[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]




 
                   EQUITY MARKET STRUCTURE: A REVIEW 
                         OF SEC REGULATION NMS

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

                                HEARING

                               BEFORE THE

                  SUBCOMMITTEE ON CAPITAL MARKETS AND
                    GOVERNMENT SPONSORED ENTERPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                    ONE HUNDRED THIRTEENTH CONGRESS

                             SECOND SESSION

                               __________

                           FEBRUARY 28, 2014

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 113-67


                                 ______

                   U.S. GOVERNMENT PRINTING OFFICE 
88-529                     WASHINGTON : 2014
____________________________________________________________________________ 
For sale by the Superintendent of Documents, U.S. Government Printing Office, 
http://bookstore.gpo.gov. For more information, contact the GPO Customer Contact Center, U.S. Government Printing Office. Phone 202ï¿½09512ï¿½091800, or 866ï¿½09512ï¿½091800 (toll-free). E-mail, [email protected].  


                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    JEB HENSARLING, Texas, Chairman

GARY G. MILLER, California, Vice     MAXINE WATERS, California, Ranking 
    Chairman                             Member
SPENCER BACHUS, Alabama, Chairman    CAROLYN B. MALONEY, New York
    Emeritus                         NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma             GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia  MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey            RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas              WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina   CAROLYN McCARTHY, New York
JOHN CAMPBELL, California            STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota          DAVID SCOTT, Georgia
KEVIN McCARTHY, California           AL GREEN, Texas
STEVAN PEARCE, New Mexico            EMANUEL CLEAVER, Missouri
BILL POSEY, Florida                  GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK,              KEITH ELLISON, Minnesota
    Pennsylvania                     ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia        JAMES A. HIMES, Connecticut
BLAINE LUETKEMEYER, Missouri         GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan              JOHN C. CARNEY, Jr., Delaware
SEAN P. DUFFY, Wisconsin             TERRI A. SEWELL, Alabama
ROBERT HURT, Virginia                BILL FOSTER, Illinois
MICHAEL G. GRIMM, New York           DANIEL T. KILDEE, Michigan
STEVE STIVERS, Ohio                  PATRICK MURPHY, Florida
STEPHEN LEE FINCHER, Tennessee       JOHN K. DELANEY, Maryland
MARLIN A. STUTZMAN, Indiana          KYRSTEN SINEMA, Arizona
MICK MULVANEY, South Carolina        JOYCE BEATTY, Ohio
RANDY HULTGREN, Illinois             DENNY HECK, Washington
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
KEITH J. ROTHFUS, Pennsylvania

                     Shannon McGahn, Staff Director
                    James H. Clinger, Chief Counsel
  Subcommittee on Capital Markets and Government Sponsored Enterprises

                  SCOTT GARRETT, New Jersey, Chairman

ROBERT HURT, Virginia, Vice          CAROLYN B. MALONEY, New York, 
    Chairman                             Ranking Member
SPENCER BACHUS, Alabama              BRAD SHERMAN, California
PETER T. KING, New York              RUBEN HINOJOSA, Texas
EDWARD R. ROYCE, California          STEPHEN F. LYNCH, Massachusetts
FRANK D. LUCAS, Oklahoma             GWEN MOORE, Wisconsin
RANDY NEUGEBAUER, Texas              ED PERLMUTTER, Colorado
MICHELE BACHMANN, Minnesota          DAVID SCOTT, Georgia
KEVIN McCARTHY, California           JAMES A. HIMES, Connecticut
LYNN A. WESTMORELAND, Georgia        GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan              KEITH ELLISON, Minnesota
MICHAEL G. GRIMM, New York           MELVIN L. WATT, North Carolina
STEVE STIVERS, Ohio                  BILL FOSTER, Illinois
STEPHEN LEE FINCHER, Tennessee       JOHN C. CARNEY, Jr., Delaware
MICK MULVANEY, South Carolina        TERRI A. SEWELL, Alabama
RANDY HULTGREN, Illinois             DANIEL T. KILDEE, Michigan
DENNIS A. ROSS, Florida
ANN WAGNER, Missouri


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    February 28, 2014............................................     1
Appendix:
    February 28, 2014............................................    31

                               WITNESSES
                       Friday, February 28, 2014

Campos, Hon. Roel C., Partner, Locke Lord LLP; and former SEC 
  Commissioner (2002-2007).......................................     7
Lofchie, Steven, Partner, Cadwalader, Wickersham & Taft LLP......     8
Sirri, Erik R., Professor of Finance, Babson College; former SEC 
  Chief Economist (1996-1999); and former Director of the SEC 
  Division of Trading and Markets (2006-2009)....................    10
Spatt, Chester, Pamela R. and Kenneth B. Dunn Professor of 
  Finance, Tepper School of Business, Carnegie Mellon University; 
  and former SEC Chief Economist (2004-2007).....................    11

                                APPENDIX

Prepared statements:
    Campos, Hon. Roel C..........................................    32
    Lofchie, Steven..............................................    36
    Sirri, Erik R................................................    60
    Spatt, Chester...............................................    65


