[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]





                     REVIEWING U.S. CAPITAL MARKET
                     STRUCTURE: THE NEW YORK STOCK
                      EXCHANGE AND RELATED ISSUES

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

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                     CAPITAL MARKETS, INSURANCE AND
                   GOVERNMENT SPONSORED ENTEREPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                            OCTOBER 16, 2003

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 108-57


92-639              U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2003
____________________________________________________________________________
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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 BARNEY FRANK, Massachusetts
DOUG BEREUTER, Nebraska              PAUL E. KANJORSKI, Pennsylvania
RICHARD H. BAKER, Louisiana          MAXINE WATERS, California
SPENCER BACHUS, Alabama              CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware          LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York              NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California          MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma             GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio                  DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice Chair   JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                GREGORY W. MEEKS, New York
JIM RYUN, Kansas                     BARBARA LEE, California
STEVEN C. LaTOURETTE, Ohio           JAY INSLEE, Washington
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, Jr., North          CHARLES A. GONZALEZ, Texas
    Carolina                         MICHAEL E. CAPUANO, Massachusetts
DOUG OSE, California                 HAROLD E. FORD, Jr., Tennessee
JUDY BIGGERT, Illinois               RUBEN HINOJOSA, Texas
MARK GREEN, Wisconsin                KEN LUCAS, Kentucky
PATRICK J. TOOMEY, Pennsylvania      JOSEPH CROWLEY, New York
CHRISTOPHER SHAYS, Connecticut       WM. LACY CLAY, Missouri
JOHN B. SHADEGG, Arizona             STEVE ISRAEL, New York
VITO FOSSELLA, New York              MIKE ROSS, Arkansas
GARY G. MILLER, California           CAROLYN McCARTHY, New York
MELISSA A. HART, Pennsylvania        JOE BACA, California
SHELLEY MOORE CAPITO, West Virginia  JIM MATHESON, Utah
PATRICK J. TIBERI, Ohio              STEPHEN F. LYNCH, Massachusetts
MARK R. KENNEDY, Minnesota           ARTUR DAVIS, Alabama
TOM FEENEY, Florida                  RAHM EMANUEL, Illinois
JEB HENSARLING, Texas                BRAD MILLER, North Carolina
SCOTT GARRETT, New Jersey            DAVID SCOTT, Georgia
TIM MURPHY, Pennsylvania              
GINNY BROWN-WAITE, Florida           BERNARD SANDERS, Vermont
J. GRESHAM BARRETT, South Carolina
KATHERINE HARRIS, Florida
RICK RENZI, Arizona

                 Robert U. Foster, III, Staff Director

  Subcommittee on Capital Markets, Insurance and Government Sponsored 
                              Enterprises

                 RICHARD H. BAKER, Louisiana, Chairman

DOUG OSE, California, Vice Chairman  PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut       GARY L. ACKERMAN, New York
PAUL E. GILLMOR, Ohio                DARLENE HOOLEY, Oregon
SPENCER BACHUS, Alabama              BRAD SHERMAN, California
MICHAEL N. CASTLE, Delaware          GREGORY W. MEEKS, New York
PETER T. KING, New York              JAY INSLEE, Washington
FRANK D. LUCAS, Oklahoma             DENNIS MOORE, Kansas
EDWARD R. ROYCE, California          CHARLES A. GONZALEZ, Texas
DONALD A. MANZULLO, Illinois         MICHAEL E. CAPUANO, Massachusetts
SUE W. KELLY, New York               HAROLD E. FORD, Jr., Tennessee
ROBERT W. NEY, Ohio                  RUBEN HINOJOSA, Texas
JOHN B. SHADEGG, Arizona             KEN LUCAS, Kentucky
JIM RYUN, Kansas                     JOSEPH CROWLEY, New York
VITO FOSSELLA, New York,             STEVE ISRAEL, New York
JUDY BIGGERT, Illinois               MIKE ROSS, Arkansas
MARK GREEN, Wisconsin                WM. LACY CLAY, Missouri
GARY G. MILLER, California           CAROLYN McCARTHY, New York
PATRICK J. TOOMEY, Pennsylvania      JOE BACA, California
SHELLEY MOORE CAPITO, West Virginia  JIM MATHESON, Utah
MELISSA A. HART, Pennsylvania        STEPHEN F. LYNCH, Massachusetts
MARK R. KENNEDY, Minnesota           BRAD MILLER, North Carolina
PATRICK J. TIBERI, Ohio              RAHM EMANUEL, Illinois
GINNY BROWN-WAITE, Florida           DAVID SCOTT, Georgia
KATHERINE HARRIS, Florida
RICK RENZI, Arizona


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    October 16, 2003.............................................     1
Appendix:
    October 16, 2003.............................................    71

                               WITNESSES
                       Thursday, October 16, 2003

Coffee, John C. Jr., Adolf A. Berle Professor of Law and 
  Director, Center on Corporate Governance, Columbia University 
  School of Law..................................................    48
Colker, David, President and Chief Executive Officer, The 
  Cincinnati Stock Exchange......................................    46
Frucher, Meyer S., Chairman and Chief Executive Officer, The 
  Philadelphia Stock Exchange....................................    43
Glassman, James, Resident Fellow, American Enterprise Institute..    39
Greifeld, Robert, President and Chief Executive Officer, The 
  Nasdaq Stock Market, Inc.......................................    34
Lackritz, Marc E., President, Securities Industry Association....    37
Putnam, Gerald D., Chairman and Chief Executive Officer, 
  Archipelago Holdings, L.L.C....................................    41
Reed, John, Interim Chairman and Chief Executive Officer, New 
  York Stock Exchange, Inc.......................................     7

                                APPENDIX

Prepared statements:
    Oxley, Hon. Michael G........................................    72
    Castle, Hon. Michael N.......................................    74
    Clay, Hon. Wm. Lacy..........................................    75
    Emanuel, Hon. Rahm...........................................    76
    Gillmor, Hon. Paul E.........................................    77
    Hinojosa, Hon. Ruben.........................................    78
    Kanjorski, Hon. Paul E.......................................    79
    King, Hon. Peter.............................................    81
    Royce, Hon. Edward R.........................................    82
    Coffee, John C. Jr...........................................    83
    Colker, David................................................    92
    Frucher, Meyer...............................................   103
    Glassman, James..............................................   120
    Greifeld, Robert.............................................   128
    Lackritz, Marc E. (with attachments).........................   135
    Putnam, Gerald D.............................................   182
    Reed, John...................................................   192

              Additional Material Submitted for the Record

Glassman, James:
    Profitability Analysis of NYSE Trading Specialists by Brian 
      C. Becker Ph.D.............................................   203

 
                     REVIEWING U.S. CAPITAL MARKET
                     STRUCTURE: THE NEW YORK STOCK
                      EXCHANGE AND RELATED ISSUES

                              ----------                              


                       Thursday, October 16, 2003

             U.S. House of Representatives,
     Subcommittee on Capital Markets, Insurance and
                   Government Sponsored Enterprises
                           Committee on Financial Services,
                                                   Washington, D.C.
    The Subcommittee met, pursuant to call, at 10:05 a.m., in 
Room 2128, Rayburn House Office Building, Hon. Richard Baker 
[Chairman of the Subcommittee] presiding.
    Present: Representatives Baker, Ose, Shays, Bachus, Castle, 
Royce, Oxley (ex officio), Kelly, Ney, Ryun, Biggert, Capito, 
Hart, Kennedy, Tiberi, Harris, Leach, Kanjorski, Sherman, 
Meeks, Moore, Gonzalez, Frank (ex officio), Hinojosa, Lucas of 
Kentucky, Crowley, Israel, McCarthy, Baca, Miller of North 
Carolina, and Maloney.
    Chairman Baker. [Presiding.] I would like to call this 
meeting of the Capital Market Subcommittee to order.
    This morning, the Subcommittee meets to begin a review of 
the nation's capital marketplace structure and it is the first 
in what, I think, will be a series to examine the many complex 
challenges facing today's marketplace. From ensuring proper 
regulation for the protection of investors to facilitating 
enhanced competition, we must maximize opportunities and 
preclude misinformation and potential losses.
    We must also think forward, beyond merely the next quarter 
of business performance, but what our capital markets should 
really look like within the decade to remain competitive and 
the dominant force in the international marketplace.
    The focus of today's hearing will be on the corporate 
governance question relating to the New York Stock Exchange and 
the appropriate role of the proposed reforms. Is the SRO model 
one, as some suggest, too troubled to succeed?
    I am sure each of our witnesses today will provide valuable 
insight into this question, and I am anxious to learn of their 
perspectives. It is my judgment, however, that the lessons of 
the Sarbanes-Oxley Reform should not be overlooked.
    The committee looked at the issue of audit team 
independence, and for the first time statutorily required the 
audit team to report to the Audit Committee to establish, not 
Chinese, but firm concrete high walls between CEO/CFO conduct 
and the audit function to ensure that the financial statement 
is an accurate reflection of corporate value for the 
shareholder's assessment.
    This model, I think, establishes a valuable point: that 
those charged with regulatory or compliance functions within 
the Exchange should not directly report to the CEO of the for-
profit enterprise. How this can be achieved is left to those 
within the market to best determine, but I think assurances of 
the separation are essential.
    Of recent note, the NYSE has been criticized for failing to 
recognize conflicts of interest and potential abuses in IPO 
allocation practices. Criticism has been levied at the Exchange 
for not enacting all essential corporate governance reforms. 
This criticism has increased in volume following the 
announcements of Mr. Grasso's compensation.
    Mr. John Reed, who will testify later this morning, has 
been installed as the interim Chairman and would quickly note, 
in contrast to his predecessor, Mr. Reed has agreed to a single 
dollar of compensation for his tenure, which began earlier this 
month. And that he has begun implementing changes that will 
enhance the regulatory efficiency of the Exchange.
    This committee will certainly look forward to Mr. Reed's 
leadership and do all that is necessary to facilitate that 
those stakeholders in the New York Stock Exchange understand 
appropriate governance and, more importantly, that those who 
extend their valuable dollars by investing in America's capital 
markets can be assured that it is not only a transparent 
functioning marketplace, but it is one that engages in fair and 
ethical practice that should instill confidence in the 
performance of our capital markets.
    To restate, our capital markets function in the most 
efficient and helpful manner of any in the world, and no other 
market, other than the New York Stock Exchange, can be cited 
for its dynamic contributions over the history of economic 
growth of our country.
    But change is on the horizon. And, not only should we 
concern ourselves with ethical and appropriate conduct, but we 
must assess the impact of technological changes in the broader 
marketplace and facilitate that trades occur in the most 
appropriate fashion at the best price for those who invest.
    The investing landscape has changed. Now, over 50 percent 
of our households in America, through the workplace or through 
direct investment, are participants directly in our capital 
markets function. And, accordingly, the Congress has 
appropriately enhanced its sensitivity to these issues because 
it literally affects every congressional district and, 
potentially, the economic fabric of this country.
    For these reasons, the committee has turned its attention 
to this important matter and we look forward to the insights of 
those who will appear here today.
    Mr. Kanjorski?
    Mr. Kanjorski. Thank you, Mr. Chairman.
    We meet today to review, generally, the structure of our 
nation's capital markets and examine specifically corporate 
governance issues of the New York Stock Exchange.
    In recent years, a variety of securities industry 
participants have questioned one or more aspects of the 
regulatory structure of our capital markets. Recent events at 
the New York Stock Exchange have also brought to light some of 
the potential conflicts that exist in a self-regulatory model. 
I, therefore, congratulate you for convening this well-timed 
hearing.
    Debate on market structure focuses on such important issues 
as competition, the definition of an exchange, access to market 
data, information transparency and technological advances. Each 
of these issues have evolved considerably in recent years. As a 
result, we have come to a crossroads facing a number of 
decisions that could fundamentally alter the structure of our 
capital markets for many years to come.
    As my colleagues well know, I have made investor protection 
one of my top priorities for my work on this Committee. I, 
consequently, share your concerns, Mr. Chairman, that our 
committee must conduct vigorous oversight to examine whether 
the regulatory system for the securities industry is working as 
intended and to determine how we could make it stronger.
    In addition, I continue, by and large, to favor industry 
resolving its own problems through the use of self-regulation. 
Since the enactment of our Federal Securities Laws, U.S. Stock 
Exchanges have served both the marketplaces for securities 
trading and as regulators of their member companies. For the 
last 70 years, this system has worked remarkably well and 
balanced in protecting the integrity of our markets.
    In order for self-regulation to endure, however, the system 
must maintain the confidence of investors. We developed the 
self-regulatory model under the stewardship of William O. 
Douglas, who, before he became a Supreme Court justice, 
determined that it was impractical, unwise and unworkable for 
the Federal government to try to regulate our decentralized 
securities markets directly.
    In order for self-regulation to work, he also determined 
that the Securities and Exchange Commission needed to keep a 
shotgun, so to speak, behind the door loaded, well-oiled, 
cleaned, ready for use but with the hope it would never have to 
be used.
    Despite my strong support for self-regulation, recent 
events at the New York Stock Exchange have revealed some of the 
conflicts that exist in self-regulatory models and the need for 
effective Federal oversight.
    I, consequently, look forward to hearing from the interim 
head of the New York Stock Exchange about his recommendations 
for eliminating and abating these conflicts within his 
organization. In particular, I want to learn his thoughts as to 
how we should best separate the Exchange's regulatory and 
commercial functions.
    Additionally, I look forward to hearing from our 
distinguished witnesses on the second panel, which includes 
representatives from some of the regional exchanges, noted 
securities industry experts, and other market participants.
    Their observations will help us to understand how the New 
York Stock Exchange might restructure its internal governance 
system. They will also help us to understand more about how 
important market structure subjects.
    As we begin this series of hearings on market structure 
issues in the 108th Congress, I must caution my colleagues on 
both sides of the aisle to move carefully and diligently in 
these matters.
    In testimony before the Senate yesterday, SEC Chairman 
Donaldson indicated that the Commission would be focusing with 
increased intensity on the structure of our equities markets in 
the upcoming months. It is my hope that the Commission will 
move expeditiously in these deliberations.
    It is also my hope that our securities market participants 
and their Federal regulator will resolve these issues without 
unnecessary congressional interference.
    In closing, I want to assure each of our witnesses that I 
approach the market structure debate with an open mind. Their 
comments about these matters will help me to discern how we can 
maintain the efficiency, effectiveness and competitiveness of 
our nation's capital markets in the future.
    I also look forward to continue to work closely with you, 
Mr. Chairman, and with others as we address these multi-
faceted, complicated and important matters so that we can 
conduct effective oversight over our capital markets and ensure 
that we maintain an appropriate and sufficiently strong 
supervisory system for them.
    [The prepared statement of Hon. Paul E. Kanjorski can be 
found on page 79 in the appendix.]
    Chairman Baker. I thank the gentleman for his statement and 
look forward to working with him as well.
    Chairman Oxley?
    Mr. Oxley. Thank you, Mr. Chairman, and thank you for 
holding this timely hearing and your leadership on investor 
protection issues.
    The New York Stock Exchange is an important symbol of 
capitalism here and throughout the world. It has a rich and 
storied history and has served investors well for over 200 
years.
    The past year, though, has been a difficult one for the 
Exchange. Highly publicized controversies have tarnished the 
image of the New York Stock Exchange and have led many to call 
for changes to the corporate governance of the Exchange, its 
role as a self-regulator, and also to its defining 
characteristic: the auction market system.
    And these calls for reform have heightened the urgency of a 
thorough review and modernization of the regulatory and 
operational structure of our capital markets. As electronic 
trading and the growth in investor participation in the 
securities markets have transformed those markets, problems 
have arisen that were never envisioned when many of the 
significant rules affecting market structure were put into 
place.
    Indeed, the notion of a securities market as its own 
regulator is now in question. Several years ago, in response to 
a scandal on the over-the-counter market, the governance of the 
NASDAQ market was reformed considerably leading to a separation 
of its regulator from the market. Today, some are calling for a 
similar change to regulation of all exchanges.
    The corporate governance of exchanges is now receiving the 
kind of close scrutiny that corporate America underwent leading 
up to, and since the passage of, Sarbanes-Oxley. It is vitally 
important to investor confidence that the management of the 
Exchanges that are at the heart of our capital markets be held 
to the highest possible standards of integrity and 
transparency.
    Increasingly, institutional investors are calling for 
reforms of the New York Stock Exchange specialist system. Some 
view the specialist as an unnecessary middleman who impedes the 
efficiency of the marketplace. Even if the New York Stock 
Exchange is correct about its ability to achieve price 
improvement, large investors say they place a higher value on 
speed of execution and anonymity.
    If we wanted to build a stock market from scratch, would it 
be run by humans or computers? Why does the New York Stock 
Exchange control 80 percent of the trading volume of its listed 
companies when NASDAQ controls only about 20 percent of the 
volume of its member companies? Have current rules and 
regulations contributed to these results? How does the current 
structure benefit or harm investors?
    These are important questions, and, fortunately, we will 
hear from an esteemed group of witnesses this morning that can 
provide answers. And, the first one, of course, Mr. John Reed, 
who has come out of a well-deserved retirement to accept this 
challenging position and is off to an impressive start.
    We are pleased to have you here, Mr. Reed, and we look 
forward to your testimony, and I please yield back.
    [The prepared statement of Hon. Michael G. Oxley can be 
found on page 72 in the appendix.]
    Chairman Baker. I thank the Chairman.
    Ranking Member Frank?
    Mr. Frank. Thank you, Mr. Chairman.
    I appreciate Mr. Reed's being here, and I appreciate even 
more Mr. Reed's being where he is in New York because it would 
seem, to the naked eye, to be a degree of aggravation which he 
did not need. And I am very appreciative of his stepping up 
here.
    It is a very great service to have someone who is literally 
disinterested, not bored, but in the literal sense of 
disinterested, someone who has no axe to grind, no interest 
other than trying to improve a very important institution.
    Now, I will not be making any great number of substantive 
comments here because I will confess that the governance of the 
New York Stock Exchange is not one of the subjects which has, 
heretofore, fascinated me. It was not within the jurisdiction 
of this Committee for most of my service on the committee, and 
we tend to be in a situation where, if things have not reached 
a crisis stage, we often aren't able to get there.
    I now understand that we have some serious questions to be 
resolved. The question of a conflict between regulation and 
promotion, the question of--we are all for self-regulatory 
organizations--but the question is whether we have, in this 
instance, allowed self-regulation to be carried too far. And I 
appreciate Mr. Reed's willingness to address this.
    I understand that the compensation issue, of course, called 
our attention to it, but that, as I look at it, does not seem 
to be at the core of what we need to do here. We need to talk 
about what is the appropriate governance for a very important 
part of the American economic system.
    So, I think this hearing is an entirely appropriate one. I 
look forward to learning from it. I won't be able to stay for 
the whole hearing, but when we have a Congress that meets a day 
and a half a week, it tends to clutter up your day with other 
things to do. I regret that, but I have no control over it yet.
    But I will be taking the testimony with me, and I 
appreciate the chance for Mr. Reed to come and share with us 
his thinking.
    And I can say, finally, I am also struck by the way in 
which Mr. Reed has approached these issues, Mr. Chairman, 
namely, that he is prepared to listen, that he has outlined 
what the questions are, and I have hopes that we will come out 
of this with a very useful set of decisions.
    Thank you.
    Chairman Baker. Thank the gentleman.
    Mr. Bachus, you had an opening statement?
    Mr. Bachus. Thank you, Mr. Chairman.
    Mr. Chairman, and Chairman Reed, I have read your testimony 
today, and I appreciate your testimony.
    I do want to say that I think the issue that we are not 
discussing today, which is far more important, is the way that 
stocks are traded on the New York Stock Exchange. The fact that 
specialists are member firms which have an exclusive right to 
trade in each of the New York Stock Exchange listed stocks, and 
if a broker wants to trade in that stock he has to go to that 
specialist, and that specialist alone has the right to execute 
that sale or buy that stock.
    And what, to me, is amazing about what I see as a monopoly 
is that the specialists make the bulk of their money by buying 
and selling stock for their own account. And, to me, that seems 
like a monopoly situation in which the specialist, who has 
monopoly, has an inherent right to make a lot of money at 
others' expenses.
    And I would hope that, as we go forward, we discuss this, 
the fact that this appears to be a monopoly at the expense of 
the public and that these specialists, the bulk of their money 
is buying and selling stock for their own account.
    So, I appreciate your attendance here.
    Chairman Baker. Does the gentleman yield back?
    Mr. Bachus. Yes.
    Chairman Baker. The gentleman yields back his time.
    Mr. Israel, did you have an opening statement?
    Mr. Israel. Thank you, Mr. Chairman. I will just be very 
brief.
    Mr. Reed, I represent a district in New York that is about 
40 miles away from the Stock Exchange. And I want to welcome 
you and thank you for the important undertaking that you are 
engaged in and look forward to continuing to work with you for 
the betterment of the Stock Exchange, for investors and for all 
of our financial institutions.
    And I yield back, Mr. Chairman.
    Chairman Baker. Thank the gentleman.
    Mr. Royce, did you have a statement?
    Mr. Royce. I do, Mr. Chairman.
    I want to thank you for holding this hearing on recent 
developments of the New York Stock Exchange. I also want to 
thank Mr. Reed, and I think you are to be commended for your 
current role at a particularly difficult time for the New York 
Stock Exchange.
    And I have had the opportunity to review your prepared 
remarks today and I was very pleased to see that you are 
addressing a number of corporate governance issues, Mr. Reed, 
that are before the Exchange. I think the New York Stock 
Exchange Board is too large; it needs reform. I think the 
Exchange also needs to alter the make-up of those that serve on 
the board.
    It seems odd to me that regulatees are represented on the 
board and have a say in the compensation of the regulator. It 
would be as if bank CEOs decided the compensation of the 
comptroller of the currency.
    I believe the New York Stock Exchange's largest 
constituencies should be represented on the board. As a holder 
of some $6.7 trillion of assets, the mutual fund industry 
should have at least one board seat, it would seem to me.
    And the New York Stock Exchange should consider separating 
the dual roles of its CEO. There are clearly times when the 
role of regulator conflicts with the role of business leader.
    Finally, it is my view that the Exchange should not limit 
itself to examining corporate governance issues. I have felt, 
for some time, that the New York Stock Exchange needs to do a 
better job of explaining the benefits of the specialist system 
to the marketplace. I was very troubled to learn of this 
morning's news that five separate firms had engaged in improper 
trading activity.
    Mr. Chairman, I want to thank you, again, for your 
leadership on this issue and thank you for this timely hearing. 
And I look forward to the other testimony of the other 
panelists that are here today.
    I yield back.
    [The prepared statement of Hon. Edward R. Royce can be 
found on page 82 in the appendix.]
    Chairman Baker. I thank the gentleman for his statement.
    If there are no other members desiring to give an opening 
statement, at this time I would like to welcome Mr. John Reed, 
Interim Chairman and Chief Executive Officer of the New York 
Stock Exchange.
    Mr. Reed, as you can tell from the members' expectations, 
your reputation precedes you in a very advantageous way. I 
think we are all very excited to have you here to receive your 
comments, and we look forward to working with you, sir.
    Please proceed at your leisure. We will make your official 
statement part of the record.

