[Senate Hearing 113-413]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 113-413

                     OF CONFIDENCE, AND HIGH SPEED
                     TRADING IN U.S. STOCK MARKETS



                               before the


                                 of the

                              COMMITTEE ON
                          UNITED STATES SENATE


                             SECOND SESSION


                             JUNE 17, 2014


         Available via the World Wide Web: http://www.fdsys.gov

                       Printed for the use of the
        Committee on Homeland Security and Governmental Affairs


89-752                     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 202�09512�091800, or 866�09512�091800 (toll-free). E-mail, [email protected]  


                  THOMAS R. CARPER, Delaware Chairman
CARL LEVIN, Michigan                 TOM COBURN, Oklahoma
MARK L. PRYOR, Arkansas              JOHN McCAIN, Arizona
MARY L. LANDRIEU, Louisiana          RON JOHNSON, Wisconsin
CLAIRE McCASKILL, Missouri           ROB PORTMAN, Ohio
JON TESTER, Montana                  RAND PAUL, Kentucky
MARK BEGICH, Alaska                  MICHAEL B. ENZI, Wyoming
TAMMY BALDWIN, Wisconsin             KELLY AYOTTE, New Hampshire

                   Richard J. Kessler, Staff Director
               Keith B. Ashdown, Minority Staff Director
                     Laura W. Kilbride, Chief Clerk
                   Lauren M. Corcoran, Hearing Clerk


                     CARL LEVIN, Michigan Chairman
MARK L. PRYOR, Arkansas              JOHN McCAIN, Arizona
MARY L. LANDRIEU, Louisiana          RON JOHNSON, Wisconsin
CLAIRE McCASKILL, Missouri           ROB PORTMAN, Ohio
JON TESTER, Montana                  RAND PAUL, Kentucky
TAMMY BALDWIN, Wisconsin             KELLY AYOTTE, New Hampshire

            Elise J. Bean, Staff Director and Chief Counsel
                      Daniel J. Goshorn,  Counsel
       Henry J. Kerner, Minority Staff Director and Chief Counsel
                 Jack Thorlin, Counsel to the Minority
             Brad M. Patout, Senior Advisor to the Minority
           Scott Wittmann, Research Assistant to the Minority
                     Mary D. Robertson, Chief Clerk

                            C O N T E N T S

Opening statements:
    Senator Levin................................................     1
    Senator McCain...............................................     4
    Senator Johnson..............................................     6
Prepared statements:
    Senator Levin................................................    55
    Senator McCain...............................................    59

                         Tuesday, June 17, 2014

Robert H. Battalio, Professor of Finance, Mendoza College of 
  Business, University of Notre Dame, Notre Dame, Indiana........     7
Bradley Katsuyama, President and Chief Executive Officer, IEX 
  Group, Inc., New York, New York................................     9
Thomas W. Farley, President, New York Stock Exchange, New York, 
  New York.......................................................    31
Joseph P. Ratterman, Chief Executive Officer, BATS Global 
  Markets, Inc., Lenexa, Kansas..................................    33
Joseph P. Brennan, Principal and Head of Global Equity Index 
  Group, The Vanguard Group, Inc., Malvern, Pennsylvania.........    35
Steven Quick, Senior Vice President, Trader Group, TD Ameritrade, 
  Omaha, Nebraska................................................    36

                     Alphabetical List of Witnesses

Battalio, Robert H.:
    Testimony....................................................     7
    Prepared statement...........................................    61
Brennan, Joseph P.:
    Testimony....................................................    35
    Prepared statement...........................................    87
Farley, Thomas W.:
    Testimony....................................................    31
    Prepared statement...........................................    77
Katsuyama, Bradley:
    Testimony....................................................     9
    Prepared statement...........................................    69
Quick, Steven:
    Testimony....................................................    36
    Prepared statement...........................................    93
Ratterman, Joseph P.:
    Testimony....................................................    33
    Prepared statement...........................................    79

                              EXHIBIT LIST

1.a.  GMaker-Taker Conflict, chart prepared by the Permanent 
  Subcommittee on Investigations.................................   102
  b.  GPayment for Order Flow Conflict, chart prepared by the 
  Permanent Subcommittee on Investigations.......................   103
  c.  GConflict for Brokers Trading for Institutional Investors, 
  chart prepared by the Permanent Subcommittee on Investigations.   104
  d.  GConflicts for Retail Brokers Trading for Retail Investors, 
  chart prepared by the Permanent Subcommittee on Investigations.   105
2. GLetter from the Securities and Exchange Commission to the 
  Senate Permanent Subcommittee on Investigations, dated June 18, 
  2014, regarding the impact of high-frequency trading on the 
  efficiency, stability, and integrity of the U.S. capital 
  markets........................................................   106
3. GLetter from the Securities and Exchange Commission to the 
  Senate Permanent Subcommittee on Investigations, dated August 
  5, 2014, regarding conflicts of interest in the U.S. equities 
  markets, including ``maker-taker'' fee schedules and payment 
  for order flow by wholesale brokers to retail..................   123
4. GLetter from TD Ameritrade, dated June 19, 2014, clarifying 
  June 17, 2014 testimony of Steven Quick........................   125
5. GResponse of Steven Quick, TD Ameritrade, Inc., to 
  supplemental questions for the record of Senator Carl Levin....   126
6. GResponse of Joe Ratterman, BATS Global Markets, Inc., to 
  supplemental questions for the record of Senator Carl Levin....   127
7. GResponse of Thomas Farley, NYSE Group, to supplemental 
  questions for the record of Senator Carl Levin.................   128
8. GResponse of Joseph Brennan, The Vanguard Group, Inc., to 
  supplemental questions for the record of Senator Carl Levin....   129

                     OF CONFIDENCE, AND HIGH SPEED
                     TRADING IN U.S. STOCK MARKETS


                         TUESDAY, JUNE 17, 2014

                                   U.S. Senate,    
              Permanent Subcommittee on Investigations,    
                    of the Committee on Homeland Security  
                                  and Governmental Affairs,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 9:35 a.m., in 
room SH-216, Hart Senate Office Building, Hon. Carl Levin, 
Chairman of the Subcommittee, presiding.
    Present: Senators Levin, McCain, and Johnson.
    Staff present: Elise J. Bean, Staff Director and Chief 
Counsel; Mary D. Robertson, Chief Clerk; Daniel J. Goshorn, 
Senior Counsel; Joseph Bryan, Robert Heckert, and Timothy 
Everett (Sen. Levin); Adam Henderson, Professional Staff 
Member; Henry J. Kerner, Staff Director and Chief Counsel to 
the Minority; Jack Thorlin, Counsel to the Minority; Brad M. 
Patout, Senior Advisor to the Minority; Scott Wittmann, 
Research Assistant to the Minority; John Lin, Law Clerk to the 
Minority; Joel Churches, Detailee (IRS); Admad Sarsour, 
Detailee (FDIC); Jacob Rogers, Law Clerk; Rebecca Pskowski, Law 
Clerk; Michael Avi-Yonah, Intern; Amy Dreisiger, Law Clerk; 
Owen Dunn, Law Clerk; Josh Katz and Richard Drucker (Sen. 
Levin); Ritika Rodrigues and Meris Petek (Sen. Johnson); and 
Myles Matteson (Sen. Ayotte).


    Senator Levin. Good morning, everybody. Most Americans' 
image of the U.S. stock market is shaped by a single room: the 
trading floor of the New York Stock Exchange, where traders 
await a ceremonial bell to kick off the day's activity, then 
trade shares worth millions on scraps of paper.
    In reality, most shares are traded not on a floor in 
Manhattan, but in racks of computer servers in New Jersey. 
Trades happen not at the speed of a human scribbling on paper, 
but in the milliseconds it takes for an order to travel through 
fiberoptic cables. And, increasingly, the money made on stock 
markets comes not from thoroughly assessing companies for their 
investment potential, but from exploiting infinitesimal 
advantages at unfathomable speeds, earning billions off price 
differences measured in pennies.
    We are in the era of high-speed trading. I am troubled, as 
are many, by some of its hallmarks. It is an era of market 
instability, as we saw in the 2010 ``flash crash,'' which this 
Subcommittee and the Senate Banking Committee explored in a 
joint hearing, and in several market disruptions since that 
flash crash. It is an era in which stock market players buy the 
right to locate their trading computers closer and closer to 
the computers of stock exchanges--conferring a minuscule speed 
advantage yielding massive profits. It is an era in which 
millions of trade orders are placed, and then canceled, in a 
single second, raising the question of whether much of what we 
call the market is, in fact, an illusion.
    Many, including this Senator, question whether the rise of 
high-speed trading is, overall, a good thing for markets and 
investors. But without question, this era has seen a rise of 
conflicts of interest. These conflicts will be my focus today. 
Other Senators may focus on this or other aspects of high-speed 
    New technologies should not erase enduring values. 
Financial markets cannot survive on technology alone. They 
require a much older concept: trust. And trust is eroding. 
Conflicts of interest damage investors and markets--first, by 
depriving investors of the certainty that brokers are placing 
the interests of their clients first and foremost; and, second, 
by feeding a growing belief that the markets are simply not 
    In fact, polling shows that roughly two-thirds of Americans 
believe the stock market unfairly benefits some at the expense 
of others. This distrust may be a factor in the fact that just 
over half of Americans, according to a Gallup survey earlier 
this year, own stock or mutual funds, which is down from more 
than two-thirds of Americans who owned stock or mutual funds in 
2002. That lack of faith--if allowed to fester and grow--will 
undermine a very important public purpose of stock markets: to 
efficiently raise capital so that businesses may grow, create 
new jobs, and add to America's prosperity.
    In previous hearings and investigations, this Subcommittee 
has shown that our financial markets have become plagued by 
conflicts of interest. We have uncovered investment banks 
willing to create securities based on junk assets, tout them to 
their clients, and then bet against those same securities, 
making a fortune at the expense of their clients. We have seen 
credit rating agencies assign artificially high ratings to 
securities in order to keep or gain business. Now, with that 
history in mind, those who argue that the conflicts we will 
explore at this hearing are manageable or acceptable have a 
mighty high burden of proof.
    What seems to your average investor to be a simple stock 
market trade is usually a complicated series of transactions 
involving multiple parties, complex technology, and an ever-
increasing number of order types and payment arrangements. 
There are retail brokers, like the ones found in Main Street 
offices across the country and on TV advertisements. There are 
wholesale brokers who buy orders from retail brokers. And there 
are dozens of trading venues where shares are bought and sold. 
Most Americans know the New York Stock Exchange, but there are 
now 11 public exchanges, plus more than 40 alternative trading 
venues including ``dark pools,'' which are essentially private 
exchanges run by financial institutions.
    As that complex structure has emerged, so have a number of 
conflicts of interest. I will focus on two. The first conflict 
occurs when a retail broker chooses a wholesale broker to 
execute trades. The second occurs when a broker, acting on 
behalf of either a retail client or an institutional investor 
that manages pension funds and retirement accounts, chooses a 
trading venue, often a public exchange, to execute a trade. At 
both of these decision points, the party making the decision 
should only be influenced by the best interest of the investor. 
That is what ethics demands, and it is what the law requires.
    But there is another factor in play. At both decision 
points, the current structure gives brokers an incentive to 
place their own interests ahead of the interests of their 
clients. And here is how.
    The first conflict, which is illustrated in that chart,\1\ 
occurs when retail brokers receive payments from wholesale 
brokers for their orders. This money, known as ``payment for 
order flow,'' can add up to untold millions, and almost every 
retail broker keeps these payments rather than passing them on 
to clients. The reasons wholesale brokers are willing to pay 
for order flow are complex, but one big one is that wholesale 
brokers can fill many of those orders out of their own 
inventory and profit from the trade--a practice known as 
    \1\ The chart titled ``Payment for Order Flow Conflict,'' appears 
in the Appendix on page 103.
    The second conflict, shown on the second chart,\2\ arises 
when a broker decides to use a public trading venue and then 
chooses which venue it will send orders to for execution. Under 
what is known as the ``maker-taker'' arrangement, there is an 
incentive for the broker to choose the trading venue based on 
the broker's financial interest, rather than the client's.
    \2\ The chart titled ``Maker-Taker Conflict,'' appears in the 
Appendix on page 102.
    Now, ``maker-taker'' can be complicated, but here is a 
simplified explanation. When a broker makes an offer on an 
exchange to buy or sell a stock at a certain price, the broker 
is classified as a ``maker,'' and most exchanges will pay the 
broker a rebate when that offer to buy or sell is accepted. A 
broker who accepts a maker's offer to buy or sell is called a 
``taker'' and will generally pay a fee to the trading venue. 
The important thing to remember is that brokers, by maximizing 
maker rebates and by avoiding taker fees, can add millions of 
dollars to their bottom line, giving them a powerful incentive 
to send the order to the trading venue that is in their best 
interest even if it is not in their client's best interest.
    It is significant that earlier this year, speculation that 
regulators were considering restrictions on payment for order 
flow sent shares of some brokerage firms significantly lower.
    Obviously, there is a lot of money at stake in preserving 
these conflicts of interest.
    Even if firms disclose these payments, disclosure does not 
excuse them from their legal and ethical obligations to 
clients. Their legal obligation is to provide clients with what 
is known as ``best execution.'' Whether they are meeting that 
obligation is a subjective judgment. The outcome of this 
subjective judgment affects the way tens of millions of trades 
are executed.
    Now, some who profit from these payments argue that seeking 
this revenue does not interfere with their obligation to seek 
best execution. However, one of our witnesses today, Professor 
Robert Battalio of the University of Notre Dame, has done 
research indicating that when, given a choice, four leading 
retail brokers send their orders to the markets offering the 
biggest rebates at every opportunity. The research further 
suggests that exchanges offering the highest rebates do not, in 
fact, offer the best execution for clients. These brokers argue 
that they can pocket these rebates while still meeting their 
obligation to provide clients with best execution. So while 
they make a subjective judgment as to which trading venue 
provides best execution, on tens of millions of trades a year, 
that subjective judgment always just happens to also result in 
the biggest payment to brokers. I find it hard to believe that 
this is a coincidence.
    Many market participants are worried about the conflicts of 
interest embedded in the current market structure. In addition 
to Professor Battalio, today's first panel will include Bradley 
Katsuyama, the president and CEO of IEX and a prominent Wall 
Street advocate for market reform. Our second panel will 
include four witnesses. They are Thomas W. Farley of the New 
York Stock Exchange, whose corporate owners have described 
conflicts as having a ``corrosive impact'' on stock markets. 
The next person on the second panel is Joseph Ratterman of BATS 
Global Markets, which operates exchanges that compete with the 
New York Stock Exchange and has a different view. The third 
witness on the second panel is Joseph Brennan of Vanguard 
Group, a major mutual fund company that has expressed concerns 
about these conflicts. And the fourth witness on the second 
panel is Steven Quirk of TD Ameritrade, a retail broker that 
derives significant revenue from payment for order flow from 
wholesale brokers and rebates that they receive from exchanges.
    The duty of lawmakers and financial regulators is to look 
out for the interests of investors and the wider public. There 
is significant evidence that these conflicts can damage 
retirement savings, pension holdings, and other investments on 
which Americans rely. And even Americans without a single share 
of stock or a mutual fund account have something at stake 
because stock markets exist to foster investment, growth, and 
job creation. Conflicts of interest jeopardize that vital 
    Americans do not shy from innovation or technology; indeed, 
we embrace them. But Americans are understandably suspicious 
when technology can be turned against them and their families' 
financial interests. They are rightly concerned when technology 
and innovation are used to undermine basic, enduring principles 
such as trust and duty to a client. Our goal is to advance the 
protection of investors and our free markets by promoting those 
enduring values.
    I want to thank Senator McCain and his staff for their 
close cooperation in this matter, as has always been the case 
in all matters. Senator McCain.


