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





                     MARKET STRUCTURE III: THE ROLE
                   OF THE SPECIALIST IN THE EVOLVING
                           MODERN MARKETPLACE

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

                             FIELD 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

                               __________

                           FEBRUARY 20, 2004

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 108-68



93-839              U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2003
____________________________________________________________________________
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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

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


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    February 20, 2004............................................     1
Appendix:
    February 20, 2004............................................    51

                               WITNESSES
                       Friday, February 20, 2004

Greifeld, Robert, President and Chief Executive Officer, The 
  Nasdaq Stock Market, Inc.......................................    18
McCooey, Robert H. Jr., President and Chief Executive Officer, 
  The Griswold Company...........................................    14
Nicoll, Edward J., Chief Executive Officer, Instinet Group 
  Incorporated...................................................    12
Putnam, Gerald D., Chairman and Chief Executive Officer, 
  Archipelago Holdings...........................................     6
Sauter, Gus, Chief Investment Officer and Managing Director, The 
  Vanguard Group.................................................    24
Sullivan, Francis, President, Chief Executive Officer and Chief 
  Operating Officer, RPM International Inc.......................    21
Thain, John A., Chief Executive Officer, New York Stock Exchange, 
  Inc............................................................     9

                                APPENDIX

Prepared statements:
    Kanjorski, Hon. Paul E.......................................    52
    Greifeld, Robert.............................................    54
    McCooey, Robert H. Jr........................................    61
    Nicoll, Edward J.............................................    73
    Putnam, Gerald D.............................................    79
    Sauter, Gus..................................................    95
    Sullivan, Francis............................................   106
    Thain, John A................................................   117

              Additional Material Submitted for the Record

Bachus, Hon. Spencer:
    Letter to Hon. William H. Donaldson, Chairman, U.S. 
      Securities and Exchange Commission, February 18, 2004......   128

 
                     MARKET STRUCTURE III: THE ROLE
                   OF THE SPECIALIST IN THE EVOLVING
                           MODERN MARKETPLACE

                              ----------                              


                       Friday, February 20, 2004

              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 10:00 a.m., in 
the Auditorium of the Native American Museum, One Bowling 
Green, New York, New York, Hon. Richard H. Baker [chairman of 
the subcommittee] presiding.
    Present: Representatives Baker, Kanjorski, Ackerman, Meeks, 
and McCarthy.
    Chairman Baker. I'd like to call this meeting to order and 
express my appreciation to Mayor Bloomberg and the great city 
of New York for making these facilities available to the 
committee this morning. As usual the reception by your great 
city has been warm and courteous and we appreciate that very 
much.
    This morning the committee is here to conduct a review of 
the regulatory environment in which the New York exchange and 
our capital market currently function. The New York exchange 
has long been held up as the premier example of how the capital 
market function could even double. In recent weeks, however, 
there have been developments that have brought into question 
many aspects of conduct of the exchange beginning unfortunately 
with disclosures of the compensation package made available to 
the chief executive officer on his departure. It also became 
evident with the discussions of those discomforting facts that 
the oversight board of the employee compensation and other 
matters may need to be examined and other matters more closely. 
The revelations begin to turn in the direction of the adequacy 
of regulatory oversight of those engaged in fiduciary 
responsibilities on the floor of the exchange for millions of 
investors not only in our own country but around the world.
    We are here to receive comment with regard to the adequacy 
of or the need for modification to this regulatory structure. I 
have recently corresponded with the SEC with regard to taking 
moves now under consideration with the view that the current 
rules may in fact constrain competitive opportunity. And it 
appears to at least cursory examination that individuals may 
have engaged in actions to enhance their own financial 
condition at the expense of the uninformed investor class made 
evident by several recently announced in the newspapers in the 
city just two days ago. And let me digress as to the obvious 
need by the Congress to engage in this overview. The Capital 
Markets Subcommittee of the Financial Services Committee, then 
congressional terms has only recently been given the 
responsibility to oversee directly the securities markets. But 
it is our professional responsibility within the Congress to 
ensure that we have rules which are fair, that disclosures 
which are transparent because today there are over 95 million 
households directly invested in mutual funds alone.
    It is one thing in the financial past for the sophisticated 
investor to deal at arms length with another sophisticated 
investor. It is another matter when there are those people who 
do not have the time nor pay the attention necessary to make 
investment decisions properly that they engage in these 
activities without the necessary tools or skills to protect 
their financial interests. Stated another way, it was perhaps 
okay for Congress to turn its head to the conduct of markets 
when it was one shark after another. But when the sharks turn 
their attention to the minnows it's time for the Congress to 
make sure the minnows know which body of water they are in.
    This will not be a one press conference, one bill remedy if 
remedies are in fact needed. This is the obligation of the 
Capital Market Subcommittee. It will be an ongoing duty from 
year to year to ensure that our markets are in fact the 
broadest, most liquid center of capital market function in the 
world. That they operate consistent with the highest standards 
of fiduciary responsibility with sufficient transparency for 
responsible judgments to be made by all and with significant 
and prompt responses for those who violate their professional 
duties.
    We are most appreciative of those who are here on the panel 
this morning to hear their perspectives, and the Committee will 
carefully consider those recommendations as they are received.
    Mr. Kanjorski, for an opening statement.
    Mr. Kanjorski. Mr. Chairman, we meet for the third time in 
the 108th Congress to review the structure of our capital 
markets and evaluate the needs for further reforms in light of 
technological advances and competitive developments. Today's 
hearing will examine the role of specialists on the New York 
Stock Exchange and recently announced changes to the Big 
Board's trading systems.
    As I have noted at our previous hearings, a variety of 
participants in the securities industry have questioned one or 
more aspects of the regulatory system during the last several 
years. We have also, without question, come to a crossroads in 
the securities industry, facing a number of decisions that 
could fundamentally alter its structure for many years to come.
    Because we have elaborately interlocking systems and 
relationships in our securities markets, however, I believe 
that we should refrain from pursuing change for change's sake. 
In our last hearing, the Chairman of the Securities and 
Exchange Commission further observed that in pursuing any 
change to fix those portions of the system experiencing genuine 
strain, we must ensure that we do not disrupt those elements of 
our markets that are working well.
    In the near future, the Commission is expected to put 
forward for comment a series of proposals that would reshape 
the structure of our securities markets. In adopting the 
Securities Act Amendments of 1975, the Congress widely decided 
to provide the Commission with a broad set of goals and 
significant flexibility to respond to market-structure issues. 
From my perspective, this legal framework has worked generally 
well over the last three decades.
    Mr. Chairman, I have made investor protection one of my 
highest priorities for my work on this Committee. As the 
Commission proceeds with its reform proposals, it is therefore 
my expectation that it will thoroughly examine the effects of 
these plans on average retail investors.
    Under our present regulatory system, retail investors are 
guaranteed the best price that our securities markets have to 
offer regardless of the location of the trading transaction. By 
ensuring fair treatment, this best-price guarantee has 
significantly increased confidence in our securities markets.
    Interestingly, some recent news reports have suggested that 
the Commission may issue a proposal to permit participants in 
our capital markets to opt out under certain circumstances of 
this best-price guarantee. Such a plan has the potential to 
produce unintended consequences like fragmenting our securities 
markets, decreasing liquidity, and limiting price discovery. 
Because such results could prove deleterious for small 
investors, I will be monitoring this issue very closely in the 
weeks and months ahead.
    At our previous hearings on these matters, Mr. Chairman, 
some have further suggested that specialists are an anachronism 
in our capital markets. I have a different view. The human 
involvement of specialists in the trading process can 
contribute to smooth and efficient functioning of our capital 
market. Rather than complain about the specialist system, each 
securities marketplace should, with the appropriate oversight 
of the Commission, have the freedom to decide for itself the 
best way to organize the trading operations.
    As I have studied the role of the specialist on the New 
York Stock Exchange, I have also come to appreciate its 
similarity to the role of legislators in Washington. With 
today's technology, we could each remain in our district 
offices and vote on pending bills. It is, however, our 
interaction with one another in the halls of the Capitol 
complex and during the debate on the House floor that allows us 
to improve legislation and get the best deal for our 
constituents. In the same way, it is the interaction of the 
specialist with floor brokers and others that should help to 
produce the best price for investors.
    Before I close, Mr. Chairman, I should acknowledge that we 
are fortunate to have John Thain, the new leader of the New 
York Stock Exchange, with us today. In the last few weeks, he 
has announced several important reforms, including one to 
significantly expand the Big Board's automatic trading platform 
and another to restrict specialists from participating in 
certain trades. As the Commission proceeds in its market-
structure deliberations, I hope that it will follow a prudent 
course of action and allow sufficient time for the effective 
implementation of these recently announced changes before 
creating greater uncertainty with respect to reforming our 
National Market System.
    In sum, Mr. Chairman, I believe that our panel 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 should make it 
stronger. The observations 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.
    Thank you.
    [The prepared statement of Hon. Paul E. Kanjorski can be 
found on page 52 in the appendix.]
    Chairman Baker. Thank the gentleman for his statement.
    Mr. Ackerman?
    Mr. Ackerman. Thank you very much.
    Good morning, Chairman Baker, Ranking Member Kanjorski. I 
would like to take a moment to welcome you to New York, yet 
again. This city is not just great, but as you might have 
noticed, it is also quite big. We have more of anything than 
anybody else has.
    New York is the home of the greatest financial markets in 
the world. We employ more than 110,000 people in our financial 
industry in addition to having 20 of the top 25 foreign 
branches of international banks, 8 of the world's 10 top 
security firms. We also have more Irish than Limerick and Cork, 
more Italians than Genoa, more Haitians than Port-au-Prince, 
more Muslims than Mecca, more Jews than Jerusalem, more 
gentlemen than Verona and more barbers than Seville.
    That being said, we thank you for the opportunity to hear 
today from the distinguished panelists on the issues that are 
so important to our capital markets. Each panelist has a unique 
insight into our markets, and I am interested in hearing their 
perspective on the costs and benefits to investors of the 
continuation of the trade through rule, the role of the 
specialists in today's market and increasing technologically 
advanced and yet uncertain times and the outlook of the future 
of the capital markets. I am particularly interested in what 
effect any proposed changes would have on New York, it's 
capital markets and its people.
    As times and technology changes, I think it is wise to 
examine the processes used to make sure that we are providing 
the best opportunities and protections for investors.
    Again, I appreciate being here. Appreciate having such 
distinguished panelists before us. And thank you, Mr. Chairman 
and Mr. Kanjorski for conducting this hearing.
    Chairman Baker. I thank the gentleman. He should have 
included one more little enumeration only, he should have 
included more gold than Texas. But that would have been perhaps 
a little more than necessary.
    Mr. Meeks, you are recognized.
    Mr. Meeks. And more bears.
    Thank you, Mr. Chairman, and it is good to have you in New 
York, and Mr. Kanjorski, the ranking member, good to have you 
here.
    The financial markets are one of America's great strengths, 
especially in this city, the city that I call home and been 
born and raised in; my city, New York.
    In the most recent economic boom of the late 1990's, as 
Wall Street went, so went New York's economy. And as New York's 
economy went, so went the U.S. economy.
    The New York Stock Exchange is the granddaddy of the 
capital markets. Constantly reinventing itself to keep pace 
with the needs of ever more demanding and sophisticated 
investors.
    The electronic communication networks are the new kids on 
the block, maximizing the use of remote technology to serve 
their customers and help many newly public companies raise 
critical expansion capital. The competition among these 
different entities is welcomed and desired because in a free 
market society the advantage of competition is higher quality, 
more efficient services for customers.
    As members of Congress, we ask ourselves what is our role 
and the role of the regulatory agencies in this great free 
market process. I say it is a balancing act of protecting 
investors' interests, ensuring fair play and knowing when you 
just stay the heck out of the way.
    The question that we are seeking to answer is where does 
the trade through rule fit in the balancing act? Some say we 
should eliminate it. Others say maintain the status quo, or 
perhaps we should expand it beyond the New York Stock Exchange 
listed stocks. The right answer, in my opinion, is probably 
what works best for investors; big and small.
    I look forward to hearing most of the hearing today from 
all of our panelists, particularly the new CEO at the New York 
Stock Exchange. We welcome you here. And all of the CEOs from 
the ECNs and other current companies. As long as you all keep 
creating jobs and making the city money, you will have my 
continued support.
    Thank you.
    Chairman Baker. Thank you, Mr. Meeks.
    Ms. McCarthy?
    Ms. McCarthy. Thank you, Mr. Chairman.
    As which is always been my habit, I will hand you my 
opening statement. I would prefer hearing from those that are 
waiting. I apologize for being late, but I had to give a speech 
at 8:00 this morning, and that could not be changed.
    Though, I am happy you are in New York. As you can see we 
need some money for restructure of our cities and our streets, 
and I hope you will vote with us when the bill comes up. But 
welcome to New York.
    Chairman Baker. Thank you so much.
    This morning I would like to proceed----
    Mr. Kanjorski. Mr. Chairman?
    Chairman Baker. Mr. Kanjorski?
    Mr. Kanjorski. Could I suggest, I have done a count of the 
Committee here.
    Chairman Baker. Yes.
    Mr. Kanjorski. And it is proper under the rules for us to 
put a nomination of the new chairman. I think we out number 
you, Chairman.
    Chairman Baker. We will certainly take that under 
advisement. Let us see how it goes and I may be happy to hand 
over the reins.
    Mr. Ackerman. Some of us New Yorkers are open to a deal, 
Mr. Chairman.
    Chairman Baker. Well, I am from Louisiana, and that's music 
to my ears.
    Let me again express my appreciation to our distinguished 
list of panelists representing broad perspectives and enormous 
skill and knowledge of the function of our markets.
    As is the usual custom, your statements will be made a part 
of our official record. To the extent possible, if remarks can 
be limited to five minutes each, it will enable the members of 
the Committee then to engage in questions to obtain information 
that would be helpful to Committee considerations.
    With that in mind, I would first welcome to give his 
testimony, Mr. Gerald D. Putnam, Chairman and Chief Executive 
Officer of Archipelago Holdings.
    Welcome, Mr. Putnam.

