[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]





                     THE STOCK MARKET PLUNGE: WHAT
                       HAPPENED AND WHAT IS NEXT?

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

                                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 ELEVENTH CONGRESS

                             SECOND SESSION

                               __________

                              MAY 11, 2010

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 111-133












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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York         PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina       RON PAUL, Texas
GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California             WALTER B. JONES, Jr., North 
GREGORY W. MEEKS, New York               Carolina
DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
RUBEN HINOJOSA, Texas                SHELLEY MOORE CAPITO, West 
WM. LACY CLAY, Missouri                  Virginia
CAROLYN McCARTHY, New York           JEB HENSARLING, Texas
JOE BACA, California                 SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio              KEVIN McCARTHY, California
ED PERLMUTTER, Colorado              BILL POSEY, Florida
JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
JACKIE SPEIER, California            LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York

        Jeanne M. Roslanowick, Staff Director and Chief Counsel
 Subcommittee on Capital Markets, Insurance, and Government Sponsored 
                              Enterprises

               PAUL E. KANJORSKI, Pennsylvania, Chairman

GARY L. ACKERMAN, New York           SCOTT GARRETT, New Jersey
BRAD SHERMAN, California             TOM PRICE, Georgia
MICHAEL E. CAPUANO, Massachusetts    MICHAEL N. CASTLE, Delaware
RUBEN HINOJOSA, Texas                PETER T. KING, New York
CAROLYN McCARTHY, New York           FRANK D. LUCAS, Oklahoma
JOE BACA, California                 DONALD A. MANZULLO, Illinois
STEPHEN F. LYNCH, Massachusetts      EDWARD R. ROYCE, California
BRAD MILLER, North Carolina          JUDY BIGGERT, Illinois
DAVID SCOTT, Georgia                 SHELLEY MOORE CAPITO, West 
NYDIA M. VELAZQUEZ, New York             Virginia
CAROLYN B. MALONEY, New York         JEB HENSARLING, Texas
MELISSA L. BEAN, Illinois            ADAM PUTNAM, Florida
GWEN MOORE, Wisconsin                J. GRESHAM BARRETT, South Carolina
PAUL W. HODES, New Hampshire         JIM GERLACH, Pennsylvania
RON KLEIN, Florida                   JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              MICHELE BACHMANN, Minnesota
JOE DONNELLY, Indiana                THADDEUS G. McCOTTER, Michigan
ANDRE CARSON, Indiana                RANDY NEUGEBAUER, Texas
JACKIE SPEIER, California            KEVIN McCARTHY, California
TRAVIS CHILDERS, Mississippi         BILL POSEY, Florida
CHARLES A. WILSON, Ohio              LYNN JENKINS, Kansas
BILL FOSTER, Illinois
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan











                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    May 11, 2010.................................................     1
Appendix:
    May 11, 2010.................................................    67

                               WITNESSES
                         Tuesday, May 11, 2010

Duffy, Terrence A., Executive Chairman, CME Group Inc............    47
Gensler, Hon. Gary, Chairman, U.S. Commodity Futures Trading 
  Commission.....................................................    14
Leibowitz, Larry, Chief Operating Officer, NYSE Euronext.........    42
Noll, Eric, Executive Vice President, NASDAQ OMX Group, Inc......    45
Schapiro, Hon. Mary L., Chairman, U.S. Securities and Exchange 
  Commission, accompanied by Robert W. Cook, Director, Division 
  of Trading and Markets, U.S. Securities and Exchange Commission    12

                                APPENDIX

Prepared statements:
    Kanjorski, Hon. Paul E.......................................    68
    Duffy, Terrence A............................................    70
    Gensler, Hon. Gary...........................................    85
    Leibowitz, Larry.............................................    95
    Noll, Eric...................................................   106
    Schapiro, Hon. Mary L........................................   114

              Additional Material Submitted for the Record

Kanjorski, Hon. Paul E.:
    Written statement of Bart Chilton, Commissioner, Commodity 
      Futures Trading Commission.................................   135
Hinojosa, Hon. Ruben:
    Insert regarding establishing a joint CFTC-SEC Advisory 
      Committee on Emerging Regulatory Issues....................   138
    Written responses to questions submitted to Chairman Schapiro   143
Schapiro, Hon. Mary L.:
    ``Preliminary Findings Regarding the Market Events of May 6, 
      2010--Report of the Staffs of the CFTC and the SEC to the 
      Joint Advisory Committee on Emerging Regulatory Issues,'' 
      dated May 18, 2010.........................................   150

 
                     THE STOCK MARKET PLUNGE: WHAT
                       HAPPENED AND WHAT IS NEXT?

                              ----------                              


                         Tuesday, May 11, 2010

             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 3 p.m., in 
room 2128, Rayburn House Office Building, Hon. Paul E. 
Kanjorski [chairman of the subcommittee] presiding.
    Members present: Representatives Kanjorski, Ackerman, 
Sherman, Capuano, Hinojosa, Miller of North Carolina, Scott, 
Bean, Klein, Perlmutter, Donnelly, Carson, Foster, Adler, 
Kosmas; Garrett, Lucas, Manzullo, Royce, Biggert, Capito, 
Hensarling, Campbell, and Neugebauer.
    Ex officio present: Representatives Frank and Bachus.
    Also present: Representative Moore of Kansas.
    Chairman Kanjorski. This hearing of the Subcommittee on 
Capital Markets, Insurance, and Government Sponsored 
Enterprises will come to order. Pursuant to committee rules, 
each side will have 15 minutes for opening statements.
    Without objection, all members' openings statements will be 
made a part of the record.
    I ask unanimous consent that Congressman Moore be allowed 
to participate in today's subcommittee hearing. Without 
objection, it is so ordered.
    Good afternoon. At today's hearing, we will examine the 
frightening afternoon of May 6th, one of the most volatile 
trading days in history. Within minutes, stock market indices 
dropped precipitously, erasing more than $1 trillion in 
capitalization before recovering. While we may not yet have all 
of the facts about these events, we must quickly analyze what 
happened and embrace reforms in order to restore market 
integrity and promote investor confidence.
    Going back to 2003, questions surrounding market structure 
have received considerable attention in this subcommittee. Many 
of the issues we have previously explored remain just as 
relevant today, especially the longstanding debates of man 
versus machine and price versus speed.
    These prior hearings have also taught me that our 
regulators must remain nimble by continuing to adapt market 
structure rules to respond to an ever-evolving environment. 
Technological advances have dramatically altered the way Wall 
Street operates. Such progress is natural. For the United 
States to continue to lead the world's capital markets, we must 
continue to encourage innovation.
    But change also can have its downside. Many have cited the 
role of computers in contributing to and exacerbating last 
week's gyrations. In recent years, high-frequency trading has 
exploded. Barely a blip 2 decades ago when technology 
constraints and growth last crushed the markets, automated 
traders today move in miniseconds and make up as much as two-
thirds of daily trading volume. Their decisions to trade or not 
to trade can produce real consequences.
    We too have moved from a model of two major trading centers 
to an electronic network with dozens of marketplaces for 
trading equities, creating new headaches for regulators. The 
ascendency of computerized trading and automated exchanges in 
our capital markets appears to have created a plot as 
intriguing as ``2001: A Space Odyssey.'' Today, however, it is 
2010, and we must figure how to effectively balance artificial 
intelligence with human judgment.
    This hearing will help us to achieve that goal. It can also 
help us to determine how to harness technology to create 
effective audit trails for regulators.
    Somewhere along the way, competition among exchanges, 
alternative trading systems and others has additionally led to 
increased fragmentation. As old trading methods have given way 
to modern techniques, the rules governing our market 
architecture have lagged behind. We now must better integrate 
our markets.
    In this regard, I encourage that regulators and exchanges 
are already working together to adapt new rules for creating 
uniform single-stock circuit breakers and updating archaic 
marketwide trading halts. Most importantly, we must protect 
investors' interests. They deserve fair and orderly markets, 
which the Securities and Exchange Commission exists to ensure.
    Despite this mandate, the markets were hardly fair or 
orderly during last Thursday's roller coaster ride. In this 
turmoil, some investors lost mightily. One recent news story 
highlights a couple who lost $100,000 because their trade 
cleared at the wrong moment during Thursday's chaos. This 
turbulence additionally triggered costly stop-loss orders for 
many investors and may have placed others in unintended short 
positions as trades unwound.
    The market mayhem also, unfortunately, revealed the 
arbitrariness of the process for identifying and canceling 
clearly erroneous trades. Moreover, the decision to rescind 
some trades may have ultimately benefited those who aided and 
abetted the plunge. This is wrong. They placed a bet and 
deserve to lose.
    Although stock values quickly sprang back this time, the 
experience may prove quite different next time. A ghost-in-the-
machine scenario in which an enormous computer selloff sparks a 
vicious cycle of selling and panic seems completely plausible. 
To thwart this doomsday hypothetical, regulators must act with 
great speed and great care to promulgate new rules. The SEC has 
already begun this process with its January concept release on 
market structure.
    In sum, our witnesses can shed light on the 20 harrowing 
minutes of last week's flash crash. They can also explain how 
we should respond to technological advances, increased 
competition, and other market evolutions in ways that best 
protect investors.
    I thank each of the witnesses for appearing, especially on 
such short notice, and I am eager to hear their testimony.
    I would now like to recognize the ranking member, the 
gentleman from New Jersey, Mr. Garrett, for 5 minutes.
    Mr. Garrett. I thank the chairman, and I thank the 
witnesses.
    Yes, today's hearing is certainly timely, given the events 
of the last week. But in retrospect, considering the work that 
the regulators have already been doing the last few days, it 
might have been wise to wait just a few more days to hold this 
hearing, to give our witnesses additional time to gather 
information more fully and to analyze the events of the last 
few weeks so ultimately we could come here and be fully 
informed as to this subcommittee's inquiries.
    Broadly speaking as well, in a more ideal situation, I 
guess you could say that this subcommittee should be conducting 
oversights of the SEC and our financial markets, I guess you 
would say in a more proactive way, rather than a reactive way. 
Until her recent testimony here with regard to the Lehman 
bankruptcy, Chairman Shapiro had testified just twice since she 
was sworn in. That is far less frequently than her peers who 
head other major financial regulatory agencies. Never before 
today has she been asked to testify on market structure reform, 
despite the SEC's ambitious agenda in this area.
    So it is precisely for this reason that Ranking Member 
Bachus and I sent a letter to Chairman Frank requesting that 
this committee hold one or more SEC oversight hearings and to 
do it soon--4 weeks ago, we asked that.
    We stated in the letter, ``It is our constitutional duty to 
perform regular oversight to allow members and the general 
public to determine the suitability and impact of the SEC 
proposals as well as judge the quality of the Commission's work 
in furtherance of its congressionally mandated mission to 
protect investors, maintain a fair, orderly, and efficient 
market, and facilitate capital formation.''
    Clearly, some will say the degree to which the SEC is 
currently fulfilling all of the aspects of this mission might 
be said to be called into question during at least the events 
of this last week, which is why it is important that this 
subcommittee does examine what went on. That being said, the 
events of last week will only serve to heighten the already 
politicized atmosphere surrounding the SEC's examination 
overall of market structure.
    In another letter, in a comment letter on the Commission's 
equity market structure concept release that I sent to Chairman 
Schapiro on April 22nd, I wrote, ``While I appreciate the 
Commission's recent efforts to undertake a comprehensive review 
of our Nation's equity market structure, I want to ensure that 
this analysis starts from the vantage point of preserving or 
enhancing that which makes our equity trading markets strong 
and that change is not pursued purely or largely in response to 
any external pressures on entities.''
    I went on to write, ``As an independent, nonpartisan 
agency, the SEC has been entrusted with the responsibility to 
make its decisions based on objective, prudent, and disciplined 
analysis, and it is a great responsibility and requires an 
adherence to a balanced and data-driven empirical approach to 
ensure that regulatory efforts focus on those most productive 
areas.''
    Finally, I expressed concern in a letter that, in the 
concept release, the Commission's request for comments 
respecting the interests of long-term and short-term investors 
seems to focus on a perceived conflict between such groups with 
really no reference to the critical interdependency between 
those groups and the overall equity market structure.
    So I am hopeful that the tone of such requests are not 
really reflective of the SEC's analytical framework, and would 
rather urge the Commission to consider that it should be 
determined that the additional rulemaking be required and the 
most successful outcome would be the one that benefits the 
synergy relationship as a whole.
    So at today's hearing I will be as interested as everyone 
else to hear from both the SEC and the CFTC, as well as 
representatives from the other exchanges, to better understand 
their perspective on the events of last week. Clearly, concerns 
over the financial stability of Greece and other European 
countries were weighing heavily on investors last week, but it 
appears that something else may have factored into the sudden 
drops in the markets as well.
    I am hopeful that today's hearing will begin to provide 
clarity as to what exactly happened, and I am also hopeful that 
we will begin to have a measured and thoughtful discussion on 
what, if anything, should be done in a regulatory manner to 
address what happened then. We should not, however, rush to 
judgment for the sake of any political cover in any of this. If 
prudent steps can be taken to improve the performance of our 
markets, we should always take those and be open to new ideas, 
while keeping in mind throughout our discussion what potential 
negative consequences might occur due to any proposed reforms.
    Again, I look forward to all the witnesses' testimony. 
Thank you.
    Chairman Kanjorski. The Chair recognizes the chairman of 
the full committee, Chairman Frank, for 2 minutes.
    The Chairman. Mr. Chairman, I want to begin by 
congratulating you for having this hearing. I think the 
suggestion by the ranking member that we should have waited is 
clearly wrong. The American people are rightly disturbed. The 
world is questioning it. This is a very important issue. This 
need not be the last word. But to have failed to have a public 
hearing on these issues right away would have been to not have 
done our duty, and you are to be congratulated for moving so 
quickly to begin this process.
    I also would say I was somewhat struck when the ranking 
member made two points that seemed to me to be somewhat at odds 
with each other: One, that we haven't had enough hearings in 
which members of this committee can criticize the SEC for 
overregulating, which is essentially what he was talking about; 
and two, that we should respect their independence. He has a 
right, obviously, to be concerned that the SEC is being more 
activist in its regulatory agenda than the previous 
Administration had been. I welcome that. I think that what they 
are doing is very appropriate, and in fact I think hearings, 
with the frequency which we have had them, have been a useful 
way to do that.
    I also want to note that one of the issues we need to be 
addressing--and I will be talking about this later--is there 
are some innocent victims here. There are individuals who had 
invested in American stocks, as they have been urged to do, who 
suffered losses through no fault of their own, and I think we 
should continue to look at what could be done by way of 
compensation.
    Finally, it is clear that we have the interaction here of 
some technical issues plus the crisis in Europe. I welcome--and 
here, again, there was a difference amongst some of us; the 
House Republican Conference had written to Vice President Biden 
telling him to stay out of any efforts by the IMF to try to 
deal with the crisis in Europe. I am glad that advice was 
disregarded. I think the action in which the American officials 
participated was very helpful in averting further damage, and 
we will obviously be looking into that further.
    Chairman Kanjorski. Thank you, Chairman Frank.
    The gentleman from Alabama, Mr. Bachus, is recognized for 4 
minutes.
    Mr. Bachus. Thank you, Mr. Chairman.
    The American financial markets are the most modern in the 
world. They execute trades more efficiently and economically 
than ever before. They are the envy of the world, the fastest 
and most liquid in the world.
    However, some of the innovations, high-frequency computer-
driven trading across multiple platforms and forums, does 
create the possibility of the events that we witnessed last 
week.
    All innovations bring problems but also progress. Our 
challenge is to find a solution that addresses the problems, 
but does not destroy the benefits. In my opinion since, really, 
January, the SEC has done this. They have acted in a measured 
way, and I think the meeting yesterday was most appropriate. As 
the full Financial Services Committee ranking member, I did say 
that we probably should wait until at least the trades were 
completed to meet and let you have an opportunity to respond, 
and I think you have done so appropriately. But we are here, 
and whether they we are here today or 2 days from now is, I 
think, probably irrelevant.
    Rational concern, rising risk, and a technically over-
bought market that had raced ahead 70 percent in the past year 
resulted in a skittish market, increased volatility, and an 
environment subject or vulnerable to panic.
    Any number of events could have contributed to the market 
plunge last Thursday. We have all read the laundry list of what 
could have happened, what may have happened, or it could have 
been a combination of things. But I think what is safe to 
assume is without some preventive measures, they can happen 
again, because any number of things, as were mentioned, could 
precipitate such an event.
    In fact, prior to last Thursday, on April 27th, you had a 
smaller event occur, not of the velocity or steepness or 
quickness, but you have had similar events happen in individual 
stocks, but none as widespread as last Thursday. However, I 
think because of the dramatic and suddenness of last week's 
event, there is something constructive in that, and although it 
undermined investor confidence, I think it clearly pointed out 
the need for action.
    In January of this year, the SEC, to its credit, voted 
unanimously to move forward with a broad review of equity 
market structure and issued a concept release seeking public 
comment on such issues as high-frequency trading, collocating 
trading terminals, dark liquidity, market quality metrics, and 
the fairness of the market structure.
    Last Thursday's events, I believe, give the SEC the 
political clout it needs to take action to institute measures 
to help insulate the markets from what has been described as 
electronic meltdown, and I think it has brought a consensus 
among the exchanges. It won't be a total cure, nor will there 
ever be, but it is a good first move or good preventive 
measure.
    As we move forward, my only advice is to be cautious. 
Solutions are likely to take careful thought and time, and I 
commend the exchanges and the SEC for the good start on Monday. 
It is more important to get it right than it is to get it done 
quickly and with less precision.
    I will close by saying when you see the type of temporary 
anarchy that we witnessed last Thursday, it is appropriate to 
take some preventive measures. With our children and 
grandchildren, we take a timeout, and I think that we are 
establishing a procedure similar to that with our markets when 
they do lapse into what we witnessed last Thursday. It restores 
our children's sanity, and I think these preventive measures 
you proposed will restore investor confidence and a certain 
amount of stability to the markets.
    So I commend you for what I have witnessed in the last 72 
hours. You have done a commendable job.
    Chairman Kanjorski. The gentleman's time has expired.
    The gentleman from New York, Mr. Ackerman, is recognized 
for 2 minutes.
    Mr. Ackerman. Thank you, Mr. Chairman.
    I have been advocating for the reinstatement of the uptick 
rule for the better part of 3 years, and for the better part of 
3 years, critics of the uptick rule have argued that 
reinstating the price test that had been in place for 70 years 
would have had little or no practical impact on protecting our 
exchanges and America's investors from nonsensical, irrational, 
and arbitrary runs.
    Then the Dow lost 1,000 points in a matter of minutes last 
Thursday, despite the New York Stock Exchange's circuit breaker 
protections, and apparently as a result of a well-intentioned 
SEC regulation meant to encourage more faster trading that 
mandates electronic trades bypassing exchanges that cannot 
guarantee the investors the best price for a particular stock.
    In other words, the SEC's regulation NMS overrode the New 
York Stock Exchange's protection mechanisms, exacerbated a 
nonsensical, irrational, and arbitrary run last Thursday, a run 
that briefly wiped out $1 trillion, a run that the uptick rule 
would have prevented.
    I hate to say I told you so, so I won't. Instead, I will 
say what I have been saying for years. I will say that the 
uptick rule would have prevented the Dow's 1,000 point plunge 
last Thursday. I will say that investor confidence is of 
paramount importance to our markets and the ability of our 
economy to recover from the deepest recession since the Great 
Depression. And I will say, instead, that in the wake of last 
Thursday's events, if our regulators don't reinstitute some 
type of meaningful, permanent, across-the-board price test 
similar to the uptick rule very soon, investors will have very 
little confidence in our markets and in our regulators, and I 
can't say that I blame them.
    I yield back the balance of my time.
    Chairman Kanjorski. Thank you very much, Mr. Ackerman.
    We now have the gentleman from California, Mr. Royce, for 3 
minutes.
    Mr. Royce. Thank you, Mr. Chairman. I appreciate the time 
here.
    I am not sure the uptick rule would have done anything to 
stave this off at all. In terms of the studies I have seen--and 
I understand the SEC is still going to take the balance of the 
week to give us the triggering event, and I know that they are 
sorting through 40 different market participants, market 
centers here, in order to try to glean that information.
    But in the meantime, let me make some observations. One is 
that I think if you ask the average American investor what is 
important, he would say an orderly, well-functioning, trading 
environment. I think she or he would say that there is a little 
bit of apprehension in terms of what has happened in the past 
in the market.
    I am going to go back to October of 2002 when Bear Stearns 
sent an order to sell $4 billion in stocks in the Standard & 
Poor's 500 stock index. They meant to send an order for $4 
million, not $4 billion. Fortunately, at the time, the New York 
Stock Exchange specialists saw that and they sent that 
information back to the Bear Stearns floor brokers. After all, 
this was a time when we had specialists handling and slowing 
down a lot of these problems. But they didn't get it handled 
before $622 million in stock had been sold, instead of $4 
million.
    So that gives us a window back into what has happened in 
the past, where I think investors first began to get spooked 
about what could happen in the market. Back then, of course, we 
only had two dominant centers: the New York Stock Exchange; and 
NASDAQ. Now, the SEC is looking at 40 different market centers.
    So I think as we go forward, we can look at some of the 
upsides that we have seen. The bid-ask spreads have been 
reduced by the fact that everything has sped up in the market. 
In some ways, the market is more efficient. But we know that 
Germany and other countries have looked at ways to look at 
individual stocks and put real-time circuit breakers in effect, 
where if those stocks drop more than 5 percent, you are going 
to have a hold; in 5 minutes, you are going to have a hold 
after that on transactions as regulators and market 
participants focus on what is afoot, in case we have something 
like the Bear Stearns errant order back in 2002.
    As we move forward, I think we recognize that our markets 
now react in milliseconds to events, but they are monitored by 
humans who respond in minutes, and in those minutes, you can 
have the loss of billions of dollars of damage.
    Let me also say that I don't think the members here are 
criticizing the SEC for overregulating. I think we want the SEC 
to regulate. I think my concern has been that market knowledge 
and experience is greatly lacking at the agency. As myself and 
my colleagues have said in the past, it is overlawyered at the 
SEC.
    We had the observations during the Bernie Madoff and the 
Alan Stanford Ponzi scheme cases, where we heard from Mr. 
Markopolos about the problems at the SEC. And we are hoping 
that culture can be changed as the SEC looks into this 
particular problem as well, and reengineering the oversight, 
and perhaps putting into effect better circuit breakers to 
handle this problem.
    Thank you, Mr. Chairman.
    Chairman Kanjorski. Thank you, Mr. Royce.
    Now, we will hear from the gentleman from California, Mr. 
Sherman, for 2 minutes.
    Mr. Sherman. Thank you, Mr. Chairman.
    I think the issue before us is, what is the social utility 
of high-frequency trading. Should it be limited? Should it be 
taxed? Or do we benefit from enormous quantities of money 
moving in and out of a stock for a few minutes?
    We are told that the meltdown will cause no lasting harm. I 
think this is shortsighted. Investors for many years will be 
demanding a risk premium for what they perceive as a market 
that can go crazy, at least for an hour or half an hour, and we 
will be told that with a few patches, the system will work fine 
in the future and this could never happen again.
    Sure.
    In our society, we have allocated some of the smartest 
business and computer minds to Wall Street. We are told that 
they should earn the highest rates of return on their 
intellectual capital of any profession because they allocate 
capital to our real businesses.
    But what does that have to do with high-frequency trading? 
Is high-frequency trading a necessary part of allocating 
capital to real businesses, or is it a parasitic attachment in 
which some smart people with some fast computers can take a 
little piece of the profit that each real investor should get 
and divert it to themselves? Are Accenture and Procter & Gamble 
and 3M better off today as operating businesses because their 
stocks are subject to high-frequency trading?
    I would think that what is likely to happen is we will 
patch up the present system and tell the American people not to 
worry. But I hope, instead, that we will take a look at high-
frequency trading and see whether it should be limited or 
subject to just a small tax to recognize that there is a social 
cost to this activity and it is something that we might want to 
discourage so that real investors reap the profits on Wall 
Street.
    I yield back.
    Chairman Kanjorski. Thank you very much, Mr. Sherman.
    The gentleman from Texas, Mr. Hensarling, for 3 minutes.
    Mr. Hensarling. Thank you, Mr. Chairman.
    I certainly agree this is an important hearing. Any time $1 
trillion of market value disappears in a matter of minutes and 
a lot of small investors are hurt, we need to have a 
congressional hearing. To the extent that we are going to 
receive answers today from our panel, then I applaud the timing 
of the hearing. To the extent we are hindering the panelists 
from finding those answers, then I question the timing of the 
hearing.
    Frequently, when we have extreme market volatility, the cry 
goes out, somewhere quick, ``Let's shoot the computers.'' I 
have never really agreed with that particular position, 
although I do have an open mind that perhaps some reprogramming 
may be in order. Specifically, I do believe that we at least 
need to look and examine the desirability of having stock-
specific circuit breakers across all of our markets, and 
certainly, there is an open question on the impact of canceling 
trades. How many folks ended up with unintended short positions 
while arguably adding needed liquidity in a sinking market?
    But at the end of the day, I think we should tread very, 
very carefully in this space. Improved technology, rule MNS, 
have brought great benefits to trading: more competitive 
markets; cheaper trades; and really a democratization of 
investment opportunities. But more importantly, I believe that 
we need to look beyond simply the mechanics of the panic and 
look to its likely underlying cause, that being the 
international debt crisis that is first manifesting itself in 
Greece. A number of media outlets have spoken to this.
    We had a CBS-AP report, ``Greek Debt, Trader Error Eyed in 
Market Selloff,'' on May 6th: ``Traders were not comforted by 
the fact that Greece seemed to be working towards a resolution 
of its debt problems. Instead, they focused on the possibility 
that other European countries would also run into trouble.''
    Wall Street Journal: ``Many traders worried about the 
economic situation in Europe. The Dow had already been moving 
lower as television screens displayed scenes of rioting on 
Greek streets.''
    Fox Business quoted a managing director of Nye Capital 
Partners: ``The tone and tenor of the global debt crisis has 
taken over the market. Everything else has taken a back seat.''
    So there is an open question among many in our investing 
public whether or not we are on the road to becoming Greece 
ourselves, given that the deficit has increased tenfold in just 
2 years, and the President has put forth a budget that will 
triple the national debt in 10 years. There is fear that Greece 
is the preview of coming attractions to the United States, and 
no matter how many well-designed exits you have, no matter how 
many well-trained ushers you have, no matter how well-designed 
your exit plan, if people in the theater sense that something 
is smoldering, you cannot ultimately remove the conditions of 
panic.
    Thank you, Mr. Chairman. I yield back.
    Chairman Kanjorski. Thank you, Mr. Hensarling.
    We will now hear from the gentleman from Georgia, Mr. 
Scott, for 1 minute.
    Mr. Scott. Thank you, Mr. Chairman. I think what we have 
here is a clear example of how we as a society have become more 
the servants of the machine that was created to serve us. Our 
technology has now far surpassed our human ability to keep up 
with it.
    I think we have to move with caution, to make sure we get 
the right causes of this problem, to understand that our 
foremost obligation at this point is to make sure we have 
investor confidence, that the American people have confidence 
in our system.
    So it is important that we listen to you: The Securities 
and Exchange Commission, you have to make it work; the 
Commodities Trading Commission; NASDAQ; the Chicago Mercantile 
Exchange; and, of course, the New York Stock Exchange.
    But we have a very complex system. We have nearly 50 
markets. We have hundreds of millions of computers that are 
making these sales in megaseconds, far outpacing our human 
capacity to deal with it. If we do get the circuit breaker 
concept, we have to make sure how that is going to work. Will 
it do the job? What is important here is to move carefully and 
thoughtfully to get the right correction to this problem. The 
American investors and the world investors are depending on us.
    Chairman Kanjorski. Thank you, Mr. Scott.
    We will now hear from Mr. Perlmutter for 2 minutes.
    Mr. Perlmutter. Thank you, Mr. Chairman. I just would like 
to remind the committee and the panelists that in the financial 
reform bill that we passed to the Senate, we were sort of 
directed to this nanotrading high-frequency trading issue by 
some of our prior hearings; and there is a section of the bill, 
section 7304, asking the SEC and other regulators to take a 
look at high-frequency trading and its impact upon the markets. 
The good news is, it is in the bill. The bad news is that 
Thursday hit us before there was any action on the bill.
    I know that the regulators have been looking at this under 
their own authority, and I would encourage them to continue to 
do this. I am surprised by my friends on the other side of the 
aisle who question whether it is too early to look at this. We 
should be looking at this high-frequency trading; 5,000 trades 
per second, how do you manage something like that? That is the 
real question. In the blink of an eye, by a mistake or by an 
intentional act, whatever it might be, boom, this country lost 
$1 trillion over 20 minutes.
    My friends on the other side of the aisle complain about 
the spending and all this stuff by the Obama Administration; 
when, because of failures in the market, because of sales and 
failure of the uptick rule, not having those kinds of things, 
we lost $17.2 trillion in the last 18 months of the Bush 
Administration. Since the Obama Administration has come in, we 
have gained about $6.5 trillion back. We lost $1 trillion last 
Thursday, and then have gained most of that back.
    There has to be a real good understanding of the algorithm-
driven nanotrading that we have. It has benefits, Mr. 
Hensarling is right, the liquidity that it brings. But 
certainly if you were on the wrong side of that sale, you lost 
a lot of money, and we can't have that in this system.
    I yield back, Mr. Chairman.
    Chairman Kanjorski. Now, the last presenter, Mr. Foster, 
for 2 minutes.
    Mr. Foster. Thank you. I want to thank the chairman for 
holding this important and timely hearing.
    As a high-energy particle physicist, I spent many years 
programming and debugging large systems of high-speed digital 
logic computers. So the fact that large interconnected 
processing systems, individually programmed by very smart 
individuals, exhibit complex and erratic behavior when they are 
simply thrown together, does not surprise me at all. However, 
the fact that these complex systems are put in control of a 
large and important section of our economy, without 
sufficiently robust testing of their interoperability and 
immunity to coherent instabilities is an outrage.
    The absence of systemwide circuit breakers to limit the 
damage when a single element or set of elements malfunctions is 
indefensible, as is the absence of uniform legal clarity when 
it comes time to bust trades that have been made on a clearly 
erroneous basis.
    Part of the problem that we are facing is the mismatch 
between the time scales of human thought and machine action. 
While the logic of circuit breakers and market pauses to 
restore liquidity has been understood for decades, we see now 
that it must be implemented on a time scale of computer trading 
and it must be implemented uniformly across a wide variety of 
trading platforms.
    The race towards lower latencies and higher-speed trading 
shows no sign of abating. Startup companies are already 
developing trading and matching engines based not on clusters 
of computer servers, which will be too slow to compete, but on 
dedicated pipeline logic based on field-programmable data 
arrays that will typically perform a dedicated calculation 100 
times faster than a dedicated computer processor.
    In particle physics, these venues for years have been used 
to perform specialized calculations at high speed. I have 
personally spent years using them to stabilize large numbers of 
particles traveling near light speed around the circumference 
of a giant particle accelerator.
    So while a market pause of 5 seconds may be appropriate to 
restore liquidity for today's trading algorithms, using today's 
technology, a market pause of only 50 milliseconds may be 
appropriate when the next generation of technology comes on 
line. We have to stay ahead of the technological curve and have 
to institutionalize appropriate interoperability and stability 
tests before new components and algorithms are brought on line.
    The reason that secondary capital markets exist is to 
provide a reliable and transparent means for investors to 
appropriately profit from their wise investments in the real 
economy. Events like those of last Thursday where $1 trillion 
disappeared and then reappeared in the financial markets 
destroys that transparency and destroys confidence and are 
simply unacceptable.
    I thank you, and I yield back the balance of my time.
    Chairman Kanjorski. Thank you, Mr. Foster.
    Now, we will move to the panel. But I want to make an 
observation that the issue is not one of decline in stocks. The 
issue is volatility. While some stocks like Accenture fell from 
$40 a share to just pennies, others, like Sotheby's, soared. On 
Thursday, the Auction House reported a $2.2 million quarterly 
loss. Its shares went from $34 to over $100,000 within minutes. 
Something was clearly wrong.
    That is the reason that some 2 hours after that break, 
Chairman Schapiro, I had the pleasure of calling you, and you 
were so kind as to take that call, where we could structure 
this public meeting.
    I say that because, as you know, I stated to you I thought 
that we would have a much more disturbed population as a result 
of the happenings on Thursday. I am happy that it does not seem 
to reflect that in the marketplace. But I am sure that has 
something to do with the way you and Mr. Gensler as regulators 
have handled this and publicly stated what you are doing.
    So I commend you. I thank you for taking the time out to 
take the call on Thursday and to be here today on such short 
notice.
    Now, we are going to charge you with the opportunity within 
the next 5 minutes of reducing your statement to 5 minutes, as 
best as possible, and tell us in its entirety what caused this 
problem; what can be done about this problem; and how we can 
get started.
    We now would like to hear from Chairman Schapiro.
    Accompanying Chairman Schapiro is Mr. Robert W. Cook, 
Director of the Division of Trading and Markets, United States 
Securities and Exchange Commission.

