0001
 1     THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION
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 6   
 7              EQUITY MARKET STRUCTURE ADVISORY 
 8                     COMMITTEE MEETING
 9   
10   
11                   Wednesday, May 13, 2015
12                         9:38 a.m.
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23              Securities and Exchange Commission
24                      100 F Street, N.E.
25                    Washington, D.C. 20549
0002
 1   PARTICIPANTS:
 2   
 3   Commissioners of the Securities and Exchange Commission:
 4   Chair Mary Jo White
 5   Commissioner Luis Aguilar
 6   Commissioner Daniel Gallagher
 7   Commissioner Kara Stein
 8   Commissioner Michael Piwowar
 9   
10   Equity Market Structure Committee Members: 
11   Matthew Andresen
12   Reginald Browne
13   Kevin Cronin
14   Brad Katsuyama
15   Ted Kaufman
16   Richard Ketchum
17   Manisha Kimmel
18   Mehmet Kinak
19   Andrew Lo
20   Joseph Mecane
21   Jamil Nazarali
22   Eric Noll
23   Maureen O'Hara
24   Joe Ratterman
25   Nancy Smith
0003
 1   PARTICIPANTS (CONT.):
 2   
 3   Equity Market Structure Committee Members (cont.):
 4   Chester Spatt
 5   Gary Stone
 6   
 7   Guests:
 8   Bill Baxter, Head of Global Program Trading and Market
 9        Structure, Fidelity Management and Research Company 
10   Brandon Becker, Former Executive VP and 
11        Chief Legal Officer, TIAA-CREF
12   Jeffrey Brown, Senior VP and Head of Schwab's Office of
13        Legislative and Regulatory Affairs, Charles Schwab
14   Thomas Farley, President, NYSE Group 
15   Dave Lauer, President and Managing Partner, KOR Group LLC 
16   Jamie Selway, Managing Director and Head of Electronic
17        Brokerage, ITG 
18   Thomas Wittman, Executive VP of Global Trading and Market
19        Services, NASDAQ OMX 
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0004
 1   PARTICIPANTS (CONT.):
 2   
 3   Securities and Exchange Commission:
 4   Steve Luparello, Director, 
 5        Division of Trading and Markets 
 6   Gary Goldsholle, Deputy Director, 
 7        Division of Trading and Markets 
 8   David Shillman, Associate Director, 
 9        Division of Trading and Markets 
10   Daniel Gray, Acting Head, Office of Analytics and
11   Research, Division of Trading and Markets
12   Charles Collver, Financial Economist, Office of Analytics 
13        And Research, Division of Trading and Markets 
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0005
 1                        C O N T E N T S
 2   
 3   Introductory Remarks                                    7
 4   Self-Introduction of Committee Members                 40
 5   Review and Consideration of Proposed Bylaws            85
 6   Presentation on Rule 611 by SEC Staff                  86
 7   Lunch/Administrative Session                          109
 8   Presentation and Q&A on Rule 611                      109
 9        - Thomas Farley, President, NYSE Group 
10        - Jamie Selway, Managing Director and Head
11          Of Electronic Brokerage, ITG 
12        - Thomas Wittman, Executive VP of Global 
13          Trading and Market Services, NASDAQ OMX 
14   Break                                                 161
15   Presentation and Q&A on Rule 611 - Continuation       161
16        - Bill Baxter, Head of Global Program Trading 
17          And Market Structure, Fidelity Management and
18          Research Company 
19        - Brandon Becker, Former Executive VP and Chief
20          Legal Officer, TIAA-CREF 
21        - Jeffrey Brown, Senior VP and Head of Schwab's
22          Office of Legislative and Regulatory Affairs,
23          Charles Schwab
24        - Dave Lauer, President and Managing Partner, 
25          KOR Group LLC 
0006
 1   
 2                    C O N T E N T S (CONT.)
 3   
 4   Committee Discussion of Rule 611                      190
 5   Discussion of next steps                              222
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0007
 1                     P R O C E E D I N G S
 2             MR. LUPARELLO:  I'd like to call the meeting to
 3   order, with, I think, order being a relative term during
 4   the pendency of this conversation.  I believe we have a
 5   quorum. 
 6             On behalf of the Commission, I'd like to thank
 7   all of you for attending the inaugural meeting of the SEC
 8   Equity Market Structure Advisory Committee.  I'd also
 9   like to thank the members for their service on the
10   committee.     
11             While we would like to have as lively a
12   discussion as possible, please hold your questions or
13   comments until after all the introductions have been
14   given.  There will be plenty of time to have healthy
15   dialogue throughout the day. 
16             With that said, on behalf of the newly formed
17   advisory committee and as the designated federal officer
18   for the committee, I'd like to welcome Chair White. 
19   Chair White is the 31st chair of the Securities and
20   Exchange Commission. 
21             CHAIR WHITE:  You've learned to count also,
22   Steve.  That's good. 
23             (Laughter.)
24             MR. LUPARELLO:  It's hard to keep count.  I
25   haven't been here for all of them.  And I'd like to turn
0008
 1   it over to Chair White for her opening remarks. 
 2             CHAIR WHITE:  Thank you very much, Steve. 
 3   Before I go on, I know I speak for everybody in the room
 4   that our thoughts and prayers go out to the victims and
 5   their families of the Amtrak derailment.  I know a lot of
 6   you -- a lot of us, frankly -- travel that route, so it
 7   brings it particularly close to home. 
 8             But I want to add to Steve's welcome to
 9   everyone to the inaugural meeting of the Equity Market
10   Structure Advisory Committee.  Maintaining and enhancing
11   the high quality of the U.S. equity markets is one of the
12   SEC's most important responsibilities, and this
13   committee's work is an important part of that and will be
14   of great assistance to the Commission as we continue our
15   efforts to ensure that the equity markets optimally meet
16   the needs of investors and public companies. 
17             We're grateful to each and every one of you for
18   agreeing to devote your time and knowledge to such an
19   important public purpose.  All of you bring valuable
20   insight and perspectives on the markets. 
21             I've spoken at some length on the subject of
22   equity market structure, and to allow as much time as
23   possible to hear from all of you, I'll be relatively
24   brief -- I said "relatively" -- brief in my remarks this
25   morning.  And I'll post my complete statement on our
0009
 1   website later today. 
 2             To state the obvious first, the U.S. equity
 3   markets have of course experienced a sweeping
 4   transformation over the last 20 years.  Primarily, manual
 5   market structures have been replaced by high-speed
 6   electronic markets in which computer algorithms dominate
 7   trading.  As I've detailed before, empirical evidence
 8   shows that investors are doing better in today's
 9   marketplace than they did in the old manual markets. 
10   There is, however, work to be done. 
11             The SEC has taken a series of important steps
12   to address market structure issues, both on its own and
13   in coordination with the self-regulatory organizations. 
14   It's worth noting, I think, for example, that concerns
15   about extraordinary volatility, as seen most prominently
16   in the flash crash, have been met with automated circuit
17   brokers, a market access rule requiring brokers to manage
18   the risks of, among others things, automated systems for
19   accessing markets, clearer rules for breaking trades, and
20   banning so-called stub quotes. 
21             Responding to concerns about the strength of
22   critical market infrastructure, the SEC adopted
23   Regulation SCI last year to reduce the occurrence of
24   systems issues and improve resilience when systems
25   problems do occur.  In February, the SROs submitted an
0010
 1   amended plan for a consolidated audit trail that will
 2   greatly improve regulators' ability to monitor and
 3   enforce rules.  We're all anxious for its completion, and
 4   I anticipate that the plan will be published for public
 5   comment later this year. 
 6             In March the SEC proposed a rule to heighten
 7   regulation of active proprietary traders by requiring
 8   them to be FINRA members.  And throughout this time, the
 9   SEC has brought a series of actions against all types of
10   market participants to enforce rules that protect market
11   integrity and fairness. 
12             Although important initiatives to address
13   discrete market structure issues have thus already been
14   implemented or are in development.  Many of the core
15   critical questions remain to be fully addressed, and this
16   committee will play a key role in doing so. 
17             In that spirit, I just want to briefly touch on
18   one overarching issue that reaches across many aspects of
19   our market structure and deserves close attention.  And
20   that is market complexity.  
21             Complexity itself, of course, is not always
22   bad.  Complexity can be useful if it contributes to
23   better markets for investors and public companies. 
24   Complexity clearly is good when, for example, it enables
25   intermediaries to tailor their services to meet the
0011
 1   varying needs of the different types of investors in
 2   public companies. 
 3             One example of such constructive complexity may
 4   be the potential refinement of market structure for
 5   smaller companies.  I've noted before that we should
 6   question any assumption that our equity market structure
 7   should be one size fits all.  While today's market
 8   structure is largely the same for large and small
 9   companies, that does not mean that it is optimal for
10   smaller companies. 
11             The tick size pilot program, which we approved
12   last week, is intended to generate useful data to help
13   determine whether changes in the market structure for
14   smaller companies are warranted.  If the data indicates
15   that changes would be helpful, implementing such changes
16   would increase complexity to some degree, but it would be
17   based on the empirical conclusion that investors in
18   public companies would be better off. 
19             In contrast, I think much of the concern
20   expressed about our current market structure can be
21   distilled to at least a perception that it is
22   unnecessarily complex.  And by unnecessarily, I mean
23   complexity that is not directed primarily toward
24   producing better markets for investors in public
25   companies.  That kind of complexity can lead to less than
0012
 1   optimal equity market structure. 
 2             Complexity can, for example, result in
 3   instability if the sophisticated order routing and
 4   trading systems necessary to deal with a complex
 5   structure do not operate as they are intended to operate. 
 6   It can create a lack of transparency for investors about
 7   how their orders are handled and executed. 
 8             It can lead to unfair outcomes if professional
 9   traders, using the fastest, most sophisticated tools, are
10   able to exploit the complexity in ways that disadvantage
11   investors.  Complexity can also make the always-difficult
12   task of regulators in effectively overseeing the markets
13   and enforcing the rules even more difficult.  
14             Now, all of these potential effects can
15   undermine investor confidence in the integrity and
16   fairness of equity markets.  Such confidence is essential
17   if equity markets are to attract the investors needed to
18   meet the vital economic purpose of promoting vigorous
19   capital formation and economic growth. 
20             We must work to ensure that our equity market
21   structure is fair and efficient both in fact and as
22   perceived by investors.  We should look closely at our
23   own current rules to determine how and to what extent
24   they have needlessly fostered complexity. 
25             But critically, regulations alone almost
0013
 1   certainly are not responsible for all of the complexity
 2   in our market structure.  We should also look closely at
 3   industry practices that have developed over the years as
 4   market structure has evolved.  This committee will
 5   provide an excellent forum for the healthy debate and
 6   analysis that is needed. 
 7             In addition, as will occur today, there will be
 8   opportunities for others who are not members of the
 9   committee to make presentations and participate in the
10   discussions and to submit written comments for posting on
11   the SEC's website for the committee. 
12             I think it's fitting today that we are starting
13   our market structure discussion with the committee with
14   an assessment of Rule 611 of Regulation NMS, the order
15   protection rule.  The selection of this rule for the
16   inaugural meeting is reflective of how important it is to
17   examine the fundamentals of our current market and
18   regulatory structure, to explore their impact, and assess
19   their continued utility. 
20             And this is not done just for an interesting
21   discussion, although I can't believe that it won't be an
22   interesting discussion.  Rather, we are about the serious
23   business of optimizing the structure of our equity
24   markets through a careful, data-driven assessment where
25   no issue is off limits or any assumption unquestioned. 
0014
 1             And Rule 611 is most certainly a rule that
 2   features prominently in the discussion of market
 3   structure, with different views on its various aspects,
 4   including critiques that it has contributed to excessive
 5   fragmentation, led to increased off-exchange trading,
 6   harmed institutional investors, and failed to achieve the
 7   objective of enhancing displayed liquidity. 
 8             The Division of Trading and Markets has very
 9   helpfully prepared and posted on our website a memorandum
10   that is intended to help explore the extent to which
11   these claims may or may not be accurate.  Addressing Rule
12   611 will no doubt serve to highlight the other forces
13   that have shaped our market structure, whether they be
14   regulatory, competitive, or technological. 
15             Obviously, there are a number of other very
16   important aspects of our market structure that will be
17   studied and examined in future meetings.  I anticipate,
18   for example, this is only for example, that the staff
19   will circulate and publish memoranda that address topics
20   such as the maker-taker pricing model, along with the
21   access fee cap and lock/cross restrictions of Rule 610 of
22   Regulation NMS, the SEC's regulatory approach for
23   exchanges and other types of trading venues. 
24             So let me stop there and close by really
25   reiterating my very deep appreciation to the members of
0015
 1   the committee.  Your work, assisted by investors, public
 2   companies, the securities industry, and the public will
 3   greatly assist the SEC as we really work together to enc
 4   the efficiency, integrity, and fairness of our equity
 5   markets. 
 6             I also want to thank all of my fellow
 7   Commissioners for their work and support of this
 8   committee.  And I actually want to make special mention
 9   of my colleagues and friends Luis Aguilar and Dan
10   Gallagher.  The press reports of last night tell us that
11   both may be leaving the agency in the coming months.  "No
12   comment," he says.  I want to say, was it something I
13   said?  Something I said yesterday?  I don't know.  But
14   actually, I'm repressing the thought a bit, or more than
15   a bit. 
16             Commissioner Aguilar and Commissioner Gallagher
17   have both continue to just contribute tremendously to the
18   Commission and its mission, including its work on market
19   structure.  And we look forward to continuing to draw on
20   their knowledge and insights, both as long as they're
21   here and I'm sure after that. 
22             Thank you, Steve. 
23             MR. LUPARELLO:  Thank you, Chair. 
24             I would now ask the Commissioners to make their
25   opening statements, starting with the aforementioned
0016
 1   Commissioner Aguilar. 
 2             COMMISSIONER AGUILAR:  Thank you, Steve.  And
 3   let me join the Chair in welcoming everyone to the first
 4   meeting of the Equity Market Structure Advisory
 5   Committee.  I look forward to hearing your thoughtful and
 6   informed views on the topic of market structure. 
 7             Now, earlier this week, on May 11th, I publicly
 8   released a statement that discussed in detail certain key
 9   aspects of our equity market structure, particularly the
10   issues of market fragmentation and competition for order
11   flow.  I have shared this discussion with the members of
12   this committee, and I hope that you will find it helpful. 
13             Given the length of that document, I thought it
14   best to keep my remarks today brief.  However, if there's
15   a demand for it, I'd be happy to take the next hour and a
16   half and do a dramatic reading of my remarks, including
17   the 184 footnotes.  Is there such a demand? 
18             (Laughter.)
19             COMMISSIONER AGUILAR:  Hearing no demand, I
20   will proceed. 
21             Clearly, and this could be the understatement
22   of the day, our equity markets have witnessed profound
23   changes in recent years, and the result has been a market
24   structure that is tremendously complex, highly
25   interrelated, and constantly evolving. 
0017
 1             These characteristics make clear that any
 2   analysis of our markets is a challenging task.  This
 3   underscores the critical role that this committee will
 4   play in helping the Commission navigate the many
 5   difficult issues that have arisen in recent years. 
 6             Our current market structure embodies a series
 7   of tradeoffs that elevate certain policy goals above
 8   others and which benefit certain market participants more
 9   than others.  Some of these tradeoffs are perhaps
10   unavoidable.  That doesn't mean, however, that they
11   cannot be managed and fully disclosed.  I'll look forward
12   to the committee's ideas on how these tradeoffs should be
13   addressed. 
14             More importantly, as the committee conducts its
15   deliberations, I ask the members to keep in mind the
16   indisputable fact that our equity markets need to be
17   structured first and foremost to meet the needs of
18   investors and issuers.  These market participants are the
19   very reason that our equity markets exist, and it is
20   their interests that need to come first. 
21             In fact, I urge the committee to begin its
22   deliberations by asking a simple question:  How can our
23   markets better serve investors and issuers?  It is the
24   answer to this question that should drive the committee's
25   agenda.  I further urge the committee to view each of the
0018
 1   issues it considers not from the industry's perspective
 2   but from the perspective of investors and issuers.  An
 3   analysis that begins with the needs of investors and
 4   issuers is the key to ensuring that the committee's
 5   discussions are not vulnerable to vested interests. 
 6             Now, to that end, I cannot help but note that
 7   this committee is composed mainly of representatives from
 8   the financial industry rather than investors and issuers. 
 9   Accordingly, for this committee to fulfill our high
10   expectations, it will be important for members who are
11   affiliated with financial firms to check their business
12   interests at the door and focus on identifying a market
13   structure that works for investors and issuers, not for
14   their firm's bottom line.  Simply stated, the committee
15   should focus on what's good for investors and issuers and
16   not what market structure changes will put more money
17   into their pockets. 
18             This committee is a form of public service, and
19   public service is a public trust, one that requires us to
20   place the public interests above our own personal gain. 
21   I am a realist, and I recognize that it won't be easy. 
22   But I am sufficiently optimistic to believe that each and
23   every one of you will do the right thing. 
24             And clearly, we need your best and most
25   objective guidance.  Although our equity markets appear
0019
 1   to be working well by many measures, there are some
 2   aspects of our markets that require immediate attention. 
 3   Indeed, this is the very reason this committee was
 4   convened. 
 5             In my May 11th statement, I discuss some of the
 6   more pressing issues such as: 
 7             First, the need to closely monitor whether the
 8   fragmentation of our equity markets is approaching the
 9   tipping point, where the rising of lit and dark trading
10   venues may be impairing our markets' ability to discover
11   prices efficiently; 
12             Second, the importance of providing brokers
13   with better guidance on how to deliver best execution in
14   a highly decentralized marketplace that is documented by
15   speed-of-light trading; 
16             Third, the importance of defending the order
17   protection rule against efforts to limit this reach to
18   exchanges that meet a certain market share threshold; 
19             Fourth, the importance of updating the rules
20   governing the disclosure of order routing practices and
21   execution quality, which has severely lagged industry
22   developments; 
23             And fifth, the need to develop a pilot program
24   to test whether a limited trade ad restriction would
25   improve market quality. 
0020
 1             Now, these are some of the matters discussed in
 2   more detail, in way more detail, in my May 11th
 3   statement.  Of course, the statement is quite long, with
 4   over 184 footnotes, so I'm leaving a lot out this
 5   morning.  But in deference to tim considerations this
 6   morning, I'll stop now. 
 7             But let me end by again thanking the committee
 8   members for their assistance as the Commission tackles
 9   some of the more complicated issues confronting our
10   markets today that need our prompt attention and need
11   your sage advice.  And I thank you for your time and
12   deduction.  We all know you have a lot of other things
13   you could be doing, and the fact that you're here speaks
14   a lot to your commitment.  So thank you for that.  And
15   that's it, Steve. 
16             MR. LUPARELLO:  Thank you, Commissioner
17   Aguilar. 
18             Commissioner Gallagher? 
19             COMMISSIONER GALLAGHER:  Thanks very much,
20   Steve.  And Commissioner Aguilar, I think for your future
21   plans, give me your passion for footnotes.  I think a job
22   on the SEC staff in the rule-writing divisions might be
23   appropriate. 
24             COMMISSIONER AGUILAR:  That's under discussion. 
25             (Laughter.)
0021
 1             COMMISSIONER GALLAGHER:  Well, I wanted to
 2   start, like my colleagues, by welcoming the members of
 3   the committee and thanking you in advance for all the
 4   hard work we know that you're going to do.  But before I
 5   do, I also want to thank the Division of Trading and
 6   Markets, my old division, and Steve Luparello in
 7   particular, for all the hard work that goes on behind the
 8   scenes for events like this, and all the hard work that
 9   Steve's committed to do with respect to the market
10   structure review and with this committee. 
11             The task before the committee is to provide
12   advice and recommendations to the Commission on equity
13   market structure issues, and that is of immense
14   importance.  The need for fair and efficient equity
15   markets is of paramount concern for investors, American
16   businesses, and our economy as a whole.  And here at the
17   SEC, it permeates each aspect of our mission. 
18             It's been over 20 years since we last conducted
19   a comprehensive market structure review.  I think I see
20   Brandon Becker in the audience; I'll embarrass him by
21   reminding him it was his Market 2000 report in 1994.  And
22   it's been nearly three years since I first issued my call
23   for the Commission to undertake a comprehensive market
24   and regulatory structure review. 
25             So today's inaugural meeting of the Market
0022
 1   Structure Advisory Committee, I believe, is a watershed
 2   moment in the process of conducting this holistic review. 
 3   I hope and expect that the committee will be able to
 4   avoid the pitfalls that so often plague financial
 5   regulators attempting the type of big picture review that
 6   lies before you today. 
 7             Specifically, it's my hope that you'll avoid
 8   the incrementalism that leads regulators to attempt to
 9   solve each individual problem in a vacuum, leading almost
10   inevitably to additional layers of regulation.  This
11   approach exacerbates and is exacerbated by the regulatory
12   tendency to treat all problems as failures of the markets
13   themselves. 
14             Approaching a comprehensive market structure
15   review with an assumption that markets and market
16   participants are the source of any perceived problem is
17   both intellectually and pragmatically a dead end.  I
18   believe that the members of the committee are
19   well-positioned to reject such blanket assumptions and
20   instead recognize that many of the major market structure
21   issues we face today have more to do with the unintended
22   effects of regulation than failures of the markets
23   themselves. 
24             A thorough and credible review of market
25   structure must acknowledge and address the role that
0023
 1   regulation has played in developing the structure of
 2   today's markets.  I urge you not to take anything for
 3   granted in your discussions.  Everything, including
 4   statutes, regulations, and interpretations, must be on
 5   the table.  There cannot be any sacred cows. 
 6             Instead, we need to be willing to go back to
 7   first principles.  I hope that the committee will not shy
 8   away from challenging the underlying rationales of the
 9   legislation and regulations that impact market structure
10   in evaluating whether those rationales continue to make
11   sense today. 
12             Some laws and rules, such as those governing
13   the status of exchanges as self-regulatory organizations,
14   were drafted to address markets that look nothing like
15   those of today.  Others, like Reg NMS, were fatally
16   flawed from the outset.  Reg NMS in particular has come
17   to stand as the Commission's poster child for unintended
18   consequences and the need for the Commission to institute
19   retrospective reviews of its rules. 
20             Although well-intentioned, Reg NMS has
21   distorted market structure much in the way Commissioners
22   Atkins and Glassman warned it would in dissenting from
23   the rule's adoption.  Their joint dissent asserted that
24   Reg NMS was a series of unnecessarily complex
25   non-market-based rules.  One needs to look no further
0024
 1   than the staff's most recent FAQs on Rule 610 and 611,
 2   which alone span 45 pages, to vindicate their prediction
 3   of unnecessary complexity. 
 4             I'm therefore thrilled that the committee is
 5   starting its review with an examination of Rule 611 of
 6   Reg NMS.  One would be hard-pressed to find a more
 7   perfect example of regulatory distortion of market
 8   competition.  As a certain high-profile book recently
 9   stated, and I'll quote: 
10             "The fragmentation of the American stock market
11   was fueled in part by Reg NMS, which had also stimulated
12   a huge amount of stock trading.  Essentially, the more
13   places there were to trade stocks, the greater the
14   opportunity there was for high-frequency traders to
15   interpose themselves between buyers on one exchange and
16   sellers on another.  This was perverse."  Sound familiar,
17   Brett? 
18             The trade-through rule creates distortions by
19   assuming that price is all that market participants care
20   about when buying or selling equities.  What makes the
21   adoption of Rule 611 particularly frustrating is the fact
22   that there exists a less complex and burdensome
23   alternative to the trade-through rule, one which was
24   recommended at the time by Commissioners Atkins and
25   Glassman, a rule further clarifying a broker's duty of
0025
 1   best execution.  I encourage the committee to look at
 2   that and other alternatives to the trade-through rule,
 3   and review how FINRA implements its own best execution
 4   requirement for broker dealers. 
 5             There are, of course, other aspects of Reg NMS
 6   and many other SEC rules ripe for the committee's review. 
 7   For example, I hope that the committee will assess Reg
 8   NMS's flawed market data provisions and prohibitions on
 9   locked or crossed markets.  And as the committee expands
10   its review, another area in desperate need of
11   reevaluation is the SRO status of exchanges. 
12             In focusing on exchange responsibilities and
13   privileges, I strongly encourage the committee to revisit
14   the fundamental question of whether national securities
15   exchanges should continue to be self-regulatory
16   organizations.  The SRO framework was developed in the
17   context of private mutualized exchanges, a set of
18   circumstances that no longer exist. 
19             The primary rationale behind SRO status was to
20   leverage exchanges' ability to provide regulatory
21   oversight of their members.  Yet a majority of the
22   equities exchanges today outsource their regulatory
23   obligations and market surveillance to FINRA, and FINRA's
24   board is increasingly filled with independent directors,
25   which calls into question whether both the "self" and the
0026
 1   "regulatory" in self-regulatory organizations are now
 2   misnomers. 
 3             The status of exchanges matters because
 4   alternative trading systems are not subject to the same
 5   rules and restrictions as SROs.  ATSs, for example, do
 6   not face ownership restrictions and can change their
 7   operations without going through the formal and sometimes
 8   lengthy Rule 19b process.  As the exchanges continue to
 9   move away from self-regulation, the differing treatment
10   of ATSs and SRO exchanges becomes more difficult to
11   justify. 
12             I hope the committee does not shirk from
13   discussing whether and how to level the playing field
14   between SROs and ATSs, not by imposing more requirements
15   on ATSs, but rather by lessening the burden on exchanges
16   and reevaluating the benefits enjoyed today by exchanges
17   under the federal securities laws. 
18             We need to challenge the utility mindset that
19   permeates federal securities law today, whether it be the
20   notion of mutualized exchanges, the lack of competition
21   for the clearance and settlement of equities and options,
22   or the monopolistic nature of SIPs. 
23             These anachronistic ideas come to us from
24   Congresses long ago and do not reflect the markets of
25   today.  Any truly holistic review of the market structure
0027
 1   by the Commission should inevitably result in
 2   recommendations to Congress on how to update or eliminate
 3   these vestigial provisions. 
 4             Again, I want to thank the members of the
 5   committee in advance for their commitment to performing a
 6   meaningful market structure review and providing the
 7   Commission with their advice, analysis, and
 8   recommendations.  My door is always open to you, and I
 9   look forward to engaging with all of you as your work
10   proceeds.  Thanks very much. 
11             MR. LUPARELLO:  Thank you. 
12             Commissioner Stein? 
13             COMMISSIONER STEIN:  Thank you, Steve.  I look
14   around the room; it's a very impressive group of
15   individuals we have.  And I really want to thank you for
16   the pro bono time that you're going to be committing to
17   this committee. 
18             I want to echo my colleagues in welcoming you
19   to this inaugural meeting of our Market Structure
20   Advisory Committee.  It's been a long time coming, and
21   I'm excited to finally convene with you and my fellow
22   Commissioners to start to tackle some tough issues. 
23             This group is fairly large, and each of you has
24   a unique perspective on the effectiveness and the
25   efficiency of our equity markets.  Each of you has an
0028
 1   important voice, and yet not every perspective is or can
 2   be represented at this meeting today. 
 3             So as Commissioner Aguilar mentioned, I urge
 4   each of you to focus on thinking about what we must do to
 5   improve the structure and operations of the United States
 6   equity markets on behalf of all Americans.  This is the
 7   true end goal. 
 8             This includes considering and seeking out views
 9   from those not in this room today.  For example, while
10   the discussions you undertake will focus on the market
11   structure of stocks, there's no representative on the
12   committee from a public company that actually issues the
13   underlying stock.  I think that we also have to be
14   mindful that we do not have representation from retail
15   brokerage.  We need to carefully consider these
16   constituencies and interests as we move forward.  That's
17   something we all need to do. 
18             Since today's meeting is the first of this
19   important new advisory group, I thought I would briefly
20   put your work in the context of the broad sweep of the
21   Commission's efforts to develop efficient, fair, and
22   orderly markets. 
23             In the late 1960s and the early 1970s, it
24   became apparent that our securities markets were in need
25   of an overhaul.  And in response, Congress passed the
0029
 1   Securities Act Amendments in 1975, which were also called
 2   the National Exchange Market System Act. 
 3             The goals at the time were relatively clear. 
 4   They're stated in the legislation.  It was to improve the
 5   transparency of market quality information, improve the
 6   speed and the efficiency of the market, and ensure -- I
 7   also want to say promote -- fair trading, and to ensure
 8   that orders get the best price.  These were lofty and
 9   noble goals, and the SEC developed a series of rules to
10   implement this vision. 
11             First, in 1978, the Commission issued rules
12   requiring the public dissemination of quotes.  Then in
13   1981, the Commission provided additional rules creating
14   national market system securities.  Over time, the
15   Commission issued a series of other rules, and sought to
16   keep the market structure rules up to date with the
17   changing conditions.  Finally, in 2005, the Commission
18   amended and consolidated its national market system rules
19   in to Regulation National Market System, or Reg NMS,
20   which some of my colleagues have mentioned today. 
21             However, many believe that the markets have
22   outpaced regulation.  Others have questioned whether the
23   current market structure provides the best ecosystem for
24   market participants, especially investors in companies. 
25   It's time to explore those questions about the current
0030
 1   and future state of our equity markets -- in particular,
 2   whether the Commission's existing regulatory framework
 3   needs to evolve to deal with the transformative changes
 4   occurring in our markets as a result of the new
 5   technologies and methods of communication. 
 6             Today's agenda begins an examination into Reg
 7   NMS.  Since the implementation of the rules that comprise
 8   Reg NMS, there has been a vigorous and ongoing debate
 9   regarding its effectiveness.  Many of you in this room
10   have been part of that debate over time.  However,
11   there's no debate that the enactment of Reg NMS has
12   altered and transformed how our equity markets function. 
13             The Commission adopted Reg NMS nearly ten years
14   ago, and I'll just say again, a lot has changed in ten
15   years.  In 2005, mobile phones were not yet smart, and
16   the VCR was the most popular home entertainment device. 
17   In 2005, laptops were not yet popular, and only a few had
18   access to WiFi. 
19             In our financial markets in 2005, the New York
20   Stock Exchange executed nearly 80 percent of the
21   consolidated share volume compared to about 25 percent
22   today.  Today nearly 20 percent of the dollar volume of
23   NMS securities takes place on alternative trading
24   systems, not on exchanges, and that number is on the
25   rise.  As the Chair mentioned, the volume and the
0031
 1   complexity of today's securities markets is
 2   unprecedented, with activity spread among exchanges,
 3   alternative trading systems, and broker dealer
 4   internalizers. 
 5             The transformation of our markets can also be
 6   seen in daily order audit trail systems reports, or OATS
 7   reports.  As many of you are well aware, OATS reports can
 8   be a fairly good indicator of the increase in the
 9   complexity of order flow.  Between 2005 and 2015, the
10   average number of daily OATS reports for NASDAQ-listed
11   and over-the-counter-quoted securities increased over 700
12   percent, from approximately 107 million in 2005 to 868
13   million in 2015. 
14             In addition, the average daily number of all
15   OATS reports -- so that's all NMS stocks and
16   over-the-counter securities -- has more than doubled over
17   just the last four years, increasing from 1.487 billion
18   in the fourth quarter of 2011 to 3.151 billion in the
19   first quarter of 2015.  If this is where we've come in
20   just the last ten years, where will we be in the next
21   ten? 
22             So stating the obvious here, while rapid
23   advances in communications, technology, globalization,
24   and changes to the Commission's own rules have brought
25   dramatic improvements to many aspects of our equity
0032
 1   markets, they've also brought about new structures and
 2   new practices that raise serious questions about market
 3   efficiency, market fairness, resiliency, and capital
 4   formation. 
 5             In effect, today's market structure has both
 6   its strengths and its weaknesses.  And as Commissioner
 7   Aguilar mentioned, there are tradeoffs, and I think you
 8   all need to be actively talking about what those
 9   tradeoffs are.  And I also would like to reiterate what
10   Dan said -- I think everything should be on the table. 
11   We need to go back, I think, in many ways to first
12   principles. 
13             I hope that the committee's discussion today
14   about one NMS rule, the order protection rule, which is
15   also known as Rule 611, will sort of start out that
16   conversation.  I think it is a good starting place, a
17   good place to begin. 
18             I've also brought a few questions I hope you
19   can explore as the committee moves forward.  Does the
20   Commission's regulatory approach to market structure
21   continue to make sense in the current environment?  What
22   incentives are at work?  What incentives drive off
23   exchange trading?  What factors contribute to complex
24   order routing and handling?  
25             How could better disclosure and transparency
0033
 1   result in benefits for all market participants?  How
 2   should the Commission approach conflicts of interest? 
 3   How can data and audit trails support a
 4   better-functioning market?  And then there's another set
 5   of questions along the lines of, how do our markets
 6   interact with other markets out there, like the futures
 7   market?  
