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





                     REVIEWING U.S. CAPITAL MARKET
                    STRUCTURE--PROMOTING COMPETITION
                   IN A CHANGING TRADING ENVIRONMENT

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

                                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 30, 2003

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 108-60



92-981              U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2003
____________________________________________________________________________
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Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512ï¿½091800  
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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 30, 2003.............................................     1
Appendix:
    October 30, 2003.............................................    63

                               WITNESSES
                       Thursday, October 30, 2003

Donaldson, Hon. William H., Chairman, Securities and Exchange 
  Commission.....................................................     5
Foley, Kevin, Chief Executive Officer, Bloomberg Tradebook LLC...    42
Giesea, John, President and Chief Executive Officer, Security 
  Traders Association............................................    36
Joyce, Thomas M., President and Chief Executive Officer, Knight 
  Trading Group, Inc.............................................    38
LaBranche, Michael, Chairman, Chief Executive Officer, and 
  President, LaBranche & Co., Inc................................    40
McCooey, Robert H. Jr., President and Chief Executive Officer, 
  The Griswold Company Inc.......................................    34
Nicoll, Edward J., Chief Executive Officer, Instinet Group 
  Incorporated...................................................    45

                                APPENDIX

Prepared statements:
    Oxley, Hon. Michael G........................................    64
    Clay, Hon. Wm. Lacy..........................................    66
    Emanuel, Hon. Rahm...........................................    67
    Fosella, Hon. Vito...........................................    68
    Hinojosa, Hon. Ruben.........................................    70
    Kanjorski, Hon. Paul E.......................................    71
    Donaldson, Hon. William H....................................    73
    Foley, Kevin.................................................    88
    Giesea, John.................................................   111
    Joyce, Thomas M..............................................   119
    LaBranche, Michael...........................................   145
    McCooey, Robert H. Jr........................................   155
    Nicoll, Edward J.............................................   163

              Additional Material Submitted for the Record

Fossella, Hon. Vito:
    Organization of Independent Floor Brokers, prepared statement   196
Donaldson, Hon. William H.:
    Written response to questions from Hon. Doug Ose.............   199
    Written response to questions from Hon. Ruben Hinojosa.......   201
    Written response to questions from Hon. David Scott..........   203
Foley, Kevin:
    ``Competition, Transparency, and Equal Access to Financial 
      Market Data.''.............................................   204
Giesea, John:
    Fulfilling the Promise of the National Market System, STA's 
      Perspective on U.S. Market Structure, Special Report, 
      August 2003................................................   238
    Written response to questions from Hon. Ruben Hinojosa.......   266
LaBranche, Michael:
    Written response to questions from Hon. Ruben Hinojosa.......   269
Nicoll, Edward J.:
    Written response to questions from Hon. Ruben Hinojosa.......   270

 
                     REVIEWING U.S. CAPITAL MARKET
                    STRUCTURE--PROMOTING COMPETITION
                   IN A CHANGING TRADING ENVIRONMENT

                              ----------                              


                       Thursday, October 30, 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 10:07 a.m., in 
Room 2128, Rayburn House Office Building, Hon. Richard Baker 
[chairman of the subcommittee] presiding.
    Present: Representatives Baker, Ose, Gillmor, Bachus, 
Royce, Oxley (ex officio), Kelly, Fossella, Biggert, Hart, 
Tiberi, Brown-Waite, Renzi, Kanjorski, Sherman, Meeks, Inslee, 
Hinojosa, Lucas of Kentucky, Crowley, Clay, Matheson, Emanuel, 
Scott and Maloney.
    Chairman Baker. [Presiding.] I would like to call this 
meeting of the Capital Market Subcommittee to order.
    Committee is convened to receive comment and testimony with 
regard to the adequacy of our current market structure 
regulatory environment.
    The inexorable press of technology combined with the 
effects of decimalization, have brought about changes in the 
market that are not entirely clear to be beneficial at the 
moment.
    At this point, artificial rules that constrain where a 
customer might execute the best trade to their own personal 
advantage, does not, in itself, lead one to conclude that the 
current system enables that to occur on every occasion.
    Also recent unfortunate events surrounding corporate 
governance issues at the New York Exchange, have opened the 
entire debate as to whether the specialist system continues to 
serve the highest and best purpose of the American investor.
    And, at the same time, raises issues as to whether 
regulation and compliance can be subservient to the same board 
which has responsibilities for operation of a for-profit, 
shareholder-owned corporation.
    All of these issues raise the whole discussion to an 
important level. ``What do we do and when do we do it?'' I do 
believe that the SEC, over the years, has conducted a number of 
evaluations and studies, and I think, because of the unique 
circumstance we now find ourselves in, it is appropriate to 
consider taking some action.
    Whether it is statutory or whether by SEC regulation, I do 
believe the forces of technology are bringing about the 
potential for significant market structure changes that will be 
in the best interest of the individual investor.
    With now over 50 percent of American homeowners invested 
directly in the marketplace, this is no longer an issue which 
can be relegated to a second-tier importance. It is a principle 
importance, not only for those individual investors, but for 
the success and growth of our own economic systems, and the 
exchanges and the capital markets are at the core of our 
opportunity for economic growth.
    To that end, I am anxious to hear from the Chairman this 
morning as to their observations and recommendations and hope 
that we can come to relatively quick closure on an action plan, 
not only from the commission's perspective, but for this 
Committee to consider as well.
    With that, I recognize Mr. Kanjorski.
    Mr. Kanjorski. Mr. Chairman, we meet today for the second 
time in the 108th Congress to review the structure of our 
capital markets and evaluate reforms that might enhance 
competition in light of recent technological advances and 
marketplace developments.
    In recent years, a variety of participants in the 
securities industry have questioned one or more aspects of the 
regulatory system.
    Today's proceedings will, therefore, help us to better 
understand these issues and their concerns. In my view, we have 
come to a crossroads in the securities industry, facing a 
number of decisions that could fundamentally alter its 
structure for many years to come.
    As I did in our last market structure issues hearing, I 
must caution my colleagues on both sides of the aisle to move 
carefully and diligently in these matters. Because we have 
elaborately interlocking systems and relationships in our 
securities markets, I believe that we should refrain from 
pursuing change for change's sakes.
    Moreover, in pursuing any change to fix those portions of 
the system experiencing genuine strain, we must also ensure 
that we do not disrupt these elements of our market that are 
working well.
    In adopting the Securities Act Amendments of 1975, the 
Congress wisely decided to provide the Securities and Exchange 
Commission with a broad set of goals and significant 
flexibility to respond to market structure issues. From my 
perspective, this system has worked generally well, over the 
last three decades, in adapting to technological changes and 
other developments.
    This legal framework ought to continue to provide the 
commission with the flexibility that it needs to consider and 
adopt further reforms in the future.
    In testimony before the Senate earlier this month, SEC 
Chairman Donaldson indicated that the Commission would be 
focusing on increased intensity on the structure of our 
securities markets in the upcoming months.
    I, therefore, look forward to learning from the Chairman, 
later this morning, about his current views on these matters. I 
want him to know that it is my hope the Commission will move 
expeditiously and methodically in its deliberations.
    Mr. Chairman, I have made investor protection an important 
issue of mine in this Congress, and during my opening statement 
at our last hearing in market structure issues, I outlined some 
of my thoughts regarding self-regulation in the securities 
markets.
    Today, I would like to focus on another important investor 
protection issue: transparency.
    For our securities markets to work well and advance the 
interest of investors, I believe, as a general rule, that we 
should seek to promote transparency to the maximum extent 
possible.
    Transparency helps to ensure that all participants in the 
marketplace have access to the same information for making 
decisions. Transparency, therefore, ensures that no participant 
in a marketplace is either advantaged or disadvantaged because 
of their access to information.
    For these reasons, I have apprehensions about any market 
structure reform proposal that would limit access to 
information, including those that would allow for 
internalization of market orders.
    In my view, such proposals have the potential to jeopardize 
the transparency of our markets and harm investors.
    During their tenures, the two most recent former commission 
chairmen have expressed concerns about the internalization of 
market orders by broker dealers.
    Additionally, the current SEC Chairman has previously 
observed that internalization can discourage markets from 
competing on the basis of price and pose a conflict of interest 
for broker dealers.
    As we deliberate on market structure issues this morning, 
it is my expectation that he will comment further on the 
importance of further enhancing transparency in the securities 
industry.
    In closing, Mr. Chairman, I believe our Committee must 
continue to conduct vigorous oversight of the securities 
industry to determine whether its regulatory structure is 
working as intended and to examine how we could make it 
stronger.
    The observation of today's witnesses about these complex 
matters will also help us to discern how we can maintain the 
efficiency, effectiveness and competitiveness of our nation's 
capital markets into the foreseeable future.
    I look forward to this hearing, Mr. Chairman.
    [The prepared statement of Hon. Paul E. Kanjorski can be 
found on page 71 in the appendix.]
    Chairman Baker. Thank you, Mr. Kanjorski.
    Chairman Oxley?
    Mr. Oxley. Thank you, Chairman Baker, for holding this 
important hearing.
    There are a few issues that come before this Committee that 
are as fundamental as how investors buy and sell securities. I 
want to particularly welcome our distinguished witnesses today; 
Chairman Donaldson and Annette Nazareth, for appearing.
    This Committee's first market structure hearing earlier 
this month, I think all the members would agree, was quite 
encouraging. I was pleased with John Reed's candid and 
forthright testimony.
    There is no question that he has volunteered for a 
difficult job, under trying circumstances, but I believe he is 
the right leader, at the right time, to right the ship at the 
New York Stock Exchange.
    And even more importantly, I also believe that the recent 
controversies at the New York Stock Exchange present a real 
opportunity to enact significant and long overdue reforms to 
our market structure. An opportunity like this does not come 
around often, and we must not squander it.
    I have long taken the position that investors benefit from 
multiple market centers that engage in vigorous competition 
based on speed and certainty of execution, anonymity and price.
    The government should not decide which markets prosper. In 
fact, it is our obligation to ensure that no market have 
regulatory advantages that inhibit competition and artificially 
preserve market share.
    Accordingly, it is imperative that we revisit the rules and 
regulations that have governed the markets for more than a 
quarter of a century.
    What Congress did in 1975, may have made sense at the time, 
but those policy decisions were made prior to the greatest 
technological advances in human history.
    It makes no sense, whatsoever, for these outdated 
regulations, which preceded, for example, the advent of 
Netscape by two decades, to be controlling in today's high-tech 
environment.
    With a change in leadership at the NYSEC, I believe we are 
at a crossroads with an important opportunity to implement 
changes that will foster competition and make our markets even 
more efficient.
    The Intermarket Trading System is an outdated construct 
that has outlived its usefulness. It is time to revamp the 
system that links our markets so that market forces and modern 
technology can replace bureaucratic, restrictive regulatory 
systems.
    There has been a great deal of talk about the need to 
reform the ITS's trade-through rule. I expect we will hear from 
virtually all of our witnesses here today about this issue.
    It is clear to me the time for reform is long overdue. 
Price simply is not the only factor to be considered for the 
purposes of best execution. The trade-through rule, as it 
stands, is standing smack in the way of more efficient, 
competitive markets.
    The viability of the SRO model depends on whether it is one 
that uses regulation to protect investors and promote 
confidence or to hamper competition. We will examine many of 
these rules today.
    Central to today's discussion, will be the role of the 
specialist. It has been widely criticized as monopolistic, 
anachronistic and unnecessary in today's highly-evolved 
technological environment.
    John Vogel, who has appeared before this Committee several 
times, calls it, ``A dinosaur that maintains as much of a 
monopoly as you can get in this world.''
    Even more alarming are the allegations of wrongdoing that 
call into question the integrity of this model and whether it 
creates an irresistible opportunity to put the specialist's 
interests ahead of investors.
    Critics of decimal pricing argue that decimal pricing has 
led to front-running and other trading violations.
    I would argue that these abuses are symptomatic of a flawed 
structural system, not the result of decimal pricing which has 
resulted in what one commentator has called a, ``Billion-dollar 
tax cut for investors.''
    It is time to review the specialist system. Today's hearing 
is an important step toward that end.
    I have long argued that market data, the fundamental 
information about securities prices that is the oxygen of our 
marketplace, needs to be free from ownership interest that 
could restrict access to that data.
    It is essential that we ensure that investors have 
guaranteed full access to this information.
    I am eager to hear from SEC Chairman Donaldson, this 
morning and, particularly, I look forward to learning how he 
intends to expedite consideration of all the pending issues 
before the Division of Market Regulation.
    As many petitioners know all too well, the failure to make 
a regulatory decision is often worse than the adverse decision.
    Again, I want to commend you, Chairman Baker, for putting 
together an excellent and balanced second panel of witnesses 
and I look forward to hearing their testimony as well.
    And I yield back.
    [The prepared statement of Hon. Michael G. Oxley can be 
found on page 64 in the appendix.]
    Chairman Baker. Thank you, Mr. Chairman.
    Do members have--further members have opening statements? 
If not, at this time, I would like--I am sorry, Mr. Emanuel, 
did you have?
    Yes. All members may submit their opening statements in 
writing for the record, without objection.
    If there are no members seeking recognition at this time, I 
would like to welcome back Chairman William Donaldson, who is 
no stranger to the hearing room, unfortunately for him, I 
guess.
    But we certainly do appreciate the courtesy of your 
appearance and we look forward to receiving your testimony this 
morning, Sir.

