1 Securities and Exchange Commission 2 3 Roundtable: Market Structure Hearing 4 Date: October 29, 2002 5 Pages: 1 through 214 6 Location: Securities & Exchange Commission 7 450 Fifth Street, N.W. 8 Washington, D.C. 20549 9 ATTENDEES: 10 SECURITIES & EXCHANGE COMMISSION 11 Commission, Chairman Harvey Pitt; 12 Commissioner Harvey Goldschmid, 13 Commissioner Paul Atkins 14 Commissioner Roel Campos 15 Commissioner Cynthia Glassman 16 Annette Nazareth 17 Bob Colby 18 Alden Adkins 19 Larry Harris, Chief Economist 20 21 22 23 24 Diversified Reporting Services, Inc. 25 (202) 467-9200 1 ATTENDEES Continued 2 SECURITIES & EXCHANGE COMMISSION: 3 Giovanni Prezioso, General Counsel 4 Meridith Mitchell 5 Steve Jung 6 Mary Head 7 Brian Stern 8 9 ADDITIONAL ATTENDEES 10 Professor Maureen O'Hara, Cornell 11 Wayne Wagner, Plexus Group 12 Sal Sodano, Amex 13 Gus Sauter, Vanguard 14 Larry Leibowitz, Schwab 15 Rick Ketchum, NASDAQ 16 Cathy Kinney, The New York Stock Exchange 17 Bernie Madoff, Madoff 18 David Whitcomb, Automated Trading 19 John Markese, American Association of Individual Investors 20 Ed Nicoll, Instinet Corporation 21 Gary Gastineau, ETF Advisors; 22 Prof. Joel Hasbrouck, NYU 23 24 25 1 P R O C E E D I N G S 2 COMMISSIONER GLASSMAN: Good morning. For those 3 who don't know me, I'm Commissioner Glassman. And on behalf 4 of the Commission, I want to welcome all of you today to this 5 market structure hearing, and to thank you all for your 6 participation. I know I speak for all of my colleagues when 7 I say that we've been looking forward to this interactive 8 session today, and our next session in New York next month, 9 with great anticipation. 10 The purpose of today's session is to educate the 11 Commission on issues relating to the structure of the U.S. 12 equity markets, with emphasis on how the public interest and 13 the protection of investors can best be served. A key sub- 14 theme is whether our well-intended rules to protect investors 15 and to protect the public are having unintended negative 16 consequences. We want the benefit of your views on the 17 topics we have chosen for discussion today. Even more useful 18 to us will be the opportunity to listen as you, the 19 panelists, discuss and debate this array of issues. 20 In my nine months as Commissioner, I've had 21 meetings with representatives of many different markets and 22 market participants, and I've learned a lot from each of the 23 meetings. But what I really wanted to do was to get all of 24 the differing points of view on a particular topic 25 represented in one room and let people advocating different 1 positions have the opportunity to counter each other with no 2 holds barred. And that's what I hope will happen today. 3 As far as our expectations, it's obvious that two 4 days of hearings, no matter how productive they are, are not 5 going to answer all of our questions. But today's discussion 6 will enhance our understanding of current market structure 7 policy concerns, as well as the possible tradeoffs that may 8 have to be made as we attempt to resolve the important issues 9 before us. 10 Before we get started, I'd like to thank the key 11 members of our market structure working group: Annette 12 Nazareth, Bob Colby, and Alden Adkins and their staff in 13 Market Reg; Larry Harris, our Chief Economist, and his 14 colleagues; our general counsel, Giovanni Prezioso, and his 15 principal associate, Meridith Mitchell; Steve Jung on the 16 chairman's staff; and last, but not least, Mary Head and 17 Brian Stern on my staff. Now let's get started. I'll turn 18 the session over to Annette. 19 MS. NAZARETH: Thank you, Commissioner Glassman. 20 I, too, would like to welcome the Commission, our 21 distinguished panelists, and members of the public, to this 22 first market structure hearing. Today the continue -- the 23 Commission continues in its more than 30-year tradition of 24 critically examining issues related to the structure of our 25 equity markets. Prior Commissions have faced many complex 1 and novel issues in this particularly challenging area of 2 securities regulation, both before and after the Securities 3 Act Amendments of 1975 that gave the Commission a mandate to 4 build a better National Market System. 5 To its credit, the Commission took actions that 6 have resulted in a vibrant, healthy, and efficient 7 marketplace -- A marketplace, indeed, that is the envy of 8 the world. As technology continues to transform our lives 9 and the way we do business, once again we stand at a 10 crossroads with respect to various market structure issues. 11 And the solutions we arrive at will have far-reaching 12 consequences, especially in this highly competitive 13 marketplace. 14 We hope that these hearings will achieve several 15 important objectives. First, as Commissioner Glassman 16 mentioned, we hope that these hearings will provide a 17 comprehensive picture of the structure of the U.S. equities 18 markets. Our marketplace consists of a sweeping variety of 19 market centers and trading methods that cater to different 20 types of securities and different categories of investors. 21 Some markets are centralized; others are decentralized. Some 22 markets are driven by the interaction of customer orders; 23 others are propelled by the willingness of designated market 24 intermediaries to commit capital. Some markets are grounded 25 in a physical trading floor where bids and offers meet face- 1 to-face; others float in the anonymous realm of cyberspace. 2 Another goal of these hearings is to discuss the 3 complex tradeoffs that we have to make in regulating market 4 structure. How should we reconcile the investor's need to 5 obtain current information about market activity with each 6 market center's desire to exploit the commercial value of the 7 data it generates? How should we reconcile the investor's 8 desire to have access to the best prices with the right of 9 individual market participants to employ the business model 10 of their choice? And when should a market be required to act 11 in the public interest, rather than in the interest of its 12 members or shareholders? These questions do not have simple 13 answers, and there are many difficult decisions to be made. 14 We are nevertheless committed to resolving these competing 15 interests in the fairest and most balanced manner. 16 A third goal of these hearings is to use what we 17 learn to maintain consistent policy decisions on the key 18 issues facing the Commission. In recent years, the 19 Commission has undertaken a number of market structure 20 initiatives. Just to name a few, the Commission adopted 21 order handling rules for market makers and ECNs in 1996; 22 Regulation ATS governing alternative trading systems in 1998; 23 and order execution and order routing quality disclosure 24 obligations for market centers and retail brokers in 2000. 25 While some may differ, most would say that these rules have 1 significantly improved the transparency and accessibility of 2 our markets. 3 The Commission has also solicited comment on a 4 number of specific areas of market regulation. Among others, 5 the Commission has issued concept releases on the regulation 6 of market data fees and revenues, the fragmentation of the 7 U.S. securities markets, and the regulation of exchanges. 8 The Commission also convened an advisory committee in 2000, 9 chaired by Dean Joel Seligman of the Washington University 10 School of Law in St. Louis, to consider issues related to the 11 collection and dissemination of market information. These 12 efforts to develop sound policies for market regulation must 13 continue if we are to make our markets fairer, more 14 efficient, and more transparent. To this end, the Commission 15 seeks to ensure that the decisions it makes in the coming 16 months will benefit from the wise counsel of the industry, 17 the academic community, and the public. 18 Before I introduce our participants today, I'll 19 briefly mention just a few housekeeping matters. This 20 morning there will be two sessions. In this opening session 21 we will touch on the overarching principles of market 22 structure, and discuss whether there is consensus on those 23 principles. This session will last only an hour, and will be 24 followed by a 15-minute break between 10:30 and 10:45. We'll 25 then follow with our first major session on market data, to 1 be moderated by Larry Harris, our Chief Economist. At 12:15, 2 we'll break for a one-hour lunch, and we'll pick up with our 3 afternoon program at 1:15. 4 As to general ground rules, in order to keep the 5 dialogue moving and to afford everyone an opportunity to 6 speak, I would ask that each of you attempt to limit your 7 responses to questions to about two to three minutes. Given 8 the limitations on time, we also ask that you try not to 9 repeat points already made. And, now, the next ground rules 10 get even tougher. Please attempt to leave all egos at the 11 door, and try to think about the questions and topics from a 12 public policy perspective, and not simply from the 13 perspective of your own business model. And, finally, keep 14 in mind that the Commission's goal ultimately is the 15 protection of investors. 16 I would also like to note that we will have 17 Commission staff occasionally coming around into the audience 18 with note cards, and the audience is invited to write 19 questions for our participants. We will try to address some 20 of those questions raised by the audience as time will allow. 21 So, with that out of the way, I'd like to introduce 22 each of the participants, and then circle back for any 23 opening remarks that each of you may wish to make. First, 24 I'd like to introduce our Commission, Chairman Harvey Pitt; 25 Commissioners Goldschmid, Atkins, and Campos; and, of course, 1 Commissioner Glassman. I would especially like to thank 2 Chairman Pitt for his leadership in calling for these 3 hearings, and Commissioner Glassman for her substantial 4 efforts in putting together this program today. We also have 5 some SEC staff at the table besides myself. We have Bob 6 Colby, who is the Deputy Director of Market Regulation; Larry 7 Harris, our Chief Economist; and Giovanni Prezioso, our 8 general counsel. 9 And I'll just briefly go around and introduce the 10 rest of the panelists, and then we'll circle back and give 11 anyone the opportunity to -- to make some introductory 12 remarks. Skipping our -- at my own risk, skipping our 13 Commissioners, we have Professor Maureen O'Hara from Cornell; 14 we have Wayne Wagner from the Plexus Group; Sal Sodano from 15 Amex; Gus Sauter from Vanguard; Larry Leibowitz from Schwab; 16 Rick Ketchum from NASDAQ. And then we circle all the way 17 back here to Cathy Kinney from the New York Stock Exchange; 18 Bernie Madoff from the eponymous firm Madoff; David Whitcomb. 19 We have -- I don't know -- have I... 20 MR. WHITCOMB: Automated Trading. 21 MS. NAZARETH: Oh, I'm sorry, David. I should have 22 written that down. 23 MR. WHITCOMB: That's okay. 24 MS. NAZARETH: Automated Trading. John Markese, 25 who is from the American Association of Individual Investors; 1 Ed Nicoll from Island (sic); Gary Gastineau, who is from ETF 2 Advisors; Joel Hasbrouck from NYU. 3 And with that, I will circle back, I guess, 4 starting with Maureen. If -- if there's anybody -- you're 5 certainly welcome to skip if you don't have any introductory 6 remarks. But if you would like to take your allocated two or 7 three minutes for some introductory remarks, you're welcome 8 to do so. Otherwise, you may pass. 9 MS. O'HARA: I'll pass. 10 MS. NAZARETH: Okay. 11 MR. WAGNER: My name is Wayne Wagner. I am 12 Chairman of the Plexus Group. We study institutional 13 trading. And if I represent any interest here, it would be 14 the interest of the institutional investors. And, you know, 15 the institutional trading dominates the -- the volume, and 16 not necessarily the thinking of the -- of the Commission 17 here. 18 When we look at institutional trading, we find that 19 it's really quite different from the -- from the retail 20 trading. We see that institutional orders average over 21 250,000 shares a -- a -- as the portfolio manager is making 22 the decision. And this gets reduced down through a process 23 of going from the trader to the broker to the exchange, to 24 average orders which are somewhere around 1000 shares here. 25 And this reduction process is a -- is a difficult one that -- 1 that leads -- what we find is that over half of the 2 institutional dollars traded exceed 20% of daily volume as 3 the portfolio manager is thinking of the trade that he wants 4 to make, or she now, while only 1/6th of the trading occurs 5 in a volume of more than 20% of daily volume. So there's 6 obviously a three-to-one dispersion of the orders that 7 portfolio managers want to fill in order to manage funds, and 8 what actually gets traded. 