    [Senate Hearing 114-238]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 114-238

             REGULATORY REFORMS TO IMPROVE EQUITY MARKET STRUCTURE

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

                                    HEARING

                                   before the

                                SUBCOMMITTEE ON
                     SECURITIES, INSURANCE, AND INVESTMENT

                                     of the

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

                        ONE HUNDRED FOURTEENTH CONGRESS

                                 SECOND SESSION

                                       ON

    EXAMINING RECENT EFFORTS BY THE SEC AND FINRA IN AIDING THE FUNCTIONING
     AND STABILITY OF THE EQUITY MARKETS, AND IDENTIFYING KEY ISSUES UNDER
        CONSIDERATION TO REDUCE MARKET COMPLEXITY, INCREASE OPERATIONAL
                             STABILITY, AND PROMOTE
                 EFFICIENCY, COMPETITION, AND CAPITAL FORMATION

                                   __________

                                 MARCH 3, 2016

                                   __________

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

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                     Available at: http://www.fdsys.gov/
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                COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      RICHARD C. SHELBY, Alabama, Chairman

    MIKE CRAPO, Idaho                    SHERROD BROWN, Ohio
    BOB CORKER, Tennessee                JACK REED, Rhode Island
    DAVID VITTER, Louisiana              CHARLES E. SCHUMER, New York
    PATRICK J. TOOMEY, Pennsylvania      ROBERT MENENDEZ, New Jersey
    MARK KIRK, Illinois                  JON TESTER, Montana
    DEAN HELLER, Nevada                  MARK R. WARNER, Virginia
    TIM SCOTT, South Carolina            JEFF MERKLEY, Oregon
    BEN SASSE, Nebraska                  ELIZABETH WARREN, Massachusetts
    TOM COTTON, Arkansas                 HEIDI HEITKAMP, North Dakota
    MIKE ROUNDS, South Dakota            JOE DONNELLY, Indiana
    JERRY MORAN, Kansas

               William D. Duhnke III, Staff Director and Counsel

                     Mark Powden, Democratic Staff Director

                           Dawn Ratliff, Chief Clerk

                          Troy Cornell, Hearing Clerk

                          Shelvin Simmons, IT Director

                              Jim Crowell, Editor

                                     ______

             Subcommittee on Securities, Insurance, and Investment

                          MIKE CRAPO, Idaho, Chairman

              MARK R. WARNER, Virginia, Ranking Democratic Member

    BOB CORKER, Tennessee                JACK REED, Rhode Island
    DAVID VITTER, Louisiana              CHARLES E. SCHUMER, New York
    PATRICK J. TOOMEY, Pennsylvania      ROBERT MENENDEZ, New Jersey
    MARK KIRK, Illinois                  JON TESTER, Montana
    TIM SCOTT, South Carolina            ELIZABETH WARREN, Massachusetts
    BEN SASSE, Nebraska                  JOE DONNELLY, Indiana
    JERRY MORAN, Kansas

                   Gregg Richard, Subcommittee Staff Director

               Milan Dalal, Democratic Subcommittee Staff Director

                                      (ii)

                                C O N T E N T S

                                  ----------

                            THURSDAY, MARCH 3, 2016

                                                                       Page

    Opening statement of Chairman Crapo..............................     1
        Prepared statement...........................................    26

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

                                   WITNESSES

    Stephen Luparello, Director, Division of Trading and Markets,
      Securities and Exchange Commission.............................     4
        Prepared statement...........................................    26
    Richard G. Ketchum, Chairman and CEO, Financial Industry
      Regulatory Authority...........................................     6
        Prepared statement...........................................    37

                  Additional Material Supplied for the Record

    Letter to Committee from Mary Jo White, Chair, Securities and
      Exchange Commission............................................    43

                                     (iii)

             REGULATORY REFORMS TO IMPROVE EQUITY MARKET STRUCTURE

                                  ----------

                            THURSDAY, MARCH 3, 2016

                                           U.S. Senate,
                                    Subcommittee on Securities,
                                     Insurance, and Investment,
              Committee on Banking, Housing, and Urban Affairs,
                                                        Washington, DC.
        The Subcommittee convened at 10 a.m., in room 538, Dirksen
    Senate Office Building, Hon. Mike Crapo, Chairman of the
    Subcommittee, presiding.

                OPENING STATEMENT OF CHAIRMAN MIKE CRAPO

        Chairman Crapo. The Committee will come to order.
        This is a hearing of the Subcommittee on Securities,
    Insurance, and Investment relating to market structure. I think
    we will have a very good hearing today and I appreciate
    everyone's attendance.
        The landscape of stock markets and trading today is
    substantially different than it was 20, 10, or even 5 years
    ago. Regulations and technological innovation have moved stock
    trading from the floors of exchanges to virtually all trading
    now being conducted electronically on automated markets.
    Technology and innovation has benefited investors by leading to
    tighter spreads, lower costs, and more efficient markets.
        However, the expansion of trading venues, speed, and
    mandated interconnectedness of exchange and market participants
    has raised questions regarding market complexity and
    resiliency. For the past several years, the Securities and
    Exchange Commission and the Financial Industry Regulatory
    Authority have been working to better understand whether their
    market structure rules have kept pace with the changes in
    trading technology and practices.
        In 2014, the Banking Committee held a hearing with a broad
    mix of market participants to examine the role of regulation in
    shaping today's markets as well as whether these markets are as
    resilient and as stable as they should be. Several witnesses at
    the hearing argued that Regulation NMS, a set of SEC market
    structure rules that passed by a three-two vote over 10 years
    ago, needed to be reexamined.
        Later in the year, SEC Chair White provided an update to
    her market structure agenda in a response to a letter Senator
    Johnson and I sent and highlighted three fundamental policy
    questions that the Commission would be focusing on.
        First, the trade-through restrictions in Rule 611 of
    Regulation NMS and whether they should be rescinded or
    modified.
        Second, the current regulatory model for exchanges and
    other trading venues and whether it makes sense for today's
    markets.
        And, third, the maker-taker fee structure, including the
    related issue of restrictions on locking and crossing
    quotations in Rule 610 of Regulation NMS.
        These are complicated issues and I appreciate the data-
    driven approach by the SEC and FINRA and the extensive comments
    from market participants, investors, and academics. It will be
    helpful to understand from our witnesses what progress has been
    made in identifying and prioritizing the key concerns with our
    equity market structure and what options are being explored to
    address them. After all, the 2010 Flash Crash is still fresh in
    many of our minds and additional market events have raised
    concerns about market integrity and resiliency.
        In fact, the SEC's Equity Market Structure Advisory
    Committee met to diagnose and discuss one of the latest market
    disruptions, namely, what went wrong last August 24 when
    dramatic price moves triggered more than 1,000 trading halts in
    hundreds of stocks and exchange-traded funds.
        Today, this Committee hopes to hear from our witnesses
    about what lessons were learned from recent market disruptions
    and what steps need to be taken to strengthen the operation of
    the markets. The U.S. capital markets are vital to the growth
    of our economy and we need to take the necessary steps to make
    sure that the U.S. financial system and markets remain the
    preferred destination for investors throughout the world.
        I do look forward to the testimony of our witnesses, who I
    will introduce in just a moment, but let me turn first to my
    colleague, Senator Warner.

                  STATEMENT OF SENATOR MARK R. WARNER

        Senator Warner. Well, thank you, Chairman Crapo, and thank
    you for holding this hearing on this very important topic.
        I was going to remark that, knowing how it is a little
    complicated, I was happy to see that at least one of our
    colleagues was here, but already our comments have driven him
    out of the room, so----
        [Laughter.]
        Senator Warner.----but we are glad to see him----
        Chairman Crapo. I am sure he is listening on his iPhone.
        Senator Warner. Over the past few decades, we have seen
    remarkable technological progress and innovation in our
    security markets, coupled with substantial regulatory reform.
    Some of these advances and reforms, including decimalization,
    have brought considerable rewards for individual investors by
    narrowing spreads and increasing liquidity. Most trades today
    can happen within fractions of a second, providing good prices
    and counterparties for those seeking to buy equities around the
    world.
        But, at the same time, we have seen increased volatility
    and periodic dislocations. In recent years, as the Chairman
    mentioned, we have seen a market-wide Flash Crash, a series of
    mini-Flash Crashes in individual equities in Blue Chip stocks,
    a Flash Freeze at NASDAQ in 2013, problems with high-profile
    IPOs like Facebook and BATS, a glitch at the New York Stock
    Exchange in July 2015 that halted trading for hours, an ETF
    meltdown in 2015, and numerous allegations of and settlements
    for misbehaviors by dark pool operators.
        It is clear much work around market structure remains. So,
    where do policymakers go from here? Let me make four quick
    points.
        First, in the era of microsecond trading, we need to
    reevaluate the way our stock markets function. Chair White has
    made the right call by asking the Commission to conduct a
    holistic market structure review. We need data to be able to
    rationally analyze the market so appropriate investor
    protections can ultimately be implemented.
        Second, I believe strongly we should explore additional
    pilots. It has been nearly 2 years since Chair White announced
    her holistic review. Some have argued against conducting pilots
    in the interim as inconsistent with this review, but I do not
    think this is necessarily the case. As long as pilots are
    carefully crafted and done in a timely fashion, they can
    produce valuable data.
        Last week, I saw a stunning graphic from RBC Capital
    Markets that charted 839 different fee schedules that are
    composed of 3,729 separate fee variables. When one examines
    these variables in detail, it appears that certain exchanges
    are using their fee engineers to put together bespoke pricing
    terms for one or a small handful of customers in order to
    attract and retain order flow. Given this incredible
    complexity, it is likely very difficult for market participants
    to know whether they are getting best execution and the benefit
    of a fair and orderly market.
        To address this, there is a proposal pending before the SEC
    that would, for a 6-month period, eliminate rebates or
    comparable inducements for a random sample of 50 of the 100
    most actively traded stocks. I strongly endorse this maker-
    taker pilot to help detect conflicts of interest, promote price
    transparency, and reduce inefficiencies.
        Third, we should examine the role dark pools play in market
    structure, particularly in light of recent settlements with the
    SEC and the New York Attorney General. The original rationale
    for alternative trading venues--executing block sales, large
    block sales--appears to have diminished, with only an average
    trading size of 187 shares at the five largest dark pools,
    according to a recent FINRA study in 2014. I would love to hear
    more on that subject. The SEC has made recent studies in both
    enforcement and regulation of this space, recent strides, and I
    hope it continues.
        Fourth and finally, we must have the regulatory tools
    necessary to conduct adequate market oversight. This means
    establishing the Consolidated Audit Trail (CAT) so the SEC can
    have real-time insight into the mechanics of the stock market.
    It is beyond frustrating that nearly 6 years after the Flash
    Crash we still have not built the CAT. Both of our witnesses
    today have a critical role in its approval, so I look forward
    to hearing their explanations on its timely completion.
        Thank you, Mr. Chairman, and I look forward to our
    witnesses' testimony.
        Chairman Crapo. Thank you very much, Senator Warner.
        I saw the same graphic you did, and it is remarkable to see
    the kind of analysis that can show the complexity of the
    markets that we are now dealing with.
        And, again, I appreciate the work that both the SEC and
    FINRA are doing. We want to both, I think, encourage that that
    work proceed quickly and that we address these critical issues
    and get the advice and counsel of those who regulate these
    markets.
        And, in that context, our witnesses for today's hearing on
    Regulatory Reforms to Improve Market Structure are Mr. Stephen
    Luparello, Director of the Division of Trading and Markets at
    the U.S. Securities and Exchange Commission, and Mr. Richard
    Ketchum, Chairman and CEO of Financial Industry Regulatory
    Authority.
        As many of you may know, Rick Ketchum has announced that he
    is going to be retiring later this year, and I know that I will
    miss you, Rick. All of us will. Thank you for your service and
    for your dedication to improving our markets. We appreciate it
    very much.
        Mr. Ketchum. Thank you very much for those words.
        Chairman Crapo. Gentlemen, I think you know the rules very
    well. We have allocated 5 minutes to each of you, and we will
    have you go in the order I introduced you. And at that point,
    then, we will have an opportunity for some questions and
    dialogue.
        Mr. Luparello.

     STATEMENT OF STEPHEN LUPARELLO, DIRECTOR, DIVISION OF TRADING
            AND MARKETS, SECURITIES AND EXCHANGE COMMISSION

        Mr. Luparello. Chairman Crapo, Ranking Member Warner,
    Members of the Subcommittee, thank you for inviting me to
    testify regarding equity market structure. I welcome this
    opportunity to discuss a topic of such importance to investors,
    public companies, our securities markets, and capital
    formation.
        Enhancing U.S. equity market structure continues to be a
    primary focus of the SEC. It was a primary focus in 2015 and
    will continue to be in 2016. My written testimony lays out the
    full range of the SEC initiatives.
        In 2015, for example, the SEC published a proposal to
    enhance the operational transparency of alternative trading
    systems, proposed amendments to a rule that would require
    broker-dealers who engaged in proprietary trading in off-
    exchange venues to become members of a national securities
    association, and approved a pilot program to assess the effect
    of tick sizes on market quality for smaller issuers.
        Before I touch briefly on a few upcoming initiatives, I
    want to give an overview of the Commission's program for equity
    market structure to help illuminate how particular initiatives
    fit into the program as a whole.
        Today's equity markets, as you know, are dominated by
    computer algorithms. These algorithms are capable of
    generating, routing, and executing orders with enormous
    sophistication, volume, and speed. They have enabled types of
    market mechanisms and trading practices that were not possible
    in the days of manual markets.
        Our regulatory regime must keep pace with and adjust
    appropriately in response to these market changes. But doing so
    requires thorough study and an appreciation of the workings of
    the full market. Market structure issues typically are complex
    and highly interrelated. Even when a particular problem is
    identified, efforts to develop a response must reflect the full
    consideration of the risk of unintended consequence.
        To meet this challenge, our ongoing equity market structure
    review is based on three key elements. First, it is data
    driven. A vital first step in dealing with market structure
    questions is to marshal relevant data. Although data analysis
    alone cannot dictate particular outcomes, it is extremely
    valuable to help narrow the range of viable regulatory
    responses.
        Accordingly, the SEC has made a concerted effort in recent
    years to strengthen its capabilities for data collection and
    analysis. These efforts include capturing a wider range of data
    sources, deploying more sophisticated technology tools and
    analyzing data, and employing additional personnel with the
    necessary quantitative skill sets.
        Second, our review of equity market structure is open to a
    wide range of views. Many market structure issues arise in the
    context of proposed SEC rules, national market system plans,
    and exchange rules. These procedural contexts provide an
    extensive opportunity for public comment. But given the
    complexity of market structure issues, the SEC has taken an
    extra step of seeking out a wide range of views in contexts
    other than specific proposals and adoptions. These have
    included concept release, public roundtables, a request for
    comment on particular topics, and the establishment of the
    Equity Market Structure Advisory Committee.
        Finally, our equity market structure review is
    comprehensive in scope. Properly assessing market structure
    issues requires full appreciation of the extent to which market
    participants, the tools they employ, and the trading venues
    they use are interrelated. Rarely, if ever, does a material
    change in one aspect of market structure not have important
    effects on other aspects of market structure.
        Accordingly, the SEC does not address issues in isolation.
    Rather, as outlined in my written testimony, the SEC has
    advanced initiatives that encompass market stability, high
    frequency trading, fragmentation, broker conflicts, and the
    quality of markets for smaller companies. Focus on this wide
    range of substantive issues is intended to help address
    particular areas of concern while still providing an
    opportunity to assess the extent to which these issues and
    initiatives across different categories are interrelated.
        I will finish by briefly mentioning four particular
    initiatives that should see important developments in the
    coming months. One, as mentioned already, is the Consolidated
    Audit Trail, or CAT, which would represent a major step forward
    in oversight of the equities markets. We have approved certain
    exemptions and approved the CAT project manager, clearing the
    way for the staff to be in a position soon to make a
    recommendation to the Commission for publishing the CAT plan
    for notice and comment.
        Another noteworthy new rulemaking initiative involves
    institutional order routing transparency, which would expand
    investors' understanding of the brokers' routing decisions--of
    their brokers' routing decisions--by mandating standardized
    order routing disclosures. I anticipate that the staff will
    make a recommendation on this initiative in 2016.
        Another noteworthy new initiative is an anti-disruptive
    trading rule. Staff is developing a recommendation that would
    be narrowly tailored to address aggressive destabilizing
    strategies in conditions where they have the most possible
    impact to exacerbate price volatility.
        And, finally, a fourth initiative is the potential for a
    pilot program, as discussed, on maker-taker fee structures. A
    subcommittee of the SEC's Equity Market Structure Advisory
    Committee is assessing this issue and I anticipate that it will
    have a recommendation ready to discuss by the full committee at
    its next meeting in April.
        Thank you for inviting me to testify to discuss these
    issues and I look forward to answering your questions.
        Chairman Crapo. Thank you very much, Mr. Luparello.
        Mr. Ketchum.

