    [Senate Hearing 112-756]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 112-756

       COMPUTERIZED TRADING VENUES: WHAT SHOULD THE RULES OF THE ROAD BE?

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

                                    HEARING

                                   before the

                                SUBCOMMITTEE ON

                     SECURITIES, INSURANCE, AND INVESTMENT

                                     of the

                                  COMMITTEE ON

                       BANKING,HOUSING,AND URBAN AFFAIRS

                              UNITED STATES SENATE

                          ONE HUNDRED TWELFTH CONGRESS

                                 SECOND SESSION

                                       ON

                     EXAMINING COMPUTERIZED TRADING VENUES

                                   __________

                               DECEMBER 18, 2012

                                   __________

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

                     Available at: http: //www.fdsys.gov /

                      U.S. GOVERNMENT PRINTING OFFICE
    80-273                    WASHINGTON : 2013
    -----------------------------------------------------------------------
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    20402-0001

                COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      TIM JOHNSON, South Dakota, Chairman

    JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
    CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
    ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
    DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
    SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
    JON TESTER, Montana                  MIKE JOHANNS, Nebraska
    HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
    MARK R. WARNER, Virginia             MARK KIRK, Illinois
    JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
    MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
    KAY HAGAN, North Carolina

                         Dwight Fettig, Staff Director

                  William D. Duhnke, Republican Staff Director

                           Dawn Ratliff, Chief Clerk

                         Riker Vermilye, Hearing Clerk

                          Shelvin Simmons, IT Director

                              Jim Crowell, Editor

                                     ______

             Subcommittee on Securities, Insurance, and Investment

                       JACK REED, Rhode Island, Chairman

                  MIKE CRAPO, Idaho, Ranking Republican Member

    CHARLES E. SCHUMER, New York         PATRICK J. TOOMEY, Pennsylvania
    ROBERT MENENDEZ, New Jersey          MARK KIRK, Illinois
    DANIEL K. AKAKA, Hawaii              BOB CORKER, Tennessee
    HERB KOHL, Wisconsin                 JIM DeMINT, South Carolina
    MARK R. WARNER, Virginia             DAVID VITTER, Louisiana
    JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
    MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
    KAY HAGAN, North Carolina
    TIM JOHNSON, South Dakota

                    Kara Stein, Subcommittee Staff Director

             Gregg Richard, Republican Subcommittee Staff Director

                        Catherine Topping, FDIC Detailee

                                      (ii)
    ?

                                C O N T E N T S

                                  ----------

                           TUESDAY, DECEMBER 18, 2012

                                                                       Page

    Opening statement of Chairman Reed...............................     1

    Opening statements, comments, or prepared statements of:
        Senator Crapo................................................     2

                                   WITNESSES

    Joseph Mecane, Executive Vice President and Head of U.S.
      Equities, NYSE Euronext........................................     4
        Prepared statement...........................................    27
        Responses to written questions of:
            Senator Reed.............................................    51
    Daniel Mathisson, Head of U.S. Equity Trading, Credit Suisse
      Securities LLC.................................................     6
        Prepared statement...........................................    29
        Responses to written questions of:
            Senator Reed.............................................    65
    Eric Noll, Executive Vice President and Head, Nasdaq OMX
      Transaction Services...........................................     7
        Prepared statement...........................................    35
        Responses to written questions of:
            Senator Reed.............................................    68
    Robert C. Gasser, Chief Executive Officer and President, ITG.....     9
        Prepared statement...........................................    40
        Responses to written questions of:
            Senator Reed.............................................    74

                                     (iii)

       COMPUTERIZED TRADING VENUES: WHAT SHOULD THE RULES OF THE ROAD BE?

                                  ----------

                           TUESDAY, DECEMBER 18, 2012

                                           U.S. Senate,
         Subcommittee on Securities, Insurance, and Investment,
              Committee on Banking, Housing, and Urban Affairs,
                                                        Washington, DC.
        The Subcommittee met at 9:31 a.m., in room SD-538, Dirksen
    Senate Office Building, Hon. Jack Reed, Chairman of the
    Subcommittee, presiding.

                OPENING STATEMENT OF CHAIRMAN JACK REED

        Chairman Reed. Let me call the hearing to order, and let me
    welcome our witnesses. I thank my colleague, the Ranking
    Member, Senator Crapo, for joining us this morning.
        This hearing will be focused on how computers, market
    regulation, and competition have dramatically changed equity
    markets in the United States. In recent decades, the United
    States equity markets have experienced tremendous technological
    innovation and intensified competition between an expanding set
    of trading venues, some of which have been driven by regulatory
    changes.
        As of December 2012, there are 13 official stock exchanges
    registered with the Securities and Exchange Commission. In
    addition, there are nearly 40 ATSs, alternative trading
    systems, through which broker-dealers can access the market.
    Included among the ATSs are the so-called dark pools that do
    not publicly display quotes or prices. There are also more than
    200 broker-dealers that execute orders in-house in a process
    known as ``internalization.'' In short, liquidity has
    fragmented over numerous trading venues as competition has
    intensified.
        Two SEC regulations dramatically changed or accelerated
    changes in the structure of our financial markets. In 1998, the
    Securities and Exchange Commission adopted Regulation ATS to
    encourage the development of innovative new market centers.
    Regulation ATS exempted these alternative trading systems from
    having to register as exchanges. And in 2005, the SEC adopted
    Regulation National Market System, or Regulation NMS, a series
    of rules and regulations designed to modernize and strengthen
    the national market system for equities. Implemented in 2007,
    Regulation NMS is credited by some to have caused the biggest
    change of the two by requiring that orders be sent to the
    trading platform with the best price.
        The adoption of Regulation ATS and Regulation NMS led to a
    proliferation of new trading platforms. It also put a premium
    on speed, giving an advantage to firms that could place orders
    first and take advantage of minuscule price differentials
    between the trading venues. Such high-frequency, computer-based
    training has grown in recent years, representing about 50
    percent of equity trading in the United States. High-frequency
    trades employ many different automatic strategies with rapid
    orders and short-term holding periods. High-frequency trading,
    advanced computer technology, and trading strategies have led
    to changes in the marketplace that minimize latency or the time
    it takes to send and execute a trade.
        In response to the demand for faster execution, exchanges
    are allowing trading firms to place or collocate their service
    in the exchanges' data centers. Some trading venues also allow
    direct access through which certain trading firms access the
    exchanges' matching engine directly. Exchanges also offer
    direct data feeds on a proprietary basis to their customers.
    These feeds cost more, but the data arrives sooner. It has been
    reported that some exchanges and trading firms have developed
    an ultra-fast micro wavelength to provide even faster speeds.
        The growth of new trading venues and the increasing use of
    automation and advanced computing technology have raised
    questions about the effect that these changes have had on the
    stability, fairness, and integrity of our marketplaces. Flash
    Crash, the BATS and Facebook IPOs, and Knight's trading debacle
    all bring into question the very rules that govern our market
    structure.
        Do market rules reflect the realities of today's market
    structure? Are the markets fair and transparent? Is the
    marketplace too complex or to fragmented? Should all markets
    have the same rules? Is there a great potential for systemic
    risk propagation as a result of the interconnection of highly
    computerized markets? Or, essentially, the ultimate question,
    do the rules of the road need to be changed?
        I look forward to our witnesses' testimony and a robust
    discussion of these issues.
        I will now turn to my colleague Senator Crapo and thank him
    for his indulgence for my long opening statement. Thank you.

                    STATEMENT OF SENATOR MIKE CRAPO

        Senator Crapo. Thank you very much, Mr. Chairman. I
    appreciate you holding this important hearing today. It is our
    second in a series of hearings on computerized trading.
        At our last hearing, we heard from witnesses representing
    the buy side: high-frequency traders and the research and
    advisory firms. Today we are going to hear from witnesses
    representing exchanges and alternative trading venues.
        Because there have been too many market disruptions caused
    by software errors since the Flash Crash of 2010, there has
    been a lot of discussion on how to fortify our markets during
    times of market stress.
        In October, the Securities and Exchange Commission held a
    Technology Roundtable on how to minimize trading errors and
    market malfunctions as well as how to respond to them in real
    time. The use of kill switches, automated switches that would
    turn off trading at securities firms when their volume exceeded
    preset maximums, appears to be the first choice of many market
    participants. Our market infrastructure should be able to
    handle a trading error or technology failure in an appropriate
    way to minimize disruptions.
        I am interested in learning more about how effective kill
    switches can be and what their effectiveness is with regard to
    other safeguards.
        I also look forward to hearing from our witnesses about how
    the industry, working with the SEC, has made progress in
    implementing kill switches since the Technology Roundtable. In
    addition, I look forward to a discussion about the changing
    landscape of our securities markets and how different trading
    venues impact investor protection, market integrity, and
    capital formation.
        Our witnesses today provide a deep expertise on these and
    other issues, and I appreciate them being here and bringing us
    their expertise and their thoughtfulness in addressing these
    questions.
        Again, Mr. Chairman, I appreciate you, not only our working
    relationship but holding this hearing, and I look forward to
    working on this and other issues with you as we move forward.
        Chairman Reed. Thank you very much, and I also look forward
    to working with you, Senator Crapo.
        Senator Corker, do you have a statement?
        Senator Corker. No.
        Chairman Reed. Thank you very much, Senator Corker.
        Let me introduce our witnesses now and then ask them to
    present their testimony.
        Our first witness is Mr. Joe Mecane. Mr. Mecane is an
    executive vice president with NYSE Euronext and oversees
    strategy, business development, and operations for the
    company's U.S. equities platforms. Prior to joining the
    company, Mr. Mecane was managing director in the Equities
    Division of the UBS Investment Bank. Thank you, for joining us.
        Mr. Dan Mathisson is the head of Advanced Execution
    Services at Credit Suisse. AES is a full-service suite of
    algorithms, strategies, tools, and analytics for trading
    securities throughout the world. He is on the board of
    directors of BATS trading, the Credit Suisse Global Equities
    Operating Committee, and is a member of the New York Stock
    Exchange Electronic Traders Advisory Committee. Thank you, Mr.
    Mathisson.
        Mr. Eric Noll is executive vice president, Transaction
    Services, of the Nasdaq OMX Group, Inc., the world's largest
    exchange. Mr. Noll oversees the trading operations of all U.S.
    transaction services businesses. Mr. Noll joined Nasdaq OMX
    from Susquehanna International Group. Thank you very much, Mr.
    Noll.
        And our final witness is Mr. Robert Gasser. Mr. Gasser is
    chief executive officer and president of Investment Technology
    Group, Inc., ITG. Before joining this organization, Mr. Gasser
    was head of U.S. equity trading a JPMorgan. Thank you very
    much.
        Gentlemen, all of your testimony will be made part of the
    record. We ask you to summarize within the 5 minutes allocated
    to you, and we will begin with Mr. Mecane. Thank you, Mr.
    Mecane.

     STATEMENT OF JOSEPH MECANE, EXECUTIVE VICE PRESIDENT AND HEAD
                    OF U.S. EQUITIES, NYSE EURONEXT

        Mr. Mecane. Chairman Reed, Ranking Member Crapo, and
    Members of the Subcommittee, my name is Joe Mecane, and I am
    EVP and head of U.S. Equities at NYSE Euronext--a leading
    global operator of financial markets and provider of trading
    technologies.
        While the U.S. continues to have the most liquid markets in
    the world and remains at the forefront of innovative technology
    used to conduct electronic trading, the infrastructure used to
    operate the markets each day has grown so sophisticated that
    few fully appreciate how well our markets actually operate in a
    highly competitive and complex environment.
        This has made it difficult for market participants,
    regulators, and Congress to determine if the growth in the
    number of trading venues and use of automated trading is
    beneficial.
        However, in light of the market events that have occurred
    in recent years, I would like to focus on how technology and
    our market structure have created both unnecessary complexity
    and mistrust of markets; and, relatedly, what we believe the
    industry, regulators, and Congress should be doing to address
    it.
        Electronic trading has added tremendous benefits to the
    capital markets, including lower costs of trading, faster speed
    of execution, and in some cases greater transparency. However,
    there were several regulatory changes that drove the market to
    become more electronic. One significant factor was
    decimalization of the markets in 2001, which had an effect of
    decreasing average spreads by roughly 38 percent, directly
    benefiting end investors. The narrowing of spreads led to a
    huge expansion of electronic trading because human traders
    could no longer effectively make markets in this environment
    and because institutions and brokers began relying more on
    algorithmic trading to access the markets and reduce their
    costs of trading. This process started before Regulation NMS.
    In fact, almost all reductions in spreads occurred during the
    pre-Regulation NMS period.
        In 2007, just as the technology was becoming more
    sophisticated, the SEC adopted Regulation NMS through which
    exchanges began to compete by establishing the NBBO, and speed
    became the competitive differentiator based on one market's
    ability to set the national best bid or offer faster than a
    competing market.
        Regulation NMS also established the Order Protection Rule
    to protect visible orders and encourage displaying quotes, yet
    today over 3,000 securities have 40 percent of their volume
    occurring off-exchange. This level of off-exchange activity
    erodes the incentive for market makers to continue to trade the
    less active securities and threatens to further decrease the
    incentives for companies to go public.
        Today, there are 60 execution venues in the U.S. markets.
    Exchanges find themselves competing more directly with other
    venues that are able to employ different practices than
    exchanges with less oversight and disclosure. As a result of
    these advantages, broker-dealers continue to move more order
    flow into their own trading venues before routing to the public
    markets.
        As you can see, the technology and the rules that govern
    the U.S. equity markets have resulted in the creation of a
    trading infrastructure primarily focused on speed and
    complexity through which traders can identify and access
    liquidity. To accomplish this, exchanges, brokers, and vendors
    have had to build expensive networks with robust capacity, as
    well as learn how to interact in a very complex ecosystem.
        In response to this new flow of orders, exchanges have
    developed new order types and evolved their market structures.
    Regardless of the reason for the specific order type, most are
    premised on the goal of attracting liquidity to the public
    markets, and all must be reviewed by the SEC and published for
    public comment, something unique to national securities
    exchanges.
        The bottom line is that our market structure incentivizes
    these various levels of increased complexity. Our main message
    today is that if we want to reduce the complexity of technology
    and the related framework of our markets, we should simplify
    the overall market structure.
        NYX believes that the SEC is best suited to propose
    meaningful market structure changes, and regulators in other
    global markets, including Canada, Australia, and Europe, are
    already taking action. With congressional oversight, the SEC
    should continue with the holistic review it began in 2010 with
    the Concept Release on Equity Market Structure by proposing
    changes that will promote transparency, fairness, and long-term
    capital formation.
        We believe that changes to be considered should include a
    review of market maker obligations, the Sub-Penny Rule, the
    Order Protection Rule, tick sizes for illiquid securities, and
    addressing the conflicts and overlap between broker-dealers and
    exchanges, including the obligations and responsibilities of
    each when providing like services.
        The Consolidated Audit Trail, proposed by the SEC, also is
    a vital component to ensuring effective surveillance in a
    highly fragmented marketplace.
        NYX also believes that, in light of the existing complexity
    of the markets and the trading glitches that have occurred this
    year, all trading venues should ensure a robust set of policies
    and procedures around their systems development life cycle.
    Although testing may not be the most exciting part of the
    industry's initiatives, the hyper-competition that exists in
    the securities markets lends itself to excessive levels of
    change to remain competitive and compliant with new regulatory
    requirements.
        In closing, I want to reiterate our belief that although
    our capital markets are the best in the world, there remains
    room for improvement. Our recommendations for change have a
    simple premise: implement market structure changes that enhance
    transparency for investors and level the playing field for
    trading venues.
        Thank you for inviting me to testify, and I look forward to
    your questions.
        Chairman Reed. Thank you very much.
        Mr. Mathisson, please.

      STATEMENT OF DANIEL MATHISSON, HEAD OF U.S. EQUITY TRADING,
                      CREDIT SUISSE SECURITIES LLC

        Mr. Mathisson. Thank you, Chairman Reed, Ranking Member
    Crapo, and Members of the Subcommittee. My name is Dan
    Mathisson, and I am the head of U.S. Equity Trading for Credit
    Suisse. Credit Suisse's U.S. broker-dealer unit, formerly
    called First Boston, has been in operation in the U.S. since
    1932, and today Credit Suisse employs 9,200 people in the
    United States. We are one of the largest U.S. broker-dealers,
    having executed 12.4 percent of total volume in 2012, and we
    own and operate two alternative trading systems: Crossfinder,
    which has been the largest ATS in the U.S. since 2009, and
    Light Pool, a newer ATS that publicly displays bids and offers.
        I have been working in the equity markets for over 20
    years, and it is a privilege to have the opportunity to speak
    here today.
        Credit Suisse believes that the U.S. equity markets are
    better than they have ever been and remain the envy of the
    world. We recently published a broad survey of market quality
    where we found that the markets have improved in almost every
    measurable way. We believe that Regulation ATS, decimalization,
    and Regulation NMS were successful at making the U.S. markets
    more efficient, fair, and equitable. However, while they are
    good, the markets are not perfect, and we have seen several
    market disruptions that became big news stories in the past few
    years. But we believe that the SEC has moved aggressively and
    thoughtfully to fix these issues, and Credit Suisse fully
    supports the pending Limit Up/Limit Down rule, the consolidated
    audit trail, the market access rule, the tighter marketwide
    circuit breakers, and the creation of the SEC's new Office of
    Analytics and Research. We applaud the SEC for these actions
    and believe they will serve to significantly reduce the risks
    of disruptions in the future.
        In addition to those SEC actions, we have a further
    suggestion that we believe will decrease the likelihood of
    disruptions. We recommend that the SRO status of the exchanges
    be examined. The trading errors that occurred on the day of the
    Facebook IPO last May served to highlight a peculiar quirk of
    the U.S. market structure: that exchanges do not have material
    liability for their failures. As SROs, exchanges have long been
    considered by courts to be quasi-governmental entities and are
    therefore entitled to the common law doctrine of sovereign
    immunity, which protects Government entities from liability
    judgments.
        Yet exchanges today are clearly not governmental entities.
    They are for-profit private companies that are not particularly
    different from broker-dealers. While they still have a few
    vestigial regulatory functions, the majority of their
    regulatory responsibilities are typically outsourced to FINRA.
    We believe that exchanges should not have been allowed to
    retain their SRO status when they converted to for-profit
    entities 6 years ago. Businesses or individuals are inherently
    more cautious when they have the potential to be found liable
    for their actions. It is time for policy makers to correct this
    mistake.
        Our second suggestion is that it is time for the regulators
    to do a comprehensive review and overhaul of the market data
    revenue plans. The Consolidated Tape Association has a legal
    monopoly on providing a stream of real-time data from our
    Nation's stock markets. The CTA is the only source of this
    data, and it sells it at a high cost to the investing public.
    After all of its operational and administrative costs, the CTA
    makes a profit of approximately $400 million a year, which is
    then rebated to the exchanges based on a complex formula.
        Historically, the SEC has justified granting exchanges this
    exclusive right to sell market data as a form of user tax to
    fund the exchanges' regulatory expenses. However, based on what
    we can glean from earnings reports and SEC filings, the amounts
    earned by the exchanges today far exceed the regulatory
    expenses, and tape revenue acts as a major profit center for
    the exchanges. It appears that somewhere along the way market
    data revenue became a Government-granted windfall at the
    expense of the investing public. The current market data system
    was passed in November 1972. After 40 years, we believe it is
    time to give it a fresh look.
        In summary, removing immunity from exchanges would increase
    reliability over the long term and, therefore, reduce market
    disruptions, and overhauling the tape revenue system would
    reduce costs for the investing public.
        Thank you for the opportunity to appear here today, and I
    will be happy to answer any questions that you may have.
        Chairman Reed. Thank you very much, Mr. Mathisson.
        Mr. Noll, please.

      STATEMENT OF ERIC NOLL, EXECUTIVE VICE PRESIDENT AND HEAD,
                    NASDAQ OMX TRANSACTION SERVICES

        Mr. Noll. Good morning. Thank you, Chairman Reed and
    Ranking Member Crapo, for the opportunity to testify today on
    computerized trading. My name is Eric Noll. I am the executive
    vice president of Nasdaq Transaction Services for Nasdaq OMX.
        Computerized trading is a fact of life and the default
    method for billions of trades over the past several years--
    billions of trades that happen without any concern or problem
    in the market every day. While there are issues, computerized
    trading has a proven track record of delivering benefits for
    investors, equalizing the information advantage that was the
    staple of manual markets, lowering trading costs, and allowing
    the market to handle trade traffic that would freeze otherwise
    manual markets.
        In light of recent events, do not forget the unique role
    exchanges continue to play in the U.S. equity markets. All that
    your constituents associate with ``the market'' starts with an
    exchange. The iconic public companies--Apple, Google, eBay, and
    Amazon--must satisfy exchanges listing standards and
    regulations against corporate fraud and abuse. Only equity
    exchanges carry the important responsibility to support that
    growth and wealth creation from those companies.
        Exchanges have heavy responsibilities to create a safe
    market for investors, characterized by fair access,
    transparency, and efficiency. No other market participant is
    charged with or even permitted to undertake that burden. One
    need only look at the list of SRO responsibilities that
    registration triggers to understand why so few of our lightly
    regulated competitors voluntarily take that step.
        All of the buying and selling and active trading in the
    markets is not a grand game of speculators. It has real job
    creators and investors relying on the market's best information
    to make rational business and investing decisions. Price
    discovery, the best bid and offer, and visible liquidity are
    very important to public companies seeking activities like
    secondary offerings for expansion and to use their stock as a
    currency in the marketplace to achieve strategic goals like
    acquisitions.
        Exchanges are not in the business just to see trading for
    trading's sake. We are in the business to produce transparent
    quoting and trading that helps price discovery, helps add
    liquidity, tightens spreads, and benefits the continuous
    market, ultimately helping job creation and economic growth.
        U.S. markets are complex, fragmented, and interconnected.
    We are working tirelessly to ensure that markets are strong and
    fair, and that as the pace of trading accelerates, so too does
    the pace of regulation and investor protection.
        For example, after May 6th, the SEC and the exchanges
    worked quickly and cooperatively to devise new protections and
    reform rules for breaking trades, instituted single stock
    circuit breakers, and will implement updated marketwide circuit
    breakers and the Limit Up/Limit Down mechanism in the first
    quarter next year. Nasdaq also fully supports and is helping to
    lead and define the implementation of Peak Net Notional
    Exposure levels, or what is commonly known as ``kill
    switches.''
        On the issue of high-frequency trading, many vilify HFT as
    a business model. We urge caution against that sweeping
    criticism. It seems the tenor of the debate about HFT has
    become too broadly negative toward it as a business model.
    Academic evidence, like the British Beddington study, suggests
    that HFT trading tightens spreads and adds valuable liquidity--
    certainly positives for the market.
        It is not enough simply to vilify fast trading. Regulators
    and exchanges are working to identify and address specific bad
    actors and specific bad outcomes such as false, misleading, or
    deceptive practices.
        To improve our own regulatory program and the regulatory
    programs of exchanges around the world, in 2010 Nasdaq acquired
    The SMARTS Group, the leading provider of automated
    surveillance for post-trade high-speed trading.
        As you have heard, our markets are complex: 13 exchanges
    and 40-plus alternative venues. Each venue has its own systems
    and competes for orders. Each has its own order types and is
    continually developing new ones with input from investors.
        While some order types have come under scrutiny, let me be
    clear: Nasdaq OMX order types do not provide advantages to
    certain users allowing them to jump ahead in line at a given
    price level. We believe that order types should be designed to
    make our markets better, improve transparency, and improve
    price discovery. We go through a rigorous process to get our
    order types approved and to expose our innovative ideas to the
    market through the notice and comment period at the SEC, often
    allowing competitors to mimic our ideas and beat us to the
    market. That is part of our SRO burden. To help members
    understand our order types, we recently posted on our Web site
    a plain-language list and a description of Nasdaq's order
    types.
        We are passionate about the critical role we play in
    capital formation, and while it presents challenges to
    everyone, ultimately we believe technology is an important part
    of that solution. We appreciate the opportunity to testify. I
    look forward to your questions.
        Chairman Reed. Thank you very much, Mr. Noll.
        Mr. Gasser, please.

