, the

 10 markets raise -- the organized markets raise it

 11 with us all the time.

 12 I wonder if you have any just very

 13 preliminary thoughts about what we should be

 14 exploring there specifically? I mean, I can

 15 imagine a range of responses to do nothing at all,

 16 all the way to, perhaps, ban internalization, to

 17 something in the middle that might require price

 18 or size improvement, if you internalize, and I

 19 just wonder if you had other points in the

 20 spectrum that we ought to be looking at and

 21 thinking about?

 22 MR. KETCHUM: I don't personally. I
 102

 1 think your concept release set out the issues,

 2 both the benefits from choice and competition and

 3 the issues with respect to proprietary trading,

 4 different definitions of internalization with

 5 respect to the firm's own order flow, their

 6 customers, and aggregating a variety of broker- 

 7 dealers order flow in different models, and I --

 8 as an old NASDAQ, I would note that in a market

 9 structure that no longer exists, the effective

 10 result of that requirement where internalization

 11 really mostly existed in the old world was in the

 12 NASDAQ market. There was always a requirement, at

 13 a minimum to quote reasonably related to the

 14 market and that there was transparency associated

 15 with any dealer trading that existed in NASDAQ.

 16 That, for a variety of legal reasons, et cetera,

 17 has kind of disappeared over time. That would

 18 seem to me to be a starting point. The question

 19 of price improvement and what's appropriate for

 20 that, I think, are issues that the committee

 21 thought were important for the Commission to

 22 explore, but I don't think -- while individual
 103

 1 committee members might have views one way or

 2 another, I don't think we, as a subcommittee, had

 3 a view one way or another.

 4 CHAIRMAN GENSLER: It strikes me, while

 5 it's beyond the remit of what we're doing today,

 6 it's certainly within the advice that we look for

 7 from this committee is, there's a whole market

 8 that both of us are -- right now is internalized,

 9 but we're taking on, is the swaps market as well,

 10 and so, I mean, the futures market has not had

 11 this issue of dark poles, but in a sense we have

 12 because swaps are just another derivative that is

 13 dark, and I don't want to compare the percentages.

 14 If it's 30 percent there, the swaps markets are

 15 bigger. So, as we directionally move to bring the

 16 swaps market into greater transparency, some of

 17 what you've said today is really helpful for that

 18 market as well.

 19 MR. KETCHUM: And just know, Chairman

 20 Gensler, that I think you're absolutely right on

 21 that. And it really goes to the point we made

 22 before that the asset integration of trading today
 104

 1 is so dramatically different than it was even 10

 2 or 20 years ago, that the opportunities that come

 3 from swap dealer regulation from the standpoint of

 4 both transparency and information from a

 5 regulatory oversight standpoint, I think, is

 6 tremendously important. And I look forward to the

 7 environment you get afterwards vis-à-vis -- and I

 8 think a large part of what Jack raised is that

 9 consolidated audit trails, as, I think, the

 10 Commission basically said in its release, now has

 11 to not stop at borders across commodities and

 12 futures and over- the-counter derivatives and the

 13 like, because each of them impact the other. And

 14 the regulation of the swap dealer marketplace, I

 15 think, could provide some real opportunities for

 16 significant enhancements in the sophistication of

 17 surveillance.

 18 CHAIRMAN SHAPIRO: Could I ask another

 19 question maybe generally of the committee?

 20 International regulators have been following May

 21 6th very closely, as you can imagine, and as they

 22 see their markets evolving some to look more and
 105

 1 more, particularly in Europe, like the U.S.

 2 Market, did you -- have you talked at all about or

 3 could you perhaps at another committee meeting

 4 start to give some thought to the extent to which,

 5 as we begin to take steps in this area, we need to

 6 be coordinated with our international

 7 counterparts. I wouldn't imagine on everything

 8 that that would be necessary, but I would imagine

 9 that there would be discrete areas where we might

 10 move to address certain issues, that we don't want

 11 to have an unintended effect on the migration

 12 business out of the United States or create an

 13 opportunity for arbitrage for a less

 14 well-regulated market.

 15 MR. KETCHUM: Well, I'd certainly say

 16 yes although some of the things we're just trying

 17 to catch up to you on such as consolidated trade

 18 reporting to get there, but decisions as to how to

 19 deal with the liquidity fragmentation issues, I

 20 think, makes great sense for their consultation.

 21 CHAIRMAN GENSLER: Maureen?

 22 MS. O'HARA: I think one of the things
 106

 1 that emerges from looking at these episodes is

 2 that the nature of markets today is just very

 3 different, the nature of where liquidity comes

 4 from, and one of the things that actually -- is

 5 highlighted by May 6th is that in general, markets

 6 actually work extraordinarily well, it's these

 7 episodic periods of ill liquidity that are

 8 obviously not acceptable. And there have to be

 9 ways to deal with these. One of the things that

 10 becomes clear is that trading now is at such speed

 11 that a lot of trading decisions are made ex ante,

 12 that is people choose the algorithms that they're

 13 going to use and then the algorithms go off in

 14 trade, and poor decisions up front can result in

 15 poor outcomes at the end.

 16 I think the same thing translates into a

 17 mandate for regulation that's on an ex ante and

 18 not an ex post basis, that it's almost too late by

 19 the time the problem emerges to have the

 20 regulatory response. And so a lot of what I know

 21 our subcommittee chatted about, and I would feel

 22 confident, but don't know, that the other
 107

 1 subcommittee talked about, is that the regulatory

 2 structure now has to move to an ex ante basis.

 3 And a lot of the things that we've talked about,

 4 the notion of pre-specified trading halts that

 5 will occur, right, before any event occurs, we

 6 know that that's going to occur, I think that's

 7 the nature of regulatory structures going forward.

 8 And I think a lot of the suggestions

 9 that we will be making will be, how do you move a

 10 regulatory structure that in the past probably

 11 operated more ex post because trading was slower

 12 and couldn't be done that way, into an ex ante

 13 basis? And how do we measure the risks of the

 14 various types of challenges that arise in

 15 high-frequency worlds so that we're not dealing

 16 with these problems in the past, that we're

 17 monitoring and going forward? And that speaks to

 18 questions about, how do we want exchanges to

 19 provide information so that traders can see what's

 20 happening without, sort of, having to react as

 21 well?