9 And, you know, that means that if those trades are 10 not traded on the day that the portfolio manager wants it, 11 they're carried over to further days. And that induces 12 delays here. One thing Plexus is most famous about is 13 describing an iceberg of transaction costs, where the bulk of 14 the costs lie unseen in the delay costs and opportunity costs 15 of the inability of institutional traders to trade fast 16 enough. Those costs represent approximately 75 to 80% of the 17 total cost of executing trades here. And they're sort of off 18 the -- out of the range of normal thinking about market 19 structure and -- and the costs of -- of executing here. 20 But to my mind, these institutional investors are 21 managing funds for individuals here, and the interest of -- 22 of breaking these orders down and -- to the degree that they 23 have to be broken down in order to get through the exchange 24 leads to these delay costs, and it is a friction and an 25 inefficiency in taking the research that these institutional 1 investors do, and allowing that to have its full impact on 2 the performance of the portfolios. Thank you. 3 MS. NAZARETH: Thank you. 4 Sal? 5 MR. SODANO: Thanks, Annette. I'm Sal Sodano, 6 Chairman and Chief Executive Officer of the American Stock 7 Exchange. And first I'd like to thank the Commission for 8 holding these very important meetings. The American Stock 9 Exchange looks forward to working with the Commission and 10 other market participants to address many very challenging 11 issues in the weeks and months ahead. And please note that I 12 use the time frame of weeks and months ahead, in that these 13 issues really are very important and require, as we know, 14 very timely focus. 15 The American Stock Exchange has a very long history 16 of innovation and is unique among U.S. security markets in 17 that. We are the only U.S. market that actively lists and 18 trades across three diverse product lines: equities, 19 options, exchange-traded funds, commonly referred to as ETFs. 20 Quite frankly, we invent investment concepts and products. 21 Therefore, we'd like to clarify that the term 22 "entrepreneurial entrent" as used in the outline for these 23 hearings could equally apply to exchanges, especially the 24 American Stock Exchange. 25 Indeed, in this context I'd like to make some 1 general recommendations. And I will basically only make two, 2 taking into account the limitation on time. First, as we 3 move forward, it is important that the Commission ensure, as 4 you said, Annette, in your early comments, that the 5 principles enshrined in the congressionally mandated National 6 Market System be restored: best execution, transparency, 7 equal regulatory oversight, and fair competition. To achieve 8 this, we believe the last year-and-a-half, especially the 9 recent weeks with Island going dark, demonstrates that 10 Regulation ATS did not and is not serving its intended 11 purpose. Therefore, we believe the first step should be to 12 abolish Regulation ATS and require all markets that meet the 13 definition of an exchange to basically register as such. 14 Further, we believe the Commission should take very 15 concrete steps to modernize the exchange regulation. Again, 16 Annette, as you pointed out, many of these regulations date 17 back to 1975. The disparity between markets is simply too 18 vast. These need to be addressed. 19 Finally, the Commission should bring an immediate 20 end to an obvious conflict of interest that has led to 21 nothing but regulatory abuse, reduced liquidity, and 22 therefore investor harm. Market-sponsored payment for order 23 flow must and should be eliminated immediately. Thank you. 24 MS. NAZARETH: Thank you, Sal. 25 Gus? 1 MR. SAUTER: Thank you, Annette. I'm Gus Sauter. 2 I oversee the portfolio management and trading of Vanguard's 3 internally managed equity funds. We believe that there is a 4 very significant role that the financial intermediary 5 community should fulfill, and we think of the -- this 6 community as including exchanges, specialists, market makers, 7 broker-dealers, institutional money managers, and so on. 8 We think that that role is to provide for the 9 efficient flow of capital from investors to businesses. Its 10 secondary role is to effect efficient exchange of ownership, 11 whether it be stocks or bonds, from one investor to another. 12 We believe that the marketplace should provide for best 13 execution. And we define "best execution" in several 14 characteristics, including consideration for immediacy and 15 certainty of execution, as well as execution at the most 16 favorable price. 17 To satisfy best execution, we believe that the 18 markets need to be liquid, and that the structure of the 19 market should be designed to provide for this greatest 20 liquidity. And I fully expect we will be discussing this 21 further, but in short, we believe that price-time priority is 22 paramount for a most liquid market. We also believe, to cut 23 to the chase, that a central limit order book satisfies the 24 best efficiency of the marketplace. Thank you. 25 MS. NAZARETH: Thank you. 1 Larry? 2 MR. LEIBOWITZ: Okay. I'm Larry Leibowitz. I run 3 the Equities Division of Schwab Capital Markets. We are one 4 of the largest retail firms in terms of customer accounts, 5 over nine million accounts, both traditional retail and 6 direct access traders. We're the 14th largest mutual fund 7 complex, a growing institutional business, regional 8 specialists, and one of the largest OTC market makers, and a 9 founding member of one of the most successful ECNs. Bottom 10 line is we're affected by almost any of the different 11 viewpoints that -- that come across this table, and we view 12 it with many different hats. The bottom line for us is that 13 markets that are open, transparent, with equal access for all 14 is what's going to be good for individual investors, 15 institutional investors, and, in the long run, good for the 16 market. 17 We believe in the critical importance of 18 competition to encourage maximum innovation. We're strong 19 supporters of a National Market System of multiple competing 20 markets. We're always wary of SROs abusing their regulatory 21 authority to advance their competitive interests. Allowing 22 markets to regulate their competitors creates inappropriate 23 conflicts of interest. We believe the SEC must unbundle the 24 functions of markets and the regulator. The concept of 25 competition among interacting orders is code for the CLOB. 1 While it may be a desirable outcome to some, order 2 interaction should never be promoted at the expense of 3 competition among the markets. 4 MS. NAZARETH: Thank you. 5 Rick? 6 MR. KETCHUM: Thank you, Annette. I want to first 7 agree with your characterization that, speaking from a NASDAQ 8 perspective, I think in the last ten years there has been, in 9 large part as a result of Commission oversight, a dramatic 10 change for the good in markets overall, and in the NASDAQ 11 market, in particular, encouraging competition, innovation, 12 while balancing that with greater rights for investors to be 13 represented immediately in the marketplace. 14 I think at the same time, though, that historic 15 high watermark for both individual and institutional 16 investors' participation in the NASDAQ market also sets up, 17 by those very same actions, risks that indeed, remembering 18 your stricture at the beginning, raise particular risks for 19 the protection of investors, unless the SEC steps in actively 20 to mold an efficient and competitively fair environment that 21 encourages both investor protection and risk-taking. 22 In short, we believe that market linkages are 23 needed now, perhaps more than ever, but not cynically 24 inefficient ones that degrade these existing trading 25 environment. We believe that best execution standards must 1 take into account the accessibility in markets in designing 2 what those standards are. We believe that competition must 3 be fair among ECNs and market makers, among ATSs and markets. 4 That requires, at a minimum, consistent rules with respect to 5 access fees and -- and greater flexibility with respect to 6 exchanges in markets such as NASDAQ, and being able to move 7 and respond to competitives threats. 8 And finally, we believe that the Commission must 9 aggressively step in to ensure that legitimate competition 10 among markets do not spawn -- does not spawn regulatory 11 fragmentation and arbitrage that seriously harms investor 12 protection. Thank you. 13 MS. NAZARETH: Thank you. 14 Cathy? 15 MS. KINNEY: I'm Cathy Kinney, the President and 16 Co-Chief Operating Officer of the New York Stock Exchange. 17 Mr. Chairman, members of the Commission, and senior staff, 18 the NYSE is pleased to participate in today's forum, and 19 would like to thank and commend the Commission for opening 20 this dialogue. 21 Nothing is more important to the future of our 22 capital markets than reestablishing the trust and confidence 23 investors place in our system. The trust and confidence has 24 been severely tested in recent times by accounting scandals, 25 by the breach of senior corporate officials and professionals 1 in discharging their obligations, by compromised analysts 2 betraying investors, and by questionable IPO practices. We 3 feel that we are one storm short of the perfect storm. Dark 4 clouds have already gathered over the secondary markets. For 5 notwithstanding the best of intentions, competition and 6 innovation, we've allowed a number of anti-investor practices 7 to gain a foothold in our market practices at the core that 8 fail to put the investor first. 9 Today in our market system, internalization, 10 preferencing, payment for order flow, and other forms of pay- 11 to-play compromise the agency obligations of brokers, and 12 interpose dealers between customer orders. Markets engaged 13 in regulatory arbitrage disseminate non-competitive quotes 14 and purchase tape prints that inflate their volume and convey 15 phantom liquidity. These practices are bad for the health of 16 the markets, and erode public trust and confidence. So far, 17 our secondary markets have escaped the assignment of 18 responsibility for the $9 trillion in missing investor 19 savings. If we do not move quickly, we will have -- all have 20 very much to answer for when the current storm comes, only to 21 find ourselves in the eye of the storm. 22 Mr. Chairman, members of the Commission, and staff, 23 we now have the opportunity to shore up the foundation of 24 transparency, and the resolution of conflicts in our markets 25 for current and future investors. Set the standard for 1 markets and for broker-dealers to do better, much, much 2 better to restore the investor to the premier position by 3 fostering order competition within markets, and at the same 4 time, foster competition among markets. Optimize public 5 price discovery, and delineate and demand best execution, 6 which are two sides of the same protection for investors. 7 Make size, price, and depth, breadth of services, compression 8 of execution costs, and quality of information the basis for 9 intermarket competition. Attack not just the symptoms, but 10 the root causes of anti-investor practices. Require that 11 customers go first. Preclude dealers from trading ahead of 12 public customers on exchanges, and outlaw practices like 13 internalization, preferencing, and phantom auctions. Ban 14 play to -- pay-to-play schemes of all varieties. Preclude 15 any market from hiding its quotes, blocking access to its 16 facilities, or ignoring better priced orders resident in 17 other markets. Restore tape integrity by making the place of 18 execution the place of tape reporting. Allow markets to 19 withdraw from the data consortia, end market data rebates, 20 and painting the tape by ending the subsidies that fund them. 21 Principles of the free market process should be 22 strengthened. Remove advocates of the free-for-all market 23 process from our system, and neutralize the systemic risk 24 they impose. Now is the time to bring investors back to the 25 safe harbor of the finest, most admired and tightly regulated 1 market system the world has known. To do anything less would 2 jeopardize America's tradition of leadership, and betray 3 America's 85 million investors. Thank you. 4 MS. NAZARETH: Thank you, Cathy. 