1 1 BEFORE THE SECURITIES AND EXCHANGE COMMISSION 2 -----------------------------------x 3 HEARING RE: REVISED: 5/03/04 4 PROPOSED REGULATION NMS File No. S7-10-04 5 -----------------------------------x 6 InterContinental The Barclay New York 7 111 East 48th Street 8 New York, New York 9 April 21, 2004 10 9:01 a.m. 11 COMMISSIONERS: 12 WILLIAM H. DONALDSON, Chairman 13 PAUL ATKINS 14 CYNTHIA A. GLASSMAN 15 HARVEY GOLDSCHMID 16 ROEL CAMPOS 17 ANNETTE L. NAZARETH, Director 18 Division of Market Regulation 19 ROBERT L.D. COLBY, Deputy Director 20 Division of Market Regulation 21 JONATHAN G. KATZ, Secretary 22 23 24 Diversified Reporting Services, Inc. 25 (202) 467-9200 2 1 P-R-O-C-E-E-D-I-N-G-S 2 MR. DONALDSON: Good morning. There's a ring to 3 that "good morning," everyone. We are missing Commissioner 4 Campos so we'll wait for just a second while we're waiting 5 for him to arrive. Let me just introduce my fellow 6 commissioners, on my right, Commissioner Glassman, on my 7 left, Commissioner Goldschmid, Commissioner Atkins, and 8 Commissioner Campos hopefully to arrive momentarily. 9 Let me begin by saying, on behalf of the Securities 10 and Exchange Commission, I'd like to welcome our panelists 11 and I particularly want to thank you all in advance for your 12 participation at today's hearing on Regulation NMS. Reg NMS 13 was proposed by the Commission for comment in February and 14 the aim is to modernize the regulatory framework of the 15 National Market System. 16 I also want to welcome members of the public and 17 other interested parties to today's hearing. Although the 18 format of the hearing restricts participation and discussion 19 to the panelists, it is our hope that the proceedings will 20 inform and stimulate observation and questions by all who are 21 attending today. We hope, too, we'll have the full benefit 22 of your thoughts via written submissions during the formal 23 comment period and through ongoing discussions and 24 consultations. 25 The National Market System was mandated, as many of 3 1 you know, by Congress in 1975 and laid the foundation for 2 competition among markets trading the same securities, while 3 preserving wherever possible and practical the benefits of 4 orderly interaction and price competition. The National 5 Market System relies on, one, public display of firm 6 accessible quotations in a consistent format; two, the 7 immediate display of orders to trade at or better than a 8 specified price, commonly known as a limit order; three, 9 consolidated publication of market quotation and trade data 10 in a form that is both reliable and widely available; four, 11 linkages between markets trading the same securities in order 12 to foster efficiency and competition; and, five, in the 13 exchange markets, rules that are designed to ensure that the 14 best quote is honored before trades are executed at inferior 15 prices. 16 In general, our system of multiple competing 17 markets has worked remarkably well. Our markets are among 18 the world's most competitive and efficient. Competition 19 among markets has fostered technological innovation and the 20 creation of trading platforms and order routing systems that 21 address the needs of all types of investors, regardless of 22 size and sophistication. Investor participation in the 23 markets has exploded in the last decade. 24 Over the past decade, however, there have been 25 significant developments in our markets that threaten to 4 1 erode the efficient functioning of our National Market System 2 regulatory structure. Advances in technology and trading 3 have led to the development of new alternative trading 4 venues, particularly ECNs. Their instantaneous electronic 5 capabilities often do not interact seamlessly with 6 floor-based exchanges and vice-versa. 7 The number of trading venues has increased, and it 8 has become more and more complicated and costly to access 9 them, as some market centers charge fees to access liquidity. 10 These fees not only raise trading costs, but also cause 11 identical published quotations to reflect significantly 12 different true prices. 13 Revenue from the dissemination of market data has 14 become a significant funding source for SROs, giving them 15 powerful incentives to maximize reported trade volume. In 16 turn, the structure of these incentives has produced 17 problematic practices, such as so-called "wash trades" and 18 "shredding," as ways to generate more "tape prints" and thus 19 more market data revenue. 20 The growth in subpenny trading has increased the 21 risk that trivial quote increments will be used to step ahead 22 of limit orders. Limit orders have already been discouraged 23 by decimalization, and the opportunities to "step ahead" of 24 the trade increase geometrically in a subpenny environment. 25 Regulation NMS as currently proposed grew out of 5 1 considerable preliminary fact-finding efforts and extensive 2 discussions with industry participants and represents the 3 critical next step toward the resolution of these issues. In 4 brief, the regulation in its current form is designed to 5 encourage honoring the best price between markets by 6 establishing a uniform trade-through rule for both exchange 7 and NASDAQ listed securities, with proposed exceptions for 8 slow markets and informed investor opt-outs. It seeks to 9 address the issues of efficient access between markets and 10 inconsistent quote prices by establishing a uniform market 11 center access rule with a de minimis fee standard. It 12 proposes to ban the display of subpenny quotes in most 13 stocks. And it would alter the rules concerning how market 14 data is disseminated and priced. 15 Regulation NMS was intended to advance the 16 discussion by setting forth concrete proposals and then 17 subjecting them to wide-ranging questions and critique. 18 While its publication was a critical step, focusing public 19 comments on these critical market structures, I want to 20 emphasize that the Commission has in no way reached any final 21 decision on any of the proposals' provisions. We are fully 22 aware that these rules are complex and may have consequences 23 not contemplated by the drafters of the proposals. 24 The purpose of this hearing is to broaden the 25 dialogue with respect to our proposals. We intend to use 6 1 this opportunity to probe your responses and ensure that we 2 understand the informed, analytical and factual underpinnings 3 of your observation. We will use this hearing, the written 4 comments that we have already received, the comments we will 5 receive subsequent to the hearing, and the results of a 6 continuing process of consultation, to obtain insights to 7 help us determine whether to adopt or modify the Regulation 8 NMS proposal. 9 To say that market structure issues are complex and 10 controversial is an understatement, to say the least. So the 11 perspectives of the market participants here today and those 12 who submit comments to the Commission are vital to assess the 13 impact of the choices implicit in these proposals. The 14 efficient functioning of our capital markets has intense 15 public policy aspects. For example, the advantage obtained 16 by some market participants at the expense of another subset 17 of participants must be balanced against public policy 18 mandates of fairness to all and not just those directly 19 involved in a particular transaction. 20 So I would ask that you put on your public policy 21 hats for today's hearing. You can help the Commission by 22 putting yourself in our shoes. You can help us by 23 identifying public policy goods that can be achieved by 24 enacting the right and appropriate market structure rule 25 proposal. 7 1 With the reminder that there will be plenty of 2 opportunity during the comment period to assess the fairness 3 of the economic impact of these proposals on certain industry 4 participants, I would ask that in your responses today, you 5 try to put aside your institutional interests, your biases, 6 and even your current business models. I would ask that you 7 set time-worn and all-too-familiar rhetoric to the side and, 8 instead, give us the benefit of your frank and succinct 9 insights about how the proposals and the alternatives to the 10 proposals would serve our capital markets and the investing 11 public from a public policy perspective. 12 With that opening plea or prayer, I believe the 13 time for considering market structure issues is now, and I 14 very much look forward to delving deeply into the issues 15 during today's hearing. 16 Commissioner Campos has arrived. Welcome. So why 17 don't we begin. 18 Annette Nazareth, who heads our Division of Market 19 Regulation, will have a few words to say. 20 MS. NAZARETH: Thank you, Bill. I would like to 21 thank all of our panelists, who so generously agreed to 22 participate today in these proceedings. As you know, we have 23 a very ambitious agenda. We have seven panels and we expect 24 to go to about five-thirty. Each panel is designed to 25 address a specific element of proposed Regulation NMS. 8 1 The first two panels will address the trade-through 2 proposal which, as you undoubtedly know, has engendered 3 perhaps the greatest amount of controversy of the proposals. 4 We look forward to a very constructive dialogue on those 5 issues. 6 I thought I'd very briefly summarize the proposal 7 for you and then introduce our panel. The trade-through 8 proposal would require any market center that executes orders 9 to establish policies and procedures reasonably designed to 10 prevent a trade-through, which is the execution of any 11 incoming order for a security at a price that is inferior to 12 the best price displayed in another market. The 13 trade-through proposal would apply to both exchange listed 14 and NASDAQ securities. 15 At the same time, the proposal would include two 16 important exceptions that are designed to accommodate market 17 centers with different market structures. First, a customer, 18 or a broker/dealer acting for its own account, would be able 19 to consent on an order-by-order basis to having its order 20 executed in one market, without regard to the prices in 21 another market. This exception is designed to provide 22 greater flexibility to informed traders while preserving the 23 average customer's expectation of having his or her orders 24 executed at the best price. 25 Second, an automated market, one that provides for 9 1 an immediate automated response to incoming orders for up to 2 the full size of the best displayed bid or offer without 3 restriction, will be able to trade through a better displayed 4 price on a non-automated market up to a certain amount that 5 would reflect to the greatest extent possible the cost of 6 attempting to access the other market. 7 This exception was designed to reflect the 8 comparative difficulty of accessing market quotes from 9 non-automated markets and to enhance the ability of 10 individual markets to compete fairly with each other. 11 Overall, the proposal is designed to be a practical 12 response to the current criticisms and changes in the 13 marketplace while still maintaining and indeed enhancing the 14 important customer and market integrity goals of best 15 execution and the protection of limit orders. 16 So with that brief introduction, I would like to 17 introduce our panel. I can assure you that they look much 18 better from this angle than the angle that you all are 19 seeing. 20 First on my far left is John Thain, who is the 21 chief executive officer of the New York Stock Exchange; next 22 to John is Bob Greifeld, who is president and CEO of The 23 NASDAQ Stock Market. Next, we have Scott DeSano, who is the 24 head of the equity trading department at Fidelity 25 Investments, then Ed Nicoll, the CEO of Instinet Group; next 10 1 Bob Steel, the vice-chairman of Goldman Sachs and who serves 2 as co-chair of the market structure committee of SIA and we 3 have Ivan Freeman, who is the chief operating officer, 4 institutional equities of Morgan Stanley and, last but not 5 least, Gus Sauter, who is chief investment officer of 6 Vanguard Group. 