    Senator McCain. Thank you very much, Mr. Chairman, and I 
think this is a very important hearing, and I appreciate the 
hard work that you and your excellent staff have done on it. 
And I want to thank the witnesses for being here today.
    When Michael Lewis' book ``Flash Boys'' came out, the 
public knew very little about high-frequency trading. Important 
questions were raised: Is the stock market ``rigged'' by 
unethical high-speed traders with faster access to market 
information, advanced technology, and sophisticated trading 
algorithms? Is high-frequency trading adding costs for other 
traders without contributing any real value to the market? Will 
stock markets face another flash crash like in 2010 when the 
Dow Jones temporarily lost $1 trillion in market value in 20 
    These concerns about high-frequency trading have fueled 
suspicions that Wall Street may well have become the ultimate 
insiders' game, where the average investor can no longer 
meaningfully participate. Consumers see firms that can make 
trades in fractions of a second using cutting-edge technology 
and wonder if the stock exchanges are still a place where their 
interests matter. Hopefully, this hearing will shed light on 
the high-frequency trading practices used on Wall Street and 
help restore confidence in our financial system.
    The Subcommittee interviewed many industry participants, 
academic researchers, and key financial regulators. While the 
problems facing the market are complex, we can address them 
with a few commonsense solutions. For example, one of the most 
predatory high-frequency trading practices depends on the 
unintended consequences of the SEC's Regulation National Market 
System, or Reg NMS. That regulation essentially mandated that 
investment firms must buy or sell stocks at the best price 
available. While that might sound like a reasonable 
requirement, high-frequency trading firms can take advantage of 
the rule by putting out offers to buy or sell small amounts of 
stock at attractive prices. When a large investor, seeking to 
make a big order, accepts the high-frequency trading firm's 
offer because it is the best price available, the high-
frequency trader can predict that the large investor will have 
to go to another exchange to purchase the rest of his order. 
The high-frequency trader can then race ahead of that investor 
to the other exchanges, buy up all available shares, and sell 
them to the large investor at a higher price. Changing Reg NMS 
so that investment firms are no longer legally required to take 
the high-frequency traders' bait is an easy, clear first step 
to cleaning up the worst high-frequency trading practices.
    Another key tactic used by high-frequency trading firms is 
co-location. This practice involves trading firms literally 
renting space for their computers in the same room as the 
computers that run the stock exchanges so that they can receive 
market information directly from the exchanges' computers as 
fast as possible. The investors that do not buy this direct 
connection to the exchanges receive market data via a 
government-established system using out-of-date technology 
called the Securities Information Processor that compiles 
market data much more slowly. But as experts told the 
Subcommittee, there is no reason why public data feeds like the 
Securities Information Processor cannot be improved so that 
they are effectively as fast as private data feeds acquired 
through co-location. Updating the technology in the Securities 
Information Processor is another helpful measure that can be 
quickly adopted to shore up consumer confidence in the market.
    In addition to high-frequency trading, ``Flash Boys'' also 
described how stock exchanges often pay rebates, as Senator 
Levin pointed out, to stockbrokers to entice them to trade on 
those exchanges. Those rebates, again, as Senator Levin pointed 
out, called ``maker-taker payments,'' create an apparent 
conflict of interest for the stockbrokers, who must choose 
between sending their clients' orders to exchanges offering a 
higher rebate or to exchanges that would fill the orders as 
quickly as possible. While many trading firms argue that those 
payments spur more market activity and reduce costs for 
consumers, some experts have argued that these benefits are 
minimal and that investors are harmed by their brokers' 
conflict of interest.
    The Subcommittee has found that there is a lack of publicly 
available data regarding maker-taker payments, leading to 
difficulties in determining whether the payments actually have 
an adverse effect on the market. A logical first step would be 
to have more transparency in the payments, allowing neutral 
researchers to study the issue in greater detail.
    I hope this hearing will educate the public about high-
frequency trading and broker conflicts of interest, and I hope 
that as a result of this hearing and the information that we 
will obtain from our expert witnesses that action will be taken 
to restore investor confidence, which has clearly been eroded 
in recent months, especially since the publication of Michael 
Lewis' book.
    I thank you, Mr. Chairman.
    Senator Levin. Thank you very much.
    Senator Johnson.


    Senator Johnson. Thank you, Mr. Chairman. I also want to 
thank you for holding this hearing. It was very interesting 
getting prepared for it.
    Both Chairman Levin and Senator McCain mentioned the word 
``complex,'' and there is no doubt about it. What is happening 
in terms of trading is highly complex.
    From my standpoint, having been an individual investor, I 
think the primary solution is increased competition and 
transparency so that we really understand what is happening. 
But because it is complex, it is difficult to fully understand. 
I am hoping this hearing will really lay out the reality of the 
situation, and, again, as an individual investor who has bought 
stocks for literally decades, the competition has increased in 
the marketplace. I used to pay hundreds of dollars to buy 100 
shares of stock. Now I pay about $10.
    So I really do hope that this hearing conveys exactly what 
is happening in the marketplace, what benefits have come to 
consumers over the years, what dangers may be out there, but 
the bottom line is that this hearing should be about restoring 
confidence. I do not think it restores confidence if we try and 
create a state of fear and set up straw men in terms of the 
bogeymen out there trying to game the system. The best way to 
ensure confidence and to ensure best price, is through maximum 
competition and transparency in the marketplace. I am hoping 
that is certainly what this hearing reveals, and, again, I just 
want to thank all the witnesses. I am looking forward to the 
    Senator Levin. Thank you, Senator Johnson.
    We will now call our first panel of witnesses for this 
morning's hearing: Professor Robert Battalio, Professor of 
Finance at the Mendoza College of Business at the University of 
Notre Dame in Notre Dame, Indiana; and Bradley Katsuyama, 
President and CEO of the IEX Group in New York.
    I appreciate both of you being with us this morning, and we 
look forward to your testimony. And pursuant to Rule 6, all 
witnesses who testify before the Subcommittee are required to 
be sworn. So at this time, I would ask both of you to please 
stand and raise your right hand. Do you swear that the 
testimony you are about to give before this Subcommittee will 
be the truth, the whole truth, and nothing but the truth, so 
help you, God?
    Mr. Battalio. I do.
    Mr. Katsuyama. I do.
    Senator Levin. We will be using a timing system today. 
Please be aware that 1 minute before the red light comes on, 
you will see the light change from green to yellow, giving you 
an opportunity to conclude your remarks. All of your written 
testimony will be printed in the record in its entirety, and we 
would ask that you try to limit your oral testimony to 5 
    Professor Battalio, we will have you go first. Thank you 
again for coming today and for your work.

                         DAME, INDIANA

    Mr. Battalio. Good morning. Chairman Levin and Ranking 
Member McCain, thank you for inviting me to testify today. It 
is an honor to have the opportunity to present my views on 
conflicts of interest in U.S. equity markets to the Senate 
Permanent Subcommittee on Investigations. My expertise is the 
relationship between order flow inducements offered by dealers 
and exchanges and the quality of trade execution.
    \1\ The prepared statement of Mr. Battalio appears in the Appendix 
on page 61.
    Before discussing my current research with Shane Corwin and 
Robert Jennings, I would like to provide a bit of context. 
Orders used by retail investors can be broadly classified into 
two categories.
    Investors who want to trade quickly at the best available 
price use marketable orders. These orders demand or take 
liquidity from the market. Investors who are willing to buy or 
sell stock but not at the prices that are currently prevailing 
in the marketplace use nonmarketable or standing orders to 
express their trading interests. Nonmarketable orders do not 
immediately execute when they arrive in the market. Exchanges 
use electronic order books to keep track of their nonmarketable 
orders, and they typically use price-time priority to determine 
which nonmarketable order trades when a marketable order 
arrives. The nonmarketable orders resting on the electronic 
books make or supply liquidity for other market participants.
    Several exchanges use make or liquidity rebates to attract 
nonmarketable orders. A make rebate is paid to an investor or 
her broker when her nonmarketable order trades. To fund the 
make rebates, the same exchanges charge marketable orders a 
take fee when they trade with nonmarketable orders. As a result 
of competition, exchanges offering high make rebates also tend 
to charge high take fees, and those offering low make rebates 
tend to charge low take fees.
    The incentives created by the maker-taker fee structure 
suggest marketable orders will tend to be first routed to 
venues that have low take fees and, thus, low make rebates. As 
a result, nonmarketable orders on high-fee, high-rebate venues 
are likely to trade last at a given price and, thus, can miss 
out on profitable trading opportunities. All else equal, this 
suggests that the likelihood that nonmarketable orders trade is 
lowest on the exchanges with the high make rebates.
    NASD Notice to Members 01-22 states that brokers must take 
into account differences in the likelihood of execution when 
determining where to route nonmarketable orders and that 
brokers must not allow inducements to interfere with the duty 
of best execution. The conflict of interest associated with 
make-take fee schedules arises from the fact that most brokers 
do not pass fees and rebates directly through to their 
customers, but instead charge fixed commission rates that 
reflect fees, rebates, and other costs of doing business.
    Thus, while investors prefer that their orders be routed to 
the venue offering the highest possibility of trade, a broker 
may have an incentive to route orders to the venue offering the 
highest liquidity rebate. It may seem that economics and 
competition should align the incentives of a broker and its 
customers; however, this alignment of incentives is hampered by 
an important agency problem. Brokers that maximize rebates may 
be able to charge lower commissions. If investors choose 
brokers based primarily on commissions--perhaps because they 
lack the sophistication and/or the necessary information to 
evaluate limit order execution quality--it may be profit 
maximizing for brokers to focus on liquidity rebates rather 
than the likelihood of execution when deciding where to route 
their nonmarketable orders. Unfortunately, investors whose 
orders do not execute do not receive the benefit of the low 
    In our paper, we examine two issues. We begin by exploring 
whether make rebates appear to influence the routing decisions 
of retail brokers. We present evidence from SEC-mandated Rule 
606 filings that four popular retail brokers route 
nonmarketable orders in a manner that is consistent with the 
goal of maximizing make rebates. Our Rule 606 data are from the 
fourth quarter of 2012, but subsequent Rule 606 filings suggest 
these brokers have not significantly altered their routing of 
nonmarketable orders.
    After establishing that rebates appear to impact the order 
routing decisions of some brokers, we next analyzed the 
relationship between make rebates and several measures of 
execution quality, including the likelihood that and the 
conditions in which nonmarketable orders trade. Our analysis 
makes use of a proprietary data set of nonmarketable orders 
that represent about 1.5 percent of average daily volume and a 
publicly available data base that contains all trades and 
    As hypothesized, we find that nonmarketable orders routed 
to venues with low make rebates are more likely to trade, trade 
faster, and suffer less adverse selection than nonmarketable 
orders routed to venues with high make rebates. Our results 
suggest that when deciding where to route nonmarketable orders, 
situations frequently arise in which brokers must decide 
whether to maximize the likelihood of an execution or to 
maximize make rebates.
    Thanks for the opportunity to discuss my research with 
Shane and Bob today.
    Senator Levin. Thank you very much, Professor Battalio.
    Mr. Katsuyama.