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

    Mr. Putnam. Good morning, Chairman Baker, Ranking Member 
Kanjorski and other distinguished members of the Subcommittee.
    I am Jerry Putnam, the CEO of The Archipelago Exchange or 
``ArcaEx.'' And it is a privilege to be here this morning to 
provide my testimony.
    Something that is pretty unusual for us, we do not really 
have a strong opinion on whether the specialist system has a 
role in the evolving marketplace. We feel very strongly that 
the specialists have the right to conduct their business and 
the New York Stock Exchange has the right to promote that 
market structure. Because ultimately competition, if we have a 
fair and level playing field among competing marketplaces, 
customers and market participants, will ultimately decide on 
which system that they favor. And the specialist system in New 
York is either going to live or die by the vote of its 
customers.
    The real issue is the anti-competitive rules that bind the 
inter-market trading system and protect the interests of 
various competitors. This has been a big problem with the New 
York Stock Exchange, and a problem for us over the years. And I 
would like to cite a couple of examples, and you are all 
familiar with these.
    One of the best is Rule 390, which was a prohibition on 
off-board trading by New York Stock Exchange members. So if you 
chose to trade someplace else, you were not allowed to. And as 
an industry we held our nose over that rule for about 15 years 
until it was finally regulated out of existence by the New York 
Stock Exchange.
    Another important rule is Rule 500. This was a prohibition 
on New York listed companies who later chose to list on another 
trading venue from actually doing that. And recently Rule 500 
was abolished. NASDAQ was a huge leader in this fight, because 
they were obviously a major beneficiary of a potential 
delisting of a New York company stock and onto Nasdaq.
    We went along. Obviously with Nasdaq. We didn't have a 
stake in the issuers game at the time. But we certainly 
supported the elimination of any anti-competitive rule that was 
a barrier to competition among those of us competing in the 
marketplace.
    The final one I will cite is the trade through rule. And 
you are real well versed on the trade through rule at this 
point. But I think somebody who works for me, I think has 
really summed up what it means, the trade through rule, in our 
current market structure. And what it boils down to is--I mean 
it sounds to everyone that the best price is certainly what you 
want to achieve. And we want to achieve best price for our 
traders on our exchange. And New York wants to achieve the same 
for its customers. But the New York price has historically not 
been a best price, but a maybe price. It is an indication of 
where New York specialists may be willing to conduct a trade, 
but not necessarily a firm quote.
    And it is interesting, actually I should say curious, that 
along the way depending on the trade, New York has either been 
the biggest defender of the trade through rule or the biggest 
offender of the trade through rule.
    This week we had--and you all know about it, because I have 
talked about this many times before, the infamous ITS 
Committee. And we had one of those meetings this week out in 
California. And at that meeting a lot of conversations about 
New York's new electronic interface it is going to provide to 
its customers was discussed, but our interest was mainly in 
what kind of an interface are you going to provide to your 
competitors. Because the barriers, like trade through and maybe 
price is definitely affected by that linkage. And to our 
disappointment, we were told that New York has no intention of 
linking the ITS system up to its direct plus system, which 
means customers in New York can get an electronic execution, 
but if you are a competitor, you stand in line, you wait just 
like we do today for an execution.
    The second disappointment was we have had a promise that 
has gone about nine months now. New York, you know there is an 
issue with trade groups and New York promised us in the first 
quarter a software solution that would prevent its specialists 
from trading through better prices elsewhere. So the Exchange 
itself would generate a commitment, ship it off to an away 
market, us in my example, and they would deliver fill back to 
the specialists. What we heard this week was, you know what, we 
are really busy with Direct+, that is software that prevents a 
trade through, maybe 2005, maybe 2006.
    So what we are hearing at the headline level is electronic 
executions, what is really happening beneath the surface is 
that New York is trying to defend the old model, which is use 
trade through when you want it and avoid it when it does not 
suit your interests.
    Another situation that occurred just in the last couple of 
weeks. This is just the most incredible thing that I have seen 
in the 7 years that I have been doing this.
    NASDAQ has recently introduced its version of Rule 500, a 
prohibition on listing on another exchange. And let me explain 
to you how this works.
    NASDAQ has an index. It's called the NASDAQ 100. And that 
index is comprised of the 100 largest companies that trade on 
NASDAQ. NASDAQ also has a product known as the Triple Qs, which 
is a security that is intended to track that index. And the way 
this works is investors come in and buy QQQ, give their money 
to a trust and the trust goes out and buys the company's actual 
stock in the NASDAQ 100. It is a great benefit, right? You get 
into the 100. Investors buy the QQQs. NASDAQ goes out and buys 
your stock with the trust.
    They made a change to the document that governs eligibility 
to being in the NASDAQ 100. And they did this on January 30th, 
effective January 1st. And they changed one word in one 
sentence describing eligibility. And it changed from you need 
to be on NASDAQ to be eligible to be in the NASDAQ 100 to 
saying ``You need to be exclusively listed on NASDAQ to be 
eligible for the NASDAQ 100.''
    What that means is if you choose to duly list your security 
on another exchange, NASDAQ will remove you from the index and 
dump millions of your shares on the open market. What company 
would ever choose to list on another exchange and have that 
happen?
    Now, I want to quote something here from a brochure that 
NASDAQ made available to potential listers. And it is called 
The NASDAQ Dual Listing Guide: The Power of Choice. And here it 
says make a choice to dual list for the benefit of your company 
and your investors. Now who on earth could say that and then 
provide a rule that would create an index requirement that 
basically says if you do what we think is good for New York 
Stock Exchange companies and you are a NASDAQ 100 company or 
you want to be, we are going to dump millions of your shares on 
the market on a single day? It is a prohibition to dual listing 
and it is a disgrace.
    Now knowing I was going to come in here and talk about 
this, I wanted to give NASDAQ the benefit of the doubt. So we 
contacted them and said, ``Guys, you did not mean that word 
``exclusive?'' I mean, you could not possibly have fought the 
Rule 400 or against Rule 500 all of these years and put the 
word exclusive in there.`` And there is a simple solution. What 
you need to say is instead of exclusive, say primary. And what 
primary does is preserve the value of the NASDAQ 100 because 
primary means this is where your stock trades, you are 
primarily listed here. Exclusive means if you choose a 
competing model like the New York Stock Exchange or ArcaEx to 
list your stock, you are out, we are going to dump your stock. 
No CEO or CFO would ever agree to do that. So this is 
effectively a Rule 500. And we were very disappointed to hear 
from an NASDAQ official that when we said, you know what, guys, 
it is Rule 500. They said New York got theirs for 15 years, now 
it's our turn.
    I guess I would like to conclude with a final remark. You 
have to remove barriers to competition so markets can evolve. 
We do not have to worry about whether specialists are going to 
evolve. But if there is fair, open level playing fields markets 
will evolve. And ultimately, that is what is going to serve 
investors and that is what is going to serve issuers.
    Thank you very much.
    [The prepared statement of Gerald D. Putnam can be found on 
page 79 in the appendix.]
    Chairman Baker. Thank you.
    Our next witness is Mr. John A. Thain, Chief Executive 
Officer of the New York Stock Exchange. We certainly welcome 
you here this morning, Mr. Thain. We know the transitions the 
Exchange has been engaged in in recent months have been broad 
and meaningful, and I know to a great extent your leadership 
has been a contributor to those efforts. So welcome.

STATEMENT OF JOHN A. THAIN, CHIEF EXECUTIVE OFFICER OF THE NEW 
                   YORK STOCK EXCHANGE, INC.

    Mr. Thain. Thank you. Good morning, Mr. Chairman, 
Congressman Kanjorski, Congressman Ackerman, Congressman Meeks 
in absentia and Congresswoman McCarthy. It is good to see you 
this morning.
    Thank you for inviting me to testify this morning. But also 
thank you particularly for coming to New York and for coming to 
lower Manhattan. Those of us who work in lower Manhattan 
appreciate the show of support to come to the financial 
district.
    I'd like to start my comments just giving you a little bit 
of overview of my thoughts after the first five weeks on the 
job. The first comment I would make is the New York Stock 
Exchange is a great American institution. And I am very proud 
to have been offered the opportunity to be the CEO and serve 
the Exchange.
    It is also a fundamental part of the U.S. financial system. 
And I think it is a leading component of what makes the U.S. 
financial markets the most robust markets in the world.
    I would also like to put on the record a thank you to John 
Reed, who I think has done an excellent job of restructuring 
the governance of the New York Stock Exchange and beginning the 
process of rebuilding and restoring the credibility of the 
Exchange.
    Now in the first five weeks I have focused first on our 
customers, and I have spent time with listed companies and 
various institutions listening to their concerns and comments. 
I have also spent a lot of time with the members, both the 
specialists and the brokers. And I have obviously spent a lot 
of time with the employees.
    And I am pleased to report that although there is much to 
do, the New York Stock Exchange and the agency-auction model 
is, I believe, fundamentally sound. And it does, in fact, offer 
investors the best prices over 90 percent of the time. It 
offers the most liquidity and it is the most efficient venue to 
buy and sell stocks in this country, and for that matter in 
most countries in the world.
    Now, there are a set of changes that have been referred to 
already which I want to just cover. And those changes are 
really derived from listening to our clients and trying to be 
responsive to our clients.
    One of the comments I heard was listed companies were 
concerned about the performance of their specialist and they 
wanted to be able to change their specialist if they were 
unhappy with that performance. And we have now made that much 
easier for companies to do.
    We also have to develop a better set of metrics so that we 
can actually measure what is good performance on the part of 
specialists.
    A second rule change that we have applied for will allow 
that customers always come first. There were certain 
circumstances where specialists were allowed to trade alongside 
customers. We are in the process of eliminating that so our 
customers have always the right to trade first before our 
specialists.
    And the third set of changes has to do with the ability of 
customers to execute trades on the Floor of the Exchange 
electronically. One of the comments that I heard, particularly 
from large institutional customers, was that they wanted a 
higher speed, a higher degree of certainty and an anonymous 
form of execution. And although the Exchange has an electronic 
execution mechanism called Direct+ which allows for sub one 
second execution, it had both timing and size restrictions that 
made it unattractive to large financial institutions to use. So 
we are in the process of removing those timing and size 
restrictions so that in fact if institutions or individuals 
want, they can execute trades electronically, quickly, 
anonymously and be competitive within any marketplace in the 
world. They will, of course, still be able to choose price 
improvement if they desire.
    I also want to comment for a moment on competition. And 
there has been commentary in the press and other places about 
the New York Stock Exchange having a monopoly. That is simply 
not true. The New York Stock Exchange has very good and very 
tough competitors, many of which are on this table here today. 
The New York Stock Exchange trades about 80 percent of the 
volume in its listed securities. That means that 20 percent of 
the trades trade away; again, many of those trade on the 
various different ECNs and exchanges are listed here.
    Also, if you look at the best bid and ask spread, the best 
bid/best offer, you have seen a tremendous contraction over the 
last 12 months where for the S&P 100 stocks, those listed on 
the Exchange, you have seen the spread contract from five cents 
to two cents, which obviously benefits investors.
    Now, although the New York Stock Exchange does have the 
best price 93 percent of the time, if customers want to, they 
can trade away. And if they want to execute in a different way 
than the New York Stock Exchange offers, they have the right to 
do that, and they do. So there is no question, I believe, that 
the New York Stock Exchange has a tremendous amount of 
competition and we do have to be responsive to our customers to 
allow them to execute in the way that they choose or they will 
in fact trade away.
    I just want to cover briefly the role of specialists. The 
specialists along with the Floor brokers are the ones who 
really facilitate the competition between buyers and sellers 
which ultimately leads to the best price.
    The specialist also reduces intra-day volatility. And the 
best proof of that is if you look at companies that move from 
NASDAQ, where there is not a specialist, to the Floor of the 
Exchange. There are about 39 stocks that have moved over a 15 
month period. You see intra-day volatility in those stocks has 
been cut in half.
    Specialists also provide liquidity, bridging the gaps 
between buyers and sellers. And the specialist also manages 
imbalances and sometimes commits their own capital when they do 
that.
    The specialist helps to establish a fair market price on 
opens and closes. And I think this is a particular strength of 
the Exchange.
    You know, I was on the Floor of the Exchange the morning 
that Comcast announced its hostile bid for Disney. And as we 
worked to get the stock open, the specialist was balancing 
about 5 million shares, of buys and sells and balancing those 
orders to come up with a fair price for both the buyers and the 
sellers. That is not something that can happen in an electronic 
marketplace.
    I am pleased that there has been a settlement of the 
specialist investigation. I am confident that the new systems 
and procedures that we put in place will prevent these types of 
abuses from occurring. I think that it is in the best interest 
of the Exchange that we move forward. There is no question that 
there were abuses and I think that those are being suitably 
dealt with.
    On the trade-through rule specifically, the trade-through 
rule is one of the mechanisms that guarantees that investors 
get the best price. Now, I am sympathetic to the concerns on 
the part of institutions who say where there are dramatically 
different execution speeds, that price is not the only 
important thing. But if competing markets offer comparable 
execution capabilities, then the best price has to be what 
prevails.
    Who is harmed if you trade through a better price? Well, 
first obviously the investor who either paid too much or sold 
too cheaply. But also, and this is actually what the trade-
through rule was meant to protect, it is the investor who had a 
better bid or who had a lower offer who did not get traded 
with.
    Also, trade-throughs undermine the process of price 
discovery and undermine confidence in the quoted market prices, 
because obviously those prices are not the best prices. And 
market liquidity will suffer over time if buyers and sellers 
who have the best bids or the best offers on the books are not 
executed on, they will then stop doing that.
    There has also been talk about a de minimus exemption. And 
in today's market of pennies, I do not think there is anything 
de minimus about two or three cents a share. We trade on the 
New York Stock Exchange about 1.7 billion shares a day. And two 
or three cents a share worse execution quickly adds up to 
billions of dollars. So I think it is very important when we 
are talking about the trade-through rule that all investors, 
big or small, sharks or minnows, should get the best price. 
Anything less, I think, undermines confidence in the markets.
    So, in conclusion, I am committed to helping to rebuild the 
reputation of the New York Stock Exchange and investor 
confidence in the marketplace overall. I am also committed to 
making sure the New York Stock Exchange is in fact more 
responsive to its clients. And I am committed to providing 
buyers and sellers of stocks the absolute best price. And I am 
certainly willing and committed to working with you, Mr. 
Chairman and your Committee, on these important topics as you 
deliberate on the structure of the marketplace.
    Thank you.
    [The prepared statement of John A. Thain can be found on 
page 117 in the appendix.]
    Chairman Baker. Thank you, Mr. Thain. We appreciate your 
participation.
    Our next witness is Mr. Edward J. Nicoll, Chief Executive 
Officer, Instinct Group Incorporated.
    Welcome, sir.

    STATEMENT OF EDWARD J. NICOLL, CHIEF EXECUTIVE OFFICER, 
                  INSTINCT GROUP INCORPORATED

    Mr. Nicoll. Thank you. Thank you, Chairman Baker and 
members of the Subcommittee. Thanks for holding this hearing 
and for inviting me to speak before you.
    Today I would like to make three brief but important 
points. First, it is time to eliminate barriers to competition 
with the New York Stock Exchange monopoly.
    Second, if the New York Stock Exchange continues to 
advocate a market structure that puts specialists in a 
privileged trading position even after recent revelations that 
they have abused that privilege, then we should at the very 
least demand greater disclosures of specialist trading 
positions and activity.
    And third, if NYSE wants to claim the benefits of 
electronic markets, we should insist that it adopt the 
principles of transparency and immediacy that are fundamental 
to electronic markets.
    As you look into the role of the specialist system and the 
regulations that keep it in place, I would encourage you to 
support regulatory changes that allow electronic markets to 
compete on a level playing field with manual Floor based 
markets. The most significant impediment, of course, is the 
trade-through rule. Media reports and the hard work of many in 
this room have educated most legislators and regulators on why 
the trade-through rule in fact hinders competition and hurts 
investors. And the chorus calling for the rule's reform 
continues to grow:
    In October 2003, the Wall Street Journal published an 
editorial calling the abolition of the rule.
    In January 2004, California State Controller Steve Blestly, 
a Democrat whose oversees billions of dollars invested on 
behalf of California retirees, wrote to Chairman Donaldson that 
``the trade-through provision is obsolete'' and ``reforming 
trade-through will improve investor choice.''
    Just last week, Florida Attorney General Charlie Crist, a 
Republican who also sees his State's retirement investments, 
wrote Chairman Donaldson that ``elimination of the trade-
through rule would abolish this antiquated system. Progressive 
reform would ensure Florida's investors access to a competitive 
marketplace, prevent manipulation, and guarantee securities are 
bought and sold at the true best price.''
    And of course, Mr. Chairman, your leadership on this issue 
is well known. However, there are still opponents to trade-
through reform. They argue that without a rule, investors would 
not get the best price. But as you heard in last fall's 
testimony by numerous experts, this is simply not the case. 
Brokers still have a fiduciary duty to secure best execution 
for their clients, but best execution does not and should not 
mean attempting to execute against the best-advertised price 
without considering other factors.
    The debate about trade-through is really a debate about 
whether one market structure fits all or whether investors 
should be free to choose how and where they trade. It's about 
competition.
    The NYSE's prestige may make some reluctance to submit it 
to the competitive forces of the marketplace. They want to 
preserve the monopoly status of the specialists because they 
claim the specialist helps to maintain a ``fair and orderly 
market.'' But they offer little proof to support that claim.
    We do not really know whether the specialists trade in a 
way to maintain fair and orderly markets or whether they trade 
in a way to maximize their own profits at the expense of 
others. In fact, recent headlines seem to suggest the latter. 
But this is too important an issue to leave to either 
apologists of the status quo or headline writers. Thus, I 
challenge the New York Stock Exchange to make all specialist 
trading activity publicly available. Trades where specialists 
participate accompanied by their trading position at that time 
should be promptly disclosed so market participants, academics 
and policymakers can better evaluate specialists' trading 
activity.
    Today when investors complain about an execution, they 
cannot obtain sufficient data to evaluate the propriety of the 
specialist's activity. Without a real time audit trail, they 
have little insight into the NYSE's trading process and less 
confidence that their orders receive fair treatment.
    Lastly, the NYSE has recently responded to investor 
complaints by updating Direct+. With great fanfare, the NYSE 
recently submitted rule changes to the SEC that would at least 
in theory make it easier to obtain automatic executions via 
Direct+. In fact, the NYSE now boasts that Direct+ will provide 
``ECN-like'' features to investors. But let's look at how 
Direct+ will really operate.
    While it may provide some automatic executions, there will 
be some pretty substantial exceptions. One exception is that 
there is no obligation to automatically execute an order if the 
quote is in ``non-firm'' mode. How often does the NYSE publish 
quotes that are non-firm? Again, there is not much transparency 
into how the specialist operates its book.
    Another exception is that automatic execution is not 
available when the market is only for 100 shares. I am told 
this is frequently around 10 to 20 percent of the trading day. 
While this does not sound like much, it is likely that 10 to 20 
percent of the trading day occurs at moments when the market is 
volatile and receiving an automated execution is most valuable.
    A further exception is that auto execution is only 
available against the orders composing the NYSE's quoted 
market, and not the usually substantially amount of trading 
interest available at a penny or more behind it. And once the 
interest at the NYSE's quote is exhausted, Direct+ is 
unavailable until the specialist displays a new quote.
    In sum, it seems the NYSE is guaranteeing an automatic 
execution except when it is not, which may be often. Not much 
of a guarantee.
    In contrast to the NYSE, every order on an ECN is real and 
immediately accessible. It is not possible to display an order 
that is non-firm. There are no delays and no turning off the 
automated nature of ECNs. Further, every order sent to an ECN 
for display is immediately displayed. No delays, no freezing 
and no manual keystrokes from a clerk. That is why I am 
surprised that the NYSE would even try to compare itself to an 
ECN.
    If they truly want to offer an automated execution system 
that competes with ECNs, I challenge the New York Stock 
Exchange to make two additional changes:
    First, immediately display all limit orders received 
electronically for display; no delays, no human intervention, 
and no exceptions.
    Second, immediately execute all matching orders that are 
received electronically; no delays, no human intervention, no 
exceptions.
    These two changes would be a start in making the NYSE into 
a fair 'ECN-like'' marketplace.
    In conclusion, over the past months, NYSE has desperately 
tried to perpetuate the current regulatory structure by 
asserting that it's market model is superior. I do not believe 
that the NYSE provides sufficient data to adequately evaluate 
that assertion. I also believe that the changes that the NYSE 
is making to Direct+ will have little impact on investors. 
Regardless of these changes, there is still a need for 
unleashing competition between markets. Certainly if the NYSE 
is stirred to propose these changes to simply stave off the 
threat of competition, actual competition will produce even 
greater benefits for investors.
    Clearly, Mr. Chairman, the time for reform is now.
    Thank you.
    [The prepared statement of Edward J. Nicoll can be found on 
page 73 in the appendix.]
    Chairman Baker. Thank you very much.
    Next witness to speak is Mr. Robert H. McCooey, Jr., 
President and Chief Executive Officer of The Griswold Company.
    Welcome, sir.