      STATEMENT OF ROBERT C. GASSER, CHIEF EXECUTIVE OFFICER AND
                             PRESIDENT, ITG

        Mr. Gasser. Chairman Reed, Ranking Member Crapo, and other
    Members of the Subcommittee, thank you for the opportunity to
    testify this morning on the topic of rules of the road for
    computerized trading venues. On behalf of a leading agency
    broker, my goal is to offer an unbiased, fact-based view on the
    current state of U.S. equity market structure.
        ITG is a New York Stock Exchange-listed company with 17
    offices across 10 countries and nearly 1,100 employees. As an
    agency broker, ITG provides trading services, technology,
    analytics, and research to a wide array of leading asset
    managers. Throughout our 25-year history, we have worked in
    partnership with major mutual funds, pension funds, and other
    institutional investors, innovating to improve trading and
    investment performance. In my testimony today I would like to
    offer a brief overview of current market structure, discuss
    some recent events which have impacted investor confidence, and
    look at some ways to restore this confidence. This morning we
    hope we can infuse some data and analysis into the debate.
        Competition amongst market centers and broker-dealers
    spawned by the passage of Regulation ATS in December 1998 has
    led to intense competition for liquidity and ultimately to
    fragmentation. This fragmentation has undoubtedly introduced
    complexity into our marketplace but has been a positive force
    in reducing execution costs.
        Technology has provided market participants, including
    retail investors and mutual funds, with the tools necessary to
    aggregate liquidity and derive the full benefit of free market
    competition for order flow.
        Global asset managers, as fiduciaries, have an obligation
    to achieve best execution. The global market standard requires
    all asset managers of size to measure the quality of their
    execution and its effect on the investment process. ITG is the
    world's largest provider of TCA, or transaction cost analysis.
    We measure millions of trades executed on behalf of hundreds of
    global asset managers. Our TCA data clearly demonstrates that
    institutional investors have benefited greatly from the
    evolution of U.S. market structure. Over the past 12 years,
    there has been a 70-percent decrease in average total equity
    trading costs in the U.S. As the data indicates, market
    structure is not broken. The current ecosystem of displayed and
    dark markets has resulted in significantly reduced costs that
    in almost all cases have been distributed back to investors.
    There is no evidence to suggest that competition and
    fragmentation have damaged price discovery or harmed capital
    formation.
        ITG is not a market maker, and we do not take on
    proprietary positions. In other words, we do not have ``skin in
    the game'' when it comes to the debates around broker
    internalization, as our system provides ``meaningful price
    improvement'' to buy-side investors as described in Regulation
    NMS.
        Based on our data, we would conclude that broker-dealer
    internalizers, or ``broker-dealer dark pools,'' as they are
    sometimes known, provide a useful permeable layer between the
    client and the displayed markets. Brokers have a fiduciary
    responsibility to their clients while exchanges do not, and
    these liquidity pools would not exist unless benefit was
    derived by the customer.
        Most recently, Australia and Canada have imposed
    regulations around internalization that will provide us with
    data sets to examine when considering the implications of
    potentially taking similar action here in the U.S. Early
    returns do not look promising in terms of the effects on
    liquidity and trading costs. Regressing to an oligopoly of
    exchanges is clearly not the answer.
        Unfortunately, the evidence also suggests that the
    investing public has become disenchanted with equities.
    According to the Investment Company Institute, over half a
    trillion dollars has been pulled from U.S. equity mutual funds
    since the start of 2008.
        Much of this can be attributed to the reduced risk appetite
    of baby boomers and the relative safety of bonds supported by
    easy monetary policy.
        The May 2010 Flash Crash, the Facebook IPO, and Knight
    Capital's trading debacle this past summer provide little
    comfort that U.S. equity markets are a safe place to trade or
    invest. Add in the suspicions that the investing public has
    about high-frequency trading and its perceived impact on the
    quality of markets, and you have a recipe for anecdote and
    conjecture overcoming facts and reason.
        In our opinion, we can focus on five tangible initiatives
    to accomplish restoring confidence:
        The SEC's Consolidated Audit Trail, if implemented properly
    and cost effectively, will give investors confidence that
    regulators can police bad actors and predatory strategies.
        The consistent application of the market wide circuit
    breakers and the Limit Up/Limit Down Plan to all market centers
    would likely prevent a market disruption of Flash Crash
    proportions.
        Costs should be borne by market participants who create
    excessive quote traffic without executing order flow.
        Market data should be distributed to all market
    participants equally.
        Marketwide risk should be monitored at a central
    clearinghouse that would have the ability to terminate a
    broker-dealer's connectivity to the national market system in
    the event of a rogue program released to the market.
        These five measures would give the investing public the
    protections they need to confidently invest in the world's
    strongest and most resilient market while still deriving all of
    the cost savings and liquidity benefits which have been
    achieved over the past decade.
        Last, as the regulations called for by the Dodd-Frank Act
    begin to take hold across other asset classes, the lessons we
    have learned in equities will be applied to those markets.
    Price discovery, central clearing, transaction cost analysis,
    and pre- and post-trade transparency will become as deeply
    integrated into foreign exchange and fixed-income markets as
    they are in equity markets. And innovation will come more
    quickly to those markets because of the lessons learned. For
    this reason, our equity market structure is all the more
    important to our broader financial system.
        Thank you again for the opportunity to share our views on
    these important questions. I would be happy to answer any
    questions at the appropriate time.
        Chairman Reed. Thank you very much, gentlemen, for your
    excellent testimony. One of the major driving forces of this
    discussion is technology, and one of the things about
    technology, it tends to make good things better and bad things
    worse. So when it comes to markets, there has been, I think,
    evidence showing a decrease in spreads and savings to
    investors, but I think our job is to applaud those good things,
    but also look very seriously about what the costs might be
    because of this new technology and new markets. And it raises a
    threshold question about--and you all alluded to it, but let me
    start with Mr. Gasser--the complexity of markets. I think the
    dark pools, internalization, in fact, I think every one of the
    exchanges--and correct me, Mr. Noll and Mr. Mecane--has their
    own dark pools. Is that accurate?
        Mr. Noll. We do not have----
        Chairman Reed. You do not have a dark pool? Do you?
        Mr. Mecane. We have a small investment in an ATS.
        Chairman Reed. But the trend is that the proliferation of
    dark pools, the internalization, and it goes to the issues
    which--your question about investor confidence, investor
    enthusiasm. Price discovery, is that--even if you are saving
    prices, in the dark pools is price discovery for the average
    investor being compromised or complicated? What about capital
    formation for new companies? A lot of this trading is being
    done in a very small range of stocks, not all the stocks that
    are listed. So can you talk, again, accepting the benefits,
    what are the costs, the complexity, and what things might we
    do--and I would like everyone to respond--to make it a little
    simpler and a little more easy to bear?
        Mr. Gasser. Thank you, Senator. I think as we think about
    complexity, as I alluded to earlier, I think we need to retain
    the benefits that we have derived from current market structure
    while making the markets less opaque to retail investors. There
    is no evidence to suggest that the market share of
    internalization or trades that are executed away from the
    exchanges is harming price discovery. There has been a lot of
    academic focus on that. So we tend to go back to transaction
    costs and how they affect the institutional investor, which is
    our core constituency.
        But, clearly, the complexity, it has given rise to this
    view that there is a certain opacity to our marketplace. I
    would say that, you know, the IPO market in the U.S. has
    actually been leading the globe in terms of capital formation.
    It is not a great number this year, but I would submit to you
    that it is a function of the economy, of Sarbox, of some of the
    things that have been certainly imposed on growth companies
    that make it difficult for them to think about the critical
    mass they need in terms of market capitalization, to really
    think about the public equity markets as opposed to a private
    equity market or a recapitalization somewhere else on their
    balance sheet.
        So at the end of the day, I think there is a lot of market
    forces, a lot of macroeconomic forces that come to bear as well
    on that equation. But I think in terms of speed and latency, we
    have gotten to a place now where it is a law of diminishing
    returns. Do we need to trade in micro seconds? I do not think
    so. That might be heretical for someone who has spent almost
    their entire professional career trying to improve markets
    through technology at delivery. But at this stage of the game,
    micro seconds are, I think, a vast overachievement, if you
    will, technologically in terms of the benefits that people
    derive from it, and it just creates more and more suspicion
    that the market is controlled by dark forces sitting in a data
    center and deploying more and more servers and software to
    attack a business motive.
        So I think at this stage of the game, there are some very
    clear things--consolidated audit trail, clearly. If folks have
    confidence that the SEC can enforce and regulate--and I think
    by their own admission it has been very difficult to do that
    given the complexity of the market--I think it will restore
    quite a bit of investor confidence. So I think the CAT, as it
    is commonly referred to, is very, very important.
        Chairman Reed. Let me ask Mr. Noll and the whole panel to
    respond to this question. Then I will ask Senator Crapo for his
    questions, and then we will do a second round.
        Mr. Noll, the same issue, the general issue of complexity,
    and also I think when you talk about the SEC, there are two
    issues: one is the authority and one is the resources. So we
    have to make sure that if they get authority, they also have
    resources, but that is an aside.
        Mr. Noll, please, your comments.
        Mr. Noll. Thank you, Chairman. A couple of comments around
    this.
        First of all, I do think the markets are incredibly
    complex. I disagree with Mr. Gasser, respectfully, that the
    increase in off-exchange trading is not harming price
    discovery. We have started to see some evidences of that. I
    want to be clear, though, however, in responding to that. We do
    think there is an important role for off-exchange trading. We
    think there is an important role for ATSs. We think there is an
    important role for dark trading.
        Our concern is really about the primacy of price discovery
    and price formation. And to the extent that those are being
    negatively impacted by current market structure, we think that
    those issues should be revisited as we move forward.
        Other issues, you know, clearly to address more directly
    your question about the SEC, I do believe that they have the
    regulatory authority here. I do think that they are incredibly
    interested in this topic, concerned, and working very hard to
    address some of these issues. Some of the steps that we have
    taken as an industry, like the adoption of CAT, will give them
    some of the tools that they need in order to correctly assess
    what is going on in the marketplace as we move forward.
        Clearly, they are also deeply embedded in some of the other
    issues that we are debating and rolling out and implementing.
    Circuit breakers were the first of many. They are intimately
    involved with the Limit Up/Limit Down scenario currently being
    worked on by the industry as we roll that forward, and we have
    to address Senator Crapo's earlier comment. The exchanges,
    working with the industry, are working with the SEC to adopt a
    format of kill switches that will prevent runaway algorithms
    from damaging the marketplace.
        So I do think that they certainly have the regulatory
    authority, they certainly have the commitment to be involved in
    this space. And to finalize my answer here, I think one of the
    important things to look at is complexity in and of itself is
    not a bad thing. Technology in and of itself is not a bad
    thing. What we should be doing around market structure is
    making sure that we can recover from incidents and that we do
    not create scenarios whereby incidents are much more likely to
    happen.
        And so much of the efforts that we are working on at Nasdaq
    and with the industry and our fellow exchanges are designed
    really to either recover from incidents or prevent new
    incidents from occurring. But the competition around the
    development and innovation around new market structure, new
    developments in the marketplace, is important. I think it adds
    value, and I think it brings real benefits to investors.
        Chairman Reed. Thank you.
        Mr. Mathisson, please, and then Mr. Mecane.
        Mr. Mathisson. Thank you. Mr. Noll just commented on the
    move to off-exchange trading, and I would actually dispute the
    data that there has been a move to off-exchange trading. In
    October of 2012, 33 percent of the volume was traded on what is
    called the TRF, the Trade Reporting Facility, which is the
    trading that is done off-exchanges. If you go back 5 years to
    October of 2007, 30 percent of the volume was traded on the TRF
    or off-exchange. We have seen a fluctuation between 25 and 35
    percent of the volume done off-exchange every month for the
    last 5 years, with no exceptions. There is no trend if you look
    at the long term of flow actually moving off the exchange. You
    have to get pretty creative in how you cut the data to come up
    with a trend that the flow actually is moving off. So, you
    know, I think that there has not been an increase in off-
    exchange trading. That is important to acknowledge.
        Now, I concur with Mr. Gasser that we do not want to lose
    the benefits of competition, and we have seen many of them, as
    every panelist acknowledged in their testimony. At Credit
    Suisse, we are not in favor of setting any type of a speed
    limit or doing anything drastic. We would not be in favor of
    setting a 55-mile-per-hour speed limit across the board. We
    think the solution is to put proper safety mechanisms in place,
    to put seat belts and air bags in the cars, but not necessarily
    to say that people are not allowed to drive at the speed that
    they want to drive.
        We believe that some of the things that the SEC has already
    done--the Limit Up/Limit Down rule, marketwide circuit
    breakers, market access rules, and the discussion of kill
    switches--are the right solutions and do put the right safety
    mechanisms in place to allow the markets to continue to enjoy
    the benefits of competition.
        Chairman Reed. Thank you.
        Mr. Mecane, please, and then I will recognize Senator
    Crapo.
        Mr. Mecane. Thank you. While I think we would all agree on
    this panel that markets for the most part have improved
    significantly, we are concerned about the direction of some of
    the evolution of our markets. And I think it is also important
    to acknowledge that while we have had a lot of practices evolve
    over the period that markets have improved, not all the
    practices that existed necessarily contributed positively to
    some of the changes that we have had in the marketplace.
        And, while we are supportive of competition, some of the
    evolution that has happened has been a little bit unintended,
    and the two things that we have highlighted in a lot of our
    testimony and statements is around ensuring that from a public
    policy standpoint we have the right incentives in place for
    people to display orders publicly in the public markets, and
    ensuring that we have similar levels of rules and oversight for
    activities that occur on different venues.
        You know, I would respectfully disagree with some of Mr.
    Mathisson's statements about the level of off-exchange trading,
    and it gets into a little bit of micro structure complexity
    around the ECNs that did publicly quote back in the early
    periods, and we are happy to address that offline. But, I think
    what it highlights is our markets have become extremely
    complex. I think the SEC and the industry have done a good job
    of responding to some of the crises that we have seen over the
    last few years, but clearly there is more that can be done.
        One of the things that we would encourage is because the
    markets are so complex and because when you do try to address
    one issue in isolation, it raises a host of other questions and
    issues. We have suggested that a holistic review of market
    structure, as the SEC had intended back in 2010 with the
    Concept Release on Equity Market Structure, is probably the
    best way to try and address all the issues that are being
    raised on this panel because it is difficult to address any of
    these issues in isolation.
        We would also suggest that perhaps one area that is
    discussed but not fully addressed yet is having testing
    standards in the industry. I think we need to be careful not to
    be too heavy-handed with that type of approach. But certainly
    having some best practices, some requirement for firms, trading
    firms, trading venues to have policies and procedures that
    address their testing standards, how they roll out new code,
    and setting that as a standard in the industry could certainly
    be very helpful. And as Mr. Noll highlighted, all of the
    Members of this Committee are involved in the industry
    discussions around potential kill switches that Senator Crapo
    mentioned before and working with the SEC about ways to
    potentially implement safeguards along those lines.
        Chairman Reed. Thank you very much.
        Senator Crapo.
        Senator Crapo. Thank you, Mr. Chairman.
        Let me follow up on the kill switch question. I guess I
    will start with you, Mr. Mecane. What progress is being made
    right now in implementing the idea of the kill switches since
    the SEC Roundtable?
        Mr. Mecane. Sure. It is a good question, and there is a
    very active dialog around the kill switch concept. As you know,
    all the SROs and a number of industry firms, including the
    firms on this panel, were involved in discussions leading up to
    the roundtable about a possible framework for a kill switch.
    And subsequent to the roundtable, we have all engaged in a much
    more detailed assessment of how a kill switch could work. We
    have been working with DTCC, and, you know, as they say, the
    devil is in the details. It gets very complex once you start
    designing it and outlining it, and I believe we are getting
    close to a possible framework as we iterate through the
    different possible ways to implement something like that in the
    industry, you know, what parts should be mandatory, what parts
    should be optional, whether it should be at the clearing level,
    whether it should be at the SRO level. All these types of
    issues are under discussion, but I think we are hopeful to have
    something to report in the first quarter next year.
        Senator Crapo. Thank you.
        Let me turn to you, Mr. Gasser. You indicated that you felt
    it would be very helpful for a central clearinghouse to monitor
    market risk. Could you explain that a little better?
        Mr. Gasser. Yes, Senator. You know, all of us have a
    substantial amount of capital committed to the business of
    clearing client trades, and they are held within the national
    clearinghouse, and there is a central clearing facility here in
    the U.S. which is actually very effective and much different in
    terms of global market structure. So it is very efficient, very
    effective. We have quite a bit of capital on deposit to support
    all of our trading activities there.
        One issue, I think, that is a relatively scary one for the
    industry is that Knight gave us some interesting lessons in
    terms of a potential for a firm to blow through their capital
    and for an unprecedented call on other firms' capital at one
    stage or another to fill the gap. So that event I think had
    some interesting implications for not only the national market
    system, but for individual broker-dealers and their
    participation within the central clearinghouse.
        So when I alluded to that--and I know that Joe and Eric and
    others, and Dan and our firms, have been involved in this
    dialog. One of the things I think folks keep coming back to is
    that notional limitation that we should all be held accountable
    to. When you blow through that, then you are now at a place
    where you may substantially affect other firms and their
    capital on deposit.
        Senator Crapo. Well, thank you.
        Mr. Noll, I will ask you this question--well, actually, I
    think Mr. Mecane and Mr. Noll both in their testimony indicated
    that you support a pilot program for an increased tick for the
    smaller capitalized companies, so I suppose the question would
    be for Mr. Gasser or Mr. Mathisson. Do you agree with that
    approach as well?
        Mr. Mathisson. We would support a pilot program to test it
    out. We think it would be a significant change to the market
    structure, and as such, it should be done cautiously. But we
    would definitely support a pilot program if explicit metrics
    and goals were set out ahead of time to define success.
        Senator Crapo. Thank you.
        Mr. Gasser.
        Mr. Gasser. We would also support that, Senator, and think
    that from the perspective of capital formation it has
    potentially positive or could have positive effects.
        Senator Crapo. Thank you. And I guess this question is to
    everyone but Mr. Mathisson since I am going to ask about his
    recommendation that the immunity of SROs be addressed in this
    system. Do you all agree with Mr. Mathisson's recommendation?
    Mr. Mecane.
        Mr. Mecane. Sure. The concept of being an SRO is founded on
    or historically based on the idea of having obligations to the
    market and getting certain benefits for meeting that
    obligation. Some of the obligations include the rule-filing
    process, the oversight that we have, the regulatory obligations
    that we have, and some of the benefits that we accrue are
    economic in nature. And we would encourage a review--which,
    again, I think falls into the SEC's holistic review of market
    structure--of the benefits and obligations of an SRO and what
    an SRO means.
        I think it is important to note that SROs by their nature
    do not have blanket immunity. SROs have immunity when
    performing certain of their regulatory functions. And beyond
    that--and most of those regulatory functions are around our
    function as a listing market. And when you expand beyond our
    regulatory responsibilities, we have immunity that is set
    contractually with our members.
        We would encourage, again, a holistic review of all the
    costs and benefits of being an SRO. Most of the items Mr.
    Mathisson raised are focused on reducing the economics for
    exchanges and transferring a lot of that benefit back to the
    investment banks. Again, I think that should be part of the
    holistic review that would potentially be done.
        Senator Crapo. Mr. Noll.
        Mr. Noll. Not unsurprisingly, I disagree with Mr. Mathisson
    on this. You know, I do think that there are several things
    about the exchange SRO model that are important to recognize as
    we talk about our immunities and our limitational liabilities,
    not the least of which is our obligation to provide fair access
    to all investors under all circumstances. So exchanges by their
    very definition exist to perform the price discovery function
    by gathering trading interest from all participants who want to
    participate and conduct that activity in a fair, transparent,
    accessible manner for all market participants.
        Under current market models, no other market participant
    has those same obligations, and that also performs what I think
    is a very critical role in the marketplace of establishing
    price discovery, providing liquidity, and providing information
    to not only investors and traders but issuing companies about
    how capital should be formed, how it should be allocated, and
    the risks in the marketplace. And I think because of the value
    of that function in the marketplace, the immunities are well
    established and should be enforced.
        Senator Crapo. Mr. Gasser.
        Mr. Gasser. Yes, I would agree with the examination as part
    of a holistic examination of U.S. market structure. We were
    actually, I think, very close to that--obviously, this issue
    was not on the table. It was pre-Facebook, back in 2010. But we
    were very close to what I thought was the end of a long comment
    process, industry engagement, exchange engagement, and that was
    obviously a pushback as a result of the Flash Crash. I think
    bringing that back on board and engaging the same way with the
    Commission amongst all market participants I think would be a
    good thing.
        In terms of immunity, I mean, I think we are all--as a
    broker, as an agency broker, I think we are all feeling the
    same thing. I do not want to speak for all brokers, but we are
    all feeling the same thing. There has got to be consequence for
    a system-wide failure of the type that we have experienced in
    the Facebook circumstance. Our clients suffered. Other broker-
    dealers suffered. Clearly, there were some decisions made that
    were, with all due respect, the wrong ones in terms of opening
    that stock. That is a very, very sharp contrast to the BATS
    failed IPO where actually they walked away when they realized
    that the software was not performing properly.
        That does not mean that electronic markets cannot open
    IPOs. I mean, they have done so successfully. Archipelago,
    which Joe's firm acquired many years ago, did basically an
    electronic auction and was very successful.
        So the devil is in the details in terms of the technology
    that we all operate today and its effect on the outcome, but if
    the outcome is significantly negative and folks are harmed,
    there has got to be some consequence felt. We certainly would
    feel that consequence if we had a failure within our system and
    it was attributed to our technology and acting as a fiduciary
    on behalf of a client.
        Senator Crapo. Thank you.
        Chairman Reed. Thank you, Senator Crapo.
        Senator Hagan, please.
        Senator Hagan. Thank you, Mr. Chairman, and thank you for
    holding this hearing. I think it is very interesting and
    timely.
        I just wanted to ask a couple of questions, one having to
    do with the dark pools. Mr. Mathisson, this question is, first
    of all, for this part directed to you. I have got definitions
    of dark pools, but I would like to have you give me your
    definition of a dark pool.
        Mr. Mathisson. Sure. A dark pool is a trading system that
    is organized under Regulation ATS that does not show bids or
    offers. So it is a computerized trading system where people
    enter a bid or an offer, say a buy of 100,000 shares of IBM,
    that would not be displayed publicly. It just sits within the
    computer. If somebody happens to come in with a sell order of
    100,000 IBM, then the two cross. But the difference between a
    dark pool and a displayed ATS or a displayed order on an
    exchange is that the displayed order gets shown to the world,
    so everybody sees there is a 100,000-share bid for IBM. In the
    dark pool, it just sits in the hope that somebody might bump
    into it.
        Senator Hagan. How much of the trading is done on dark
    pools now, percent-wise?
        Mr. Mathisson. The best numbers out there are considered to
    be Rosenblatt survey numbers, and Rosenblatt puts it at about
    14.5 percent of volume.
        Senator Hagan. And has that been growing since they have
    been introduced after 1998, or however long?
        Mr. Mathisson. That is right. It was probably----
        Senator Hagan. Has it been growing in the last----
        Mr. Mathisson. It has been growing, yes. It has picked up a
    lot of volume at the expense of the TRF, the Trade Reporting
    Facility. Broker internalization is down from about 26 percent
    to 15 percent, and that 11 percent of the market moved to dark
    pools. So we have seen broker internalization go down. We have
    seen dark pool volume go up from approximately 4 percent 5
    years ago to 14 percent today.
        Senator Hagan. And what is typically the average trade in a
    dark pool?
        Mr. Mathisson. The average trade sizes are small. I mean,
    they vary for different pools. Some pools are specifically
    aimed at crossing blocks. Mr. Gasser runs a pool that has a
    fairly high average crossing size. Some pools are as low as 200
    shares, their average crossing size, which is comparable to
    exchange average size crosses.
        Senator Hagan. OK. Thank you.
        Mr. Gasser, ITG has observed in the past that the traders
    in these dark pools will often experience adverse selection,
    and a trader will see a stock move in his or her favor
    immediately after he or she executes a block trade in a dark
    pool. The question is: Can you discuss why the adverse
    selection is occurring in dark pools? And how does the lack of
    transparency in these venues contribute to adverse selection?
        Mr. Gasser. Yes, Senator. Actually, ``dark'' is probably an
    unfortunate, nefarious term.
        Senator Hagan. I agree with that.
        Mr. Gasser. But I----
        Senator Hagan. Why do we call it ``dark''?
        Mr. Gasser. Because these are orders and executions that
    are not exposed to the lit market, so basically a quote that
    you can find on the screen. So I think that was basically the
    origin of ``dark.''
        ITG has been operating a dark pool for 25 years, and that
    is POSIT. POSIT is the granddaddy of dark pools, if you will.
    It is a system that brings together institutional investors,
    allows them to interact with one another directly and
    anonymously, so they do not know size, they do not know who
    their counterparty is, and we improve price. So, in other
    words, we trade at the midpoint, and then we report--and this
    is very important. We report that trade immediately to the TRF.
    So there is complete transparency in terms of the trade having
    been done and now reported to the tape.
        As Dan alluded to, our average execution size in our block
    trading system is 29,000 shares, so it is significantly in
    excess of the average size cross, and this is because it is an
    institutional constituency.
        I think over time what has happened over that 25-year
    period that brings us to today is that internalization pools
    have become more multiconstituent, if you will; in other words,
    folks are not only crossing institutional flow, they are
    crossing retail flow. They are acting as market maker. There is
    high-frequency folks or, you know, strategies that are sitting
    within those pools and interacting, and they look much more
    like exchanges. So I think that has been a very steady
    evolution over time.
        To get to your point about adverse selection, one of the
    things that we find is that, given the opportunity for
    institutions to interact with one another directly, that is the
    highest--and I think Dan would acknowledge that as well. That
    is the highest-quality execution that one can achieve.
        Now, one order may be larger than the other. That is
    unavoidable in terms of negative selection. In other words, if
    you are a buyer and the seller is ten times your size,
    ultimately the price is going to go down if you extinguish that
    order. But that is what I would describe as organic to the
    environment we operate in.
        What is much more difficult to control is that once you are
    forced into the lit market and you are forced into other
    trading venues, you now have less control over who you are
    interacting with. And so adverse selection can come from dark
    pools. It can come from lit pools. It can come from a variety
    of different places. And there are predatory strategies that we
    find every day, folks that are trying to, you know, basically
    probe liquidity pools and find the size of your order, the
    limit of your order, and are trying to trade against that
    order.
        Senator Hagan. Do you think that occurs in transparent
    pools versus the dark pools? Where is it most likely to occur?
        Mr. Gasser. I think they are interchangeable. I think they
    come in and out of those markets, you know, looking for--you
    know, it is----
        Senator Hagan. Do the rest of you all agree with that?
        Mr. Noll. I have a slightly different view of that. I
    think, you know, Mr. Gasser said something I thought was
    illustrative, which he said dark pools look a lot like
    exchanges, except I would make some real distinctions around
    that. You know, one is they do not have to display prices that
    are accessible by outside investors. They are not required to
    take all investors on an equal and fair basis. The rules are
    not public. Their order types are not filed for a public notice
    and comment. So there are some significant differences, and I
    think that is where our concerns as exchange operators come in,
    which is to avoid the negative externalities of off-exchange or
    dark trading, which I will reiterate has real value for
    investors, and POSIT is one of the real benefits for
    institutional investors in the marketplace. It does what it is
    intended to do, which is allow buy-side investors to find
    liquidity in an efficient, information-less way.
