0001 1 U.S. SECURITIES AND EXCHANGE COMMISSION 2 3 4 5 6 EQUITY MARKET STRUCTURE 7 ADVISORY COMMITTEE MEETING 8 9 10 11 Wednesday, April 5, 2017 12 9:50 a.m. 13 14 15 AMENDED 4-25-2017 16 17 18 19 20 21 22 23 U.S. Securities and Exchange Commission 24 100 F Street, N.E. 25 Washington, D.C. 20549 0002 1 PARTICIPANTS: 2 3 SEC COMMISSIONERS PRESENT: 4 Michael S. Piwowar, Acting Chair 5 Kara M. Stein 6 7 EQUITY MARKET STRUCTURE ADVISORY COMMITTEE MEMBERS 8 PRESENT: 9 Reginald Browne 10 Cantor Fitzgerald & Co. 11 Kevin Cronin 12 Invesco Ltd. 13 Ted Kaufman 14 Duke University Law School and former U.S. Senator 15 from Delaware 16 Richard Ketchum 17 Former Chairman and CEO, FINRA 18 Manisha Kimmel 19 Thomson Reuters 20 Mehmet Kinak 21 T. Rowe Price Group 22 Joseph Mecane 23 Barclays PLC 24 Jamil Nazarali 25 Citadel Securities, LLC 0003 1 PARTICIPANTS (CONT.): 2 3 EQUITY MARKET STRUCTURE ADVISORY COMMITTEE MEMBERS 4 PRESENT (CONT.): 5 Eric Noll 6 Convergex Group 7 Joe Ratterman 8 BATS Global Markets, Inc. 9 Nancy Smith 10 AARP Inc. 11 Chester Spatt 12 Carnegie Mellon University 13 Gary Stone 14 Bloomberg Tradebook LLC 15 16 PANELISTS: 17 Jeff Brown, SVP, Legislative & Regulatory Affairs, 18 Charles Schwab 19 Charles Jones, Professor of Finance & Economics, 20 Columbia Business School 21 Adam Nunes, Head of Business Development, Hudson 22 River Trading 23 Paul Russo, Global Co-COO - Equities, Goldman Sachs 24 Thomas Witmann, EVP for Global Equities & CEO, 25 NASDAQ/PHLX/ISE/BX Exchanges 0004 1 PARTICIPANTS (CONT.) 2 3 PANELISTS (CONT.): 4 Anthony Albandese, Chief Regulatory Officer, NYSE 5 Lev Bagramian, Senior Securities Policy Advisor, 6 Better Markets, Inc. 7 Thomas Gira, EVP, Market Regulation & Transparency 8 Services, FINRA 9 John Kerin, CEO & President, Chicago Stock Exchange 10 Brett Redfearn, Global Head of Equity Market Structure 11 Strategy, JP Morgan Securities 12 13 14 15 16 17 18 19 20 21 22 23 24 25 0005 1 C O N T E N T S 2 PAGE 3 Welcoming Remarks by Acting Chair Piwowar, 4 Commissioner Stein, and Acting Director of Trading 5 and Markets, Heather Seidel 6 6 Regulation NMS Subcommittee Presentation and 7 Preliminary Recommendations Relating to Rule 611 13 8 Discussion of Rule 611 and Preliminary 9 Recommendations 26 10 Trading Venues Regulation Subcommittee Presentation 11 on Regulatory Centralization and Preliminary 12 Recommendations Relating to SRO Rule-Based 13 Limitations Of Liability 80 14 Discussion of Regulatory Centralization and 15 Preliminary Recommendations 89 16 Market Quality Subcommittee Status Report to the 17 Committee 140 18 Customer Issues Subcommittee Status Report to the 19 Committee 147 20 Discussion of Next Steps/Adjournment 151 21 22 23 24 25 0006 1 P R O C E E D I N G S 2 MS. SEIDEL: Good morning. We have a slight 3 back up at security, so one or two more might come on in. 4 But I figured we can start. 5 On behalf of the Commission, I'd like to thank 6 you all for joining us for today's meeting of the SEC 7 Equity Market Structure Advisory Committee. We have a 8 majority of members in attendance and have a quorum, and 9 so I will call the meeting to order. 10 I'll begin by asking Chairman Piwowar to make 11 his opening remarks. 12 CHAIRMAN PIWOWAR: Thank you, Heather. Good 13 morning, everyone. 14 On behalf of the Commission, I would like to 15 welcome you to the first meeting of the Equity Market 16 Structure Advisory Committee of -- in 2017. Let me also 17 extend thanks to the EMSAC members for your continued 18 service and to the distinguished panelists who have 19 joined us today. 20 At the first EMSAC meeting in May of 2015, I 21 challenged the committee to let your collective 22 experience guide your work, and you have done just that. 23 I commend you for continuing to provide your expert 24 perspective on the structure and operation of U.S. equity 25 markets. 0007 1 In doing so, the EMSAC has contributed a great 2 deal to my own thinking. For example, your advocacy of a 3 pilot to test how various levels of access fee caps under 4 Rule 610 of the Exchange Act affects equities trading has 5 helped to inform Commission action. I recently asked 6 Commission staff to develop an SEC rulemaking that 7 identifies specific parameters of an access fee pilot. I 8 look forward to being able to vote on such a proposal in 9 the near future. 10 Today, the committee will take up two issues. 