 STATEMENT OF HON. WILLIAM H. DONALDSON, CHAIRMAN, SECURITIES 
                    AND EXCHANGE COMMISSION

    Mr. Donaldson. Thank you very much.
    Good morning Chairman Baker, Ranking Member Kanjorski, and 
members of the Subcommittee. I am very pleased to be here to 
discuss some of the significant market structure issues that we 
are facing in the U.S. equities market today.
    Our markets are comprised of intricately-interwoven systems 
and relationships.
    While the Commission recognizes the importance of 
addressing market structure issues expeditiously, the extent to 
which structural changes are needed, and what those changes 
should be, are complicated problems to say the least and not 
subject to quick and easy resolution.
    We must take care not to disrupt those areas of our market 
that are working well in our haste to fix those areas which we 
think are not.
    The Commission staff has made significant progress in 
analyzing the structure of the securities markets, identifying 
the sources of the strains to which it is increasingly subject, 
and formulating a road map for responding to these concerns.
    The staff is now in the process of drafting concrete 
proposals to address the root causes of the stresses on the 
U.S. market structure. I have asked the staff to produce, in 
the coming months, a plan that includes proposals to respond to 
several of the more pressing market structure issues.
    As you know, Congress formally directed the Commission to 
address market structure when it enacted the Securities Act 
Amendments of 1975.
    That legislation instructed the SEC to facilitate the 
creation of a national market system for securities that would 
maintain fair and orderly markets and tie together all buying 
and selling interest so that investors would have the 
opportunity for the best possible execution of their orders, 
regardless of where in the system they originate.
    Rather than attempt to dictate the specific elements of the 
U.S. market structure, however, Congress chose to rely on an 
approach designed to provide maximum flexibility to the 
Commission and the securities industry in its development.
    The 1975 amendments to the Exchange Act created a framework 
for fostering transparency, interconnectivity and competition 
in our securities market.
    As a result, today, equity market centers compete with one 
another in an environment where quotes and transaction prices 
are widely available to all market participants.
    Direct and indirect linkages among competing market centers 
help ensure that brokers can access the best quotes available 
in the market for their customers.
    Market centers, including exchange markets, over-the-
counter market-makers and alternative trading systems have an 
incentive to offer improvement in the execution quality and to 
reduce trading costs in order to attract order flow away from 
other market centers.
    Taking a step back and looking at the market as a whole, 
our National Market System has worked remarkably well for the 
past quarter century and, in recent years, it has become 
increasingly efficient.
    At the same time, we recognize that this very efficiency, 
arising from the technological and other market developments, 
has put strains on existing national market structures.
    One significant change has been the proliferation of the 
new electronic markets, such as the ECNs, that offer fast 
executions and have spurred competition among market centers, 
but, at the same time, exacerbated concerns about market 
fragmentation, the feasibility of integrating different market 
models into the National Market System, and maintaining a level 
regulatory playing field among the functionally-equivalent 
market participants.
    The implementation of decimal pricing in 2001 and the 
concurrent move to a minimum tick of one penny in the equity 
markets have narrowed spreads and enhanced the efficiency of 
the price discovery process but, at the same time, reduced the 
liquidity available at each price point, made it easier to step 
ahead of limit orders, and placed economic strains on the 
dealer business.
    Decimal pricing has also put a premium on swift access to 
displayed prices so investors can quickly reach these smaller 
quotes before they change.
    The trend toward demutualization of exchanges and their 
conversion to for-profit enterprises has heightened concerns 
about the inherent tensions in the self-regulatory model, in 
particular the concern that the funding and vigor of the 
regulatory function might be sacrificed in favor of delivering 
returns to shareholders.
    As noted, over the last several years, the Commission has 
taken a number of steps to address concerns facing our National 
Market System.
    In the Order Handling Rules and Regulation ATS, for 
example, the Commission broadened the class of market centers 
required to make their quotations and orders publicly 
accessible. In doing so, it sought to redefine the idea of an 
exchange to include, not just traditional exchanges, but also 
trading systems where orders interact according to specified 
trading rules.
    The Commission also adopted rules to improve the disclosure 
by market centers of execution quality data and the disclosure, 
by broker-dealers, of their order routing practices in order to 
enable investors to comparison shop among the myriad market 
centers and to stimulate competition on the basis of execution 
quality.
    There is no doubt that there are issues regarding our 
National Market System that call for our attention; and, 
indeed, the Commission and its staff have been increasingly 
focused on addressing these issues and resolving perceived 
conflicts in a timely manner.
    Commission staff is in the midst of developing proposals 
that address, in a comprehensive fashion, the various market 
structure issues.
    I would like to focus the remainder of my testimony on the 
four key areas of the Commission's market structure initiative: 
access to markets; market data; the self-regulatory model 
itself; and the nature of a securities exchange.
    Fair access: a significant market structure issue on the 
Commission's agenda is making sure that access between markets 
is as fair and as efficient as it can be.
    If best execution is to be achieved in an environment 
characterized by multiple competing markets, broker-dealers 
must be able to identify the location of the best available 
prices and obtain access to those prices routinely and 
efficiently.
    The Commission's approval, last year, of the NASD's 
Alternative Display Facility as a pilot program has heightened 
the issue of intermarket access.
    Rather than obtaining access through ``hard'' linkages 
directly between markets, in the way that competing markets can 
access the New York Stock Exchange, in the Alternative Display 
Facility competing market centers obtain access to each other 
directly through privately-negotiated access agreements and 
indirectly through subscribers.
    The Commission is evaluating this decentralized access 
approach to determine whether, as a practical matter, it would 
be an appropriate model for the National Market System, and 
this could be applied to other market centers.
    Access fees: access fees charged to reach a quote create 
another difficult market structure problem. Some markets charge 
varied per-share transaction fees for access to their quotes.
    Therefore, a displayed price may represent the true price 
that a customer will pay, or it may represent only a base price 
to which an undisclosed access fee will later be added.
    To ensure real access to public quotes between competing 
markets, it is important that quotes be accessible to other 
market participants on clear and fair terms.
    Price protection: as a part of our examination of 
intermarket linkages, we also are actively reevaluating the 
question of intermarket trade-throughs, which occur when orders 
are executed in one market at prices inferior to the prices 
disseminated on another market.
    The challenge before the Commission is to devise standards 
that allow faster markets and slower markets to thrive within a 
single system of interconnected markets while, at the same 
time, providing order executions to customers that display 
prices for those customers who desire the best price on their 
order.
    Market data: an additional market structure challenge 
facing the Commission involves the collection and reporting of 
trading information and the influence of the market data 
revenues on market structure.
    Under the current system, distributions of market data 
revenues to self-regulatory organizations are based primarily 
on each self-regulatory organization's reported trade volume.
    This compensation scheme has created a financial incentive 
for self-regulatory organizations to report as many trades as 
possible.
    As a result, markets are vying for ECNs and market-makers 
to report their trades through them, as this allows markets to 
tap more deeply into the pool of available market data revenue 
and to rebate substantial portions of the additional revenue to 
the entity reporting the trade.
    All of this calls into question whether the current method 
of distributing market data revenue creates appropriate 
economic incentives and whether it furthers the goal of 
rewarding markets that make valuable contributions to the 
market data being disseminated.
    The self-regulatory model: another matter of great 
importance is the effectiveness of the self-regulatory system 
of our securities markets.
    The principle of self-regulation is based on the idea that 
regulation can be best done as close as possible to the 
regulated activity. However, an SRO that operates a market has 
a potential conflict of interest between its role as a market 
and as a regulator.
    The advent of for-profit, shareholder-owned exchanges 
creates additional issues, including ensuring that self-
regulatory obligations do not take a back seat to the interests 
of shareholders.
    The challenge for the Commission and the SROs is to ensure 
that, as the securities markets grow more competitive, the SROs 
continue to dedicate their energies and resources to 
surveillance and enforcement.
    We also must prevent fragmentation of trading from creating 
gaps in the SRO oversight of the markets.
    As a part of our review of the self-regulatory structure, I 
believe the Commission must thoroughly review the SROs 
governance. Recent events at the New York Stock Exchange point 
to the need for this review.
    SROs play a critical role as the standard setters for sound 
government practices. Just as SROs have demanded that their 
listed companies strengthen their governance practices, we must 
demand that, at a minimum, SROs match the standards they set 
for listed companies.
    There are several topics that merit our consideration, 
including board composition and the independence of directors; 
the independence and function of key board committees; the 
transparency of the SRO's decision-making process; and the 
diligence and competence required of board and committee 
members and ensuring their focus on the adequacy of regulation.
    The last topic I would like to touch upon is what it means 
to be registered as a national securities exchange.
    All currently-registered exchanges have a limit order book 
in which better-priced orders take precedence. But a mandatory 
order book system is not easily reconciled with a dealer model, 
such as the NASDAQ stock market, in which there is no central 
limit order book.
    I spoke earlier about the merits of price protection across 
markets. NASDAQ's application to register as an exchange places 
squarely before the Commission, the issue of whether price 
protection, within a market, is a requirement of an exchange 
registration.
    One issue is customer expectations. I suspect that 
customers generally expect their better-priced orders to be 
protected within an exchange.
    We do not expect all exchanges to be identical, much less 
to replicate any market's faults. Yet, until now, all exchanges 
have given their limit orders priority throughout their 
marketplace.
    If the Commission were to approve NASDAQ's application, 
other exchanges would likely seek to eliminate intra-market 
price priority from their rules. As a result, the protection of 
limit orders within markets would decrease. For this reason, 
NASDAQ's exchange application raises overall market structure 
issues that transcend the particular question of whether 
NASDAQ, or any other particular market, should be registered as 
an exchange.
    In conclusion, I would like to reiterate that the market 
structure challenges that I have discussed today may shape the 
National Market System for years to come. The Commission 
recognizes the importance of addressing these challenges in an 
effective and timely manner.
    At the same time, however, we have got to be mindful not to 
rush to judgment but, instead, take a deliberate and reasoned 
approach to reach the right result.
    That said, we fully acknowledge the need to resolve the 
conflicts, and it is my expectation to be able to review 
proposals from Commission staff, in the coming months, with an 
eye towards publishing proposals soon thereafter.
    I look forward to continued input from this Subcommittee on 
those important matters throughout this process. Thank you 
again for inviting me to speak on behalf of the Commission.
    I would, obviously, be happy to answer any questions that 
you may have. Thank you.
    [The prepared statement of Hon. William H. Donaldson can be 
found on page 73 in the appendix.]
    Chairman Baker. Thank you, Mr. Chairman.
    We do have announced a series of votes; there are three now 
pending.
    First is a 15-minute vote. It would be my intention to 
proceed with my questions, perhaps those of Mr. Kanjorski, if--
well, at least I will go through mine, if that is the case.
    And then the Committee would stand in recess for about 15 
minutes to complete the remaining part of the first 15-minute 
vote and the other two fives.
    Mr. Chairman, it is my understanding the SEC is in 
preparation of a concept release on the trade-through rule.
    When do you anticipate some product being ready to release 
for public consideration?
    Mr. Donaldson. Well, it is implied in my comments. We are 
looking at a number of issues that we believe are inter-
related.
    We believe the trade-through rule is a very critical rule 
now, in terms of any modifications, eliminations or, whatever, 
that we might make on that rule.
    I believe we want to consider that within the context of a 
couple of other issues that I have mentioned.
    As I say, I hope that--we are working on it right now; we 
have taken testimony; we have talked, and now is the time for 
action. I think it is a matter of months, not years, but not 
weeks, either.
    Chairman Baker. I posed that question in light of what, I 
understand, was the pilot in August of last year, which looked 
at relief from the trade-through rule.
    And the reported observations about the success or failure 
of the pilot indicated that it seemed to work very, very well 
and that there were efficiencies, other than best price, that 
were of material importance to investors.
    And it just seems, from my perspective, that it is a very 
significant first step in providing more efficient functioning 
of markets to either expand the pilot or to take some further 
definitive action as quickly as possible, given the benefits 
of, at least reported benefits of, that pilot effort.
    What is your opinion with regard to the specialist system? 
And I make the observation, perhaps not in a sophisticated way 
but, in Louisiana, as a former realtor, if I were to represent 
a buyer and a seller and I knew that the seller would take $100 
thousand for the house, and I knew the buyer would pay 
$125,000; if I exercised an option or bought the property for 
my own account and then turned around and sold it to the buyer 
I knew of, by virtue of my fiduciary position, for $125 
thousand, it is not only unethical; it is illegal, and I would 
go to jail.
    How is that illustration different from what the specialist 
may do when he trades for his own account, given that market 
knowledge?
    Mr. Donaldson. The specialist system, as practiced on the 
New York Stock Exchange, has, in the structure and the rules, a 
negative and a positive obligation, if you will.
    Specialists have a positive obligation to make a market in 
the stock and to provide liquidity when there is not a ready 
buyer or seller for the other half of a trade----
    Chairman Baker. And I think that is very valuable, and I 
don't want to lose that in the mix but, often, there is not 
concurrent disclosure and the time--if there is a liquidity 
reason to act, that is a great thing.
    And I could buy that house and sell that house as long as I 
made concurrent simultaneous disclosure to both parties, and if 
they both agreed it was okay for me to make the $25,000, fine. 
But I couldn't do it without providing that notice.
    Mr. Donaldson. Right. Well, the other part of the 
specialist obligation is not only to the positive obligation to 
step in and provide liquidity but also the negative obligations 
to not step ahead of the customer account, and this is the very 
essence of the auction system.
    And I believe that there are issues associated with that 
which have to do with what I referred to before, which is the 
advent of technology and the ECNs, which are able to transact 
instantaneously.
    And, I might add that, in many of the ECNs, they are not 
that instantaneous unless there happens to be a matching order 
on their books. I mean, an order can sit there for minutes or 
hours.
    That does not happen on the New York Stock Exchange because 
of the liquidity provided by the specialist.
    Chairman Baker. Understood, and there is value to the 
system. I just think there are some areas of concern that, 
perhaps, need to be thoughtfully examined by the commission----
    Mr. Donaldson. Absolutely. That is exactly what we are 
doing----
    Chairman Baker. If the trade-through rule, recommendations, 
analysis of the specialists concerns or modifications of rules 
governing practice, all of this, as you indicate, is part of a 
larger market structure recommendation.
    Would that go to the point of the regulatory model of the 
New York Exchange? Is that viewed as being essential in this 
package of recommendations that might be later forwarded?
    And I make that observation in light of this thought: what 
if someone were to come to the Congress and say, ``The SEC 
ought to own a securities firm or the Federal Reserve ought to 
own a large national bank?''
    You probably wouldn't get many co-sponsors, and the hearing 
date would probably be a long time in the future.
    But, at the same time, we have the CEO of the for-profit 
enterprise often as the Chairman of the regulatory body, 
investment bank analyst--you know the litany of subjects we 
have dealt with in the Committee over past years has always 
generally resulted in very clear-cut separations of authorities 
between regulation and for-profit decisions.
    Do you have a view today as to the appropriateness of 
maintenance of the current structure or should we really be 
thinking through perhaps a more radical modification?
    And what will the SEC actions likely--will that be a 
consideration in the package of issues that the SEC is now 
considering?
    Mr. Donaldson. Critical consideration; bottom line. 
Clearly, the responsibility of an SRO for running a 
marketplace, as well as the responsibility for the regulation 
of that marketplace, brings into the forefront a potential 
conflict of interest.
    And we are concerned about that conflict of interest.
    There are a number of different ways of addressing that, 
ranging all the way from a total separation of the regulatory 
function to a partial separation to an internal structure that 
separates the reporting function and financing of the 
regulation inside an SRO.
    I think this is what John Reed, the Acting Chairman of the 
New York Stock Exchange, is wrestling with right now, in terms 
of coming up with a corporate governance structure that 
addresses those issues.
    But I think the point you are making is right on, which is, 
we must pay attention to the independence of the regulatory 
function.
    And we must pay attention to the financing of the 
regulatory function, the adequacy of its financing. And we must 
separate, either by the way it is organized internally or 
totally externally, we must separate that potential conflict.
    Chairman Baker. Mr. Chairman, we are down to about three 
minutes on the vote. We are going to have to excuse ourselves.
    Just one final, sort of, comment from my perspective.
    Your observation was that we don't expect a recommendation 
or a package from the SEC within days or weeks; we don't expect 
it to take years; we are kind of in the months range.
    So this might well be something pursuant to the Exchange 
action early next year, early spring; we might have some 
recommendations that would give us a global picture of where 
you think we should go.
    Mr. Donaldson. Right. I think the first indication of an 
approach and whether it is an acceptable approach will be the 
governance structure proposed by the New York Stock Exchange.
    Chairman Baker. We are in recess. Thank you.
    [Recess.]
    Chairman Baker. I would like to reconvene our meeting.
    Mr. Chairman, I just have one more, sort of, follow up from 
our earlier line of questions, not on the principle subject of 
the hearing today, but on the related matter of mutual fund 
governance.
    I read, with interest, some comments by Mr. Spitzer in the 
morning news about his perspective of SEC actions in relation 
to his findings, which were troubling to me, a bit.
    But, more importantly, in our last hearing in which you 
appeared, I had expressed interest in having Agency comment 
with regard to H.R. 2420, which is still pending, on any 
modifications or improvements that might be considered to that 
act, with regard to mutual fund governance.
    And in light of the developments reported in the media by 
actions of the Attorneys General, your own agency, I just renew 
that request in light of current market circumstances if the 
Agency could review and forward any comment that might be 
appropriate.
    Certainly, we don't expect immediate action on H.R. 2420, 
but it is within that weeks range; not days, but not years, 
kind of, category.
    And whenever you could get us something, it would be very 
helpful.
    Mr. Donaldson. We would be glad to do that.
    Chairman Baker. Thank you, Mr. Chairman.
    Mr. Kanjorski?
    Mr. Kanjorski. Thank you, Mr. Chairman. Welcome back, Mr. 
Chairman. We look forward to having you here, particularly in 
these trying times.
    I think one of the things I am trying to organize, in my 
mind, is recognizing some of the threats of investor confidence 
that exists as a result of the continuum of things that have 
happened over the last year, year and a half.
    Is there any method or methodology that should be employed 
by the regulator, by the Commission, to get all of this out on 
the table, once and for all, instead of the slow bleeds and the 
information coming forth, whether it is the mutual fund 
industry, or whether it was the governance at the New York 
Stock Exchange, or whether it was the inappropriate activities 
of some of the huge corporations?
    Can't we find some method to bring this to an end?
    And, in light of that, what I am thinking of is, in the 
past, the Chairman of the SEC has always said he really doesn't 
need a larger budget. We tried to give him one a couple of 
years ago, and there was always some hesitation of taking it.
    Do you think you are sufficiently staffed now?
    And the one reason that brings that to my mind--and I know 
we will have another hearing on this subject--but I am really 
disappointed with the whistleblower that brought, apparently, 
timing evidence in the mutual fund industry to the Enforcement 
Office of the Commission back in March and had an attorney 
follow up on a monthly-weekly basis.
    And it wasn't until the State Attorney Generals took action 
that anything happened.
    On the face of that, it certainly makes it appear that 
perhaps the federal regulator is not ahead of the game. I know 
the pressures that the Commission has been under and the wide 
range of activity they have to do.
    But while you are reviewing all these governance issues and 
other issues involved in the exchanges, are you going to also 
look at your enforcement regulation budget and what you need so 
that we can make sure that we can, once and for all, say to the 
American people that this is the bottom line and draw our two 
lines and close this out?
    Or, other than that, we are just going to go on and on, 
internally bleeding and, every time we seem to have an uptake 
in the market or in the economy, we get hit with another 
investor confidence question.
    Mr. Donaldson. Let me confine my remarks, I think, to the 
central thrust of your question which is the issues with the 
mutual fund industry right now.
    You are talking about other issues, too, that are on our 
docket but, most recently, the issues that have come to the 
fore on market timing and late trading, and so forth.
    I could give you a number of answers but first and 
foremost, there is no doubt about the fact that we can improve 
our methodology.
    We have a huge universe of funds, some 5,000 mutual funds 
with over 8,000 portfolios of securities, and over 7,000 
advisers in which we are expected to conduct inspections.
    We have to have a set of priorities, if you will, in terms 
of what we are looking for, and I believe that the issue of 
risk assessment, if you will, is one that we are addressing 
right now, in the Commission, in terms of how we determine 
exactly what we are looking for. And I think that can be 
improved, and we are working toward that end.
    We are working toward a better synergy, if you will, 
between our divisions of investment management, our divisions 
of inspections and so forth.
    But we do have new troops coming in: a substantial increase 
from, I think, 350 people in our inspection group to almost 
increasing that by 50 percent so we will have more bodies.
    But the real issue is how we determine where the risks are, 
and we, I think, probably have not had the issues of market 
timing as high in our priority as we should have.
    We are taking steps now, I might add, to do something about 
that and do something about it quickly.
    The other thing is that, in the case of some of these 
issues that have come to the fore, you had, basically, an 
alleged collusion between two entities; the Canary Hedge Fund 
and the mutual fund that they were doing business with.
    And unless you have a direct tip, unless you have a direct 
insight, it is very hard to find collusion, particularly in the 
case of Canary when we didn't have the authority to go in and 
examine them.
    Mr. Kanjorski. If that is the case, I can understand that 
being the case, then part of this argument on a totally 
electronic market raises a lot of questions in terms of how are 
we going to pick these transactions up.
    Those of us that aren't informed on the technology assume 
that, with computers today, everything is seen. And when there 
is improper activity it would set off some sort of a tilt so 
that regulators would look at it.
    And you have layers of regulation, as you pointed out. The 
SRO is the first responsible party to know what is going on but 
then you, over them, have some idea.
    Now, this last weekend--and Monday I was in Chicago looking 
at the markets and trying to understand what they are doing--
and they brought me aware of the fact of what internalization 
may or may not do, and some of the advantages of it, and some 
of the deference of it.
    But one of the things that we talked about with quite 
seriousness, that you referred to in your testimony, is this 
idea of the penny market and how that can interfere with 
