[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]




 
  HOW ROADBLOCKS IN PUBLIC MARKETS PREVENT JOB CREATION ON MAIN STREET

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

                                HEARING

                               before the

                SUBCOMMITTEE ON TARP, FINANCIAL SERVICES
              AND BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS

                                 of the

                         COMMITTEE ON OVERSIGHT
                         AND GOVERNMENT REFORM

                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                           NOVEMBER 15, 2011

                               __________

                           Serial No. 112-121

                               __________

Printed for the use of the Committee on Oversight and Government Reform


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              COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM

                 DARRELL E. ISSA, California, Chairman
DAN BURTON, Indiana                  ELIJAH E. CUMMINGS, Maryland, 
JOHN L. MICA, Florida                    Ranking Minority Member
TODD RUSSELL PLATTS, Pennsylvania    EDOLPHUS TOWNS, New York
MICHAEL R. TURNER, Ohio              CAROLYN B. MALONEY, New York
PATRICK T. McHENRY, North Carolina   ELEANOR HOLMES NORTON, District of 
JIM JORDAN, Ohio                         Columbia
JASON CHAFFETZ, Utah                 DENNIS J. KUCINICH, Ohio
CONNIE MACK, Florida                 JOHN F. TIERNEY, Massachusetts
TIM WALBERG, Michigan                WM. LACY CLAY, Missouri
JAMES LANKFORD, Oklahoma             STEPHEN F. LYNCH, Massachusetts
JUSTIN AMASH, Michigan               JIM COOPER, Tennessee
ANN MARIE BUERKLE, New York          GERALD E. CONNOLLY, Virginia
PAUL A. GOSAR, Arizona               MIKE QUIGLEY, Illinois
RAUL R. LABRADOR, Idaho              DANNY K. DAVIS, Illinois
PATRICK MEEHAN, Pennsylvania         BRUCE L. BRALEY, Iowa
SCOTT DesJARLAIS, Tennessee          PETER WELCH, Vermont
JOE WALSH, Illinois                  JOHN A. YARMUTH, Kentucky
TREY GOWDY, South Carolina           CHRISTOPHER S. MURPHY, Connecticut
DENNIS A. ROSS, Florida              JACKIE SPEIER, California
FRANK C. GUINTA, New Hampshire
BLAKE FARENTHOLD, Texas
MIKE KELLY, Pennsylvania

                   Lawrence J. Brady, Staff Director
                John D. Cuaderes, Deputy Staff Director
                     Robert Borden, General Counsel
                       Linda A. Good, Chief Clerk
                 David Rapallo, Minority Staff Director

  Subcommittee on TARP, Financial Services and Bailouts of Public and 
                            Private Programs

              PATRICK T. McHENRY, North Carolina, Chairman
FRANK C. GUINTA, New Hampshire,      MIKE QUIGLEY, Illinois, Ranking 
    Vice Chairman                        Minority Member
ANN MARIE BUERKLE, New York          CAROLYN B. MALONEY, New York
JUSTIN AMASH, Michigan               PETER WELCH, Vermont
PATRICK MEEHAN, Pennsylvania         JOHN A. YARMUTH, Kentucky
JOE WALSH, Illinois                  JACKIE SPEIER, California
TREY GOWDY, South Carolina           JIM COOPER, Tennessee
DENNIS A. ROSS, Florida


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on November 15, 2011................................     1
Statement of:
    Noll, Eric W., executive vice president of NTS Management, 
      NASDAQ OMX Group, Inc.; and Joseph Mecane, executive vice 
      president and chief administrative officer for U.S. 
      Markets, on behalf of NYSE Euronext........................     8
        Mecane, Joseph...........................................    18
        Noll, Eric W.............................................     8
Letters, statements, etc., submitted for the record by:
    Mecane, Joseph, executive vice president and chief 
      administrative officer for U.S. Markets, on behalf of NYSE 
      Euronext, prepared statement of............................    20
    Noll, Eric W., executive vice president of NTS Management, 
      NASDAQ OMX Group, Inc., prepared statement of..............    10
    Quigley, Hon. Mike, a Representative in Congress from the 
      State of Illinois, prepared statement of...................     5


  HOW ROADBLOCKS IN PUBLIC MARKETS PREVENT JOB CREATION ON MAIN STREET

                              ----------                              


                       TUESDAY, NOVEMBER 15, 2011

                  House of Representatives,
      Subcommittee on TARP, Financial Services and 
           Bailouts of Public and Private Programs,
              Committee on Oversight and Government Reform,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 9:48 a.m., in 
room 2203, Rayburn House Office Building, Hon. Patrick T. 
McHenry (chairman of the subcommittee) presiding.
    Present: Representatives McHenry, Guinta, Gowdy, and 
Quigley.
    Staff present: Drew Colliatie, staff assistant; Gwen 
D'Luzansky, assistant clerk; Linda Good, chief clerk; Peter 
Haller, senior counsel; Christopher Hixon, deputy chief 
counsel, oversight; Devon Hill, minority staff assistant; 
Jennifer Hoffman, minority press secretary; Brian Quinn, 
minority counsel; and Steven Rangel, minority senior counsel.
    Mr. McHenry. The committee will come to order. This is the 
Subcommittee on TARP, Financial Services and Bailouts of Public 
and Private Programs. Our hearing is entitled, ``How Roadblocks 
and Public Markets Prevent Job Creation on Main Street.''
    It is the tradition of this subcommittee to begin with the 
reading of the Oversight and Government Reform Committee's 
mission statement.
    Oversight Committee Mission Statement: We exist to secure 
two fundamental principles: First, Americans have a right to 
know that the money Washington takes from them is well spent; 
and, second, Americans deserve an efficient, effective 
government that works for them. Our duty on the Oversight and 
Government Reform Committee is to protect these rights. Our 
solemn responsibility is to hold government accountable to 
taxpayers because taxpayers have a right to know what they get 
from their government. We will work tirelessly in partnership 
with citizen watchdogs to deliver the facts to the American 
people and bring genuine reform to the Federal bureaucracy. 
This is the mission statement of the Oversight and Government 
Reform Committee.
    With that, I will recognize myself for 5 minutes for an 
opening statement.
    Over 2 years into our economic recovery, America's labor 
and capital markets continue to face unprecedented challenges. 
Tens of millions of Americans remain unemployed or 
underemployed, economic growth is anemic, and small business 
continues to struggle to access capital, all of which exists 
despite an endless number of government initiatives.
    Recently, our subcommittee examined barriers to small 
business capital formation, particularly focusing on the pre-
IPO market. We heard from market participants and experts who 
explained the repercussions that outdated SEC regulations have 
on the formation of startup companies. I am proud to say that 
earlier this month the House passed with broad bipartisan 
support--which is often rare in Washington and right now 
exceedingly rare--we passed several pieces of legislation to 
roll back these out-of-date and burdensome regulations. Now the 
next move goes to the U.S. Senate, where we hope that they will 
take positive action.
    Today's subcommittee hearing takes the next step of 
examining the life of small- or medium-sized businesses, this 
time in the post-IPO world. While some might associate the IPO 
market with people becoming overnight billionaires or ringing 
the bell at the New York Stock Exchange, or the bell at NASDAQ, 
the reality is that the health of our Nation's IPO market is a 
signal of its economic growth, innovation, and job creation. 
Businesses use the capital that they raise through an IPO to 
grow and expand, which means investing and hiring. In fact, 
over 90 percent of jobs created by a company are done after it 
goes public. That is important to note. This is not about the 
founders putting money in their pockets. It is about giving the 
company the capital it needs to grow and expand and innovate.
    Recognizing today's dismal unemployment rate and job 
numbers, it is no surprise that America's IPO market is 
suffering. Experts point to market structure and liquidity 
issues for small- and medium-sized companies as a primary 
reason. For one, the rapid increase in high-frequency trading 
has directed money toward the established liquidity of the 
higher cap companies. This trend has discouraged the kind of 
attention startup companies used to garner from investors who 
used to target them and other small businesses that showed 
promise of hidden value. Another mentioned item is the abrupt 
reduction in equity research. Even if investors are intent on 
finding a diamond in the rough, the lack of information 
discourages this effort.
    These market realities and others are why we have invited 
two of the world's major stock exchanges, the New York Stock 
Exchange and NASDAQ, to explain the importance of liquidity for 
small-cap companies and what can be done to strengthen the U.S. 
IPO market.
    Our focus is not to reverse market expansion or 
efficiencies. Instead, our aim is to understand why small- to 
medium-sized companies have second thoughts about going public 
and the influence that hesitation has on our economy and job 
creation. With small companies out to fend for themselves in 
the public market, experts and academics have suggested the 
formation of agreements between companies and brokers or even 
exchanges to create a market in the issuer's security. Such 
agreements would allow small companies the ability to produce 
an orderly liquid market for their stocks that is observed for 
many household brands. As the saying goes, liquidity begets 
liquidity. Research has shown that these agreements, already 
permitted overseas, have led to a positive influence on 
liquidity for small public companies.
    However, like most new ideas, such a direct agreement 
requires a change in regulation, this time by both FINRA and 
the SEC. Today is an opportunity to learn the purpose and 
effects of these regulations and where there is room for 
improvement. Orderly markets are one of our Nation's greatest 
strengths. Providing capital, access to businesses, and choice 
to investors is obviously at the heart of this. In the midst of 
our slow recovery, it is imperative that we continue to improve 
our markets to spur innovation and job creation.
    I am interested to hear from both our witnesses and both 
exchanges today about the challenges our small, public 
companies face and what can be done to fortify our post-IPO 
world. I appreciate their attendance and I look forward to 
their testimony.
    With that, I recognize the ranking member, Mr. Quigley of 
Illinois for 5 minutes.
    Mr. Quigley. Thank you, Mr. Chairman.
    Today's hearing will examine how roadblocks in public 
markets prevent job creation on Main Street. It will focus on 
how newer and smaller publicly traded companies encounter 
problems accessing capital from U.S. equity markets. The stock 
of smaller publicly traded companies often suffers lower 
trading liquidity. This means that small companies often cannot 
offer enough shares at prices that are acceptable to buyers or 
that companies cannot sell their shares quickly enough. Small 
publicly traded companies do not have brand name recognition 
and often have difficulties attracting investors. Some suggest 
that the U.S. market structure itself is a roadblock for small 
companies.
    In a statement prepared for a joint CFTC-SEC Advisory 
Committee on Emerging Regulatory Issues meeting, David Weild, a 
former vice chairman of NASDAQ, stated, ``The stock market 
structure today is disastrous for the vast majority of small 
capitalization stocks with asymmetrical order books. Who is 
there to create liquidity for the small capitalization stocks? 
The answer is often no one.''
    I think it is important that our examination seeks to 
answer why no one is there to create liquidity for small 
capitalization stock. I also believe we should be innovative in 
finding ways to create liquidity for small-cap stock in the 
United States to ensure equity markets are competitive and 
attractive for both issuers and investors. Improving small 
publicly traded companies' access to capital will contribute to 
the growth of these companies and their ability to create jobs.
    Any solutions we explore today must also permit our U.S. 
markets to function effectively and help ensure investor 
confidence in U.S. markets. However, while I favor bold action 
in bringing capital to American businesses, we must not 
sacrifice investor protection. Only a couple years ago in 2008, 
we witnessed how inadequate financial oversight led to fraud, 
recklessness, unscrupulous behavior, and manipulation in the 
market which caused the greatest financial crisis since the 
Great Depression. That is precisely why Congress passed the 
Dodd-Frank Wall Street Reform and Consumer Protection Act, to 
reform the U.S. financial regulatory system and to address the 
lack of accountability for Wall Street firms that caused the 
crisis or helped cause the crisis.
    Mr. Chairman, I thank you for holding this important 
hearing and I look forward to the testimony of our two 
witnesses. I yield back.
    Mr. McHenry. I thank the ranking member.
    [The prepared statement of Hon. Mike Quigley follows:]

