[Senate Hearing 111-434]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 111-434


  DARK POOLS, FLASH ORDERS, HIGH-FREQUENCY TRADING, AND OTHER MARKET 
                            STRUCTURE ISSUES

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

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                 SECURITIES, INSURANCE, AND INVESTMENT

                                 of the

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

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                                   ON

  EXAMINING THE DARK POOLS, FLASH ORDERS, HIGH-FREQUENCY TRADING, AND 
                     OTHER MARKET STRUCTURE ISSUES

                               __________

                            OCTOBER 28, 2009

                               __________

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


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







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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman

TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         JIM BUNNING, Kentucky
EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 KAY BAILEY HUTCHISON, Texas
MARK R. WARNER, Virginia             JUDD GREGG, New Hampshire
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado

                    Edward Silverman, Staff Director

              William D. Duhnke, Republican Staff Director

                       Dawn Ratliff, Chief Clerk

                      Devin Hartley, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

         Subcommittee on Securities, Insurance, and Investment

                   JACK REED, Rhode Island, Chairman

            JIM BUNNING, Kentucky, Ranking Republican Member

TIM JOHNSON, South Dakota            JUDD GREGG, New Hampshire
CHARLES E. SCHUMER, New York         ROBERT F. BENNETT, Utah
EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              DAVID VITTER, Louisiana
SHERROD BROWN, Ohio                  MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia
MICHAEL F. BENNET, Colorado
CHRISTOPHER J. DODD, Connecticut

               Kara M. Stein, Subcommittee Staff Director

       William Henderson, Republican Subcommittee Staff Director

                      Randy Fasnacht, GAO Detailee

                                 (ii)













                            C O N T E N T S

                              ----------                              

                      WEDNESDAY, OCTOBER 28, 2009

                                                                   Page

Opening statement of Chairman Reed...............................     1
    Prepared statement...........................................    44

Opening statements, comments, or prepared statements of:
    Senator Bunning..............................................     2
        Prepared statement.......................................    44

                               WITNESSES

Edward E. Kaufman, Senator from the State of Delaware............     3
    Prepared statement...........................................    45
James Brigagliano, Coacting Director, Division of Trading and 
  Markets, Securities and Exchange Commission....................     7
    Prepared statement...........................................    57
    Responses to written questions of:
        Senator Menendez.........................................    90
        Senator Vitter...........................................    91
Frank Hatheway, Senior Vice President and Chief Economist, NASDAQ 
  OMX............................................................     8
    Prepared statement...........................................    61
William O'Brien, Chief Executive Officer, Direct Edge............    10
    Prepared statement...........................................    63
Christopher Nagy, Managing Director of Order Routing Sales and 
  Strategy, TD Ameritrade........................................    13
    Prepared statement...........................................    65
Daniel Mathisson, Managing Director and Head of Advanced 
  Execution Services, Credit Suisse..............................    14
    Prepared statement...........................................    67
Robert C. Gasser, President and Chief Executive Officer, 
  Investment Technology Group....................................    16
    Prepared statement...........................................    71
Peter Driscoll, Chairman, Security Traders Association...........    18
    Prepared statement...........................................    84
    Responses to written questions of:
        Senator Bunning..........................................    93
Adam C. Sussman, Director of Research, TABB Group................    20
    Prepared statement...........................................    88

              Additional Material Supplied for the Record

Statement submitted by Larry Leibowitz, Group Executive Vice 
  President and Head of U.S. Execution and Global Technology for 
  NYSE Euronext..................................................    94
Statement submitted by Thomas M. Joyce, Chairman and Chief 
  Executive Officer, Knight Capital Group, Inc...................   100
Statement submitted by the Investment Company Institute..........   107

                                 (iii)

 
  DARK POOLS, FLASH ORDERS, HIGH-FREQUENCY TRADING, AND OTHER MARKET 
                            STRUCTURE ISSUES

                              ----------                              


                      WEDNESDAY, OCTOBER 28, 2009

                                       U.S. Senate,
     Subcommittee on Securities, Insurance, and Investment,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 9:32 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Jack Reed (Chairman of the 
Subcommittee) presiding.

            OPENING STATEMENT OF CHAIRMAN JACK REED

    Chairman Reed. Let me call the hearing to order, and I want 
to begin by welcoming my friend and colleague, Senator Ted 
Kaufman. Ted has spent a considerable amount of time examining 
some of these cutting-edge issues facing increasingly high-tech 
capital markets. And I also want to welcome the witnesses who 
will join us for the second panel.
    As many families struggle to regain their footing, stay in 
their homes, and keep their jobs in the wake of a severe 
recession caused by reckless profit seeking on Wall Street, it 
is appropriate and timely to meet today to ask questions about 
the role of technology in our financial markets. Today's 
hearing is a check-up on our equity markets amid concerns that 
technological developments in recent years may be 
disadvantaging certain investors.
    Electronic trading has evolved dramatically over the last 
decade, and it is important that regulators keep up. For 
example, trading technology today is measured not in seconds or 
even milliseconds, but it in microseconds, or one-millionth of 
a second. So even a sneak peek of a fraction of a second using 
what is called a ``flash order'' may give some market 
participants a significant advantage.
    Our hearing will take a closer look at such flash orders, 
along with other market structure issues such as dark pools, 
which are private trading systems that do not display quotes 
publicly; and high-frequency trading, a lightning-fast 
computer-based trading technique.
    According to the SEC, the overall proportion of displayed 
market segments, those that display quotations to the public, 
has remained steady over time at approximately 75 percent of 
the market. However, undisplayed liquidity has shifted from 
taking place on the floor of the exchanges or between 
investment banks to what are currently known as ``dark pools,'' 
with the number of such pools increasing from approximately 10 
in 2002 to approximately 29 in 2009. Dark pools today account 
for about 7.2 percent of the total share of stock volume.
    Dark pools and other undisplayed forms of liquidity have 
been considered useful to investors moving large numbers of 
shares since it allows them to trade large blocks of shares of 
stock without giving others information to buy or sell ahead of 
time.
    However, some critics of dark pools argue that this has 
created a two-tiered market in which only some investors in 
dark pools, but not the general public, have information about 
the best available prices. The SEC has recently proposed 
changes in this area to bring greater transparency to these 
pools.
    Flash orders and high-frequency trading have also raised 
concerns. Flash orders, which enable investors who are not 
publicly displaying quotes to see orders before other 
investors, have raised questions about fairness in the markets, 
and the SEC has recently proposed to ban them. High-frequency 
trading, a much more common technique used extensively 
throughout the markets, is the buying and selling of stock at 
extremely fast speeds with the help of powerful computers. This 
activity has raised concerns that some market participants are 
able to game the system using repeated and lightning-fast 
orders to quickly identify other traders' positions and take 
advantage of that information, potentially disadvantaging 
retail investors.
    Other investors argue that the practice has significantly 
increased liquidity in the markets, improved price discovery, 
and reduced spreads, and that high-frequency trading is being 
used by all types of investors.
    Today's hearing will help to answer some important 
questions about these issues. Have recent developments helped 
or hurt the average investor? How have these developments 
impacted the average household's ability to save for college 
and retirement? What risks must we be vigilant about in how we 
structure and operate our markets going forward?
    I have asked today's witnesses to discuss the potential 
benefits and drawbacks of dark pools and other undisplayed 
quotes now used and historically used in our markets. I have 
also asked them to talk about flash orders and high-frequency 
trading.
    Finally, as the SEC has recently taken steps to ban flash 
orders and increase transparency in dark pools, we will hear 
perspectives on the SEC's actions and ask our panelists what 
additional legislative or regulatory changes, if any, are 
needed to protect retail investors and ensure fair markets.
    And now let me recognize the Ranking Member, Senator 
Bunning.

                STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Mr. Chairman. I think this will 
be an educational hearing about several complex topics that 
have been in the news lately.
    A lot of things have changed in the security market since I 
sat at a trading desk. Just about all trades take place over 
computers now. Trading used to be done over the phone or in 
person. There are many more stocks and other securities traded 
now, just as there are many more investors.
    But even though the technology and the amount of money 
changing hands has changed, a lot is still the same. Investors 
are still looking for the best price, and traders are still 
using every tool they can to get an edge. And there is always 
someone trying to make a quick buck off the unsophisticated or 
uninformed or even through manipulation and fraud.
    Historically, the way we have tried to make our markets 
safer and fairer is by increasing transparency and access, and 
I think that it has worked. But in order for those principles 
to continue to work, the SEC must stay on top of the changing 
markets and update its rules as necessary. I am glad to see the 
Commission is reviewing its market structure rules, and I hope 
it does not limit those reviews to just topics that have been 
covered in the news.
    I also hope the Commission will let this Committee know if 
there are any gaps in its authority that we need to fill so any 
market structure can be properly addressed.
    Thank you, Mr. Chairman. I am looking forward to hearing 
from our witnesses.
    Chairman Reed. Thank you very much, Senator Bunning.
    Senator Johanns.
    Senator Johanns. I am going to pass on an opening 
statement.
    Chairman Reed. Senator Corker.
    Senator Corker. I do not make opening statements. I would 
like the Senator to realize that Republicans are here to listen 
to him and Democrats are not, whatever that means.
    [Laughter.]
    Chairman Reed. We have heard a lot from him.
    Senator Gregg.
    Senator Gregg. [Inaudible.]
    [Laughter.]
    Chairman Reed. And now it is my privilege to introduce 
Senator Kaufman. Senator Kaufman is recognized as the chief of 
staff for Senator Joe Biden for 19 years, but he has also been 
teaching at Duke University, courses in Congress for 18 years, 
and he has been a member of the board of Broadcasting Board of 
Governors for 13 years, and he has trained as an engineer at 
the University of Pennsylvania and has an MBA from the Wharton 
School. And before he started working for the Vice President, 
he worked for DuPont, which I think brought him to Delaware, or 
kept him in Delaware. So I am very happy to have him here this 
morning.
    Senator Kaufman.

   STATEMENT OF EDWARD E. KAUFMAN, SENATOR FROM THE STATE OF 
                            DELAWARE

    Senator Kaufman. Thank you. Thank you, Chairman Reed and 
Senator Bunning, and I want to thank my Republican friends for 
showing up for my presentation.
    I want to thank you. This is a very important hearing, and 
I think both your opening statements from my standpoint were 
excellent in terms of pointing out some of the things that we 
have to deal with. And I hardly think there are many things 
that we have to deal with at a time when we are dealing with so 
many important things that are really much more important than 
what is going to happen in this Committee.
    I want to keep my remarks brief, but I have a longer 
statement I would like to submit for the record.
    Chairman Reed. Without objection, all statements will be 
made part of the record.
    Senator Kaufman. Mr. Chairman, our stock markets have 
evolved rapidly over the past few years, as Ranking Member 
Bunning said, in ways that raise important questions for this 
hearing to explore. Technological developments have far 
outpaced--far outpaced--regulatory oversight, and traders who 
buy and sell stocks in milliseconds--capitalizing everywhere on 
very small price differential in a highly fragmented 
marketplace--now predominate over value investors. Liquidity as 
an end seems to have trumped the need for transparency and 
fairness. We risk creating a two-tiered market that is opaque, 
highly fragmented, and unfair to long-term investors.
    I am very concerned that only timely and effective 
examination, such as what this Committee is going through, 
which leads to clear and enforceable rules can maintain the 
integrity of U.S. capital markets, which we all know is an 
essential component of our Nation's success.
    It was the repeal of the uptick rule by the SEC in 2007 
which first brought my attention to this issue. When I was at 
Wharton getting my MBA in the mid-1960s, the uptick rule was 
considered a cornerstone of market regulation. As many on the 
Subcommittee have noted, the uptick rule's repeal made it 
easier for bear traders, bear raider traders--no longer 
constrained to wait for an uptick in price between each short 
sale--to help bring down--this activity, I am convinced, helped 
to bring down Lehman Brothers and Bear Stearns in their final 
days.
    In April, Senators Isakson, Tester, Specter, Chambliss, and 
I introduced a bill prodding the SEC to reinstate the rule. As 
the months have gone by, I have asked myself: Why is it so 
difficult for the SEC to mandate some version of the uptick 
rule and impose ``hard locate'' requirements to stop naked 
short selling? That is not what this hearing is about today, 
but that is what got me interested. Why has it taken them so 
long to do it? And that is how I got interested in the issues 
that you are going to deal with today. It became clear to me 
that none of the high-frequency traders who now dominate the 
market, almost 70 percent of the market, want to reprogram 
their computer algorithms to wait for an uptick in price or to 
obtain a ``hard locate'' of available underlying shares. That 
means basically selling something they do not have, have not 
borrowed, and do not own. Something that is kind of basic to 
our markets, you have to own what you are selling.
    I began to hear from many on Wall Street and other experts 
concerned about a host of questionable practices, all connected 
to the decimalization and digitalization of the market and the 
resulting surge in electronic trading activity. I am not 
opposed to electronic trading, but I think we need to take a 
hard look at what is going on here. It became clear to me that 
the SEC staff was considering issues piecemeal--like the rise 
of flash orders, which was in your statements--without taking a 
holistic view of the market's overall structure, applying rules 
from a floor-based trading era--and Senator Bunning was on the 
trading floor--to the current electronic trading venues in ways 
that are clearly questionable.
    The facts speak for themselves. We have gone from an era 
dominated by a duopoly of the New York Stock Exchange and 
NASDAQ to a highly fragmented market of more than 60 trading 
centers. Dark pools, which allow confidential trading away from 
the public eye, have flourished, growing from 1.5 percent to 12 
percent of market trades in under 5 years.
    Competition for orders is intense and increasingly 
problematic. Flash orders, liquidity rebates, direct access 
granted to hedge funds by the exchanges, dark pools, 
indications of interest, and payment for order flow are each a 
consequence of these 60 centers all competing for market share.
    Moreover, in just a few short years, high-frequency 
trading--which feeds everywhere on small price differences in 
many fragmented trading venues--has skyrocketed from 30 percent 
to 70 percent of daily volume. Indeed, the chief executive of 
one of the country's biggest block traders in dark pools was 
quoted last week as saying that the amount of money devoted to 
high-frequency trading could, and I quote, ``quintuple between 
this year and next.''
    So I am pleased that the Securities and Exchange Commission 
has begun to address flash orders and dark pools.
    Let me quickly lay out three reasons why this hearing is so 
important:
    First, we must avoid systemic risk to the markets. Our 
recent history teaches us that when markets develop too 
rapidly, when they are not transparent, effectively regulated, 
or fair, a breakdown can trigger disaster.
    Second, while rapid advances in technology can produce 
impressive results, they are combined with market fragmentation 
in ways that are moving us from an investor's market to a 
trader's market.
    Third, we must ensure that retail investors are not 
relegated to second-tier status. Let me repeat that. Third, we 
must ensure that retail investors are not relegated to second-
tier status. The markets should work best for those who want to 
buy and hold in hopes of a golden retirement, not just for 
high-frequency traders who want to buy and sell in 
milliseconds.
    As SEC Chair Schapiro acknowledged just yesterday, and I 
quote, ``I believe we need a deeper understanding of the 
strategies and activities of high-frequency markets and traders 
and the potential impact on our markets and investors of so 
many transactions occurring so quickly.''
    Technology should not dictate our regulatory destiny; 
rather, our regulatory policy should provide the framework and 
guidelines under which technology operates. As values, 
transparency and fairness must always trump liquidity. Our 
foremost policy goal must be to restore the markets to their 
highest and best purposes. Serving the interests of long-term 
investors, establishing prices that allocate resources to their 
most productive uses, and enabling companies--large and small--
to raise capital to innovate, create jobs, and grow.
    Thank you, Mr. Chairman.
    Chairman Reed. Thank you, Senator Kaufman.
    Do my colleagues have any questions?
    Senator Corker. Out of courtesy, I will not ask any, but 
thank you so much for the testimony.
    [Laughter.]
    Senator Kaufman. Thank you.
    Chairman Reed. Senator Corker always says the right thing. 
He is just impeccable. Thank you, Senator Kaufman, for your 
testimony.
    Senator Kaufman. Thank you.
    Chairman Reed. I would call up the second panel.
    [Pause.]
    Chairman Reed. We appreciate your interest in this topic, 
and we thank you for being here today. All of your statements 
will be made part of the record, so there is no need to simply 
read the statement. And I ask you to keep your remarks to 5 
minutes so that we can get to questioning pretty quickly. That 
is 40 minutes this way, as Senator Bunning points out. Let me 
introduce the panelists and then ask them to begin their 
testimony.
    Our first witness is Mr. James Brigagliano, Coacting 
Director of the Division of Trading and Markets at the 
Securities and Exchange Commission. In that capacity, he shares 
responsibility for the regulation and oversight of securities 
firms, clearing organizations, and the United States securities 
markets. Prior to joining the Division of Trading and Markets, 
Mr. Brigagliano was an assistant general counsel for litigation 
in the Commission's Office of the General Counsel and began his 
career in private practice in New York. Thank you.
    Our next witness is Dr. Frank Hatheway, and he is the 
Senior Vice President and Chief Economist at NASDAQ OMX, where 
he is responsible for a variety of initiatives related to the 
company's global markets and market structure. Prior to joining 
NASDAQ OMX, Dr. Hatheway was a finance professor at Penn State 
University, and he has served as an economic fellow and senior 
research scholar with the U.S. Securities and Exchange 
Commission. Thank you.
    Mr. William O'Brien is the Chief Executive Officer of 
Direct Edge, a large U.S. stock market that currently operates 
as an electronic communications network, a type of alternative 
trading facility. Prior to joining Direct Edge, Mr. O'Brien 
held senior management positions at the NASDAQ stock market and 
Brut ECN.
    Our next witness is Mr. Christopher Nagy. He is the 
Managing Director of Order Routing Sales and Strategy at TD 
Ameritrade. As such, he is responsible for developing and 
implementing best execution and order routing strategy for the 
company. With more than 20 years in the securities industry, he 
has also worked with NASDAQ Quality of Markets Committee, QMC, 
the Securities Trade Association Trading Issues Committee, the 
Options Industry Council Roundtable, among others. Thank you, 
Mr. Nagy.
    Mr. Dan Mathisson is a Managing Director and Head of 
Advanced Execution Services at the Investment Banking Division 
of Credit Suisse. Mr. Mathisson joined Credit Suisse in 2000 as 
a Director of Index Arbitrage. Prior to that, he was the head 
of Equity Trading at D.E. Shaw, a quantitative hedge fund based 
in New York.
    Mr. Bob Gasser is the Chief Executive Officer and President 
of the Investment Technology Group. Mr. Gasser was previously 
CEO at NYFIX, Inc., a global electronic trading execution firm. 
Before NYFIX, Mr. Gasser was head of U.S. Equity Trading at 
JPMorgan. Concurrently, Mr. Gasser served on the Board of 
Directors of Archipelago Exchange as well as on the NASDAQ 
Quality of Markets Committee and the New York Stock Exchange 
Upstairs Traders Advisory Committee.
    Mr. Peter Driscoll is the Chairman of the Security Traders 
Association as well as the Chair of the Executive Committee and 
Cochair of its Washington Committee. He is also a member of the 
NASDAQ Institutional Advisory Council. Mr. Driscoll is also a 
Vice President and Senior Equity Trader at the Northern Trust 
Company in Chicago, Illinois, which he joined in 2000. Prior to 
joining Northern Trust, he worked on the floor of the Chicago 
Stock Exchange from 1975 to 2000, the last 10 years of which he 
served as the President of Driscoll Trading Group, an 
institutional floor brokerage firm.
    Our final witness is Mr. Adam Sussman, the Director of 
Research at TABB Group. Mr. Sussman joined the firm in 2004 as 
a senior analyst, serving as the senior product manager 
responsible for order management systems, routing, and next-
generation trading tools focused on the equities and options 
markets at Ameritrade, a brokerage industry subsidiary of 
Ameritrade Holding Corporation.
    Thank you, gentlemen, and now, Mr. Brigagliano, please 
begin.

STATEMENT OF JAMES BRIGAGLIANO, COACTING DIRECTOR, DIVISION OF 
    TRADING AND MARKETS, SECURITIES AND EXCHANGE COMMISSION

    Mr. Brigagliano. Thank you, Chairman Reed, Ranking Member 
Bunning, and Members of the Subcommittee, for giving me the 
opportunity to speak to you today about the U.S. equity markets 
on behalf of the Securities and Exchange Commission.
    The Commission currently is taking a broad and critical 
looking at market structure practices in light of the rapid 
developments in trading technology and strategies. In 
September, the Commission proposed to prohibit the practice of 
flashing marketable orders. In general, flash orders are 
communicated to certain market participants and either executed 
immediately or withdrawn immediately after communication. Flash 
orders are exempt from the Exchange Act's quoting requirements 
as the result of an exemption formulated when most trading took 
place on the floors of the exchanges.
    The Commission is concerned that the exception for flash 
orders from Exchange Act quoting requirements is no longer 
necessary or appropriate in today's highly automated trading 
environment.
    The flashing of order information could lead to a two-
tiered market in which the public does not have access, through 
the consolidated quotation data streams, to information about 
the best available prices for U.S.-listed securities that is 
available to some market participants through proprietary data 
feeds.
    Last week, the Commission made additional proposals related 
to dark pools. The first proposal would require actionable 
indications of interest to be subject to the same disclosure 
rules that apply to quotations. The second proposal would lower 
the automated trading system, or ATS, trading volume threshold 
for displaying best-priced orders in the consolidated quote 
stream. Taken together, these changes would help make the 
information conveyed by actionable IOIs, by dark pools and 
others, available to the public instead of just to a select 
group. At the same time, both proposals would exclude from 
their requirements certain narrowly targeted IOIs related to 
large orders.
    The Commission also proposed to create a similar level of 
post-trade transparency for ATSs, including dark pools, as 
exist for registered exchanges. Specifically, the proposal 
would require real-time disclosure of the identity of dark 
pools and other ATSs on the public reports of their executed 
trades.
    But these steps are just the beginning. Over the coming 
months, I anticipate that the Commission will consider 
additional issues relating to dark liquidity more broadly, 
perhaps by issuing a concept release.
    Another practice that is being examined by Commission staff 
is high-frequency trading. While the term lacks a clear 
definition, it generally involves a trading strategy where 
there are a large number of orders and also a large number of 
cancellations--often in subseconds--and moving into and out of 
positions many times in a single day.
    High-frequency trading plays a significant role in today's 
markets by providing a large percentage of the displayed 
liquidity that is available on the registered securities 
exchanges and other public markets. Many are concerned, 
however, that high-frequency trading can be harmful, depending 
on the trading strategies used, both to the quality of markets 
and the interests of long-term investors.
    We are also exploring ways to assure that the Commission 
has better baseline information about high-frequency traders 
and their trading activity. This would help to enhance the 
Commission's ability to identify large and high-frequency 
traders and their affiliates.
    Another market structure issue that the Commission staff is 
exploring is sponsored access--also known as ``direct market 
access'' or ``DMA''--where the broker-dealer members of an 
exchange allow nonmembers--in many cases, high-frequency 
traders--to trade on that exchange under their name. Sponsored 
access raises concerns about whether sponsoring broker-dealers 
impose appropriate and effective controls on sponsored access 
to fully protect themselves and the markets from financial risk 
and to assure compliance with all regulatory requirements. In 
evaluating these market structure issues, the Commission is 
focused on the protection of investors, maintaining fair, 
orderly, and efficient markets, and facilitating capital 
formation.
    Thank you for giving me the opportunity to speak to you 
today. I am happy to answer any questions you may have.
    Chairman Reed. Thank you very much.
    Dr. Hatheway.

 STATEMENT OF FRANK HATHEWAY, SENIOR VICE PRESIDENT AND CHIEF 
                     ECONOMIST, NASDAQ OMX

    Dr. Hatheway. Good morning, Chairman Reed, Ranking Member 
Bunning, and Members of the Subcommittee. Thank you for the 
opportunity to offer my perspectives on recent developments in 
U.S. equities markets. I speak as an economist who has studied 
equities markets for several decades from multiple vantage 
points--as an options trader on the floor of the Philadelphia 
Stock Exchange, as a professor at Penn State, as an Economic 
Fellow at the SEC, and, currently, as NASDAQ's Chief Economist.
    The topics before us--dark pools, high-frequency trading, 
flash orders--represent transformations of the market from an 
environment where the predecessors of these practices were 
carried out between people rather than in their current 
computerized guise. The fundamental economics of these 
practices are not new. Similarly, the debate over the 
appropriateness of the latest technology is only new in the 
sense that the specific technology and the speed at which it 
operates is new, not the issue of replacing slow with fast or 
old with new.
    As an economist, my remarks are going to focus on what 
makes a good market, focus on the market as a whole, not on an 
order-by-order basis or broker-by-broker basis. And because 
these innovations in the market have historical precedence, we 
can look at historical criteria for a good market.
    A good market is one that maximizes price discovery. That 
means you bring supply and demand together at a single point. 
That is what we do as an exchange. We produce information about 
the price. And markets do this at their best when they are 
open, when they are transparent and offer everyone a level 
playing field.
    The components that tend to make up a good market are a 
market that encourages innovation and competition--competition 
between exchanges and nonexchanges using the best technology 
available to execute trades at the right price, quickly, 
cheaply. Automation of trading for clients and market makers 
has made this process much more efficient than it was in 1984 
when I started. Fair and equal access is also important. The 
markets should reflect everyone's supply and demand.
    In 1997, order handling rules ended a two-tier market that 
existed on NASDAQ and greatly democratized the markets, 
ultimately taking control of price setting away from market 
makers and specialists and giving it to everyone who is 
interested in participating in the market.
    Sound regulation is a final critical component. Markets 
will be rational when trading rules are clear and fair, 
rigorously enforced, with strong surveillance and compliance. 
And in my opinion, the best way to do this, to establish an 
effective market, is to emphasize public orders over private, 
investors over professionals, a market structure that sets the 
best possible benchmark by which everyone will trade, a market 
that facilitates price discovery.
    There are negatives to dark pools, and by dark pools, I 
will use the same definition as Chairman Reed did in his 
opening statement, that this is a market that does not offer 
information about its quotes. There are going to probably be 
different definitions of that today. In economic terms, there 
is no pretrade transparency into the market. These markets have 
the potential to isolate limit orders and potentially widen 
spreads and hurt market quality. As SEC Commissioner Walter 
wisely said, ``Every share that gets executed in the dark does 
not contribute fully to price discovery. The question becomes 
how many dark shares are too many and do I think there is a 
problem today.''
    Dark trading has increased in the U.S. over the last year 
and a half, 2 years, potentially 5 to 10 percentage points 
across the board. We began looking at this by looking at three 
NASDAQ-listed Dow stocks: Microsoft, Intel, Cisco. They 
experienced a steady increase in dark trading and a steady 
deterioration in their quoted spread, in the benchmark that 
people use to monitor prices.
    Turning from anecdotes, we looked broadly at all the stocks 
that trade on the NYSE and on NASDAQ. Controlling for factors 
of influence and spread, we came to a similar conclusion: that 
as dark trading approaches 35 or 40 percent of volume for 
active stocks, the deterioration in spread quality becomes 
increasingly material, on the order of fractions of a cent--
three-tenths of a cent to half a cent--but given the narrowness 
of spreads in today's efficient markets, that is a 10- to 15-
percent increase in the width of the benchmark.
    Collectively, darkness is harming the market. Individually, 
dark pools have value. Negotiation is critical for large block 
orders and always has been. Broker-dealers do this with skill, 
with capital, and with technology, and need to continue to do 
so. But these orders need a robust public quote to serve as a 
benchmark. We support the SEC proposals to reposition dark 
pools to require public display of actionable IOIs when volume 
crosses a certain threshold and also to exempt blocks. The SEC 
proposal prioritizes the public market, transparency, 
competition, and fair access.
    Turning to other topics, we support banning flash orders. 
We also believe that dark pools and flash orders are wrongly 
confused with high-frequency trading and algorithmic trading. 
High-frequency trading and algorithmic trading is automation. 
It improves efficiency and improves price discovery. It brings 
competition, fair and equal access to the market, and we do not 
want to step away from those goals. The market should be open, 
transparent, competitive, and well regulated. That is what 
serves investors. Technology employed today means speed and 
efficiency. We should keep it.
    Thank you very much, and I look forward to your questions.
    Chairman Reed. Thank you very much, Doctor.
    Mr. O'Brien, please.

 STATEMENT OF WILLIAM O'BRIEN, CHIEF EXECUTIVE OFFICER, DIRECT 
                              EDGE

    Mr. O'Brien. Chairman Reed, Ranking Member Bunning, Members 
of the Subcommittee, I would like to thank you for the 
opportunity to testify today on behalf of Direct Edge, the 
Nation's third largest stock market.
    Over the past 2 years, our share of U.S. stock trading has 
risen from under 1 percent to approximately 12 percent because 
we have innovated in response to a changing market structure to 
deliver better solutions for our customers and their customers, 
the Nation's investors. Certain of these changes have triggered 
a debate over the past several months regarding the structural 
integrity of our markets, which is now at a critical juncture. 
In this regard, the work of the Subcommittee to hold this 
hearing is both very timely and very valuable.
    I believe that through careful examination, appropriate 
regulatory protections can be preserved without taking steps 
that would ultimately undermine investor confidence by 
restricting innovation, competition, or efficiency. I like to 
structure that belief by offering some guiding principles 
toward any shape market structure reform should take so we can 
deal with what really matters, improving our Nation's stock 
market for the benefit of investors.
    First, current market structure is fundamentally fair and 
sound. By every quantitative and qualitative measure, the U.S. 
cash equities market serves as a model for the entire world, 
performing as well as it ever has in terms of liquidity, 
implicit and explicit transaction costs, and transparency. 
During the worst financial crisis of our lifetimes, the U.S. 
equity market operated efficiently, while markets for certain 
other financial instruments, such as auction-rate securities, 
mortgage-backed securities, virtually ceased to operate. Recent 
developments have not materially eroded the efficiency of our 
marketplace.
    While the evolution of technology, functionality, and the 
economics of trading require everyone to adapt, that alone 
should not be the root reason for market structure reform. 
Trends and changes always require a continual analysis of how 
regulation needs to respond, but this should not be confused 
with a broader need to re-architect our market due to any 
fundamental flaw or unfairness.
    Second, high-frequency trading and technology are valuable 
components of current modern market structure. The innovation 
and efficiency that technology has brought to stock trading 
inures to the benefit of every American investor. When 
decimalization, trading in pennies, came to the markets in 
April 2001, there was a near total evaporation of traditional 
capital commitment, with market makers far less willing to 
provide competitive bids and offers as spreads narrowed. Firms 
willing and able to adapt to this reality, along with new 
competitors, rose in their place with business models 
predicated on extremely efficient use of technology to 
facilitate our markets.
    The benefits of high-tech trading continue to this day in 
several forms, including more efficient price discovery, lower 
investor costs, and greater competition, which benefit all 
investors. All brokers have, in some form, adapted high-
frequency technology, to the point that retail investors can 
have their orders executed in under a second via the Internet 
from anywhere on the planet.
    As with the technological transformation of any market, 
issues have emerged which warrant close examination and likely 
new regulation. High-frequency trading strategies are now 
pursued by unregulated entities who have been given broker-like 
access to exchanges without adequate controls of the compliance 
or systemic risks, often called naked access. Exchange products 
that offer a direct presence at exchange data and trading 
facilities, called colocation, need to be regulated in a manner 
as transparent as all other fees. But any evaluation of these 
issues should start from a productive vantage point that, when 
well regulated, high-frequency trading and technology are 
generally healthy and positive.
    Second, exchanges aren't always the best place to execute a 
trade. The over-the-counter and the exchange markets have 
operated side-by-side for over 30 years to the great benefit of 
retail and institutional investors. There are many legitimate 
economic, execution quality, and policy reasons why investors 
and their agents seek an off-exchange execution through a dark 
pool, a market maker, or other means. Exchanges do play a 
critical role in providing pretrade transparency and price 
discovery and that benefits those who tradeoff-exchange. If the 
level of that activity were to drop precipitously below 
historical norms, a greater examination probably would be 
necessary, but we are simply not near that point.
    To keep exchanges relevant as central hubs of trading 
interest, however, we need to pursue regulation that doesn't 
drive the exchange markets and nonexchange markets further 
apart. Direct Edge pioneered the use of flash order technology 
precisely to bring retail and other investors access to dark 
pools that they previously had never had access to. This is 
what any good exchange does, bringing as many buyers and 
sellers together in a way that makes sense for all concerned.
    True inequities can and should be eliminated, and we 
applaud the thoughtful approach the Securities and Exchange 
Commission has taken on this topic to date. But undue focus on 
optional esoteric order types at the expense of ignoring the 
broader trends that motivate customers to use these tactics, at 
a minimum, provide only false comfort to investors and 
potentially leave them more at risk than ever before.
    Fourth, brokers are those best equipped to decide how to 
execute customer orders. Every order type offers a range of 
explicit-implicit costs and other features. Brokers are best 
suited to decide how to use the tools that exchanges provide in 
executing their orders. Delegation of this responsibility by an 
investor to their broker is a cornerstone of our capital 
markets. While each broker brings their own perspective and 
execution strategy to the table, investors are free to choose 
among scores of reputable brokers with data that is better than 
ever before.
    Fifth, equal access prevents two-tiered markets. The 
broader range of technologies and products that brokers have at 
their disposal is greater than ever. Every broker does not do 
everything the same way, at the same speed, or with the same 
resources. Brokers choose which exchanges to be members of and 
which products of those exchanges to use. Investors participate 
by choosing their broker and choosing the level of self-
direction they engage in. When a broker elects to use a certain 
functionality, it does not imply that those who do not are 
somehow unfairly disadvantaged. Markets do need to be 
fundamentally fair, but that is not achieved on the basis of 
attempting to mandate that everyone has substandard but equal 
capabilities.
    Sixth, in debating the need for reform, a data-driven 
approach is optimal. The National Market System Amendments of 
1975, the Order Handling Rules, and Reg NMS were all successful 
because of their comprehensive approach. When considering 
market structure reform, a big picture approach that values 
objective data over subjective intuition or allegation is 
highly preferable. To do otherwise could alter a market 
structure that is generally performing well without adequate 
basis for believing that improvements will make it even better.
    Our stock market is the model for the entire world because 
we anticipate and implement change better than anyone, and 
adapting regulation is a key element of that. If we can address 
these outstanding issues in a constructive fashion, we will 
have provided a strong structural foundation for our Nation's 
economic recovery to be realized upon.
    Thank you for the opportunity, and again, I look forward to 
your questions.
    Chairman Reed. Thank you very much.
    Mr. Nagy.

