[Senate Hearing 113-478]
[From the U.S. Government Publishing Office]





                                                        S. Hrg. 113-478


     THE ROLE OF REGULATION IN SHAPING EQUITY MARKET STRUCTURE AND 
                           ELECTRONIC TRADING

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


                                HEARING

                               before the

                              COMMITTEE ON
                              
                   BANKING,HOUSING,AND URBAN AFFAIRS
                   
                          UNITED STATES SENATE

                    ONE HUNDRED THIRTEENTH CONGRESS

                             SECOND SESSION

                                   ON

     EXAMINING THE INFLUENCE OF REGULATION ON THE GROWTH OF MARKET 
  STRUCTURE, THE SYSTEMS AND OPERATION OF MARKET PARTICIPANTS AND THE 
 DEVELOPMENT OF BUSINESS PRACTICES RELATED TO HIGH-FREQUENCY TRADING, 
                ELECTRONIC MARKETS AND AUTOMATED TRADING

                               __________

                              JULY 8, 2014

                               __________

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


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


                                   ______

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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York         RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon                 MARK KIRK, Illinois
KAY HAGAN, North Carolina            JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia       TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts      DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota

                       Charles Yi, Staff Director

                Gregg Richard, Republican Staff Director

                  Laura Swanson, Deputy Staff Director

                   Glen Sears, Deputy Policy Director

         Brett Hewitt, Policy Analyst and Legislative Assistant

                  Greg Dean, Republican Chief Counsel

              Jelena McWilliams, Republican Senior Counsel

                       Dawn Ratliff, Chief Clerk

                       Taylor Reed, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)


                            C O N T E N T S

                              ----------                              

                         TUESDAY, JULY 8, 2014

                                                                   Page

Opening statement of Chairman Johnson............................     1

Opening statements, comments, or prepared statements of:
    Senator Crapo................................................     2
    Senator Heller...............................................     3
    Senator Reed
        Prepared statement.......................................    41

                               WITNESSES

Jeffrey Sprecher, Chairman and CEO, Intercontinental Exchange, 
  Inc............................................................     4
    Prepared statement...........................................    41
Kenneth C. Griffin, Founder and Chief Executive Officer, Citadel 
  LLC............................................................     5
    Prepared statement...........................................    43
Kevin Cronin, Global Head of Trading, Invesco, Ltd...............     6
    Prepared statement...........................................    48
James J. Angel, Ph.D., CFA, Associate Professor of Finance, 
  Georgetown University McDonough School of Business.............     8
    Prepared statement...........................................    51
Tom Wittman, Executive Vice President and Global Head of 
  Equities, NASDAQ OMX Group, Inc................................    23
    Prepared statement...........................................    60
Joe Ratterman, Chief Executive Officer, BATS Global Markets, Inc.    24
    Prepared statement...........................................    62
    Response to written question of:
        Senator Brown............................................   123
David Lauer, President and Managing Partner, KOR Group LLC.......    26
    Prepared statement...........................................    69

                                 (iii)

 
     THE ROLE OF REGULATION IN SHAPING EQUITY MARKET STRUCTURE AND 
                           ELECTRONIC TRADING

                              ----------                              


                         TUESDAY, JULY 8, 2014

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:04 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Tim Johnson, Chairman of the 
Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. I call this hearing to order. Good 
morning. Today the Committee will examine equity market 
structure. It is a complicated topic, and a whole new 
vocabulary is needed to understand market structure and 
electronic trading. Words like ``dark pool,'' ``high-frequency 
trading,'' and ``data feed'' are pieces to understanding the 
market puzzle. Even experts disagree on the details of how the 
markets work and what issues and problems exist.
    In less than a decade, the stock market has moved from 
being dominated by two exchanges to an extremely competitive 
but fragmented marketplace with 11 stock exchanges and over 40 
private alternative trading centers, increasing complexity and 
instability in the system. However, many rules and market 
conventions date back to the days of less complex markets.
    The regulatory environment has to recognize the new 
electronic trading landscape, one where institutions, 
individuals, market makers, and traders interact at high-speed 
over dozens of connected markets. The benefits of lower costs 
and more efficient trading are important, but fairness and 
market resilience are also vital and should continue to be 
examined.
    Additionally, while we have seen a sizable stock market 
rally since the Flash Crash 4 years ago, we also hear reports 
of declining stock market investment and loss of faith by 
individual investors. Many reasons have been suggested, but 
doubts about market integrity and market stability are heard 
too often.
    Although many market participants call for reform, they 
often disagree as to where that reform should occur. Any path 
to reform must be built on good data and the goals of 
preserving a competitive market and the interests of long-term 
investors, while protecting the market from future disruptions. 
I am encouraged to see the SEC move forward with a 
comprehensive review of market structure and an initiative for 
small company stocks that recognizes one size does not fit all. 
But pilots and reviews are just a first step. I want to see 
urgent and thorough attention given to the market structure 
review so that any corrective measures that would help restore 
trust in the fairness of our markets are taken as quickly as 
possible.
    I look forward to the witnesses' testimony today as the 
Committee examines whether today's market structure has the 
right kind and amount of regulation to maintain a stable, 
competitive, and efficient marketplace and what additional 
measures would be useful.
    With that, I turn to Ranking Member Crapo for his opening 
statement.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you, Mr. Chairman.
    The U.S. capital markets are vital to the continued growth 
of our economy. I have repeatedly stressed the need for the 
U.S. financial system and markets to remain the preferred 
destination for investors throughout the world. This hearing 
will examine the role of regulation in shaping today's markets 
as well as whether these markets are as resilient and stable as 
they should be, given the rising different types of technology 
and automated trading.
    Recent news about the practices of certain market 
participants and automated trading has raised concerns as to 
whether the stock market is rigged against small investors. SEC 
Chair White recently stated her view that the market is not 
rigged, but there is a need to review the current equity market 
structure, and such a review should be disciplined and 
conducted in a data-driven manner.
    While much has been made recently of the potential dangers 
of automated trading, what is often forgotten is that 
technology and innovation has benefited investors by leading to 
tighter spreads, lower costs, and more efficient markets.
    Today an individual retail investor has an easier time 
participating in our stock market than at any time in the 
history of these markets. With fees under $10 a trade, the 
spreads between bid and ask prices for most stocks as narrow as 
they have ever been, and with trading being done in a matter of 
sub-seconds rather than minutes, retail investors have been 
able to enjoy greater involvement in and access to the markets.
    To continue this level of investor participation, we must 
ensure that the markets have the resiliency and the 
capabilities to handle the evolving speed and complexity of 
today's trading world. I am encouraged by speeches and comments 
given by SEC Chair White and other SEC Commissioners 
acknowledging both the positive and negative roles that SEC 
regulations played in shaping today's market structure, as well 
as an appetite to address unintended consequences of those 
regulations.
    As evidenced by today's testimony and by the academic 
discussions of the U.S. markets, many of the concerns raised by 
market participants and investors are the outgrowth of the SEC 
Regulation NMS and the overall patchwork approach to market 
trading infrastructure and stability taken by the SEC in the 
past.
    It is important and prudent for regulators to periodically 
review the regulations to ensure that they are still 
appropriate in today's automated world. However, any such 
holistic review of regulations should be based on empirical 
analysis, should be data driven, and incorporate the input of 
market participants, industry, and the investors who make the 
investments. Everyone should have a seat at the table in this 
important discussion, and everyone must be willing to roll up 
their sleeves to find the right solutions.
    I am particularly interested in the panel's views on 
whether the benefits to the market participants and investors 
from the rapid expansion of various trading venues and 
increased competition have been outweighed by the strain to the 
market infrastructure. I am also interested in what can be done 
to build better markets for smaller companies. And what further 
measures do market participants and trading venues need to take 
to minimize market disruptions and increase the resiliency and 
durability of the systems?
    Investor confidence is the key. Our markets cannot afford 
another Flash Crash or major market disruption. I look forward 
to hearing from today's panelists about their thoughts on 
potential enhancement to market structure and integrity and 
hope to hear from them about what changes they believe are 
appropriate.
    Thank you, Mr. Chairman.
    Chairman Johnson. Thank you, Senator Crapo.
    Would any of my colleagues like to make a brief opening 
statement?
    Senator Heller. Chairman Johnson?
    Chairman Johnson. Senator Heller.

                STATEMENT OF SENATOR DEAN HELLER

    Senator Heller. Thank you very much. Mr. Chairman, also 
thanks to the Ranking Member for this hearing today. I want you 
to know that in my previous life I worked as a trader on the 
Pacific Stock Exchange, specifically the L.A. Floor, which goes 
to show you how old I am. That floor, because of progress, does 
not even exist anymore. Needless to say, I may be one of only a 
handful of Senators here serving currently that has passed the 
Series 7 exam.
    Recently, SEC Chair Mary Jo White stated that ``the U.S. 
markets are the strongest and most reliable in the world'' and 
that ``the retail investor is very well served by the current 
market structure,'' and I end the quote with that. While I have 
concerns about the potential bubbles in the equity market 
caused by quantitative easing, structurally today's markets are 
very beneficial for retail investors with spreads for many 
stocks, typically a penny or less, and access to markets has 
never been easier, and commissions to trade are at all-time 
lows.
    While there has been much debate about the new methods of 
trading, I would caution any desires to roll back the 
technology clock. With every new Internet-based technology, I 
believe that we must ensure proper safeguards while maintaining 
an environment that continues to promote new financial 
technologies and innovative growth.
    U.S. markets have changed greatly since I left the trading 
floor, and this hearing will help the public better understand 
today's competitive modern markets, and I look forward to 
hearing from our witnesses on what can be done to increase 
investors' confidence and further promote market stability.
    Mr. Chairman, thank you for the opening statement.
    Chairman Johnson. Thank you.
    Would anybody else like to make a brief opening statement?
    Senator Moran. Mr. Chairman?
    Chairman Johnson. Yes.
    Senator Moran. Mr. Chairman, thank you. I just want to 
welcome fellow Kansan Joe Ratterman who will be on the second 
panel testifying this afternoon. I appreciate you including him 
in today's hearing.
    Chairman Johnson. Yes. Before we begin, I would like to 
apologize to my colleagues and the witnesses on the second 
panel, but I will have to excuse myself after the first panel 
due to a prior engagement. I thank my good friend Senator Reed 
for agreeing to take over the gavel for the second panel and 
will follow up with the witnesses later if I have any further 
questions.
    With that, I would now like to introduce our witnesses on 
the first panel.
    Mr. Jeffrey Sprecher is the Chairman and Chief Executive 
Officer at Intercontinental Exchange.
    Mr. Kenneth Griffin is the Chief Executive Officer at 
Citadel.
    Mr. Kevin Cronin is Global Head of Trading at Invesco.
    Dr. James Angel is an Associate Professor of Finance at the 
Georgetown University McDonough School of Business.
    Mr. Sprecher, please begin your testimony.

       STATEMENT OF JEFFREY SPRECHER, CHAIRMAN AND CEO, 
                INTERCONTINENTAL EXCHANGE, INC.

    Mr. Sprecher. Chairman Johnson, thank you for having me, 
along with Ranking Member Crapo and the Members of the 
Committee. I appreciate the opportunity to testify.
    By way of background, in just 14 years my company, which is 
known as ICE, grew from a startup in Atlanta to become one of 
the world's largest marketplaces, and today we operate 11 
exchanges and 5 clearinghouses in the United States, Canada, 
the United Kingdom, continental Europe, and Asia; and most 
recently we acquired the New York Stock Exchange. None of this 
would have been possible for us without our ability to raise 
funds in the U.S. capital markets, which I believe are the best 
in the world for entrepreneurs like me that seek to build 
companies. And much of our growth can be attributed to trying 
to make capital raising and risk management more accessible and 
more transparent. We have inevitably faced head winds as a 
result of challenging the status quo, but we believe very 
strongly in that vision.
    The United States has a number of regulatory policies that 
were intended to improve markets but, we believe, need to be 
revisited in light of evolving industry practices. And so we 
offer five recommendations that we hope can be quickly adopted.
    Number one, we believe we should enhance order competition 
by giving deference to regulated, transparent trading centers 
where orders compete with one another and contribute to 
providing price discovery information to all others.
    Second, we would eliminate and ban maker-taker pricing 
schemes at trading venues. Rebates that were once used to 
encourage participants to quote have evolved and now add too 
much order complexity and add the potential for conflicts of 
interest in our market.
    Third, we would lower the statutory minimum cap on exchange 
fees that exist within Regulation NMS. So in combination with 
giving deference to regulated and transparent markets and 
eliminating maker-taker rebates, we believe that the SEC should 
require lower maximum fees, including on my company, the New 
York Stock Exchange.
    Fourth, we should revamp the current market data delivery 
system to promote fairness. We support the SEC's examination of 
the current Securities Information Processors and the 
proprietary data feeds to adopt new policies.
    And, last, we should require increased transparency by 
having the SEC demand that all trading centers report trade 
executions in real time and all routing practices be disclosed 
by trading centers and the brokers who touch customer orders.
    So, in summary, my firm's proposed solutions are based on 
reducing complexity, reducing conflicts of interest, and 
treating people fairly when investing in the U.S. markets.
    Thank you again for inviting me to testify, and I look 
forward to answering your questions.
    Chairman Johnson. Thank you.
    Mr. Griffin, please begin your testimony.

 STATEMENT OF KENNETH C. GRIFFIN, FOUNDER AND CHIEF EXECUTIVE 
                      OFFICER, CITADEL LLC

    Mr. Griffin. Chairman Johnson, Ranking Member Crapo, 
Members of the Committee, I am Kenneth Griffin, the founder and 
CEO of Citadel. I appreciate the opportunity to be here today 
to testify.
    Citadel's experience as both an institutional investor and 
a leading market maker gives us deep insight into the strength, 
structure, and resilience of our markets today. I can say 
without hesitation that the U.S. equity markets are the 
fairest, most transparent, resilient, and competitive markets 
in the world.
    Over the past two decades, a wave of innovation has swept 
through the markets in response to new technologies and 
thoughtful regulation. Simply put, today's markets are faster, 
they are better, and they are incredibly competitive. The cost 
of trading has plummeted for investors.
    That said, we can further improve our equity markets. In my 
written testimony I have included a more detailed list of 
suggestions, but I would like to highlight a few.
    First, we can and should take steps to increase the 
resiliency of our markets. The SEC should require mandatory 
exchange-level kill switches and ensure that exchanges have 
clear authority and responsibility to block and stop aberrant 
activity before it adversely impacts the markets. The activity 
of a large number of market participants intersects on 
exchanges, and exchanges are thus best positioned to 
efficiently and constantly oversee trading activity.
    Second, we believe the SEC should require brokers to 
publicly report consistent, standardized execution quality 
metrics in a way that allows retail investors to easily compare 
performance. We can empower retail investors with information 
about brokers' execution quality and position them to make 
informed choices. We recommend that the SEC require all 
execution quality reports to be comprehensive, understandable, 
and made available for at least 3 years. Investors can then 
track the quality of executions over time and hold their 
brokers accountable.
    Third, dark pools should be subject to the same anti-
discrimination rules that our securities exchanges are subject 
to and should be required to offer fair and impartial access to 
all market participants. In recent years, increasing amounts of 
trading have taken place on dark pools. While public quotes on 
exchanges are available to all investors, this is not 
necessarily the case for liquidity present on dark pools. In 
fact, dark pools may refuse access, give execution priority, 
and charge different fees to different market participants.
    Dark pools should only be allowed to determine execution 
priority based on the characteristics of an order, such as 
price, size, and time of arrival, and should not be allowed to 
allocate executions based upon the identity of the 
participants.
    For example, broker preferencing is a practice that could 
return our markets to the old boys' network of prior decades 
when who you were and who you know mattered more than the 
merits of your order.
    Fourth, I agree with Jeff that the maximum fee of 30 cents 
per 100 shares that is charged to access exchange liquidity is 
now significantly greater than the cost of providing matching 
services by the exchanges and should be reduced to reflect 
today's competitive reality. We believe a reduction in the 
minimum tick size for the most liquid low-priced securities, 
combined with a reduction in the maximum permitted access fee, 
would best serve the interests of all investors.
    There are other important steps that we should take to 
enhance market quality, improve market resilience, and 
strengthen investor protections. However, we must pursue this 
agenda without sacrificing the extraordinary achievements we 
have made for investors in terms of market efficiency, lower 
costs, increased transparency, increased fairness, and 
competitiveness over the prior two decades.
    Thank you for the opportunity to testify before this 
Committee today. We commend the Committee and the SEC for 
taking a data-driven and comprehensive review of U.S. equity 
markets and look forward to a robust dialogue. And I would be 
happy to answer your questions.
    Chairman Johnson. Thank you.
    Mr. Cronin, please proceed.

  STATEMENT OF KEVIN CRONIN, GLOBAL HEAD OF TRADING, INVESCO, 
                              LTD.

    Mr. Cronin. Thank you very much for the opportunity to be 
here today on behalf of Invesco, a global asset management firm 
with $790 billion of assets under management. We serve 
individuals who are saving for their retirement and other 
personal financial needs. These are long-term investors, and 
they are the cornerstone of our Nation's capital formation 
process. Retaining their confidence is fundamental to well-
functioning U.S. equity markets.
    We need to make sure that those markets are highly liquid, 
transparent, fair, stable, and efficient. Due to regulatory 
changes and developments in technology, there is robust 
competition among exchanges and alternative execution venues. 
These changes have benefited investors in the former of lower 
commissions, spreads, and implicit transaction costs, which 
have in turn enhanced the liquidity in the markets.
    But there are unintended consequences which have unleveled 
the playing field. These include:
    Market fragmentation. Markets have become too complex and 
fragmented, not because they need to be but, rather, because we 
have allowed them to become so. This complexity has contributed 
to a number of technological mishaps which shake investor 
confidence. Sophisticated participants can get an unfair 
advantage over ordinary investors, for example, when exchanges 
sell direct data feeds that allow certain market participants 
to more quickly act on trading information.
    Fragmentation also means that the rules governing 
securities exchanges are very different for those governing 
alternative trading venues, including dark pools. Determining 
which execution venue will lead to the best trading outcome can 
be very difficult even for a firm like Invesco.
    Conflicts of interest. As much as 35 to 40 percent of all 
trading activity today now takes place away from the exchanges, 
which has weakened the robust price discovery that is an 
essential element of an efficient market. The movement away 
from the exchanges is partly the result of broker-dealer 
routing practices such as internalization and the proliferation 
of alternative trading venues. Much of this is due to two 
inherent conflicts of interest.
    The first is the broker-dealer's interest in capturing 
liquidity rebates associated with the so-called maker-taker 
pricing model and other inducements, including payments for 
order flow.
    The second is a broker-dealer's interest in avoiding paying 
access fees to take liquidity from other trading venues. A 
broker tries to keep as many trades as possible within its own 
internalized system, including its own dark pools. This can 
driven order-routing decisions that may be at odds with their 
clients' best execution interest.
    High-frequency trading. High-frequency trading is not bad 
in itself, but there are certain strategies that can be unfair. 
These strategies have arisen as a result of technology, market 
fragmentation, and a lack of uniform regulation. Also, high-
frequency trading appears to focus primarily on large-cap 
securities. This increases trading volumes, but it is not clear 
that it creates real liquidity. Moreover, while market makers 
historically have provided valuable liquidity for mid- and 
small-cap stocks, they have not benefited from the evolution of 
market structure.
    To be clear, there is much about today's markets that 
benefit all investors. However, Invesco advocates that 
regulators take steps to address certain unintended 
consequences. To restore a level playing field in the markets, 
and to restore investor confidence in the fairness and 
transparency of the markets, we recommend: requiring broker-
dealers to provide greater disclosure about order routing; 
ensuring the market data is fairly disseminated to all 
participants; eliminating the maker-taker pricing model and 
reducing access fee caps; harmonizing the regulation of all 
trading venues; requiring that all high-frequency traders be 
effectively regulated; instituting a pilot program for a 
comprehensive trade-at rule; and facilitating market-making 
activities for mid- and small-cap stocks.
    Thank you again for your attention to these important 
issues, and I look forward to answering any questions that you 
may have.
    Chairman Johnson. Thank you.
    Professor Angel, please begin your testimony.

STATEMENT OF JAMES J. ANGEL, Ph.D., CFA, ASSOCIATE PROFESSOR OF 
  FINANCE, GEORGETOWN UNIVERSITY McDONOUGH SCHOOL OF BUSINESS