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    Mr. McHenry. The full committee chairman has joined us and 
has requested 2 minutes, and the chairman is recognized for 2 
minutes.
    Mr. Issa. I thank you chairman, and I thank you for holding 
this important hearing. Your leadership in this area has been 
essential, whether it is public companies reforming the 
mistakes made under Dodd-Frank, including the DATA Act and 
other essential reforms that were never included in that act. 
As we all know, Bernie Madoff succeeded in the largest Ponzi 
scheme in American history because of an absence of 
transparency that could have easily made not just a few smart 
people who pushed the SEC on behalf of the investors, but the 
entire public very aware that he was trading in nothing. So I 
know that the work you are doing there, along with crowd 
funding, is essential.
    I join with Mr. Quigley on the need to have small capital 
funds not become orphans. But at the same time it is very clear 
that a great many companies should be allowed to have a broad 
group of sophisticated investors without the need for full 
public scrutiny and full public access. Often institutional 
investors, knowledgeable and with their own resources, given an 
audited financial statement, will make a wiser, more informed, 
and larger contribution. So there are many ways in which we can 
help reform the capital markets.
    I share with Mr. Quigley the need to make sure we never 
again have a meltdown, and that is where the work that you and 
others on the committee have done to try to get at Fannie and 
Freddie, very much the causes of moneys not being traceable or 
accountable had a root in that collapse that we all suffer from 
to this day.
    So, Mr. Chairman, thank you for the continued work. I might 
note the presence of the House Chaplain who has seen fit to 
begin looking at the work of our committee, and perhaps that is 
the best sign of all. I yield back.
    Mr. McHenry. Thank you, Mr. Chairman.
    Father, we ask for your prayers.
    Members will have 7 days to submit opening statements for 
the record. We will now recognize the panel of witnesses.
    We have Mr. Eric Noll, who is the executive vice president 
of NASDAQ OMX Group. We have Mr. Joseph Mecane, executive vice 
president and co-head of U.S. Listings in Cash Execution and is 
testifying on behalf of NYSE Euronext.
    It is the policy of this committee that all witnesses be 
sworn in before they testify. If you will please rise and raise 
your right hands.
    [Witnesses sworn.]
    Mr. McHenry. Let the record reflect the witnesses answered 
in the affirmative. Thank you. You may be seated.
    With that, we will recognize you each for a period of 5 
minutes to summarize your opening statements. We have a simple 
light system. It is a traditional light system. Green means go; 
yellow means whoa up and sort of wrap it up; and red, go as 
fast as you can, says Mr. Quigley. So at the yellow light that 
means you have 30 seconds to wrap it up.
    We will now begin with Mr. Noll.

  STATEMENTS OF ERIC W. NOLL, EXECUTIVE VICE PRESIDENT OF NTS 
    MANAGEMENT, NASDAQ OMX GROUP, INC.; AND JOSEPH MECANE, 
 EXECUTIVE VICE PRESIDENT AND CHIEF ADMINISTRATIVE OFFICE FOR 
            U.S. MARKETS, ON BEHALF OF NYSE EURONEXT

                   STATEMENT OF ERIC W. NOLL

    Mr. Noll. Thank you, Chairman McHenry and Ranking Member 
Quigley. At NASDAQ OMX we believe the challenges that we face 
in today's equity markets around liquidity and capital 
formation can be addressed by actions in four areas: one, 
addressing market structure weaknesses and their concurrent 
effect on price discovery; two, changing the lack of regulatory 
focus on rules and trading venues that would assist in the 
development of vibrant small company growth; three, removing 
regulatory barriers to small- and mid-cap companies that impede 
the IPO process and raise the cost of being public for those 
companies; and, finally, not directly related to liquidity and 
capital formation, but to assist companies in building their 
business, the development of an H1B and other immigration 
reforms to assist those companies in their internal hiring and 
growth plans. We believe that addressing these issues is 
critical for generating job creation and growth in the U.S. 
economy.
    Today's U.S. markets, the engine of economic growth, are 
increasingly fragmented and volatile. Liquidity in U.S. stocks 
is disbursed across 13 exchanges and over 40 other execution 
venues. Nearly one-third of public company stocks trade 40 to 
50 percent of their volume away from the organized exchanges. 
In the past 2 years the percentage of U.S. market share traded 
in those systems that do not post their bids and offers rose 
from 20 percent to over 30 percent. Many retail and core 
investor orders are executed away from those primary exchanges.
    While we identify market fragmentation as the source of 
some of the issues in regard to capital formation in the United 
States, there have been many benefits of that fragmentation. 
They have reduced investor costs and improved execution 
qualities in already listed securities. However, the unintended 
consequences of that market fragmentation have been a lack of 
liquidity and price discovery in listed securities outside of 
the top 100 traded names and a disturbing absence of market 
attention paid to small-growth companies by all market 
participants, including exchanges.
    Although recent market volatility has led to a slight 
movement toward exchange markets, trading in shares of public 
companies on these private trading systems accounts for more 
volume than on NASDAQ and the NYSE combined. Price discovery 
and available transparent liquidity are essential parts of 
vibrant market systems.
    Just as our markets continue to evolve and adapt, so must 
the regulatory structure of our markets. We support the 
development of a consolidated audit trail with real-time market 
surveillance and new regulatory tools to help regulators keep 
pace with technology advances and other changes in the markets.
    Between 2003 and 2007, the amount of capital raised by 
private equity funds increased by 300 percent. Issuing private 
equity allows companies to avoid disclosure and governance 
obligations created to protect investors. 2008 and 2009 were 
the worst years for IPOs since at least 1980. In 2009, there 
were just 12 venture-backed IPO's, raising $1.6 billion, and 
270 acquisitions with disclosed deals totaling $14.1 billion.
    U.S. stock listings are on the decline. In 1995, there were 
around 8,000 U.S. listings. Today, there are around 5,000. 
Meanwhile, the number of listing on non-U.S. exchanges has 
increased from around 23,000 in 1995 to over 40,000 today.
    Exchange listings help companies raise capital, both 
directly and indirectly. In addition to selling shares, 
exchange trading establishes a fair transparent price for a 
company. A company that has a clear price and many potential 
buyers will attract further investors and lenders to help them 
fund growth.
    It is well recognized that companies that do not trade on 
exchanging are valued at a discount. Financial experts, the 
U.S. IRS, the SEC and courts, recognize that discounts for lack 
of marketability range from 30 percent to as high as 75 
percent. A company valued 30 percent or more below its true 
value will not be able to invest, grow, or create jobs as 
quickly. Plainly stated, the higher the number of bidders for 
an asset, the higher the sales price.
    Academic research has estimated that between 2000 and 2005, 
a $50 billion drop in foreign IPOs on U.S. markets cost the 
U.S. $3.3 billion in lost annual trading-related revenues for 
U.S. brokers. These revenue losses mean jobs in financial 
services and related industries, and are moving from the United 
States to foreign markets.
    In any free market society, the number one source of job 
creation is entrepreneurship. Canada, the United Kingdom, and 
Sweden have successful venture markets with significant numbers 
of listed companies and substantial capital-raising success. 
These markets list hundreds of small companies that create jobs 
at a fast rate. Venture market companies regularly grow and 
then graduate to the main markets in those countries.
    The United States has no equivalent U.S.-supported and 
U.S.-organized venture market. NASDAQ OMX has received approval 
to create such a market on the former Boston Stock Exchange. 
The companies listed on BX will be smaller companies and the 
availability of the BX market will facilitate their ability to 
raise capital to continue and expand their business, creating 
jobs and supporting the U.S. economy.
    In conclusion, we would also like to quickly address the 
regulator barriers for IPOs. We ask the SEC be open to market-
based solutions to create competitive solutions to market 
problems. We also think that Sarbanes-Oxley reform is critical 
as we go forward to help small companies go public and remove 
some of the impediments to their ability to go public.
    Thank you for inviting me to testify. I look forward to 
responding to your questions.
    [The prepared statement of Mr. Noll follows:]