5 Bernie Madoff? 6 MR. MADOFF: Good morning. I'm Bernie Madoff from 7 Madoff Securities. These are very difficult issues, and I 8 have been participating in -- in this process for certainly 9 close to 30 years of the 40 that I've been in the industry. 10 And I would like to thank the Commission for establishing 11 this type of forum. 12 I would encourage the Commission to not give up on 13 the industry's role in helping to participate in solving the 14 problems that we are constantly facing. That being said, I 15 think the Commission plays a pivotal role. And, as Rick 16 Ketchum said, the only way that these issues will ever hope 17 to be resolved is with the active participation of the SEC in 18 this process. I would also like to say that I think the 19 industry and investors would be very well served if all of us 20 that are participants in this marketplace focused in on what 21 we think is the right thing for the investor and for the 22 market, overall. And I've never been sure that those are two 23 related issues. And to lay aside the individual marketing 24 and the individual self-interest that the various market 25 participants all have in this whole issue. 1 So this is a difficult process. I'm sure it's -- 2 it'll be ongoing. And I think this is a great opportunity 3 for all of these issues to be aired. So thank you for having 4 this function. 5 MS. NAZARETH: Thank you. 6 David Whitcomb? 7 MR. WHITCOMB: Hi. I'm Dave Whitcomb of Automated 8 Trading Desk. I want to thank the Commission also for having 9 the hearings, and for inviting me. 10 Let me give you first my background and biases. 11 I'm a retired finance professor from Rutgers, and I'm also 12 founder and chairman of Automated Trading Desk. ATD develops 13 and operates expert systems for fully automated limit order 14 trading. We have two broker-dealer subsidiaries. ATD 15 Brokerage Services does proprietary trading, and trades for 16 institutions. Chicago Securities Group is a specialist on 17 the Chicago Stock Exchange. The two subsidiaries trade about 18 4% of the NASDAQ volume, 2% of listed volume, and about 10% 19 of total ECN volume. So you won't be surprised that I will 20 focus my comments on how to make the world safe for limit 21 order trading. You will be surprised that I still favor 22 decimalization, despite the fact that it cut ATD's profits in 23 half on the day it began. You'll also be surprised that I 24 favor radical reform of listed trading, despite the effect it 25 might have on our Chicago specialist unit. 1 The order handling rules and decimalization 2 revolutionized the NASDAQ market. They freed limit order 3 trading via ECNs to compete with dealers' quotes in what I 4 call E-market making. The result is much tighter spreads and 5 new pools of liquidity, although it's what I call distributed 6 liquidity. Market makers and E-market makers like us make 7 less money in this environment, but the market is growing and 8 modernizing, and I think it's good for us in the long run. 9 I want to complete the revolution by extending the 10 order handling rules to the listed market, ending a variety 11 of restraints on competition between limit orders and 12 specialists. Among the restraints are delays in displaying 13 limit orders, delays in executing market orders, stepping 14 ahead by specialists. Nothing wrong with stepping ahead, but 15 only if limit orders can compete. Stepping ahead for the 16 benefit of investors. 17 I also want to demutualize the exchanges and 18 trading systems to put rule making and enforcement where it 19 should be, at the SEC. SROs were a bad idea in the New Deal, 20 and they're a bad idea today. Thank you. 21 MS. NAZARETH: Thank you. 22 John? 23 MR. MARKESE: Good morning everyone. I'm John 24 Markese. I am President of the American Association of 25 Individual Investors. We're an educational group, and I have 1 to say that the one thing we can't seem to educate our 2 investors on are market structure issues. But if they listen 3 to the comments that we've heard already around the table, 4 they'd be even more depressed than they currently are about 5 the stock market. 6 (Laughter.) 7 MR. MARKESE: While they -- they know we're not 8 trading under the Buttonwood Tree any longer, markets have 9 gotten away from them. They don't quite know how their 10 orders are executed. I wouldn't give them a test on any of 11 this, but I have to say this, that they still demand and they 12 still want -- and there's no one individual investor, but 13 they still demand liquidity; they still demand regulation; 14 they still demand timely, pertinent information; they want 15 operational efficiency; and they don't want to pay anything 16 for it. That has not changed. 17 (Laughter.) 18 MR. MARKESE: I fear, looking at this from a view 19 -- I'm also an ex-academic and a few other things along the 20 way, that what I see in this marketplace today, we have 21 fragmentation of regulation; we have fragmentation of 22 execution; in fact, we have simply fragmentation. We need to 23 coordinate this. We need a national -- a true National 24 Market System. The technology, the products have run faster 25 than our abilities to make it all work well together. 1 So I'm here for best execution, and I don't think 2 there's any one definition that I would subscribe to of best 3 execution. At times it's -- it's certainty; at times it's 4 time priority; at times it's price; at times it's the 5 package, meaning the brokerage costs and everything else. So 6 it's a complex issue. Individual investors have an inherent 7 interest in this, but unfortunately they're not as well 8 informed as they should be. I think we have some serious 9 issues that we need to discuss, and I look forward to today. 10 Thank you. 11 MS. NAZARETH: Thank you. 12 Ed? 13 MR. NICOLL: Well, good morning, Mr. Chairman, 14 members of the Commission. Thank you for this opportunity to 15 participate in today's round table. Annette, I am Ed Nicoll, 16 CEO of Instinet. 17 MS. NAZARETH: I know. I -- I apologize. 18 (Laughter.) 19 MS. NAZARETH: I -- I've got to get with the 20 program. 21 (Laughter.) 22 MR. NICOLL: And Instinet is the world's largest 23 electronic agency broker serving its customers for over 30 24 years. Today Instinet handles almost a third of all the OTC 25 shares traded in NASDAQ listed securities. There could not 1 be a better time to have these meetings. We are probably 2 facing today a greater number and more diverse set of 3 challenging public policy issues than we've seen in years. 4 While some may be concerned about how to manage these issues, 5 I actually see them as an opportunity for all of us, market 6 participants and regulators, to shape a stronger, healthier, 7 and more robust marketplace. 8 Perhaps the greatest common theme cutting across 9 these challenges is how to integrate electronic markets into 10 the National Market System, while at the same time ensuring 11 that both traditional and electronic markets can offer their 12 unique products and services. Let us today not get 13 distracted into debating which is better; but, instead, let's 14 see if we can begin to lay out the regulatory framework that 15 would allow both models to compete fully and fairly, and 16 deliver the greatest value to all investors. Thank you. 17 MS. NAZARETH: Thank you. 18 Gary? 19 MR. GASTINEAU: I'm Gary Gastineau. In my career 20 I've been on the buy side, I've been on the sell side, and 21 I've even worked for an exchange. Effective Friday morning, 22 I will be an issuer. So I'm probably as close to John 23 Markese, in terms of what I'm interested in, as anyone else 24 here. 25 Over the years I've sat at the feet of gurus like 1 Wayne Wagner and Larry Harris talking about market 2 microstructure and transaction cost issues. And as I read 3 over the sort of talking points or discussion points for 4 today, I think if I'd been a Commissioner I would be either 5 extremely pessimistic or extremely optimistic. Pessimistic, 6 in that I doubt very much that it's possible to solve all 7 those problems in any kind of coherent way. Optimistic in 8 the sense that, unless I do something really bad, I can't 9 make it much worse. 10 (Laughter.) 11 MS. NAZARETH: Joel, can you one-up that? 12 MR. HASBROUCK: This is a bad position. I teach at 13 New York University, and one of the courses I teach is a 14 course in trading and markets. And I can certainly attest to 15 the complexity of the securities markets, at least my 16 students can. Because by the time I find I finish a 17 semester, we can just cover really only essentially the 18 basics. 19 I would also note that many of the things we're 20 talking about today are about tradeoffs. One of the basic 21 tradeoffs is going to be between what the SEC, in its 390 22 release, called "price competition," that is, all -- bringing 23 all of the trading activity together in the search for the 24 best price, with market center competition, which is the 25 innovation and competition of diverse trading mechanisms. 1 The SEC, in its Rule 390 concept release, outlined these two 2 goals. One or the other will not be chosen. The best we can 3 do is strike a balance. Thank you. 4 MS. NAZARETH: Thank you. Well, I think you can 5 all tell from these introductory remarks that we're in for a 6 very interesting dialogue in the course of the day. I think 7 that most of the major issues that we'll be grappling with 8 were, in one way or another, touched upon in -- in your 9 opening statements. 10 I thought before we move on, you know, in the 11 program to the -- to the more specific programs, we should 12 have a very general discussion about what the core precepts 13 are of the National Market System, to see whether, going 14 forward, we agree that those are the principles that -- that 15 we agree should be those that we're operating under, you 16 know, whether there is consensus on those. So I'll go 17 through them. 18 The core principles of the National Market System 19 are, first, transparency of information. That is, the 20 availability to brokers, dealers, and investors of 21 information with respect to quotes and trades. The second is 22 economically efficient execution of securities transactions. 23 The third is ease of obtaining best execution. The next is 24 fair competition among markets and intermediaries within 25 markets. And finally, the opportunity, consistent with the 1 aforementioned goals, for investor orders to be executed 2 without the participation of a dealer. 3 So again I think it would be helpful to have a 4 brief discussion to establish whether there is sort of 5 general consensus on these core principles before we move on 6 to a more detailed discuss of market structure. And if these 7 aren't the correct goals---and obviously these are sort of 8 our template, you know, this is what the legislation requires 9 that we have as our goals in -- in regulation---if they're 10 not the correct goals, what should the goals be. And 11 obviously, any changes would require legislation. 12 Since we're starting out, though, in this -- in 13 this brief segment with a somewhat theoretical topic, I 14 thought I'd turn to one of our master theoreticians here, 15 Maureen O'Hara, and ask you -- start with you, and ask you... 16 Sure, you have a... 17 MR. COLBY: Well, I just want to say if -- if you 18 don't believe there should be any National Market System or 19 any Commission involvement at all, this is probably the time 20 to say it. 21 MS. NAZARETH: Right. Well, that's true. If you'd 22 like us to lay off everything. I'd start with Maureen, but 23 we don't necessarily have to go, you know, around the room 24 with everyone opining. What -- whoever would like to 25 participate. 