    Mr. Katsuyama. Good morning, Chairman Levin, Ranking Member 
McCain, Senators, staff, ladies and gentlemen. Thank you for 
the opportunity to participate in this hearing and share our 
thoughts on issues affecting the U.S. equity markets. My name 
is Brad Katsuyama, and I am the President and CEO of IEX Group.
    \1\ The prepared statement of Mr. Katsuyama appears in the Appendix 
on page 69.
    Since October 2013, IEX has been operating as an 
alternative trading system for U.S. equities, and we intend to 
pursue registration as a national securities exchange with the 
Securities and Exchange Commission later this year.
    IEX was founded on the premise of institutionalizing 
fairness in the market through the use of technology and by 
offering a balanced, simplified, and transparent market model. 
IEX believes strongly in a market's responsibility to ensure 
just and equitable principles of trade as required by Section 6 
of the Securities and Exchange Act of 1934.
    With that in mind, IEX deliberately sought to build a 
platform that would eliminate conflicts of interest in the 
operation of our market. Specifically, IEX is owned by a 
consortium of mutual funds, hedge funds, family offices, and 
individuals, but only has registered broker-dealers as trading 
participants. IEX does not pay rebates or provide any other 
payment for order flow, and as a result, we have a very limited 
number of order types.
    IEX has instituted a time buffer that applies to all of our 
trading participants to neutralize certain structural 
inefficiencies that we have discovered. IEX uses direct market 
data feeds from all U.S. exchanges rather than the slower SIP 
to price orders and trades in our market. And IEX was the first 
ATS to publicly publish our confidential form ATS in an effort 
to promote transparency.
    It is important to recognize that IEX was created within 
the current regulatory framework, serving as evidence that the 
spirit of the rules governing our current market do allow for 
innovative free market solutions to emerge. We believe that the 
U.S. equity markets have improved dramatically over the past 20 
years as participants can now trade less expensively and faster 
than they did in the past. But we believe this was mainly due 
to the inevitable improvements that technology has delivered 
across many industries, with financial markets being no 
    Despite those benefits, it has become apparent to our team 
and our supporters that the U.S. equity markets are also far 
from perfect, and these imperfections that we have discovered 
over the last several years are the reason we started IEX and 
the reason I am sitting here today.
    We believe that the number of independent equity trading 
destinations across exchanges, dark pools, and other 
internalizers, each having their own unique technology, 
products, rule sets, and pricing schedules, creates a 
tremendous amount of complexity. This complexity, combined with 
the lack of clear language disclosure, has created structural 
inefficiencies which allow unfair advantages and disadvantages 
to various market participants.
    This complexity has also put the health and stability of 
the overall market at risk without contributing to the market's 
ability to serve its core function--capital formation.
    There are four main conflicts of interest that we would 
like to highlight.
    First, due to the complex fee and rebate structure of 
trading venues, brokers have perverse incentives when deciding 
where and how to route customer trades. Many high-quality 
studies, including the one from Professor Battalio, have 
demonstrated the direct relationship between a broker 
attempting to harvest rebates and worse execution quality for 
their customers. Based on our team's prior experience, we can 
confirm these findings.
    Second, to avoid high fees for taking liquidity on 
exchanges, many of the largest brokers created their own 
private dark pools to internalize order flow, in the process 
isolating client orders away from the broader market. Although 
many of these broker pools are interconnected, at times brokers 
are unwilling to route orders to other broker pools to avoid 
improving the performance of a competitor, even though it may 
be in the best interests of their client to do so.
    Third, trading venues, including exchanges and dark pools, 
naturally seek to maximize profits by increasing their own 
trading volumes, and as a result, there are many predatory, 
high-volume trading strategies that are left unattended--
intermediating between venues--as certain market centers 
prioritize market share over protecting the interests of client 
    And, fourth, markets that offer co-location and different 
speeds of market data and connectivity have a direct conflict 
in the profits garnered from selling these services versus the 
structural inefficiency created when those same products enable 
a participant to trade faster than the market itself to the 
detriment of any participant who relies on the market to fairly 
price trades.
    Although many of these issues are deeply embedded in our 
market structure, IEX believes that the best policies to 
address these conflicts are those that promote transparency and 
disclosure. The SEC's Midas website and FINRA's ATS reporting 
rule are recent positive steps, and we would encourage further 
pursuit of transparency, specifically these three points: 
first, standardization of data collection and reporting; 
second, disclosure of both routing and trading information in a 
standardized form between brokers and clients; and, third, full 
disclosure of rules, products, and services from all market 
    The most important implication of transparency is that it 
brings accountability to all participants in our market. 
Heightened forced transparency will give participants the 
information they need to ask critical questions and to make 
better decisions. This will allow the market to self-regulate.
    We respectfully ask that if Congress or the Commission 
looks to further modify the structure of the equity markets, 
careful consideration is given to deciding which issues are 
better solved through regulation and which issues are better 
addressed through free market solutions.
    In closing, IEX would like to echo SEC Chair White's recent 
statement that, ``The secondary markets exist for investors and 
public companies, and their interests must be paramount.'' As 
the financial services work through this period of change, none 
of us should forget why the market exists in the first place.
    Thank you.
    Senator Levin. Thank you very much, Mr. Katsuyama.
    Let us try a first round of 8 minutes, if that is all 
right, and we will have as many rounds as we need. And that is 
true with both panels. We have four votes that are going to 
begin at 11 o'clock. I will stay here at least through the 
first two votes and miss those votes as currently planned, and 
others can come and make the votes should they wish.
    Professor Battalio, let us talk about the nonmarketable 
orders. These are the ones that do not have an immediate match 
and that add or make liquidity.
    Now, under the maker-taker pricing, most exchanges are 
willing to pay brokers for sending them nonmarketable orders. 
Is that correct so far?
    Mr. Battalio. Yes, sir. Very good.
    Senator Levin. Some retail brokers send virtually all 
nonmarketable orders to exchanges that pay a rebate. Is that 
    Mr. Battalio. That also appears to be true.
    Senator Levin. OK. Now, your paper looked at where retail 
brokers routed nonmarketable customer orders and stated that 
Ameritrade, E*Trade, Fidelity, and Scottrade route orders in a 
way that suggests that they may be focused on liquidity 
rebates. How often did those retail brokers route nonmarketable 
orders to the exchange offering the highest rebate?
    Mr. Battalio. Those four brokers--well, three of the four 
brokers either route things called--the SEC reports are not 
good enough to distinguish between marketable and nonmarketable 
limit orders, OK? But based on an assumption that is pretty 
solid, three of the four either route limit orders to people 
that pay for order flow--and those are probably marketable 
orders--or to the high-fee venue, nowhere else.
    Senator Levin. And the high-fee venue are the exchanges.
    Mr. Battalio. It is one venue offering the high make 
    Senator Levin. All right. So when it comes to order flow, 
they go to the wholesale brokers generally. Is that correct?
    Mr. Battalio. With the marketable stuff, they go to the 
    Senator Levin. With the marketable stuff, and they are paid 
for that.
    Mr. Battalio. Yes, sir.
    Senator Levin. And they always go to the high rebate 
    Mr. Battalio. The one high----
    Senator Levin [continuing]. For the nonmarketable ones?
    Mr. Battalio. Yes, sir.
    Senator Levin. OK. Now, your paper assessed whether the 
decision by retail brokers to route nonmarketable customer 
orders to exchanges that pay the highest rebate was consistent 
with the broker's obligation to obtain best execution of their 
customers' orders. And this is now quoting from your paper: 
``The results of our analysis suggest that routing all 
nonmarketable orders to a single exchange that offers the 
highest liquidity rebates is inconsistent with maximizing 
nonmarketable order execution quality.'' Is that quote correct?
    Mr. Battalio. Yes, sir.
    Senator Levin. All right. Now, the decision, your paper 
says, ``to use a single venue that offered the high liquidity 
rebates does not appear to be consistent with the objective of 
obtaining best execution.'' Did I quote you correctly?
    Mr. Battalio. Yes. It results in diminished fill rates.
    Senator Levin. All right. That is the reason why, but, 
nonetheless, I quoted you accurately.
    Mr. Battalio. Exactly.
    Senator Levin. All right. Now, is that then evidence of a 
conflict that harms consumers?
    Mr. Battalio. We certainly think that the routing could be 
done better, yes.
    Senator Levin. Well, to put it in terms that I understand, 
is that then evidence of a conflict that would harm consumers?
    Mr. Battalio. Yes, sir.
    Senator Levin. And your data then shows and your conclusion 
shows that the highest rebate and best execution do not go 
    Mr. Battalio. Yes, sir. In certain circumstances, they do 
not go together. Not always, but in certain circumstances.
    Senator Levin. Would that be in most circumstances where 
these orders are routed to an exchange?
    Mr. Battalio. So in the most actively traded stocks where 
the lines to trade are the biggest, that is where it matters 
the most.
    Senator Levin. And that would be true, what I just said?
    Mr. Battalio. Yes.
    Senator Levin. Now, Mr. Katsuyama, I expect that some of 
the retail brokers that are named in Professor Battalio's paper 
would claim that the fact that they directed all of their 
nonmarketable orders to the exchange that pays them the most is 
not inconsistent with providing best execution to their 
customers. What is your view of that?
    Mr. Katsuyama. So from a practitioner's standpoint, prior 
to IEX, I worked and ran trading at a large broker-dealer. You 
know, I think there are two ways to look at it. The first is 
that the exchange that pays the highest rebate will have the 
longest queue because people that are posting liquidity let us 
just say on the bid, they want the rebate, so more people will 
line up because of that inducement.
    The first thing to consider--that getting in the longest 
line will lower your probability of getting filled because 
there are more people in front of you in line. The second thing 
to consider is the inducement of, let us say in this instance, 
the seller. Where is the seller most likely to go when selling 
stock, looking to sell stock on the bid? The seller is most 
likely to go to the place that either pays them a rebate or 
definitely to attempt to avoid those who charge the highest 
fees. So getting in the longest line, posting in the highest 
rebate venue, exposes you to larger competition, reducing the 
probability of fill, and it also makes you the least likely 
venue to get filled on because the seller on the other side of 
the order is not incentivized to go there first.
    So it hurts you in two ways. We have run a series of tests 
on this using our own capital back when I was at RBC, and the 
tests confirmed the findings that Professor Battalio outlined 
in his paper.
    Senator Levin. And can you repeat that finding in your 
    Mr. Katsuyama. Sure, that routing specifically with the 
goal of maximizing your rebate lowers the probability of 
getting filled and leads to adverse execution quality or worse 
execution quality for the client's order who you are 
representing or even your own order if a bank is routing on its 
own behalf.
    Senator Levin. Does that create a conflict of interest?
    Mr. Katsuyama. Yes.
    Senator Levin. Let me just go back to Professor Battalio 
for one moment. Is best execution a subjective determination, 
at least in part?
    Mr. Battalio. At least in particular. We would argue more 
so subjective for market orders because a lot of determinants 
go into figuring out whether you have a good trade price or 
not. With standing orders or these nonmarketable limits, it 
seems like getting filled is paramount. And we came across the 
Nasdaq Notice to Members 01-22 after we submitted this draft to 
a journal, and we will incorporate--and we will certainly use 
that to buttress what best execution means for nonmarketable 
limits. Fill rate is paramount.
    Senator Levin. But are there also subjective factors in 
that determination for both?
    Mr. Battalio. You are pushing the bounds of what I----
    Senator Levin. All right. If you cannot answer it, you 
cannot answer it.
    Mr. Battalio. I cannot answer it.
    Senator Levin. Mr. Katsuyama.
    Mr. Katsuyama. Can you repeat the question?
    Senator Levin. Are there subjective factors in determining 
which market to go to for the ones for the orders which are 
non--let me get the right word here--the nonmarketable?
    Mr. Katsuyama. Sure. So at times there are. For example, if 
there are--if you are establishing a new price, meaning that 
you will be the only person on the bid at that price, bidding 
on an exchange that pays a high rebate, since you are the only 
person on the bid, it is justifiable; it makes sense. If you 
are joining a queue that is very thick, that has multiple 
exchanges represented, and you choose to get at the end of the 
longest line to get a rebate, I would say that that would be a 
    Senator Levin. Would that be a subjective factor? Are there 
subjective factors in that determination?
    Mr. Katsuyama. Yes. It is based on what is currently on the 
bid, which would primarily be determined by the stock. So there 
are factors where, a broker looking to get a rebate is not 
necessarily in conflict with their duty to their client. So it 
is subjective based on the conditions of the stock when you 
come into--sorry if this is a complicated answer, but based on 
what is happening in the stock, there are different decision 
points, and there are times when you could be getting the 
highest rebate, but also serving your client's interest.
    Senator Levin. And there are times when that is not true.
    Mr. Katsuyama. Yes.
    Senator Levin. Senator Johnson.
    Senator Johnson. Thank you, Mr. Chairman.
    Professor Battalio, I am hearing terms--``adverse execution 
quality,'' ``conflict of interest,'' ``dark pools.'' It all 
sounds pretty sinister. What I want is an example of a trade, 
so we can really put this all in perspective. So let us talk 
about 100 shares at $20, just a retail customer placing that 
with a broker. Now, if you are using one of the online brokers, 
it is costing you $10.
    Mr. Battalio. Yes.
    Senator Johnson. So if you are basically buying $2,000 
worth of stock, you are paying $10 to buy $2,000 worth of 
stock. Twenty years ago, I know I would be paying $20, $30 
commission, correct?
    Mr. Battalio. Yes.
    Senator Johnson. Now we are paying $10. So if this is going 
into one of these dark pools or if this is to go into one of 
these maker-taker arrangements, how much additional money could 
it cost the consumer if there is a conflict of interest, if it 
is routed to a situation where there is a higher maker-taker 
    Mr. Battalio. So imagine you have two orders to buy--one 
here, one there. This one is the high-fee venue; this is the 
low-fee venue. Only one trades. So they want to buy at $10. One 
is going to trade, and then the price is going to rise to $20. 
Which one trades? The one on the low-fee venue.
    Senator Johnson. First of all, how many times in the stock 
market do you try and buy a stock for $10 and it goes up to 
    Mr. Battalio. OK, make it go to $11, $10.50.
    Senator Johnson. I mean, again, realistically, when I put 
in a trade, I say I want to buy a stock. I have made a decision 
that this company is worth $20 a share. And I put in an order 
for 100 shares. I am going to get that executed at $20, aren't 
    Mr. Battalio. So Goldman Sachs and others have done studies 
kind of with better data than we have, so data is a big problem 
to do these types of analyses. To really get at what you asked, 
we need to have data that we do not have. All right? So Goldman 
Sachs, the claim would be that you would lose three basis 
points, five basis points over the course of a day by making an 
inferior order routing----
    Senator Johnson. No, no. I am talking about a retail 
investor like myself, I buy 100 shares of stock at $20. I am 
going to pay $2,000 to buy the stock. OK? I am going to get 
that stock at $20, aren't I? If I put in an order that I say I 
want to buy that stock at $20, I get it at $20.
    Mr. Battalio. No. It will not trade. One person----
    Senator Johnson. So what do I--well, if an order----
    Mr. Battalio. You are going to cancel----
    Senator Johnson [continuing]. Is on the books----
    Mr. Battalio. You are going to cancel and chase the market 
up. That is the point. Does this happen always? No.
    Senator Johnson. Listen, I cannot remember a trade that I 
have put in where I say I want to buy 100 shares at $20 where I 
do not get it at $20, because I put in a stop loss. I am only 
going to buy it at $20.
    Mr. Battalio. So your trade----
    Senator Johnson. And I get it at $20.
    Mr. Battalio. You are trading volatile stocks that do not 
have long queues. That is my answer to you. The data----
    Senator Johnson. That is what most people do. So, anyway, 
again, I am trying to get--forget the price movement, OK? Let 
us talk about just the dollar value of this maker-taker fee. On 
a $2,000 trade, how much is that maker-taker fee? On 100 shares 
of stock at $20 a share, how much is that maker-taker fee?
    Mr. Battalio. Thirty cents per hundred.
    Senator Johnson. Thirty cents per hundred what, dollars or 
    Mr. Battalio. Shares.
    Senator Johnson. So if there is a maker-taker fee that is 
just outrageous at, what, 50 cents?
    Mr. Battalio. The maximum is 30 cents per hundred that they 
can charge, the taker fee.
    Senator Johnson. For a hundred shares. So we are talking 
about on a $2,000 trade that is a conflict of interest, a 
broker is going to push a trade into a maker-taker arrangement 
where he gets 30 cents----
    Mr. Battalio. So an accurate----
    Senator Johnson [continuing]. Versus what--I mean, what is 
the high range of this: 30 to 50, 30 cents to--what is the 
range of pricing on this maker-taker arrangement per hundred 
    Mr. Battalio. Negative 14 cents, maybe, to 32 cents per 
hundred. These are all per hundred.
    Senator Johnson. So you have a maximum range of 40 cents, 
so if I am doing a $2,000 trade, you are concerned about a 
conflict of interest where I might have to pay an additional 40 
cents on a $2,000 trade. Is that what this is about really?
    Mr. Battalio. No. It is about the fact that you did not get 
to trade. So your assumption that you trade is wrong.
    Senator Johnson. But I always have been able to trade.
    Mr. Battalio. Maybe you have.
    Senator Johnson. How many times do people not get to trade?
    Mr. Battalio. The difference for certain types of stocks in 
certain circumstances, the difference in fill rate is 25 
percent. Sanford Bernstein puts out reports since 2010 
highlighting the stocks in which this type of routing has a 
huge impact on whether or not you trade at a price.
    Senator Johnson. Now, how much of that is the institutional 
investor and the high-frequency trader versus the standard 
retail guy that--again, I am looking--I am a very long-term 
investor, and I am looking at a stock, and I go, really, I 
think this thing is worth $20 and I am willing to buy it at 
$20, but if not, no harm, no foul. So there are definitely 
different investors, right? So when you are talking about 25 
percent of trades not being executed--is that in all the 
institutional, the very high volume, or is that really 
individuals like myself that say--I want to buy that hundred 
shares of stock, I will pay any price, or I will put a stop 
order and say I am only going to buy it at $20?
    Mr. Battalio. So is Schwab a retail broker? Because they do 
not make this decision. They do not do what these four brokers 
do. Interactive brokers, a retail----
    Senator Johnson. So let me ask you, how many--and I will 
surely ask in the next panel, of those folks. How many trades 
in to retail brokers like Schwab, like TD Ameritrade do not get 
executed? Do you have any idea on that?
    Mr. Battalio. We have asked for their data, and they have 
never responded to give us the data. We cannot answer.
    Senator Johnson. So where did you get your data from then?
    Mr. Battalio. From a major iBank.
    Senator Johnson. And, again, what is the data on?
    Mr. Battalio. Orders. They get routed to two different 
venues. They show up at the marketplace at exactly the same 
time, and we watch what happens. And then we use data from the 
entire marketplace, all trades and quotes.
    Senator Johnson. So I did see TD Ameritrade revealed how 
much they are making on these maker and taker, this order flow 
fee, something like $200 million. It sounds like an awful lot 
of money, but isn't it true that the market trades almost $27 
trillion per year?
    Mr. Battalio. Sure.
    Senator Johnson. So what is $200 million in relation to $27 
    Mr. Battalio. We are not----
    Senator Johnson [continuing]. As a percentage?
    Mr. Battalio. What we are here to speak to is the poor 
investor, not like you, that wanted to buy at $10 and did not 
get to because the market moved away and the broker chose to 
route--make sure that--so the broker routed the order----
    Senator Johnson. Again, I am trying to figure out how----
    Senator Levin. Let him finish.
    Senator Johnson [continuing]. Often that is. OK. I am 
    Senator Levin. Do you want to finish the answer?
    Mr. Battalio. With better data I could answer that. In our 
data set, it can be as big as 25 percent difference in getting 
the trade done.
    Senator Johnson. OK. I will just finish by saying what I am 
concerned about is, again, just creating this sinister 
atmosphere with words like ``dark pool'' and ``conflict of 
interest,'' and what we are talking about literally, I think, 
is 30 or 40 cents on a $2,000 trade or maybe a $30,000--or a 
$3,000 trade. I mean, we are really talking about minuscule 
amounts. And, again, what I am looking at is over time of 
investing, I have looked at my cost of a trade going from 
hundreds of dollars down to $10. And now we are arguing over if 
it should be $10.30 or $10.40. I do not know. I am just trying 
to put it into perspective and trying to figure out where the 
problem is here that I guess we are talking about potentially 
government regulation intervention, which I think might have 
very harmful unintended consequences versus letting the free 
market competitive system drive transparency, drive 
competition, and that is what has happened certainly over my 
lifetime of investing over 20 years. It has gotten, from my 
standpoint, more transparent and a whole lot cheaper.
    Mr. Battalio. I am not arguing with that.
    Senator Johnson. OK. Well, thank you. I will be back.
    Senator Levin. Thank you.
    Senator McCain.
    Senator McCain. Do you want to give a more elaborate 
response to that really this hearing does not matter, either 
you, Mr. Battalio, or you, Mr. Katsuyama?
    Mr. Katsuyama. So I guess just to respond to that--the fact 
that it is 30 cents for a hundred shares and it is a $2,000 
trade, I think that is exactly the point. I mean, we are 
talking about conflicts where there is evidence that their 
brokers are routing to get this 30 cents, and they are 
representing a $2,000 order. It can be used on both sides of 
the argument. You can view it as trivial, but you can view the 
trivial nature of why is the broker doing that in the first 
place if they are representing a $2,000 trade? So it is one 
where the conflicts are real, and I think that even though the 
harm is diffuse, there are more retail investors invested in 
large pension funds and mutual funds who also are affected by 
this practice.
    So I think that, just trying to say that since it is a 
small amount it could be used to deny that the conflict exists, 
is wrong. I think that it needs to be a principle-based 
    The other part on costs, costs have come down. Of course 
they have. Technology has delivered that cost reduction. There 
is a Harvard Business Review study titled, ``How to Win a Price 
War,'' and it talked about ``electronic brokers are changing 
the competitive terrain of financial services with their 
extraordinarily low [-priced] brokerage services. The 
prevailing price for discount trades has fallen from $30 to $15 
to $8 in the past few years.'' That report was written in 2000. 
So when you look at the costs of technology since the year 
2000, it has fallen even further.
    So I think that it is one where competitive forces--I agree 
with the fact that competitive forces should be setting prices. 
The problem is that the inducement is so great, we do have a 
prisoner's dilemma, where if every exchange pays an exchange 
rebate, the one that moves away from the exchange rebate if 
brokers are still incentivized to go after that rebate--they 
will lose market share.
    So I do think when you look at payments, it is something to 
say there is a known conflict in the market and lets just 
address it. The size of the conflict relative to the notional 
amount traded is not a reason just to ignore the issue.
    Senator McCain. And with that increasing technology, hasn't 
that facilitated to a significant increase in volume of trades 
as well?
    Mr. Katsuyama. I think the fact that advances in technology 
have been harnessed by certain participants, that is part of 
free market competitive forces, and there is absolutely nothing 
wrong with that. I think the challenge that the market was 
faced with was one of the biggest confusions out there is that 
the person that buys co-location and pays for this service has 
an unfair advantage versus the person sitting at home trading 
over a retail account. There will always be asymmetries----
    Senator McCain. See, I think that is the key to this 
problem, that there are certain players that have made this an 
unlevel playing field, whether it is 30 cents or whatever.
    Mr. Katsuyama. Sure. In order for the person at home to get 
disadvantaged by the person that has spent all of the money on 
high-speed technology, in order for them to be disadvantaged, 
they have to trade, and that trade has to happen on a market. 
The market's responsibility, at least in our view, is that 
knowing that different parties will have different access to 
technology and different levels of resources, different levels 
of information; but when the trade happens, that the condition 
with which this trade happens is done--is fair, meaning that we 
have no bias one way or another what happens when this trade 
occurs. And the problem is that as technology has evolved, the 
exchange or the dark pool, the market itself should have 
advanced their own technology to ensure that we are investing 
in technology and building solutions with technology that 
maintains this fairness. And the problem is that as the markets 
have evolved, people got in the business of selling technology. 
People got in the business of actually enabling participants 
rather than creating and maintaining their neutrality. And I 
think as that happened, the conditions for fair trading 
changed. When your participants understand the market, what is 
happening in the market, faster than the market itself, that 
creates a pretty significant situation that we believe is 
    Senator McCain. Well, sir, many commentators, including the 
editors of the Wall Street Journal, have noted that Reg NMS has 
enabled or exacerbated a number of predatory, high-frequency 
trading practices. Do you think that Reg NMS should be 
reformed? And if so, what would you recommend?
    Mr. Katsuyama. Sure. So I think Reg NMS, the spirit of Reg 
NMS, as was indicated, makes sense. You have multiple 
competitive markets, and you want to try to attempt to tie them 
all together. I think if you eliminate some of the conflicts in 
how orders are routed, that brokers have invested heavily in 
technology that can get around this issue of liquidity 
disappearing. At RBC we had this problem from 2007 to 2009, and 
then we solved the problem. So I think that free market 
solutions can emerge to address the issues with Reg NMS. I 
think undoing Reg NMS runs the risk of, again, further 
unintended consequences, how exactly do you address those?
    I think that it is something that definitely warrants 
review. It just depends on what regulation comes out of 
redefining what Reg NMS does, and that is something that 
obviously I cannot comment on.
    Senator McCain. Do you have any suggestions, Mr. Battalio?
    Mr. Battalio. If you do anything to Reg NMS, do it with a 
pilot study and study it very carefully.
    Senator McCain. Have you got other solutions to this issue?
    Mr. Battalio. With regard to high-frequency trading, that 
is not something I have extensively studied, no.
    Senator McCain. Mr. Katsuyama, Michael Lewis in his ``60 
Minutes'' interview regarding his excellent book, ``Flash 
Boys,'' said that the stock market is ``rigged.'' Is that an 
accurate description?
    Mr. Katsuyama. We have discovered that investors are 
systematically disadvantaged in the way that the markets have 
been set up. I think ``rigged'' is a word that can be used to 
describe that. I think it is loaded. But I think at the same 
time, the investment process is not broken. I am still an 
investor in this market. You know, ``rigged,'' what it did is 
it kind of gave our critics and people who are part of the 
problem a reason to talk about something else other than what 
we were actually talking about, which are these--a much more 
precise way to put it or a much more precise question, which is 
these systematic disadvantages and how they are created.
    So, it was a distraction, which was unfortunate. I guess 
the interesting part is that the people who took most offense 
to that word were people on Wall Street. We have a tendency to 
talk to ourselves on Wall Street, and I think that the response 
we have seen from the general public is anything but. The claim 
that we hurt investor confidence in the things that we brought 
to light everything that we have seen I think would be exactly 
the opposite of that in terms of the general public and their 
reaction to what we have said and what we have done.
    Senator McCain. On this issue of co-location, how do you 
address something like that? Somebody rents a place or rents a 
computer somewhere, they are free to do that. That is America. 
How do you address that issue since co-location seems to be one 
of the facilitating aspects of this whole system?
    Mr. Katsuyama. Sure. I do not think you can regulate co-
location. If you say to an exchange you cannot sell space next 
to your matching engine, cottage industries will pop up and buy 
real eState across the street from the exchange and throw 
cables over the fence. So I think it is every market's choice 
to decide how they would like to set their market up.
    At IEX, what we have done is we have introduced almost the 
opposite of co-location where we have put 350 microseconds of 
latency in between us and all of our customers, which 
essentially means that we have coiled 38 miles of cable in a 
data center, and we do that for all of our participants. The 
opposite of getting close is pushing everyone an equal distance 
    Senator McCain. I understand what you have done, but what 
is the remedy to this?
    Mr. Katsuyama. I think the remedy is, we keep harping on 
transparency and disclosure, and I think that there are 
    Senator McCain. It should be disclosed if they are co-
    Mr. Katsuyama. It should be disclosed, but also things like 
anonymous listings of participants on venues, meaning does one 
participant represent 35 percent of your trading volume or 50 
percent of your trading volume on any dark pool or exchange? 
And if they do, do they represent 50 percent of the volume on 
every other market? Because if they are an outsize portion of 
your own order flow, then that would indicate something.
    Are the message rates across certain participants so much 
higher than others? I think that we lack, as Professor Battalio 
said, the data. What we learned--and we learned from 
experience, we learned from talking in the industry, but we 
lack the data. And I think, again, the SEC's Midas website, the 
FINRA ATS report, we learned a lot in basically two attempts to 
provide clearer understanding of what is happening in the 
market. We could learn so much more.
    The thing about co-location is that, just discussing and 
understanding what the advantage is of being 5 or 10 
microseconds away from a matching engine, you get information 
quickly, and you can react quickly to getting information. As 
we push that boundary farther out to 350 microseconds, what we 
found is that we did have certain high-frequencing traders that 
did show up to IEX. But the number of those high-frequency 
traders was small, right now three. There are dozens and dozens 
