[Senate Hearing 108-881]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 108-881

 
                   IMPROVING THE CORPORATE GOVERNANCE
                     OF THE NEW YORK STOCK EXCHANGE

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

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                                   ON

   BROKER-DEALER SELF-REGULATION AND REGULATORY AUTONOMY WITH MARKET 
                              SENSITIVITY

                               __________

                           NOVEMBER 20, 2003

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


      Available at: http: //www.access.gpo.gov /congress /senate/
                            senate05sh.html


                                 ______

                    U.S. GOVERNMENT PRINTING OFFICE
25-149                      WASHINGTON : 2005
_____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512ï¿½091800  
Fax: (202) 512ï¿½092250 Mail: Stop SSOP, Washington, DC 20402ï¿½090001


            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky                EVAN BAYH, Indiana
MIKE CRAPO, Idaho                    ZELL MILLER, Georgia
JOHN E. SUNUNU, New Hampshire        THOMAS R. CARPER, Delaware
ELIZABETH DOLE, North Carolina       DEBBIE STABENOW, Michigan
LINCOLN D. CHAFEE, Rhode Island      JON S. CORZINE, New Jersey

             Kathleen L. Casey, Staff Director and Counsel

     Steven B. Harris, Democratic Staff Director and Chief Counsel

                    Douglas R. Nappi, Chief Counsel

                       Bryan N. Corbett, Counsel

                 Dean V. Shahinian, Democratic Counsel

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                      THURSDAY, NOVEMBER 20, 2003

                                                                   Page

Opening statement of Chairman Shelby.............................     1

Opening statements, comments, or prepared statements of:
    Senator Sarbanes.............................................     3
    Senator Bunning..............................................     4
    Senator Schumer..............................................     5
    Senator Crapo................................................     7
    Senator Allard...............................................     8
    Senator Chafee...............................................     8
    Senator Corzine..............................................    18
    Senator Sununu...............................................    19

                               WITNESSES

William H. Donaldson, Chairman, U.S. Securities and Exchange 
  Commission.....................................................     9
John S. Reed, Interim Chairman and CEO, New York Stock Exchange..    31
    Prepared statement...........................................    45

                                 (iii)


                   IMPROVING THE CORPORATE GOVERNANCE
                     OF THE NEW YORK STOCK EXCHANGE

                              ----------                              


                      THURSDAY, NOVEMBER 20, 2003

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:06 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Richard C. Shelby (Chairman of 
the Committee) presiding.

        OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

    Chairman Shelby. The hearing shall come to order.
    This hearing is part of the Committee's ongoing oversight 
of our national market system and the role of self-regulatory 
organizations. As a result of the controversy surrounding Dick 
Grasso's compensation, investors have questioned the New York 
Stock Exchange corporate governance standards and its 
effectiveness as a regulator.
    Many have criticized the current structure of the 
Exchange's board of directors for being dominated by directors 
representing specialists and member firms and lacking 
sufficient independent directors. Many also contend that the 
Exchange's self-regulatory structure in which the chairman is 
essentially paid by the industry that he oversees, calls into 
question the Exchange's role as an unbiased regulator.
    In early November, interim Chairman and CEO John Reed, who 
is with us today, proposed several reforms aimed at eliminating 
the conflicts of interest within the Exchange's governance 
structure. These proposals were approved by the Exchange's 
membership on November 18 and are currently awaiting final SEC 
approval. Mr. Reed proposed bifurcating the Exchange's 
governance structure into a board of directors and a board of 
executives. There will be, under that plan, 8 independent 
directors on the board and approximately 20 constituent 
representatives on the board of executives. Mr. Reed also 
proposed a litany of new disclosure practices to improve the 
transparency of the Exchange's operations. And, finally, Mr. 
Reed proposed the creation of a Chief Regulatory Officer who 
would report to the board's regulatory committee comprised of 
independent directors.
    The public reaction to Mr. Reed's proposals has been 
decidedly mixed. Some have endorsed the plan for significantly 
altering the Exchange's board structure, improving the 
transparency of the Exchange operations and insulating the 
Exchange's regulatory function from the influence of its 
members. Others have criticized the proposals for not going far 
enough to address conflicts at the Exchange. Some find the 
proposals deficient for failing to require the Exchange to 
separate its regulatory function from the business operations, 
contending that as long as the business and regulatory 
functions of the Exchange are combined within one entity, 
member firms will continue to influence the directors and 
impede proper regulation.
    Some have also criticized the proposals for failing to 
require an independent chairman of the board and for neglecting 
to put a representative of the investing public on the board of 
directors.
    The Committee has a significant interest in examining 
reforms to the Exchange's governance structure and 
understanding how any such changes will impact the Exchange's 
regulatory function. Given our reliance on self-regulatory 
organizations in actively monitoring our markets, I believe it 
is critical that the Congress, the SEC and, most importantly, 
investors have confidence that the self-regulatory 
organizations are on the job and keeping a watchful eye. 
Following the recent revelations of abuses in the mutual fund 
industry, many are questioning the effectiveness of the 
regulatory structures for our markets.
    I understand that Chairman Donaldson has worked closely 
with Mr. Reed since he began his tenure at the Exchange. I 
fully expect the SEC to continue scrutinizing the governance 
structure and regulatory capabilities of the Exchange during 
the coming months. It seems to me that Mr. Reed's proposals may 
be the first step in a more lengthy reform process.
    Mr. Chairman, I understand that the Exchange governance 
proposals are currently pending before the Securities and 
Exchange Commission and awaiting approval. Therefore, I 
recognize that you must refrain from providing us with certain 
confidential information regarding the SEC's deliberations.
    Mr. Chairman, it has been a busy week for you. You have 
been here, this is your second time. You can just about move in 
if you want to.
    [Laughter.]
    Chairman Shelby. Thank you for testifying before this 
Committee twice in one week, and I look forward to your 
testimony.
    In addition, this morning--before I recognize Senator 
Sarbanes--the Committee will consider S. 1531, the Chief 
Justice John Marshall Commemorative Coin Act. This piece of 
legislation, introduced by Senator Hatch, with the support of 
75 of our colleagues, will commemorate the 250th anniversary of 
John Marshall's birth. Often considered the founder of 
constitutional law, John Marshall is the longest-serving Chief 
Justice whose tenure, from 1801 to 1835, spanned 34 years and 
five Presidents. The influence of his decisions, most notably 
in Marbury v. Madison, established the principle of judicial 
review and ultimately helped shape and define our Nation's 
judicial system. A prominent figure in our Nation's history, it 
is fitting, I believe, to recognize and honor the Great Chief 
Justice, whose influence continues to be reflected, even in the 
Court's work today.
    We will also be voting, when we get a quorum, on two 
important nominations this morning. Today's nominees, if 
confirmed, will play a vital role in overseeing the safety and 
soundness of our Nation's financial institutions. Our nominees 
are Ms. Alicia Castaneda, nominated to be a Member of the Board 
of Directors of the Federal Housing Finance Board, and Mr. 
Thomas J. Curry, nominated to be a Member of the Board of 
Directors of the Federal Deposit Insurance Corporation.
    Senator Sarbanes.

             STATEMENT OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. Thank you, Mr. Chairman, and this is a 
very timely hearing on the governance and operation of the New 
York Stock Exchange. Actually, the Exchange is virtually as old 
as our country. It was organized in 1792, when 24 New York City 
stockbrokers or merchants met on Wall Street, under a 
Buttonwood tree, as we are reminded, to sign what was 
thereafter called the Buttonwood Agreement. To many, the 
Exchange, since then, has been an important symbol of 
capitalistic economic system.
    Few institutions play as important a role in our economy as 
the components of our securities markets. These include the 
stock exchanges, the over-the-counter markets, and combinations 
of the two. Together, they form the central mechanism for 
raising capital for our businesses and for investing the 
savings of our citizens. Their reputation for maintaining fair, 
liquid, and efficient markets, and continuing to do so as the 
volume of shares traded daily has climbed ever higher, is what 
makes the U.S. markets the center of the international capital 
markets, and in my judgment, a very important and major 
economic asset for this Nation.
    If the New York Stock Exchange is to continue to command 
the confidence of investors at home and abroad, it obviously 
will have to address effectively some serious questions have 
arisen in recent months concerning its governance, its strength 
as a self-regulatory organization, and the efficiency of its 
market-making mechanisms.
    The adequacy of the Exchange's governance was brought into 
question by disclosures only a few months ago, which led to the 
resignation of its Chairman, followed by some members of the 
Exchange's Board.
    Under the Securities Exchange Act, the Exchange has been 
granted the right, ever since 1934, to act as a self-regulatory 
organization, subject to SEC oversight. A recent SEC 
investigation of floor trading practices has cast doubt on the 
effectiveness of Exchange self-regulation. In fact, SEC 
Chairman Donaldson himself has said that there was a 
``distressing breakdown'' in the regulation of trading-floor 
specialists, and according to a report in The Wall Street 
Journal, an internal Commission report, ``paints a picture of a 
floor-trading system riddled with abuses, with firms routinely 
placing their own trades ahead of those by customers--and an 
in-house regulator, either ill-equipped or too worried about 
increasing its workload to care.''
    Further, changes in technology and the globalization of 
financial markets have led some to ask whether a trading floor 
in which brokers match buyers and sellers, and liquidity is 
maintained by ``specialists'' who trade in assigned stocks, is 
out-of-date. Most of the rest of the world has moved to 
electronic systems on which securities dealers advertise prices 
at which they will buy and sell securities, rather than 
matching buyers and sellers.
    Each of these subjects obviously raise it to its own set of 
specific issues, and important issues are being raised about 
the independence of the Exchange's regulatory function. In 
fact, some have raised the question whether its regulatory 
operations should be spun off from the business function of the 
Exchange.
    The cumulative impact of these questions have left the New 
York Stock Exchange facing major challenges at a very important 
time. Chairman Donaldson emphasized, during our last hearing on 
this subject, that the Nation's market structure and governance 
are the result of 200 years of growth and that it is important 
that the consequences of any regulatory or structural changes 
be carefully considered. I think that is an important 
admonition. But we also need to recognize that we have seen 
during the last few years that the trust in the institutions of 
our capital markets, once lost, is hard to regain.
    The answers to the questions faced by the Exchange must 
involve a thorough and comprehensive review carried out of the 
Exchange's structures and functions by the Exchange itself, by 
the Commission, and by the Congress. And this hearing, Mr. 
Chairman, is a valuable step in that process, and I appreciate 
your convening it, and I welcome the opportunity we have this 
morning to hear again from Chairman Donaldson. I join you in 
welcoming him back before the Committee. Any time, Chairman 
Donaldson, we are happy to receive you, and we are also looking 
forward to the hearing from Mr. Reed and the subsequent panel.
    Thank you.
    Chairman Shelby. Senator Bunning.

                STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Mr. Chairman. I would like to 
thank you for holding this timely hearing today. Also, I would 
like to thank all of our witnesses for their testimony.
    We all have been very concerned with the reports about the 
corporate governance issue and the New York Stock Exchange. I 
am very happy to see that the Exchange has moved to correct 
some of those problems. I look forward to hearing from Mr. Reed 
on exactly how the Exchange is going to change, and from 
Chairman Donaldson, who has been up here a lot, as we have 
said, we have a chair in the back that you can have and share 
with us any time.
    Chairman Donaldson. Thank you.
    Senator Bunning. You have been here a lot lately, and we 
are getting the SEC's take on the Exchange's proposals. It 
seems like this Committee has spent an enormous amount of time 
on corporate governance issues in the past couple of years. I 
wish we did not have to. I wish corporations and organizations 
would do a better job of behaving in self-policing. But, 
obviously, in many cases they have not, and Congress has been 
forced to get involved. That is not good.
    I do not like it when we have to get involved. Sometimes we 
do a good job--such as when we passed the Sarbanes-Oxley Act 
last year--sometimes we do not, and at times we have overkill. 
But if we are forced to do something, we will do the best job 
we can.
    Investors have taken a lot of hits over the past few years, 
and the Exchange's turmoil is another hit on investors' 
confidence. This needs to end. I am hopeful the Exchange-
proposed reforms will help restore confidence. I hope you end 
up with a strong, tough, and independent self-regulator that 
will work with the SEC and restore confidence.
    It is essential that you have, for the American investor 
and the economy, to have that type of self-regulator. If your 
new model does not restore confidence, then there may be many 
on Capitol Hill who will feel the need to get Congress 
involved. You do not want that to happen. I do not want that to 
happen, but I know you really will try to get it done. Please 
make sure the reforms you make are thought out, executed well, 
fully disclosed, and the right ones.
    Once again, Mr. Chairman, I want to thank you for holding 
this very timely and important hearing.
    Chairman Shelby. Senator Schumer.