 STATEMENT OF JOHN REED, INTERIM CHAIRMAN AND CHIEF EXECUTIVE 
             OFFICER, NEW YORK STOCK EXCHANGE, INC.

    Mr. Reed. Chairman Baker, thank you very much.
    If I could also say, Ranking Member Kanjorski and Chairman 
Oxley and Ranking Member Frank, I greatly appreciate the 
comments and the welcome that you have extended. And to all of 
the members of the Subcommittee, I am delighted to be here.
    I appreciate that you invited me, and I hope that I can, at 
least, share with you what it is that we are doing.
    I did, in fact, submit a written statement, and I 
appreciate that it will become part of the record, but what I 
will do is just summarize, very quickly, what it is that I am 
trying to do, where we stand. And I will touch on some of the 
issues that have been raised.
    The New York Stock Exchange, as everybody has said, is an 
extremely important institution, not only in terms of its 
function and role within the capital markets, but, indeed, I 
think it is a symbol of much that is important to this country 
in terms of its market system in general. And it is a symbol, 
not only within the United States, but, I believe, globally.
    And, so when I was asked if I would step in during a period 
of difficulty, I did so because I do recognize the importance 
of the Stock Exchange, and I felt that it was extremely 
important that we restore the credibility that the investing 
public, the American public and, in fact, the world at large, 
wants to have in this institution.
    And my job, in fact, is to try to see if we can restore 
that credibility as quickly as possible. My job is pretty 
clear: I have three things to do.
    The first is I must understand what happened recently at 
the board that caused it to arrive at its current situation. I 
do this, not because I have any interest in pointing fingers or 
anything else, but because, obviously, you must understand what 
happened if you are going to try to correct for the failures 
that we clearly suffered.
    The second thing I have to do is draft a proposal for a new 
governance structure, processes at the board level. And, 
indeed, architecture at the board and managerial level that not 
only prevents a reoccurrence of the kind of problems that we 
have had but, more importantly, would be appropriate to serve 
the interests of the Stock Exchange and the investing public in 
the years ahead, because as many members of this Committee have 
said, clearly we are at a period of change and a period of 
transition.
    And it is extremely important that the board and the senior 
management structure of the Stock Exchange be appropriate to 
deal with the many issues that are coming down the pike. And, 
so, when I am looking at this architecture, I am doing so, not 
only from the point of view of trying to correct for whatever 
mistakes we did make, but, indeed, to try to make sure that the 
Stock Exchange has in place the kind of corporate governance 
and structure that can serve it going forward.
    The third thing I have to do is find a permanent leader for 
the Stock Exchange. As much as I may be able to help in the 
short term, having interim leadership is not in the interests 
of the Exchange nor the markets. You need a permanent leader 
who is there and can be expected to be there for a period of 
time.
    Whether we should end up with a Chairman separate from the 
CEO or a single person, I think, depends very much on the 
structure that we embrace. We first must have a structure then 
fill the slots, and the success of the structure depends, on 
the people. I think either structure could work. There are 
clearly benefits for having a separation.
    There are advantages sometimes to having it together, but I 
think that we should allow for either and when the new 
governance structure is in place, we will then be in a position 
to deal with that issue. I am hopeful that we will be able to 
go to the members of the Exchange with a proposal for a new 
structure by the end of this month; that means in the next 10 
days, approximately.
    As you know, the bylaws of the constitution of the Exchange 
require that the members vote for any changes to that 
structure. Of course, the Securities and Exchange Commission 
must approve such changes as well. The SEC takes the position, 
I think correctly, that any change to the constitution is a 
change of rules which they also have to approve.
    And so, there is a process here that involves first making 
recommendations, then getting a vote from the membership and 
approval from the Securities and Exchange Commission. I am 
hopeful, as I said before, that by the end of this month I will 
have that proposal in the public domain for discussion with the 
members.
    I would be hopeful because the bylaws require that we give 
the members between 10 and 50 days to make any change; I am 
planning on approximately two weeks. I am hopeful that we could 
have a vote by the membership that would take place by the 
middle of the month of November, and that would allow us to 
have a new structure in place, a new board in place that would 
then permit us to go on with my final task, which would be the 
selection of a permanent Chairman and CEO or Chairman/CEO.
    So this is my timetable. I have had nothing but cooperation 
from everybody surrounding the Exchange and, in the Exchange, 
we all feel that this task is extremely important. There is no 
question that our historic governance structure did not serve 
us well, and clearly the flaws that Mr. Frank made reference to 
happened to take the form of compensation, but there were 
fundamental flaws in the structure as it existed.
    It is not my task to make decisions about the long-term 
architecture of markets. This deserves, frankly, the attention 
of a permanent management and a new board. It is, 
intellectually, extremely interesting. It is not something that 
I would shy away from working on, but it is not the task of an 
interim Chairman to make important decisions with regard to 
architecture. But, indeed, I think we need a permanent 
management to get into this.
    And, frankly, as this Committee and others in the Congress, 
I am sure will ensure, whatever is done has to be done within a 
broader public debate that focuses, not on the role of the 
Exchange and the role and advantages and disadvantages of a 
given intermediary, but on what is good for the investing 
public, and, frankly, what is good for the issuers: those 
companies that come to these markets to raise the capital to 
strengthen their own business, and so forth.
    I am sure that the public debate will focus on how these 
markets can best serve those who issue securities and those who 
might wish to buy securities. And the role of exchanges and the 
role of intermediaries are important but, I think, the well-
being of the economy rests with the investors and with the 
issuers, and the mechanisms in between should serve their 
interests.
    I do think that we should all take pride that the capital 
markets in the United States stand alone in terms of their 
competence and their efficiency and their effectiveness. So 
while there is reason to anticipate change going forward--and I 
certainly would welcome this change--there is no reason to look 
backwards and feel anything but pride, because I think the 
capital markets in their aggregate have served the country and 
the investors, as well as the issuers, extremely well.
    I will make a few comments with regard to some of the items 
that have been mentioned. They are, obviously, comments of 
somebody who is new to this business. But, with regard to 
regulation, I have had, in fact, in my business career, a fair 
amount of exposure to regulation, and I think I do have some 
understanding of it.
    There is no reason to doubt that the current structure of 
self-regulation that exists can be made to work. We, in the New 
York Stock Exchange, are good regulators. We are not perfect 
regulators, there are things that will need to be corrected and 
it is a continual improvement kind of thing, but we are quite 
good at it.
    And there is no reason to believe that there needs to be a 
change to correct that. It is true that the governance 
structure is probably unacceptable as a supervisory structure 
for a regulatory function, and it is my intention, in the 
proposals that we will be making public in the next couple 
weeks, that we would correct that.
    In other words, I intend to propose a governance structure 
that would clearly get rid of the conflicts that exist and, I 
think, were pointed out by one of the Members of having people 
who are regulated also sitting on the board that oversees the 
regulatory function itself. I would hope to have a board that 
is, essentially, independent and can pursue its activities 
without any conflicts whatsoever.
    But I do not think there is any reason to believe that you 
need change the regulatory structure because of its ability to 
operate. I think it can operate well in its current 
configuration, and the need is to correct the supervisory, or 
the governance structure that sits on top of it, and my 
proposal is intended to, in fact, do that.
    There may be other reasons to look at regulation, but it 
shouldn't be because it cannot be made to be effective. I think 
it can.
    All indications are that the auction market serves 
investors well. It, too, can be improved. I am sure it will be 
improved, and the desire of large fund managers for more 
automation can, undoubtedly, be accommodated. I think it is 
important that we distinguish between accessing pools of 
liquidity and providing pools of liquidity.
    Automation will improve access, it won't improve the 
providing of liquidity to the markets. The auction system is 
intended to provide liquidity to the markets and that is an 
important function, but trade-offs can shift. Somebody said in 
their prepared comments that there are people who would trade 
price for speed. Those trade-offs can shift as people's 
interests shift.
    But the role of the auction market, every time it has been 
studied, has always been seen to have positive benefits for 
both investors and issuers. That doesn't mean that there is any 
reason to stop any further changes; I think changes should be 
looked at from the point of view of what is good for the 
overall functioning of the markets. And the New York Stock 
Exchange has, historically, embraced change, and there is no 
reason to believe that we will not do so going forward.
    The role of the Exchange in promulgating standards for 
corporate governance of listed companies is important. 
Obviously, we are not in any position to promulgate standards 
if our own behavior doesn't pass those standards themselves.
    So, obviously, one of my objectives in my proposals will be 
to make sure that our corporate governance is at least as good 
as anything that one might expect to be demanded of listed 
companies.
    But the role of the Exchange in promulgating standards, 
while being in contact with the leadership of listed companies 
to make sure that those standards result in the improvement of 
governance but not in bureaucracies, I think is extremely 
important, and it is a role that the Exchange welcomes. And, I 
think, it will help the Exchange in its overall functioning.
    I believe very strongly that the strength of this company 
is in its private sector. I think the recent weaknesses that we 
have seen, not only in the New York Stock Exchange, but within 
the business community, point to the need for better boards and 
better governance. Obviously, the Congress has come to this 
opinion as well, because you have passed legislation that 
emphasizes that.
    But I would simply say that the Exchange welcomes its role 
in that and I think that it is important that we improve the 
functioning of boards and corporate governance, not only in the 
New York Stock Exchange, but throughout our private sector 
economy.
    So, I thank you, Mr. Chairman, for the opportunity to 
testify, and I welcome the opportunity to answer any questions 
that anybody might have.
    [The prepared statement of John Reed can be found on page 
192 in the appendix.]
    Chairman Baker. Thank you very much, Mr. Reed, for your 
appearance and your testimony.
    I, for one, am not yet ready to say the SRO model is 
fatally flawed and we need to go to the NASD, NASDAQ or some 
other model that has successfully operated. But I do believe 
the responsibility in this interim period is a very significant 
responsibility to demonstrate that the regulatory and/or 
compliance functions be clearly separate and above question as 
to their relationship to the CEO of the for-profit entity.
    To that end, I think the Sarbanes-Oxley legislation is very 
instructive in that the importance of that audit function be 
maintained as in independent, beyond reach, activity from the 
corporate leadership side.
    In looking at what post-Gramm-Leach-Bliley, post-Sarbanes-
Oxley and what the Exchange has done--and I will note, again, 
prior to your arrival in facilitating certain ethical changes 
in conduct, for example, investment banking analyst 
relationships--it is clear to me that the Exchange has demanded 
of its listed companies conduct which, at the same time, is not 
applicable to itself. I find that troubling.
    Not that all those rules are applicable or appropriate for 
the Exchange's operations but, in spirit and context, if we 
don't move away from the SRO model, we must establish a very 
clear high bar over which the Exchange must pass in order to, I 
think, obtain investor confidence that is so essential for all 
of us.
    And, sort of the last piece of this--because under our 
business we get five minutes and then you can talk for as long 
as you like--I am very impressed by your aggressive outline of 
the schedule.
    And it would also lead me to the observation that in that 
same time period, during which you are pursuing such 
extraordinary changes, how do we feel comfortable that a 
selection process for your successor can concurrently be 
engaged? And how would you suggest that that selection process 
be obtained?
    Mr. Reed. Mr. Chairman, if I could respond to a few of 
these, I share this feeling that there is no way that the New 
York Stock Exchange could ask that listed companies have 
standards of governance which we ourselves don't meet.
    I fully expect that we will embrace a set of standards that 
go perhaps even beyond that which we are expecting of listed 
companies. And I share your sense of wonder that it took a 
problem of this sort to cause us to get there. Clearly that had 
to be done.
    I think it is imperative to us that we have governance of 
our regulatory functions that is visibly good, solid, without 
conflict and without problem with regard to our role as an 
exchange and as a regulator of both participants in the 
Exchange and the activity of the exchange itself.
    I would point out that governance and regulatory structures 
like this abound. Most banks have internal controls for both 
audit and risk taking, and the national banking examiners and 
the Federal banking examiners from the Federal Reserve System, 
sit on top of that and make sure that those systems do, in 
fact, work and work adequately.
    And it is true that the SEC does sit on top of our own 
self-regulatory function and I must say, they do so quite 
effectively. And so, while we are self-regulated, we are self-
regulated within a construct that does have checks and balances 
which, I think, are needed, and I do think they serve the 
investor public. But to your point, I will be proposing a 
governance structure for the Exchange that speaks directly to 
that issue and I believe would satisfy your concerns and those 
of the general public.
    The final issue is, of course, important. We had a board 
meeting two days after I took this job, or three, and we are 
not scheduled to have another board meeting until December. And 
so, just to expedite things, I asked that the existing search 
group that had been put in place by the board would be 
reactivated so we could begin to look at potential candidates 
to fill my job on a permanent basis.
    I don't, frankly, believe we want to get into it very 
seriously until we have revised the corporate governance 
because it is a little hard to figure out what kind of person 
you want if you don't know what the structure of the 
institution is going to be. But I didn't also want to wait 
until December to start, which would have been my next 
opportunity to have a meeting.
    What I am actually planning to do, I am hopeful, I can't 
guarantee this because it is difficult to do, but I am hopeful 
that when I go to the members for a vote to change corporate 
governance, I will also go to them with a slate of potential 
board members, which will be an essentially new board for the 
Exchange.
    Assuming that I am able to do that, the problem, of course, 
as you might appreciate, is that it is not easy to get people 
to be willing to stand in a public election of quite that sort. 
But I am hopeful that I will, in fact, be able to have a 
proposed board of directors slate for the members to vote on at 
the same time that they vote for the various changes.
    I would then propose to go to that board, which will be a 
newly-constituted board and a board that has had the expression 
of support from the membership, and use them as the body to 
make the decision about my replacement. Because I think they 
would, by virtue of the election and by virtue of the new 
governance proposals, be seen by everybody to be a legitimate 
body to make that selection, as opposed to the situation we 
have today, where I have to rely on the old board.
    And so that was my answer to your final question, Mr. 
Chairman.
    Chairman Baker. Thank you, sir.
    Just by way of clarification, it is my understanding that 
Mr. Grasso's compensation issue, which started all of this, he 
forewent in excess of $40 million, but he is legally entitled 
to and will receive, as far as I understand, $140 million 
package, which was the subject of controversy, or is that not 
the case?
    And secondly, in your new construct for the committee that 
would do the selection process for the follow-on CEO, would 
they also have similar authorities with regard to compensation? 
And would that disclosure be made public?
    Mr. Reed. Yes. The answer with regard to your second 
question is, ``Yes.'' With regard to Mr. Grasso's compensation, 
as I said, the first thing I am doing is to try to find out 
what happened. The facts are: Mr. Grasso did receive a check 
and cashed it for $139.5 million prior to my election. The 
first question I asked was, ``Has the money, in fact, been paid 
out?'' The answer is yes.
    He has, under the contract that I guess was approved at the 
board meeting, other claims on the Exchange. I have taken the 
position that I don't want to deal with those until I feel 
comfortable that I know how all this transpired, because I have 
to feel that I am on solid ground as to what transpired and 
what is the nature of his claims to us.
    And I just felt that it wasn't prudent for me to speak to 
Mr. Grasso, whom I have never met, nor ever spoken with, until 
such a time that I was on, sort of, solid ground. I would 
expect to be there by early November. Subsequent to that time, 
when I have a firmer understanding of what happened and the 
basis on which decisions were made, I then would expect to call 
Mr. Grasso. Hopefully he will be able to sit down and resolve 
any continuing claims or any problems that I might have with 
regard to what he has already received.
    Chairman Baker. Thank you, gentleman. I am way over my 
time.
    Mr. Kanjorski?
    Mr. Kanjorski. Thank you, Mr. Chairman.
    Mr. Reed, it is interesting that we come at a time when a 
conflict of interest internally on payment should have been 
made, but it seems that you may have some ability to look out 
over so many areas of our society that tests the same question: 
conflict of interest, greed, misstatement, lack of 
transparency, lack of accountability.
    And when I listened to your testimony I just thought of so 
many of the institutions across the board, whether it is the 
church, whether it is political institutions, whether it is the 
New York Stock Exchange, or some companies: Enron, WorldCom, we 
go on and on.
    It seems to me that it has always been our proposition that 
we presume an honest, participating society and whatever 
institutions they are in. Do you see any reason why we should 
start questioning that basic presumption? And that we have to 
develop processes and methodologies that anticipate that where 
opportunity of conflicts could be taken advantage of, they will 
be?
    And as a result, are we required now to go to some 
cellophane society to see what the product is before we buy it?
    Mr. Reed. If I could say, I think that the great majority 
of practitioners in all of these institutions, be it the 
church, be it private sector, be it government, are honest, 
hard-working people that we have every reason to believe will 
do the right thing, serve the right interest and so forth.
    I do think we have all learned over the years that 
transparency is valuable. We embodied it in the Constitution of 
the United States in the form of free press and so forth, and I 
think most of us have felt that having a society in which you 
have a free press has been an appropriate thing.
    And I think transparency with regard to corporate 
governance and how decisions are made and who is making them 
and whether or not there is the potential for conflict; these 
transparencies which have been enacted, I think, are 
appropriate. And checks and balances work.
    I think it is true that what we have seen recently was 
written about by the Greeks thousands of years ago; power does 
corrupt, greed is alive and well. But I repeat, I think our 
system works extremely well and the people who are not in the 
headlines, the companies that have had no problems far 
outnumber the ones that are in the headlines and that have had 
problems.
    But I think that it is appropriate that we have checks and 
balances; we have a board of directors that sits on top of the 
operating management of companies, with clear responsibilities. 
And I think transparency with regard to compensation, 
transparency with regard to accounting standards and 
performance, and so forth, is an appropriate safeguard.
    So, while I am fundamentally an optimist and fundamentally 
believe that most people in this world are pretty good and work 
pretty hard and do pretty well, I do support the idea that we 
need checks and balances and that transparency is useful.
    Had we, in the Stock Exchange, for example, had the same 
transparency with regard to compensation, I think some of the 
issues with regard to Mr. Grasso's pay would have come up years 
earlier when the first large compensation decisions were made, 
which, at that time, were not disclosed and therefore were not 
subject to any kind of conversation or reaction.
    Mr. Kanjorski. I think I will just consume my time, Mr. 
Chairman. I yield back.
    Chairman Baker. Thank the gentleman.
    Chairman Oxley?
    Mr. Oxley. Thank you, Mr. Chairman.
    And again, Mr. Reed, it is comforting to know that you are 
at the helm and I know that, based on your testimony and your 
answer to the questions, that you are setting up a governing 
structure, changing the board, doing some of the architectural 
things that are absolutely necessary and it is good to know 
that you are working yourself out of a job. And based on your 
compensation, I can understand why you would want to do that.
    But it is also true that, I think, the members of the 
committee would agree that you understand what your position is 
as an interim leader at the big board and are making the 
changes necessary. But the long-term market structure 
implications, obviously, will be after your departure, which, I 
think, is entirely understandable and laudatory in my 
estimation.
    It gives you a certain amount of leeway and autonomy to 
deal with some of those difficult issues that we struggle with, 
frankly, when we passed the legislation dealing with corporate 
governance, and your response has been extraordinary.
    Let me first begin on the SRO question, and I know that you 
have expressed a strong support for the idea of having an SRO. 
It has been my belief all along that without an SRO the SEC 
really is in a position where they are almost certainly 
overwhelmed in the real world trying to deal with regulatory 
matters.
    And for a long time, the concept of a self-regulatory 
organization working hand in glove with the SEC has been a 
pretty effective model, in my estimation. Do you agree with 
that?
    Mr. Reed. Yes, Mr. Chairman, I definitely do. And I think 
that the facts would suggest that that is true. In other words, 
we are not here discussing a regulatory failure.
    Mr. Oxley. Exactly. And I would think, when we have 
Chairman Donaldson here, I think next week, or soon anyway, I 
would ask him the same question. I think, perhaps, we would get 
the same answer, particularly given the fact that he once sat 
where you do. And that does make a difference, I think, in 
where we are headed.
    Obviously you can make some changes and nothing is perfect, 
but at the end of the day, without an effective SRO, it really 
does burden the SEC rather dramatically and diffuses their 
ability to deal with the real big issues.
    On the auction system and specialists--this goes back to 
when I chaired a Subcommittee that had jurisdiction over 
securities and exchanges--and we had always, I think, most of 
the members of the committee, at that time, and we were told 
and learned that the special system and the auction system was 
to provide liquidity; that specialists were there to make a 
market.
    And to some extent, well it was before the advent of the 
ECNs, the changes in technology, the demands for more speed. To 
what extent has the creation and the birth of these ECNs, and 
even with the ability of the New York Stock Exchange to make--I 
think one of the great untold stories is the fact that the New 
York Stock Exchange, during this time--made significant 
improvements on their electronic capabilities?
    And the last time I was at the Exchange I was, frankly, 
amazed at how successful that the Exchange had been in adapting 
to the new world. Does it appear to you that the Exchange needs 
to continue to move in that direction? And what is the future 
of the auction market as you see it?
    Mr. Reed. Well, Mr. Chairman, my impression is: number one, 
that the auction market has served us well. Every time we take 
a look and study it, it turns out that the process of searching 
for an appropriate price is greatly facilitated by the fact 
that you do have a specialist who is part of that system. And 
to the question that was asked before about the role of the 
specialists, it is true that specialists intervene in 
transactions, but there are distinct rules as to how they can 
intervene so as to ensure that they are not just snipping 
little profits. And indeed, the report in this morning's 
newspaper about some disciplinary and disgorgement actions that 
are underway, are because specialists did misbehave and broke 
the rules and they will be forced to disgorge those profits.
    But the system works well. Every time we look at it, the 
benefit of having an auction system seems to rest on solid 
ground. But as you say, Mr. Chairman, I have been shocked 
myself. I, obviously now, have spent some time on the floor, 
and having been away for a while, the degree to which there is 
automation on the floor is amazing.
    Clearly the New York Stock Exchange is making use of the 
latest computer technology, a tremendous number of transactions 
never have to get to a specialist. If you have two people 
wanting to buy and sell a commodity at the same price, the 
computer can do that rather well.
    The problem is when the prices at which somebody wants to 
buy and sell are not the same, and then the question is, ``How 
do you move them toward a common price?'' And that is where the 
auction system is thought by those who look at it to provide 
better results.
    I think the challenge here--and by the way, the investors 
have changed in their desires, there was a time when price was 