 22 Those are issues that, I think,
 108

 1 internationally arise because we're all dealing

 2 with the same issues, and one of the things that,

 3 I think, you know, the good news that comes out of

 4 all bad events is, you know, life is never wasted,

 5 you could always serve as a bad example. We now

 6 have an opportunity to be a good example in taking

 7 all the things we've learned and suggest a

 8 template, not only for how we will regulate

 9 markets, but how markets in general, so, I'd like

 10 to think that we can go there and cooperate, of

 11 course, we don't have all the good ideas on our

 12 side, but we have had the opportunity to think

 13 about these.

 14 CHAIRMAN GENSLER: Maureen, thank you.

 15 I'm wondering if I can quote you with my kids on

 16 that last piece.

 17 MR. BRENNAN: That's so much better than

 18 the camel thing. Let's stay with that one. That

 19 is really good.

 20 CHAIRMAN GENSLER: Brooksley?

 21 MS. BORN: Well, just one small specific

 22 point on internalization that I think shouldn't be
 109

 1 lost, you know, the report indicates that a great

 2 deal of the broken trades were retail customer

 3 trades that an internalizer sent to the public

 4 markets and because they were market sell orders

 5 and/or stop loss orders, they were executed at the

 6 bottom, and it seems to me that really raises some

 7 issues about whether that kind of order is

 8 appropriate for retail customers and whether

 9 internalizers should be accepting those orders

 10 without limits.

 11 CHAIRMAN GENSLER: David?

 12 MR. RUDER: I have a couple of points.

 13 The first, I think, is something that we know

 14 about as regulators and that is that the

 15 technology of the markets is something that we

 16 find it very difficult to anticipate. And I've

 17 always said, and it may be a shame, but it's true,

 18 that the regulations follow market innovations.

 19 So, I think we need to be aware in our -- in

 20 whatever's done, that we don't restrain the

 21 markets so that they can't accomplish their true

 22 purposes.
 110

 1 And that sort of drives me to sort of

 2 where we were talking about, the market

 3 information process. It seems to me we're not

 4 going to prevent the high-frequency traders from

 5 getting information first and having an advantage

 6 over the retail customers, so we need -- the study

 7 has to be some way in which to impose some costs

 8 on -- for those people in terms of advantage. And

 9 we used to have costs in the days of the

 10 specialists, we used to have costs that were

 11 imposed on specialists. We had market continuity

 12 report requires no gapping, sometimes we asked a

 13 specialist to step up in times of problems. And

 14 what we're really talking about is whether or not

 15 there should be some obligations placed on the

 16 people who are in the high- frequency trading

 17 mechanism and whether there should be some

 18 requirements that they provide liquidity, and

 19 that's sort of the broad picture. I don't know

 20 whether you want to call them market makers and

 21 place market making obligations on them, or

 22 whether you simply want to say, here are your
 111

 1 liquidity preserving obligations.

 2 I had one thought that's been coming to

 3 me due to a seminar I've been operating on this

 4 same subject, but the question is whether or not

 5 the decimalization process has affected the

 6 markets. The fact that the quotes are in a penny

 7 really prevents, I think, the market-making

 8 function from existing the way it used to be. You

 9 don't have clusters of liquidity around pricing

 10 points, and one of the suggestions that might be

 11 looked at is whether or not the pricing intervals

 12 should be increased from a penny to two pennies or

 13 three pennies or a nickel so that you could then

 14 reinvigorate the market-making structure, and I

 15 see this as an economic incentive that might be

 16 inserted in the markets instead of a regulatory

 17 incentive, because if you do create incentive for

 18 market making, then you may get more liquidity.

 19 CHAIRMAN GENSLER: I had a -- Susan?

 20 MS. PHILLIPS: I guess I'd like to make

 21 just a couple comments, first of all on the

 22 report, and compliment the staffs for a deeply
 112

 1 forensic analysis and I don't think I've ever seen

 2 this much detail packed into 300 pages between the

 3 two reports. And I think one of the things that,

 4 you know, when you see in detail the different

 5 types of trading that's going on, you realize that

 6 the fragmentation is occurring in a variety of

 7 different ways, not just between exchanges and

 8 over the counter, but between and among computers

 9 and people, and computers and people have

 10 different reaction times. And I have to say that

 11 when we first, within our subcommittee, started

 12 talking about the first report, in particular, you

 13 know, the thought that we were going to start

 14 seeing lots more pauses and lots more constraints

 15 on the market, I have to say, as sort of a more

 16 free market-oriented person, gave me significant

 17 pause myself. But I'm becoming -- I'm coming to

 18 an understanding that some of these things, like

 19 the LRPs, some of the pauses, even the limit

 20 up/limit down kinds of things do provide a way for

 21 all of the participants to get the information

 22 within a reasonable amount of time.
 113

 1 And so, I think, as you're going

 2 forward, in looking at some of these trade -- you

 3 know, these various constraints and perhaps

 4 guidance for broker dealers, for example, to try

 5 to balance keeping the markets operating, as David

 6 has mentioned, but at the same time creating an

 7 environment in which all market participants can

 8 participate.

 9 You know, in some ways I think it's

 10 really very surprising that the markets recovered

 11 as quickly as they did. I mean, the fact that

 12 they came back as quickly as they did, I think,

 13 does demonstrate the strength of the overall

 14 market system, and including the fact that you had

 15 all of this back and forth between all of the

 16 different markets and traders.

 17 I do think that there were some things

 18 that -- sort of structural things that had been

 19 brought out by this learning opportunity of May

 20 6th and it's not just -- you know, we talk about

 21 transparency, but the question then is, what is

 22 meaningful transparency. I mean, you can dump a
 114

 1 lot of data out there and it may not be all that

 2 helpful, and one of the things -- just to give an

 3 example, and Maureen has talked about this in our

 4 subcommittee calls -- maybe there are different

 5 kinds of data that would be useful for either the

 6 exchanges or through some kind of consolidated

 7 reporting system such as depth of the limit order

 8 book. You know, to the extent that you know, you

 9 know, how many orders are available on either side

 10 of the market should give some guidance to market

 11 participants in the way they submit their

 12 executions, and so maybe some simple -- some kind

 13 of simple ratios would be useful to traders to try

 14 to figure out. And I would hope that the

 15 exchanges themselves would be thinking about this

 16 kind of information because it does give more

 17 confidence to traders that they know what they're

 18 doing when they drop an order in there.

 19 So, I think that in many ways it's kind

 20 of surprising that this very sizable move in the

 21 market one day, we had fairly quick recovery and

 22 yet we do have an opportunity to make some 
 115

 1 changes, and both commissions have started down

 2 the path, and the exchanges have too, it's not --

 3 exchanges, FINRA, NFA -- I mean, they're looking

 4 at things they should be doing to try to figure

 5 out a way to prevent these things because it is a

 6 market confidence issue. So, I commend you, but I

 7 think it's going to be an iterative process and

 8 it's going to take some pilot programs like this.