of firms who have decided not to connect. I cannot speculate as 
to why that is, but clearly we have taken away something that 
some high-frequency trading firms they found valuable.
    So it is every market's choice to do something. It becomes 
a very hard practice to regulate. But I think with the 
increased transparency and disclosure, people can make better 
decisions on whether they want to trade in venues that do offer 
such services.
    Senator McCain. Thank you.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you very much, Senator McCain.
    You made reference to disclosure on things like co-
location, but when it comes to the best execution obligation, I 
gather that cannot be waived. Is that correct?
    Mr. Katsuyama. Yes, absolutely. Best execution, I think it 
might need some further refinement. It is a pretty subjective--
I guess it is a pretty subjective term. I think it is used 
fairly liberally. One thing that we definitely think----
    Senator Levin. That is a legal obligation. Is that correct?
    Mr. Katsuyama. It is.
    Senator Levin. So you cannot disclose--``we do not engage 
in best execution in this firm.'' That does not fly. Is that 
    Mr. Katsuyama. That would not fly, no.
    Senator Levin. Do you agree with that, Professor?
    Mr. Battalio. Yes, sir.
    Senator Levin. Going back to best execution as to who 
determined--did I interrupt you?
    Mr. Katsuyama. No.
    Senator Levin. Who determines best execution for a broker? 
Is it the broker himself?
    Mr. Battalio. The broker, my understanding, is supposed 
to--based on what I read--have monthly meetings and just 
evaluate where they are routing, can it be done better where 
should we alter things around the edges?
    Senator Levin. But it is the broker who determines best 
    Mr. Battalio. Yes.
    Mr. Katsuyama. Yes.
    Senator Levin. OK. Now, I believe, Mr. Katsuyama, that you 
indicated that the maker-taker system creates a conflict of 
interest, and I think the testimony of both of you is that this 
is a significant matter. Let me just ask you, Mr. Katsuyama, 
should the maker-taker system be eliminated?
    Mr. Katsuyama. I think that steps should be taken to 
address what happens to the market if it is eliminated. I know 
that a pilot study has been proposed----
    Senator Levin. You mean--say that again?
    Mr. Katsuyama. The pilot study that has been proposed, I 
think that it should have----
    Senator Levin. Which eliminates it?
    Mr. Katsuyama. Which eliminates maker-taker in certain 
stocks, I think that it should be given the chance to prove 
that eliminating maker-taker will not harm the quality of the 
    Senator Levin. All right.
    Mr. Katsuyama. So, yes, I definitely think that that step 
should be taken. It should be analyzed, and then we should----
    Senator Levin. At least that step ought to be taken.
    Mr. Katsuyama. Definitely.
    Senator Levin. Professor.
    Mr. Battalio. I am not a risk taker. I am an academic.
    Senator Levin. OK.
    Mr. Battalio. So my view would be maybe not push to 
eliminate maker-taker because you might push things underground 
into the soft-dollar world where it would be even less able to 
kind of see what people are doing.
    Senator Levin. OK.
    Mr. Battalio. So our view would be, with Shane Corwin and 
Jennings, perhaps what you should do is push disclosure back 
onto the broker so it is easier to tell, so you do not have to 
do the studies we just did to map how is your broker doing 
regarding routing your orders. Since the SEC took a first step 
with this in 2000 and 2001, we think that you could do a better 
job of that now.
    Senator Levin. Would you support that test case that Mr. 
Katsuyama talked about?
    Mr. Battalio. If you insist of doing away with maker----
    Senator Levin. Not me. I am not----
    Mr. Battalio. A pilot is----
    Senator Levin. A lot of other people are insisting on it, 
and I happen to agree with that, but it is not----
    Mr. Battalio. A pilot is better than going all-in.
    Senator Levin. All right. Some have argued that the maker-
taker system is beneficial and that it has led to tighter 
spreads, and I think you indicated, did you not, Mr. Katsuyama, 
that that was technology that did that long before----
    Mr. Katsuyama. Yes, I think decimalization and technology 
both contributed to the lowering of spreads.
    Senator Levin. All right. Now, does IEX make a similar 
distinction that some high-frequency trading may be predatory?
    Mr. Katsuyama. So I think not all high-frequency trading is 
predatory, but some practices are, yes.
    Senator Levin. Do you make a distinction that some high-
frequency trading may be predatory?
    Mr. Katsuyama. Yes.
    Senator Levin. And that that would hurt regular investors 
while others may benefit the market?
    Mr. Katsuyama. Yes.
    Senator Levin. And has the maker-taker system led to the 
creation of more exchanges in trading markets and more complex 
order types, Mr. Katsuyama?
    Mr. Katsuyama. Yes.
    Senator Levin. Has the proliferation of trading venues and 
order types created opportunities for predatory high-frequency 
traders to take advantage of investors?
    Mr. Katsuyama. At times, yes.
    Senator Levin. And what are those opportunities? What kinds 
of opportunities?
    Mr. Katsuyama. Sure. I think given the structure, a quick 
example is if there are 10,000 shares on offer to sell Intel at 
$21 a share, a high-frequency trading firm could be offering 
stock across multiple markets. One of those markets where they 
are offering stock might be what is called a taker-maker venue 
that actually charges someone to post liquidity and will pay a 
rebate to the other side of the trade who comes to access that 
liquidity. So this inducement, what it does is it--if a broker 
is going to follow that inducement, it causes them to route 
orders and remove liquidity from Intel, in a very predictable 
and systematic way, starting at the highest rebate market for 
taking liquidity and working its way down to the venue charging 
the highest fee. This predictable pattern of routing leads to 
lower fill rates and ultimately worse execution for the client 
being represented.
    So, it is a combination of fast technology, a combination 
of inducements, and a combination of the broker falling for 
those inducements. So that would be a series of events.
    Senator Levin. You have been quoted as saying that people 
have lost confidence that the markets are fair and that they 
are working in their best interest. Would charging a standard 
fee, regardless of whether the order adds or removes liquidity, 
increase investors' confidence that they are getting a fair 
    Mr. Katsuyama. I think it is a step--at IEX we charge a 
flat fee, regardless of whether you are making or taking. Price 
competition is something that is hard to regulate, so if some 
people want to charge a lesser or higher fee and justify it 
through their service, I think that is acceptable. But I think 
eliminating a conflict, most of the general public do not even 
know this conflict exists. I think that as we talk through it, 
as we try to regain the trust of the general public, talking 
through these issues and admitting to the fact that they exist, 
and then addressing these conflicts, that is the way to restore 
that confidence. So I think that, yes, addressing this issue 
will help restore confidence, or at least it is a step in the 
right direction.
    Senator Levin. And eliminating the conflict would help 
restore confidence?
    Mr. Katsuyama. Without question.
    Senator Levin. Professor.
    Mr. Battalio. Yes, sir.
    Senator Levin. Would it?
    Mr. Battalio. Yes, sir.
    Senator Levin. Critics of your paper, Professor, said that 
the data that you used to assess whether retail brokers were 
getting best execution does not accurately reflect typical 
retail order flow and that your results cannot be generalized 
to judge the best execution performance of retail brokers. How 
do you respond to that?
    Mr. Battalio. In a couple ways. So those critics seem to 
kind of ignore the back third of our paper where we use all 
trades and all quotes in the U.S. equity market over the same 
time horizon to demonstrate the results that we find with our 
limited data generalized to the marketplace.
    Second, as we have been pushing the paper around, we have 
seen lots and lots--we wrote the major exchange that operates 
two different fee structures, and they showed us that for the 
retail orders resting on their exchange for a couple weeks, 
they get the same results we get. You know, Sanford Bernstein, 
we came across a report, same results we get.
    So you can argue that our most detailed data analysis comes 
from specialized data, but the results generalize with a lot of 
different data sets. So we are quite comfortable.
    Senator Levin. Now, would you be willing to run your 
analysis using data from the retail brokerages identified in 
your paper if they were willing to give you that?
    Mr. Battalio. Of course. Anybody. The hard part for an 
academic, we spent 2 years asking for data to test this, 
because people--and it is just very, very hard. So, yes, that 
is a standing offer that we make. It has become--we thought we 
were going to be able to work with a guy who is starting to do 
this with institutions, and, unfortunately, the sell side is 
pushing back and threatening. So the executing venues have 
threatened that if this guy shares data with us, they will stop 
doing business with their buy side clients. So it is very hard 
to get data to do the analysis that we did. We were very lucky 
to find these data.
    Senator Levin. Some argue that 30 cents on an order is a 
tiny, minuscule amount, you have given a very strong answer or 
response to that, by the way, in terms of the orders that are 
not filled. And, also, Mr. Katsuyama, you have given a pretty 
strong answer to that as well. These 30 cents also add up to 
hundreds of millions of dollars for a broker, do they not?
    Mr. Battalio. Yes, they do. Compare the payment revenue of 
the brokers that do this practice to the ones that do not, and 
you will see a marked difference at the aggregate.
    Senator Levin. Mr. Katsuyama.
    Mr. Katsuyama. Yes, I think it is----
    Senator Levin. It is a big revenue source for the broker, 
is it not?
    Mr. Katsuyama. Yes. Well, some brokers. I think we cannot 
paint them all in the same brush. Some brokers end up paying 
the high take fee, and that high take fee is subsidizing 
payments to other players. So some are hurt worse and some 
benefit, depending on who the broker is.
    Senator Levin. Thank you.
    Senator Johnson.
    Senator Johnson. Thank you. I have a little more time here, 
so I do want to go back and really explore exactly what is 
happening and exactly what type of harm could be happening.
    When you are talking about 25 percent of trades that just 
simply are not executed, can you describe that a little bit 
more to me in terms of the volatility of that, what is being 
missed? And aren't those trades basically because people put in 
stop orders and say, ``I will buy a stock at this price''? I 
mean, just tell me how that does not work?
    Mr. Battalio. So you have people that maybe place an order 
before they go to work, and they say, I want to buy a share of 
stock at $20, a hundred shares of stock at $20, and it is just 
a standing order--not a stop or anything like that, just a 
standing order. What we identify in our paper is that some 
brokers are routing that order so that they trade last at a 
price. And so if throughout the day the market goes through 
your limit price, you trade. It does not matter where you were 
routed. That is true a large part of the time. Right? And that 
would be, what I would argue, that is your trading experience. 
    But some stocks are much less volatile throughout the 
trading day, and not all of the people looking to trade at a 
price get to trade. Some do not, and they miss out. Why? 
Because the price trades a little bit and moves up. The ones 
that do not trade missed out.
    Senator Johnson. So, I mean, part of the problem is some 
investors have a lot of time to just be watching this in real 
time 100 percent of the time.
    Mr. Battalio. That is right.
    Senator Johnson. Most investors, like myself, you look at 
it about once a year, and you put a trade. So that is always 
going to be the case, right? I mean, if you were watching this 
100 percent of the time, if you were putting in the right type 
of order, you could make sure that you were going to have an 
executed trade, just about, I mean, couldn't you? Can't you, as 
an investor, make sure that you get that stock purchased no 
matter what?
    Mr. Battalio. Not if all the interest at a given price does 
not trade, no, because of the way they route. They are putting 
you at the back of the line at a price all the time. And so if 
the line does not fully exhaust, you go wanting.
    And is this--this happens in certain--is this all stocks 
all the time? No. But measurable time, 10, 20 percent of the 
time, certain stocks, yes.
    Senator Johnson. Again, I am trying to get my head around 
the magnitude of this problem.
    Mr. Battalio. OK. I guess----
    Senator Johnson. Because it is true--I mean, we are using 
all these sinister figures, and I agree with the Senators, this 
is about restoring confidence in the market. And I am concerned 
by throwing out those types of terms and making it seem like 
everybody is in this business and they are just really trying 
to stick it to the individual retail investor. That is not what 
I have seen. I am not saying----
    Mr. Battalio. And I would hope----
    Senator Johnson [continuing]. That I have been pleased with 
the transparency within the investment banking community during 
my lifetime. But it just seems like we are moving in the right 
direction, greater competition, lower prices, far easier 
trading today than it was 20 years ago where you just kind of 
call your broker and you did not know what was pulling off. Now 
you have the computer. Now you can plug it in, and say how come 
I did not get that--right now it is almost instantaneous, isn't 
it, on online brokers? You put in an order----
    Mr. Battalio. Or a market order, yes.
    Senator Johnson [continuing]. And, boom, it comes right 
    Mr. Battalio. For a market order, yes. And I am not going 
to sit here and argue that we have not made great gains over 
the past 20 years. That is not what our paper is about. Our 
paper--and we are not crying ``Fire'' in a theater.
    Senator Johnson. Well----
    Mr. Battalio. No. Have you read our paper carefully? I 
think we are very caveated, OK? We are pointing out certain 
circumstances where routing only to the high-fee venue is going 
to disadvantage investors. So statements that get made like, 
``We employ sophisticated order routing technology and 
processes to seek best execution for client orders,'' how can 
that be if you are routing always to the high-fee venue? That 
is what got us interested as academics in this problem.
    Senator Johnson. And, again, you may not be shouting 
``Fire,'' but I think the way that it is recorded in the press, 
I think it really is. Do you disagree with that?
    Mr. Battalio. I think there are some people out there 
yelling ``Fire,'' but I would hope that we would not be 
    Senator Johnson. Good. So, again, that is what I appreciate 
about this hearing. It is about trying to lay out the reality 
of the situation, put this all in perspective. And, again, I 
want to get back to the overall dollar value of these maker and 
taker arrangements, that type of thing, in relationship to 
total trades----
    Mr. Battalio. All right. So I can give you----
    Senator Johnson [continuing]. In terms of--if at all 
possible, if you had some sort of historical perspective in 
terms of how much trading commissions there were 20 years ago 
versus what we are talking about today.
    Mr. Battalio. I will give you one stat, and then I will 
give it to Brad. So if you eliminated all the rebates and 
inducements, Bernstein Research predicts that one broker would 
have a 16-percent earning-per-share decline.
    Senator Johnson. But what----
    Mr. Battalio. That is real time now, and then I have to say 
I do not know the answer to your question and give it to Brad.
    Mr. Katsuyama. I think there is no question that price per 
trade has come down with technology. I think that--again, I 
read this last time. I will read it again. Harvard Business 
Review report, which is titled, ``How to Win a Price War,'' 
talks about ``electronic brokers are changing the competitive 
terrain of financial services with their extraordinarily low-
priced brokerage services. The prevailing price for discount 
trades has fallen from $30 to $15 to $8 in the past few 
years.'' And that report was written in the year 2000. Here we 
are in 2014, and my tech team sent me this, but the price of a 
gigabyte worth of storage in 2000 was $10, today it is 10 
cents. So when we talk about lower fees, lower commissions, 
yes, they have come down. But they stopped going down, and I 
think that they could probably come down further. The notion 
that if a payment goes away then the price will go up, I think 
that would be hard to justify. And, again, as you said, 
competitive forces will force that out of the market. If you 
double your price per share or price to trade, then new 
entrants will come into the market.
    So I think that it is one where they have come down, but 
that is not an excuse, I think, for what is happening right 
    Senator Johnson. Are there competitors in the marketplace 
that actually conduct trades the way you want to see the trades 
conducted? And compare those to some of the online models of 
companies that we are familiar with what they provide with 
their service. Because, one of the things I value in the online 
is I have got research, There is just an awful lot within those 
online platforms that are very helpful to a competitor--or to 
an investor.
    Mr. Katsuyama. Sure.
    Senator Johnson. Do those competitive systems have similar 
types of things? Is that part of the reason--again, I am a 
business guy. It does not bother me that people make money. 
They need to make money to provide different products and 
    Mr. Katsuyama. So, I am not as familiar with each 
individual retail platform, what they offer. I do know 
Interactive Brokers routes in a way that would be consistent 
with how I would route. You know, they are connected to IEX. 
They trade with us. So I think that there are examples, and 
they have been pretty vocal about that. I look at institutional 
brokers. As Professor Battalio has noted, my experience at RBC 
or Bernstein or even working with the people at Goldman Sachs, 
people have spent a tremendous amount of time in understanding 
this conflict, where you can route for a rebate and not harm 
your client and where you route for a rebate and you do harm 
your client. And it is one where, because it can toggle--for 
example, there are 100,000 shares on offer in Intel at $21 
[inaggregate, across the markets], and a market will pay me a 
rebate to route there and is offering 10,000 shares, and I have 
200 shares to buy, I can route it there, buy the 200, get the 
rebate, and no one is harmed. If I have 100,000 shares to buy, 
I cannot route the 100,000 to that one venue that is going to 
pay me because they are only showing 10,000, because I will 
ruin my experience with the rest of the venues, because of the 
    So there are times when you can get a rebate and fulfill 
your obligation, and there are times where you cannot, and I 
think it is up to every broker to understand where that 
inflection point is and to be very transparent in terms of how 
they route.
    Senator Johnson. So I guess my point is if those companies 
are already present in the marketplace that trade the way you 
are suggesting without a conflict of interest, so that an 
individual investor, if they are buying $2,000 worth of stock, 
does not have to worry about being charged 40 cents versus 30 
cents--OK?--those platforms exist, those competitors--the 
marketplace, the free market competitive system have already 
provided that investing model with that level of transparency. 
And kind of getting back to part of your opening statement, you 
said, well, this is a question of whether we need government 
regulation to force the transparency, the competition, or the 
free market competitive systems doing it.
    I guess based on your answer, you are saying the free 
market competitive system has already reacted to it, and that 
possibility exists. If you are concerned--as an individual 
investor, you are concerned about not being able to have your 
trade executed or paying another 10 cents on a $2,000 trade, 
there are people out there and they just need to do a little 
more advertising so Americans understand it, right? Or maybe 
this hearing will help out and more investors will take a look 
at finding companies like yours.
    Mr. Katsuyama. So, yes, I totally agree with you. I think 
that, first off, you have to----
    Senator Johnson. I like that answer.
    Mr. Katsuyama. First off, you have to make people aware 
that the conflict does exist, and you have to educate them on 
what that conflict means to them, and now they can make a 
better informed decision versus before, when they did not even 
know that the conflict existed in the first place. I think 
disclosure and transparency will let people make better 
decisions, and then the market sorts it out. It is one where 
with increased disclosure and increased transparency, everyone 
knows exactly how the game works and things still happen. Then 
you can kind of look back and say, OK, I guess the inducement 
was enough or warranted the fact that they made this decision. 
But right now a lot of it is opaque.
    And as Professor Battalio noted, it is really, really hard 
to get data, and the data you get is not standardized. So it is 
very hard to synchronize data across multiple places because 
the data comes back, I have seen client data where they have 
got them from different brokers or even brokers from different 
venues, and it is coming back in all sorts of forms. So I think 
that standardization and transparency, forced disclosure, 
people will just ultimately make better decisions. That is the 
most proactive way to advance this discussion.
    Senator Johnson. OK. Thank you.
    Thanks, Mr. Chairman.
    Senator Levin. Professor, do you have a comment?
    Mr. Battalio. So the reason this is an agency problem was 
first pushed for----
    Senator Levin. When you say ``agency,'' what do you mean?
    Mr. Battalio. Agency--and I will describe. So two former 
chief economists, Chester Spatt and Larry Harris--OK, Larry was 
around with Reg NMS, so was Chester--and then a guy who is on 
the board of Direct Edge, Jim Angel, put forth--it is their 
theory that we test in our paper, and they claim that the 
retail investors, maybe not you, are able to shop on 
commission. So the broker that offers the lowest commission 
will get the retail trade. OK? The brokers that maximize 
rebates are able to offer the lowest commissions. In fact, 
anecdotal evidence suggests that Interactive Brokers, at least 
during our sample period, had a higher commission than these 
other four brokers. So these four brokers attract the retail 
investor by offering low commission, and the retail investor 
trusts the broker because of the best execution obligations, 
and it does not have the tools--you could look at our paper and 
decide how hard it is to figure out what we did. They do not 
have the tools to understand, gee, in this instance did my 
broker route to the right venue to maximize the likelihood of 
execution like NASD 01-22 says? That is the agency problem.
    You can shop on commission. You cannot evaluate the 
execution quality. And so they are doing things that may 
compromise execution quality. They have the lowest commission. 
And they are going to attract a swath of customers that way.
    And if you talk to people on the board of Interactive 
Brokers, they will complain about this. So certainly 
competition is forcing commissions lower, but people who do the 
practice of routing all the nonmarketable to the high-fee venue 
and selling the marketable to the wholesalers, they get more 
revenue that could be used to push back through commissions, 
right? And so it is hard--this would be a case where maybe the 
market cannot fix things unless you can educate the investor to 
evaluate this decision of routing nonmarketable orders, which 
is tough.
    Senator Levin. So you are saying maybe it cannot be solved 
in this case----
    Mr. Battalio. I am all about free markets, trust me.
    Senator Levin. Of course. In this case, it may not and has 
not so far worked, is what you are saying.
    Mr. Battalio. That is what we think.
    Senator Levin. Do you agree with that, Mr. Katsuyama?
    Mr. Katsuyama. IEX is a new venue. Before the SEC published 
the Midas data and before FINRA had their ATS reporting rule, 
we had no idea how we compared to other markets. So other 
markets would make claims that could or could not be 
substantiated. So as you are competing, how do you compete in a 
market that is completely opaque and, is primarily dictated by 
word of mouth or self-generated reports? I do not think we 
fully had a chance to solve this problem from an industry 
standpoint because the data was just not available for people 
to make good decisions, or better decisions.
    Senator Levin. But do you think the average investor can 
make a decision on where a broker is going to get best 
    Mr. Katsuyama. That is a good question. I would say 
probably not. But the key part is that the people that do spend 
the time to look at it, some people in the media are very 
sophisticated. They understand the heart of this issue. And I 
think that as they report on things that are happening as the 
retail investors who do look at it start to make decisions, it 
does create the right amount of momentum so that someone who 
does not have time or inclination to understand market 
structure understands that people are looking out for their 
best interests and they can make decisions that way.
    Senator Levin. How do they make a judgment on best 
execution, is it a subjective judgment? How does your average 
investor just looking at the fees, the commission, think that 
is lower, that is pretty attractive? This is what the professor 
is saying. Is that not right, Professor?
    Mr. Battalio. That is correct.
    Senator Levin. So now how does that average investor do 
what you think needs to be done, make some kind of assessment 
on best execution? How does he do that?
    Mr. Katsuyama. Sure. You have to put in the requisite 
amount of time to understand it, to make that judgment. Most 
people will not. So, again, I think that the more that this is 
discussed and reported on, hopefully the venues that are doing 
the right things get the right amount of credit.
    Senator Levin. If transparency is the answer, should the 
government force transparency?
    Mr. Katsuyama. I do believe there are cases where that 
would definitely help.
    Senator Levin. The government actually would have to force 
    Mr. Katsuyama. I think outlining the types of metrics that 
need to be reported and the way those metrics need to be 
calculated and presented would definitely be helpful, yes.
    Mr. Battalio. The government has done this one, and it is 
not a big step, what they would have to do to kind of clean 
things up.
    Senator Levin. But the market has not done that yet. It 
would take the government forcing that. Is that correct?
    Mr. Katsuyama. There has been no attempt by the market to 
try to solve this issue and just standardize across themselves 
and to say let us make this easier for people to understand. We 
have not seen evidence that that is happening.
    Mr. Battalio. And indeed----
    Senator Levin. And, therefore?
    Mr. Katsuyama. And, therefore, I think the government would 
be very helpful in helping to get the industry to coordinate to 
a level to make these issues easier to identify.
    Senator Levin. And it would be helpful if the government 
required that?
    Mr. Katsuyama. Yes.
    Senator Levin. Thank you.
    Mr. Battalio. The options market tried to do it on a 
voluntary basis back in 2010, and the numbers they put out were 
garbage, mostly, so yes.
    Senator Johnson. Just a quick comment. Again, as an 
individual investor, the way I evaluate best execution is I put 
in an order for $20, I got it for $20. Again, this is so 
incredibly complex, and there are so many esoteric terms of art 
here. You have got to bring it back--I am trying to bring it 
back to just the simplicity of what is happening in the 
marketplace with individual retail investors, and if I put in 
an order for 100 shares at $20 and if I get it and I am only 
paying $10, I am reasonably satisfied.
    Now, occassionally, there may be some very strange 
circumstances where I do not get that share, but I kind of 
shrug and go, OK, well, I did not get it. Maybe there is some 
harm, but I am highly concerned about government interference 
in the marketplace. If there is a very minimal amount of 
transparency legislation in terms of this is the data that we 
want everybody to report, again, minimal, not a huge overall 
regulation that harms the market, that is something I would be 
willing to support.
    But, again, I really want to put this in perspective, what 
is the real harm being caused, and let us make sure we do not 
do more harm in trying to solve a problem that right now this 
is really a solution looking for a problem in many respects.
    Mr. Katsuyama. Yes, I definitely would say that focusing on 
disclosure will create the least amount of harm and 
implementation risk rather than diving into things such as co-
location and the actual mechanics of the market. So, if we are 
going to move forward, I think that----
    Senator Levin. Professor.
    Mr. Battalio. I agree 100 percent.
    Senator Levin. OK, with what he just said.
    Mr. Battalio. Yes, and what Mr. Johnson said.
    Senator Levin. OK. That you want to have disclosure, you 
want to have transparency, but you would agree it may take 
government action to get that transparency?
    Mr. Battalio. Yes, and push it back on to the brokers.
    Senator Levin. Push it on the--thank you.
    Senator McCain. And this is just a minor issue that we 
should not be concerned about in the overall scheme of things. 
Is that correct?
    Mr. Battalio. My view is the reason academics are around 
and reporters are around is if the retail investors cannot 
understand it, we study it, bring it to light, and then things 
get cleaned up, somewhat.
    Senator McCain. Is it a serious issue?
    Mr. Battalio. We think it is. But we also think it is an 
easy one to fix.
    Senator McCain. Thank you.
    Senator Levin. Mr. Katsuyama, is this a significant issue?
    Mr. Katsuyama. I think it is significant it is a principle-
based issue. I think that you can try to minimize it by trying 
to relate how much it is pennies, etc., and people are holding 
stocks for years. But this is a principle-based issue, and it 
comes down to the foundation of why the markets exist and 
people's trust in those markets. Trust is really about saying: 
``Without me paying attention, I believe that the right things 
are happening in my best interests,'' and when you find out 
that they are not, those are instances which undermines trust.
    In your opening statement, discussing the fact that we have 
had a tremendous rally from 2009, yet the amount of households 
owning equities [participating in that rally] has not followed 
that trend. So, I would argue that a series of events over the 
last number of years have lead to a decrease in investor 
confidence which led us to quit our jobs and start IEX. And I 
think that, from an investor confidence standpoint, my hope is 
that March 31 [publication date of Michael Lewis' ``Flash 
Boys''] becomes a low point. We have received a tremendous 
amount--thousands and thousands of calls and emails and letters 
from people who are actually looking to get back into the 
    If there are people that feel like we did the wrong thing 
by speaking about it, we have not heard from them, we have not 
heard from the general public. We have gotten a lot of anger 
from Wall Street--not all--but, again, people embedded in the 
status quo do not want to see change happening. And I think 
that those who do want change have been very supportive of us.
    Senator Levin. Thank you. Thank you both. I appreciate your 
    Mr. Katsuyama. Thanks a lot.
    Mr. Battalio. Thank you.
    Senator Levin. Let us see. What time is it now? Have the 
votes started? I think the votes have started.
    We are checking to see if the votes have begun. Again, I am 
going to stay here through these first two roll call votes, so 
my colleagues here, you can adjust how you wish.
    We will now call our second panel of witnesses: Thomas 
Farley, the President of the New York Stock Exchange Group in 
New York; Joseph Ratterman, Chief Executive Officer of BATS 
Global Markets in Lenexa, Kansas; Joseph Brennan, Principal and 
Head of Global Equity Index Group at the Vanguard Group in 
Malvern, Pennsylvania; and Steven Quirk, Senior Vice President 
of the Trader Group at TD Ameritrade in Omaha, Nebraska.
    We appreciate all of you being here today, and under our 
Rule 6, as I think you heard, all of our witnesses are required 
to be sworn, so we would ask you to please stand and raise your 
right hands. Do you swear that the testimony you are about to 
give to this Subcommittee will be the truth, the whole truth, 
and nothing but the truth, so help you, God?
    Mr. Farley. I do.
    Mr. Ratterman. I do.
    Mr. Brennan. I do.
    Mr. Quirk. I do.
    Senator Levin. Thank you, and we will use, again, the 
timing system. A minute before the red light comes on, you will 
see the light change from green to yellow, giving you an 
opportunity to conclude your remarks. Your written testimony 
will be printed in the record in its entirety. Please try to 
limit your oral testimony to no more than 5 minutes.
    Mr. Farley, we are going to have you go first, followed by 
Mr. Ratterman, then Mr. Brennan, and then Mr. Quirk. Thank you 
all for being with us.