7 We've agreed prior to these proceedings that in the 8 interests of time, we were not -- we were going to dispense 9 with prepared statements. If any of the panelists have 10 prepared statements that they would like to introduce in the 11 record, we would be happy to do that but we do want to get 12 right on with the debate. 13 Generally, the discussion of the trade-through rule 14 and the questions that we want to address will fall into 15 three general categories, the first being, is there really a 16 need for a trade-through rule; the second being, is there a 17 need for an opt-out and the third, would you need an opt-out 18 if all markets were sufficiently -- provided for automated 19 execution. 20 So I wanted to start with the first group of 21 questions that go to the need for the trade-through rule, and 22 we'll go in order. Again, in the interests of time, I guess 23 if we could limit our initial remarks to two or three 24 minutes, that would be very helpful. 25 So the first questions are, are there any benefits 11 1 from an intermarket trade-through rule beyond those that are 2 produced by the duty of best execution and investor interest, 3 would an intermarket trade-through rule encourage the display 4 of limit orders and would it make it more likely that such 5 orders receive the best price? And we'll start with John 6 Thain. 7 MR. THAIN: Thank you. Good morning. Mr. 8 Chairman, Commissioners, Annette, Bob, and other members of 9 the Commission. Thank you for the opportunity to be here 10 today. 11 The New York Stock Exchange is the largest and most 12 liquid equity market in the world. And one of its 13 fundamental tenets is that orders are executed at the best 14 price. A trade-through rule ensures that all investors, 15 minnows or sharks, get that best price. And investors who 16 provide liquidity to the market by entering limit orders are 17 protected from their orders not being ignored. 18 Individual investors, who unfortunately are not 19 represented here today, overwhelmingly view price as the most 20 important factor when they are executing trades in the 21 marketplace. The trade-through rule encourages markets to 22 compete by offering the best prices. 23 Weakening the trade-through rule, particularly 24 allowing certain investors to opt out of the trade-through 25 rule, will undermine investor confidence and reduce liquidity 12 1 in the marketplace. The investor who provides liquidity to 2 the market by entering the best bid or best offer is not 3 being asked if he or she wants to opt out, and that's the 4 person who the trade-through rule was originally designed to 5 protect. The prices at which trades are reported if the 6 trade-through rule was weakened or people were allowed to opt 7 out, would not reflect the true best prices available in the 8 marketplace, undermining confidence in the reported prices. 9 And allowing trade-throughs will increase internalization of 10 order flow and fragmentation of the marketplace. 11 I believe, Mr. Chairman, as you said, that the 12 interests of America's investing public must come first 13 before the interests of certain large institutional investors 14 or certain proprietary trading venues. Weakening the 15 trade-through rule, particularly the opt-out provision, is 16 not in the best interests of U.S. and global investors, be 17 they minnows or sharks. Thank you. 18 MS. NAZARETH: Thank you. Bob Greifeld? 19 MR. GREIFELD: This trade-through proposal has 20 certainly received more publicity and created more 21 self-appointed experts than those of us who work in the 22 industry could reasonably imagine. But if we attempt to 23 reduce this issue to its essence, we realize that the heart 24 of the matter is, what is the best protection for investors? 25 The best protection for investors is best execution. 13 1 I remember reading in 1993 the Commission's 2 payment-for-order-flow release that defined best execution in 3 terms in addition to price. The Commission specified that 4 liquidity, cost, price impact, accessibility and certainty 5 were other important factors in determining best execution. 6 At that time, I was attempting to build a business 7 with a trade order management system called Brass. And I 8 recognized that incorporating best execution features into 9 that trade order management system was a good business 10 opportunity. It was good for my business, but it was most 11 importantly good for investors. 12 Now, NASDAQ has operated without a trade-through 13 rule for its entire history. The NASDAQ Stock Market is 14 governed by the principle of best execution. 15 If we look at The NASDAQ Stock Market in its two 16 hundred most actively traded stocks, we have a spread of one 17 cent. Our minimum price variation is one cent. We cannot do 18 any better. These narrow spreads mean that we have vigorous 19 limit order competition in our market. The market orders in 20 The NASDAQ Stock Market are the beneficiaries of this 21 vigorous limit order competition. 22 Reg NMS represents a bold step forward by the 23 Commission and as we contemplate the impact, we should be 24 guided by the principles that first, we should not fix what 25 is not broken, and two, let's ensure that we do no harm. We 14 1 understand the desirability for uniformity in the U.S. equity 2 market and we support the Commission's effort with respect to 3 Reg NMS. We believe that careful implementation of a fast 4 market definition with an opt-out provision will enable the 5 NASDAQ market to suffer no harm. We do state, however, that 6 the failure of this Commission to adopt the opt-out rule is a 7 denial of the full benefits of best execution as the 8 governing force in our markets. 9 We believe that the government should only be 10 involved where the government must be involved. The 11 definition of a fast market by the Commission should be a 12 two-paragraph description that mandates automated response 13 and automated update. The investors should determine the 14 finer points of fast. How do we allow the investors to 15 determine the finer points of fast and how do we allow the 16 investors to achieve best execution according to their 17 investment objectives? 18 The opt-out clause allows investors to opt in, to 19 choose which attributes of best execution are important to 20 them for that transaction. The opt-out clause allows 21 investors to opt in to their definition of fast. 22 Without the opt-out clause, best execution is 23 reduced to a single dimension of a concept of price. Our 24 industry's concept of best execution is derived from common 25 law agency principles and fiduciary obligations. Best 15 1 execution is truly a flexible concept that meets the needs of 2 customers under diverse circumstances. Reg NMS is about 3 modernizing our equity markets. Reg NMS is not about rolling 4 back carefully evolved principles that govern many diverse 5 industries in our country. I urge the Commission not to put 6 the concept of best execution in a straitjacket. Thank you. 7 MS. NAZARETH: Scott? 8 MR. DeSANO: It's better to be called a shark than 9 an eight-hundred-pound gorilla. 10 Well, our view on trade-through is a very simple 11 one, I think, and I would contend that we don't have an 12 effective trade-through rule today and would echo a lot of 13 the things that Bob just mentioned with respect to the fact, 14 how NASDAQ has worked without a trade-through rule for all 15 time. 16 There's concern about limit orders out there if we 17 don't have trade-through rules. And I will assure you that 18 we as an institution are more apt to put limit orders on 19 NASDAQ than we are on other exchanges and we are not 20 concerned whatsoever with there not being a trade-through 21 rule. We're a fiduciary and we are charged with doing the 22 best job possible for our shareholders each and every day. 23 That is the best all-in price that we can achieve 24 for our shareholders, not the best individual price. Walking 25 a stock up or down is a painful process, trying to achieve 16 1 execution of large orders. If we have the opportunity to see 2 and capture liquidity at a price two, three, four cents away, 3 but it completes our order, that's a much more effective way 4 for us to do our transacting. 5 Our fiduciary responsibility should allow us to 6 have the ability to make decisions to go where we want, when 7 we want, how we choose to. Investors act in their own 8 economic self-interest all the time. They don't need to be 9 instructed to do so. We were going to get to the opt-out on 10 the next go-around, but the simple fact is we don't see the 11 need for a trade-through rule, we think that it works just 12 fine without one on NASDAQ now and we're about choice. 13 MS. NAZARETH: Ed? 14 MR. NICOLL: In trying to answer the question 15 without referring to our other rhetoric, I think the -- one 16 of the things that I think the Commissioners have to be very 17 cognizant of is that the trade-through rule is not -- does 18 not give people priority for their limit orders, in the sense 19 that it allows -- the trade-through rule allows 20 internalization by all parties cap the limit order. 21 So if the New York Stock Exchange, for instance, an 22 order goes down there and establishes -- a limit order is 23 displayed on the New York Stock Exchange, the rule is that 24 people can trade through it. The rule is not that people 25 have to hit that limit order, because there's no time 17 1 priority. There's price priority but not intermarket time 2 priority. 3 So what we are allowing is parasitic behavior at 4 the price. We are allowing competition at the price. But 5 somehow, we're concerned about the very few exceptions where 6 one market center might want to trade through another by a 7 few pennies. And it seems to me that the notion that some 8 put forth in which they conflate the duty of best execution 9 with the trade-through rule, that somehow, supporting the 10 trade-through rule is about protecting people's limit orders, 11 is disingenuous unless they take the view, which very few 12 people do, that those limit orders have to be respected both 13 from a time-priority basis and a price-priority basis. 14 And there's, I think, as far as I know, only one 15 person on this panel who actually advocates that, at least 16 it's a consistent, in my view, philosophical point of view. 17 If you are concerned -- the real issue here, and some imply 18 that what the trade-through rule protects is the person who 19 placed the limit order, then we ought not allow people to 20 match that limit order in competing venues. Yet we do all 21 the time, and we allow that kind of internalization to take 22 place between competing venues. 23 In our view, you get very little benefit from the 24 trade-through rule and yet you get a lot of harm. You are 25 disincentivizing competition. You are allowing markets that 18 1 can manipulate their best advertised price to effectively 2 freeze out other markets that are pure agency marketplaces. 3 There's a lot of cost to the trade-through rule, and we 4 believe there's extremely little benefit. 5 And for those who advocate the rhetoric that the 6 trade-through rule is about protecting limit orders, let them 7 totally protect limit orders and advocate a time priority as 8 well as price priority. Yet they don't do that. 9 I think that, you know, our view is that the 10 opt-out is a reasonable compromise between the two views. 11 It's a moderate and very modest exception to the 12 trade-through rule. We've seen this kind of modest proposal 13 work in the past with respect to the three cent de minimis 14 exception for the ETFs that has been very successful. Of 15 course, I think it's well known that we would favor total 16 competition between market venues and let investors and 17 traders choose how to execute their orders. 18 But given where we come from and the market 19 structure, we think that the opt out is an important but 20 modest improvement to the current regulatory environment. 