 9 Limit up/limit down works in futures markets

 10 pretty well. That's been a tradition for many

 11 years. But you also have a pit style trading and

 12 is it going to be transferrable to securities

 13 markets where you've got fragmented markets.

 14 So, it's hard to know how the

 15 implementation will work, so I think it's going to

 16 take a bit of experimentation, some pilot

 17 programs, but it seems to me that you're on the

 18 right track.

 19 CHAIRMAN GENSLER: Rick. I'll just save

 20 my questions.

 21 MR. KETCHUM: Well, I'd just add on to,

 22 I think, Chairman -- former Chairman Phillips'
 116

 1 really good points. Maureen's probably too shy to

 2 note it, but she's done what I think are two

 3 exceptional papers that I'd recommend to the

 4 Commission on -- that propose ways of thinking and

 5 measuring with regard to order toxicity.

 6 CHAIRMAN GENSLER: I've read ones that

 7 --

 8 MS. O'HARA: We distribute it, yeah.

 9 CHAIRMAN GENSLER: -- the one with the

 10 tutor. What's the other one?

 11 MR. KETCHUM: Well, no, one of them is

 12 actually in English for lawyers and then the other

 13 one does the numbers that you can read, Gary, but

 14 --

 15 CHAIRMAN GENSLER: No, no.

 16 MR. KETCHUM: I really like the one that

 17 was English for lawyers.

 18 CHAIRMAN GENSLER: That one I might not

 19 be able to read.

 20 MR. KETCHUM: No, that one I can't read.

 21 No, you can read them both. The point I really

 22 want to make on it other than the fact that it was
 117

 1 terrific, terrific original work is that it does

 2 describe again the questions of what makes books

 3 empty. And what makes books empty is uncertainty

 4 and risk and it is interesting how VIX contracts

 5 have provided the ability to address one set of,

 6 in a fairly gross way, uncertainty and risk.

 7 I think greater information on things

 8 that in some way or another are a foreteller of

 9 toxicity or even the possibility of contracts that

 10 allow liquidity providers to more effectively

 11 hedge the risk of informed order activity or

 12 otherwise high-risk activity for liquidity

 13 providers could be really valuable and it's for

 14 that reason I mention Maureen's -- and I think

 15 Susan's absolutely right, that that type of

 16 exploration from the standpoint of, how do you

 17 create an environment where people can offload

 18 some of that toxicity risk.

 19 CHAIRMAN GENSLER: Can I just ask one of

 20 my two questions because it relates to the empty

 21 books? My question for the group that you might

 22 think about today and further is this empty book
 118

 1 scenario, might that relate to market pauses? I'm

 2 bringing the two together. But market pauses

 3 currently in the equities markets and cross market

 4 are about price movement, but they don't

 5 necessarily speak directly to the empty book

 6 issue.

 7 CHAIRMAN SHAPIRO: Except to the extent

 8 they exist to help rebuild the book.

 9 CHAIRMAN GENSLER: Right, they

 10 certainly, as Chairman Shapiro says, exist to

 11 rebuild the book, but they're only triggered by a

 12 certain price movement and a certain time period,

 13 either like cross markets since the prior day's

 14 close or the pilot program that has had, I think,

 15 some very real effect, but it's still uncertain

 16 over minutes. And I highlight that because in the

 17 futures marketplace there was a market pause that

 18 does relate somewhat to the book. The stop loss

 19 limit that occurred on May 6th was because the --

 20 I guess it was the next trade would have been down

 21 six full points, six handles, right? So, it

 22 somewhat relates to the book, but that book in the
 119

 1 E-Mini which started the day with about 100,000

 2 contracts and the order book went both sides, it

 3 was about 50,000 contracts when the large trade

 4 came in, was down to 1,000 by -- resting buy

 5 orders. And so, fortunately, the stop loss

 6 happened, but you could have seen that, what if

 7 that 1,000 order was inside the 6 points, they

 8 would have actually probably just -- excuse the

 9 expression -- but blown through the order book as

 10 happened to Ascencia and other things in the

 11 equities market. So my question for the group is

 12 -- to keep it in English is -- might any part of

 13 the order book, maybe in the futures market more

 14 relevant than the securities market, relate to

 15 market pauses, again, as Chairman Shapiro said, to

 16 rebuild to book or give it -- maybe give it five

 17 seconds, five minutes, whatever, to rebuild?

 18 Maureen?

 19 MS. O'HARA: I think, you know, our

 20 committee did speak about these issues because it

 21 -- the challenge in a high-frequency world, and in

 22 a world, as David Ruder has born it out so well,
 120

 1 that resting orders on books now is not -- is

 2 certainly in equities as common as it was, and so

 3 liquidity almost has a just in time feel to it.

 4 The challenge of an empty book is, you

 5 know, once you have an empty book you really are

 6 dead in the water, in a sense, and so providing

 7 proactive information about the state of the

 8 amount of liquidity seems a sensible approach to

 9 go. I think the futures stop logic was really

 10 demonstrated as an excellent approach in the sense

 11 that the stop logic was ex ante, it moved in

 12 advance of what was going to be a disaster. I

 13 think we have to sort of keep that in mind. And

 14 you're right, it's not necessarily basing things

 15 off of the price that just happened, it has to

 16 look forward and think about the prices that will

 17 happen. It's a lot easier to do that in futures

 18 though than it is in a fragmented equity market,

 19 and therein lies the real challenge that,

 20 unfortunately, our subcommittees did not solve,

 21 but I think the issue is one that we do have to

 22 think about and it may have to do with disclosure
 121

 1 of depth on books so that routing decisions are in

 2 advance realizing you don't go there because it's

 3 going to create problems. But I think that is a

 4 huge, huge issue and not completely solved by just

 5 simply limits in prices.

 6 CHAIRMAN GENSLER: So, if I can leave

 7 that question, at least from one of your

 8 colleagues or chairs, is just whether market

 9 pauses themselves have any triggering from

 10 information from the book, the emptiness of the

 11 book, or the thinning out of the book.

 12 MR. BRENNAN: One of the questions

 13 though that we've heard loud and clear, and this

 14 is not just the book but sort of what's real

 15 liquidity and what's ephemeral liquidity has

 16 changed a lot Maureen in terms of what we think it

 17 is. So, because of the withdrawn orders that that

 18 happens often, and so it's a great question and it

 19 would be a fourth or fifth catalyst for a market

 20 pause and we'll certainly kick it around, but

 21 there's a subsidiary question that I think we kind

 22 of scratch our heads on at this stage seeing what
 122

 1 we see from this --

 2 CHAIRMAN GENSLER: You mean, what's real

 3 liquidity?