   STATEMENT OF CHRISTOPHER NAGY, MANAGING DIRECTOR OF ORDER 
           ROUTING SALES AND STRATEGY, TD AMERITRADE

    Mr. Nagy. Chairman Reed, Ranking Member Bunning, and 
Members of the Subcommittee, thank you for allowing me the 
opportunity to testify on equity market structure.
    I am Chris Nagy, Managing Director of Routing Strategy with 
TD Ameritrade. TD Ameritrade, based in Omaha, Nebraska, was 
founded in 1975 and was one of the first firms to offer 
negotiated commissions to individual investors. Over the course 
of the next three decades, TD Ameritrade pioneered 
technological changes, such as touchtone telephone trading and 
Internet investing, to make access by individual investors more 
accessible, affordable and transparent. TD Ameritrade has long 
advocated for market structures that create transparency, 
promote competition, and reduce trading costs for individual 
investors.
    As technology rapidly advances, it is ever more important 
that the SEC complete a comprehensive review of the national 
market system to ensure individual investors are not adversely 
impacted. At the same time, regulation has the potential to 
result in unintended consequences, making it critically 
important that rulemaking be based on empirical data and 
reasoned analysis.
    Our Nation's stock markets have evolved dramatically over 
the course of the last decade. In 2001, the average individual 
investor transaction took upwards of 18 seconds to receive an 
execution, while today that same transaction is done in less 
than 1 second. These changes have been driven primarily by 
technological innovation, but also in response to carefully 
crafted regulations.
    In addition, the move to decimalization early in the decade 
reduced spreads by up to five-and-a-quarter cents, whose 
benefits went largely into the pocketbooks of individual 
investors.
    In fact, today, the individual investor enjoys superior 
pricing, lightening fast trade execution, fulfillment, and 
ample liquidity in the markets. At no other point in the 
history of the markets has the individual investor been closer 
in terms of pricing to that of the institutional trader.
    Variations of dark pools have been in our markets for 
decades, taking on various forms from a broker taking an order 
over the phone to a floor broker acting as agent. When 
Regulation NMS was enacted in 2005, exemptions to the display 
rule were granted, spawning the creation of the modern day 
electronic dark pool. This market dynamic has given rise to 
well over 40 alternative trading systems, transacting by some 
estimates upwards of 35 percent of all stock market orders each 
day.
    Retail clients have little ability to react or interact 
with these pools of liquidity. The irony is that dark orders 
receive their pricing from the transparent exchanges where the 
retail clients are. In many ways, dark pools are an excellent 
example of a two-tiered market that gives institutional traders 
a way to use retail order flow to their own benefit.
    While the benefits of dark pools to reduce overall market 
impact are there, serious questions need to be asked if we have 
reached the tipping point. Conversely, innovative strategies 
that promote efficiency and reduce investor costs in the 
markets are critical if we are going to continue to level the 
playing field for individual investors.
    There has been much fanfare that flash trading is harmful 
to retail investors. However, little data is offered to back 
these claims. Defenders of flash argue that it allows users to 
lower transaction costs and obtain better prices in the both 
equity and options marketplaces. Although TD Ameritrade can 
find no evidence that flash trading harms individual investors, 
our firm believes that flash is a symptom of our current market 
structure, and in many ways the perception that it is unfair 
and predatory became the reality.
    As we embark on an overhaul of our Nation's markets, it is 
imperative that we continue to provide a low-cost, competitive 
infrastructure that ensures individual investors have low 
barriers to entry, which in turn promote investor confidence. 
We must, however, ask if we have reached the tipping point with 
an excess of alternative trading systems.
    Interestingly, we can draw insight from a very different 
yet similar circumstance. During the Great Depression, there 
was an overabundance of taxi drivers, which reduced driver 
earnings and congested city streets. To address the issue and 
restore proper balance, the Medallion system was created, 
placing a moratorium on the issuance of taxicab licenses. This 
system created the proper balance of taxis while not crowding 
the city streets.
    In today's markets, as we emerge from the recent market 
downturn, one must question if we have too many taxis 
fragmenting our streets of liquidity. We should seek a solution 
to provide competition in our markets without an over-surplus 
of trading systems.
    I appreciate the opportunity to appear before the 
Subcommittee, not only on behalf of TD Ameritrade, but more 
importantly, on behalf of our clients' individual investors. 
Thank you.
    Chairman Reed. Thank you very much.
    Mr. Mathisson, please.

 STATEMENT OF DANIEL MATHISSON, MANAGING DIRECTOR AND HEAD OF 
           ADVANCED EXECUTION SERVICES, CREDIT SUISSE

    Mr. Mathisson. Good morning and thank you, Chairman Reed, 
Ranking Member Bunning, and Members of the Subcommittee for 
giving me the opportunity to share my views on the best 
structure for our Nation's stock market.
    My name is Dan Mathisson. I am the Managing Director at 
Credit Suisse. The U.S. subsidiary of Credit Suisse, which is 
formerly known as First Boston, has been operating continuously 
in the United States since 1932. I run a unit called Advanced 
Execution Services, which is a team of approximately 200 
financial and technology professionals headquartered in New 
York. We execute trades electronically on behalf of mutual 
funds, pension funds, hedge funds, and other broker-dealers. 
Credit Suisse trades approximately 1.2 billion shares a day, or 
about one out of seven shares traded in the U.S. this year. We 
also own and operate the largest dark pool by volume, which is 
called Crossfinder.
    On the topic of dark pools, we believe that despite their 
unfortunate name, dark pools are beneficial to long-term 
investors and occupy an important niche within our market 
structure. We believe investors have a right to remain silent 
and that dark pools merely automate a trading methodology that 
has always existed.
    We believe that much of the debate over dark pools has not 
been properly focused. Long-term investors typically make 
decisions based on corporate fundamentals, while short-term 
traders typically make decisions based on interday trading 
information, such as displayed orders. Those who would compel 
dark pools to display their bids and offers in real time or to 
reveal ATS identities in real time are helping precisely the 
wrong side. Who would benefit from additional quantitative 
information hitting the tape in real time, fundamental long-
term investors or short-term information-based traders?
    Given the fears that already exist that high-frequency 
traders are somehow taking advantage of the existing electronic 
information, isn't it ironic that we are considering mandating 
a slew of new very sensitive trade data to be delivered to them 
in real time?
    Now, some have questioned whether dark pools damage price 
discovery in the markets. Despite popular belief, dark pools 
must report all their trades immediately to the consolidated 
tape. They are a valuable source of last trade data. In 
addition, it should be noted that dark pools only make up 
approximately 7 percent of U.S. stock volume. Dark pools will 
likely always remain a niche trading product and will not lead 
to the end of publicly displayed bids and offers.
    But there is a problem with dark pools and that is 
regarding equal access to them. Under Regulation ATS, dark pool 
operators are allowed to decide who can participate in their 
pool. Broker-dealers are sometimes denied access to each 
other's dark pool for competitive or capricious reasons, 
meaning that investors cannot be guaranteed access to the 
entire marketplace currently.
    We believe that markets work best when they are open to 
all, and therefore, we propose that the fair access provision 
of Reg ATS be changed to force all dark pools to be open to all 
broker-dealers, and through those broker-dealers to the entire 
investing public.
    On the topic of high-frequency trading, there is no clear 
definition of the term, making it very difficult to analyze its 
effects or estimate what percent of the market it is, resulting 
in what appear to be wide overestimates of what percent of the 
market high-frequency trading makes up. We believe the focus at 
this point in the debate should be on creating a clear 
definition so that analysts and academics can perform rigorous 
studies and we can separate the facts from the conspiracy 
theories.
    Regarding the issue of whether high-frequency firms have an 
unfair advantage over others, we believe that disparities that 
result from differentiated levels of investment and technology 
are natural and occur in any industry. It is only unfair if the 
opportunity to build similar technology doesn't exist for some. 
We have seen no evidence of anyone being denied the opportunity 
to build a high-frequency trading system as of yet.
    In summary, we believe that the key to a strong and 
resilient stock market is a healthy competition for order flow 
among multiple venues, both dark and light, along with mandated 
fair access to each of them. We believe that if all broker-
dealers have fair access to all venues, then all investors, 
whether institutional or retail, would have an equal 
opportunity to get the best price.
    Thank you again for inviting me to participate in today's 
hearing and I very much look forward to your questions.
    Chairman Reed. Thank you.
    Mr. Gasser, please.

 STATEMENT OF ROBERT C. GASSER, PRESIDENT AND CHIEF EXECUTIVE 
              OFFICER, INVESTMENT TECHNOLOGY GROUP

    Mr. Gasser. Chairman Reed, Ranking Member Bunning, and 
Members of the Subcommittee, thank you for the opportunity to 
testify this morning on current issues affecting U.S. market 
structure. My name is Bob Gasser. I am the CEO of Investment 
Technology Group. As a fully transparent and neutral player in 
the industry, I would like to offer ITG's unbiased, fact-based 
perspective on these issues to help you better understand the 
current trading landscape.
    ITG is a New York Stock Exchange listed company with 18 
offices across 10 countries employing nearly 1,300 people 
worldwide, and nearly 900 here in the U.S. As a specialized 
agency brokerage firm, ITG provides technology to a broad 
collection of the globe's largest asset managers and hedge 
funds, allowing them to independently source liquidity on 
behalf of their clients. Throughout our 22-year history, we 
have run our business in the best traditions of U.S. innovation 
and market leadership.
    In 1987, POSIT was launched as one of the first dark 
electronic matching systems. Since then, ITG's POSIT crossing 
system has harmoniously existed within U.S. market structure, 
including the Reg ATS and Reg NMS frameworks in more recent 
years. We firmly believe that institutions need a place to 
confidentially interact with each other to find natural block 
liquidity. Nondisplayed pools of liquidity, such as POSIT, 
provide a valuable solution for the buy side to comply with 
their obligations as fiduciary to offer their clients the best 
possible execution. Our analysis of millions of institutional 
trades post the advent of Reg NMS confirms that POSIT reduces 
market impact of block trades and enhances execution quality.
    In my testimony today, I will begin by addressing the role 
of dark pools and other undisplayed quotes historically in our 
markets. I will outline the advantages nondisplayed pools of 
liquidity provide for the marketplace. Finally, I will provide 
our views on several topics that seem destined for further 
regulatory scrutiny, sponsored access and exchange colocation.
    Contrary to the pejorative name, dark pools have played a 
positive role in the transformation of the U.S. equity markets 
over the past decade. As SEC Commissioner Kathy Casey herself 
points out, there is nothing sinister about dark pools. They 
exist for legitimate economic reasons. Institutional investors 
seeking to make large trades have always wanted to avoid 
revealing the total size of their order. This, in turn, 
benefits the millions of individual investors who invest in 
mutual funds and pension plans. Without a facility like POSIT, 
institutions with a natural interest in trading with one 
another would be subject to unnecessary frictional cost.
    We wholeheartedly embrace and support the broad concepts 
the SEC highlighted during its open meeting last Wednesday. The 
staff of the SEC's Division of Trading and Markets exercised a 
tremendous amount of care and diligence in their examination of 
current U.S. market structure. We interpret the SEC's recent 
pronouncements as establishing a bright line between truly dark 
pools and lit pools, with an exception for block liquidity. We 
welcome the clarity. As a truly dark pool, POSIT will continue 
to provide large executions and price improvement to its 
customers.
    Academic research demonstrates that market fragmentation, 
including the proliferation of dark pools and other off-
exchange trading venues, does not harm market quality. We 
support efforts to increase post-trade transparency so long as 
the rules are applied consistently across the competitive 
landscape. In fact, we believe that the data arising from such 
transparency will better enable market participants to measure 
the quality of the executions that they receive from the 
various trading venues, thus enabling them to make better 
routing decisions in the future.
    We do have concerns about sponsored access and the risk it 
potentially creates for market participants. Sponsored access 
generally refers to the practice of a broker-dealer member of 
an exchange providing other market participants, possibly 
nonregulated entities, with access to that market center 
without having the sponsored participants order flow flow 
through the member systems prior to reaching the market center. 
One of the concerns associated with sponsored access is that 
the service can be provided without rigorous compliance 
oversight and/or appropriate financial controls. We believe 
that the issue of sponsored access firms deploying high-
frequency strategies on behalf of nonregulated entities 
deserves regulatory scrutiny.
    On the topic of exchange colocation, U.S. exchanges have 
logically become mission critical technology providers to the 
brokerage industry. They now host brokerage firms within 
exchange-owned and operated data centers and provide access to 
the circulatory and respiratory system of today's national 
market system, market data and the matching of executed trades.
    It is our hope that the SEC will provide similar clarity on 
the issue of colocation within exchange data centers in a 
future concept release. No firm should enjoy an advantage over 
another firm based on physical proximity to exchange 
technology. Principles of fair access and transparency must be 
applied equally to this issue.
    While we support the SEC's recent proposals, we are wary of 
the dangers of unintended adverse consequences for market 
structure. We note that Reg ATS and Reg NMS did produce the 
competition that they were intended to foster without 
compromising investor protection. The increased competition 
evidenced by the existence of approximately 40 execution venues 
in the U.S. market has reduced transaction costs and increased 
execution speeds without degrading the transactional or 
informational efficiency of the U.S. equity markets. To the 
contrary, U.S. market systems withstood the demands of 
unprecedented volatility and transaction volumes through the 
financial turmoil of last fall with remarkable stability and 
resiliency.
    The confidence that global investors have in the efficiency 
of the U.S. national market system is well placed. This 
confidence is essential to U.S. leadership in the formation of 
capital. All of our collective efforts toward structural reform 
must focus on the preservation of this confidence.
    Thank you, Mr. Chairman, and we look forward to your 
questions.
    Chairman Reed. Thank you very much, Mr. Gasser.
    Mr. Driscoll, please.

    STATEMENT OF PETER DRISCOLL, CHAIRMAN, SECURITY TRADERS 
                          ASSOCIATION

    Mr. Driscoll. Chairman Reed, Ranking Member Bunning, 
Members of the Subcommittee and staff, thank you for the 
opportunity to testify at this important hearing on behalf of 
the Security Traders Association. I am Peter Driscoll, the 
Senior Equity Trader at the Northern Trust and Chairman of the 
Security Traders Association. I am here today representing the 
STA, where we provide a forum for our traders to share their 
unique perspective on issues facing the securities markets.
    Today's individual investor trades in markets that are 
characterized by narrow bid-ask spreads, low commissions, and 
immediate execution of trades. It is, however, important to 
realize that the majority of savings and investments are 
institutionalized, invested through savings plans at work, 
401(k) plans, and the like. Institutional investors also value 
low commissions, tight spreads, and competition. The size of 
these aggregated orders also requires us to identify deep pools 
of liquidity where we can secure the best possible execution of 
larger orders.
    The U.S. equity markets functioned extremely well during 
our recent economic crisis. The markets remained open. Security 
prices accurately reflected the equilibrium between buyers and 
sellers at the moment of execution.
    The SEC recently held a meeting where it voted to issue 
rules intended to strengthen the regulation of dark pools. 
These rules were issued in the regular notice and comment 
rulemaking process, affording all market participants the 
opportunity to comment on the rules. The STA feels that the 
process is the best way to uncover the unintended consequences 
the proposed rules may have prior to it causing any market 
disruptions.
    Undisclosed liquidity has been part of the market since 
their inception. In fact, many believe the New York Stock 
Exchange was the largest dark pool. Floor brokers working large 
orders traditionally posted only a small percentage of those 
orders in the publicly displayed quotes. The advent of 
decimalization and electronic trading required participants to 
find alternative ways to execute their orders. Reg ATS made it 
easier for investors' orders to execute without the 
participation of a dealer. At the same time, it allowed 
restricted access to some trading venues and decreased the 
transactional data available to investors. As such, the STA 
believes it is appropriate for the Commission to evaluate dark 
pool access and transparency standards.
    Many believe alternative liquidity pools provide efficiency 
by lowering execution costs and providing competitive choices 
in the execution process. Some believe trading in dark pools 
degredates the price discovery process. We do not feel dark 
volumes trending around 10 to 15 percent of overall volume are 
anywhere near that degradation point. As with most things in 
life, moderation is a key.
    An efficient market structure can include alternative 
liquidity pools and public quoting venues coexisting. The STA 
does not believe limiting dark pools to de minimis percentages 
of volume is the appropriate answer. Should the SEC determine 
that too much volume is trading in these dark pools, the 
standards that ATSs must adhere to should be updated and 
competitive pressure should be allowed to solve the problem. 
Increasing access and transparency is the answer.
    Once a dark pool decides to broadcast information beyond 
their own members, that information should be publicly 
distributed. This transparency must be increased without 
jeopardizing the pool participants' anonymity. The STA has long 
held that similar products should be regulated by consistent 
rules. The regulatory gap between ATS regulation and exchange 
regulation should be rationalized. Balancing regulations will 
allow all venues to compete more robustly.
    Our 2008 report raised concerns about businesses being 
built solely to capture rebates from maker/taker models and 
market data plans. We remain concerned about the distortive 
effects these businesses could have on issues by issuing quotes 
and trades without investment intent. STA suggested the SEC 
adjust the market data revenue allocation formulas to only 
reward quality and tradable quotes. This remains good advice.
    Sponsored access must include appropriate trade risk 
management controls. Allowing naked access to markets in 
today's interconnected market is undesirable from both an 
industry and regulatory perspective. There is nothing unfair in 
colocation as long as the access is provided to all who desire 
it at a reasonable cost. Last week, two trading venues 
voluntarily accepted Commission oversight of their colocation 
plans, and we feel that this was a great step forward in the 
regulation of these plans.
    The SEC needs the resources to upgrade their technology and 
hire more people to surveil today's markets. Trying to monitor 
35,000 registered entities with 3,000-some-odd staff members 
seems a daunting task.
    We underscore the importance that changes to the current 
regulatory framework need to be done in a deliberate and 
carefully considered manner. If rules are adopted, pilot 
programs should be used whenever possible to insure against the 
possibility of market disruptions. We also emphasize the need 
for the SEC and Congress to avoid picking winners and losers 
and to allow competition and innovation to drive the market 
changes when possible. Thank you.
    Chairman Reed. Thank you, Mr. Driscoll.
    Mr. Sussman, please.