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    Mr. McHenry. Mr. Mecane.

                   STATEMENT OF JOSEPH MECANE

    Mr. Mecane. Chairman McHenry, Ranking Member Quigley and 
members of the subcommittee, I want to thank you for inviting 
NYSE Euronext to discuss whether new and smaller public 
companies suffer from liquidity issues as a result of our 
current market structure and whether the current structure 
contributes to a lower level of IPOs.
    I intend to focus my attention on three main topics. First, 
I will focus on the importance of liquidity for companies with 
small market capitalizations and a proposal we believe may help 
small-cap issuers. Second, I will discuss liquidity 
fragmentation in the marketplace. And last, I will address the 
subcommittee's question regarding liquidity payments to market 
makers.
    Before I jump into the points previously outlined, I would 
like to give some background about smaller issuers and why it 
is important to focus on this segment of the market. Small- and 
medium-sized enterprises, so-called SMEs, are the backbone of 
the American economy, and in previous economic downturns 
entrepreneurs and small businesses have been the main source of 
job creation. In fact, 18 of the 30 Dow Jones Industrial 
Average companies were founded during economic downturns.
    However, in order to enable SMEs to reach their full 
potential, capital must be easily accessible. In that effort, 
NYSE Euronext has been vocal in its support for Congress to 
adopt legislation to increase the threshold for Regulation A 
offerings as well as to adopt a larger exemption for SMEs from 
Sarbanes-Oxley, section 44-B. Each of these and other efforts 
are with a keen eye toward not only capital formation, but also 
job creation, which increases significantly as companies move 
through the capital formation process. To echo some of the 
remarks by Chairman McHenry at the beginning, over 90 percent 
of jobs in a company are created after a company goes public.
    There is one reason that liquidity is so vital for new and 
smaller issuers. Companies with small capitalizations 
consistently raise two concerns about going public as it 
relates to market structure. First, whether there will be 
sufficient liquidity in my stock; and second, will I have 
sufficient analyst coverage?
    As the Securities and Exchange Commission recognized in its 
2010 concept release on equity market structure, small-cap 
stocks can and often do trade differently than large-cap 
stocks. In particular, we have observed less liquidity at the 
national best bid and offer for small-cap stocks which we 
believe may be hampered by too narrow of a spread increment of 
a penny. While narrower spreads are generally a very positive 
result for investors, we believe that a penny minimum tick size 
may counterintuitively reduce the amount of liquidity at the 
best price, thus resulting in smaller quoted sizes and thinner 
markets.
    Accordingly, NYSE Euronext has advocated that a market-wide 
pilot with wider spread increments for less liquid securities 
could be a worthwhile exercise. During the pilot period, market 
participants and the Commission can review data to determine 
whether the impact is providing added investor benefits to less 
liquid securities. This could help increase the appetite for 
research coverage which declined after the global research 
settlement, and should be combined with a separate review of 
the restrictions around IPO communications.
    Liquidity concerns for emerging growth companies transcend 
the public markets with volumes fragmented across multiple 
exchange and non-exchange venues. While we believe that 
competition has been a positive factor for the marketplace, we 
have noted that the level of off-exchange participation in less 
liquid stocks is frequently above average. However, price 
discovery is dependent on interaction among a diverse set of 
market participants.
    In this vein, we have recently filed for approval of our 
newly created Retail Liquidity Program. This program will allow 
for superior execution prices for retail investors and 
encourage additional price competition for retail orders from 
liquidity providers, and we believe this program could help 
consolidate and potentially increase the liquidity in less 
liquid securities.
    Finally, the committee requested comment regarding what if 
any additional incentives could be adopted to incent market 
makers to post liquidity in less liquid stocks, including the 
allowance of issuers to pay market makers to provide liquidity 
directly. The committee has discussed the creation of a program 
where small-cap companies could enter into agreements directly 
with broker-dealers. NYSE Euronext believes the idea discussed 
warrants further review from both FINRA and the SEC and it is a 
topic that we have been separately pursuing. We would note, to 
echo Chairman McHenry's comments, that this is a process that 
exists in Europe and has shown beneficial effects on the 
liquidity of smaller issuers.
    In closing, NYSE Euronext believes that Congress and the 
appropriate regulatory authorities should work together with 
the industry to identify appropriate steps that can be taken to 
increase the level of liquidity for smaller public companies. 
Even if only on a pilot basis, trying new things will allow the 
market to determine which approaches could have the greatest 
impact on increasing the level of liquidity in illiquid stocks.
    Jobs are the number one issue facing our Nation, and 
although only part of a broader solution, we believe that 
adopting some of the approaches previously outlined will have a 
positive impact in reversing some of the negative trends we 
have recently seen.
    Thank you for the opportunity to present.
    [The prepared statement of Mr. Mecane follows:]

