[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



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                 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.]

















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                             June 20, 2012



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