 4 MR. BRENNAN: Yeah.

 5 CHAIRMAN GENSLER: I'm sorry.

 6 Brooksley?

 7 MS. BORN: Well, I mean, I'm going to

 8 pick up on that point because I really think that

 9 some in depth looking at high-frequency trading is

 10 necessary and demonstrated by the staff's report.

 11 It's pretty clear in the staff's report that

 12 although that one trader who put in the very large

 13 sell orders on the E-Mini was a trigger, the

 14 high-frequency traders moved in immediately,

 15 bought it, decided whoops, you know, their

 16 algorithms told them to dump it, and a number of

 17 them then withdrew liquidity from the market.

 18 I do think investor confidence in the

 19 markets is being affected by perceptions that

 20 high-frequency traders have unfair access to the

 21 markets and unfair access to market information,

 22 and it seems to me that it would be very
 123

 1 beneficial for the commissions to look at this

 2 carefully. The suggestion, I think, David Ruder

 3 made that perhaps with their advantages of

 4 information and advantages of access, they should

 5 also have some responsibilities of either a

 6 market-making kind of role to some kind of role to

 7 maintain liquidity would be useful to explore. I

 8 also think there are some major problems with

 9 order cancellations which, at least from a futures

 10 perspective, would seem to almost, you know, be

 11 fraudulent orders, putting in orders that you have

 12 no intention to do anything but probe for where

 13 the rest of the market is.

 14 So, I would strongly recommend that some

 15 looking at the role of high-frequency traders, the

 16 impact they have on liquidity, the appropriateness

 17 of their activities, and whether they should be

 18 regulated in some meaningful way.

 19 MR. RUDER: Could I just talk about

 20 something else slightly different? I think that

 21 with regard to halts and pauses that the

 22 commissions need to be careful that they're
 124

 1 talking about two things. One is a circuit-wide

 2 -- one is a market-wide circuit breaker and the

 3 other are the single stock circuit breakers. But

 4 if you're talking about the market-wide circuit

 5 breakers I think we're in a very new world because

 6 we not only have the futures contracts which

 7 effect the whole securities markets, but we now

 8 have the spy contracts, the ETF contracts, which

 9 are somehow demonstrative of where the market's

 10 going. So you need to structure the circuit wide

 11 -- the market-wide circuit breakers in order to

 12 take into account what kind of signals are being

 13 made from the ETFs.

 14 And the second thing that's just -- that

 15 is interesting is that we're not talking about

 16 circuit breakers that are going to be a long pause

 17 so that the market can get all the information.

 18 Rick, we did half an hour or an hour in 1988 and

 19 --

 20 MR. KETCHUM: Both.

 21 MR. RUDER: Both. Yeah. And they're

 22 the ones that are still in place, but we're
 125

 1 talking about what the machines are thinking

 2 about, and we need to know, I think, in looking at

 3 the algorithms, what kinds of inputs the algorithm

 4 -- the algo-makers are putting in in terms of what

 5 their activities are going to be if certain events

 6 take place, and I don't know how you get that

 7 information. Maybe the staff can go out and ask

 8 everybody what are your aglos -- what are your

 9 protections against major crises?

 10 CHAIRMAN GENSLER: You know, I say one

 11 thing, I was in Chicago this week for a number of

 12 reasons, mostly with Michelle Barnie, who's the

 13 European Commission for Internal Markets, but I

 14 also, Monday night, had a dinner with eight

 15 high-frequency traders. These were founders, I

 16 think amongst them, they did say at one moment --

 17 and they weren't bragging or anything -- they

 18 said, you know, there's some days that the eight

 19 of our firms are probably half the volume in

 20 certain contracts. And I didn't ask which, but

 21 amongst them, they all wanted what Andre said

 22 earlier. They want certainty. They want to be
 126

 1 able to program their programs and if something's

 2 going to be deemed a disruptive trading practice

 3 ex ante, they want to know it. They want to put

 4 it in their boxes so that they -- you know, they

 5 do that.

 6 But they did have one suggestion that

 7 I'd be curious of your reactions to. Again, you

 8 don't have to react today. They'd like the

 9 exchanges to have more, both in the equities and

 10 in the futures markets, the exchanges have more

 11 risk parameters. And I said, well, they do have

 12 them, they have price banding and they have a

 13 whole sort of things, like in the E-Minis, you

 14 can't put more than 2000 orders in. And they

 15 said, well, our programs could break down and we

 16 could, for instance, have like a machine gun, a

 17 1,999 volume, you know, just hit, repeatedly.

 18 They actually all wanted -- they'd like the

 19 exchanges to have something to shut them down at

 20 some point as a risk parameter.

 21 It was just an interesting -- to your

 22 point. There may be other things like that.
 127

 1 MS. O'HARA: I think that one of the

 2 things we have to bear in mind is that the

 3 exchanges are in the business to do -- you know,

 4 to provide liquidity and execute volumes and I

 5 think the exchanges would love to design things

 6 that work well. I think the firms are not out to

 7 ruin markets. I think they're out to try and

 8 provide a service and create liquidity and they

 9 need tools. And I think part of what the

 10 regulators can help do is really give a template

 11 for both groups to think about how they fit into

 12 this.

 13 So, I think that one advantage that will

 14 come out of this is I suspect firms will be

 15 looking to be smarter and exchanges will be

 16 looking to be smarter and I certainly think the

 17 great work the staff has done really helps all the

 18 parties figure out the new world in ways that I

 19 don't think anyone completely appreciated before

 20 this started.

 21 CHAIRMAN GENSLER: Commissioner O'Malia?

 22 MR. O'MALIA: Thank you. I'd be
 128

 1 interested to know -- following on your point,

 2 Gary -- the issue of direct market access and

 3 should the exchanges have these authorities to,

 4 you know, set the access barriers.

 5 The FIA did a paper, which was the first

 6 issue the Technology Advisory Committee here at

 7 the Commission looked at, on direct market access.

 8 I was wondering if either subcommittee looked at

 9 that paper and had any thoughts about it and/or

 10 additional recommendations that should be

 11 implemented to support that?

 12 CHAIRMAN GENSLER: And if you haven't

 13 seen it, we'll make sure Andre or somebody will

 14 send it around.

 15 MR. O'MALIA: Either the staff or the

 16 advisory committee.