                   EQUITY MARKET STRUCTURE: A REVIEW 
                         OF SEC REGULATION NMS

                              ----------                              


                       Friday, February 28, 2014

             U.S. House of Representatives,
                Subcommittee on Capital Markets and
                  Government Sponsored Enterprises,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 9:30 a.m., in 
room 2128, Rayburn House Office Building, Hon. Scott Garrett 
[chairman of the subcommittee] presiding.
    Members present: Representatives Garrett, Hurt, Royce, 
Neugebauer, Huizenga, Stivers, Fincher, Mulvaney, Hultgren, 
Ross; Maloney, Hinojosa, Lynch, Scott, Himes, Peters, Foster, 
Carney, and Kildee.
    Ex officio present: Representative Hensarling.
    Chairman Garrett. Greetings. The Subcommittee on Capital 
Markets and Government Sponsored Enterprises is hereby called 
to order. Today's hearing is entitled, ``Equity Market 
Structure: A Review of SEC Regulation NMS.'' Let me thank all 
the members of the panel for being with us here today. We will 
begin in regular order with our Members' opening statements and 
then proceed to the panel after that.
    I now yield myself 8 minutes for an opening statement. 
Today's hearing will focus on the structure of our Nation's 
equity markets--in other words, the stock market--and will 
provide a retrospective review of Regulation National Market 
System (Reg NMS) which was adopted by the SEC in 2005. I do 
want to thank our esteemed panel for joining us here today to 
provide their expert testimony on a very important topic. I 
also want to thank the ranking member for her attention to 
these important issues and the constructive bipartisan job that 
she has done to promote strong capital markets here in the 
United States.
    Mrs. Maloney, along with Mr. Hurt and Mr. Grimm and Mr. 
King, as well as Commissioner Dan Gallagher, joined me at a 
roundtable on market structure up in New York back in May. That 
was a great opportunity to hear from some of the foremost 
experts on the history and evolution of the equity markets and 
the regulatory regime governing those markets. While modern 
equity markets trace their origin back to an agreement signed 
under the buttonwood tree on Wall Street in 1792, over time 
these markets have become essential to Main Street as well.
    Companies all around the country need robust equity markets 
to raise capital to grow their business and create jobs. 
Likewise, investors require fair, efficient, and competitive 
equity markets so that they can do things like invest for their 
retirement, buy a home, or pay for a child's education. And so, 
I commend Chair White and her fellow Commissioners for their 
commitment to prioritize a review of equity markets and the 
rules that govern them.
    A comprehensive review hasn't been conducted by the SEC 
since 1994, yet the structure of these markets and the rules, 
including NMS, look much different today. Another review is 
long overdue, and the unanimous agreement of the SEC on this 
point, which seems rare these days, speaks volumes to the 
significance of this issue.
    Before Congress and the SEC can take another hard look at 
the U.S. equity market, however, I believe it is important to 
set a baseline to suggest a few basic parameters for this 
review. First, U.S. equity markets are among the deepest, most 
liquid, and lowest cost markets in the world. This does not 
mean that these markets are perfect, that there is no room for 
improvement. There is. It simply means that when we review the 
market structure and explore making future changes, we must 
keep in mind the axiom, ``First, do no harm.''
    Second, a review of the equity market structure must be 
based on a deep set of objective data rather than anecdotes or 
politically convenient arguments. It follows that we should 
avoid, at the outset, buying into a sensational narrative in 
the media that portrays fast markets that rely on computer 
technology as inherently fragile or bad for investors before we 
even have a chance to collect and analyze all the data on it.
    I know that the very capable staff at the SEC's Division of 
Trading and Markets is in the process of gathering and 
examining quality data with their new Market Information Data 
Analytics System (MIDAS). I also look forward to the arrival of 
the Division's new Director, Stephen Luparello, who has shown 
an impressive grasp of these complex issues. I am pleased that 
the SEC appears to recognize the importance of making any 
future decisions on equity market structure based on empirical 
economic data that has been peer-reviewed and formally 
commented on by the public and by market participants.
    Third, a quality review must put everything on the table. 
In other words, it should be truly comprehensive. We simply 
will not be able to form a complete picture of how our equity 
markets work, and develop smart reforms to improve these 
markets, if we are not prepared to ask all the tough questions 
and reassess every aspect of market structure. This includes 
reevaluating the objectives and impacts of Reg NMS, and other 
regulations concerning equity markets, as well as congressional 
mandates such as the Security Acts Amendment of 1975.
    Last but not least, we must resist all calls to impose 
additional layers of complex regulations on individual market 
participants in order to control or influence their behavior 
before we understand the underlying drivers of those behaviors. 
While I agree that we must take a close look at high-frequency 
trading, broker-dealer internalization, the proliferation of 
order types, the maker-taker model, and trading in so-called 
``dark pools,'' the first steps should be to determine how and 
why these behaviors and business models developed.
    To the extent that the regulatory regime played a role, I 
question whether adding another layer of new rules onto an 
already complex structure will do anything to actually improve 
this structure or protect investors.
    This brings us back to the subject of today's hearing. 
Recently, Reg NMS has been identified as a potential source of 
problems occurring in the U.S. equity markets. A central part 
of the SEC's review of the equity market structure, therefore, 
should be to determine whether regulations, including NMS, are 
driving market complexity and dislocation and incentivizing 
suboptimal behavior by market participants.
    For example, by linking all market venues together through 
technology, prioritizing price and speed in executing orders, 
and protecting only automated quotations, has Reg NMS been the 
primary contributor to what we may now lament as needlessly 
complex and fragmented equity markets? Have these efforts to 
link markets together to promote a national market system also 
led to the many recent disruptions which originate at one 
location and then seem to ripple throughout the system?
    Recent data also suggests a rise in volatility in the 
market post-Reg NMS. Is this because Reg NMS led to an increase 
in the amount of high-speed algorithmic trading in the markets? 
Is it related to the so-called end-of-market sweep exception of 
Reg NMS or the protection rule?
    So in addition, there are literally hundreds of different 
complex order types that exist in today's equity markets, and 
these unique order types develop as strategies to get around 
the market protection of top-of-the-book quotes in NMS or 
exploit other market participants. These are just some of the 
questions about Reg NMS that need to be explored.
    At this point, I don't believe anyone has a definitive 
answer to any of these questions, but they leave the door open 
to the possibility that the government's own rules might be at 
the center of the problem. That is precisely why any serious 
review of equity market structure must include an examination 
of these complex issues and ask the difficult questions.
    This all-encompassing review should also assess the 
regulatory regime that governs various intermediaries in the 
market, ways to improve disclosure of post-trading pricing and 
routing decisions to investors, and additional ideas to ensure 
that intermediaries are acting in the best interest of their 
customers.
    I know this will not be an easy task, but I am hopeful that 
Chair White, the other four Commissioners, the SEC staff, and 
this subcommittee will devote the necessary time, energy, and 
effort to study these important issues. We owe it to the 
investors and the issuers who depend on these markets to 
facilitate the appropriate flow of capital.
    Finally, in a recent speech on the need to review market 
structure, current SEC Commissioner Michael Piwowar recently 
succinctly noted, ``In order to move forward, we must look 
back.'' I sincerely agree with the Commissioner, and I look 
forward to beginning this through a look back on Reg NMS with 
today's panel.
    And with that, I yield back, and at this point I recognize 
the gentlelady from New York, the ranking member of the 
subcommittee, Mrs. Maloney, who has taken a lead interest in 
all of these issues, for 5 minutes.
    Mrs. Maloney. I want to thank the chairman for calling this 
hearing, and for your very informative conference that we had 
earlier in New York on market issues. And I thank all of the 
distinguished panel members, including the former head of the 
SEC. We welcome your comments today.
    This is a very important hearing, and I would like to thank 
you for your leadership and for the willingness to tackle this 
in a nonpartisan way. The United States has the deepest, most 
liquid, and most effective capital markets in the world. The 
U.S. stock market is 13 times larger than the British stock 
market and 14 times larger than Germany's stock market. The 
strength of our markets is a key contributor to our country's 
overall economic strength. We need to continually work to make 
sure that our markets are safe, competitive, innovative, and 
fair to all investors.
    The sheer size of our stock market is attractive for 
investors because they know they will be able to sell their 
investment quickly if they need to. Investors also know that 
they will get the best price available to them when they do 
decide to sell their stocks, which increases the attractiveness 
of trading in our markets.
    The purpose of this hearing is to review the foundation of 
our successful market structure, and particularly Regulation 
NMS, the National Market System. When the SEC passed Regulation 
NMS in 2005, the goals were to promote price competition, 
protect investors, and enhance market efficiency. Now, nearly 9 
years later, it makes sense for Congress to take a step back, 
review the changes that have taken place, and ask what we did 
get right in Regulation NMS, what we did get wrong, and what 
can we improve?
    Price competition has undoubtedly increased as the number 
of different trading venues available to investors has 
exploded. Some in the markets argue that the price competition 
has come at the expense of market efficiency. However, as the 
large number of trading venues has led to fragmented markets, 
there is obviously a fine line between too many trading venues 
and too few trading venues, and whether we have the right 
balance is one of the issues I hope we will explore today.
    But if we have learned anything from Regulation NMS, it is 
that even small changes in market structure regulations can 
have large consequences. That is why I think the best changes 
in market structure will be grounded in data and empirical 
evidence. I am pleased that the SEC is already developing a 
tick-size pilot program to test whether tick sizes for stock 
trading really will enhance liquidity, and this one pilot 
program will look at raising it from a penny to 5 cents.
    And as we explore other potential changes to our market 
structure, we should also keep in mind that our equity markets 
are undoubtedly better today than they were a decade ago. 
Today's retail investors have better access to the markets and 
at lower costs than ever before. It is important not to lose 
sight of these benefits.
    I look forward to a robust, informative discussion from our 
distinguished panel, and I yield back the balance of my time.
    Chairman Garrett. The gentlelady yields back.
    The vice chairman of the subcommittee is recognized for 2 
minutes.
    Mr. Hurt. Thank you, Mr. Chairman. Mr. Chairman, thank you 
for holding today's hearing. And I want to thank our witnesses 
for joining us today to examine Reg NMS and our Nation's equity 
market structure.
    Last Congress, this subcommittee led the charge to pass the 
JOBS Act to decrease burdensome regulations and provide 
incentives for emerging growth companies to access capital and 
public markets. While we continue to see successes of the JOBS 
Act, it is essential that we also ensure that our equity 
markets themselves are functioning as efficiently and 
effectively as possible. Our markets and the technology 
underpinning them have continued to advance quickly in the year 
since Reg NMS was implemented. I believe this hearing is an 
important opportunity to allow Members to explore how it is 
that our equity markets have evolved since that time and 
potentially where they are headed in the future.
    I agree with others who have called for a wholistic review 
of the Nation's market structure. This issue is too important 
and too complex for a disjointed review that could lead to 
unintended consequences. It is imperative that we get this 
right, not only for the markets but for retail investors, 
pensioners, emerging growth companies, and all market 
participants.
    I am encouraged that Chair White and all of the SEC 
Commissioners have publicly supported the idea of this review 
of our equity market structure. I look forward to moving this 
process forward so we can ensure that the United States 
continues to have the most efficient, competitive, and liquid 
markets the world has ever known. I would like to thank our 
witnesses again for their appearance. I look forward to your 
testimony.
    Mr. Chairman, I yield back my time.
    Chairman Garrett. The gentleman yields back.
    Mr. Lynch for 2 minutes.
    Mr. Lynch. Thank you very much, Chairman Garrett and 
Ranking Member Maloney, for holding this hearing. And I want to 
thank the panelists for coming forward and for your willingness 
to help the subcommittee with its work. This hearing on equity 
market structure is long overdue. It is an important issue that 
we need to be addressing.
    The U.S. equity markets are often described as the deepest 
and most transparent in the world, and I guess that is probably 
true. And it is true because the vast majority of the trading 
in the United States, about 63 percent this past January, is 
conducted on open and transparent exchanges with robust pre- 
and post-trade transparency. An open market obviously reduces 
spreads, decreases volatility, and creates a safer environment 
for investors.
    However, over the past 5 years there has been a marked 
increase in the volume of trades that are being conducted in 
dark pools or opaque alternative markets, and that is a real 
problem. Off-exchange trading has expanded by some accounts 
from 15 percent to 40 percent over recent years.
    There are some legitimate reasons for the use of dark 
pools. I know that institutional investors execute large volume 
trades which can't necessarily be performed well on open 
markets because of the likelihood that there may be some actors 
out there trying to game those trades. However, we are seeing a 
trend where trading that should normally be able to be 
conducted on open exchanges, public exchanges, is going off 
exchange, and that is a problem. We should be fostering 
policies which ensure that all trading can be done on open and 
public exchanges to the extent possible, and we should ensure 
that for off-exchange trading, when necessary, we still have a 
window to observe that trade is being done in the most 
transparent manner possible.
    I look forward to the testimony. I have some questions for 
you that I hope you can help us with. And again, I want to 
thank the witnesses for their willingness to come forward and 
help the subcommittee.
    I yield back the balance of my time.
    Chairman Garrett. The gentleman yields back.
    Mr. Scott, for 3 minutes, please.
    Mr. Scott. Thank you very much, Mr. Chairman. And this is 
indeed a very, very important hearing, a critical hearing to be 
able to really examine the equity market structure. 
Specifically, though, I think we need to really gear in on the 
SEC's regulations of the National Market System, which is 
commonly referred to as Reg NMS.
    There are two principles that are outlined in Reg NMS: the 
first one is competition among markets and competition among 
orders; and the second one is serving the interest of long-term 
investors' listed companies. The point is that while Reg NMS 
appears to have been a success in increasing competition among 
markets, given the significant growth of what is referred to as 
dark trading, this dark trading volume, which is now 40 percent 
of average daily volume in this country, is in the dark, and an 
increase in liquidity fragmentation, 13 equity exchanges, 
around 45 dark pools, and many more broker-dealer 
internalizers. NMS appears to have resulted in not more 
competition, but less competition among orders.
    And in addition, many large institutional investors who act 
on behalf of long-term investors have raised concerns about the 
extreme fragmentation of liquidity and a lack of disclosure 
coming from dark trading venues.
    So the ultimate question I think we have to answer today 
is, has order competition decreased, and what should the SEC do 
about this? Shouldn't the SEC be looking for ways to rebalance 
this? I think this is the overreaching, overarching issue in 
question that we have to answer today because many investors 
are concerned with these dark pools, and that process is not 
increasing competition but lessening competition, and we must 
do something to address that. And it would be good to examine 
what steps must be taken to make sure there is adequate 
competition.
    Thank you, Mr. Chairman. I yield back.
    Chairman Garrett. The gentleman yields back.
    We now turn to our panel. And again, I thank every member 
of our panel for being with us today. For those of you who have 
not testified before, I always do the admonition to make sure 
that you pull the microphone close to you because sometimes I 
can't hear up here. You all will be recognized for 5 minutes. 
And without objection, your complete written statements will be 
made a part of the record, so we ask you to summarize your 
testimony right now in 5 minutes. We will start, as we always 
do, from left to right.
    Former SEC Commissioner Campos, good morning, and welcome 
to the panel.