 STATEMENT OF ADAM C. SUSSMAN, DIRECTOR OF RESEARCH, TABB GROUP

    Mr. Sussman. Chairman Reed, Ranking Member Bunning, 
Subcommittee Members, thank you for holding these hearings. 
Although I believe that U.S. equity markets are the standard 
for market efficiency and investor protection, as my wife likes 
to remind me, there is always room for improvement, and I am 
glad to be a part of that process.
    When I began in this industry in 1998, I worked for a young 
retail online brokerage outfit. I was in charge of routing 
their orders, designing the logic for their orders, and not 
only would execution take minutes, but also there was a great 
deal of uncertainty as to the status of the order. Clients 
would call up asking what is going on with that order and we 
couldn't even tell them what was going on because of the lack 
of transparency in the markets.
    When I left in 2004, execution times were reduced to 
seconds and order status was no longer an issue. This is the 
result of a great deal of regulatory and technological process 
that we have made since then.
    Now, as Director of Research at TABB Group, a financial 
markets research and consulting firm, we are an organization 
that is dedicated to helping folks understand this changing 
trading landscape. Our clients and contacts span the entire 
investment community, including pension plans, retail brokers, 
mutual funds, hedge funds, high-frequency traders, exchanges, 
brokers, and dark pools.
    Some of the research I am going to talk about today is 
based on detailed conversations with head traders at 
traditional asset management companies that represent 41 
percent of our Nation's institutional U.S. equity assets.
    Now, these folks are the ones that are tasked with the 
responsibility of overseeing the safe handling of our orders, 
the orders that reside that come from pension funds, from 
mutual funds, from 529 plans, and our hard-earned savings, and 
they have a fiduciary obligation to balance the tradeoff 
between price and time. As some of my copanelists mentioned, 
this isn't just about price formation. This is about the proper 
handling of orders, and in some cases, you have an order that 
you need to get executed right away.
    If you need to get that order executed right away, you are 
going to broadcast that to as many folks as possible in order 
to attract willing counterparties. However, if the order is 
sensitive to price, you need to keep that order tighter to 
your--you need to play those cards a little bit tighter. Any 
information that leaks out about that order could cause the 
price of the stock to move against you and thus harm your 
investors.
    So they have always had to make these choices, and it is 
never as clear as just shouting from the hilltops or making 
barely a whisper. There are a lot of degrees in between. And so 
for price sensitive orders, they have always used dark 
liquidity.
    Now, in the past, that dark liquidity may have been calling 
up a floor broker at the New York Stock Exchange where they 
would discuss the parameters of these orders--size, price, how 
urgently does it need to get done--and then that floor broker, 
on behalf of that trader, would go out to the floor and seek 
that liquidity out. Nowadays, those same instructions are 
encoded in electronic messages and sent to the various 
marketplaces that are available, but the intention is the same.
    The challenge is that there was a value in that floor 
broker. The relationship between the trader and the floor 
broker was based on trust. It was based on a kinship that was 
built up over time. In an electronic world, how do we build 
that trust and confidence up?
    At TABB Group, we believe that is with more disclosure, 
more openness about the trading practices. That is why we 
believe that dark pools should be more public about their types 
of participants they have in their pools, the mechanisms they 
use to execute plan orders.
    Now, a lot of progress has been made on this front. In a 
recent study that we conducted with those traders I mentioned 
earlier, 71 percent now say that they are comfortable with the 
practices that take place in these dark pools. That is up from 
53 percent in 2008. So clearly, the dark pools on a voluntary 
basis have been out there trying to educate the clients.
    However, we do think that there needs to be more work done 
here. We believe that that information should be public. We 
believe it should use standardized terms so we can easily 
compare the practices across these dark pools and that 
regulators have a better chance of ensuring that these 
disclosures actually match the actions that take place within 
these dark pools.
    However, I want to distinguish between this type of 
disclosure about practices and the real-time identifiable 
reporting of trading volume that was recently proposed by the 
SEC. We believe that any real time identifiable reporting of 
dark pools would hinder the institutional traders' fiduciary 
obligation to protect the orders that come from a large portion 
of our investor public.
    Just quickly, I want to touch on high-frequency trading, 
because we really believe that these are just today's 
intermediaries. We used to call them market makers and 
specialists, but because of the automated high-speed nature of 
today's markets, anyone that wants to be an intermediary has to 
execute in a high-speed fashion. And so when an institutional 
trader wants to get an order done, they are likely to be 
interacting with a high-frequency trader. Now, we do think it 
is incumbent on high-frequency traders, which often shroud 
themselves in secrecy, to be more forthcoming about their 
activities and be more involved in trying to improve our market 
structure.
    I could talk on these issues for many more minutes, but I 
have already overrun, so I will just wait for your questions. 
Thank you very much.
    Chairman Reed. Thank you, Mr. Sussman. Thank you all, 
gentlemen, for testimony that was very thoughtful and also very 
helpful to us. As some have indicated on the panel, we are just 
beginning deliberations as technology becomes more evident and 
the impact of the market is more evident.
    We will do 7-minute rounds. I anticipate a second round, 
but I want to get somewhat quickly to my colleagues.
    Let me start with Mr. Sussman and ask the panel one 
question, and we will let the SEC conclude. What are the 
several--one, two, three big challenges that this new 
technology poses to regulators? As you indicated, several 
individuals indicated, this practice has been going on as long 
as there have been markets trading without publicizing the 
price. But what are the dangers, the three biggest challenges? 
The SEC has to maintain fair and orderly markets. What are the 
three issues that might affect that? Mr. Sussman, and then 
right down the line.
    Mr. Sussman. Yes, thank you. That is a great question.
    For the institutional trader, it is knowing what is going 
on with their order. In today's electronic markets, there are 
so many different types of software that they use in order to 
execute their orders, it is difficult for them to keep up with 
what is actually happening with their orders. They need to use 
these tools in order to efficiently interact with the 
marketplace, you know, in order to efficiently distribute their 
orders trading against other institutional investors, trading 
against high-frequency traders.
    But the issue is how much do they really understand about 
the algorithms and the dark pools that they are handling. You 
know, sometimes they feel overburdened by the amount of 
information that they have to keep track of in order to execute 
these orders.
    But I do not think that they would, you know, ask for 
anything else. I mean, this is a challenge that they accept 
wholeheartedly as a part of their job, and they would rather 
have the responsibility of understanding these pieces, you 
know, rather than some regulatory framework force them to act 
one way or another. You know, freedom is obviously a 
responsibility as well as a right, and they accept that 
challenge.
    Chairman Reed. Thank you.
    Mr. Driscoll, please.
    Mr. Driscoll. Following on what Mr. Sussman said, at the 
Security Traders Association several years ago, we were 
concerned about the lack of knowledge on how institutional 
orders were being routed through these dark pools, and we set 
about a survey of the dark pools to try to discover how orders 
were routed, why they were routed, and where they were finally 
executed.
    We ran into quite a bit of trouble getting those answers. 
It seems that there was a lot of confidentiality clauses that 
prevented pools from talking about where their orders were 
executed. A lot of legalistic roadblocks. We again early this 
year attempted to map liquidity and ran into similar 
roadblocks.
    So I would strongly emphasize that we are the ones sending 
the orders to these dark pools, and it is our right to know how 
these orders are executed and handled, and we have to have that 
transparency so that we can provide best execution for our 
clients. Transparency in the order routing process is extremely 
important.
    I would think that another one of our big concerns is the 
process in which rules are promulgated. We feel very strongly 
that regular notice and comment rulemaking is the right 
procedure, and I would also say that the SEC is doing a 
fantastic job trying to promote the transparency and fairness 
in markets.
    Chairman Reed. Mr. Gasser, please.
    Mr. Gasser. Thank you, Mr. Chairman. I think there are a 
couple of challenges here that I think are interesting ones 
and, from the perspective of a fact-based approach, I think 
provide more complexity to the question set up and asked of the 
panel.
    One is the issue of surveillability. With 40 liquidity 
pools by most estimates now in operation in the U.S., how do 
you bring that all back together? And I think that the proposal 
that the Commission has put in place and the concept release 
around the disclosure of transactions I think is--as I said in 
my testimony, I think it is an important step in that 
direction. So surveillance I think is a big challenge, and 
clearly the Commission is taking some proactive steps, I think, 
to improve that.
    There has been, obviously, a lot of discussion here about 
high-frequency trading. The question there is high-frequency 
traders are important providers of liquidity to the market 
today. One panelist had made the analogy to the days of the 
specialists and the market maker. These guys have replaced 
those folks, we would say in a much more transparent way, 
actually, than existed in the past. But the question becomes: 
What is a reasonable liquidity provision versus sometimes 
manipulation of prices and markets?
    Clearly, the high-frequency traders that are regulated, 
there is obviously a tremendous amount of transparency 
available to the regulators in terms of their practices, and so 
we think that there is a significant amount of attention, 
deservedly, on that particular issue.
    To the point of a two-tiered market, I think one of the 
issues of complexity that has arisen here is--and when I say 
two-tiered market, I am not talking about institutional versus 
retail. What I am referring to is the notion of folks that have 
information and folks that do not have information. And this 
notion of creating a virtual marketplace of dark pools that 
selectively IOI to each other, indicate out to each other, I 
think is also deserving of quite a bit of scrutiny going 
forward. And as Pete alluded to, it is sometimes very difficult 
to get to the bottom of exactly what is going on out there in 
terms of this virtual linkage.
    One great benefit of the current environment that we are 
operating in--and it is great that you bring more light to this 
topic--is that institutions are more sensitive to the issues we 
are discussing today than they ever have been. So the best 
practices now have been elevated amongst institutions in which 
they are sending out questionnaires, asking very, very granular 
questions about the practices that we as broker-dealers deploy 
on their behalf. And so sunshine is the best disinfectant here, 
and so I think, you know, the free market certainly is at work.
    Chairman Reed. Thank you very much. I want to yield to 
Senator Bunning so he has a chance. We will do a second round. 
I will pick up with Mr. Mathisson and ask the same question and 
give you more opportunity to think through it. Senator Bunning.
    Senator Bunning. Thank you. I want to start with the SEC.
    First of all, the question I pose to you is not one of--it 
actually is not a question. It just is a feeling that the 
American people have. It seems to me that the SEC has all the 
power to address the market structure issues that we are 
talking about today. Or does the SEC feel that Congress needs 
to give them more authority?
    Mr. Brigagliano. Thank you, Ranking Member Bunning. We have 
indeed considerable authority to address most of the market 
structure issues we have talked about today, and I should point 
out that the legislative initiatives currently in Congress with 
respect to bringing over-the-counter derivatives into the 
regulatory tent and with respect to the regulation of hedge 
funds are important adjuncts to our authority.
    With more specificity on the trading structure, we 
currently have a large-trader authority, and we are working on 
possible proposals to better identify large traders so that we 
can see who is trading, who the principals are, who their 
affiliates are, get better information for time, get a better 
audit trail. But it may be that enhanced authority to require 
registration of some of these traders would be helpful as well.
    Senator Bunning. OK. What steps are you taking to ensure 
fair access for everybody to dark pools?
    Mr. Brigagliano. Senator Bunning, with respect to dark 
pools, as you know, we thought that addressing the two-tiered 
market and the access to the best price information of orders 
was step one.
    Senator Bunning. But why should somebody be excluded? That 
is my basic question. In other words, there are dark pools that 
certain people get in and certain people do not. Why should 
somebody be excluded?
    Mr. Brigagliano. Senator Bunning, that is an excellent 
question. One reason could be, for example, if a dark pool 
caters to large-size traders, to mutual funds and pension 
funds, it may well want to monitor the more predatory traders, 
if you will. People who are going to try to front-run those 
larger orders do not get in.
    At the same time, when the Commission issues its concept 
release in looking at dark pools more broadly and ATSs, I would 
expect it to include a discussion, a broader discussion, as you 
suggest, of fair access.
    Senator Bunning. OK. This is for everybody, but I am going 
to start with Mr. Driscoll and Mr. Nagy. Quickly, do you think 
identifying a trade on the tape as coming from a specific dark 
pool would affect prices in that stock?
    Mr. Driscoll. I do not think it would affect prices in that 
stock. I do think that it would affect the institutional 
traders' order routing decisions. It would give them more 
information as to where the stock was actually trading and help 
us----
    Senator Bunning. Well, if I am Fidelity and I have 100,000 
shares, obviously I am not going to sell 100,000 shares. I am 
going to give it to a broker and say, ``Break it down. Do 300, 
300, 500, 800.'' And, obviously they have enough wherewithal to 
do that. They are not going to trade 100,000 shares, and they 
are not going to show 100,000 shares.
    Mr. Driscoll. In the old days, that would be true. In 
today's market, I have the technology on my desk to break that 
order down and route it----
    Senator Bunning. That is exactly right.
    Mr. Driscoll. And you are right. Unless the portfolio 
manager has made the investment decision to execute that order 
at one time----
    Senator Bunning. In other words, to show it.
    Mr. Driscoll. Well, we probably would not show it in that 
case, anyway. We would probably go and get a capital commitment 
from one of our broker-dealers.
    Senator Bunning. Well, but, see, in my opinion, I think all 
trades should be put on the tape.
    Mr. Driscoll. Absolutely. We concur wholeheartedly with----
    Senator Bunning. As soon as the trade is made, it should be 
put on the tape so everyone can see it.
    Mr. Driscoll. In today's marketplace, the trades do hit the 
tape right away. It is just a matter of----
    Senator Bunning. I do not think we should identify the 
person that is making the trade.
    Mr. Driscoll. We would respectfully request that that 
information be made available on a delayed basis so that our 
information could not be used by somebody who would like to 
take advantage of it.
    Senator Bunning. Mr. Nagy.
    Mr. Nagy. Ranking Member Bunning, thank you. It is 
interesting because the little guy, the retail client, is 
literally forced to have their trade printed to the tape 
immediately upon that transaction occurring.
    Senator Bunning. But that is not--a hundred, five hundred 
shares, a thousand shares is not going to affect the market.
    Mr. Nagy. That is true. Conversely, large institutional 
trades are not required--especially in the dark pool, it is not 
required to be printed right away. The benefit to that is 
that----
    Senator Bunning. Well, I disagree with that, so, you know, 
I am--I think they should be.
    Mr. Nagy. What I am saying is that I do believe that dark 
pool trades, institutional trades, should be printed to the 
tape.
    Senator Bunning. The time the trade is made should be on 
the tape.
    Mr. Nagy. For the benefit of transparency in the 
marketplace----
    Senator Bunning. Yes.
    Mr. Nagy. Yes, I think that is absolutely important and 
paramount to ensure that we do not precipitate a two-tiered 
market structure in our system.
    Senator Bunning. OK. I agree.
    Mr. Mathisson. Just to throw in a factual correction, dark 
pools do have to print the trades immediately to the tape in 
the current structure.
    Senator Bunning. That is what I thought. But you do not 
identify either side.
    Mr. Mathisson. No. That is correct. That is not identified. 
It is anonymous as to who traded it or which company or dark 
pool put it up.
    Senator Bunning. OK. I only have one more question left. I 
have got lots of questions, but I only have time for one. One 
thing I did not see mentioned in any of your testimony is 
liquidity rebates or so-called ``maker-taker'' pricing designed 
to draw order flow. Is the Commission going to look at these 
practices, especially in regards to high-frequency traders that 
make a big part of their business collecting these fees that 
are ultimately paid by investors through higher costs?
    Mr. Brigagliano. Senator, Ranking Member Bunning, I note 
that when the Commission adopted Reg. NMS, it effectively 
capped those maker-taker rebates at three mils. At that time, 
there was significant comment suggesting that the maker-taker 
model did encourage display in liquidity, which could be 
salutary. Nonetheless, as the Commission looks further at high-
frequency trading in its concept release, it would make sense 
to look at the impact of particular market pricing models on 
trading behavior.
    Senator Bunning. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Reed. Thank you, Senator Bunning.
    Senator Corker.
    Senator Corker. Mr. Chairman, thank you, and I thank each 
of you for your testimony.
    I am trying to develop some kind of consensus with all of 
you who are testifying, and, again, thank you for being here 
with the vast amount of knowledge you have. I do not hear 
anybody--the notion of high-frequency trading, nobody here 
really has an issue with that, right? I mean, it is the way the 
market is made today; it is done electronically. Does anybody 
have a problem with high-frequency trading? I just want to sort 
of move that one off the table. I have not heard any complaints 
about the issue of high-frequency trading.
    Mr. Driscoll. Senator, I would like clear up a notion that 
was addressed earlier. At our conference, our annual 
conference, Seth Merrin did say that high-frequency trading 
could quintuple over the next decade. But he also followed that 
up by saying that he had no facts to back that up and he should 
not be quoted on it. I think a lot of times----
    Senator Corker. But he is quoted again.
    Mr. Driscoll. Yes. I think a lot of times, you know, 
numbers are tossed out there without any substance or empirical 
evidence of them, and that makes us concerned.
    I would also say that as far as high-frequency trading 
goes, it is my job to stop the people that are trying to take 
advantage of my orders. When I have an order working and I see 
it is starting to move up because high-frequency traders have 
sniffed it out, I will remove that order from the marketplace 
and wait until it reverts to where I want to buy the stock or 
sell the stock. So it is part of the job of the institutional 
trader to trade against these people.
    Senator Corker. But there is no problem that--there is no 
essential problem with the fact that high-frequency trading 
exists to create price discovery and----
    Mr. Nagy. Senator, just to note on that, I would say that 
one issue we would have in terms of high-frequency trading 
would be more of one with capacity utilization. What is 
commonplace with high-frequency trading is that there is 
typically a very large number of orders that are submitted to 
anyone particular entity. At the same time, there is equally a 
very large number of cancellations that are submitted. What 
that leads to is very low fulfillment rates. That effectively 
creates many, many quote changes out there that may or may not 
be necessary and unnecessary in the marketplace. For example, a 
high-frequency trader puts a price out there, then immediately 
removes that price; puts a price out, immediately removes that 
price. The infrastructure that is built upon distributing those 
quotes, of course, is taxed in that regard, so the question is: 
How are those fees distributed in terms of the market data 
costs and getting that to the retail investor? And how does 
that impact market data? And I do not think today that those 
costs are fairly disseminated amongst the marketplace.
    Senator Corker. Any response to that, SEC?
    Mr. Brigagliano. Yes, Senator Corker. As with other 
strategies and technologies, high-frequency trading may well 
have both benefits and raise concerns, and we have heard the 
benefit about increasing liquidity. But concerns that we will 
look hard at as we develop further audit trails and get into a 
deeper dive in our concept release, for example, would be if a 
trader is taking positions and then generating momentum through 
high-frequency trading that would benefit those positions. That 
could be manipulation, which would concern us. If there was 
momentum trading designed--or that actually exacerbated intra-
day volatility, that might concern us because it could cause 
investors to get a worse price. And the other item I mentioned 
was if there were liquidity detection strategies that enabled 
high-frequency traders to front-run pension funds and mutual 
funds, that would also concern us.
    Now, those are the things that we will look for as we do a 
deeper dive, Senator.
    Senator Corker. OK.
    Mr. Driscoll. I think that it is important to mention also 
that what high-frequency traders do do is they keep the fees 
down for all the other investors. But the exchange fees are 
distributed across a number of trades, and as those trades go 
up, the fees become less for the other investors in the 
marketplace.
    Senator Corker. It seems to me that, aside from some of the 
things that can happen with any system that need to be 
regulated, high-frequency trading has made the cost of a 
transaction far less for the investing public. And so, you 
know, we hear it and it sounds like it is a bad thing. It looks 
to me like, generally speaking, there are lots of attributes 
that these market makers are bringing to the system.
    It seems to me the other debate on--you know, let us move 
to dark pools for just 1 second. It seems to me that if I am 
hearing correctly, one base debate is whether a dark pool 
should disclose after the transaction occurs or when actually 
an order is made. Is that correct? Is that what I am hearing?
    Mr. Driscoll. I think it is important to understand that 
those trades are reported to the tape immediately. It is just--
--
    Senator Corker. After the trade.
    Mr. Driscoll. After the trade, but there is not any 
attribution to who actually traded it. The transparency we are 
talking about is attributing the trade to a specific dark pool.
    Senator Corker. And I guess I am having difficulty 
understanding if that is the case, the problem with--I mean, it 
seems to me very much like what existed on the New York Stock 
Exchange where you would call a specialist, they would make a 
trade for you. So they would not move the market too quickly, 
they would break it up. They would do it, and it seems like to 
me that is exactly what these dark pools are doing, except 
doing it electronically. Am I missing something?
    Mr. Sussman. No. I think that is a correct 
characterization, and the reason why, you know, we would oppose 
the SEC's proposal as currently stated or as I interpret it is 
that attributing it to the dark pool would then give the entire 
market the sense that, hey, in this particular dark pool where 
we know there are only certain market participants, there is 
activity----
    Senator Corker. Smart participants.
    Mr. Sussman. Yes. There is activity going on, and they 
would be able to use that information to trade ahead of the 
institutional traders that are in that dark pool. So that is 
the concern that we have.
    Senator Corker. Respond, SEC.
    Mr. Brigagliano. Yes, well, Senator, the Commission's post-
trade transparency initiative requires not that the individuals 
trading be identified, but that the dark trading venue be 
identified as an exchange would be identified. And where there 
were concerns about disclosing information that could hurt an 
institutional order, a large size order, the Commission did 
propose an exception. But, preliminarily, the Commission saw no 
reason not to display the smaller orders that other markets 
must display.
    Dr. Hatheway. And an issue from my perspective is on the 
pretrade transparency, retail investor orders, at least the 
best one in possession of a broker, have to be displayed to the 
public so everyone is aware of those. Those orders become the 
benchmark under which the dark pools trade.
    Dark pools individually provide a number of the benefits 
that have been mentioned here. Collectively, as the amount of 
dark pool volume increases, you lose the transparency into 
where people are willing to buy and sell. And I think the 
pretrade dimension of what the SEC has on the table is 
something that we should consider and adopt.
    Senator Corker. I know my time is up, but it would seem to 
me then that an institutional buyer would in that case, in your 
case, be better off going back to the one person making the 
trade. But it really seems like you would be setting things 
back hugely solely to benefit an electronic exchange like you 
have.
    Mr. Gasser. Based on the data we collect, Senator, the 
institutional buyer and seller will always be best served by 
finding a natural institution on the other side. So in the 
example of a Fidelity 100,000-share print, rather than split 
that up into 300 shares and disseminate--into 300-share lots 
and disseminate it over 40 execution venues, if they can find 
Vanguard on the other side, within the framework of the exist 
bid-offer spread, that is a frictionless trade, right? So----
    Senator Corker. Let me say this. I am going to stay here 
and ask more questions. We can talk more about it. My time is 
up.
    Senator Bunning. Let me enter in there, because the best 
price is not going to exist.
    Mr. O'Brien. I think it is about striking a healthy balance 
between the price discovery that exchanges provide----
    Senator Bunning. If I am going to try to trade 100,000 
shares of IBM, and I am going to put it on somebody's trading 
block or some institution has a trading block, I will not get 
the best price for that 100,000 shares if I am the seller 
unless I break it down and do it in many, many smaller trades.
    Mr. Gasser. That is correct, Senator, unless there is an 
equilibrium price of----
    Senator Bunning. Well, how often----
    Mr. Gasser. In our system, that happens every day. We 
trades tens of millions of shares between institutions in a 
dark manner.
    Senator Bunning. Well, we will bring the institutions in 
and ask them.
    Mr. Gasser. What is that?
    Senator Bunning. I said we will bring the institutions and 
ask them.
    Mr. Gasser. Absolutely. And I think what you would find is 
that they are very supportive of that mechanism.
    Chairman Reed. Thank you.
    Senator Schumer. Thank you. And I think Senator Bunning's 
questions were on the money. And if the market is so 
fragmented, you never know that best price. That is the problem 
here. That is the fundamental problem that we are trying to 
create. But let me just say a few words and then ask some 
questions.
    I want to thank Senator Kaufman and, of course, you, Mr. 
Chairman, and all the witnesses. Sorry I could not be here 
during your testimony. I have looked at it.
    As you know, I have taken an active interest in many of the 
issues being discussed at today's hearing because I believe 
America's capital markets have been and should continue to be 
the leading markets in the world. For decades, why have they 
been the leading capital markets? They are the most efficient, 
the most transparent, the most fair, greatest integrity, and 
they have been the envy of the world. When other countries are 
setting up their capital markets, they look to us. And people 
think they are getting a fair deal here, that things are less 
likely to be manipulated here than anywhere else. We cannot 
lose that.
    An important part of that success is due to regulation that 
has historically ensured that the little guy, while he might 
not have as much money or these days the most advanced computer 
systems, can be sure when he puts in an order, the price he 
gets is fundamentally fair. That is what we are worried about 
here.
    And as I stated in my letter to the SEC last week, the 
proliferation of alternative trading venues has significantly 
altered the trading landscape. Many of these changes have been 
largely for the better.
    The competition provided by alternative trading systems 
brought significant benefits to retail investors, and that has 
been discussed by many of our witnesses. But these benefits 
have come at a cost because our capital markets have become 
increasingly fragmented, and market surveillance has not kept 
pace, making it increasingly difficult, especially in light of 
the technological developments that facilitate large volumes 
trading at high speeds, to conduct adequate market surveillance 
across the markets. I am concerned that this will erode the 
confidence in the fundamental fairness of our markets.
    And so I agree with Senator Corker. High-speed trading, 
nothing wrong with it. It is good. To stop it would be Luddite. 
But it can produce certain problems in the market in terms of 
equality, that the little guy and the big guy have the same 
shake. And that is what we have to guard against.
    So the way to do this is not to abolish high-speed trading. 
That would make no sense. The way to do it is to acknowledge it 
is here and it has benefits, but we have to guard against the 
liabilities that it brings.
    So I propose to the SEC that market surveillance should be 
consolidated across all trading venues to eliminate the 
information gaps and coordination problems that make 
surveillance across all the markets virtually impossible today. 
It would deal with the problem that Senator Bunning correctly 
brought up.
    So my first question is to Mr.--I think you were wise to 
call him ``Mr. SEC.'' Mr. Brigagliano--see? OK? As I noted in 
my letter to Chairman Schapiro last week, I am concerned that 
our fragmented market system of surveillance makes it nearly 
impossible to monitor market manipulation, monitor trading 
ahead of customer orders, and other abuses at the same time 
that the fragmentation of our markets and technological 
advances make such abuses easier to carry out.
    Now, I understand that the SEC is looking at options to 
increase the information available to regulators, but would the 
SEC consider requiring fully consolidated market surveillance 
across all markets?
    Mr. Brigagliano. Senator Schumer, that has to be an 
important element of enhancing our ability to surveil because 
while there is an Intermarket Surveillance Group, while markets 
share technologies, while they share information, without some 
central focus something could be missed.
    Senator Schumer. Right.
    Mr. Brigagliano. So as we move forward in trying to develop 
a better audit trail and better surveillance, you know, that 
concept has to be part of it.
    Senator Schumer. Good. I am glad to hear that. So you are 
moving in that direction, right?
    Mr. Brigagliano. Chairman Schapiro has an inter-division 
task force working hard on those issues.
    Senator Schumer. But you agree basically with the thrust, 
the SEC agrees with the thrust of my remarks.
    Mr. Gasser. Senator, may I----
    Senator Schumer. Wait, wait. Let him answer first. He has 
got the power.
    Mr. Brigagliano. Senator, we are absolutely moving to 
consider that. We think there is benefit to centralized 
surveillance.
    Senator Schumer. Great. Good. OK. My next question is for 
Dr. Hatheway. You say in your written testimony that, ``Rapid 
detection and enforcement through real-time and post-trade 
surveillance are critical to fair and orderly markets.'' Would 
NASDAQ endorse consolidated market surveillance? And if you can 
answer yes or no, that would be just fine.
    Dr. Hatheway. I will work the yes or no in there, Senator. 
Thank you. We engage in multiple industrywide initiatives for 
cooperative surveillance, including the Intermarket 
Surveillance Group and the Options Regulatory Surveillance 
Authority plan, the joint activity you mentioned a moment ago 
to surveil for insider trading. We look forward to gaining 
experience from these joint plans and the options initiative, 
and we are moving ahead on consolidated regulation----
    Senator Schumer. I did not quite----
    Dr. Hatheway. So, yes.
    Senator Schumer. Yes. Good. Thank you.
    Mr. Nagy, what about you? From an investor's perspective--
did I pronounce your name right, sir? I am sorry.
    Mr. Nagy. Close.
    Senator Schumer. Mr. Nagy, from an investor perspective, do 
you think consolidated surveillance would benefit your 
customers and improve confidence in the integrity of our 
markets?
    Mr. Nagy. Senator Schumer, I think [inaudible].
    Senator Schumer. Great. OK. Now, Mr. O'Brien of Direct 
Edge, one of the concerns I have raised about flash orders, 
that it might allow someone receiving a flashed order to detect 
a pattern and trade ahead of those orders on other markets. 
What is Direct Edge doing to make sure this doesn't happen? 
Isn't it true that you can only monitor what is happening on 
your own trading platform? You can answer those, and then 
finally, we didn't agree on flash orders, but do you agree, 
then, with my proposal for consolidated market surveillance 
across all markets? You can answer all three questions.
    Mr. O'Brien. I will answer that question first, which is 
yes, because there is only so much one market center or 
exchange can do in surveilling marketwide trading activities--
--
    Senator Schumer. This is great.
    Mr. O'Brien. ----for the patterns and the practices.
    Senator Schumer. Good.
    Mr. O'Brien. I think any order type that--whether it is a 
flash, using flash order technology, or a limit order, 
basically exposes information to other people and other people 
may take action in response to that. That is the nature of 
markets. Everyone wants to keep their cards to themselves, but 
ultimately, you have to show information to other people in 
order to get a trade executed.
    What we have tried to do to ameliorate those concerns 
within our own market is, one, make those order types optional. 
Make people choose to see them so that they see that the 
advantages of using them outweigh those risks.
    Number two, the technical implementations we have done have 
allowed us to look at the activity of the individual receiving 
that information and trading on them within our market.
    But third, and to go back to your, I think, underlying 
thrust of your questioning, we have tried to and would support 
better marketwide surveillance.
    Senator Schumer. Good. Does anyone disagree with that, of 
the other--Mr. Gasser, Mr. Driscoll, and Mr. Sussman?
    Mr. Driscoll. I would be concerned that if we went to a 
consolidated regulation regime, we would lose the nuances of 
the markets. You know, the NASDAQ marketplace is quite 
different than the New York Stock Exchange. So I would think 
that we would want to go on to harmonize regulation more than 
consolidate regulation so that we could keep those nuances that 
add value in those marketplaces for us.
    Senator Schumer. Why don't you--I don't quite understand. 
You can still have nuances in the market and have a 
consolidated market surveillance.
    Mr. Driscoll. The regulators at the NASDAQ understand their 
marketplace to a much better degree than somebody from the New 
York Stock Exchange Regulation Department, is my point. So we 
would want to make sure that those people had the ability to 
continue working.
    Senator Schumer. My time is up. Mr. Chairman, Mr. Gasser 
wanted to----
    Mr. Gasser. Yes. Senator Schumer, in my response to the 
Chairman's question about the challenges that face the 
marketplace, surveillability was the number one issue, so we 
would be very supportive of consolidated surveillance.
    Senator Schumer. Thank you, Mr. Chairman.
    Chairman Reed. Thank you very much, Senator Schumer.
    Senator Schumer. Thank you for those excellent answers.
    [Laughter.]
    Chairman Reed. I posed a question to roughly half the panel 
about the challenges that we face, stepping back a bit, with 
this new technology, given that many of these practices on a 
person-to-person basis existed for years. So you have had time 
to think about it, and if you could be as succinct as possible, 
starting with Mr. Mathisson.
    Mr. Mathisson. All right. Well, thank you. So you would ask 
for the three issues that the regulators should be looking at 
and the first one we believe they should be looking at is fair 
access for dark pools, which we have already spoken about 
today, but we believe that there is a significant problem, not 
so much--the SEC raised the issue that dark pools might want to 
shut out a type of investor because, as Mr. Brigagliano put it, 
they might want to only trade with institutional investors and 
keep out what he called predatory investors.
    We believe that could be accomplished with objective 
standards. We think that they could shut out people based on 
order size, based on time people are willing to leave the 
orders in the system. They could shut out people based on 
disciplinary action history, to try to get out the guys who are 
perceived to be sleazy. But we think it can be done in an 
objective way, where you can set objective standards and say 
anyone who doesn't meet this--anyone who meets this criteria is 
allowed in. Anyone who does not is out. We don't think it 
should be capricious in that they should be able to shut out 
individual brokers that they perceive to be competitors.
    The second issue would be the issue of what is called naked 
access, which is when certain broker-dealers allow traders to 
go straight to the market centers through their own technology 
and give up the broker's name. It is referred to as naked 
access. It means that there are no risk checks and it is not 
passing through the broker's system. We believe that that does 
raise issues of systemic risk.
    And the third issue would be around proper transparency and 
surveillance, as was just being discussed. We believe that 
there should be real-time transparency to the regulators. There 
should be real-time disclosure of a whole lot of things to the 
regulators, but not to the trading public because there are 
situations--information in the trading markets is not always a 
good thing and transparency is not always a good thing in real 
time in the trading markets because it does potentially allow 
traders to get ahead of longer-term investors. So while we 
believe there should be real-time disclosure of quite a few 
things to the regulators, things to the overall market can wait 
until the end of the day, end of the week, or end of the month.
    Chairman Reed. Thank you very much.
    Mr. Nagy, please.
    Mr. Nagy. Thank you, Chairman. The first issue, I would 
say, would be that of unintended consequences. In respect to 
that, the SEC, particularly the Division of Trading and 
Markets, has been very effective at creating a market structure 
that serves the retail investor. Moreover, we think the SEC is 
uniquely qualified to really have a deep understanding of micro 
market structure that we are talking about here today and to be 
able to see what some of those unintended consequences are 
through the public rulemaking process that they currently have 
today.
    The second issue is really of investor integrity in our 
markets. With that being said, the Senate oversight 
responsibilities that you are conducting today, particularly of 
the SEC, are paramount to ensure that our markets continue to 
be fair for the individual investor. While today the markets do 
function in a very competitive and robust fashion, we need to 
ensure that the average Joe continues to get a fair shake in 
the marketplace.
    Finally, one of the issues which has benefited the markets 
greatly over the years has been one of transparency. We need to 
continue to promote transparency, as transparency is really the 
key to driving long-term investment from the individual 
investor in our marketplace.
    Chairman Reed. Thank you very much.
    Mr. O'Brien.
    Mr. O'Brien. I think the first thing that is not often 
talked about in this debate is just greater investor education. 
I think we are all realizing, now more than ever, that we are 
stewards of investor confidence and the average American has a 
woefully antiquated understanding of how stocks are traded in 
this day and age. And so there are a variety of steps that I 
think need to be taken, and it is hard when the pace of change 
is so rapid in order to do that. Rational disclosures, greater 
education across the board. That allows investors, one, not to 
wake up one day and realize that they feel like their stock 
market is spinning out of control, and they can make informed 
choices about how to get their orders executed.
    I think the second, and I won't reiterate on this, but just 
echoing Senator Schumer's concerns, regulators who are 
accountable need the tools, talent, tenacity, and information 
to be able to do their job in rapidly changing market 
conditions. And I think maybe the biggest challenge is just 
managing the--both important equally, but at times conflicting 
objectives of promoting efficiency and competition.
    We had a system 10 years ago that was very centralized and 
in some ways very efficient, but it had its own problems--DOJ 
investigations, specialists leaving the floor in handcuffs, 
exchange executives having tens of millions of dollars of 
compensation. We don't have those problems anymore, or 
challenges, but we have new challenges and the line in this day 
and age, especially with technology, between a trader and a 
broker and a market and an exchange are increasingly blurred. 
And so how to manage that competition in a way that, over time, 
is producing a continually efficient market that investors have 
confidence in.
    Chairman Reed. Thank you very much, Mr. O'Brien.
    Doctor.
    Dr. Hatheway. Thank you very much, Mr. Chairman. The topics 
we have been talking about today--high-frequency trading, dark 
pools, flash orders--either originated with or were popularized 
by ATSs. I think one thing that is missing in the current 
regulatory structure is a thorough scrutiny by the SEC of the 
business model of new ATSs when they are launched and SEC 
review of new policies that ATSs intend to put in place as part 
of their business. This is not rulemaking at the level the 
exchanges are subject to. Instead, this is simply review by 
another set of eyes as to what the potential market impacts may 
be from innovative and competitive ideas should they become 
widely adopted in the industry, as was the case with flash 
orders.
    The second point on disclosure of actionable IOIs, if that 
should be adopted in rulemaking, the SEC needs to remain 
vigilant as to whether that is sufficient to incur good 
pretrade transparency. Some of us on this panel will remember a 
time when you wanted to get a price in a stock, you had to make 
three phone calls. You don't want an environment where you need 
to ping three dark pools to find out what the price is, because 
in a computerized environment, an outbound message or an 
inbound message both can be done very, very quickly.
    Finally, as Dan Mathisson said, sponsored access is 
something that needs thorough scrutiny. NASDAQ has a rule 
filing requiring pretrade risk management for the users of 
sponsored access. We would encourage that to become standard 
and other exchanges to file similar rules. Thank you.
    Chairman Reed. Thank you very much.
    Now, Mr. Brigagliano, you have the floor to summarize.
    Mr. Brigagliano. Thank you, Chairman Reed. Advances in the 
technologies and strategies in the market have resulted often 
in lower trading costs and better prices for investors, and 
they drive our economy and that is well and good.
    At the same time, our job as regulators is to make sure 
that the core principles of the Exchange Act--best execution, 
fairness, nonmanipulated markets--are maintained. So as we look 
at high-frequency trading, direct market access, dark pools, 
colocation, flash orders, to pick up on Senator Schumer's 
point, it is not a question necessarily of saying one is good 
or bad, but it is addressing through rulemaking, auditing, and 
surveillance any threats to those core principles that could 
arise as the markets innovate and develop.
    Chairman Reed. Thank you very much.
    One other point I think you would agree to is that the 
issue of adequate resources, what has impressed me is that I 
would suspect these gentlemen have sort of much more 
sophisticated software, hardware, every kind of ware, and sort 
of more Ph.D.s and et cetera than the SEC. There is a real 
issue here, a basic issue of just keeping up with the 
technology, by having the technology and the expertise. Is that 
an issue that you are working on at the SEC and ready to ask or 
tell us what you need?
    Mr. Brigagliano. Yes, Chairman Reed. Particularly as we 
refine what we believe is necessary to make sure we adequately 
can monitor and analyze trading with the new technologies, we 
likely will need advanced in technology and additional 
individuals with the skill sets to make that technology most 
efficient for us.
    Chairman Reed. Thank you very much.
    I have one additional question, so I will recognize Senator 
Bunning, Senator Corker, and then I will ask the question. If 
you want to stay and ask other questions----
    Senator Bunning. I will try to get mine in all this time, 
since I have got 5 minutes.
    First of all, you all seem very happy about the way things 
are, or reasonably happy, but we have had some unbelievable 
messes. I mean, a $50 billion mess is a pretty big mess. Now, 
we somehow in regulations were not able to discover Bernie and 
his Ponzi scheme that he was doing, and he wasn't even doing 
it. It was all a hoax on the people. So somehow, the SEC has 
got to be able to have the power to regulate those kind of 
people that are dealing in securities or nonsecurities and just 
plain fraud. I just hope that you have the tools to do that 
with. Are you going to not answer, or are you going to answer 
me?
    Mr. Brigagliano. Ranking Member Bunning, I would be happy 
to answer. I wanted to make sure that your question was 
completed.
    Senator Bunning. Oh, OK.
    Mr. Brigagliano. We have identified the additional 
enhancements we think we need in terms of better audit trail, 
more information about large traders----
    Senator Bunning. Quicker information?
    Mr. Brigagliano. Quicker information and also who is really 
behind the trade. Quicker access, really, is the way, you are 
right, to find out who the principals are, who their affiliates 
are, to sort that out more quickly when we need to find out, 
and we are working on developing that capacity. And then, of 
course, the additional technology to analyze this huge volume 
of high-speed trading.
    Senator Bunning. Mr. Driscoll, in your statement, you 
suggested that regulatory gaps between exchanges and 
alternative trading systems should be addressed. Do you have a 
specific suggestion about what should be done?
    Mr. Driscoll. As these dark pools that are incubated under 
Reg ATS mature, we think that they should pick up one of the 
responsibilities that the exchanges have. Whether that entails 
sharing some of the regulatory burden, the costs, or starting 
to manage the----
    Senator Bunning. You are all making enough money to share 
the burden.
    Mr. Driscoll. ----or sharing the--starting to regulate some 
of the members that are coming into their pools. We think that 
the way to really weed out the ones that aren't providing more 
value than the lit venues is to bring that regulation up and 
let them share some of the burdens, making the playing field 
more level for the exchanges and the ATSs.
    Mr. O'Brien. Ranking Member Bunning, I would just add to 
that. There is an example of how that is working. So Direct 
Edge operates as a form of an ATS today, and we embraced that 
regulation when we were very small. We have now become a 
material part of the market and we are voluntarily in the 
process of applying to the SEC to register our markets as 
exchanges. We are actually, given our growth, seeking greater 
regulation and responsibility overall.
    Mr. Driscoll. I think----
    Senator Bunning. Congratulations.
    Mr. Driscoll. I think that that is exactly our point, is 
that we want to develop deeper and better players in the 
marketplace. So the incubation brings these more mature players 
and they come in and pick up some of the responsibilities that 
other markets are taking right now.
    Senator Bunning. Mr. Nagy, you seem to be concerned about 
the impact of dark pools and high-frequency trading practices 
on retail investors, especially on the accuracy of displayed 
prices. What do you think needs to be done to level the playing 
field for retail investors while keeping the benefits for 
institutional investors who are likely also representing the 
same retail investors through retail funds?
    Mr. Nagy. Sir, the concerns I put forth in my discussions 
today represent our concern in terms of to what degree do you 
reach a tipping point in terms of reducing the transparency in 
the public marketplace for the benefit of dark trading. Today's 
retail client, when they decide to purchase or sell a security, 
the only real way they can be enabled to do that is by 
ascertaining a quotation which is only available in the public 
marketplace to decide what they are going to buy or sell.
    As we see growth proliferation within dark pools, and I 
don't focus so much on volume percentages per se. I would 
rather focus on sheer numbers. It is estimated that there are 
over 40 dark pools today. At any one point in time, that could 
increase really exponentially because the process, the 
Regulation ATS process is a fairly simplistic process.
    Senator Bunning. I think that the information we have 
gotten is different from the information you just quoted.
    Mr. Nagy. How so, sir?
    Senator Bunning. There are 29 dark pools that represent 7.2 
percent of the market.
    Mr. Nagy. Yes, that is--I have heard a lot of different 
numbers, actually.
    Senator Bunning. Well----
    Mr. Nagy. We did a study last year where we found 42 
different dark pools in the marketplace.
    The real question, though, is to what degree does 
proliferation of dark pools provide real benefit, and one of 
the concerns or potential unintended consequences of some of 
the dark pool regulation that the SEC is proposing by reducing 
the display percentage to 0.25 percent is do you then 
exponentially simply increase the number of dark pools in the 
marketplace and further fragment the market, and we don't see 
that being comprehensively addressed. Therefore, we believe 
that there should be some sort of rigorous standards to ensure 
that the process itself is robust, that process----
    Senator Bunning. You are eating up all my time, so thank 
you.
    Mr. Nagy. Sorry, Senator.
    Senator Bunning. This is a toss-up. Are there any practices 
or market developments that we have not talked about today that 
benefit select firms or groups over individual investors that 
you think need to be addressed? That is a toss-up for anybody. 
Don't all of you----
    Mr. Sussman. If I could take the conversation away from the 
U.S. equity markets, I think that the retail investor does not 
have access to all of the products and instruments that 
institutional investors do have access to.
    Senator Bunning. Do they want them?
    Mr. Sussman. Well, we should ask them.
    Senator Bunning. Are they sophisticated enough to deal with 
them?
    Mr. Sussman. I think so, yes. I mean, I think that if you 
are willing to--if you have an understanding of the market--I 
mean, there are suitability requirements that brokers have----
    Senator Bunning. When I was in the business, we said if you 
want to do options and other things like that, go to the track. 
You have got a better shot.
    Mr. Sussman. Well, I mean, I think that if we are going to 
allow our pension funds and mutual funds to trade in these 
instruments and investors the same, why not give folks an equal 
opportunity to trade those instruments themselves, as well. In 
fact, when an individual investor takes on that responsibility, 
they can be sure of how their money is invested, right? When 
you put your money into a pooled fund, you actually are losing 
that connection with your investments, and I think that is part 
of the problem that we have today, is that people are so far 
removed from the investment practices that go on that when 
something like Bernie Madoff happens and everyone is surprised, 
it is no surprise that when you start to disassociate----
    Senator Bunning. Greed is no surprise. There is enough 
going around.
    Mr. Sussman. Right.
    Senator Bunning. So when someone specifically bilks $50 
billion out of the market, it doesn't surprise anybody who sits 
up here. It may surprise some of you who are in the business, 
but I doubt it.
    So my question was is there something that we are missing--
--
    Mr. O'Brien. Ranking Member Bunning, I will make a point, 
and it has to do with market data. There has been a lot of 
focus on flash as potentially giving select market participants 
a millisecond advantage. I disagree with that for some reasons, 
but the broader point and something that is very well known on 
the street is that the consolidated quote, the national best 
bid, best offer, is very slow and totally noncomprehensive 
related to the proprietary data feeds that some exchanges are 
selling to high-frequency traders and other customers and 
earning----
    Senator Bunning. Well, maybe that is a very key point that 
the SEC should be looking at.
    Mr. O'Brien. Yes, and our market data infrastructure on a 
national basis hasn't been upgraded to reflect that reality.
    Senator Bunning. Thank you.
    Mr. Driscoll. Senator, if I may, just one further point on 
that. I was concerned, too, about the slowness of the SIP quote 
and was discussing it last week with the representative of a 
major exchange who informed me that while that was a problem in 
the past, the SIP quote is now up to three milliseconds behind 
the direct data feeds from the exchanges. I don't know for a 
long-term investor if that is a significant amount, but they 
have made good strides in bringing that up to speed.
    Senator Bunning. Thank you.
    Chairman Reed. Senator Corker.
    Senator Corker. Mr. Chairman, thank you, and we have so 
many great witnesses today, I apologize for not being able to 
talk with each one of you. You all have been great witnesses.
    But I want to get back to the dark pool issue just to sort 
of take one topic at a time, at least for me. Mr. Nagy, it 
seems to me that the dark pools are an outgrowth of electronic 
exchanges where people are trying to sell large bulks of shares 
in a way that used to be done by individuals. So if we are 
going to be almost all electronic exchanges, even the New York 
Stock Exchange--I am just wondering whether that is not the 
world they should have been in years ago--what is another 
mechanism for large institutional traders of large blocks of 
stock, what is a fairer way for them to be able to make those 
types of trades without moving the market substantially and 
really harming the very people they are investing for? What is 
a better mechanism than a dark pool?
    Mr. Nagy. So, Senator, you bring up a very, very good 
point, and to clear my points, although I have concerns of 
where dark pools are going, the proliferation or the birth of 
dark pools, particularly after Rule 301 Reg ATS, has been very 
beneficial in turning that volume and bringing that volume into 
much more of an electronic format. If you do away with all dark 
pools, then do you simply drive that business in back, and I 
believe you stated this earlier, into its previous form, which 
was a sales trader sitting up at a shop taking paper order 
tickets down on the floor.
    So I want to make sure that you understand that dark pools 
do have a place to minimize transparent market impact in 
today's marketplace. However, we must be cognizant and careful 
of the proliferation of them.
    As we approach, as Ranking Member Bunning said, we have 
29--I have counted more than that--to what degree and what 
measures do we put in place so that we don't have hundreds out 
there, or perhaps even thousands----
    Senator Corker. So your point is not that they are bad----
    Mr. Nagy. Correct.
    Senator Corker. ----it is just that too many of them might 
be bad.
    Mr. Nagy. That is correct.
    Senator Corker. And you are talking about numbers, not 
percentages of the market, is that correct?
    Mr. Nagy. Yes, sir.
    Senator Corker. OK. So, Mr. Mathisson, you made the point, 
I think, that you shouldn't be able to exclude people, that 
everybody ought to have access to a dark pool. But it seems to 
me that if you do that, you kind of do away with the whole 
purpose of the dark pool in the first place, don't you?
    Mr. Mathisson. Well, the purpose of the dark pool is to be 
able to buy or sell without displaying bids and offers to the 
marketplace. It is not to avoid trading with any particular 
type of party. So, no, I don't think--I think the purpose of a 
dark pool is to replicate what in the old days was equivalent 
to a broker putting the order in his pocket and looking for the 
other side without actually displaying to the world that there 
is a new buyer or a new seller in the marketplace.
    Senator Corker. Mr. O'Brien, do you agree with that?
    Mr. O'Brien. I think it is a combination. I mean, I think 
the focus is how to allow dark pools to each have their own 
kind of independent value proposition, but keep everyone 
connected as reasonably possible, right. So that is really the 
one reason why we use flash technology, in that while each dark 
pool wasn't necessarily letting everybody in, we created a 
network of 25 or so dark pools that people could access using 
flash technology and get an execution on our exchange at the 
same time. So it is about bringing everyone together in a way 
that works for everybody, both over the short term and the long 
term, and I think we can preserve that.
    Senator Corker. Yes, sir?
    Mr. Gasser. Senator Corker, I would respectfully disagree 
with Dan. You know, just from ITG's and POSIT's perspective, 
the vast majority of our executed volume in our dark pool was 
institutional and we are very selective about the constituents 
from the perspective of there are a lot of broker-dealers and 
competitors that have competing business models, right, and 
some of them have principal trading objectives. They are 
operating as a fiduciary for another client, right, in some 
cases. So our focus is singularly on the client, singularly on 
the quality of execution, and it is not necessary about just 
building market share and building executed volume. So I think 
we need to maintain some sense of independence.
    Taken to its logical extent is the upstairs market would, 
in effect--I mean, taking it to that extreme, the upstairs 
market would disappear. If I give Goldman Sachs access to 
POSIT, why shouldn't I have access to their HOOT [phonetic] and 
the communications that are going on between their sales 
traders and block traders? So there is a level of transparency 
here that I think could be counterproductive to the quality of 
execution.
    Mr. Driscoll. I would agree with that. You know, as an 
institutional trade, I do not want my orders going into fuel 
somebody's proprietary trading engine. I want to protect my 
orders, and the way to do that is for me to know who is in 
those pools and be able to trade with the people that I want to 
trade with.
    Senator Corker. And just for what it is worth, it seems to 
me that is the most sensible place, and I realize there ought 
to be a lot of disclosure, and I understand that is what most 
people are pursuing. Some people want it before the transaction 
occurs. Some people want it after. Again, it seems to me that 
after makes more sense because the whole purpose is to keep 
that order in your pocket until you know that you have been 
able to transact it without moving the market. So, anyway, it 
seems like a natural outgrowth of where our country and where 
the world markets have gone.
    But back to NASDAQ, Dr. Hatheway, moving on now to flash 
trades, you all used to do that, and you stopped doing that. 
And you all have been on the leading edge of--you know, maybe 
you are the one that created all this mess in the first place 
because of your great electronic exchange and people have 
mimicked that. And I thank you for that, and I enjoyed visiting 
your facilities.
    But you all did have flash trading, and you stopped, and I 
wonder if you might educate us as to why.
    Dr. Hatheway. Certainly, Senator. Thank you for the 
question. Flash trading was a feature of the market that 
existed in the hands of our competitors. We undertook a 
detailed analysis of flash trading, its impact that we saw on 
the market. We also entered into discussions with the SEC. 
Before we launched it, we had reservations about what it would 
do to market quality. When we launched it and when the SEC 
decided they would undertake rulemaking in this area, we 
withdrew it. It never became a particularly material part of 
our business. It was, as I said a few moments ago, a feature 
that originated in other parts of the market, perhaps without 
sufficient review when it first arose, and it became something 
that was a missing part of our product suite. We were happy to 
do without it and happy to see it eliminated from all the 
markets.
    Senator Corker. May I ask one more question?
    Chairman Reed. Go ahead, Senator.
    Senator Corker. Again, I thank each of you. The issue of 
colocation, do you mind, since you all--obviously, I am sure 
people want to collocate near NASDAQ. From your perspective, 
what are the things that those who want to make sure that 
markets act in transparent and fair ways, what are the main 
issues that we ought to be concerned about as it relates to 
colocation?
    Dr. Hatheway. With colocation you cannot stop people from 
striving for proximity, to be close to the exchange. We think 
colocation----
    Senator Corker. That has been while Wall Street existed in 
the first place, right?
    Dr. Hatheway. Wall Street existed, Threadneedle Street, 
pick your street. They are all the same way. We think by 
bringing the proximity within the exchange into a regulatory 
environment where you have fair and nondiscriminatory access, 
it provides benefits to the industry and to the investing 
public. Small firms can gain access to the market, startups, 
firms that are not particularly close to the city of New York. 
So it brings competition.
    The key thing for the Commission and for us is to be sure 
that we have sufficient access so people who want to collocate 
with us can, that it is provided fairly, and that the benefits 
of colocation are nondiscriminatory between those who want it 
and have it.
    Senator Corker. But colocation, are there any real issues 
right now that exist with colocation?
    Dr. Hatheway. There are no issues that I am aware of. The 
firms that are in our data center tend to be happy with what 
they have, the resources that we make available to them. There 
is a space available if more people want to come into the data 
center. I cannot speak for other market centers that offer 
colocation.
    Senator Corker. And the benefit, just for novices like 
myself, of actually being in your data center to someone who is 
operating a dark pool or whatever, that benefit to them is?
    Dr. Hatheway. The benefit to them is reaction time to 
changes in the market. It is obviously----
    Senator Corker. So it is the length of time that data takes 
to get from point A to point B and, therefore, being adjacent 
to it, it is literally that transmission that benefits that 
collocator. Is that correct?
    Dr. Hatheway. That is the perception among the collocators. 
As an economist, I think if they were across the street, it 
would not make an appreciable difference. But I am not a 
technologist. But the technologists tell me that the speed of 
light does not make a difference. You get the signal. Then the 
time advantage becomes how fast you can process that 
information.
    As an old floor trader, yes, that is what mattered more, 
not how quickly you could hear, how far across the pit you 
were, but how quickly you could think.
    Senator Corker. I could go on and on. Mr. Chairman, I thank 
you. I do want to say, Mr. Sussman, I did not ask you any 
questions, but I thought your presentation was outstanding and 
very easy to understand. I think all of you have helped us 
tremendously, and I thank you for having this hearing, Mr. 
Chairman.
    Chairman Reed. Thank you, Senator Corker.
    I have got one final question, and that is, we have talked 
about high-frequency trading, and I think it has been 
characterized in many different ways. But I was somewhat 
startled a few months ago when I read an article reporting on 
the arrest of an employee of Goldman Sachs who had allegedly 
stolen code for their high-frequency trading programs, and the 
Federal attorney who was before the judge arguing for a very 
high bail or no bail at all said that he was informed that with 
this software, there is a danger that somebody knew how to use 
the program and used it to manipulate markets in unfair ways. 
So, you know, I think it is important now with this technique, 
is there a way to use it? I mean, I think the presumption 
underlying all your questions, is this being used in a 
scrupulous way, just like our presumption was in many cases 
that, you know, fellows like Bernie Madoff, et cetera, were 
living up to their obligations, et cetera. But we have to be 
prepared for a world in which one, two, or three people are not 
scrupulous about their responsibilities. Mr. Gasser.
    Mr. Gasser. Yes, Chairman Reed. We talked about 
surveillability earlier on and the level of sophistication that 
is needed to understand, you know, what is a liquidity 
provision on the part of a high-frequency trader--in other 
words, providing liquidity to the market--and what is potential 
manipulation. We deploy, as I know other firms do, a tremendous 
amount of technology to recognize patterns in the marketplace, 
such that when we do enter the lit market, we understand 
exactly how our orders are being interacted with.
    And, you know, from our own experience, I can tell you that 
there are some frictional trades going on out there that 
clearly look as if they are testing the boundaries of liquidity 
provision versus market manipulation. And so I think that the 
technology we alluded to earlier--the software, the hardware, 
the intellectual capital needed to do that--I think for most 
firms that are operating in the U.S. marketplace today that 
have a significant institutional share, it is a requirement in 
terms of doing business. And certainly I think the SEC would 
benefit greatly from having the same capabilities, but there is 
clearly an issue at the extreme end. And I am sure it applies 
to nonregulated enterprises, folks that do not have a 
transparent regulatory environment to operate under. But that 
is our----
    Chairman Reed. Let me follow up with a basic question, 
which I probably should have asked initially. These high-
frequency trading platforms can be located anywhere in the 
world. Is that correct?
    Mr. Gasser. Absolutely.
    Chairman Reed. So you could have someplace beyond the reach 
of regulators----
    Mr. Gasser. Right, and that is why sponsored access is an 
issue that is closely linked to this in terms of who are these 
folks, are they regulated, nonregulated, are they entering 
marketplaces without the proper compliance checks, the proper 
financial checks. Even from a completely innocent perspective, 
do folks have the ability to fat finger and move markets 
arbitrarily, you know, completely unintentionally?
    I think the high-frequency trading issue certainly is 
deserving of focus, as is sponsored access. Those are highly 
correlated.
    Chairman Reed. Let me follow up. I know some other might 
have comments, but I will follow up with one more question, Mr. 
Gasser. That is, what happens when you suspect that the 
envelope has been pierced and that someone--you just simply 
protect your own trade or----
    Mr. Gasser. Well, I think we are given quite a bit of 
discretion on the part of our institutional clients to 
participate and withdraw from the market as we see fit. So if 
we are in what we describe as ``not held'' in that situation, 
in other words, the sense of urgency that the institution has 
is reasonable relative to what is going on in the market and we 
have the ability or the authority or the discretion to pull out 
of the market, we will, and we will return----
    Chairman Reed. But there is no requirement, informal or 
formal, to report your suspicions to the SEC----
    Mr. Gasser. You know, it is a hard thing from the 
perspective to determine, you know, exactly whether or not that 
is just, you know, a circumstantial issue or something that is 
clearly being--you know, one person. And it gets to that whole 
issue of surveillability and transparency.
    Mr. Sussman. Just a quick comment. I think this issue of 
determining liquidity provisioning versus market manipulation, 
you know, the issue with, well, there are 29 dark pools or 
there are 42 dark pools, I think that is all symptomatic of the 
fact that there is just a lack of standardized terminology 
across the industry, and that the industry needs to come 
together and say, you know, here is how we are going to define 
what a dark pool is, here is what we are going to define as 
appropriate liquidity provisioning versus market manipulation. 
I mean, we cannot get much further in the process, we cannot 
have the regulators expect to monitor how many dark pools there 
are or if there is market manipulation going on unless everyone 
agrees about the terminology. And I just think that that has 
fallen behind the progress that we have made on other fronts.
    Chairman Reed. Very good. Mr. Driscoll.
    Mr. Driscoll. Just three follow-ups. On the fat thumb type 
of an error, I think the exchanges with their harmonized 
``clearly erroneous'' rules have taken a big step in preventing 
a lot of the risk that goes along with that.
    As far as people trying to take advantage of my orders, I 
can see--I do not need technology to show me that. I can see it 
and react as I need to, and that is my job. That is what we are 
sitting on those desks to do.
    Chairman Reed. But, there is no formal or informal 
obligation to say, ``I have suspicions,'' to anyone so that 
this--you self-correct.
    Mr. Driscoll. I would not be able to get off the phone with 
the SEC. I am an institutional trader. My job is to be 
suspicious of the counter side of my trades.
    Chairman Reed. Well, OK. Anyone else? I do want Mr. 
Brigagliano to comment on behalf of the SEC.
    Mr. Brigagliano. If I could get the microphone on, I will, 
Chairman Reed. I think that this line of discussion has 
highlighted two issues. One is the sponsored access issue, 
which Ranking Member Bunning asked what is of most concern, and 
there seems to be a pretty clear consensus that that should be 
front burner, and it is at the SEC.
    The other issue that really you have raised is cyber 
security, and the Commission has technology people who work 
with the markets to make sure that there is cyber security. But 
we do hear about hacking incidents, sometimes from abroad, into 
financial institutions, and that is certainly a problem that 
the country needs to pay more attention to, and we are, and 
that is another ground where we may need to put more resources.
    Chairman Reed. Well, thank you very much. There may be 
additional questions by my colleagues, those that attended and 
those that may not have attended, and we would ask you to 
respond to them as quickly as possible.
    We will keep the record open until this Friday if there are 
additional comments that you want to make or statements that 
anyone would like to make.
    Thank you very much. This has been a very informative 
hearing on a topic that is important and is just beginning to 
be recognized here. It has been recognized, I think, in the 
regulatory community and the technology community and the 
trading community, but we are beginning to recognize it, so 
thank you for helping us understand this issue. The hearing is 
adjourned.
    [Whereupon, at 11:52 a.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
                PREPARED STATEMENT OF CHAIRMAN JACK REED
    I want to start by welcoming my friend and colleague Senator Ted 
Kaufman, who has spent considerable time examining some of the cutting 
edge issues facing our increasingly high-tech capital markets. I also 
want to welcome the witnesses joining us on our second panel this 
morning.
    As many families struggle to regain their footing, stay in their 
homes, and keep their jobs in the wake of a severe recession caused by 
reckless profit seeking on Wall Street, it is appropriate and timely to 
meet today to ask questions about the role of technology and our 
financial markets.
    Today's hearing is a check-up on our equity markets, amid concerns 
that technological developments in recent years may be disadvantaging 
certain investors. Electronic trading has evolved dramatically over the 
last decade, and it is important that regulators keep up. For example, 
trading technology today is measured not in seconds or even 
milliseconds, but in microseconds, or one-millionth of a second. So 
even a sneak peek of a fraction of a second using what is called a 
flash order may give some market participants a significant advantage.
    Our hearing will take a closer look at such ``flash orders,'' along 
with other market structure issues such as ``dark pools,'' which are 
private trading systems that do not display quotes publicly, and ``high 
frequency trading,'' a lightning-fast computer-based trading technique.
    According to the SEC, the overall proportion of displayed market 
segments--those that display quotations to the public--has remained 
steady over time at approximately 75 percent of the market. However, 
undisplayed liquidity has shifted from taking place on the floor of the 
exchanges or between investment banks, to what are currently known as 
dark pools, with the number of such pools increasing from approximately 
10 in 2002 to approximately 29 in 2009. Dark pools today account for 
about 7.2 percent of the total share of stock volume.
    Dark pools and other undisplayed forms of liquidity have been 
considered useful to investors moving large numbers of shares, since it 
allows them to trade large blocks of shares of stock without giving 
others information to buy or sell ahead of them. However, some critics 
of dark pools argue that this has created a two-tiered market, in which 
only some investors in dark pools but not the general public have 
information about the best available prices. The SEC has recently 
proposed changes in this area to bring greater transparency to these 
pools.
    Flash orders and high-frequency trading have also raised concerns. 
Flash orders, which enable investors who have not publicly displayed 
quotes to see orders before other investors, have raised concerns about 
fairness in the markets, and the SEC has recently proposed to ban them.
    High-frequency trading, a much more common technique used 
extensively throughout the markets, is the buying and selling of stocks 
at extremely fast speeds with the help of powerful computers. This 
activity has raised concerns that some market participants are able to 
``game'' the system, using repeated and lightning-fast orders to 
quickly identify other traders' positions and take advantage of that 
information, potentially disadvantaging retail investors. Other 
investors argue that the practice has significantly increased liquidity 
in the markets, improved price discovery, and reduced spreads, and that 
high-frequency trading is being used by all types of investors.
    Today's hearing will help to answer some important questions about 
these issues. Have recent developments helped or hurt the average 
investor? How have these developments impacted the average household's 
ability to save for college and retirement? What risks we must be 
vigilant about in how we structure and operate our markets going 
forward?
    I have asked today's witnesses to discuss the potential benefits 
and drawbacks of ``dark pools'' and other undisplayed quotes now and 
historically in our markets. I have also asked them how flash orders 
and high-frequency trading have impacted the markets, and whether tools 
like this may disadvantage certain investors, especially retail 
investors.
    Finally, as the SEC has recently taken steps to ban flash orders 
and increase transparency in dark pools, we will hear perspectives on 
the SEC's actions, and ask our panelists what additional legislative or 
regulatory changes, if any, are needed to protect retail investors and 
ensure fair markets.
                                 ______
                                 