 17 CHAIRMAN SHAPIRO: I guess I'd be

 18 curious as we figure out this issue about whether

 19 exchanges should have more risk parameters on the

 20 extent to which it will really be important that

 21 they be the same at all the exchanges and all the

 22 venues or we've just actually made the world a
 129

 1 little bit more complex by having order routing

 2 decisions then made based on individualized risk

 3 parameters at each of the different exchanges or

 4 trading venues.

 5 MR. KETCHUM: It seems to me there's

 6 sort of a nuanced answer to that. I do think that

 7 the Commission's role on the equity market side or

 8 the stock side, is critical, because we shouldn't

 9 have the illusion that the exchanges have the

 10 leverage to be able to act. They are commoditized

 11 from a competitive standpoint. The flow of --

 12 order flow even with respect to minor pricing

 13 changes is quite remarkable at this point and I

 14 don't think any exchange can make a series of

 15 decisions from an access standpoint and providing

 16 things that may both reduce speed, to some degree,

 17 and/or reduce some order -- the flexibility of

 18 some orders. I think the Commission has to

 19 fundamentally define it.

 20 I would say within that context, though,

 21 I would be a little cautious in not letting -- if

 22 an exchange feels they can differentiate in that
 130

 1 way, letting them go beyond a Commission minimum

 2 because I think, first, it provides different

 3 alternatives for best execution decisions or

 4 execution decisions, and secondly, it provides an

 5 opportunity for experimentation, but I do think

 6 you're right, Chairman Shapiro, that the only way

 7 this will work on the stock side of the equation

 8 is for the Commission to be very aggressive to

 9 ensure at least a minimum level of consistency.

 10 Experimentation beyond that, perhaps, but a

 11 minimum level of consistency because the exchanges

 12 just don't have the leverage.

 13 CHAIRMAN GENSLER: Do you know of the

 14 FIA?

 15 MR. KETCHUM: I would love to see the

 16 FIA paper, but I have not had a chance to review

 17 it, and I'd certainly be very interested in

 18 including it in the committee's evaluations.

 19 CHAIRMAN SHAPIRO: Maybe we could

 20 circulate both of the two papers Maureen's done

 21 and the FIA paper to the committee later today.

 22 CHAIRMAN GENSLER: Joe? I haven't heard
 131

 1 you and I don't know if you're still there.

 2 Professor Stiglitz?

 3 MR. STIGLITZ: I'm still there. I don't

 4 have anything particular to add at this point

 5 except for a point that I've made on other

 6 occasions which is some people have, you know,

 7 remarked about -- well, two points. One is the

 8 function of the market, and obviously I keep it

 9 focused on what do you mean by the function of the

 10 markets. And here, I guess, is related to the

 11 other point that I've raised which is one needs to

 12 see the whole ecology, the whole system, as they

 13 interact. And I've been concerned -- this issue

 14 that we've raised on other occasions -- that the

 15 -- one of the things that's going on here is that

 16 the flash traders may be extracting ranks from the

 17 fundamental traders by trying to extract

 18 information from them, and, therefore, actually

 19 undermining the efficiency of the market as a

 20 whole. That is, to put it another way, you know,

 21 the paper that Sandy Grossman and I wrote a number

 22 of years ago showing that if we had fully
 132

 1 efficient markets, nobody would have any incentive

 2 to invest information because prices convey

 3 information and that eliminates the incentive for

 4 anybody to get it. And the problem here is that

 5 flash trading may in effect increase the

 6 efficiency of extracting information from the

 7 informed to the uninformed in the sense that flash

 8 traders aren't using information that is of any

 9 fundamental value. They're using information --

 10 they're getting information from others who are

 11 getting information and, therefore, undermining

 12 the efficiency of the market.

 13 And therefore, a lot of the discussion

 14 about worrying about is it interfering with the

 15 functioning of the market looking at it from the

 16 perspective of the flash traders, or from those

 17 engaging in these very fast trades I think may be

 18 fraud in terms of what our broader objective --

 19 which should be protecting consumers, investors --

 20 ordinary investors, and in terms of making a

 21 market that is truly more efficient.

 22 CHAIRMAN GENSLER: I couldn't tell
 133

 1 whether people wanted to comment on Joe's comment.

 2 Jack?

 3 MR. BRENNAN: The one comment would be

 4 that his comment on fundamental traders believing

 5 they're paying rent to high-frequency traders is a

 6 deeply felt position on the part of what we call

 7 much more traditional traders. We actually had

 8 one on one of the panels from Southeastern Asset

 9 Management and you would think they were long-term

 10 holders and why do they care, the rest of this is

 11 noise, but there is a deeply held view, partly on

 12 Brooksley's point that there really is an effect

 13 that one wouldn't think was natural, but because

 14 of being on this panel I hear from lots of

 15 "traditional, fundamental traders" that they

 16 believe there is a curious effect on the

 17 efficiency of the market when one would think that

 18 it had the opposite effect.

 19 MR. STIGLITZ: Theoretically, you can

 20 show that that has to be the case. So I -- you

 21 know, I was on the phone on that meeting and I

 22 remember his saying that and I get that from other
 134

 1 people, too. But I just wanted to say that

 2 there's actually a very strong theoretical case

 3 for what -- for that claim that they're making.

 4 In fact, it's hard to believe it's not true.

 5 CHAIRMAN GENSLER: That what's not true?

 6 So, if you say affirmatively, what is --

 7 MR. STIGLITZ: That is to say that they

 8 aren't in fact doing any fundamental research on

 9 the -- the flash traders are not doing fundamental

 10 research on what the underlying supply and demand

 11 trends in our real economy. What they're trying

 12 to do is extract information from prices, order

 13 flow, you know, market -- that's what we're all

 14 talking about, how they're trying to gain the

 15 algorithms and algorithms are trying to stop them

 16 from gaining them, and so forth. And so given

 17 that, they aren't adding information, they're just

 18 reprocessing other peoples' information, and in

 19 that sense, they almost inevitably are taking away

 20 -- to the extent that they make a return, they're

 21 taking away rents from those who are providing

 22 information.
 135

 1 CHAIRMAN GENSLER: Joe, at the risk of

 2 raising my head above this fox hole about

 3 high-frequency traders, but the market ecosystem

 4 has some who do fundamental research and has many

 5 investors who buy and hold for long term, but it

 6 has traditionally for decades had people who were

 7 also either specialist or pit traders who one

 8 might contend did a modest amount of fundamental

 9 research, but very little when you stand in the

 10 pits in Chicago. Even today there are still pits.

 11 How do you differentiate the people that

 12 did that and provided very short-term liquidity

 13 based on order, flow, and information from what a

 14 high-frequency trader does?

