[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]



 
     THE IMPACT OF MARKET VOLATILITY ON SECURITIES TRANSACTION FEES

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                    FINANCE AND HAZARDOUS MATERIALS

                                 of the

                         COMMITTEE ON COMMERCE
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             FIRST SESSION

                               __________

                             JULY 27, 1999

                               __________

                           Serial No. 106-41

                               __________

            Printed for the use of the Committee on Commerce




                      U.S. GOVERNMENT PRINTING OFFICE
58-512 CC                     WASHINGTON : 1999



                         COMMITTEE ON COMMERCE

                     TOM BLILEY, Virginia, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     JOHN D. DINGELL, Michigan
MICHAEL G. OXLEY, Ohio               HENRY A. WAXMAN, California
MICHAEL BILIRAKIS, Florida           EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas                    RALPH M. HALL, Texas
FRED UPTON, Michigan                 RICK BOUCHER, Virginia
CLIFF STEARNS, Florida               EDOLPHUS TOWNS, New York
PAUL E. GILLMOR, Ohio                FRANK PALLONE, Jr., New Jersey
  Vice Chairman                      SHERROD BROWN, Ohio
JAMES C. GREENWOOD, Pennsylvania     BART GORDON, Tennessee
CHRISTOPHER COX, California          PETER DEUTSCH, Florida
NATHAN DEAL, Georgia                 BOBBY L. RUSH, Illinois
STEVE LARGENT, Oklahoma              ANNA G. ESHOO, California
RICHARD BURR, North Carolina         RON KLINK, Pennsylvania
BRIAN P. BILBRAY, California         BART STUPAK, Michigan
ED WHITFIELD, Kentucky               ELIOT L. ENGEL, New York
GREG GANSKE, Iowa                    THOMAS C. SAWYER, Ohio
CHARLIE NORWOOD, Georgia             ALBERT R. WYNN, Maryland
TOM A. COBURN, Oklahoma              GENE GREEN, Texas
RICK LAZIO, New York                 KAREN McCARTHY, Missouri
BARBARA CUBIN, Wyoming               TED STRICKLAND, Ohio
JAMES E. ROGAN, California           DIANA DeGETTE, Colorado
JOHN SHIMKUS, Illinois               THOMAS M. BARRETT, Wisconsin
HEATHER WILSON, New Mexico           BILL LUTHER, Minnesota
JOHN B. SHADEGG, Arizona             LOIS CAPPS, California
CHARLES W. ``CHIP'' PICKERING, 
Mississippi
VITO FOSSELLA, New York
ROY BLUNT, Missouri
ED BRYANT, Tennessee
ROBERT L. EHRLICH, Jr., Maryland

                   James E. Derderian, Chief of Staff

                   James D. Barnette, General Counsel

      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

            Subcommittee on Finance and Hazardous Materials

                    MICHAEL G. OXLEY, Ohio, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     EDOLPHUS TOWNS, New York
  Vice Chairman                      PETER DEUTSCH, Florida
PAUL E. GILLMOR, Ohio                BART STUPAK, Michigan
JAMES C. GREENWOOD, Pennsylvania     ELIOT L. ENGEL, New York
CHRISTOPHER COX, California          DIANA DeGETTE, Colorado
STEVE LARGENT, Oklahoma              THOMAS M. BARRETT, Wisconsin
BRIAN P. BILBRAY, California         BILL LUTHER, Minnesota
GREG GANSKE, Iowa                    LOIS CAPPS, California
RICK LAZIO, New York                 EDWARD J. MARKEY, Massachusetts
JOHN SHIMKUS, Illinois               RALPH M. HALL, Texas
HEATHER WILSON, New Mexico           FRANK PALLONE, Jr., New Jersey
JOHN B. SHADEGG, Arizona             BOBBY L. RUSH, Illinois
VITO FOSSELLA, New York              JOHN D. DINGELL, Michigan,
ROY BLUNT, Missouri                    (Ex Officio)
ROBERT L. EHRLICH, Jr., Maryland
TOM BLILEY, Virginia,
  (Ex Officio)

                                  (ii)


                            C O N T E N T S

                               __________
                                                                   Page

Testimony of:
    Brodsky, William J., Chairman and CEO, Chicago Board Options 
      Exchange...................................................     5
    Cader, Andrew, Senior Managing Director, Spear, Leeds & 
      Kellogg, on behalf of the Specialist Association of the New 
      York Stock Exchange........................................    10
    Kearney, Arthur J., Director of Equity Capital, John G. 
      Kinnard & Co., on behalf of Security Traders Association, 
      accompanied by Lee Korens, President and CEO, Security 
      Traders Association........................................    19
    Nelson, Stephen J., Vice President of Special Projects, 
      Herzog Heine Geduld, on behalf of Securities Industry 
      Association................................................    14
Material submitted for the record by:
    Securities and Exchange Commission, prepared statement of....    40

                                 (iii)

  


     THE IMPACT OF MARKET VOLATILITY ON SECURITIES TRANSACTION FEES

                              ----------                              


                         TUESDAY, JULY 27, 1999

                  House of Representatives,
                             Committee on Commerce,
           Subcommittee on Finance and Hazardous Materials,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10 a.m., in 
room 2322 Rayburn House Office Building, Hon. Michael G. Oxley 
(chairman) presiding.
    Members present: Representatives Oxley, Largent, Lazio, 
Shimkus, Fossella, Blunt, Towns, Engel, DeGette, Barrett, 
Luther, Pallone, and Rush.
    Staff present: Brian McCullough, professional staff; Robert 
Simison, legislative clerk; David Cavicke, majority counsel; 
Linda Rich, majority counsel; and Consuela Washington, minority 
counsel.
    Mr. Oxley. The subcommittee will come to order. The Chair 
will recognize himself for an opening statement.
    The Dow average has been closing near or above 11,000 
points in recent weeks. When I became chairman of this 
subcommittee at the start of 1997, I remarked how unprecedented 
the sustained growth in the markets had been. At that time we 
thought it impressive that the Dow was approaching the 7,000 
point barrier.
    Remarkably, the trend has continued. Every week a new IPO, 
a new Internet stock price going through the roof, and online 
trading, bringing the markets directly into the homes of 
individual investors. These are all positive benefits of one of 
the strongest economic periods this country has ever enjoyed. 
Our robust markets have translated into more jobs, better 
services and better quality of life as they have kept our 
economic engine going.
    But with the good, we must also be prepared for the bad. 
There is the possibility of inflation and therefore the 
possibility of higher interest rates that could naturally 
follow this economic boom.
    Are there other potentially damaging effects of our recent 
good fortune that we can prevent? We know the capital markets 
have been good for investors, but could they be better, more 
efficient than they are today?
    Those are some of questions that will be discussed today. 
One such question has to do with the effect of the record-
breaking performance of the securities markets on transaction 
fees.
    The impact that market volume has had on these fees has 
gone largely unnoticed outside of those who directly pay the 
bill. But it should not be overlooked. As more and more 
Americans rely on investing in the markets for retirement 
through work-sponsored retirement plans, IRAs and individual 
stocks, these fees are paid indirectly by the investor. With 
the growing importance of these savings mechanisms, it is 
incumbent upon Congress to do everything possible to ensure 
that our markets are operating at maximum efficiency.
    In that regard, I am proud to say that this committee has 
continued our commitment to improve our markets whenever 
possible. This subcommittee has produced several legislative 
efforts that will result in greater transparency in our 
markets, that will benefit investors and market participants.
    The most relevant legislative efforts to today's hearing is 
a new fee structure enacted into law in 1996 under the 
leadership of Chairman Bliley. The intention was to provide a 
more stable funding structure for the SEC and reduce fees over 
time to reflect the cost of running the agency. At the time, 
total fee revenue collected was roughly $700 million, or more 
than double the cost of funding the SEC. Last year, fee revenue 
collected by the SEC was approximately $1.7 billion, more than 
5 times the cost of funding the SEC, which again raises the 
concern that these fees are an unnecessary tax on the investor.
    This hearing will focus on the current status of the 
application of securities transaction fees and their impact on 
capital formation, the efficiency of the markets, investor 
savings and any competitive disparity that may result from 
these fees. Our witnesses will share their views on how these 
fees impact their normal course of business and what the larger 
implications for our economy might be. With this information, 
we will be able to determine if this is an issue the Congress 
should reexamine. Should the Commerce Committee decide to 
reexamine the fee structure, there are several legislative 
proposals which deal with this concern that we may wish to 
discuss.
    However, I would like to remind my colleagues and witnesses 
that this is an oversight hearing only. We will not be 
addressing any particular legislative proposal on this issue 
today. I welcome our witnesses and look forward to their views 
on this subject.
    [Additional statements submitted for the record follow:]
 Prepared Statement of Hon. John Shadegg, a Representative in Congress 
                       from the State of Arizona
    Thank you Mr. Chairman. I am pleased the subcommittee is addressing 
today the collection of securities transaction fees and their impact on 
the nation's equities markets. I share the concern held by Chairman 
Oxley and other members of this subpanel regarding the skyrocketing fee 
collections that have resulted from an unprecedented bull market over 
the last several years. I commend the Chairman for his leadership on 
this issue.
    Currently, several securities fees are charged for various 
activities associated with the equities markets. These fees are 
intended to compensate for the operations of the federal securities 
regulator, the Securities and Exchange Commission (SEC). The current 
budget for the SEC is roughly $340 million, annually. However, the 
projected revenue for securities fees in FY1999 is $1.6 billion.
    Two of the more predominant securities fees are the Section 6(b) 
registration fee and the Section 31 transaction fee. The Section 6(b) 
registration fee is paid by corporations when they register new 
securities for sale to investors. The rate of this fee is $200 per $1 
million in securities sold, or \1/50\th of 1 percent. The Section 31 
transaction fee, collected on the sale of corporate stock on exchanges 
and the Nasdaq market, is currently at a rate of \1/300\th of 1 
percent.
    In 1996, Congress passed the National Securities Markets 
Improvement Act which lowers the rate of these fees over 10 years. The 
Section 6(b) fee will decline to \1/150\th of 1 percent or $67 per $1 
million in 2007. The Section 31 fee will be reduced from \1/300\th to 
\1/800\th of 1 percent in 2007. However, even with these reduced fee 
rates, revenue from securities fees continues to increase, far 
outweighing the SEC's annual budgetary needs to regulate the equities 
markets.
    These so-called ``user fees'' are, in fact, an unnecessary 
burdensome tax on America's investors. I believe Congress must enact 
legislation to further reduce the rate of securities fees and put an 
end to this unfair tax on investors in the stock market. I look forward 
to hearing from the witnesses assembled today to testify before this 
subcommittee. In particular, I am interested to hear their thoughts on 
the concerns some experts have regarding the reduction in fees and a 
possible downturn in the market. Again, I thank the Chairman for 
bringing this issue before the subcommittee today and I yield back the 
balance of my time.
                                 ______
                                 
   Prepared Statement of Hon. Vito J. Fossella, a Representative in 
                  Congress from the State of New York
    Thank you, Mr. Chairman. I want to start by thanking Chairman Oxley 
for scheduling this important OVERSIGHT hearing. I know that the issue 
of SEC transaction fees is one in which the Chairman has had a 
longstanding interest, and I commend him for his leadership on this and 
many other issues that are important to securities professionals and 
investors in my district and across the United States. I share the 
Chairman's commitment to addressing the issue of excessive Section 31 
fees in a bipartisan, timely and meaningful fashion.
    I also want to thank the witnesses for appearing today. These folks 
and the industry they represent are an integral part of our economy--
they provide the oil which makes it possible for our economic engine to 
continue running at peak efficiency. They help raise the capital 
necessary for businesses to invest in new jobs and equipment, and they 
are vital liquidity providers that help keep our secondary trading 
markets vibrant.
    As you will hear today, the government collected over $1.75 billion 
in SEC fees last year, which is over five times the SEC's budget. The 
SEC performs a crucial function, admirably I might add--of protecting 
the integrity of the U.S. capital markets, and helping them remain the 
deepest, most liquid and efficient in the world. Having said that, 
there is simply no public policy rationale to justify such an absurd 
amount of user fee collections. SEC fees have become a tax on capital 
formation and on securities trading. This tax disproportionately 
impacts areas such as my home, Staten Island, New York, which has one 
of the largest concentrations of securities professionals in the 
country.
    I have introduced legislation, H.R. 1256, that would address this 
issue, and I also want to thank Chairman Oxley for working with me and 
other interested Members of this Committee to shed some light on this 
growing problem. I also want to acknowledge the efforts of the lead 
Democrat on the bill, Bob Menendez of New Jersey, who has worked 
closely with me on this issue.
    I am pleased that my bill now has 53 cosponsors from both sides of 
the aisle, including conservatives, moderates and liberals--reflecting 
what I believe is the essentially nonpartisan, nonideological nature of 
this issue. I also want to thank my 20 colleagues on this Committee who 
have joined as cosponsors of H.R. 1256. As Members may know, my 
legislation would cap the amount of SEC fees at levels closer to what 
was intended in 1996, when the various SEC fees were restructured. This 
legislation is similar in approach to a bill that was scored as revenue 
neutral by the CBO last year.
    I am pleased to note that SEC Chairman Arthur Levitt recently told 
this Subcommittee that he believes the most appropriate way to address 
this problem is through a flexible cap--which is exactly the type of 
approach embodied in my legislation. Nevertheless, I want to stress 
that while I feel that my legislation represents the best approach, as 
I have stated before, I would be fully supportive of any solution that 
this Committee in its wisdom deems appropriate.
    Once again, I want to commend Chairman Oxley for holding this 
hearing, which I believe is an important step towards enactment of real 
Section 31 fee relief. I understand that the Chairman is holding open 
the option of holding a separate LEGISLATIVE hearing at a later date, 
during which the Committee could explore the merits of specific 
proposals to address the Section 31 fee issue. I will await such an 
opportunity to discuss the details of my proposal, but it is my hope 
that we will indeed be able to move forward towards a mark up of 
legislation to provide American investors and securities professionals 
with much-needed relief from Section 31 fees. Thank you, Mr. Chairman, 
and I look forward to the testimony of this excellent panel.
                                 ______
                                 
 Prepared Statement of Hon. Tom Bliley, Chairman, Committee on Commerce
    I would like to thank the Chairman of the Subcommittee for holding 
this oversight hearing today. It is vital that this Committee maintain 
a close eye on all aspects of our securities markets. As more Americans 
invest their hard earned dollars in the markets for retirement, we must 
ensure that the markets are as fair and efficient as possible. Concerns 
have been raised that the revenue generated by securities transaction 
fees has increased so quickly that it does not correspond with those 
goals. Investors and businesses that rely on capital may actually be 
disadvantaged by excessive transaction fees. That is money that could 
be put to use elsewhere for more savings and investments.
    This is not the first time that this Committee has dealt with the 
fee structure. In 1996, Congress determined that the fee revenue 
generated by the securities markets had grown to such a level that it 
was a tax on investors. Fees needed to be reduced to more closely 
reflect the SEC's budget. It was also determined that the SEC should 
have a more sound funding structure. This accomplishes both goals. 
After difficult negotiations with the Senate and the Administration, we 
enacted changes to the fee structure as part of a larger securities 
markets reform legislation. The intention was to save investors money 
and eliminate the reliance on fee revenue to fund the SEC. Having spent 
many hours working on that legislation, I have a special interest in 
today's hearing.
    In the 1996 Act, we applied transaction fees to NASDAQ traded 
stocks for the first time to eliminate any competitive advantages they 
had over exchange listed stocks. Removing competitive discrepancies is 
good public policy. Unfortunately, it was impossible to anticipate the 
explosive growth in the stock markets. Annual trading volume is 
reported to be up nearly 50 percent over the last 2 years from the 1996 
level. The impact of this dramatic increase has contributed largely to 
the enormous level of total fee revenue being collected.
    At the time we were considering the legislation in 1996, fee 
revenue collected was double the cost of funding the SEC. There was a 
consensus that this was a problem worthy of Congressional action. 
Despite the intentions of that legislation, fee revenue being collected 
has increased dramatically. With last year's total fee revenue of $1.7 
billion collected--over 5 times the cost of funding the Commission--
this Committee may want to consider reexamining this issue.
    The focus of the problem in 1996 was on the revenue being generated 
by increases to the fee rate for securities registrations. We heard the 
arguments, and agreed that it was a tax on capital formation. We 
provided significant relief in the legislation for registration fees. 
These changes will become more evident with each passing year as the 
rate continues to decline.
    Now, with transaction fees applied across the board to include 
NASDAQ traded stocks, the issue is somewhat different. Combined with 
the unprecedented level of market volume, the transaction fees are 
generating far more revenue than was ever contemplated. This raises 
serious public policy concerns when the laws we enact do not function 
in the manner we intended.
    Investors should not be paying more for a stock than its worth, nor 
should they be paying excess fees that could be invested. I look 
forward to learning how the transaction fees impact American investors, 
the quality of our markets, and our economy. If these fees do pose 
unnecessary burdens on our investors and capital markets, it may be an 
issue that we need to reexamine.
                                 ______
                                 
Prepared Statement of Hon. Frank Pallone, a Representative in Congress 
                      from the State of New Jersey
    Thank you, Chairman Oxley. I want to commend you and Ranking Member 
Towns for holding this important hearing on Section 31 fees. I know 
that this Committee will carefully consider the facts regarding the 
current SEC fee structure and hopefully move to change the law to bring 
Section 31 fees in line with the needs of the Securities and Exchange 
Commission. I believe this is an issue of importance to all savers and 
investors. In the end, it is individual Americans who pay these fees. 
The payment of excessive fees directly reduces their hard-earned 
savings.
    Excess Section 31 fee collections also have a negative impact on 
financial firms located in New Jersey, many of whom are NASDAQ market 
makers. For many, Section 31 fee payments have become quite onerous, 
comprising a significant portion of their overhead. I note that today 
we will hear from Steve Nelson from Herzog Heine Geduld, a New Jersey 
firm and Mr. Kearney's group, the Securities Traders Association, which 
also has many members in the State of New Jersey.
    I have cosponsored H.R. 1256, the ``Savings and Investment Relief 
Act of 1999,'' a fee cap bill introduced by Reps. Fossella (R-NY) and 
Menendez (D-NJ) as well as H.R. 2441 ``The Fairness and Securities 
Transaction Act'' cosponsored by Rep Lazio (R-NY) and Towns (D-NY) 
which would lower the rate. Twenty-four members of this Committee have 
collectively cosponsored both bills. Clearly something needs to be done 
to correct this situation and I believe either approach, if properly 
structured, could meet our policy concerns.
    In closing, let me state that I strongly support full and ample 
funding for the SEC. The Agency does an admirable, professional job and 
should be given ample resources. However, the government should not 
continue to collect fees that are five times in excess of what is 
necessary to run the SEC.