               PREPARED STATEMENT OF SENATOR JIM BUNNING
    Thank you, Mr. Chairman.
    I think this will be an educational hearing about several complex 
topics that have been in the news lately.
    A lot of things have changed in the securities markets since I sat 
at a trading desk. While just about all trades take place over a 
computer now, trading used to be done over the phone or in person. 
There are many more stocks and other securities traded now, just as 
there are many more investors.
    But even though the technology and the amount of money changing 
hands has changed, a lot is still the same. Investors are still looking 
for the best price and traders are still using every tool they can to 
get an edge. And there is always someone trying to make a quick buck 
off the unsophisticated and uninformed, or even through manipulation 
and fraud.
    Historically, the way we have tried to make our markets safer and 
fairer is by increasing transparency and access, and I think that has 
worked. But in order for those principles to continue to work, the SEC 
must stay on top of the changing markets and update its rules as 
necessary. I am glad to see the Commission is reviewing its market 
structure rules, and I hope it does not limit those reviews to just the 
topics that have been covered in the news. I also hope the Commission 
will let this Committee know if there are any gaps in its authority 
that we need to fill so any market structure issues can be properly 
addressed.
    Thank you, Mr. Chairman. I look forward to hearing from our 
witnesses.
                                 ______
                                 
            PREPARED STATEMENT OF SENATOR EDWARD E. KAUFMAN
    It's a privilege for me to testify at today's hearing, and I 
commend Chairman Reed and Ranking Member Bunning for convening it.
    Mr. Chairman, our stock markets have evolved rapidly in the past 
few years in ways that raise important questions for this hearing to 
explore.
    Technological developments have far outpaced regulatory oversight; 
and traders who buy and sell stocks in milliseconds--capitalizing 
everywhere on minute price differentials in a highly fragmented 
marketplace--now predominate over value investors. Liquidity as an end 
seems to have trumped the need for transparency and fairness. We risk 
creating a two-tiered market structure that is opaque, highly 
fragmented and unfair to long-term investors.
    I am very concerned about the integrity of the U.S. capital 
markets, which are an essential component to the success of our Nation.
    It was the repeal of the uptick rule by the SEC in 2007 which first 
caught my attention. When I was at Wharton getting my MBA in the mid-
1960s, the uptick rule was considered a cornerstone of effective 
financial regulation. As many on this Subcommittee have noted, the 
uptick rule's repeal made it easier for bear raiders--no longer 
constrained to wait for an uptick in price between each short sale--to 
help bring down Lehman Brothers and Bear Stearns in their final days.
    In April, Senators Isakson, Tester, Specter, Chambliss and I 
introduced a bill prodding the SEC to reinstate the rule. As the months 
have gone by, I have asked myself--why is it so difficult for the SEC 
to mandate some version of the uptick rule and impose ``hard locate'' 
requirements to stop naked short selling? Then it became clear: None of 
the high-frequency traders--who dominate the market--want to reprogram 
their computer algorithms to wait for an uptick in price or to obtain a 
``hard locate'' of available underlying shares.
    I began to hear from many on Wall Street and other experts 
concerned about a host of questionable practices--all connected to the 
decimalization and digitalization of the market and the resulting surge 
in electronic trading activity. It became clear that the SEC staff was 
considering issues piecemeal--like the rise of flash orders--without 
taking a holistic view of the market's overall structure, applying 
rules from a floor-based trading era to our current electronic trading 
venues.
    I wrote SEC Chairman Schapiro on August 21 calling for a 
comprehensive ``ground up'' review of the equity markets (my letter and 
the Chairman's September 10 response are attached):

        Actions by the SEC over recent decades have, perhaps 
        unintentionally, encouraged the development of markets which 
        seem to favor the most technologically sophisticated traders. 
        The current market structure appears to be the natural 
        consequence of regulations designed to increase efficiency and 
        thereby provide the greatest benefits to the highest volume 
        traders. I believe the SEC's rules have effectively placed 
        ``increased liquidity'' as a value above fair execution of 
        trades for all investors.

        Markets have become so fragmented--and the rise of high-
        frequency trading that can execute trades in milliseconds has 
        been so rapid--that the SEC should review and quantify the 
        costs and benefits of these market structure developments to 
        all investors.

    The facts speak for themselves. We've gone from an era dominated by 
a duopoly of the New York Stock Exchange and NASDAQ to a highly 
fragmented market of more than 60 trading centers. Dark pools, which 
allow confidential trading away from the public eye, have flourished, 
growing from 1.5 percent to 12 percent of market trades in under 5 
years.
    Competition for liquidity is intense--and increasingly problematic. 
Flash orders, liquidity rebates, direct access granted to hedge funds 
by the exchanges, dark pools, indications of interest, and payment for 
order flow are each a consequence of these 60 centers all competing for 
liquidity.
    Moreover, in just a few short years, high frequency trading--which 
feeds everywhere on miniscule price differences between and among the 
many fragmented trading venues--has skyrocketed from 30 percent to 70 
percent of the daily volume. Indeed, the chief executive of one of the 
country's biggest block traders in dark pools was quoted last week as 
saying that the amount of money devoted to high frequency trading could 
quintuple ``between this year and next.''
    So I'm pleased that the Commission has begun to address flash 
orders and dark pools.
    Let me quickly layout three reasons why this hearing is so 
important:
    First, we must avoid systemic risk to the markets. Our recent 
history teaches us that when markets develop too rapidly, when they are 
not transparent, effectively regulated or fair--a breakdown can trigger 
a disaster.
    Second, rapid advances in technology, which can produce impressive 
results, combined with market fragmentation are moving us from an 
investor's market to a trader's market. This can have significant 
consequences. Last week, I met with the author of a soon-to-be released 
Grant Thornton study that found that market structure changes since the 
1990s have severely undermined the ability of small companies to raise 
capital and issue IPOs.
    Third, we must ensure that retail investors are not relegated to 
second-tier status. When the average investor believes he or she is 
paying a higher price for 100 shares of IBM, even if only marginally, 
the integrity of our markets is significantly tarnished. The markets 
should work best for those who want to buy and hold in hopes of a 
golden retirement, not just for high frequency traders who want to buy 
and sell in fractions of a second.
    As Chairman Schapiro acknowledged just yesterday, ``I believe we 
need a deeper understanding of the strategies and activities of high 
frequency traders and the potential impact on our markets and investors 
of so many transactions occurring so quickly.''
    Many on Wall Street assure us we have nothing to worry about: that 
high-speed technology has only led to positive changes: greater 
liquidity, narrowed spreads and lower costs. Rules ensuring ``best 
execution,'' they say, will always protect the investor. Don't take 
those claims on face value.

    Many of these ``liquidity providers'' are not regulated 
        market makers. Furthermore, liquidity mainly follows high-
        volume stocks because that's where the profit is; in low volume 
        stocks, spreads remain wide.

    Our regulators and broker-dealers are using antiquated 
        benchmarks and measurements to ensure fair trades. By the time 
        the consolidated best bid and offer data has been aggregated 
        from the many different market centers and then disseminated, 
        the time lag is large enough for an entire industry of high 
        frequency traders to book millions of dollars in profits.

    Payment for order flow is an inherent conflict of interest. 
        Because it encourages broker dealers to send retail order flow 
        to the highest bidder and not to the trading center that is 
        necessarily best for the buyer or seller, payment for retail 
        order flow is a highly dubious practice.

    Growing trading volumes in dark pools is undermining public 
        price discovery. While certain dark pools serve a useful 
        function--permitting large blocks of stock to change hands 
        without creating temporary price drops or gains--their 
        proliferation is undermining public prices.

    High-frequency gaming strategies may be forcing retail 
        investors to pay higher prices, although the lack of 
        transparency and effective regulatory surveillance prevents us 
        from knowing the extent to which this might be happening. But 
        it is telling when sophisticated clients are reportedly 
        demanding that their major broker-dealers ``not hand over their 
        orders on a silver platter''--and when seminars for 
        institutional fund managers are conducted openly on how to 
        avoid being ``gamed'' in dark pools.

    Technology should not dictate our regulatory destiny; rather our 
regulatory policy should provide the framework and the guidelines under 
which technology operates. Our foremost policy goal should be to 
restore the markets to their highest and best purposes: serving the 
interests of long-term investors, establishing prices that allocate 
resources to their most productive uses, and enabling companies--large 
and small--to raise capital to innovate, create jobs and grow.
    The SEC's ground-up review of these issues should leave nothing 
out, reviving old ideas and examining new ones: should markets be 
centralized or decentralized; should we separate the markets based on 
investor types; what should be the role of market makers; what role 
might there be for real time risk management?
    At a minimum, a few straightforward propositions should guide us to 
a regulatory framework that permits vigorous competition while 
substantially reducing the possibility of a two-tiered trading network, 
one where long-term investors are vulnerable to powerful trading 
companies that exist not to value or invest in the underlying 
companies, but to feed everywhere on small but statistically 
significant price differentials. As values, transparency and fairness 
should trump liquidity.
    First, we should reconsider the criteria for becoming an exchange 
or market center. The market's unhealthy fragmentation, and the high-
speed trading strategies which thrive on its fractured state, are 
growing far too rapidly to ensure that there are not unintended 
negative consequences for the investing public.
    Second, we should consider rule changes that ensure the best prices 
are publicly available, not hidden from view in private trades. The 
strength of a free market is based on this public display. We should 
reduce ``internalization'' by broker-dealers, by insisting on 
meaningful price improvement in comparison to the public quotes or by 
granting the public quotes the right to trade first. And we should 
reduce trading in dark pools by reducing the permissible threshold for 
dark pool trading and by defining indications of interest, and other 
quote-like trading signals, as quotes.
    Third, we should root out conflicts of interest by ending payments 
from market centers that encourage orders to flow their way. The search 
for best execution by broker-dealers should not be subject to 
temptation from the highest bidders. Liquidity rebates and direct 
access to the exchanges by hedge funds, which are still unregulated 
entities, also deserve careful review.
    Fourth, regulators should measure execution fairness in 
milliseconds for stock trades of all kinds, as only then can the 
credibility of the markets be assured. The audit trails and records of 
order execution in fragmented venues must be synchronized to the 
millisecond and made readily available in statistically understandable 
formats to regulators and the public. This obligation must be placed on 
broker-dealers as well as market centers. Currently, while high 
frequency traders bank profits in milliseconds, the first column for 
time on the Rule 605 form, used by regulators to measure execution 
quality, reads ``0-9 seconds.''
    Fifth, regulators must develop more sophisticated statistical tests 
to gain a granular view of gaming strategies, such as following high 
frequency trading volume patterns. Only then can regulators separate 
high frequency strategies that add value to the marketplace from those 
that inexcusably take value away.
    As a Nation, our credit and equity markets should be a crown jewel. 
Only a year ago, we suffered a credit market debacle that led to 
devastating consequences for millions of Americans. While we must 
redress those problems, we must also urgently examine opaque and 
complex financial practices in other markets, including equities, 
before new problems arise. It is essential to ensure the integrity of 
U.S. capital markets.



                PREPARED STATEMENT OF JAMES BRIGAGLIANO
  Coacting Director, Division of Trading and Markets, Securities and 
                          Exchange Commission
                            October 28, 2009
    Thank you Chairman Reed and Members of the Subcommittee for giving 
me the opportunity to speak to you today about the U.S. equity markets 
on behalf of the Securities and Exchange Commission (``SEC'' or 
``Commission'').
    The U.S. equity markets have undergone a transformation in recent 
years due in large part to technological innovations that have changed 
the way that markets operate. As markets evolve, the Commission must 
continually seek to preserve the essential role of the public markets 
in promoting efficient price discovery, fair competition, and investor 
protection and confidence.
    For this reason, the Commission is undertaking a broad review of 
equity market structure to assess its performance in recent years and 
determine whether market structure rules have kept pace with, among 
other things, changes in trading technology and practices. This review 
will address the advantages and disadvantages of matters including high 
frequency trading, sponsored access, and dark forms of liquidity. In 
fact, the Commission has already proposed rules related to banning 
flash orders and three issues designed to shed greater light on dark 
pools. Before I discuss these efforts in greater detail, however, let 
me provide some important background.
Background: Operation of U.S. Equity Markets
    The United States has a highly competitive market with a large 
number of participants, including exchanges, electronic communications 
networks or ``ECNs,'' alternative trading systems or ``ATSs,'' over-
the-counter (OTC) market makers, and proprietary trading firms. 
Currently, ten registered exchanges trade equity securities. An 
exchange brings together the orders of multiple buyers and sellers and 
is required to provide the best bid and offer prices for each stock 
that it trades, as well as last-sale information for each trade that 
takes place on that exchange. This information is collected and made 
public through consolidated systems that are approved and overseen by 
the SEC. Any investor in the United States can see the best quotation 
and the last-sale price of any listed stock, in real time. This 
transparency is a key element of the national market system mandated by 
Congress.
    Under that system, the SEC seeks to promote competition among 
trading venues, since this can lead to benefits for institutional and 
retail investors, including lower transaction costs, improved liquidity 
and execution, enhanced price discovery, and more choices for 
investors. The SEC also seeks to ensure there is proper coordination 
among all trading centers, and is mindful of any potentially harmful 
effects of having orders placed in different markets rather than a 
single, central market.
    Competition among markets has increased dramatically, especially in 
recent years. Thirty-four years ago, when Congress charged the SEC with 
creating an integrated national market system, the New York Stock 
Exchange (NYSE) accounted for the vast majority of trading volume in 
listed stocks and NASDAQ was becoming a major market for OTC stocks. 
NYSE and NASDAQ still play a significant role, but other markets, 
including ECNs and ATSs that didn't exist a decade ago, are now major 
participants in the national market system.
    As a preliminary matter, let me describe ATSs and their origin, 
since certain types of ATSs figure prominently in market structure 
issues that I will discuss in a moment. ATSs are broker-dealers that 
match the orders of multiple buyers and sellers according to 
established, nondiscretionary methods. Although these types of systems 
have existed since the late 1960s, they began to proliferate in the mid 
1990s in response to technological developments that made it easier for 
broker-dealers to match buy and sell orders. In 1998, the SEC created a 
new regulatory framework, called Regulation ATS, which sought to reduce 
barriers to entry for these systems and promote competition and 
innovation, while appropriately regulating the exchange functions that 
they performed.
    Currently, there are 73 active, registered ATSs, and they trade all 
types of securities. Four of these ATSs have chosen to publicly display 
their best orders in the consolidated quote stream as exchanges do and 
to allow their quotes to be accessed (at least indirectly) by any 
investor. This subgroup of ATSs is known as ECNs. Over the last 15 
years, ECNs have driven many beneficial changes in the equity 
marketplace, such as faster trading technologies, new pricing 
strategies, and robust intermarket linkages. Some ECNs have merged with 
registered exchanges or have registered as exchanges themselves. For 
example, BATS, the newest registered exchange, was until recently an 
ECN. Direct Edge, which is currently an ECN, is applying to become a 
registered exchange. Not only have ECNs, as well as other ATSs, 
acquired significant market share, the competition they have brought to 
the markets has caused incumbent exchanges to adapt and compete to 
provide better services to investors.
    Another type of ATS is the so-called ``dark pool.'' An ATS that 
operates as a dark pool does not provide quotes into the public quote 
stream. The number of active dark pools transacting in stocks that 
trade on major U.S. stock markets has increased from approximately 10 
in 2002 to approximately 30 in 2009. For the second quarter of 2009, 
the combined trading volume of dark pools was approximately 7.2 percent 
of the total share volume in these stocks, with no individual dark pool 
executing more than 1.3 percent. Like ECNs, dark pools operating under 
Regulation ATS must register as broker-dealers and become members of 
FINRA. The Commission has recently been reviewing the regulatory 
structure applicable to dark pools.
    Although the phrase ``dark pool'' is new, the concept is old. Dark 
liquidity--meaning orders and latent demand that are not publicly 
displayed--has been present in some form within the equity markets for 
many years. Traders are loath to display the full extent of their 
trading interest. Imagine a large pension fund that wants to sell a 
million shares of a particular stock. If it displayed such an order, 
the price of the stock would likely drop sharply before the pension 
fund could sell its shares. So the pension fund, assuming it could 
execute its trade at all, would be forced to sell at a worse price than 
it might have if information about its order had remained confidential.
    In the not-so-distant past, the pension fund might have placed the 
order, or some part of it, with a broker-dealer, which would attempt to 
find contraside interest (whether on the floor of an exchange or by 
calling around to other traders), preferably without giving up enough 
information to move the market against its client. Information leakage 
about a larger order was a serious problem, and the ``market impact'' 
of large orders would impose a major cost on investors.
    Historically, many dark pools developed as computerized ways of 
searching for contraside trading interest while preserving 
confidentiality. While early dark pools were designed to cross large 
orders, and such pools still exist today, most of the newer dark pools 
are designed to trade smaller-sized orders. In some cases, these small 
orders are derived from large ``parent'' orders that have been chopped 
up into smaller pieces. In addition, some small orders represent orders 
that the broker-dealer operating the ATS is attempting to cross 
internally, rather than lose the execution to another market.
    Looking at overall U.S. equity market structure, competition among 
different markets appears to have yielded significant benefits to 
investors, both retail and institutional: lower commissions, tighter 
spreads, faster execution speeds, and greater systems capacity. And 
from a systemic risk standpoint, having a network of interlinked 
markets is preferable to having a single point of failure. When trading 
is disrupted in one market, which happens occasionally, volume quickly 
migrates to other markets.
    Our equity markets have faced serious tests since the onset of the 
financial crisis, and generally the markets have performed well. 
Despite record volumes and volatility, particularly in the fall of 
2008, the markets for U.S.-listed securities have remained open and 
continued to operate in a fair and orderly manner and to perform their 
vital price discovery function. Buyers and sellers could see current 
prices and expect to execute their trades promptly at the prices they 
saw on their screens.
    But markets continually evolve, and among the questions that have 
been raised about recent changes in the market are questions about 
whether certain current market practices might create a two-tiered 
market. The Commission's job is to make sure that the core principles 
of the Exchange Act--fairness, efficiency, and best execution--are 
maintained as the markets, and the environment in which they operate, 
change. So the challenge for regulators is to monitor these changes and 
update regulation when needed. The Commission currently is taking a 
broad and critical look at market structure practices in light of the 
rapid development in trading technology and strategies. I will address 
some steps the Commission has taken recently, and some that I 
anticipate it may take in the near future.
Commission Action on Market Structure Reforms
Flash Orders
    In September, the SEC proposed to prohibit the practice of flashing 
marketable orders. In general, flash orders are communicated to certain 
market participants and either executed immediately or withdrawn 
immediately after communication. Flash orders are exempt from the 
Exchange Act's quoting requirements as the result of an exemption 
formulated when most trading took place on the floors of the exchanges. 
The exception was originally intended to facilitate manual trading in 
the crowd on exchange floors by excluding quotations that were then 
considered ``ephemeral'' and impractical to include in the consolidated 
quotation data.
    The Commission is concerned that the exception for flash orders, 
whether manual or automated, from Exchange Act quoting requirements is 
no longer necessary or appropriate in today's highly automated trading 
environment. The consolidated quotation stream is designed to provide 
investors with a source of information for the best prices in a listed 
security, rather than forcing investors to obtain such information by 
subscribing to all of the data feeds of the many exchanges and ATSs 
that trade listed securities. The flashing of order information could 
lead to a two-tiered market in which the public does not have access, 
through the consolidated quotation data streams, to information about 
the best available prices for U.S.-listed securities that is available 
to some market participants through proprietary data feeds.
    In addition, the recipients of the flashed order can trade at the 
same price as the displayed quote without publicly quoting themselves. 
At the same time, the investor who is publicly quoting may miss out on 
the opportunity to receive an execution. The recipients of the flashed 
order also may obtain an informational advantage by seeing and being 
able to react to orders in the market before others can. As a result, 
flash orders could lead to a two-tiered market where the public does 
not have equal access to information about the best available prices 
for listed securities.
    Flash orders also offer potential benefits to certain types of 
market participants. For example, for those seeking liquidity, the 
flash mechanism may attract additional liquidity from market 
participants who are not otherwise willing to display their trading 
interest publicly, and could help lower the transaction costs of those 
responding to flash orders. Flash orders may be executed through the 
flash process for lower fees than those charged by many markets for 
accessing displayed quotations.
    Taking these factors into consideration, the Commission recently 
proposed to ban flash orders, noting that while flash orders may 
potentially be providing benefits to certain traders, it may no longer 
serve the interests of long-term investors or the markets as a whole. 
The Commission has stated, both in adopting Regulation NMS and in 
proposing to ban flash orders, that the interests of long-term 
investors should be upheld as against those of professional short-term 
traders, when those interests are in conflict. The comment period on 
the proposal to ban flash orders remains open until November 23, and 
the staff and the Commission look forward to carefully analyzing the 
comments received.
Dark Pools
    Last week, the SEC made additional proposals related to market 
structure. These proposals relate to three issues relevant to dark 
pools and so-called actionable ``indications of interest'' or ``IOIs.'' 
IOIs, like flash orders, potentially create two-tiered markets in which 
selected participants are made aware of prices that are available in 
the market but that other investors don't know about. IOIs are used by 
some market makers and dark pools to alert certain other market 
participants about available trading opportunities. Some of these IOIs 
are actionable IOIs: they contain enough information for a recipient to 
act on them in the same way it would act on quotes.
    Therefore, the Commission has put forth three proposals in this 
area. The first proposal would require actionable IOIs to be treated 
like quotations and be subject to the same disclosure rules that apply 
to quotations. The second proposal would lower the ATS trading volume 
threshold for displaying best-priced orders in the consolidated quote 
stream. Currently, an ATS, if it displays orders to more than one 
person, must display its best-priced orders to the public when its 
trading volume for a stock is 5 percent or more. This proposal would 
lower that percentage to 0.25 percent, meaning that dark pools that use 
actionable IOIs and exceed the volume percentage threshold would be 
required to publicly display those actionable IOIs as quotes. Taken 
together these changes would help make the information conveyed by 
actionable IOIs available to the public instead of just to a select 
group.
    At the same time, both proposals would exclude from their 
requirements certain narrowly targeted IOIs related to large orders. 
These size discovery mechanisms currently are offered by dark pools 
that specialize in large trades. In particular, the proposal would 
exclude IOIs for $200,000 or more that are communicated only to those 
who are reasonably believed to represent current contra-side trading 
interest of equally large size. The ability to have a method for 
connecting investors desiring to trade shares in large blocks could 
enable those investors to trade efficiently in sizes much larger than 
the average size of trades in the public markets.
    As you know, Chairman Schapiro has expressed concern about 
transparency in dark pools generally. I mentioned earlier that all 
trades, even those in dark pools, have to be reported to the 
consolidated tape in real time. However, under the current system, 
investors can see only that a trade occurred somewhere off an exchange. 
They don't know which ATS executed the trade, or even whether it was 
executed in a dark pool at all.
    Therefore, the Commission also proposed to create a similar level 
of post-trade transparency for ATSs, including dark pools, as for 
registered exchanges. Specifically, the proposal would amend existing 
rules to require real-time disclosure of the identity of dark pools and 
other ATSs on the public reports of their executed trades. As with the 
Commission's IOI proposal, this proposal also would exclude the 
identification of the ATS for large trades of $200,000 or more, to 
prevent potential detrimental information leakage that could interfere 
with the ability of institutions to efficiently trade large blocks of 
stock. \1\ In considering post-trade transparency, some have suggested 
that such transparency may compromise proprietary trading strategies 
and allow the market to ascertain the trading interest of investors, 
while others have suggested that post-trade transparency disclosures do 
not raise such concerns.
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     \1\ The proposals discussed above do not attempt to address all of 
the issues regarding dark liquidity.
---------------------------------------------------------------------------
Looking Forward
    But these steps are just the beginning. As Chairman Schapiro has 
indicated, now is an appropriate time to take a broad look at the whole 
of U.S. equities market structure. Over the coming months, I anticipate 
that the SEC will consider additional issues relating to dark liquidity 
more broadly, perhaps by issuing a concept release.
    Dark liquidity is offered not just by dark pools, but by large 
dealer firms that internalize customer orders, ECNs, ATSs, and 
registered exchanges, which have a variety of dark order types. As part 
of the Chairman's directive to take a broad look at market structure 
issues, the staff plans to examine whether the degree or nature of 
trading with dark liquidity has changed in recent years and, if so, 
whether it is having detrimental effects on the quality of the markets, 
such as efficient price discovery.
    Another practice that is being examined by the Commission staff is 
high frequency trading. While the term lacks a clear definition, which 
partially explains the confusion on the subject, it generally involves 
a trading strategy where there are a large number of orders and also a 
large number of cancellations (often in subseconds), and moving into 
and out of positions, often many times in a single day.
    High frequency trading plays a significant role in today's markets 
by providing a large percentage of the displayed liquidity that is 
available on the registered securities exchanges and other public 
markets. Many are concerned, however, that high frequency trading can 
be harmful, depending on the trading strategies used, both to the 
quality of the markets and the interests of long-term investors.
    The Commission recognizes that concerns have been raised that high 
frequency traders have the ability to access markets more quickly 
through high-speed trading algorithms and colocation arrangements. This 
ability may allow them to submit or cancel their orders faster than 
long-term investors, which may result in less favorable trading 
conditions for these investors. This quicker access could, for example, 
enable high frequency traders to successfully implement ``momentum'' 
strategies designed to prompt sharp price movements and then profit 
from the resulting short-term volatility. In combination with a 
``liquidity detection'' strategy that seeks solely to ascertain whether 
there is a large buyer or seller in the market (such as an 
institutional investor), a high frequency trader may be able to profit 
from trading ahead of the large order.
    High frequency trading, however, can also play a constructive role. 
Some have argued that high frequency traders played a role in 
continuing to provide liquidity during the recent market turmoil. High 
frequency trading may also help to reduce market spreads. I expect that 
the Commission would seek the public's views on the potential benefits 
and drawbacks associated with high frequency trading, perhaps by 
issuing a concept release to explore these issues in greater detail.
    Commission staff is also exploring ways for the Commission to use 
its statutory authority to assure that the Commission has better 
baseline information about high-frequency traders and their trading 
activity. This would help to enhance the Commission's ability to 
identify large and high-frequency traders and their affiliates.
    Another market structure issue that the Commission staff is 
exploring is sponsored access--also known as ``direct market access'' 
or ``DMA''--where broker-dealer members of an exchange allow 
nonmembers--in many cases, high frequency traders--to trade on that 
exchange under their name. As electronic trading has become the norm, 
this type of access to exchange execution systems has increased 
significantly. In some cases, broker-dealers offer sponsored access to 
customers without requiring the orders to pass through the broker-
dealers' systems. The appeal of the arrangement is that it helps 
preserve anonymity and enables the fastest possible trading. There are, 
however, a variety of risks involved when trading firms have unfiltered 
access to the markets. These risks can affect many of the participants 
in a market structure, including the trader's broker, the exchanges, 
and the clearing entities. Sponsored access could raise concerns about 
whether sponsoring broker-dealers impose appropriate and effective 
controls on sponsored access to fully protect themselves and the 
markets as a whole from financial risk, and to assure compliance with 
all regulatory requirements. The Commission staff is looking at these 
issues.
    In evaluating these market structure issues, the SEC is focused on 
the protection of investors, maintaining fair, orderly, and efficient 
markets, and facilitating capital formation.
    Thank you for giving me the opportunity to speak to you today on 
behalf of the Securities and Exchange Commission. I welcome any 
questions you may have.
                                 ______
                                 