11 First, the Regulation NMS Subcommittee will revisit 12 Regulation NMS Rule 611, the Order Protection Rule, which 13 you will recall was addressed at EMSAC's inaugural 14 meeting. 15 Also, the Trading Venues Regulation 16 Subcommittee will deliver a presentation on a new topic, 17 the regulatory centralization and the liability of SROs. 18 Undoubtedly, each subcommittee's presentation and 19 preliminary recommendations will stimulate thoughtful 20 discussion. 21 Before I turn the meeting over -- back over to 22 Heather Seidel, Acting Director of the Division of 23 Trading and Markets, I'd like to make note of another 24 body whose efforts, in parallel with the EMSAC will help 25 lay the groundwork for future enhancements of our equity 0008 1 market structure. 2 I recently spoke to a group of economists, 3 legal scholars, and industry practitioners at the 4 Columbia Law School's program on law and economics of 5 capital markets. They are commending a new special study 6 of securities markets to be modeled on the much lauded 7 special study of securities markets in 1963. I believe 8 that this project, which has a targeted completion date 9 of 2020, will complement the excellent work of this 10 committee and continue -- and we'll continue to undertake 11 on behalf of our country and our capital markets. 12 Thank you and back to Heather. 13 MS. SEIDEL: Thank you, Acting Chairman 14 Piwowar. 15 I'll now ask Commissioner Stein to make her 16 opening statement. 17 COMMISSIONER STEIN: Good morning. It's nice 18 to see all of you again. 19 Today's agenda covers two recommendations that 20 have come from the hard work of two of the advisory 21 committee's subcommittees. I'm going to go back, I 22 guess, like Mike did to May 2015 at the inaugural meeting 23 of this advisory committee where you began your 24 examination of Reg NMS and, in particular, the order 25 protection rule. As you know, this rule is one of 12 0009 1 that collectively make up Reg NMS. 2 Today, the committee continues that examination 3 and will discuss its subcommittee's recommendations. At 4 the time Rule 611 was adopted, the Commission noted that 5 many internalized trades were actually small trades made 6 by or for retail investors and that nearly one in 30 of 7 such trades was executed at a price inferior to readily 8 available quotes in the lit venues. Accordingly, Rule 9 611 restricted trades at prices that were worse than a 10 protected quotation. 11 In the year since the adoption of Reg NMS, our 12 markets have changed dramatically. Trading volumes have 13 increased while the average trade size has decreased. 14 Market fragmentation has increased significantly. 15 In addition to the 21 registered securities 16 exchanges, there has been increase in dark pool, ATSs, 17 and other off-exchange venues such as broker-dealer 18 internalizers. 19 The substantial increase in trading in dark 20 venues means that displayed limit orders interact with a 21 much smaller percentage of volume today than they did 22 prior to the enaction of Rule 611. 23 The committee and its work provides us with an 24 opportunity to actually reexamine the purpose of Rule 25 611. What was it for? Arguably, the purpose behind 611 0010 1 was to ensure that investors do not get inferior prices 2 in a complex, fragmented market. 3 Essentially, it's a principles-based rule that 4 sets forth a floor that investors get best execution. 5 This raises a number of questions in my mind: do today's 6 investors need this particular protection; what are the 7 incentives in today's markets that impact routing and 8 execution; how do those incentives affect behavior in 9 today's markets, and how are we measuring for it; what 10 are the pros and cons of changing Rule 611 prior to 11 modernizing the Commission's order execution and order 12 routing disclosures. 13 I look forward to hearing from today's panel 14 and the subsequent discussion about whether and how Rule 15 611 should be changed. 16 The second item on the Committee's agenda is 17 the Trading Venues Regulation Subcommittee's preliminary 18 recommendations -- it's a mouthful -- concerning SRO 19 liability limits and regulatory centralization. 20 As our markets have grown more complex and 21 automated, we have seen technical glitches that have 22 impacted both the markets and market participants. The 23 subcommittee's first recommendation concerns how SROs 24 compensate those harmed by such errors. 