                  EXCHANGE, NEW YORK, NEW YORK

    Mr. Farley. Thank you. Chairman Levin and Senator Johnson, 
we appreciate your interest in the regulatory structure of the 
U.S. capital markets. My name is Tom Farley, and I am the 
President of the New York Stock Exchange. I have been in the 
business of running exchanges for most of my career including 
as President and COO of ICE Futures US--formerly the New York 
Board of Trade.
    \1\ The prepared statement of Mr. Farley appears in the Appendix on 
page 77.
    As market operators, we have come to the view that the U.S. 
equities market is highly fragmented--making it overly complex 
and opaque. The regulations and structures in place today 
incentivize participants to make it more complex and more 
opaque. Numerous surveys and recent history have shown that 
this structure does not contribute to investor confidence or 
high systems reliability.
    As the dominant rule setting the boundaries of equity 
market structure, Regulation NMS set out to accomplish several 
objectives. The first was to increase competition among markets 
and among orders. While the rule did an excellent job of 
increasing competition among markets, we believe competition of 
orders has been severely damaged, particularly in recent years, 
due to the record level of off-exchange trading and increased 
levels of order fragmentation. In fact, just last week, off-
exchange trading reached a record high of 40.5 percent across 
all Regulation NMS securities. This means that despite someone 
taking a risk to establish the National Best Bid or Offer on a 
displayed market--fully regulated exchange--brokers decided to 
execute the trade away from the displayed, or fully regulated, 
market 40 percent of the time rather than rewarding the people 
who established the NBBO--national best bid or offer--with an 
execution. We find this troubling and damaging to price 
    The second objective of Regulation NMS was to design a 
structure to the benefit of long-term investors and public 
companies. Long-term investors have benefited in many ways from 
the implementation of Regulation NMS; however, data now shows 
that some of these benefits, such as lower costs, might be 
reversing. In addition, we consistently hear from large 
institutional investors that there are too many conflicts in 
the current market structure and that they would like to see 
those conflicts eliminated or, at least, reduced.
    Perhaps most importantly, we hear from listed companies and 
entrepreneurs that they believe the market is not designed for 
them but rather for the trading community, and as a result, 
they have lost confidence in the market. Newly listed companies 
via the IPO process are the lifeblood of our economy and our 
    The New York Stock Exchange will take a leadership role in 
bringing about beneficial change. Our goal is simple: reduce 
the level of complexity and fragmentation of the U.S. stock 
market. To accomplish this goal, there are several unilateral 
steps that we are committing to take and that we would welcome 
our industry colleagues to also adopt. To start, we are self-
imposing a 6-month moratorium on any new, or novel, order types 
that further segment the market. In addition, we have already 
announced the elimination of more than a dozen existing order 
types. We believe these are first steps toward reducing 
complexity and toward a more efficient market structure, and we 
will look for other steps that we can take along these lines.
    At an industry level, we are seeking support for the 
elimination of maker-taker pricing and the use of rebates. 
Broad adoption of this policy would reduce the conflicts 
inherent in such pricing schema and further reduce complexity 
through fewer order types and fewer venues. In conjunction with 
the elimination of maker-taker and rebates, we believe 
regulation should require that deference be given to displayed 
quotes on fully regulated exchanges. There is risk involved in 
displaying a quote on such a venue, and we believe strongly 
that the person taking that risk should be rewarded with an 
execution at that price. Unfortunately, in today's environment, 
those displayed quotes are used to inform trading on dark 
markets which are not contributing to the price discovery 
process. The original investors who posted these public quotes 
are all too often left with no trade at all. Several countries, 
including Canada and Australia fairly recently, have adopted 
rules that establish this type of primacy of public quotes. In 
the cases of Canada and Australia, the regulators have 
established that this policy has simplified and even improved 
their markets.
    Last, as you heard on the first panel this morning, there 
are questions as to whether or not some market participants are 
able to build an advantage over others by using high-speed data 
feeds and co-location services. While it should be noted that 
both of these services are regulated and made available to all 
investors equally, we believe that if something results in a 
loss of investor confidence, we should find a way to change it. 
NYSE is willing to put all options on the table as it pertains 
to the delivery of market data; however, we highlight that this 
cannot be done in a vacuum, and any changes must be applied 
equally to all exchange and dark pool venues.
    Thank you for your time, and I look forward to answering 
any questions you may have.
    Senator Levin. Thank you very much, Mr. Farley.
    Mr. Ratterman.