another market that deals in more than pennies and 10 cents, as 
the Chicago markets do.
    And how that delays a transaction until someone filters 
through that 10-cent spread.
    And that goes to the question of that unique characteristic 
on the New York Stock Exchange of the specialist. They drive 
and create that market and it doesn't get as delayed.
    But I was most impressed about a meeting I recently had 
with John Reed, in terms of what the specialists did during the 
1987 crash and that, without their existence there--and if we 
had a totally electronic market--we potentially would have no 
buyers when the market was falling as rapidly as it was.
    Could you tell us whether or not their--because we hear of 
all the negatives, everything from extraordinary income, which 
all of us know is impossibly true, or General Electric; own all 
the specialist positions on the market--a lot of misinformation 
is out there but it is having an effect on people because it is 
misinformation. But a lot of us aren't sufficiently 
knowledgeable about these exchanges and how they work.
    What is your impression, really, of whether, one: we have a 
problem in the specialist field in the New York Stock Exchange 
particularly?
    And, two: do they, in your estimation, fulfill a necessary 
function?
    Mr. Donaldson. Clearly, I think that you have to draw a 
distinction between the rules and regulations under which the 
specialists operate. And the enforcement of those rules and 
regulations, which I believe is a separate issue from the 
function of the specialist system itself.
    I think John Reed was absolutely correct when he referred 
to the effectiveness of the auction market system as, ``A 
deliverer of liquidity in times of stress.''
    And I think we have seen that time and time again over the 
course of my business career, where in turbulent markets the 
liquidity pool is developed on the floor of the New York Stock 
Exchange.
    It is a tremendously valuable national asset.
    Now, the game has changed a bit, as you correctly say, with 
the advent of penny spreads and decimalization and, the fact 
that, although you have narrower spreads, you have less of the 
true size of the market displayed.
    In other words, there is a bid and an ask that are 
separated by a penny, but that doesn't really disclose what the 
real depth of the market is behind that bid and offer. And I 
think that has been to the detriment of informed trading.
    The trick here, as far as I am concerned personally, and I 
believe as far as the Commission is concerned, is to get an 
interface between this rapid trading and possible price 
improvement. In an environment where you only have a penny 
spread, a case can be made by some, that they, the customer, 
the client, the broker, doesn't want to wait for a penny 
improvement. They want to get a trade done; they are interested 
in speed.
    But I don't think you can apply that across the board to 
the fundamental concept of price improvement and the customer 
getting the best price that he or she can possibly get.
    And I think we tread on thin ice when we suggest that we 
are not going to get the best price for somebody. And I think 
that is the beauty of our market.
    Chairman Baker. Thank you, Mr. Kanjorski.
    Chairman Oxley?
    Mr. Oxley. Thank you, Mr. Chairman.
    Chairman Donaldson, I ought to call your attention to the 
lead editorial in today's Wall Street Journal, and it tracks 
very closely, the views that I expressed earlier in my opening 
remarks.
    And we operate on a separate track; I don't write the 
editorials for the Wall Street Journal, nor do they write my 
opening statements.
    But I want to quote from that editorial.
    ``We hope he, that John Reed and especially folks in 
Washington, don't ignore the largest public policy issue at 
stake: the rules and regulations governing the national market 
for stock trading. Specifically, the monopoly created for the 
New York Stock Exchange by the Intermarket Trading System.''
    ``The heart of this system is a prohibition mandated by the 
Securities and Exchange Commission against trade-throughs. In 
theory, this sounds like good market organization and practice; 
it allows the New York Stock Exchange an artificial market 
advantage.''
    Do you disagree or agree with those sentiments? And how 
does the Commission intend to address those thorny issues?
    Mr. Donaldson. I think, in the testimony upcoming, you are 
going to see the disagreement that exists out there.
    If I have correctly read some of this testimony that you 
are about to get, you have people arguing violently on the side 
of what that editorial said; that there ought to be a total 
elimination. There are equally strong arguments on the other 
side.
    I believe the answer is probably somewhere in between, as 
it always is in many disputes where there are extremes.
    I think we have to be very cognizant of the tradition of 
the central market structure that says the customer, the 
client, the small investor, the large investor ought to be able 
to get at the best price.
    And when you get into defining execution as something other 
than best price, such as speed, or a number of other criteria, 
you get a little bit on slippery ice. This isn't to say that 
there aren't certain customers that would sacrifice price 
improvement for speed. We have to come up with a system whereby 
in a unified market, we can satisfy both kinds of customers. 
And that is our challenge.
    Mr. Oxley. Has the SEC looked at the--I guess, for want of 
a better term--the European model? Virtually all of the bourses 
in Europe have gone to all-electronic trading.
    Is there any evidence over there that there is a lack of 
liquidity or failure of folks to make a market? It appears that 
they have totally abandoned the auction system there. Does that 
give the SEC any guidance one way or the other?
    Mr. Donaldson. I don't want to comment generally on the 
quality of pan-European markets, except to say that I think I 
could make the generality that our markets are still the envy 
of the free world; that there is no market system that operates 
as efficiently and effectively in the interest of individual 
customers, as well as institutions, as the U.S. markets do.
    Now, that is the basic premise from which we start, which 
is, we are still the best. And I think all evidence indicates 
that. Can we improve it? Can we adjust the technology? Yes. I 
believe we can, and that is what we are working on right now.
    The system--if you want to go into the history of the 
formation of the auction market system long before technology 
was designed to create a market that, as much as possible, 
eliminated dealer interface and allowed natural customers to 
meet each either directly with no intermediary. And that system 
was developed over a number of years and has worked pretty 
well.
    However, if you are starting up new systems, which are 
characteristic of many of the European markets, they are 
basically started by dealers who want to get a dealer spread 
and want to interpose themselves in between natural buyers and 
sellers.
    Now, that is the fundamental clash, if you will, between 
those systems and our systems. And now you add onto that the 
new technology that has come in.
    And, again, I would say that we do not want to lose the 
benefits of the auction market of which the specialist is a 
primary part, but we also do not want to deny the speed that is 
available in some of our electronics markets.
    So the trick is bringing them both together and having an 
option for customers.
    Mr. Oxley. But is there evidence, that you know of, that 
there is a severe lack of liquidity in the European markets as 
a result of having an all-electronic system of trading?
    Mr. Donaldson. Well, I will give you one man's view, and 
that is I think our markets are much deeper, much more liquid 
and particularly so in times of stress.
    It is easy to have functioning markets when you are in a 
relatively calm period. It is a little more difficult to 
assemble liquidity to offset imbalances when markets are 
turbulent. And I think that is when the auction market really 
works the best.
    Mr. Oxley. If I may, just one more, Mr. Chairman.
    In regard to SROs, do you think that there is an essential 
function--I am not talking now about structure or design, but 
just in a general sense--do you agree that there is a need for 
SROs to exist?
    Mr. Donaldson. Yes, I do.
    Mr. Oxley. Okay.
    Mr. Donaldson. I believe that the original decision that 
was made back in the 1930s, to create an SRO structure, was a 
very sound decision.
    And that, fundamentally, was based on the idea that, if you 
set up a government agency, such as the SEC, and gave it the 
responsibility for totally regulating the markets, you would 
create a bureaucracy, you would create a federal expense, and 
you would create a lack of being in touch with the marketplace 
that would impede our markets.
    So, I think that the concept of a self-regulatory 
organization, which gets the regulation down to people who are 
familiar with the marketplace, is a very sound concept.
    It also gets the expense of regulation down where it should 
be, on our participants in a marketplace.
    Then, the question is, ``Can you structure that self-
regulation so it is totally unbiased?'' So that it is 
uninfluenced by the responsibility for running a market as a 
business. And, that is the trick.
    How do you get that self-regulation independent so that it 
is not being influenced in any way by those who are trying to 
build the marketplace?
    Mr. Oxley. Do you think the NASD model fits that 
description?
    Mr. Donaldson. I think the NASD model is an interesting 
model.
    I think that it still has the need to regulate the NASDAQ 
market, itself. It is being done by NASDR, I think is one 
approach. I think there are other approaches.
    Mr. Oxley. Thank you. Thank you, Mr. Chairman.
    Chairman Baker. Thank you, Mr. Chairman.
    Mr. Emanuel?
    Mr. Emanuel. Thank you, Mr. Chairman.
    I was intrigued by what you said earlier to the Chairman. I 
think the way you said it is that the SEC was caught a bit 
flat-footed by the market timing and late-trading scandal. And 
this is part question as well as part statement--my hope here 
is that the mutual fund industry investigation doesn't become a 
turf battle between the New York Attorney General and the SEC.
    Although the Attorney General has been leading the effort, 
I would like to see a coordinated strategy without any dispute 
over ``real estate.''
    Because given how many Americans are invested in mutual 
funds, the integrity of that industry and its managers is 
essential. As much as we discuss market regulation, with 96 
million Americans investing in mutual funds, it is essential 
that that investigation be done without any squabbling between 
the States and the SEC.
    With that said, how widespread do you think this market 
timing issue is in the mutual fund industry and among its 
managers?
    Mr. Donaldson. Let me address the first part of your 
observation there.
    Mr. Emanuel. Sure.
    Mr. Donaldson. Which is this should not be a competitive 
situation between regulators.
    Mr. Emanuel. Good.
    Mr. Donaldson. This should not be a competitive situation 
between the federal regulators or any of the State regulators. 
We have worked with the State regulators for years.
    We have recently formed a joint committee between the State 
regulators and ourselves to try and iron out cooperative 
attitudes; how we can help each other; how we can improve that 
cooperation.
    I think that the spectacle of one regulatory agency 
criticizing another is not healthy. We look to cooperate, the 
New York Attorney General, we have tried to cooperate with him, 
we are cooperating with him right now on a number of issues.
    We have a much broader responsibility, a much larger staff. 
The whole investigative thing is going on now as we enable it 
not to be a rifle shot but to be a broad-gauged investigation.
    To answer the second part of your question, we believe, as 
a result of a net that we have cast, that the market timing and 
late-trading issues are quite widespread.
    We are still gathering data on this. But we think it is 
more widespread than we originally anticipated.
    Mr. Emanuel. Mr. Chairman, we have worked on an agreement 
that we are going to be holding hearings on the mutual fund 
industry in the not-too-distant future. Correct?
    Chairman Baker. That is our intention.
    Mr. Emanuel. Okay.
    To me, what is critical here is the integrity of the 
financial markets in the United States, and the trust investors 
have in the markets. I feel strongly that these scandals have 
become for mutual funds what Enron, Tyco, and WorldCom were to 
corporate America.
    And I think we are all vested in making sure that 
everybody's level of confidence is restored to the highest 
level, as quickly as possible.
    So, I applaud you for creating this joint task force. 
Please let this Committee know if there is anything we can do 
to help you on the funding level, because I think what is 
happening, as evidenced by today's news about the Strong funds, 
is an unparalleled threat to the public's confidence in this 
sector of the financial markets.
    Thank you for you leadership on these issues. I look 
forward to continuing to work with you on meaningful reform.
    Mr. Donaldson. Thank you.
    Mr. Emanuel. No further questions.
    Chairman Baker. Thank you, Mr. Emanuel.
    Mr. Bachus?
    Mr. Bachus. Thank you. Does someone need to put something 
in the record?
    Chairman Baker, I understand.
    Chairman Baker. Thank you, Mr. Bachus. I didn't realize Mr. 
Fossella wanted to put a statement in the record.
    Mr. Fossella. Yes, Mr. Chairman, I have been asked by the 
Organization of Independent Floor Brokers to have their 
statement submitted for the record.
    Chairman Baker. Without objection. Thank you, Sir.
    [The following information can be found on page 196 in the 
appendix.]
    Mr. Bachus?
    Mr. Bachus. Thank you, Mr. Chairman. Chairman Donaldson, 
Chairman Oxley asked you about the trade-through rule and you 
indicated that there is consideration for reforming that rule. 
Is that correct?
    Mr. Donaldson. Yes.
    Mr. Bachus. That would go from anything from abolishing the 
rule to maybe establishing the same practices we have for the 
queues and the spiders today, is that correct?
    Mr. Donaldson. Yes. Let me just make a couple of comments 
on the trade-through rule.
    The trade-through rule was designed to force executions to 
be done at the best available bid or ask. And it was a rule 
that was put in to make sure that, no matter where listed 
stocks were traded, the customer would be afforded the 
opportunity of the best bid or the best offer.
    What has changed the scene now is two things.
    The first is the speed of electronics with some of the ECN 
markets, and the second is decimalization.
    The speed is so fast that it is hard to monitor the trade-
through rules, and you have trade-throughs going on where, in 
the name of speed, the customer may be getting a worse price.
    It may well be that because the worst price is only a 
penny, as opposed to an eighth, or a quarter, or a half, that 
some class of customers say that, ``I don't care. I would 
rather have the speed.''
    But to design a market that just throws out the ability to 
match at the best bid or offer is quite a move.
    So as we look at this rule and try to contend with it, in 
terms of the modern clash that we are having, I think we have 
to be very careful what we do with that rule. And that is just 
what we are looking at right now.
    Mr. Bachus. Thank you.
    Do you know when you will maybe disclose the results of, at 
least, your preliminary findings?
    Mr. Donaldson. The timing of this and several other market 
structure issues, as I intimated earlier, is----
    Mr. Bachus. Months; not days.
    Mr. Donaldson.----in months now, not days or weeks. And not 
years.
    Mr. Bachus. Thank you.
    Earlier, in response to a question from the other side, you 
mentioned the orderly markets and the fact that one thing 
specialists do is they stabilize the market and supply 
liquidity.
    There was an article in the Wall Street Journal yesterday 
that actually said--I am sure you probably read it--that 
actually said that, ``The NYSE apparently does not have any 
data demonstrating that their specialists actually step in and 
provide capital to stabilize the trading on a particular 
security during times of market stress.'' That was the Wall 
Street Journal, yesterday.
    Do you know if those press reports are accurate? I have 
also heard that Mr. Reed had requested that information and it 
wasn't available.
    Mr. Donaldson. I don't know that study. Did you?
    Ms. Nazareth. Yes. I take it they know how much they bought 
or sold in times of stress, but they are having difficulty 
retracing how much capital they committed at the time.
    Mr. Bachus. When they determine that, will they determine 
their profits? Are you seeking that information? Is that an 
area that you are inquiring or examining?
    Mr. Donaldson. Yes. Sure. Yes.
    Ms. Nazareth. Yes.
    Mr. Donaldson. Yes.
    Mr. Bachus. Do you know what the status of that inquiry is?
    Mr. Donaldson. I don't want to give you a direct answer on 
that because I don't know the exact status. It is under way.
    I will come back to you with just how far we are into it.
    Mr. Bachus. But you are also trying to gain that same 
information?
    Mr. Donaldson. Yes.
    Mr. Bachus. Yes, Okay.
    In Trader magazine--I guess it is a magazine--I want to 
just read to you a quote.
    They said that, ``The NYSE's recent release of SEC-mandated 
order execution qualities statistics actually suggest that 
investors don't get the best possible execution on the floor of 
the NYSE, despite the NYSE's claims.''
    And this is really of particular concern, ``The NYSE's 
public claim is consistent with complaints by large NYSE 
members that when such members have considered routing investor 
order flow to alternative market centers away from the NYSE, 
the NYSE regulatory arm has threatened the members with best 
execution investigations.''
    You have probably heard some of those allegations? And let 
me put another question on top of that.
    What disturbs me about that is that the regulatory arm of 
the NYSE could be used to stifle competition, if that is true. 
And I would just like your comment on that.
    Chairman Baker. And that will have to be the gentleman's 
last question. His time has expired, but please respond, Mr. 
Chairman.
    Mr. Donaldson. Let me just put newspaper articles and 
studies in context. What we are dealing with here is a 
competitive situation.
    As a former academic myself, there are studies, and there 
are studies, and there are studies that are sponsored by 
groups--I am not referring to any particular study----
    Mr. Bachus. Absolutely.
    Mr. Donaldson.----but I think that you have a right to 
believe that the studies being done by the SEC are non-biased, 
straight down the middle, with one purpose in mind: the 
effective structure of the marketplace.
    And I think it is very hard for people to separate out the 
competitive markets that are out there today and the prejudices 
associated with that, including, but not limited to, the New 
York Stock Exchange, the American Stock Exchange, the ECNs, et 
cetera.
    They are trying to promote a marketplace. And so, I take 
some of these studies with a grain of salt.
    Mr. Bachus. I guess I would just say, would you agree that 
if they were using the regulatory arm to stifle competition 
that would be improper?
    Mr. Donaldson. Well, I think that this gets to the issue of 
where the locus of the regulation is, and I am sure that there 
are accusations on all sides about the regulation being biased 
or not being biased, or being used for other purposes.
    I think the solution to that is to have the regulation 
independent of those that are trying to build the market itself 
and to have it be a truly independent entity.
    And that goes to, as I said before, a number of different 
ways of doing it: internally structured or externally and 
totally separated, or a mixed mode, such as NASDAQ has.
    Mr. Bachus. I thank you.
    Chairman Baker. Gentleman's time is expired.
    Mr. Hinojosa?
    Mr. Hinojosa. Thank you, Chairman Baker and Ranking Member 
Kanjorski.
    I want to thank you for holding this second hearing on 
market structure. I recall that the first hearing on this 
series was on governance issues at the New York Stock Exchange, 
including the potential conflicts of interest created by 
regulators.
    This leads me to my question. Chairman Donaldson, what role 
can the public equity markets, specifically, real estate 
investment trust equity funds, play in providing capital to 
invest in affordable multi-family and home ownership efforts?
    For example, can the public equity markets play a role in 
providing capital the same way Citigroup and Fannie Mae 
announced yesterday that $100 billion of financing through the 
end of the decade to help lower-income families obtain 
mortgages to buy homes?
    Is that something you would support?
    Mr. Donaldson. My answer to your statement or question is 
that the equity markets, in this country in particular, are 
highly liquid. And they are highly transparent. And, because of 
the liquidity and the transparency, they give people an 
opportunity to set the cost of capital, if you will, by the 
multiples of earnings, or whatever, that stocks sell at.
    So it is a great capital-generating machine. The equity 
ownership has, inherent in it, the raising of new equity and 
the raising of new capital.
    As far as what vehicles are better for distributing it to 
one industry: housing or whatever, we could sit here and talk 
about that for a long time.
    Mr. Hinojosa. Well, that answer is a little bit unclear.
    It seems to me that you and I and many in this room, 
understand that the housing industry is the one that is helping 
keep unemployment rates down to the point that they are.
    Otherwise, it would probably be one or two points higher.
    So it seems to me that there needs to be a boost in terms 
of monies available, particularly for working families who want 
an opportunity to have their first home.
    Are you saying that you don't favor one industry over 
another?
    Mr. Donaldson. No.
    There are many mortgage security mutual funds to begin 
with, but I think the political issue of how money is directed 
to different parts of the economy is not really my function or 
the SEC's.
    I may have personal views on it, but I think it really is 
not in our mission.
    Mr. Hinojosa. Okay.
    Chairman Baker, I look forward to learning more about our 
capital markets from today's and, hopefully, future witnesses.
    I also look forward to working with you and with Ranking 
Member Kanjorski should this Subcommittee conclude that it 
needs to formulate legislation to change corporate governance, 
or possibly encourage the exchanges to adopt certain best 
practices.
    With that I yield back.
    Chairman Baker. I thank the gentleman for his good 
statement.
    Ms. Biggert?
    Mrs. Biggert. Thank you, Mr. Chairman.
    Just to follow up on Mr. Bachus's question for a moment. 
You were saying that you are moving expeditiously on the market 
structure issues and that would be within months.
    Do you have a list of how you are going to proceed and what 
issues will the Commission tackle first?
    Mr. Donaldson. Yes. There are a number of issues that are 
on our agenda.
    Obviously, the issues we have been discussing this morning: 
trade-throughs; trade-through rules and other rules; access; 
market access; the openness or lack, thereof, of access. And we 
have a number of concerns about the way the market data tape 
revenues are determined and distributed. Those are a few of the 
categories that are on our agenda right now.
    Clearly, governance is a part of that and regulation.
    Mrs. Biggert. One of the issues that I am particularly 
interested in is internalization.
    And it just seems like, with all of the recent conflict of 
interest scandals, that little has been said about the 
internalization which, obviously, involves the brokerage firms 
trading against their own customers' orders.
    And I have concerns that this practice in the listed 
options markets may soon be systematic and taken to a new level 
if the SEC approves the pending proposal from the Boston Stock 
Exchange, called BOX.
    Could you comment on the timeframe for completing that 
proposal? And could you also comment on what the SEC is 
currently doing to study the beneficial, or the adverse, 
effects of internalization?
    Mr. Donaldson. As you intimate, the proposed BOX system was 
proposed to the SEC. We had a number of questions about various 
aspects of that proposal.
    We received answers from not only the BOX promoters but 
also answers from the public. We are in the process now.
    I think our cut-off date was less than a month ago?
    Ms. Nazareth. Yes.
    Mr. Donaldson. Yes, less than a month ago.
    And so we are now examining the comments. Clearly the 
internalization aspect of that proposed system is one that 
concerns us, as does internalization generally, not just in the 
option markets, but the potential for internalization in the 
equity markets.
    Again, the negative potential of capturing buy and sell 
interests inside an entity--as opposed to exposing them to buy 
and sell interests across the country, and the world for that 
matter.
    Mrs. Biggert. Would the impact of the one-cent trading have 
any effect on that issue as well? On the BOX?
    Mr. Donaldson. I am sorry, I didn't hear that.
    Mrs. Biggert. Would the one-cent trading have any effect in 
the listed options industry?
    Mr. Donaldson. Well, as you know, options are traded at 
nickel increments and that spread has a lot to do with the 
dangers of internalization. Yes.
    Mrs. Biggert. Okay.
    Thank you. Thank you, Mr. Chairman.
    Chairman Baker. Thank you, Ms. Biggert.
    Mr. Scott?
    Mr. Scott. Thank you very much, Chairman Baker.
    Chairman Donaldson, I would like to ask you a couple of 
questions about the National Security Clearing Corporation. 
There is a proposed rule change.
    This rule change will allow the National Security Clearing 
Corporation to enter into services that are already being given 
and serviced very effectively and efficiently by the private 
sector.
    It would, basically, if you are not familiar with it, it 
would create a new service for the NSCC that would provide its 
current members with other data services, only for members, 
would specifically propose to provide a service for its members 
that would enable the NSCC to provide a messaging hub for the 
communication of information among sponsors of Separately 
Managed Accounts, or SMAs, and the investment managers 
participating in this program.
    If that rule goes into effect, it would historically change 
the basic statutory purpose of the NCA.
    And it seems to me that given the current level of private 
competition present in a marketplace, it could very well be a 
violation of the NSCC's mandate and would be inappropriate from 
a policy perspective, for any SOR, including NSCC, to become an 
active participant in an existing competitive market.
    So it seems, to me, Mr. Chairman, as a matter of policy, 
that the fundamental role of self-regulatory organizations, or 
SROs, subject to SEC supervision, should be to facilitate the 
efficient operation of the markets, as an extension, if you 
will, of the Commission itself.
    I am very concerned, though, that the National Securities 
Clearing Corporation, long an essential link in the securities 
payment process, may be trying to meddle in the kind of 
function that has been exclusively reserved for the private 
sector alone.
    What do you know specifically about this rule change that 
the NSCC is in the process of proposing to the SEC?
