[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 /




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            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.
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     \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.
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    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\
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     \1\ Credit Suisse provides its clients with private banking, 
investment banking, and asset management services worldwide. Credit 
Suisse offers advisory services, comprehensive solutions and innovative 
products to companies, institutional clients and high-net-worth private 
clients globally, as well as retail clients in Switzerland. Credit 
Suisse is active in over 50 countries and employs approximately 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.

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    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\
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     \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.
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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\
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     \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).
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    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\
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     \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.
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     \9\ Id. at 28.
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    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\
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     \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.''
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    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.
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     \12\ See, Regulation NMS Rule 611(a).
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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.
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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.
