[House Hearing, 112 Congress] [From the U.S. Government Publishing Office] MARKET STRUCTURE: ENSURING ORDERLY, EFFICIENT, INNOVATIVE, AND COMPETITIVE MARKETS FOR ISSUERS AND INVESTORS ======================================================================= HEARING BEFORE THE SUBCOMMITTEE ON CAPITAL MARKETS AND GOVERNMENT SPONSORED ENTERPRISES OF THE COMMITTEE ON FINANCIAL SERVICES U.S. HOUSE OF REPRESENTATIVES ONE HUNDRED TWELFTH CONGRESS SECOND SESSION __________ JUNE 20, 2012 __________ Printed for the use of the Committee on Financial Services Serial No. 112-137 [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] U.S. GOVERNMENT PRINTING OFFICE 76-108 PDF WASHINGTON : 2013 ----------------------------------------------------------------------- For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC 20402-0001 HOUSE COMMITTEE ON FINANCIAL SERVICES SPENCER BACHUS, Alabama, Chairman JEB HENSARLING, Texas, Vice BARNEY FRANK, Massachusetts, Chairman Ranking Member PETER T. KING, New York MAXINE WATERS, California EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois RON PAUL, Texas NYDIA M. VELAZQUEZ, New York DONALD A. MANZULLO, Illinois MELVIN L. WATT, North Carolina WALTER B. JONES, North Carolina GARY L. ACKERMAN, New York JUDY BIGGERT, Illinois BRAD SHERMAN, California GARY G. MILLER, California GREGORY W. MEEKS, New York SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York JOHN CAMPBELL, California JOE BACA, California MICHELE BACHMANN, Minnesota STEPHEN F. LYNCH, Massachusetts THADDEUS G. McCOTTER, Michigan BRAD MILLER, North Carolina KEVIN McCARTHY, California DAVID SCOTT, Georgia STEVAN PEARCE, New Mexico AL GREEN, Texas BILL POSEY, Florida EMANUEL CLEAVER, Missouri MICHAEL G. FITZPATRICK, GWEN MOORE, Wisconsin Pennsylvania KEITH ELLISON, Minnesota LYNN A. WESTMORELAND, Georgia ED PERLMUTTER, Colorado BLAINE LUETKEMEYER, Missouri JOE DONNELLY, Indiana BILL HUIZENGA, Michigan ANDRE CARSON, Indiana SEAN P. DUFFY, Wisconsin JAMES A. HIMES, Connecticut NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan JAMES B. RENACCI, Ohio JOHN C. CARNEY, Jr., Delaware ROBERT HURT, Virginia ROBERT J. DOLD, Illinois DAVID SCHWEIKERT, Arizona MICHAEL G. GRIMM, New York FRANCISCO ``QUICO'' CANSECO, Texas STEVE STIVERS, Ohio STEPHEN LEE FINCHER, Tennessee James H. Clinger, Staff Director and Chief Counsel Subcommittee on Capital Markets and Government Sponsored Enterprises SCOTT GARRETT, New Jersey, Chairman DAVID SCHWEIKERT, Arizona, Vice MAXINE WATERS, California, Ranking Chairman Member PETER T. KING, New York GARY L. ACKERMAN, New York EDWARD R. ROYCE, California BRAD SHERMAN, California FRANK D. LUCAS, Oklahoma RUBEN HINOJOSA, Texas DONALD A. MANZULLO, Illinois STEPHEN F. LYNCH, Massachusetts JUDY BIGGERT, Illinois BRAD MILLER, North Carolina JEB HENSARLING, Texas CAROLYN B. MALONEY, New York RANDY NEUGEBAUER, Texas GWEN MOORE, Wisconsin JOHN CAMPBELL, California ED PERLMUTTER, Colorado THADDEUS G. McCOTTER, Michigan JOE DONNELLY, Indiana KEVIN McCARTHY, California ANDRE CARSON, Indiana STEVAN PEARCE, New Mexico JAMES A. HIMES, Connecticut BILL POSEY, Florida GARY C. PETERS, Michigan MICHAEL G. FITZPATRICK, AL GREEN, Texas Pennsylvania KEITH ELLISON, Minnesota NAN A. S. HAYWORTH, New York ROBERT HURT, Virginia MICHAEL G. GRIMM, New York STEVE STIVERS, Ohio ROBERT J. DOLD, Illinois C O N T E N T S ---------- Page Hearing held on: June 20, 2012................................................ 1 Appendix: June 20, 2012................................................ 55 WITNESSES Wednesday, June 20, 2012 Coleman, Daniel, Chief Executive Officer, GETCO.................. 3 Cronin, Kevin, Global Head of Equity Trading, Invesco, on behalf of the Investment Company Institute (ICI)...................... 5 Gawronski, Joseph C., President and Chief Operating Officer, Rosenblatt Securities.......................................... 6 Joyce, Thomas M., Chairman and Chief Executive Officer, Knight Capital Group, Inc............................................. 9 Mathisson, Daniel, Head of U.S. Equity Trading, Credit Suisse.... 37 Niederauer, Duncan, Chief Executive Officer, NYSE Euronext....... 11 O'Brien, William, Chief Executive Officer, Direct Edge........... 38 Smith, Cameron, President, Quantlab Financial.................... 14 Solomon, Jeffrey M., Chief Executive Officer, Cowen and Company.. 40 Toes, Jim, President and Chief Executive Officer, Security Traders Association (STA)...................................... 42 Weild, David, Senior Advisor, Capital Markets Group, Grant Thornton LLP................................................... 45 APPENDIX Prepared statements: Coleman, Daniel.............................................. 56 Cronin, Kevin................................................ 70 Gawronski, Joseph C.......................................... 82 Joyce, Thomas M.............................................. 91 Mathisson, Daniel............................................ 112 Niederauer, Duncan........................................... 125 O'Brien, William............................................. 136 Smith, Cameron............................................... 148 Solomon, Jeffrey M........................................... 163 Toes, Jim.................................................... 174 Weild, David................................................. 178 Additional Material Submitted for the Record Garrett, Hon. Scott: SIFMA concept release letter, dated April 29, 2010........... 196 SIFMA letter dated June 25, 2010............................. 220 SIFMA paper on liquidity, dated August 31, 2009.............. 232 MARKET STRUCTURE: ENSURING ORDERLY, EFFICIENT, INNOVATIVE, AND COMPETITIVE MARKETS FOR ISSUERS AND INVESTORS ---------- Wednesday, June 20, 2012 U.S. House of Representatives, Subcommittee on Capital Markets and Government Sponsored Enterprises, Committee on Financial Services, Washington, D.C. The subcommittee met, pursuant to notice, at 9:06 a.m., in room 2128, Rayburn House Office Building, Hon. Scott Garrett [chairman of the subcommittee] presiding. Members present: Representatives Garrett, Schweikert, Royce, Manzullo, Biggert, Neugebauer, Campbell, Pearce, Posey, Hayworth, Hurt, Grimm, Stivers, Dold; Waters, Miller of North Carolina, Maloney, Moore, and Green. Also present: Representative McHenry. Chairman Garrett. Good morning. Today's hearing of the Subcommittee on Capital Markets and Government Sponsored Enterprises, entitled, ``Market Structure: Ensuring Orderly, Efficient, Innovative, and Competitive Markets for Issuers and Investors,'' is called to order. We welcome the panel before us, and look forward to an interesting hearing this morning on this, as someone was just saying to me in the audience, very timely matter. Before we get to our panelists, we will have an opportunity for opening statements, and with that, I will recognize myself for 3 minutes. And as I say, today's hearing has a fairly long title, ``Market Structure: Ensuring Orderly, Efficient, Innovative, and Competitive Markets for Issuers and Investors.'' I believe that when examining the state of our equity markets, we must first look at the data, and the data tells us something, that by any traditional measuring stick, the United States equity markets are the best in the world, whether it is at execution of speed, liquidity, or pricing, both retail and institutional investors are recognizing the direct benefits of this very evolving marketplace. So what I am hopeful to learn about from our two esteemed panels that we have today are ways that Congress, the regulators, and the market participants can continue to ensure that our markets remain the envy of the world. Specifically, I look forward to learning and hearing some ideas from all of you on: first, promoting improved competition between the market participants; second, increasing innovation in the marketplace; and third, facilitating additional capital formation for small businesses. First, I believe that improved competition in the wake of implementation of Regulation National Market System (Reg NMS) has been a major contributor to the improved data seen in our equity markets. Narrower spreads, faster execution, and increased liquidity have all been direct results of additional competition in the marketplace. And so promoting improved competition should be achieved by lowering barriers to entry and establishing a more efficient process to bring new technology to bear, not by saddling market participants with additional burdens and raising transaction costs eventually to the investors. Second, increased innovation in the marketplace must be a priority. Technological innovations in our marketplace over the last decade have really been amazing. Markets have become more automated, and I believe this automation has yielded significant positives for all the investors. While there have been isolated cases out there we have read about in the paper-- things like flash crash and the recent Facebook IPO--we must look at the empirical data as a whole because if you focus simply on a couple of isolated anecdotal evidence or events, I think that takes away from the truly extraordinary strides that have been made in large part because of the technological innovations in the marketplace. And finally, on the heels of the successful and bipartisan JOBS Act, I look forward to examining ways to facilitate additional capital formation for small businesses. While the JOBS Act will help small businesses go public, I am also interested in further discussing ways to help increase liquidity and trading once they do. So there are two proposals out there. One, Mr. McHenry has a draft legislation to implement a market quality incentive program, and Mr. Schweikert over here has a proposal to allow for increased tick sizes for smaller companies. These could be ways to provide much needed support for small businesses. As I say, I believe that Reg NMS has achieved many benefits for the large cap firms. I am not certain that the current one-size- fits-all is in its best interests. So, in conclusion, as a piece of advice to the regulatory community, I quote my good friend, Mr. Hensarling, who is not here, who often says, ``First, do not harm.'' I guess that was not Mr. Hensarling; Hippocrates actually said that originally, but anyway, any change to the rules of the equity markets should be a thoughtful, empirical data analysis and benefits of any potential change. Ensuring we maintain the deepest, most liquid, and most efficient equity markets in the world is a top priority of this subcommittee, and I do look forward to a robust discussion today on these important issues and examining whether there are better ways to facilitate investment, capital formation so American businesses can grow and create jobs. And with that, I look to our next speaker, and neither one are here. Does the vice chair have--no? Mr. Schweikert. Mr. Chairman, I can do the other side if you want. Chairman Garrett. Mr. Schweikert will speak for the other side of the aisle for 10 minutes. No, I guess not. With that, since the other two gentlemen on our side of the aisle have not arrived yet, we will then go to why we are really here, not to hear from us, but to hear from the panel. So we look to the members of the panel to make your presentation. First, will be Mr. Coleman. And, of course, for those of who you have been here before, you know your complete written statement will be made a part of the record, and so you can summarize your statement in 5 minutes. I think I say this every single day to people, make sure you push your microphone on and make sure, most importantly, that you pull the microphone as close as you can because someone will say that to you during the course of your remarks. So, good morning, Mr. Coleman, and you are recognized for 5 minutes. STATEMENT OF DANIEL COLEMAN, CHIEF EXECUTIVE OFFICER, GETCO Mr. Coleman. Good morning, Chairman Garrett, and members of the subcommittee. My name is Daniel Coleman, and I am the chief executive officer of GETCO. GETCO is a global trading firm providing multi-asset class market-making and trade execution services for institutional clients, broker-dealers, and investors. GETCO participates in the market both as a liquidity provider, through our market-making services, and as an agency broker executing customer orders. As a firm, we say we are market-driven, that is, our business is predicated on the integrity and soundness of the global capital markets. For this reason, I am honored to be here today with my distinguished fellow panelists. Today's hearing offers the opportunity for a comprehensive discussion about the quality of our markets and the reforms policymakers should be considering. Specifically, my remarks will touch upon the need for a more concerted focus on policy measures designed to increase stability and foster confidence; the challenges institutional investors face in sourcing liquidity and understanding whether their trades are, in fact, receiving best execution; and finally, the benefits and risks posed by a more automated marketplace. Past policy initiatives have promoted competition and innovation. This, in turn, has leveled the playing field for new entrants. The ``old boy's club'' that existed on many of the trading floors is gone. In keeping with the best qualities of capitalism, ability above all else is now the most critical determinant of success. As with any highly competitive marketplace, firms that are unable or unwilling to meet changing markets will struggle. The global market demands change, and companies adapt or they disappear. That is the power of competition. When it comes to market structure, however, the power of competition without the stability and confidence to attract investors and issuers leads to highly efficient markets that serve no purpose. The markets need confidence above all else. Today, investor confidence has been shaken by a series of high-profile events that paint a picture of an overly complex, fundamentally fragile market system. Individual investors are skeptical of our markets in part because of the prolonged economic downturn and in part because of a host of new and nefarious sounding terms that seem unnecessarily complex and opaque. And yet, the individual investor's cost of execution is unquestionably better than ever before. If it were not for these high-profile, confidence-shaking events, I believe the individual investor would have few qualms with their overall experience. The institutional investor, on the other hand, does have justifiable issues with how the market structure has changed their day-to-day business. Executing larger orders throughout the day, institutional trading desks face the issue of lack of transparency due to speed and fragmentation. This leads to a sense, I would say, of a loss of control. As a former trader, I know how disconcerting it can be to place an order and not have confidence in how it is being executed. Back in the day, when I was a trader, I could hit up time and sales on my market data system. I could see my order, and I would know when it traded. Today, it is impossible to tell which trade is yours. It is this loss of control that causes many critics to long for the markets of old. While highly inefficient, they were far simpler to understand and to navigate, but attempting to roll back the clock is shortsighted, if not impossible. So what should be done to holistically address these concerns? It is our belief that policymakers must place the same emphasis on fostering market stability that they once placed on increasing market efficiency and competition. As part of this focus, we urge regulators: first, to consider modernizing market-maker obligations; second, to make a concerted effort to provide more stringent standards around what constitutes best execution for institutional investors; third, provide greater flexibility for exchanges to compete; and, finally, to emphasize the thoughtful testing and deployment of new trading technology to minimize risks posed by errors or bugs. In conclusion, all of our lives have become increasingly complex as a result of the immediacy, access, and optionality technology presents. Understanding how to harness these benefits while minimizing their concurrent risks is not a phenomenon unique to financial services. Regulators should move swiftly to implement sensible reforms and to put stability on the same footing with efficiency and competition. We should look to minimize disruptions from new technologies and strive to return a measure of control to the institutional investor. All of these steps are necessary if we are to retain public confidence in the overall health and integrity of our global capital markets. Thank you. [The prepared statement of Mr. Coleman can be found on page 56 of the appendix.] Chairman Garrett. And I thank you, Mr. Coleman. Good morning, Mr. Cronin. We welcome you here, and you are now recognized for 5 minutes. STATEMENT OF KEVIN CRONIN, GLOBAL HEAD OF EQUITY TRADING, INVESCO, ON BEHALF OF THE INVESTMENT COMPANY INSTITUTE (ICI) Mr. Cronin. Good morning. Thank you for having me today, Chairman Garrett and members of the subcommittee, and thank you for the opportunity to speak here today. My name is Kevin Cronin, and I am global head of equity trading for Invesco. Invesco is an independent global asset management firm with operations in more than 20 countries and assets under management of $632 billion. Our responsibilities including managing the equity, equity derivatives, and FX trading activities of the 45 traders Invesco employs on 9 trading desks in 7 countries. I am pleased to participate today on behalf of the Investment Company Institute at this hearing, examining the structure of the U.S. securities markets. ICI is the national association of U.S. investment companies, including mutual funds, closed-end funds, ETFs, and unit investment trusts. The structure of the securities market has a significant impact on ICI members, who are investors of over $13 trillion in assets and who held 29 percent of the value of publicly traded U.S. equity outstanding at the end of 2011. ICI members are institutional investors but invest on behalf of over 90 million individual shareholders. We are encouraged by the benefits that advancements in market structure have brought to funds and other investors. In general we believe investors, both retail and institutional, are better off now than they were just a few years ago. The costs of trading have been reduced. More trading tools are available to investors with which to execute trades. And technology has increased the efficiency of trading overall. Nevertheless, there are a number of steps which I will outline in a moment that we believe can be taken to further enhance the quality of U.S. markets, securities markets. One of the fundamental elements of an efficient market also is active participation of long-term investors. It is therefore important that operation of securities markets fosters the confidence of investors. Unfortunately, long-term investor confidence has recently been challenged by a series of scandals, financial crises, and technological mishaps affecting trading venues. To further improve the quality of the securities markets and to ensure long-term investor confidence, we believe it is time for regulators and market participants alike to address and to take action on many of the difficult and complex issues impacting investors today. These include conflicts of interest that exist in the markets, including those surrounding so-called liquidity rebates and the increased number and complexity of the types of orders utilized by market participants. In order to gather data to examine the impact of liquidity rebates on the markets, ICI recommends that a pilot program be established where a set of securities would be prohibited from being subject to liquidity rebates. We also recommend that regulators vigorously examine any conflicts of interest raised by order types and ensure sufficient and readily available information on the details of order types are available to all investors. Issues surrounding automated trading and high frequency trading also may impact investor confidence. While ICI believes automated trading and certain high frequency trading strategies arguably bring several benefits to the securities markets, regulators and market participants must act to address several issues of concern to investors, including, for example, the number of order cancellations in the securities markets, and consider truly meaningful fees or other deterrents that would adequately address this behavior. In addition, the need for enhanced surveillance capabilities to detect potentially abusive and manipulative trading practices cannot be ignored. Participation by and confidence of long-term investors in the market also is critical to the capital formation process. Difficulties surrounding capital formation, particularly for small companies that want to come to market, have been well- documented. ICI strongly supports the need to stimulate capital formation. We therefore recommend that a pilot program be established to examine whether changes to the current penny spread should be implemented. Finally, issues associated with undisplayed liquidity must be examined. For ICI members like myself who frequently execute large block orders, venues that provide undisplayed liquidity, such as the so-called dark pools, are critical to lessen the cost of implementing trading ideas and mitigate the risk of information leakage. We would be concerned if any regulatory reforms impeded funds as they trade securities in such venues. Broker-dealer internalization, however, is a form of undisplayed liquidity that does raise concerns for investors. Internalization may increase market fragmentation and degrade the price