21 MS. NAZARETH: Bob? 22 MR. STEEL: Thank you, and it's a pleasure to be 23 here. I speak to you today on behalf of the Securities 24 Industry Association so, as I've tried to develop a 25 perspective that represents all 600 members of the SIA, I 19 1 have some sympathy for the task that you've assigned yourself 2 to developing a single view. 3 I think in reality, though, while I certainly will 4 disappoint some members of the SIA, that the consensus is in 5 favor of a trade-through rule for the reasons that have been 6 articulated by the far right of my panel here today; that 7 basically, and we'll get into this in the next question, that 8 there should be some exceptions for choosing a different 9 alternative or opting out, that in general the SIA favors 10 that the trade-through rule protect the book as it is. 11 MS. NAZARETH: Ivan? 12 MR. FREEMAN: Thank you. Thanks for having us 13 here. We operate as a broker/dealer in the U.S. equity 14 markets and as a broker, we represent both individual and 15 institutional investors and as a dealer, we can do capital 16 trading in virtually every market in the U.S. and in every 17 instrument. 18 So against that backdrop, and really in the spirit 19 of what Chairman Donaldson asked us to do, we put on both a 20 public policy hat and in our interest in evaluating efforts 21 to enhance the efficiency and fairness of the U.S. equity 22 markets. And we approached this without a bias toward a 23 particular exchange or market center. Instead, we really 24 tried to evaluate what is the impact on the market itself, 25 and on the ability for investors to accomplish what they want 20 1 to accomplish in the marketplace. 2 Short of forcing interaction of orders to a single 3 venue, we believe that a National Market System in which 4 participants are economically induced to compete vigorously 5 for market share on a level playing field is an attractive 6 objective. I think the overarching objective of an enhanced 7 national market still should be to leverage these 8 state-of-the-art meetings that we have at our disposal today 9 to put in higher standards of best execution, so the National 10 Market System should ensure that there is immediate 11 accessibility of better prices on an away market. But that 12 also requires that we recognize that speed is an important 13 element in obtaining the best execution. 14 Ultimately, the informed customer's freedom of 15 choice needs to be respected, and I'll defer the comments 16 with respect to the opt-out in specifics to the next question 17 round. But I think that it is clear that from our 18 perspective, the proposed Regulation NMS does move us closer 19 to a National Market System objective that is attractive. 20 A certain level of trade-through protection should 21 be available to those placing market and marketable limit 22 orders so long as you have clear standards of accessibility 23 and that those standards are strictly enforced. 24 We think that, as we read the rule, we don't view 25 this as a safe harbor. We don't view it as a substitute for 21 1 best execution. It doesn't alleviate the burden on somebody 2 handling an order on behalf of a customer to meet its best 3 execution requirements. So we think that standard is still 4 going to hold. But in the context of the question that's 5 asked relative to whether the intermarket trade-through rule 6 would produce benefits beyond those that due to the best 7 execution and investor self-interest already do, we would say 8 it does. It quantifies something that creates a minimum 9 standard and creates competitive behavior among market 10 centers that allows market orders to be obtained in a manner 11 in which they may not have been in the absence of the rule. 12 MR. SAUTER: I'd like to thank for you having me 13 here today. When Ed Nicoll referred to one person in the 14 crowd who believed in price/time priority, I hope he was 15 referring to me. We have been consistent supporters of the 16 concept of price/time priority. In fact, we have been 17 consistent supporters to the idea of a central limit order 18 book; but I have no delusion that we're going to be able to 19 argue that one today so I'll leave that one alone. 20 Quite naturally, all investors want to minimize 21 transaction costs and how do we do that? By having the most 22 liquid market possible. So our view is, try to create a 23 marketplace that is -- that does provide the maximum 24 liquidity; in other words, provide the incentive to put limit 25 orders on the book. Price/time priority does create that 22 1 incentive. At the same time, we think that a trade-through 2 rule is necessary to preserve price/time priority. 3 I would note that there's a natural tendency for 4 investors to not place limit orders. Who wants to convey 5 that much information to the marketplace? It's like playing 6 a poker game where you're revealing your hand. At the same 7 time, you're also providing a free option to the marketplace. 8 You're willing to allow someone to put an order to you. If 9 they want to exercise against you, they have that right. 10 You're standing there always willing to be traded against. 11 So that there is a natural tendency not to place 12 limit orders, a natural tendency not to create liquidity in 13 the marketplace which is, I think we all agree the optimal 14 benefit to investors is to have a totally liquid market. 15 Therefore, we think that we need to create some 16 sort of incentive to place limit orders to get around that 17 natural tendency to not placing orders. We need to have some 18 form of price priority, time priority ideally as well. But 19 we think a trade-through rule is necessary to ensure that the 20 markets are not totally fragmented, to ensure that an 21 investor that does place the best limit offer or bid is 22 executed first. We think it would be a tremendous 23 disincentive to place limit orders if in fact other orders 24 can be executed around you. 25 We think that frequently the new entrant into the 23 1 marketplace, the entrant who is taking liquidity out of the 2 market, is favored. We think that the entrant that puts 3 liquidity into the market, that places a limit order, should 4 be favored. So while we would say that there are many times 5 where we would like to access all of the liquidity, say, 6 perhaps away from the NBBO, we believe that would be 7 detrimental to the marketplace. We might be best served at 8 that instant in time taking a price away from the NBBO by 9 being able to fill a hundred-thousand-share order or 10 half-a-million-share order. But we think in the long run 11 we're creating a disservice to ourselves if we do skip the 12 NBBO and hit the maximum liquidity provided at a different 13 price, an inferior price. 14 We've created a disincentive to put limit orders on 15 the books. If the person who established the NBBO is 16 ignored, they won't come back. They won't continue to place 17 limit orders. 18 What we -- we, ourselves, place fewer limit orders 19 than we used to because of some of the recent changes in the 20 marketplace which we actually view as being positive, that 21 being decimalization; but at the same time, it showed many of 22 the problems in the marketplace. So we do place fewer limit 23 orders now than we used to. 24 I would note some of the comments about limit 25 orders not needing a trade-through rule in the NASDAQ 24 1 marketplace. I would point out that in fact, NASDAQ market 2 makers have a best-execution requirement. And I believe if 3 you ask most of them, they think that means that they have to 4 honor the NBBO. So in effect, you do have a quasi limit 5 order requirement in the NASDAQ marketplace. 6 And I would also note that ECNs are designed to 7 honor price-time priority; at least price-time priority is in 8 their own system but they also seek best price outside of 9 their system. So I don't think that comparing the NASDAQ 10 marketplace, that, quote-unquote, does not have a limit 11 order -- I'm sorry, a trade-through requirement, with the 12 listed markets, and saying, "Well, one market functions fine 13 without trade-through rule, therefore, the other market 14 doesn't require it as well," I think that in effect, there is 15 a quasi trade-through rule being honored in the NASDAQ 16 marketplace. 17 So again, we think that limit orders should be 18 encouraged and we think the best way to encourage them is to 19 make sure that they are protected and given price priority if 20 not time priority as well. 21 MR. DONALDSON: I'm sure that my fellow 22 Commissioners have got questions they would like to ask. I 23 suspect maybe all of you have got questions you'd like to ask 24 of each other. Let's start and see if the Commissioners have 25 anything. 25 1 MS. GLASSMAN: Yes, I have a couple of questions. 2 First, on our proposal to except the trade-through rule for a 3 slow market so the trade-through would only be for fast 4 markets, what is fast enough? What does "fast" mean? 5 MR. NICOLL: If I could jump in, I think that's one 6 of the problems. At Instinet, we've worked to reduce our 7 response time from milliseconds to microseconds. We now have 8 total turnaround times under a millisecond. For those 9 uninformed a millisecond is a thousandth of a second. 10 We're not -- we're not, you know, we're leery of a 11 rigid definition of what is and what is not a fast 12 marketplace. We think, for instance, if you were to say that 13 a fast marketplace is one that responds within seconds, that 14 would create not a, you know, not a ceiling, but in effect a 15 floor. And, you know, and you would have all markets 16 basically responding to a second, because there would be, you 17 know, it would give everybody the ability to be part of this 18 large trade-through regime and yet have the slowest 19 marketplace. This is essentially the problem. You are 20 looking at one simple criteria of competition, which is 21 price. 22 Now, without -- without, you know, preaching, I 23 mean, I think it is -- I agree with the New York Stock 24 Exchange. At the end of the day, it's all about price. 25 Customers want to get the best price. 26 1 The question is, how do they achieve that? Do they 2 achieve that simply by chasing the best advertised price or 3 by interacting in the marketplace according to various 4 criteria that they believe will get them the best net price 5 in terms of executing their orders? And if we are to simply 6 reduce competition to the best advertised price, as we do in 7 the trade-through rule, then we have a -- we have a set of -- 8 of perverse incentives to actually go to the slowest, to 9 create the slowest market within the rules. 10 So whatever you define as -- as an automated market 11 is effectively going to be the floor and it's going to, in my 12 view, it's going to stop innovation from people trying to 13 offer better, faster, different kinds of marketplaces. And 14 this is the -- my worry about the trade-through agreement. 15 MR. DONALDSON: If I could just jump in on part of 16 your question, that is, a one-second market, two-second 17 market, what's the need for a micro or millisecond execution 18 capability? How much of the marketplace is affected by that? 19 MR. NICOLL: Let me just answer that and then I'll 20 let others answer. We are working on microseconds because we 21 want our system to be completely responsive and real-time, in 22 the most contentious environment -- 23 MR. DONALDSON: My question is, responsive to whom? 24 MR. NICOLL: Everybody. 25 MR. DONALDSON: How much of the overall market is 27 1 interested in micro or millisecond trading? 2 MR. NICOLL: I think it's important to everybody 3 because when you reduce response times, and you have massive 4 spikes in demand into the system, those reduced response 5 times give everybody what amounts to a seamless interaction 6 into the marketplace, even in the fastest time. 7 You're right, a trader right now cannot even tell 8 the difference between twenty milliseconds where we used to 9 be, and three hundred microseconds where we are now. 10 But when the Fed chairman has something to say, and 11 everybody wants to enter the market at the same time, 12 reducing response times to microseconds is important to 13 eliminating latencies in the system due to overall demand 14 into the system. 15 MR. DONALDSON: Do you have any idea how much of 16 the marketplace is affected by that? That's my only 17 question. 