I hereby respectfully request to testify at the April 21, 2004 public hearing in New York on proposed Regulation NMS.
I am the Monfort Distinguished Professor of Finance at the Kenneth W. Monfort College of Business at the University of Northern Colorado, and have taught there for more than 11 years. I was a senior officer and director of a large NYSE firm, a founding Director of the National Clearing Corporation, and Governor and Vice-Chairman of the National Association of Securities Dealers, as well as an international consultant on securities market structure.
In April 1976, together with two colleagues, I presented to the National Market Advisory Board of the Commission a proposal for using computers and telecommunications to trade stocks in a "visual" auction market, rather than a manual, "auditory" market, such as a traditional stock exchange. This proposal, which we called "The National Book System," had the following characteristics:
This proposal, which was made 28 years ago, seemed to meet all the congressional mandates of Section 11A of the Securities Exchange Act of 1934. This market system would also have provided an instant, fully-electronic audit trail, tracking every bid and offer entered, executed and/or cancelled, thus ensuring low-cost and timely regulation.
In the early 1980s, I was a founder and president of the first electronic futures exchange, Intex, located in Bermuda. I have consulted domestically and internationally in several countries on market structure, design and operations, and have given many academic and industry papers and speeches on the issues surrounding the use of electronic execution in the trading process.
I have commented for many years on the Commission's Releases on the national market system, and my comments have been cited frequently in later Commission Releases.
I have often been asked to give my opinions in testimony on market structure before committees of both Houses of the Congress, starting in 1971.
In sum, I believe I am qualified to give testimony before the Commission once again in this important matter.
Regulation NMS and the Invitation to Testify
Proposed Regulation NMS is very complex, and would be very costly to implement. For example, in the Release, the Commission makes the following cost estimates merely for the trade through provision (Page 41-42):
"The Commission staff estimates that there would be an initial one-time burden of 200 burden hours per SRO or 1,800 hours, and 150 burden hours per non-SRO order execution facility or 1,015,200 hours, for a total of 1,017,000 burden hours to establish policies and procedures designed to prevent the execution of a trade-through for an estimated one-time initial cost of $145,469,475 The Commission estimates a capital cost of approximately $101,655,000 for both SROs and non-SROs resulting from outsourced legal work."
And again, the estimated cost merely for disclosure of the proposed opt-out provision (Page 43):
"...(T)he Commission staff estimates that there would be a one-time burden of 893,376 hours for broker-dealers to make changes to their systems necessary to provide disclosure to investors regarding the impact of opting out of the protections offered by the proposed rule for a total onetime cost of approximately $83,923,200, plus a one-time capital cost of approximately $16,243,200 resulting from outsourced legal work."
The Release is 247 pages long, contains 377 footnotes, and has 105,804 words. The Commission's invitation for commentators who may wish to testify on this Release was made on Friday, March 12, 2004, and requires a request to testify to be made by March 22, only five working days later, since the 10-day window includes two weekends. Copies of oral statements or summaries of intended testimony must be submitted by Friday, March 26, 2004, just 4 days later.
Summary of Testimony
Because of these time constraints, I would propose to focus my testimony on one piece in Regulation NMS. The Commission seems to believe it must decide between the equivalent of Scylla and Charybdis: Either give up its long-standing protection against "trade-throughs," or continuing to let slow and fast market centers coexist, with all the problems that entails.
I believe this choice to be unnecessary. The correct solution would require that all market centers operate at the same electronic speed. If any market center cannot receive, process and execute orders using modern technology, it has not earned a place in the market structure for the 21st Century.
In the Release (Page 27), the Commission notes: "As discussed in Section IV below, the Commission historically has not dictated the means of execution provided by competing market centers"
But let me propose a hypothetical question: "If a market center still used the abacus and smoke signals in their trading system, would the Commission propose writing rules that keep it as a part of the 21st Century "national market system?"