  STATEMENT OF THE HONORABLE MARY L. SCHAPIRO, CHAIRMAN, U.S. 
 SECURITIES AND EXCHANGE COMMISSION, ACCOMPANIED BY ROBERT W. 
     COOK, DIRECTOR, DIVISION OF TRADING AND MARKETS, U.S. 
               SECURITIES AND EXCHANGE COMMISSION

    Ms. Schapiro. Thank you, Mr. Chairman. I hope I won't 
disappoint you.
    Chairman Kanjorski, Ranking Member Garrett, and members of 
the subcommittee, I appreciate the opportunity to testify 
concerning the market disruption that occurred last Thursday. 
As you mentioned, I am joined today by Robert Cook, the 
Director of the Division of Trading and Markets at the SEC, who 
has been deeply involved in the analysis of the market events.
    The sudden evaporation of meaningful prices for many major 
exchange-listed stocks in the middle of the trading day is 
unacceptable and clearly contrary to the vital policy objective 
of maintaining fair and orderly financial markets. The SEC is 
working around the clock to identify the causes of this sudden 
spike and to make changes which will help prevent disruptions 
of this type in the future.
    On May 6th, the Dow Jones Industrial Average dropped more 
than 573 points in just 5 minutes. As quickly as the market 
dropped, it suddenly and dramatically reversed itself, 
recovering 543 points in approximately a minute and a half. 
Many individual securities experienced much larger swings in 
their trading activity and certain trades were executed at 
absurdly low prices.
    Pursuant to exchange rules, after closing, the equity 
markets worked out a common standard to cancel trades effected 
at prices sharply divergent from prevailing market prices. The 
exchanges determined to cancel any trades from 2:40 p.m. to 
3:00 p.m. at prices 60 percent away from the last trade at or 
before 2:40 p.m.
    Today, the SEC has more than 100 people working tirelessly 
on this issue. We are sorting through literally millions of 
trades and carefully comparing timing and activity across 
markets to isolate the cause or causes of the spike. We will 
take action to change any aspects of our market structure which 
may have contributed to the extreme volatility.
    We have made progress in our ongoing review and can provide 
some preliminary findings.
    First, while we cannot yet definitively rule out the 
possibility of a ``fat-finger'' error, our own review and 
reviews by the relevant exchanges and market participants have 
not uncovered such an error.
    Second, there have been reports that one or more 
exceptionally large orders in certain stocks may have preceded 
and helped to trigger the broader decline. However, there does 
not yet appear to have been any unusual prior securities 
trading that would have triggered the broader market decline.
    Third, while some have focused on the role of the E-Mini 
S&P 500 future in leading the market decline and recovery, it 
must be recognized that the fact that stock prices follow 
futures prices chronologically does not necessarily suggest 
what may have triggered the price movements. Given that the E-
Mini futures price fell by more than 5 percent in a few minutes 
and then quickly recovered all of the 5 percent decline, it 
should be no surprise that the broader stock market indices 
showed similarly fast and similarly large declines and 
recoveries.
    Finally, at this time we have not identified any 
information consistent with computer hacker or terrorist 
activity.
    Ultimately, we may learn that the extraordinary disruption 
in trading was the result of a confluence of events, which, 
taken together, exacerbated what already had been a down day 
and led to an extraordinarily steep price drop and recovery. 
However, we continue our efforts to identify the triggers and 
will share them with the public as they are identified.
    Earlier today, the SEC and the CFTC announced the creation 
of an advisory committee that will, among other things, work 
with us in reviewing appropriate regulatory changes in response 
to the events of May 6th, and the staff of our agencies intend 
to provide that committee with our preliminary findings next 
week.
    Last Thursday's events could be likened to many dominos 
falling, and while we are all understandably focused on why the 
first domino fell, it is equally important to understand why so 
many others fell as well. I believe we will eventually pinpoint 
the triggering events, but it is fair to say that disparate 
exchange rules and trading conventions caused many more dominos 
to fall than should have.
    For this reason, the SEC convened a meeting yesterday with 
the leaders of six exchanges and FINRA, where we agreed to 
strengthen cross-market circuit breakers, circuit breakers that 
will not unnecessarily interfere with market activity, but that 
will pause trading while the markets check for technical 
problems and recover liquidity.
    We also reached general consensus on the need for stock-by-
stock circuit breakers. I expect later today we will further 
refine when those circuit breakers might be triggered and for 
how long.
    Further, we are also committed to creating a sound 
framework for better handling the breaking of erroneous trades.
    I believe all these actions can help to prevent a repeat of 
Thursday's remarkable market volatility. But these are only 
interim steps. We must quickly consider what additional steps 
are necessary to strengthen our market structure and minimize 
future disruptions.
    We have already launched initiatives that will address many 
of the issues illuminated last week. Earlier this year, we 
issued a concept release on market structure that solicited 
public comments on steps to minimize short-term volatility and 
systemic risk. We also formally proposed creating a large trade 
reporting system to enhance the Commission's surveillance and 
enforcement capabilities. And we have proposed strong broker-
dealer risk management controls when a broker allows a customer 
direct access to our markets.
    In order to help regulators keep pace with technology and 
trading patterns, we have also been working on a proposal to 
create a consolidated order tracking system, or consolidated 
audit trail. Within the next few weeks, I expect the Commission 
to consider this proposal, which would capture all the data 
needed for effective cross-market surveillance. This will 
significantly improve our ability to conduct timely and 
accurate trading analyses for market reconstructions and 
complex investigations like that which is currently underway.
    In conclusion, the SEC is making progress in its ongoing 
review. We will ultimately find the cause or causes of the 
disruption and will put in place safeguards that will help 
prevent the type of unusual trading activity that occurred last 
week.
    I look forward to working with you on these issues in the 
coming weeks, and, of course, we would be pleased to answer any 
questions.
    [The prepared statement of Chairman Schapiro can be found 
on page 114 of the appendix.]
    Chairman Kanjorski. Thank you very much, Madam Chairman.
    Next, we have the Chairman of the Commodity Futures Trading 
Commission, Chairman Gensler.
    Incidentally, Mr. Gensler, thank you very much for 
responding, too, as quickly as you did. Fortunately, I did not 
have to call you, because I did not think it stretched to the 
futures market. That becoming apparent, it is good that you can 
be here as a corollary regulator so we can get to the bottom of 
this.
    Mr. Gensler, you are under the same restrictions, hopefully 
to give us about a 5-minute presentation so we can get to 
questions.