 15 MR. STIGLITZ: That's a harder -- you're

 16 exactly right. I mean, and the provision of this

 17 kind of liquidity is of some value. The real

 18 question is, as you go from smoothing out

 19 movements from within, you know, within a week to

 20 within micro -- within a minute, the social value

 21 goes down to zero clearly. And so the question

 22 is, the specialists always were, in fact, taking
 136

 1 out rents from the fundamental trader, but they

 2 were providing a benefit that allowed people to

 3 sell the asset when they wanted. But what did

 4 that mean sell it when they wanted? It wasn't

 5 selling it within the next, you know, nanosecond,

 6 it was really, can I convert this stock into cash

 7 within a reasonable period of time?

 8 So, it's that balance that I think we've

 9 lost. I don't think that there is any incremental

 10 social value in the price information. That's

 11 clear. There's no real -- and is the right

 12 provision of liquidity -- the question is, does it

 13 actually not drain liquidity from the system for

 14 the relevant -- what we really care about which is

 15 say fundamental traders who want to be able to

 16 have the option of selling when they want -- when

 17 they need cash for one reason or another. Does

 18 that make sense?

 19 MS. O'HARA: Joe, this is Maureen

 20 O'Hara, and I think, you know, what I would

 21 interpret your remarks as saying is that we

 22 shouldn't lose sight of the fact that markets have
 137

 1 very important roles, one is liquidity and the

 2 other is price discovery. The price discovery

 3 role is really based upon the ability of

 4 fundamental traders to learn new information and

 5 be able to trade on that information in markets in

 6 a way that compensates them for their efforts.

 7 So, to the extent that any of our

 8 structures inhibit the ability of fundamental

 9 traders to do the important work of bringing new

 10 information to the market, that would be a bad

 11 thing and we definitely need to be careful that

 12 any sort of practices that degrade the ability to

 13 trade on fundamental information are avoided.

 14 The issue of whether high-frequency

 15 traders, by definition, degrade that is somewhat

 16 more challenging because I think the

 17 high-frequency guys would argue that they really,

 18 instead, allow the markets to have a great deal of

 19 liquidity and that allows the fundamental traders

 20 to be able to trade on their information and earn

 21 a rent. Right? If you learn new information but

 22 you can't trade on it, then actually it's going to
 138

 1 be difficult to earn rent. So, I think you've

 2 raised a very good point for this Commission and

 3 the task force to think about which is balancing

 4 those two very important topics and making sure

 5 that the provision of liquidity doesn't erode the

 6 ability to trade on information and make markets

 7 efficient.

 8 MR. STIGLITZ: That's right, and let me

 9 just say, you know, some of the earlier research

 10 before the flash trading occurred actually

 11 suggested that there could be even advantages of

 12 having markets that were not continuous, so you

 13 could aggregate liquidity, so if you meet -- you

 14 know, markets that met once a day or even less

 15 frequently than that, because they -- you know,

 16 the price discovery isn't going on in continuous

 17 time, but decisions aren't made in those same kind

 18 of continuous time and certainly not in

 19 nanoseconds.

 20 And so that literature actually

 21 suggested that there were advantages in terms of

 22 liquidity for the fundamental traders and
 139

 1 incentives for providing information from having

 2 less frequent trading. So, that highlights the

 3 point that you just raised and that I was trying

 4 to emphasize, that we really want to keep in mind

 5 -- and this is (inaudible) I just want to

 6 emphasize -- keep in mind what the real functions,

 7 social functions, of these markets are.

 8 MR. KETCHUM: Just a brief supplement

 9 with the leeriness of a lawyer wandering into

 10 social good discussions, but I agree with both of

 11 the points in some ways. I think Professor

 12 Stiglitz rightly says that I think we need to look

 13 at the overall impact. I do agree with Professor

 14 O'Hara that it seems to me, at least to me, that

 15 there is contributions to both market liquidity

 16 and market efficiency and pricing that comes from

 17 high-frequency trading that shouldn't be ignored.

 18 I would say there's one subset that is

 19 interesting in viewing trading around the world

 20 versus the United States that would suggest that

 21 there is at least a reallocation of cost, to some

 22 degree. Most of the rest of the world and the
 140

 1 world and the United States on the equity side

 2 until fragmentation became the reality, charged,

 3 at least with respect to ratios of high levels of

 4 message traffic with low levels of executions.

 5 Without saying whether it's social good or not

 6 social good or the rest, it clearly was viewed by

 7 exchanges or exchange-like things as less valuable

 8 than quoting activity that generally resulted in

 9 executions because it imposed significant

 10 transactional costs from a technology standpoint,

 11 surveillance, regulation, et cetera. That has

 12 disappeared from pricing, I think, in the United

 13 States in both areas -- not in the futures so much

 14 --

 15 CHAIRMAN GENSLER: No, actually in the

 16 futures world there's still a premium charge if

 17 you have high quote or message volume compared to

 18 your transaction.

 19 MR. KETCHUM: More to my point, in a

 20 futures world where there is more concentration,

 21 there's some of it --

 22 CHAIRMAN GENSLER: But it's only a small
 141

 1 premium, but there is a premium.

 2 MR. KETCHUM: And I would suggest that

 3 even the small premium probably suggests the

 4 greater risk of potential competition that exists

 5 in the futures market today rather than a few

 6 years ago.

 7 In the equity market it's completely

 8 disappeared. I think it hasn't disappeared

 9 because there's a different view with respect to

 10 the overall benefit of a low quoting to trade

 11 ratio from a cost standpoint, it's disappeared

 12 because there's no pricing power left and I do

 13 think it's worth the Commission looking from an

 14 allocation standpoint with respect to price, at

 15 least pricing if nothing else, that I think you've

 16 had a reallocation because the exchanges can't

 17 price against activity that may generate huge

 18 numbers of quotes for relatively few trades in the

 19 high-frequency world.

 20 CHAIRMAN SHAPIRO: I guess I'd just say

 21 that I think this last discussion really points to

 22 the issue Jack raised about investor confidence
 142

 1 and it's really intimately tied to that, and I

 2 would add to that issue of confidence in the

 3 quality of the markets and the capability to raise

 4 capital efficiently and effectively. I think we

 5 have to sort of bare that in mind as an umbrella

 6 over this discussion.