everything. Some of the large mutual funds, and others, put a 
premium on time as opposed to price, and so maybe there is 
reason to look at this again.
    But, I think--to answer your question--the position of the 
Stock Exchange is that we should continually want to modernize. 
If there ever were to come a time when the specialist system 
didn't serve us well, we would have to acknowledge that. At 
this point, we don't believe we are there. And we think 
examination would support our position, but I am sure an 
examination will take place.
    The one thing that I would urge us to all do, is focus on 
the investor. I don't think we are trying to move profits from 
one intermediary to another. We are trying to ensure the 
investor's interests are served. Are the issuer's interests 
served? Can you go list on a market, get people to buy your 
stock reasonably? If you want to buy stock, can you go to the 
market and find things in a reasonable way to buy?
    Everything I have seen, says, number one, the current 
system works pretty well. It has been substantially automated 
and it is not the position of the New York Stock Exchange that 
we are just trying to defend history and we are unwilling to 
make modifications and changes; quite to the contrary.
    And I must say, Mr. Chairman, in my own thinking, with 
regard to the kind of board and management that I would hope we 
will be able to put in place over this next five-or six-week 
period, I am looking for the kind of board that would be 
knowledgeable and be willing to accept change and the kind of 
management that would be willing to engage deeply with the 
investing community, including the State treasurers and the 
large mutual funds and all of what we refer to as the ``buy 
side'' of the market, as well as the traditional broker dealers 
and the ``sell side.''
    So when I am looking at the kind of governance structure, 
the kind of board and the kind of management that we want to 
have, I am looking at it from the point of view of people who 
are going to have to intermediate these different desires that 
exist and have to deal with them. I am not looking for the kind 
of board, or the kind of governance structure, that could 
simply ``tough it out'' as the saying goes.
    I don't think that would serve the American public and I 
don't think that it would serve the members of the Exchange. 
And so, my view is we have done a very good job to date.
    We have certainly embraced automation; There is always room 
for improvement and clearly, this is the time when there are 
many people asking for change and we have to accept that and 
deal with it. But we should deal with it from the point of view 
of what serves the American public, as opposed to what serves a 
special interest.
    Mr. Oxley. If I could just use the Chairman's prerogative 
for one more question, Mr. Chairman, I would appreciate your 
indulgence.
    There is a lot of skepticism out there, as you well know, 
about the specialist system, ``market makers are profit 
makers.'' I was stunned by the specialist firms' free tax 
margins are between 35-60 percent compared to 9.7 percent for 
the rest of the comparable industry.
    Even during the bear market, I am told, that none of these 
firms even lost money in a bear market, which if you are making 
a market and the market is going south, I guess that is pretty 
good. But I am not quite sure that that wasn't because of their 
particular position. I guess that skepticism will continue to 
be out there; it is obviously being fed now by advertising by 
some of the ECNs as a result.
    Can the specialist systems survive given all of that 
skepticism out there? It was a statement that your predecessor 
made a few years ago with the advent of the ECNs when he said 
he didn't want to preside over the New York Stock Exchange 
becoming the largest museum in Lower Manhattan.
    And it struck me because we had visited several of the 
bourses in Europe and not one of the, not one, had an auction 
exchange. As a matter of fact, we had a meeting on the floor of 
the Swedish Stock Exchange in Stockholm, where there was nobody 
there except the participants in this meeting.
    So, there is, I think, a lot of skepticism out there fed 
by, what appears to be, some rather interesting facts regarding 
the auction/specialist system.
    Mr. Reed. Mr. Chairman, we, the New York Stock Exchange, 
and others who make use of an auction system have the 
responsibility for making the case as to why this serves the 
public interest and the investors. And we accept the challenge.
    There is, as you correctly say, a lot of skepticism. It is 
up to us, to answer that skepticism and I believe that we will 
be able to do it.
    There is nothing that I have seen on the Exchange during 
the very, very short time that I have been there that suggests 
to me that the specialists are unusually profitable. I would 
guess that they are profitable; from what I hear, they struggle 
hard to be profitable.
    As you probably well know, many of the specialist firms, if 
not the majority, are owned by broker dealers themselves, in 
part because private individuals simply didn't have the capital 
and the capacity to perform this kind of function and they 
exited and sold their businesses because they were under such 
pressure and such need to invest capital in order to perform 
the function.
    And so it may be that, at one time or another, specialists 
have reported high margins. I don't get the impression from 
talking to these people--and I have asked about profitability--
that they are particularly profitable, nor particularly 
confident about the continuing profitability.
    And I think the price of the one specialist firm that is 
publicly quoted probably reflects some investor skepticism as 
to the long-term attractiveness of this. So, I am not worried 
that money is being creamed away from the American people, if 
you will, by the specialist system, but it certainly is worthy 
of discussion.
    I think you want to look at all of the intermediaries. I 
would say that from the point in time that somebody decides to 
make some investments to provide for their retirement until 
they feel comfortable that they have done so, there are lots of 
intermediaries in that chain, each of which tends to be 
relatively profitable.
    But in any event, I think the specialist system is subject 
to question. I think it is up to us to defend it. I believe the 
facts I have read, some of the studies that were made; I have 
looked at times of dislocation.
    I have also looked, with regard to Europe, at some of the 
exchanges that did give up the auction system and moved to 
computers, and one of the things that strikes you is that the 
number of listed companies on those exchanges has dropped, 
which suggests that at least, from a listed company point of 
view, they didn't find that to be the best place to attract the 
type of investors they wanted.
    And it seems to me that the volume of transactions that 
take place in some of these highly automated exchanges reflects 
the fact that they aren't great pools of liquidity. And it is 
important for us not to fracture the pools of liquidity around 
the system. I think it is important to point out to the 
American public that we in the New York Stock Exchange, and 
others, have an obligation to take the best price.
    So, if there is a price on the New York Stock Exchange, 
that at the moment, that second, that it is going to be taken, 
there is a better price available through an ECN, the 
obligation is to take the best price so that the person engaged 
in the transaction is not disadvantaged by us, vis-a-vis some 
other particular pool of liquidity.
    But if you look at some of the European Stock Exchanges 
that have gone into automation, while they function well and it 
is true that you could have a cocktail party on the floor 
without worrying about the number of people, it is not clear 
that it has served the listing companies, i.e., you have seen 
listings fall on those exchanges, nor does it appear that they 
have attracted great pools of liquidity.
    So, I think, as this Committee, and others, examine this 
there will undoubtedly be witnesses a bit more confident than I 
am who will be able to put these issues in full context.
    My whole career has been a career of trying to bring 
technology into the banking business, so I am not somebody who 
is up here trying to push back appropriate technology. I just 
think that we want to bring it into a system that serves the 
investors and the listers in an appropriate way.
    Mr. Oxley. Thank you, Mr. Chairman.
    Mr. Chairman, let me just say that the turnout for members 
of this Subcommittee is quite extraordinary. It indicates how 
interested the members are on this critical issue, and again, 
thank you for your leadership.
    Chairman Baker. Thank you, Mr. Chairman.
    Ranking Member Frank?
    Mr. Frank. Mr. Chairman, we have been taking a lot of time 
so far and I worry about all of the members not getting a 
chance to question, so I am going to waive. Would you go on to 
the next Democrat?
    Chairman Baker. Mr. Chairman?
    Thank you.
    Mr. Sherman. I want to thank the Ranking Member.
    Mr. Reed you have made headlines by saying you would accept 
only $1 in compensation. Can you assure the committee--and I 
know it is not legally binding--that you will not accept any 
additional compensation, fixed or contingent, current or 
deferred?
    Mr. Reed. I can indeed. I would like to state, just for the 
record--since you seem concerned--I have no contract. When I 
was called and asked if I would take this job and the 
representative of the Exchange talked to me about compensation, 
I said, ``Why don't we simply agree on $1?'' I have no 
contract, it is not in writing, I am not sure that I could make 
good that claim that I have on the Exchange, if it came to 
that.
    My understanding is it is $1 to get the job done, not $1 
per year, so if I can get it done in three months I would like 
to take the dollar, not only a quarter.
    Mr. Sherman. I understand your point. I understand your 
point.
    Mr. Reed. But I would like----
    Mr. Sherman. Yes. But the reason I have to bring this up is 
that you serve under a board of directors that, in dealing with 
your predecessor, was either grossly negligent or is suffering 
from a strange new disease that I would identify as 
kleptophilia: a strange love and affection for those who would 
want to rip off institutions.
    How you have a board--and I will point out--that includes 
very prominent Democrats, as well as prominent Republicans, who 
would embrace the contractual relationship with your 
predecessor is just amazing. And it is this kleptophilia that 
seems to afflict a number of boards of directors around the 
country.
    But it is particularly bad when you have, in effect, a 
public utility, a quasi-monopoly, a regulated industry, and 
even more so when that board's representative's here in 
Washington came to our committee and said, ``You have got to 
serve the American people by reducing the transactions cost on 
selling stock on the New York Stock Exchange. Cut that SEC 
tax.''
    So we cut the tax, reduced the Treasury; we thought that 
was going to inure to the benefit of investors. We didn't know 
the money was going to Grasso.
    The board of directors you work for has made some very 
strange decisions. It is also often argued that our exchanges 
are somehow the best in the world--God it feels good to say 
that--I have no reason to think that it is anything other than 
a reflection of the incredible hard work of American working 
families that have built this incredible economy.
    Yes, we have to assume that WorldCom and Enron are the 
exceptions, but we have no assurance that they are as limited 
exceptions as we thought. I am going to be working, hopefully 
with others would join me, in putting together legislation 
designed to regulate the compensation of those who work for the 
Exchanges and design to set standards for those who serve on 
the boards of directors, so that we don't have kleptophiliacs 
continuing to serve on these boards.
    I don't know how people missed what was going on, or 
whether they just thought, ``$180 million"; sounds good to 
them. But one way or another, this system has got to be checked 
and you may be gone--and if your wishes are complied with in 
just a few months--and this strange, new disease could rear its 
head again.
    Can you tell me, is there any reason why your successor 
should--well we couldn't find a person to do a good job for $5 
million in current dollars?
    Mr. Reed. I would certainly expect that you could find a 
person who would do the job for that, or less.
    Mr. Sherman. So, we would not be preventing the Exchange 
from finding a competent replacement in allowing you to go off 
into the sunset, as you so wishly desire, if we limited your 
successor's total compensation to $5 million?
    Mr. Reed. Well, I wouldn't want to be thought to agree that 
you should legislate this, because, by and large, I would 
prefer that you have transparency and accountability and allow 
that work to----
    Mr. Sherman. We had transparency, accountability, and----
    Mr. Reed. Well, we certainly did not in this case, 
Congressman, but to the point of what I believe will be 
necessary to have appropriate leadership of the Exchange, I 
don't think that we want people to take the job because of what 
it pays.
    And there are many jobs, such as the President of the New 
York Fed, which is certainly a job of immense responsibility 
and with operating responsibility and markets and so forth, and 
you don't have any lack of people willing to take that job. And 
none of them: Mr. Volcker, Mr. Corrigan, Bill McDonough, none 
of these people were paid exceptional amounts.
    I believe that we can find appropriate leadership for the 
Exchange at a quite reasonable price. But I would not encourage 
you to legislate it.
    Mr. Sherman. Well, the system we had last year didn't work 
very well.
    And I yield back.
    Chairman Baker. I thank the gentleman.
    Mr. Bachus?
    Mr. Bachus. Thank you, Mr. Chairman.
    Chairman Reed--is it on?
    Chairman Reed--is it working now?
    Chairman Baker. No.
    Mr. Bachus. Sorry. I hope my time starts right now, right?
    Chairman Reed, as a self-regulatory body, of course, you 
have rules, and then when people violate the rules they are 
fined or other actions taken against them. The GAO recently did 
a study and they found that the NASD levied $211 million worth 
of fines between 1997 and 2002 in about 4,700 cases.
    The New York Stock Exchange during that same period of 
time, as opposed to 4,700 cases, brought 256 cases, and as 
opposed to $211 million in fines there were only $19 million in 
fines. While I recognize that the NASD has more entities under 
its regulatory jurisdiction, this wide disparity does seem to, 
at least, send the wrong message, and that message is about how 
rigorous the NYSE's enforcement is.
    Does it trouble you that you have such a wide discrepancy 
between at least the fines levied?
    Mr. Reed. Congressman, it doesn't, to be honest. I, 
obviously, don't know what the circumstance at the NASD is or 
was. I would like to have no actions and no fines, in other 
words, I would love to run an exchange where people knew what 
the rules were and followed them.
    And I don't think the level of fines or the number of 
actions is necessarily a measure of the regulatory function, it 
might be a measure of the quality of the market.
    Mr. Bachus. Well, it would either show that people are not 
violating the rules or the rules aren't being enforced. I think 
it would----
    Mr. Reed. It could be either, obviously. In other words, 
you could have a situation where the rules were being violated 
and we weren't paying attention. But I wouldn't take that one 
indicator as a negative. I have----
    Mr. Bachus. You wouldn't take it as a negative or, at all 
as a negative, or at least----
    Mr. Reed. Frankly, it would make me look at what is going 
on in the NASD, if you wanted an honest answer, not necessarily 
the politically correct answer. Because it seems to me----
    Mr. Bachus. Do you believe that by the high level of fines 
there, that that is----
    Mr. Reed. You would worry about it, because--when I was 
running Citi, which was a pretty big company strewn around the 
world, and we had a very disciplined audit process and 
regulatory process and so forth--when we started seeing a lot 
of audit comments and problems that typically to us was an 
indication that we had bad management and sloppy activities, 
not that we had a particularly diligent audit group.
    Mr. Bachus. I would think that when actions are being 
brought and fines are being levied, it is certainly an 
indication that enforcement is going forward.
    Mr. Reed. That certainly is true.
    Mr. Bachus. And the absence of that would, to me----
    Mr. Reed. You could at least ask the question.
    Mr. Bachus. It could either indicate that nothing bad was 
going on or the rules weren't being enforced.
    Mr. Reed. That is certainly true.
    Mr. Bachus. All right.
    You referred to this, and others have, as an auction system 
or an auction market. But I think when the public thinks about 
an auction, they think about an auctioneer who does it by 
himself for his own profit, so that is a distinction, is it 
not?
    Mr. Reed. Certainly it is.
    Mr. Bachus. Does it bother you that the specialists, who 
really have a monopoly in a certain listed stock, that the bulk 
of their money is made buying and selling stock for their own 
account? Is that troubling?
    Mr. Reed. It is disturbing. If you look over the last five 
years there has been a shift from Commission to trading income 
on the part of the specialist. This reflects, frankly, that the 
Commissions have been squeezed to almost nothing. Whether that 
is good for the functioning of the market, you could debate.
    Mr. Bachus. To me, at a time when the market is falling and 
people are losing money, and as you mentioned earlier, they 
have to hang back or they have to step in, so if anything, it 
ought to be harder for them to make a profit, than----
    Mr. Reed. And I think it is. In other words, from what I 
could gather talking to only one with public data--we obviously 
have other data--I don't think there is anybody who believes 
that the specialists have been doing particularly well over the 
last year or so.
    Mr. Bachus. Let me just, and I will say this.
    Mr. Glassman is going to testify, I read his testimony, and 
he actually says, as opposed to not being particularly well 
over this period of time, that their pre-tax--and I think the 
Chairman mentioned this, it is on page six of his testimony--
their pre-tax margins are between 35 and 60 percent, compared 
to a little less than 10 percent for the industry.
    So it would appear as if, if Mr. Glassman and, I think a 
Mr. Becker--he quotes him--if their figures are right, it has 
been a very profitable enterprise in a time of falling market. 
And you would think a period of time, if they were ever going 
to lose money, they would lose money over that period of time.
    But I would ask----
    Mr. Reed. I would suggest you ask them directly and they 
will be in a better position than I am to answer. My overall 
impression is it is not a great business, certainly not a 
business I would invest in.
    Mr. Bachus. Not that profitable?
    Mr. Reed. First of all, you have to commit capital, so I 
don't know if this margin you are making reference to is the 
return on revenue or a return on capital. I would be astounded 
if it were a return on capital.
    And it is hard work. It is hard work and it is a difficult 
business. And I don't believe that you have seen the 
consolidation of specialists that we have all witnessed and the 
buying of specialists by institutions----
    Mr. Bachus. Let me----
    Mr. Reed.--because it is a great business.
    Mr. Bachus. Let me say this. I will end with this.
    Actually, I think four specialists account for 80 percent 
of activity on the floor, so you had a consolidation. And all 
of those either sit on the board or the company that owns them 
sits on the board. Is that a possible area to be addressed, 
whether those two specialists or the two representatives of 
those companies that own them sit on the board?
    Mr. Reed. Absolutely.
    Mr. Bachus. Thank you.
    Chairman Baker. I thank the gentleman, his time has 
expired.
    Mr. Gonzalez?
    Mr. Gonzalez. Thank you very much, Mr. Chairman, and good 
morning, Mr. Reed and thank you for your testimony.
    I want to clarify something at the outset and then go into 
the questions. And I think in response to Chairman Oxley's 
inquiry you indicated, ``We are not discussing a regulatory 
failure.'' Is that correct?
    Mr. Reed. That is correct.
    Mr. Gonzalez. Okay. All right.
    And I want to kind of put the world on notice that Congress 
doesn't require a regulatory failure in order to revamp, modify 
and alternate any regulatory scheme. And the legislation we 
have pending now in GSEs would be a real good example of that. 
And I don't think anyone has ever said that regulatory scheme 
that was in place, in any way, failed to detect anything that 
would affect safety and soundness, which is really the 
cornerstone of what the regulatory apparatus is supposed to 
protect.
    Nevertheless, we will move forward with that. So, anyone 
that comes before this Committee or Congress needs to be placed 
on notice that it doesn't have to be broken in order for us to 
try to fix it. Now do I agree with that? Not necessarily.
    And there are those that will say, ``You don't have to be 
sick to feel better.'' And in Texas--I will end this with 
another little Texas axiom--and it all depends whose ox is 
being gored at any given time in this Congress.
    What is curious about what you have stated, and I do wish 
you well, because I like the concept of self-regulation. The 
strength of self-regulation is its weakness, and I think your 
written testimony points that out, and somehow you are trying 
to find this balance.
    You still want individuals in a self-regulatory scheme that 
have the familiarity and the knowledge of the Stock Exchange 
and what goes on, but maybe not have as great a stake in what 
is going on, directly. How do you accomplish that when you keep 
talking about this independence?
    You are talking about independence in the context of a SRO. 
So I guess what I am trying to get at is how do you keep all 
the strength and the familiarity and the knowledge and all 
that, and still somehow insulate those individuals from some 
self-interest and conflict of interests?
    Mr. Reed. If I could, first of all, I fully accept and do 
understand that you may well have very good reason to change 
regulation with no visible failure. So I cede to you the point.
    My hope here is that we will create a board that is 
independent. In other words, a board that is not made up of 
people who are regulated or who have interests in the industry. 
But I want to, at the same time, create an industry group that 
can get deeply engaged in the substance of what we are 
concerned about here, with regard to regulation and with regard 
to the evolutionary pathway, if you will, of these markets.
    In order to keep the regulatory function clean you clearly 
need professionalism at the level of the people who do the 
regulation itself, just as within a firm you need an audit 
department that is professional as auditors, even though they 
may rest within the structure of the firm.
    And you need to make sure that, with regard to 
compensation, with regard to budgets, with regard to manpower, 
and things of this sort, that the regulatory process is quite 
free of any constraints that might stem from the operational 
side of the business.
    In most private sector companies, the audit department 
tends to report to the Chairman of the audit committee and not 
to the CEO of the company, even though they work within the 
company. And usually budgets for audit functions, and so forth, 
are approved by the audit committee and not within the overall 
budget process for the rest of the company.
    And so, I think, you could set up mechanisms that give you 
some reason to be comfortable that self-regulatory activities 
can live in a particularly good environment without any kind of 
conflict. And frankly, you don't want a board that is engaged 
in compensation decisions and other things that is made up of 
people who are regulated because there is no question but that 
there is a chilling effect on their willingness to operate as 
fiduciaries if they also are in a position where they are being 
regulated.
    And so I think we need to come up with a governance 
structure that cleans up some of these things. On the other 
hand, at the working level, you want a regulatory function that 
is tightly coupled with the activities.
    And when you get into situations, for example, such as the 
one reported in today's newspaper where we are going to pursue 
some of the specialists firms for possible misbehavior, those 
conversations will have to be where the people know exactly how 
the specialist system works and what the rules are. Because, 
obviously, in order to decide whether something improper has 
happened or not happened, you have to be a hands on 
practitioner.
    And you will see that in the existing structure of the 
Exchange, which I am told has worked well, the court of last 
appeal, if you will, of a member who is being fined by the 
Exchange is a committee of the board with a majority of outside 
directors, but with two representatives from the Stock Exchange 
floor itself, who bring to that deliberation some 
understanding. Obviously, not people representing the 
particular firm being disciplined.
    But you do need the coming together with expertise and 
independence at that level. And by the way, the overview of the 
SEC is extremely important. The fact that the SEC gets engaged 
in these disciplinary matters, the matters that were reported 
this morning in the press, the SEC was deeply engaged. We 
happened to find the first problems and we obviously shared 
that with the SEC.
    But they came back to us with subsequent demands for 
further information, that frankly, broadened the investigation 
and made it a better one, I think.
    And so, this interaction between an SRO, as we are calling 
it, and the overall regulatory function is a delicate one. It 
does, I think, work pretty well. And what I am trying to do is 
to clean up the board and its supervision of the regulatory 
function so there is no conflict there.
    But I am also going to try to clean up the board with 
regard to its other functions, including compensation, so that 
we don't have people who are being regulated by the Exchange 
making decisions, with regard to the compensation of the 
management of the Exchange. I don't believe that people are 
incapable of dealing with those conflicts, but I think most 
people would say it has a chilling effect.
    If you are being investigated by the regulatory side of the 
Exchange, and you happen to sit on the compensation committee 
of the board, it is probably quite likely that you are going to 
be a quiet participant in those discussions, because anything 
you say is going to be taken out of context. They are either 
going to think you are trying to affect the regulatory process 
or you are trying to behave improperly on the other side.
    So my proposal, with regard to corporate governance, is 
designed to eliminate those potential problems on both sides; 
to provide an appropriate governance structure, budget and 
manpower structure for the regulatory function that is 
independent of other considerations. And also make sure that 
those on the board who have fiduciary responsibilities and 
include the compensation and selection of management, and so 
forth, aren't people who also are subject to the regulation.
    Mr. Gonzalez. Thank you very much and good luck.
    Mr. Reed. Thank you.
    Chairman Baker. Ms. Hart?
    Ms. Hart. Thank you, Mr. Chairman.
    I also wanted to welcome you, Mr. Reed. And ask my 
colleagues to have confidence in you because of your pedigree, 
as a fellow Washington and Jefferson alum. And also, knowing of 