    Mr. Angel. Thank you. And, first of all, I want to thank 
the Committee because you are asking exactly the right 
questions. If you get regulation right, the regulators will get 
the details right, and you will not have to worry about whether 
the kill switches are properly designed or not.
    The problem is we have a very fragmented and broken 
regulatory structure. We have literally hundreds of different 
financial regulatory agencies at the State and Federal levels, 
and they do not always play nicely together. Stuff falls 
between the cracks. There are turf battles. Nobody with a clean 
sheet of paper would design a regulatory structure like we have 
now.
    Let me give you just a few examples of this dysfunction. 
And, first of all, I want to state very clearly it is not the 
fault of the people who work at the regulatory agencies. Most 
of them are very smart, hard-working people, diligently trying 
to do what Congress has told them to do.
    But look at the JOBS Act, a bipartisan bill to create jobs. 
Everything in the JOBS Act could have been done by the SEC with 
its own pre-existing authority, but they chose not to. You 
know, as an institution, they were incapable of understanding 
the problems and acting on them in a timely manner.
    If you look at the implementation of the Volcker rule, 
there are four different agencies trying to figure out how to 
implement it.
    If you look at the Flash Crash, look at how long it took to 
try to figure out what happened in that situation. And there is 
controversy that they still have not figured it out.
    But when we have a regulatory system that cannot enforce 
existing laws, when investors complain to the SEC about obvious 
rule violations and nothing happens, that zaps investor 
confidence more than anything else.
    In my written remarks, I provide a few details about a case 
of which I have some personal knowledge, the case of W2007 
Grace Acquisition I. To make a long story short, for over a 
year there has been an issue proceeding at the Commission as to 
whether this company should be required to file financial 
statements. You know, under the rule, if they have more than 
300 shareholders of record, they should be filing financial 
statements.
    Well, you would think that the SEC would be able to count 
to 300 in less than a year, and, you know, there are many other 
apparent violations going on there, but when investors report 
rule violations, legal violations, and nothing happens, that 
kills investor confidence.
    Now, as far as the equity market structure goes, what we 
have today is pretty much what Congress ordered in 1975 in the 
National Market System Amendments to our Exchange Act. Congress 
said: Give us competition among exchanges, between exchanges 
and off-exchange trading platforms, a place where investors can 
trade with each other without going through a dealer. And so 
what we have today is something that is an open architecture 
market, and that is a good thing. Any innovator can plug in a 
new system if they think they have a better solution, because 
the trading problem has not yet been solved. Trading is a lot 
more than just matching limit orders. And we need a system 
where we can continue to have a lot more innovation and 
experimentation.
    Now, the rest of the world, if you look around the world, 
they are copying our market structure. You know, they are going 
to a competitive system where you have for-profit exchanges, 
because if you do not want a monopoly, you need competition. If 
you want competition, profit is a great motive. But they are 
not copying our regulatory structure.
    Now, there are a lot of market practices that are very 
controversial. I would like to add that using high-speed 
computers is neither good nor bad. Some of the strategies, like 
market making and ETF arbitrage, help low-frequency retail 
investors like me. Others, you know, like order ignition and 
excess cancellation strategies, are harmful and should be 
curtailed.
    We need regulators who are smart enough to understand what 
is going on, to know the difference between the good and the 
bad, and have the resources to get the bad out while keeping 
the good in.
    Now, as far as technical stability goes, we are in trouble. 
Our market is a complex technological system. There is nothing 
we can do about that. That is the modern world. And complex 
technological systems fail in weird and strange ways. Most of 
the regulatory focus has been on making individual parts work 
well, but not in dealing with what happens when the parts do 
not work together nicely. So more work needs to be done there.
    So there is a lot more that needs to be done, but the most 
important thing Congress can do is start the process of overall 
structural reform. But in the meantime, what you can do is you 
can make sure that our regulators have the resources they need 
to do their job. If you look at how much we have spent on the 
SEC since the beginning of time, it is less than investors have 
lost from one Bernie Madoff. But you need to monitor them to 
make sure that they spend those resources properly. You need to 
make sure that they have enough people with degrees in 
economics, business, engineering, computer science. You need to 
make sure they have more people who have passed the Series 7, 
they have more people with real work experience, more people 
who are CFAs or CPAs. They have got enough lawyers. They need 
people with market experience.
    So I have got plenty of other things, but I would like to 
finish up by saying, hey, if we do not fix regulation, we will 
be saddled with a system which is more expensive than it has to 
be, both in terms of direct cost to the taxpayer as well as 
compliance costs; we will have a system which will not protect 
investors as well as it should; we will have a system that will 
not permit capital formation, and that means less jobs.
    Thank you very much.
    Chairman Johnson. Thank you all.
    As we begin questions, I will ask the Clerk to put 5 
minutes on the clock for each Member.
    Mr. Sprecher, as the operator of equity and derivatives 
markets while maintaining a competitive marketplace, what can 
the equity markets learn from the derivatives markets?
    Mr. Sprecher. That is a very good question. I think the 
main difference in U.S. equity markets and U.S. commodity and 
derivatives markets is that in U.S. commodity and derivatives 
markets, investors can choose where they trade. While we all 
have talked a lot about the competition in U.S. stocks with 
many different trading venues, the reality is neither you nor I 
can choose where our orders are routed. And as a result of 
that, we have third parties that are making those decisions for 
us, oftentimes potentially not in our best interest.
    What we have seen in the commodities markets is that when 
investors have a choice, they want obviously low transaction 
costs, honest brokers, and also they want to find the most 
buyers and sellers. So they tend to gravitate to a fewer number 
of highly competitive exchanges and trading venues. It is 
competitive but it is not fragmented.
    In the equity markets, because you and I and even 
institutional managers like Mr. Cronin do not have an 
opportunity to choose where we trade, consequently we have a 
lot of other interests that cause fragmentation.
    Chairman Johnson. Mr. Griffin, do you think market-maker 
obligations should be revisited?
    Mr. Griffin. Market makers have obligations that are 
mandated by each exchange on which they trade, and today in the 
U.S. equities market, if you are a NASDAQ market maker, for 
example, you must provide a continuous two-way quote.
    The largest market makers also have a commercial reality 
that they service the important retail investors, institutional 
investors in the United States, and those investors have a very 
high expectation of continuous liquidity being provided, and it 
is done so by the largest market makers.
    Chairman Johnson. Mr. Cronin, what do you think?
    Mr. Cronin. Market makers are invaluable participants in 
the market structure. Efficient markets are made from the 
participation of all kinds of different participants. While I 
might recommend that investors like ourselves are probably the 
most important component, having a robust market-making 
structure is very important as well. We are concerned that the 
one-size-fits-all proposition that the market structure is 
today does not appropriately address the needs of mid-cap and 
small-cap stocks. So as part of our recommendations, we would 
like to work with regulators and market makers and other market 
participants to really get to some ideas that will facilitate 
that.
    Today we know that there are a lot of people who portend to 
be market makers, but it is unclear to us whether this is 
really just trading volume or if it is real liquidity. And we 
need to ensure that our markets are liquid at all levels and 
all market capitalizations.
    Chairman Johnson. Professor Angel, what are we learning 
about market structure from recent regulatory actions?
    Mr. Angel. Any particular actions you are interested in, 
sir? I could talk a lot on this.
    [Laughter.]
    Chairman Johnson. The most significant actions.
    Mr. Angel. OK. The most significant actions were the 
tremendous changes in market structure that have occurred over 
the last 15 years. Twenty years ago, we had a very different 
market structure for small-cap companies. The old NASDAQ world 
was very different from the old NYSE world, and listing 
companies had a choice. But now over the years, you know, a 
very well meaning Commission, through a series of decisions, 
has now given us a one-size-fits-all market where the market 
structure for tiny little companies is basically the same as 
for large-cap companies. And what we are learning is that one 
size does not fit all.
    One of the reasons why we have half as many U.S. companies 
listed on our exchanges is our public markets are no longer 
welcoming to small- and mid-cap companies. And, you know, I 
think this is a problem for capital formation and for job 
growth going forward.
    Chairman Johnson. Mr. Cronin, many have pointed out that 
additional disclosure by non-exchange trading centers would be 
helpful. What kind of additional disclosure would influence 
your trading decisions?
    Mr. Cronin. Well, there are two dimensions of that. One is 
about the execution facility itself, so we would like to know 
as much as we can about the order-routing practices of those 
facilities, the kinds of order types that reside within them, 
who the people who are interacting in these various dark pools, 
for example, are. That helps us determine whether or not we 
want to use those destinations, so we need to have that 
information.
    The second part gets to the executions itself. We need more 
information to ensure that the execution quality that we need 
to achieve for our clients is sufficient enough to really make 
those determinations. Today we do not have enough information. 
As it was recommended by Mr. Griffin, there is more of a 
requirement that should be made standardized to all 
participants in the marketplace.
    Chairman Johnson. Senator Crapo.
    Senator Crapo. Thank you, Mr. Chairman.
    This question is addressed to the whole panel, and 
basically I am just asking you to prioritize for me. Given your 
respective roles and work, where do you think the greatest 
weakness in today's market structure is? And if you do not want 
to limit it to one thing, that is OK. But where should we look 
at the greatest weakness to focus right now? Mr. Sprecher?
    Mr. Sprecher. The market is too complex. While we all 
support competition--and, in fact, I would not be here in front 
of you if--I started with nothing and have built one of the 
largest exchanges in the world, so I am pro-competition. But 
there is a difference between competing to get you, the 
investor, the best price and simply all the intermediaries, 
exchanges included, trying to split up commission dollars. It 
is great that we compete for those commission dollars, but we 
have lost track of getting the best price for a company that is 
trying to raise capital and an investor that would like to meet 
a company. And I think if we just look at holistic practices to 
do the right thing for investors, we will land on the right 
public policy.
    Senator Crapo. Thank you.
    Mr. Griffin?
    Mr. Griffin. In my opinion, the issue of complexity is 
dwarfed by the issue of resilience. The impact of the Flash 
Crash or the events that took place in Knight securities dwarf 
the day-to-day issues around complexity in the marketplace. And 
putting in place the appropriate infrastructure that allows for 
the market to not undergo moments of chaos and panic is of the 
utmost importance to protecting the confidence that we should 
all have in the functioning of the U.S. equity markets.
    Senator Crapo. Thank you.
    Mr. Cronin?
    Mr. Cronin. My biggest concern probably gets around 
investor confidence. As I suggested earlier, investor 
confidence is the key that we are all really trying to solve 
for. All good things come from higher levels of confidence from 
market participants. Where I get concerned is there are certain 
elements of our market that are not where they should be. So, 
for example, the price discovery mechanism, which has 
historically defined our markets as the most robust and best in 
the world, has been under assault because so much activity is 
now trading away from those markets. We think that, frankly, 
why we supported Regulation NMS is because we thought it would 
facilitate more price discovery, that there would be more 
interest in institutions and other investors in posting their 
bids and offers. And we are concerned that that has not 
happened and that there is at this point really not a lot of 
incentive for activities to facilitate more posting of bids and 
offers. So we are concerned about price discovery.
    If I may, the other thing that is concerning to us is just 
making sure that the markets are fair. Here is a low--you know, 
high-impact, sort of low-effort kind of thing that we can do. 
If there is unfair dissemination of data, let us make the 
dissemination of data fair. Right? I think everybody would 
agree that if there are smart people who can process that data 
at speeds that none of us can comprehend, that is fine. But in 
the first instance, let us make sure that everybody gets the 
data at the same time. That would seem to be a very good 
fundamental start.
    Senator Crapo. Thank you.
    Dr. Angel?
    Mr. Angel. The biggest problem is that our regulatory 
structure as a whole is too slow, too cumbersome, and just does 
not really understand what is going on in the markets quickly 
enough to craft appropriate solutions, that instead what we get 
are hyper-complex rules like NMS that just add to the 
complexity of the markets without solving the underlying 
problems.
    Senator Crapo. Thank you. I actually have questions on each 
of these issues, the complexity, the resiliency, the 
disclosure, and so forth. I am going to have time for one more 
question, and so I am actually going to pick resiliency. And so 
I will come back to you, Mr. Griffin, on that, and others can 
jump in on this if we have time, too. But this issue has been 
mentioned already. What further changes do we, the SEC, 
industry stakeholders, or others need to undertake to 
strengthen market integrity and prevent future market 
disruptions like the Knight trading error or the Flash Crash? 
Do you want to start, Mr. Griffin?
    Mr. Griffin. I do. So if we look at both the Flash Crash 
and what took place at Knight, it concerned orders of undue 
size or quantity entering the market without appropriate checks 
and balances. The broker-dealers that route orders into 
America's exchanges need to have solid and robust fail-safes to 
prevent such orders from being routed into the marketplace.
    But of equal importance, the exchanges should act as the 
last line of defense to prevent such orders from entering the 
marketplace and creating disruption. We need both the broker-
dealer community and the exchange community to work hand in 
hand to prevent aberrant orders from having an undue and 
unfortunate, in fact, devastating impact on investor 
confidence.
    Senator Crapo. Thank you. I am out of time. I know, Dr. 
Angel, you wanted to give a quick response. Could I do that?
    Mr. Angel. Yes. And, in addition, we know that sooner or 
later all systems break in some unanticipated way. So what we 
need is a market-wide holistic view of the entire national 
market system. Current rules and current thinking is to make 
sure every individual little widget keeps working. But what 
happens when they are all working individually but they do not 
as a system work properly? And so what we need is better 
thinking about what happens when the next tsunami of market 
information, you know, overwhelms the market and it starts 
behaving erratically?
    That is where insufficient work has been done and a lot 
more needs to be done to, you know, prevent the next disruption 
from turning into a catastrophe.
    Senator Crapo. Thank you.
    Chairman Johnson. Senator Warren.
    Senator Warren. Thank you, Mr. Chairman.
    At a Subcommittee hearing a few weeks ago, I noted that 
high-frequency trading is not really trading in the traditional 
sense. While regular traders have days when they make money and 
days when they lose money, high-frequency traders almost never 
lose money. In its recent IPO filing, the high-frequency 
trading firm Virtue disclosed that in its 1,238 trading days, 
it had made money on 1,237 of those days. That means that in 
nearly 5 years of trading, the company had come out ahead on 
its trades every single day save one.
    Now, that is not trading. High-frequency traders are not 
making money by taking on risk. They are making money by 
effectively charging a small fee to investors on millions of 
transactions. And in that circumstance, the question is whether 
they are providing a valuable service in return for that fee or 
they are just skimming money off the top of these trades.
    So at a prior hearing, I asked Andrew Brooks, the head of 
equity trading for T. Rowe Price, and Jeffrey Solomon, CEO of 
the investment bank Cowen and Company, a simple question: Does 
high-frequency trading provide any valuable service in exchange 
for the money it sucked out of the markets? And they both said 
no. In particular, they disputed the often repeated claim that 
high-frequency trading is valuable because it provides 
liquidity to the market. So I want to push on the liquidity 
question since they had rightly raised it.
    Mr. Griffin, your company has run a fund for several years 
called the ``Tactical Trading fund,'' and this fund relies 
primarily on high-frequency trading strategies, and it has been 
very profitable. Just for context, can you tell me what the 
average holding period for securities is in that fund?
    Mr. Griffin. So, Senator Warren, I am not sure of the 
source of the information that you have on our Tactical fund, 
but our Tactical fund's largest source of profitability, to the 
best of my recollection, over the last several years has been 
from fundamental equity long/short trading.
    Senator Warren. So you are saying you do not do high-
frequency trading?
    Mr. Griffin. No, I am not. I am saying that within our 
Tactical fund----
    Senator Warren. Well, do you have a fund that does high-
frequency trading?
    Mr. Griffin. The Tactical fund conducts high-frequency 
trading but conducts it along with a variety of other trading 
activities.
    Senator Warren. So you are saying it is just a mixed fund 
at this point, and it was never a high-frequency trading fund 
primarily or exclusively?
    Mr. Griffin. Starting from roughly January 1, 2009, it has 
been a mixed fund with equities being the single largest 
allocation of risk capital, equities trading through----
    Senator Warren. All right. So let me ask the question a 
different way, and I will just ask Mr. Cronin about this 
question. At an earlier hearing, Mr. Brooks, the head of 
trading at T. Rowe Price, said their average hold time was 
about 3 years. So my question is: What is the average hold time 
for a high-frequency trading fund? Mr. Cronin?
    Mr. Cronin. I do not have personal knowledge but I know it 
is one heck of a lot less than 3 years.
    Senator Warren. Under a month?
    Mr. Cronin. Under a month, probably under----
    Senator Warren. Under a day?
    Mr. Cronin. Under a minute.
    Senator Warren. Under a minute, OK.
    Mr. Cronin. Yes.
    Senator Warren. OK. So I want to ask the question then 
about liquidity. If you are buying a stock and turning it 
around and selling it within a minute, within a second later to 
someone else, how does that provide liquidity to the markets? 
Couldn't the original seller have just sold the stock to the 
ultimate buyer 1 minute later?
    Mr. Cronin. We are worried about excessive intermediation 
in the markets. We are also worried that we are probably all 
not in a great position to truly understand all of the HFT 
activities that take place. It might be easy for me to say that 
some of it is good and some of it is bad. I think we should not 
be in the business of conjecture. We should be in the business 
of data.
    We recommend that there be a specific regulatory regime 
that is in charge of high-frequency trading so that we can all 
be better informed.
    Senator Warren. Well, Mr. Cronin, I appreciate that, and I 
appreciate that you want to see more regulation here, and that 
is something we certainly should talk about. But I at least 
want to ask the question how it is that--this is the principal 
claim for high-frequency trading, is that it provides liquidity 
in the marketplace. And all I am saying is it takes place in a 
very short space where someone jumps in ahead of a trade and 
buys and then turns around and sells. And I am trying to figure 
out how that adds more liquidity to a market if that seller 
would have found that buyer, only found them a nanosecond later 
or 2 seconds later.
    Mr. Cronin. Senator, that is why we make a distinction 
between trading volume, which is exactly what you describe, and 
real liquidity. Liquidity provision is a far, far different 
concept, and that is what we are trying to protect and promote. 
But some of these high-frequency trading strategies are 
inconsistent with that.
    Senator Warren. All right. I am out of time. Thank you, Mr. 
Chairman.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Mr. Sprecher, you mentioned that the market is too complex. 
Is that because of the electronic growth, the use of 
electronics as we have seen a technological change? I have seen 
it in my 28 years here on the Banking Committee, and you have 
seen it in the marketplace. Is it too complex because of that? 
Or is it too complex because of what?
    Mr. Sprecher. I think there are actually two reasons. One 
is that because the decision where your trade goes is made by a 
third party, it is legal, lawful, and accepted right now that 
that third party can route that trade to their own wholly owned 
trading venue where they can make additional profit, 
theoretically. So we have now seen every major broker-dealer 
either create their own dark pool or come up with some 
relationship with another market maker that would allow them to 
participate in trading. So that is number one. It is the person 
that makes the routing decision.
    Second, Regulation NMS, which was intended to try to bring 
the markets together as a single whole, suggests that any new 
entrepreneur like me that starts a venue, everybody must 
connect to it. So it is a law that says if you open a story, 
everybody must walk through your store and at least check on 
shopping there. So it makes--it lowers the bar for entering the 
market, and as a consequence, we have a lot of trading venues.
    Senator Shelby. Dark pools, Mr. Griffin. Dark pools have 
grown, according to my information, from approximately 16 
percent of all trades in 2008 to over 40 percent of all trades 
last month. Why have they grown so fast? And is it--it is 
obviously lucrative, but what is driving all this? Is it 
technology?
    Mr. Griffin. So, Senator, the exact statistics that you 
have are somewhat off. The numbers that you referred to are 
probably an approximation of the proportion of trading that 
takes place off exchanges, both at retail-oriented wholesale 
market makers, such as Citadel, and on dark pools. So retail 
orders in the United States are handled differently than most 
other orders. A handful of market makers compete vigorously for 
this order flow and, based on their execution quality, are 
allocated more or less order flow by the various major retail 
brokerage houses.
    American retail investors benefit from the trading acumen 
of the wholesale market-making community. Dark pools, which are 
generally run by the large broker-dealers, were created to 
facilitate block trading and to provide a low-cost means of 
trading in competition with the exchanges.
    Now, over the years we have seen the rise of algorithmic 
trading. Large block trades occur less frequently. Large trades 
are broken into small trades of hundreds of shares--100 shares, 
200 shares, 300 shares at a time--and these trades are still 
executed in dark pools.
    I would concur with Mr. Sprecher that the dark pools do add 
a layer of complexity to the marketplace. They are not subject 
to the same anti-discrimination provisions of the exchanges. We 
should level the playing field between the exchanges and the 
dark pools, and the dark pools that compete on the merits 
should have vibrant businesses.
    Senator Shelby. I assume you are familiar with this, and if 
you are not, tell me. On June 25th, just a few weeks ago, the 
SEC announced a 1-year tick size pilot program in conjunction 
with FINRA which would allow some small capitalization 
companies to trade in 5-cent increments instead of the 
traditional 1-penny increments. Commissioner Piwowar of the SEC 
has been advocating for such an initiative, saying in January, 
and I will quote him:

        As the one-size-fits-all approach to market structure is not 
        currently working for small capitalization companies, I support 
        such a pilot and would like to see it implemented.

    What is the effect of this? Are you familiar with that, Mr. 
Griffin?
    Mr. Griffin. I am.
    Senator Shelby. Good.
    Mr. Griffin. My personal belief is that the larger tick 
size will actually erode liquidity. As the tick size increases, 
transaction costs go up, and investors shy away from trading 
equities with a high transaction cost.
    But here is the good news. We will know the answer at some 
point in the next 1 to 2 years when the SEC completes the 
study, and I applaud the SEC's data-driven approach to 
analyzing what is taking place in our equity markets.
    One thing to keep in mind is that smaller issues in the 
United States are suffering from the consequence of the rapid 
rise of concentration of holdings by large asset managers. The 
gentleman to my left, for example, speaks to how they manage--
was is 700 and change billion?
    Mr. Cronin. $790 billion
    Mr. Griffin. $790 billion. It is difficult for an 
institution that manages $790 billion to focus on investing its 
resources, its time and energy on the issuers that have a 
market capitalization of a few hundred million. So we need to 
think about how do we encourage the development of more mutual 
funds and more investment vehicles that specialize in growth 
opportunity stocks and in the small-cap and mid-cap issuer 
space.
    Senator Shelby. I think both the gentlemen want to comment.
    Mr. Cronin. Yes, Senator Shelby, thank you. So I would just 
add, institutions like Invesco do want to have more ownership 
of small company stocks. What prevents us from doing that is 
that the way that they trade does not facilitate liquidity in a 
way that makes it allowable for us to invest in more. We have a 
number of funds that are focused on small-cap stocks, so we 
recommend--and we were very happy to see that there was a pilot 
program, because we actually think the opposite might happen. 
We do not worry about spread. The 5-cent spread is not what 
determines the value of implementing an idea in our portfolio. 
The very fact that you have more people willing to post bids 
and offers might well incur, frankly, from an institutional 
perspective, far less cost. So we are very encouraged that the 
pilot is taking place and very happy to see what the results 
are.
    Senator Shelby. Professor, have you got a comment, quickly?
    Mr. Angel. Yes. I am strongly in favor of evidence-based 
regulation. We should have a culture of innovation and 
experimentation so that the SEC is regularly running pilots on 
a variety of things to see what happens. It is far better to 
have hard data to know what we are doing rather than to just 
say, well, I think it is a good idea.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman. Thank you all 
for your testimony.
    It seems to me that to make our equity markets the best 
place in the world to have investors invest in companies to 
raise capital, the SEC in trading venues has to balance some 
fundamental market structure tensions. Notably, investors 
receive better information about market prices when they have 
more transparency regarding pre-trade quotes and post-trade 
prices. But there may also be times when investors obtain 
better execution for their own trades by providing less 
transparency to the market.
    For example, if an institutional investor wants to sell a 
large block of shares, it might be concerned about its sell 
orders driving down market prices before it has completed the 
sale of the entire block. So what I would like to hear from the 
panel is what do you think is the appropriate way to balance 
this tension between wanting to know about everyone else's 
trades, but sometimes not wanting anyone else to know about 
your own.
    Mr. Sprecher. Thank you. I talk to my staff a lot about the 
fact that everybody wants to know how much everybody else is 
paid----
    [Laughter.]
    Mr. Sprecher.----but nobody wants to disclose what they 
make after they negotiate their raise.
    I think you have hit on a very salient point. We have been 
advocating that in today's world where the smart order routers 
are breaking big trades up into little digestible bites, there 
is very little difference between you and I as a retail trader 
and Mr. Cronin as an institutional trader in terms of what the 
exchange and the matching engines see. We see little bits and 
bytes. But it is fair that a large institution should have the 
opportunity to find another large institution and do a large-
size trade without moving the market.
    And so I think if we could develop a standard by which we 
had an agreed trade size that would be somehow excluded from 
being in the public markets, that would be a fair tradeoff. 
Right now there is no such differentiation, and so we see tiny 
little trades being traded off exchange.
    Senator Menendez. Anyone else? Does anyone else believe--do 
we have the right balance here?
    Mr. Angel. This is a very difficult issue that people have 
been debating for years. What is the right amount of 
transparency? And this is why I think experimentation is the 
answer, because we all have ideas on how it should work and how 
we think it should work, but, you know, the proof is in the 
pudding. So, you know, I think that we should experiment with 
different transparency regimes to see what happens.
    Senator Menendez. Mr. Cronin.
    Mr. Cronin. Senator, as a large institutional investor, I 
can tell you that our responsibility is to make sure that our 
clients' best interests are protected. To facilitate that, we 
need different kinds of execution venues that allow us to trade 
large blocks. As you might guess, when you have 500 shares to 
buy, it is a fair different way you approach the order than 
when you have 5 million shares to buy. So we have to balance 
trying to make sure that the price discovery process is as 
robust as it can be. And, by the way, we are more than happy to 
trade in the public markets, but we have to balance all the 
different complications that the market structure brings to us.
    For example, there are a number of participants in the 
marketplace who would love to get wind of that 5-million-share 
orders you might guess and try to take advantage of that. We 
are trying to protect and preserve as much value of our 
transactions into our clients' hands as possible. So we need 
tools like dark pools. Dark pools have lost their way to be 
clear, when the average trade size is 200 shares when it was 
proposed to be a block trading system, something is broken. Our 
belief system around what is broken is that brokers have a 
conflict of interest in how they route our orders. They break 
them up into tiny pieces, as Mr. Sprecher describes, but they 
also send them to destinations which actually are serving to 
maximize their own economic best interests but may not be 
serving our best execution interest.
    So we would encourage more disclosure around that practice. 
We have advocated for getting rid of these incentives like 
maker-taker which promote activities which may be incongruent 
with our shareholders, and other things that will promote 
fairness and integrity.
    The last point is that we need to make sure that there are 
incentives for people like us to post our bids and offers in 
the markets. That robust price discovery mechanism must be 
protected.
    Senator Menendez. Let me ask you all, is competition 
between trading venues currently producing the right balance 
for investors? And if not, what do you think should change?
    Mr. Sprecher. I think it has gone too far, honestly. I 
think data that we have seen showed that years ago there was a 
low point in terms of execution costs, but more recently the 
true cost of execution has been increasing as the markets have 
fragmented and people are no longer able to find the best price 
for their shares.
    Senator Menendez. Anyone else?
    Mr. Griffin. I think to add to that answer, though, we have 
seen a disruptive innovation in the form of Regulation NMS. The 
arc of disruptive innovation is generally the rapid entry of 
many new competitors. We have seen many new exchanges form 
since the introduction of Regulation NMS. We have seen many new 
market-making firms come into being since the introduction of 
Regulation NMS. And what are we seeing today? We are seeing 
rationalization. We have seen an exchange just recently cease 
to function. They shut down their business.
    We have seen countless high-frequency trading firms shut 
their doors because of their inability to generate profits. We 
are seeing the arc of disruptive innovation play out, and we 
will see a logical rationalization of our markets take place on 
the back of this. It takes time. It is hard to imagine how much 
the equity markets have changed in just 7 years, in the blink 
of an eye. And so I think that many of the issues that we are 
concerned about will be addressed as competition plays out in a 
fair and orderly way over the years to come.
    Senator Menendez. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Johanns.
    Senator Johanns. Thank you, Mr. Chairman, and thank you to 
all the witnesses.
    Let me, if I might, just follow up with a question or two 
on the high-frequency trading issue. Let us say that this 
Committee finds that high-frequency trading is not doing much, 
if anything, for liquidity. Maybe we find that we cannot figure 
out where it is benefiting the market. Would anybody on the 
panel recommend that we ban it, just say you cannot do it 
anymore? Just a simple, straightforward yes or no.
    Mr. Griffin. No, absolutely not. And can I add just a few 
sentences?
    Senator Johanns. Sure.
    Mr. Griffin. All right. What has been lost in the dialogue 
around high-frequency trading today is the important role that 
it places--that it facilitates fairness between the prices of 
securities in the marketplace. When you buy or sell an S&P 500 
futures contract, you are buying and selling 500 underlying 
stocks in one fell swoop. And somebody needs to keep the market 
in Chicago in line with the markets in New York, and that is 
done by high-frequency trading firms, who literally buy and 
sell 500 stocks when the futures move in price.
    When you trade XLF or spy or the diamonds or any number of 
ETFs, you do not ask yourself what is the underlying net asset 
value of that ETF. You know the price that you are going to 
tradeoff at is fair because the high-frequency trading firms 
continuously arbitrage between the ETFs, which are a very 
important retail trading vehicle and the underlying common 
stocks. This all happens, in fact, at an incredibly low cost in 
the context of our capital markets.
    Senator Johanns. Mr. Cronin, would you suggest we ban it?
    Mr. Cronin. I would not suggest that we ban it because I 
think it is too prescriptive that high-frequency is all one 
kind of behavior. I think as Mr. Griffin describes, there are 
kinds of trading activities that are pursued by firms that 
would be defined as high frequency which are very helpful to 
efficiencies in markets. There are others which probably are 
harmful. We need to be in the business of being able to 
understand which is which.
    Senator Johanns. Professor?
    Mr. Angel. I would not ban high-speed trading. There has 
always been a race for speed, and even if you put in speed 
bumps, people will race to be as fast as they can to jump 
around those bumps. Some of the high-speed traders, as was 
pointed out, do good things. I am a retail investor. When I buy 
an exchange-traded fund, I trust that the price of that fund 
will match the stocks that it represents. Those arbitrageurs, 
those high-frequency traders doing that in and out, buy and 
sell, are making sure that those prices are aligned.
    Senator Johanns. So the panel is unanimous on that.
    That kind of takes me to my next point. Pre-2005, if you 
were an exchange, man, thing were pretty darn good, right? I 
mean, virtually everything is moving through the exchanges and 
life is good and you are happy and why be more innovative. You 
have got all the business, right?
    Isn't part of what we are seeing here the fact that people 
are looking for a better way, a faster way? Mr. Cronin, on 
behalf of your clients, you want these options. You want dark 
pools. You want a whole host of opportunities to maximize the 
return on your clients' investment and, to be very honest about 
it, maximize your income. And somebody made a point here that I 
think is a very valid point, and that point is this: We work in 
a very cumbersome way here. Even if we were firing on all eight 
cylinders, which I would argue we are not these days, we are 
cumbersome. We were meant to be cumbersome. Our Founders wanted 
us to be cumbersome.
    Isn't this whole debate and trying to figure out what best 
to do best left with the regulators? And focus on that 
question. Wouldn't we be better to make sure that they are 
properly empowered, which I would argue they are, and then do 
evidence-based regulation to try to figure out what is the best 
approach? Professor, I will start with you and go across the 
table.
    Mr. Angel. I agree 100 percent that, you know, if the 
regulators are capable, we should trust them. And, indeed, they 
do have adequate authority to do what they need to do. But do 
they have the adequate resources, you know, not just the 
monetary resources but the human capital resources? I think you 
need to monitor them closely to make sure that they have the 
ability to do their job well.
    Senator Johanns. I am out of time. If I could just ask each 
of you to give me one or two sentences, and if you want me to 
know more about this, call me, OK?
    Mr. Cronin. Yes, I think there is a balance to be struck 
between the regulators and market participants. I think that is 
how we manage the good things that regulation can bring, but at 
the same time manage the unintended consequences which we all 
fear.
    Mr. Griffin. I concur with your sentiments.
    Senator Johanns. OK. Thank you.
    Mr. Sprecher. I think the market participants themselves 
have an obligation to take on some this. That is why we have 
been very open about wanting to make changes.
    Senator Johanns. And others are doing the same, such as TD 
Ameritrade has indicated they----
    Mr. Sprecher. Well, there is actually pretty much unanimity 
on this panel with a number of things that we all agree should 
be done.
    Senator Johanns. Thank you.
    Chairman Johnson. Senator Brown.
    Senator Brown. Thank you, Mr. Chairman. There are a number 
of people--and I assume the four of you are among them--who 
object to the characterization of our financial markets as 
being ``rigged'' against ordinary investors. But the concerns 
raised about equity markets coincide with accusations of 
manipulation in LIBOR and the foreign exchange setting. My 
Subcommittee has done hearings on aluminum and zinc and gold 
and silver and oil and electricity markets, what has played 
there. Professor Angel notes in his written testimony that the 
lack of financial crisis-related prosecutions has also 
undermined investor confidence, and I would hope--and I am not 
asking for a response on this part, but I would hope that you 
would at least understand, regardless of agreement or 
disagreement, that consumers and investors and users feel that 
certain well-connected institutions enjoy special privileges in 
the financial markets. Again, whether you agree or disagree 
with that, I hope you at least understand that large numbers of 
people in all those groups feel that way.
    Mr. Sprecher, my question or first set of questions is 
directed at you. You have been outspoken about high-frequency 
trading. We appreciate your sharing constructive solutions as 
you have. But since at least 2012, former high-frequency 
traders have been expressing concerns about exotic order types 
that technically comply with SEC regs but which allow high-
frequency traders to jump the queue and exploit price 
advantages that come from latencies. The New York Stock 
Exchange has actively sought to address the issue by announcing 
in May it was eliminating 15 order types, if that number is 
correct; however, ICE estimates there could be as many as 100 
different order types. I have heard concerns that the stock 
exchange continues to allow high-frequency traders to use some 
predatory order types, like Post No Preference Blind, in which 
high-frequency traders' bids remain blocked from the market and 
then, as I said, jump to the head of the queue.
    Mr. Sprecher, when is the stock exchange going to terminate 
hidden order types like Post No Preferences Blind? The critics 
have been saying for more than 2 years that it helps high-
frequency traders. What are you going to do?
    Mr. Sprecher. Well, we have owned the stock exchange for 7 
months. I have been the Chairman for maybe 3 months, and as you 
say, I am uncomfortable with having all these order types. I do 
not understand why we have them, and I have started 
unilaterally eliminating them.
    The problem that we have is that orders today are--
decisions on where orders go are not made by humans. They are 
made by computers that are so-called smart order routers. And 
many of these order types exist to attract the orders, and I am 
trying to balance cleaning up my own house--I live in a glass 
house, and I am trying to clean it up before I criticize 
others. At the same time, I cannot make the New York Stock 
Exchange go to zero. It would be bad for this country for the 
New York Stock Exchange to no longer have trading activity.
    So it is why I have been outspoken. I hope that other 
exchange leaders will follow my lead. I would like to get us 
all working together to eliminate these types. I would be happy 
if we can do it as a private sector initiative. I would be 
happy if the SEC ordered us to get rid of them. I would be 
happy if Congress took action. Any way we can reduce them, I 
would be happy.
    Senator Brown. So if you came back here 6 months from now, 
ICE would have owned the New York Stock Exchange for a little 
over a year then. You would have been its CEO for 9 months by 
then. What number would--where will we see progress? How do we 
quantify that and measure that?
    Mr. Sprecher. Well, let me say this: I very much appreciate 
the IEX exchange, which is the exchange that is the subject of 
the ``Flash Boys'' book. They have four order types. I would 
love to get the four order types. They also have less than 1 
percent market share. It shows me how four order types are 
dealt with in the market. I cannot take the New York Stock 
Exchange to 1 percent, but I appreciate your allowing me to 
talk about this publicly to you all and to the camera and a 
microphone, because I think that I need to put pressure on all 
my colleagues to follow my lead.
    Senator Brown. Mr. Cronin, in my last couple of minutes, 
let me ask you a question. One broker-dealer testified before 
Senator Levin's Subcommittee that virtually all the trades 
eligible for rebates in the first quarter of this year, 
numbering in the millions, as you know, were executed through 
the trading venues that offered the highest rebates. You said 
in your testimony:

        Investors are given only limited insight in how and where 
        broker-dealers route their orders. As a consequence, it is very 
        difficult for investors to make informed decisions about the 
        quality of executions they have received.

    You have a duty, as you know, to act in the best interests 
of your clients to protect the retirement savings of millions 
of working Americans. How can you be sure you are meeting this 
obligation without that information?
    Mr. Cronin. Yes, sir. So we spend a lot of time and energy, 
as you might guess, trying to make those determinations. 
Transaction cost analysis, which is what we perform to 
understand how our trades have been handled, is not perfect, 
right? And it has evolved pretty dramatically over the years, 
and I think we have a very good sense of where we are with 
respect to the quality of executions we receive. But we could 
do better. We could get more information that would be helpful 
to us.
    For example, most of the transaction cost analysis 
information we get is just about the trades that we have 
received. Well, if you thought about it, our trades go to a 
number of destinations before they actually receive an 
execution. We have been trying to get the brokers to give us 
more information about where exactly the trades went that they 
did not get executed, because, quite frankly, you might find 
that you are giving up a lot of information to all these 
different destinations that orders get routed to that actually 
give you no benefit whatsoever.
    So we have been very vocal about the issue of the conflicts 
of interest that drive where brokers route orders. We think 
removing this conflict of interest is critical. But in the 
first instance, making sure that we have the right amount of 
information to make determinations is also a very, very 
important concept for us.
    Senator Brown. Thank you.
    Thank you, Mr. Chairman.
    Chairman Johnson. Senator Kirk.
    Senator Kirk. Thank you, Mr. Chairman.
    I would like to ask Mr. Griffin a question. This is a copy 
of ``Flash Boys.'' When Michael Lewis wrote this, you being a 
leader in high-frequency trading, describe your conversation 
with Lewis when he wrote this book.
    Mr. Griffin. I have never spoken to Michael Lewis about 
this book.
    Senator Kirk. So he never called you?
    Mr. Griffin. He did not.
    Senator Kirk. All right. Thank you.
    Thank you, Mr. Chairman.
    Senator Reed. [Presiding.] Thank you, Senator Kirk.
    I was not here for the first panel because of a classified 
hearing with respect to the situation in Iraq and Afghanistan, 
and I respect the panel and thank them for their testimony. But 
if you are ready to move forward to the second panel--or is 
there anyone else seeking to be recognized?
    [No response.]
    Senator Reed. In that case, gentlemen, thank you so much 
for your participation, and I am sure we will be back again and 
engage again on this issue.
    At this point I would like to ask the second panel to come 
forward and take their seats, please. Thank you.
    [Pause.]
    Senator Reed. Let me at this time introduce the second 
panel.
    Our first witness is Mr. Thomas Wittman. He is the 
Executive Vice President and Global Head of Equities at NASDAQ 
OMX Group. Thank you, Mr. Wittman.
    Next we will have Mr. Ratterman. Mr. Ratterman is the Chief 
Executive Officer at BATS Global Markets. Thank you.
    And, finally, Mr. David Lauer is the President and Managing 
Partner at KOR Group.
    Gentlemen, thank you all very much, and, Mr. Wittman, you 
can begin your testimony, please.

 STATEMENT OF TOM WITTMAN, EXECUTIVE VICE PRESIDENT AND GLOBAL 
            HEAD OF EQUITIES, NASDAQ OMX GROUP, INC.

    Mr. Wittman. Thank you, Senator Reed and Ranking Member 
Crapo, for the opportunity to testify today.
    As my testimony points out, the efforts of SEC Chair Mary 
Jo White are to be commended, and we agree with many of her 
recent actions. You have my full testimony, but I wanted to 
quickly summarize my key points, and there are four.
    Number one, the lit exchanges play a critical and 
indispensable role in the U.S. economy. Public companies and 
investors both need price discovery to feel that the market is 
working for them. Exchange listed public companies use stock 
issuances to expand their businesses and create jobs.
    Number two, market structure needs to be re-examined with a 
goal to improve transparency and reduce fragmentation. It is 
clear from the debate that investors and listed companies view 
the current market structure as an impediment.
    Number three, we must act deliberately to encourage 
transparency and price discovery so the best markets in the 
world can continue to be the engine for economic growth and job 
creation. The stakes are high.
    Number four, all venues that trade stocks need to be 
brought into a system of well-conceived regulation and 
oversight. One idea that we are considering, which was not 
included in my written testimony, is whether there are ways to 
capture unique trading experience and needs of participants in 
dark venues. We want to look at the feasibility of translating 
those experiences and benefits into a more transparent and 
regulated NASDAQ venue.
    We intend to proceed with this and other innovations 
because at NASDAQ we are committed to making the markets work 
better. NASDAQ is passionate about the role we play in capital 
formation and improving the performance of our marketplace. The 
SRO model and the U.S. market structure have been effective in 
protecting investors, but as technology and trading have 
evolved, so too must the regulatory environment in which 
markets operate.
    We look forward to working with this Committee. Thank you 
for your invitation to testify. I look forward to your 
questions.
    Senator Reed. Thank you very much.
    Mr. Ratterman, please.

   STATEMENT OF JOE RATTERMAN, CHIEF EXECUTIVE OFFICER, BATS 
                      GLOBAL MARKETS, INC.

    Mr. Ratterman. Thank you and good morning. My name is Joe 
Ratterman, Chief Executive Officer of BATS Global Markets and 
one of the original founding employees. I would like to thank 
Chairman Johnson, Ranking Member Crapo, Senator Reed, and the 
entire Senate Banking Committee for inviting me to participate 
in today's hearing.
    Let me say at the outset that I was encouraged by SEC Chair 
White's recent comments that our markets are ``not broken, let 
alone rigged.'' I strongly agree with the Chair and appreciate 
her leadership in this area. The automation of the U.S. equity 
markets has resulted in significant enhancements in market 
quality for long-term investors. However, I also recognize that 
our markets are not perfect and that our efforts to improve 
them should never cease.
    Our current market structure is largely the product of 
Congress' 1975 amendments to the Exchange Act and subsequent 
rulemaking by the SEC to implement a national market system as 
well as advancements in technology that have made our equity 
markets capable of processing order messages in timeframes 
unthinkable even a decade ago. The increases in speed and 
improvements in latency found in today's markets have served to 
mitigate risk which benefits all investors in the form of lower 
risk premium, expressed as tighter spreads and lower 
transaction costs.
    Today our equity markets are widely considered the most 
liquid, transparent, efficient, and competitive in the world. 
Costs for long-term investors in the U.S. equities are among 
the lowest globally and declining. The gains are quantifiable 
and 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 
flow directly to investors in the form 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 since 1998, institutional trading costs have 
declined and are among the lowest in the world. And just last 
month, ITG reported that 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.
    Moreover, the efficient operation of our market structure 
throughout the stress of the 2007-09 financial crisis indicates 
the systemic risks that have been reduced as a result of 
advancements in technology.
    Efforts to address infrastructure risk since the Flash 
Crash of 2010 are producing further beneficial results. For 
example, the number of erroneous executions occurring on our 
markets is on pace this year to be nearly 85 percent lower than 
the previous 5-year average, results related to the recently 
enacted limit up/limit down rule. In addition, exchange system 
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 helping Americans realize their investment and 
retirement goals, but it plays directly into the overall health 
of our country's economy. 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 participating 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 voluntarily disclosed. Consistent 
and thorough reporting standards will create the greatest level 
of investor confidence, so additional regulatory direction may 
be required here.
    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 non-
marketable orders and specific broker execution quality data.
    Third, I continue to support initiatives to make the SIPs, 
also known as the ``consolidated tape,'' as fast as possible to 
address any perceptions of unfairness that can affect investor 
confidence. BATS has advocated this position since becoming an 
exchange in 2008.
    And, finally, I support eliminating the ban on locked 
markets, which is a primary driver of excessive complexity in 
our national market system.
    Thank you for the opportunity to appear before you today. I 
applaud the Banking Committee's oversight efforts and would be 
happy to answer any questions.
    Senator Reed. Thank you very much.
    Mr. Lauer, please.