            STATEMENT OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Thank you, Mr. Chairman, and I want to 
thank you for holding this hearing. You are really ``Johnny on 
the spot'' having timely hearings on important issues.
    I want to thank Chairman Donaldson and Mr. Reed for being 
here on an issue of great importance, obviously, to me as a New 
Yorker, but also to all of America and the world, in terms of 
our financial system. I also want to thank Mr. Reed for taking 
this job. It was not an easy job, and your expertise is really 
important.
    We are all here today because of the circumstances that led 
to the former New York Stock Exchange Chairman Dick Grasso's 
resignation, and they are serious, and they have to be 
addressed. It is now clear there was not enough hands-on 
oversight, that there was too much abuse of the regulatory 
function, there were too many conflicts of interest. The new 
governance proposal that is the subject of the hearing today is 
an important step in that reform process. Government is really 
about trust. Is the right system in place to look out for all 
of the people's interests, not just the insiders? My biggest 
concern with the market today is that although stock prices are 
way up, trust is down, and nothing is worse for New York or our 
markets if that continues. The stories are not getting any 
better, as the mutual fund scandals indicate. Trust is the glue 
that holds our markets together and makes this hearing so 
important.
    I want to commend Mr. Reed for taking decisive action. I 
think your job, Mr. Reed, is a little like being a tightrope 
walker. Everyone knows what you need to do. There is a big 
audience watching, and there are a few people who may secretly 
be hoping that you fall off the wire. The trick is keeping the 
right balance, and that is what I think you have done.
    On the one hand, we have very substantial reform. You have 
changed the board 180 degrees, from a large insider group to a 
small outsider group. I am impressed with the talent of the 
board members you have attracted. It is clearly a world-class 
group. You have realized the admonition that some degree of 
self-regulation, through an advisory board, listed companies 
and traders, who will know what rocks to look under and help 
ensure regulation keeps pace with the dynamic market.
    People inside the business will know, and react, much more 
quickly to abuses than any regulator outside the business. We 
have seen that in the last while. But at the same time, you 
have cut the knot of conflicts of interest within that 
structure. It strikes me as a good balance. Self-regulation 
without conflicts of interest seems to me to be the right place 
to go. And I want to say that self-regulation--or lack of it--
or having outside regulation is not a panacea. Unfortunately, 
in the past year, we have seen problems with all areas of our 
financial markets, highly regulated areas, less regulated 
areas, areas supervised by the SEC, areas supervised by SRO's.
    I think the self-regulation debate is important, but we 
cannot forget the larger challenge of reinstilling some basic 
principles in the markets. Smart and unethical people will find 
a way around whatever regulatory structure we come up with if 
we fail to have strong rules and tough enforcement.
    Finally, I believe your proposal leaves room for future 
adjustment. We make some major changes now, see how they go and 
adjust as necessary, and I think that is the right thing to do. 
This approach is important. Because while there is no excuse 
for governance issues and conflicts of interest that have come 
to light in management and governance of the NYSE, in the 
spirit of fixing what is broken, we need to be mindful that 
change can have unforeseen consequences. Striking the right 
balance is critical. You have renovated the structure of self-
regulation without losing benefits, but we have to be careful 
not to throw out the baby with the bathwater, and there are 
real risks if we move in a precipitous or wrong-headed way.
    We need to keep in mind that the Exchange is a huge asset 
for this country. It gives the United States home-field 
advantage, with the largest equity market in the world and the 
deepest pool of liquidity. It is home to almost $15 trillion of 
market value. Thanks, in part, to the Exchange, the United 
States, and New York became--and remain--the global center for 
financial innovation.
    We also need to recognize that in this global age there are 
other exchanges, some in other countries, that would love to 
take market share from the NYSE, particularly in a time of 
perceived weakness. From my State's perspective, of course, the 
Exchange supports thousands of jobs on the trading floor, it is 
supportive, et cetera, and it also supports jobs in both 
Senator Dodd's and Corzine's States.
    But that is not the main issue here. The main issue is to 
have a deep liquid and unified market. So, I want to comment on 
what I think is one of the keys to the Exchange's success and 
related to this issue, and that is the unique specialist-based 
trading system.
    I know that it is not subject of today's hearing, but it 
has come under fire under the guise of reform. We clearly need 
to get to the bottom of charges that a few specialists may have 
violated the rules and regulations, and it is important we do 
that quickly, but that is not what the controversy is about.
    Some are now arguing that specialists are outdated and that 
making the quickest trade on an electronic black box is more 
important than finding and delivering the best price. I could 
not disagree more. The human element at the heart of the 
specialist system is still critical, and the proof is in the 
pudding. The NYSE specialist system beats competing markets, 
100-percent electronic markets, and gets the best price 94 
percent of the time on listed shares.
    More importantly, most average investors, want the best 
price. That is what they think they are getting when the 
execute a trade. My father is a small stock trader. I know what 
he wants. I have asked him. He wants best price. He does not 
care if he has to wait 10 minutes to get the best price. He 
wants the best price. So it is not how fast; it is, rather, 
getting the best price, and the specialist system beats all 
others hands-down.
    I hope today and other times, when we hear some criticism 
of the specialists, we recognize where it is coming from. It 
seems to me the cards are not always on the table. Some of the 
vocal critics are guilty of their own conflicts of interests 
through their ownership of rival electronic markets. I have 
heard a lot from some people in Fidelity. They say we have to 
get rid of the specialist system. They do not mention that 
Fidelity, a vocal critic of the NYSE, owns a big stake in 
Archipelago, an ECN and a competitor. Schwab is also part of an 
ECN.
    I am not saying the specialist system does not need to make 
adjustments, but if we eliminate the specialist system by 
design or by accident, we risk fragmenting the market into many 
little electronic black boxes, where trades are quick, but 
prices suffer. It is in a fragmented, nontransparent market 
that investors suffer the most. That is where all of the 
behind-the-scenes tricks and things will occur, not in an open 
system. That is what we found. So keeping one efficient deep 
and liquid market, where orders compete head-to-head, is a goal 
that serves all investors worldwide. Fragmentation of the 
markets to me is the greatest nightmare we face, not just for 
New York, not just for America, but for every investor who 
wants to be treated fairly worldwide.
    In closing, Mr. Chairman, I appreciate the indulgence of 
the Committee. This issue is important to me. I would ask that, 
while the governance reforms that are so important to 
maintaining trust in the NYSE are paramount, and we have to get 
them right, I also hope that we will hear about efforts to 
maintain the Exchange's place at the cutting edge of innovation 
and preeminence. We need to do that for the sake of investors 
worldwide.
    Thank you.
    Chairman Shelby. Senator Crapo.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you very much, Mr. Chairman, Mr. 
Donaldson, and Mr. Reed. I appreciate you coming here before 
us. As has been indicated already, we seem to have a full 
agenda of issues relating to corporate governance and 
management of the problems that have arisen in our markets in 
the United States and globally every week, as we go through 
these issues in Congress, and I appreciate your constant and 
sincere attention to these issues.
    Thank you very much, Mr. Chairman. I do deeply appreciate 
the concern that is being brought here and share the concerns 
that already have been raised by many of my colleagues. I look 
forward to the testimony we will hear today.
    Thank you.
    Chairman Shelby. Senator Allard.

               STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Mr. Chairman, I just have a few comments I 
would like to make.
    First of all, I want to compliment you on having this 
hearing. We have had a lot of good hearings I think this past 
year, and as Chairman and the hard work that goes into the 
hearings, sometimes you are not recognized for the hard work, 
but I think lots of times it makes a bigger difference, and you 
do not get credit for it. And sometimes I think it is much 
better than passing legislation, more laws and whatnot if we 
can just get things to happen without legislation, and that is 
the value I think of close oversight, and I want to compliment 
you on all of that hard work.
    This is a challenge with what we have facing today on 
confidence, and I agree with what my predecessors have said 
here on this panel. Trust and confidence is key. That is what 
we all want to look forward to. I am looking forward to the 
testimony. The New York Stock Exchange and the SEC have some 
serious challenges, and I want to hear what your solutions are, 
and we need to restore confidence as quickly as possible.
    Here, in the United States, I view our exchanges, not just 
the New York Stock Exchange, but all of our exchanges, as 
premier in the world. There is no other country in the world 
that has the kind of exchanges that we have, and the New York 
Stock Exchange is always one that has been looked up to. And it 
is getting more and more competitive on a worldwide basis, and 
we have to make sure that we have that confidence because that 
is what separates us from the other markets.
    I, as a small businessman, learned to appreciate the value 
of good records and accountability. And as you are looking on 
your internal controls and everything, you have to know what is 
happening, and so you need to be open, you need to know what is 
happening, you have the records and accountability, but it 
needs to be done within so that it is a minimal--we do not want 
to get carried away with our rules and regulations, but we need 
to have enough there that the customers have confidence that 
the management has confidence that they know what is happening 
in the business.
    I look forward to hearing about what your reform proposals 
are, and I think that self-regulation can work when it is done 
properly, and I am hopeful, in this particular case, that that 
will happen.
    Again, I would just like to thank Mr. Donaldson, Chairman 
of the Securities and Exchange Commission, for coming before 
the Committee, and I also thank Mr. Reed, Chairman and CEO of 
the New York Stock Exchange, for coming here. I know it takes 
away from your daily responsibilities, but this is important.
    Thank you very much, Mr. Chairman.
    Chairman Shelby. Senator Chafee.

             STATEMENT OF SENATOR LINCOLN D. CHAFEE

    Senator Chafee. Thank you, Mr. Chairman, and welcome to Mr. 
Donaldson and Mr. Reed. We look forward to your testimony.
    Chairman Shelby. Chairman Donaldson, welcome again to the 
Committee. Your written statement will be made part of the 
record in its entirety. You may proceed as you wish.