 8             Finally, when considering equity market
 9   structure, I think it's far too easy to lose sight of the
10   forest for the trees.  So I hope you'll continue to ask
11   some of the broad, big picture questions that underlie
12   our current market structure architecture.  Is the market
13   fair?  Is the market efficient?  Is the market supporting
14   capital formation?  If not, what are some new ways to
15   rethink market structure, given all of the current
16   disruptions? 
17             I look forward to listening to the committee's
18   work and today's discussion.  I want to thank you again
19   for the time that you're dedicating to the committee of
20   the Commission, and in my mind on behalf of the American
21   people.  My hope is the committee's work and insights
22   will lead us not to look at the past but to look forward
23   to the future. 
24             I'll arbitrarily pick 2025 and beyond, but, you
25   know, in effect, the next ten years.  We need to be
0034
 1   actively thinking about where we think things are going
 2   and how we can, I think, think about a more maybe
 3   flexible approach to deal with those changes. 
 4             So thank you again, and I look forward to the
 5   discussion today. 
 6             MR. LUPARELLO:  Thank you, Commissioner Stein. 
 7             Commissioner Piwowar? 
 8             COMMISSIONER PIWOWAR:  Good morning, and
 9   welcome.  I echo Chair White and my fellow Commissioners
10   in thanking everyone assembled for this inaugural meeting
11   of the Equity Market Structure Advisory Committee, or
12   #EMSAC, as it seems to be known on Twitter.  And a
13   special thank you to each of the committee members for
14   joining us and agreeing to serve as well as the panelists
15   for participating today. 
16             Notwithstanding our standard disclaimer that
17   the views I express do not necessarily reflect the views
18   of my fellow Commissioners, I think I can safely say that
19   all of us are pleased that we are commencing a discussion
20   of equity market structure issues.  Each of us has been
21   highlighting for some time the need to focus our
22   attention on equity market structure, and I personally
23   have been eager to get a comprehensive and substantive
24   review underway. 
25             Today's event is a good step forward.  As has
0035
 1   already been noted, the focus of today's meeting is Rule
 2   611 of Regulation NMS.  It is an important rule that is a
 3   central aspect of our current equity market structure,
 4   and thus is a perfectly reasonable starting point for the
 5   committee's review. 
 6             But in the future, I would propose that rather
 7   than have the Commission dictate a particular rule or
 8   issue for discussion at these meetings, we let the
 9   committee members themselves identify and prioritize the
10   equity market structure topics to be analyzed in this
11   forum. 
12             The committee should not just propose items for
13   the agenda.  My preference would be for the committee to
14   control the agenda.  We are fortunate to have assembled
15   this distinguished and diverse group of individuals, and
16   I would hate for us to squander their expertise by
17   artificially limiting the issues on which the committee
18   can opine. 
19             There is simply no substitute for the insights
20   that come with living and breathing the complexities that
21   Chair White mentioned and the challenges of the market. 
22   The committee members each have unique perspectives on
23   these complexities and challenges, and we should let that
24   collective experience guide the work of the committee. 
25             Furthermore, having the Commission sequence
0036
 1   meeting topics, such as proceeding rule by rule, creates
 2   the possibility that we will get lost in the proverbial
 3   forest by looking only at the trees.  Let's hand over the
 4   compass to the talented members of the committee. 
 5             The dialogue we begin today is inherently
 6   forward-looking, focused on how we can enhance current
 7   equity market structure.  However, it is important for
 8   this discussion to be grounded in the appropriate
 9   historical framework. 
10             When Regulation NMS was adopted, there was
11   uniform support for enhancing the efficiency of our
12   markets.  But what may have been forgotten in the
13   intervening decade is that the means by which the
14   Commission sought to achieve that goal was quite
15   controversial. 
16             As Commissioner Gallagher mentioned, the
17   rulemaking was approved by a 3-2 vote, with the
18   dissenting Commissioners taking the unusual step of
19   having their joint statement published in the Federal
20   Register.  That lengthy dissenting statement was
21   primarily focused on trade-through rule, the topic in the
22   spotlight today. 
23             And like Commissioner Gallagher, I implore you
24   to take the thoughtfully articulated views of
25   then-Commissioners Cynthia Glassman and Paul Atkins into
0037
 1   account as you think through the difficult issues related
 2   to the trade-through rule and equity market structure
 3   more generally. 
 4             With the benefit of ten years of experience, we
 5   should measure the impact of Regulation NMS, as well as
 6   our other rules and regulations, as well as any potential
 7   changes, against the goals and concerns that were
 8   articulated at the time it was adopted. 
 9             I hope that today's discussion and those that
10   will follow will be robust and animated.  I expect that
11   we will hear differing opinions on the issues; I would be
12   disappointed if we do not.  We need the benefit of all
13   your views to fully achieve our objective of developing a
14   better understanding of our equity markets and laying the
15   groundwork for future regulatory efforts to enhance those
16   markets. 
17             On this point, I'm not limiting my remarks to
18   just the members of the committee.  The committee is
19   necessarily limited in size, but as Commissioner Stein
20   mentioned, its composition should not be to the exclusion
21   of other perspectives.  I hope that everyone in the room
22   today, people watching by webcast, and additional
23   interested parties will provide meaningful feedback on
24   the issues we discuss or those that we have failed to
25   address. 
0038
 1             With that, I will turn it back over to Chair
 2   White for the reason we have all gathered, to hear from
 3   all of you.  I look forward to a lively discussion. 
 4   Thank you. 
 5             CHAIR WHITE:  Steve, I think it's to you. 
 6             MR. LUPARELLO:  Unfortunately, you have to
 7   listen to me for a couple more minutes before we turn it
 8   over. 
 9             Let me briefly just introduce my colleagues in
10   the Division of Trading and Markets.  To my immediate
11   right is Gary Goldsholle; he is the deputy director.  To
12   his right is David Shillman, who is the associate
13   director for the Office of Market Supervision.  And to
14   his right is Dan Gray, who is the acting head of the
15   Office of Analytics and Research, which is a name I
16   always get wrong, but I worked harder to get it right
17   this time.
18             Standard disclaimer applies, as Mike pointed
19   out, to the staff.  Our views expressed in this forum are
20   ours and cannot be attributed to the Commission or the
21   Commissioners or the body as a whole. 
22             So with that, let me do a couple of quick
23   housekeeping things.  We'll spend most of the morning on
24   administrative items, and then with a brief presentation
25   on Rule 611, which will set the stage for the afternoon's
0039
 1   conversation. 
 2             At that point, after the presentation, we'll
 3   adjourn for lunch, and then begin the afternoon with a
 4   presentation of 611 from our first panel.  We'll have a
 5   short break after the first panel, followed by a
 6   presentation by the second panel.  And finally, we'll
 7   begin the process of framing the issues with an open
 8   discussion. 
 9             In terms of an end product, I don't envision
10   that we'll be delivering a single comprehensive report as
11   a committee.  Instead, during the life of the committee,
12   we'll look to have the committee provide a series of
13   recommendations to the Commission as those
14   recommendations are formulated. 
15             In terms of thinking about how we might conduct
16   our business going forward, we anticipate at this point
17   that we'll have quarterly meetings, and at least
18   initially, anticipate that all of our meetings would be
19   in person here at the Commission. 
20             So that concludes my brief introductory
21   remarks.  And I'd like to take some time to give you, the
22   committee members, an opportunity to give a brief
23   self-introduction to your colleagues.  Please don't
24   revert to me, but just tag the person to your left, and
25   we'll move it along quickly.  Matt, why don't we start
0040
 1   with you. 
 2             MR. ANDRESEN:  Good morning.  My name is Matt
 3   Andresen.  I'm the co-CEO of Headlands Technologies.  We
 4   are a global trading firm with offices in San Francisco
 5   and London, and headquarters in recently downgraded
 6   Chicago. 
 7             (Laughter.)
 8             MR. ANDERSEN:  I am honored by the opportunity
 9   to serve on this committee with such an accomplished
10   group of experts.  I've been in and around the world of
11   electronic trading since its infancy.  Back in the '90s,
12   I was the CEO of Island, which was the largest of the
13   original wave of electronic markets. 
14             Many of the issues we'll discuss on the
15   committee can trace their origins back to that time.  But
16   we have a few examples.  In 1998, we invented the
17   maker-taker pricing model, so you're welcome. 
18             (Laughter.)
19             MR. ANDERSEN:   In 2002, Islands' dominance of
20   the price discovery process for major ETFs brought issues
21   like the imbalance between ATSs and exchanges and locked
22   and crossed markets to the fore.  And perhaps most
23   notably for today's agenda, the centerpiece of Islands'
24   public policy platform back in those days was the
25   trade-through rule. 
0041
 1             In 2000, I penned an op-ed for the Wall Street
 2   Journal pointing out what we felt were the unintended
 3   negative consequences of that rule.  I'll submit a copy
 4   of it for circulation to the committee.  The piece is a
 5   15-year-old time capsule of market structure debate, and
 6   a powerful reminder that most market structure issues are
 7   not new and are often not easy. 
 8             Questions abounded at that time, as they do
 9   now, about the tradeoffs to the benefits of having new
10   markets, the costs of resulting fragmentation and the
11   balance between electronic and human-driven price
12   discovery.  These important issues deserve to be debated
13   thoroughly, and I look forward to sharing any relevant
14   experiences and observations I have to the committee, and
15   hope that we will aid the Commission in plotting the path
16   forward.  Thank you. 
17             MR. BROWNE:  Good morning, Chair White,
18   Commissioners, members of the SEC staff, members of the
19   advisory committee.  Thank you for the opportunity to
20   provide an opening statement in connection with this very
21   important inaugural meeting of the Equity Market
22   Structure Committee. 
23             It is indeed a privilege to serve on this
24   committee and an honor to be part of an August group of
25   market structure experts.  By way of brief background,
0042
 1   I'm senior managing director at Cantor Fitzgerald on the
 2   ETF team, and formerly I was managing director of the ETF
 3   team at Knight Capital Group. 
 4             Cantor Fitzgerald was formed in 1945 and today
 5   is a premier global financial service organization around
 6   equity and fixed income markets.  Cantor operates trading
 7   desks in every major financial center in the world, with
 8   offices in 30 locations and approximately 8,000
 9   employees. 
10             When considering the structure of U.S. equity
11   markets, it is important to note that execution quality
12   has never been better for investors large and small. 
13   Indeed, studies conducted by Jim Angel, Larry Harris, and
14   Chester Spatt, three of the country's leading economists,
15   in 2010 and '13 concluded that virtually every dimension
16   of U.S. equity market quality is better than ever for
17   investors. 
18             Nevertheless, a review of market structure is
19   necessary in a market as dynamic as U.S. equities.  As
20   the Chair and the Commissioners have correctly emphasized
21   over the years, the most prudent rulemaking is based on
22   careful empirical data. 
23             We need to look closely at physical evidence
24   and how efficiently equities currently operate, and
25   assure that any rulemaking withstands rigorous
0043
 1   cost-benefit analysis.  I think all would agree that
 2   competition rather than mandated paths of trading
 3   benefits all investors and market participants. 
 4             Today's meeting centers on Rule 611, also known
 5   as the trade-through rule, which was adopted as part of
 6   Regulation NMS in 2005.  We all know that Rule 611
 7   restricts execution trades at one venue at prices that
 8   are inferior to protect quotations on other venues. 
 9             Many have argued that Rule 611 has helped to
10   level the playing field, ensuring that better price
11   quotations in the market are not ignored, as they have
12   sometimes been prior to the rule's adoption.  Thus, Rule
13   611 has assured that investors receive the best price on
14   their buy and sell orders. 
15             I would like to now just briefly touch upon a
16   few items I think would make good discussion points in
17   the future meetings of the committee. 
18             As we all know, ETFs continue to play an
19   important role in both institutional and retail investor
20   portfolios.  Indeed, assets invested in ETFs now stand
21   well over $2 trillion in the United States versus $230
22   billion on ten years ago.  ETFs continue to provide
23   investors with exposure to sectors and industries that
24   only are otherwise unable to mimic using other financial
25   instruments. 
0044
 1             Nevertheless, I do believe there are areas that
 2   should be discussed and could lead to improved efficiency
 3   in the manner in which ETFs trade -- for example,
 4   thinly-traded ETFs.  The most active ETFs, the S&P 500
 5   and NASDAQ 100, are very liquid and trade very
 6   efficiently.  However, of the approximately 1700 ETFs
 7   today traded, roughly one-third trade below 5,000 shares
 8   per day. 
 9             As more ETFs come to the market, I think it's
10   imperative to discuss ways to improve the liquidity and
11   efficiency of all market securities, not only ETFs.  One
12   potential path forward is the localized trading of ETFs
13   below a certain volume level on a single exchange,
14   allowing all market participants to display their quotes
15   on one venue.  In this way, liquidity will gather at a
16   single venue, allowing for better price discovery and
17   trading efficiency. 
18             Another topic relates to market maker
19   obligations.  As a market maker myself in U.S. equities
20   and efforts, I believe the Commission should consider
21   improvements to the rules around market maker
22   obligations, including debt requirements, percentage of
23   time at the inside, and the thesis is simple.  We need to
24   have a proper obligation and a census in place to ensure
25   market makers remain an integral part of our markets. 
0045
 1   The liquidity and stability that market makers provide is
 2   invaluable to the resilience of our markets. 
 3             Finally, amendments to Regulation SHO should be
 4   considered as well.  Today market makers generally have a
 5   few days to close out short positions following a failed
 6   deliver.  In light of this very short time frame, market
 7   makers cannot sell short to buyers in thinly-traded
 8   securities unless they cover short positions quickly, in
 9   which illiquid securities is not often the case. 
10             I appreciate the very constructive role this
11   committee will play in identification of very important
12   regulatory issues.  I echo views that are important to
13   market structure must be driven by careful analysis and
14   empirical data.  The time is right for a robust
15   evaluation of equity markets and proper discourse on what
16   changes may be appropriate.  Thank you for this
17   opportunity to serve. 
18             MR. CRONIN:  Thank you, Reggie. 
19             So first I want to thank Chair White and the
20   Commissioners, and certainly the Trading and Markets
21   Division and its staff, for putting this group together
22   and for having the fortitude and the foresight to
23   recognize that there are issues in the capital markets
24   that really do need to be addressed. 
25             My name is Kevin Cronin.  I'm the global head
0046
 1   of trading for Invesco.  And for those who don't know,
 2   Invesco is a leading global independent investment
 3   manager with about $800 billion in assets under
 4   management.  I've been with Invesco for about 20 years,
 5   and in those 20 years, I've had the opportunity and,
 6   frankly, the privilege to trade and to manage the trading
 7   of trillions of dollars on behalf of our clients. 
 8             Also in that time I've had the opportunity to
 9   participate in a number of the debates that have gone on
10   in market structure, including the debate around NMS
11   about ten years ago.  It was my belief at the time that
12   NMS was an important regulation that was going to really
13   enhance competition that really was lacking in the
14   marketplace. 
15             Our thought was, bringing through 611, for
16   example, a level of order protection was important
17   because I can tell you, as a participant, bidding $30 and
18   watching a stock trade at $29.99 or -.98 is exceptionally
19   confounding.  I promise you, if I'm confounded, others in
20   the marketplace are confounded.  So we thought it was an
21   important rule to put in place.  Maybe it would confer
22   more reason for people to post their bids and offers,
23   which of course is always a very healthy and important
24   thing in an efficient and effective market. 
25             While 611 has become the linchpin, and
0047
 1   certainly was at the time, for the debate, I would
 2   mention that I believe, and I think many of my
 3   contemporaries believe, that markets are more efficient
 4   now, certainly for the top tier of stocks.  It is clear
 5   that our transaction costs have gone down, that we have
 6   much more control and choice over where we execute our
 7   transactions, and these were important parts of the NMS
 8   initiative. 
 9             Now, while I say that, you're probably not
10   going to be surprised to hear me say there is room for
11   improvement.  There are challenges with the current
12   market structure.  I will tell you, from an institutional
13   perspective, there is way too much fragmentation.  Right? 
14   There is certainly, from our perspective, a number of
15   conflicts that have been created around order routing and
16   other things that can at times seem to contravene our
17   best execution interest. 
18             Transparency has been lost in many aspects of
19   the market, and transparency is the best way to manage
20   conflicts, certainly when it pertains to investors.  But
21   I think in the final analysis, it would be somewhat
22   one-dimensional to try to blame 611 for some of these
23   challenges.  I think it's all Matt's fault, to be honest
24   with you. 
25             (Laughter.)
0048
 1             MR. CRONIN:  The access fees and the rebates
 2   have so distorted behaviors and activities that we have
 3   now skewed the market, which I think is effective in many
 4   ways, but has skewed the market towards the trading end
 5   of the spectrum and not the long-term investing end.  And
 6   I think that that really has to be understood and
 7   addressed. 
 8             So I thank the Commission and the Trading and
 9   Markets staff for inviting me and allowing me to
10   participate in this.  I look forward to having a healthy
11   and I'm sure at times lengthy debate with my
12   contemporaries on the panel.  But I do believe the time
13   is now to really address some of these issues, which are,
14   I think, preventing us from really reaching a much more
15   efficient and effective state for investors. 
16             You probably know Brad. 
17             MR. KATSUYAMA:  Thanks, Kevin. 
18             Chair White, Commissioners, members of the
19   Trading and Markets staff, thank you very much for
20   allowing me to participate on this committee.  My name is
21   Brad Katsuyama.  I'm the president and CEO of IEX Group. 
22             We operate an alternative trading system that's
23   focused on being a simple, transparent, and fair access
24   marketplace, with the goal of creating a level playing
25   field for all market participants.  We expect to file an
0049
 1   application for registration as a national securities
 2   exchange in the near future.  Hope to launch operations
 3   as an exchange later this year. 
 4             Prior to IEX, I was the head of U.S. cash
 5   trading at the Royal Bank of Canada, and also the head of
 6   global electronic sales and trading at the Royal Bank of
 7   Canada.  So hopefully I can lend perspectives both from
 8   the broker side, cash, electronic trading, ATS
 9   operations, and obviously forward thinking as a potential
10   exchange operator.  I hope to, I guess, use all of that
11   experience to give as constructive of an opinion as I
12   possibly can. 
13             I'm definitely honored to have this
14   opportunity.  When we talk about the order protection
15   rule or trade-through rule, 611, definitely it's a
16   logical place to start the discussion because it just
17   forces a greater appreciation for how interconnected our
18   market is. 
19             As our team thought through this and as I
20   personally thought through this, you just realize how
21   many different issues are involved.  It's like a sweater,
22   and you're pulling a thread, and you're just watching
23   different things come into play, and I think it is a good
24   place to start.  611 is linked to things such as best
25   execution, access fees, market data fees, routing
0050
 1   disclosures, locked and crossed markets, and many other
 2   things. 
 3             Given the complexity and the interconnectedness
 4   when looking at the order protection rule, we feel the
 5   most constructive way to really look at it and address it
 6   would be: 
 7             First, reviewing the intended purposes of the
 8   rule at the time it was adopted, gather any evidence to
 9   support its success in achieving those purposes, and
10   defining the objectives we'd seek to achieve by repealing
11   it. 
12             Second, consider whether we can address any of
13   the current concerns, and there are many, with the order
14   protection rule through modifications to the rule rather
15   than a repeal of the rule in its entirety. 
16             And I think lastly, and this is to echo many of
17   the comments I heard this morning, during these
18   discussions we realize that different business interests
19   will inform opinions as to what is best for the entire
20   industry.  We'd like to remain cognizant of the
21   importance of the issuer and the investor in any of these
22   considerations. 
23             And as Chair White expressed in a speech on
24   market structure reform last June, as we heard several
25   times this morning, we continue our monitoring internally
0051
 1   at IEX; as the secondary markets exist for investors in
 2   public companies, their interests must be paramount. 
 3   That's the lens we'd like to view the discussions here. 
 4   And again, just thank you very much for the opportunity
 5   to participate, and look forward to talking about it. 
 6             Over to Senator Kaufman. 
 7             SENATOR KAUFMAN:  I want to thank the
 8   Commissioners, and especially the staff, for putting this
 9   on today.  This is very impressive, the information we
10   got before the meeting, and the layout for today is
11   impressive. 
12             I'm Ted Kaufman.  I first became involved in
13   financial market regulation in just 2009.  I'd spent 22
14   years on the staff of Senator Joe Biden, 19 of those
15   years as his chief of staff.  When he was elected Vice
16   President, the governor of Delaware decided to appoint me
17   to his Senate seat. 
18             I had been a market investor since receiving my
19   MBA from Wharton, and had traded stocks and bonds and
20   engaged in short selling on occasion.  This was not the
21   major thing that I was interested in when I came to the
22   Senate and just kind of gravitated into it.  And what got
23   me started was I was concerned when I learned the uptick
24   rule had been eliminated. 
25             I had always been a fan of the uptick rule even
0052
 1   though I'd engaged in short selling.  I thought it was
 2   important.  It goes back a long way.  So I joined a
 3   Republican from Georgia, Johnny Isakson, Senator Isakson,
 4   and a bipartisan group of senators to reinstate the
 5   uptick rule. 
 6             The first thing I learned was that the major
 7   opponent had argued it would not work in a digital world
 8   of high-frequency trading.  And that caused me to look
 9   into those dramatic changes in our financial markets,
10   which frankly, in my other interests, I had not been
11   involved in. 
12             The more I looked, the more I became concerned
13   that federal regulators had not kept up with the speed
14   and fragmentation of our financial markets.  I met with
15   the SEC Chair then, Mary Shapiro, and CFTC Chair Gary
16   Gensler, and found that they agreed. 
17             Some of our discussions and correspondence in
18   2009 and 2010 contributed to the proposal for a
19   consolidated audit trail.  Unfortunately, five years
20   later we are still a long way from an operating
21   consolidated audit trail.  I have a mechanical
22   engineering degree from Duke and I am not afraid of
23   technology. 
24             But after the flash crash and the length of
25   time it took to propose a cause, my concern increased
0053
 1   about both the operation and the credibility of our
 2   financial markets.  Clearly, the recent new developments
 3   on the causes of flash crash give me even more concern. 
 4             I congratulate Chair Mary Jo White for setting
 5   up this committee.  I look forward to working with you on
 6   how to deal with some of these very complex challenges. 
 7   Thank you. 
 8             MR. KETCHUM:  Good morning.  I'm Rick Ketchum,
 9   the CEO of FINRA.  First I want to thank the Commission,
10   and particularly Chair White and of course the staff of
11   my beloved Trading and Markets, for beginning this
12   session.  I think it speaks, as usual, very, very well of
13   the Commission. 
14             As I think everyone around this table knows,
15   FINRA is a registered national securities association
16   under the Exchange Act.  Among our responsibilities, both
17   directly with regard to the over-the-counter equity and
18   fixed income markets and through contractual delegation
19   with regard to equity and options exchanges, delegation
20   of some but not all of their responsibilities on the
21   regulatory side. 
22             We conduct market surveillance and look in
23   particular at crossed market abusive activity with
24   respect to the equity markets, both directly through our
25   market surveillance program and through our trading exam
0054
 1   program, looking particularly at abusive momentum
 2   ignition strategies, including some recently spoken to a
 3   great deal about with respect to layering and spoofing,
 4   marking the close, and wash sales. 
 5             Beyond that, we have rulemaking responsibility
 6   that has led us to propose a number of rules in response
 7   to Chair White's, I think, exceptionally thoughtful
 8   equity market structure speech, basically focusing on
 9   trying to enhance the transparency of the marketplace,
10   improve the quality of the present audit trail, and also
11   increase the requirements and clarity with respect to
12   firm supervisory responsibilities. 
13             In another lifetime far, far away, having begun
14   at the Commission in -- gulp -- two years after the
15   Securities Reform Act of 1975, I think it's appropriate
16   to recognize just how dramatically the Commission has
17   guided markets from the standpoint of its focus on
18   encouraging competition, transparency, and execution
19   efficiency. 
20             And markets today, whatever changes should be
21   made, are remarkably more fair, more liquid, and
22   dramatically more open from a competitive standpoint than
23   they ever have been in my lifetime, and that's to the
24   great credit of the actions the Commissions have taken
25   over decades through multiple leadership. 
0055
 1             I do think, though -- I praised the Commission
 2   for beginning this.  It is clear, as noted by other
 3   members, that with that has come substantial complexity
 4   that has resulted and often influenced trading strategies
 5   in ways that I think make sense to step back and look at
 6   carefully to determine where it truly is enhancing and
 7   protecting investors and increasing market liquidity and
 8   where it's not.  So I look forward to the conversation. 
 9             MS. KIMMEL:  Hi.  I'm Manisha Kimmel.  I'm the
10   chief regulatory officer for the wealth management
11   division of Thomson Reuters.  Thomson Reuters is a
12   leading provider to the wealth management community,
13   including front office applications and back office
14   processing.  I also sit on the consolidated audit trail
15   development advisory group, representing an
16   implementation perspective on that forum as well. 
17             Before joining Thomson Reuters, I spent ten
18   years running the Financial Information Forum, also known
19   as FIF.  The focus of FIF is the implementation of market
20   structure initiatives.  Most relevant to today's
21   discussion, one of the first major initiatives I worked
22   on at FIF was the implementation of Reg NMS.  We led the
23   operations and technology working group for the industry,
24   which included participation from the SROs, broker
25   dealers, and the vendor community. 
0056
 1             In order to continue to bring a broad
 2   perspective, industry perspective, on implementation
 3   issues to this group, FIF has formed the market structure
 4   implementation group that I chair.  And while
 5   implementation in general is borne by the industry, I
 6   think it's important to recognize that the costs of
 7   implementation are ultimately borne by both investors and
 8   issuers.  And given the scope of the regulatory cost, it
 9   could also have an impact on competition. 
10             My goal with respect to this committee is to
11   focus on the initial and ongoing impact from an
12   operations, technology, and compliance perspective.  We
13   talk a lot about the role of technology in terms of
14   changing the marketplace.  I think we also need to
15   acknowledge the role of technology in meeting compliance
16   with the rules. 
17             I'd like to thank the Commission for the
18   opportunity to serve on this committee.  Thank you. 
19             MR. KINAK:  Chair White, Commissioners, members
20   of the Trading staff, thank you for the opportunity to
21   participate.  My name is Mett Kinak.  I'm a vice
22   president, head of global equity market structure and
23   electronic trading at T. Rowe Price.  This is my
24   sixteenth year at T. Rowe and my sixth in my current
25   role, which oversees electronic and program trading,
0057
 1   market structure, and transaction cost analysis. 
 2             T. Rowe Price is a Baltimore-based global
 3   advisor with $772 billion in assets under management as
 4   of March 31st.  T. Rowe Price has a firm belief in
 5   commitment to always act in the clients' best interest,
 6   seeking best execution on trades executed on their
 7   behalf.  We are grateful to serve on the SEC Equity
 8   Market Structure Advisory Committee on behalf of close to
 9   2 million individual investors, both retail and
10   institutional. 
11             We are consistently focused on serving the
12   needs of long-term investors, ensuring that securities
13   markets are highly competitive, transparent, and
14   efficient, and that the regulatory structure that governs
15   the securities markets encourages depth, liquidity,
16   transparency, and efficient price discovery. 
17             Consistent with these goals, T. Rowe Price has
18   strongly supported efforts to address issues that may
19   impact the fairness and stability of the securities
20   markets and investors' confidence in those markets.  We
21   appreciate that a healthy market requires the
22   participation of all types of entities, but it certainly
23   seems the markets have become overly complex and
24   inherently conflicted, and deserve the serious attention
25   and assessment that the committee will hopefully provide. 
0058
 1             While I agree with Chair White's comments
 2   earlier that we need to look at current rules to
 3   determine their effects on complexity, I still feel that
 4   the best remedy for conflicts and complexity itself
 5   remains transparency.  And I urge the committee to always
 6   think about enhancing transparency and disclosures across
 7   the market structure as we discuss and determine if rules
 8   need to be modified or rescinded. 
 9             We look forward to the opportunity in advancing
10   our interests and the interests of long-term investors as
11   a whole.  Thank you. 
12             PROFESSOR LO:  Chair White, Commissioners, and
13   SEC staff, I want to thank you for inviting me to serve
14   on this committee.  It's a pleasure and a privilege.  My
15   name is Andrew Lo.  I'm a professor of finance at the MIT
16   Sloan School of Management and also the founder,
17   chairman, and chief investment strategist at AlphaSimplex
18   Group, a registered investment advisor. 
19             This is my 27th year at MIT, and in addition to
20   my appointment at the Sloan School of Management, I'm
21   also an affiliated faculty member in the electrical
22   engineering and computer science department and the
23   computer science and artificial intelligence lab.  And in
24   that capacity, I want to thank the SEC and the industry
25   for the complexity because it's created wonderful jobs
0059
 1   for our students. 
 2             (Laughter.)
 3             PROFESSOR LO:  I'll make just three very brief
 4   points.  First, I think this is an enormously important
 5   task that the SEC has set out for itself and us, and I'm
 6   honored to be a part of it.  The technology has brought
 7   some tremendous benefits to investors, but at the same
 8   time, technology also creates unintended consequences.  
 9             The second point is that as an economist, I
10   have to say that investors and all market participants
11   respond to incentives.  And as that technology develops,
12   investors will make use of it and their agents will make
13   use of it. 
14             As a case in point, a few years ago you may
15   recall that an experiment out of Switzerland, the Large
16   Hadron Collider, demonstrated erroneously that the
17   existence of tachyons, faster-than-light particles,
18   existed.  The next day after the announcement, I received
19   a phone call from an algorithmic trader, asking me to
20   introduce him to a physicist engaging in tachyon
21   research. 
22             (Laughter.)
23             PROFESSOR LO:  So regardless of whatever
24   regulations we put out and whatever technology exists,
25   investors and market participants will take advantage of
0060
 1   it. 
 2             And the last point I'd make is that complexity
 3   is itself a source of systemic risk.  And as Chair White
 4   pointed out, we have to be concerned about the growth of
 5   complexity.  So if there's any way that this body can
 6   propose rules that will simplify markets, I think that
 7   will be a benefit to all concerned.  Thank you. 
 8             MR. MECANE:  Good morning.  I'm Joe Mecane. 
 9   I'm managing director in Barclays credit and equity
10   division, and I'll start by echoing my fellow panelists
11   in thanking Chair White and the Commissioners and the
12   staff for allowing me to serve on this committee. 
13             At Barclays, I oversee the electronic equities
14   execution business, where we're focused on meeting the
15   execution needs of buy side customers.  Prior to this
16   role, I served as the head of U.S. markets for NYSE
17   Euronext, and prior to that I oversaw retail
18   internalization businesses at the UBS investment bank and
19   Charles Schwab. 
20             My diverse experience has allowed me to see
21   market structure from a number of different vantage
22   points -- buy side, sell side, exchange, internalizer,
23   and retail.  And as a result, I'd like to quickly
24   highlight three contextual observations heading into
25   today's discussion. 
0061
 1             First, our markets function reasonably well,
 2   and specifically by allowing execution offerings to cater
 3   to each of these investor groups.  As a result, we should
 4   be deliberate about making data-driven changes to our
 5   markets, given their tendencies towards a zero sum game. 
 6             Secondly, to me much of today's market
 7   structure debate becomes circular because we don't have a
 8   standardized framework for evaluating market quality. 
 9   And specifically, a retail firm, for example, will define
10   market quality primarily based on price improvement.  An
11   exchange will base market quality primarily based on an
12   NMS-like evaluation of displayed liquidity.  Buy side and
13   sell side firms will primarily evaluate market quality
14   based on transaction cost analysis and liquidity. 
15             And part of today's discussion will focus on
16   the original intent of Rule 611, which was to encourage
17   the display of limit order, which, while noble, is
18   unclear whether that is the right framework with which we
19   should consider market quality, or at least as a holistic
20   view of how we should be thinking about market quality. 
21             Third, our markets are obviously, as has been
22   noted, very complex and interrelated, and we need to be
23   cautious, to look holistically at making any significant
24   rule changes in an attempt to fully anticipate what
25   impact any rule changes might have on the operations of
0062
 1   our marketplace. 
 2             Thank you, an I look forward to today's
 3   discussion. 
 4             MR. NAZARALI:  Good morning.  My name is Jamil
 5   Nazarali, and I'm the head of Citadel Execution Services,
 6   the client market making business of Citadel Securities.  
 7             Citadel Securities is one of the largest market
 8   makers in the U.S. and the largest destination for retail
 9   equity and options investor orders.  On an average day,
10   we trade approximately 14 percent of U.S. consolidated
11   volume and handle about 30 percent of retail equity
12   orders. 
13             I'd like to thank Chair White and the
14   Commission for creating the Equity Market Structure
15   Advisory Committee and for inviting me to participate,
16   though I wish you would have chosen a different name.  I
17   think the committee will be a great mechanism for the
18   Commission to collect and understand different
19   viewpoints, and I hope that we can be helpful to you as
20   you review and analyze equity market structure. 