        But I do think that our concerns are really about
    asymmetrical information leakage, fair access, and
    nondiscriminatory activities.
        Mr. Gasser. Just for clarity, when I said some dark pools
    look like exchanges, I was actually alluding to the average
    execution size, so other dark pools that are outside the POSIT
    system.
        Senator Hagan. Mr. Noll, let me ask you a question having
    to do with the minimum price variation. In the U.S., the MPV
    for all stocks of a dollar is one penny, and in Europe, their
    minimum price variations are less uniform. How do MPVs impact
    high-speed trading? And particularly I am looking at like a
    stock--at Google at $670 a share versus B of A at $9.50 a
    share.
        Mr. Noll. I think one of the things that we have noticed in
    the marketplace is that actively traded securities, not
    necessarily limited to stock price, so that certainly is a
    factor to consider here, but actively traded securities trade
    extraordinarily well in our national market system today. There
    is price discovery, there is liquidity, there is activity.
        I think where we become very concerned is outside of those
    actively traded names, and European markets, as you alluded to,
    Senator, use what they call an ``intelligent tick size regime''
    to determine what the appropriate tick size is based on a
    variety of characteristics for the underlying security, a lot
    of which have to do with liquidity in addition to price amount,
    available float, size of the bid-offer spread. And so where we
    are interested in looking at this as a pilot--and I agree with
    the rest of the panel here that a pilot is a good thing for us
    to do here, particularly if set up well--is to uncover ways in
    which we can get better liquidity in less actively traded names
    and smaller cap securities. And I think minimum price variation
    will help us do that. I think a pilot will help us address that
    as we go forward.
        Senator Hagan. Thank you.
        Thank you, Mr. Chairman.
        Chairman Reed. Well, thank you very much, Senator Hagan,
    for your excellent questions.
        Let me just begin another round, and if Senator Crapo
    returns, obviously, I would invite him to join, too.
        I think we all recognize that the interrelationships of
    these different issues are such that requires across-the-board,
    marketwide approach, holistic in Mr. Mecane's terms, but I
    think we also have to look at some sort of specific issues and,
    therefore, we have been talking about dark pools and ATSs, et
    cetera.
        Just with respect to stepping back, the national market
    system, my sense, the motivating force was to make sure that
    orders sent to the trading platform were the best price,
    regardless of where the orders originate. And with these dark
    pools in particular, that does not seem to be the case. Is that
    a fair--since to be a member of a dark pool, that is not
    something that is--anyone can do or--let me use that as a
    prelude to ask Mr. Gasser to comment and others to comment.
        Mr. Gasser. I keep coming back to the notion of a broker
    being a fiduciary on behalf of the client order. So we have
    very, very--the U.S. has very prescriptive regulations about
    how we report our execution quality, how we relate that back to
    customers. Obviously transaction cost analysis is core to what
    we do as a firm. So, you know, the highest priority is not to
    internalize order flow within POSIT for us. It is to find the
    best price. So that could exist in the lit market, other dark
    markets, or our system.
        Now, fortunately for us, I think we can demonstrate a long
    history of very, very substantial cost savings, trading cost
    savings within our dark pool. But that is part of an ecosystem
    that we are forced to aggregate with technology every day, and
    we do not aggregate it based on being able to internalize it.
    We aggregate it based on the ability to find the best price,
    and we know that we are all--as brokers, we are going to be
    measured by the customer at the end of the day, and the
    customer votes typically with their feet in terms of quality of
    execution.
        Chairman Reed. Mr. Mecane, do you have a comment. Then Mr.
    Mathisson, because this is----
        Mr. Mecane. Sure. Just to your question, Senator, I think
    it is a slightly different issue, at least from our
    perspective. As far as I know, most executions, dark pools,
    wherever, do happen at what the best price is in the public
    markets. From our standpoint, there is a slightly different
    issue that we think should get addressed, which is whether the
    person who is setting that best price in the public markets is
    properly incentivized, meaning the person who is creating that
    best bid or offer price very frequently, roughly one-third of
    the time, will see trading happening at the price that he is
    displaying. And while the executions that are happening away
    from the public market are at that best price, the concern that
    we have from a broader public policy standpoint is whether
    there is diminished incentive for people to display their
    orders publicly if a significant amount of activity happens in
    front of their displayed price. And so when we have talked
    about incentives for people to display liquidity, whether the
    right balance is in place to ensure that the person who sets
    the best price, and Regulation NMS in its main mission set out
    properly incentivizing the public display of orders as its
    objective, we would just highlight that we should probably step
    back and review whether we think the balance that has evolved
    is the right one.
        Chairman Reed. Mr. Mathisson? And then I have another
    question. I will change the topic slightly.
        Mr. Mathisson. Yes, when traders decide whether to put out
    a bid order on an exchange or on a displayed ATS or put one
    into the dark, on a dark pool, they are making a tradeoff
    decision. If you show it publicly, then you get what is called
    NMS protection, meaning that nobody can trade through your
    price. So, in other words, if I show a bid at 27.50 into the
    national market and I choose to display it, then a trade cannot
    occur at 27.49 or lower anywhere. It cannot occur in a dark
    pool, it cannot occur anywhere. So I have what is called
    protection. Now, that is the plus side.
        The negative side of doing it is that I show this bid which
    might scare the price up, and that is a tradeoff that traders
    decide to make, and they are constantly weighing whether it is
    better to display it and get protection and potentially attract
    a seller or whether it is better to put it in a dark pool, take
    on a lower fill rate, but have less chance of scaring the
    price. And that is essentially what trading is. It is a
    tradeoff between what we call signaling risk and fill rate. And
    that is what trading algorithms do. That is what people,
    traders, are deciding. And so the system allows traders to make
    that choice.
        Now, Regulation NMS does ban the trade outside of the trade
    price. Once you put that price up, trading cannot occur in a
    dark pool at a different price, and the dark pool trades are
    reported to the tape immediately, so the whole world does know
    about them after the fact, and they do occur at or within the
    national best bid or offer.
        Chairman Reed. Thank you. This testimony and the questions
    have been very thought-provoking, so you can anticipate
    additional questions in writing, in fact, some detailed
    questions, and I know you will respond.
        Let me change, again, quickly from my last set of
    questions, and then I will recognize Senator Crapo again.
        We do understand this is a systemic approach--we should
    take a systemic approach, but issues crop up. One of them is
    the order type issue, which is getting a lot of attention. The
    proliferation of order types adds to the complexity, raises
    lots of questions, and it goes back to sort of the public
    perception of markets, too. Are these orders being written to
    induce people to come into your market to give them tailored,
    bespoke approaches to the market which other particularly
    retail investors do not have? Are there too many of these?
    Should there be a standard set of order types that every market
    alternative as well as exchanges follow? And this general
    question of order types I think is important, at least to
    broach at this point. So let me start quickly--and, again,
    because I want to recognize as briefly as possible Mr. Mecane
    and then we will go down the panel.
        Mr. Mecane. Sure. It is a good question, very topical. I
    think there are two main points that I would draw out. One is
    that it is important to recognize why a lot of these order
    types have evolved. Some of them are to comply with Regulation
    NMS; some of them are to guarantee economic results; some of
    them are to compete with some of the practices, customer
    segmentation, et cetera, that happens off-exchange. So I will
    go back to one of my earlier points, that the order type
    evolution is largely because the market structure that we have
    creates the need or the demand for different order types to
    replicate certain behaviors, some of which used to happen
    nonelectronically. But, again, my first point is if we want to
    review the order type issue or simplify the markets, we should
    simplify the market structure that they operate in, and there
    will be less need for these order types.
        The second point I would just make is that it is important
    to recognize that all exchange order types are publicly filed,
    reviewed by the SEC, put out for public comment, disclosed, and
    can be utilized by any member of an exchange. Now, if there are
    any order types that are not adequately disclosed or not
    described accurately in the filings, that I think is a separate
    issue that needs to be addressed. But at least in terms of the
    intent of the process, all the rule filings should describe
    order types and order type behaviors, which, again, is
    something that is very distinct from how nonexchanges operate.
        Dan's and Bob's firms have algorithms. There are probably
    more algorithms for institutional customers in the industry
    than there are order types for broker-dealers to use. So I
    think it is just the evolution of our complex market structure.
        Chairman Reed. Mr. Mathisson, just for clarification, is
    there a requirement for ATS to submit order types or algorithms
    for review?
        Mr. Mathisson. No. I mean, they do get filed in what is
    known as a Form ATS, but it is not reviewed and subject to
    approval. You just tell the SEC what you are doing. So that is
    correct.
        Chairman Reed. All right. The order type issue.
        Mr. Mathisson. I agree with Mr. Mecane that complex
    orders--that the line between algorithms that broker-dealers do
    and the line between complex order types that exchanges offer
    is blurry, and there are a lot of similarities between the two.
    But I think that the broker-dealer is the right place to have
    that complexity, and the reason is because the broker-dealer is
    a fiduciary to the client. The broker-dealer has an error
    account, and the broker-dealer has liability. And complex order
    types are more likely to fail than simple matches. I would be
    in support of a market system where ATSs and exchanges only
    offer very simple order types, just buy-and-sell matches,
    market on close, market on open, just the traditional, most
    simple order types, and put that complexity within a structure
    where there is an error account, there is a fiduciary
    responsibility, and there is liability if things go wrong. The
    more complicated an order type gets and the more complicated an
    algorithm gets, the more likely it is to fail, and so the
    question becomes who eats the error when that fails. With an
    exchange, the answer is--you know, the exchange does not eat
    the error. The error gets borne by the broker-dealer who used
    the order type.
        Now, finally, the order types, while they are reviewed--all
    the exchange order types are reviewed by the SEC. The Wall
    Street Journal put out a piece that said every single order
    type that has ever been submitted by the exchange has been
    approved. There has never been one that has been rejected. You
    know, so I would question how thorough and meaningful a review
    that actually is.
        Chairman Reed. Thank you.
        Mr. Noll? And then again, to allow Senator Crapo, your
    brief comments.
        Mr. Noll. Well, factually what Mr. Mathisson says about
    order types, from my own experience around the SEC review of
    order types and order type introduction, we have withdrawn many
    more order types at the suggestion of the SEC than we have had
    approved. So while the public notice and comment period does,
    in fact, exist and so I do think historically order types have
    been improved, many, many order types, many variations on order
    types have, in fact, been asked--we have been asked by the SEC
    to withdraw them for a variety of reasons, having to do with
    their view of what is the appropriate market structure. So they
    do not go unreviewed I guess is the point I would try to make.
        I agree with Mr. Mecane on most of what he said. I think
    order types have evolved in various ways, some due to
    regulatory reasons, Regulation NMS being the primary one; but
    also because in an electronic market--and make no mistake about
    it, our markets are electronic today--order types fill the
    function and allow the function of what used to be done
    manually to be done electronically and with technology. And
    order types are a tool to do that. And I think it is important
    to recognize that they need to be applied fairly, they need to
    be made available to everyone, and they have to be used so that
    they are not favoring one type of party over another in an
    unfair way. And I think we have strived to achieve that, and I
    think for the most part we have been successful with that.
        Chairman Reed. Mr. Gasser, your comment, quickly.
        Mr. Gasser. Senator, you heard in your first hearing, I
    think there is a significant cross-section of the institutional
    investor community that has become frustrated with the
    permutation of these order types. At the end of the day, I
    think our view is--as Dan alluded to, as a fiduciary, it is our
    job to make sure that their orders are properly represented and
    that we are taking advantage of all the technology available to
    use, and it is all in the public domain. So I think it is--from
    the perspective of preventing competition and further
    innovation, I would be hesitant to say that we need to prevent
    further innovation there on that front.
        Chairman Reed. Thank you very much.
        Senator Crapo.
        Senator Crapo. Thank you, Mr. Chairman. I just had one
    final issue to get into.
        Mr. Mathisson, in your written testimony, you indicate that
    so-called quote flickering has increased with decimalization.
    And, similarly, Mr. Gasser, you indicated in your testimony
    that you recommend that market participants who create
    excessive quote traffic without executing order flow should
    bear the costs of this activity.
        How does quote flickering work? And what is its impact to
    the system? Mr. Mathisson first.
        Mr. Mathisson. Well, quote flickering is when somebody
    shows a bid or an offer for a very short amount of time and
    then keeps changing it repeatedly. Now, the cost of it on the
    system--I mean, the reason it is done is it would be typically
    done by high-frequency trading systems that are just making
    decisions very rapidly and they are deciding they want to buy
    something and the price of something else moves and they
    decide, you know, a thousandth of a second later to pull the
    bid or the offer. And so the result is that they can get quote
    flickering. It is empirical fact that quote flickering has
    increased. The number of quotes per day is up dramatically
    versus what it was about 5 years ago, and it is up, you know,
    something like 100 times from what it was 10 years ago.
        Now, the cost of quote flickering is primarily in
    technology infrastructure. When you have a lot of quoting going
    on, people need to build networks and computer systems that are
    capable of digesting hundreds of millions of quotes a day. And
    so it is an expense, essentially, on everybody. All trading
    systems by broker-dealers and typically by mutual funds and
    pension funds and other investors read all these quotes and
    respond to them, and so they all have to spend a great deal
    more money on technology than they otherwise would.
        Senator Crapo. Thank you.
        Mr. Gasser.
        Mr. Gasser. Yes, in 2010, we gave a speech to an industry
    trade group and recommended, you know, some type of tax on what
    is--you know, there is no benefit to the broader national
    market system of having folks come in and basically flicker on
    the bid or the offer, as Dan alluded to. We spend a tremendous
    amount of money on infrastructure to support that, as I said,
    with no discernible benefit to investors or anyone else in the
    ecosystem.
        While equity volumes have steadily declined, the duress or
    the stress that it places on our infrastructure has increased
    logarithmically, so we are getting less liquidity, less volume,
    and we are being forced to support this activity in terms of
    our own investments in our business.
        Senator Crapo. Thank you.
        Mr. Noll and Mr. Mecane, do you want to comment.
        Mr. Noll. Sure. I agree that quote stability is an
    important goal for exchanges and for the marketplace. You know,
    we at Nasdaq have tried to take some steps on our own to bring
    more quote stability to the marketplace. So, you know, the
    first thing we have done is introduce an order type called the
    minimum life order type that creates economic incentives to
    have an extended quote as opposed to a short quote. We have
    also introduced and I believe we are the only exchange today
    that has an excessive messaging fee for rapid quote changes
    without trades and without taking on discernible obligations in
    the marketplace.
        And then, last, we introduced a new market model called
    PSX, which is a price six exchange, which was designed really
    to get away from being at the top of the book because you were
    there first in terms of your quote ability, but being there in
    size as the incentive for the market participants. I wish I
    could say that that has had more success in the marketplace in
    developing as a real alternative to some of the other market
    models. That has yet to do that. But I do think that there is
    room for innovation here. I do think achieving quote stability
    is an important goal in the marketplace. I think it makes the
    markets better for everyone.
        Senator Crapo. Thank you.
        Mr. Mecane.
        Mr. Mecane. I would just add two quick points. I think we
    would all agree that message traffic in general is a high cost
    for the industry and for all of us. The two points I would
    make, the first is just a recognition, again, that some of that
    message traffic or a lot of that message traffic arises not
    only because of Regulation NMS but because there are 50 venues
    out there for people to trade on. So in a lot of cases, traders
    will put their quotes in a subset of that many venues. They get
    executed on one venue, and then they pull their quotes from
    everyone else. And so some of the market complexity does
    contribute to the amount of message traffic. So, again, that
    points back to the holistic review of market structure.
        The second is while the consolidated audit trail is still
    very much a development in process, one of the discussions is
    around whether there is a mechanism through the consolidated
    audit trail to potentially align some of the costs of
    surveillance and producing the consolidated audit trail records
    back to the person who has created the quotation. And so there
    is potentially another mechanism down the road to help address
    message traffic.
        Senator Crapo. Thank you very much. I really appreciate the
    testimony of these witnesses. It has been very helpful.
        Chairman Reed. It has been very, very helpful, and Senator
    Crapo's question has raised a question in my mind, a real
    question not a rhetorical one, and I will just see if anyone
    would like to respond to it. Is this flickering phenomenon
    related to entities that do not have market-making
    responsibilities so that they can come in and just ping the
    system without any responsibility to actually follow through?
    Is that related and we should be thinking about that?
        Mr. Gasser. Yes, I would not say that I know for certain,
    but I think it stands to reason that it is probably--and I
    certainly do not want to tar the HFT community with a brush
    here, but it is probably a high-frequency strategy, as Joe
    alluded, that has been deployed into every market center
    liquidity pool. We have seen, you know, some pretty significant
    anomalies from time to time, and, you know, 10 o'clock in the
    morning, 10:30 in the morning, where you have got these just
    huge spikes. They tend to be focused on large cap liquid names,
    and to get back to the point of investor perception, if folks
    had, you know, more insight into this, I cannot see that it
    would be a positive from that perspective. In fact, it would
    probably be perceived as just another example of a participant
    that had the ability to affect other participants in orders of
    magnitude larger than the capital they have deployed or their
    desire to actually execute trades.
        Chairman Reed. So I think that unless someone objects, this
    issue of--one of the categories we have to look at in market
    formulation is the responsibilities of market makers, who
    should be a market maker and what rights, what responsibilities
    they have, and that is an open question now given the new
    technology. I assume that that would be a point of agreement by
    the panel.
        I want to thank you all again. Senator Crapo was absolutely
    correct. Your testimony has been both thoughtful and thought-
    provoking, so expect lots of written questions.
        We appreciate the time that you have made. The preparation
    that you have undertaken has been obvious in this testimony.
        I will ask my colleagues, all the colleagues on the
    Subcommittee, if they have additional questions or written
    statements, please get them to us by December 28th, and then we
    will get them to you as quickly as possible and ask for your
    prompt response.
        The only thing, as we have been going back and forth about
    these dark pools, and I think you, Mr. Gasser, made the point
    that it is probably not the best term, I think there might be a
    rule of thumb that anything that could be used as a title for a
    Batman movie is probably not something that is good in the
    financial markets. But that is just a quip.
        With no further questions, I will adjourn the hearing.
    Thank you, gentlemen.
        [Whereupon, at 10:51 a.m., the hearing was adjourned.]
        [Prepared statements and responses to written questions
    supplied for the record follow:]
                      PREPARED STATEMENT OF JOSEPH MECANE
       Executive Vice President and Head of U.S. Equities, NYSE Euronext
                               December 18, 2012
    Introduction
        Chairman Reed, Ranking Member Crapo, and Members of the
    Subcommittee, my name is Joe Mecane and I am EVP and Head of U.S.
    Equities at NYSE Euronext (NYX)--a leading global operator of financial
    markets and provider of trading technologies. NYX's exchanges in Europe
    and the U.S. trade equities, futures, options, fixed-income, and
    exchange-traded products. In the U.S., we operate three equities
    exchanges, two options exchanges, one futures exchange, and a
    technology business that provides comprehensive commercial technology,
    connectivity, and market data products and services.
        While the U.S. continues to have the most liquid markets in the
    world and remains at the forefront of innovative technology used to
    conduct electronic trading, the infrastructure used to operate the
    markets each day has grown so sophisticated that few fully appreciate
    how well our markets actually operate in a highly competitive,
    fragmented, and complex environment. This has made it difficult for
    market participants, regulators, and Congress to determine the extent
    to which the growth in the number of trading venues, the speed at which
    trading platforms operate, and use of automated trading are beneficial.
        However, in light of the market events that have occurred in recent
    years, I'd like to focus on how technology and our market structure
    have created unnecessary complexity and mistrust of markets; and,
    relatedly, what NYX believes the industry, regulators, and Congress
    should be doing to address it.
    Market Structure Drivers Toward Computerized Trading
        Decimalization. Electronic trading has added tremendous benefit to
    the capital markets, including lower costs of execution, faster speed
    of execution and, in some cases, greater transparency. However, the
    trend toward computerized trading was accelerated and fostered by
    several significant regulatory changes that drove the market to become
    more electronic. One important factor was decimalization of the markets
    in 2001, which had an effect of decreasing average spreads by roughly
    38 percent in NYSE- and NASDAQ-listed securities, directly benefiting
    end investors. \1\ At the same time institutional commissions, borne
    directly by end investors, were declining and decreased 33 percent \2\
    in the years leading up to Regulation NMS (Reg. NMS) implementation. In
    fact, almost all reductions in spreads and commissions occurred prior
    to the implementation of Reg. NMS and led to a huge expansion of
    electronic trading because human traders could no longer effectively
    make markets in this environment, and because institutions and brokers
    began relying more on algorithmic trading to access the market and
    reduce their costs of trading. This began a steady progression to have
    the most sophisticated algorithms and technology, since the smartest,
    the fastest, and the first prevailed--well before the implementation of
    Reg. NMS in 2007.
    ---------------------------------------------------------------------------
         \1\ Data is calculated based on decrease in dollar value of
    spreads between 2001 and 2007, when the next major market structure
    changes were implemented through Reg. NMS. Consolidated Tape
    Association and NYX.
         \2\ Tabb Group: U.S. Long-Only Institutional Average Commission
    Rates, 2005-2012.
    ---------------------------------------------------------------------------
        Regulation NMS. In 2007, just as the technology among the trading
    community was becoming more sophisticated, the Securities and Exchange
    Commission (SEC) adopted Reg. NMS. This regulation gave brokers the
    freedom to trade around markets such as the New York Stock Exchange
    (NYSE) when the NYSE was in ``slow'' mode, \3\ and at the same time
    forced participants to access the national best bid or offer (NBBO) in
    the market. Because exchanges competed by establishing the NBBO, speed
    among markets became the competitive differentiator based on one
    exchange's ability to set the NBBO faster than a competing market.
    While Reg. NMS also established the Order Protection Rule to protect
    visible orders and encourage displaying quotes, today more than 3,000
    securities have over 40 percent \4\ of their volume occurring off-
    exchange in dark markets. In the NYSE MKT listed market, which
    represents 709 securities, off-exchange trading accounted for 42
    percent of the volume in November. This level of off-exchange activity
    erodes the incentive for market makers to continue to trade the less
    active securities, has a negative effect on price discovery \5\ and
    threatens to further decrease the incentives for companies to go
    public.
    ---------------------------------------------------------------------------
         \3\ Reg. NMS: http://www.sec.gov/rules/final/34-51808.pdf.
         \4\ Consolidated Tape Association.
         \5\ CFA Institute: ``Dark Pools, Internalization and Equity Market
    Quality'', October 2012, Weaver: ``Off Exchange Trading and Market
    Quality in a Fragmented Market'' (May 2011), Tabb Group: ``A Spotlight
    in the Dark: An Inevitable Debate'', November 2012.
    ---------------------------------------------------------------------------
        ATSs and internalization. Today, there are around 63 execution
    venues in the U.S. markets, including 13 exchanges and 50 dark pools.
    Exchanges find themselves competing more directly with Alternative
    Trading Systems (ATSs or dark pools) and broker internalization, which
    are able to employ different practices than exchanges with far less
    oversight and disclosure. Some of this competition is through cost,
    some through order handling practices, and much of it is through client
    segmentation whereby nonexchange venues are able to incentivize their
    own or third party liquidity provisions based on the nature of the
    person they are trading against. As a result of this advantage, large
    broker-dealers continue to move more order flow into their own private
    trading venues for a ``first look'' before routing on to the lit public
    markets. Since the implementation of Reg. NMS, we've seen two markets
    evolve--the lit public, regulated and accessible market versus the
    dark, selective and private nontransparent market.
        As you can see, technology and the rules that govern the U.S.
    equity markets have resulted in the creation of a trading
    infrastructure primarily focused on speed and resulting complexity
    through which professional traders can identify and access liquidity--
    too often at the expense of retail investors and market integrity. To
    accomplish this, exchanges, brokers, and vendors have had to build
    expensive networks with the capacity to keep up with the growth of
    messages delivered each day to market participants seeking liquidity,
    as well as learn how to interact in a very complex ecosystem.
        In response to this new flow of orders, exchanges have developed
    new order types. Order types have different purposes, such as giving
    cost certainty or competing with the client segmentation that exists
    off-exchange. Regardless of the reason for the specific order type,
    most are premised on the goal of attracting liquidity back to the
    public markets for the purpose of enhancing transparency and price
    discovery. Moreover, all order types must be pre-approved by the SEC
    and published for public comment, something that is unique to exchanges
    and which does not exist for ATSs or brokers who internalize.
    Recommendations
        The bottom line is that our market structure incentivized these
    various levels of increased complexity. Our main message is that if we
    want to reduce the complexity of technology and our markets, we should
    simplify the overall market structure. Doing so would certainly prove
    beneficial for the future of our national market system, for investors
    and issuers, and to the growth and well-being of our economy--including
    efficient access to capital to fund innovation, new business and job
    creation.
        In this regard, key questions include determining who should lead
    the change process, and what should be done to correct course while
    ensuring that we continue to have the most transparent and liquid
    markets in the world.
        NYX believes that the SEC is best suited to propose meaningful
    market structure changes--and, in fact, regulators in other global
    markets, including Canada, Australia, and Europe, are already taking
    action. With Congressional oversight, the SEC should continue with the
    holistic review it began in 2010 with the Concept Release on Equity
    Market Structure \6\ by proposing changes that will promote additional
    transparency, fairness, and long-term capital formation. This
    unfinished initiative needs to be completed and made a 2013 priority.
    ---------------------------------------------------------------------------
         \6\ http://www.sec.gov/rules/concept/2010/34-61358.pdf
    ---------------------------------------------------------------------------
        We believe that changes to be considered should include a review of
    market maker obligations, the Sub-Penny Rule, the Order Protection
    Rule, tick sizes for illiquid securities, and addressing the conflicts
    and overlap between broker-dealers and exchanges, including the
    obligations and responsibilities of each when providing like services.
        The Consolidated Audit Trail, proposed by the SEC, also is a vital
    component to ensuring effective surveillance in a highly fragmented
    marketplace. Such surveillance should include better identification and
    reporting on high frequency trading, similar to that being discussed by
    the Commodity Futures Trading Commission, to increase the transparency
    of this practice.
        NYX also believes that, in light of the existing complexity of the
    markets and the technology and trading glitches that have occurred this
    year, all trading venues should ensure a robust set of policies and
    procedures around their systems development life cycle. Although
    testing may not be the most exciting part of our markets, the hyper-
    competition that exists in this industry lends itself to excessive
    levels of change rates just to remain competitive and compliant with
    new regulatory requirements. The industry has been faced with
    implementing new back stops such as single-stock circuit breakers,
    market-wide circuit breakers, limit up-limit down, and possibly kill
    switches. These regulatory mechanisms have cost the industry tens of
    millions of dollars to implement over the past several years and have
    been developed in response to some of the negative effects of highly
    complex markets, in an effort to protect against those inevitable
    situations when the unforeseen occurs.
    Conclusion
        In closing, I want to reiterate our belief that although our
    capital markets are the best in the world, there remains room for
    improvement. Technology and innovation should not be the cause of
    crisis and fear in our markets. Under the right conditions and
    structure, they are assets and produce opportunity for all market
    participants. Our recommendations have a simple premise: implement
    market structure changes that enhance transparency, fairness and price
    discovery for investors and level the playing field for trading venues.
        Thank you for inviting me to testify and I look forward to your
    questions.
                                     ______