    Mr. Ratterman. Good morning. My name is Joe Ratterman, 
Chief Executive Officer of BATS Global Markets and one of the 
founding employees. I want to thank Chairman Levin, Ranking 
Member McCain, and Senator Johnson for inviting me to 
participate in today's proceedings.
    \1\ The prepared statement of Mr. Ratterman appears in the Appendix 
on page 79.
    I was encouraged with the sentiments recently expressed by 
SEC Chairman Mary Lou White who said that our markets are ``not 
broken, let alone rigged.'' I agree with her. The automation of 
the U.S. equity markets has resulted in significant 
enhancements in market quality for long-term investors. 
Importantly, however, I also recognize that our markets are not 
perfect and that efforts to improve them should never let up 
and never cease. Our current market structure is a product of 
Congress' 1975 amendments to the Exchange Act and subsequent 
rulemaking by the SEC to implement a national market system.
    The SEC, working in significant part through the exchanges 
and other SROs, has created a system that allows market 
competition while at the same time, and just as vital, 
fostering price competition.
    Today our equity markets are widely considered to be the 
most liquid, transparent, efficient, and competitive in the 
world. Costs for long-term investors in U.S. equities are among 
the lowest globally and declining. These gains have been noted 
by investors and experts alike.
    In April 2010, Vanguard confirmed estimates of declining 
trading costs over the previous 10 to 15 years, ranging from a 
reduction of 35 percent to more than 60 percent, savings which 
flowed directly to investors in the former of higher returns.
    Three respected economists recently found that between 2001 
and 2013, the spread paid by investors had decreased by more 
than 70 percent for NYSE-listed stocks.
    In April 2014, BlackRock noted that, since 1998, 
institutional trading costs had declined and are among the 
lowest in the world.
    Earlier this month, ITG reported between 2009 and 2013, 
implementation shortfall costs decreased from roughly 45 basis 
points to 40 basis points, following a drop from 63 basis 
points in 2003.
    Further, our market is able to handle volume and message 
traffic considered astronomical only a short time ago. The 
efficient operation of our market structure throughout stress 
of the 2007-09 financial crisis indicates the systemic risks 
that have been reduced as a result.
    Efforts to address infrastructure risks since the flash 
crash of 2010 are producing further beneficial results. For 
example, the number of erroneous executions occurring on our 
markets is pace this year to be nearly 85 percent lower than 
the previous 5-year average, results that stem from the success 
of the recently enacted limit-up/limit-down plan.
    In addition, exchange systems issues as measured by self-
help declarations have dropped by more than 80 percent since 
the first years after Regulation NMS. We must, nonetheless, 
remain squarely focused on improving market quality and 
stability in a coherent and responsible way. We are also keenly 
aware that investor confidence is important not only to help 
Americans realize their investment and retirement goals, but it 
plays directly into the overall health of our country's 
    Simply put, when investors are confident enough to put 
their hard-earned capital to work in our stock market, 
entrepreneurs and corporations can grow and thrive as well. As 
such, we are fully supportive of the SEC's plan for a 
comprehensive market structure review, and we look forward to 
actively participated in that process.
    Among other things, I see the following four areas as 
offering potential benefits without disrupting existing market 
quality gains.
    First, institutional investors could benefit from 
incremental transparency related to the ATSs that their brokers 
route orders to, including the publication of Form ATS, which 
some of the ATSs have already done. Consistent and thorough 
reporting standards will create the greatest level of investor 
confidence, so additional regulatory direction may be required 
    Second, I support reviewing current SEC rules designed to 
provide execution quality and routing transparency. For 
example, Rule 606 could be amended to require disclosure about 
the routing of institutional orders as well as separate 
disclosures regarding the routing of marketable versus 
nonmarketable orders.
    Third, to strengthen the confidence of the investing public 
in market data, I continue to support initiatives to make the 
SIPs, also known as consolidated tapes, as fast as possible. 
This is a position that BATS has advocated since becoming an 
exchange in 2008.
    And, finally, I support the eliminate of the ban on locked 
markets, part of Reg NMS, which we believe is a primary driver 
of excessive complexity in our national market system.
    Thank you for the opportunity to appear before you today, 
and I would be happy to answer your questions.
    Senator Levin. Thank you very much, Mr. Ratterman.
    Mr. Brennan.


    Mr. Brennan. Thank you, Chairman Levin, Ranking Member 
McCain, and Members of the Subcommittee for inviting me to 
participate today. My name is Joe Brennan. At Vanguard, I am 
responsible for overseeing the management of our equity index 
mutual funds.
    \1\ The prepared statement of Mr. Brennan appears in the Appendix 
on page 87.
    Vanguard serves more than 20 million investors who entrust 
us with $2.6 trillion of their retirement and education 
savings. Vanguard's core mission is simple: to take a stand for 
all investors, to treat them fairly, and to give them the best 
chance for investment success.
    Before getting into specific comments on potential 
improvements to our current equity market structure, I would 
like to make two fundamental points.
    First, the markets are not rigged. We have a high degree of 
confidence in the markets as a safe place for investors to 
place their assets.
    Second, all investors have benefited from improvements to 
our equity market structure. Through regulatory initiatives 
over the past two decades, most notably Regulation NMS, our 
equity markets have evolved to a competitive marketplace that 
is connected through highly advanced technology. Over time, 
this structure has led to lower transaction costs for all 
market participants. Individual investors who access the equity 
markets through asset managers like Vanguard have benefited 
from the market structure improvements that have been made over 
the past 20 years. Additional improvements can be made, and we 
are very pleased to discuss those issues with the Committee 
    We also commend SEC Chairman White for initiating a 
comprehensive review of ways to further strengthen the markets. 
We look forward to working with the Commission in this regard.
    I will now briefly discuss a topic that has garnered 
considerable public attention recently: high-frequency trading. 
While the term ``high-frequency trading'' has become shorthand 
for disruptive trading, there is a significant amount of 
legitimate activity, such as market making, which also falls 
under this broad umbrella. Today's market structure contains 
many venues in which trades can be executed. Professional 
traders and technology are the yarn that knits these venues 
    Our efforts should not be focused on banning high-frequency 
trading; rather, we suggest examining our market structure 
holistically to ensure it is providing the incentives for the 
type of activity we would like to see.
    To accomplish this goal, Vanguard supports efforts by 
regulators to comprehensively reevaluate Reg NMS. As time has 
passed and the markets have changed, most would agree that it 
is time to reassess whether this regulation continues to 
further the goals of our national market system. We would 
suggest the most important goal of a national market system is 
to create a structure that encourages market participants to 
publicly display limit orders. Such a structure promotes price 
discovery and lowers transactions costs for all investors.
    In that light, Vanguard supports regulatory efforts to 
revisit the current maker-taker pricing model of the exchanges. 
Fundamentally, it is important to understand that these models 
did not develop from any nefarious intent. They are the 
exchanges' response to the proliferation of market centers 
enabled by Reg NMS and a way for the exchanges to continue to 
attract liquidity. However, the models have become unnecessary 
complex, and the decision to submit orders to the public 
markets should not be driven by the desire to capture a rebate 
or avoid a fee.
    Any reevaluation of the maker-taker models must be 
connected to an analysis of other ways to encourage publicly 
displayed orders. Specifically, we support a pilot of a 
``Trade-At'' rule under Reg NMS. Today a market center can 
execute an order at the best publicly displayed price without 
actually contributing to the public price discovery process. 
Generally speaking, those that publicly display their interest 
first should be first in line for any execution at that price 
across the markets.
    A well-designed pilot of a ``Trade-At'' rule under Reg NMS 
could help strike the appropriate balance between promoting 
public competition of orders while still encouraging 
competition among a variety of market centers. Regulators and 
industry participants have been working diligently over the 
past few years to take steps to continuously improve the manner 
in which our markets operate. The equity markets are extremely 
complex, and it is vitally important to examine all of the 
potential consequences of any changes to our structure.
    We believe the SEC and FINRA are well equipped to continue 
to evaluate ways to improve our markets, and we commend them 
for the work they have already performed.
    I thank you for allowing me to participate in this 
discussion, and I welcome your questions.
    Senator Levin. Thank you very much, Mr. Brennan.
    Mr. Quirk.