     STATEMENT OF RICHARD G. KETCHUM, CHAIRMAN AND CEO, FINANCIAL
                     INDUSTRY REGULATORY AUTHORITY

        Mr. Ketchum. Chairman Crapo, Ranking Member Warner, and
    Members of the Subcommittee, I also want to thank you for the
    opportunity to testify today.
        In recent years, there has been an increased debate about
    the structure of capital markets. Once the domain of
    regulators, market operators, and large sophisticated
    investors, market structure is now a topic for much broader
    public discourse. This discourse often, appropriately, includes
    questions about whether or not the markets are fair and whether
    they provide a level playing field for all investors.
        Questions of market structure can be broad and complex and
    it can be difficult to pinpoint what really needs to be
    addressed. I believe there are three key aspects of the markets
    that securities market participants and regulators should
    always be working to strengthen: market fairness, market
    transparency, and market liquidity.
        Investors must have confidence that they can access
    current, accurate market prices that reflect true investor
    supply and demand. That means that market structure must foster
    and promote accurate prices and low trading costs for retail
    investors. Having been in this business for a long time, I have
    seen many significant market structure changes that have
    benefited investors, but some of these changes have also led to
    a more complex and fragmented market.
        FINRA has responsibility to oversee and regulate over-the-
    counter trading of exchange listed and non-exchange listed
    securities as well as trading in many fixed income instruments.
    In addition, FINRA provides automated surveillance and other
    regulatory services to U.S. equity and options exchanges,
    conducting surveillance for approximately 99 percent of the
    listed equity market and approximately 70 percent of the listed
    options market.
        As a result, while the markets have become increasingly
    fragmented, we have been able to aggregate trading data across
    the markets to conduct comprehensive cross-market surveillance.
    This is important because we have found many instances where
    market participants have consciously dispersed their trading
    activity across multiple markets in an effort to avoid
    detection.
        In addition, FINRA's cross-market surveillance program
    enables us to detect those market participants who are acting
    in concert to engage in market manipulation schemes. Our
    innovative program allows us to run dozens of surveillance
    patterns and threat scenarios across the data we gather to look
    for manipulation and front running as well as layering,
    spoofing, algorithmic gaming, and other abusive conduct. This
    sophisticated surveillance allows us to detect activities that
    we were not able to see before. We are also starting to design
    surveillance programs that will span equities and options
    markets together to detect potential cross-product manipulative
    conduct.
        Transparency is another market feature of paramount
    importance to investors, and FINRA recently proposed a series
    of initiatives designed to increase the scope of trading
    information we receive and provide more transparency into
    trading activities to market participants and investors. In
    general terms, these efforts include a call for alternative
    trading systems to provide more in-depth order information for
    regulatory surveillance, greater transparency of volume
    executed away from stock exchanges, more granular audit trail
    information, and tighter restrictions around allowable clock
    drift to better ensure proper sequencing of events.
        These FINRA initiatives align with broader market structure
    changes implemented by the SEC and other market participants.
    Since the May 2010 Flash Crash, the SEC, FINRA, and the U.S.
    stock exchanges have implemented a variety of initiatives to
    minimize the impact of extreme volatility. Among the changes,
    regulators adjusted the market-wide trading pause, which gives
    market participants an opportunity to assess their positions,
    valuation models, and operation capabilities when extreme
    periods of volatility occur. In addition, FINRA and the
    exchanges implemented a limit up-limit down initiative which
    addresses the type of sudden price movements that the market
    experienced during the Flash Crash.
        We had an excellent opportunity to evaluate the
    effectiveness of these changes last August 24. The events of
    that day illustrated both the value of having appropriate
    controls in place and areas where those controls might be
    enhanced, and I look forward to discussing this in greater
    detail with the committee.
        Many of these issues are being considered by the SEC's
    Equity Market Structure Advisory Committee, of which I am a
    member. Among other things, the committee is reviewing the
    current regulatory model for exchanges and other trading venues
    as well as the current state and impacts of Regulation NMS, and
    in particular, the EMSAC is considering whether rules on
    limiting trade throughs, capping access fees, and preventing
    locked and crossed markets continue to serve their intended
    purposes.
        I appreciate the opportunity to testify today and would be
    happy to answer any questions you may have. Thank you.
        Chairman Crapo. Thank you very much. And, again, I
    appreciate the effort that both of you and your organizations
    have been involved in on this. And, to start with, I would note
    that, as Senator Warner indicated, Chair White 2 \1/2\ years
    ago now embarked on the holistic approach and we had been
    looking at these issues even for a couple of years before that.
    I am in the mode of wanting to find out how soon we will get to
    go on some of the answers.
        Each of you in your testimony have identified some specific
    areas and proposals that you think are--I assume you think are
    ready to move forward. So, what I would like to ask you to do,
    both of you to do right now for the remainder of the time I
    have in my questioning in this round is to pick maybe the top
    two proposals or actions that you think need to be made, and I
    am talking about in terms of what we can get to as quickly as
    we can, or how quickly we can get to some proposals on the
    table so we can start moving and then give me a little bit of a
    timeframe idea of what you think that we are looking at in
    terms of getting to these proposals. Mr. Luparello.
        Mr. Luparello. So, it is a fortunate coincidence that I
    think my top two are the ones that are next up in terms of us
    getting proposals out, both of which I alluded to in my oral
    statement, but specifically the Consolidated Audit Trail and
    our institutional order routing disclosure rule, which in
    shorthand, we call Institutional 606.
        Chairman Crapo. And I heard you say ``soon'' on the
    Consolidated Audit Trail and during 2016 on the other, so how
    about--can you specify that a little bit?
        Mr. Luparello. Well, you know, I generally get in trouble
    when I put specific dates on things----
        [Laughter.]
        Mr. Luparello.----but I will at least reference that the
    Chair recently said that it is her desire to have the
    Consolidated Audit Trail approved and the plan processor
    selected in 2016, and if you back out some of the hard dates
    that go into that, that would require us to get the plan out
    for notice and comment in the coming few weeks.
        Institutional 606 is something we are working hard to get
    out in somewhat a similar timeframe. One of the reasons why I
    think it is both an important rule and an important rule to get
    out soon is it works nicely in complement with our Reg ATS
    proposal that we put out. Both of those rules stand on their
    own as very good, important disclosure-based rulemakings. But,
    in a way, they work even better together.
        Chairman Crapo. All right. Thank you.
        Mr. Ketchum.
        Mr. Ketchum. Well, let me start and agree with Steve on
    both of his pieces, without counting them as my two, but I will
    just briefly----
        [Laughter.]
        Chairman Crapo. We will grant you that.
        Mr. Ketchum. But, I will briefly mention on the
    Consolidated Audit Trail, FINRA obviously does a substantial
    percentage of the market surveillance tasks where audit trail
    information is so critical and CAT is a huge step forward. The
    ability to move from a two-step process of identifying the
    firms that are executing and clearing trades where they may be
    problematic to an ability to identify customers as opposed to
    having to go out to firms to get that information dramatically
    reduces false positives, dramatically improves our ability to
    identify problematic activity, and I could not be more
    supportive of the SEC's efforts there.
        I would just note, it is a complex task, and I know,
    Chairman Crapo, that you have always been interested in balance
    and ensuring that this is done the right way, as well. I think
    the SEC's exemptive order, which I compliment Steve on for
    getting out yesterday, was a great example from what was
    submitted by the exchanges and FINRA of the type of efforts to
    both move CAT forward but also move it forward in a way that is
    operationally the most efficient and effective, and I look
    forward to the publication of the plan and moving it as quickly
    as possible.
        Two other things I will mention. It is the right time to
    address and manage and look closely at the maker-taker issue. I
    compliment the SEC for moving forward on a pilot, working with
    the exchanges and FINRA, and I think there were a variety of
    excellent reasons to set the maker-taker pricing and access fee
    provisions where it was at the time the SEC did. The markets,
    as both, Chairman Crapo, you and Ranking Member Warner
    indicated, have changed dramatically since then. The arbitrage
    issues around maker-taker pricing today raise real questions
    from the standpoint of efficiency and investor confidence. It
    is the right time to look at it.
        And, the last piece is, we collectively, both the SEC, the
    exchanges, and FINRA, all need to respond to the areas where
    there is still more to be done showing up from the standpoint
    of trading on August 24. Fundamentally, the markets and the
    steps that were put in place worked and operated well to reduce
    the type of volatility that we had seen earlier at the Flash
    Crash. But, there are a range of issues, as I indicated in my
    testimony, that deserve to be looked at closely, and I think
    that also, from an investor confidence standpoint, is something
    we ought to get to.
        Chairman Crapo. Well, thank you very much, and you both
    kept me right on time.
        Senator Warner.
        Senator Warner. I appreciate the Chairman's questions.
        I am going to come at it maybe with a little more edge. I
    think it is great, what you have--and I say this--I know you
    guys are both trying to get us where we need to be, but, you
    know, it is 6 years on the CAT, and I hope you will take back,
    Steve, the notion to the Commission that at least this
    Senator's patience is wearing very thin. I also wonder, on the
    Consolidated Audit Trail, since the SEC does not have
    jurisdiction over the futures markets, obviously, that is CFTC,
    but as we saw with the Flash Crash, if you have something
    happen on the futures side, it can also affect the equities
    side.
        So, I am going to get out at least two of my questions and
    I am going to ask you to both answer quickly, because I have
    got three or four more. How do we deal with that jurisdictional
    issue, recognizing that you have committed that we are going to
    get this project--the CAT finished in 2016, point number one.
        Point number two, to where, Mr. Ketchum, you were at, I
    think the maker-taker pilot is really, really important. I do
    not know if--Senator Crapo and I both saw it. I do not know if
    Senator Warren saw the RBC chart that showed--again, I just say
    to say again--839 different fee models and over 3,700 different
    kind of fee structures, a level of complexity that even for
    Wall Street is over the top, that clearly is driving
    commissions, fees, and rebates in a way that is not
    transparent, that does not guarantee best markets, that under
    the guise of bespoke products, I think, is creating a real
    disservice, and my understanding, at least, in terms of a
    maker-taker pilot, if you decide to move forward, this would
    not require months and months of preparation. You could simply
    pick an arbitrary 100 equities, put 50 in the control batch and
    50 in the noncontrol batch and flick a switch and we could
    start that pilot.
        So, I would like you on the first round, briefly, because I
    have got, again, a few others to whack at--to hit on--how hard
    around the CAT without the jurisdiction on futures, and can we
    be assured that we are going to move forward on maker-taker in
    a timely manner, in either order.
        Mr. Luparello. I will be happy to start. CAT could not be a
    higher priority for us, and getting a recommendation to the
    Commission----
        Senator Warner. Six years is a long time.
        Mr. Luparello. I--I appreciate that, and I have lived that
    for--I have lived in that space for all of it, including some
    time living with access to inadequate information. So, we--like
    I said, it could not be a higher priority for the Commission,
    for the Chair, and especially for me and my staff, and we
    expect to have something very, very soon.
        I think the issue of other products, it cannot be
    overstated. There are some jurisdictional issues. I know the
    CAT plan participants, and Rick is more close to this than I
    am, have been identifying those potential expansions into other
    products, because August 24 proved what I think we already
    knew, which is that the futures markets and the cash markets
    are inextricably linked, and if we do not have a good vision
    into those, we are still--we are going to be seeing a much more
    complete picture on a day in, day out basis, but during times
    of extreme market stress, we are going to be missing an
    important part of the picture if we do not have futures there.
        I agree, I think maker-taker is a pilot that, unlike some
    other pilots, where I think we are concerned that we are adding
    even more complexity when you put a pilot into place, that
    maker-taker is one that can be done very simply. We look
    forward to the recommendation from the Equity Market Structure
    Advisory Committee. I think it will be something we will be
    able to act on very quickly.
        Senator Warner. When?
        Mr. Luparello. The subcommittee is supposed to make a
    recommendation to the full committee at the next full committee
    meeting, which is late April. And, so, that full committee will
    then----
        Senator Warner. Do you think there will be a
    recommendation, either go or no go?
        Mr. Luparello. I think the Subcommittee will be ready to
    make a recommendation to the full committee. Given the
    conversations that the full committee has had, I obviously
    cannot commit the full committee. I would expect that they
    would probably have some questions about the construction of a
    pilot, but I think there is broad-based support, which is,
    obviously, very important because it is a committee with a
    number of different market participants and constituents, that
    I think there will be broad-based support for a pilot.
    Obviously, the details of how you construct the pilot are to be
    determined.
        Senator Warner. Rick.
        Mr. Ketchum. As the operator of most of the market
    surveillance activity going on in the markets today, nothing
    could be more important to us than moving to CAT. We are
    fortunate now that we can look across markets and across
    products, but the Consolidated Audit Trail dramatically
    enhances the effectiveness of our job.
        You are right, Senator Warner, that there is no question
    that including futures and, frankly, on the way, credit default
    swaps would be a huge step forward with respect to the
    Consolidated Audit Trail and efforts should be made to move
    across jurisdictional lines. We have worked closely with the
    MERC with respect to investigations for years and they have
    been tremendously cooperative. But, the only way to effectively
    identify or recreate markets is to have it all in one single
    database, and your point is absolutely correct.
        Senator Warner. Can you quickly address, since my time is
    out and I want to come back next round on tick size and bond
    market transparency, just very quickly on maker-taker.
        Mr. Ketchum. Maker-taker, I absolutely support a broader
    pilot. It is something that should be done from the standpoint
    of data. There are a lot of interesting questions around it.
    But, to me, sitting as just one member of the Equity Advisory
    Committee of the Commission, I think this is absolutely the
    right time to look and make changes to the maker-taker pricing.
        Chairman Crapo. Thank you, Senator Warner.
        And, Senator Warren. Senator Warren has to leave to another
    Committee meeting, and so she is going to get a few extra
    minutes on this one instead of waiting for the second round, if
    that is all right with you, Mr. Warner.
        Senator Warren. Thank you.
        Senator Warner. Sure.
        Senator Warren. Thank you very much Mr. Chairman. I really
    appreciate your cooperation so I can cover two hearings, and
    also appreciate your calling this hearing. This business about
    market structure is just powerfully important. That makes this
    hearing very important.
        I want to focus on the self-regulatory aspect of this
    market. FINRA is not a Government agency. It is instead an
    independent nonprofit organization that is responsible for
    regulating parts of the securities industry. So, I looked on
    your Web site and the Web site for FINRA says that it is
    dedicated to investor protection and works everyday to ensure
    that every investor receives the basic protections they
    deserve. I want to explore whether this industry self-
    regulation really works.
        This week, three economists from the University of
    Chicago's Booth School of Business released a study that looked
    at records on 1.2 million registered financial advisors and
    brokers from 2000 to 2015, and they found that 1 in 13 had a
    documented record of criminal, civil, or regulatory misconduct.
    Amazingly, only about half of them had been fired by their
    firms because of this misconduct, and of the half that were
    fired, 44 percent got a job at another advisory firm within a
    year.
        Now, the study also finds that certain advisory firms hire
    a huge number of advisors with a history of misconduct and
    those firms tend to, quote, ``cater to unsophisticated
    consumers, particularly the elderly and those with less
    education.'' For example, a customer walking into an
    Oppenheimer and Company retail location looking for financial
    advice has a one in five chance that the advisor will have a
    documented history of misconduct.
        Mr. Ketchum, as the head of FINRA, what are you doing to
    make sure that the elderly and people who can least afford bad
    financial advice do not fall into the net of someone who has
    already got a documented history of misconduct?
        Mr. Ketchum. Senator Warren, I am glad you asked that
    question. First, I read that study, as well, with great
    interest, and I do find it dismaying that firms do hire in many
    circumstances persons with those type of records. Those are
    exactly the factors we look at from the standpoint of where we
    focus our exams and where we focus our enforcement
    investigations. It is exactly those type of factors which
    result in us barring or suspending up to a thousand persons a
    year, bringing action with respect to a wide range of firms and
    more than a thousand actions a year. And we care very much
    about the issues from the standpoint of recidivism and the
    potential impact with respect to investors.
        Senator Warren. Well, I appreciate, Mr. Ketchum, that you
    care about this, but these are the data about what is going on
    right now. I want to know what you plan to do about it. You
    know, we have got FINRA-registered companies where 15 to 20
    percent of the FINRA-registered advisors have a history of
    misconduct. What is going on here?
        Mr. Ketchum. Well, first up, and let us go back to the
    definition of misconduct, which is, among other things, that
    the firm settled an arbitration or a complaint for some amount
    of money without admission one way or another with respect to
    the investor.
        Senator Warren. But----
        Mr. Ketchum. These are absolutely incidents of exactly the
    type of thing we look at from an exam standpoint----
        Senator Warren. Well, I am glad you are looking at it----
        Mr. Ketchum.----but we do actually have to find somebody--
    --
        Senator Warren.----but you are not taking them off the
    street. And let us be----
        Mr. Ketchum. We do when they violate the rule. Yes, we do.
    We bar----
        Senator Warren. Then how can it be so----
        Mr. Ketchum. We bar hundreds of----
        Senator Warren. How can there be so many? How can it be
    that you could walk into an Oppenheimer and Company and have a
    one in five chance of encountering someone who has prior--
    recorded prior misconduct? And, let us keep in mind, this does
    not--these are not trivial.
        The other thing that the study found was that advisors who
    have engaged in prior misconduct are five times more likely to
    engage in future misconduct when compared with the average
    advisor. So, we are talking about real risk here.
        Mr. Ketchum. And that is exactly the risk we look at with