STATEMENT OF THE HONORABLE ROEL C. CAMPOS, PARTNER, LOCKE LORD 
          LLP; AND FORMER SEC COMMISSIONER (2002-2007)

    Mr. Campos. Chairman Garrett, Ranking Member Maloney, and 
members of the subcommittee, thank you very much for inviting 
me here today. It is a privilege to be here with you. And I 
agree that the Reg NMS and the U.S. capital market structure is 
a very worthy subject of your consideration. I appreciate that 
you are working very closely with the Securities and Exchange 
Commission, my old agency.
    As you know, I served as a Commissioner of the Securities 
and Exchange Commission from 2002 to 2007. During my service, I 
was part of the Commission that implemented Sarbanes-Oxley, and 
part of the Commission that, with the work of the SEC staff, 
adopted Regulation NMS. I was there when all of the 
considerations, all of the battles, all of the presentations, 
and all of the arguments about market structure, about 
different business models were debated, considered, and 
presented.
    I will be brief. My testimony and written portions of it 
will be a part of the record.
    First, I agree with the comments that have been made by the 
Members. Today's U.S. markets are the envy of the world. When I 
was a Commissioner at the SEC, I had the privilege of 
representing the agency internationally, and what I discovered 
internationally was that the largest investors of various 
countries invest in the United States. And I remember 
distinctly a manager of a sovereign wealth fund that invested 
billions of dollars in the United States said to me, ``I invest 
in the United States because I know, first of all, that my 
investments there are safe. If something wrong happens, I can 
get redress in your courts. And secondly, I can get good prices 
and a fast reaction.''
    This feature, that the U.S. markets bring foreign capital 
into the United States, is a huge benefit and a huge feature of 
our particular markets. I agree that nothing is perfect. Any 
system needs to be revisited. And our National Market System, I 
am sure, could be improved. However, as my father used to say, 
and as all of you have noted, we shouldn't be fixing what isn't 
broken.
    So let me just very briefly tell you about what we thought 
about with the staff and the Commissioners that I was a part of 
when we looked at NMS. We saw a system that was not working 
very well. We saw traditional exchanges that gave opportunities 
to flow brokers to trade ahead, to give them many seconds of 
advantage in being able to work trades. We heard that 
individual investors and institutional investors were not 
getting fair executions and fair prices, and we heard that the 
markets overall were not working well.
    So, our first and foremost objective was to create a system 
in which investors were treated fairly and were treated safely. 
And as has been noted, the 1975 Congress actually gave the SEC 
the direction to establish the National Market System, and it 
gave the Commission the guidelines which were to be the areas 
that it was supposed to concentrate on: efficient execution; 
fair competition; transparency; market access; and dealer 
disintermediation.
    One of the things we wanted to do was to accommodate the 
unique features of the American system, which is that we have 
many different trading centers. We wanted the markets to make 
the choices as to which of the different trading centers and 
market models would survive the markets. So our system 
essentially had another concept, and that is that it was a 
system, not a building, not a buttonwood tree, but a system of 
many centers that needed to be electronically connected.
    So today, when people talk about fragmentation, be careful. 
If we have a system that is connected, you may have liquidity 
from different sources, but it doesn't mean that it is 
necessarily fragmented. It doesn't mean that investors today 
are not getting the best price. And I assure you that today, 
the prices and the executions investors receive are far better 
than they were in 2002, when I ended up voting to approve the 
NMS.
    Clearly, the markets need some regulation. Our history is 
clear that bad things happen when there isn't any regulation. 
So the question is not whether there will be regulation, but 
how much, and what is the right balance. Also, technology is 
the big issue of the day.
    [The prepared statement of Mr. Campos can be found on page 
32 of the appendix.]
    Mr. Hurt  [presiding]. Mr. Campos, thank you very much.
    The Chair now recognizes Mr. Steven Lofchie.
    Thank you for being here. You are recognized for a period 
of 5 minutes.

STATEMENT OF STEVEN LOFCHIE, PARTNER, CADWALADER, WICKERSHAM & 
                            TAFT LLP

    Mr. Lofchie. Thank you very much for having me, Chairman 
Garrett and Ranking Member Maloney. My name is Steven Lofchie, 
and I am head of the financial regulation practice at 
Cadwalader, Wickersham & Taft. In addition to practicing law in 
the area of financial regulation for the past 20 years, I have 
also written a number of books on the topic including, ``The 
Guide to Broker-Dealer Regulation,'' which is commonly regarded 
as the standard text in the area.
    I have prepared written testimony that I have submitted for 
the record. Again, I am very appreciative of the opportunity to 
testify to the subcommittee on the rules governing the equity 
markets.
    Since 1975, the operation of these markets has been 
governed by the principles that Congress established in Section 
11A of the Securities Exchange Act of 1934, that there should 
be efficient trade execution and fair competition, and that 
market data should be made widely available. But while the 
principles established in 1975 still hold true today, today's 
problems are not the same problems that existed in 1975.
    Then, the problems of the equity markets were the problems 
of the near monopoly of the NYSE at the time which stifled 
innovation, the snail's pace of trade execution, and that the 
exchanges were largely private clubs at which admission was 
limited by members. Those problems of 1975 have been remarkably 
well-addressed thanks to the regulatory efforts of the SEC and 
the technological innovation and the competitiveness of market 
participants. Unlike in 1975, trades are executed in 
milliseconds, bid and ask spreads are at a penny, numerous 
exchanges and alternative trading systems compete, and trade 
information is real time.
    But today's markets present different problems. Today's 
problems, in fact, are so different from those which existed in 
1975 that they are almost the mirror of them. Instead of 
trading being too slow, perhaps it is too fast. Instead of too 
much reliance on an individual specialist, perhaps we are too 
vulnerable to technology failures. Instead of exchanges being 
private clubs where members have an interest in the support of 
the organization and vice versa, today the exchanges have 
become business organizations with distinct interests from 
their members. Instead of trading on a monopoly market, trading 
is fragmented or dispersed, depending upon your choice of 
words.
    This means that if the SEC assumes it can address the 
problems of today's market using the same tools and the same 
rules that it did in 1975, there is a danger it will worsen 
problems rather than resolving them. Forty years after Section 
11A was adopted, as you have all noted, it is time for the SEC 
to take a ground up look, and it must study not only the front 
page matters, such as market volatility and technology 
vulnerability, it must also look at behind-the-scenes issues 
such as market data feeds and how those impact market trading 
incentives.
    The SEC must also conduct a self-examination as to its own 
assumptions of how markets work. The markets, as they exist 
today, and as they existed in 1975, are not simply the the 
result of interaction between buyers and sellers. They are also 
very much a creature of market regulation. The NYSE was able to 
dominate trading for so long not because it had a better 
market, but because rules permitted it to disadvantage 
competition. When the current set of market rules were adopted, 
the dissenting Commissioners worried that these rules would 
increase fragmentation and volatility. Those concerns have 
proved justified.
    In addition, it makes sense to look at regulatory 
structure. Does it make sense for the exchanges to regulate 
their competitors? And finally, I want to talk about the issue 
of technology failure. How do we deal with the technology 
failure that is such a front page issue? One of the things I 
have suggested in my written testimony is that we look at other 
models of regulation, such as the airline industry, where the 
focus is more on gathering information as to how a problem 
occurs.
    Thank you very much for inviting me to the hearing, and I 
look forward to questions.
    [The prepared statement of Mr. Lofchie can be found on page 
36 of the appendix.]
    Mr. Hurt. Thank you, Mr. Lofchie.
    The next witness is Mr. Erik Sirri, former Director of the 
SEC Division of Trading and Markets.
    Thank you for being here, and the Chair recognizes you for 
5 minutes.

   STATEMENT OF ERIK R. SIRRI, PROFESSOR OF FINANCE, BABSON 
  COLLEGE; FORMER SEC CHIEF ECONOMIST (1996-1999); AND FORMER 
DIRECTOR OF THE SEC DIVISION OF TRADING AND MARKETS (2006-2009)

    Mr. Sirri. Chairman Garrett, Ranking Member Maloney, and 
members of the subcommittee, thank you for having me here today 
to testify.
    U.S. equity markets consist of more than a dozen registered 
exchanges and more than 60 market centers. Their efficiency is 
remarkable. Today, a modern electronic market maker that trades 
as much as 15 percent of a large-cap NASDAQ stock may earn as 
little as 1 or 2 hundredths of a penny for every share it 
trades. The old worries about a dominant market maker being a 
monopolist have been replaced by new issues concerning fair 
access, connectivity, computerized trading, and the robustness 
of systems.
    Reg NMS today is almost 9 years old, and still, it remains 
a rule with both proponents and detractors. It highlights the 
fact that market structure regulation is necessarily a 
difficult exercise. For example, traders value confidentiality 
for their orders because unnoticed trading results in better 
prices for traders' ultimate customers. Any regulatory desire 
to increase market transparency is constrained by a trader's 
desire for secrecy. Traders forced into a transparent market 
against their wishes will elect not to submit their orders into 
the market and will hold them upstairs until they are ready to 
trade. There is thus a limit on how much transparency can be 
brought to any marketplace.
    As a second example, not even the strictest regulations can 
force liquidity providers or market makers to provide liquidity 
to a marketplace if it is not profitable for them to do so. 
They will simply exit the market. This principle contributed to 
the demise of traditional market makers and specialists on 
physical exchanges like the NYSE.
    U.S. equity markets are generally very efficient. Changes 
of fees of as little as one-tenth of a cent per share will 
clause flow to move from one venue and cause it to be rerouted 
to another market center as brokers attempt to lower trading 
costs or earn higher rebates from their customer flow. This is 
both a testament to the quality and efficiency of our markets 
and a cautionary tale to regulators. It demonstrates how 
sensitive market participants' business models are to very 
small changes in costs and how quickly trading platforms, 
brokers, and investors react to changes in the competitive 
landscape. We should expect that any meaningful changes in 
equity market regulations will have large consequences in the 
routing and execution of orders and the business model of 
market participants.
    SEC Commissioners have been calling for a broad review of 
our market structure. These market structure questions are 
eminently amenable to empirical analysis, and any revisions to 
our trading rules should be preceded by meaningful and 
objective analysis of economic data. I believe that an 
encompassing, data-driven, empirical study is an important step 
to complete before implementing any substantive change to 
market structure regulation.
    I would like to offer two final thoughts. First, I would be 
remiss if I didn't highlight the need for improvements in the 
structure of our fixed income markets. The fixed income markets 
are larger than our equity markets. Investors in corporate and 
municipal bonds trade using an opaque network of OTC dealers, 
and retail investors can price spreads of as much as 5 percent. 
All this happens at the same time that these investors trade in 
equities, in percentage spread measured in tenths, and in 
submillisecond timeframes. I hope that in the near future, 
regulators will turn their focus to the trading structure of 
these vital markets.
    And second, I think it is important that any review of 
equity market structure include a focus on the best execution 
duties of brokers that handle customer orders. Existing 
interpretations of best execution have not kept pace with the 
changes in market structure and with automated trading. 
Examples of potential concerns include the effective access 
fees and liquidity rebates on broker routing decisions and the 
routing of nonmarketable customer limit orders to exchanges 
rather than to other venues more advantageous to the limit 
order.
    The Commission should, as part of its review of market 
structure, revisit their guidance on best execution and 
consider whether another approach, such as one based on 
policies and procedures, would be useful in augmenting any 
change to market structure under consideration.
    Thank you for your time this morning.
    [The prepared statement of Mr. Sirri can be found on page 
60 of the appendix.]
    Mr. Hurt. Thank you, Mr. Sirri.
    Our final witness is Mr. Chester Spatt, former SEC Chief 
Economist.
    Thank you for being here, and you are recognized for 5 
minutes.