               STATEMENT OF WILLIAM H. DONALDSON

       CHAIRMAN, U.S. SECURITIES AND EXCHANGE COMMISSION

    Chairman Donaldson. Good morning Chairman Shelby, Ranking 
Member Sarbanes, and Members of the Committee. I am very 
pleased to be here today and to discuss the governance of the 
New York Stock Exchange. This issue is one that has received my 
attention from my very first day in office. I was confirmed as 
the SEC Chairman in mid-February of this year. In March, I 
wrote to the New York Stock Exchange and other SRO's asking for 
a thorough review of their governance, a review that has led to 
changes at the New York Stock Exchange under consideration 
today. While distinct from the issues of market structure, 
which the Commission is also working strenuously to address, as 
we have discussed before, the governance issue has been of 
great importance to me.
    This issue has my attention because of its importance for 
the markets. As I have said in the past--and I will say again 
today--we have the world's most efficient and effective 
securities markets, but the success of our markets is directly 
dependent on the confidence the investors have in their 
integrity. This is particularly true with respect to the New 
York Stock Exchange. The NYSE has a leading role in our markets 
as the largest equity market in the world, as the regulator of 
the Nation's largest securities firms, and as the arbiter of 
corporate governance standards for many of the Nation's largest 
corporations. The New York Stock Exchange's leading role makes 
it imperative that the NYSE's own governance be above reproach.
    The link between governance and the New York Stock 
Exchange's role was recognized as far back as 1938 in the New 
York Stock Exchange Conway Committee Report, which said it 
recommended governance changes which, ``Really represent merely 
another step in a long evolutionary development of the Exchange 
as the Nation's primary securities market.'' It was also 
recognized again in 1971, when the last major changes in the 
governance of the New York Stock Exchange were shaped by a 
report by William McChesney Martin. Among other things, the 
Martin Report said that the New York Stock Exchange should be 
reorganized, ``to give proper recognition of its public nature 
and the respective interests of the public, the companies 
listed on the Exchange and the members of the securities 
industry involved.'' In response to the Martin Report, the New 
York Stock Exchange created a board balanced between securities 
firms and issuers, institutional investors, and public 
representatives. It also created a nominating committee that 
was independent of members and the New York Stock Exchange 
board to select new candidates for the board. The New York 
Stock Exchange itself, at that time, became a nonprofit, 
nondividend paying corporation owned by its members.
    Although these 1971 changes in the governance of the NYSE 
were dramatic for their era, time brings new challenges, and 
even an institution once looked to as the model must respond to 
these challenges to retain its preeminence. As the Conway 
Committee said in 1938: ``It is apparent to us that the 
organization of the New York Stock Exchange should be revised 
to accord with changing times and conditions.''
    The current pressing need for a review of the New York 
Stock Exchange's governance was signalled by a series of recent 
events. In the Sarbanes-Oxley Act, the Congress entrusted the 
New York Stock Exchange, as a listing market for the Nation's 
largest corporations, and other listing markets, with 
heightened responsibility to set standards for the governance 
of these listed companies. This initiative raised the bar for 
the New York Stock Exchange's own governance structure. In 
addition, the New York Stock Exchange's selection of the 
chairman of a financial services company that owned a large 
broker-dealer to serve as a public director called into 
question the New York Stock Exchange's board selection process, 
if not its dedication to the principle of a balanced board. And 
the reports of the compensation of the New York Stock Exchange 
Chairman and CEO gave further credence to concerns about the 
New York Stock Exchange governance process.
    In March of this year, I wrote to the Chairman and CEO of 
the New York Stock Exchange, as well as to the heads of the 
other SRO's, asking them to review their SRO's governance 
practices in light of the standards that had just been proposed 
for listing companies. In that letter, I expressed the view 
that, just as the New York Stock Exchange and Nasdaq were 
demanding that publicly traded companies meet high governance 
standards in order to list on their markets, SRO's must demand 
the same standard of themselves. I asked each SRO to undertake 
an exhaustive review of its governance procedures and report 
back to me by mid-May.
    Each SRO submitted written responses that detailed its 
governance practices and, in my view, revealed some areas that 
appear to warrant improvement. Following my letter, and I hope 
perhaps in response to my letter, several SRO's convened 
special governance committees whose mandates were to examine 
the strengths and weaknesses of the SRO's governance practices. 
The New York Stock Exchange provided an interim report, but 
indicated it was conducting a thorough review through a Special 
Governance Committee which would subsequently provide the New 
York Stock Exchange board with a final report.
    While the New York Stock Exchange's review was still 
underway, and before issuance of the report, we learned of the 
New York Stock Exchange's extension of the New York Stock 
Exchange Chairman's employment agreement, as well as its 
substantial payout of his accrued compensation. In response, I 
wrote to the head of the New York Stock Exchange Compensation 
Committee and Special Governance Committee, asking for further 
information regarding the then-Chairman's compensation and the 
decisionmaking processes at the NYSE that led to his pay 
package. In my letter, I indicated that approval of such an 
extraordinary compensation package raised serious questions 
regarding the effectiveness of the New York Stock Exchange 
governance structure, and asked the New York Stock Exchange to 
provide me with detailed information regarding the then-
Chairman's compensation arrangement and how it was approved by 
the NYSE board.
    In my view, the documents produced by the New York Stock 
Exchange raised troubling questions about its governance. The 
then-Chairman's package was set by the Compensation Committee 
of the New York Stock Exchange board and approved by the full 
board of directors. However, the then-Chairman appears to have 
exercised considerable influence, both formal and informal, 
over the composition and operation of the board in the 
Compensation Committee. In addition, it is not clear that the 
full New York Stock Exchange board or the Compensation 
Committee fully endorsed the intricacies of the then-chairman's 
compensation arrangements, and the ``ripple effects'' the 
approval of one element had on the others. Finally, there 
appears to have been a lack of transparency at the New York 
Stock Exchange regarding the operation of the Compensation 
Committee and the nature and substance of its review of 
compensation matters. In my opinion, if there had been broader 
dissemination of information regarding executive compensation 
at the New York Stock Exchange, it is unlikely it would have 
reached such extraordinary levels.
    In light of the governance issues at the NYSE relating to 
the then-Chairman's compensation package, I again wrote to the 
heads of each of the SRO's to ask for more details about the 
extent of public representation on their boards and key 
committees, including the compensation committees, the 
decisionmaking process with respect to the nomination of 
directors, their assignments to committees, the compensation of 
executives, and the SRO's past practices and current plans for 
public disclosure of these processes and compensation 
arrangements of key executives. Commission staff is in the 
process of assessing the responses of those SRO's.
    As you know, Congress and the Commission have long 
recognized that self-regulation has both benefits and 
weaknesses. The principle of self-regulation is based on the 
notion that regulation can best be done as close as possible to 
the regulated activity. As a Congressional committee said in 
1938, the alternative to SRO oversight will mean: ``A 
pronounced expansion of the organization of the Securities and 
Exchange Commission, the multiplication of branch offices, a 
large increase in the expenditure of public funds, an increase 
in the problem of avoiding the evils of bureaucracy and a 
minute, detailed, and rigid regulation of business conducted by 
law.'' SEC Chairman William O. Douglas, back in 1937, said it 
all when he said: ``By and large, Government can operate 
satisfactorily only by proscription. That leaves untouched 
large areas of conduct and activity, some of it susceptible of 
Government regulation, but in fact too minute for satisfactory 
control, some of it lying beyond the periphery of the law in 
the realm of ethics and morality. Into these areas, self-
government, and self-government alone, can effectively reach.''
    The utility of self-regulation has been reiterated many 
times through the years in Congressional, Commission, and 
industry studies. In 1975, the House Commerce Committee said, 
``Perhaps expectantly, SRO regulation has, on occasion, been 
found seriously deficient, and it has not operated as 
effectively or as fairly as the public interest will require. 
Nonetheless, the Committee found that the system, on the whole, 
has worked and recommended that it be preserved and 
strengthened.''
    Where self-regulation has not worked, this often is the 
result of the inherent tension between an SRO's role as the 
regulator and as the operator of a market, and between its role 
as a regulator and a membership organization. Today, two key 
factors in addressing these conflicts are the independence of 
the SRO board from the interests of specific members or even 
specific users of the SRO's market and the independence of the 
regulatory function of the SRO from the self-interest of the 
members or the business interests of the market itself.
    The independence of the regulatory function can be 
accomplished through a range of alternatives along a spectrum. 
At one end of the spectrum is an SRO that is wholly separate 
from any market, yet responsible for supervising member firms 
and the operations of unaffiliated markets. I would consider a 
model that has an autonomous regulatory office of an Exchange 
that is supervised and controlled directly by an entirely 
independent Exchange board to be toward the middle of this 
spectrum. I would also put the NASD-NASDR-Nasdaq model of 
separate regulatory and market affiliates overseen by a 
balanced board in this same middle category. At the further end 
is the prior New York Stock Exchange model of regulation and 
market combined in one entity under the direction of the 
Exchange CEO, and ultimately a balanced Exchange board. The 
appropriate regulatory structure for one SRO may not be 
appropriate for others, given their different memberships, 
sizes and regulatory responsibility. For all SRO's, however, 
the challenge before the Commission and the SRO's is to develop 
governance structures that help assure SRO regulatory programs 
that are effective, yet insulated from any undue influence of 
potentially conflicting business or membership pressures.
    As you know, under the leadership of Interim Chairman John 
Reed, the New York Stock Exchange recently took a critical step 
toward governance reform that deserves our serious 
consideration. On November 7, the NYSE filed with the 
Commission a proposal that would amend the New York Stock 
Exchange Constitution to implement a series of governance 
changes at the New York Stock Exchange, including those 
designed to strengthen the independence of the New York Stock 
Exchange board and its key committees and better insulate the 
New York Stock Exchange regulatory function from its business 
as a market. These steps include creation of an autonomous 
regulatory office headed by a Chief Regulatory Officer who 
reports directly to a committee of the new, wholly independent 
New York Stock Exchange board. This board committee is 
responsible for ensuring the effectiveness, vigor, and 
professionalism of the New York Stock Exchange regulatory 
program. The Committee determines the budget, regulatory plan, 
and staffing of the regulatory office, assesses the New York 
Stock Exchange regulatory performance, and recommends 
compensation and regulatory actions to the independent board.
    The New York Stock Exchange proposal is subject to 
Commission approval. Because of the significant public interest 
in the New York Stock Exchange's proposed governance reforms, 
the Commission immediately issued a notice seeking public 
comment on the NYSE's proposal. To assure widespread awareness 
of the New York Stock Exchange proposal, the Commission has 
both published it in the Federal Register and highlighted it on 
the Commission's website. The comment period will extend 
through December 4. I encourage any interested persons to 
formally submit comments on the New York Stock Exchange's 
proposal for Commission consideration. Although the Commission 
reserves judgment on the proposal until all public comments are 
received and evaluated, I must commend the New York Stock 
Exchange, and in particular John Reed, for taking this 
substantial and critical first step toward revamping its 
governance structure.
    In conclusion, I would like to thank the Committee for 
recognizing the importance of effective governance of the NYSE 
and other self-regulatory organizations. I look forward to 
continued input from your Committee. Thanks again for inviting 
me. I would be delighted to answer any questions.
    Chairman Shelby. Thank you, Chairman Donaldson.
    Mr. Chairman, many people contend that the Exchange's 
proposals do not get at the root of the problems at the Stock 
Exchange. Some believe that after the reforms are implemented, 
we will be left with a situation perhaps where the Exchange's 
regulators will continue to report to a board elected by 
members of the Exchange.
    Mr. Chairman, as head of the SEC, how do you respond to 
that criticism, that as long as the members select the 
directors, then the institutional conflict remains and true 
regulation will not occur. Have you heard that?
    Chairman Donaldson. Yes. You know I have to reserve 
judgment, basically, until all of the public comment----
    Chairman Shelby. So, when you say the ``first step,'' is 
that in the context of all of it?
    Chairman Donaldson. Well, no. All I want to say is that 
this is out there for the public to comment on, and I want to 
make sure that everybody recognizes that.
    Chairman Shelby. But you are very cognizant of the 
concerns.
    Chairman Donaldson. The structure is set up in such a way, 
and I will not go through the details of that structure, that, 
in effect, every possible safeguard has been given so that the 
reporting of the regulatory function, the compensation of those 
involved in implementing it, and so forth reports to an 
independent board, and that the CEO of the New York Stock 
Exchange, whether that be a Chairman and CEO in one person or 
two separate functions, will have absolutely nothing to do with 
the regulatory function and so that the regulatory function 
will not be compromised.
    Now, to address your specific question, there will be an 
opportunity for the board to have its own nominating committee, 
to nominate new directors as their terms expire, and I think 
that, fundamentally, you have a group of shareholders, if you 
will, who are called seat-holders, who have tremendous 
investments in their seats, and I believe they will understand 
that the integrity of the Stock Exchange, the integrity and the 
independence of the board is something that we should not, and 
could not, and would not allow to be compromised in terms of an 
election process.
    Chairman Shelby. It is in their interest, is it not?
    Chairman Donaldson. I would also say that----
    Chairman Shelby. But is it not in their interests to have 
integrity first, a board that functions well, too? It is in the 
interests of the seat-owners, the owners of the seats on the 
Exchange for the Exchange to work well, to be independent as 
much as you can, to function well, to not be in the critical 
path every day.
    Chairman Donaldson. I think that the fundamental proposal 
that Interim Chairman Reed has put forward has, at its core, a 
totally independent, highly experienced group of former 
executives or sitting executives, and I think that that is 
absolutely critical to the going forward of the Exchange.
    In terms of what happens in the future, there will be 
continuing elections of new boards as the years go on, and I 
think the self-interests of the owners of the Exchange, I mean, 
the seat-holders of the Exchange, will be such that they will 
not even begin to dare to change the integrity of the process.
    Now, having said that, there is scope for, and 
responsibility for, the SEC to oversee the governance of the 
Exchange. And should there be any deterrence from the new 
course that is being set out here, we have the power, and the 
independent board of directors has the power, to make sure that 
any changes in directorship that do not meet our standards do 
not happen.
    Chairman Shelby. Mr. Chairman, you have been quoted as 
stating that the SEC will continue to consider further 
marketwide reforms, including governance, and regulatory 
reforms and additional reforms beyond what Mr. Reed proposed. 
You have alluded to this already.
    Assuming that the SEC approves Mr. Reed's proposals that 
you are now considering, what are the SEC's next steps in 
evaluating the Exchange's market structure, including the role 
of specialist and its regulatory function.
    Chairman Donaldson. Well, I would answer that in two 
phases.
    Number one, this is, if approved, definitely a first step. 
I think the second step is to give the new independent board an 
opportunity to function, and give it an opportunity to move in 
as it, I am sure will, in the evaluation, reorganization and so 
forth of the regulatory function itself.
    There is a second part of this which is not in the purview 
of the New York Stock Exchange itself, and that is market 
structure. In other words, there will be, as we have talked 
about before in this Committee, and as we are working on very 
diligently right now, there will be changes in market structure 
coming down the pike that will affect the way the New York 
Stock Exchange operates, but I think that is separate from the 
issue of the governance of the Exchange. And separate from the 
paramount issue, as far as I am concerned, is the locus of this 
regulatory function.
    Chairman Shelby. Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman. And I thank you 
for your testimony, and I understand that you do not want to 
prejudge whatever the SEC does. I guess it is pretty clear from 
you comments I think it is a good structure, and I think you 
should go with it and then see how it works, just as you said.
    But let me ask you, I guess you heard what I had to say. Do 
you worry about fragmentation of the markets? Do you worry, and 
do you think, that the one has anything to do with the other. 
Changing the regulatory structure, whether it is done by the 
NYSE itself or by the SEC or the SEC recommends changes, has an 
effect on the market issues, the way stocks are traded, the 
things that are within the SEC's exclusive purview.
    Chairman Donaldson. We are very concerned, as we deal with 
market structure, about fragmentation.
    Senator Schumer. Good.
    Chairman Donaldson. We are very concerned also with the 
arrival on the scene in recent years of new ways of trading 
stocks, and in particularly electronic ways, ECN's. And by the 
way, the electronics at the New York Stock Exchange are much 
greater than they are given credit for.
    Senator Schumer. And much changed over the last 10 years.
    Chairman Donaldson. Yes. Having said that, our dilemma, if 
you will, is to try to create a structure that involves 
bringing together the benefits of some of the so-called ``rapid 
markets,'' the nanosecond trading that we have talked about 
before in this Committee, the ability to execute in seconds--
and that, of course, has been exacerbated by the decimalization 
of spreads and the fact that you have just a penny between the 
bid and the ask, and you have a nanosecond ability to trade--
trying to make that way of trading available to those who want 
it. And there is a segment of the market population that wants 
to interface that with the price improvement auction market 
specialist system that has stood for years for getting a better 
price for people.
    And I do not throw out the idea that speed is important to 
some people, and I definitely do not throw out the idea that 
getting a better price is important to probably a lot more 
people.
    So the job here is to bring these two systems together in a 
way that basically gets for the public investor out there what 
they want.
    Senator Schumer. And without fragmenting the markets 
because the depth and liquidity of markets, I believe, you tell 
me, not only is the best system and gets the best price, but 
also is the best one for openness, for regulation, to avoid the 
problems that we have seen throughout the financial markets in 
the last while.
    Chairman Donaldson. Well, there are two aspects to what you 
are saying, Senator, and that is we are not only talking about 
speed, price improvement, and fragmentation, but we are also 
talking about liquidity. We are also talking about the massing 
of liquidity. And, again, there are all sorts of statistics 
about who has the better prices and so forth. I do not want to 
get into that now, but I just would remind the Committee of the 
importance of the liquidity pool that exists at the New York 
Stock Exchange.
    Senator Schumer. So you share my worries about 
fragmentation.
    Chairman Donaldson. And particularly in times of stress, 
and I do not mean this to be a brief for the New York Stock 
Exchange because there are other markets here, and there are 
other ways of trading. But I think, since we are talking about 
the New York Stock Exchange this morning, I just cannot pass by 
without making that statement: The liquidity and the liquidity 
that develops in down markets, when I say ``liquidity,'' that 
is depth of markets. It is a great national asset that we have 
there, and we do not want fragmentation to break that up.
    Senator Schumer. Correct. Let me ask you this, and I could 
not agree more with your comments, and I am glad to hear you 
were saying them. I think that if most people study the markets 
without any specific bias, they would agree with that comment.
    Does technology not, the trick here I guess is to harness 
the technology and keep the depth and liquidity.
    Chairman Donaldson. That is it.
    Senator Schumer. That is a tough job.
    Chairman Donaldson. Yes.
    Senator Schumer. And in my view, that has been a strength 
of the New York Stock Exchange. As you may know, I was a critic 
of the Exchange 5 years ago and got them pretty mad because I 
thought they were not moving quickly enough to deal with that 
issue, but I think they have, and I think they have done a 
pretty good job of that. And maybe while they were focusing on 
that, they let some of these other things go by the wayside 
that you, and Mr. Reed, and others have to correct now because 
you need both. There is no question about it.
    I guess my fundamental question--he is telling me my time 
is up--is it an either/or proposition?
    Chairman Donaldson. Either/or in what sense, Senator?
    Senator Schumer. Either/or the governance issues, and the 
regulatory issues, and the technology, trading, liquidity 
issues--can we not have both?
    Chairman Donaldson. We have to have the purest governance 
structure that we can possibly create. We have to have the 
cleanest separation of responsibility for regulation that we 
possibly can create, and not to repeat myself, I believe that 
can be created in a number of different ways, and I do not 
think we should mistake form over substance here. I believe 
that the concept that John Reed has come up with has gone a 
long way, almost all the way toward the separation of that 
responsibility from the business side of the Exchange.
    In terms of market structure, I do not think it is an 
either/or situation. I think that we will be coming up with 
what we hope are approaches to the structure of the market that 
will get the best of these two different worlds, if you will, 
without throwing out the liquidity and so forth that have made 
the New York Stock Exchange successful.
    Senator Schumer. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Bunning, thank you very much for 
your indulgence.
    Senator Bunning. Thank you.
    Chairman Donaldson, I would like to follow up on something 
that the Chairman spoke about earlier. It seems to me, in most 
cases, that self-regulation does not work. Self-regulation does 
not work, whether it be mutual fund self-regulation, whether it 
be New York Stock Exchange self-regulation, whether it be the 
Federal Home Loan Bank self-regulation, whether it be Fannie 
Mae and Freddie Mac self-regulation or wherever we are going.
    And in the proposals that Mr. Reed has, there is still 
self-regulation, and I want to know how investors' confidence 
is going to be restored in the New York Stock Exchange or any 
exchange, for that matter, mutual funds, whatever it might be, 
if we still have the fox in the henhouse.
    Chairman Donaldson. I think that the failures of self-
regulation are what has caused the changes that are going on 
right now at the New York Stock Exchange. I think the 
governance aspect is only one part of self-regulation. I think 
that if you go back in history, I believe that the fundamental 
decision that was made in 1933 and 1934 to give the right of 
self-regulation down to the people who are operating the 
markets was the right decision. I think if we had gone the 
other way and had a Securities and Exchange Commission or some 
other agency that tried to run these markets from Washington, 
we would have had a bureaucracy, and we would have had a 
Federal expenditure that would have impeded the growth of the 
markets.
    Senator Bunning. Mr. Chairman, I am not going to violently 
disagree with you, but we had an antique called the Securities 
and Exchange Commission and the Act of 1934 that made certain 
rules and regulations in governing the security markets. Just 
like the Social Security System was founded a few years later, 
we have made strong changes in how we operate Social Security, 
and we are about to do it again somehow because it needs to be 
done.
    While we have this great opportunity because we have found 
some major flaws in what we have been doing, I am not going 
back to 1934 and saying that was a good thing to do. Maybe it 
was in 1934, but it is not in 2003.
    Chairman Donaldson. I could not agree with you more, 
Senator, and I do not mean to imply that we are going back. I 
just use that as a reference point. What I do believe is what 
we are attempting to do now is to gain from our experience with 
self-regulation and to change the rules, as you suggest, to 
enhance self-regulation. I think it is too soon to simply say 
self-regulation does not work and to throw it out.
    Senator Bunning. Well, history dictates otherwise. And I am 
an old baseball player, and when owners in baseball elect the 
commissioner and run the game, the health of the game is in 
jeopardy.
    You need someone with a knowledge of the game but outside 
of the game. That is what I think is almost essential if we are 
going to restore investors' confidence in these markets. 
Without investors' confidence, I do not give a darn how good 
the exchange is run and how great the executions are and if it 
is a nanosecond and we get the best price. The investor has to 
have confidence in that market. And if we do not restore that 
investor confidence, that market is going to go to England, 
that market is going to go somewhere other than New York.
    I would suggest in the regulatory section of governance 
that we really look at who is the last person to have the say, 
because it is essential that that not be somebody from the 
floor, that it not be somebody from one of the brokerage 
businesses, that it be somebody that has the knowledge but is a 
separate, independent operator. And I would suggest that you 
look at that, and I thank you for your time.
    Chairman Donaldson. Senator, can I just thank you, and I 
hear what you are saying, and I believe that the structure that 
has been put forth--and it is only a first step--does exactly 
what you say. It has taken all that conflict out from those who 
were responsible for--it has taken the conflicts inherent in 
what seat-holders want, what floor brokers want, what 
institutions want, and so forth. It has put it aside, and that 
is to be run as a business. And it has taken the regulatory 
side of things and has as pure a structure as you could 
possibly conceive of, even though it is still in under the same 
umbrella, it is a structure inside that goes from independent 
regulatory function reporting to an independent board who has 
on it nobody with special interests. That is the nature of this 
board.
    Senator Bunning. Well, we will see how it works.
    Chairman Donaldson. Okay. Thank you for your comments, 
Senator.
    Chairman Shelby. Senator Corzine.