    STATEMENT OF THE HONORABLE GARY GENSLER, CHAIRMAN, U.S. 
              COMMODITY FUTURES TRADING COMMISSION

    Mr. Gensler. Thank you, Chairman Kanjorski, Ranking Member 
Garrett, and members of the subcommittee. I am pleased to be 
here alongside SEC Chair Mary Schapiro, with whom we have been 
working very closely and diligently since last Thursday to 
explore and see what we can find out about the events.
    Before I turn to those events, let me just say something 
about the stock index futures market. Stock index futures trade 
on centralized exchanges and they are based upon the broad 
market index. The total outstanding is about $360 billion. This 
compares to the approximately $13 trillion of the overall 
equity markets; however, stock index futures do play an 
integral role to the pricing of the overall market. The largest 
contract, the E-Mini S&P 500 contract, trades on the Chicago 
Mercantile Exchange. It is about 80 percent of that market, and 
we will focus on that a little bit in our testimony.
    There are procedures on that contract, and I want to 
mention four quick procedures that are risk-management 
procedures to ensure the orderliness of the market.
    First, electronic trading systems on all of the markets for 
these contracts reject orders priced outside of a narrow band, 
about a 1 percent band up or down.
    Second, the exchanges actually have maximum order sizes. 
Congressman Royce mentioned something from years ago, but 
today, only about a $100 million transaction can be entered. 
The average transaction, though, in the E-Mini is about 
$330,000 in size.
    Third, exchanges have something that limit stop-loss 
orders, and I can get more into that in the testimony.
    Fourth, they also have something which is a market pause, a 
5-second pause if the order book gets out of balance. In fact, 
last Thursday, that 5-second pause occurred exactly when the 
market bottomed.
    In terms of the preliminary review, we are looking at 
millions of trades. The CFTC, fortunately, has all of the 
trading data entered into our systems by the very next morning 
because under our act, we are able to get that from the 
exchanges. I think it would be good, and I know the SEC is 
working on that, but the staffs of our agency, the SEC, and the 
exchanges have looked at it and it is a very ongoing process.
    Let me mention four things, though. May 6th started 
turbulent. You can think of an airplane in turbulent skies. It 
was very turbulent that day with the economic news emanating 
out of Europe. Volatility pricing was pricing up. It had 
actually gone up about 60 percent interday from Wednesday to 
Thursday on some measures.
    Further, the futures markets and other markets are so 
intertwined that stock index futures looked to other price 
signals from all of the other markets, and there were a lot of 
markets coming in with signals that were showing risk premiums 
were widening. Currency markets were volatile, and small 
capitalization equity securities began declining sharply. 
Between 2:00 p.m. and 2:20 p.m. East Coast time and by 2:24 
p.m. East Coast time, there were 8 securities that were 
exchange-traded securities that were already off 50 percent in 
the preceding 24 minutes.
    Other price signals started to come in after 2:30 p.m.--
some of the large markets started to delink under what is 
called a self-help program that you will hear about a little 
later, NASDAQ and some of the others. So some of these 
signalings kept coming in.
    Our own review of trading data shows that somewhere 
starting around 2:40, some of the most actively traded 
participants in the futures market, the high-frequency traders, 
started to limit their participation around 2:42, 2:43, and so 
forth; and that is exactly when that V was happening as some 
people were limiting or even withdrawing from the market.
    Another factor, in the midst of this, one large investor 
executed a hedging transaction, a bona fide hedging transaction 
in the E-Midi, in the size that on normal days would move 
through the market. It was about 9 percent of the volume during 
the period down and up. But that was also--and may have had 
some participation within this.
    So between 2:40 and 2:45, the market did go down 5 
additional points. At 2:45 and 28 seconds, this 5-second pause 
happened on the Chicago Mercantile Exchange. This was so the 
order book could get sort of rebalanced in the computer, and in 
fact, that was the bottom. The SPDR, which is the exchange-
traded fund that is a security but trades in the market, 
bottomed 7 seconds later. The cash markets bottomed all in the 
next minute, the 2:46 minute. And then you saw the market move 
back up.
    Exchanges and market participants have asked this question 
about a ``fat-finger'' mistake. The exchanges have looked at it 
closely. We have reviewed some of their work, of course, and 
have not found the ``fat-finger'' issues, similar to what Mary 
said earlier in that regard.
    Despite the high volatility, the clearinghouses and the 
settlement and the margin posting all worked, both Thursday and 
Friday. So the plumbing or the backside of this worked. But we 
continue to review May 6th with the SEC, particularly how the 
S&P futures traded in relation to the cash market and, to the 
extent of that trading, keyed in on some of the other indices. 
And as Mary said earlier, we set up this morning a joint 
advisory committee that will be issuing a preliminary staff 
report early next week and hopefully convening that committee 
to actively look at recommendations.
    With that, I look forward to working with this committee 
and taking your questions.
    [The prepared statement of Chairman Gensler can be found on 
page 85 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Chairman.
    I will take the first set of questions.
    I think I heard you say, Madam Chairman, that there will be 
an answer to this within a reasonably short period of time, 
within a matter of weeks. Is that what you anticipate?
    Ms. Schapiro. I didn't actually give a timeframe. I said we 
will get to the bottom of this. I think we will be able to 
determine what the initial triggers were. That is going to take 
time. There were 66 million trades on May 6th, covering 19.5 
billion shares of stock.
    You think about what happened in 1987 when the market had 
its largest move in history and the Brady Commission was 
created. There were a tiny fraction of the number of trades 
that we have experienced today, about 600 million shares of 
stock compared to 19 billion shares. So that took several 
months with a dedicated group of people working on it.
    We will move as quickly as we can, but I can't give you a 
date when we will have any final answers. But we will. We will 
make them public. Next week, we plan to give preliminary 
findings to our new advisory group, and we will make those 
public at the same time.
    Chairman Kanjorski. That is a very important question. In 
order to have the stability in the market, I think that we 
should not withhold anything from the public, because if we do, 
we are apt to get all the conspiracy theorists very busy and 
very active, and, as you know, you could imagine almost 
anything. But you cannot rule out any particular cause at this 
point; is that correct?
    Ms. Schapiro. I think that is fair to say. We have not 
found evidence of terrorist activity. We have not found 
evidence of computer hacking or a ``fat finger'' or a 
particular large trade that drove the markets initially. But we 
are not ruling anything out at this point. And that is one 
reason we want to make some preliminary findings available next 
week, so the public can have confidence that we are moving 
forward.
    Chairman Kanjorski. What is the possibility that tomorrow 
the same thing could happen?
    Ms. Schapiro. I have to say it is not impossible. There is 
no reason to expect that it would happen tomorrow. But that is 
one reason, with quite a sense of urgency, we brought all of 
the markets to Washington yesterday to start to work on some 
solutions to the problem, focusing in particular on stock-by-
stock circuit breakers.
    Chairman Kanjorski. So it is reasonable to assume, without 
knowing the absolute cause of this event, you could put new 
rules in place and organize the regulators and the markets to 
prevent a similar occurrence of this in the future, even before 
we get to the final cause?
    Ms. Schapiro. Exactly. I think it is important to 
understand the initial cause or triggering events. I think it 
is critical. We know what the damage was that was done. We need 
to put in place the mechanisms that can prevent that from 
happening again, while we continue to diagnose the source of 
the problem.
    Chairman Kanjorski. I will ask this as a joint question 
between the two of you, but do you have any suspicions that it 
was done for profit or some other means by a group or 
conspiracy group of any kind, or is this just a glitch in your 
opinion, if you have one?
    Ms. Schapiro. I don't think we have evidence--and, of 
course, I will let Chairman Gensler speak to this as well--that 
this was done in any kind of a malicious way. I think what my 
inclination is is that we have a widely dispersed equities 
market in the United States, several members have mentioned the 
number of trading venues, and we had different rules and 
conventions applying in those different markets that allowed 
for activity to be transmitted rapidly from one place to 
another without everybody following the same protocols.
    Mr. Gensler. We may find that there is something that our 
enforcement arm has to take up, and we have been very active as 
of Thursday afternoon putting out a special call under our act 
to large participants. There are about 250 participants in this 
E-Mini contract during the course of the critical 20 to 30 
minutes. We have been investigating most closely the 10 largest 
shorts and the 10 largest longs in that market, but we are 
looking at others as well.
    I think it was sort of the turbulence in the skies added 
with a lot of signals that were coming in, that markets do work 
on, as they say, fear and greed, and in those critical moments, 
I think in a sense, the fear took over. There was a second 
factor, that individual stocks were breaking further down, and 
that is an issue that we are talking about.
    Ms. Schapiro. Mr. Chairman, if I may add, we have fully 
integrated our enforcement group as well into the analysis, and 
they have sent out a number of subpoenas so that we can look at 
particular activity in very granular detail. Of course, if 
there is anything there, we will be following up on it.
    Chairman Kanjorski. As you know, we have passed in the 
House the regulatory reform bill and it is now pending in the 
Senate and being acted upon. There have been some individuals, 
particularly some United States Senators, who have suggested 
that there may be a remedy to be had that we could include 
within the reform, regulatory reform provision.
    Do you see that as a possibility? I guess the open question 
I want to ask: Do either of you see a need for additional 
authority as regulators to ultimately get to the solution to 
this problem?
    Ms. Schapiro. I think, Mr. Chairman, that we believe we 
have the authority that we need with respect to the issue of 
circuit breakers and potentially imposing stock-by-stock 
circuit breakers. We certainly have the authority we need to 
create and develop with the markets a consolidated order audit 
trail which will facilitate our work greatly. And the other 
issues that come out of the events of Thursday, looking at 
whether market orders should be limited in certain 
circumstances or how do we deal with canceled trades going 
forward, I think we believe we have the full authority we need 
there.
    Coming out of our broader review of market structure, it is 
possible that we will need to come to Congress for some kind of 
authority, but I can't even predict at this point what that may 
be.
    Mr. Gensler. I would say, Mr. Chairman, I think that since 
markets are so interrelated--securities, futures, but also the 
over-the-counter derivatives marketplace--I think the reform 
this committee has moved and hopefully Congress will move on 
over-the-counter derivatives will give us a greater window, 
because right now, our full review is on the listed securities 
and, of course, the futures markets, but not the over-the-
counter derivatives that may have played some role on Thursday 
as well.
    Chairman Kanjorski. Thank you very much.
    Now, the gentleman from New Jersey, Mr. Garrett.
    Mr. Garrett. Thank you, Mr. Chairman, and I thank the 
panelists again.
    Just following up along that last line, I guess I was a 
little confused by some of the comments from the Senate, which 
often happens, as well. You had Senator Dodd saying we need to 
get in place our bill, meaning the bill you just referenced, 
and have the President sign it so we can have the tools to 
protect our economy from these kind of events, sort of implying 
that we do need to pass that legislation and give you that 
authority.
    Then, in the same breath, he also said, ``I don't think you 
need the legislation in this area.'' My guess is you need the 
regulators to step up and make sure that this high-frequency 
trading, this flash trading that is going on, that is something 
that clearly we ought to take a look at.
    So on the one hand, he was saying we need more statutes and 
more laws, but on the other hand, I think he recognized what 
you just said, Madam Chairman, that you have the authority in 
all these areas to address the situation.
    Ms. Schapiro. We believe we have the authority to address 
these events. Again, there may be issues that arise as we work 
through the market structure concept release, all the many 
issues we have raised there with respect to high-frequency 
trading, volatility, and other matters that might require us to 
come to you for legislation. But with respect to these issues, 
and circuit breakers in particular, we have a high level of 
confidence.
    Mr. Garrett. Let's go to the circuit breaker situation for 
just a second. I was just in Manhattan yesterday, meeting with 
a number of my constituents who work in that area, and there 
are, as you can anticipate, a number of rumors that are out 
there right now. So maybe you dispelled one, and that is that 
it was hackers. Maybe you can dispel another. But will you be 
using your emergency authority in order to implement these 
rules? That will be the first question.
    Ms. Schapiro. First of all, we don't have final rules 
constructed yet. And, one of the reasons we brought the markets 
to Washington to discuss here in some detail and then to charge 
them with going off and coming back with recommendations is 
that we want the deep expertise and knowledge that they have 
from running marketplaces every single day.
    I think we are likely to do this through exchange rule 
filings primarily that would come to the Commission for 
approval. We understand the need for adequate time for 
programming computer systems, and for educating other market 
participants with respect to how the rules would operate.
    Mr. Garrett. Okay. I will just throw out--here is an easy 
one probably, as far as the rumors that are out there, is that 
if you were going to suggest circuit breakers as far as 
percentages of deviation of around as small as 2 percent, where 
some of those traders would say that's just woefully too low.
    Ms. Schapiro. We very much understand that issue. And that 
is why again the exchanges are really assisting with how to 
fine tune both the level of change in the stock price, over 
what period of time, whether it's done off a rolling average or 
off the prior day's close, and then what period of time for a 
pause that gives the human being a sufficient amount of time to 
make decisions that they need to make about whether algorithms 
are not operating correctly, whether there is additional 
liquidity that can be brought into the marketplace. So those 
are all the issues we are discussing.
    Mr. Garrett. I thought that was a simple question. So the 
answer is, ``maybe?''
    Ms. Schapiro. There is complexity to it. So I can't tell 
you it would be 2 percent over 5 minutes in price changes. We 
are just not at that point yet.
    Mr. Garrett. Okay. Now, you also said, you all there at the 
table, have set up a joint advisory committee? I am not sure--
    Ms. Schapiro. That is right.
    Mr. Garrett. That is right, a joint advisory committee? And 
who all is on that joint advisory committee?
    Ms. Schapiro. We selected people who have expertise in 
markets and market microstructure in particular. So we have two 
former CFTC Chairs: Susan Phillips, who was actually the first 
woman appointed to Chair of a financial regulatory agency at 
the Federal level by President Reagan; and Brooksley Born, also 
a former CFTC Chair. We have David Ruder, a former SEC Chair 
who went through the market break in 1987 and its aftermath; 
Jack Brennan, the former CEO and chairman of Vanguard, a very 
large institutional investor.
    Mr. Garrett. I think my time is running out. Just quickly, 
do you have any current market participants other than--
    Ms. Schapiro. Actually, we have a current market regulator, 
Rick Ketchum, who spent time at both NASDAQ and the New York 
Stock Exchange. We did not want to have people who have a very 
direct vested interest in advising the Commission, although 
this group's deliberations will be fully in public and all of 
our meetings will be public, but we tried to pick people, 
particularly the academics, Maureen O'Hara from Cornell, Robert 
Engel from NYU.
    Mr. Garrett. It might just be good to have some of the 
participants who are actually involved and up-to-date--
    Ms. Schapiro. They are very involved. They will present to 
this group. They will submit information to the group.
    Mr. Garrett. One last--but you get my point on that area, 
my concern there?
    Ms. Schapiro. Yes.
    Mr. Garrett. And in the last 10 seconds here, the chairman 
indicated that he phoned you about 2 hours after this all 
occurred. You are now asking the participants, the regulated 
entities, to respond back in 24 hours from yesterday. One of 
the questions I had over what happened yesterday is, if 
Congress could call you within 2 hours to begin the process to 
find out what's going on, did you have the authority actually 
to e-mail out immediately to all 40 or 50 entities and say, we 
want to have an answer back from you just like you did 
yesterday from them?
    Ms. Schapiro. I spoke with the heads of the major exchanges 
on Thursday, through Thursday evening, all day Friday, and our 
staffs were in minute-by-minute contact virtually the entire 
day Saturday and Sunday. I did not want to bring them to 
Washington on Friday. I thought they needed to be there when 
their markets opened to handle any other fallout or issues that 
might have come from Thursday. But Monday morning was a good 
time. I wanted everybody in the room together. I didn't want ad 
hoc e-mails with loose ideas. I wanted people together so that 
we could think through what the issues were and how we might 
best solve them as a group.
    Mr. Gensler. And we, too, were talking directly to our 
exchanges by 1 a.m., which, I guess, would have been Thursday 
night. On Friday, we had our first memo from the Chicago 
Mercantile Exchange analyzing this contract. We had the entire 
data set loaded into our computers by 9:30 Friday morning.
    Mr. Garrett. Okay. I appreciate that.
    Chairman Kanjorski. The gentleman's time has expired.
    Now, we will hear from the gentleman from California, Mr. 
Sherman.
    Mr. Sherman. Thank you, Mr. Chairman.
    Volatility leads to perceived risk. Perceived risk leads to 
higher cost of capital for real businesses in the real America. 
If we had markets in which all the profits accrued to real 
investors, I think that would be appealing to those making real 
investments in real American companies. In contrast, a market 
in which Procter & Gamble can drop to 1 cent is not appealing 
to those who want to provide real capital to real companies.
    Most of the testimony here simply assumes that we are going 
to let people keep doing what they are doing unlimited and 
untaxed and we are going to patch up the system in the hope 
that it won't happen again. This is like the reaction if we had 
an unplanned explosion of nitroglycerin. If that explosion took 
place in a mining operation or something else socially useful, 
we would say, let's have better regulations so that we can get 
that social utility of the nitroglycerin without having it 
explode in an unplanned way. But if this inherently risky 
nitroglycerin had an unplanned explosion because kids or 
gamblers were playing with it, we might instead say, how can we 
somewhat reduce the risk of an inherently risky activity? We 
would ask, why are we allowing this activity to take place? So 
it raises the question of whether high-frequency trading serves 
a social purpose.
    Imagine--Chairman Schapiro, imagine if somehow by magic we 
created a world in which those investing in U.S. stocks 
actually held them for a couple of hours before they sold them 
or went short for a couple of hours before they covered, and 
let's say that applied to Procter & Gamble or 3M. How would the 
employees of Procter & Gamble or 3M--what catastrophe would 
they face if the stocks of their companies were not subject to 
high-frequency trading? Would that help those employees in 
those operating companies, or would there be some cataclysmic 
problem if high-frequency trading did not apply to those 
companies?
    Ms. Schapiro. Congressman, let me first of all agree that 
the purpose of our capital markets is to help companies raise 
capital to create jobs, to help our economy grow, and that 
investors who commit their capital to those markets get to 
share economically in that growth and development. We have lots 
of questions about high-frequency trading and its role in our 
capital markets. It's one reason we have exposed many of the 
issues related to high-frequency trading for public comment 
and--
    Mr. Sherman. Madam Chairman, I know you have many 
questions. I have one question, and it is my time. What 
catastrophe would occur to the employees of Procter & Gamble if 
the stock of that company was not subject to high-frequency 
trading?
    Ms. Schapiro. I don't know that any catastrophe would. 
There are those who will argue perhaps on the next panel that 
high-frequency trading adds significant liquidity in the 
marketplace so that when those Procter & Gamble employees want 
to sell, it is easier for them to do that.
    Mr. Sherman. Now, to what extent do you agree with the view 
that those high-frequency traders are just parasites on the 
market? You have a market in which real investors are buying 
and selling and then people come into that market and grab a 
little piece of the profit for themselves who are not engaged 
in real investing.
    Ms. Schapiro. I guess I can't really answer that question.
    Mr. Sherman. So they may be parasites; they may not be. And 
I will ask you to answer that for the record because I am going 
to go on to the next question. Would a tax of 1/20 of 1 cent 
per $1,000 be sufficient to disrupt the business model of those 
who are engaged in high-frequency trading so that they would 
substantially diminish the amount of high-frequency trading?
    Ms. Schapiro. I honestly don't know the answer to that 
question; so I will be happy to think through and--
    Mr. Sherman. I will ask you to think it through, and then 
we will have the argument that if we don't have the casinos on 
our Main Street so they will play the casinos in Monte Carlo, 
but I would say that if all the American markets trading 
American stocks were insulated from most of this high-frequency 
trading that is where real investors would want to go, and if 
over in Dubai, somebody wants to bet for a millisecond on what 
happens on the U.S. markets, at least it is not American minds, 
American computers, or the American markets put at risk. And I 
believe my time has expired.
    Chairman Kanjorski. Thank you very much, Mr. Sherman.
    Now, we will hear from the gentleman from Alabama, the 
ranking member of the full committee, Mr. Bachus.
    Mr. Bachus. Thank you, Mr. Chairman.
    When the steam engine came along, it hit a lot of livestock 
and a lot of the farmers thought that they should probably do 
away with the steam engine. It also set fire to some of the 
fields. But we figured out some preventative measures, and we 
have done okay with it. Of course, it was replaced by the 
diesel engine, and a lot of people thought that was a setback. 
I kind of think high-frequency is not such a bad thing.
    As I said in my opening statement, you identified some of 
these problems back in January and started asking for public 
comment, which is what we have always heard you to do. So I 
think you have your hands around the problem. How do you--we 
have gone from a highly structured duopoly, NASDAQ, not with 
options, but with NASDAQ and the New York Stock Exchange. The 
40 or now what I am now hearing 50 different trading platforms. 
How do you ensure the integrity of the markets price discovery 
without hurting competition and without degrading those 
individual models which all have their strengths and 
weaknesses. So I would ask both chairmen.
    Ms. Schapiro. It is a great question because there are 
clearly challenges associated with our highly automated and 
highly disbursed and fragmented marketplace. And I think the 
way we ensure integrity is to have those markets linked so 
investors' orders get the best execution that they can, and 
that is a requirement under Regulation NMS. But looking forward 
what we have to do is make sure that the markets are operating 
under basically the same rules so that an investor is not 
disadvantaged by trading the same stock in different venues. 
They should be able to get the best price wherever they are. 
And I think the issues that are highlighted by Thursday, many 
of them are addressed--not solved but addressed well by the 
creation of single stock circuit breakers that would allow for 
the times when the technology gets ahead of the people by too 
much, to take a time out and refresh the marketplace. But we 
have raised so many of these issues in our market structure 
concept release because we really do want to explore them in a 
thoughtful way.
    While we do that, there are some short-term things I think 
are very important for us to do. The circuit breakers are among 
those. Dealing with direct access by customers into the 
exchanges is something I think we need to deal with and some 
issues around dark pools of liquidity and the use of flash 
orders and others, all of which we have under consideration 
right now.
    Mr. Gensler. And I just think that--although it is outside 
of my lane a bit, that it is really important that those 40 or 
so venues, and it may be 70 in the future, have consistent 
transparent rules that are available to the public. If there is 
a timeout or a pause, whether it is 5 seconds, milliseconds, or 
a minute, that it be consistently applied. If you go dark on a 
stock somewhere, you go dark elsewhere. You even do it in 
single stock futures where we co-regulate and so forth.
    Mr. Bachus. And I commend you. I used the word ``address'' 
not ``solve'' in my opening statement too, because I think we 
are trying to address them but you never quite solve all the 
problems. I also believe--and both you and your statements, and 
Chairman Gensler, you mentioned that there is already a lot of 
skittishness in the market, a lot of increased volatility. 
People are on the edge of their chairs anyway. So obviously, as 
I said, it created an environment. Do you think we could find--
and I suspect that there is not one contributing cause of this, 
that it was probably a combination. Now, you could have had a 
large trade in the S&P 500 SPDRs and you could point to that as 
possibly a part of it, but that doesn't mean that wasn't a 
legitimate hedging to buy.
    Mr. Gensler. Right. I think, Congressman, in our capital 
markets there's not one king or one czar or something. It is 
diverse. That is in a sense the beauty of markets. But I think 
that this was a very turbulent time. I think there were a lot 
of price signals by 2:00 to 2:30 that were going negative. If 
it was an airplane analogy, you had the indicator lights now 
sending charges back. You also had one of the engines start to 
not run too well because liquidity was stepping out of the 
market. We did see by 2:40, 2:42 a number of active market 
makers, even these high-frequency traders were limiting their 
capacity. The major exchanges have said their order books 
seemed thinner. That means there were less bidders in it. In 
addition to that, you had a little extra cargo, this bona fide 
hedging program. It was only 9 percent of the E-mini, but it 
may have had some factor in this.
    Mr. Bachus. I know the SEC has addressed at least dark 
liquidity as part of their concept. Do you have any comment, 
Chairman Schapiro?
    Ms. Schapiro. The only thing I might add to the scenario 
that Chairman Gensler ran through is we also saw, because of 
the skittishness in the market, I think, a lot of stop-loss 
orders had been entered by investors hoping to limit their 
losses. Those were run through, and as a result, the market 
continued to drive down.
    So one of the things we want to look at is the use of stop-
loss orders and the use of market orders, which get you a fast 
execution, but maybe at a really terrible price, along the 
lines of the chairman's comments at the very beginning. So 
those are two other areas.
    Mr. Bachus. It seems there should have been some obligation 
by the brokers not to execute an order on a $30 stock at a 
penny. That is just good--I think that is a fiduciary 