   STATEMENT OF CHESTER SPATT, PAMELA R. AND KENNETH B. DUNN 
   PROFESSOR OF FINANCE, TEPPER SCHOOL OF BUSINESS, CARNEGIE 
 MELLON UNIVERSITY; AND FORMER SEC CHIEF ECONOMIST (2004-2007)

    Mr. Spatt. I would like to thank Chairman Garrett, Ranking 
Member Maloney, and the members of the subcommittee. I am 
pleased and honored to have the opportunity to present my views 
at today's important hearing. I served as Chief Economist at 
the SEC from 2004 to 2007, and I am currently still involved in 
regulatory issues. I am a member of the Shadow Financial 
Regulatory Committee and the Federal Reserve's Model Validation 
Council, among other activities.
    There have been dramatic changes in the structure of our 
equity markets over the last 2 decades, reflecting changes in 
technology and changes in regulation. Prior to NMS, there was 
decimalization, which had big impacts on our markets. NMS led 
to a series of changes focusing on much greater automation in 
the trading process by its emphasis on fast markets, and 
partially as a byproduct of NMS and other considerations, there 
has been a dramatic change in fragmentation. For example, the 
New York Stock Exchange share of trading in its own listings 
has fallen from 80 percent to 20 percent.
    I am pleased that the subcommittee has organized today's 
hearing to focus on NMS because more generally, I believe that 
financial regulators should undertake serious retrospective 
reviews of the consequences of their actions and that, at least 
in the past, this has not been so much of a focus. I am pleased 
that going forward, there is more orientation toward that, that 
the SEC, for example, is signaling its interest in undertaking 
an experimental pilot analysis with respect to decimalization, 
although I think my own views are rather doubtful that wider 
ticks will necessarily meaningfully impact IPO decisions.
    One thing that NMS did do is it had the effect of resolving 
some open issues in its day, which I think provided some 
clarity to the trading community, and at least some of the big 
changes that occurred in the aftermath of NMS just simply 
reflected that there were some rules of the game that were 
specified, whatever those rules were, and then various 
platforms felt comfortable to enter.
    In the aftermath of NMS as well, New York Stock Exchange 
specialists no longer retained potentially a 30-second option 
to send orders to other platforms through the ITS system. So 
NMS led to, I think, a variety of important changes.
    One of the most striking aspects of NMS is the structure of 
its order protection rule. Orders were protected, but the only 
orders that were protected were at the top of the book, and I 
think that is an important point to highlight. So in a way, NMS 
is a bit schizophrenic, that NMS basically says that orders at 
the top of the book are deserving of protection, but other 
orders are not. And certainly, I would not favor providing 
protection down the book. That would be, I think, even more 
prescriptive and would add to the technological burden of the 
rule, but I think it points to a lack of coherence within the 
structure of NMS, because the protection that is provided is 
only for orders at the top of the book.
    Indeed, I think that points to one of the contributors to 
fragmentation directly in the rule, because if you have 
distinct platforms as opposed to a consolidated platform, you 
get more protection out of NMS, because every top of the book 
is protected; whereas, if platforms are not separated, they 
have less protection.
    An additional important aspect of NMS is how it integrates 
the markets. Brokers, of course, have had longstanding best 
execution responsibility. NMS also has the effect of routing 
orders to the platforms that potentially would provide the best 
execution at the top of the book. But in a sense, then, NMS is 
providing a substitute for best execution, and I think one 
metric to look to, which has really not been focused on, is 
whether NMS in fact reduces somewhat the extent of abuse of 
best execution responsibilities. If NMS were successful, you 
should now see less abuses of best execution than previously.
    An important set of distortions, in my view, with respect 
to the trading is the ``make or take'' features of the market, 
which NMS provides some structure around. There are incentives 
to collect liquidity rebates and avoid fees for taking 
liquidities. But I think there are real conflict of interest 
issues that are raised, and in fact, I think some interference 
with best execution, because orders would be isolated where 
they don't fill most quickly.
    Thank you very much very much for the opportunity to speak.
    [The prepared statement of Mr. Spatt can be found on page 
65 of the appendix.]
    Mr. Hurt. Thank you, Mr. Spatt.
    Now, we will turn our attention to questions from the 
Members, and I will first recognize myself for 5 minutes.
    It seems like everyone agrees that this is an important 
endeavor that we are undertaking, but I guess the question is, 
is how is the best way to do that and what information do we 
need, what information does the SEC need to be able to navigate 
through this? And I guess my question, and I would like to 
start with Mr. Campos and then just go down the line, is what 
data does the SEC currently have that is needed to be able to 
do this, and what data do they perhaps not have that they need 
to have to be able to make the right decisions regarding 
strengthening our equity markets?
    Mr. Campos. That obviously is an excellent question. And 
there is, first of all, a lot of data. My colleagues who are 
economists and researchers deal with that daily. But 
essentially, a study of whether investors are getting best 
execution, as was just discussed, studies as to whether the 
pricing tends to reflect the best price in the markets, all of 
that data is there. Are orders being routed from market and 
trading centers to reflect the best top of the book price? 
Again, all of those things are data that is available.
    And what we don't know, I suppose, are things about whether 
liquidity is being held back, about whether there are things 
going on in internalization models. I would argue that the 
enforcement mechanisms and the examinations have been very 
robust. But nonetheless, that could be looked at.
    Mr. Hurt. Okay. Thank you.
    Mr. Lofchie?
    Mr. Lofchie. Thanks very much. I think there is a lot of 
quantitative data. What I think there needs to be is more focus 
on qualitative data, an understanding of the motivations of 
market participants. I think we need to understand why do 
mutual funds and institutional investors prefer going to 
alternative trading systems rather than to trade on the 
exchanges? It is not enough just to look at the numbers. It is 
important to understand why they find one venue preferable to 
another, and that will help us understand how rules changes 
that we will make in the future will affect their incentive 
scheme.
    Mr. Hurt. Mr. Sirri?
    Mr. Sirri. I think we all talked about how tricky it is to 
trade with computers, but one of the good things about that is 
that you have the data. It is in electronic form to begin with. 
That is not how it was 20 years ago. So, the SEC has the access 
to a chunk of that, not all of it.
    I think partners in this revision have to come from 
industry. The street, the broker dealers, the users, they also 
have data in electronic form. Hopefully, as part of the process 
that this committee is envisioning, they will cooperate, they 
will do their own analysis, and they will contribute that data 
to the public, to the Commission, so that its analysis can be 
fruitful and you get a better answer to these questions.
    Mr. Hurt. Thank you, Mr. Sirri.
    Mr. Spatt?
    Mr. Spatt. I think much of the data is potentially 
available because of the electronic structure of our markets. 
Historically, the SEC was not in a good position to integrate 
the data from various platforms, given the large number of 
platforms and the importance of the fine time stamping, and I 
don't know whether those are still issues going forward.
    It seems to me the types of things that one would want to 
analyze in a serious way are to try to understand, especially 
the routing decision. It seems to me the routing decision is at 
the core of the issues. My comments earlier about the ``make or 
take'' decision are illustrative of that, but you can think of 
the routing decision more broadly. I think that is an 
absolutely essential feature that it is important to try to 
drill down on. It is also related to issues involving how 
orders at a higher level are packaged. How does the 
institutional investor piece out his order? And it is a bit 
related to best execution, but I think in some ways it is 
broader.
    Now, that would be data that I think typically the SEC 
wouldn't currently have. That would be data that would be 
available in the brokerage community or in the asset management 
community, in effect, how do they put in orders, and then what 
are the paths by which they execute over time. And I think 
understanding that would be incredibly helpful.
    Mr. Hurt. Thank you, Mr. Spatt. My time has expired.
    I now recognize the ranking member, Mrs. Maloney, for 5 
minutes.
    Mrs. Maloney. Thank you very much.
    Professor Sirri, you noted in your testimony that one of 
the SEC's goals in passing Reg NMS was to promote price 
competition. With at least 58 different trading venues today, 
we certainly have increased competition. Some people say it is 
too much. As you know, many in the markets, including the 
exchanges, believe that we now have too many trading venues and 
that the markets have become too fragmented. What is your 
opinion? Have we reached the point where fragmentation of 
markets is a bigger problem than competition? Or do you think 
the markets are fragmented?
    Mr. Sirri. I think if you talked about fragmentation as 
being anyone's stock can trade in 50, 60, 70 places, yes, they 
are fragmented. But if you talk about fragmentation being they 
are insufficiently connected or other people are not able to 
get the best price across these markets, that is a tougher 
question to answer.
    The computerized trading, the private linkages help 
integrate those markets together, but the linch pin of it all 
in the end is the person who sends the order, who has the order 
to begin with and picks where am I going to trade it. That 
person has to be smart, that person has to use technology, and 
they have to figure out, in their routing decision, how to 
link. So I think while the markets are somewhat dispersed, 
there exists technology and smarts to bring them together.
    Mrs. Maloney. Okay. So you support NMS? You think it has 
brought the improvements?
    Mr. Sirri. I wouldn't say I support or don't support NMS. 
Like all regulation, it has its problems and it can be 
improved, and I think probably that is why a lot of us are here 
today.
    I think dispersion of market centers was going on before 
NMS came up. We had separated market centers. NMS created a 
platform where more of it could happen and it at the same time 
allowed them to be more connected. I think the empirical 
studies that you all are calling for will help answer the 
question you are asking, which is, is it too much?
    Mrs. Maloney. And Mr. Campos, as the SEC Commissioner who 
voted for Reg NMS, I would like to ask you one simple question. 
Is the current market structure what you envisioned when you 
passed it? And if not, what has surprised you?
    Mr. Campos. None of us--just like we have 20/20 hindsight, 
we don't have 20/20 foresight. We were worried initially about 
whether the connectivity was going to be sufficient and whether 
it would work.
    As Erik Sirri, Professor Sirri has just said, there were 
many markets already existing at the time that we adopted it. 
It would be a very arrogant regulator to believe that they can 
control or should control what the markets will look like in 
the future. So, the effort here again was to create a situation 
in which the technology connected and we had a market system. 
None of us had any idea of how many that would be, whether it 
would be 20, it would be 30, or maybe it would be 10. But we 
expected that business models providing service and value to 
investors would be what would determine how many existed.
    I think it is a unique feature of the American system to 
have competition among markets. And recall that some of these 
markets produce very positive results. There is price 
improvement in some of these markets where there is an 
execution at the midpoint. I will just leave you with that.
    Mrs. Maloney. Thank you.
    We certainly have the data elements out there, but they are 
not really in a way we can use them. And we created in Dodd-
Frank the Office of Financial Research, and they have been in 
existence now for a number of years, and all they have done is 
proceed to give an LEI, which is an identification to every 
broker and person in the business, and that seems to me like a 
waste of time. I think the best data element is the trade 
itself, and that trade itself is identified with a broker and a 
firm. Am I not correct? I will just ask Mr. Campos or anybody?
    Mr. Campos. Yes. I think getting an execution at a decent 
price, being able to access the best price, and that can be 
tested, I think is ultimately the best test of the situation.
    Mrs. Maloney. My time is almost up, and I don't think I 
have time for you to answer, but I would like back in writing 
from you, if we were to look at this, and we have the data 
elements, what would be the best way to look at it? You have 