 7 CHAIRMAN GENSLER: I would agree with

 8 that and even though I stuck my head above the fox

 9 hole, I just -- you know, I absolutely think our

 10 markets have changed because of technology and

 11 what was once done in the specialist or in the pit

 12 -- seven of these eight high- frequency traders I

 13 met with Monday night who founded their own firms,

 14 they employ collectively 2,500 employees, and, you

 15 know, they're not just 3 people somewhere. Many

 16 of them are programmers. But seven of the eight

 17 were former pit traders and one was just a

 18 software developer, if I remember, because we went

 19 around the table and they said how they started

 20 their firm.

 21 It's all within the last 10 years, some

 22 within the last 3 or 4 years. So, it's this
 143

 1 dramatic shift of markets and how we maintain

 2 investor confidence, issuer confidence in our

 3 markets, the hedgers that hedge and use these

 4 instruments. It's absolutely critical that the

 5 price discovery function and liquidity is

 6 provided.

 7 I just want to make sure whether Elise

 8 or Scott had things or if any commissioners are on

 9 the phone, I know Bart Chilton was on earlier.

 10 MS. WALTER: I'd just like to plant a

 11 thought. I mean, I know we're coming close, to

 12 come pick up on two themes that were mentioned

 13 before, and that's the interrelatedness of the

 14 markets and informational advantages or

 15 disadvantages. I would love to get the wisdom of

 16 the committee members on -- and this is probably a

 17 long-term issue -- how important the consolidation

 18 of information across markets in a standardized

 19 sort of way that gives people truly comparable

 20 access at a comparable point in time in a combined

 21 fashion is? I mean, how much of a disadvantage

 22 are market participants at that their flows of
 144

 1 information are coming from different places at

 2 slightly different times?

 3 I feel pretty strongly about that in the

 4 regulatory area but I don't know whether that's a

 5 difficult issue to solve and I don't know how

 6 important all of you would think it is

 7 particularly with respect to market participants

 8 and I don't know if anybody has any comments on

 9 that today, but if I could kind of put that on

 10 your thinking agenda for the future, that would be

 11 great.

 12 MR. O'MALIA: I'd also like to extend my

 13 thanks to everyone who's participated here, the

 14 staff and the committee members. It's interesting

 15 to hear some of this debate and it's less about

 16 specific recommendations, but also what role the

 17 fundamental market plays, and it's an important

 18 debate to have.

 19 I do have a couple of questions on some

 20 of the solutions or potential solutions. We've

 21 talked about circuit breakers and pauses and LRPs,

 22 et cetera. I'd like to get a sense -- somebody
 145

 1 raised the issue of, you know, the book being

 2 empty or a fully emptied book. Which of these

 3 various remedies might apply to which category and

 4 how we can avoid emptying the book and then what,

 5 you know, specific solutions are for an empty book

 6 and how we restore that?

 7 The other one is the speed of the

 8 market, and I think Maureen raised it, and I think

 9 Susan raised it as well, but what would the impact

 10 be of slowing down the market? Would it

 11 exacerbate the liquidity crisis or not? And at

 12 what point is it -- obviously when it came back,

 13 it looked -- the market looked like a great thing

 14 to have, all the liquidity coming back as fast as

 15 possible. So, if we could take some thought to

 16 the speed of the market and whether slow downs in

 17 market crisis would help or not.

 18 And any solutions on high-frequency

 19 trading are more than welcome. Thank you.

 20 CHAIRMAN GENSLER: I don't know if

 21 Commissioner Chilton is still with us or any of

 22 the other commissioners are on the phone.
 146

 1 COMMISSIONER CHILTON: I'm here, Mr.

 2 Chairman. I know it's awkward on the phone for

 3 folks, so I appreciate your patience. But I'll

 4 try to be quick and forthright and I won't go too

 5 much overboard in thanking everybody, but I really

 6 am impressed by both the staffs and our advisory

 7 committee with all the discussion now and the work

 8 that's gone into this, and particularly with you, 

 9 Mr. Chairman and Chair Shapiro, with all the work

 10 you've done, not jus ton this, but on the Wall

 11 Street Reforms Act. We really owe you a debt of

 12 gratitude.

 13 My quick takeaways here are, first, as

 14 Gregg suggested early on when he was talking,

 15 perhaps the circuit breakers need to be more

 16 fine-tuned. When I say that it strikes me that it

 17 strikes me that the circuit breakers and the stop

 18 logic, you know, what's used in the futures

 19 market, really need to be harmonized between the

 20 two markets. If we do that it might help avoid

 21 sort of the arbitrage opportunities that HFTs were

 22 looking at in the flash crash and sort of stop
 147

 1 that cascading calamity that the staff described.

 2 Those sorts of harmonized shock

 3 absorbers, if you will, I think could be of real

 4 assistance in ensuring some market integrity.

 5 And then second, at the CFTC, and the

 6 Chairmen refer, I think, briefly to this, we're in

 7 the process of coming up with a proposal for

 8 mandatory position limit but those position limits

 9 are for commodities of finite supply -- energy,

 10 metals, and ags -- but given what we saw in the

 11 flash crash, you know, perhaps we should be

 12 looking at -- I think we should -- limits on

 13 financial futures or even, you know, robotic

 14 algos. And Professor Stiglitz and Maureen were

 15 talking about both of these things, but it seemed

 16 to me, so say you have a limit of whatever it is,

 17 it's a hard number limit or it's a percentage

 18 limit, but for the sake of argument, say it's 10

 19 percent, and that might be fine. But should an

 20 HFT or an algo trader be able to buy or sell 10

 21 percent of the market 10 times in a minute? You

 22 know, that has a possibility, it seems to me, of
 148

 1 roiling the market.

 2 Now, you know, some high-frequency

 3 trading cowboys may be able to scoop up the micro

 4 dollars in nanoseconds, but it could also disrupt

 5 markets. So, it seems that there's a good

 6 argument to me, you know, that this sort of

 7 trading, as Professor Stiglitz was saying to some

 8 extent, could be, you know, in some regard

 9 parasitical trading which doesn't really have a

 10 great contribution to market efficiency.

 11 So, and then the last thing is that, you

 12 know, it seems to me as regulators, at least at

 13 the CFTC, that we should have some team, Mr.

 14 Chairman, that we should have some team of folks

 15 who are IT experts, who look at this, look at

 16 algos. I know that folks will get concerned about

 17 proprietary information -- the exchanges do this,

 18 the CME does this a little bit, but there's got to

 19 be some responsibility on the government to have

 20 some sense. There's a story that's posted on the

 21 FT's site, they call it the trading room site,

 22 online. Jeremy Grant wrote it, this morning, and
 149

 1 it talks about how the Indian regulators both on

 2 the securities side and on the futures side, test

 3 the algos before they get put into the production

 4 environment. I don't know if that's something we

 5 should do or not, but it seems to me that we

 6 should certainly look at it.