    respect to our exams and enforcement investigations, and that
    is why many of those people get barred every year.
        Senator Warren. Well, all I can say, Mr. Ketchum, is you
    obviously are not getting them out of the industry. They are
    still there. They are there in big numbers. And they are
    concentrated in places where they are most likely to encounter
    unsophisticated consumers and I think that is a real problem
    that we have got.
        So, let me look at another aspect of the industry self-
    regulation. Almost every advisory contract these days includes
    a forced arbitration award, and that means that if investors
    think they have been cheated, they cannot go to court, and if a
    bunch of them get cheated by the same broker in the same
    scheme, they cannot combine their claims into a class action.
    They have to come to you, to FINRA, for arbitration.
        Now, it turns out that investors do not win very often in
    arbitration and that even if they do manage to win, they do not
    get paid. A recent report from the Public Investors Arbitration
    Bar Association found that over $60 million in arbitration
    awards to investors in just 1 year, 2013, are still unpaid. And
    just to put that in context, that means of the people who
    finally made it all the way through the arbitration process and
    managed to actually win against their broker or advisor, about
    a quarter of them still have not gotten the money that they won
    in the arbitration award.
        Now, the same issue--main issue here seems to be that these
    security firms do not have the money on hand to pay these
    awards. They stay in business, but they do not have the money.
    So, what is FINRA planning to do to ensure that these firms and
    brokers actually have the money to pay an arbitration award
    when they cheat people?
        Mr. Ketchum. OK. Three sets of responses to your very valid
    question.
        First, with respect to any firm that continues to do
    business in the securities industry, unless they leave and
    become an investment advisor, we will bar them if they do not
    pay their awards, plain and simple as that. No one can stay in
    as a FINRA member and not pay their arbitration awards. And we
    do that----
        Senator Warren. So, you are telling me--I just want to make
    sure I understand what that means. You are saying of the $60
    million in arbitration awards from 2013, all of those people
    are now barred? They are not part of FINRA anymore?
        Mr. Ketchum. If I can get through my three answers----
        Senator Warren. OK.
        Mr. Ketchum.----I will try to address each part. If they
    continue to have money, if they continue to do business as a
    FINRA member and they do not pay their arbitration awards, we
    will bar them.
        Now, you are right, and one of the things that we have is
    that firms become insolvent, leave FINRA, and in those
    situations, we lose our jurisdiction from that standpoint and
    investors--from the standpoint of barring them, they are
    already gone--just as, by the way, they do if they are an
    investment advisor bringing an action against the firm and that
    firm goes insolvent with respect to enforcing a court decision,
    they have to go to court to enforce it, and that is a big
    problem from the standpoint of the number of people that are
    not paid.
        You raised exactly the right questions. The question as to
    whether the capital requirements are at the right level are
    fair questions. They are things we will look at at FINRA,
    although I will note capital requirements are essentially
    something that the SEC has taken responsibility for. Now, most
    of the time, we want to get these people out of the industry if
    they are doing bad things to investors.
        But, whether there should be jumps before firms leave to
    ensure that they have left capital to meet their arbitration
    obligations that may come forward is something we are looking
    at. Whether, one way or another, there should be a fund to try
    to at least address this with respect to small investors that
    are terribly harmed by that. I could not agree more that each
    of those issues ought to be looked at.
        Senator Warren. OK. So, what I am hearing you tell me, and
    I just want to make sure I have this right, is that you believe
    that there ought to be more regulation so there is money
    available when people get cheated. And, second, you are telling
    me that all of the people who were cheated in 2013 who got
    arbitration awards who have not paid out, that all of those
    dealers and brokers are now out of the business and out of your
    jurisdiction. Is that right?
        Mr. Ketchum. I am not--I am saying that those that have not
    paid out will either be in a short period of time barred or are
    already out.
        Senator Warren. This is now 3 years.
        Mr. Ketchum. Well, but with respect to those, they are
    gone. Those are firms that have left FINRA.
        Senator Warren. All of them from 2013 are gone.
        Mr. Ketchum. Those--yes.
        Senator Warren. OK.
        Mr. Ketchum. Those are firms that have left FINRA and the
    collection issues are exactly the same collection issues you
    have when a firm goes insolvent with respect to court.
        Senator Warren. Well, I just want----
        Mr. Ketchum. But something should be done about it, and I
    want to repeat what you just said. I do believe this is an
    issue we want to be part of, we want to work with the SEC on,
    and it is a real concern.
        Senator Warren. Well, I just want to say on both of these,
    I think something should be done about brokers and dealers who
    put customers at risk. Brokers and dealers have arbitration
    awards against them and cannot even pay when there is an award
    against them. They are serious issues. They affect ordinary
    investors. FINRA is supposed to be looking out for these folks,
    not for the advisory firms, and I hope you will address these
    issues quickly.
        Thank you, Mr. Chairman. Thank you for your indulgence in
    giving me the extra time.
        Chairman Crapo. Thank you, Senator Warren.
        Senator Donnelly.
        Senator Donnelly. Thank you, Mr. Chairman.
        I appreciate the efforts of the SEC and Chair White in
    recent years to review and improve the structure of our equity
    markets. They are significantly more complicated, and in recent
    decades, we have moved from a single dominant stock exchange to
    a marketplace now featuring 12 exchanges, 40 dark pools, and
    hundreds of broker-dealers. Additionally, trading is electronic
    and highly automated.
        And, Mr. Ketchum, you spent 14 years with the SEC before
    working for the exchanges and on Wall Street. Can you describe
    the significant changes in market complexity you have witnessed
    and the effect.
        Mr. Ketchum. Well, I will try to, Senator Donnelly, and you
    are right. The changes are dramatic. I think over a period of
    years, with a combination of technological advances and the
    SEC's focused effort to reduce barriers to entry and encourage
    competition, the markets have changed dramatically. We have
    moved from an environment where the New York Stock Exchange and
    NASDAQ stock market accounted for virtually all trading that
    occurred, where they operated with respect to either a single
    specialist system or a constrained market-maker system from the
    standpoint of providing liquidity to the environment that Mr.
    Luparello described earlier in his statement where liquidity is
    essentially provided through a range of algorithmic active
    traders, some of whom have requirements and obligations built
    into their exchange registrations and some of whom do not.
        The markets are also dramatically fragmented across large
    numbers of exchanges and automated trading systems, and that
    has changed the environment and raised issues from the
    standpoint of transparency, disclosure as to how orders are
    handled, issues from the standpoint of best execution, and,
    obviously, as has been discussed before, maker-taker pricing.
    This is an area that continues to deserve great----
        Senator Donnelly. Let me ask both of you, do you think the
    regulators have the tools to keep pace with the technology
    development and the efforts that are being put forward to try
    to constantly move the ball? You know, we have seen time after
    time some of these flash situations and others where the
    regulators are on this effort and the ball has already moved to
    this point.
        Mr. Luparello. So, jurisdictionally, clearly, we have the
    tools we need. From the ability to both gather and analyze
    data, we have improved dramatically over the past few years,
    but there is still some way to go. So, in all of these issues,
    we always try to start first by analyzing the data we have
    available. I think, as you can see with the work we have done
    after the August 24 event, that is still a process that is a
    little more burdensome, a little more cumbersome than we would
    like. As we make progress on that, I think the ability to
    analyze data in a more nimble way, use both the expertise and
    the jurisdiction we have, and work with the
    variety of market participants, will give us the ability to
    react in a timely fashion to market events.
        Mr. Ketchum. I will agree with Steve that between us, and
    particularly the SEC has the regulatory tools necessary to
    address this and also analyze the markets. I will stick on the
    market surveillance side, where FINRA takes a primary
    responsibility. We have dramatically better capabilities now
    than we ever had before through our contracts across exchanges,
    both stock and options, to look across markets and identify
    manipulative activity that does not define the most active
    traders, but with respect to those aberrant ones. But, we can
    do better. A key tool is the Consolidated Audit Trail and I
    look forward to----
        Senator Donnelly. What concerns both of you the most about
    the current structure of the equity markets? Where, when you
    look, you go, here is a hole that somebody is about ready to
    exploit, here is a problem that we are--you know, and it is a
    hard question to answer. What are the problems you are missing
    that almost you do not know you are missing at this point?
        Mr. Luparello. Well, all right, the answer is what you do
    not know. I think we are less--we are always attentive to the
    issues of the robustness of the structure, but, again, I think
    the pattern over the past few years has demonstrated that a
    number of the steps that the Commission has asked for and the
    markets have put into place have made the market broadly a more
    robust place. I think you look at the events in July, where one
    of the major markets was out for an extended period of time,
    fortunately the middle of the day, neither the beginning nor
    the end of the day, and the markets were able to trade pretty
    efficiently without that one primary market being in the
    marketplace.
        I think in terms of what we worry about, we worry about
    what everybody else worries about, which is cyber and those
    kinds of issues and whether the rules we have put into place,
    which are significant, are right, rightly tailored, and being
    adhered to to ensure that we are doing everything we can from
    that standpoint to make the market robust.
        Senator Donnelly. Mr. Ketchum.
        Mr. Ketchum. The market has dramatically improved from a
    resiliency standpoint in addressing some of the excess
    volatility issues when you look back to the Flash Crash, where
    I think the markets, as a result of the changes, were truly
    unsafe at any spade. We still need to step back, look at events
    like August 24, and identify the additional steps needed to
    address and ensure that those protections against unnecessary
    volatility continue to be improved. And we still need to
    enhance our audit trail to ensure we are identifying those
    small numbers of serious manipulative activities and creative
    activities in the most effective way possible.
        Senator Donnelly. If I could ask just one more question,
    and this is--you may consider this a little bit offbeat, but
    when you look and you saw that there was a whole system set up
    to try to race ahead of trades, to try to gather the
    information and race ahead of trades that were being made to
    make more money, and part of it was putting locations and
    buildings right next door to buildings next door to buildings,
    when you look, is there anybody in your organizations that look
    for unusual activities, where you go, why are seven firms going
    into this building right next to this building, for instance?
    Do you look for things that, for want of a better way to put
    it, seem to have no real reason other than something may be
    going on?
        Mr. Luparello. So, there is a very important question about
    whether the race for speed reaches a point of diminishing
    returns and whether we should do things in the market that
    enable market participants of different speeds and different
    capabilities to have as good an experience as possible.
        I think in the context of co-location, that is, in fact, a
    regulated function, that these are functions that the exchanges
    provide to their members. They must provide them on equal terms
    to all of their members. So, there is that aspect, at least,
    issues around speed and latency are highly regulated. It is a
    very important separate question about whether people are
    taking those speed advantages and using them for improper
    purposes. I think that is something that both we and FINRA--and
    again, FINRA is the front-line regulator--spend a lot of time
    both thinking about and looking at.
        Mr. Ketchum. Certainly, our primary focus of our
    surveillance is looking at the outcomes, the trading and
    whether that trading is, in one way or another, taking
    advantage of other investors. And, I think, there, we are far
    more sophisticated in identifying patterns that suggest those
    problems than we have ever been before.
        Senator Donnelly. Thank you, Mr. Chairman.
        Chairman Crapo. Thank you, Senator Donnelly.
        We will have a second round of questions, and I will start
    it out with you, Mr. Ketchum. In fact, this is an issue that I
    think I am really sort of teeing up for Senator Warner here,
    but I wanted to get my bite at it first.
        FINRA and the Municipal Securities Rulemaking Board are
    expected to finalize rules to increase the disclosure of broker
    fees for retail trades and bonds. How will that work, and do
    you expect retail investors to get better pricing?
        Mr. Ketchum. Thank you for that question, Chairman Crapo,
    and I think it shows--and both of you have demonstrated over
    time through your recognition that while there are many
    important issues to look at with respect to the equity market,
    there are also significant issues with respect to the evolving
    fixed income market.
        Yes, when I look at the present environment with respect to
    fixed income securities and look at the range of trade prices
    that exist with respect to similar bonds, we see a pattern in
    which firms, although they are not engaging in illegal activity
    from the standpoint of the markets, they charge meaningfully
    significant, as in multiple times of the amount of markup. That
    is precisely the type of situation where additional disclosure
    to investors that can--will, I think, encourage a more
    efficient market.
        We saw that happen with respect to TRACE when we began, and
    on the municipal security side, where trade reporting began and
    that resulted in more efficient pricing. I think this will, as
    well. It is not a cure all. And, in addition, we need to look
    very closely at the operational cost, which is what we will
    certainly continue to follow as we file these proposals with
    the SEC through that comment period.
        Chairman Crapo. All right. Thank you very much.
        I am going to let Senator Warner dig deeper into that one,
    if he chooses to. I want to use the rest of my time in this
    questioning period with you, Mr. Luparello. Well, actually,
    this could be for both of you, too, so you will have to listen
    in, Mr. Ketchum.
        The SEC Equity Market Structure Advisory Committee has four
    different subcommittees, and this kind of follows on my first
    line of questioning. I am trying to pull out of you just where
    we are on all of this and what we can expect to see and how
    soon. But, those four subcommittees are subcommittees on Reg
    NMS, on trading venue regulation, on retail customer issues,
    and on market quality. And, I realize that is a pretty broad
    swatch, but I am curious to hear from you just, basically, what
    are the main options that we are seeing develop in these
    subcommittees and what more decisions need to be made before we
    get some proposals.
        Mr. Luparello. So, the Equity Market Structure Advisory
    Committee--and it is true that Rick is on at least two of those
    subcommittees, so he has got a vantage point in terms of the
    operations of the subcommittees that I do not have--the
    committee itself has been in place for about a year or so. It
    is relatively new. The creation of the subcommittees is even
    newer than that. And, so, to a certain extent, how they are
    going to define their jurisdiction, what they are going to
    choose to focus on is something that they are still
    considering.
        We talked about asking one of--we directed one of--
    requested that one of the subcommittees focus immediately on
    constructing a maker-taker pilot. I think that is an important
    first tangible deliverable that a subcommittee will deliver and
    it is absolutely the right priority.
        There are a number of other things in play. I think one of
    the other ones we continue to think is a good area for a
    subcommittee to focus on and to make recommendations to us
    about is around issues of plan governance.
        So, in some ways, the work of the committees is still
    fairly
    nascent and what they are going to choose to focus on is
    something that they are trying to figure out at this point.
    But, again, progress on an access fee pilot and progress on
    advice around plan governance are two very important things,
    and if they deliver those to the committee in the near term,
    they will be really delivering some valuable benefit.
        Chairman Crapo. Thank you.
        Do you want to add something to that, Mr. Ketchum?
        Mr. Ketchum. Well, as Mr. Luparello indicated correctly, I
    am on two--lucky enough to be on two of those subcommittees,
    one of which is focusing on best execution and customer order
    routing information, the other of which is looking at venue
    issues from the standpoint of the operation of plans and the
    appropriate regulatory treatment of exchanges and automated
    trading systems.
        The great advantage of the subcommittees, the Commission
    has set up these meetings so that we get input from a wide
    variety of persons with regard to the committee as a whole. The
    subcommittee allows us to also bring in a variety of experts
    and have more open two-way conversation to discuss potential
    actions, and that is what we are really trying to look through
    there with respect to both of my subcommittees.
        I expect that this will result in very concrete
    recommendations for improvements with respect to the type of
    information that is now provided with regard to executions by
    both the market-making firms and the order routing firms, and
    also responses with respect to the appropriate environment for
    exchange and ATS regulation. So, I think the subcommittees help
    with that.
        My impression is the focus now is that the--I expect in
    each of the areas that Steve discussed there will be concrete
    recommendations coming out, Mr. Chairman.
        Chairman Crapo. Well, thank you.
        And, again with regard to both of you, quickly--I have got
    2 minutes, basically, here--what issues in the fixed income
    markets, do you think, need to have some heightened attention?
        Mr. Luparello. I would start by complimenting Mr. Ketchum
    on the work that FINRA has done in preparing to get a rule
    filing to us as well as MSRB in the area of retail order
    execution transparency. I think that is an enormous step
    forward. It is a long time coming. For Rick and I, it is an
    especially long time coming. So, we are looking forward to
    that.
        I think the other thing we are spending a lot of time on is
    that there has been a real development, again, mostly in the
    retail space, of the creation of transparency venues that
    basically look like ATSs that are bringing pre-trade
    transparency to the fixed income markets where it really has
    not existed before.
        I think one of the things we spend, like I said, a lot of
    time thinking about is are there ways we can encourage and push
    that forward without, as the regulator, perhaps interfering
    with what would otherwise be positive natural developments. So,
    we are in conversations with many of the platforms that provide
    these liquidity venues and trying to figure out what we can do
    to make sure that that development, which is a very positive
    development for investors, continues to move forward.
        Chairman Crapo. Thank you.
        Mr. Ketchum.
        Mr. Ketchum. I would completely agree with the two issues
    Steve identified. I will mention one in a slightly different
    area, and that is Treasury securities. The agencies
    responsible, including Mr. Luparello with respect to the SEC,
    put out, I think, an excellent study that demonstrated the lack
    of transparency and also the dramatic changes with respect to
    how Treasury securities are trading now versus just a few years
    ago, and the time to move forward on that, and there has been a
    request for comment coming out of the Treasury Department that
    I thought was really very well done, time to move forward to