25 The subcommittee's second recommendation deals 0011 1 with the best way to surveil the modern markets. The 2 markets today are increasingly interconnected by all of 3 these computers. And just as the markets have evolved, 4 so, too, must market regulators. Is there a better, more 5 efficient way to identify misconduct across markets? 6 I look forward to the committee's discussion on 7 the best way to conduct cross-market surveillance in an 8 error of automated trading and at the inception of the 9 consolidated audit trail. 10 After the two panel discussions, we'll also 11 hear status reports from the Market Quality and the 12 Consumer Issues subcommittees. I'm interested, in 13 particular, in the Market Quality Subcommittee's current 14 analysis of the tick size pilot. How is it going? 15 And as I've said in the past, I very much 16 appreciate the time and the attention that each of you 17 has dedicated pro bono to the important work of this 18 committee. This work requires you to put your own 19 business interests aside and to think through solutions 20 for the good of our markets as a whole. I'm counting on 21 you, and I know the American people are counting on you 22 to recommend improvements to our equity market structure 23 for the benefit of all. 24 So, I look forward to today's discussion and 25 analysis and your best thoughts regarding what is best 0012 1 for our markets. Thank you. 2 MS. SEIDEL: Thank you, Commissioner Stein. 3 I'd also like to introduce my colleagues in the 4 Division of Trading and Markets. To my immediate right 5 is Gary Goldsholle, a deputy director in the division. 6 To his right is David Shillman, an associate director in 7 the Office of Market Supervision. And to my far left is 8 John Roeser, also an associate director in the Office of 9 Market Supervision. Next to John is Scott Bauguess, the 10 acting director and acting chief economist of the 11 Division of Economic and Risk Analysis. 12 And I will also note that the standard 13 disclaimers apply to today's meeting. Any views 14 expressed by the staff in this forum are ours alone and 15 cannot be attributed to the Commission or the 16 commissioners. 17 The last advisory committee meeting in November 18 focused on the recommendations of the Market Quality and 19 Customer Issues subcommittees. As a result of those 20 efforts, the full committee has now made formal 21 recommendations to the Commission with respect to limit 22 up/limit down, market-wide circuit breakers, and the 23 market opening as well as modifications to Rule 605 and 24 606. 25 Today, we turn to the ongoing work of the other 0013 1 two subcommittees, the Regulation NMS Subcommittee and 2 the Trading Venues Regulation Subcommittee. These two 3 subcommittees will be presenting their preliminary 4 recommendations to the full committee. 5 A lot of work has gone into developing the 6 subcommittee recommendations being considered today. As 7 you may recall, Rule 611 was one of the first market 8 structure topics presented by Commission staff for 9 committee consideration. And last April, the Trading 10 Venues Regulation Subcommittee considered SRO rule-based 11 limitations of liability as well as regulatory 12 centralization as part of their initial recommendations. 13 In addition to the prior discussion on these 14 topics, several expert panelists representing a range of 15 perspectives discussed their views on the issues and 16 participated in an open dialogue with committee members, 17 the Chair, Commissioners, and Commission staff. 18 Separately, the subcommittees have held a number of 19 meetings and have invited outside experts to provide 20 their views on the various issues under consideration. 21 To set the stage this morning, each 22 subcommittee chair will present their preliminary 23 recommendations. We will then hear the views of our 24 expert panelists before turning it over to the full 25 committee for discussion. 0014 1 Let's move on to the first agenda item, the 2 preliminary recommendations of the Regulation NMS 3 Subcommittee. And I'd like to ask Kevin, as the chair of 4 that subcommittee, for an overview of those 5 recommendations. 6 MR. CRONIN: So, first of all, thank you for 7 the opportunity today to share some of our thoughts. To 8 be clear, we are not at the stage of making any official 9 recommendations, as we'll describe this process as a 10 little bit more complicated than probably addressing 11 something that had a lot more universal appeal, for 12 example, in access fees. So, thanks for the 13 commissioners; thanks to the staff, the same panelists 14 for being here today and to my fellow EMSAC for the 15 consideration. 