The Release goes on to state (Page 63): "The Commission has been reluctant to mandate automatic execution, in part because of a concern that doing so might be incompatible with the business models of individual market centers and interfere with the ability of individual market centers to compete. Given the changes that have occurred in the markets in recent years, however, and particularly the widespread use of electronic execution in some markets, the Commission requests comment on whether its proposed access standards should require a "quoting market center" or a "quoting market participant," as defined in the rule, to execute orders at its quote automatically."
And again (Page 63): "...the Commission requests comment as to whether it should promulgate performance standards to ensure that the quotes of all market participants
are available for automatic execution. Such performance standards would be designed to ensure that all automatic execution systems satisfy minimum standards that would assure that market participant orders are executed in substantially equivalent timeframes across markets."
To that, I would comment (if invited): "Yes."
And, finally on this point, let me quote the Release once again (Page 64): "The Commission also believes that, if quoting market centers and quoting market participants were required to offer automatic execution, it would be critical that the automatic execution functions of quoting market centers and quoting market participants not unfairly discriminate by offering their members faster automatic execution than they offer to non-members. In the Commission's view, such discrimination would be inconsistent with the standard of equivalent access and would thwart the goals of Section 11A of the Exchange Act."
I believe the correct solution would be to require that all orders-at the time of entry-carry some calculable measurement execution price or prices (which could include conditions under which an order could be canceled if unexecutable in whole or part).
Not only traditional limit orders could be entered under such a program. Orders to trade at the opening price, at the closing price, at the volume weighted average price ("VWAP"), the median price of the day, Immediate or Cancel ("IOC"), Fill or Kill ("FOK"), best bid or offer when received at the trading arena, or similar type orders, should also be able to be entered. Short sale price restrictions can still be followed, and other regulatory restrictions, such as buy "minus" or sell "plus" could also be continued, with the present "market order" condition replaced with either highest bid or lowest offer.
Execution should be on strict price-time priority, based first on disclosed bids or offers, and secondarily on reserve orders (undisclosed, but entered orders) at the same prices as disclosed orders.
More than a month ago, on February 6, the New York Stock Exchange ("NYSE") filed a proposed rule change (SR-NYSE-2004-06) with the Commission. This proposed rule change has not yet been published in the Federal Register, so the timetable for its approval or disapproval by the Commission has not commenced.
While not a part of the rules under proposed Regulation NMS, there is no question that, if approved, the NYSE's proposed rule changes would purport to address some of proposed Regulation NMS's questions.
The intent of the NYSE is clearly to be declared a "fast" market under proposed Regulation NMS, thus permitting no trade-throughs to take place other than orders designated individually as "opt-outs," should that portion of the Commission's proposed Regulation NMS be approved. I do not believe in "opt-outs," nor do I believe them to be necessary in a properly designed and constructed market.
However, it should be obvious that the NYSE's proposed rule changes, since they would not handle orders to be executed under present or proposed short sale rules (among several other deficiencies), would not meet any rudimentary test that would lead a reasonable person to consider the NYSE using its proposed structure to be a "fast" market.
The Commission is at an historical crossroads. A true "national market system" is now within its reach. However, to attain that congressional goal put forth nearly three decades ago, requires an all-electronic market structure. The largest exchange in the United States, the NYSE, is not an all-electronic market. Writing rules that leave the NYSE still using obsolescent technology to maintain their present structure is strictly a political decision, not a regulatory one.
Given the traditionally glacially-paced time frame for the writing and implementing of Commission rules, the NYSE would have plenty of time to properly automate its execution systems, as have so many of its competitors, both domestically and worldwide.
If invited to testify, I would be able to elaborate further, if asked, since I would have had an additional month or more to study the proposed rules prior to the hearing.
I look forward to your decision.
Very truly yours,
Junius W. Peake
Monfort Distinguished Professor of Finance
Kenneth W. Monfort College of Business
University of Northern Colorado
Campus Box 128
Greeley CO 80639-0019
Home page: http://mcb.unco.edu/facstaffdir/peakej.htm