much more expertise than any of us because you have lived 
through it and you have been part of the markets, you study it 
every day. I think that would be very helpful to us as we look 
at this.
    My time has expired. Thank you.
    Mr. Campos. I would be very pleased to do that. I am sure 
all the other members would, too, on the panel.
    Mr. Hurt. Thank you, Mrs. Maloney.
    The Chair now recognizes the gentleman from South Carolina, 
Mr. Mulvaney, for 5 minutes.
    Mr. Mulvaney. I do have a couple of different types of 
questions.
    Mr. Sirri, I want to follow up on a question. I don't know 
if I understood the answer to Mrs. Maloney's question, so I 
will put it to the entire panel. Has Reg NMS led to too much 
fragmentation within the markets? I think Mr. Sirri said no, 
but I wonder if that is unanimous amongst the panel?
    Mr. Spatt?
    Mr. Spatt. I am not so concerned that it has led to too 
much fragmentation, although it may have led to too much 
fragmentation in particular ways. It certainly creates some 
incentives toward fragmentation by the focus on the top of the 
book in particular, but it is not so much of a concern to me on 
the broad issue because spreads are substantially down. Before 
you had a situation where a lot of the market making was 
occurring in a very noncompetitive way. So it is not a huge 
concern to me, but this is obviously a first order issue to 
consider.
    Mr. Mulvaney. Mr. Lofchie? Mr. Campos?
    Mr. Lofchie. I think what I am hearing from all of the 
panel is that fragmentation per se is not an issue, and that 
remarkably trades can be executed across markets much faster 
today than they could be in 1975 or pre-NMS.
    I think the real issue is why we have so many markets. Is 
it because it is serving the interests of market participants 
or is it because rules incent people to move customer orders in 
ways that may be inefficient in order to take fees rather than 
to serve their customers. And I think if we have rules that 
incent brokers and institutional investors to act in the best 
interests of their customers, then the market will decide how 
many exchanges and how many alternative trading systems 
survive.
    Mr. Mulvaney. Does your analysis change if we start talking 
about the lit versus unlit of these dark pool markets? Do we 
need to update the regulatory environment to allow them to 
compete on a more even playing field? Mr. Lofchie?
    Mr. Lofchie. One of the things that I think we need to look 
at, again, is the motivation of traders. There is clearly a 
tremendous incentive of traders, as Professor Sirri said, not 
to show their quotes on the exchange markets. And I think, 
given the increase of trading in these alternative trading 
systems, we need to understand why they provide benefits. 
Clearly, they do provide a benefit. And I am anxious as to any 
system that would force the person at the point of trade, the 
institutional investor, the mutual fund, the pension plan, not 
to trade in a way that he sees as serving the interests of his 
investors.
    Mr. Campos. Could I serve a caution?
    Mr. Mulvaney. Please.
    Mr. Campos. The term ``dark pools'' is used often, and it 
has sort of a sinister connotation. After all, it is dark. But 
the reality is that the rules regarding dark pools are very 
clear. They have to at least reflect the last best price. And 
often what they reflect is a negotiation, and there is price 
improvement because they tend--or at least one particular 
system that I am very familiar with executes at the midpoint, 
which is a positive for both, and then it is reported to the 
tape.
    So the actual execution and the price that they agree upon 
is not kept from the market. It is not a secret. And it offers 
something that is very important to many large institutional 
investors, which is that they have large block trades to 
execute, and if they put them in through regular execution 
situations they have to be shredded or so-called, split up into 
small. It is very expensive to do that. And so, there is a 
reason why many of these markets exist. They provide a service 
that is necessary
    Mr. Mulvaney. There is an efficiency that comes from that.
    Mr. Campos, I am going to do something unusual. I am going 
to go off topic, but since we have you here today, I want to 
ask you about something that just became public this week. It 
deals with the SEC, it doesn't deal with you individually, but 
I am curious to know your opinion of it. There was a fairly 
widely reported paper, I think published by the University of 
Virginia by two professors out of Georgia, regarding insider 
trading by SEC employees. Specifically, how they are able to 
apparently pick better times to sell stocks than the ordinary 
public and that they apparently, I guess the allegation is, 
they use information that is inside the SEC on upcoming 
investigations.
    How should we best approach the issue going forward as a 
committee as we want to focus on possible wrongdoing by the 
employees at the SEC?
    Mr. Hurt. Mr. Campos, because we are running up against the 
votes, is it possible for you to please respond in writing?
    Mr. Mulvaney. I would appreciate it. I wasn't aware of the 
votes. Thank you, Mr. Chairman. Yes, sir.
    Mr. Hurt. Yes.
    Mr. Campos. Certainly
    Mr. Hurt. And so, if you would please respond in writing, 
that would be very helpful.
    Mr. Hurt. The Chair now recognizes Mr. Lynch for 5 minutes 
for questions.
    Mr. Lynch. Thank you, Mr. Chairman. I would be interested 
in having the response to the earlier question as well.
    This is a great discussion, and the problem at the root of 
this sometimes--and I know that Congress has been late in 
responding to this. I think the SEC agreed to take up a study 
of market structure back in 2010, and that has not happened 
yet. One of the problems that we have is the pace at which 
technology changes and the pace at which government changes. We 
would still have powdered wigs, if we looked good in powdered 
wigs still.
    Meanwhile, technology changes at a breakneck speed. And so 
in a way, we find ourselves in a reactionary mode in 
government. We are trying to, in this case, with market 
structure, respond to the plumbing of these super fast trading 
platforms and things like that. Oftentimes, we find ourselves 
trying to catch up, and that has been a real struggle. So maybe 
there is a way we can, if the SEC gets serious about that, 
together we can envision a platform that might be able to 
address all of the concerns that we have.
    But let me get to my question. Not only has the volume of 
dark pools, of trading in dark pools has increased, but also we 
are seeing some individual stocks where over 50 percent of the 
trading in individual stocks is going to dark pools, and that 
is a different issue than people having large trades, trying to 
move those institutionally without being gamed by some of these 
other traders.
    I know that in the international literature there has been 
a couple of studies by Australia and our friends in Canada that 
have looked at the U.S. markets, and they have had real 
concerns about price discovery and whether our markets are as 
efficient as they once were. And it is interesting because both 
of those countries, after studying the United States, are 
implementing measures to preserve their price discovery 
process. Both are implementing ``trade at'' rules to try to 
preserve the ability of large trades to be done in the dark but 
also requires most other trades to be routed to the best price 
on the transparent markets.
    What do you think that our next step should be in terms of 
moving towards markets that move trades back onto these lit 
markets, lit exchanges, public exchanges, what do you think 
that the greatest incentives we could give to move some of 
these trades back onto, again, lit markets, public markets, 
NASDAQ, the New York Stock Exchange, so that the risk of--well, 
the risk of something happening in the opaque markets is 
reduced?
    Mr. Campos. Is that directed to me?
    Mr. Lynch. Yes.
    Mr. Campos. Thank you for the question; it is very 
thoughtful.
    First of all, I think you need to ask yourself, and the 
whole committee does, is it really a worthwhile goal to want to 
increase the volume on the exchanges per se, is that a real and 
a worthy goal? I submit to you that if orders are being routed 
correctly, if the connectivity is working and investors are 
getting the best price at that particular instant, that in 
itself is a worthy result. And the fact that volume is now 
dissipated may or may not be a negative.
    Mr. Lynch. Just to interject here.
    Mr. Campos. Sure.
    Mr. Lynch. With the rebate system, I am not sure I can tell 
whether the customer--in the dark pool situation. So I don't 
know, I don't really have a window into that, or government 
doesn't have a window into that to determine, with the speed of 
these trades, with the offering of rebates and other 
considerations, whether the customer is getting the best 
available price. I know that is the idea.
    Mr. Campos. Right.
    Mr.Lynch. But we have seen in other situations where there 
have been opaque markets, that whatever advantage a trader can 
get, they will take. That is just the way it works.
    Mr. Campos. I know there is a time issue, so I will make it 
very brief.
    Mr. Lynch. Yes.
    Mr. Campos. Again, it is a great question. One should look 
at it. I believe that many so-called dark pools and ATS's, if 
they offer price improvement, that is what has been used in 
Australia and other places to allow sort of a license to be in 
that particular--
    Mr. Hurt. Thank you, Mr. Campos.
    Mr. Lynch. I yield back.
    Mr. Hurt. And I apologize to the witnesses for this time 
constraint.
    What I would like to do, if there is no objection, I think 
we probably have time to squeeze in two more questions, one 
from Mr. Ross and then one from Mr. Scott, and then we can 
adjourn temporarily to vote and then we will come back. And I 
apologize to the witnesses and to the audience for that and to 
the Members.
    But the Chair now recognizes Mr. Ross for 5 minutes.
    Mr. Ross. Thank you, Mr. Chairman.
    Commissioner Campos, do you feel that Reg NMS is the reason 
we have so many trading centers?
    Mr. Campos. Not per se. I think it accommodated it. 
Remember, Reg NMS was intended when we did it to allow the 
markets to work in the manner that markets work.
    Mr. Ross. So they have naturally evolved, in other words, 
irrespective.
    Mr. Campos. Exactly. And there were already many, many 
centers when NMS was--
    Mr. Ross. And that is not a bad thing, is it?
    Mr. Campos. I don't think it is a bad thing at all.
    Mr. Ross. Mr. Lofchie, you spoke earlier in your opening 
statement about the monopoly of the NYSE back in 1975, and I 
think that some would say that back then we had two dominant 
exchanges, the NASDAQ and the NYSE, and they had high barriers 
to entry. Back then, some would argue, it was simpler and 
safer. Do you think that is something that we should consider 
going back to? Is it even possible?
    Mr. Lofchie. It is certainly not possible. It was clearly 
simpler. I don't know that it was safer.
    Look, there is no question that today's markets, as 
disbursed as they are, in fact, I think provide investors much 
better protection, that all of these various markets work 
together more quickly than the NYSE did back then. So I think 
we have to deal with the markets that we have and the 
technology that we have. There is no turning back.
    Mr. Ross. And technology has been good, but retail 
investors have been a little bit hesitant, have they not, 
because of technology, when you look at how technology has 
permeated so many areas of our world, whether it be medicine or 
transportation or anything. And so when you have a flash crash 
occurring, would you say that technology has been somewhat of 
an impediment, although a benefit?
    Mr. Lofchie. I think overall, it has been an extremely 
large benefit. Again, I think our ability to track information, 
to know whether investors are getting the best price, to link 
markets, if you compare the markets of today to the markets of 
1975 or of pre-NMS, there is no question they are far better. 
On the other hand, when something goes wrong, it goes wrong 
big, and I think that is something that needs to be focused on. 
I think the SEC, with some of the moves to start markets, has 
made moves in that direction.
    Mr. Ross. In your opening statement, I very much enjoyed 
your discussion semantically about dark pools and protective 
coves versus naked bazaars. Is this more of an issue of 
semantics? We have probably the deepest and most transparent 
equity markets of anybody. And we look at dark pools, and is 
the first problem that we have one of semantics?
    Mr. Lofchie. I think there is a risk that we judge markets 
by their name rather than by the service that they provide. And 
it does worry me that when mutual funds and institutional 
investors are electing to trade on what we are calling a dark 
pool, that we are saying, oh, that is not good, because we 
don't like the name of it.
    Mr. Ross. The dark pool. But it does help retail. It helps 
the markets. It is a necessary tool, wouldn't you agree?
    Mr. Lofchie. Clearly, the way that retail investors for the 
most part trade in the market or participate in the market are 
through these institutional entities like mutual funds and like 
pension plans, which very much avail themselves of dark pools.
    Mr. Ross. Mr. Sirri, with regard to market data, and I 
think Mr. Lofchie's earlier testimony about more qualitative 