16 So, again, taking a step back, from the NMS 17 subcommittee's perspective, when we looked all the 18 various issues related to NMS, it struck us again that 19 the access fees, in particular, were issues that had 20 universal support that something needed to be done. We 21 could argue that that something was varied. But clearly 22 there were strong opinions that something needed to be 23 done to fix or to address what many people, including 24 myself, view as the root problem of the things that I 25 think are wrong in the market structure today. 0015 1 So, we went through the process. We certainly 2 tried to be inclusive. And as was noted, we came up with 3 an access fee pilot recommendation, which I think was a 4 thoughtful recommendation. And if there is movement to 5 take that forward, certainly encourage the industry to 6 participate in the debate. I know a number of us get a 7 lot of solicitations about what we did wrong. We 8 strongly encourage those who believe that to be part of 9 the conversation, and we'll get to the right answers. 10 As it pertains to 611, I think it's less clear 11 that people conclude that something needs to be done. 12 And even the crowd that agrees that maybe something needs 13 to be done, it's much less clear what is the something 14 that needs to be done. 15 So, I think, maybe as we take a step back, what 16 we're really trying to do, again, is principally to be 17 thoughtful about the recommendations we make to make sure 18 that the issues are considered from a number of different 19 perspectives. And it was suggested by Commissioner Stein 20 that we remove, as best we can, our self-interest from 21 the conversations, which can be a little bit challenging, 22 certainly, as we go through this. 23 I will tell you, as we've already had a number 24 of conversations, including several years ago, what's 25 clear to me -- and I suspect to other members of the 0016 1 subcommittee -- is that -- 2 (Mic malfunction.) 3 MR. CRONIN: -- incremental limit orders is 4 questionable at most that that's happened. The burdens 5 of compliance is high relative to what the benefit is of 6 fixing this trade-through problem. 7 On the other hand, we'll hear from the crowd 8 who is a proponent of doing nothing who will say, "What 9 is the problem? Help us identify what we're trying to 10 solve for because it's unclear to us. And secondly, why 11 would want to move a protection that ensures that the 12 investors will not get an inferior price when they post a 13 bidder offer?" 14 So, these are very weighty sort of questions 15 and things to understand and try to figure out. And so, 16 as we go through this process, I can promise you this. 17 We will be try to be as thoughtful as we possibly can and 18 consider all the different options. And we will present 19 what we think is the most appropriate action to go 20 forward, including potentially doing nothing. 21 So, with all that said, I'll let Joe do all the 22 fun work and give you some of the thoughts that we have 23 had as we've gone through the initial conversations on 24 611, again, keeping in mind, I think, at some point, 25 whereas 610 was a much easier issue to isolate, in 0017 1 particular, access fees, 611 is a much more complicated 2 issue to try to isolate. And I think you automatically 3 bring other elements of the rules in as you try to do 4 some sort of thoughtful consideration of the issue. 5 So, Joe, with that, I'll pass it to you. 6 MR. MECANE: Sure. So, I'll just expand on 7 Kevin's points and outline a little bit of the highlights 8 from the summary that we had -- we had put together. 9 I think that the number one issue that we 10 struggled with is that it's difficult to resolve the 611 11 question in a data-driven capacity. And I think where 12 that ends up is that we end up having a lot of 13 philosophical arguments about the benefit or harm that 14 611 caused or continues to cause the markets. 15 Aside from clearly converting markets to an 16 electronic format, in looking at the data that the SEC 17 staff helped us prepare, it wasn't necessarily clear or - 18 - nor were we able to draw a strong conclusion about 19 whether 611 had a meaningful impact on displayed limit 20 orders and liquidity in the market or whether the burdens 21 of compliance with 611 outweigh those -- those benefits. 