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    Mr. McHenry. I certainly appreciate your testimony. This is 
very helpful and instructive.
    I want to begin this way. There is a lot of discussion 
about what our public markets actually do and it is missed on a 
lot of individual Americans what the public markets are really 
all about. So I want to ask you, what net benefit do you 
provide to society through your exchange, through the public 
markets? I will just begin there. Mr. Noll?
    Mr. Noll. I think we provide several. The first one is what 
I will call the ability to discover prices for assets. So if a 
key tool for investors of all types, retail and institutional, 
is to understand the real value of an asset that they are 
investing in and the willingness to risk their own capital by 
investing in that, understanding the true price of that 
underlying asset is critical. So the ability of exchanges to 
discover that price for all investors on a fair and transparent 
way where everyone has access to that same price is critical 
for the determination of the underlying value of those assets.
    Linked to that price discovery formation is what I will 
call liquidity discovery. So just as important as discovering 
the price, is the size at which I can transact at. So exchanges 
perform a valuable function in gathering together all of the 
available buying and selling interest that is out there so that 
investors not only can discover price, but they can discover 
the size in which they can transact at, at that price.
    Ultimately that price discovery and that liquidity 
discovery enables companies not yet public to help themselves 
determine how they will be valued when they become public and 
provide a framework and a platform in which they can in fact 
bring their asset forward, attract investor interest, and see 
the liquidity in that investor interest develop and therefore 
raise prices to create jobs and grow their own businesses.
    So if I were to summarize, those are the big three that I 
think add value from the exchange side.
    Mr. McHenry. Mr. Mecane?
    Mr. Mecane. I will echo Mr. Noll's comments. I will also 
add that one of the primary purposes of an exchange are to 
match companies who are looking to raise capital in a public 
venue with potential investors who may look to invest in that 
company, help it grow and expand.
    Clearly companies that do want to go public or want to 
raise capital have a number of different options that they can 
pursue in order to do that. They can look to private investors 
and do a private capital raise. They can look to be acquired, 
either through a traditional M&A transaction or through a 
private equity or venture capital-type transaction, or they can 
choose to raise capital in a public format.
    Obviously the theme of this panel is talking about why 
companies may choose to go one of those other routes instead of 
going the public company route, and that is obviously a complex 
question, but I would view that last piece as being the primary 
responsibility of a public market.
    Mr. McHenry. With IPOs, it is about accessing capital in 
order to grow your business and it is a choice that you 
described, Mr. Mecane, between the various options. Many small 
businesses put it on a credit card to get started or get a 
loan. Probably not right now. They probably put it on their 
credit card more so. And then once they grow, they can get to 
the stature by which they can go to the public markets to 
access capital to more fully grow their business and take leaps 
and bounds. It also provides investors, individual small mom-
and-pop investors, the average American, to access this type of 
equity-side upside benefit of companies going public.
    I think it is important to begin there, because a lot of 
discussion about financial service products right now isn't 
related right back to what their net benefit is. It isn't a 
benefit as a product, it is a benefit of price discovery and 
accessing capital to grow a business.
    So I wanted to begin there. I would hope that we can come 
back for other rounds of questions. But with that, I would like 
to recognize Mr. Quigley for 5 minutes.
    Mr. Quigley. Thank you, Mr. Chairman. It is interesting the 
chairman brought this up to the 30,000-foot level. Sometimes we 
have questions that are more specific. I guess I would like to 
ask a specific question, but then get back to a larger 30,000-
foot perspective.
    My initial question had to do with Mr. Mecane. In your 
written testimony I think the quote is, ``Although the FINRA 
Rules adopted in 1997 prohibit any direct or indirect payment 
by an issuer to a market maker, NYSE Euronext believes the idea 
discussed may warrant review by both FINRA and the SEC and it 
is a topic we have been pursuing.'' Obvious concerns are 
because the rule in the first place dealt with manipulation, it 
dealt with the potential that executives of a company are 
incentivized to have their stock valued very high so it creates 
an opportunity for inappropriate activities.
    That question, and I would like you to both address it, 
really gets to the core of the issue here with what we try to 
do here. Put yourself in our place. What we are really dealing 
with for yourselves and for ourselves is faith and trust both 
with the American public and with potential investors. 
Investors have to have faith that there won't be a 
manipulation, but also the larger issue of giving you the 
opportunities to do what needs to happen to create jobs when 
the American public still has a gaping hole in faith and trust.
    Can you address that as a larger issue?
    Mr. Mecane. Sure. It is a very good point, and we echo your 
concerns about ensuring that investors have full faith and 
confidence in our public markets. Part of why my words were 
chosen carefully is because I don't think it is a very 
straightforward topic, and there are different sides to the 
same equation.
    The reason the restriction was originally put in place was 
to avoid exactly the point that the Congressman raised, that 
there is a conflict inherent in a situation where a company 
itself is paying a liquidity provider to make a market in the 
stock. So it is part of why, while we believe it may be a 
worthwhile discussion and experiment to try, it would need to 
be done in a way where there was sufficient disclosure and 
discussion around the conflict itself and whether it could be 
addressed.
    When I specifically stated that it is an avenue that we 
have been pursuing separately, part of our thought--and where 
we have been looking at this as an opportunity--is specifically 
in the ETF market. While that is not a topic of this committee, 
it is relevant because with ETF products, which are generally 
linked back to the underlying securities, there is less 
opportunity for manipulation because there is an arbitrage 
between the ETF price and the stock price.
    My point is that one avenue to try is an experiment 
specifically with ETFs with this type of a program to see if it 
actually helps with liquidity in those names, and that could 
then give more support and documentation as to whether it would 
be worth trying in the public markets also. So it could be done 
in a two-step process to try and minimize the conflict that you 
raised, Congressman.
    Mr. Noll. Thank you, Congressman. Like the New York Stock 
Exchange, this has been an issue that we have been paying 
attention to for a while. NASDAQ OMX in Stockholm operates a 
market called True North which is a venture market in which 
market makers do receive payments from issuers, and we have 
seen some great success in that platform in developing 
liquidity in the Nordic markets.
    Here in the United States, I think our concerns are echoed 
by you and by the New York Stock Exchange that the ability to 
create conflict or have conflicts in this area is something 
that we have to be very careful about. We are proposing, not 
unlike the New York Stock Exchange, to come forward with our 
own set of rules around this kind of process. One would be for 
our BX venture market in which we would create a structure by 
which the exchange in an open and transparent way would collect 
payments from issuers and then use them to provide to market 
makers to provide liquidity. So we are preparing a rule filing 
now to submit to the SEC that would allow us to do that.
    I think it brings two very good benefits to us by doing 
that, not only to us but to the marketplaces. One is that it is 
a rule set that would be transparently argued, debated, and 
approved by the SEC, and therefore monitored by them on an 
ongoing basis and the rules would be available and open to 
everyone to see and to participate in.
    Then I think it would address a problem that this committee 
has identified, which is that there is a lack of liquidity in 
these small-cap stocks. And I think it is fair to say and 
important to say that market makers will respond to economic 
incentives, so passing a rule that says that market makers need 
to make markets in small-cap stocks won't add any more 
liquidity. What will add liquidity to them is creating economic 
incentives to them to benefit by providing liquidity, and we 
think that this program will do that.
    Likewise, on the ETF side, NASDAQ is preparing a rule 
filing to do the same thing as well, which is to stimulate 
market maker interest in less active, less interesting ETFs, or 
not less interesting, but less followed ETFs to help stimulate 
liquidity in those as well. And I agree with Mr. Mecane that in 
both cases I think that these are valuable experiments for the 
Commission to try.
    Mr. Quigley. Thank you.
    Mr. McHenry. Mr. Guinta, the vice chair of the committee, 
is now recognized for 5 minutes.
    Mr. Guinta. Thank you very much, Mr. Chairman. Thank you 
both for coming here today.
    In a series of subcommittee hearings that we have been 
having over the last several weeks, we have been focusing a lot 
on how to create access to a stronger job market in this 
country. Obviously, the country is concerned about that 
primarily, and it has a dramatic effect on just about 
everything we do nationally and internationally.
    My focus is more narrow in scope, and I want to talk a 
little bit about the IPO market, I want to talk a little bit 
about the decline of IPOs that we have seen recently in this 
country, and I want to ask you both to focus a little bit on, 
number one, why you think we have had a decline in IPOs, where 
those IPOs are being listed, and what the negative effect of 
that is in terms of job creation here in America.
    Mr. Mecane, if you want to begin.
    Mr. Mecane. Sure. Thank you for the question. I will borrow 
from a report that was recently issued which the committee may 
or may not have seen, but it is a series of recommendations 
from the IPO task force which tried to tackle this issue and 
did, I think, do a good job of generating some data to support 
the issues that were being discussed.
    What seems to be the prevailing trend around the decline in 
IPOs is specifically concentrated in the smaller part of the 
market, so the sub-$50-million-type companies, and it does not 
appear that those companies are not being created or that they 
are actually going public on other venues. What appears to be 
the trend is that they are choosing to, when they get to a size 
where they are at a decision point about what the next step is 
for them to proceed, they are choosing increasingly to go 
through a private M&A-type transaction, either being acquired 
by a larger firm or a private equity-type firm, instead of 
going the route of the public market.
    I would say that has been the very broad trend over the 
last 20 years, where the first decade of the last 20 years was 