                     PREPARED STATEMENT OF DANIEL MATHISSON
           Head of U.S. Equity Trading, Credit Suisse Securities LLC
                               December 18, 2012
    Introduction
        Good morning, and thank you for giving me the opportunity to share
    my views on the best structure for our Nation's stock markets. My name
    is Dan Mathisson, and I am the Head of U.S. Equity Trading for Credit
    Suisse. \1\
    ---------------------------------------------------------------------------
         \1\ Credit Suisse provides its clients with private banking,
    investment banking, and asset management services worldwide. Credit
    Suisse offers advisory services, comprehensive solutions and innovative
    products to companies, institutional clients and high-net-worth private
    clients globally, as well as retail clients in Switzerland. Credit
    Suisse is active in over 50 countries and employs approximately 48,400
    people. Credit Suisse is comprised of a number of legal entities around
    the world and is headquartered in Zurich. The registered shares (CSGN)
    of Credit Suisse's parent company, Credit Suisse Group AG, are listed
    in Switzerland and, in the form of American Depositary Shares (CS), in
    New York. Further information about Credit Suisse can be found at
    www.credit-suisse.com.
    ---------------------------------------------------------------------------
        The U.S. broker-dealer subsidiary of Credit Suisse Group has been
    operating continuously in the United States since 1932, when the First
    Boston Corporation was founded. Today, Credit Suisse employs
    approximately 9,200 people in the United States, and 48,400 people
    globally. We are one of the largest U.S broker-dealers, executing 12.4
    percent of all U.S. equity volume in 2012. Most of that volume derives
    from our 1,600 institutional clients, which include the largest mutual
    funds and pension funds in America, representing the savings of tens of
    millions of Americans.
        I have been working in the U.S. equity markets for more than 20
    years, the last 12 of which have been at Credit Suisse in New York.
    This is the second time I have been given the privilege of appearing
    before this Committee, and I appreciate the chance to appear here
    today.
    Summary
        Credit Suisse believes that equity market quality has improved
    markedly over the past two decades, and that the competition spurred by
    the adoption of Regulation ATS and Regulation NMS has benefited the
    average investor. However, there is still plenty of room for
    improvement in the market structure. Within the past decade, our
    Nation's exchanges have transitioned to a for-profit model, after more
    than 200 years as not-for-profit, member-owned organizations. Despite
    their new for-profit status, exchanges have retained quasi-governmental
    status as SROs (Self-Regulatory Organizations), and exchanges still
    receive significant public funding through the market data revenue
    plans. We believe that this new model for the markets has proven itself
    to be costly to investors, unfair to broker-dealers, and rife with
    conflicts for the exchanges themselves. We suggest that ending
    exchanges' status as SROs and transferring those regulatory
    responsibilities to FINRA or the SEC would put all market players on a
    level playing field and would benefit the average investor by creating
    markets that would be simpler, less vulnerable to disruptions, and less
    expensive to operate.
    1. Are the U.S. markets working effectively?
        Although the markets are not perfect, Credit Suisse believes that
    the market structure changes of the past 20 years have been successful
    in their goal of creating equity markets that are better than in the
    prior era. The empirical evidence shows that Regulation ATS and
    Regulation NMS have led to an increase in liquidity and a decrease in
    the total number of market disruptions. We have found this holds true
    for both large and small issuers.
        Credit Suisse recently completed a broad survey of market quality
    in the U.S. equity market, and found that in every empirical measure,
    the U.S. markets are functioning better than ever. \2\ The study found:
    ---------------------------------------------------------------------------
         \2\ Ana Avramovic, ``Who Let the Bots Out?'' Credit Suisse Trading
    Strategy, May 2012. Also see ``June 2012 Chartbook'', Credit Suisse
    Trading Strategy.

    ---------------------------------------------------------------------------
        Positives:

        Overnight market volatility in 2012 is at a 15-year low.

        Intraday market volatility has been steadily decreasing
            since 2005.

        Bid-Ask spreads in the U.S. are the tightest in the
            developed world.

        Bid-Ask spreads have been clearly and steadily declining
            since Reg NMS was introduced, controlling for volatility.

        Average size of bids and offers has increased since 2004.

        The number of market disruptions, a.k.a. ``mini flash
            crashes'', has been decreasing since 2000.

        Negatives:

        Quote flickering has increased, with the number of daily
            changes in the NBBO (National Best Bid Offer) per million
            shares traded at an all-time high in 2011.

        Overall the study concluded there was no empirical evidence of
    negative market performance other than the increased cost of message
    traffic. Many other academic studies have found similarly positive
    results. A Rutgers University study released in September 2012 that
    examined data back to 1993 concluded that market quality breakdowns are
    41 percent less frequent post-Reg NMS than prior to the rule. \3\ A
    Feb. 2010 broad review of the equities markets by three well-respected
    professors concluded, ``Virtually every dimension of U.S. equity market
    quality is now better than ever.'' \4\
    ---------------------------------------------------------------------------
         \3\ See, Cheng Gao and Bruce Mizrach, Rutgers University, ``Market
    Quality Breakdowns in Equities'', Sept. 2012.
         \4\ James Angel, Lawrence Harris, Chester Spratt, ``Equity Trading
    in the 21st Century'', Feb. 23, 2010.
    ---------------------------------------------------------------------------
    2. Have liquidity and price discovery been impacted by the flow of
            stock trading volume to off-exchange venues?
        Implicit in this question is a statement that volume has been
    moving to off-exchange venues, which is factually incorrect. Over the
    past 5 years, volume has not shifted to off-exchange venues. Figure 1
    shows the percentage of U.S. volume executed on exchanges from January
    2008 through November 2012. As can be seen, the percentage of volume
    executed off-exchange has been remarkably constant over the past 5
    years.

        While the level of on-exchange vs. off-exchange volume has stayed
    remarkably constant, there has been a shift in volume from NYSE and
    Nasdaq to two new exchanges: BATS and DirectEdge. As seen in Figure 2,
    from October 2007 to October 2012, Nasdaq and the NYSE floor lost a
    combined 24.6 points of market share. New exchanges BATS and DirectEdge
    gained 22.4 points over that same period. Virtually all of the loss in
    the traditional exchanges' market share is explained by the rise of
    these two well-managed and efficient exchange competitors.
    3. How does the current market structure impact market integrity or
            investor confidence?
        Credit Suisse believes that the current market structure is not
    optimal for investor protection and market integrity. The aftermath of
    the Facebook IPO on May 18, 2012, revealed a significant flaw in the
    existing market structure. As has been widely reported, the Nasdaq
    exchange experienced extensive system failures during the initial
    public offering of Facebook Inc., causing others to suffer losses
    estimated to exceed $500 million. \5\ Nonetheless, Nasdaq has only
    offered a $62 million settlement to those that suffered losses due to
    Nasdaq's failures, an offer it views as an ``accommodation,'' given its
    view that it is legally immune from liability. \6\
    ---------------------------------------------------------------------------
         \5\ Ashley Lau, ``Nasdaq Defends Facebook Compensation Plan-Letter
    to SEC'', Reuters, Sep. 19, 2012, available at http://www.reuters.com/
    article/2012/09/19/us-nasdaq-facebook-letter-idUSBRE88I18V20120919.
         \6\ See, Self-Regulatory Organizations; The NASDAQ Stock Market
    LLC; Notice of Filing of Proposed Rule Change to Amend Rule 4626--
    Limitation of Liability, Exchange Act Release No. 67507 at 4 (July 26,
    2012).
    ---------------------------------------------------------------------------
        Because the Exchange Act of 1934 vests the exchanges with self-
    regulatory authority, courts have traditionally afforded exchanges
    ``absolute immunity'' from civil liability for damages arising in
    connection with their regulatory operations. \7\ The basis for this is
    the common law doctrine of sovereign immunity, under which a Government
    entity may not be held liable for acts taken in its official capacity.
    Because an exchange is empowered to perform a ``quasi-governmental''
    regulatory function, courts have found that exchanges ``stand in the
    shoes'' of the SEC, and they receive the same immunity that the SEC
    would be granted. \8\
    ---------------------------------------------------------------------------
         \7\ See, e.g., Barbara v. NYSE, 99 F.3d 49 (2d Cir. 1996); DL
    Capital Group, LLC v. Nasdaq Stock Market, Inc., 409 F.3d 93 (2d Cir.
    2005).
         \8\ See, e.g., D'Alessio v. NYSE, 258 F.3d 93 (2d Cir. 2001).
    ---------------------------------------------------------------------------
        It is a dangerous situation when a for-profit enterprise can cause
    half a billion dollars of losses for others, and not have the risk of
    being held legally liable. Instead of bearing the cost of its own
    failures, Nasdaq believes that ``the risks associated with system
    malfunctions should be allocated among all exchange members, rather
    than being borne solely by the exchange.'' \9\ In other words, Nasdaq
    asserts that the costs should be borne by the shareholders of the for-
    profit broker-dealers that suffered the harm, rather than the
    shareholders of the for-profit exchange that caused the harm.
    ---------------------------------------------------------------------------
         \9\ Id. at 28.
    ---------------------------------------------------------------------------
        The contrast to recent events involving Knight Capital Group is
    striking. On August 1, 2012, a system error caused a Knight Capital
    Group broker-dealer subsidiary to send a slew of erroneous orders,
    resulting in $440 million in losses. Since Knight is not an exchange,
    and therefore does not benefit from sovereign immunity, rather than
    externalizing these costs on the market as a whole, Knight's
    shareholders suffered the losses. \10\
    ---------------------------------------------------------------------------
         \10\ See, e.g., Scott Patterson, ``SEC Nixed Knight's Plea for a
    Do-Over'', Wall St. J., Aug. 6, 2012, available at http://
    online.wsj.com/article/
    SB10000872396390444246904577571113923528168.html.
    ---------------------------------------------------------------------------
        A fundamental principle of the law is that if a private enterprise
    wrongfully causes harm to others, it may be held liable to pay for the
    financial damages that ensue. In conducting its operations and
    implementing new systems, a broker-dealer must consider the risks and
    potential costs of potential liability and act accordingly. An
    exchange, on the other hand, may operate in a reckless manner.
        Sovereign immunity may have made sense when exchanges were not-for-
    profit, member-owned regulatory organizations that existed for the good
    of their members. But today, the NYSE and all exchanges are for-profit
    enterprises that are not particularly different from broker-dealers.
    While they still have a few vestigial regulatory functions, they
    outsource the vast majority of their regulatory responsibilities to
    FINRA.
        Exchanges now function as broker-dealers in many ways. For example,
    Nasdaq announced in May of 2012 they would compete with broker-dealers
    by selling execution algorithms, which involve significantly more
    complex technology than simply crossing stock like the Facebook IPO.
    \11\ Complex trading technology like algorithms should go through
    rigorous quality assurance testing, and maximum caution should be
    exercised when rolling out these types of programs. We believe that
    providers of trading technology will naturally exercise greater caution
    if they have material liability when their technology fails.
    ---------------------------------------------------------------------------
         \11\ ``Nasdaq to Offer Algorithms, Competing with Brokers'', by
    Nina Mehta, Bloomberg News, May 14, 2012. Article quotes Professor
    Bruce Weber saying, ``Before electronic trading really took off, it was
    clear where the exchange function ended and the brokerage function
    began. That line is getting blurred.''
    ---------------------------------------------------------------------------
        Repairing this problem in the current market structure is
    especially important since Regulation NMS does not allow broker-dealers
    to ignore an exchange's bids or offers, essentially compelling brokers
    to trade with every exchange, whether or not they find an exchange's
    technology to be reliable, and whether or not they find the exchange's
    liability policy to be fair and equitable. \12\ Policy makers should
    examine whether it still makes sense for exchanges to be considered
    quasi-governmental entities, given that they are no longer member-
    owned, no longer not-for-profit, and no longer have much of a direct
    regulatory function.
    ---------------------------------------------------------------------------
         \12\ See, Regulation NMS Rule 611(a).
    ---------------------------------------------------------------------------
    4. Are exchanges and dark pools on a ``level playing field''?
        Regulation ATS was specifically passed to allow broker-dealers to
    create electronic crossing networks that automated their traditional
    job of crossing client orders. ATSs, a subset of which are known as
    ``dark pools'', operate under a very different regulatory structure
    than exchanges. Nasdaq and NYSE have claimed that regulators need to
    ensure that exchanges and dark pools are on a ``level playing field''
    to protect the for-profit exchanges from losing further market share.
    \13\ However, their ``level the playing field'' argument has the
    situation backwards, because there is a clear and massive economic
    advantage to being an exchange.
    ---------------------------------------------------------------------------
         \13\ See, ``U.S. Market Structure Overview: Briefing for House
    Staff'', Nasdaq/NYSE, June 12, 2012.
    ---------------------------------------------------------------------------
        Within the past 5 years, two major ATSs, BATS, and DirectEdge, both
    voluntarily chose to become exchanges, \14\ spending millions of
    dollars and devoting years of effort to make the switch. In describing
    its history, the parent company of BATS Exchange explained that it
    converted from an ATS to an exchange in order ``to participate in and
    earn market data fees from the U.S. tape plans [and] reduce our
    clearing costs . . . .'' \15\ While many ATSs have applied to the SEC
    to convert to exchange status, and all were willing to accept exchange
    responsibilities, \16\ we are not aware of a single exchange that has
    tried to convert to ATS status. While exchange status does come with
    some burdens, clearly market participants are happy to accept those
    costs in return for the five significant advantages of being an
    exchange.
    ---------------------------------------------------------------------------
         \14\ See, In re the Applications of EDGX Exchange, Inc., and EDGA
    Exchange, Inc. for Registration as National Securities Exchanges,
    Exchange Act Release No. 61698 (Mar. 12, 2010); In the Application of
    BATS Exchange, Inc. for Registration as a National Securities Exchange,
    Exchange Act Release No. 58375 (Aug. 18, 2008) [hereinafter BATS
    Exchange Registration Order].
         \15\ See, Amendment No. 5 to Form S-1, BATS Global Markets, Inc.
    (Mar. 21, 2012) at 2, available at http://sec.gov/Archives/edgar/data/
    1519917/000119312512125661/d179347ds1a.htm [hereinafter BATS Form S-1].
         \16\ See, e.g., ``SEC Special Study: Electronic Communication
    Networks and After-Hours Trading'', at n. 27 (referring to the
    applications of Island ECN, NextTrade, and Archipelago), available at
    http://www.sec.gov/news/studies/ecnafter.htm.
    ---------------------------------------------------------------------------
        The 5 big advantages exchanges have over ATSs:

      1.  Exchanges have absolute immunity on errors, having historically
            been considered quasi-governmental entities. \17\ Courts have
            typically ruled that exchange immunity holds even in cases of
            gross negligence or willful misconduct. An ATS is a regular
            business that has liability for its actions.
    ---------------------------------------------------------------------------
         \17\ ``Nasdaq Exchange Immunity May Limit Losses From Facebook
    Claims'', by Nina Mehta, Bloomberg News, June 13, 2012.

      2.  Exchanges receive ``tape revenue.'' The CTA (Consolidated Tape
            Association) has a legal monopoly on providing a consolidated
            stream of real-time data from our Nation's stock markets. The
            CTA makes a profit of approximately $400 million per year,
            which is then distributed to its participant exchanges based on
    ---------------------------------------------------------------------------
            a complex formula. ATSs do not receive tape revenue.

      3.  Exchanges pay no clearing fees. An ATS is a party to both sides
            of each transaction that passes through it, while an exchange
            merely facilitates the transaction. Therefore ATSs pay
            significant clearing fees, whereas exchanges pay no clearing
            fees.

      4.  Exchanges have no net capital requirements. An ATS operator must
            meet stringent net capital requirements. Exchanges face no such
            requirement.

      5.  Exchanges can display bids and offers directly into the National
            Market System. An ATS cannot display a bid or offer directly
            into the National Market System. Instead, an ATS must pay an
            exchange to display bids and offers on their behalf. \18\
    ---------------------------------------------------------------------------
         \18\ FINRA hosts an ``Alternate Display Facility'' to allow ATSs
    to display their bids and offers, but due to outdated technology, this
    service is not operational as of December 2012.
    ---------------------------------------------------------------------------
    5. How has the operating model of exchanges been influenced by their
            change from not-for-profit organizations to for-profit
            companies?
        Since becoming for-profit companies, exchanges have a fiduciary
    responsibility to their shareholders to maximize profits. A major
    source of revenue and profit for the exchanges comes from the sale of
    market data.
        The exchanges, together with FINRA, have a Government-granted
    monopoly over the sale of market data to the public--including the fees
    from market data generated by off-exchange trading. The Consolidated
    Tape Association (the ``CTA''), which administers the consolidated tape
    on behalf of the exchanges and FINRA, charges high fees to the
    investing public for real-time market data. While there is no
    systematic transparency into the CTA's finances, some information can
    be gleaned from the exchanges' parent companies' public financial
    disclosures:

        NASDAQ: The NASDAQ OMX Group, Inc. reported earning $115
            million of net U.S. tape revenue from the CTA during 2011. \19\
            This amount is separate from, and in addition to, the $135
            million NASDAQ earned from the sale of proprietary U.S. market
            data products.
    ---------------------------------------------------------------------------
         \19\ NASDAQ OMX Group, Inc., 2011 Form 10-K at 57, available at
    http://sec.gov/Archives/edgar/data/1120193/000119312512077518/
    d259668d10k.htm.

        NYSE: NYSE Euronext earned $193 million from market data
            relating to U.S. equity trading in 2011, although it is not
            entirely clear from their disclosure whether this includes
            revenue unrelated to the U.S. consolidated tape plans. \20\
    ---------------------------------------------------------------------------
         \20\ NYSE Euronext, 2011 Form 10-K at 60, available at http://
    sec.gov/Archives/edgar/data/1368007/000119312512086538/d275617d10k.htm
    [hereinafter NYSE 2011 Form 10-K].

        BATS: BATS Global Markets, Inc. earned $55.4 million from
            its share of revenue from the U.S. tape plans in 2011. \21\
    ---------------------------------------------------------------------------
         \21\ See, BATS Form S-1, supra note 15 at 18, 39.