                  PREPARED STATEMENT OF FRANK HATHEWAY
         Senior Vice President and Chief Economist, NASDAQ OMX
                            October 28, 2009
    Good morning Chairman Reed and Ranking Member Bunning. Thank you 
for the opportunity to offer my perspective on recent developments in 
U.S. equities markets. I speak as an economist who has studied equities 
markets for several decades from multiple vantage points--as an options 
trader on the floor of the Philadelphia Stock Exchange, as a Professor 
of Economics at Penn State, as an Economic Fellow at the SEC, and, 
currently, as NASDAQ's Chief Economist.
    Based on my experience, while equities markets are in a period of 
rapid transformation, it is important to view developments such as 
flash orders, dark pools, and high frequency trading through a long 
lens. These phenomena are, generally speaking, iterations of constant 
market behavior adapting to new technology. The unmatched strength of 
U.S. markets is the continual ability of Congress, the SEC, and self-
regulatory organizations to adapt to these iterations and protect 
investors during periods of change as well as stability.
    Markets have always harnessed the power of speed and communication 
to drive trading efficiency--from telegraph, to telephone to fiber 
optics. Transparency and price discovery are continually evolving 
products of technology and market conditions. They reflect ever-present 
tension between average investors' needs for meaningful public 
reference prices and institutions' desires to execute block orders 
while minimizing market impact.
    This history reveals the following sound principles with which to 
assess the latest market developments.
    First, maximize efficient price discovery. Markets are most 
efficient at promoting price discovery when the participants in the 
markets are numerous and diverse, with divergent objectives from their 
investments and divergent views on value. Discovering the true value of 
securities requires maximizing transparency, display, and order 
interaction.
    Second, encourage innovation and competition. Secondary markets 
function most efficiently when exchanges and nonexchanges compete to 
develop the most advanced trading technology to execute trades quickly, 
at the right price, and at a lower cost. Electronic markets and 
electronic traders, who built their business and technology to compete 
in this modern world, provide critical liquidity during good and bad 
markets.
    Third, guarantee fair and equal access. The definition of 
``market'' assumes fair and equal access to all market participants. 
Any step away from this principle and towards selective disclosure and 
access will tend to create a two-tiered market where sophisticated 
investors have unfair advantages over average investors. Selective 
disclosure and access also creates distortions to the market, with 
unknowable and unintended consequences.
    Fourth, prioritize sound regulation. Markets and market 
participants are more likely to behave in an economically rational 
manner when trading rules are clear, fair, and rigorously enforced. 
Rapid detection and enforcement through real-time and post-trade 
surveillance are critical to fair and orderly markets.
    Only by prioritizing public markets over private and average 
investors over professionals can we simultaneously achieve all four of 
these important goals: efficient price discovery, innovation and 
competition, fair and equal access, and sound regulation. Consequently, 
orders should first attempt to execute in the public market before 
turning to the nonpublic markets. Without efficient price discovery, 
competition, access, and sound regulation in the public markets, there 
will be no accurate price for nonpublic market to reference.
    Viewed through this lens, dark pools--meaning any market that does 
not offer pretrade price transparency--are potentially problematic on 
several grounds. They undermine public price discovery by shifting 
liquidity away from the lit markets, isolating displayed limit orders, 
widening public spreads, and decreasing execution quality. SEC 
Commissioner Elisse Walter wisely said recently: every share that gets 
executed in the dark does not contribute fully to price discovery. The 
question becomes how many dark shares are too many?
    Based on comparisons between stocks with otherwise similar 
characteristics, execution quality begins to deteriorate when stocks 
experience dark trading in excess of 40 percent of total volume. At 
that point, the spread of the public reference price widens and 
execution quality deteriorates. This conclusion is based on studying 
snapshots of empirical data for the top 3,000 U.S. stocks by trading 
volume that individually trade in excess of $500,000 average daily 
dollar volume and 50,000 average daily shares.
    This is not to say that dark pools don't have valued uses that are 
consistent with core market principles. The transparent markets have, 
since the beginning of markets, had difficulty in servicing the 
requirements of large ``block orders'' without market impact. Broker 
dealers have traditionally performed this necessary function, through 
the use of capital, trading acumen, and the transparent market. The 
broker dealer-operated block execution services are needed and must 
continue. Broker dealers have advanced their services through creative 
and innovative uses of technology.
    NASDAQ supports the SEC's proposals, announced last week, to 
reposition dark pools. The SEC proposed to require full public display 
of ``actionable indications of interest'' or IOIs when dark pools 
execute greater than 0.25 percent of aggregate share volume. Many Dark 
Pools use IOIs to show trading interest to a select group of members 
without displaying that trading interest with the broader public. The 
SEC created an exception from the display requirement for block orders 
of $200,000 or more in value. The SEC proposals prioritize public 
markets, increase transparency, and encourage fair and equal access 
while still respecting the need for traders to execute block trades 
with minimal market impact.
    One question I have as an economist is whether limits on using 
actionable indications of interest would be a binding constraint on 
dark pools. Even in the absence of actionable indications of interest, 
some market participants may employ ``pinging'' strategies to probe for 
and discover liquidity that is not advertised by outbound messages. In 
other words, is it systemically beneficial for dark pools to choose to 
remain completely dark no matter how large they grow?
    Turning away from dark pools, NASDAQ also supports the SEC's 
proposals to ban the use of flash orders. Flash orders originated from 
and remain an accepted practice of floor exchanges, with the 
effectiveness of the ``flash'' limited by the distance a human voice 
could travel. As technology was added to floor trading operations, 
automation of these flash capabilities occurred through systems such as 
Block Talk on the NYSE. Later, fully electronic versions of this floor 
flash capability were introduced by the CBSX and Direct Edge.
    After full consultation with the SEC, NASDAQ OMX was one of the 
last to offer flash orders. Most importantly, consistent with our core 
principle of fair and equal access, NASDAQ created a flash order type 
that was available to all investors rather than a select group of 
members. NASDAQ was then the first exchange voluntarily to cease 
offering the ``flash'' dark order type when Chairman Schapiro announced 
a comprehensive review of the use of flash orders. NASDAQ will submit a 
comment letter supporting the SEC's proposal to ban flash orders.
    Recent commentary on flash orders and dark pools has wrongly 
conflated these market structure concerns with questions on the 
validity of market participants who engage in high-volume algorithmic 
trading. Price discovery is most efficient when the participants in the 
markets are numerous and diverse, with divergent objectives from their 
investments and divergent views on value. This philosophical view of 
proper markets is codified in our rules that mandate fair and equal 
access to all market participants.
    Any step away from this principle will create distortions to the 
market, with unknowable and unintended consequences. Electronic markets 
and electronic trading is the foundation of modern markets. The 
activities of electronic market makers, who built their business and 
technology to compete in this modern world, provide critical liquidity 
during good markets and bad markets. These activities benefit all 
investors.
    Speed in the execution of transactions is another way in which 
markets and market participants compete, and competition is the 
lifeblood of efficient markets. In turn, open, transparent markets 
facilitate competition. So long as information is available on an equal 
basis to all market participants, the increased speed at which 
transactions are executed provides tremendous benefits to investors by 
enhancing liquidity and reducing transaction costs.
    As we reflect on the current state of the U.S. equities markets we 
see that investors had and continue to have faith that public markets 
are discovering, displaying, and making accessible the best price for 
each and all securities at all times. The steady, reliable performance 
of equities markets during this time is a result of a constant 
evolution of, and improvement of our markets.
                                 ______
                                 
                 PREPARED STATEMENT OF WILLIAM O'BRIEN
                  Chief Executive Officer, Direct Edge
                            October 28, 2009
    Chairman Reed, Ranking Member Bunning, and Members of the 
Subcommittee, I would like to thank you for the opportunity to testify 
today on behalf of Direct Edge, the operator of the third-largest stock 
market in the Nation. Over the past 2 years Direct Edge's market share 
of U.S. stock trading has risen to approximately 12 percent, up from 
only 1 percent in early 2007, because we have innovated in response to 
changing market structure to provide new solutions for brokers and 
their customers. Certain of these changes have triggered a debate over 
the past several months regarding the structural integrity of our 
equities markets, which is now at a critical juncture. Individual 
investors are in need of greater clarity and education as to how our 
stock market operates, and how to improve it. In this regard, the work 
of the Subcommittee in conducting this hearing is timely and valuable.
    Direct Edge believes that current market structure issues should be 
framed so that investors understand how the evolution of stock trading 
benefits them, and that through careful examination, appropriate 
regulatory protections can be preserved without taking steps that would 
ultimately undermine investor confidence by restricting innovation, 
competition, and efficiency. To this end, Direct Edge offers guiding 
principles for any market structure reforms, in order to focus the 
current dialogue on what really matters--improving our stock market for 
the benefit of the Nation's investors.
1. Current market structure is fundamentally fair and sound
    By every quantitative and qualitative measure, the U.S. cash 
equities market serves as a model for the world, performing as well as 
it ever has in terms of its liquidity, implicit and explicit 
transaction costs, and transparency. During the worst financial crisis 
of our lifetime, the U.S. equity market was continually liquid and 
efficient, while price discovery for certain other financial 
instruments, such as auction-rate and mortgage-backed securities, was 
virtually nonexistent. Recent developments have not materially eroded 
the efficiency of our marketplace.
    While the evolution of the technology, functionality, and economics 
of trading require everyone to adapt, that should not be the root 
reason for market structure reform. Though trends and changes always 
require a continual analysis of how regulation needs to respond, this 
should not be confused with a broader need to re-architect our market 
due to any underlying fundamental flaw or unfairness.
2. High-frequency trading and technology are valuable components of 
        modern market structure
    The innovation and efficiency that technology has brought to stock 
trading inures to the benefit of every American investor. When 
decimalization came to the equities markets in April 2001, there was a 
near-total evaporation of traditional capital commitment, with market 
makers far less willing to provide competitive bids and offers as 
spreads narrowed. Firms willing and able to adapt to this new reality, 
along with new competitors, rose in their place with business models 
predicated on extremely efficient use of technology to facilitate our 
markets. Without these trading firms continuously providing liquidity, 
the market transition to pennies would have been much more turbulent 
and expensive for investors. The benefits of high-tech trading continue 
to this day in several forms, including more efficient price discovery, 
lower investor costs, and greater competition, which benefits all 
investors. All brokers have in some form deployed high-frequency 
technology, to the point that retail investors can have their orders 
executed in under a second via the Internet from anywhere on the 
planet.
    As with the technological transformation of any market, issues have 
emerged that warrant close examination and likely new regulation. High-
frequency trading strategies are now pursued by unregulated entities 
who have been given broker-like access to exchanges without adequate 
control of the compliance or systemic risks, often called ``naked 
access''. Exchange products that offer brokers a direct presence at 
exchange data and trading facilities--often called ``colocation''--need 
to be regulated in the same manner as transaction and other exchange 
fees so that all investors have confidence that equal access and 
opportunity are being provided. Any evaluation of these issues and 
potential remedies should start, however, from a productive vantage 
point that when well-regulated, high-frequency trading and technology 
are generally healthy and positive.
3. Exchanges are not always the best place to execute a trade
    Even though Direct Edge currently operates one exchange facility 
and has applied to operate two new exchanges, we do not believe that 
our market structure would be well served by requiring all orders to be 
placed on exchange facilities. The equity exchange and over-the-counter 
markets have existed symbiotically side-by-side for over 30 years, to 
the great benefit of retail and institutional investors. There are many 
legitimate economic, execution quality, and policy reasons why 
investors and their agents seek an off-exchange execution, whether in a 
dark pool, through an institutional or wholesale market maker, or other 
means.
    Exchanges do, however, play a critical role in providing pretrade 
transparency and price discovery, which benefits those who trade off-
exchange. The recent Securities and Exchange Commission proposal to 
increase the post-trade transparency of dark pool activity is an 
appropriate first step in monitoring the balance between on and off 
exchange trading and providing insight to the investing public. If the 
level of overall market share among exchanges were to fall 
precipitously below historical norms, it would be appropriate to 
examine what further steps would be needed to maintain the role 
exchange liquidity and price discovery plays in our market. But with 
on-exchange liquidity consistently above 70 percent in recent times, we 
are simply not near such a point.
    To preserve the place of exchanges as central hubs of trading 
interest, regulation that drives the displayed exchange markets and 
nondisplayed off-exchange markets further apart must be avoided. Direct 
Edge pioneered the use of flash order technology in the equities 
markets precisely to give retail and other investors' access to dark 
pool and other off-exchange liquidity they previously never had access 
to, and our data shows investors receive better prices on their trades 
as a result. This is what any good exchange does--bring buyers and 
sellers together in a way that makes sense for all concerned. True 
inequities should be examined and eliminated, and the thoughtful 
approach the Securities and Exchange Commission has taken to date 
should be commended. But undue focus on optional, esoteric order types, 
at the expense of ignoring the broader trends that motivate customers 
to use these tactics, at a minimum would provide only false comfort to 
investors, and potentially leave them more at risk than ever before.
4. Brokers are best equipped to choose how to execute their customer 
        orders
    Every order type offered by an exchange or other market center 
provides some combination of immediacy, explicit fees, implicit costs, 
opportunity for price and/or size improvement and market impact. 
Investors that value an immediate execution above all else use market 
orders, taking the price the market gives them and foregoing a chance 
to do better. Those who seek price improvement use limit orders, 
knowing full well they may wind up not trading at all. There are 
countless other examples of how order flow should be managed in light 
of investor objectives and preferences.
    Brokers are best suited to decide when and how to use the tools 
exchanges provide in executing customer orders. Delegation of the 
responsibility to manage these aspects of execution quality by an 
investor to a broker is, for all but the more sophisticated or self-
directed investor, a critical concept in how markets operate. The vast 
majority of brokers fulfill their fiduciary obligations with integrity 
and extreme efficiency. While each broker brings their own perspective 
and execution strategy to the table, investors are free to choose among 
scores of reputable, experienced brokers using a range of criteria and 
information as the basis for deciding who to employ.
5. Equal access prevents ``two-tier markets''
    The broad array of market technologies and products that brokers 
have at their disposal is greater than ever. This empowers brokers to 
customize their order-execution approach to the needs of their business 
and customers. Every broker does not do everything the same way, at the 
same speed, or with the same resources. Brokers choose which exchanges 
to become members of, and then choose to use the products or services 
offered by the exchange at their discretion. Investors participate by 
choosing their broker and level of self-direction they engage in. This 
is part of the fabric of competition, rather than a flaw in market-
based capitalism.
    When a broker or investor elects not to utilize certain 
functionality, technology, or strategies, it does not imply that those 
who do are somehow unfairly advantaged. Markets need to be 
fundamentally fair, but that is not achieved on the basis of attempting 
to mandate that everyone has ``substandard but equal'' capabilities. 
With equivalent access to exchanges for brokers and transparent 
competition for customer business among brokers, all market 
participants benefit from both fairness and differentiation.
6. In debating the need for market structure reform, a broad, data-
        driven approach is optimal
    Market structure reform that takes the entire context of recent 
trends into account generally produces better results than issue-by-
issue reforms. The National Market System encouraged by the Securities 
Act Amendments of 1975, the Order Handling Rules of 1996, and even 
Regulation NMS are all viewed as having successfully advanced the 
liquidity, transparency, and efficiency of our markets. Their strengths 
lie in the comprehensive nature of the approach taken. Emergency 
actions can be counterproductive because they tend to ignore root 
causes and the likely unintended consequences. When considering market 
structure reform, Direct Edge strongly believes in a ``big picture'' 
approach. We also highly value objective data over subjective intuition 
or conjecture. To do otherwise could alter a market structure that is 
generally performing well without an adequate basis for believing 
improvements will result.
Conclusion
    Our stock market is the model for the entire world because we 
anticipate and implement change better than anyone, and adapting 
regulation is a key element of this. If we can address outstanding 
issues in a constructive fashion, focusing on how to improve regulation 
while promoting what currently works well, we will have provided a 
strong structural foundation upon which our Nation's economic recovery 
can be realized. Once again, I'd like to thank the Subcommittee for the 
opportunity to testify and I look forward to answering your questions.
                                 ______
                                 
                 PREPARED STATEMENT OF CHRISTOPHER NAGY
       Managing Director of Order Routing Strategy, TD Ameritrade
                            October 28, 2009
    Chairman Reed, Ranking Member Bunning, and Members of the 
Subcommittee, thank you for the opportunity to testify on equity market 
structure issues. I am Chris Nagy, Managing Director of Order Routing 
Strategy for TD Ameritrade. \1\
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     \1\ TD Ameritrade is a wholly owned broker-dealer subsidiary of TD 
Ameritrade Holding Corporation (TD Ameritrade Holding). TD Ameritrade 
Holding has a 33-year history of providing financial services to self-
directed investors. TD Ameritrade Holding's wholly owned broker-dealer 
subsidiary, TD Ameritrade serves an investor base comprised of over 5.2 
million funded client accounts comprised from every State in the union 
with approximately $289 billion in assets (as of August 2009). TD 
Ameritrade continues to focus on serving individual investors, 
providing low-cost services, ranging from completely self-directed 
investors to those served by registered independent advisors. During 
August 2009, TD Ameritrade handled an average of 431,000 investor 
trades per day, representing an average of 478 million shares per day. 
We do not directly execute client orders, but rather act as agent in 
routing orders to the marketplace. We use our position in the 
marketplace to drive the markets to compete on price and cost. As a 
result of our efforts, during June-September 2009, we were able to 
obtain price improvement for 66 percent of our client share orders and 
saved our clients $12.5 million by getting them better than the then 
best price when they entered their order.
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    TD Ameritrade, based in Omaha, Nebraska, was founded in 1975 and 
was one of the first firms to offer negotiated commissions to 
individual investors following the passage of the Securities Act 
Amendments of 1975. Over the course of the next three decades, TD 
Ameritrade pioneered technological changes such as touch-tone telephone 
trading and Internet investing to make market access by individual 
investors more accessible, affordable and transparent.
    TD Ameritrade has long advocated for market structures that create 
transparency, promote competition, and reduce trading costs for 
individual investors. As technology rapidly advances, it is ever more 
important that the SEC complete a comprehensive review of the National 
Market System to ensure individual investors are not adversely 
impacted. At the same time, regulation has the potential to result in 
unintended consequences, making it critically important that rulemaking 
be based on empirical data and reasoned analysis.
    Our Nation's stock markets have evolved dramatically in the last 
decade. In 2001, the average individual investor transaction took 
upwards of eighteen (18) seconds to receive an execution while today 
that same transaction is done in less than one (1) second. These 
changes primarily have been driven by technological innovation, but 
also in response to carefully crafted regulations. In fact, today the 
individual investor enjoys superior pricing, lightning-fast trade 
fulfillment, and ample liquidity. At no other point in the history of 
the markets has the individual investor been closer in terms of pricing 
with the institutional trader.
    Gone are the days of slow human traded manual markets. The decline 
in manual trading was not only due to technology, but also Regulation 
NMS, which was designed to encourage fast quotes and limit order 
display, with the goal of ensuring investors obtain the best prices 
available in the markets. We also have witnessed a proliferation of 
market center competition for order flow, a result of technological 
innovation and Regulation ATS which lowered the barriers to entry. In 
addition, the move to decimalization early in this decade reduced 
spreads by up to 5\1/4\ cents whose benefits went largely into the 
pocketbooks of individual investors.
    It is natural in a highly competitive environment, particularly 
when combined with rapid technological innovation, for market evolution 
to occur. The facilitation of a National Market System, as called for 
in the Securities Acts Amendments of 1975, has provided a framework for 
this market evolution. As such, regulation has always been an integral 
part of the development of the National Market System, with the SEC 
refining rules such as requiring quote displays and ensuring that 
trades are rarely executed at inferior prices.
Dark Pools
    Variations of Dark Pools have been in our markets for decades 
taking on various forms from a broker taking an order from an 
institution over the phone to a floor broker acting as agent on an 
order received via teletype. When Regulation NMS was enacted in 2005, 
exemptions to the display rule were granted spawning the creation of 
the modern day electronic Dark Pool. Because of decimalization, the 
declining size of the quotes, and the need to minimize market impact, 
institutional traders began seeking block trading alternatives or 
algorithmic trading. This market dynamic has given rise to well over 
forty Alternative Trading Systems transacting, by some estimates, 35 
percent of all stock market orders each day. Retail clients have little 
ability to interact with these growing pools of liquidity. The irony is 
that dark orders receive their pricing from the transparent exchanges 
where retail client trades are executed. In many ways, Dark Pools are 
an excellent example of a two-tiered market that gives institutional 
traders a way to use retail order flow to their own benefit. Certainly 
no one intended for these exemptions to lead to such a stark, two-
tiered system of trading. While there is benefit to Dark Pools reduce 
overall market impact, serious questions need to be asked if we have 
reached the tipping point.
Flash Orders, High Frequency Trading and Market Access
    Innovative strategies that promote efficiency and reduce investor 
costs in the markets are critical if we are going to continue to level 
the playing field for individual investors. There has been much fanfare 
that flash trading is harmful to retail investors, however little data 
is offered to back these claims. Defenders of Flash argue that it 
allows users to lower transaction costs and obtain better prices in 
both the equity and option markets. Interestingly, it is estimated that 
Flash trading accounts for less than 2 percent of all market activity. 
Although TD Ameritrade can find no evidence that flash trading harms 
individual investors, our firm believes that Flash is a symptom of our 
current two-tiered market structure and that in many ways the 
perception that it is unfair and predatory became the reality. We fully 
support the SEC's goal of ensuring that Flash is not used to further 
two-tiered access and we support a comprehensive solution in this area.
    High Frequency Trading on the other hand is estimated to be as high 
as 75 percent of all daily trading volume on our stock exchanges. The 
benefits cited are that High Frequency Trading provides additional 
liquidity to the markets. While perhaps true, the issue of High 
Frequency Trading is not of liquidity but rather one of capacity 
utilization. While High Frequency traders send millions of orders to 
exchanges they also send an equal number of cancellations leading to 
low fulfillment rates. Some stocks can see more than seventy (70) quote 
changes in a single second because of this activity. The sheer volume 
creates technological issues for the dissemination of market data to 
individual investors as they receive such data in their homes perhaps 
thousands of miles away from the originating source. Meanwhile, High 
Frequency Traders subscribe to specialized data feeds and situate their 
technology on the exchanges' property, otherwise known as colocation. 
While colocation improves speed of execution for all parties including 
individual investors, oversight on how this process is administered is 
nonexistent. Moreover, some exchange members provide High Frequency 
Traders with direct access to the markets. These arrangements create 
systemic risk by allowing High Frequency Traders to act as de facto 
specialists without the capital obligations and at little cost while 
the rest of the market picks up their tab.
Conclusion
    As we embark on an overhaul of our Nation's markets it is 
imperative that we continue to provide a low cost, competitive 
infrastructure that ensures individual investors have low barriers of 
entry, which, in turn, promote investor confidence and long-term 
investment into our Nation's markets. We must, however, ask if we have 
reached the tipping point with an excess of Alternative Trading 
Systems. Interestingly we can draw insight from a very different yet 
similar circumstance. During the Great Depression there was an 
overabundance of taxi drivers, which reduced driver earnings and 
congested city streets. To address the issue and restore a proper 
balance, the Medallion system was created placing a moratorium on the 
issuance of taxicab licenses. This system created the proper balance of 
taxis while not crowding city streets. In today's markets as we emerge 
from the recent market downturn, one must question if we have ``too 
many taxis'' fragmenting the streets of liquidity. We should seek a 
solution to provide competition in our markets without an over surplus 
of trading systems.
    I appreciate the opportunity to appear before the Committee not 
only on behalf of TD Ameritrade but more importantly on behalf of our 
clients, individual investors.
                                 ______
                                 