    Mr. Quirk. Good morning, Chairman Levin, Ranking Member 
McCain, and Members of the Subcommittee. My name is Steve 
Quirk. I am Senior Vice President with TD Ameritrade. I 
appreciate the opportunity to appear before you today. I 
thought I would spend a brief moment on TD Ameritrade and the 
clients that we serve so you have a better understanding of 
what we do.
    \1\ The prepared statement of Mr. Quick appears in the Appendix on 
page 93.
    We are a financial services company serving primarily 
retail investors. We have over 6 million client accounts with 
$600 billion in assets, including custodial services for 4,500 
individual representative registered investment advisors and 
their clients. We are based in Omaha, Nebraska, and we were one 
of the first firms to offer discounted commissions to retail 
investors. Since our founding in 1975, we have also pioneered 
innovations such as touch-tone trading, Internet trading, and 
most recently mobile trading.
    We have been on a quest to level the playing field between 
Wall Street and Main Street investors for almost 40 years. As a 
result of that, our clients have entrusted us with 
approximately a quarter trillion in net new assets since 2007. 
We interact with these clients daily and do third-party surveys 
to better understand their market sentiment. Based on this and 
other data, we do believe that the current U.S. equity market 
structure has never been better for those retail investors. In 
fact, the number of our firm's accounts that are trading is up 
31 percent on a year-over-year basis.
    Our retail clients tell us they want their entire orders 
filled quickly and inexpensively at the price quoted or better. 
In each of those areas, we have seen significant improvement in 
the last decade, as detailed in the written testimony.
    When it comes to order routing, brokerage firms have two 
options: they can internalize and trade against that, or they 
can route that to the market centers and destinations. Based on 
our open architecture and unbiased and unconflicted business 
model, we believe it is in the best interest of our clients to 
send their orders to a mix of market centers, including 
exchanges, wholesale market makers, and ECNs. While these 
market destinations serve a variety of purposes, we think they 
are all vital in driving the competition, which ultimately 
benefits investors.
    The Subcommittee has asked for our views on conflict of 
interests for brokers obligated to obtain best execution for 
client orders but also receive payments or rebates based on 
where that flow is directed. We strongly believe that with 
compliance with best execution obligations and proper 
disclosure, brokers can effectively manage any conflict that 
may arise from payments. Furthermore, we strongly believe that 
we effectively manage any such conflict.
    Brokers are required to seek the most favorable terms 
reasonably available under the circumstances for client orders. 
At our firm we consider the opportunity to obtain a better 
price than currently quoted, the speed of execution, and the 
likelihood of execution, amongst other factors when making that 
    We also give our clients a choice. Their orders can be 
routed using our proprietary order routing logic, or they can 
choose from a list of direct routing destinations.
    Finally, we work with multiple market destinations. Rather 
than internalize our client flow, we believe that routing all 
orders to the market is more transparent and better aligned 
with the needs of our clients. We select these market centers 
based on rigorous due diligence where execution quality is the 
top priority. After, and only after, a market satisfies our 
standards for best execution do we consider transaction costs 
or revenue opportunities. This process complies with SEC rules 
enacted after thoroughly reviewing this issue on numerous 
    The payments or rebates that brokers receive are 
transparently disclosed as an average per share in our 
quarterly 606 reports; they are also on our account Statements 
and are on confirmations, which are all required by SEC rules.
    Finally, we have provided the Subcommittee with a list of 
recommendations that we believe could enhance our Nation's 
current market structure without compromising many of the 
benefits retail investors have realized in the past years. Just 
as we constantly seek to improve our client experience, our 
industry should do the same. But let us not lose sight or 
compromise many of the improvements that have been made.
    We appreciate the opportunity to be part of the 
conversation. Thank you.
    Senator Levin. Thank you very much, Mr. Quirk.
    Let me start first with you, Mr. Farley. Jeff Sprecher, the 
head of the Intercontinental Exchange, which owns the New York 
Stock Exchange, which you represent here today, has said that 
the maker-taker system misaligns the interests of brokers and 
their customers and hurts everyone in the market. ``We should 
get rid of it,'' he said. Do you agree with him?
    Mr. Farley. Yes. Jeff also says--and let me start by 
saying, Senator, that the U.S. capital markets are indeed the 
best in the world, but for 225 years the New York Stock 
Exchange has advocated on behalf of customers and stood for 
improving markets and not just accepting a flawed status quo.
    To answer your question directly, there are really two 
areas where we are most concerned about the markets today: one 
is the appearance of conflicts, primarily because we think that 
undermines confidence in the markets; and the second is undue 
cost and complexity in the markets that we have heard a lot 
about today. Maker-taker gets to the heart of both of those 
issues and concerns that we have, and it is for those reasons 
that we have advocated eliminating maker-taker in its entirety 
in the equity markets in this country.
    Senator Levin. Well, very significant testimony when an 
exchange which has been here as long as you have been here 
makes that point. And you have said in your testimony that we 
are seeking support for the elimination of maker-taker pricing 
and the use of rebates. And then you said, ``Broad adoption of 
this policy would reduce the conflicts inherent in such pricing 
schema . . .'' Explain that now to the Subcommittee. I happen 
to agree with you that those conflicts are inherent, but tell 
us in your words why elimination of the maker-taker pricing 
would reduce conflicts that are inherent in such pricing.
    Mr. Farley. Sure. And if I may, if I could just provide a 
little bit of context, I came from a company called 
Intercontinental Exchange, and we agreed to acquire the New 
York Stock Exchange on Thanksgiving of 2012. And so we came to 
this with a perspective of other markets like the futures 
markets, which are deep and liquid and people generally will 
acknowledge that those markets function properly. And there is 
no such thing in those markets as maker-taker pricing, for 
example. So it was something we very quickly wanted to 
understand more about.
    The first thing that we noticed was that the maker-taker 
schema results in many more order types in the equities markets 
than you have in other markets, such as, for example, the 
futures markets. And many of those order types are simply in 
existence to help market participants capture the maker-taker 
    And so we realized while this pricing schema introduces a 
good deal of complexity, with respect to the conflicts issue 
that you described in particular, it has been frustrating to us 
that in a period of rising stock prices we have not seen more 
participation in the equities markets from investors. In fact, 
data shows that the participation in terms of percentage 
participation of U.S. citizens is at a 16-year low. And we 
think a reason for that, an important reason for that, is just 
confidence in the markets. Markets rely on confidence. We 
cannot say that enough.
    And irrespective of whether or not there is an actual 
conflict or a conflict that is resulting in some sort of bad 
behavior, the appearance of conflict matters. And it is for 
that reason that we look at maker-taker pricing, and we say 
there may be an appearance of conflict there if a broker-
dealer's interests are not aligned with their customers, and 
that is something that can potentially arise with maker-taker 
    Senator Levin. Well, the appearance of a conflict is 
obviously important because of the confidence issue and also 
because underneath the appearance there may be more than an 
appearance. But your testimony actually is even clearer than 
that. As you say, you support elimination of maker-taker 
pricing and the use of rebates, and that broad adoption of that 
policy would reduce the conflicts inherent--you use the word 
``inherent.'' Explain that.
    Mr. Farley. So any reasonable business person does not like 
to be in a position of having their interests not aligned with 
their customers'. When you have maker-taker pricing, there are 
examples, as Professor Battalio described this morning, where a 
broker-dealer has an incentive to post a price on a high-make 
rebate venue even if the execution quality on that particular 
venue is not as high as another venue. That arises specifically 
because of--or it is certainly exacerbated because of maker-
taker pricing.
    Senator Levin. And that is why there is a conflict inherent 
in that pricing schema.
    Mr. Farley. That is right.
    Senator Levin. Now, Mr. Ratterman, I will give you a chance 
now to--first of all, before we ask you to comment or react to 
that, you said earlier this year, I believe, that businesses 
offer incentives for customers to be in their ecosystem all the 
time. Who are the customers you were referring to? Are they 
    Mr. Ratterman. Yes, our customers are all brokers.
    Senator Levin. All right. Now, let me give you an 
opportunity to respond to Mr. Farley's testimony.
    Mr. Ratterman. Sure. So from my perspective, in our firm we 
do not believe that there should be a ban on maker-taker. We 
are certainly open, if there is a pilot, to looking at the 
data, but my answer stems from my concern for the potential 
benefits and spread reduction that maker-taker may have 
produced over the last 10 or 15 years, not for any commercial 
purpose about the way we run our exchange. Our exchange is in 
the business of matching buyers and sellers, fair and orderly 
markets. When we have a trade, we are going to deserve revenue 
for that trade as it happens. How we do that, there is today a 
significant amount of flexibility, and I believe that 
flexibility has allowed for innovation in pricing and markets, 
and that incrementally the rebates that are offered in many 
cases to market makers to take the risk to put bids and offers 
in the market has yielded tighter spreads over time.
    I also do not believe that eliminating maker-taker would 
eliminate a conflict. I am thinking, as Senator Johnson walked 
through an example earlier, a broker's evaluation of a trade, 
examining where he would get a rebate for 30 cents or maybe pay 
15 cents, he is looking at a spread of 45 cents in relation to 
the likelihood or not likelihood of getting an execution where 
he actually does get paid, and when he does not trade or his 
order does not fill, there is no commission to the broker.
    So by eliminating maker-taker, you would only compress the 
range of the conflict, but the conflict would still exist as 
long as there is differential pricing between exchanges. So I 
think the only way to potentially eliminate the conflict then 
is to mandate exchange pricing at a fixed level for all 
exchanges all the time.
    So the conflict will remain unless there is a significant 
intervention, and I believe disclosure, as we have talked about 
earlier today in the hearing, is the right answer to provide 
the information so that not only brokers but their customers 
can evaluate whether these conflicts have actually been managed 
well in favor of the client or not. But I do not see any path 
by which the elimination of the conflict can be achieved.
    Senator Levin. Mr. Farley, do you want to comment on that?
    Mr. Farley. Sure.
    Senator Levin. Can we reduce the conflict that is inherent 
that you talked about? And can we reduce the appearance by 
removing the maker-taker pricing? Or have you changed your mind 
after hearing Mr. Ratterman? [Laughter.]
    Mr. Farley. I actually found more areas of agreement with 
Mr. Ratterman than maybe I would have otherwise expected from 
the way his answer started. I think he--if I am putting words 
in your mouth, Joe, correct me. But he said, look, that may 
reduce the conflict, but it would not eliminate it. And so we 
are both agreeing directionally that it would have an impact on 
conflict or the appearance of conflict in the market.
    But I also want to highlight that, again, the reasons why 
we have been focused on this are twofold: one is around this 
conflict issue, and the second is around complexity in the 
markets, additional order types and venues. And it is worth 
noting that, at the New York Stock Exchange, I have three 
equities trading venues, Mr. Ratterman has four. We have a 
competitor that also has four. A lot of those venues exist 
really principally because of maker-taker pricing, and those 
venues are creating different pricing schemas using maker-taker 
pricing for our customers.
    And then, finally, and I will conclude briefly, I agree 
with Mr. Ratterman about another point he made, which is that 
we have to be careful about the elimination of maker-taker to 
make sure that there are not wider spreads on fully regulated 
exchanges, which is why it is very important to us that such a 
move would be tightly coupled with giving what we call primacy 
of the public quote on lit exchanges to the participants who 
made those quotes. And that is something that does not exist 
today, and people are able to trade in dark markets at the same 
price as is posted on an exchange.
    Senator Levin. And reducing the conflict would be valuable 
even if you cannot eliminate it?
    Mr. Farley. Yes.
    Senator Levin. Mr. Sprecher, your boss, in January said the 
following: ``The price that we see as a bid-offer price in the 
market is really not the price because there are rebates and 
other discounts that are applied. . . . So we do not have a 
view of the actual price which I think is to a certain degree 
false advertising when you have a public ticker.''
    Do you agree that maker-taker fees are distorting market 
    Mr. Farley. I agree with what Jeff said. He is my boss, 
after all.
    Senator Levin. If he were not your boss--he is not 
listening. [Laughter.]
    Do you believe that maker-taker fees are distorting market 
    Mr. Farley. Well, if I can just address the comment that 
Jeff made, I think it is a matter of fact that posted prices on 
exchanges--and also there are posted prices that go out through 
our own raw data feeds or public feeds--do not include the fees 
associated with them. So that is accurate that they do not 
include all-in prices.
    So to the extent somebody is viewing that data and assuming 
that it does include the various make rebates and take fees, 
from their perspective it would be distorted. If somebody 
understands that it is not included, they are just receiving a 
different data set.
    Senator Levin. Did anything that you hear Mr. Ratterman say 
change your view that the maker-taker schema, as you put it, 
creates an inherent conflict?
    Mr. Farley. No.
    Senator Levin. Now, Mr. Sprecher also said the following, 
Mr. Farley, that maker-taker ``creates false liquidity.'' Do 
you agree with that?
    Mr. Farley. I suppose I have a slightly different 
perspective on it.
    Senator Levin. Give us your perspective.
    Mr. Farley. So, again, I come from a career mostly spent in 
the futures markets, and the type of liquidity and market 
making we most value comes from participants who will show up 
and buy from sellers and sell to buyers and actually engage in 
risk transference where they will hold a position for a period 
in time.
    Fairly new to the equities markets now--a year and a half 
in--what I see is there is a whole swath of market making that 
is essentially stitching back the 50-plus venues you mentioned 
earlier this morning, and there are many examples of 
participants who are buying and selling at the exact same price 
at the exact same time on different venues, in part to capture 
maker-taker rebates. That is a different form of liquidity. I 
would choose different words than Jeff did, ``false 
liquidity,'' but it is not as valuable as the type of liquidity 
that we have always valued at ICE in building markets.
    Senator Levin. It is a different kind of liquidity which is 
not as valuable as the kind of liquidity which is created where 
there is a real shifting of risk.
    Mr. Farley. No question. And it is a blanket of cost on the 
industry, stitching back together those--50 is a conservative 
number, but stitching back together those 50 venues.
    Senator Levin. I think we have all heard about a recent 
survey of equity market participants that suggested that the 
majority of those surveyed thought that the equity markets were 
not fair for all participants. Is there a lack of confidence? 
Would you agree, Mr. Farley? And do the conflict of interests 
fuel that lack of confidence?
    Mr. Farley. I look at statistics such as the one that I 
believe you cited, Senator, that two-thirds of Americans had 
equities in their account not too long ago, maybe a decade ago, 
and now it is half; that participation in the equities markets 
is at a 16-year low; and I look at that empirical data. I also 
look at the anecdotal data, and I am sure you, like I, have 
conversation about the equity markets with your friends and 
family. I grew up down the road here in P.G. County, and when I 
go back home, inevitably people ask me, ``What is going on in 
the equities markets? Tell me about these high-frequency 
traders.'' And there is a sense, it is unfortunate, but there 
is a sense that we do not have as much confidence in the 
markets as we once had, which is why we as the New York Stock 
Exchange, from the moment ICE agreed to acquire the New York 
Stock Exchange, has been standing for what can we do to 
increase confidence, what can we do to simplify the markets. 
Because as simple as you can make--to inspire confidence, you 
would to make the market as simple as you possibly can and as 
transparent as you possibly can.
    Senator Levin. And as free of conflict of interests as you 
possibly can?
    Mr. Farley. Yes.
    Senator Levin. Mr. Brennan, your main business is 
investment management, and you offer mutual funds and other 
investment opportunities for your customers. Do you believe 
that the maker-taker pricing creates a conflict of interest 
between a broker's duty to seek best execution and the money a 
broker can make by pursuing rebates?
    Mr. Brennan. Yes, we think the maker-taker pricing model 
creates an appearance of a conflict of interest and adds 
additional complexity to the market. We are in favor, as we 
have stated, of looking at maker-taker as part of a 
comprehensive review of Reg NMS in our market structure.
    Senator Levin. Do you think that that should be eliminated?
    Mr. Brennan. I think we should test any changes with a 
pilot. I am not sure elimination is the answer. I think pilots 
and data-driven analysis are the best way to really make 
decisions on changes in market structure.
    Senator Levin. And the pilot would be to remove maker-taker 
in a particular pilot area?
    Mr. Brennan. Sure. I think----
    Senator Levin. What area would you suggest that maker-taker 
be eliminated on a pilot basis? How would you describe the 
pilot or how would you define the pilot area?
    Mr. Brennan. I think experts at the SEC should work with 
industry participants to define the pilot. I think all market 
participants should be involved in the definition of the pilot.
    Senator Levin. And the reason that you want to move in that 
direction is because you believe, and your company believes 
that there is an appearance of a conflict?
    Mr. Brennan. Yes, maker-taker does create an appearance of 
a conflict. I think we are all in agreement.
    Senator Levin. Now, Mr. Brennan, some of the conflicts that 
we discussed today are the result of payments that are a penny 
a share or a few cents a share. Why does it matter to you that 
a conflict or an appearance of a conflict be removed if it is a 
few pennies a transaction?
    Mr. Brennan. Well, we generally stand for what is in the 
best interests of our clients, and we are--for transparency and 
a fair market, and conflicts--eliminating conflicts and 
reducing conflict of interests in our market is something that 
would benefit our clients.
    Senator Levin. Does it also create a problem for you to 
check on execution?
    Mr. Brennan. It does not create a problem for us.
    Senator Levin. Do you spend time looking at the execution 
of brokers?
    Mr. Brennan. Yes, so----
    Senator Levin. If maker-taker were eliminated, would that 
result in less time being spent by you and your company 
reviewing the execution of brokers?
    Mr. Brennan. Our approach to our counterparties is probably 
four- or five-fold.
    Senator Levin. When you say ``counterparties,'' who----
    Mr. Brennan. Brokers, to the use of brokers, our choice of 
brokers. We have a lot of choices in who we can transact with. 
We really scour the marketplace looking for the best place to 
execute our transactions. We have highly skilled traders who 
manage our portfolios on behalf of our clients. And we have 
choice to eliminate a broker if they are not living up to our 
    Along with that skill and expertise, we also have a trust 
but verify mode of operation where post-trade analytics are 
performed to see that our brokers are actually living up to our 
    Senator Levin. And I think your company told our staff that 
monitoring brokers to ensure or try to ensure best execution is 
a significant effort and that they would rather not have to do 
so in a conflicted environment. Is that true?
    Mr. Brennan. We think it would be a significant effort, 
whether maker-taker existed or not. To be honest, we do a lot 
of trading, $1 billion, $2 billion of trading a day, 6 million 
trades a year. I think we owe it to our clients to do 
everything to ensure their execution is top-notch.
    Senator Levin. And even though the amount of money per 
transaction may be 30 cents, or whatever it is, is that still 
true? Do you worry about that being added to a transaction?
    Mr. Brennan. The 30 mil cap?
    Senator Levin. Yes.
    Mr. Brennan. Yes, so that is a pricing model, and that is a 
cap on a pricing model. What actually happens with our 
transactions is not necessarily 30 mils. We have a lot of 
control over our trades. We do not just hand them over to a 
    Senator Levin. You spend time, as you said, reviewing this.
    Mr. Brennan. We spend time in the actual trading and the 
review of the trades.
    Senator Levin. And the review of them.
    Mr. Brennan. Yes.
    Senator Levin. And if there were less of a conflicted 
environment, would you have less need to review?
    Mr. Brennan. I think we would still review, to be honest 
with you.
    Senator Levin. But would you rather be in a nonconflicted 
    Mr. Brennan. It might make the complexity and the review 
process a little easier in the data that comes back.
    Senator Levin. Would you rather review the trading in a 
nonconflicted environment?
    Mr. Brennan. Sure.
    Senator Levin. Now, as a retail broker, does Vanguard 
accept payments from wholesale brokers, so-called payments for 
order flow?
    Mr. Brennan. Vanguard has a retail brokerage. That is not 
the area of the company that I am associated with.
    Senator Levin. Do you know whether or not Vanguard accepts 
payments from wholesale brokers?
    Mr. Brennan. Vanguard in its retail brokerage does not 
accept payments for equity flow.
    Senator Levin. Do you know why?
    Mr. Brennan. We would have to talk to that area of our 
company. I am quite separate from our retail broker.
    Senator Levin. All right. Here is what the person in that 
area told our staff. Tell me whether or not you disagree with 
this. They told us that they could make money by selling their 
retail order flow, but they believe accepting payments would 
create a conflict, so they do not do so.
    Do you have any reason to not believe that or----
    Mr. Brennan. I have not talked to the person that runs that 
area of our company, so I cannot confirm or deny that.
    Senator Levin. That would be fine. Would you take back to 