1 MS. O'HARA: Well, thank you, Annette. 2 Let me start off and say that I think that the 3 National Market System is a wonderful dream, and it's totally 4 impractical. We'll just start with there, in the sense that 5 much of the difficulties that people around the table have 6 alluded to is that we all agree on the notions of fairness 7 and competition. But, by definition, what becomes 8 competitive for one market oftentimes becomes anti- 9 competitive for another. So I think the challenge that this 10 Commission faces---and let me stress that I do think you play 11 an extremely important role---while I believe firmly that 12 where the -- that the competition that we've seen the last 13 decade amongst market centers has dramatically improved the 14 quality of the U.S. markets, the difficulty is that as we 15 move forward into an era of increasingly privately owned 16 trading systems, we need a central, shall we say, market cop 17 to keep things even. And so I would encourage the Commission 18 to recognize that their role is probably greater now than 19 ever. 20 Having stated that, I do believe that the National 21 Market System, as it's currently envisioned, is too 22 simplistic. The challenge that the Commission faces is 23 recognizing that for individual customers the ability to get 24 a fair price may not come at the same expense that 25 institutions face, as Wayne points out. Moreover, the 1 ability to compete by smaller markets is only really 2 feasible, given our current National Market System, if they 3 can somehow manage to compete in a way that may not 4 necessarily result in a better price for the consumer. 5 These are not all necessarily bad tradeoffs, but I 6 think they require us to think more seriously about the 7 difficulties of trying to balance features such as 8 transparency and efficiency. When I look at efficiency, I'm 9 more concerned about the ability of corporations to raise 10 funds efficiently, and investors to be able to trade at 11 prices that approximate the fair values of securities. 12 As we fragment, the only way fragmentation gets us 13 there is if market centers that have better ways of 14 accomplishing either of those goals are able to compete. But 15 our current system, I think, leads us far astray. Our 16 national best bid and offer to me has become problematic 17 because it isn't the national best bid or offer. You can 18 trade at better prices in a number of markets, including our 19 largest ones. 20 So I -- I urge the Commission to think seriously 21 about whether price competition is currently being met, 22 whether prices currently are efficient, whether things truly 23 are fair. I -- I have serious doubts that practices that 24 allow dealers to undercut best bids and offers necessarily 25 lead us to where we want to go. 1 MS. NAZARETH: Ed, I bet you have a view. 2 MR. NICOLL: Well, I don't know if I disagree. I 3 mean, we're -- we're on such a theoretical level here, I'm 4 not sure which way some of those comments cut in terms of, 5 you know, our -- where we are today. 6 I certainly am in favor of the Commission's role, 7 first of all, to answer Bob's question. And I believe that 8 it's absolutely critical today, more than ever, to have a 9 strong SEC play a role here. And, you know, I think the 10 issues have been laid out and -- and people have already sort 11 of staked out, you know, their positions in their opening 12 statements. 13 I obviously -- and we obviously are concerned 14 about, you know, our ability to compete with markets that are 15 protected by regulations that we don't think serve our 16 customers. And, you know, we find ourselves in a situation 17 in which, you know, we have the demand for a very efficient 18 marketplace where we have investors who have chosen our 19 marketplace over competing marketplaces, and where we've 20 become the de facto primary marketplace in some instances. 21 And yet, because of what we believe are -- are, you know, 22 antiquated regulatory structures that -- you know, that favor 23 one market structure over another, do not allow us to -- to 24 compete as efficiently as we could. We think that -- that 25 that competition benefits all investors, not just the 1 investors who trade over our networks. We think that the -- 2 when even the most sophisticated investors come together and 3 trade at the most efficient price, that that -- that that's 4 critical that we promote that. Because, you know, the 5 average retail investor---excuse me---who wades into that 6 market at any -- any time will benefit greatly from the 7 liquidity and the efficiency that's being created by even the 8 most sophisticated investors. 9 So, you know, what we're interested here in -- in 10 exploring is finding a way to promote the competition between 11 these new electronic marketplaces, of which we're certainly 12 one of the preeminent players, while at the same time 13 preserving the role of the -- of the traditional marketplace 14 when they make more sense, when investors choose them. And 15 -- and, of course, finding a regulatory framework that's 16 flexible enough for both of these markets to exist at the 17 same time. 18 MS. NAZARETH: Thank you. 19 Bernie? 20 MR. MADOFF: I think that it's important to 21 everybody to keep their focus. You know, we -- we operated 22 our firm saying that no good deed goes unpunished. And I 23 think that's what you have to look at when you look at this 24 National Market System. Number one, I do believe we do have 25 a National Market System. I think it's -- I think it's 1 important to have one. I -- I think that what this industry 2 has accomplished is nothing short of amazing. If you -- if 3 you look at the cost of executions, if you look at the 4 efficiency of executions, if you look at the transparency of 5 the marketplace that exists, it is nothing to be ashamed of. 6 Yes, there are problems that always arise when 7 you're trying to do what we're trying to do. In my mind, the 8 big risk is to try and undo rather than just try and fix and 9 to tinker. I think the SEC, all the years that I've been 10 involved in this process, has always taken the position 11 "let's go forward, let's run the risk of making mistakes in 12 allowing innovation and allowing competition to go forward, 13 and we can always circle back and correct the problems that 14 occur." There is no way of accomplishing what we're trying 15 to accomplish without having some fallout, and that clearly 16 will be negative. 17 But I don't think the markets are in disarray. I 18 don't think they're -- they're a disaster by any stretch of 19 the imagination. I think what you're seeing is dislocation 20 of certain -- certain markets, of certain participants in the 21 marketplace. Quite frankly, that's -- that's what is 22 supposed to happen, and I think that's -- that's beneficial. 23 I think that it's a mistake for the SEC to try and overreact 24 to some of these problems. Fortunately, in my experience, 25 they never have. And they have shown a great deal of 1 restraint in not taking the advice of those people whose oxes 2 have been gored in this competitive process. I remember 3 everybody saying ban payment for order flow. They're still 4 saying ban payment for order flow. We don't even pay for 5 order flow any longer, although we're considering going back 6 to paying for order flow. It is -- all of these things are 7 constantly resurface (sic). And I think that, you know, I -- 8 first of all, I enjoy this process, and I think the markets 9 have enjoyed the process, and I think that it's important for 10 everybody to constantly take a deep breath, including the -- 11 the regulators, and just try and fix some of the dislocations 12 that are occurred. It won't be easy, but it is a heck of a 13 lot better than going back to where we started before you had 14 the '75 Securities Act. 15 MS. NAZARETH: Rick? 16 MR. KETCHUM: Perhaps because I've lived with them 17 for 28 years, I may be prejudiced, but I think the core 18 principles are exactly the right principles for today, just 19 as they were in 1975. Although I do have to remark that I 20 think only someone with a boundless optimism of Bernie can 21 speak of some of these things as enjoyable. 22 (Laughter.) 23 MR. KETCHUM: I think they're the right core 24 principles, not because they drive you to a single 25 conclusion. In fact, they're the right core principles 1 because they don't. Because they are, by necessity, 2 overlapping; often inherently contradictory. Back when I was 3 at the Commission we liked that because it gave us a lot of 4 discretion. Now I find it a little bit more terrifying. But 5 nevertheless... 6 (Laughter.) 7 MR. KETCHUM: ...nevertheless, good, because there 8 is a tendency, with the magic words of "National Market 9 System," to think of something that could be tied up in a 10 bow, put under a tree, and be finished. And in the end, the 11 National Market System is messy, just as the core principles 12 are. It reflects a marketplace that continually changes as a 13 result of technology, as a result of investor demand, as a 14 result of innovation by entities such as Ed represents. And 15 if -- if the principles are not broad enough for the 16 Commission to step back, reapply them, and recognize that any 17 decision they make has to inherently be a balance, then 18 they're very dangerous. These allow you to do that, and 19 always require you to recognize that you're making a balance 20 and you're accepting tradeoffs, and to accept them knowingly. 21 If there's any piece that -- where I had the chance 22 to rewrite back in 1975 I would do, it is to make more 23 explicit economic efficiency of transactions. Not because 24 it's wrong, but because I think there is a risk of the 25 Commission not focusing on that means as much efficiency, and 1 a great part of efficiency is liquidity. And then one must 2 balance the needs, as were indicated before, of individual 3 investors with institutional investors throughout. 4 And the last piece I'd say is the standards 5 themselves are great precisely because they must be balanced. 6 I think the one thing we all have to watch, and -- and 7 certainly the Commission, as well, and all self regulatory 8 organizations, is to get too attached to what worked 20 years 9 ago, and recognize that, while the principles remain correct, 10 the solutions of 20 years ago aren't always correct. 11 MS. NAZARETH: Thank you. 12 Larry, did you want to go next? 13 MR. LEIBOWITZ: Yeah. I mean, I think there's a 14 tendency, in listening to a lot of what's going on here, to 15 say, "Oh, my God, what's happening to our markets?" The 16 reality is we're in a bear market, and that's what's happened 17 to our markets. 18 Over the last few years---and I've been in this 19 business for 20 years, so, Bernie, I'm junior to you by quite 20 a bit---I mean, I've seen -- we have seen so many changes 21 over the last few years, almost all of which have been to the 22 investor good, whether it's order handling rules, 23 decimalization, increased linkages, the 1-5 rule disclosure, 24 all in the name of increased transparency, increased 25 fairness. And they've had a major effect if you look at 1 profitability of dealers and -- and spread sizes and all of 2 these things. It shows that our markets are much more 3 efficient than they were. That's all been accomplished 4 through improved regulation and improved competition of 5 alternative trading systems. And I think it's -- it's a 6 mistake to sort of think, 'Oh, well, we can come up with one 7 big solution that's going to fix everything that's wrong.' 8 The reality is our job is -- is to remove any unfairnesses 9 and inequities that we see between the markets, some of which 10 are a result of regulation, and some of which are a result of 11 different constituents having more market power than others. 12 And what we have to do is balance these things as we figure 13 out how to move forward. 