    ensure first, at a minimum, that there is full regulatory
    reporting of all transactions involved in the Treasury market
    and looking closely at the question of greater transparency.
    This is one of the most important markets of the world, but it
    distinguishes itself from all other fixed income markets in the
    United States from the lack of transparency.
        Chairman Crapo. Well, thank you very much.
        Senator Warner, the floor is yours.
        Senator Warner. Well, thank you, Mr. Chairman, and really,
    again, very much appreciate the fact that you have called this
    hearing.
        And, I just want to make an editorial comment before I get
    to--I have got a whole series of additional questions and
    buckets we have not even gotten into yet. But, I think it is
    really important that you hear us that the public's faith in
    the markets and the transparency and is it going to be treated
    fairly, I think we are not out of the woods on that. I think
    Senator Warren's comments about arbitration and the failure to
    get paid, you know, that came up late February in the Wall
    Street Journal, I think we do need action and we need prompt,
    quick action from FINRA, Mr. Ketchum, so that there is, whether
    it is a reserve fund or some action, but not an action that is
    studied for years.
        You know, on the Consolidated Audit Trail, it is
    complicated. I understand that, appreciate that. But, it is 6
    years, 6 years since the Flash Crash. You know, on the maker-
    taker pilot, I have not done all the research, but just common
    sense says if you have got 839 different fee schedules and over
    3,700 different fee variables all trying to create bespoke
    products that push fees and rebates to individual brokers, that
    is not on the up and up. And, I appreciate the idea that the
    subcommittee is going to recommend something in April, but we
    really do need to know when the full committee is going to act
    and when is this pilot going to take place.
        Let me get out a couple more before I even start on my next
    round. You know, the bond market transparency that Senator
    Crapo raised, Senator Coburn and I raised this issue in
    legislative form 2 years ago, and yet we still do not have a
    full-fledged answer, and there are mark-ups and mark-downs and
    selling bonds. I mean, the bond markets ought to be the most
    transparent of our markets.
        So, do either one of you want to respond on that, on the
    generic, and I have got three or four more things on specific I
    want to question you on. You might tell me that the
    subcommittee is going to act in April and the full committee is
    going to act by July or something.
        Mr. Luparello. No, I think the subcommittee will make the
    recommendation to the full committee in April. I expect to get
    the full committee's reaction to that at their meeting in
    April, and so----
        Senator Warner. Do you think they will actually act?
        Mr. Luparello. I--that is--that is our--I cannot speak for
    the committee, since it is an independent committee, but I
    would assume that a number of these--first of all----
        Senator Warner. So, it is not unrealistic to think that we
    might have a maker-taker pilot at least started or close to
    started this summer?
        Mr. Luparello. No. Unfortunately, a committee
    recommendation is just a recommendation to the staff. Again, I
    think you find that--that recommendation will find a very ready
    audience with the staff, but the staff still needs to make a
    recommendation to the Commission. Then the Commission would
    need to put it out for notice and comment. So, a Commission-
    mandated maker-taker pilot would take a few months after that.
        Senator Warner. Mr. Ketchum, do you want to comment on----
        Mr. Ketchum. Well, on that, I just----
        Senator Warner.----either that or on market transparency?
        Mr. Ketchum.----speak as one member of the committee and
    recognize in the end this will be a Commission decision, as
    Steve indicates. But, I certainly support a pilot. I look
    forward to see exactly what the subcommittee recommends, but I
    am pretty confident we will be supportive of it.
        I just want to take a second on fixed income. You are
    right. This is an area that has dramatically changed. It has
    become more and more an area where retail investors are
    participating both directly and indirectly through bond funds.
    I think the steps we have proposed with respect to mark-up
    disclosure and what I expect will come out of the MSRB is
    critically important and there is nothing that is more
    important to me than to see that go forward.
        And, as far as the points you made, Senator Warner, on
    arbitration, since I am retiring this year, I am not thinking
    in multiple years. This is a year that is terribly important to
    me as to what we do and this is something that is very
    important to me to make progress on.
        Senator Warner. Done this year, in terms of some level of
    reserve or some ability for firms not to exit and leave people
    holding the bag?
        Mr. Ketchum. I need to have that conversation with my board
    and there needs to be specific proposals, but yes, I hope so.
        Senator Warner. Mr. Chairman, can I take a couple more?
        One of the areas that, Mr. Chairman, you raised at an
    earlier hearing and we both focused on terms of trying to
    provide more liquidity for small stocks, or smaller traded
    stocks, we talked about a tick size pilot. Again, agreement.
    Again, hope and expectation that that tick size pilot was going
    to take place this year. We saw it was supposed to take place
    and move forward in May. That date slipped to October.
    Arguably, some of the exchanges seem to have put forward
    proposals that seem to be more focused on preserving their own
    commercial interests than actually trying to provide a
    legitimate experiment.
        Are we going to hit October? I know there were three
    proposals. Where does it stand?
        Mr. Luparello. We are----
        Senator Warner. How do we actually get this one on the
    ``done'' list?
        Mr. Luparello. You have identified exactly the right issues
    that have caused the delay, but we are going to get it done by
    October. We have now filings in from----
        Senator Warner. That is for the record, October, no further
    delay?
        Mr. Luparello. That is. That is from the standpoint of what
    we can deliver. So, we now have--we now have filings in from
    two of the markets that define some of the provisions, I think,
    in a manner more consistent than we--more consistent than had
    originally and more in line with what we were expecting. We
    assume the other markets will find that to be consistent with
    what their expectations of what a trade act component would
    look like. We are ready to move forward on all of them. I think
    we now have that level of consistency. We have the data
    gathering part of the
    rulemaking done, and so I think we are in very good shape to
    move forward in a way perhaps we had not been in good shape up
    until these past few weeks.
        Senator Warner. But, it is a fair critique, not of you all,
    but some of the exchanges, that their first round of proposals
    were more about preserving their own commercial interest than
    actually trying to figure out how we can bring more trading
    frequency and liquidity to smaller cap stocks.
        Mr. Luparello. I guess I would say that for certain
    markets, the definition of trade, that is in the eye of the
    beholder. There was certainly differences of opinion on how
    that should be scoped.
        Senator Warner. One of the things that we have, when I
    think anyone questions, whether it is HFTs or other aspects of
    the market, the ever more technologically driven market, I feel
    at times that you get kind of a dismissive response of, well,
    gosh, the god of liquidity trumps everything. So, that is the
    answer to any question that any nonperson from the market gets.
    You guys just do not understand because it is all about
    liquidity.
        Well, part of liquidity is, you know, the ability also for
    market making, and yet we do not have any kind of standardized
    definition of what a market-maker would end up looking like.
    Does it make sense to think about standardizing a definition
    around market maker? You know, should there be something that
    says you have got to have 99.9 percent of the time the ability
    to make a market? You do question some of these folks who say
    they are market makers, but at the end of the day have a closed
    out, completely closed-out position. It seems just--again, I am
    not as sophisticated as some, but that seems inherently
    contradictory of the notion that you are making a market if you
    have closed out your position at the end of the day.
        We all know since 1987 to the Flash Crash and others market
    making is great when it is going up, but nobody wants to catch
    the knife when it is falling. So, thoughts on the whole
    question about some level of standardization around market
    making.
        Mr. Luparello. It is a very important issue and I think it
    was part of Rick's response to Senator Donnelly in terms of the
    dramatic changes in the market over the past couple of decades.
    It is fair to say that the obligations of being a market maker
    are considerably less than they used to be. The benefits of
    being a market maker are also less. So, the idea of potentially
    giving market makers some advantages that they do not have now
    in exchange for certain obligations that they do not have now
    is one that is a very important question and one that touches
    on a variety of different areas in the overall analysis of
    market structure.
        I think it is something where, again, the expertise of the
    committee is something we look to rely upon, but not
    exclusively. But, it is a very complex question.
        Mr. Ketchum. I agree with Steve. With respect to my first
    SEC advisory committee, I was associated with the
    recommendation that this be looked at. I do think that greater
    definition of market-making obligations and market-making
    incentives is something that should be focused on. I entirely
    support the SEC looking at it.
        Senator Warner. But, I hope we would actually move forward,
    because I think, again, whether it is liquidity or market
    making, there are lots of broad-based rationales given that,
    when the stuff hits the fan, sometimes if they are not there,
    then this value disappears.
        Let me get even a little more out there. One of the tools
    that SEC has, FINRA has, the FTC has, as the markets move more
    and more into algorithmic computer-driven trading, we know you
    all have the ability in certain instances to actually go in and
    look at the underlying code. Now, understanding that many of
    these firms believe that that underlying code is their
    proprietary secret sauce, I understand that as somebody who
    used to be in the tech world. But, I wonder, does it make sense
    to actually tag some of those codes so that in an event of a
    market meltdown or enormous turmoil, in kind of a post-action
    report, you could have tagged that code to see which of these
    secret sauces may have actually contributed to market
    meltdowns? And is anybody thinking through that?
        Mr. Luparello. Yes, but I need to point out that there are
    a couple of assumptions that are in that that need to be
    validated or acted upon, one of which is that active
    proprietary traders are broker-dealers. I think that is
    something where, while most of them are now, it is important
    for the Commission to clarify that. It is something we are
    working on. And also that the code that is embedded in some of
    the algorithmic programs are, in fact, books and records of the
    broker-dealer.
        So, I think, as a general matter, like I said, most active
    traders, most HFTs are broker-dealers. I think they generally
    think of those things as books and records. When push comes to
    shove, I would hope they continue to hold those positions.
    Those are very important things for the Commission to clarify
    and are on our list of things to do in the coming months.
        But, absolutely, a better understanding of how algorithms
    are developed, how they are deployed, what their purposes are,
    and what order flow came from what algorithms is a very
    important piece of information that we need to have when we
    reconstruct markets, especially during volatile----
        Senator Warner. Right, I understand the proprietary nature
    and that needs to be protected, but the ability to go in after
    the fact and see the results--Mr. Ketchum, do you want to----
        Mr. Ketchum. I will just add two supplemental things from
    that standpoint. I completely agree that both being better able
    to identify problems with respect to an algorithm and in
    particular to create greater accountability from the standpoint
    of the supervisory obligations of the broker-dealer that is
    essentially providing the route to execute those orders is
    absolutely critical.
        In the present environment where we are trying to do that,
    recognizing that these are very clever folks who now send their
    strategies when they are manipulative over multiple broker-
    dealers, as I indicated before, to numerous markets, we are
    starting to throw report cards back to the firms that are
    executing when we see algorithms repeating again and again,
    manipulative activity using multiple broker-dealers, so those
    firms, even if they do not see the whole activity, can
    recognize their accountability from a supervision standpoint
    to, frankly, shut that algorithm off.
        Separately, as we move to a Consolidated Audit Trail, I
    know I am just--this is throwing a red flag at you----
        Senator Warner. Adding fire----
        Mr. Ketchum.----but as we move to a Consolidated Audit
    Trail----
        Senator Warner.----fuel to the fire here.
        Mr. Ketchum.----we will then have exactly the ability to
    pinpoint with greater granularity the specific algorithm
    activities. And, I could not agree more that both the
    accountability of supervision and getting to that point where
    we can pinpoint the algorithm activity is really important.
        Mr. Luparello. And, I guess the one thing I would add is
    while we absolutely have access--need to have access to the
    information to be able to understand the markets, we are not
    insensitive to the issue of the secret sauce. The number of
    times you would need to ask for code, the protections around
    asking for information of that sensitive and proprietary a
    nature is something that we would need to be very careful of.
        Senator Warner. I would just say, and I do not want to
    state the Chairman's position, but the Chairman and I want the
    markets to work. We are generally supportive of, you know, some
    of the advantages that have come out of the technological
    developments over the last 20 years. But, we also know, and we
    both went through kind of a litany in our opening statements of
    all of the glitches and challenges that the markets have seen
    even post-2008.
        And, at least from this Senator, I would take as a real
    deep concern that the things that we need to do to keep
    investor trust, and not just nonsophisticated investors, all
    the way up the food chain, and recognizing--I think one of you
    mentioned--there is so much money to be made, we are always
    going to be chasing wherever the markets and the advances move
    forward.
        But, when we look at the CAT taking 6 years, when we look
    at transparency in the bond markets, talking about it now for
    two-plus years, when we have been looking at questions like the
    tick size pilot being continued to be pushed off, when we are--
    I appreciate, Steve, your comments about maker-taker, but
    trying to get to a point of, all right, when is it going to
    actually happen, and this one, at least if I understand, at
    least, you may have to write a--put out a Notice of Proposed
    Rulemaking, but the ability to actually turn on--we are talking
    about a 100-size pilot of which 50 would be in the control and
    50 would be in the noncontrol--it is not that complicated, and
    you cannot not look at the RBC data and not say something funky
    is going on here. That is a technical term.
        I would just encourage us that we act with as much speed as
    possible, and I would appreciate your--let me add to what
    Senator Crapo has said--appreciate your service. But, I can
    think of no--nothing better in terms of part of your legacy
    than to say, at least on this issue of arbitration, people who
    rightfully have an ability to collect from malfeasance, that
    simply being able to escape the marketplace or go out of
    business where there needs to be some financial obligation,
    that would be a great legacy coming out of your tenure.
        Thank you, Mr. Chairman.
        Chairman Crapo. Thank you, Senator. And, you and the others
    have all helped us get into a number of very critical issues
    here today.
        I cannot help but say that, when you talked about the god
    of liquidity in terms of being the answer to so many of the
    questions, I wonder if the power behind the curtain is order
    flow as opposed to liquidity in some of these contexts.
        But, that being said, I want to really thank you, Senator
    Warner, for really providing the exclamation point to the
    reason this hearing was called, which is that we want to--you
    know, we want to see things studied. We appreciate the
    importance of getting the appropriate data. We want to get it
    right.
        But, there is an increasing level of frustration in terms
    of getting around the board and back to go again and starting
    to implement some of the needed reforms for our market
    structure. I do not think there is any disagreement, if much at
    all anywhere, about the fact that we need to have some movement
    in terms of having our regulatory system keep up with our
    market structure and with the dynamics that we are dealing
    with.
        So, I appreciate both of you, our witnesses, being here and
    being willing to come up and be grilled in front of a
    Committee. But even more than that, I appreciate the work you
    are doing and your commitment that you have given us here today
    to help us get some of these issues over the goal line and help
    us start to move on some of these critical processes and
    reforms.
        Unless you have anything else, Senator Warner, we will
    adjourn the hearing. Thank you.
        [Whereupon, at 11:15 a.m., the hearing was adjourned.]
        [Prepared statements and additional material supplied for
    the record follow:]
                   PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO
        The landscape of stock markets and trading today is substantially
    different than it was 20, 10, or even 5 years ago.
        Regulations and technological innovation have moved stock trading
    from the floors of exchanges to virtually all trading being conducted
    electronically on automated markets. Technology and innovation has
    benefited investors by leading to tighter spreads, lower costs, and
    more efficient markets.
        However, the expansion of trading venues, speed, and mandated
    interconnectedness of exchange and market participants has raised
    questions regarding market complexity and resiliency.
        For the past several years the Securities Exchange Commission and
    the Financial Industry Regulatory Authority have been working to better
    understand whether their market structure rules have kept pace with
    changes in trading technology and practices.
        In 2014, the Banking Committee held a hearing with a broad mix of
    market participants to 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.
        Several witnesses at the hearing argued that Regulation NMS, a set
    of SEC market structure rules that passed by a 3-2 vote over 10 years
    ago, needed to be reexamined.
        Later in the year, SEC Chair White provided an update to her market
    structure agenda in a response to a letter Senator Johnson and I sent
    and highlighted three fundamental policy questions the Commission would
    be focusing on:
        The trade-through restrictions in Rule 611 of Regulation NMS and
    whether they should be rescinded or modified.
        The current regulatory model for exchanges and other trading venues
    and whether it makes sense for today's markets.
        The maker-taker fee structure, including the related issue of
    restrictions on locking and crossing quotations in Rule 610 of
    Regulation NMS.
        These are complicated issues and I appreciate the data driven
    approach by the SEC and FINRA and the extensive comments from market
    participants, investors, and academics.
        It will be helpful to understand from our witnesses what progress
    has been made in identifying and prioritizing the key concerns with our
    equity market structure and what options are being explored to address
    them.
        After all, the 2010 Flash Crash is still fresh in many of our minds
    and additional market events have raised concerns about market
    integrity and resiliency.
        In fact, the SEC's Equity Market Structure Advisory Committee met
    to diagnose and discuss one of the latest market disruptions, namely
    what went wrong last August 24 when dramatic price moves triggered more
    than 1,000 trading halts in hundreds of stocks and exchange-traded
    funds.
        Today, this Committee hopes to hear from our witnesses about what
    lessons were learned from recent market disruptions and what steps need
    to be taken to strengthen the operation of the markets?
        The U.S. capital markets are vital to the growth of our economy and
    we need to take the necessary steps to make sure the U.S. financial
    system and markets remain the preferred destination for investors
    throughout the world.
                                     ______