discovery process because it can result in customer orders not being publicly exposed to the markets. In addition, it may risk conflicts of interest between broker-dealers and their customers. We, therefore, recommend that any internalized orders should be provided with significant price improvement. ICI looks forward to working with other market participants to tackle these complex issues to ensure the securities markets remain highly competitive, transparent, and efficient, and that the regulatory structure that governs the securities markets encourages rather than impedes liquidity, transparency, and price discovery. Thank you, and I look forward to answering any questions you may have. [The prepared statement of Mr. Cronin can be found on page 70 of the appendix.] Chairman Garrett. And I thank you. Good morning, Mr. Gawronski, and welcome to the panel. You are recognized for 5 minutes. STATEMENT OF JOSEPH C. GAWRONSKI, PRESIDENT AND CHIEF OPERATING OFFICER, ROSENBLATT SECURITIES Mr. Gawronski. Good morning. Chairman Garrett, Ranking Member Waters, and members of the subcommittee, thank you for convening today's hearing on equity market structure and inviting us to share our views. My name is Joe Gawronski, and I am the president and chief operating officer of Rosenblatt Securities. Rosenblatt is an agency broker serving institutional investors in the U.S. equities markets and an authority on market structure. Traders, investors, exchanges, and governments all around the world rely upon our independent granular analysis of the rules, regulations, competitive dynamics, and behavior of participants in equity and derivative markets globally. We have studied extensively the massive changes to U.S. equity market structure that have occurred since 1996. We have also lived through them as brokers representing institutional orders in the market. We believe there are two major points regarding market structure that must be understood above all others by the subcommittee. First, today's market structure is a Rube Goldberg creation of sorts. It is the product of a gradual 15-year evolution during which government repeatedly acted in big ways and market forces repeatedly reacted accordingly. The result of this to and fro is that today's profoundly complex patchwork market structure is certainly not what one would have designed if starting with a blank slate. But it generally results in better outcomes for both retail and institutional investors than what it replaced. This is a second major point. With apologies to Sir Winston Churchill, what we have today is the worst market structure possible except for all the others that have been tried. This does not mean that things are perfect. There are a few critical problematic gaps in today's structure that merit exploration by regulators and legislators. Among these are the rules regarding off-exchange trading, safeguards against systemic risk, and the quality of markets for shares of smaller companies, and best execution obligations of brokers need to be enforced given the conflicts today's market structure engender. In our written testimony, we have elaborated to some extent on how we got to where we are today with this cycle of government action and market reaction, with the order handling rules, Reg ATS, decimalization, and finally Reg NMS being the highlights. But to provide a thorough count here would require more of your time and patience than we have today. Importantly, the result of all of it is that both explicit costs such as exchange fees and brokerage fees, as well as the implicit costs such as bid-ask spreads and market impact have come down dramatically during this period. Investors who once paid 25 cents per share in spread alone when buying and selling stocks like Intel and Microsoft now pay no more than a penny or two. Exchanges that once extracted monopoly rents from trading customers now compete vigorously to offer the lowest fees. But there are corners of the market that either have not shared in the benefits of this transformation or have largely failed to transform in ways that result in the best possible outcomes for investors. One such cause for concern is the explosion in off-exchange trading in recent years. According to our analysis of public data, 16.4 percent of U.S. equity volume was executed away from markets that display price quotes in January of 2008. By January 2012, nondisplayed trading had more than doubled to an all-time high of 34.2 percent. According to nonpublic data that we collect directly from the various brokers and ATSs, about 14 to 15 percentage points of this off-exchange trading is done in so-called dark pools. Most of these trades are executed at the midpoint of the national best bid-offer spread, so both customers receive significant price improvement, but a significant fraction of off-exchange trades do not result in materially better outcomes and therefore do not seem justified in receiving special rule protection. A minority of trades in the aforementioned dark pool simply match the NBBO or offer de minimis price improvement over the best prices quoted on the exchanges. Additionally, we estimate that approximately 10 percentage points of off-exchange market share is retail orders that are executed as principal by wholesale market makers. In the vast majority of cases, these wholesalers either match the NBBO or offer de minimis price improvement, about 10 percent of the spread. Typically, the wholesalers also offer cash payments to the retail brokers of roughly 10 to 15 cents per hundred shares. The end customer benefits from any price improvement if offered but does not see any of the payment for order flow, which is kept by the retail broker. In a few cases, big online brokers serving retail customers have contracted to execute either 100 percent or substantial portions of marketable customer order flow with certain wholesalers. The vast majority of liquidity-seeking retail orders in the United States never interact with the bulk of the country's available trading interests in the exchange environment. This is important because trading markets exist to ensure that companies can raise capital and that the prices of the securities they sell are as accurate as possible. This, in turn, enables the efficient allocation of capital in the U.S. economy. It is axiomatic that the more trading interests interaction in the centralized market or at least the market that is virtually centralized using technology, the more accurate prices will be. Historically, certain brokers have argued that internalization without significant price or size improvement is necessary to counter the immense market power of exchanges. Today, however, there are 13 exchanges scratching and clawing for market share, and no one exchange carries more than 20 percent market share. Exchanges can and would adopt pricing and rule structures that would be economically attractive to retail brokers and customers without lopping this important segment off from the wider market. The SEC in early 2010 floated the idea of a Trade-At Rule, which would prohibit internalization without significant size or price improvement. We believe the United States should consider this seriously and other mechanisms that would maximize the interaction of orders in the secondary markets with the goal of optimizing price discovery and efficient capital allocation. Another area that merits continued regulatory scrutiny is the reality that today's automated fragmented markets, although they deliver better outcomes for investors under normal circumstances, do not perform as well under stress as the more manual consolidated markets that preceded them. In general, we think the SEC's focus on systemic risk issues in the fast-moving, highly automated, highly fragmented markets we now have has been well-placed, and the back burnering of issues like internalization were appropriate steps at the time. However, I think perhaps we have a little more time to examine some of these issues now. Finally, of particular interest to this subcommittee is the quality of markets for small companies. We and other market participants have observed a divide in outcomes for large cap actively traded stocks and smaller issues. Small company shares may not be experiencing the efficiency and cost benefits that have accrued to bigger, more liquid stocks as a result of the 15-year market structure transformation I have discussed. We support experimentation by regulators and legislators to provide new incentives for making markets in the shares of smaller companies. The provision of the recently adopted JOBS Act requiring the SEC to study whether minimum price increments would improve market quality for emerging growth companies is one example of such measures. Chairman Garrett. I am going to ask you to wrap up there. Mr. Gawronski. Sure. In closing, I would like to reiterate that modern U.S. equity market structure is the creation of 15 years of back and forth between government regulation and market reaction to that regulation. It is far from perfect, and there are several aspects of it that merit further investigation and potential reforms, but it serves the investing public better than what preceded it. As a result, fundamental reforms like the ones that triggered the great market structure transformation back in 1997 should be considered only with the greatest of care. While market participants have proved quite adaptable, the market structure is, nevertheless, an ecosystem that functions well overall and changes need to be carefully considered, backed up by empirical data, and in most cases should be explored with pilot programs. Thank you. [The prepared statement of Mr. Gawronski can be found on page 82 of the appendix.] Chairman Garrett. Thank you. Good morning, Mr. Joyce. You are recognized. STATEMENT OF THOMAS M. JOYCE, CHAIRMAN AND CHIEF EXECUTIVE OFFICER, KNIGHT CAPITAL GROUP, INC. Mr. Joyce. Good morning, Mr. Chairman. Chairman Garrett, Ranking Member Waters, and members of the subcommittee, thank you for the opportunity to offer my testimony in connection with this very important hearing. Knight Capital Group opened for business in 1995. 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 institution 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, fixed income, derivatives and currencies. In 2011, Knight executed more than 900 million trades and 1 trillion shares for more than $6.4 trillion in notional value. The majority of the trades we execute today are on behalf of retail investors. We count amongst our clients some of the largest retail brokerage firms in the United States, including Scottrade, Ameritrade, and Fidelity. In addition, we service some of the largest institutional investors in the industry. We have spent the last 17 years evolving our technology infrastructure so that we can process millions of trades a day on behalf of investors in a fast, reliable, cost-effective manner, while providing superior execution quality and service. This is all brought to bear in our endeavor to secure best execution on behalf of our customers. Importantly, access to this sophisticated gateway is available to nearly every investor in the country. We appreciate the opportunity to comment on the market structure issues which are the focus of the hearing, all of which revolve around the notions of execution quality, liquidity, fair access, and responsible rulemaking through rigorous cost-benefit analysis. Make no mistake, the U.S. equity market is the best functioning and fairest market in the world. This has been achieved through fact-based decisions, prudent rulemaking, structural transparency, and timely and efficient disclosure, all of which are products of a competitive and fair market structure that allows choice and fosters innovation. Frankly, there has never been a better time to be an investor, large or small, in U.S. equities. Execution quality is at historically high levels while transaction costs are at historically low levels. In 2010, we sponsored an academic study authored by three of the Nation's leading academic scholars: Jim Angel from Georgetown; Larry Harris of USC; and Chester Spatt from Carnegie Mellon. The study concluded that, ``virtually every dimension of U.S. equity market quality is now better than ever: execution speeds have fallen; retail commissions have fallen substantially and continue to fall; bid-ask spreads have fallen substantially and remain low; market depth has marched steadily upward; and institutional transaction costs continue to be the lowest in the world.'' And the slides in our written testimony present evidence that these same metrics hold true today. Investors have seen substantial improvement in execution quality over the last 5 to 7 years. In point of fact, one of the more notable things is price improvement. Over the last 2 years, over half a billion dollars of price improvement has been credited towards the retail investor, and that money flows into their pocketbooks and back into the economy. The facts show that investors have benefited greatly over the years as a direct result of the developments in market technologies. High- speed computers, dark pools, et cetera, are not the problem. Indeed, they are the culmination of our free market system, competition. This competition is what keeps the U.S. capital markets great. Market venues spend hundreds of millions of dollars a year in technology. We all look for new and improved ways to source and access liquidity in a most efficient fashion. Access to all this liquidity and the gateway to the marketplace is available to the retail investor at no additional charge. We fully support this subcommittee's initiative to review the broad range of market developments which have helped shape our equity markets in recent years. Today, the equity markets offer more benefits to investors than at any time in history. Regulatory fine-tuning is necessary in a market as dynamic as the U.S. equities. However, as the renowned statistician William Edwards Deming once said, ``In God we trust; all others must bring data.'' Now, I would like to spend 1 minute talking about the so- called trade at proposal, which seems to raise its head every few years. For the last 25 years, the SEC has consistently rejected these proposals, noting that a competitive choice- driven market is far better for investors. Internalization is one such benefit for investors. Internalization is arguably the one great defense for the retail investor against the professional traders in the marketplace. We believe a Trade-At Rule would stifle innovation and set the U.S. equity markets back more than a decade. We have some suggestions as to how we think the markets could evolve, not so much that they are not working properly, but perhaps for the benefit, if you will, for investor confidence. I would like to touch on a couple of them. Access fees: They have been at the core of almost every debate that has taken place around the market structure in almost the last 2 decades. The so-called maker-taker model is an exchange that provides makers with a fee and takers pay a fee. We believe this has encouraged a large group of traders to trade with the only goal to collect those fees as opposed to true investing or intermediating. Therefore, we recommend the SEC take a hard look at that. Second, we support the proposal to widen spreads for certain tiers of securities, including higher-priced stocks as well as less-liquid stocks. In that regard, Knight fully supports the tick size study recommended by Representative Schweikert that was included in Title 1, Section 106(b) of the JOBS Act. Knight has previously proposed to the SEC that it consider adopting additional market-maker obligations. We believe market makers should be required to keep their quotes live for at least one second. In our view, this will restore a good deal of credibility to the posted quotes in the market and eliminate a lot of trading behavior that does not contribute meaningfully to the liquidity in the market. So, in conclusion, Knight appreciates the constructive roles this committee and subcommittee have played in the oversight of the markets in the rulemaking process. Your oversight helps ensure that U.S. capital markets remain competitive and innovative, thus benefiting all investors. Competition and innovation spurred by insightful rule changes fostered by the SEC have resulted in dramatic improvement in market technologies and execution quality for the benefit of public investors. The U.S. equity markets are the most liquid and efficient in the world and have all performed exceedingly well over the last decade. Thank you for your interest in these issues and the opportunity to contribute to this debate. [The prepared statement of Mr. Joyce can be found on page 91 of the appendix.] Chairman Garrett. Thank you, Mr. Joyce. You are also welcome to the panel this morning, and you are recognized for 5 minutes. Good morning. STATEMENT OF DUNCAN NIEDERAUER, CHIEF EXECUTIVE OFFICER, NYSE EURONEXT Mr. Niederauer. Thank you, sir. Chairman Garrett, Ranking Member Waters, and members of the subcommittee, I want to thank you for inviting me today. U.S. equity market structure is an issue of the utmost importance to re- instilling confidence in markets, and we applaud you for holding today's hearing. NYSE Euronext is a global exchange operator of several equities and derivatives exchanges in the United States and in Europe. This provides us with a unique vantage point from which to compare global securities markets and to learn from the experiences we accumulate by operating in these various jurisdictions. In most developed markets, there is one national stock exchange and a handful of competing platforms. However, in the United States there are hundreds of competing trading venues which include exchanges, dark pools, electronic communication networks, and broker-dealer-owned liquidity pools. On one hand, this competition has spurred tremendous innovation in the form of increased automation and speed of trading, greater reliability of trading systems, improved functionality, and lower transaction costs. Most importantly, the combination of regulatory change and competition has benefited at least some investors. However, these reforms have also had unintended negative consequences. The reforms created lower barriers to entry for new trading venues, some of which lacked price transparency. These alternative venues also operate under a less rigorous regulatory framework, and the result has been a dramatic rise in off-exchange trading. Today, one-third of all equity trading takes place off exchange, and over 1,200 listed securities have more than 50 percent of their volume traded off exchange, an increase of nearly 150 percent in less than 2 years. As a result, we are rapidly approaching a bifurcated market structure in the United States. On one tier, regulated exchanges, such as the NYSE, serve as price makers. Price makers are critical to the price discovery process since they show the best available prices with associated share sizes for all securities. These quotes referred to as the national best bid and offer, or NBBO, are constantly changing with activity in the markets and are what established a reference price for nonexchanges and all other liquidity pools. On the other tier, alternative trading venues are price matchers. They match willing buyers and sellers that participate in their venues but do not contribute to price discovery by displaying quotes to be included in the NBBO. That is, the off-exchange trading centers provide so-called undisplayed liquidity. Undisplayed liquidity can serve an important function for investors seeking to trade large blocks of securities. However, today the average trade size is similar in both exchange and nonexchange venues. Moreover, undisplayed trading currently accounts for a substantial volume of overall equity trading. We believe now is the time for policymakers to consider at what level does price discovery materially suffer. A common argument made in support of the growth in off- exchange trading is that spreads have decreased as a result of heightened competition. However, the data clearly shows us that spread compression actually is the result of the move to decimalization in 2000, and since 2006, spreads actually are wider by nearly three basis points. That doesn't sound like much, but on an average price stock, that is a doubling of the spread since 2006. This tells us there has been a dilution of market quality to the detriment of investors, so do not be misled by charts that show you the trend since 2000. Dark pools had little volume in 2006. The markets were working fluidly, displayed liquidity was a more significant part of the market, and the spreads had already been tightened due to decimalization. Thus, we believe there is good reason for Congress and the SEC to be concerned that without action, we risk greater loss of investor confidence and decreased market stability. To address the issue, we recommend that policymakers focus on establishing fairer and more transparent equity markets as well as a more level regulatory playing field among trading centers. So, with that, I would respectfully recommend a number of solutions. First, promote public price discovery by requiring that internalizing firms simultaneously display a protected and accessible quote at the NBBO or provide meaningful price or size improvement versus the NBBO if not quoting. As I am sure the committee is aware, this was the primary recommendation of the joint committee that was passed to study the aftermath of the flash crash in 2010, yet this recommendation has not even been reviewed or considered. Second, create an audit mechanism that can adequately surveil the consolidated market. This could be assigned to FINRA or to