18 MR. NICOLL: I think it's most important at the 19 time when the most amount of people want to access the market 20 immediately. And I don't know -- I don't know. I don't know 21 if we are actually getting a bang for a buck in terms of 22 trying to reduce the response time as much as we have. I do 23 believe that we ought to be able to try give kinds of systems 24 and compete on different criterias of value and let 25 traders -- I'm trying to get Scott's business. I'm not quite 28 1 sure what it is that I've got to do to get Scott's business, 2 but I think you ought to let competition play out and let 3 Scott and Gus -- let us know what it is that we have to do to 4 meet the demands. And the demands of the Ameritrades and the 5 customers around the world. 6 Just one last thing. I made a lot of money 7 offering a system that guaranteed retail investors 60-second 8 response times. Last, I think, two weeks ago, the 9 competition in terms of response time is now down to two 10 seconds. One of the on-line brokers is guaranteeing a 11 two-second execution. Those people are responding to the 12 needs of individual investors and the demands for speed by 13 individual investors. I don't know how well it's going to 14 go, Mr. Chairman, I honestly don't. 15 MR. FREEMAN: I think this question actually goes 16 to the heart of one of the question that outlines the opt-out 17 issue. Because the concept of fast or the concept of 18 autoexecution is to some degree in the eyes of the beholder. 19 What does that constitute? And we could be talking about the 20 turn-around time from the time an order actually hits a 21 market center, is processed and turned around, but from an 22 investor's perspective, you probably also have to consider 23 the trip from the investor's point of decision to the market 24 center. So really you need to look at the time between, and 25 understand where the access can accommodate peak volume or 29 1 whether or not in fact there's some latency as a result of 2 that. 3 And I think to a large degree different investors 4 will have different priorities in terms of how they look at 5 what is fast and in particular, how fast impacts their 6 meeting their overall objective of what they would consider 7 best execution to be in the context of their overall rules in 8 the marketplace. 9 MR. SAUTER: Our view of fast is immediate. It's 10 faster than humans can do. It's an automated process. We 11 would like to be able to access all of the liquidity of the 12 marketplace to fill an order. That might mean that we would 13 have to jump from venue to venue and perhaps hit ten 14 different venues in order to get our entire order filled. In 15 a volatile marketplace, if there's a second delay or even a 16 half a second delay, at a given exchange, that may mean that 17 our order goes unexecuted. We believe that best execution 18 has two components. I mentioned earlier best price and 19 certainty. 20 And with speed, you get certainty. We can look and 21 see what the national book, quote-unquote "national book" 22 looks like at this instant in time. If we had linkages in 23 place, we could hit every -- every offer out there at a very 24 instant in time. 25 That is, for us, an ideal. So a fast market is an 30 1 instantaneous market to us. 2 MS. GLASSMAN: I have a lot of questions but I know 3 we have limited time so I will just ask just one that follows 4 up on what George just said. 5 The debate in some sense has been characterized as 6 speed vs. price, speed vs. best price. But isn't it really, 7 speed is certainty, certainty now, vs. uncertainty later, and 8 so the slower market means less certainty that you'll 9 actually get that advertised price? Isn't that the issue? 10 MR. SAUTER: Yes, it is, in our view. 11 MR. DeSANO: Let me also add one more component to 12 that. Speed, certainty and volume. Your buying a couple of 13 hundred shares here and there is not a lot of use to a lot of 14 institutional investors. So we look at it in three 15 components; the all-in price, and buying is a very key 16 component. Speed and certainty are equivalent. 17 MR. GREIFELD: I think the global issue is again 18 about choice. But we believe the best execution allows the 19 investor to have choice of what's important for them. 20 I tie back to Gus' comment. He said that in the 21 NASDAQ market, we essentially operated with a trade-through 22 rule in place, even though none exists. And that is a direct 23 result of the fact that we're governed by best execution. So 24 we talk about standards of best execution, we ourselves 25 include price as first among equals. It's not the only one, 31 1 the only standard. But it's first among equals, and that's 2 how the NASDAQ market operates today without a trade-through 3 rule. 4 In the rules contemplated here with Reg NMS, to get 5 us back to the competitive dynamic that exists, we think we 6 need to have the opt-out. The opt-out represents the opt-in 7 opportunity for investors to choose; choose based upon 8 various criteria that are outlined under best execution that 9 have been supported by this Commission for a long period of 10 time. 11 MR. DONALDSON: Anyone else? 12 MS. NAZARETH: Why don't we -- 13 MR. GOLDSCHMID: Annette, let me lead you into 14 where I think we've got to go. On the opt-out, will it 15 fragment the market, will it give too much advantage to, 16 whether you want to call them sharks or whales, gorillas, 17 pick your own. But tell me what's really going to happen. 18 MR. THAIN: Commissioner Goldschmid, let me add on 19 to some of the prior panelists and get your answer to the 20 question. First of all, price is not the only criteria, and 21 one of the reasons why we support the Commission's position 22 on fast market/slow market is that we understand that if 23 there is a dramatically different execution time, that 24 markets do move very quickly. And so speed does make a 25 difference to people. 32 1 And I also agree, though, that price should be 2 first among equals. So the fast market/slow market 3 definition, and the differentiation between those markets, 4 and I do think there's issues about exactly how you define 5 automatic fast markets, I think the simplest way is that they 6 provide automatic execution, which basically means 7 computer-to-computer execution, and I frankly don't think it 8 makes very much difference whether we argue about 9 milliseconds or microseconds or anything like that, as long 10 as you get a direct computer-to-computer execution which, by 11 the way, also gives you the certainty. 12 But once you have fast markets, once you have 13 computer-to-computer certain automatic execution, there is no 14 reason why you shouldn't go to where the best price is. And 15 if you allow people to opt out after you get comparably fast 16 markets and comparable certainty, and by the way, the other 17 thing the NASDAQ would like, which I'm sure he'll say 18 eventually, is anonymity, which he also gets with an 19 electronic execution, a computer-to-computer execution. Once 20 you get to that stage, there is no good reason and no good 21 public policy reason why you should not execute at the best 22 price. 23 And the ability for institutions or "informed 24 investors" to opt out after they have that same execution 25 capability will lead to internalization of order flow, which 33 1 is bad for the market, it will not protect the limit orders, 2 which you've heard from a number of people, is a very 3 important thing, and ultimately, will lead to fragmentation 4 in our marketplace. 5 MR. DONALDSON: I'd like to ask just a general 6 question of, Scott, you and Bob have talked about, I think 7 your words were, "Executing an order in terms of what's 8 important for that order." And I guess my question is, is 9 there an obligation, a fiduciary obligation if you want to 10 call it that, an obligation for a marketplace itself to look 11 beyond your interests in a particular transaction toward the 12 interests of the marketplace itself? 13 In other words, is there any obligation to think 14 that this may be best for me at this particular moment to opt 15 out and hit the best execution, and in so doing, perhaps I 16 damage other parts of the market that aren't involved in my 17 transaction to get a limit order that gets passed? 18 MR. GREIFELD: A very good question. I think the 19 question results from the concept of an existing limit order 20 that gets opted out. And the thought seems to originate from 21 the fact that an existing limit order that's opted out is 22 frozen in time and is not, in itself, portable. 23 The way I look at this discussion is, we have 24 competing self-interest. And the competing self-interest is 25 governed by best execution. So that limit order that is sent 34 1 to a market is sent by a broker who has an obligation of best 2 execution for that order. And that broker has to evaluate, 3 dash 5, dash 6 status, to make sure he's sending it to the 4 proper market center. And I think the fundamental fear of 5 the New York Stock Exchange and others is that an existing 6 limit order will choose the best outcome for itself and has 7 the ability to move in the new world. 8 So you have the order that can be opted out, and 9 you have the new order coming in. But they both have their 10 self-interest under best execution, and they both will come 11 to arrive at what's best for that order. So the fact is, if 12 I send an order to an exchange and I'm not getting a fill, I 13 have the ability to move that order. And I was going to move 14 that, I was going to say picoseconds, which is billionths of 15 a second, but we're not there yet, but I can move that very 16 quickly. So that order that is there is portable and can 17 move the milliseconds and get to the place where you want to 18 go. 19 MS. NAZARETH: Bob, you could answer Commissioner 20 Goldschmid's questions, maybe everybody can answer both sets 21 of questions, and I think John, if you want to jump in on the 22 last part -- 23 MR. GREIFELD: Make sure I answered it properly. I 24 wanted to make sure I got the full benefit. 25 MR. GOLDSCHMID: Fundamentally, Bob, it goes to the 35 1 heart of what opt-out is going to be, will it fragment, will 2 it help out the big guy and not the small guy, what's really 3 effected? 4 MR. GREIFELD: I think opt-out will be used less 5 and less in time as the market centers learn to compete, and 6 we saw this happen in the NASDAQ marketplace after Reg ATS. 7 Certain ECNs were actually faster to respond. And we had to 8 learn that customers were measuring milliseconds and making 9 intelligent routing decisions. And there was a big gap of 10 performance. Ed mentioned 22 milliseconds. They might -- 11 somebody's at 22 milliseconds, everybody else was at, you 12 know, a hundred, 150. 13 Within twelve months, it wasn't days and it wasn't 14 weeks, but within twelve months all the competitors were in 15 around 22 milliseconds and at a point it doesn't matter, the 16 speed difference, and I would say once you're into 17 milliseconds, the difference between 20, 25 and 30 really 18 doesn't matter to very many investors at all. So what you 19 saw is investors responded to what the customer wanted and 20 what they did is improve their systems. And the incidence of 21 opt-out in the NASDAQ marketplace declined as competitors had 22 to respond to the market forces. 23 We're saying what the opt-out is, is the market 24 forces will be released to make sure that we all have to 25 compete and compete effectively. 36 1 MR. GOLDSCHMID: You say it as basically a 2 corrective to keep flexibility and pressure on, if I 3 understand. 4 MR. GREIFELD: The way I look at it is, right now 5 you can define a fast market literally in two paragraphs. If 6 you don't do it that way, if you don't have an opt-out, you 7 have to write a book. You have to write a book of rules, and 8 writing a book of rules is difficult but it can be done. But 9 the really insurmountable task is to follow and track who is 10 following that rulebook, and you have to follow that not in 11 an audit once a week, once a month. You have to follow it 12 every second of every single trading day. And Ed points out 13 that there are certain points in the trading day where the 14 volume just explodes. You have to have a whole set of rules 15 and a whole set of tracking for that. The opt-out will let 16 the market determine who is actually providing the fast 17 market. 