 STATEMENT OF DAVID LAUER, PRESIDENT AND MANAGING PARTNER, KOR 
                           GROUP LLC

    Mr. Lauer. Good morning, Senator Reed, Ranking Member 
Crapo, and Members of the Committee. Thank you for inviting KOR 
Group here to testify today.
    KOR Group is a market structure research and consulting 
firm focused on data-driven analysis. Healthy Markets is our 
nonprofit initiative that seeks to build consensus on a 
coalition of firms in the industry on substantive market 
structure reforms.
    My name is David Lauer, and I am the president and managing 
partner of KOR Group. My background is in technology 
architecture and high-performance computing. I have designed 
and operated high-frequency, low-latency trading platforms. I 
have filed detailed written testimony and will only touch upon 
the key points here.
    In our industry, we are used to hearing that ``past 
performance is not indicative of future returns.'' The same 
could be said about past technology failures. As much as we 
like to think we're learning from our mistakes, past technology 
failures tell us very little about the next crisis on the 
horizon. To think otherwise is called the ``fallacy of the 
broken part.''
    I will begin by stating the obvious: Complex systems fail. 
They must be designed to degrade gracefully, not to crash. 
Technology should be invisible. Today's markets are 
characterized by interconnectedness and speed. Regulations 
since 1975 have not only created complexity in technology, 
connectivity, and order routing, but have also created 
intractable conflicts of interest. It should be no wonder that 
we are confront concerns about market integrity in such a 
conflicted environment. It is only by peeling back some 
regulations and refining others that we can hope to simplify 
market structure, increase market efficiency, and prevent 
catastrophic technology failures.
    Complexity is not necessarily bad, but unnecessary 
complexity certainly is. Today SROs still follow rules under 
the Exchange Act of 1934. It should come as little surprise 
that these rules are antiquated, a product of a time when 
electricity had reached just 70 percent of households, not an 
era in which a gigabyte of data can be transmitted around the 
world in seconds.
    SROs are now for-profit organizations, owned either by 
public shareholders or broker-dealers, and in so many instances 
they act in their shareholders' interests and not for fair and 
efficient markets. Consider, as I do in my written testimony, 
the following actions which SROs have either neglected to take 
or have only taken as a consequence of regulatory intervention 
or catastrophic failure.
    Firstly, why aren't exchange server clocks synchronized to 
each other? How can regulators understand or surveil markets 
with this? And why is regulation needed to make this happen?
    Why wasn't the SIP infrastructure improved the same way as 
direct feed technologies? This need was identified by the SEC 
as early as 2001.
    Why haven't order types been re-examined industrywide 
through a retrospective review? Why isn't detailed, objective 
market data available to academics? And why haven't SROs 
mandated industrywide disaster testing?
    In each case, the need is obvious and the failure to act 
absurd. We also have antiquated best execution standards that 
allow brokers to operate their own dark pools while routing 90 
percent of their customers' orders through them. The consequent 
level of fragmentation and off-exchange trading should not be 
surprising.
    Fragmentation, conflicts of interest, payment for order 
flow, internalization, and maker-taker have collectively 
increased off-exchange trading and adverse selection on lit 
markets, making lit markets more fragile and less stable. This 
condition can be remedied by strengthening best-X, re-examining 
maker-taker, and considering a trade-at rule.
    On a more systemic level, one of the greatest risks to 
market integrity is from regulators who lack the data and tools 
to understand or keep up with the rapid pace of technology 
change in markets. At the heart of this struggle is a shortage 
of appropriate technology resourcing and a failure to embrace 
the language and ideas of complexity and systems theory. This 
in turn contributes to the public perception that our industry 
is operating with reckless abandon and little policing. 
Regulators need to embrace technology-centric regulation and 
systems theory and to revamp the SRO structure to make it more 
efficient, less conflicted, and more data driven.
    I have also been invited to follow up on the 
recommendations from my 2012 Senate testimony. At the time I 
advocated for market-wide surveillance and broad access to data 
to be driven by regulators. Unfortunately, MIDAS misses more 
than half of the activity in markets and lacks participant IDs. 
No centralized data store has been made available to academics, 
and the consolidated audit trail remains on the distant 
horizon.
    If the SEC had built the system I advocated for in 2012, it 
could have been operational for a year by now and would have 
given regulators an ability to surveil and study markets that 
is years ahead of their current approach.
    There is no issue that is more critical to ensuring market 
integrity than proper access to data for study and 
surveillance, and there is no reason this cannot be done 
quickly.
    My testimony also called for a mandate requiring SROs to 
demonstrate the utility of order types or retire them. While 
the NYSE recently acted, the SEC only announced a nascent 
effort on this issue last week.
    I would like to thank the Committee for inviting me to 
testify and hold this hearing, and I applaud the SEC for 
initiating a comprehensive review of market structure and for 
the scope and ambition of Chair White's speeches last month. I 
urge regulators to undertake a review that addresses not just 
the rules that govern trading but also the staffing 
requirements and mind-set necessary to do so properly. And I 
urge Congress to fund regulators appropriately to ensure they 
can succeed.
    Thank you. I am happy to answer questions.
    Senator Reed. Well, thank you very much, Mr. Lauer, and let 
me begin with you. I recall that hearing--Senator Crapo and I 
presided over it--and we asked you specifically to go back and 
review. And what you said then is even more relevant today with 
subsequent events that have taken place.
    Looking at your testimony, one point among many leaped out: 
``It should be concerning to anyone reading this that there is 
no algorithmic, cross asset-class surveillance being performed 
right now. This leaves little doubt that there is market 
manipulation taking place. Bad actors know that nobody is 
watching. There is no issue that is more critical to ensuring 
market integrity than proper access to data for study and 
surveillance, and no issue that is more readily and easily 
solved. It is time to stop making excuses.''
    Would you like to elaborate on that?
    Mr. Lauer. So last month I was invited to testify before 
the CFTC Technology Advisory Committee by Commissioner O'Malia 
on how to do surveillance in the 21st century, and I included 
my testimony there in my submission for the Committee here. In 
it, I have outlined a system that can be built relatively 
quickly. Certainly in the private sector, it is something that 
most firms have a form of. And it can combine futures data, 
options and equities data into a cloud-based platform in which 
you could have algorithmic analytics running.
    I am very concerned--and I have yet to talk to somebody in 
the industry who does not concur--that there is, of course, 
something going on in cross asset class trading because nobody 
is watching, and why anybody would expect otherwise, you know, 
I cannot understand. I think that when you look at the primary 
issue there, I believe it is regulatory agencies working 
together, and I think that that is the main concern. So the SEC 
and CFTC should be collaborating on a surveillance platform. 
There is no participant in the markets, especially in HFT, who 
sees things in only an equity silo. You are looking at equities 
in futures and options and all sorts of other data. The 
regulators should be, too.
    Senator Reed. Thank you very much.
    Let me ask both Mr. Wittman and Mr. Ratterman a question. 
You both in your positions have the very difficult challenge of 
balancing technology, which you all indicated provides 
significant advantages in terms of prices and liquidity, with 
the possibility of error. And as Mr. Lauer said, complicated 
things break, and so we have to assume that.
    Given Chair White's speech, what other message might you 
sort of identify and emphasize with respect to the structural 
integrity of your markets? And let me start with Mr. Wittman, 
then ask Mr. Ratterman to comment.
    Mr. Wittman. Thank you, Senator. My background is 
technology. I spent my first 10 or 12 years writing software in 
our equity environment under the Philadelphia Stock Exchange, 
so I understand technology and the process.
    As the previous panel explained, you know, with 
fragmentation, I think with technology you can do just about 
anything. But with the more fragmented markets as they are 
getting now, it has become more of a challenge. I think with 
Regulation SCI that the SEC has talked about, I think that is a 
good step forward for exchanges, and, quite frankly, any 
platform that executes an order should come under those same 
Regulation SCI restrictions when those are implemented. I think 
that is a great first step.
    Senator Reed. Thank you.
    Mr. Ratterman, please.
    Mr. Ratterman. So as an exchange operator, we do take 
technology very seriously. We try to do everything we can 
within our own systems to provide redundancy at each step of 
the way, whether it be an order handler, a matching engine, the 
routing infrastructure, even within data centers having 
technology in two different places, and all that goes a long 
way to making sure that within our market center we stay 
stable. But that is not good enough, and I think that what we 
have today in today's equity market structure is a competitive 
landscape where, when my systems might fail, then NASDAQ's 
systems would pick up. And that is something that was 
instituted with Regulation NMS that has worked extremely well.
    In my testimony I talked about the number of times that an 
exchange declares self-help on another exchange having gone 
down. So it has worked over the years to allow the market to 
route their orders around the failing node in this connected 
network, and the number of instances of those failures has come 
down and is continuing to come down.
    So I support the current competitive landscape because no 
matter how much we think about redundancy and build disparate 
data centers across the country, if something in our technology 
fails in real time, NASDAQ or NYSE can pick up the load, and 
customers rarely really notice the impact of that.
    Senator Reed. Thank you, Mr. Ratterman. My time has just 
about expired. I will entertain a second round. Let me now 
recognize Senator Crapo. Senator?
    Senator Crapo. Thank you, Senator Reed.
    Mr. Wittman, according to reports, the JOBS Act has been 
very helpful in aiding companies enter our capital and equity 
markets. But there is still a lot of concern that smaller 
companies are unable to tap into our equity markets.
    Given your role as a listing exchange, could you give us 
some of your thoughts on what can be done to help smaller 
companies IPO? And what can be done to help small-cap companies 
succeed in today's secondary markets?
    Mr. Wittman. Sure. There are probably two parts to the 
answer to that, and one is the recent move by the SEC with the 
tick size pilot to try to liquefy those less liquid small-cap 
names. So we look forward to that program and measuring the 
effectiveness of that program to see how that works.
    Also, NASDAQ has initiated an alternative way to bring 
companies to the listed market through our private markets 
program. So with those two efforts, I think that we will watch 
the growth of those newly small-cap companies come to market.
    Senator Crapo. Thank you very much.
    This second question is addressed to all three Members of 
the panel. I would like you, if you would, please, to discuss 
with me what the proper role, if any, there is for dark pools 
in today's markets, especially for institutional investors. Is 
there a role for dark pools? Or should we look at eliminating 
them?
    Mr. Lauer. I would say that the proper role for dark pools 
is probably how they were originally envisioned, which is as 
crossing networks for block trades, a way for institutional 
investors to put interest out there without tipping their hand 
to the market, not as a place that is extremely fragmented with 
order sizes that are the same as or smaller than the lit 
markets.
    Senator Crapo. Mr. Ratterman.
    Mr. Ratterman. I believe that there is a definition place 
in our market infrastructure for dark pools. As Mr. Cronin 
commented on the previous panel, as a representative of the 
institutional investors, you cannot do large size in a 
displayed market at all times, and we would like to encourage 
more trading on exchange. But the fact is that a large order 
will impact the price adversely, and so having choices to place 
your orders in pools that do not display bids and offers and 
move the price before you are able to get your trade done is an 
important facility in today's marketplace.
    I believe that transparency, as referenced on the first 
panel, is something that could go a long way to helping improve 
the cohesiveness between displayed and non-displayed markets 
that transparency around the rules within the engine, 
transparency around the pricing, and fairness amongst 
participants, and those dark pools would go a long way to 
taking away some of the mystique about a dark pool. But the 
fact is that dark pools are a necessary, important part of the 
institutional trading tool set.
    Senator Crapo. Thank you.
    Mr. Wittman?
    Mr. Wittman. Yes, so in short, you know, we agree with the 
use of dark pools for institutional block size trading. But 
over the years, we have seen those facilities being used for 
more than just the facilitating of large block trading. The 
average trade size is now down in the 200 shares range.
    So, you know, we believe there should be more transparency 
there. We think that the addition of all these dark pools helps 
fragment liquidity, which in the end hurts our listed companies 
and listed companies on exchanges. So block size is fine, but 
the proliferation of the use beyond that is beginning to be 
worrisome.
    Senator Crapo. So am I hearing that it would be appropriate 
or encouraged to prohibit smaller than the large block size 
transaction? And is part of the answer as simple as figuring 
out what that size is and prohibiting dark pools from engaging 
in that sector of business?
    Mr. Ratterman. I will go first and say that I am not sure 
that I would support that. I think large institutions have a 
long history now of breaking their orders up into small sizes, 
and so even though the average execution size in a dark pool is 
a small number of shares typically, some number of those 
executions are a result of larger sizes that have been broken 
up and sent to the dark pools, the same way they would have 
been sent to the exchanges. And so careful regulation here to 
make sure that we do not inadvertently take away tools from the 
institution given that so much of their infrastructure has 
probably already been designed to break up their large orders 
given the way the markets work.
    Mr. Lauer. I think that prohibition in this type of top-
down regulation can be dangerous. We can see unintended 
consequences from it. One thing that we are pushing with the 
Healthy Markets platform is for a trade-at rule and for pilot 
tests around the trade-at rule. I agree with Mr. Cronin from 
the earlier panel that a comprehensive trade-at pilot would 
help us to see what the effects would be from imposing a burden 
to execute off-exchange for small orders. And what it says is 
if you are going to damage the price discovery process on the 
lit markets by displaying your interest off-exchange and 
executing off-exchange, there has to be significant price 
improvement, with an exclusion for block trades. And I think 
that when you see the change in behavior that that will 
encourage and the change in the dynamics of the types of orders 
that reach lit markets, it would be healthier for both the dark 
venues trying to facilitate block trades and the lit markets 
trying to improve liquidity.
    Senator Crapo. Thank you.
    Senator Reed. Thank you, Senator Crapo.
    Senator Warren, please.
    Senator Warren. Thank you, Mr. Chairman.
    So we have been talking about investor confidence, the 
importance of investor confidence. But there is obviously a 
real problem here.
    According to a survey conducted last December by the 
University of Chicago's Booth School of Business and 
Northwestern University's Kellogg School of Management, only 
about 15 percent of Americans trust the stock market. That is 
one in seven. And just to give some comparison, about 35 
percent of the public said they trusted banks and about 17 
percent said they trusted large corporations. Fifteen percent 
is not a good number. And this matters because people are not 
going to invest in the stock market if they do not trust it. 
And, in fact, that is exactly what the data seem to show.
    Historically, when stocks are going up, net flows into the 
stock market are going up. People want to get into the market 
when they see that it is rising. When interest rates are low, 
that effect should be even stronger. But that is not what 
happened in 2012 and part of 2013. Interest rates were low. The 
market was shooting up. And net flows were actually down. And 
according to survey data from Gallup, the percentage of the 
public with money invested in the stock market is steadily 
declining over time.
    So trust in the stock market is not the only thing that 
explains this trend. There are certainly other things going on. 
But it is also certainly a contributing factor. Lack of trust 
in the stock market means less capital for growing companies, 
slower growth in the economy, slower job growth, and it means 
that fewer Americans have an opportunity to share in the wealth 
that is created by a rising stock market, and that further 
increases the disconnect between Wall Street and everybody 
else.
    Now, we have talked some about it. Michael Lewis made 
headlines when he said that the stock market was rigged. And 
there was a lot of debate over whether he was technically 
correct. But when a company can claim to be trading on stocks 
and come out ahead 1,237 days out of 1,238 days, you can see 
why some people think the game is rigged for the big buys to 
make money and everybody else to lose.
    So I would like to get your views on this. Mr. Wittman, let 
us start with you. What steps do you think are needed to 
improve public trust in the stock market?
    Mr. Wittman. Well, I think hearings like these where people 
can listen in and hear the comments from the experts I think is 
helpful. I think, you know, with some of the failures that have 
been alluded to and have been talked about on the panel, the 
previous panel, I think are some of the issues that investors 
worry and care about. But I believe the exchanges are working 
toward improving those situations, as Joe alluded to in his 
remarks about self-help and stability and resilience.
    Senator Warren. Mr. Wittman, I presume, though, that you 
have been doing this over some period of time, and what we see 
is confidence in the market seems to be going down, and 
people's willingness to invest their money in the market seems 
to be going down.
    Mr. Wittman. I am not 100 percent sure that the confidence 
in the market and the decline in investments are tied 
completely together, though, myself. So I am not sure if that 
is a true correlation.
    Senator Warren. All right, although people are certainly 
reporting that they do not have confidence in the market and 
that they are over time investing less and less money. And that 
is certainly what the flows seem to show. So I do not know what 
evidence you have to the contrary, but it seems to me something 
needs to be done here.
    Maybe you have an idea, Mr. Ratterman. What are your views 
on how we can increase investor confidence?
    Mr. Ratterman. Two primary points. One is, luckily, the one 
that is underway right now, and that is, SEC Chair White's plan 
for a holistic review of the equity markets. By my 
understanding, that is completely comprehensive and covers 
every tenet of market structure that we have today. And while 
it may take some time to go through methodically, and as we 
have talked about before, you know, a data-driven approach, 
what I see is the ability for the regulator, along with 
industry, to touch every single point of our market structure 
and determine whether it could be improved or maybe it is fine 
the way it is. But one way or another, at the end of this 
holistic review, it will have touched every single element of 
our market structure from a fresh pair of eyes. So I am 
encouraged that we have not done that in many, many years, and 
that will be a nice point in time to mark that we have looked 
and we have assessed. And communication about that process I 
think can go a long way.
    And then, too, as a subset of, you know, that holistic 
review and some of our recommendations is just more 
transparency--transparency around how dark pools operate, 
transparency around how order execution quality is being 
achieved by different brokers. I think the increased 
transparency around these elements will go a long way as well.
    Senator Warren. Mr. Chairman, I am over time, but would it 
be all right if, instead of a second round, I just asked Mr. 
Lauer to go ahead.
    Mr. Lauer. Thank you, Senator Warren. So I think that I 
agree that more openness and more transparency is the first 
step and the most obvious step, and we have proposed many 
different enhancements to current disclosures and refinements 
of current disclosures. Rule 605 and 606 were developed in 2000 
and 2001, and they no longer pertain to the current market. So 
we need to see more transparency.
    I think we need to see more data-driven analysis. We keep 
talking about data-driven analysis, but the facilities, the 
tools to facilitate that data-driven analysis have not kept up 
with the times. Regulators are still using data sets that just 
do not pertain to current markets, do not have the right kind 
of time stamps and clock resolution. And these things might 
sound too mechanical and wonky for the average person, but they 
hear lots of things. They hear about feeds that are gamed 
because of latencies, and they hear about high-frequency 
trading, trading on these time scales, and there seems to be 
little public indication that regulators are able to keep up 
with that and are able to study markets.
    So if regulators could take a different approach, an open 
approach where they facilitate access to people in the industry 
and academics to study that data and come out with reports that 
can conclusively demonstrate the health of the markets, I think 
that would go a long way. On top of that, the markets need to 
get out of the news. I said in my opening statement that 
technology should be invisible. If regulators and SROs can 
embrace the complexity theory and understand that technology is 
going to fail and design around that, have the systems degrade 
gracefully, they could stay out of the news. And I think that 
would go a long way toward improving confidence.
    Senator Warren. Well, I want to thank you all. I do not 
think we can overstate the importance of investor confidence, 
and that means investors have got to believe that these markets 
work. And they are not going to believe it so long as you 
continue to stay in the news, and continue to stay in the news 
with this kind of evidence that the market works for the big 
guys but not for anybody else. So I appreciate your work on 
this. Thank you.
    Senator Reed. Senator Shelby.
    Senator Shelby. Thank you.
    What percentage of the market trades are so-called e-retail 
as opposed to institutional trading, roughly? Mr. Wittman?
    Mr. Wittman. I believe the stats have retail at around 40 
to 42 percent, but I can get back to you with the exact----
    Senator Shelby. Would you furnish that for the record?
    Senator Shelby. But it is a high percentage of 
institutional trades versus say if I was trading retail trades.
    Mr. Wittman. Well, an institutional carveout besides the 
other trading that takes place between professionals and market 
makers. So you have retail, you have institutional, and you 
have got the professional that trade with each other. So I am 
not sure if the institutional makes up the balance or if others 
on the panel have an answer on that.
    Senator Shelby. But do you basically agree that confidence 
or integrity in the market is key to the markets?
    Mr. Wittman. I do, and I think I said that in my oral 
statement, yes.
    Senator Shelby. Whether it is retail investors or even if 
it is institutional investors.
    Mr. Wittman. I agree.
    Senator Shelby. They have got to believe there is integrity 
in the market.
    Mr. Wittman. I agree, yes.
    Senator Shelby. Do you agree with that, Mr. Ratterman?
    Mr. Ratterman. I do.
    Mr. Lauer. Yes.
    Senator Shelby. What has been driving the so-called dark 
pools' or private pools' growth in the market from 16 percent 
of all trades in 2008 to over 40 percent as of last month? Is 
it because of money? Because they can make more money doing it 
privately as opposed to going through the exchange with 
transparency?
    Mr. Wittman. I will categorize that into two buckets, and I 
think Mr. Griffin talked about it a bit on the first panel. The 
two buckets for what I consider dark would be, you know, retail 
internalization, and then another set was institutional, and I 
would call it almost cost avoidance, avoiding probably the take 
fees from exchanges. So those two buckets. So profitability and 
probably cost avoidance would be the two top points in there 
which create this fragmented market structure, lack of 
transparency.
    Senator Shelby. Of course, we all know that technology has 
changed just about everything, not just the capital markets, 
but it has changed it tremendously. But when you have the high-
frequency trades--and this is a result of technology and 
growth, we know that--it does give these people a certain edge. 
I mean, they might hold a stock for 2 seconds or a split second 
and they make money out of it, and people are looking for the 
best investment in the market. But how do retail people--say if 
I wanted to buy some stock in the market, how do I compete with 
that? Or do I?
    Mr. Lauer. You do not.
    Senator Shelby. You do not. That answers that. You agree 
with that.
    Mr. Lauer. I agree. It is----
    Senator Shelby. You cannot compete with it, can you?
    Mr. Lauer. No. There is no sense in it. Your holding period 
is months or years.
    Senator Shelby. Does that go back to the issue of 
confidence, people say, well, gosh, I cannot compete with these 
people in the marketplace? Does that erode the capital markets? 
Or does it just keep the retailers out?
    Mr. Lauer. I am not sure from that angle that that erodes 
confidence, but I do think that an amount of uncertainty or 
misunderstanding about the nature of high-frequency trading and 
the confidentiality with which those firms treat everything 
that they do. I mean, obviously their code is confidential, but 
there has been very little publicity or in-depth understanding 
until very recently about what high-frequency trading even is 
and how varied the trading activity is that occurs under this 
umbrella term. So I think that from a retail perspective, if 
you do not quite understand it and you hear about dark pools 
and--you know, it used to be that the market was easy to 
understand. Your order made it to a guy down on a floor.
    Senator Shelby. Do you agree that dark pools, the term 
``dark pools'' has a negative connotation with the average 
person?
    Mr. Lauer. I think that the connotation has become 
negative, and when you look at what the Attorney General 
discovered recently, there is not--that is not unfounded. And I 
think that when you look at the tremendous conflicts of 
interest with brokers operating their own dark pools and the 
conflicts of interest in the payment for order flow model, the 
retail internalization, and the way that retail brokers make 
routing decisions, and the fact that there is no enough 
transparency and accurate transparency into those broker 
routing practices, all of that contributes to increasing 
concern and increasing tension on the retail trader side.
    Senator Shelby. Mr. Wittman, let me ask you this question. 
I do not know how you regulate or overregulate, or whatever you 
do to block trades. I mean, we have had block trades. We have 
great institutional trading of pension funds, of endowments 
from universities, everything else, and they have always had 
block trades. How do we not fool with that, not mess with that, 
yet try to bring some confidence into the market?
    Mr. Wittman. Well, the whole institutional side of the 
business has changed a lot in the last 5 years. I think they 
have learned to try to adapt to the current marketplace, as Joe 
pointed out. They take these larger orders now, and they are 
trying to put them on exchanges, in dark pools, to try to get 
their executions and try not to impact the market. So I think 
the days of seeing, you know, a million share block go up on a 
TRF are not coming back anytime soon, unless there is 
regulation in place which allows them to find the counterparty 
more easily and print that. But I do not see that anytime soon.
    Senator Shelby. Mr. Ratterman?
    Mr. Ratterman. So in today's matrix of trading venues, 
there are two locations where large block trades can happen and 
do typically, and Liquidnet and ITG POSIT are two examples of 
large block trading venues. And the average trade size, as I 
understand it, can be as high as 30,000 or 40,000 shares on 
Liquidnet.
    So there are opportunities, and this goes back to, I think, 
the competition and the choice that is offered institutional 
investors, if they want to try and find a large counterparty to 
their trade, they can try to advertise, if you will, in a place 
like Liquidnet or ITG. If they do not feel confident that they 
can find that large counterparty, they can break their order up 
into small pieces and put them on exchanges or dark pools.
    It is a very challenging task, especially in small- and 
mid-size stocks, to find a counterparty, and in reality, given 
that everybody has adopted to today's market structure, the 
other large size has already been broken up before it can find 
a counterparty, and so people have simply adopted to the way 
that the markets have brought some of the benefits of 
competition, but the challenge of fragmentation is that these 
orders are not coming to the market in their original large 
size very often.
    Senator Shelby. Mr. Lauer?
    Mr. Lauer. Yes, I completely agree. I think the main issue 
with that is fragmentation, and when you have broker-operated 
dark pools and brokers incentivized to rest these large orders 
in their dark pools, you have all of these shallow pools 
sitting around and nobody able to find each other. ``Ships 
passing in the night'' it has been called.
    Senator Shelby. One last question. My time has gone, but 
how do you discern and differentiate between people looking for 
the edge in the marketplace, which they all are, as 
manipulation of the market itself? They are probably two 
different things. Sometimes maybe it is murky. Mr. Wittman?
    Mr. Wittman. Yes, you know, your question takes me toward 
the HFT angle a bit and Senator Warren's comments earlier. You 
know, with HFT, I would look at it more as high-frequency 
market making. You have got to take a look at not that they are 
latency sensitive if they are HFT labeled, but what are they 
actually doing with their algorithms? Are they doing something 
nefarious? Are they doing something across markets? Are they 
trying to push a market or do something else in the equity 
market? We have the opportunity to run and equity and options 
markets, so what are the relationships between what they do in 
equities and options?
    So it is not the fact that they are latency sensitive or 
they have got a tag of HFT. They are putting capital at risk. 
They are making markets for others to trade at on exchange, 
which is different than a dark pool. They are not accessible. 
So I think that is what the difference is. We have got to take 
a look at from a surveillance perspective, what are their 
algorithms doing, how are they behaving, and look at that 
behavior.
    Mr. Lauer. I think surveillance is just a critical issue, 
and it is something that has been very underinvested in, and 
even with the amount of investment, there has not been 
innovation. So one of the ideas that I put forward in 2012 was 
to have an open platform where people could design manipulation 
detection algorithms for prizes, and you would have 
participants competing over better and better algorithms to 
find that type of behavior, and either there could be a stake 
put up or they could have a percentage of fines collected. I 
think creative solutions like that--and I am sure there are 
better ones out there--are the way--that is the way forward in 
trying to understand the activity in the market. It is not 
going to come from individual regulators or even individual 
people. It has got to come from the marketplace and from the 
expertise that you have from practitioners. You know, if you 
had--you cannot tell me that regulators, for example, can 
understand nuanced mathematical manipulation across the 
treasury yield curve, for example, but there are certainly 
practitioners out there who could. The same could be said for 
cross asset class manipulation as well.
    Senator Shelby. But all markets would work better with 
integrity and a perception of integrity in the market, would 
they not?
    Mr. Ratterman. I absolutely agree. Perception is vital to 
people's confidence. Whether it is actually as solid as people 
think or if they think it is not, the perception is what drives 
the investment decision.
    If you do not mind, I would just like to throw out three 
additional points here. One is that I do believe that we have a 
competition amongst regulators with regards to surveillance, 
and maybe that is not talked about enough. But each of NASDAQ 
and NYSE and BATS and Chicago in the equity markets--those are 
the four equity market operators--have their own separate 
surveillance technologies, each of which has been developed 
independently and looking for not only on-market but across-
market surveillance problems.
    In addition--and I would like to give more credit to the 
SEC's MIDAS system and Gregg Berman and their efforts there. 
You know, that system has actually taken every single direct 
feed from every single electronic book as well as the SIPs, the 
consolidated tape, and has done comparative analysis of the 
numbers and the flow and been able to produce what I think are 
some very insightful discoveries about the functioning of our 
equity markets.
    Then, finally, while it is taking probably longer than it 
should, there is an effort by the industry the SEC led with the 
SROs to create the consolidated audit trail. That will get 
done. It will have all the data so that multiple regulators can 
peek inside for true cross-market surveillance with a 
competitive angle to it. So I see a lot of light down the road.
    Senator Shelby. Thank you, Mr. Chairman.
    Senator Reed. Thank you very much.
    Mr. Lauer, in your 2012 testimony and again today, you 
talked about the central role that has to be developed for 
comprehensive surveillance. Do you believe that we need an 
legislative initiative to give the SEC the authority to do 
that? Or is that something within their authority today?
    Mr. Lauer. I cannot say I know the regulatory authority 
rules well enough, but it does seem like something needs to be 
done to get different agencies working together. Whether that 
is legislative or through FSOC and OFR or just sitting them 
around the table, I think it is a critical issue.
    Senator Reed. And Mr. Ratterman has made comments about 
MIDAS, and I think you in your testimony also commented on 
MIDAS. Can I have your view?
    Mr. Lauer. Yes, and I do not mean to denigrate the work 
that the SEC is doing, but there is no arguing with the fact 
that MIDAS is missing over half of the activity just in 
equities markets. They do not receive the resting orders on 
dark pools, hidden orders on lit exchanges, immediate or cancel 
orders that do not interact with liquidity on lit exchanges, 
certain characteristics of exotic order types. There are no 
participant IDs. It is a system that any private firm would 
build in order to study markets, and that is exactly what 
happened, is that it was built by a private firm, an HFT firm 
that also builds out infrastructure. And I do not, you know, 
say that in any way other than to say they probably understood 
the technology best, but in my mind regulators should have 
better technology than participants. And I think that when you 
are talking about feeling confident and comfortable that 
regulators are on the beat and are on top of things, that is 
one of those areas in which you would have expected them to do 
more than just build what any other private firm has.
    Senator Reed. And I will make the obvious point that the 
regulators have a much more limited IT budget than any one of 
the participants. We tried to fix that a little bit, but we 
have not gone as far as we think we must.
    An interesting point, and it goes to this discussion of 
Senator Shelby and Senator Warren, about confidence in the 
market. The market has changed. I mean, the old-fashioned, 
nostalgic view of the stock market is capital formation. That 
is where you form capital, which ultimately created jobs. And 
now it is about trading.
    John Bogle, who will know more about this stuff than I will 
ever, made a speech a few months ago, in April, and he said, 
you know, the numbers tell the story: $56 trillion per year in 
trading volume as investors buy from and sell to one another, 
minute after minute, day after day, year after year. That $56 
trillion of trading volume dwarfs the capital formation total 
of $270 billion. Result: Short-term trading on the Wall Street 
casino represents 99.5 percent of the market's activity, and 
long-term capital formation, which is the small investor 
putting money in hoping that someday it will pay for college 
for the kids is just a sideshow, really. And that I think is 
becoming a reality that people appreciate. They are looking at 
this--and high-frequency traders are the ones that have got the 
most sort of attention at the moment because of the book and 
because of other things, but the market itself is--you know, as 
he says, it is a casino. And I think people are getting that 
impression.
    Then, of course, you have got two recent suits by FINRA and 
by the Attorney General of New York questioning the operations 
in dark pools.
    So all this is coming together for the perception that--as 
I say, this skepticism about the market working for long-term 
capital formation, which is--so I will just get your comments, 
Mr. Lauer, and then----
    Mr. Lauer. Yeah, I agree. I think it is unfortunate----
    Senator Reed. And I must say the FINRA--the FINRA was a 
settlement without acknowledging any malfunction. The suit by 
Schneiderman is an allegation now. It has not been concluded.
    Mr. Lauer. Yes, I agree with you, Senator Reed. I think it 
is unfortunate, the perception of the industry. I know a lot of 
people in it. They work really hard, and, you know, a lot of 
people are trying their best to help fix things or to make it a 
little simpler, reduce complexity. But there is an ongoing 
debate over market structure, and you have several different 
parties, but there are people in the industry, very well 
regarded, who understand markets and do not think that things 
are right. They think that there are problems that need to be 
fixed. Even people who think that markets are better than they 
have ever been agree that there are serious problems that need 
to be addressed.
    And so when that is the message that comes out, it is no 
wonder that perception is where it is, and I think that if we 
had more data, if there were much clearer answers, the issues 
that we were debating would not be as severe. We would be able 
to have clearer answers, and that is the frustration, because I 
know the answers are out there. It just seems like the data is 
not being analyzed.
    Senator Reed. Mr. Ratterman, please.
    Mr. Ratterman. Senator Reed, I think you are right to point 
out the difference not only in function but in the notional 
side of capital formation versus price formation. And, you 
know, from my perspective, as both an operator of an exchange 
as well as an individual investor, I look at those as very 
different activities, and I try not to conflate them.
    You know, when I think about capital formation, I think 
about small companies trying to raise money to, you know, grow 
their operations or, you know, whatever they are going to do 
down the road. And they need that money from investors, and 
investors typically would be institutional investors that are 
providing the funds for these growth companies, I think, as 
opposed to individual investors. I myself am just too risk 
averse to want to invest in an IPO. I would rather see a track 
record before I invest.
    So I think that market structure is probably maybe one 
element of maybe a friction for capital formation and the fact 
that maybe small-cap and medium-cap stocks are not as well 
handled in today's one-size-fits-all market structure. Things 
like the tick size could potentially, you know, help 
institutional investors feel a bit more confident to enter and 
exit a position in a small-cap stock, which would then 
encourage small-cap companies to come to market.
    I think there might be other things to look at as well. You 
know, it could be that the weight of being a public company, 
given other regulation, completely outside the equity markets, 
Sarbanes-Oxley compliance, et cetera, you know, may be a factor 
in determining whether a company goes public or not. I am not 
saying you should do away with Sarbanes-Oxley. I am just saying 
that there is a balance between the security of a company who 
has gone through those rigors and the weight that it carries in 
the decision to go public or not to go public.
    So when I look at price formation as the larger of the two 
notional values, you know, I look at it as an individual 
investor. When I go to trade a stock that I can see a track 
record, there is somebody standing there day in and day out 
willing to take the other side of my trade, and that is the 
trading, I think, that happens in the secondary markets that is 
beneficial to the investor who is not risk averse--who is risk 
averse, who does not want to invest in IPOs, but wants to 
invest in companies with a track record. That is where you can 
go and find the standing market day in and day out.
    Senator Reed. Mr. Wittman, please.
    Mr. Wittman. The amount of trading that is taking place in 
the top 50 or 100 issues, it is all consolidated up in those 
names. So the more, I think, that we see trading take place 
off-exchange, the less liquidity we are going to have in these 
lower small-cap names. The exchanges are providing indicative 
prices to the public. They are on-screen. But for the most 
part, when it comes to customer flow, that flow is executing 
off of an exchange. It is using indicative pricing from the 
U.S. exchanges and executing off-exchange and reporting through 
a trade reporting facility, which in the end I think is going 
to hurt the capital formation and price discovery.
    Senator Reed. Thank you.
    Senator Crapo, any questions?
    Senator Crapo. No.
    Senator Reed. There are no further questions. Gentlemen, 
thank you for your excellent testimony, and this hearing is 
adjourned. Thank you.
    [Whereupon, at 12:11 p.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]
                PREPARED STATEMENT OF SENATOR JACK REED
    Thank you, Mr. Chairman. In 2012, Senator Crapo and I, as the then 
Ranking Member and Chair of the Securities Subcommittee, held two 
hearings on Computerized Trading, taking a critical look at what the 
rules of the road should be. And in one sense, not much appears to have 
changed because we're still asking the questions we asked back then. 
Are our markets still fair? Is everyone playing by the same set of 
rules? And are our markets focused on long-term capital formation and 
the creation of jobs?
    Given the complexity of our markets and the pace at which 
technology is advancing, these are questions we will ask with 
regularity in order to ensure that we continue to harness the 
advantages of technology and minimize, to the best of our ability, the 
errors that technology can magnify in our markets. Our capital markets 
are a public good, much like our interstate highway system. While no 
analogy is perfect, I do believe that we need clearer rules of the road 
here in our markets, and as the markets continue to evolve, the 
regulators and we must keep pace to ensure that our markets are fair, 
accessible, and effective.
    Before I conclude, I would like to apologize ahead of time for 
missing the first panel of witnesses due to a closed hearing on the 
situation in Iraq and Afghanistan in the Armed Services Committee, on 
which I also serve. I will, however, return for the second panel of 
witnesses before the Banking Committee today. Thank you, Mr. Chairman.
                                 ______
                                 
                 PREPARED STATEMENT OF JEFFREY SPRECHER
           Chairman and CEO, Intercontinental Exchange, Inc.
                              July 8, 2014
     Chairman Johnson, Ranking Member Crapo and Members of the 
Committee, my name is Jeff Sprecher and I am the founder, Chairman and 
Chief Executive Officer of Intercontinental Exchange, or ICE. We very 
much appreciate the opportunity to appear before you today to share 
with you our views on the U.S. equity markets.
    As background, ICE was established in 2000 as an over-the-counter 
(OTC) marketplace with the goal of providing transparency and a level 
playing field for the previously opaque, fragmented energy market. In 
the past 14 years, we have grown our business substantially from a 
startup company in Atlanta to a global company with 11 exchanges and 
five central clearing houses in the United States, Europe and Asia.
    Much of our growth can be attributed to solving complicated 
problems by investing in existing businesses and making them more 
efficient and transparent to the benefit of our clients and the broader 
marketplace. We have inevitably faced headwinds as a result of 
challenging the status quo but believe strongly that our vision, 
together with our ability to work with regulators and customers, is 
what has allowed us to be here today.
    In November of last year, ICE completed its acquisition of NYSE 
Euronext. I quickly learned that operating an equities exchange comes 
with a much higher profile given the public price discovery function it 
performs. Combined with the New York Stock Exchange's role in the 
global capital markets, we understand the strong public interest and 
economic importance of well-functioning markets. Meeting with 
participants from every corner of the securities market, it is clear 
that the business has changed in less than 10 years. While some of this 
change has been beneficial, the equities market has become far more 
complex and fragmented than participants want it to be, and that we 
believe it needs to be. We believe competition among trading venues is 
important to markets, but also that there are other equally important 
factors, such as the ability of buyers and sellers in a marketplace to 
meet and compete with each other.
    Although we may not all agree on the details of an equities market 
structure, I think there are a few points of agreement among the 
panelists today worth highlighting. First, the capital markets are a 
critical tool that businesses need to permit investment in new 
companies and to expand existing ones. Second, one of the most 
important factors in maintaining a strong capital market is the trust 
and confidence of issuers and investors that the market will be fair. 
And third, in our current markets, investors--particularly individual 
retail investors--enjoy greatly improved, cost-efficient access to the 
stock market.
    ICE, however, believes that because markets are not stagnant, there 
are improvements that can be made in response to the market's evolution 
that will benefit investors and market intermediaries if we simplify 
the structure and realign incentives to improve the fairness of markets 
to investors.
    There are several issues we have raised and continue to question. 
For example, we do not believe it is fair that some investors are 
permitted to trade in dark markets without either first interacting 
with lit markets or providing some tangible benefit to the investor 
such as meaningful price improvement or size improvement. We question 
whether the maker-taker pricing model used by trading venues to 
compensate liquidity providers adds to the complexity problem and 
increases the appearance of conflicts of interest that brokers face in 
executing trades on behalf of clients. We also have concerns about the 
rising level of fragmentation and believe that the increased technology 
cost and risks that are born from maintaining connections to as many as 
60 trading centers is unnecessary and ultimately increases costs to 
investors.
    While Regulation NMS sought to increase competition among markets 
and consequently increased fragmentation, the costs associated with 
maintaining access to each venue, retaining technologists and 
regulatory staff, and developing increasingly sophisticated risk 
controls are passed on to investors and result in unnecessary systemic 
risk. The fragmentation also decreases competition among orders. Orders 
routed to and executed in dark trading centers do not interact or 
compete with other orders, which detracts from the price discovery 
function that participants in lit markets provide. The lack of order 
competition in a fragmented market negatively impacts markets in the 
form of less liquidity, information leakage and wider spreads.\1\
---------------------------------------------------------------------------
    \1\ Securities Exchange Act Release No. 51808, 70 FR 37,533, 37,608 
n.990 (June 29, 2005) (Reg. NMS Adopting Release); Request for Comments 
on Measures to Improve Disclosure of Mutual Fund Transaction Costs, 
Investment Company Act Release No. 26,313, 68 FR 74,820, 74,822 (Dec. 
24, 2003); Daniel G. Weaver Study available at: http://www.sec.gov/
comments/s7-02-10/s70210-127.pdf. John McCrank, ``Dark Markets May Be 
More Harmful than High-Frequency Trading'', Reuters, April 6, 2014 
(http://www.reuters.com/article/2014/04/06/us-dark-markets-analysis-
idUSBREA3508V20140406).
---------------------------------------------------------------------------
    Excessive complexity also hurts market confidence and I believe 
deters some investors and entrepreneurs from accessing the public 
markets. Although there has been an uptick in IPOs recently, 
entrepreneurs don't seem as positive about taking their company public 
as they used to be, which limits job creation and economic growth. And 
investing in the market is the best available option that millions of 
Americans have to grow their savings. We need a resilient, long-term 
investor base that believes the markets are fair, operate on a 
sufficiently robust infrastructure and have minimal intraday 
volatility. And maintaining minimal intraday volatility is often a 
result of sufficient order competition.
    As we highlight below, there are several items that we believe, if 
addressed, would help fix many of the cracks that have been brought to 
our attention since entering the equities business. However, the goal 
of our recommendations is largely grounded in the same goals as 
Regulation NMS: To increase competition among individual markets and 
competition among individual orders; and to minimize the transaction 
costs of long-term investors and thereby reduce the cost of capital for 
listed companies.\2\ While NMS achieved its goal of increasing 
competition among markets,\3\ the pendulum has swung too far at the 
cost of less competition among orders.
---------------------------------------------------------------------------
    \2\ Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 
37498, 37501 (June 29, 2005) (Reg. NMS Adopting Release).
    \3\ There are currently 13 equities exchanges, none of which 
maintains more than 20 percent of consolidated average daily volume.
---------------------------------------------------------------------------
    To correct these trends and rebalance the tradeoffs of yesterday, 
we believe now is the time to take action to build the confidence of 
individual investors and companies seeking to access the public markets 
and to bring back the balance set out in the Securities Exchange Act of 
1934.
    While we should move forward expeditiously with pilot programs, 
where data gathering and analysis is necessary, my firm has outlined 
the following recommendations for the industry that we believe should 
be quickly adopted:

  1.  We should enhance order competition by giving deference to 
        regulated, transparent trading centers where orders compete and 
        contribute to public price discovery information. Limited 
        exceptions could apply for those with unique circumstances.