the SEC. Third, enhance transparency by restoring dark pools to their original envisioned function of facilitating block transactions, i.e. have minimum trade sizes. Fourth, level the competitive playing field between exchanges and nonexchanges by ensuring that we all must comply with the same standards concerning SEC filings, fair access, and market surveillance. In other words, make our rule proposals effective on filing or subject our competitors to our elongated approval processes. Fifth, fairly distribute the cost of regulation across all exchanges and other liquidity pools. Our cost of regulation as a percentage of the cost of regulating the markets is exponentially greater than our market share. Sixth, consider rule changes or pilot programs that would ease the burdens on smaller publicly traded companies and enhance their liquidity. These might include increasing the minimum price variation or tick size for smaller companies, perhaps letting each company choose their own, increasing the market cap threshold for Sarbanes-Oxley compliance from $75 million to $250 million, and allowing companies and exchanges to collaborate to develop and fund liquidity provision programs. In closing, let me reiterate that while the U.S. capital markets are the best in the world, there is room for improvement which would benefit investors and market participants. Public confidence in the markets stems at least in part from leadership, and we need this leadership to come from Congress, the Administration, market participants, and exchanges working together to achieve a better market structure, restore investor confidence, and as Chairman Garrett said, make sure our markets remain the envy of the world. Thank you for allowing me to testify, and I look forward to your questions. [The prepared statement of Mr. Niederauer can be found on page 125 of the appendix.] Chairman Garrett. Thank you very much. Mr. Smith, you are now recognized. STATEMENT OF CAMERON SMITH, PRESIDENT, QUANTLAB FINANCIAL Mr. Smith. Good morning, Chairman Garrett, Ranking Member Waters, and members of the subcommittee. Thank you for inviting me to participate in today's hearing. My name is Cameron Smith, and I am the president of Quantlab Financial, a Houston-based quantitative trading firm. Quantlab was founded in 1998, and we now employ more than 100 people. Our company operates in the United States and around the world. As you know, in recent years computer technology has shifted the marketplace to an open, competitive electronic environment. I would like to briefly discuss the current state of the U.S. equity market, the role we play, and then share a few suggestions for policymakers to consider. In any discussion on market quality, perspective is needed. The United States has the world's leading equity market, and empirical studies show that investors have never enjoyed lower transaction costs. The United States has achieved this position by adhering to certain core values: fairness; transparency; and open competition. So what does this all mean for investors? As Gus Sauter, who is the chief investment officer of Vanguard says, ``Vanguard investors have enjoyed a 50 percent reduction in trading costs over the last decade.'' This means an investor saving for retirement over 30 years could see their balances in their account increase by 30 percent. So, this is real savings. While the general trend of improving market quality is clear, there still remains a great deal of misunderstanding around the role of modern professional traders, sometimes referred to as high frequency traders. Markets have always had professional traders that bridge the temporary gaps between supply and demand, and today that role is both automated and highly competitive. It is no coincidence that as market quality has improved--the bid market quality has improved with these developments. Empirical studies show that high frequency trading improves price discovery, reduces short-term volatility, and lowers investor transaction costs. However, we are here today because market quality can always be improved, and I would like to quickly provide four substantive ideas on that. First, regulators should have easier access to all the data they need to oversee our markets and to ensure they operate with the highest integrity. In this regard, we support initiatives such as consolidated audit trails and large trader reporting. Further, we have encouraged the formation of industry working groups to offer technical assistance to regulators to fully utilize the richness of the data that electronic markets provide. Second, we must continue to enhance broker-dealer risk management practices and market safeguards like circuit breakers or limit up/limit down protections. While the SEC and the exchanges have already implemented some of these protections, they need to be calibrated and refined in response to experience in a variety of market conditions. Third, policymakers and the industry must continue to monitor and consider ways to address the issue of market fragmentation. The challenge has long been to balance the benefits of competition against the complexities from fragmenting the market among too many trading venues. We must therefore ensure that regulations don't inadvertently contribute to fragmentation by hindering the ability of a public market to compete with the private markets, such as dark pools and internalization venues. In this regard, we support two relatively incremental initiatives. One would just be amending Reg NMS to allow markets with zero bid-ask spreads to be displayed. The second would be to allow exchanges to experiment with smaller tick sizes that will drive volumes and price discovery back to public markets. Finally, I am sure that we all agree that policies must be shaped by facts established through rigorous data analysis rather than anecdotes, rumors or unsupported assertions. It is imperative that policymakers and industry together develop and specify common metrics that we can all refer to for accessing the current health of our markets, and we need to make these measures available through a publicly available dashboard, perhaps on a Web site so that anyone can track them. Mr. Chairman, thank you for the opportunity to appear today, and I look forward to answering any of your questions. [The prepared statement of Mr. Smith can be found on page 148 of the appendix.] Chairman Garrett. Thank you. And I thank the entire panel. So, moving to questioning, I will first recognize myself for 5 minutes. Just an observation from the six people on the panel is that one of the common themes is the benefits of competition and the necessity to try to achieve any regulatory reform to encourage additional competition in the marketplace. Another, a second take-away, and a couple of you made this point; Mr. Smith just did, and you had the comment earlier with regard to information and data. What was the statement? In God we trust; all others must provide data. So that was the other take-away that I took is that whatever we do here and also whatever the regulators eventually come up with as well should be data and factual driven and empirically driven as opposed to anecdotally driven or politically driven or otherwise. It should not be moved by simply just recent cases in the headlines and that sort of thing. So that is all good. Let's take a look at a couple of things then, first, with regard to competition. In order to do that, the rule process that is currently in place for the lit exchanges, as we have heard, is time-consuming in certain cases. Cumbersome is another way to describe it. Now, that was supposed to be addressed, it was my understanding, in Dodd-Frank. That was supposed to be addressed with Section 915, I believe, of that law, to set what is sort of like a time limit on the rule process approval process, but now I understand that the way it is actually being implemented is that before the proverbial clock starts ticking, they ask for drafts and what have you, and that can take a long period of time. Does anyone want to comment on what the existing process is, whether you are involved with it or not, and what we need to be doing in that area? Mr. Niederauer. Sure. Looking down the panel, I guess that one is mine. So as we have said before, I think we were optimistic, Mr. Chairman, that when the streamlining proposals that you are referring to were talked about and hopefully implemented, that they would work in practice the way they were written up. Regrettably, they have not worked in practice the way they were designed. So our frustration stems from the fact that we are all in favor of competition. We did not appear at the hearing today to talk about mitigating or eliminating competition. We would just like the opportunity to compete, too. And we feel that at the stage we are at as an exchange, we are able to innovate at the pace that many of our competitors are able to innovate, but we have one hurdle in our way that doesn't appear to be in the way of many with whom we compete, and that hurdle is because of our history, we are required to file a rule change every time we would like to implement one of these innovations, and many of the venues with whom we compete are not under a similar burden. So we would simply like that playing field leveled, and I think we would prefer to see it leveled by letting us innovate at their pace rather than slowing everyone else's pace of innovation down to our rulemaking process. Chairman Garrett. Let me just interpose and let the other members of the panel discuss that, and also when you discuss that, let's just also maybe throw in another aspect, the regulatory nature that we have of lit exchanges of the SRO model and that these are now for-profit entities and what have you, whether that changes anything from where we used to be, if you want to morph that into your answer. I see, Mr. Joyce, you were wanting to chime in? Mr. Joyce. Yes, Mr. Chairman. Obviously, we certainly respect the work the New York Stock Exchange has done, but I think when we talk about a level playing field, we need to keep in mind that an exchange is an exchange, and a broker-dealer is a broker-dealer. Exchanges have a certain rule set: They have to treat clients, for example, all the same; they don't commit capital. Broker-dealers can commit capital. We can commit capital at various degrees to various clients. We can preference some clients. We cannot do business with other clients. So I think we need to be careful when we talk about leveling the playing field. This is apples and oranges, dogs and cats. Similar but different. An exchange has certain responsibilities that are decidedly different than the responsibilities broker-dealers have. Just to point out one, for example, we have best execution responsibilities. When we take an order on behalf of a retail client, we have a certain fiduciary responsibility that is mandated by the SEC; an exchange does not have best execution responsibilities. So I completely agree that they should be allowed to compete in a more facile fashion. Having said that, let's not confuse the fact that an exchange is an exchange, and broker-dealers are broker-dealers. Chairman Garrett. Does anybody else want to chime in? Mr. Gawronski. We don't operate an exchange or a dark pool, so we are users of both of these systems, both of their products, in fact, and they are both good products. But I guess I tend to agree with Duncan on this one in that I don't think it is a level playing field. When the Reg ATS and other rules were adopted, there wasn't competition in the markets, so that has brought on meaningful competition. It is cutthroat competition at this point, and I do feel that what ends up happening is that we end up with the sort of other side of the coin of competition is fragmentation, and we should limit that in some instances or at least make it so that if people are competing on a level playing field, I think you will probably see a little decrease in that fragmentation, and the SEC framed it pretty well at one point. They said their job with respect to market structure, at least one aspect of it, is to balance the competition among exchanges and market centers versus the competition among orders, and I think the competition among orders is suffering a little bit. We have gone, the pendulum maybe has swung a little bit too far and maybe we just need to--I don't think we need to make massive wholesale changes, I just think we need to look at leveling the playing field. Mr. Joyce. I would love to comment just a little bit more on the issue around the quality of the quote, the quality of the issues of fragmentation. I just think we should tread carefully. Again, there is not a scintilla of data to indicate that fragmentation is hurting investors. I think we have just heard six people say the markets have never been better. If we are going to address things like off-exchange trading, which, P.S., the reasons there are venues to trade off-exchange was to solve problems. Dark pools were originally set up to help institutional traders resolve the issue around accessing large pools, large orders, without displaying their issues into the marketplace, and if you will, a large institutional trader displays what they do in the marketplace, it can move a price. Very dangerous. Retail investors utilize internalization because they get instant prices, generally better than the NBBO, and they don't have to worry about issues like co- location, competing with professional traders, and market data issues. These things have been set up, and they have been solving problems and solving them well. Chairman Garrett. I thank you. I am over my time, Mr. Smith, so I will recognize the gentlelady from California. Ms. Waters. Thank you very much, Mr. Chairman. I did come in a little late, but there seems to be an overriding theme in the testimony that we are hearing today. Everybody agrees that we have the world's leading equity market: it is healthy; and the SEC is doing a great job. Is that what I heard? Let me go on to the questions. Let me go to Mr. Joe Gawronski. You discuss how the Canadian government has already adapted a so-called Trade-At Rule requiring significant price improvement if a trade is going to be executed off an exchange. You said that Australia and Europe are considering adopting similar rules. Should the United States pursue such a rule? If so, why? And are broker- dealer conflicts of interest a problem when it comes to internalization? Mr. Gawronski. Sure. Thank you for the question. Yes, we do think the United States should consider a similar rule to what the Canadians have adopted. Of course, that is not live yet; I think it goes live in October. So I do sympathize or agree with a lot of the participants here that we need to be careful about big changes. Just to be clear, and I think this has been mischaracterized in the press quite a bit actually, we are big users of dark pools, and we are not suggesting that all dark trading be eliminated. Off-exchange trading can be valuable. I tend to think, though, when the off-exchange trading looks very similar to on-exchange trading, meaning similar order size or similar pricing, I am not quite sure why it is allowed and we shouldn't push it into the publicly displayed markets. So I think we should consider something. The Canadians have adopted this. I think the Australians probably will follow. Obviously, the genie is a little bit out of the bottle here so it is a little more difficult because it does affect people's business models. But I think if we do it in a way that is requiring significant size and/or price improvement, I think you will not see off-exchange trading go away. I just think you will limit it and reverse it a bit. In terms of broker conflicts, yes, they are rampant. I am a broker, and I am embarrassed by what some of the people in my industry do. They put the rebate that they will receive or the lower cost fee ahead of best execution for the customer. So even though it will mean more regulation for me in terms of proving to the SEC or FINRA when they come in that we have done the best job for our customers, I welcome it because I know how we treat our customers. And I don't see that same type of resolve or commitment by the vast majority of the broker- dealers. Ms. Waters. Let me hear what Mr. Joyce and Mr. Cronin have to say about that. Mr. Cronin. Thank you. As an institutional investor and again representing ICI, we do have concerns about hidden liquidity in terms of internalization, and part of that is centering around the fact that these orders don't ever hit the lit markets, so the price discovery mechanism, that is where buyers and sellers interact, that not taking place could be detrimental. We recognize that there could be benefits to investors by price improvement that happens with internalization. Our point is that if the price improvement is a tenth of a cent, which is about 10 cents on 100 shares, we are not sure that the benefit outweighs the cost, which could be that those orders, if seen in the lit market, could do appreciably better or help the price formation process. Of course, the other point is that as we look at this issue, there are complications around the Trade-At Rule. Most specifically, that the Trade-At Rule is unclear to us whether or not there would have to be a move to subpenny increments to really appropriately reflect bids and offers that have access fees within them. As an institution, I can promise you that we believe that moving to subpennies would be exceptionally disruptive for institutional investors. The minimum risk increment, as we described, at a penny is wonderful for some population of securities, the top hundred, two hundred names certainly, but there is a population of traders of stocks of issues that that penny increment doesn't seem to make a whole lot of sense, that is that the price formation, the process of trading the efficiency breaks down, so we would be very, very careful specifically about a trade issue. Ms. Waters. Mr. Joyce, how about you get a word in here before the time expires? Mr. Joyce. Thank you very much. With all due respect to our friends in Canada and Australia, there are more retail investors in the United States than there are people in those countries. So I think we have to make sure that we take pride in the fact that the United States has the best markets in the world, and we certainly want to follow best practices, but I think the lead on these issues should come from here, with the data-driven decisions and not be looking at smaller countries to lead the way for us. Ms. Waters. Thank you very much. I yield back, Mr. Chairman. Chairman Garrett. Mr. Campbell from California. Mr. Campbell. Thank you, Mr. Chairman. I heard you all talk a lot about trading costs, how they are down, and liquidity and how it is up and institutional investors and so forth. I would like to suggest that those are trees within the forest and not looking at the forest. And in spite of what you just indicated, Mr. Joyce, the forest to me is a couple of things. First of all, that the public increasingly does not trust Wall Street and therefore does not trust you. And whether that is due to flash crash, dark pools, high frequency trading, MF Global, all of these things put together, that the public increasingly believes that there are a lot of big people doing funny things behind closed doors that they don't understand and can't control and that, therefore, they can't participate equitably in this game because it is not a fair or level playing field. That, to me, is not good. It is not good for the markets, and it is not good for America that we are disconnecting the public from public markets. Second of all--and this is my own little metric--I always thought there were kind of four participants in markets and that there is investment, there is trading, there is speculating, and there is gambling, and that those things all go on. The gambling, speculation, and trading have been on a dramatic increase of late and that investment is almost disappearing. And that is not good for markets, for America, or, in my view, for capital formation. Because if you are on the other end of this and you have a company--and we talk about IPOs and all that sort of stuff, you want investors. You really don't want traders, you really don't want speculators, and you don't want gamblers. But there are lots of them out there. They are moving the markets, moving them around, and fewer investors. That is my perspective, and that is what I think we should be talking and focusing more on. And if that means, in my view, that the cost of trades go up a bit, I will exchange that all day long for a market that has more investment and more connection with the public and less domination by a very few people behind closed doors and so forth. In the remaining time, I would love to hear your reaction; and if any of you think I am completely full of garbage, feel free to say so. People up here on the panel have no problem doing that. Chairman Garrett. We will give you extra time. Mr. Campbell. The chairman is particularly adept at that. So feel free to do so or to give comments. Mr. Niederauer. I would love to start. Thank you for your comment, Congressman. Because I don't know what your colleagues think of you, but that is my first impression of you, and that is why I think we are actually all here today, right? We can still be proud of what we have in the equity markets, and you heard a lot of positive comments about some innovations that have helped a lot in the last decade. But, ultimately, whatever we have done, to sit up here and say, oh, it is all fine, let's not tamper with it because it is working great--the public has never been more disconnected, the public has never had less confidence in the