14 MS. NAZARETH: Thank you. 15 Sal? 16 MR. SODANO: I'd like to say that we do agree with 17 the definition of the National Market System. I guess the 18 point that we'd like to make has to do with the aspect of 19 fair competition. When you look at the players in the 20 marketplace, and I'll use ourself as an example, when -- and 21 obviously we look to and foster innovation and -- and new 22 ways to do things and ways to better the investor, none 23 better than at the Amex. We do that. 24 But when you have issues such as timing that's 25 required to effect changes in rule makings because of one 1 standard versus another and one market compared to another 2 and the regulatory costs overall to operate a marketplace 3 versus a competitor, the redundancy requirements to put up as 4 a primary market versus another market in the marketplace 5 where those requirements are just not there, and quite 6 frankly can shut down if they'd like to. 7 The investor protection rules that are evident and 8 required on one side versus another. Quite frankly, from 9 someone like ourselves, that would pose the -- the situation 10 of why bother to -- how do we protect investment that we put 11 into our marketplace and try to do things better. There's 12 just an incredibly unequal playing field, and the -- the one 13 section, fair competition, just needs a lot of work. 14 One last comment with regard to payment for order 15 flow. I guess I make that more timely with regard to the 16 options industry in relationship to the Philadelphia Stock 17 Exchange announcing that they want an organized payment for 18 order flow program. I can tell you, without any hesitation, 19 that many market makers will stop becoming market -- or 20 continue to be market makers in the market as a result of 21 those additional costs which basically are passed along to 22 order flow providers and not the investor, which has the 23 direct effect of reducing liquidity in the marketplace. So 24 we have an additional cost levied on the market which is not 25 advantageous to anyone. So, I mean, it goes on into the 1 equities markets, as well. And I don't want to get into that 2 long discussion. I think that'll happen this afternoon. But 3 in particular, with the options industry, it is absolutely a 4 very bad thing that needs to be stopped. 5 MS. NAZARETH: Okay. 6 Gus? 7 MR. SAUTER: Thank you. I'd like to agree with 8 many of the other comments, that the principles of the 9 National Market System we think are well-founded. It would 10 be hard to argue against them. They sound like motherhood 11 and apple pie. 12 I would, though, say that while we do believe the 13 markets are much better today than they were ten years ago or 14 even five years ago, we think there have been many great 15 innovations, the order handling rules, the Reg ATS, that have 16 greatly improved the situation for investors. Nevertheless, 17 we think there are additional improvements that can be made. 18 We believe there are many situations where the 19 rules really are designed for the financial intermediary 20 community. That instead of benefitting the investor, they 21 benefit the -- the intermediary community. We think it 22 should be the other way around. Ultimately, everything 23 should be designed around the benefit to the investor. 24 So we think there's -- there's a ways to go. We 25 think there are some very important changes that could be 1 made. Market linkages. We think that it's problematic to 2 have internalization. But yes, we do believe in these 3 principles. We do believe the markets are better, but 4 they're not perfect by any means. 5 MS. NAZARETH: Okay. 6 Cathy? 7 MS. KINNEY: I think the good news and bad news is 8 that there is nobody but the Commission who can help us work 9 through a lot of the issues and principles that you've laid 10 out today. As Gus said, it would be hard to argue with these 11 principles. These are the right principles. But I would 12 agree completely with his -- his view that unless these 13 principles are centered around the investor, we can all find 14 ourselves in a very difficult position. 15 I think some of the issues that we've heard around 16 the table today and the issues that you're going to grapple 17 with in the very subject topics are where there have been 18 misalignments or misapplication of the principles in certain 19 rule making that has occurred. And I think this is an 20 opportunity for us to step back. Because, to be sure, Rick's 21 correct. Technology, innovation, many of the things that we 22 all know about the success of the markets today really have 23 come and -- and created a certain amount of change. But I 24 think if we go back to the basic principles, we can all agree 25 they're the right principles if we keep the investor in front 1 of all of our deliberations about how to apply these 2 principles, I think we'll stay on track. And I -- I can't 3 imagine that we can go too far afield if we keep those 4 principles and the investor in mind. 5 MS. NAZARETH: Thank you. 6 Yes, Gary? 7 MR. GASTINEAU: Well, I -- I agree with everyone 8 else that the principles are -- are terrific. The problem 9 is, as Gus says, they're like motherhood and apple pie. I 10 think that what we need to do is we need to step back a 11 little bit and think about the possibility that the best 12 solution for some of these issues is deregulation. 13 Now, I realize that in the current political 14 environment it's going to be pretty hard to move very far in 15 that direction, certainly as a major agenda. But at the same 16 time, as the Commission looks at the market out here, we have 17 the best markets in the world. Now, there are two reasons 18 for that. One of those is the Commission, and one of those 19 is that markets work, and markets work to make themselves 20 work and to operate efficiently, unless they are frustrated 21 at every turn. 22 The Commission needs to think about how much of 23 this is due to the results of prior Commissions, and how much 24 of this is due to the fact that the market would do pretty 25 well in a lot of respects without the kind of intense 1 scrutiny and the intense regulation that it has today. 2 MS. NAZARETH: Okay. 3 John? 4 MR. MARKESE: This is a rather naive statement, and 5 I'm -- I'm admitting to it from the beginning. But when I 6 look at these principles, I see competition merely as 7 trumping efficiency and transparency. I think we have 8 probably stood in the way of competition many times with 9 regulation. I think if we had truly competitive markets, 10 we'd have more efficient and more transparent markets. But 11 what I'm aghast at is the fairness issue. I think that's 12 been lost somewhere along the line. I see payment for order 13 flow, and I can't think of a good thing that that does for 14 investors. I know some will argue it's liquidity, it creates 15 pools of liquidity. I see rebates, I see regulatory 16 arbitrage. And frankly I don't see the Commission having in 17 the past addressed those issues sufficiently from the 18 individual investor viewpoint. And, again, I'm taking that 19 simple viewpoint. 20 But if we look at a truly competitive market, we're 21 going to get low cost providers, we're going to get efficient 22 execution for all participants. And as far as transparency 23 was, we'll sell transparency, but it will be there, and 24 competition will push that price very low. So I see these 25 principles as being reasonable, but it starts with 1 competition, and I think we've hindered it. I'll agree with 2 Gary. And the fairness issue, I think we've lost it along 3 the way. I've -- I -- from the viewpoint of the individual 4 investor, I'm really saddened by that. 5 MS. NAZARETH: On that sad note... 6 MR. MARKESE: That note. I'm sorry. 7 (Laughter.) 8 MS. NAZARETH: Sorry. I think this has been a 9 tremendous opportunity to sort of tee up the issues that 10 we're going to be discussing for the rest of the day. I 11 think we'll take a 15 minute break and come back and talk 12 much more in depth about market data. 13 (Brief recess.) 14 MR. HARRIS: Welcome to the market data section. 15 Thank you for joining us. Before delivering my remarks, I'll 16 now note that now batting for the New York Stock Exchange... 17 (Laughter.) 18 MR. HARRIS: ...Richard Bernard. 19 MR. BERNARD: If you like my answers, I am -- I'm 20 Rich; if I'm not, I -- 21 MR. HARRIS: Oh, Michael Ryan for Amex. Thank you. 22 U.S. investors today have access to a consolidated 23 real-time stream of market information, data on trades and 24 quotes for each of the thousands of stocks traded in our 25 markets. Price transparency is a cornerstone of the U.S. 1 National Market System. Many people believe that it 2 facilitates the best execution of customers' orders, promotes 3 investor protection, and mitigates the fragmentation of 4 buying and selling interest among different market centers. 5 The best quotation and last sale are the most basic 6 bits of market information. The best quotation is the 7 highest bid and the lowest offer price currently publicly 8 available for a security. It is the national best bid or 9 offer, or NBBO. The last sale identifies the price at which 10 the most recent trade occurred, the size of that trade, and 11 the market in which the trade took place. 12 The National Market System legislation adopted by 13 Congress in 1975 as part of the Securities Acts Amendments 14 governs price transparency in the United States. The 15 amendments gave the SEC the authority to adopt rules to 16 implement the essential mechanisms of an integrated market, 17 such as the collection and consolidation of market 18 information. At the same time, Congress recognized the 19 importance of relying on competitive forces to the greatest 20 extent possible to shape the National Market System. 21 Under the market information rules adopted by the 22 Commission, stock exchanges, and the NASD, under -- I'm 23 sorry. Under the market information rules adopted by the 24 Commission, stock exchanges and the NASD make available 25 quotes, trade prices, and volumes for all exchange-listed and 1 NASDAQ stocks within seconds of the quote or trade. This 2 information is consolidated across markets and distributed to 3 the public. Presently, the current NBBO quotation, 4 individual market center, OTC market maker, and ECN quotes 5 and reports of all trades are disseminated for each stock on 6 a real-time basis. 7 The SROs have established several National Market 8 System plans to jointly disseminate consolidated market 9 information. These plans govern all aspects of the 10 arrangements for collecting and distributing market 11 information. They require the individual SROs to transmit 12 market information to a central processor, which then 13 consolidates the information to a single stream for 14 dissemination to vendors and some large -- larger end users. 15 In turn, market data vendors disseminate the information to 16 the public. 17 The plans also govern the fees that users pay for 18 market data, the distribution of revenues derived from those 19 fees, various reporting obligations, hours of operation, and 20 regulatory halt procedures. The resulting net revenues, 21 which currently total about $400 million a year, are divided 22 among the exchanges, NASD, and NASDAQ. They represent a 23 significant percentage of their revenues. 24 The implementation of decimal pricing in penny 25 increments in 2001 increased the demand for deeper levels of 1 market data. For example, in January 2002, the New York 2 Stock Exchange began to provide a real-time, dynamically 3 updated view of the limit order books for all NYSE traded 4 issues. NASDAQ's SuperMontage, which began to operate in -- 5 on October 14th, 2002, combines NASDAQ's stand-alone 6 quotation and order routing systems with the means for 7 aggregating orders and quotes at multiple price levels to 8 create an integrated trading system. Certain ECNs, such as 9 Island and Archipelago, make their limit orders book -- limit 10 order books available on their websites at no charge. In 11 addition, several Internet portals offer free access to ECN 12 limit order books and other market data. 13 Nevertheless, the impact of decimalization has led 14 some market participants to believe that additional 15 regulation is required to standardize the collection of such 16 information. Several market centers now rebate or seek to 17 rebate a significant percentage of their market data revenues 18 to their members or users based on the business that they 19 generate. These rebates have affected order routing 20 decisions, and have created incentives for tape shredding and 21 wash trading. The very existence of the rebates has led some 22 to suggest that market data fees are too high. Moreover, 23 many traders resent paying for data that they helped create. 