        The estimated $400 million in market data revenues that the CTA
    distributes to the exchanges are after operational and administrative
    expenses have been paid. Given that real-time data is a Government-
    granted monopoly, and market data prices are not set by the market and
    are not subject to competition, the investing public is arguably being
    overcharged for market data by approximately $400 million a year.
        Historically, the SEC has justified granting exchanges the
    exclusive right to sell market data as a form of user tax to fund the
    exchanges' regulatory expenses. In 1999, the SEC stated that exchanges
    are entitled to market data revenues to offset the cost of regulating
    their markets. \22\ However, the amounts earned by the exchanges today
    far exceed their regulatory expenses and act as a major profit center
    for exchanges.
    ---------------------------------------------------------------------------
         \22\ See, ``Concept Release: Regulation of Market Information Fees
    and Revenue, Exchange Act Release No. 42208'' (Dec. 9, 1999)
    [hereinafter SEC 1999 Market Data Concept Release].
    ---------------------------------------------------------------------------
        In Congressional testimony, the CEO of NYSE Euronext estimated that
    it would ``spend nearly $85 million for U.S. equity market surveillance
    in 2012.'' \23\ This is far outpaced by the market data revenue NYSE
    Euronext earns, which appears to have totaled $193 million in 2011 from
    market data relating to U.S. equities trading. \24\ NASDAQ OMX Group
    earned $115 million of net U.S. tape revenue during 2011, but spent
    only $35 million on regulatory expenses across the entire holding
    company--apparently even including regulatory expenses relating to
    their non-U.S. exchanges. BATS Global Markets, Inc. earned $55.4
    million from its share of the U.S. tape plans in 2011. But it spent
    only one tenth of this amount on regulatory expenses of $5.5 million in
    2011, including costs under its outsourcing agreements for regulatory
    services to be provided by other SROs. \25\
    ---------------------------------------------------------------------------
         \23\ 2012 Market Structure Hearings, supra note Error! Bookmark
    not defined. (statement of Duncan Niederauer, CEO, NYSE Euronext),
    available at http://financialservices.house.gov/uploadedfiles/hhrg-112-
    ba16-wstate-dniederauer-20120620.pdf.
         \24\ NYSE Euronext, 2011 Form 10-K at 60, available at http://
    sec.gov/Archives/edgar/data/1368007/000119312512086538/d275617d10k.htm
    [hereinafter NYSE 2011 Form 10-K].
         \25\ See, BATS Form S-1, supra note 15 at 73-74.
    ---------------------------------------------------------------------------
        The enormous revenues from market data are way out of proportion
    with the costs of exchanges' self-regulatory responsibilities. Market
    data revenue has simply become a Government-granted windfall at the
    expense of the investing public.
        Furthermore, the current tape revenue system potentially encourages
    odd distortions in the markets. Because the CTA allocates revenue to
    the exchanges based on a complex formula involving variables such as
    each exchange's number of quotations, for-profit exchanges try to set
    policies and services that will increase the level of quoting activity.
    We believe this is a major factor in why quote flickering has markedly
    increased, with the number of daily changes in the NBBO (National Best
    Bid Offer) per million shares traded recently climbing to an all-time
    high. \26\ It is logical to assume that if the tape revenue system were
    reformed, quote flickering would be seen as a wasteful expense rather
    than a lucrative source of revenue.
    ---------------------------------------------------------------------------
         \26\ Ana Avramovic, ``Who Let the Bots Out?'' Credit Suisse
    Trading Strategy, May 2012.
    ---------------------------------------------------------------------------
    6. What regulatory or legislative changes should be considered by
            regulators or Congress?
        Credit Suisse suggests three policy changes, each of which is
    designed to make markets more reliable than they are today or reduce
    investor cost:

      1.  Remove the SRO status of the for-profit exchanges. For-profit
            entities should not be shielded from liability for damages that
            arise as a result of their own actions. For-profit entities
            should not be able to audit and regulate their competitors.
            Exchanges have already transferred most of their regulatory
            tasks to FINRA. It is time for Congress to revoke their special
            quasi-governmental status and Government privileges.

      2.  Perform a review of the pricing and rebate system operated by the
            consolidated tape plans. The CTA plans collect over $400
            million a year from the investing public, most of which then
            gets rebated to the for-profit exchanges that collectively run
            the plans. Forty years after these plans were established, \27\
            we believe the tape revenue model is obsolete. In the current
            system, the investing public overpays for market data, and the
            exchanges receive a Government-granted windfall.
    ---------------------------------------------------------------------------
         \27\ The SEC adopted Rule 17a-15 in November 1972, establishing
    the current tape plans.

      3.  Lift the restrictions that limit broker-dealers to 20 percent
            ownership in exchanges. Although there is no rule or law
            limiting broker-dealer ownership in exchanges, there is a
            precedent set by the regulators to cap broker-dealer ownership
            of an exchange at 20 percent. Allowing broker-owned ATSs to
            follow in the footsteps of BATS and DirectEdge and become
            exchanges would level the playing field between exchanges and
    ---------------------------------------------------------------------------
            ATSs, ultimately resulting in lower costs for investors.

        Thank you for the opportunity to appear today and I will be happy
    to answer any questions that you may have.
    Witness Background Statement
        Dan Mathisson is the Head of U.S. Equity Trading for Credit Suisse.
    He is responsible for block trading, program trading, and electronic
    trading at Credit Suisse.
        Mr. Mathisson joined Credit Suisse in 2000 as a trader in the Index
    Arbitrage department, shortly after which he founded the Advanced
    Execution Services (AES) group, which executes trades on behalf of
    institutional clients using algorithmic techniques. Prior to joining
    Credit Suisse, he was the head equity trader at D.E. Shaw Securities,
    where he worked from 1992-2000.
        Mr. Mathisson writes a column about trading and markets for Traders
    Magazine. In 2011 he was named one of the ``Top Ten Innovators of the
    Decade'' by Advanced Trading magazine, which cited him for creating the
    modern algorithmic trading desk. Mr. Mathisson received a B.A. in
    Economics from the University of Michigan, and he is a Chartered
    Financial Analyst.
                                     ______

                        PREPARED STATEMENT OF ERIC NOLL
       Executive Vice President and Head, Nasdaq OMX Transaction Services
                               December 18, 2012
        Thank you Chairman Reed and Ranking Member Crapo for the
    opportunity to testify today on computer trading in U.S. securities
    markets.
        Computer trading is a fact of life and has been the default method
    of trading for billions of trades over the past several years--Billions
    of trades that happen on our market and others without any concern or
    problem. While there are issues to review, computer trading has a
    proven track record of delivering benefits for investors and market
    participants that includes bringing new investors to the markets,
    equalizing the information advantage that used to be the staple of
    manual markets, lowering trading costs and giving the market expanded
    abilities to handle trade and message traffic growth that would freeze
    manual markets. As we saw during the financial crisis of 2008, the U.S.
    equities markets did not freeze-up and billions of trades that
    investors needed were handled by our computers. And of course, this was
    done without any contribution from the equity asset class to the list
    of problems that had to be managed. So, while we have experienced some
    trading anomalies like the Flash Crash of May 6, 2010, and a number of
    computer-trading events. I believe these are isolated technology
    incidents and not symptoms of deeper market structure concerns. At
    NASDAQ OMX we are laser-focused, every day, on how do we improve our
    market and make it more resilient and robust?
        This question is critical because a well-functioning equity market
    is needed for efficient capital formation, innovative competition, and
    job creation. Companies like Microsoft, Cisco, and Intel, used capital
    raised from listing on NASDAQ to make cutting edge products that have
    transformed our lives. Along the way, these companies created millions
    of jobs and strengthened many communities. Innovative high-growth
    companies attract new talent and that talent pool then demands new
    goods and services. This virtuous cycle has played out in dozens of
    venture zones, from Silicon Valley to the Northern Virginia high tech
    corridor. And they have created enormous wealth opportunities, allowing
    millions of average investors to share in that wealth--enabling them to
    buy homes, put children through college, and retire with financial
    security.
        In light of recent events, some may forget the unique and central
    role exchanges have played and continue to play in U.S. equities
    markets. All that your average constituent associates with ``the
    market'' starts with an exchange. The iconic public companies they
    recognize--Apple, Google, eBay, and Amazon--must satisfy exchanges
    listing standards, and they remain subject to exchange regulations
    against corporate fraud and abuse. The exchange listing process and
    regulatory program culminate in the IPO process that provides
    entrepreneurs with efficient platforms for capital formation and job
    creation. Only equities exchanges such as NASDAQ are entrusted with the
    important responsibility to be a catalyst for growth and wealth
    creation.
        After the IPO, exchanges have a unique and continuing duty to
    foster price discovery and transparency. Exchanges like NASDAQ create
    and disseminate the ticker symbols and prices that your constituents
    see on television stations like CNBC, in newspapers like the Wall
    Street Journal, and at Internet portals like Yahoo Finance. Exchange
    quotes then create the reference price for all other trading, not only
    in equities but in other asset classes as well. Dark pools and other
    competitors use exchange quotes as a reference price for trading
    equities. Markets, such as the Chicago Mercantile Exchange and the
    Chicago Board Options Exchange, use equities exchange quotes to trade
    options, futures, and other derivatives. Vanguard, Fidelity, and Schwab
    use exchange prices for mutual funds, ETFs, and other instruments.
    Those ticker symbols are a byproduct of the rules and sophisticated
    regulatory systems that equities exchanges develop and enforce to
    protect investors and to provide orderly markets. They are the result
    of a system that is by law fully transparent, and that publicly
    discloses all rules and prices to all customers and treats all
    customers equally.
        Only exchanges have the authority and responsibility to oversee
    broker-dealers as they interact with the market. That authority is the
    result of a rigorous public process of qualifying to be an exchange
    conducted by the SEC--in the case of NASDAQ it took 6 years. Exchanges
    alone adopt member and market regulation rules, develop automated
    surveillance systems to detect rule violations, and discipline broker-
    dealers that violate rules and harm investors. Congress recognized that
    enforcing rules in U.S. securities markets is so important that two
    regulators rather than one are needed to enforce them. Congress
    codified the authority of exchanges to act as self-regulatory
    organizations (SROs), to set and enforce trading rules and to halt
    trading during extraordinary national or international events. SROs
    supply the SEC and other regulators vital information about the trends
    and performance of U.S. capital markets. The SEC is our partner in
    protecting investors.
        In fact, exchanges have heavy responsibilities to create a safe
    market for investors, characterized by fair access, transparency, and
    efficiency. No other market participant is charged with or even
    permitted to undertake this burden. Alternative trading systems (ATSs)
    are not entrusted to regulate and discipline their users in this
    manner. An ATS can choose to regulate its users, but it must then
    register as an exchange and accept SRO responsibilities. Today,
    virtually every ATS has the option to register as an exchange. One need
    only look at the list of SRO responsibilities and obligations that
    registration triggers to understand why so few ATSs voluntarily take
    that step.
        While we often discuss the importance of capital formation, our
    regulatory responsibilities and the IPO process, let me add another
    important, but sometimes overlooked branch of our role in the markets--
    our role in the daily trading dynamics of the market. Trading and
    trading behaviors like price discovery, best bid and best offer and
    visible liquidity are very important to companies as they might seek
    secondary offering cash injections to their businesses and use their
    stock as currency in the market to achieve strategic goals like
    acquisitions. Price discovery and transparent liquidity are also very
    important to investors as they make informed decisions about which
    stocks to buy and at what price and when to sell. All the buying and
    selling and active trading in the equities market is not a grand game
    of speculators--it has real job creators and investors looking for the
    market's best information to make rational business and investing
    decisions. Exchanges maximize transparency, strive for fairness and
    support that price discovery engine and it is our unique market role to
    perform that function. We are not in business just to see trading for
    trading's sake. NASDAQ OMX is an exchange to produce transparent
    quoting and trading that helps price discovery, helps add liquidity,
    tightens spreads and benefits the continuous market is what we strive
    to support.
    Cooperation
        The role of exchanges is more important than ever in today's
    challenging environment. U.S. markets are complex, fragmented, and
    interconnected. Markets and traders leverage new technologies to trade
    near the speed of light. We at NASDAQ are working tirelessly to ensure
    that markets are strong and fair, and that as the pace of trading
    accelerates, so too does the pace of regulation and investor
    protection.
        When computerized trading appears as a threat to investors, the SEC
    naturally turns first to exchanges for assistance. Regardless of where
    the problems began, regardless of where the damage was felt, the
    exchanges are always on the front lines partnering with the SEC and we
    work closely with the SEC to fix and improve the equities markets. In
    the aftermath of May 6th, the SEC and the exchanges worked quickly and
    cooperatively to devise new protections to keep computer trading errors
    from spreading too rapidly or inflicting unacceptable harm on the
    overall market. The exchanges reformed their rules for breaking trades,
    instituted single stock circuit breakers, updated market-wide circuit
    breakers, and we will implement the Limit Up/Limit Down mechanism in
    February. NASDAQ has also developed tools to help broker-dealers manage
    their obligations under the Market Access Rule.
        In the wake of several highly publicized computer malfunctions, the
    exchanges are again leading the industry in a collaborative working
    group. A key and challenging initiative being discussed by this
    Industry Working Group, and one that NASDAQ fully supports and is
    helping to lead and define, is the implementation of ``Peak Net
    Notional Exposure'' levels, or ``kill switches,'' that would
    automatically trigger a cessation of trading when an individual firm
    exceeds predetermined risk thresholds. The Industry Working Group is
    considering various approaches to both the SRO-level and broker-dealer
    level requirements, as well as a means for coordinating cross-market
    checks to create the market-wide check needed to combat the effects of
    market fragmentation and interconnectedness.
    Testing
        One important area of focus is testing and industry preparedness.
    NASDAQ is partnering with Carnegie Mellon University to form the
    Carnegie Mellon Software Engineering Institute dedicated to help bring
    the industry together to improve the resilience of financial services
    technology. We hope to form and lead a group of market participants,
    regulators, technology providers, and academic institutions with the
    goal of driving resilience in the large scale software engineering and
    technology arena and being recognized globally as a leader in helping
    the financial markets become more resilient and robust.
        The industry has learned through experience that it must change the
    way we test. In the past, industry-wide system changes have utilized a
    testing methodology that tested for system design integrity. For
    example we might test a software update by having our members send us
    test orders to ensure the software does what we are asking it to do.
    Or, we might ask members to challenge our systems with high volumes.
    Instead, we should be testing each other's systems to try to break
    them. A more robust testing environment would assume breakdowns by all
    testing participants to visualize the impact on a system's integrity.
    Such ``destructive'' testing will spot troubles that the kinder-gentler
    testing of the past would not uncover.
        High Frequency Traders (HFT) firms have attracted much media
    attention, but they are not the only ``fast'' players in the
    marketplace. Exchanges, dark pools and broker systems are all connected
    and all use sophisticated technology. These systems communicate in
    slices of time that approach the speed of light. This is a great
    achievement, but it means that previously minor events now represent
    profound risks that can tangibly affect investor confidence. NASDAQ OMX
    is not immune to this issue, and we are committed to answering this
    challenge.
    High Frequency Trading
        NASDAQ believes that technological developments must be implemented
    in a manner that ensures all investors a ``fair deal.'' Average
    investors must not be placed at a disadvantage to professional traders
    by rules that permit selective disclosure of information, preferential
    access to trading interest, or the appearance of a two-tiered market.
    All markets that trade the same securities should be equally
    transparent about their operations, including the rules governing their
    trading systems, the criteria for admission and the prices of
    comparable services. The Commission must regularly examine whether the
    application of new technologies contribute to regulatory arbitrage.
        For example, exchanges and regulators around the world are
    analyzing the pros and cons and overall impact on markets of HFT. The
    International Foresight Project was commissioned by the British
    Government's Department for Business, Innovation, and Skills (BIS) to
    investigate the effects of HFT. This definitive and independent study,
    led by Sir John Beddington, Chief Science Officer for the British
    Government, found that HFT is likely positive for markets. Similarly,
    the Swedish Financial Services Agency released its own report finding
    that HFT in that country also had a positive impact on liquidity, and
    that regulators and exchanges continue to refine their tools for
    ensuring proper surveillance.
        Many in the public arena vilify HFT as a business model issue. It
    is our view to always caution against such sweeping criticism. When,
    like the Beddington study, HFT is studied in depth, you find benefits
    to several metrics from the broad participation in our markets by firms
    that we consider to be high frequency traders. Like the British and
    other studies, we find that HFT trading tightens spreads and adds very
    valuable liquidity--certainly positive for our markets. We know that
    everyone in the markets has a profit motive and that generally
    incentivizes innovation and competition among participants. What we
    know from experience is that our industry, no matter the business
    model, will always attract individual players who cross the line and
    NASDAQ OMX, the other exchanges, FINRA (the Financial Industry
    Regulatory Authority) and the SEC work to expose those individual bad
    actors. It seems the tenor of the debate about HFT has become too
    broadly negative towards the business model. The academic evidence
    about HFT supports the fact that they generally add value to the
    market.
        It is not enough simply to vilify fast trading. Regulators and
    exchanges are working to identify and address specific bad actors and
    specific bad outcomes such as false, misleading or deceptive practices.
    NASDAQ has worked diligently to ensure that the pace of its regulation
    matches the pace of trading. NASDAQ has partnered with FINRA to develop
    special HFT inspections. For example, in December of 2010, NASDAQ OMX
    retained outside experts to assist in assessing and improving our
    internal training program on HFT strategies. Through focus and effort,
    NASDAQ's Market Watch staff has developed 11 new alerts (algorithms
    specifically designed to spot certain trading behaviors) in addition to
    the 21 surveillances FINRA utilized for HFT related reviews.
        To improve our own regulatory program and the regulatory programs
    of exchanges around the world, NASDAQ invested in state-of-the-art
    technology. In 2010, NASDAQ acquired The SMARTS Group, the world's
    leading provider of software for automated surveillance for exchanges,
    regulators, and brokers. With SMARTS, NASDAQ literally can deploy high
    speed surveillance to match high speed and any other kind of trading.
    We have held demonstrations for many Members and staff of this
    Committee to demonstrate the power of the SMARTS system. The feedback
    from those demonstrations has been positive.
        These efforts have paid off. NASDAQ surveillance and referrals to
    FINRA and the SEC have improved compliance. While we cannot go into
    great detail, we have a full plate of pending Investigations on issues
    related to High Order/Low Execution Ratios, Wash Trading, Layering,
    Manipulation of the closing auction, Manipulation through master-sub
    relationship, Supervision, Order Entry controls. NASDAQ has detected
    violations by high frequency traders resulting in fines as high as $3.5
    million and in the expulsion of firms and individuals from the
    securities industry. NASDAQ is protecting investors from people that
    use technology to prey on them. Our goal is always to constantly
    evaluate and improve our market to make it as robust and fair as
    possible using technology and the wisdom and experience of our
    industry-best employees.
    Complexity
        Any evaluation of the health of our markets and the ecosystem of
    computer trading must include a discussion of complexity. There are 13
    registered exchanges active in the U.S. equities markets. The SEC also
    allows trading on 40+ venues in the U.S. where a broker can send one or
    more of their orders. Each of these venues has its own systems and
    procedures and each competes for orders from brokers and ultimately
    investors. Each venue has its own order types and each is continually
    talking to investors to develop new order types that satisfy their
    needs. The result is dozens or even hundreds of different order types
    for members to understand and program. Is the explosion of order types
    helpful or harmful for the market?
        While some order types have come under intense media and regulatory
    scrutiny, let me be clear, NASDAQ OMX order types do not provide
    advantages to certain users allowing them to jump ahead in line at a
    given price level. NASDAQ believes that each order type it creates
    should be designed to make our markets better, and to improve
    transparency and price discovery. Fairness and equal access are key SRO
    responsibilities and we will always adhere to those principles. NASDAQ
    goes through a rigorous process to get order types approved by the SEC.
    As an exchange we have to expose innovative ideas to the market through
    the notice and comment process, often allowing our competitors time to
    mimic our idea and beat us to market. That is part of our SRO burden.
    For the sake of transparency and to help members understand our order
    types, we recently posted on our Web site a list and a plain-language
    description of NASDAQ's order types.
        Computer trading and some of the concerns that have been outlined
    to Congress are in many respects the direct result of market structure
    decisions. Many problems with our markets stem from well-intentioned
    regulations like Regulation ATS and Regulation NMS, which sought to
    promote competition and to resolve tensions between electronic and
    floor-based trading. Regulation NMS has led to an increase in dark
    trading, which denies market participants a clear view of trading
    interest in a given stock. Dark trading is a concern in many countries;
    Canada recently modified its market structure to limit dark trading and
    to maximize price discovery. The Commission has similar market
    structure proposals pending since 2009.
    Market-Based Approaches
        In addition to regulatory enhancements, NASDAQ has also developed
    several market-based approaches to improve the trading experience, and
    help reestablish the prominence of the public company model. For
    example, NASDAQ launched the first ``price/size'' market to create
    incentives for quotes that offer deep liquidity rather for quotes that
    are fast. Also, NASDAQ voluntarily eliminated flash orders from its
    equity markets. NASDAQ also introduced the ``MinLife'' order to
    incentivize a longer quote life. Finally, NASDAQ is the only exchange
    to recently institute a charge for excessive messages to discourage a
    trading technique used primarily by high frequency traders.
        NASDAQ OMX is also working to improve the market structure for
    small public companies that are job creation dynamos when given a
    supportive ecosystem. This past year, the JOBs Act recognized the
    importance of special rules for these emerging companies. However,
    Congress did not go far enough and consider how these companies were
    treated once they actually go public. Regulation NMS subjects these
    smaller stocks to a one-size-fits-all market structure. Apple,
    Microsoft, GE, and other large cap stocks trade relatively well,
    despite a highly fragmented marketplace. Small companies however are
    not best suited for a fragmented liquidity pool and dark trading.
    Smaller stocks do not perform well in the fragmented marketplace no
    matter their listing venue. This can compromise the momentum for
    smaller public companies and capital formation within this class of
    stocks. There are innovative ideas to empower small companies to help
    their stocks trade more often and more efficiently:

        Tick Size Pilot Program: Allows smaller companies to opt-in
            for a wider tick size for their stock to allow more spread for
            market-makers to be incentivized. Multiple tick size regimes
            are already used already in numerous other countries
            successfully.