    Mr. Oxley. Let me now turn to our panel and introduce the 
witnesses. Our first witness is Mr. William J. Brodsky, 
Chairman and CEO of the Chicago Board Options Exchange, who has 
been here in the past; Mr. Andrew Cader, Senior Managing 
Director, Spear, Leeds & Kellogg of New York, on behalf of the 
Specialist Association of the New York Stock Exchange; Mr. 
Steve Nelson, Vice President of Special Projects for Herzog 
Heine Geduld, on behalf of the Securities Industry Association; 
and Mr. Art Kearney, Director of Equity Capital; and John G. 
Kinnard & Company from Minneapolis, representing the Securities 
Traders Association.
    Welcome to all of you for appearing here today, and let us 
begin with Mr. Brodsky.

  STATEMENTS OF WILLIAM J. BRODSKY, CHAIRMAN AND CEO, CHICAGO 
BOARD OPTIONS EXCHANGE; ANDREW CADER, SENIOR MANAGING DIRECTOR, 
SPEAR, LEEDS & KELLOGG, ON BEHALF OF THE SPECIALIST ASSOCIATION 
    OF THE NEW YORK STOCK EXCHANGE; STEPHEN J. NELSON, VICE 
 PRESIDENT OF SPECIAL PROJECTS, HERZOG HEINE GEDULD, ON BEHALF 
  OF SECURITIES INDUSTRY ASSOCIATION; AND ARTHUR J. KEARNEY, 
DIRECTOR OF EQUITY CAPITAL, JOHN G. KINNARD & CO., ON BEHALF OF 
   SECURITY TRADERS ASSOCIATION, ACCOMPANIED BY LEE KORENS, 
        PRESIDENT AND CEO, SECURITY TRADERS ASSOCIATION

    Mr. Brodsky. Thank you, Mr. Chairman. I will ask to have my 
testimony entered into the record.
    Mr. Oxley. Without objection, all of the members' opening 
statements as well as the witness' testimony will be made a 
part of the record.
    Mr. Brodsky. The Chicago Board Options Exchange is the 
world's largest options exchange. We trade options on 1,300 
stocks and over a dozen stock indexes, including the Standard & 
Poor's 500 Index, the NASDAQ 100 and the Dow Jones Industrial 
Average. Our volume has been averaging almost a million 
contracts per day which accounts for 51 percent of all listed 
options volume in the U.S. On behalf of the CBOE, I commend you 
for holding this hearing on the transaction fees collected by 
the SEC. As an organization whose products are subject to 
transaction fees, and who represents market professionals who 
pay such fees, we have a strong interest in bringing the fees 
paid more into balance with the budget of the SEC.
    Fees have been imposed on listed securities transactions 
since the passage of the Securities Exchange Act of 1934 for 
the purpose of funding the operations of the SEC, along with 
fees such as those for registering securities. The legislative 
history behind these fees does not show any intent by Congress 
to use them as a general revenue source, but rather evidences 
an intention to use the fees solely to defray the costs of 
regulating the securities markets.
    The amount of fees now collected, however, greatly exceeds 
the SEC's budget. We believe that fees revenues in excess of 
the SEC's budget represents a tax on capital which penalizes 
investors and businesses and puts the U.S. Securities markets 
at a competitive disadvantage. As you observed earlier, the 
National Securities Improvement Act of 1996, or NSMIA, 
restructured various fees with the intention of creating a 
predictable funding source of the SEC and reducing, over time, 
the fees collected by the SEC. This act was intended to bring 
the SEC fee collections more into line with the level of funds 
appropriated by Congress. This goal has been thwarted, however, 
because of the market averages greatly increasing to levels 
unforeseen in 1996, and trading volume has increased 
substantially since that time. As a result, these collections 
have increased significantly.
    I will not go through the numbers that you have already 
mentioned, only to say that waiting until fiscal year 2007 for 
reductions will result in investors paying hundreds of millions 
of dollars and maybe billions of dollars more in fees than 
those needed to support the agency.
    What I want to talk about next is why I am here and why the 
options business is uniquely challenged in this area and where 
we are seeking your help.
    As the largest securities options exchange, we are 
particularly disadvantaged by the imposition of these fees 
which competitively injure us in a number of ways. First the 
transaction fees applies to stock index options traded on the 
CBOE that compete with stock index futures and options on stock 
index futures traded on U.S. Futures exchanges, as well as off-
exchange derivatives markets such as swaps and over-the-counter 
options. Stock index futures and options on stock index futures 
and off-exchange derivatives are not subject to section 31 fees 
at all.
    This adds a competitive penalty for the use of exchange-
traded securities such as stock index options and places these 
products at a substantial competitive disadvantage. Broad-based 
stock index options compete directly with these products on the 
futures exchanges. They are used by the same customers and are 
employed for the same risk-shifting purposes.
    As part of the decision whether to use an option or a 
future for a particular strategy, a customer or trader will 
evaluate the costs of both products to determine which will be 
more effective. Because section 31 fees places the equivalent 
of a transaction tax on exchange-traded securities such as 
stock index options but not on stock index futures or options 
on stock index futures, the fees can be a determining factor in 
the decision of which product to select.
    I implore Congress to remedy this disparity by eliminating 
section 31 fees for broad-based stock index options so that 
they can compete on a level playing field with economically 
equivalent products. I think probably the best way to explain 
this, Mr. Chairman, is because of the legislative accord that 
goes back 17 years that is called Shad-Johnson, what you have 
is a disparity where you have in the city of Chicago 
economically equivalent products trading in 2 or 3 different 
exchanges. One is being taxed by Federal law, and the other is 
not.
    And my favorite example would be--take an airplane ticket. 
And if I said to my staff, you can fly American or United from 
Chicago to Washington, and one has a Federal tax of $18 and the 
other doesn't, which plane will they use when you hold them to 
a standard of fiduciary responsibility of getting the best 
price? And we have this anomaly that until now we really have 
not had a forum to bring to your attention.
    The second area is a complicated area that relates to the 
option business, and that relates to what we call spread 
strategies or other transactions that relate to multiple legs 
of a transaction. And the way that this tax was structured, 
when people used these strategies, they can be very expensive 
based upon the way that the tax applies. And what we are asking 
for in consideration by the committee is that the committee 
look at the total transaction and not the individual legs of 
the transaction.
    I would be happy to go into this with you now or later or 
with your committee staff, but it is in my testimony. It is 
somewhat complex, but when this law was devised, options didn't 
exist. Option strategies didn't exist, and the tax on option 
strategies has created some very anticompetitive results which 
I don't think that the committee intends. And I am happy to go 
through it now but it is in my testimony.
    In conclusion, I would say that aside from the relief that 
I requested, the stock index options and the spread 
transactions, we also favor an acceleration in the timetable 
approved by Congress in 1996 for reducing section 31 
transaction fees. A stepped-up timetable to reduce the fees as 
soon as possible is justified by the unanticipated increase in 
market activity which has resulted in significant overfunding. 
The reduction would benefit all market participants, including 
individual investors, pension funds, mutual funds, and market 
professionals who provide customers with on-demand liquidity 
and maintain orderly markets.
    Consequently, we support the legislation such as H.R. 4269, 
introduced last year, and recently introduced H.R. 2441, which 
would reduce fees on securities transactions while maintaining 
the full funding of the SEC.
    I want to make very clear that we have no desire to do 
anything that would limit or in any way threaten the 
underpinning of the SEC's funding, but obviously the numbers 
have become so compelling that there is an opportunity to 
reduce the fees.
    We are also aware that the introduction of H.R. 1256, which 
would cap the transaction fee once a stated amount of revenue 
has been collected in any given year--while we generally favor 
anything that would reduce the burden of what we believe is an 
unfair and unnecessary tax on investors, we believe that 
reducing the percentage rate at which the fee is imposed on all 
investors is a more equitable and easier-to-administer solution 
to the problem than making the fee apply at its existing rate 
to certain investors while making it not apply to others.
    We also believe that a reduction in fees is more consistent 
with the approach taken in NSMIA. NSMIA provided that the 
transaction fee was reduced from \1/300\ of 1 percent to \1/
800\ of 1 percent in fiscal year 2007. While the act was 
intended to bring SEC collections more in line with the level 
of SEC funding appropriated by Congress, the gradual percentage 
reduction has not been swift enough to prevent transaction fees 
from greatly exceeding the levels envisioned during the 
consideration of that act. Consequently, an accelerated 
reduction in the percentage of fees is needed at this time.
    Mr. Chairman, we commend you and the committee for your 
recognition of this problem and look forward to working with 
you to solve it. Thank you for giving me the opportunity to 
present the views of the Chicago Board Options Exchange and 
particularly how the impositions of section 31 fees hurts the 
options markets. Thank you very much.
    [The prepared statement of William J. Brodsky follows:]
Prepared Statement of William J. Brodsky, Chairman and Chief Executive 
                Officer, Chicago Board Options Exchange
    I am William J. Brodsky, Chairman and Chief Executive Officer of 
the Chicago Board Options Exchange (``CBOE''). I would like to present 
CBOE's views on the transaction fees imposed by Section 31 of the 
Securities Exchange Act of 1934.
    The CBOE is the largest options exchange in the world. We trade 
options on 1,300 stocks and over a dozen stock indexes such as the 
Standard & Poor's 500 Index, the Nasdaq 100 Index, and the Dow Jones 
Industrial Average. Our volume averages over 900,000 contracts per day, 
which accounts for 51% of all the listed options volume traded on U.S. 
securities exchanges. On behalf of the CBOE, I commend you for holding 
a hearing on transaction fees collected by the Securities and Exchange 
Commission. As an organization whose products are subject to 
transaction fees, and who represents the market professionals who pay 
such fees, we have a strong interest in bringing the fees paid more 
into balance with the budget of the SEC.
    Fees have been imposed on listed securities transactions since the 
passage of the Securities Exchange Act of 1934 for the purpose of 
funding the operations of the SEC, along with other fees such as those 
for registering securities. The legislative history behind these fees 
does not show any intent by Congress to use them as a general revenue 
source, but rather evidences an intention to use the fees solely to 
defray the costs of regulating the securities markets. The amount of 
fees now collected, however, greatly exceeds the SEC's appropriated 
budget. We believe that fee revenues in excess of the SEC's budget 
represent a tax on capital which penalizes investors and businesses and 
puts the U.S. securities markets at a competitive disadvantage.
    The National Securities Markets Improvement Act of 1996 (NSMIA) 
restructured various SEC fees with the intention of creating a 
predictable funding source for the SEC and reducing, over time, the 
fees collected by the SEC. NSMIA was intended to bring SEC fee 
collections more in line with the level of funding appropriated by 
Congress. This goal has been thwarted, however, because market averages 
have greatly increased to levels unforeseen in 1996, and trading volume 
has increased substantially since that time. As a result, actual 
collections of transaction fees are significantly exceeding the levels 
projected during consideration of NSMIA, and they are projected to do 
so into the future. The revenue generated by Section 31 transaction 
fees alone in fiscal year 1998 was $476 million, which exceeded the 
SEC's entire appropriated budget of $315 million by $161 million. In 
fiscal year 1999, total SEC fee collections are expected to exceed $1.6 
billion, more than four times the Commission's appropriated funding of 
$337 million. We strongly support adequate funding for the SEC, whose 
regulatory program contributes to the strength and integrity of U.S. 
securities markets, and would not want legislation to result in a 
reduction of SEC appropriations. On the other hand, the transaction fee 
has greatly exceeded revenue expectations since the passage of NSMIA 
two years ago. The excess amount represents a hidden tax on all 
investors. Waiting until fiscal year 2007 for a reduction in the 
transaction fees will result in investors paying hundreds of millions 
of dollars in fees over and above those needed to support the cost of 
regulation.
    As the largest securities options exchange in the world, we are 
particularly disadvantaged by the imposition of transaction fees, which 
competitively injure us in a number of ways. First, the transaction fee 
applies to stock index options traded on the CBOE that compete with 
stock index futures and options on stock index futures traded on U.S. 
contract markets as well as with off-exchange derivatives such as swaps 
and over-the-counter options. Stock-index futures, options on stock 
index futures, and off-exchange derivatives are not subject to Section 
31 fees. This adds a competitive penalty to the use of exchange-traded 
securities such as stock index options and places stock index options 
at a substantial competitive disadvantage. Broad-based stock index 
options compete directly with stock index futures and options on stock 
index futures. They are used by the same customers and are employed for 
the same risk shifting purposes. As part of the decision whether to use 
an option or a future for a particular strategy, a customer or trader 
will evaluate the costs of both products to determine which will be 
more cost-effective. Because Section 31 fees place the equivalent of a 
transaction tax on exchange-traded securities such as stock index 
options but not on stock index futures or options on stock index 
futures, the fees can be a determining factor in the decision of which 
product to select. I implore Congress to remedy this disparity by 
eliminating Section 31 fees for broad-based stock index options so that 
they can compete on a level playing field with economically equivalent 
products.
    Second, options traders often use multi-part strategies such as 
spreads and straddles that involve multiple transactions as part of a 
single trade. Each part of the trade is subject to Section 31 fees, 
which, when combined, adds a significant cost to these strategies. For 
example, a so-called box spread involves four simultaneous trades as 
part of a single transaction. Each of the four trades is charged a 
Section 31 fee. In the case of many box spreads, the impact of the 
transaction fee is compounded by the fact that, although the spread as 
a whole represents a market-neutral position used by market makers as a 
financing technique, it is often the case that two parts of the spread 
represent deep-in-the-money, high premium trades. This can cause the 
transaction fee, which is based on the premium paid on the sell sides, 
to be disproportionately high. This can act as a huge disincentive for 
market makers to engage in these trades, thereby depriving the market 
of added liquidity. I urge Congress to examine whether there are ways 
to reduce the special burden that transaction fees place on box 
spreads. For example, the fee could be calculated on the basis of the 
average price of all the parts of the spread, which would reduce the 
overall amount of the transaction fee for the strategy. We are ready to 
work with you to find a way to ensure that multi-part trades such as 
box spreads are not subject to a special, compounding cost from Section 
31 fees.
    In these and many other ways, Section 31 fees act as an expensive 
surcharge on securities options. Our options markets are the best in 
the world, offering both retail and institutional investors an 
opportunity to reduce or transfer risk in an efficient manner. With 
international competition from overseas derivatives markets and growing 
competition domestically from new options markets and over-the-counter 
derivatives, however, it is increasingly difficult to compete because 
of the loadstone of transaction fees on our products.
    Aside from the relief I have requested for stock index options and 
box spreads, we also favor an acceleration of the timetable approved by 
Congress in 1996 for reducing the Section 31 transaction fee. A 
stepped-up timetable to reduce fees as soon as possible is justified by 
the unanticipated increase in market activity which has resulted in 
significant overfunding from fee collections. The reduction would 
benefit all market participants, including individual investors, 
pension funds, mutual fund investors, and the market professionals who 
provide customers with on-demand liquidity and maintain orderly 
markets. Consequently, we support legislation such as H.R. 4269, 
introduced last year, and the recently introduced H.R.2441, which would 
reduce fees on securities transactions while maintaining the full 
funding of the SEC.
    We also are aware of the introduction of H.R. 1256, which would cap 
the transaction fee once a stated amount of revenue has been collected 
in any given year. While we generally favor anything that would reduce 
the burden of what we believe is an unfair and unnecessary tax on 
investors, we believe that reducing the percentage rate at which the 
fee is imposed on all investors is a more equitable and easier to 
administer solution to the problem than making the fee apply at its 
existing rate to certain investors, while making it not apply at all to 
others.
    We also believe that a reduction in fees is more consistent with 
the approach taken in NSMIA. NSMIA provided that the transaction fee 
would be reduced from \1/300\ of one percent to \1/800\ of one percent 
in fiscal year 2007. While NSMIA was intended to bring SEC fee 
collections more in line with the level of SEC funding appropriated by 
Congress, the gradual percentage reduction has not been swift enough to 
prevent transaction fees from greatly exceeding the levels envisioned 
during consideration of NSMIA. Consequently, an accelerated reduction 
in the percentage of the fees is needed.
    We commend your recognition of this problem and look forward to 
working with you to resolve the problem. Thank you for giving me the 
opportunity to present the views of the CBOE and, particularly, how the 
imposition of Section 31 fees hurts the U.S. options markets.