24 They believe that the national market data belong to the 25 public, rather than to the exchanges and NASDAQ. The 1 exchanges and NASDAQ, of course, disagree. 2 In light of the wide range of views on the issue, 3 the SEC formed an advisory committee in August of 2000 to 4 assist it in evaluating issues related to the public 5 availability of market information in the equity markets. In 6 its final report dated September 14th, 2001, the committee 7 affirmed the importance of price transparency and 8 consolidated information to the health and vitality of our 9 securities markets. The committee also recommended, with 10 varying degrees of consensus, a number of measures to 11 increase the flexibility of market centers and data vendors 12 to make data available to the public. The committee also 13 suggested that technological and competitive developments may 14 have lessened the need for requiring market centers to act 15 jointly to consolidate data under existing National Market 16 System plans. 17 Our first session today will cover the way that 18 market data---in particular real-time market data---are 19 collected, processed, and made available to investment firms 20 and individual investors. The questions that we hope to 21 address are: What are the fundamental pieces of information 22 that professionals and investors use to determine whether and 23 when to trade a security, and at what price? What 24 information should be available to professionals and 25 investors, and on what terms? To what extent is regulation, 1 rather than market forces, required to ensure availability of 2 this information on a consistent basis? Who should benefit 3 from controlling market data? Who should determine how 4 information is made available to the public? How should 5 revenues from the sale of market data be allocated? Should 6 market data rebates be prohibited, or do they represent the 7 formation of a competitive market that should be promoted? 8 Finally, do regulators need to intervene to ensure that 9 market information is fairly priced? 10 Our purpose now is to examine this ambitious 11 agenda. Unfortunately, we have less than an hour-and-a-half 12 available to us to hear viewpoints from 13 highly informed 13 panelists. Accordingly, I'll be ruthless in allocating time. 14 I'll ask panelists to offer comments only when they can 15 introduce -- when they can introduce new ideas and 16 perspectives. We will measure success today not by our 17 ability to resolve these questions, but by whether we have 18 identified every important issue. 19 So let's start by asking what information is 20 necessary for traders to complete their trades? Wayne, you 21 had mentioned that you represent institutional investors. In 22 a post-decimal environment, is the best bid or offer that's 23 presently disseminated enough? 24 MR. WAGNER: The problem is the size associated 25 with that price, rather than the price itself, here. I mean, 1 the prices tend to be very quickly changing, which means that 2 there is a little bit of a problem of between the time you -- 3 you open your eyes and you -- and your first blink, the price 4 may have changed several times. But that's a fairly minor 5 problem. 6 The real problem is that it -- to my mind, that it 7 is -- there's -- what an institution will use the best bid 8 and offer for is -- is a sort of a voluntary means of 9 advertising interest in the -- I want to trade. It's a way 10 of placing an advertisement that says, "Come to me. I'm here 11 willing to trade on -- on this." 12 It's gotten very difficult for an institution to 13 make that kind of a statement, given the -- the ability to 14 move codes quickly at very low price ahead of that here. So 15 the quote I think means less than it did before, and the -- 16 and the question remains: Where is the liquidity? How do I 17 get to it? How do I get the -- find the other side, and how 18 do I message in order to be able to do that? 19 MR. HARRIS: Gus, are your traders getting all the 20 -- all the information that you believe that they need at 21 Vanguard? 22 MR. SAUTER: No. We believe that we need to see 23 the total book. And there are movements in certain venues to 24 provide that. We think it is important, not to see the BBO, 25 we need to see all the way up and down the book, both price 1 and size. We think we do need to see historical executions, 2 which obviously we do have access to at this point in time. 3 And we -- we also use historical best bid and offer, as well. 4 So the biggest piece of information we need at this 5 point is full transparency of the book. And that would be 6 consolidated across all markets. 7 MR. HARRIS: Are you willing to display orders into 8 a fully transparent book? 9 MR. SAUTER: With -- with appropriate protection on 10 those orders, absolutely. Limit orders, we would -- we 11 historically have been large users of limit orders. Under 12 the current conditions, in the penny environment, we have 13 pulled back a little bit from that. We do -- we do observe 14 limit orders being much smaller than they were just five 15 years ago, or even two years ago. And -- and part of that is 16 us pulling back a little bit away from limit orders. It's 17 now more advantageous, if you're doing floor trading, to use 18 a floor broker and -- and to hide. But we would be 19 absolutely willing to use more limit orders again if those 20 limit orders had protection. 21 MR. HARRIS: Let me turn now to retail investors. 22 And -- and, John, I'm going to ask you. In an environment 23 where the -- what's published as the national best bid or 24 offer, but where people often trade at better prices, are 25 retail traders getting all the information that they need to 1 make decisions? 2 MR. MARKESE: No, our average member holds 12 3 stocks and trades six times a year. I know there are day 4 traders out there. Declining species, probably. And there's 5 some people who thought they were day traders. But for the 6 average individual investor who's trading not particularly 7 often, the end national best bid or offer is a reasonable 8 benchmark, with the assumption that they can get, you know, 9 potential for price improvement. I would say the last 10 transaction is also important; obviously the last trade. 11 Are there -- are there investors willing to pay up 12 for better data or more data, more elaborate data? Of 13 course. But I think that is more than sufficient for their 14 trading, given the average investor. 15 MR. HARRIS: Dave, running an electronic trading 16 operation, you depend critically on market data. Are you 17 getting everything that you need? 18 MR. WHITCOMB: It depends on the market. In the -- 19 in the current NASDAQ market system, including the ECNs, we 20 get everything -- almost everything we need. We need more, 21 of course. But I think the important point is that the 22 structure of the market really determines a lot of these 23 issues. It determines whether the NBBO is meaningful, which 24 it is in a market where you have electronic trading 25 dominating, as -- as in the case in the NASDAQ market these 1 days. It's not in the listed market because of so-called 2 price improvement, which makes it unmeaningful. 3 Whether things like the deep book will be freely 4 given or given at marginal cost to investors again depends on 5 market structure. The ECNs typically give their entire deep 6 book free, both via websites and also by direct -- by a 7 direct transmission, again, because they don't have any 8 profit incentive for suppressing that information. In the 9 listed market, there's a strong profit incentive for 10 suppressing the information. The deep book that we now have 11 from the NYSE is only updated every ten seconds, which sounds 12 fast. But, in fact, for an electronic trader, it's a 13 lifetime. If that were really a real-time deep book, it 14 would convey more information. But that information would 15 hurt the interests of the specialists who have a pretty 16 important role in making the rules in that market. 17 So there's a tremendous linkage between whether -- 18 whether the markets are run on a pure profit-making basis or 19 whether they're a traditional SRO market, and the provision 20 of information. 21 MR. HARRIS: Now, Dave, would you have the New York 22 Stock Exchange provide that information? And if so, at what 23 price? 24 MR. WHITCOMB: If they were a private competitor in 25 the listed -- in the market for exchange services, I'll bet 1 they'd provide it free. They do provide the deep book that 2 they provide very, very cheap, but they don't update it as 3 often as I would like because it's not in the self-interest 4 of the specialists to let that information be out. 5 And, by the way, if people would look at that deep 6 book, they would see quotes on that book that are much better 7 than the transactions that are actually occurring. When you 8 send orders via Direct+, they execute at the NYSE quote, even 9 though there are limit orders on the deep book at the same 10 moment that are at better prices. That's again a problem of 11 market design. When you have a -- a free enterprise 12 electronic trading system, things like that don't happen 13 because they're not in -- in the profit interest of the 14 people who run the system. 15 MR. HARRIS: Rich, would you like to take an 16 opportunity to respond? 17 (Laughter.) 18 MR. BERNARD: Delighted. A couple of things. 19 First, on -- on the NYSE open book, which is our display 20 book, that ten seconds has nothing to do with specialists, 21 and everything to do with just a decision that was made about 22 the amount of data and the amount of data changes that we 23 were spewing out. And we would go to zero seconds if that 24 were proved to be the demand. You have to remember that that 25 is not an executable book. You want to execute against the 1 New York Stock Exchange, your general choice is to come 2 through Super DOT, NYSE Direct is a automated execution of 3 the best quote at the time it gets there. It's not a full 4 depth of market opportunity. And then just to speak to where 5 we're going, I -- we maybe filed, I can't remember, but we 6 are about to file, if we haven't, for the depth quote or the 7 dual quote or the liquidity quote, as -- as we've called it 8 in different incarnations. Remember that the New York Stock 9 Exchange is not just the book, it's also the trading 10 interests in the crowd, and it's the interest of the 11 specialists. Those interests will be rolled up into a single 12 depth quote at a -- a level that the specialist judges to be 13 a good place to reestablish what the institutional market is 14 looking for and -- and executable in -- in the regular way. 15 And for the point of information, because it has -- has 16 implications for capacity, just think a second that we were 17 quoting the inside quote, not five years ago, was at an 18 eighth. We now have inside quotes at pennies. That, as -- 19 as the institutions will tell you, that retail quote is not a 20 particularly useful piece of information if you're trying to 21 trade in size. 22 What we're going to be doing is going back and, in 23 effect, quoting at the eighth or whatever the right number is 24 for the depth quote, and then we will auto quoting (sic) the 25 real quote -- the realtime, the retail quote off of that 1 depth quote. But that does have profound capacity 2 implications, because it means that our retail quote will 3 change more often, it means that the markets that are machine 4 generating their retail quotes off of our retail quotes will 5 change more often, and God help the auctions exchanges who 6 are doing all the series that they do off that quote. So we 7 do have some capacity issues coming down the pike. 8 MR. HARRIS: Joel? 9 MR. HASBROUCK: Thank you, Larry. 10 I'd like to make two points. First, there's often 11 a presumption that the principle of transparency, more is 12 better, always renders visible that which was formerly 13 invisible. In fact, it changes the incentives. If you know 14 that one of your -- part of your trading interest is going to 15 be visible, it changes your incentives for putting it out 16 there in the first place. This ties into a point that Gus 17 Sauter made; namely, that the limit order books we have now 18 are much thinner. There seems to be less liquidity on them 19 than, well, of course, people would like, but also less 20 liquidity than many people suspect is really out there. 