[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
SELF-REGULATORY ORGANIZATIONS:
EXPLORING THE NEED FOR REFORM
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
CAPITAL MARKETS, INSURANCE AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
__________
NOVEMBER 17, 2005
__________
Printed for the use of the Committee on Financial Services
Serial No. 109-65
U.S. GOVERNMENT PRINTING OFFICE
26-755 WASHINGTON : 2006
_____________________________________________________________________________
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts
RICHARD H. BAKER, Louisiana PAUL E. KANJORSKI, Pennsylvania
DEBORAH PRYCE, Ohio MAXINE WATERS, California
SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice Chair JULIA CARSON, Indiana
RON PAUL, Texas BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio GREGORY W. MEEKS, New York
JIM RYUN, Kansas BARBARA LEE, California
STEVEN C. LaTOURETTE, Ohio DENNIS MOORE, Kansas
DONALD A. MANZULLO, Illinois MICHAEL E. CAPUANO, Massachusetts
WALTER B. JONES, Jr., North HAROLD E. FORD, Jr., Tennessee
Carolina RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois JOSEPH CROWLEY, New York
CHRISTOPHER SHAYS, Connecticut WM. LACY CLAY, Missouri
VITO FOSSELLA, New York STEVE ISRAEL, New York
GARY G. MILLER, California CAROLYN McCARTHY, New York
PATRICK J. TIBERI, Ohio JOE BACA, California
MARK R. KENNEDY, Minnesota JIM MATHESON, Utah
TOM FEENEY, Florida STEPHEN F. LYNCH, Massachusetts
JEB HENSARLING, Texas BRAD MILLER, North Carolina
SCOTT GARRETT, New Jersey DAVID SCOTT, Georgia
GINNY BROWN-WAITE, Florida ARTUR DAVIS, Alabama
J. GRESHAM BARRETT, South Carolina AL GREEN, Texas
KATHERINE HARRIS, Florida EMANUEL CLEAVER, Missouri
RICK RENZI, Arizona MELISSA L. BEAN, Illinois
JIM GERLACH, Pennsylvania DEBBIE WASSERMAN SCHULTZ, Florida
STEVAN PEARCE, New Mexico GWEN MOORE, Wisconsin,
RANDY NEUGEBAUER, Texas
TOM PRICE, Georgia BERNARD SANDERS, Vermont
MICHAEL G. FITZPATRICK,
Pennsylvania
GEOFF DAVIS, Kentucky
PATRICK T. McHENRY, North Carolina
Robert U. Foster, III, Staff Director
Subcommittee on Capital Markets, Insurance and Government Sponsored
Enterprises
RICHARD H. BAKER, Louisiana, Chairman
JIM RYUN, Kansas, Vice Chair PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut GARY L. ACKERMAN, New York
PAUL E. GILLMOR, Ohio DARLENE HOOLEY, Oregon
SPENCER BACHUS, Alabama BRAD SHERMAN, California
MICHAEL N. CASTLE, Delaware GREGORY W. MEEKS, New York
PETER T. KING, New York DENNIS MOORE, Kansas
FRANK D. LUCAS, Oklahoma MICHAEL E. CAPUANO, Massachusetts
DONALD A. MANZULLO, Illinois HAROLD E. FORD, Jr., Tennessee
EDWARD R. ROYCE, California RUBEN HINOJOSA, Texas
SUE W. KELLY, New York JOSEPH CROWLEY, New York
ROBERT W. NEY, Ohio STEVE ISRAEL, New York
VITO FOSSELLA, New York, WM. LACY CLAY, Missouri
JUDY BIGGERT, Illinois CAROLYN McCARTHY, New York
GARY G. MILLER, California JOE BACA, California
MARK R. KENNEDY, Minnesota JIM MATHESON, Utah
PATRICK J. TIBERI, Ohio STEPHEN F. LYNCH, Massachusetts
J. GRESHAM BARRETT, South Carolina BRAD MILLER, North Carolina
GINNY BROWN-WAITE, Florida DAVID SCOTT, Georgia
TOM FEENEY, Florida NYDIA M. VELAZQUEZ, New York
JIM GERLACH, Pennsylvania MELVIN L. WATT, North Carolina
KATHERINE HARRIS, Florida ARTUR DAVIS, Alabama
JEB HENSARLING, Texas MELISSA L. BEAN, Illinois
RICK RENZI, Arizona DEBBIE WASSERMAN SCHULTZ, Florida
GEOFF DAVIS, Kentucky BARNEY FRANK, Massachusetts
MICHAEL G. FITZPATRICK,
Pennsylvania
MICHAEL G. OXLEY, Ohio
C O N T E N T S
----------
Page
Hearing held on:
November 17, 2005............................................ 1
Appendix:
November 17, 2005............................................ 39
WITNESSES
Thursday, November 17, 2005
Bang, Kim, President and Chief Executive Officer, Bloomberg
Tradebook LLC.................................................. 27
Brodsky, William J., Chairman and Chief Executive Officer,
Chicago Board Options Exchange, Inc............................ 7
Glauber, Robert R., Chairman and Chief Executive Officer, NASD... 2
Ketchum, Richard G., Chief Regulatory Officer, New York Stock
Exchange, Inc.................................................. 4
Lackritz, Marc E., President, Securities Industry Association.... 25
Plotkin, Ben A., Chairman and Chief Executive Officer, Ryan Beck
& Co........................................................... 29
APPENDIX
Prepared statements:
Oxley, Hon. Michael G........................................ 40
Baker, Hon. Richard H........................................ 42
Castle, Hon. Michael N....................................... 46
Kanjorski, Hon. Paul E....................................... 47
Bang, Kim.................................................... 48
Brodsky, William J........................................... 78
Glauber, Robert R............................................ 87
Ketchum, Richard G........................................... 94
Lackritz, Marc E............................................. 107
Plotkin, Ben A............................................... 119
SELF-REGULATORY ORGANIZATIONS:
EXPLORING THE NEED FOR REFORM
----------
Thursday, November 17, 2005
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance,
and Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 2:33 p.m., in
Room 2128 Rayburn House Office Building, Hon. Richard H. Baker
[chairman of the subcommittee] presiding.
Present: Representatives Baker, Kelly, Fossella, Biggert,
Kennedy, Feeney, Sherman, Clay, and Wasserman-Schultz.
Also Present: Maloney.
ChairmanBaker. I will go ahead with my opening statement,
and then we will proceed as members arrive.
Today, the Capital Markets Subcommittee meets to continue
its examination of the regulatory structure of our Nation's
securities markets.
Over the past several Congresses, our committee has hosted
a number of hearings on issues relating to the structure of
markets, including the recently adopted Reg NMS.
Today, we return our focus to a review of the self-
regulatory organizations, generally known as SROs. Self-
regulation of the securities markets and market participants is
an essential cornerstone of our Federal securities law and
market function. All broker-dealers are required to be a member
of an SRO, and many SROs also operate and regulate market
centers.
SRO regulation, as opposed to direct SEC regulation, helps
provide efficient and cost-effective oversight to markets.
Thousands of market participants would make it cost
prohibitive for the SEC alone to provide the necessary
regulatory presence, in my opinion.
While SROs provide benefits to the markets, there has been
some concern expressed that conflicts of interest now exist in
the regulatory regime when the SRO represents the competitive
interests of its members and market center while, at the same
time, regulating their conduct.
Partially in response to those stated concerns, the SEC, in
a November 2004 rule, required enhancing transparency and the
corporate governance standards at SROs. In addition, the SEC
also issued a concept release discussing various alternative
regulatory models.
Our markets and the manner in which trading is conducted
continues to evolve at an ever accelerated pace and is very
innovative, and the competition resulting is forcing change in
the way these markets are regulated as well.
As order flow migrates across multiple SRO market centers,
broker-dealers are subjected to burdensome and duplicative rule
books, inspections, and enforcement actions which cause both
regulatory redundancies, ambiguities, and enhanced costs.
Several SROs have taken the initiative to self-reform. The
New York Exchange has already adopted many of the corporate
governance enhancements in the proposed SEC rule. In addition,
the NYSE and the NASD recently announced the possible pursuit
of a partnership to share regulatory duties to reduce burden on
the 180 members of both SROs.
The CBOE has also taken the initiative to allocate its
sales practice examinations to the NASD to reduce duplicative
regulation.
I welcome all of these steps as appropriate and proper.
The core mission of our Nation's securities regulators is
the protection of investors and the fostering of efficient and
transparent markets.
Today, I look forward to hearing from our distinguished
witnesses who have their particular insights to receive their
thoughts on the current environment and their ideas as to the
future of SRO regulation, and where appropriate, suggested
steps that may be taken to further advance a more efficient and
effective system of self-regulation.
[The prepared statement of Hon. Richard H. Baker can be
found on page 42 in the appendix.]
ChairmanBaker. Couldn't have said it better if I had said
it myself.
Mr. Feeney, do you have an opening statement?
Mr.Feeney. I do not, Mr. Chairman. You said it all for us.
ChairmanBaker. Thank you very much.
At this time, I will proceed, pursuant to additional
members' arrival, who may wish to make additional statements,
but it is my pleasure to welcome back the chairman and chief
executive officer of the NASD, Mr. Robert Glauber, who has
appeared here many times, and as is the usual custom, your full
statement will be made part of the official record.
Please proceed as you wish.
STATEMENT OF ROBERT R. GLAUBER, CHAIRMAN AND CHIEF EXECUTIVE
OFFICER, NASD
Mr.Glauber. Thank you very much, Chairman Baker,
Congressman Feeney.
Good afternoon.
I am Robert Glauber, chairman and CEO of NASD, the private
sector regulator of the U.S. securities industry.
I am grateful to the subcommittee for inviting me to
testify on the current and future state of the self-regulatory
system.
This is a terribly important subject, and the committee is
to be commended for addressing it.
This is a time of immense change in the securities
industry, and regulation must not only keep pace, but stay
ahead of that change. To do less would badly serve investors.
Their protection is our number one goal.
Mr. Chairman, the SEC's November 2004 concept release
quoted some alternatives to the present SRO system.
They range from making some moderate adjustments to
scrapping the whole system and replacing it with a so-called
universal non-industry regulator along the lines of PCAOB that
would oversee everything--brokers, firms, markets, and
exchanges.
NASD firmly believes in preserving a securities industry
regulatory model that encompasses self-regulation supervised by
the SEC. Self-regulation is a key component of the effective
regulation, growth, and vitality of the U.S. securities
markets, offering a range of benefits that non-industry or
Government regulation alone could not provide.
At the same time, there are inherent conflicts and
inefficiencies present in the current regulatory environment.
NASD believes that these shortcomings would be best addressed
by adopting a form of the hybrid models set forth by the SEC in
its concept release.
Adopting this model would enhance efficiency by eliminating
inconsistent member rules, eliminating redundant
infrastructure, strengthening inter-market surveillance, and
meaningfully reducing the current conflicts in the self-
regulatory system.
As you know, NASD was the creator, owner, and regulator of
NASDAQ.
By the late 1990s, NASD had created a separate subsidiary
to house its regulatory activities, much as the New York Stock
Exchange has done now, but in 2000, when NASDAQ decided to
become a shareholder-owned publicly traded exchange, NASD
determined that the existing subsidiary structure did not
afford sufficient protection for investors.
Operating an exchange to maximize profits for shareholders
and simultaneously managing regulatory activities to fully
protect investors could not be conducted under the same
corporate structure without unmanageable conflicts, in our
view.
We, therefore, restructured NASDAQ and NASD as two wholly
separate companies, with separate managements, separate funding
sources, and separate non-overlapping boards of directors.
This separation is complete except for the SEC designation
of NASDAQ as an exchange and the sale of NASD's remaining
minority share ownership in NASDAQ, which we are seeking to
complete within a year of NASDAQ exchange registration.
NASD still monitors all trading on NASDAQ, and will
continue to do so, pursuant to a contract, after NASDAQ becomes
an exchange.