your reputation in your prior business, I am pleased that you 
have decided to take this on, as well.
    One of the things that you discuss in your testimony was 
that you believe that the board must be independent, and I 
think all of us in this room agree with that. And having read 
the last several weeks' worth of articles, numerous newspapers 
about the whole situation and the resignations that followed 
and all those interesting drama, I would agree.
    Does that also mean that you believe the Chairman's 
position and the CEO position should be separate?
    Mr. Reed. Not necessarily. In other words, I certainly 
believe that there are places where a Chairman and a CEO being 
the same person can work. I suffer, of course, I was Chairman 
and CEO for 16 years, and we didn't have that separation, and 
so I am sure I have biases resulting from that.
    I think the jobs are quite different. In other words, I 
think as Chairman your responsibility is to make sure that the 
board functions effectively; that it is sort of like the 
Chairman of the Subcommittee, his responsibility is to make 
sure that the right subjects are talked about with the right 
kind of witnesses in the right kind of environment allowing the 
right discussion, and so forth.
    A Chairman of a board has to make sure that the board 
thinks about the right things, has the right information when 
they do, the meetings are arranged so that, in fact, you could 
have substantive discussions, et cetera, et cetera, et cetera. 
The CEO is responsible for running the company.
    You can do the two as one person. There are some distinct 
advantages in having two people, because, obviously, you have 
two human beings sharing a responsibility and it gives you 
twice the manpower, if nothing else, or womanpower. And in the 
case of the Stock Exchange, you could argue that our public 
responsibilities as a leader of the community almost require a 
Chairman who has a public role and maybe being hands on running 
the place everyday makes that somewhat harder.
    So, I am quite open as to which is the better 
configuration. Frankly, I am just getting engaged in the 
process of looking at who might be potential candidates to take 
my job. Clearly you have more people to look at if you separate 
it. You have a broader potential arena if you separate it.
    There are, however, at least two people I have thought of 
that I would be quite happy to see in a joint role. So, I could 
be persuaded either way.
    Ms. Hart. What, when you say, you have already found 
several people that you believe may fit the role, what kind of 
qualities and background are you looking for someone who may be 
able to take on those roles, or separate roles?
    Mr. Reed. Well, I could read you the job description if you 
would like.
    You need somebody who is capable of acting as a spokesman 
for the industry and who can be fully engaged with the industry 
and bring all these disparate views about regulation, about the 
role of computers and automated exchanges and so forth to 
fruitful discussions. You need somebody who is credible in 
that, capable and can play a public, as well as a private role 
in that.
    Obviously, whoever is there has to have the capability to 
run the board, which, if one could criticize Mr. Grasso, you 
would have to say he didn't run the board very effectively. 
And----
    Ms. Hart. Or, if you are a banker, he did.
    Mr. Reed. Clearly the board did not function well.
    Ms. Hart. Not enough.
    Mr. Reed. He may have been the best CEO the Exchange ever 
had, I have no opinion, but I think there is enough evidence on 
the table that the board didn't do its job very well. And so 
running the board is an important capability. I wouldn't want a 
person on the job who hadn't had some experience at running 
boards and doing so properly, and so forth. Integrity is 
everything.
    When you get down to operational characteristics, you need 
somebody who can be an engaged leader of the diverse 
communities who are in the Stock Exchange. You go down to that 
Stock Exchange floor and it is a bunch of very small businesses 
that all come together and interact; you have broker dealers, 
you have independent brokers, you have specialists.
    And each of those communities, and many of the members of 
the Exchange, rent their seats from owners who are retired. 
They have a very different point of view on things than some of 
the owners, who are retired. And so whoever comes in has to be 
an engaged and effective leader of all those various 
communities.
    And the most difficult problem we are going to be facing 
going forward is what I call this ``evolutionary pathway.'' 
Today, the New York Stock Exchange, I believe, functions 
exceedingly well. We have 80-plus percent of the volume, we 
have the best of the companies listed on the Exchange. The real 
challenge for the new leadership is, ``Will that be true seven 
years from now?"
    And if so, it has got to be because we continue to occupy 
that position where people want to list on our exchange and 
where people want to come to the Exchange to transact business. 
And if anything we do over the next seven years loses either of 
those constituencies: those who would list and those would 
bring business to us, then the Exchange is going to get 
fragmented.
    And so the principal requirement of the new leadership, 
including the board, is how you manage yourself through that 
evolutionary pathway.
    Chairman Baker. Gentlelady's time has expired.
    Ms. Hart. Unfortunately. Thank you.
    Chairman Baker. Thank you, Ms. Hart.
    Mr. Hinojosa?
    Mr. Hinojosa. Thank you, Mr. Chairman.
    In light of recent developments in the capital markets, 
particularly the reported New York Stock Exchange actions 
against the five largest specialist firms, I appreciate hearing 
the testimony of Interim Chairman Reed and learning what 
initial changes you believe must be made to corporate 
governance at the New York Stock Exchange.
    I further understand that the Senate Banking Securities 
Subcommittee held another hearing on market structure 
yesterday, at which SEC Chairman William Donaldson testified. 
It is clear to me that Chairman Donaldson expressed certain 
concerns about the current corporate governance at the various 
exchanges.
    And after the hearing, he reportedly stated that SEC 
approval for the New York listing standards proposed by the New 
York Stock Exchange and NASDAQ is imminent. Having said that, 
do you believe that there are directors who would be willing to 
accept directorships on the New York Stock Exchange after you 
have finished with your remodeling of such corporate 
governance?
    Mr. Reed. Congressman, that is a very good question. I 
believe so, obviously, because I couldn't put in place a 
proposal that would fail simply by being unable to get a board 
together. But there is no question that sitting on a public 
board nowadays is an undertaking of greater gravity, if you 
will, and accountability than maybe it was 20, 25 years ago.
    And there is no question that there are any number of 
people who would be very good directors, but who when 
approached, simply are unwilling to accept those extra 
responsibilities. I am hoping that the same thing that causes 
me to be here with you this morning will cause directors to 
serve on the Exchange; that is, an appreciation of the 
importance and the role of the Exchange.
    And it is a semi-public both honor and responsibility. This 
is not the same as sitting on the board of a purely for-profit 
quoted company. We have a greater public role and public 
responsibility and I am hoping that we will find very good 
directors who respond to the public responsibility associated 
with being on the board and are willing to serve, in part 
because it is a challenging technical, intellectual business 
activity, but more because they sense the importance of this 
particular entity and the imperative that it have appropriate 
governance.
    Mr. Hinojosa. Knowing that you will be stepping down after 
you get this job done, would you personally accept such a 
directorship?
    Mr. Reed. That is an interesting question, Congressman. 
From a personal point of view, I would rather not, because I am 
happily retired and you never quite appreciate retirement as 
much as when you give it up.
    But on the one hand, and there is a second concern, I 
wouldn't want to bring in a new Chairman who, in any way, found 
it difficult to have the prior Chairman, sitting there on the 
board. Obviously, the new Chairman should not, in any way, 
worry that somebody before him was sitting on the board.
    On the other hand, I will be honest, when I have talked to 
some people about the possibility of joining the board, they 
inevitably ask me, ``Hey John, are you going to be willing to 
stay on the board?'' And it is hard for me to say, ``I am not, 
but you should.'' And so I get a little bit of a problem there, 
and I don't have a strong point of view.
    My personal preference would be to not stay on. But if it 
seemed to me that in order to help getting the board to gel and 
so forth, that my continuing presence for a short period of 
time--a year, two years, whatever, would be useful, I certainly 
think that I have some obligation to take that seriously.
    Mr. Hinojosa. Well, I think you would make a great 
director, and I will respect whatever decision you make.
    But let me ask you for some clarification. In today's New 
York Times' article entitled ``Big Board Plans Fines for 
Specialists,'' dated October 16th, it States that, ``The New 
York Stock Exchange has decided to fine its five largest floor-
trading firms about $150 million for trading in ways that 
deprived investors of the best price they could have 
received.''
    Has that amount already been set, or is it plus or minus 
that $150 million? And the second part to that question, is it 
a $150 million per-trading firm?
    Chairman Baker. And that will have to be the gentleman's 
last question as his time expired. But please respond, sir.
    Mr. Reed. The answer is that--first of all, I don't know 
where that number came from because the press release that the 
Exchange issued did not have any numbers in it--what happened 
is very simple.
    We detected, some time ago--I say we, I was not there--but 
the Exchange detected that there seemed to be some strange 
behavior in the price of a stock and they investigated and they 
discovered that there had been some inappropriate behavior on 
the part of the specialist. They expanded the investigation and 
said, ``Hey, if one specialist did this, maybe other 
specialists have done this.''
    And it is amazing--you might not be aware of this--but they 
actually could cut down to every five seconds, so that they 
could look in five second slices at all the information that 
was displayed on all of the screens that are available to the 
specialist and then they could see what the specialist did 
every five seconds.
    And therefore, if you know what the specialist should have 
done, given the information that was available to him, and 
compare it to what they did do, you can decide whether or not 
they behaved properly or not. Needless to say, you could fill a 
fairly large room with the data accounting for transactions.
    We went back and looked over a three-year period across all 
the specialists. At the end of that analysis, it was decided, 
not by me but by the people in our enforcement division, that 
indeed, there had been, amongst these firms, improper behavior. 
That doesn't mean all transactions, all specialists, but within 
each of these firms, there had been improper behavior, i.e., 
they didn't do what the facts, circumstances would have 
dictated they do.
    You can calculate the difference between the price that was 
agreed to and the price that should have been agreed to and, 
therefore, you could sum it up and come up with a number, and 
the number you have is in the ballpark.
    Each of the firms will be called up, and we will be talking 
to them both about disgorging the profits back to the people 
whose transactions were involved as well as paying a fine. In 
other words, it is not sufficient simply to disgorge, but also 
these firms--our proposal is going to be--that these firms will 
be fined.
    There is an appeals process within the Exchange where the 
firms can contest, they could argue with the data, they could 
suggest that our calculations are incorrect, et cetera, et 
cetera.
    And so, what you are seeing here is simply the first 
notification that we have given to these firms of our intention 
to pursue it. And my guess is what you are seeing here will be 
pretty close to what, in fact, will actually happen. But there 
is a process and it is subject to disagreement and that process 
has to be allowed to take place.
    Chairman Baker. That gentleman's time has expired.
    Mr. Hinojosa. Thank you, Mr. Chairman. I look forward to 
learning more about it and working with you and our Ranking 
Member.
    Chairman Baker. I thank the gentleman.
    Ms. Kelly?
    Mrs. Kelly. Thank you, Mr. Chairman.
    Welcome, Mr. Reed. We are glad to have you here.
    Yesterday, Chairman Donaldson testified, and he was talking 
about the market system being fair and efficient and so forth. 
And he raised an issue that I would like you to address, if 
possible.
    He was talking about some questions regarding the 
fragmentation of the markets and whether or not that is 
reducing the effectiveness of the regulatory process. I wonder 
if you would give us some of your thoughts on that issue.
    Mr. Reed. Well, I think it is a very important issue. It is 
not in anybody's interest to see these markets fragment. The 
reason being, of course, if you don't have all of the potential 
buyers and sellers in contact with each other, the danger of 
getting a bad price goes up, for obvious reasons.
    This is the reason why in buying and selling houses, 
brokers tend to list with all the brokers in a community so 
that you are sure that all of the people who might be 
interested in buying your house, not just the ones who happen 
to deal with the broker that you selected to sell it, get a 
chance to come and look at the home and maybe buy it.
    And, so, it is in everybody's interest that the liquidities 
be pulled together, now they can be pulled together by rules 
that require, as I mentioned before, that you be aware of 
prices and alternative locations and, if they are better from 
the customer's point of view, you must take advantage of them.
    From a regulatory point of view, the fragmentation is even 
worse because you have more things to regulate, but you also 
have to regulate the interaction among them. And, so not only 
do you have to regulate each individual exchange, but you must 
make sure that the interactions among them are as they should 
be so as to produce the best possible result.
    And, so from a regulatory point of view, the fragmentation 
is also a problem and it makes it more difficult to be assured 
that the total marketplace is working the way you want it to. 
And, as you well know, some of these markets exist only in 
software. I mean, it isn't that there is something there you 
could watch.
    All of a sudden the regulatory function becomes one 
actually of looking at the software and seeing whether that 
software would respond to potential different scenarios in ways 
that you would deem to be appropriate.
    And, so, you are beginning to have to regulate the 
underlying logic under each exchange. I think Mr. Donaldson, 
who has the ultimate responsibility, is quite correct to point 
out that this fragmentation is a danger not only to the well 
functioning of the markets, but it is also a danger to the 
regulatory process itself.
    And the likelihood of having an aberrant something off in a 
corner someplace, that you maybe didn't fully understand that 
could lead to some problems for you, becomes quite important. 
So, I am happy that I am not the regulator who would have to 
overview all of this.
    Mrs. Kelly. Since we are talking about regulation, in your 
testimony you say, ``Self-regulation is one of the two legs of 
a larger regulatory regime that includes government regulations 
by the SEC and Congress.''
    I am curious as to where you see State legislators and 
State security regulators fitting into the framework since you 
didn't talk about them. I think we would all agree that it is 
better to have a lot of cops on the beat, but it would be good 
to, anything we can do, to ensure against fraud. But do you see 
any benefit to having States participating in setting 
securities regulation?
    Do you think this could create fragmentation?
    Mr. Reed. Yes, I would prefer that the regulation--this is 
a personal preference--be at least tightly coupled together, if 
not that we simply have national regulation. But you would have 
to honestly say that the States have played a role in bringing 
some discipline to some recent misbehaviors.
    It is certainly true that there have been States attorneys 
general who have felt that there have been inappropriate 
behaviors and have made a constructive contribution to reform. 
So, I do believe that the diversity of State vs. Federal 
interests are there.
    I would hate to have States begin to enact legislation that 
started to conflict with the legislation that this body might 
enact because then you really do put the working entities in a 
situation where you can conceivably have conflicting regulation 
and it makes it almost impossible to operate.
    But certainly the activism on the part of some of the State 
Attorneys general, I think, has to be seen as positive. I would 
like to hope that the framework, whether it be the State or the 
Federal government, be approximately the same.
    Mrs. Kelly. But you are not worried that this would add to 
fragmentation and impact the market structure?
    Mr. Reed. It clearly would.
    If you started getting significant differences in 
regulation it would, in fact, fragment the market. And that 
should be avoided to the extent that it can be.
    My own sense is the Federal government stepped in in the 
1930s after our problems with the big crash and created an 
over-arching framework for the capital markets that looks 
pretty good across time.
    If you look at it, it seems to me, that as compared to 
other regulatory regimes, the securities acts and the creation 
of the SEC have served the American public rather well. I would 
hate to see lots of independent States creating their own 
regulation even though, as I say, their attorneys general 
probably helped this process a little bit, if we look at recent 
history.
    Mrs. Kelly. Thank you.
    Chairman Baker. I thank the gentlelady.
    Mr. Tiberi?
    Mr. Tiberi. Thank you, Mr. Chairman. Thank you, Mr. Reed, 
for coming here today.
    I am concerned--you touched on this throughout the hearing 
today but let me get more specific--I am concerned about the 
apparent conflict at the Exchange between the one hat you wear 
as a regulator, the other hat you wear as a marketplace 
competitor.
    The former Chairman once said he viewed his job as one-
third regulator, two-thirds businessman. The NASD solved that 
conflict by separating its marketplace competition function 
from its regulatory function.
    Two questions. One: do you believe, specifically, there is 
a conflict? And two: would you support what the NASD did at the 
Exchange by separating those two functions clearly?
    Mr. Reed. I don't believe there is a conflict. I said this 
in a press conference once, ``I believe that regulation in the 
New York Stock Exchange is analogous to quality control in 
Toyota.'' People come to the New York Stock Exchange because 
they believe it is a well-regulated market.
    I have personally--when I was in my prior incarnation--
listed the stock of Citi at other exchanges and the New York 
Stock Exchange and delisted from most of these other exchanges. 
And I have sat over the years on any number of investment 
committees, and I would tell you that in a couple of instances, 
I have insisted that we simply make no investments in certain 
markets because I didn't have confidence in the functioning of 
those markets.
    And, if you don't have confidence in how they function, you 
are really at risk if you buy and sell in them.
    And, so, this question of the quality of the market--I 
think one reason that the United States attracts something in 
the area of $200 billion to $300 billion a year of excess 
investment, by excess I mean more than our current account 
might suggest that we would have--is because if you were to be 
given a large sum of money and you were to live any place in 
the world and you say, ``Gee, where do I want to invest?'' You 
would inevitably come here.
    And you would come here, in part, because the underlying 
companies are attractive investments, but you would also come 
here, in part, because you could invest in the American capital 
markets knowing that they are honest, that they are straight, 
that they are well-regulated and that you will be fairly 
treated.
    So my view is, were I to be the permanent leader of the 
Stock Exchange, I would want to keep regulation only because I 
think the better regulated that we are, and the better our 
reputation is for being toughly regulated, the more people who 
would want to list on us and the more people who would want to 
do business with us.
    So I view the promise that you make to your customers that 
you are going to do things properly, which can only be enforced 
through supervision and regulation, is part of the business and 
shouldn't be separated as if it were on the side.
    And I don't think there is a conflict because anybody who 
would want to run the business poorly--I mean, it is good for a 
week, it is good for a month--but you will lose business over 
time.
    The particular path that NASDAQ took, I don't have an 
informed view. It may have served their interests quite well 
given where they were and what they were trying to do. I am 
going to hope to propose, to you and to the American public, a 
governance structure that permits the regulation to work side 
by side with the Exchange in a positive way and that would 
appear to everybody to be an appropriate governance structure. 
And that is my objective.
    Mr. Tiberi. Second question, briefly. The exchange, in the 
past--talking about corporate governance--has resisted 
representation on its board from the mutual fund industry. 
There are 95 million mutual fund investors out there--I am one 
of them--what do you propose doing to allow mutual fund 
industry?
    Mr. Reed. Absolutely. I am going to come up with a 
complicated structure--but within the structure we are going to 
have representation from the big, state pension fund 
leadership, the big, private pension fund leadership, the 
large----
    Mr. Tiberi. The board representatives?
    Mr. Reed. We are going to try to get senior representatives 
from each of these constituencies to sit with us on a board 
that will have the broker dealer community, the floor 
community, and so forth; the professionals who surround this 
industry. I think that we all believe we need the buy side, 
which are these people, as well as the sellers.
    Mr. Tiberi. Thank you. Thank you, Mr. Chairman.
    Chairman Baker. We have a vote pending and at least one, 
perhaps two more votes. I am going to recognize Ms. Biggert. I 
would then go to Mr. Castle, and then to Mr. Shays, if time 
permits.
    Ms. Biggert?
    Mrs. Biggert. Mr. Chairman, I would thank Mr. Reed for 
coming, but I think that he has answered, several times, all 
the questions that I had. So I would just yield back.
    Chairman Baker. I thank the gentle lady.
    Mr. Castle?
    Mr. Castle. Thank you, Mr. Chairman. I will also be brief. 
Let me just, first of all, thank you and Mr. Kanjorski. I think 
these hearings are necessary.
    I will say, Mr. Reed, I just become increasingly concerned 
with all the corporate scandals that we have had with the 
mutual fund issues and they seem to always be holier than thou, 
if you will, and some of the securities exchange issues which 
have arisen in a variety of ways.
    And, in addition, we are trying to deal with some of the 
housing entities here, and some questions have been raised 
about some of their practices.
    It just seems, to me, when we get into large monetary 
circumstances people try to develop ways to, obviously, take 
advantage of whatever they can, not necessarily always in a 
criminal way, but in the sense of perhaps deprivation to the 
smaller owners of this. So, all those things concern me.
    And I am delighted you are here, I am delighted you are 
there. If these notes are correct and you are being paid $1 for 
the rest of your tenure there, then maybe you should get a pay 
increase like some of the others we have had there in the past.
    I guess I do have one very brief question and, that is--and 
you may have already answered this, I wasn't here--but I think 
the New York Stock Exchange is probably going to get away from 
the specialists and go to electronic at some point. I don't 
know when; that is what I gleaned from everything.
    If that happened, can you opine as whether it would be 
easier or more difficult to regulate or is that just not 
something that is in your purview at this point?
    Mr. Reed. It will be more difficult to regulate if you get 
there. Electronic systems of whatever sort, are more difficult 
to deal with than human systems. There is no question, just ask 
Microsoft how many bugs are in some of their releases and how 
long it takes to get the bugs out. Even Intel has occasionally 
had to recall a chip because it turned out that there was a 
flaw in the architecture.
    When we get into highly-automated systems, the regulation 
becomes much, much more difficult because, basically, you have 
to regulate the code, and that is inherently difficult.
    Mr. Castle. Thank you. I yield back, Mr. Chairman. Thank 
you.
    Chairman Baker. I thank you, Mr. Castle.
    Mr. Shays?
    Mr. Shays. Thank you, Mr. Chairman. Just to thank you for 
holding these hearings; to apologize to Mr. Reed for my not 
being here, I was in the district.
    And look forward to the next panel, and just, also, to 
thank him for, not just being here, but for the good work; the 
very important work that he needs to do.
    Thank you.
    Chairman Baker. I thank the gentleman.
    Mr. Reed, we certainly appreciate your patience and 
courtesies extended today. Your remarks and responses to 
questions have been most helpful. We look forward to working 
with you and the Administration of the Exchange to assure all 
investors that our markets are transparent and functioning 
fairly for all those who are involved.
    And we appreciate your contributions.
    To the participants in our second panel, it is unclear 
whether we have two or three votes. We are well into the first 
vote. We will just stand in recess for 20 minutes. Thank you.
    Mr. Reed. Chairman Baker, thank you for your courtesy.
    Chairman Baker. Oh, thank you, sir.
    [Recess.]
    Mrs. Biggert. [Presiding.] The committee will come to 
order.
    We are happy to have our second panel. Sorry for the delay 
with the votes.
    I would like to introduce the second panel and, as you 
know, give you five minutes, and then we will have questions. 
And I am sure there will be more members back by then.
    First on our panel is Mr. Robert Greifeld, President and 
Chief Executive Officer of NASDAQ Stock Exchange; second, Mr. 
Mark Lackritz, President, Securities Industry Association; 
third, Mr. James Glassman, Resident Fellow, American Enterprise 
Institute; and then Mr. Gerald D. Putnam, Chairman and Chief 
Executive Officer, Archipelago Holdings.
    Mr. Meyer ``Sandy'' Frucher--the names are very difficult 
here, for me, anyway--Chairman and Chief Executive Officer, 
Philadelphia Stock Exchange; Mr. David Colker, President and 
Chief Executive Officer of the Cincinnati Stock Exchange.
    And a special welcome to Mr. Colker, who is a resident of 
Chicago, even though the name of the Stock Exchange at the 
current moment is Cincinnati, it does exist in Chicago, 
Illinois. Professor John C. Coffee, Jr., Columbia University 
School of Law.
    You can correct my pronunciation when you give your 
testimony. And so we will start with Mr. Greifeld.