21 Now, the question is: Is this a consequence of the 22 visibility of these books, or a consequence of the inadequate 23 protection for the orders that reside on it? I know one 24 industry commentator has gone so far as to call it, "the 25 death of the limit order." Now, he's only exaggerating 1 slightly. What he means is that the old sense of the limit 2 order as being a provider of liquidity, much like a dealer, 3 has been replaced by the concept of the limit order as a 4 quick in-and-out sort of thing, something that can be 5 canceled within one second or two, and becomes almost more a 6 medium for negotiation, or an advertisement, than a true 7 provision of liquidity. 8 MR. HARRIS: Let's turn a little bit more towards 9 some regulatory issues, but not too far from where we've 10 been. The -- in the current regulatory environment, we 11 require that all markets deliver a certain amount of 12 information that goes into the formation of the best bidder 13 offer. The New York Stock Exchange and NASDAQ and others are 14 providing more information on a presumably value-added basis. 15 And so I'd like to ask: Where should the line be between 16 what is -- must be delivered to everybody, and what the 17 exchanges or the ECNs or dealers can retain and sell on a 18 proprietary basis, maybe. 19 Rick? 20 MR. KETCHUM: I think it's a very good question, 21 Larry. You know, there -- the great thing about truths are 22 that -- that you can say enough of them and -- and forget 23 that they -- they are relative vis-a-vis various different 24 points. The consolidated best bid and offer is not nearly as 25 valuable for active traders as it used to be. Just as John 1 indicated, it remains extremely valid -- valuable with 2 respect to monitoring the quality of the execution you 3 receive, and generally understanding and being able to 4 develop strategies to where the market is and where it's 5 moving. 6 And it is -- it has been the focus of SEC oversight 7 in this area, and a requirement from the standpoint of 8 consolidation of that information, it should be -- it should 9 continue to -- to be for a couple of reasons. One is that 10 it's still valuable and important for those reasons. 11 Secondly, unlike the montage of information that we proved, 12 either of quotes or now orders through SuperMontage or the 13 New York Stock Exchange provides, where we have enormous 14 incentives to be able to reach out and get as many people to 15 follow it as possible, both for them to feel good about our 16 market, to trade in our market, and also, frankly, to compete 17 from other people who collect orders. The consolidated best 18 bid and offer, because it's a reference price, essentially 19 everybody has to have, and it makes sense from that 20 standpoint to have a substantial amount of regulatory 21 oversight. 22 When you move away from that, I -- I'd say the last 23 couple of years are pretty clear indications, from how the 24 ECNs have made the information available to how NASDAQ makes 25 it available, we kind of -- we think it's a good idea to have 1 a depth quote, but we kind of think the best way to figure 2 that out is to have all the orders there and let you execute 3 against them. And -- and I think that there will be 4 continuing competition between markets, ECNs, and others who 5 collect orders, to make that information available as much as 6 possible. And the price will be impacted from that 7 standpoint. If I turn out to be wrong, the Commission will 8 always have authority to deal with market information with 9 respect to price, and be able to evaluate that. Although I'd 10 strongly urge that it start looking at it and recognizing 11 that we compete across categories, exchanges, ECNs, and 12 others, and that, therefore, that regulation should be very, 13 very light outside of the consolidated best bid and offer. 14 MR. RYAN: Just to add to that, I think Rick's 15 right about the Commission stepping in too -- too far and 16 hard into the area of market data in terms of getting away 17 from the national best bid and offer. I think that a 18 consolidated NBBO is going to continue to be important. I 19 think the Commission should look at the -- the depth of book 20 issue and providing that, the way that that's provided, and 21 look at certain -- at certain areas; for example, any anti- 22 competitive practices along those lines. 23 But beyond that, I think the Commission should 24 really focus on the NBBO and how that's handled, and how 25 market data revenue is distributed, and the -- and the impact 1 that that has on all investors in getting information out in 2 a -- in a timely manner, making sure that the information and 3 the systems that support that information, whether it's a -- 4 whether they're regulatory systems or technology systems or 5 competitive practices where markets try to differentiate 6 themselves from one another, and how that revenue is -- is 7 used in supporting that -- that infrastructure. But let 8 competitive forces deal with depth of book type of issues. 9 MR. HARRIS: Gus, please. 10 MR. SAUTER: Yeah, Larry, you mentioned whether or 11 not information should be restricted to only certain market 12 participants, and -- and not made available to all. I -- I 13 believe that would be inappropriate. I believe that, again 14 with -- using the principle that ultimately the market should 15 be designed in the interest of investors, then all 16 information should be available to investors. Making 17 information available only to certain financial 18 intermediaries necessarily gives them an advantage over the 19 investor. It may make them participate in certain situations 20 where they would not, but I do believe it's -- it's 21 definitely to the disadvantage of investors by giving certain 22 intermediaries information not available to all. 23 MR. HARRIS: Gus, would you like the SEC to require 24 all markets to deliver up enough limit order information that 25 they could create an analog to the NBBO, a consolidated book? 1 2 MR. SAUTER: We would love to see a consolidated 3 book. If we have a large execution, we would love to know 4 how far down that book we need to go to execute it all 5 immediately. We may then decide to sweep the, you know, 6 mythical consolidated book, or we may decide to execute in 7 smaller pieces, depending on how far down the book we would 8 need to go. But being able to determine the true liquidity 9 actually out there would great enhance our ability to trade. 10 MR. HARRIS: Now, can you get that without our 11 intervention? 12 MR. SAUTER: Data vendors do compile a lot of this 13 information and consolidate it for us. So we -- as -- as 14 various venues have opened up their books and made them 15 available for full viewing, we are getting more and more 16 transparency. We need to continue to do so, and make sure 17 that, one way or another, investors or institutions---the 18 "buy" side, if you will---has access to all of the data 19 available, whether it's aggregated by their vendors or 20 provided some other means. But it's important that the 21 complete book of every venue is -- is distributed. 22 MR. HARRIS: Larry? 23 MR. LEIBOWITZ: Yeah. I would say from -- from our 24 standpoint, and -- and with deference to John, while the NBBO 25 is -- is an interesting indication, I can tell you from the 1 number of call center calls that we get every day from 2 confused investors about flickering quotes that they can't 3 see, and about not being able to see what's really going on 4 in the market, that it does have a major impact on -- on 5 confidence in what's going on in the market. 6 I also think that we've got to get out of this 7 notion that this data belongs to the exchanges or belongs to 8 a market center. As you said in your opening remarks, in the 9 old days we used to give our data to the exchanges and then 10 have to buy it right back. Well, now, in some markets, we 11 actually have to pay to provide our data to the -- to the 12 market, and then have to buy it back. But the reality is, 13 while the vendors can compete, if the initial providers of 14 the data are allowed to have a monopoly pricing or monopoly 15 control of what they do with that data, it makes -- makes for 16 an inefficient market and an unfair market. 17 MR. HARRIS: Well, many people have spoken in favor 18 of competition. Why won't competition work here? Couple of 19 folks. 20 Ed? Want to answer the former question first? 21 MR. NICOLL: Right. Yeah. The first question -- 22 the first answer is you have an inherent conflict in the 23 Vendor Display Rule in which you require this consolidated 24 information, and as soon as you require it, that confers 25 monopoly power on the people who distribute it. If -- if one 1 particular market center, who may or may not -- who may or 2 may -- where demand in a free market otherwise might not 3 exist, is required -- you are required to purchase that 4 information from them, you're conferring certain powers on 5 them to sell that information. 6 And then you're essentially creating, I believe, as 7 an obligation on your part, to regulate, you know, how much 8 that is charged. Obviously, if you didn't regulate that, 9 there wasn't some sense of what a reasonable charge was, then 10 you would be conferring almost unlimited economic power on 11 that particular entity. So the Vendor Display Rule, as of 12 itself, is a -- is a real tension in that. 13 I want to, if I just could, just sort of tease out 14 some of the -- the conflicts that sort of Gus intentionally 15 or unintentionally indicated in -- in his viewpoint. I mean, 16 what we all should understand is that what everybody wants 17 is, everybody wants everybody else to display their 18 intentions to trade, without themselves being required to 19 display their own intentions to trade. 20 So you've got -- a particular example here, where 21 Gus is talking about, well, what I want is I want everybody's 22 -- I want a display of everybody's intentions to trade, and I 23 will sweep the book. Okay? Well, why isn't he out there 24 displaying the fact that he wants to purchase or sell 100,000 25 or 500,000 shares of a particular entity? Why does he get to 1 decide, and step back and hide his intention to trade, while 2 he views everybody else's displayed intentions to trade, and 3 choose to effect the option, the free option, in effect, that 4 he's being given by hiding his intentions. 5 Now, that intention to trade, we cannot regulate 6 that. We can only regulate that down so far. We can't go to 7 every individual and every institution in the United States 8 today and say, "Anytime you're thinking about trading, you're 9 required to raise your hand and say, 'I'm -- I have an 10 intention to trade here.'" And there is this inherent 11 tension between when we require people to display their 12 intentions to trade and when we don't. And in designing the 13 -- the market structure system, we have to be very cognizant 14 of the fact that if we overregulate and put a -- you know, 15 and take a -- what I would describe as a naive view of -- of 16 limit orders, then we may be setting up a situation in which 17 you have less transparency and less liquidity than you 18 otherwise would have. 19 MR. HARRIS: Gary had a hand up as well. 20 MR. GASTINEAU: Couple of comments. One relates to 21 something that -- that Joel had said in terms of the 22 protection of the orders. Gus's comment, as well. If you 23 provide for limit orders that are hidden, perhaps not on the 24 primary market, but perhaps on a competitive market, that's 25 an interesting way in which markets could compete. You have 1 a limit order book, but you also know that in some markets, 2 behind the posted market, there might be another 1000 or 3 million shares waiting to be done at that price. And if Gus 4 decided to hit the book at a certain thing, he may be 5 surprised to find that he's filled at the national best bid 6 and offer on a million share trade. I wouldn't want to bet 7 on that, but, you know, things like that could happen. 