   STATEMENT OF ROBERT H. MCCOOEY, JR., PRESIDENT AND CHIEF 
           EXECUTIVE OFFICER OF THE GRISWOLD COMPANY

    Mr. McCooey. Good morning, Chairman Baker, Ranking Member 
Kanjorski and members of the Subcommittee.
    Excuse my laryngitis.
    My name is Robert McCooey and I am proud member of the New 
York Stock Exchange and President and Chief Executive Officer 
of The Griswold Company, a member firm. Griswold is an agency 
broker working for institutional clients on the Floor of the 
New York Stock Exchange. I'm a practitioner. As an agency 
broker, we execute trades on behalf of our customers. We do not 
make markets in securities or engage in proprietary trading. 
Our clients include some of the largest mutual and pension 
funds in the United States.
    Thank you for inviting me here to testify in connection 
with your review of the capital market structure in the United 
States. I would like to commend the Chairman for his choice of 
New York City, the center of global capital markets, as the 
site for this hearing. New Yorkers take great pride in our 
city. We have clearly worked hard to achieve this status, one 
that is the envy of our international competitors.
    Chairman Baker, I am also very pleased that you have chosen 
my new partner at the New York Stock Exchange, John Thain, to 
address the Committee today. Five weeks ago, John joined an 
organization that was desperate for new leadership to implement 
previously announced changes and to address important customer 
needs.
    What John has accomplished in just this short period of 
time coupled with the work of interim Chairman John Reed is 
nothing short of remarkable. I think it is clear to all that 
there has been a dramatic change at the New York Stock 
Exchange. The membership is hopeful that regulators and 
legislators will support these changes for the continued 
benefit of all the users of our institution.
    The discussions we will engage in today should focus on how 
we should enhance the National Market System for the benefit of 
all investors. In that vein, we should promote the aspects of 
the current National Market System to provide positive results 
in the execution of investors' orders. I would contend that the 
agency-auction market at the New York Stock Exchange is one of 
those important competitive aspects. The specialist, the focus 
of today's hearings, plays a vital role in that system.
    The topic of today's hearing is to identify that role the 
specialist will play as the markets continue to change. As an 
agent on the Floor of the stock exchange I've seen that role 
evolve over the past 16 years. A fundamental principle is to 
place the interest of the customer first and provide each 
customer the best experience trading at the New York Stock 
Exchange. The specific value that accrues to investors can be 
broken down into two major categories: information flow as an 
important part of the specialist catalyst function and 
liquidity provides to the marketplace.
    As I speak to my customers about multiple marketplaces in 
which they trade, one theme about the NYSE is consistently 
voiced. Customers appreciate the fact that the Floor-based NYSE 
provides participants in that market with valuable information 
that aids buyers and sellers in making market entry and exit 
decisions. Through this information flow specialists act as 
catalysts for actively bringing together buyers and sellers, 
thus creating trades that otherwise would not have occurred.
    Responding to a buyer, for example, a specialist may recall 
selling interests on the part of a particular agent and then 
call that agent into the crowd to help effect a trade. This 
happens within seconds. The buyer can then negotiate directly 
with the agent representing the seller. This results in natural 
buyers meeting natural sellers almost 90 percent of the time 
with minimal market impact. Without the specialist as the 
catalyst for providing that information, the trade may have 
occurred at the wrong price or worse, never have happened at 
all. This kind of information flow is impossible in electronic 
markets. Furthermore, the information gathered from the 
specialist at the point of sale is available impartially to all 
who ask.
    The second and equally important function to customers is 
the liquidity that the accountable specialist adds to the 
marketplace. It is important to remember that specialists do 
not set the price for stocks. At the New York Stock Exchange, 
that pricing function is reserved for the buyers and the 
sellers. The important role of the specialist is to provide the 
liquidity necessary to the market to assist agents in getting 
orders executed correctly for their clients. What specialists 
do is risk their capital, in excess of $11 billion on a daily 
trading day, to add market depth and stabilize prices. They 
inject liquidity by bridging temporary gaps in supply and 
demand. Each of these trades for the specialist is a one-sided 
risk transaction. The best method for me to explain is to give 
you an example.
    With a market $28 bid for 25,000 shares and 18,000 offered 
at $28.05. My customer entrusts me with an order to buy 25,000 
shares. My goal is always get that order executed at the best 
possible price with minimal market impact. I want to purchase 
my stock at $28.05, but there is only 18,000 shares offered. 
The only way for this to happen is to have the specialist add 
the necessary liquidity. Sell that 7,000 shares to complete my 
client's order. In the absence of the specialist, my natural 
buyer would have to reach to the next price point where 
liquidity is available to purchase those shares. For the sake 
of the argument, let us assume that the customer had to pay 
$28.10 to purchase the shares. Without that capital it would 
cost that customer $350. That may seem like a very small amount 
but multiple those savings by the thousands of times that 
happens daily on the New York Stock Exchange and the millions 
of dollars adds up very quickly.
    Contrast that with an ECN. It is true that if two orders 
reside in an ECN system match, the computer can execute that 
trade instantaneously. But because ECNs are passive, order 
driven systems in which orders wait on the ECN book until a 
matching order arrives. In the absence a contra side the order 
is sitting on a park bench waiting for it to go. There is no 
obligation on the part of market makers on NASDAQ to provide 
for a fair and orderly market. No rule that forces them to buy 
or sell at any price, no matter how far the security has moved 
from its previous price.
    A perfect example of this occurred last week, the infamous 
stock of Imclone. Absent any news and in just three minutes the 
stock dropped more than 20 percent, from 42 to 33.50 on no news 
before it was faulted. Reviewing these trades paint a picture 
of a stock that was in free fall where 100 share lots declined 
the stock by a dollar or more. Where were the NASDAQ market 
makers? Mr. Greifeld's written where it claims 300 market 
makers who were willing to commit capital to help with the 
execution of buy and sell orders. In this example, how were 
those investors well served by those NASDAQ market makers.
    Therein lies the difference between markets and goes to the 
heart of why we are here today. At the New York Stock Exchange 
specialists have an obligation to investors to provide that 
fair and orderly market, cushioning moves between price points 
for investors. There is no such obligation in other market 
models. Their market makers can simply decide when they want to 
participate and when they do not.
    The trade-through rule was designed to convert multiple 
marketplaces in to a National Market System. The rule turns 
each market into a gateway to ever other market and ensures 
that investors will not be disadvantaged by the virtue of 
having bids and offers displayed in one venue versus another.
    I will not go through my example that I previously put on 
the record back in October, but John Thain went through very 
clearly the fact that multiple people, buyers, sellers getting 
wrong prices is a reason why we should protect and maintain the 
trade-through rule. Investors are ignored when we have a trade-
through rule.
    One of the major factors that draws companies to the New 
York Stock Exchange is the incontrovertible fact that reduced 
volatility after a stock has moved from NASDAQ to the New York 
Stock Exchange. Management and boards of directors realize that 
tightening of spreads and minimizing trade to trade volatility 
are serving their shareholders, your constituents best 
interests. A key factor in why this occurs is the accountable 
specialist. The liquidity the specialist adds to the market on 
a moment to moment basis prevents stocks from declining or 
advancing too quickly. Volatility scares investors and 
therefore has an impact on the capital raising process for many 
firms. The dampening of volatility by a specialist give 
confidence to the investor that there will always be a 
continuous two-sided market in that security. Trading that 
occurs outside of the NBBO will effect volatility, it will 
increase it in these issues and adversely affect those 
investment decisions.
    Modifying or eliminating the trade-through rule would 
produce inferior prices and increase costs, increase market 
volatility, reduce accountability and transparency. These added 
costs and negative impacts to the market would have dramatic 
harmful effects on your constituents' accounts. This is not the 
way we want to promote investor trust and confidence.
    The role of specialists and that of the Floor broker, for 
that matter, will continue evolve. At the New York Stock 
Exchange we embrace change. Providing choices to our customers 
has been the hallmark of the New York Stock Exchange for as 
long as I have been a member and we are again addressing the 
news of our customers who have asked us for more choice.
    Two weeks ago our board passed on significant structural 
proposals sent to the SEC for final approval. Briefly the plan 
calls for automatic execution of all displayed liquidity To 
enhance the product, we have proposed removal of prior 
restrictions to our Direct+ and this will allow execution 
choice for 87 percent of the orders that are entered in our 
marketplace for a one second execution, thus disposing of the 
issue of the New York Stock Exchange as a slower market. We are 
going to trade a 100 million shares in this manner today. 
Within our price discovery dynamic we will preserve the role of 
the specialist and bring the buyers and sellers together, 
committing capital to dampen volatility and the contribution of 
agency Floor brokers who will reduce market impact and 
execution costs for institutional size orders.
    Mr. Chairman, I must say that I am very disappointed in the 
way this debate, not today but in general, has progressed. 
Competitors, some of who have garnered over 10 percent of the 
New York Stock Exchange volume on a daily basis, have resorted 
to the use of media driven buzz words to describe the New York 
Stock Exchange. Others complain about what I do as a Floor 
broker as I diligently work in my fiduciary capacity to produce 
the best results for my client on each and ever order. I do not 
think that those who employ different execution models should 
attempt to eliminate other models that their competitors find 
very effective.
    Moreover, some techniques employed by a Floor broker in 
filing his customer's orders exist in electronic markets, too. 
They just go by fancy names like Egging and Reserve Book.
    Finally, I would like to refocus our debate on the end 
result: Creating market models that benefit investors. Mr. 
Chairman, this is not a debate about diet coke or milk or ice 
cream, none of which I believe the Subcommittee has any 
jurisdiction over. What we ought to debate about is best price, 
something we have delivered at the New York Stock Exchange for 
200 years and will continue to deliver everyday going forward. 
At the New York Stock Exchange we will continue to change, 
adapt and innovate to serve our customers' needs and for 
fulfill our commitment to producing the highest level of market 
quality. We will continue to provide a fair and level playing 
field for investors, something that they expect of us. We will 
compete on the basis of discovering price and delivering it 
coupled with the highest levels of transparency. The 
interaction between specialist and agency Floor brokers creates 
a value proposition at the New York Stock Exchange that 
delivers to customers the best prices, the deepest liquidity, 
the narrowest spreads and the lowest volatility. This results 
in multi million dollars of savings to your constituents each 
and every year. In all that we do we take pride in the fact 
that we always place the investor first.
    Thank you, sir.
    [The prepared statement of Robert H. McCooey Jr. can be 
found on page 61 in the appendix.]
    Chairman Baker. Our next witness is Mr. Robert Greifeld, 
President and Chief Executive Officer of the NasDaq Stock 
Market, Inc.
    Welcome.