 7 And then the final thing, and Mr.

 8 Chairman, you mentioned this and Commissioner

 9 O'Malia and I have talked about this before, too,

 10 whether or not we actually hold folks who actually

 11 run these renegade algos accountable, that we have

 12 a disruptive trading practice rule out for comment

 13 right now. One of the questions is whether or not

 14 these algos gone wild. There should be some

 15 accountability for them. I mean, I think so. But

 16 what that is, Mr. Chairman, you were talking

 17 about your meeting with the HFTs the other night.

 18 They definitely need some certainty. It would

 19 have a quelling impact on the market if we just

 20 left it right open, so we've got to have some

 21 certainty as to what this is, but it seems to me

 22 some sort of parameters with some sort of
 150

 1 accountability is needed.

 2 But I look forward to getting the

 3 comments, and thank you again for dealing with me

 4 on the phone. I know it's a little awkward for

 5 you guys. Thank you.

 6 CHAIRMAN GENSLER: No, thank you,

 7 Commissioner Chilton. And I think Commissioner

 8 Dunn is on the phone as well.

 9 COMMISSIONER DUNN: Yes, I am. Mr.

 10 Chairman, thank you and thanks to this advisory

 11 group and the staff for all their hard work

 12 they've put in this, and especially to Rick and

 13 Jack for being volunteered to chair up those

 14 subcommittees. I really appreciate it. I was

 15 most interested in your reports, but I guess,

 16 Maureen, you get the tip of the hat for the quote

 17 of the day. I certainly hope we don't end up as

 18 that bad example.

 19 Two points that come to mind to me

 20 listening today, and first of all, to the two

 21 chairmen, I think it is just absolutely imperative

 22 that we go forward on getting the definitions out
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 1 for our implementation into Dodd-Frank, and

 2 frankly, I'm disappointed that staff has not been

 3 able to reach conclusions on that. It looks like

 4 we're slipping a little bit in the timeframe that

 5 was our goal. But I think it's important that we

 6 all are working with the same nomenclature and as

 7 I listen to this discussion today, that just has

 8 been reinforced, so please make sure that we get

 9 those definitions as soon as possible. There's

 10 just too much uncertainty out there without

 11 knowing what we're actually talking about.

 12 The second point on the high definition

 13 and algorithms, I had said during our technical --

 14 Technology Advisory Committee meeting that I

 15 wanted to know who was responsible for oversight,

 16 who should be privy to what algorithms are based

 17 on, who should be regulated and how can they be

 18 regulated, and the discussion today has really

 19 moved this, in my mind, much further down the

 20 road. I have a much better understanding of what

 21 the expectations are out there.

 22 Mr. Chairman, your meeting with the
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 1 high- frequency traders reminds me of the old

 2 B-grade movies where the detective walks into the

 3 murder site and sees written on the mirror:

 4 Please stop me before I kill again. I think it's

 5 incumbent upon us to have that certainty, I think,

 6 as a template or best practices guides are

 7 something that we need to be working on.

 8 And the third issue is funding. I would

 9 be remiss if I didn't bring this up because

 10 everything that the advisory group has talked to

 11 us about today I see as going to be requiring some

 12 type of financial output on the behalf of both

 13 commissions. And to that end, since so many of

 14 the issues that we have are a result of the

 15 interrelationship between the two markets, I think

 16 it is incumbent upon the CFTC and the SEC to work

 17 collectively on these issues and not to be

 18 reinventing the wheel in both commissions. I

 19 think we can save some money for the taxpayers,

 20 but, again, without the fiscal and human resources

 21 to address these issues, it's going to be the

 22 public and the financial world that's going to be
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 1 the victim if we don't have those resources.

 2 So, again, thanks to all the members of

 3 the advisory group, and especially the staff for

 4 the work that they've done.

 5 CHAIRMAN GENSLER: Thank you,

 6 Commissioner Dunn. I want to assure you it was a

 7 dinner that I asked for and it was very helpful.

 8 It was very helpful.

 9 These are active participants in our

 10 markets. I just wanted to -- we do have to

 11 approve minutes, but I also wanted to suggest that

 12 if each of the committee members could get back to

 13 the staffs on your availability in early January.

 14 What we'd like -- I know it's an ambitious

 15 schedule, but what we'd like -- and Chairman

 16 Shapiro and I were just chatting so this is maybe

 17 a little audible here, meaning our staffs don't

 18 know I was going to say this -- but what we'd

 19 really like is that if you all could be prepared

 20 to come back with some recommendations, you know,

 21 through your subcommittee work and whether you

 22 need some ways under the FACA committee to have
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 1 conference calls and so forth, but this committee

 2 doesn't go away after January. I mean, you

 3 continue to advise us, not just on May 6th, but on

 4 other matters, but if we can try to get to that in

 5 this timeframe, that would be terrific.

 6 So, but with that, finally we need to

 7 actually discuss and approve the minutes of the

 8 August 11th meeting of this committee. And I

 9 think I'm supposed to --

 10 MR. BRENNAN: Second.

 11 MR. KETCHUM: Third.

 12 CHAIRMAN GENSLER: Any discussion? All

 13 in favor.

 14 GROUP: Aye.

 15 CHAIRMAN GENSLER: Any opposed? Minutes

 16 being approved. And I think then given the

 17 minutes, we're done.

 18 I think the next thing I'm supposed to

 19 do -- do I need a motion to adjourn this meeting?

 20 Just want to make sure. All in favor.

 21 GROUP: Aye.

 22 CHAIRMAN GENSLER: Thank you so much.
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 1 Thank you, Commissioner Chilton and --

 2 CHAIRMAN SHAPIRO: Thank you all very

 3 much.

 4 (Whereupon, at 11:57 a.m., the

 5 PROCEEDINGS were adjourned.)

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 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Steve Garland, notary public in and

 4 for the District of Columbia, do hereby certify

 5 that the forgoing PROCEEDING was duly recorded and

 6 thereafter reduced to print under my direction;

 7 that the witnesses were sworn to tell the truth

 8 under penalty of perjury; that said transcript is a

 9 true record of the testimony given by witnesses;

 10 that I am neither counsel for, related to, nor

 11 employed by any of the parties to the action in

 12 which this proceeding was called; and, furthermore,

 13 that I am not a relative or employee of any

 14 attorney or counsel employed by the parties hereto,

 15 nor financially or otherwise interested in the

 16 outcome of this action.

 17

 18

 19 -----------------------------------

 20 Notary Public, in and for the District of Columbia

 21 My Commission Expires: May 31, 2014

 22