8 But the point is you need to have the ability to 9 innovate, and that's one of the places where the transparency 10 argument falls down, because it's clearly in the best 11 interest of all investors to permit some kind of hidden 12 orders, particularly for a large investor who at this point 13 is fairly significantly disadvantaged in terms of the way the 14 market structure works. The NBBO is great for John's people, 15 but doesn't work at all for Gus. 16 MR. HARRIS: My sense is that at issue here is not 17 whether we will compel people to display orders, but rather 18 whether we will aggregate orders that are -- or aggregate 19 displays across markets. So, while the comments are well 20 taken, I don't think that's the market data issue that 21 presently presents us. 22 Rich, I -- did you want to speak to the question of 23 independence of pricing? I thought I saw a glimmer in your 24 eye. 25 MR. BERNARD: Well, I've got many items. I just 1 wanted to speak on this issue of displaying away from the -- 2 the inside quote. I completely agree with Rick, and -- and 3 it's where the Seligman committee came out, which is that the 4 market is doing a pretty good job of having people come 5 forward with depth of market information. We have to 6 remember that the institutional market is not spread all over 7 the score, so markets that are -- are competing here, by and 8 large, the -- that interest is represented in New York, 9 NASDAQ, Instinet, and a few other places. And those markets, 10 in fact, are and in some cases have been for many years 11 displaying their -- their depth of market information. So I 12 don't -- I don't see a case for Commission regulation beyond 13 the -- the sort of light once-over that Rick was talking 14 about. 15 If I could come a little bit to pricing and -- and 16 a comment that -- that Larry said, you know, we -- when we 17 got to the Seligman committee we had a -- it was a 15 to 8 18 vote for getting rid of consortia. And if you had gotten -- 19 and there's a lot of reasons for that. 20 Secondly, which we really haven't gotten to yet, 21 but we need to. The current system of giving a franchise to 22 any exchange in the country to jump into the consolidated 23 data stream, that is what's causing the -- the subsidies, 24 that's what's causing the rebates, and that's what's funding 25 much of the payment for order flow, now that the spread 1 doesn't support it anymore. And I hope we're going to get to 2 those issues. 3 MR. HARRIS: Well, we most certainly will. Let's 4 -- why don't we turn to them now. There are about $400 5 million that are being collected through the consortia right 6 now. If anybody had any doubt as to the importance of the 7 national best bid or offer, despite the criticisms displayed 8 here, they certainly are worth at least $400 million to 9 participants. Many folks, though, believe that that data is 10 really theirs, and they wonder why they have to pay for it. 11 And I was wondering whether anyone wanted to speak to -- to 12 that point of view. 13 Larry? 14 MR. LEIBOWITZ: Yeah. I mean, I think it's clear, 15 when you -- when you look at the arbitrage that's going on, 16 particularly prior to the abrogation of -- of tape revenue 17 sharing, that there's an awful lot of money there to be 18 spread around. And what we wonder is why that isn't going 19 back to the investors. 20 Now, at least with tape revenue sharing, that was 21 an indirect way to get money back to people who were trading. 22 So, in some senses, maybe there's some fairness there. But 23 the reality is that clearly there's a lot of money there, and 24 -- and how do we ensure competition to either make that 25 distributed to the proper people, or make that pot smaller? 1 Because I think what we've done is, we've intermingled the 2 different reasons and uses of that money, whether it be 3 incentives to people to trade on their exchanges, or paying 4 for operating costs for exchanges, it's not doing what it was 5 intended to do. 6 MR. HARRIS: Michael? 7 MR. RYAN: Yeah. I think this is probably the most 8 important issue when it comes to market data, in terms of 9 what we -- what we do with that -- the revenue that we 10 receive. And for a long time, the system, I think, has 11 probably worked fairly well, although increasingly that's 12 been less true in terms of the way that revenue is 13 distributed among market participants in simply -- in the 14 listed side on -- based on trades. 15 And we just submitted to the CTA participants on 16 Friday, and began distributing to the Commission yesterday, a 17 proposal to amend the CTA plan that would really shift in a 18 significant way and say that market data revenue really 19 should be distributed among the exchanges that are providing 20 quality markets, so that there would be -- the proposal we're 21 putting forth would say that revenue should be distributed in 22 part on trades, in part on share volume, and also in part on 23 the national best bid and offer. And we've put some quality 24 parameters around the way that would work so that just 25 putting up a quote doesn't -- doesn't get you credit. It 1 would have to be a quote that would be up for some time, and 2 the greater the size, we give you even more credit. And we 3 believe that that's the -- that those types of incentives 4 should be put in the marketplace. 5 A little bit off the topic, but we -- to get to the 6 ownership issue, we think that the Commission should look 7 real hard at the current environment for exchange regulation, 8 and abolish Regulation ATS, relook at the -- and modernize 9 the way exchanges are -- are regulated, so that it is easier 10 for other markets to become exchanges, but once you cross 11 over from a broker-dealer into an exchange world, your -- 12 there's similar fair regulation, even regulation, that the 13 regulatory environment is focused on what is important, not 14 -- not the solutions. I think Rick mentioned earlier today 15 that solutions 20 years ago may have been good and worked 16 then, but they don't necessarily matter anymore. And the 17 Commission should take a real hard look at what -- what 18 they're focusing on, and that the exchanges should -- the 19 market data is really the critical output of the operation of 20 a marketplace, operation of an exchange. And that I think 21 that the exchanges and markets should be compensated for 22 that, and they should be compensated on the quality of the 23 job that they do. 24 COMMISSIONER PITT: Let me ask a very sort of basic 25 question, which is: Why should there be any revenues at all? 1 If IBM, AT&T, and others have to report on what the results 2 of their operations are, they don't charge anyone for that 3 information. Why is there a fee associated with market data 4 for transactions that are executed in public securities in a 5 public market? 6 MR. RYAN: Oh, I think, quite simply, that is -- I 7 mean, IBM is compensated for the output of what they do as an 8 organization, and that -- and any organization should be 9 compensated for their output. And that is one of the outputs 10 of operating a marketplace. And we -- and we, the markets, 11 should be compensated fairly and reasonably for that. And we 12 think that the process, by and large, has worked very well. 13 We think that the process of having the rate set by the 14 exchanges initially, which are required to have public 15 members upstairs and floor members on their boards in 16 analyzing that, it goes out -- then out for public comment 17 before the rates are approved, so there's plenty of 18 opportunity for the -- for the public in a variety of arenas 19 to address. And then the Commission has to approve it, 20 finding that it's consistent with the Act. And that the -- 21 the -- going back to what I said earlier, the distribution of 22 the revenues should be based on market quality. 23 The other two components that I would add to that 24 is that -- that no -- no market center should get credit for 25 trades or quotes coming from a market participant when that 1 market participant isn't fully participating in the National 2 Market System. That we really should focus on what it means 3 to be a National Market System, and -- and create incentives 4 to -- to add value to that process. 5 And the other piece, going back to what a number of 6 people have said, is that ending markets paying for order 7 flow, whether they're using market data revenues or 8 otherwise, and focus on providing quality markets and 9 efficient markets. 10 COMMISSIONER PITT: Yeah. With -- with due 11 respect, I don't know whether that answers the fundamental 12 issue. 13 COMMISSIONER GLASSMAN: Can I -- can I just follow 14 up on that question? 15 MR. HARRIS: Sure. 16 COMMISSIONER GLASSMAN: What would happen if there 17 were no payment? How would the market evolve? What would 18 change? 19 MR. RYAN: Well, I think if you -- if you go and 20 put into place the process that we're proposing in terms of 21 market quality, market centers would evolve, exchanges would 22 evolve that are providing value added services, better 23 quotes, you know, better transaction reports, because that's 24 what they're -- that's the way they get credit for providing 25 market data. And there would be incentives to develop 1 innovative trading systems, quotation methodologies, and 2 products that would allow them to earn greater market data 3 revenue. 4 MR. HARRIS: It would appear that we've touched 5 some interesting controversies. Let's go -- Bernie, Rich, 6 and Rick, and then David, and we'll see how we -- let's see 7 if we run out of new ideas. 8 MR. MADOFF: I think the Chairman is -- is breaking 9 the rule. You've asked a simple question and you want a 10 simple answer. 11 CHAIRMAN PITT: No, I'll take any answer. I just 12 want it to be direct. 13 (Laughter.) 14 MR. MADOFF: I'll try to give you a direct answer. 15 That's the way it was. I think that there was this -- going 16 back as long as I can remember, there was this revenue pool 17 that was generated from the information. The exchanges 18 needed a funding process, whether it be for regulation or to 19 -- to run their businesses, and this was a convenient pool 20 that they were the only ones at that time that were able to 21 -- to put it -- put it together, and then said this was a 22 valuable -- a valuable commodity. 23 I think the problem that we all faced in -- on the 24 Seligman committee that I had the misfortune of participating 25 in... 1 (Laughter.) 2 MR. MADOFF: ...was that it really boils down to a 3 -- an allocation process. And there were people who felt 4 that there was no way of reconciling a checkbook, so to 5 speak. That there were these -- these funds were being used 6 for -- for all valid purposes, but nobody could really get 7 their arms around saying, "Give me a reconciliation. Tell me 8 how much money is spent for regulation, how much is being 9 spent for other issues." 10 So I -- my -- I would answer your question, is that 11 theoretically you could stop charging or -- or taking this 12 market data and giving it to the exchanges, and come up with 13 some other way of funding the -- their various operations. 14 It's just something that no one has even -- in my -- in my 15 memory, has attempted to do it. But I don't think there is a 16 -- I think the question you're searching for is -- is not out 17 there, because it's just never been attempted in the past. 18 MR. BERNARD: Let me build on Bernie's comments and 19 -- and also Michael's. Remember Merrill Lynch or Schwab 20 could sell their orders for their data content, and -- and I 21 would have no objection to doing that, but they're not very 22 interesting until they interact with other orders, other 23 interests, either to generate the quote and know where that 24 order stands in the queue, to generate the book, or to 25 generate an execution. That's all work done by the stock 1 exchanges. 2 So that the first answer to your question, and I'm 3 not -- you know, this isn't a legal answer, but I can give -- 4 I can cite you to the Supreme Court cases. But the point is 5 that there is work done when you produce executions and -- 6 and market data jointly, which is what exchanges do. 7 The second part of your answer which Bernie touched 8 on, and I'll use the New York Stock Exchange as -- as the 9 example. Round numbers, it costs $800 million a year to run 10 the Ne