Mr. Chairman and Members of the Subcommittee: We are pleased to be here today to provide the results of our assessment of the securities industry’s readiness to trade stocks using decimal prices. In 1997, your Subcommittee held a series of hearings on a proposed amendment to the Securities Exchange Act of 1934 that would have directed the Securities and Exchange Commission (SEC) to require, within 1 year of enactment, that securities trading be in dollars and cents instead of the fractional increments of a dollar, such as eighths and sixteenths, used today. Shortly after those hearings, various exchanges and markets indicated that they were committed to converting to decimal trading, and Congress took no further action on the legislation. Subsequently, after market participants indicated that the conversion to decimal trading should be postponed until after 2000, you asked us to determine whether anything could be done to accelerate that time frame. With a few exceptions, the majority of the exchanges; market support organizations, such as those that transfer payments and securities after a trade; and securities firms of various sizes that we contacted had made limited progress toward converting to decimal trading. Most organizations were extensively involved in modifying their systems to be ready for the date change in 2000 and the impending implementation of the new European Monetary Union (EMU), both of which have dates that cannot be changed. Market participants expressed strong concerns that attempting to convert to decimal trading while these and other information technology initiatives were under way represented a great risk to the success of any of them and to the industry as a whole. After consulting with SEC in January 1998, the securities markets established a working group to expand on previous industry discussions of decimal trading and to begin developing decimal conversion standards and establishing time frames for completing the conversion to decimals. The time frames this group has proposed envision that decimal trading would begin during the third quarter of 2000. completed April 16, 1998, when the Securities Industry Association (SIA) agreed to act as the industry focal point for the implementation of decimal trading. The industry has also been working on the other elements, but additional work remains for SEC and the industry to reach consensus on the approach for the implementation, as well as on an implementation date, milestones, and technical standards and specifications. Further, because decimal trading may have significant effects on U.S. markets and market participants, assessing and addressing any such effects would be an important part of preparing for and planning its implementation. Potential issues include ensuring that adequate processing and communications capability exists in the industry to support decimal trading and evaluating any changes needed in market regulations to ensure that market operations remain fair and orderly. In doing this work, we contacted officials from SEC and eight major exchanges and markets that trade stocks and options in the United States as well as four support organizations for these markets, such as those that transfer payments and securities after a trade. We also contacted representatives from 12 securities firms of various sizes as well as 2 organizations that provide information technology support services for hundreds of additional firms. In addition, we discussed the readiness for decimal trading with officials of two major market information vendors. To obtain information from an exchange that had recently undergone a transition to decimal trading, we contacted the Toronto Stock Exchange (TSE). We also discussed decimal trading with various securities market experts, including academics who had conducted relevant studies. We did our work between February and April 1998, in accordance with generally accepted government auditing standards. with others would require less time and fewer resources than many of the other initiatives already under way in the industry, such as the work being done for the Year 2000 date change. Of the eight stock and options exchanges we contacted, four had begun system modifications. The farthest ahead was the New York Stock Exchange (NYSE), which began its conversion 2 years ago to prepare for listing and trading the ordinary shares of foreign companies using decimal prices denominated in foreign currencies instead of the American Depositary Receipts currently traded. NYSE officials told us they plan to complete system modifications by September 1998, when internal testing is to begin. They said their conversion efforts do not involve the accounting and processing systems used by NYSE specialists. One official said that NYSE has not formally attempted to determine the readiness of specialists’ systems for decimal trading, but he indicated that some firms have begun converting. The Nasdaq Stock Market, Inc. (Nasdaq), the American Stock Exchange, and the Chicago Stock Exchange have begun replacing older systems with newer technology that will be capable of decimal trading, and the new systems are scheduled for completion and internal testing by the third quarter in 1999. NASD Regulation, Inc. would not be ready until March 2000. The other four exchanges generally had done only internal assessments to determine which systems would require modifications. Of the 12 securities firms we contacted, only 1 had modified and internally tested its systems for trading in decimals. Officials of this firm said they had replaced their older systems with newer ones that were capable of processing decimal prices. Many smaller securities firms rely on third-party firms to perform their data processing, but the two