your company that request?
    Mr. Brennan. Sure.
    Senator Levin. And give us an answer for the record----
    Mr. Brennan. Absolutely.
    Senator Levin [continuing]. As to whether or not what the 
staff Vanguard folks told us that they believe accepting 
payments would create a conflict, so they do not do so? Would 
you let us know for the record if that, in fact, is the case?
    Mr. Brennan. Yes, sir.
    Senator Levin. Mr. Quirk, I understand that your company, 
TD Ameritrade, sends marketable orders which would incur a fee 
if sent to an exchange to a wholesale broker-dealer. Is that 
    Mr. Quirk. That is correct.
    Senator Levin. And that the broker-dealer pays Ameritrade 
for those orders. Is that correct?
    Mr. Quirk. That is correct.
    Senator Levin. And that you send nonmarketable orders, 
which are the ones that are eligible for rebates to exchanges. 
Is that correct?
    Mr. Quirk. That is correct.
    Senator Levin. And is it correct that TD Ameritrade 
receives payment either from a wholesale broker as payment for 
order flow or from an exchange as a rebate on nearly every 
trade completed?
    Mr. Quirk. I would not say on every trade completed----
    Senator Levin. I said ``nearly every.''
    Mr. Quirk. Nearly every trade, yes.
    Senator Levin. All right. On nearly every trade, TD 
Ameritrade receives two payments: one is the commission paid by 
the customer, and another is from the venue where the trade is 
executed. Who decides whether an exchange or a wholesaler has 
provided best execution? Is it TD Ameritrade itself? Do you 
make that decision?
    Mr. Quirk. We would have committees that would make that 
    Senator Levin. So a best execution committee?
    Mr. Quirk. We do. We have a best execution committee.
    Senator Levin. All right. Can different brokers reach 
different conclusions about which venue offers the best 
    Mr. Quirk. Yes, I think--yes. The answer to the question is 
yes. But I think what is going to drive the decision as to what 
is the best execution is the client, and what I mean by that is 
if a retail client puts in a market order, they are telling us 
they want a quick, timely execution at or better, at the 
current price or better, in its entirety.
    Senator Levin. If there is a market order?
    Mr. Quirk. If it is a market order.
    Senator Levin. Other than that?
    Mr. Quirk. If it is a limit order, they are telling you 
they want that order to be visible. They have picked a price, 
they have determined where their interested in purchasing that 
stock, and they want it to be visible.
    Senator Levin. But basically the question is still the 
same: Could different brokers reach different conclusions about 
which venue offers the best execution?
    Mr. Quirk. Yes, but I think the determinant factor would be 
what is in the best interests of their client or what is their 
client looking for. Our clients are not going to look like, for 
example, your clients, so we are going to have different needs 
with respect to execution.
    Senator Levin. But the answer to the question is different 
brokers, even with the same clients, can reach different 
conclusions about the best venue. That is why you have a 
    Mr. Quirk. Yes.
    Senator Levin. Would you all agree with that? Are you 
shaking your heads yes, that different brokers----
    Mr. Ratterman. Yes.
    Senator Levin [continuing]. Can reach different conclusions 
as to which venue offers the best execution?
    Mr. Farley. Yes.
    Mr. Brennan. Yes.
    Senator Levin. All right. Now, for Mr. Quirk, back in 2009, 
Chris Nagy, who is TD Ameritrade's managing director of order 
routing strategy, said the following: ``With maker-taker, there 
is a higher cost to retail investors.''
    Now, that is not your position today. Is that correct?
    Mr. Quirk. No, and I do not know what that is in reference 
    Senator Levin. All right. But that is not your position 
    Mr. Quirk. No.
    Senator Levin. And he also--that was in Forbes Magazine, 
September 10, 2009, and he was the managing director of order 
routing strategy, and he said the following in the September 
21, 2009, edition of Securities Technology Monitor: ``We felt 
it would become deleterious to the retail investor if maker-
taker were allowed to proliferate.'' That was in 2009. Is that 
your position?
    Mr. Quirk. No, it is not.
    Senator Levin. Do you know what changed?
    Mr. Quirk. I do not know what his position was, so I 
actually was not involved with the order routing.
    Senator Levin. Were you there in 2009?
    Mr. Quirk. I was there, but not in this capacity.
    Senator Levin. OK. Do some trading venues, Mr. Quirk, offer 
higher rebates than others?
    Mr. Quirk. Yes.
    Senator Levin. Is the size of the rebate offered by an 
exchange a factor in determining where you route nonmarketable 
customer orders?
    Mr. Quirk. The way that our committees and the people 
responsible for order routing approach this is they start with 
the best execution, and they would go through a list of 
variables that we should consider as hurdles. And in order to 
get to a point where the revenue sharing is even considered, 
those hurdles have to be cleared.
    Senator Levin. And the revenue sharing that you are talking 
about is the rebate?
    Mr. Quirk. Correct, sir.
    Senator Levin. When you get to that point----
    Mr. Quirk. Yes.
    Senator Levin [continuing]. After you say you have looked 
at the other factors, and then you look at the rebate issue, my 
question is: Is the size of the rebate offered by an exchange a 
factor in determining where you route those nonmarketable 
customer orders?
    Mr. Quirk. Yes. It would be the last factor. All things 
being equal, that would be a factor.
    Senator Levin. And so the greater the rebate, that would be 
where you would go if it is otherwise best market.
    Mr. Quirk. Yes.
    Senator Levin. How many trades does Ameritrade route to 
exchanges in a typical quarter?
    Mr. Quirk. We route--about 37 percent of our flow would go 
to an exchange on a daily basis, so I am assuming that 40--I 
will call it 40 percent of, let us call it, 400,000 trades a 
day, so we are talking about----
    Senator Levin. 150,000 trades a day?
    Mr. Quirk. 150,000 trades a day times--you said a quarter, 
right? So that is going to be about--let us see.
    Senator Levin. Well, a week it would be about--let us round 
it off, say half a million a week?
    Mr. Quirk. Yes.
    Senator Levin. And so maybe in a month that would be about 
2 million. A quarter that would be about 8 million. How does 
that sound?
    Mr. Quirk. That sounds good.
    Senator Levin. Round it off, OK.
    Mr. Quirk. We did about 90 million trades last year.
    Senator Levin. OK. Well, then, why would it be only 8 
    Mr. Quirk. You asked----
    Senator Levin. Well, that is through exchanges.
    Mr. Quirk. Yes, and you asked per quarter.
    Senator Levin. OK. So that is about 8 million, to exchanges 
in a typical quarter.
    Now, we looked at your Form 606 quarterly order routing 
disclosures for the quarter that was covered in the Battalio 
paper, and I am going to have to go vote. I apologize. We are 
going to have to recess here for about 15 minutes. That will 
give you all a chance to do something else that you might need 
to do.
    We will reconvene at 12:15. Thank you all.
    Senator Levin. We will come back into session. We thank our 
witnesses for their patience and understanding with the Senate.
    Let me pick up where we left off, Mr. Quirk. I guess we 
were talking about how many trades Ameritrade routes to 
exchanges in a typical quarter, and I think we rounded it off 
to about 8 million, something like that. Is that correct?
    Mr. Quirk. That is correct.
    Senator Levin. Now, we looked at your Form 606 quarterly 
order routing disclosures for the quarter covered in the 
Battalio paper, and according to those disclosures, for the 
quarter covered in that paper, which was the fourth quarter of 
2012, TD Ameritrade directed all nonmarketable customer orders 
to one venue in that quarter, Direct Edge. Is that correct?
    Mr. Quirk. That is correct.
    Senator Levin. Now, among all the exchanges, Direct Edge 
paid the highest rebate during the fourth quarter of 2012, 
which is, again, the period covered by the Battalio paper, and 
you say that the orders, it was your policy, are directed first 
and foremost on the basis of best execution. But as we have 
learned today, best execution is a subjective judgment.
    So your subjective judgment as to which market provided 
best execution for tens of millions of customer orders a year, 
about 8 million in a quarter, allowed you to route all of the 
orders to the market that paid you the most. Now, I find that 
to be, frankly, a pretty incredible coincidence.
    Now, you directed all your orders for that quarter to 
Direct Edge because what you have said is that that exchange 
offered your company the best execution. The disclosure did not 
show a single order being directed to the New York Stock 
Exchange, for instance.
    So, Mr. Farley, was the New York Stock Exchange just 
consistently worse than Direct Edge in getting best execution 
on retail orders?
    Mr. Farley. No.
    Senator Levin. And, Mr. Quirk, how much did TD Ameritrade 
receive in rebates from exchanges last year for routing orders 
to venues that pay maker rebates? Do you know how much you made 
just from payment for order flow and rebates?
    Mr. Quirk. I can estimate it was based on what we have 
discussed. It would be about $80 million.\1\
    \1\ See Exhibit No. 4, June 19, 2014 letter from TD Ameritrade to 
the Permanent Subcommittee on Investigations, revising $80 million to 
$36 million, which appears in the Appendix on page 125.
    Senator Levin. About $80 million?
    Mr. Quirk. Yes.
    Senator Levin. And that would be just the part that goes to 
the venues that pay maker rebates?
    Mr. Quirk. Maker-taker.
    Senator Levin. Maker-taker, right. Well, how much did TD 
Ameritrade pay in fees to exchanges last year for routing 
orders to venues that charge taker fees?
    Mr. Quirk. I do not know the answer to that question, but I 
can get it.
    Senator Levin. Well, I think it is close to zero, isn't it?
    Mr. Quirk. No, it is not close to zero, but I do not know 
what the answer is. It would not be significant.
    Senator Levin. All right. Will you get the answer for the 
    Mr. Quirk. Yes.
    Senator Levin. So, anyway, for virtually every trade, your 
customers you say were better off by your routing their orders 
to the exchange that paid you a rebate rather than a venue that 
TD Ameritrade would have had to have paid a fee. Is that true?
    Mr. Quirk. I would say in the subsequent 24 months, you 
will note in our 606s that we have routed to a number of 
exchanges in one quarter, and some of those exchanges would not 
be the exchanges which were paying the highest rate.
    Senator Levin. Well, let me go into that. In your 606 
disclosures, for the first quarter of 2014, TD Ameritrade 
routed all disclosed nonmarketable orders to either Direct Edge 
or Lavaflow, the exchanges that appear from our review of your 
disclosures to have offered the highest rebates available in 
the market. Is that true?
    Mr. Quirk. That would be true.
    Senator Levin. And so, again, your subjective judgment as 
to which market provided best execution for tens of millions of 
customer orders virtually always led you to route orders to the 
markets that paid you the most.
    Mr. Quirk. No, it would not have always led us----
    Senator Levin. I said ``virtually always.''
    Mr. Quirk. Virtually, yes.
    Senator Levin. Senator McCain.
    Senator McCain. I want to thank the witnesses for coming.
    Mr. Ratterman and Mr. Farley, what effect would banning 
maker-taker payments have on your stock exchanges? Mr. 
    Mr. Ratterman. Thank you, Senator McCain. The effect would 
have us, as a commercial operation, change the way in which we 
charge our broker-dealer customers to access our market. As I 
mentioned earlier today, we take on the order of 2 cents for 
every hundred shares traded as revenue for conducting the 
services of an exchange. So if you take away the maker-taker 
rebate, we will simply reconfigure the pricing mechanism that 
we have so that we can continue to operate our business. So it 
is not fundamental to the way we do business, and so related to 
your question, we would simply adjust our pricing to whatever 
framework that the law allowed.
    Senator McCain. Mr. Farley.
    Mr. Farley. We would have fewer order types, which would 
reduce complexity in the market. We would likely have fewer 
venues, Senator, as well. We have three separate equities 
trading venues, and we would not need all three of those in a 
world where we did not have maker-taker, and I suspect some of 
our competitors would also reduce the number of venues they 
    However, I do want to point out that if we ban maker-taker 
in isolation, it is also probable that more business would move 
away from fully regulated exchanges into dark markets. 
Therefore, we would need to couple it with what is called a 
trade-at provision, which would establish the primacy of public 
    Senator McCain. I guess I have a question for all four of 
you. In your business and ours, perception is reality and 
reality is perception. And I think you would agree that we 
would not be having this hearing if it was not for significant 
questions out there about whether you do business fairly or 
unfairly, if there is favoritism, if there is, even as was 
charged in Michael Lewis' book, that there is real corruption. 
I think you would agree that there is a problem out there. 
Would you agree with that, all of you? Or you do not think 
there is a problem of public perception?
    Well, first of all, I guess beginning with you, Mr. Farley, 
and going down the line here, do you believe there is a public 
perception problem? And if there is, what do you think we ought 
to do? What measures ought to be taken? If you think there is 
no PR problem out there, then just say, ``I do not think there 
is a problem.'' But if you think there is a problem, what do 
you think we ought to do?
    Mr. Farley. Markets are built on confidence and perception, 
as you point out, and I think the perception could be a lot 
better, the perception of the equities markets in this country. 
We are talking a lot about trading businesses. At the New York 
Stock Exchange, the most important part of our business is 
actually our listings business--in other words, that part of 
our business where entrepreneurs come to market to raise 
capital to help create jobs, and that is built entirely on 
perception. And so we want to do whatever we can to improve the 
perception of the equities markets.
    We have proffered several suggestions. We actually think 
doing away with maker-taker, coupling it with a trade-at rule 
would improve perception by itself because of some of the 
aftereffects, reducing complexity, reducing order types, 
reducing messaging, reducing venues. And when you bring that 
sort of simplicity to the markets, that breeds confidence 
because people can understand it. It is more tangible.
    Senator McCain. Would co-location be part of that reform? I 
think we all would agree transparency is. Would co-location, 
elimination of that, also be a positive effect or no effect?
    Mr. Farley. Eliminating co-location would go in the other 
direction. I actually think that would be a perception problem. 
But bringing more transparency to the practice of co-location I 
think is a great idea, to whatever extent we can.
    Senator McCain. Mr. Ratterman.
    Mr. Ratterman. In my mind there is no question that these 
questions about market structure have entered into the 
mainstream and that people are wondering how the markets work. 
I think that to address that, maybe a few things.
    First, there are probably some areas of immediate 
transparency that can be brought into the market, and I think 
we are seeing market forces to some extent start to do that. 
IEX and Credit Suisse and Goldman Sachs I believe are three 
dark pool operators that have all released their Form ATS as an 
example. Prior to recent months, those were forms that were not 
made available to the public.
    So I think you are seeing a trend in the direction of 
transparency. In our testimony we have talked about areas of 
Rule 606 and 605 and other areas of operation of dark pools 
where transparency, I think, would yield a lot of insights and 
potentially some additional confidence in the markets. So that 
is the immediate response.
    The medium-term response I believe is to let the SEC do the 
holistic review that SEC Chairman White has articulated to the 
industry. This holistic review will be fully comprehensive. It 
will cover every tenet of market structure as we understand it 
today, put everything on the table. And some things will 
undoubtedly change through that process. They will find ways to 
optimize and improve what are already some pretty good 
attributes for today's market. But also, even things that we do 
not change, there will be a recent mark where the regulator 
will have said, ``We looked at this, we got the data, we have 
concluded that this is a good tenet of market structure, and we 
are going to leave it in place.''
    And so I think every element of our market structure will 
be addressed in this holistic review, and nothing will be left 
out. And I think that process will be very healthy for our 
    Senator McCain. Mr. Brennan.
    Mr. Brennan. Thanks, Senator McCain. As to whether the 
markets--there is a perception problem or not and a confidence 
issue, the only thing I can judge that on is generally our 
business and our customers and our clients. At Vanguard we have 
seen record interest over the last few years in our products. 
The majority of the flows we have seen have been into our 
equity market-based products. Vanguard had $138 billion of 
client assets come in the door last year and $76 billion in the 
first 5 months of this year. And, again, the vast majority of 
those sums have been going to our equity products.
    Senator McCain. Well, Mr. Brennan, I think it is like the 
old story of a guy in a small town who said to the other guy, 
``What are you going to do on Saturday night?'' And he says, 
``I am going to the poker game.'' He said, ``Why are you doing 
that? Because you know the game is crooked.'' And the guy said, 
``It is the only game in town.''
    So, Mr. Brennan, I do not accept your allegation that 
everything is fine. But if that is your view, I respect it, but 
I do not agree with it.
    Mr. Quirk.
    Mr. Quirk. I would probably have a closer view to Mr. 
Brennan's. When I discuss the view, I am going to discuss the 
view of our 6 million clients and just tell you in the 
behaviors that they have exhibited in the last couple years, 
again, it would be consistent with Mr. Brennan's. We have seen, 
trading accounts increase 31 percent, and we have a proprietary 
index which we created a couple years ago which indicates how 
much exposure people are taking in the market. In other words, 
are they participating in the rally that has happened over the 
course of the last couple years? And a significant portion of 
them have.
    That being said, I would agree with you that there is a 
perception problem in a segment of these clients. Those would 
be the clients that are probably closest to this. Most of mom-
and-pop, really these terms do not mean anything to them. ``Co-
location'' and ``HFT,'' they are just terms to them.
    The problem for us is in that segment trying to make sure, 
as I think Senator Johnson pointed out, that we do not spook 
them. We do not want them to think that they are being treated 
    Senator McCain. Thank you. I thank the witnesses.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you, Senator McCain.
    Mr. Brennan, earlier this year, you said that some high-
frequency traders play a role in knitting back together a 
fragmented market structure, but that other high-frequency 
traders ``may be unfairly taxing the system through their 
    Now, when you mentioned that some high-frequency traders 
unfairly taxed the system, were you talking about firms that 
engage in practices like rebate arbitrage where they try to 
capture rebates without actually providing liquidity?
    Mr. Brennan. That would be one example, yes.
    Senator Levin. And, therefore, the maker-taker system 
contributes to that problem.
    Mr. Brennan. I think the market structure as a whole has 
improved dramatically over the past 20 years.
    Senator Levin. I am talking about the part that has not 
improved. I am talking about what you just said, that some 
high-frequency traders unfairly tax the system and that you 
agreed, you were referring to those firms that engage in rebate 
arbitrage. And then I just asked you whether or not the maker-
taker system is obviously, by definition, contributing to that 
    Mr. Brennan. I think the maker-taker in combination with 
the lack of a trade-at, in combination with differential data 
speeds contribute to potential issues.
    Senator Levin. And can you have rebate arbitrage without 
    Mr. Brennan. No.
    Senator Levin. So, therefore, rebates contribute to the 
problem. I did not say it is the whole problem. I am just 
saying, does it contribute to the problem?
    Mr. Brennan. Yes.
    Senator Levin. Mr. Quirk, I think you were critical of the 
Battalio testimony, and I am wondering whether you would be 
willing to provide Professor Battalio with TD Ameritrade's 
order routing data so that he could analyze it.
    Mr. Quirk. Yes, we were actually asked by Professor 
Battalio after his paper was published or the draft of that 
paper was published if we would be willing to share data, and I 
think we would be willing to share data. Of course, with 
security, we would have to ensure that that was not going 
    Senator Levin. And when you were asked, what was your 
    Mr. Quirk. To be honest with you, I am not entirely sure. I 
believe that he was told that it was being considered, but I am 
not certain.
    Senator Levin. Let me conclude by very briefly saying the 
    We have had a good hearing today, I think a very 
constructive hearing, a very illuminating hearing. And we have 
heard a consistent message, and that is that there is a lack of 
confidence in the markets. The conflict of interests that we 
have discussed contribute to that lack of confidence. Both the 
actual conflicts as well as the appearance of conflicts 
contribute to that lack of confidence. And they may lead also 
to regular investors, average investors, being worse off. That 
is what Professor Battalio told us today, and what his study 
    All these problems should be and can be addressed, and one 
of the ways we have got to do it is to remove the conflict of 
interests. This Subcommittee has looked at other conflicts, 
some of which have been very dramatic, in earlier hearings, and 
we have to rid our market of conflicts of interest to the 
extent it is humanly possible if we are going to restore 
confidence in our markets. And it is very important that we do 
have confidence in our markets.
    And so hopefully the regulatory agencies are going to take 
action. SEC Chairman White, as a number of you have mentioned, 
has said that they are going to look at structural issues, long 
overdue, and hopefully they will not take as long as they take 
on a whole lot of other things that sometimes just fester at 
the agency, the regulatory agency, for years.
    And I think there may be also a role for Congress. These 
things sometimes happen, hopefully more often than not through 
the operations of a free market, but some of them just do not 
happen without government saying, ``You have got to change your 
ways, folks. You have got to take Steps A and B if you are 
going to restore confidence.''
    Now, we may disagree perhaps as to what those steps are, 
but there are steps which must be taken either by regulators or 
by Congress to deal with conflicts and to deal with the other 
kinds of problems which exist in the current market, because it 
is clear there can be improvements.
    We very much appreciate your testimony. We are sorry that 
it was interrupted by two votes of the Senate, but that is the 
way our life works around here. I wish we could pass a law to 
end interruptions in hearings or have some regulatory agency 
perhaps figure out a way that we could avoid these kind of 
interruptions. But that is not yet in the cards.
    Thank you all. We will stand adjourned.
    [Whereupon, at 12:44 p.m., the Subcommittee was adjourned.]

                            A P P E N D I X