18 MR. GOLDSCHMID: After yesterday, you think there 19 can be an explosion? 20 MR. DeSANO: I would add in on the fast market 21 notion that we would like to be able to access multiple 22 levels of the book, in order to be considered a fast market. 23 Also with respect to where this fragment, I mean, 24 SuperMontage has about 18 percent market share and Mr. Thain 25 has a much higher market share and we see very little 37 1 difference in our day with respect to trying to get done what 2 we need to get done given that disparate market share 3 difference. 4 What else do we have? 5 MS. NAZARETH: Opt-out. What does the opt-out do? 6 MR. DeSANO: Well, the opt-out, there are different 7 constituencies who obviously have different purposes and 8 needs. And you spoke to, you know, if we need to do 9 something, do we worry about hurting other people. That 10 would be really difficult for me to go in to our board of 11 trustees and say, "I really didn't take care of our 12 shareholders because I was afraid I was going to damage the 13 marketplace." 14 That's an unacceptable explanation from me to the 15 board of trustees. And that's why we get involved in this 16 process, to try to worry about those issues in this kind of 17 setting so that we work in a viable market structure that's 18 good for all. 19 But the opt-out is about choice. And it's about 20 having informed investors go where they want to go, when they 21 want to go, in a manner that suits their needs. 22 To have this dictated to me precludes you from 23 being able to achieve best execution. Best execution is best 24 all-in price to us. That's what it is. And if I have to do 25 a hundred trades at the best price at that moment to get a 38 1 certain order done as opposed to ten trades, I guarantee it's 2 going to cost a lot more money for our shareholders. And so 3 we need to be able to exercise our judgement to go where we 4 want and when we want using our fiduciary responsibility and 5 our understanding of best execution. And that's why I 6 believe the opt-out is absolutely necessary in this process. 7 MR. DONALDSON: Let me just push on that now. You 8 know, in terms of your trustees. Assume for a minute what -- 9 an extension of what you're saying is, we ought to be able to 10 trade anywhere, any time that suits your particular purposes 11 at that moment. 12 Supposing that the result of that was people's 13 unwillingness to place limit orders, and supposing the day 14 after tomorrow, one of your trustees asks you, "What's 15 happened to the marketplace? There's no limit order, there's 16 no market that I can refer to; has your doing anything you 17 want for a period of time done this to our market?" 18 MR. DeSANO: Essentially that's where we are now. 19 We don't place limit orders because there's no real 20 protection out there. We're going through this in the hopes 21 that by having each venue have to compete, you know, head to 22 head, just pure competition, that we get to a world where he 23 will be comfortable placing limit orders. The situation is 24 not a comfortable one now and I think this is a means. 25 Allowing the opt-out is a means to create and foster 39 1 competition between venues to get order flow and in the end, 2 I think that you'll see far more limit orders show up. 3 MR. DONALDSON: What change, now, would make you 4 more comfortable placing limit orders? 5 MR. DeSANO: Everybody gets to trade by the same 6 rules. You don't have a geographic advantage. Our orders 7 don't get broken up. We don't get price improved. There's a 8 lot of -- 9 MR. DONALDSON: You're talking about access? 10 MR. DeSANO: Access. I think time priority by 11 venue is important. But not across venues. 12 MR. NICOLL: Can I try and really touch on your 13 concern? Really, what you're talking about is that if we 14 allow people to trade through limit orders, that people will 15 stop placing limit orders. And while it might be in the -- 16 in an individual's interest to trade through an order, that 17 the -- at the Commission, there's a public policy issue here 18 that we want to protect the incentives market-wide to 19 place -- limit orders, getting people -- I mean, placing 20 limit orders is getting people to reveal their reference 21 points, you know? I mean, that's what really market 22 structure ought to encourage, it's getting people to openly 23 say what they want to try and sell. And we need to create a 24 set of policies to the greatest extent possible that 25 incentivizes people to reveal their reference price in the 40 1 marketplace, to, in effect, place limit orders. 2 And you're worried that an opt-out provision to the 3 trade-through rule will create disincentives for people to 4 place limit orders and yet, what we're really talking about 5 here now, okay, is a world in which stocks are trading in 6 increments of a penny, okay? Not eighths and quarters and 7 when the trade-through rule was passed thirty years ago, but 8 a penny. 9 We are allowing people, and there's no talk, other 10 than Gus, there's no talk of a CLOB anymore, there's no talk 11 of time priority. So although the New York Stock Exchange 12 talks about protecting limit orders, they are quite happy to 13 compete with the Chicago Stock Exchange by matching the 14 Chicago Stock Exchange's limit orders and not sending their 15 order to the Chicago Stock Exchange. So really what you're 16 saying -- so we don't have that now, largely. We have an 17 occasional -- an occasional trade-through and there are 18 literally hundreds of traders on the streets now, as we've 19 reduced the cost of trading, who will arb markets for a 20 penny. 21 So do we want to create this structure with all the 22 disincentives for competition to worry about that, the rare 23 occurrence when markets trade through each other, while at 24 the same time we allow them to ignore each others' limit 25 orders simply by matching them? One of the reasons why 41 1 people don't place limit orders now in particular venues, 2 because another venue can simply match those orders and 3 internalize against that. 4 So the fact of the matter is, we don't have a lot 5 of protection for limit orders. We have a situation in which 6 venues are competing. The people who place limit orders are 7 the people who are the power. They are -- they are the 8 people that venues compete for. And I think the best from a 9 public policy position is, you ought not to worry about the 10 occasional trade-through for a penny. What you ought to 11 worry about is incentivizing these various venues to compete 12 with each other so that you know, we -- the competition 13 settles in on that venue which meets the needs of most 14 investors. 15 There's -- this is not a world in which people are 16 trading through each other for twelve-and-a-half cents 17 anymore and I submit to you that there's rare -- we rarely 18 see trade-throughs that -- that the Commission would need to 19 be concerned about in the NASDAQ marketplace, where there is 20 no trade-through rule 21 MR. STEEL: I think there are two questions. Let 22 me try to address them specifically. One, I think from 23 Commissioner Goldschmid was, the issue, would you end up with 24 a fractured marketplace, and I think it's that consternation 25 that the SIA interprets that we should have a narrowly 42 1 available opt-out provision and we should do this in a more 2 patient way as opposed to an opening where there's more, a 3 greater degree of flexibility with regard to opting out. So 4 I think that addresses that issue and I think that is a 5 consternation, and so the fast-slow is our first step in 6 trying to think about that, and so that I think is a public 7 policy issue. 8 I think the second issue that the Chairman raises 9 is one that really has to be the -- the big issue for all of 10 us, and that is that it's quite imaginable to me that some of 11 us are going to have to have a reduction in our ambition 12 because it's for the public policy good. And I think that to 13 the extent that you help proscribe that and say that these 14 are the rules of the road that are required for the benefit 15 of the marketplace, it will be helpful to all because Scott 16 does have a fiduciary duty. And to have him be unclear as to 17 how to do that is a little bit unfair to him, and I think the 18 dialog with his trustees is a challenging one for him to 19 have. And so I think the conclusion would be that a 20 relatively proscribed opt-out, and then with clarity about it 21 so then people can begin to play within the defined rules 22 would be I think a policy perspective that addresses both of 23 your questions, I think. 24 MR. FREEMAN: I think the point that was made about 25 freedom of choice is an important one and that we support the 43 1 view that -- 2 MR. DONALDSON: Get closer to your microphone. 3 MR. FREEMAN: I'm sorry. That the customer should 4 be a final arbiter of what constitutes best execution for him 5 or her in the context of the markets and to resolve the issue 6 of how fast is fast, et cetera. But I think we should also 7 look at the existence of antitrade-through rules or 8 trade-through protection and the behavior modification that 9 that engenders on the same aspect of behavior modification 10 with respect to the placement of limit orders, and I'll 11 elaborate on -- for those who aren't familiar, that means 12 that they -- they move around in time and space and price and 13 react to the market as well. 14 They are moving. And you have to presume that the 15 impact of a trade-through rule on the execution of market 16 orders, and marketable limit orders, is also going to have an 17 impact on the behavior of how limit orders get routed, and 18 that this concept that there's a best execution obligation 19 for how to route limit orders is quite valid, that if 20 somebody is getting traded through routinely because maybe 21 that was perceived as a slower venue, there will be a 22 decision to be made, is that the right place to place limit 23 orders. So I think we have to be cognizant of both the 24 interaction of the two as well as the dynamics of limit 25 orders. 44 1 One other point that I would make is that we should 2 also recognize that even in the absence of an opt-out rule, 3 just the dynamics of the marketplace are going to lead to 4 things that will be trade-throughs on the tape. There's lots 5 of market dynamics today including capital commitments if you 6 traded intraday and need to get put up on the tape because we 7 want to see all trades that take place when they get 8 reported -- by the way, there's a 90-second requirement for 9 posting trades if the first place, so you can see latency in 10 trades that are not as late, but could look to the limit 11 order placement as trade-throughs. 12 And there's also lots of activities that take place 13 in the cash markets that is reflective of activity that was 14 going on in the derivative market. So you can see that 15 executions are taking place where they are at the market, but 16 they are against, not cash, but against derivative 17 transactions, and may not look like they are meeting a best 18 execution standard from the perspective of a trade-through 19 rule but are quite valid trades and may be perceived by a 20 limit order placer as a trade-through. 21 So I think we need to tolerate that even in the 22 absence of any opt-out protection, or even in the other 23 exemptions, and given the other exemptions that are in the 24 rule with respect to contemporaneously trading, there will be 25 appearances of trade-throughs. And that's a factor in the 45 1 market today and you'll see that continues as the 2 trade-through rule change goes through as proposed. 