    Mr. Oxley. Thank you, Mr. Brodsky.
    Mr. Cader.

                    STATEMENT OF ANDREW CADER

    Mr. Cader. Thank you, Chairman Oxley and members of this 
subcommittee. I am Andrew Cader, I am Vice President and Member 
of the Board of Directors of the Specialist Association of the 
New York Stock Exchange. I am pleased to appear before you to 
present the Association's views concerning the transaction fees 
imposed by section 31. By way of further background, I am also 
the Senior Managing Director of Spear, Leeds & Kellogg, the 
largest specialist operation on the New York Stock Exchange and 
the American Stock Exchange. Spear, Leeds also maintains a 
significant presence as an over-the-counter market maker, and 
clears trades for a number of smaller specialists and market 
makers who are particularly adversely impacted by section 31 
fees.
    We are also ourselves members of and clear for many members 
of the CBOE. I sit on the board of directors of the SIA, who 
Steve Nelson is representing, and our over-the-counter group is 
in fact in the same business as Herzog Heine Geduld and we are 
members of the STA as well. So I think we have a broad 
experience with all of the liquidity providers who are impacted 
by this. As you may suspect, I have strong views on the topic.
    The Specialist Association is comprised of 27 broker-dealer 
firms which include all of the individual specialists of the 
New York Stock Exchange. Our specialists are at the heart of 
the auction market of the world's most active stock exchange. 
The New York Stock Exchange's auction trading marketplace is 
the mechanism through which the prices of stock listed on the 
exchange are discovered and liquidity is provided to buyers and 
sellers. We supply liquidity when necessary to the proper 
operation of the market, acting as buyer or seller in the 
absence of public demand to buy or sell in our respective 
specialty stocks. We coordinate orderly trading in those 
stocks.
    Over 169 billion shares of stock were traded on the 
exchange in 1998 in over 135 million transactions. Specialists 
participated as principal, buying or selling for their own 
accounts in 12.5 percent of those transactions, paying in 
excess of $30 million in section 31 fees last year, an amount 
we expect to increase to in excess of $40 million this year. A 
total of $242 million was paid in section 31 fees in 1998 on 
New York Stock Exchange transactions by all stock exchange 
member firms and their customers.
    Beginning the 1930's, the Federal Government through the 
SEC has collected fees in respect to sales securities 
registered under the Securities Act of 1933, the section 6(b) 
fees, and, in respect to the sales effected in the trading 
markets subject to regulation under the exchange act, section 
31 fees. Although these fees were conceived as user fees to 
defray the costs of Federal securities regulation, the amounts 
collected have exceeded the cost of running the SEC ever since 
1983. As will be discussed momentarily, those collected amounts 
now surpass the SEC's budget by a factor of greater than 5.
    In short, the section 6(b) and section 31 fees have become 
a general tax on capital raising. Moreover, as I will discuss 
in a moment, section 31 fees represent a tax imposed at a 
particularly inopportune time in the life cycle of a 
specialist's or market maker's capital and its deployment in 
the marketplace.
    Before going further, please let there be no 
misunderstanding. We support continued full funding for the 
SEC, an agency that has overseen our constantly growing, 
remarkably fair and efficient markets, that raise new capital 
and serve the public investor, contributing to our worldwide 
reputation for fairness and integrity. What we object to is 
misuse of the financing mechanism designed to compensate the 
government for providing that funding--the section 31 fees, 
through overcollection of the fee and application of the 
proceeds to completely unrelated objectives.
    When congressional appropriators began to increase the 
section 6(b) fees annually in 1990, various Members of Congress 
recognized that the fee increases amounted, in reality, to a 
new tax because the amounts collected so significantly exceeded 
the SEC's annual budget. In 1993, the House responded by 
unanimously passing a bill that, after fiscal 1998, would have 
required the SEC to set and collect fees for the exclusive 
purpose of recovering for the government the cost of funding 
the SEC's regulatory activities. No further action was taken on 
that bill.
    A similar effort was made by both Chambers of Congress in 
1996, in the National Securities Markets Improvements Act, to 
compel a slowdown and finally a reduction in the amounts of 
section 6(b) and 31 fees collected. The basic idea of limiting 
the section 31 fee to the cost of funding the SEC, however, has 
proven to be very elusive.
    In fiscal 1997, the SEC's collections from 6(b) and 31 fees 
and all other sources grew to $990 million, significantly more 
than 3 times the agency's budget of $305 million. To bring 
transaction fees back into line with the cost of running the 
SEC, a bipartisan bill was introduced in the House in 1998 to 
cap section 31 fees. Another bill was introduced in the House 
in that year that would have cut the section 31 fee in half 
rather than capping it. These initiatives were cosponsored by 
over 60 House members, and one or the other was endorsed by, 
among many others, the STA, the Chicago and Pacific Stock 
Exchanges, the Securities Industry Association, the NASD, the 
Profit Sharing/401(K) Council, Americans for Tax Reform, the 
National Taxpayers Union, Citizens for a Sound Economy, the 
U.S. Chamber of Commerce, as well as the New York Stock 
Exchange and our Association. Neither bill was voted upon.
    More recently, two new bipartisan bills have been 
introduced in the House to remedy the section 31 fee: H.R. 2441 
and 1256 introduced by Representatives Lazio and Towns and 
Representatives Fossella and Menendez respectively. Each have 
garnered more than 30 cosponsors. In fiscal 1998, the SEC's fee 
collections mushroomed to an astounding $1.78 billion. That is, 
the SEC's fee collections amounted to 5\1/2\ times its $322 
million budget.
    Our colleagues of the Security Traders Association have 
laid out in detail in their written testimony to the 
subcommittee the history of how the section 31 fee has been 
transformed from an SEC funding mechanism into a general tax 
and the efforts of Members of the House and the Senate over the 
last decade to return the section 31 fees to its original 
purpose. We wish to associate ourselves with the STA's 
recitation of that history and see no need to repeat or 
elaborate upon it.
    As things stand, the section 31 fee cannot be viewed as 
anything but a tax on the sale of securities, a purpose for 
which it was never intended. That tax, although levied in 
relatively small increments, is creating a near billion dollar 
drag on the capital markets. That drag on our markets 
represents a cost paid by all investors, including the huge 
number of individually small participants in mutual funds, 
pension plans, and other forms of retirement accounts.
    Moreover the section 31 tax is imposed at a particularly 
inopportune time in terms of its ultimate effect on market 
liquidity. Unencumbered by section 31 fees, revenue generated 
by specialists and market makers and other liquidity providers 
in securities transactions would in many cases be put to its 
normal use and leveraged in a manner allowing those market 
professionals to provide liquidity to the market in a multiple 
exceeding many times the absolute amount of the revenue itself. 
Thus, investors and the market in general lose more than simply 
the amount of the section 21 fees themselves in terms of 
sacrificed market liquidity.
    We would also be wise to remember that we have had the 
benefit of a thriving and competitive bull market for an 
unprecedented number of years, as the chairman mentioned in his 
opening remarks. During such times, the impact of measures 
placing inappropriate burdens on capital formation and market 
activity can be softened or blunted. As is often the case with 
respect to ill-advised policy, it is only when market 
conditions eventually decline and liquidity becomes more scarce 
that the full brunt of a cloaked tax, such as the current 
section 31 fees, will be felt by us all. This will be 
particularly true to the extent that market prices might 
stagnate or decline, but today's record volume levels remain 
the norm.
    In conclusion, general tax revenue is the objective of 
other laws, not the exchange act. Congressional action to 
restore the unintended tax now represented by the section 31 
fee to its original purpose--to fund the operations of the SEC 
and not for any other type of Federal expenditure, is long 
overdue.
    We applaud your inquiry into this matter and hope for a 
solution in the near term. We would support any realistic 
method of achieving the objective of bringing the revenue 
collected from the section 31 fee back into line with the SEC's 
annual budget.
    The Association is thankful for the opportunity to express 
our views on the section 31 fee. Thank you, Mr. Chairman. I 
would be pleased to respond to any questions you or your staff 
have now or later.
    [The prepared statement of Andrew Cader follows:]
  Prepared Statement of Andrew Cader, Vice President, The Specialist 
               Association of the New York Stock Exchange
    Chairman Oxley, Members of the Subcommittee, good morning. I am 
Andrew Cader, Vice President and member of the Board of Directors of 
The Specialist Association of the New York Stock Exchange. I am pleased 
to appear before you to present the Association's views concerning the 
transaction fees imposed by Section 31 of the Securities Exchange Act 
of 1934. By way of further background, I also am a Senior Managing 
Director of Spear, Leeds & Kellogg, the largest specialist operation on 
the New York Stock Exchange and American Stock Exchange. Spear Leeds 
also maintains a significant presence in the over-the-counter market, 
and clears trades for a number of smaller specialists and market makers 
who are particularly adversely impacted by Section 31 fees. Therefore, 
as you might suspect, I have strong views on today's topic.
    The Specialist Association is comprised of 27 broker-dealer firms 
which include all of the individual specialists of the New York Stock 
Exchange. Our specialists are at the heart of the auction market of the 
world's most active stock exchange. The Exchange's auction trading 
marketplace is the mechanism through which the prices of stocks listed 
on the Exchange are ``discovered'' and liquidity is provided to buyers 
and sellers. We supply liquidity when necessary to the proper operation 
of the market, acting as buyer or seller in the absence of public 
demand to buy or sell in our respective specialty stocks. We coordinate 
orderly trading in those stocks. Over 169 billion shares of stock were 
traded on the Exchange in 1998 in over 135 million transactions. 
Specialists participated as principal, selling for their own accounts, 
in 12.6% of those transactions, paying in excess of $30 million in 
Section 31 fees last year (an amount we expect to increase to in excess 
of $40 million this year). A total of $242.6 million was paid in 
Section 31 fees in 1998 on NYSE transactions by all NYSE member firms 
and their customers.
    Beginning in the 1930s, the federal government, through the 
Securities and Exchange Commission, has collected fees in respect to 
the sales of securities registered under the Securities Act of 1933 
(``Section 6(b) fees'') and in respect to the sales effected in the 
trading markets subject to regulation under the Exchange Act (``Section 
31 fees''). Although these fees were conceived as user fees to defray 
the costs of federal securities regulation, the amounts collected have 
exceeded the cost of running the SEC ever since 1983. As discussed 
below, those collected amounts now surpass the SEC's budget by a factor 
of five. In short, the Section 6(b) and Section 31 fees have become a 
general tax on capital raising. Moreover, as I will discuss in a 
moment, Section 31 fees represent a tax imposed at a particularly 
inopportune time in the life cycle of a specialist's or market maker's 
capital.
    Before going further, please let there be no misunderstanding. We 
support continued full funding for the Securities and Exchange 
Commission, an agency that has overseen our constantly growing, 
remarkably fair and efficient markets that raise new capital and serve 
the public investor, contributing to our worldwide reputation for 
fairness and integrity. What we object to is misuse of the financing 
mechanism designed to compensate the government for providing that 
funding--the Section 31 fee--through over-collection of the fee and 
application of the proceeds to completely unrelated objectives.
    When Congressional appropriators began to increase the Section 6(b) 
registration fees annually in 1990, various members of Congress 
recognized that the fee increases amounted, in reality, to a new tax 
because the amounts collected so significantly exceeded the SEC's 
annual budget. In 1993, the House responded by unanimously passing a 
bill that, after fiscal 1998, would have required the SEC to set and 
collect fees for the exclusive purpose of recovering for the government 
the cost of funding the SEC's regulatory activities. No further action 
was taken on that bill. A similar effort was made by both chambers of 
Congress in 1996 in the National Securities Markets Improvements Act, 
to compel a slow-down and, finally, a reduction in the amounts of 
Section 6(b) and 31 fees collected. The basic idea of limiting the 
Section 31 fee to the cost of funding the SEC, however, has proven to 
be very elusive.
    In fiscal 1997, the SEC's collections from Section 6(b) and 31 fees 
(and all other sources) grew to $990 million, significantly more than 
three times the agency's budget of $305 million. To bring transaction 
fees back into line with the cost of running the SEC, a bipartisan bill 
was introduced in the House in 1998 to cap Section 31 fees. Another 
bill was introduced in the House in that year that would have cut the 
Section 31 fee in half rather than capping it. These initiatives were 
cosponsored by over 60 House members and one or the other was endorsed 
by, among many others, the Security Traders Association, the Chicago 
and Pacific Stock Exchanges, the Securities Industry Association, the 
NASD, the Profit Sharing/401(k) Council, Americans for Tax Reform, the 
National Taxpayers' Union, Citizens for a Sound Economy, the U.S. 
Chamber of Commerce, as well as the New York Stock Exchange and our 
Association. Neither bill was voted upon. More recently, two new 
bipartisan bills have been introduced in the House to remedy the 
Section 31 fee problem. H.R. 2441 and 1256, introduced by 
Representatives Lazio (R-NY) and Towns (D-NY), and Representatives 
Fossella (R-NY) and Menendez (D-NJ), respectively, each have garnered 
more than 30 cosponsors.
    In fiscal 1998, the SEC's fee collections mushroomed to an 
astounding $1.78 billion. That is, the SEC's fee collections amounted 
to five and one-half times its $322 million budget.
    Our colleagues of the Security Traders Association have laid out in 
detail in their written testimony to the Subcommittee the history of 
how the Section 31 fee has been transformed from an SEC funding 
mechanism into a general tax and the efforts of members of the House 
and Senate over the last decade to return the Section 31 fee to its 
original purpose. We wish to associate ourselves with the STA's 
recitation of that history and see no need to repeat or elaborate upon 
it.
    As things stand, the Section 31 fee cannot be viewed as anything 
but a tax on the sale of securities, a purpose for which it was never 
intended. That tax, although levied in relatively small increments, is 
creating a near billion-dollar drag on the capital markets. That drag 
on our markets represents a cost paid by all investors, including the 
huge number of individually small participants in mutual funds, pension 
plans, and other forms of retirement accounts.
    Moreover, the Section 31 ``tax'' is imposed at a particularly 
inopportune time in terms of its ultimate effect on market liquidity. 
Unencumbered by Section 31 fees, revenue generated by specialists and 
market makers in securities transactions would, in many cases, be put 
to its normal use and leveraged in a manner allowing these market 
professionals to provide liquidity to the market in a multiple 
exceeding the absolute amount of the revenue itself. Thus, investors 
and the market in general lose more than the simply the amount of the 
Section 31 fees themselves in terms of sacrificed market liquidity.
    We would also be wise to remember that we have had the benefit of a 
thriving and competitive bull market for an unprecedented number of 
years. During such times, the impact of measures placing inappropriate 
burdens on capital formation and market activity can be softened or 
blunted. As is often the case with respect to ill-advised policy, it is 
only when market conditions eventually decline and liquidity becomes 
more scarce that the full brunt of a cloaked tax such as the current 
Section 31 fees will felt by us all. This will be particularly true to 
the extent that market prices stagnate or decline, but today's record 
volume levels remain the norm.
    In conclusion, general tax revenue is the objective of other laws, 
not the Exchange Act. Congressional action to restore the unintended 
tax now represented by the Section 31 fee to its original purpose--to 
fund the operations of the SEC, and not for any other type of federal 
expenditure--is long overdue. We applaud your inquiry into this matter 
and hope for a solution in the near term. We would support any 
realistic method of achieving the objective of bringing the revenue 
collected from the Section 31 fee back into line with the SEC's annual 
budget.
    The Association is thankful for this opportunity to express its 
views on the Section 31 fee. Thank you, Mr. Chairman.
    I would be pleased to respond to any questions you, other 
Representatives, or your staff may have.

    Mr. Oxley. Thank you, Mr. Cader.
    Mr. Nelson.