                    PREPARED STATEMENT OF STEPHEN LUPARELLO
                   Director, Division of Trading and Markets
                       Securities and Exchange Commission
                                 March 3, 2016
        Chairman Crapo, Ranking Member Warner, and Members of the
    Subcommittee:

        Thank you for inviting me to testify on behalf of the U.S.
    Securities and Exchange Commission (SEC or Commission) regarding equity
    market structure. I welcome this opportunity to discuss with you a
    topic of such importance to investors, public companies, our securities
    markets, and capital formation.
        The securities markets are ever-evolving and technology has been
    the primary driver of the changes. The ongoing challenge for regulators
    is to ensure that regulatory regimes are appropriately updated to
    respond to evolving market mechanisms and trading practices.
        Today, I will update you on the SEC's efforts for meeting this
    challenge with respect to the U.S. equity markets. Enhancing equity
    market structure continued to be a primary focus of SEC efforts in
    2015, as it will be in 2016. Among other things, the SEC published a
    proposal to enhance the operational transparency of alternative trading
    systems (ATSs), proposed amendments to a rule that would require
    broker-dealers engaging in proprietary trading at off-exchange venues
    to become members of a national securities association, and approved a
    pilot program to assess the effect of tick sizes on market quality for
    smaller companies. We plan to continue to make important strides in
    2016.
    I. Overview of the SEC's Program for Equity Market Structure
        Today's equity markets, as you know, are dominated by computer
    algorithms. These algorithms are capable of generating, routing, and
    executing orders with enormous sophistication, volume, and speed. They
    have introduced types of market mechanisms and trading practices that
    were not possible in the days of manual markets.
        Our regulatory regime must keep pace with and adjust appropriately
    in response to these market changes. But doing so requires thorough
    study and an appreciation of the workings of the full market. Market
    structure issues typically are complex and highly interrelated. Even
    when a particular problem is identified, efforts to develop a response
    must reflect a full consideration of the risk of unintended
    consequences.
        To meet this challenge, the SEC is engaging in an ongoing equity
    market review that is based on three key elements--it is data-driven,
    open to considering a wide range of views on all issues, and
    comprehensive in scope.
    Data-Driven Analyses
        A vital first step in dealing with market structure questions is to
    marshal relevant data. Although data analyses alone cannot dictate
    particular outcomes, they are extremely valuable in helping to narrow
    the range of differences in perspectives and of viable regulatory
    responses. Accordingly, the SEC has made concerted efforts in recent
    years to strengthen its capabilities for data collection and analysis.
    These efforts include capturing a wider range of data sources,
    deploying more sophisticated technology tools for analyzing data, and
    employing additional personnel with the necessary quantitative skill
    sets to use these tools.
        The SEC is committed to bringing data analysis fully to bear on
    equity market structure issues. Many of the results of these efforts
    can be found on an SEC Web page that is devoted to helping inform the
    public debate on equity market structure.\1\ The Web page includes a
    series of research papers, underlying data highlights, and literature
    reviews prepared by SEC staff that address issues such as the speed of
    trading, trading in off-exchange venues, high frequency trading, market
    fragmentation, and market quality for small capitalization companies.
    Most recently, staff-prepared papers were added that address two
    notable market events that occurred in 2015--the New York Stock
    Exchange (NYSE) trading suspension on July 8th and the August 24th
    market volatility--both of which are discussed further below.
    ---------------------------------------------------------------------------
        \1\ See http://www.sec.gov/marketstructure/.
    ---------------------------------------------------------------------------
    Open to Wide Range of Views
        Many market structure issues arise in the context of proposed SEC
    rules, national market system (NMS) plans, and exchange rules. These
    procedural contexts provide an opportunity for public comment. Given
    the complexity of market structure issues, however, the SEC has taken
    the extra step of seeking out a wide range of views in contexts other
    than specific proposals and adoptions. These have included a concept
    release,\2\ public roundtables,\3\ and a request for comment on
    particular topics.\4\ The SEC also has approved over 40 exchange-level
    active pilots, as well as two market structure-related pilots initiated
    by the Commission and implemented in the form of NMS plans submitted by
    the exchanges and FINRA.
    ---------------------------------------------------------------------------
        \2\ Concept Release on Equity Market Structure, Securities Exchange
    Act Release No. 61358, 75 FR 3594 (January 21, 2010) (File No. S7-02-
    10), available at http://www.sec.gov/rules/concept/2010/34-61358fr.pdf.
        \3\ A roundtable on decimalization was held at the SEC on February
    5, 2013, and a roundtable on market structure was held at the SEC on
    June 2, 2010.
        \4\ Request for Comment on Exchange-Traded Products, Securities
    Exchange Act Release No. 75165, 80 FR 34729 (June 17, 2015), available
    at https://www.gpo.gov/fdsys/pkg/FR-2015-06-17/pdf/2015-14890.pdf.
    ---------------------------------------------------------------------------
        To further provide an opportunity for a wide range of views and
    inputs, the SEC established the Equity Market Structure Advisory
    Committee (EMSAC), which held its first meetings in 2015. The 17
    members of EMSAC bring an enormous range of expertise, experience, and
    perspectives to their deliberations on equity market structure. EMSAC
    brings in an even wider range of perspectives by inviting nonmembers to
    make presentations on key issues at each EMSAC meeting. EMSAC also has
    formed four subcommittees to affirmatively seek out additional
    viewpoints and conduct detailed evaluations of market structure issues
    for EMSAC's consideration. As discussed further below, EMSAC's public
    proceedings already have shed a great deal of light on key market
    structure issues,\5\ and I anticipate this will continue in 2016. To
    date, the EMSAC has not provided the Commission with any
    recommendations.
    ---------------------------------------------------------------------------
        \5\ See http://www.sec.gov/spotlight/equity-market-structure-
    advisory-committee.shtml.
    ---------------------------------------------------------------------------
    Comprehensive in Scope
        The U.S. equity market is a complex ecosystem in which different
    types of market participants employ a range of tools and strategies to
    trade on 12 registered exchanges, more than 40 ATSs, and more than 200
    non-ATS broker-dealers. Properly assessing market structure issues
    requires a full appreciation of the extent to which these market
    participants, tools, and trading venues are interrelated. Rarely, if
    ever, does a material change in one aspect of market structure not have
    important effects in other aspects of market structure.
        Accordingly, the SEC's equity market structure program does not
    attempt to address issues in isolation, but rather is comprehensive in
    scope. As laid out in Chair White's market structure remarks in June
    2014,\6\ the SEC has advanced initiatives that address five broad
    categories of issues: market stability, high frequency trading,
    fragmentation, broker conflicts, and quality of markets for smaller
    companies. Focus on these substantive issues is intended to help
    address particular areas of concern, while still providing an
    opportunity to assess the extent to which issues and initiatives across
    different categories are interconnected.
    ---------------------------------------------------------------------------
        \6\ Chair White's June 5, 2014 speech, entitled ``Enhancing Our
    Equity Market Structure,'' is available at https://www.sec.gov/News/
    Speech/Detail/Speech/1370542004312.
    ---------------------------------------------------------------------------
    II. Equity Market Structure Developments and Initiatives
        A. Market Events in 2015
        There were two notable market structure events that occurred in
    2015--the NYSE's suspension of trading on that exchange for more than 3
    hours on July 8, 2015, and the unusual level of price volatility on
    August 24, 2015. While the markets generally responded well, each event
    brought to light certain issues and provided a useful opportunity for
    focused empirical analysis by SEC staff.
    NYSE Trading Suspension on July 8, 2015
        On July 8, 2015, the NYSE, because of a systems issue, suspended
    trading in all symbols on the exchange at 11:32 a.m. and reopened at
    3:10 p.m.\7\ To help assess the effect of this suspension on trading,
    on February 3, 2016, SEC staff in the Office of Analytics and Research
    (OAR) within the Division of Trading and Markets published a Data
    Highlight on the SEC's equity market structure Web site. The Data
    Highlight examines trading volume, quoted spreads, and quoted depth
    before, during, and after the suspension.\8\
    ---------------------------------------------------------------------------
        \7\ See www.nyse.com/market-status/history for a description of the
    events leading up to the trading suspension at NYSE on July 8, 2015.
        \8\ The data highlight is available at http://www.sec.gov/
    marketstructure/research/highlight-2016-01.html.
    ---------------------------------------------------------------------------
        Total trading volume in NYSE-listed corporate stocks on July 8 was
    well within the range of observed trading volume in the first 7 months
    of 2015. While the NYSE's share of trading volume declined, other
    market centers--especially other exchanges--experienced corresponding
    large increases in trading volume in NYSE-listed stocks on July 8. The
    Data Highlight observed, however, that NYSE-listed stocks experienced
    substantial increases in spreads and substantial decreases in depths.
    Not all NYSE-listed stocks were equally affected by the NYSE trading
    suspension. Large cap NYSE-listed stocks experienced the biggest
    declines in depth, while small cap NYSE-listed stocks experienced the
    biggest increases in spreads.
        The observations in the Data Highlight reflect the resilience of
    the U.S. equity market structure to the sudden withdrawal of even a
    large exchange, but also suggest that such a withdrawal is not without
    effects on market quality. In this respect, the event demonstrates the
    need for continued emphasis on systems reliance and integrity that has
    been a focus of the SEC's efforts in recent years and is discussed
    below.
        In addition, although the NYSE was able to resume trading on July 8
    prior to its closing auction, the potential that it would not be able
    to do so highlighted the need to address a ``single point of failure''
    in equity market structure at the close. This type of vulnerability has
    been targeted by the critical market infrastructure initiative of the
    SEC and self-regulatory organizations (SROs). The opening and closing
    auctions on primary listing exchanges are integral aspects of a normal
    trading day and continue to be dominated by the primary listing
    markets. As discussed below, NASDAQ and NYSE are working to achieve
    redundancy in these auctions.
    Price Volatility on August 24, 2015
        On Monday, August 24, 2015, the U.S. equity markets and equity-
    related futures markets experienced unusual price volatility,
    particularly during the period surrounding the 9:30 a.m. opening of
    regular trading hours at the start of a new trading week. To help
    assess the operation of the U.S. equity markets under stressed
    conditions, SEC staff in OAR published a Research Note on the August 24
    event on the SEC's equity market structure Web site.\9\ In recent
    years, the SEC and SROs have implemented several regulatory initiatives
    to address severe short-term price volatility.\10\ The events of August
    24 provided a useful opportunity to evaluate the practical operation of
    these initiatives under stressed market conditions. The Research Note
    provides empirical data and other information to help assess trading on
    August 24, including several issues that have been debated among market
    participants and observers. These issues include the opening process at
    primary listing exchanges, the triggering of trading pauses under the
    National Market System Plan to Address Extraordinary Market Volatility
    (commonly known as the ``Limit Up-Limit Down,'' or ``LULD Plan''), and
    the effects of market volatility on trading in exchange-traded products
    (ETPs).
    ---------------------------------------------------------------------------
        \9\ The Research Note is available at https://www.sec.gov/
    marketstructure/research/equity_market_volatility.pdf.
        \10\ Such initiatives include the revision of market-wide circuit
    breakers that apply across the securities and futures markets and the
    National Market System Plan to Address Extraordinary Market Volatility
    (commonly known as the Limit Up-Limit Down, or LULD, Plan).
    ---------------------------------------------------------------------------
        The empirical data in the Research Note suggests that, in contrast
    to the Flash Crash on May 6, 2010,\11\ broad market prices did not
    ``flash crash''--defined as a sudden and extreme price decline that is
    unexplained by the arrival of new information and is soon reversed. On
    August 24, broad market prices already had declined by 5 percent in
    pre-9:30 trading. At 9:30, the equity markets opened for regular
    trading hours at broad market price levels that were consistent with
    the pre-9:30 trading. The broad market then absorbed a surge in price-
    insensitive selling (with volume as much as 4 to 8 times higher than
    normal in many securities) with a relatively small price decline of 2
    percent and soon recovered. Also, unlike the 2010 Flash Crash, equity
    market infrastructure and trading systems held up without serious
    incident to the high trading volume and message traffic of August 24.
    ---------------------------------------------------------------------------
        \11\ The report of the staffs of the CFTC and SEC on the May 6,
    2010, Flash Crash is available at https://www.sec.gov/news/studies/
    2010/marketevents-report.pdf.
    ---------------------------------------------------------------------------
        However, the empirical data in the Research Note also suggests
    certain issues that arose on August 24 that generally fall within three
    broad categories and require attention.
        First, in the opening minutes of trading on August 24, a
    significant minority of ETPs experienced what could be described as a
    breakdown in arbitrage--specifically, they traded at substantial
    discounts to the underlying indexes they were designed to track.
        Second, many of these ETPs that experienced high volatility
    triggered trading pauses under the LULD Plan. These trading pauses
    helped prevent the irrational prices that occurred during the 2010
    Flash Crash (such as one penny prices). The ETPs, however, did not
    resume trading in an orderly fashion, but traded erratically in ways
    that triggered additional LULD pauses. More than 80 percent of LULD
    pauses on August 24 occurred in ETPs, and most of these were repeat
    pauses in the same symbols and occurred when prices were recovering
    upward. Notably, although a significant minority of ETPs experienced
    severe volatility and multiple LULD pauses on August 24, a majority of
    ETPs experienced levels of volatility consistent with broad market
    prices, and 80 percent of ETPs did not experience a single LULD pause.
        The third category of issues on August 24 related to corporate
    stocks. Unlike for the market broadly, prices for a relatively small
    number of individual corporate stocks experienced flash crashes--
    extreme price declines followed by quick recoveries. These included six
    corporate stocks with very large capitalizations. In addition, 4.7
    percent of the more than 4,000 corporate stocks analyzed in the
    Research Note declined by 20 percent or more from the previous Friday's
    close price, while 19.2 percent of the more than 1,400 ETPs analyzed in
    the Research Note declined by 20 percent or more.
        The unusual volatility on August 24 warrants continued close
    evaluation to consider whether regulatory responses may be appropriate.
    As noted below, the SRO participants in the LULD Plan are considering
    potential modifications, and
    individual exchanges also are assessing their opening and reopening
    processes. And prior to August 24, the Commission broadly requested
    comment on ETPs, including the extent to which arbitrage mechanisms are
    effective in aligning ETP prices with their underlying indexes.\12\
    ---------------------------------------------------------------------------
        \12\ Request for Comment on Exchange-Traded Products, Securities
    Exchange Act Release No. 75165, 80 FR 34729, 34740-34741 (June 17,
    2015), available at https://www.gpo.gov/fdsys/pkg/FR-2015-06-17/pdf/
    2015-14890.pdf. The Comment period closed in August 2015, and the SEC
    has received 40 comment letters, which are available at https://
    www.sec.gov/comments/s7-11-15/s71115.shtml.
    ---------------------------------------------------------------------------
        SEC staff continues to examine a broad spectrum of issues related
    to trading on August 24. These include, among other things:

      (1)  factors that may have been associated with volatility in ETPs
            and other securities, including the nature of selling pressure,
            sources of liquidity provision, and, for ETPs, create and
            redemption activity;

      (2)  the effect of Regulation SHO short-sale restrictions;

      (3)  the opening process on primary listing exchanges, including the
            nature of trading prior to and immediately after the opening
            auction on the primary listing exchange;

      (4)  the reopening process following LULD pauses, including the
            nature of participants in the reopening auctions on primary
            listing exchanges and the rules and practices employed by
            exchanges in connection with reopenings;

      (5)  the operation of the LULD Plan, particularly as it applies in
            the period following the opening of regular trading hours and
            to reopenings following LULD pauses; and