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

    Mr. Greifeld. Thank you, Chairman Baker. I am proud to be 
here today. And I like to thank Ranking Member Kanjorski and 
other members of the panel for this invitation.
    NASDAQ is a New York based company. Through NASDAQ and the 
National Association of Security Dealers we collectively employ 
over 500 people in New York. In addition, NASDAQ supports 2500 
employees who directly work on NASDAQ listed tradings here in 
the city. These include market makers and order entry firms.
    The subject of today's hearing is the role of the 
specialist in the evolving modern marketplace. But we cannot 
separate the market structure debate from the specialist 
settlement announced just this week. The $240 million 
settlement with five specialist firms is an outward symptom of 
an organizational problem at the New York Stock Exchange and an 
organizational failure at the Stock Exchange because its 
regulatory structure when it was unable to proactively address 
the issue of specialist trading ahead of investors.
    Now, this large settlement may make us feel good, but it 
does not in fact solve the problem. Let us examine the failures 
and the root cause.
    The overriding principle that we must hold foremost in our 
mind is that we are entrusted with the protection of investors' 
interests. Our markets must have this as a guiding philosophy. 
The New York Stock Exchange did not protect investors as the 
settlement makes clear, and the failure to protect investors 
and the continuing failure that is harming investors today 
reveals a structural flaw in their market structure.
    The monopoly specialist system of the New York Stock 
Exchange allowed these intermediaries to put their profit 
interests ahead of investors. The trade-through rule isolated 
these intermediaries, these monopolists from competition. 
History shows us that absolute power will corrupt. If they did 
not have this absolute power, they would not have been in this 
position to harm investors.
    The fundamental flaw in the New York Stock Exchange model 
is there is a lack of intra-market competition and the outdated 
protectionist rule such as trade-through prevent intra-market 
competition. This result has not been positive.
    We have heard of the New York Stock Exchange plans to 
introduce reforms into their market. As we listened to the 
press conference we said we have to pay attention to the 
details. The devils are in the details. It did not take us long 
for the details to see how transparent and shallow this attempt 
is. And I quote from their proposal which they have filed to 
the Securities and Exchange Commission. ``An auto-X order shall 
receive an immediate automatic execution against orders 
reflected in the Exchange's public quotation and shall be 
immediately reported as New York Stock Exchange transactions.'' 
That's the good part. One caveat: ``Unless with respect to a 
single sided auto-X order the New York Stock Exchange published 
bidder offer is a 100 shares.'' In other words, the specialist 
can turn off auto-X for 10 shares. When he does that, they are 
operating in the same manner that has resulted in this $240 
million penalty.
    But, if the Stock Exchange chooses to pursue this approach, 
truly I believe it is their business. They should have the 
ability to dictate the market structure that they deem 
appropriate for themselves. If they believe a monoplus 
controlled market structure that pays lip service to 
electronics is best for the Stock Exchange, they should be 
permitted to adopt that policy. But, we have to be clear. The 
competition has to be in place. If you have competition in 
place, if you have intra-market competition, then the New York 
Stock Exchange's structure will be resolved through competitive 
measures. We will not have to read the details in this sort of 
electronic release. Competition will ensure that that 100 share 
rule and others like it disappear.
    Investors know that, and investors have spoken. 
Institutions, pension funds like CalPERS and the elected public 
officials and investor advocates like the Attorney General of 
the State of Florida and the Comptroller of the State of 
California all believe the trade-through rule has outlived is 
usefulness and is preventing competition.
    How can you argue as a public policy matter that investors 
cannot have choice that they cannot seek the best deal as they 
define it for themselves?
    As we think about the repeal of trade-through, we certainly 
have to be concerned about what that will mean for the U.S. 
markets. We are not talking about Coca Cola, we are not talking 
about milk, we are talking about something that is incredibly 
important. But the interesting thing is NASDAQ is the case 
study for competition. We do not have a trade-through rule in 
the NASDAQ marketplace today, and we have never had one. So 
what is the results? Let us look at it.
    The SEC several years ago mandated something that we know 
as the Dash 5, and it measures the actual performance of the 
markets. What I have for you today is data that comes from this 
SEC mandated program.
    We also wanted to pick data that made sense that was clear 
and objective. So we picked indices in this country. One is S&P 
50 stocks, the large cap stocks. In the large cap stocks NASDAQ 
has an effective spread of 1.2 seconds. New York Stock Exchange 
1.7. In the Dow Jones Index we are at 1.1 cent. They are 1.7. 
Russell 1000, we are 1.4, they are at 1.9. That spread, that 
difference between the buying and the selling is really the 
effective measure of how well the market works.
    The NASDAQ market structure where we have open competition 
between multiple participants where we allow buyers and sellers 
to meet electronically, if that is what makes sense, yields a 
tighter spread.
    In addition, we want to look at how often we actually trade 
at or within the spread. We consider that the quality of the 
market. The S&P large caps, we trade at or within our narrower 
spread 91 percent of the time. New York Stock Exchange 82 
percent. The Dow Jones large cap, 91 percent again for NASDAQ, 
New York 80 percent. Their spread is wider and they trade 
outside of it more often.
    The Russell 100 91 percent for NASDAQ, 82 percent for the 
New York Stock Exchange.
    Our market model without a trade-through works.
    In addition, we talk about how we have multiple 
participants. Our market makers have to compete with each other 
to get any order flow, to get any trading activity. They do not 
get to put a single, say I am a market trader, send all the 
orders to me like you do have to do in the specialist system. 
They have to compete among each other.
    We also run a continuous market system. I think it is very 
interesting to point out what happened in Disney and Comcast. 
Comcast is a NASDAQ traded company. Last week they made the 
announcement, an offer to buy Disney. New York Stock Exchange 
opened up Disney at 9:57. They halted the stock. Did not trade 
it. To me, that is not a market, it is an absence of market. 
NASDAQ opened up Comcast at 9:30. At 9:57 had traded 20 million 
shares of Comcast within one percent of its opening price.
    We, in fact, then had greater volatility than New York. One 
percent movement. But we had a market and we traded. They had 
zero volatility, they did not have a market. It was halted to 
9:57. We had traded 20 million shares by 9:57.
    When we talk about this $240 million settlement, one thing 
that really stands out is how they came to that determination. 
Early reports was the settlement was going to be around $30 
million. The reports said it was $30 million because they were 
looking at sample trades that happened outside of 60 seconds. 
SEC got involved, said 60 seconds is too long. Investors should 
have an execution sooner than that, and at 15 seconds which is 
what the settlement was reportedly agreed upon, the fine become 
$240 million. At 60 seconds investors outside of 60 would have 
gotten $30 million. At 15 seconds it was $240 million.
    The average execution time on NASDAQ is 5 seconds. If the 
Commission had held the New York Stock Exchange to the 
practicing standards that exist on the NASDAQ, we can 
extrapolate the fine would have been a lot closer to three 
quarters of a billion dollars. The NASDAQ market where we have 
a electronics and we have competition works.
    It is time to take the next step. More shares are traded on 
the NASDAQ on every day than any other market in the world. We 
protect investors, we support the principles of free markets. 
It is time for the repeal of the trade-through rule.
    One last comment. I alluded to the organizational failure 
with respect to regulation. We strongly believe that the 
regulatory body has to be separated from the market centers. 
These market centers and the individuals represented on this 
panel compete vigorously every day for order flow. We want a 
fair structure to allow that competition to proceed. The 
regulatory function has no function being anywhere near the 
competitive function. The regulatory function has to be 
separated out. That will ensure investors know there is a tough 
cop on the beat.
    It is an exciting time. In conclusion, we are about 
competition. Let us ensure that we have competition. Let us 
ensure that we have benefits of participants. If we have that 
kind of competition, then we know that we do not have to worry 
about the details of is it 100 shares, is it a 1,000 shares; we 
know the competition will force the better outcome.
    We look forward to an engaged debate on this in the weeks 
and months to come.
    [The prepared statement of Robert Greifeld can be found on 
page 54 in the appendix.]
    Chairman Baker. Thank you, sir.
    Our next witness is Mr. Frank C. Sullivan, President and 
Chief Executive Officer and Chief Operating Office, RPM 
International, Inc.
    Welcome, Mr. Sullivan.

  STATEMENT OF FRANK C. SULLIVAN, PRESIDENT, CHIEF EXECUTIVE 
  OFFICER AND CHIEF OPERATING OFFICE, RPM INTERNATIONAL, INC.

    Mr. Sullivan. Thank you, Mr. Chairman, Congressman 
Kanjorski and the members of the Subcommittee for extending an 
invitation to appear before you to discuss market structure, a 
matter of great importance to the shareholders, board of 
directors and management of RPM International, a company traded 
on the New York Stock Exchange.
    I am Frank Sullivan, President and Chief Executive Officer 
of RPM, a company founded by my grandfather in 1947. Fifty-six 
years later, RPM is a world leader in specialty coatings, 
serving both industrial and consumer markets. We have achieved 
record growth in each of our 56 years and have delivered 30 
consecutive years of cash dividend increases to our 
shareholders. RPM products include such well-known names as 
Rust-Oleum Paints, DAP Caulks and Sealants, and many other 
industrial and consumer DIY products.
    For the fiscal year ended May 31, 2003, RPM had sales of 
$2.1 billion and $122 million in net income before we took a 
$140 million asbestos charge, asbestos being another issue we 
are hopeful the Congress will address soon.
    A member of the S&P 400 Midcap Index, we are highly 
committed to our approximately 300 institutional investors and, 
more importantly for us, our more than 100,000 individual 
shareholders. RPM is a favorite of retail investors who are 
members of the National Association of Investment Clubs. We 
have made it a priority to get to know these retail investors 
very well and we feel that we appreciate their needs. We take 
very seriously the quality and fairness of our trading in our 
shares to ensure the interests of all investors, large and 
small, are well served.
    I would like to relate to the Committee today my 
perspectives on how stock exchanges and their models affect 
companies, and specifically how the specialist system has 
impacted our business. As my company has experience with both 
NASDAQ and the New York Stock Exchange, we can give you through 
our experience a case study in how they have differed.
    RPM went public in 1969 and was one of the original 
listings on NASDAQ in 1971. In 1997 as CFO of RPM, I understood 
a review of our markets to determine whether there was a reason 
to consider a transfer then to the New York Stock Exchange. One 
of the most important decisions we had to make in moving to the 
NYSE was selecting a specialist. From the beginning, we 
understood the importance of the specialist as he or she would 
be accountable for the quality of the trading in our stock and 
also available to provide commentary and help us understand 
trading dynamics.
    After interviewing five firms, we ultimately ended up 
choosing Benjamin Jacobson and Sons, which was later acquired 
by Speer Leeds and Kellogg. In June of 1998, we transferred to 
the New York Stock Exchange.
    In the five and a half years we have been listed, we and 
our investors have come to appreciate the value of both the 
Exchange model and the specialist in a very practical sense. 
Our objectives in listing have been met as we have continued to 
maintain a broad individual investor base while increasing our 
institutional ownership from 43 percent when we listed to 57 
percent today. At the same time we have seen a significant 
increase by almost two-thirds in our liquidity since listing.
    Our specialist, Speer Leeds and Kellogg, accounts for eight 
percent of the trading in RPM on average. So 92 percent of the 
time public orders are meeting directly to set the price. I 
believe that having orders for our shares compete in one pool 
of liquidity is the most effective mechanism for pricing. The 
specialist role in overseeing this process and ensuring fair 
and orderly markets is, in and of itself, a benefit. But it is 
in times of stress that this value has been most clearly seen 
and appreciated by us. And I'd like to relate two examples.
    The first occurred on January 22nd, 1999, shortly after we 
listed. Our stock did not trade until 9:51 when it opened at 
$12.87, down eight percent from the prior day's close. I was 
informed by the Exchange staff and also by Jim Jacobson, head 
of the specialist firm, that the opening would be delayed due 
to a sell side imbalance equal to three quarters of our average 
trading volume. The specialist acting as a catalyst attracted 
buyers to our stock and acting as a dealer, purchased shares 
himself ultimately opening the stock on a trade of 143,000 
shares. On that day the specialist represented 15 percent of 
our market, nearly double their average. There is no doubt in 
my mind that had RPM been trading on NASDAQ, the stock would 
have opened lower and been more volatile as there is no 
regulatory requirement or formal process for dealers or ECNs to 
step in and stabilize a market.
    What impressed me most, however, was that Jim Jacobson, 
having explained the trading to me himself, took the extra step 
of asking the Exchange to take a formal review. I received the 
report about a week later. It was a detailed chronology of the 
day, showing how and when the specialist stepped in to 
stabilize the market. I clearly would not have received this 
level of detail or service in my prior market, quite simply 
because at that pace there was no one to call.
    Another example occurred in March 2002 when we issued $150 
million of common stock to reduce debt associated with a recent 
acquisition. While investors were attracted to the offering due 
to the sound fundamentals of RPM, there is no doubt that we 
benefitted from the liquidity that existed on the New York 
Stock Exchange, our reduced volatility and investors' 
confidence in the market for our shares. On March 26th the 
stock closed at $14.91. That evening we priced 10 million 
shares at $14.25 and opened the following morning at $14.93. 
The increase in shares amounts to 10 percent dilution but the 
stock price held steady, reflecting the ability of a 
centralized market to absorb the significant increase in shares 
with minimal price dislocation.
    The specialist kept us well appraised of the buy and sell 
interest indicated prior to the market open, throughout the 
opening itself, and for the remainder of the day. We were well 
informed at all times. Investors' ability to buy shares in the 
offering and just as important, to add to or liquidate their 
position in the future with minimal price dislocation is 
critical in ensuring their confidence. And this example 
highlights one of the factors in our decision to change to the 
NYSE as our experience in secondary or follow-on equity 
offerings on the NASDAQ was relatively very poor.
    The principle point of these examples and our experience is 
that trading our shares on the New York Stock Exchange has 
provided better liquidity and better execution versus our prior 
market and other alternatives. And this is confirmed by 
numerous studies.
    As important to us is the accountability the New York Stock 
Exchange and our specialist provides that cannot be found in 
competing markets.
    I'd like to make a few concluding points. I'm very well 
aware of the current debate regarding the importance of speed 
versus price. I support the Exchange Initiative to increase its 
automatic execution capabilities, but do so because they are at 
the same time preserving the principle of best price. As both 
an investor myself and CEO of a company who actively engages 
with retail investors on a regular basis, it is hard for me to 
imagine why speed, all things being equal, would take 
precedence over best price for any reason.
    Investors expect and deserve to have the confidence that 
they will be getting the right price, or to put it another way, 
the fair price. One of the great things about our current 
system is it allows small investors to buy and sell their 
shares on exactly the same terms as large institutions. There 
is no wholesale price or retail price for our shares. There is 
just one price. And I and our other investors can always find 
out what that price is.
    Whatever the motive of large institutions, it should be 
fully transparent and understood by those who entrust their 
hard-earned dollars to them. The New York Stock Exchange 
already provides what investors most want. The Exchange has the 
best price 93 percent of the time. Around 78 percent of RPM 
shares are traded at the exchange precisely because it offers 
the best price. That matters because it ensures a deep and 
liquid market for RPM shares, dampens volatility and correctly 
prices our shares so the value of our company is fairly 
reflected. I believe that the combination of all these factors 
results in a much more confident investing public and 
ultimately reduces our cost of capital.
    Finally, I applaud this Committee's undertaking to study 
market structure and to ensure fair and orderly markets for all 
investors. The decisions you reach are important for the future 
of our company and many others like it, and, most importantly, 
for the investors of this country.
    I am pleased to have an opportunity to share my experience 
with you and hope that any changes you consider will strengthen 
the market, but not diminish the liquidity and accountability 
that the auction market model provides to our shareholders. 
Clearly, the New York Stock Exchange has been and will continue 
to be central to our capital raising process. I fully support 
its goal of ensuring that all investors, large and small, have 
fair and equal access to the shares of companies traded on the 
largest and most liquid equities market in the world, and that 
they can do so with great confidence.
    Thank you.
    [The prepared statement of Francis Sullivan can be found on 
page 106 in the appendix.]
    Chairman Baker. Thank you, sir.
    Our final witness is Mr. Gus Sauter, Chief investment 
Officer and Managing Director of the Vanguard Group.
    Welcome, sir.