    And what assurances can you give to this Committee, and the 
nation, and to the private sector, that SROs, because of their 
inherent competitive advantages that accompany their status as 
quasi-government entities, ought not to be in the business of 
competing in the private sector with established businesses?
    Mr. Donaldson. Congressman, I will begin by saying that I 
am not familiar with the issues that you have just brought up. 
I just checked with Ms. Nazareth, who, likewise, is not 
familiar with the particular issues you have brought up.
    But I would like to come back to you with answers to your 
statement and will do so.
    Mr. Scott. That is very good. Thank you, Sir. And I will 
look forward to getting that information.
    There are a lot of companies who are involved in this area 
that are very much impacted and would like to get some answers 
to that. So I look to get that from you.
    Thank you.
    Chairman Baker. Thank you, Mr. Scott.
    Mr. Chairman, I don't know if you have previously announced 
time constraints, but we have several members who are still 
indicating an interest in asking questions, and we would return 
right after a brief break with Ms. Kelly on our side.
    And there are several other members on the Democrat side 
who would like to have the ability to ask questions.
    We have two votes, we think. One for sure that is down now 
to about six, seven minutes, and possibly a procedural motion 
would keep us over there another 10, 15 minutes, and we would 
be right back.
    Mr. Donaldson. That is fine.
    Chairman Baker. If that doesn't present a problem, then we 
will stand in recess for about another 15 minutes.
    Thank you, Sir.
    [Recess.]
    Chairman Baker. I would like to reconvene our meeting of 
the Capital Market Subcommittee.
    And at this time, I would recognize Ms. Kelly for her 
questions.
    Mrs. Kelly. Thank you very much, Mr. Chairman.
    Mr. Donaldson, my neighbor, I am delighted to have you here 
today. Thank you very much for coming and for your patience and 
answering our questions.
    A couple of things that I was interested in: one of the 
things we have been talking about--I, also, don't know if 
anybody has noted the fact that we are pretty close to October 
29th, Black Tuesday, and this is the 75th anniversary of the 
market, so I am glad you are here and we have a strong market 
and I hope it stays that way, but--you were talking about the 
buyer of last resort.
    And I would like your thoughts on the practice of the buyer 
of last resort has played in providing liquidity and in 
preventing disturbances and how the market structure reforms 
might have an impact on that principle.
    Mr. Donaldson. Well, I think if I understand your question, 
I did make comments earlier about the liquidity that is 
available in the concept of the auction market and the 
``crowd'' and so forth; liquidity that seems to appear at times 
of stress.
    There is a mechanism there for drawing out that liquidity 
and putting it together; that I think has served the country 
well.
    Mrs. Kelly. I am sorry, sir, I wasn't able to be here 
earlier, I had to go out to the Pentagon, so I didn't hear that 
at that prior discussion. But thank you for answering that 
question. I am sorry it was redundant.
    Have you also discussed naked short-selling?
    Mr. Donaldson. I am sorry, did we----
    Ms. Nazareth. No. Naked short-selling, we did not discuss 
that.
    Mr. Donaldson. No, we did not discuss naked short-selling.
    Mrs. Kelly. I would be very interested in what you plan to 
do in that area.
    Mr. Donaldson. Yes.
    We have just put out a new proposed rule that deals with 
naked short-selling. It deals with short-selling, in general, 
but as a part of that, naked short-selling.
    And, in the proposed rule, we have proposed that there be 
new restrictions on naked short-selling.
    I will give you, in general terms, the concept. It would be 
the obligation of the short seller's agent to identify where 
the certificates were for the short sale.
    In other words, it would not prohibit short-selling, but it 
would severely restrict the short-selling where the short 
seller can't deliver the certificates. And there are certain 
leverage advantages to doing that, but it is something we think 
should be eliminated.
    Mrs. Kelly. And you have a plan to do that is that what I 
understand?
    Mr. Donaldson. Yes we have. We have put out a rule on that.
    Mrs. Kelly. Good. Thank you very much for doing that.
    Mr. Donaldson. Right.
    Mrs. Kelly. I think that will help market stability and 
trust for the public.
    I am going to ask one other question and that is when the 
market went to decimalization it went to a penny on the spread.
    I am wondering if we have the opportunity now to take a 
look, if we are going to standardize, across the board, a 
certain number of things, whether or not it would behoove us to 
maybe not take action, but at least evaluate the effect on that 
regarding the depth of the market.
    And whether or not it might be prudent for us to move to a 
five-cent, rather than a penny spread. I will give you some 
leeway to answer that, but I would like to hear.
    Mr. Donaldson. Yes. Well, I think there has been a lot of 
examination of just exactly what the effect of the 
decimalization has been.
    Clearly, part of what you imply is true, in my view, which 
is that the liquidity or the displayed liquidity is hidden, if 
you will. There can be a penny spread, but that can be for a 
hundred shares.
    And you really don't know what liquidity is there,I think 
that is a disadvantage.
    In terms of the monies either saved or not saved by the 
reduction--going to decimalization and all the way down to 
penny spreads--I think that is a debatable item.
    There are studies that have been done that say this has 
been to the advantage of the individual investor and to the 
disadvantage of institutional investors.
    Again, I think that the more light we can shed on just 
exactly what the implications of decimalization have been, the 
better.
    In terms of increasing the spread, I think it is probably 
premature to do that unless and until we have evidence that 
negative aspects of penny spreads are hurting the liquidity in 
a marketplace.
    Mrs. Kelly. Are you examining that? Is anyone tasked with 
an examination of what that effect was on the market and 
continues to be?
    Mr. Donaldson. Yes.
    A lot of it is hard to identify in the sense that you have, 
with the reduced spread, reduced profitability.
    It is quite possible that we have had a reduced liquidity 
in lesser-traded stocks that market-makers are less inclined to 
commit their capital with less of a profit margin available to 
them.
    There are other issues on the other end of the scale: the 
sub-penny spread issue, which is, ``How far does this go? Do we 
now get down into not just pennies, but fractions of pennies?''
    You didn't ask me that question, but I will give an answer 
to it. I think it would be counter to the public interest to 
get into sub-penny spreads, and that is one of the things we 
have to address in our market study.
    Mrs. Kelly. Would you also be including commodities markets 
in that?
    Mr. Donaldson. Right.
    Mrs. Kelly. In that study?
    Mr. Donaldson. Yes. Right.
    Mrs. Kelly. Thank you very much. I yield back.
    Chairman Baker. I thank the gentle lady.
    Mr. Inslee?
    Mr. Inslee. Thank you, Mr. Chair.
    Two questions. I have a quote, Mr. Chair, I believe is 
yours.
    You said, at one point, to the Senate Banking Committee, 
you said, ``Like payment for order flow, internalization can 
discourage markets from competing on the basis of price and 
pose a conflict of interest for broker dealers,'' which, I 
think, evinces a concern that many of us have.
    But, we are told that you are actively considering this 
proposal by the BOX, which would, in its essence, increase, as 
I understand it, the practice of internalization from a 
structural standpoint.
    Given your apparent concern about internalization, why are 
you actively considering this? And in what circumstances would 
you consider approval to try to reduce or eliminate those 
concerns about internalization?
    Mr. Donaldson. Well, we, as I said, we have the BOX 
proposal. We put it out for comment. We got a lot of comments 
back.
    The most negative comments had to do with the 
internalization aspect of the BOX procedure. We have asked 
additional questions based on the earlier responses. We now 
have this new wave of responses back, and we are looking at the 
situation.
    We are concerned about internalization, and we are 
concerned about the spread of internalization, not just from 
that market, if it were allowed to exist, but the spreading 
into other markets.
    Mr. Inslee. Well, just by way of editorial comment, on our 
main street on the hustings of the small towns we represent, 
credibility really is an issue and we hope that you will focus 
on that and give this very exquisite care.
    Second question. I have spoken recently to some leading 
managers of leading hedge funds and they have expressed real 
frustration at timeliness of execution of their orders.
    Sometimes they believe that the exchanges have ignored 
orders, sometimes they have cited inefficiencies. And so I, 
kind of, have two questions.
    Is it time for some changes to the pass-through rule?
    And secondly, why has the SEC not responded to, what I 
understand--I haven't seen the paper on this, but I have been 
told--there are hundreds of complaints regarding unfulfilled 
orders, particularly with Amex?
    If that is not correct, perhaps you can tell me. And if so, 
tell us how we get those complaints responded to.
    Mr. Donaldson. Yes.
    Well, again, this gets to the heart of the analysis that we 
are doing now, in terms of the viability of that rule and the 
negative aspects of the rule given the trade-throughs that are 
occurring.
    Also, the positive aspects of that rule that ensure that 
the best price is available no matter what the market is; and I 
think you are right at the heart of the debate, if you will, 
and we are aware of some orders that don't get executed.
    We are also aware of orders that, because of the system, 
have gotten the best price that they otherwise probably might 
not have gotten.
    So, we have to work at that interface and figure out how it 
should be adopted, given the circumstances we are in right now.
    Mr. Inslee. How can such a basic situation not get 
remedied?
    Just getting an order executed, if there are hundreds of 
these, how can the SEC not solve problem in a timely fashion?
    It is an honest question, because what I am told is that 
there are hundreds of these without a resolution of this. Maybe 
you could help me understand why that can't get resolved, 
number one.
    And number two: why don't you attempt to resolve these 
complaints and get to the heart of what has happened here 
before you go forward on the BOX situation?
    Mr. Donaldson. Again, I think you have to put the whole 
situation within the context of our overall marketplace and how 
it is functioning.
    With all the hundreds that may not get executed, there are 
millions that do get executed in the best interests of the 
public.
    I think it is not that we were not looking at this, it is 
not that we were not paying attention to it; it is just that it 
is a very tough question.
    And we have got the best brains that we can assemble, not 
just at the SEC, but elsewhere, in terms of trying to figure 
out what is the right answer.
    Mr. Inslee. Clearly, we are hoping now we do see aggressive 
action. I come from Washington State where William O. Douglass 
got the bowl rolling on the SEC and we would like to see that 
tradition followed. And we hope that you move in that 
direction.
    Thank you, Mr. Chair.
    Chairman Baker. Thank you, Mr. Inslee.
    Mr. Crowley?
    Mr. Crowley. Thank you, Mr. Chairman for the hearing today. 
Thank you, Chairman, for coming before us and spending the 
better part of the morning with us.
    I would like to redirect the focus, just a bit, of the 
hearing away from the issues like speed and intermediaries and 
refocus back to the special interests of the investor.
    I am not speaking of the professional investor, something I 
think the New York Stock Exchange has done remarkably well and 
demonstrated throughout its prestigious history of 211 years.
    As you can tell, I am from New York City, and I am a little 
jealous about the Exchange and concerned about the image that 
has been portrayed of it most recently. What basically the 
tenet behind the trade-through rule, as I understand it, was to 
produce the best price.
    Do you, Mr. Chairman, believe that that has been 
successful, as far as the public interests are concerned? And, 
has it worked? I would like to have your personal, maybe, your 
opinion about this.
    And additionally, in light of the emerging ECNs and the 
speed, again, would you favor amending or discarding the trade-
through rules so that speed could take precedence over price?
    And do you believe that such an action, again, would be in 
the interest of the investing public?
    Mr. Donaldson. As I said before, the trade-through rule is 
one that we are looking at right now. What the trade-through 
rule does do is to encourage the display of limit orders.
    And the display of limit orders is what makes for depth in 
the market. So that the trade-through rule also assures, or 
helps to assure, that the best price is being received.
    Now, when you get to the definition of some other 
definition of best price, such as best execution, then you 
bring into play a more complex attitude as to what is the best 
execution.
    And that kind of attitude might have with it somebody that 
is willing to have a fast execution and sacrifice price. And 
that is the issue we are talking about. That is the issue of 
the goals and desires of different types of investors.
    I would be very hesitant to sacrifice the opportunities to 
getting the best price entirely in order to have fast 
execution. But it is a trade-off. It is a compromise. And that 
is what we are working towards.
    Mr. Crowley. That is a fair answer. I appreciate that.
    At the last market structure hearing we had, you mentioned 
that the floor-based market, such as the NYSE, often enjoy 
greater liquidity than non-floor-based markets. Could you 
expand on that and just give some examples and cite some 
examples of that?
    Mr. Donaldson. Yes, I can expand on it colloquially, if I 
may, in the sense that, if we were in a market where there are 
large amounts of stock for sale, let's say, and there are not 
enough bids around, I think the floor has a mechanism for 
creating liquidity to offset the temporary imbalance between 
sell pressure and buy pressure there.
    And I think that that liquidity is, in many instances, the 
liquidity that is created by human beings, if you will, whether 
it be the specialists, their floor brokers or whatever, who 
bring that liquidity in the marketplace to offset an imbalance.
    And I think that creates a market that has less fluctuation 
to it and that is in the interests of the investors. So I think 
that that is really what I am talking about.
    And, again, not to repeat myself, I think that the trick 
here is to create a New York Stock Exchange, if you will, or a 
marketplace, that is able to have the speed associated with, 
let us say, an ECN, but yet has this liquidity aggregating 
capability that the auction market has.
    Mr. Crowley. You would also take by this sort of the 
discussion that has gone on that the stock exchange has not 
invested in technology, none by the huge--you are stating 
that--but it is almost--and they have invested billions of 
dollars in upgrading technology at the stock exchange.
    Mr. Donaldson. There is a lot of rhetoric about technology, 
and I think there have been--in the competitive juices flowing 
out there--characterizations of an antiquated system with 
people running around and no technology. And, of course, that 
is not so.
    Mr. Crowley. And it isn't that you all are very 
competitive.
    Mr. Donaldson. There is tremendous technology at the New 
York Stock Exchange. And it happens to be blended with human 
judgment. And I think that characterization of the stock 
exchange is pretty unfair in this day and age.
    Mr. Crowley. Thank you.
    Chairman Baker. Gentleman's time has expired.
    Mr. Meeks?
    Mr. Meeks. Thank you, Mr. Chair. And being last and knowing 
that I am in the way between letting the Chairman go about his 
busy day, or keeping him here with us, I will be very brief, so 
that we can get to the next panel.
    I have, basically, two quick questions.
    And like Mr. Crowley indicated, I am from New York and both 
the New York Stock Exchange and NASDAQ are very important to me 
and to the city, and I do believe the station.
    But as we move on, the key to a lot of this is transparency 
and credibility and to make sure that there is confidence from 
the investors, et cetera.
    And I know that the New York Stock Exchange is currently 
investigating several specialists for getting in between trades 
for their own profit.
    My question basically is, ``Do you see this as just an 
isolated incident, something that will be a rarity? Or 
something that is occurring on a frequent basis?''
    Mr. Donaldson. I think you bring up an important point. I 
am being reminded that there is a pending investigation on this 
issue that I will be directly involved in as a member of the 
Commission.
    But let me just say that I think there is a difference 
between an attack on the specialist system as a system versus 
the specialist system when some of their rules have been 
violated.
    In other words, if the allegations in the investigation are 
true and there has been a breaking of the rules, that is one 
thing. That goes to enforcement of the rules and perhaps it 
goes to changing the rules.
    But in terms of throwing out the whole system because the 
rule has been broken, that is something that, I think, one has 
to examine very, very carefully.
    Mr. Meeks. In essence, throw the baby out with the bath 
water.
    My other question is that we know that recently John Reed 
announced that he is reforming the Board of the Directors of 
the New York Stock Exchange.
    And he is reforming it so that no members will be on the 
board of directors and securities industry's representatives 
will be only on an advisory panel with no jurisdiction over 
regulatory or compensation issues.
    To what extent will you; will the SEC be weighing in at all 
on the restructuring of the New York Stock Exchange board? What 
role would you play in that, if any? Will you oversee it? Have 
any comments in that regard?
    Mr. Donaldson. Yes. The bottom line is that the SEC has to 
approve the rules that will come from the reorganization of the 
stock exchange. Net, net, that is what has to happen.
    Now we have tried to be of what help we can be in helping 
John Reed contend with, what are, I believe, necessary changes 
in the governance system of the stock exchange, that is to 
attempt to address this issue of separating out by virtue of 
reporting mechanisms: the regulatory side of the house with the 
market side of the house.
    And I think that John Reed and his advisers are moving in a 
direction that seems to make sense, I haven't seen the final 
proposal yet, but the direction that they are moving in is to, 
in essence, have a totally independent board without any 
attachments or alliances or to listed companies or floor 
members or floor brokers or seat holders and have the reporting 
mechanism of the regulatory side of the house, plus some other 
reporting mechanisms: compensation, director selection and so 
forth, report into that entity.
    And then to have an entity on the side that would have 
representation from all the constituencies that would serve as 
an advisory board to the independent board.
    That is a general thrust of what is being proposed, I 
believe. But we will have to see the details of that because 
we, in the final analysis, have to approve the implementing 
rules that will come from these suggestions.
    Mr. Meeks. But will you be involved and how then will you, 
Mr. Chairman? Will you be involved?
    Are you going to just wait until you see what the proposal 
is before you either approve or not approve it? Will there be 
conversations in between, which I think that I am hearing is 
taking place?
    And you will be giving some guidance as to what you think 
is acceptable or not acceptable, while they are trying to 
develop the plan?
    Mr. Donaldson. We are anxious to get involved, we are 
anxious to be of what help we can be in looking at proposals 
before they go out for votes.
    And I think that has been the tradition of the SEC: to try 
and anticipate objections, if you will, that we might have 
before they are out to be objected to in a general publishing 
of the rules. So that is the route that we hope we are on.
    Mr. Meeks. Thank you, Mr. Chairman.
    Thank you, Mr. Chairman.
    Chairman Baker. Thank you, Mr. Meeks.
    Mrs. Maloney?
    Mrs. Maloney. Thank you, Mr. Chairman. It is always an 
honor to welcome an outstanding New Yorker to the committee and 
to congratulate you on your public service. It has been an 
outstanding one throughout your life, and private service.
    I would like to touch on a part of market structure that I 
don't believe has been talked about in this hearing.
    And that is the recently issued report from the SEC on the 
hedge fund industry. And it was reported that they are now 
roughly 6,000 to 7,000 of these unregulated investment tools 
and some have suggested that there should be a register at the 
SEC.
    And I agree with the commentators that these funds do make 
a positive contribution in greatly increasing the liquidity in 
the markets.
    But at the same time, I am concerned about the increasing 
trend towards hedge funds which lower the financial resources 
needed to get into the hedge funds and the movement into retail 
of the hedge funds.
    I want to know, do you support making hedge funds available 
to retail investors?
    Mr. Donaldson. As you may know, we have had the hedge fund 
industry under review for over a year. We have done as much 
research as we could accomplish.
    We have had groups of hedge fund people brought together on 
all sides of the issue: advisers, hedge fund managers and so 
forth.
    And as a result of all of that, the staff has presented the 
commission with a report and with a series of recommendations, 
perhaps the most prominent of which is that we register the 
advisers to these funds under the Investment Advisers Act.
    And I think that that recommendation is based on several 
considerations.
    Number one is, what you say, which is that there are 
upwards of 6,000 to 7,000 of these funds out there right now. 
They account for somewhere around $600 billion to $700 billion; 
they are growing like a weed.
    And we have no right in most of these funds to go in and 
find out what is going on. Why do we want to go in and find out 
what is going on?
    Two reasons: one is we want to understand the accounting 
that is being used, we want to understand the pricing that is 
being used. We don't want to interfere with investment 
techniques or disclose those to other people; proprietary 
techniques, but we need to have the right to go in.
    Perhaps more important than that, in my view, is we need to 
understand what impact these funds are having on the 
marketplace itself.
    It has been said that hedge fund investors are wealthy 
investors and they can take care of themselves.
    That may or may not be so, but what we can't afford to have 
is a hidden impact, if you will, in terms of some of these 
techniques that act against the best interests of our 
functioning markets. And that is why that proposition was put 
forward.
    We have put it out for further comment to address the issue 
of small investors without a means test investing in hedge 
funds.
    I think a good case can be made for that, if there is 
complete transparency within the hedge fund itself.
    And, as we move toward these so-called funds of funds, 
funds of hedge funds, where you have weekly or monthly pricing, 
it is all the more important to assure that the small investor 
knows what he is or she is buying. And knows how the internal 
holdings are being priced, et cetera.
    Mrs. Maloney. But that is pretty much important that 
transparency. And I truly do believe that our capital markets 
run on trust as much as they do on money.
    And therefore, your position is incredibly important to the 
country and the trust the country will have in financial 
markets.
    So, as one who represents the New York Stock Exchange, I 
have been there many times and I have met with some incredibly 
impressive people and the technology and oversight into the 
building, I would say, is State of the art.
    And you have touched on this earlier, but I would like to 
have it clarified; given the controversies at the exchange, you 
stated earlier, I believe, that you support this self-
regulation model in general.
    But my question is, ``Should the job of regulating the 
Exchange be separate from the job of running the Exchange's 
business?''
    I know that the NASDAQ is split from the NASD, possibly 
these are different models, but you, I believe said you support 
self-regulation, but do you believe the head of the exchange 
should also be the head regulator?
    Mr. Donaldson. Well, again, I think that the issue is the 
definition of separation. And to me, separation can run a 
gamut. It can be a physical; an ownership separation with a 
regulator out there, somewhere.
    Or it can be an internal structure that separates the 
reporting function such that the regulators are reporting to an 
independent board and reporting not to the same people that are 
running the exchange market, as a business.
    And, I think, the stock exchange is now wrestling with 
where they come down on that.
    And I think we have an open mind toward a solution that 
solves the issue of potential conflict of interest between the 
business side and the regulatory side.
    Mrs. Maloney. Well, my time is up and I thank you, Mr. 
Chairman.
    Thank you, Mr. Donaldson.
    Chairman Baker. I thank the gentle lady.
    Mr. Chairman, we express our appreciation for your courtesy 
of your time today. It has been very helpful for the 
Committee's considerations.
    I am advised that a number of members, who could not come 
back, that wish to ask additional questions requested that the 
record remain open so their submission of questions to you 
could be, perhaps, responded to by correspondence at a later 
time, but would be made part of the official committee record.
    With that one caveat, and I also will forward my own 
correspondence relative to a question concerning the window 
during which some of these ongoing analyses may be completed 
for the Committee's planning for next year.
    Understanding that we would very much like to have the 
Commission's recommendations finalized, in order, for the 
Committee to act upon where it is needed to be acted upon 
within a reasonable time constraint, next congressional year.
    So, we do appreciate your courtesies and your willingness 
to participate. Thank you very much, Sir.
    Mr. Donaldson. All right. Thank you.
    Chairman Baker. Thank you.
    And I would ask that the participants in our second panel, 
please, come on down.
    I welcome each of you to the Committee's hearing today. All 
of your formal statements will be incorporated into the 
official record. We would request that your oral testimony be 
limited as best possible to five minutes.
    And I do expect members in and out as the course of the 
hearing proceeds, but all of your recommendations will be 
reviewed by members of the Committee as we go forward.
    At this time, I would like to recognize Mr. Robert H. 
McCooey, Jr., President and Chief Executive Officer of the 
Griswold Company. Welcome, sir.
    Please proceed at your leisure.