analysis of the data as opposed to just a collection of 
quantitative collection of data, do you feel that the SEC is 
doing that now and using it effectively? Are they doing more 
quantitative collection as opposed to qualitative?
    Mr. Sirri. I think relative to, say, 5 or 10 years ago, the 
SEC has improved on both fronts. Their quantitative data use is 
better than it has been, they have tooled up in that area, they 
have expanded the group that does such analysis, it has many 
more people in it now and it has more skilled people than it 
used to. That has improved.
    As to your question about qualitative data, I am not as 
well informed about that. I would expect they have. That 
necessarily involves outreach, that involves talking to people 
and understanding that.
    Mr. Ross. Right. It is more than just collection.
    Mr. Sirri. Absolutely. And I will tell you from having been 
there, there is usually no shortage of people who want to walk 
in the door and explain their views to you. So unless that has 
changed in the last few years, I expect they are hearing their 
views.
    Mr. Ross. One quick question, and, Mr. Spatt, I will give 
this to you. A recent Wall Street Journal article states that 
many Wall Street executives point to extreme complexity created 
by Reg NMS as the cause for technical glitches. Has the 
combination of technical complexity and more exchanges created 
an environment where glitches are more likely to occur?
    Mr. Spatt. There seem to be more glitches in recent years. 
Inherently, to the extent that the platforms need to interface 
with each other, that is maybe part of the source of a glitch. 
But I think one also has to assess the glitches from a broad 
perspective in terms of the everyday performance of the market.
    Mr. Ross. Higher volume, higher frequency may lead to more 
glitches.
    Mr. Hurt. Thank you.
    Mr. Ross. Thank you.
    Mr. Hurt. Thank you, Mr. Spatt.
    Mr. Ross. I yield back.
    Mr. Hurt. The gentleman's time has expired.
    The Chair now recognizes Mr. Scott from Georgia.
    Mr. Scott. Thank you very much.
    I want to go back to this issue of the dark pools, because 
I think we need to understand my point and the concerns about 
the fair competition. We, in Congress, amended the Securities 
Exchange Act to add Section 11A, which was to foster fair 
competition.
    Now, it is important for us to understand what these dark 
pools are. I am not casting a bad light on them. But what these 
dark pools are, they provide institutional, large institutional 
investors with anonymity in the equities market with the option 
to execute these large orders without identifying either 
themselves or the location of trade to the consolidated market 
data, and such secrecy allows market participants to prevent 
other traders from pricing in that arena. Therefore, this 
concern is certainly a legitimate concern, especially now that 
40 percent of the average daily volume is in the dark. And with 
the increase in liquidity fragmentation--13 equity exchanges, 
45 dark pools--many, many of our investors are raising 
concerns.
    So my question is, don't each of you agree that order 
competition as a result of this has decreased and that the SEC 
should be looking for ways to rebalance this? Please, each of 
you.
    Mr. Spatt. I don't agree. I agree that the issue of 
transparency is an important one, but I also feel that the 
institutional investors, how they manage their orders to some 
extent is part of their intellectual property. If we were to, 
for example, declare that we would not allow the dark pools to 
operate, to some extent they are going to follow very different 
tactics. They are going to presumably then shred their orders 
to a much greater degree. There is a balancing act.
    Mr. Scott. That is what I am asking for. I am not asking 
that we do away with the dark pools. I am just simply saying 
that there should be an examination for a more fair competition 
within that.
    Mr. Spatt. I am very comfortable with the idea of studying 
the issues, but I think it is important to keep in mind that 
there is a bunch of balancing, and that to some extent, if the 
rules were to change, institutional investors will change how 
they respond to those rules, and I think it is important to 
keep that in mind. And I also think it is important to keep in 
mind that even for dark pools, there is post-trade price 
reporting, for example, that is required of the dark pools as 
well.
    Mr. Scott. Mr. Sirri?
    Mr. Sirri. I think if you wanted to create an environment 
where there was more transparency in dark pools, Congress could 
do that and the SEC could do that, incrementally if they chose. 
For example, you could cause the dark pool to report when a 
trade occurred in that particular dark pool. That is not done 
today. A dark pool is not identified as such.
    But as to what Mr. Spatt said, I would agree with it, which 
is if you choose to do that then traders, as they use that 
particular dark pool, will change. They will do something 
different. Net-net, is that better or worse? I can't tell. But 
I think part of what gets at the answer to your question and to 
Mr. Lynch's question will be a comparison of how well did a 
particular trade do on an exchange that was lit and how well 
did that same trade or an equivalent trade do on a dark pool 
that was dark?
    Mr. Scott. Good.
    Mr. Lofchie?
    Mr. Lofchie. I think one of the issues that you implicitly 
identified, Representative Scott, is the fact that large 
traders may move the market. And I think the concern that all 
of us have, and I think likely share with you, is that when 
mutual funds and pension plans trade in large volume, if they 
are going to do that in a fully exposed manner, are they going 
to move the markets against them and will that end up hurting 
retail investors indirectly.
    Mr. Scott. Thanks.
    Mr. Campos?
    Mr. Campos. Representative Scott, thank you. That is a very 
thoughtful question.
    The issue here really is, can you stop human nature? People 
since time immemorial have made deals outside any market 
system. If you own stock and I own stock, we can trade it 
without any market. And so what you are hearing is essentially 
that there is a need for large investors to do their trades 
cheaply, which helps pensioners, which helps retirees, and they 
need to save money on executions and they need to get the best 
price. So these dark pools serve that purpose very well.
    Mr. Hurt. Thank you, Mr. Campos.
    Mr. Scott. Thank you, sir.
    Mr. Hurt. And I think, unless there is any objection, Mr. 
Huizenga from Michigan has asked to be recognized for 5 
minutes. I think we can work him in before we have to run to 
votes, so I am going to recognize him for 5 minutes.
    Mr. Huizenga. Thank you, Mr. Chairman. I promise to try to 
fold time and space here and make it as fast as possible so we 
can get to votes.
    I was going to start by asking, and I think we have 
explored this quite a bit, how the rules and regulations may 
have pushed, not forced, but maybe pushed some of these trades 
off of the exchanges and into these dark pools. I think it has 
been explored quite a bit, and Mr. Lofchie I think asked a key 
question: Why are they going to these alternatives?
    And I am going to go to another dark and ominous place, 
high frequency trading, or I think as some of my friends in New 
York call it, automated trading, much less ominous than the 
high frequency sounding.
    But, Mr. Sirri, talking about mandating a focus on price 
and speed in executing trades, I am curious about your take on 
how Reg NMS has impacted equity markets and the investors who 
participate in these markets, and has it led to some of these 
high frequency tradings, HFTs, or is that separate in your 
mind?
    Mr. Sirri. I think certain provisions of Reg NMS certainly 
contributed to that, most specifically the ones that required 
private market linkages. Before Reg NMS, the linkages between 
our exchange markets was very primitive. An exchange like the 
New York could hold an order for 10, 20, 30 seconds and not 
interact with that.
    Today, the exchanges have to be automated, those automated 
exchanges are protected, and they route orders between each 
other on high-speed computer networks. This has gone on to the 
point where if you are serious about trading in these markets, 
you need to collocate your computers, you need to trade 
physically close to your market center, because like travel 
time, as fast as that is, that is an important determiner.
    Mr. Huizenga. I know there was a story not that long ago 
about the use of some of the military technology on 
communication with lasers now being utilized. I am trying to 
get my head wrapped around fractions of nanoseconds and the 
amount of information, the multiple terabytes that are being 
exchanged sometimes.
    But does anybody have a concern with the speed, what has 
occurred? Mr. Spatt?
    Mr. Spatt. Well, not necessarily a strong concern. It is 
surprising, though. I share your at least implicit surprise. I 
think what it is pointing out is that the various 
intermediaries must feel that these are profitable investments, 
and that despite incurring the costs for these investments, 
they are still able to make money as intermediaries, and I 
think that is important to keep in mind.
    Mr. Huizenga. Does anybody care to address what equity 
markets in Europe or Asia have rules equivalent to Reg NMS, how 
do these markets perform compared to the United States, and are 
there any differences in performance in part attributable to 
Reg NMS? I would love to hear about Canada as well. As Chair of 
the Inter-Parliamentary Group on Canada, we are working on a 
trip up there, and would love to have this conversation with my 
Canadian friends.
    Mr. Sirri. I am not sure I can speak to Canada, but I can 
talk generally about, for instance, Europe.
    Mr. Huizenga. All you have to do is add an ``eh'' on the 
end of the sentence and you are good.
    Mr. Sirri. There you go.
    Our markets are quite integrated relative to, say, the 
European markets generally. So, for example, as primitive as it 
sounds, they won't have an integrated quote across all their 
pan-European market centers. They won't even have a synchronous 
clock across those centers. We take for granted that all our 
market centers know what time it is down to a millisecond. That 
is not necessarily true in a pan--
    Mr. Huizenga. Meaning the DAX and the CAC and everybody 
else aren't necessarily on the same page?
    Mr. Sirri. That is not necessarily integrated in that same 
way. So in that sense, we have a much higher degree of 
integration in our markets.
    Mr. Huizenga. Do you see them going in that direction?
    Mr. Sirri. I think there are different issues there. They 
have different incentives and they have different governing 
principles. They have MiFID and certain other things that 
govern that. I am not sure I am up-to-speed enough to tell you, 
but I don't think I have seen big movements.
    Mr. Huizenga. Have they not done that because there is a 
fear that it may put them at a disadvantage? I'm sorry, Mr. 
Campos, I think you were--
    Mr. Campos. No. I was just going to add that if you are 
interested, I believe in Europe there is more of a protection 
of their particular market. It is viewed as a national asset. 
As we know, their governments protect major industries, major 
businesses. Germany has a big interest in the Deutsche Borse, 
and the U.K. in the LSE.
    But in addition to the difference that Professor Sirri just 
mentioned, clearing and settlements in Europe is a private 
matter. It is not a utility like it is here in the United 
States essentially. So you have additional costs to trade. This 
is why the U.S. markets are--one of the reasons, among many, 
that they are much cheaper. So, there is a big difference in 
that world.
    Mr. Hurt. Thank you, Mr. Campos.
    The subcommittee will now stand in recess, and we will get 
started again as soon as we can. Thank you.
    [recess].
    Mr. Hurt. I am going to call the subcommittee to order. 
Without objection, the Chair is authorized to declare a recess 
of the subcommittee at any time. Would the witnesses please 
return to the table?
    I want to again thank you all for your appearance today. I 
think the ranking member is here. I don't think she has any 
other questions. I might just kind of wind up with a final 
question and ask for each of you to sort of comment on it. As 
you know, SEC Chair White and her fellow Commissioners recently 
supported the need to review equity market structure. What 
ultimately, from their standpoint and from ours, should the 
goal of that review be? And if you wanted to just kind of wrap 
up with your thoughts on that question, Mr. Campos.
    Mr. Campos. I appreciate the question. Thank you for the 
question.
    I think that, as we began, and in your remarks as well, the 
caution is not to throw the baby out with the bathwater, if I 
can use a common phrase. I think technology is an issue. 
Technology has moved faster, quicker, in ways that no one has 
foreseen. And I think the discussion about speed in trading is 
a legitimate issue to discuss. That shouldn't be confused with 
structure and whether we have competition appropriately among 
markets and among the orders. And I think the issues that 
technology has brought, the flash crash and other instances 
like that, may have to do with plumbing and may have to do with 
better connections and that sort of thing, and that is a 
separate review.
    Mr. Hurt. Mr. Lofchie?
    Mr. Lofchie. One of the interesting issues, I think, for 