22 As Kevin said, there are very strong arguments 23 on both sides of the 611 topic. And just to summarize a 24 few of them -- Kevin mentioned a couple. 25 But the main arguments on the side of keeping 0018 1 611 fall into three general categories. One is defining 2 what the actual problem is that we would solve by taking 3 611 out. The second is around a best execution back- 4 stop. As Commissioner Stein mentioned. It ends up being 5 at least a fallback for some form of best execution. And 6 the third topic ends up becoming the -- or the fear of 7 the compliance burden that would fall on firms if 611 was 8 taken out in terms of ensuring that you were putting your 9 limit orders in a venue that wasn't getting traded 10 through and you were achieving best execution for its 11 customers, again, all strong arguments. 12 On the remove side, the arguments were 13 primarily for. One is around whether 611, especially 14 once you draw in the lock/cross component of Rule 610, 15 has contributed to an increasingly complex marketplace 16 that has become fragmented and difficult to navigate. 17 The second -- kind of the flip side to last 18 point I made on the arguments for keeping, which is the 19 burden of compliance with 611 and the amount of 20 infrastructure that the industry has built to ensure that 21 they don't violate 610 or 611 and whether that cost of 22 the industry outweighs any of the benefits of the trade- 23 through rule. 24 The third point is around a lack of compelling 25 evidence about -- other than the conversion to electronic 0019 1 markets that Rule 611 has had on displayed limit orders 2 in the marketplace. And at least the data that we looked 3 at, there was certainly some marginal benefit but not a 4 clear compelling case to be made that 611 contributed to 5 displayed liquidity in the marketplace. 6 And then, the last point is around the form 7 that venue competition has taken where there's a view 8 that we've seen competition largely evolve along the 9 dimensions of price and speed because of the framework 10 that 611 puts under us. 11 So, our general takeaway, after a lot of 12 deliberation, was that those pros and cons, all valid, 13 not academically resolvable. And so, a lot of the debate 14 comes down to philosophy about how the market should 15 function; what type of framework should we have for 16 operating the markets and, you know, what do we think 17 collectively is the better direction for markets to 18 evolve. 19 So, as Kevin said, we're not at the point of a 20 formal recommendation, but similar to the framework that 21 I think we approached the access fee pilot, our thought 22 was that our role at this point should be to outline, if 23 the commission were to move forward with a framework for 24 evaluating 611, what would that look like; what do we 25 think the main factors of it would be; and what would be 0020 1 the measures of success. 2 So, there were a few goals that I think we 3 thought, if a 611 removal were to go forward, that we 4 would want to have as goals for that type of initiative, 5 the first would be quantitatively measuring whether 611, 6 in fact, does or does not have an effect on displayed 7 limit orders in the marketplace. 8 The second is, there is at least an argument to 9 be made that, if 611 were taken out and we saw no change 10 in marketplace behavior or displayed liquidity, that that 11 could be a positive outcome from the standpoint of 12 reducing a lot of the frictions and compliance burden on 13 the industry from complying with it. 14 The third goal would be to see whether the 15 operational complexity of the marketplace would be 16 reduced without 611 in place in terms of fragmentation; 17 various order types; difficulty setting the NBBO. 18 And then, a longer-term goal, which would be 19 evolutionary, would be to see whether competition evolved 20 in different dimensions other than speed and price as the 21 market adapted to a non-611 world. 22 So, two last general topics, one around what we 23 think the specific framework for a pilot would look like 24 if one were to move forward. And as Commissioner Piwowar 25 outlined, the access fee pilot which we previously 0021 1 suggested really was intentionally meant to control for 2 one variable and not introduce a lot of other components 3 of Reg NMS into an access fee pilot to be able to draw a 4 definitive conclusion around what affect access fees have 5 on displayed liquidity in the marketplace and execution 6 quality. 