STATEMENT OF GEORGE U. ``GUS'' SAUTER, CHIEF INVESTMENT OFFICER 
           AND MANAGING DIRECTOR, THE VANGUARD GROUP

    Mr. Sauter. Thank you.
    Good morning, Chairman Baker, Ranking Member Kanjorski and 
all of the other distinguished members of the Subcommittee. My 
name is Gus Sauter, and I am the Chief Investment Officer of 
The Vanguard Group. I oversee the management of approximately 
$520 billion in mutual funds held by more than 7 million 
investors.
    I am very pleased to be here representing The Vanguard 
Group. We have been working with various market places over the 
past decade to improve the quality of the markets to meet 
investors' needs.
    I would like to thank the Subcommittee for having this 
hearing on the role of the specialist system. The issues 
surrounding the market structure of the specialist system are 
very important issues for investors to ensure a fair and 
efficient marketplace.
    We have heard arguments over time that investors are best 
served by always obtaining the best price. We have also heard 
that investors are best served by obtaining speed of execution 
and certainty. In short, I believe investors should not have to 
make that choice. We need all of these features.
    Speaking as an institution that invests for more than 7 
million individual investors and being bold enough to assume 
that I speak for all investors, we're not greedy but we want it 
all. We want the best price and we want it immediately with no 
uncertainty. We want to be able to execute our entire trade at 
the most favorable price in an instant. In other words, we want 
a perfectly liquid market which will by definition enable 
investors to minimize transaction costs and maximize their 
returns. In the final analysis we are indifferent to market 
structure as long as it provides perfect market liquidity.
    So what is a perfectly liquid market? It is one that has an 
infinite number of limit orders willing to buy or sell a stock 
with a very small spread between the buy and sell price. In our 
view, the challenge is to create a market structure that 
attracts and even incents investors to place limit orders. I 
cannot overstate the value of limit orders. Limit orders are 
liquidity. Limit orders are the backbone of a perfectly liquid 
market.
    So how do we encourage limit orders? In order to incent 
limits orders, they must be protected. In other words investors 
or traders should not be allowed to hide in the crowd and jump 
in front of a limit order. If jumping in line is permitted, 
then there is no incentive to stand in the line in an orderly 
fashion.
    We at Vanguard have lived this. We stood in line to the 
point where we realized it worked against us. In response, we 
now place fewer limit orders than we used to. We now hire more 
people to jump in line for us. This is not an efficient market 
system.
    In the short run, this is the optimal strategy for our 
investors, and for many investors. However, in the long run it 
significantly negatively impacts the quality of the market. 
Limit orders will disappear.
    In addition to providing protection to limit orders, these 
orders must be made accessible. How can we do this? By 
implementing automatic execution for all orders. Automatic 
execution is a process of matching new orders in the 
marketplace with existing orders. Auto-X ensures that natural 
order flow interacts with the limited orders on the book 
allowing limit orders to fill the demand without interference.
    There are arguments that without automatic execution a 
market order might have been able to receive price improvement. 
If so, this advantages the market order while detrimenting the 
limit order. The market order gets filled and it would have 
been filled anyway, while the limit order goes unfilled. Market 
orders are like Pac Man. They roam around the market devouring 
liquidity. It is not the market order that should receive 
preferential treatment. Simply put, limit orders should not be 
disadvantaged in favor of market orders.
    Limit orders not only need protection within the market in 
which they've been entered, they also need protection from 
other markets. The trade-through rule protects limit orders 
across markets. It prevents a trade from being executed in 
another exchange at an inferior price. Without the trade-
through rule trading would tend to be locked into the 
marketplace in which the orders are entered, a process known as 
internalization. In the short run, this would enable trades to 
be executed immediately. In the long run, it would create a 
tremendous disincentive to place limit orders, or should I say 
a tremendous disincentive to provide liquidity. Who would place 
a limit order in one market with the knowledge that trades 
could be executed all around that limit order in another market 
without the limit order ever being filled?
    I agree that with the current market structure environment 
the trade-through rule impedes efficient execution. There are 
legitimate complaints about orders not being filled when they 
must be transmitted to another exchange. We certainly 
experience this. However, we believe the best way to address 
these issues is to fix the linkages between markets and to 
require automatic execution, not to completely eliminate the 
trade-through rule at this time.
    Again, I would like to thank the Subcommittee for allowing 
me to express our views, and I would be happy to answer any 
questions you might have.
    [The prepared statement of Gus Sauter can be found on page 
95 in the appendix.]
    Chairman Baker. Thank you, Mr. Sauter.
    I would like to start first with an observation and 
question to you, Mr. Thain. It was in the spring of 2001 this 
Committee began its work examining the reported conflicts of 
interest between investment banking community and that of the 
analyst. And we were assured by those in the business at the 
time that although there were conflicts of interest, that they 
were managed and that there were Chinese walls constructed to 
ensure accountability. We did not know at that time that there 
was a very prosperous Chinese ladder business ongoing in the 
community at the same time. It was only later revelations that 
indicated that those conflicts had not been properly managed.
    Professional conduct is at the heart and core of any 
capital market functioning in a reliable and in the long term 
consistent manner. And it has only been in recent years, the 
last two perhaps, that the Exchange's conduct has come into 
question. It has been for decades the center of world 
capitalism. And for that, I am very appreciative.
    I do have concerns, however, that prior to your arrival--
and this is not a statement as to your own conduct, for which I 
have great appreciation, that the Board apparently did not have 
insight or understanding of Mr. Grasso's compensation package. 
I have found, when the disclosure was made, it to be excessive. 
Do you have a public position on whether that compensation was 
appropriate or not? If not, I will get back to you later.
    Mr. Thain. Mr. Chairman, as you know, I was not involved 
with or present at that point in time. But the Exchange itself, 
including me and the new Board of Directors of the Exchange has 
taken the position that that compensation package was excessive 
and has, in fact, turned over a report which was prepared which 
came to that same conclusion. And turned that report over to 
the SEC and to the New York Attorney General.
    Chairman Baker. Thank you.
    Secondly, I was distressed to read in the paper that it 
took the SEC, not noted for its swift enforcement actions of 
recent date, to discover and take action with regard to 
specialist misconduct.
    I note in your statement you indicate that you believe 
sufficient regulatory enhancements have been made to ensure 
such activity will not occur into the future. It would appear 
on the face of it, however, that the authorities granted in the 
manner in which the business is conducted, there is inherent 
conflicts of interest when a person can trade for his own 
account on dollars which only he has access to as to the price 
a willing buyer will pay and a willing seller will take with 
him having the ability to legally trade for his own account, 
given Mr. McCooey's persuasive testimony relative to those 
instances in which there wasn't a proper match and the 
specialist can step into the gap and provide that momentary 
liquidity to close the deal purportedly for the interest of the 
consumer. My observation would be if the specialist knew that 
transaction would ultimately lead to his own personal financial 
loss, how likely would he be to extend that courtesy?
    Mr. Thain. Mr. Chairman, you are getting at the function of 
the specialist as a whole. The specialist at the point in time 
when they commit capital don't know whether they will recognize 
a gain or a loss. The positions on the book, the limit orders, 
are in fact available to the marketplace. We disclose the limit 
book positions. So the specialists at the point in time where 
they're actually doing a transaction does not necessarily have 
any special information.
    Chairman Baker. The fact that there were five firms fined 
$240 million for something that apparently didn't fit the mold 
of appropriate conduct, there has been the accusation that 
things don't work perhaps the way they should. In your 
testimony you said best price must be the model of standard for 
all of us to comply. I agree. There is one critic publicly 
stating that in a one-week period through their own work, there 
were perhaps 7500 trades that could have been executed on their 
exchange which were not, they were traded on the New York 
Exchange to the best price detriment of the customer.
    Do you believe that criticism to be valid or is it 
something that is worth further examination?
    Mr. Thain. Mr. Chairman, there are trade-throughs that 
occur in the marketplace as a whole, including at the New York 
Stock Exchange. I think that is not a good state of affairs. I 
think it would better if the linkages between the markets were 
such that trade-throughs were minimized. But there's also one 
fundamental difference between trade-throughs that occur on the 
exchange.
    The trade-through rule, as I mentioned before, was designed 
to protect the investor who wasn't traded with. The New York 
Stock Exchange as a policy, if it trades through someone, will 
in fact make the person who wasn't traded with whole.
    Chairman Baker. Let me go on with one other observation. If 
I knew for a fact as a former Louisiana real estate person that 
a buyer was willing to pay $125,000 for a home, the seller was 
willing to sell for $100,000; if both asked me to represent 
them in the transaction, under current law we must have a 
written dual disclosure agency statement signed. And at that 
point I can no longer advise either client other than as to 
what is publicly known information. I can't tell one what the 
other take, I cannot tell the other one what the other might 
sell for. The point being that under Louisiana State licensure 
law I can't do what the New York Stock Exchange permits a 
specialist to do. And if I were to step into the transaction 
and buy it for 105, give the seller a really good deal and turn 
around and sell it to the buyer at 120 giving him a really good 
deal, I would still go to jail. Because I can't represent both 
parties and not disclose my position in the transaction.
    I guess that is what has brought me to the concerns about 
the current market structure. I told Mr. Kanjorski some days 
ago I really hadn't made up my mind about whether elimination 
of the trade-through rule was to the market's best advantage or 
not. And if I were convinced that obtaining the best price was 
in fact the consequence of the trade-through rule it might 
definitively be in the consumer's best interest. But based on 
the data provided to date, at least that I have seen, I don't 
know that that in fact is occurring.
    Let me throw one more thing out, and we'll come back for at 
least a couple of rounds, and this will be my last. I know some 
have schedules. They need to be on their way.
    Attorney General Crist of Florida just wrote Chairman 
Donaldson of the SEC stating that the trade-through rule 
effectively grants Floor specialists monopoly power over the 
New York Exchange-listed stocks. As a result, investors suffer 
from slower trade executions, increased transaction costs and 
decreased competition. I know there are others at the table who 
would probably agree with that statement. But can you give to 
the Committee any other groups, organizations, certainly the 
Louisiana based ArcaEx company that's engaged in activities 
found benefit of the specialist system? Other than those who 
have a direct financial linkage to the Exchange, where are the 
arguments outside the Exchange relationships for maintenance of 
the trade-through rule?
    Mr. Thain. Mr. Chairman, as I've said in my testimony, the 
trade-through rule ensures that investors get the best price. 
My constituency that defends that rule are the 95 million 
Americans that own stocks. They are the ones who are damaged if 
we eliminate or substantially change the trade-through rule.
    Chairman Baker. I appreciate that view and the only thing I 
would suggest is that of the 95 million that own stocks, there 
is probably 94.9 who do not know what it is. They are looking 
to the Congress and the SEC to provide a fair and transparent 
marketplace, and I'm not sure we have.
    Mr. Kanjorski?
    Mr. Kanjorski. Thank you, Mr. Chairman.
    I'm glad you still have an open mind, Mr. Chairman, as 
regard to our discussion on the floor the other day. And I'm 
glad you allowed for this hearing, because I've got to tell you 
as I break this down, I think we have mud fights in the 
Congress, good-natured guys. Don't all have a drink afterward?
    Anyway, almost everybody at that table has a self interest, 
starting all the way down the first five witnesses. And I'm 
going to get back to you.
    But I do want to congratulate Mr. Sullivan and Mr. Sauter. 
Compelling testimony. If you were closing your case and I were 
the jury, I think you have persuaded me that if it isn't 
broken, don't change it. And particularly Mr. Sullivan. You are 
the corporation out there that had the choice of staying with 
NASDAQ and taking their stock restriction. You were dealing 
with the interest of your corporation. Obviously, self interest 
because you are obviously a large stockholder in the 
corporation. I think that is very compelling evidence and I 
think you delivered the advantages of having a more stable, 
less broadly fluctuating market. It's very compelling.
    Now let me move to the others. Mr. Thain, you're on the 
team pretty young, so we are not going to punch too much of 
you. But, obviously, the New York Stock Exchange is the 800 
pound gorilla. Mr. Nicoll, you were talking about, you don't 
have, thank you, you're an operating exchange, competitive as 
hell, you're going to beat those guys, you're going to close 
down the New York Stock Exchange because you're so good at 
doing what doing you do that why, in a competitive market like 
America, would anyone go to the New York Stock Exchange when 
they can have all the advantages that you've put forth in your 
testimony. And that sounded pretty compelling. What I couldn't 
understand is why do you want to set the rules for the other 
guy and interrupt his rules since they do not impact on you and 
you can be so competitive with all your electronic transfer and 
not having to have specialists create a market, you're going to 
clean their clock. The best thing in the world for us to do, 
and the Commission to do, is leave the rule in place and you're 
going to have 100 percent of the trades of stock in this 
country because you're so competitive.
    Now, the fact of the matter is there is a reason why you 
should exist and I think a reason, probably, why they should 
exist and why an auction market with a specialist gives some 
advantages as to Mr. Sullivan's corporation. And, as Ms. Sauter 
said, there are limited trades out there that otherwise could 
get blown off the table and just eliminated. And as far as the 
big institution buyers, oh sure, they want that price and they 
would like to have anonymity and no one know what they're doing 
and have a double-market situation. But, you know, the only 
person not sitting at this table is Mrs. Jones, the independent 
private owner of stock in this country.
    I mean, in a way I'm sort of surprised to--I am pleased, 
because as I said, it is obviously not the Congress alone that 
argues like hell and makes fools of ourselves; it also is the 
financial market participants.
    But I do not see at this time, and Mr. Nicoll, we have had 
the occasion to discuss, you are a competitor. You are trying 
to sell something. And I understand that. And I think if I had 
what you have, I would be out here trying to sell it too and 
close anybody that stopped buying what I have.
    Mr. McCooey, he probably owns a yacht somewhere because of 
the great business he can do as a specialist. But in our system 
we don't punish him for that. We reward him if in fact Mrs. 
Jones gets a better price and has a market at 9:30 for her 
stock that she wants to make available for her grandson to go 
to school. He is there. It would not have been the tremendous 
loss that we just reflected in the testimony, the $10 without a 
market. That does not happen on a pure electronic market. It 
takes a specialist, somebody in there to shore up that market.
    Mr. Thain, the New York Stock Exchange probably over the 
last six months or a year are not going to win any accolades 
for success. The institution has been attacked. But my 
observation in the American system is that whenever you slip, 
fall or show weakness, the rest of us kick the living bejesus 
out of you. So as long as you move in with what I understand 
your tenants are to, again, make the auction market one of the 
most--and maintains its greatest success and example in the 
world, I am not worried about it. We will be back to effort.
    I am going to persuade my friend here from Louisiana that 
ultimately we've got several choices here. If your markets are 
so bad, I guess we should prove we're Democrats and just put 
the government to run the markets.
    Chairman Baker. The gentleman's out of order.
    Mr. Kanjorski. I think if we had that proposition here 
today, we would have at least seven witnesses testifying 
against us. We're obviously not going to do that.
    But taking the next best thing, we have a very open 
nonprofit set of exchanges that have been functioning, some, 
for over 200 years very successfully and new ones coming in 
with new technology and operating very successfully.
    It would be my predilection to give you all the chance to 
clean up your act, to enforce some of your rules, amend and 
change some of the rules necessary for better market operations 
for the customer. And for us to get involved only when it's 
essential to do so.
    I really don't think you would want to convince the 
Congress to get involved in this in a big way, or even the 
Commission to try and find some politically acceptable position 
as opposed to what's the most efficient effective rule or non-
rule to allow to be implemented.
    I'm glad we had this hearing, Mr. Chairman. I hope it's 
given the rest of the Committee, and I hope the members of the 
Committee that haven't been here today are going to be able to 
read some of this testimony and get a little more appreciation 
of trade-through rule, specialist operations, electronic 
exchanges, option exchanges. I know I knew nothing about them 
when I first came to Congress, or very little.
    And I'm not asking a question. Who knows I thought I was 
going to put some of you on the spot, however, I am not. I 
think I have classified what I thought your testimony would be. 
I'm critiquing it. But as I close and allow my fellow members 
of a majority of Democrats, I again want to tell you, Mr. 
Sauter, but you particularly Mr. Sullivan compelling, 
absolutely compelling, you just publish what you've testified 
here today and I think this argument is over. And if I have a 
copy of your testimony, if it was prepared and in writing and 
not extemporaneous, I myself would go forward.