marked by a very high level of capital issuance by those 
smaller companies and the last decade of the last 20 years has 
been marked by more of these private M&A transactions.
    Obviously, it is an important question from a job creation 
standpoint, because as we noted earlier, much of the job 
creation that does happen in a company's life cycle occurs 
after they go public when they do have access to all these 
additional funds to expand their business and to hire and to go 
into new business lines.
    So the question as to why companies are choosing that 
private route instead of the public route is an important one. 
It is also, I believe, a complex one with a number of different 
dynamics occurring simultaneously.
    To paint one side of the equation, clearly the private 
equity and private capital part of the market has become a lot 
stronger in the last decade, and so some of what we are seeing 
could just be the evolution of that part of the market and an 
increasing ability to have another option other than going 
public. But at the same time, I think it is hard for us to 
ignore the fact that the cost of going public and the oversight 
of being a public company, especially for a smaller $50-million 
to $100-million-type company, has been increased significantly 
over the course of the last few years.
    Obviously it is a balancing act post-Sarbanes-Oxley and 
other types of reforms to make sure that there is confidence in 
our companies and willingness of investors to know that the 
company that they would be putting money into is safe. But at 
the same time it does call into question whether there are 
things that we can do to make it easier, less costly, 
especially for the first few years of a company being public, 
to be able to go public more easily.
    Mr. Guinta. I want to get to Mr. Noll, but just one final 
question. Would you agree with the statement that an M&A 
transaction, rather than an IPO, is missing an opportunity for 
job creation?
    Mr. Mecane. I don't want to over-generalize too much, but I 
would agree in a lot of M&A transactions the focus tends to be 
on synergy opportunities as opposed to expansion opportunities, 
and that is an over-generalization. It is not always true, but 
I do generally agree.
    Mr. Guinta. Generally speaking, yes.
    Mr. Noll, can you just maybe add to what Mr. Mecane said?
    Mr. Noll. Sure. Following up on Mr. Mecane's comments about 
M&A, which I generally would agree with, I think one of the 
issues that we are facing as an exchange and as an economy is 
that when that becomes increasingly the only avenue, it creates 
limitations on the way companies can grow their business, the 
way they can ask for capital, and the way they can use that 
capital to grow their businesses.
    So it isn't so much that M&A represents a bad way for 
companies to grow their business or private equity is a bad way 
for companies to grow. Quite to the contrary, those are all 
valid and very good ways to grow businesses. But as the IPO 
window for those businesses has closed, it removes some of the 
optionalities for what companies can do in a way that is most 
ideal for them, so that we become very worried about that and 
making sure we are developing that market for that small-cap 
company.
    You had asked earlier as well where a company is going. So 
the small companies are clearly going to the private markets. 
Foreign issuers, who traditionally had come to the United 
States to raise capital, are choosing not to list here, and a 
lot of that is compliance with our Sarbanes-Oxley rules, which 
may create additional costs for them that they would not like 
to face. I think the costs of market fragmentation are 
expensive for them.
    It is an interesting day when Manchester United, a very 
large U.K. sports team, chooses to list its stock on Singapore, 
and, quite frankly, never considered a U.S. listing. Twenty 
years ago, they would have come to the United States almost by 
default. So how we think about those issues I think is 
important as we go forward.
    So I think it is critical that we try to clear up the IPO 
calendar and the IPO structure for those small-cap companies 
and those foreign issuers.
    Mr. Guinta. I see my time has expired. I appreciate the 
chairman's indulgence.
    Mr. McHenry. All right. Thank you. Now we will begin a 
second round.
    So the bid-ask spreads have tightened, but out of that 
order flows have gone way up. I mean, the volume has gone way 
up. That is correct, right? So what does that do for exchange 
revenue? Does that mean exchange revenue goes up with the order 
flow? Mr. Mecane?
    Mr. Mecane. Sure. I would make two points. One is that 
there has been two separate dynamics going on in the industry. 
One is that clearly as bid-ask spreads have compressed, we have 
seen an increase in volume. But I would also highlight the 
point that in that same period of time, part of why those two 
trends happened is because there has been increasingly 
aggressive competition in the space, and the prices that 
exchanges and other venues have charged has also declined 
commensurate or even in excess of the spread decline. So I will 
just highlight that. Even though there is higher volume, 
because of those trends we are actually, frankly, making less 
money than we were in the prior periods.
    But it also leads to a second point, which is more specific 
to the small- and mid-cap part of the market. A lot of the 
spread compression and increased competition that we have seen 
has been in the very large liquid stocks where you have seen a 
lot of algorithmic-type trading, high-frequency-type trading, 
which tends to narrow the spread and make it very cheap and 
efficient and fast for the large-cap stocks to trade.
    The unfortunate reality is those same trends haven't 
occurred in the small- and mid-cap part of the market. Those 
stocks don't have sufficient liquidity for the high-frequency-
type automated traders to traffic in those names, and as a 
result, you have not seen a commensurate level of volume or 
liquidity or spread compression that you have seen in some of 
the large-cap names. And that is part of why we have suggested 
the experiment with perhaps wider spreads, as counterintuitive 
as that is, for those names.
    Mr. McHenry. Okay. So there is less revenue of a new 
listing based on competition.
    Mr. Mecane. Correct.
    Mr. McHenry. Okay. But order flow has gone way up, the 
volume has gone way up. So part of that is with the spreads 
compression but with the order flow going up. In those terms, 
spread compression, order flow going up, have they offset each 
other roughly?
    Mr. Mecane. I think probably, roughly.
    Mr. McHenry. Roughly. Is that how you see it with NASDAQ?
    Mr. Noll. I do, although I would note that volumes have 
actually come down in the last year, year and a half. And while 
I think there is a great deal of truth to the statement that 
tighter spreads and lower costs have driven volumes up, I think 
one of the things to remember about volumes and participation 
in the marketplace, it is ultimately about confidence in the 
market and it is market structure, and it is also about the 
ability of investors to transact in an effective way. So we 
have seen some of that confidence impaired.
    Quite frankly, we have seen volumes come down. And some of 
that confidence isn't necessarily in exchanges or exchange 
systems, but in the strength of the U.S. economy. So we have 
seen much higher volume days 2 or 3 years ago than we have in 
the last year. So while there certainly is a link between low 
costs and higher volumes, it isn't the only driver for volumes. 
So I think that is an important thing to know.
    Mr. McHenry. So order flow is more important than new 
listings though; is that fair to say, as a business concern?
    Mr. Noll. Well, I think two things about new listings that 
are critical for us and why we are starting to pay a lot of 
attention to this sector. One is this is where the new 
companies are going to come from, and we as exchanges, and 
particularly at NASDAQ, if we can't get those companies to be 
public and listed on one of our platforms for trading as they 
grow up to be big companies and very important companies in the 
U.S. economy, we won't be performing our function in the way 
that we hope to be performing it.
    Mr. McHenry. So therefore your investment on what used to 
be the Boston exchange.
    Mr. Noll. Right. So the creation of the BX venture market, 
try to look at market maker structures to try to provide 
liquidity there, which for us is a long-term investment in the 
development of new companies, because ultimately we think that 
is where the future growth is going to come from and we need to 
participate in that.
    Mr. McHenry. Okay. So you get an IPO. Immediately, because 
of fragmentation, the market fragmentation, liquidity 
fragmentation, you have a substantial amount of your order flow 
off your exchange, right? Am I correct?
    Mr. Mecane. Yes.
    Mr. Noll. Yes.
    Mr. McHenry. Okay. So what you do to incentivize liquidity 
instantly benefits these folks. It doesn't benefit you. It 
benefits this order flow off your exchanges; is that correct?
    Mr. Mecane. Yes.
    Mr. McHenry. So this is part of the challenge, is what that 
incentive is for you, actually benefits not your companies.
    Mr. Mecane. Yes.
    Mr. McHenry. To be clear, I mean you have both accessed the 
public markets in a very unique way as an exchange, so you do 
have to be concerned about your revenue. So as a policymaker I 
look at this and am trying to figure out how to incentivize 
you. But instantly, how much of the order flow after an IPO 
goes off your exchange? Mr. Mecane?
    Mr. Mecane. It is roughly--in a given name we will have 
roughly 30 percent of the market share across our different 
venues, 30-35 percent of the market share on our exchange, and 
then the rest will be fragmented across other exchanges and 
non-exchange venues.
    To your point, a lot of the focus, and clearly we are self-
interested in that argument also, but a lot of the focus is 
in--it is twofold. One is attracting as much liquidity to our 
market as possible; and, second, it is creating as much 
liquidity in general from that name. Clearly that benefits us 
from a revenue standpoint, but I think the more important point 
is to really take a particular company or their stock to the 
next level, it needs to be a name that institutional investors 
and long-term investors are comfortable investing in. And 
unless there is enough liquidity available, they are not going 
to be comfortable putting their funds into that particular 
company.
    Mr. McHenry. Mr. Noll? And then I will pass off to Mr. 
Quigley. I have gone over my time.
    Mr. Noll. Thank you, Chairman.
    So I think the competition between marketplaces has 
actually been very healthy. It has been very healthy for us as 
an institution. I think it has been healthy in many ways for 
the marketplace. And I agree with Mr. Mecane that when we take 
a company public, we retain post-IPO about 30-35 percent of the 
volume in that name on an ongoing basis.
    But the competition between markets has actually helped us 
to innovate. In many ways it created the success of NASDAQ over 
the long term. And so as we go forward and we start to think 
about what we need to do for small cap companies, it is not the 
competition with other venues that I worry about, it is the 
ultimate market structure that we put in place that will 
enhance the development of getting those companies to be 
public.
    I think the competition between venues is a very healthy 
one. It inspires us to do better. It inspires us to work 
harder. And I think for us to compete for volume and for us to 
compete for success in this marketplace is not a bad thing. I 
