[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


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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/.
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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.
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    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.
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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.
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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\
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    \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\
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    \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.
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    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\
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    \13\ Chair White's November 19, 2014, statement is available at 
https://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370543489640.
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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.
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    \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.
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    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.
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    \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.
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    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.
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    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\
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    \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).
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    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.
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    \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.
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    \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.
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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.
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    \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.
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    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.
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    \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.
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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\
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    \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.
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    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.
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    \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.
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    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.
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     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.
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    \29\ The paper is available at http://www.sec.gov/spotlight/emsac/
memo-regulatory-model-for-trading-venues.pdf.
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    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.
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    \30\ The paper is available at https://www.sec.gov/spotlight/emsac/
memo-maker-taker-fees-on-equities-exchanges.pdf.
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    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.
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    \31\ The paper is available at http://www.sec.gov/spotlight/equity-
market-structure/issues-affecting-customers-emsac-012616.pdf.
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    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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