  STATEMENT OF ROBERT H. MCCOOEY, JR., PRESIDENT AND CEO, THE 
                        GRISWOLD COMPANY

    Mr. McCooey. Thank you, Chairman Baker.
    Chairman Baker, Ranking Member Kanjorski and members of the 
Subcommittee. My name is Robert McCooey.
    I am a proud member of the New York Stock Exchange and 
President and Chief Executive Officer of the New York Stock 
Exchange member firm The Griswold Company.
    Griswold is an agency broker executing orders for some of 
the largest mutual and pension funds in the United States.
    Thank you for inviting me here today to testify in 
connection with your review of the capital market structure 
here in the U.S. I would like to highlight some aspects of my 
previously submitted written testimony.
    As a floor broker, I know the important role that we play 
in the price discovery process. The competition between orders 
represented by brokers at the point of sale on the floor helps 
to ensure fair, orderly and liquid markets.
    The floor broker serves as a single point of accountability 
and information not found in dealer markets and ECNs, and who 
employs the most advanced technology to support his or her 
professional judgment.
    The floor broker relies upon a digital hand-held 
communication device which receives the orders, transmits the 
reports, and engages in an ongoing dialogue with the client 
through the use of digital images.
    All this is done without ever leaving the trading crowd.
    With regard to the trade-through rule, when trading is 
allowed to occur outside of the National Best Bid and Offer, 
the NBBO, two investors are being disadvantaged. The bid, or 
offer, that has been posted, as well as the buyer or seller who 
receive the inferior price to the NBBO.
    To amplify this, I would like to offer the following 
example. A buyer posts a bid of $49.05 to buy 5,000 shares of 
XYZ.
    In the absence of a trade-through rule, a 5,000 share trade 
might occur at $49. In this instance, two investors are not 
being afforded the full protection that they deserve in the 
marketplace.
    The seller who sold the stock at $49 did not receive the 
highest price that was bid for those shares in the market. 
Further, the buyer with the $49.05 bid was left unfilled.
    This investor posted the best bid in the marketplace and 
was ignored.
    I do not believe that this is the message that we want to 
disseminate to the investing public. Unfortunately, this is a 
message that is being promoted by some of our competitors.
    In my opinion, some of those who have sat here before you 
prior to today, have engaged in competitive positioning rather 
than factual presentation. Simply stated, the facts do not 
support their contention of the unfair system that stifles 
competition.
    At the New York Stock Exchange, we welcome competition. 
However, that competition must be one that ends with the 
customer's order being executed at the best available price.
    The reality is that the NYSE posts the best price nearly 94 
percent of the time in all listed securities. That is the 
single reason why we have been successful.
    With 30 co-sponsors, Chairman Mike Oxley sponsored H.R. 
1053 to eliminate legal impediments to the quotation in 
decimals for securities transactions in order to protect 
investors and to promote efficiency, competition and capital 
formation.
    So what happened along the way to the penny? Has something 
changed in these few short years? Do investors no longer 
deserve to save money?
    Is it acceptable for fiduciaries to accept a worse, though 
speedier, price for stocks that they are buying and selling on 
behalf of the millions of shareholders who have entrusted them 
with their hard-earned money.
    There is, however, an answer to these questions about the 
penny.
    I think that somewhere between common sense and today 
client interests have been abandoned and replaced with those 
that are self-interested.
    During our difficult period for both the financial markets 
and broker dealers, client interests have been secondary to the 
economic interests of firms and market centers.
    It is not time to encourage or reward this type of 
behavior. Quite the contrary, the message of the investor first 
should be quickly and firmly reinforced.
    And pennies add up. If fiduciaries are advocating their 
responsibility to achieve the best price available, the impact 
to their shareholders is very significant.
    If an investment manager decides to forego better, 
available and accessible prices for the sake of speed, the 
negative cost impact to the fund shareholders is in the 
millions of dollars.
    For a fund trading average of 10 million shares a day, to 
receive that incremental penny of price improvement on all 
those shares, multiplied by 250 trading days in a year, the 
savings are $25 million.
    This is the shareholder's money, the investor's money. 
Furthermore, I am giving you only one example, from one fund 
manager. Across thousands of funds and billions of shares 
traded, the negative impact to investors cannot be ignored.
    Finally, how do we ensure that the national market system 
benefits all investors? We begin with what has worked for years 
and continues to work today.
    At the NYSE, we provide investors with the best price, 
liquidity, transparency, accessibility, the highest certainty 
of an execution, protection of customers' orders and their 
interests.
    At the NYSE, we will continue to change, adapt and innovate 
to best serve our customers and to fulfill our commitment to 
producing the highest levels of market quality.
    In all that we do, we take pride in the fact that we always 
place the investor first.
    Thank you.
    [The prepared statement of Robert H. McCooey can be found 
on page 155 in the appendix.]
    Chairman Baker. Thank you very much, sir.
    Our next witness is the President and Chief Executive 
Officer, Security Traders Association, Mr. John Giesea.
    Welcome, sir.

STATEMENT OF JOHN GIESEA, PRESIDENT AND CEO, SECURITY TRADERS' 
                          ASSOCIATION

    Mr. Giesea. Thank you, Chairman Baker and members of the 
Subcommittee.
    I would like to take opportunity to introduce the Security 
Traders Association to you, which we refer to, and I will refer 
to, as STA, which is a 70-year-old organization comprising 
6,000 individual professionals involved in the purchase and 
sell of equities securities.
    Representatives of our organization are on the buy side and 
the sell side and participation is included amongst members of 
ECNs and exchanges.
    Myself: my background is simply 23 years at Kidder, 
Peabody, 10 years with Advest in senior trading and management 
positions and two years in the current position as President 
and CEO of STA.
    Our sole focus as an organization is market structure.
    And the imposition, or the hosting, of the market structure 
hearings held by the SEC in November and December of last year, 
formed the basis for a desire on our part to comment on issues 
that we felt we could add value through our experience and 
expertise.
    The outcome of that process was this report, ``Fulfilling 
the Promise of the National Market System,'' which I have asked 
to be submitted along with my written testimony.
    In preparation for this report, we examined the origin of 
the National Market System in 1975 and discovered the five 
principles that this National Market System was built upon are 
as valuable today as they were at its inception.
    And the Congress got it right: those include transparency, 
economic efficiency, ease of the best execution, fair 
competition and the opportunity to transact without need of an 
intermediary.
    The fact is, 28 years later, we need to update, but we need 
to retain those principles, but update market structure.
    Three areas I would like to touch on quickly and that are 
included in our testimony include fragmentation, regulation and 
access fees.
    We have heard mention of fragmentation a couple of times 
today, and in and of itself, we would represent that 
fragmentation is not positive. On the other hand, competition 
is the foundation upon which our business has been built.
    We have succeeded in encouraging and thriving on 
competition. And competition in the area, particularly NASDAQ 
stocks, through use of the UTP, Unlisted Trading Privileges, 
has created fragmentation in the marketplace.
    Excuse me.
    Alone, fragmentation represents a hurdle to overcome. The 
hurdle is overcome through linkage and connectivity. We believe 
that there should be linkage to all markets, that includes 
automatic and immediate execution.
    In the area of regulation, we are pleased with the SEC's 
SHO short sell regulation, which promotes and suggests the rule 
that crosses markets.
    This is the principle that STA recommends for basic 
customer protection rules, as well as basic trading rules, such 
as short sell and sub-penny quotations. Market share gains by a 
market center should not have root in less regulation.
    Thirdly: access fees. We have long opposed, our association 
has long opposed, the imposition of access fees which was done 
as part of the 1996 Order Handling Rules by way of a footnote.
    This footnote allowed one segment of the market to charge a 
fee for accessing its quotes. We think this is unfair and 
represents a hidden cost to investors and should be eliminated.
    We praise the NASD, on behalf of NASDAQ, for putting a cap 
of three mils, a suggested cap of 3 mils, 0.003, on an access 
fee; though we believe we are still three mils away from where 
it should be in order to be transparent and fair.
    Next, I would just like to make a quick mention of the area 
of liquidity. Through my conversations and my work, we need to 
be sure that when we talk about liquidity we make no 
assumptions.
    And another thing the SEC did in their short-sell rule is 
they allowed for a provision for the most liquid, 300 stocks, 
to be exempt from the bid test. It recognizes there is a 
difference in the trading of stocks.
    G.E. on the New York, Intel on the NASDAQ seldom, if ever, 
need an intermediary. They trade efficiently and transparently.
    But those other stocks that are less active benefit greatly 
through the activity of the liquidity provider, called a 
specialist or a marketmaker. And I think that this is something 
that the SEC needs to be careful of in putting regulation in 
place, not to assume that all stocks trade alike.
    Then, lastly, in terms of the ability for young, worthy 
companies to raise capital, we believe liquidity is an 
important part of that.
    And we believe that with issues involving investment 
banking and research over the past year, together with 
liquidity, issues and lessons, liquidity, date of market 
structure, that the underwriting and the ability to raise 
equity capital is challenged and we don't want that to happen 
for the U.S. economy or for job growth within the United 
States.
    STA is honored to be present today and is proud of its 
tradition of representing the principle, ``What is good for 
investors of all kinds, is good for our market and good for our 
members.''
    Thank you, to the Committee for the important work that you 
do and, in particular, Chairman Oxley, Chairman Baker, Ranking 
Member Frank and Congressman Fossella for having joined STA in 
its spring conference earlier in this year.
    And we appreciate the opportunity to be before you today.
    [The prepared statement of John Giesea can be found on page 
111 in the appendix.]
    Chairman Baker. Thank you, sir.
    Our next to be heard is Mr. Thomas M. Joyce, President and 
Chief Executive Officer, Knight Trading Group.
    Welcome.

STATEMENT OF THOMAS M. JOYCE, PRESIDENT AND CEO, KNIGHT TRADING 
                          GROUP, INC.