              STATEMENT OF SENATOR JON S. CORZINE

    Senator Corzine. Thank you, Mr. Chairman.
    Welcome back, Chairman Donaldson. It seems like you spend a 
lot of time here these days. Unfortunately, the read of the 
newspapers I think makes that far too important the reality of 
what we see in the markets. It is going to be disappointing to 
all of us who have been a part and have benefited from markets, 
and I must say the ongoing revelations we see almost day-to-day 
is extraordinarily disturbing to me. And I think this 
discussion of the New York Stock Exchange, which is really 
emblematic of the greatness of our markets in its totality, 
needs to make sure that we do this right, because there is 
this--there has to be a serious erosion based on the 
multiplicity of events, starting with the corporate problems 
that we had in the late 1990's and the early part of this 
decade, the mutual fund discussion that we had the other day. I 
am personally seriously disturbed by the events in the foreign 
exchange market revealed, at least to the public, yesterday.
    I think that is why it is so important that in one of the 
most important institutions we get it absolutely right, and I 
congratulate Mr. Reed for taking on this herculean task. I 
think his own personal integrity is one that starts us off in 
the right process.
    But I do have some sympathy for looking for the purest 
response because I think the seriousness of the nature of the 
undermining of the confidence that people have with regard to 
the integrity ultimately is the fundamental issue that will 
determine whether we have price, speed, depth, breadth, 
liquidity, and the capital formation function going on, and 
that somehow or another we have to get that restored in an 
absolute sense. And I think that the pattern that is 
established here is essential.
    I did not mean to give a statement. I have a formal 
statement, Mr. Chairman, that I will put into the record, but 
this discussion and the quality of leadership we have seen so 
far on this from the people at the exchange post some of the 
problems I think has been terrific. But I do not know whether 
it goes far enough in my view.
    I want to take off on a question--I think I understood the 
question that Senator Schumer was talking about, either/or. I 
think the governance issue is absolutely linked to the 
structural issue because ultimately the governance issue is 
where you are going to get the best perspective and effort to 
drive to the results. And then you are going to actually, even 
outside of the regulatory function, make sure that the best 
structural ideas that are laid down get implemented and 
executed.
    Am I missing something? I think they are actually linked.
    Chairman Donaldson. I do not think you are. If I understand 
what you are saying, I think the structure of the governance of 
the New York Stock Exchange is the fundamental fountain from 
which the integrity of the place will flow. And I think that 
the structure that has been suggested by Chairman Reed goes 
amazingly far in that direction.
    Having said that, you know, the structure is out for 
comment. It is out for people to make their own judgments and 
come back to us with them. I believe it is a first step. And, 
again, without prejudicing the listening to other people's 
views that we will do, I will do, the Commission will do, I 
believe that this step probably deserves a chance. I think 
that, if it does not work, if that board itself says it does 
not work and cannot work, they have the power to go one step 
further if they want, if they determine that somehow this 
structure is imperfect.
    They have been given that power now by the change in the 
constitution. There is tremendous power that resides with that 
board in terms of taking it another step. And we will see where 
that goes.
    Senator Corzine. Let me ask something slightly less macro. 
Do you believe that there is the potential to transform the 
auction system into a technologically executed system? Is it 
possible to do?
    Chairman Donaldson. I guess anything is possible, you know, 
in this day and age in terms of technology. I believe that you 
can probably someday take an airplane and fly it from New York 
to Washington without any human beings flying it. I would not 
want to fly on that plane. And although that is a poor analogy, 
I think there is some merit here. I think the combination of 
technology and human judgment becomes particularly important in 
the marketplace, particularly important when there is stress in 
the marketplace. So, I think that the agency auction specialist 
system has to modify itself to have enough increased technology 
side-by-side, but, again, I am not prepared to throw human 
judgment out of it.
    Senator Corzine. Thank you.
    Chairman Shelby. Senator Sarbanes.
    Senator Sarbanes. Has he had a chance?
    Chairman Shelby. No, but you were here earlier.
    Senator Sarbanes. No, that is all right. Go on.
    Chairman Shelby. Okay. If you want to defer to Senator 
Sununu, that is fine with me.
    Senator Sununu.

              STATEMENT OF SENATOR JOHN E. SUNUNU

    Senator Sununu. I do not want to get into any trouble.
    Senator Sarbanes. Oh, no, you are not in trouble.
    Senator Sununu. Thank you.
    Chairman Shelby. He is having a good day.
    [Laughter.]
    Senator Sununu. He deserves a very good day.
    Chairman Shelby. So take advantage of it.
    Senator Sununu. Thank you.
    Mr. Donaldson, the last time you were here, I asked some 
questions about specialist behavior, about their use of 
proprietary information, perhaps inappropriately, about 
practices of front-running, and whether there were rules that 
encouraged that kind of behavior or that facilitated that kind 
of behavior.
    You gave a reasonable answer, I thought at the time. It was 
not especially specific, though. And the next day the SEC 
announced that it was taking action against five specialist 
firms for front-running and other violations of SEC rules. I 
guess I can understand why you were maybe a bit vague in 
responding to my inquiries.
    What is the status of the action in those specific cases? 
What have the findings of the SEC been with regard to the rules 
violations in those cases? And what changes to specialist rules 
might you propose or recommend as a result of these cases?
    Chairman Donaldson. Well, there are two aspects to your 
question: One is violations of existing rules, and number two 
is an examination of those existing rules to see whether they 
should be changed. I think they are two very different things.
    Clearly, there have been a series of events originally 
discovered, if you will, by the New York Stock Exchange 
regulatory system itself, that involves alleged breaking of 
those rules. The SEC moved in swiftly because we thought the 
possible breaking of the rules, if you will, went beyond what 
was being investigated. We broadened the investigation. And we 
are now in the process--and I am being very careful here 
because, you know, we do not comment on possible enforcement 
proceedings, for obvious reasons. But you can be sure that the 
SEC will take whatever enforcement actions are indicated by our 
surveillance system and act upon them.
    I want to make sure that I am making it very clear that 
that is one part of the problem.
    Senator Sununu. Okay. And I do want you to move forward to 
the second issue about the rules changes. But let me ask you, 
with regard to that answer, why did the SEC have to step in to 
broaden the investigation? Why in your opinion wasn't the 
investigation appropriately broad to begin with?
    Chairman Donaldson. I think that is a very legitimate 
question, and I guess the bottom line is there was what we 
considered to be a failure or something lacking in the 
oversight at the Stock Exchange itself. And that is why we 
stepped in, and that has been the problem, and that is a 
problem that needs to be solved.
    Senator Sununu. But if I understand your answer to Senator 
Bunning's question, when you answered his question you seemed 
to suggest that the nature of this self-regulatory structure 
was not a problem, was not necessarily a limiting factor and 
that here you seem to suggest that the nature of the regulatory 
structure resulted in the SEC having to step in to broaden what 
in my view is a very important investigation.
    Chairman Donaldson. I think that what I was trying to say 
was that the concept of self-regulation is born of an attempt 
to accomplish two things: To have regulation close to the 
marketplace so that the marketplace can operate in rapidly 
changing times, to not have that regulation outside, 
disembodied by a bureaucratic organization that would impede 
the functioning of the market. And this is not to say that 
self-regulation cannot break down. And I think we have a 
particular instance here where in that particular niche on the 
floor of the Stock Exchange it did break down.
    But that is not a reason to throw it out, in my view. What 
you do about that is you change the rules and then you make 
sure that the rules are followed, and you change the reporting 
structure of the regulation to enhance the enforcement.
    Chairman Shelby. Senator Sarbanes.
    Senator Sarbanes. Thank you.
    Chairman Shelby. We want this good day to continue.
    Senator Sarbanes. Thank you, Mr. Chairman.
    Chairman Donaldson, do you know how many people work in the 
Enforcement Division at the New York Stock Exchange as they 
carry out their self-regulation? Do you have any idea?
    Chairman Donaldson. Do I--I am sorry. I did not----
    Senator Sarbanes. How many people work in the Enforcement 
Division of the New York Stock Exchange?
    Chairman Donaldson. Broadly defined, in terms of both 
enforcement, surveillance, and so forth, I would say close to 
half of their employment is involved in that somehow.
    Senator Sarbanes. How many people would that be?
    Chairman Donaldson. Five hundred fifty.
    Senator Sarbanes. Five hundred fifty people. Well, I am 
interested in that figure because and I am not suggesting this 
as a remedy, but just in terms of the range of thinking that is 
done--it is constantly asserted that unless the Exchange does 
its self-regulation, the alternative would be a huge Government 
agency. I think is the way the phrase is put.
    Now, how many people work at the SEC currently?
    Chairman Donaldson. Well, as you know, we are adding 
people. I cannot give you the exact up-to-date figure, but we 
started at the 3,200 level, and we are moving toward 4,000.
    Senator Sarbanes. Four thousand. The New York Stock 
Exchange, I understand, has 550 doing regulation.
    Chairman Donaldson. That is apples and oranges, though, 
Senator, because, you know, the regulation being done by those 
500 people is very different than what the 4,000 people at the 
SEC are doing.
    Senator Sarbanes. Well, I understand that. But if the SEC 
were to do the regulation that the New York Stock Exchange 
does, conceivably the SEC could do it with an expansion of 10 
to 15 percent in its current staff. I only throw that out to 
try to address this constant assertion that is being made that 
this alternative that maybe it should be done directly by an 
independent Government agency, that has none of these conflict 
problems built into it, would create this huge bureaucracy. It 
is thrown out as though, you know, it is going to require a 
doubling or tripling of the SEC.
    If reasonable resources are now being devoted to it by the 
Exchange--and maybe there are not. Maybe they should have more 
people. But on this current calculation a significant but not 
an overwhelming increase in the SEC staffing would enable 
another alternative to be considered, namely, that the 
regulation be done directly.
    Chairman Donaldson. First of all, you are talking about not 
just one entity, the New York Stock Exchange. You are talking 
about 12 exchanges----
    Senator Sarbanes. So we would have to see what the NASD 
does and others. Yes, that is a reasonable----
    Chairman Donaldson. And all the other players in the 
marketplace, the ECN's and so forth. I mean, you have a major 
array of organizations.
    Senator Sarbanes. But the direct approach would eliminate a 
lot of these conflict problems, wouldn't it?
    Chairman Donaldson. And I think it would bring on a lot of 
bureaucratic problems.
    Senator Sarbanes. It is very clear that some people in the 
system at the Exchange have been prepared to feather the nest 
for everybody else in order to gain--to aggrandize themselves. 
Would you say that is correct? Actually, let me ask the 
question this way because I want to quote. The Wall Street 
Journal on November 3 wrote an article, and it quotes, I guess, 
from an SEC report. I am not sure this report has been made 
public yet. It says,

    The SEC report paints a picture of a floor-trading system 
riddled with abuses, with firms routinely placing their own 
trades ahead of those by customers and an in-house regulator 
either ill-equipped or too worried about increasing its 
workload to care. And it concludes that when the New York Stock 
Exchange does act on investor abuses, the exchange often does 
little more than admonish the specialists in a letter or slap 
them on the wrist with a light fine. The SEC staff is concerned 
that the New York Stock Exchange's disciplinary program is 
viewed by specialists and specialist firms as a minor cost of 
doing business, that it does not adequately discipline or deter 
violative conduct, the report says. It adds that the four 
trading firms have no meaningful compliance programs for 
reviewing their specialists' compliance to various trading 
rules.