  2.  We should eliminate and ban maker-taker pricing schemes at 
        trading venues. Rebates that were used to encourage 
        participants to quote on regulated, transparent markets add to 
        complexity and the appearance of conflicts of interest.

  3.  We should lower the statutory maximum cap on exchange fees. 
        Regulation NMS set a cap of what regulated transparent markets 
        can charge to access a quote. In combination with giving 
        deference to regulated, transparent markets and eliminating 
        maker-taker rebates, we believe that the SEC should require 
        lowered exchange access fees.

  4.  We should revamp the current market data delivery system. We 
        support the SEC taking a closer look at the current Securities 
        Information Processors and proprietary data feeds to adopt 
        policies that promote fairness.

  5.  We should require increased transparency in the way that markets 
        operate. The SEC should demand that all trading centers report 
        trade executions in real time, and all routing practices should 
        be disclosed by those trading centers and brokers who touch 
        customer orders.

    In summary, we believe that adopting these proposals will help to 
inspire confidence in the investing public in the U.S. capital markets. 
Thank you again for inviting me to testify today and I look forward to 
your questions.
                                 ______
                                 
                PREPARED STATEMENT OF KENNETH C. GRIFFIN
            Founder and Chief Executive Officer, Citadel LLC
                              July 8, 2014
    Chairman Johnson, Ranking Member Crapo, Members of the Committee, I 
am Kenneth Griffin, Founder and CEO of Citadel LLC. I appreciate the 
opportunity to testify here today and share our views regarding the 
state of the U.S. equity markets.
    Established in 1990, Citadel is a leading global financial 
institution that provides asset management and capital markets 
services.
    Citadel manages in excess of $20 billion in investment capital on 
behalf of institutional investors and high net worth families. As a 
significant investor in the U.S. equity markets, Citadel has a strong 
interest in the integrity, transparency, efficiency, and stability of 
our markets. Our equity research teams follow over 1,800 public 
companies, seeking to identify appropriate investment opportunities. 
Our equity research process, combined with our ability to execute upon 
our investment ideas in a cost-effective manner, enables us to deliver 
returns to the pensions, endowments, sovereign wealth funds and other 
institutions that entrust us with their investment dollars.
    Citadel Securities is one of the leading market makers in the 
United States, and is a market leader in the execution of orders on 
behalf of retail investors. Citadel Securities makes markets in more 
than 7,000 U.S.-listed securities and 18,000 OTC securities worldwide. 
Since 2005, we have used our automated trading systems to deliver 
greater reliability, innovation and service to retail investors. In 
short, we empower retail investors by deploying sophisticated 
technology with respect to market data, order routing, and execution 
strategies in providing best execution.
    Our capabilities allow us to deliver faster, more reliable and 
lower-cost trades for millions of retail investors. This has made us a 
trusted and valued resource to most of America's major retail brokerage 
firms. Our continued investment in people, compliance, process and 
technology earns us business on the merits, and I am proud to say that 
our continued growth is evidence of the enormous commitment we have 
made to support the interests of retail investors.
    Citadel's experience as both an institutional investor and an 
active liquidity provider in the U.S. equity markets gives us deep 
insight into the strength, structure and resilience of our equity 
markets. From that vantage point, I can state without hesitation that 
the U.S. equity markets are the fairest, most transparent, resilient 
and competitive markets anywhere in the world.

                                *   *   *   *   *

    The U.S. equity markets play a fundamental role in our economy. 
They facilitate capital formation by channeling savings into productive 
enterprises, creating a win-win for American investors and businesses, 
both small and large. The more efficiently our markets operate, the 
greater the benefit to the investing public and to the enterprises that 
rely on them to fund the growth of their businesses.
    In recent months, some have questioned the fairness of U.S. equity 
markets. They have raised serious questions about the changes that have 
taken place in our markets. They have called into question the motives, 
and in some cases even the integrity, of market participants, 
exchanges, regulators and virtually everyone else who has introduced 
the changes that have unleashed competition and revolutionized the way 
our securities markets work.
    It is my intent today to respond to this criticism, and to separate 
fact from fiction.
    Over the past two decades, a wave of innovation has swept through 
the markets in response to new technologies and thoughtful regulation. 
This has disrupted the ``old boys' network'' to the benefit of all 
investors. While the basic function of the stock market--matching 
buyers and sellers--remains the same, the mechanisms through which 
buyers and sellers come together has been revolutionized. In the 
supposed ``good old days,'' much of the trading in a given stock 
happened on the trading floor of a single stock exchange in a single 
specialist post under the control of a single specialist.
    In recent years, regulatory changes combined with technological 
innovation have disrupted the old order. Today's markets are incredibly 
competitive, wherein a variety of competing trading venues have emerged 
alongside the exchanges. Orders are now matched and executed by 
computers and a new generation of analytically driven and 
technologically sophisticated market participants has emerged as the 
dominant liquidity providers, displacing the manual intermediaries that 
once controlled the markets.
    The unleashing of competition and surge in innovation has markedly 
improved conditions for all investors, who benefit from dramatically 
lower trading costs, improved market transparency and liquidity, and 
increased competition by liquidity providers. As a result, bid-ask 
spreads are substantially narrower, currently averaging less than 0.03 
percent for S&P 500 stocks, while displayed market depth for the 
average stock, measured as the value of the shares displayed on the bid 
and offer, is nearly triple what it was a decade ago.
    Fees and commissions are also much lower--retail investors can now 
trade for under $10 (down from $25+) and institutional brokerage 
commissions often are less than 2 cents per share (down from 6 cents), 
and can be as low as a fraction of a penny per share. Retail investors 
in particular have benefited--not only do they frequently get better 
prices than those publicly quoted, but they often get their orders 
filled at such prices for more size than is publicly displayed.
    The disruptive innovation that has taken place within the equities 
market has created winners and losers. While investors have clearly 
benefited, most legacy market participants have lost out. They simply 
cannot compete in today's hyper-competitive and incredibly efficient 
marketplace. And so we should not be surprised that they publicly yearn 
for the old days when they extracted disproportionate rents from 
investors on the basis of anti-competitive business practices.
    I applaud the regulatory efforts to ensure that U.S. equity markets 
continue to best serve the interests of all investors. In this regard, 
Citadel supports a data driven and comprehensive review of U.S. equity 
market structure, and we believe the SEC is taking constructive steps 
to gather and analyze relevant data and information, ensure the 
market's operational stability, and protect market quality and 
fairness.
    The SEC has implemented several measures to obtain the data it 
needs to evaluate market operations, quality, and performance. For 
example, the SEC has adopted the Large Trader Rule and the Consolidated 
Audit Trail framework, and has implemented the MIDAS system through its 
new Office of Market Analytics so that it may efficiently gather key 
data and analyze significant market events and trading activities. The 
financial crisis and the May 2010 ``Flash Crash'' illustrated the need 
for the SEC to be able to swiftly reconstruct and analyze market 
events. Moreover, as the SEC considers various reform ideas and 
assertions about problems with the current equity market structure, it 
needs a rich set of data to analyze methodically. That will ensure that 
the SEC has the best information available when making these critical 
decisions.
    With the balance of my testimony, I want to focus on a handful of 
ideas and concepts that I believe will further strengthen investor 
protections, further improve price transparency and market liquidity, 
and promote market resiliency in times of crisis.

                                *   *   *   *   *

Enhancing Market Quality
    Today's markets are more competitive and liquid, with lower overall 
transaction costs, than ever before. To further improve market quality, 
we must continue to take steps that encourage competition. Encouraging 
competition leads to greater price discovery and market liquidity and 
reduces both the cost of trading for investors and the cost of capital 
for American businesses. As we foster greater competition, we must 
continue to take steps to protect the interests of retail investors in 
our equity markets.
    I recommend the following proposals to enhance our market quality.
Take a Rational Approach to Tick Sizes
    The SEC recently ordered the exchanges and FINRA to jointly develop 
a pilot plan that would require certain stocks to trade in minimum 
price increments larger than the current one penny trading increment 
(the so-called minimum ``tick size''). We applaud the SEC for its 
efforts to gather hard data on this topic before embarking on any 
broader or longer term policy changes. We nonetheless remain concerned 
that widening tick sizes will artificially widen spreads and thus drive 
up trading costs for all investors without any tangible offsetting 
benefit to market quality.
    We believe that the SEC should instead focus on tick increment 
reforms that will both promote liquidity on displayed markets and 
reduce the cost of trading. Specifically, the SEC should establish a 
half-penny tick increment for the highest trading volume stocks trading 
under a specified dollar value. In many cases, the half penny shaved 
off the one-cent increment will go directly into the pockets of 
investors. And rather than having to go to dark pools to find mid-point 
liquidity in such stocks, smaller tick sizes would allow this liquidity 
to be displayed and readily accessed in the lit markets. This 
modification would thus bring substantially more of the orders and 
trades in these stocks to lit markets, and move them away from the dark 
markets.
Reduce Access Fees to Reflect Declining Transaction Costs; Broaden Caps 
        on Access Fees
    Under Regulation NMS, the charge to liquidity takers in today's 
maker-taker system is called an ``access fee.'' The current NMS maximum 
access fee of 30 cents per 100 shares is now significantly greater than 
the cost of providing matching services by the exchanges and should be 
reduced to reflect the current competitive reality. Exchanges are 
permitted to share the access fees they charge with liquidity providers 
in the form of exchange rebates. A meaningful reduction in the maximum 
access fee would materially reduce exchange rebates.
    In general, exchange rebates encourage exchanges and liquidity 
providers to be more competitive. Exchange rebates also reward and 
encourage displayed liquidity, which greatly benefits the price 
discovery process. Banning exchange rebates would dampen competition 
between exchanges and would result in less posted liquidity and could 
result in wider quoted spreads. The SEC has wisely focused on 
disclosure and other mechanisms to manage any potential conflicts of 
interest that may arise as a result of these fee structures. We believe 
a reduction in the minimum tick size for the most liquid low priced 
securities combined with a reduction in the maximum permitted access 
fee would serve the best interests of all market participants.
    More importantly, we urge the SEC to close gaps by adopting an 
access fee cap in important segments of the market that have no access 
fee cap. First, we urge the SEC to expand the access fee cap to include 
quotes that are not protected by Regulation NMS. Second, we urge the 
SEC to implement a parallel (and proportionate) access fee cap for sub-
dollar stocks. Third, the SEC should move forward with its proposed 
rulemaking to cap access fees in the options markets.
Reduce Regulatory Arbitrage Between ATSs and Exchanges
    In recent years, increasing amounts of trading has occurred on 
Alternative Trading Systems (``ATSs''). While public quotes on 
exchanges are available to all investors, this is not necessarily the 
case for liquidity present on ATSs. In fact, ATSs may refuse access to 
certain market participants, make available order types that will not 
interact with certain types of participants, give execution priority to 
certain market participants, and/or charge different fees to different 
types of participants.
    ATSs (which include dark pools) should be subject to anti-
discrimination rules comparable to those that apply to securities 
exchanges, and should be required to offer fair and impartial access to 
market participants. In particular, ATSs should only be allowed to 
determine execution priority based on the characteristics of an order 
(e.g., price, size, time of arrival), and should not be allowed to 
allocate executions based on the identity of the sender. For example, 
broker preferencing is a practice that has the potential to return our 
markets to the ``old boys' network'' of prior decades when who you were 
and who you knew mattered more than the merits of your order.
    Reducing the regulatory arbitrage between ATSs and exchanges will 
foster greater competition between the venues, and reduce the 
incentives to conduct business on the often discriminatory ATSs at the 
expense of our public markets.
Preserve the Transparent and Regulated Practice of Payment for Order 
        Flow
    We support the SEC's well-established policy of permitting payment 
for order flow for a number of reasons. First, payment for order flow 
is a transparent and regulated practice, whereby exchanges and market 
makers pay a fee to broker-dealers that route orders to them. If a 
broker-dealer receives payment for order flow, it must disclose this 
arrangement under SEC regulation, so that its customers may decide 
whether they want to continue to send their orders to the broker-dealer 
in light of the payment for order flow arrangements. Second, payment 
for order flow does not affect a broker-dealer's obligation to obtain 
best execution for its retail customers. Third, and perhaps most 
importantly, payment for order flow that is subject to a robust 
disclosure framework is far better and creates more accountability than 
opaque reciprocal business practices that would otherwise proliferate 
and could not realistically be prohibited.
Enhance Retail Investors' Transparency into Brokers' Execution Quality
    In an effort to ensure that investors are receiving the best 
execution possible, we believe the SEC should require brokers to 
publicly report consistent, standardized execution quality metrics in a 
way that allows investors to easily measure performance. We can empower 
retail investors with information about brokers' execution quality and 
position them to make better decisions, while also enforcing an 
important check on the brokerage community. Today, retail investors 
don't have access to all the information they could or should have, and 
can only see which destinations are utilized by their brokers, along 
with very basic information about payment for order flow arrangements. 
While retail investors may request more specific information regarding 
their orders, they have no way to compare the quality of the executions 
received by competing retail brokers.
    We recommend that the SEC require all execution quality reports to 
be comprehensive, understandable, accessible in a downloadable format, 
and published for at least 3 years. Investors can then track the 
quality of executions over time, and hold their brokers accountable. 
Moreover, the disclosure of payment for order flow could be enhanced by 
requiring that precise amounts of remuneration (hundredths of a cent) 
be disclosed as opposed to the current practice of providing rounded 
numbers in the reports (typically preceded by the phrase, ``less 
than'').
Increase Protections for Retail Investors Trading Odd Lots
    We recommend that the SEC amend applicable order protection rules 
to reclassify an odd lot to be an order for value of less than $500. 
Currently, any order for less than 100 shares is considered an odd lot 
and does not receive the same protections as the best round lot quote 
in the same stock. Because many stocks are trading at a high dollar 
value, many investors are being unnecessarily deprived of the benefits 
of protections received by round lot orders. For example, Google, 
ticker symbol ``GOOG,'' ended the month of May trading at over $550 per 
share. An investor placing a 50 share GOOG order is investing over 
$27,500--yet that investor's limit order is not protected from being 
traded through because it is considered an odd lot. As a result, quoted 
spreads are wider than they should otherwise be since this liquidity is 
not reflected in the protected quote. Given that odd lots accounted for 
nearly 5 percent of trading volume in 2013, odd lot status needs to be 
redefined and based on total order value, not share quantity.

                                *   *   *   *   *

Improving Market Resilience
    Operational soundness and stability are fundamental to the 
confidence that participants have in any market. Automation and 
computerized trading have dramatically improved these conditions. 
Previously, markets were notoriously opaque and errors and control 
breakdowns were the norm. Participants in manual markets, including 
Citadel, would routinely encounter workflow control issues, trade 
breaks, and delays in receiving fills and trade confirmations. Although 
some have chosen to reminisce fondly about the past, the reality was 
much different.
    In recent years, the SEC has taken important steps to further 
strengthen the stability and operational functioning of our markets. 
The Regulation SCI proposal, the adoption of Rule 15c3-5 on market 
access, and the post-``Flash Crash'' reforms addressing liquidity gaps 
through limit up/limit down and circuit breaker rules, along with more 
predictable clearly erroneous rules and the abolition of stub quotes, 
represent important progress.
    Those reforms, among others, have served to enhance confidence in 
our markets by minimizing the incidence of disruptive trading and 
managing and mitigating the consequences of any systemic trading 
malfunctions that do occur. Nonetheless, we recommend a number of 
additional measures to fully achieve the goal of greater market 
resilience.
Mandate and Harmonize Exchange-Level Kill Switches
    The SEC should require mandatory exchange-level kill switches, and 
ensure that exchanges have clear authority and responsibility to 
immediately block and stop activity that appears erroneous and so 
severe that it is likely to materially impact other members and the 
market. The activity of a large number of market participants 
intersects on exchanges and they are thus best positioned to 
efficiently and consistently monitor activity across a very large 
number of market participants.
    To cite one example, while NYSE detected erroneous trading activity 
by Knight Capital on August 1, 2012 within a few minutes, the erroneous 
activity continued for 30 more minutes. If NYSE had a kill switch in 
place, it could have halted Knight Capital's erroneous trading much 
sooner, and prevented disastrous results.
    While a number of exchanges have responded by implementing some 
kill switches, the kill switches that have been implemented to date 
suffer from certain weaknesses that have limited their effectiveness.
    First, they only provide market participants with the optional 
ability to set certain thresholds that may then trigger notifications, 
disable order entry, or cancel open orders. We should not rely on 
market participants alone to protect the market from their mistakes. 
Exchanges should still be required to implement and administer their 
own mandatory kill switches.
    Second, kill switches add latency to the processing of orders. As a 
result, firms that voluntarily use kill switches are disadvantaged 
because their orders reach the exchange more slowly than other market 
participants' orders. Kill switches offered by exchanges should be 
implemented in a manner that introduces no additional latency and 
promotes a level playing field.
    Third, kill switches are designed differently at each exchange. 
This lack of uniformity significantly reduces utility and efficacy 
because it requires significant resources to properly configure and 
maintain overlapping and inconsistent kill switch parameters at each 
exchange.
Remove Exchange SRO Powers and Immunity
    The special status of exchanges as SROs that have regulatory 
authority over their broker-dealer members, combined with a history of 
limited liability, has created a conflicted and weaker market structure 
than is optimal for fair and efficient markets.
    Exchanges face an irreconcilable conflict of interest in the 
performance of their duties as SROs. This conflict of interest in the 
dual role of regulator and competitor has led to inconsistencies in the 
manner in which the exchanges regulate their members. On the one hand, 
public exchanges are bound by their fiduciary duty to maximize 
shareholder profits, while on the other hand, they are required to be 
fair and impartial regulators of the broker-dealers with whom they 
compete. Exchanges and broker-dealers have become direct competitors in 
many aspects of their businesses. For example, acute competition exists 
for order flow, order routing services, and the provision of 
algorithmic trading services. Yet, to a significant extent, exchanges 
are able to control the landscape on which they and broker-dealers 
compete for business.
    Further, as SROs, exchanges claim to be insulated from private 
liability for damages they might cause, based upon both a judicially 
created doctrine of ``absolute immunity'' and limitations on liability 
codified by their own rules. Limiting this immunity would increase the 
stakes for exchanges in connection with general culpability for 
operational failures. Facing liability for operational failures would 
give exchanges very strong financial incentives to invest heavily in 
steps to prevent or minimize the impact of operational failures.
Apply Regulation SCI to All Alternative Trading Systems
    All ATSs, most of which are dark, should be subject to proposed 
Regulation SCI. Regulation SCI, as currently proposed, would impose 
substantial requirements on how exchanges and the largest ATSs design, 
develop, test, maintain, and monitor systems that are integral to 
operational integrity. ATSs, which perform the same exact market 
function as exchanges, should be subject to the same standards as 
exchanges with respect to the issues covered by Regulation SCI. 
Proposed Regulation SCI would only apply to the largest ATSs, and we 
see no reason for this size limitation.
Balance Benefits and Costs of New Entrants to Check Fragmentation
    Regulation NMS and the foundational regulations that preceded it, 
along with technological advances, have helped unleash an enormous 
degree of competition among market centers. In recent years, however, 
the costs that each new market center imposes on the market in terms of 
additional complexity and operational risk have started to outweigh the 
marginal benefits of a new competing market center. The steps described 
above will help restrike this balance by requiring that market centers 
have sufficient resources and make sufficient investments in 
operational excellence. We expect that over time, this will reduce 
fragmentation by eliminating marginal market centers that rely on low 
cost of market entry and operation, externalization of the costs of 
catastrophic failure, and internalization of the profits of any 
success.