the regulators is determining whether we need a more rules-
based system or a more policy-based system. And I think one of 
the issues that has been raised is the difficulty of regulation 
keeping up with technological advancement. I think the more 
that we have a rules-based system, really the more difficult it 
is for the law to keep up with technology. And I think 
Professor Sirri has raised the possibility of going to a more 
policy-based system, and that might be one that in fact proves 
more flexible in keeping up with technology.
    Mr. Hurt. Thank you.
    Mr. Sirri?
    Mr. Sirri. Your question was about the goal of searching 
for these. I think the goal would be to learn as much as you 
can from all sectors and synthesize it before you make your 
decision. Sectors here are investors, they are brokers, they 
are market centers. You learn quantitative things, you learn 
qualitative things, you look at data. Then you put it together 
in a way that in fact many other people can't, because there 
are a lot of people who see pieces, but few people see it all. 
The SEC has the potential to see much more than anyone else. 
Synthesize it and then use that to inform your regulatory 
choices after you have synthesized.
    Mr. Hurt. Great. Thank you.
    Mr. Spatt?
    Mr. Spatt. I think the review in part should try to assess 
what have been the impacts of the major regulations from the 
past, including NMS and decimalization, what have been the 
broad impacts of these, and to what extent do the regulators 
feel that there are distortions in the routing process. 
Especially in an environment where there are as many platforms 
as there are, the routing decision is absolutely central to the 
competitive process. And I think trying to drill down on that 
in a variety of ways has implications for understanding some of 
the detailed rules, like the rules about maker-taker, it has 
implications for the interface between NMS and best execution.
    I think understanding the decision process by which firms 
route orders seems to me an absolutely central issue, and it 
seems to me potentially at the heart of the overarching theme. 
I think the regulators want to try to learn as much as they 
can. There is a wealth of data. And I think by putting the 
right lenses on, there is the potential to learn.
    And I think the regulators also ought to step back, and 
following on the theme of some of the prior witnesses, the 
regulators should step back and try to identify what are the 
objectives and goals and try to lay those out and potentially 
maybe try to consider pulling back from as prescriptive a set 
of rules as we currently have.
    Mr. Hurt. Great. Thank you.
    And with that, I will yield back my time. And I am pleased 
to recognize the gentleman from California, Mr. Royce, for a 
period of 5 minutes.
    Mr. Royce. Thank you very much, Mr. Chairman.
    I wanted to ask Mr. Sirri and maybe Mr. Lofchie on order 
protection, can you give us your best guess on what the market 
would look like without an order protection rule? Would markets 
be less connected, and would there be fewer or would there be 
more trading venues? What would be the evolution?
    Mr. Sirri. Those are the hardest kind of questions to 
answer, you change one thing and then what does the world look 
like? And the reason why they are hard to answer is because I 
have to tell you what the banks, what the brokerages would do 
next with that. It is hard to predict.
    I think if the world were to come to pass as you suggest, 
you put a lot more weight on the brokers' obligations. For 
example, since there is not an automated way to protect certain 
quotes, then brokers are going to have to do that on their own. 
Certain things might speed up, you might get even faster 
trading in some ways. But I think to the extent that you are 
thinking about a world where that might actually happen, you 
would probably have to make some other changes to go along with 
it, because that is, of course, just one piece of what NMS 
provided. So I wish I had a better crystal ball, but it is just 
a tough question.
    Mr. Royce. Mr. Lofchie?
    Mr. Lofchie. I am going to be bolder than Erik, but I feel 
comforted that he said this was a hard question. My guess would 
be that there would be fewer markets and that you would--
    Mr. Royce. There would be fewer exchanges. Instead of 15 
exchanges, there might be--
    Mr. Lofchie. I think the order protection rule provides 
some incentive to split orders among markets rather than 
concentrating them.
    Mr. Royce. Yes.
    Mr. Lofchie. I appreciate Professor Sirri's remark that you 
really are guessing at the motivations of participants, but I 
think that is the challenge that the SEC faces, is to 
anticipate--
    Mr. Royce. So this is propping up some of the smaller 
exchanges, presumably the existing structure that otherwise, 
given the efficiencies, might be collapsed. Is that your--
    Mr. Lofchie. I think that would be my hypothesis.
    Mr. Royce. Yes.
    Mr. Lofchie. And, again, I think it is really about 
anticipating how rule changes would affect the markets.
    Mr. Royce. And that takes me maybe to the next question. As 
we look at the issue from 30,000 feet, you have investors 
seeking to purchase a product in a market. Required in every 
one of those transactions is an intermediary, a broker has to 
be involved in that transaction.
    So, Mr. Sirri, your testimony notes that it is important to 
have this factor of the responsibilities of brokers that handle 
customer orders and their best execution duties, and what does 
that best execution mean for the end investor? That is who we 
are focused on here. And what should the Commission look at in 
this space when considering the responsibility of brokers and 
ensuring the end investor receives the best experience?
    Mr. Sirri. The reason why that duty, the best execution 
duty, is important in securities markets is because individual 
investors in particular can't tell how well they are being 
treated. Mom and pop, when they place an order on their screen, 
they don't know whether they should be trading at 20, 20.01, 
20.02 or 20.03. They just don't know. They don't have the 
information.
    That duty confers upon the broker the obligation to act in 
the interest of the customer whose order they are handling. 
Hence, it becomes more important the less sophisticated the 
investor is. So the Commission has always used the duty of best 
execution to help foster the interests of individual investors 
when they can't monitor things for themselves. I think it 
continues to be as important as it ever was, if not more 
important today.
    Mr. Royce. So my last question would be, then, what is so 
complex about the current system, other than there being so 
many trading venues, other than there being so many exchanges, 
and how does this complexity actually affect the average 
investor?
    Mr. Spatt. The complexity, I think, comes from many 
sources. There are a whole range of different types of 
investors with different business models, intermediaries trying 
to have their own business models that accommodate the needs of 
different types of investors. And obviously, we put those 
together. At a high level you see this about exchanges and 
platforms without exchange obligations, you see this with 
respect to dark pools, you see a whole range of types, and then 
they are interacting.
    And I do think that NMS has made this trading environment 
more complex because of the obligation to hunt for liquidity 
across the tops of all of these vehicles.
    Mr. Royce. Let me, if the chairman would indulge me, I know 
Commissioner Campos wrote about this at one point. If I could 
just finish up with your observations, Commissioner?
    Mr. Campos. Thank you. If we are talking complexity, as has 
been said, complexity comes from many sources. And it is almost 
like fighting the wind. It is going to keep coming, because you 
have many different types of consumers, let's just think of it 
in another context, and you have a lot of different people who 
want to sell consumers.
    So I would caution that reducing complexity in and of 
itself should not be the goal. Instead, fairness is the goal. 
Is the average small investor, for example, getting almost all 
the time the best price at that particular instant? If you let 
things like that guide you--and I know you have a great staff 
and you think about these things deeply--but if you let 
principles like that guide you, you will get through this 
complexity and you will be able to essentially do the proper 
analysis, which I know you are going to do.
    Mr. Royce. Thanks, Commissioner, and thanks, panel, very 
much.
    Mr. Hurt. The gentleman's time has expired.
    The Chair now recognizes Ranking Member Maloney for a 
period of 5 minutes.
    Mrs. Maloney. I would like to hear your comments on what 
you think caused the flash crash and the 3-hour stall in NASDAQ 
and what you can do to correct that.
    And one of you mentioned the churning of selling stocks all 
over the place in order to generate fees. I think that was you. 
Mr. Lofchie, in your statement, the fear of churning or moving 
stocks around just to get fees? One of you talked about that.
    Mr. Lofchie. I think I expressed a concern, Representative 
Maloney.
    Mrs. Maloney. Yes. And I would like to hear more about 
that.
    And lastly, in reading one of these news articles, they 
looked at a $2.5 million transaction for stocks, and the 
broker, they tracked it, the broker offered to buy 750 million 
shares of stock in order to hide the fact he was buying 2.5 
million, and the author questions how that is going to distort 
the market, trying to hide what they are doing.
    So, any comments from any of you on those four questions? 
Thank you very much. It was very insightful and it was 
wonderful to have so many well-informed people speak to us 
today. Thank you.
    Mr. Spatt. I will try to take on some of the questions, but 
not all of the questions.
    On the issue of why we have these glitches, I think there 
are a range of reasons. To some degree, the so-called fat 
finger where one trader makes--one trading firm makes a big 
error, like being off by a zero or maybe two zeros, this has 
been at the root of some situations, and then as it transmits 
through, then the market participants, they think that it is 
real information and then so people react to that in a major 
way. This has been at the root of some of the glitches.
    I think to some degree, even in the flash crash, this was 
there. In the case of the Knight fiasco, I think the problem 
was they were responding to what they perceived to be a change 
in the rules on the NYSE, and on the first day that those 
changes in rules got rolled out, they started running their 
modified procedure against that, but without having the 
opportunity to pretest it, and then further reinforced by they 
didn't have a kill switch to stop things.
    So I think the stories for the glitches differ across 
situations. I do think that when you have many different 
platforms, a problem at one can feed into the others. In the 
NASDAQ case, it was actually in the key information channel, 
the SIP, and ultimately that is kind of a unique thing, but 
that kind of brought much of it down.
    With respect to your final question about the firm wanting 
to trade a couple million shares but then scales it up to a 
couple hundred million shares to try to hide its intent, this 
is actually a question I have thought about a lot in recent 
weeks. I think it is a difficult question, because the party 
that has a couple million shares to trade does seem to me to 
have a legitimate interest in not wanting the markets to 
immediately figure out what it is they are up to and have their 
investors squeezed by the other side of the market. So it tries 
to create what in my discipline we sometimes might call more of 
a randomized or mixed strategy. But I was struck in this 
example by how off the charts, then, the scaling up was, but it 
does seem to me it started from an investor trying to solve a 
legitimate business problem, but then clearly they pushed the 
envelope on it. But it seems not obvious to me where I would 
ultimately want to come down on that.
    Mr. Sirri. I think the one thing I would say to that last 
point, Congresswoman Maloney, is that as technology changes, 
the form of manipulation can change, and so your interpretation 
of what you call manipulation has to change along with it. You 
pointed to something that you probably couldn't have done 10 or 
15 years ago. You can do it today, and I think the way you 
track manipulation, the regulator tracks manipulation has to 
change.
    Mrs. Maloney. And what about the churning for fees?
    Mr. Lofchie. I think the regulators need to look at not 
only the high profile issues, such as high frequency and algo, 
they need to look at more subtle issues like market data fees 
and to ask whether those kinds of fees are altering the way 
investors trade to alter the order routing decisions, as 
Professor Spatt has said.
    Mrs. Maloney. Thank you. My time is up.
    Mr. Hurt. I would like to thank today's witnesses for your 
testimony.
    The Chair notes that some Members may have additional 
questions for this panel, which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 5 legislative days for Members to submit written questions 
to these witnesses and to place their responses in the record. 
Also, without objection, Members will have 5 legislative days 
to submit extraneous materials to the Chair for inclusion in 
the record.
    With that, this hearing is adjourned. Thank you.
    [Whereupon, at 11:57 a.m., the hearing was adjourned.]