3 MR. SAUTER: To answer Chairman Donaldson's 4 question first about fiduciary obligation and the requirement 5 to minimize transaction cost, we would -- we believe there's 6 a very different set of circumstances in the short run vs. 7 the long run. If you try to minimize your transaction costs 8 on one trade, you can do that by perhaps opting out and 9 leapfrogging the NBBO. 10 We think that that perhaps does not minimize -- we 11 believe strongly it does not minimize transaction costs in 12 the long run and our goal is to minimize our total 13 transaction costs. So we do worry that the opt-out rule 14 really does lead to fragmentation in the marketplace as well. 15 We would like to see a marketplace that ultimately is 16 somewhat of an integrated National Market System that would 17 enable investors to literally ping back and forth across the 18 National Market System hitting limit orders as they go on 19 their way to getting complete execution. 20 If you had that instantaneous type of system set 21 up, there would be no logical need for an opt-out rule. Who 22 would chose to opt-out if you could take everything on the 23 way up? 24 So we strongly oppose an opt-out rule because we 25 believe that in the long run, that does disincent limit 46 1 orders, even though it might enable us to get a better fill 2 in the very short run. 3 We would support the de minimis exception in the 4 short run because we believe that actually sunsets on itself. 5 The de minimis exception really would ultimately require all 6 markets to become automatic, fast, if you will, and once that 7 happens, it does create a national market book, if you will, 8 and therefore, would sunset on itself. 9 MR. THAIN: May I just add one thing? Mr. 10 Chairman, there are markets that don't have these kinds of 11 rules. Many of the fixed income markets don't have these 12 kinds of rules. And those markets are characterized by lack 13 of transparency, by much wider bid-ask spreads, by no 14 centralized source of liquidity, and frankly, by 15 broker/dealers being able to make a lot of money in them. 16 And so I think that there are examples of what 17 happens when you don't have these types of rules but I don't 18 think that's good for the U.S. equity markets and I don't 19 think that's good public policy. 20 MR. CAMPOS: Can I ask what the status is of this 21 ideal world of interconnectivity, is that something that can 22 be accomplished relatively soon, are we -- I mean, I keep 23 hearing about this pinging back and forth from market to 24 market. But yet, when we get down to details, it doesn't 25 seem to really be there. 47 1 MR. SAUTER: It's pretty well there in the 2 ECN/NASDAQ marketplace. 3 MR. THAIN: I think, Commissioner, probably -- I 4 don't -- there aren't many things probably all of us would 5 agree with, but hopefully this is one, and we'll see. 6 I think most of us will agree that ITS in its 7 current construct doesn't work. And so it needs to be fixed 8 so that you do in fact get good interconnections between the 9 marketplaces. 10 MR. ATKINS: Well, actually that was one question I 11 wanted to give back because I have a lot of questions about a 12 lot of this. But to get to a practical question, with 13 respect to what is it right now, and we're talking about the 14 trade-through rule, that at least when we were looking at 15 this with respect to the ETFs last year, year-and-a-half ago, 16 whenever it was, and then what was seen through some of our 17 enforcement actions, I really wonder what does exist right 18 now with respect to the trade-through rule and with respect 19 to ITS, you know, a lot of people say that ITS was meant from 20 the beginning to not work. And so we're sort of seeing that 21 now. 22 So I'm wondering what, as far as each of your 23 perspectives go, whether or not the trade-through rule is 24 effective right now in the markets. 25 MR. NICOLL: I think it's ironic, I agree with -- 48 1 this is where I just have to say how ironic it is, with my 2 good friend Gus, we're saying that we had an effective 3 national market system in NASDAQ where there is no 4 trade-through rule, which has created competition where there 5 are mechanisms in which we are accessing each other's markets 6 at lightning speed and an effective de facto CLOB as a result 7 of that and I would argue, Gus, and I would argue to the 8 Commission, that that's because of competition that is played 9 out without the rigid hand of regulation requiring people to 10 go to one venue vs. another. 11 And I don't think, I think there are thousands and 12 thousands of trade-throughs within the listed -- between the 13 markets, I mean, I think, you know, there are -- there are 14 trade-throughs in the ETFs all day long and the markets are 15 apparently locked all day long, yet they shouldn't occur 16 because things -- because when you trade a hundred million 17 shares a day, which is what the QQQs trade, every day, 18 whether we like it or not, it's trading a hundred million 19 shares a day, it's so fast that it's almost impossible to 20 have an orderly National Market System where everybody goes 21 in absolute order, even with computers, even with a 22 trade-through rule overlying it. 23 And really what we have is a kind of chaos of 24 activity which has in fact, you know, lowered transaction 25 costs. The QQQs, since we created a de minimis exception in 49 1 the QQQs, we've seen the spread go from an average of six 2 cents where, today on Inet, the spread is three tenths of a 3 penny. That is effectively trading with no -- with no cost 4 between the bid and the offer. And that kind of -- of 5 competition and the interplay of technology -- 6 MS. NAZARETH: Ed, I have to add I have no 7 recollection of the spread on that -- 8 MR. NICOLL: Well, I -- 9 MS. NAZARETH: -- I hadn't finished -- extremely 10 narrow all along and the three cent de minimis with a market 11 that normally trades at a tenth of a cent is enormous. So -- 12 MR. NICOLL: Well, I can go back and we can 13 question the statistics that were given to me and we can go 14 through that. Clearly, the spread is narrowed and the spread 15 today is three tenths of a penny and we can certainly 16 demonstrate that that's the case. And it's not around a 17 penny increment. It's a true subpenny spread. But we -- but 18 there are lots of trade-throughs. There always have been 19 lots of trade-throughs, and certainly it's very difficult to 20 keep an orderly marketplace of, you know, when stocks trade 21 with that kind of velocity and that kind of volume. 22 MR. DONALDSON: Well, there's a flashing signal 23 over here that we're coming to the end of this allotted 24 period. I want to say, we're going to see some of this panel 25 back on a couple of the other panels. I'm sure that there 50 1 are just thousands of questions sitting behind this table and 2 over there, so this is just a beginning. I hope we're going 3 to have a chance to talk to you all in a different forum. I 4 do want to thank you for coming here and -- thank you. 5 MR. NICOLL: Thank you, Chairman. Annette, my 6 notes -- I misspoke. It was -- our records show that it was 7 four cents when we traded on the American, not six cents. I 8 apologize. 9 MR. DONALDSON: Okay. We're going to take a little 10 break here, a ten-minute break and then we're back at 10:30. 11 (Recess taken.) 12 MR. DONALDSON: Okay. Why don't we get going here. 13 Welcome to our second panel. Since you have your backs to 14 the audience, maybe you would all, starting with you John, 15 say who you are and who you represent so the people can hear 16 you. 17 MR. WHEELER: I'm John Wheeler with American 18 Century Investments and I'm here representing the Investment 19 Company Institute, the trade group for the mutual fund 20 industry. 21 MR. HERRON: Dave Herron, Chicago Stock Exchange. 22 MR. FAGENSON: Robert Fagenson, VDM Specialists on 23 the New York Stock Exchange, and Stock Exchange Specialists 24 Association. 25 MR. MADOFF: Bernard Madoff of Madoff Securities. 51 1 MR. CRONIN: Kevin Cronin from AIM Management, 2 actually now AIM Investments. Under the Act of full 3 disclosure, I'm also the chairman of the New York Stock 4 Exchange Institutional Creditors Advisory Committee. 5 MR. PETERFFY: Thomas Peterffy, Interactive 6 Brokers. 7 MR. PUTNAM: I'm Gerry Putnam, CEO of Archipelago. 8 MS. NAZARETH: Since this group has a little unfair 9 advantage, it's like having a quiz after having seen somebody 10 just ahead of you take it. Perhaps we'll even be able to get 11 into some more in-depth questions because we do have some 12 sense of what's going to be discussed. But I thought maybe 13 we could start with the same basic questions, which are, you 14 know, are there benefits to the trade-through rule beyond 15 best execution and investor -- beyond the duty of best 16 execution and you do have views on that, Gerry? 17 MR. PUTNAM: Thanks for having me. I think, Mr. 18 Chairman, you mentioned in your opening remarks that this was 19 a complex rule, and we agree with you, and in many ways, we 20 think it's actually too complex, which would make it 21 difficult to actually enforce in the context of a 22 trade-through situation. Today, we do have a trade-through 23 rule for New York listed stocks, and that rule is routinely 24 violated. It's a very simple rule. It just says, "Don't 25 trade through." 52 1 The rule that's proposed here obviously has more 2 components to it with exceptions and opt-outs and all of 3 that. 4 I had one of our folks take a look yesterday at -- 5 in light of doing this today, what's going on right now on 6 our trade-through situation, and we actually automated the 7 process of dealing with trade-throughs, complaining about 8 them and trying to get them resolved. And yesterday, in one 9 four-minute period between 1:52 and 1:56 in the afternoon, we 10 actually had 37 outstanding complaints with no resolution -- 11 again, a simple rule, just don't do it -- in 32 different 12 stocks. 13 Not surprisingly, 70 percent of them were with the 14 New York Stock Exchange, and they do have the largest market 15 share so that's where you would expect it would happen the 16 most often. But our concern is that the rule is too complex 17 to enforce when you consider the rule today, which is very, 18 very simple. 19 I also have concern with, we've come up with this 20 new definition of fast vs. slow markets. And I think that's 21 going to be difficult to define, and I think it's dangerous 22 to go in that direction. 23 There's another standard that we've worked with in 24 the over-the-counter marketplace, which is really the issue 25 of firm quotes vs. soft or what we like to call "maybe" 53 1 quotes. 2 And we think that's really where the distinction 3 should lie and that's where investors are asking for a 4 choice. In the case of what you'd call or the analogy would 5 be a slow market, we would say that is a market that has 6 "maybe" quotes or indications. 7 At times, investors would like to choose to avoid 8 the "maybe" market, in exchange for trading with a certain 9 market or a market that had a firm quote, one that they knew 10 would not be manually interfered with. 11 I think that's where you'll find the -- if you look 12 back to what happened in the NASDAQ world, and Bob Greifeld 13 mentioned it earlier, NASDAQ had a different structure than 14 the ECNs did when they came in. ECNs came in with firm 15 quotes. Today all quotes for the most part are firm in 16 NASDAQ and we don't have a trade-through problem. 17 I think finally, just touch on NASDAQ, another 18 thing that you mentioned was the possibility of unintended 19 consequences. And I think there are serious unintended 20 consequences for the NASDAQ world if we impose a 21 trade-through rule. 22 Today, through competition, a large number of very 23 sophisticated routing systems have been made available to the 24 marketplace. And the way they operate is, they operate on 25 the basis that all quotes in NASDAQ are firm, and I'll just 54 1 make a quick example, say we have a quote on Instinet at five 2 cents, one in NASDAQ at six and one in ours at seven. One of 3 these smart order routers will say, take the five, take the 4 six, take the seven, all at the same time, so they have 5 imposed a trade-through always seeking best price. But if we 6 put a trade-through rule in the NASDAQ world, a quote coming 7 into your system, to take the seven stock, the seven cent 8 stock, we'd either have to hold it up and not display a 9 customer limit order, which is exactly the opposite of what 10 we're trying to get at here today, which is to display 11 customer limit orders, or we'd have to send that order back 12 to that participant saying, "It's going to trade through, we 13 can't handle it," at which point we interfere with time 14 priority within our own system. So -- 15 MR. COLBY: Before you stop, could I ask the other 16 panelists, could you address the fundamental question that 17 the prior panel was addressing, which was, they all said that 18 we need to protect limit orders in order to encourage price 19 discovery. Do we need a trade-through rule to help protect 20 limit orders? 