data processing firms we contacted—which process information for hundreds of medium and small securities firms—had not begun to modify their systems. Although most organizations we contacted had not begun converting their systems for decimal trading, many reported having at least conducted an informal inventory or assessment of their systems to determine which ones would be affected by such a conversion. The readiness of the four market support organizations we contacted varied. Officials of the largest U.S. securities depository organization, the Depository Trust Company, which maintains records of securities holdings for securities firms, custodian banks, and their customers, said they had only one affected system and it was already decimal ready. The Securities Industry Automation Corporation, which operates the NYSE and American Stock Exchange trading systems, also operates the systems that make up the National Market System. These systems allow quotes and orders to be routed among the exchanges in New York and other exchanges or dealers across the country. According to Corporation officials, those systems that route quotes are ready; those that route orders will be ready in the third quarter of 1999. Officials of the National Securities Clearing Corporation, which is the largest clearing organization for U.S. stocks, indicated that decimal trading modifications to the systems used for exchange-listed stocks were completed in March 1998, but the modifications for systems used for the stocks traded on Nasdaq are not expected to be complete until May 1998. Officials at the Options Clearing Corporation, which performs clearing functions for options trading, told us that they had not yet begun systems modifications. The time and cost estimates for converting to decimal trading offered by exchanges, support organizations, and securities firms varied. The estimates generally ranged from 2 to 6 months and no higher than $10 million but usually closer to $5 million or less. Developing cost estimates was difficult for many organizations, because they (1) did not know the specifications, (2) had not yet started converting, and (3) had to consider the impacts of other information technology initiatives already under way at their organizations. An industrywide study done for SIA found that the level of effort required for securities market participants to ready themselves for decimal trading was less than that required for other ongoing information technology efforts. For example, the study estimated that decimal trading conversion industrywide would require slightly over 300 person years, the equivalent of about $170 million, which is less than 5 percent of the estimated 8,800 person years and about $5 billion for Year 2000 work. Despite the less involved effort needed to convert individual firm systems to decimals, securities market participants told us the industry is unlikely to be able to implement decimal trading before 2000. The primary reasons cited were inadequate time and resources, given the demands of the Year 2000 effort and other information technology initiatives already under way. Representatives of almost all of the exchanges, support organizations, and securities firms we contacted indicated that they would not have sufficient time and resources available to both modify and test systems necessary for decimal trading until Year 2000 efforts were completed. Because decimal trading will affect all market participants’ systems, they said that systems changes would have to undergo comprehensive streetwide testing similar to that required for the industry’s Year 2000 effort. Nasdaq officials noted that the Year 2000 tests will be complex and that developing the testing plan has required months of effort by large numbers of staff across various organizations. NYSE officials indicated that most organizations can conduct systems testing on only 2 weekends a month, because processing associated with options expiration and the month’s end is done during the other weekends. Industry officials noted that this is especially true for medium or smaller securities firms, which lack dedicated testing systems and can test only at those times when necessary business processing is not being done. TSE officials told us that extensive testing was done as part of the exchange’s conversion to decimals and was a major factor in its smooth transition. practice and would make identifying and correcting any resulting processing errors very difficult. Officials at one exchange also indicated that making modifications for both 2000 and decimals would make it difficult for them to certify that their systems were Year 2000 compliant. Further, our work reviewing the Year 2000 efforts of numerous federal agencies and other entities has generally found that organizations are avoiding the simultaneous implementation and testing of multiple major systems changes to mitigate the risk of malfunctions. Officials from most of the organizations advised us that obtaining the necessary internal and external resources for conducting information technology projects is extremely difficult, largely because such resources are already working on either Year 2000 efforts or the other industrywide initiatives. For example, representatives at four organizations said that they intended to use the same staff to convert to decimals that they are using for Year 2000 work now. Officials from one large securities firm said that the work entailed in converting systems for decimal trading requires an understanding of internal systems and the information flows among them and cannot be done by less experienced staff or external resources. Staff capable of performing this work are already engaged at their firm doing Year 2000 and EMU modifications.