        Market-Maker Support Pilot Programs: Allows the company to
            opt-in to a program to provide economic support for more
            aggressive quoting and trading in their stocks. These programs,
            common around the world, allow the exchange to stand between
            the broker and the listed company to improve the trading of a
            stock.
    Conclusion
        NASDAQ OMX is passionate about the critical role we play in capital
    formation, investor protection and job creation. While it presents
    challenges to everyone, ultimately we believe that technology is an
    important part of the solution for ensuring orderly and fair markets.
    We view efforts to slow-down our markets as counterproductive. Building
    robust and dependable markets requires legislators, regulators and
    market participants to continue to come together to drive positive
    evolution. NASDAQ OMX is committed to working with Congress, the SEC,
    our fellow exchanges and all market participants to make the U.S.
    equity market the best in the world. NASDAQ OMX appreciates the
    opportunity to testify. I look forward to your questions.
                                     ______

                     PREPARED STATEMENT OF ROBERT C. GASSER
                   Chief Executive Officer and President, ITG
                               December 18, 2012
    Introduction
        Chairman Reed, Ranking Member Crapo, and other Members of the
    Subcommittee, thank you for the opportunity to testify this morning on
    the topic of ``rules of the road'' for computerized trading venues. On
    behalf of a leading agency broker, my goal is to offer an unbiased,
    fact-based view on the current state of U.S. equity market structure.
    ITG is a NYSE-listed company with 17 offices across 10 countries and
    nearly 1,100 employees. As an agency broker, ITG provides trading
    services, technology, analytics and research to a wide array of leading
    asset managers. Throughout our 25-year history, we have worked in
    partnership with major mutual funds, pension funds and other
    institutional investors, innovating to improve trading and investment
    performance. In my testimony today I would like to offer a brief
    overview of current market structure, discuss some recent events which
    have impacted investor confidence and look at some ways to restore this
    confidence. There has been much written of late about the quality of
    our equity markets. This morning we hope we can infuse some data and
    analysis into the debate.
    Market Structure
        Competition amongst market centers and broker dealers spawned by
    the passage of Regulation ATS in December 1998 has led to intense
    competition for liquidity and ultimately to fragmentation. This
    fragmentation has undoubtedly introduced complexity into our
    marketplace but has been a positive force in reducing execution costs.
    Technology has provided market participants, including retail investors
    and mutual funds, competition for order flow.
        Global asset managers, as fiduciaries, have an obligation to
    achieve best execution. The global market standard requires all asset
    managers of size to measure the quality of their execution and its
    effect on the investment process. ITG is the world's largest provider
    of TCA, or Transaction Cost Analysis. We measure millions of trades
    executed on behalf of hundreds of global asset managers. Our TCA data
    clearly demonstrates that institutional investors have benefited
    greatly from the evolution of U.S. market structure. Over the past 12
    years, there has been a 70 percent decrease in average total equity
    trading costs in the U.S. As the data indicates, U.S. market structure
    is not broken. The current ecosystem of displayed and dark markets has
    resulted in significantly reduced costs that in almost all cases have
    been distributed back to investors. There is no evidence to suggest
    that competition and fragmentation have damaged price discovery or
    harmed capital formation.
        ITG is not a market maker, and we do not take on proprietary
    positions. In other words, we do not have ``skin in the game'' when it
    comes to the debates around broker internalization, as our system
    provides ``meaningful price improvement'' to buyside investors as
    described in Regulation NMS. Based on our data, we would conclude that
    Broker-Dealer internalizers, or broker-dealer dark pools as they are
    sometimes known, provide a useful permeable layer between the client
    and the displayed markets. Brokers have a fiduciary responsibility to
    their clients while exchanges do not, and these liquidity pools would
    not exist unless benefit was derived by the customer. Most recently,
    Australia and Canada have imposed regulations around internalization
    that will provide similar action here in the U.S. Early returns do not
    look promising in terms of the effects on liquidity and trading costs.
    Regressing to an oligopoly of U.S. exchanges is clearly not the answer.
    Investor Confidence
        Unfortunately, the evidence also suggests that the investing public
    has become disenchanted with equities. According to the Investment
    Company Institute, over half a trillion dollars has been pulled from
    U.S. equity mutual funds since the start of 2008. Much of this can be
    attributed to the reduced risk appetite of baby boomers and the
    relative safety of bonds supported by easy monetary policy.
        The May 2010 Flash Crash, the Facebook IPO, and Knight Capital's
    trading debacle this past summer provide little comfort that U.S.
    equity markets are a safe place to trade or invest. Add in the
    suspicions that the investing public has about high frequency trading
    and its perceived impact on the quality of markets, and you have a
    recipe for anecdote and conjecture overcoming facts and reason.
        Where speed is concerned, it is clear that the law of diminishing
    returns must be applied to further dramatic shifts in the foundations
    of our equity marketplace. Microseconds versus milliseconds do not
    matter to the wider, more important, audience. We need to restore
    investor confidence, but not at the cost of disturbing the progress
    that has been made.
    Recommendations
        The SEC's Consolidated Audit Trail, if implemented properly
            and cost effectively, will give investors confidence that
            regulators can police bad actors and predatory strategies.

        The consistent application of the Market Wide Circuit
            Breakers and the Limit-Up Limit-Down Plan to all market centers
            would likely prevent a market disruption of ``Flash Crash''
            proportions.

        Costs should be borne by market participants who create
            excessive quote traffic without executing order flow.

        Market data should be distributed to all market
            participants equally.

        Marketwide risk should be monitored at a central clearing
            house that would have the ability to terminate a broker-
            dealer's connectivity to the national market system in the
            event of a rogue program released to the market.
    Conclusion
        These five measures would give the investing public the protections
    they need to confidently invest in the world's strongest and most
    resilient market while still deriving all of the cost savings and
    liquidity benefits which have been achieved over the past decade.
    Lastly, as the regulations called for by the Dodd-Frank Act begin to
    take hold across other asset classes, the lessons we have learned in
    equities will be applied to those markets.
        Price discovery, central clearing, transaction cost analysis, and
    pre- and post-trade transparency will become as deeply integrated into
    foreign exchange and fixed income markets as they are in equity
    markets. And innovation will come more quickly to those markets because
    of the lessons learned in equities. For this reason, our equity market
    structure is all the more important to our broader financial system.
        Thank you again for the opportunity to share our views on these
    important questions. I would be happy to answer any questions at the
    appropriate time.

            RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN REED
                           FROM JOSEPH MECANE

    Q.1. There was testimony that ``dark trading'' is a concern in
    many countries and that Canada recently modified its market
    structure to limit dark trading and to maximize price
    discovery. Canadian regulators have imposed a new framework
    governing how dark pools and undisplayed orders are allowed to
    operate including priority of lit over dark flow and a minimum
    price improvement requirement for dark orders. What is your
    view of these reform proposals? Would these measures make the
    U.S. markets more or less fair and transparent? Please explain.
    Would these measures be feasible in the U.S. markets? Why or
    why not?

    A.1. To be clear, we are not adverse to the concepts of
    internalization or dark pools. We believe they are a valuable
    part of the market in terms of facilitating the execution of
    institutional block orders and providing significant amounts of
    liquidity to retail orders. However, there is a balance that
    must be struck between internalization and public price
    discovery in order to maintain a healthy public market. We
    believe the new Canadian rules--which are designed to encourage
    transparency, support the price discovery process, reward
    displayed orders with increased execution opportunities, and
    increase liquidity for all--can be incorporated into the U.S.
    markets to help achieve this difficult balance. Additionally,
    the Canadian rules recognize the value that dark trading can
    offer to minimize the market impact of trading blocks and
    provide meaningful price improvement--again, useful paradigms
    for preserving the value of internalization while creating
    mechanisms to facilitate publicly displayed liquidity.
        A key objective of the Canadian rules was to encourage the
    posting of visible orders and expose liquidity to the widest
    variety of participants by ensuring that visible orders execute
    before dark orders at the same price across the entire market.
    \1\ In stark contrast to Canada, in the U.S., market
    participants who take an added risk by displaying their orders
    are being traded ahead of, normally at the same price, on dark
    markets. This has the effect of reducing the execution
    experience on ``lit'' markets and further encourages liquidity
    providers to move into the dark markets. We believe this effect
    is borne out by the statistics we noted in our testimony that
    show that U.S. market structure has led to widespread and rapid
    growth in dark trading. \2\
    ---------------------------------------------------------------------------
         \1\ After significant analysis and industry commentary, the
    Investment Industry Regulatory Organization of Canada (IIROC) and the
    Canadian Securities Administrators (CSA) took the position that
    limiting the use of off-exchange trading was critical to maintaining
    the quality of the price discovery process and adopted new rules which
    went into effect on October 15, 2012. http://www.bcsc.bc.ca/
    uploadedFiles/securitieslaw/policy2/23-
    405%20Dark%20Liquidity%20in%20the%20Canadian%20Market.pdf. Rosenblatt
    Securities indicated the portion of Canadian equity trading done by
    dark pools was 2.06 percent in November 2012, down from 5.67 percent in
    September 2012. Rosenblatt Securities, ``Let There Be Light'', December
    19, 2012.
         \2\ Off-exchange dark trading grew from 19.5 percent in October
    2007 to a record level of 36.6 percent as of January 2013, including
    38.5 percent in Nasdaq-listed securities. Off-exchange trading has
    increased 300 basis points in only two months since October 2012.
    Moreover, as of January 2013, approximately 3800 securities (49 percent
    of total securities) have over 40 percent of volume traded off-exchange
    (CTA).
    ---------------------------------------------------------------------------
        We are concerned about the aggregate effect of dark or
    internalized activity on the overall U.S. marketplace, mainly
    the effect on spreads and volatility, as noted in recent
    research by the CFA Institute and Professor Daniel Weavers of
    Rutgers Business School \3\--especially in the thousands of
    less actively traded securities, as well as the selection bias
    in orders that do make it to public markets. Moreover, the
    Joint CFTC-SEC Advisory Committee urged the SEC to review the
    issue of internalization/dark trading in 2010. \4\ Changes such
    as these are also in line with a key objective of Regulation
    NMS (Reg. NMS), namely displayed order protection. \5\
    ---------------------------------------------------------------------------
         \3\ http://www.cfapubs.org/doi/abs/10.2469/ccb.v2012.n5.1; http://
    papers.ssrn.com/sol3/papers.cfm?abstract_id=1846470
         \4\ In a summary report on Recommendations Regarding Regulatory
    Responses the Market Events of May 6, 2010, the Joint CFTC-SEC Advisory
    Committee noted that ``the impact of the substantial growth of
    internalizing and preferencing activity on the incentives to submit
    priced order flow to public exchange limit order books deserves further
    examination'' and recommended the SEC review whether to ``adopt its
    rule proposal requiring that internalized or preferenced orders only be
    executed at a price materially superior (e.g., 50 mils for most
    securities) to the quoted best bid or offer. http://www.sec.gov/
    spotlight/sec-cftcjointcommittee/021811-report.pdf
         \5\ In the rule the Commission stated: ``The Commission agrees
    that strengthened protection of displayed limit orders would help
    reward market participants for displaying their trading interest and
    thereby promote fairer and more vigorous competition among orders
    seeking to supply liquidity.'' http://www.sec.gov/rules/final/34-
    51808.pdf

    Q.2. What is an example of an order type that the NYSE has
    created to make our markets better, and improve transparency
    and price discovery? How does this order type provide equal
    access? Does the NYSE allow dark or undisplayed orders or
    ---------------------------------------------------------------------------
    provide dark execution? Why or why not?

    A.2. The number and characteristics of order types offered by
    exchanges has been of recent discussion in the press and within
    the industry. It is important to note the overarching market
    structure context within which new order types are created, not
    the least of which is the competitive and complex dynamic among
    Exchanges and non-Exchange participants that is fostered by
    inequitable regulation. Among other things, we develop order
    types to allow clients to control how their orders interact
    with others in a complicated market environment. Many order
    types are developed to help participants comply with
    requirements of Reg. NMS, while others enable a participant to
    control their execution costs. More recently and significantly,
    Exchanges have developed order types to attempt to compete with
    practices that are allowed by non-Exchange venues, some of
    which are undisplayed. One of these order types, and perhaps
    the newest and most innovative in our suite of order types, is
    the RLP order.
        The Retail Liquidity Program (RLP), which was approved in
    July 2012, gives retail investors the ability to receive price
    improvement at a sub-penny increment of at least $0.001 in an
    exchange environment. In comparison, off-exchange venues have
    been permitted to segment customer order flow, and trade in
    sub-penny increments, without limits since the inception of
    Reg. ATS. Approval of this relatively simple and beneficial
    order type took several months to develop and discuss with the
    SEC before the 240 day public process that took place once we
    publicly filed the proposal with the Commission. Prior to the
    existence of RLP, exchanges were not permitted to target
    specific customer segments, even where there could be
    significant benefits to the retail investing public. While
    arguments can be made about whether sub-penny executions and
    segmentation are the ``right'' market structure, in general we
    firmly believe that exchanges should be able to compete on
    equal footing with other venues when the investing public can
    benefit from price improvement in a competitive, liquid price
    discovery process.
        The development, testing, and approval process for a new
    exchange order type is extensive and lengthy--sometimes taking
    a year or more to receive SEC approval. Exchange orders types
    are required to be available to members on a fair and
    reasonable basis and are detailed in SEC rule filings which are
    published for public comment and subject to the scrutiny of our
    direct competitors. \6\ By contrast, ATSs and brokers offering
    ``dark'' or internalized trade execution services do not
    publicly disclose details about how their trading functionality
    works, including order ranking and execution rules, and the
    algorithms and order types offered to clients are not subject
    to prior public comment, SEC approval, or even SEC review.
    These participants use their regulatory advantage as a
    competitive edge to develop order functionality and this often
    drives client demands for Exchange order types.
    ---------------------------------------------------------------------------
         \6\ NYSE Euronext operates three equity exchanges in the U.S.,
    NYSE, NYSE MKT (MKT), and NYSE Arca (Arca), each of which publicly
    discloses all order types in SEC-approved rule filings and on our
    publicly available Web site. http://usequities.nyx.com/markets/nyse-
    equities/order-types; http://usequities.nyx.com/markets/nyse-arca-
    equities/order-types
    ---------------------------------------------------------------------------
        Overall, to the extent an initiative develops to
    ``streamline'' the number of order types, the most effective
    way to accomplish this would be through a simplification across
    all market venues of the underlying market structure that gave
    rise to the proliferation of order types.

    Q.3. Rule 612 of Regulation NMS prevents sub-penny quoting.
    However, under an exemption in Rule 612 the SEC actually allows
    broker-dealers to execute orders in sub-penny increments.
    Because there are no quoting obligations for broker-dealer
    internalization, broker-dealers can provide price improvement
    to their customers in the form of sub-penny executions. What
    are advantages or disadvantages of sub-penny quoting? Is
    special pricing good for retail investors? Why or why not?

    A.3. Sub-penny quoting and trading raise two separate but
    interrelated issues. First is the ability for certain venues to
    trade in sub-penny increments. The second is whether quoting
    should similarly be allowed down to the sub-penny level.
        Our primary viewpoint is that the rules applying to sub-
    penny trading and quoting should be consistent across venues,
    regardless of the market participant utilizing it. From a
    public policy perspective, if sub-penny trading is allowed in
    non-Exchange venues, we believe similar conventions should be
    allowed in Exchange venues also. On a related note, as we've
    highlighted elsewhere, we worry about the rising level of
    activity that trades in front of visible, displayed liquidity
    and would suggest that a minimum amount of price improvement be
    required for this convention. Until the RLP program, Exchanges
    were only permitted to offer midpoint executions to its
    members. However, in August 2012, under the RLP program, for
    the first time an Exchange was allowed on a pilot basis to
    permit the execution of retail orders in sub-penny increments
    at a minimum of $.001 to mirror some of what occurs in
    internalization. \7\ However, the RLP program remains far more
    restrictive than broker internalization, and is currently
    limited to a small segment of the marketplace. Despite the
    positive impact it may have on the retail investor, the RLP
    program only accounted for 0.14 percent of consolidated volume
    in December 2012.
    ---------------------------------------------------------------------------
         \7\ SEC Release No. 34-67347: http://www.sec.gov/rules/sro/nyse/
    2012/34-67347.pdf.
    ---------------------------------------------------------------------------
        The related question is whether sub-penny quoting should be
    allowed alongside sub-penny trading. This is also the topic of
    an upcoming SEC Roundtable, and should also be considered in
    the context of our previous point. However our basic view is
    that to the extent sub-penny trading continues to be allowed,
    then a more fair market structure would be to similarly provide
    for sub-penny quoting. While we agree with many of the negative
    implications of sub-penny quoting--such as investor confusion,
    a noneconomic denomination, quote traffic implications--we
    believe the current structure puts the public markets are at a
    significant competitive disadvantage that should be addressed.
        The chart below shows sub-penny trading (excluding mid-
    point executions) in securities priced above $1 rose from 2.7
    percent in January 2006 to 10.5 percent of volume in January
    2013. In securities priced between $1 to $5, sub-penny trading
    (excluding mid-point executions) rose from 3.3 percent in
    January 2006 to 14.0 percent in January 2013. Nearly all sub-
    penny trading (excluding mid-point executions) occurs off-
    exchange.

    Q.4. Does the larger percentage spread in low-price stocks lead
    to greater internalization by OTC market makers or more trading
    volume in dark pools? If so, why? Should the Commission
    consider reducing the minimum pricing increment in Rule 612 for
    lower priced stocks?

    A.4. We believe the current penny quoting requirement has
    created artificially wide spreads in many liquid low-priced
    stocks where there is significant internalization. \8\ There
    are two primary ways to potentially alter this dynamic--one by
    decreasing the minimum tick increment, and the other by
    incentivizing displayed public liquidity over that traded
    privately, as we have highlighted in our previous answers.
    Reducing the minimum pricing increment in liquid low-priced
    securities would lower investor trading costs and improve
    market transparency. In contrast to the ``one size fits all''
    approach of the U.S., many countries have adopted tiered tick
    sizes based on the price level of a stock, with tick increments
    less than a penny.
    ---------------------------------------------------------------------------
         \8\ http://www.sec.gov/spotlight/regnms/
    jointnmsexemptionrequest043010.pdf
    ---------------------------------------------------------------------------
        The decision to internalize a trade is influenced by the
    trade-off of profit opportunity versus ``risk'' assumed. In
    general, the wider the spread in a lower-priced stock, the more
    profit opportunity and incentive to internalize. This incentive
    is further distorted to the extent there are differing
    increment rules on different types of venues, and also to the
    extent venues are allowed to trade in front of displayed
    liquidity in sub-penny increments.
        The other contributing factor to greater internalization in
    low-price stocks is the uniform access-fee cap of $.0030 per
    share that applies across all stocks as defined in Regulation
    NMS. Some thought should be given to reducing the access-fee
    cap in these stocks commensurate with either price or spread.

    Q.5. Some commentators have suggested that the Securities and
    Exchange Commission (SEC) should lift the ban on locked
    markets. Locked markets occur when a trader attempts to place a
    bid on one exchange at the same price as an offer on a
    different exchange. They argue that bids and offers at the same
    price but different venues should be forced to interact, and
    this could reduce fragmentation in the marketplace and perhaps
    reduce the prevalence of trading in dark pools and
    internalization venues. What is your view of this proposal?

    A.5. Prior to Reg. NMS market centers were allowed to display
    quotes that locked or crossed other markets for NASDAQ-listed
    securities. Commenters at that time noted that locked/crossed
    markets could cause investor confusion and detract from market
    efficiency and were prohibited within Regulation NMS. Recently,
    some market participants have suggested that locked markets
    should potentially be allowed as a way to reduce fragmentation
    and internalization.
        We agree that the current market structure has incentivized
    too much fragmentation and executions purely based on the
    public market quotes. There are several ways to potentially
    address this issue, some of which have been addressed in our
    previous responses. Locked markets are another way to
    potentially reduce the fragmentation incentive by decreasing
    the potential profit opportunity from internalizing, and/or
    reducing the need for a similar number of protected quotes.
        As with any proposed changes, it is important to evaluate
    both the positives and negatives of any changes. On the
    positive side, locked markets would make transparent more
    trading interest--nondisplayed buy and sell orders on market
    centers that are executable but not currently eligible for
    display. Locked markets would also reduce trading costs by
    eliminating the spread and would potentially simplify some
    order types that were developed to comply with Reg. NMS rules.
        However, on the negative side, we specifically worry that
    locked markets would become common in many active securities
    that continually quote at a penny spread today, potentially
    creating investor confusion.
        The benefits and concerns resulting from locked markets
    need to be carefully considered as part of a holistic review of
    U.S. equity market structure. Other potential alternatives to
    allowing locked markets exist and should be considered. These
    include depth-of-book protection as well as other suggestions
    highlighted in other responses such as incentivizing displayed
    liquidity and/or introducing consistent trade and quote
    increments in the industry.

    Q.6. Internalizing broker-dealers often pay retail brokers to
    direct customer orders to their trading venues. Does this
    practice advantage or disadvantage retail investors? Why or why
    not? Why is retail flow valuable to trade against?

    A.6. Trading with retail flow is regarded as advantageous for
    two reasons--on average, the ``informational'' content tends to
    be lower than other types of order flow encountered in the
    market, and secondly, retail flow tends to be smaller and have
    less liquidity impact in a given stock. When a small order is
    sent by an institutional client, it is often a part of a larger
    order, and the counterpart interacting with the first order
    does not know that there will be significantly more stock
    behind it.
        Payment for order flow is an issue that has been widely
    debated in the industry and also warrants further ongoing
    review due to the inherent conflicts that exist when the
    payment is not directly accruing to the end investor. It is
    also important that payment for flow not be viewed in
    isolation. Payment for order flow, price improvement, and
    access fees are interrelated topics that should be dealt with
    concurrently.
        The traditional retail internalization model that exists
    today is primarily done through the interaction of retail
    market orders with a single wholesaler. Internalization is
    beneficial to the individual retail counterparty to the trade
    if the execution results in meaningful price improvement.
    However, internalization deprives both retail and institutional
    limit orders displayed on exchanges from interacting with those
    orders. The markets and price discovery optimally function
    through interactions with multiple, diverse market
    participants. When there is a proper mix of market
    participants, there is a greater incentive for market makers to
    quote more aggressively than a single participant. This
    incentive affords investors an opportunity to receive a
    superior fill on an exchange, one of the primary drivers behind
    the development of our RLP program. The Exchange environment
    brings competition from multiple liquidity providers, which
    offers retail investors greater price improvement potential,
    while also continuing to protect displayed quotes, which is
    fundamental to preserving market quality for all investors.

    Q.7. Broker-dealers that operate their own dark pools can get a
    fee advantage when they route customer orders through their own
    dark pools rather than through a lit exchange. Does this create
    a conflict of interest between investors, who want to buy or
    sell stocks at the best prices, and brokers, who want to avoid
    exchange fees? Why or why not?

    A.7. There are two related topics that this question raises.
    The first is one of best execution and whether the interests of
    the customer are being put first. The second is a broader
    question about the cumulative impact of these practices on
    overall market quality.
        There are 13 equity exchanges offering a wide variety of
    fee choices for customers. Some exchanges offer high rebates to
    encourage liquidity providing and charge corresponding fees to
    remove liquidity. Under this model, investors who take
    additional risk by posting liquidity and showing their
    investment interest may be rewarded as price makers through a
    rebate. Investors who do not want to set prices but rather only
    act as takers of liquidity are charged a fee. This model was
    created by exchanges as a way to incentivize market
    participants to make public markets and assist in the price
    discovery process. This mechanism has become increasingly
    depended upon by exchanges as the more highly desired order
    flow from retail and institutional investors is executed in
    dark trading venues. Several exchanges also offer low take fees
    or even rebates to remove liquidity--minimizing the incentive
    for brokers to avoid exchanges simply because of fees.
        As noted in the previous response, investors trading
    through a single private broker venue may not be optimizing
    their execution if the reason is to avoid exchange take fees or
    to maximize business in the broker-dealer owned dark pool. In
    an exchange environment, however, the order would be exposed to
    competitive participants within a transparent environment with
    a real chance for execution optimization.
        As was expressed by Invesco's Chief Investment Officer
    during the June 2012 House Financial Services Committee's
    hearing, internalization whereby the broker-dealers garner
    information advantages creates a conflict of interest that they
    believe does not advantage the investor. \9\ Similar conflict
    and disclosure issues were also recently raised by FINRA. \10\
    ---------------------------------------------------------------------------
         \9\ http://financialservices.house.gov/uploadedfiles/hhrg-112-
    ba16-wstate-kcronin-20120620.pdf
         \10\ 2013 Regulatory and Examination Priorities Letter: http://
    www.finra.org/web/groups/industry/@ip/@reg/@guide/documents/industry/
    p197649.pdf.
    ---------------------------------------------------------------------------
        More significantly, however, is the effect this aggregate
    activity has on overall market quality. As outlined in recent
    research by Tabb Group and the CFA Institute, \11\ the
    incentive to segment markets and reduce transparency
    jeopardizes the price discovery process and can adversely
    impact costs for all investors. Contrary to the stated goals of
    Reg. NMS, today's market structure incentives result in
    increasingly higher levels of dark trading in broker owned
    venues, resulting in increased conflicts between investors and
    their executing brokers.
    ---------------------------------------------------------------------------
         \11\ Tabb Group, ``A Spotlight in the Dark: An Inevitable
    Debate'', p. 8, Exhibit 4, November 2012; http://www.cfapubs.org/doi/
    abs/10.2469/ccb.v2012.n5.1.

    Q.8. The U.S. exchanges are required to submit data to a
    centralized network where it is aggregated before being
    disseminated to the public. However, the Consolidated Tape
    Association/Securities Information Processor or SIP now lags
    behind direct proprietary market data feeds. As a result, high
    frequency trading firms and other market participants now
    usually colocate their computer servers at every exchange and
    subscribe to proprietary data feeds offered by the exchanges in
    order to capitalize on latency arbitrage opportunities. Why
    should anyone receive market data flow from other than the
    consolidated tape? Should market data be distributed to all
    market participants equally? How do you think this can best be
    ---------------------------------------------------------------------------
    accomplished?