Today, the New York Stock Exchange finds itself in a
similar position as it merges with Archipelago and moves
towards going public.
Whether it should continue operating as a regulator after
it begins operating as a for-profit company has been the
subject of a great deal of healthy and needed debate in our
industry. The concern is that for-profit publicly-traded
exchanges will be faced with the conflicting goal of having to
maximize profits while not compromising regulation.
To solve this conflict, I believe that we should change how
securities firms are regulated.
The SEC's hybrid model contemplates one self-regulatory
organization that would be responsible for member regulation of
all securities broker-dealers.
A mechanism to bring that model to life would be to have
the NYSE and NASD handle, in partnership, the regulation of the
180 firms that are members of both organizations. Under such an
arrangement, firms would be regulated according to one rule
book, instead of two, examined by one corps of examiners, and
disciplined by one set of enforcement attorneys.
To best serve investors, Mr. Chairman, any new structure
would have to solve the conflict inherent in both being a
regulator and managing a for-profit exchange.
It would also have to eliminate the redundancies and
inefficiencies of having two regulatory groups performing the
same functions.
This would result in clear and consistent regulation of
securities firms, regulation that provides more effective
protection of investors.
Mr. Chairman, that concludes my statement. I, of course,
want to thank the committee again for inviting me, and I will
be happy to answer any questions.
[The prepared statement of Robert R. Glauber can be found
on page 87 in the appendix.]
ChairmanBaker. I thank the gentleman for his testimony.
I understand that Mr. Fossella wishes to be recognized to
make a comment at this time.
Mr.Fossella. Thank you, Mr. Chairman.
I want to welcome the panel, all three gentlemen,
especially Mr. Brodsky--good to see you again--and it is my
pleasure to also welcome Mr. Ketchum, the chief regulatory
officer for the New York Stock Exchange since 2004.
Mr. Ketchum has spent 12 years at the National Association
of Securities Dealers and NASDAQ. He served as president of
NASDAQ for three years and as president of NASD for seven.
Prior to that, he was at the SEC for 14 years, eight of
those years as director of market regulation.
So to all three gentlemen, I say welcome, and thank you for
your testimony in advance, and it is my pleasure to welcome, as
well, Mr. Ketchum.
Thank you, Mr. Chairman.
ChairmanBaker. Thank you, Mr. Fossella.
Please proceed at your leisure, Mr. Ketchum.
STATEMENT OF RICHARD G. KETCHUM, CHIEF REGULATORY OFFICER, NEW
YORK STOCK EXCHANGE, INC.
Mr.Ketchum. Thank you.
Chairman Baker, Congressman Fossella, and distinguished
members of the subcommittee, I am Richard Ketchum, chief
regulatory officer of the New York Stock Exchange, and I first
want to commend you, Mr. Chairman, for holding this hearing on
the important issues relating to securities self-regulation.
Protecting investors and preserving confidence in market
integrity is critical to the success of our securities markets,
and the New York Stock Exchange is extremely proud of our role
in contributing to that effect.
New York Stock Exchange regulation has primary
responsibility for regulating the activities of our members,
member firms, and listed companies, as well as enforcing
compliance with NYSE rules and Federal securities laws. Our
nearly 400 firms, among the largest in the world, maintain 84
percent of the total public customer accounts, with assets of
over $4 trillion.
In that connection, the SEC has appointed New York Stock
Exchange regulation as the designated examining authority for
financial and operational issues for nearly all of the 170
firms that are members of both the New York Stock Exchange and
the NASD. Here there is no overlap or duplication.
In this regard, we believe it is essential, regardless of
how the duplication issues that we discuss here today are
resolved, that the expertise provided by the NYSE staff in
ensuring the financial and operational soundness of the largest
firms be maintained.
Last year, the SEC issued a concept release that raised a
series of thoughtful questions regarding the costs and benefits
of possible changes in the present self-regulatory system.
Underpinning those questions were concerns regarding both
the management of conflict of interest and the impact of
regulatory duplication in the present system. I would like to
briefly address both of those concerns.
As much as we believe in the wisdom of self-regulation, we
believe just as passionately that independence is critical to
our operations.
In December of 2003, the New York Stock Exchange
implemented, with the SEC's approval, sweeping changes to its
governance structure. The NYSE became the only SRO to require
that all members of its board of directors, with the exception
of CEO John Thain, be independent.
NYSE regulation was also separated from market operations.
A new position of chief regulatory officer, of which I am
the first, was created.
I report directly to the board of directors through its
regulatory oversight committee.
The result is that our decision making is independent from
the business and market side.
Once the merger of the New York Stock Exchange and the
Archipelago is approved and a new for-profit publicly-traded
holding company known as NYSE Group is created, the
independence of NYSE regulation will be strengthened again.
NYSE regulation will have its own board of independent
directors, a majority from the NYSE Group, the remaining
directors unaffiliated and independent from the marketplace,
with the exception of myself.
We will be self-funded from regulatory fees and from
contractual commitments from the New York Stock Exchange and
Archipelago.
No NYSE regulation staff will receive stock or options from
the New York Stock Exchange or otherwise be financially
incented by the financial performance of the New York Stock
Exchange.
Because the conflicts of marketplace self-regulation have
and can in the future be addressed, we feel strongly that the
possibility raised in the concept release of the creation of a
universal regulator or full dependence on Government regulation
would be a tragic mistake.
In simplest terms, self-regulation offers the benefit of
greater expertise, the ability to leverage Government
resources, and impose higher ethical standards than are
required under Federal law.
It should remain the cornerstone for the regulation of
broker-dealers and the securities markets.
The SEC also, in the concept release, properly expresses
concerns identified by the securities industry regarding
duplication.
Many of these concerns stem from an important increase in
the breadth and aggressiveness of both our program and the
NASD's, as well as the CBOE's and other self-regulatory
organizations.
The committee should know--and I appreciate, Mr. Sherman,
your acknowledging--that there are many ways in which New York
Stock Exchange regulation and the NASD have already been
coordinating efforts.
Coordination of exams, rulemaking, and enforcement are
three areas that have had the greatest impact in reducing
regulatory duplication.
With the tremendous support and leadership of Bob Glauber
and Mary Shapiro at the NASD, our efforts to coordinate and
eliminate duplication are improving constantly, but we
understand the industry's continuing concerns and recognize
that more must be done.
We understand that the SIA and some members of the
securities industry favor the creation of a separate hybrid SRO
that would oversee all broker-dealers doing business with the
public.
We believe that concept is a constructive proposal that we
are willing to explore. However, we fear that the creation of a
new separate hybrid regulator risks losing much of the
expertise critical to self-regulation.
Market surveillance and examination functions work closely
together to ensure complete coverage of trading and market
abuses.
NYSE regulation brings unique credentials and market
oversight knowledge to its regulatory efforts, just as the NASD
and CBOE possess unique understanding of NASDAQ and derivative
trading issues, respectively. Separating examination of market
regulation, therefore, risks a less effective system.
Nevertheless, we recognize our responsibility to
aggressively expand our efforts with our regulators to further
reduce or eliminate duplication. We believe that a dialogue
among the SEC, securities industry, and self-regulatory
organizations would be an important next step, and we stand
ready to actively participate.
Thank you, and I would be happy to answer any questions you
may have.
[The prepared statement of Richard G. Ketchum can be found
on page 94 in the appendix.]
ChairmanBaker. I thank you for your comments, sir, and at
this time, I recognize Mrs. Biggert to make any introductory
comments.
Mrs.Biggert. Thank you very much, Mr. Chairman.
I am very happy to introduce William J. Brodsky, who is the
chairman and chief executive officer of the Chicago Board of
Options Exchange.
We are very proud in Illinois of all of our capital
markets, and he has an outstanding career, serving more than 36
years in the securities industry, began as an attorney with
Moddell Rowan & Company in 1968, then joined the American Stock
Exchange, where he became head of options trading, and then
served as executive vice president for operations, and then
served as the AMEX representative on the board of the Options
Clearing Corporation, and joined the Chicago Mercantile
Exchange in 1982 as executive vice president and chief
operating officer, and was then president and chief executive
officer, and served in that capacity until joining the CBOE in
February of 1997.
So he has certainly had the experience on all of the
exchanges.
He also serves as a director of People's Energy
Corporation, Futures Industry Association, Swifts Futures and
Options Association.
We are very happy to welcome him.
He holds an A.B. degree and J.D. degree from Syracuse
University.
Welcome.
Mr.Brodsky. Thank you.
ChairmanBaker. Let me add, certainly no stranger to the
committee.
Welcome back, sir.
STATEMENT OF WILLIAM J. BRODSKY, CHAIRMAN AND CHIEF EXECUTIVE
OFFICER, CHICAGO BOARD OPTIONS EXCHANGE, INC.
Mr.Brodsky. Thank you very much, and Mr. Chairman, I
congratulate you and your fellow committee members for having
hearings like this.
I think this is a very constructive way of having the
committee do oversight in terms of what is going on in the
industry, and as my colleagues have said, this is a very
significant time in our industry.
Congressman Biggert makes me feel much older than I
probably am, but I must say that, in my tenure in the business,
the changes that we are undergoing now are probably more rapid
and more significant than we have had in 25 years, and as my
colleagues have said--and I want to mention both Bob Glauber
and Rick Ketchum.
We have been colleagues in many different ways, even as we
have changed our careers along the way.
These two gentlemen are the most dedicated professionals
that you will find, and I think we agree on more things than we
do not agree with and that the opportunity for a dialogue like
this is very constructive.
Let me start by mentioning that CBOE, which was the creator
of the listed option business, is really a small player in this
bigger conversation that we are having.
We have 1,400 members. We have regulatory responsibility
over a certain amount of firms, but in reality, we are really
specialists in the option business and believe that where you
can eliminate duplication, it's a good thing, but this should
not be done in a hasty way, and I am concerned that the
proposals that the SEC promulgated, in some cases, a year ago,
in two different releases, were in reaction to some of the
events that recently occurred, and our view is--and I know, Mr.
Chairman, our formal comments are in the record. Our view is
that we should not proceed with haste here, because we are
dealing with a very delicate balance.
Let me explain a little bit about our regulatory program.
We have and did establish a regulatory oversight committee
composed solely of independent directors of ours. The committee
is composed of four independent directors and is chaired by
Susan Philips, who happens to be currently the dean of the
George Washington School of Business but was formerly chair of
the Commodity Futures Trading Commission and then served with
great distinction on the Federal Reserve Board. We have other
people of significant caliber who serve as an independent board
committee overseeing our regulatory efforts, and we believe
that this structure strikes a very healthy balance.
Our chief regulatory officer reports to this group on a
very regular basis, and this group actually meets with the SEC
on an annual basis.
So we believe that, although we don't have the total
separation that some people have advocated, that we have found
a way to deal with the potential for conflicts of interest and
that the opportunity that we have had to make this work along
with SEC oversight is an effective way of dealing with our role
as a self-regulatory organization.
What I am advocating is that there should not be a once-
size-fits-all solution to all these situations. It is important
also to recognize that in the option business it is very
important that there be the specialization because this is a
very unique business, and since we have been the leaders in
this realm since the creation of the industry, we take our
responsibility very seriously.
We believe that the existing model of multiple SROs, where
each is responsible for regulating its own market, has been,
for the most part, successful, and this model has permitted the
specialization of knowledge that each exchange or SRO has in
interpreting its own rules and procedures which can be brought
to bear on the regulation of its markets.
This also fosters competition in the development of new and
more efficient regulatory systems, which benefits the overall
quality of regulation.
Congress has demonstrated its belief that, with appropriate
safeguards, self-regulation can lead to better regulation of
the securities markets by permitting this specialized knowledge
and experience of those closest to the markets to be brought to
bear through self-regulation.
We do not think that a single SRO is the answer at this
time.
We believe that you should balance the pluses and minus of
multiple SROs, and we believe that the best answer is not to
delegate market regulation to a sole or single regulator that
would be independent of and would not be involved in the
operation of the markets.