  STATEMENT OF ROBERT GREIFELD, PRESIDENT AND CHIEF EXECUTIVE 
             OFFICER, THE NASDAQ STOCK MARKET, INC.

    Mr. Greifeld. Thank you, Madam Chairman, and all the 
members of the Subcommittee.
    I appreciate the invitation to testify before you today. As 
you may know, I became CEO and President of NASDAQ Stock Market 
some five months ago. I consider NASDAQ to be a unique asset of 
the U.S. economy and the growth of this economy. Our success is 
driven by how well we serve the individual investor.
    My premise today is that the individual investor is best 
served by free choice, competition and fundamental fairness. Of 
course, every aspect of this country's capital markets is 
affected by the decision of the public policymakers. In this 
regard, we are fortunate to be served by an institution, like 
the SEC, with its expertise and tradition of excellence.
    I have learned that the SEC can say, ``Yes,'' and can say, 
``No.'' And for a manager, such as myself, in a fiercely 
competitive market, when they don't say anything, this means 
``no'' as well. So, as we examine the issue of capital market 
structure, I urge you to encourage the SEC to continue to be 
deliberative and cautious, but also expeditious.
    With respect to the debate about securities market 
structure, the Securities and Exchange Commission is faced with 
critical decisions at a unique time in our economic history. 
Now is the time to face these decisions.
    At the top of the list, I would put three issues. One: 
reform of the trade-through rule; two: the need to separate the 
securities regulator from the market center, and in this 
position, we are not advocating the abolition of the SRO 
function, but we are advocating that the SRO function needs to 
be separated from the market center. And third: the need to 
ensure uniform regulation of the marketplace by addressing the 
emergence of trading in sub-pennies.
    NASDAQ is the listing market for over 3,500 companies. 
Corporations list their shares because of the good name of 
NASDAQ, our listing standards and our government practices. The 
corporation's decision to list on the NASDAQ stock market does 
not mandate trading on the NASDAQ stock market.
    Currently, 55 percent of the trading of stocks on NASDAQ, 
occurs within our system. NASDAQ competes for every listing, 
every quote, every execution, and every trade report, and we 
feel other markets should do so as well.
    Competition has always been good for NASDAQ. Our open 
architecture has facilitated competition. We have nearly 300 
market makers who are willing to commit capital and we have 
numerous ECNs matching buyers and sellers, all helping with the 
execution process. Our market structure promotes efficiency and 
market quality stats mandated by the SEC bear this out.
    Attached to my written testimony is an analysis of how 
stocks trade on the electronic NASDAQ market vs. the floor-
based New York Stock Exchange. As an example, the trading of 
the S&P 500 stocks, NASDAQ has a spread that is 38 percent 
better than what you see on the floor-based market. Our order 
execution time is 3.3 times faster and our trading costs are 37 
percent lower. At NASDAQ, the speed of execution is faster than 
ever and the spreads are tighter.
    Many argue that a floor-based monopoly can produce short-
term benefits. But history and economics show that monopoly 
power is corrupting and is bad for citizens, markets and 
investors. Competition forces market participants to focus on 
how to best serve the customer and the investor.
    Rapid technological strides, as well as decimal pricing, 
has helped to promote the spread of electronic markets and 
should lead to a reappraisal of market structure. Electronic 
trading has revolutionized trading on NASDAQ, but the listed 
arena is frozen in time. When electronic orders try to move in 
the listed environment, they are held up for an eternity of 
seconds because of the trade-through rule. Trading in New York 
Stock Exchange stocks is slowed to the pace of the slowest 
market.
    The example I use to illustrate this point is a story I 
have. It happened two Saturdays ago. My son had a football 
game. And after the football game, we went to our local fast-
food place. And we sat down to have, as us good Americans do, a 
burger and a Coke. My son was about to sip on his Coke, and I 
said, ``You cannot have that.''
    And he said, ``Dad, why not? I am thirsty. I just played a 
game.''
    I said, ``That Coke is 99 cents in this fast-food place. 
But if you go across the six-lane highway, there's a place 
advertised at 98 cents.''
    And he said, ``But I want the Coke now.''
    And I said, ``Well, in this market that we have today, you 
do not have the right to drink that Coke.''
    The amazing thing is if he decided to cross that six-lane 
highway, when he got there, there is no obligation for that 
Coke to be available at 98 cents. In fact, it could be 99 
cents. It could be a dollar. It could be $1.01.
    We need to have choice for investors. My son wanted to 
drink that Coca-Cola then and there. He was willing to pay 99 
cents. He did not want the possibility of going across the six-
lane highway.
    And when I talk to individual investors, which I do on a 
regular basis--I see it as a key part of my job--I ask them 
what do they value most in an execution. And they describe a 
situation where they are on an online Web site and they click 
on that button to buy or sell a stock. They care about two 
things.
    One is speed. When they click on it, the sooner they get 
that execution message back, the happier they are. And two is 
certainty of price. They see 99 cents advertised, 98 cents. If 
they get it back at 98 cents in two seconds, they are happy.
    This trade-through rule is a 20-year-old provision of a 
plan approved by the SEC. Clearly, now is the time for reform 
of the trade-through.
    Much is being written these days about corporate governance 
within the Exchange itself. America's exchanges rely on the 
trust of investors. At the moment, NASDAQ is in the process of 
separating from its regulator, the NASD, based on the belief 
that separation is the only structure that works for all 
markets.
    As CEO and President of the NASDAQ, I cannot imagine 
explaining to Congress that my regulator hat was on one day and 
off the next. This is why we contract with the NASD to provide 
our market with unsurpassed regulation. NASD regulations are on 
the case 24 hours a day, seven days a week. It is untenable to 
combine a market center with a regulator in one corporate 
parent. It would be as if the FDA had an ownership interest in 
Merck.
    And as we were waiting for this meeting to restart, I came 
up with another analogy. It is this. If I was going to sit here 
and testify, be done with my testimony, take my hat off, walk 
up there, sit down and put my other hat on, it just does not 
work.
    And what is important, again, in the eyes of the individual 
investor, you can come up with tortured descriptions of why it 
is tenable. But they don't buy it. We are in a post-Enron era 
where we have to be very concerned about our credibility.
    I sit here and I say, ``Really, I do like the position the 
Exchange takes and that they want to keep the things 
together.'' I think that is great for our business, my listing 
business. The listing companies, the corporate CEOs that I talk 
to understand that you have to be separated from a regulator. 
So in a real sense, I would have a competitive advantage if the 
New York Stock Exchange chose to keep the regulator combined 
with the market center.
    What really would have to carry the day is the individual 
investor. You cannot have these investors walk away from this 
market because they believe the game is rigged. And I do tie 
back to John Reed's comment. And he came up with a couple of 
words that I think are very interesting.
    He said, ``You can become comfortable with having a 
regulator and the market center together.'' He said, ``I am 
going to come up with a complicated structure.'' Clearly, there 
are ways to engineer it, but in that engineering process, you 
will lose the interest and the faith of the individual 
investor.
    NASDAQ does not simply list public companies. It is itself 
part of the environment of public companies. No NASDAQ CEO has 
ever sat on the board of a listed company. NASDAQ is subject to 
Sarbanes-Oxley and it adheres to the same listing requirements 
that we impose upon our listed companies. This list includes 
standards such as Sarbanes-Oxley 404 and Regulation FD.
    NASDAQ will not complete the task of separating from the--
--
    Mrs. Biggert. If you could come up----
    Mr. Greifeld. I sure will. Okay.
    Just a last point that we want to make is with respect to 
subpennies. We have a market today that really disadvantages 
retail investors. Professional investors trade in subpennies. 
Retailer investors that I talk to; every survey shows that they 
are not aware of this. I think it is harmful and would erode 
investor confidence. And we need to make sure that the 
investors believe Main Street and Wall Street play by the same 
rules.
    If the SEC does not act quickly, we will be forced to 
accept no action as a policy decision endorsing subpennies.
    I do thank you for your time.
    [The prepared statement of Robert Greifeld can be found on 
page 128 in the appendix.]
    Mrs. Biggert. Thank you very much.
    Mr. Lackritz?

  STATEMENT OF MARC LACKRITZ, PRESIDENT, SECURITIES INDUSTRY 
                          ASSOCIATION

    Mr. Lackritz. Thank you, Madam Chair.
    My name is Marc Lackritz, and I am the President of the 
Securities Industry Association. I appreciate the opportunity 
to testify on this very important topic of the structure of the 
U.S. capital markets, because our nation's securities markets 
have long been the most transparent, liquid and dynamic in the 
world.
    This is a really important issue because the functioning of 
our secondary markets allows us to raise capital in the primary 
markets that finances economic growth and is the engine of 
entrepreneurs and jobs and success.
    In the past 10 years, the securities industry has raised 
over $21 trillion of equity and debt to finance economic 
growth. So in a lot of ways, we are at the center of the engine 
of growth. And these secondary markets are critical to ensuring 
that that function continues.
    The success of these markets depends on one word, trust. 
Investors and market participants must always have confidence 
that the markets operate fairly and with complete integrity. 
And they must also trust that the regulators will make fair and 
well-informed decisions about how to regulate these complex 
markets and that they will enforce the rules evenhandedly.
    The dot.com meltdown, the economic recession, terrorist 
attacks, and accounting and corporate scandals have combined to 
form a perfect storm that has greatly shaken the public's trust 
in our industry.
    But Congress and the regulators have taken decisive steps 
through enactment and implementation of the Sarbanes-Oxley Act 
and, more importantly, through tough enforcement actions to 
address corporate wrongdoings, bad faith behavior and outright 
criminal conduct.
    Our industry has worked closely with Congress and the 
regulators on these legislative and regulatory initiatives, and 
we have undertaken efforts on our own to help restore the 
public's faith in our markets and our industry.
    And new revelations at the New York Stock Exchange have 
raised concerns about the dual role of the Exchange as both 
marketplace and regulator of its own activities and those of 
its members. We believe that action should be taken to address 
these concerns, and we suggest that one near-term step should 
be to separate clearly the New York Stock Exchange's member 
regulatory function from its function as a marketplace.
    For example, it might be appropriate to remove regulatory 
activities from the marketplace reporting lines and put them in 
a separate unit within the New York Stock Exchange. There are 
other models, too, that we have outlined in a white paper that 
we submitted to the committee along with my testimony. In the 
longer term, it is appropriate to address the broader issue of 
the structure of self-regulation, and we believe that this 
debate should be shaped by the following four considerations.
    First and foremost, investor protection: Regulation should 
put investors' interests first and foremost. Effective, 
consistent and transparent regulation is essential to keeping 
investors' trust, the most essential element in the success of 
our markets. Secondly, competition: Regulation should promote 
competition, rather than favoring or protecting one market over 
another.
    Three, uniform national standards: The regulatory system 
should ensure the primacy of the SEC as a strong, national 
regulator. The system also should include appropriate roles 
for, and coordination with, the self-regulatory organizations, 
the States, and broker-dealer firms, to achieve uniform 
national standards. And, fourth, expert regulation: Our system 
should be structured in such a way as to ensure that the 
regulatory staff overseeing day-to-day activities possesses the 
requisite expertise necessary to perform their duties.
    We believe the current model of self-regulation has worked 
quite well for our nation, and that this model should be 
preserved and strengthened. Self-regulation contemplates self-
policing by professionals who have the requisite working 
knowledge and expertise about the intricacies involved in the 
marketplace and the technical aspects of regulation.
    The system of self-regulation is supplemented, of course, 
by government oversight. This tiered regulatory structure 
provides the checks and the balances that protect investors 
much better than might otherwise be achievable. Moreover, it 
can be more effective and less costly than regulation by 
government alone.
    Before the recent controversy at the New York Stock 
Exchange, other events raised questions about the needs to 
alter the current regulatory system. We have long advocated 
making timely improvements to self-regulation when appropriate, 
and we strongly support the elimination of unnecessary 
inconsistencies among Federal regulators and self-regulators. 
Duplicative and inconsistent regulation diminishes investor 
protection and contributes to the cost of regulation.
    Investor protection should not be subject to the 
happenstance or whim of whether a broker-dealer is a member of 
one SRO as opposed to another. Redundant regulation also hurts 
investors. They ultimately pay for costs of compliance through 
higher fees or costs. We owe it to investors to give them 
absolutely the best protection we can at the lowest cost.
    We believe there are opportunities to improve the current 
self-regulatory structure, and we stand ready to contribute to 
that effort. In that vein, as I mentioned, we are attaching our 
White Paper that we prepared three years ago, evaluating the 
advantages and disadvantages of six different approaches to 
self-regulation.
    Our securities markets remain the envy of the world. The 
United States continues to offer investors and companies the 
most liquid, innovative, and fair capital markets available 
with unparalleled levels of investor protection.
    And it is this structure that really allows us to raise the 
capital that fuels the economic growth of the broad economy. 
But we hope that an improved regulatory structure can preserve 
these goals that we all share, effective, efficient regulation 
that maintains the trust of investors and all market 
participants.
    We are confident that by working together we can seize this 
opportunity to enhance corporate governance and transparency 
within the SROs and further improve the securities industry's 
regulatory system.
    Thank you very much.
    [The prepared statement of Marc E. Lackritz can be found on 
page 135 in the appendix.]
    Mrs. Biggert. Thank you very much, Mr. Lackritz.
    Mr. Glassman?

    STATEMENT OF JAMES GLASSMAN, RESIDENT FELLOW, AMERICAN 
                      ENTERPRISE INSTITUTE

    Mr. Glassman. Thank you, Madam Chair, members of the 
Subcommittee. My name is James K. Glassman. I am a fellow at 
the American Enterprise Institute, host of the Web site Tech 
Central Station and a syndicated financial columnist.
    One of my main concerns is the nexus between finance and 
public policy, especially as it affects small investors.
    Madam Chair, may I first ask for permission to enter into 
the record the study of economist Brian Becker that was 
referred to earlier by Congressman Bachus. This shows the high 
level of profitability of specialists. This study was the 
subject of a conference just last week at the American 
Enterprise Institute.
    Mrs. Biggert. Without objection.
    [The following information can be found on page 203 in the 
appendix.]
    Mr. Glassman. Thank you.
    The recent resignation of the CEO of the New York Stock 
Exchange in the wake of controversies over specialist activity, 
board composition and compensation has provided a once-in-a-
lifetime opportunity to reform a management structure built on 
a massive conflict of interest. So far, this opportunity has 
been squandered.
    This hearing coming at a crucial time must help reverse a 
course that will inevitably lead to more scandals like those 
involving specialists that we just learned of this morning and 
a further erosion of confidence among your constituents.
    The remedy is to put an end to an unconscionable conflict 
through two steps: first, separating the regulatory and 
business functions of the Exchange and, second, making the NYSE 
a public company owned by thousands of outside shareholders 
just like the nearly 3,000 companies that the Exchange itself 
lists.
    The regulatory function of the New York Stock Exchange and 
of every other exchange and market should be separated by 
contract and by structure from its commercial market function. 
As the best insurance against conflict, the NYSE and the NASDAQ 
should become public companies with the majority of their 
shares owned by outside shareholders who would choose 
directors.
    A system of electing board members, whether there are 27 or 
17 based on the constituencies that they represent, is doomed 
to failure. All directors must be rowing in the same direction 
toward the same goal.
    Unfortunately, top officials of the New York Stock Exchange 
and the Securities and Exchange Commission have not supported 
separation. It happened again today in Mr. Reed's testimony. 
This is a shame, and it is inexplicable, especially today with 
the news that at long last five large NYSE specialist firms 
will face disciplinary action for trading violations that, 
according to reports, could cost investors $100 million.
    And let me be clear: Such violations are inevitable given 
the current structure of the Exchange. Five specialist firms 
have been named. Four of them sit on the board of the NYSE.
    The structure is behind not merely specialist trading 
violations but the very existence of the anachronistic floor 
trading system of the NYSE, the only exchange in the world--the 
only major exchange--that uses an auction system with 
specialists.
    The alternative is to separate the regulated from the 
regulator and to take the Exchange public. And the Exchange 
would not be a completely passive party. It would choose its 
regulator, either private or public, and be responsible for 
that choice.
    The model exists today: the National Association of 
Securities Dealers. The NASD, a private entity with a staff of 
2,000, already regulates the NASDAQ stock market and 5,330 
securities firms. The NASD used to own NASDAQ outright and the 
structure was self-regulatory. The separation was part of an 
effort by the SEC to remedy serious trading proprieties of the 
NASDAQ that emerged in 1996.
    It has worked well, but it is still unfinished. And to 
achieve complete separation, the SEC should move quickly to 
grant exchange status to NASDAQ. A similar complete separation 
should be effected for the NYSE. And both exchanges would then 
be free to launch initial public offerings.
    Finally, the decline in scandals at the NYSE should not 
have been surprising. As Sarah Teslik, executive director of 
the Council of Institutional Investors put it, ``The nicest 
thing you can say about the NYSE and their performance is that 
they are set up in such a way that you can't expect them to do 
a good job. And they have not disappointed us.''
    The Congress, the SEC and the Exchanges and markets 
themselves have the opportunity to end the conflict that 
brought about the current scandals by establishing a new 
regulatory regime when built on choice, competition, strict 
compliance and investor protection. Time is short.
    Thank you.
    [The prepared statement of James Glassman can be found on 
page 120 in the appendix.]
    Mrs. Biggert. Thank you very much.
    Mr. Putnam?

 STATEMENT OF GERALD DEAN PUTNAM, CHAIRMAN AND CHIEF EXECUTIVE 
                 OFFICER, ARCHIPELAGO HOLDINGS

    Mr. Putnam. Thank you, Madam Chair, members of the 
Subcommittee. I am honored to have the chance to testify here 
today on behalf of Archipelago today, which I refer to as 
ArcaEx. Just one moment of branding opportunity here--we used 
to be a very large ECN--today, we are a U.S. national 
securities exchange.
    We have heard a lot today about the virtues of an auction 
marketplace. We, in fact, operate an auction marketplace. The 
difference between ours and the New York Stock Exchange is that 
our auction marketplace involves no specialists and it is 
entirely electronic.
    Today, we operate the largest electronic exchange in the 
world based on dollar volume and the second largest exchange in 
the United States behind the New York Stock Exchange. I guess, 
in the spirit of the season, one of my favorite quotes, it is 
deja vu all over again. We have been here before.''
    Why is the New York Stock Exchange in need of reform? Why 
does the New York Stock Exchange not innovate? And the simple 
answer is that the New York Stock Exchange does not have to 
compete.
    Back in 1995, we were in a similar situation. NASDAQ was 
coming out of a massive scandal: price fixing, collusion by 
market makers.
    One of the solutions, a new rule came from the SEC that 
lowered the barriers to entry and created a competitive 
environment, which actually is the reason why I started my 
firm, Archipelago.
    The results are in. Seven years later--I think it was seven 
years later--we have a marketplace where NASDAQ, the trading of 
a NASDAQ stock like Microsoft went from horrific to where it as 
good or better than the trading of GE, the largest stock on the 
New York Stock Exchange.
    I was asked for my opinion or my views, my expert views, on 
what we should do to fix the New York Stock Exchange; some of 
these things are actually in my best interest to stay broken. 
As a competitor, we like to differentiate ourselves from the 
New York Stock Exchange.
    But one of the key areas, I think, in terms of creating 
more competition for New York, is that a large part of the 
problem is based on New York as a monopoly and New York as the 
regulator.
    We read in the Wall Street Journal today about the 
specialists' scandal. How can a situation like this exist? This 
is not a recent event. This has been going on since that 
blasted goat came into Wrigley Field and cursed our team in 
1945. It is not new.
    How can that happen? And how can we have a CEO of a 
monopoly earn $185 million? When Mr. Bachus pointed this out to 
earlier, there are conflicts on that board and the thing that 
comes to my mind, are things like, ``Why rock the boat?'' I 
won't rock the boat if you don't rock the boat. One hand washes 
the other.
    There are conflicts there. The business head is in charge 
of regulation. Those on the floor that do the things that are 
pointed out in the Wall Street Journal, sit on the board of the 
company and the compensation committee that rewards that 
individual.
    As far as Archipelago is concerned or ArcaEx is concerned, 
we don't like the bullying that takes place. When the regulator 
shows up at our member's office and says, ``We noticed you have 
been trading on ArcaEx. We understand that the floor of the New 
York Stock Exchange represents best execution. We are not sure 
about ArcaEx. So we think we are going to need to have, 12 of 
our police officers in your company for the foreseeable future 
just to make sure you are getting best X.'' It is a competitive 
weapon. It is used.
    I think if you compare the New York's model to the ArcaEx 
model, we actually have this situation of having to be a 
regulator and a marketplace, although our model is very 
similar, is actually similar to the NASDAQ and NASD model.
    I head up the business unit. The people that work for me 
run the business of operating an exchange. Phil DeFeo heads up 
the regulator. The people who are in the business of regulating 
report to him, there is no cross reporting. I have no say over 
their compensation. I have no say over their duties.
    And for those of you--and we heard earlier today about how 
it is hard to regulate electronic marketplaces--for any of you 
that believe that, just one word, the movie ``The Matrix.'' It 
is not a documentary, it is science fiction. It is not hard. 
The machines aren't taking over and thinking for themselves. 
Humans do.
    A very important point to us, and this is something that 
has been raised at the Commission. I have raised it down there 
many times. And we have a window of opportunity to fix 
something here.
    How do you get New York to compete? It is through ITS 
reform. ITS is governed in a way where if any one of the 
competitors of the New York Stock Exchange so much as eyeballed 
that moat around 11 Wall Street, they show up for the meeting 
with a blackball.
    There is a current example. Three very unlikely 
competitors: NASDAQ with its market-makers; ArcaEx with its 
electronic model; and the Chicago Stock Exchange, joined 
together to bring a proposal to the ITS Committee; a major 
reform. The thing that you heard from Bob Greifeld earlier, 
this reform will allow us to compete.
    We showed up with a very, very negotiated proposal. The New 
York Stock Exchange showed up with a black walnut in their 
front pocket. That proposal for change; reform was put on the 
table. The New York Stock Exchange used its single veto and 
vetoed it.
    Fortunately today, we actually have a program that was put 
in place by the SEC, a pilot program about a year ago in three 
securities: these three securities, one of which is QQQ. It is 
the largest, most liquid stock in the world. We have a de 
minimus trade-through experiment going on there. You can trade 
through the better price by up to three cents when a customer 
chooses speed over absolute dollar best price.
    Well, the results are in. We are the largest marketplace, 
ArcaEx is, for trading QQQs. New York has one-third the market 
share that we do in that security. Put them in a competitive 
environment with their system, and they don't do so well.
    I am going to ask the question: Why don't we do as well in 
GE, the most liquid, largest stock that trades on the New York 
Stock Exchange? It is because of the competitive barriers. 
Those competitive barriers need to be removed.
    Thank you.
    [The prepared statement of Gerald D. Putnam can be found on 
page 182 in the appendix.]
    Mrs. Biggert. Thank you very much.
    Mr. Frucher?