21             Since the committee's agenda was published a
22   week and a half ago, we've actively engaged with our
23   retail equity clients, and the ones we've talked to have
24   strongly expressed their support for Rule 611.  They feel
25   that any changes to 611 would not only harm retail
0063
 1   investor clients but also, as importantly, damage
 2   investor confidence and the perception of fairness in the
 3   market. 
 4             Over the past ten years, equity markets have
 5   dramatically improved.  Today retail investors get
 6   better, faster, cheaper executions than ever before. 
 7   Retail equity investors in the U.S. get a better deal
 8   than anywhere else in the world or in any other market. 
 9             Today, on average, it costs a retail investor 4
10   basis points after price improvement to do a round-trip
11   trade.  That means an investor can buy and sell $100,000
12   of stock for $40 in transaction cost.  That same trade in
13   corporate bonds would cost them 2- to $3,000. 
14             Despite all the gains to retail investors over
15   the last ten years, there continues to be a lingering
16   perception of unfairness or that the markets are rigged. 
17   The last thing we need right now is to remove the
18   fundamental protection of the trade-through rule, which
19   has been so beneficial to our clients. 
20             Critics complain about complexity.  These
21   critics ignore the fundamental simplicity of Rule 611
22   that it provides to the marketplace and our retail
23   clients.  Today retail investors know their orders must
24   be executed at or better than the best available price. 
25   Fundamentally, this seems fair.  Today retail investors
0064
 1   know that their limit orders must be executed before the
 2   market trades at an inferior price.  Anything else would
 3   be unfair.  The Commission should not jettison these
 4   fundamental protections. 
 5             Once again, thank you to the Commission, and we
 6   look forward to the discussions. 
 7             MR. NOLL:  Good morning.  My name is Eric Noll. 
 8   I'm the CEO of Convergex Group.  Prior to joining
 9   Convergex a little over a year ago, I was the executive
10   vice president in charge of U.S. equity and options
11   markets for NASDAQ and other global venues for NASDAQ
12   other than the Nordic markets. 
13             Thank you, Chair White, and Commissioners, for
14   the opportunity and honor to represent the interests of
15   agency brokers and our customers, institutional
16   investors, as well as the market at large, at this
17   important committee. 
18             When it was first determined that the topic to
19   be addressed was Rule 611 and the rest of the order
20   protection safeguards, I thought this might be an
21   opportunity to address directly some of the broader
22   issues raised by many market commentators. 
23             Taking as a starting point Commissioner
24   Aguilar's first priority of putting investors and issuers
25   who utilize the equity markets first, and in the spirit
0065
 1   of Commissioner Gallagher's point putting everything back
 2   on the table, I think the time might be now to change the
 3   nature of order priority in the marketplace -- in short,
 4   to replace what is now the strict price-time priority
 5   schemes that operate mostly in the equity markets with
 6   one that grants priority to customer orders over all
 7   others. 
 8             While new in the modern market context, it has
 9   existed with some success in the equity options markets
10   here in the United States, and there are several ATSs in
11   other market venues who have used customer priority to
12   great effect to drive benefits of the market to the end
13   investor.  By allowing real customer orders to go to the
14   top of the order queue, it prioritizes that investor
15   interest over all others in the market at that price. 
16             While potentially disruptive to the markets as
17   they are structured today, including potentially
18   affecting the business models of many market
19   participants, the change would have the benefit of
20   putting the customer front and center in the interactions
21   in the marketplace. 
22             It also has the potential to drive flow back
23   into the lit market, eliminate and reduce latency
24   arbitrage if implemented appropriately, potentially
25   increase order execution size, and concentrate liquidity
0066
 1   and increased certainty of execution for customer orders. 
 2             By creating customer priority in the equity
 3   markets, there would still be many complex questions to
 4   be answered.  Is customer priority on the book
 5   consistent, workable, or advisable in our maker-taker
 6   environment?  And if so, how would that work?  And if
 7   not, should there be the creation of another class of
 8   market participants, market makers who have obligations
 9   and affirmative rights and responsibilities in the
10   marketplace? 
11             Should a concept of internalization or broker
12   priority go hand in hand with customer priority as an
13   incentive to drive flow back to the lit markets and to
14   increase certainty of execution?  Should customer
15   priorities exist across venues, the market as a whole, or
16   should they exist only within a venue?  
17             Should the concept of a professional customer
18   also be developed similar to the way it works in the
19   options market to eliminate and reduce the risk of
20   current proprietary trading broker dealers changing their
21   legal status to take advantage of customer priority in
22   the marketplace?  And then finally, how does this affect
23   market data, proprietary data feeds, in the way market
24   data is distributed, in the way order book priorities are
25   currently made available to the rest of the marketplace?  
0067
 1             While these questions certainly may be
 2   challenging to answer, I think they are subject to
 3   testing, analysis, and a reasonable conclusion.  I think
 4   the benefit of making this kind of change in the market
 5   as a whole is, again, it enshrines the customer as the
 6   centerpiece of our markets and in capital formation,
 7   which I think is the most important thing that we as this
 8   committee should be working on. 
 9             In conclusion, I would also ask the committee
10   to think about other secondary effects.  Commissioner
11   Stein mentioned a few of them.  Joe Mecane also mentioned
12   a few of them.  But some that have not been mentioned
13   this morning which I think are equally as important and
14   probably not well thought of at this point is, what are
15   changes that this committee recommends going to do to the
16   equity options markets?  
17             Those two markets are inextricably linked. 
18   Whatever changes we do around order protection or changes
19   in the market structure will, of necessity, cause changes
20   to the equity options market.  What will changes that we
21   recommend herein do for the futures market and the way
22   those markets change?  
23             How will that interaction affect the way the
24   overall market ecosystem works?  And finally, what other
25   changes will this make for index calculation, ETFs, and
0068
 1   other asset managers that rely on market data for the
 2   results and in the way they manage their firms?  
 3             So I think those are important to keep in mind
 4   as we make these changes because there will be secondary
 5   consequences to the changes that we recommend here to all
 6   of those aspects of the market ecosystem.  Again, thank
 7   you for the opportunity to serve. 
 8             PROFESSOR O'HARA:  Good morning.  I'd like to
 9   join the precedent set before me and thank Commissioner
10   White and the other Commissioners and the staff for the
11   opportunity to join this very important committee that
12   we're meeting for the first time today. 
13             I'm Maureen O'Hara.  I'm a professor of finance
14   at Cornell University; that's my day job.  But I also am
15   chairman of the board of ITG.  We are a global agency
16   broker dealer firm.  We're very active in crossing
17   networks.  Our POSIT crossing network is one of the
18   largest.  We're also a very active algorithmic trader,
19   and we meet the needs of buy side clients. 
20             I have in the past spent a lot of time doing
21   research on market microstructure.  And as a finance
22   professor, I have been involved in trying to think
23   through carefully what do we want our markets to do?  How
24   do we want to change the structure to make them
25   successful?  I was very pleased to have been part of the
0069
 1   infamous flash crash commission and have an opportunity
 2   to be part of the solutions that came out of that. 
 3             I'd like to talk today about just a couple of
 4   things that I would like us to think about as we go
 5   through the important work of this committee.  One of the
 6   things that I would like to take us back to is, actually,
 7   issues that the Commissioners each raised, which is, what
 8   do we want our markets to do?  And fundamentally, we
 9   often talk about markets as providing liquidity and price
10   discovery.  So whatever we do, we really have to keep in
11   mind, how is that going to be effective?  
12             One of the things that's become very clear in
13   the high-frequency world that has emerged since the last
14   time the market structure issues were put in place is
15   that the nature of information has changed.  Even what
16   information is -- who's informed?  What is adverse
17   selection?  How does any of that work -- is very
18   different. 
19             And that has a particular implication for what
20   does market data have to be.  So I join Eric in arguing
21   that the market data issues in some sense are
22   extraordinarily important because with information
23   changing, what information the market needs may have to
24   change. 
25             And yet prices and quotes have been essentially
0070
 1   the way we've looked at it.  Does that make sense any
 2   more?  How should we be thinking about structuring that
 3   environment?  Because as Commissioner Stein pointed out,
 4   our work today is not to fix what evolved over the last
 5   ten years.  It's really to be thinking about what's going
 6   to evolve over the next ten as well.  And so I think
 7   that's extremely important. 
 8             In addition, one of the things that's also
 9   changed is the nature of regulation.  One of the things I
10   think we learned during the flash crash and the issues
11   surrounding that is that nothing is a silo any more.  And
12   I think that echoes, again, points that Eric has made. 
13             We cannot actually think about the equity
14   market structures independently of how they're going to
15   be linking into the future.  And, as we've seen with the
16   issues that Mr. Browne brought up, the entire existence
17   of the ETF world lying on top of this basic equity world
18   that we're used to changes the nature of how the
19   information is going to flow both across, within, and
20   around all of these markets. 
21             So one of the things we learned in the flash
22   crash, I believe, is that regulation has to be
23   forward-looking.  You do not have time to change the
24   market after problems occur.  You have to have already
25   prespecified what's going to happen.  You have to have
0071
 1   contingent regulation.  And I think the SEC has done a
 2   good job of moving forward on that.  I think, as we think
 3   about these issues, so do we (sic). 
 4             And finally, I would like to just come back to
 5   the idea of Reg NMS.  I think of Reg NMS as the rules of
 6   the road.  As anyone who's ever tried to teach a
 7   16-year-old how to drive, we all know the simpler the
 8   rules of the road, the better.  And the rules have to be
 9   clear, and the rules have to be applying to everyone. 
10             I think that that doesn't necessarily mean that
11   we want one market for everyone.  That's not the way it
12   works.  We need a market that works well for everyone. 
13   And the rules of the road have to be clear.  I think
14   looking at Rule 611 and 610 is a great opportunity
15   because the rules of the road change over time as
16   technology changes.  And the one thing that we know has
17   happened is the market now is not the market of ten years
18   ago.  The rules that may want to govern that technology
19   are not the rules from before.  
20             So thank you for asking me to join this group,
21   and I look forward to learning from all of you and our
22   discussions. 
23             MR. RATTERMAN:  Good morning.  My name is Joe
24   Ratterman.  I'm the former CEO and current chairman of
25   BATS Global Markets.  I'd like to thank the Commissioners
0072
 1   and the staff for inviting me to participate on this
 2   Market Structure Advisory Committee. 
 3             By way of background, I was one of the founding
 4   employees of BATS in 2005.  And prior to helping launch
 5   BATS, I held a variety of positions in and out of the
 6   securities industry, with a price focus on technology in
 7   each of those positions. 
 8             The adoption of Reg NMS with the order
 9   protection benefits it provided to automated markets
10   served to further enhance a trend well underway towards
11   the greater automation of our equity markets.  As a
12   practical matter, Regulation NMS led to the full
13   automation of the New York Stock Exchange, enhancements
14   to the already automated NASDAQ, and widespread adoption
15   of sophisticated order routing technology, which
16   ultimately linked together increasingly dispersed pools
17   of liquidity. 
18             As the operator of four SROs in the U.S., BATS
19   has had a unique view of the impact of Regulation NMS
20   through both the implementation and the enforcement of
21   its requirements.  Reg NMS paved the way for increased
22   competition between limit orders, between exchanges, and
23   between exchanges and broker dealers, marrying in several
24   key respects the intent behind Congress's 1975 National
25   Market System Amendments to the Exchange Act. 
0073
 1             The automation of our markets along with the
 2   continual performance improvements over the years has
 3   served to mitigate risk, which benefits all investors in
 4   the form of a lower risk premium, expressed as tighter
 5   spreads and lower transaction costs for retail and
 6   institutional investors alike. 
 7             In fact, our equity markets are widely
 8   considered the most liquid, transparent, efficient, and
 9   competitive in the world.  Costs for long-term investors
10   in the U.S. equities are among the lowest globally and
11   declining.  And these gains have been quantified by noted
12   investors and experts alike. 
13             Yet despite these measurable benefits,
14   transformational change also tends to bring new
15   opportunities and challenges, many of which may not be
16   easy to foresee.  And the changes wrought by the
17   implementation of Reg NMS were no exception. 
18             It is unquestionable that certain provisions of
19   Reg NMS, including the prohibition on the display of
20   locked or crossed markets, has created increased
21   complexity in the markets as SROs like BATS implemented
22   systems controls to enforce those requirements through
23   complex order handling logic. 
24             And despite the near perfect operation of the
25   equity markets through the unprecedented market volumes
0074
 1   and volatility during the financial crisis of 2008 and
 2   '09, the flash crash in 2010 highlighted some fragility
 3   brought on by our highly automated and fragmented equity
 4   markets. 
 5             In response, the industry, guided by the SEC,
 6   took several impactful measures to prevent a recurrence,
 7   including the elimination of so-called stub quotes,
 8   modernization of the industry-wide circuit breakers, the
 9   adoption of single stock circuit breakers, and finally,
10   the rollout of limit up/limit down. 
11             I believe some key principles emerged from
12   these market developments over the last decade and are
13   worth keeping in mind as we debate ideas and develop
14   recommendations for potential action. 
15             First, let's recognize the benefits of our
16   current market structure and what it delivers to
17   investors, and not take action that will risk undermining
18   those benefits. 
19             Second, because we cannot know with certainty
20   the impact of any regulatory change, to the greatest
21   extent possible let's test new ideas through discrete
22   pilot programs and analyze the resulting data before
23   deciding whether to implement permanent change. 
24             Third, let's consider the possibility that the
25   current size-fits-all nature of our existing equity
0075
 1   market structure may not work well for securities of some
 2   companies and may underserve others. 
 3             And finally, let's agree not to be dogmatic
 4   about prior market structure changes.  While we each have
 5   held different views at the time on the merits of any
 6   particular proposed regulation and any of those that form
 7   the backbone of our equity market structure today, the
 8   industry has adapted to these changes and has delivered
 9   an efficient experience for investors.  It is not enough
10   to assume that assumptions in the past that may have been
11   true are now going to be true in the absence of the
12   implementation of the rule. 
13             So finally, I'd like to thank again the
14   Commission and the staff for the opportunity to represent
15   my views on market structure in this forum, and I look
16   forward to working with my fellow committee members on
17   the road ahead. 
18             MS. SMITH:  Hello.  My name is Nancy Smith, and
19   I'm with the AARP.  I must admit I feel a little lonely
20   here today, but I would like to thank Chairman White and
21   the Commissioners for making me feel very welcome because
22   what I heard you say, and I just want to repeat the key
23   take-aways that I heard, I think speak to the role of all
24   of us representing individual investors as we do the work
25   of this advisory committee. 
0076
 1             So what I heard was, put investors and issuers
 2   first.  Examine complexity, conflicts of interest,
 3   inappropriate incentives.  Look at the regulations and
 4   laws that are in some cases behind the pace of change in
 5   the markets.  Everything is on the table, music to my
 6   ears and I think others as well.  Don't get lost in the
 7   trees.  Is the market fair?  Represent those that are not
 8   on this committee.  So you made me feel very welcome, and
 9   you brought in the scope of what we're all about here
10   today. 
11             So why AARP?  Well, AARP has a broad social
12   mission:  Meeting the needs of those 50-plus.  Central to
13   our mission is financial security.  Every dollar makes a
14   difference for the vast many of Americans who are
15   investing for retirement.  If investors feel the markets
16   are too complex, too dangerous, too risky, their
17   retirements will suffer as they withdraw and decide not
18   to invest, and investor confidence will erode over time. 
19             I've spent most of my career in the service of
20   individual investors.  I got my feet wet in security
21   issues in October of 1987, working in the U.S. House of
22   Representatives for Edward Markey.  That was the first
23   time I think we saw program trading, portfolio insurance,
24   index arbitrage, all those things. 
25             And in many ways, the issues are similar. 
0077
 1   Where is the liquidity going to be if there is another
 2   stress event in our markets?  I've been a state
 3   securities regulator, and yes, I've worked at the SEC.  I
 4   helped open our first office, SEC's office, focused on
 5   individual investors, and while I was doing that, did a
 6   major project on plain language, plain English.  And I
 7   would say we have a lot of work still to do on that.  But
 8   I'll bring those skills hopefully to bear as I work with
 9   my fellow colleagues here. 
10             So I would like to very much thank you all for
11   the opportunity to serve and represent the views of
12   retail investors, and I look forward to working with my
13   fellow colleagues here on the committee as well. 
14             PROFESSOR SPATT:  Thank you.  My name is
15   Chester Spatt.  I'm a professor of finance at Carnegie
16   Mellon University, and I had the opportunity to serve as
17   the Commission's Chief Economist from 2004 to 2007, which
18   of course was the period of time when NMS was adopted by
19   the Commission.  And I appreciate the opportunity to
20   serve on this committee to talk about market structure,
21   which will examine and help the Commission deal with
22   these complex issues of market structure. 
23             I first started studying electronic markets in
24   the early 1990s.  Of course, the U.S. was far from
25   electronic in much of that period of time, so my earliest
0078
 1   slide of electronic markets actually involved data from
 2   the Paris Bourse.  And I learned a lot about how
 3   electronic markets could work, did work, in that era. 
 4   Another early study that I did actually used data from
 5   Matt ANDERSEN's emerging platform at the time, Island,
 6   and was an opportunity to study competition between the
 7   Island platform and NASDAQ. 
 8             NMS, of course, has had many effects.  It moved
 9   us forward with respect to the focus on fast markets.  It
10   created in some respects a more competitive environment
11   by transforming the former NYSE specialist system and
12   changing the market shares within the securities
13   industry.  It led to dramatic declines in the costs of
14   trading for small investors, although, frankly, less
15   clear impacts on the costs of trading by small investors
16   when their orders are part of institutional positions,
17   which they also often area. 
18             NMS has also had, obviously, a variety of
19   impacts on the trading process in many ways.  It's led to
20   features, which many have objected to, such as at the
21   inherent backing away from quotes after small execution. 
22   That's sort of inherent in the nature of the trading
23   process, in the nature of adverse selection and selection
24   bias, that small executions sometimes are the first piece
25   of larger executions, so naturally there's backing away
0079
 1   after initial executions. 
 2             It's led to much more fragmentation, I think
 3   partially for good reasons, partially, perhaps, for not
 4   so good reasons.  How has it done that?  Well, it's
 5   provided for more scope for diverse models; that
 6   inherently has led to fragmentation.  That's perhaps a
 7   good reason. 
 8             Perhaps not such a good reason, it's provided
 9   special regulatory relief to orders that are at the top
10   of the book, but not of orders anywhere else.  So it's
11   provided order protection, but only at the top of the
12   book, and that provides an inherent incentive to enter. 
13   And so in that sense, I think it has partially led to
14   entry and led partially to the proliferation of
15   platforms.  Also, the electronic focus, I think, has led
16   to less of a need to get unified fills.  So in some ways
17   it's made fragmentation probably much less costly than it
18   probably would have been in the prior regime.  
19             As pointed out earlier today, in a way NMS
20   could be viewed as a little bit of a substitute for best
21   execution.  Now, NMS was a requirement, of course, on the
22   platforms.  Best execution is the responsibility of the
23   broker dealers.  In a way, some of the motivation for NMS
24   was more about best execution, I think, than many of
25   these other issues.  But in a way, it's sort of a
0080
 1   substitute.  And I was pleased to hear that issue joined
 2   today; I don't see that as having gotten the attention
 3   that that really deserves. 
 4             Finally, I just thought I would make just a
 5   brief remark about the things that I'm currently involved
 6   in as an academic.  So recently I certainly have been
 7   thinking a lot about the equilibrium consequences of
 8   access fees and the incentive effects associated with
 9   some of the conflicts of interest, and also have been
10   thinking about some related types of issues which seem to
11   me somewhat relevant, although perhaps nominally outside
12   the sphere of this committee. 
13             One aspect, which a number of folks alluded to,
14   are the costs of fixed income trading.  I've been
15   involved using data from FINRA on understanding
16   securitization of trading costs.  And in a somewhat
17   different context, I've been involved in understanding
18   the impact of lending fees and specialness.  And I think
19   that's one of the aspects of the plumbing of our equity
20   markets that's also important. 
21             And if I think of maybe one aspect of the
22   equity markets where there's much greater scope for
23   transparency, it does seem to me the lending markets are
24   probably ones that deserve maybe a fair amount of
25   scrutiny, and like the fixed income markets, perhaps a
0081
 1   lot of opportunity and scope for significant improvement
 2   for America's investors. 
 3             I look forward very much to learning from our
 4   committee's discussions. 
 5             MR. STONE:  And everyone has a sigh of relief
 6   that I'm the last one.  It's like my high school
 7   graduation, the last person in line. 
 8             Thank you, Chair White, for forming the
 9   committee, the Commissioners for your opening statements,
10   Mr. Luparello for putting together the agenda, and my
11   fellow market structure committee members.  My name is
12   Gary Stone.  I'm the chief strategy officer of Bloomberg
13   Tradebook, which is Bloomberg's global agency broker.  I
14   would like to thank the Commission for appointing me to
15   this committee.  I take this honor very seriously, as
16   does everybody else on the panel. 
17             I hope to be able to provide our group with a
18   multi-asset-class insight from a practitioner's point of
19   view.  I believe it was Professor O'Hara and also Reggie
20   who pointed out that technology is making correlated
21   assets affect our equity market structure.  And so when
22   we think about the rules, we have to think about the
23   influences of the futures market and options market on
24   the U.S. equity market. 
25             I hope to provide also the views of Bloomberg's
0082
 1   325,000 terminal-based clients, a universe that includes
 2   HFTs as well as hedge funds, broker dealers, buy side
 3   institutions, sell side clients of our trading systems,
 4   and our electronic trading products and services. 
 5             Bloomberg Tradebook, which is where I work, is
 6   an agency broker that provides services in 65 global
 7   markets and the U.S. options market, global equity
 8   markets and the U.S. options market.  We operate an FX
 9   marketplace, and we also are an independent service
10   vendor for futures commissions merchants for 35 global
11   futures markets and their related fixed income and
12   options products. 
13             I think everyone would agree in this room that
14   the U.S. equity markets are among the best in the world,
15   and everyone has said that there are challenges and we do
16   need to address them.  A holistic review of Reg NMS is
17   really long overdue, and while Rule 611 is a starting
18   point, it's really only one piece of the market structure
19   puzzle. 
20             We can be most assistance to the Commission if
21   you tap our collective expertise in the scope of the
22   market structure challenges and the regulatory proposals
23   impacting the structure, both the stuff that's in the
24   work and the stuff that we're going to be talking about. 
25             While consensus may be elusive, debate
0083
 1   discussion will be illuminating.  And you brought us
 2   together, so I'm going to ask you, please, to use us. 
 3   Use us not only for our perspective, but use us to help
 4   set the future agenda of what we're going to talk about. 
 5             After speaking with scores of clients, they
 6   identified a wide range of issues that they felt needed
 7   to be considered as we work through the longer-term
 8   holistic review.  And, for example, when we spoke to
 9   institutions such as Kevin and Matt, one of the things
10   that they wanted was a recognition from the Commission
11   what their orders represent, which is pooled retail
12   participation.  And as such, they believe that gives them
13   the right to be able to have a block trade exemption from
14   Rule 611 because they feel that Rule 611 is limiting a
15   key driver of block trade negotiation of price. 
16             Also, as we conduct this market structure
17   review, we also have to be mindful of the fact we live in
18   today's markets, and as such, many felt that there are
19   issues that need immediate attention and consideration
20   that we believe this group can help with, not only
21   identify but also talk about potential solutions and
22   guidance. 
23             We still get flash crashes and melt-ups.  Our
24   clients told us that we need to look at limit down and
25   determine if we need to tighten the ranges.  They also
0084
 1   noted that we sorely need guidance on quoting
 2   responsibilities under Rule 610 because that goes to the
 3   heart of the principle, displayed protection, as well as
 4   promoting the market depth through the treatment and
 5   promotion of reserve orders. 
 6             And some noted that the Commission needs to
 7   start to look more about the safety and soundness in
 8   today's market structure by expanding the support for
 9   either NASDAQ or the New York Stock Exchange's test
10   tickers to all ATSs and exchanges, as well as the front
11   office and back office. 
12             Other issues they said that we needed to look
13   at was SIP governance.  605/606 transparency needs to be
14   reworked prior to MiFID coming out.  The U.S. needs to
15   take a lead role in the definition of order routing
16   statistics because that is something that the Europeans
17   are working on, and we need to have a say in it from our
18   perspective and our market structure. 
19             Many of the issues that I have just laid out
20   actually don't require new rules.  They actually require
21   just simple guidance and transparency notices in order to
22   not only level the playing field as to how things are
23   supposed to and what the standards are in the market, but
24   they can have a dramatic impact in a positive way for how
25   the markets work today. 
0085
 1             And so I just want to close by saying that I
 2   look forward to discussing Rule 611.  I look forward to
 3   setting up, potentially, subcommittees on some of the
 4   topics that we talked about to deal with today's issues. 
 5   As we talk about Rule 611, we tend to talk about it in
 6   the aggregate.  I hope that our panelists' and our
 7   comments are actually segregated out as high-volume
 8   stocks and lesser liquid stocks, and discuss Rule 611 in
 9   that context rather than just generally how it works. 
10             Again, I thank you very much for the
11   opportunity to serve, and I look forward to working with
12   everyone. 
13             MR. LUPARELLO:  Thank you, Gary, and thank you
14   to the rest of the panelists.  That was all tremendous. 
15             We're going to do a quick administrative item
16   on the bylaws and then we'll take a short break after
17   that.  I thought about flipping the order, but I think
18   it'll keep the bylaw conversation shorter if we have it
19   before the break as opposed to after. 
20             So the charter was provided to you in advance,
21   as were the proposed bylaws.  So if you would turn to
22   your first tab in the book, and I would just ask if we
23   could have a motion from one of the committee members for
24   consideration. 
25             COMMITTEE MEMBER:  So moved. 
0086
 1             MR. LUPARELLO:  Do we have a second? 
 2             COMMITTEE MEMBER:  Second. 
 3             MR. LUPARELLO:  Very good.  Are there any
 4   questions or clarifications about the bylaws or any
 5   concerns? 
 6             (No response.)
 7             MR. LUPARELLO:  I think, in aid of a quick
 8   break, it seems like there's none.  I call for a vote. 
 9             All in favor of the bylaws? 
10             (A chorus of ayes.) 
11             MR. LUPARELLO:  Any opposed or abstentions? 
12             (No response.)
13             MR. LUPARELLO:  Great.  So we will take a
14   ten-minute break and come back with a presentation from
15   the staff on Rule 611. 
16             (A brief recess was taken.)
17             MR. LUPARELLO:  Next on our agenda is a brief
18   presentation of the Trading and Markets paper on 611. 
19   It'll be presented by Dan Gray, who I introduced
20   previously.  I would encourage you during the course of
21   his presentation to challenge him or us or each other
22   with questions or issues or observations.  We'll try to
23   keep this part of the agenda to 20 to 30 minutes.  We'll
24   then break for lunch and pick back up on these
25   conversations with panel presentations at 1:00. 
0087
 1             So Dan? 
 2             MR. GRAY:  Thanks, Steve.  My task is to kick
 3   off today's discussion of Rule 611.  As Steve mentioned,
 4   the Division has prepared a memo that is intended to help
 5   facilitate an assessment of Rule 611 that was circulated
 6   to the committee members a few weeks ago.  It has been
 7   posted on the SEC's website. 
 8             It begins with some background on the rule and
 9   how it operates.  And I'm not going to rehash that this
10   morning, particularly given that this is the last time
11   slot before lunch, but did want to highlight some points
12   from the back part of the memo, which is the heart of the
13   memo, which tries to give some analysis and some data
14   tables that can help at least get one into the right
15   ballpark for assessing what the effects of Rule 611 are. 
16             It's obviously an important issue because
17   certainly, if you're talking about reforming 611,
18   rescinding it, or modifying it in a number of different
19   ways, one of the good ways to try and assess how those
20   changes would operate is to have an understanding, a
21   realistic understanding, of what the effects were in the
22   past. 
23             And it's an important issue because I think if
24   you take a 30,000-foot level of what's happened to the
25   U.S. markets over the last ten years, and particularly
0088
 1   you focus on New York Stock Exchange-listed stocks, it's
 2   easy to overstate the importance of 611. 
 3             And I think everyone knows that narrative,
 4   where Rule 611 was adopted in 2005 and implemented in
 5   2007.  Before 611, the New York Stock Exchange trading
 6   floor had dominated trading in its stocks for many, many,
 7   many years and maintained an 80 percent market share. 
 8   Two years after Rule 611 was implemented, it was down to
 9   less than 30 percent, and what had been a manual trading
10   environment was an electronic trading environment. 
11             What the memo tries to highlight, though, is
12   that if you look a little closer, you can see that
13   probably there were some other forces, some important
14   forces, working there as well, whether it be other
15   regulations, competitive forces, or technology forces. 
16             And the way it tries to do that in particular
17   is by separately looking at data and analyzing
18   NASDAQ-listed stocks before and after Rule 611 was
19   implemented and New York-listed stocks.  And when you
20   focus on NASDAQ-listed stocks, you can see that the story
21   is pretty different from what the story and what the
22   chronology was for New York Stock Exchange-listed stocks. 
23             When Rule 611 was adopted in 2005, the market
24   had already transformed from what had been the
25   traditional dealer market.  You have some very electronic
0089
 1   lit venues that had acquired a dominant market share. 
 2   You had seven lit venues trading, splitting the volume
 3   among lit venues.  And you had significant levels of
 4   trading at dark venues, 29 percent. 
 5             Given that all those changes had happened even
 6   though NASDAQ stocks had never up to that point been
 7   subject to a trade-through rule, I think you have to
 8   recognize that some of those changes -- or it's hard to
 9   attribute those changes to Rule 611. 
10             The tables are intended to show that if you
11   compare NASDAQ stocks before and after to New York stocks
12   before and after, there are definitely changes in NASDAQ
13   stocks.  But they just weren't on the order of magnitude
14   that happened with New York stocks. 
15             Another point that the memo tries to highlight
16   is with respect to New York stocks, one of the major
17   complicating factors was it had been subject to a
18   trade-through rule pre-611, and that old trade-through
19   rule had protected manual quotes and gave manual markets
20   30 seconds to respond to incoming orders. 
21             So that old rule was rescinded at the same time
22   Rule 611 was implemented in 2007, which creates a pretty
23   difficult problem of causation versus correlation.  And
24   one way to think about the relative effects of rescinding
25   the old versus implementing the new is to put on your
0090
 1   imaginative hat and think, today, what would be the
 2   difference if the Commission just decided to rescind Rule
 3   611 alone versus what if it decided to reinstate the old
 4   trade-through rule with its protection of manual quotes
 5   and 30-second response times?  What would be the effect
 6   on the current market structure? 
 7             So when you think about that, I think it
 8   highlights the point that if you've done a more realistic
 9   assessment of Rule 611 effects, NASDAQ stocks probably
10   are a better place to look. 
11             I'm just going to finish up with a couple more
12   points that are hit in the last part of the memo.  One
13   is, to what extent did the rule hit its intended targets? 
14   It had two primary objectives, one of which was to
15   minimize the extent to which investor orders are executed
16   at unfavorable prices or inferior prices to accessible
17   quotations.  And to focus on that issue, the memo
18   provides some trade-through rates that came from the
19   adopting release for Rule 611 versus trade-through rates
20   that were calculated for February of last year. 
21             Prior to Rule 611, trade-through rates were
22   more than 2 percent of trades.  As of February last year,
23   the trade-through rate was 0.1 percent.  So trade-through
24   rates definitely declined a great deal.  I think the
25   extent to which you think investors have benefitted from
0091
 1   that would depend to a great extent on how many of the
 2   trade-throughs prior to Rule 611 were in fact inferior
 3   prices that investors didn't want versus traders
 4   deliberately bypassing quotes they didn't think were any
 5   good. 
 6             But if you read the Commission's adopting
 7   release, certainly, for Rule 611, it's clear the
 8   Commission thought that a substantial part of those
 9   pre-611 trade-throughs were inferior prices for retail
10   investors.  And looked at from that perspective, I think
11   you can say that the rule did hit its intended target. 
12             The other intended target was to promote the
13   display of limit orders, and particularly by increasing
14   the chance that they're going to get a timely execution. 
15   And on that one, it's harder to say that it hits its
16   intended target because the percentage of order flow that
17   actually interacts with displayed limit orders on lit
18   venues is down pretty significantly from what it was  And
19   that's happened as the level of executions in dark venues
20   have gone up, since they're two sides of the same coin. 
21             And when you talk about fragmentation, that
22   leads to probably what's the most significant or
23   often-heard criticism of Rule 611, which is that it has
24   increased fragmentation and increased unnecessary
25   complexity.  
0092
 1             The memo doesn't try to answer that question,
 2   but tries to just highlight some points it's good to
 3   think about when considering that.  And I think the one
 4   in particular is you need to distinguish lit venue
 5   fragmentation from dark fragmentation because there's the
 6   direct link, potentially, between lit venue fragmentation
 7   and Rule 611 because the rule does in some circumstances
 8   require market participants to trade on lit venues that
 9   they otherwise might not do. 