    I want to make it very clear at the outset. The report they 
are referring to, as I understand it, deals with conduct that 
took place before Chairman Reed took over and moved in there in 
order to----
    [Laughter.]
    Senator Dodd. The record should note he is smiling.
    Senator Sarbanes. Yes.
    Chairman Shelby. I think that is an acknowledgment.
    Senator Sarbanes. Before he moved in there to try to clean 
this thing up.
    But does the Journal article, in your view, accurately 
describe what has been going on at the Exchange?
    Chairman Donaldson. Senator, you know, that was a 
journalistic review of a confidential report, and I do not 
think that it is perhaps fair for me to comment on the 
journalist's comments on a confidential report in terms of some 
of the language being used by the journalist. And I cannot 
comment on whether any of that language was used in our report.
    And I do not mean to sit here and tell you that there was 
not a failure in supervision and there was not a failure in 
adherence to the rules and regulations of the Stock Exchange. 
And we are addressing that.
    Senator Sarbanes. Aside from the bureaucracy argument--and 
one would have to look carefully at the numbers and make some 
judgment about it--what other arguments are there against the 
SEC assuming these responsibilities directly?
    Chairman Donaldson. Well, I think in talking about 
bureaucracy, I think what you are--what I am talking about is a 
package that addresses a remoteness from where decisions have 
to be made, and a remoteness that will slow down the decisions 
that have to be made in a fast-moving marketplace. There are 
decisions all the time being made on the floor of the Stock 
Exchange by its own--not only the regulatory, the hired 
employees of the stock exchange, but the informal network of 
exchange governors and so forth on the floor that interpret 
those rules and make sure that they are being adhered to. And 
as you know, rules can be interpreted in a lot of different 
ways, so it is a day-to-day activity, and I think it does not 
fit with the concept of a Government agency operating out of 
Washington trying to do that.
    Senator Sarbanes. Of course, it could operate out of New 
York, too. I mean, the Chairman of the SEC could have an office 
right there in New York, and you could have a much larger----
    Chairman Donaldson. That is a great idea.
    Senator Sarbanes. You could have a much larger New York 
staff in order to do that. I mean, the ultimate aim is the 
honesty and integrity of the Exchange and how it works.
    Now, we have a system where we have these self-regulating 
organizations under the oversight of the SEC. Now, if they are 
not producing the result--and, of course, some would argue, 
well, the SEC has fallen down, you know, on the job, for 
instance, on the mutual funds, but we are trying to boost your 
capacities now, and we have some good leadership at the SEC 
now. So we think progress is being made.
    The question then becomes whether the system with the SRO's 
has so much conflict of interest almost built into it and 
abuses that you despair of making that system work in order to 
assure this overarching objective of the honesty and integrity 
of the trading floor there. And it is not clear. I mean, if 
someone said, ``Well, you know, you are going to have to get 5 
times--you are going to have to expand the SEC by a factor of 3 
or 4 or 5, or something,'' then I would say, ``Oh, wow, this is 
really big''--but, you know, just on this preliminary 
examination of this, the numbers are not in that category.
    I guess in part I am sending a message not to Mr. Reed 
because I think he is trying to address this situation, but he 
has to deal with a big constituency up there. And presumably 
some of that constituency is resistant to change. He is trying 
to perhaps go as far as he thinks he can, but maybe it is not 
as far as he should go, and maybe the SEC will reach that 
judgment. And that is something we are going to have to look 
at. But the people that he is encountering who are resisting 
change and shaping up the organization itself in order to do it 
I think should be sent a message that the alternative of the 
direct assumption of responsibility by the Securities and 
Exchange Commission is not something that is so far out of 
proportion that it could not be considered.
    I want to get the debate into a more open environment on 
these important issues, and that is the only reason I am 
putting these questions to you. I think the SEC--I know you are 
trying to make it work, and good luck. But I do not think you 
should just, in effect, find yourself constrained in a way 
where you cannot say to people, well, if you cannot make it 
work, maybe this is going to happen.
    Chairman Donaldson. Senator, I understand your point, and I 
think that I would make a statement in terms of the reluctance 
to change and so forth. I think this is the greatest change 
that the New York Stock Exchange has seen during my lifetime in 
terms of the change of the constitution and the willingness of 
the owners, if you will, the seat-holders, to delegate to a 
totally independent board the future of the stock exchange.
    And then, going back to your original question--is it just 
a matter of bureaucracy?--no. It is a matter of regulation that 
goes beyond law. It goes to integrity. It goes into certain 
concepts of integrity and business conduct that cannot be done 
by red-line laws. I think we have the same thing in corporate 
governance issues in front of us. We write the laws, we have 
independent audit committees, et cetera. But it is going to be 
the personal integrity that goes beyond the law. And I think 
that is what has to be reinstated at the New York Stock 
Exchange. And I think that is what this structure does.
    Senator Sarbanes. Well, I think that is a reasonable point. 
I would make this observation: When the securities laws were 
enacted in the 1930's, at a hearing before the Senate in which 
the representative of the accounting profession was at the 
table, one of the Senators asked, ``Well, now, we are putting 
this whole system into place,'' he said, ``but who is going to 
oversee the accounting industry?'' They were setting up the SEC 
to oversee certain aspects of the securities industry. And the 
response that he got was, ``Well, our conscience will do that, 
Senator.''
    And, of course, they were allowed all these years to 
proceed on that basis. But it did not seem to work, and that is 
now why we have Bill McDonough and his colleagues over at the 
Public Company Accounting Oversight Board.
    Further, I would make one final observation. If the 
exchange were to commit these resources that they were 
committing to these outsized compensation payments, that would 
go a long way to funding an effective enforcement budget.
    Thank you, Mr. Chairman.
    Senator Corzine. Mr. Chairman, would the Chairman object to 
a follow-on question? This leads right out of----
    Chairman Shelby. Would Senator Dodd yield you the time, do 
you think?
    Senator Dodd. No.
    [Laughter.]
    Go ahead.
    Senator Corzine. I actually wanted to ask about this SEC 
report that was reported in The Wall Street Journal on November 
3. Is that going to be made public? If not, why? If so, when?
    Chairman Donaldson. This is a matter where the SEC has 
traditionally not made these internal reports public. I am not 
sure of the law on it.
    I think a referral to Enforcement and an action by 
Enforcement would make these allegations public.
    Chairman Shelby. Senator Dodd.
    Senator Dodd. Thank you, Mr. Chairman. And let me thank you 
once again, Mr. Chairman, for having these hearings, and we 
thank the Chairman of the SEC for being back here. You may want 
to consider moving the SEC building a little closer to the 
Senate. We have a tunnel we are putting in over here. Maybe you 
could arrange it, given the frequency of your appearances here. 
We thank you very much and are looking to hearing from John 
Reed as well when he testifies.
    Let me, if I can, Chairman Donaldson, follow up with a 
couple of questions. I do not know if you had a chance, with 
everything else you have got to do--there was a recent 
article--I think it is about 2 or 3 days old--in Business Week. 
I presume maybe John has looked at this thing, but it is ``Too 
Little, Too Late, Mr. Reed?'' A question mark on the end of it. 
And I want to raise the issue about the governance question, if 
I can, and there has been some discussion about whether or not 
the SEC may do more following on Senator Sarbanes' questions 
that he raised with you.
    The question that I have for you has to do with the 
possibility--or one of the criticisms that is being raised by 
some people. Most agree that the steps that have been taken so 
far are good steps in the right direction, but just on the 
governance question, let me raise this, if I can, with you.
    What the Business Week article says--and I would ask 
unanimous consent, Mr. Chairman, that it be included as part of 
the record.
    Chairman Shelby. It will be included, without objection.
    Senator Dodd. It reports that the plan--and I am quoting--
``allows just 40 members to nominate a director and 100 to 
nominate an entire slate.'' It cites Jack Ehnes--I think that 
is how you pronounce his name, E-h-n-e-s--who is the CEO of the 
California State Teachers Retirement System, he says, ``Having 
members in any way involved in setting up and getting board 
members nominated is a problem. It is a regulatory body with a 
public purpose, and in my mind, that is a clear conflict.''
    The article goes on and quotes some other people as well. 
It quotes this fellow who is the North Carolina Treasurer, 
Richard Moore, as well here. Their concern is that you could 
end up having a wonderful board. This board, I think, that John 
has put together is a great board, but the possibility exists 
for the membership coming in and just getting rid of a board. 
There is a vote every June on the board. And I wonder if this 
has gone--and John will have a chance to talk about this as 
well when he comes up, but I would like your comments. I do not 
know if you have had a chance to look at this. But it is almost 
like you could drive a Mack truck through this when it comes to 
governance. And if you do, then you have got the very people 
back again picking the board again, and you are right back 
potentially where you were before.
    Are you familiar with this?
    Chairman Donaldson. Well, I know you were not here earlier, 
Senator Dodd.
    Senator Dodd. I apologize.
    Chairman Donaldson. I tried to address that question, 
probably inadequately. You have a series of seat-holders, both 
leasees and lessors. Their asset is principally the value of 
their seat, and that seat is dependent upon the perception and 
reality of the New York Stock Exchange having organized itself 
to service and serve the public and to serve the public 
investor. And I think any attempt by the electorate, if you 
will, to move back to something that was not working is not 
what is going to happen because that would be self-defeating 
from a commercial point of view. However, having said that, the 
SEC still has its oversight responsibility. And just as we 
moved at this point, we could move again.
    Senator Dodd. Well, am I taking from that that you would 
object--and the article goes on to suggest--I do not know which 
one of these individuals made the suggestion that the SEC 
should actually approve the board members themselves rather 
than just have oversight. Would you go further?
    Chairman Donaldson. Well, we basically are interested in 
comments such as yours that will be coming to us as people look 
at this proposal. And, you know, we will take a look at the 
comments. We will take a look at the questions that you put up. 
We will take a look, I am sure, at a lot of other questions. 
And I go back to what I have said before and what the 
Commission has said: This is a first step. This is a first 
step, and I think you cannot take all that has happened at the 
New York Stock Exchange, all that needs to happen, and take it 
out of the context of the reality now of needing to do 
something now. I think a structure has been brought in. I think 
there are people of the highest integrity involved. I think we 
probably should give them a chance to address some of these 
issues. And, again, I do not think this is the last step. I 
think it is a first step. And I do not want to prejudice where 
the Commission is going to come out on even this first step.
    Senator Dodd. I understand that, and I appreciate your 
point. It is a very rational and reasonable position to take. 
But also having been around here a number of years, there are 
moments when there is attention on these questions and that we 
will move on to other issues--we already are--involved with the 
mutual fund industry. There are going to be issues involving 
the GSE's. There are all sorts of questions coming up, and it 
is the natural inclination of these institutions and others for 
their attention to get diverted. And so there is a moment here 
in which we need to obviously take a look at all of this, and I 
agree with you that it has to be done thoughtfully and you need 
to think about what you are doing in all of this. And I do not 
need to tell this to you, obviously, as someone who has spent 
an adult lifetime working in this industry, how critically 
important this exchange is. Of all the exchanges, this is the 
gold-letter exchange. This is the one the world really looks 
to, and a sense of confidence in it, for investor confidence 
issues.
    So there is a special responsibility, in my view, to really 
get this right and to send a message to people that we are 
getting it right. And, again, you can go overboard on this, and 
you have to be careful in doing that. But I would hope there 
would be some sense of urgency tempered by being responsible 
and thinking clearly through all of this, but that we do not 
miss this hour in time as other issues overtake us and we move 
on to other questions.
    So things like the question of is the chairman of the board 
going to be independent, whether or not there is going to be a 
good oversight or just kind of we will look at it when problems 
arise, I would like to hear more. And I am not going to press 
you on it today, but I would like to have you get back with 
some of these ideas and suggestions and give us some sense of 
where we should go.
    Chairman Donaldson. I think your comments are well taken, 
and without going overboard on my own observation, because John 
Reed has had to contend with what is going on in the Stock 
Exchange right now, but I believe that the very vote that was 
taken, the fact that it was an almost 100-percent vote for 
radical change, indicates something about the attitudes of that 
group of people there. And I also think, the structure that has 
been put forth and the type of people who have been brought on 
board as new directors says something about the new leadership.
    I look forward to hearing the comments. I look forward to 
watching this thing evolve. And, clearly, the necessity now, I 
think, is to take a first step but to recognize it as just 
that, a first step.
    Senator Dodd. Thank you.
    Mr. Chairman, Senator Sarbanes--and this may have been 
asked as well, so I will not pursue it. But on this inherent 
tension between the notion of being the regulator as well as 
creating the market issue--and you have addressed this in your 
comments--and whether or not the proposal that has been made 
fashioning the independence of the board and the independence 
of the regulatory function, how you marry those in an effective 
enough way so you can create the kind of confidence that there 
will be a solid oversight function is really rather critical. 
And I hope you will give that a lot of serious thought and get 
back to us. But I think Senator Sarbanes' line of questioning 
in that area--I regret it deeply. I have been a great advocate 
over the years of SRO's. I am saddened in many ways that we are 
even talking about having to go this route. But I do not know 
of anything to do in the short-run, but to get you more 
involved in this and get the SEC more involved. I wish I could 
think of some other idea that would not have to move us in that 
direction. But I do not think we are going to rebuild investor 
confidence in the country without the SEC getting a lot 
stronger. Maybe we will be able to come back to it at some 
point, but for the time being, I think we make a mistake if we 
assume that we can just rely on what has, fortunately, in many 
ways worked very, very well for many years, but does not seem 
to be doing the job today. So, I come down on the side of 
getting you more actively involved in this, the Commission I 
speak of.
    Thank you, Mr. Chairman.
    Chairman Shelby. Mr. Chairman, I just want to go back 
briefly to the specialist role. I wish Senator Schumer were 
here now. He talked about it. Others did, and Senator Sununu 
asked some very important questions about some things that went 
on at the market and what has happened.
    I just throw out to you that we all know that the New York 
Stock Exchange is very important to all of us as the capital 
markets. It is the largest. But there are other markets, and my 
predecessor here, Senator Gramm, used to talk about when the 
candle makers of America came to Washington to try to block the 
idea of electricity and the light bulbs for everybody that 
Edison came up with, and you know that story. But you also 
know, Mr. Chairman, you cannot block technology. Technology 
will ultimately prevail.
    So how do we implement or integrate technology into a 
system where it has been the human being, you know, executing 
orders and so forth? Because I do not believe technology is 
going to go away. Can you manipulate technology? Absolutely. 
Humans learned to do that a long time ago. But humans 
manipulate a situation, as you well know, and he alluded to it 
earlier.
    Whenever we are looking at the New York Stock Exchange or 
any market, I think to try to think technology in the future, 
the electronic market is not going to play a role, I think that 
is nonsense. You know, I think you have to do it. How you do it 
I do not know. But you cannot protect people from progress. The 
technology will trump it--or generally will. You might regulate 
it. You might try to do this. But, you know, I think history is 
a guide there.
    Senator Sununu, I believe you had another question.
    Senator Sununu. And it certainly relates to some of the 
points you were making.
    Mr. Donaldson, do you consider the terms ``best price'' and 
``best execution'' to be synonymous?
    Chairman Donaldson. Well, I think that there are different 
concepts of what best execution means to different people. 
There are certain people who consider the best execution to be 
an immediate execution. There are certain investors who are 
willing to sacrifice getting the best price in order to get a 
rapid execution. And that is the essence of the electronic 
markets, the ECN's, versus the New York Stock Exchange. And 
that has been exacerbated by the decimalization and the penny-
ization, if you will, because the benefit of gaining an extra 
penny may be not worth the wait to some people. But if you 
really get into what goes on in a market and the amount of 
transactions that take place at a single price point, you have 
to get below that--into spreads that are larger than pennies, 
and then price improvement really does mean something.
    But I think the concept of best execution--I refuse to 
believe in my own mind based on my own experience that the 
concept of an organization that gets the best price for 
somebody is something that gets easily thrown away. Again, I 
will let Chairman Reed speak for the New York Stock Exchange. 
But I believe that the liquidity that is inherent in and 
developed on the floor of the stock exchange--again, I am 
repeating myself--in times of stress is unique. And I also 
believe that the meshing of human intelligence with technology 
is where things are going. And I think there is a 
characterization of the New York Stock Exchange, of a floor and 
people running around on that floor, that is an outmoded model. 
I think the technology on the New York Stock Exchange is 
cutting-edge. The electronics on the New York Stock Exchange 
are cutting-edge. It is just a matter of how much electronics 
and how much human judgment you use and put together and then 
mesh that with the ECN's.
    Senator Sununu. Would it be appropriate to paraphrase your 
answer as no?
    [Laughter.]
    Chairman Donaldson. I will let you do that, sure.
    Senator Sununu. And I do want to explore this a little bit. 
It is obviously relevant to the points made by the Chairman, 
but it was brought up, I think, in some of the opening 
statements as well. And I appreciate and agree with the 
important points you make about technology and the utilization 
at the NYSE and the liquidity role that it plays and the 
important role that it plays in our capital markets. And I 
think you would have a hard time finding any disagreement on 
this Committee about those points.
    But if someone wants to sell 100 shares of stock and an 
investor has placed a bid to buy 100 shares of that stock at 
$20 and a specialist sees that bid to buy 100 shares of stock 
at $20 and chooses to buy 100 shares for $20.02 on their own 
account, would that be appropriate?
    Chairman Donaldson. Well, that particular circumstance you 
set up--I mean, the specialist has both an affirmative and 
negative obligation, and the specialist steps in--in terms of 
his affirmative obligation, the specialist steps in to make a 
market when the market--is to close the market and narrow the 
spread.
    Senator Sununu. To make a market--to narrow the spread or 
to make a market when one is not available? Those are two 
different things.
    Chairman Donaldson. Well, both. I mean to make a market and 
to narrow the spread.
    Senator Sununu. So you think that is appropriate? The 
hypothetical I just described where there is a bid to buy 100 
shares at $20, someone is offering to sell the shares at 
market, and the specialist buys on their own account for 
$20.02, that is appropriate?
    Chairman Donaldson. I think the particular thing you are 
saying is that the specialist was stepping ahead in that 
instance, and that is----
    Senator Sununu. I am sorry. I do not mean to be flip, but I 
really did not think it was that tricky a question. Is it 
appropriate or not appropriate?
    Chairman Donaldson. State it again, Senator.
    Senator Sununu. Senator Shelby wants to sell 100 shares of 
stock. He says, ``I am going to sell this stock at market.'' 
Sell it at the market. I want to buy 100 shares of stock, and I 
offer $20. The specialist has Senator Shelby's request, has my 
offer, my bid to buy at $20, and buys the shares, 100 shares, 
at $20.02 for their own account.
    Chairman Donaldson. No sir, he would be stepping ahead of a 
public bid.
    Senator Sununu. I would be inclined to agree with you. I 
just wanted to make sure that that was your answer, because 
that is a clear case where the person selling the shares got 
the best price--got a better price than what I wanted to buy 
them at, but it was not appropriate behavior, it was not right. 
And it is a simple point, and I think maybe most people 
understand it. But the best price only is not always the best 
execution. It is not always legal. It is not always legal, 
because if you are using proprietary information to take 
advantage of your position in a way that is not fair to the 
markets, then the markets are not being well-served, and 
ultimately customers are not necessarily being well-served.
    So, I am sorry to belabor the question, but I wanted to 
make sure that you answered in a way that you were comfortable. 
And certainly if I misunderstood anything, feel free to correct 
it for the record.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Corzine, would you like to ask any 
more questions?
    Senator Corzine. I actually will repeat the question on the 
report because I did not hear the answer exactly. You are 
saying because it was involved with an enforcement action or 
mentioned or involved enforcement proceedings that it, 
therefore, would not be made public?
    Chairman Donaldson. No, what I said was that the report 
that the SEC gave to the New York Stock Exchange is a 
confidential report. A second step here would be a 
recommendation by our Inspection Division to refer that report 
to Enforcement.
    If Enforcement decided, based on their own investigation, 
that an enforcement action was warranted, then an enforcement 
action would be taken, and that enforcement action would be 
made public, and the reasons for it would be made public. But 
during the enforcement process where the reinvestigation is 
going on, you would not divulge that. But it would come out if 
an enforcement action were taken.
    Senator Corzine. Certainly the elements of discussion that 
at least were categorized in the newspapers--again, commenting 
on comments of private memos is never an attractive element, 
but the commentary that surrounded the nonenforcement elements 
of it seem very germane to the discussion that we are having 
with regard to forming judgments about where one would go with 
some of these structural issues that we talk about, and maybe 
ultimately some of the corporate governance issues, very much 
germane to that discussion. So that to the extent that the 
elements that did not deal with Enforcement but were 
categorization, it would certainly be useful for those of us 
who are forming judgments about--or at least want to 
participate or have a responsibility to participate in the 
discussion have the best information available.
    Thank you.
    Chairman Shelby. Mr. Chairman, we appreciate your coming. 
Again, as everybody says, we have a place for you back in the 
back here. You are welcome again, and I know you will be back. 
Let us continue to work for the right thing here.
    Chairman Donaldson. Thank you.
    Senator Dodd. We thank you for what you are doing.
    Chairman Shelby. We do.
    Senator Dodd. If the questions seem a little tough in some 
cases, it is because it is obviously a deep concern we share. 
But many of us have said it. I have said it before and I will 
say it again: I think you are the right person for the job 
today, and I have a lot of confidence in the work you are going 
to do.
    Chairman Shelby. I do not know if the Chairman is glad he 
took the job, but we are glad he did.
    [Laughter.]
    Thank you.
    Chairman Donaldson. Thank you.
    Chairman Shelby. We will go to our second panel, Mr. John 
S. Reed, the Interim Chairman of the New York Stock Exchange.
    Mr. Reed, we appreciate your indulgence here today. These 
are important issues not only for the Senate Banking Committee 
but also for all Americans. Your written testimony, which we 
have, will be made part of the record in its entirety. If you 
would, sum up your points as quickly as you can, because you 
can tell the day is moving fast.