relationship.
    Thank you, Mr. Chairman.
    Chairman Kanjorski. The gentleman's time has expired.
    Now, we will hear from the gentleman from Texas, Mr. 
Hinojosa.
    Mr. Hinojosa. Thank you, Mr. Chairman. Thank you for having 
this hearing.
    Before I make a statement and ask some questions, I ask 
unanimous consent to enter into the record the Joint CFTC and 
SEC Advisory Committee on Emerging Regulatory Issues, dated May 
10, 2010.
    Chairman Kanjorski. Without objection, it is so ordered.
    Mr. Hinojosa. Thank you.
    I agree with my colleagues on both sides of the aisle that 
the Dow Jones Industrial Average plummeting 990 points, losing 
22 percent of its total value cost caused a great deal of 
concern for those of us on the House Floor that Thursday 
afternoon. The S&P 500 dropped 20 percent, falling from 282 to 
225 points, and this was the greatest loss Wall Street had ever 
received on a single day.
    I want to ask a question first of Chairman Schapiro. Was 
market fragmentation a key cause of last week's 990 point drop 
in the Dow Jones index?
    Ms. Schapiro. Congressman, I don't think there is any 
question that the fact that we have a highly fragmented market 
is a contributing factor here and creates challenges. It 
doesn't have to be the result that we had last Thursday if the 
markets, while dispersed and many of them, play by the same 
rules and have the same trading convention, so that if all of 
the markets are subject to halting trading in a stock when it 
reaches a certain price, then I think we would not have had 
some of the fallout that we had last week.
    Mr. Hinojosa. Having a Brady Commission which has made lots 
of recommendations, tell me, have any of those recommendations 
been put into effect?
    Ms. Schapiro. Oh, yes. The actual marketwide circuit 
breakers that exist today were a direct result of the Brady 
Commission's report in January of 1988. One of the things we 
are also looking at jointly between the two agencies is whether 
those marketwide circuit breakers that have the market shutting 
for brief periods of time when the DOW goes down 10, 20, and at 
30 percent shutting completely need to be updated and 
modernized, and that is an effort we are undergoing right now.
    Mr. Hinojosa. So if you could tell me the similarities then 
of that October 19, 1987, market crash and give me the 
similarities, and is that being investigated so, as you said, 
that it not happen again?
    Ms. Schapiro. Absolutely. If you look--I actually went back 
and looked at the Brady Commission report over the weekend and 
it is interesting that their findings are that there were 
multiple events that caused the market to decline--I believe it 
was 26 percent in October of 1987 on that day. And that is 
similar, I think, to what we will ultimately find here, that 
there were multiple contributing events. The difference is that 
trading largely took place at that time on the NASDAQ stock 
market and the New York Stock Exchange. There were not multiple 
trading venues, although there was trading in the futures 
markets that was delinked from the trading in the equity 
market.
    The delinkage issue exists today among the equity market. 
So we see another similarity there. We are trying to do the 
same careful and thoughtful review of the events that we expect 
will lead us to some kind of recommendations that, while not 
the same as the Brady Commission, are similar in that they lead 
us to further elaboration on circuit breakers, for example, or 
order types that we might want to limit going forward.
    Mr. Gensler. I would say one thing, that 23--and I remember 
because I was back then in a financial firm--I think one thing 
is that 23 years ago, though there were computers back then, 
there was nothing like what we have now, and this whole concept 
of trading in nanoseconds and microseconds and automated 
traders. That is why both of our agencies have active reviews 
of high-frequency traders that includes looking at issues of 
co-location, where they put the computers, where the exchanges 
are, looking at issues with regard to account identification 
and all of the issues in terms of access to the markets of 
these high-frequency traders. That is something really new in 
this market environment from 23 years ago.
    Mr. Hinojosa. Chairman Gensler, let me ask you a question, 
then, with that comparison you just gave. We need the SEC and 
your group, the CFTC, to step up to the plate and ensure that 
such market disruptions don't occur in the future. Do you have 
enough funding and authority to prevent such an event from 
reoccurring?
    Mr. Gensler. I thank you for that. We are a sorely 
underfunded agency and actually shrunk about 23 percent in the 
8 years before this Administration. With Congress' help, we are 
back to just about the size of we were 10 years ago, and we 
have put in a request, particularly if over-the-counter 
derivatives reform came into being to grow significantly from 
where we are. We do need more enforcement lawyers, cops on the 
beat, and we need more computer systems to try to stay up with 
the automated surveillance that we need of these markets.
    Mr. Hinojosa. Do you leave it to--I think my time has been 
exhausted, and I thank you, Mr. Chairman.
    Chairman Kanjorski. Thank you.
    Next, we will hear from the gentleman from California, Mr. 
Royce, for 5 minutes.
    Mr. Royce. Thank you, Mr. Chairman. I think it was a London 
economist who wrote--gave us a British perspective. They said 
when Congress doesn't understand or like something like work or 
investment, Congress has a tendency to further tax it or 
legislate it out of existence, and I was reminded about that 
when the legislation was referenced earlier. And I wanted to 
ask Chairman Schapiro--there is legislation here in Congress 
for a transaction tax on every financial transaction, and I was 
going to ask you, is the solution to slow our markets through 
this transaction tax on financial transactions, or is the 
solution to speed up our protections through real-time circuit 
breakers? I had mentioned earlier in my opening remarks the 
concept that Germany has employed with respect to looking at 
individual stocks.
    If individual stocks fall more than 5 percent in 5 minutes, 
then you have those circuit breakers go into effect until the 
markets have sorted it out. And it just seems to me that if we 
put this transaction tax on trading, what we are really going 
to do is provide less liquidity, and I wanted to ask if that is 
a valid concern there and your thoughts.
    Ms. Schapiro. Let me, say I have studied the Deutsche Borse 
individual stock mechanism, and it informed very much our 
conversation that we had with the exchanges yesterday because 
my personal view is that if we can do circuit breakers on 
individual stocks, depending upon the velocity with which they 
are declining in value, it will allow us to take a timeout for 
some period of time, and that every market must honor that 
timeout, we will have done a lot to make a difference here.
    And I think it is important for us to do that in relatively 
short order. I guess tax policy is way beyond my pay grade and 
really my depth, but I don't--I just don't have a view, I 
guess, about whether imposing a transaction tax would be an 
effective mechanism to slow the market or not. I don't know 
what the impact necessarily would be on high-frequency or 
algorithmic traders.
    Mr. Royce. My colleagues have brought it up on the other 
side of the aisle, so I thought I would pursue that. But let me 
ask you another question and that goes to the events on 
Thursday. Does this situation justify looking at trying to put 
all of the markets under one regulator? You have equities, 
options, future markets--they are all interconnected. They are 
all correlated against each other. And we passed a regulatory 
reform bill out of the House last year which I think moves us 
in the right direction, but you still have two separate 
agencies with two separate sets of rules, and I just think 
about some of the studies that I have seen where whether you 
are liberal or conservative or in the center, these think tanks 
and economists that have looked at this have all asked the 
question, if you have the same entities trading the same 
products but two different regulators with two different sets 
of rules, aren't you compounding the difficulty here and isn't 
this simply the result of not being able to move forward with 
real world-class regulation? So I would like to ask you, 
Chairman Schapiro, for your view on that.
    Ms. Schapiro. Certainly. Let me just say that the SEC does 
have jurisdiction over all of the equity and options markets; 
we don't over the future markets. And I know Chairman Gensler 
has heard me say this before, that I think if we were writing 
on a clean slate, we would not create the regulatory structure 
around these instruments or these market participants that we 
have today and that there would be efficiencies gained by 
merger of the two agencies. But I want to hasten to add that 
I--and I was CFTC Chairman quite a few years ago and I have 
been around both agencies for many years. Never in the history 
of either of those agencies have I seen closer collaboration or 
cooperation or willingness to support each other as we try to 
get done these things that we think are important in each of 
our marketplaces. So while we don't have a merged agency, I 
think we have very--the next best--
    Mr. Royce. Very good. Let me quickly ask you my last 
question: Is there any evidence that the uptick rule would have 
prevented this calamity on Thursday? I recall reading an SEC 
study which said that there's no way that the uptick rule in 
today's markets could be of assistance, but what is your view 
on that?
    Ms. Schapiro. As you know, we did pass a new version of the 
uptick rule, a short sale circuit breaker rule that is not in 
effect yet, and won't be until November. It is possible new 
rules may have helped to the extent short sellers were active 
during this time period, but what we actually understand is 
that the level of short selling as a percentage of trading 
volume during that critical 30 minutes from 2:30 to 3:00 was 
lower than it was at other times during the day. So to the 
extent the sales we saw were long sales, the uptick rule would 
not have made a difference.
    Mr. Royce. So it really seemed to be a lack of liquidity 
problem?
    Ms. Schapiro. To the extent they were short sales and 
probably something we are looking at, it might have made--it 
might have had some impact.
    Mr. Royce. Thank you very much.
    Chairman Kanjorski. Thank you very much, Mr. Royce.
    And now, the gentleman from North Carolina, Mr. Miller, for 
5 minutes.
    Mr. Miller of North Carolina. Thank you, Mr. Chairman.
    I assume that the value to our economy of securities 
markets is that it matches people with money to invest with 
people who can put the money to productive use, and the usual 
justification for high-frequency trading is that it adds to 
liquidity. And I could understand, for instance, that someone 
who thought they might buy a house for an investment but might 
need to sell it would be reluctant to buy a house because they 
might have trouble selling. But I really don't think, before 
high-frequency trading, that there was that much difficulty in 
unloading a stock.
    Is there any evidence that people are more willing to 
invest in stocks now because of increased liquidity, that 
people who really want to buy and hold a stock who actually 
want to own the company?
    Ms. Schapiro. I don't want to dodge your question, but I do 
want to say this is exactly the kind of issues we are looking 
at in our high-frequency trading release, the issues that we 
published for public comment and public dialogue. And we want 
to understand, what is the role of high-frequency trading? Is 
there a benefit to our marketplace? Are the interests of high-
frequency trading aligned with long-term investors or are they 
at odds with long-term investors? And if so, because our 
markets serve the purpose of, just as you say, allocating 
capital to useful endeavors and to creating jobs, we want to 
make sure nothing is detracting from that. So we are doing a 
very deep dive. The comment period just closed about 2 weeks 
ago, and we are working through those issues now.
    Mr. Miller of North Carolina. A stunning number of trades 
are announced every day. Is there any reason to think--and I 
know that you are still in the middle of this--that there are 
more trades, more purchases every day by people who really want 
to own a stock, who want to buy it and hold it and invest in a 
company? We used to think of patient capital as being someone 
who would hold a stock for years. Now, patient capital seems to 
be a couple of hours or less.
    Ms. Schapiro. I don't know the answer to that offhand, but 
I would love to have some research done and see if we could 
provide you with more detail. There are--just on this 1 day 
last week on Thursday, there were 66 million trades and what 
percentage of those were long-term buyers and holders versus 
high-frequency traders who held instantaneously, I don't have 
an answer, but I would like to see if we could get one for you.
    Mr. Miller of North Carolina. The statistics or the 
estimates that I have seen are that 40 to 70 percent of all 
trades are high-frequency trading. Is that roughly correct?
    Ms. Schapiro. Yes. We have heard those numbers as high as 
70 percent.
    Mr. Miller of North Carolina. Okay. Jon Stewart had a piece 
the other night showing the number of times that events in the 
financial markets have been called a ``perfect storm,'' and 
they seem to happen every couple of weeks, which is maybe not 
the idea of the definition of perfect storm, which is this 
completely unpredictable combination of events that maybe 
happens every 100 years. They seem to happen every couple of 
weeks. In looking at what happened, can you also look at what 
else--it seems unlikely that this very thing will happen again, 
but something that we had no reason to think might happen seems 
to be happening with disturbing frequency. Can you look at 
destabilizing factors in the market generally so that maybe not 
this perfect storm will happen again, but other ones also?
    Ms. Schapiro. Absolutely, and that is part of our broader 
market structure review that we are doing.
    Mr. Miller of North Carolina. Okay. Thank you, Mr. 
Chairman.
    Chairman Kanjorski. Thank you very much, Mr. Miller.
    The gentleman from Oklahoma, Mr. Lucas.
    Mr. Lucas. Thank you, Mr. Chairman.
    And Chairman Gensler, let me thank you for attempting to 
track me down on Thursday evening. I was on a plane, but I 
appreciate your attempt to call me in my role as ranking member 
of the Agriculture Committee.
    You mentioned earlier in one of your comments in reference 
to last week that derivatives may have played a role. Chairman 
Gensler, is that a hunch? Is that a gut feeling? Or is that 
something you potentially see in all those reams of data you 
are working through now?
    Mr. Gensler. There are derivatives that are on exchange, 
futures, and we can see that data. I think my earlier comment 
was just saying that we can't look right now into over-the-
counter derivatives, and with your support and this committee's 
support, I think the bill that you passed out of the House last 
December would at least, in the future, in a similar 
circumstance, allow us to at least see that data.
    Mr. Lucas. Along that line, Mr. Chairman, you have always 
been a very vocal supporter of the mandatory exchange trading 
for derivatives that listed for clearing with little or no 
regulatory flexibility. After last week's trading activity and 
the listed equities market, which is, I think we would all 
agree, about as liquid a market as you can have, do you still 
believe that mandatory trading is the sensible route to go for 
over-the-counter derivatives, which are very illiquid 
instruments? And thinking about that reduced volume and reduced 
liquidity, if there is a wild action or an aberrant trade, 
isn't the potential far more damaging?
    Mr. Gensler. I appreciate the question. I very much still 
am. I think that the over-the-counter derivatives market, which 
dwarfs the future exchange derivatives market by about 8 to 10 
times the size, no small amount, I think we must bring the 
transparency there. Not for all contracts, however. There will 
be a whole group of contracts that are customized. There will 
be a whole group that aren't listed, even if they are 
clearable. But I think that for the portion of the market that 
can be listed and has some characteristics that will add 
transparency, we should have exceptions for block trading.
    If somebody is doing a lower transaction, then it is just 
reported afterwards, just as it is in the futures and 
securities markets now, but I think that the events of last 
Thursday are important to look at. They don't change my overall 
view that we need to bring transparency to the off-exchange or 
over-the-counter derivatives marketplace where we can, not in 
the customized portion of the market but in the more 
standardized portion of the market.
    Mr. Lucas. So ultimately, when you do and your good folks 
over there and your friends at the SEC grind through all of 
this and come up with some sort of a determination, we will 
have a much better feel. I just personally still have to 
believe that having watched what the Agriculture Committee did 
and working in conjunction with Financial Services, trying to 
be a bit more flexible, a bit more rational in how we handle 
these derivatives, I personally think was the route to go. I 
know ultimately after last week, we will reassess the 
situation. But I just wanted your perspective on that because 
while both of you have indicated today there was no ``fat 
finger,'' no magic mystery key stroke, no great confusion in 
somebody's software, nonetheless, if whatever did occur could 
have such an effect on the most massive, most liquid market in 
the world, it does cause concern for me about these other 
markets, these other instruments that don't even begin to 
approach that.
    Mr. Gensler. And that is why I think it is not only 
important that we have strong risk management in the 
clearinghouses that the Congress has been supportive of, but 
also that these exchanges for derivatives have very strong 
rules. I think the futures market has some very important 
guidance, the four that I have mentioned earlier in terms of 
not being able to put prices in in the outset of a ban; and 
having the pause, the 5-second pause that happened in the 
futures market last Thursday was, in fact, right at the bottom 
where the order book got refilled. And the mention that 
Chairman Schapiro was talking about of trying to do that across 
the securities markets, I support her initiative on that.
    Mr. Lucas. One last brief question. If indeed we do 
determine what happened, what the odds that it will be 
something of a proprietary nature where you won't be able to 
share that with all of us and the public?
    Mr. Gensler. We plan to make our findings public both to 
Congress and this committee. Next week will just be initial 
findings of staff. If there was a need to talk about individual 
trading, information of individual accounts, than we would work 
with this committee to do that in the appropriate setting.
    Mr. Lucas. I look forward to letting the chips fall where 
they may. Thank you.
    I yield back, Mr. Chairman.
    Chairman Kanjorski. Thank you very much, Mr. Lucas.
    And now, we will here from the gentleman from Georgia, Mr. 
Scott.
    Mr. Scott. Thank you very much, Mr. Chairman.
    First, let me commend you, Chairman Schapiro and Chairman 
Gensler. Your presentation certainly gives us all confidence 
that you have your hands around the problem. While you are 
looking for the causes, you have certainly shown that you have 
put certain measures in place to give confidence to investors 
to keep on investing with confidence. It seems to me though 
that what we really have here is a way we are trying to find to 
stop a freefall in a free market in a free economy while it is 
very important to keep the markets free. That is the strength 
of our markets, the freedom. So as we move with controls, my 
question has to evolve around this element that you are 
presenting as the most basic means of controlling this free 
market so at the same time making sure it is still free to 
function in the beauty and the strength that it has. And your 
instrument for doing this apparently is the circuit breaker.
    And the circuit breaker basically is a function of time 
increments. It is a function of pricing. And I wonder, how 
would you determine that? Who will determine that? Will it be 
an increment of 15 minutes if it goes down 5 percent, or would 
it be 2 or 3 hours if it goes down 10 or 20 percent? And will 
it apply across each exchange? We have seven of those 
operative. Or would it apply just to individual stocks? How 
simply would that circuit breaker work and allow still for the 
freedom of trading?
    Ms. Schapiro. Congressman, that is a great question. And I 
think it is important to note that we very much believe in the 
market and in the market mechanism, but I don't think anyone 
would argue that when the market went down 900 points in a 
very, very short period of time, and 500 points in a matter of 
a couple of minutes, that the real forces of supply and demand 
were operating. We clearly had a problem that was related to 
the fact, in my view, that we had markets operating under 
different sets of rules.
    We also had some issues about liquidity leaving the 
marketplace. Certain types of orders exacerbated that. The use 
of something called stub quotes that allowed transactions to be 
executed at a penny contributed to that. But clearly, something 
didn't work unrelated to market forces that we normally applaud 
and think make our markets better.
    The circuit breakers that we are talking about with the 
exchanges would be designed based on longtime experience in 
other markets around the world which already have circuit 
breakers on a stock-by-stock basis as well as the experience 
of, for example the New York Stock Exchange which already has 
the equivalent of a circuit breaker, which I am sure they will 
talk about in their testimony in the next panel. Bringing in 
collective experience of all those markets together with the 
ultimate approval of the SEC for any rules that would institute 
circuit breakers, I think gives us some confidence that we will 
be able to get it right, and if we don't, we will have to 
revisit it and make adjustments.
    On a marketwide circuit breaker, as we have in our markets 
today that applies across the equities options and futures 
markets, both the SEC and the CFTC would ultimately decide 
whether changes to those existing circuit breakers are 
appropriate.
    Mr. Scott. Part of the problem is the lack of uniformity 
across the markets.
    Ms. Schapiro. Absolutely.
    Mr. Scott. So who in your estimation would be the entity 
that would make that determination at the particular time that 
circuit breaker goes into effect?
    Ms. Schapiro. There are two ways to do it, and the way I 
favor, quite honestly, is the one that has people knowing every 
day when they walk in that the price of--if a stock moves--and 
these are just examples--5 percent in 5 minutes that the market 
for that stock will be shut at every place it trades for a 
period of 3 minutes or 5 minutes or whatever is appropriate. 
The certainty of knowing ahead of time, I think, is of enormous 
benefit to markets because they thrive on that kind of 
certainty about what the rules would do.
    Another way to do it would be to allow a listing market, so 
if it is a New York Stock Exchange stock for the New York Stock 
Exchange, to be able to say that we are shutting down or we are 
going into slow mode or we are turning off the electronic 
systems for 1 minute in this stock and all other markets would 
have to follow if that doesn't provide all of the upfront 
certainty that we get from circuit breaker.
    Mr. Scott. Let me just ask, since my time is up, would this 
circuit breaker also work for a dramatic rise in price of stock 
as well as a lowering?
    Ms. Schapiro. There seems to be less appetite, I will say, 
for circuit breakers on the upside.
    Mr. Scott. And if you had your druthers, would we have one 
centralized entity for determining when the circuit breaker 
goes, or would you recommend that each of the major exchanges 
have their own individual and that reaction sets in for the 
others?
    Ms. Schapiro. I think there has to be a minimum circuit 
breaker that applies across every market that trades for 
whatever the stock is or we will have exactly the problem that 
we had on Thursday.
    Mr. Scott. Okay. Thank you, Mr. Chairman.
    Chairman Kanjorski. The gentleman's time has expired.
    The gentleman from Texas, Mr. Hensarling.
    Mr. Hensarling. Thank you, Mr. Chairman.
    I have been here since the hearing was gaveled into order 
and noticing the title of our hearing, ``What Happened and What 
is Next?'', I don't think I have heard what has happened, but I 
have heard a lot of debate about what is next, and I somewhat 
question the wisdom of debating what is next when we don't know 
what happened. Perhaps I missed something, but I think--
Chairman Schapiro, I believe I heard you say that you are 
working around the clock to find the cause, but you don't have 
an answer today; is that a fair paraphrase of what you said?
    Ms. Schapiro. That is fair.
    Mr. Hensarling. And that you will share the trigger as 
identified with the public when you identify the trigger?
    Ms. Schapiro. As we--trigger or triggers--
    Mr. Hensarling. Trigger or triggers.
    Ms. Schapiro. When we understand what the cause is, we will 
absolutely share it with the public.
    Mr. Hensarling. Okay. And Chairman Gensler, I think I heard 
you say something similar, that your people are diligently 
fact-finding at this point, but you are not prepared to 
announce a cause of--
    Mr. Gensler. I would say that I think that the four factors 
I mentioned contributed to the turbulent market--we are 
continuing to research to see if there is a fifth or a sixth 
(and so forth) factor but the four factors I mentioned, the 
turbulent environment that this--the market--if I can use the 
airplane analogy, there were a lot of signaling advices. When 
market participants start to see bad signaling, they start to 
sell. They start to lay off risk, if I can use an old market 
term.
    Third, there were some active traders providing liquidity 
stepping back from the market. I think there will probably be 
others that we will find as we do more research. And we were 
saying in a down market, we need to hedge. We need to put on 
bona fide hedges.
    Mr. Hensarling. So is it fair to say then that certainly 
you have localized individual factors worthy of further 
research, but you still have yet to draw the conclusion as to 
the trigger for this incredible violent market volatility?
    Mr. Gensler. I think we will have staff report preliminary 
findings next week that will have more in them. However, there 
is a factor that I think we have definitely identified, which 
is across the securities markets that individual securities 
trading down to a penny a share, if I can swim outside my lane, 
as Chairman Schapiro said--really is not acceptable in the 
capital markets when they were tracking moments before at $40. 
That is something--that cross-market pauses or circuit breakers 
is about.
    Mr. Hensarling. I certainly agree, Mr. Chairman. It seems 
like, to some extent, the hearing is concentrated less on 
perhaps what is the underlying cause and is kind of turning 
into a debate of high-frequency trading, its relative benefits 
or relative cost. I have in my hand an editorial that was 
written, Chairman Schapiro, by one of your predecessors, Arthur 
Levitt, that appeared in The Wall Street Journal about 8 or 9 
months ago. In the editorial, he posits, ``Due to the rise of 
high-frequency trading, investors, both large and small, enjoy 
a deeper pool of potential buyers and sellers and a wider 
variety of ways to execute trades.'' He went on in this 
editorial to write, ``Choice abounds and investors now enjoy 
faster, more reliable execution technology and lower execution 
fees than ever before. All of that contributes significantly to 
market liquidity, a critical measure of market health and 
something all investors value.''
    Do you have a comment on your predecessor's thoughts?
    Ms. Schapiro. I do think investors have a lot of choices 
today. I think that is generally a good thing. I do think that 
they benefit from narrower spreads and lower costs as a result 
of competition in our marketplace. But I also don't think they 
benefit from the kind of conduct that happened on Thursday 
where, in part because of disparate rules across marketplaces, 
investor orders were treated very differently and we had the 
phenomenon of a stock at $40 trade at a penny.
    And so while we don't know all the causes of the 
volatility, we do know what some of the symptoms were, and we 
can go ahead and tackle those, I think, understanding that we 
want to be cautious, we want to be thoughtful. We don't want to 
harm what is good about our markets. But I also think we run 
the risk of losing investor confidence if we don't move forward 
to fix some of the things that we believe and the exchanges 
believe are problems.
    Mr. Hensarling. If I could, Chairman Schapiro, have you 
comment on another part of his editorial dealing with the 
suggested 25 basis points per trade tax on all trades. Chairman 
Levitt said, ``Such a tax has been tried before from 1914 to 
1966. There is a transfer tax set at .2 percent of stock 
trades. That expense was simply passed on to investors. A tax 