      (6)  the operation of market-wide circuit breakers, particularly as
            they apply in the period following the opening of regular
            trading hours.
        B. Regulatory Initiatives
        The Commission advanced a series of key regulatory initiatives
    relating to equity market structure in 2015, and more are on the SEC's
    agenda for 2016.
          1. Preventing Market Instability
        One of the most serious concerns about highly electronic markets is
    the risk of instability and disruption. Sophisticated technology tools
    can enhance efficiency, but they also can facilitate the rapid onset of
    a trading disruption. These disruptions can arise when systems that
    drive algorithmic trading fail or malfunction, and also when high-speed
    trading leads to sudden gaps between liquidity demand and supply that
    can cause extreme price volatility. Addressing the risk of instability
    and disruption from these two sources has been a high priority of the
    SEC in recent years and will continue to be a focus in 2016.
    Regulation Systems Compliance and Integrity (SCI)
        The Commission adopted Regulation SCI in November 2014 to
    strengthen the technology infrastructure of the U.S. securities
    markets. Regulation SCI imposes requirements on key market participants
    intended to reduce the occurrence of systems issues, improve resiliency
    when systems problems do occur, and enhance the Commission's oversight
    and enforcement. Subject to a few exceptions, SCI entities were
    required to start complying with the requirements of Regulation SCI on
    November 3, 2015. The Technology Controls Program in the SEC's Office
    of Compliance Inspections and Examinations is now examining SCI
    entities for compliance with Regulation SCI.
        A CyberWatch team has also been established that is responsible for
    triaging all system events reported to the SEC under Regulation SCI.
    This team currently monitors all the filings required by Regulation SCI
    that are submitted by SCI entities to the SEC. When a major SCI event
    is reported, they maintain constant communication with the SCI entity
    until the event is deemed resolved. Since Regulation SCI went live on
    November 3, 2015, CyberWatch has received 326 filing submissions,
    including Non-De Minimis Event Notifications & Filings, Quarterly De
    Minimis and System Change Reports, and Annual Review Reports.
        The Commission staff, in response to Chair White's directive, is
    preparing recommendations for the Commission's consideration as to
    whether an SCI-like framework should be developed for other key market
    participants, such as certain broker-dealers and transfer agents, whose
    operations can have a significant market impact if they are
    disrupted.\13\
    ---------------------------------------------------------------------------
        \13\ Chair White's November 19, 2014, statement is available at
    https://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370543489640.
    ---------------------------------------------------------------------------
    Critical Market Infrastructure
        Since 2013, SEC staff has been working with the SROs, including
    clearing agencies, on a range of market structure and infrastructure
    initiatives. One of these initiatives involved improving the resiliency
    of systems that constitute potential single points of failure,
    including the securities information processors for consolidated market
    data feeds (SIPs). In June 2014, the SIPs implemented enhancements to
    their disaster recovery sites and systems to establish a ``hot/warm''
    backup process to provide for a 10-minute fail over from the primary to
    the backup sites. In addition, the equity exchanges have amended their
    clearly erroneous rules and the options exchanges have amended and
    harmonized their obvious error rules to provide greater clarity to
    market participants regarding trade breaks. The equity and options
    exchanges also have been enhancing their risk mitigation mechanisms.
    Most recently, the NYSE and NASDAQ have progressed on an initiative to
    serve as each other's backups if they are unable to fail over to their
    backup sites in time to run their respective closing auctions. These
    efforts compliment the new requirements of Regulation SCI, which are
    applicable to critical market infrastructure.
    LULD Plan
        Initially approved on a pilot basis in 2012,\14\ the LULD Plan
    establishes a market-wide mechanism that is intended to moderate
    extraordinary price volatility in individual securities and reduce the
    incidence of erroneous trades. In particular, the LULD Plan requires
    trading centers to have policies and procedures reasonably designed to
    prevent trades from occurring outside specified price bands. If the
    national best offer (bid) reaches the lower (upper) price band, a limit
    state is initiated. If such national best bid or offer does not recover
    to inside the price bands within 15 seconds, a 5-minute trading pause
    is triggered to accommodate more fundamental price moves (as opposed to
    erroneous trades or momentary gaps in liquidity). The LULD mechanism is
    intended to reduce the negative impacts of sudden, unanticipated price
    movements in securities, thereby protecting investors and promoting a
    fair and orderly market. In particular, the LULD Plan is designed to
    address the type of extreme short-term price volatility that occurred
    during the 2010 Flash Crash.
    ---------------------------------------------------------------------------
        \14\ See Securities Exchange Act Release No. 67091, 77 FR 33498
    (June 6, 2012) (File No. 4-631), available at https://www.sec.gov/
    rules/sro/nms/2012/34-67091.pdf.
    ---------------------------------------------------------------------------
        The LULD Plan continues to operate on a pilot basis. Consistent
    with the SEC's data-driven approach to market structure issues, the
    SROs were required to provide an assessment of the LULD Plan. The SROs
    engaged a third-party consultant to provide an empirical assessment of
    the Plan's operation, which was submitted to the SEC in May 2015.\15\
    The consultant found that the LULD Plan generally had succeeded in
    preventing erroneous trades in large cap stocks during regular trading
    hours, and that the vast majority of limit states resolved themselves
    without triggering a trading pause. The consultant observed, however,
    that many LULD limit states and trading pauses occurred in small, low
    volume stocks, and that most were unnecessary and related more to
    difficulty in determining the opening reference price when the opening
    auction on the primary listing exchange did not produce a trade rather
    than to excess volatility.
    ---------------------------------------------------------------------------
        \15\ See Angel, James J., ``Limit Up-Limit Down: National Market
    System Plan Assessment To Address Extraordinary Market Volatility''
    (May 28, 2015), available at http://www.sec.gov/comments/4-631/4631-
    39.pdf.
    ---------------------------------------------------------------------------
        The Commission recently published the SROs' proposal to extend the
    LULD Plan for another year until April 2017.\16\ As noted by the SROs,
    extension of the pilot period will enable the SROs and the Commission
    to further evaluate the LULD Plan's operation. The SROs also have
    proposed to amend the LULD Plan to modify the identification of the
    first reference price of the day for those securities that do not have
    an opening auction trade. The first reference price for these
    securities would be the closing price of the security on the primary
    listing exchange on the previous trading day, or if no such closing
    price exists, the last sale on the primary listing exchange reported by
    the SIP. The Commission will consider whether to approve or disapprove
    the proposed amendment to the LULD Plan after the notice and comment
    process.
    ---------------------------------------------------------------------------
        \16\ See 81 FR 10315 (Feb. 29, 2016). The comment period for the
    proposal ends on March 21, 2016.
    ---------------------------------------------------------------------------
        The SROs are continuing to evaluate additional issues regarding the
    operation of the LULD Plan, including those that may have been revealed
    by the events of August 24, 2015. On August 24, for example, trading
    centers resumed trading following a LULD pause but before new price
    bands were disseminated by the SIP. Many of these trades were executed
    at prices outside the new price bands. I
    understand that the SROs are working quickly to enhance their
    procedures to ensure they do not resume trading following a LULD pause
    without an effective price band in place, either by waiting for the
    message from the SIP or by temporarily calculating the new price bands
    internally. Given the potential for this problem to undermine the
    effectiveness of the LULD Plan when securities reopen following a
    trading pause, I have asked that each SRO enhance its procedures as
    soon as possible, but no later than April 1, 2016.\17\
    ---------------------------------------------------------------------------
        \17\ See Letter from Stephen Luparello, Director, Division of
    Trading and Markets, SEC, to Mr. Paul Roland, Chairman of the LULD Plan
    Operating Committee, dated February 10, 2016 (Re: Limit Up-Limit Down
    Plan to Address Extraordinary Market Volatility).
    ---------------------------------------------------------------------------
        I also understand that the SROs intend to propose a LULD Plan
    amendment to refine the operation of the LULD mechanism to eliminate
    the need for clearly erroneous execution rules, except in very limited
    objective circumstances. I expect that such an amendment will be filed
    for Commission consideration during the course of the next pilot
    period, should the Commission approve the proposed extension.
        Finally, I understand that there are a number of other issues that
    the SROs are analyzing with a view toward possible further amendments
    to the LULD Plan, including: (i) a review of ETPs to determine whether
    adjustments should be made to the Plan to account for the particular
    trading characteristics of ETPs; (ii) the impact of double-wide price
    bands during the opening period, (iii) the advisability of coordinated
    reopening procedures; and (iv) potential enhancements to the
    categorization of securities into different tiers.
    Shortening the Settlement Cycle
        Currently, most securities transactions in equity and debt settle 3
    days after the trade has been executed, which is referred to as ``trade
    date plus three'' (T+3). Last spring, the Industry Steering Committee
    (ISC),\18\ established by the Depository Trust Clearing Corporation and
    co-chaired by Securities Industry and Financial Markets Association
    (SIFMA) and the Investment Company Institute (ICI), published a white
    paper that addresses certain procedural steps it believes are necessary
    to achieve the move to T+2.\19\ The white paper also includes an
    implementation timeline that targets the transition to T+2 by the end
    of the third quarter of 2017.
    ---------------------------------------------------------------------------
        \18\ The ISC oversees the Industry Working Group and Sub-Working
    Groups. All these groups are responsible for assessing the scope,
    requirements, and changes needed to facilitate the implementation of
    T+2.
        \19\ PricewaterhouseCoopers LLP, Shortening the Settlement Cycle:
    The Move to T+2 (2015), available at http://www.ust2.com/pdfs/ssc.pdf.
    ---------------------------------------------------------------------------
        Chair White and the Commissioners have expressed their support for
    the industry T+2 initiative,\20\ and Chair White has asked the staff to
    develop a proposal to amend Rule 15c6-1. The staff is currently working
    on a proposal for the Commission's consideration, and is actively
    engaged in discussions with the ISC regarding industry planning and
    preparation for the prospective migration to T+2.
    ---------------------------------------------------------------------------
        \20\ Letter from the Hon. Mary Jo White, Chair, U.S. Securities and
    Exchange Commission to the ICI and SIFMA (September 16, 2015),
    available at: http://src.bna.com/i7; Statement Regarding Proposals to
    Shorten the Trade Settlement Cycle, Commissioner Michael S. Piwowar and
    Commissioner Kara M. Stein (June 29, 2015), available at https://
    www.sec.gov/news/statement/statement-on-proposals-to-shorten-the-trade-
    settlement-cycle.html.
    ---------------------------------------------------------------------------
    Transfer Agent Regulation
        On December 22, 2015, the Commission issued an advanced notice of
    proposed rulemaking concerning a range of potential new requirements
    for transfer agents.\21\ This marked the first significant action by
    the Commission in this area in over 40 years.\22\ The staff will
    consider comments received as it develops further recommendations to
    the Commission for transfer agent reform.
    ---------------------------------------------------------------------------
        \21\ See Transfer Agent Regulations, Securities Exchange Act
    Release No. 34-76743 (Dec. 22, 2015), available at http://www.sec.gov/
    rules/proposed/2015/34-76474.pdf.
        \22\ See Chair Mary Jo White, U.S. Securities and Exchange
    Commission, Beyond Disclosure at the SEC in 2016 (Feb. 19, 2016),
    available at http://www.sec.gov/news/speech/white-speech-beyond-
    disclosure-at-the-sec-in-2016-021916.html; see also Commissioners
    Michael Piwowar and Kara Stein Statement of Support for the Need to
    Modernize the Commission's Transfer Agent Rules (June 11, 2015),
    available at http://www.sec.gov/news/statement/statement-of-support-
    modernize-sec-transfer-agent-rules.html.
    ---------------------------------------------------------------------------
        2. Addressing High Frequency Trading
        As algorithmic trading has increasingly dominated equity market
    volume, concerns have been raised about the speed and fairness of the
    equity markets. Algorithmic trading encompasses the high frequency
    trading strategies employed by proprietary trading firms, as well as
    much of the trading by brokers acting on behalf of institutional
    investors. Algorithmic traders use a variety of low-latency tools.
    These include co-located services in the data facilities of trading
    venues and direct data feeds from these venues rather than consolidated
    data feeds, which are on average less than 1 millisecond slower than
    the direct data feeds due to the time needed for consolidation of data
    at the SIPs. While rolling back the technology clock is neither
    feasible nor appropriate, the SEC must assess the extent to which
    specific elements of an algorithmic trading environment may not
    optimally serve the interests of investors, as well the effectiveness
    of its regulatory oversight of high-speed and high-volume trading.
    Additional Timestamps for Consolidated Data Feeds and Data Feed Usage
        In response to Chair White's request to enhance the ability of
    market participants to monitor market data latencies, the SROs added
    additional timestamps to the consolidated data feeds in 2015 that
    reflect, for each order or execution processed by an exchange, the
    event processing timestamp included on the exchanges' direct data
    feeds. The exchanges also enhanced their procedures for clock
    synchronization. With a common event time reflected in both the
    consolidated and direct data feeds, market participants can now more
    readily assess the absolute and relative latencies of each, and
    determine which data feed best meets their trading or other business
    needs. In 2014, the exchanges, again in response to a request from
    Chair White, disclosed in their rules how they use the consolidated and
    direct market data feeds in their operations, thereby enhancing the
    opportunity for public understanding of today's equity markets.
    Membership Requirements for Dealers Trading in Off-Exchange Venues
        In March 2015, the SEC proposed amendments to Exchange Act Rule
    15b9-1 that would require broker-dealers engaging in proprietary
    trading at off-exchange venues to become members of a national
    securities association.\23\ SEC staff is reviewing comments on the
    proposal and is working to prepare a recommendation for the Commission
    to consider in 2016.
    ---------------------------------------------------------------------------
        \23\ Exemption for Certain Exchange Members, Securities Exchange
    Act Release No. 74581, 80 FR 18036 (April 2, 2015), available at
    https://www.gpo.gov/fdsys/pkg/FR-2015-04-02/pdf/2015-07293.pdf. The
    Commission has received 21 comment letters on the proposal, available
    at https://www.sec.gov/comments/s7-05-15/s70515.shtml.
    ---------------------------------------------------------------------------
    Enhanced SEC Recordkeeping Requirements for Trading Algorithms
        SEC staff is developing a rulemaking recommendation for the
    Commission to consider that would strengthen recordkeeping requirements
    for algorithmic trading. Such requirements may encompass key elements
    of the algorithm itself, as well as a record of the orders generated by
    the algorithm. Such records would provide greater transparency for
    regulators into algorithmic trading.
    Status of Unregistered Broker-Dealers
        SEC staff is developing a recommendation for the Commission to
    consider in 2016 that would clarify the status of active proprietary
    traders that are not registered as broker-dealers and subject certain
    of them to the SEC and SRO regulatory regime for broker-dealers.
    Anti-Disruptive Trading Rule
        SEC staff is developing a recommendation for the Commission to
    consider that would address the use of aggressive, destabilizing
    trading strategies in conditions when they could most seriously
    exacerbate price volatility. Such a rule will need to be carefully
    tailored to apply to active proprietary traders in short time periods
    when liquidity is most vulnerable and the risk of price disruption
    caused by aggressive short-term trading strategies is highest.
    EMSAC Discussions
        EMSAC has formed a Market Quality subcommittee that will consider
    the impact of technology on the efficiency of the markets and systemic
    risks. Among other things, the subcommittee will consider market-maker
    obligations and high frequency trading strategies that may exacerbate
    volatility. Any advice or recommendations of the subcommittee (and
    other subcommittees mentioned below) would be presented to the full
    advisory committee for its consideration.
        3. Consolidated Audit Trail
        In July 2012, the SEC adopted Rule 613 under Regulation NMS
    requiring the SROs to submit an NMS plan to create, implement, and
    maintain a Consolidated Audit Trail (CAT). The CAT would capture
    customer and order event information for orders in NMS securities,
    across all markets, from the time of order inception through routing,
    cancellation, modification, or execution. CAT would represent a
    significant step forward in regulatory capabilities for oversight of
    the equity markets. In 2015, the SEC and SROs continued to make
    substantial progress toward a CAT.
        First, the SROs filed amendments to the CAT plan in 2015 that
    contained additional information than the original plan necessary to
    the consideration of an operational plan. On February 27, 2015, the
    SRO's filed an Amended and Restated CAT NMS Plan.\24\ On December 24,
    2015, and February 9, 2016, the SROs filed an amendment to the Amended
    and Restated CAT NMS Plan.\25\
    ---------------------------------------------------------------------------
        \24\ See Letter from the SROs, to Brent J. Fields, Secretary,
    Commission, dated February 27, 2015.