While delegation of regulatory responsibilities to a sole
single regulator might well avoid some of the problems cited in
the SEC's concept release, the consequence of following this
approach would be to destroy one of the major advantages of
self-regulation.
There are other choices for regulation.
There are better ways to reduce duplicative costs and
inefficiencies from multiple SROs. We are intrigued by the
approach of the SIA, which would consolidate regulation and
members into a single SRO but leaving regulation of trading to
each individual market.
The SIA's proposal is designed to eliminate duplication by
regulation of multiple SROs at the level where such regulation
overlaps but maintain specialized regulation at the trading
level where it is most needed.
While the SIA approach is one way of achieving greater
efficiencies, there are other alternatives which SROs can and
do utilize.
One approach is the use of SEC Rule 17D2 agreements, which
are used by SROs to allocate regulatory responsibility with
respect to common members.
Another alternative that has great potential at eliminating
duplication and increasing efficiency and enhancing overall
quality of regulation is the use of a national market system
plan to conduct regulatory functions that are common among
SROs.
For example, five U.S. options exchanges recently filed
with the Commission a proposed options regulatory surveillance
authority, which we call ORSA. The purpose of this plan is to
enable the five exchanges to act jointly with respect to
insider trading investigations involving options at any of the
five participant exchanges.
The functions that would govern ORSA could be expanded in
the future.
The core part of the plan, as currently proposed, is the
delegation to the CBOE of a joint surveillance and enforcement
facility for detecting and investigating possible instances of
insider trading.
By sharing the cost of these investigations and by sharing
the regulatory information generated by ORSA, the five
exchanges will be able to support a regulatory program that is
comprehensive and eliminates duplicative efforts and costs.
Under the plan, the five exchanges will establish a policy
committee to oversee the operation of the plan. Thus, the
governance of ORSA will remain with the five exchanges, and
enforcement actions conducted will be done by each exchange as
appropriate.
The conduct of regulatory functions through ORSA would also
eliminate concerns of uneven regulation among markets. ORSA
shows that SROs working together can preserve the benefits of
multiple SROs while reducing the cost of the regulation.
I want to make one other comment as I wrap up, and that is
that we think there is one area where the SEC could help
improve its general oversight role, and that would be to have
the Commission make clear written statements of the standards
and best practices it believes it should apply to specific
regulatory matters across all markets where it concludes that
such clarification is warranted.
In our view, too often, there are disparities in the way in
which certain regulations are interpreted and applied from one
exchange to another because of the absence of clear guidance
from the Commission. We believe that if the SEC were to make
its views known in such matters to all SROs in a clear and
consistent way and to do so promptly upon the determination
that such guidance is needed, SROs would have a better
understanding of what is required of them and would be in a
better position to regulate their markets and their members
accordingly and in a uniform way.
We had the pleasure of having a breakfast with Chairman Cox
in Florida last Friday, and interestingly, without even hearing
this particular concern, he was concerned about clarity and
consistency of regulations.
So I would hope that, in his new tenure, Chairman Cox may
be able to address this issue, and I wanted to bring this issue
to the committee's attention.
So I would like to thank the committee for holding this
hearing. I think it, again, is very constructive, and I would
be happy to answer your questions.
[The prepared statement of William J. Brodsky can be found
on page 78 in the appendix.]
ChairmanBaker. Thank you very much.
I will start with you, Mr. Brodsky.
I think I understand your concern with a pure, sole, self-
regulatory structure is the potential loss of specialization in
an area where you feel it is important to the applicability of
your industry and that a line could be drawn, in your mind, as
to where the rules and constraints and regulatory oversight
that is applicable to all market participants would be at one
level, but then at a--I do not want to say B-level, another
level--there would be a specialized market function applicable,
perhaps, only to your organization that would be maintained for
adequate regulatory involvement.
Do you think--and I am sure you--I know the answer before I
ask, but I have to ask.
Obviously, my concern is duplication of regulatory
requirements and then the cost to do business. Does that really
net us a gain in the elimination of duplication and fee-based
relief for market participants?
Mr.Brodsky. I think that we can distinguish between those
functions that are common to all firms and the trading on
different markets.
In our industry--when I say ``our industry,'' we are all in
the securities industry, but the options business now includes
six exchanges, where there is very intense competition. Each
exchange does not have the same trading model as each other,
and, therefore, the rules are different, and the SEC
understands that.
I think it is very important to have the expertise close to
where the trading is done at the marketplace level for people
who have that expertise to understand how those rules are
designed and how the trading should occur in a proper fashion.
I do not think that that has to be done at, what I will call,
the super-regulator level.
On the other hand, as we filed our comments to the SEC's
release back in March--and I will quote--we say here the SEC
should encourage SROs to establish joint and coordinated
regulatory efforts where it makes sense to reduce unnecessary
costs and efficiencies.
I think that we can sit around a table and figure out a way
to avoid the duplication of effort and cost and still have a
very effective program, and that is really what we are
advocating most.
ChairmanBaker. Thank you.
Mr. Glauber, from your perspective as a sole regulator of
an independent entity for a period of time, do you have a
countervailing view that a single regulator provides value
added to the market in a consolidated regulatory function, or
do you have an understanding that this bifurcated system offers
some advantages?
Mr.Glauber. I think, Mr. Chairman, you raise exactly the
right question.
My view is that there are conflicts that exist when
regulation is embedded in a for-profit exchange, different from
a not-for-profit exchange. But at the same time, that has to be
weighed against the value of having, as Mr. Ketchum said, and
Mr. Brodsky, regulation close to markets where it counts, and I
think you have made exactly the right distinction, as has the
SEC, at the layer of or level of what we call firm regulation,
the regulation of what goes on in firms, as contrasted with the
regulation of what goes on in markets, on the floor of Mr.
Brodsky's exchange or Mr. Ketchum's exchange. There really is
an important distinction.
At the level of firm regulation, we think that we have--and
have had since we were founded--enough knowledge of what goes
on in firms to perform that regulation.
I think, there, as it was suggested by the SEC, the values
of eliminating obvious duplication and relieving these kinds of
conflicts that I discussed, clearly outweigh any argument of
being necessarily attached to a market.
So as you have and as the SEC has, we would make the
distinction and say the right place to start is with firm
regulation, and to worry there about duplication, and try and
construct the mechanism that would have a single regulator deal
with all of these firms at once, and not have, as we have with
the New York Stock Exchange, two regulators dealing with them
twice.
ChairmanBaker. Understood.
Mr. Ketchum, as sort of the group in transition, and
particularly since I believe the merger approval is imminent,
if not done, where do you see the regulatory function going,
given the transitions the exchange has already gone through
with Archipelago addition coming on?
Mr.Ketchum. Well, Chairman Baker, it is a great question,
and we do still await SEC approval with respect to the merger,
so there is still--as well as, perhaps most importantly,
approval by the membership on a vote. So there are steps still
to go.
As I briefly alluded to in my comments, I am absolutely
confident that--that we can create an environment that builds
on where we are today that ensures absolutely the independence
of decision-making by New York Stock Exchange regulation.
We will operate as a separate, discrete corporation, with
board members both of the holding company, to ensure that they
buy into the importance of regulation, and unaffiliated board
members to raise their hand if they have any concerns.
I have found, with my connection with New York Stock
Exchange board members, that they are passionately concerned
about the integrity of the markets. I would be shocked to find
that that passion, concern, or the belief that that integrity
is critical to the future and success of the New York Stock
Exchange would change.
So I think we will build in numerous means to protect and
ensure that New York Stock Exchange regulation decisions are
independent, while we continue to have access into the
knowledge of how the exchange market really works, but none of
that is to suggest that there is not more that must be done
with respect to reducing duplication.
It has been a pleasure to work with Bob Glauber--he is a
great leader--in trying to identify ways--and I think we need
to step back, each of our organizations, and look at means,
even out of the box, to do far, far more, but I do confidently
believe that the Exchange will be able to meet its regulatory
obligations on the other side of the merger with Archipelago.
ChairmanBaker. Let me quickly add, because my time has long
expired, I do not want to mislead that I have concerns about
the adequacy of current regulatory structure. It is just that
confidence of markets in the regulatory regime is
extraordinarily important as we see more baby boomers seeking
retirement and the growth in investment opportunities enormous
on the horizon that if there is any hint of impropriety, the
economic consequences for capital markets are significantly
adverse. So I know we are all united in this.
The difficulty is trying to figure out which model makes
the most sense in the current environment.
Mr. Clay?
Mr.Clay. Thank you, Mr. Chairman, and thank you for
conducting this hearing.
I thank the witnesses for being here.
I have a couple of questions that I would just like to ask
all of the witnesses to attempt to answer, starting with Mr.
Glauber and moving down the table.
Of the options for regulation contained in the SEC's
concept release, tell me which ones you think are the worst,
which ones are the best, and are there any other options that
they may not have suggested?
ChairmanBaker. We can guarantee nobody at the SEC is
listening.
Mr.Clay. I am certain.
Mr.Glauber. Thank you for the question, and I can answer, I
think, with confidence because the SEC has proposed these as
just issues to discuss.
My view is that the options that involve a layer of
industry-based regulation, in particular, in the options they
put forward, the hybrid model is the one that I think makes
most sense.
Models which would involve no industry involvement, either
something like the PCAOB or direct regulation by the SEC, I
think, are far less preferable, and they are, first, because as
Mr. Ketchum said--and he knows very well because he has been a
regulator in this industry for a number of years and an
outstanding one--having industry involved in the regulation
brings an expertise, brings a focus on ethics, brings a level
of resources, non-taxpayer resources, to the job which I think
is invaluable.
So I think industry regulation should be preserved.
Therefore, I prefer that to a PCAOB model or a non-industry
model or direct SEC model, and as I have said before, I think
the place to start in dealing with conflicts and with
duplication is in trying to find a mechanism, as we are now
discussing with the New York Stock Exchange, of uniting firm
regulation so that we do not do the regulation of firms twice.
Mr.Clay. How about you, Mr. Ketchum?
Mr.Ketchum. I have found in many things over the years that
I have agreed with Bob Glauber, and I certainly agree with him
on what is worst here.
As Bob indicates, I have been both an SEC regulator and a
proud alumni of that agency and a self-regulator for some
years, and I believe that the combination of strong and focused
and stern SEC oversight with self-regulatory organizations that
provide access, while making independent decisions, provides
access for the industry to effectively raise issues, try to
address concerns with respect to the burden or sense of
particular regulations makes a great deal of sense.
I've seen it work--not to suggest it has always worked
perfectly, but I've seen it effectively work for my entire
career, and I think a movement to full Government regulation or
a single regulator that is removed from the industry is not a
good idea.
I believe the best approach would be, out of the SEC
choices, to adopt, hopefully with care to reduce some
duplicative and burdensome parts of it, their particular
proposed specific rules that ensure a minimum level of
independence and corporate governance of SROs and enhance their
oversight of our activities, and at the same time, as Bill
Brodsky mentioned, to provide the self-regulatory organizations
continued time to work, as Bob indicates we continue to try to
do together, to address issues of duplication.
If we cannot demonstrate our ability to operate separate,
completely separate from any conflicts and effectively,
Chairman Baker made the right point. The most important thing
is public investor confidence, and we must preserve that, but I
am confident we can.
Mr.Clay. Thank you for that response.
How about you, Mr. Brodsky?
Mr.Brodsky. I am in agreement with my colleagues that the
least desirable alternative would be to have direct Government
regulation: (a) It would be costly; (b) it would be terribly
bureaucratic, and we do lose, as Bob Glauber said, the
expertise from the industry.
So to me, that would be, by far, the worst, and I think
some variation of the hybrid is where we should strive to
reach. In some respects, we have that now.
I think what we are all trying to do, as Rick Ketchum said,
is we want to maintain the public confidence and the output of
what we have, but it is very important that we should let--
there has been a lot of change that has occurred in all our
organizations over the last couple of years.