21 MR. PUTNAM: In the NASDAQ world we don't have one, 22 and all protected competition has done it. The ultimate 23 reward, by giving people a choice, if you place your order, 24 if you make the distinction between firm quotes and soft 25 quotes, and then give customers the opportunity to opt out of 55 1 trading with the soft ones, what's going to happen is, you're 2 going to get rewarded for making a firm quote. 3 At that point, Scott's got what he wants. He puts 4 an order out there, it will be interacted with. It's exactly 5 what happened in the NASDAQ world as it went from being 6 semiautomatic with market makers and totally automated with 7 ECNs to one that is a totally automated marketplace today. I 8 think it will -- it's self policing, best execution, Gus 9 mentioned best execution. It applies in both the listed 10 world and the NASDAQ world. Leave it there. 11 Let the markets compete and they will automate like 12 they did in the OTC world and I think we'll get to our best 13 result that way, but you do have to give customers the 14 opt-out, I mean, the opt-out being the choice between trading 15 with the best quote, which is just the best price, and being 16 able to say, "On this particular order, I want to override 17 the system. I don't want to trade with the 'maybe' quotes. 18 I only want to interact with the ones that are firm." 19 MR. DONALDSON: How do you define a firm quote? 20 MR. PUTNAM: It's -- 21 MR. DONALDSON: Is there a time that it's firm? 22 MR. PUTNAM: The fast flow thing, because that it's 23 a question of time. So you say, "Well, one second, geez, 24 that's really fast, but not necessarily firm." Firm means 25 the order is available on the touch. If another order comes 56 1 in, it will execute against that order without any human 2 intervention. The order doesn't stop for someone to look at 3 it and think about what they might do with -- they might do 4 that really quickly. 5 MR. DONALDSON: How long does it have to remain 6 firm? 7 MR. PUTNAM: It just has to be firm to begin with. 8 Today's world, in electronic marketplace, all of our quotes 9 are firm, if they are displayed and if an order comes in and 10 that order still exists, it will execute. In the listed 11 world, where, if you look at the competing -- competing 12 models like the floor-based specialist model on New York, 13 those quotes aren't necessarily firm. You can see it. 14 And Scott says, you know, in the interests of his 15 shareholders, he wants to take that quote? Well, he gets 16 there to find out that that ten thousand shares at a nickel 17 isn't really there. There's ten thousand shares at a nickel 18 but there are 17 other people that are going to take that 19 order. So to him, that's not firm. Or there's some price 20 improvement that takes place, or it traded ahead because 21 there's other people standing there. So they are not -- the 22 distinction needs to be made between quotes that are 23 interfered with or could be, and quotes that are purely 24 sitting will with an electronic trigger on them that says, 25 "If you touch it and you're the first one in line, you get 57 1 it." And that's where the market wants, I believe would like 2 to be able to make a choice. 3 MR. PETERFFY: Well, we enthusiastically support 4 the Commission's proposed trade-through with some 5 modification. We believe that instead of focusing on whether 6 market center is automated, we should focus on whether any 7 particular quote disseminated by that market center is 8 automated. 9 We propose that automated quotes be followed by one 10 corrector symbol that signifies that the quote is 11 automatically traded when a matching order meets. 12 Automatically executed quotes, whether they are on the top of 13 the book or up and down the book, should be protected by the 14 trade-through rule, and manual quotes should not be. This is 15 a simple and technically easy idea to implement, focusing on 16 whether a particular disseminated quote by market center is 17 electronically executable, on a hybrid market such as the New 18 York Stock Exchange, to get the benefit of the trade-through 19 rule protection for those quotes that deserve it, and would 20 provide these market centers with the flexibility to evolve 21 towards a more automated system in any way they see fit. 22 In addition, this approach would deal with the 23 question of whether quotes away from the NBBO should be 24 protected or not, and how those trades should be done. 25 Accordingly, a rule should allow automated markets 58 1 to trade through manual markets by any amount. Limiting the 2 trade-through, trading through of manual markets to the de 3 minimis requirements would merely entice manual exchanges to 4 adjust the quotes lower so as to be off the market by more 5 than the trade-through requirement and thereby force orders 6 to come to them and to continue to take advantage of these 7 three options. 8 Conversely, we see no justification not to give 9 best execution against automatically available quotes. We do 10 not see an up tick as a valid option and we do not believe 11 that we should go along with that. Lastly, there was a 12 proposal that brokers should disclose to their customers the 13 amount by which they trade through manual quotes. We do not 14 believe that you should require this because this would 15 merely create a false impression that those prices were 16 actually attainable where we all know that most of the time 17 they are not. 18 MS. NAZARETH: Thomas, can you address whether you 19 think there are benefits to protecting the best price limit 20 order in the market, at least not -- 21 MR. PETERFFY: There certainly are benefits to 22 liquidity providers. If you like our firm is a large 23 liquidity provider. If we were told that anybody can trade 24 through our quotes, we would stop providing such quotes. 25 MR. GOLDSCHMID: I just want to ask a question. I 59 1 want to make sure if I understand both of you. Instead of 2 using "fast" terminology, you're using automated quotes that 3 can be taken as -- 4 MR. PUTNAM: That's correct. 5 MR. PETERFFY: And by the way, we also think that 6 there should be a clear standard as to what an automated 7 quote is. And in today's market, most internally tradable 8 orders by ECNs are executed in less than a tenth of a second. 9 So we believe that an automated quote should be one that 10 either executes or books or declines or routes an order to a 11 better market in less than a quarter of a second, at least 98 12 percent of the time. 13 MR. GOLDSCHMID: Gerry, do you agree with that? 14 MR. PUTNAM: I think that it could actually be, and 15 that's sort of where the marketplace is today, that's the 16 standard for it, it could be simpler than that. It is simply 17 what we all do today in the electronic world is, there is no 18 manual intervention in that quote. Tom's point is well 19 taken. If we sat there with a two-second quote, it took us 20 to automatically fill an order in two seconds, we'd have no 21 customers. So the marketplace takes care of -- takes care of 22 that. 23 MR. PETERFFY: But that's not true for other 24 dominant market centers, right? If you give them two 25 seconds, they will take two seconds. 60 1 MR. CRONIN: Thank you for giving me the 2 opportunity to today present our views on the proposed Reg 3 NMS. As we look at the proposal, I think it's clear in that 4 general concept, this proposal promotes some of the most 5 valuable tenets we think of what will ultimately forge the 6 most efficient capital market structure in the world and that 7 clearly is innovation, transparency, speed and efficiency, 8 and ultimately we believe that this proposal would provide us 9 as institutions, and investors in general, the competition 10 that's necessary with the investor protections that are 11 necessary and ultimately with the choice that's necessary for 12 us to pursue best execution. 13 You hear a lot of talk about these terms, 14 competition and choice and protection. And it's unfortunate 15 in the earlier panel that protection, it didn't seem to me, 16 it was dismissed as rhetoric. I don't believe that 17 protection of limit orders is rhetoric. If you look at the 18 absence of protection today, I think many of us have come to 19 the conclusion that the marketplace isn't nearly as efficient 20 as it should be or could be. And part of our process here 21 today should be to collectively figure out what will lead to 22 a greater benefit for investors. What will lead to greater 23 incentives for investors to post their limit orders? 24 And I think clearly the trade-through proposal and 25 uniform application of it is part of that protection. If 61 1 necessary, I know that there might be some unintended 2 consequences I believe that Gerry specifies that are 3 tangible. But I also believe that the technological 4 advancements that are made and the capabilities that many of 5 these systems provide will overcome that problem. 6 In theory, it's hard for us to imagine any concept, 7 public policy that would not advance the protection of the 8 limit orders. So again, in theory, I support Reg NMS's 9 proposal for the uniform application of the trade-through 10 rule. 11 Opt-out is a vexing issue for institutions. 12 Opt-out would allow us in theory to trade at, quote-unquote, 13 inferior prices and I think Scott did a good job earlier of 14 describing how his institutions' displayed prices aren't 15 necessarily either certain or the best prices and are pursued 16 in terms of best execution. 17 And yet it is troubling to advance any policy that 18 would promote our ability to pursue these inferior prices at 19 basically the exception of those who are willing to display 20 their limit orders. 21 In the end, I think opt-out does give investors 22 needed flexibility and I do believe that it creates an amount 23 of competition that's necessary to facilitate the advancement 24 of the marketplace, but I'm not sure that the end justifies 25 the means. And that is to say, I believe that competition 62 1 will ultimately get us to where we need to be in terms of 2 efficiencies, in terms of automatic execution capabilities 3 that many of us want. But it's very hard to establish a 4 public doctrine that, in order to facilitate that end, 5 basically takes away some of the protections that we feel are 6 very important to this whole process. 7 I will probably bring my comments to a close there 8 in the interests of letting others speak, but the issue is a 9 very difficult one for institutions, as I know it is for the 10 Commission. I believe that if we properly define what fast 11 markets are, and I think you have to very specifically define 12 what a fast market is, and I believe it's under a second. 13 I'm not going to get into picoseconds or whatever that term 14 was earlier for billionths of seconds. I think that's 15 nonsensical to most investors, Mr. Chairman. 16 However, I think it is clearly in the best 17 interests of investors in general that that time frame be 18 very specific, that it be flexible over the course of time, 19 because our fear is that the lowest common denominators would 20 be all that we would get. 21 But it's critically important to define that, to 22 define the standards of linkage, and I know others will 23 advance that all levels of the book need to be electronically 24 accessible for it to be deemed automatic or fast. I don't 25 view that as appropriate. I think it infringes on the form 63 1 of structure. I think it's asking for example an option 2 market to be something more than it is. 3 I think it is reasonable for the top of the book 4 initially. I think competitive forces will ultimately lead 5 us to a better sweeping capability at the exchanges, for 6 example, and I think the advancement, again, is by and large 7 to make sure that we all understand what a fast market is, to 8 make sure that competitive forces are there, to make sure all 9 the market centers have the ability to get to that point, and 10 do get to that point, and in the absence of that, I think 11 unfortunately, an opt-out may be necessary. 