   STATEMENT OF MEYER ``SANDY'' FRUCHER, CHAIRMAN AND CHIEF 
         EXECUTIVE OFFICER, PHILADELPHIA STOCK EXCHANGE

    Mr. Frucher. Thank you very much. I would like to thank the 
committee for having me here today.
    My name is Sandy Frucher. I am Chairman and Chief Executive 
Officer of the Philadelphia Stock Exchange. On behalf of the 
Philadelphia, I appreciate the opportunity to speak at this 
hearing. And I would like to express our views on market 
structure.
    This is a complicated subject, but I think it is very 
simple in a lot of ways. It is all about competition.
    Let me begin by saying a word about the Philadelphia and 
the role of the regional Stock Exchanges. The Philadelphia is 
the oldest securities exchange in the United States. We trade 
over 2,000 stocks listed on the New York and American Stock 
Exchanges, over 1,000 equity options, and industry sector and 
currency options.
    Collectively, the Philadelphia, the Chicago, the Pacific, 
the Boston and the Cincinnati Stock Exchange form an essential 
pillar of our national market system. While we differ in many 
respects, we all make markets in stocks listed by the New York 
and, thereby, provide needed competition for the Big Board.
    The regional Stock Exchange survived because competition 
forces us to innovate. For example, the Philadelphia employs an 
electronic system of remote competing specialists. On our 
exchange, many stocks have three or four specialists competing 
to offer the best price rather than a single specialist as on 
the New York.
    But frankly, that should be their choice. Their market 
structure should be their own. And how they compete in the 
marketplace, the marketplace should ultimately determine their 
fate, not a regulator.
    The legal and regulatory environment in which the regional 
exchanges operate must foster the broadest possible 
competition. Congress has already endorsed this view. In 1975, 
Congress told the SEC to promote, ``Fair competition among 
brokers and dealers, among exchange markets and between 
exchange markets and markets other than exchange markets.''
    Congress understood that greater competition produces 
greater benefits for investors and more dynamic and fair 
markets. To maximize competition, exchanges and dealer markets 
must be free to compete in terms of all the services they offer 
investors. Markets obviously compete on price, generally the 
best bid and offer available on each market. We also compete on 
the basis of fees we charge, on speed of execution, the depth 
of our liquidity, the convenience of our technology, our 
trading rules and so on.
    The Philadelphia believes that exchanges must also be free 
to compete on factors such as degree of order interaction and 
possibility for price improvement. So long as the SEC allows 
all exchanges the chance to explore different modes of trading, 
this competition between marketplaces will translate directly 
into benefits for investors.
    Let me turn to the self-regulation functions for a second. 
The Philadelphia believes that self-regulation by individual 
exchanges has worked very, very well. Each exchange is most 
knowledgeable about its own trading system and trading rules, 
its own members and the dynamics of trading in its marketplace. 
As the local authority, each exchange is therefore better 
situated to assess conditions, enforce its rules and prevent 
violations than is a distant regulator.
    Monopoly in regulation is as bad as monopoly in trading. 
The fact is is that self-regulation is not sole regulation. 
There is a tiered system of regulation. And it is very, very 
important, I believe, to keep the ethic of regulation, of 
integrity in the marketplace. To separate it would be a grave 
mistake.
    The cornerstone of our financial system is the obligation 
of every player to self-regulate. And that should not be lost 
during this period of time.
    While the PHLX does not support a single self-regulator, we 
do support regular evaluation by Congress and the SEC on how 
well the Exchanges are doing their job. Recent events at the 
New York Stock Exchange may create a perception that exchange 
regulatory functions are subject to inappropriate influence.
    Rather than abandoning self-regulation, the Philadelphia 
believes the SEC and the New York Stock Exchange should look at 
overall governance issues. That is the key; that is the 
problem. And Mr. Reed seems to be doing that.
    Since 1997 in the Philadelphia, non-industry members have 
consisted of a majority, they have been a majority of our 
board. They have played a very influential role based on their 
enhanced participation in our governing committee. We believe 
that this structural change has been a very, very important 
part of the integrity and the enhancement of our regulatory 
program.
    Exchange members also have an important role to play in 
exchange governance, particularly because they bring to bear 
critical knowledge of industry trends, operations, and 
practices. We don't want to dumb up the boards. We just want to 
make sure that there isn't a conflict of interest.
    Therefore, they have, and should have, a significant role 
on exchange board and committees. But there is an appropriate 
balance that must be struck between public members' 
representation and how oversight is conducted in key functions 
such as regulation, audit, compensation, and nomination of 
future directors.
    This is the best way to safeguard independence of the 
regulatory function through the governance. You have to have a 
majority public, and they have to be in the key areas to ensure 
that you don't have a conflict.
    I will conclude by touching on two risks important to 
independent regulation.
    First, we understand that the SEC is considering proposals 
that would affect the structure of market data revenues and the 
distribution among market participants. Exchanges are required 
to collect and disseminate market data from their members and 
incur costs in doing so. Revenue from the sale of that data is 
an important source of funding, particularly for regional 
exchanges.
    Reducing the market data revenue available to regional 
exchanges would limit our ability to fund our operations, 
including regulatory functions, and to provide competition to 
the New York and to the NASDAQ.
    A second concern is the creation or sponsorship by 
exchanges of programs for payment for order flow. Exchange-
sponsored payment for order flow programs, in my view, are a 
conflict. We believe that these programs may create conflicts 
in the exercise of exchanges' self-regulatory obligations, and 
we have submitted a petition to the SEC and we have asked them 
to ban the practice.
    A more complete statement of my views on these important 
matters is contained in my written testimony.
    I want to thank the Chairman and the members of the 
committee for affording me the opportunity to share my views 
and those of the Philadelphia Stock Exchange.
    [The prepared statement of Meyer Frucher can be found on 
page 103 in the appendix.]
    Mrs. Biggert. Thank you very much, Mr. Frucher.
    Mr. Colker?

   STATEMENT OF DAVID COLKER, PRESIDENT AND CHIEF EXECUTIVE 
               OFFICER, CINCINNATI STOCK EXCHANGE

    Mr. Colker. Madam Chair and other members of the 
Subcommittee, I would like to thank you for the chance to share 
my thoughts on the important issues of the day.
    I would also like to thank Mrs. Biggert for her kind 
recognition of our presence and important place in the Chicago 
financial community. Thank you.
    Last year, Cincinnati became one of the largest Stock 
Exchanges in the country. We recently set a trading record of 
415 million shares and 900,000 trades. We currently trade 20 
percent of all the business in NASDAQ-listed issues.
    We have achieved this growth by being a leader in 
technology, market structure, innovation, cost reduction, and 
effective regulation.
    For example, we were the first exchange to eliminate our 
physical trading floor and go totally electronic. We were also 
the first exchange to provide automatic executions in the 
Intermarket Trading System, as well as the first to develop a 
complete electronic audit trail for trading activity.
    In addition, we were the first exchange to implement a 
competing specialist system and to combine that system with a 
professional time modification called preferencing to 
facilitate electronic internalization of order flow.
    Finally, Cincinnati was the first exchange to share all of 
its excess transaction fee and market data revenue with its 
members. By combining the operating leverage that comes from 
being all-electronic with the adoption of a utility cost model, 
we have established ourselves as the low-cost provider of 
exchange services.
    All these innovations have come in the face of enormous 
resistance to change by the incumbents. For too long we have 
had to live with policies that protect monopolies rather than 
promote competition. For too long policymakers have accepted 
the false belief that if only all order flow could be directed 
to one physical location, then customer order interaction would 
be maximized and the public investor would get the best price.
    Lip service was paid to the idea of competition between 
exchanges, but if any of the non-primary exchanges came up with 
too good an idea and started capturing order flow, this 
accomplishment was viewed as a problem and labeled with the 
pejorative word ``fragmentation.''
    Recent events, however, have called these beliefs and 
policies into question. More importantly, recent troubles in 
New York are symptomatic of deeper problems and highlight the 
need for the SEC to seriously address the outstanding market 
structure issues.
    We hope that the current problems in New York will 
translate into constructive market structure modification so 
that the public investor can benefit from the interplay of true 
competition.
    While Cincinnati certainly doesn't have all the answers, 
there are two issues, however, that we believe deserve 
immediate attention. First, we would like to address the 
unfairness that allows NASDAQ to monopolize the decentralized 
market model, a model that does not require price-time 
priority.
    Exchanges have been trying for over two years to get SEC 
permission to compete with NASDAQ by adopting NASDAQ's model 
when the Exchanges trade NASDAQ issues. This request is just 
plain fairness and common sense; particularly in light of the 
fact that the empirical evidence shows that a decentralized 
trading model like NASDAQ's actually provides better execution 
quality than New York's auction market.
    In a world where NASDAQ is handling 12 percent of all the 
trading in New York-listed issues, there is no longer any 
legitimate distinction between exchanges and the securities 
association, and therefore it is no longer appropriate to 
prevent Cincinnati from trading NASDAQ stocks in the NASDAQ 
style simply because it is an exchange.
    If the SEC is unwilling to permit an exchange to make 
price-time priority voluntary because of perceived investor 
harm, then the Commission should act to equally protect 
investors who trade on NASDAQ by requiring NASDAQ to impose 
price-time priority.
    Second, the Intermarket Trading System needs to be changed, 
as my compatriots have also said. Three developments are 
driving this need for reform.
    First, the world is much more electronic than when ITS was 
first created. Second, the minimum trading variation has been 
reduced to a penny. And, third, the national best bid and offer 
is no longer a reliable indicator of the best available price.
    All of this has created tensions and frictions as automated 
markets are struggling to interact with manual markets. No 
other market structure change would do as much to force New 
York to have to compete than the modification or elimination of 
the ITS trade-through and locked market rules.
    The definition of best execution has evolved beyond just 
price and now really is defined as a variable set of 
expectations that include price, cost, speed, and certainty of 
execution. Best execution can no longer suffer the inherent 
delays in ITS.
    If the SEC were to remove the constraints of the ITS trade-
through and locked crossed-market rules, and require ITS 
participants to provide automatic executions, then the broker-
dealer community would have the tools it needs to provide 
investors with best execution and the securities industry would 
begin to realize the full potential of a national market 
system.
    In closing, let me just stress to you just how profoundly 
the capital markets have changed. Because of electronic markets 
it is an entirely different world than even a few years ago. 
Our regulatory overseers have to adapt to this change.
    It is imperative that the rules establishing the structure 
of our markets change soon so that the full value of 
competitive choice can be unlocked. Anything short of that will 
only protect the incumbent exchanges and hurt the public 
investor.
    Thank you.
    [The prepared statement of David Colker can be found on 
page 92 in the appendix.]
    Mrs. Biggert. Thank you very much, Mr. Colker.
    Professor Coffee?