on such transactions would probably drive high-frequency 
traders and the liquidity they bring to foreign markets.'' I 
know you didn't want to get dragged into tax policy, but do you 
have an empirical observation on whether or not historically 
such taxes have been passed on to investors?
    Ms. Schapiro. I really don't know the answer to that. I 
assume most costs are passed on to investors one way or 
another.
    Mr. Hensarling. I agree. Thank you for your time.
    I yield back, Mr. Chairman.
    Chairman Kanjorski. The gentleman's time has expired.
    Now, we will hear from the gentlewoman from Illinois, Ms. 
Bean.
    Ms. Bean. Thank you, Mr. Chairman. And thank you, Chairmen 
Schapiro and Gensler, and Director Cook, for your testimony 
today.
    In the Wall Street reforms that we have already passed in 
the House and are pending in the Senate, an amendment that I 
authored and was included will require evaluation by the 
oversight camp council, the systemic risk council, to 
evaluate--identify and evaluate potential threats to the 
stability of the financial system. It would also require that 
they establish plans and conduct exercises in the same way that 
the Department of Homeland Security and other agencies do to 
potentially avoid or respond to or contain emergencies that 
would happen. And then they will provide a report back to 
Congress on the results of what they have anticipated and what 
they have discovered.
    My question to both the chairmen is, the functional 
regulators such as yourselves already have the authority to do 
those types of exercises and plan ahead for eventualities, 
however slight you think the probability. Can you share with me 
in terms of those types of exercises reports and plans what had 
been done prior to May 6th in each of your organizations? I 
will start with Chairman Schapiro.
    Ms. Schapiro. Sure. And I may ask Mr. Cook to jump in here, 
because we do something called an ARP, an automation review 
policy examination, of all of our regulated markets to test the 
quality of their systems, the security of their systems, the 
robustness and the resiliency of their systems and their 
backups, and that is a routine program we engage in regularly. 
We are also gathering data, as I have said, probably 300 times 
here and everyone is tired of hearing, through our market 
structure concept release on issues that will relate in some 
part to systems and particularly the impact of strategies that 
are utilized by algorithmic traders and high-frequency traders 
on quality and the integrity of our markets.
    Ms. Bean. Chairman Gensler?
    Mr. Gensler. We are fortunate to be able to get the 
position data every day, so what we got last week was not 
unusual because under our statute, we are able to get the whole 
set every day. Every Friday, the five commissioners sit in a 
room and get a surveillance brief on the activities of that 
marketplace for that week. Then, we also look at over the next 
week as to how the futures market is coming together. So we do 
it on a real-time basis week to week in terms of our 
surveillance in the markets. In terms of last Thursday, if I 
might say, Secretary Geithner had us and the whole President's 
working group together--I think it was a 4:15 call.
    I can't remember the evening call we had. The first thing 
Friday morning again, and maybe there was a second one Friday. 
I can't recall. So the President's working group may sort of 
mutate into this council in a sense. But, there was a very 
active cross-governmental collaboration Thursday evening, 
Friday, and over the weekend.
    Ms. Bean. Thank you. Director Cook, did you want to add 
anything further? No?
    I guess my question would then be, moving forward, do you 
anticipate further rigorous planning, out-of-the-box thinking 
about potential scenarios that you may not have otherwise 
anticipated?
    Ms. Schapiro. Absolutely. And one of the reasons we 
proposed just a couple of weeks ago a large trader reporting 
system, which exists on the CFTC side--I recall it from my days 
there--on the equity side so that we can actually identify much 
more quickly the activity of high-frequency traders in the 
markets on a routine basis. And we are--the Commission will 
vote in about 2 weeks on the proposal to create a consolidated 
audit trail so that we can track from the inception of an order 
through execution and settlement every modification, every 
change, every hand that touches that order through our market 
processes. And we can then do these kinds of market 
reconstructions far more efficiently than we are able to do 
this one now, having to combine multiple audit trails from 
every one of our trading venues.
    Ms. Bean. I guess my question is audit trails are after the 
fact, but preemptively, will you be doing scenarios and 
anticipating if someone seeks to do harm in the market or to 
manipulate the market in some way for their own gain--are you 
anticipating those potential attempts and running through 
scenarios?
    Ms. Schapiro. I think we are doing that now, and certainly 
Thursday heightened our urgency about doing that. But I also 
think that having an audit trail and understanding the trading 
data better will enable us to think more creatively about what 
kind of scenarios we ought to be thinking about and worrying 
about.
    Ms. Bean. I have another question--go ahead.
    Mr. Gensler. I was just going to say that although we do 
similar things internally, we don't think that is enough. One 
of the reasons we came together to form this joint advisory 
committee is really to have outside experts looking out over 
the horizon and saying what is the next emerging risk that we 
ought to be looking at.
    Ms. Bean. I see my time has expired. I will yield back.
    Chairman Kanjorski. Thank you. We will now hear from the 
second gentlelady from Illinois, Mrs. Biggert.
    Mrs. Biggert. Last but not least. Thank you, Mr. Chairman.
    Following up on that, I think that some of us might recall 
that we do have Chicago First, which is really a public-private 
partnership that was created in 2003 legislation, and this was 
following 9/11 that was a model for the rest of the country, 
and I think there are quite a few of these groups. Have you 
worked with them at all?
    Ms. Schapiro. I have not.
    Mrs. Biggert. Maybe we can discuss that at some time later. 
But my next question was for Chairman Gensler and--
    Mr. Gensler. Actually, to answer your question, we have 
worked with them.
    Mrs. Biggert. As you know, CME uses a number of risk 
management controls. Can you explain how CME was able to 
contain the contagion that originated in the equities markets? 
Specifically, can you explain how the stop price logic works?
    Mr. Gensler. There are a number of risk management controls 
in the futures markets. The stop price logic, which is one of 
four, works within their computerized trading platform called 
glowbacks. As the market goes down or up, if the orders in the 
book are going to be spreading so much that there will be a 
cascading of what is called stop-loss limit orders--that is a 
mouthful. But if there is a cascading that I believe goes more 
than 6\1/2\ points, then it will actually pause, give 5 seconds 
for more orders to come in.
    That is what happened right at the bottom of the market at 
2:45.28, there was a 5 second pause. As the market traded up 
three-quarters of a point and then as it did it sort of moved 
up.
    Mrs. Biggert. So should a similar rule be applied to other 
markets, equities?
    Mr. Gensler. I think that Chairman Schapiro is talking--
because there are different characteristics, but across the 
platforms to see whether there is something, I would say 
broadly similar though not identical.
    Ms. Schapiro. Broadly similar though not identical. We are 
looking at individual stocks having circuit breakers that would 
operate to stop trading for a period of time so that algorithms 
can be refreshed and additional liquidity can be attracted to 
the markets.
    Mrs. Biggert. Next then, has the trading technology gotten 
ahead of the regulators? If the regulators aren't ahead of the 
technology, won't we have problems like last Thursday?
    Mr. Gensler. I am very proud of the group at the CFTC. I 
inherited most of them but it is a terrific group. But I do 
think that we have been underfunded on technology. We have a 
significant investment in front of us to do what we call 
automated surveillance and compliance. We are trying to build 
the flags and alerts to look at the hundreds of thousands of 
transactions a day by basically what is called simply exception 
reports and then flagging them for good people like Mr. 
Sharrits, who is sitting behind me, and his team.
    Mrs. Biggert. Okay. Chairman Schapiro?
    Ms. Schapiro. We are significantly underfunded in 
technology. Until just this year, our discretionary technology 
budget for development projects was 50 percent below what it 
was in 2005 and our markets are vast and complex--
    Mrs. Biggert. I know, and I have asked you this question 
before: How old is your technology? Is it 10 years, 20 years?
    Ms. Schapiro. I think it probably depends system by system. 
But Congress has been generous in the past year, we have been 
able to build some new technology to consolidate our tips and 
complaints and referrals more effectively, but we have some 
very old systems, some of which I recall from when I was a 
commissioner in the early 1990's.
    Mrs. Biggert. And as you talked about your markets, I think 
it has been said that you are still aggregating data from 50-
some electronic trading venues, and this really highlights the 
fragmented nature, doesn't it, of our markets? And while this 
fragmentation may be at least partially to blame for this 
Thursday's market drop, is it also hampering the SEC's search 
for explanations?
    Ms. Schapiro. It is making the job more complex. I will say 
I have been envious of Chairman Gensler's ability to download 
files from a single marketplace largely and conduct their 
analysis. We have to download voluminous files from multiple 
market participants--19\1/2\ billion shares of stock traded on 
May 6th in 66 million transactions. Once we are done analyzing 
that, we then need to compare our analyses with the CFTC so 
that we are sure we are linking the two markets together 
appropriately. So more technology would absolutely enable us to 
do this job a little bit faster.
    Mrs. Biggert. Is there a plan and a timeline for 
implementation of updated technology?
    Ms. Schapiro. We still don't have the resources to do much 
of what we would like to do. The Commission will consider in 
the next couple of weeks a proposal to create a consolidated 
order audit trail that will give us vast amounts of data and 
make this kind of reconstruction far simpler than what we are 
going through right now. That will largely be developed by the 
markets and we will have full access to the data.
    Chairman Kanjorski. The gentlewoman's time has expired.
    The gentleman from Massachusetts, Mr. Capuano.
    Mr. Capuano. Thank you, Mr. Chairman. I want to thank the 
two chairmen and Mr. Cook for coming today.
    I also didn't expect a whole lot of final answers today. I 
have faith that you will rip this apart for the next several 
weeks or more and come back with a more thorough response, and 
I think that is an appropriate thing.
    I do want to focus on one thing I do think is within your 
purview, not so much for a conclusion as much as just 
questions, particularly Chairman Schapiro, the decision to 
cancel trades.
    I have no problem with the concept. My concern is, where do 
you draw the line? As I understand it, give or take 300 
entities, or whatever it may be, if you are going to cancel 
some, why not just cancel them all? Pick out the timeframe when 
people started to fall off the table, and just from that point 
forward, something went wrong. Because no matter where you draw 
the line, somebody is going to get hurt and somebody is going 
to sue somebody. They are probably going to sue you, not me, so 
that is okay. But I just don't understand why you drew the line 
that you drew.
    Ms. Schapiro. We didn't draw the line, although let me 
agree with you that this was a highly unsatisfying process from 
my perspective. Under the rules of the exchanges, they draw the 
line about when to cancel erroneous trades, and they met right 
after the market closed on Thursday.
    Mr. Capuano. ``They,'' meaning who?
    Ms. Schapiro. The stock exchanges. And they came up with a 
common standard to cancel trades at prices that they think are 
sharply divergent from the previous day's close. They selected, 
and it would be great to ask them, I think at the next panel, 
60 percent off the prior day's close, or the 2:40 trades, the 
last probably really solid trades in the market.
    A lower threshold would have resulted in many, many, many 
more trades being canceled, which would have had some ripple 
effect in the markets in terms of traders who were hedged in 
other markets would have had this trade canceled, but their 
hedges are still standing.
    But it is clear that it is not a process that I think works 
to the advantage of investors. So when we brought the exchanges 
to town on Monday, we asked them to think about how we can make 
a more certain and clear process so that investors know up 
front what trades might be broken and what trades might not be 
broken if we have another kind of event like we had on 
Thursday.
    Mr. Capuano. Is this issue now settled? It is done? Going 
forward is one thing, but for this particular day, is that 
decision final in stone, not to be reviewed?
    Ms. Schapiro. I believe the exchanges will tell you that 
decision is final. I expect that there will be--
    Mr. Capuano. I hope they have good lawyers.
    Ms. Schapiro. You may be right about that.
    Mr. Capuano. Oh, no, I am right about that. I am a lawyer. 
I would sue you. Depending on what happened in my pension fund, 
I might be suing you. I don't know. I think it is ridiculous. I 
think it is inappropriate. I think it is arbitrary. Again, I am 
hoping to hear answers, and if not from you, I will ask the 
next panel. But 60 percent is some magic number and 59.9 isn't? 
That is ridiculous.
    Ms. Schapiro. Exactly. I share your concern, and we are 
going to fix this going forward.
    Mr. Capuano. Mr. Gensler, I am not exactly sure whether you 
did the same thing.
    Mr. Gensler. There were no busted trades in the futures 
market. The rules in the futures markets are very tight, in 
terms of what is called a ``busted trade,'' they have to occur 
within a certain number of minutes after the trade and there is 
a certain limit as to how many ticks away from any future that 
trades that could actually generate that. So, there are very 
prescribed rules.
    Mr. Capuano. That is subject to a specific standing rule?
    Mr. Gensler. That is correct.
    Mr. Capuano. I may argue with what the rule might be, but 
at least everybody who gets into it knows what the rules are.
    Mr. Gensler. It is very transparent.
    Mr. Capuano. I think the problem with the other exchanges 
is the lack of transparency and arbitrariness. I think we have 
enough problems with this. Generating hundreds of thousands of 
lawsuits on the basis of probably billions or tens of billions 
of dollars doesn't help the situation. But I will ask the next 
panel.
    Thank you, Mr. Chairman. I yield back the remainder of my 
time.
    Chairman Kanjorski. Thank you.
    Now, we will hear from the gentleman from California, Mr. 
Campbell.
    Mr. Campbell. Thank you to all three chairmen and Director 
Cook.
    I am trying to understand what we know and what we don't 
know at this point. So, Chairman Schapiro and Chairman Gensler, 
jump in at any point if you want, but just sort of rapid-fire 
questions.
    If we focus on these well-publicized trades, the penny, the 
Accentures and so forth, and P&G, which didn't go to a penny 
but went down; those trades, those trades occurred and were 
consummated, correct, at the time? So someone bought and sold 
those stocks at a penny.
    Ms. Schapiro. Yes.
    Mr. Campbell. What sort of volume transacted at that level? 
Do we know that?
    Ms. Schapiro. I don't know that. I would be happy to 
provide it for the record. I know that there were about 300 
stocks where trades were broken because they were 60 percent or 
more away from the market, and I believe the last number I was 
told was about 19,000 trades.
    Mr. Campbell. Nineteen thousand trades across all those 
securities at significant volume. So in a given security, were 
there 1,000 shares traded at a penny, or were there 300,000 
shares traded at a penny, or do we know?
    Ms. Schapiro. I would be happy to provide that for the 
record. I don't know that we have all that data yet.
    Mr. Campbell. Okay. Where were these trades transacted? The 
New York Stock Exchange, NASDAQ, other exchanges?
    Ms. Schapiro. At many places. And that is the nature of our 
very fragmented and dispersed marketplace. NASDAQ. No stock 
exchange trades basically more than 20 percent of the volume or 
25 percent of the volume in its own listed securities because 
we have so many trading venues. So they traded in markets like 
NASDAQ, the New York Stock Exchange, the ECNs, like Direct Edge 
and BATS, and in dark pools where they are not so transparent, 
and through internalization by broker-dealers. So there are 
multiple ways for a securities transaction to be executed.
    Mr. Campbell. So again, if we take a given security that 
traded at a penny, those transactions occurred on multiple 
exchanges at a penny at that point; or do we know?
    Ms. Schapiro. We don't know.
    Mr. Campbell. That is part of what we don't know?
    Ms. Schapiro. Of what we are working on.
    Mr. Campbell. Okay. I suspect a lot of this is what we 
don't know. And what I think we need to find out before we can, 
you know--you can or we can jump to any conclusions about where 
this should go.
    I understand we have stop-loss orders and those turn into 
market orders. But then how does it run through--if that 
happens at $30, how does it run through everything to a penny? 
How did that occur? I understand at that point it is a market 
order and if the market is a penny, the market is a penny. But 
somehow, it has to run from $30 to a penny.
    Were there significant transactions all the way down the 
line, or did we have a 20-point gap?
    Ms. Schapiro. In some cases, there were, and in some cases, 
there weren't. As the orders started to cascade down, there 
were not buy orders on the books of these multiple venues that 
could soak up that selling activity, and as there was continued 
pressure from the sellers, nervous investors who put in stop-
loss orders that convert basically into a market sell order as 
they go down, the sellers that were remaining in the market 
ended up executing against what we call stub quotes, and that 
is where you get the penny price.
    A market maker does not want to stand there and provide 
liquidity. They have to make a two-sided market. They will make 
a one-cent to a $100 market, so that one-cent price is out 
there in the marketplace, and some of these orders hit that.
    Stub quotes--I think the view of the exchanges, as we 
discussed yesterday, was universally that they serve no purpose 
in our marketplace. So that is another issue that we have on 
our immediate agenda, to consider whether we either have to 
have real market-maker obligations to make genuine competitive 
markets, tight spreads, or we get rid of the obligation to have 
two-sided quotes, so we don't end up with these penny quotes.
    Mr. Gensler. And if I could say, there is a difference in 
rules in futures and securities, but I am not sure you could 
translate one to another. There are no stop-loss market orders 
in the futures market on both of the major exchanges. It is a 
stop-loss limit order, meaning when the stop is hit. A stop is 
when the price goes down and it hits a price and then the order 
goes in; it has to have a limit to it.
    Mr. Campbell. Let me just ask one more question, then, 
before my time runs out, which is what has changed--this could 
not have happened, I suspect, 15 years ago or 20 years ago or 
25 years ago or 40 years ago, particularly if you go back to 
traders on the floor with a piece of paper 40 or 50 years ago 
and so forth. But I guess what has changed that enabled that 
kind of significant--because stop-loss orders turning to market 
orders are not a new thing. This has been around for a long 
time. What is the new thing that occurred that caused this?
    Mr. Gensler. I think that volatility is part of markets and 
huge volatility was in 1987. I think the change is the floor 
traders, the specialists, or the pit traders in futures, are 
now more and more in some office with computers, and the 
computers are located right next to the exchange engines--that 
is called co-location--and everything is down to nanoseconds, 
rather than those liquidity providers used to be either a floor 
specialist or in the pit. That is one thing that has changed in 
the 20-some years.
    Ms. Schapiro. I would say that while we did have tremendous 
volatility in October of 1987, we had many more market 
participants who don't have the same sort of affirmative 
obligations to the marketplace that we had at that time with 
specialists, with market-makers on the NASDAQ stock market. So 
speed, volume, velocity of trading, volatility, and lesser 
obligations to the market as a whole.
    Mr. Campbell. My time has expired. Thank you.
    Chairman Kanjorski. Thank you very much.
    Now, we will hear from the gentleman from Illinois, Mr. 
Foster.
    Mr. Foster. Thank you, Mr. Chairman.
    Does anyone yet understand the origin of the tremendously 
high share prices that were bid, at least reported, $100,000 
for Sotheby's and so on? Were these algorithmic bids, or what 
was the nature of them and what was the nature of the firms 
that made them?
    Ms. Schapiro. I believe we are still looking at that, and I 
will ask Robert to jump in here. Interestingly, there were 20 
stocks that traded at 90 percent above their 2 p.m. price 
during that period when there were 250 or more stocks that 
traded at 90 percent below their 2 p.m. price. But I don't know 
if we know yet the reason.
    Mr. Cook. No, we don't. There are many more that traded 
below their 2 p.m. price than above, but we don't yet know the 
nature of the orders that came in that fed into those prices 
above.
    Mr. Foster. So you don't even know who made them?
    Mr. Cook. Not at this time. That is part of the information 
we are gathering together, because we are pulling together the 
information as to where the orders originated, at which trading 
venue, and then we will go back further and find out who put 
them in through the brokers.
    Mr. Foster. So this many days later, you don't know who it 
was that made these funny-sounding bids.
    Chairman Gensler, would that be the case with you?
    Mr. Gensler. No. In the futures market, we didn't have 
either, because there are so many curbs and limits in this risk 
management. One of the things that high-frequency or 
algorithmic traders do is called ``sniping,'' if I may use the 
term, in which the computers actually put in a bid, one 
contract or one security at a time, and try to pull out the 
liquidity and find it. If there was a resting order, a resting 
bid at a penny or a resting bid at $100,000, the computers can 
strip through and maybe find it. That may be a possible thing 
to look at it--it may have been what happened.
    Mr. Foster. Are there mandates that automated trading firms 
appropriately version and archive their algorithmic code and 
their databases so they can reproduce their trading decisions 
after the fact in the course of these investigations?
    Mr. Gensler. We have actually asked for some of these 
largest traders to actually sit down and see their code. Our 
folks in our Division of Market Surveillance are sitting down 
this week with a number of the largest ones and are actually 
looking at their codes.
    Mr. Foster. Right. But it is a possible response that they 
say, ``We just don't know. We had some version, but then we 
overrode it.''
    Are there enforced industry standards so that you can 
actually go back and say what version of what code were you 
running last Wednesday afternoon?
    Ms. Schapiro. If they are regulated entities, yes, we can 
see their code and they need to freeze their code if asked. And 
we have told specific firms post-Thursday that we want the code 
frozen so it is not changed. If they are not regulated 
entities, we have to get that information by a subpoena.
    Mr. Foster. Could you explain briefly how trade busting 
works on synthetic positions? If the underlying stock is 
determined to be broken, does that automatically imply the 
breaking of various synthetic positions? How does that work? Is 
there an agreed-upon way that should happen, and is that the 
way it happens?
    Ms. Schapiro. I can speak to how the securities trades are 
busted. And as I think we have talked about, it is a pretty 
unsatisfying process because it lacks real clarity and 
consistency for the investors up front. But the exchanges in 
this situation--and this is unusual, because your normal trade 
bust situation is a single stock--something goes wrong in the 
technology and you need to bust a lot of trades in one stock. 
Here we had hundreds of stocks where trades needed to be busted 
because prices were sharply divergent from where they had been 
on the previous day's close. Exchanges meet. They come up with 
a common standard so that they are all busting trades at the 
same level.
    Mr. Foster. My question was: How does that percolate back 
into positions that are derivative positions on equities?
    Ms. Schapiro. In terms of busting, I don't believe it does. 
But it does have an impact on them. If they have hedged a 
position that is then busted, they have a hedge, they are now 
exposed.
    Mr. Cook. To follow up on your question, in the securities 
markets, the options markets would make the decision of whether 
to break the trade if the underlying security trade had been 
broken. In this case, I believe very few options trades were 
broken, but some were.
    Again, the process was not fully coordinated in the sense 
that the options markets made that decision separately from the 
securities markets, and that is one of the things we are 
looking at going forward.
    Mr. Gensler. Though I don't remember everything in CME Rule 
5(8)(a), which is their busting rule, what we had last 
Thursday, the indices themselves, S&P and Dow, didn't reprice 
their indices. They didn't come back and say there was a 
different thing, and I know that was relevant to those markets.
    Mr. Foster. Okay. Would you say that overall what happened 
last Thursday strengthens or weakens the case for merging the 
CFTC and the SEC? First off, you all know my position that they 
should be merged and moved to Chicago.
    Ms. Schapiro. Okay, I am with you on half of that. I have 
long held the view that the two agencies should be merged; that 
the participants in these markets, the products are 
increasingly similar and the markets are increasingly linked, 
and there would be efficiency and economy of scale to a merger. 
But if the political will for that to happen doesn't exist, I 
think--as I said earlier, this is the best working relationship 
in my many years of being around these two agencies I have ever 
seen in terms of collaboration and cooperation--I am not sure 
that the event of Thursday would have played out differently 
had there been just one agency.
    Mr. Foster. Do you share the development of software tools 
that you are both frantically developing to analyze this, or do 
you have independent groups? Do you have any comments?
    Ms. Schapiro. I will tell you, it took an act of Congress 
to allow us to create a joint advisory committee. So the 
ability of Federal agencies to actually share things mystifies 
me in its limitations.
    Mr. Gensler. We actually want to thank you. You didn't know 
you were voting on it at the time, but it was part of the 
appropriations bill last year. Congressman Lucas probably did 
know about it. I think that our two agencies, and I thank 
Chairman Schapiro for her support the last 11 or 12 months I 
have been in this job, have been very collaborative, and very 
close. I think the will of Congress has been, since the 1930's 
really, a strong agency in the SEC overseeing its orbit, 
another agency overseeing the exchange derivatives markets, and 
now we are trying to fill this gap in the over-the-counter 
derivatives market as well.
    Mr. Foster. I yield back.
    Chairman Kanjorski. Thank you very much, Mr. Foster.
    That completes our questioning for this panel. I will just 
take a moment before we excuse you, I want to thank both of you 
again and I want to reiterate something that Mr. Scott said in 
his questioning. After hearing the testimony from our two 
regulators, I feel a lot more secure. I am not certain I could 
tell you why, but I feel a lot more secure. I look forward over 
the next several weeks to open disclosure with the American 
public and the Congress as to what you find, as soon as you 
find it, so that we can get to a final conclusion, but in the 
meantime, to participate in such rules or changes that can help 
prevent what has happened last Thursday.
    With that, I thank you both very much. We are going to 
allow you to leave so you will be able to enjoy the rest of the 
day.
    Our second panel, first of all, I thank you for appearing 
before the subcommittee today. Without objection, your written 
statements will be made a part of the record. You will each be 
recognized for a 5-minute summary of your testimony.
    First of all, we have Mr. Larry Leibowitz, chief operating 
officer, NYSE Euronext.
    Mr. Leibowitz?