12 MR. MADOFF: Our firm has made a, you know, fairly 13 decent living as a fast market competing with a slow market, 14 so I'm not sure that it's in our own best interests to have 15 everyone on a fast market but, since our good Chairman has 16 asked us all to take off our selfish hats and speak for the 17 public good, I'm going to try to do that. 18 I agree a little bit with what everybody has said 19 here. And I think that really this debate comes down to fast 20 markets vs. slow markets. If you were in a situation just 21 looking at the NASDAQ world today, which is operating without 22 a trade-through rule, which is a fast market, I don't think 23 this discussion would be taking place for the most part. 24 I think what's triggered it is that you now have a 25 lot of fast markets represented primarily by ECNs that are 64 1 trying to compete with what is a slow market. We have 2 accomplished that by putting our own capital at risk and 3 being willing to protect limit orders and trade-throughs from 4 taking place because we do operate in an environment that has 5 a trade-through rule. In the NASDAQ market, we don't have 6 that issue. 7 But the ECNs who don't really have their own 8 capital that they can put into play, they are just 9 representing customer orders, they cannot make capital 10 commitments and therefore, do not protect orders in a 11 marketplace, and that's why it makes it very difficult for 12 them to compete in an area where there's a trade-through 13 rule. 14 And if you look at the fact that they were able to 15 successfully compete in the NASDAQ market where there isn't a 16 trade-through rule and it's fast market against fast market, 17 you're now asking them to compete with a slow market that has 18 a trade-through that doesn't allow that to take place. So 19 the ECNs, you had to give them the de minimis exception to 20 enable them to function there. 21 If you want a clear example of the difficulty of 22 having a fast market compete with a slow market and not 23 having chaos with a rule that says they can't trade through 24 it, you just have to look at the AMEX trading of ETFs with 25 the NASDAQ marketplace. When it first happened, and I can 65 1 tell you as a very active player in the ETF world, it was 2 sheer chaos the first few days when you allowed trading of 3 ETFs on both the AMEX and in the NASDAQ marketplace where you 4 had a clear example of a slow market competing with a fast 5 market. 6 In reality, if you made all markets become fast 7 markets and -- up to certain share size, this issue goes 8 away. I know of no reason why slow markets today, and let's 9 talk about the New York because that's basically what we're 10 here to talk about, if they automated their marketplace, 11 which they certainly have the capability to do, and probably 12 will do, then, and you -- you said that there was a 13 trade-through rule that you could not, fast markets could not 14 trade through other fast markets, we would support that. I 15 can see no justification for one fast market trading through 16 another fast market. 17 You asked for a definition of a fast market, Mr. 18 Chairman. My definition would be, which other people I think 19 have already echoed, is that an immediately accessible or an 20 automatically accessible market. It doesn't have to be under 21 a second. Our average execution speed is clearly under one 22 second for almost 99 percent of our executions. I don't need 23 to go down to milliseconds, picoseconds and so on. I just 24 want to know that when I see a quote, that that quote is 25 immediately accessible and the only way that that quote will 66 1 not be accessible to me would be if another automatic 2 execution takes place before mine. 3 If I'm going to send an order to a marketplace and 4 someone is going to be able to take that order, hold it up 5 for 30 seconds or even five seconds, show it to other orders 6 that are in the crowd who are going to get a second look, 7 that's not fair. 8 If you want to encourage people to put orders into 9 quotes, which is really what this is all about, you cannot 10 allow them to get a second look at an order. 11 I'm not going to get into the data of CLOB because 12 that's not why we're here, and I don't think that's 13 necessary. In any event, I think competition levels that 14 playing field. But you cannot have an order go down to a 15 marketplace in an automatic fashion and then once it arrives 16 at that marketplace, manual intervention takes that order and 17 then delays the execution of that order because, while that 18 process is going on, even if it might afford a better price 19 to the order that is currently shown in that marketplace as a 20 quote, I may very likely and probably will miss executing 21 that order, and then the order that is below that price will 22 no longer be there because those orders come and go, you 23 know, literally before you can blink your eye. 24 So the way to solve this issue is force all market 25 centers up to a certain share size to become automated. 67 1 Otherwise, you can opt out of that market. 2 Now, to deal with the opt-out issue, I believe that 3 there should be an unfettered opt-out of a slow marketplace 4 because, as a practitioner in the marketplace, it's very 5 important for me to have a rule that I can comply with. I 6 don't want a rule that I cannot properly comply with. And I 7 cannot comply with a rule unless there are linkages in place, 8 whether those markets are accessible, and they are accessible 9 at a fair price which I guess we'll discuss at the next -- 10 the next panel. 11 So as far as opting out is concerned, you cannot 12 force fast markets, you know, to not be able to opt out of a 13 slow market. And the opt-out has to be unfettered because I 14 have concerns that even with this one, two and three cents 15 ban that you are proposing, because in a marketplace that 16 takes place today, these prices flicker and I don't know 17 whether a spread that is three cents, when I decide to opt 18 out, may be two cents, you know, by the time I press that 19 button. 20 So it sounds simple to -- and I'm not sure how much 21 compliance there is, even with the three cent de minimis ban, 22 and -- I mean, somebody here, I guess Bob Greifeld, said the 23 problem is going to be how do you surveil, you know, all of 24 these -- all of these issues. That's a very difficult 25 situation and I genuinely believe that most practitioners in 68 1 the marketplace want to comply with the rules. They are not 2 trying to disadvantage anybody. 3 I would like to start with the premise that most of 4 the practitioners in our industry come in to their firms in 5 the morning saying they want to comply with the rules, they 6 want to do what is best for their client. I don't think 7 anybody is trying to opt out of an execution that they think 8 they could really get. 9 So those are the issues that I think are important 10 to dealing with in any rule proposal that you may make. 11 Thank you. 12 MR. FAGENSON: Mr. Chairman, Commissioners, 13 Annette, Bob, and Jonathan Katz, I finally get to see the man 14 who is behind all those letters. 15 In many ways, at certain times, today, it sounded 16 like a Congressional hearing. Some of the panelists find no 17 need to get a clear question that's asked, but simply get 18 their comments into the record. And I will try and adopt the 19 Chairman's opening comment that we should try and keep a 20 public policy hat firmly on our heads, because that's really 21 what we're here to talk about. 22 The good news is that because we have the deepest, 23 most liquid markets in the world, and are in fact the envy of 24 the world, we're not talking about something that's damaged 25 or broken, we're simply talking about something that's 69 1 terrific and trying to make it better. That makes our job 2 easier but also more challenging because we have to be 3 certain not to upset that which has built over so many years 4 and served us and the people of this country and the world so 5 well. 6 So the question is, a trade-through rule, is it 7 necessary? Is it going to incent people to put limit orders 8 in the book? And my answer to that is, absolutely yes. 9 If we turn the clock back to the confusion that 10 existed in the old NASDAQ pricing model where people would 11 enter a limited buy order at 15 and see the stock trading 12 that was at 14 and seven eighths and not understand why they 13 didn't buy that stock at 15 and the broker would calmly take 14 their hand and say, "We can't buy it at 15 unless it's 15 offered at 15," and it can be trading at 14 and seven eighths 16 or 14 and three quarters forever. And unless it's offered at 17 15, you cannot get it. 18 That was extremely confusing and I think some of 19 the elements of what we're talking about, if it's not 20 perfectly clear in terms of absolute limit order protection, 21 will be extremely confusing and will disincentivize investors 22 large and small to enter their limit orders if they don't 23 feel that those limit orders are going to be afforded price 24 protection. 25 Now, I testified to the Common Sense Pricing Act, 70 1 which made it very clear from what was stated at the time, 2 that every penny saved investors over a year would be a 3 billion dollars in their pockets. We have to be careful, if 4 we eliminated a trade-through rule, and have a de minimis 5 exemption or an opt-out, we're talking about three cents. 6 Well, it may not be every share. 7 But if we do the multiplication, if the Common 8 Sense Pricing Act put five billion dollars in investors' 9 pockets, this has the potential to take nine billion out of 10 their pockets because if everyone were pure and all motives 11 were perfect, and as one of the earlier panelists said, it 12 only happened occasionally, and people didn't set up systems 13 to take advantage of what the system offers, then everything 14 would be fine. But I think history has proven that not to be 15 the case. 16 Where an exemption exists, people are going to find 17 a way, I think, to take intermarket/intramarket advantage of 18 it. And that poses a tremendous danger because the opt-out, 19 as well-intentioned as it may be, creates to a certain extent 20 an elitist two-tiered market, two classes of citizens, and I 21 can't find anything within that that speaks of good public 22 policy. 23 I think we have to be careful as we take a look at 24 the benefits that the trade-through rule provides to 25 investors that we don't start designing a system for 71 1 practitioners and forget about the customers. 2 Now, I heard it's no longer politically correct to 3 talk about the eight-hundred-pound gorillas, they have been 4 on the Atkins diet, no pun intended. So now they are five 5 hundred pound gorillas. Pretend they are not sitting in the 6 corner of the anteroom and that large institutional investor 7 does not have a certain weight in the marketplace. It would 8 be disingenuous at the very least. 9 In fact, what we haven't talked about today is the 10 medium sized institution, the small Midwest bank, the 11 individual investors, and what the effect on public 12 confidence will be if we do away with the trade-through rule. 13 And that is a huge danger here. In some ways, before talking 14 about the SEC, I feel like I'm in front of FAA or should be, 15 because if it's not price, then it would be safety, and 16 certainly there are other issues that are important. And 17 whether it's the food quality, or on-time performance, if you 18 don't get there, nothing else really matters much. 19 In this case, the best price and the ability to 20 have confidence that you're going to be protected are the key