    And thank you very much.
    Chairman Baker. Thank you.
    Mr. Ackerman?
    Mr. Ackerman. Thank you, Mr. Chairman.
    I want to agree with Mr. Kanjorski. He's gotten tough. I 
kind of suspect that money's involved here.
    As people in our position in the Congress, we are required 
with any investments that we make over some very minimum, 
couple hundred dollar threshold, to make public disclosure of 
it. And I think that those things in which we might have some 
financial vested interest are being done not to our own 
advantage, but because of the interests of the public.
    With that, I'd like to ask Mr. Thain why wouldn't you 
accept Mr. McCooey's challenge for thorough transparency with 
specialist accounts?
    Mr. Thain. First, Congressman Ackerman, on the toughness. 
You know, I may be new to this game, but I have many years in 
the investment banking business. And I found there were many 
ways to slice and dice data to be able to show that you were 
number one in this or that over some period of time. But I have 
never seen information used in quite so misleading a way as 
some of the information that was thrown out here today. Let me 
just give you one little example.
    Mr. Greifeld talked about the spreads in NASDAQ and the 
fact for the S&P 500 the spreads in the NASDAQ stocks were 1.21 
cents. And that the spreads were in the New York Stock Exchange 
stocks was 1.76 cents. Well, that's a very interesting 
statistic except for one small problem. The average prices that 
NASDAQ stock trades at are much lower than the stock prices 
that New York Stock Exchange stocks trade at.
    So if you think about, a two-cent spread on a $2 stock is 
not at all the same as a two-cent spread on a $100 stock. It 
would be similar to saying if you had a sales tax, a fixed 
sales tax of a nickel is the same on a dollar purchase as on a 
$100 purchase.
    So if you actually use exactly those same numbers that Mr. 
Greifeld talked about and you divide them by the average stock 
prices, you would see that in fact the New York Stock Exchange 
spreads are 42 basis points cheaper than the NASDAQ spreads.
    So just an interesting example of the use of information--
--
    Mr. Greifeld. This is the tough part of the conversation. I 
have to interrupt in that the spreads that we talked about were 
net effective spreads----
    Mr. Ackerman. Just for the sake of decorum, wait until he's 
finished.
    Mr. Greifeld. Okay.
    Mr. Thain. Thank you. It was interesting to see how much 
decorum exists here.
    The information about the specialists----
    Mr. Ackerman. It's a good thing we're not on ceremony.
    Mr. Thain. That's true.
    The actions of the specialists are not--the actual 
positions of the specialists are currently not disclosed 
because there is a concern about the trading against those 
positions. They, like any other principal trader, if they have 
a position and it were widely known that they were long stocks, 
they'd be up against the ability to short against them; if they 
were short stocks, you would have the ability to be long 
against them. But the activities as a specialist are very 
tightly constrained. And so they cannot operate inside of their 
customers. They cannot trade in front of their customers. The 
only thing you can do is provide liquidity in ways that are 
helpful to customers.
    The number of times--you look at the total trading activity 
on the Floor of the Exchange, the specialists are only involved 
about 10 percent of the time. So 90 percent of the time it is 
natural customers, natural buyers, natural sellers, being 
matched up in the marketplace. The 10 percent of the time is 
the times that the specialists are operating, and there they 
are in fact using their capital to dampen the volatility. So as 
the stock prices are trading down, they tend to be buying. As 
stock prices are trading up, they tend to be selling. They are 
the ones who are providing that buffer or that capital when 
buyers and sellers don't exactly match.
    Mr. Ackerman. Well, why not take away the question that 
people are concerned about and why the fine was levied and show 
the transparency so that everybody would know what is or is not 
happening?
    Mr. Thain. The fines were actually levied against behavior 
that was against the rules. And so in the case of the 
specialist fines, they're being fined for violating the rules.
    At the time that those violations took place, we didn't 
have the technology to actually catch those. Today the 
technology actually prevents them from doing most of that 
activity and we have much better oversight over what exactly 
they're doing so that in fact those types of behavior can't 
occur anymore.
    Mr. Ackerman. Mr. Greifeld, you had stated that it's 
paramount to protect the interest of the investors, the 
investors come first. But you also said competition has to be 
in place. And you also said we are about competition. With all 
that being said, how do you respond to Mr. Putnam's suggestion 
that in changing one word to ``exclusive,'' you have basically 
eliminated the ability of people to have competition?
    Mr. Greifeld. Well, I'll first respond to Mr. Thain's point 
with respect to spreads. The spreads that we quoted were net-
effective spreads. So to the extent that it was a $10 stock, it 
was a percent of $10. And if it was a $100 stock, it would mean 
percent of $100.
    With respect to competition, we certainly believe that as a 
bedrock principle in this country, and it should be a bedrock 
principle in these markets, and we want to see the ability to 
compete against the New York Stock Exchange for their trading 
volume and we think that's the best discipline that will exist. 
Competition, the discipline of competition will prevent us from 
getting in a situation where investors were cheated out of $240 
million.
    Mr. Ackerman. But that does not answer my question.
    Mr. Greifeld. I am going to respond to the question. We 
have a separate product which is an index product which we 
compete with a very large number of index companies. Right? We 
compete against S&P. We compete against Dow Jones. And we 
certainly welcome Mr. Putnam to get into the index products 
game.
    In our index products we have certain ways that we 
constitute it and we look at that on a regular basis. And it is 
a feature of that particular product, and we're proud of it.
    Mr. Ackerman. I appreciate your promotion, but how do you 
answer the question?
    Mr. Greifeld. That's a----
    Mr. Ackerman. How does dumping somebody out of your 
exchange because they want to participate somewhere else----
    Mr. Greifeld. No, no, no.
    Mr. Ackerman. How does that promote competition?
    Mr. Greifeld. No. We would not dump somebody----
    Mr. Ackerman. And what effect does that have on the value 
of their company?
    Mr. Greifeld. Okay. Let me get to that. We would not dump 
anybody out of the NASDAQ Exchange. If they choose to do a list 
on another exchange, we certainly don't welcome that, but that 
happens and certainly companies have left NASDAQ who have gone 
to New York. And we have no restriction on that movement. All 
it requires is a vote of the board of directors and the company 
can move from NASDAQ to New York Stock Exchange or any exchange 
that they want. A simple vote of the board.
    Now, we have an independent product, which is an index 
product which is called the NASDAQ 100. We have developed it 
over the last 10 years. It's a very successful product, we're 
proud of it. And we define the rules for that index product the 
same way the S&P does for the S&P 500, the same way the Dow 
does. And that index product is geared around the concept of 
NASDAQ being a growth market and a growth industry. And we have 
a requirement that if you want to be part of NASDAQ's index 
product, you are on the NASDAQ Exchange. But you're not forced 
to stay on the NASDAQ Exchange, you can certainly go wherever 
you want.
    Mr. Ackerman. So you would have to leave?
    Mr. Greifeld. What's that?
    Mr. Ackerman. You have to leave.
    Chairman Baker. If I may clarify for the gentleman. I think 
what I am hearing is that you are not suggesting you have to 
vacate the Exchange.
    Mr. Greifeld. No.
    Chairman Baker. But what I think he's asking you, is once 
you vacate the index--excuse me. When you were simultaneously 
listed on another exchange----
    Mr. Greifeld. Then you are not on the index.
    Chairman Baker.----then you are out of the index.
    Mr. Greifeld. Then you are out of the index. And that is 
what the NASDAQ listing companies want. I mean, it is an 
attribute of the product of being listed on New York. And when 
we talk to our customers, such as, you know, Microsoft, Dell, 
Cisco and we get their advice on the index, they said this is 
for companies that list on the NASDAQ stock market.
    Mr. Ackerman. Okay.
    Mr. Greifeld. It's an attribute of the stock market.
    Mr. Ackerman. Not interested in Tom, Dick and Harry then.
    Anyway, can I ask Mr. Putnam to respond, too?
    Mr. Putnam. Thank you.
    You know, ARCA has come up on the rough end of this, being 
an upstart in 1997. So I could tell you an awful lot about 
competition and anti-competitive rules. And I'd like to answer 
the question, but just to point out a couple of examples.
    We have suffered from the day last February when we went to 
move our first NASDAQ stock onto our Exchange. NASDAQ called us 
the night before and said, ``If you move it, we're going to 
disconnect your wires, deny access to NASDAQ.'' That was 
settled by the SEC, thank God, that evening.
    Prior to that when we really started to make some inroads 
in the ECN business, Instinet--and not all these people that 
were at the companies that are there today that were at the 
time. But Instinet said to us you know what, you guys are doing 
pretty well we're going to create a special class of customer. 
And you're in that class. You are the only one in it. And we 
are going to charge two to five times what we charge our other 
customers for similar access. We protested and said we are not 
paying the bill. Guess what? Do not pay the bill, we are going 
to disconnect your wires.
    When we went to get our exchange approved, we had to become 
a member of the ITS plan. The New York Stock Exchange said to 
us you're electronic, you're different, you can't use this 
system. You agree to a 15 percent cap on your use of the system 
or we are going to disconnect your wires.
    So this has been used. We know it. I think, actually our 
model and I feel like I can stand here and speak purely. I mean 
our model has been do the right thing and you'll win. And we're 
talking about doing the right thing by Mrs. Jones. Now what has 
happened here with the NASDAQ 100, everything you have heard is 
absolutely true. It is an index. It is a product. The problem 
is that rule about or qualification for being in that index has 
been extended to compete with us on dual listings. Because what 
you didn't hear was, yes, you are free to dually list on the 
New York Stock Exchange and you are free to dually list on 
ArcaEx, but if you do you're no longer a participant in this 
index. And what that means is we will dump millions of shares 
of your stock on the open market. Now what CEO is going to 
agree to do that? And that's what the implication is.
    So it's fine to have your index. S&P has an index. If you 
do dually list on ArcaEx or New York, S&P doesn't blow your 
stock out of the index, doesn't dump your shares. I mean this 
is a prohibition against dual listing, something these guys 
have told us is so important and preached, and is now injected 
into the system. It's wrong. It's got to go away. It's Rule 500 
in sheep's clothing, and that is the problem with it.
    Chairman Baker. You will be yield----
    Mr. Ackerman. I would be delighted, Mr. Chairman.
    Chairman Baker. I think it would be designated in the past 
as the roach motel room--roach motel rule. You check in but you 
never check out. And that's the consequence of this to--in the 
old days when it was the New York Exchange is how it was 
characterized. That's Mr. Ackerman's----
    Mr. Kanjorski. This wouldn't be a monopolistic practice, 
would it?
    Chairman Baker. Oh, of course not. It sounds like the State 
of Legislature in Louisiana's competition rules. If you're not 
on the right team, you got a problem.
    Mr. Ackerman, have you concluded?
    Mr. Ackerman. Yes. I just want to let you know, Mr. 
Chairman, back where I live which is in Queens, not too far 
from here, there's a guy painting my bedrooms in the house. And 
I interviewed a couple of painters. And one of them, I said to 
him, are you good and are you reasonable. And he said, no, but 
I'm fast.
    Chairman Baker. I don't want to get into your personal 
business.
    Mr. Ackerman. Thank you, Mr. Chairman.
    Chairman Baker. Thank you, Mr. Ackerman.
    Ms. McCarthy?
    Ms. McCarthy. Thank you, Mr. Chairman.
    Number one, let me say that the competition that we're 
seeing at the table ahead of us has to be one of the most 
lively debates that we've seen in front of our Committee in a 
long time.
    Number two, I want to make sure, we have been kidding back 
and forth with the Chairman only because he talks funny, but 
one of the things I have to say, I'm one of the newest members 
on the Committee. Our Committee actually does work very 
bipartisanally and we actually try and do the best thing for 
the country and for everybody else. And I thank you, Mr. 
Chairman, for the leadership. It is not too often we outnumber 
the Republicans, so we got to throw a rib in once in a while. 
After all, we are New Yorkers.
    But in all seriousness, listening to all your testimony and 
I think what was terrific we were able to get the testimony 
yesterday so we could actually read it. And reading each and 
every testimony, I found it fascinating. Of course, I probably 
would have preferred reading a novel in some instances. But 
we're very used to hearing both sides or three sides, or four 
sides and then it's up to us to really go through all of that 
and to try and find out--I mean we do it in Washington all the 
time. You know, we get information on both sides and then it's 
up to us to try and find out where is the truth, and where is 
it really in there.
    I guess the bottom line is, though, certainly myself in 
looking at it is where the competition is. What is going to be 
the best thing for the average buyer. Now, obviously, the large 
corporations, they're going to have people representing them, 
they're going to be there. It is the small buyer I am actually 
interested in, because it is the small buyer that ends up 
getting hurt if someone is not watching out for them. We have 
seen that in the past.
    So I'm worried about my next door neighbor or myself, to be 
honest with you. I'm 60. I only have, you know, a few more 
years. I got to make sure Social Security is there. I got to 
make sure that the money I have put away in the market, when it 
recovers a little bit more--let's hope the market keeps going 
up. But I mean, that's the money that we are going to be living 
on. That is the average person in this country. And, 
unfortunately, in the last two years we have seen corporations, 
we've seen some bumps with the stock exchange where people have 
lost confidence. And that is the worst thing in the world for 
any of you, and it is. Because the only thing any of you have 
is your reputation. If your reputation is not there, if it's 
not on the line, I am certainly going to go back to the bank 
and put my money for 2 percent; at least I'll know. But we are 
trying to keep this country growing, so we need all of you and 
we need the competition that's out there.
    But I think the thing that confuses me when you have talked 
about you have never used the buy-through or the best price, 
why do you care if they do? I mean, that is the part I do not 
understand. Because customers, businesses, your clientele, 
they'll leave the New York Stock Exchange, they'll go with any 
of you, whoever gives them the best deal. I mean, that is the 
way I am looking at it. Now I am not as smart as my colleagues 
that have been on the Committee a lot longer than I have. But 
just sitting here if I am the customer, I am going to go to who 
is going to take care of me the best. So whether it is I want 
the best time, great, I will go to you. If I want the best 
price, I will go to you. I mean, that is how I kind of look at 
things.
    And so I do not understand where you see the competition 
not being there.
    Mr. Greifeld. Well, to respond to the question, in the 
NASDAQ market we do not have trade-through, and as a result of 
that NASDAQ has very capable competitors on the trading of its 
stocks, and they are on this panel here. And you probably could 
not tell it from the testimony, but the fact that we have good 
and effective competitors is a better thing for investors. And 
I do appreciate the fact that Jerry and Ed are here competing. 
We are better for it and investors are served.
    So when we talked about how tight our spreads are and how 
we often trade inside the spread, that is because our 
competitors are here driving us to a better outcome for 
investors. You do not have that situation today with the New 
York Stock Exchange. So myself and the ECNs here are saying let 
us bring to investors in this country the good results that we 
have gotten in the NASDAQ market in the trading of New York 
Stock Exchange stocks. That is the request.
    Ms. McCarthy. Then just go to you.
    Mr. Greifeld. What is that?
    Ms. McCarthy. I mean, that is the part I am trying to 
understand.
    Mr. Nicoll. Congresswoman, you have asked the question, let 
me if I can and then you can respond.
    Let me try and give you an exact example of how the trade-
through rule prohibits Instinet from competing with the Floor. 
Note that we have no trade-through rule in NASDAQ. We do about 
a quarter of the NASDAQ volume. We have no trade-through rule 
in three listed stocks, and we do about a quarter of the volume 
in those three listed stocks where we have a three-cent de 
minimus exception. In all the rest of the stocks where there is 
a trade-through, we do less than one percent.
    So our contention is that the trade-through rule--the 
direct and causation is that the trade-through rule prohibits 
competition rather than another away around. And let me give 
you a precise example.
    The New York Stock Exchange has a bid on the Floor, it is a 
high bid, maybe for a 100 shares of a particular stock. And let 
us say it is for something and 10 cents. There is a bid on 
Instinet system for something and nine cents. Maybe it is for 
100,000 shares in this particular example.
    We have a customer who wants to hit that bid right now. 
They want to sell to Instinet at nine cents even though there 
is a 100 shares on the New York for 10 cents. Now why would he 
want to trade for less on Instinet than he could trade on the 
New York? Because he has found time and time again when he goes 
down to the Floor, not only does he not get that 10 cents, but 
he may end up selling for seven cents. And he is better off 
hitting the nine-cent bid that is on Instinet.
    The trade-through rule specifically prohibits Instinet from 
accepting that trade. When the trade comes in, we have two 
alternatives. We can ship it down to the specialist. We can 
say, we cannot execute that order, we have got to send it down 
to New York because there is a better bid down there. Of 
course, if we do that, as you can tell from what is happening 
here, we are not doing our customers any favor because all of a 
sudden that order is being shipped to the New York under the 
guise of Instinet and it does not get treated very well, quite 
honestly. So we are left with the only thing that we can do, 
which is to reject the order.
    The trade-through rule does not allow the customer to 
choose that nine-cent bid on Instinet or to choose the bid that 
is on Archipelago. It requires the competing exchange or the 
competing ECN to not accept the order. That is why it is so 
anti-competitive.
    And you said, Congresswoman, that you should let 
competition play out. The trade-through rule prevents 
competition from playing out. And it is not a question of us 
advocating that customers want to get an inferior price on our 
system than they get on the Floor. The question is what is the 