                 STATEMENT OF STEPHEN J. NELSON

    Mr. Nelson. Chairman Oxley, Congressman Towns, members of 
the subcommittee, I am Steve Nelson, vice president of Herzog 
Heine Geduld, a leading NASDAQ market maker. I am here today 
representing the Securities Industry Association. Thank you for 
inviting me to testify at this hearing on the subject of 
securities transaction fees. This is a subject on which the 
chairman of the full committee, Congressman Bliley, has been a 
leader for a number of years and we are grateful to him for the 
leadership he has provided.
    Chairman Oxley, we commend and appreciate your interest in 
the subject of today's hearing, and, more broadly, your 
interest in fair, efficient, and internationally competitive 
securities markets. We look forward to working with you on this 
issue.
    Congressman Towns, we are also grateful for the work you 
have done to reduce regulatory burdens and reduce costs to 
investors. We appreciate your continued interest and 
involvement in issues affecting the securities markets.
    We also wish to express our special gratitude to 
Congressman Lazio, Congressman Fossella, and Congressman 
Menendez for the leadership they have demonstrated on the 
subject of SEC transaction fees.
    We know that our markets have been made better and fairer 
by the presence of a strong and effective Securities and 
Exchange Commission. And because it is in our interest and, 
more importantly, in the public interest to have an effective 
SEC, the SIA has been a strong supporter of full funding for 
the agency so it can carry out its important mission of 
investor protection. Our support for legislation today to 
reduce the excess fees charged to the industry, investors, and 
issuers will still provide more in revenues than the budget of 
the SEC.
    NSMIA was adopted in 1996 with the goal of bringing fees 
collected by the SEC more in line with the cost of running the 
agency. But in 1996, no one anticipated the explosion of market 
activity that has taken place over the past several years. In 
particular, no one could have predicted the phenomenal 
influence that online investors would have on equity markets. 
The investing public has found a new way to participate in the 
markets, and we believe at Herzog Heine Geduld that this is 
only the beginning. Fees now paid by investors, issuers, and 
the industry amount to 5 times the cost of running the SEC. We 
do not believe it is in the interest of investors or in the 
interest of our capital markets for these fees to so grossly 
dwarf the regulatory costs involved.
    The fees have a particularly profound impact on NASDAQ 
market makers and on specialists in traditional exchanges who 
perform similar functions. The market makers' business is 
similar in many ways to that of the grocer who buys milk for 10 
cents and hopes to sell it for 11. The section 31 fee is 
particularly burdensome to a market maker because where the fee 
exceeds the cost of regulation, it amounts to a tax on the 
market makers' gross revenues. The fee must be paid, whether we 
sell the milk profitably for 11 cents or at a loss for 9.
    In the last several years, technological advances have 
lowered transaction costs. These reduced costs have encouraged 
more trading activity. We have larger share volume and even 
larger trading volume but margins have also declined. We are 
selling more milk but we are making less on each sale. As 
transaction volume and market evaluations have increased, the 
amount of fees collected under section 31 has ballooned. In 
contrast, our profit margins have declined.
    As a result, section 31 fees comprise an increasing share 
of our gross trading revenues, even though the rate of the fee 
has remained constant. Herzog Heine Geduld's payments of 
section 31 fees currently amount to more than 3 percent of our 
gross trading revenues. Market makers must continue to make 
significant investments in technology to handle ever-increasing 
volumes. The increase in volumes is accompanied by lower 
margins and increasing SEC fees. We are on a collision course 
that, if left uncorrected, will have a significant effect on 
the ability of market makers to conduct their business 
profitably.
    We believe that our equity markets, much admired and envied 
throughout the world, would operate much less efficiently if 
there were no market makers. This result was certainly not 
intended by Congress. The language of section 31 states that 
transaction fees to be collected by the SEC are designed to 
recover the cost to the government of the supervision and 
regulation of the securities markets and securities 
professionals and costs related to such supervision and 
regulation.
    We have demonstrated that we are more than willing to pay 
the costs associated with regulation. But it is simply not 
right to charge investors, issuers. And market makers 5 times 
the cost of regulation. At a minimum, a burden of this size 
with its potential to adversely effect the structure of the 
capital markets should not be allowed to happen inadvertently 
because of changing circumstances.
    Mr. Chairman, we urge you to craft a solution that will 
better align fees with the cost of regulation. We have 
confidence that Congress, once it reviews the facts, will make 
a decision that is in the interest of millions of investors. We 
are committed to work with this subcommittee to find an 
appropriate solution. Thank you for the opportunity to testify. 
I am ready to answer any questions.
    [The prepared statement of Stephen J. Nelson follows:]
 Prepared Statement of Stephen J. Nelson, Vice President, Herzog Heine 
                                 Geduld
    Chairman Bliley, Chairman Oxley, Congressman Towns and Members of 
the Subcommittee, I am Steve Nelson, Vice President of Herzog Heine 
Geduld, a leading NASDAQ market maker. I am here today representing the 
Securities Industry Association.1 Thank you for inviting me 
to testify at this hearing on the subject of securities transaction 
fees. This is a subject on which the Chairman of the full Committee, 
Congressman Bliley, has been a leader for a number of years, and we are 
grateful to him for the leadership he has provided.
---------------------------------------------------------------------------
    \1\ The Securities Industry Association brings together the shared 
interests of more than 740 securities firms to accomplish common goals. 
SIA member-firms (including investment banks, broker-dealers, and 
mutual fund companies) are active in all U.S. and foreign markets and 
in all phases of corporate and public finance. The U.S. securities 
industry manages the accounts of more than 50 million investors 
directly and tens of millions of investors indirectly through 
corporate, thrift and pension plans. The industry generates 
approximately $300 billion of revenues yearly in the U.S. economy and 
employs more than 600,000 individuals. (More information about the SIA 
is available on its home page: http://www.sia.com.)
---------------------------------------------------------------------------
    Chairman Oxley, we commend and appreciate your interest in the 
subject of today's hearing and, more broadly, your interest in fair, 
efficient and internationally competitive securities markets. We look 
forward to working with you on this issue.
    Congressman Towns, we are also grateful for the work you have done 
to reduce regulatory burdens and reduce costs to investors. We 
appreciate your continued interest and involvement in issues affecting 
the securities markets.
    We also wish to express our special gratitude to Congressman Lazio, 
Congressman Fossella and Congressman Menendez for the leadership they 
have demonstrated on the subject of SEC transaction fees.
    We believe it is critical that Congress examines the issue of SEC 
fees, because the facts and assumptions on which enactment of the 
current statutory fee structure was based have changed. Fees that were 
developed several years ago to fund the cost of regulating the 
securities markets now exceed the government's cost of regulation to 
such a degree that they constitute a tax on capital formation, and a 
special tax on every American investor.
    Our securities markets serve as a strong engine of growth and job 
creation for our economy, furnishing the seed capital for start-up 
companies, providing the liquidity essential to bring investors into 
the market, harnessing investment for growth and expansion for our 
economy, and creating savings and investment vehicles for millions of 
Americans. Today, forty-eight percent of U.S. households own stock, 
directly or indirectly. By the year 2000, the number of individuals who 
own stock is likely to exceed 80 million. The more than 600,000 men and 
women who go to work in the securities industry every day work hard to 
ensure that we have the fairest, deepest and most liquid securities 
markets in the world.
    We know that our markets have been made better, and fairer, by the 
presence of a strong and effective Securities and Exchange Commission. 
And, because it is in our interest--and, more importantly, in the 
public interest--to have an effective SEC, the SIA has been a strong 
supporter of full funding for the agency, so that it can carry out its 
important mission of investor protection. In the past, the SIA has 
supported full funding for the SEC, even at times when budget freezes 
and budget cuts were being pressed on all federal agencies. Our support 
for legislation today to reduce the excess fees charged to the 
industry, investors and issuers will still provide substantially more 
in revenues than the budget of the SEC.
    Three years ago, the industry was asked to step up to the plate and 
pay additional fees in order to help Congress move to a more reliable 
funding mechanism for the SEC. We agreed to do so, because we believed 
it was in the long term interests of our markets. The fee structure 
adopted as part of the National Securities Markets Improvement Act of 
1996 for the first time assessed transaction fees on the NASDAQ 
markets. This provision was intended to establish parity between the 
fees assessed on exchange and NASDAQ markets.2 While it was 
expected that, as a result of these changes, the fees paid by investors 
and the industry would increase in the near term, the ultimate goal of 
NSMIA's fee provisions was to bring fees collected by the SEC more in 
line with the cost of running the agency.
---------------------------------------------------------------------------
    \2\ NSMIA provided for a gradual reduction over 10 years in filing 
fees for securities registration statements under Section 6(b) of the 
Securities Act of 1933. The securities registration fee was set at $295 
per $1 million in 1998, to be lowered over time to $67 per $1 million 
in 2007. NSMIA also expanded the reach of securities transaction fees, 
which previously had been assessed on transactions in exchange-
registered securities, to include transactions in NASDAQ markets. The 
transaction fee, under Section 31 of the Exchange Act, was set at 1/300 
of one percent during the years 1997 through 2006, and was scheduled to 
be reduced to 1/800 of one percent in 2007.
---------------------------------------------------------------------------
    At the time these provisions were enacted, no one anticipated the 
explosion of market activity that has taken place over the past several 
years, and that appears to be continuing and increasing. In particular, 
no one could have predicted the phenomenal influence that online 
investors would have on the equity markets.
    In 1996 average daily trading volume on the exchange, NASDAQ and 
regional markets was 1.0 billion shares a day, by 1998 it had risen to 
1.5 billion shares. Total annual share volume in these markets was 261 
billion shares in 1996; by 1998 volume had risen to 400 billion shares 
traded annually--a 50% jump in just two years.
    Transaction volume has increased even more dramatically than share 
volume with the rise in popularity of online investing. In 1996, when 
Herzog Heine Geduld moved into its new trading room in Jersey City, our 
facilities were handling on average approximately 25,000 trades each 
day. Since the beginning of this year, less than four years later, we 
have averaged more than 100,000 trades each day, and we are 
experiencing a 10% growth in trade volume each quarter. The investing 
public has found a new way to participate in the markets, and we 
believe that this is only the beginning.
    During this period, SEC appropriations have risen in an effort to 
give the SEC sufficient resources to oversee the markets and enforce 
the federal securities laws. However, the increase in transaction and 
other fees paid by investors, issuers and the industry has far exceeded 
the increase in the cost of running the SEC. The following chart sets 
forth the fees collected by the SEC during fiscal years 1996-1998 and 
estimated to be collected during the current and next fiscal year 
(including Section 6(b) fees, Section 31 fees, and other fees), 
compared with the amounts appropriated or requested to be appropriated 
to the SEC during these years (dollar amounts in millions): 
3
---------------------------------------------------------------------------
    \3\ Where estimates of fee collections are indicated, they are OMB 
estimates; CBO estimates may differ. SEC appropriations for certain 
years are stated as the amounts requested; actual funding amounts may 
differ slightly.

----------------------------------------------------------------------------------------------------------------
                                            Sec.  6(b)  Sec.  31   Other    Total            SEC Budget
----------------------------------------------------------------------------------------------------------------
FY 1996...................................       $575       $134      $65     $774  $297.4
FY 1997...................................        653        274       63      990   305.4
FY 1998...................................      1,034        632      114    1,780   315.0
FY 1999 (est.)............................      1,040        432       50    1,522   337.4
FY 2000 (est.)............................      1,079        491       50    1,620   360.8 (Req.)
----------------------------------------------------------------------------------------------------------------

    Fees now paid by investors, issuers and the industry amount to five 
times the cost of running the SEC. In 1998 alone, while the SEC's 
budget was just over $315 million, securities registration, transaction 
and other fees collected by the SEC totaled more than $1.7 billion. 
From FY 1998 through FY 2000, if the present trend continues, the 
amounts paid by investors, issuers and the industry will have exceeded 
the SEC's budget by more than $3.8 billion. We do not believe it is in 
the interest of investors--or in the interests of our capital markets 
more broadly--for these fees to so grossly dwarf the regulatory costs 
incurred. These fees drain capital from the private markets--removing 
it at the very beginning of the capital raising process--and diverting 
it into the U.S. Treasury.
     The fees have a particularly profound impact on NASDAQ market 
makers and on specialists at traditional exchanges, who perform similar 
functions. The market maker's business is similar in many ways to that 
of the grocer, who buys milk for ten cents and hopes to sell it for 
eleven. The Section 31 fee is especially burdensome to a market maker 
because, where the fee exceeds the cost of regulation, it amounts to a 
tax on the market maker's gross revenues, unlike an income tax, for 
example, which taxes profits. In other words, we must pay the fee 
whether we sell the milk profitably for eleven cents or are forced by 
market conditions to sell at loss for nine cents. Moreover, the Section 
31 fee must be paid before the electric bill, the rent, salaries to the 
staff or even federal and state income taxes, and whether or not our 
business is profitable.
    In the last several years, technological advances have lowered 
transaction costs. These reduced costs have encouraged more trading 
activity--larger share volume and even larger trading volume. Margins 
have also declined, but to some extent, increases in volume have 
compensated for lower margins. We are selling more milk, but making 
less on each sale. These declining margins have greatly magnified the 
effect on our industry of the Section 31 tax--the portion collected in 
excess of the cost of regulating the NASDAQ and Exchange equity 
markets.
    Section 31 fees are based on the value of transactions. As 
transaction volume and market valuations have increased, the amount of 
fees collected under Section 31 has ballooned. In contrast, the market 
maker's revenue on these transactions, our profit margins, have 
declined. As a result, Section 31 fees comprise an increasing share of 
our gross trading revenues, even though the rate of the fee has 
remained constant. Herzog Heine Geduld's payments of Section 31 fees 
currently amount to more than 3% of our gross trading revenues. To 
illustrate the significance of this tax, the current amount of the 
Section 31 fee is about twice as much as the rent paid on the property 
that houses our Nasdaq trading operations.
    Market makers must continue to make significant investments in 
technology to handle ever-increasing volumes. The increase in volumes 
is accompanied by lower margins and increasing SEC fees. We are on a 
collision course that, if left uncorrected, will have a significant 
effect on the ability of market makers to conduct their business 
profitably. We believe that our equity markets--much admired and envied 
throughout the world--would operate much less efficiently if there were 
no market makers.
    This result certainly was not intended by Congress. When Congress 
adopted NSMIA's fee provisions, its intent was clear. The language of 
Section 6(b) states that the registration fees to be collected by the 
SEC under that section ``are designed to recover the costs to the 
government of the securities registration process, and costs related to 
such process . . .'' The language of Section 31 states that the 
transaction fees to be collected by the SEC ``are designed to recover 
the costs to the Government of the supervision and regulation of 
securities markets and securities professionals and costs related to 
such supervision and regulation . . .''
    Unfortunately, the fees have far exceeded the cost of regulation. 
They divert resources which could be used more productively elsewhere 
in our economy; and they discourage capital investments in technology 
that could be used to make our equity markets more efficient and 
attractive to investors. This is real capital that could be used to 
fund new businesses, to build plants, to create jobs, and to add to the 
national wealth.
    There may be some who believe that, since the U.S. stock market is 
near an all time high, market makers, specialists and other market 
participants somehow can, or should, pay these fees. So what if they 
pay a little more here or there?
    In the first place, specialists' and market makers' profits are not 
related to the value of stocks. Our willingness to devote capital to 
making markets necessarily depends on our ability to make a fair and 
reasonable profit on transactions. We have demonstrated that we are 
more than willing to pay the cost associated with regulation. But, it 
simply is not right to charge investors, issuers and market makers five 
times the cost of regulation. At a minimum, a burden of this size, with 
its potential to adversely affect the structure of the capital markets, 
should not be allowed to happen inadvertently because of changed 
circumstances.
    Mr. Chairman, we urge you to craft a solution that will better 
align fees with the cost of regulation. We have confidence that 
Congress, once it reviews the facts, will make a decision that is in 
the interest of millions of investors. We are committed to work with 
this subcommittee to find such a solution.
    The securities industry is faced with a number of challenges in the 
immediate future: how to make a successful conversion to the Year 2000, 
so that it is seamless for investors and issuers; how to make systems 
``Euro'' compatible; how to make the conversion and expand quote 
capacity to accommodate decimalization; how to ensure that investors 
and issuers benefit from the explosion in technology and electronic 
commerce; and, how to meet the competitive challenges of globalization. 
All of these challenges have required, and will continue to require, 
significant financial investment on our part, as well as the time and 
efforts of our most talented industry professionals. We intend to meet 
these challenges, to maintain and enhance the international preeminence 
of our capital markets, to help fund the continued growth of the U.S. 
economy, and to ensure that investors and issuers have even more 
opportunities in the next century.
    Thank you again for the opportunity to testify. I am ready to 
answer any questions.

    Mr. Oxley. Thank you, Mr. Nelson.
    Mr. Kearney.