  STATEMENT OF LARRY LEIBOWITZ, CHIEF OPERATING OFFICER, NYSE 
                            EURONEXT

    Mr. Leibowitz. Good afternoon. Chairman Kanjorski, Ranking 
Member Garrett, and members of the subcommittee, my name is 
Larry Leibowitz. I am the chief operating officer of NYSE 
Euronext. Thank you for the opportunity to be here today.
    We commend the subcommittee for your rapid response to the 
events of last Thursday. As you know, we have begun a dialogue 
with our regulators and our other trading venues, and it has 
been very productive. We are committed to working with you and 
other market participants to restore confidence and enhance 
investor safeguards in the future.
    Today, I would like to discuss three things: first, the 
high-level causes of the events last Thursday; second, 
clarifications about NYSE's market model and how it worked; and 
third, our recommendations going forward.
    It is understandable that everyone is looking for a smoking 
gun behind last Thursday's dip. However, the circumstances are 
more complicated than that. I will leave it to the regulators 
we just heard from to link the interactions of various markets, 
but from our standpoint, we see no evidence of the ``fat 
finger'' error or market manipulation. But we also note that 
more and more our markets within the United States, and indeed 
within the world, are intertwined.
    However, we do see the following: elevated market activity 
coming from adverse European news, including a huge and a 
broadly-based wave of orders and quotes at around 2:30 p.m.; a 
significant reduction in market liquidity as measured by the 
size of order books through the day which accelerated 
dramatically through the downturn; and various microstructure 
issues that resulted in certain marketplaces not interacting 
with one another which exacerbated the liquidity effect.
    The NYSE has embraced electronic trading, and we believe 
our market model provides the best combination of cutting-edge 
technology with human judgment. The NYSE hybrid market rules 
expressly provide mechanisms to mitigate volatility and large 
price swings, which we always have believed is a critical piece 
of our offering to listed companies and their investors.
    Specifically, the NYSE incorporates in our trading 
structure a type of circuit breaker mechanism known as 
liquidity replenishment points, or LRPs, which temporarily and 
automatically pause trading in stocks when significant price 
movement occurs. On a typical day, LRPs are triggered 100 to 
200 times, lasting for seconds at most, and, during the recent 
financial crisis, served the market well.
    Let me be clear: The LRP mechanism does not halt trading. 
Instead, for a short time, trading is automatically paused to 
facilitate more accurate price discovery and prevent the market 
from a sudden and significant move. During this pause, our 
quote is visible to other market participants and new orders 
are accepted. To jump on Chairman Gensler's analogy, our LRPs 
are analogous to taking the controls of a plane off autopilot 
during turbulence.
    I want to highlight a few specifics and clarify some 
anecdotal statements that have been made. This is not meant as 
a comment on other markets or other market models, just to 
clarify from the NYSE standpoint what we saw.
    During the 2:30 to 3:00 period, market share on NYSE was 5 
percentage points higher than usual during that time of day. 
Participation rate of our designated market-makers, formally 
known as specialists, was equally strong. This was evidence 
that our liquidity providers did not walk away from the market 
as we actively traded during the downturn. Furthermore, to 
demonstrate that LRPs protected orders in our market, stocks 
listed on other markets had price declines and erroneous 
executions far greater than on NYSE-listed stocks.
    Lastly, the overall marketplace needed to cancel 
approximately 15,000 executions after Thursday's decline. On 
NYSE, even though we handled the largest share of orders in the 
marketplace, we had to cancel zero trades because of the 
protective measures in our market.
    One note: LRPs are not intended to prevent the market from 
falling. Rather, our LRPs are designed to protect the integrity 
of our market by preventing a panic-led downdraft and 
mitigating systemic risk. Yet when we are in a slow mode, other 
electronic markets may choose to ignore our quotes as permitted 
under regulation NMS.
    The bottom line is that while there is always room to 
improve LRPs and other such mechanisms, these actually worked 
reasonably well on Thursday. However, the mechanism is only 
truly effective if observed by other trading venues, and that 
is why Chairman Schapiro's plan for an industry-wide trading 
circuit breaker is needed.
    In terms of recommendations, I want to focus on three main 
topics, echoing much of what Chairman Schapiro stated earlier.
    First, our markets need a preestablished and coordinated 
way to respond to extreme rapid volatility. The LRP system has 
worked, but marketwide circuit breakers are necessary and will 
be even more effective. The listing and trading venues have 
agreed to develop these stock-level circuit breakers to pause 
trading when the price of a security has changed dramatically 
in a short period. Once circuit breakers have been triggered in 
a security, they will apply to all trading in the security, 
wherever it takes place.
    Second, the current marketwide circuit breakers were 
established long ago and are based on market moves of 10 
percent, 20 percent, and 30 percent. There has not been a move 
greater than 10 percent in a single day post-2000. These levels 
will be tightened and the circuit breaker will be based on a 
broader index, rather than a narrow Dow Jones index.
    Third, the rules on cancellation of trades will be further 
defined. On May 6th, it was announced, after markets closed, 
that any trades executed at 60 percent above or below the last 
price at 2:40 would be canceled. This action was not 
predictable and caused confusion in the markets. We are working 
with regulators and other exchanges to establish clear 
cancellation rules for the future, though circuit breakers will 
help mitigate this problem substantially.
    To facilitate a review of extraordinary trading events, 
there should be a consolidated audit trail that will allow 
regulators to easily review marketwide trade data. We 
understand the SEC is developing such a proposal and we are 
committed to assisting in that effort.
    Ultimately, these and other important actions may best be 
achieved by consolidating market surveillance in one securities 
regulator, probably FINRA, which will require an act of 
Congress. We also at the same time need to ensure that both 
FINRA and the SEC have the full funding required to perform 
these duties.
    Finally, the SEC should continue its broad-based market 
review to help find ways to improve our current market 
structure.
    In closing, we applaud the SEC and the CFTC for working 
together to review the events of May 6th and to develop a 
coordinated response. We at NYSE Euronext are committed to 
maintaining our ongoing productive dialogue with these agencies 
and other trading venues.
    Once again, thank you for the opportunity to appear, and 
later on I will be happy to answer any questions you may have.
    [The prepared statement of Mr. Leibowitz can be found on 
page 95 of the appendix.]
    Chairman Kanjorski. Thank you, Mr. Leibowitz.
    Now, we will hear from Mr. Eric Noll, executive vice 
president, NASDAQ Transaction Services.

 STATEMENT OF ERIC NOLL, EXECUTIVE VICE PRESIDENT, NASDAQ OMX 
                          GROUP, INC.

    Mr. Noll. Good afternoon, Chairman Kanjorski, Ranking 
Member Garrett, and members of the subcommittee. Thank you for 
letting me speak to you today.
    We met yesterday, along with our fellow exchanges, with 
Chairman Schapiro to develop a strategy to combat market 
instability and protect investors in the wake of last Thursday. 
We will act jointly to assess and implement changes to enhance 
the market's ability to handle unusual trading events in the 
future.
    Our markets are strong despite the 17 minutes of unusual 
trading that occurred on May 6th. In fact, the market's rapid 
recovery during the day confirms their resilience under 
extraordinary strength.
    To fully understand May 6th, you have to look at the state 
of the markets heading into last week. Markets were nervous and 
operating during an unusually long upward trend. From a market 
low of below 1300 March 2009, the NASDAQ composite index had 
risen steadily to 2535 on April 26, 2010.
    Chairman Kanjorski. Mr. Noll, could you see if your 
microphone is on or whether it is close enough to you?
    Mr. Noll. Sorry.
    Markets were also becoming increasingly volatile, according 
to the CBOE Volatility Index, which measures volatility of the 
S&P 500 expected over the next 30 days. Note that the VIX is 
normally below 20, and by May 5th, the VIX reached the upper 
20's, and on May 6th and 7th, it closed above 30, and it did in 
fact trade above 40 on several occasions during that period of 
time.
    This increased volatility is tied to the escalating 
financial crisis in Greece and Europe. While percolating for 
several months, the potential harm seemed to sink into the U.S. 
markets last week.
    Against this backdrop, we arrive at the afternoon of May 
6th. First, the Dow Jones Industrial Average was already 
trading off 272 points for the day and 500 points in the last 3 
days. Second, the Chicago Mercantile Exchange was beginning to 
experience unusual trading activity in the E-Mini Junes at the 
same time as equities handled heavy trading in the highly 
correlated equities to that E-Mini future.
    E-Mini volumes rose and prices began sinking rapidly at 
2:42, just before equity prices sank rapidly as well. At 
2:45:30, the E-Mini trading became so volatile that the CME 
triggered an automatic 5-second trading pause in the E-Mini 
futures. The price of the E-Mini future immediately leveled off 
and began to climb rapidly. Equities followed shortly 
thereafter.
    Third, the NYSE Arc Exchange began experiencing data 
communication issues that hindered the electronic linkages 
between it and other exchanges. Simultaneously, the New York 
Stock Exchange began reporting multiple liquidity replenishment 
points, or LRPs, and gap quotes that impacted the trading of 
individual stocks in the New York exchange market.
    From 2:39 to 2:47, the Dow dropped 723 points to 9800.69, 
its low for the day, and down 995 points total from the prior 
close. From 2:47 to 2:56, the Dow recovered just as rapidly, 
rising 612 points, from 9862 to 9974, down 387 points for the 
day. From 2:56 to the close, the Dow rose another 45 points, 
ending the day down 324 points.
    NASDAQ's preliminary analysis indicates the unusual trading 
activity on May 6th was triggered by a confluence of unusual 
events, including events outside the cash equities markets. 
NASDAQ continues to investigate Thursday's events, but at 
present has located no smoking gun that single-handedly caused 
or explained Thursday's events.
    From a systems standpoint, NASDAQ's market operated 
continuously during the day and the critical 17 minutes. Each 
and every one of NASDAQ's electronic systems functioned as 
designed and as intended: our execution engine, our market data 
feeds, and our surveillance systems.
    We have detected no system malfunction or errant trade by a 
NASDAQ member interacting with the NASDAQ stock market. No 
NASDAQ member has identified a system error or aberration 
within their own systems.
    As stated, NASDAQ supports the response of the SEC. We 
support the recommendation to update market circuit breakers. 
We think a circuit breaker should automatically halt trading in 
all stocks and in all markets in measured stages. We would 
expect that Chairman Schapiro, based on her testimony, will 
have some announcements about what those finally will look like 
in the very near future.
    We also support the Commission's desire to explore cross-
market single-stock trading halts. The important 
characteristics of such a halt should be consistency across all 
the markets, initiation by the primary market, and an orderly 
resumption of trading by the primary market. Any rule should 
recognize that stocks trade in different ways rather than a 
one-size-fits-all approach.
    We do believe, however, that trading halts and other 
regulator actions should never be a tool used by a primary 
market or any other other marketplace for any competitive 
reason or to disadvantage any other national market system 
participant.
    Finally, we are exploring other ideas that will improve and 
encourage high-quality and continuous quoting on all markets.
    Thank you again for the opportunity to share our views. I 
am happy to respond to any questions you may have.
    [The prepared statement of Mr. Noll can be found on page 
106 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Noll.
    Now, I recognize the gentlelady from Illinois, Mrs. 
Biggert, to introduce our next witness.
    Mrs. Biggert. Thank you, Mr. Chairman. I would like to 
welcome my constituent, Mr. Terrence Duffy, and thank him for 
joining us today. Mr. Duffy is the executive chairman of the 
CME Group, and I thank him for joining us and sharing his 
expertise.

 STATEMENT OF TERRENCE A. DUFFY, EXECUTIVE CHAIRMAN, CME GROUP 
                              INC.