7 As we went down the 611 path, I think we 8 reached the conclusion that a 611 pilot is difficult to 9 address in isolation. And so, we ended up spending a lot 10 of time talking about the interrelatedness of 611 with 11 lock/cross markets and access fees. And so, the 12 framework that we are discussing really tries to address 13 all of those pieces together. 14 A few different premises that we thought a 611 15 pilot would have to have around that framework is that we 16 thought specifically with lock/cross markets that that 17 issue could not be addressed without also addressing the 18 rebate or access fee issue because many of us remember 19 that part of the debate, when the lock/cross market ban 20 was introduced, was to rein in a lot of rebate-driven 21 activity. And that also led to the introduction of the 22 30-cent access fee cap. 23 And so, one view was that, if lock/cross comes 24 out, that has to be coupled with some access fee reform 25 to not recreate the situation that we dealt with. 0022 1 The other is that what we call a pilot in this 2 case we thought is different than the pilot term that we 3 used with the access fee framework. And specifically 4 with the access fee framework, we thought of a pilot in 5 terms of different control groups of stocks where you 6 could simultaneously measure what impact different groups 7 had with different parameters. 8 For 611, because we think the effect would 9 mainly be at a venue level, we think 611, if it were to 10 be removed, would need to be done on a market-wide basis. 11 And what we're calling a pilot in this case is really 12 meant to function as an ability to stop the pilot if we 13 see unintended consequences, as opposed to being able to 14 run it in different groups. We feel, if we were to do it 15 in isolation or with select groups of stocks, you would 16 not see the impact that you would otherwise expect to see 17 because of the venue component of the experiment. 18 And then, the last framework point was that we 19 thought, especially to address some of the concerns 20 around the best ex backstop that 611 provides, is that 21 any removal of 611 would need to be coupled with some 22 additional best execution guidance or at least 23 reinforcement of some of the rules out there to ensure 24 that orders weren't disadvantaged just by nature of the 25 fact that the rule was removed. 0023 1 I think most people believe that the same level 2 of oversight would be provided, but we thought it would 3 be prudent to put that out there in a -- in a more 4 specified manner. 5 The other framework question that we suggest is 6 that, as I said, you could have a 611 pilot in isolation. 7 We think it would more likely be done with a removal of 8 the lock/cross market ban and also addressing access 9 fees. So, the question that that raises, which we 10 haven't fully resolved but we put out there is that 11 there's two paths that could go down. 12 Depending on whether we collectively wanted to 13 conduct the access fee experiment -- or pilot first and 14 draw conclusions from that or wrap everything together 15 and enact them simultaneously, one is obviously more 16 informed than the other. But there's a logistical and 17 sequential consideration. 18 The last topic that I'll just quickly mention 19 are the other possible paths that we considered but, you 20 know, haven't, I would say, gained as much traction as 21 the previous items we discussed. 22 Clearly, there is a -- an argument or a strong 23 argument to do nothing, that the markets work reasonably 24 well as they are and it's not worth the effort of taking 25 it out. That's clearly one alternative. 0024 1 We also discussed the other side of the 2 spectrum in terms of introducing something more 3 restrictive. So, we discussed trade-at as an example, or 4 depth of book protection. You know, all have their pros 5 and cons, but I would say that didn't rise to the top of 6 the recommendation list. 7 We discussed certain tactical pieces, such as a 8 block exemption under Reg NMS or additional -- additional 9 exemptions. I think those are still supported. But as 10 we headed down that discussion, I think we ended up back 11 where we were in terms of more of a holistic approach. 