10             On dark fragmentation, though, the rule never
11   requires anybody to execute at a dark venue.  So if you
12   think the rule actually has contributed to dark venue
13   fragmentation, you have to find another causal mechanism,
14   something that's more indirect. 
15             And the interesting thing is if you look at
16   some of the tables in the memo, you can see that the
17   number of lit venues has increased from eight exchanges
18   pre-611 to 11 operating today, though it was up to 13 --
19   two ceased operating in 2014, though there are others
20   that want to become exchanges and begin trading. 
21             But the level of dark fragmentation, and not
22   just the overall level that's executed on lit venues
23   versus dark venues but the number of dark venues, has
24   increased much more substantially, probably from around
25   ten dark pool ATSs pre-Rule 611 to more than 40 today. 
0093
 1             So that issue of what exactly does contribute
 2   to reduced interaction of order flow with limit orders
 3   and what leads to trading on dark venues I think
 4   naturally highlights at least a consideration of some of
 5   the other forces other than Rule 611 that might
 6   contribute to that, whether it's other regulations,
 7   market forces, or competitive forces.  
 8             I think these are all likely topics to be
 9   discussed this afternoon as well as in future meetings,
10   and I'll leave it at that.  And I think we would be very
11   happy to try and answer any questions you have on the
12   memo or Rule 611. 
13             MR. KETCHUM:  Dan, the memo was excellent, and
14   the statistics certainly are consistent with what we
15   found from reduced trade-throughs from a surveillance
16   standpoint.  Your points on dark pools are important and
17   deserve a lot more conversation. 
18             But there are other pieces of 611 that at least
19   might be contributing one way or another to dark pools,
20   one of which is the operation of ISO orders and whether
21   those ISO orders are operating in the manner in which the
22   staff and Commission expected them to, from the
23   standpoint of reaching and identifying greater size in
24   the market, while still complying Reg NMS. 
25             Are there pieces like ISOs, et cetera, that you
0094
 1   personally think deserve some more analysis as you step
 2   back and look at what you expected from the time you
 3   adopted the rule versus today? 
 4             MR. GRAY:  Well, I'm not sure exactly what the
 5   causal chain is from ISOs to dark venue routing.  I think
 6   one of the things we have heard is perhaps that some of
 7   the complexities of dealing -- that 611 at least has
 8   contributed to some of the complexities of trading on lit
 9   venues and has led people to make it more desirable to
10   trade on dark venues. 
11             We certainly heard that, and I think that would
12   be a worthwhile topic to pursue, as to what extent 611
13   has had the unintended consequences of making lit venues
14   less desirable and indirectly led to more trading on dark
15   venues. 
16             MR. STONE:  So, Mr. Gray, the staff memo was
17   very good.  I just have a couple questions.  
18             When you read the regulation, it wanted to
19   increase display size as an increased depth.  Did the
20   staff look at whether or not the depth of market has
21   increased, decreased, or has stayed the same since Reg
22   NMS went in place? 
23             MR. GRAY:  Well, we have looked at that.  We
24   didn't put those stats in the memo, and the interesting
25   thing is that spreads have mostly narrowed somewhat, not
0095
 1   a great deal since Rule 611.  Depth actually has
 2   increased a great deal.  So it does seem like even if you
 3   think Rule 611 didn't achieve its objective of promoting
 4   the display of limit orders, that there are incentives,
 5   at least for some, to display limit orders because depth
 6   has not -- those metrics of limit orders on lit venues
 7   haven't declined. 
 8             I think one issue would be, have you promoted
 9   the types of limit orders and the types of liquidity that
10   would most benefit investors in the most stable sources
11   of liquidity? 
12             MR. STONE:  So I slightly disagree with the
13   staff's contain that it's the interaction of display
14   which was the measure.  It's actually the amount of
15   display versus where the market is now that I think is
16   what the intent of NMS was supposed to be.  And the fact
17   that the depth has increased is actually kind of
18   interesting. 
19             The 2003 study said that it cost investors $230
20   million, I think annually, from trade-throughs.  Did the
21   staff calculate what the amount is now, the .14? 
22   Because, arguably, I think you said that the market has
23   gone up 87 percent in New York stocks and slightly more
24   for NASDAQ.  What's the new number? 
25             MR. GRAY:  We did not calculate.  I think it
0096
 1   was more than -- for the NMS release, the calculation of
 2   the volume of quotes that were traded through was more
 3   than $300 million.  We haven't calculated the 0.1
 4   percent.  I think you have to consider to some extent
 5   what accounts for that remaining 0.1 percent because we
 6   didn't exclude, and it wasn't possible with current data
 7   to exclude, legitimate exceptions to Rule 611, like a
 8   self-help exception. 
 9             So if somebody self-helped somebody and traded
10   through, that would have been picked up in the 0.1
11   percent.  So I think we think the figure is small, but we
12   didn't calculate that. 
13             MR. STONE:  And just my last question:  The
14   2003 study was highly controversial.  I mean, Fidelity
15   and NASDAQ resubmitted.  I think it was Professor
16   Battalio who put together another study that said that
17   the trade-through rate was far less than the 7.9 or 1.5
18   percent -- take the average. 
19             Did the staff consider going back and looking
20   at the methodology?  Because it was done a little bit
21   fast because it was toward the end because it was part of
22   a cost-benefit analysis that had to be done as part of
23   the process.  Was any consideration given to going back
24   and looking at with a fresh set of eyes and challenging
25   the assumptions of the day? 
0097
 1             MR. GRAY:  Well, we never reran the
 2   trade-through studies for pre-Rule 611 trade-throughs.  I
 3   think one study you may have referred to from NASDAQ that
 4   was discussed in the NMS adopting release found that
 5   looking at internalized trades, more than 3 percent were
 6   trade-throughs prior to the proposal of Rule 611, and
 7   that reduced to something like 1-1/2 percent after the
 8   proposal. 
 9             I think what the Commission in the adopting
10   release said it was afraid of was the fact that when
11   there was a spotlight on trade-throughs and people knew
12   that it was being measured and was part of a Commission
13   rulemaking, that might explain why the trade-through rate
14   went down after the proposal. 
15             MR. STONE:  Thank you. 
16             PROFESSOR O'HARA:  Dan, I really enjoyed it and
17   thought you did a great job.  I just have a clarifying
18   question. 
19             When you were calculating your trade-through
20   percentages, were you using trade-through relative to a
21   one-second window? 
22             MR. GRAY:  Yes.  
23             PROFESSOR O'HARA:  So did you look at what
24   happened when you shrunk that window down to something
25   much smaller, and then presumably your trade-through
0098
 1   numbers would have gone up correspondingly? 
 2             MR. GRAY:  Well, we did look at that.  And
 3   Chuck Collver, who's one of our quantitative analysts who
 4   actually did that, maybe can shout out from the back.  My
 5   understanding was you would think it would make a big
 6   difference, but it actually did not make an order of --
 7   it was higher, but did not make an order of magnitude
 8   difference, as you might think. 
 9             Is that right, Chuck? 
10             MR. COLLVER:  Well, the only popular metric I
11   used was zero seconds.  So it was actually just a natural
12   prevailing slope, and it would be about double what was
13   produced in that table. 
14             PROFESSOR O'HARA:  Thank you. 
15             MR. LUPARELLO:  The memo also includes
16   critiques of 611, which Dan touched upon.  I think one of
17   the things we hope to get out of at least this
18   conversation which will roll over into this afternoon's
19   conversations are a framework for how we think about
20   this. 
21             And one of those things is, did we get those
22   critiques right?  Are they the full list or are there
23   critiques of 611 that we have included that are for some
24   reason not as valid or don't hold up to scrutiny?  If
25   anybody's got a view on that section of the memo, that, I
0099
 1   think, would be very helpful to the staff. 
 2             MR. MECANE:  I have a question/statement along
 3   those lines. 
 4             To me, and especially as we've thought about
 5   611 and asked people their views and where there is a
 6   strong belief that 611 is unnecessary, generally I feel
 7   like the category that people use to justify why 611
 8   isn't necessary is that it causes unnecessary complexity,
 9   overhead, infrastructure, burden on the industry, for
10   something that doesn't yield the benefit today that it
11   did, obviously, back when NMS went into place. 
12             And so just going with that for a second, the
13   question that I struggle with around that, which is
14   something that's very well discussed so nothing novel
15   here, is:  How do you define or think about excessive
16   complexity?  Or how do you measure where that complexity
17   yields positive versus negative implications for the
18   industry?  And I thought in the first critique, you sort
19   of allude to that.  And I don't know how intentional this
20   was, so this is my question. 
21             There's at least some correlation in that first
22   critique about excessive fragmentation and market
23   complexity.  And so my question is, is that how the
24   Commission is thinking about complexity and how to define
25   it vis-a-vis excessive fragmentation?  Or am I reading
0100
 1   too much into it, and is that just one statement or one
 2   factor, but we maybe need to think more broadly about
 3   what excess complexity means? 
 4             MR. LUPARELLO:  I'll take the first shot, the
 5   first of which is I think we raise these critiques as
 6   ones that are worthy of further conversation without
 7   necessarily endorsing them or not one way or the other. 
 8   But I just think that's exactly the right question to
 9   ask, and I think we've had these conversations in a
10   variety of different contexts about just how do you put
11   costs around the complexity? 
12             And so I would certainly open it up to the
13   folks around the table to offer a point of view on that. 
14   We've had a number of bilateral conversations, but I
15   think one of the benefits of a group like this is for you
16   to interact with one another on issues about, how do we
17   measure when complexity reaches a tipping point and goes
18   from enhancing competition to creating costs and
19   potentially fragility in the market?  I think that's
20   something we have struggled with. 
21             MR. NOLL:  On that first critique, Steve and
22   Dan, I think one of the points you make in there is that
23   an exchange's ability to display quotes doesn't guarantee
24   success.  But I think if you flip it around the other way
25   without order protection rules, without Rule 611, no lit
0101
 1   market has a chance of success. 
 2             So to me it's a pre-necessary condition.  It
 3   almost causes unnecessary fragmentation and complexity
 4   just by definition because you have no chance of success
 5   of attracting any flow unless you become a lit exchange
 6   and you have order protection under the current regime. 
 7             So even though it doesn't guarantee success, it
 8   is a precondition for just existence.  And so just by the
 9   way it operations, I think it's going to continue to
10   introduce new venues as people come up with new ideas. 
11             MR. CLARK:  I get defining complexity in the
12   context of this.  I really do.  But let's be clear.  The
13   rule itself is pretty simple.  You're protecting the best
14   bid and offer.  Right?  And markets should confer some
15   protection to those, certainly in these days, who are
16   actually willing to post a better offer.  Right?  
17             I think it's again a little bit myopic to train
18   in on 611 and say, this has caused excess fragmentation. 
19   Certainly it's probably a contributing factor, but so,
20   too, are a number of other things.  And so I think maybe
21   if you take a step back and say, the rule isn't complex,
22   all of the infrastructure around it has become so complex
23   that implementing a rule like that is very complex, I
24   think what we need to do is take a step back and say,
25   listen. 
0102
 1             From a principled perspective, is it right to
 2   give investors who are willing to take the risk of
 3   posting a better offer some modicum of protection in the
 4   marketplace?  As I said, ten years ago it certainly
 5   sounded like a good idea.  Are there now reasons to
 6   really think more about an exception for block trades? 
 7   Probably.  Is there a reason to think about giving
 8   protection to only those who have a certain amount of
 9   market share?  Interesting.  
10             But I think we can't get away from the concept
11   itself, which is, if it causes a lot of complexity, we
12   have to weigh that.  But the rule itself is kind of an
13   important concept, and I think we can't let that get
14   diluted here. 
15             MR. NAZARALI:  Yes.  If I could add something
16   to that, a lot of the complexity is really about your
17   best ex obligations because even in absence of the rule,
18   most of us would have to monitor all the best prices out
19   there and execute at that best price. 
20             So a lot of that complexity would not go away
21   if Rule 611 went away.  Now, we recognize that for the
22   exchanges, there is some more complexity in their
23   matching engines because they have to manage all these
24   different order types.  But they have shown a great
25   ability to manage that, and we ought not to throw out a
0103
 1   really, really important investor protection just because
 2   it causes the exchanges some complexity in their order
 3   types. 
 4             MR. RATTERMAN:  Let me weigh in on two points I
 5   want to make.  One is just kind of an obvious one,
 6   thinking about Dan's perspectives of pre-Reg NMS and
 7   post-Reg NMS and is he going from 80 percent to 20
 8   percent. 
 9             More than that was going on.  Basically, you
10   had a monopoly, and then you didn't have a monopoly.  And
11   the stated objectives of the SEC is to balance
12   competition between venues and competition between
13   orders, and 611, I think, did both of those. 
14             And the fact is that BATS probably wouldn't be
15   here today.  We would not exist had it not been for 611. 
16   There would still be a monopoly and there'd still be a
17   manual floor and you would not have competition among
18   venues if you didn't have 611.  So that was a stated
19   objective.  The markets might continue to promote
20   competition without it today because competition has been
21   inserted.  But before that, there was not competition and
22   it wasn't possible. 
23             With regards to complexity, just from a pure
24   programming perspective or systems or technology
25   perspective, you can count the number of points in a
0104
 1   complex network really simply.  There's either zero, one,
 2   or more than one.  So the moment that you have more than
 3   one, you have the same level of complexity as if you have
 4   ten or 20 or 50 or 60.  So unless we want to go back and
 5   accept that a monopoly is a good outcome, the complexity
 6   that comes from fragmentation comes the moment you have
 7   more than one. 
 8             MR. KATSUYAMA:  If I could just add one thing. 
 9   Complexity has gotten a negative connotation as we
10   discuss market structure primarily because of the lack of
11   transparency and the lack of disclosure.  So I think in a
12   complex market, without the proper disclosures, without
13   the proper amount of transparency across brokers, ATSs,
14   exchanges, I think it generally leads to people
15   questioning whether complexity can hide intent. 
16             You can't just ask a simple question and get a
17   simple answer.  You have to ask a very, very specific
18   question, hoping that the person responding is going to
19   give you the answer that you intend to receive when you
20   ask that question.  And I think that what we really need
21   to talk about, and I think it's been talked about quite
22   broadly, is nailing down certain elements of disclosures
23   that are just required, table stakes to be in the game. 
24             And as those disclosures get disseminated, I
25   think that the end investor is now more sophisticated
0105
 1   than they've ever been in interpreting what the data is
 2   and making better and more informed decisions.  So I
 3   think that complexity has become a scary thing because we
 4   don't have the proper disclosures.  But again, in an
 5   interconnected system, things will be complex. 
 6             The more exchanges, again -- it's the routing
 7   logic, and we've been working through this as well.  It
 8   requires a very great amount of detail.  But that
 9   shouldn't scare people if it's properly disclosed and
10   that information is available to everybody. 
11             So I think we shouldn't simply be trying to
12   avoid complexity just because it's gotten a negative
13   connotation.  We did a survey with over a hundred buy
14   side respondents, and the number one issue that they
15   asked for is greater transparency in disclosures, i.e.,
16   to make better decisions.  611 came third. 
17             So I think that they're related, but I do think
18   at a very high level these are some things that are
19   absent in the market that cause people concern, possibly
20   hurts investor confidence where they can't get the
21   information that they want or need to make better
22   decisions. 
23             MR. ANDERSEN:  I just want to clarify one point
24   from before.  Not to go back too far into history again,
25   but back in the '90s and long before Reg NMS, as the
0106
 1   staff pointed out, you have a problem of comparing
 2   different control groups. 
 3             You had, as Joe said, a single monopoly on the
 4   New York Stock Exchange protected by a trade-through rule
 5   because it was a human market.  They could post a price
 6   and not have any necessity to honor that price to anyone
 7   else in any meaningful amount of time, and therefore no
 8   electronic market, whose value-add is to be immediate and
 9   accessible would be able to actually compete against that
10   market.  And that's what you had. 
11             And it was the SEC's implementation of Reg NMS
12   that upset that applecart and forced them, if they wanted
13   to be protected, to be electronic.  So that was mission
14   accomplished, and all of the benefits of greater volume,
15   tighter spreads, and greater turnover on the New York
16   Stock Exchange-listed stocks, I think, has been a huge
17   win for the industry. 
18             Just to clarify, though, on the NASDAQ side you
19   had no trade-through rule in the NASDAQ rule.  And this
20   was the vast majority of traded volume prior to Reg NMS. 
21   And there was many markets that got to critical mass in
22   that market with absolutely no 611 equivalent. 
23             So I don't think that in a competitive market
24   with ease of entry and exit, I don't think there is a
25   need to stimulate new markets to have 611.  You could
0107
 1   have had that.  We did it.  Island and Archipelago did
 2   it.  REDI did it.  There was lots of markets that got
 3   over that hump. 
 4             I don't think you need the order protection
 5   rule to get that because as Jamil pointed out, every real
 6   participant in the marketplace I was not going to avoid
 7   those prices.  And no one with a rational incentive in
 8   the marketplace who wants to interact with the best for
 9   themselves, or has a sophisticated client who demands
10   that, or if you're handling a retail order, has execution
11   quality disclosure obligations and hyper-sophisticated
12   order rooms which are holding you accountable for every
13   order, the question is, what is the problem solving in
14   2015? 
15             MR. LUPARELLO:  Chester, last word before we
16   break? 
17             PROFESSOR SPATT:  So I agree with certainly
18   many, maybe even most, of the comments.  There were a
19   couple of specific ways, though, in which I think that
20   611 sets up some challenges and some awkwardness.  I
21   think two particular aspects of it I would highlight. 
22             Because 611 provides protection specifically at
23   the top of the book but not all the way down -- and I'm
24   not advocating providing protection all the way down, let
25   me be clear -- but if protection were provided all the
0108
 1   way down, arguably there wouldn't be an artificial
 2   incentive to enter because whatever your quote is, your
 3   quote is, and you'd have the same protection whether you
 4   were one firm or you were representing ten firms. 
 5             But because the protection is provided at the
 6   top of the book, if I split up my business into ten
 7   different entities, then one is quoting at the top and
 8   one is my second-best quote and my third-best quote but
 9   I'm now doing it under separate umbrellas, each of those
10   would get protection. 
11             And so that's an aspect in which I do think
12   that 611 directly, in a somewhat adverse way, leads to
13   fragmentation because it's providing regulatory incentive
14   to enter.  So that's the first point that I want to put
15   out there. 
16             And then the second point has to do just with
17   the nature of access fees and potentially directing
18   execution toward a business model that perhaps has those
19   fees versus not having those fees.  Now, I understand the
20   nature of the grid size is such that those are within the
21   -- because of the restrictions on sub-pennies, it's
22   within that, but still arguably that's not exactly as
23   pro-competitive a situation as I would have thought maybe
24   the Commission would like to be in, in a sense,
25   subsidizing one business model over another business
0109
 1   model. 
 2             It seems like, if I'm understanding how that
 3   aspect of the rule works, that also seems to me kind of
 4   an awkward aspect and I would think one that the
 5   Commission would be struggling with. 
 6             MR. LUPARELLO:  Thank you.  I think we'll
 7   break.  The committee will go into a private session
 8   where I do promise the committee will get fed.  And we'll
 9   be back as close to 1:00 as possible for our first panel. 
10   Thank you. 
11             (Whereupon, at 12:13 p.m., a luncheon recess
12   was taken.)
13               A F T E R N O O N   S E S S I O N
14             MR. LUPARELLO:  Welcome back.  We're going to
15   again try to stay on schedule as much as we possibly can. 
16             Beginning the afternoon session is a
17   presentation on 611 issues by our panel here.  We're very
18   lucky to have, both in the first and second panel, real
19   experts on it who will make presentations.  I encourage
20   the committee members to engage with the panelists during
21   the course of their presentation.  Also, I encourage you
22   to engage with one another, although I trust that won't
23   be too difficult to encourage you to do that. 
24             Quickly, by way of introduction, facing towards
25   them on the left is Tom Farley.  He is the president of
0110
 1   New York Stock Exchange Group.  To his left is Jamie
 2   Selway, who's the managing director and head of
 3   electronic brokerage at ITG.  And to his left is Tom
 4   Wittman, who is the EVP of global trading and market
 5   services at NASDAQ OMX. 
 6             I don't know if you collectively had a sequence
 7   of who is going first, second, or third, but if not,
 8   there's no time for rock/paper/scissors, so I'll look at
 9   Jamie to lead us off. 
10             MR. SELWAY:  Good afternoon, Chair White. 
11   Commissioners.  Were they here?  Division staff. 
12             MR. LUPARELLO:  They are here for the record. 
13             MR. SELWAY:  They're here in spirit.  Thank you
14   for the opportunity to participate in today's panel
15   discussion regarding Rule 611 of Reg NMS.  My name is
16   Jamie Selway and I'm managing director and head of
17   electronic brokerage at ITG.  ITG is a global execution
18   broker that provides market-leading trading technology
19   and analytics to clients that include the world's largest
20   institutional investors. 
21             At ITG, electronic brokerage includes
22   algorithmic trading, routing to exchanges and other
23   trading venues, and POSIT, one of the largest, most
24   established dark pools in the world.  We execute roughly
25   3 percent of daily volume in U.S. equities, 3.5 percent
0111
 1   of daily notional in Europe, and almost 50 basis points
 2   of daily activity in Asia Pacific.  We trade
 3   electronically in 40 countries and operate POSIT in 35 of
 4   those. 
 5             As an agency-focused broker, our interests are
 6   aligned with our clients and our clients benefit
 7   materially from sound market structure.  Whether
 8   developing block crossing capabilities in Brazil and
 9   India, or reducing intermediation and the effects in
10   corporate bond markets, or continually improving our
11   order-routing acumen in U.S. equities, ITG commits
12   significant resources to understand, utilize, and through
13   POSIT, create sound market structure for the benefit of
14   our customers. 
15             We are active in the continuous dialogue
16   between market participants and policy-makers to improve
17   our market structure for investors.  While much has
18   changed since the approval of Reg NMS ten years ago, the
19   U.S. markets remain the envy of the world. 
20             By our measurements, the average all-in U.S.
21   trading costs borne by institutional investors, which
22   include both the implicit costs, such as market impact,
23   and explicit commission costs fell by nearly 40 percent
24   between mid-2004 and mid-2014.  This important
25   achievement directly benefits the investing public. 
0112
 1             While we recognize our industry success in
 2   improving the marketplace over the past decade, we firmly
 3   believe that additional progress can be made.  It is in
 4   this spirit that the SEC Equity Market Structure Advisory
 5   Committee will review 611 today, and we look forward to
 6   contributing to this discussion.  We believe it is
 7   important to regularly review the outcomes of major
 8   policy changes, and we commend the Chair for creating the
 9   committee and the Division for organizing today's event. 
10             Rule 611, the order protection rule, is known
11   colloquially as the trade-through rule.  At its core is a
12   very sensible idea:  Best price wins.  Under Rule 611,
13   one market center cannot execute at a price that is
14   inferior to the publicly displayed price of a second
15   protected market, subject to limited exemptions. 
16             Before Rule 611, NYC- and Amex-listed
17   securities were subject to flawed version of
18   trade-through implemented via the sclerotic intermarket
19   trading system plan, which Matt knows.  Rule 611
20   modernized this approach and incentivized markets to
21   automate by affording no trade-through protection to
22   non-automated markets.  NASDAQ-listed securities were not
23   subject to trade-through rule until Rule 611 was
24   implemented. 
25             While "best price wins" is a sensible idea, it
0113
 1   comes with some practical difficulties.  Because prices
 2   exclude asset access fees charged by trading venues, the
 3   SEC needed to cap such fees via Reg NMS Rule 610.  As
 4   Rule 611 illustrates, implementing "best price wins"
 5   required the SEC to be fairly prescriptive in terms of
 6   order routing, as opposed to flexibility traditionally
 7   afforded to broker dealers under the common law fiduciary
 8   duty of best execution. 
 9             Under best execution, factors other than price,
10   such as speed or size, for example, can determine routing
11   decisions.  Moreover, "best price wins" works best in
12   frictionless markets, which existed neither in 2005 nor
13   2015.  Order routing is fast but not instantaneous, and
14   market data collection and delivery mechanisms, foremost
15   among them the exclusive securities information
16   processors, are imperfect.  Although Rule 611 tries to
17   accommodate these factors, it cannot always do so.
18             Because Rule 611 is a prescriptive approach to
19   routing and executing in a market that is highly
20   competitive and complex, it has difficulty accommodating
21   innovations in the marketplace.  In the minds of some,
22   the lack of innovation has led to a "sameness" across
23   U.S. exchanges, where a group of price-time priority
24   venues with high-performance technology compete on
25   substantially similar rate cards.  
0114
 1             While the role of Rule 611 in connection with
 2   this condition is debatable, it is certainly the case
 3   that its inflexibility hinders new market structure
 4   ideas.  For example, as IEX progresses from ATS to
 5   exchange, its latency-injecting "magic shoebox" will
 6   require SEC intervention with respect to Rule 611's
 7   standards for automated quotations. 
 8             Additionally, NYSE's recent proposal for an
 9   intra-day auction attracted as much attention for its
10   merits as for the way in which it might be exempted from
11   611.  More fundamentally, Rule 611 is a de facto
12   requirement that all competing markets use the same
13   minimum tick size, so that experimentation here can only
14   occur via joint action by all venues, as opposed to
15   competition amongst them. 
16             So we have a rule that is based on an appealing
17   notion -- investors should get the best price -- but is
18   prescriptive in implementation and possibly challenging
19   to marketplace innovation.  Two paths are open to the
20   SEC:  the Commission can improve or remove 611. 
21             A number of suggestions have been made to make
22   Reg NMS more flexible and efficient, and also to address
23   some of its perceived unintended consequences.  Among
24   these enhancements, we suggest consideration of the
25   following:
0115
 1             First, create a "de minimis" exemption to Rule
 2   611, under which market centers with volume below a
 3   certain threshold level, such as 1 percent of the
 4   consolidated tape, do not enjoy price protection from
 5   displayed quotations.  Such an exemption would constrain
 6   market complexity, reduce fragmentation, and lower
 7   connectivity costs.
 8             Second, create a block exemption to Rule 611,
 9   under which large trades above a certain size, such as
10   10,000 shares or $200,000 in value, could execute without
11   triggering an obligation to protect quotations at
12   superior prices.  Such an exemption would make block
13   trading more seamless at limited costs to protected
14   quotations.
15             Third, repeal the prohibition of locked markets
16   under Rule 610(d) and lower the access fee cap under Rule
17   610© from three cents per hundred shares to one cent per
18   hundred shares.  As described above, Rule 610 is
19   necessitated by Rule 611, and its prohibition on locked
20   markets creates complexity in terms of order types and
21   matching engine logic.  
22             The access fee cap facilitates a wide spread
23   between fees for consuming liquidity and rebates for
24   providing liquidity that creates a potential conflict of
25   interest for brokers.  While conflicts can be managed,
0116
 1   and rebates for liquidity have an economic rationale, the
 2   wide spread has concerned institutional investors for
 3   some time.
 4             As an alternative to these improvements, the
 5   Commission could remove 611.  In considering a market
 6   without Rule 611 would look like -- not unlike NASDAQ
 7   before Reg  NMS -- a number of factors warrant
 8   consideration:
 9             First, best execution would become critical. 
10   In some respects, Rule 611 is a proxy for best execution,
11   despite its irrelevance for institutionally-sized orders
12   and the fact that retail-sized orders typically receive
13   better execution than the best displayed prices.  In the
14   absence of Rule 611, the industry would benefit from
15   improved standards for best execution, as well as
16   increased disclosure relating to institutional order
17   handling.
18             Second, the importance of limit order execution
19   would also be tested.  In adopting Rule 611, the
20   Commission theorized that protection would lead to more
21   limit orders.  Has it?  Counterfactuals defy analysis. 
22   In 2007, BATS was able to grow its market share ahead of
23   Reg NMS, and IEX recently launched a displayed market
24   without protection.  The first example is dated, however,
25   and the second is likely early and likely limited.
0117
 1             Third, the message to retail investors would be
 2   important.  As stated earlier, retail investors enjoy an
 3   execution quality better than that afforded by Rule 611. 
 4   That said, SEC repeal of a "best price wins" rule would
 5   strike many as counterintuitive.  The justification for
 6   the change must be explained so that retail investors
 7   remain confident in our market structure.  Other
 8   facilities, such as wholesale market makers, alternative
 9   trading systems, and exchange retail liquidity programs,
10   would enable retail investors to continue receiving price
11   improvement when trading on- and off-exchange.
12             Any discussion of Rule 611's future would be
13   incomplete without briefly addressing the Commission's
14   approval of the proposed tick size pilot last week. 
15   Under the approved plan, 400 less liquid securities will
16   be subject to a "trade-at" rule, which essentially
17   requires an executing market center to display the best
18   price before the trade.  If "trade-through" means "best
19   price wins," then "trade-at" means "best price, first,
20   wins."  If Rule 611 is prescriptive and inflexible,
21   leading to complexity and foregone innovation, "trade-at"
22   is all the more so.
23             Complicating matters, the pilot program
24   implements its changes, including "trade-at," as an NMS
25   plan organized and operated by the exchanges and FINRA. 
0118
 1   Given the manifest challenges of NMS plan governance, and
 2   the fact that "trade-at" is essentially an amplification
 3   of Rule 611, we are concerned by this approach.  We hope
 4   that today's deliberations will affect not only the
 5   future of Rule 611 but of "trade-at" as well and that
 6   both notions will be addressed conclusively by a single
 7   SEC rulemaking, as opposed to an NMS plan outsourced to
 8   the exchanges and FINRA.
 9             In summary, the Commission has an opportunity
10   to enhance U.S. equity market structure by either
11   improving or removing Reg NMS Rule 611, and we welcome
12   the opportunity to engage with the SEC Equity Market
13   Structure Advisory Committee on this important question.
14             Thank you for the opportunity to share our
15   views, and I look forward to addressing your questions at
16   the appropriate time. 
17             MR. LUPARELLO:  Thank you, Jamie. 
18             Tom? 
19             MR. FARLEY:  Thanks, Steve.  Thanks,
20   Commissioner Aguilar, colleagues around the table.  I
21   very much appreciate you allowing me to come in today and
22   represent the New York Stock Exchange.  We prepared some
23   written remarks, which I believe were handed around the
24   table here. 
25             I'm going to dispense with those and just speak
0119
 1   extemporaneously and try to give a few minutes back for
 2   Q&A at the end.  But my comments should by and large
 3   follow the written remarks, and I will refer to a couple
 4   charts that are at the end of that pamphlet as I speak. 
 5             The trade-through rule had a couple objectives. 
 6   One objective was to reduce the number of trade-throughs,
 7   aptly named, and by any measure it was successful in that
 8   respect.  And so for that reason primarily, the
 9   trade-through rule was and is a step forward in terms of
10   equity market structure in this country, and we should
11   all view that as a very good thing, in our estimation. 
12             A second objective of the trade-through rule
13   was to reward those who would make their price and size
14   known on a public market.  And by that measure, by that
15   objective, the trade-through rule fell short.  Subsequent
16   to the adoption of the trade-through rule, whether you're
17   looking at NASDAQ stocks and NYSE stocks -- and there
18   were very different things going on in each of those
19   markets, as my colleague just referred to -- but
20   regardless of which set you look at, the amount of
21   fragmentation, and in particular the amount of dark
22   fragmentation, increased significantly. 
23             We would submit that that is in part because
24   the trade-through rule did not in fact include a great
25   enough reward for those market participants who would
0120
 1   contribute to public price formation and public price
 2   discovery.  And therefore, we think that this dialogue is
 3   fantastic, and this is a good first topic for this
 4   committee. 
 5             But we think it's very important to go back and
 6   say, what is it that we're doing to reward those who
 7   would contribute to public price formation?  Because --
 8   and perhaps this is a little bit of motherhood and apple
 9   pie -- but it's very important in this country that we
10   have deep, liquid, transparent markets that are available
11   to all, and our policy should reflect that end goal. 
12             If I can set aside just for a moment those two
13   objectives of the trade-through rule, if we at the New
14   York Stock Exchange had been putting together the
15   trade-through rule, we would have had a third objective. 
16   And the third objective, simply put, would have been to
17   make sure that anything we did, whether it was a
18   trade-through rule or other facets of NMS, contributed to
19   a safe and sound equity market in this country,
20   characterized by a good deal of transparency. 
21             And by that third objective, again, the
22   trade-through rule, if you view it through that lens, is
23   a bit troubling because there was such a good deal of
24   fragmentation that came about subsequent to the adoption
25   of the trade-through rule. 