    Mr. Duffy. Thank you, Congresswoman Biggert. Chairman 
Kanjorski, Ranking Member Garrett, and members of the 
subcommittee, I am Terry Duffy, executive chairman of the CME 
Group, and I want to thank you for allowing me to testify 
today.
    It is widely known that futures markets are the leading 
indicators for cash markets. Our reviews of the market's 
activity revealed no suspicious or erroneous activity by our 
customers. The exchange did not bust or reprice any 
transactions. Further, our analysis indicates that the decline 
in the SPDR ETFs and 3M stock preceded the drop in the S&P 500 
contract. As I will show you in a moment, they were far more 
severe, even after substantial price recovery in the S&P 500 
futures contract. Liquidity in the S&P futures and its 
effective spreads were considerably better than the SPDR ETFs 
throughout the day on Thursday.
    At this point, it is premature to draw any definitive 
conclusions as to what caused the extreme market volatility on 
May 6th. What we do know is that there were a number of 
macroeconomic conditions, as well as lack of operational 
harmonization across the multiple trading venues of the equity 
markets. This resulted in the cancellation or busting of 
securities transactions by the NASDAQ stock market and NYSE 
Arca. In contrast, CME Group's E-Mini S&P 500 futures contract 
performed smoothly despite significant market activity and 
volatility.
    The selloff and subsequent rebound in the E-Mini S&P 500 
Index futures, while dramatic, was very orderly. Our markets 
provided the liquidity investors needed to hedge against the 
turmoil happening elsewhere.
    As I mentioned earlier, CME Group's E-Mini S&P 500 is a 
leading indicator, not a cause, of the decline in the 
underlying primary market. Futures contracts, by design, 
provide an indication of the market's view of the value of the 
underlying stock index. This makes index futures a valuable 
risk-management tool for market participants.
    To illustrate this point, I would like to draw your 
attention to these charts. When looking at this information, it 
is important to note there is a difference between futures and 
cash reporting. Cash index values are only updated every 15 
seconds, while futures prices are updated on a real-time basis. 
This means the futures market reflects conditions in real time, 
while the cash market has a 15-second delay.
    The first chart shows the comparative value of the E-Mini 
traded on the futures market versus the equities markets. It 
illustrates that the E-Mini S&P, which is the blue line, moved 
virtually in tandem with the SPDR ETF market as well as the S&P 
500 Index, which is the red line.
    You can see at 13:46 p.m., the market had had time to 
attract liquidity and rebalance, and the E-Mini led the 
recovery, leading the Dow Jones to recover 400 points in 3 
minutes.
    Moving to chart 2, this graph shows price movement in the 
E-Mini S&P futures as well as 3M stock. As you can see, the 
price of 3M stock declined much more rapidly, starting at 13:45 
while the E-Mini S&P 500 was hitting a low at 13:45 and 50 
seconds, at which time you can see the market and the E-Mini 
reverses, while the 3M stock continues to decline.
    Market integrity is of the utmost importance to CME Group. 
We have developed systems that maintain integrity in all our 
markets, including a number of controls to protect market 
users.
    For example, CME is the only exchange in the world that 
requires pre-execution credit controls. As Chairman Gensler 
mentioned, CME Globex maintains functionality that causes the 
match engine to pause when orders, if they were executed, would 
exceed predetermined levels. Following the 5-second pause, new 
orders would come into the market. This is a critical point.
    We believe this functionality and these protocols do not 
exist in the cash market. If they did, it would have been 
highly effective in eliminating price dislocations in 3M and 
Procter & Gamble. Furthermore, CME Globex electronic trading 
infrastructure incorporates numerous risk protection tools. 
They provide added safeguards to customers and clearing firms, 
including stop price logic functionality, price banding and 
circuit breakers.
    As I mentioned earlier, stop price logic functionality 
helps to mitigate market spikes that can occur because of the 
continuous triggering or the election of trading of stop 
orders. This is what happened last week with the E-Mini and S&P 
futures, allowing liquidity to come into the market and 
ultimately leading to the rally in the equities market.
    We believe the focus of your review should be on the 
national market system. We support Chairman Schapiro's 
recommendation regarding harmonization across these platforms. 
We have seen no evidence that high-frequency or other specific 
trading practices in any way magnified the decline on May 6th. 
In fact, we believe that high-frequency traders in our market 
provided liquidity on both sides of the market on this 
extraordinary day.
    We do, however, recognize that changes should be considered 
to avoid a repeat of the events of May 6th. We would make the 
following recommendations.
    As Chairman Schapiro pointed out, circuit breakers, 
including circuit breakers for individual stocks, such as those 
implemented by the NYSE, must be harmonized across markets.
    We also believe that stop logic functionality should be 
adopted across markets on a product-by-product basis to prevent 
cascading downward market movements. The circuit breaker levels 
of 10, 20, and 30 percent and the duration of the halt and time 
of day at which triggers are applicable should be reevaluated 
in light of current market conditions to determine whether any 
changes are warranted. Any such changes must be implemented 
across all market venues.
    I thank the committee for the opportunity to share CME's 
views, and I look forward to answering your questions.
    [The prepared statement of Mr. Duffy can be found on page 
70 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Duffy.
    Now, we will move on to questions. I will take my question 
period first.
    Mr. Noll and Mr. Leibowitz, listening to your testimony, I 
am not sure anything happened on Thursday. Everything worked. 
Is that correct?
    Mr. Leibowitz. Oh, I don't think any of us would say that 
everything worked. I think, in fact, what Mr. Noll was saying 
was his systems worked. But I think we would all agree that the 
market did not.
    Chairman Kanjorski. What caused the market not to work?
    Mr. Leibowitz. I think what both of us have found is 
liquidity fled the market through the day as the market was 
skittish, and then an overwhelming wave of orders came in on 
the sell side that built on itself. I think having a marketwide 
circuit breaker in effect would have helped mitigate that 
problem. But in effect, the market was illiquid just at the 
wrong time as sellers broke into the market.
    Eric?
    Mr. Noll. Thank you, Larry.
    Mr. Chairman, I think there are two things to observe that 
happened. I would agree with Mr. Leibowitz that in fact the 
markets did not behave normally on that day. I think my point 
was really our technology behaved as it was designed to behave 
that day.
    I think it is important to observe two things. One is that 
the marketwide circuit breakers we do in fact have in place 
today were not triggered, because the market did not fall to 
the point where they were triggered and therefore cause a 
marketwide halt. So I think Chairman Schapiro is correct when 
she says that we should in fact revisit those and reinstitute 
different types of marketwide circuit breakers that will arrest 
those marketwide halts as they happen.
    I think the other point that she made vividly today, which 
we certainly agree with at NASDAQ, is that we do need a 
coordinated stock-by-stock circuit breaker across all the 
markets, which we don't currently have on our books and we 
don't have the authority to implement. So I think we will see 
that soon coming out of the SEC.
    Chairman Kanjorski. There was no problem on your part on 
either of the two exchanges with the fact that the New York 
exchange did a slowdown operation, but NASDAQ continued going 
right on and allowed the sales to pass through to the NASDAQ 
exchange. That had no effect; is that correct?
    Mr. Noll. I think we would say that was a contributing 
cause to a confluence of events here. It points to what we 
would argue, the need for a coordinated stock-by-stock circuit 
breaker.
    Mr. Leibowitz. From our standpoint, I think what we have 
shown or what we see is we don't think the fact we were moving 
slowly exacerbated the effect. In fact, the fact that we were 
trading high-market share, keeping the stock prices in line, 
might actually have helped, and the fact that other markets 
that didn't have circuit breakers at all, like the NASDAQ 
listed market, had even more damage than in the New York listed 
market. But I think we can all agree that having uniform 
marketwide circuit breakers would have helped in all events.
    Chairman Kanjorski. I have a question there. Everybody 
wants to protect the private market and have the market 
function. But is this the first time you have made that 
observation, either of the two major markets, that one set of 
rules was in place in the New York Stock Exchange and another 
set of rules in NASDAQ, and that you were not coordinated to 
operate in tandem together, so that this could happen--or you 
did not realize this could happen?
    Mr. Noll. I think what is fair, Mr. Chairman, is our 
markets are very coordinated in many ways. We have very similar 
corporate governance standards for our listed companies. As an 
example, not having to do specifically with trading, but for 
marketwide declines, overall market circuit breakers, we are 
coordinated. We have open ``meet me'' lines that we use 
frequently during trading problems and technology problems.
    Chairman Kanjorski. Mr. Noll, do not give me everything you 
are coordinated on. We do not want to know that. We want to 
know why this abnegation occurred.
    Mr. Noll. I am suggesting that we speak often about many 
issues. The one issue that had never appeared yet as a 
significant problem between our two markets is the coordination 
of a stock-by-stock circuit breaker.
    Chairman Kanjorski. What you are saying is because it never 
occurred, you did not simulate the possibility that it could 
occur, and you did not cooperate together to put in place 
common rules that would have prevented it from occurring; is 
that correct?
    What I am trying to drive at here is obviously two free-
market operations relying on either the United States Congress 
or the regulators to take care of the problem rather than doing 
it yourselves.
    Mr. Leibowitz. So as permitted by SEC regulations, we do 
have different trading models. We rely on designated market-
makers who have an obligation to the market. They have a 
different type of trading markets. So there are various areas 
where our rules are slightly different.
    We have seen times during the crisis in the fourth quarter 
of 2008 where there was significant breakage of trades in the 
electronics markets, erroneous trades, that there were not in 
the NYSE-traded market. At the time, no one felt that the 
separate rules exacerbated the problem. It is just there were 
more breaks in the electronic markets. There were tens of 
thousands of trades taken off the tape in the fourth quarter of 
2008.
    Chairman Kanjorski. My time has expired. The gentleman from 
New Jersey, Mr. Garrett.
    Mr. Garrett. And as is often the case, I will follow up 
where the chairman was perhaps going on that.
    So is this something, from what you are saying, is this a 
situation then, thinking back if you had this hearing awhile 
ago, that we just could not have seen coming?
    Mr. Noll. I think it is hard to say that we could have seen 
this coming. So we have a set of rules in place called Regena 
MES which governs the respect of different markets, and when 
they are quoting and when they are not quoting, and a whole set 
of procedures around that, that we believe have worked very 
well up until to this point. I do believe they continue to work 
very well. As a matter of fact, Mr. Leibowitz operates an 
electronic market on NYSE Arca well that participates in Regena 
MES as well as the New York floor. They were engaged in the 
same electronic trading we were on Thursday and participating 
with us. So generally I think that rule set works 
extraordinarily well.
    We did hit a confluence of events where clearly we need to 
do something to address--and I think what Chairman Schapiro 
suggests, which we agree with fully, is that we need that 
coordinated stock-by-stock circuit breaker.
    Mr. Garrett. And just to go down that road a little bit, 
Mr. Leibowitz, maybe you were touching on it, if I was hearing 
you as you were saying it, as far as those issues that are out 
there, the confluence of issues, was one of those issues that 
were in the confluence what was going on over in Europe and the 
fact of the whole Greek situation?
    And, Mr. Noll, I think you said the United States was 
finally paying attention to that. Was part of that the fact 
that the value of the Euro currency was going down, other 
foreign currencies in relationship were going up, and the banks 
were having a difficult time with their carry trade in that 
respect, and so in order to deal with that, they had to do 
something, which I guess is to unload equities? Was that an 
element of what was coming out of Europe at that period of 
time?
    Mr. Leibowitz. I don't think we have any visibility into 
that, and we haven't heard that. I think we are really focusing 
on our market and leaving the SEC and CFTC to see the cross-
market effects.
    Mr. Garrett. Does anybody else have a thought on that, as 
far as what the influence of that, as being one of the 
confluences of their impact to their trades as well?
    Mr. Noll. We have seen no evidence of that, and as Larry 
said, we are very focused on what happened in our individual 
markets.
    Mr. Garrett. To the extent you are focused on what is 
happening in individual markets, the chairman was saying before 
that here, 4 days later, we are still trying to get all the 
data collected from all the 40 or 50, however many there are 
right now, data sources. There is no central repository for all 
those trades, and that is why she is going out to get them, as 
she is, I guess. Is that a problem? Is that something that we 
should have seen in the past and tried to address?
    Mr. Noll. I think the chairman and I think other people in 
the marketplace have recognized that was a potential problem 
before. As a matter of fact, there have been ongoing 
discussions with FINRA and the SEC and all the markets about a 
consolidated audit trail that predates the May 6th event. It is 
unfortunate that we have not gotten to that point so far in the 
marketplace.
    Mr. Garrett. Is there something that holds that up? Is 
there somebody opposed to that?
    Mr. Noll. As far as I know, no one is opposed to that. I 
think it is a matter of applying the process and getting it 
done.
    Mr. Garrett. Who is responsible for that?
    Mr. Noll. Again, it is a marketwide issue among multiple 
regulators. I think there may even be, I am not absolutely 
positive about this, but I think there may be some 
congressional authority needed for the SEC in order to do so.
    Mr. Garrett. To do something like that. To the point as far 
as what authority the SEC has now and what they may need in the 
future, one of the points has already been addressed, and you 
raised this to some extent as far as the commonality of the 
market callers that potentially bid on there.
    Is there a difference as far as the folks who are at the 
table right now, the major participants in it, and some of the 
smaller alternative platforms, as far as whether this should be 
uniform across them all? And if the answer is no, why shouldn't 
it be? And if the answer is yes, would that impact upon the 
slightly different models that some of the smaller market 
participants would have?
    Mr. Leibowitz. The answer is there should be one standard 
across all platforms, whether it is an exchange, an ETS, an 
ECN, any different venue. And there will be.
    Mr. Garrett. And if we didn't have any of them here, but if 
they were sitting here, what would their argument be why that 
should be the case?
    Mr. Noll. I don't believe anyone would argue against a 
stock-by-stock circuit breaker at this point.
    Mr. Leibowitz. I think you have already seen CESMA and 
various other bodies come out in favor of it. I think that the 
industry at this point would line up 100 percent behind it.
    Mr. Garrett. Okay. And what about the time to implement 
these changes? As you said, a lot this has been looked at for a 
long period of time. Regulation NMS took a long time in order 
to implement. We are talking here about implementing this like 
this quickly. Is there a problem if we move too quickly at this 
point in time, or is this just the right thing to do?
    Mr. Noll. I think on the marketwide circuit breaker issue, 
I think we can move very quickly on that. I think the chairman 
will be discussing with us making rule filings, adopting new 
marketwide circuit breakers, relatively shortly, and then we 
will process those and put them in place very efficaciously.
    I think as we deal with some of the stock-by-stock issues, 
we may run across some technology issues with that--
    Mr. Garrett. What issues? I am sorry.
    Mr. Noll. There may be some technological issues putting 
them in place, but I think those are short-dated, not long-
dated.
    Mr. Garrett. Thank you. I thank the Chair. Thank you to the 
witnesses.
    Chairman Kanjorski. Thank you very much, Mr. Garrett.
    The gentleman from California, Mr. Sherman.
    Mr. Sherman. Thank you.
    We are talking here about how to make high-frequency 
trading safer. The question is, does it fulfill any social 
utility at all? In the old days, somebody would want to sell a 
stock for $10 and somebody else might want to buy it for 
$10.05. I remember when there was an 18th of a point. 
Somewhere, there was a settlement in between, and maybe--or the 
other of those two real investors got a slightly better deal. 
Now there is somebody with a fast computer who can come in and 
scoop up that 5 cents to make sure that neither of the real 
investors benefits from it.
    I realize Wall Street makes a lot of money from all this 
high-frequency trading, but the question is: Does it help 
provide liquidity or in some other way allocate capital? Now, 
the events of last week seem to indicate that high-frequency 
trading doesn't provide liquidity, it uses up liquidity, 
demands liquidity, and in fact, there was no liquidity for a 
few minutes.
    I will start with Mr. Leibowitz. If we didn't have high-
frequency trading, would this hurt the companies that are doing 
business and their employees?
    Mr. Leibowitz. Sure, though I am going to stay away from 
whether there is any social value to this. What I will say is, 
the market-makers have existed for hundreds of years, so it is 
not correct to say that in the past if somebody sold at $10 and 
they wanted to buy at $10.05, they matched up. The difference 
is they were physical people, whether sitting on the floor of 
the stock or market-makers at NASDAQ. But there has always been 
a middleman in trading, and what they do is they match up 
buyers and sellers. Sometimes they play a role, sometimes they 
actually don't, they just match them together. And sometimes 
when somebody wants to sell, the buyer doesn't happen to be 
there. So they are matching different time horizons on the buy 
and the sell.
    I think as technology caused trading to speed up, people 
were unable to keep up with that in a market-making capacity. 
That is why the specialists have been replaced by what we call 
``designated market-makers,'' who in effect are high-frequency 
traders, but they have obligations into our market. They have 
to have a quoting requirement. They have to provide a certain 
amount of liquidity. They are not allowed to take more than a 
certain amount of liquidity from the market. So they are high-
frequency traders that operate in a very structured 
environment.
    Mr. Sherman. What percentage of the high-frequency trading 
is done by these--I will use the old term, ``market-makers?''
    Mr. Leibowitz. I would say first, in the case of DMMs, they 
provide 10 percent of the liquidity to the New York Stock 
Exchange market. There is another form of market-maker that we 
have also in that variety that is another 10 percent. I would 
say on the broader market--
    Mr. Sherman. If I can interrupt, because I only have 5 
minutes, I am not asking what percentage of liquidity is 
provided by these individuals, I am asking what percent of the 
high-frequency trading.
    It has been reported that two-thirds of the trades in the 
United States are these high-frequency traders; you are 
describing what would seem to be just a very small percentage 
of the high-frequency traders.
    Mr. Leibowitz. I would estimate that about 40 to 45 percent 
of the market is high-frequency market-makers of some form, 
either DMMs, SOPs or other things. The balance of what you make 
into that two-thirds is really algorithmic trading. That could 
be a big mutual fund deciding to sell 10 million shares in an 
electronic form that is implemented in a series of small trades 
that looks like a high-frequency trade.
    So you have to be really careful, and that is why we 
heartily endorse Chairman Schapiro's large trader reporting 
scheme where we can get some transparency into what these high-
frequency trades are doing.
    Mr. Sherman. Most of us, when we think in terms of high-
frequency trading, are looking at those buying and selling the 
same stock within a short window, not somebody who is selling 
it and selling it and selling it; which, as you say, could be 
an investor deciding to unload a stock or a portion of it.
    Mr. Noll, do you have a comment on this?
    Mr. Noll. Yes. I think when you look at--notwithstanding 
last Thursday's events, I think if you look at the quality of 
our markets over the last number of years, I think you would 
see an increasing tightening of the bid-offer spread and an 
increasing provision of liquidity at those tighter spreads.
    So I think our concern would be as we look at this issue--
and we agree with Mr. Leibowitz and Chairman Schapiro that we 
do really have to study what high-frequency traders are doing 
and how they are operating in the marketplace--I think the 
prima facie evidence is, however, that they provide a real 
value in the sense they provide deep markets, they provide 
tighter bid-offer spreads, they have reduced costs for all 
market participants to access the markets.
    I do think, however, that we need to also look at how they 
interact in the market on an ongoing basis. I think they have 
to provide real liquidity.
    Mr. Sherman. Obviously, last week they were the cause of 
the absence of liquidity. But I believe my time has expired. 
You can respond further for the record.
    Mr. Noll. I would say that we are not sure that is in fact 
the case. I think it is an overstatement to say that we know it 
was high-frequency traders. I think that is an issue that we 
are continuing to look at at this point. It appears to have 
been a very broad market selloff with many market participants, 
not just high-frequency traders involved in that.
    Chairman Kanjorski. The gentleman from Alabama, Mr. Bachus.
    Mr. Bachus. I know history teaches us there have been some 
pretty dramatic falls in the market before we even had 
electronic trading, so I don't think the culprit is high-
frequency trading. I guess that is part of the debate.
    One thing I think we can never prevent is negative market 
developments or economic developments from affecting the 
market, so I am just trying to think of--you have shifts in 
sentiment, so that is going to move the market and cause 
changes in volatility. So what you really want is the market to 
reflect all those things and to do it, I guess, as efficiently 
as possible.
    I am very encouraged by what I hear today and what happened 
yesterday, in that I think that there has been, maybe as a 
result of last Thursday, and the concern that I think everyone 
had before, is that we are coming into an agreement that there 
ought to be some sort of marketwide circuit breakers. Is that 
right? Do you all agree on that?
    Mr. Leibowitz. Absolutely.
    Mr. Noll. Absolutely.
    Mr. Bachus. And coordinated maybe stock-by-stock circuit 
breakers?
    Mr. Noll. We all agree with that.
    Mr. Bachus. Mr. Duffy, do you agree with that?
    Mr. Duffy. Yes. We agree with that and we see no issue with 
that. But, again, this is not pertaining to the CME Group. We 
don't trade individual stocks.
    Mr. Bachus. Okay. I guess if you trade an option or you 
trade an ETF or something, you trade options, do you trade 
those?
    Mr. Duffy. The CME Group, no. We trade futures. We trade 
options on futures. We don't trade the SPDR.
    Mr. Bachus. All right. Let me ask all of you, we have kind 
of gone from a highly structured duopoly, at least with stock 
trading, to a much more fragmented system. How would you advise 
the regulators to meet the challenges of addressing marked 
integrity and price discovery without hurting competition?
    Mr. Duffy. I will be happy to start, even though I think 
this is more your bailiwick, but I will jump in.
    I do think that you need to have the same set of standards 
and protocols across the multiple markets, and I think it is as 
simple as that. You can't have one set of rules at the NYSE and 
at NASDAQ, and then you have different sets of rules at BATS 
and other ECNs. It is not going to work. It is a recipe for 
disaster. No one has been able to explain how Accenture went 
from $41 to a penny yet, and that to me is just amazing, how 
you can't explain that. I think you have to have the same 
protocol across these marketplaces.
    Mr. Bachus. All right. Mr. Leibowitz or Mr. Noll?
    Mr. Leibowitz. Sure. I think that it is clear that the 
complexity of our market represents a challenge for regulators. 
There is no doubt about it. And I think that the SEC is trying 
to respond to that challenge.
    I think the concept, the release that they just issued to 
review various aspects, whether it is ATSs, whether it is Reg 
NMS, whether it is sponsored access, are all exactly well-
timed, and they just need the resources and need to be nimble 
enough to get through that.
    I think the challenge is that it is just that we are in an 
environment that is relatively complex, and small changes have 
unintended consequences. So for example, just saying, ``Let's 
ban high-frequency trading,'' I think we would be stunned with 
the consequences. I think that even small changes have very big 
effects that we may not see, and they just need to be careful, 
while at the same time moving quickly when we see a problem 
where we all agree, like marketwide circuit breakers on 
individual stocks. That is easy one. That is a no-brainer.
    Mr. Noll. I would agree with Mr. Leibowitz. And I think 
some of the things that we have talked about already indicate 
that we are moving in that direction, both on marketwide 
circuit breakers on individual stocks changing marketwide 
circuit breakers on the entire market as well as talking about 
things like the consolidated audit trail and other 
functionality that we give the SEC.
    I think this is a very complex market. I think Chairman 
Schapiro and Chairman Gensler are fully aware of how complex it 
is and have the tools and intellectual capital to deal with 
that. And we are here to assist them to do with that.
    Mr. Bachus. All right.
    Mr. Leibowitz, what you said I agree with, that the markets 
and exchanges handled volatility quite well during the 
financial crisis in 2008. They didn't react quite as well to 
the volatility last Thursday. What do you see is the 
difference?
    Mr. Leibowitz. It is interesting because we actually 
discussed this at considerable length. And I think it has to do 
with things happening at a certain point in the day. A lot of 
the news on the financial crisis came out overnight, where 
markets had a chance to absorb that news.
    This is something that happened during the day. And, as Mr. 
Noll was saying, it was almost, like, set up. The market was in 
a jittery situation. The VIX was rising. There was nervousness 
about Europe. And then there was the speculation through the 
day and the announcement of what was going on in Greece. And it 
really just happened at a bad time.
    Had that news come out overnight, my guess is we would not 
have seen nearly the sort of swing that we saw during the day.
    Mr. Bachus. All right. Thank you.
    Mr. Scott. [presiding] Let me follow up on that. Let me ask 
this question on the circuit breaker concept.
    Right now, we are in a situation where we have computers 
which are using very difficult mathematical formulas to trade 
millions of shares of stock in milliseconds. And our solution 
to this, as I hear you say, and Chairmen Schapiro and Gensler, 
is to institute stock-by-stock circuit breakers marketwide in a 
centralized way.
    I saw a movie about a couple of weeks ago, and it is a fun 
movie if you want to see it. It is called ``Eagle Eye.'' I 
don't know if you saw that movie, but if you get a chance, it 
is very interesting. It just simply points out what happens in 
concentrating and putting so much control into a computer.
    So what I want to ask each of you--because, apparently, as 
I hear your testimony, particularly the New York Stock 
Exchange, have said that you have circuit breakers. The 
complaint was that maybe that moved too slow.
    So, as we debate this issue of circuit breakers, I want 
each of you to tell us, are there any downsides? Is there 
anything we have to fear here? Is there an element of freedom 