        \25\ See Letters from the SROs to Brent J. Fields, Secretary,
    Commission, dated December 23, 2015, and February 8, 2016.
    ---------------------------------------------------------------------------
        Second, the SEC approved an amendment to the CAT plan processor
    selection plan in June 2015 allowing the SROs to move forward with
    selecting the plan processor, which would build and operate the CAT.
    The CAT plan processor selection plan, which is separate and distinct
    from the CAT plan, governs the SROs' governance and selection of the
    CAT processor. The SEC also approved an amendment providing for recusal
    of plan participants in circumstances that might present conflicts of
    interest. In accordance with these amendments, the SROs narrowed the
    bids for CAT plan processor from six bidders to a shortlist of three
    bidders in November 2015.
        Third, in anticipation of the SROs' completion of the CAT plan, we
    appointed a CAT project manager in November 2015. This person will be
    the technological point person for the development and usage of the CAT
    at the SEC, as well as the SEC's liaison with the SROs and the CAT plan
    processor. The CAT manager will maintain an open line of communication
    with the SROs and market participants.
        Fourth, on March 1, 2016, the Commission approved exemption
    requests submitted by the SROs to provide the SROs the flexibility to
    include, in the CAT plan for notice and comment, alternative approaches
    to those described in Rule 613.\26\
    ---------------------------------------------------------------------------
        \26\ See Order Granting Exemptions from Certain Provisions of Rule
    613 Pursuant to Section 36(a)(1) of the Securities Exchange Act of
    1934, Securities Exchange Act Release No. 34-77265 (March 1, 2016).
    ---------------------------------------------------------------------------
        Fifth, SEC staff is reviewing the Amended and Restated CAT NMS Plan
    to provide a recommendation to the Commission regarding publication of
    the plan for notice and comment. Although I cannot provide exact
    timing, I hope the staff will be in a position to submit a
    recommendation to the Commission soon to publish the CAT plan for
    public notice and comment.
        If the Commission approves publication of the plan, there would
    likely be a 60-day comment period during which interested parties may
    submit comments to the Commission on the plan as noticed. SEC staff
    will consider comments received and evaluate what recommendations to
    make to the Commission, including potential modifications to the plan.
    Upon Commission approval of a CAT plan, Rule 613 provides that a plan
    processor shall be selected within 2 months of the effective date of
    the plan. SROs begin reporting data within 1 year of effectiveness; SRO
    members, except those that qualify as small broker-dealers, begin
    reporting data within 2 years of effectiveness; and SRO members that
    qualify as small broker-dealers begin reporting with 3 years of
    effectiveness.
        4. Enhancing Market Transparency and Examining Trading Venue
            Regulation
        As noted earlier, equity trading volume now is divided among 12
    exchanges, more than 40 ATSs, and more than 200 non-ATS broker-dealers.
    The competition for order flow among these venues benefits investors by
    encouraging services that meet particular trading needs and by keeping
    trading fees low. As noted above in connection with the NYSE suspension
    of trading on July 8, multiple trading venues also can help avoid
    disruptions if one venue, even a major exchange, experiences a systems
    problem. Fragmented markets, however, also can raise questions
    regarding the rules that govern their operations and intermarket
    trading, including the extent to which their operations are transparent
    to investors and whether the rules establish a fair and level playing
    field for competition.
    Proposal To Enhance ATS Operational Transparency
        In November 2015,\27\ the SEC proposed to amend Regulation ATS to
    require ATSs that facilitate transactions in NMS stocks to make public
    disclosures on Form ATS-N about: (1) the activities of the broker-
    dealer that operates the ATS, and its
    affiliates, that relate to the ATS; and (2) the manner in which the ATS
    operates, including disclosures about types of subscribers, order
    types, execution procedures, and use of market data. These proposed
    rules are designed to provide greater transparency around the
    operations of ATSs so market participants can better evaluate ATSs as
    potential trading venues and make more informed routing decisions.
    ---------------------------------------------------------------------------
        \27\ Regulation of NMS Stock Alternative Trading Systems,
    Securities Exchange Act Release No. 76474, 80 FR 80998 (December 28,
    2015), available at https://www.gpo.gov/fdsys/pkg/FR-2015-12-28/pdf/
    2015-29890.pdf. The comment period closed on February 26, 2016, and
    comments are available at http://www.sec.gov/comments/s7-23-15/
    s72315.shtml.
    ---------------------------------------------------------------------------
        The Commission also proposed rules to provide a process for the
    Commission to determine whether an ATS qualifies for the exemption
    under which it operates and declare an NMS Stock ATS's initial Form
    ATS-N either effective or, after notice and opportunity for hearing,
    ineffective. The proposal includes a process for an ATS to file, and
    the Commission to review, amendments to Form ATS-N. The Commission also
    proposed rules to provide a process for the Commission to suspend,
    limit, or revoke the exemption after providing notice and opportunity
    for hearing. Finally, the Commission proposed that all ATSs' safeguards
    and procedures to protect subscribers' confidential trading information
    be written. These proposed rules are designed to facilitate the
    Commission's oversight of ATSs and thus, better protect investors.
        The comment period on the ATS proposal closed on February 26, 2016.
    SEC staff is reviewing comments on the proposal and preparing a
    recommendation for the Commission to consider in 2016.
    SEC Staff Papers and EMSAC Discussions regarding Rule 611 of Regulation
            NMS and Trading Venue Regulation
        In April 2015, SEC staff prepared a briefing paper on Rule 611 of
    Regulation NMS, which restricts the execution of trades at prices that
    are inferior to quoted prices.\28\ The paper first notes Rule 611's
    place in the U.S. regulatory regime for equity market structure and
    then summarizes the Rule's requirements and the SEC's objectives for
    the Rule when adopted. It then addresses changes in equity market
    structure that have occurred since Rule 611 was adopted in 2005,
    supported by a series of data tables. The tables provide data on
    changes in the market shares of trading venues, visible and dark
    fragmentation, trading volume, average trade size, and trade-through
    rates.
    ---------------------------------------------------------------------------
        \28\ The paper is available at https://www.sec.gov/spotlight/emsac/
    memo-rule-611-regulation-nms.pdf.
    ---------------------------------------------------------------------------
         EMSAC considered issues raised by the Rule 611 paper at a meeting
    in May 2015. It also has formed a Regulation NMS Subcommittee that will
    consider, among other things, the impact of Regulation NMS, including
    Rule 611, and whether it should be modified to reflect changes in
    trading technology and practices, and competition.
        In October 2015, SEC staff prepared a briefing paper on the current
    regulatory model for trading venues and for market data
    dissemination.\29\ It contrasted the regulatory model applicable to
    national securities exchanges, which are SROs, with that applicable to
    ATSs, which are registered as broker-dealers. The paper also was
    intended to facilitate a discussion of the SROs' role in the
    collection, processing, and dissemination of market data and the
    treatment of associated fees.
    ---------------------------------------------------------------------------
        \29\ The paper is available at http://www.sec.gov/spotlight/emsac/
    memo-regulatory-model-for-trading-venues.pdf.
    ---------------------------------------------------------------------------
        EMSAC considered issues raised in the trading venue papers at a
    meeting in October 2015. It also created a Trading Venues Regulation
    subcommittee to consider the current regulatory model for trading
    venues and whether it is optimally serving all market participants and
    the market as a whole.
        5. Mitigating Broker Conflicts
        Another area of focus in equity market structure is broker
    conflicts and how they are exacerbated or mitigated by the availability
    of many different trading venues. These venues offer a plethora of
    order types and other trading services, as well as various fees and
    payments related to these services. Most investors rely on their
    brokers to navigate market complexities of fragmented markets on their
    behalf, but monitoring execution quality can be difficult for even
    sophisticated investors.
    Institutional Order Routing Transparency
        SEC staff is developing a recommendation for the Commission to
    consider in 2016 that would expand investors' understanding of their
    brokers' routing decisions. Among other things, the staff's
    recommendation would enhance the information provided to institutional
    customers through standardized order routing disclosures. Requiring
    standardized disclosures, in combination with the recently proposed
    enhanced ATS operational transparency rulemaking, would be intended to
    provide sufficient baseline information to institutional investors to
    bolster their ability to: (1) assess the potential for harmful
    information leakage concerning their orders; (2) assess the conflicts
    of interest their broker-dealers may face in handling their orders; (3)
    assess the performance of a broker-dealer in handling their orders and
    achieving best execution; and (4) compare the services of their routing
    broker-dealers.
    Exchange Order Type Transparency
        As another means of increasing transparency in the markets, Chair
    White asked the exchanges in 2014 to conduct a comprehensive review of
    their order types and how they operate in practice.
        The exchanges also were asked to consider appropriate rule changes
    to help clarify the nature of their order types and how they interact
    with each other (including a clear description of all material aspects
    of the operation of their order types). As a result, all of the
    exchanges reviewed their order types and related rules, and submitted
    proposed rule changes that provide substantial additional detail on
    their operation.
    SEC Staff Papers and EMSAC Discussions regarding Maker-Taker Fee
            Structure and Customer Issues
        In October 2015, SEC staff prepared a briefing paper on the maker-
    taker fee structure offered by many exchanges.\30\ The purpose of the
    paper was to facilitate an objective assessment of maker-taker fees in
    the U.S. equity markets by outlining the development of the maker-taker
    fee model, summarizing the current public debate about its impact on
    equity market structure, and presenting both the asserted advantages
    and disadvantages of maker-taker fee structures. EMSAC also discussed
    maker-taker fee issues at multiple meetings in 2015, and its Regulation
    NMS subcommittee will consider approaches to a potential access fee
    pilot.
    ---------------------------------------------------------------------------
        \30\ The paper is available at https://www.sec.gov/spotlight/emsac/
    memo-maker-taker-fees-on-equities-exchanges.pdf.
    ---------------------------------------------------------------------------
        In January 2016, SEC staff prepared a briefing paper that was
    intended to facilitate consideration of certain issues affecting
    customers--particularly retail customers--in the current equity market
    structure, namely: (1) the risks of using certain order types; (2) the
    potential conflicts presented by payment-for-order-flow arrangements;
    and (3) the development of more meaningful execution quality
    reports.\31\ EMSAC discussed these customer issues at its February 2016
    meeting and also has created a Customer Issues subcommittee to consider
    initiatives to protect investor interests and promote investor
    confidence.
    ---------------------------------------------------------------------------
        \31\ The paper is available at http://www.sec.gov/spotlight/equity-
    market-structure/issues-affecting-customers-emsac-012616.pdf.
    ---------------------------------------------------------------------------
        6. Building Quality Markets for Smaller Companies
        Smaller public companies face market structure challenges that are
    not the same as those of larger companies. These include the need for a
    sufficiently liquid market that provides their investors with a
    reasonably efficient means to establish and liquidate positions. A
    single market structure may not fit all companies, and the SEC has
    sought to focus concretely on how to enhance the equity market
    structure for smaller companies.
    Tick Size Pilot
        One initiative designed to address concerns about improving
    liquidity in the secondary market for smaller companies is the
    development of a pilot program that would allow smaller companies to
    trade at wider tick sizes. In June 2014, the SEC directed the equity
    exchanges and FINRA to act jointly in developing and filing a national
    market system plan to implement a tick pilot program. The Commission
    noted particularly that a pilot program could facilitate studies of the
    effect of tick size on liquidity, execution quality for investors,
    volatility, market-maker profitability, competition, transparency, and
    institutional ownership in the stocks of small-capitalization
    companies.
        In May 2015, the Commission approved a plan filed by the equity
    exchanges and FINRA (Participants) to implement a tick size pilot
    program (Tick Size Pilot).\32\ In November 2015, the Commission issued
    an exemption to the Participants from implementing the Plan until
    October 3, 2016.\33\
    ---------------------------------------------------------------------------
        \32\ Securities Exchange Act Release No. 74892, 80 FR 27513 (May
    13, 2015), available at http://www.sec.gov/rules/sro/nms/2015/34-
    74892.pdf.
        \33\ Securities Exchange Act Release No. 76382, 80 FR 70284
    (November 13, 2015), available at http://www.sec.gov/rules/exorders/
    2015/34-76382.pdf. The Tick Size Pilot was scheduled to begin in May
    2016. However, in order to give the SROs and their members sufficient
    time to implement the Tick Size Pilot, the Commission issued the
    exemption to the Participants.
    ---------------------------------------------------------------------------
        The Tick Size Pilot will have a 2-year duration (Pilot Period), and
    will include exchange-listed common stocks that have the following
    characteristics: (1) a market capitalization of less than $3 billion;
    (2) a closing price of at least $2 per share on the last day of the
    measurement period (and a closing price of not less than $1.50 per
    share during the measurement period); (3) a consolidated average daily
    volume of one million shares or less; and (4) a volume-weighted average
    price of at least $2 per share (Pilot Securities).
        Pursuant to the Tick Size Pilot, Participants will collect data
    reflecting a variety of market quality metrics with respect to the
    Pilot Securities and transmit such data to the Commission. The
    collected data will be publicly available in an aggregated form. In
    addition, the Participants are required to conduct, and provide the
    Commission with, a publicly available impact assessment. The
    Participants are scheduled to begin collecting Tick Size Pilot data in
    April 2016, which is 6 months prior to the start of the Pilot Period.
        The Participants have submitted to the Commission proposed rule
    changes to implement the quoting and trading requirements and the data
    collection requirements.\34\ The Commission has approved the proposed
    rules to implement the data collection requirements that have been
    submitted, as well as one of the proposals to implement the quoting and
    trading proposals that have been submitted.\35\
    ---------------------------------------------------------------------------
        \34\ See, e.g., Securities Exchange Act Release No. 76552 (December
    3, 2015) (File No. SR-BATS-2015-108), available at http://www.sec.gov/
    rules/sro/bats/2015/34-76552.pdf; Securities Exchange Act Release No.
    76229 (October 22, 2015) (File No. SR-NYSE-2015-46), available at
    http://www.sec.gov/rules/sro/nyse/2015/34-76229.pdf.
        \35\ Securities Exchange Act Release No. 77105 (February 10,
    2016)(order approving BATS' rules to implement the data collection
    requirements of the Tick Size Pilot), available at http://www.sec.gov/
    rules/sro/bats/2016/34-77105.pdf; Securities Exchange Act Release No.
    77164 (February 17, 2016) (order approving FINRA's rules to implement
    the data collection requirements of the Tick Size Pilot), available at
    http://www.sec.gov/rules/sro/finra/2016/34-77164.pdf; Securities
    Exchange Act Release No. 77218 (February 23, 2016) (order approving
    FINRA's rules to implement the quoting and trading requirements of the
    Tick Size Pilot), available at http://www.sec.gov/rules/sro/finra/2016/
    34-77218.pdf.
    ---------------------------------------------------------------------------
    Venture Exchanges
        On March 4, 2015, the SEC's Advisory Committee on Small and
    Emerging Companies held a meeting at which it considered venture
    exchanges and other means to increase secondary market liquidity for
    investors in smaller companies. Previously in 2013, this Advisory
    Committee had recommended the development of a separate U.S. equity
    market that would facilitate trading in the securities of small and
    emerging companies.
        On March 10, 2015, the Commission submitted testimony to this
    Subcommittee for its hearing on venture exchanges and small
    capitalization companies.\36\ The Commission stated that it was
    considering innovative approaches that appropriately balance the needs
    of smaller companies for efficient secondary markets and the interests
    of investors in smaller companies. It noted that venture exchanges
    potentially could achieve such a balance by providing investors a
    transparent and well-regulated environment for trading the stocks of
    smaller companies that offers both enhanced liquidity and strong
    investor protections. The Commission observed that it had previously
    approved a proposal for a venture exchange, but the exchange had never
    been launched. It emphasized, however, that, as it did with the BX
    Venture Market, it would carefully consider any efforts of exchanges
    that were particularly designed to meet the needs of smaller companies
    and their investors.
    ---------------------------------------------------------------------------
        \36\ A copy of that testimony is available at http://www.sec.gov/
    news/testimony/testimony-venture-exchanges.html.
    ---------------------------------------------------------------------------
        The Commission continues to be receptive to efforts that would
    appropriately balance the needs of smaller companies and the interests
    of their investors.
    III. Conclusion
        Thank you again for inviting me to discuss the SEC's efforts to
    strengthen the U.S. equity market structure. As is evident from the
    many initiatives noted above, the SEC's program for optimizing equity
    market structure is actively moving forward. I look forward to
    answering your questions.
                                     ______