I think the SEC should give it a chance to work.
The SEC should be the organization to whom you in Congress
look to for oversight of the markets and their accountability
to you. I do not think that some of the changes that have been
brought about, either at the New York Stock Exchange or at our
exchange, over the last couple of years have really been given
a fair chance, and I feel that that should be done because we
are very sensitive to the potential and real conflicts of
interest. I, quite frankly, do not know whether it makes a
difference whether you are for profit or de-mutualized or
public as it relates to this issue.
The goal in all our organizations is to have the confidence
of investors, and if you do not have the confidence, it does
not matter what form you are in, and we all are very conscious
of these potential conflicts and are bending over backwards to
make sure that the substance of what we do is much more
important and contemplates the conflicts and overshadows them,
and it is really for the SEC to make those evaluations and
report back to you on that.
Mr.Clay. I thank each of you for your responses, and I
appreciate your attendance at the hearing.
Thank you, Mr. Chairman.
ChairmanBaker. I thank the gentleman.
Mr. Feeney?
Mr.Feeney. Well, thank you, Mr. Chairman, and thank you to
all of our witnesses.
I especially want to thank Mr. Brodsky, who was my host as
I went out to Chicago to tour the exchange, when I was out
there.
I hope you put your colleagues from the north side and
south side back together again. The weekend I was out there,
the White Sox fans were euphoric and the Cubs fans were just
sort of disoriented watching the White Sox still playing at
that time of year.
Maybe you could give us an update on the transition that
the Chicago Board of Options Exchange is making, where you are
in your transition.
Mr.Brodsky. Well, thank you, and I was very glad to host
you, and I will tell you that it will be interesting to see
whether the White Sox are able to fill the stadium at each game
next year, the way the Cubs do, whether they win or lose.
We are actually moving in the same direction that some of
the other exchanges around the country have done, and that is
to move to a for-profit model. This change really relates more
to governance and changing the way we operate, and we are
beginning in January with the first part of that, and that is
to go for-profit. Hopefully, later in the year, we will de-
mutualize.
The New York Stock Exchange is actually doing that in a
different sort of way by merging with a public company. They're
skipping the pain and heartache that others have gone through.
To the point of this program, I can only reiterate that we
are very, very aware of the importance of regulation in what we
do, and I think what is very important, some of which has been
lost over the last few years, is that there are times when the
relationship between the SEC and the SROs has become adversary,
and it is very important for us to maintain the regulatory
partnership that must exist because the Government, quite
frankly, does not have the resources nor the expertise to do
the front line work that the self-regulatory organizations must
do.
Mr.Feeney. Do you anticipate any changes in your conflict
of interest rules, your independence requirements for members
of your SRO as a consequence of your likely change to for-
profit status?
Mr.Brodsky. We have gone through dramatic changes. The SEC
has a proposal out called Reg SRO which actually will have
impact on what we do going forward. The problem, quite frankly,
is that it was put out a while ago. We have all filed our
comments, and we have not heard anything.
So at a certain point, as Mr. Cox said to us recently at
the Securities Industry meeting, so ably chaired by Mr.
Lackritz, who is next on your witness list, and that is that we
need clarity.
The SEC can come out with lots of different things and we
all can respond to them, but at a certain point in time, we
say, "just tell us what the rules are."
Mr.Feeney. This was the best practices that you are
advocating that would be applied across the board to the
different exchanges.
Mr.Brodsky. Well, the SEC has proposed things that relate
to the governance of the organization.
When I talk about best practices, I am saying that, in a
competitive marketplace--in our case, it is options and in Mr.
Ketchum's, it is stocks--the SEC has established what we
believe are standards or expectations, but we do not believe
that they have enforced them evenly among the exchanges, and we
have sought clarification on that, and I am hoping that, with
new leadership with the SEC, we might actually obtain it.
Mr.Feeney. I would like to ask all the members of the board
to tell us, as we contemplate certain changes to enhance
investor confidence and do away with superfluous and
duplicative regulations, what are our foreign competitors
doing, and what is it that you worry about that we have in
place now that is putting you at a competitive disadvantage or
that we might do that would put you at a competitive
disadvantage.
Mr. Glauber, maybe we will start with you.
Mr.Glauber. Well, again, let me start by saying that we do
not, as you know, own an exchange--well, we own a minority
interest in NASDAQ as an exchange, but we are selling that, and
we will own none.
So I cannot speak from the perspective of an exchange as
well as Mr. Ketchum can, or Mr. Brodsky, but clearly, what has
gone on in other countries is those exchanges have become
publicly owned, shareholder-owned entities and, therefore, have
access to the capital markets and can invest in technology and
compete more effectively. I think that has been very important,
and that is why I think it is a very good thing that both the
exchanges that are represented here on this panel, as well as
NASDAQ, have moved to public ownership, shareholder ownership,
so that they have access to the capital markets and the
benefits of being able to compete with capital in a robust way.
I think that is as important as anything that can be done.
The challenge they are going to face in Europe and the
challenge we face here is adapting the regulatory model, the
regulatory structure, to account for that very marked change in
the way exchanges are owned and overseen. As I say, when NASDAQ
did that, we separated completely from NASDAQ, and this is
really the issue that is before you and before the SEC and that
we are discussing.
Mr.Ketchum. I think Bob is absolutely right, that the
primary challenge we must respond to in the United States--and
let me say, I say this as an observer who has lived in both the
regulatory and the market side of the U.S. securities industry
for some time, because we really do mean the thing about
separation between regulation and markets at the New York Stock
Exchange, but without doubt, the European exchanges, in
particular, are ahead of us from the standpoint of operating as
public companies. That has enhanced their funding, has created
a level of discipline that is important in their ability to
compete.
They are able, through their regulatory system, to get
quick answers with respect to being able to make changes in how
their trading systems operate, and I think those are all things
that are important for exchanges and for the SEC to respond to
in the United States.
Mr.Brodsky. I would add that we are at a great competitive
disadvantage to our European exchanges for two reasons.
One, the rules under which we operate in terms of making
changes to our business are subject to great delays at the SEC,
under the rules that have been in place for 30 years, when
there were many exchanges but we weren't really competing.
We really compete now, and the system that we have is a
dis-incentive to innovation and competition, and again, these
are issues that we raised with Chairman Cox at the SIA meeting
this past Friday. That is how recent we have had this
conversation.
The second is that, at least in my side of the business,
which is the derivative business, in the United States, we have
the bifurcated situation of having futures under the ag
committees and under the CFTC and securities under the SEC and
this committee, and as you well know, this raises issues of
jurisdiction intramurally within this country and puts us,
again, at a disadvantage to others because sometimes we end up
spending time sparring with each other when other countries--
England, for example, they have the FSA, where it is all
combined.
In fact, in virtually every country in the world except the
United States, regulation is combined. I recognize that the
solution is not so simple, but I am just trying to answer your
question.
ChairmanBaker. No, my solution is real simple.
The gentleman's time has expired.
Mrs. Maloney.
Mrs.Maloney. A lot of us have been talking about that for a
long time, but to get Congress to change, that is a real
challenge.
I really want to thank Chairman Baker for calling this, and
as a representative of New York City, that has many financial
institutions and markets there, I am particularly delighted to
welcome to this hearing and to congratulate both the New York
Stock Exchange and NASDAQ on the Justice Department's approval
yesterday of both of your proposed acquisitions, and of course,
this development makes this hearing all the more important on
reforming the SROs that govern the markets, and it makes it
more timely.
I also would like to welcome, also, Mr. Brodsky. You have
hosted me in Chicago, and I had the pleasure of having one of
your nephews work in my office for a while. So it is a delight
to see you, also.
Yesterday we passed out of this committee a regulatory
relief bill, and we really tried to streamline some of the
regulations on financial institutions. We had a lot of hearings
and testimony where a lot of the paperwork was really a
duplication, and if anything, it loaded down the system, and
the real goal of looking for any type of corruption or money
laundering was hindered. The law enforcement came in and
testified in support of our reforms.
So I would like to ask you if there are any duplications
that are in the regulations that are just loading you down and
not really helping in any way, in fact you would be more
efficient and better able to serve our constituents without
them, and I would also like to ask Mr. Ketchum and Mr. Glauber
to comment further on the differences between the present
regulatory structures of their two markets and which features
of each they would point to as best addressing the potential
for conflicts of interest in the SRO framework and anything
else you would like to talk about.
Mr.Glauber. Well, let me take them in the order in which
you asked.
First, on duplication, certainly the focus that I have, I
think Mr. Ketchum has, Mr. Brodsky, all of us have, is on the
way we implement the self-regulatory structure, and indeed, the
thrust of my comments and Mr. Ketchum's comments, and Mr.
Brodsky's, is on how we can handle duplication.
One obvious place is in the way we presently regulate,
self-regulate firms, and firms are presently regulated by both
Mr. Ketchum and the New York Stock Exchange and by us, and we
are talking about what we can do.
We think a great deal can be done to coordinate, as Mr.
Ketchum has said, and since his arrival, the level of
coordination has gone way up. It is a model, I think, for
coordination. Nevertheless, I think it would be best for
investors if we spent all of our resources on examining and
enforcing and regulating and less of them on the need for
coordinating. That is why we are engaged in a discussion of
whether there isn't a structure that we could employ that would
provide that coordination and rid us of the duplication that
exists.
On conflicts, I have made the point a number of times--and
just let me say it one more time. We decided at NASD, when
NASDAQ became a for-profit shareholder-owned exchange, that the
best way to deal with conflicts was total separation. We
thought that, for a director of the exchange who is also a
director of the regulatory operation, that that director would
have what I would characterize as unmanageable conflicts to
deal with. They would owe a duty of loyalty to both a profit-
making entity that has to provide for profits for shareholders
and, of course, to the public as a regulator.
We thought the best way of managing those conflicts was
total separation, and I think, as you can understand, at this
stage, the New York Stock Exchange has taken a different
approach.
That, I think, is a major focus of the issue of conflicts.
Mr.Ketchum. Congresswoman Maloney, your questions, as
always, are both incisive and broad. Let me try to answer them,
again, in pieces.
First, I think the questions of regulatory reform that this
committee has been so good at focusing regulators on remain
important at multiple levels.
From a rulemaking standpoint, we still have miles to go,
where the SEC has shown leadership in rationalizing our
financial regulation into a global world and a world in which
the products range beyond registered broker-dealers.
Steps were made with respect to major firms in net capital.
Additional steps probably need to be made.
Additional steps need to be made in things like portfolio
margining that stretch across our marketplaces, and we are
absolutely committed to work with the SEC and other regulators,
on all of those issues.
The rule-filing process, as we mentioned earlier, must be
faster, must be quicker, and allow markets to compete, and
allow regulatory changes necessary to protect investors to be
implemented and implemented quickly, and finally, steps must
continue to be taken with respect to removing duplication.
I do draw a slightly differently line than Bob from the
standpoint of the uniqueness of an exchange trading
environment.
It is absolutely critical, after the exchange in
Archipelago merger occurs, for us to protect the independence
of New York Stock Exchange regulation, absolutely critical. We
need a separate board. We need separate oversight. We need my
reporting directly to that.
It is also important for me and for my organization to have
a special understanding of how the exchange operates,
particularly as the exchange market structure changes, to be
involved in those changes, to identify regulatory concerns, and
make sure they get fixed up front.
So I think there is a way to balance it, but you are asking
absolutely the right questions.
Mrs.Maloney. Thank you very much.
ChairmanBaker. I thank the gentlelady.
Mr. Fossella.
Mr.Fossella. Thank you, Mr. Chairman.
Specifically, Mr. Ketchum, and anybody else who wants to
answer, with respect to the non-independent directors on the
board, what percentage of your boards are now independent?
Mr.Ketchum. Our entire New York Stock Exchange board, which
was an innovation made by John Reed, as he shifted the
governance in 2003, is independent, with the exception of John
Thain.