                   STATEMENT OF JOHN S. REED

                    INTERIM CHAIRMAN AND CEO

                    NEW YORK STOCK EXCHANGE

    Mr. Reed. Yes, Mr. Chairman and Ranking Member Sarbanes, 
thank you very much.
    If you could add for the record, to my written comments a 
copy of our proxy.
    Chairman Shelby. We will do that without objection.
    Mr. Reed. Let me just very quickly summarize what I would 
like to say to you.
    First of all, let me say I enjoyed the prior session and 
could have stayed here listening for quite a while. Much that 
was discussed is quite germane, of course, to what I have been 
trying to do. And I am only sorry I could not have participated 
a little.
    I was called in to deal with what was a serious breakdown 
in governance. The exact circumstances of what happened are not 
yet 100 percent clear, maybe never will be, but clearly we had 
a very fundamental breakdown in governance at the New York 
Stock Exchange which resulted in the departure of Mr. Grasso 
and my coming in. And my mandate was pretty simple: Try to 
understand what happened, propose a new governance structure, 
find a replacement for myself, and return to retirement. And 
that is what I am trying to do.
    As you know, I did submit to the membership recently a 
proposal for a new governance structure that reflects my 
thinking on this subject and my assessment of what is going on 
and, in fact, my concern about many of the issues that have 
been raised here this morning.
    The proposed structure, very simply, is that we create an 
outside independent board of directors--we have a slate of 
eight people that were voted for by the members on Tuesday--and 
that we maintain our contact with the industry through the 
mechanism of what we call a board of executives which consists 
of the customers of the Exchange, the owners of the Exchange, 
and the operators of the Exchange. This will be a forum that 
allows us to deal with the substantive issues associated with 
market performance and the evolution of market structure, but 
it will be a forum that is totally separate from and distinct 
from the responsibility with regard to governance of the 
Exchange itself and the fiduciary responsibility that the board 
of directors has to the New York Stock Exchange.
    I happen to think that it is a pretty good structure. I 
think it very clearly resolves the problem that we were trying 
to deal with in the first instance, which was the breakdown of 
the governance structure as it had to do with compensation and 
management of the Exchange itself. But, frankly, when I was 
looking at what to propose, I did not look only at how to 
resolve that problem. I really wanted to position the Exchange 
to be in a place where it could deal with all these very 
important issues that the Committee has been talking about.
    I did not try to deal with these issues in my proposal. I 
did not think it was appropriate that you bring in somebody on 
a temporary basis and try to deal with the very important 
issues that you are talking about. What I did was try to create 
a structure that would be robust and would serve the investing 
public well and serve the Exchange well.
    And so what I have proposed is an outside independent 
board. It will be responsible as a fiduciary for the well-being 
of the Exchange and the American public in that sense. They 
clearly have the capability. The people that I recommended for 
the original slate were people who have had experience as 
chairmen of big public companies, because the breakdown of our 
governance clearly reflected the fact that the prior board was 
ill-equipped to deal with some of the responsibilities that are 
associated with a good board of directors. There are four 
people on that list who have been chairmen for an extended 
period of time of major public companies.
    I also recommended a number of people for that board who 
know something about markets and finance, and more importantly 
from my point of view, I put a good number of people on that 
board who know an awful lot about technology and are 
analytically strong, because some of the issues that have been 
raised here about the structure of markets and what constitutes 
good execution, ultimately are problems that are going to 
require important analysis.
    We have a two-tiered structure in the sense that the 
discussions that require the input of the customer, be it on 
the buy side, be it on the sell side, or be it our listed 
companies, are going to be well represented on the board of 
executives. I have set it up so the board of directors can 
listen in, but this committee has nothing to do with the 
responsibilities of the board, and I frankly think it is a 
structure that is going to serve the Exchange well, and I think 
deserves the support of this Committee.
    Everything can be improved upon. I do not have any doubt 
that as time goes on this also--but I think it is a good first 
step. I simply say to you that I think it is something that the 
members have voted for, indicating their own recognition of the 
need to make this kind of change. I look forward to your 
questions, where we can draw out some of the subtleties that 
you were talking about before.
    Thank you.
    Chairman Shelby. Mr. Reed, thank you very much.
    Some contend that you cannot eliminate the conflicts of 
interest at the Exchange unless you change the ownership 
structure. Some believe that as long as the business operations 
and the regulatory function are located in the same entity, 
then regulation will always be a secondary function. How do you 
respond to that assertion?
    Mr. Reed. I do not believe that is an accurate case. I 
think it is very much in the interest of the Exchange that it 
be well regulated. I believe that regulation of the Stock 
Exchange is like quality control is to Toyota.
    Chairman Shelby. Do the members know that? I agree with 
what you are saying. It is in the long-term interest of the 
Exchange to have no conflicts, no ethical problems, none of 
that, but do all the members know that?
    Mr. Reed. I would not say all. Clearly, there must be one 
who does not. But my experience with the Exchange is that they 
have been sobered by the recent problem with Mr. Grasso and I 
think that the vote says something about what the Exchange 
thinks, and I believe that the members know full well that the 
integrity of the Exchange lies at the foundation of the 
Exchange.
    Chairman Shelby. It has to be number one, the integrity of 
the Exchange?
    Mr. Reed. It is number one. You have no market if you have 
no integrity. I think they fully understand that, so I do not 
see this inherent conflict.
    I would also point out to you that 900 of the 1,400 members 
are retired, and so they just look at this as an economic 
interest. They are not active on the floor of the Exchange.
    Chairman Shelby. They own the seats.
    Mr. Reed. They own the seats, and they have rented them 
out, often to Merrill Lynch and to others who need to have 
seats on the floor, but they rent them as opposed to owning 
them.
    But the point is, these votes, which are more than 900 out 
of 1,400, a pretty good majority, these are people whose 
primary interest is in the economic well being and hence the 
integrity of the Exchange.
    Chairman Shelby. Mr. Reed, you stated that the Exchange's 
regulatory arm should not be separated because regulators 
really have to be engaged with the members in order to be 
effective. It seems to a lot of people that the securities 
industry is one of the few major industries that continue with 
self regulation. Are there unique factors that make self 
regulation more appropriate in the securities markets than any 
other industries? If so, what are they?
    Mr. Reed. I think really, Senator, if you look at it 
carefully, all of your work with regard to audit committees and 
all the efforts with regard to public companies, we rely on the 
audit function that is contained within companies to ensure the 
integrity of the operation of those companies, and that is true 
in the banking industry or with regard to the internal audit.
    It is true that we have external auditors in the banking 
industry, but they rely tremendously on the internal audit 
capability. Much in the legislation of Sarbanes-Oxley was 
designed to ensure that the audit committee could supervise 
appropriately the internal audit function, and that they 
certify that the accounting is done properly, and that they 
certify that controls are in place. So the fact of the matter 
is, we rely on self-audit and self-regulation throughout the 
entire private sector. We are not saying sole reliance. In the 
case of individual companies you tend not to have an outside 
agency that then sits on top of the auditors. In the financial 
community, be it banks, be it the New York Stock Exchange, you 
have banking regulators and the SEC that sits on top of the 
internal capability, the self-regulating capability, and have 
the capability to oversee and intervene, as Chairman Donaldson 
just said, if they believe that is not being carried out 
properly.
    But the essence of what you all have put in Sarbanes-Oxley 
with regard to the oversight of the internal audit function of 
corporate America is contained in our proposal here. It is the 
committee of the board of directors, which is comprised totally 
of outsiders, to sit on top of the regulatory arm, approve the 
budget, the staffing, the compensation, the audit plan, so 
forth and so on. It is exactly the same as exists in the 
Sarbanes-Oxley Act to ensure that that internal function is 
held to the highest standard. There are no foxes in the chicken 
coop.
    Chairman Shelby. But there are no criminal penalties there.
    Mr. Reed. With regard to?
    Chairman Shelby. The self governance.
    Mr. Reed. I am not a lawyer. I do not know about criminal 
penalties.
    Chairman Shelby. Sarbanes-Oxley has some criminal 
penalties.
    Mr. Reed. The board of the Exchange must come under those 
same laws with regard to their duties, and so it seems to me 
that that board that I am relying on to ensure that we get the 
integrity that we must have, that board which surrounds the 
self-regulatory process, has the same obligations to the 
public, I believe, as any public board would have.
    Chairman Shelby. Mr. Reed, what is your reaction--we have 
already been talking about and you have been here in the 
hearing--what is your reaction to allegations of trading 
misconduct by the specialists? Senator Sununu asked the 
Chairman about that, the status and so on.
    Mr. Reed. We clearly discovered that there were instances 
where the specialists misbehaved. That was originally 
discovered by the internal surveillance at the New York Stock 
Exchange. It later, as Chairman Donaldson says, was expanded in 
terms of its scope.
    Chairman Shelby. Is this widespread? Some people believe it 
is widespread.
    Mr. Reed. Let me try to put it in context. We looked at 3 
years of activity in all shares. Approximately a billion 
transactions would have occurred in that time. Something less 
than a million transactions appear to us, ``us'' being both the 
SEC and the enforcement arm of the Stock Exchange, to have been 
inappropriate. They fall in three different buckets. We are in 
the process now of trying to ascertain, of those approximately 
one million transactions, just to what extent they were 
improper and to what extent they were not. Clearly, some 
significant portion was improper.
    So, I would say there clearly were failures. There were 
failures to follow the rules, and the people involved, there 
are 450 individuals who work as specialists on the floor of the 
Exchange every day. There is some lumpiness, that is, this 
behavior is not uniformly distributed across 450 individuals. 
Some people have already been dismissed. It is quite likely 
that those people will never again work in any exchange.
    There are some problems that are pretty evenly distributed, 
which causes an analyst to say there is a systemic problem. The 
great difficulty here has to do with a category where a 
specialist intervened in a transaction that would appear not to 
have been proper if you take into consideration that there was 
an electronic order on the book and if he had done his job 
properly he would have paid attention to it, but he did not.
    We have corrected this going forward by putting a computer 
fix in so that the specialists cannot hit an execution button 
if that information is on the book. It stops him from being 
able to do it. That was not there in the years we are talking 
about.
    Chairman Shelby. Stopping them, rather than the specialists 
stopping themselves.
    Mr. Reed. The question is, and this is the----
    Chairman Shelby. True, though?
    Mr. Reed. Yes, sir. The question is, how long does that 
information have to be displayed for a reasonable person to 
decide that the specialist should have seen it? That is what I 
call waving for a taxicab in the rain. How often do you have to 
wave before you decide, the taxi did not want to stop. It was 
not that it did not see me, but he did, but nonetheless went 
on, which I would tell you happens in New York. But it is 
illegal. Taxis are supposed to stop, but it happens.
    We have sliced it down to 5-second intervals. If you take a 
look at the incidents, in the difference between using a 10-
second slice and 15-second slice there is a tremendous decay. 
In other words, if you say 10 seconds is the criteria, there 
are many more instances of missed opportunities than if you 
take 15 seconds. Obviously, the problem is to find out--and we 
will find out. There are mechanisms for finding out, and I was 
talking to some of the enforcement people in the SEC yesterday. 
I want truth. I am not trying to whitewash the specialists. If 
a specialist misbehaves, that hurts all of us because we 
promise the American public that if you go to the Exchange you 
will get a fair and decent transaction.
    Senator Dodd. Is misbehave the right word?
    Mr. Reed. Pardon?
    Senator Dodd. Misbehave has a tone or tenor to it that 
almost sounds venial. I mean we are talking about violating the 
law, are we not?
    Mr. Reed. I do not know if it is law or not, Senator. It 
certainly is regulation. There are very detailed rules on how 
specialists are supposed to operate. This violates these rules.
    Chairman Shelby. The Senator makes a good point.
    Mr. Reed. I do not know if they are embedded in the law or 
not. If they are, then they are violating--as far as I am 
concerned, if we do not serve the customer properly, we have 
failed.
    Chairman Shelby. Whatever it is, it is either illegal or 
unethical, is it not?
    Mr. Reed. And it is wrong, just wrong, period.
    Chairman Shelby. Both of those would be wrong.
    Mr. Reed. But my point is, to the specialists, and I have 
met with the head of the specialists, my point is if it is not 
right from a customer's point of view, I do not care what 
excuses, why, then it is not right, and we, (A) have stopped 
it, but (B) you are going to pay the money back, and (C) you 
are going to pay a fine. If there is a pattern----
    Chairman Shelby. Do they keep on being a specialist too?
    Mr. Reed. If there is a pattern of abuse that focuses on an 
individual, the answer is no. We will have to go to court 
because you are taking away a person's ability to work, but 
they will not be working as a specialist.
    Chairman Shelby. You are not going to be reluctant to do 
that, are you?
    Mr. Reed. I am not at all reluctant to do that, and I do 
not think that the owners or the major specialist firms are 
reluctant either.
    Chairman Shelby. Mr. Reed, a lot of people have brought up 
that the allegations surrounding specialist trading practices 
are symptomatic of the New York Stock Exchange by its 
regulatory structure. Assuming that the SEC approves your 
reform proposals and that the Exchange fully implements the 
reforms that you have brought forth, what additional reforms do 
you think that the Exchange must adopt to strengthen its 
regulatory function in light of recent criticism? Are you to 
that point yet?
    Mr. Reed. Clearly the criticisms are justified, and there 
is reason to assess where we are as a regulator. I intend to 
recommend to the new board, when we get it installed, that the 
first thing we do is that we bring in some outside experts, do 
a review of our regulatory competence, and use that as the 
basis for change to our regulatory function. Frankly, the idea 
of outside peer reviews of regulators is a very valid, and I 
think a potentially strong tool, to rebase and rethink just how 
good are we.
    Chairman Shelby. Mr. Reed, you are very familiar with the 
criticism that the reform proposals are lacking because they do 
not mandate an independent chairman. Also, what is your current 
thinking on whether the exchange should have an independent 
chairman, and if not, why not?
    Mr. Reed. I did not hard-wire it into the proposal changes 
to the actual constitution of the Exchange because I did not 
want to put future generations in a position where, every time 
you change chairmen, you have to go back to have a vote to 
change the constitution in the event that they do it 
differently. What I said is that we could either have a 
chairman and a CEO separate, or you could have it together. If 
you have it together you must appoint a lead director as in 
Sarbanes-Oxley, so I simply mirrored the private sector.
    I frankly do not know which way we are going to end up 
going because finding the right person for this job is 
important. If we had a person who was exceptional but only was 
interested in the job in the event that he or she could have 
both chairman and CEO role, I sure would prefer that than to 
have a less competent set of people in a split role. I happen 
to have some personal sympathy for the idea that a split role 
may turn out to be a more appropriate one at this time. We do 
not yet have a board. It is very difficult for me to do my job. 
I do not want to be a dictator, talk about bad corporate 
governance. Having a visiting chairman is not great corporate 
governance.
    Chairman Shelby. He may not be a dictator, but it is a real 
time for leadership.
    Mr. Reed. It is a time and I think I am trying, without 
overstepping, to do that. But I am intending to meet with the 
proposed new board to see if they would allow me to move 
forward to bring to them, when they become legal, candidates 
for my position. I am going to press them. I have my own view, 
but I would like to get the benefit of their view as to whether 
they think a split is better or not. But we do provide for the 
lead director, and all of the responsibilities of the lead 
director with the board in the event we happen to end up with 
one person in the chairman and CEO role.
    Chairman Shelby. Mr. Reed, I understand you hired an 
outside law firm to examine the circumstances surrounding the 
approval of Mr. Grasso's pay package. What have you learned 
from that investigation?
    Mr. Reed. Nothing yet. I have asked Mr. Daniel Webb to give 
us a verbal briefing on Monday of next week, and he is 
intending to give me a written report around the first week of 
the month of December.
    Chairman Shelby. Will you share that with us?
    Mr. Reed. I probably would prefer not to.
    Chairman Shelby. We might have to get you back down here.
    Mr. Reed. Not having seen the report, it is a little----
    Chairman Shelby. I know.
    Senator Sarbanes.
    Senator Sarbanes. Let me just follow right up on the 
Chairman's question, because I was going to pursue that line 
myself. The Financial Times on November 6 wrote an article 
about bringing in the outside investigative attorney and former 
prosecutor, Dan Webb, to look into this matter. The article 
states that you expect to receive Mr. Webb's report by December 
1, but that the report's findings will not be made public. The 
article goes on to say in justifying the decision to keep the 
report private, you said it could be highly embarrassing.
    That does not strike me as an adequate rationale for 
keeping the report private. Is that the rationale for it?
    Mr. Reed. I have not seen the report, so I have no basis on 
which to form an opinion one way or another. Obviously, I have 
learned over the years that when something goes wrong, and 
something clearly did here, you better figure out what actually 
happened, and because to rely on the press or a similiar source 
to tell you what happened is simply a mistake managerially.
    I hired an outside law firm because I felt that having the 
confidentiality surrounding a lawyer-client relationship was 
important, and it was important to get people willing to talk 
to this lawyer. They are not obliged to do so by law. I did 
meet with the board of directors and ask that they all be 
willing to meet with Mr. Webb. They all have. I understand Mr. 
Grasso is meeting with Mr. Webb this week. I do not know that 
that is true, but that is what I was told. So everybody has 
been cooperating with Mr. Webb.
    I think they cooperate with him in part because they 
understand it is important. We know it happened, but I think 
they believe there is some degree of confidentiality with 
regard to what they might say, and having that assurance helps 
in the process.
    It is extremely important for us to understand what 
happened and it obviously is the basis I am going to use for my 
continued discussions with Mr. Grasso because there is a 
contract that was signed with him that is floating out there. 
He indicated publicly, but to my knowledge never in writing, 
that he intended to waive payments that he might potentially 
claim under that. I have no knowledge as to what he currently 
intends. I have never either met or spoken to Mr. Grasso, and I 