                                *   *   *   *   *

    To conclude, these are important steps that we should take to 
further enhance market quality, improve market resilience and 
strengthen investor protection. However, we must pursue this agenda 
without sacrificing the extraordinary achievements we have made in 
terms of market efficiency, lower costs, and increased fairness and 
competitiveness. We must not jeopardize the preeminent global standing 
of the U.S. equity markets.
    Thank you for the opportunity to testify before this Committee 
today.
    I would be happy to answer your questions.
                                 ______
                                 
                   PREPARED STATEMENT OF KEVIN CRONIN
                  Global Head of Trading, Invesco Ltd.
                              July 8, 2014
    Thank you, Chairman Johnson, Ranking Member Crapo and Members of 
the Senate Committee on Banking, Housing and Urban Affairs for the 
opportunity to speak here today. I am pleased to participate on behalf 
of Invesco at this hearing examining U.S. equity market structure. 
Invesco is a leading independent global asset management firm with 
operations in over 20 countries and assets under management of 
approximately $790 billion. Many of the investors served by Invesco are 
individuals who are saving for their retirement and other personal 
financial needs, including U.S. investors in defined benefit and 
defined contribution plans, such as 401(k) plans, IRAs and similar 
savings vehicles.
    Through its investment advisor affiliates, Invesco manages money 
for investors worldwide who seek professional participation in the 
markets, both directly and through vehicles such as mutual funds and 
ETFs. These are long-term investors who are saving for their 
retirements, to purchase a home or send their kids to college. These 
long-term investors are the cornerstone of our Nation's capital 
formation process, and retaining their confidence is fundamental to 
well-functioning U.S. securities markets, which are the envy of the 
world. To ensure long-term investor confidence, it is incumbent upon 
regulators and market participants to address issues raised by 
developments in the structure and operation of the U.S. equity markets, 
and we are grateful to this Committee for its attention to these 
important issues today.
    All who seek to maintain our U.S. equity markets as the most 
respected in the world should have a strong interest in ensuring that 
those markets are highly liquid, transparent, fair, stable and 
efficient. Those qualities create a level playing field for all 
investors, including ordinary American savers served by Invesco. In 
order to foster investor confidence and preserve robust liquidity, the 
regulatory structure governing our financial markets should promote, 
and not impede, those qualities.
    Today, due in large part to regulatory changes and developments in 
technology in recent years, there is robust competition among exchanges 
and alternative execution venues. These changes have spurred trading 
innovation and enhanced investor access to markets. Market 
participants, including Invesco, now have much greater choice and a 
higher degree of control in how and where to execute our trades. These 
changes have materially benefited investors in the form of lower 
commissions, spreads and implicit transaction costs, which in turn have 
enhanced the all-important liquidity of the equity markets.
    Unfortunately, some of these regulatory, competitive and 
technological changes have also brought unintended consequences, which 
have included un-leveling the playing field to a degree where certain 
sophisticated market participants can reap benefits at the expense of 
ordinary savers. We also are concerned that the one-size-fits-all 
approach of the current market structure fails to recognize the very 
real differences between trading large-cap stocks versus trading mid-
cap and small-cap stocks. These developments challenge investor 
confidence in the liquidity, transparency, fairness, stability and 
efficiency of the markets. These unintended consequences include the 
following:
Market Complexity and Fragmentation Have Negatively Impacted Investor 
        Confidence
    Many investors, including Invesco, believe markets have become too 
complex and fragmented, not because they need to be but rather because 
we have allowed them to become so. This complexity has contributed to a 
number of the technological mishaps over the past several years. These 
mishaps shake investor confidence in markets. While we commend the 
Securities and Exchange Commission (``SEC'') for the actions it has 
taken to address many of the structural issues relating to these 
events, it is important to recognize that today there are underlying 
structural issues that can give sophisticated participants an unfair 
advantage over ordinary investors.
    For example, exchanges sell co-location services to market 
participants that allow those participants to locate their servers in 
the same facility as the exchange's order matching engines and offer 
these participants direct data feeds from the exchange. These direct 
data feeds are faster than the indirect data feeds that other 
participants get from the Securities Information Processor. Because of 
this speed differential, co-located participants with direct data feeds 
can gain an unfair advantage over those participants that are not co-
located and do not receive direct data feeds, allowing the former to 
react more quickly to trading information. In our opinion, there is 
nothing more corrosive to investor confidence than allowing some market 
participants to have an unfair advantage over others.
    Today in the United States, there are 11 exchanges and over 40 
alternative trading systems in which investors can trade equities. The 
rules governing the exchanges are very different from those governing 
the alternative trading systems (e.g., ``dark pools''), a difference 
that can be very confusing to market participants. These different 
rules also have facilitated an un-level playing field that unfairly 
favors sophisticated participants over ordinary investors. Many of 
these execution venues offer economic inducements to broker-dealers and 
high-frequency traders to route their orders to them. A number of these 
destinations offer high-frequency trading participants complex order 
types (e.g., ``conditional orders'') that may enable them to detect the 
trading interests of other participants and then use that information 
to their advantage. In such a complex and fragmented environment, 
determining which execution venue will lead to the best trading outcome 
can be very difficult even for a firm like Invesco.
Conflicts of Interest Have Impacted Market Transparency and Fairness
    The robust price discovery that historically has defined our 
markets has been weakened as a result of the amount of trading activity 
occurring away from exchanges. It is believed that as much as 35-40 
percent of all trading activity in U.S. equities now takes place away 
from the exchanges. Much of the movement away from the exchange markets 
is a result of broker-dealer order routing practices including 
``internalization'' and the proliferation of specialized alternative 
trading venues, including ``dark pools.''
    The order routing practices of some broker-dealers raise a number 
of concerns for investors. For example, investors are not provided the 
information from broker-dealers needed to determine if they are 
receiving best execution within these dark pools. They are also given 
only limited insight into how and where broker-dealers route their 
orders. As a consequence, it is very difficult for investors to make 
informed decisions about the quality of executions they have received.
    Much of the problem can be traced to two inherent conflicts of 
interest. The first is a broker-dealer's interest in maximizing 
economic inducements by capturing liquidity rebates associated with the 
so-called ``maker-taker'' pricing model and by receiving payment for 
order flow from off-exchange market makers. The second is a broker-
dealer's interest in avoiding paying access fees to take liquidity from 
other trading venues. Under the current regulatory structure, a broker 
is incented to keep as many trades as possible within its own 
internalized systems, including within its own dark pools. These 
problems are not well-disclosed to clients, and yet they can drive 
brokers' order routing decisions that may be at odds with their 
clients' interest in obtaining best execution.
High-Frequency Trading and Market Liquidity
    There has been much discussion about high-frequency trading and its 
impact on trading markets. Today, there are a number of different types 
of participants within the marketplace who could be referred to as 
high-frequency traders. It is our view that high-frequency trading is 
not bad in and of itself, but there are certain trading strategies 
performed in connection with high-frequency trading that have the 
effect of being manipulative or disruptive. These can include using an 
information and speed advantage to trade ahead of other market 
participants. These strategies have arisen as a result of enabling 
technology, the fragmented structure of the markets and a lack of 
uniform regulation and market practices among trading venues.
    Changes to market structure have had a pronounced impact on the 
role of traditional market-makers and the evolution of electronic 
market-making. While there are today a number of market-makers and 
high-frequency market-making strategies that make markets in a number 
of securities, much of this appears to be focused on large-cap 
securities. While it is true that these high-frequency market-making 
strategies have increased trading volumes in many of these stocks, it 
is less clear that they are creating real liquidity. Moreover, the area 
of the market where market-makers have historically provided the most 
valuable liquidity--mid-cap and small-cap stocks--have not benefited 
from the evolution of market structure and the move to electronic 
market-making.
    To restore a level playing field in the markets--and, thereby, 
restore investors' confidence in the fairness and transparency of the 
markets--we believe it is time for regulators and market participants 
to address these issues. Invesco recommends the following improvements:

  1.  Require broker-dealers to provide much greater disclosure about 
        their order routing activities, their dark pool operations, 
        order types used and all other data required for investors to 
        make accurate determinations of execution quality. If there is 
        greater disclosure about how and where clients' orders are 
        routed and other necessary data for investors to make accurate 
        best execution determinations, investors will be able to make 
        much better informed decisions about how their brokers are 
        performing and, consequently, which brokers they should choose 
        to use.

  2.  Ensure that the dissemination of market data is fair to all 
        market participants. This could be achieved in a number of 
        different ways, including by eliminating direct data feeds, 
        slowing down the direct data feeds or through greatly enhancing 
        the Securities Information Processor's infrastructure to allow 
        it to transmit market data to participants at substantially the 
        same speed as the direct data feeds. It is in the nature of 
        competition that some participants will be able to process 
        information much faster than others, but these participants 
        should not be given unequal access to allow them to front-run 
        other investors' orders.

  3.  Eliminate the maker-taker pricing model and substantially reduce 
        access fee caps. We believe eliminating the maker-taker pricing 
        model--and, more specifically, the liquidity rebates provided 
        therein--and substantially reducing market access fee caps, 
        would remove certain inherent conflicts faced by broker-
        dealers. This would make it more likely that broker-dealer 
        activities will be performed in a manner and with an outcome 
        more consistent with their clients' best execution objectives 
        rather than their own pecuniary interests.

  4.  Harmonize the regulation of exchanges, alternative trading 
        systems and other trading venues. This will level the playing 
        field between ordinary investors and other participants and 
        ensure fairness, consistency and integrity to the trading 
        markets.

  5.  Require registration for all high-frequency trading participants 
        and the establishment of a uniform regulatory regime. The 
        activities and strategies employed by high-frequency traders 
        are sufficiently disparate, nontransparent and complex that a 
        reasonable first step in regulation would be to ensure that all 
        entities that engage in high-frequency trading be required to 
        register under a uniform regulatory regime that has the 
        resources and capabilities to detect and, where appropriate, 
        take action against any trading strategies that are deemed 
        manipulative or predatory.

  6.  Institute a comprehensive ``trade-at'' rule pilot program. The 
        trade-at rule would require any orders internalized by broker-
        dealers to provide meaningful price improvement. If material 
        price improvement cannot be provided, then those orders would 
        be routed to more transparent markets. Such a rule would reduce 
        broker-dealer conflicts and may result in much more robust 
        price discovery for investors. We recommend that the SEC work 
        with exchanges, investors and other market participants to 
        structure this pilot program.

  7.  Market-making participants, exchanges, issuers and investors 
        should work with regulators to facilitate market-making 
        activities by creating sensible, transparent incentives and 
        obligations for making markets generally, but for mid-cap and 
        small-cap stocks in particular.

    Invesco believes that these recommendations, if acted upon, will 
result in less complicated and more robust, highly liquid, transparent, 
fair, stable and efficient markets. They would address concerns of 
ordinary savers that otherwise threaten confidence in the integrity of 
the U.S. equity markets. We are highly encouraged by Chair White's 
recent speech outlining a number of initiatives that the SEC is 
considering to improve U.S. equity market structure. These initiatives 
will address many of the issues we have raised historically and are 
raising again here today. We also would like to commend the SEC for its 
recent action to establish a thoughtful pilot program to assess tick 
sizes for small company stocks.
    Thank you again for your attention to these important issues here 
today. I look forward to answering any questions you may have.
                                 ______
                                 
            PREPARED STATEMENT OF JAMES J. ANGEL, Ph.D., CFA
Associate Professor, Georgetown University McDonough School of Business
                              July 8, 2014
    My name is James J. Angel and I am an associate professor of 
finance at the McDonough School of Business of Georgetown 
University.\1\ I wish to thank the Committee for looking at these 
important issues and for asking me to appear before you. I have been 
asked to focus on the regulation, practices, and structure of the 
United States stock markets. I will begin with regulation.
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    \1\ My comments are strictly my own and do not necessarily 
represent those of Georgetown University or anyone else. From 2000 
through 2010 I served as an independent director on the board of 
directors of the Direct Edge stock exchanges (EDGX and EDGA). I was a 
Visiting Academic Fellow from 1999 to 2000 in residence at the NASD 
(now FINRA), and have served as Chair of the Nasdaq Economic Advisory 
Board. As an investor I practice what I preach in terms of portfolio 
diversification and hold a well-diversified stock portfolio that 
includes small investments in a large number of public companies, 
including most financial services firms. I also provide expert 
consulting services to Government agencies, law firms, exchanges, 
financial services firms, and others.
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Regulation
    If Congress gets regulation right, then the regulators will make 
the right decisions on the details. Congress can then devote its scarce 
time to other important matters. If our regulatory system worked 
properly, Congress would not have to spend its time addressing minutiae 
(albeit important minutiae) such as the tick size in our financial 
markets.
    Money attracts thieves just like garbage attracts flies, and that 
is one of the reason why we need good cops to keep the bad guys out of 
our financial markets. We all benefit from fair and orderly markets 
that protect investors, supply capital to support economic growth, 
provide useful risk management tools, and promote economic efficiency.
    Unfortunately, the United States has an extremely fragmented 
financial regulatory structure. There are literally hundreds of 
different financial regulatory agencies at the State and Federal level. 
As we learned in the financial crisis, many items can fall through the 
cracks and the different regulatory agencies do not always play nicely 
with each other, to say the least.
    Congress attempted to address many regulatory issues in the Dodd-
Frank and JOBS Acts. However, these Acts did not really address the 
structure of our regulatory system, which is badly in need of reform. 
Here are just a few of the symptoms of dysfunction in our regulatory 
system:
1. The JOBS Act could and should have been done by the SEC with its 
        pre-existing authority.
    In 2012, Congress passed the JOBS Act with a broad bipartisan 
consensus in order to make capital more freely available to growing 
enterprises and thus create more jobs. Among other things, the JOBS Act 
temporarily reduces regulatory burdens for newly public ``emerging 
growth companies,'' reduces restrictions on private share offerings, 
and provides a framework for crowdfunding.
    All of these provisions could and should have been done by the SEC 
using its pre-existing legislative authority. In particular, Section 36 
of the Securities Exchange Act gives the SEC broad powers to exempt 
particular entities or groups of entities from various rules. The SEC 
should have recognized the problems in capital formation that led 
Congress to adopt the JOBS Act and used its existing powers to do what 
the JOBS Act mandated. Yet it did not. As an institution, it was unable 
to recognize the problems facing our capital markets and craft 
appropriate solutions. Worse yet, the SEC has missed, perhaps 
intentionally, many of the mandated deadlines in the JOBS Act.
2. The implementation of the Volker Rule demonstrates the fragmentation 
        of our financial regulatory system.
    As part of the 2010 Dodd-Frank legislation, the Congress passed the 
so-called ``Volker Rule'' to prohibit ``proprietary trading'' by banks. 
Alas, our regulatory system is so fragmented that no less than four (!) 
agencies have had to engage in rulemaking to implement this 
provision.\2\ The rulemaking sausage factory has come up with an 
extremely complex and expensive rule. Similar evidence of fragmentation 
arises in the various swap rules in which the CFTC has the bulk of the 
responsibility and yet the SEC has to do rulemaking for the tiny slice 
in its jurisdiction.
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    \2\ See http://www.sec.gov/rules/proposed/2011/34-65545.pdf.
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3. Glacially slow responses by the SEC to apparent violations of 
        Federal securities laws hurt investor confidence.
    The old saying ``Justice delayed is justice denied'' is just as 
true now as it has always been. When investors perceive that little is 
done to enforce our securities laws, they lose confidence in our 
financial system. The lack of high-level prosecutions from the recent 
financial crisis is but one example.
    Even if our regulatory system is vigorously attempting to enforce 
the laws, the long delays between the observation of the alleged 
offense and any visible regulatory action create the impression that 
the SEC is incapable of properly enforcing our securities laws. Here is 
one example of which I have some personal knowledge:

    In April of 2013, W2007 Grace Acquisition I, (``Grace'') a Goldman 
Sachs controlled entity, filed an application with the SEC seeking an 
exemption from its registration requirements under the Securities Act 
of 1934.\3\ To make a very long story short, Grace was the successor 
company to Equity Inns, a publicly traded firm. Goldman led a leveraged 
buyout in 2008 that bought up the common shares of Equity Inns, but not 
the NYSE-listed preferred shares. Most of these preferred shares were 
held by retail investors, many of them senior citizens. Grace claimed 
that it had less than 300 shareholders of record, which permitted it to 
deregister its shares from the SEC and stop providing public financial 
information.\4\ One of the shareholders, a Mr. Joseph Sullivan, created 
a series of trusts in order to increase the measured number of 
shareholders ``of record'' over the 300 threshold, which would require 
Grace to once again file public financial statements with the SEC.\5\ 
Grace filed for an exemption, claiming that the Sullivan trusts should 
be counted as only one shareholder of record.
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    \3\ Disclosure: I own less than 100 shares of Goldman Sachs common 
stock as well as less than 100 shares of the preferred stock of W2007 
Grace Acquisition I. There are many more plot twists in this soap 
opera. See the SEC comment file 81-939 at http://www.sec.gov/rules/
other/2013/34-69477-application.pdf. Even if the SEC and FINRA are 
investigating allegations of various infractions, this should not stop 
the SEC from ordering the firm to resume its filing of public financial 
statements.
    \4\ Title VI of the JOBS Act reiterated the 300 shareholder of 
record threshold below which issuers could deregister from the SEC, 
which suspends their filing requirements. Under SEC Rule 12(h)(3)(e), 
if the number of shareholders ``of record'' of a deregistered issuer 
increases above the 300 threshold as of the end of its fiscal year, 
then the issuer has 120 days to resume filing.
    \5\ For the purposes of counting the number of shareholders ``of 
record'' to determine whether a company is required to file financial 
statements with the SEC, current interpretations of SEC rules do not 
count beneficial shareholders who hold shares in street name in 
brokerage accounts. Grace has well over 1,000 beneficial shareholders. 
It is quite odd that the SEC does not count retail shareholders who 
hold shares in street name in brokerage accounts when it determines 
whether a company has enough shareholders to merit required 
registration with the SEC.
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    It has been more than a year since this petition was filed, and the 
SEC has not announced any decision in the matter. It is my 
understanding that the SEC has not even bothered to contact Mr. 
Sullivan to examine the nature of his trusts. For the SEC to take over 
a year on this matter without even contacting the creator of the trusts 
to learn more about their nature shows a shocking slowness or 
sloppiness in its handling of the matter. However, my examination of 
the shareholder of record list indicates that there are and have been 
many more than the required 300 shareholders of record needed to 
require a resumption of its registration requirements even without the 
Sullivan trusts.\6\ Grace appears to be openly and flagrantly 
delinquent in its SEC reporting obligations, to the detriment of its 
preferred public shareholders. That the SEC has allowed this 
delinquency to fester leads to the suspicion that Goldman is getting 
the Bernie Madoff or John Mack treatment in this case. Even if the SEC 
in its infinite wisdom rules otherwise, this proceeding should not have 
been dragging on for over a year with no end in sight. This does not 
bode well for public confidence.
---------------------------------------------------------------------------
    \6\ For more details, see one of my comment letters at http://
www.sec.gov/comments/81-939/81939-41.pdf.
---------------------------------------------------------------------------
    I would like to emphasize that the problems with our regulatory 
structure are not the fault of the people who work there. Most of the 
people who work in these agencies are hard working and intelligent 
people who are honestly trying to do their jobs as best as they can. 
The problem is the structure of the regulatory system, and this is 
something that only Congress can fix. I will get to my suggested 
solutions at the end.
Practices
    Trading technology has changed dramatically in recent years, and 
there has been much controversy over various practices used in the 
financial markets. This section describes some of the controversial 
practices in financial markets.
Not all users of high-speed computers are the same.
    There has been much discussion lately of modern trading practices. 
Often all uses of high-speed computers are lumped into one catch-all 
phrase of ``high-frequency trading.'' ``High-frequency trading'' is a 
misleading catchall term. Some ``HFT'' practices help the market, and 
some hurt. This is why we need a regulatory system that is smart enough 
to tell the difference between the good and bad uses of high speed 
computers and that has the capacity to keep out the bad while not 
harming the good.
Market making and ETF arbitrage benefit low-frequency retail investors.
    Here is one example of a ``high frequency'' technique that is 
beneficial to low frequency retail investors like me. Many retail 
investors invest through exchange traded funds (``ETFs''), convenient 
basket products that allow an investor to buy part of a large basket of 
securities with a single trade. For example, an investor can buy a 
basket of all 30 stocks in the Dow Jones Industrial Average by buying 
the Dow Diamonds ETF. Retail investors can trade the ETF with the 
confidence that its price will closely track the price of the stocks in 
the index because arbitrageurs monitor the price of the ETF and the 
price of the stocks that go into the ETF. When the price of the ETF 
gets out of line with the price of the stocks in the basket, 
arbitrageurs swoop in to buy the cheap side and sell the expensive side 
in order to capture the difference. This pushes the cheap side up and 
the expensive side down, and thus pushes prices back into the proper 
alignment. Because this is such a simple strategy, it is easy to 
duplicate and there are many competitors. When an arbitrage opportunity 
arises, there is a race to take advantage of it. The first trader to 
trade wins, and the rest lose, even if they lose by only a thousandth 
of a second. Therefore, the traders invest in technology to speed up 
their trading by buying the fastest computers they can and then putting 
them as close to the stock exchange computers as they can get so that 
their orders will get to the exchange even faster.
     Traders use high speed computers to engage in a variety of other 
trading strategies as well. These include market making, a strategy 
similar to that of a car dealer who provides the service of convenience 
by buying at a trade-in price and selling at the retail price. The car 
dealer does not want to be a long-term owner of the car, but to sell it 
as quickly as possible. Likewise, market makers do not want to be long-
term investors, but they provide the service of immediacy to investors 
who want to buy or sell a stock quickly. By being willing to buy and 
sell at all times, they make sure there is a buyer when long-term 
investors want to sell and vice versa. Competition between market 
makers helps to keep transactions costs low for the long-term 
investors.
Other strategies are more controversial.
    Traders have been looking for trends in stock prices since the 
beginning of financial markets. Generations ago, ``tape watchers'' 
would gather in brokerage firms to watch the ticker tape and guess 
where prices were going. Later, chartists and day traders would do the 
same. These investors attempt to discern where prices are going by 
learning from the information that large investors leak when they break 
up large orders into many smaller trades. As the price and quantity of 
every stock trade in the highly transparent U.S. market become public 
knowledge immediately, every time one of these small pieces of a larger 
order trade, they are leaving clues about their future trading.
    Now, instead of standing in brokerage firms and reading a paper 
ticker tape, some traders use computer programs to guess which way 
prices are going. Some would call these predictive traders 
``predatory'' traders as they seek to gain from the stock price 
movements caused by larger traders. It is a myth, however, that such 
traders ``see'' institutional orders before they hit the market. Such 
traders merely guess at the direction of future stock price movements 
based on the data that are available to anyone who wants to pay for it.
    Here is an example known as ``latency arbitrage.'' Suppose that 
there are two stock exchanges that are 25 miles apart. It takes about 
one hundred microseconds (millionths of a second) for light, and thus 
information, to travel from one exchange to the other by the fastest 
route. Both exchanges are offering to sell 5,000 shares at $20.00 per 
share. Suddenly someone buys all 5,000 shares available on the first 
exchange, and now the only shares available for sale on the first 
exchange are priced at $20.01. At this point it stands to reason that 
if a sophisticated large trader has bought up all of the shares on the 
first exchange, then prices are going up. Those 5,000 shares that are 
offered on the second exchange might still be available, and whoever 
buys them will make money as the price goes up. Indeed, the large 
trader who bought up all the shares on the first exchange may well be 
on his or her way to try to buy up the shares on the second exchange. 
Now the race is on. Traders use the fastest computers and communication 
links they can to rush to the other exchange and buy up the cheap 
shares there before anyone else does. If the large trader is using a 
slow communication line, the fast trader may well arrive at the second 
exchange in time to scoop up the available shares at $20.00, leaving 
none behind for the large trader whose order initiated the transaction.
    These high speed traders use a variety of techniques to trade as 
fast as possible. Not only do they buy the fastest computers they can, 
they try to locate them as close as possible to the computers used by 
the stock exchanges to process trades, a process known as co-location. 
They subscribe to the fastest data feeds possible, the direct data 
feeds offered by the exchanges, and transmit their orders using the 
fastest data lines they can.\7\ There has been a considerable hue and 
cry over the fact that some investors pay for faster data feeds than 
other investors receive. The important fairness consideration is to 
make sure that such high speed data feeds are available on 
nondiscriminatory terms to all market participants.
---------------------------------------------------------------------------
    \7\ The direct feeds are faster than the consolidated data feed 
that contains the data from all of the exchanges. The consolidated data 
feed will always be slower because it takes time for the information to 
travel from the exchange that created it to the point of consolidation 
and to be consolidated into the data feed.
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    As a low-speed low-frequency investor, I am not concerned that 
some, if not most, market participants have faster computers and faster 
data feeds than I do. My trading strategies, like those of most retail 
investors, are not based on reacting instantaneously to news or other 
information, but instead on longer-term buy and hold strategies. As I 
am not racing to react faster than other participants, I do not care 
that other high-speed investors are racing with each other.
Some uses of high speed technology are just plain bad.
    I will not argue that all uses of high-speed computers are 
necessarily good. Manipulators can use fast computers as well. One 
manipulative strategy is known as order ignition. Here is an example. A 
computer program (known as an algorithm, or ``algo'') searches for a 
stock where the amount of buy orders seems unusually small and the 
stock seems vulnerable as a result. Then the algo puts in a large short 
sale order with the intent of pushing down the price in order to 
trigger ``stop'' orders, orders to sell after a stock has dropped below 
a specified price. The triggered selling of the stop orders causes the 
stock to drop further, at which time the algo kicks in and buys the 
stock back to cover the short at a profit. Such manipulative trading is 
antithetical to a fair and orderly market.
Maker-taker pricing
    The current pricing system used by most stock exchanges is usually 
called ``maker-taker'' pricing. The exchanges charge a fee to market 
orders because they ``take'' liquidity and pay a rebate to a limit 
order that gets filled because it made liquidity. For example, suppose 
a customer puts in a limit order to buy 100 shares of BAC at a price 
not to exceed $15.00 per share. Later, another customer market order 
comes in and is matched with that resting limit order. Under typical 
exchange pricing schedules, the market order would pay the exchange 30 
cents and 28 cents of that (93 percent!) is rebated to the resting 
limit order.
    I have long criticized maker taker pricing.\8\ It has created a 
number of distortions in the market, and I have called for its 
elimination or restriction. However, as I believe in evidence-based 
rulemaking, it would be appropriate to conduct a scientifically 
designed pilot experiment to examine the impact of reducing and 
eliminating exchange access fees. I believe that eliminating or 
reducing maker-taker pricing would greatly reduce the incentive for 
investors to send orders to some so-called ``dark pools'', as one of 
the advantages of such trading platforms is to avoid exchange fees.
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    \8\ See my comment letters to the SEC at http://www.sec.gov/rules/
proposed/s71004/jjangel012505.pdf and http://www.sec.gov/rules/
proposed/s71004/jjangel051904.pdf, as well as my joint articles with 
Larry Harris and Chester Spatt, Equity Pricing in the 21st Century and 
Equity Pricing in the 21st Century: An Update.
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Broker order handling practices
    The practices by which brokerage firms route customer orders are 
also controversial. Brokerage firms have a duty of ``best execution'' 
in handling their customers' equity orders.\9\ The SEC currently 
requires market centers to disclose execution quality statistics in 
Rule 605 and for brokerage firms to disclose how they route orders in 
Rule 606. However, these disclosures currently do little to inform 
retail customers how well their orders are being filled. A better 
solution would be for the brokerage firms themselves to disclose 
execution quality directly to their customers.
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    \9\ I concur with SEC Chair White's comments that brokers should 
have a similar best execution requirement for retail fixed income 
orders. http://www.sec.gov/News/Speech/Detail/Speech/
1370542122012#.U7o0A_ldWSo.
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Exchange order types
    The proliferation of special order types at the stock exchanges has 
also been controversial. Critics charge that these order types create 
an unfair advantage as well as add complexity to the marketplace. 
However, they are available to all investors.\10\ The real question is 
whether they can cause the market to react in an unstable or otherwise 
undesirable manner. So far I have seen no evidence that they do.
---------------------------------------------------------------------------
    \10\ However, many retail trading Web sites are simplified to the 
point that they do not offer complex order types. Investors wanting to 
use complicated order types would have to go to brokerage firms that 
offer them.
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Tick size: Issuers should be allowed to choose their own tick size.
    The tick represents the smallest allowable price differences in 
stocks. Currently, the United States has a ``one tick fits all'' model 
with a tick size of one penny for all stocks over $1.00. Thus, brokers 
are allowed to accept orders at $10.00 and $10.01, but not $10.0001. 
The tick represents the smallest amount of money an investor has to pay 
to jump to the next level in the queue. A wider tick benefits patient 
traders who place limit orders, as investors would have to pay more to 
jump in front of them. However, a wider tick harms impatient traders 
who cross the bid-ask spread and trade with market orders and thus pay 
a higher transaction price. The optimal tick represents a tradeoff that 
results in a balanced ecosystem of liquidity takers and demanders. The 
optimal tick is not zero and not infinity, but somewhere in between. 
And it is not the same for all stocks.
    The SEC is currently planning a pilot study to examine the impact 
of different tick sizes on smaller stocks. This is good as far as it 
goes, as it will provide useful information with which to inform 
rulemaking. However, the big issue is ``Who decides what the tick size 
will be for various companies?'' I believe that each issuer should be 
able to select their own tick size, as they have the proper incentive 
to select a tick that provides optimal liquidity for their company. 
Neither the exchanges nor the SEC have the similarly powerful incentive 
to get it right.
The risks of technology: We are still vulnerable to major disruptions 
        like the Flash Crash.
    Most of the time our markets work well. Except when they don't. The 
Flash Crash of May 2010 is a case in point. I had warned the SEC in 
writing five times in the year before the Flash Crash that our market 
was vulnerable to such disruptions.\11\ Our market is still vulnerable. 
Our market is a complex nonlinear network. It is in the nature of 
financial markets that from time to time they are overwhelmed with 
tsunamis of trading activity that can overwhelm the capacity of the 
market network to produce fair and orderly prices. Complex networks 
that are pushed beyond their capacities fail in weird and strange ways 
that are difficult if not impossible to predict.
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    \11\ These are listed in my December 8, 2010 testimony to the 
Senate Committee on Senate Subcommittee on Securities, Insurance, and 
Investment and the Senate Permanent Subcommittee on Investigations. 
This testimony also contains a summary of the events of the Flash 
Crash. http://www.banking.senate.gov/public/
index.cfm?FuseAction=Files.View&FileStore_id=
a4f49d29-fe78-4ed9-839-3a6c09917298.
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    Subsequent to the Flash Crash, the U.S. equity markets instituted 
several types of circuit breakers:

  1)  The ``Limit Up-Limit Down'' system causes a short trading halt in 
        individual stocks if the market price moves outside of a 
        predetermined price band.\12\
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    \12\ See http://www.sec.gov/rules/sro/nms.shtml#4-631 for details.