So in other words, each of those members are not affiliated
either with a broker-dealer or with a listed company.
Mr.Fossella. How would you characterize that
transformation?
Mr.Ketchum. I think it has been excellent. I think it is,
to me, the new and appropriate balance of self-regulation.
The beauty of self-regulation is a passion and fascination
of what makes the industry and markets tick and an ability to
provide access to the industry, to issue, spot, and identify
areas where rules or interpretations need to change.
It should not be about decision making. Decision making
should be about independent persons that do not have the
conflict space of being both representing the industry and
representing the public interest.
So I am very happy and I have been very impressed at how
the New York Stock Exchange Board operates with that
independence.
Mr.Fossella. Mr. Glauber or Brodsky, do you care to weigh
in?
Mr.Brodsky. Yes, I would be happy to. Where we are right
now is that our board is 50 percent independent and 50 percent
member, and while I understand what caused the New York Stock
Exchange to become 100-percent independent--and there were many
things that were in the newspapers, and you know about that--I
think that we have to recognize that our business, by its
nature, is a very complex business, and we have, we think, a
good balance, and the balance we have is 50-percent
independent, 50-percent industry, because it is very difficult
for independent directors who are truly independent to have the
feel for the activities that go on in the market and the
changes that are occurring, and I know the New York Stock
Exchange has a separate--I call it a shadow board of industry
people who advise the board of directors.
I do not know if--without the issues that the New York
Stock Exchange had two-and-a-half years ago--you would have
ended up with what they have today.
I think it has a very good ring to it, but I think there
are practical ramifications, and so, in our case, we have half
industry, half public, where in their case, they have a full
independent board, but then they have a separate board that
meets apparently prior to when the other board meets.
What exists today is similar to our Federal system when
Congress watches the States experiment as laboratories on
similar issues.
I think it is very important for SROs to be able to have a
certain amount of flexibility provided that there is integrity
in what they do.
Mr.Glauber. Our board is presently about 60-percent
independent, 40-percent industry, and it has been a majority
independent or non-industry, public, for about 8 years.
As Bill Brodsky just said--I guess it is a nice way of
characterizing it. New York has taken a little different
approach. It has what Mr. Brodsky called a shadow board, which
is all industry, and its main board all independent, and that
is a way of involving both points of view.
We have chosen to put them in the same place on the board,
with a majority always independent, so that our board is
controlled by the independent members of the board, which is as
it should be, and we provide the perspective of the industry in
the board room, rather than through what Mr. Brodsky
characterizes as a shadow board.
Mr.Fossella. Okay.
Another question--Mr. Brodsky, you talked in, I guess, your
testimony--to use your words, an adversarial approach to SROs
from the SEC.
What recommendations would you make specifically to
strengthen this partnership that serves both the regulator and
yourself and, ultimately, investors to improve not just
communications but the overall relationship as we move forward
to the reform itself?
Mr.Brodsky. Well, over the years, the relationship has been
a very good one between the SEC and the SROs. We have been
through a very difficult period that I do not have to recount
to this group, over the last 5 or so years of scandals. This
has created an atmosphere where the SEC has, I think, been--in
their dealings with us--very different than they had in the
past, not because we had done anything wrong, but because they
felt under a certain amount of pressure, and, therefore, you
could feel the change in the relationship.
I am hoping that, with a new chairman and new members of
the Commission--the Commission has now two members it did not
have a few months ago--and the fact that things have settled
down, that we can get back to what's normal.
So I do not think it is anything that has to be done other
than the passage of time and some new members in the leadership
of the Commission.
That is my hope.
Mr.Fossella. I will just throw it out there, and if you
have a quick response--you all talk about the competitive
disadvantage about the lack--because of the lack of clarity,
because of other sort of over-arching issues.
What does that all mean? I mean, at the end of the day, how
do you quantify what that means to our economy, what that means
to the market, what it means to investors, to best articulate--
other than the frustration everybody shares, acknowledging that
it is self-evident that we are at a competitive disadvantage?
Mr.Brodsky. There is a cost in innovation and there is a
cost in flexibility and there is certainly a cost among the
exchanges of some people not being able to take advantage of or
wanting to make a change quickly. If you look back to the
Commodity Futures Modernization Act that passed this Congress 5
years ago, the futures exchanges, which again are much more
closely related to my business, have the ability to make
changes in their business and introduce new products virtually
by filing with the CFTC and it is approved effective on filing.
We could make an exactly comparable filing for a similar
product or a similar rule change and have it languish at the
SEC for a year.
What is the cost in that?
It is hard for me to tell you in dollars and sense, but
there is clearly a cost.
Mr.Ketchum. I think Mr. Brodsky makes an excellent point.
Again, the SEC is blessed in its staff with extraordinarily
knowledgeable people who do an excellent job at identifying
issues, but the process itself built into the rule-filing
process--I do not know how to quantify it, Congressman
Fossella, but it does impact the ability to quickly react,
either for marketplaces or for regulators, and it is something
that I believe would be a very good thing for Chairman Cox and
the Commission to focus on in the coming year.
Mr.Brodsky. If I could, I would like to underscore what
Rick is saying.
This is not in any way directed in a negative way to the
SEC staff.
This is a statute that was passed by this Congress in 1975
in a very, very different competitive environment.
Mr.Fossella. Fair enough.
Thank you.
ChairmanBaker. The gentleman yields back.
Mrs. Biggert?
Mrs.Biggert. At least we did not pass it.
For all of you, the three witnesses on our second panel
today, the Securities Industry Association and Bloomberg and
Ryan Beck, oppose using market data fees to fund regulation.
Could you comment on this and talk about support for a cost-
based approach to market data fees?
Mr.Ketchum. Congresswoman Biggert, you raise two important
and discrete points that are raised by them.
First, I can speak for the New York Stock Exchange. New
York Stock Exchange regulation is not directly funded from
market data fees. We are funded--and we will move to the other
side of becoming a public company to be funded directly by
regulatory fees and by contracts with the marketplace.
Of course, it is important that the marketplace be
profitable and be able to meet its obligations for us from a
contract standpoint, and that comes to your second point with
respect to cost-based fees.
Again, I speak only as an observer, emphasizing that it is
best for the New York Stock Exchange market people to respond
to that, but I do think the existing environment, where the SEC
reviews any fees and identifies whether those fees are
reasonable or not, does provide protections to ensure that
those fees are appropriate, and it is, I guess, not clear to me
personally that change really is required.
Mrs.Biggert. Thank you.
Mr. Glauber?
Mr.Glauber. I think my perspective is the least valuable on
this panel because we do not manage an exchange. I think the
position of the exchange that we regulate, which we do as a
separate entity under contract--that is, NASDAQ--ought to be
provided you by NASDAQ. So let me defer both to Mr. Ketchum and
to Mr. Brodsky.
Mrs.Biggert. Mr. Brodsky, do you have any comment on that?
Mr.Brodsky. I would say, in the options industry, the
market data fees are not nearly as substantial as they are on
the stock side, but the SEC, in its request for comments, has
taken up this issue, and this is something that the SEC
currently is studying.
It is obviously an important issue. We feel that it should
be part of the work that the SEC is doing now. We look forward
to discussing it with them.
Mrs.Biggert. Thank you.
Mr. Brodsky, I remember at one point we were discussing
portfolio margining, and I think that you were--there was a
problem with two regulators. Is that still an issue? Do you
think that a single regulator will solve that?
Mr.Brodsky. Well, we will not have the luxury of having a
single regulator in time to solve that.
You may or may not be aware, but there is a bill that
exists in the Senate side--and I know this will eventually
happen in the House side, at the ag committee--to re-authorize
the CFTC. Part of the reauthorization of CFTC deals with work
that should have been done between the SEC and the CFTC over
the last 5 years to achieve portfolio margining in single stock
futures and options.
Unfortunately, those agencies did not get it done, and the
result of that is that now the presidential working group has
directed the SEC and the CFTC to get it fixed, and the upshot
of that is that, hopefully, the New York Stock Exchange and the
CBOE will take the lead in proposing rules that will allow for
portfolio margining on the securities side. Once those rules
are clarified, there will be, hopefully, counterparts on the
CFTC side.
It is complicated by the fact that you do have two
agencies, but I would say that, in this particular realm, and I
appreciate the lengthy introduction that you gave to me, I did
spend almost 15 years on the futures side, and I will tell you
that the futures industry is at least a decade ahead of the
securities industry in portfolio margining, and all we are
trying to do at the CBOE, in leading the six options exchanges,
is to give us a chance to catch up because competitively, we
are being harmed by the fact that we do not have portfolio
margining available to customers, as the futures industry does.
Again, this is one of those intramural things that we have to
deal with, but this can be solved by not only the New York
Stock Exchange and the CBOE working together, which we are, but
with the leadership of the SEC in working with the CFTC.
So I am hoping that sometime between now and the end of the
year, there will be some rules filed for the SEC to approve.
Mrs.Biggert. Thank you.
Thank you, Mr. Chairman.
I yield back.
ChairmanBaker. I thank the gentlelady.
Mrs. Kelly
Mrs.Kelly. Thank you, Mr. Chairman.
I would like to ask our panelists--the SEC recently
published Regulation SHO on naked short selling, and they are
collecting the first information on the effectiveness of this
rule. I would like each of you to explain to the committee how
each structure that you recommended in your testimony is best
able to stop illegal naked short selling and cut the incidence
of failed trades down to the lowest possible level, and I do
not care where you want to start, but I would really like to
hear from each one of the three of you.
Mr.Ketchum. Congresswoman Kelly, let me start and be
identified with your concern.
Improper naked short selling, indeed, is a concern and a
bad thing for efficient markets and something that we at the
New York Stock Exchange and I know the NASD, with the SEC, are
absolutely committed to ensuring strict enforcement.
We have worked with the SEC, after the adoption of Reg SHO,
which substantially tightened up the requirements for being
able to ensure that you locate securities and do not engage in
improper naked short selling. We worked in a sweep exam, which
was a good example of coordination among the regulators, where
we, the NASD and the SEC, split up firms across the entire
industry.
We have completed that.
We have found generally strong compliance with the rules,
but also instances of problems that we will address in a
variety of ways, as will the NASD and the SEC, and I can just
underline to you that we are absolutely committed to the strict
enforcement of Reg SHO and believe in it very, very strongly.
Mrs.Kelly. Thank you.
Mr. Glauber?
Mr.Glauber. Thank you.
I am speaking to you now from our position as the contract
regulator of the NASDAQ market.
First, I would endorse exactly what Mr. Ketchum has said.
Further, what we have done is submitted to the SEC a rule
which would extend the mechanisms of Reg SHO to non-listed pink
sheet securities. We submitted the original rule back in March.
We amended it a couple of months ago, and, in fact, the SEC has
now just put it out for comment. I assume that once the comment
period expires, it will make whatever changes are necessary,
and then that rule will become effective.
So the protections of Reg SHO will be extended to the pink
sheet securities, as well, and I think they are important
protections.
Mrs.Kelly. I agree.
Mr. Brodsky.
Mr.Brodsky. Yes.
First of all, I agree with the concept or the objective of
Reg SHO, and that is that people who sell stock short must be
in a position to borrow that stock before they sell the stock.
That is a fundamental concept, and I agree with my two
colleagues here, but this is an SEC rule. The SEC, I think, is
in a good position to deal with this. I would say,
Congresswoman Kelly, having come from New York and now living
in Chicago for many years, I will tell you that we take a much
more free market approach to short selling in general, and that
is that the whole concept of having to sell at an up-tick is an
anathema to free markets, and I cannot resist the opportunity
to make this comment, but if you do sell short, you should be
in a position to borrow the stock, and I, therefore, support
the goal of Reg SHO.
Mrs.Kelly. Good.
Thank you very much.
Mr. Glauber--
Mr.Glauber. Yes.