0121
 1             In my capacity running the New York Stock
 2   Exchange, which is, as you know, a very large listing
 3   venue, I speak to a lot of listing company CEOs.  Just
 4   coincidentally, before walking over here, over in Union
 5   Station I was on the phone with a $30 billion company
 6   CEO, and I mentioned about a different topic, but I
 7   mentioned off-handedly my reason for being here in New
 8   York (sic). 
 9             And he said, "Hey, the one thing you can
10   advocate on my behalf is trust in the market.  More trust
11   in the market from the American public, that will bring
12   more buyers and sellers to the market."  And when I dug a
13   little deeper, his best advice for how to get more trust
14   in the market was to bring more transparency and less
15   complexity to the workings of our equity capital markets. 
16   And I do think that with some simple tweaks to this
17   trade-through rule, we could achieve a good deal of that. 
18             So if I can just point you to a couple of the
19   charts that I referred to.  And there's a lot of data
20   available at the fingertips of all of us in this room,
21   and so we're not trying to wow you with the charts, but
22   just want to start by putting some context around some of
23   the off-exchange trading and the dark fragmentation that
24   we referred to. 
25             And if you look, the first chart that I have is
0122
 1   a simple pie chart.  And really what it says is round
 2   about 70-ish percent of all trades that occur
 3   off-exchange occur at the NBBO or within some de minimis
 4   amount from the NBBO.  For ease, I'm just going to refer
 5   to it as the NBBO. 
 6             Why am I highlighting that?  Again, an
 7   objective of the trade-through rule, an initial objective
 8   of the trade-through rule, was to provide appropriate
 9   rewards for those who would contribute to public price
10   discovery. 
11             Well, those who are contributing to public
12   price discovery are those who are establishing the NBBO,
13   and yet more than one-third of all trades are occurring
14   away from the exchanges where this NBBO was set, and 70
15   percent of those trades are occurring at that price. 
16   That person not only is not being rewarded, quite the
17   opposite.  They're being punished because they're
18   providing information that others are utilizing. 
19             And if I just flip to what's labeled in here as
20   chart 2, really what this is, this is just one example. 
21   Last week we were putting our thoughts together on May
22   7th, and I asked our team, just go and grab an example of
23   an NBBO established on the public markets, and let's see
24   some of the trading that occurs elsewhere. 
25             This is but one example.  Literally thousands
0123
 1   occurred on this same day.  This happens to be
 2   Interpublic Group.  You can see it's for around about a
 3   minute and a half.  The exchanges have a tight spread, in
 4   fact, the tightest statutory spread, a penny wide, and
 5   yet I think there's 17 trades that occur away from an
 6   exchange, and not a single one occurs with price
 7   improvement. 
 8             And those who made the prices on the exchanges
 9   were not rewarded, again, I would submit; in fact, they
10   were punished because none of the market participants
11   that were publishing on the trades -- unless by
12   coincidence they were the same ones participating
13   off-exchange -- but none of those market participants
14   participated in the trade. 
15             This is the issue that we think the
16   trade-through rule fell a little bit short on, and that's
17   why I wanted to show you this example.  Again, this is
18   one of but thousands on this very day. 
19             Then finally, if I could flip you to what looks
20   like the most complicated chart in the history of the
21   world, but I'm going to simplify it as best I can, if you
22   could just bear with me.  What this is this is all NMS
23   securities.  We took our ETPs because those are really a
24   derivative.  And it doesn't include stocks that trade
25   less than 100,000 a day.  So this is all NMS securities. 
0124
 1             And then we sliced it by the dollar value of
 2   the stock and how frequently it trades.  And really, the
 3   reason we did that is we wanted to get cohorts of stocks
 4   that had similar characteristics.  And as you can see
 5   here, we have seven times one, two, three, four, five,
 6   six, seven -- we have 49 different cohorts. 
 7             Within each cohort, at the top you see what
 8   percent trades off-exchange.  So I'm just going to start
 9   with the -- let's start with the 50 to 100 bucket, 2
10   million to 5 million a day.  So 28.1 percent of that
11   cohort, 28.1 percent of the volume, trades off-exchange. 
12   There's 91 stocks in this cohort; that's what the 91
13   refers to. 
14             And it's this next green number, .0073 -- what
15   this says is, let's look at the spread, the quoted
16   spread, of all of those stocks that trade -- the 50
17   percent of those stocks that are the greatest in terms of
18   trading off-exchange, and then let's subtract that by the
19   spread of those that are the least traded off-exchange. 
20             And what you will see therefore is a positive
21   number.  It says that stocks that trade off-exchange have
22   a higher quoted spread.  And then finally, the fourth
23   bucket, that just gives you a sense of the total volume
24   on this chart, how much comes from this cohort.  And so
25   in this particular case it's 4.99 percent from this
0125
 1   cohort. 
 2             Why am I pointing all this out to you?  Because
 3   out of -- and the blue boxes are really the best ones to
 4   orient yourself on because the kind of orangish-pink to
 5   the right, those are all constrained by the one-penny
 6   statutory minimum spread.  Those blue boxes -- 19 out of
 7   20 show that those stocks that trade a greater amount
 8   off-exchange have a higher spread than those that trade
 9   on-exchange. 
10             So to us, it looks like irrefutable evidence
11   that those stocks that are trading a greater amount
12   off-exchange have a wider quoted spread.  And it's
13   another policy reason why we think it's important to
14   again reward those who are contributing to public price
15   formation, price discovery. 
16             So in conclusion, if I had to summarize, we're
17   not advocating throwing the baby out with the bath water
18   with respect to Rule 611.  I think it was definitely an
19   incremental step forward for policy.  We think there's
20   more to do in particular around rewarding those who quote
21   on public markets because we think that it's very much a
22   public policy good.  We think it'll help bring even
23   greater trust and transparency to what are the best
24   capital markets in the world.  Thank you. 
25             MR. LUPARELLO:  Thank you, Tom. 
0126
 1             Tom? 
 2             MR. WITTMAN:  I want to thank Jamie and Tom for
 3   giving me the next half hour and surrendering their time. 
 4             (Laughter.)
 5             MR. WITTMAN:  I'm just kidding.  Good
 6   afternoon, Commissioners, committee members, and fellow
 7   panelists.  My name is Tom Wittman.  My background is in
 8   exchange technology.  Since joining the Philly Exchange
 9   in 1987, I've been engaged in every element of market
10   structure infrastructure and change. 
11             I've designed, coded, tested, and operated
12   technology for front ends, trading engines, routers, back
13   office, and clearance and settlement systems.  I've
14   migrated systems from open outcry to electronic trading. 
15   Today I serve as executive vice president and global head
16   of equities at NASDAQ OMX.  
17             I'm responsible for the management and strategy
18   of NASDAQ's three U.S. equities markets, our three U.S.
19   options exchanges, and our equities and equity
20   derivatives exchanges in Helsinki, Stockholm, Amsterdam,
21   and Copenhagen.  I also serve as the CEO and president of
22   the NASDAQ stock market, NASDAQ PHLX LLC, and Boston Inc.
23             NASDAQ spans the world of the life cycle of
24   trading.  NASDAQ owns and operates the global
25   infrastructure of public markets, markets for securities
0127
 1   that are publicly traded and available to all investors. 
 2   We are the largest single liquidity pool for U.S.
 3   publicly traded equities and provide technology behind
 4   one in ten of the world's securities transactions. 
 5             Based on my 28 years in the industry, I can say
 6   without reservation the U.S. market structure continually
 7   evolves.  It never stands still.  Regulation must evolve
 8   with it.  Markets are not self-correcting, as we can see. 
 9   They are a complex dynamic, and they grow and decay and
10   like any organic ecosystem.  As the speed of evolution
11   increases, so too must the speed of regulation and
12   change. 
13             If we don't give our markets the attention and
14   upkeep they demand, the U.S. markets will deteriorate in
15   relation to other global competitors.  Quite simply, like
16   in so many areas, the U.S. must continually improve to
17   stay on top.  
18             We heard from the Chair and other Commissioners
19   and others on this committee about issuers and investors. 
20   Let's spend a small amount of time on issuers here. 
21             NASDAQ runs what we view as the world's largest
22   public company listing operation.  On our markets, we
23   list over 3500 companies worldwide in nine countries,
24   with a total market valuation of $9.5 trillion.  NASDAQ
25   has been and is the birthplace and home of growing,
0128
 1   innovative, job-creating companies.  We like to say that
 2   supporting emerging high-growth companies is in our DNA. 
 3   NASDAQ supports these companies as they grow, and they in
 4   turn bolster the U.S. economy by creating millions of
 5   jobs. 
 6             When we look at the question that was raised
 7   today, 611, first my initial reaction was, this is the
 8   wrong question.  NASDAQ's heritage derives our belief
 9   that market structures should serve all investors and in
10   particular strengthen and nourish growth companies.  In
11   our view, the current U.S. market structure does not
12   sufficiently emphasize serving investors, and it is
13   definitely not well-suited to help emerging growth
14   companies. 
15             By creating this committee, the SEC is also
16   recognizing that the markets need to evolve to serve
17   investors and support both large and small companies. 
18   You've asked us to focus on Rule 611, but with all due
19   respect, evaluating Rule 611 as a standalone rule is not
20   the best way to evaluate its effectiveness.  And I can
21   tell from conversations here there is, I think, more of
22   an opinion that that is also true. 
23             For example, the introduction of new order
24   types as well as increased fragmentation of lit and dark
25   venues are the product of a variety of additional
0129
 1   factors, including distortionary rebates, differential
 2   regulation for ATSs, single dealer systems, proliferation
 3   of exchanges, as well as many other forces.  Evaluation
 4   Rule 611 based only on its two primary objectives would
 5   overly simplify the issues we face. 
 6             Rule 611 alone has magnified the role of access
 7   fees, creating more and more momentary monopolies, as Bob
 8   Greifeld predicted in an editorial in the Wall Street
 9   Journal many years ago.  We know the U.S. markets can
10   work better.  Today the U.S. markets are increasingly
11   fragmented, volatile, and a source of systemic risk. 
12   Liquidity in U.S. stocks is dispersed across 11 exchanges
13   and over 50 other registered equity execution venues and
14   uncounted other trading facilities. 
15             The declining costs of launching and operating
16   an electronic order crossing system has led to the
17   proliferation of decentralized pools of liquidity that
18   compete by offering their owners and customers a
19   reduction in fees, obligations, transparency, and order
20   interaction. 
21             Foreign markets have used the evidence provided
22   by U.S. markets as a basis to reform their own market
23   structures while avoiding the dysfunction of the U.S.
24   markets.  We have wrung out hands at this dysfunction,
25   but have done little to fix it in over a decade.  But
0130
 1   we're now taking first steps here to try to correct some
 2   of that. 
 3             I think one of the issues we have in this, and
 4   we heard conversation here, is that one size does not fit
 5   all for the market structure that we have in the U.S.
 6   market.  Our exchange systems and rules are based on a
 7   one-size-fits-all approach, one approach to access and
 8   one approach to display, one approach to order protection
 9   and order interaction. 
10             Just last week the Commission approved a
11   two-year experiment with multiple quoting and trading
12   increments.  We applaud the pilot, but it was triggered
13   by Dodd-Frank almost five years ago and will not yield
14   definitive benefits for another two or three years.  We
15   must find a better and faster way to implement rules and
16   structures that differ depending on issuer size and
17   trading patterns. 
18             Market simulations using agent-based modeling,
19   for example, offer substantial benefits in reducing the
20   time and resources expended by the Commission staff on
21   essentially routine matters.  As simulation technology
22   evolves, it may also be able to tackle the more complex
23   questions of market structure and design and changes. 
24             Exchanges should be free to evolve and
25   experiment with the market as it evolves.  NASDAQ is
0131
 1   about to complete a four-month pilot experiment to
 2   generate data on lower access fees paired with lower
 3   rebates.  We didn't know what the data would show.  We
 4   weren't sure if it would increase or decrease market
 5   share or profit.  However, we did know it was going to
 6   generate valuable data in advance of the debate over
 7   maker-taker pricing. 
 8             We also learned that the rebate-sensitive
 9   market makers in this structure fled from some of the
10   NASDAQ stocks and moved to other venues.  We also learned
11   that it did not change the behavior of what we thought
12   would have been the sensitivity in the remove rates. 
13             The SEC must give more leeway to experiment
14   like that.  While such experiments by a single exchange
15   may vary from a universally applicable rule, there's
16   still value in experimentation and flexibility but little
17   to be gained from stifling them. 
18             There has been a great deal of focus on the
19   JOBS Act and whether our market structure supports growth
20   companies.  While I agree with the attention given to
21   growth stocks, I question whether our market structure
22   serves investors in the more active issues as well. 
23             Proponents of the status quo point to the fact
24   that trading costs in active stocks are as low as they
25   have ever been.  Few issues are to be addressed in these
0132
 1   stocks.  From my perspective, the committee's charged to
 2   consider the profusion of complex order types in
 3   precisely these most active stocks.  So we've seen a
 4   change in behavior in the creation of new order types in
 5   the actively listed issues as well as the less active, so
 6   I think we need to focus on the active issues as well. 
 7             Complex order types exist in large part to
 8   capture liquidity rebates to avoid paying access fees. 
 9   As the executive in charge of the NASDAQ global trading
10   business, I believe our fee experiment shows that access
11   fees and rebates in the most active stocks serve solely
12   as a means for exchanges and dealer systems to compete
13   with each other. 
14             These changes are largely unnecessary as
15   incentives to provide liquidity in these stocks.  I
16   believe a tiered structure in the U.S. for pricing of
17   both fees and rebates, tick sizes, fragmentation, and
18   other aspects of market structure or based on the
19   liquidity profile of particular stocks make far more
20   sense than one-size-fits-all. 
21             Once the committee's valuable work is complete,
22   I believe the committee will share my belief that the
23   U.S. equity markets are complex, and there are risks of
24   failing in another mission to investors in listed
25   companies.  Rule 611 plays a role in market complexities
0133
 1   but is merely one of many factors at work. 
 2             While one approach to addressing the need for
 3   reform in the regulation of U.S. equity markets would be
 4   a Reg NMS 2.0 with detailed, prescriptive,
 5   one-size-fits-all requirements, based on my experience I
 6   cannot endorse such an approach. 
 7             Instead, I encourage the committee and the
 8   Commission to channel the energy and creativity shown by
 9   this industry in responding to Reg NMS by encouraging
10   innovation and experimentation through adopt of
11   principle-based approach, regulation that emphasizes
12   serving the investor, and supporting capital formation. 
13             Specifically, the tick pilot is a positive
14   development for recognition that one size does not fit
15   all.  In addition, the Commission could delegate the
16   authority to define tick sizes to the listing exchange. 
17   It's our view that the listing exchange, with the
18   oversight of the SEC, is in the best position to optimize
19   tick size policy, and to do so in a way that is
20   responsive to ever-changing needs of listed companies. 
21             Just as not all issuers are the same, all
22   investors are not the same.  The Commission and the
23   exchanges can do more to protect Main Street investors. 
24   The Commission has long differentiated among investors
25   based on investable assets.  
0134
 1             Equity exchanges have attempted limited
 2   programs to support retail investor orders, and as my
 3   friend Eric Noll pointed out, we've done this in the
 4   options market.  We've been able to define what a
 5   customer is and carve out different functionality and
 6   features for that end customer.  I think we should do the
 7   same for the equity markets.  I don't know why it's got
 8   to be a flat base to treat all bids and offers equally. 
 9             In conclusion, Rule 611, I think, is an
10   important part as far as the mechanism to protect
11   displayed bids need offers was a good thing.  My full
12   written statement has been submitted, and I look forward
13   to answering any questions from the Commission, the
14   staff, and any committee members.  Thank you. 
15             MR. LUPARELLO:  Thank you, Tom.  I'll open it
16   up to committee members for questions. 
17             Eric? 
18             MR. NOLL:  Jamie, to your comments about locked
19   markets with reduction in access fees, what would be your
20   expectation in a reduced access fee market where you
21   would allow locked markets?  How persistent would locked
22   markets remain in existence on the screen? 
23             MR. SELWAY:  Yes.  I would say -- I'm recalling
24   pre-NMS NASDAQ.  I think names like Microsoft and Intel
25   were locked 30-ish percent of the time.  I would expect
0135
 1   it would be substantial, and I don't suspect it would be
 2   a problem.  I think people would view, hopefully, if
 3   properly communicated, the locked market as a
 4   frictionless market, as a zero cost market.  I think what
 5   the locked market's essentially telling you is that in
 6   certain names, the increment of a penny is too coarse. 
 7             MR. NOLL:  I think one of the issues that I've
 8   heard or concerns about locked markets, and I'd love your
 9   thoughts on this, is that if I am -- let's take a retail
10   order, a retail order posted on one market.  So I'm 12
11   bid.  The market's locked 12/12.  
12             I sit there.  I don't execute all day long. 
13   How do I as a retail investor gain trust in the
14   marketplace?  How does the marketplace respond to that
15   kind of environment where I just never get filled? 
16             MR. SELWAY:  Yes.  And I think it's beyond the
17   retail context.  It matters in the institutional context. 
18   As an institutional broker, if we were deploying a
19   view-up strategy and we found that our posted bids or
20   offers were being locked regularly, we would pull the
21   quote and access those. 
22             And that gets to your point on the access fee. 
23   So if an access fee is too high and you allow locked
24   markets, gamesmanship can obtain such that people will
25   systemically capture that spread.  So that needs to be
0136
 1   addressed.. 
 2             MR. NAZARALI:  Eric, if I could just address
 3   your question on the retail perspective because we
 4   engaged with a number of our retail brokerages or clients
 5   and talked about locked and crossed markets.  I think
 6   that they felt pretty strongly that locked and crossed
 7   markets were a market failure. 
 8             And it's very hard to explain to a retail
 9   customer why, if there's a buyer willing to buy at $10
10   and seller willing to sell at $10, why that cross goes
11   off.  It gets into an arcane discussion about access
12   fees, and it just doesn't fundamentally feel fair.  And
13   so I think that they felt very, very strongly that we
14   just shouldn't go there because it would add to this
15   perception of unfairness in the marketplace. 
16             MR. CRONIN:  I would agree with that.  Of the
17   things that concern me in the marketplace, it would seem
18   a step backwards to suggest that we should be allowing
19   locked and certainly crossed markets.  Crossed markets
20   make no sense to me whatsoever. 
21             A locked market really just gets back to our
22   good friend the access fee -- thank you again for that,
23   Matt, by the way; it's like a theme here -- but I think
24   we would probably be far better served to identify that
25   group of stocks where we think the markets would be
0137
 1   locking systemically and saying that maybe the increment
 2   shouldn't be a penny for these things. 
 3             I think that's probably a far better
 4   conclusion, ultimately, in terms of confidence of
 5   investors and the outcome of looking at markets and not
 6   seeing them locked 30 percent of the time.  It's just a
 7   very big step backwards, and I think we should take that
 8   off the table. 
 9             MR. STONE:  I just have a question.  Are locked
10   markets a result of the fact that we volume tier
11   accesses, whereas if we had a flat one rate, markets
12   wouldn't lock because then the all-in price would be what
13   you see on the screen plus whatever or minus whatever the
14   access fee was? 
15             Goldman in 2004 argued that there should not be
16   volume tiering and the full price should be whatever the
17   price was plus the access fee going out to four decimal
18   places and then markets wouldn't lock. 
19             MR. CRONIN:  I mean, the answer is yes.  The
20   access fees figure very prominently in this, and the
21   question is, how do you address that?  Should we reduce
22   access fees dramatically and move the trading increment
23   to a tenth of a cent and say that the access fee is
24   maximized at five mils?  It would seem that that would
25   remove any consideration, in large respect, or problem
0138
 1   that you would have with locked and crossed market. 
 2             MR. STONE:  I think there are two issues.  The
 3   first one is the level of the access fee case, so that's
 4   bringing them down from 30 cents.  It hasn't been
 5   updated.  My question is the next level down. 
 6             What is the regime that you can actually charge
 7   on access fees?  Because the problem with them is you
 8   can't figure out in the current regime what you're
 9   actually charged until the end of the month when you
10   figure out what your volume is, whereas if you just say
11   it's 01, 03, or 05 and 10 or whatever, then you know at
12   the time of trade what it is. 
13             And now it opens up different things of
14   innovation, as to market quality, of what the exchange is
15   trying to do.  Buy side people can ask for their rebates
16   to be passed through because you know at the time of the
17   trade what it is.  And then if you put that into the
18   price, it can't cross. 
19             MR. CRONIN:  So I think anybody -- certainly
20   Matt can jump in -- but I think the institutional
21   community would say transparency, yes, good.  And having
22   a better understanding certainly of what the access fees
23   are, I think all of us would say today that they're too
24   high, certainly relative to the technology innovations
25   that taken place. 
0139
 1             I think that that would be a way that you could
 2   address some of the issues.  But I still say, as a matter
 3   of public policy, allowing a crossed market doesn't sound
 4   like a good idea. 
 5             MR. STONE:  But I don't see how they would
 6   cross, though.  Because if you add in the access fee into
 7   it, I don't understand how it actually could cross
 8   through. 
 9             MR. CRONIN:  A crossed market, I don't know. 
10   But a locked market -- 
11             MR. STONE:  But a locked wouldn't be able to,
12   either, because you're adding or subtracting the access
13   fee to it.  The only reason it locks right now is because
14   you have whole decimal places and you're not able to take
15   out what the access fee is because of it. 
16             I'll give you a little insight into the access
17   fee thing.  In 2004 and actually all the way through,
18   Tradebook was very dead set against access fees and
19   payment for order flow.  We thought about the distortions
20   there was.  But now we look at it -- and maybe I'm
21   changing, so I'm representing myself, not the official
22   organization. 
23             Transparency is a big deal.  And what I fear is
24   that if we get rid of the maker-taker regime, a lot of
25   what happens is going to go into the back room.  Oh, you
0140
 1   get the free server, or you get a discount here. 
 2             At least with maker-taker, we at least know
 3   what the incentives are because it's more transparent and
 4   it applies equally to all groups in terms of whoever is
 5   giving the order flow and you can figure out exactly what
 6   the incentives are for the broker who's routing the order
 7   for the institution.  
 8             So I sort of threw out three things.  I'm sorry
 9   to complicate it, but it's -- 
10             MR. RATTERMAN:  Let me just add to the dialogue
11   here, combining things that have been said and that Tom
12   mentioned.  And we were on record earlier this year as to
13   bring forward a proposal that, like other things, access
14   fees could benefit from a not one-size-fits-all. 
15             So just to level set, I personally don't think,
16   BATS doesn't think, that just reducing the access fee to
17   the bare minimum is going to be the best market structure
18   for all securities.  Certainly for very active securities
19   we would propose that there's probably excessive
20   incentives in terms of the rebate that's offered, and the
21   fees that are charged are possibly too high to account
22   for that. 
23             But you make your way down the list of
24   securities in the U.S. past the most active ones, and a
25   reduction in access fees and thereby a reduction in
0141
 1   rebates would potentially have a harmful effect on the
 2   liquidity provision in less liquid securities. 
 3             So I just want to make sure we keep in mind
 4   here that we don't necessarily need to push
 5   one-size-fits-all, especially in this conversation.  We
 6   would be an advocate of a tiered approach based on the
 7   liquidity profile of the securities in question. 
 8             MR. WITTMAN:  I think when you look at the less
 9   liquid stocks, you could argue for a rebate of higher
10   than 30 to make sure that you force some liquidity there
11   and tighten the spreads.  So we're on the same page
12   there.  And non-U.S. venues use notional pricing.  So
13   that's another option.  Obviously, that's not going to
14   help tighten spreads for some securities.  But there's
15   other ways to look at this. 
16             MR. STONE:  But this is a question of, do you
17   feel that eliminating volume tiers and adding that back
18   into the price would increase transparency and
19   simplicity? 
20             MR. WITTMAN:  As far as?  So we have volume
21   tiers where the biggest firms in the tier get a 30 or
22   higher rebate. 
23             MR. STONE:  Right. 
24             MR. WITTMAN:  But the problem is, that rebate
25   is used for -- it could be used for Facebook or Intel or
0142
 1   Priceline, and a 30 rebate in Priceline is not
 2   beneficial.  It doesn't help things at all. 
 3             MR. STONE:  No, no, I understand.  And I'm
 4   talking about in general.  So the entire activity that a
 5   broker or member of NASDAQ does goes into what volume
 6   tier they're in that is created.  
 7             What I'm saying is you get rid of that and you
 8   say, we are 29/30 for everything, period.  It doesn't
 9   matter how much you do.  Or make it three mils.  I don't
10   know.  But would that increase the simplicity and the
11   transparency that would benefit all investors, including
12   retail?  Because they would know exactly what are the
13   charges that they're getting from the exchanges and from
14   the marketplace. 
15             MR. WITTMAN:  No.  I think you're still on the
16   one-size-fits-all for that 29/30. 
17             MR. STONE:  No, no, I get it.  You can tier. 
18             MR. WITTMAN:  You've got to do it by size. 
19             MR. STONE:  Tier it by stock.  But my point is
20   the question.  All right?  So you tier it by stock,
21   increasing them through.  But I'm changing the volume
22   tiers that actually set the access fee for the
23   institution at the time of trade.  I'm not doing it at
24   the end of the month. 
25             MR. NAZARALI:  Gary, if I could just add to
0143
 1   that or I could just address that. 
 2             MR. STONE:  Yes.  
 3             MR. NAZARALI:  I think that only works if you
 4   allow sub-penny pricing of orders because if I'm a retail
 5   investor and I see a price out there of $10.003, I want
 6   to trade up that.  Right?  So I want to be able to enter
 7   that order at 10.003.  And if I can't enter that order at
 8   10.003 and I enter an order at 10, I'm wondering why is
 9   my order not executing. 
10             It's very confusing to me to have an order at a
11   price that I can't input.  So then if you then allow
12   sub-penny pricing, then you get into a whole host of
13   other issues about, okay, is someone going to step in
14   front of my order by a tenth of a cent, and is that going
15   to discourage displayed liquidity? 
16             So in theory, that sounds really good.  But I
17   think in practice, it creates a host of other problems. 
18             MR. WITTMAN:  And to Jamil's point, I think we
19   should look at intelligent tick sizes.  We have very
20   unintelligent tick sizes.  In our pilot, if we would have
21   had a product like Bank or Siri traded, a quarter of a
22   penny, I think you'd have a completely different outlook. 
23             MR. LUPARELLO:  And what are the costs and
24   risks of going to less coarse, to pick up on Jamie's
25   terminology, tick sizes at the more liquid end of the
0144
 1   market? 
 2             MR. WITTMAN:  I think one's been mentioned. 
 3   Right?  The cost of the front run is decreased.  I think
 4   historically --  I'd like to Matt and Kevin for this
 5   commentary here -- but institutions were quite hesitant
 6   to think about a sub-penny tick size.  It's pretty
 7   confusing already.  It makes them really hard outside of
 8   a stable of extremely liquid low-price names. 
 9             MR. CRONIN:  Yes.  I think that is the issue. 
10   Right?  What would you have to go to in decimals to make
11   such an arrangement work?  If we're talking about tenths
12   of a cent or half of a cent or a quarter of a cent or
13   whatever the increment is, remember how it works. 
14             Somebody has the ability to bid in front of us
15   for a very, very small increment.  So we take the risk,
16   posting a better offer, and instantaneously, instead of a
17   penny, now we're getting jumped in front of by a tenth of
18   a cent or less. 
19             So I don't see that we would have a whole lot
20   of incentive to post liquidity in some of those names
21   when the increment of jumping in front is so small and
22   the risk associated with that activity is so small, it
23   seems like it would become more of a problem for us. 
24             Now, in some of these highly liquid names, I
25   couldn't say for sure because we do routinely post large
0145
 1   bids and offers in these kinds of stocks without too much
 2   detrimental impact.  But I think it's a whole new world
 3   when you start talking about trading in increments of a
 4   thousandth of a cent, for example. 
 5             MR. STONE:  We agree with that.  I agree with
 6   that wholeheartedly.  Sub-penny pricing was bad.  I
 7   actually wondered why the Commission didn't ban sub-penny
 8   executions, actually, in the marketplace when they got
 9   rid of sub-penny pricing. 
10             But my point was more that if you add the
11   access fee into the equation, the investor sees exactly
12   what his fees are, and they can get passed through.  So
13   the conflicts of interest that a lot of us wonder about
14   in terms of how things are actually routed go away
15   because it gets passed through and the actual price that
16   you see is the actual price that you're actually paying. 
17             MR. ANDERSEN:  Yes.  I'm skeptical of opening
18   that can of worms because if you're going to go to true
19   pricing, a retail investor would want his explicit costs
20   of execution, his commission, updated in his price. 
21   Maybe the broker would want to know, with all of the
22   market data fees -- I know my firm has to pay for access,
23   for safety, for connecting to BX, connecting to all these
24   licenses.  Those are all fees, and where do you draw
25   that? 
0146
 1             I think the critical part here is what Kevin
 2   was talking about, which is something that the Commission
 3   was considering and was summarized in our documents this
 4   meeting, which is the incentive to quote.  And I've seen
 5   this all manner of experience. 
 6             I know Tom has done a lot of work in the
 7   options markets, and in that market you have limited
 8   internalization and primarily size per route of markets. 
 9   So the incentive is to make a bigger market.  And that
10   works to do that, and so you have these ghastly big bids
11   and offers for products that seldom trade.  That is what
12   the market wanted to incent, and that's what the market
13   got. 
14             If you go to finer increments, the thing you
15   have to be so careful with is based on the liquidity
16   profile of the particular asset class, what is the cost
17   to jump the queue?  So any time there is an innovation in
18   price, there's a race to get there and a time/price
19   priority market, as opposed to the options market, to get
20   to be first in the queue. 
21             And people invest enormous sums, and they call
22   MIT professors apparently to bend the space-time
23   continuum, which I'll be thinking about that on the plane
24   ride back.  They go to great lengths to try to get to
25   that queue first.  If you can just be slow and then say,
0147
 1   well, I'll just improve it again, you get a very thin
 2   market and very little incentive to display your price
 3   aggressively. 
 4             In our Island days, when we first went from
 5   fractions to pennies, we had a spirited debate about what
 6   the increments should be.  If I really want to scare the
 7   hell out of you, I'll tell you that the original
 8   suggestion was six decimal places. 
 9             And then we took a calculator out and we
10   realized that you had to have a trade of -- I don't
11   remember what the math was, but something like 20,000
12   shares to make like a penny of difference on the
13   settlement price.  And we figured that was pathological. 
14             We went to tenths of pennies, and we watched
15   our market share go down because no one wanted to price
16   there just to get jumped.  And so we went back.  The
17   right answer here, I do think, is some degree of tiering,
18   as has been suggested by a bunch of you, because there
19   are certain names, hyper-liquid, like the Spiders or
20   queues, which could easily support sub-penny pricing. 
21   But for the other ones, you can't. 
22             I tend to prefer there being a flexibility in
23   the regulatory regime that would allow an exchange, if
24   they want to try to incent behavior in a particular asset
25   class, to have the flexibility with their pricing to be
0148
 1   able to incent the behavior they like. 
 2             MR. NOLL:  I wanted to briefly return to the
 3   locked market question, and this is really for both Tom
 4   and Tom.  One of the things I've heard is allowing locked
 5   markets would eliminate complexity in the marketplace and
 6   reduce unusual order types or really reduce complexity in
 7   the way the markets interact with one another. 
 8             From your perspective, as operating two
 9   exchanges -- and Joe, chime in as well -- do you really
10   think that changes the complexity?  Or are there still a
11   tremendous number of complex order types out there, even
12   away from those that accommodate the prohibition on
13   locked markets. 
14             MR. RATTERMAN:  I'll jump in real quick.  In
15   terms of complexity in the order types and the
16   regulations that create the demand for those order types,
17   it is true that a vast percentage of our time in thinking
18   about the matching engine logic has to do with keeping
19   orders from interacting that shouldn't interact by the
20   regulation.  There is a simplicity that would come in our
21   systems if much of that regulatory compliance work were
22   taken away.  No question it would be simpler.  
23             But for many of the reasons that have been
24   brought up here, you have to measure complexity against
25   the benefit it brings.  And if the benefit is an
0149
 1   understanding of how the markets should work and a sense
 2   of fairness, then the complexity to implement that surely
 3   is justified. 
 4             So yes, our systems would get easier if we
 5   could ignore the rest of the world, if we didn't have to
 6   worry about best prices anywhere else, if we didn't have
 7   to worry about whether orders were going past each other,
 8   and just let a free-for-all happen on the market.  That
 9   would be a simpler matching engine, no question. 
10             MR. WITTMAN:  And the complexity doesn't scare
11   a tech guy because we've solved those problems, I think. 
12   And yes, they were challenges.  But I think they're
13   challenges that already have been solved.  Some are
14   because market makers want to maximize their rebate. 
15   Some are because they've got latent market data and they
16   think they're going to be adder and they're not, and they
17   don't want to cross, they don't want to lock. 