    Mr. Joyce. Chairman Baker, Ranking Member Kanjorski, 
members of the Subcommittee, thank you for inviting me to 
participate in this hearing regarding the structure of the U.S. 
equity markets.
    My name is Tom Joyce. I am the CEO and President of the 
Knight Trading Group, the largest, independent market maker in 
the industry. To give you some sense of context, on a typical 
day, we do over a million trades and well over a billion shares 
of equity trading.
    I have been a member of the securities industry for the 
past 25 years, including 15 years at Merrill Lynch. I have been 
both a student of and an active participant in the debate over 
market structure for over a decade.
    In fact, many of the issues you are hearing about today 
were examined back when I was the Chair of the Quality of 
Markets Committee of NASDAQ, and when I served as a member of 
the New York Stock Exchange's Market Performance Committee.
    Having worked both in the option model and the electronic 
model, I believe I can bring to you a unique perspective on 
market structure.
    Although U.S. equity markets remain the most vibrant and 
liquid markets in the world today, they are facing severe 
problems.
    The conversion to decimals has successfully narrowed 
spreads, but it has also sparked a series of unintended 
consequences that have resulted in new trading challenges for 
investors.
    It is our hope that these hearings will lead to a fair 
market structure in an even-handed application of rules that we 
all seek.
    There are three main points I would like to convey to the 
Committee today. The first is on the issue of best execution.
    We at Knight strongly believe that the definition of best 
execution resides with our clients. To attempt to define a 
single standard of best execution is simply wrong footed. Each 
client has different needs at different moments. It is our job 
to know our clients and to perform accordingly.
    Thus, the standard of best execution should be defined by 
competition on a level playing field with the proper 
transparency associated with it.
    As for transparency, each month we publish on the web data 
regarding the quality of our executions, scored against 
statistics such as speed and price improvement. They are 
located in the 1-5 and 1-6 statistics.
    This public disclosure, linked to our competitive efforts, 
is the right approach. Ultimately, if we fail to give our 
clients what they want, they will vote with their feet. And 
conversely, as we do a good job for our clients, they will 
reward us with more business.
    The second main point I would like to make is that there 
needs to be certain high standards established across the 
various trading venues.
    Again, decimal trading has been a success on many fronts, 
but many of the trading rules that are being applied to our 
markets today date from the era of eighths.
    I would suggest action on the following issues: sub-penny 
trading; flatly, it should be banned.
    Virtually no other retail product in the United States 
trades in units below a penny. The only beneficiaries of sub-
penny trading are professional traders who can use it to game 
the system.
    I would submit to you, you couldn't find a single 
traditional retail investor who would ask for sub-penny 
trading.
    If people complain about so-called penny jumping that 
supposedly takes place in the New York Stock Exchange, think 
about how divisive mil-jumping, tenth of a penny, jumping is in 
NASDAQ.
    To me, this is a race to the bottom. Therefore, I strongly 
suggest we go back to penny spreads and establish it as a 
standard of our markets.
    The trade-through rule: it exists today to protect price 
priority across markets. The time has come to adapt the rule to 
the common market dynamics. When volume aggregated at an eighth 
or a sixteenth, it made sense.
    Now, however, in an era of decimal trading, we see volume 
dispersed over 100 price points, thus, aggregating it is more 
difficult.
    More importantly, the speed at which many markets trade 
today make the quote literally flicker. It is not uncommon in 
highly liquid stocks, like Microsoft, for example, to see 50 
quote changes in a second.
    In an environment like this, we firmly believe that a de 
minimis exception of three cents around the quote should be the 
core component of a new trade-through rule.
    Third, we also believe that it is time to establish 
standards for intermarket access.
    The best examples of the need to introduce change here are 
the unlisted trading privileges NASDAQ and the Intermarket 
Trading System in the listed market. In each case, you often 
see the conflict between electronic trading and the old, open-
outcry manual systems.
    We believe, if markets are expected to interact, then 
certain minimum standards of connectivity must exist which 
would allow for electronic access up to some practical trade 
size.
    And the third, and last, point I would like to make is that 
market-makers matter.
    For too long now, ECNs and other ATSs have been receiving 
most favored nation status in certain regulatory circles, 
highlighted by the abilities of ECNs to charge fees, while we 
as market-makers cannot.
    We would like to see changes to the current status quo that 
favors this class of execution providers. A privileged class 
protected not by competitive superiority, but by regulatory 
authority.
    Now many stocks, particularly the largest stocks, do 
benefit when trading on ECNs. Admittedly, they do a fine job 
there.
    But as one gets further down the liquidity spectrum without 
capital committed by market-makers, many nit cap and small cap 
stocks would trade with much greater volatility and much less 
liquidity.
    This in turn, diminishes the ability of these companies to 
see additional, or initial, capital through the U.S. Capital 
Market System.
    Marketmakers supply an enormous amount of liquidity in this 
segment of the market. We believe that if they continue to walk 
away from this segment of the market, it is a long term 
negative for the market, for issuer companies and investors.
    If it continues unabated, I would argue that ultimately, 
the capital formation process of the economy could be 
negatively affected.
    In conclusion, give us a level playing field in which to 
compete in different market centers and a regulator who will 
establish the appropriate rules set and apply it evenly.
    In any market we believe we can compete with any model any 
time. And ultimately, it is the investor, our end user, who 
will dictate which service provider succeeds and hopefully, in 
our case, flourishes.
    So on behalf of Knight, I would like to thank you for the 
consideration of our testimony. And, of course, we would 
welcome any comments and questions at the appropriate time.
    [The prepared statement of Thomas M. Joyce can be found on 
page 119 in the appendix.]
    Chairman Baker. Thank you, Mr. Joyce.
    Our next witness is Mr. Michael LaBranche, Chairman, Chief 
Executive Officer and President of LaBranche and Company, 
Incorporated.
    Welcome, Sir.

 STATEMENT OF MICHAEL LABRANCHE, CHAIRMAN, CEO AND PRESIDENT, 
                     LABRANCHE & CO., INC.

    Mr. LaBranche. I would like to make some general 
observations about the New York Stock Exchange; what it means 
to the American economy and especially in light of all the 
press that is being given to it.
    One of the things about the New York Stock Exchange that 
many people do not understand that it is the world's largest 
electronic stock exchange.
    People don't realize how much technology goes into a trade 
on the New York Stock Exchange. More than 90 percent of the 
orders that are delivered to the New York Stock Exchange are 
delivered on our Super DOT system.
    We also have a specialist system which is coupled with that 
which adds capital to the system, which has human capital as 
well as financial.
    We have a market that has the most liquidity of any market 
in the world. You can see statistics about how many orders get 
executed in certain markets.
    I can tell you that 100 percent of the market orders that 
are transmitted to the New York Stock Exchange are executed. 
That is unparalleled liquidity that has not been equaled in any 
other marketplace.
    The United States Capital Markets are by far the best 
capital markets in the world and the New York Stock Exchange 
has played a very large part in the development of the Capital 
Markets.
    It has a direct effect on everybody in this country, in 
terms of the development of the economy and the standard of 
living.
    One of the things that we hear about very often, especially 
in the press today, is about the importance of speed versus 
price. And that is a very important concept to us, and I think 
it is a lot more complex than simply the trade-through rule.
    Remember that speed is really access to the market, but the 
price is by far the most important thing.
    Even for large institutions they are ultimately 
representing individuals and they are representing individuals 
that go about their work, or go about go on vacations, or do 
things in their daily routine.
    They don't know if their orders are being executed in two 
seconds or 12 seconds or 20 seconds. What they care about is 
what their returns are at the end of the year. And so, to them, 
the most important thing is to have a mechanism that gives them 
the best price.
    So, when we talk about the trade-through rule, I think it 
really goes beyond simply talking about a trade-through rule.
    I think the most important thing that we have to talk about 
here today is the fact that we have to be able to send the 
message to the investment community and investors that their 
interests are being looked after.
    That broker's primary responsibility is to always find the 
best price for the people they represent.
    I think if we go down the road where people believe that 
their brokers are not necessarily looking for the best price, 
but more broker-convenient, then I think we are going down a 
path that might lessen investor confidence.
    So, whether the trade-through rule gets reformed, I think 
it is very important that the message remains that brokers are 
looking after the interests of their clients.
    When we talk about speed, one of the things about the New 
York Stock Exchange that people tend not to realize is that it 
really is a much more efficient and quick execution platform.
    It is, to me, irrational to think that anybody would want 
to give up a better price for five or 10 seconds, but the fact 
is that 50 percent of all orders 500 shares or less that are 
executed on the New York Stock Exchange are executed within 
five seconds.
    Beyond that, institutional orders that run between 2,000 
and 10,000 shares on the New York Stock Exchange are executed 
on an average of 18.7 seconds. Now, that would compare to the 
same execution and time span on an ECN of 61 seconds.
    So we are a very efficient market, we are a quick market. 
And we are always looking for the best possible price.
    The other important thing that I think we should talk about 
here--the point I would like to make--is the talk about what 
does the auction mean. Now the auction is very often confused 
with a busy trading crowd. But the auction is not an 
anachronism.
    The auction is what allows investors of all kinds, whether 
or not they have a 100 shares to buy or sell, or a million 
shares to buy or sell, the auction is what allows them to 
interact in the market in a fair way.
    It means that if you are willing to pay the highest price 
for a stock, if you have one share to buy or a million shares 
to buy, you get the first chance to buy it. If you have one 
share to sell, or a million shares to sell, you get the first 
chance to sell it.
    That is the basic benefit that the public derives from the 
auction.
    And I think that if you think about it that way, people 
take that basic right for granted, but the auction, in essence, 
represents the Bill of Rights for investors.
    I think the New York Stock Exchange works very hard to make 
sure that that auction is adhered to in a way that protects 
investors in all circumstances, whenever possible.
    The specialist, we are a very important part of that 
auction, but we are one piece of the puzzle. We represent one 
constituency on the New York Stock Exchange.
    We are an important part of it, but we function within that 
community working to make sure that people get the best 
possible price.
    So, thank you.
    [The prepared statement of Michael LaBranche can be found 
on page 145 in the appendix.]
    Chairman Baker. Thank you very much, sir.
    Our next participant is Mr. Kevin Foley, Chief Executive 
Officer, Bloomberg Tradebook.
    Welcome.

       STATEMENT OF KEVIN FOLEY, CEO, BLOOMBERG TRADEBOOK

    Mr. Foley. Thank you, Mr. Chairman, members of the 
Subcommittee.
    My name is Kevin Foley, and I am pleased to testify on 
behalf of Bloomberg Tradebook.
    Bloomberg Tradebook is owned by Bloomberg L.P. Bloomberg 
L.P. provides multimedia, analytical and news services to more 
than 175,000 terminals used by a quarter of a million financial 
professionals in 100 countries worldwide. Bloomberg News is 
syndicated over 350 newspapers and on 550 radio and television 
stations around the world.
    Bloomberg Tradebook is an electronic agency broker serving 
institutions and other broker-dealers.
    We count among our clients many of the nation's largest 
institutional investors representing, through pension funds, 
mutual funds and other vehicles, the savings of millions of 
ordinary Americans.
    Bloomberg Tradebook specializes in providing innovative 
tools that subdivide large orders into small orders and 
eliminate the traditional barrier between the upstairs market 
and the trading floor market.
    Through that technique we bring upstairs liquidity directly 
into contact with small retail orders, with the options market-
makers and with program trading order flow.
    In the process, we consolidate what has been a fragmented 
market and we increase the efficiency of the market.
    Our clients have rewarded our creativity and our service by 
trusting us with their business, allowing us regularly to trade 
more than 180 million U.S. shares a day, about 20 percent of 
that in listed shares; and a third again as much business in 
international shares.
    We have consistently been among the top five providers of 
liquidity to NASDAQ's supermontage.
    And a large percentage of our listed order flow is executed 
using our technology and through New York Stock Exchange 
members on the floor of the New York Stock Exchange.
    The House Financial Services Committee has long been 
concerned with potential conflicts that might lessen market 
efficiency or compromise investor protections.
    The Committee has devoted significant time and effort to 
addressing some of these conflicts in the context of analysts, 
accountants and others.
    Recent conflicts relating to the New York Stock Exchange 
provide an opportunity to make the U.S. equity markets more 
competitive.
    New York, in 2003, looks strikingly like NASDAQ in 1995. 
The SEC made decisions on market structure in the mid-1990s 
intended to combat conflicts of interest in the NASDAQ market 
by enhancing transparency and competition.
    Specifically, the SEC's 1996 issuance of the Order Handling 
Rules permitted electronic communications networks to flourish, 
benefiting consumers and the markets generally.
    Indeed, the increased transparency promoted by the SEC's 
Order Handling Rules and the subsequent integration of ECNs 
into the National Quotation Montage contributed to NASDAQ 
spreads narrowing by nearly 30 percent.
    These, and subsequent reductions in transaction costs, 
constitute significant savings that are now available for 
investment that fuels business expansion and job creation.
    Chairman Oxley has asked, ``Why does New York control 80 
percent of the trading volume in its listed companies when 
NASDAQ controls only about 20 percent of the volume in its 
listed companies?'' And we think the answer is simple.
    There have historically been a series of barriers to 
competition in the New York listed markets that have the effect 
of centralizing order flow and impairing intermarket 
competition, and depriving the market of the opportunity to 
test whether competitors could bring the same benefits to the 
New York Stock Exchange investor as they have to the NASDAQ 
investor.
    To unleash competition and promote an efficient market, we 
believe Congress and the Commission should consider the 
following: repeal the trade-through rule.
    This 20-year-old rule protects inefficient markets while 
depriving investors of choice. Today's lead editorial in the 
Wall Street Journal, we believe, is on target.
    Facilitate display of New York listed stocks in the 
Alternative Display Facility. The ADF has been providing a 
competitive spur to the NASDAQ's supermontage and serving as a 
check on anti-competitive behavior.
    We believe the ADF could provide a similar tonic for the 
New York Stock Exchange listed market.
    Ensure the oxygen supply. The Financial Services Committee 
has long accurately held that market data is the oxygen of the 
markets, but the oxygen supply has been imperiled in the past 
and is imperiled today.
    Before the 1970s, no statute or rule required self-
regulatory organizations to disseminate market information to 
the public or to consolidate information with information from 
other market centers.
    Indeed, New York claimed an ownership in market data and 
severely restricted access to that market information. Congress 
responded by enacting Securities Act Amendments of 1975.
    These amendments empowered the SEC to facilitate the 
creation of a National Market System for securities, with 
market participants required to provide, immediately and 
without compensation, information for each security that would 
then be consolidated into a single stream of information.
    Bloomberg, in consultation with two distinguished 
economists, has submitted to the SEC a discussion paper 
entitled, ``Competition, Transparency and Equal Access to 
Financial Market Data.''
    The paper delineates the ways in which exchanges, in the 
absence of structural protections, may abuse their monopoly 
power over the collection of market information to the 
detriment of consumers.
    Those concerns were borne out this year when the New York 
and its liquidity quote ``proposal'' sought to make available 
data that had inadvertently been made less transparent by 
decimalization, but only under contractual terms that would 
have required vendors to display it in a way that disadvantaged 
other market centers, as well as prohibiting data vendors from 
integrating it with data from other markets.
    The promise of enhanced transparency at the heart of 
decimalization would have been thwarted.
    Under Chairman Oxley's leadership, the Congress has pushed 
hard for decimals, and that additional transparency has indeed, 
benefited investors. We applaud the SEC for striking down New 
York's restrictive contracts and liquidity quote.
    The controversy underscores, however, that policymakers 
should give strong consideration to updating the vendor display 
rule. Otherwise, investors will actually have less useful 
information than existed prior to decimalization.
    Ensuring the oxygen supply also entails greeting efforts to 
create new property rights in data, with a measure of 
skepticism.
    As this Committee well knows, in past Congresses, both New 
York and NASDAQ have supported legislation which would create a 
new and unprecedented property right in factual data, including 
even government-sponsored monopoly market data.
    In hearings in the last Congress, the Financial Services 
Committee heard a number of market participants express strong 
opposition to this proposal.
    A few weeks ago, H.R. 3261, the Database and Collections of 
Information Misappropriation Act, was introduced and referred 
to the House Judiciary Committee.
    The legislation is sufficiently contentious that an 
incredibly diverse array of public and private entities; 
ranging from the U.S. Chamber of Commerce to the American Civil 
Liberties Union, the Eagle Forum to the Consumers Union, have 
already voiced strong opposition.
    While some market data has been exempted out of the 
proposed legislation, the bill continues to potentially bar 
access to much other information critical to market 
participants, hence, may well have important ramifications for 
market transparency.
    Finally, in the NASDAQ market: access fees. Bloomberg has 
long believed that ECN and NASDAQ access fees should be 
abolished for all securities and all markets. And we have urged 
the SEC to take this important step.
    In conclusion, this Committee has been in the forefront of 
the market structure debate. I appreciate the opportunity to 
discuss how these seemingly abstract issues have real-world 
impact on investors.
    Policymakers should set rules, but encourage competition 
and let the market do the rest. And the New York Stock Exchange 
will successfully adapt, as it has for more than 200 years, and 
investors will benefit.
    Thank you.
    [The prepared statement of Kevin Foley can be found on page 
88 in the appendix.]
    Chairman Baker. Thank you, Mr. Foley.
    And our next witness is Mr. Edward J. Nicoll, Chief 
Executive Officer, Instinet Group, Incorporated.
    Welcome.