                    PREPARED STATEMENT OF RICHARD G. KETCHUM
           Chairman and CEO, Financial Industry Regulatory Authority
                                 March 3, 2016
        Chairman Crapo, Ranking Member Warner and Members of the
    Subcommittee:

        On behalf of the Financial Industry Regulatory Authority, or FINRA,
    I would like to thank you for the opportunity to testify today about
    current issues and potential regulatory changes that could improve
    equity market structure.
        In recent years, there has been increased debate about the
    structure of capital markets. Once the domain of regulators, market
    operators and large, sophisticated investors, market structure is now a
    topic for much broader public discourse. This discourse often includes
    questions about whether or not the markets are fair and whether they
    provide a level playing field for all investors.
        Partly this concern is a reaction to volatility. For example, last
    August the Dow Jones Industrial Average plummeted more than 1,000
    points within the first 10 minutes of trading, with message traffic
    nearly doubling. And the Chicago Board Options Exchange Volatility
    Index--the U.S. market's so-called ``fear gauge''--surged 45 percent to
    its highest level in nearly 4 years. While the gauge has cooled since
    then, it remains elevated, recently hovering around 22, which is nearly
    double last year's low mark of just under 12.
        While I can't fully diagnose what may at times be ailing the equity
    markets, this tumult exemplifies the importance of the structure of
    markets for financial instruments. All of us here know today that
    questions of market structure can be broad and complex, and it can be
    difficult to home in on what really needs to be addressed. I believe
    there are three key aspects of the markets that securities market
    participants and regulators should always be working to strengthen:
    market fairness, market transparency and market liquidity.
        SEC Chair Mary Jo White has set out a road map for potential future
    changes in the equity and fixed income markets, which specifically
    includes an important, ongoing role for FINRA and other SROs. A number
    of changes have already been made or are in progress; many remain under
    discussion and analysis. As all such changes are contemplated, it is
    important to consider how proposals might enhance market fairness,
    transparency and liquidity.
    FINRA
        Before I address specific market structure issues and initiatives,
    I'd like to provide a brief overview of FINRA and its regulatory
    programs. FINRA provides the first line of oversight for broker-dealers
    and the U.S. securities markets, and through its comprehensive
    regulatory programs, regulates the firms and brokers that sell
    securities in the United States. FINRA oversees nearly 4,000 brokerage
    firms and over 600,000 registered brokers. FINRA touches virtually
    every aspect of the broker-dealer business--from registering
    individuals to examining securities firms; writing rules and enforcing
    those rules and the Federal securities laws; informing and educating
    the investing public; providing trade reporting and other industry
    utilities; and administering the largest dispute resolution forum for
    investors, brokerage firms and individual brokers.
        We also work behind the scenes to detect and fight fraud. In
    addition to our own enforcement efforts, each year we refer hundreds of
    fraud and insider trading cases to the Securities and Exchange
    Commission (SEC) and other agencies. FINRA regularly shares information
    with other regulators, leading to important actions that can prevent
    further harm to investors.
        More than 10 years ago, FINRA established the FINRA Investor
    Education Foundation to support innovative research and educational
    projects aimed at improving the financial capability of all Americans.
    Together with the Foundation, FINRA is committed to providing investors
    with information and tools they need to better understand the markets
    and basic principles of investing--and to help them protect themselves.
        In addition, FINRA operates and regulates OTC market transparency
    facilities that provide the public and professionals with timely quote
    and trade information of publicly traded equity and debt securities.
    They are the primary source for regulatory data on these transactions,
    and provide FINRA-registered firms with tools to comply with reporting
    obligations in secondary-market activity in fixed income and equity
    securities. In this role, we are continually evaluating and identifying
    areas where enhanced transparency can benefit investors and the
    markets.
        Finally, and of particular relevance to today's hearing, FINRA,
    directly and through our regulatory service agreements with exchanges,
    monitors approximately 99 percent of all trading in U.S. listed
    equities markets and 70 percent of the options markets. In fact,
    FINRA's market surveillance systems process approximately 42 billion
    market events each day to closely monitor trading activity in equity,
    options and fixed income markets in the United States.
    Evolution of Market Structure
        Any sound evaluation of equity market structure should begin with
    an understanding of where things stand now, and how we got here. In the
    past 20 or so years, the equity markets have changed in many
    fundamental ways. Perhaps the most significant development has been the
    shift from human-intermediated markets to electronic intermediation.
    While some observers have noted that high frequency trading (HFT)
    activity may be declining since its peak around 2009, it is
    nevertheless clear from various estimates that automated trading has
    become the predominant force in equities markets. We have seen many of
    the traditional floor-based brokers and market-maker specialists of
    previous years replaced by firms commonly characterized as HFT.
        Market structure arrived at its current state because of several
    interrelated factors. Technological advancements have most obviously
    allowed for the rise of highly automated, low-latency trading systems
    capable of digitally ingesting orders, trades and news and making
    advanced trading decisions. Many also point to the impact of regulatory
    action, including Regulation ATS, decimalization, and Regulation NMS,
    all of which have the underlying goals of promoting competition,
    lowering trading costs, and enhancing best execution.
        However, as SEC staff has observed recently in a number of
    detailed, thoughtful papers, there are no easy explanations. For
    example, while Regulation NMS is commonly cited as a cause of market
    fragmentation and the proliferation of HFT, even prior to Regulation
    NMS, Nasdaq had undergone a major transformation from a traditional
    dealer model to a new, electronic market structure. Similarly, some
    believe HFT owes its existence to the increase in the number of trading
    venues, yet HFT is also a significant force in the E-Mini futures
    contract, which trades in a highly centralized market.
        The fact that market structure developments cannot always be easily
    explained does not prevent regulatory improvement. It simply
    underscores the need for careful data analysis. For example, the SEC's
    MIDAS project has been providing greatly enhanced insight into the
    functioning of markets and has helped provide a foundation for market
    structure refinements. Similarly, FINRA, through it Order Audit Trail
    System called OATS, collects and processes billions of order-related
    events each day that also helps shed light on some of the fundamental
    market structure policy questions.
        There is undoubtedly more work to be done. The rise of automation
    has delivered many benefits to investors, who are now able to trade
    much more quickly and cheaply than ever before. But there are potential
    inefficiencies in today's market structure that we must continually
    evaluate to make sure markets are fair, transparent and liquid.
    Market Fairness
        Investors must have confidence that they can access current,
    accurate, bona fide market prices that reflect true investor supply and
    demand. That means that the market structure established, including the
    regulatory framework supporting it, must foster and promote accurate
    prices and low trading costs for retail investors. Having been in this
    business for a long time, I've been part of many significant regulatory
    changes that have benefited investors. However, competition and
    regulatory changes have also led to a more complex, fragmented market.
    In today's increasingly fragmented market, bad actors can consciously
    disperse their trading activity across markets, asset classes and
    broker-dealers in an attempt to hide their footprints and avoid
    detection. It is part of our job at FINRA to monitor what's happening
    in the market and ensure that the markets operate fairly.
        FINRA has responsibility to oversee and regulate over-the-counter
    (OTC) trading of exchange-listed and non-exchange-listed securities, as
    well as trading in corporate and municipal debt instruments and other
    fixed income instruments. FINRA also conducts examinations of market
    making and trading firms to assess compliance with FINRA trading rules
    and the Federal securities laws. In addition, FINRA provides automated
    surveillance and other regulatory services to U.S. equity and options
    exchanges. FINRA has regulatory service agreements (``RSAs'') in place
    with 10 of the 12 U.S. equity exchanges and all U.S. options exchanges.
    By virtue of these agreements, FINRA conducts market surveillance for
    approximately 99 percent of the listed equity market and approximately
    70 percent of the listed options market. As a result, while the markets
    have become increasingly fragmented, through our contracts with
    exchange clients, FINRA has been able to aggregate trading data across
    the markets to conduct comprehensive, cross market surveillance. This
    is important because FINRA has found many instances where market
    participants have consciously dispersed their trading activity across
    multiple markets in an effort to avoid detection. In addition, FINRA's
    cross market surveillance enables us to detect those market
    participants who are acting in concert to engage in market manipulation
    schemes. We have found that such activity accounts for a significant
    percentage of our cross market surveillance alerts.
        We developed an innovative cross-market surveillance program that
    allows us to run dozens of surveillance patterns and threat scenarios
    across the data we gather to look for manipulation and frontrunning, as
    well as layering, spoofing, algorithmic gaming, and other abusive
    conduct. This sophisticated surveillance allows us to detect activities
    that we were not able to see before. For example, 51 percent of our
    cross-market alerts identify potential manipulative activity by two or
    more market participants acting in concert. And 57 percent of our
    cross-market alerts identify potential manipulation by a market
    participant on multiple markets. FINRA also is starting to design
    surveillance programs that will span equities and options markets
    together to detect potential cross-product manipulative conduct.
        In addition to SEC and FINRA oversight, firms themselves have a
    fundamental obligation to supervise their own trading activity to
    ensure that the activity does not violate any applicable SEC or FINRA
    rules. A number of existing SEC and FINRA rules specifically govern
    firms' trading activities including the SEC's Market Access Rule, which
    requires firms with market access to have a system of effective risk
    management controls and supervisory procedures. Although a reasonable
    supervision and control program may not foresee every potential failure
    or prevent every undesirable consequence, it is an additional
    protective measure in today's regulatory structure that promotes and
    supports market fairness.
        And as you know, in July 2012, the SEC adopted Exchange Act Rule
    613 requiring 19 SROs--FINRA and the 18 national securities exchanges--
    to work together to jointly file a NMS plan to govern the creation,
    implementation, and maintenance of a Consolidated Audit Trail, or CAT,
    which will collect information on virtually every order and trade in
    equity securities and options in the United States. The CAT will be the
    world's largest repository of securities data, processing approximately
    58 billion records on a daily basis.
        FINRA strongly supports the SEC's action to require the development
    of the CAT, an important initiative that will even further enhance
    regulators' ability to conduct surveillance of trading activity across
    multiple markets and perform market reconstruction and analysis.
    Comprehensive intermarket surveillance is essential to ensuring the
    overall integrity of the U.S. securities markets and maintaining the
    confidence of investors in those markets.
    Market Transparency
        Transparency is of paramount importance to the equity markets. The
    SEC said recently, and I agree, that transparency is a primary tool by
    which investors protect their own interests. To this end, the FINRA
    Board of Governors formed a Working Group to assess FINRA's rules and
    regulatory programs related to HFT, which resulted in a series of
    initiatives designed to increase the scope of trading information FINRA
    receives and provide more transparency into trading activities to
    market participants and investors.
        In general terms, these efforts include a call for alternative
    trading systems (ATSs) to provide more in-depth order information for
    regulatory surveillance, greater transparency of volume executed away
    from stock exchanges, more granular audit trail information and tighter
    restrictions around allowable clock drift to better ensure proper
    sequencing of events.
        These initiatives build on an earlier initiative from 2014, when
    FINRA began publishing on its Web site weekly volume information
    regarding transactions in equity securities executed within ATSs. Since
    that time, FINRA has been considering additional data that may be
    useful to market participants and investors and is expanding this
    initiative to provide more insight into larger-sized, or ``block,''
    trades. Later this year, FINRA will begin publishing monthly aggregate
    ATS block trading statistics, which will provide interested parties
    with more detailed information on ATS trading activities, thus further
    enhancing transparency in the over-the-counter market. In addition,
    FINRA will be further expanding its transparency initiative by
    publishing the remaining equity volume executed over-the-counter by
    FINRA member firms, including the trading activity of non-ATS
    electronic trading systems and internalized trades. The ATS and non-ATS
    volume data on FINRA's Web site will be free of charge to all users.
        Data from FINRA's ATS transparency initiative helped inform the
    SEC's recent proposal to significantly revise the disclosure regime for
    NMS Stock ATSs. The SEC's proposal would, among other things, require
    greater public disclosure concerning the operation of business dealings
    of NMS Stock ATSs and would provide for enhanced oversight of these
    ATSs' filings. As it stated in its recent comment letter on the
    proposal, FINRA fully supports the proposal's objective of enhancing
    market transparency.
    Market Liquidity and Volatility
        Since the May 2010 Flash Crash, the SEC, FINRA and U.S. stock
    exchanges have implemented a variety of initiatives to minimize the
    impact of extreme volatility, the causes of which can vary from market
    forces to technological malfunctions. These initiatives have created a
    multi-faceted safety net for the markets and are designed to promote
    investor confidence. Among the changes, regulators adjusted the market-
    wide trading pause, which gives market participants an opportunity to
    assess their positions, valuation models and operational capabilities
    when extreme periods of volatility occur.
        On top of that, FINRA and the exchanges implemented a limit up/
    limit down initiative, which addresses the type of sudden price
    movements that the market experienced during the Flash Crash. Under the
    plan, a limit up and limit down mechanism prevents trades in NMS stocks
    from occurring at prices outside of certain ranges. And if the changes
    in price are more significant and prolonged, the limit up/limit down
    plan would trigger a trading pause in that security.
        We had an excellent opportunity to evaluate the effectiveness of
    these changes last August 24th, when the Dow plummeted more than 1,000
    points within the first 10 minutes of trading. The events of that day
    illustrated not a market out of control, but the value of having
    appropriate controls in place. Were it not for the limit up/limit down
    procedures, the market fluctuations last August would have been more
    dramatic. There were over 1,200 trading pauses that day, with over
    1,000 occurring in exchange-traded products (ETPs), many which were
    repeats in the same ETP.
        Clearly, the August events showed these processes are serving a
    crucial function, but also showed that additional refinements are
    necessary. One of the issues that day was the big gaps between the
    value of underlying indexes and the exchange-traded funds (ETFs) that
    track them. ETFs combine aspects of mutual funds and conventional
    stocks. They operate like a mutual fund by offering an investor an
    interest in a professionally managed, diversified portfolio of
    investments. Unlike mutual funds, however, ETF shares trade like stocks
    on exchanges and can be bought or sold throughout the trading day at
    fluctuating prices, whereas mutual funds are priced just once at the
    end of the trading day. On August 24th, unusual trading affected many
    of the major ETFs as well as many less liquid ones. While trading
    volume surged, public display of trading interest--or liquidity--
    dropped. And we saw pricing volatility in ETFs because of the conflicts
    between halts on the underlying stocks within the indices and the
    pricing of the index.
        The volatility and the issues we saw with ETFs offers up a great
    opportunity for regulators to take another look at the effectiveness of
    the initiatives put in place after the 2010 Flash Crash, as well as our
    market structure generally. Among the issues ripe for review are the
    opening processes on primary listing exchanges; the operation of the
    limit up/limit down at the opening of trading, at re-openings after a
    trading pause and where the price is rebounding; the use of single
    market prices rather than consolidated prices for index calculations at
    times when the primary market opens outside its normal process; the use
    of stop orders, which become market orders when triggered and can
    execute at a price substantially worse than anticipated by the
    investor, particularly in volatile markets; and whether market-maker
    quoting obligations are stringent enough to promote market stability.
        Liquidity in the U.S. markets has thrived because of confidence in
    the markets. Investors need to be sure that markets will operate
    predictably. And it's important for us as regulators to implement
    programs that minimize the impact of market volatility and to limit
    market disruption while also promoting an efficient price discovery
    that encourages the provision of liquidity.
    Work of the SEC's Equity Market Structure Advisory Committee
        As noted in the Subcommittee's invitation to testify, the questions
    enumerated above as well as a number of other market structure issues
    are also being considered by the SEC's Equity Market Structure Advisory
    Committee (EMSAC), of which I am a member. In addition, given the
    number and broad ranging issues to address, the EMSAC created four
    subcommittees to focus on specific equity market structure areas:
    Regulation NMS, Trading Venues Regulation, Customer Issues and Market
    Quality. These subcommittees have met several times between full EMSAC
    meetings. Both the SEC staff and EMSAC members have dedicated
    significant time and effort with good progress being made, and I look
    forward to seeing where the process takes us.
        EMSAC discussions have ranged from more broad, thematic topics such
    as increased coordination between the equities and futures markets to
    more specific regulatory and market-based improvements, like retail
    investors' use of certain order types. For example, discussions have
    included efforts to update the SEC's rules on the public disclosure of
    execution-quality statistics and order-routing practices. These rules
    brought much needed transparency to the markets when they first were
    adopted, but market structure has been largely transformed since then
    and they are in need of updating to better reflect the current market
    structure.
        In addition, the committee is reviewing the current regulatory
    model for exchanges and other trading venues, as well as the current
    state and impacts of Regulation NMS. In particular, the EMSAC and its
    subcommittees are considering whether the Regulation NMS rules on
    limiting trade throughs, capping access fees, and preventing locked or
    crossed markets continue to serve their intended purpose. These rules
    were generally intended to bolster investor protection when they were
    adopted, but some market observers have questioned whether they might
    also have contributed to market fragmentation and rebate arbitrage.
        The EMSAC also is actively considering many of the questions about
    market volatility highlighted above, including the operation of limit
    up/limit down and whether firms could better educate their customers
    about the risks of market and stop orders. This issue is one example of
    a place where FINRA believes it can work in parallel to complement
    EMSAC efforts. Guided by the recent EMSAC discussion, and based on
    FINRA's own regulatory analysis, FINRA is currently considering
    providing additional guidance to firms to underscore the importance of
    investor education in this area. The EMSAC has heard a variety of views
    on these important market structure questions, which is why, as I noted
    above, I believe it is critical to use data as the guide forward as we
    evaluate how any potential changes may impact market fairness,
    transparency and liquidity. I look forward to continuing to offer my
    and FINRA's experience and expertise as the EMSAC moves forward with
    its work.
    Small Company Issues
        Issues related to small company issues deserve careful
    consideration as well. FINRA has been involved in several projects
    focused on this segment of the market.
    Tick Size Pilot Program
        On May 6, 2015, the SEC approved an NMS Plan submitted by the SRO
    Participants to implement a Tick Size Pilot Program. The Order approved
    the NMS Plan for a 2-year period, which is to commence on October 3,
    2016. The Plan is designed to allow the Commission, market
    participants, and the public to assess the impact of increment
    conventions (commonly referred to as tick sizes) on the liquidity and
    trading of the common stock of small-capitalization companies. The Tick
    Size Pilot is a data-driven test and will evaluate whether or not
    widening the tick size for securities of smaller capitalization
    companies would impact trading, liquidity and market quality of those
    securities. The pilot will consist of a control group and three test
    groups, with each test group having approximately 400 securities. Each
    SRO Participant, including FINRA, is required to comply, and to enforce
    compliance by its member organizations, as applicable, with the
    provisions of the Plan. The SROs have filed rule changes in furtherance
    of the Pilot and have been working closely with the industry on
    implementation issues, including the data reporting requirements
    necessary to allow for effective data and impact analysis of the
    different test groups.
    JOBS Act Implementation
        In order to fulfill our mandate under the JOBS Act crowdfunding
    provisions, we filed proposed rules and forms with the SEC for SEC-
    registered funding portals that become FINRA members. FINRA streamlined
    the rules to reflect the limited scope of activity that Congress
    permitted to funding portals while also maintaining investor
    protection. The SEC approved FINRA's Funding Portal Rules, which became
    effective on January 29, 2016. FINRA's systems were ready as of that
    date to begin receiving applications from prospective funding portals.
    FINRA's regulatory program is fully prepared for the May 16, 2016,
    effective date of the SEC's Regulation Crowdfunding.
    Conclusion
        FINRA appreciates this opportunity to discuss these important
    market structure issues and its programs with the subcommittee. We
    remain committed to working closely with the SEC, other regulators,
    this subcommittee and the full committee as we continue to work toward
    our dual mission of protecting investors and safeguarding market
    integrity.

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