 STATEMENT OF JOHN COFFEE, JR., PROFESSOR, COLUMBIA UNIVERSITY 
                         SCHOOL OF LAW

    Mr. Coffee. Good morning, Madam Chair.
    As your final speaker, I will try to be brief and keep my 
message very simple; focused on the corporate governance 
issues.
    When you pierce through the lurid tabloid-style details 
about Mr. Grasso's extravagant compensation, and when you get 
just beneath the surface, you hit the real public policy issue, 
that this embarrassment, this scandal, revealed a deep-seated 
conflict of interest.
    Put simply, Mr. Grasso's 1995 and 1999 contracts were 
negotiated with a compensation committee of the New York Stock 
Exchange Board, all of whose members were Chief Executive 
Officers of broker-dealers.
    In effect, the securities industry had a structure, under 
which, it held a carrot and a stick by which it could reward or 
punish, not just Mr. Grasso, but all the senior officers of the 
New York Stock Exchange, including those who had primary 
responsibility for regulatory and enforcement matters.
    That compromises, at least in the eyes of the public, the 
independence of the New York Stock Exchange as a regulator. Mr. 
Donaldson testified yesterday that he considered it to be, ``An 
inherent conflict to combine regulatory and market functions.''
    Okay, I think there is no need to further argue the point 
that there is a deep conflict of interest. What do we do about 
it? I think there are two potential models that the SEC would 
see. And I am going to suggest that the more conservative of 
the two is perfectly adequate. But we have to go all the way 
with that more conservative model.
    That is, there is already a proven and workable remedy, 
which lies in what was done in 1996 when the NASD was 
reorganized. Following a scandal, at that time, the NASD was 
also in the public eye as an organization that had become 
dysfunctional.
    And it solved the problem based on a committee led by 
Senator Warren Rudman, which recommended separating the two 
functions and placing all of the regulatory activities of the 
NASD in a new, wholly-owned subsidiary called NASD Regulation, 
which was in principle, to have an all independent board of 
directors having no contact with the securities industry.
    Okay. That was done 1996, 1997. Once, and not so long ago, 
well within my professional memory, the NASD was seen by most 
as a tame and largely toothless tiger, not a very powerful 
enforcer.
    Today, the world has changed. The NASD, or NASD Regulation 
is perceived by all as proactive and a very effective enforcer. 
What is the message? The message, I believe, is that 
independence makes a difference. Independence can improve the 
quality and the quantity of enforcement.
    Now, please note that if we were to follow the NASD model, 
we would place all of the regulatory activities of the New York 
Stock Exchange in a wholly-owned subsidiary--call it New York 
Stock Exchange Regulation, Inc.--which would have independent 
directors having no contact with the industry. What would be 
the costs of doing that?
    Let me suggest that there is no wrenching organizational 
change that follows from this simple step. No one even would 
have to change their office, no lines of authority or reporting 
would be changed, no one becomes more distant. I am not 
suggesting having the New York Stock Exchange regulated by some 
super regulator located in Washington.
    I am suggesting the same people doing it today, who 
continue to do their job, but they would have an independent 
board of directors to insulate them. And insulation is what you 
need, particularly when an organization faces increased 
competitive pressure.
    In the past, the New York Stock Exchange did not face 
competitive pressure. As you are hearing, it is going to face 
more pressure for the future. When you look at what really 
happened in the NASD embarrassment in 1996, most commentators 
have said, as I summarize in my materials, that essentially a 
very zealous management of the NASD subordinated their 
regulatory responsibilities to their desire to maximize their 
marketing of their institution: the NASDAQ market.
    That same thing could happen in the future to the New York 
Stock Exchange even if all compensation problems are resolved. 
Even though we have a perfectly clean system for determining 
the compensation of the New York Stock Exchange's officials, 
there is still the desire in the competitive world not to 
embarrass your organization. And that could lead to having 
regulators pull their punch.
    Therefore, what you want is an insulated regulatory arm 
with its own board of directors. And the key role to that board 
of directors would really be to determine each year what is an 
adequate regulatory budget, because that is the invisible issue 
that no one else has yet mentioned.
    You have got to have an independent board to say, ``Here's 
what we need to function effectively.'' And that adds 
transparency to the process. That group could handle those 
issues.
    My time has run out so let me not address anything more on 
this issue. Let me just add one final sentence. You have heard 
a lot of talk about other reforms that might be pursued. Let me 
say from some experience in this deal that there are very 
inconsistent goals in securities market regulation.
    The public wants the lowest possible spread, the highest 
possible liquidity, the quickest possible execution, and oh, 
yes, a buyer and seller of last resort always there. Those 
things don't all go together. There are trade-offs. There are 
inevitable trade-offs.
    You have to move incrementally. There is no magic bullet. 
And I would suggest to you that many of these problems require 
SEC study.
    The one simple problem is minimized conflicts of interest. 
And if all we do is come back in a few months and have a better 
board for the New York Stock Exchange, we haven't protected and 
insulated the regulatory function.
    That requires a truly independent board of directors so 
that enforcers know they will not be subject to invisible 
reprisals.
    Thank you.
    [The prepared statement of John C. Coffee, Jr. can be found 
on page 83 in the appendix.]
    Mrs. Biggert. Thank you very much, and now we will turn to 
questions. And each of us will have five minutes, so I will 
yield myself five minutes for questions.
    Mr. Glassman, in your testimony, you criticized the SRO 
framework. And self-regulation has been viewed as having 
certain advantages over direct government regulation.
    Number one: that industry participants bring expertise and 
intimate knowledge of the complexity of the industry. And, two: 
self-regulation supplements the resources of the government, 
thus reducing the need for large government bureaucracies.
    What do you say about these purported benefits? And do they 
justify the existence and continuing of the current system?
    Mr. Glassman. Yes. Madam Chair, I agree that there are 
benefits to, let us call it private regulation rather than 
government regulation, and that is, in fact, why I advocate 
private regulation.
    But that regulation should be separate from the commercial 
activities of the institution that is being regulated.
    So in my model what I would suggest would be something very 
similar to what is going on right now with the NASD's 
regulation of NASDAQ. NASD is a private company that has been 
contracted, that NASDAQ has contracted with, to provide its 
regulation.
    There might be other private companies that could compete.
    In fact, there could be public regulators who could also 
compete, and compete for the regulatory contract and would be 
paid by the institution being regulated. But I do not advocate 
this as an extra function for, for example, the SEC.
    Mrs. Biggert. Okay, thank you.
    Professor Coffee, when you talk about the independent 
directors--and I know Mr. Reed talked about the independent 
directors as excluding individuals from the trading floor and 
other broker-dealer industry, as well as the current CEOs of 
the listed companies, and he kept talking about how you need a 
professional board--so, who would serve on such an independent 
board that is not tied into the industry?
    Mr. Coffee. I think you could look at NASD Regulation. They 
also set up an independent board. There are people from the buy 
side. There are retired CEOs. There are people who once upon a 
time, five years ago, were chairmen. There are New York Fed 
bank Presidents. There are Nobel Prize economists in economics.
    All of these people understand something about trading 
markets. They are not people who are very distant from it. And 
I think they would be interested in such a role.
    I think there is going to be a lot of people who would be 
very interested in working with the New York Stock Exchange, 
either at the board of the entire exchange, or in a board 
specially focused on regulation.
    On the regulatory board, you could have people who had 
formerly been the head of enforcement of the SEC. All those 
people know about enforcement and know what makes it work.
    Mrs. Biggert. As long as there is no conflict of interest, 
then.
    Mr. Coffee. I think anyone who is going to be head of 
enforcement of an agency knows that there is body language by 
which the Chief Executive can signal to him he doesn't want 
this pursued, ``This is embarrassing, this is messing up our 
IPO we had planned for next year, or this is giving us a bad 
image, you are doing too much.''
    If you instead are insulated by a board of independent 
directors who know their function is to make you an effective 
regulator, I believe your behavior will be different and I 
think the change in behavior at NASDR is some evidence of that.
    Mrs. Biggert. Thank you.
    Mr. Putnam, I share the concern about the goat's curse of 
the Cubs. ``Wait till next year!"
    You talked about the 1990s investigation of the NASDAQ 
stock market that led to the separation of the regulatory to 
the NASD.
    And then there is an ongoing investigation of the 
specialists for the New York Stock Exchange, and that has been 
in the paper this morning. Did that announcement color your 
speech as far as--the action against the five specialists--has 
that colored your view any more or was that expected?
    Mr. Putnam. It was expected. And as a participant in the 
industry for 22 years, what goes on with the specialists on the 
floor of the New York Stock Exchange, since the first day I 
learned about New York Stock Exchange trading, it has been 
going on. So it is not recent.
    Mrs. Biggert. And how would you recommend that the New York 
Stock Exchange restructure its market trade function to prevent 
the middlemen in the trading of securities from benefiting at 
the public expense?
    Mr. Putnam. Again, I think that what I was trying to say is 
that when you have the head of the business wear the same hat 
as the head of the regulator, these inherent conflicts are 
going to exist. And we have seen this, ``Right?"
    So a very large paycheck goes out to the CEO of a monopoly 
who is also looking the other way when those people, who are 
the participants on the floor, are making a bundle of money by 
violating these rules and standards.
    So you need to separate, at a minimum. I am not saying New 
York needs to spin off that regulator into a separate company 
that has no relationship to it, but, at a minimum, you can't 
have the same head of each organization.
    In our PCX relationship, PCX is independent of us. They 
have a committee called the ROC, the Regulatory Oversight 
Committee. It is made up of independent directors. No 
relationship whatsoever to me. That is the ultimate 
jurisdiction.
    On the regulatory side of that business, it governs ArcaEx, 
the Exchange. It is clean. There are no conflicts.
    Mrs. Biggert. Thank you.
    Mr. Kanjorski is recognized for five minutes.
    Mr. Kanjorski. Well, thank you very much, Madam Chairman.
    One of the issues in the debate about the market structure 
that concerns internalization of customer orders--I know that 
some of the panelists have views on this issue--if 
internalization of orders increased, how will this affect the 
investors? And I would actually like an opinion of all seven of 
you, if I can.
    But we can start off with the Philadelphia Exchange and 
then go to NASDAQ----
    Mr. Frucher. I am sorry. Could you repeat the question just 
a bit? I have lost----
    Mr. Kanjorski. The issue of internalization.
    Mr. Frucher. Oh, internalization.
    Mr. Kanjorski. Yes.
    Mr. Frucher. I am glad you raised that issue. The SEC has 
taken a position on two issues. And three Chairman, actually 
that I have known, have all wagged their fingers at us and said 
both internalization and the question of payment for order flow 
is a terrible, terrible thing. And yet they proceed to move the 
ball forward in both those areas as they promised continuously 
to come out with a position paper to clarify their position.
    Internalization itself is not necessarily bad; it is the 
degree of internalization. If you have extensive 
internalization, you have an inherent, or the potential for an 
inherent, conflict of interest. If you have a regulator--such 
as an exchange engaged in a taxing process where we take money 
from one player, give it to another player to buy order flow to 
the Exchange--it is inherently a conflict of interest.
    That and issues like the ITS system really require 
leadership from the SEC. We need to know their position on 
these issues, and then you need to devise policies, or at least 
get comment from the public, including the affected public on 
where it stands.
    So, I think that internalization and payment for order flow 
by exchanges are two issues that the SEC really must come 
forward before they allow a new exchange like the BOX, which is 
an internalization model, to proceed and before payment for 
order flow further erodes the integrity of the marketplace.
    Mr. Greifeld. Internalization really is another word for 
competition. NASDAQ has been about competition since its 
inception in 1972. And the market makers in the NASDAQ market 
structure provide execution solutions to investors. And they 
need to improve upon what is available through the NBBO.
    And what we have today is a very clear measuring stick and 
it is called the Dash 5 stats. And that is what the SEC 
mandated when they collected the data. And the Dash 5 stats 
clearly show that NASDAQ's competitive model yields a better 
outcome for investors.
    In my testimony, I have made reference to the S&P 500, 
where our spreads are tighter; our speed of execution is 
quicker. That does not happen by accident. That happens because 
we have competition; we have competition between ECNs, we have 
competition between market makers who are trying to offer a 
better execution solution.
    And that is in stark contrast to the competing model, where 
there is one specialist who is monopolous. NASDAQ has multiple 
market participants and it yields a better outcome, and you can 
track that through the Dash 5 stats.
    Mr. Colker. Mr. Kanjorski, if I may also, respond to that 
question?
    Mr. Kanjorski. Yes.
    Mr. Colker. Thank you.
    First of all, internalization is a widespread practice on 
all exchanges. As Bob mentioned, the NASDAQ is really entirely 
an internalized market and also just on Cincinnati and the 
other exchanges. The empirical evidence, as Bob said, shows 
that, in fact, maybe it appears counterintuitive to people that 
are not in the business, but the empirical evidence shows that, 
in fact, internalized markets provide better executions than in 
the auction market.
    And the reason is it gives the brokers better control over 
the execution quality for their own customers. It is like Wal-
Mart wanting to keep control of their customers vs. sending it 
down to Target. And the reality is that all this activity is 
transparent. The SEC is requiring the Exchanges to disclose 
this information.
    And so the customers see the quality of service they get. 
And you can bet that if they are not getting the service they 
need, they are going to go to a competitor. So, internalization 
is really a necessary tool in the community to keep control 
over execution quality and efficiency of execution.
    Mr. Kanjorski. Yes?
    Mr. Lackritz. Mr. Kanjorski, I think that internalization 
is an inevitable result of deregulation of Commissions and 
encouraging competition. Since the regulatory structure that we 
favor should encourage competition, internalization and payment 
for order flow obviously are outcomes of that.
    But that doesn't mean that the transactions are removed 
from other kinds of considerations in the regulations, such as 
best execution. The broker-dealer still has the obligation of 
getting best execution for the customers under any 
circumstance.
    And so there is a check and a balance to protect against 
any kind of abuse or excess that result from it. But the 
existence of internalization really is a natural outgrowth of 
competition and, therefore, it is not a bad thing, although it 
sounds like it initially.
    Mr. Putnam. I would agree that internalization is certainly 
an outgrowth of competition. It is one way that an investor can 
get a stock executed. But it is important, and there is some 
missing information here. Is a lot of that one-five data that 
we are talking about, so that measuring how a marketplace does; 
a big component of that is executions that occur in our system 
where internalization is not allowed.
    In our system, price competition is rewarded. If you are 
the first one in line at the best price, you are guaranteed to 
get the next trade at that price. In that way, investors 
compete aggressively to make tight spreads, to be the next one 
in line.
    There is a serious question today about whether exchanges 
should be allowed to play both roles. And I would say it is a 
serious mistake to change the definition of an exchange that 
takes the value of that price competition away by allowing an 
internalizer to merely match, to step in front of the next 
investor that is in line.
    You will dilute the value of price discovery if you allow 
it. It is on the table today with NASDAQ's exchange 
application. It absolutely should be prohibited.
    Mr. Frucher. Mr. Chairman, I just want to say, you know, 
every Chairman of the SEC in the last six years has raised 
questions about the question of internalization. What is 
internalization? It is one firm taking both sides of the market 
and that looks inherently like a conflict.
    I think it is very, very important--it doesn't necessarily 
mean it is--it looks like it is a conflict. And I think that we 
really need guidance here from the regulator as to what their 
position is on these issues.
    You can't just keep shaking your finger at it, saying it is 
a vile practice, and then not give us any direction or any 
insight on your thoughts.
    I really think that we are all waiting for this SEC 
position paper on this issue so that we can have a reasonable 
debate. People with different business models obviously have 
different points of view, as you do on things like the ITS 
system.
    But I think it is important for the regulator to step 
forward and give us its views so that this debate can begin.
    Mr. Coffee. For the future--I am giving you a slightly 
dissenting view here from the rest--for the future, the problem 
with internalization, which certainly is the product of 
deregulation, and it is not a sinister practice--it is 
predatory in design, but its problem is that it is a form of 
market fragmentation.
    When the broker-dealer internalizes the order and trades at 
what the distant market price was, we are losing order flow 
that went into the former process of price discovery.
    Today, NASDAQ trades less than 20 percent of NASDAQ-listed 
stocks. Maybe 30 or 35 percent are internalized, the rest go 
through ECNs which match limit orders in Cincinnati. Against 
that backdrop, if that trend continues, and if NASDAQ were to 
fall to trading something around 10-12 percent, we don't have 
the same deep, liquid market determining price discovery.
    We have got 70 percent or more of the market being 
determined, with reference to a relatively thin market, because 
internalization effectively is drawing stock outside of the 
normal processes of price discovery. And I think the historic 
goal of the SEC is to make sure there is a deep, centralized, 
liquid market, and they have a reason to be nervous about 
excessive fragmentation.
    If the orders fragment away from the central market, over 
the long run I think there are some dangers to small investors.
    Mr. Putnam. My branding speech, though: Cincinnati 
exchange, ARCA exchange, ECNs, NASDAQ.
    Mr. Colker. I have one quick thing. What people may not 
realize today is that the market really is centralized 
electronically. There is no give-up of interaction in market 
information today simply because of internalization.
    Anybody who is internalizing or trading in any other 
fashion has complete information today on their PC of the 
market information of every other exchange and ability to 
route. So, there really is a centralization. And fragmentation 
really is just a pejorative word for competition.
    Mr. Kanjorski. I have never seen Jim without an opinion. 
Did you want to throw yours into----
    Mr. Glassman. Actually, thank you, Congressman.
    I actually don't have a very strong opinion on this. I am 
generally in favor of internalization, but I think you have 
heard from people who are more expert than I am.
    You probably never thought you would hear me say this.
    Mr. Kanjorski. Very good.
    Mr. Glassman. Thank you.
    Mr. Kanjorski. Thank you, Madam Chair.
    Chairman Baker. [Presiding.] Thank the gentleman.
    Mr. Shays?
    Mr. Shays. Thank you, Mr. Chairman.
    Mr. Chairman, I am grateful that all of these gentlemen are 
here. I was kind of enjoying the fact that there were few of us 
here so we could ask lots of questions. I was feeling very 
honored that so many would speak to so few.
    As I see Mr. Glassman and Mr. Coffee, I view you more as 
disinterested parties, in the sense that you are not speaking 
for the businesses that you are involved in.
    Mr. Glassman, when I heard you speak, I said, ``Yes, I 
agree with everything. It was pretty definitive and so on.'' If 
you were listening to Mr. Coffee, he started to qualify--
educate me a little bit more about all of these other things I 
should consider--he went beyond your area of discussion.
    Where would you disagree with him?
    Mr. Glassman. Well, I think that Mr. Coffee was saying that 
he feels that as long as you separate the regulatory function 
from what is called the business function, within the same 
institution, but with different boards of directors, that you 
can do the job.
    I don't want to misstate anything that he said. I would 
say, go all the way. I don't see why that is necessary.
    What I would say would be essentially something similar to 
the, as yet, incomplete NASD NASDAQ separation where you have a 
business that contracts with a regulator--in this case NASDAQ 
contracting with NASD, or the NYSE contracting with NASD or 
anyone else that it chooses--and has a complete arm's length 
relationship, is a contractor, really.
    And I think that would provide much more of a separation 
than what Professor Coffee just said. I don't have a huge 
disagreement with what he said, but I think at any rate that is 
the direction that it ought to go in.
    Let me just repeat what I said in my testimony. I think 
this is a massive conflict of interest. And it is hard for me 
to even understand why there are----
    Mr. Shays. I am kind of with you on that. So you reached 
me.
    Mr. Glassman. Okay.
    Mr. Shays. I would probably make sure that my conflicts of 
interests are stated, given that NASDAQ is in the district that 
I represent. First, they are first among equals with this 
group, but obviously I have a conflict here.
    What I would love to have--and I gather that the other 
exchanges have variations on what we are talking about, some 
don't go, ``All the way,'' as you say, Mr. Glassman--but I 
would love to have someone speak to the issue of why the New 
York Stock Exchange has--in fact, I am almost feeling sorry for 
this organization and I never thought I would, given what 
everybody has said about it today--but given it has 84 percent 
of the trading that it has listed--and I believe NASDAQ has how 
much of the trading?
    Mr. Greifeld. Fifty-five percent.
    Mr. Shays. Not 20?
    Mr. Greifeld. Well, we have 20 percent in our time price 
priority product called Super Montage. And then in addition to 
that, you have the market makers internalization, which 
represents another 30-something percent of the market.
    So the percent of trades that happen in NASDAQ is around 55 
percent. And I think it is important to note in tying back to 
Professor Coffee's point, before NASDAQ had execution systems, 
the way the Professor was defining it, our market share was 
zero.
    So you have to understand that NASDAQ has never been about 
doing executions in and of itself. It is about providing 
competition in a given market structure where market makers can 
provide execution solutions.
    Mr. Shays. So you have benefited by the competition, but 
there are others who want to compete with you. And are you in 
any way, can anyone accuse NASDAQ of opposing others from 
competing with what it is doing?
    Mr. Greifeld. No. I mean, post-1997, as I think a lot of 
panelists have said NASDAQ truly was an open, competitive 
environment. What you saw is when decimalization came about--
and it was a good act of Congress that brought that on--you had 
a demand for an agency solution in our marketplace. And that 
demand was met quite effectively by the ECNs.
    The market makers are geared around principle transactions. 
And when decimals made the spread so tight, they didn't want to 
act on a principle basis; the ECN stepped in NASDAQ marketplace 
and really helped drive the great outcome we see for investors 
today.
    Mr. Shays. Let me quickly ask, ``Can someone give me a keen 
defense of why we have to have specialists?"
    Mr. Frucher. Yes. Specialists provide depth of liquidity to 
the market. I think everyone has a right, or should have a 
right, Congressman, to create and to execute their market 
structure. I think competition is a good thing.
    The New York specialist is not the only specialist. We have 
multiple specialists in the same stock in Philadelphia, which I 
think is an advantage. It may work for us; it may not work for 
New York. A single specialist did not work for us.
    I think market structure should be left to the individual 
market and the market will determine who the winners and the 
losers are. What you need to ensure is the integrity of the 
marketplace, an integrated national market system so that you 
can, in fact, have best executions for the customer.
    So it is a question of integrity and competition. Those 
should be the two cornerstones. Regulation shouldn't determine 
New York market structure any more than it should the NASDAQ 
market structure, but frequently regulation does. And with all 
due respect to Mr. Greifeld's statement, before he got to 
NASDAQ, NASDAQ spent a whole lot of time trying to protect its 
own monopoly, if you will.
    And Mr. Greifeld was on the other side----
    Mr. Shays. You don't believe in being born again?
    Mr. Frucher. What?
    Mr. Shays. You don't believe in being born again?
    Mr. Greifeld. I am the same guy I was before.
    I am the same guy I was, but I came to NASDAQ recognizing 
we are in an open, competitive environment and if we didn't 
have that, I probably would not have come to NASDAQ. And that 
is my background, that is what I like to do. And that is truly 
the----
    Mr. Shays. I am going to let him get the last word, only 
because I am the constituent.
    Mr. Frucher. You know, all politics is local.
    Mr. Shays. All politics is personal. Thank you.
    Chairman Baker. Enough of that. Thank you.
    Mr. Meeks?
    Mr. Meeks. Thank you, Mr. Chairman. I thought he was good.
    Coming from New York or being from New York and finding 
basically the capital markets in particular are important to 
New York's economy, but it is also important for the cause of 
this nation.
    In fact, I think that one of the reasons why the World 
Trade Center was targeted by terrorists is because they really 
want to attack our economy and our financial institutions. And 
all of you, including the New York Stock Exchange, are very 
important to our great economy.
    And so, having you here at once and seeing you basically 
competing in that competition between you, I think that is a 
good thing. It is a good thing for me because competition is 
good, and I just wish that all of you and I hope that all of 
you prosper and become very prosperous and make a whole lot of 
money over the next coming years, because it is good for 
America, it is good for the American people.
    I just have one--just trying to understand--one quick 
question that I will throw out to the group. And that is that 
some argue that there is a trade-off between attempting to 
receive price improvement and obtaining fast, certain execution 
speed.
    My question is, ``How often does a 10-to 30-second delay in 
execution cause a change in the original best price?"
    Mr. Greifeld. If I can respond to that.
    Decimals, again, really represented a sea change in our 
environment. Before Congress mandated decimals, you had spreads 
that approached 25 cents, 12.5 cents. And you could argue, I 
think successfully then, that there was true value in running 
an auction on a floor, where you could save an investor a 
nickel or a dime, you could say that was worth the time 
differential.
    But post-decimals, we see that stocks trade for the one-
cent spread or a two-cent spread. I was with the CFO of 
Microsoft a week or so ago and I was reviewing his trading 
characteristics, and he actually trades with a net effective 
spread today less than a penny.
    The investors in Microsoft do not want to wait. Once you 
have got the price discovery happening in the quote, where the 
spread is a penny, investors demand speed, first and foremost.
    That was very public this week with Fidelity in the press, 
but it is also very much the concern of the retail investors. I 
talk to them on a regular basis and they care about speed. When 
they click on that buyer sale order, they want to see that 
execution come back.
    So in the world that we live in today, where you have tight 
spreads as a result of decimals, speed is paramount.
    Mr. Putnam. If I could add something. The 10-to 30-second 
price improvement period without competition, it causes this: 
the specialist probe. It is during those 10 to 30 seconds that 
all the shenanigans in the name of price improvement take 
place.
    Now, you get a choice. If you have real competition without 
barriers, you don't like the food in that restaurant, you don't 
go there. But in our world, there is no choice to use us. There 
is no choice to use NASDAQ. There is no choice to use another 
venue for trading listed stocks because of the ITS plan rules.
    It forces us, as competitors, to always go to the New York 
Stock Exchange because of this definition of what best price 
is. You have got to expand the definition of best price. So, 
like Bob's example, his son can choose to drink the Coke for 99 
cents instead of running across the expressway and drinking the 
Coke for 98 cents.
    I mean, this is absolutely the key ingredient to changing 
the New York Stock Exchange. It will not change on its own. The 
NYSE will stay in the condition it is today if it is not 
actually forced to change the way that it operates as a result 
of competition.
    Mr. Meeks. Mr. Coffee?
    Mr. Coffee. As I mentioned earlier, this is a field that 
has inherent trade-offs, and all good things don't go together.
    Investors want the best price and they want maximum 
liquidity, and they want the fastest possible execution. They 
can't both be maximized at the same time. And different 
investors want different things.
    I understand that Fidelity wants speed, and that is why 
Fidelity did criticize the specialist system. They are 
responding to the impact of decimalization. Decimalization 
reduced the spread to such a narrow level that specialists no 
longer provide the same level of liquidity and they force 
investors to break up large trades into smaller blocks; that 
takes longer to execute.
    How much that costs you, depends on who you are. If you are 
a big trader, like Fidelity, the inability to trade large 
blocks like you could in the past is a severe injury.
    If you are a small investor trading 500 shares as your 
typical order or less, you like the fact that the spreads are 
now down to 2.5 or 3 cents. So I think different investors want 
different things. And I think a complete thorough-going reform 
that eliminated the trade-through rules wouldn't work to the 
best interest of the smaller investor.
    There are all kinds of compromises here, and I am not 
arguing against compromises that might permit some kind of opt-
in systems for some investors who are willing to sacrifice.
    But I think you want to keep the central market with a 
strong trade-through rule that tries to enforce best execution. 
I agree we could have some different definitions about what 
best execution was.
    Mr. Meeks. Mr. Chairman?
    Chairman Baker. Congressman Meeks?
    Mr. Meeks. This is a very complicated subject and everybody 
has a vested interest in the outcome of that subject. Even on 
my own floor, in Philadelphia, I would say if you went to three 
different people who function on the Exchange, they all have 
different business models and they all would have a different 
point of view.