18             But as Joe said, we built that logic into these
19   match engines and they're there now.  And as someone else
20   earlier said, once you've got more than one other
21   exchange that you've got to consume data for, if you've
22   got three, you have 20, you have 50, it really doesn't
23   matter.  You've got the infrastructure.  So to me, the
24   complexity really doesn't matter from that standpoint. 
25             MR. FARLEY:  It would, no question, reduce
0150
 1   complexity, as Joe said.  It does introduce an added
 2   complexity, though, as Jamil said, which is now you're
 3   going to have an entire swath of the trading public
 4   saying, well, wait a minute.  I was 12 bid here and it
 5   was allowed to be 12 offered there.  And it is a little
 6   confusing.  I understand choice markets occur in FX and
 7   interest rates and other areas.  But we would win away
 8   those two things against each other. 
 9             In addition, I think the benefit of reduced
10   complexity you would get with allowing locked markets is
11   small.  It's not huge.  It's not orders of magnitude. 
12   And I actually think maybe we step up a level and say,
13   well, wait a minute.  Why is it that we even have locked
14   markets?  
15             And is maker-taker pricing -- the reason we
16   have it is maker-taker pricing.  You wouldn't have it if
17   everything was just -- buyers and sellers were charged
18   the same amount, with some provision for those who want
19   to make markets.  So I think that's a conversation worth
20   having. 
21             Do we have the right incentives and pricing
22   structure in the market at large causing locked markets
23   in the first place? 
24             MR. WITTMAN:  Back to Jamil and retail.  So if
25   you're a retail customer and you enter a limit order, you
0151
 1   lock the offer.  Don't get an execution, cancel the
 2   order, enter a mark, or you get an execution -- it
 3   doesn't make a lot of sense to a retail investor, I don't
 4   think. 
 5             MR. NAZARALI:  Yes.  I agree. 
 6             MR. SELWAY:  But if I could ask, what retail
 7   broker would abide that?  We already know, as I'm sure
 8   Jamil could attest, that the service levels provided to
 9   retail investors today far exceed -- price improvement
10   rates are substantially larger than zero.  Right?  
11             So your clients are already doing so much
12   better than the displayed mark were that to occur, why
13   wouldn't you simply reroute the order and maybe even --
14   you probably wouldn't try price improvement because you
15   couldn't.  But you wouldn't let a retail order be locked. 
16   Correct? 
17             MR. NAZARALI:  Well, not if the order came in
18   while the market was locked.  But it might have been
19   sitting out on the exchange, and then it becomes locked,
20   and that still doesn't feel fair that you're not getting
21   executed. 
22             MR. FARLEY:  We can come up with a new order
23   type for that. 
24             (Laughter.)
25             MR. RATTERMAN:  And Jamie, it is the difference
0152
 1   between a marketable order and a passive order that
 2   enters the market that becomes locked later.  So picking
 3   up an order and moving it and chasing is probably a
 4   difficult decision for a retail broker.  The passive
 5   order has a place to rest.  It has to rest.  And so the
 6   rest of the market structure has to support that
 7   execution once that order's rested. 
 8             MR. LUPARELLO:  Any last questions for the
 9   panel before -- 
10             MR. KETCHUM:  Let me go back, Jamie, to your --
11   not that I don't love -- I could spend hours on locked
12   and crossed markets, just too good.  But you suggested
13   more broad reactions to 611 as it sits now as opposed to
14   incrementally tweaking things on locks and the rest from
15   the standpoint of either a block exemption or depending
16   on a different type of best execution definition that's
17   certainly applied, when NASDAQ operated in a fragmented
18   environment, with no 611. 
19             So what's the behavior you think that is being
20   discouraged now or being hindered that you'd like to see
21   happen, either with the block exemption, or more broadly,
22   from the standpoint of not having 611?  And what would
23   you want to protect against from the standpoint of a
24   different type of best execution view? 
25             MR. SELWAY:  Yes.  I think it would be healthy,
0153
 1   maybe to Matt's point, maybe to Commissioner Gallagher's
 2   point earlier.  I think that 611 is a very rough proxy
 3   for best ex.  I think it doesn't go far enough from a
 4   retail perspective.  I don't think it's relevant in
 5   institutional perspectives.  I think we're a healthier
 6   industry if we had a more clearly articulated, more
 7   robustly articulated set of best execution standards. 
 8             I think institutional disclosure would
 9   certainly be helpful.  Certainly our firm and many others
10   around the table provide an awful lot of disclosure to
11   our customers.  The problem with it is that it's long and
12   it varies by firm.  So we wind up doing piles of it, and
13   it's not uniform. 
14             I think that from the institutional context,
15   611 doesn't do much.  It does throw a little bit of sand
16   in the gears from a compliance perspective, and we have
17   to document things, and there's that to it.  I think at
18   the margin you might get more flexibility for large
19   trades outside the posted quote. 
20             I think Tom's proposal on the intra-day auction
21   is quite interesting.  As a broker, I'd like to use it. 
22   The notion of pricing a block outside the midpoint, which
23   industry is quite good at doing, but maybe up a nickel,
24   up a dime, that's interesting in an automated fashion. 
25             But we instantly head right towards how do we
0154
 1   comply with 611.  I just don't know that that's a very
 2   helpful question.  So I think more flexibility to the
 3   larger trade, and particularly to the less liquid stocks,
 4   I think we could be leaving something on the table in
 5   that context. 
 6             MR. STONE:  Can I ask a question?  Tom, I'm
 7   looking over your chart here, and it's very interesting. 
 8   My question is that if the threshold was lowered for
 9   ATSs, would that increase the display that would happen
10   in these groups? 
11             MR. FARLEY:  What do you mean, the threshold? 
12             MR. STONE:  The threshold for ATSs is 5
13   percent.  So if they basically go down to 2-1/2, which
14   was the proposal, I think, in 2009, or even lower, that
15   forces -- dark will become more like an ECN.  It's quoted
16   in some fashion or it's just not traded.  Would that help
17   this phenomenon that you're talking about in this grid? 
18             MR. FARLEY:  I suspect that would help.  That's
19   just my knee-jerk reaction.  I think another thing that
20   would really help would be to, in a more bona fide way,
21   reward the guy who made the price in the first place on a
22   public venue, whether it's a lit ATS or an exchange,
23   which is independent of where the threshold is.  I think
24   that's kind of where the big benefit can come in and
25   what's missing in trade-through. 
0155
 1             MR. STONE:  Yes.  My hesitancy is prescribing
 2   how people trade with that.  And I'm very hesitant on it
 3   because you get unintended consequences, like you're
 4   pushing a balloon and something pops up the other way. 
 5             Whereas if you actually sit there with a
 6   principle that displayed markets are really good and
 7   we're going to force people to display because it's
 8   healthier and it's what we're trying to get at, if you
 9   deal with that principle, then lowering the threshold and
10   it solved some of this problem, I would be more looking
11   to do something that than prescriptive things. 
12             As I think Jamie said, the prescriptive things
13   is what's causing the balloon to be popped out in
14   different directions, trying to make it whole. 
15             MR. FARLEY:  I think we're already in a world
16   where there's -- we're in the world of prescriptive.  So
17   I think that cat's out of the bag.  But my concern would
18   be doing what you described, as then you would just have
19   the next dark pool would get created until it got to that
20   2-1/2 percent, and then the next dark pool would be
21   created until it got to 2-1/2 -- I think you said 2-1/2
22   percent. 
23             So again, I think the real way to do it is for
24   us to put our heads together and figure out, how do we
25   reward the person who's providing a policy good and
0156
 1   making that in a public place? 
 2             MR. KINAK:  Tom, can I ask a quick question,
 3   Tom Farley?  Since you talk about rewarding people that
 4   are displaying, but all the exchanges run on pretty
 5   substantial dark book, and you guys trade similarly to
 6   dark pools, and dark pools are trying to similarly trade
 7   to exchanges, and it's all one market center and
 8   everyone's behaving the same way, how do you justify
 9   running such a big gray pool while still saying, I want
10   to reward people for displaying liquidity? 
11             MR. FARLEY:  It sounds very ominous the way you
12   present that.  The New York Stock Exchange, I think we're
13   unique among our exchange peers, perhaps -- I'm not
14   certain, Tom and Joe -- in that we disclose on our
15   website, not just for the NYSE but Arca, all of the order
16   types that we use including those that aren't displayed,
17   so for instance, the reserve portion of a limit order,
18   for example. 
19             And I think our total volume that comes from
20   those order types is single digits.  I haven't looked at
21   it recently.  So I'm not sure what you're referring to
22   with very large, but of our volume, it's actually quite
23   small, as to be barely consequential. 
24             MR. RATTERMAN:  Let me follow on with that as
25   well.  In my mind, in BATS' mind, the answer is not all
0157
 1   lit and no dark.  The market is served well by a variety
 2   of ways to express your order and to get executions done. 
 3             Some of that is by showing some of your size,
 4   and some of it's by having some reserve or hidden
 5   liquidity available.  Different players have different
 6   needs to different kinds of liquidity.  And so the answer
 7   is a good mix.  We're actually deviated a little bit from
 8   the other exchange groups in terms of our views on the
 9   level of dark activity. 
10             I shared a similar perspective to what might be
11   causation but at least is correlation, and it's hard to
12   tell if it was causation or correlation in terms of
13   spreads and off-exchange activity.  And as I sought out
14   to canvass the market and talk to those who are
15   displaying limit orders, I was seeking out who was being
16   harmed by not having an execution.  And I actually didn't
17   find those that I thought I would find. 
18             Most of the folks that were posting on the
19   displayed markets were also posting in the dark markets. 
20   And their price discovery that they were contributing to
21   was being rewarded in a dark market.  And so there's
22   probably some more research that needs to be done into
23   the damages or the harm thesis to this. 
24             Protecting the displayed orders, retail orders,
25   come into the market in a very different way than
0158
 1   institutional orders do.  And trying to find who's really
 2   harmed and are they feeling like they're harmed for not
 3   getting rewarded on the displayed markets is something
 4   that I haven't found a good answer to yet. 
 5             MR. FARLEY:  If I can just add one more
 6   comment, reflecting on my comments over the last hour.  I
 7   haven't been explicit in saying that we actually support
 8   dark trading.  We think it's an important part of the
 9   marketplace.  Large-size transactions occurring on dark
10   pools is eminently sensible, for example, block trades,
11   so on and so forth. 
12             And the key is to reward those that are
13   actually making lit prices.  Case in point:  With respect
14   to dark orders that we have on the New York Stock
15   Exchange, those always trade after any lit order.  So
16   there's always priority and there's always a reward for
17   that person that shows up first and makes the lit price. 
18             MR. WITTMAN:  Now do I just answer?  We execute
19   about 50 million shares a day that's midpoint and dark. 
20   But I think the fact that it is married with lit, and
21   customers come in and reach across the spread, there's a
22   decent percentage of time they get the midpoint execution
23   as a positive thing so they aren't run separately. 
24             So I think it's a positive thing.  I'm not sure
25   if others feel differently than that.  
0159
 1             MR. RATTERMAN:  I'll just add real quickly that
 2   a vast majority of the dark executions on the BATS
 3   exchange, and I assume it's true for NASDAQ and NYSE as
 4   well, is done at the midpoint.  That's a place where you
 5   can't display a quote.  It's impossible with today's
 6   market structure to display a midpoint interest. 
 7             And so those midpoint executions are a
 8   reflection of the inability to post those quotes, and
 9   also a direct benefit to those who are attempting to
10   cross the spread to begin with and found themselves with
11   an execution halfway in between in the form of a full
12   half-increment price improvement. 
13             MR. LUPARELLO:  Jamil, maybe the last question? 
14             MR. NAZARALI:  Yes.  This is more addressing
15   the issue about who's harmed and is the lit liquidity
16   harmed by having these executions happen in the dark. 
17             In our analysis of retail limit orders, the
18   vast, vast majority of them -- and we can get you the
19   numbers -- get filled when there's a trade at that price. 
20   So it's not that they're not getting filled.  They might
21   not get filled at that particular moment; there may be a
22   bunch of dark fills going off.  But they will get filled. 
23   So that's one point. 
24             And then the second point I'd like to make is
25   that we are a very, very big supporter of lit venues.  We
0160
 1   recognize the importance of that price discovery.  But
 2   there's a balance in that I think a lot of the benefits
 3   that have come in the marketplace over the last ten-plus
 4   years have been the result of the competition. 
 5             We heard a number of people talk about how the
 6   New York Stock Exchange had 80 percent market share; it
 7   now has 25 percent market share.  A lot of that was
 8   driven by competition and innovation.  And so we really
 9   have to balance that public good of lit markets with the
10   competition that has driven a lot of this benefit that
11   we've got over the last couple years. 
12             MR. LUPARELLO:  Thanks again to the committee. 
13   I think this is a very helpful conversation that shows
14   the challenge for the committee and the folly of maybe
15   trying to think about these issues in isolation.  I think
16   in discussing 611 we hit on maker-taker, trade-at, locked
17   and crossed markets, sub-penny pricing, and ATS reform,
18   and I think, actually, institutional order routing
19   disclosure, all of which are necessary adjacencies but
20   make it a challenge to think about these issues.  So
21   thanks again to Jamie, Tom, and Tom. 
22             Five minutes just to switch out, and then we'll
23   go with the second panel. 
24             (A brief recess was taken.)
25             MR. LUPARELLO:  Well, we have our second panel,
0161
 1   and I will introduce them in alphabetical order and then
 2   ask them to speak in reverse alphabetical order. 
 3             Starting on my left is Bill Baxter, the head of
 4   global program trading and market structure at Fidelity. 
 5   To his left is Brandon Becker, a former executive VP and
 6   chief legal officer at TIAA-CREF, and also somebody who,
 7   along with Rick, had the job that I have now; there can
 8   be no more than three in the room at any given time, so
 9   one of us will have to leave if one of the other formers
10   comes in. 
11             To his left is Jeff Brown, senior VP and head
12   of Schwab's office of legislative and regulatory affairs,
13   which I'm told is a new title; congratulations, Jeff, at
14   Charles Schwab.  And to his left is Dave Lauer, who's the
15   president and managing partner of KOR Group, LLC. 
16             Thank you very much, gentlemen, and we'll start
17   with you, Dave. 
18             MR. LAUER:  Thank you.  Chair White,
19   Commissioner Stein, Commissioner Gallagher, Senator
20   Kaufman, members of the advisory committee, thank you
21   very much for having me here today and inviting me to
22   speak.  I've submitted a full written statement, and I'll
23   only touch upon some of the points here. 
24             My name is Dave Lauer.  I'm the co-founder and
25   CTO of KOR Group, a market structure research and
0162
 1   analysis firm that specializes in execution quality
 2   measurement and order routing optimization.  Our focus is
 3   quantitative analysis of market structure and helping
 4   asset managers and brokers make better order routing
 5   decisions.  I'm also speaking to you today as co-founder
 6   and chairman of the Healthy Markets Association, a
 7   nonprofit coalition working to empower regulators and
 8   market participants with better data and analysis. 
 9             I am not by training a policy analyst.  I'm a
10   technologist.  I began my career designing hardware to
11   power low latency trading desks before ultimately going
12   on to design and run high-frequency trading strategies. 
13   I focus on data and analytics, and it is with that
14   mindset that I approach the issues that we are addressing
15   here today.  I also serve as an independent director for
16   Aequitas, a new investor-focused Canadian stock exchange. 
17             I want to begin my remarks by congratulating
18   the Commission on formulating this advisory committee,
19   and by applauding the continued focus on improving our
20   market structure.  Regulation NMS has been a
21   transformative force in U.S. equity market structure, and
22   Rule 611 forms the foundation of this modern market
23   structure.  This is an excellent place for the committee
24   to begin its analysis and review. 
25             Our market structure has had -- oh, I'm sorry. 
0163
 1   I forgot about my slides for a second.  That's us. 
 2             Our market structure has had no shortage of
 3   critics over recent years, myself included.  This is not
 4   to say that Reg NMS has not been a success.  Its
 5   objectives, when adopted, were intended to democratize
 6   trading.  It has accomplished this resoundingly.  But the
 7   market ecosystem it created also has some fundamental
 8   flaws.  We must update the rules, but we should not scrap
 9   the entire framework.  Instead, we should focus on the
10   problems and issues and address them.  
11             Some will argue that, above else, we should "do
12   no harm."  I disagree.  We live in a world of unintended
13   consequences.  Some are good.  Others are not.  If I make
14   a mistake in my business, I will adjust and try to move
15   forward.  So too should it be with regulations.  It's
16   time to push forward. 
17             Rule 611 has not had many public defenders in
18   recent years, so I'd like to take a moment to remind
19   everyone of its benefits.  The original goals of this
20   rule were to protect investors from execution at inferior
21   prices and promote displayed limit orders. 
22             First and foremost, Rule 611 is, unfortunately,
23   one of the only explicit protections that investors have
24   to force their brokers to demonstrate best execution. 
25   This point cannot be overstated.  The state of best
0164
 1   execution in U.S. markets is abysmal.  
 2             The regulatory expectations of best execution
 3   have not kept pace with the changing execution
 4   environment.  Quantitative analytics need to play a much
 5   larger role in best execution analysis, and conflicts
 6   need to have a far greater standing. 
 7             When adopting Reg NMS, Rule 611 sought to
 8   provide strong intermarket price protection on an
 9   order-by-order basis.  This was supposed to be
10   supplemented by Rules 605 and 606, which were meant to
11   provide transparency into execution quality and broker
12   order routing, and allow investors to make informed
13   decisions based on quantitative metrics. 
14             Unfortunately, because Rules 605 and 606 are so
15   outdated, they don't offer much.  As such, Rule 611 is
16   one of the few protections that investors have in place
17   on an order-by-order basis to ensure that they're
18   receiving the best price in the market and that their
19   orders are not trading through.  Unfortunately, as was
20   said earlier, maybe not this strongly, Rule 611 is a
21   terrible proxy for best execution. 
22             Rule 611 is also an important component of
23   promoting a competitive and innovative environment, at
24   least in theory.  It provides the means for an upstart
25   execution convenient to compete with entrenched
0165
 1   incumbents.  In the absence of order protection, the
 2   broker dealer community could readily ignore an upstart
 3   exchange with a radical innovation that threatens its
 4   finances.  This would be to the detriment of the market. 
 5             The Commission staff briefing memorandum does
 6   an excellent job of addressing the price criticisms of
 7   Rule 611, but I'd like to add a few more. 
 8             Rule 611 is often accused of increasing
 9   fragmentation, creating unnecessary complexity,
10   subsidizing nonviable exchanges, increasing costs and
11   systemic risks to the industry, and promoting a
12   one-size-fits-all market structure.  Let's examine two of
13   these criticisms, starting with fragmentation. 
14             Rule 611 is often blamed for increased market
15   complexity, whether due to fragmentation or increasingly
16   exotic order types.  However, the data on fragmentation
17   does not necessarily bear this out.  For example, here's
18   a table examination fragmentation in the U.S., Canada,
19   and Europe.  We've calculated the Herfindahl index for
20   various global markets.  This index ranges from zero to
21   1, with zero being a perfect monopoly and highly
22   fragmented markets approaching a value of 1. 
23             The Commission staff calculated this index
24   based on per-share values in their briefing memo, but we
25   prefer to use notional values as of last month.  So is
0166
 1   fragmentation connected to an order protection rule and a
 2   ban on locked or crossed markets?  The answer is
 3   inconclusive, to say the least. 
 4             As you can see from the chart, fragmentation in
 5   the U.S. far exceeds fragmentation elsewhere, but the
 6   order protection rule may not be the cause.  For example,
 7   Canada has an order protection rule, but its market is
 8   still much more monopolistic than ours.  While Canada has
 9   this rule, Europe does not. 
10             However, Canadian fragmentation is very similar
11   to that of London and Frankfurt, two countries (sic)
12   dominated by individual venues but still with robust
13   competition.  Compare that to Milan, a market in which
14   two venues make up 90 percent of the trading, and which
15   is far closer to a perfect monopoly. 
16             It is also important to recognize the role of
17   historical forces.  The U.S. markets outside of NYSE
18   listings have been competitive and fragmented for longer
19   than Rule 611 has been in place, while Canadian and
20   European markets are relatively new to market center
21   competition.  Once we start thinking about NASDAQ's
22   history, it becomes relatively clear that any allegations
23   of a causal relationship are tenuous. 
24             But there are some established causal
25   relationships.  For example, Rule 611 may play a key role
0167
 1   in sustaining unnecessary fragmentation.  Aside from
 2   costs, this increases the number of failure points and
 3   thus systemic risk.  But the costs alone are not
 4   insignificant. 
 5             While it may always be the case that no
 6   participant must connect to a particular venue, the
 7   reality is that market participants need comprehensive
 8   connections and information to remain competitive. 
 9   Participants bear direct and indirect costs as a result
10   of market data, collocation, order routing, and
11   connectivity.  As the NetCoalition cases illustrated,
12   market centers have incredible pricing power over the
13   private data feeds.  This also applies to connectivity
14   and data fees as well. 
15             I also want to take a moment to discuss one
16   area where I feel the Commission has dropped the ball. 
17   The Commission should never have allowed exchanges to
18   also become order routers.  This decision has blurred the
19   line between broker and market center, both with lit
20   venues and in regards to ATSs.  Brokers are now acting
21   like exchanges and vice versa, and both have overwhelming
22   conflicts of interest. 
23             Trading venues have become competitive to their
24   broker clients while at the same time being responsible
25   for routing orders to their own competitors.  On the
0168
 1   other hand, brokers now compete against exchanges by
 2   routing to their own ATSs.  This has increased lit venue
 3   toxicity and reduced average trade size and dark pools to
 4   the level of the lit market.  Something is quite
 5   obviously wrong here. 
 6             But Rule 611 is not alone in its blame.  For
 7   its part, the Commission must more critically assess
 8   order handling, routing expectations, and complex order
 9   types.  The rules are not as much at fault as are their
10   interpretations. 
11             Speaking of unnecessary complexity and
12   fragmentation, we should understand why some firms may
13   own multiple trading venues with nearly identical
14   features.  Common sense and basic economics would suggest
15   consolidation would help eliminate redundant operational
16   and regulatory compliance costs. 
17             Nevertheless, these powerful forces for
18   consolidation seem to be overcome by the able to reap
19   additional data fees, connective fees, market data
20   revenues, and the trading that occurs due to order
21   protection.  These fees do not help the markets, but
22   instead act as explicit taxes borne by brokers and,
23   ultimately, by investors. 
24             Put simply, the more trading venues we have,
25   the more fees.  It's clearly time to focus on reform.  We
0169
 1   think market structure reform should be designed to
 2   better protect investors, promote market center
 3   innovation and competition, simplify structure and reduce
 4   complexity, and incentivize displayed liquidity.  With
 5   these goals in mind, we recommend the following reforms,
 6   both within and beyond Rule 611. 
 7             First, the Commission should update Rules 605
 8   and 606 to provide for better transparency into execution
 9   quality and order routing practices.  This includes
10   ensuring that investors can get a full order audit trail
11   upon request from their broker.  I know I'm starting to
12   sound like a broken record on this, but I won't stop
13   until it gets done. 
14             Second, the Commission desperately needs to
15   modernize best execution rules and recommend firms to
16   have audit trails quantitatively analyzed and audited
17   independently.  Conflicts of interest need to be examined
18   and elevated, and brokers should be required to
19   transparently demonstrate execution quality on a
20   quantitative basis. 
21             Third, Rule 611's order protection
22   responsibility should be borne by the brokers, not by the
23   exchanges. 
24             Fourth, the Commission should reexamine order
25   handling and routing rights for exchanges and complex
0170
 1   order types. 
 2             Fifth, the Commission should reduce or
 3   eliminate market data revenue sharing to stop subsidizing
 4   nonviable educations. 
 5             And sixth, the Commission should boldly explore
 6   ideas to promote trading in displayed markets and reduce
 7   conflicts of interest.  These efforts should include a
 8   pilot to eliminate maker-taker, exploring whether to
 9   require a meaningful price improvement for off-exchange
10   non-block executions, demanding increasing transparency
11   into dark pool operations, and examining the propriety of
12   major brokers owning and referencing their own ATS. 
13             We recognize that some of these recommendations
14   are bold.  Some may work while others may not.  But we
15   simply can no longer wait.  Market participants and
16   regulators need more and better data.  By looking at the
17   data, we will see where natural evolution, conflicts of
18   interest, and perverse incentives have distorted out
19   markets and hurt market participants. 
20             I urge this committee to focus on the data, but
21   also be bold in pushing the Commission forward.  Thank
22   you very much for the invitation to speak with you today,
23   and I look forward to the discussion. 
24             MR. LUPARELLO:  Thank you, Dave. 
25             Jeff? 
0171
 1             MR. BROWN:  Hi, everyone, Chair White,
 2   Commissioners, staff, and the committee.  Thank you for
 3   having me here.  It's a great pleasure.  I wish you all
 4   well in your deliberations and recommendations. 
 5             Just a little bit about myself, just so you
 6   know.  I've been in the market since about 1981.  I was
 7   an option market maker at one time.  I was at the SEC.  I
 8   was general counsel of an exchange.  I chaired one of the
 9   governance cartels of the market data system.  And so
10   I've had quite a broad and deep experience. 
11             When I got an invitation to come speak today, I
12   was kind of surprised about 611 being the first topic. 
13   And I think, actually, our conversation that we just had,
14   a very interesting conversation to listen to in the last
15   panel, reflects it. 
16             There are really a lot of other issues that we
17   want to get to -- maker-taker, locked/crossed,
18   institutional execution.  But certainly it is a great
19   discussion-starter.  I think you really did it on the
20   head in doing that.  So that's good. 
21             Now, for full disclosure, Schwab opposed Rule
22   611 when it was proposed in 2004 and 2005, for several
23   reasons.  One, we didn't think a trade-through rule was
24   necessary.  If you go back to then, the New York Stock
25   Exchange was still operating with a trade-through rule in
0172
 1   the ITS system, and that was a terribly inefficient and
 2   anti-competitive system -- if you competed against it, it
 3   was very difficult; whereas the NASDAQ market was no
 4   trade-through rule, but very efficient and one that our
 5   clients liked to trade at that time. 
 6             So we thought that -- in fact, we urged in our
 7   comment letter; I went back and looked -- that we have a
 8   pilot at that time at the New York Stock Exchange where
 9   there would be no trade-through rule.  Let's see what
10   happens in New York in listed securities when there's no
11   trade-through rule.  Well, that didn't happen.  But now
12   we've come full circle, and yet we still are concerned
13   about having a trade-through rule across our marketplace. 
14             But I guess the second reason we feel that way
15   is that we thought it was beyond the scope of the
16   Commission to really inject itself into micro market
17   structure, that their role is to sit above and provide
18   oversight and guidance, but that competition needs to
19   drive our markets. 
20             Markets are dynamic vessels, and they thrive in
21   a place where they can be dynamic and reactive.  And so
22   we felt like at that time, having the Commission inject
23   itself, create how the algorithms would work, where
24   orders would be routed, order types -- order types; the
25   Commission had to create order types in order to make the
0173
 1   system work -- we felt that that was not Congress
 2   intended in the '75 Act Amendments when they said that
 3   competition, not regulation, should be the guiding hand
 4   in the development of our national market system. 
 5             So I think our third point was with such a
 6   massive change, you're going to have unintended
 7   consequences.  And as Commissioner Gallagher reflected
 8   this morning, we certainly have had unintended
 9   consequences with this rule. 
10             Now, oddly, one of the biggest unintended
11   consequences has been the growth of off-exchange volume,
12   largely at the cost of the New York Stock Exchange.  But
13   that growth in off-exchange volume has turned out to be a
14   tremendous boon to retail investors. 
15             Retail investors have never had it better.  As
16   Commissioner Aguilar pointed out in his tome this week,
17   in the fourth quarter of 2014, execution quality was
18   better than even.  And in fact, as we look at our numbers
19   from throughout 2014 -- and we use a measurement of
20   effective spread over quoted spread, and for example,
21   that means that if you buy on the offer of the NBBO or if
22   you sell on the bid of the NBBO, that percentage should
23   be 100 percent -- our execution quality for all of 2014
24   was about 53 percent.  So you can see that competition
25   among the off-exchange retail vendors is driving
0174
 1   execution quality better and better.  That's what our
 2   markets ought to do. 
 3             At the same time, exchanges are reacting to
 4   that.  We've heard some mention this morning, or this
 5   afternoon, about retail liquidity provider programs and
 6   executions at the midpoint on exchange.  Those are
 7   programs we support, and some of our float does end up
 8   being executed there. 
 9             We think that's the appropriate response.  And
10   so I guess I'd be very concerned about, well, now we need
11   to do something to the environment because we're
12   concerned about the way things are instead of letting
13   competition play out and develop systems that operate
14   better. 
15             Now, there's no question, then, that what's
16   happened leaves us in a conundrum at Schwab.  We still
17   support free markets, and we ought to let our markets
18   operate freely.  But how can we ignore the fact that this
19   system has developed, unintended, that gives us much
20   better quality than we've ever had?  And that when we
21   compare it to the execution quality on the exchanges
22   today, there's no comparison.  We're required to monitor
23   best execution for our clients orders.  We get that
24   through these retail vendors. 
25             So I guess my point is, before you do anything,
0175
 1   I would urge caution.  As Joe Mecane said this morning,
 2   urge caution.  We need to test things.  And certainly the
 3   Commission is to be commended for the tick test pilot. 
 4   Now, again, a disclosure:  We opposed it. 
 5             But that was because we felt like widening
 6   spreads is just a wealth transfer from retail investors
 7   who have to cross the spread to waiting professional
 8   traders at the bid or offer.  All right?  So we felt that
 9   generally, that wasn't something to test. 
10             And even more pernicious, we felt, was the
11   trade-at provision.  But at least it's being tested, and
12   you're going to get data.  You're going to be able to
13   evaluate it.  And we can make decisions about its broader
14   application.  So that's the right approach. 
15             And as we go forward with fixing 611 or, by the
16   way, maker-taker, locked and crossed, we don't believe
17   there ought to be locked and crossed markets, and we
18   would be very opposed to a rule that says you can lock
19   and cross.  Locked and crossed is a market failure, and
20   it's only because of rebate collection that you have some
21   wanting to lock or cross.  So we would think that that's
22   something clearly this body should address. 
23             Before I finish, I guess one other area that I
24   would like this committee to look at is the NMS planned
25   governance structure as well as the market data system. 
0176
 1   There's so much more that we could do to make our system
 2   better and offer investors better information.  And yet
 3   we're kind of constrained in a context that hasn't
 4   changed since the late '70s. 
 5             So thank you very much, and I'm happy to answer
 6   questions. 
 7             MR. LUPARELLO:  Thank you, Jeff. 
 8             Brandon? 
 9             MR. BECKER:  My thanks to the Chair, the
10   Commissioners, the staff, and members of the advisory
11   committee for allowing me to speak to you today.  In
12   particular, I want to compliment Dan Gray again on
13   another thoughtful paper that's not only very insightful
14   but eloquently written, if you can say that about a
15   market structure piece. 
16             In that regard, I think Commissioner Aguilar's
17   note is especially helpful when framing the issues, and
18   would draw your attention to the Fox, Glosten, and
19   Rauterberg paper from last March that he relies upon in
20   part for his analysis.  I think it gives you a very
21   useful analysis of high-frequency trading and some of the
22   issues related thereto. 
23             I began my journey in market structure in the
24   fall of 1977 with the late Walter Werner and Sid Robbins. 
25   Professor Werner was director of the office of policy
0177
 1   planning at the special study, and Professor Robbins was
 2   the chief economist.  They would be surprised that I
 3   would presume to speak for the dead to discover the
 4   continued relevance of volume 2 of the special study to
 5   much of the analysis that we seem to circle around. 
 6             In that regard, one of the things that I think
 7   is particularly important that this committee speak to is
 8   the relationship, as you've heard throughout the day,
 9   between market data fees, rebates, and where orders get
10   routed.  In my view, the rain forest of order types is
11   basically fertilized by rebates and the prohibition on
12   locked and crossed markets. 
13             So I would actually commend to the committee
14   the ability to try and provide some specific guidance on
15   that.  I would recommend that there be some material
16   reduction in what is the de facto cap that's in place
17   now.  That, I think, would help to change the economics. 
18             I do think that it is a fool's errand to
19   basically chase order types and display requirements
20   under the name of best execution but not address the
21   underlying economic incentives.  If you don't talk about
22   that, then you're only going to shift the conversation to
23   a different place. 
24             You've got to get the economics to align with
25   the behavior that you want.  You can't get at it just by
0178
 1   redefining order types or by providing differential
 2   treatment of those orders.  I think you've got to make
 3   the economics fit the behavior because otherwise, I do
 4   think you're just playing whack-a-mole with the problem. 
 5             Now, I recognize that as a historical matter,
 6   the Commission has been very reluctant, with very good
 7   reason, not to go down the road of what is perceived as
 8   fundamentally rate-making, and I think that's a good
 9   judgment on the part of the Commission.  Unfortunately, I
10   don't think that's appropriate as a metaphor any more,
11   but there's an old joke about that. 