Mrs.Kelly. I have just had a very interesting experience
with regard to fast-growing equities markets, and I do not
think a lot of people really are aware that the fastest growing
ones really are not in the United States or even in the Far
East. They seem to be in Arabia and the Arabian Peninsula.
I recently had an opportunity to visit that region, and I
saw firsthand a commitment to professionalism in both men and
women doing trading.
These young traders were there actively engaged and working
the world market.
I understand that NASD has been working with some of these
emerging exchanges, and I would really like you to share with
the committee your experience in working with the emerging
markets in the Middle East and the export potential of the
professional market regulation services that you might have.
Mr.Glauber. Thank you.
We have, indeed.
We have worked with the regulators in Jordan and in Saudi
Arabia.
We have done so because we have been told by them and we
believe we do possess an expertise in regulation that they have
sought. And we think that it is an appropriate responsibility
for us to share that expertise when it is asked. We ask only
that our costs be paid. We are not going to make any profit
from this.
We do so because we think that developing safer and better
regulated markets in these countries is likely to foster the
growth of capitalism and better provide a platform for
democracy in these countries. We believe--more generally--that
our markets will be better if they exist in a broad network of
markets around the world that are safe, well regulated capital
markets.
So we have done that. It has provided us, I think, a useful
opportunity. We have learned from it. I believe that our
clients have learned from it, and we will continue to do it on
a limited basis when markets come to us and tell us we can be
helpful to them.
Mrs.Kelly. Anyone else want to comment about that?
Mr.Brodsky. I would comment that CBOE has, in the last 12
months, signed five memoranda of understanding with Chinese
exchanges which provides for information sharing and
cooperation in derivative markets. I will tell you that, having
been to China a year ago, it is breathtaking the progress that
has been made in that country. I must say the potential there
is so enormous because of the size of the market, the industry
of the people, and their love for trading.
Mrs.Kelly. Thank you very much.
It is an interesting experience to go to these markets, and
I am delighted to hear that we are talking about having an
impact on making sure that there is a professional regulation
that is understood across the board.
So thank you both.
I yield back.
ChairmanBaker. I thank the gentlelady.
Before I ask the panel to step aside, I would just observe
that, in a world where digitalization is taking place
enormously rapidly, and if it can be digitalized, it can be
shipped anywhere, and if we currently have a market reg
environment where there is the potential for market arbitrage
to evade cost and enhance efficiency, we have got to be very
sensitive to where we are going with this, and I know you are,
but it bothers me greatly unless we can get our house in really
top shape order.
Let me express to each of you my appreciation for your
appearance, your assistance.
We know this is complicated business, but it is essential
business, and we want to be a partner going forward, to be
helpful as best we can.
Thank you very much.
I would ask now that, as appropriate, our members of the
second panel come forward.
ChairmanBaker. Let me welcome each of the panelists here
this afternoon.
As you are familiar, we will ask that you attempt to keep
the remarks to 5 minutes. Your formal statement will be made
part of the record.
We certainly appreciate the courtesy of your participation,
and I welcome back, after many prior appearances, Mr. Marc
Lackritz, president of the Securities Industry Association.
Please proceed at your leisure.
STATEMENT OF MARC E. LACKRITZ, PRESIDENT, SECURITIES INDUSTRY
ASSOCIATION
Mr.Lackritz. Thank you, Mr. Chairman, and members of the
subcommittee.
I appreciate the opportunity to testify this afternoon on
reforming the securities industry self-regulatory system.
Our Nation's securities markets, as you well know, are the
most transparent, liquid, and dynamic in the world. New forms
of competition, technological advances, globalization, and
broader investor participation have driven phenomenal changes
in the capital markets and securities industry over this past
decade, further strengthening our capital markets' global
preeminence.
Self-regulation has been a key ingredient in the regulatory
framework in which our markets have thrived. The extensive
expertise of members and their involvement in the rulemaking
process has led to more effective and less costly self-
regulatory rules. This tiered regulatory system, supplemented
by Government oversight, has provided a greater level of
investor protection than Government alone might have been able
to achieve, but self-regulation does have significant
drawbacks.
First, conflicts of interest, which we just heard about,
between SROs' roles as both market operators and regulators,
and second, regulatory inefficiencies resulting from
duplication among multiple SROs.
The proposed mergers between the New York Stock Exchange
and Archipelago and the NASDAQ stock market and Instinet's
network add an additional concern about the profit motive of a
shareholder-owned SRO detracting from self-regulation.
We strongly believe that the proposed mergers present a
unique opportunity now to address these concerns and to bring
the structure of self-regulation into the 21st century.
The SIA strongly supports adoption of the hybrid self-
regulatory model as the best alternative to the current
structure of self-regulation.
The hybrid self-regulatory model would split regulation
into two functions.
Each marketplace would have its own SRO which would
regulate and enforce all aspects of trading, markets, and
listing requirements, but there would also be a single-member
SRO that would handle regulations relating to the operations of
broker-dealers.
This body would be transparent to both the investing public
and to its members. Both the public and broker-dealers would be
involved in its governance, and the SEC would oversee its
budget, funding, and performance.
Combining the SRO broker-dealer regulatory programs into
one centrally managed entity, the hybrid SRO, would eliminate
the duplication, inefficiency, and redundancy that occurs with
rulemaking, data reporting, examinations and enforcement
actions.
These regulatory inefficiencies consume time, energy, and
money, thereby stunting innovation and growth.
In addition to the waste of regulatory resources, the cost
on broker-dealers, and especially the smaller firms, is heavy.
Uniform efficient regulation would allow firms to use their
internal compliance resources much more effectively, further
strengthening investor protection.
A hybrid SRO would also remove the potential conflicts of
interest between an SRO's regulatory duties and its market
functions by splitting regulation into two functions. Such a
revamped self-regulatory structure will strengthen investor
protection and increase the competitiveness of the U.S. capital
markets.
For the hybrid model to function effectively, however, the
SEC will have to provide attentive, cost-effective regulatory
oversight that includes vigilant review of the single-member
SRO's costs and fee structures. Strong public and member
involvement will become even more important to prevent a
single-member SRO from becoming an unresponsive bureaucracy
with prohibitive cost structures.
We also recommend that the SROs define the costs necessary
to meet their self-regulatory obligations, prepare and make
public a budget to meet those obligations, and then fairly
apportion those costs among members.
Regardless of the outcome of regulatory consolidation, the
SEC should deal immediately with longstanding concerns by
market participants about the opaque and non-accountable way in
which market data fees are currently set. Congress certainly
never intended for market data to generate revenues for SROs to
subsidize their regulatory obligations or to fund competitive
business activities in the manner that it does today.
The purpose of disseminating market data is to create
transparency in the prices that investors receive for buying
and selling securities and, where there are competing market
centers, to increase investor choice and opportunity.
For that reason, we have advocated that the SEC adopt a
narrow, cost-based approach for funding regulation that does
not depend on revenue from market data fees. Our approach does
not put the SEC in the role of rate-maker for data fees but,
instead, encourages the agency to rely on its oversight role to
ensure that access to this information is available on a fair
and reasonable basis.
Importantly, a cost-based approach will minimize the
conflicts of interest that arise from control over a monopoly
product with the ability to use the resulting revenue to
subsidize other activities.
We have reached the ideal moment now for implementing
significant structural reform of self-regulation that will
strengthen our global preeminence and ensure that investors are
fairly protected.
SIA is eager to work with Congress, this committee and
subcommittee, the SEC, the SROs, and all interested parties to
take advantage of this very unique opportunity to bring the
structure of self-regulation into the present.
In doing so, we will ensure our markets remain the most
transparent, liquid, and dynamic, with unparalleled levels of
investor protection.
Thank you very much, Mr. Chairman.
[The prepared statement of Marc E. Lackritz can be found on
page 107 in the appendix.]
ChairmanBaker. Thank you for your testimony, sir.
Next, we welcome Mr. Kim Bang, president and chief
executive officer of Bloomberg Tradebook.
Welcome, sir.
STATEMENT OF KIM BANG, PRESIDENT AND CHIEF EXECUTIVE OFFICER,
BLOOMBERG TRADEBOOK, LLC
Mr.Bang. Thank you, Mr. Chairman and members of the
committee.
My name is Kim Bang. I am pleased to testify on behalf of
Bloomberg regarding self-regulatory organizations, exploring
the need for reform.
Bloomberg L.P. provides multi-media analytic and news
services to more than 250,000 financial professionals in more
than 100 countries worldwide. Bloomberg News is syndicated in
over 350 newspapers and on 550 radio and television stations
worldwide.
With the approval of the mergers and with major market
structure initiatives pending, this is a good time to hold this
hearing.
The most significant consequences of the proposed New York
Stock Exchange-Archipelago merger is, in fact, that the New
York Stock Exchange will now become a for-profit entity. As a
for-profit entity, a regulator, a marketplace, and a
beneficiary of a Government-sponsored information monopoly, the
New York Stock Exchange is playing a lot of roles, and many of
them conflicting.
As a for-profit entity, the New York Stock Exchange will
have an incentive to extract maximum benefit for shareholders.
The ramifications are substantial, and the need for
regulatory and congressional oversight will be, as well.
There are many perspectives from which to look at the SEC
Reg SRO and the issue of how SROs should be governed and how
they should act.
Our preferred vantage point is how they will distribute
market data and how much they will charge for this market data.
Market data, as you know, is the oxygen of the financial
markets.
There are critical priorities here. Market data must be
available and affordable for retail investors, and market
participants must have the widest possible latitude to see best
execution and add value to that data by devising analytics,
databases, and other innovations.
Before the New York Stock Exchange-Archipelago and NASDAQ-
Instanet mergers were announced, the SEC launched a public
discussion of market data revenues and whether they should be
cost-based.
Bloomberg joined the SIA in strongly supporting cost-based
limits on market data fees and believes the for-profit status
of the SROs lends greater urgency to this initiative.
In its 1999 concept release on market data, the Commission
noted that market data should be for the benefit of the
investing public.
Indeed, market data originates with specialists, market
makers, broker-dealers, and investors, and the exchanges in the
NASDAQ marketplace are not the sources of this market data but,
rather, the facilities through which market data are collected
and disseminated pursuant to regulatory fee and without
compensation to investors or their brokers.
In its 1999 release, the SEC proposed a cost-based limit to
market data revenues.
A cost-based approach would not require the New York Stock
Exchange and NASDAQ to sell data at cost. Instead, it would
require the charges to be reasonably related to the costs of
collecting and disseminating this data with a reasonable
profit.
Today, as not-for-profit entities, the SRO network spends
approximately $40 million on collecting and disseminating this
data, and they receive over 10 times that much, $424 million in
revenue.
Yet, a detailed accounting of these revenues, including the
underlying costs to the SROs and an account of the use of these
revenues, has been unavailable.
Would the State and local public service commissions that
regulate other type of public utilities, those that supply us
with electricity, gas, telephone, rail service--would they
tolerate the idea of a 1000-percent markup over the cost?
Hardly, but the Congress told the SEC in 1975 to regulate these
data monopolies, including the New York Stock Exchange and
NASDAQ, as public utilities.
Market data revenues come from investors. If investors were
paying roughly 10 times the cost when dealing with not-for-
profit entities, where significant competing venues were
potentially restraining costs by giving away this market data,
what will investors be paying now that the New York Stock
Exchange and NASDAQ will no longer face that competition?
On the best execution obligations, moreover, each broker-
dealer and fiduciary is required by law to ascertain what
trading venue has the best price in every stock, every
millisecond.
If having complete access to this data is effectively
required by law, broker-dealers and fiduciaries have absolutely
no capacity to bargain over the price of this data.
Access to information will also be a challenge. Bloomberg
L.P.'s 3-year-long conflict with the New York Stock Exchange
over Liquidity Quote and Open Book illustrate this point.