                 STATEMENT OF ARTHUR J. KEARNEY

    Mr. Kearney. Chairman Oxley, members of the subcommittee, 
thank you for the invitation to testify before you today on the 
subject of SEC transaction fees, an issue in which you have had 
an interest for quite some time. I do very much appreciate this 
opportunity to present the views of the Security Traders 
Association, and I applaud your leadership in scheduling a 
hearing on this important issue.
    I also want to specifically commend Congressman Fossella, 
Congressman Lazio, and Congressman Towns for the outstanding 
leadership that they have shown on this issue this year as well 
as Congressman Bob Menendez. Mr. Chairman, with your permission 
I would like to summarize my written testimony and I would ask 
that my full written testimony be made part of the record.
    I am Arthur Kearney, Chairman of the Security Traders 
Association, the STA, and Director of Equity Capital Markets 
and a member of the board of directors of John G. Kinnard & 
Company, a broker-dealer located in Minneapolis, Minnesota. I 
am accompanied by Lee Korens, President and CEO of STA, who is 
available to answer any questions.
    STA is composed of 34 regional affiliates and over 7,000 
individual members throughout North America and Europe, and it 
is the largest group of its kind in the world. Our membership 
represents all facets of the securities industry. While many 
members are traders for securities firms and institutions, 
others are partners, specialists, floor traders, proprietors, 
or registered representatives, all of whom are charged with the 
responsibility of executing orders at the fairest prevailing 
prices.
    Mr. Chairman, in my written testimony I have provided a 
fairly detailed description of the history and structure of SEC 
fees, so I will give a brief overview and turn to our position.
    Before I start, however, I do want to thank this committee 
for its longstanding interest in this issue and its hard work 
in attempting to reduce these fees paid by the investing public 
and securities professionals. As you know, the government 
collects various Securities and Exchange Commission SEC user 
fees imposed by the securities laws in order to recover the 
Federal Government's cost of running the SEC, including 
transaction fees on sale of stocks assessed pursuant to section 
31 of the 1934 act.
    Over time, these fees have grown to significantly exceed 
the SEC's budget. By 1996, collected fees exceeded the SEC's 
budget by a factor of more than 2 to 1. Under this committee's 
leadership, Title 4 of the NSMIA of 1996 significantly 
restructured the various SEC fees with the intent of reducing 
total SEC fee collection over time and providing the SEC with a 
more stable funding source.
    We commend Chairman Bliley and others on this committee for 
working tirelessly to produce legislation designed to reduce 
these fees. Indeed, the committee prevailed in designing a fee 
structure which explicitly contemplated that section 31 fees 
would recoup the cost of the SEC's supervision and regulation 
of the securities markets and securities professionals. 
Unfortunately, actual fees collections have significantly 
outpaced the CBO's and OMB's conservative estimates of market 
growth relied on by this committee and Congress.
    In fiscal year 1997, actual collections from all sources 
grew to $990 million, over 3 times the SEC's budget of $3.5 
million. In fiscal year 1998, the excess worsened considerably 
when actual fees collection ballooned to a staggering $1.78 
billion, 5\1/2\ times the SEC's $322 million budget. Clearly, 
this is not the scenario the committee intended when it 
redesigned the SEC funding structure in 1996 to reduce the 
amount of fee surplus.
    I want to emphasize that the issue here is not SEC funding. 
The issue is that the government is taking in over 5 times as 
much fee revenue as is reasonably needed to fund the SEC's 
activities. What was explicitly designed to be a user fee has 
become a large unintended back-door tax on the securities 
markets.
    Excessive SEC fees have a tremendous negative impact on 
securities professionals. The effect is particularly severe for 
NASDAQ market makers and exchange specialists who often must 
trade from their own accounts in order to fulfill their legal 
responsibility to maintain orderly markets and to provide 
customers with on-demand liquidity. Section 31 transaction fees 
operate as a tax on the gross trading revenue of these 
professionals. One STA member firm which makes markets in 
NASDAQ 100 stocks, estimates that its section 31 fee payments 
amounted to a whopping 6 percent of OTC trading income over a 
recent 16-month period.
    Another firm found that its section 31 fee payments were 
twice the amount of its rental payments for the building 
housing its trading activities.
    Let me also give you my perspective as an employer in the 
regional brokerage and underwriting business. Our firm trades 
NASDAQ stocks and underwrites IPOs and secondaries. Some of the 
recent ventures we have been involved in include Excelsior-
Henderson, a motorcycle manufacturer, and Zomax, an optical 
media softwear company. These are the types of companies that 
create 75 percent of all new jobs in America. We also make 
markets in approximately 175 NASDAQ stocks, and Kinnard employs 
over 350 people.
    Section 31 fees operate as a gross receipt tax. This means 
that the fees are paid before Federal and State taxes, before 
salary and before allocations of overhead. The result is to 
magnify the impact on our firm's profitability. Changes in the 
NASDAQ market, which include increasing cost pressures 
associated with the newer handling rules, the regulatory-driven 
computer upgrades and monitors, have greatly reduced the 
profitability of NASDAQ market making activities across the 
board. Excessive section 31 fees only exacerbate the situation.
    Mr. Chairman, excessive section 31 fees negatively impact 
our trading revenue, and reduced revenues translate directly to 
fewer jobs. As a manager, when I am looking at a reduced 
revenue from section 31 fees, it means I can hire one less 
analyst, one less trader, one less support staff. Reduced 
revenues go right to our bottom line and right to our core 
business decisions. It is really that simple. Excessive fees 
also contribute to reduced liquidity in the markets. The major 
impact falls on thinly traded stocks of those small and startup 
companies in which we specialize. STA urges Congress to take 
swift corrective action to eliminate the SEC transaction fee 
excess and reduce the burdensome and unintended tax on 
America's savers, investors, and securities professionals. 
While this result could be achieved through a number of 
approaches, STA is committed to support any initiative that 
produces meaningful relief for all investors.
    STA is encouraged by the continuing commitment of this 
committee to reduce SEC fees, as reflected in Chairman Oxley's 
scheduling this hearing, and the fact that 24 Commerce 
Committee members have cosponsored two separate bills this year 
to address the issue. We are also heartened that SEC Chairman 
Arthur Levitt testified in March that the fee problem needs to 
be addressed and pledged to work with Congress to fashion a 
solution.
    In closing, Mr. Chairman, STA applauds you for scheduling 
this prompt hearing on an issue of great importance to our 
members across the United States. Thank you, and I will be 
happy to answer any questions.
    [The prepared statement of Arthur J. Kearney follows:]
  Prepared Statement of Arthur J. Kearney, Chairman, Security Traders 
                              Association
                            i. introduction
    Chairman Oxley, Chairman Bliley, Members of the Subcommittee, thank 
you for the invitation to testify before you today on the subject of 
SEC transaction fees, an issue in which you have had an interest for 
quite some time. I do very much appreciate this opportunity to present 
the views of the Security Traders Association, and I applaud your 
leadership in scheduling a hearing on this important issue. I also want 
to specifically commend Congressman Fossella, Congressman Lazio, and 
Congressman Towns for the outstanding leadership they have shown on 
this issue this year, as well as Congressman Bob Menendez.
    I am Arthur Kearney, Chairman of the Security Traders Association--
the STA--and Director of Capital Markets and a Member of the Board of 
Directors at John G. Kinnard & Co., a broker/dealer located in 
Minneapolis, Minnesota.
    STA is composed of 34 regional affiliates and over 7,000 individual 
members throughout North America and Europe, and it is the largest 
group of its kind in the world. Our membership represents all facets of 
the securities industry. While many members are traders for securities 
firms and institutions, others are partners, specialists, floor 
traders, proprietors or registered representatives--all of whom are 
charged with the responsibility of executing orders at the fairest 
prevailing prices. The fact is that no one speaks for individual 
professionals in the securities industry better than STA. It is the 
only organization that represents, at all levels, the interests of over 
7,000 individuals.
    Before I start, however, I do want to take a moment to thank this 
Committee for its longstanding interest in this issue and its hard work 
in attempting to reduce these fees paid by the investing public and 
securities professionals.
                ii. history of the sec funding structure
    Public Law 104-290, the National Securities Market Improvement Act 
of 1996, was signed into law by President Clinton on October 11, 1996. 
The Act combined securities and mutual fund market reforms with a 
reauthorization of the Securities and Exchange Commission (SEC). The 
Act extended the imposition of the Securities Exchange Act of 1934's 
Section 31 transaction fees to NASDAQ stock transactions. The SEC 
reauthorization was the result of a complex deal worked out between 
House and Senate authorizers and appropriators, the Office of 
Management and Budget (OMB), and the SEC, following years of 
Congressional wrangling over a new SEC funding mechanism.
Background
    Since the 1930s, the federal government has levied SEC fees on the 
regulated community, including registration fees authorized by Section 
6(b) of the Securities Act of 1933, and transaction fees authorized by 
Section 31 of the Securities Exchange Act of 1934. These fees were 
deposited in the Treasury's General Fund as general revenues. The SEC 
received no credit for collected fees and could not directly use the 
funds, but rather was funded through an annual appropriation from the 
Appropriations Committee. Since 1983, the SEC has been a net 
contributor to the Treasury, collecting far more fees than necessary to 
cover its budget.
    In 1990, the budget rules were significantly changed. Specifically, 
the 1990 Budget Enforcement Act set limitations on specific spending 
categories and created ``pay-as-you-go'' procedures to require offsets 
for decreases in revenue or increases in entitlement spending. These 
rules put severe restraints on discretionary spending, forcing 
appropriators to choose among competing programs. The SEC was thus 
forced to compete for discretionary funding with the Departments of 
Commerce, Justice and State. The income collected by the SEC fees did 
not create any additional funding for the appropriators.
    Beginning in 1990, appropriators decided to respond to the problem 
of insufficient resources to fund competing programs by imposing one-
year rate increases in the Section 6(b) registration fee in the annual 
Commerce, Justice, State Appropriations Bill through which the SEC is 
funded. The amounts attributable to such increases were credited 
against the agency's appropriation account as an offsetting collection. 
Offsetting collections are deposited in special appropriations 
accounts, as opposed to the General Fund, and are available to 
appropriators to finance agency activities. This funding mechanism 
increased the overall funds available to the appropriators.
    This practice eventually led to objections by various Members of 
Congress on both jurisdictional and public policy grounds. Since the 
agency was collecting far more in fees than its budget required, 
opponents argued that increasing SEC fees constituted a tax. Members 
began to call for a new SEC funding structure that allowed the 
government to cover the costs of the SEC's regulatory activities 
without artificially inflating the cost of raising capital in the 
markets. In 1993, this Committee, under the leadership of then-Chairman 
Dingell and current Chairman Bliley, crafted a bill which would have 
established a mechanism by which the SEC would set and collect fees 
solely to recover the costs of its regulatory activities.1 
The House subsequently passed the bill unanimously.
---------------------------------------------------------------------------
    \1\ H.R. 2239, passed on July 20, 1993, would have authorized the 
SEC to continue to collect general revenues for fiscal years 1994 
through 1998, in order to avoid raising the deficit and maintain pay-
as-you-go budget scorecard neutrality. After fiscal year 1998, SEC fees 
would have been set and collected so as not to exceed the costs of 
running the agency.
---------------------------------------------------------------------------
    During that same year, the House and Senate again passed an SEC 
appropriations measure which raised registration fees and credited the 
amount as an offsetting collection. After several complaints were 
lodged with the Appropriations Committee by both House Ways and Means 
and House Energy and Commerce Committee members, language was included 
in the conference report on the Commerce, Justice, State Appropriations 
bill conference report indicating that the practice would be ended.
Funding Crisis
    The funding situation came to a head the following year. When the 
Commerce, Justice, State Appropriations Bill for fiscal year 1995 came 
to the floor of the House on June 28, 1994, the bill again contained a 
provision that would have imposed additional registration fees as 
offsetting collections. House Members frustrated with the Senate's 
failure to act on the SEC funding issue succeeded in striking the 
provision from the House bill on procedural grounds, and subsequently 
prevailed in an effort to keep the provision out of the conference 
agreement. This move left the SEC with an appropriation of $59.6 
million, significantly below the $297 million originally provided by 
appropriators. The agency indicated that it would have to severely 
restrict its operations beginning in October 1994 absent Congressional 
action.
    This funding crisis prompted Congress, with the help of this 
Committee's leadership, to pass a stop-gap measure (P.L. 103-352), 
authorizing the registration fee increase 2 and offsetting 
revenue practice for another year, in order to fund the agency through 
1995. House Report 103-739 indicated that this was done as a one-time 
fix to avert an SEC shutdown, and contemplated passage in the next 
Congress of an SEC reauthorization that would ``eliminate the need for 
one-year-at-a-time increases in registration fees.'' The bill 
originated in the House Ways and Means Committee with the support of 
the this Committee. The stage was thus set for an SEC reauthorization 
that would establish a predictable and adequate fee structure to 
recover funds solely to offset the cost of the agency's regulatory 
activities.
---------------------------------------------------------------------------
    \2\ The fee was continued at \1/29\ of 1% of the maximum offering 
price of the securities, the rate supplied in the FY 1994 Commerce, 
Justice, State Appropriations Act. Without the stop-gap extension, the 
rate would have fallen to its statutorily authorized rate of \1/50\ of 
1%.
---------------------------------------------------------------------------
Action in the 104th Congress
    During 1995, the first session of the 104th Congress, control 
shifted to the Republican party and the legislative agenda was crowded, 
leaving unaddressed the SEC fee issue. However, in light of the prior 
year's funding crisis, the Administration's FY 1996 budget proposal 
submitted at the beginning of 1995 stressed the need for a sound, 
stable and long-term funding structure for the SEC. H.R. 2076, the 
Commerce, Justice, State Appropriations Bill which passed that year, 
was vetoed by the President due to unrelated policy disputes, and the 
SEC's FY 1996 budget was funded by a series of continuing resolutions. 
Finally, an omnibus spending bill (H.R. 3019) was passed, providing SEC 
funds for the remainder of the year.
    In 1996, House Commerce Committee Chairman Bliley (R-VA) introduced 
H.R. 2972, the SEC Reauthorization Act of 1996. The bill was designed 
ultimately to end the appropriators' practice of funding SEC activities 
through the yearly ritual of raising registration fees as offsetting 
collections. The proposal would have reduced 6(b) registration fees 
over a 6-year period, incrementally extended the Section 31 transaction 
fees to NASDAQ trades, and reduced the rate for all transaction fees 
beginning in 2002. In total, the package was projected to reduce fee 
collections by $751 million by 2002. Initially, a portion of the fees 
was to be deposited as offsetting collections. Beginning in 2002, all 
fees would be deposited as general revenue and no fees would be 
allotted as offsetting collections. Thus, by 2002, the SEC would rely 
on the allocation made to the appropriators for Commerce, Justice, 
State and related programs. The House unanimously passed H.R. 2972 on 
March 12, 1996.
    A similar transaction fee provision was included in a bill also 
introduced in 1996 by then Senate Banking Securities Subcommittee 
Chairman Gramm (R-TX), S. 1855. However, Gramm and then Senate Banking 
Committee Chairman D'Amato (R-NY) agreed to postpone consideration of 
the SEC reauthorization in response to concerns by Senate Democrats and 
the Administration. They were concerned that ending the offsetting 
collections funding practice would require appropriators to fund the 
SEC's full budget out of the General Fund, subject to the discretionary 
spending caps, forcing reductions in other programs.
    The House passed H.R. 3005, the Securities Amendments of 1996, on 
June 19, 1996, but not before adding the SEC reauthorization provisions 
originally embodied in H.R. 2972. The Senate amended and passed H.R. 
3005 without the fee provisions on June 27, 1996, setting up a 
conference in which the SEC fee issue would have to be resolved. The 
fee issue was highly controversial in conference. Negotiations among 
House and Senate authorizers and appropriators, the OMB, and the SEC 
held up the bill for weeks and threatened to entirely derail the 
legislation. An agreement was finally reached on the fee issue and the 
bill was passed in the closing days of the 104th Congress. The 
conference report was agreed to by the House on September 28, 1996, and 
by the Senate on October 1, 1996. H.R. 3005 became P.L. 104-290 when 
the President signed the bill on October 11, 1996.
    Under the complex deal worked out in conference, registration fees 
are gradually reduced until FY 2007, when they drop dramatically. A 
portion of the registration fee is deposited as General Fund revenue, 
and a portion is made available to appropriators as offsetting 
collections. Transaction fees remain at 1/300 of 1% until FY 2007, when 
they drop dramatically. Beginning in 1997, NASDAQ trades became subject 
to the full transaction fee rate. While the exchange transaction fees 
are collected as General Fund revenue, the NASDAQ transaction fees are 
deposited as offsetting collections and must be triggered on each year 
by Appropriations Act. By pushing general revenue losses into the out-
years, the new fee structure avoided budget scoring problems.
                   iii. current situation and impact
    Unfortunately, actual fee collections have significantly outpaced 
the CBO's and OMB's conservative estimates of market growth relied on 
by this Committee and Congress. In fiscal year 1997, actual collections 
from all sources grew to $990 million dollars--over three times the 
SEC's budget of $305 million. In fiscal year 1998, the excess worsened 
considerably, when actual fee collections ballooned to a staggering 
$1.78 billion--five and one-half times the SEC's $322 million budget. 
Clearly, this is not the scenario this Committee intended when it 
fought to redesign the SEC funding structure in 1996 to reduce the 
amount of the fee surplus.
    I want to emphasize that the issue here is not SEC funding. The 
issue, very simply, is that the government is taking in over five times 
as much fee revenue as is reasonably needed to fund the SEC's 
activities. What was explicitly designed to be a user fee has become a 
large, unintended backdoor tax on the securities markets.
    Excessive SEC fees have a tremendously negative impact on 
securities professionals. The effect is particularly severe for NASDAQ 
market markers and exchange specialists, who often must trade from 
their own accounts in order to fulfil their legal responsibility to 
maintain orderly markets and to provide customers with on-demand 
liquidity. Section 31 transaction fees operate as a tax on the gross 
trading revenue of these professionals. One STA member firm which makes 
markets in about 100 NASDAQ stocks estimated that its Section 31 fee 
payments amounted to a whopping 60 percent of OTC trading income over a 
recent sixteen month period. Another firm found that its Section 31 fee 
payments were twice the amount of its rental payments for the building 
housing its trading activities.
    Let me also give you my perspective as an employer in the regional 
brokerage and underwriting business. Our firm trades NASDAQ stocks and 
underwrites initial public offerings and secondaries. Some of the 
recent ventures we have been involved in include Excelsior-Henderson, a 
motorcycle manufacturer, and Zomax, an optical media software company. 
These are the types of companies that create 75 percent of all new jobs 
in America. We also make markets in approximately 175 NASDAQ stocks. 
Kinnard employs over 350 people.
    Section 31 fees operate as a gross receipts tax. This means that 
fees are paid before federal and state taxes, before salary, and before 
allocations for overhead. The result is to magnify the impact on our 
firm's profitability. Changes in the NASDAQ market--which include 
increasing costs pressures associated with the new order handling rules 
and regulatory driven computer upgrades, among others--have greatly 
reduced the profitability of NASDAQ market making activities. Excessive 
section 31 fees only exacerbate this situation.
    Mr. Chairman, excessive section 31 fees negatively impact our 
trading revenue, and reduced revenues translate directly into fewer 
jobs. As a manager, when I am looking at reduced revenue from section 
31 fees, it means that I can hire one less analyst, one less trader, 
one less support staff. Reduced revenues go right to our bottom line, 
and right to our core business decisions. It's really that simple. 
Excessive fees also contribute to reduced liquidity in the market. The 
major impact falls on the thinly traded stocks of those small and 
start-up companies in which we specialize.
    I should also note that it appears the primary factor contributing 
to the transaction fee collection overage is that the projections for 
the dollar volume growth in the markets have been based on extremely 
conservative assumptions. Actual transaction fee collections have 
consistently outpaced the government's projections by a significant 
amount. The transaction fee overage is not a result of a temporary 
spike in volume, but is a recurring and compounding problem. Without a 
statutory correction that somehow limits the amount of fees collected, 
the amount of the fee collection overage will continue to grow 
exponentially into the foreseeable future.
                             iv. conclusion
    STA urges Congress to take swift, corrective action to eliminate 
the SEC transaction fee excess and reduce this burdensome and 
unintended tax on American savers, investors and securities 
professionals. While this result could be achieved though a number of 
approaches, STA has committed to support any initiative that produces 
meaningful relief for all investors.
    STA is encouraged by the continuing commitment of this Committee to 
reduce SEC fees, as reflected in Chairman Oxley's scheduling this 
hearing and the fact that 24 Commerce Committee members have 
cosponsored two separate bills this year to address this issue. We are 
also heartened that SEC Chairman Arthur Levitt testified in March that 
the fee problem needs to be addressed, and pledged to work with 
Congress to fashion a solution.
    In closing, Mr. Chairman, STA applauds you for scheduling this 
prompt hearing on an issue of great importance to our members across 
the United States. Thank you, and I will be happy to answer any 
questions.