  2)  The short sale circuit breaker restricts short selling at the bid 
        price for the rest of the day and the subsequent day if a stock 
        drops 10 percent below the previous day's price.\13\
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    \13\ See http://www.sec.gov/rules/final/2010/34-61595.pdf for 
details.

  3)  Market-wide circuit breakers halt the entire market for various 
        periods of time under various conditions.\14\
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    \14\ See http://www.sec.gov/rules/sro/bats/2012/34-67090.pdf. 
Indeed, note that the market-wide circuit breakers were done as rule 
filings by 16 separate SROs. See SR-BATS-2011-038; SR-BYX-2011-025; SR-
BX-2011-068; SR-CBOE-2011-087; SR-C2-2011-024; SR-CHX-2011-30; SR-EDGA-
2011-31; SR-EDGX-2011-30; SR-FINRA-2011-054; SR-ISE-2011-61; SR-NASDAQ-
2011-131; SR-NSX-2011-11; SR-NYSE-2011-48; SR-NYSEAmex-2011-73; SR-
NYSEArca-2011-68; SR-Phlx-2011-129. This is another example of the 
absurd fragmentation of our regulation among SROs.

    These are mostly improvements as far as they go, but there is still 
more work to be done.\15\ In particular, there is no evidence of any 
coordination in these efforts across the equity, options, and futures 
markets, despite the fact that the Flash Crash demonstrated the close 
interrelationships between these markets and the ease with which a 
disruption in one market can be transmitted to other markets. This is 
another example of the dangers caused by the fragmentation of our 
regulatory system.
---------------------------------------------------------------------------
    \15\ For more technical comments on circuit breakers, see my 
comment letter at http://www.sec.gov/comments/sr-bats-2011-038/
bats2011038-2.pdf.
---------------------------------------------------------------------------
    The current system deals appropriately with disruptions to the 
trading of individual stocks, although more refinement is needed for 
handling small stocks with wide bid-ask spreads. However, the system is 
totally untested in dealing with large market wide disruptions across 
multiple asset classes. The rigidity of the rules could also hamper the 
restart or lack thereof when the next tsunami hits the markets. And 
there will always be another one coming. We just don't know when.
Structure
The United States has a competitive, ``open-architecture'' equity 
        market structure.
    Many commenters use the pejorative term ``fragmented'' to describe 
the current U.S. market structure. This word has a negative 
connotation. Its synonyms include broken, shattered, splintered, and 
disorganized. It is anything but these. Our markets are better than 
they have ever been by traditional measures of transactions costs, 
speed of execution, intraday volatility, transparency, and certainty of 
settlement.
    However, the high quality of the U.S. markets does not imply that 
they can't get better. The fundamental trading problem has not been 
solved. Our market structure allows new market entrants to ideas for 
better trading systems to plug into our National Market System. This 
competition improves the breed.
    It should be noted that we have the market structure that Congress 
rightly decreed in 1975. In 1975, Congress passed the so-called 
National Market System amendments to our securities laws. In 
particular, Congress added Section 11A (a)(1)(c) to the Securities 
Exchange Act which called for a competitive market structure with 
competition among exchanges, broker-dealers, and other than exchange 
markets. And that is what we have today.
    Some complain that we have ``too many'' exchanges or other places 
to trade. Do we have too many supermarkets or gas stations to choose 
from? Normally we depend upon competition to provide incentives for 
efficiency and good customer service. The cost of trading is much lower 
in the hyper competitive equity space than in the highly concentrated 
futures industry.
A competitive market structure makes good economic sense.
    The logic behind a competitive market structure is simple and 
compelling. A monopoly exchange structure suffers from all of the 
normal problems of a monopoly. Even a not-for-profit monopolist will 
lack incentive to improve the product or to run the operation 
efficiently. A for-profit monopolist will charge high prices to the 
detriment of social welfare. In the olden days, the technology was such 
that the NYSE was an almost natural monopoly. As the saying goes, 
liquidity attracts liquidity, and the old NYSE had a huge network 
advantage over everyone else because it had the liquidity that 
investors sought.
    In order to prevent monopoly there is a need for competition. And 
the profit motive is a great motivator for competition. That gives us a 
world of competing for-profit exchanges.
    Fortunately, the computer revolution has changed the economics of 
the equity exchange business. An equity exchange is no longer a natural 
monopoly, but a hotly competitive enterprise. Low cost and high speed 
communications have neutralized most of the network advantage of the 
dominant exchanges, making it possible for entrants to enter the 
business.
    The United States is not alone in adopting this structure. Most 
developed countries are moving toward market structures in which for-
profit entities compete with each other. The European approach 
expressed in MIFID (Markets in Financial Instruments Directive) is an 
example.
    Some observers claim that the current market structure is a result 
of Regulation NMS, which was passed by the SEC in 2005. However, NMS 
merely codified and updated a number of rules. What was significant, 
was that it extended trade-through protection to NASDAQ-listed stocks, 
which did not have it before, and it provided trade-through protection 
only to orders that were electronically accessible, which forced the 
NYSE to more fully automate its systems.\16\
---------------------------------------------------------------------------
    \16\ A trade-through occurs when one exchange trades at a price 
even though another exchange was quoting a better price. I commented at 
the time, and still believe, that a trade-through rule that prevents 
trade throughs is unnecessary. The economic incentives pushing 
brokerage firms to get the best price for their customer are so 
overwhelming that they can and do go to the market with the best price. 
A trade-through rule just adds significant complexity to the market 
network with little improvement in market quality.

For the record, here is an oversimplified summary of NMS (CFR 
---------------------------------------------------------------------------
Sec. Sec.  242.600 through 242.612):

        Rule 601: All trades in NMS stocks must be reported to the 
        consolidated tape.

        Rule 602: Each exchanges best bids and offers must be reported 
        so that the consolidated National Best Bid and Offer (NBBO) can 
        be calculated.

        Rule 603. Brokers must display consolidated trade and quote 
        information to clients. They can't just give out the data from 
        only one exchange.

        Rule 604. Dealers must display customer limit orders to the 
        market.

        Rule 605. Market centers must report execution quality 
        statistics.

        Rule 606. Brokerage firms must report each quarter how they 
        route customer orders and what kind of payment for order flow 
        they receive.

        Rule 607. Brokers must disclose payment for order flow to 
        customers.

        Rule 608. Exchanges work together to form NMS plans.

        Rule 609. Securities Information Processors (SIPs) must 
        register on Form SIP.

        Rule 610. The access fee (take part of maker-taker) is limited 
        to $.003 per share. Locked and crossed markets are prohibited.

        Rule 611. Exchanges must have policies to prevent trade 
        throughs.

        Rule 612. The tick size for all stocks over $1.00 is $.01.

Recommendations to Congress
1. Start the debate to fix regulation.
    This will be a long and sometimes painful process that will take 
many years. Even though pessimists will say that nothing will be passed 
due to partisan gridlock, or that an SEC-CFTC merger is impossible 
because the various committees do not want to give up their oversight 
powers, we need to start the process now. Reform will not occur unless 
the debate begins.
    Congress should direct all of the Federal regulatory agencies and 
self-regulatory organizations such as FINRA to conduct thorough studies 
of the structure and effectiveness of regulation and make suggestions 
for reforms that 1) simplify the currently complex and overlapping 
regulatory system, 2) reduce unnecessary compliance costs, 3) provide 
usable rights of appeal for high-handed regulatory action or inaction, 
4) enhance consumer protection, and 5) enhance economic efficiency and 
capital formation. Although these goals sometimes appear to conflict, 
we need to start the process now.
    Congress should also fund a study similar to the U.K. Foresight 
project in which experts from around the world are invited to submit 
studies on the relevant topics.
    Of course, there should be lots of hearings as part of this debate.
    However, this process should also closely examine experience around 
the world. We did not invent financial regulation. We copied much of 
the U.S. system from the U.K. many years ago. Congress should 
explicitly study the experience of other countries around the world to 
see what we should do here. In particular, there has been a lot of 
fresh thinking in Europe as the Europeans struggle to harmonize their 
regulation, and we can learn from their debates as well.
2. Consider functional-based regulation.
    Currently, our regulatory system is a hodgepodge of institutional-
based regulators. However, financial services spill across these 
institutional boundaries, leading to many overlaps and gaps. We should 
seriously consider a functional-based system with regulatory bodies 
based on function rather than institution. We would thus have a markets 
regulator, a consumer protection regulator, a solvency regulator, a 
guarantee fund, and so forth.
3. The role of SROs needs to be rethought.
    This debate should include a thorough examination of the SRO model. 
The current SRO model came about as part of a political compromise 
during the creation of the SEC. The industry would regulate itself 
through exchange-based SROs, and the SEC would regulate the SROs. This 
moved part of the cost of regulation off the Federal budget, and 
provided some industry input into the result. Since the NYSE was the 
dominant exchange, it regulated exchange member firms and the NASD 
regulated the rest. This worked well for many years. However, in a 
world with competing trading platforms, there needs to be a market-wide 
regulator. Although FINRA has become the de facto market wide 
regulator, its role should be examined carefully.
4. Put the SEC and CFTC in the same buildings.
    The SEC and CFTC in particular should integrate their operations. 
Even if a full merger is not yet politically feasible, placing the 
agencies in the same buildings with shared common facilities will 
enhance cooperation between the agencies.
5. Move the locus of SEC/CFTC operations from DC to NY and Chicago.
    Our regulatory agencies have problems attracting enough good people 
with industry experience. These people are usually found in New York 
and Chicago, and are often unwilling to uproot their families for the 
kind of salaries the Government offers. By moving most operations to 
our financial centers, the SEC will be able to hire people who know 
where the bones are buried, and more closely and personally monitor the 
industry.
6. Fully fund the SEC budget with close oversight of how the money is 
        spent.
    We have been pennywise and pound foolish in how we fund the SEC. We 
have gotten what we have paid for. The sum total of every dollar spent 
on the SEC since its founding in 1934, even grossed up for inflation, 
is less than investor losses from one Bernie Madoff. A properly 
functioning agency will more than pay for itself with lower compliance 
costs for law abiding citizens, faster and more efficient capital 
raising, and fewer investor losses due to fraud. However, the SEC has a 
history of misallocating resources in the past. Congress should specify 
carefully where the money should be spent and follow up on the results.
7. Monitor the qualifications of the people in the regulatory agencies.
    One longstanding problem with the SEC is that it has plenty of 
lawyers but an insufficient number of people with other necessary 
qualifications. Congress should demand regular updates from regulatory 
agencies on the nature and qualifications of the staff. In particular, 
every time a regulator testifies before you, I suggest asking the 
following questions:

  a)  How many people are working on this issue?

  b)  How many of them have two or more years of industry experience?

  c)  How many of them have passed a FINRA exam such as Series 7?

  d)  How many of them have degrees in:

     a)  Economics or business?

     b)  Engineering or computer science?

  e)  How many of them have professional certifications such as CFA or 
        CPA?
8. Monitor the speed of execution, but watch out for games.
    One of the major problems with the SEC is the slow speed with which 
it operates. The slowness of its operations is a major impediment to 
investor confidence. While accuracy is more important than speed, speed 
is nonetheless important. The SEC's lawyer-dominated culture feels that 
the glacial progress of judicial and legislative processes is 
appropriate for regulation, when in fact it is wholly inadequate in the 
modern world. The SEC needs to have a cultural change so that it 
recognizes that delay is costly to the country.
    Congress has repeatedly attempted to address this issue by 
providing deadlines for the SEC to respond. The SEC repeatedly misses 
these deadlines with seeming impunity, while misallocating resources to 
other nonmandated areas. However, Congress needs to be very careful 
that the SEC does not play VA-style games with the numbers.
    Congress needs to demand statistics from regulatory agencies on the 
length of time that an agency is taking on various areas. For example, 
Congress should expect and pay attention to statistics on the status of 
mandated rulemakings, length of investigations in process, SRO rule 
filings, and no-action letter requests.
9. Create a Serious Fraud Office to prosecute criminal financial 
        offenses.
    It was a great disappointment to me and others how few criminal 
prosecutions occurred subsequent to the financial crisis.\17\ 
Currently, the SEC only has civil jurisdiction and must turn over 
criminal cases to the Department of Justice. However, DOJ has many 
other responsibilities, and it is understandable that terrorists and 
gangsters will be their top priority. A separate agency focused only 
with prosecuting financial fraud will be able to develop expertise in 
complex financial fraud will leaving financial fraud FBI et al. get 
distracted by going after terrorists and truly bad guys.
---------------------------------------------------------------------------
    \17\ See http://www.justice.gov/oig/reports/2014/a1412.pdf.
---------------------------------------------------------------------------
10. Encourage agencies to provide more status information to tipsters.
    The agencies should be encouraged to be more open with tipsters and 
complainants about the status of investigations. I can attest from 
personal experience that it is extremely frustrating to receive no 
follow up after submitting a tip. A simple follow up message to the 
effect of ``The case is still open'' or ``We plan no further action at 
this time'' would help to increase investor confidence in the integrity 
of the system by letting them know that something is being done with 
their complaints.
11. Open an investor advocate offices in or attached to every State and 
        Congressional district.
    As Members of Congress, you are well aware of the numerous 
complaints that you get from frustrated citizens with regard to 
financial matters. Often citizens are so confused by the overwhelming 
alphabet soup of Federal and State agencies that they don't know where 
to turn for help. A properly funded financial ombudsmen type office 
attached to every Senator or Representatives office would provide 
appropriate guidance to help citizens navigate the regulatory maze. The 
office would also follow up on cases to make sure that they do not get 
the Bernie Madoff and John Mack treatments. This will increase investor 
confidence because investors will feel heard and have a sense that 
their tips are getting a proper investigation.
12. Continue to build a culture of evidence-based rulemaking at Federal 
        regulatory agencies.
    The forthcoming pilot experiment with regard to tick size is a 
great step forward. It is sad that once again it took Congressional 
action to prod the SEC to do something it could and should have done on 
its own volition. The Congress should encourage a culture of evidence-
based rulemaking through carefully designed pilot experiments. I have 
heard that there is some concern at the SEC that the agency may not 
have legislative authority to conduct properly randomized scientific 
pilot studies. Congress should clarify the relevant statutes to 
indicate that the SEC does indeed have such authority.
13. Amend the APA to require agencies to look at how other countries 
        and other entities address similar issues.
    Many agencies have an insular culture that does not naturally 
explore how other entities deal with similar problems. This is a 
mistake. We do not have to keep reinventing the wheel. The 
Administrative Procedures Act should be amended to require each 
rulemaking to explicitly address how other countries and other entities 
have addressed similar issues. This is particular important given the 
global nature of financial services, and the need to work with other 
regulators. Explicitly examining how other regulatory entities address 
a problem makes it more likely that we will adopt a similar approach, 
leading to a more uniform global regulatory environment and thus 
reducing compliance costs.
                                 ______
                                 
                   PREPARED STATEMENT OF TOM WITTMAN
          Executive Vice President and Global Head of Equities
                         NASDAQ OMX Group, Inc.
                              July 8, 2014
    Thank you Chairman Johnson and Ranking Member Crapo for the 
opportunity to testify today on ``The Role of Regulation in Shaping 
Equity Market Structure and Electronic Trading.''
    Thanks to the efforts of SEC Chairman Mary Jo White, the debate as 
to whether we change our equity market structure is over. The SEC has 
launched an evaluation of what changes are needed and has taken a first 
step by releasing the guidelines for the creation of special market 
structures for a range of smaller stocks known as the Tick Size Pilot. 
We support Chair White's efforts which also include the launch of a 
series of efforts to evaluate more holistically the broader market 
structure and to take action to ensure robust regulation of all 
participants in the markets. These are all positive developments that 
NASDAQ OMX absolutely endorses.
    Now it is time for us to talk about solutions.
    We agree with Chair White that our markets are not rigged, but, are 
indeed the strongest capital markets in the world. And we at NASDAQ OMX 
have been dedicated to ensuring fair access to all investors in our 
marketplace and view fair access as a hallmark of our organization. Let 
me be clear, NASDAQ OMX endeavors to ensure everyone has a fair and 
equitable experience with us, and we fully support any effort to ensure 
that there is fairness and transparency in the market. While we are 
firm in our belief that the U.S.-licensed exchanges provide a fair and 
highly efficient market platform, we agree with many others that the 
markets are complex today. And, while that complexity can bring 
benefits to participants, we agree that it also brings a need for 
regular examination. When appropriate, we should move quickly to update 
the market rules consistent with the Exchange Act principles of 
fairness and transparency. As an exchange, we believe that the bedrock 
principle for well-functioning and fair markets is the need for robust 
price discovery--and transparent price discovery is at the center of 
what exchanges do for our economy.
Special Role of Exchanges:
    Companies like Comcast, Cisco, GoPro, Intel, AmGen, Celgene and 
Mylan use capital they raise from listing on The NASDAQ Stock Market 
(NASDAQ) to finance their missions of making cutting-edge products that 
transform lives and industries. The public trading of these companies 
allows Americans to invest in and participate in the American Dream, 
and allows companies to understand the value of their company and raise 
additional capital by issuing new shares. With financing provided by 
the public markets, these companies create millions of jobs and bolster 
the American and global economies. We see tangible evidence of this, 
from Silicon Valley to the Northern Virginia high tech corridor and in 
my home State of Pennsylvania.
    An exchange listing is a valuable asset to a company's livelihood. 
The iconic public companies that your constituents recognize, such as, 
Apple, Microsoft, Google, eBay and Amazon, must provide broad and deep 
transparency regarding their operations; they must satisfy exchanges' 
listing standards; and they remain continuously subject to exchange 
rules protecting investors against corporate fraud and abuse. Exchange 
listed companies have an ongoing responsibility to maintain high 
financial, operating, and governance standards, which are rigorously 
enforced by the exchanges, to ensure investor confidence.
    Equity exchanges in the United States are uniquely entrusted with 
the important responsibility of being a catalyst for growth and wealth 
creation. After the IPO, exchanges have a continuing role in fostering 
price discovery and transparency. By allowing investors to come 
together in an efficient and open manner, we enable them to discover 
the price at which these public companies can be bought and sold 
throughout each trading day. Exchanges, like NASDAQ, then disseminate 
those prices for your constituents to see on television, online and in 
newspapers. Exchange equity quotes create the reliable reference price 
for all trading. Exchange quotes are a byproduct of the SEC-approved 
rules and robust regulatory systems that equities exchanges must 
develop and enforce to protect investors and to provide lit and orderly 
markets. We fully disclose and seek SEC approval of all of the policies 
and practices that we use to operate our markets.
Market Structure:
    Now we turn to the details regarding the processes and mechanisms 
within the U.S. market system used to create a transparent market. 
First, with regard to order types, NASDAQ OMX supports the Chair's call 
for a thorough review of existing order types, which highlights the 
difference between exchanges and lighter regulated ATSs. Each venue 
(exchange or broker owned) has its own systems and procedures and each 
competes for orders from brokers and ultimately investors. Each venue 
has its own order types and each is continually talking to market 
participants to develop new order types that satisfy the needs of the 
marketplace.''
    Unlike less-regulated ATS trading venues, including dark pools, 
when seeking to launch a new order type, NASDAQ was subject to a 
rigorous process to define, design, evaluate, explain and obtain SEC 
approval of order types. As an exchange we are required to expose 
innovative ideas to the market through the notice and comment process. 
We were subject to public scrutiny and examination of our ideas by our 
competitors. This process often undermines the benefits of our 
innovation, allowing our competitors, particularly those who are less 
regulated, time to potentially mimic our ideas before we even had our 
ideas approved. This is one of the costs of maintaining an SRO license. 
For the sake of transparency and to help members understand our order 
types, we have posted on our Web site a list and a plain-language 
description of all of NASDAQ's order types.
    Turning to the issue of dark pools, many of our concerns with 
today's fragmented market structure are the direct result of layers of 
iterative market structure decisions that have built up through the 
years when SEC approval was based upon the technological and market 
needs at the time these rules were proposed and approved. Many current 
problems with our markets stem from well-intentioned regulations like 
Regulation ATS and Regulation NMS, which sought to promote competition 
and to resolve tensions between electronic and floor-based trading. 
But, regulations cannot be adopted and forgotten; they must evolve as 
conditions change. Regretfully, over time Regulation ATS and Regulation 
NMS have led to a significant increase in dark trading, which denies 
market participants a clear view of trading interest in a given stock--
preventing the full strength of supply and demand to determine price. 
The latest dark trading data available to us from Rosenblatt for June 
indicates that almost 40 percent of all trading in our markets was done 
away from the lit exchanges.
    While alternative trading venues certainly have an appropriate role 
within a well-functioning market, we strongly believe that the current 
trend toward dark trading as the market's default setting is an 
unhealthy phenomenon. The United States is not alone in its challenges 
with dark trading. Other countries are adapting their rules to address 
the concern that dark trading reduces the fairness and transparency of 
the markets. Specifically, Canada modified its market structure to 
limit dark trading and to maximize price discovery and the EU has 
included a regime for capping the level of dark trading in its recent 
MIFID policy changes. It's time for the United States to update 
Regulation NMS, and we can benefit from examining other countries' 
efforts to determine a structure that could work within our own 
markets.
    On the topic of high frequency trading, NASDAQ supports Chair 
White's call to have all high frequency trading firms register. While 
we have not seen the details, we believe there are benefits in the SEC 
assuming a broader role and to lay the groundwork for greater 
transparency into all trading activity. Many in the public arena have 
attacked high frequency trading as a business model. We encourage and 
support a thorough analysis of the subject in order to reach a rational 
conclusion. In our view, high-frequency firms that are registered 
broker-dealers--whose primary function is as a regulated market-maker--
offer the valuable service of providing liquidity throughout the 
trading day, which stabilizes pricing in the market and aids in price 
discovery. However, what we know from experience is that our industry, 
no matter the business model, will always attract individual players 
who cross the line. They forget the true purpose of the markets, and 
they find opportunities to exploit them. The role of NASDAQ, the other 
licensed, regulated exchanges, FINRA (the Financial Industry Regulatory 
Authority), and the SEC is to surveil the market and identify those 
individual `bad actors.' We will continue to be vigilant in serving 
that critical industry function.
Systems Resiliency:
    Another area of focus in recent years has been the resiliency of 
the systems that underpin the U.S. markets. At NASDAQ OMX we are 
focused every day on how to improve our markets and make them more 
resilient and robust. We recognize that past events across the markets, 
including our own, may have harmed investors' confidence in the U.S. 
markets. We are extremely focused on identifying and mitigating risks 
in our systems and infrastructure, as well as in the interconnectivity 
across the markets. Providing resilient and robust markets is critical 
for efficient capital formation, investor confidence, and job creation. 
We are confident we can provide that resiliency. In this area we are 
engaged in many efforts to be a catalyst for positive change. For 
example, we recently implemented so called ``Kill Switch'' to provide 
another backstop against a computer incident going from a localized 
issue to a market-wide problem.
    The role of exchanges is more important than ever in today's 
challenging environment. And yet, market complexity continues to create 
new risks that we are constantly working with other market participants 
and the SEC to address. Investor demand and the nature of regulatory 
complexity have made U.S. markets lightning fast, fragmented and deeply 
inter-connected. This complexity has added many more friction points 
where mistakes can occur.
    That's why NASDAQ OMX favors the adoption of Regulation SCI, which 
the Chair highlighted in her recent public remarks. The U.S. market is 
only as strong as its weakest link. To protect investors, all market 
participants and trading venues--not just exchanges--must be subject to 
rigorous standards of technology design, testing, and implementation. 
While NASDAQ OMX favors the expansion of protections that Regulation 
SCI will bring to some ATSs and brokers, in our view the obligation 
should be expanded further to include all ATSs because every ATS poses 
a systemic risk to a tightly linked market.
    The SEC deserves credit for its leadership through recent, 
challenging times. In the aftermath of the May 6th, Flash Crash, the 
SEC and the exchanges worked quickly and cooperatively to devise new 
protections to keep trading errors from spreading too rapidly or 
inflicting unacceptable harm on the overall market. The exchanges 
reformed their rules for breaking trades, instituted single stock 
circuit breakers, updated market-wide circuit breakers, and implemented 
the Limit Up/Limit Down mechanism. NASDAQ OMX has also, on its own, 
developed tools to help broker-dealers manage their obligations under 
the Market Access Rule.
    At NASDAQ OMX we are passionate about and steadfast in the role we 
play in capital formation and improving the performance of the 
economies we serve. We think that the SRO model and U.S. market 
structure have been effective in protecting investors over many 
decades. But as technology and the inter-relation among all traded 
asset classes evolve, so too must the regulatory environment in which 
the markets operate. If it does, we will continue to protect investors, 
transparently set prices for the stocks of our listed companies, and 
support our economy through highly efficient capital formation and job 
creation. All of our employees, including our CEO work hard to deliver 
a dependable, fair and safe environment for investors and to fuel the 
U.S. economy. We look forward to working with this Committee. Thank you 
for your invitation to testify. I look forward to your questions.
                                 ______
                                 