    This is precisely the area, or the kind of area, that 
requires us to get some leadership.
    I think the SEC needs to put its proposals on the table, 
not to dictate an outcome, but to start the dialogue and the 
debate, to elicit comments, to come to you and to present their 
views and get your views and to get our views as part of a 
public debate.
    Because the rules are one aspect of it, and the structure 
of the ITS is the second, as Mr. Greifeld and others here have 
indicated.
    Right now, you have a system--I think Harry pointed out--
right now you have a system where you have 100 percent; you 
require a unanimous vote of the committee in order to change 
the ITS rules. Sometimes I think that is terrific. I am the 
small guy on the block and so it is good not to have the big 
guys be able to force change down our throat. And so, we have a 
veto.
    But on the other hand, that veto is used, sometimes, to 
perpetuate a monopolistic position.
    So the structure of ITS has to be looked at, as well as the 
rules. And one of the problems now is that the regulator is 
very reluctant to step in even though it has the authority to 
be an arbitrator or a judge as to what is appropriate behavior 
or what is appropriate rules, et cetera.
    I think that needs to be clarified as well. I think there 
needs to be reform. I think there needs to be reform, not just 
of the rules, but of the process. And I think there also needs 
to be an arbitration process, if you will, by the overall 
regulator, the SEC, to ensure that there is fairness and 
equity.
    Chairman Baker. Thank you, Mr. Meeks.
    Mr. Bachus?
    Mr. Bachus. Thank you.
    This first question will be for Mr. Putnam in Archipelago.
    Mr. Putnam, reading your testimony--and tell me if I am 
wrong--I get the sense that what you are saying is that the 
recent corporate governing issues at the New York Stock 
Exchange were not really the problem, they were the symptom of 
the problem. And that the symptom of the real problem was lack 
of competition in trading of listed securities. Is that----
    Mr. Putnam. That is exactly the point. When you are in an 
environment--and, again, we have seen this, we have seen this 
before, we saw this with NASDAQ and the NASD as a monopoly--
when the monopoly and the regulator are the same, the conflicts 
exist, one hand washes another, one side doesn't want to rock 
the boat to disrupt the other. And that is exactly the point.
    Mr. Bachus. So if competition existed, then they would be 
incented to have appropriate corporate governance rules?
    Mr. Putnam. You want to watch the New York Stock Exchange 
change? Let that market share go from 80 percent to 60 percent. 
And that thing is going to change overnight.
    I mean, my worst nightmare is that they change so fast that 
I can't make an impact myself, so that we actually have a 
differentiation to where people will choose us.
    But today the problem is that you don't have the right to 
choose us. So if you want to fix it, you have got to scare 
them. And they are only going to be scared if they think that 
they are going to lose some of that market share.
    Mr. Bachus. Okay. Let me ask you this: In your judgment, 
what are the greatest structural obstacles to competition in 
trading of listed securities?
    Mr. Putnam. I think the two that I pointed out: one is when 
the chief of regulation and the chief of the business in this 
monopoly organization is the same person, members are afraid to 
speak up.
    And we heard earlier today, we are going to go to the 
members and ask them what they think. Well, if you disagree 
with the New York Stock Exchange, they send the cops over to 
your office and start tearing your books and records apart. 
That is what happens. So they can't be the same person.
    The second thing, again, is this ITS reform; we are not 
allowed under the current rules to differentiate ourselves, 
except in three securities where there is a pilot program going 
on. In those three securities, ArcaEx outweighs the New York 
Stock Exchange in market share: QQQ, SPY, and DIA, the most 
liquid stocks in the world by three times.
    They do one-third of the volume that we do every day in 
those stocks. There, they are forced to compete. And guess what 
happens, investors aren't getting cheated. We have better 
markets.
    The reason why we have attracted that volume is because we 
offer this choice of immediacy at the best price. We cannot do 
that in the, what is it, 2,000 other stocks that trade on the 
NYSE.
    Mr. Bachus. Okay. Thank you.
    Mr. Frucher, let me ask this question to you and the 
Philadelphia Stock Exchange.
    And this is somewhat related to the specialists, but how 
does the Philadelphia Stock Exchange differ from the NYSE? What 
aspects of the Philadelphia Stock Exchange corporate governance 
and also the business model should Mr. Reed be looking at as he 
considers changes at the NYSE?
    Mr. Frucher. Well, I would say that there were two 
fundamental differences. The first one, we went through our own 
corporate governance issues seven years ago. The SEC basically 
came down and told us to change, and we did.
    And what we did was we totally restructured our board so it 
is 100 percent, there is a clear majority public directors. And 
when I mean public directors, I mean people like one of 
Professor Coffee's colleagues. You know, we have professors. We 
have deans of law schools and Presidents of colleges so that 
the corporate governance distinguishes it.
    We believe we can conduct self-regulatory practices because 
the audit committee, which is three public directors, has a 
direct reporting responsibility that goes to them by our 
regulatory function. Compensation is done by public directors. 
Nominations done by public directors so that the governance, I 
believe, is the key.
    Self-regulation is critical. You must have a culture of 
regulation and compliance. You understand. You want to have a 
local cop and not the FBI do your local law enforcement.
    You have a tiered system. It's not a sole regulatory 
responsibility. You have the SEC there. And the other 
distinction here is that they have a broader function and 
responsibility New York and at the NASD. They regulate the 
industry, and that's a different function than the self-
regulatory function of the marketplace and that seems to be 
getting lost in this dialogue.
    So we have to look at these separate issues. The other 
thing that we do differently in Philadelphia is that we have a 
multiple specialist system. So it's not just one specialist. 
Gerry Putnam has no specialists.
    I think the marketplace should determine it. And New York 
will decide, as Mr. Reed said, whether or not the sole 
specialist system will prevail or survive.
    I think what we are all saying is you need to have 
integrity. You have to have the appearance of integrity. You 
have to have open markets and access. Competition is the key, 
integrity and competition.
    Mr. Bachus. And your specialist there is competition.
    Mr. Frucher. Yes. You have competing specialists within our 
marketplace.
    Mr. Bachus. Third question is for NASDAQ, Mr. Greifeld. 
Have there been any differences following the separation of 
NASDAQ from its regulator, NASD?
    Do you believe this should be the model for the rest of the 
U.S. market community? And if so, why?
    Mr. Greifeld. There certainly has been dramatic 
differences. If you go back five or six years ago, the standard 
reputation, or standard conventional wisdom, was the NASD was 
essentially a toothless tiger.
    And if we fast forward to today and we look at the stats 
with respect to the amount of fines they collect and the fact 
that they are functioning as the tough cop on the beat, we see 
that good things have happened. So there has been dramatic 
change in really a few years when you look at it from an 
historical context.
    So it has worked, it has worked well. We think it truly is 
the only way to go forward. I believe that you can set up 
separate boards and you can convince yourself and you can 
convince professionals that this is the right way to go. And we 
heard that from Professor Coffee.
    But in my direct discussions with retail investors, they 
don't buy it. Why create that inherent conflict? Why have any 
NYSER? Separate it out. If you are going to have a separate 
board, you are 80 percent of the way there. Get it 100 percent, 
and you will eliminate that issue in investors. And I think we 
all: New York, NASDAQ, everybody here will benefit from that.
    Mr. Bachus. Have you actually been adversely affected by 
having the New York Stock Exchange marketplace and the 
regulator under the same roof?
    Mr. Greifeld. Yes. I tie back to the comment. I flew back 
to New York last night and I had dinner with one of the large 
bulge-bracket firms, and I said, ``We want you to post two-
sided bids and offers upstairs for listed stocks.''
    And this was a senior person there. And in spite of 
everything that has transpired in the last month or two, he 
said, ``You have to understand, New York is our largest 
regulator.''
    And for them to now actively post markets to effectively 
compete with the specialists, they are reluctant to do it. So, 
when you have that separation, and when that potential 
retribution threat goes away, that is when you will introduce 
real competition into this phase.
    Mr. Bachus. Okay. Final question, then a series of 
questions.
    Why do you feel the modification or repeal of the trade-
through rule would be a desirable change? And is that a NASDAQ 
position or have you heard from other market participants who 
share your view?
    Mr. Greifeld. Well, it is certainly a NASDAQ position. And 
I believe this is one of the positions in the industry that you 
truly have broad consensus. Everybody that I know and have 
talked to is for reform or repeal of trade-through.
    It really is a rule that in today's day and age is 
protectionism. And it is protecting New York's volume; it is 
protecting them from competition. It is allowing the specialist 
to be the only person making markets in the stock.
    So to the extent that we can have reform, you will see true 
competition in the trading of listed stocks and you will have a 
better outcome for investors as a result.
    Mr. Bachus. Final question and this follows up on that: the 
trade-through rule. Is it your position that all listed stocks 
should be traded in any approved venue or whether or not it is 
the primary listing venue?
    Mr. Greifeld. Well, we at NASDAQ are the primary listing 
venue for 3,500 stocks. And as I said, 45 percent of the volume 
doesn't trade in our market.
    And I think that is good for investors. And it has resulted 
in helping competition and forces us to continue to improve. 
And we think that should be the outcome with respect to New 
York.
    They will become a more effective competitor and yield a 
better outcome for investors if they are forced to compete.
    Mr. Bachus. Okay. All listed stocks traded in any approved 
venue?
    Mr. Greifeld. Yes.
    Mr. Bachus. Thank you. Thank you very much.
    Chairman Baker. Thank you, Mr. Bachus.
    Chairman Leach?
    Mr. Leach. Thank you, Mr. Chairman. And I appreciate your 
allowing a non-Subcommittee member to come.
    I have just been trying to seek perspective. And it strikes 
me all markets depend on confidence and we have had that 
confidence shattered. And I am struck by, despite the vigorous 
discussion here, the silence of much of corporate America.
    And one has a sense that silence relates to a concern that 
frankness might have a downside to their individual companies. 
But all of us were a bit surprised by one person's compensation 
and in the world in which a lot of people get a lot of big 
compensation, that doesn't seem overly startling.
    But the strong impression was that it was an insider's 
compensation based on full implicit understanding that the 
insider was protecting an insider's game. And that is the issue 
on the table. And then when you have an issue of confidence, 
the question is, ``How do you rectify it?"
    And obviously there can be a role for government. Several 
of you have suggested the SEC's preeminence in this regard. But 
in addition, when you comment on competition, in a free market 
economy, competition is often antidote. And so to stress 
competition I think is startlingly important.
    And that is one of the reasons why one is taken very 
strongly by some of your testimony, Mr. Greifeld.
    Now having said that, there are definitions. And I got in a 
little bit late here, but I keep reading in newspaper article 
after newspaper article, ``What is the problem?'' Ninety-three 
percent of the trades are done on the best price basis.
    And I am saying to myself, ``What is the definition of best 
price? Is there a criteria out there that everyone accepts that 
statement?'' So I want to go to you, Mr. Greifeld.
    There is an assertion that 93 percent of the trades are at 
the best price for the consumer at the New York Stock Exchange. 
Is that a true statement?
    Mr. Greifeld. To answer the second part of your question 
first, I think that is an impossible question to answer in that 
there is not competition to yield a better price. So I think 
when they say 93 percent, they are defining it within the 
strict confines of an essentially noncompetitive market.
    And what we are here today to say is, ``Let us introduce 
competition into that marketplace and let us yield a better 
outcome.''
    It is very interesting to note that with certain listed 
stocks, they trade very actively on the NASDAQ stock market, in 
spite, of the current rule environment. And they trade that way 
because certain investors just cannot tolerate the special 
system any longer.
    So, we are saying, ``Let us have competition and we will 
yield the outcome for investors that we need.''
    With respect to your first question on governance, I think 
certainly that is at the heart of a lot of different issues. 
And clearly, we believe the NASDAQ model is the right model. 
But what you have to realize, and you folks do better than I, 
there is so much effort going on with corporate governance. And 
I think exchanges should follow along in their draft.
    We, as a publicly traded company, follow Sarbanes-Oxley, we 
are struggling with Sarbanes-Oxley 404, like the rest of the 
world, we are subject to F.D. and I have to have people stop me 
from saying things on a regular basis, and I will become well-
trained on that soon enough.
    And we also have an independent board of directors that has 
a tough comp committee. And certain executive officers cannot 
be approved by the comp committee. It has to go to the full 
board.
    So I think governance will solve a lot of problems. We have 
the governance structure in place for all of corporate America. 
And I don't see why that just doesn't apply to exchanges en 
masse.
    Let us go with that.
    Mr. Leach. Let me return to a topic that you have discussed 
several times, and this is just an issue of buying on account, 
I have heard this all my adult life and how this is very 
helpful to the system when it comes from the New York Stock 
Exchange's perspective.
    And I can visualize situations where it is. I can't 
visualize what might have been the case 30 years ago on a 
thinly traded stock being the same thing today when you have 
options of electronics in many environments.
    And therefore, when you look at the trends, which is, that 
the trends are that the makers of markets are increasing their 
percentage of buying on account rather than decreasing at a 
time when the need seems to be less. Does that strike you as 
inherently a conflict of interest or not? Is this one of the 
great moral issues of American economics or is it one of the 
very practical circumstances on the world's largest trading 
floor?
    Mr. Greifeld. Well, it is certainly counterintuitive 
because I agree completely with the thought. As the stocks 
become more and more liquid and trade more and more actively, 
there is less and less reason for dealer intervention. So if 
you look at the New York Stock Exchange and their actively 
traded stocks have increased dealer intervention, I think it is 
a symptom of something that is not right.
    What we like about the NASDAQ model, with the growth of 
ECNs in our market, you see the ability for buyers and sellers 
to get together electronically at a very low cost. And we have 
300 market makers. And that is really the same thing as a 
specialist in that they will commit capital, but you are 
getting that to the right balance of where they should be in 
the market.
    So market makers going back in the NASDAQ market was 100 
percent of the volume 10 years ago. Today, they are about a 
third. And we think that is approaching the proper balance, 
based upon the trading characteristics of our stocks.
    Mr. Leach. And so, when you emphasize the word ``speed,'' 
you are really talking about the trained dealer intervention?
    Mr. Greifeld. I didn't catch the last part.
    Mr. Leach. When you were talking about the speed, you are 
really talking about the issue of dealer intervention?
    Mr. Greifeld. That is part of it. The second part of it is 
they are trying essentially to run an auction where the auction 
has little value. And in that period of time where they are 
running the auction, that is when the dealer can intervene and 
sometimes, as we see in the paper today, not for the benefit of 
the investors but, obviously, for his benefit.
    Mr. Leach. Well, I would only like to stress that the 
history of regulation, to the degree there is a history of 
regulation and economics, is to protect the small guy and that 
means Main Street rather than what we figuratively refer to as 
Wall Street.
    One has a sense that New York has been a bit slow. And most 
of us know people that we respect a great deal in these 
markets. I think there is nothing more insensitive to say than 
to say someone's livelihood might be reduced. But that is what 
is partly at stake.
    But I think that the great state for the system is to have 
confidence in it. And confidence is the overwhelming issue and 
there is no other issue that is more important. And confidence 
depends upon an assumption of minimalist conflicts of interest 
and total integrity.
    And that raises a lot of issues that I think the SEC is 
empowered to handle, Congress could address, although I, 
frankly, think you are more likely to get a better result from 
the SEC than you are in your Congress.
    But I would just say as a citizen representing a group of 
very small investors. The one thing you don't want in the 
American system is a question of confidence. And many of us 
inherently are very proud of the New York Stock Exchange, but I 
think this is a time for some change.
    Anyway, thank you very much, Mr. Chairman.
    Chairman Baker. I thank the gentleman.
    We have come to the end, but, unfortunately, I haven't had 
my turn. So, I just want to--in listening to the discussion, it 
has been very informative, very helpful, to some extent 
troubling--Mr. Frucher, I think it was your example when you 
talked about the individual buying the 98-cent Coke and walking 
across the street.
    You were the Coca-Cola man?
    Mr. Greifeld. Yes. That was my son.
    Chairman Baker. Okay.
    But Mr. Frucher, maybe along a similar thing was talking 
about standardization in national market regulation, and that 
is not an Eliot Spitzer question. It means an ability to trade 
under similar rules wherever the venue might exist.
    If we are to achieve a national regulatory structure where 
you can go buy the cola at $.98 or $.99, depending on whether 
you want it with ice or without, doesn't that lend itself to a 
single national regulator in order to enable that activity to 
be uniformly governed and to give everybody free access to 
whatever market they want to go to?
    As I understand, most of you have expressed concerns about 
the consequences of the trade-through rule and limiting access 
of customers to products that are listed at the New York Stock 
Exchange.
    But somebody be un-delicate. Are we saying we need to do 
more than just worry about corporate governance at the New York 
Stock Exchange; that we need to rebuild the blocks?
    Mr. Colker. Mr. Chairman, I would be happy to address that 
briefly.
    I think we really have a unified regulatory scheme, and 
that is the SEC which oversees all of the Exchanges. And on a 
routine basis, inspects the Exchanges to make sure that they 
can enforce their rules on best execution.
    Chairman Baker. But at this point, if I wanted to buy ABC 
stock, I can't go anywhere I want to if it is listed on the New 
York Stock Exchange. There are constraints on where I can 
exercise that trade.
    Mr. Frucher. Well, there are limitations. The fact of the 
matter is they have 82 percent. That means 18 percent is, in 
fact, traded somewhere else. What, in fact, is happening is 
that New York has rules that have effectively protected it.
    What we are saying is you have to reduce some of those 
rules. But the issue of regulation----
    Chairman Baker. Well, I think that is exactly my point. I 
am suggesting that we may need to be more aggressive. We may 
need to review everybody's rules.
    If we are going through the painful exercise of shrinking 
the New York Stock Exchange Board in attempting to provide the 
appearance and reality of self-regulation, with an interim 
Chairman in a window, in which every person who is a 
stakeholder has questions about what is going on out there, the 
difficulty presents an opportunity.
    And we ought not be looking at necessarily just the New 
York exchange alone, but the rules that govern the function of 
our capital market system to enable us to transition to 
whatever we all ultimately know it is going to look like five 
years from now anyway.
    The Congress should not be an interference lobby to make it 
more costly to ultimately get to the reform goal. And to great 
extent, the Congress drags its feet; the SEC has not yet acted. 
We are in the midst of a confidence crisis with investors. Why 
don't we fix this thing?
    And I am looking for the plan. I mean, I recognize 
everybody has a particular view of the current system from 
their own stakeholder position, as I think you did indicate.
    Mr. Frucher. Yes.
    Chairman Baker. And each of us has a reason to want to 
protect or promote that perspective. How do we get to the 
broader view where we are not taking Archipelago or the 
Philadelphia Exchange or somebody else's perspective as a 
committee exercising its responsibility in public policy and 
help formulate the construction of an open, transparent capital 
market, where you can go buy what you want where you want to 
go?
    Mr. Frucher. Mr. Chairman, I think that you have hit a lot 
of points right on the head. And I want to make that nexus, 
that connection; because I think it is an important one.
    A lot of the problems associated with competition was a 
function of a regulator effectively protecting noncompetitive 
situations, so that a single regulator--let us just say the 
SEC--has allowed the ITS rule and the trade-through rule to 
exist.
    That is not a question of self-regulation. That is a 
question of central regulation that has, in fact, created 
barriers to competition.
    It was only under the pressure from people like yourselves 
and yourself included, that the SEC only seven years ago 
changed the rules to have Rule ATS that allowed open 
competitive markets that brought in electronics.
    You are right. Everybody is going to be a lot more 
electronic, certainly floor-based exchanges are either going to 
be hybrids or they are going to be electronic.
    The issue is you want to have different kinds of structures 
with different kinds of rules and different kinds of 
technology. You want to have 1,000 flowers bloom and give the 
investing public the opportunity to invest in a number of 
different ways.
    What has to be uniform is the integrity of the marketplace 
and the access to the marketplace. But the rules shouldn't be 
similar. And the notion of regulation really does start at 
home. A bank has to be responsible for its tellers. A market 
has to be responsible for its players. But that doesn't mean 
that they are the only regulatory player.
    They can't be. We are not a sole regulator, we are a self-
regulator. On top of that there should be different regulators. 
The issue of self-regulation of the marketplace seems to be 
confused with self-regulation of the industry.
    We currently have two regulators--actually three--that 
regulate the industry: the broker-dealers, outside of the 
trading community. You have NASDR, you have New York and you 
have the SEC.
    That isn't, you know, a self-regulation issue. It is a 
designation that New York is the listing market and the NASDAQ, 
now through NASDR, becomes the regulator of the industry.
    These are very interesting, very complicated questions. You 
want to have multiplicity. You want to have different kinds of 
systems and approaches. But what you need to have is 
independence in that regulatory process.
    You have to have independent directors ensure the integrity 
of that market, whether it is local or whether or not it is 
central. And that is the key. So a lot of it does come back to 
governance. But you have helped create the most robust, most 
liquid marketplace in the world by enhancing competition.
    And that means different rules, different technologies and 
1,000 flowers blooming.
    Chairman Baker. Thank you, sir.
    Mr. Lackritz?
    Mr. Lackritz. Thank you, Mr. Chairman. I would echo what 
Sandy has just said, but also address the issue about how to 
design, you know, the architecture of this entire system.
    We talk about investors' interests first, which is the most 
important principle for the self-regulation and for the 
regulatory structure. We are talking about different kinds of 
investors. We have retail investors, individuals on the one 
hand, and we have institutions on the other.
    They have different preferences for the way they want to 
trade. For some of them, time is of the essence. Certainty is 
of the essence. Anonymity is much more important than anything 
else. And for some, price is the most important.
    That says to me, and I think it is reflected in the 
structure, that the key is regulation that promotes 
competition, promotes transparency, and ensures integrity. And 
if you could keep those principles in the forefront, and at the 
same time, you get the expertise of people close to the market 
regulating it, that allows the system to evolve in a way that 
takes advantage of technological innovation, provides the best 
service to investors, and assures that investors are going to 
get the best execution.
    Chairman Baker. Let me give you a bank analogy. And these 
are old numbers, but it still makes the point. At one juncture 
a study indicated that if you were to do a transaction at the 
teller window, it would cost the bank $1.30. If you were going 
to do the same transaction through the ATM, it would be 67 
cents. And if you had access to do it online, it dropped to 4 
cents.
    Now, I as an individual, on many occasions when I call the 
bank, I want to talk to a teller. I don't want to have a nice 
recording telling me what their business hours are.
    So I make a choice whether I want to go get cash for dinner 
at the ATM or whether I really want to go in and talk to a 
person, but that gives me the flexibility. I am not arbitrarily 
steered toward any particular point of service; I make the 
choice as the consumer of the product.
    Secondly, as a consumer of product, I want to understand 
the cost I cannot apparently see today, where somebody on the 
other end of the phone line, even if I am talking to them, may 
be engaged in activities that are not disclosed to me that 
don't offer me the clinical best price to which Mr. Leach 
referred, that the best price may be determined by the 
regulatory constraints. It is the best price because we don't 
let anybody else look.
    That is not the best price, not in the common investor's 
mind. And I guess that is what I am driving to. I don't think 
it necessarily is prejudicial to any one participant's stake in 
future markets necessarily as to survival. There may be 
readjustments in the percentages.
    But I think people will pick, when the institutional 
investor wants large block trades instantaneously, he goes that 
route. When it is someone investing for their retirement, and 
it is a $1,000, they want to know who it is getting, where it 
is going, what am I going get and the full service treatment. 
That is great.
    I am not confident that the rules we now have enable me to 
be able to make an informed choice as to what I am getting 
until after I get that lovely statement at the end of the year 
which requires my CPA and three of my neighbors to tell me what 
I lost.
    So, we are looking for a simple way through this mess, 
which apparently is very convoluted. And without delaying what 
has been a much longer hearing than anyone probably expected, I 
want to ask each of you from your various professional 
perspective, we are not looking to jump to any quick remedy 
because we understand the value that the system currently makes 
to our overall economic vitality.
    But we have got to start talking about blueprints. 
Recognizing that each of you will have varying reasons for your 
particular perspective, the committee really needs to have, 
whether it is trade-through rule concerns, whether it is a 
grand scheme, whether it is regulatory, whether you defend the 
current system and think is how we make it work better; really 
reach out to this panel of experts and say, ``Let the committee 
hear from you further detail about your views as to what 
directions the committee should consider.''
    There will be others to follow this panel in the weeks to 
come. It will not be something the committee will casually 
engage in. There are considerable concerns, we think, as a 
matter of public policy, need to be reconciled. And we want to 
work with those who understand the markets to ensure we develop 
the best product.
    Unless, anyone has further comment--yes, sir?
    Mr. Greifeld. Just as a follow up, we published a white 
paper yesterday, which we will be happy to give you copies of, 
with respect to our positions as NASDAQ, on a variety of these 
mortgage structure issues that are facing us all.
    Chairman Baker. Terrific.
    Yes, sir?
    Mr. Glassman. Could I just make one comment that sort of 
ties together the last two discussions.
    Your mention of choice, which I think it really is perhaps 
the most important thing. Right now, because of the trade-
through rules, people don't have choice. And I think that is 
one of the reasons that the New York Stock Exchange has been 
able to maintain the system that it has now.
    But if it were pushed, it were buffeted by competitive 
winds there is no way that the current self-regulatory system 
could exist, I don't think. Because, for competitive reasons, 
it would have to be modified to serve the interests of the 
actual customers; but right now it is insulated.
    So, the first thing that ought to be done, certainly, is to 
end the SRO. But really, the reason that it exists at all is 
because of the trade-through rules and I think that needs to be 
addressed.
    Chairman Baker. Yes, sir.
    Mr. Frucher. Mr. Chairman, if I hear you correctly--and I 
hope I did--I want to congratulate you on what I hear you 
saying.
    You are saying that you are going to start and this 
Committee is going to help engage this community, and the 
broader community, in a dialogue on a lot of these market 
structure issues.
    Some of these things have really been dormant for the last 
couple of years. I mean, the NASDAQ application, whether it 
goes up or down, shouldn't be sitting here for three years. And 
my, as a smaller exchange, my rules sit behind his rules, my 
rules to allow us to compete with him is dormant because we 
were waiting three years for a resolution on his application.
    So whether or not, through your structure, you are going to 
engage this debate and have the regulator come forth with its 
proposals or whether or not you end up with statute that, in 
fact, directs it, I congratulate you and I want to pledge the 
support of the Philadelphia Stock Exchange and myself to this 
endeavor as best we can.
    Chairman Baker. Well, I don't know that we will be helpful 
in the process, but I think we will engage in the process.
    Mr. Frucher. You know, transparency always helps, in any 
forum.
    Chairman Baker. I would only point to my experience with 
investment banks, analysts, mutual funds, GSEs; be careful what 
you ask for. But I will say that this is a process, and we 
don't intend to jump off a cliff and, ill-advisedly, take the 
wrong step.
    But I have got to tell you, over the last several years, 
becoming more conversant with the way in which the capital 
markets have functioned, it looks like a novel written by 
Stephen King to a great extent. Every time I turn the page, I 
get a new surprise, and it isn't always good.
    And I think what we want to do is to take the surprise out, 
get it to where somebody, a member of Congress, can understand 
it. And get it to that level. And then I think we have got 
something transparent and understandable that our constituents 
can engage themselves in as well.
    If there are no further comments, I do appreciate your 
participation and your helpful comments. And we look forward to 
hearing from you again soon.
    The meeting is adjourned.
    [Whereupon, at 2:28 p.m., the Subcommittee was adjourned.]


                            A P P E N D I X



                            October 16, 2003


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