that takes out of the free enterprise system the freedom of the 
market exchange?
    Let us be very clear. Is there anything we have to fear if 
this is the solution of putting this much control in a stock-
by-stock, marketwide, one central location of a circuit 
breaker?
    Mr. Noll. If I could address that in two parts, Mr. 
Chairman. I think the issue for us is that technology, in and 
of itself, is a tool. It is a tool used by market participants 
and, I think, used very effectively by market participants. We 
view the functioning of our market and its continuous operation 
as one of the envies of the world. And, generally, with the 
exception of that 17-minute period on May 6th, it functions 
extraordinarily well.
    And I would argue, even during that period of time, our 
technology functioned well, but the market participants that 
were on our market experienced an absence of liquidity. So what 
we are really concerned about here is when our markets become 
dysfunctional.
    And I think what the chairman has proposed and what we have 
discussed as exchanges is not putting centralized control over 
the marketwide, stock-by-stock circuit breakers, but adopting 
similar rules so that we all have the same standard rule for 
when a stock gets halted.
    We each have our own technology. We will continue to 
operate our own technology separately from one another, with 
the oversight of the SEC. So I don't think that we are talking 
about a central computer that is going to control this. I think 
what we are talking about is a coordination of our rule sets 
with one another on when a marketwide, stock-by-stock halt 
should be called.
    Mr. Scott. Okay.
    Mr. Leibowitz. I think we would agree with Mr. Noll, which 
is that information is transmitted to the market faster and 
faster. When events happen, it just ripples through the market. 
It is on CNBC within seconds. And the fact that trading is 
speeding up every day means that the market reacts faster.
    I think all this is really designed to do is cause a quick 
pause to make sure that everybody understands what is happening 
and the symbols of liquidity so that we don't hit a down pocket 
like we did before.
    I think all of us are strong believers in free market. We 
compete with each other, and we compete with each other 
aggressively. And yet we can agree on certain principles like 
these circuit breakers that I think make the market far better 
for investors. Because, in the end, if we don't very a market 
that investors believe in, if they feel it is a rigged game, 
they are not going to invest their money. That is going to harm 
capital formation, retirement savings, all of these things.
    Mr. Scott. Mr. Duffy?
    Mr. Duffy. Mr. Scott, I think you asked a very interesting 
question, which is, what about technology? We continue to build 
it; will it eventually consume us, is what I think I heard your 
question to be, and what are we doing besides putting circuit 
breakers in place to make sure that events like this don't 
happen again?
    There is more to it than just circuit breakers, sir. There 
is pre-execution. There are multiple different technology 
vendors you have to go to. But then you have to really get into 
what is the most important, in my opinion; you have to have an 
experienced risk management team. You have to have a deep 
regulatory department within your institution to make certain 
that all these transactions are done legitimately and your 
technology team can work with your management team and your 
risk management parameters to make certain that these computers 
don't go out of control.
    Mr. Scott. Exactly. That is my point. I know my time is up 
here, but that is a very serious point. Because if we are going 
to coordinate this, there has to be some mechanism that 
triggers it.
    And I think that was the failure in the New York Stock 
Exchange. You have a circuit breaker there, and apparently it 
did not work because of something with the trigger. Is that 
correct?
    Mr. Leibowitz. No, that is not correct, actually.
    Mr. Scott. All right.
    Mr. Leibowitz. Our circuit breakers actually triggered 
perfectly well. The problem is that in the current U.S. market 
regulations, the other venues don't have to obey us when we are 
in a circuit breaker mode.
    Mr. Scott. I see.
    Mr. Leibowitz. So it worked perfectly well for our market 
and for any other markets that observed our circuit breaker. 
However, it clearly shows a failing in our market if another 
market doesn't have to follow that circuit breaker. So that is 
why we have agreed on marketwide circuit breakers.
    But I would agree with Mr. Duffy that this doesn't end the 
conversation. We have to continually look at ways that we can 
safeguard the market, that we can make sure the technology is 
doing what it is supposed to be doing, and that we don't, sort 
of, go down this path.
    Mr. Scott. My final point on this, and I will be finished, 
is: If we go with this circuit breaker, marketwide, stock by 
stock, from each of you very quickly, is there any downside? Is 
there anything we have to worry about if we go this way?
    Mr. Noll. I think, very quickly on that point, I think the 
only downside is the true price discovery is not being found.
    Mr. Scott. I am sorry?
    Mr. Noll. The true price discovery could be interfered 
with. So I think it is important for us, as we design these 
marketwide, stock-by-stock circuit breakers, if we do so, that 
we want to make sure that buyers and sellers are able to find 
each other in an efficient and fair fashion but that we aren't 
otherwise closing off price discovery inadvertently. Because 
the impact of that closing it off will re-effect itself when 
the stock starts to trade again, and you will have this 
cascading effect as opposed to true price discovery.
    Mr. Scott. All right. Thank you.
    Mr. Duffy. I do believe that Mr. Noll is correct, but I 
also believe that price discovery is done throughout a period 
of the trading session, not on a microsecond. So you do need to 
discover price over a period of time and let everybody 
participate. So I hear what he is saying, but at the same time 
I don't completely agree with that.
    Mr. Scott. All right.
    Mr. Leibowitz?
    Mr. Leibowitz. I think it is incumbent upon us to build 
these circuit breakers in a way that helps the market function 
properly, go through the auction process, which is what is 
supposed to happen, and give the market a chance to pause and 
establish the right price.
    I think Mr. Noll is right. If we don't do a good job of it, 
then we will be in the same place we were. But it is incumbent 
on us, as exchanges, to work together to make that process work 
properly.
    Mr. Scott. Thank you very much. My time is way past. I 
thank the rest of the committee for my indulgence.
    Ms. Biggert?
    Mrs. Biggert. Thank you, Mr. Chairman.
    Mr. Duffy, in your testimony, you talked about the stop 
price logic. You also highlight a number of risk management 
controls used at CME in addition to the circuit breaker rules.
    Specifically, could you walk us through the difference 
between the circuit breakers and the stop price logic employed 
at CME?
    Mr. Duffy. Sure. Circuit breakers, as we all know, were 
coordinated amongst the securities exchanges with the futures 
exchanges. There is a 10 percent, 20 percent, 30 percent 
circuit breaker depending on what time of day it happens. So, 
in the first half of the day, up until 1:30, it is 10 percent 
of the market. Then it goes to 20 percent, and then it goes--if 
it goes to 30 percent of the market, the market is closed all 
day.
    What the stop functionality that we have deployed at CME 
Group is, if our market goes up or down in a--roughly, if you 
used the equivalent price of the E-mini S&P contract today or 
the S&P index, it is a half of 1 percent. If it cannot find 
liquidity to fill that order in a half of 1 percent, it stops 
for 5 seconds, it allows the market to take a breath to try to 
seek liquidity. If it cannot seek liquidity in that 5-second 
period, it will then halt another 5 seconds and then try to 
seek the liquidity again. So that is the way the stop logic 
functionality works.
    And then, obviously, we have the circuit breakers in place 
also, in coordination with the--
    Mrs. Biggert. Then what happened on Thursday that 
stabilized the market activity?
    Mr. Duffy. There is no question, Congresswoman--we brought 
these charts for a purpose because they absolutely make sense. 
And you can see that the stop logic worked. The futures market 
stop logic kicked in. People had an opportunity to assemble 
liquidity. The market started to go the other direction, and we 
led that direction. So I think our functionality worked 
flawlessly.
    Mrs. Biggert. You say that this functionality is not 
available in the securities market. Is it just because they 
don't use it or--
    Mr. Duffy. To be perfectly honest with you, this is 
patented technology by CME Group. And I am certain that we 
would be happy, without a cost, to give it to the securities 
exchanges if this made the whole system better.
    Mrs. Biggert. So it can work for, really, any individual 
stocks or--
    Mr. Duffy. We do believe it could.
    Mrs. Biggert. Okay.
    I would also like to ask the other gentlemen, Mr. Noll and 
Mr. Leibowitz, would you consider using this? Do you think that 
this would be available?
    Mr. Leibowitz. I think we would consider all options. But, 
on the other hand, right now we actually have a circuit 
breaker, the functionality of which works. The problem is it is 
not marketwide.
    So the LRPs are very similar, hopefully not patent-
infringing on what the CME is doing. In terms of what we do is 
if the stock moves a certain amount in a certain amount of 
time, and that amount is gauged by how much liquidity in the 
stock and what the stock price is, it triggers a slow quote, in 
which case we take some amount of time to attract liquidity and 
unwind the slow quote. So it is very similar to what the CME 
does, except theirs is fully automated, as I understand it, 
just triggered by time. Ours involves DMM involvement to unwind 
it.
    Now, each exchange, we will figure out a way, Mr. Noll will 
figure out a way for NASDAQ, we will discuss the rules for 
implementing--but, essentially, in the end, the stock circuit 
breakers will be very similar to the stop-loss pauses that Mr. 
Duffy has explained.
    Mrs. Biggert. Except that it is not now. It didn't work on 
Thursday.
    Mr. Leibowitz. No, I disagree. They actually worked in the 
New York Stock Exchange market. The failure was that not all 
the markets were obeying them. So what we need to do is just 
implement them. Whether we implement his version, Mr. Duffy's 
version, or a slightly different version, because securities do 
trade slightly differently, we will figure that out.
    But this is really--as Mr. Noll said, it is an 
implementation from a technology standpoint, because we, as 
exchanges, and the SEC have agreed essentially on a framework 
for going forward with that.
    Mrs. Biggert. In other words, for it to work, it has to be 
implemented across all market venues?
    Mr. Leibowitz. What will most likely happen is it is a 
listing venue; so, in the case of--when I say ``listing 
stocks,'' our exchange--in the case of NASDAQ listed stocks, 
NASDAQ will implement the stop-loss trigger, and the other 
markets will have to obey it with respect to their listed 
stocks, as I understand it.
    Mrs. Biggert. Okay.
    Mr. Noll. I agree. I think that is where we will end up.
    Mrs. Biggert. Mr. Noll, I am sorry. I didn't hear you.
    Mr. Noll. I said that I think that is where we will end up, 
where the listing venue will determine when a stock should be 
halted across the markets, and all the other listing venues 
will obey that stock.
    Mrs. Biggert. How long do you think this will take to work 
that out?
    Mr. Noll. I think the rules set or at least an 
understanding of the functionality will probably take place 
over the next couple of days, where we will all agree on this 
is the outside framework in which we should operate this--the 
marketwide stock-by-stock framework in.
    The actual implementation, I think, is still subject to all 
of us revisiting our technology and revisiting how long it will 
take us to implement that.
    Mr. Leibowitz. Right. I think we are going to have answers. 
We all have this as a high-priority item. Obviously, as the New 
York Stock Exchange, we would throw out using our system and 
having everybody obey the circuit breakers that are now in 
place, but we recognize that is not amenable to most market 
participants.
    Mrs. Biggert. Okay.
    Thank you. I yield back.
    Mr. Scott. Thank you.
    Now the gentleman from Indiana, Mr. Carson.
    Mr. Carson. Thank you, Mr. Chairman.
    A question for Mr. Duffy, even though no one had answers on 
May 6th, CME took the unusual step of commenting on individual 
participation in its markets when it denied that Citigroup may 
have executed an irregular trade.
    First, how was CME able, during that frenetic day, to 
absolve Citigroup of any involvement? And, second, how do you 
reconcile CME's Citigroup statement with its policy of not 
commenting on individual market participation?
    Mr. Duffy. Congressman, that is a great question. It was a 
very difficult situation for us at the time because you have to 
realize we are working on real time, with the situation 
happening, with the rumors that somebody from Citigroup entered 
in a $16 million notional transaction in the E-mini and instead 
entered $16 billion of notional into the E-mini. We knew, 
because of the systems we have in place, that was categorically 
false.
    We could ring-fence Citibank's inventory that they did on 
CME Group on a real-time basis within moments. We traditionally 
would not ever make statements like that because of the 
situation the banks have been in. We thought it was the prudent 
thing to do on Citibank's behalf and, actually, on behalf of 
the taxpayers, since they own such a big portion of Citi. We 
thought it was the right thing to do to make the statement to 
make sure the rumor went away.
    Mr. Carson. Mr. Leibowitz, although the cause of the May 
6th volatility spike has yet to be determined, do preliminary 
investigations indicate flaws in the current regulatory 
framework? And, also, can regulatory improvements, whether at 
the SEC or the CFTC or exchange levels, prevent what 
essentially could be an extraordinary technological glitch?
    Mr. Leibowitz. I think what we have recognized is the lack 
of marketwide circuit breakers that everyone obeys on a stock-
by-stock basis is clearly a failure among our markets to work 
together properly and create the right market environment.
    I think the SEC concept review, which they are doing right 
now, will help identify other areas where we may feel that 
either regulation is lacking; maybe there is not enough 
surveillance. I think many of us believe, at this point, that 
centralized surveillance is critical in this market.
    To be honest, I feel sorry for the SEC staff who has to 
assemble from 40 different venues the amount of data they have 
done. And they have done amazing work in doing it. But we need 
to not be in this situation going forward, and I think we are 
committed and I know Mr. Noll's group is committed to working 
with the SEC to make that happen.
    Mr. Carson. Okay. And lastly, Mr. Noll, can you please give 
us a rundown of the decision-making process that resulted in 
the cancellation of almost 300 trades of stocks and exchange-
traded funds?
    Mr. Noll. Sure, I would be happy to do that.
    First of all, I think it is important to note that this was 
a multi-exchange decision. All the marketplaces participated in 
the decision to break the trades that occurred in that period 
of time between 2:40 and 3:00, so it was not one market making 
the decision on behalf of all others; it was all markets in 
consultation with one another.
    And I think we were governed by two things that influenced 
our decision-making process there. The first one was: When, in 
fact, did the markets become disorderly as opposed to orderly? 
So, if you look at some of the time in sales and some of the 
trades that occurred in that period of time, their fall, even 
though it was drastic and fast, was what we would call orderly. 
In other words, they were walking down the order books step-by-
step in the way they were supposed to happen. It was only at 
the very bottom where we started to see very anomalous prints. 
So we were very concerned about drawing the line at a level 
where we addressed the anomalous prints and not the, sort of, 
order-by-order orderly trading that was going on.
    And we were very cognizant of what I would call the moral 
hazard problem, which is that people should bear the 
consequences of their actions. We didn't know who was going to 
win or lose by drawing the line where we did, but we were sure 
that below that line, we were capturing the bulk of the 
anomalous trades, but above that line, people's behavior--they 
bear some consequence for that. And so, whether they won or 
lost during that period of time, they should bear that 
consequence for being a market participant there.
    So we were very cognizant not to reward people for bad 
behavior, but to save people from what we considered to be an 
anomalous failure of the markets at that particular time.
    Mr. Carson. Thank you, sir.
    Mr. Chairman, I yield back.
    Mr. Scott. Thank you very much.
    The gentleman from Indiana, Mr. Manzullo--I am sorry, 
Illinois. I apologize.
    Mr. Manzullo. It is close.
    Mr. Duffy, on page 1 of your testimony, you state that, 
``The most significant equity index futures contract traded on 
the CME Group exchanges is the E-mini S&P 500 futures 
contract.''
    Mr. Duffy. Yes, sir.
    Mr. Manzullo. And then, also, ``In 2009, the average daily 
volume for the E-mini S&P 500 futures contract was 2,207,596 
contracts.''
    And then you continue that theme on page 2. You discuss the 
trading data for the time period between 1:00 and 2:00 Central 
Standard Time. Your analysis of the trading activity during 
that hour indicates that the E-mini S&P futures contract was 
not the triggering event. I have heard reports that the E-mini 
S&P futures contract led the sell-off that precipitated the 
decline of the Dow.
    Can you walk us through what happened with the E-mini and 
your thoughts on what may have been the true triggering event?
    Mr. Duffy. I think we have heard a lot about different 
events in the marketplace leading up to the time coming into 
question. The volume in the E-mini was heavy. This is not 
unusual. E-mini trades about 4X or 4 times the amount of the 
SPDR contract. At that particular time, we traded about 10 
times the volume. So we saw a flight to quality, to CME Group, 
to trade our most highly liquid product.
    As I said earlier, futures contracts, by design, are 
indicators of people's potential viewpoint on what they think 
is going to happen. So they are traditionally leaders, up and 
down, in the marketplace.
    And, again, our markets operated within all the protocols 
of CME's systems. So we didn't have any ``fat-finger'' issues; 
we were confident of that. The market was moving quite rapidly. 
At the same time, there were a lot of macroeconomic events that 
were happening.
    So, yes, it was unusual activity. Nobody is going to deny 
that. It happened, and it happened quickly. But, again, we 
didn't bust trades. We looked at some of the algorithmic 
traders, as has been questioned here. They were basically more 
liquidity providers at the time in question; they were not 
aggressors or taking the market. So they were there on both 
sides, bid and offer. So they were leading the market because 
of the nature of the product, sir.
    And then, as you could see, our stop logic worked, and the 
listed stocks kept going down for whatever reason. That is 
still yet to be explained, why they went to the prices they 
did. We did not trigger, which would have been only--a stop 
circuit breaker for CME would have been the 20 percent circuit 
breaker that is instituted amongst all the exchanges, and we 
were roughly about 9.5 percent at the lowest point in the S&P 
contract, sir.
    Mr. Manzullo. Let me ask you an unrelated question because 
something obviously--maybe not obviously, but apparently 
something spooked the market. Anything to do with the problem 
in Greece or worldwide activity or inability to predict what is 
going on with regard to the euro? Do you see any connection 
there at all, or is it just a coincidence?
    Mr. Duffy. I have seen a lot of high volatility, sir, 
especially coming into that day. So all those events were on 
the front page, so I am sure they had a contributing factor to 
the market conditions that led up to the precipitous down-move.
    And, at the same time, you have to remember we saw a couple 
stocks trading at a penny that were $40 stocks. So one was 
probably wondering what was going on in the marketplace.
    Mr. Manzullo. Mr. Noll, would you like to comment on that 
last question?
    Mr. Noll. On the volatility in the marketplace at that 
time?
    Mr. Manzullo. Yes.
    Mr. Noll. Yes, I--
    Mr. Manzullo. It doesn't have to be a precise answer 
because no one knows.
    Mr. Noll. I don't think we have a precise answer yet, and I 
am not sure that we will ever get a precise answer as to the 
nature of what was the root cause of the uncertainty in the 
marketplace.
    But I do think what is very clear is that we saw an 
increasing amount of volatility on the days leading up to May 
6th. We have seen the spike in all the measurements of 
volatility. The day of May 6th itself was already a volatile 
day before the events we are talking about here happened. So it 
was already a severe down day. It was also the third day in a 
row of down equity markets.
    So I think when we hit these air pockets or this confluence 
of events, if I could call it that, we were in a position where 
there was just a massive downdraft in the marketplace, which we 
recovered from, but nonetheless I think it is important for us 
to address the causes and to prevent that from happening going 
forward.
    Mr. Manzullo. Mr. Leibowitz?
    Mr. Leibowitz. Yes, I think the two gentleman to my left 
have hit it right, which is it was a spooked market--I think 
you even used that term. The market became very illiquid and 
choppy. And it is very likely that some news out of Europe 
might have gotten people selling.
    But I think the behavior that you then saw, selling some 
stocks down to a penny, that is not permissible behavior. That 
is a market structure failure that we have it incumbent upon us 
to correct.
    On the other hand, markets are allowed to sell off in a 
reasonable way. And so, if investors were afraid of Greece and 
the euro and anything else that was going on, they should be 
selling the market off. What we are really addressing is, is it 
happening in a reasonable and orderly way? Are investors being 
disadvantaged by events transpiring on the exchange? It would 
be hard to justify to a retail investor that he sold the stock 
at a penny.
    And so, that clearly has to be addressed. The fact that 
something triggered a sell-off--if we can't find an actual 
cause, meaning a trader or--and there are so many rumors, and 
that is part of--what we live with that every day in our 
market. The rumors get transmitted so quickly that we just have 
to deal with that.
    Mr. Manzullo. Mr. Chairman, could I ask one more question?
    Mr. Scott. Yes, you may.
    Mr. Manzullo. Thank you.
    Your answers take into consideration or are obviously based 
upon the fact that there really wasn't anybody out there who 
``made a killing'' that day. Is that correct? There is no bad 
person out there or somebody that you can say, look what he or 
she or they did as a group that caused this?
    Mr. Noll. I think the investigations and looking at the 
evidence will take place over the next couple of days and weeks 
until all the determinations are made of everyone's behavior, 
whether it was good or bad or within the rules or not within 
the rules.
    As of today, on the NASDAQ systems and in the NASDAQ 
market, we have not seen anything that would suggest to us that 
anyone was behaving in an inappropriate fashion.
    Mr. Leibowitz. And I would say quite the opposite of making 
a killing, if algorithmic traders did, in fact, follow the 
market down, chances are they got hurt pretty badly, because 
the market just snapped right back and they sold way below 
where the market ended up.
    So, while retail investors and others followed it down with 
them, my guess is whoever led it down, intentionally or not, 
did not make a killing.
    Mr. Manzullo. Okay.
    Mr. Duffy. Congressman, yes, I agree with both of these 
gentlemen. I have not heard anything extraordinary. But, then 
again, it is a sensitive topic, and we will let our regulatory 
departments investigate that with due process.
    Mr. Manzullo. Thank you.
    Mr. Scott. Thank you, sir.
    Now, we will hear from the gentleman from New Jersey, Mr. 
Garrett.
    Mr. Garrett. Just with one last question. And I appreciate 
all your time here.
    You are all on board with the circuit breaker idea, and I 
have spent a lot of time on it. And, Mr. Duffy, I think you 
just mentioned with what your system, as far as the 20 
percent--
    Mr. Duffy. Our system on a circuit breaker?
    Mr. Garrett. Yes.
    Mr. Duffy. It is basically--the way that it works today, it 
goes down roughly a half a percent of what the value of the S&P 
contract is today. If it doesn't have the liquidity to fill the 
number of contracts, buy or sell, it will halt for 5 seconds, 
and then it will try to attract that liquidity. If it doesn't 
do it, it will try to halt another 5 seconds to attract that 
liquidity to fill the order in that period.
    Mr. Garrett. Okay.
    And from the other gentlemen, when you will be meeting with 
Chairman Schapiro and the rest in the next few days and what 
have you to try to come up with uniformity on these issues, is 
there a lower level that you would say this was just not a 
realistic figure?
    If you here at my opening comment, I said there were rumors 
out there saying that you are looking at bands of 2 percent or 
so that would just be too restrictive for individual stocks and 
what have you. So what is the appropriate level? That is my 
final question.
    Mr. Noll. Yes, I think we are still engaged in that effort 
of determining the appropriate level. I happen to share your 
concern that we not draw the bands too tightly.
    Mr. Garrett. And what is that?
    Mr. Noll. I think 2 percent, quite frankly, is too tight. I 
think what we saw on Thursday was the LRP functionality going 
off at 2 percent levels, which caused dislocations in the 
marketplace, perhaps unintentionally, but nonetheless caused 
dislocations in the marketplace, while other markets continued 
to provide liquidity at that level.
    So, I think as Larry has suggested earlier, we need to 
agree on what the right, appropriate levels are. I don't think 
2 percent is the right level. We tend to believe that it should 
be 10 percent. But I think that is still a moving target for 
all of us.
    Mr. Leibowitz. Yes, I would agree with Mr. Noll 100 
percent. We use for our LRPs relatively tight bands. In Procter 
& Gamble, it actually is about 2 percent. But the intention is 
to continue trading and get it going relatively quickly.
    Mr. Garrett. Right.
    Mr. Leibowitz. I think for this, we are going to use 
broader bands, because we want them to be marketwide and we 
need everyone to agree to them.
    Mr. Duffy. Congressman, if I could just make one comment, 
the 10 percent, 20 percent, and 30 percent, which the gentleman 
is referring to here, can certainly be narrowed, but I think if 
you narrow those percentages, what is more important then is to 
narrow the timeframe that the markets close, because they will 
be seeking liquidity at other venues, whether it is overseas or 
somewhere else.
    So if you narrowed a time to 5, 15, and 10--whatever you 
want to come up with, pick your favorite number, you can't be 
closed for an hour or you can't be closed all day. You narrow 
those time windows and narrow the bands, and it will work out 
for everybody.
    Mr. Leibowitz. Yes, I think that is a great point. On a 
stock-by-stock basis, we are talking about a couple of minutes 
at most. And on a marketwide basis, as we narrow the marketwide 
bands, we are really talking about moving the timeframe in for 
the close, so it is not as long a close as it was in the past.
    Mr. Garrett. Yes. That is a good point about overseas 
trades. I was going to bring that up before, but--
    Mr. Duffy. That is exactly where it will go, sir.
    Mr. Garrett. --thank you, Mr. Chairman.
    Mr. Scott. Thank you, Mr. Garrett.
    I want to thank each of you--Mr. Leibowitz, Mr. Noll, Mr. 
Duffy, and also Chairman Schapiro and Chairman Gensler--for 
your excellent, superb, and well-presented testimony today on 
this very critical issue as we move to make sure we maintain 
the strongest investor confidence in our financial markets and 
in our investor trading. Thank you again, very, very much, for 
coming before our committee and helping us with this.
    The Chair notes that some members may have additional 
questions for this panel which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 30 days for members to submit written questions to these 
witnesses and to place their responses in the record.
    Before we adjourn, the following will be made part of the 
record of this hearing: the written statement of Commissioner 
Bart Chilton, Commodities Future Trading Commission. Without 
objection, it is so ordered.
    The panel is dismissed, and this hearing is adjourned.
    [Whereupon, at 6:32 p.m., the hearing was adjourned.]






                            A P P E N D I X



                              May 11, 2010




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