think that is going to spur us to do a better job of it going 
forward, and we would fully expect to win more than our fair 
share of that business back in that kind of competitive 
environment.
    So I am less worried about that kind of functionality than 
I am in the overarching market structure that would enhance 
small companies being able to go public.
    Mr. McHenry. Thank you.
    Mr. Quigley.
    Mr. Quigley. Thank you, Mr. Chairman. So we want to help. 
We recognize that this is about striking a balance, to protect 
investors and the public and creating jobs.
    Mr. Noll, you started off on a bit of a pessimistic note, 
which I appreciate and respect. But give me a little glimmer 
here. I am reading quotes from Renaissance Capital about 2010 
being not so bad, that it was the first year since 2007 where 
the number of IPOs was back in the triple digit range. 
Obviously, it is not just the number that matters, but their 
performance. But they also quote and say IPOs didn't have just 
a good year in terms of numbers; their performance was strong, 
too. The average U.S. IPO rose 25 percent, the best returns for 
IPOs since 2006.
    Do you agree with those numbers, see a trend or some hope 
along the future?
    Mr. Noll. Well, I think clearly there has been a lot of 
successes in this past year. On NASDAQ, of course, we look at 
Groupon and Zillow that have recently listed on our marketplace 
and done very well for investors, and in many ways those are 
both household names that many investors are very familiar 
with. So we have seen some repair in the IPO market from the 
depths of the financial crisis in 2008 and 2009.
    I think what concerns us less is whether the household 
names go public, right, who have grown, they are big, they have 
significant revenues, they have a share of mind in the 
investing public because of their success off exchange. What 
concerns us much more than that is we are not seeing support 
either for going public or to, in the after-market for small 
companies who may not be as big as Groupon or may not be as big 
as Zillow, to go public. So small biotech companies, small 
green-energy companies who need to access capital and are 
struggling to find ways to do so.
    So while there has certainly been a very positive change 
from the depths of the financial crisis to today in terms of 
IPOs, I still think that there are issues around those smallest 
capital companies and their ability to access capital.
    Mr. Quigley. Mr. Mecane?
    Mr. Mecane. I would echo that comment. There has been a 
fairly robust IPO market in 2011. We have had a number of very 
large companies go public with us this year, Kinder Morgan, 
Linked-In, Pandora. The issue, as Mr. Noll said, is we are 
seeing much of that IPO activity concentrated with the large-
cap stocks and not with some of the small- and mid-cap stocks 
that we have seen historically.
    Mr. Quigley. You alluded earlier to rules and concerns and 
issues. I look forward to the continued discussion. The devil 
is in the details. So on an ongoing basis we would encourage 
and appreciate your participation. Thank you.
    I yield back.
    Mr. McHenry. The vice chair, Mr. Guinta, for 5 minutes.
    Mr. Guinta. Thank you, Mr. Chairman.
    Mr. Noll, I want to touch a little bit on what the chairman 
was talking about and relate it to market structure. I guess I 
wonder, there is obviously competition between the New York 
Stock Exchange and NASDAQ. But I guess I would start to ask the 
question this way: Who do you really see as your competition? I 
mean, I have great concern about market structure, I have great 
concern about the willingness of an IPO to occur on an exchange 
here in America. And I see a lot of these either M&As or 
listing overseas, I see that as a fundamental long-term problem 
economically, not just for job creation but for the potential 
and future investor.
    So we are talking about the benefits that one exchange 
would have over the other, but I worry that we are focusing too 
much on you--not you, but NASDAQ focusing too much on the New 
York exchange or the New York Stock Exchange focusing on NASDAQ 
and the benefits that one would get from services provided by 
the other, when I think the longer term and the larger problem 
is a different competitor.
    So how do you see it? Do you see the person sitting next to 
you as the competitor or do you see some other exchange as the 
real competitor?
    Mr. Noll. Clearly, Mr. Mecane and I are colleagues and 
respect one another's ability tremendously. And, yes, the New 
York Stock Exchange is a competitor of ours. But I think in 
fairness to where we really view competition is not just the 
New York Stock Exchange. In many ways it is a global 
competition, so we compete with other marketplaces, other 
venues around the world.
    We also compete domestically, not necessarily against the 
New York Stock Exchange, but alternatives for capital raising. 
And what I mean by that is when a company is looking to raise 
capital or grow its business, who are we competing with for 
that capital raise? Oftentimes it is with a private equity firm 
or some other alternative for raising capital.
    So, yes, there is a vigorous competition for listings 
between the New York Stock Exchange and NASDAQ in the United 
States on a daily basis, but our competition is much broader 
than that on the listing side.
    On the trading side, it is even more robust than that. So 
clearly the New York Stock Exchange is one of our key 
competitors on providing a transaction platform, but we compete 
with transaction platforms among 13 other exchanges in the 
United States and 40-plus other trading venues, plus broker-
dealers, plus foreign trading there. So we view our competition 
on the trading side in a much more robust way as well. And 
essentially what we are hoping to do in responding to that 
competition is with innovation, things like the BX Venture 
Market and other things that we have done that will help us 
gain trading volume and share by doing a better job. So our 
competition is very broad competition, not a very specific one.
    Mr. Guinta. So how much are you concerned about the 
services that you provide benefiting a competitor?
    Mr. Noll. I am much less concerned about the services we 
provide benefiting the New York Stock Exchange or, quite 
frankly, any of our other exchanges. I view that as state of 
being. We have a competitive environment out there and we have 
to respond to it by being better at our jobs.
    I do think, though, that one of the critical things that we 
are going to have to think about in terms of going forward is 
how do we provide liquidity, whether it is on NASDAQ, whether 
it in the marketplace as a whole for these small-cap companies. 
So ultimately the market structure that has to be put into 
place is one that identifies that, not necessarily benefiting 
one market over another market.
    Mr. Guinta. What about off-exchange equity trading venues?
    Mr. Noll. They exist. They provide value in many ways. So I 
think it is important that off-exchange trading venues continue 
to exist where they can do things that we can't do or they do 
things for customers that we have been unable do. One of those 
is provide price improvement. One of those is to retain the 
ability to not have a large institutional order exposed to the 
marketplace; in other words, solve the information leakage 
problem. And, ultimately, if they are contributing to price 
discovery, you know, we have less issues with those things.
    I think where we do have issues is when we as an exchange 
are barred or otherwise restricted in our ability to compete in 
that marketplace because of SEC rules or other strictures that 
allow us or prevent us from competing effectively and where 
those off-exchange venues are not contributing to a fair 
transparent market and to price discovery.
    Mr. Guinta. So liquidity is dispersed, you say, over 13 
different exchanges. Are you suggesting that that is part of 
the liquidity problem?
    Mr. Noll. No, it is a fact. What I am noting is in those 
large-cap names, liquidity is scattered across 13 venues and 
40-plus more off-exchange. Those venues aren't trading small-
cap stocks though. All of that liquidity, all of that trading 
is taking place in what are essentially 100 very large names.
    Mr. Guinta. Okay. So if we want to grow the IPO market, 
should we be focusing on a small-cap----
    Mr. Noll. I think large companies to a large extent take 
care of themselves. Where we need help is in that small- and 
mid-cap sector, and I think that is where we should focus on 
our market structure rules, is how do we help those companies 
get liquidity, get research analyst coverage and access the 
public markets.
    Mr. Guinta. That is where I think we ought to be focusing 
as well. So through either a further line of questioning or 
additional future testimony, I would be very interested to know 
what you feel the two or three or four things that we can be 
doing to enhance that and augment that are. Because I think 
that is the direct nexus to job creation, whether it is in my 
home State of New Hampshire or anywhere in the country, but 
that is going to greatly benefit the local economy and I think 
the national economy.
    Thank you, again, Mr. Chairman, for allowing me to extend 
my remarks.
    Mr. McHenry. I certainly appreciate it. With the panel's 
indulgence, I would like to go for another round, if that is 
all right.
    To be honest with you, at this point I started with the 
broad concept, why do the public markets matter, right? I mean, 
to the point where most--your hardworking American looks at the 
public markets and thinks it doesn't have relevance to them. 
But it does, because it brings in capital to the United States, 
lowers the cost of capital in a competitive marketplace, makes 
capital more available and cheaper. That is sort of the ideal 
here.
    It also means that as opposed to private equity, that the 
hardworking American can put their money, whether it is $500 or 
$5,000 or $5 million, into the public markets and actually have 
proper price discovery and at the same time, hopefully, over a 
period of decades, get a nice return. But we are also talking 
about this challenge with small cap companies.
    So one of the challenges is liquidity. So to discuss this, 
we begin with liquidity. What can you do as an exchange legally 
now to provide these small cap companies a measure of 
liquidity? Mr. Mecane?
    Mr. Mecane. Sure. The primary mechanism that we as an 
exchange can use to incentivize liquidity is we have various 
market maker programs on our exchange where we incentivize 
those liquidity providers to meet certain liquidity and quoting 
obligations. In exchange for that, we share a portion of the 
economics that we obtained through our transaction services.
    We have actually skewed some of those payments to the point 
where in some of the small cap names we are actually sharing 
almost more, or all or more of the revenue that we are able to 
get in the transaction part of the business just to try and 
incentivize further liquidity creation.
    Mr. McHenry. The transaction part of the business, meaning 
the IPO, or is that the----
    Mr. Mecane. Meaning the trading piece. So we're able to use 
some of the revenue that we generate from the trading part of 
the business, and we use that to subsidize the market making 
community.
    One of the circular issues is that there's, in some of 
these names, not--we're paying out all the revenue that we 
generate and it's not necessarily enough to help get the 
liquidity to where we would like it to be.
    Mr. McHenry. Uh-huh.
    Mr. Mecane. That's part of the reason for why we think the 