underlying mechanism, and that is why in my closing remarks I talked about the need for all of us to work together. Because that is the root issue, right? We are not going to be able to be the group that prevents crises from happening. They have happened throughout the country's history, right? But at the end of the day, the citizenry has lost trust and confidence in the underlying mechanism, and it is for some of the reasons you talked about. What used to be an investor's market is now thought of as a trader's market, and I think we have convinced ourselves along the way that speed is synonymous with market quality. In some cases, it might be; and in other cases, it clearly isn't. So I think your comment speaks at the heart of why we are here. Because to say we should just leave it alone because it is working great, when people have never had less confidence in what is going on, I think is a call to action. So I appreciate your comment. Mr. Campbell. Thank you. Let me just on that, whichever one of you said we ought to hold the price for a second--yes, Mr. Joyce--when you talk to people out there who want to invest 5 years, 10 years, whatever, invest, and you say you have to hold prices for a second because most of the time people trade in and out in 30 milliseconds, understandably, they have absolutely no faith in this thing. So, Mr. Cronin, he had his hand up first. I am sorry. It appears I am out of time. But go ahead. Mr. Cronin. I appreciate the opportunity to quickly say that we understand entirely your point. As I suggested, in representing ICI, we have $13 billion in assets and 90 million of those investors whom you reference. Our interest is clearly that investor confidence is well-placed in this market. And while we recognize there are some benefits that recent developments have made, there is clearly still work to be done, including things, as we discussed, around regulatory capabilities to ensure that any activity that is nefarious or improper or manipulative is able to be seen, spotted, and prosecuted. Mr. Campbell. Mr. Chairman, my time is up, so I will defer to you on what happens now. Chairman Garrett. The gentleman yields back. Mr. Campbell. Then, I will yield back. Chairman Garrett. The gentlelady from New York. Mrs. Maloney. Thank you, Mr. Chairman, for having this hearing, and I thank all the panelists for being here. I would like to focus on the growing percentage of the market of these dark pools, which seems to be the exact opposite of what we are trying to achieve in Dodd-Frank: making our markets more transparent, putting them on exchanges, letting everyone know what is going on. And this seems to be growing. So I would like to know what percentage exactly of the market are these dark pools and why are they growing? Why are they making up more and more of the market? I would like to understand more of it. I would like to start at this end and go down, if people would like to comment on it. Mr. Smith? And then, I would like to know what is the impact that they are having of not really being transparent or on exchanges and why is this segment of the market growing and what is the impact it is having on competitiveness of our markets? Mr. Smith. Okay. That is a good question. It is definitely something we should be focused on. I, too, am concerned about the fragmentation and support a goal of trying to reduce it and try to consolidate the markets. The markets have splintered over the last decade or so. They have gone from a couple of centralized markets that had the majority of the market share to, as we heard today, dozens of markets where the trading volume is spread all out. Mrs. Maloney. Do you have a sense of how much of the market it is? Mr. Smith. I will have to defer to Duncan on that, who has a staff who probably looks at that. Mr. Gawronski. I am known as the dark pool boy in this world, so I will do the data. About 14 to 15 percent of the market is what we would characterize as dark pools, but you actually have to about double that figure to almost a third of the market when you include things other people would call internalization or wholesaling activity. So about two-thirds of the market is on exchange, and about one-third of the market is off exchange. Mrs. Maloney. How would you define a dark pool? Not being on the market? Mr. Gawronski. There is no quote displayed. Like when you see a bid and offer on the New York Stock Exchange or NASDAQ, you would not see a quote. As Duncan talked about-- Mrs. Maloney. Are they regulated by the CFTC? Mr. Gawronski. No, by the SEC. Mrs. Maloney. By the SEC. Mr. Gawronski. Yes, although there is this different rule book in the sense that some of them are broker-dealers and not ATSs, and so therefore FINRA could also be the primary regulatory body. Mrs. Maloney. Why is it growing as a percentage of the market? Mr. Gawronski. I think there are a couple of reasons. One is the fee differentials that exist between some of the dark pool markets and the displayed markets. Another reason is some of the things that you were talking about in terms of the sort of fast world we live in. There is some arbitrage activity between the displayed market pricing and what is happening in the dark pools. Someone can maybe buy at the midpoint in a dark pool and sell in a displayed market, capturing that differential in time. So I think a lot of it is driven by those types of things. And I think institutional investors do seek refuge in dark pools in terms of doing blocks. But the reality is most of the activity in dark pools is not blocks anymore. That is my problem with it, is that I would like to reserve it to situations where either blocks are getting done or significant price improvement is being achieved. Mrs. Maloney. See, I don't understand how they do not have to do a quote display and be more visible. Because that was the total goal, to put people on exchanges in Dodd-Frank. How is this happening that they are being excluded from the effort to put quotes out there, increase competition. Any answer? Mr. Joyce. Yes, Congresswoman. First of all, I think they started because they saw the problem in the marketplace where there were institutions trying to access liquidity or retail investors trying to get protection. But, fundamentally, they were to protect investors. And you shouldn't think that the prices are--it is some kind of Wild West. The prices are dictated by the NBBO. They cannot trade away from the stated price. So they basically fundamentally solve problems that investors had. That is why they were created. Somebody came up with an idea to deal with an issue, and a dark pool was created, and they enhanced competition. Mrs. Maloney. How are they increasing competition? You say they are or they are not? Mr. Joyce. They are increasing competition because people are competing. They come up with new, clever ideas that serve investors' needs. Mrs. Maloney. Why have the spreads decreased in recent years? Dark pools have suggested that the tightening of bid-ask spreads is at least partially a function of the emergence of new dark liquidity venues. Could you comment on that? Mr. Joyce. I think the fact that the spreads are tighter, tighter spreads make it cheaper to trade. So that is a net benefit. Mrs. Maloney. My time is up. Thank you. Chairman Garrett. And I see Mr. Hurt as joined us. He is recognized for 5 minutes. Mr. Hurt. My question is for Mr. Joyce and Mr. Niederauer. As the trading rules and regulations deal with or have affected small and mid-cap companies, perhaps in a disproportionate way, I was wondering if you could each talk just generally about what the solution is or how it is that we can increase the--make it easier for the smaller and mid-cap companies to access capital in the current structure? Maybe Mr. Joyce, or whoever wants to go first. Mr. Joyce. I think the small and mid-cap companies by definition trade differently because there is just simply less of a flow. They have fewer investors. So they just behave differently, if you will, because of the structure of how they have been set up. I think in order to introduce more interest in the area, you have seen over the years a diminution of research coverage on the small and mid-cap names because of certain rule sets that have been introduced to the marketplace. I think any of the policies that have been pursued, including the JOBS Act where we can encourage more research, would be a wonderful thing. We also think the opportunity to widen spreads so that liquidity aggregates in places that people can more visibly see, as opposed to having to trade in penny spreads all the time in some cases, is probably another net benefit. So I believe that more sunlight in the form of research, the ability, if you will, for market makers to sponsor some of these small and mid-cap names. For example, we have about 80 percent market share in the bulletin board and pink sheet names, which is the real, if you will, micro-cap names. We don't have that market share because we wanted it. We have that because people, other competitors, backed away from it. So any way you can incent people in the form of even sponsoring market-making opportunities in these names would be helpful. Mr. Hurt. Thank you. Mr. Niederauer. And I would echo some of that, Congressman. I think the JOBS Act was a great start, and I think our next challenge now collectively should be how do we reconcile some of the opportunities that the JOBS Act promised us to deliver to small companies that are not yet in the capital markets with the SMEs that already are, who as you probably heard us say before we think are overly burdened by some earlier regulations. And I think whether we try things like Mr. Joyce just recommended or that ICI recommended, we would be very much in favor of experimenting with allowing companies to select their own tick size. Ultimately, you could argue that could be their decision. We have studied internally what we think it would take for us to implement something like that. I don't think the implementation process would be long, although, obviously, all the industry participants would have to code their systems accordingly as well. And I think we are very much in favor of what Congressman Schweikert and others have recommended in terms of experimenting with some kind of liquidity provision program. Because I think if we don't do that combination of things, we do run a risk that, even though we don't intend for that to be the outcome, the good news is we get a lot of small companies to market and they access the growth capital that creates the jobs we desperately need. The other news is, once they get there, they run the risk of being orphaned from a research coverage and liquidity provision point of view. So I think we would be very, very interested in working with the industry and with all of you to figure out ways we can improve the situation for some of these SMEs that are already on the public markets. Because we think that is the future of the country in terms of job creation. Mr. Hurt. With respect to the JOBS Act, at what point do you think we will have concrete results that we can say are a consequence of the action that we have taken here in Washington? At what point will we be able to really judge the effectiveness of that Act? Mr. Niederauer. Assuming that it gets implemented by the regulatory authorities in the time which you have asked them to implement it, I would be very optimistic that we would be able to share results with you as early as next year. I can tell you that we are in conversations with--just our exchange is already in active conversations with 50 to 100 companies by my estimate, and I can honestly tell you I don't think we would be having the conversation with them about accessing the capital markets if it were not for the JOBS Act. So I think the early returns are already very, very positive. Mr. Hurt. Thank you. I yield back my time. Chairman Garrett. Thank you. The gentleman yields back. Mr. Green? Mr. Green. Thank you, Mr. Chairman, and I thank the witnesses for appearing. I want to speak to you very briefly about a couple of things. Let's start with the ability to arbitrage. Do you agree that this is a good or a bad thing, the ability to arbitrage in the marketplace? Who would like to respond? Mr. Joyce. I am happy to do it, Congressman. I think it is a good thing. Because I think for a really healthy marketplace, you need a variety--sometimes a wide variety--of market participants. You need the retail investor, the long-term investor, the institutional investor, the intermediaries, the arbitrageurs. I think if you want to have a healthy, vibrant market, you need a broad spectrum of participants. And arbitrageurs, while they take up a niche in the market, they do benefit the marketplace. Mr. Green. Is there anyone who differs? Talk to me for just a moment about hedging. As you know, this has been in the news lately. And I don't want to get you involved in somebody else's debate, but I think it is a great opportunity for me to hear from some other folks about hedging and how it benefits the market. I would like to hear your pros and cons, if you would, on hedging. Who would like to be the first? Mr. Cronin. I guess what I would say, as it pertains to the ICI, is we are not here to testify on behalf of what the banks are doing on their balance sheets and that sort of thing. But in the world of trading, risk management is an important component, so the ability for our contemporaries and counterparts, Morgan Stanley, Merrill Lynch, et al, to hedge risk, is an important feature of us finding liquidity. If we wanted to sell a large position of stock to them, they would take it in their inventory with their own capital and try to hedge the risk of that position using a number of different derivative contracts. So in the context of, at least for us, finding liquidity in the markets, hedging and the ability for our counterparts to hedge risk is an important notion. Mr. Green. Because time is of the essence, I will go next to my final point, which is, given that we appreciate hedging and we appreciate the ability to arbitrage, some contend that there is a thin line of distinction between these two and a highly technical term known as gambling. Can someone give me an opinion as to when you cross that line and you no longer are hedging but you are now moving into another arena? I don't mean to make you uncomfortable. I am reading body language. If this is something you don't feel comfortable talking about, I suppose I will understand, but since you are experts, maybe someone can help me understand. When is it that you cross the line and it becomes Las Vegas in the investment market? Mr. Coleman. I think, generally speaking, hedging is meant to decrease your risk and gambling is often to increase your risk. Mr. Green. Is it possible for the structure of the actual product that you produce to become more of a gamble than a risk? Mr. Coleman. I would say, not in our business line. Mr. Green. Not in yours. Let's not talk about anybody individually. What I am trying to speak for will be people who invest in these markets. So don't let this become personal, please. But just help me to understand, do we have this thing called gambling taking place? And, if so, I would like for somebody to address it. Mr. Joyce. If I could, I will take a shot at it, Congressman. I don't know if you can ever quantify a term like gambling that you have used, and this is probably not a very official answer or a very concise answer, but I think it is kind of in the eye of the beholder. Your view or somebody's view of gambling might be somebody else's view of a healthy intermediary doing his job or her job. So I hate to have--I don't want to sound like I am vacillating, but I believe applying the term ``gambling'' to components of the investment world basically defaults back to, it is in the eye of the beholder. Mr. Green. Okay. Let me just give you a quick example of something. I don't know that I can do it in 25 seconds, but, some time ago, there was something known as the numbers racket. You may not have heard of it. But in the numbers racket, when one runner had a big hit on a given number, usually 7 or 11-- for some reason these are popular numbers--he would go to another number runner and say, ``Look, I have a big run on 7. I will give you $10,000 if you will cover all of my losses above a certain amount if 7 hits.'' And if 7 hits, then that person would cover. As it turns out, that was kind of a credit default swap. Now, those people who were doing that went to jail. But if you can go to one of our Ivy League institutions and get a great amount of credibility, you can go into the stock market and bring these innovations, and these innovations are embraced, and they become a good way to do business. So I am just trying to get a better sense of when is it that these innovations that at one time were not received warmly became so enthusiastically embraced? What happens so that you can cross that line with these things and have this kind of circumstance? My time is up. Thank you very much. You have been wonderful. Thank you, Mr. Chairman. Chairman Garrett. Okay. It looks like everyone wanted to answer that question, but time is up. The gentleman from Texas is recognized. Mr. Neugebauer. Thank you, Mr. Chairman. I think this is a very important hearing, and I think the fact we have a very diverse panel here is healthy. I think one of the things--I heard Mr. Campbell make his comments earlier about how the little guy probably feels a little bit disenfranchised sometimes, that he sees other people making money by investing and he is maybe not doing so well. And I think as policymakers, one of the things we have to be careful about here is that I have seen since I have been in Congress that sometimes Congress is trying to make markets where nobody ever loses any money, and that is not the role of Congress. The role of Congress is for transparency and integrity of the markets. That is our goal. One of the things that we have seen is with technology is a lot of innovation in almost every area of business and finance, and particularly in the finance area, which has created some new opportunities and some new efficiencies in the market. So when I was kind of listening to Mr. Niederauer--you would think somebody with the name ``Neugebauer'' would be able to say that. So how about if I just call you ``Duncan'' and you call me ``Randy?'' But I think the question is--I heard you say the competition is healthy, the efficiency that is created by the technology and all of that--hopefully, everybody is invested, whether you are a small investor or big investor. It is how we manage this new competition, these new outlets, and are we doing it in a proper way. Would you kind of expand on that just a little bit? Mr. Niederauer. So, with your permission, I will call you ``Randy,'' rather than ``Congressman,'' and we will call it even. Mr. Neugebauer. That is great. Mr. Niederauer. Thanks, Randy. So it goes back to what several of your peers on the committee have talked about, in my opinion. So it goes back to Congressman Campbell's comment about the little guy feels disenfranchised, whether we are proud of the market structure or not. So if the customer is always right, that is the customer, that is who we are supposed to be serving. It goes back to Congresswoman Maloney's comment about the increasing opacity in the U.S. equity market is hard to reconcile with what we think we have learned in the crisis, that the products that got us in trouble were pretty opaque, right? It wasn't the transparent markets that got us in trouble. It was the opaque markets. So I think competition is a good thing, and let's start with figuring out how to try to measure its impact. I will help the committee with one thing. We can all bring you mountains of data. I guarantee you the data will be inconclusive. We can prove one thing. Mr. Joyce can prove another thing. Mr. Cronin can prove another. We can all prove different things from the data. It will be inconclusive. So at the end of the day, we are obliged to figure out if we think we have a policy or a confidence issue or we don't, because the data--we are going to take a lot of time gathering data, and I am not sure--we were going to draw very different conclusions from it. I want to be very clear. My statements earlier--we don't think there is anything nefarious going on in the equity markets. The broker-dealers are simply executing in a way that is consistent with the rules they are given. And in fairness to them, if internalizing is better economics for them, less regulation, why wouldn't they execute there, right? Why not? Now, I do disagree with one thing my friend, Mr. Joyce, said. If it were as simple as a broker-dealer were a broker- dealer and an exchange were an exchange, we are all for that. That is okay with us. That is how it was, historically. What has changed in the last 5 to 10 years is broker-dealers can own things that look a heck of a lot like an exchange; and we certainly can't own anything, nor are we asking to, that looks a heck of a lot like a broker-dealer. So that is point number one. My final point, point number two, is I want to be very, very clear, if the size that is getting executed in a dark pool is much bigger than we can provide in the public market, or if the price is better, we don't have a leg to stand on. That is called competition. But if you think about what the dark pools were envisioned to do, where it was about institutional customers like Mr. Cronin needing to find an alternative to the public market because the public market was not serving them properly, that was fine if the average order size was still large in the dark pools. The data that I have is, for the top five dark pools, the average execution size