                 PREPARED STATEMENT OF DANIEL MATHISSON
   Managing Director and Head of Advanced Execution Services, Credit 
                                 Suisse
                            October 28, 2009
Introduction
    Good morning, and thank you for giving me the opportunity to share 
my views on the best structure for our Nation's stock markets. My name 
is Dan Mathisson, and I am a Managing Director and the Head of Advanced 
Execution Services for Credit Suisse. \1\
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     \1\ Credit Suisse provides its clients with private banking, 
investment banking and asset management services worldwide. Credit 
Suisse offers advisory services, comprehensive solutions and innovative 
products to companies, institutional clients and high-net-worth private 
clients globally, as well as retail clients in Switzerland. Credit 
Suisse is active in over 50 countries and employs approximately 47,400 
people. Credit Suisse is comprised of a number of legal entities around 
the world and is headquartered in Zurich. The registered shares (CSGN) 
of Credit Suisse's parent company, Credit Suisse Group AG, are listed 
in Switzerland and, in the form of American Depositary Shares (CS), in 
New York. Further information about Credit Suisse can be found at 
www.credit-suisse.com.
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    The U.S. broker-dealer subsidiary of Credit Suisse Group has been 
operating continuously in the United States since 1932, when the First 
Boston Corporation was founded. Today, Credit Suisse is the market 
share leader in electronic trading, \2\ and Credit Suisse owns and 
operates Crossfinder, the largest Alternative Trading System (ATS) by 
volume. \3\
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     \2\ Greenwich Survey, May 2009, Tabb Report, October 2009.
     \3\ Rosenblatt Survey, September 2009, Tabb Survey, September 
2009.
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    Advanced Execution Services (AES) is a team of approximately 200 
financial and technology professionals based in New York that executes 
trades electronically on behalf of mutual funds, pension funds, hedge 
funds, and other broker-dealers. AES currently connects with 31 U.S. 
trading venues, and we help clients solve the problem of fragmentation 
by electronically linking many market centers into one order. The AES 
group does not engage in proprietary or risk trading. 100 percent of 
our revenue comes from institutional client commissions, and therefore 
our success depends on our ability to minimize our client's transaction 
costs while providing safe and reliable trading systems.
    I have been managing the AES group at Credit Suisse since founding 
it in 2001. Prior to that, I traded stocks for 8 years for a New York 
investment firm called DE Shaw & Co. In addition to my role at Credit 
Suisse, I am presently on the Board of Directors for the BATS Exchange 
based in Kansas City, and I am a regular columnist for Traders 
Magazine, where I write about market structure issues. I appreciate the 
chance to appear here today representing Credit Suisse.
Summary
    Credit Suisse supports fair markets for all investors, and fair 
access to all market venues. We believe that several of the recent 
changes in the trading and markets area proposed by the Securities 
Exchange Commission (SEC) are positive developments. For example, Rule 
204, which we supported and which has already been implemented, has 
dramatically reduced ``naked'' short-selling. The proposed ban on flash 
orders is another positive step, and we support this change as well.
    On the topic of dark pools, we believe that they merely automate a 
process that has always existed, and that they are beneficial to the 
U.S. market structure. However, we believe there is a problem with 
today's market structure, due to a lack of fair access to dark pools 
for all investors. Under Regulation ATS, dark pool operators are 
allowed to decide who can participate in their pool, and broker-dealers 
are often denied access to each other's pool for competitive or 
capricious reasons. We believe that markets work best when open to all, 
and therefore we propose that the Fair Access provision of Regulation 
ATS be changed to force all dark pools to be open to all broker-
dealers, and through those broker-dealers, to the investing public.
    While we acknowledge the need for fair access reform, we believe 
that much of the debate over dark pools is misguided and is fueled by a 
desire by exchanges to avoid healthy competition. We believe investors 
have a right to remain silent, and that dark pools and dark order types 
fill a critical need. Those who would compel dark pools to display bids 
and offers have the issue exactly backwards: we believe dark pools and 
dark order types help long-term investors, by giving them an avenue to 
trade without revealing sensitive trading intentions to short-term 
traders. We do not think that forcing investors to play poker with 
their cards face-up would solve any problems, though it would 
potentially create many new ones.
    We believe that the ``price discovery'' argument is a red herring. 
Despite popular belief, dark pools must report all their trades 
immediately to the consolidated tape, and dark pools have always been, 
and will remain, a niche product that will not lead to the end of 
publicly displayed bids and offers.
    In summary, we believe that the key to a strong and resilient stock 
market is a healthy competition for order flow among multiple venues, 
whether dark or light, along with mandated fair access to each of them.
The Role of Dark Pools
    Selling 200 shares of ABC without moving the price is easy. Selling 
2,000,000 shares is difficult--if word leaks out that a large pension 
fund or other big investor is selling millions of shares, institutional 
buyers of ABC will pull back, anticipating a price decrease, and other 
sellers will be more aggressive, driving the price down. The result of 
this information leak is that the stock would likely drop quickly, 
potentially costing the pension fund a lot of money.
    To avoid this scenario, institutional traders, and the brokers who 
trade on their behalf, expend a great deal of effort figuring out ways 
to buy and sell large amounts of stock that avoid signaling that a 
large investor is buying or selling. This has always been the case. To 
accomplish it, traders use a variety of trading techniques to reduce 
trading signals. There are four main types of signals that can reveal a 
trader's intentions to others: traditional phone calls, electronic 
messages like ``IOIs'' (Indications of Interest), reading patterns 
within the ``tape,'' or displaying bids and offers on exchanges.
    Of the four types of signals, displayed bids and offers are the 
most obvious signals, and therefore the most dangerous for investors--
by design, displayed bids and offers are immediately shown to every 
trader in the marketplace. Therefore, the decision to display a bid or 
an offer is not made lightly by an institutional trader.
    Before computerized ``dark pools'' existed, traders often chose to 
keep their bids and offers undisplayed, to avoid sending a signal of 
their trading intentions to the marketplace. This was accomplished by 
giving a ``not-held'' order to the floor brokers on the exchange who 
would then keep sensitive orders ``in their pocket.'' The broker would 
literally drop the order ticket in his pocket, without displaying it to 
the world, while keeping his eyes and ears open for the other side of 
the trade. This process also occurred at the specialist post on the 
exchanges, and in the ``upstairs'' market, where brokers would hold 
client orders while looking for the other side.
    A ``dark pool'' merely automates this age-old process. Traders drop 
orders into the computer's ``pocket.'' The computer, just like the 
floor broker of old, does not tell anyone about the order in its pool. 
If the other side of the trade happens to also drop into the pool, the 
computer matches the two orders, and a trade occurs.
    Computerized dark pools have been around since 1987. Today, they 
are an enmeshed part of the trading ecosystem, and they exist because 
they fill a need: the need for an institutional investor to be able to 
trade without telling the entire world that a new buyer or seller has 
entered the marketplace. Since decimalization, the number of shares 
required to be considered potentially ``market-moving'' has decreased, 
as the average trade size dropped from over 1400 shares in 1999, to 
under 300 in 2009. In a decimalized environment of constant small 
trades, even small orders can benefit from dark pools.
    Questions have been raised about whether dark pools contribute to 
``price discovery.'' Dark pools must report all trades to the 
consolidated tape immediately, and their prints are a valuable source 
of ``last trade'' data. When buying a house, buyers determine the 
appropriate price based on the prices at which similar houses actually 
sold in the neighborhood. Asking prices are interesting, but actual 
home sales are far more important. To assert that ``last trade'' data 
from dark pools does not contribute to price discovery is disingenuous.
    The next question that is raised by dark pool opponents is: what if 
all bids and offers went dark? Would there no longer be a quote? 
Current estimates are that dark pools make up 8.6 percent of 
consolidated U.S. equity volume, \4\ which we believe is in line with 
historical amounts from when the dark market was ``upstairs'' or run in 
the pockets of floor brokers. Dark pools fill a particular niche in the 
trading ecosystem, and they are here to stay, but we think scenarios of 
them taking over entirely are far-fetched and do not need to be 
addressed further.
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     \4\ Rosenblatt Securities, ``Market Structure Analysis and Trading 
Strategy'', September 30, 2009.
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    Exchanges, which are for-profit entities, are natural competitors 
to dark pools. Every share matched silently on a dark pool is by 
definition a share that the exchanges have lost to rigorous 
competition. Therefore, the exchanges are understandably advocating for 
their interests by cloaking their arguments around rhetoric such as 
``price discovery'' and ``transparency.'' They are also trying to 
harness the current debate around high-frequency trading to try to 
somehow link it to dark pools in an attempt to increase the regulatory 
costs for dark pool operators.
    But the argument that dark pools are somehow part of the high-
frequency trading debate simply does not make sense. High-frequency 
traders make their money by digesting publicly available order 
information faster than others; dark pools hide order information from 
everyone. Moving orders out of dark pools and onto exchanges would 
enable high-frequency traders to use new streams of information that 
are today kept quiet. This would not help retail investors, long-term 
investors, or the capital markets.
Recommended Regulatory Changes To Ensure Fair Markets
    Credit Suisse believes that several of the recent changes in the 
trading and markets area proposed by the SEC are positive developments 
and will help to ensure fair markets. However, one critical need has 
not yet been addressed--fair access to all market venues. While we 
believe that dark pools play a critical role in the marketplace, 
institutions searching for liquidity across dark pools do face a 
fragmentation problem.
    Currently, Regulation ATS allows dark pool operators to decide 
which broker-dealers can participate in their pool. There is a ``fair 
access'' requirement, but it is not effective. The current rule 
requires that ATS's only have to open their system to all users in any 
individual stocks where they have exceeded 5 percent of the volume for 
4 of the past 6 months. On top of that very high bar, there is a long 
list of exemptions, including exempting any ATS that systematically 
prices at the midpoint of the bid and ask.
    Last week, the SEC proposed lowering the threshold for quoting by 
ATS's when they send out so-called ``IOI's'' (which are electronic 
messages that reveal trading information). The SEC specifically decided 
to split the quoting threshold from the fair access threshold. Credit 
Suisse believes that the SEC needs to focus on the issue of ensuring 
that all broker-dealers have the ability to access all ATS's, enabling 
all broker-dealers to send dark orders to all dark pools. We propose 
the 5 percent threshold on the Fair Access provision be removed, and 
that all investors receive an equal opportunity to swim in all dark 
pools. Regulation NMS effectively connected the Nation's exchanges. A 
simple change in the fair access provision of Regulation ATS could do 
the same for dark pools.
The Role of Flash Orders and High-Frequency Trading
    ``Flash'' refers to orders that exchanges post for a fraction of a 
second to subscribers of their data feed before forwarding them to 
another exchange. Flash orders were created in 1978, when an exemption 
was included as part of what is now Rule 602 of Regulation NMS. Credit 
Suisse supports the proposed ban on flash orders.
    But while we support the proposed ban, it is worth noting that we 
do not support it for the reasons flash orders have been opposed in the 
media. Opponents of flash orders have repeatedly stated an incorrect 
argument: that flashes represent nonpublic information only available 
to a group of privileged insiders. This is not correct--anyone can 
subscribe to the exchange data feeds and anyone has the opportunity to 
read flash quotes. Several of the major exchanges provide their data to 
the public for free, while others charge a nominal monthly fee that 
must be approved by the SEC. It is important to the debate to 
acknowledge that flash orders are in fact publicly available 
information, and that orders ``flashed'' are done so at the request of 
the ``flashing'' client.
    The reason that we do support the proposed ban is that flash orders 
are allowed to virtually lock the market for a fraction of a second. 
``Locking'' a market means that the highest bid is the same as the 
lowest offer. Regulation NMS expressly banned locked markets, mandating 
that a bid and offer at the same price must trade. Flash orders 
therefore violate the spirit of Regulation NMS and weaken the concept 
of a national market system.
    High-frequency trading is linked in the debate to flash orders, but 
unlike flash orders, it is an undefined term. High-frequency trading is 
conceptualized as very short-term computerized trading, in which 
traders go in and out of stocks at high speeds. But how fast to qualify 
as a ``high-frequency trader'' is unclear--is a trader who goes in and 
out of a position once every 5 minutes a high-frequency trader? How 
about once an hour? Once a day? Most in the industry seem to use 
Justice Potter Stewart's ``I know it when I see it'' obscenity 
definition, but the result is that estimates of high-frequency trading 
range from 10 percent up to 60 percent of the volume. Credit Suisse 
believes the lower bound seems to be closer to the truth, but the lack 
of a formal definition makes it impossible to estimate what percentage 
of the marketplace they make up, or to perform any rigorous 
quantitative analysis to evaluate their effects.
    We believe the focus at this point in the debate should be on 
creating a clear and specific definition of high-frequency trading, so 
that analysts and academics can perform rigorous studies, and we can 
separate the facts from the conspiracy theories. Only after rigorous 
study of the nature and impact of high frequency trading should any 
remedies be prescribed.
Equal Access and the Advantages of Technology
    There is a big philosophical debate behind many of these questions: 
what does ``an unfair trading advantage'' actually mean? Is it unfair 
if a trader has any advantage at all, or just unfair if they have an 
advantage that can't be replicated by others?
    A staple of the argument against high-frequency trading is that 
these traders have an informational advantage, since most people don't 
have the technology to read and respond to market data in a split-
second time frame. This raises the question of why we would single out 
technological advantages without also looking at other types of 
advantages--no one has been suggesting that it is unfair to spend more 
money on fundamental research, for example, or to hire smarter or 
faster-thinking traders.
    The question should not be: do people who have invested in 
technology and figured out how to build smarter or faster computers 
have an advantage? Of course they do, as they would in any industry or 
undertaking. The question should be: do they have unfair access that 
others can't replicate?
    Here, we believe the answer is clearly no. High-frequency traders 
base their investment decisions on publicly available market data. They 
buy computer hardware the same way everyone else does. And they compete 
for computer programming talent in the same job market as every other 
company in America. In short, there are no unfair barriers to entry: 
any entrepreneur can buy machines, hire programmers, subscribe to the 
public data feeds and attempt to become a successful high-frequency 
trader.
    The only example that is used to demonstrate their ``unfair'' 
advantage is around the issue of colocation. ``Colocation'' refers to 
the practice of setting up your trading computers in the same physical 
building as the exchange's computers, to get a time advantage over your 
competitors. Like ``dark pools'' being the 21st century version of 
floor brokers putting order tickets in their pocket, colocation is the 
21st century version of traders trying to get office space close to the 
exchange. In the days before the telephone, brokers would send 
``runners'' down the block to deliver orders. The closer a broker's 
office was to the exchange, the faster they could execute orders, which 
was a major selling point for brokers that were clustered near the 
exchanges.
    Today, firms do the computerized version of the same game of trying 
to stay physically close to the exchanges. Credit Suisse has hundreds 
of computers located in a data center operated by a third party, where 
several exchanges and many other brokers and trading firms cluster 
their machines. As in days of old, physical proximity to the exchanges 
and speed of execution remains a major selling point. And the general 
public can get access to the benefits of sophisticated technology and 
colocated machines by selecting a technology-savvy broker-dealer to 
transact on their behalf.
    If data center owners discriminate against giving leases to certain 
brokers or traders, it would be unfair, just as it would've been unfair 
in the old days for landlords near the exchange to refuse to lease to a 
particular ethnic group. But there is no evidence of unfairness in the 
market for data center leases, and it was reported last week that 
NASDAQ voluntarily agreed to have access to their data center regulated 
by the SEC going forward. \5\
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     \5\ Traders Magazine, October 22, 2009, ``SEC to Regulate NASDAQ's 
Colocation Business'', by Peter Chapman.
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    Therefore, while fair access is critically important, Credit Suisse 
does not believe there is currently any unfairness of colocation 
access. More generally, we oppose regulatory changes based on 
disparities that result from some firms investing in technology while 
other firms choose not to.
Conclusion
    Credit Suisse believes that the main principles governing market 
structure decisions should be the principles of fair access and 
information protection. Fair access does not mean equality of results 
or forced equality of technological capabilities--it means an equal 
opportunity to participate in trading destinations, whether displayed 
or dark, and an equal opportunity to invest in technology and processes 
that allow investors to perform their best.
    Fair access, when combined with the existence of multiple venues, 
both dark and light, and protected by Regulation NMS and a robust Best 
Execution standard, add up to a marketplace where all buyers and 
sellers have an equal opportunity to achieve the best price. And it 
adds up to a competitive marketplace where exchanges and dark pools 
compete over technology and techniques to the benefit of all investors.
    Information protection means that investors have a right to ask 
their brokers to keep their orders ``in the pocket.'' It means 
acknowledging that investors have the right to remain silent, and that 
they deserve access to dark pools and dark order types that fill this 
critical need.
    In summary, we believe that:

  1.  Fair Access to all exchanges and dark pools is the solution to 
        solving problems of inequality in the markets. The ``Fair 
        Access'' provision of Regulation ATS should be overhauled to 
        allow all investors to participate in all dark pools. Access to 
        ATS quotes is not enough.

  2.  Attempting to steer orders from dark pools to displayed exchanges 
        is misguided and would benefit short-term information-based 
        traders, at the expense of big long-term investors.

  3.  High-frequency trading is a term that needs to be officially 
        defined by the SEC before it can be properly analyzed or 
        evaluated, and careful analysis is needed before prescribing 
        remedies for problems that may not exist.

  4.  Disparities that result from differentiated levels of investment 
        in technology are natural. It is only unfair if the opportunity 
        to invest and build similar technology does not exist.

    Thank you for the opportunity to appear today and I will be happy 
to answer any questions that you may have.
                                 ______
                                 
                 PREPARED STATEMENT OF ROBERT C. GASSER
   President and Chief Executve Officer, Investment Technology Group
                            October 28, 2009
Introduction
    Chairman Reed, Ranking Member Bunning, and Members of the 
Subcommittee, thank you for the opportunity to testify this morning on 
current issues affecting U.S. market structure. As a fully transparent 
and neutral player in the industry, I would like to offer ITG's 
unbiased, fact-based perspective on these issues to help you better 
understand the current trading landscape.
    ITG is a NYSE listed Company with 18 offices across 10 countries 
employing nearly 1,300 people worldwide. As a specialized agency 
brokerage firm, ITG provides technology to a broad collection of the 
globe's largest asset managers and hedge funds, allowing them to 
independently source liquidity on behalf of their clients. Throughout 
our 22-year history, we have grown our business in the best traditions 
of U.S. innovation and market leadership.
    In 1987, POSIT was launched as one of the first ``dark'' electronic 
matching systems. Since then, ITG's POSIT crossing system has 
harmoniously existed within U.S. market structure, including the 
Regulation ATS and Regulation NMS frameworks in more recent years. We 
firmly believe that institutions need a place to confidentially 
interact with each other to find natural block liquidity. Nondisplayed 
pools of liquidity such as POSIT provide a valuable solution for the 
buyside to comply with their obligations as fiduciary to offer their 
clients the best possible execution. Our analysis of millions of 
institutional trades post the advent of Regulation NMS confirms that 
POSIT reduces market impact of block trades and enhances execution 
quality.
    In my testimony today, I will begin by addressing the role of 
``dark pools'' and other undisplayed quotes historically in our 
markets. I will outline the advantages nondisplayed pools of liquidity 
provide for the marketplace, along with the concerns that exist today 
about the activities within such pools and their effect on the broader 
markets. I will then describe the effects of high-frequency trading on 
the markets, and discuss the advantages and disadvantages that have 
been cited for such techniques. Finally, I will provide our views on 
several topics that seem destined for further regulatory scrutiny: 
sponsored access and exchange colocation.
Dark Pools
    Contrary to their pejorative name, dark pools have played a 
positive role in the transformation of the U.S. equity markets over the 
past decade. As SEC Commissioner Kathy Casey herself points out, there 
is nothing sinister about dark pools; they exist for legitimate 
economic reasons. Institutional investors seeking to make large trades 
have always wanted to avoid revealing the total size of their order. 
This, in turn, benefits the millions of individual investors who invest 
in mutual funds and pension plans. Without a facility like POSIT, 
institutions with a natural interest in trading with one another would 
be subject to unnecessary frictional costs.
    We whole-heartedly embrace and support the broad concepts the SEC 
highlighted during its open meeting last Wednesday. The staff of the 
SEC's Division of Trading and Markets exercised a tremendous amount of 
care and diligence in their examination of current U.S. market 
structure. We interpret the SEC's recent pronouncements as establishing 
a bright line between truly dark pools and lit pools with an exception 
for block liquidity. We welcome the clarity. As a truly dark pool, 
POSIT will continue to provide large executions and price improvement 
to its customers.
    Academic research demonstrates that market fragmentation (including 
the proliferation of dark pools and other off-exchange trading venues) 
does not harm market quality. We support efforts to increase post-trade 
transparency, so long as the rules are applied consistently across the 
competitive landscape. In fact, we believe that the data arising from 
such transparency will better enable market participants to measure the 
quality of the executions that they receive from the various trading 
venues, thus enabling them to make better routing decisions in the 
future.
Indication of Interest
    Indications of interest, commonly known as IOI's, have become a 
commonly accepted method by which brokers and their clients communicate 
trading interest to one another efficiently. In the past couple of 
years, IOI's have empowered what we consider to be a potentially 
harmful mutation in market structure by which various ATSs can in 
effect create an ``inside'' market by sharing actionable IOI's 
selectively while still operating with no requirement to display that 
message. This practice has the potential to create a two-tiered market 
of participants with and without access to information. The SEC has 
deservedly focused on this issue and is recommending appropriate action 
to eliminate the grey area between lit and dark marketplaces.
High Frequency Trading
    As a pure agent and independent observer of high-frequency trading, 
ITG does not have a stake in the use of this practice. However, we are 
committed to looking out for the best interests of our clients and the 
future of U.S. market structure. We hold the view that high-frequency 
trading plays an important role in the marketplace. Specifically, high-
frequency firms take risk, commit capital, and provide liquidity in all 
market conditions.
    In today's highly evolved market, these high-frequency firms are 
both large customers of exchanges/ECNs as well as some of their 
strongest competitors. Accordingly, these firms are able to provide 
cost saving opportunities for broker dealers that are ultimately passed 
on to retail and institutional investors. Many of the high-frequency 
firms are broker-dealers and, as such, are subject to the oversight of 
the SEC and FINRA. Furthermore, many serve both institutional and 
retail clients and are critically assessed on the quality of their 
execution. Hence, these firms do not fly under the regulatory radar.
Sponsored Access
    However, we do have concerns about ``sponsored access'' and the 
risks it potentially creates for market participants. Sponsored access 
generally refers to the practice of a broker-dealer member of an 
exchange providing other market participants (possibly nonregulated 
entities) with access to that market center without having the 
sponsored participant's orders flow through the member's systems prior 
to reaching the market center. One of the concerns associated with 
sponsored access is that the service can be provided without rigorous 
compliance oversight and/or appropriate financial controls. We believe 
that the issue of sponsored access firms deploying high-frequency 
strategies on behalf of nonregulated entities deserves regulatory 
scrutiny.
    It is important to realize that the issues of high frequency 
trading and sponsored access are not black and white. Clearly, outsized 
returns generated by questionable trading practices must be 
scrutinized. However, retail and institutional clients benefit greatly 
today from the liquidity provided by high frequency firms, which 
generate reasonable returns in relation to the risk they assume. To 
impair that through broad-brush regulatory intervention without a 
targeted focus on abusive practices and the potential risks of 
sponsored access could possibly harm the continuity and quality of U.S. 
equity markets.
Equal Access to the Markets and Exchange Colocation
    U.S. exchanges have logically become mission critical technology 
providers to the brokerage industry. They now ``host'' brokerage firms 
within exchange owned and operated data centers and provide access to 
the circulatory and respiratory system of today's national market 
system: market data and the matching of executed trades. It is our hope 
that the SEC will provide similar clarity on the issue of colocation 
within exchange data centers in a future concept release. No firm 
should enjoy an advantage over another firm based on physical proximity 
to exchange technology. Principles of fair access and transparency must 
be applied equally to this issue.
Conclusion
    While we support the SEC's recent proposals, we are wary of the 
dangers of unintended adverse consequences for market structure. We 
note that Regulations ATS and NMS did produce the competition and 
innovation that they were intended to foster without compromising 
investor protection. The increased competition evidenced by the 
existence of approximately 40 execution venues in the U.S. market has 
reduced transactions costs and increased executions speeds without 
degrading the transactional or informational efficiency of the U.S. 
equity markets. To the contrary, U.S. market systems withstood the 
demands of unprecedented volatility and transaction volumes through the 
financial turmoil of last fall with remarkable stability and 
resiliency. The confidence that global investors have in the efficiency 
of the U.S. National Market System is well placed. This confidence is 
essential to U.S. leadership in the formation of capital. All of our 
collective efforts toward structural reform must focus on the 
preservation of this confidence.
                               Exhibit A
    Biography of Robert Gasser, CEO and President of Investment 
Technology Group--Bob Gasser is Chief Executive Officer and President 
of Investment Technology Group. Mr. Gasser was previously CEO at NYFIX, 
Inc., a global electronic trade execution firm. Before NYFIX, Mr. 
Gasser was Head of U.S. Equity Trading at JPMorgan. Concurrently, Mr. 
Gasser served on the Board of Directors of Archipelago Exchange as well 
as on the NASDAQ Quality of Markets Committee and the NYSE Upstairs 
Traders Advisory Committee. Mr. Gasser holds a Bachelor of Science 
degree from Georgetown University, School of Foreign Service.
                               Exhibit B
Culs de Sacs and Highways



                  PREPARED STATEMENT OF PETER DRISCOLL
                 Chairman, Security Traders Association
                            October 28, 2009
    Chairman Reed, Ranking Member Bunning, and Members of the 
Subcommittee, thank you for the opportunity to testify at this 
important hearing on behalf of the Security Traders Association.
    I am Peter J. Driscoll, a Vice President and Senior Equity Trader 
at the Northern Trust Company, Inc., in Chicago, Illinois, and the 
Chairman of the Security Traders Association (STA). I am here today 
representing the STA, a professional trade group that provides a forum 
for our traders, representing institutions, broker-dealers, ECNs, 
exchanges, market makers, and floor brokers to share their unique 
perspective on issues facing the securities markets. Our members work 
together to promote investor protection and efficient, liquid markets.
    The financial services industry robustly competes for order flows 
today. Individual investors trade in markets that are characterized by 
narrow bid ask spreads, historically low commissions, immediate 
electronic execution of trades, and research provided without charge.
    It is important, however, to realize that the vast majority of 
savings and investments are institutionalized, invested through savings 
plans at work, 401(k)s, pension plans, or mutual funds. Professional 
money management and diversification is critical for most investors who 
have neither the time and training or the resources to manage their own 
money. The institutions that work to identify investments for these 
funds are in reality representing the individual investors and working 
on their behalf. The aggregation of the interests of retail and 
institutional investors brings its own challenges. Like retail 
investors, institutional investors also value low commissions, tight 
bid ask spreads and competition for their order flow. The size of these 
aggregated orders also focuses their efforts on identifying pools of 
liquidity, be they exchanges or other trading venues that provide deep 
liquid markets where they can secure the best possible execution of 
these large orders on behalf of their shareholders.
    The U.S. equity markets functioned extremely well during our recent 
economic crisis. The markets remained open, collectively trading 
billions of shares daily and priced equity securities efficiently 
according to the economic laws of supply and demand despite the 
dramatic financial news that was impacting the Nation. Throughout the 
declining markets, security prices were accurate and represented the 
equilibrium between buyers and sellers at the moment of execution. As 
most are aware there are times when there were more sellers than buyers 
and prices decline significantly. Though painful, this is a natural 
operation of the markets and our equity markets functioned exactly how 
they were designed to function. Because of this, our markets have been 
referred to as a national jewel and the envy of the world and they 
lived up to that billing every single day during the economic upheaval.
    We commend the Subcommittee for taking a proactive approach to 
being an informed overseer of the markets. Your scrutiny is welcome and 
this debate is a healthy one. Open forums such as this are an important 
part of the regulatory process. Unfortunately, the topics before us 
today are technically complex and not well understood outside the 
industry itself. Additionally, the industry's flair for the dramatic 
has given these rather mundane mechanisms names like dark pools that 
carry a negative connotation. The market practices that we are 
examining today are not new; they have merely been transformed to be 
effective in the ever evolving electronic market structure. At the 
Security Traders Association, we characterize this evolution as natural 
growing pains that require industry debate to determine if regulatory 
attention is needed. It is my pleasure to be here on behalf of the STA, 
to be part of the informed debate by industry participants who 
understand trading processes and the potential ramifications any 
proposed regulations may have on our markets.
    The Securities and Exchange Commission (SEC or Commission) 
announced that they will issue a concept release concentrating on the 
topics that we are addressing here today. The Commission also held an 
open meeting where they voted unanimously to issue proposals intended 
to strengthen regulation of dark pools of liquidity. These proposed 
rules were issued in the regular notice and comment rulemaking process 
affording all market participants the opportunity to comment on the 
rules and discuss their concerns about their effect on the markets. The 
STA feels that this process is the best way to uncover any unintended 
consequences that a proposed rule may have prior to it causing any 
serious disruption to the market.
    Targeted regulation that ensures technology is used appropriately 
and that all participants have equal access to market data and trade 
execution is a mandate of the regulators. Identifying manipulation is 
the appropriate priority of regulators. The Congressional Oversight 
panel in their January Special Report on Regulatory Reform said:

        The essential debate . . . [is a debate] between wise 
        regulation and counterproductive regulation. ``Wise regulation 
        helps make markets more competitive and transparent, empowers 
        consumers with effective disclosure to make rational decisions, 
        effectively polices markets for force and fraud, and reduces 
        systemic risk. Counterproductive regulation hampers competitive 
        markets, creates moral hazard, stifles innovation, and 
        diminishes the role of personal responsibility in our economy. 
        It is also procyclical, passes on greater costs than benefits 
        to consumers, and needlessly restricts personal freedom.''

    We believe that there is room for wise regulation targeted to the 
areas currently under review.
    Dark or undisclosed liquidity has been part of the markets since 
their inception. In fact, many believe that the New York Stock Exchange 
was one of the largest dark pools in the markets. Floor brokers working 
large orders traditionally posted only small portions of the order in 
publicly displayed quotes. Dark liquidity is nothing new, though its 
use has grown.
    Like dark liquidity, market making has always played a role in the 
equity markets. The participation of market makers has historically 
helped promote efficient pricing as they make orderly two-sided 
markets, stepping in to buy or sell a security when other market 
participants were unwilling to do so.
    Concerns have arisen about how these two functions fit in the new 
electronic markets. Dark pools and electronic market making have 
largely replaced the old manual processes and have increased in 
popularity for several reasons. Decimalization of the markets in 2000 
reduced the risk/reward scenario for market makers by reducing the 
potential spread capture, the traditional means for market maker 
remuneration, from 6.25 cents to a penny. They retained all of their 
obligations to the market, including providing continuous two sided 
markets and being the liquidity of last resort, but the rewards for 
these obligations were cut dramatically. Traditional market making 
became unprofitable and most market making firms reduced their market 
making activity or bowed out of the business altogether. For the 
institutions, decimalization meant smaller trade increments and 
institutions had to change the way they worked orders in the market. 
Anonymity is essential to prevent market players from capitalizing on 
the information about their large institutional orders.
Alternative Trading Systems
    Private trading facilities began to attract institutional order 
flow and prosper because they provided the anonymity institutional 
traders desired and reduced the likelihood of information leakage. 
These new trading venues provided the institutions with a means of 
executing their orders without impacting the price of the stock 
significantly in this penny pricing environment. Private trading 
facilities would match orders within their systems using the current 
public quote to price the matches while depriving other market 
participants the opportunity to step ahead of their orders.
    These private trading facilities are subject to Regulation 
Alternative Trading System (ATS), promulgated by the SEC to foster 
competition among exchanges and other liquidity pools. The rule has 
been tremendously successful in incubating new technology and fostering 
technological competition for the exchanges. Regulation ATS provides a 
registration and regulation regime for upstart businesses to enter the 
markets and compete with minimal regulatory hurdles.
    While Regulation ATS has gone further than any other regulation in 
fulfilling a Congressional goal of the Securities Act Amendments of 
1975 by making it practical for ``investor's orders to be executed 
without the participation of a dealer,'' restricting access to certain 
dark pools and limiting reporting of quotes and transactional data 
appears to run contrary to another Congressional goal of those 
amendments. Namely, that ``linking of all markets for qualified 
securities . . . will foster efficiency, enhance competition, increase 
information available to brokers, dealers and investors . . . and 
contribute to best execution of such orders.'' As such, the STA 
believes that it is appropriate for the Commission to evaluate dark 
pool access and transparency standards.
    Trading and the pursuit of ``best execution'' involves strategy and 
the use of dark liquidity is one tactic in that strategy. Working an 
order in the dark allows the buy side trader to keep control of the 
order, keep the trading strategy confidential and limit the number of 
shares exposed to the price discovery process at one time. Limiting the 
size of the order exposed to the price discovery process allows the 
trader to avoid overwhelming the supply/demand equilibrium and thus 
achieve better priced executions. A great majority of market 
professionals believe that dark pools, or alternative liquidity pools 
as the STA generally refers to them, increase efficiency by lowering 
execution costs and providing competitive choices in the execution 
process.
    Some market participants believe that trading in dark pools 
degradates the price discovery process, the results of which 
alternative liquidity providers use to price orders. Traditionally, the 
large institutional orders have not been the driver of the price 
discovery process. It has been the small orders, fragments of the 
larger orders that interact to find the equilibrium price. While we 
understand the price discovery concerns and believe that at some point 
degradation may occur, we do not feel that with dark volumes trending 
around 10-15 percent of overall volume we are anywhere near that 
degradation point. As with most things in life moderation is a key. An 
efficient market structure can include alternative liquidity pools and 
public quoting venues coexisting. As long as we keep the appropriate 
level of order flow pumping through the price discovery process we 
should not see negative effects from this coexistence. In fact, recent 
statistics indicate that the overall level of alternative liquidity use 
has plateaued and individual pool gains now come at the expense of 
other alternative liquidity pools. In our 2008 Special Report we 
suggest that the Commission ``should closely monitor the aggregate and 
individual volumes of alternative liquidity pools in order to ensure 
adequate price discovery.'' We stand by that recommendation today.
    It has been suggested that trading in alternative liquidity venues 
disadvantages the ordinary retail investor. This is simply not factual. 
As we mentioned earlier the ``average investor'' invests through 
organized investment plans. These institutions use alternative 
liquidity providers to increase the efficiency with which portfolio 
decisions are implemented and reduce the costs associated with that 
implementation. If you consider the average retail investor who has a 
discount brokerage account and executes trades daily we would continue 
to point out that alternative pools of liquidity provide benefits to 
those participants. Prior to the advent of electronic trading and 
alternative liquidity pools small investors were concerned about trade 
certainty. Orders took several minutes to execute and the investor was 
at risk during those minutes. Electronic markets provide instantaneous 
executions, dark pools have provided the retail investor with the 
opportunity for price improvement as their orders flow through these 
alternative pools and the participation of high frequency traders 
assures that the size desired by the investor will be present when an 
execution consummates.
    Assuring fair access to these alternative pools of liquidity and 
increasing their transparency are important goals. As individual dark 
pools gain market share and their volumes grow it will be important to 
allow other market participants to not only see the order flow through 
the quotes required once threshold levels have been achieved but also 
interact with that order flow. The STA does not believe that limiting 
the successful dark pools to de minimis percentages of volume is the 
appropriate answer. Regulation NMS was promulgated to promote the 
public display of limit orders, it drove more trading to dark venues. 
Trimming the quoting and access thresholds to unrealistically low 
levels could result in an explosion of new ATSs and further fragment 
the market. Once a pool sponsor has developed the logic for the dark 
pools matching engine, it may easily replicate it under a separate ATS 
filing. Structural speed bumps will not force the dark pool operators 
to push order flow to lit venues. There needs to be an incentive for 
order senders to prefer the lit venues over the alternative venues. 
Should the SEC through empirical evidence determine that too much 
volume is trading in dark pools or that there are too many dark pools, 
the standards that ATSs must adhere to should be upgraded and 
competitive pressures should be allowed to solve the problem. 
Increasing access and transparency is the answer, not arbitrarily 
limiting the amount of business that can be done by one alternate 
liquidity provider.
    Dark pools should not be allowed to selectively share trading 
information. Once a pool decides to share information beyond what they 
provide to their members that information should be publicly 
distributed. This transparency must be increased without jeopardizing 
the pool participant's anonymity. Our members believe that a consistent 
reporting regime must be developed so that participants can make 
informed routing decisions. We further believe that pool operators must 
provide participants with detailed information about how their routing 
decisions are made and where the orders entrusted to them are executed. 
The STA also believes that post-trade transparency must be upgraded in 
such a way to allow other market participants to see which pools are 
attracting flows in which issues while preserving the anonymity of pool 
participants.
    The STA has long held that similar products should be regulated by 
consistent rules. We understand that exchanges receive some benefits 
that ATSs do not. We are also aware that ATSs benefit from the 
displayed quotes produced by the exchanges. We do not believe that the 
offsetting of these benefits is disproportional enough to support the 
degree of regulatory bias favoring one market structure over the other. 
ATSs have changed the trading landscape. We believe that while it is 
always important to incent competitive behavior, the regulatory gap 
between ATS regulation and exchange regulation should be rationalized. 
Balancing the regulations will allow all venues to compete more 
robustly.
High Frequency Trading
    The term ``high frequency trading'' is used to reference many 
different business models. For example, statistical arbitrage firms 
search for price disparities in the relationship between securities. 
They purchase the theoretically cheaper security and sell the more 
expensive one hoping to profit when prices regress to the mean. This 
type of arbitrage helps make markets more efficient and dampens 
volatility. Other high frequency traders hold themselves out as the new 
market makers. Market makers, as mentioned before, have traditionally 
had significant obligations to the markets and generally position risk 
for longer than milliseconds. Some question if market making is needed 
in the high volume millisecond trading environment that exists for 
primary tier stocks. We believe that there is a need for market making 
in secondary and tertiary issues, but not necessarily the primary tier 
stocks where data suggests most high frequency traders concentrate 
their activity. As competition enters the high frequency market making 
arena we would expect that trading profits would constrict forcing 
these market makers to begin making markets in lower tier stocks. Our 
members believe that high frequency traders provide liquidity and that 
their trading volumes help keep exchange fees low.
    In the Special Report, ``The STA's Perspective on U.S. Market 
Structure'' that the STA issued in May of 2008 we expressed concerns 
about businesses being built solely to capture rebates from maker/taker 
models and market data plans. We remain concerned about the distortive 
effects these businesses could have on issues by generating quotes and 
trades without investment intent contributing to the flickering quote 
problem. STA suggested that the SEC adjust market data revenue 
allocation formulas to only reward ``quality and tradable quotes and to 
discourage quotes that serve only commercial interests . . . .'' We 
believe this remains good advice and look forward to working with the 
Commission to bring it about.
Sponsored Access
    Sponsored access, the ability of an exchange member to provide 
access to a customer, must include appropriate trade risk management 
controls. Allowing ``naked'' sponsored access in today's interconnected 
markets is undesirable from both the industry and regulatory 
perspectives. One minor mistake in order entry could become a major 
problem across many different trading venues if trades are allowed to 
bypass risk management tools. Problems of this nature would put at risk 
many market participants and not just the participant who created the 
problem.
Colocation
    Colocation is arrangement where a market participant can locate 
their server in the same location that houses the trading venue's 
matching engine. There is nothing inherently unfair in colocation as 
long as access is provided to all who desire it at a reasonable cost. 
Last week two major trading venues voluntarily accepted Commission 
oversight of their colocation plans. We feel that this is an extremely 
positive advancement in the regulation of colocation and that the 
Commission should monitor changes in these plans to ensure a level 
playing field.
Regulatory Resources
    To adequately monitor and regulate the many issues we have 
discussed, we believe that the SEC needs the resources to upgrade their 
technology and hire more people to survail today's highly complex 
markets. Trying to monitor 35,000 registered entities with only 3,000 
plus or minus staff members seems a daunting task. The already 
knowledgeable staff could also be bolstered through the addition of 
staff who are seasoned market professionals.
Conclusion
    The Security Traders Association looks forward to working with 
market participants, governmental and self regulators, and the Congress 
on these technical market issues that have grown to be of national 
economic importance. We underscore the importance that any changes to 
the current regulatory framework need to be done in a deliberate and 
carefully considered manner, and if rules are adopted, to use pilot 
programs whenever possible to ensure against the possibility of market 
disruptions. We also emphasize the need for the SEC and the Congress to 
avoid ``picking winners and losers'' and to allow competition and 
innovation to drive market changes whenever possible. Regulation should 
not protect inefficiencies that must ultimately be paid for by 
investors.
    That concludes my remarks on behalf of the Security Traders 
Association. I thank you for the opportunity to participate in this 
important hearing today.