experiment of also letting issuers compensate market makers 
could help, because in some circumstances, we're already paying 
all the revenue we have because most of that is on a per-
transaction basis and these issues don't trade very frequently. 
It doesn't generate enough revenue to necessarily incentivize 
the liquidity providers.
    Mr. McHenry. Okay, so the company goes through the whole 
process of going to the public markets. When they go to the 
public markets oftentimes what their broker dealer will say, 
well, we want to have price support for the first month or 6 
months or year, whatever that may be, right? So the broker 
dealer provides price support.
    Mr. Mecane. Correct. That's generally very specific around 
the IPO time when there is Reg M exemptions and permitted 
activities that broker-dealers can use too. But there isn't 
necessarily an economic relationship going forward after that 
specific IPO event.
    Mr. McHenry. Okay, sure. The reason why I bring that up is 
structurally there is a level of support that currently exists 
in the marketplace legally.
    Mr. Mecane. Correct.
    Mr. McHenry. So what are the possible solutions? Let's just 
talk about some of the solutions?
    Mr. Mecane. On the liquidity side, again, there's the idea 
of creating a different spread environment for small- and mid-
cap stocks. It's hard to know in a perfect world whether that 
would actually work or not, that's why we've advocated perhaps 
a controlled experiment. But one of the dynamics of a penny 
spread environment, which, again, has been very beneficial in 
the large-cap stocks, is that when you have stocks that will 
trade with a wider spread of a nickel or a dime, something 
along those lines, but there's the ability for another market 
participant to come into the marketplace and better whatever 
prices are there by just a penny, so not significantly 
narrowing the spread, but just narrowing it by a small 
increment.
    We think that by actually holding wider spreads in discrete 
intervals of a nickel or a dime, it could actually incentivize 
people to put more liquidity into the market because they will 
be more confident that someone won't step in front of their bid 
or their offer with a de minimis amount. Again, it wouldn't be 
the only fix to the issue that we're talking about. I think 
anything we do has to be part of a comprehensive package.
    Mr. McHenry. So that actually--on its face, that increase 
is then efficiency.
    Mr. Mecane. That's why it is very counterintuitive. In a 
way, we think it could actually improve efficiency. And that's 
why we are not saying it should be nickels or dimes with the 
very liquid stocks where a penny works very well. If the 
natural spread for a stock is a penny, then it makes sense that 
the stock should trade at a penny. What we are more targeting 
is where the natural spread for a stock looks like it's more in 
the $0.05 or $0.10 range, but you're still allowing very small 
increments to be quoted in the marketplace and whether that's 
actually efficient, even though it appears inefficient.
    Mr. McHenry. So is that spread differential based purely on 
volume?
    Mr. Mecane. I think there are a number of factors, and it 
would be need to be debated by the industry and the SEC what 
the right framework would be. But I think it would be some 
combination of volume, market cap, perhaps the price of the 
stock. I think there are a number of factors that would go into 
determining the right intervals.
    Mr. McHenry. And so could you create--I mean, conceptually, 
could you create a system by which the competition would 
determine what that spread is? So as the volume goes up and the 
market cap goes up, the spread could tighten?
    Mr. Mecane. Correct. And I think it would need to be a 
collaborative industry solution. Part of why we haven't done 
something like this on our own and why we can't on our own is 
because if we're the only ones quoting in different increments 
but everyone else is quoting in penny increments, it just 
doesn't work. It needs to be an industrywide solution. When the 
SEC put their concept release out in early 2010, this was one 
of the items that they raised. We, in our comment letter, 
indicated that this would be a good market-wide experiment to 
help the trading and small- to mid-cap stocks, but it would be 
an industry wide solution.
    Mr. McHenry. Mr. Noll, would you like to touch on some of 
these areas?
    Mr. Noll. Sure. You know, I think I go back to an earlier 
statement I made, which is what's critical here is that market 
makers have to be incented in the right way to provide 
liquidity. So they will not do so at the risk of their own 
capital where it's not economically viable for them. What's 
important is to create that viable platform for us to be able 
to incent market makers. Some of that may be tick sizes in 
making the spread more viable for them to provide liquidity 
there. Some of it may come from liquidity payments directly 
from issuers or through exchanges. And some, quite frankly, is 
what I would call a time and place advantage, which is under 
our current market construct, you know, every market maker 
starts out evenly, and it's best price that wins and oftentimes 
the first at that best price of what we call price time 
allocation system.
    So for smaller cap stocks what might be more important is 
creating a time and place advantage for market makers rewarding 
them by providing liquidity at that--in those small-cap 
companies. So by ensuring that they get a larger piece of the 
trade, not necessarily because they were there first. So within 
that mix of ideas, I think there are many things that exchanges 
can do to provide liquidity in these small-cap companies.
    Mr. McHenry. So you both mention the benefits--well, you 
mention the positive nature of market fragmentation. What if 
you took these small-cap companies and there was--and you were 
only to market, there was no market fragmentation, walk me 
through that.
    Mr. Noll. Well, if there was no market allocation----
    Mr. McHenry. Is that objectionable to you or positive to 
you or----
    Mr. Noll. I think the critical thing would--to make sure 
that that would not be permanent. I think there is a certain 
benefit for what I would call a runway period of time. So if 
you had a small-cap listing on your venue and you had a runway 
to establish liquidity, incent market makers to create that 
liquidity and build a marketplace there, I think that could 
have some very positive effects.
    I think where it starts to become dangerous is if that 
looks like it could be a permanent state of being. And so where 
I think we would want to see the market go is if that was a 
market structure and a mission it was developed to help 
concentrate liquidity and IPOs and small-cap companies, we 
would want to make some very clearly delineated lines around 
that whereby other advantages could start to compete for that 
business as well, because ultimately, I think that competition 
is necessary.
    So if you want to give companies runways, I think that's an 
interesting idea and one that we'd be certainly willing to 
explore, but I'd want to see an end date for that.
    Mr. McHenry. Mr. Mecane, do you want to touch on that? I'm 
not trying to create a bunch of controversy, but we're throwing 
out concepts to--on this problem and----
    Mr. Mecane. It is a very good question, and it's one that 
does get a significant amount of debate in the industry, 
obviously given that there isn't a clear-cut solution. There is 
obviously a balancing act between concentrated liquidity and 
the whole liquidity begets liquidity argument, about, you know, 
having as much robust price discovery, having it in one place 
versus the benefits of competition, and having diverse 
competing venues also trying to generate liquidity and market 
share, etc. And the question is, where's the tipping point 
between the healthy level of fragmentation and, you know, when, 
if any, does it go too far?
    One of the factors that we highlighted is that while 
there's an average level of activity that happens away from the 
primary market or away from exchanges, it tends to be much, 
much higher in the small and mid-cap stocks. There's a lot of 
reasons for that, it is not necessarily clear, but one reason 
is because the spreads are wider, so there's an increased 
incentive to trade those names proprietarily if firms can. Some 
of it is because a lot of those names tend to have a higher 
proportion of retail investors in them, so they tend to get 
traded away from the exchanges.
    One of the things that we've done, as I mentioned, is we've 
launched a program recently which isn't in effect yet but it's 
out for comment, to try and attract retail orders specifically 
to exchanges where we think in mid- and small-cap stocks, it 
will be beneficial.
    Again, the theory there being that perhaps if we 
concentrate more liquidity together, especially in those small- 
and mid-cap names, perhaps there could be a feedback loop in 
terms of also generating additional liquidity. It is unclear 
what the result will be, but again, we are just trying 
different things to get at the problem.
    Mr. McHenry. Sir, you mentioned in your opening remarks the 
ability to purchase liquidity support. Explain to us how that 
functions?
    Mr. Mecane. Sure. So right now in many European markets, 
including the ones we operate, private companies have the 
ability to contract with brokers to offer a certain amount of 
liquidity support for their stocks. In general, the academic 
research has shown that it is beneficial, and it helps improve 
the spread in liquidity in the name. The one distinction is 
that those programs do exist in a very different market 
structure where--than the one we exist in, especially the 
periods of time that have been studied in those academic 
studies tended to focus on more monopolistic-type environments 
and----
    Mr. McHenry. Less fragmented.
    Mr. Mecane. Less fragmented. And so the only point I'm 
raising is that I am hesitant to draw a direct analogy, but 
think it's worth an experiment.
    Mr. McHenry. Worth----
    Mr. Mecane. Trying.
    Mr. McHenry. Seeing if it works.
    Mr. Mecane. Right.
    Mr. McHenry. Thank you for your indulgence. And I now 
recognize the vice chair, Mr. Guinta.
    Mr. Guinta. Thank you, Mr. Chairman. I want to go back a 
little bit to the competitive issue, and how ultimately we 
ought to be providing flexibility and options for small-cap 
companies. I guess I should be a little more specific in my 
line of questioning.
    The first question I would have is the services that you 
provide--I will ask Mr. Mecane first, the services that you 
provide, would you say that they help a competitor once a 
company's listed?
    Mr. Mecane. I do think there is a certain level of that 
because of the nature of our industry where it is a very 
competitive market, and anything that we create can be 
generally replicated or copied by other venues. I don't think 
it is necessarily a bad thing in that the--there is a benefit 
to first mover advantage, but clearly, it could be--you know, 
there's a certain negative result when everyone else ends up 
doing the same thing.
    Where I do think, though--but generally, the competition 
that we're talking about, whether it is price competition or 
new product competition, even though it might not be as 
beneficial for us as venues, ultimately the consumer benefits 
from that. It generally will result in more product choice, or 
it will result in lower prices. Where I do think that 
competition becomes unhealthy or a problem is where it becomes 
regulatory competition to use a different phrase. One of the 
things that we advocated for is that all participants in the 
marketplace were performing similar functions should be subject 