is half of what we typically display in the public market. I don't get how that is serving anybody. That is just making the markets more opaque, with no benefit to the end customer. Thank you, sir. I left you 12 seconds. Oh, I went over 12 seconds. Sorry. Mr. Neugebauer. With the chairman's indulgence, to be fair here, Mr. Joyce, if I am a little investor and I am trying to move 100 shares and there is an institutional investor out there that needs liquidity or something and they are trying to move 200,000 or 500,000 shares, does the dark area provide me some protection in--one of the things, I guess, do I want to be in front of that trade or on the back of that trade in a normal exchange trade? Mr. Joyce. We believe firmly that internalization is a huge benefit for the retail investor because we give instant execution at the price quoted, generally at a better price quoted. If I could just add one more thing in regard to the disenfranchised little guy, I think we need to understand again that there are many, many different people participating, many different types of investors in the market. A retail investor should not and I think cannot, worry about a 15-second time horizon in their investment; and if they get upset if they miss by a penny--and, of course, all the market data says they are doing better than that--but if they get upset and they miss by a penny and they run away from the market, they have missed the opportunity to--in the last 24 hours, I think Hershey has hit an all-time high, Costco has hit an all-time high, McDonald's is near an all-time high. These are household names. So we need to work on the education component of this, too. There are different people with different time horizons. If you are in there for the long term and you are not getting frustrated, which can happen, there are plenty of opportunities out there to build wealth. Mr. Neugebauer. Thank you. Chairman Garrett. Thank you. And Mr. Stivers is here and is recognized for 5 minutes. Mr. Stivers. Thank you, Mr. Chairman. My first question is for Mr. Niederauer. The purpose or the benefit of an exchange to the entire system is to provide price transparency to the entire market, is that correct? That is one of the benefits. Mr. Niederauer. That is what we aspire to do, yes, sir. Mr. Stivers. And even if shares are traded in dark markets, the exchanges provide sort of goalposts or left and right limits for people throughout the markets to know what the alternative price would have been, is that correct? Mr. Niederauer. The public market quote that I referenced in my opening--in my oral remarks, the so-called NBBO, is typically used as a reference price for those opaque markets, yes, sir. Mr. Stivers. So I guess the beginning point here is that, even though there is some opacity on the part of the markets, the exchanges are there to help everybody understand what the alternative price would be, and so it is very publicly known what the alternative would be. Is that correct or incorrect? Mr. Niederauer. Yes. We actually have an obligation to publish that bid and offer at all times with an associated size. So, yes, sir, that is correct. And we think that if the customer experience was better in the dark pools, as I alluded to a minute ago, then there is no argument, from our point of view. When it is clearly better for the executing broker but it is less clear that it is better for the customer, that is the only issue we have, really. Mr. Stivers. Can you help me understand, from your perspective on the New York Stock Exchange, what have your volumes been over the last couple of years? Has this rise in dark markets been at your expense in volumes? I thought your volumes were continuing to go up. Mr. Niederauer. Until the last 6 months of the markets--or really the first 6 months of this year, when we all see for all of us in the business the volumes are lower, which I think gets to the confidence issue, potentially, volumes in the overall market have gone up. That was a pretty steady increase after decimalization; and with the advent of some of the technologically enabled trading strategies, volume has generally increased. If you want to measure it by market share, the market share has gone down in the transparent exchanges at the expense of the opaque venues the last couple of years. And in the last 6 months, I think volume is down for everybody relative to the last few years. Mr. Stivers. But is there anybody on the panel--and you can just raise your hand on this one if you disagree with this--who believes that the dark markets have actually done anything to reduce the efficiency of the marketplace or reduce liquidity in the marketplace? They have increased liquidity for sure, right? Mr. Niederauer. Yes, I think competition generally increases liquidity. I think we focus more to the first part of your question about how much of that is displayed. Because the regulations that we put in place--let's put decimalization aside. That was for a different reason, and that was really why spreads went lower and volume went up. It was the advent of NMS 6 or 7 years ago that was designed and hoped to encourage the display of liquidity, in addition to fostering competition. I think it certainly fostered competition. I am not sure it led to more display of liquidity. Mr. Cronin. Can I just comment from an institutional perspective on that as we talk? Mr. Stivers. Go ahead. Mr. Cronin. Institutions obviously represent retail investors; and whether it is the self-directed guy who is buying 100 shares with Tom's firm or somebody who invests in a mutual fund, they both deserve the same positive outcome. So from an institutional perspective, when we have a big order--maybe it is 500,000 shares, maybe it is 5 million shares--there has to be a recognition that when we take that order to the market, there are a number of participants, probably including some on this panel, who would like to know about that order and could take advantage of it. So we need to be able to protect those orders. Dark pools, as originally conceived, were ways that we could go into the dark, interact with other large intermediaries and get big-sized trades done. Now, clearly, the market-- Mr. Stivers. I do need to get to one more question. I hate to cut you off. I really apologize, but I am limited on time. The other thing I would like to quickly discuss is, I worked in a broker-dealer a long time ago and the whole rise of market makers--and a lot of this was for the small issuers. So I do want to talk about the impact on small issuers of the rise of dark markets. And I know on a lot of the exchanges, including the New York Stock Exchange, you have to meet certain qualifications to get listed. I am out of time, but maybe there will be a second round of questions where we can talk about the impact. I know it has come up a little bit on small issuers. Thanks, Mr. Chairman. I yield back. Hopefully, there will be a second round. Chairman Garrett. Thank you. The gentleman yields back. The gentleman from Arizona is recognized. Mr. Schweikert. Thank you, Mr. Chairman. Sorry to run out on that. We had something that affected Arizona-- Forgive me if you have now gone into this in great depth, but, first off, tell me the pros and cons, and if you would even have a brilliant mechanical way you would do it of smaller capped companies, thinly traded. Would you allow them to choose or participate in choosing their tick size? Let's start from one end, and tell me good or bad. Mr. Coleman. I think our preference would be the exchange to decide or something along those lines. We would be flexible to changing tick size and seeing what impact we have, so we are not opposed to it. But I think an exchange is probably better situated to get the tick size right for everybody involved. Mr. Cronin. I don't know that we would be too prescriptive on who exactly should set those. The only thing I would say is it seems like the exchanges and even investors would be in a better position than necessarily the issuing companies to determine what that tick size should be. Mr. Gawronski. I agree with Kevin. Mr. Schweikert. Oh, that makes it easy. Mr. Joyce. I am not sure how much time management of these smaller companies think about tick size, but I am all for choice, and if they think it would be beneficial to the way their company trades with the data that they collect, then I am all for choice. Mr. Niederauer. We did touch on some of this while you had to step out, and I think there was general consensus that that is directionally correct. It is consistent with all the things we have talked about in the past of what can we do generally for the SMEs that are already listed to enhance their liquidity. We talked about liquidity provider programs. We talked about choosing their tick sizes. I mentioned in some of my earlier remarks that I think it would be--we shouldn't have so many different ones that it confuses the marketplace. But I think they are fairly easy to implement. We could do it with the companies. We would report it to the market participants. I think it is a pretty easy job for everybody to change their underlying systems to deal with different tick sizes. So we talked about a range of things, all targeted to enhance liquidity for the small companies. Mr. Smith. I think investors, since they are the ones who own the securities, have the most interest in having the appropriate tick size. So I don't think that having issuers select them on behalf of somebody who owns that stock makes a lot of sense. In terms of tick sizes in general, I think we need to calibrate them. So there is no reason, for instance, that Berkshire Hathaway should have the tick size as some $5, very actively traded stock. And I think in Europe, for instance, they have different tick sizes based on the value of the stock; and optimally you probably would like to do it with the value and the liquidity of the stock taken into consideration. So I think there is some calibration that could be done on that, both reducing tick sizes because of a lower investor transaction cost and potentially even increasing them in the appropriate circumstance as well. Mr. Schweikert. We end up in the discussion about increasing the tick size, particularly for the very thinly traded stocks. But many of us--and we have had this testimony here--is the crisis, as you may see, since Sarbanes-Oxley, we have almost one-third fewer publicly traded companies today. Does monkeying with something of this nature make it more possible with the new Reg A and some of the other mechanics out there to have the next sort of generation of publicly traded companies come to market, does it work? Are we talking about something that actually would provide liquidity? Mr. Smith, are we--and this is for not companies that are already listed, but for the next generation, particularly the small players. Would this help bring them? Mr. Smith. Certainly, I tend to favor the calibrated tick size approach, but, at the same time, I always favor innovation. So to the extent that one of the exchanges wants to experiment with having even a bigger tick size for some small cap companies or some up-and-coming companies and they want to have a pilot to do that, I would be supportive of that as well. Mr. Niederauer. I strongly agree with your statement. If you think about what the root of the work on the JOBS Act and Reg A was all about, it was to open the door for that next wave of entrepreneurial companies to find their way to the growth capital that the capital markets provide, Congressman. And I think what we have been talking about today is what else can we do for them as they are arriving or when they get there. Mr. Schweikert. I know we are up against time, but that is what we are in many ways hungry for, is what else should we be doing to get those companies out there. Mr. Niederauer. Right. And I think the on-ramp is a great start. I think we talked earlier about reconciling that for the already listed companies. We talked about liquidity provision programs, which I know you have championed, and incentives for a research provision as well. So we are going to keep brainstorming on that, and I think tick size is just one of many things we can do to try to make sure we encourage that next round of entrepreneurial companies to come to the market. Mr. Schweikert. I am now out of time, but please give us your ideas. Thank you, Mr. Chairman. Chairman Garrett. And I thank you. The gentlelady from New York is recognized. Dr. Hayworth. Thank you, Mr. Chairman. It was just mentioned again, the support for a pilot project to see how we can enable liquidity of small cap stocks to access capital more effectively and get investors more easily into that mix as well. Maybe we could just talk about some parameters for a pilot project, if we were to do them, so that we can get some guidance here on the committee. I am getting the sense that there could be a lot of flexibility, I presume facilitated by technology, to experiment with flexibility for tick sizes. Is there broad support for that being an element of a pilot project? Mr. Niederauer? Mr. Niederauer. I think it probably would be. We can follow up as panelists with other people in the industry. I think if you listen to the different recommendations that are being made, one approach is to tie it more to basis points and just have it naturally be a function of the price of the underlying stock. I think that is going to be inadequate from the standpoint of a lot of the small companies, because their concern is less about their spread but the underlying liquidity in their stock. So I think just doing the same spread for every stock that trades at $25, I am not sure that is going to get at the answer. I do think that with all the technology that has been brought to bear that you have heard a lot about today on the panel, it is pretty trivial for a lot of us to figure out how to put a pilot program in place and to be able to study it. And before we get too nervous about it, it is an unfortunate but true fact that Congressman Schweikert shared. There are only a few thousand publicly traded companies in the United States, and this is an issue that is probably relevant to a fraction of those few thousand. So I think if you can let us go to work and work together and figure out where we don't make it too complex but we get at the right answer, I think that is a great follow-up that we can all work on together. Mr. Joyce. If I can just add one thing, I think we need to be careful we don't get too caught up in the technicalities of how they trade. Let's face it. If you are a small company, you want to build momentum. You want to build enthusiasm for what are doing. You want to get your story out in the marketplace. So, as such, I think you should investigate things like allowing companies to sponsor market makers to actually make markets in their stock. As I said earlier, we have like 80 percent market share in the bulletin board and pink sheet names. Not because we wanted it--we are happy to have it--but because a lot of our competitors faded and walked away from it because it wasn't profitable enough. We also need to get the research story out there. You need to think about ways where you can publish research in a professional fashion and have the research analyst still work with the investment banker as they bring the company out. So I think we certainly have to look at the technicalities of trading, but let's make sure we give these companies a chance to tell their story. Dr. Hayworth. Mr. McHenry can obviously nod assent or not, but I think what you are talking about, Mr. Joyce, sits right in with the legislation you have introduced, does it not, Mr. McHenry? That is exactly what we are talking about. Mr. Joyce. Yes, we are in violent agreement. Dr. Hayworth. Right. It sounds like common sense. Because, as I understand it, the regret that people have expressed about switching to decimalization is that the markets providing for that kind of dissemination of research and the investment of time into that research was severely compromised by changing the tick size. Who should be--which entities should be the ones to be most heavily involved in a pilot project? Who should provide the overarching supervision? I don't know, Mr. Niederauer, if you have a-- Mr. Niederauer. I was hoping that the other panelists would volunteer us, because it is always easier to be volunteered than to volunteer. I think we would have to take the lead on it with the other exchanges, and I would like to start by working closely with the issuers. So I think that would be step one. But I think we have to dampen the issuers' enthusiasm a bit. Because as Tom and Kevin and Cameron have all said, the investor should have some say in this, too. We don't want to just hit the target on one thing and create another problem for ourselves somewhere else. But I think we could take responsibility for starting and beginning by working with the issuers whom we know care deeply about this, see if we can get as far as implementing some rules that let them choose it and calibrate it properly, and then make sure before we launch it that the investors are okay with it as well. I think you have heard Mr. Cronin express from ICI's point of view, that you guys would be okay with the pilot, subject to the details, right? Mr. Cronin. Yes, we would definitely support a pilot program. And if I can just give you some perspective, as investors, one of the things that we look at when we invest in companies clearly beyond growth opportunities and the industry they are in and that sort of thing is the liquidity. So the more things that we can do to enhance the liquidity and participation, the better. We quite clearly are supportive from an ICI perspective of trying this pilot program with traditional tick sizes being moved from a penny to--if it is 5 cents, if it is more than that, we are completely open. But we certainly would have all kinds of interest--Duncan, thank you for offering--of being very involved in that process. Because at the end of the day, it is our investors' money that you are looking to really get more engaged in this. And one of the prices for admission for that is just more transparency, better liquidity; and I think the pilot program can help get us to a better place for that. Dr. Hayworth. I appreciate that. Thank you. My time is up. I yield back. Chairman Garrett. And we move from the gentlelady from New York to the gentleman from New York. Mr. Grimm. Thank you, Mr. Chairman. Good afternoon to everyone on the panel. I appreciate your input today. Being a New Yorker, I am very interested in how our exchanges are working. I think that, overall, we have had an explosion in spreads tightening and better executions over the last several years. But I want to go back to something Mr. Niederauer said before. You were mentioning when my colleague from New York, Ms. Hayworth, talked about the company being concerned about-- they are less concerned about the spread and they are more concerned about liquidity. But when there is a larger spread, doesn't that always mean that for the market makers, there is more opportunity for them to make money? Therefore, more market makers and possibly more liquidity? Is there something to be said about that, that there is a correlation between the spread and liquidity? Mr. Joyce. Yes. If you don't mind, Congressman, I would like to jump in on that one. At Knight Capital Group, we make markets in 19,000 companies. We make markets in every single publicly traded company in the United States. Of course, about 6,000 or 7,000 are listed on exchanges, and the rest of them are actually too small to actually warrant a listing on an exchange. And that is where we have ended up with outsized market share, because that business of making markets for small companies has become very tough and a lot of market participants walked away from the opportunity that we stayed with. So I agree with you completely that if spreads widened, market makers might have an opportunity to have more of a profitable business, that it might attract more sponsorship for more companies. I think that is something that is a likely outcome if spreads widened in an appropriate fashion. Mr. Grimm. Is it true to assume that if that is the case, more market makers making markets, they are more likely to do at least some research? And then these companies, it is hard for them to get their research coverage, it is hard for investors to find anything on these companies, that would help the process along as well? Mr. Joyce. Yes, sir. Back when I worked at Merrill Lynch, back in the old days when my hair was a whole lot darker, we only made markets in names that we had research coverage. So there are a lot of firms out there that will tie research coverage to market making. Mr. Grimm. If I could go back to Mr. Niederauer, exchanges are very heavily regulated under the 1934 Act, but ATSs, including dark pools, are regulated as DDs under Reg ATS. So I would concede, I guess, that ATSs are not as heavily regulated as exchanges. So if I am understanding--I read your testimony, your suggestions correctly, and I just want to make sure I have it correct--it seems to me that NYSE is advocating for its competitors really to be saddled with the same regulatory burdens as exchanges that they are subject to. Is that correct? Mr. Niederauer. I think it is a tale of two cities. I think what we are saying is if the playing field is uneven and the ATSs are looking more like exchanges than broker-dealers, then there are two ways to level the playing field. You can make it easier for us to compete, or you can burden some of the ATSs that collectively are an important part of the market now with some exchange-like regulation. So I think what we are trying to say is we could