                  PREPARED STATEMENT OF JOE RATTERMAN
           Chief Executive Officer, BATS Global Markets, Inc.
                              July 8, 2014
    Thank you and good morning. My name is Joe Ratterman, Chief 
Executive Officer of BATS Global Markets, Inc. (``BATS''), and one of 
the founding employees. I am pleased to be here and want to thank 
Chairman Johnson, Ranking Member Crapo, and the entire Banking 
Committee for inviting me to testify on matters related to the U.S. 
equity market structure. This Committee has played a leading role in 
the development of the securities laws over the past 80 years, and I 
appreciate the attention to these timely and important issues related 
to our capital markets.
    BATS was a startup less than a decade ago, formed in 2005 in 
response to a competitive void that emerged in the U.S. equity markets. 
The NYSE and NASDAQ had acquired the first generation of efficient, 
technology-oriented exchange competitors, namely Archipelago, Inet 
(which reflected the merger of Instinet and Island), and Brut. In the 
face of this exchange duopoly, BATS stepped into the competitive void, 
launching as a small alternative trading system (``ATS'') from a north 
Kansas City storefront in January 2006. In January of this year, we 
merged with Direct Edge, an innovative exchange operator that was 
similarly formed in 2005 to enhance competition among markets.
    BATS remains headquartered in the Kansas City area, and maintains 
offices in New York, New Jersey, and London. With approximately 300 
employees globally, we compete vigorously every day in the United 
States and Europe to earn our customers' business and trust. We have 
leveraged technology to significantly reduce execution costs for all 
investors and deliver innovative products and services to market 
participants.
    I agree with the sentiments recently expressed by SEC Chair Mary Jo 
White, who said that our markets are ``not broken, let alone 
rigged.''\1\ Academic and empirical evidence overwhelmingly 
demonstrates that the automation of the market over the last decade or 
more has resulted in significant enhancements in market quality for 
long-term investors, whether retail or institutional. But like Chair 
White and her fellow commissioners, I recognize that our markets are 
not perfect; indeed, the search for perfection is a never-ending quest. 
As exchanges, we are not only competing market centers, but also 
regulators and, therefore, approach these issues with utmost 
seriousness. Because of this, I am particularly grateful to be here 
today and have the opportunity to share my views.
---------------------------------------------------------------------------
    \1\ Mary Jo White, Chair, SEC, Enhancing our Equity Market 
Structure (speech given at Sandler O'Neill & Partners, L.P. Global 
Exchange and Brokerage Conference, New York, NY, June 5, 2014).
---------------------------------------------------------------------------
I. Background
    In 1975, Congress amended the Exchange Act of 1934 (``Act'') to 
adopt Section 11A, which was designed to facilitate the establishment 
of a national market system to link together the multiple individual 
markets that trade securities. Congress intended for the SEC to take 
advantage of opportunities created by advancements in technology to 
preserve and strengthen the securities markets. By leveraging 
technology, our national market system is designed to achieve the 
objectives of efficient, competitive, fair, and orderly markets that 
are in the public interest and protect investors.
    In response to this Congressional mandate, the SEC has adopted 
various rules since 1975 to further the objectives of the national 
market system, including the order handling rules in 1997, Regulation 
ATS in 1998, decimalization in 2000, and Regulation NMS in 2005. Many 
of the innovative structural characteristics of our market owe their 
existence to Congress' 1975 amendments to the Act, and subsequent SEC 
rulemaking in furtherance of those amendments.
    Our national market system is premised on promoting fair 
competition among individual markets, while at the same time assuring 
that all of these markets are linked together in a unified system that 
promotes interaction among the orders of buyers and sellers. The 
national market system thereby incorporates two distinct types of 
competition--competition among individual markets and competition among 
individual orders--that together contribute to efficient markets. 
Vigorous competition among markets promotes more efficient and 
innovative trading services, while integrated competition among orders 
promotes more efficient pricing of individual stocks for all types of 
orders, large and small. Together, they produce markets that offer the 
greatest benefits for investors and listed companies.
    In adopting Regulation NMS, the SEC stated that its primary 
challenge in facilitating the establishment of the national market 
system has been to maintain the appropriate balance between fostering 
competition between markets and fostering competition between orders; 
mandates that at times come into conflict. The SEC further stated that 
it attempted to avoid the extremes of: (1) isolated markets that trade 
securities without regard to trading in other markets, and (2) a 
totally centralized system that loses the benefits of vigorous 
competition and innovation among individual markets. The SEC navigated 
these extremes by allowing market competition, while at the same time 
fostering order competition through the adoption of the order 
protection rule, which prohibits markets from trading without regard to 
the prices posted on other markets.
    As a result, today we have an equity marketplace that is widely 
considered to be the most liquid, transparent, efficient and 
competitive financial market in the world. Costs for long-term 
investors, both institutional and retail, in the U.S. equity 
marketplace are among the lowest globally and these gains in market 
quality have been noted by academics, institutional buy-side investors, 
and agency brokers:

    In April 2010, Vanguard noted that estimates of declining 
        trading costs over the previous 10 to 15 years ranged from a 
        reduction of 35 percent to more than 60 percent and stated that 
        Vanguard's own experience was in line with that range. Reduced 
        trading costs, as Vanguard noted, flow directly as a 
        ``substantial benefit to investors in the form of higher 
        returns.''\2\
---------------------------------------------------------------------------
    \2\ See Letter from George Sauter, Managing Director and Chief 
Investment Officer, Vanguard Group, Inc., to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, dated April 21, 2010.

    In June 2013, three economists, including former SEC Chief 
        Economist Larry Harris, found a dramatic change in the spread 
        for NYSE-listed and Nasdaq-listed stocks over the preceding 12 
        years. In particular, between 2001 and 2013, the spread paid by 
        investors had decreased from more than 6 cents to below 2 cents 
        for NYSE-listed stocks and from above 5 cents to below 3 cents 
        for Nasdaq-listed stocks.\3\
---------------------------------------------------------------------------
    \3\ See Angel, James J., Lawrence E. Harris and Chester S. Spatt, 
``Equity Trading in the 21stCentury: An Update'' (June 21, 2013), 
available at http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=1584026.

    In April 2014, Blackrock noted the same positive trends in 
        their assessment of market structure performance since 1998, 
        stating that bid-ask spreads have narrowed significantly and 
        that institutional trading costs have declined and are among 
        the lowest in the world.\4\
---------------------------------------------------------------------------
    \4\ See BlackRock, ``U.S. Equity Market Structure: An Investor 
Perspective'' (April 2014).

    In June 2014, ITG's Global Cost Review Report further 
        confirmed the decline in institutional trading costs, noting 
        that from Q3 2009 to Q4 2013, implementation shortfall \5\ 
        costs decreased from roughly 45 basis points to 40 basis 
        points. (This decline followed a drop from 63 basis points in 
        Q3 2003).\6\
---------------------------------------------------------------------------
    \5\ ITS defines Implementation Shortfall cost as the difference, or 
slippage, between the arrival price and the execution price for a 
trade.
    \6\ See ITG, ``Global Cost Review Q4/2013'' (June 6, 2014), 
available at http://itg.com/marketing/
ITG_GlobalCostReview_Q42013_20140509.pdf; see also Speech by Chair Mary 
Jo White: Enhancing Our Equity Market Structure. (June 5, 2014)

    Further, our market is able to handle volume and message traffic 
considered astronomical only a few decades ago, and the efficient 
operation of this market throughout the recent financial crisis and 
resulting volatility should serve as a reminder of the systemic risks 
that have been reduced as a result.
    Despite the overall high quality of our equity capital markets 
today, we must remain focused on identifying areas in which market 
quality and stability can be improved and regulators should consider 
responsible, data-driven regulatory action where appropriate. In this 
regard, we are encouraged by the SEC's plan for a continuous and 
comprehensive review of the state of our market structure, and we 
appreciate the Banking Committee's oversight. Such a review is timely 
because the aforementioned changes, particularly those following from 
the implementation of Regulation NMS in 2007, reflect a relatively 
recent and dramatic evolution in the manner in which securities trade.
    We should always strive to improve market quality, but should act 
only when we can be sure to avoid disrupting or reversing the 
substantial improvements in market quality we have experienced. While 
it has been widely recognized that retail investors have benefited the 
most from improvements in market quality over the last decade, I also 
believe institutional investors have experienced measurable benefits in 
the form of the above-referenced reductions in implementation shortfall 
costs. That said, I recognize that institutional investors continue to 
face challenges in executing large orders with a minimum of market 
impact. To be sure, finding a ``natural'' investor or liquidity 
provider willing to take the opposite side of a well-informed 
institutional investor's order is a complex problem to solve regardless 
of market structure.
    Policymakers looking to reform our equity market structure must be 
cognizant of the concern that enacting rules that tip the scales for or 
against particular market constituents runs the very real risk of 
negating benefits currently delivered by our equity markets. Therefore, 
we advocate for responsible and carefully crafted changes supported by 
reliable data and perhaps even tested through pilot programs of 
sufficient duration to obtain data that adequately demonstrates the 
impact of the change.
II. Speed of Today's Markets
    There has been much commentary of late regarding the speed at which 
our equity market operates, and the benefits and risks associated with 
that speed. It is certainly true that today's fully automated equity 
market is capable of processing order messages in timeframes that were 
unthinkable a decade ago. These gains in speed (or reductions in 
latency) have been made possible by advances in the computer hardware 
and software that underpin the equity market structure, as well as 
innovations by industry participants.
    The increasing speed at which equity trading occurs is but another 
dimension of how technology has improved the efficiency of our markets. 
Whether trading as an investor or acting as a market maker, time equals 
risk, and execution speed reduces that risk and the costs associated 
with it. This risk mitigation benefits all investors in the form of a 
lower risk premium, expressed as tighter spreads and lower overall 
transaction costs. Importantly, these benefits are quantifiable; as 
noted above, the evidence shows a market that has experienced declining 
spreads for retail investors and declining implementation shortfall 
costs for institutional investors.
    Long-term investors are the primary beneficiaries of this risk 
mitigation through the narrowing of spreads. Both institutional and 
retail investors have access to tools that leverage the benefits of 
these improvements in speed. For example, institutional investors can 
and regularly do utilize trading algorithms programmed on brokers' 
servers co-located within market centers. And, retail investors 
accessing real-time market data can act on trading decisions from their 
brokers' Web sites and receive an execution report within a matter of 
seconds or even less, at a price at or better than the national best 
bid and offer (``NBBO'') prevailing at the moment the trade was placed, 
and with a commission rate of less than $10. This result is widely 
taken for granted today, but it was not that long ago when retail 
orders were processed much slower, with much less certainty of outcome, 
and at commission rates considerably higher than those today.
    It is not readily apparent why regulators should be particularly 
concerned about the extent to which firms are willing to pay for tools 
that help them achieve increased speed. It stands to reason that if the 
marginal cost of gaining additional speed exceeds the marginal benefit, 
firms will decide not to spend the money seeking that gain. As a 
practical matter, it is worth noting that we are probably reaching that 
point now.
    That said, there are risks and concerns associated with the speed 
of trading that warrant managing and addressing. Differentials in speed 
associated with the dissemination of market data may create perceptions 
of unfairness. Because of the flexibility of our national market system 
for market data, it is in many ways the fairest in the world. With 
side-by-side competition between a nationally consolidated feed and 
direct feeds from multiple exchanges, market participants pay only for 
the content and related infrastructure they actually need. Given that 
quote and trade information serve multiple needs ranging from real-time 
trading data to back-office reference information to news and 
information, providing multiple products through multiple sources meets 
the needs of market participants in a diverse, constructive, and 
efficient fashion.
    Nonetheless, there remain perceptions that differences in content 
and speed of dissemination confer unwarranted advantages on select 
market participants. And perceptions affect investor confidence about 
the integrity of the markets, so I take them very seriously. While Rule 
603 of Regulation NMS dictates that exchanges do not release market 
data to private recipients before disseminating that data to the public 
securities information processor (``SIP''), differences in content and 
downstream technologies can still create a perception of unfairness.
    To address this perception issue most effectively, exchanges should 
continue to strive to make the dissemination of consolidated data 
through the SIPs as fast as possible, and should consider including 
aggregated depth-of-book data per exchange based on industry demands.
    Perceptions of unfairness are also present with respect to the 
market data exchanges use in their matching engines and routing 
infrastructure to calculate the NBBO. Some have suggested that 
exchanges using the SIP data to calculate the NBBO provide unfair 
opportunities to sophisticated traders engaging in risk-free latency 
arbitrage. Exchanges historically have used SIP data to determine the 
NBBO with the changeover to direct feeds being a relatively recent 
phenomenon. While that change yields an optimization in the speed with 
which quotes can update, there are reasons why that optimization is not 
as significant at an exchange as the difference in the speed between 
the SIPs and direct feeds. Specifically, this is because exchanges 
accept intermarket sweep orders (``ISOs''), which can display on an 
exchange at a price from the SIP data that appears to lock another 
exchange's quote. The ISO designation on an order tells the exchange 
that the sender has either sent an order to execute against the locking 
quote or that the sender has a faster view of the market and knows that 
the locking quote no longer exists. Therefore, when SIP data is 
augmented by ISOs, exchanges are able to update the quote in their 
matching engines nearly as fast as direct feeds update.
III. Conflicts of Interest
    Certain practices surrounding broker agency relationships, such as 
payment for order flow and soft dollar arrangements, as well as 
exchange fee structures create the potential for conflicts of interest; 
however, I believe these potential conflicts of interest can be and 
generally are managed by vigorous oversight within broker-dealers, and 
can be supplemented through additional transparency as well as 
oversight and enforcement by FINRA and the SEC. For example, I believe 
institutional investors could benefit from additional transparency 
about the ATSs to which their brokers route orders. I support the 
voluntary initiatives of some ATSs to make public their Form ATS, and 
additional steps could be considered to require ATSs to provide 
customers with their rules of operation, which would include order 
types, eligible participant and participant tiers, all forms of data 
feed products, and order-routing logic and eligible routing venues. 
With this information, institutional investors would be better 
positioned to determine which trading venues best meet their trading 
needs, and compare disparate broker product and service offerings.
    Moreover, I support reviewing current SEC rules designed to provide 
transparency into execution quality and broker order routing practices. 
In particular, Rules 605 and 606 of Regulation NMS require execution 
venues to periodically publish certain aggregate data about execution 
quality and require brokers to publish periodic reports of the top 10 
trading venues to which customer orders were routed for execution over 
the period, including a discussion of any material relationships the 
broker has with each venue. Publication of this data has helped better 
inform investors about how their orders are handled.
    Nonetheless, these rules were adopted nearly 15 years ago \7\ and 
the market has evolved significantly enough to warrant re-examining 
whether additional transparency could be provided that would benefit 
investors. For example, advances in technology now permit significant 
market events to occur in millisecond timeframes, and audit trails are 
granular enough to capture that activity. However, the current 
requirements of Rule 605 effectively allow a trading venue to measure 
the quality of a particular execution by reference to any national best 
bid or offer in effect within the 1-second period that such order was 
executed. Given the frequency of quote updates in actively traded 
securities within any single second, compliance with this requirement 
may not in all cases provide adequate transparency into a particular 
venue's true execution quality. In addition, the scope of Rule 605 
could be extended to cover broker-dealers, and not just market centers. 
Transparency could further be improved by amending Rule 606 to require 
disclosure about the routing of institutional orders, as well as a 
separate disclosure regarding the routing of marketable and 
nonmarketable orders.
---------------------------------------------------------------------------
    \7\ Exchange Act Release No. 43590 (Nov. 17, 2000) (Rules 605 and 
606 were originally adopted as Rules 11Ac1-5 and 11Ac1-6, respectively, 
under the Exchange Act).
---------------------------------------------------------------------------
    Some have suggested that exchange fee structures may be the source 
of unmanageable conflicts of interest associated with order routing 
decisions. The dominant exchange pricing mechanism over the last decade 
has been the so-called maker-taker model, which generally encourages 
liquidity makers to take the risk of exposing an order in the 
marketplace by paying them a small rebate, if and only when their order 
is executed. Under Regulation NMS, exchange fees to access--or 
``take''--liquidity are capped at 30 cents per 100 shares, which 
effectively serves as a cap on the rebate that can be paid to liquidity 
makers.
    These rebates provide an effective incentive to encourage liquidity 
makers to post tight bid-offer spreads, which benefit all investors. I 
believe restricting incentives to provide liquidity could be counter-
productive. Whether it is banning the current maker-taker fee 
structure, limiting payment for order flow generally, or other attempts 
to alter the fundamental economics of trading, price controls are a 
blunt instrument likely to cause disruptions and consequences that are 
unforeseeable and potentially detrimental to all types of investors. I 
am concerned that additional pricing restrictions could drive 
significantly more volume to dark venues or order types, make the 
compensation brokers receive for their liquidity far less transparent, 
and widen the displayed bid-ask spread in a manner that effectively 
taxes all investors. Efforts to avoid these potential consequences 
could lead to a set of regulations so complex that the root cause of 
future behaviors could never fully be known.
IV. Venue Complexity--How Many Is Too Many?
    Competition and automation have combined to dramatically improve 
the market's trading infrastructure. The low commissions, diversity of 
products and ability to handle large order and trading volumes are a 
direct result of these forces. Regulation ATS and Regulation NMS 
provided a framework for this competition to thrive, and maintaining a 
system whereby new entrants can prove their value to the market is 
essential. At the same time, we need to reconsider where regulation may 
artificially subsidize competition or encourage complexity that does 
not address a market need.
    In particular, all exchanges are given a significant competitive 
advantage regardless of their size by virtue of the order protection 
rule under Regulation NMS. While this was necessary in an era where 
legacy exchanges routinely ignored their competitors, current practices 
have reduced the need for regulatory protections of smaller venues. 
Recent events provide evidence that market forces ultimately can 
correct for venues that add only marginal value; the existing 
concentration of exchanges among scale providers--including BATS--means 
that in some cases the marginal operating cost for a ``new'' exchange 
is near zero. The cost and complexity of connectivity to a small venue 
for market participants, however, can be substantial.
    Accordingly, Regulation NMS should be revised so that, until an 
exchange achieves greater than a de minimis level of market share, 
perhaps 1 percent, in any rolling 3-month period:

    They should no longer be protected under the order 
        protection rule; and

    They should not share in/receive any NMS plan market data 
        revenue.

    The combination of these two provisions would: (a) potentially 
reduce client costs in connecting to small exchanges, giving them the 
flexibility to route around them should they so choose, while still 
protecting displayed limit orders on all venues of meaningful size; and 
(b) take away market data revenue that may be the basis for the 
continued operation of marginal venues.
V. Order Type Complexity--Drivers and Solutions
    While I am sensitive to concerns about the complexity of our 
markets, the vast majority of market functionality exists because it 
meets the needs of a diverse group of market participants.\8\ 
Functionality becomes counter-productive when it exists solely to 
address arcane or trivial requirements, rather than addressing 
important economic, operational or regulatory needs of market 
participants. This is especially true when the level of complexity is 
high in relation to the supposed benefits.
---------------------------------------------------------------------------
    \8\ See e.g., Gregg E. Berman, Associate Director, Division of 
Trading and Markets, SEC, What Drives Complexity and Speed of our 
Markets (speech given at the North American Trading Architecture 
Summit, New York, NY, April 15, 2014).
---------------------------------------------------------------------------
    One such driver of excessive exchange complexity is rooted in an 
often-overlooked provision of Regulation NMS--the ban on locked 
markets. Price-sliding logic and other order types such as ISOs often 
stem directly from this discrete prohibition. Given that existing 
regulatory guidance already effectively prohibits locking a market for 
the sole purpose of avoiding or reducing fees, revisiting regulatory 
obligations in this regard could be a simple yet powerful way to 
materially reduce the complexity of exchange operations.
VI. Systemic Complexity--Strengthening Critical Infrastructure
    Technology has undoubtedly transformed our market for the better, 
but it has also created new challenges and risks. Even in a market with 
fewer exchanges and fewer order types, the risk of IT or operational 
malfunctions will remain. Since 2010, the SEC and the industry have 
worked constructively to improve coordination and systemic risk 
management, from the implementation of Limit Up/Limit Down execution 
price bands to the enactment of the Market Access Rule to the 
harmonization of the standards for clearly erroneous trades. Taken 
together, these initiatives represent significant progress with respect 
to enhancing market stability.
    This progress is measurable. According to the Financial Information 
Forum, exchange system issues as measured by self-help declarations 
have dropped more than 80 percent since 2007 and 2008, the first years 
after Regulation NMS. In addition, the number of clearly erroneous 
executions across the industry has dropped dramatically over the last 
few years. For example, clearly erroneous events reported on the BATS 
BZX Exchange in 2014 is on pace to be approximately 66 percent lower 
than 2013 and 85 percent lower than the previous 5-year average.
    Further mitigating operational risk requires continuous vigilance 
and a flexible framework. More can and needs to be done with respect to 
critical market infrastructure as a whole, and by the individual 
institutions that actively participate in the markets. In particular, a 
well vetted and properly scaled Regulation SCI should be finalized and 
adopted with respect to exchanges, SIPs and clearance and settlement 
facilities. While the SEC should work with these future Regulation SCI 
entities to refine its requirements in a manner that will achieve the 
best outcomes, completing this regulation should be prioritized. I am 
encouraged by Chair White's recent comments on her desire to finalize 
the proposal. This would strengthen market infrastructure truly deemed 
to be ``critical'' around industry best practices and help better 
manage the complexity that competition brings where it is needed.
VII. Conclusion
    While our current equity market structure is certainly not perfect, 
I believe that it is by far the fairest, most efficient and most liquid 
market in the world. And because it is a complex ecosystem, 
policymakers need to be mindful of the potential unintended 
consequences of sudden, significant changes. I fully support the SEC 
conducting a deliberate, data-driven study of the quality of our market 
structure and advocate for reforms where that analysis supports the 
likelihood for market quality improvement.
    Thank you for the opportunity to appear before you today. I would 
be happy to answer any of your questions.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


    RESPONSE TO WRITTEN QUESTION OF SENATOR BROWN FROM JOE 
                           RATTERMAN

Q.1. Since at least 2012, former high-frequency traders have 
been expressing concerns about exotic order types that 
technically comply with the SEC's regulations, but which allow 
high-frequency traders to jump the queue and exploit price 
advantages that come from latencies.
    NYSE announced in May that it was eliminating 15 order 
types. However, NYSE continues to allow high-frequency traders 
to use some predatory order types, like ``Post No Preference 
Blind,'' in which high-frequency traders' bids to remain 
blocked from the market and then jump to the top of the queue.
    Nasdaq has a similar order type called ``Post Only with 
Automatic Re-Entry,'' DirectEdge has ``Hide Not Slide,'' and 
BATS offers ``Only Post Only.''
    When I asked Mr. Sprecher about these order types at the 
hearing, he said:

        [A]s you say, I'm uncomfortable with having all these order 
        types. I don't understand why we have them. And I've started 
        unilaterally eliminating them. The problem that we have is that 
        orders today are--decisions on where orders go are not made by 
        humans. They're made by computers that are so-called smart 
        order routers. And many of these order types exist to attract 
        the orders. And I'm trying to balance cleaning up my own 
        house--I live in a glass house, and I'm trying to clean it up 
        before I criticize others. At the same time. I can't make the 
        New York Stock Exchange go to zero. It would be bad for this 
        country for the New York Stock Exchange to no longer have 
        trading activity. So, it's why I've been outspoken. I hope that 
        other exchange leaders will follow my lead. I'd like to get us 
        all working together to eliminate these types.

        I'd be happy if we can do it as a private sector initiative. 
        I'd be happy if the SEC ordered us to get rid of them. I'd be 
        happy if Congress took action. Any way we can reduce them, I'd 
        be happy . . .

        I can't take the New York Stock Exchange to 1 percent, but I 
        appreciate your allowing me to talk about this publicly to you 
        all and to the camera and a microphone. Because I think that I 
        need to put pressure on all my colleagues to follow my lead.

    My question is this: will you work with Mr. Sprecher to 
eliminate predatory order types from your exchanges, including 
the specific order types identified above?

A.1. My perspective is that an order type should satisfy one of 
two primary objectives, and if it doesn't, then and only then 
should it be eliminated from the market.
    The first primary objective would be to allow a member to 
maintain compliance with the current regulatory environment. 
Rather than remove these order types, we should re-examine the 
regulatory requirement that drove the development of the order 
type to begin with.
    The second primary objective of an order type would be to 
allow a member to fully express their intentions for the 
handling of their order in electronic form, so that the 
exchange can make electronic decisions during the life of that 
order that conform to the member's original intentions. Much of 
the order type functionality that exists is simply electronic 
``check boxes'' for how the exchange needs to manage the order 
at each decision point during the order's lifetime.
    Order types that don't meet one of these two criteria 
should be considered for retirement, and that's how I have 
historically thought about reducing the complexity from within 
our own platform's software code base.
    I don't believe that we have any order types that would be 
considered predatory, but if we ever determined that an order 
type on our system had been used in a predatory way, we would 
first seek an enforcement action against the firm who employed 
the predatory approach, and we would review whether the order 
type inherently attracted predatory behavior, and if so, we 
would take actions to eliminate the predatory nature of the 
order type or even the order type itself.