to similar regulation. I think that also fits into surveillance 
and oversight theme. One of the initiatives that the SEC has 
advocated is this creation of a consolidated audit trail, and 
what that will do is aggregate together all the activity in the 
marketplace and give a consolidated view of all the trading and 
all the activity that's happening, not just on exchanges, but 
on other venues. And I think that type of consolidation is very 
important, especially as it relates to people's confidence in 
the public markets.
    Mr. Guinta. What about the idea, or the notion of a new 
issuer paying for their own services or designating some of 
their funds for that--for that specific service. I know earlier 
you said that you utilize the revenue that you gained for that 
to provide that service, but you also--I don't know if you said 
it, but I will assume it that you don't have enough revenue. 
Therefore, should we be exploring the opportunity of allowing a 
new issuer?
    Mr. Mecane. Yes. To link all those things together, 
everything you said is correct. We do share the revenue that we 
generate in incentivizing liquidity providers. One of the 
challenges with small and mid cap stocks is that in a lot of 
cases, we're paying everything that we make. And so 
supplementing that with a direct payment from the issuer is, we 
think, a worthwhile experiment. Clearly, there's issues that 
need to be tackled.
    Mr. Guinta. Sure.
    Mr. Mecane. One of the things I said earlier is there is a 
conflict inherent in that relationship. And one of the things 
that we've explored and been pushing is that the ETF market, 
where you don't have that same conflict, but you still have 
some of the liquidity concerns with newly created products 
could be an area to conduct an experiment and see whether you 
get beneficial liquidity in some of the less liquid ETFs as a 
result of this type of program. And then assuming we can 
document positive results, we can then try a second experiment 
with some stocks and see if it has the same effect.
    Mr. Guinta. There are a number of ways we could meet that 
objective that ensure the conflict of interest is mitigated.
    Mr. Mecane. Correct.
    Mr. Guinta. Talk to me a little bit about, you mention the 
regulatory concerns. What are some of the regulatory issues 
that we should try to address?
    Mr. Mecane. One just general topic that has been discussed, 
and is a frequent topic of the SEC's agenda and one of the 
things that they are working on is around the level of 
disclosure for different activities and filings that have to be 
made. Clearly exchanges have a very high level of public 
disclosure about our activities and how we handle orders and 
our pricing. And one of the topics is whether that level of 
disclosure should be applicable to all market participants. And 
there is valid reasons on both sides of the argument, but 
clearly from our standpoint, we think that a similar level of 
disclosure is warranted.
    Mr. Guinta. Okay. Thank you, Mr. Chairman.
    Mr. McHenry. Thank you. Thank you, the discussions about 
the consequences or potential negative consequences of this 
liquidity support. So walk me through this, if liquidity 
support agreement required these following couple of things, 
four things, the agreement is publicly disclosed, the liquidity 
provider does not provide hedging service to third parties, the 
liquidity provider does not trade on a proprietary basis of the 
issuer's security, and the liquidity provider does not reveal 
its trading strategy or the plan transactions to the issuer. Do 
you think that would be sufficient to counter the possible 
negative consequences?
    Mr. Mecane. I think that's definitely a good place to 
start.
    Mr. McHenry. Are there additional things you would require?
    Mr. Mecane. There could be a public disclosure of the terms 
of the arrangement. We could, through the exchange or SEC, 
there could be a mechanism to, you know, disclose exactly 
what's being done. There might be confidentiality concerns 
around that. So we could debate at what level, but I think 
perhaps some additional public disclosure of certain terms 
could be helpful.
    Mr. McHenry. And duration.
    Mr. Mecane. What the obligations are, what the payment 
structure is.
    Mr. McHenry. Okay. Mr. Noll.
    Mr. Noll. I agree with Mr. Mecane, those are very good 
places to start. A couple areas perhaps to pay a little more 
attention to, when you talk about proprietary trading, clearly 
as a market maker, the market maker is going to be taking 
positions in the security, that's one of the things that 
providing liquidity means----
    Mr. McHenry. Yes.
    Mr. Noll [continuing]. So delineating what is a market 
maker position and what is market maker behavior from what is a 
speculative proprietary position.
    Mr. McHenry. That can't be too complicated, how many pages 
is the simple Volcker rule? It adds what, 300 pages?
    Mr. Noll. I think you could burn a lot of brain cells 
trying to find that line. Those are the areas that I think we 
would have to spend some attention on.
    One possible area to look at, I think as an addition is 
what is the definition of market called that you're looking 
for, and having that be a transparent part of this proposal 
which is, this is our expectation as a company for what we 
expect to see, from supporting this kind of market maker 
support system, spreads of X percent and depth of Y securities. 
As part of that overall process, I think maybe a healthy area 
as well.
    Mr. McHenry. Okay, okay, interesting. This has been very 
helpful. I know we've touched on a number of things here, you 
know, global competition is certainly a concern, obviously you 
both touched on that to some degree, and the importance of 
really bringing capital to the United States. I mean, that's 
really what our capital markets are about, it is sort of being 
a sponge to bring in capital. Are there any things you want to 
add additionally, just in this broad concept we're talking 
about? Ideas, solutions problems we haven't touched on in this 
hearing? Mr. Noll.
    Mr. Noll. We have touched on almost everything, but I do 
want to emphasize I think the problem here is not just about 
liquidity and not just about market structure. There is clearly 
regulatory impediments for companies going public. You could 
group them most largely in what I will call Sarbanes-Oxley, but 
there are more than those. I think addressing those I think is 
also going to be critical to making the success if we are going 
to improve the IPO market for small----
    Mr. McHenry. Do you want to talk about anything in 
particular with Sarbanes-Oxley?
    Mr. Noll. Well, clearly the 404 restrictions and allowing 
that market to have companies that are exempt from that to be 
higher than it is today.
    Mr. McHenry. Uh-huh.
    Mr. Noll. We agree with the billion dollar mark that we've 
seen out there. And we think that that's something that would 
be very useful for companies as they go forward. You know, 
implementing perhaps a time or a grace period for companies 
after they go public may also be very beneficial.
    And then we are very concerned about the new PCAOB 
requirement that companies change auditors as we go forward, 
because it feels to us, in many ways, like an unnecessary 
expense. One of the benefits of working with an auditor over 
time is that they know the company and they become very 
familiar with the way the company works. And so the cost of the 
audit actually goes down. To hit the switch, auditors on a 
frequent basis to bring new auditors in creates a very 
expensive proposition for companies, and yet another reason why 
a company may not want to go public. So I think it's important 
that we think about those in this context as well.
    Mr. McHenry. Mr. Mecane.
    Mr. Mecane. I will echo what Mr. Noll said and the point I 
made earlier which is that any type of reform that we do needs 
to be part of a broader package, I don't think any market 
structure fixes, in and of themselves, are going to necessarily 
fix the problem. I point again to the IPO task force report 
which I thought did a very good job of coming up with very 
discrete, concrete recommendations that are reasonably 
implementable as a path forward for increasing potentially 
research coverage, making it easier for companies to go public, 
and perhaps palatable, regulatory relief that could help loosen 
up some of the trends that we've been seeing.
    Mr. McHenry. What about securities class action lawsuit 
reform?
    Mr. Mecane. As a non lawyer----
    Mr. McHenry. I like the stare off here.
    Mr. Mecane. It is something we can certainly get back to 
you on.
    Mr. McHenry. That is a creative answer. Let me ask this in 
a different way, because that wasn't even--it was an open-ended 
statement really. Do security class action lawsuits and the 
structure and form and the payment and expense, do they 
disincentivize the public markets?
    Mr. Mecane. What I would say very broadly is that I believe 
that when companies are evaluating their different future 
options that there's a perception of a cost of being public, 
some of that being the oversight of quarterly earnings, and 
complying with the different rules. Some of it is, to your 
point, chairman, subjecting yourself to potential lawsuits from 
investors, etc. I think that goes into the evaluation and the 
equation whether conscious or subconscious about whether 
people's best path forward is a public or a private one. I 
think anything that potentially increases the cost of going 
public is negative.
    Mr. McHenry. Mr. Noll.
    Mr. Noll. I would agree with Mr. Mecane there. We would 
have to also get back to you with our opinion about securities 
litigation reform. I do want to emphasize that one of critical 
things that exchange markets do do by being transparent markets 
is create a set of rules by which all companies have to abide 
by, both in their listing standards and in the trading of those 
rules. And so keeping investor protection in the front of our 
minds is also important. So to the extent that anything that 
supports investor protection in this process is something that 
we wouldn't want to give up as we go forward.
    Mr. McHenry. Okay, well on that area of agreement you'll 
both get back to us. I certainly appreciate your willingness to 
have the conversation here this morning. This is the roadblocks 
to public markets and the impact that has on job creation. I 
mean, this is not something we touched on, but obviously, when 
companies are able to go to the public markets, access capital, 
they are able to greatly expand their work force and what their 
able to do in terms of offering a product or their service.
    And so having a vibrant public market goes right along with 
vibrant labor markets and modern societies around the world 
historically, but I appreciate your willingness to have the 
conversation about these ideas, about these concerns, potential 
solutions, but also the current struggles that we're facing 
right now.
    I appreciate your ability to have that conversation and 
sort of engage in a broader range of subject matters this 
morning. We very much appreciate it. And as policymakers here, 
those watching from their offices and those of us that are 
trying to craft legislation to free up capital formation in 
this country, this is very helpful. Thank you for your time. 
With that, you'll have--you'll each have--I've got my final 
script here, you'll have 7 days to add additional comments to 
the record, as do Members. With that, this meeting stands 
adjourned. Thank you.
    [Whereupon, at 11:18 a.m., the subcommittee was adjourned.]

                                 
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