net price that the customer is going to get. And we believe 
that the customer is best situated to make that decision. Not 
you, not me, not Mr. Thain. The customer.
    Mr. Kanjorski. If I may?
    Ms. McCarthy. Absolutely.
    Mr. Kanjorski. Did you listen to your----
    Mr. Nicoll. Sure.
    Mr. Kanjorski. 100 shares and 100,000 shares.
    Mr. Nicoll. Sure.
    Mr. Kanjorski. You are interested in 100,000 shares. I 
think if you recall Ms. McCarthy, what she was telling you, we 
got to protect the 100 share customer. And what you fellas are 
going to do is, you know, just as Mr. Putnam indicated, you 
want to cut the lines on anything other than 100 shares.
    At some point, you know, that is what disturbs me. We hear 
competition, but you do not really want to compete. Everybody 
here is trying to get a role that advantages them and is 
monopolistic in some way. And everybody can turn the facts and 
the information to highlight that. And I appreciate that. But 
the reality is if the New York Stock Exchange is so archaic, an 
anachronism, it will fall of its own weight. If the specialist 
system on the New York Stock Exchange is so grossly and 
grievously acting, although it has acted for 200 years and a 
lot of people have dumped billions and billions and hundreds of 
billions of transactions and it is still surviving, it will 
fall of its own weight.
    What I sort of resent is you all have a business-
competitive interest here and you are either trying to use the 
SEC or the Congress to give you a leg up on that business. And 
what I was trying to warn you about, you may not want to win 
that competition because here I am the guy arguing Burkean 
political philosophy, that is pretty conservative. My party 
normally says these cats cannot get along, the government will 
run it. You really want us to?
    Mr. Nicoll. Let me respond in two ways. First, my 
background is retail. I started two very large retail brokerage 
firms. And I have served millions of retail investors over the 
last 20 years. That is where I cut my teeth. I know what it is 
like to serve individuals, and those that are knowledgeable, 
have been bitterly complaining about the treatment that they 
have gotten at the hand of the specialist since I started my 
firm, Waterhouse Securities in 1978.
    Two, the real individuals I believe who do not understand 
what is going on and who are ill served by the system are the 
millions and millions of mutual fund customers who rely upon 
professionals and institutions to trade upon those behalf. 
Those are the real people.
    The people that I used to serve at Waterhouse and at 
Daytech and that are now at Ameritrade, those are pretty 
sophisticated investors and they want choice. I believe we have 
to think about the mutual fund investors who are represented by 
institutions.
    Mr. Kanjorski. And I----
    Mr. Nicoll And if I could just respond. And lastly, I 
totally agree with your assessment, Mr. Kanjorski. We need to 
get the government out of regulating these entities and let 
competition play out amongst them. The trade-through rule is 
already a barrier----
    Mr. Kanjorski. Except because you have a punter on your 
team or a field goal kicker that can kick 90 yards, you want 
the field to be 90 yards. I have a kicker that can only kick 10 
yards and I say I want 10 yards. And that's what this fight is. 
It is who's going to get the short term advantage out of the 
rules promulgated by the SEC or statutes passed by the 
Congress. And I am saying the pox on both your houses. Unless 
there is some criminality, and if there is that is what we have 
a great Attorney General from New York to move in. And we are 
going to keep him with a variety of business.
    Chairman Baker. Ms. McCarthy.
    Ms. McCarthy. Reclaiming my time.
    Chairman Baker. I am sorry. I hope your time has expired, 
Ms. McCarthy.
    Ms. McCarthy. Well, I am trying to reclaim it.
    I actually would like Mr. Thain to answer.
    Mr. Thain. Yes, I wanted to respond.
    Ms. McCarthy. We never had this opportunity, by the way, in 
Congress. You are cut off, that is it and we can never have a 
real conversation----
    Chairman Baker. And let the record note this Chairman is 
most accommodating.
    Ms. McCarthy. Yes, he is.
    Mr. Thain. Well, let the record also note that if this is 
any indication of the degree of competition that is in this 
marketplace, then I do not think anyone has to worry about an 
uncompetitive environment.
    I wanted to make one thing clear, though, because I think 
some of my colleagues need to read what the trade-through rule 
really says. The trade-through rule does not say that you could 
not trade with that 100,000 shares if it happened to be at a 
slightly worse price. It only says that you have to make whole 
the 100 shares that you did not trade with. So as long as you 
in fact take care of that 100 share, which is the little 
person, you can in fact do the trade, the 100,000-share trade 
at the lower price. And that does in fact happen and it does in 
fact happen quite frequently, but you have to make whole that 
100-share person. That is what the trade-through rule does. It 
protects the little person.
    Mr. Kanjorski. Eventually they will be able to create their 
own little specialty operation that they are handling.
    Mr. Sullivan. Congresswoman, I would like to address your 
question on competition. We chose to move from NASDAQ to the 
New York Stock Exchange because we were convinced that we would 
have better liquidity and better execution in our perspective 
of raising capital at the best cost and providing a good market 
for our shareholders.
    I can assure you when the day comes that we feel that our 
shareholders would be best served and our company could raise 
capital deeper and at lower costs at the NASDAQ, we would move 
from our current market. And that competition exists today.
    Chairman Baker. The gentlelady yields back her time.
    Again, I want to come back at this. I certainly understand 
Mr. Kanjorski's view of getting out of the way of competitive 
interests and not having the Congress determine winners or 
losers. That is not our role. Our role is to review the market 
requirements to determine if in fact there is not a competitive 
bias in one direction or another.
    In 1995 Netscape had five employees. Today they are a 
fairly significant business enterprise which many people in 
this room use for Internet activities.
    The trade-through rule was adopted in 1975, 20 years 
earlier. Now, the reason for making those two observations is 
that trade rule at that time in the inter-market trading system 
adoption was to ensure that given the technologies of the day, 
that the individual investor did in fact get operatively the 
force and effect of the best price available.
    I think the consequence of that rule today in a world 
crammed with technology where you buy processors at 3 gigahertz 
processing speed when we couldn't spell gigahertz in 1975, is 
that the market delivery systems have changed, the rules have 
not.
    For years members of Congress come to Washington and we 
look at the capital markets as a big pasture. And a good 
successful influential New York delegation comes in and tries 
to fence off as much of that pasture as is possible up on the 
lush, green fertile valley end while you push the Louisianans 
down on the rocks on a small two-acre patch; that would be a 
successful outcome. I understand it. And over the course of the 
years, many fence lines have been built and delegations sent to 
Washington to move the fence line, your fence line, just a 
couple of yards over into the other guy's back yard while of 
course not relinquishing any of your own fenced-in property.
    My view is that we should take down all the fences and let 
you roam where you choose, eat as much grass as you like. But 
if you get sick, do not come back to me, that's your problem. 
What I think we now have is a relic of that fenced in pasture 
and I do not believe the result is a competitive environment 
for the consumer.
    Now, I have not heard yet any discussion, for example, of 
the SEC pilot on the 3 ETFs, which has run for about a year 
with a three-cent de minimus trade provision. I would be 
interested to know from those who defend the current 
circumstance, what was wrong with the outcome of the pilot, 
because I have not heard anything that was negative. It appears 
the SEC has now extended it for another time certain so that we 
can further assess it. It looks to me that that in a microcosm 
is an example of what the outcomes would be. If Mr. Sullivan 
wants to continue to go to the New York Exchange and work 
through his associates, he could continue to do so. Elimination 
of the trade-through rule won't eliminate his access to that 
capital and those opportunities.
    Mr. McCooey, I see you are anxious to respond?
    Mr. McCooey. Absolutely. I have not had a chance yet. Tough 
group here.
    First of all, when we talk about Mr. Nicoll, I used to talk 
about them as stocks. ETFs are not stocks. They're exchange 
traded funds. They are baskets of stocks. They are derivative 
product. They have underlying net asset values and most of them 
are being used by professional trade marketers.
    Chairman Baker. They have a net value. It is done on a day-
to-day, hour-to-hour basis. It may be a slightly different 
disease, but it is similar.
    Mr. McCooey. These are products that are derivative 
products, Mr. Chairman
    Chairman Baker. Certainly.
    Mr. McCooey. And so, therefore, there are underlying stocks 
that people use to offset their positions in those stocks, and 
they do that--and this is a minute-to-minute time, second-to-
second time that they are. And Mr. Thain, I know, wants to talk 
about this. But if you will notice, at the time when the New 
York Stock Exchange entered the fray and began to trade the 
ETFs, the compression between the spreads went from six cents 
to two cents. There is the competitive marketplace. There is 
where we continued to add best price and value to our 
customers, and we do not believe that there should have been a 
de minimus trade-through in the ETFs.
    Chairman Baker. And then you make a good point. The New 
York Exchange showed up, and when they did the spreads 
narrowed. Why would that not be the case without a trade-
through rule? If you are a player, and you are in the market 
and your liquidity and your resources are so overwhelming, why 
do you worry about the nets?
    Mr. McCooey. Well, first of all, we're a bit player. We are 
late to the game and people who were there before us, kept 
spreads wide to the disadvantage of their clients. The bigger 
players kept spreads wide to the disadvantage of their clients 
until competition came in and spreads narrowed. And we think 
that there should be a trade-through rule in the ETF products. 
We think there should be a trade-through rule in NASDAQ. In the 
same way as you want to talk about your green pastures, it sets 
the barriers for investors. It sets a benchmark to make sure 
that investors get the best price. And that is at the end of 
the day what this is all about; this is about the investors 
getting the best price. Not trading outside.
    And when we talk about a competitive marketplace, the word 
monopoly has been thrown around like monopoly money so far 
today, but I think what we need to understand is the New York 
Stock Exchange boasts 93 percent of the best bids and offers on 
a daily basis. We only get 80 percent or a little less than 80 
percent of the volume on a daily basis. Thirteen percent of 
that goes to NASDAQ, our fine competitors there.
    Chairman Baker. I heard that 93 percent figure was 94, but 
I never could find out who was doing the calculating. If there 
is some sheet someone can send me about how that is derived, 
that would be helpful.
    And let me jump to Mr. Thain because I know he wanted to 
respond.
    Mr. Thain. Well, I just wanted to add something. First of 
all, what Mr. McCooey said is absolutely true. The biggest 
reduction in the spreads in the ETFs is when the New York Stock 
Exchange started to trade them, and I would be happy to give 
you the information. In fact I have a chart that shows that.
    The de minimus rule when it was applied to the ETFs in 
terms of the bid ask spread actually did not make any 
difference. Their spreads are not that different since that 
rule has been put into place. But what is different is if you--
and we did this in a particular day, and it was a randomly 
picked day, calculated how many times and how much did it cost 
investors to not trade at the best price. So what would be that 
value of that two or three cents' difference that they got, and 
it was $900,000 on that particular day. So it cost people real 
money to not trade at the best bid and the best offer.
    Chairman Baker. But I will----
    Mr. Thain. Can I just continue?
    Chairman Baker. I will let you continue, but just 
specifically on that point, hold your thought.
    But aren't there not occasions and is it factually 
incorrect that there are times when best price was offered on 
other exchanges and the trade occurred the New York Exchange 
instead in light of the fact that there was a best price 
offered on an alternative exchange and it was not executed? Is 
that not also true?
    Mr. McCooey. Well, yes, although that is a different point. 
The point that I was making on the ETFs is that two or three 
cents de minimus rule when you are trading in the case of the 
stocks on the Floor of the Exchange, 1.7 billion shares a day, 
and the second best bid--so if you just looked at the best bid 
and the best offer and you said customers should have to 
execute the best bid/best offer; if you look at the second best 
bid and the second best offer, on average that is about a four-
cent worst execution.
    So if you allowed people even to get the second best bid or 
offer, it would cost consumers billions of dollars over the 
course of the year to not be able to get at that best bid or 
best offer.
    Now, I will go back to what you said. It is in fact true 
that trade-throughs occur both with the Exchange and off the 
Exchange. That is not good. One of the reasons they occur is we 
do not have good enough linkages between the exchanges, and we 
should fix that. And that is actually one of the things that 
Mr. Putnam said. But the other thing is, the trade-through rule 
as I was saying before, is designed to protect the person who 
was not traded with. So if the New York Exchange trades through 
on 100,000 shares, which is actually the much more likely case 
because we have 80 percent of the volume; if the New York Stock 
Exchange trades 100,000 shares and there is 100 shares 
somewhere else that had a better price, we will make that 
person whole. And that is the difference.
    Chairman Baker. Mr. Putnam.
    Mr. Putnam. We heard earlier from John Thain that the 
numbers and the way you measure things have a funny way of 
working out depending on who is doing the measuring. And we 
have heard about how spread the tightening on ETFs at the time 
when the New York Stock Exchange started trading them. Well, 
there is another part to that story.
    Instinet and ArcaEx, we control roughly 50 to 60 percent of 
the trading that is done in those ETFs, and we also happened to 
start trading them at the time of the New York Stock Exchange 
came in. We were a little bit of ahead of them, but the price 
compression has incurred on our open systems where buyers and 
sellers are free to compete for price without any intermediary. 
And the fact is with these ETFs, I mean these are extremely--
and in the case of the triple Qs or the Spiders, extremely 
liquid securities. You need nobody's help in getting that trade 
done. There is so much liquidity there, there is always a buyer 
and a seller that can agree on price, they can do it 
instantaneously. We compress the spreads, we actually dominate 
that marketplace.
    Mr. Thain. But the trade-through rule was in effect at that 
time.
    Mr. Putnam. The modification to the trade-through rule has 
had very little effect on the trading because investors have 
great access to those. Those securities they trade very 
heavily. But here is what the issue is with the trade-through 
rule, and I think it is to clarify, maybe make this a little 
bit--we need to step back on what it means. We heard, you know, 
New York, NASDAQ, you guys you do not have, you have one; why 
do you not just go ahead and do your own thing. Now the problem 
with that is there is two rules. There is one rule for trading 
Microsoft, which says you can trade-through and there is 
another rule for trading IBM which says you cannot trade 
through. So NASDAQ does not have the right to trade through on 
IBM because it is listed in the New York like they do to offer 
that in Microsoft. So there is a difference. The reason why you 
cannot just do your thing and you do your thing is because 
there is separate rules. Now, we think there should be a 
uniform rule.
    The other point is we heard earlier today investors are 
ignored without a trade-through rule, and we agree 
wholeheartedly with that. We have investors on our system. We 
do not have specialists. We only represent investors' orders.
    We get traded through about 7500 times a week by the New 
York Stock Exchange. So investors are harmed, investors are 
ignored. We are screaming bloody murder about the trade-through 
rule.
    Now, our solution, it is a bit in between where the two of 
you come out. We are not saying eliminate the trade-through 
rule. We are saying either enforce it, because it is not 
enforced today because investors are ignored, enforce the rule 
or modify it so our customers can choose to ignore it.
    As long as New York is going to ignore it whenever they 
want to--see, we will not break the rules on our system. They 
are hard-wired not to ever let that happen. The computer will 
never trade at a worse price. It is programmed to always go 
after the best regardless of where it is. We do not have that 
option of just ignoring the rules.
    So we are saying if you are not going to enforce it, at 
least let our customers choose when they want to trade-through. 
And, I think that is where we have come out on it, and that is 
what has to happen. One of those two things or the rule is a 
joke and it is anti-competitive when a marketplace can choose 
when they want it and when they do not want it arbitrarily.
    Chairman Baker. Well, it seems the consequence of the rule 
and the listing criteria and how difficult it appears to leave 
any exchange to be listed on another, the cost and time 
necessary to go through those exercises is very little. What 
happens if everybody, let us assume there is no IBM, Microsoft 
division anyway and that you have access to trade any stock 
through any exchange and the best price execution is still the 
standard?
    Mr. McCooey. At the New York Stock Exchange with the rule 
proposal that we put in front of the SEC and our automatic 
execution there is no reason why people should ever trade-
through. We should make sure that customers still get the best 
price. We are going to have automatic execution on all the 
liquidity displayed on the inside market. And so customers that 
want to buy 100 shares, 1,000 shares or 100,000 shares offered 
in General Electric will be able to instantaneously, from their 
desktop, access our liquidity on a one second execution.
    Mr. Thain. Mr. Chairman?
    Chairman Baker. Go ahead.
    Mr. Thain. IBM currently does trade on all of these 
markets. So IBM is available on all these different markets, 
and I do not know the specifics about IBM, but on average about 
20 percent of the volume trades--spread among these different 
marketplaces.
    Mr. Putnam. And you know what you are hearing here, too, 
you know, is this is our marketplace. But when it is our 
investor those rules do not exist on the New York--they are not 
worried about when it is our investor getting the best price. 
Just when it is New York's investor getting the best price. And 
history proves that that's exactly where we stand.
    Mr. McCooey. That's as long they do not want to be hidden 
by a reserve book and not be displayed through a transparency 
which allows for price discovery.
    Chairman Baker. Anybody else?
    Mr. Nicoll. If I could, if I can just make a couple of very 