12             It is problematic to have market data fees and
13   rebates and have them in Commission rules and then not
14   deal with those on a sustained basis.  So you can't just
15   be a little bit in rate-making.  Once you start setting
16   the rates, you've got to be actively engaged because
17   otherwise you get the kind of results you're seeing in
18   the proliferation of order types and the gamesmanship. 
19   And then you get individual investors wondering who's
20   running the video game.  And I think that's not helpful. 
21             So in that regard, I would lower the rebates
22   materially.  And in addition, I would permit locked and
23   crossed markets for the various reasons that Jamie
24   described earlier.  I recognize the problem in doing
25   that, and I think the consumer and investor confidence
0179
 1   issues are real.  So I'd rather deal with the underlying
 2   economics and get them aligned than futz around with
 3   locked and crossed markets.  But I do think that you've
 4   got to deal with those sort of hand-in-glove to get to a
 5   resolution of these matters. 
 6             In addition, I think infrastructural issues
 7   continue to be important, so I would try and encourage
 8   additional dark pool transparency to try and address some
 9   of the ongoing issues in that regard.  The SIP/NBBO
10   upgrade is just -- it's got to get done.  It should have
11   been done a long time ago, and the SEC should make it
12   happen. 
13             The cap needs to be built so that we know what
14   we're looking at.  It's tough and it's expensive but
15   that, too, needs to be done.  With respect to the block
16   carveout, I have some concern that you would probably
17   need something, if I remember correctly, like a New York
18   Rule 127, if we got the right site, where you need a
19   block cleanup process. 
20             The idea that you would take the current market
21   and interject a block execution, and then have the retail
22   wondering why there was a print but they didn't get a
23   fill, does not seem like a happy answer.  And telling
24   them, the big kid traded ahead of you, would not be part
25   of a confidence-inspiring exercise. 
0180
 1             There is, I think, a very important role for
 2   this committee to play that I think could be very
 3   helpful.  There is the old saw, promise them anything but
 4   give them a study.  It would be really helpful if the
 5   committee could try and focus on one to three things that
 6   this Commission could actually do, recognizing the
 7   demands on its resources, recognizing the conflicting
 8   priorities, recognizing that we'll have a new President
 9   in 2017. 
10             It would be nice to get something done in this
11   space because there's certainly enough to talk about, and
12   you could fill a lot of time and write a lot of PhD
13   dissertations between now and then, but you wouldn't get
14   action. 
15             Whereas I think if this committee could find
16   some way to reach a consensus -- I'm not trying to drive
17   which one of those; personally, I'd go after the fees and
18   the rebates because I think that's where the economic
19   misalignment is -- but if you didn't like that, I would
20   still urge you to try and give a narrow set of actionable
21   items that either the Commission or the SROs could
22   address.  And I think that would be a really valuable
23   service not only for the Commission but for public
24   investors. 
25             Two items, just because I have a minute to
0181
 1   spiel.  I think it's important that we address equity
 2   market structure.  I think in terms of order of
 3   magnitude, this would be quantum mechanics and the fixed
 4   income market would be Newtonian.  So if I were looking
 5   to save money for retail investors, I would be looking at
 6   the fixed income market. 
 7             And second, if what I was worried about, as is
 8   Nancy, was really retail investors, I'd be worrying about
 9   how we deliver savings and retirement services to people
10   with less than -- pick a number -- a million dollars,
11   five million dollars, because those people aren't being
12   served and they're going to get hurt as they go into
13   retirement and age, and they need to find ways in which
14   they can get reliable services in a cost-friendly manner. 
15   Thank you. 
16             MR. LUPARELLO:  Thank you, Brandon. 
17             Bill? 
18             MR. BAXTER:  Thank you.  Chair White,
19   Commissioners, Director Luparello, and members of the
20   advisory committee, thank you for the opportunity to
21   speak with you today on the topic of Rule 611, the order
22   protection rule.  My name is Bill Baxter and I'm head of
23   global program trading and market structure at Fidelity
24   Management and Research Company.  In this role, I am
25   primarily responsible for constructing our approach to
0182
 1   equity market access on behalf of the Fidelity mutual
 2   funds. 
 3             Fidelity Management and Research Company and
 4   its affiliated companies are more commonly known as
 5   Fidelity Investments.  Founded in 1946, Fidelity is a
 6   leading provider of investment management, retirement
 7   planning, portfolio guidance, brokerage, benefits
 8   outsourcing, and many other financial products and
 9   services to more than 24 million individuals and
10   institutions as well as 10,000 financial intermediary
11   firms. 
12             Fidelity believes that the U.S. equity markets
13   are fundamentally strong, and that in recent years both
14   retail and institutional investors have benefitted from
15   numerous advances.  Technology in a competitive
16   marketplace of multiple trading centers has led to
17   improve costs, liquidity, speed, and product innovative. 
18             Since May 2010, the SEC has undertaken a series
19   of initiatives designed to strengthen the equity markets,
20   including but not limited to the limit up/limit down
21   mechanism, rules regarding clearly erroneous
22   transactions, the market access rule, and Regulation SCI. 
23   We support these reforms.  We look to the Commission to
24   help promote market stability and integrity, which in
25   turn can help bolster investor confidence. 
0183
 1             We appreciate the SEC's current focus on the
 2   order protection rule.  The U.S. equity markets have
 3   changed significantly since the rule was first adopted
 4   close to ten years ago, and a retrospective can help
 5   determine if the regulatory structure established by the
 6   rule is still appropriate for today. 
 7             In conjunction with this review, we would like
 8   to see the development of agreed-upon standard
 9   measurements that can help to evaluate market quality
10   characteristics.  Agreement on the right metrics to view
11   market quality can facilitate a data-driven approach to
12   building a better market and can mitigate effects by
13   market participants that seek to protect existing
14   business models, trading behavior, and execution
15   strategies. 
16             Prior to releasing any recommendations to the
17   Commission on equity market structure issues, we ask that
18   the committee first advise the Commission on which
19   specific measurements to use to evaluate market quality
20   characteristics. 
21             Rule 611, along with other regulatory changes,
22   has fostered competition and forced automation across all
23   market venues.  It has also significantly reduced
24   trade-throughs and provided a minimum standard for best
25   execution on the routing of marketable orders. 
0184
 1             From an institutional asset management
 2   perspective, we have been able to operate within the
 3   structure of the order protection rule and exceptions to
 4   the rule, as promulgated by the SEC.  Although the vast
 5   majority of non-U.S. equity markets do not have a form of
 6   regulated price protection, we believe that a requirement
 7   to honor the best quote from a protected venue is a
 8   reasonable foundation for the U.S. equity markets. 
 9             Some have suggested that Rule 611 has
10   contributed to excess fragmentation across trading
11   venues, thereby increasing market complexity and
12   connectivity cost.  For better or for worse, the order
13   protection rule, along with other factors, has
14   contributed to a complex and fragmented market. 
15             Issues associated with market complexity, such
16   as access fees, maker-taker pricing, and the growth of
17   displayed and not-displayed trading venues, are so
18   interconnected to the order protection rule that any
19   assessment of the order protection rule must also
20   consider how these other aspects of market structure and
21   market quality have changed over the past ten years. 
22             For example, we welcome competition and choice
23   in the marketplace, but question whether the current
24   number of smaller trading venues adds to market
25   complexity and operational risk.  The order protection
0185
 1   rule effectively requires all market participants to do
 2   business with all trading venues that display orders,
 3   regardless of a venue's market share.  The number of
 4   trading venues has increased significantly in recent
 5   years, and new venues are expected to join the market
 6   shortly. 
 7             Market data revenue is shared across trading
 8   venues, a factor that many believe helps to subsidize the
 9   business operation of smaller venues.  To help reduce
10   market complexity involved in monitoring quotes and
11   routing orders, we believe that the definition of a
12   protected bid or protected offer in Regulation NMS should
13   be revised such that trading venues without significant
14   aggregate market share receive protected quote status
15   across the venue for only a finite period of time. 
16             At the conclusion of this initial period, if
17   the trading venue fails to achieve a specified market
18   share, the trading venue's quotations would cease to be
19   protected quotes.  We believe that this approach will
20   maintain competition in the markets while permitting
21   market forces to determine the success of a particular
22   trading venue. 
23             In addition, as competition has evolved, the
24   trading behavior of market participants and the liquidity
25   characteristics of venues has been heavily influenced by
0186
 1   fee structures in both ATSs and exchanges.  Rule 610 of
 2   Regulation NMS, among other items, requires fair and
 3   nondiscriminatory access to quotations and establishes a
 4   limit on access fees to harmonize the pricing of
 5   quotations across different trading venues. 
 6             We are concerned that access fees and liquidity
 7   rebates have increased complexity and potential conflicts
 8   of interest in the market, and don't show the true
 9   inclusive costs of quoted spreads.  We recommend that the
10   SEC reexamine the need to reduce or cap access fees as
11   part of a broader review. 
12             Similarly, we support measured reforms to
13   maker-taker pricing and access fees based on empirical
14   data and through a well-structured pilot across
15   securities with a wide range of market capitalizations
16   and volumes. 
17             Some have also suggested that Rule 611 has
18   harmed institutional investors that need to trade in
19   large size by forcing them to access small size
20   quotations, thereby signaling their trading intentions to
21   short-term proprietary traders.  We do not agree. 
22             We have the flexibility to trade block size
23   either in a high-touch environment or electronically in
24   broker dealer ATSs that specialize in block-sized trades. 
25   Broker routing technology has evolved such that they are
0187
 1   able to access and aggregate small orders on behalf of
 2   block-sized orders in the marketplace.  Moreover, we have
 3   found exceptions permitted under Rule 611 allow us to do
 4   our job. 
 5             Another critique of the order protection rule
 6   is that it has failed to achieve the SEC's stated
 7   objective of enhancing the reward for the display of
 8   limit orders that has indirectly led to more dark trading
 9   by constraining the nature of competition on lit venues
10   to factors such as speed, fees, and exotic orders, in
11   contrast to factors that may be more appealing to
12   investors, such as liquidity and stability. 
13             We believe that the order protection rule has
14   significantly reduced trade-throughs and resulted in
15   better execution quality for direct retail investors who
16   benefit from some type of protection on their orders. 
17             At the same time, we acknowledge that many
18   market participants believe Rule 611 has driven more
19   flows to nondisplayed venues.  One of the reasons why
20   institutional investors use nondisplayed venues and
21   nondisplayed order types on lit venues is to reduce
22   transaction costs by limited potential information
23   leakage associated with market impact that can occur when
24   transacting on behalf of large block orders. 
25             For some time, the Commission has expressed an
0188
 1   interest in investigating whether the quality of public
 2   price discovery may be harmed by nondisplayed liquidity. 
 3   We have yet to see evidence that price formation is
 4   deteriorating or data establishing the quality of public
 5   price discovery is harmed by nondisplayed liquidity. 
 6   Moreover, in the absence of actual data that public price
 7   formation is deteriorating, we would argue that trading
 8   in these venues lowers our cost, provides a valuable
 9   service, and actually contributes to price discovery. 
10             In closing, I'd like to reiterate that Fidelity
11   believes that the U.S. equity markets are fundamentally
12   strong and well-regulated.  Our interconnected national
13   market system allows thousands of market participants to
14   interact across 11 stock exchanges and more than 40
15   private trading venues every day. 
16             Unfortunately, the same interconnectedness has
17   increased complexity and made it impossible to know with
18   certainty the impact of a single change to the market as
19   a whole.  Any proposed changes to U.S. equity market
20   structure should be reviewed and tested carefully to help
21   avoid unintended consequences that may negatively impact
22   investors. 
23             On behalf of Fidelity, I'd like to thank you
24   for your focus on the issues and for the opportunity to
25   discuss them with you today. 
0189
 1             COMMISSIONER GALLAGHER:  Steve, can I ask a
 2   quick question of Bill before you -- 
 3             MR. LUPARELLO:  Yes.  
 4             COMMISSIONER GALLAGHER:  Bill, you mentioned
 5   metrics that you had hoped that we would use.  And I
 6   didn't know if you had any more details on what you think
 7   those should be. 
 8             MR. BAXTER:  Sure.  As an industry, we don't
 9   have a clear definition of market quality, and we don't
10   distinguish between measurements of market quality and
11   measurements of trading strategies.  There's an overlap
12   between the two, but they're distinct. 
13             Our trading strategies are built upon a base of
14   market quality, but there's a behavioral component in how
15   we implement our trading strategies.  So, for example,
16   we've talked about how much change there's been in the
17   marketplace today. 
18             We've got two firms that have invested
19   differently in their guess model.  Firm A may have
20   adapted to a changing environment, adopted algorithms,
21   invested in technology, created a system of measurement
22   where they measure all aspects of their business.  Firm B
23   maybe didn't invest as heavily or was slow. 
24             Most likely when you talk to each of those
25   firms, they're going to have a different answer in terms
0190
 1   of how their costs have changed and what they think about
 2   market quality and price discovery.  
 3             Market quality, on the other hand, should be
 4   focused on core pillars of liquidity and price
 5   efficiency.  So the factors that are highly correlated to
 6   our costs are liquidity, core volume, volatility, bid/ask
 7   spread, and the depth of book at the bid/ask spread. 
 8             So two securities, if we create a security with
 9   low volume versus a security with high volume, the
10   security with high volume generally will have lower
11   costs.  If that high-volume security has lower
12   volatility, generally speaking, over a lot of iterations,
13   we will have lower costs. 
14             COMMISSIONER GALLAGHER:  Thanks for that, Bill. 
15             MR. LUPARELLO:  Great.  Questions for the
16   panelists? 
17             MR. RATTERMAN:  Bill, I heard Jeff say that the
18   retail investors never had it better, that the experience
19   is good, and I have to imagine that part of that has to
20   do with the quality of execution that they're getting. 
21   And I heard Bill say that you found it very easy to trade
22   in today's markets, and that you think that costs have
23   come down and your costs of trading have come down,
24   another practical experience of market quality. 
25             And I heard Dave say that -- I think your quote
0191
 1   was, the state of execution quality is abysmal in the
 2   U.S.  So there's clearly -- 
 3             MR. LAUER:  I did say the best execution, not
 4   execution quality. 
 5             MR. RATTERMAN:  But either way, these two
 6   parties appear to be getting good results for their
 7   investors.  Is it more about the foundation or the
 8   structure of reporting it, or is it the actual
 9   experience?  Because it sounds like the experience is
10   pretty good. 
11             MR. LAUER:  I think there are two very
12   important points.  The first is, as you're saying, it's
13   the framework and the transparency into execution
14   quality.  As much as I respect everybody here, it's hard
15   to go on anecdote.  There aren't really well-established
16   metrics, as Bill was saying. 
17             As an industry, we need to develop those
18   metrics and we need transparency and visibility into how
19   different firms achieve those execution quality metrics. 
20   I think that's a no-brainer.  Right?  I can't imagine an
21   argument against it. 
22             As far as execution quality goes, we talk a lot
23   about active retail traders.  And I think Gary made a
24   fantastic point earlier in the day, and I think we should
25   not lose sight of that, that institutions are pooled
0192
 1   retail.  And I don't possibly see how we can separate the
 2   two and talk about how great this market structure has
 3   become for active retail traders trading very small
 4   orders versus institutional investors who admit to being
 5   flummoxed by complexity, by fragmentation. 
 6             And nobody's arguing that execution costs
 7   haven't come down.  But it seems clear to me and to many
 8   of the buy side firms that we work with and to the folks
 9   that we talk with on a regular basis that they believe
10   that there needs to be far more insight into what true
11   costs are, again making order audit trails available for
12   quantitative analysis, and more visibility across the
13   industry and transparency across the industry into how
14   brokers are handling orders and what the execution
15   quality is after you make these very complex order
16   routing decisions. 
17             MR. BAXTER:  Could I just step into that?  I'm
18   a little unclear about that because at least at my former
19   employer, we worked very hard on getting best execution
20   right.  We, like I think every large house on the street,
21   have very careful procedures.  We are examined by a
22   variety of folks with respect to how we implement those
23   procedures. 
24             And I don't think -- one never knows when
25   you're flummoxed -- we don't think we're flummoxed.  In
0193
 1   fact, we think we work very hard to get good prices for
 2   our customers, and we think we do it on a routine basis. 
 3             MR. LAUER:  I do think it's worth mentioning
 4   that, not to answer anecdote by anecdote, but last year
 5   before a Senate PSI panel, we heard a retail brokerage
 6   get up and say that they route nearly all of their
 7   orders, their resting limit orders, to the highest rebate
 8   venue.  Yet that's considered best execution, and I'm
 9   surprised by that. 
10             MR. BECKER:  If I might, I'm not so sure that
11   might be considered best execution, and it's not an
12   industry practice.  I do agree with the point you made
13   about 605 and 606.  I do believe that disclosure can be
14   better.  There's no reason why we can't update those
15   disclosures, and I think that's why we're working on how
16   we can make better disclosures just internally so that
17   our clients are aware of what they're getting. 
18             And that's critical because in this day and
19   age, they do deserve to know everything about their order
20   and how it was handled and how it was executed.  So we
21   don't dispute that.  In fact, I know we are participating
22   with an FIF program to publish -- even though we're not
23   an order execution firm, we are publishing on our website
24   605 data in order to try to help our clients understand
25   just what's happening. 
0194
 1             MR. LUPARELLO:  Maureen? 
 2             PROFESSOR O'HARA:  So Dave, again, to continue
 3   this discussion, I think one of the interesting questions
 4   is who should be responsible for providing that
 5   information.  Right?  Certainly if you have institutions
 6   -- and I think on behalf of ITG -- our clients are more
 7   than vocal in telling us that, as a broker dealer, they
 8   want to know how we did it, what we did, and they expect
 9   us every day prove to them that we gave them extremely
10   good best execution.  And if they're not, plenty of other
11   people can go after them. 
12             And so I'm wondering what it is that you think
13   is the problem in retail.  Why aren't the retail firms
14   able to provide that information?  And I would suspect
15   Jeff would suggest that you do.  But why would it
16   necessarily be the responsibility of the SEC to mandate
17   that?  What is the market failure that's causing that, in
18   your view, if in fact that is the case? 
19             MR. LAUER:  Honestly, I'm not trying to single
20   out retail.  I understand that's where we headed with
21   this.  A lot of the work that we do is on the
22   institutional side.  I would say, again, just the example
23   of that retail broker seems distributing to me, and it
24   seems strange that that can be considered best execution,
25   and you're not talking about a minor player in the
0195
 1   market.  You're talking about one of the largest retail
 2   brokers who last year made that admission. 
 3             Also, they agreed to provide data to Robert
 4   Battalio to help him with his study that was
 5   demonstrating inferior execution quality when making
 6   order routing decisions based on fee structure.  They did
 7   that under oath.  Of course, they never provided that
 8   data, so we're still here talking in theoretical terms
 9   instead of having concrete data to answer these questions
10   with. 
11             If 605 had been updated by now and 606 had been
12   updated by now, we simply wouldn't be having this
13   discussion.  There would be really easy data to point to
14   and say that this is concrete evidence that everybody's
15   getting best execution, and it's able to be distilled to
16   retail investors so that they can make better decisions. 
17   And I don't think we've seen that happen. 
18             And of course, on the institutional side, I
19   know ITG is one of the brokers that will supply a full
20   order audit trail when their customers ask.  Other
21   brokers will not.  And that's something that needs to be
22   codified so that proper independent firms like ours can
23   come in and do quantitative analysis and help buy side
24   firms navigate these increasingly complex and fragmented
25   markets. 
0196
 1             MR. LUPARELLO:  Joe, then Jamil. 
 2             MR. MECANE:  I was going to ask a slightly
 3   different question.  So did you want to respond to
 4   something? 
 5             MR. NAZARALI:  Sure.  I'd like to just speak to
 6   this issue of retail disclosures.  While it's true that
 7   individual retail broker dealers are not required to
 8   disclose with execution quality, many of them are now
 9   voluntarily doing that.  And the market centers, like
10   Citadel and the other wholesale market makers that handle
11   retail client orders, are required to make those
12   disclosures. 
13             And if you look at the data over the last ten
14   years, it's unequivocal that retail executions have
15   gotten much, much better.  The level of price improvement
16   and the aggregate amount of price improvement given range
17   in the hundreds of millions a dollars a year. 
18             So there's absolutely no question, and the data
19   supports it, that retail investors are getting a much
20   better execution that they ever have before.  So I just
21   wanted to make sure that that was well understood. 
22             MR. MECANE:  So a slightly different but
23   related question for Jeff.  Do you have a sense, if 611
24   wasn't in place, do you think that would have a
25   significant impact on retail limit order execution, or do
0197
 1   you think the market would largely operate as it does? 
 2   Do you have a view on that rule vis-a-vis your limit
 3   orders? 
 4             MR. BROWN:  No.  We had a view ten years ago
 5   that you didn't need a trade-through rule in order to
 6   have an efficient market, that yes, you might have a
 7   trade-through, but it would last for milliseconds, and
 8   particularly with new technology. 
 9             It's hard for me to say what would happen
10   because we've had the trade-through rule.  But I'll say
11   this, that the execution quality that Jamil is talking
12   about occurred, really, outside of that system.  Because
13   that system was created in such a way that it made it
14   more difficult to operate, I think the best part of Reg
15   NMS occurred off-exchange. 
16             Now, does that mean that the price discovery
17   process was harmed?  I don't know.  Could retail limit
18   orders be executed on-exchange without a trade-through
19   rule?  I think they can.  I'd be more worried about
20   dictating trade-at, which says you must go to an exchange
21   to trade. 
22             That to me would be extremely anti-competitive,
23   and while we hear a lot about what it will protect, it
24   will provide true price protection, which was, by the way
25   -- if you go back and look at the dialogue in the
0198
 1   adopting release and then versus the dissent, there was
 2   discussion in the dissent by the Commissioners that said,
 3   well, you're not really protecting orders because you
 4   aren't trading at.  You didn't have a trade-at element in
 5   it. 
 6             And so what worries me is that, well, now the
 7   thought is now we can fix that by going to trade-at. 
 8   Well, I think you would be really moving away from a free
 9   market and a competitive environment that existed. 
10             MR. LAUER:  Can I -- I just wanted to mention
11   that as we've seen off-exchange trading increase and
12   wholesaling and internalization increase, and yes,
13   there's certainly been some price improvement, we've also
14   seen toxicity increase on lit venues by a significant
15   degree, market and order book fragility increase, flash
16   crash notwithstanding, mini-flash crashes constantly. 
17             This is a trend that transcends just the active
18   retail trader experience.  And we're just a firm believer
19   in getting the order flow and competing over order flow. 
20   Open competition for order flow is the answer, not back
21   room deals that siphon off order flow into these
22   internalization systems. 
23             We feel that that will benefit the market as a
24   whole and pooled retail funds in institutions to the
25   betterment of everyone rather than just the active retail
0199
 1   trader. 
 2             MR. KATSUYAMA:  Sure.  Just a couple thoughts. 
 3   I thought Mr. Becker's comments were actually pretty spot
 4   on.  There's a struggle with asking the Commission or the
 5   government to set rates, and I think that free market, we
 6   hear that word tossed out there quite often.  Yet I think
 7   he put it -- fundamental rate-making, I think, is a
 8   challenge.  But at the same time, realizing the duality
 9   of that problem, is that the fees offer a very perverse
10   incentive with routing, et cetera. 
11             I also heard Dave mention prohibitions on
12   exchanges routing or on brokers matching.  And although I
13   can kind of see the logic in that as well, if you were to
14   take those problems and just move it one level higher,
15   disclosures do solve a lot of those issues. 
16             And if brokers were forced to disclose fees,
17   not just on a one-off per client basis but in aggregate,
18   if exchanges were forced to disclose their methods for
19   routing, the performance on their routing, to give market
20   competitors choice on whether to or to not use an
21   exchange router, and if brokers were forced to disclose
22   ATS statistics, et cetera, right -- putting more
23   information out there rather than having to prohibit
24   anyone from competing or doing anything and setting
25   prices, I think the market structure debate and the
0200
 1   players have evolved to the point where putting more
 2   hands in the information of certain people will
 3   ultimately let the market sort out a lot of these very
 4   nuanced outcomes. 
 5             Dave's firm is one of many firms that is
 6   thirsting for data.  And I think that it's the market's
 7   job to deliver the data to the people that want to make
 8   use of that.  If better choices are made, if certain
 9   business models fail, if other ones succeed, I think
10   that's kind of what we want out of the free market, to
11   let businesses stand and fall on their own merit as
12   opposed to a lack of being able to evaluate the success
13   of each business line. 
14             I think that we do have to look at this from a
15   principle standpoint because we are going to get lost in
16   the nuances.  I've heard a lot of different opinions.  I
17   can't even say if I know exactly where anyone sits on any
18   particular issue. 
19             But if we talk about principles, I think the
20   one thing that we are lacking is standardized
21   disclosures.  And I feel like that is something that we
22   should absolutely hammer home.  If I'm going to sound
23   like a broken record, I apologize in advance.  But I will
24   keep coming back to that because I think a lot of these
25   problems the market can sort out on its own if given the
0201
 1   proper information. 
 2             MR. KETCHUM:  Just getting back to 611 for a
 3   second, I guess what I hear from the four of you is,
 4   Jeff, you opposed 611 initially.  The world's changed. 
 5   You still sort of think it would work fine, and that most
 6   of the benefits have come despite it.  But it doesn't
 7   sound like you're passionate about getting rid of it. 
 8             Bill, you align with a variety of people from
 9   the standpoint of knocking out -- at least it sounds
10   like, after a period of time -- low-volume exchanges. 
11   Dave, you were there, and you also were calling to have
12   611 key off only at the broker level rather than the
13   exchange level. 
14             So from the standpoint of low-volume exchanges,
15   to Joe's point earlier, how much does it really save you? 
16   Is it quantifiable, and does it matter?  And from the
17   broker's side versus exchanges with order routing speeds
18   at the present time, why does that matter, Dave? 
19             MR. LAUER:  I guess just to answer that, the
20   reason I like the idea of moving it from the exchanges to
21   the brokers as part of an enhancement in disclosure and
22   transparency and best execution is because it could help
23   to dramatically simplify the market structure. 
24             I think it's one of those few things where if
25   you start to pull out some of this complexity from the
0202
 1   market center and shift it to the people that are
 2   sophisticated and incentivized in the right way and have
 3   developed order routing technologies that simply weren't
 4   there when this rule was being considered, it's appealing
 5   to me that you could help eliminate complex order types. 
 6             You could help eliminate some of these complex
 7   interactions that lead to these feedback loops that we
 8   still don't have quite a handle on even though we've
 9   passed rules that I think are Band-Aids for trying to
10   prevent these problems.  We haven't really addressed some
11   of the underlying causes of order book fragility and
12   excess complexity and intermediation.  So I think that is
13   one of those things that could elegantly, perhaps, reduce
14   complexity. 
15             MR. KATSUYAMA:  I think just one additional
16   point -- sorry -- is that also, some brokers do a really,
17   really good job of executing client orders.  Some brokers
18   actually do a really good job of managing their own ATSs,
19   managing that conflict, and still finding ways to use
20   their ATS when it's right to use it and route out when
21   it's right to route out. 
22             And the challenge becomes, without standardized
23   disclosure, if they were ultra-transparent about what
24   they did, it would actually be a negative for them
25   because they're providing information while their
0203
 1   competitors aren't.  So I do feel like there's almost a
 2   punishment for being transparent.  We put our Form ATS
 3   out there.  We're the first one to do it at IEX.  And
 4   what that did is it unleashed a lot of questions towards
 5   us, some of them being asked by people who hadn't
 6   published theirs. 
 7             But I think when the playing field is set, all
 8   parallel are disclosing, I think that it's not to say
 9   that everyone's not doing a good job.  We know a lot of
10   brokers who are.  When we encourage them to say, why
11   don't you start publishing some of the statistics, they
12   say, well, if our competitors don't, we're just basically
13   opening ourselves up to scrutiny as opposed to having
14   that comparison to show that we are doing a good job. 
15             So I think that also, we need to reward people
16   who are making the good and right decisions because there
17   are a lot of them in the market.  And ultimately, what
18   happens is they start to get rewarded and the people who
19   aren't necessarily making those choices will have to
20   follow suit. 
21             So I do feel it wasn't slight on everyone.  I
22   think that there's actually an inherent punishment in
23   being too transparent, which I think is a flaw in not
24   having it standardized. 
25             MR. BROWN:  If I could respond just to what
0204
 1   Rick had said.  I think you accurately characterized how
 2   I feel, that changing 611 now, we don't know the
 3   unintended consequence of that.  And the market has
 4   adapted and moved into a position where, as we've turned
 5   and as I've said, retail investors are doing well.  I'm
 6   nervous about something that changes again.  And what do
 7   we end up with, and is it going to be harmful to my
 8   clients? 
 9             On the 1 percent and having a de minimis
10   standard for obtaining order protection as well as market
11   data revenue, and that's a key element of this, I was at
12   a small exchange, and I understand the difficulties of
13   operating a small exchange. 
14             And in fact, we were a small exchange until we
15   did a deal and we became a large one.  So we wouldn't
16   have survived without market data revenue.  Now, you can
17   say you shouldn't have, and in fact, it hasn't since
18   then.  But the fact is, we had two exchanges go out of
19   business last year.  And so it's not necessarily that
20   there's this subsidy that is always there.  You still
21   have to attract volume. 
22             So I'm afraid about how we would impact
23   innovation.  People can come up with different ideas, and
24   that can be harmed by the fact that we are, one, having
25   -- I recall back in the days when you traded against New
0205
 1   York.  It was like have -- they had an order of
 2   protection.  They protected their orders. 
 3             You were unprotected.  They were going to trade
 4   wherever they wanted, and you'd call on ITS and try to
 5   get a fill, and it was impossible.  So I wouldn't want to
 6   institutionalize that type of unlevel playing field. 
 7             MR. RATTERMAN:  From a market structures
 8   perspective, since Andrew put on the table that it would
 9   simplify our market if we didn't have to worry about 611,
10   I agree, and I think I made that point earlier, that
11   clearly our systems could get simpler.  Our software
12   could get easier to manage and maintain if we didn't have
13   to help our customers maintain compliance with Rule 611. 
14             But Jeff certainly inspired me earlier because
15   it's something I felt pretty strongly and you affirmed
16   it, that the retail experience, you can look your retail
17   investors in the eye and say, put an order in here or at
18   Ameritrade or wherever.  You're going to get the best
19   price, guaranteed by law. 
20             That's a pretty big back and forth that we have
21   with this rule, is to look any investor in the eye and
22   say, no matter what broker you use, what day of the week
23   you go in, no matter what path you insert yourself into
24   the system, you come out with the best price guaranteed
25   by law. 
0206
 1             So this is one of those ones where I personally
 2   make the tradeoff that a little more complexity yields
 3   this benefit, this statement that I can make without any
 4   hesitation, without any hedging.  You're going to get the
 5   best price by law every time, no matter how you enter our
 6   market. 
 7             And that's what 611 does.  So there's a benefit
 8   there that can't be overstated or overlooked, that if we
 9   start peeling back, we might have to say, well, if you
10   get a good broker, you're going to get a good price.  Or
11   most of the time you get a good price, and most of the
12   time is pretty good. 
13             But 100 percent of the time today by law, no
14   matter how you go into the market, you get the best
15   price, whether it's a passive or it's a marketable order. 
16   And I think that's what it gives us, and if we're talking
17   about modifying thought or repealing it -- that's kind of
18   what we're talking about -- that's the tradeoff. 
19             MR. ANDERSEN:  Can I just make a point to Joe? 
20   So BATS has obviously done a tremendous job managing
21   multiple exchange licenses and handling that complexity. 
22   But again, the question has to be, what is the benefit of
23   that complexity? 
24             And clearly, when there is a catastrophic event
25   in the marketplace that is new -- you're a pilot, so you
0207
 1   know most plane incidents are the result of multiple
 2   incidents, each of which seemed innocuous but happening
 3   together and in concert. 
 4             When you add complexity, you are going to
 5   increase the likelihood of a bad series of outcomes.  And
 6   while it may be easy as, now, a well-established exchange
 7   operator, that does make it a big barrier to entry for a
 8   new entrant.  So if you're going to open an exchange now
 9   -- what we had to do at Island in 1997 was worry about
10   our own market, and that's all we had to worry about, and
11   it was technologically trivial. 
12             To do that today, and to worry about the prices
13   at every other market and do that, is a tremendous
14   endeavor, and you're getting a negative there.  It's a
15   negative because it's a barrier to entry to the
16   marketplace. 
17             So I concede your point that being able to say,
18   well, we have the trade-through and therefore I can give
19   the -- it doesn't seem to help with marketing of the
20   health of the equity markets and the experience of the
21   retail investor because I still go to cocktail parties
22   and am still asked, well, jeez, don't I get a terrible
23   shake?  