              Attachment: The Security Traders Association

What We Are
    Founded 75 years ago, the STA is an association of some 5,200 
individual professional traders of equities and options, represented in 
and by 26 affiliates across North America. Our members represent all 
segments of the industry--the buy side, the sell side, exchanges, ECNs, 
and ATSs. They trade on behalf of investors of all types: individual, 
institutional, and professional.
    Over the years, STA has contributed significantly and expertly to 
the legislative and regulatory discussion around market structure 
issues. Because our membership is drawn from all segments of the 
industry, the consensus views we develop, through our committee 
process, often render the best ``prevetted'' market structure solutions 
for investors, issuers, the industry, and our members. Our Committees 
provide a voice for: the sell side (Trading Issues Committee); the buy 
side (Institutional Committee); options traders (Options Committee); 
and compliance officers (Compliance Committee). Positions are 
recommended and voted on, and are then reviewed and approved by our 
Board of Governors.
    We have issued eight position letters in 2009. In addition, we have 
produced two important White Papers: ``Fulfilling the Promise of the 
National Market System--STA's Perspective on U.S. Market Structure'' 
(2003); and ``The STA Special Report--U.S. Market Structure 2008'' 
(2008).
What We Believe
    The U.S. equity markets have demonstrated the ``modernization and 
strengthening'' intended with the SEC's implementation of Regulation 
NMS in 2007. The National Market System is always an evolving ``work in 
progress.'' As in the past, the current market structure issues are a 
result of explosive growth due primarily through technological and 
regulatory changes. Examination of today's issues is not only 
important, but also is appropriate and healthy.
    We believe that a balance of competition and regulation yields 
superior results for all investors, issuers, markets, and the industry. 
We support the SEC as the appropriate regulator for our markets. In 
such a highly technical environment, the SEC has the understanding and 
procedures in place allowing for efficient regulation, consistent with 
goals mandated in the Securities Act Amendments of 1975. We encourage a 
pragmatic approach to ensure appropriate outcomes, based on empirical 
evidence and domain expertise.
    Given the role of the SEC, we strongly support the maintenance of 
the Concept Release and notice and comment process as a critical 
component of effective rule making by allowing all interested parties 
to submit their views. This process allows a broad review by the SEC 
prior to issuance of a final rule. Escaping the ``unintended'' is a 
major benefit.
                                 ______
                                 
                 PREPARED STATEMENT OF ADAM C. SUSSMAN
                    Director of Research, TABB Group
                            October 28, 2009
    Dear Chairman and Committee Members, first, thank you for holding 
this hearing. The U.S. equity markets have long been a pinnacle of 
market efficiency and investor protection and critical to economy. 
However, to maintain our leadership we ought to examine our system in 
order to make sure it supports a wide range of investors.
    During my career, the markets have undergone unprecedented 
regulatory and technological change. I entered the industry in 1998, 
designing retail order routing logic. In those days, executions would 
take minutes. When I left Ameritrade in 2004, executions were measured 
in seconds, and today they are measured in milliseconds.
     Now, as Director of Research at TABB Group, a financial markets 
research and consulting firm, I am part of an organization dedicated to 
helping market professionals understand the trading landscape. Our 
clients span the professional investment community from pension plans, 
mutual funds, hedge funds, high frequency firms, and brokers, to 
Exchanges and ATSs. Our studies put us in constant dialogue with head 
traders of our Nation's top money management firms. Indeed, a 
forthcoming piece of research, based on conversations with head traders 
at firms that manage 41 percent of U.S. institutional assets, is on the 
topic we are here to discuss.
    For institutional money managers, trading is a balance between 
price and time. If order information is not handled carefully execution 
quality can deteriorate, which would harm pensioners, retirees, and 
investors. Time-sensitive orders tend to be widely disseminated in 
order to increase the speed of execution, while price-sensitive orders 
stay dark to minimize impact on the stock. The tradeoff between dark 
and lit is never black and white as instructions differ, liquidity 
patterns are not consistent, and market conditions change.
    While dark pools are new, underlying trading principles have not 
changed since the Buttonwood tree. Large orders influence the market 
and will never be fully unveiled. As trading has evolved to rely on 
automated tools to facilitate decision making and execution, we need to 
ask, ``What tools should investors have to control the dissemination of 
trading information?'' In the past, traders gave large price-sensitive 
orders to NYSE Floor Brokers. Now traders have the ability to codify 
the execution decision and more closely manage how that order interacts 
with the market. The complex mechanisms of today's market reflect the 
competition to provide traders with state-of-the art tools.
    TABB Group's concern about dark pools is ensuring that traders who 
utilize these pools adequately understand their execution process. We 
have seen much progress on this front. This year, 71 percent of traders 
we interviewed were comfortable with dark pool practices, up from 53 
percent in 2008. The increased voluntary disclosure by dark pools is a 
positive step. TABB Group believes that there should be even greater 
dark pool order handling disclosure so traders can be sure their 
intentions are properly fulfilled. While we believe in disclosure, we 
do not necessarily believe in pretrade or real-time post-trade dark 
pool transparency, especially for small or midcap stocks. The 
dissemination of this information in real time can harm execution and 
force liquidity into other more manual dark forms. In this situation, 
end of day disclosure is more desirable.
    Opposite dark liquidity is high frequency trading (HFT). Markets 
require intermediaries to provide liquidity. In the past they were 
called specialists or market makers, while today we call them high 
frequency traders. Little has changed in providing liquidity except 
speed. HFT is merely an outgrowth of the regulatory and technological 
progress reflecting the cost of immediate liquidity. Among the 
institutional investors we spoke with 83 percent feel HFT has either a 
positive or neutral impact. Those that believe HFT has a positive 
influence on the markets cited the added liquidity and tighter spreads 
as key benefits. Those that are neutral believe the responsibility of 
execution quality rests on their shoulders. The 17 percent that believe 
HFT has a negative influence on the market feel as if HFT profits 
represent an unnecessary liquidity tax on their investors.
    Finally, it is important to make the important distinction between 
flash orders and high frequency. Flash orders at their height 
represented only 3 percent of overall share volume. With BATS and 
NASDAQ discontinuing the process, flash represents a small and 
decreasing fraction of overall equity market volume. Flash orders are 
another tool used to balance price and time--trading off information 
for a better price or more volume. Flash has existed for years on the 
NYSE Floor and on the market maker's desk, albeit manually. For flash 
trading, TABB Group believes disclosure is paramount and the ability to 
opt-out a must.
    Trading is both an art and a science. To effectively balance the 
price/time tradeoff, traders need a variety of tools. When we want to 
tread lightly, we trade in the dark. When immediacy is virtue, we take 
liquidity from wherever we can. As our markets evolve, so must our 
tools. No one idea trumps all others and a single market does not serve 
all. It is this competition among and within these different investment 
philosophies, trading strategies, and market structures that creates a 
more efficient marketplace for all market participants.
    With that, I would like to thank this Committee for its time.
 RESPONSES TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM JAMES 
                          BRIGAGLIANO

Q.1. Does integrating dark liquidity with displayed markets 
improve execution quality for retail investors?

A.1. In general, vigorous competition among trading centers to 
attract and execute retail investor orders is likely to improve 
the execution quality of those orders. In the current U.S. 
equity market structure, most marketable orders of retail 
investors (either market orders or limit orders with prices 
that make them immediately executable at the current best-
priced quotations) are routed to OTC market makers--a type of 
dark liquidity. OTC market makers generally execute small 
marketable orders of retail investors at the best displayed 
prices or better. The nonmarketable orders of retail investors 
typically are routed to displayed markets (such as exchanges 
and electronic communications networks (ECNs)) that will 
display the orders in the consolidated quotation data that is 
widely distributed to the public.
    Some displayed markets have attempted to integrate 
displayed and undisplayed liquidity by using ``flash'' orders. 
Flash orders are marketable orders that a displayed trading 
center cannot execute immediately at the best displayed prices. 
Rather than routing them to execute against the best displayed 
prices, the trading center ``flashes'' the orders for a short 
period (usually less than a second) to its market participants 
in an effort to attract dark liquidity to execute the order. As 
discussed in the recent Commission proposal to eliminate a rule 
exception for flash orders (Securities Exchange Act Release No. 
60684, 74 FR 48632 (Sept. 23, 2009)), while flash orders may 
offer certain benefits, such as reduced trading fees, they 
could disadvantage investors if their orders do not receive an 
execution in the flash process and market prices move away from 
the orders. In addition, use of flash order could create two-
tiered access to information about market liquidity as well as 
discourage others to display their best quotes thereby 
potentially widening spreads for all investors. The comment 
period for the flash order proposal recently ended. The 
Commission is reviewing the comments and will determine whether 
and how to proceed with the proposal.

Q.2. What is the danger that SEC proposed rules will force dark 
pools to interact less with the displayed market?

A.2. If the Commission were to adopt its flash order proposal 
discussed above, flash orders could not be used by displayed 
markets to access dark liquidity. This proposal would not, 
however, prohibit displayed markets from routing orders to dark 
pools. The use of dark liquidity in all its forms is an issue 
that the Commission may consider as part of a concept release 
or similar document.
    The Commission has also published a proposal to address the 
use of actionable indications-of-interest, or ``IOIs,'' by dark 
pools (Securities Exchange Act Release No. 60997, 74 FR 61208 
(Nov. 23, 2009)). These actionable IOIs sometimes are sent to 
displayed markets in an attempt to attract order flow. 
Actionable IOIs are not, however, included in the consolidated 
quotation data that is widely distributed to the public. As 
discussed in the Commission's proposal, the use of actionable 
IOIs potentially can create private markets and two-tiered 
access to information about the best displayed prices. The 
comment period for the Commission's proposal ends on February 
22, 2010. At that time, the Commission will consider the 
comments and determine whether and how to proceed with the 
proposal.

Q.3. Many concerns have been raised respecting fragmentation of 
the markets, what are the positives?

A.3. Fragmentation can occur when many different trading 
centers compete to attract order flow, and order flow is 
dispersed widely among those trading centers. Vigorous 
competition among trading centers for order flow can have many 
benefits. These include the tailoring of trading services to 
meet the needs of different types of market participants, 
innovation in the design of trading services, and pressure to 
keep trading fees low.
    Section 11A of the Exchange Act directs the Commission to 
facilitate the establishment of a national market system that 
achieves fair competition among trading centers, but also other 
objectives, such as efficiency, best execution of investor 
orders, and the offsetting of investor orders. Fragmentation 
can interfere with these other objectives. Linkages among 
trading centers are the primary means to balance the goals of 
competition among trading centers with the other national 
market system objectives. Whether the linkages in the current 
equity market structure are sufficient to achieve the benefits 
of competition among trading centers while minimize the 
potential harms of fragmentation is an issue that is part of 
the Commission's ongoing review of market structure.

Q.4. Retail investors have different needs from firms who 
engage in short term trading, how do we incorporate these 
different needs in a manner that maximizes benefits for all?

A.4. The Commission repeatedly has emphasized the importance of 
long-term investors, including retail investors, when 
addressing market structure issues. The interests of long-term 
investors and short-term professional traders often coincide, 
but when they do not, the Commission has stated that its clear 
responsibility is to uphold the interests of long-term 
investors.
    A good market structure should create a framework in which 
competitive forces work for the benefit of long-term investors. 
As noted above, for example, retail investors benefit when 
there is strong competition among trading centers to attract 
and execute their orders. The marketable orders of retail 
investors generally are executed at prices that reference the 
best displayed prices. When short-term traders compete to 
provide liquidity at the best prices, this competition can 
narrow quoted spreads and thereby directly benefit retail 
investors by improving the prices at which their orders are 
executed.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
                     FROM JAMES BRIGAGLIANO

Q.1. At an open meeting on October 21, 2009, the Securities and 
Exchange Commission (the ``Commission'' or ``SEC'') voted to 
publish for public comment three proposals that would 
significantly tighten the Commission's regulation of so-called 
``dark pools.'' Given that and your participation in today's 
hearing clearly the issue is very much on your radar screen. 
Can you please lay out a little more clearly the pros and cons 
of dark pools and flash orders? How do you weigh the liquidity 
and pricing function that they provide institutional investors 
with a need to ensure all market participants have equal access 
to information and pricing?

A.1. The potential cons of dark pool orders (particularly the 
actionable indications of interest, or ``IOIs'', that are the 
focus of the dark pool proposals) and flash orders are: (1) 
they may create a two-tiered market in which the public does 
not have access, through the consolidated market data that is 
widely available to the public, to information about the best 
available prices for listed securities; (2) they may discourage 
the public display of trading interest and harm quote 
competition among markets, which could lead to wider spreads 
and higher transaction costs for investors; (3) they may divert 
a significant amount of valuable order flow from the markets 
that publicly display the best prices and thereby detract the 
quality of public price discovery in listed securities (such as 
reduced depth or increased volatility); (4) if not used 
appropriately, they can cause information leakage about the 
dark pool or flash order that can harm the interests of the 
submitter of the order; and (5) the flashing of orders at 
marketable prices may undermine the purposes of the rules which 
protect previously displayed quotations from being locked by 
equal-priced contra-side quotations.
    The potential pros of dark pool orders and flash orders 
are: (1) the dark pool or flash mechanism may attract 
additional liquidity from market participants who are not 
willing to display their trading interest publicly and thereby 
improve execution quality for the dark pool or flashed order 
than if it were routed elsewhere; (2) a reduced or no fee for 
executing the dark pool order or flashed order than the fee 
that would have been charged (known an access fee or ``take'' 
fee) if the order were routed elsewhere; and (3) an ability for 
institutional investors or brokers representing the interests 
of institutional investors to trade without revealing their 
large trading interest to the public and thereby to lower the 
transaction costs of institutional investors.
    A vital step in weighing the pros and cons of dark pool 
orders and flash orders, including the liquidity and pricing 
function and equal access to information and pricing, is 
publishing the proposals and receiving the benefit of public 
comment on the issues. The comment period on the flash order 
proposal ended on November 23, 2009. The comment period on the 
dark pool proposals ends February 22, 2010. The Commission 
likely will want to assess the potentially serious drawbacks 
associated with dark pool orders and flash orders, including 
the danger of creating a two-tiered market, when considering 
any benefits for long-term investors, such as quality of 
execution, that may be provided. The Commission also likely 
will want to consider whether such benefits are otherwise 
obtainable.
                                ------                                


       RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING
                      FROM PETER DRISCOLL

Q.1. Mr. Driscoll, you suggested in your written statement that 
market makers, especially high frequency traders claiming to be 
market makers, aren't really making markets where it is needed 
and are concentrating on the highest volume stocks. What should 
the SEC or market participants do to fix this?

A.1. Market makers have always been (and continue to be) a 
critical part of the U.S. capital markets. Day in and day out, 
they provide billions of dollars of much needed liquidity to 
the market, which enhances price discovery, transparency and 
execution quality. Most traditional market makers provide 
continuous two-sided markets and a wide spectrum of specialty 
services in thousands of issues. Without these services, 
capital markets would have dramatically wider bid-ask spreads, 
volatility would increase and execution quality would quickly 
deteriorate, especially in secondary and tertiary issues where 
the lack of liquidity has traditionally been a problem.
    Market makers have adapted technologies to make their 
market-making operations more efficient. These technologies 
help manage risks, execute orders quickly and enable the market 
maker to remain competitive in the new electronic trading 
structure. This investment in high-speed technology benefits 
the market maker, their clients and the markets in general--a 
case where competition and innovation directly benefit 
investors.
    It is essential to our members that we and the regulators 
continue to evaluate and assess the benefits of competition 
from new market making entrants to ensure that the benefits to 
the investor are both quantifiable and tangible.
              Additional Material Supplied for the Record
                 PREPARED STATEMENT OF LARRY LEIBOWITZ
 Group Executive Vice President and Head of U.S. Execution and Global 
                      Technology for NYSE Euronext
Introduction
    Chairman Reed, Ranking Member Bunning, and Members of the 
Subcommittee, my name is Larry Leibowitz, and I am Group Executive Vice 
President and Head of U.S. Execution and Global Technology for NYSE 
Euronext. I greatly appreciate the opportunity to share with the 
Committee our written testimony on the subject of today's hearing. We 
are grateful for the Committee's leadership in addressing the market 
structures issues that are the focus of so much debate in today's 
evolving marketplace.
    This is a timely subject worth examining for several reasons. SEC 
Chairman Schapiro has announced that the Commission is undertaking a 
broad review of market structure issues; and, in fact, has already made 
several proposals, all steps in the right direction. These issues are 
important in the context of both the financial regulatory reforms the 
Committee is considering and the advances in market practices and 
technology that have become the focus of the public, regulators, 
legislators, market participants, analysts, and commentators.
    NYSE Euronext is a leading global operator of financial markets and 
provider of innovative trading technologies. The company operates cash 
equities exchanges in five countries and derivatives exchanges in 
Europe and the United States, on which investors trade equities, 
futures, options, and fixed-income and exchange-traded products. With 
more than 8,000 listed issues, NYSE Euronext's equities markets--the 
New York Stock Exchange, NYSE Euronext, NYSE Amex, NYSE Alternext, and 
NYSE Arca--represent nearly 40 percent of the world's equities trading, 
the most liquidity of any global exchange group. NYSE Euronext also 
operates NYSE Liffe, the leading European derivatives business, and 
NYSE Liffe U.S., a new U.S. futures exchange. We also provide 
technology to more than a dozen cash and derivatives exchanges 
throughout the world. The company also offers comprehensive commercial 
technology, connectivity and market data products and services through 
NYSE Technologies.
    Regulation is an integral and important part of the NYSE Euronext 
business structure. It is our belief that smart regulation--when 
properly administered--adds value to the marketplace overall, as well 
as to our business model. The current attention by this Committee, the 
SEC, and policymakers and commentators to the questions of how to 
update market structure regulation to address today's marketplace is 
timely and of utmost significance to our own business as well as the 
marketplace as a whole.
    Specifically, today I would like to address:

    the evolution of the equity markets since the adoption of 
        Regulations ATS and NMS in 1998 and 2005, respectively;

    the SEC's dark pool proposals;

    the SEC's proposal to eliminate ``flash'' orders;

    high frequency trading;

    colocation; and

    direct market access.

    In each case, I would like to identify what we view as the 
principal issues and ideal solutions.
Evolution of the Equity Markets
    In 1998, the SEC adopted Regulation ATS and Rule 3b-16, which 
allowed new electronic trading markets to operate as exempt 
``alternative trading systems'' instead of complying with the extensive 
regulatory requirements borne by registered exchanges. Although 
electronic trading systems were exchanges in all but name, prior to 
Regulation ATS they were regulated not as exchanges but solely as 
broker-dealers, with some additional reporting requirements. The SEC's 
purpose in adopting Regulation ATS was to encourage ``innovative new 
markets'' while providing ``an opportunity for registered exchanges to 
better compete with alternative trading systems,'' by reducing the 
regulatory disparities that existed at the time between regulated 
exchanges and automated trading centers, \1\ Regulation ATS sought to 
achieve these purposes by exempting alternative trading systems from 
exchange registration subject to conditions that imposed some but not 
all of the core obligations of exchange regulation on those ATSs, and 
only when an ATS reached a significant market-share threshold. These 
conditions include disseminating public quotes, providing fair access, 
maintaining reliable and secure systems, and ensuring the 
confidentiality of orders. Under the regulations in effect today, 
quoting and fair access obligations are triggered when a particular ATS 
crosses a fairly high threshold in volume in a particular security. 
Taking a step in the right direction, the SEC has recently proposed 
lowering the threshold that triggers the obligation to publicly display 
quotes from 5 percent to .25 percent. We believe the SEC should review 
whether the fair access threshold should also be lowered.
---------------------------------------------------------------------------
     \1\ Regulation ATS Adopting Release, Exchange Act Release No. 
40760 (December 22, 1998).
---------------------------------------------------------------------------
    Regulation ATS facilitated the development of numerous 
nontransparent trading systems (informally known as ``dark pools'') and 
transparent electronic communication networks, or ECNs, that 
disseminate public quotes. Prior to the adoption of Regulation ATS, the 
U.S. equity markets were primarily characterized by trading on 
transparent floor-based exchanges, with some blocks trading upstairs on 
broker-dealer block desks, and some retail orders executed internally 
by over-the-counter market makers. Regulation ATS fostered new 
competition from electronic trading markets, some bright, some dark. 
The competition presented by these new trading centers has changed the 
operations of exchanges, upstairs block desks, and over-the-counter 
market makers. For example, transaction volume that occurs off of 
regulated, transparent exchanges now routinely exceeds one-third of 
total market volume. This shift demonstrates the growth of highly 
competitive markets, but itself suggests that we are at a point where a 
reexamination of our market structure is warranted.
    Today we have the opportunity to step back and consider how to 
ensure that the regulatory framework keeps pace with the changes that 
Regulation ATS fostered. Before the adoption of Regulation ATS, the SEC 
rightly identified the need to bring parity to the regulatory treatment 
of registered exchanges and ATSs. Although the SEC's actions 
facilitated significant innovation and lower costs for investors as a 
result of the competition among the various market centers, it is 
important that policymakers continue to evaluate the marketplace and 
the effects of regulatory reforms to assure that they are achieving 
objectives that make sense in today's market and have not exposed the 
marketplace to regulatory arbitrage among participants. We must 
reexamine whether the SEC achieved its parity objective with the 
implementation of Regulations ATS and NMS and whether market practices 
and technology have outgrown the original designs of Regulations ATS 
and NMS. In particular:

    ATSs that are under the 5 percent volume threshold that 
        triggers the public quoting requirement are able to quote 
        privately, using prices that are based on the public quote that 
        is formed for the most part by registered exchanges. There is a 
        cost to creating the public quote, and private ATSs are not 
        contributing to that cost by contributing their quotes. As off-
        exchange transaction volume grows, there is a greater risk that 
        this pattern could harm the effectiveness and the integrity of 
        the public quote. The recent proposals by the SEC to address 
        this issue, as well as their anticipated concept release, are 
        important steps in the right direction.

    As trading spreads across more bright and dark markets, it 
        becomes increasingly difficult to monitor, both for practical 
        data aggregation reasons and because the task of monitoring 
        trading is spread differently across self-regulatory 
        organizations, without any one SRO seeing the majority of 
        trading. At a minimum, the cost of surveillance of the equity 
        markets should be spread across all trading centers and should 
        be fairly and proportionately borne by each marketplace, 
        whether an SRO or not. ATSs do not bear direct surveillance 
        obligations as exchanges are required to do, and do not 
        contribute directly to the costs of market surveillance 
        conducted by other SROs. We should look to create a more 
        equitable and consolidated approach to marketplace 
        surveillance.

    Registered exchanges are subject to an extensive 
        registration process to ensure that their trading systems 
        comply with national market system principles and that they are 
        structured and funded to operate effectively as self regulatory 
        organizations. Exchanges also must submit their rule changes 
        for prior SEC approval. It is important to recognize that this 
        rule review by the SEC is not a quick rubber stamp process: 
        many of the strongly held market structure principles of the 
        SEC are not expressed through notice and comment rulemaking, 
        but through the conditions and limitations the SEC imposes on 
        exchange rules through the approval process. This process often 
        is very time consuming. ATSs are not subject to similar 
        oversight, because they do not need to seek approval to operate 
        or file their rules for approval. As a result, ATSs are able to 
        modify their rules and respond to user feedback quicker than 
        registered exchanges, and they are not subject to the SEC's 
        behind-the-scenes application of market structure principles. 
        ATSs should be subject to SEC approval before becoming 
        registered, and prior SEC review and, where appropriate, 
        approval of their material system changes.

    And, most fundamentally, there is the question of whether 
        trading centers that account for a substantial percentage of 
        all trading volume should be permitted to benefit from any 
        exemption from fair access and quoting obligations, at least 
        with respect to small-sized orders.

    The regulation of ATSs requires additional changes to achieve the 
Regulation ATS objectives. Not just the ATS threshold for public 
quoting, but the ATS threshold for fair access should be lowered below 
5 percent. In fact, to lower the quoting threshold but not the fair 
access threshold is counterintuitive: it is like requiring a department 
store to advertise its sale prices but allowing the guards at the door 
to deny entry to all but the most privileged customers.
    Other jurisdictions are undertaking similar reviews. For example, 
Charlie McCreevy, EU Commissioner for Internal Market and Services, has 
stated that the European Markets in Financial Instruments Directive 
(MiFID), the EU's analogue to Regulation NMS, needs to be reexamined in 
light of the rise of dark trading venues, which he said ``gives rise to 
questions as to whether there are unfair commercial advantages for the 
operators of these venues and whether the trend undermines price 
discovery, market integrity and efficiency for the market as a whole.'' 
\2\
---------------------------------------------------------------------------
     \2\ Speech by Charles McCreevy, ``Towards an Integrated Approach 
to Regulation Across the EU'' (September 18, 2009), available at, 
http://europa.eu/rapid/pressReleasesAction.do?reference=SPEECH/09/
398&format=HTML&aged=0&language=EN&guiLanguage=en.
---------------------------------------------------------------------------
The SEC's Dark Pool Proposals
    In 2005, the SEC adopted Regulation NMS, with the goal of 
establishing a truly integrated national market system. Since then, the 
rise of dark trading venues has contributed to fragmentation, 
undermining the goals of Regulation NMS. Requiring ATSs to publicly 
display quotes and treating actionable indications of interests as firm 
quotes under Regulations NMS and ATS would help forestall further 
fragmentation by integrating many ATSs into the national market system 
of displayed quotes.
    Last week, the SEC proposed several rule amendments to address some 
of these issues. The SEC's proposals would (1) amend the definition of 
``bid'' or ``offer `` in Regulation NMS to require actionable 
indications of interest to be included in the public quote stream; (2) 
lower the volume thresholds that triggers the quote display obligations 
of ATSs from 5 percent to 0.25 percent; and (3) require trades reported 
by an ATS to identify the ATS on which the trade took place (today the 
trades are reported generically as having been executed ``over-the-
counter''). These proposals represent a useful and productive first 
step.
    Moving forward, it is important to address the additional market 
structure issues that I mentioned earlier: flash orders, high frequency 
trading, colocation, and direct market access. We understand that the 
Commission plans to publish a concept release exploring these topics, 
and in particular whether high frequency traders are contributing to 
liquidity in the displayed markets, whether long-term traders have 
shifted into dark markets, and whether these changes have resulted in 
greater volatility in the displayed and dark markets overall, to the 
detriment of long-term investors. While, as described below, we do not 
believe that high frequency trading and colocation in particular raise 
these concerns, other issues like flash orders are more problematic. We 
welcome the SEC's review of this area.
Flash Orders
    The rapid growth and widespread use of flash orders in part 
demonstrates how the regulatory framework has not kept pace with the 
evolution of the market. In this regard, the SEC should be commended 
for its recent proposal to eliminate flash orders. We agree with the 
SEC that flash orders undermine public price discovery and the 
efficient functioning of the markets by drawing liquidity away from the 
displayed markets and by allowing unsurveilled information leakage. In 
addition, flash orders represent a form of ``unfair access'' because a 
flash order is only available to a select group of market participants, 
thus the broader market is disadvantaged because a displayed order was 
not given the opportunity to execute against the order that was flashed 
to a select group. This undermines the incentive to display limit 
orders, which play an essential role in the public price discovery 
process by establishing outer limits as the market price moves. Flash 
orders also create a two-tiered market as they allow select 
participants to have advance access to order information in a given 
security. And flash orders create the opportunity for a recipient of 
the ``flash'' to trade on the public markets utilizing the information 
that the ``flash'' revealed about the price movement in a security, 
with no surveillance oversight of recipients of the information.
    Flash orders are an example of an innovation that if left unchecked 
would harm the markets and the integrity of public price discovery and 
create advantaged groups. On the other hand, there are innovations in 
technology and market practice that benefit the broader market. One 
example of a beneficial innovation is high frequency trading.
High Frequency Trading
    High frequency trading is a natural evolution of longstanding 
practices of active market participants and traditional market makers. 
A variety of firms engage in high frequency trading, including firms 
that have evolved from more traditional market making models. High 
frequency trading firms engage in various trading strategies, but 
generally operate by entering orders on a highly automated and high-
volume basis, based upon proprietary algorithms. Many orders are 
entered seeking rapid execution at their limit price and are cancelled 
immediately if not executed instantaneously.
    High frequency traders represent a significant portion of trading 
volume on the NYSE and other U.S. market centers. For example, it is 
estimated that high frequency traders accounted for approximately two-
thirds of all volume on U.S. equity markets over the last nine to 12 
months. \3\ High frequency trading should not be confused with flash 
orders. In fact, one analysis has suggested that almost all high 
frequency trading takes place outside of the flash process. \4\ High 
frequency traders provide substantial liquidity to the market, a 
positive development that should be encouraged. We believe that absent 
the liquidity provided by high frequency trading, the volatility in the 
equity markets would be much greater. In addition to providing 
liquidity, high frequency trading firms contribute to the narrowing of 
spreads, resulting in lower transaction costs for all market 
participants.
---------------------------------------------------------------------------
     \3\ See, ``Rosenblatt Securities Inc., Trading Talk: An In-Depth 
Look at High-Frequency Trading'' (September 30, 2009).
     \4\ See, id.
---------------------------------------------------------------------------
    High frequency traders invest in systems and trading algorithms 
that enable them to respond quickly to price changes by entering and 
canceling many orders at a time. As a result, high frequency traders 
trade at higher speeds and in greater volume than many other investors. 
But it is worth recalling that differences in speed and volume have 
always existed, and are harmful to investors only if they are on 
balance taking liquidity that would otherwise be available to other 
investors, or are manipulating the market in some manner. We have not 
observed either of these concerns.
Colocation
    Colocation is the practice of trading firms locating their servers 
at the physical location of a trading center's matching engine servers. 
In today's electronic trading environment, orders travel extremely 
quickly, so the physical proximity of a trading firm's server to the 
market affects execution speed (at a rate of approximately 1 
millisecond per 100 miles). This puts a firm located in, for example, 
San Francisco at a significant speed disadvantage to one in New York. 
In fact, a lack of available colocation facilities could trigger a 
scramble for real estate located next to market centers on behalf of 
parties that are outside the regulatory reach of the SEC or exchanges. 
The practice of colocation has been commonplace in both the equities 
and derivatives markets, and is the logical result of the automation of 
the U.S. marketplace. As U.S. market structure has evolved (due to 
Regulation ATS, Regulation NMS and other factors driving electronic 
automation and fragmentation), aspects of trading technology 
infrastructure (especially colocation) have started to commingle with 
the market structure itself.
    We do not believe that retail investors are disadvantaged by 
colocation. In fact, most retail orders do not enter the market 
directly, but rather through wholesalers, who instantaneously fill 
orders out of inventory at prices determined by the National Best Bid 
or Offer (NBBO), or place orders on exchanges using their own colocated 
infrastructure. Retail investors thus benefit from the utilization of 
colocation through tighter spreads, lower volatility and deeper 
liquidity.
    Colocation provides operational, not informational advantages. 
There have always been operational differentials in the marketplace, as 
a result of technological innovation and the extent to which 
participants choose to compete by spending resources on those 
innovations. Computers reading price feeds and making decisions have 
always been faster than people in their broker's office reading a 
ticker screen. As technology has become more prominent in the market, 
this operational differential has become most easily measured by speed.
    While operational advantages are a natural result of a competitive, 
free market, informational advantages are not--they distort price 
discovery and unfairly disadvantage other market participants. An 
informational advantage exists when a market participant has prior 
access to information that others do not have, as in the case of flash 
orders. Colocation does NOT in itself allow a participant to see orders 
before they hit the marketplace, as flash orders do.
    The SEC is presently reviewing the way fees are structured for 
exchange-owned/controlled colocation space and will require that such 
colocation fees be filed as is required for any other exchange pricing. 
The SEC has oversight over the exchange markets that offer colocation, 
but not colocation offered by ATSs or other third parties who do not 
operate marketplaces. We think it is important that the SEC consider 
ways in which to fairly regulate the practice of colocation across 
marketplaces, regardless of how colocation to a particular marketplace 
is offered.
    It is also particularly important to ensure fair access in 
connection with colocation in order to prevent both anticompetitive 
results for regulated exchanges and gaps in oversight regarding 
colocation by third parties, such as landlords of premises where market 
centers lease space to host their matching engines. It is impossible to 
prevent third parties from obtaining space close to an exchange data 
center and then subletting it to trading firms. Third party data center 
operators--acting on their own or on behalf of market centers (some of 
which are regulated and some of which are not)--are under no obligation 
currently to ensure fair access. As a result, not all markets are 
regulated equally, which creates competitive disadvantages among 
marketplaces offering colocation and creates an opportunity for market 
participants to engage in regulatory arbitrage. In addition, not all 
markets offer colocation in the same manner (e.g., the NYSE will own 
our U.S. equities colocation space and control the entire data center 
housing the matching engines for our European derivatives exchanges, 
subjecting us more directly to regulation, but our competitors might 
provide it via third parties, taking it out of the realm of regulation 
simply by virtue of the structuring of their real estate arrangements). 
This could result in an extremely tilted playing field that allows 
market participants that are significant contributors to overall 
activity and volume to avoid SEC regulation.
    We are working with the SEC to develop best practices for 
allocation of colocation space. We welcome the SEC guidelines in this 
area. We encourage the SEC to develop effective mechanisms for 
monitoring the practice among ATSs and third party vendors as well.
Sponsored Access
    Firms that colocate at market centers often connect to the market 
center though a direct market access arrangement. Direct market access 
refers to the practice for trading firms that are usually not 
themselves members of a particular trading venue obtaining access to a 
market center through a broker-dealer's trading identifier, thereby 
allowing such trading firm to enter orders directly onto the market 
center's systems. Direct market access takes at least two forms, 
including: arrangements whereby a member of a market center permits a 
sponsored participant to (1) enter orders directly onto the market 
without first passing through the member's systems (including risk 
management systems), sometimes referred to as ``unfiltered'' or 
``naked'' access, or (2) enter orders directly onto the market through 
the member's systems (including risk management systems).
    We support the SEC's initiative to develop clear, consistent 
supervisory standards for sponsoring firms in order to ensure that 
there are adequate risk controls in place to minimize systemic risk as 
a result of inadequate oversight of trading activity; we also support 
FINRA's efforts to monitor the sponsoring firms' risk management 
procedures--a role that properly belongs with a regulatory agency 
capable of examining across the industry in a consistent manner instead 
of in the hands of discrete exchanges with varying examination 
methodologies and processes.
Conclusion
    In conclusion, NYSE Euronext supports leveling the playing field 
between ATSs and registered exchanges by (1) requiring ATSs that cross 
a more realistic threshold in volume to be required to quote publicly, 
as the SEC has recently proposed; (2) reducing the Regulation ATS fair 
access threshold in parallel with the quoting threshold; (3) requiring 
ATSs to contribute to their proportional cost of market surveillance 
and for there to be a universal surveillance authority; and (4) 
requiring ATS rule changes to be subject to regulatory oversight and 
approval similar to the oversight and approval process that applies to 
registered exchanges. In addition we advocate:

    eliminating flash orders, as the SEC has recently proposed; 
        \5\
---------------------------------------------------------------------------
     \5\ NYSE Euronext will be submitting a comment letter on the 
Commission's proposal.

    encouraging high frequency traders to continue to play the 
        market stabilizing role that was demonstrated during the market 
---------------------------------------------------------------------------
        stresses experienced last year;

    ensuring that there is no regulatory disparity between 
        market centers that offer colocation opportunities in owned 
        data centers and nonexchange third-party data centers that 
        offer colocation opportunities; and

    requiring providers of direct market access to perform 
        pretrade monitoring of the trading activities of sponsored 
        participants in accordance with a uniform rule.