quick points.
    It is interesting to listen to the New York Stock Exchange 
talk about trade-through. One of things they say is, for 
instance, is that anybody can trade-through, that they can make 
the trade that is traded through whole. Well, that is only the 
case if you are an exchange which really is a partnership 
between traders, okay, and the exchange itself. It is a mixed 
model.
    The New York Stock Exchange is a mixed model. The reason 
why I am standing between two people who are saying the same 
thing is because they're a partnership. The Floor members and 
the bureaucrats who run the Exchange should really be seen as 
one entity, okay? No, seriously.
    And the reason that they can choose to make somebody whole 
is because they both trade on an agency and a principle basis.
    Now, what an electronic market does is it rigorously 
enforces the fact that it only is an agent. It never takes a 
position.
    Instinet pledges to its customers, and one of its value 
propositions is that it will never be in a conflicted position. 
The only way to make another market whole is to be a mixed 
model and be both an agent and a principle. And that requires--
and what is interesting about the New York Stock Exchange rule, 
you know, we found the Chinese walls do not work between 
departments of firms.
    What the New York Stock Exchange expects of a specialist is 
that he build a Chinese wall in his brain. We expect one person 
to rigorously enforce standards of conduct which sometimes 
allows him to profit and sometimes does not allow him to 
profit.
    If Chinese walls do not work within firms, they certainly 
are not likely to work within the brain of an individual, and 
they have shown by recent headlines not to work.
    So when you have a model which is strictly an agency model, 
you can never choose to ``clean up'' the activity at a 
competing firm.
    The other point I would like to make is that the trade-
through rule allows a specialist to be in compliance with this 
trade-through rule by matching the competing exchange's bidder 
offer. In other words, if they are in the same situation that 
Instinet is in and they got that 100 shares at another 
exchange, which is preventing them from executing their order, 
they can choose rather than ship it to literally give a trade 
to the customer at that price. Act as a principal.
    If Mr. Thain is so right and he is so concerned about that 
person who has placed that limit order not getting an execution 
on the other exchange, how can he justify his specialist 
matching the order that is sitting on the other exchange? 
Because the consequence of that is that that order does not get 
executed.
    So we have to be careful about comparing mixed models with 
agency models. And this is exactly the point. And I actually 
agree with the minority member, Mr. Kanjorski, that everybody 
up here is going to give you a different set of numbers. 
Everybody up here is going to sell their own book.
    The answer from my perspective, from a policy perspective, 
is let them compete. And the trade-through rule prevents them 
from competing.
    Chairman Baker. I think it would be best to keep the 
members of the Committee informed on the subject, get away from 
the distinguished quests and contrive a marketplace set of 
rules that were focusing on delivery of product at the best 
price to consumer, not constructing any competitive edge for 
any participant. The members on a philosophic basis would think 
that is a worthwhile goal if the gentleman believes that the 
current system does not provide that opportunity. And I think 
that may be the issue at hand.
    Mr. Kanjorski, I have taken so much time.
    Mr. Kanjorski. Yeah, Mr. Chairman, I think you perhaps 
properly pointed out that the trade-through rule is--in fact I 
think it was some 30 years ago. In my understanding it was not 
to the advantage or disadvantage any one group, it was 
instituted to create a national market and not fragment the 
market. And now we have these competing interests here who 
would like us to do away with a rule that the unintended 
consequence may easily be that we fragment a market again. And 
that market become fragmented based on technological change.
    Mr. McCooey has the advantage and Mr. Putnam has the 
technological change today but it may be someone else tomorrow. 
And they are going to come in and see how they can benefit the 
rule.
    What I would suggest is I think we heard from Mr. Putnam, 
his solution is if we had enforcement. Well, who is the 
responsible party to enforce?
    Mr. Putnam. One, it is the SROs themselves that have to 
regulate their members----
    Mr. Kanjorski. So we have to do something to the SROs to 
enforce? And if they are not enforcing, who is the next?
    Mr. Putnam. SEC.
    Mr. Kanjorski. SEC.
    Mr. Putnam. SEC then enforces it on the SROs.
    Mr. Kanjorski. So I could go back to Washington and say I 
was up in New York, and Wall Street had really condemned the 
SEC for lack of enforcement, is that correct?
    Mr. Putnam. Yes.
    Mr. Kanjorski. Good. I am with you.
    Mr. Putnam. Okay. And you know one great point that you 
made here is whether it is a mandated linkage like was done 
with ITS. We actually do not have a trade-through rule on the 
NASDAQ side of the business and there was no mandated linkage. 
But guess what is happening there? Competition, so we do not 
have this trade-through rule--competition has forced us all to 
link. We have very, very good private high speed linkages and 
we do not trade through one another.
    Mr. Kanjorski. Great.
    Mr. Putnam. Because we are accessible and open. So 
competition----
    Mr. Kanjorski. We would hope eventually as a specialist 
here said that the market works so efficiently and effectively 
that the trade-through rule disappears because you've struck.
    Mr. Putnam. That is right.
    Chairman Baker. I will quote you on that, too.
    Mr. Kanjorski. No. In the meantime to get to that efficient 
market, why do away with a rule that is protective of Mrs. 
Jones? I wanted to make a point.
    You know one of the things I hate more than almost anything 
else in life to do? Is to shop for an automobile. Have you ever 
had the experience regardless of what dealership you go in, 
this guy is giving you 10 percent off, this guy is giving 
$2,000 off, he is going to give you an interest rate of 3.8 
percent, another one gives you zero interest rate, most amazing 
thing I have ever seen. You can lend money without cost. And it 
was very appealing to me when finally Saturn came along and 
said we are just not going to play this silly game. We are 
going to have one price, we are going to disclose it and 
everybody gets it.
    I imagine that Saturn buyers are the most satisfied 
automobile buyers because they know for one thing they did not 
get taken. Everybody pays the same price.
    Now, that is what really we are trying to do or was 
attempted with the beginning of the trade-through rule that now 
has had the overlay of technology. And what I am hearing from 
this panel is that we could probably get closer to the Saturn 
single price for Mrs. Jones if we had better enforcement. But 
we do not have to be radical, strike out the rule which gives 
the tremendous competitive advantage to the electronic market 
and disadvantages the auction market, does away with the 
specials.
    And incidentally, I know you--I was going to come back to 
Ms. McCarthy--you referred to Mr. Thain as a bureaucrat.
    Ms. McCarthy. Yes.
    Mr. Kanjorski. Damn. He is the most highly paid bureaucrat.
    Chairman Baker. And I would out point, Mr. Thain, he is on 
your side.
    Mr. Thain. I would also point out that as a highly paid 
bureaucrat, I also took a substantial pay reduction to do this 
job.
    Could I just give one perspective on this? In my prior 
life, my prior employer is one of the biggest players on the 
Floor of the New York Stock Exchange. It also one of the 
biggest participants in the NASDAQ market. It also owns the 
biggest single piece of Archipelago or certainly one of the 
biggest pieces of Archipelago.
    And my prior employer, and the ability to access all of 
these markets and to look across all of the markets and figure 
out where can you in fact get the best price.
    And I agree that there are things that have to be changed. 
And one of the things is the linkages between the markets have 
to be made better so that they are fast linkages and there are 
certain linkages. And as Mr. Putnam knows, because he is 
already doing this, he will in fact have the ability to link 
with the New York Stock Exchange and execute there. But no 
matter what at my prior employer we still always sought to get 
the best price for our customers.
    So, there are things we should fix, and one of them is the 
linkages between the marketplaces, but we should not move away 
from the concept which has been fundamental to this marketplace 
for about 30 years that customers should get the best price 
wherever it is. And that is particularly true for the small 
investor.
    Mr. Kanjorski. Let me make my point here, because I heard 
what I did not like, what I considered a monopolistic practice, 
the threat of cutting the lines if you do something that would 
benefit--I imagine the SEC has rules and regulations that 
protect you against that, do they not?
    Mr. Putnam. Yes, they do. And they are called fair-access 
rules so you are not allowed to discriminate against 
participants. In each one of these cases the SEC did come to 
our rescue and did prevent the lines from being cut.
    Mr. Kanjorski. The difficulty of enforcement again.
    So, you know, I sat on this Committee. And I have got to 
tell you this, and I cannot resist telling you. So about three 
or four years ago when Wall Street came in to the Congress and 
said oh my heavens, we have all these fees on transactions that 
we were paying, overpaying, billions. $2 billion, I think. And 
we think we ought to reduce those fees because the SEC does not 
need any money for enforcement or other purposes. And I think 
there was a starvation diet out there, about $400 million a 
year that suddenly the present Administration had a meeting, a 
come to Jesus meeting and now it has doubled it or on its way 
to tripling it.
    You know, you guys ought to cooperate, too, with our side 
of the transaction. You knew that the SEC was underfunded and 
lacked the enforcement and that an extraordinary amounts of 
money were being paid inappropriately for the Justice 
Department and other agencies of the Federal Government to keep 
this market as straight and as honest as possible. And I do not 
think anybody has made this point. But all of you up here in 
Wall Street are just perhaps as responsible as anyone else for 
not having the enforcement that allowed things to get out of 
hand. And you got to stop that.
    I mean, the fact that you saved a little money on the less 
fees you paid have not only cost the customer, but I think it 
has cost you and the credibility of this marketplace because of 
your shortsightedness. Now you got to stop that.
    I know there is a competitive advantage in everything here. 
But you know what? Long term, that is not important. Long term 
is that we get the trillions of dollars that this American 
market needs and the world market needs to transact or we are 
all going to be poor.
    And in some ways I am hoping, and I want to compliment this 
Chairman. I think this meeting has brought a lot together here. 
And I think we are getting closer to finding something that can 
be formulated that meets everybody's needs; better enforcement, 
not doing necessarily away with a rule that protects us and 
encouragement of more efficient operation and spread in the 
specialist area because of the electronic technology. Keeping 
the access to private corporations to select and drive in a 
competitive sense who is going to get their business. And then 
finally, through Mr. Sauter, making available to all investors 
across America the best price. And then everybody links.
    Mr. Sauter. Mr. Kanjorski, may I say that if we step back 
and started a new system today and suppose it is a central 
limit order book. Essentially we would have one marketplace in 
the United States. Then we would be sure that everybody would 
get the best price because there is only one place to get the 
price.
    That has a lot of merit to it. The downside of having the 
central limit order book is that there is no competition. So 
having many different marketplaces, I think is beneficial. They 
can compete against each other and create innovation. At the 
same time we do not want to throw away the advantage of the 
central limit order book that every investor will definitely 
get the best price. And I think that's the advantage of the 
trade-through rule that it does require that all of the various 
exchanges are linked together.
    The problem we have now is a technological problem that I 
think is easily solved with money, and that is linking the 
exchanges together and making sure that there are no trade-
throughs.
    Mr. Kanjorski. So you think instead of throwing out the 
rule, let us get our work done. Let us get the linkage made. 
Let us get the--the efficiency is the technology. But we do not 
have to do away with the rule that later on can be prostituted 
to the extent that we slip off and will not have the best 
price. Is that what you are saying?
    Mr. Sauter. Yes. As an institution we do have smart routing 
systems that can go to the exchange with the best price. 
However, an individual certainly does not have that ability.
    At the same time it would be nice to be able to enter an 
order and know that it is going to receive best execution 
regardless of where it is entered. Then the various 
marketplaces really compete on services. They become a portal 
into the marketplace and compete on service that they give us.
    We do like the concept of automatic execution. And we think 
that ensures that investors will get the best price.
    There are trade-throughs happening now. It happens to us 
all the time. What Mr. Nicoll said earlier happens to us, where 
we will enter an order on an ECN, it goes to New York, it is 
not filled there. It could have been filled on the ECN at a 
slightly different price. That is extremely frustrating.
    So we do like the concept of automatic execution without 
the ability to reject it. But we think that there are 
tremendous advantages of having the exchanges linked together 
and we need the technology to make sure that all happens.
    Mr. Kanjorski. I just want to the question here. I just ran 
across a proposal that we could be much more efficient and save 
a lot of money if we move the New York Stock Exchange to 
Bombay.
    Mr. Greifeld. Just probably one last thing.
    We have a trade-through rule today. Investors suffer under 
it. We just had a settlement. So the system where you had a 
concentration of power in one market center did not work. What 
we are saying here, myself, Ed, Jerry and many others is the 
best way to solve that problem to prevent it from happening 
again is to introduce greater levels of competition. And the 
current trade-through rule is preventing this. And that is a 
simple request.
    Mr. Kanjorski. We should not a team to $25 million for a 
particular player, is that it? It is not competitive.
    Mr. McCooey. But, Bob, you are mixing things that have 
nothing to do with each other. The settlement that none of 
these trades happened outside of the best price. They all 
happened inside of the quote, inside the best price. So you're 
in apples and Diet Coke here.
    Chairman Baker. Ms. McCarthy, did you have follow up?
    Ms. McCarthy. No. Thank you. I actually have enough in my 
brain right now.
    Chairman Baker. Well, let me respond to my good friend's 
observations and conclusion. I would think it would enhance the 
regulatory enforcement would be desirable, no matter what the 
rules may look at underlying the competitive marketplace. I 
would be interested to know what Mr. Spitzer thinks about the 
trade-through rule, for example, and where has he been with all 
of the current reported misconduct, an issue which of course I 
have discussed with him on occasion, in fact.
    But more importantly, I do believe that there is inherently 
some question about the ability of our marketplace to function 
as you philosophically have outlined, Mr. Kanjorski. And I 
would quickly add I do not think you and I have differing 
goals. I think that the members of the Committee who 
participated here this morning, because there are 95 million 
Americans invested in the markets, want to assure every 
constituent and every investor that you are being treated 
professionally and offered the same opportunity to invest as 
any other investor, whether it is a $100 or a $100 million. And 
that you are treated with respect. That is the goal.
    My observation is the system we currently have in place 
does not achieve that. Even proponents of the trade-through 
rule provision acknowledge that the current technologies do not 
enable someone to be assured. The best price quote issued by 
the New York Stock Exchange is not a best price quote 
guarantee. It is a representation. By the time the trade 
actually occurs, it could be actually a higher price than you 
could obtain on another exchange. That seems to fly in the face 
of the goals that members have indicated.
    If we are all about competitiveness and assuring that to 
the best of professional competency individual investors are 
treated fairly and do actually get access to the best price, we 
have I think two choices. To pursue technological advance to 
where everyone is tied at the hip to such an extent that 
mechanically no such misstep can occur with severe penalties 
for failure to act professionally or one considers the 
elimination of the trade-through rule. Despite the fact that we 
have had a hearing of some length this morning, we have not 
really talked a great deal about the implications of what would 
happen if the trade-through rule was suspended. I did raise the 
ECN question, which was quickly dismissed by advocates as not 
being a measure of comparability.
    There seems to be a great deal of academic, editorial and 
outside world comment including some within the SEC that 
elimination has value. I want to explore at some future point 
the potential consequences to the markets and better understand 
what would happen if the rule was suspended or eliminated. I 
think we owe it to ourselves to explore all avenues before 
arriving at some final determination. But I think we are 
together as members of the Committee on seeking out the remedy 
that affords the best opportunity for all American investors, 
Republican or Democrat, and that everyone be treated similarly 
whenever they put their hard earned money at risk in these 
capital markets.
    Mr. Kanjorski. Mr. Chairman, I want to agree with what you 
have just said. And I think it indicates just how far the 
Subcommittee has come along these last several months. It is 
vitally important that we understand the unintended 
consequences of the change. And I think all the parties have 
been very responsible and perhaps will assist us and aid that. 
Maybe they can get together and work out what changes, what 
things can be done to accomplish a better and more efficient 
and more better priced market. If we accomplish that, we are 
home.
    Chairman Baker. I thank the gentleman.
    I just want to make sure that no one leaves with the 
thought that this is going to be a grand project that takes 60 
years. This is going to be something the Committee will make 
some final determinations on in the near term and put it behind 
us. There are many other issues of grave concern to the capital 
market function, but this is one that should be set aside one 
way or the other.
    Mr. Kanjorski. And we know we do not have anything else 
important going on.
    Chairman Baker. Absolutely not.
    If there are no further comments, I wish to again thank our 
participants for the lively discussion and informative debate. 
Our meeting stands adjourned.
    [Whereupon, at 12:53 p.m., the Subcommittee was adjourned.]


                            A P P E N D I X



                           February 20, 2004


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