24             And all I can say is, well, that's a terrible
25   impression for you to have because if you looked at the
0208
 1   disclosed data on these websites, you'll see that with
 2   Schwab, it's 53 percent, which, having been in that
 3   business, just makes me really happy I'm not in that
 4   business any more.  Those are incredible numbers. 
 5             We as an industry have to tell that narrative. 
 6   And I'm not sure that there's a benefit, given the
 7   complexity and given the fact that it doesn't seem to be
 8   helping with that marketing effort.  Having that barrier
 9   to entry for new entrants seems a steep price to pay. 
10             MR. NAZARALI:  Matt, I agree with you that the
11   fact that we have 611 and that the retail investor is
12   guaranteed to trade at the best price available in the
13   market is not in and of itself instilling confidence. 
14             Having said that, if you get rid of that, I
15   think that that would be a blow for investor confidence
16   and the perception of fairness, this idea that the SEC
17   just passed a new regulation eliminating the best price
18   govern.  I think that that would be really bad. 
19             With respect to the complexity argument, you're
20   right -- for a new exchange or a new broker to establish
21   themselves, there is complexity to make sure that you are
22   monitoring everyone's prices and executing at the best
23   available price. 
24             But you should be doing that.  Irrespective of
25   Rule 611, you should be monitoring every price in the
0209
 1   marketplace and you should be making sure that your
 2   customers get executed at the best price available.  And
 3   so that complexity lives with us because we have
 4   competition, and it lives with us because we no longer
 5   have the duopolies. 
 6             So there's a number in the marketplace. 
 7   They're all competing.  And we need to monitor all of
 8   them and make sure that we execute our customers' orders
 9   at the best available prices.  That creates complexity,
10   but that's the price of competition and that's a price of
11   making sure that that investor gets the best execution
12   possible. 
13             MR. LAUER:  Can I just -- one second.  Just two
14   points, one to Jamil's point.  I would never advocate for
15   simply rescinding 611.  That's not the case that I'm
16   trying to make.  And I haven't heard that from anyone. 
17   I've heard that execution quality, transparency,
18   standardized disclosure, and true best ex standards would
19   need to be put in place. 
20             And then to Joe's point, I would just ask you,
21   to your question of what do you say to this person if you
22   can no longer say you will get the best price or if you
23   only get a good broker, wouldn't that simply be a failure
24   of enforcement of best ex rather than the need to have
25   this very explicit protection in place? 
0210
 1             I'm not trying to argue for or against that
 2   protection.  But it seems like best ex should encompass
 3   that.  And if we had enough transparency and enough
 4   visibility into these things, we would have enforcement. 
 5   And so it seems like it's easy to make an argument
 6   against one part of what's being said, but I think if you
 7   consider it as a holistic whole, it actually does hold
 8   together pretty well. 
 9             MR. RATTERMAN:  And just a quick reply is that
10   I think that it's a benefit that we just need to
11   recognize that we can say, by law, you get the best
12   price.  No questions asked.  We're done.  You get the
13   best price. 
14             And where we go to is we hope that you get the
15   best price if you pick the right broker and there's a
16   framework in place to show that you're getting good
17   execution quality or not.  So go read all the reports and
18   make a long decision about which broker you use.  That's
19   not necessarily the worst outcome.  
20             But today where we stand is that we can say to
21   them, regardless of the framework that doesn't exist,
22   you're going to get the best price no matter who you use. 
23   That's the way our markets have been designed.  So I'm
24   not saying that that's the end-all and that we should
25   stop there. 
0211
 1             I'm just saying that we should recognize that's
 2   where we are at, and even if we haven't marketed it very
 3   well, I think we can always follow up to anybody who
 4   asked that that's how it does work.  And maybe we could
 5   do a much better job of marketing that that's how our
 6   markets work today. 
 7             So yes.  I think we would just kind of devolve
 8   back to, well, you're probably going to get good price
 9   depending upon who you picked.  And that's the nature of
10   competition.  But do we put that burden on the individual
11   investor to go read those reports, make their own
12   decision, and switch brokers as those numbers change back
13   and forth if they're not always 100 percent guaranteed by
14   law? 
15             MR. LUPARELLO:  Gary or Bill.  I wasn't sure
16   who -- 
17             MR. BAXTER:  One comment that's come up today
18   in creating a best execution standard for institutional
19   orders -- not retail orders, for institutional orders. 
20             In the market today, the commercial standard
21   for best ex is more comprehensive than 611.  So what I
22   mean by that is that for the most part, we trade with
23   algorithms in the marketplace today.  Algorithms, there's
24   a statistical framework and there's a router.  Those
25   routers have to comply with 611 in addition to more
0212
 1   requirements in terms of sourcing liquidity.  
 2             And a second point is, I think it would be very
 3   difficult to have a prescriptive-based solution for best
 4   ex for an institution.  There are too many factors.  I
 5   would recommend that we enhance a more principles-based
 6   standard for an institutional order. 
 7             MR. STONE:  I just wanted to jump in.  In the
 8   remarks that I had in the beginning, one of the things
 9   that Brad -- and you were spot-on about the transparency
10   and disclosure.  But I think that's one of the things
11   that we can actually act upon now as we continue looking
12   over the holistic -- oh, everyone's like, that's the word
13   of the day -- but as we look at the overall market
14   structure and plan on it.  And I think that's something
15   which is important because along those lines of -- we'll
16   just leave it at that. 
17             But my other point is this, and this is where I
18   get kind of caught up in something.  It's interesting.  
19   The '34 Act, I think it was, also reaffirmed in the '75
20   Act in Section 11(a), both said that Congress believed
21   that competition among exchanges needed to be fostered by
22   the Commission.  And so that is a fundamental principle
23   that was handed down from our legislative process. 
24             And so when we talk about fragmentation, my
25   question is this:  Is it a problem that we have too many
0213
 1   exchanges, or is it that we have too many venues? 
 2   Because we're talking only about the fact of what's
 3   protected because of 611, and I get that.  That's what
 4   we're talking about. 
 5             But if you draw the arbitrary line of 1
 6   percent, there's only two exchanges that don't meet that
 7   threshold.  So all you're doing is getting rid of two,
 8   and now all of a sudden we have the magic number where
 9   it's okay.  
10             And the reason why I ask that is because one of
11   the fundamental principles of Reg NMS, and it's actually
12   cited in the dissenting opinion, is that it's okay to be
13   fragmented because 11(a) says we're supposed to guard
14   that.  But the interconnectivity of the marketplace is to
15   assure that it's a check on the fragmentation because we
16   create a virtual market because of it. 
17             And so my question is to the committee:  Have
18   we reached that point where it's too much?  Or do we not
19   want to be that prescriptive, but figure out other ways
20   that exchanges, like Bill said, if you get it for a
21   certain amount of time and then that's it, maybe that's
22   how you start collapsing the amount of changes.  But then
23   you have to set a threshold as to what that number is,
24   and now you're back to being prescriptive. 
25             I know I threw a bunch of stuff out, and this
0214
 1   is like the complicated thing that goes with this
 2   discussion.  I haven't quite figured it out in my head,
 3   but I just wanted to pose it to you. 
 4             MR. MECANE:  I'll just quickly give an opinion
 5   on that, which is, I think it's a good question that
 6   brings in just a few different things that are related
 7   but separate.  I think, in my opinion, the question that
 8   people ask around protected status for a period of time
 9   is largely an economic question, when people are reacting
10   to the fact that they have to pay fees and are forced to
11   connect and forced to interact with venues that have a
12   benefit which essentially requires them to do so.  And
13   that's an economic question. 
14             And so to me, we could deal with that in an
15   economic fashion, built throughout the suggestion, which
16   I think works in fixing that problem.  Then I think,
17   Gary, you're bringing up a separate but related question,
18   which is, at what point are there too many venues from an
19   execution quality or fragmentation or market quality
20   standpoint?  
21             And so I think that's a separate question,
22   which I feel like isn't the issue that people raise when
23   they raise the 1 percent question.  You know what I mean? 
24   I think it's separate. 
25             MR. NOLL:  From my perspective, I think I'm
0215
 1   made very uncomfortable with some almost arbitrary
 2   decision that there's a venue, that we could only have so
 3   many venues.  I do like a structure, however, that would
 4   say, we could ignore these venues if they don't perform
 5   up to a certain level after a period of time.  So they're
 6   allowed to be launched.  They're allowed to be connected
 7   to. 
 8             But if they don't achieve a certain critical
 9   mass, then they can be dropped out of the system.  I do
10   think it would be overly prescriptive to say that, oh,
11   no, we only need ten exchanges, or we need five, or we
12   need 15.  I don't think we know the answer to that.  So
13   I'd be much more comfortable with an objective standard
14   of how to measure success and drop those that don't meet
15   it. 
16             MR. BROWN:  Maybe just a quick follow-on, just
17   a technicality here, to Eric's point I totally agree
18   with.  And competition can solve the problem for the firm
19   or for the venue that doesn't reach and maintain that
20   level, and it has in the past through the NSX and through
21   the ADF. 
22             There are ways for venues to get their quote
23   into the national market system, not directly but
24   indirectly, and the economics are nearly the same,
25   speaking from experience.  And so I think there are
0216
 1   market solutions that would allow aggregation of smaller
 2   pools into a smaller quoting facilitate that could solve
 3   the problem and allow them to stay alive, just not
 4   directly in the national market system. 
 5             MR. BROWNE:  In my view, clients care about two
 6   metrics, price and liquidity.  And I think that if we
 7   flatten out or harmonize venues by access fees -- because
 8   you see arbitrage and access fees if you look at Canada,
 9   for example.  You talk about it in your example.  I
10   believe the majority of the retail flow is executed in
11   offshore Canada because of their structure, where there
12   is depth of book or fees accessed at marketplace. 
13             But if we flatten out the venues and let the
14   venues compete fairly, I think you would see
15   opportunities from venues being innovative, and then let
16   the venue market itself fairly on the equal playing
17   field. 
18             And then, Mr. Brown, you had said something
19   about Schwab was in favor of test pilots.  I'll be
20   interested in your view -- and this is a question for all
21   the retail firms -- the view on the economic costs or the
22   risks introduced into your system by pilots.  And then
23   how do you measure that? 
24             Because I think that this body here, over the
25   course of time, will talk about pilots and test phases,
0217
 1   and we have to take that into consideration of inherent
 2   costs and risks associated with the very systems at our
 3   firm delivery mechanisms. 
 4             MR. BROWN:  Well, you raise a very important
 5   point, that it better be an important concept you are
 6   testing in order to impose upon the cost of programming
 7   for it.  And that's certainly part of the calculus that
 8   the Commission has to go through in order to propose. 
 9             A cost/benefit analysis should be required that
10   comprehensively analyzes what are the true costs to the
11   industry in developing these tests?  Because the tick
12   test pilot is a perfect example.  A great deal of the
13   comment on the original proposal was that it would be too
14   complex.  It was going to be extremely costly,
15   particularly the bucket 3, with the trade data element. 
16             And while some of that complexity was reduced
17   in the final, and I'm not a quantum person to understand,
18   or a programming person to understand, exactly how that's
19   going to impact the costs.  And I'm sure the industry's
20   looking at that now.  But that complexity, I believe, is
21   still there, and it's going to be very costly.  So what
22   you're really testing has to be important in order for it
23   to matter. 
24             MR. LUPARELLO:  Manisha? 
25             MS. KIMMEL:  Yes.  Just to add to that, the
0218
 1   tick test pilot, for example, any pilot, you still have
 2   to implement like you're going to be doing it forever. 
 3   And so it's not like the implementation cost changes
 4   necessarily with the length of the pilot. 
 5             I think one of the things we should consider as
 6   we consider these different options is that changing fees
 7   is a lot easier from an implementation perspective than
 8   changing order routing logic, for example. 
 9             MR. KATSUYAMA:  I think one interesting thing
10   to note when we talk about Canada is on Dave's slide, the
11   Herfindahl index.  There's order protection there. 
12   There's order protection here.  Obviously, the U.S. is
13   much more fragmented. 
14             And if you ask yourself the question, why is
15   the U.S. so fragmented, it's really because of
16   internalization.  If a broker h both sides of the trade,
17   they want to put that up.  You have something called
18   broker preferencing in Canada that allows that to happen
19   in the open market, and as a result, the largest Canadian
20   banks -- I think all the Canadian banks -- none of them
21   have their own ATSs. 
22             So it's a market-based solution that I think
23   limited the need to fragment.  And I think that that's
24   something that's definitely worth noting as we talk about
25   fragmentation as being an issue.  That's exactly why the
0219
 1   Canadian index looked the way it did in Dave's slide. 
 2             MR. LAUER:  To that point, in Canada you do not
 3   have payment for order flow, which is actually one of the
 4   main forces that pushes the retail order flow down to the
 5   U.S. and something that Canadian regulators are wrestling
 6   with right now. 
 7             But you also have very incidence of
 8   off-exchange trading, something like 5 percent at this
 9   point.  You have market integrity rules in which you say
10   you need a meaningful price improvement index cued
11   off-exchange, which has kept off-exchange trading down. 
12             And a recent study came out that showed that
13   there was no deleterious effect on market quality from
14   those rules.  So again, I think that's something, if
15   we're talking about pilots or ideas that are worth
16   testing, that strikes me as a very important one. 
17             MR. STONE:  Can I just ask the panelists a
18   question?  So we've been talking at a very high level
19   about 611.  And my question is, if you were to separate
20   the world into the high-ADV stocks and then the mid- and
21   low-ADV stocks, has it worked for retail investors in the
22   lower-ADV stocks now?  Or are there other challenges that
23   we need to do? 
24             For example, in 2003, Matt, we increased free
25   ETFs, the trade-through rule for Amex-listed stocks, to 3
0220
 1   cents just before Reg NMS came in.  Is that something
 2   which -- just your feeling about what's going on in the
 3   lower ADVs, and do you feel as if this should be
 4   breathing room within Rule 611 for the lower-traded
 5   stocks? 
 6             MR. NAZARALI:  If I could make a point on --
 7   sorry -- if I could make a point on counter.  I'm glad
 8   you guys brought that up because I think that that's an
 9   example of a market we do not want to emulate.  As you
10   know, in Canada they have the equivalent of a trade-at
11   rule.   And as we saw from the reading materials here,
12   that had a negative impact on spreads.  It certainly
13   forced volume back on the exchange. 
14             And the Canadian market is actually so broken
15   that it is less expensive for a retail investor to send
16   their order down to the U.S. in inter-listed stocks.  And
17   no, Dave, that has nothing to do with order flow because
18   Canadian banks don't accept payment on inter-listed
19   securities. 
20             So it's actually less expensive for them to
21   send their order to the U.S., to pay the foreign exchange
22   rate, and to get their trade done in the U.S. because you
23   have narrower spreads and you have price improvement,
24   than it is for them to send that order to the exchange
25   there. 
0221
 1             And because of that, IIROC, the regulatory body
 2   in Canada, has recently passed regulations that prohibit
 3   retail firms from sending those orders to wholesalers in
 4   the U.S.  So I think that's definitely an example of a
 5   market we do not want to emulate. 
 6             MR. BROWN:  Dave or Gary, to go back to your
 7   question, I hadn't really thought of that, frankly, and I
 8   could ask some folks back in Schwab and get back to you. 
 9   It seems to me that 611 doesn't have that great a
10   differential in impact between low-ADV and high-ADV
11   securities, so just thinking off the top of my head. 
12             I do believe that the maker-taker and rebate
13   has a dramatically different impact.  High-ADV securities
14   with very low spreads are being impacted by what I would
15   call an excessive rebate and access fee regime.  That's
16   why we're very supportive of BATS' proposal to tier the
17   maker-taker system because for low-ADV securities, it
18   makes some sense to still try to incentivize people to be
19   in those markets.  And we're confident that that should
20   be the way we go forward. 
21             MR. LUPARELLO:  Any last questions for our
22   panel or any last questions by our panelists? 
23             MR. CRONIN:  Can I just say something real
24   quick?  So it strikes me, we started talking about 611
25   here, and for all the right reasons.  Where we've ended
0222
 1   is there's more consensus around the fee element of this
 2   than there is with exactly what we should do with 611. 
 3   So I'm just struck by that.  If the advisory committee
 4   agrees, maybe that would be the first thing that we could
 5   try to address. 
 6             MR. LUPARELLO:  Well, at least more interest,
 7   if not consensus. 
 8             MR. CRONIN:  Right. 
 9             MR. LUPARELLO:  Any last comments by the
10   panelists?  If not, thank you again.  You've really
11   helped with this conversation.  Appreciate it. 
12             At this point I think I'd actually pick up on
13   Kevin's insightful comment and talk about what the next
14   steps should be of this committee.  I'd like to open it
15   up for ideas.  I think we as the staff have certain
16   ideas, but would like to see what your reactions are,
17   first both to the structure of the day, and then what the
18   expectations are, next steps, both on this specific issue
19   and generally. 
20             So I'll throw that open.  Or if you would
21   prefer that we go first with how we're thinking about it,
22   we could do that as well. 
23             MR. NOLL:  Steve, if you don't mind, just a
24   couple of quick observations.  Obviously, we talked about
25   a tremendous number of things today in really broad
0223
 1   swathes.  I think my concern would be that we would end
 2   up as a committee being a book discretion group at the
 3   end of the day if we didn't find a way to focus attention
 4   on a couple of key things. 
 5             If I could make the suggestion that we divide
 6   them up into smaller bite-sized groups and perhaps tackle
 7   a subcommittee structure that takes on some of these
 8   things and then reports back to the larger committee at
 9   the end of the day with the results of that because I
10   think otherwise we'll talk about interesting things but
11   we won't get anywhere. 
12             MR. KETCHUM:  Yes.  I'd just support that.  I
13   think this meeting has been great to focus in on, I
14   think, areas where there's if not consensus that a lot of
15   focus should be done on.  I think it would be enormously
16   valuable for us to split into subcommittees and generate
17   at least straw man proposals to bring back for
18   discussion.  I think that would be valuable. 
19             And maybe the Commission wants one more meeting
20   first to get there, but personally, I think the sooner we
21   try to do that from the standpoint of trying to focus the
22   conversation, it would be great. 
23             MR. MECANE:  I'll echo that.  I'll also add,
24   and this is, I think, something that became fairly
25   obvious today, but the interrelatedness of at least
0224
 1   lock/cross, access fees, and trade-through seem
 2   intertwined enough that those should perhaps be tackled
 3   as a more holistic package rather than just trying to
 4   make one-off decisions around those.  So maybe that could
 5   be one topic. 
 6             MR. LUPARELLO:  Are there any dissenting voices
 7   on the idea of breaking out into subcommittees, putting
 8   aside for the moment exactly what the jurisdiction of
 9   those subcommittees will be from a substantive
10   standpoint?  Is there a general consensus that that's a
11   good idea for making progress? 
12             MANY VOICES:  Yes. 
13             MR. LUPARELLO:  Which also happened to be the
14   staff's idea, so I think that's all great. 
15             (Laughter.)
16             MR. LUPARELLO:  And so I think, Joe, you
17   pointed out, and I think it's been clear, that our desire
18   to start at 611 was a good place to start, but obviously
19   it led to a variety of other conversations. 
20             We'd love to get feedback on what the natural
21   adjacencies are off of a 611 conversation.  It seems to
22   me that both maker-taker and lock/cross are clearly ones,
23   although I wonder whether, whatever we started with,
24   people would argue that maker-taker was a natural
25   adjacency off of that. 
0225
 1             And so I open that up to conversation.  I think
 2   your articulation sounds right to me, but I'd like to
 3   hear other voices as well. 
 4             MR. RATTERMAN:  I'll weigh in.  I would like to
 5   change the word maker-taker to access fees just in
 6   general because I think one implies a specific direction,
 7   and I think just generally the economics of accessing -- 
 8             MR. LUPARELLO:  You're trying to let Matt off
 9   the hook, actually. 
10             MR. RATTERMAN:  But yes, access fees and
11   transparency seem to be two elements that in my mind seem
12   eminently actionable and came up over and over and over
13   again today as common themes.  While it may not be the
14   whole kit, I think the whole kit's going to take some
15   time.  But just my vote would be access fees and
16   transparency standards seem to be the things that I heard
17   over and over and over again and seem actionable to me. 
18             MR. LUPARELLO:  Yes, Nancy? 
19             MS. SMITH:  Do you mean, by the transparency,
20   the discussion we just had, I think, between Dave and
21   Brad especially saying we need to get more disclosure out
22   into the market?  Is that what you're talking about?  I
23   would agree with it. 
24             MR. LUPARELLO:  I should say on that,
25   referencing back to the Chair's speech of a few months
0226
 1   ago, that issues around order routing disclosure,
 2   especially in the institutional space, is something that
 3   she has asked the Commission staff to work on.  And there
 4   is an effort that's already underway. 
 5             I think having a conversation on that
 6   specifically to figure out whether it's ripe for the
 7   committee or it's something where conversations are
 8   already far along both at the staff level with the
 9   Commission and, frankly, in one-off other conversations,
10   whether that's something that the committee's involvement
11   helps move forward or actually slows up I think is
12   something we probably want to think about and get back to
13   you. 
14             But I think, as a general matter, those issues
15   are important issues.  And certainly one person's scope
16   on greater transparency in order routing is not
17   everybody's scope.  But I just would hold that out as one
18   potential element we should think about. 
19             MR. STONE:  And just as a general thing, I
20   think it's great that the staff is working on it.  But I
21   would just say that maybe we form a subcommittee that can
22   work with the staff just so you can bounce those ideas
23   off of us to further or maybe get more clarity early on
24   about some of the things that we would see that you might
25   see differently.  So it's another way that you could use
0227
 1   us. 
 2             But with that, and you may not be able to
 3   comment on it, but the question I have is, does 605/606
 4   reform -- we've heard it a few times today -- does that
 5   morph into the quantitative metrics that go into actual
 6   order routing and order routing proving?  
 7             You can all the transparency in the world, but
 8   unless you have something behind that actually points to
 9   the fact you're actually doing, this is what the FCA said
10   in their thematic statement, I think that that might be
11   the subcommittee actually looking at the metrics as to
12   what we would actually want to give people the ability to
13   be able to say, all right.  Yes.  You're generally doing
14   what you say you do. 
15             MR. LUPARELLO:  Jamil? 
16             MR. NAZARALI:  One thing that was actually
17   really helpful was having all this reading material and
18   having you guys pull together the data on the particular
19   issue, for example, on 611 and the impact.  And I think
20   it would be really helpful for whatever topics we cover
21   to have some background material and some data that we
22   can look at, and it's not going to be complete. 
23             I think the other thing that would be helpful
24   would be, as we examine various issues, to have questions
25   that we can pose to various constituencies.  For example,
0228
 1   in 611, some of the arguments against 611 were, one,
 2   complexity.  So we could have people at the exchange who
 3   handle most of the order type complexity talk about that
 4   and talk about, okay, does that create more fragility in
 5   your system? 
 6             Another criticism of 611 is around block orders
 7   for institutions, so having a couple of institutions and
 8   saying, is this really a problem, or do you get around it
 9   with ISOs?  Why not use ISOs?  So just having some very
10   specific questions to those constituencies. 
11             If we're looking at maker-taker, having some
12   order routers, and does this impact how you route orders. 
13   I don't know.  But that kind of thing, I think, would be
14   helpful. 
15             MR. LUPARELLO:  Is your question around the
16   ability to do that as one-off members of the committee? 
17   Or is that a suggestion that the committee engage in that
18   kind of feedback? 
19             MR. NAZARALI:  The suggestion is to the extent
20   that you could -- 
21             MR. LUPARELLO:  Facilitate? 
22             MR. NAZARALI:  -- facilitate that, I think that
23   would actually be really helpful. 
24             MR. LUPARELLO:  Great. 
25             MR. MECANE:  I just had a couple of other
0229
 1   random ideas that I'll just throw out.  But following on
 2   what Jamil said, the prep material is definitely very
 3   helpful.  I think having data come from the Commission is
 4   very helpful because it's independent and not subject to
 5   potential bias. 
 6             And then maybe just echoing back to my comments
 7   earlier, I think to the extent we could broaden out the
 8   metrics that we use to judge market quality, I think it
 9   would be very helpful, especially as we think about
10   potential pilots and measuring impact, and a few specific
11   examples. 
12             We tend to go back to the standard, spreads and
13   order size and volume, and those are all good.  But we're
14   having a more sophisticated discussion now that talks
15   about retail price improvement and execution quality, and
16   I'll over-generalize that as maybe the benefits of
17   segmentation, which I think feed into a lot of the
18   conversation about whether it's on-exchange,
19   off-exchange, dark pools, ATSs. 
20             To me, access fees are obviously a piece of
21   that.  But the other big piece are the benefits of
22   segmentation.  And that's why people use a lot of those
23   different venues.  And to me, that's really the judgment
24   call for the pros and cons of those types of activity. 
25             So I think to the extent -- and I know it's
0230
 1   hard -- but to the extent we could start to put numbers
 2   around whether it's TCA for institutional orders over
 3   periods of time or retail execution quality, and at least
 4   establish a benchmark, I think those types of data
 5   points, even if it's hard to give an absolute opinion on
 6   them, will at least become helpful in terms of evaluating
 7   things.  So that's one thought. 
 8             The other thought is -- and this is maybe just
 9   a way of also repackaging some of the other things that
10   we've talked about.  One thing that we haven't talked
11   extensively about today but obviously is a very important
12   part of our market structure is competition and how
13   important competition has been to a lot of the benefits
14   that we've seen. 
15             And you could make an argument that there are
16   some I'm going to call them artificial incentives, and I
17   don't mean that negatively, but there are some artificial
18   incentives that drive a lot of competitive behavior.  And
19   you could put rebates in that category.  You could put
20   611 in that category.  You could put market data in that
21   category. 
22             And we may agree that those are proper and good
23   and ultimately drive a lot of beneficial behavior for the
24   marketplace, and we should continue them.  But it might
25   be helpful just to think about or separate natural
0231
 1   competition from competition that we've created
 2   intentionally and think about which pieces we want to
 3   intentionally continue and which pieces we should
 4   rethink.  So I'll just put that out there. 
 5             MR. LUPARELLO:  Those are great thoughts. 
 6   Thank you. 
 7             MR. STONE:  Can I ask this question?  So I
 8   applaud FINRA for going out and actually getting the data
 9   as to the ATSs so we can find out what's trading.  Has
10   there been any thought given about expanding that to all
11   off-exchange trading so we can understand the other 25
12   percent -- excuse me, the other 20 percent -- as to
13   what's happening so we can figure out the motivations as
14   to why things are moving off into the dark -- or
15   off-exchange; forget about the dark, off-exchange? 
16             MR. KETCHUM:  Actually, yes.  The board's
17   approved moving in exactly that direction.  You'll see a
18   proposal shortly.  And thanks for the question. 
19             MR. STONE:  I'm not on the board so I didn't
20   know about it, but -- 
21             MR. KETCHUM:  Anything else you'd like us to
22   do? 
23             MR. STONE:  Yes.  Could you make it free,
24   though? 
25             (Laughter.)
0232
 1             MR. KETCHUM:  And we're looking at the fees. 
 2             MR. LUPARELLO:  That seems more like a
 3   bilateral conversation.  
 4             MR. STONE:  But actually, a related thing about
 5   that.  You know we had our private meeting where we got
 6   our ethics training and things like that, which is great. 
 7   My question is, to what extent can the data that's coming
 8   out of the Commission into the subcommittees be given to
 9   academics to be able to assist us in looking at these
10   issues?  
11             This is something that's been bandied about. 
12   There's been a lot of comment on it, about the SEC
13   sharing information and things.  We can come back to it,
14   but I do want to put that as a placeholder, that this is
15   an opportunity for us to actually explore that and
16   actually involve a lot of people who have done a lot of
17   work. 
18             A lot have basically done it with Chester.  But
19   there are other people out there that might want to -- we
20   want their opinion also. 
21             MR. LUPARELLO:  I think that's something we'll
22   have to get back to you on.  Obviously, anything that
23   happens in the -- while subcommittees don't need to be
24   public meetings, all the deliberations of the
25   subcommittees need to come back through the committee. 
0233
 1   How the data that's provided works in alignment with that
 2   is something we'll have to get back to you on. 
 3             MR. STONE:  That's like a bunch of lawyers in a
 4   room. 
 5             PROFESSOR SPATT:  If I could just follow up on
 6   that point, though, because I do think it's an extremely
 7   important point.  And this is an issue I hear a lot about
 8   as a former chief economist. 
 9             There is, I think, a lot of surprise and a lot
10   of frustration in the academic community that the
11   Commission hasn't been more forthcoming with some of the
12   data resources that it has.  So I do think that's an
13   extremely important issue.  
14             And the one tangible context where I think it
15   worked actually extremely well was on the short sale
16   pilot, for example, where the data was readily made
17   available, and it resulted not only in some very nice
18   studies, but it resulted in very informative evidence
19   being available to the Commission. 
20             So I don't know think that this is a very
21   important issue and a way for the staff to seriously
22   leverage its resources and its capacity. 
23             MR. LUPARELLO:  Any last questions?  Any
24   questions from the members of the Commission? 
25             (No response.)
0234
 1             MR. LUPARELLO:  We appreciate your presence and
 2   your attention.  It, I think, has added a lot. 
 3             Anything else? 
 4             MR. CRONIN:  So can I ask, what is the action
 5   item now?  So are we going to at this stage divide and
 6   conquer, or is it a subsequent email chain that will try
 7   to get to this? 
 8             MR. LUPARELLO:  So the action item is for the
 9   staff to come back with a recommendation as to the
10   creation of a subcommittee or multiple subcommittees, and
11   to have subject matter assigned to those subcommittees. 
12             I think what we'd like to do is go back and
13   think about what our first thoughts about how those
14   subcommittees are best organized, socialize that with the
15   committee, and then ask the committee to vote on that. 
16   But thank you.  That's an important clarification. 
17             MR. STONE:  And also, if we have ideas, it's
18   hard to package.  Joe put out two of them, I thought,
19   which were really good.  If we had ideas as to where a
20   subcommittee might be formed, would we send it to you so
21   that you can be part of that process? 
22             MR. LUPARELLO:  Absolutely.  And I would also
23   point out, I think one of the things that benefitted this
24   conversation, and others have pointed out, we always
25   appreciate the compliments, when we get them, on the
0235
 1   preparation of materials. 
 2             But the ability to prepare materials on other
 3   issues -- say, access fees -- and have a similar
 4   broad-based conversation before that conversation moved
 5   -- or maybe even after that conversation moved into
 6   consideration by a subcommittee, I think, would continue
 7   to benefit the dialogue.  So I think part of this is us
 8   figuring out the best way to sequence these things as
 9   well. 
10             MR. BROWNE:  So is it your vision that the
11   subcommittees would be formed at the next meeting, and
12   then that meeting starts at that time?  Or are we waiting
13   a period of time for that to occur? 
14             MR. LUPARELLO:  I think TBD.  I think we want
15   to think about the most effective way to get that done. 
16   And that is certainly a possibility that we would form
17   the subcommittees or we'd have the vote to form the
18   subcommittees when the committee got back together.  But
19   if there is a way to do it the interim to make progress
20   sooner, I think we'd like to be open to that as well.  
21             Any last comments? 
22             MR. STONE:  I just had -- I'm sorry.  I just
23   have another question. 
24             MR. LUPARELLO:  I always look at you first. 
25             MR. STONE:  I know.  So my question is in terms
0236
 1   of trying to push the subcommittees through because we're
 2   supposed to meet quarterly.  Is that something that can
 3   be done under the rules as a conference call with us
 4   that's open to the public? 
 5             MR. LUPARELLO:  Right.  That's exactly what we
 6   have to figure out.  That's right. 
 7             So at this point, I'll entertain a motion to
 8   adjourn. 
 9             COMMITTEE MEMBER:  So moved. 
10             MR. LUPARELLO:  Any second? 
11             COMMITTEE MEMBER:  Second. 
12             MR. LUPARELLO:  All in favor? 
13             (A chorus of ayes.) 
14             MR. LUPARELLO:  I would add only one comment,
15   where I'm sure not everybody will agree with me, but go,
16   Rangers. 
17             (Whereupon, at 4:01 p.m., the committee was
18   adjourned.)
19                           * * * * *
20   
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23   
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25   
0237
 1                   PROOFREADER'S CERTIFICATE
 2   
 3   In The Matter of:   EQUITY MARKET STRUCTURE 
 4                       ADVISORY COMMITTEE
 5   File Number:        OS-0513
 6   Date:               May 13, 2015
 7   Location:           Washington, D.C.
 8   
 9             This is to certify that I, Nicholas J. Wagner,
10   (the undersigned), do hereby swear and affirm that the
11   attached proceedings before the U.S. Securities and
12   Exchange Commission were held according to the record and
13   that this is the original, complete, true and accurate
14   transcript that has been compared to the reporting or
15   recording accomplished at the hearing.
16   
17   _______________________       _______________________
18   (Proofreader's Name)                    (Date)
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