  STATEMENT OF EDWARD NICOLL, CEO, INSTINET GROUP INCORPORATED

    Mr. Nicoll. Thank you, Mr. Chairman. I will be mercifully 
brief.
    Mr. Chairman, Ranking Member, members of the Subcommittee; 
thank you for inviting me to testify today on the issue of how 
to reform our market structure and promote competition in a 
changing market environment.
    Americans have long known the value of competition and that 
without it, a monopoly can strangle innovation and lead to 
higher prices. This is, after all, why we have anti-trust laws.
    But when it comes to securities markets and trading in New 
York Stock Exchange-listed securities in particular, we have a 
regulatory regime that stifles competition and undermines 
investor choice.
    Let me be clear, I am not here to tell you how the New York 
Stock Exchange should change. Rather, I am here to tell you 
that we must modernize the regulations that govern listed 
trading, so that there are finally robust and competitive 
alternatives to the NYSE.
    If investors want to use a system of floor-based trading, 
conducted through specialists, they should have that option. If 
they would prefer to take advantage of modern technology that 
has led to more efficient electronic marketplaces, they should 
have that choice as well.
    So what impact would real competition have on our capital 
markets? Fortunately, we have two real-world examples to use as 
our guides.
    First, when NASDAQ dealers effectively wielded exclusive 
control of the NASDAQ market, it ultimately resulted in the 
Justice Department's allegations of fraud, price fixing and 
collusion by these dealers.
    To address the situation, the SEC wisely avoided 
micromanaging the existing NASDAQ structure and, instead, in 
1997, opened the NASDAQ and its dealer system to competition.
    The defenders of the old system argued that the dealers 
provided a valuable public service by providing liquidity and 
they questioned how investors would benefit from increased 
competition.
    But the impact of the new competitive marketplace imposed 
upon them by the new SEC rules is lower spreads in the NASDAQ 
stocks, as well as lower overall transaction costs that have 
saved investors hundreds of millions of dollars in just a few 
short years.
    Here is the second example. Up until 1999, each options 
exchange exclusively controlled trading in a given option.
    For example, Dell options were traded on the Philadelphia 
Stock Exchange and nowhere else, while IBM options were traded 
exclusively on the floor of the CBOE.
    While there was competition on each floor, there was no 
competition between markets. These monopolistic practices led 
the Justice Department to seek to enjoin the options markets 
from colluding to restrict competition.
    Again, the defenders of the status quo said that the so-
called fragmentation that would result from competition between 
exchanges would ultimately hurt consumers.
    But independent studies conducted after competition between 
exchange was imposed showed that spreads in the options market 
decreased by between 30 and 40 percent practically overnight, 
while transaction costs also dropped; both to the benefit of 
consumers.
    Today we find ourselves facing a similar situation: the 
NYSE enjoys a monopoly on trading NYSE-listed securities. But 
as recent events indicate, this monopoly may harm investors.
    Past experience shows us how to solve this problem: we must 
identify and eliminate barriers to competition.
    In the case of the NYSE, the single, greatest barrier to 
competition is the trade-through rule. The overall effect of 
the trade-through rule is to undermine the competitive 
advantages of an electronic marketplace: speed and certainty of 
execution.
    Those who would preserve this regulatory advantage for the 
NYSE make two basic arguments in defense of the trade-through 
rule.
    First, consumer protection: defenders of the status quo 
argue that the trade-through rule ensures that investors will 
receive the ``best price.'' But then how do you explain the 
superior execution quality in NASDAQ market where there is no 
trade-through rule?
    Indeed, SEC-mandated statistics indicate that overall 
execution quality for investors is higher in NASDAQ-listed 
stocks like Microsoft, where there is no trade-through rule, 
than it is for IBM in other New York Stock Exchange-listed 
securities where the rule is in place.
    One other reason that investors still receive quality 
executions in NASDAQ stocks is that brokers have a duty to get 
their customers best execution. In fact, due to the existing 
broker duty of best execution, the trade-through rule is 
unnecessary.
    And ironically, actually contributes to investors seeing 
the inferior prices and inhibiting beneficial competition.
    The second defense of trade-through is that there is 
nothing wrong with the short delay that it engenders if 
investors receive a better price.
    But the supposed trade-off between speed and price is based 
on a faulty premise. And that is, that the best advertised 
price is the best price. Often, it is not.
    As I discuss in my written testimony and in the attached 
documents, it is often the case that investors will end up with 
a worse price if they delay their execution attempting to chase 
the best-advertised price.
    Sure, if investors know with certainty that they are going 
to get a better price in 30 seconds, they would always accept 
the delay.
    The problem is that there is only the possibility of 
receiving a better price. If there is only a possibility, what 
should an investor do? The answer is it depends on the 
investor.
    Once again, investor choice and competition should be our 
guiding principles. Moreover, the SEC has already provided us 
with a glimpse of what a more competitive future in listed 
trading would look like.
    Specifically, we have, in effect, been without the trade-
through rule on three Exchange-Traded Funds, or ETFs, for over 
a year, including the most widely traded security in the 
country: the QQQs.
    The SEC's 2002 decision to ease the trade-through rule on 
ETFs has been an unqualified success. It has fostered 
competition without producing any of the harmful effects that 
defenders of the trade-through rule so often complain.
    As this Committee knows, Congress set out two clear 
principles in 1975 market reform legislation that are as 
important today as they were nearly three decades ago.
    The National Market System must not favor any particular 
market, or market structure, and it should foster competition 
between markets. Through such competition and the innovation it 
drives, investors receive the best value.
    As we have seen with NASDAQ and the options market, 
allowing any one market to exercise monopoly control, 
ultimately leads to abuse and increases transactions costs for 
investors.
    Competition on the other hand, leads to narrower spreads, 
lower transaction costs and investor choice. That is why we 
urge the repeal of the trade-through rule.
    Thanks again for the opportunity to testify and I would be 
happy to answer any questions.
    [The prepared statement of Edward J. Nicoll can be found on 
page 163 in the appendix.]
    Chairman Baker. Thank you, Mr. Nicoll.
    Mr. LaBranche, I understand your statement in defense of 
the trading practices at the New York exchange is centered 
primarily on assuring investors in 96 percent of the cases, 
that they are actually executing the sale at the best price 
available in the market at the time.
    Rarely do I rely on newspaper accounts to ask a question 
but, the Journal, in its editorial, raises a point that I would 
like your opinion on because it goes to the heart of that 
defense of the Exchange.
    Specifically, in referencing the New York exchange and, 
``The frustrating opportunity for mischief occurs when the best 
price appears on another exchange,'' meaning not the New York.
    ``Instead of routing the order to that exchange, 
specialists on the NYSE have been known to ignore it. The 
number of NYSE trade-through violations is huge.''
    Again, this is the paper.
    ``ArcaEx, an electronic exchange that competes with the big 
board has found the NYSE has ignored better prices on ArcaEx up 
to 7,500 times in a single week.''
    Is there any legitimacy to that claim? Or how do you 
respond to that accusation?
    Mr. LaBranche. I would----
    Chairman Baker. Hey, Mick, get your mike on.
    Mr. LaBranche. Thank you.
    Well, I think that that editorial brings up some very 
important, interesting points.
    One of the things about the trade-throughs that exist is 
that ITS was designed 25 years ago. It has really outlived its 
usefulness.
    And what I think we have today is much better technologies 
available to us that would allow, say, smart order routing 
systems to take the place of ITS. But, still it would be kept 
in mind that you are still trying to get the best price.
    On ITS, we have to wait up to 30 seconds to execute a 
trade. Now, in the investment world when we are trading in 
pennies, that makes it almost impossible to keep the market 
going; to wait 30 seconds for someone to give you an answer.
    Chairman Baker. So, you are now saying speed is the most 
important asset?
    Mr. LaBranche. No, I am saying that I think that speed, 
when it is possible, is important, but obviously, most 
important price is there.
    But what happens is that during that 30 second interval, 
the market moves and the other market cancels. The cancel rate 
on these trade-throughs, or what you are referring to, is very 
high and other markets tend to cancel because the markets move 
during that 30 seconds.
    Chairman Baker. But as to the principle-based statement of 
this section in the article--and I am just trying to get at the 
core--that I agree, I am defensive of the individual 
shareholder's right to buy or sell in the most advantageous, 
transparent opportunity we can construct and whether the 
current body of regulation enhances or inhibits that 
capability.
    I see a value in the specialist system, I truly do. I don't 
know that the value occurs in every transactional relationship, 
however. I do believe speed is important.
    But at the very core of it all, if I know of another 
opportunity to sell someone shares at a higher price and I am 
on the New York exchange and I don't exercise that fiduciary 
responsibility, is that occurring? Is it a rarity? Or is it 
commonplace?
    What is your view of that world?
    Mr. LaBranche. Well, specialists make every effort to get 
to another marketplace if there is a better price. And that is 
a fact and that is a rule.
    Chairman Baker. And, if that is the case, then this 
editorial, or article, must be----
    Mr. LaBranche. Because markets change very quickly. And I 
think that Mr. Joyce referred to how quotes blur in decimals, 
and that happens.
    And we are talking about pennies and it makes--remember, we 
have moved from trading in eighths to sixteenths to decimals 
fairly quickly.
    We moved from eighths to sixteenths, which lowered the 
spreads by 50 percent and then in one day we made a 
transformation to decimals. So, instead of having 16 points of 
price entry for every dollar, there are 100.
    And we are, largely, using some of the same systems. The 
ITS system was put in place 25 years ago when we traded in 
eighths. And, in my opinion, it has really not kept up with the 
times.
    In some ways, I think that the Journal makes a very good 
point. I think they should probably scrap it.
    It is not up to me to do it, but I think that we need a 
better technology.
    I think smart order routing systems would be much better 
for investors, much better for the marketplace. Then you just 
choose what is the best market from on top of the markets.
    Chairman Baker. Thank you.
    Mr. McCooey, again, your general disposition to view the 
exchange, obviously and understandably, is the best place to do 
business as an individual investor, within the NASDAQ where 
there isn't a trade-through rule effective.
    How do those two worlds sit side by side?
    Does that mean--in a careful reading of your statement--
that the NASDAQ, therefore, is inefficient and those who trade 
through its avenues are not getting their best price on trades?
    Mr. McCooey. Well, Chairman, I want to preface it by saying 
that we are not here to say that one market is better than the 
other. We support the NASDAQ market and obviously, support the 
New York Stock Exchange market.
    We think that for the equity markets to be as strong as 
they are in the United States, we need both markets to be as 
strong as they can be and to try to enhance them through the 
use of technology, through the use of regulation, where 
necessary, and to be able to make those markets as transparent 
and as investor-friendly as they possibly can be.
    The NASDAQ market, I believe, grew up in an age and a time 
that allowed certain regulatory changes, regulatory--it allowed 
things to happen on the NASDAQ market that would never have 
been permitted on the New York Stock Exchange.
    NASDAQ also has a lot of stocks that we like to talk about: 
the Microsofts and Intels and Oracles of the world.
    But as Mr. Joyce alluded to, there are plenty of other 
stocks that are secondary and tertiary stocks where market-
makers are necessary, and best price is what the investor is 
looking for. And market-makers compete based upon best price.
    So when you begin to compare apples to apples, if we want 
to compare the highest, most liquid stocks on New York versus 
ones on NASDAQ, we may have an argument and a comparison there.
    But I think we need to make sure that we are serving the 
investor across all markets, across all stocks the best we 
possibly can.
    And I know that we do that on the New York Stock Exchange, 
since I don't trade on NASDAQ, I can't, necessarily, comment as 
to how they do or do not function, in terms of making sure that 
they are getting the best price for their customers.
    But I still think they should be.
    Chairman Baker. Well, and even with that explanation, I 
don't understand how elimination of the trade-through rule, if 
you had an order flow requirement to the best price, wherever 
that occurs, would operate to the detriment of the individual 
investor nor represent any significant challenge to the New 
York exchange, because of the breadth and liquidity of that 
market.
    You are a winner now; you would still be a winner no matter 
what the rules are.
    Mr. McCooey. Oh, I don't think that that is the case at 
all. I respectfully disagree.
    In the example that I gave you in my oral testimony, we 
will begin to have things such as court d'arbitrage; people 
that know that there is a nickel bid and buy it from a customer 
for $49, while at the same time, using electronic systems to 
hit the $49.05 bid.
    We will have more internalization, we will have more 
fragmentation. We will have broker dealers using this as an 
opportunity to use customer orders for their benefit, not for 
the investor's benefit.
    I think that one of the things we are missing here is that 
we are giving the intermediary the choice in this case; where 
that order goes to, how it gets executed, not the customer.
    And I have also heard about things such as, opt-out, so 
that customers in their opening documents for accounts can 
decide that the broker decides where the order goes to, whether 
they want speed, or they can opt-out of price.
    The other side of that argument is the contra-side. In my 
argument: $49.05 bid. That person didn't sign an opt-out 
document. That person had the best price in the marketplace, 
that person was ignored. Is that the message that we want to 
send?
    Chairman Baker. I am going to come back to this, but I 
don't want to go far beyond my time.
    Mr. Kanjorski?
    Mr. Kanjorski. I don't disagree with you very often, Mr. 
Chairman, but I can think of examples, exactly as he put it 
there.
    Part of our problem we are all talking about it and not 
getting down to it. For instance, we are all wanting to do the 
best things for the investor, and we think we can define the 
investor as one singular entity making up investments.
    We know that is not true. You have institutional investors, 
you have smart investors, you have dumb investors, you have 
rich investors, poor investors. You have got investors that may 
be fragments of people's imagination for all we know.
    We can't sit with that simpleton.
    But the thing that disturbs me most: it seems to me the 
reason we are into this issue is that we have had some 
significant, substantial problems.
    Everything from Enron on through to Mr. Glasso's problem 
recently that have shaken up--and the mutual fund industry--
they have shaken up confidence in the market, and the investors 
is a large class in the market. I am interested in that.
    On the other hand, I am starting to see some problems here 
that everybody who has a pet peeve or a pet advantage that they 
can thrust into this has now gotten the attention of the 
Congress.
    And it is all nice and good and I am interested in all your 
competitiveness problems, but quite frankly, that is not what 
this Committee has been addressing itself to.
    What we are trying to do is make sure that the end of the 
day we can clean all the laundry of all the markets, all the 
exchanges, to have it reflect its excellence as the best 
commercial and capital market in the world. And I think it does 
that.
    And when we have this interplay suggesting that you are not 
getting the best price here, you are not getting the best price 
there, unless we do this or that, it confuses respect for the 
marketplace.
    Now my question is--toward anybody that wants to take it--
do we have a technology problem here that can be handled within 
the institutions themselves? Or do we have a substantive value 
problem here?
    Have we had a breakdown of morality, of ethics, in the 
system? And that would go a long way to just how much time and 
how it has evolved.
    And the reason I am asking this is, look, I keep referring 
back to this: you fellows are all capitalists and free 
marketeers. And maybe with the exception of one or two of you, 
you are all asking the government to come in and be the big 
brother here and regulate the capital markets of this country. 
You may get your wish and be damned for it.
    I mean, be very careful what you are asking for here.
    You are giving us a tremendous opening here to rush in and 
start to decide some, I think, competitive issues; that there 
are going to be winners and losers simply because one person 
relies on one technology over customer tradition in another 
technology.
    And I want to use--I am not much at football or sports, but 
I do, while I was thinking here--if I have got a good passing 
team and speedy ends, I am going to want five plays on my side 
of the team.
    If I have got a heavy, chunky line and a damned good heavy 
runner, I am going to want three downs. And we are going to 
argue that all night.
    The rules are drawn. That is not up to the Congress to 
constantly change the rules because of some--unless it is 
substantial electronic change, which, if you don't address the 
rules--and then, we shouldn't be changing the rules--unless you 
want us to take over the exchanges, unless you want government 
in your boardrooms, then reexamine what you are doing.
    So I say again, take it easy on this. Take getting any 
comparative advantage because it will service your industry or 
what you can do.
    I am interested--any of you want to say--do we have a 
substantive ethics or moral question in our markets today that 
we haven't had before?
    Or is just this the squeeze of the bubble, and everybody 
wants to find fault and try and get themselves in a reorganized 
position? And that the market is still fairly good or very good 
and it will work itself out.
    And the institutions themselves and the existing authority, 
the SEC, will be able to handle all these things.
    Anybody want to take that question?
    Mr. Joyce. Yes, I will.
    Mr. Kanjorski. Yes, Mr. Joyce you were--and I was going to 
say when you were speaking, you introduced yourselves and said 
15 years ago you were sitting on all these committees and 
everything--boy you must have really done a hell of a poor job, 
because, you know.
    Mr. Joyce. That is why my hair is gray. Jet black 10 years 
ago.
    Mr. Kanjorski, thank you for introducing those topics. I 
would like to briefly address both of them.
    First of all, I don't know--clearly, technology has 
changed. As Mr. LaBranche referenced, the ITS system literally 
hasn't changed that much. Clearly technology is leaps and 
bounds ahead of where it was 10 to 20 years ago.
    The issue isn't so much around what kind of technology is 
being or isn't being utilized. Clearly, depending upon the rule 
set that is engaged, you can find the technology to cure your 
problems.
    So the issue, I would suggest, is that in the past few 
years, we have changed the way we trade equities in the United 
States: from eighths to sixteenths to decimals.
    And when I say that the quote flickers, I literally mean 
the quote flickers. If you tried to get that nickel bid that 
Mr. McCooey referenced, by the time you go for it, it is gone. 
And then it is back and then it is gone.
    So the issues around the market that, I think, in the rule 
set that we are addressing today and would like to see the SEC 
get engaged on it, is the fact that fundamentally, the way 
equities trade have changed, and most due to the fact that 
decimals have been introduced into the process.
    Decimals have provided an enormous amount of benefits, but 
they simply change the way you trade. So, rule sets should, I 
think, be adapted to take that into account.
    As for your second question about ethics, I would strongly, 
strongly emphasize that I have not seen, in any dealings, any 
kind of change or diminished ethics that are applied to this 
industry.
    When you look at what happened with the corporate world a 
year or so ago--was it 10 or 15 institutions; I would bet it 
wasn't a whole lot more than that--and yet, there are 3,000 
companies listed on New York, there are 3,000 more listed on 
NASDAQ.
    I think the statistical selection you are looking at is 
very small compared to the thousands and thousands of companies 
that are run extraordinarily ethically.
    And when it comes to members of this industry and how they 
run their business, once again, you are looking at, so far, I 
have seen a handful of mutual funding complexes that have done 
things they regret, no doubt.
    There are more mutual funds available to the investor than 
I think there are equities available. I think there are at 
least 3,000 mutual funds available.
    So once again, we have a case where there is a small, small 
subset of people behaving improperly.
    And to me, where I sit, and having watched this industry 
over the past several years, the amount of ethical behavior 
that is evident everyday is one that you would be very proud 
of.
    Mr. Kanjorski. Very good. Congratulations.
    I think we need more of that. We are scaring the hell out 
of that public out there. They are starting to look at Wall 
Street like nothing but a bunch of gangsters.
    ``You belong in Lewisburg, not in New York.'' And that is 
not true, that is not my impression. I have been looking at 
this part.
    The one thing is that--maybe the third part of my 
question--I have a hard time figuring out what my question was 