go in either direction, but what is clear to us is that the competitive landscape has changed. As I said in one of my earlier remarks, the bright line between where a broker-dealer's business begins and ends, and where an exchange's business begins and ends, is a lot blurrier than it used to be, but it seems to be only blurry in one direction. We are certainly in no position, because of the 1934 Act and other things, to be in the broker-dealer business. Yet, many of the broker-dealers are able to be owners of venues that look an awful lot like an exchange, but are not subjected to nearly the regulatory burdens that we are subjected to. It also comes down to the cost of regulation, if I can just add that. So if we thought about consolidating the ability for FINRA or the SEC to regulate the market, and then we thought about what that should cost to regulate the market, an important part of investor confidence, I think we would be delighted to pay a share of the regulatory cost of regulating the markets that was consistent with our market share. Right now, the cost that we bear is exponentially greater compared to our market share. Mr. Grimm. What are you doing now to try to compete in the meantime? Mr. Niederauer. I think we do some of the things that we have talked about on the panel today. We have tried to keep up with the pace of innovation by innovating ourselves. I think the challenge we have there, to go back to the core of your question, is that we are subjected to an elongated rule-filing process where all of our competitors can comment against us, yet we are never given the opportunity to comment on any innovation they might like to install in their less- regulated pool because they don't have a rule-filing process. Mr. Grimm. My time has expired. Thank you very much. I yield back. Chairman Garrett. The gentleman yields back. Mr. McHenry is recognized. Mr. McHenry. Thank you, Mr. Chairman; and I thank you for allowing me to sit in on this hearing and ask a question. As the panel knows, I have a bill. The committee staff has presented you with a draft. Many of you have made comments on it. The point is, we have small companies that maybe at the time--whether it is Whole Foods or Apple, Microsoft or Dell-- started life as small companies that eventually moved to prominence. My thought process here is to incentivize small companies to seek our exchanges, to seek the public markets. It is good not only for the institution but great for small investors and those that are concerned about retirement savings and the like. But, with the advent of high frequency trading and markets being what they are, liquidity begets liquidity. So how do you help those that are on the edges? The comment made just a few minutes ago is we are not talking about a large percentage of the market, whether in cap or the amount of trading, but an important segment so that we can have folks get onto the public markets, so the idea being that you have some liquidity support. So with market fragmentation, high frequency trading, those top names get enormous focus. They get lots of liquidity as well. So, Mr. Niederauer and Mr. Joyce, you have mentioned this, but could you describe what you would expect to be included in a liquidity support agreement if my legislation were to pass. Mr. Joyce. Your point is well made. I think the data has proven that most jobs are created post-IPO, so we certainly want to encourage as much of this as possible, getting companies into the public markets. I would say that we have talked about three main things, tick sizes being one. And under the heading of tick sizes, if they are wider, they may encourage more market makers to participate, more market makers to sponsor the stocks, the companies in question, more market makers to perhaps pick up research of these stocks and companies in question. I also think you need to make sure that you are comfortable with the relationship between the investment banking entity that is arguably bringing the company public and their own in- house research department. It is not always nefarious. It is not always what it has been portrayed as in the press. Usually, they work well, hand-in-glove, and it is a very beneficial relationship to have research support a new company. So, again, I would allow issuers to pay for market-making support, if that is the way they want to proceed. It doesn't have to be a whole lot of money, but it would be something that would be an incentive. Make sure you allow research to articulate the story so that the general public will be interested in it, and think about why you need tick size to encourage market makers to participate more frequently than they currently do. Mr. Niederauer. We have done things like this in other product areas already, so we think it is very applicable. In the markets we operate in Europe, this is already much more the rule than the exception. So we know there are some long- standing rules here that we hope your legislation will give us an opportunity to revisit, right? We know that it has historically has been thought of as, well, we are not going to allow such a thing as a company incenting someone to provide liquidity in their security. We think your legislation opens the door, and we would be happy to work with you to do that. We also hope that the profit opportunity by widening out the spread for the dealers will make it easy for those markets to stay transparent. Ideally, from our point of view--I realize it is talking our own book--stay on exchange, which we think would be healthier. And we hope that one of the outcomes of this would not be that it gives a perverse incentive for people to make the markets more opaque, but I think we would be willing to take that chance. Because I think your first point is the right one. This is not only good for these small companies, investors; it is good for the country, right? Because this is where job creation comes from. This is the backbone of America. We need to get back to where we are facilitating their entry to the capital markets, which is the only growth capital they can get their hands on, to help them be great companies some day, and we have to give them their start. Mr. McHenry. So what protections are required in Europe to allow this basic liquidity support to be provided by broker- dealers? What does that look like? Mr. Niederauer. Yes, I think the good news is there are not many protections required. Because it is just simply a pragmatic approach to saying that a lot of the benefits of market innovation, as you pointed out, Congressman, have helped the big companies. They really haven't helped the SMEs. And that is not just in the United States. That is all around the world. So there is not a huge set of rules around this. It is just simply a pragmatic approach, kind of like the JOBS Act and the approach we took on Reg A was, where it didn't require a huge amount of infrastructure around it. It is just common sense that says we need to create incentives for people to support these companies when they are in the public market. So we can share that with your staff, but it is not complicated in the slightest. Mr. McHenry. Thank you. Thank you, Mr. Chairman. Chairman Garrett. I thank you, Mr. McHenry, and I thank the panel as well. I believe that concludes all the Members who are here for the first panel, so I thank the witnesses very much for your time. Your testimony was fascinating. The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. Without objection, the hearing record will remain open for 30 days for Members to submit written questions to these witnesses and to place their responses in the record. With that, you are excused, and thanked as well. As you make your way out, we then look forward to our second panel. We just note that sometime today we will have votes, and I know there is another committee coming in after votes, so that is why we are moving on expeditiously to the second panel. Greetings to the second panel, and welcome as well. We welcome you here, and we look forward to your testimony, and the admonition I will give to this panel as I always do, for those who have not been here before, is to make sure you bring your microphone close and try to abide by the little red, yellow, and green lights in front of you as far as your 5- minute timeframe. We will begin with Mr. Mathisson. Thank you for being with us, and you are recognized for 5 minutes. STATEMENT OF DANIEL MATHISSON, HEAD OF U.S. EQUITY TRADING, CREDIT SUISSE Mr. Mathisson. Thank you. Good morning, my name is Dan Mathisson, and I am the head of U.S. equity trading for Credit Suisse. Credit Suisse is a U.S. broker-dealer unit formerly called First Boston, which has been in operation in the United States since 1932, and today Credit Suisse employs 9,400 people in the United States. I have been working in the equity markets for the past 20 years, and I appreciate the chance to appear here today and give my opinions on the markets. Credit Suisse believes that overall, the U.S. markets are very good and remain the envy of the world. We recently published a broad survey of market quality where we found that bid-ask spreads in the United States are the tightest in the world, intraday market volatility has been decreasing since 2005, and the total number of market disruptions has been decreasing over the past decade. After looking at these, plus a broad number of other indicators, we believe that Reg ATS, decimalization, and Reg NMS were all successful at making the U.S. markets more efficient, fair, and equitable. However, markets can always be made better, and so today we suggest three improvements. First, the trading errors that occurred on the day of the recent Facebook IPO served to highlight a peculiar quirk of the U.S. market structure that needs to be addressed, namely, that exchanges do not have material liability for their technology failures. Dating back to the days when exchanges were not-for-profit, member-owned organizations, exchanges have SRO status, and therefore, they have been considered by courts to be quasi-governmental entities. This quasi-governmental status means that they have historically fallen under the absolute immunity doctrine, which protects them from liability judgments even in cases of gross negligence or willful misconduct. Yet, exchanges today are not particularly different from broker-dealers. While they still have a few vestigial regulatory functions, the vast majority of their broker-dealer regulatory responsibilities are now outsourced to FINRA. Both exchanges and ATSs accept buy and sell orders and match them electronically; both exchanges and ATSs offer undisplayed orders, typically called dark orders; both exchanges and ATSs offer displayed orders; and both are for-profit enterprises. Although, practically speaking, they are very similar, they have very different legal status. ATSs may be held liable for their actions like almost all U.S. businesses, while exchanges may not. We believe that considering exchanges to be quasi- governmental entities no longer makes sense and that restoring exchanges' moral hazard would be an important step towards creating a more reliable marketplace. Exchanges should not have been allowed to convert to for- profit entities 6 years ago while still retaining their SRO status. You should not be able to be a for-profit and a not- for-profit at the same time. It is time for policymakers to correct this mistake by removing exchanges' SRO status. Our second policy suggestion is that it is time to eliminate the restriction on broker-dealers owning more than 20 percent of an exchange. This would allow broker-owned ATSs to be become exchanges. Historically, the 20 percent restriction was put in place to ensure that broker-dealers could not control a regulator and regulate themselves. Yet now that exchanges are also for-profit enterprises just like broker- dealers, and now that they outsource most of their regulatory function to FINRA, we believe this ownership cap is obsolete. Exchanges have four very significant economic advantages over ATSs, which is why two ATSs, BATS and Direct Edge, worked very hard over the last few years to successfully convert from being ATSs to being exchanges. Allowing ATSs to convert to exchanges would effectively level the playing field, allowing regulators to have one set of rules for everyone. Lastly, we suggest it is time for the regulators to do a comprehensive review of the consolidated tape plans. The Consolidated Tape Association has a legal monopoly on providing a consolidated stream of real-time data from our Nation's stock markets. The CTA sells this data and makes a profit of approximately $400 million per year, which is then rebated to the exchanges based on a complex formula. The revenue that exchanges receive from these rebates is significant. For example, in their annual report, NASDAQ reported receiving $116 million in tape rebates in 2011. These plans were set up in November of 1972. After 40 years, we believe the current tape revenue model is obsolete and rife with problems, and we recommend a full review of the tape revenue system. Thank you for the opportunity to appear today, and I will be happy to answer any questions that you may have. [The prepared statement of Mr. Mathisson can be found on page 112 of the appendix.] Chairman Garrett. Thank you. Mr. O'Brien, welcome, and you are recognized for 5 minutes. STATEMENT OF WILLIAM O'BRIEN, CHIEF EXECUTIVE OFFICER, DIRECT EDGE Mr. O'Brien. Thank you. Chairman Garrett, members of the subcommittee, I would like to thank you for opportunity to testify today on behalf of Direct Edge. With over 10 percent of all U.S. equity volume trading on our exchanges every day, we are one of the largest stock market operators, stock exchange operators not only in the United States but in the world. We have talked about the theme of confidence, and I think it is the right one. Investor and issuer confidence is perhaps at a low point. You can question the merits of those concerns, but those concerns exist, and I think you have to acknowledge them. I think there are some simple steps that we can take that are intellectually consistent and operationally feasible to start the process of helping to restore that confidence. I don't think monopolies are the answer; more efficient competition is. I think some people will argue that confidence is undermined by the number of choices that investors have and the complexity of navigating it. I just don't believe that. I don't think investors think the soap market is unfair because there are 500 different kinds of soap, and I don't think they think the stock market is unfair because there are 50 places to execute your trade. I think, at the same time, we have to create more efficient mechanisms for those markets to communicate with one another in times of market stress. The flash crash, the recent IPO troubles were not caused or even made worse by fragmentation. They were made worse by the lack of efficient and effective communication among market participants in those situations. In the IPO situation, there were absolute monopolies, and there was very little visibility into what was happening there, and I think that was the biggest problem. Thankfully, I think we can easily improve this, and we have already started to do that. The limit up/limit down mechanism the SEC just approved can help all market participants deal with sudden and sharp changes in stock prices in a cohesive manner. I think more work can be done so that in crisis situations, all market participants can quickly come together to make sure these problems don't cascade and investors are protected. I think rather than restricting off-exchange trading, exchanges should have greater flexibility to make their markets a better place for institutional and for retail order flow. I kind of reject the notion of an unlevel playing field. I don't like that term. Somebody has it better, we have it worse, we need to fix it. I just want to make my exchange a better place for retail and institutional orders and for all our customers, quite frankly. I think sometimes we are hamstrung by the current application of the principle of fair access under Federal securities regulation, the notion that if you can't make it available to everyone, you can't make it available to anyone. I think we need to lay down a clear mandate, whether it is through provision of the Federal securities laws or other means, to make it clear that exchanges can roll out programs that are targeted toward long-term investors. I think we also need to highlight SEC oversight of market participant technology. The SEC is already doing this very rigorously. I don't think a lot of people know it. There is the automation review policy and the related inspection programs the SEC undertakes which are very vigorous. That program, however, is still technically voluntary. I think it should be formally made a Commission rule, and I think that would send a powerful message to investors that the glitches that investors perceive to have occurred are being overseen from a regulatory perspective, and we are working to further mitigate these issues from a risk management perspective. I think with respect to technology, we have to incentivize the proper use of technology rather than trying to turn back the clock. It is going to be unique to the stock market that people view technology as the problem rather than the solution, but you can't deny that it is a source of angst how automated our markets have become. At the same time, I think taking steps to making trading slower not only wouldn't work; they wouldn't improve investor confidence in the short term or the long term. I think it is about providing the right incentives in a framework of shared responsibility. Direct Edge was the first stock exchange to roll out a program that requires members to examine the amount of orders they send to our system relative to trades and imposed economic consequences if that ratio was too high. I think that is the type of framework that we should be pursuing rather than artificially impeding the evolution of technology in our markets. I think, in addition, investors need some more transparency regarding where their orders are routed in addition to where they are executed. A basic question that investors need to answer to feel confident, to trust but verify, is what happened to my order? There is a lot of information out there right now about where your order is executed, but I think investors want to know where it was routed in the course of trying to be executed as well. We could expand SEC Rule 606 for individual investors. We can actually implement this on an order-by-order basis technically quite easily for institutional investors, and we need to explore that. I do agree with the theme in the earlier panel that regulation should be made more flexible to enhance the trading of smaller cap companies. The one-size-fits-all model doesn't work. The stock that trades 10,000 shares a day effectively trades under the same market structure as Bank of America that trades over 2,000 or 3,000 times that amount. I think the legislative proposal put forth by Congressman McHenry and Vice Chairman Schweikert would be good first steps there. I think from an informational perspective, there is a concern that there is not adequate information for all investors. We need to create a national depth of book feed, not only to give investors easy access to the best price in the market at any one point in time, but all those prices, we can leverage the existing infrastructure and I think do that quite easily. Finally, I think the consolidated audit trail needs to be approved, implemented, and funded. Investors want to know that cops on the beat have the information and the tools available to do their jobs. Again, I think this will send a powerful message that we are making sure that happens. I thank you for the opportunity to testify, and I look forward to answering your questions. [The prepared statement of Mr. O'Brien can be found on page 136 of the appendix.] Chairman Garrett. Thank you, Mr. O'Brien. Mr. Solomon, welcome, and you are now recognized. STATEMENT OF JEFFREY M. SOLOMON, CHIEF EXECUTIVE OFFICER, COWEN AND COMPANY Mr. Solomon. Thank you, Chairman Garrett, and members of the subcommittee for inviting me to speak today. My name is Jeff Solomon, and I am the chief executive officer of Cowen and Company, an emerging growth investment bank that is focused on servicing growth-oriented companies in sectors such as health care, technology, telecommunications, media, aerospace and defense, and retail. Our clients are some of the best and most motivated entrepreneurs in the country. They seek to develop products and services that create positive change for whole sections of our economy and generate substantial long-term private sector jobs. These entrepreneurs need access to capital to fund their growth, but their choices to raise capital in the public markets are impacted by a lack of trading liquidity in small cap stocks. So when we talk about market structure, my perspective is guided by the belief that fostering trade liquidity in small cap stocks will increase access to capital for emerging companies and help generate job growth in the private sector. For the record, I just want to tell you a little about me. I was born and raised in Pittsburgh; I do not come from a long line of Wall Street executives. My father owns a small manufacturing business, and his father actually worked as a machine operator for Westinghouse Electric for 35 years. Most of my 24-year career on Wall Street was on the buy side, where I was buying and selling public securities and private securities with a lot of Wall Street firms. So now, as the CEO of Cowen, I am advising companies on how to access the capital