do not intend to until I have the benefit of seeing this 
report.
    Obviously, the purpose of the report was to help me in my 
job, and to help the Stock Exchange, and it probably is a 
better report because it does have the potential of staying 
private.
    Chairman Shelby. Senator Sarbanes, can I ask him a quick 
question?
    Senator Sarbanes. Certainly.
    Chairman Shelby. You plan to share that report once it is 
finished with the SEC?
    Mr. Reed. Again, I have made no commitments whatsoever. I 
did tell the SEC at the beginning that I was doing this. The 
SEC asked if they could talk to Mr. Webb to be sure that the 
scope of the investigation was something that they felt was 
appropriate. I understand they did speak to Mr. Webb. I did not 
check. I just know that they met. I assume, but do not know, 
that the SEC thought the scope was proper. If I think it is the 
right thing to do, and I think my objective here is to serve 
the New York Stock Exchange and the American public, I would be 
quite happy to share this with the SEC, with the Committee, 
with whomever. I just do not want to be on the record up front, 
not having seen the report, not having any idea what is there. 
As you know, one has to be cautious in this modern world just 
throwing raw material out into the public domain.
    Senator Sarbanes. I will take that for now, although I 
again underscore, I do not think embarrassment is an adequate 
rationale.
    Mr. Reed. I do not either, Senator. If that was the 
question, I share your view. Embarrassment is not the 
rationale.
    Senator Sarbanes. On November 11, the Financial Times had 
an article that said ``The big board must end its costly 
costume drama.'' They went on in an editorial and said, ``Even 
at a theoretical level, the specialist system makes little 
sense for the top 500 listed U.S. companies. Why have a middle 
man to ease trading in the most liquid stocks in the world? In 
practical terms it is a recipe for abuse. Specialists can trade 
ahead of large customer orders, using privileged knowledge to 
make proprietary profits or favor other investors.'' The 
article went on: ``While specialists have a place for illiquid 
small cap stocks, an electronic auction book is sufficient for 
large listed companies.''
    I would like to get your view of that comment, because this 
issue is being raised in a lot of places. I would just be 
interested in your response to that.
    Mr. Reed. I disagree with the editorial, and I think it is 
superficial. It seems to me that the auction market, which is a 
combination both of the specialist and the broker, is quite 
robust, and seems, from everything I have seen, to be extremely 
effective at what it tries to do. It is true that under normal 
circumstances for the most liquid stocks, the role of the 
specialist, per se, is minimal. Five hundred is a big number. I 
think the most liquidity is much smaller than 500 stocks. But 
if you really look at it, what exists in the Exchange today is, 
number one, an electronic capability that does exist--we call 
it Direct Plus--to go into the market electronically and 
consummate a transaction at the then-price. There is no price 
improvement. It is the then-price, and it is an ECN built into 
the Exchange for all practical purposes, and about 7 percent of 
our transactions are done that way. We could expand its 
capacity as time goes by.
    If you are a computernik--and I have written code and know 
a little bit about computers--and you say, okay, how could we 
automate this thing? You could imagine that you could replicate 
the specialist function because it is pretty rules-based, and 
you could replicate it with an intelligent system, and it would 
be an expert system. It is not trivial, but it is probably 
doable. It becomes the second feature of the specialist system 
that is more difficult to replicate. They put capital at risk, 
on an average day about $5 billion. So you would have to, on 
the other side of this computer, have somebody willing to allow 
the computer to commit capital. In other words, the specialists 
create liquidity. An ECN finds a market, but it does not create 
any liquidity. The specialist system actually injects liquidity 
into the market by the specialist buying or selling securities, 
and as I say, on a typical day $5 billion, not a trivial sum.
    The thing that would be hardest to replicate, 
interestingly, is the broker. There are two ways to get through 
to the specialist. One is to put an order on the screen, what 
we call a DOT system, where you have an electronic introduction 
of the transaction, and the other way is to hand it off to a 
broker. Now, to write a computer program that would tell a 
broker--just imagine you go to Sotheby's and you want to buy a 
Picasso, and you are going to write a computer program that is 
going to tell your representative in the auction there when to 
raise his paddle. That depends on getting a feel for the market 
and seeing who else is waving paddles. I have watched--and I 
will tell you, I think you could write a expert system to 
replicate the specialist much more easily than you could write 
a expert system replicating when the broker goes into the 
market and how he or she presents the order.
    There is important price advantage for an investor in 
utilizing the broker's activity. In other words, I would guess 
from what I have observed that if you hand an order off to a 
broker who then goes and deals with a specialist, you could see 
very significant price improvement, whether you are buying or 
selling, because the broker senses whether he is going to wait 
a half an hour and come back because the customer wants to buy 
and he sees the market is going down. A computer, boom, you 
have done it. You bought. You bought at whatever the price is. 
The broker has the choice of when to introduce the order and 
there is important price benefit.
    Is there room for an ECN? There absolutely is. Do we have 
an ECN embedded in the New York Stock Exchange? Yes, we do. It 
is called Direct Plus. It is a pure computerized execution. 
Could we expand Direct Plus, because it is limited now to 1,000 
shares plus an odd lot, so 1,099 shares. So it is designed for 
people like you and me who might buy 500 shares or whatever. 
That is an ECN embedded today in the Stock Exchange. You get 
the price of the market the instant that the order happens to 
hit. Can you present yourself electronically to the Exchange so 
that the specialist sees your order there electronically? Yes. 
About 70 percent of the volume, 99 percent of the transactions, 
but only 70 percent of the volume goes that way, because the 
people who understand the market tend to go to a broker and get 
the benefit that the broker offers in terms of introducing the 
order at a time that is appropriate to the order.
    Would I, as an average citizen, want to throw away that 
market? I would not. I think, contrary to the Financial Times, 
that there is room to have a specialist system even on a very 
liquid stock because even on a very liquid stock, it is like 
buying and selling a house. If you want to sell your house and 
you say, I have to do so in the next 2 weeks, the price you get 
is going to be quite different than if you say I am willing to 
wait a month or two. The advantage of this auction system, the 
specialist is wonderful. We love him. And he injects capital 
into the market and facilitates the functioning of the market, 
but it is the combination of the broker with the specialist 
that constitutes the auction system.
    There is much greater robustness there than is visible to 
the naked eye, and no one is going to accuse me of not 
believing in computers. I spent my life trying to computerize 
the world, and I love ECN's and so forth. I will tell you, I 
have written a lot of software. I would hate to try to 
replicate that full auction market with an expert system.
    Now, it can be done. I mean, we have bombs that seem to be 
able to fly through windows and buildings. I am not saying that 
it is inconceivable that it be done. But it is a difficult task 
right now.
    So my sense, Senator, is where we are going to end up is 
going to be with a hybrid system. There are going to be ECN's. 
They will be on the floor of the New York Stock Exchange. They 
could be in California or wherever. But there is going to be an 
auction market also. And, interestingly enough, the more 
sophisticated people--I do not mean the bigger buyers; I mean 
the more sophisticated people--understand that that auction 
market does significantly improve the price you get if you are 
selling or the price you pay if you are buying. And I would 
really be quite concerned about taking it away as an 
alternative. I do not say everybody must use it, but it should 
be there.
    The other thing is when you have disruptions in the market 
and it is not smooth, then a system that has the combination of 
brokers and specialists has a robustness that is going to be 
awfully hard to write into a bunch of computer code.
    Senator Sarbanes. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Schumer.
    Senator Schumer. Thank you, and what you said is music to 
my ears, Mr. Reed.
    I think it is interesting that much of this hearing, which 
was dedicated to governance, has moved to market structure. I 
believe the reason is a very simple one. The two have some 
relationship, although many--I would say many--who were against 
the specialist system want to use the governance issues to undo 
the specialist system when one does not necessarily lead to the 
other.
    But the other is that the governance part of this is 
relatively easy compared to the market structure part of it. No 
one is ever going to be paid $130 million again, even if we did 
nothing. We have seen certain specialists not obeying the 
rules, and I think the way they were regulated and punished was 
too lax. But that is naturally going to change even if we did 
not change structure a bit.
    We should change structure, but that is the easy part. The 
hard part is the issues that you have just touched on in your 
questions with Paul Sarbanes and Chairman Shelby, that Chairman 
Donaldson and I touched on earlier. And that is the real 
challenge here.
    Now, for me this is both parochial and catholic--parochial 
because I care about New York, but catholic because we in 
America and we in the world want to have the best markets we 
can.
    And so one question I have--I agree with you about the 
specialist system, and it is true, right? The studies all show 
that 94 percent of the time the specialists get the best price.
    Mr. Reed. That is right.
    Senator Schumer. Some may not care about best price or say 
speed is more interesting to me, and there is no argument why 
speed shouldn't be--if that is the consumer's choice, why that 
should be there. But that does not necessarily mean you have to 
do it in five different ECN's. You could have a system that 
maximizes speed because they are all black boxes in one place. 
Is that correct?
    Mr. Reed. That is correct, yes.
    Senator Schumer. Okay. So, you know, now there is a point 
of competition, developing a better model. I understand that. 
But it does not necessarily follow.
    Here is my question, and I think this is a question that 
many who are against the--there has been competition. Any stock 
can go to a black box, and since the NYSE made the changes--and 
Grasso, for the problems he had, deserves credit for that, in 
my opinion, and he does not get it. In the world we work, you 
know, the pendulum swings. He is a god one day and he is the 
devil the next. There should be a little more balance there, 
but both ways.
    But the walk was that even though there was competition, 
under Grasso the number of companies that decided to go, even 
big companies, to the NYSE went up. The amount of trading went 
up. And the argument the other side makes is, well, Grasso 
strong-armed people, that this was not competition in its pure 
form, but, rather, that he was able to force people to do 
something that might not be in their economic interest.
    How much of that was there? It seems to me companies that 
are trading their stock, their lifeblood, are going to look for 
the best thing economically for them, not, these extraneous 
things. It may have happened in one or two instances when it is 
a borderline situation, and that was terrible and it should 
change. But give me your thoughts on that.
    Mr. Reed. I have heard the same comments you have. As you 
know, I was not there at the time, so it just has to be 
hearsay, by definition. But I will tell you, the proof of the 
pudding to some extent is that Mr. Grasso is not there today, 
and we continue to run approximately the same numbers. We 
continue to have listings. We have not lost, to my knowledge, 
any listings. And we continue to run about 82 percent of the 
transactions, meaning there are 18 percent of the transactions 
involving our stocks that are consummated elsewhere, but it is 
not a number any different than when Mr. Grasso was there.
    So to the extent that he was holding this back 
artificially, one would have expected to have observed it in 
the current set of numbers, and we have not. It cannot have 
been massive, and it cannot have been an immense build-up, or 
we would be experiencing it.
    Senator Schumer. Well, I guess, devil's advocate here, it 
will take a while for people to realize this.
    Mr. Reed. I suspect people who were strong-armed know very 
quickly when the strong arm is no longer around their throat.
    Senator Schumer. Okay. Another question. What are the 
challenges for the NYSE, particularly in light of foreign 
competition? Even whatever is here is going to be under our 
regulatory structure, and overall I think our regulatory 
structure, if you look at a 50-year period and even taking into 
account the lapses of the last several years, has served us 
fairly well. We have these deep, liquid markets that are now 
quite democratized.
    My worry is that we will go to a lowest common denominator, 
that some foreign black box will say no regulation, you are not 
an exchange, you can do whatever you want, and at least in the 
short-term, some who will think the system is not going to rook 
me--usually big, sophisticated people will go over there 
because they can save the cost of regulation, which may be 
milli-cents, but when you trade a lot it matters.
    What is your worry about foreign competition and how the 
NYSE specifically, and America in general, can deal with that 
problem?
    Mr. Reed. Well, clearly, if we start moving toward pure 
ECN's--which, by the way, are harder to regulate than human 
markets.
    Senator Schumer. Of course.
    Mr. Reed. There is a risk that once you get into that kind 
of arena, people cannot tell the difference and they will go to 
foreign markets, or wherever, if it appears they could pick up 
a millionth of a cent and so forth. And you could see a 
fragmentation of markets and a dissipation of any center of 
trading, which would be horrendous for the capital markets of 
the world.
    Senator Schumer. Right.
    Mr. Reed. You also will find, I am pretty sure, that if 
Europe can manage to get an economic recovery going--and in the 
case of Japan, I think they probably do have one going--you are 
going to see activity in other currencies and in other markets 
that is going to have an impact on the flows that go through 
the U.S. markets.
    Our defense has to be that we run the best market in the 
world and that we keep that liquidity. You made the point 
better, Senator, than I can. That pool of liquidity is 
everything. I have been on the issuer side. Many here may 
remember in the 1990's, Citibank had to go three times to the 
capital markets for capital at a time when we needed it. And 
there were people in the U.S. Congress who thought we were 
illiquid and that we could not get there.
    I looked at every market in the world. If we could issue a 
piece of paper in Tokyo or London that would have gotten us our 
capital, we would have done so, and I tried. I went to London 
first, thinking that maybe in the London markets I would find 
an appetite that I could not find in New York.
    The reality is I did three issues in the New York stock 
market, and the reason I did is that is where the money was. 
And not only is it there normally, but also for companies that 
are going through difficult times, which is when you need 
capital--either when you are a start-up and no one knows 
anything about you, or when you are a good company but you are 
going through a transition or what have you--the depth of the 
market that exists today in New York is the resource available 
to issuers in order to access people who are willing to provide 
capital in exchange for the potential upside.
    If we saw a fragmentation toward international markets, I 
assure you that that capital does not go to funny black boxes. 
And we need to keep our system robust, that kind of capital, 
which does exist in the New York Stock Exchange, and the reason 
we have foreign companies list here is they, too, understand 
that the capital that is most willing to take a 
businessperson's risk is in the New York Stock Exchange. And 
the risk of this competition of black boxes--I could just see a 
wonderful black box in Nassau. I would rather live in the 
Bahamas in terms of the weather----
    Senator Schumer. Not me.
    Mr. Reed. --and I could be a software guy, but I will tell 
you, the integrity of the system requires its location in this 
country, and it is my job to try to ensure that we take the 
steps to assure the investing public that there is nothing 
about the governance or the responsibility that exists at the 
New York Stock Exchange that is anything but a plus.
    I do not want to just be neutral. I do not want to be seen 
to be merely adequately governed. We have to be governed in a 
superior way. Frankly, I think the proposal we have in front of 
the SEC and the individual directors who have agreed to serve, 
if they can serve, will meet that commitment. You are not going 
to meet it in a day, but that is a board that is capable of 
meeting its responsibilities, which is intellectually capable 
of dealing with some of these challenges that we are facing, 
and was designed with that in mind.
    I knew what the job of the board was going to be. It has 
access to people in the industry who are at the core, and for 
the first time, by the way, including the buy side, which has 
never before been officially represented. But we have access to 
the industry competence, including the industry criticism, 
which I think is important to listen to, but that board is 
competent to deal with these issues in a responsible and 
totally transparent way.
    And so I think it is the right first step. I am not 
suggesting that any one step is the end. This is an 
evolutionary pathway. But I think it is the right first step on 
that evolutionary pathway.
    Senator Schumer. Two quick final questions, and thank you, 
Mr. Chairman.
    Number one, you touched on this. I think it is important to 
emphasize it. It is your belief that the problems we have had 
with specialists or others taking advantage of their customers 
would be far easier for somebody, a broker-dealer or whatever, 
to manipulate on a black box than in a specialist system. Is 
that correct?
    Mr. Reed. Without question.
    Senator Schumer. So the great irony--and this is the second 
question--is those who are using the governance problems to try 
and kick the specialist system out are really involved in a J-
curve, in a sense, you know, they will accomplish what they 
want in the short-run, and it could end up boomeranging on all 
of us in the long-run.
    Do you agree with me that some of them have conflicts of 
interest?
    Mr. Reed. Oh, without question. You know, there is no 
question that Mr. Grasso's departure opened up the door for 
people with quite legitimate competitive aspirations to make 
use of this problem, which admittedly we have, not only to 
raise legitimate issues about governance, but also to advance 
their competitive cause and to gain a voice at a time when the 
New York Stock Exchange seems to have lost its voice.
    A significant portion of what we are hearing--not all, but 
a significant portion--is from people arguing for their own 
competitive position and other financial intermediaries trying 
to move some of the profits from one financial intermediary to 
another financial intermediary, without any benefit whatsoever 
to the ultimate customer. We are getting the typical private 
sector, great American response. You lose your voice a little 
bit. Everybody piles on, some of it quite legitimate, some 
good, but there is an awful lot of comment that is being 
authored by competitors who are simply trying to improve their 
competitive position.
    Senator Schumer. And illegitimately using the real problems 
to make a different argument when the one does not have much to 
do with the other.
    Mr. Reed. Yes, quite unrelated. Quite unrelated.
    Senator Schumer. All right. Thank you, Mr. Chairman.
    Chairman Shelby. Chairman Reed, you are not saying there is 
not real competition out there sometimes?
    Mr. Reed. There is real competition. I would assure you, 
since arriving back from my retirement, the one thing I have 
found continues to exist here is lots of interested people 
trying to advance their own possibilities.
    Chairman Shelby. Absolutely. Well, that is the nature of 
the market, is it not?
    Mr. Reed. It is indeed, and we all depend on it.
    Chairman Shelby. Mr. Reed, we thank you for your 
appearance, and we hope to get you back sometime.
    Mr. Reed. Thank you, Mr. Chairman.
    Chairman Shelby. The hearing is adjourned.
    [Whereupon, at 12:51 p.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]