With Liquidity Quote and Open Book, the New York Stock
Exchange attempted to exploit its powers as a Government-
sponsored monopoly to require certain vendors to sign contracts
that would place severe restrictions on the use of this
critical data. Those restrictions would have required vendors
like Bloomberg to, one, refrain from integrating the Liquidity
Quote data with data from other market centers; two, advantage
the New York Stock Exchange over competing market centers when
it came to display; and three, refrain from building value-
added analytics using this data.
In short, the New York Stock Exchange proposed to leverage
its monopoly over market data downstream to unfairly
disadvantage not only exchange and ECN competitors but also
competitors in the information space.
To its credit, the SEC unanimously struck down the New York
Stock Exchange restrictive contracts.
Tying regulatory powers to for-profit incentives will
invite this kind of abusive behavior that undermines the goal
of the national market system.
While talking about market information, I would like to add
that many market problems, especially the obstacles of meeting
best executions, could be resolved in the event of display and
limit order rules if they were simply updated for a decimalized
environment.
Decimalization has been a boon to investors. They have
dramatically reduced spreads. However, the rules governing the
display of this market data, rules that were crafted in an era
of eights and sixteenths, have never been updated to reflect
decimalization.
Since decimalization induced 100 price points to the dollar
in place of the previous eighth or sixteenth, the amount of
liquidity available now at the national best bid and offer is
so much smaller than it was before. As a result, there has been
a dramatic diminution in transparency and liquidity at these
inside quotations.
The SIA, in commenting on Reg NMS, accurately observed,
quote, ``The value of the NBBO, the cornerstone of the market
data, is less than it was before decimalization. We believe the
SEC has the responsibility to address this issue,'' end of
quotation.
The simplest resolution would be to require exchanges,
market makers and other market centers to publish customer
limit orders within five cents of their best published
quotations.
This is a modest proposal.
The impact would only restore the transparency that has
been lost as an unintended and unforeseen result of
decimalization.
As a policy matter, it is hard to argue that decimalization
should leave the public with less transparency.
I conclude by noting that the major market changes we are
witnessing create enormous challenges for SROs and for the
public they serve.
We believe equal and fair access to market data and
liquidity at a reasonable cost for all market participants is
necessary for reforming self-regulatory organizations.
This must be coupled with congressional and regulatory
vigilance.
Thank you, Mr. Chairman and committee members. I am happy
to answer any questions.
[The prepared statement of Kim Bang can be found on page 48
in the appendix.]
ChairmanBaker. Thank you, sir.
Our next witness is Mr. Ben A. Plotkin, chairman and CEO of
Ryan Beck & Company.
Welcome, sir.
STATEMENT OF BEN A. PLOTKIN, CHAIRMAN AND CHIEF EXECUTIVE
OFFICER, RYAN BECK & CO.
Mr.Plotkin. Thank you, Mr. Chairman.
Mr. Chairman and members of the committee, I am chairman
and chief executive officer of Ryan Beck & Company, a 60-year-
old NASD member firm based in New Jersey. We have about 1,200
employees, 38 offices in 13 States, including Florida and New
York City. We have a number of offices in each of New York and
Florida.
I am also chairman of the Securities Industry Association's
regional firms committee, and I thank you, Mr. Chairman, and
the entire committee, for the opportunity to testify on issues
relating to need for structural reform for self-regulation, and
especially to present the regional firms committee's support of
the hybrid self-regulation organizational model. These hearings
are very timely, in light of the proposed merger involving the
New York Stock Exchange.
Regional securities firms play an important role in the
U.S. markets. Many of the so-called regional firms, like Ryan
Beck, do business from coast to coast. We are simply smaller
and much more focused to serve clients in a way that larger
national firms often cannot.
Our client base, in many respects, are typical individual
investors looking for quality advice, small businesses looking
to access the capital markets, or municipalities with financing
needs below the radar of large national firms.
Our clients expect us to provide the full complement of
services offered by national firms but on a personalized cost-
efficient basis.
Unlike national firms, we do not have the size to readily
absorb the cost of regulatory duplication. Recently, 16 of the
largest regional firms around the country signed a letter
urging regulatory reform. These firms hailed from across the
United States.
Most regional firms are members of two national SROs, the
New York Stock Exchange and the NASD. In addition, we are
regulated by the SEC and, in the case of most regionals, 50
State regulators.
All these regulators, for legitimate reasons, have been
much more active in their rulemaking, examination, and
enforcement initiatives in recent years. The cost of increased
regulation presents significant challenges to regional firms in
continuing to attract and retain a loyal client base with cost-
competitive services.
If left unaddressed, high regulatory costs will drive
continued consolidation among regional firms, leading to fewer
investor choices.
Some firms, like Ryan Beck, have chosen to access the New
York Stock Exchange through other broker-dealers to avoid
duplicate regulation. These results are demonstrative of a
situation that should not persist. All firms should be subject
to the same regulatory process, one that is efficient and non-
duplicative.
Regulatory duplication can undermine investor protection
because it means a firm's compliance efforts are refocused
towards complying with two sets of substantive standards,
rather than focusing on monitoring and preventing conduct that
could harm investors.
While the industry is certainly appreciative of the
regulators' efforts to mitigate the negative effects of
duplicative regulation, no amount of regulatory coordination
can fully counteract the inefficiencies that are inherent in
the current structure.
In short, we believe in two strong regulators, not three.
We are not advocating less in overall supervisory
resources, instead that the same resources be allocated in a
more efficient manner.
Self-regulation has worked incredibly successfully over the
years.
Self-regulation and governmental regulation are, together,
capable of achieving a level of expertise in investor
protection that is truly greater than the sum of its individual
parts. Given the current proposed mergers, now is the
appropriate time to restructure and revitalize the self-
regulatory system and truly bring it into the 21st century.
In order to effectively and efficiently address these
concerns, the hybrid model proffered by the SEC in its SRO
concept release presents an appealing and practical alternative
to the current model.
The hybrid model would minimize inconsistent regulation
that results from duplicative SRO regulatory oversight.
Regulatory resources would be expended more efficiently, as the
regulators would have to spend less time writing or reconciling
inconsistent rules or conducting duplicative examinations.
There would also be benefits from concentrating regulatory
expertise so that single-member SROs could maintain a talented,
experienced regulatory staff, rather than having that talent
and expertise fragmented across multiple SROs.
In order to protect the interests of all member firms, the
single-member SRO would require significant involvement from
both the investing public and broker-dealers. While non-
industry representatives should comprise a majority of the SRO
board of directors, adequate industry representation is
essential to ensuring that a single-member SRO is embedded with
the expertise necessary to efficiently regulate both large
national firms and small regional firms. In short, we must keep
the self in self-regulatory organizations.
In conclusion, let me say that the U.S. securities markets
are still the most efficient, transparent, and liquid in the
world, but we cannot grow complacent.
The implementation of the hybrid model will help to ensure
that U.S. markets preserve their reputation in the years to
come.
I appreciate the opportunity to speak to you today and am
prepared to answer any questions.
[The prepared statement of Ben A. Plotkin can be found on
page 119 in the appendix.]
ChairmanBaker. Thank you, sir.
Mr. Lackritz, in Mr. Bang's testimony, he went on at length
concerning the troublesome aspects of market data, the fees
associated with it.
I would assume you would share his general observations
about market data concerns?
Mr.Lackritz. Yes, absolutely.
In fact, I think we highlighted those in our longer written
testimony.
ChairmanBaker. My point in raising this is to use that as
the issue in discussing regulatory structure.
Clearly, if there is the traditional SRO, which has
conflicting task masters with shareholders on the one side and
regulatory responsibility on the other, the ability of that
regulator to assess the validity of the charges associated with
market data would appear to me to be slightly impaired.
How does the hybrid model markedly improve on that, even
recognizing that an independent regulator might have the
tendency to threaten more bureaucratic structure with less
specialization of regulatory capability?
What is more important, getting efficient value from market
data and other lower-cost regulatory assessments or having an
entity that is more specialized and, quote, ``market
sensitive'' that is closer to you?
I am having trouble figuring out where that animal lives.
Mr.Lackritz. I think the answer to your question is yes,
that we can walk and chew gum at the same time, and I think
that what we are trying to do in the proposal, in the hybrid
SRO, is to talk about both raising the quality and improving
the quality and efficiency of regulation by making it cost-
based so that, in fact, you would have a proposed budget for
this regulator that would be open, transparent for the public,
for the SEC, and for the industry to look at, and when there is
an understanding of what is appropriate in terms of the level
of regulation, that cost would be assessed across the
membership, on a per-member basis, appropriately.
At the same time we are saying that currently, under the
current structure, market data fees are cross-subsidizing
regulation because, as pointed out in Kim Bang's testimony,
they are 10 times the cost, roughly, of collecting the data.
So rather than having market data cross-subsidize
regulation--
ChairmanBaker. Are we even sure that is where the money
goes?
Mr.Lackritz. Well, it certainly goes--you know, I heard Mr.
Ketchum's testimony that market data fees do not finance
regulation, but at the same time, they are providing an
enormous amount of revenue to the exchange, and the exchange
has a variety of functions that it uses revenue for, and so,
from the standpoint of improving market data dissemination,
that also should be based on a cost-based formula, so that the
cost of collecting the data should be what the markets charge
for that data, and that is where the SEC really would come into
effect as the overseer of that market data structure, but it
needs to be cost-based, not whatever the traffic will bear or
not what the monopolists would like to charge.
ChairmanBaker. Well, I also heard Mr. Brodsky make the case
that we need people closer to us who share the specialization
of talent that is necessary to understand our activity, which
may be different from the equity side. What is your reaction to
that necessity?
Mr.Lackritz. Well, he is right, and our hybrid SRO model
would provide for that because you would have--on the one hand,
you would still have market-based surveillance activities,
enforcement activities, trading regulation based on the
marketplace.
The hybrid member--single-member SRO would only do
inspections, examinations, and audits and regulations of the
broker-dealer at the member level, at the broker-dealer level,
not at the market--not market-based.
ChairmanBaker. So you share the view that there can be a
line drawn between the regulatory responsibilities that are
applicable to all markets while recognizing the specialty
skills for individual markets that can be transparent in its
assessment of fees that is justifiable in light of the client
use.
Mr.Lackritz. Basically, yes. Yes, that is correct. You
know, I think what we are trying to do is get the best of both
possible worlds, you know, get centralized expertise, on the
one hand, for operations that are similar across the board, at
the member level, at the broker-dealer level, and that would be
the single-member SRO, and at the same time, leave market-based
surveillance, market-based expertise in the marketplaces to
enforce the rules and regulations in those marketplaces.
ChairmanBaker. Mr. Bang, do you share that general
perspective?
Mr.Bang. Yes. I am not going to repeat everything that Marc
said because obviously we agree with everything that he laid
out, but to give you a little bit of perspective, you know, we
have, in the past, heard justification for charging these--what
we consider very large market data fees on the necessity of
funding regulatory oversight.
It was interesting to hear today from Rick Ketchum and also
Mr. Glauber that, indeed, they are not--they do not believe
that market data is being used to fund the regulatory
oversight, and that seems to be sort of a change, a bit of a
change, because historically, we have sort of heard different.
ChairmanBaker. I think I also heard him indicate that it
was not that significant either.
Mr.Bang. Right.
ChairmanBaker. Okay.
Mr.Bang. So the question is, you know, what is a fair
charge for this market data, and the costs that I quoted to you
today is really just the cost for the NBBO, you know, the top-
of-file dissemination, and as you can hear, we believe that we
really should make--restore the sort of transparency that we
had at the time of--in pre-decimalization, and, indeed, that is
what the NASDAQ and New York Stock Exchange is in the process
of doing with the--providing New York Open Book available in
the marketplace for real time, which is essentially depth of
book, and the NASDAQ has a program--I believe it is called
Total View--which is also a depth of book program, which is
really essentially in a--in this sort of marketplace that we
operate in, because it is decimal pricing and that we have
fiduciary obligations to seek best execution for our clients.
So we need to consume that data; we need to buy the data.
And that data is now being sold at an additional cost that I
did not quote to you, right?