    We believe that the SEC is working on these difficult and 
complicated issues. We support the Committee's continuing efforts in 
focusing on this area, and would like to thank you once again for the 
opportunity to share our views today.
                                 ______
                                 
                 PREPARED STATEMENT OF THOMAS M. JOYCE
    Chairman and Chief Executive Officer, Knight Capital Group, Inc.
    Chairman Reed, Ranking Member Bunning, and Members of the Committee 
thank you for the opportunity to submit written testimony in connection 
with this very important hearing regarding key market structure issues; 
including dark pools, flash orders, and high frequency trading (HFT).
1. Brief history of Knight
    Knight Capital Group, Inc. (Knight) opened for business in 1995. 
\1\ Built on the idea that the self-directed retail investor would 
desire a better, faster and more reliable way to access the market, 
Knight began offering execution services to discount brokers. Today, 
Knight services some of the world's largest institutions and financial 
services firms, providing superior trade executions in a cost effective 
way for a wide spectrum of clients in multiple asset classes, 
including: equities (domestic and foreign securities), fixed income 
securities, derivatives, and currencies. Today, Knight through its 
affiliates, makes markets in equity securities listed on the New York 
Stock Exchange (NYSE), NASDAQ, NYSE Amex, the OTC Bulletin Board, and 
Pink Sheets. On active days, Knight executes in excess of five million 
trades with volume exceeding 10 billion shares. In 2008, Knight:
---------------------------------------------------------------------------
     \1\ Knight is the parent company of Knight Equity Markets, L.P., 
Knight Capital Markets LLC, Knight Direct LLC, Knight BondPoint, Inc., 
and Knight Libertas LLC all of whom are registered with SEC and various 
self-regulatory organizations. Knight Capital Europe Limited and 
Hotspot Fxi Europe Limited are authorized and regulated by the 
Financial Services Authority. Knight Equity Markets Hong Kong Limited 
is authorized and regulated by the Securities and Futures Commission. 
Knight, through its affiliates, is a major liquidity center for the 
U.S. securities markets. We trade nearly all equity securities. 
Knight's clients include more than 3,000 broker-dealers and 
institutional clients. Currently, Knight employs more than 1,000 people 
worldwide. For more information, please visit: www.knight.com.

---------------------------------------------------------------------------
    Made markets in (or traded) more than 19,000 securities.

    Executed nearly one trillion shares (roughly, 4 billion per 
        day)--more than any other broker/dealer or U.S. securities 
        exchange.

    Executed more than 640 million equity trades (approximately 
        2.5 million per day).

    Traded more than $4.8 trillion in notional value (over $19 
        billion per day).

    The majority of the trades we execute today are on behalf of retail 
investors. Although retail customers do not come to us directly, their 
brokers do. We count amongst our clients some of the largest retail 
brokerage firms in the U.S., including: Scottrade, TD Ameritrade, 
Fidelity, Raymond James, E*Trade, Pershing, Wachovia and Wells Fargo. 
In addition, we service some of the largest institutions in the 
country. These institutional clients send us orders on behalf of mutual 
funds and pension plans, whose ultimate clients are, of course, small 
investors.
    Knight has spent the last 15 years building its technology 
infrastructure so that it can process millions of trades a day on 
behalf of the retail investor--in a fast, reliable, cost effective 
manner, while providing superior execution quality and service. Our 
data centers are some of the largest and most reliable in the industry. 
We spend tens of millions of dollars every year, making our technology 
platform better, faster and more reliable. Today, we have the capacity 
to process nearly 20 million trades per day. We have connectivity to 
nearly every source of liquidity in the equities market, and our trade 
response times are now measured in milliseconds. Our years of research 
and development, technology platform enhancements, and connectivity to 
liquidity wherever it resides is all brought to bear with a single 
purpose in mind: securing best execution on behalf of our customers 
(and, in turn, their customer--the retail investor). Importantly, 
access to this sophisticated gateway is available to nearly every 
investor in the country.
    As a result, we believe that Knight is uniquely qualified to 
comment on these market structure issues. At their core, these issues 
revolve around notions of fair access and transparency--both of which 
form the foundation for our capital markets. As you will undoubtedly 
see upon the careful analysis of all of the relevant data, investors' 
level of access to the markets is extraordinary and the level of 
transparency in today's markets is better than it has ever been.
2. There has never been a better time to be an investor
    There has never been a better time to be an investor (large or 
small) in U.S. equities. Execution quality (speed, price, liquidity) 
are at historically high levels, while transaction costs (explicit and 
implicit) are at historically low levels.
    The U.S. equity markets are the fairest, most transparent and most 
liquid markets in the entire world. Remember that during the course of 
the last year, a tumultuous one to say the least, the equity markets 
worked flawlessly. One may not have liked the direction prices went at 
times but all investors could act on their investment decisions swiftly 
and with surety. The equity markets never seized up like many of the 
credit markets and loan markets. In fact, they were open every day all 
year, distinguishing themselves in their reliability and robustness.
    An extraordinarily important fact, however, continues to be 
overlooked--investors have seen substantial improvements in execution 
quality. For example:

  a.  The amount of times investors receive a price better than the 
        national best bid or offer (NBBO) has risen significantly over 
        the years.

  b.  Today, the industry average execution speed for retail market 
        orders in S&P 500 stocks is less than one second. In 2004, it 
        took nearly 12 seconds to execute that same order.
        
        
  c.  Effective spread is a comprehensive statistic designed by the SEC 
        to measure the price received by an investor relative to the 
        NBBO, and it is often set as a ratio to the quoted spread 
        (i.e., Effective to Quoted Spread, or EQ)--with the lower 
        number indicating that the investor is receiving a better 
        price. In 2004, an investor looking for an execution in a 
        NASDAQ-100 stock could expect an EQ of roughly 115 percent. 
        Today, that same order could receive an EQ closer to 90 
        percent--over 20 percent improvement in pricing for investors.
        
        
  d.  The realized spread compares the execution price to the NBBO 5 
        minutes later. The smaller the average realized spread, the 
        more market prices have moved adversely to the market center's 
        liquidity providers after the order was executed, which shrinks 
        the spread ``realized'' by the liquidity providers. In other 
        words, a low average realized spread indicates that the market 
        center was providing liquidity even though prices were moving 
        against it for reasons such as news or market volatility. 
        Retail size orders (fewer than 500 shares) in NASDAQ securities 
        are receiving some of the lowest realized spreads in the last 8 
        years--supporting the thesis that market participants are 
        providing liquidity even though prices may be moving against 
        them.

    The facts show that investors have benefited greatly over the years 
as a direct result of the developments in market technologies. In fact, 
in speaking before the Security Traders Association's Annual Meeting on 
October 4, 2007, former SEC Commissioner Annette L. Nazareth stated 
that,

        Today, the landscape has changed dramatically. In August of 
        this year [2007], for example, NYSE's market share in NYSE-
        listed equities was approximately 45.8 percent. For the first 
        time, ATSs and ECNs are now competing head-on with the listed 
        markets . . . What a difference true competition makes!

    High speed computers, IOIs, dark pools, etc., are not the problem; 
indeed, they are the culmination of our free-market system--
competition. Competition has led to better executions (both speed and 
price) for investors. We should not look to impede competition; rather 
we should always look for ways to enhance it. That is what keeps our 
capital markets great. Former SEC Chairman Arthur Levitt got it right 
when he recently said,

        Investors large and small have always been served well by those 
        looking to build the deepest possible pool of potential buyers 
        and sellers, maker trades at a better price, and all as quickly 
        as possible . . . More liquidity, better pricing and faster 
        speeds are the building blocks of healthy, transparent markets, 
        and we must always affirm those goals.----Wall Street Journal--
        August 17, 2009.
3. There are not two-tier markets
    Retail investors are able to harness the connectively and 
lightning-fast technology made available to them by their brokers and 
the execution venues that handle their order flow. From a speed and 
access point of view, investors are able to access some of the best 
trading technology available today--at little or no cost.
    Market venues spend hundreds of millions of dollars every year on 
technology, including data centers, communication lines and 
infrastructure. They look for new and improved ways to source and 
access liquidity, in the most effective and efficient manner 
(including, IOIs, dark pools, colocation, and countless order types). 
The investor community is provided access to many of these tools and 
technologies without charge (other than, of course, the small 
commission they pay their broker). That's right--investors get access 
to nearly all liquidity pools and they can harness some of the fastest 
and most sophisticated technologies in the world. For example, as noted 
above, Knight is connected to all key liquidity pools. We colocate our 
computers at various market centers, and we deploy some of the fastest, 
most sophisticated trading technology in the world, all of which is 
brought to bear for the purpose of executing our clients' trades. 
Simply put, if a retail investor gives a market order to buy 500 shares 
of Starbucks to his broker and that broker routes the order to Knight 
(or, many other execution venues), that order will likely be executed 
at the NBBO, or better, in less than a second. The cost to the investor 
is simply the commission paid to their broker (typically, less than 
$10). Knight, as well as most other nonexchange execution venues, 
provides access to all of its technology, liquidity, and gateway to the 
marketplace at no charge to the retail investor.
    We fully believe that if the SEC accounts for different forms of 
market structure needed for different participants, it will conclude 
that the ``little guy'' (i.e., retail investor) truly benefits from 
IOIs, dark pools, and the market processes designed to facilitate the 
sourcing of liquidity and enhancing execution quality. Remember, the 
retail investor is not operating alone. Retail investors give their 
orders to well-armed executing brokers who have access to the various 
liquidity pools in the market. Additionally, brokers often turn to 
executing venues (like, Knight and others) to gain further access to 
the markets. Taken together (the broker and the execution venue), these 
robust resources are brought to bear for the benefit of retail 
investors--providing them with a vibrant gateway into the marketplace 
and unprecedented access and liquidity. The investor is indeed not in 
it alone. This is not ``David vs. Goliath.'' To the contrary, ``David'' 
has retained ``Goliath,'' leveraging resources heretofore unavailable 
to retail, who swiftly and expertly accesses the market on his behalf.
4. Competition and innovation
    We fully support the SEC's initiative to review the broad range of 
market developments which have helped shape our equity markets in 
recent years. Competition and innovation have led to advancements in 
trading technologies over the last several years. In fact, Regulation 
NMS helped pave the way for competition to thrive among market 
participants. In addressing the STA at its Annual Meeting on October 
13, 2006, SEC Commissioner Nazareth stated,

        Two of the Commission's primary goals for Reg NMS are to 
        promote vigorous competition among markets and to remove any 
        competitive advantages that the old rules may have given manual 
        markets. All evidence to date indicates that these goals are 
        well on their way to being met.

    Those advancements have resulted in more liquidity, more price 
improvement and faster executions. Investors of all shapes and sizes 
(from small retail investors to large institutions) are reaping the 
fruits of those endeavors. As SEC Commissioner Kathleen L. Casey noted 
on October 21, 2009,

        Competition has transformed the equity markets. We have moved 
        light years from the slow manual trading that once 
        characterized the New York Stock Exchange. We have moved well 
        beyond the NYSE/NASDAQ duopoly. Today, the U.S. equity markets 
        offer more benefits to more investors than at anytime in 
        history. Over the past decade, advances in technology, coupled 
        with paradigm-shifting regulatory actions such as Regulation 
        ATS, have lowered barriers to entry. The resulting vigorous 
        competition for customer order flow among numerous trading 
        venues--including so-called ``dark pools''--has led to more 
        choices of trading centers, greater speed and liquidity, 
        financial innovation, tighter spreads, and lower execution 
        costs. Investors, particularly individual investors, have 
        reaped the benefits of the fierce competition that has 
        developed in this area. Therefore, it is imperative that we not 
        take any regulatory actions that would impede or 
        unintentionally reverse this considerable progress.
5. Sensible rule-making
    We believe it is especially important to craft effective trading 
rules. And there is an old saying that we believe guides this effort: 
``In God We Trust; everybody else has to bring data.'' The best rule 
making is based on careful analysis of all relevant facts. We urge the 
SEC to look closely at the statistical evidence of how efficiently the 
equities markets currently operate; to assess how much value the 
current system brings to all investors; and, to insure that any 
rulemaking withstands a rigorous cost-benefit analysis.
    Knight has advocated repeatedly that competition, rather than 
mandated and prescribed paths to trading, benefits market participants 
and all investors. For example, the SEC's Rule 605 is an excellent 
example of regulation that increases competition by promoting 
transparency and comparability. The rule requires market participants 
to post their execution statistics in accordance with standardized 
reporting metrics, thus enabling order routing firms to make more 
informed routing decisions to meet their clients' needs. This has 
increased competition and pressured market participants to continue to 
improve the execution of customer orders, while resulting in 
dramatically reduced costs for investors. We believe the dramatic 
decrease in brokerage commissions and the split-second executions for 
most marketable orders in recent years is a direct result of these 
competitive forces, not regulatory fiat. Additionally, SEC Rule 606 
requires brokers to disclose on a quarterly basis the venues to which 
it routed order flow, as well as any payment for order flow 
arrangement. The adopting release to Rule 606 states, in part:

        The purpose of requiring disclosure concerning the 
        relationships between a broker-dealer and the venues to which 
        it routes orders is to alert customers to potential conflicts 
        of interest that may influence the broker-dealer's order-
        routing practices. Currently, Rule 10b-10(a)(2)(i)(C) requires 
        a broker-dealer, when acting as agent for the customer, to 
        disclose on the confirmation of a transaction whether payment 
        for order flow was received and that the source and nature of 
        the compensation for the transaction will be furnished on 
        written request. In addition, Exchange Act Rule 11Ac1-3(a) 
        requires broker-dealers to disclose in new and annual account 
        statements its policies on the receipt of payment for order 
        flow and its policies for routing orders that are subject to 
        payment for order flow. The Commission believes that disclosure 
        of potential conflicts of interest in conjunction with a 
        quantitative description of where all nondirected orders are 
        routed may provide customers with a clearer understanding of a 
        broker-dealer's order routing practices than is provided under 
        current rules. (emphasis supplied.)

Regardless of any payments received, the SEC and self-regulatory 
organizations (SROs), like FINRA and the NYSE, have made it very clear, 
that the broker's first obligation is to seek best execution. The SEC 
has stated:

        The Commission anticipates that improved disclosure of order 
        routing practices will result in better-informed investors, 
        will provide broker-dealers with more incentives to obtain 
        superior executions for their customer orders, and will thereby 
        increase competition between market centers to provide superior 
        executions. Currently, the decision about where to route a 
        customer order is frequently made by the broker-dealer, and 
        broker-dealers may make that decision, at least in part, on the 
        basis of factors that are unknown to their customers. The 
        Rule's disclosure requirements will provide investors with a 
        clearer picture of the overall routing practices of different 
        broker-dealers. The Commission contemplates that this will lead 
        to greater investor involvement in order routing decisions and, 
        ultimately, will result in improved execution practices. 
        Because of the disclosure requirements, broker-dealers may be 
        more inclined (or investors may direct their broker-dealers) to 
        route orders to market centers providing superior executions. 
        Broker-dealers who fail to do so may lose customers to other 
        broker-dealers who will do so. In addition, the improved 
        visibility could shift order flow to those market centers that 
        consistently generate the best prices for investors. This 
        increased investor knowledge and involvement could ultimately 
        have the effect of increasing competition between market 
        centers to provide superior execution. (emphasis supplied)----
        See, SEC Release No. 34-43590 (November 17, 2000).

    This is precisely the type of transparency which has led to fierce 
competition among market centers. That healthy competition has resulted 
in the extraordinary levels of execution quality retail investors enjoy 
today. To that end, Knight supports the SEC's efforts to:

    Place more controls on sponsored access. Market 
        participants must insure that those who access the market 
        through their MPID have procedures in place to insure they 
        fully conform to industry rules and regulations.

    Require reporting of end-of-day trade volumes and 
        attribution for ATSs.

    Move to a 2 percent volume threshold for ATSs.

    Standardized rules and fees for colocation designed to 
        insure fair access to those who seek to such services.
6. The current proposals may push more liquidity into the dark
    Regulation ATS sets forth a two-prong test for determining whether 
quotes need to be displayed in the consolidated quote stream under Rule 
301(b)(3). In short, if an ATS displays orders to its subscribers and 
has at least 5 percent (.25 percent under the new proposal) of the ADV 
of the stock for 4 of the preceding 6 months, it has to reflect the 
order in the displayed market. So, increasing the possibility that ATSs 
will break the lower thresholds will simply cause more ATSs to go 
completely dark (i.e., not reflect orders to its own subscribers) in 
order to avoid displaying their orders.
    Additionally, indications of interest (IOIs) serve as a valuable 
method of market participants to communicate with each other. By using 
IOIs effectively, market participants are able to source valuable 
liquidity on behalf of investors--liquidity that may not have otherwise 
been available in the marketplace. So, further constricting their use 
will undoubtedly have the unintended consequence of further 
constricting liquidity.
    It is noteworthy to reiterate the comments made recently by SEC 
Commissioner Troy A. Paredes at the SEC's Opening Meeting on October 
21, 2009:

        [M]ore public quotes may not be the predominant result of the 
        rule amendments. Rather, as market participants adjust to new 
        public display obligations, the information contained in IOIs 
        might be scaled back so that IOIs, as a matter of practice, are 
        nonactionable and thus are not quotes that must be publicly 
        displayed. Presumably, if IOIs signal less information, those 
        looking to interact with nondisplayed liquidity would rely more 
        on ``pinging'' or other techniques to test liquidity across 
        dark pools. If this scenario occurs instead of there being a 
        meaningful increase in displayed liquidity, it is worth asking 
        whether the rule amendments before us ultimately would be 
        beneficial. In other words, might the status quo be preferable 
        to darker dark pools?

    IOIs, dark pools, and better trading technologies are the tools 
brokers use when seeking best execution for their clients. Further 
limiting their use of these resources, we believe, will not enhance the 
displayed markets; rather, it will inevitably lead to wider spreads, 
less liquidity and higher costs. One only needs to turn back the clock 
5 years to see evidence of this. When the exchanges had a dominant 
stranglehold on the markets and volume, execution quality suffered and 
trading costs for investors was exponentially higher than it is today.
7. The displayed markets are valid and robust
    Some have argued that the value of the displayed markets is somehow 
eroded when trading occurs off an exchange. We disagree. In fact, 
trades executed off of an exchange predominately occur at the NBBO (or 
better) which is completely consistent with both the letter and spirit 
of Regulation NMS. Nevertheless, the majority of trading volume today 
continues to take place on an exchange. In fact, NASDAQ, the NYSE, 
Direct Edge and the regional exchanges account for approximately 70 
percent of overall market volume. Regulation ATS and Regulation NMS 
helped to break the monopoly the exchanges had on market share. In 
fact, one of the ``darkest pools'' was the old specialist system on the 
floor of the NYSE. For years the specialists controlled trading 
information and access to data. Barriers to entry were lowered and 
competition was able to flourish, forcing the NYSE and NASDAQ to 
compete for market share, rather than simply demand it as a birth 
right. Commissioner Casey also noted on October 21:

        This trading volume migration from the incumbent exchanges to 
        other venues that publicly display trading interest 
        demonstrates the robust competition among trading centers for 
        customer order flow. It also demonstrates that nondisplayed 
        liquidity has not materially reduced the quantity of publicly 
        disseminated trade information. Therefore, it appears that an 
        obsessive focus on the rise of dark ATSs is misplaced. Quoting 
        venues in the aggregate are doing just fine, and the 
        competition among them is a good thing, not something we need 
        to ``correct.''

Market participants of all shapes and sizes actively trade both in 
displayed and undisplayed venues. If the prices in the displayed venues 
are not valid, trading firms quickly enter the displayed venues with 
orders and trades until the pricing is corrected. If this did not 
occur, those price dislocations would cause all venues (dark and light) 
to be irrational. Thus, any suggestion that undisplayed venues do not 
contribute to price discovery is illogical. Market participants trade 
in both venues, insuring that pricing is rational and bona fide.
Conclusion
    Knight appreciates the constructive roles this Committee and 
Subcommittee have played in the oversight of the markets and the 
rulemaking process. Your oversight helps to ensure that the U.S. 
capital markets remain competitive and innovative, thus benefiting all 
investors.
    We also fully support the SEC's initiative to review the broad 
range of market developments which have helped shape our equity markets 
in recent years. Competition and innovation, spurred by insightful rule 
changes fostered by the SEC, have resulted in dramatic improvements in 
market technologies and execution quality for the benefit of public 
investors--large and small. The U.S equity markets are the most liquid 
and efficient in the entire world, and have performed exceedingly well 
over the last several years. From an execution quality perspective, we 
believe that there has never been a better time to be an investor in 
U.S. equities. The advantages are considerable, including: speed and 
stability, price improvement, and a significant reduction in 
transaction costs. The empirical and statistical evidence available 
under SEC Rule 605 shows tremendous investor benefit under the current 
trading and regulatory market structure.
    We echo the comments of many of the SEC Commissioners that these 
important issues must be driven by the careful analysis of empirical 
data, and not be driven by emotion or politics. Indeed, SEC 
Commissioner Casey stated quite pointedly during the SEC's recent Open 
Meeting,

        [I] think it is necessary for the Commission to first develop a 
        deeper understanding of the whole range of U.S. equity market 
        structure issues before we consider adopting these amendments. 
        In my view, it is important that regulators act with humility. 
        Sometimes we don't know what we don't know, and if we rush to 
        regulate without a complete understanding of the extent to 
        which complex and dynamic activities may be interrelated, the 
        specter of unintended consequences looms large. The regulatory 
        process for rethinking market structure, like short selling, 
        needs to be driven by data, not politics or unfounded 
        assumptions.

    We are confident that an independent SEC will be careful and 
thoughtful in its work--and not be swayed by any market participant's 
self-interest. We urge the Committee, Subcommittee, and the SEC to look 
closely at the statistical evidence of how efficiently the equities 
markets currently operate; to assess how much value the current system 
brings to all investors; and, to insure that any rulemaking withstands 
a rigorous cost-benefit analysis. We must insure that any proposed new 
rules do not do more harm than good.
    Thank you for your interest in these issues and for the opportunity 
to contribute to this important dialogue.
                                 ______
                                 
    PREPARED STATEMENT SUBMITTED BY THE INVESTMENT COMPANY INSTITUTE
    The Investment Company Institute appreciates the opportunity to 
submit this statement for the record in connection with the 
Subcommittee's hearing on October 28, 2009, on ``Dark Pools, Flash 
Orders, High Frequency Trading, and Other Market Structure Issues.''
    The structure of the securities markets has a significant impact on 
Institute members, who are investors of over $11 trillion of assets and 
who held 24 percent of the value of publicly traded U.S. equity 
outstanding in 2008. We are institutional investors but invest on 
behalf of over 93 million individual shareholders. Mutual funds and 
their shareholders, therefore, have a strong interest in ensuring that 
the securities markets are highly competitive, transparent and 
efficient, and that the regulatory structure that governs the 
securities markets encourages, rather than impedes, liquidity, 
transparency, and price discovery. Consistent with these goals, mutual 
funds have strongly supported past regulatory efforts to improve the 
quality of the U.S. markets. We therefore support the current 
examination of the market structure in the United States.
Issues Facing the Current U.S. Market Structure
    The current debate is very similar to that which occurred during 
the last major review of the structure of our markets, specifically 
during the adoption of the Securities and Exchange Commission's (SEC) 
Regulation NMS. In Regulation NMS, the SEC noted that its proposals 
were designed to address a variety of problems facing the U.S. 
securities markets that generally fell within three categories: (1) the 
need for uniform rules that promote the equal regulation of, and free 
competition among, all types of market centers; (2) the need to update 
antiquated rules that no longer reflect current market conditions; and 
(3) the need to promote greater order interaction and displayed depth, 
particularly for the very large orders of institutional investors.
    Regulation NMS addressed these three categories but in the 
intervening years since its adoption, the securities markets have 
changed dramatically. The third category above, promoting greater order 
interaction and displayed depth, continues to be of great importance to 
mutual funds. As the SEC recognized in proposing Regulation NMS, 
``perhaps the most serious weakness of the [national market system] is 
the relative inability of all investor buying and selling interest in a 
particular security to interact directly in a highly efficient manner. 
Little incentive is offered for the public display of customer orders--
particularly the large orders of institutional investors. If orders are 
not displayed, it is difficult for buying and selling interest to meet 
efficiently. In addition, the lack of displayed depth diminishes the 
quality of public price discovery.''
    Problems surrounding the lack of order interaction, its causes, and 
its impact on the securities markets have long confronted mutual funds. 
The Institute and its members have, for many years, been recommending 
changes that would facilitate greater order interaction and, in turn, 
more efficient trading. A consistent theme throughout all of our 
recommendations was that in order to promote greater order interaction 
and displayed depth in the markets, a market structure should be 
created that contains several key components, the most significant of 
which are:

    Price and time priority should be provided for displayed 
        limit orders across all markets;

    Strong linkages between markets should be created that make 
        limit orders easily accessible to investors; and

    Standards relating to the execution of orders should be 
        created that provide the opportunity for fast, automated 
        executions at the best available prices.
Investors and the Current U.S. Market Structure
    The changes we have experienced in the structure of our markets the 
last few years have not addressed all of the components we believe 
necessary for a fully efficient market structure but great strides that 
benefit all investors have been made. Trading costs have been reduced, 
more trading tools are available to investors with which to execute 
trades, and technology has increased the overall efficiency of trading. 
Make no doubt about it, investors, both retail and institutional, are 
better off than they were just a few years ago. Nevertheless, 
challenges remain--posted liquidity and average execution size is 
dramatically lower while volatility and the difficulty of trading large 
blocks of stock have increased.
    Regulation NMS, which has been largely beneficial to investors, led 
to dramatic changes. The market structure in the U.S. today is an 
aggregation of exchanges, broker-sponsored execution venues and 
alternative trading systems. Trading is fragmented with no single 
destination executing a significant percentage of the total U.S. equity 
market. Some of the biggest and most active traders are high frequency 
traders, who by some accounts trade close to two-thirds of the daily 
volume of our securities markets. Tremendous competition exists among 
exchanges and other execution venues, primarily driven by differences 
in the fees they charge and the speed by which they execute trades, 
with floor-based exchanges quickly becoming irrelevant.
    To combat the difficulties in executing large blocks of stock, 
mutual funds have demanded much greater control over their orders to 
protect themselves from the leakage of information about their orders. 
As such, funds have adopted new trading technologies to help them cloak 
their orders and deal more directly with other institutional investors. 
This provided the incentive that led to many of the technological 
innovations in the securities markets including, as discussed below, 
the development of certain alternative trading venues.
    Trying to develop a market structure that promotes the fundamental 
principles of a national market system while balancing the competing 
interests of all market participants is no easy task. Nevertheless, one 
point should be made clear: mutual funds' sole interest in this 
discussion is in ensuring that proposed market structure changes 
promote competition, efficiency and transparency for the benefit of all 
market participants and not for a particular market center, exchange or 
trading venue business model. Market centers should compete on the 
basis of innovation, differentiation of services and ultimately on the 
value their model of trading presents to investors. We are hopeful that 
regulators can achieve the goals of a national market system while 
focusing on the interests of the markets' most important participant--
the investor.
Dark Pools
    Much of the current debate over the structure of the U.S. 
securities markets have centered on the proliferation of so-called 
``dark pools.'' We believe it is unfortunate that such a pejorative 
term has now become ingrained in the terminology used by the securities 
markets and policymakers to describe a type of trading venue that has 
brought certain benefits to market participants. We therefore are 
reluctant to use the term when discussing issues surrounding this part 
of our market structure and urge that an alternative term be 
established to describe such venues. However, since no alternative term 
has yet been formally recognized and for purposes of clarity, we will 
use ``dark pools'' in this statement to address these alternative 
trading venues.
    Dark pools are generally defined as automated trading systems that 
do not display quotes in the public quote stream. Mutual funds are 
significant users of these trading venues, which provide a solution to 
problems facing funds when trading large blocks of securities, 
particularly those relating to the frontrunning of mutual fund orders. 
They provide a mechanism for transactions to interact without 
displaying the full scale of a fund's trading interest and therefore 
lessen the cost of implementing trading ideas and mitigate the risk of 
information leakage and market impact. They also allow funds to shelter 
their large blocks from market participants who seek to profit from the 
impact of the public display of these large orders. The issue with 
these trading venues, however, is that the benefits of not displaying 
orders also lead to concerns for the structure of the securities 
markets. Sheltering orders from the marketplace can impede price 
discovery and transparency. As discussed above, these two elements are 
critical in creating an efficient market structure.
SEC Proposals
    The SEC last week set forth several proposals to bring ``light'' to 
dark pools and to address concerns about the development of a two-
tiered market that could deprive certain public investors from 
information regarding stock prices and liquidity. Specifically, the 
SEC's proposals address concerns about pretrade transparency, including 
pretrade messages sent out by dark pools in an effort to attract order 
flow but that are only sent to selected market participants (so-called 
``indications of interest'' or ``IOIs''). IOIs raise questions about 
how ``dark'' some of these venues truly are on a pretrade basis as well 
as whether these messages are similar to public quotes and therefore 
should be treated as such. The proposals also would lower the trading 
volume threshold required for the display of these venues' best-priced 
orders.
    The SEC's proposals also would address certain concerns about the 
lack of post-trade transparency, particularly concerns that it often 
can be difficult for investors to assess dark pool trading and to 
identify pools that are most active in particular stocks. Currently, 
public trade reports do not identify whether an over-the-counter trade 
was reported by a dark pool and, if so, its identity. The proposals 
would create a similar level of post-trade transparency as currently 
exists for registered exchanges.
Institute Views
    We appreciate the Government's desire to examine trading venues 
that do not display quotations to the public and understand concerns 
about the creation of a two-tiered market. As discussed above, the 
Institute has long advocated for regulatory changes that would result 
in more displayed quotes. At the same time, policymakers should take a 
measured approach to making trading through dark pools more transparent 
and we urge policymakers to ensure that there are no unintended 
consequences for mutual funds, which must execute large blocks of 
securities on a daily basis on behalf of their shareholders.
    The SEC has taken an important step in this regard in its 
proposals. The proposals would preserve the ability for mutual funds to 
trade large blocks of securities by allowing certain large orders to be 
``dark'' to address concerns about the leakage of valuable information 
about mutual fund trades or the frontrunning of fund orders. We must 
consider, however, whether additional steps must be taken by 
policymakers to address other ways that mutual funds trade, for 
example, when funds break up large orders into smaller pieces that are 
executed separately. We also urge policymakers to not view the issues 
surrounding dark pools in a vacuum without also examining other market 
structure issues. We therefore look forward to a broader debate on 
market structure that will raise important questions about numerous 
aspects of our markets in general.
High Frequency Trading and Related Issues
    High frequency traders and a host of issues connected to high 
frequency trading have also garnered the attention of regulators. The 
proliferation of alternative trading venues, including dark pools, and 
the accompanying technological advancements in the securities markets, 
set the stage for the entrance of high frequency traders. There are 
many benefits to high frequency trading that have been cited, including 
providing liquidity to the securities markets, tightening spreads, and 
playing a role as the ``new market makers.'' High frequency trading, 
however, also raises a number of regulatory issues including those 
relating to flash orders, colocation, and the risks of certain 
sponsored access arrangements, as discussed below.
    Mutual funds do not object to high frequency trading per se. We 
believe, however, that given the growing amount of the daily trading 
volume that high frequency trading now constitutes, many of the issues 
surrounding this trading practice are worthy of further examination.
Flash Orders
    The SEC already has proposed to prohibit ``flash orders.'' ``Flash 
orders'' are generally orders that trading venues disseminate, often 
for only milliseconds, to a select group of market participants, 
primarily high frequency traders, before they are displayed or traded 
against displayed bids or offers. While this advantage occurs in 
milliseconds, it gives a clear advantage to those who see it and have 
the capability to react to it, i.e., those with the requisite 
electronic connections. Most mutual funds do not allow their orders to 
be flashed, primarily because the process of displaying the orders to a 
select group of market participants could result in information 
leakage.
    The free look that flash orders provide is not new. Proponents of 
flash orders argue that flash quotes are nothing more than the 
electronic version of practices that previously occurred throughout the 
equity markets. That is correct. For many years, the specialists at the 
NYSE had the same informational advantage relative to other market 
participants and for many years mutual funds asked that this 
information advantage be eliminated. We continue to believe that such 
information advantages, and therefore flash orders, should be 
immediately banned.
Colocation
    ``Colocation'' is another ``fair access'' issue that has been 
raised relating to high frequency trading. Colocation refers to 
providing space for the servers of market participants, often high 
frequency traders, in the same data center housing the matching engines 
of an exchange. Colocation can serve to greatly reduce the delay 
associated with locating servers far away from the exchanges which, for 
high frequency traders, can mean the difference in whether they can 
execute a trade. While we do not have an issue with the concept of 
colocation, we believe that all investors should have an equal and 
reasonable opportunity for access to a colocation facility.
Sponsored Access
    Finally, sponsored access is the practice of market participants 
that are not themselves broker-dealers obtaining direct access to 
markets through a broker-dealer's trading identifier. Certain types of 
sponsored access arrangements provide access to markets without any 
broker-dealer pretrade risk management system reviewing orders being 
transmitted. For high frequency traders, this type of sponsored access 
saves valuable time in the execution of their trades.
    Mutual funds do not often use sponsored access arrangements, as the 
speed that these arrangements provide is not critical to the type of 
trades funds typically execute. We recognize, however, that unfettered 
sponsored access arrangements raise a series of supervision, compliance 
and risk-management issues that could impact the efficiency of the 
securities markets, e.g., a broker-dealer sponsoring a trader may not 
have adequate controls over the trader that it has connected to an 
exchange and the trader is not an exchange member subject to exchange 
regulation. We therefore support proper controls over sponsored access 
arrangements.
    We thank the Committee for the opportunity to submit this statement 
and look forward to continued dialogue with the Committee and its 
staff.
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