    Mr. Oxley. Thank you, Mr. Kearney. That completes the 
testimony of our witnesses. There are 4 minutes left in the 
vote. We will stand in recess for 15 minutes.
    [Brief recess.]
    Mr. Oxley. The subcommittee will reconvene. Let me begin 
with some just general questions from the Chair.
    Part of the problem of the excessive fee revenue stems from 
record-breaking volumes on transactions. I would like to ask, 
do you believe that the markets will continue to experience 
similar volume levels in the future? Is this a temporary 
phenomenon or is this something that is not going to abate any 
time soon?
    Mr. Kearney. If you look at all of the market design and 
everything that is in front of the NASD and the SEC for 
approval and all of the regulatory changes, et cetera, they are 
going to make access to liquidity easier and easier. They are 
going to make access so you as an individual investor will be 
able to buy or sell a security at a lower rate and faster. 
Everything leads me to believe that these volumes are going to 
continue to explode and increase at rates that we don't even--
we have no comprehension of. The fragmentation of the market 
today is actually slowing down the volumes. If they address 
those fragmentation issues, it is going to go higher.
    Mr. Nelson. We think that the markets have changed. Up 
until, I would say the fall of last year, as a general 
proposition, the big institutions and institutional investors 
set prices in the markets. They would give us huge orders. They 
really were the stopgap in the market.
    Last year for the first time, the online investor really 
came of age. Thousands of 200, 300, 500 shareholders would 
simply overwhelm these institutional orders and sweep them away 
in a tide up and tide down. I think--we think that this is just 
the start of this. The public has just now figured out what 
online trading is all about. All of the big bull tracking firms 
are standing in line and putting in systems that have always 
traditionally gone through a broker, which, in a fairly steady 
fashion, are now going to be hitting these machines. I think we 
have just seen the beginning of an overwhelming increase in 
volume.
    Mr. Oxley. Mr. Cader.
    Mr. Cader. I would agree with all of that. I would point 
out additionally as we see the demographic and economic 
underpinnings of the markets and volumes seem likely not to 
change in the near future--and you can have a discussion 
whether that argues for higher or lower stock prices--but stock 
ownership and stock trading that has accrued to individuals has 
exploded in a way that history suggests does not go away 
quickly, no matter which way prices move in.
    Several dynamics of market structure which are likely to 
change and which are familiar to all of you from looking at the 
industry and from reading the papers, such as decimalization, 
such as 24-hour trading or extended-hour trading, which will 
also be upon us soon, are almost certain to increase volume 
even aside from whatever other secular or cyclical trends might 
drive volume up or down.
    So for demographic and economic reasons, volumes will trend 
up, you will have an additional likelihood of volume going up 
even more if in fact decimalization and extended hours are, as 
I suspect they are, helpful to and friendly to investor access 
to the marketplace.
    So I think there are a lot of reasons to believe that 
whether prices go up or down--which, of course we don't know--
that volumes will continue at particularly high levels.
    Mr. Oxley. Mr. Brodsky, the same thing in Chicago?
    Mr. Brodsky. I would say the same thing, not only in 
Chicago but all over the world. You have seem the 
democratization of equity markets, and it is to a large extent 
attributable to the work that this committee has done over the 
years, the SEC has done. And we are seeing more and more 
business not only from abroad but from a younger group of 
investors. I think that it does flow through all of the things 
that the people spoke before me have said.
    I will give you a general statistic. The fastest growth in 
our business is through people who use the Internet, through 
brokerage firms. Our Web site, 2\1/2\ years ago, in a month had 
50,000 hits, and recently it was 50 million. These people are 
using electronics as a way of accessing markets.
    I agree with what was said. The combination of after-hours 
trading and the greater competition, we expect even though we 
are the first option exchange in the world, in the next year or 
2, there will be at least electronic competitors. This will add 
to volume.
    Mr. Oxley. I will begin with you, Mr. Brodsky. First of 
all, are you subject to 6(b) registration fees on stock 
options?
    Mr. Brodsky. No, we are just subject to section 31.
    Mr. Oxley. Let me skip then to Mr. Cader. What is the 
difference in the impact on investors between the two different 
fees, 6(b) and section 31?
    Mr. Cader. I will speak to what I call the multiplier 
effect of the section 31 fees. The 6(b) fees are leveled now at 
the point in the capital-raising process where transactions 
take place with the help of market makers, specialists and 
liquidity providers, all different names for folks doing what 
we are talking about.
    The underwriting fees occur once in the cycle of a security 
being distributed from an issuer to an owner. The section 31 
tax which falls upon the liquidity providers falls at a point 
in the capital-raising and, in fact, the capital-transferring 
process, which is what happens when shares trade on an 
exchange. The tax falls not only on the investors who trade 
those securities one to the other, but disproportionately on 
those members of the community who are the liquidity providers. 
Liquidity providers, who go by names like specialist and market 
maker, are simply those who turn the capital over many, many 
more times than typically a service provider such as a grocery 
store selling milk will do so.
    X dollars in the hands of a market maker or a specialist 
actually gets deployed many, many, many times over in the 
course even of a few hours, certainly a few days, taking the 
other side of customer trades. What happens on the exchanges is 
that customers--buyers and sellers--look for each other to find 
the best price available at the time when they wish to 
transact. In a perfect world, which of course we don't live in, 
one customer finds another and they both wish to transact the 
same amount at the same time. No need for intermediaries.
    The intermediaries, who are the buyers and sellers in the 
absence of customers who meet each other, fill in the gaps 
between supply and demand, time and time again during the day.
    So the section 31 tax takes money out of the hands of those 
who at the point of sale, the place where the transactions take 
place, would actually use that money many, many, many times 
over to satisfy many, many customer needs, one after the other, 
during relatively short spans of trading.
    A specialist or market maker in the security will buy from 
one customer and sell to another, filling in those imbalances, 
literally, in trades that are seconds apart.
    So the tax falls, aside from the question of whether 
overfunding is appropriate or not, the tax falls at the worst 
possible place given the acknowledged role of the intermediary 
liquidity provider in the system, which serves investors by 
assuring that there will always be buyers and sellers there to 
meet them in the marketplace, with reasonable capital, able to 
trade at reasonable prices at all times.
    Mr. Oxley. Mr. Nelson and Mr. Kearney?
    Mr. Nelson. We don't have a corporate finance business so I 
cannot speak about 6(b) fees.
    Mr. Kearney. I would just say that 6(b) fees are usually 
put into the cost of the whole deal, so they are spread to the 
corporate issuer, to the lawyers, to the bankers so it is more 
of a--it doesn't affect the trading firms so much. It is backed 
into the cost of doing the deal.
    Mr. Oxley. Thank you. The Chair now recognizes the ranking 
member, the gentleman from New York, Mr. Towns.
    Mr. Towns. Thank you, Mr. Chairman. There have been some 
folks who have recommended that we cap the fees. Let me get 
your views on that in terms of capping.
    Mr. Kearney. I would just like to say that from the 
perspective of STA, we would take any relief whatsoever. 
However, I think most of my colleagues and constituents in the 
STA believe that a cap is probably the way to go, and the logic 
behind it is if you have a rate increase, you basically have a 
moving target.
    In 1996 we built a formula based on what we thought the 
volumes would be in 1998, 1999 and 2000 and we missed the mark 
tremendously. If we were to do a rate decrease again, we are 
trying to predict what the volumes will be going forward. Are 
volumes going up? If they go down, the SEC might be 
underfunded. Therefore, a cap seems to be the most logical 
solution to the problem.
    Mr. Towns. I am trying in my own mind, trying to figure how 
a cap would work. Say, for instance, if there is a lot of 
activity in the first 3 months, and therefore you cap it, and 
then I recognize the fact that this is going to happen and so I 
will do business until after the cap, it seems to me a degree 
of unfairness.
    Mr. Kearney. The degree of unfairness--there are certain 
firms that are in favor of the rate cut and that is because it 
will be fair economically, it will benefit them the most. I 
think they are probably the smaller percentage of the types of 
firms in the industry. And probably if you look at the total 
industry, the fairest to the broad industry would be the cap.
    How would you compute it? I am not sure if I can answer 
that question today. But I think given the amount of dollars at 
stake, I think the securities firms could probably reach some 
kind of a consensus.
    Mr. Towns. Thank you.
    Mr. Brodsky. My problem is that this tax falls not only on 
the professionals that make the markets but also on customers, 
and you can't predict when a customer is going to buy or sell 
securities. This is a tax that falls on sales of securities. If 
the cap were reached on July 1, people who trade at the first 
half of the year would pay it, but those who traded the second 
half wouldn't pay it. My feeling is unless you can figure out 
an administrative way to deal with it, that a reduction is the 
fairest, because then it applies to everybody in a 
proportionate way.
    The committee decision has to be grounded on what is 
fiscally prudent to fund the SEC, making certain assumptions, 
and also that is realistic in terms of administration. We have 
a situation now where the amount of overfunding is so great it 
may be that you can have it--a fee can be scaled down over a 
period of years, but we would accelerate when it would start.
    Under the law that is in effect now, the scale-down 
wouldn't begin until 2007. Obviously we are way ahead of 
ourselves in terms of where the volume was. I think we have a 
threshold, based upon the chairman's questions, where we really 
believe that the volume is not going to go down appreciably, 
and you are at 5 times funding. Reasonable people ought to be 
able to sit down and figure out what is a reasonable amount of 
coverage for the current funding needs of the agency and have 
the fee reduced accordingly and start that reduction soon.
    Mr. Nelson. I represent the Securities Industry Association 
and I can tell you that the industry wants relief. Much of the 
discussion that we have had among ourselves about what approach 
to get to that relief has really involved a question of what 
would be most likely to sell up here on the Hill.
    I can tell you that we would very much appreciate any 
advice that the committee can give us as to what is likely to 
work. That has been a big topic of conversation among us.
    Mr. Cader. From the specialist perspective, we are in 
alignment with Steve's viewpoint. The issue is what is the most 
feasible way to get some relief. I think technically it appears 
to us that both a cap could work and a reduction could work and 
I would agree with what Steve said.
    Mr. Kearney. That is exactly our position at STA.
    Mr. Towns. Do you have any idea how a cap might work?
    Mr. Cader. I think there are a variety of ways that a cap 
could work. I think they are too technical to elaborate in more 
than a few seconds or minutes here. I think we would all be 
glad to come help out with that. I think there are ways that 
either approach could work. I think the industry and you all 
have dealt with more complicated mathematical propositions than 
this one. I don't think that it would be hard.
    Mr. Towns. Section 31 fees are leveled across all 
securities products. Why should options be singled out for 
special treatment?
    Mr. Brodsky. I am asking for relief not on all option 
trades but only on option trades where there is an economically 
equivalent product trading on futures exchanges in the United 
States, because we have a jurisdictional disparity in this 
country which, as I said earlier, this committee is fully aware 
of in terms of the Shad-Johnson Accord, where you have an S&P 
option trading on the Chicago Mercantile Exchange, where there 
is no tax because it is a futures product; and yet we have an 
S&P 500 option trading on the CBOE and there is a full tax 
because it is a securities product.
    And I don't think that this committee would feel very happy 
about the fact that people would choose to use a futures 
product because there is no tax and not a securities product 
because there is one. And I don't think that this was ever 
envisioned, and as we have studied the issue and talked to 
customers, they are, as all customers are in the world we live 
in today, very price sensitive. They say, Why should we pay a 
tax?
    I was President of the Chicago Mercantile Exchange almost 
13 years, and the futures exchanges have been strong and 
successful in not having any transaction tax on any of their 
trades. The securities industry is saying that we want the SEC 
funded, and funded fully, and we want to work with the 
committee. You have another industry that is trading, in this 
case, similar products and they say, We don't want any funding 
for our agency, let it come out of the General Treasury. We 
need to plead for this committee to understand that only a 
small amount of our products are subject to tax which are 
competitive with another industry in our same city. And we need 
help from this committee.
    Now, I will tell you as a percentage of our total business, 
it is a relatively small percent of our total business, less 
than 25 percent of our business. But yet it is brought home to 
us every single day that there are these competitive 
disparities that, by the way, in the past and maybe even now--
because the Agriculture Committee is looking at the Share 
Johnson Accord that can create jurisdictional battles between 
this committee and the Agriculture Committee. If we can't seek 
help from this committee, there is no place we can come.
    Mr. Oxley. The Chair recognizes the gentleman from Staten 
Island, an aforementioned sponsor of one of the bills dealing 
with section 31 fees.
    Mr. Fossella. Thank you, Mr. Chairman. I want to really 
compliment you for advancing this issue once again. You made a 
commitment to all of us that you would hold this hearing as 
soon as possible after H.R. 10 was passed, and I want to thank 
you because I think we need to maintain what this hearing is 
all about and what our focus should be. Clearly, what I think 
we need to do is understand that we want to return section 31 
fees to what they were originally intended to do.
    The witnesses all testified that they fully recognize the 
importance of the SEC in maintaining the integrity of our 
financial markets. Clearly I share, and I think every member of 
this committee shares, that view.
    We also need to understand what this fee, euphemistically, 
really is; and that is, a tax or drain on capital. If you own a 
mutual fund or stock or are involved in a pension plan, you are 
affected by this tax. And the question now becomes what do we 
do?
    Some of the witnesses went into elaborate detail as to the 
history of the SEC fee and how we got to this point. But my 
view is very simple. To do what is logical, to do what is 
right, to adequately fund the SEC, and then what is left over 
send back to investors, send back to the people who are paying 
that fee right now.
    I have a question for Mr. Brodsky. You are obviously a 
strong supporter of a rate cut, and I can understand where you 
are coming from. The reality, I guess, up here is whether this 
has been scored and whether it is revenue neutral and whether 
you know that to be true or not.
    Mr. Brodsky. Well, if we look at the numbers that Chairman 
Oxley spoke about in his opening remarks, clearly the amount of 
money that is raised by this fee far exceeds the agency's 
needs, and if you go back to the legislative history of this 
law that goes back to 1934, it was never intended to do 
anything other than the operating expenses of the SEC on an 
annual basis. I don't know if you call it revenue neutrality.
    I think there is coverage for the SEC's operating expenses 
from this fee, and it is really a question of how this 
committee will address itself to finding a way to scale back 
the amount raised and yet be sure that the SEC's operating 
expenses are covered.
    Mr. Fossella. I guess the general thing we need to find out 
is whether this complies with the budget rules in the pay-go 
provisions. Let me be clear, I share the view of everybody. I 
have a bill, a cap on the fee, and there is another bill 
introduced by my good colleague, Rick Lazio, and Congressman 
Towns. At the end of the day, we need to cut bait and do what 
is right, whether it is the rate cut or the cap. I think we 
have talked about that a number of times.
    I have a question, I guess, that Chairman Levitt of the 
SEC, who is going to be integral to this process, has testified 
before the Senate and before this committee that he would 
prefer a cap on the fee. I am curious, Mr. Kearney, what is 
your view on Mr. Levitt's testimony?
    Mr. Kearney. I wasn't allowed in the meetings when he was 
making his decision, but there is a proposal that the SEC has 
signed in March 1999 that gives some relief. However, it 
doesn't look like it is going to get implemented this year 
because of some regulatory problems, which is the riskless 
principle which will give the industry an $8 to $10 million 
relief. Maybe that is some of the logic that Mr. Levitt was 
using.
    I think his fears are that the volumes in this market are 
very unpredictable. If volumes should decrease, and we have 
seen that--I have seen it get really bad, and volumes do go 
away--if that should happen, would the SEC be underfunded? And 
I think one of the things he used in his testimony was the 
1994--when the SEC had to go to Congress and ask for additional 
funding, if I recall. I think he is just being prudent in 
saying there is a possibility that revenues--that transaction 
revenues could decrease and the Commission could be 
underfunded, and the Commission might have to increase their 
budgets due to the Internet phenomenon, et cetera.
    So we have to make sure that we do collect enough to run 
the Commission. And I think that is his logic, and that would 
be mine if I was in his chair. Maybe it is a compromise: a rate 
reduction, and once you hit that number, it is capped. There 
probably is going to have to have to be a compromise somewhere.
    Mr. Fossella. Anybody else have any thoughts? Mr. Nelson.
    Mr. Nelson. No.
    Mr. Fossella. Thank you, Mr. Chairman, for bringing 
attention to this matter. Like so many fees out there which 
have overextended their original purpose, now it has become an 
avalanche of money into the General Treasury. We have to 
maintain the trust of the American people and indicate that a 
user fee is just that, and not become just an unnecessary--or a 
tax to spend as folks see fit. Thank you.
    I want to compliment my colleague from New Jersey, Bob 
Menendez, who has helped me advance this issue as well.
    Mr. Oxley. I thank you for your attention to this issue.
    The Chair now recognizes the gentleman from Minnesota, Mr. 
Luther.
    Mr. Luther. Thank you, Mr. Chairman. I certainly want to 
thank all of the panelists, and particularly I want to make 
note of the fact that Mr. Kearney is from Minneapolis, 
Minnesota and with an outstanding firm there, a very well-
respected firm, and I certainly appreciate him being here.
    Mr. Kearney. Thank you.
    Mr. Luther. I think you have done a fine job of covering 
the subject on the rate cap and this principal trade issue that 
you dealt with. And you have touched on this area and ,Mr. 
Brodsky, I think you have done a good job of mentioning the 
notion that there are sometimes equivalent products, one is 
covered and one isn't.
    I think as we look at this issue, anything any of you can 
do to help us understand where there is a current unfairness in 
the current system, that is where there is substantially 
equivalent products, one is covered and one isn't, or maybe 
where there are some proposals which structure the transactions 
in such a way that they are covered by some places, not covered 
by other places, anywhere where there is unfairness in the 
current system, I think that would be very, very helpful to us 
as we look at this issue.
    If you want to comment on that or if you want to supplement 
anything that is in your experience with any other instances 
along those lines, I think that would be very helpful to us. 
Obviously there might be some public policy reasons for 
treating them differently. I think most of us would agree if we 
are going to have good, fair, free and open markets, that we 
would not want to have arbitrary differences applying to the 
same equivalent products or transactions.
    So anything that you want to comment on or anything you can 
supplement on that issue of fairness among transactions or 
products, I think would be very helpful.
    Mr. Brodsky. I appreciate your comment. I think I would ask 
if we could work with the staff and give them all of the 
examples and information that would be appropriate for the 
committee to have so you can see it in black and white.
    Mr. Kearney. The only comment that I would make is as it 
relates to the professional who is creating the liquidity that 
is needed to maintain the markets, and that is the specialist 
and the NASDAQ trader. That is the probably the person who is 
impacted the greatest with this rule because of the way that we 
commit our capital. And then to reliquefy as a trader, you 
don't want to hang on to positions. That is where the big 
effect is being felt, at the trading desks, both at the 
specialist level and at the NASDAQ level.
    Mr. Nelson. I think it is useful to just think about it a 
little bit. The problem is that this is a moving target. One of 
the things that you are seeing going on right now in my 
industry, in the market-making industry, is that there are 
efforts, rules being proposed, committees forming to talk about 
different ways, that when you sum it all up will be a way of 
avoiding this tax. A lot of those moves have to do with 
transforming the NASDAQ market into something, an agency market 
rather than a principal market. If it is an agency market, then 
the professionals who do the transactions are not involved in 
the tax.
    The problem with all of that is that I don't think that 
when Congress put this fee in place, they intended to transform 
the market into something other than what it was. They thought 
that the market was going to stay the way that it was. I think 
if we are just talking about the amount necessary to fund the 
SEC, that is what would happen. People would pay this little 
bit and that would be that.
    When it gets to be an enormous amount where it begins to 
affect your profitability, people begin to look for ways to 
change their business and accommodate this problem. That is the 
kind of change that I don't think it is in anybody's best 
interest to make willy nilly. That is something that people 
should think about. This is a market that has done a lot for 
the economy, and a lot of the problems we are currently seeing 
in terms of volatility, that was just unheard of a little while 
ago, are related to this problem of trying to shift away from 
principal trades and agency trades and avoid this tax and other 
issues that have come up in a similar way.
    That is what is going on. And so I think we can talk about 
what is happening now today and what people perceive as unfair, 
but you have to understand that is going to change, and in 6 
months or a year there will be a new landscape out there and it 
might not be the kind of landscape that you might like.
    Mr. Cader. I think from our perspective that really the 
greatest economic impact and the greatest fairness on public 
policy implications simply has to do with the outsized amount 
of money that is collected. I think there are, from time to 
time, fairness issues between markets, NASDAQ and New York 
Stock Exchange, Chicago Board Options Exchange, and those are 
worth paying attention to. But I think from our perspective 
they are somewhat dwarfed by the $1.8 billion next to the $320 
million. So I think as the markets continue to evolve in ways 
that we sometimes influence and sometimes don't and often can't 
predict, have a way of accommodating themselves through 
whatever fee structure is imposed, the less onerous that 
structure is, the less the markets will be faced with doing 
what Steve has just talked about and responding to tax and fee 
policy rather than competitive issues.
    Mr. Oxley. The Chair now recognizes the gentleman from Long 
Island, Mr. Lazio.
    Mr. Lazio. I want to thank the panel for their testimony 
and their efforts to try to find consensus, which I don't need 
to understate to this group, I think. It is in the end a 
question of fairness, I think. If you distill it down to its 
most basic level, where you have the SEC operating at a cost to 
the public at about $324 million and you have collections 
through the section 31 fees 5 times that amount, and growing as 
volume increases, you obviously have a huge discrepancy.
    My first question is, Why should an average investor care? 
It is broadly true that Americans no longer save their money in 
mattresses. They are less likely to keep their savings in 
banks. And they are increasingly planning for their retirement 
through 401(k)s and other pension vehicles. Almost half of all 
Americans have some equity stake through mutual funds by virtue 
of a direct equity bond investment.
    Let me ask Mr. Cader first, it doesn't amount to so much 
per small investor, does it? Why should it matter to an average 
American?
    Mr. Cader. I wouldn't stand here and argue that the extra 
$1-$2 billion, a portion of which comes out of investors' 
pockets, is going to have a significant impact on their 
economic behavior. Given the capitalizations of the equity 
markets and the size of trading, I wouldn't put forth the 
proposition that the difference of a billion dollars or so 
means people will buy stocks or not buy stocks.
    However, it is important, No. 1, for a fairness reason; 
because as someone said, a billion dollars here and a billion 
dollars there, before you know it, it is economically 
significant.
    Going back to the points that I raised during my testimony, 
that portion of the section 31 fee which falls specifically on 
the market makers, the specialists and liquidity providers, 
offers the possibility for an unpredictable and insidious and 
significant impact, although an indirect one on investors, the 
users of the markets, in the event that conditions are not as 
friendly as they are today. And by the way, the environment, 
the business environment for liquidity providers continues to 
get more competitive and margins go down for good reasons. 
Those reasons are competition, technology, and the ongoing 
benefits that are provided to consumers because of that.
    Mr. Lazio. Let me get to this point which is this liquidity 
issue. Mr. Brodsky had raised it in his testimony and you raise 
it now. Can you explain how the fees impact on the ability of 
specialists, market makers, to provide more liquidity and why 
that is important to the individual investor that there be this 
type of liquidity so that the market operates efficiently?
    Mr. Cader. It is important because what markets consist of 
simply are investors who wish to buy and sell, looking for an 
investor with exactly the opposite opinion at the same time. A 
buyer for every seller. And markets exist and the need for 
liquidity providers exists because investors don't show up at 
the same time, at the same price, with the same quantity of 
shares. So the liquidity providers, which is the fancy word for 
the buyers--the ever-present assigned obligated risk-taking 
buyers and sellers in all of the marketplaces, use their money, 
their capital, to take the other side of investors' trades, 
hundreds of thousands, millions of times a day. So capital that 
is taken from the hands of the liquidity providers is then not 
available to use to satisfy investor needs in the marketplace 
every day.
    And to the extent that market conditions are more or less 
friendly, and friendly meaning a market in which--that is not 
going up or down too much--which indicates that supply and 
demand to a certain extent balance out, as opposed to markets 
that are moving sharply which indicates an imbalance--the more 
sharply the markets are moving around, the more the investors 
with their actions are stating that there is not sufficient 
liquidity and requiring the assigned obligated risk-takers, the 
market makers, to step in and buy and sell with their money to 
take the other side of investors' trades.
    Mr. Lazio. Let me distill this. The more thinly the market 
is traded, the less liquidity there is, the more volatility 
there is potentially in price; which, am I correct in assuming 
that the smaller investors are probably more likely to be 
adversely affected in a situation like that as opposed to the 
more sophisticated players that are more attuned to what is 
going on?
    Mr. Cader. Smaller investors generally have fewer choices 
how to mitigate or deal with volatility.
    Mr. Lazio. This is not only a tax on capital, it is passed 
on to individual and institutional investors, and it increases 
the transactional costs when technology is lowering 
transactional costs and Americans are more and more likely to 
be investing in markets. But it also potentially adversely 
affects small investors because of this volatility.
    Mr. Cader. That is correct. And it happens in an indirect 
way, which is why it is a little hard to explain. The money is 
not being taken out of the smaller investors' pocket, but it is 
being taken out of a system which is designed to benefit the 
small investor at the very place where it can be most needed to 
serve the small investor under stressful market conditions.
    Mr. Lazio. One last question, and I want to pay honor to my 
colleague, Mr. Fossella, for his work on this issue as well. 
But for some arcane budgetary rules, is there any market reason 
why a rate reduction is not a more efficient, more predictable, 
and fairer way to go than a cap?
    Mr. Cader. As I think I mentioned before, what is--I think 
what is most important to us is that we find a way to some 
relief, and since I am unfamiliar with the budgetary process 
and the process here----
    Mr. Lazio. Forget about the budgetary. That may end up 
dictating results, but just in terms from the market 
standpoint.
    Mr. Cader. I don't think see where it matters. I can draw 
on a piece of paper a solution either way, or a hybrid solution 
that would involve a reduction and then a cap. I honestly 
couldn't see why one is more or less workable than the other.
    Mr. Brodsky. All of us are looking for relief and it really 
becomes a question of how it can be administered and if there 
is a way where a cap can work, that is fine. I think that from 
my perspective, about half our business is done through the 
liquidity providers.
    Again, I echo Mr. Cader's comments that we have many small 
investors, and if you make it more expensive for the liquidity 
providers, it impedes their liquidity for the small investor. I 
just wonder whether a cap can be--for the benefit of the public 
investor--can be applied in a fair and even way as opposed to 
liquidity providers. Because a cap liquidity provider, they are 
in the market all of the time. But if I am an investor that 
trades at the beginning of the year, and not at the end, I 
probably don't benefit in terms of the specific fees.
    But I think all of us are saying we really appreciate what 
you are doing. How it gets done is not as important, as we all 
believe 5 times the agency's funding makes no sense and it is 
fundamentally unfair. So if the committee in its wisdom says we 
would rather do it one way than the other, we are as willing to 
figure that out administratively. But there are administrative 
dynamics that come into play.
    Mr. Lazio. Thank you.
    Mr. Oxley. I thank the gentleman for his leadership. The 
Chair now recognizes the gentleman from Illinois, Mr. Rush.
    Mr. Rush. Thank you, Mr. Chairman. Mr. Chairman, I want to 
commend you for chairing this very important hearing. I want to 
also welcome Bill Brodsky from the Chicago Board Options 
Exchange to this hearing and it is good to have him here. The 
Chicago Board Options Exchange is an integral part of not only 
the Nation but the city of Chicago and we want to do all that 
we can to ensure that it is a healthy exchange and we want to 
make sure that the section 31 fee issue is resolved amicably 
among all of the different parties.
    I have a question for Mr. Brodsky. It has been suggested 
that the excess fees are back-door taxes which place U.S. 
Securities markets at a competitive disadvantage. Do you have 
projections of the impacts on the securities market if we as 
Members of Congress do not act to resolve the section 31 fee 
issue?
    Mr. Brodsky. Well, thank you for your warm welcome and it 
is good to see you, Congressman.
    The markets that we are all living in right now are 
changing more rapidly in the current era than they have in many 
years, and I too have been in the business over 30 years. There 
are exchanges outside the U.S. That are banging on the doors to 
try to bring terminals into the U.S. And trade products. How 
that impacts on our competitiveness is very much a concern of 
ours.
    What we want to do is maintain the strong regulation that 
we have in this country and make sure that it is paid for, but 
be mindful of the fact that if we charge more for that than 
necessary, it can limit our competitiveness. I think that is 
something that this committee, in its oversight of the 
securities markets, should be concerned about, whether it is 
section 31 fees or anything else.
    Right now, the largest derivative exchange in the world is 
no longer in the U.S., it is in Germany and Switzerland, and it 
is all screen based, and the biggest products that they trade 
are equity derivative products. If they try to offer products 
similar to ours without these kinds of fees, that is a great 
concern to us. To the extent that they offer them as securities 
exchanges in the U.S., they would be subject to our fees, but 
right now they are not registered as securities exchanges in 
the U.S.
    Mr. Rush. Mr. Nelson, would you respond to my question 
also?
    Mr. Nelson. We have an office in London. We trade 500 
European stocks. Those stocks are not subject to these fees. 
They are traded on EASDAQ, they are traded on the Deutsche 
Borse, and the London Stock Exchange. Some of those stocks are 
also traded as NASDAQ stocks here in the United States and some 
of them as listed stocks.
    I can tell you that customers who have the opportunity to 
buy those stocks over in Europe usually do. They are cheaper 
typically to do that. I don't know whether that trend will 
continue. I think to give a complete picture, their securities 
markets are not nearly as well developed or technologically 
advanced. It is much more difficult to do business in Europe, I 
can tell you that firsthand. A lot of things will have to 
change before we would really believe that those markets would 
outdo what we do here in the United States. But certainly there 
is that opportunity and they are very aware of it over there. 
They really want to develop their markets in a way that will be 
competitive. This will be a problem, I think, as time goes on.
    Mr. Rush. Currently there are two legislative proposals, 
two bills before this committee and before the Congress.
    Is there any way that any of you would suggest that we 
improve upon those bills or are those bills--if the Congress in 
its wisdom passes one over the other, would that be 
satisfactory? Or can we improve either of those bills?
    Mr. Kearney. My own insight, I think that from the 
perspective of a cap, I think that speaking to the regulators 
and to other people, Chairman Levitt, et cetera, I think that 
is probably going to be the easiest, something in the form of a 
cap is going to be the easiest bill to pass. If you don't put 
that in, I think the regulators might put a major objection to 
anything that we are trying to change. That is probably what is 
leading the STA to lean toward some form of capping it, because 
the chairman of the Commission has basically said more than 
once that he is in favor of some type of relief, but it has to 
have some form of a cap in it. So for simplistic reasons, we 
would be in favor of something along those lines. We will take 
anything, but I think that is the logical process. You tend to 
go where you are being directed.
    Mr. Rush. Mr. Cader?
    Mr. Cader. As I said before, I really believe, 
mechanically, either approach is workable. The greater the size 
of reduction, the greater the amount of money released back 
into capital markets to serve investors, the happier we will be 
and the better off the public will be. I think it is up to you 
all, with as much help as we can give you, to craft the most 
workable option.
    Mr. Rush. Mr. Brodsky, would you describe the role of 
options in the overall picture of securities markets and how 
these section 31 fees impact on capitalization, market 
capitalization?
    Mr. Brodsky. First of all, I think the question is an 
appropriate one, except that there is a time constraint. But I 
would say to you that the listed option business as it exists 
today was created in Chicago in 1973 and there are now 55 
exchanges which have copied the CBOE model. The option market 
is integral to the securities business. It has provided risk-
shifting abilities, both for individual investors and market 
makers so they can provide more liquidity to the markets. It 
gives investors, both small investors and very large investors, 
both individuals and institutions, a way to manage their risk 
that never before existed, and I think it has thrived because 
the regulation in the U.S. Has been so effective and there has 
been fairness to public investors. So it adds a lot of 
liquidity to the markets.
    My friend Dick Grasso at the New York Stock Exchange will 
always tell me that the Chicago Board Options Exchange send the 
NYSE more business a day than any other entity because our 
market makers are liquidity providers. When they deal in 
options for small public customers, we will hedge on the New 
York Stock Exchange or in the NASDAQ market in enormous 
quantities. So we have added liquidity to the system and 
everyone benefits.
    I think particularly at a time like this where we have 5 
years of unprecedented growth in equity markets, option markets 
provide customers of all types, individuals, institutions, 
large and small, with the ability to basically buy insurance on 
their stocks. So when you have a stock that has gone up 5 
times, you don't want to sell it, you want to keep it, an 
option contract can give you the way of buying insurance on 
your stock the same way you buy insurance on your house or car, 
and I think in that respect options have added a tremendous 
amount to the vibrancy and integrity of the U.S. Markets.
    Mr. Oxley. The gentleman's time has expired. The Chair now 
recognizes another gentleman from Illinois, Mr. Shimkus.
    Mr. Shimkus. Thank you, Mr. Chairman. I also want to extend 
my welcome to Mr. Brodsky, and I don't think that Illinois 
takes a second seat in financial services to any New York 
facility. All of these New Yorkers are on this bill but we have 
great boards of trades and options and the Mercantile and so we 
are proud to have you here. I think you hear commonality on the 
need to get the fees in line with the exact expenses. Look, all 
the New Yorkers are leaving now.
    And I am a proponent of budget simplification. I do think 
that it is a tax imposed upon the consumers if there is 
additional money over the identified costs of the services in 
which the fee was in place to begin with. So I think there is 
pretty much unanimity. I think the question debated here is 
caps versus deceleration of fees and how that would have 
happened, and I do feel that it will adversely affect the 
international competition if these fees remain in place. If 
they are fees in excess of the fees needed to fund the 
Commission, then I think it will adversely effect us.
    Mr. Brodsky, in your statement you talk about--for the sake 
of argument, what kind of acceleration of the reduction fees 
would you recommend? What is the disadvantage of having the cap 
in place?
    Mr. Brodsky. First of all, in terms of acceleration, I 
think the whole panel is in agreement that we seek relief as 
soon as possible. We know how difficult it is to get consensus 
on these things. But the sheer numbers indicate that there is 
money that could be used elsewhere to add to the capital 
markets, and I think that again I will share the views of those 
on the panel. We are looking for relief and looking for relief 
promptly, but we don't want to jeopardize the funding of the 
agency, and we would rather find some way to sit down--whatever 
the committee thinks it can get done, we would like it to get 
done.
    Mr. Shimkus. You are being very gallant and political in 
terms of not wanting to stir up the chairman based upon his 
proposal, and I understand that.
    The question that we have to address--and if you want to do 
that with staff as we deal with this--I think members are going 
to want to know why you prefer one or the other and what would 
be the benefits and disadvantages of each. But I guess I will 
just defer to the chairman as we move forward, if that is 
something that we want to do, to try to get a delineation 
between staff. But either you have a lot of agreement that 
there is an excess of charges being collected, that it ought to 
be in line with what the actual costs are, so what is the 
proper way to go about it for the industry; and you all as 
panelists should say, We don't like the cap, this is why. Or, 
We want immediate changing of the fee structure now; and then 
who, what, when, where, why and how?
    I am going to have to go to the floor to preside as Chair, 
and I yield back the balance of my time, or if anyone wants to 
answer. If we want to get into which one is better, I will 
leave that up to the chairman's discretion.
    Mr. Oxley. I think we have had a pretty good discussion on 
that. That is something that we need to work with the 
appropriate parties and staff on that, which will clearly be 
part of the work product of our worthy staff during the August 
recess while the members are back at the county fairs.
    Mr. Brodsky. Mr. Chairman, while Mr. Shimkus is still here, 
I appreciate your comments about Illinois, but I must say 
something. I was born in Brooklyn and I grew up on Long Island, 
and with Mr. Towns and Mr. Lazio, I had to say that.
    Mr. Oxley. The gentleman's time has more than expired.
    Mr. Lazio. Easy, easy.
    Mr. Rush. We don't hold that against him, Mr. Chairman.
    Mr. Oxley. The gentlewoman from Colorado, Ms. DeGette.
    Ms. DeGette. I guess I would like to have Mr. Brodsky 
answer Mr. Shimkus's question. We can all pussyfoot around here 
and talk to staff during the recess. We have no county fairs in 
my district in August. Tell us why you don't favor the caps and 
what you would prefer to see.
    Mr. Brodsky. In my prepared remarks, I favored the general 
reduction over the cap because I am not aware of how we could 
administer the cap as it relates to smaller investors. The cap, 
I think, would work well with the professionals who are trading 
all of the time, so when you reach X amount, you know that you 
don't pay any more. But investors don't trade on some sort of 
particular schedule. They do things because it either moves 
them or because it is in their economic benefit to do so. I am 
not ruling it out as being a bad thing, I am just not aware of 
how people would administer a cap for millions of investors who 
pay the fee as well.
    I can't tell you in dollar terms how much of it is paid by 
the liquidity providers versus the investor, and I know 
liquidity providers pay a very large amount because they do 
provide the grease that oils the wheels. But clearly I as an 
individual investor will sell stock or sell options at odd 
times during the year; and how does the cap work? You are not 
going to administer it from millions of individual accounts.
    Ms. DeGette. I wonder if some of the rest of you would 
comment on that issue, how you would administer this for small 
investors.
    Mr. Kearney. It is probably not dissimilar to the Social 
Security tax or whatever. We have a lot of caps in this economy 
that, yeah, you participate early and you don't participate 
later, and I think that one of the things STA is looking at is 
what is doable. And I think that the Commission is looking at 
some form of relief. However, they are in fear of having to go 
back to Congress at a further date if the securities business 
should slow down.
    I think that some type of compromise, a rate decrease with 
a cap, is probably the most logical thing. It is not going to 
be fair to everybody. A rate increase will benefit certain 
people. A cap will benefit certain people more or less. I don't 
think that you can reach a compromise that is going to be fair 
to every investor and the liquidity providers and everybody 
involved in this.
    The reason that we teed this up was because of the amount 
of dollars that are being collected by the government. So maybe 
the consensus is you do a rate decrease. You have a cap just in 
case the thing starts to decrease to where the SEC is 
uncomfortable, and that is probably something that the chairman 
would go along with--Chairman Levitt. He is going to be an 
obstacle if we don't--we have to listen to him. He has a lot of 
responsibility.
    Ms. DeGette. And I think one thing we have unanimous 
agreement on in this room is that we need to do something to 
establish a stable fee structure that adequately reflects an 
offset of the SEC's regulatory activities. And the only 
question we have got is how do we do that.
    Mr. Brodsky, let me ask you one more question and maybe the 
others can comment. Just to play devil's advocate, if we reduce 
the section 31 transaction fees, how can we be sure that this 
will not jeopardize SEC revenue fees over the long term, where 
there is significantly reduced market activities and the 
possibility of severe market downturns? A lot of you think that 
this will not be a problem, but I would like to hear your 
comments on it.
    Mr. Brodsky. I think if you look at the overall trend of 
volume in business over the last 20-30 years, the overall trend 
is clearly up. You would not necessarily have to have a cap 
that would go from here to here, but it could be scaled down 
over a period of years, and the committee meets more than once 
a year and they can keep an eye on it.
    I think there are lots of ways to do it. Again, I think it 
doesn't have to be all done in 1 year, but we have to recognize 
that the trend has been clearly dramatically up over every 3- 
to 5-year period of time that has existed.
    Ms. DeGette. Do the rest of you have comment on that issue? 
No? I have stumped the panel.
    Mr. Nelson. The reality is that there are significant 
design issues with either approach. We recognize that. We did 
not come prepared today to talk about this issue. I didn't. And 
this is something that we would love to get into in more 
detail, but it is a complex issue. There are--each side--you 
have certainty on one side, which is what you are referring to 
right now: the certainty that the SEC will be funded, the 
certainty that they will not be overfunded against a 
potentially greater relief through a rate reduction.
    It is a very difficult design issue and it is something 
that really needs to be explored in a lot of depth. We would 
love to get into that. We came here today to talk about the 
issue of funding. That was our mandate and that is what we came 
prepared to talk about.
    Ms. DeGette. Whatever we end up coming up with, Mr. 
Chairman, if we can try to design it as well as we can to be 
accurate and to minimize future congressional involvement. I 
know this would be a goal shared by all members of this panel. 
I yield back the balance of my time.
    Mr. Oxley. That is exactly what we would try to achieve. 
This is going to take some heavy lifting, but once that is 
completed, we would hope that we could put it on automatic 
pilot and go on to other project.
    We thank all of you for what was a most impressive 
testimony and response to questions. I think we have teed up 
the issues very, very effectively. And now we will start the 
hard work of putting together some ideas as to how we best move 
forward. We look forward to working with all of you toward the 
same goal. The subcommittee stands adjourned.
    [Whereupon, at 12 noon, the subcommittee was adjourned.]
    [Additional material submitted for the record follows:]
      Prepared Statement of the Securities and Exchange Commission
    Thank you for giving the Securities and Exchange Commission (SEC or 
Commission) the opportunity to present this statement concerning 
securities transaction fees. The SEC shares the Subcommittee's concern 
that fee collections are currently well in excess of initial 
projections. The existing fee structure, last revised in 1996, was the 
product of many years of negotiations, involving many players with 
competing interests. However, tremendous market growth in recent years 
has pushed fee collections far beyond the levels anticipated during 
those negotiations. The SEC welcomes an inclusive, reasoned dialogue on 
fee collections.
History of Fees
    Federal securities laws direct the Commission to collect three 
different types of fees: registration fees, transaction fees, and fees 
on mergers and tender offers. Securities registration fees (Section 
6(b) fees) are paid by corporations and investment companies when they 
register securities for sale. These were first enacted at a rate of \1/
50\th of 1 percent under Section 6(b) of the Securities Act of 1933. 
Starting in 1990, the Section 6(b) fee rate was increased yearly 
through the appropriations process. The first \1/50\th of 1 percent 
goes directly to the U.S. Treasury and is unavailable for funding the 
SEC. The amount over the \1/50\th of 1 percent (called offsetting 
collections) can be used to fund the agency through appropriations.
    Transaction fees (Section 31 fees) are paid when securities are 
sold. These were enacted at a rate of \1/300\th of 1 percent on 
exchange-listed securities under Section 31 of the Securities Exchange 
Act of 1934. Proceeds from this fee are deposited directly in the U.S. 
Treasury and are not available to fund the agency.
    Fees on mergers and tender offers are paid by corporations directly 
to the U.S. Treasury and also are not available to fund the agency.
    The SEC's fee collections have been a subject of concern since 
1983, when the Commission first began contributing more to the U.S. 
Treasury than was required to fund the agency. In 1988, the Securities 
Subcommittee of the Senate Committee on Banking, Housing, and Urban 
Affairs requested that the SEC examine its fee collections and funding 
structure. The report prepared by the SEC in response to this request 
was the first step in the process that eventually led to the compromise 
reached in Title IV of the National Securities Markets Improvement Act 
of 1996 (NSMIA).1
---------------------------------------------------------------------------
    \1\ Report submitted in response to the request of the Securities 
Subcommittee of the Senate Committee on Banking, Housing and Urban 
Affairs (S. Rpt. 100-105), December 20, 1988.
---------------------------------------------------------------------------
Fee Agreement in NSMIA
    Title IV of NSMIA mandates a fee structure that was the result of 
extensive negotiations between six different Congressional Committees, 
the Administration, and the SEC.
    In general, the NSMIA fee structure was designed to:

 gradually reduce total fee collections;
 ``level the playing field'' by extending Section 31 
        transaction fees, which had previously only applied to 
        transactions involving exchange-listed securities, to 
        securities subject to ``last sale reporting'' in the over-the-
        counter market;
 gradually reduce the SEC's reliance on fee collections, 
        thereby increasing the amount of new budget authority required 
        to fund the agency through the appropriations process; and
 provide the SEC with a stable, long-term funding structure.
    NSMIA set in motion a gradual reduction in Section 6(b) 
registration fee rates over a ten-year period intended to more closely 
align fee collections with the funding needs of the SEC. Specifically, 
NSMIA authorized the Commission to collect securities registration fees 
at the rate of \1/50\th of 1 percent of the aggregate offering price in 
fiscal year 2006, declining annually from \1/34\th of 1 percent in 
1998. In fiscal year 2007, the rate will be further reduced to \1/
150\th of 1 percent. In addition, NSMIA classified the portion of the 
Section 6(b) fees in excess of \1/50\th of 1 percent (i.e., the portion 
declining from 1998 to 2006) as offsetting collections that can be used 
directly to fund Commission operations, subject to prior approval by 
the Commission's appropriations committees.
    NSMIA also provided equity in the application of Section 31 fees by 
authorizing the SEC to collect these fees on transactions in the over-
the-counter (OTC) market involving securities subject to ``last sale 
reporting.'' Unlike the Section 31 fees imposed on sales of exchange-
listed securities, these new OTC fees are classified as offsetting 
collections and, therefore, can be used to fund Commission operations, 
subject to approval by the Commission's appropriations committees. 
Under NSMIA, all Section 31 fees will fall to \1/800\th of 1 percent in 
fiscal year 2007.
    Because the fees collected by the SEC are tied--directly and 
indirectly--to market activity, they are nearly impossible to predict 
accurately. The fee rates established in NSMIA were based on 1996 
projections of market activity. However, the tremendous growth in the 
markets over the past few years has far exceeded the 1996 estimates on 
which NSMIA was based, resulting in fee collections well in excess of 
original estimates. Unfortunately, the potential for either excess 
collections or shortfalls is inherent in activity-based fees.
    While the NSMIA fee structure has eliminated the funding 
uncertainties and crisis situations that surrounded the agency's 
funding from the late 1980s to the mid-1990s, it has not reduced total 
collections due to unexpectedly strong market activity.
Budget Enforcement Act
    The rules enacted as part of the Budget Enforcement Act (BEA) have 
restricted efforts to undertake a comprehensive fee reduction. The BEA 
splits our fee collections into two different categories: mandatory and 
discretionary. Under the BEA, any fees in existence prior to 1990 are 
deemed mandatory and are deposited directly into the General Fund of 
the U.S. Treasury; they are unavailable for SEC use. The SEC's fees 
that fall into this category are:

 the first \1/50\th of 1 percent of Section 6(b) registration 
        fees;
 Section 31 fees on transactions involving exchange-listed 
        securities; and
 fees on mergers and tender offers.
    These fees, which account for nearly 70 percent of total SEC 
collections, are estimated by the Congressional Budget Office (CBO) to 
exceed $1.1 billion in fiscal year 2000. Because these collections 
currently are protected by the BEA rules, they cannot be reduced 
without a corresponding increase in revenues or decrease in federal 
spending elsewhere. According to CBO's estimates, to fully repeal these 
fees, other collections flowing to the Treasury's General Fund would 
have to increase by $9.6 billion over the next seven years, or spending 
from the General Fund would have to be reduced by the same amount.
    The remaining 30 percent of SEC collections are unaffected by the 
requirements of the BEA. These ``discretionary'' fees, available for 
use by our appropriators under NSMIA, are the fees previously 
identified as our offsetting collections. Specifically, they are:

 Section 6(b) registration fees collected above \1/50\th of 1 
        percent; and
 Section 31 fees on transactions in securities subject to 
        ``last sale reporting'' in the over-the-counter market.
    The following chart shows the current CBO estimates of total fee 
collections broken down between mandatory and discretionary under the 
BEA.

                             ($ in millions)
------------------------------------------------------------------------
                                                                Total
           Fiscal Year             Mandatory  Discretionary  Collections
------------------------------------------------------------------------
2000.............................     $1,155         $501        $1,656
2001.............................     $1,206         $498        $1,704
2002.............................     $1,260         $503        $1,763
2003.............................     $1,314         $516        $1,830
2004.............................     $1,422         $508        $1,930
2005.............................     $1,544         $552        $2,096
2006.............................     $1,675         $601        $2,276
2007.............................       $783         $285        $1,068
------------------------------------------------------------------------

    As the chart illustrates, total fee collections are projected to 
increase through fiscal year 2006, and then fall sharply in 2007 when 
the final NSMIA fee reductions go into effect.
Fee Reductions
    The Commission recognizes the magnitude of this issue, and has 
tried to reduce fees, where possible, when it is within its authority 
to do so. The Commission has taken two specific actions to reduce fees 
and administrative burdens. In 1996, fees for filing certain disclosure 
documents were eliminated, saving public companies an estimated $8 to 
$12 million per year. While this is a small amount relative to the size 
of the industry, it is significant in reducing the administrative 
burden on registrants, as well as the SEC. In addition, the Commission 
responded to industry concerns that there was a double counting of 
transactions in the over-the-counter market imposing an unfair burden 
on certain market participants. The Commission encouraged and actively 
supported changes in industry practices to eliminate this problem and 
approved NASD rule proposals to implement this change in March 1999.
Conclusion
    Today, we are faced with fee collections well above the levels 
anticipated in NSMIA. As stated earlier, CBO's estimates for fiscal 
year 2000 fee collections are $1.66 billion. Not only is that amount 
far greater than our funding requirements for fiscal year 2000, but 70 
percent of that figure is unavailable to fund the agency because of the 
restrictions imposed by the BEA rules.
    However, we are still faced with many of the same issues that 
required years of Congressional negotiation and that resulted in the 
compromise embodied in NSMIA. Any alternative funding mechanism must:

 provide full funding for the SEC;
 spread the costs of regulation among those who benefit;
 consider the effect of market conditions on collections; and
 address the competing interests of all parties.
    The SEC welcomes the opportunity to discuss this issue and 
appreciates the help and support of all the interested parties in 
ensuring that the SEC remains adequately funded regardless of the 
funding approach taken.