                   PREPARED STATEMENT OF JOHN S. REED
           Interim Chairman and CEO, New York Stock Exchange
                           November 20, 2003

    Chairman Shelby, Ranking Member Sarbanes, and Members of the 
Committee, my name is John Reed. Thank you for inviting me to testify 
today concerning corporate governance at the New York Stock Exchange. I 
assumed the role of Interim Chairman and CEO for a very focused but 
challenging task: To reform the Exchange's governance and leave behind 
a board and a leadership in which the public can place its trust.
    In my testimony today, I will first outline some recent 
developments in the Exchange's modernization of its governance and its 
election of its new board. Second, I will talk about the critical issue 
of self-regulation--both why broker-dealer self-regulation through the 
NYSE remains the best answer for the U.S. capital markets and how our 
new governance architecture better addresses the conflicts inherent in 
self-regulation. Third, I will provide some more details concerning the 
autonomy of our regulatory function. Last, I will outline our essential 
next steps.
    Collectively, we face many challenges. This Committee and the 
Securities and Exchange Commission are now dealing with several key 
issues that will shape the securities industry for a generation. The 
securities industry itself--from the corporate suite to the mailroom--
must again embrace the principle that putting investors first is the 
only way to do business. Standing astride the industry's epicenter, the 
Exchange must lead this renewal to ensure that the industry regains the 
trust and confidence of its customers, the SEC and this Committee.
Recent Developments
    The day before yesterday, the membership of the Exchange 
overwhelmingly approved my proposal to create a governance architecture 
that empowers a small, outside board of directors to lead this renewal. 
Subject to approval by the SEC, for the first time in its 211-year 
history, the Exchange's board will be independent both from the 
Exchange's management and from the Exchange's members and listed 
companies. The membership also voted to populate our independent board 
with eight seasoned and talented leaders: Madeleine K. Albright--former 
Secretary of State; Herbert M. Allison, Jr.--Chairman & CEO of TIAA-
CREF; Euan D. Baird--Chairman of Rolls-Royce and former head of 
Schlumberger; Marshall N. Carter--former Chief Executive of State 
Street Corporation; Shirley Ann Jackson--President of Rensselaer 
Polytechnic Institute; James S. McDonald--CEO of Rockefeller & Company; 
Robert B. Shapiro--former head of Monsanto; and Sir Dennis 
Weatherstone--former Chairman of J.P. Morgan.
    If the SEC approves our new structure, these individuals will serve 
until June 2004. Thereafter, the entire board will stand for election 
in June of each year.
    As you know, I accepted this challenge in the wake of disclosure 
that the Exchange's board had failed in how it set its executives' 
compensation, and then failed again in how it met the crisis that 
resulted from that disclosure. It has since become evident that the 
board also failed to foster a regulatory system that anticipated and 
mitigated the regulatory risks arising from the vast changes in our 
industry over the last decade. These failures all point to a board too 
large and too conflicted to effectively govern the Exchange.
    The NYSE's 31-year-old corporate governance structure had quite 
simply not kept pace with either best practices in corporate governance 
or the tremendous changes in the nature of our constituents. 
Specifically, the Exchange's governance had to be revamped to manage 
conflicts of interest and to increase transparency. To meet the special 
challenge of serving as both a marketplace and the vehicle by which our 
members regulate themselves, the Exchange's governance also needed to 
meet and, indeed, surpass the independence standards to which our 
listed companies adhere. The changes that our membership approved this 
week create the framework to accomplish these goals.
    From the outset, it was clear to me that the NYSE needed a 
competent, engaged board free of conflicts and parochial agendas and 
dedicated to the NYSE's long-term interests. It was also clear that the 
NYSE would not recover its voice and legitimacy as a leader of the U.S. 
capital market until the public saw it as an example of good governance 
and capable of properly managing its own affairs. An ``insider board'' 
was not acceptable--not in general and certainly not as the supervisor 
of our regulatory function.
    The membership vote changed the Exchange's Constitution to achieve 
three important objectives:

 Place responsibility for governance, compensation and internal 
    controls, as well as for supervision of regulation, in the hands of 
    a board of directors that is independent both from NYSE management 
    and from our members, member organizations, and listed companies.
 Separately preserve the existing engagement of the broker-
    dealer community and listed company community with the NYSE by 
    creating a board of executives that will also include the 
    executives of major public and private ``buy side'' entities as 
    well as lessor members of the NYSE.
 Make transparent our governance process, its participants, 
    their compensation, and our charitable donations and political 
    contributions.

    The following diagram depicts the architecture we designed to 
achieve these objectives. 


    The proxy statement and supplemental letter sent to our membership 
earlier this month describes the changes in detail. Copies are 
available at this hearing.
Self-Regulation
    Now I want to address an important issue that represents our 
industry's best chance for regaining the trust and confidence of 
investors: The reinvigoration of self-regulation. As you know, broker-
dealer self-regulation is at the core of our Nation's securities law 
as, indeed, it has been at the core of the NYSE since merchants first 
gathered on Wall Street 211 years ago to trade Revolutionary War bonds. 
Yet, the governance failures at the Exchange have laid bare the 
conflicts inherent in self-regulation. Critics have seized upon these 
failures to argue that the NYSE's regulatory arm should be severed from 
the Exchange. In essence, they are calling for the end of self-
regulation. I strongly disagree with that view.
    Self-regulation recognizes that shared settlement and reputational 
risk creates an interest in each member of the Exchange to assure the 
financial responsibility and fair dealings of every other member. 
Properly channeled through an independent, professional Exchange staff, 
self-regulation represents the best chance of devising optimal 
regulatory solutions that minimize interference with delicate market 
mechanisms.
    Since 1934, when Congress created the Securities and Exchange 
Commission, self-regulation has been wedded to Government oversight. 
Since 1938, when the Exchange appointed its first full-time president, 
self-regulation has been effected through a professional staff. Since 
1972, when the Exchange created a board that included, as one-half of 
its members, men and women from outside the securities industry, self-
regulation has been enriched by the participation of customers of the 
industry.
    As the securities industry evolved, so has self-regulation. In 
1934, in 1938, and in 1972 when the self-regulatory model of the 
previous generation reached its limits, the answer to restoring 
investor confidence in the marketplace was to strengthen and modernize 
self-regulation, not to end it. I believe 2003 is no different.
    At this latest point of inflection in the evolution of self-
regulation, the Exchange must bring the independence that has 
characterized our professional staff to the board level. Yet, to be 
effective, our regulatory function must remain pervasively engaged with 
our customers, our member organizations, and our other users. Our 
membership has now approved the architecture necessary to accomplish 
both charges. If the SEC concurs, our challenge will be to implement 
our new architecture to reinvigorate self-regulation by better 
addressing its inherent conflicts while maintaining the advantages I 
have just discussed.
    In response to a question from Senator Shelby regarding the self-
regulatory structure of the NYSE, Chairman Donaldson recently reminded 
this Committee that in the 1930's, the Commission wisely co-opted the 
Exchange's existing self-regulation mechanism so there would not be a 
huge, clumsy Government bureaucracy. He recognized that today's key 
issues are (1) how the self-regulatory function is financed and (2) to 
whom the self-regulatory function reports.
    Our new architecture addresses both of these issues. The NYSE 
Regulatory Group will now have its budget set by, and will report to, a 
board that consists of directors who are independent of both the 
securities industry and the companies listed on the Exchange. The board 
will appoint a Chief Regulatory Officer (CRO) who will report directly 
to the board, and no longer to the CEO. And to better enable the SEC, 
the investing public, and Congress to ensure that we adhere to our 
public purpose, the Exchange's governance is now transparent. 
Accountability is enabled.
Regulatory Autonomy with Market Sensitivity
    Now let me take some time to detail how our plan insulates our 
regulatory function from our marketplace. As noted, our outside, 
independent directors will be responsible for regulatory oversight and 
regulatory budgeting. More specifically, our new regulatory oversight 
committee will:

 Assure the effectiveness, vigor, and professionalism of our 
    regulatory program.
 Determine the budget, staffing, and technological resources 
    for the various regulatory units of the Exchange.
 Assess the Exchange's regulatory performance and recommend 
    compensation and personnel actions involving senior regulatory 
    personnel directly to the Human Resources and Compensation 
    Committee for action.

    This means that our independent board, through its regulatory 
oversight committee, will decide how to allocate resources to ensure 
that our regulation function is adequately funded and staffed. 



    As the diagram depicting the regulatory architecture indicates, 
while the regulatory function remains close to the marketplace, only 
the independent directors bridge the substantive division between the 
marketplace and the regulatory function. In particular, the CEO, while 
a vital partner to the CRO, does not supervise the CRO.
Next Steps
    So what is next? First and foremost, we await SEC action on these 
governance changes. I want to note that the SEC staff gave us enormous 
help by critiquing our proposal before we sent it to our membership for 
a vote. In addition, we are grateful for the extraordinarily quick path 
to publication in the Federal Register that the SEC staff provided in 
order to start the 3-week comment period.
    We believe that the SEC can find our architecture to be consistent 
with the Securities Exchange Act--the statutory standard that governs 
its review. The new architecture empowers a board of directors with the 
independence to address issues objectively and the constituent input to 
address them intelligently. Directors who have the degree of 
independence and experience that our governance architecture promises--
as evidenced by the quality of our new board--will assure that the 
Exchange's regulatory function is both independent and robust. Thus, we 
believe our architecture guarantees the independence of our regulatory 
function both from members and member organizations and from 
inappropriate linkage with our marketplace, while assuring the 
function's sensitivity to the market.
    Nevertheless, we note that we are not asking the SEC to approve 
either the continuation of self-regulation through the NYSE or in the 
United States generally. That issue should be addressed in the context 
of how well the new board implements both the architecture and the 
necessary programmatic changes to our regulatory function.
    Thus, while the Exchange does seek the SEC's approval of what we 
regard as a greatly improved architecture for self-regulation, it does 
not seek the SEC's determination of the future of self-regulation at 
this time. All the Exchange seeks at this time is the SEC's approval of 
a transitional structure that allows it to move from the current 
situation to one in which a board of independent, distinguished and 
experienced men and women can take on the formidable challenges facing 
the Exchange. We are hopeful that the SEC will see the wisdom of our 
proposal, review it expeditiously, and approve it in short order.
    Second, the new board will hold its organizational meeting next 
week. Among its first tasks will be to identify the appropriate person 
or persons to replace me as Chairman and CEO, and to identify a person 
to assume the responsibilities of Chief Regulatory Officer. Thus, upon 
the SEC's action, we will have a new board and permanent management in 
place, that can then begin to demonstrate that the new governance 
structure works and thereby begin to restore investor confidence in the 

institution of the NYSE. This new leadership, the board of directors 
and the board of executives, will also be in a position to openly and 
collectively address issues of market performance, access and market 
structure that--in addition to self-regulation--are important to the 
continual modernization of our capital markets.
    To conclude, I want to assure you that we understand the damage 
done to investor confidence as a result of the Exchange's governance 
failures. We believe that we are on the right path to creating and 
implementing a governance process that will reduce and manage the 
conflicts of interests inherent in self-regulation, and provide greater 
transparency to ensure accountability. And we will not lose sight of 
the critical business of the NYSE--the business of operating the 
world's deepest and fairest equity market for the benefit of investors 
and listed companies.
    Again, thank you for the opportunity to appear before you today. I 
would be happy to answer your questions.