                            A P P E N D I X



                           February 28, 2014


[GRAPHIC] [TIFF OMITTED] T8529.001

[GRAPHIC] [TIFF OMITTED] T8529.002

[GRAPHIC] [TIFF OMITTED] T8529.003

[GRAPHIC] [TIFF OMITTED] T8529.004

[GRAPHIC] [TIFF OMITTED] T8529.005

[GRAPHIC] [TIFF OMITTED] T8529.006

[GRAPHIC] [TIFF OMITTED] T8529.007

[GRAPHIC] [TIFF OMITTED] T8529.008

[GRAPHIC] [TIFF OMITTED] T8529.009

[GRAPHIC] [TIFF OMITTED] T8529.010

[GRAPHIC] [TIFF OMITTED] T8529.011

[GRAPHIC] [TIFF OMITTED] T8529.012

[GRAPHIC] [TIFF OMITTED] T8529.013

[GRAPHIC] [TIFF OMITTED] T8529.014

[GRAPHIC] [TIFF OMITTED] T8529.015

[GRAPHIC] [TIFF OMITTED] T8529.016

[GRAPHIC] [TIFF OMITTED] T8529.017

[GRAPHIC] [TIFF OMITTED] T8529.018

[GRAPHIC] [TIFF OMITTED] T8529.019

[GRAPHIC] [TIFF OMITTED] T8529.020

[GRAPHIC] [TIFF OMITTED] T8529.021

[GRAPHIC] [TIFF OMITTED] T8529.022

[GRAPHIC] [TIFF OMITTED] T8529.023

[GRAPHIC] [TIFF OMITTED] T8529.024

[GRAPHIC] [TIFF OMITTED] T8529.025

[GRAPHIC] [TIFF OMITTED] T8529.026

[GRAPHIC] [TIFF OMITTED] T8529.027

[GRAPHIC] [TIFF OMITTED] T8529.028

[GRAPHIC] [TIFF OMITTED] T8529.029

[GRAPHIC] [TIFF OMITTED] T8529.030

[GRAPHIC] [TIFF OMITTED] T8529.031

[GRAPHIC] [TIFF OMITTED] T8529.032

[GRAPHIC] [TIFF OMITTED] T8529.033

[GRAPHIC] [TIFF OMITTED] T8529.034

[GRAPHIC] [TIFF OMITTED] T8529.035

[GRAPHIC] [TIFF OMITTED] T8529.036

[GRAPHIC] [TIFF OMITTED] T8529.037

[GRAPHIC] [TIFF OMITTED] T8529.038

[GRAPHIC] [TIFF OMITTED] T8529.039

[GRAPHIC] [TIFF OMITTED] T8529.040

[GRAPHIC] [TIFF OMITTED] T8529.041

[GRAPHIC] [TIFF OMITTED] T8529.042