markets, and we also produce high-quality research on these companies. My comments focus specifically around small cap companies because I really think that is the area we should focus on as we talk about market structure. I would like to commend Congress on the recent passage of the JOBS Act, which will help, certainly help new issuers, but there is still a lot of work to be done around market structure to facilitate capital formation. The last decade has shown a significant decrease in trading liquidity for most small cap issuers. Mutual funds and exchange traded funds are now the dominant market participants, and a lack of trading liquidity in any small cap stock makes it difficult for these institutional investors to accumulate positions. Moreover, portfolio managers carefully assess liquidity when determining position size and price as they know it will be hard to exit an investment when their price targets are reached or should they need to sell to generate liquidity to meet investor redemptions. This dynamic has severely narrowed the investment universe for small cap companies that might be looking to do an IPO, and therefore makes it difficult for them to raise capital to expand. Indeed, the number of IPOs raising less than $60 million has fallen precipitously over the past decade. One of the reasons for the lack of trading in small cap stocks can directly be attributed to the advent of decimalization or penny increments. As a direct result of reduced trading spreads, professional market makers and specialists whose job it was to provide liquidity for their clientele were forced to overhaul, sell or dissolve their businesses in order to contend with much lower revenues. This, in turn, gave rise to two forces affecting market structure, which would be electronic trading and reduced research coverage for small cap stocks. In order to reduce costs, many firms developed electronic market makers to replace human market makers and specialists, which caused a severe reduction in price discovery between buyers and sellers of small cap stocks. While some of the effects of electronic trading are hidden in the larger names, it has become uneconomic for many sell- side firms to make markets in small cap stocks. In my opinion, we need to find a way to bring back the human element that is so critical to fostering orderly liquid markets in small cap stocks. Wider spreads would certainly help to pay for that. To be clear, I am not calling for the wholesale repeal of decimalization, but like many people here, as we have heard on the panels today, decimalization is not a one-size-fits-all proposition. From what I see, decimalization has principally benefited institutional investors who trade stocks with market caps of $2 billion or greater, where the markets always exist to trade these stocks, but the benefits of trading small cap stocks in penny increments are far less clear to me when weighed against the effects of the obvious decline in trading liquidity that has occurred. As such, I am suggesting that Congress and the regulators consider increasing the tick increment from emerging growth companies or allow a company to determine their own increment size. Indeed, I recognize the SEC has undertaken a report on the impact of the decimalization on small companies as required by the JOBS Act, and I look forward to reading their findings. Some of the pilot programs proposed here today are also wonderful ideas as well. What I hear from private companies and small cap issuers is that it is essential to have published research from Wall Street firms following an offering. They understand that secondary market liquidity is critical to further capital formation needed to fund their growth, and with the support of revenue for market-making activities, Cowen would absolutely dedicate more resources to research and trading and support for these companies in the markets. To be fair, over the past decade a number of Wall Street firms have done things to damage their relationship with the American people and the investing public, but the vast majority of people on Wall Street, especially those at growth banks like my firm, had nothing to do with the mortgage mess or the financial crisis. By pursuing modifications to existing legislation and regulations around decimalization that bring back market makers for small cap stocks, Congress and the regulators will be telling Wall Street executives how they can allocate their resources to profitably meet the needs of their clients while fostering job growth in America. We can still be the leader in funding successful innovation in the United States, but in order to thrive, once again, we must make it more economically viable for small companies to access capital markets to fund their growth, create new industries, and provide Americans with the job growth from the private sector we so dearly want and need. Thank you. [The prepared statement of Mr. Solomon can be found on page 163 of the appendix.] Chairman Garrett. Thank you, Mr. Solomon, I appreciate that. Mr. Toes, you are recognized now for 5 minutes. Welcome to the panel. STATEMENT OF JIM TOES, PRESIDENT AND CHIEF EXECUTIVE OFFICER, SECURITY TRADERS ASSOCIATION (STA) Mr. Toes. Thank you, Chairman Garrett, Ranking Member Waters, and members of the subcommittee. The STA welcomes the opportunity to present comments before the Subcommittee on Capital Markets and Government Sponsored Enterprises on market structure. The STA was formed in 1934. We are an organization of individuals who are involved in the trading of financial securities. Our membership is diverse, both geographically and in the roles we fulfill in the marketplace. Much of our testimony today will reference years of comment letters STA has written on market structure, letters which were the culmination of input received from a wide range of market participants. The testimony of STA over the years has accurately informed and alerted Congress and the SEC to the possible consequences, both intended and unintended, of proposed changes to market structure. We are pleased to have the opportunity to do so today. Our testimony will focus on three areas of concern STA has with today's market structure: investor confidence; capital formation; and the quality of regulation. We will also identify specific areas which we, as practitioners, believe are the primary forces causing our concerns: operational capability; decimalization; and the rule-making process for both SROs and the SEC. Investor confidence is influenced by several factors, none more than the operational capability of the markets. Failures of that capability, even as a rare or limited occurrence, destroy investor confidence much more so than any regulatory or market structure minutia. Fostering greater operational capabilities should be the foremost consideration of any regulatory or legislative entity that has oversight or influence on our financial markets. It is imperative that such entities ensure no demands are made on the operational capacity of the industry that results in its being unable to deliver the services it purports to offer. Furthermore, behavior which stresses the operational capability of our markets should be identified and reviewed by the proper regulatory agency. Our markets need to be open to serve a wide range of market participants with varying business models. Therefore, it is critical that behavior which is deemed harmfully, potentially harmful to the overall operational capability of our markets not be allowed to exist unimpeded. Today, rules governing the securities markets are introduced to the marketplace by SEC initiatives in the form of rule proposals or the rule filings of SROs submitted to the SEC for approval. SEC approval of SRO rules and SRO rules in certain cases that are effective upon filing present unique problems. While there are similarities in these processes, they are distinct and vary primarily in the level of due diligence required of the Commission. There are efficiencies within both processes that when applied properly, serve the competitive nature of our markets and investor confidence. Our concerns at the STA reside in the lack of criteria that are used in deciding which process better serves investor confidence when rules are proposed. The Commission should consider alternative approaches to the approval of important SRO rules that have material market- wide implications on the structure of our marketplace. Rather than picking and choosing between the proposals or, in the alternative, approving all of them in cases where multiple rule filings are made that are identical or very closely related or where the SRO rule filings have material market-wide implications, the Commission should consider substituting a proposal for a uniform market-wide SEC rule in lieu of those of the SROs. STA does not suggest that changes to fee structures or other SRO proposals that attempt to differentiate themselves would merit a uniform SEC approach. Instead, the Commissioners should propose uniform, market-wide rules when there are significant market-wide implications. STA believes that in addition to the review of specifics of SEC and SRO rule proposals, the quality of regulation would be improved and investor protection better served if the SEC addressed the increased need for industry input on technology and back office operations in the rulemaking process. The existing rule review and approval process is increasingly ill- suited to obtaining this information. We submit that the SEC needs to take formal action on regulations and particularly before adopting those imposing significant technological or operational burdens on the markets, to create advisory or implementation committees as permitted by law to ensure it receives input from the trading community including experts in trading systems and products and develops an understanding of the operational demands of the proposed rules. We are encouraged that in the adoption of the limit up/limit down pilot program, the SROs responded to the STA's recommendation to establish an advisory committee which is to be composed of a broad cross-section of market participants who may submit views on the matters relating to the limit up/ limit down plan. Decimalization: There is perhaps no single market structure or event that has yielded more benefit to retail investors who transact directly with the marketplace to buy or sell securities than the introduction of decimal prices. The benefits for this class of investor are witnessed every day in the narrow bid-ask spreads in securities in which they trade. The data which shows implicit savings to these investors brought on by narrow spreads becomes even more impressive when it shows that even during moments of volatility, spreads remain tight. This benefit, which was immediate and long-lasting, however, has come with the cost of the secondary market's ability to perform their capital formation function. In its letter to the Commission dated May 14, 2003, the STA wrote, ``The raising of equity capital by corporations is the cornerstone of our economy. However, given the recent regulatory events surrounding research and investment banking and market structure changes affecting trading, the raising of capital has become exceedingly more difficult. That, in turn, is impacting the U.S. economy and its ability to create jobs. Action must be taken soon to remedy what could be soon a capital formation crisis. A reexamination of decimalization is a good place to start.'' Members of the panel, we reiterate that this letter was written in May of 2003. The unintended consequences of decimalization have been dramatic, most notably in a decline in the quantity of liquidity provided in some stocks in the small- and medium- sized companies. Shareholders benefit from the presence of liquidity providers. They dampen market volatility. STA recommends an examination of the impact of decimalization on electronic and traditional market making as well as other liquidity providers, considering the costs of maintaining trading operation in a decimalization regime and the balance of market maker obligations with the benefits. One way to conduct an examination is through a Commission- initiated pilot program utilizing a statistically significant number of small and mid-sized companies to study the impact of the secondary markets on quoting and trading securities in pricing increments greater than a penny. Thank you, and I look forward to answering your questions. [The prepared statement of Mr. Toes can be found on page 174 of the appendix.] Chairman Garrett. And I thank you very much. Mr. Weild, welcome to the committee. You are recognized for 5 minutes. STATEMENT OF DAVID WEILD, SENIOR ADVISOR, CAPITAL MARKETS GROUP, GRANT THORNTON Mr. Weild. Thank you. Chairman Garrett and members of the subcommittee, thank you for inviting me today to speak about an issue of great importance to many Americans: how to structure stock markets to better support the U.S. economy, job growth, and investors. My name is David Weild. I oversee the Capital Markets Group of Grant Thornton, one of the six global audit, tax, and advisory organizations, and I was formerly vice chairman of the NASDAQ stock market with responsibility for all of its listed companies. I also ran the equity new issues business of a major investment bank for many years. The IPO problem is, in reality, an after-market support problem. The current U.S. market structure failed to support the needs of small and mid-sized companies that were absolutely essential to U.S. economic success. My written testimony demonstrates four key structural challenges that the U.S. public stock markets must confront in order to foster the growth of small companies and in turn the economy. First, inadequate tick sizes, the smallest increment by which a stock can be bought or sold, have eroded the economic infrastructure required to support small cap stocks. This is to the forest issue that Mr. Campbell raised. This infrastructure includes equity research, sales, and capital essential to the visibility and liquidity that small public companies need. Think of tick sizes as the tolls required to maintain the bridges, roads, and tunnels of the stock market. In fact, our stock market today only covers the cost of trade execution services. Lack of after-market support for small cap companies means that fewer and fewer companies are doing IPOs, and fewer IPOs means fewer U.S. jobs. Second, inadequate tick sizes have undermined Wall Street's fundamental ability to properly execute IPOs, and the evidence is clear. Companies going public today are more mature than they were in the 1990s, and yet their IPOs are failing at increasingly higher rates. More deals are being withdrawn, more are being priced below their initial filing range, and more are trading below their initial IPO price, including Facebook. Third, U.S. stock market structure is optimized, clearly optimized for trading big brand and large cap stocks. The structure encourages computerized trading and speculation at the expense of fundamental investment, yet small cap companies under $2 billion in market value represent 81 percent of all listed companies but only 6.6 percent of market value. And finally, today's one-size-fits-all stock market, which we believe is attributable to the order handling rules, regulation ATS, decimalization and regulation NMS, has the United States averaging only 128 IPOs per year instead of the 500 to 1,000 that we project in our written testimony. This has drastically reduced the number of U.S.-listed companies and has cost America, in our view, as many as 10 million jobs. There is ample rationale for treating small company stocks differently. You have heard much of it on this panel. We specifically recommend that small company issuers be allowed to choose their own tick size within a certain range, preferably 1 to 25 cents per share, to encourage research sales and trading support for their stock. Providing better economic incentives to support small cap stocks will lead to increased IPOs and in turn higher rates of capital formation and job growth by both public and private companies. We commend Congress for passing the JOBS Act. It is a good first step, but even while passing the Act, Congress recognized the need to review U.S. market structure by requiring the United States to study the impact of decimalization on the number of IPOs and small cap securities. Following the study, the SEC is allowed to set a minimum trading increment of 1 to 10 cents for emerging growth companies. We recommend that Congress encourage the SEC to go a step further and initiate a pilot program that allows all small cap companies to choose their own tick sizes ranging from 1 to 25 cents within some tolerances. Back in 1971, there was a technology company that was unprofitable on an operating basis. It was only 3 years old when it went public and raised only $8 million. It created a revolutionary product, the first commercially available microprocessor chip. After it went public, it actually missed its product delivery date, and investors cut its stock price in half. Talk about risk. That kind of company would never make it to the IPO stage in today's unforgiving market. The name of that company? Intel Corporation. How many Intels have been needlessly lost to the U.S. economy by today's market structure? Congress has the power to help reverse our current situation and bring back the stock market that once was the envy of economies throughout the world. We recommend that Congress support an SEC pilot program that allows all small cap companies to choose their own tick sizes. Thank you for the opportunity to speak today. [The prepared statement of Mr. Weild can be found on page 178 of the appendix.] Chairman Garrett. I thank you, and I thank the entire panel. I will yield myself the first 5 minutes. Going in reverse order, Mr. Weild, on that point, so I think along the lines of some things that Mr. Campbell was raising, which were good points, the forest through the trees analysis, so we have heard, in the second panel, the second panel is a little bit different from the first panel, we have gotten into some more detailed recommendations on it. Mr. Weild, you are saying, a couple of points you are making; one is that the one-size-fits- all is not appropriate, right? Let me just drill down on that on a couple points, and I will open this up to the whole panel. One-size-fits-all with regard to the regulatory nature of it? At the other end of the panel, Mr. Mathisson was talking about that aspect of it. Would you like to chime in on that, maybe either refute or support what Mr. Mathisson was talking about as far as the advantages and disadvantages that you have now where you don't have a one-size-fits-all, where you have an exchange-regulated SRO situation out there and the cumbersome process that we have, they have with regard to changing of the processes on the platform as opposed to the ATS? Mr. Weild. Chairman Garrett, I think it is a question of perspective. From the perspective of issuers, markets have been totally homogenized with decimalization and Reg NMS and Reg ATS, and as a consequence, markets trade identically, it really doesn't matter any longer if you list on the New York Stock Exchange or the NASDAQ stock market for that matter. I think there is a separate issue, which is the regulation of those environments, and there is some diversity there, if you will, and I would take issue with Mr. Mathisson in the sense that I think it would be very unwise to create open-ended liability. We have two listed stock exchanges left in the United States, and if one of them had a catastrophic failure and were liable and were put out of business, that would just irrevocably harm investor confidence in the United States. These are two different issues. But for us to give issuers a seat back at the table, what happened with Reg ATS is that we opened up markets to lots of trading centric enterprises that don't list companies, so the representation of issuers has been undermined. So if you give them choice over tick size, it puts them into a discussion with their institutional investors and with their value providers, the investment banks, about what are the optimum number, and it actually gives them a seat back at the table, which I think is one of the things that has been lost. Chairman Garrett. Mr. Mathisson, do you want to chime in? Mr. Mathisson. To respond to that, we don't have 2 exchanges in this country, we have 13 exchanges in this country, and all of them do have the right to list stocks, and some of those inevitably will become successful at listing stocks. And if the regulators eliminated the 20 percent restriction on broker-dealer ownership of exchanges, we would likely have another 6 or 7 more, so we could have an environment where we would have 20 exchanges. If we had 20 exchanges, and one of them went down due to their own errors and had such a big trading incident that it brought their entire system down and they went bankrupt, you would have at least--in today's world, we would have 12 others; you could have 19 or 20 others if the restrictions on exchange ownership were removed. As for tick sizes, we would have no problem with an experiment to allow corporates to choose their own tick size. I think that it would not make a significant difference in the IPO markets or in the ability to raise capital. However, I do think it meets the chairman's criteria that you mentioned in the first panel of, first do no harm. I do not think it would do any harm to the markets, although I don't expect it would significantly help, either. Chairman Garrett. Moving down, Mr. O'Brien, you heard some of my questioning on the first panel, and I just wonder if you could chime in here, and also with regard to