too, so I don't doubt that anyone up there on the panel would--
but, what I am asking is--I recognize the technological changes 
and the conflicts that that causes, potentially in deciding, 
particularly in the competitive range--but would you rather the 
Congress of the United States take it upon itself to decide 
things like whether we are going to replace the ITS lines or 
whether we are going to let the exchange make that decision?
    Do you really want us in your bedroom?
    Mr. Joyce. Sir, to be completely honest with you, I think 
it is the SEC's responsibility to do that.
    I was very encouraged to see Chairman Donaldson here today 
discussing his thoughts and some of the issues they are willing 
to address. I think it has long been the mandate of the SEC to 
deal with this.
    Having said that, I think some congressional oversight is 
often a good thing. It can often move issues forward.
    And I think for that, I applaud you in getting involved.
    Mr. Kanjorski. Mr. Foley?
    Mr. Foley. Yes, thank you.
    I agree with what Tom said that we heard--I thought a 
tremendous amount of wisdom from the Chairman earlier today and 
it, I think, gives one great confidence that the SEC is taking 
its time, but not taking too much time, to address a number of 
complicated issues, that sort of weave together and are best 
addressed together.
    So, I think, we are not here before you today to ask the 
Congress to ask, but I had noted some people jotting things 
down when members of this Committee said, ``Weeks, not months'' 
or ``Months, not years'' and so forth.
    And the very fact that we are holding hearings today 
focuses attention on some of these issues.
    I don't think you see people here debating whether the 
offense should receive three downs or five downs, based on----
    Mr. Kanjorski. Yes we are. You would be one of them, Mr. 
Foley.
    Mr. Foley. No.
    Mr. Kanjorski. You talked about the policy rule.
    The policy rule is important because you are primarily in 
the electronic business in an electronic market. And I 
understand that, and there is nothing wrong with that.
    But if you are on the other side of a more conventional 
market, traditional market, that seems to be fair to have a 
pass-through rule. It protects, quote, the investor, whoever 
that six-pack carrying guy is out there.
    But the reality is why shouldn't we make it a principle 
that all equity trades on all markets are considered before a 
buy or a sell is made, if it is technologically possible?
    Mr. Foley. Well, if it is technologically possible to do it 
in a way that does promote finding the best execution.
    Here is the thing: yes, everyone responded to an incoming 
message from another market center, immediately. I don't think 
there would be anyone against a trade-through rule and against 
the obligation to find the best price.
    I know of no market-makers, ECNs, exchange system that 
doesn't seek the best price in its own system. And it doesn't, 
for those of us whose systems go out to each other, doesn't 
seek the best price that is available in a reasonable 
timeframe.
    Mr. Kanjorski. But----
    Mr. Foley. Technology has evolved. It appears to benefit, 
not investors, but to some players in the market, for the rules 
which existed for one purpose that is not relevant anymore.
    Mr. Kanjorski. Okay. And I tend to agree with that.
    And what I am asking you under self-regulatory authority, 
do you guys have the capability of being mature enough to 
regulate yourself, or do you need a cop, or do you need the 
federal government there to do it?
    I would like to think, as a lawyer, that the bar 
association can throw out the rascals. I would hope that in the 
exchanges and in the broker trading business you can identify 
the rascals.
    And you, incidentally, have a great tool in a new 
electronic revolution to find out who they are, either before 
or after the act occurs and the evidence is not destroyable. 
Why can't you self-regulate and get the people out?
    But there are a lot of good people. Hard, honest working 
people are doing their best in all these markets and throughout 
this country that are getting injured now by this over-tow that 
there is something evil. ``There are evildoers.''
    Gee, I heard that expression somewhere. But there are 
evildoers on Wall Street.
    And that doesn't play to my side of the aisle here, but I 
am just saying I am not a big person that likes to identify 
capitalism as the enemy of the people. I don't think it is. And 
on the other hand, I don't think regulation should always be 
the mantel of the Democratic Party.
    I think there is a good reason to believe that in mature 
people, regardless of what business or what profession they are 
in, they can generally police themselves.
    And we should only come into play when there is a breakdown 
of that reality and that we have to get involved, then we have 
to be heavy cop. Other than that, get the hell out of the way 
and let the place handle itself.
    Mr. Foley. I couldn't agree more.
    And we believe strongly in self-regulations and believe 
that the level of ethics and integrity in our industry is very 
high.
    You are going to need a light touch but, nevertheless, a 
role to play from the SEC for addressing issues that fall 
between the different markets.
    And I think one of the things that has gone on over the 
past couple of years is that a number of the issues regarding 
market structure, that is, rules that say you can't do certain 
things, that many of us don't think are necessary anymore.
    Those issues have, sort of, taken a back seat, while other 
issues that have gained more attention in the newspapers have 
occupied the policymakers and the lawmakers and the press.
    And many of the issues that we are raising here today are 
issues that have been sitting on the back burner and come 
forward now that the Commission appears to have the time and 
the focus to devote to them.
    And we are all very happy--I think I speak for all the 
panelists--we are going to be very happy to see a resolution, 
one way or another, on a number of these issues that have been 
outstanding for the past couple of years.
    Mr. Kanjorski. Good enough.
    Chairman Baker. Ms. Hart?
    Ms. Hart. Thank you, Mr. Chairman.
    I want to let Mr. Kanjorski go on, I liked some of his 
comments. This is good.
    Thank you for your patience, I know today's hearing has 
been going on for a while. I just have one question I want to 
ask of two of you: Mr. Joyce and Mr. LaBranche.
    If the New York Stock Exchange were allowed, or were 
forced, excuse me, to require multiple specialists for each 
security, can you tell me your thoughts about that? Do you 
think it would be harmful?
    Do you think it might bring more competition to the market 
and alleviate some of the concerns that Mr. Joyce raised in his 
testimony?
    We can start with Mr. Joyce.
    Mr. Joyce. Thank you, Ms. Hart.
    In point of fact, as you can imagine, as the largest dealer 
in the NASDAQ market, and frankly, one of the larger dealers in 
the New York Stock Exchange-listed arena, we clearly believe 
that competing specialists, competing dealers--specialist is a 
dealer as a marketmaker fundamentally--provide a lot of 
benefit.
    They particularly provide an enormous amount of benefit as 
you get into the secondary and tertiary stocks. That liquidity 
segment needs more, not less, sponsorship.
    So we do believe that the competing specialist model is a 
successful one, as is evidenced by the success of NASDAQ. As an 
old, listed block trader, incredibly enough--the back of my 
hair was black, I actually traded listed equities with Mike on 
a regular basis--I think the specialist system itself, is fine 
too.
    To introduce competing specialists: I wouldn't necessarily 
leap to do that, unless there was a better body of knowledge on 
it. But speaking from the NASDAQ model, clearly the NASDAQ 
competitive model works well, and I would suggest it would work 
equally well in the New York Stock Exchange system.
    Ms. Hart. Okay. Mr. LaBranche?
    Mr. LaBranche. Yes, well, it gets clearer that markets are 
going to be competing against each other. And I think one of 
the things we heard today was that technology should be allowed 
to access pools of liquidity.
    It should be allowed to compete. And I certainly embrace 
that concept.
    When it comes to the New York Stock Exchange as a model, we 
do use a specialist model, but the most important thing about 
the Stock Exchange is that orders compete with each other and 
they are centralized to one point of sale.
    So they interact with each other and that is a very 
important concept. It is the one market that has orders 
competing with each other.
    Now the specialist is charged with the responsibility to 
make sure that those orders compete with each other in a fair 
way; that they aren't being ignored or anything else. So, that 
is our charge.
    That is what the New York Stock Exchange has designated a 
specialist to do. He has to buy when no one else wants to and 
sell when no one else wants to.
    So if you had competing specialists, who are you going to 
pick? You buy it, or you buy it or something like that. And 
that might be something to consider.
    But what we really don't want to do is fragment the order 
flow. Because when you fragment order flow, you lose sight of 
what the best price is currently. And I think that is 
important.
    In terms of ECNs, for example, we hear a lot about ECNs. We 
are not anti-ECN, we are pro-ECN. We receive a lot of order 
flow from ECNs. ECNs look to us as a resource.
    It is our job to be price competitive so they can access 
our markets in a very cheap way.
    There is one large ECN that is very famous that sends 90 
percent of their listed business through us. They send it to us 
because we do it so cheaply.
    So, that is order flow that is competing with each other.
    So, in answer to your question, I think that what we really 
need to focus on is making sure that we have a centralized 
market where orders compete with each other.
    Mr. Joyce. Ms. Hart, if I could just elaborate a little 
bit.
    Ms. Hart. Sure.
    Mr. Joyce. When you asked the question, I was 
conceptualizing competing specialists on the floor of the New 
York Stock Exchange.
    You should be aware that the third market that NASDAQ 
sponsors--in which we are actually a very large participant--we 
do, for example, make markets in IBM and in AOL.
    So, we, within the third market realm, under NASDAQ's 
banner, we do make markets and listed equities that directly 
compete with the specialist making markets on the floor of the 
New York Stock Exchange.
    So that competing specialist model, you could say, 
currently does exist.
    Ms. Hart. Just not on the floor.
    Mr. Joyce. It is not within the floor, it is not intra, it 
is inter.
    Ms. Hart. It is inter. Okay.
    Thank you.
    I yield back.
    Chairman Baker. Thank you, Ms. Hart.
    Ranking Member Crowley?
    Mr. Crowley. Ranking by default, I will accept. There are 
many ways of obtaining positions of leadership.
    Thank you all for your testimony today and for your 
spending a better part of your day here.
    I have been following this issue very closely, as probably 
many of you know.
    I had a couple of questions and I would also, if I can, 
make some reference to the Wall Street Journal editorial that 
appeared today.
    Mr. McCooey, we have all heard reports questioning the 
value of the specialist and whether they offer a value or not.
    And as an agency broker executing trades on behalf of your 
clients, do you feel a disadvantage by specialists? And do you 
believe specialists add a value to you or to your clients or 
not?
    Mr. McCooey. I don't believe specialists disadvantage me at 
all. In fact, it is the advantages of the specialist at the 
point of sale, providing liquidity and acting as a catalyst 
that allows me to get my business done on behalf of my 
customers.
    And let me elaborate a little bit on that.
    When I talk about liquidity, what I mean, is when I have a 
buy order coming in and finding that I have 25,000 shares to 
buy, and there are only 15,000 shares residing on the 
specialist book at the offer price, that the specialist will be 
able to step in there and provide the liquidity: the other 
10,000 shares that I need to complete my order; to be able to 
be satisfy my customer at that price.
    That is important when they put their capital up.
    But even more important and really undisclosed to the 
world, because they don't understand what dynamics sometimes 
happen at the point of sale, is the fact that the specialist 
acts as the catalyst in disseminating valuable information to 
every party that comes into that trading crowd: who the buyers 
and sellers are and have been, but even more than that, is able 
to find the contra-side to my trade.
    And what I mean contra-side, if I am a buyer, the 
specialist will, instead of having me immediately trade with 
the offer side of the market, would inform me that a brokerage 
firm may have been a seller for the past hour, day, week.
    And we can contact that brokerage firm very quickly; allow 
them the opportunity to sell stock for their customer, a 
natural seller, where natural buyer and seller are meeting in 
the marketplace with very little market impact.
    And we are able to get that trade consummated.
    And I am using my digital and hand-held device at the point 
of sale, communicating with my customer, telling them exactly 
what I am doing. I am using my cellular telephone from the 
point of sale; communicating with my customer.
    And we were able to get that done for the benefit of my 
client, as well as the for the benefit of the seller, who was 
willing to sell stock at that price, but may have just 
completed their sell order and may just be getting more stock 
for sale and doesn't want to be disadvantaged by dislocation in 
the market that may happen very quickly.
    If I go in and the last sell is $49 and the liquidity is at 
$49.25, I may not want to purchase that right away, but I want 
to give my buyer the opportunity to do better. And that is what 
we do each and every day.
    And the specialist is an important part of that. And my 
customers find his information and his liquidity very valuable 
in the executing of my orders.
    Mr. Crowley. Thank you.
    Mr. LaBranche, in the evolution of the stock market, and 
there has been a lot of discussion about the ECNs and their, 
one day potentially, replacing the New York Stock Exchange as 
we know it today in terms of human touch, in many respects, and 
a lot of discussion about specialists being dinosaurs in this 
evolutionary process.
    Can you comment on that?
    Mr. LaBranche. Well, I have been hearing that----
    Mr. Crowley. You don't look like a dinosaur, but I----
    Mr. LaBranche. Well, thanks.
    But, I have been hearing that comment for a long time.
    In fact, there was a very widespread discussion back in the 
1970s about how the New York Stock Exchange only had a few 
months left to go and seats went down to $35,000 back in 1978.
    So when you think of it in those terms, you realize there 
is always going to be challenges.
    What the New York Stock Exchange needs to do is listen to 
its customers, its constituencies. Make sure that the buy side, 
for example, is getting their say of what they think needs to 
be done; the sell side as well.
    We need to integrate our system, take technology, ECNs, 
other ATFs and incorporate them so they can access our pool 
liquidity. And, I think, that is a very important concept.
    A lot of people think of ECNs as crossing networks, but 
they are communication networks, and they allow people to 
communicate with pools of liquidity. And we are a very large 
pool of liquidity.
    So, to get back to where we were before: if we make those 
transitions, if we are a resource to everybody that we can be, 
we will be around for a long time.
    If we just dig in and don't change, then that is going to 
be a different question. But we don't have any intention of not 
changing or listening to people and we are going to keep 
changing to make sure that we are able to be a resource for 
almost everybody.
    Mr. Crowley. You are adapted to the evolution.
    Mr. Chairman, I know my time is up, but can I just make a 
comment about the editorial that you alluded to?
    In the very next paragraph--and again, we are taking out of 
context, some of these things--the editorial went on to say, 
``Best price is only one of the many ways of best execution. 
The issue of speed and best price, et cetera, and what 
companies may be are looking for, what the professional trader 
is looking for.''
    But this experiment that is taking place, I know that 
Chairman Donaldson, not once in his three hours of testimony 
mentioned the success story that the Wall Street Journal is 
alluding to.
    And, I think if you ask my constituents and the investors 
in your markets that are my constituents; I think if you ask 
them, the bottom line is price to them. At the end of the day, 
the retiree, the pensioner, wants to know that they are getting 
the best price for what they are paying. And I think that is 
the bottom line for our constituency.
    I understand we have broader constituencies here in this 
Committee, as well. And the industry is important to us. But 
the bottom line is the investors.
    And people who are making up more and more, a larger 
portion, of the investment in your markets are the average mom 
and pops that we represent.
    So, I just wanted to make that point for the record.
    And I thank you all for your testimony today.
    Chairman Baker. Thank you, Mr. Crowley.
    Just welcome, come back at it one more time, from the 
perspective, not necessarily of just the editorial or news 
article, ``Reference by Numbers.''
    Maybe try just a different team this time, Mr. Nicoll. In 
reading through your written testimony, it is pretty clear, at 
least to me, that you believe that the current system does not 
automatically result in the best price for the individual, 
given the regulatory constraints which within the market must 
now function.
    You referenced the SEC trade-through rule suspension on the 
three ETFs in 2002 and that the QQQ is now the single most 
actively traded security in the entire U.S. marketplace as 
evidence that it must somehow meet the needs of investors.
    It seems, to me, that you should view the market, not as a 
particular exchange or a group of premier exchanges, but the 
entirety of every trading opportunity is the marketplace.
    It also appears to me that there are rules or regulatory 
constraints that keep information even from flowing but, 
perhaps where it does flow, it may not be a requirement to act 
on that information.
    Am I reading your testimony correctly that your 
presentation of the trade-through rule or some of the other 
constraints, if they were, at least modified, if not entirely 
eliminated, would facilitate trading at the best price as 
opposed to what now is the consequence of trading under the 
current regulatory body of rule?
    Mr. Nicoll. I think that is exactly what we are saying.
    And, what we are saying is, and we want to push back at 
everybody that keeps repeating this mantra that the choice is 
between speed and price.
    When you choose not to avail yourself of what appears to be 
the best price in an advertisement because you wonder whether 
you will get to the store or you will get to the place where it 
is advertised, whether or not you will actually get the best 
price, but you may, perhaps, choose to buy the product at what 
appears to nominally be a higher price someplace else.
    Because of your ability to actually execute the 
transaction, you are acting in your best interest and buying 
the product at what you believe is the actual best price.
    And what we are saying here is that the trade-through rule 
requires that people go after the best advertised price and 
leave behind what they know to be the best price. Our customers 
are not intentionally trying to execute their orders through 
our system at a worse price.
    They believe that by executing an order for a penny less 
than an advertised price on the New York Stock Exchange, that 
they are, in fact, representing their customer's interest, 
performing their fiduciary duties in accord with their best 
execution responsibilities and doing their best job.
    And, in fact, when they are precluded by regulation from 
accessing the best price and are forced to chase what appears 
to be the best price but what is, in fact, often not, they feel 
that the regulations are out of date and don't serve their 
needs as fiduciaries in performing their duties to get best 
execution on behalf of their customers.
    There isn't a trade-off between price and speed. Speed is 
an element in evaluating what the best price is in a trade.
    Chairman Baker. One other piece that I picked up out of 
your written comment, with regard to definition of 
fragmentation; as opposed to that being necessarily an adverse 
market consequence, others might define it as more stringent 
competition.
    And that if we are looking for the free flow of information 
so that all market participants meet the needs of their 
customers in the most efficient and timely manner, but yet 
required to pursue the highest price offered in the broader 
market.
    I think that is what I hear members saying, both sides of 
the aisle, pro-New York Exchange, pro-ECN, whatever the deal 
perspective might be, we all want one thing.
    We want the market to function efficiently, we also want it 
to function fairly and we also want to assure, that when 
Customer X or Customer Y pursues an opportunity in the 
marketplace, that they get the best terms available at the time 
of that execution.
    Now, if those are the precepts on which we all agree, then 
we can do the critical analysis if the current system really 
provides for that. And that, Mr. LaBranche, was the reason why 
I brought up that article in the first place.
    It appeared on the surface of the article. It was going at 
the heart of the Exchange's line of defense, was that in most 
cases, 94 percent, the individual gets the best price of 
execution.
    And it seems to me it ought to be a factual determination, 
whether they do or whether they don't, we ought to be able to 
get to the bottom of it, dig it out, and then ask the SEC to 
come up with a plan that is responsive.
    And I agree with Mr. Kanjorski, we don't want to put a 
board, I think, governmental representative on every board in 
America. I am a strong advocate of a whole lot less government 
than what we pay for.
    But I do believe that this discussion, today, and the 
Committee's review of this, may help facilitate broader market 
changes that, otherwise, may be very difficult to achieve.
    And let me offer Mr. Crowley, or Ms. Hart, any further 
comment?
    And let me express my deep appreciation to each of you. 
This has been a long day.
    And I appreciate your patience in hanging in there and we 
certainly will leave the record open for a few days if you have 
further comments or recommendations to the Committee, we would 
be most appreciative to receive them.
    Thank you.
    Our meeting is adjourned.
    [Whereupon, at 2:26 p.m., the subcommittee was adjourned.]


                            A P P E N D I X



                            October 30, 2003


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