This is on top of it, and it is coming as a result now of
the mergers, because in the past, Archipelago, Instanet,
Island, all of these ECNs--they did not charge for the data.
It was made available free of charge.
Now that it is going to be merged into these entities and
they are going for profit, they are going to charge separately
for providing this depth of data, and they are probably going
to charge approximately the same that they charge for the
current data.
So essentially, you are going to get a doubling of data
fees, close to a billion dollars in cost to the market
participant and investor public, which we find is quite
excessive.
ChairmanBaker. I want to do one more because Mrs. Kelly is
here, and I have gone way over my time, but Mr. Plotkin, you
have talked about the regulatory burden, the cost of
compliance, particularly for a smaller firm, in managing
business in the market.
There was mention earlier of the growth of foreign
exchanges and investment opportunities there.
From your view, given the limitations that you face now, is
that potentially something of concern to the Congress, that
unless the regulatory burden is addressed, that we are going to
see folks making decisions to move elsewhere?
Mr.Plotkin. I think it is a good question.
I mean what happens from a CEO's seat is we do have
choices.
Companies can decide to either consolidate, go out of
business, and there has been an increase in consolidation of
regionals because the burdens are too high, or they can decide
to choose regulatory bodies, which is not necessarily a good
result, as well.
So it is definitely possible in the way this is set up
right now.
ChairmanBaker. Is the regulatory cost that is of concern to
you principally market data, or is it the broader regulatory
duplication and other issues?
Mr.Plotkin. It is currently the redundancy. I mean, from my
seat, we have--we have gone from about five people in
compliance and legal to about 25 in the last 4 years, and we
are a relatively clean firm in terms of, you know, supervisory
issues.
You know, my choice as the CEO is to have people focus
internally to make sure we do not have a bad apple, that we are
doing right by our customers, or to respond--or, often, they
are spending their time responding to multiple regulatory
inquiries. So that is the real issue.
The market data issue is a separate question for us,
because it is all about clarity.
As a businessman, if I cannot measure it, I cannot manage
it.
I want to know my data cost, just like I want to know what
my health care cost is, etcetera, etcetera, and that is the
real issue on the market data, that it is very obfuscated right
now.
ChairmanBaker. I would assume you would share Mr.
Lackritz's view about the advisability of the hybrid model. Or
do you have other views?
Mr.Plotkin. Well, the regional firms around the country
support the hybrid model.
We believe that what that means is consolidation of the
broker-dealer regulation so we will have two strong regulators,
an SRO, as opposed to multiple SROs, and the SEC, along with 50
State regulators. We think that is plenty cops on the beat.
ChairmanBaker. Yeah. I do not disagree.
Mrs. Kelly?
Mrs.Kelly. Thank you.
I would like to ask Mr. Lackritz a question.
Mr. Lackritz, on page 10 of your testimony, you talk about
the issues that are conflicts between shareholders' interests
and the regulatory authority, and you talk about the New York
Stock Exchange, and mention that they are going to move
employees into a separated, affiliated--separate, affiliated,
nonprofit entity, and I am quoting here, and you go and say,
moreover, the very fact that the New York Stock Exchange
apparently seeks to maintain regulation of its broker-dealer
members under the NYSE name, with the oversight of some of its
directors, rather than spin it off into a separate entity under
a different name, with entirely separate directors, suggests
that the New York Stock Exchange sees value in continued
branding of its regulatory authority over broker-dealers.
You know, the stock exchange has had over 200 years in
self-regulation.
It has not been all bad, and the experience level--the
regulation--the members know what the regulations are, and that
is what they use.
They rely on it.
I do not quite understand how this is different, actually,
from the SIA branding that you have in your testimony you have
provided here, using your own market success as an association
to promote this in your own testimony.
So maybe you could define for me, how is this different?
Mr.Lackritz. Sure.
Thank you.
That is a good question.
I think that the point we are trying to make is not that
self-regulation has not worked.
The point we are really trying to make, I think, is that in
this new environment, as markets are evolving, as mergers are
happening, as ECNs are competing with existing exchanges, as
technology is dramatically changing the entire trading
environment, what is the structure of self-regulation going
forward that is going to be most effective for protecting
investors and preserving our preeminence globally, and
certainly the New York Stock Exchange has been extraordinarily
effective in terms of its self-regulation. At the same time, it
has imposed a huge amount of costs on the industry from
duplication, redundancy, and inefficiency that we have talked
about before.
So we are not talking about taking regulation out of New
York completely.
We are saying keep market surveillance, keep trading, keep
all the activities that you are doing in the marketplace that
you have been doing, continue to do those, but at the same
time, move the member regulation, the broker-dealer regulation,
into one organization so you are not competing, providing
conflicting interpretations, providing redundant rules with the
NASD that is also regulating and overseeing that same group of
firms. Let's come up with a more efficient and a more effective
structure without undermining any kind of self-regulation that
is at the exchange or has been at the exchange for 200 years.
Mrs.Kelly. When you are talking about redundant
regulations, many of these regulations may be redundant, but
are they essentially identical? Because that is what the need
is.
Mr.Lackritz. If they were identical, I don't think we would
have a problem.
I think the difficulty is that they are very rarely
identical.
There are separate interpretations.
They are somewhat different, you know, a little change here
and a little change there.
What we have found recently is we have made some progress
with the two SROs combining to work on rules, for example, with
respect to business entertainment gifts and travel, those kinds
of things, but at the same time, those resources that are going
toward coordination really shouldn't go to coordination.
They should really go to an effective examination, audit,
and regulation.
Those resources that are diverted toward coordination
really can't go to the regulation. If you had one body, you
could effectively align those resources and have a much more
effective and efficient regulatory structure.
Mrs.Kelly. Thank you for clarifying.
Thank you. I will yield back.
ChairmanBaker. I thank the gentlelady.
Mr. Lackritz, I just want you to help me with sort of a
forward-looking statement.
With the move by the New York Exchange to engage in the
merger with Archipelago and my view that the electronic trading
platforms, because of speed, efficiency, and reliability, tend
to grow in acceptability, that as I look at what has happened
at the CBOE and other exchanges, maybe not tomorrow but
somewhere down the road, we are looking at electronic
transactions of significant proportion in relation to what we
now call the specialist system.
Doesn't the applicability of electronic platforms diminish
the necessity for a specific market-based supervisory function
where the economic exchange, despite whether it is a future,
option, or an equity, begins to merge here a bit, and doesn't
that really lend itself to the single regulatory model where we
can get at all this duplication because the nature of the
entity being regulated is, in essence, losing that uniqueness
as we move forward into electronic markets? Explain to me why
that doesn't work.
Mr.Lackritz. I think I understand what you are saying, and
I think that the--you are absolutely right that technology is
obviously playing a much more significant--
ChairmanBaker. That is running everybody right now.
Mr.Lackritz. Right.
So then the question becomes how do you most effectively
provide for market regulation in the marketplace as it evolves
technologically, and certainly, technology is going to play a
much more important role in providing that surveillance, and
the question is whether you want to locate that centrally in
one organization that is going to be immune from basically a
monopoly organization or whether you are going to decentralize
that in the different marketplaces because of the algorithms
that are written, because of the software and the programming
and everything else that is going into the marketplace.
I think what our proposal says is it is better to have that
surveillance closer to the market, in the marketplaces, where
they are familiar with the technology and familiar with the
trading patterns and the liquidity and the movement back and
forth on the marketplace, rather than having it in a single SRO
that is removed, really, from the marketplace, that maybe is
gathering up information but doesn't have the market expertise,
doesn't have familiarity with the trading patterns or the flow
of volume during the course of the day, and so, I think I
understand your point, but I think that, from the standpoint of
effective and efficient regulation, by leaving that kind of
surveillance of the marketplace in the marketplaces themselves,
that provides the best solution, as long as you move the
broker-dealer regulatory functions to a single member.
ChairmanBaker. Well, I just need to understand better
because that would seem to argue that the SEC, as a single
regulatory securities entity, would be better served by having
divisions that sit in particular locations with expertise
geographically located close to Chicago or wherever the trading
platform might be.
My understandings of how markets are merging and where our
regulatory system currently stands is there is an extraordinary
divergence, which I think is reflected by the concerns about
duplication, cost, and so forth, but to get us back together
again, I am not convinced yet that the hybrid model is
responsive to the concerns that you have identified or at least
I am not understanding how the hybrid model is appropriately
responsive, and we may only pass this way once. Whatever we do
I have a suspicion is going to be around for a while. When I
look at Gramm-Leach-Bliley and other things of modest
consequence that have occurred around here, you know, we are
talking decades, and we are in a very formative, pivotal period
in our securities market formation, and I think we owe it to
our future investors and stakeholders to ask every possible
question we can, knowing we won't get it exactly right, but we
need to get as close as we can.
Mr.Lackritz. Mr. Chairman, I appreciate your comment. I
think that we completely agree this is a very unique moment,
and we would like to make sure we get it right.
Five years ago, we commissioned a white paper to explore
each different alternative idea for self-regulation, going from
completely done by the SEC to a PCAOB-type model to everything
in between, and we went through the pluses and the minuses, the
costs, the benefits, and came out saying that this hybrid model
really makes the most sense from the standpoint of investor
protection, from the standpoint of efficiency in terms of
costs, and from the standpoint of maintaining market expertise
and surveillance in the marketplaces themselves without
creating a large bureaucracy on the one hand but also without
duplicating inspections, examinations and audits which the
firms have complained about for a number of years and which are
getting better, but they are not getting better fast enough.
ChairmanBaker. Sure.
Well, I am with you on the PCAOB. We can start that one off
without disagreement.
I am just not sure single regulator versus hybrid has yet
emerged in my mind clearly enough to make an informed decision,
but the meeting today was to bring to the committee's attention
the various perspectives, and certainly, we want to be open to
your professional view.
As stakeholders, you certainly understand market function
much better than those of us on the committee, but we will have
some partnership in this as we go forward, and we want to make
sure we fully understand it.
Unless there is further comment--yes, sir.
Mr.Bang. Maybe I could make a comment on the hybrid for a
moment.
You may have suggested that the markets become more
electronic, they start to look more alike, and perhaps they
sort of operate in a more similar fashion and, therefore, maybe
a single regulator could perhaps regulate efficiently all of
these markets.
I think when you get into the granular details, even though
they are electronic, you can still find very significant
different rules and competitive practices within those
electronic venues.
If you look at the ISE options exchange, it is quite
different from the Chicago Board of Options Exchange versus the
Boston BOX Exchange.
There is probably more similarities on the cash side in
terms of an Archipelago ECN and an Instanet ECN, but it doesn't
preclude in, you know, sort of future development that certain
exchanges will have--like, for instance, the NASDAQ market has
market opening crosses, end of day crosses that the others
don't have, or they have, but they operate somewhat
differently. So having that expertise and understanding more on
a local level doesn't necessarily have to be on a physical
presence, but people--that sort of oversight--overseeing those
particular exchanges and those--the way they operate, I would
say are significant benefit.
The other thing is, having the SEC actively involved as
oversight to the regional SROs, let's say, is clearly critical.
You know, in our citation on the Liquidity Quote and this Open
Book, I think, illustrates that well, because the exchanges
obviously, especially the for-profit, will have incentive to
further their profitability and so forth.
ChairmanBaker. That is what led me to this questioning
along the line of single regulator versus an SRO model, and
that really is what started me, and then thinking through
market function and where we are likely headed, it just seemed
to be a logical question to ask.
Let me suggest this, going forward.
The committee's work will continue for some time. We are
not near any meaningful decision. We are just kind of
foundering around. Please forward your own opinion and
analysis; feel free, totally unsolicited, if necessary, but the
committee would very much appreciate additional information
going forward, as we discuss these issues into the coming
months and perhaps years.
Thank you very much for your kind participation.
Our meeting stands adjourned.
[Whereupon, at 4:26 p.m., the subcommittee was adjourned.]
A P P E N D I X
November 17, 2005
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