    A.8. The consolidated tape data feeds include the best-priced
    quotations of all exchanges and all reported trades, as well as
    the calculation of the NBBO, short sales restriction
    indications, single stock circuit breaker indicators, and other
    data. Proprietary data feeds of individual exchanges include
    those exchanges' own best-priced quotations and trades as well
    as other information not available through the consolidated
    tape, such as depth-of-book prices, which are required for
    trading larger or more sophisticated orders, particularly in a
    Regulation NMS environment. Because of these differences,
    market participants may choose to take market data from the
    consolidated tape and/or directly from exchanges or other
    vendors, depending on their individual needs. In any event, the
    SEC has to approve exchanges' proprietary data products before
    they are sold to the public, and one of the general
    requirements for approval is that the data is indeed fairly and
    equally accessible to those that want to subscribe to the data
    feeds. Moreover, speed differences from a user perspective are
    not unfair or unusual. Because the data that exchanges send to
    the securities information processors (SIPs) is consolidated by
    the SIPs and then redistributed, the information in the
    proprietary data feeds of exchanges is permitted to reach
    market participants faster than the information sent from the
    SIP to the same market participants. Indeed, this was expressly
    contemplated in Regulation NMS where the SEC noted:

            Commenters were concerned about the statement in the
            Proposing Release that the distribution standards would
            prohibit a market from distributing its data
            independently on a more timely basis than it makes
            available the ``core data'' that is required to be
            disseminated through a Network processor. Instinet, for
            example, requested that the Commission clarify that the
            proposal would not require a market center to
            artificially slow the independent delivery of its data
            in order to synchronize its delivery with the data
            disseminated by the Network. Adopted Rule 603(a) will
            not require a market center to synchronize the delivery
            of its data to end-users with delivery of data by a
            Network processor to end-users. Rather, independently
            distributed data could not be made available on a more
            timely basis than core data is made available to a
            Network processor. Stated another way, adopted Rule
            603(a) prohibits an SRO or broker-dealer from
            transmitting data to a vendor or user any sooner than
            it transmits the data to a Network processor. \12\
    ---------------------------------------------------------------------------
         \12\ See, SEC Release No. 34-51808; File No. S7-10-04 at p. 271
    (August 29, 2005).

        Further, in the SEC's 2010 Concept Release on Equity Market
    Structure, the Commission commented the average latency for the
    consolidated data feeds was generally less than 10 milliseconds
    at that time. This latency captures the difference in time
    between receipt of data by the SIP from the exchanges and
    distribution of the data by the SIP to the public. Since that
    time, continued improvements have been made to the SIP's
    processing and today the average quote latency is less than 1
    millisecond for Tape A&B securities and less than 2
    milliseconds for Tape C securities (such data is made publicly
    available on a quarterly basis). [http://www.nyxdata.com/CTA]
    We would note that the amount of data sent via proprietary
    feeds is far greater than on the consolidated feed, so the cost
    of telecommunications and the time to process this data when
    received is higher as well. Given these differences, we believe
    the provision of consolidated and proprietary data is largely
    ---------------------------------------------------------------------------
    about choice for customers.

    Q.9. The October closure of the markets for 2 days due to
    Hurricane Sandy raised questions about the financial sector's
    preparedness for the next natural or man-made disaster. What
    challenges did the markets face in reopening after Hurricane
    Sandy? What should have been done differently after Hurricane
    Sandy to keep providing trading services to customers and
    maintain market integrity? What can the stock exchanges do to
    prepare the market for another disaster? What changes need to
    be made by market participants and regulators?

    A.9. The effects of Hurricane Sandy on the northeast were
    devastating. Lives were lost and thousands of families were
    displaced. The markets faced several challenges leading up to
    and during Hurricane Sandy. Reports called for a severe storm
    with massive flooding, widespread power outages, the shutdown
    of major transportation methods and dangerous travel
    conditions. In retrospect, all of these reports came true.
    Further, many of the largest financial service companies,
    exchanges, the securities clearinghouse (DTCC), and countless
    related smaller firms are headquartered in areas that expected
    a severe impact. The storm was forecast to affect such a wide
    area that many firms had both their primary and backup
    facilities within the affected region.
        NYSE senior management was in contact with the SEC,
    industry trade associations, member firms, and other exchanges
    throughout the weekend of October 27th and October 28th to
    consider the challenges posed by the forecasted hurricane. In
    the end, this group collectively decided that the risk/reward
    of opening the market while all industry participants with a
    local footprint would operate in contingency seemed
    inconsistent with providing a stable, liquid market.
        Following the hurricane, the challenges faced by the
    markets were primarily borne by industry personnel. While the
    markets re-opened on October 31st, industry personnel faced
    significant obstacles common to all residents of the
    surrounding area. Power and communication outages hampered
    people's ability to work remotely. Access and transportation to
    certain areas like lower Manhattan were severely restricted.
    Basic necessities in these areas like lodging and food
    presented some challenges initially. There was significant
    damage to communications around lower Manhattan and surrounding
    areas. While there were many challenges to overcome, we note
    that the markets re-opened without incident on October 31st.
        There are several lessons to be learned from this event. At
    a minimum, businesses learned the importance of a well-prepared
    and tested business continuity plan. At NYSE Euronext, we are
    actively considering changes to our current disaster recovery
    model for NYSE and NYSE MKT. The exchanges can take steps to
    both review BCPs and regularly test backup trading locations.
    Regular testing should both include a test of connectivity with
    exchange backup facilities and cause minimal disruption to the
    financial markets or its' participants. The industry should
    consider whether to make these tests mandatory for all
    participants. Industry conversations are underway to assess
    lessons learned and prepare for similar events.

    Q.10. It has recently been reported that the SEC's Interim
    Inspector General found that some staff in the SEC's Trading
    and Markets Division did not encrypt computers containing
    confidential data from the exchanges and clearing agencies they
    were overseeing. What measures are being taken now or should be
    taken by market participants and regulators to better secure
    data in today's high tech markets?

        NYSE Euronext is committed to providing our customers with
    a secure network delivering the highest levels of reliability
    in the industry. The reliability and availability of NYSE
    Euronext's Secure Financial Transaction Infrastructure (SFTI)
    is dependent upon many dynamics including the prevention of
    security breaches and cyber attacks. The security problems
    uncovered through the SEC's Inspector General Report were
    unfortunate and deeply concerning to NYSE Euronext, however we
    believe the important outcome is that the SEC appears to be
    taking steps to prevent a similar situation from occurring
    again the future. We also support a more targeted approach to
    regulator accumulation of entity data to ensure that any
    security issues have more limited impact.
        As witnessed by several high profile cyber security
    breaches during the past several years, the Federal Government
    has developed a notification process that includes a number of
    agencies including the SEC, CIA, FBI, and DHS. NYSE Euronext is
    supportive of these coordinated efforts by Federal agencies and
    will continue to be partner with them in securing our financial
    markets.
        As offered during the hearing, we would also like to take
    the opportunity to clarify the record on some of the
    representations and data provided by the Credit Suisse witness.
    We believe the below clarifications will provide a more
    accurate depiction of the facts.

    Point 1--Levels of ``Off-Exchange'' Trading

        Mr. Daniel Mathisson of Credit Suisse offered in his
    testimony that the ``statement that volume has been moving to
    off-exchange venues . . . is factually incorrect. Over the past
    5 years, volume has not shifted to off-Exchange venues.'' \13\
    We strongly disagree.
    ---------------------------------------------------------------------------
         \13\ Written Testimony of Daniel Mathisson of behalf of Credit
    Suisse, Before the Senate Banking Committee Subcommittee on Securities,
    Insurance, and Investment ``Computerized Trading Venues: What Should
    the Rules of the Road Be?'', December 18, 2012.
    ---------------------------------------------------------------------------
        Credit Suisse's conclusions rely on data that incorporates
    a misleading and narrowly focused definition of ``off-
    exchange'' and ``on-exchange'' trading: literally, whether a
    market was registered as an exchange or not during the relevant
    time frame. In particular, Mr. Mathisson includes BATS and
    Direct Edge, which were ``Electronic Communication Networks''
    or ECNs in the ``off-Exchange'' category. These ECNs displayed
    public quotes and participated in price discovery in a way that
    was very similar to exchanges, and subsequently became
    registered exchanges. \14\
    ---------------------------------------------------------------------------
         \14\ BATS became a national securities exchange in October 2008
    and Direct Edge spun off the EDGA/EDGX exchanges in July 2010.
    ---------------------------------------------------------------------------
        Under a more accurate and accepted measurement methodology
    for ``off-Exchange'' trading, such ``off-Exchange'' activity
    would not include ECNs such as BATS and Direct Edge. When
    measured correctly, ``off-Exchange'' trading, which would only
    include dark pools and internalization desks, rose from 19.5
    percent in October 2007 to 35 percent in December 2012 and 37
    percent in January 2013, as shown in Figures 1 and 2. Similar
    classifications were highlighted in recent reports by Tabb
    Group and Rosenblatt Securities. \15\
    ---------------------------------------------------------------------------
         \15\ Tabb Group, ``A Spotlight in the Dark: An Inevitable
    Debate'', p. 8, Exhibit 4, November 2012; Rosenblatt Securities, U.S.
    Securities Volume: Year-In-Review, January 4, 2013.
    ---------------------------------------------------------------------------
        Mr. Mathisson also commented that dark pool activity has
    increased, but ``other internalization'' \16\ has declined.
    This statement also is misleading. Dark pool activity has
    indeed tripled from 4 percent to 13 percent of total volume
    over the cited period. However, what Mr. Mathisson refers to as
    ``other internalization'' has risen from 12 percent to 21
    percent of total U.S. trading activity from between January
    2008 and December 2012, as shown in Figure 2.
    ---------------------------------------------------------------------------
         \16\ Other internalization generally includes trades matched
    internally by broker-dealers based on the public quote. While these
    market-makers maintain various quoting and pricing obligations to their
    own client's orders, the desk may step in front of exchange-displayed
    orders by simply matching the displayed price. This can occur either on
    their client's behalf or for their own account (Tabb Group, ``A
    Spotlight in the Dark: An Inevitable Debate'', November 2012).

    Source: Rosenblatt Securities, Consolidated Tape Association.
    Note: Total Off-Exchange Trading excludes BATS and DirectEdge
    as they operated as ECNs at that time.

    Point 2--SRO Immunity

        In his written testimony, Mr. Mathisson stated that (1)
    ``courts have traditionally afforded exchanges `absolute
    immunity' from civil liability for damages arising in
    connection with their regulatory operations''; (2) ``It is a
    dangerous situation when a for-profit enterprise can cause half
    a billion dollars of losses for others, and not have the risk
    of being held legally liable''; and (3) that ``Exchanges have
    absolute immunity on errors . . . '' [emphasis added]. \17\
    ---------------------------------------------------------------------------
         \17\ Written Testimony of Daniel Mathisson of behalf of Credit
    Suisse, Before the Senate Banking Committee Subcommittee on Securities,
    Insurance, and Investment ``Computerized Trading Venues: What Should
    the Rules of the Road Be?'', December 18, 2012.
    ---------------------------------------------------------------------------
        These statements are flatly inaccurate and warrant
    clarification.
        Exchanges do have immunity from private lawsuits for
    damages when engaging in conduct consistent with the quasi-
    governmental powers delegated to them pursuant to the Exchange
    Act, and we believe that this well-developed doctrine is
    critical to ensuring that exchanges are protected when
    fulfilling those statutorily delegated powers. However,
    exchanges still answer to the SEC for their conduct, and can
    and have been fined by their primary regulator. This is true
    regardless of whether immunity applies in particular cases.
        Separately, we have commercial limits of liability in place
    with our members, which are governed by rules and membership
    agreements approved by the SEC. These rules and agreements
    enable members to be reimbursed for certain types of errors
    made by the exchange. Moreover, these rules are submitted to
    the normal notice-and-comment process required by the Exchange
    Act, which gives the public--including our members--the
    opportunity to voice concerns about the exchange's rules.

    Point 3--Tape Revenue for Consolidated Market Data

        In his written and oral testimony, Mr. Mathisson/Credit
    Suisse asserts that, ``The CTA (Consolidated Tape Association)
    has a legal monopoly on providing a consolidated stream of
    real-time data from our Nation's stock markets. The CTA makes a
    profit of approximately $400m per year which is then
    distributed to its participant exchanges based on a complex
    formula. ATSs do not receive tape revenue'' [emphasis added].
    \18\ Mr. Mathisson later alleges that `` . . . the exchanges
    are entitled to market data revenues to offset the costs of
    regulating their markets . . . [and] revenues from market data
    are way out of proportion with the costs of exchanges' self-
    regulatory responsibilities.'' The citation for this statement
    is the SEC's 1999 Concept Release: Regulation of Market
    Information Fees and Revenue, Exchange Act Release No. 42208
    [hereinafter SEC 1999 Market Data Concept Release]. Finally Mr.
    Mathisson/Credit Suisse alleges that ``[b]ecause the CTA
    allocated revenue to the exchanges is based on a complex
    formula involving variables such as each exchange's number of
    quotations, for-profit exchanges try to set policies and
    services that will increase the level of quoting activity.''
    \19\ Mr. Mathisson/Credit Suisse claims that a by-product of
    these alleged policies is quote flickering. These claims
    require clarification:
    ---------------------------------------------------------------------------
         \18\ Written Testimony of Daniel Mathisson of behalf of Credit
    Suisse, Before the Senate Banking Committee Subcommittee on Securities,
    Insurance, and Investment ``Computerized Trading Venues: What Should
    the Rules of the Road Be?'', December 18, 2012.
         \19\ Written Testimony of Daniel Mathisson of behalf of Credit
    Suisse, Before the Senate Banking Committee Subcommittee on Securities,
    Insurance, and Investment ``Computerized Trading Venues: What Should
    the Rules of the Road Be?'', December 18, 2012.

      1.  While the CTA plan does not directly pass tape revenue to
            non-Exchange participants, the two FINRA TRFs rebate an
            estimated $50 to $60 million in tape revenue annually
            back to brokers, including ATSs and broker-dealer
    ---------------------------------------------------------------------------
            internalizers.

      2.  The SEC 1999 Market Data Concept Release was not a
            rulemaking or adjudication by the SEC--it was an
            invitation for comment on matters the SEC was
            considering, and it did not result in rulemaking. In
            addition, the SEC 1999 Market Data Concept Release
            repeatedly refers to the market data pool as being used
            to fund ``the market's operation and regulation''
            [emphasis added]. As such, it is not accurate to
            represent that the SEC expressed a view, even in the
            context of the SEC 1999 Market Data Concept Release,
            that market data fees are exclusively meant to fund
            regulation.

      3.  The market data allocation formula is not based on an
            ``exchange's number of quotations,'' but instead is
            partly based on dollar size and the amount of time at
            the NBBO (i.e., quoting share), which accounts for 50
            percent of the allocation formula. The other 50 percent
            allocation is based on trading share. This allocation
            formula was established by the SEC in Reg NMS to
            incentivize both price discovery and market quality.
            Importantly, the formula requires that a quotation must
            be displayed for a minimum of one full second to earn
            quote credits. \20\ This minimum time period was put in
            place by the SEC specifically to prevent quote
            flickering. In this regard, the SEC stated in its
            explanation to commenters that opposed the need for a
            market data plan formula, `` . . . the Commission's
            primary objective is to correct an existing flaw in the
            current formulas by allocating revenues to those SROs
            that, even now, benefit investors by contributing
            useful quotations to the consolidated data stream.''
            \21\ As such, we believe it is incorrect to assert that
            the SEC market data allocation formula incentivizes
            quote flickering.
    ---------------------------------------------------------------------------
         \20\ http://www.sec.gov/rules/final/34-51808.pdf
         \21\ http://www.sec.gov/rules/final/34-51808.pdf, p. 264.

        More broadly, as noted in our oral testimony, registered
    exchanges operate under a regime of obligations and benefits.
    These obligations are significant, and include: rule filing
    obligations, restrictions on business operations, the inability
    to transact with public customers, member ownership
    limitations, fair access and self-regulatory obligations. Mr.
    Mathisson and Credit Suisse seem to argue that any economic
    incentives associated with the fulfillment of these important
    obligations should be allocated to the broker-dealers and
    investment banks and not to the exchanges that bear these
    significant regulatory obligations that benefit the industry
    and subsequently, the public.
        As stated in our testimony, we would welcome a holistic
    review of our current U.S. market structure, including the
    benefits and obligations of registered exchanges and broker-
    dealers; however we would caution that the investment banks'
    and broker-dealers' economic self-interests should not be the
    linchpin upon which investor protection rests.
        Thank you again for the opportunity to testify and provide
    our thoughts. We would be happy to answer any additional
    questions that you may have.
                                    ------

            RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN REED
                         FROM DANIEL MATHISSON

    Q.1. There was testimony that ``dark trading'' is a concern in
    many countries and that Canada recently modified its market
    structure to limit dark trading and to maximize price
    discovery. Canadian regulators have imposed a new framework
    governing how dark pools and undisplayed orders are allowed to
    operate including priority of lit over dark flow and a minimum
    price improvement requirement for dark orders. What is your
    view of these reform proposals? Would these measures make the
    U.S. markets more or less fair and transparent? Please explain.
    Would these measures be feasible in the U.S. markets? Why or
    why not?

    A.1. Canada rolled out new rules in October of 2012 that were
    intended to limit broker-dealer crossing platforms. The new
    rules forced several market participants to either exit
    Canadian markets (e.g., Goldman Sachs Sigma X) or drastically
    alter their business models (e.g., TSX Alpha Intraspread).
    According to the Rosenblatt Report released on December 19th
    2012, combined dark volumes in Canada fell significantly to
    2.06 percent in November, from 3.54 percent in October and an
    original 5.67 percent of equity trading volume in September
    before the new framework went into effect. While it appears the
    new rules have skewed the competitive environment, hurting
    Canadian ATS operators and helping exchanges, we have seen no
    empirical evidence that this change has been beneficial for
    investors.
        We believe that the U.S. regulators should carefully review
    any future academic studies that demonstrate how the Canadian
    change has impacted liquidity, price stability, bid/ask
    spreads, and other empirical measures of market health. In the
    absence of evidence that the rule change has helped investors,
    it would not make sense for the U.S. to blindly follow Canada's
    lead. We believe that a rule change like this would have a
    major impact on the existing market structure, and this should
    only be considered as part of a comprehensive market reform
    that reviews the entire competitive landscape of the for-profit
    exchanges and broker-dealers.

    Q.2. Rule 612 of Regulation NMS prevents sub-penny quoting.
    However, under an exemption in Rule 612 the SEC actually allows
    broker-dealers to execute orders in sub-penny increments.
    Because there are no quoting obligations for broker-dealer
    internalization, broker-dealers can provide price improvement
    to their customers in the form of sub-penny executions. What
    are advantages or disadvantages of sub-penny quoting? Is
    special pricing good for retail investors? Why or why not?

    A.2. We believe that sub-penny trading is net beneficial for
    retail clients, as well as for institutional clients. In the
    current market structure, retail clients typically receive an
    immediate fill at a price slightly better than the bid or
    offer. For example, if Ford Motors is showing a 13.83 offer, a
    retail client buying 2,000 shares would often receive a fill
    of, say, 13.829, saving a small amount of money on the
    transaction vs. the offer price. Known as ``price
    improvement,'' those small amounts can add up to significant
    sums over a lifetime of investing.
        The SEC has recently relaxed Rule 612, by approving pilot
    programs by the NYSE and BATS Exchange which offer price
    improvement and allow sub-penny trading (``Retail Liquidity
    Program'' approved in July 2012). Since exchanges are now
    permitted to accept and rank orders in sub-penny increments in
    the RLP program, we believe broker-dealer operated Alternative
    Trading Systems should be able to do so as well.

    Q.3. Some commentators have suggested that the Securities and
    Exchange Commission (SEC) should lift the ban on locked
    markets. Locked markets occur when a trader attempts to place a
    bid on one exchange at the same price as an offer on a
    different exchange. They argue that bids and offers at the same
    price but different venues should be forced to interact, and
    this could reduce fragmentation in the marketplace and perhaps
    reduce the prevalence of trading in dark pools and
    internalization venues. What is your view of this proposal?

    A.3. While the rationale for banning locked markets under Rule
    611 of Regulation NMS Rule is to prevent trading at inferior
    prices, one of the unintended effects of Rule 611 has been the
    proliferation of exchange order types with the sole purpose of
    allowing sophisticated users to unfairly gain queue priority
    over simple limit orders. These order types have contributed to
    an increase in pinging and cancellation rates. We believe that
    lifting the ban on locked markets would greatly simplify the
    U.S. equity markets and possibly lead to better execution
    results for investors. We recommend that the SEC implement a
    pilot program lifting the ban on locked markets in several NMS
    symbols to conduct analysis and gather empirical data to
    measure the effects and impact to the markets.

    Q.4. Internalizing broker-dealers often pay retail brokers to
    direct customer orders to their trading venues. Does this
    practice advantage or disadvantage retail investors? Why or why
    not? Why is retail flow valuable to trade against?

    A.4. Retail investors are advantaged by the current system,
    where brokers are allowed to engage in market-making. Market-
    makers typically pay rebates to retail brokers for order flow,
    which allows the retail brokers to charge very low commissions
    to the end customer. Market-makers typically provide better
    quality of execution than exchanges, as execution quality
    statistics are made public under SEC Rule 605, resulting in
    savings for the investor.
        Retail flow is considered valuable to market-makers because
    it typically consists of a steady stream of small market
    orders. A market-maker will try to buy near the bid from client
    A and sell near the offer to client B, capturing a spread in
    the process. Market-makers prize small orders because they are
    less risky than large institutional orders.

    Q.5. Broker-dealers that operate their own dark pools can get a
    fee advantage when they route customer orders through their own
    dark pools rather than through a lit exchange. Does this create
    a conflict of interest between investors, who want to buy or
    sell stocks at the best prices, and brokers, who want to avoid
    exchange fees? Why or why not?

    A.5. This practice does not create a conflict of interest.
    Under Regulation NMS, orders in the U.S. may not ``trade
    through'' the National Best Bid Offer (NBBO), meaning that if a
    stock is offered at 18.50 on an exchange, a broker-dealer may
    not route a buy order to a venue where the order would be
    filled at 18.51 or higher. The client is guaranteed to do no
    worse than the best current price on the national market
    system. Within that significant constraint, as part of their
    best execution obligations, broker-dealers take into account
    multiple factors when deciding where to route client orders.
    These factors include the potential for price improvement, the
    speed of execution, and the likelihood that an order will be
    filled.

    Q.6. The U.S. exchanges are required to submit data to a
    centralized network where it is aggregated before being
    disseminated to the public. However, the Consolidated Tape
    Association/Securities Information Processor or SIP now lags
    behind direct proprietary market data feeds. As a result, high
    frequency trading firms and other market participants now
    usually colocate their computer servers at every exchange and
    subscribe to proprietary data feeds offered by the exchanges in
    order to capitalize on latency arbitrage opportunities. Why
    should anyone receive market data flow from other than the
    consolidated tape? Should market data be distributed to all
    market participants equally? How do you think this can best be
    accomplished?

    A.6. In an ideal system, we believe that all intraday market
    data would be supplied by the SIP. However, we recognize that
    this would create a significant disruption to the existing
    business models of the for-profit exchanges as well as many
    trading firms, and therefore regulators should carefully
    analyze and review the costs and benefits prior to changing the
    current data distribution model.

    Q.7. The October closure of the markets for 2 days due to
    Hurricane Sandy raised questions about the financial sector's
    preparedness for the next natural or man-made disaster. What
    challenges did the markets face in reopening after Hurricane
    Sandy? What should have been done differently after Hurricane
    Sandy to keep providing trading services to customers and
    maintain market integrity? What can the stock exchanges do to
    prepare the market for another disaster? What changes need to
    be made by market participants and regulators?