how the exchanges are treated under Dodd-Frank Section 915 and the like, in your opinion? Mr. O'Brien. Sure, and let me also add a couple of remarks on your other questions. I think we are somewhere in the middle. You remember Direct Edge's history; we started as a broker-dealer-run ATS, and we volunteered for exchange regulation and classifications. It is not an accident of history or anything. We wanted to become an exchange. We took on that mantle willingly. I think, with some limited exceptions, the process works but could be improved, and I think thematically, just the approach of how exchanges are viewed as having to make everything available to everybody; we can't create more targeted opportunities within the framework of a common network. Dodd-Frank was supposed to make the process better. It really hasn't. I am not going to say it has made it worse. It has made it different in the sense that now these deadlines are hit, and the opportunities to extend review periods are taken, many more exchange rule filings are disapproved now or at least the proceeding to start disapproval begins. The SEC used to pocket veto effectively exchange rule filings they didn't like. They can't do that anymore. So rather than do that, they will just start the disapproval process, and that starts another clock. So the intent of what Dodd-Frank was meant to do is not being implemented in reality. Chairman Garrett. In 3 seconds, any buyer's remorse as far as going into the exchange format with all the restrictions you have now because of that? Mr. O'Brien. No, not at all, because it has been better for our customers. Chairman Garrett. Thank you. The gentleman from Arizona. Mr. Schweikert. Thank you, Mr. Chairman. I always hate buyer's remorse, don't you? Okay, so much for some humor. Chairman Garrett. That is right, so much for-- Mr. Schweikert. Yes, I know. One of the things, and forgive me for being somewhat fixated on this, but the discussion of tick size, particularly someone who truly wants to see that next generation of small companies come to market. Does it really make a difference? Because we heard in the previous panel of technology, that is simple, they can deal with it. So now the question is, the SEC does its study. Should we go-- should it be 1 to 25 cents, should it be 1 to 10 cents? First, does it make a difference? What should it be? Should the company be able to choose it itself or should there be some metric from the exchange choosing it? Mr. Weild? Mr. Weild. I think that there is such an incredible difference in terms of the market values and the float values, micro nano cap stocks are under $100 million, stocks that trade 10,000 shares a day, and then the behemoths that trade in the millions of shares a day, that the one-size-fits-all tick size doesn't allow people to actually create liquidity. Academic literature clearly shows that proliferating ticks, small tick sizes actually increase liquidity in large cap stocks, but they are harmful to liquidity in micro cap stocks. So to answer your question, absolutely undoubtedly if you want to commit capital, buy a block of stock and get, as we used to say on the trading desk, long and loud to go find a buyer, you need a way to get compensated for that risk. So for a tiny little nano cap stock, under a $100 million, the right answer might be something close to a quarter point. Mr. Schweikert. Is that going to be necessary to get that stock covered by research? Mr. Solomon. Yes. Sorry, David, can I just-- Mr. Weild. Go ahead. Mr. Solomon. Maybe I am--I think I am probably one of the only people on the panel who actually has a company that writes research on this, and what I would say to you is unequivocally-- Mr. Schweikert. It is your fault then, right? Mr. Solomon. We do it. I think what is incredibly important is exactly what David said here, the after-market support is really critical to funding companies going forward. I will give you an example with our own company. We are a small cap publicly traded company, we trade about 300,000 shares a day. If you take a penny increment, that is $3,000 a day if you own 100 percent of the market share in trading our stock on a daily basis. If I want to get more research coverage as an issuer today, I don't--who is going to do that? Where is the value in somebody writing research on me to generate interest when they really don't have a lot of economic incentive to do so? And I think that is a big issue. That is a very big issue. Mr. Schweikert. This is a one-off, but it is one we were just actually sitting here talking about a moment ago. For small companies, would you allow a company to provide a blind compensation for research? What would you do there? Mr. Solomon. I am not in favor of paid-for research. I think the research independence rules are good. I actually think the integrity of research should be held sacrosanct and different from anything that has to do with issuers and what they want research people to do for them to be clear. I actually think if you could set your tick increment much wider than the marketplace will react, and if you set it wide enough and there is enough profit incentive for middlemen to come in and start to make markets, then those middlemen will have an economic incentive to write research on your-- Mr. Schweikert. So your view is the tick size is ultimately the solution to get covered and get someone willing to carry you? Mr. Solomon. Yes, I do believe that is true. Mr. Schweikert. Do I have a consensus there? And then what should it be? Should it be the 1 to 25 or should it be the exchange? Who else makes the decision? Mr. O'Brien. I think it is part of the solution. When you think about what a company looking to access the capital markets needs, they are really thinking about two things. One, can I access the capital markets in a way that doesn't overly disrupt my ability to run my business day to day, and there are things that are totally unrelated to equity market structure; the application of Sarbanes-Oxley, for example, would be an example of that. So there is work to do there. The second thing is, I don't want to be creating a new problem for myself as a CEO by creating a group of new investors who feel like orphans who can't sell what they bought, who can't understand what is going on in the company. So, in that vein, the potential widening of tick sizes can definitely help. It can increase the liquidity at the bid and ask, so if I am an investor and I want to buy 500 shares, I feel like I am going to be able to sell that, even if the stock only trades 10,000 shares a day because I see 500 shares posted at the best bid or best offer at any one point in time, and I think in terms of how you decide what those tick ranges should be, issuers were ultimately going to look to their advisers. I am not sure how much merit there is in empowering the issuer to pick stock by stock, and I think you also want ease of use for the individual investor, the person looking at the Scottrade or E*TRADE screen, they want to know what the minimum increment is, so they want some standardization. Mr. Schweikert. In the 3 seconds I don't have, back to also part of the original question, does changing the tick size bring us new IPOs in the micro categories or the $100 million and less categories? Mr. Toes. Yes, and I think one area that hasn't been touched on as far as a benefit of a wider tick increment than the pennies to cost savings. When you think about the cost to maintain the trading center today, a large portion of those costs are really based on transactions. So when you have multiple price points, when you need to clear a trade, when you need to capture a quote, store that quote, those are all transactional type costs that you are incurring. Whether you are clearing a trade of 100 shares or 1 million shares, the cost on that is the same because it is based on a transactional--on a transaction. So when you take the number of price points and you reduce it from a 100 down to 20 on a dollar, you are, in fact, decreasing the amount of transactional costs you have on market data and also clearing fees. So there is a cost savings to be had. Mr. Schweikert. Thank you for your tolerance, Mr. Chairman. Chairman Garrett. Thank you. The gentleman from California. Mr. Campbell. Thank you, Mr. Chairman, and so as the clean- up hitter, it would appear, up here, I am pleased to hear, I think, unanimity both up here and down there that we want to reengage small- and medium-sized businesses in public markets again, which they have disengaged, and that we want to reengage the public at large in public markets again, which they have disengaged. I hear pretty much agreement with Mr. Weild's points on the tick sizes, with which I agree as well. Let me talk again about a couple of other broader things, and then elicit comments from the group. It appears that we have--we, the broad we, Congress, Wall Street--focused on increasing liquidity, increasing speed, and reducing bid-ask spreads at the expense of public confidence, and I say public confidence as opposed to investor confidence because we really need public confidence because everyone in the public is potentially an investor and ought to be, and as opposed to investment over speculation, gambling, and trading, and transparency, that we have sacrificed those things for the speed, the spreads, and the liquidity, and that is not a good thing, and we need to turn the tables the other way. And then when we talk about why people don't IPO, I have talked to a number of different owners, CEOs, CFOs, et cetera, of companies who have either gone private, chosen not to take an IPO, or who are now in one of these nonpublic entities that has hundreds or thousands of investors, and why don't they go public? I hear cost; that is a lot of it. We all know that, and we are trying to address that, and we have more to deal with, and that certainly is a lot of it. But I hear a lot of other things, too, that they really don't want the value of their company determined by people whose investment--I will use that term loosely this time--horizon is between milliseconds and months. And particularly if you talk to some of the people who have the large privately traded multiple stockholder companies, they want investors; they don't want traders determining the value of their company, and that that is something that my question would be, how do we get more of that? And another thing is, and it seems that a lot of what we talk, there are people on Manhattan island talking to other people on Manhattan island about how to keep people on Manhattan island happy with the possible exception of a few people in Boston, who manage some funds, and I have had a couple--and it is amazing, I have heard this from several different people, and they said, I just didn't--I went into, I was in a red--doing close to a red herring on a road show, and I realized that the entire value of my company was being determined by some 25-year-old Harvard MBA, who graduated 3 months ago, who is with a fund that will determine the entire value of this company and will tell me, and I am going to use my industry in order to keep the innocent here, but who is going to tell me, who spent 35 years in the car business, whether I am running my car business well or not, and by the way, that 25-year-old Harvard MBA doesn't own or drive a car. And I am not going to allow my company's value and subject it to that kind of ridiculous oversight. So I burned up all but a minute. But how are we going to solve those problems? Because I am not making this stuff up, and these are not single individuals who are telling me this. They are multiple individuals, and they are not in the public markets-- Mr. Solomon. --road shows in Pittsburgh, I am for that. Mr. Campbell. Okay, fair enough. I should say Washington to Boston, that little thing right along there. Anyway. Yes? Mr. Toes. There are a couple of topics that you hit on there that speed for some reason has gotten a nasty connotation next to it. Speed actually helps investor confidence. People who sit at home and they look at the--they are trading from their, they are trading directly with the marketplace, investors, traders, they want to know when they look at the price on the screen from their computer that the price is what the price is at that moment in time, not-- Mr. Campbell. Millisecond speed? Mr. Toes. Hold on a second, hold on a second. Let me finish. And they want to know that the price they are looking at is where the stock is trading at that time, and when they hit the button to buy or sell, when they make the decision to buy or sell, that the price they get is the price they are seeing on the screen. You are correct. Mr. Campbell. If they hit the button fast enough. I would make exactly the opposite argument. You cannot hit the button fast enough today. People don't--that isn't quick enough. Mr. Solomon. I think there are different kinds of investors. So speed is one attribute that is desirable, but you have to ask yourself the question of whether or not there could be balance. I certainly think that for a lot of the issuers we talk to, absolutely what you said resonates. They want long- term investors. If you buy it at a penny lower or a penny higher, it shouldn't matter if you are a long-term investor. There used to be a saying on the Street, ``Don't miss the trade for a quarter.'' I watch people every day miss the trade for a penny or half a penny, and I wonder to myself, if you really have some long-term view on whether you think the stock is going to trade higher or lower, what does it matter to you? To some people, it does, and I think we need to be able to offer that, so you don't want to take that away, and speed has helped with execution, no question about it, but you have to ask yourself at what expense, and I certainly think that if we can create, again, a fundamental marketplace where there is an opportunity for middlemen to stand and really take risk positions with the advent of creating liquidity, that is really what I think Wall Street is probably supposed to be doing, really taking risk positions and finding buyers and sellers and crossing trades and really moving product as opposed to storing product. That is really what is at the cornerstone of creating that ecosystem that is so vital for new issuance. And speed plays into that, but I don't care if the market is fast or the market is slow as long as there are people congregating at a common point that will allow for there to be more trading liquidity on a daily basis. Mr. Weild. Larger tick sizes throughout the market favor investors over traders and computer strategies. Mr. Campbell. Okay. If there are no other comments from you, then I will yield back, Mr. Chairman. Chairman Garrett. The gentleman yields back. The gentlelady from New York, where all these trades are happening, and where 25-year-olds are doing these nefarious things. Dr. Hayworth. I am 52; don't blame me. Thank you, Mr. Chairman. Mr. Weild, you just referred to tick size, and I did have the opportunity to ask members of the antecedent panel about how we might, how you might provide guidance from your industry perspective toward a pilot project, and I know Mr. Schweikert has been working, I think, with the SEC on studying the implications of tick size for the liquid small cap marketplace, but there certainly has been support for a pilot project. What elements would you like to see in terms of flexibility of setting the tick size? How would you base that? What kind of parameters would you use for that kind of flexibility? Who should be managing or participating in that kind of pilot project? And, I open it to the panel. Mr. Toes, maybe you would like to start? Mr. Toes. We do have some suggestions for the Commission on what criteria to use. We realize that it is a core function of the Act that marketplaces are supposed to allow for customer- to-customer activity and have that activity go on unimpeded by middle people, but the criteria that we would use is that the role of the market maker obviously is to offset imbalances, when there are no customer-to-customer, when there are no buyers and sellers in the marketplace. So we feel the best way to measure that occurrence is to really look at the dollar volume of these particular stocks. So we would probably look for a criteria that is based less on the price of security, less on this actual market cap of the security, but more to do with the dollar volume of what the stock trades because we feel that is probably the best indicator for what, how much customer natural flow resides in the particular stock. Dr. Hayworth. Where the marketplace is of the stock's viability, if you will, how vigorously it is trading. Yes, sir? Mr. O'Brien. I think that there are two principles we should adhere to when trying to implement any kind of experiment or pilot program with tick sizes. First, it has to be easy to assess the impact of it, right? That is why I am not necessarily in favor of each issuer choosing. The process of them choosing is going to take some time, and it may be isolated. Dr. Hayworth. Too many variables? Mr. O'Brien. Too many variables. You want to address those things out. The second is that you want it to be easy for investors to understand. Again, we may think it is good, but if the average person in your district thinks, here is another aspect of the stock market where the analyst knows what each tick size is and I don't, it could cause some disengagement, and I am not in favor of that. I would agree with Mr. Toes; the two variables I think are the size of the company in terms of its market capitalization and its trading volume on a dollar volume or perhaps even a share volume basis, and take a subset of all securities that meet certain criteria along those matrix and implement it for a period of time. That will give you not only the data, but it is something that even people who aren't lifelong Manhattan residents can understand what we are doing, why we are doing it and can understand whether or not it worked or not. Dr. Hayworth. Got it. And I appreciate those thoughts very much. Mr. Weild, any thoughts about where such a pilot should be based or how it should be administered, so to speak? Mr. Weild. Sure. I think that you need a critical mass number of stocks to get the data to do the direct comparisons the micro market economists will want to look at. I think you are going to need on the order of 500 stocks over the course of 2 to 3 years, and I think if it is proven to be successful and adequate representation based on the market value, flow values, and volumes. And again, I do think that allowing issuers, not independently, but in conversation with their institutional investors and with their value providers, like Cowen and Company, to have a discussion with them to make recommendations about what their tick sizes should be and then have the board make a decision, I think would tell the market an awful lot about what the real, what the right value is. There is a big difference. Capital Research, with nearly a trillion dollars under management, is investing in very different stocks, for example, than Wasatch Advisors in Salt Lake City that is a growth company investor, and so I think that from having that direct input, I think people are largely rational within a tolerance, they will come up with a better answer, market forces will cause a better answer than we will. Dr. Hayworth. Right. Mr. Solomon. I also think simple is better. I totally agree with you; keep it simple. I also believe investors like round numbers. Round numbers are good. When you meet somebody, you tell them you are going to meet them at the corner of something and something, you don't tell them you are going to meet them in between the corner of something and something. It is the human condition, right? So I actually think if you put it in increments that are relatively straightforward that we all understand--nickels, dimes, quarters--are good things for people to really get their heads around, and it makes it a lot easier for people to understand exactly how this is going to work. I do think, like Mr. Weild said, it needs some time because I will have to make some investments in order to bring this back. It won't just turn on all of a sudden. I will be looking at adding new research analysts. I will be making some up-front investment to see how we can sponsor companies more. So it will take time for it to work through the system. And of course, I am going to want to know that there is a commitment to this pilot program for some period of time because I am going to be making an upfront investment to see if I can get it to work for me as a CEO. Dr. Hayworth. That makes a lot of sense. I thank you, sir, and I yield back. Chairman Garrett. The gentlelady yields back, and that brings us to the conclusion of the second panel, and the conclusion of today's hearing. Again, I thank you all very much for the illumination that you brought to this topic. And I very much thank you all for being here. Without objection, I will be putting into the record three items, all of which are from SIFMA: a paper on displayed and nondisplayed liquidity, dated August 31st; a June 25, 2010, letter on market structure roundtable; and an April 29th of the same year concept release on equity market structure, which will all be part of the record, without objection. The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. Without objection, the hearing record will remain open for 30 days for Members to submit written questions to these witnesses and to place their responses in the record. And with that, this hearing is adjourned. Thank you, gentlemen. [Whereupon, at 11:55 a.m., the hearing was adjourned.] A P P E N D I X June 20, 2012 [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]