    A.7. The decision to close the U.S. equities markets on October
    29th and October 30th was made after serious consideration and
    with industry-wide consensus on Sunday, October 28th, as
    Hurricane Sandy was bearing down on East Coast. Several
    contingency plans were discussed, but the primary concern was
    the safety of employees. All contingency plans involved a
    number of key employees having to commute and work in areas in
    immediate danger of being flooded or destroyed.
        Most U.S. financial institutions, including Credit Suisse,
    have backup power generators and disaster recovery sites to
    maintain uninterrupted trading and customer service during
    fire, flooding, or any other event impacting the firms' primary
    location. However, given the rarity of events as severe as
    Hurricane Sandy, it would be impractical and tremendously
    costly for the entire industry to maintain fully operational,
    fully staffed alternative sites and facilities in various
    locations throughout the country. According to our research,
    during the past 100 years, the U.S. markets have been closed
    due to inclement weather only five times, including the two
    days of Hurricane Sandy. We agree that a continued focus on
    disaster recovery is prudent and necessary, but believe it is
    acceptable for the markets to close during extreme region-wide
    weather events, since these occur so rarely.
                                    ------

            RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN REED
                             FROM ERIC NOLL

    Q.1. There was testimony that ``dark trading'' is a concern in
    many countries and that Canada recently modified its market
    structure to limit dark trading and to maximize price
    discovery. Canadian regulators have imposed a new framework
    governing how dark pools and undisplayed orders are allowed to
    operate including priority of lit over dark flow and a minimum
    price improvement requirement for dark orders. What is your
    view of these reform proposals? Would these measures make the
    U.S. markets more or less fair and transparent? Please explain.
    Would these measures be feasible in the U.S. markets? Why or
    why not?

    A.1. NASDAQ OMX does not oppose all dark trading, but rather
    focuses on the need to make our markets as efficiently
    transparent as possible to ensure that the price discovery
    process is robust and that capital formation is maximized.
        NASDAQ OMX recognizes that large institutional trades
    between natural buyers and sellers should be able to occur at
    prevailing market prices outside the confines of an exchange or
    ECN in order to minimize disruption to the market. In executing
    all other types of transactions the emphasis should be on open,
    efficient, and transparent order interaction in order to ensure
    that the price discovery process is robust, broker-client
    conflicts of interest are minimized, and investor confidence
    and capital formation are maximized. These nonblock
    transactions can occur on exchanges or on ECNs. The Canadian
    policy decision to limit the use of closed alternative systems
    shows that regulators increasingly view it as important that
    open order interaction be strongly encouraged. We support
    innovative solutions like the Canadian Reforms and would like
    to see the SEC fully explore like-minded reforms here in the
    United States. Although the U.S. and Canadian markets are very
    different in scale there are common economic issues underlying
    the trading process in both markets. We view the SEC as
    appropriately positioned to weigh and balance the ramifications
    of investor protection, competition, liquidity, and regulatory
    complexity and look forward to working with them to understand
    the U.S. capital market's needs in this area.

    Q.2. What is an example of an order type that the NYSE has
    created to make our markets better, and improve transparency
    and price discovery? How does this order type provide equal
    access? Does the NYSE allow dark or undisplayed orders or
    provide dark execution? Why or why not?

    A.2. In comparison with some markets, NASDAQ adheres to a
    principle of maintaining relative simplicity in its roster of
    order types, and ensuring that the operation of all of its
    order types is well understood by market participants. To that
    end, NASDAQ recently posted a webinar describing its order
    types, freely available to market participants and other
    members of the public at http://www.brainshark.com/nasdaqomx/
    vu?pi=zF7zJ6aUZzoG0z0. Further descriptions of order type
    operation are available at http://www.nasdaqomxtrader.com/
    content/ProductsServices/Trading/Workstation/rash--
    strategy.pdf. Notably, NASDAQ does not offer any order types
    that allow an order to jump ahead of previously posted orders
    in execution priority. All order types are available to members
    on equal terms.
        NASDAQ believes that it is necessary to offer market
    participants the option of posting nondisplayed orders to
    enable NASDAQ to compete with the multiplicity of exchanges and
    alternative trading venues that offer this option, and because
    market participants representing large orders may have a
    legitimate need to use nondisplayed orders as a means to guard
    against adverse price movements. Moreover, nondisplayed orders
    that are designed to price at the midpoint between the national
    best bid and offer provide a means for market participants to
    offer price improvement to their counterparties.
        Of course NASDAQ believes that its exchange should be the
    preferred venue for price discovery of the securities that it
    lists and trades. To that end, our schedule of fees and rebates
    for order execution offers a rebate for liquidity provided
    through displayed orders that is higher, and in many instances
    significantly higher, than the rebate for liquidity provided
    through nondisplayed orders. The effect of these financial
    incentives is borne out through actual patterns of trading,
    with approximately 90 percent of executions on NASDAQ based on
    the use of displayed orders. In addition, order types that
    NASDAQ offers that are designed to reprice aggressively to
    increase the order's chances for execution are generally
    required, by their terms, to be displayed orders.

    Q.3. Rule 612 of Regulation NMS prevents sub-penny quoting.
    However, under an exemption in Rule 612 the SEC actually allows
    broker-dealers to execute orders in sub-penny increments.
    Because there are no quoting obligations for broker-dealer
    internalization, broker-dealers can provide price improvement
    to their customers in the form of sub-penny executions. What
    are advantages or disadvantages of sub-penny quoting? Is
    special pricing good for retail investors? Why or why not?

    A.3. NASDAQ believes that quoting increments must be uniform
    across all trading venues and market participants, including
    over-the-counter trading and broker-dealer internalization.
    Additionally, a one-size-fits-all increment regime is
    inefficient and ineffective; increments must be flexible and
    tailored to the characteristics of varying classes of
    securities. In fact, NASDAQ has several times urged the
    Commission to add tick increments both larger and smaller than
    those set forth in SEC Rule 612, most recently in its April
    2010 joint letter with the NYSE and other exchanges seeking an
    SEC exemption from Rule 612 for certain actively traded
    securities. No action has been taken on that request for
    exemptive relief.
        These two principles dictate a reversal of the above-
    referenced exemption from Rule 612. That exemption has
    contributed significantly to the migration of trading away from
    lit markets and into the dark markets. While broker-dealers
    claim to provide price improvement to retail orders executed in
    the dark, that price improvement may be financially immaterial
    and outweighed by the negative impact of dark trading on price
    formation and market fairness.

    Q.4. Some commentators have suggested that the Securities and
    Exchange Commission (SEC) should lift the ban on locked
    markets. Locked markets occur when a trader attempts to place a
    bid on one exchange at the same price as an offer on a
    different exchange. They argue that bids and offers at the same
    price but different venues should be forced to interact, and
    this could reduce fragmentation in the marketplace and perhaps
    reduce the prevalence of trading in dark pools and
    internalization venues. What is your view of this proposal?

    A.4. This is an interesting theoretical concept that we think
    should be considered along with other approaches as the SEC
    evaluates U.S. market structure. The spread between bid and
    offer historically existed to compensate providers of
    liquidity, typically trading professionals, for the risk and
    expense associated with posting orders to buy and sell. In a
    series of well-conceived reforms, the SEC has opened the
    process of posting orders to buy and sell to all investors. As
    investors are motivated to trade for reasons other than short
    term trading profits motivating the professional there is no ex
    ante reason that a positive bid and offer spread should exist
    in situations where investors are separated by their preferred
    locus of trading. Should such locked markets occur, as they do
    frequently under Regulation NMS today, we expect that these
    locked markets would quickly clear as brokers and traders act
    to buy or sell at a price more favorable than would otherwise
    exist. We recognize that the SEC's position on locked markets
    was driven in part by the market access fees charged by certain
    trading platforms during the time Regulation NMS was under
    consideration and that a review of the SEC's ban on locked
    markets might reasonably also include a review of the market
    access fee caps created by Regulation NMS.

    Q.5. Internalizing broker-dealers often pay retail brokers to
    direct customer orders to their trading venues. Does this
    practice advantage or disadvantage retail investors? Why or why
    not? Why is retail flow valuable to trade against?

    A.5. NASDAQ believes that the public would view negatively the
    practice of retail brokers ``shopping'' their orders to the
    highest bidder, particularly where it results almost
    exclusively in their orders being routed to and executed in
    dark markets. Notably, the overwhelming majority of retail
    investors' orders, whether entered by individuals, mutual
    funds, or pensions, are handled by sophisticated trading firms
    that are obligated to deliver best execution to such orders and
    to disclose payment arrangements. The question becomes whether
    those duties place sufficient constraints on potential
    conflicts of interest to overcome the negative perception of
    payment for order flow practices.

    Q.6. Broker-dealers that operate their own dark pools can get a
    fee advantage when they route customer orders through their own
    dark pools rather than through a lit exchange. Does this create
    a conflict of interest between investors, who want to buy or
    sell stocks at the best prices, and brokers, who want to avoid
    exchange fees? Why or why not?

    A.6. Fragmentation and darkness are eroding the quality and
    perceived fairness of U.S. markets. NASDAQ supported the
    Commission's November 2009 proposal to modify the regulation of
    nonpublic trading interest. That proposal would have attempted
    to address the problem of so-called ``dark'' pools that use
    indications of interest to, effectively, display quotes to only
    a small subset of the national market system. It also would
    have begun to address the proliferation of dark pools that has
    fostered the two-tiered market which is anathema to the public
    interest.

    Q.7. The U.S. exchanges are required to submit data to a
    centralized network where it is aggregated before being
    disseminated to the public. However, the Consolidated Tape
    Association/Securities Information Processor or SIP now lags
    behind direct proprietary market data feeds. As a result, high
    frequency trading firms and other market participants now
    usually colocate their computer servers at every exchange and
    subscribe to proprietary data feeds offered by the exchanges in
    order to capitalize on latency arbitrage opportunities. Why
    should anyone receive market data flow from other than the
    consolidated tape? Should market data be distributed to all
    market participants equally? How do you think this can best be
    accomplished?

    A.7. The U.S. national market system creates the fastest,
    deepest, most transparent and most reliable market data of any
    jurisdiction. No other market system creates aggregate data
    capturing a dollar or share volume of trading from as large a
    number of trading venues as the United States. In addition to
    aggregate data from the network processors, the flexibility
    granted by the Commission in Regulation NMS has sparked
    innovation and competition by exchanges, ATSs, and broker-
    dealers to create a previously unimagined variety of optional
    data products. This broad range of options supports an equally
    broad range of competing business models that require different
    amounts, types, and speeds of data. The coexistence of multiple
    competing business models, supported by a variety of data
    products, contributes positively to price formation and
    liquidity. In NASDAQ's view, eliminating proprietary data
    products that support competing business models would harm the
    U.S. market and investors with little or no off-setting
    benefit. Additionally, it is worth noting that market
    participants that collocate in exchange facilities serve a wide
    variety of business models, including many highly sophisticated
    firms that serve retail investors.

    Q.8. The October closure of the markets for 2 days due to
    Hurricane Sandy raised questions about the financial sector's
    preparedness for the next natural or man-made disaster. What
    challenges did the markets face in reopening after Hurricane
    Sandy? What should have been done differently after Hurricane
    Sandy to keep providing trading services to customers and
    maintain market integrity? What can the stock exchanges do to
    prepare the market for another disaster? What changes need to
    be made by market participants and regulators?

    A.8. Hurricane Sandy was a devastating storm that hit at both
    the physical assets and human resource center of our industry.
    It was the first time since 1885 that two trading days were
    lost to weather-related issues. We prepare for emergencies such
    as Sandy and other unexpected market events in several ways.
    With respect to physical infrastructure, NASDAQ OMX and most of
    our partners in the trading community maintain geographic and
    systems diversity that would have allowed contingency trading
    and regulation of our markets in the aftermath of Hurricane
    Sandy.
        NASDAQ OMX implemented our own emergency plans before,
    during and after Sandy made landfall. Our key employees and
    systems were in place and ready to operate. From a legal
    perspective, the SEC granted our board of directors and persons
    designated by the board the authority, memorialized in our by-
    laws, to take ``any action'' regarding the operation of our
    market or the trading of any and all securities in the event of
    an emergency or extraordinary market conditions. This gives us
    the ability to adapt to unexpected events to protect the
    integrity of the market, to protect investors and the public
    interest, and otherwise to ensure that we are fulfilling our
    mandates under the Securities Exchange Act of 1934.
        Market integrity was clearly threatened by the moral
    dilemma presented by the prospect of operating the markets
    during Hurricane Sandy. Operating the market would have
    demanded that professionals from across our industry venture
    out into dangerous conditions, potentially imposing additional
    burdens on already stressed public safety personnel. Owing to
    the risks to human life in New York and New Jersey and for
    employees of the markets, our customers and regulators, the
    markets made the best decision under the circumstances. NASDAQ
    supported this collective decision, and exercised its emergency
    authority to close its market.
        The industry learned valuable lessons from the experience.
    We have already looked at how our contingency plans worked in a
    real-life situation. We are pleased that, without hesitation,
    we can say that NASDAQ's testing and readiness plans, thanks to
    our dedicated employees, had our market ready to operate and
    trade all of our listed stocks in a normal and uninterrupted
    manner.

    Q.9. It has recently been reported that the SEC's Interim
    Inspector General found that some staff in the SEC's Trading
    and Markets Division did not encrypt computers containing
    confidential data from the exchanges and clearing agencies they
    were overseeing. What measures are being taken now or should be
    taken by market participants and regulators to better secure
    data in today's high tech markets?

    A.9. NASDAQ is fully cognizant that attaining perfection in the
    operation and implementation of technology is impossible, even
    when it is developed and monitored by the most diligent
    personnel and rigorous systems. At the SEC's own October 2,
    2012, Technology and Trading Roundtable the SEC's academic
    expert stated as much. Dr. Nancy Leveson, Professor of
    Aeronautics and Astronautics and Engineering Systems, at the
    Massachusetts Institute of Technology, describing her 47 years
    in computer science, at IBM, MIT, and in her own business
    stated:
        Let me tell you a little bit of what I've learned in the
    last 47 years. The first lesson is that all software contains
    errors. I have not in all of that time ever come across any
    software that was nontrivial in which no errors were found
    during operations. The errors may not surface for a long time
    but they are lurking there and waiting for just the right
    conditions to occur. There are also some myths about certain
    industries being able to create perfect software but
    unfortunately this is patently untrue. No industry creates
    perfect software.
        NASDAQ fully agrees with this statement and, as such,
    understands the difficulty that all organizations, including
    the SEC, experience in implementing technology in a secure,
    effective manner.
        Moreover, the SEC Inspector General findings with respect
    to computer security at the SEC are another reminder that
    security is a shared responsibility between the markets,
    participants, and Government. The SEC seems fully committed to
    resolving the issues highlighted in the IG report, which raised
    concerns about one isolated area of the SEC that can be
    addressed appropriately through training and understanding
    about security protocols and best practices for the treatment
    of all sensitive information. NASDAQ OMX would welcome the
    opportunity to work with the SEC to ensure that the data we
    share with them is communicated in a secure manner and
    protected from unauthorized disclosure in the future. NASDAQ
    OMX is investing heavily to mitigate risks in the computer
    security area--we have hired nationally respected experts,
    upgraded our own systems, are in the process of enhancing our
    systems integrity testing and are demanding similar actions by
    those with whom we interact. NASDAQ OMX supports Congressional
    action to foster information sharing between national
    infrastructure operators and Government agencies that have
    access to information about cyber security threats, technology
    best practices and other resources that can help us protect
    vital infrastructures like our security markets.
                                    ------

            RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN REED
                         FROM ROBERT C. GASSER

    Q.1. There was testimony that ``dark trading'' is a concern in
    many countries and that Canada recently modified its market
    structure to limit dark trading and to maximize price
    discovery. Canadian regulators have imposed a new framework
    governing how dark pools and undisplayed orders are allowed to
    operate including priority of lit over dark flow and a minimum
    price improvement requirement for dark orders. What is your
    view of these reform proposals? Would these measures make the
    U.S. markets more or less fair and transparent? Please explain.
    Would these measures be feasible in the U.S. markets? Why or
    why not?

    A.1. The Canadian regulators have clearly stated they made
    these changes despite a total lack of evidence that dark
    trading was negatively impacting Canadian market quality. Most
    academic evidence suggests that not only does dark not harm
    price discovery, it generally improves it. \1\ ITG's own
    analysis of the Canadian markets has shown a continued decline
    in institutional trading costs as dark pools have gained
    acceptance and grown in that market. While it is too early to
    fully discern the impact of the October 2012 rule change, there
    is certainly no glaring evidence these rules have improved the
    marketplace or added to the availability of displayed
    liquidity. Early indications in the Canadian equity markets are
    that there has been a decline in order flow at the dark venues
    and an increase in trading flow posted as dark order types on
    the displayed markets.
    ---------------------------------------------------------------------------
         \1\ See, Ian Domowitz, ITG, ``Are We Missing the Evidence in the
    Global Dark Pool Debate?'', December 2010 http://is.gd/qpumXJ. See
    also: Haoxiang Zhu, MIT, ``Do Dark Pools Harm Price Discovery?'',
    November 2012. http://www.mit.edu/zhuh/Zhu_darkpool.pdf
    ---------------------------------------------------------------------------
        The U.S. equity market is much larger and more complex than
    the Canadian market. With 13 exchanges and over 40 dark pools,
    there is healthy competition for order flow, which has resulted
    in a dramatic decrease in both implicit and explicit trading
    costs over the past decade. It is a generally accepted
    principle in the U.S. that regulators should not make changes
    that simply favor one set of competitors over another without a
    resultant improvement in overall market structure. In our
    assessment, imposing rules similar to the Canadian measures in
    the U.S. would neither be feasible nor advisable, as they would
    not result in improved liquidity or better outcomes for
    institutional or retail investors.

    Q.2. Rule 612 of Regulation NMS prevents sub-penny quoting.
    However, under an exemption in Rule 612 the SEC actually allows
    broker-dealers to execute orders in sub-penny increments.
    Because there are no quoting obligations for broker-dealer
    internalization, broker-dealers can provide price improvement
    to their customers in the form of sub-penny executions. What
    are advantages or disadvantages of sub-penny quoting? Is
    special pricing good for retail investors? Why or why not?

    A.2. There is clear value in price improvement through sub-
    penny executions, but sub-penny quoting is unnecessarily
    complex and of dubious benefit to investors. Sub-penny
    executions, in the aggregate, have lowered execution costs for
    retail investors by millions of dollars. It is appropriate for
    retail investors to receive this type of special pricing
    because retail order flow carries little risk of adverse
    selection; specifically, interaction with retail order flow
    does not involve many of the concerns that arise when
    interacting with orders from certain high frequency trading
    strategies, such as information leakage and price
    deterioration. In contrast, sub-penny quoting does not offer a
    clear benefit. It would add to the already onerous burden of
    rapidly growing message traffic and would impede market making,
    as market makers would not be able to offer meaningful price
    improvement. Sub-penny price quotes would make stock auctions
    difficult, if not impossible, eroding overall liquidity in the
    marketplace.

    Q.3. Some commentators have suggested that the Securities and
    Exchange Commission (SEC) should lift the ban on locked
    markets. Locked markets occur when a trader attempts to place a
    bid on one exchange at the same price as an offer on a
    different exchange. They argue that bids and offers at the same
    price but different venues should be forced to interact, and
    this could reduce fragmentation in the marketplace and perhaps
    reduce the prevalence of trading in dark pools and
    internalization venues. What is your view of this proposal?

    A.3. We believe the ban on locked markets causes more problems
    than it solves, and as such it should be lifted. There is much
    unnecessary complexity in current equity market structure
    stemming from efforts to prevent locking and crossing of
    markets. Locked markets are not that difficult to address from
    a market structure perspective. Market participants are capable
    of providing best execution in locked market situations when
    handling customer orders on an agency or riskless principal
    basis. Accordingly, we would support efforts to lift the ban.

    Q.4. Internalizing broker-dealers often pay retail brokers to
    direct customer orders to their trading venues. Does this
    practice advantage or disadvantage retail investors? Why or why
    not? Why is retail flow valuable to trade against?

    A.4. As discussed earlier, retail order flow is valuable
    because it is not informationally ``heavy'' and interacting
    with it does not involve significant information leakage. As a
    result, broker dealers are often willing to pay for this order
    flow, which yields clear benefits to retail investors in the
    form of lower trading commissions. We would argue that the
    practice of online brokers offering trading to retail customers
    for less than $10 per execution would not be possible without
    trading rebates or payment for order flows. In general, we do
    not believe that this practice disadvantages retail investors
    because broker-dealers have fiduciary responsibilities to their
    clients to achieve best execution. It should also be noted that
    broker-dealers that receive payment for order flow are required
    to disclose such arrangements to the public pursuant to Rule
    611 of Regulation NMS, and to their customers in confirmations
    required under Rule 10b-10 of the Securities and Exchange Act
    of 1934.

    Q.5. Broker-dealers that operate their own dark pools can get a
    fee advantage when they route customer orders through their own
    dark pools rather than through a lit exchange. Does this create
    a conflict of interest between investors, who want to buy or
    sell stocks at the best prices, and brokers, who want to avoid
    exchange fees? Why or why not?

    A.5. While the routing of customer orders through internal dark
    pools creates the potential for a conflict of interest, we
    believe it is a manageable conflict. Broker-dealers have a
    fiduciary duty to provide best execution when handling client
    orders. This duty should be the controlling factor when making
    order routing decisions Fulfillment of this duty can, and in
    most cases is, accomplished through the use of detailed
    transaction cost analysis and extensive evaluations of
    execution quality, (e.g., opportunities for price improvement,
    speed of execution, number of venues checked, character and
    volatility of the market, etc.). Such reviews and analyses can
    demonstrate whether internal crossing provides equivalent or
    better execution costs and superior transaction prices compared
    with routing orders to an external market center. In most
    cases, using an internal dark pool yields three clear
    advantages over exchanges: a lack of information leakage, lower
    latency and potential opportunities for price improvement.
        We would also note that there is much less of a conflict of
    interest with an agency dark pool as opposed to a pool which
    contains broker-dealer principal or proprietary order flow. In
    the case of an agency pool such as ITG's POSIT, the broker-
    dealer is generally unconflicted as it does not have a vested
    interest in terms of profiting from one side of the trade. In
    addition, internal crossing also protects clients from
    incurring costs for lost opportunities. For example, a dark
    pool operator could forego an internal crossing opportunity by
    routing a client order to an exchange for the purpose of
    avoiding a potential conflict of interest. However, by the time
    the order arrives at the exchange, the targeted liquidity may
    no longer be accessible. In such a situation, the client would
    have been deprived of an opportunity to execute at the same
    displayed price (or even better) in the dark pool.

    Q.6. The U.S. exchanges are required to submit data to a
    centralized network where it is aggregated before being
    disseminated to the public. However, the Consolidated Tape
    Association/Securities Information Processor or SIP now lags
    behind direct proprietary market data feeds. As a result, high
    frequency trading firms and other market participants now
    usually colocate their computer servers at every exchange and
    subscribe to proprietary data feeds offered by the exchanges in
    order to capitalize on latency arbitrage opportunities. Why
    should anyone receive market data flow from other than the
    consolidated tape? Should market data be distributed to all
    market participants equally? How do you think this can best be
    accomplished?

    A.6. We strongly believe that there should be equal
    opportunities for accessing market data. All market
    participants should have the same access to market data feeds,
    either through the SIP or direct proprietary feeds. As a matter
    of practice not all participants will elect to invest in the
    technology, subscription fees, and/or colocation costs to be
    able to take advantage of all proprietary data feeds. While we
    believe it is important to ensure equality of market data
    access, it would not be appropriate to attempt to ensure
    equality of outcomes through regulatory means.

    Q.7. The October closure of the markets for 2 days due to
    Hurricane Sandy raised questions about the financial sector's
    preparedness for the next natural or man-made disaster. What
    challenges did the markets face in reopening after Hurricane
    Sandy? What should have been done differently after Hurricane
    Sandy to keep providing trading services to customers and
    maintain market integrity? What can the stock exchanges do to
    prepare the market for another disaster? What changes need to
    be made by market participants and regulators?

    A.7. We believe the decision to shut the market for 2 days in
    the wake of Hurricane Sandy was the correct one. The damage to
    lower Manhattan and the loss of life in affected areas supports
    this contention. The 2-day hiatus ensured the safety of broker
    dealer and exchange staff and enabled market participants to
    test and fully activate their business continuity programs.
    When markets re-opened they did so in an orderly and efficient
    manner. In hindsight, better coordination between exchanges and
    market participants would have resulted in a smoother re-
    opening process. Of note, the decision to shut the equity
    markets on the Monday after Sandy hit did not come down until
    late Sunday night. There was some concern among broker-dealers
    that the exchanges' disaster recovery plans had not been
    sufficiently vetted. The lessons for preparation for future
    disasters are to increase communication among all market
    participants and to increase awareness regarding the specifics
    of exchange disaster recovery plans.