12 We discussed an idea that has been floated 13 around for a number of years with minimum market share 14 amounts for protected quote status. I think we ended up 15 at the point of not sure that that adequately addresses a 16 lot of the issues that get raised, given the limited 17 number of venues with sub one-percent market share. And 18 I'm not sure we thought that really addressed a specific 19 problem. 20 And then, we also discussed another topic 21 that's been around for a while, which is specifically 22 just passing through access fees as a little bit of a 23 proxy for at least the access fee concern. And I think 24 that gets -- that gets a lot of debate. 25 The last point I'll make is that, you know, we 0025 1 did have some very brief discussion around the market 2 data issues that are out there. And that's obviously, 3 the last remaining part of Reg NMS that we haven't 4 discussed. I think at this point we decided that that 5 would be a potential next step. While there's obviously 6 some overlap with some of the issues we're talking about, 7 we thought that that was probably better warranted as a 8 slightly separate topic, so we didn't bring that piece 9 into this, into this debate. 10 MS. SEIDEL: Thank you, Kevin and Joe. 11 Let me quickly introduce our panelists now and 12 then ask each of them to provide their statements. Going 13 from my left to right, we start with Jeff Brown, Senior 14 Vice President of Legislative and Regulatory Affairs at 15 Charles Schwab. Next to him is Charles Jones, a 16 professor of Finance and Economics at Columbia Business 17 School. Next to Charles is Adam Nunes, the head of 18 Business Development at Hudson River Trading. Next is 19 Paul Russo, the Global Co-Chief Operating Officer of 20 Equities at Goldman Sachs. And finally, we have Tom 21 Wittman, Executive Vice President for Global Equities and 22 CEO of the NASDAQ, PHLX, ISE, and BX exchanges. 23 So, Jeff, could you lead us off please? 24 MR. BROWN: Absolutely. And sorry for being 25 late this morning. It wasn't to make an entrance. 0026 1 But I want to thank Acting Chair Piwowar and 2 Commissioner Stein and Acting Director Seidel and the 3 rest of the staff as well as the committee for having me 4 here. It's my third time before this committee, so I 5 feel very honored to talk to this august body. 6 Schwab obviously remains very concerned about 7 market structure issues. The way our markets treat 8 retail investors is critical. And we really then 9 appreciate the opportunity to express our views. 10 Now, today we're -- you know, the issue is 611, 11 the trade-through rule. And I have to say, when it was 12 proposed, we opposed Rule 611 and for good reasons, we 13 felt. The -- maybe the first and foremost was that we 14 really didn't feel like the SEC's role should be to 15 dictate the structure of our markets, how orders would be 16 routed, order types in itself. And so -- and we still 17 really hold that view, that markets ought to be freer to 18 -- you know, to compete, and by -- through the 19 competition, creating better end results. 20 But another issue we had was that we felt that 21 innovation could be stifled by structuring the markets so 22 much. And I think we were right and wrong on this one 23 because what we've seen -- innovation in the exchange 24 world with IEX lately, you know, and the idea of a speed 25 bump to maybe attack the idea that speed alone is 0027 1 critical. So, you know, I think that's going to play 2 out. 3 You know, I have to say we never believed that 4 limit orders were going to increase because of Rule 611. 5 The -- and indeed, our clients are still about the same 6 in their usage of limit orders versus market orders as 7 they were, you know, over 10 years ago. We're still 8 about 80 percent market order. So, it never had the 9 impact that the Commission may have thought it would. 10 I think the place we were really wrong about 11 Rule 611 was in how our clients would feel about it, that 12 we -- you know, we didn't really understand that they 13 very much are worried about how their orders -- how 14 they're treated in the marketplace. And a trade-through 15 rule gives them a confidence that their orders are going 16 to be treated fairly. 17 And I think what we've -- as we've seen this 18 play out -- and this really goes to what Joe -- what you 19 were saying. You know, this is really a subjective 20 issue. You know, it's a philosophical issue. You can't 21 necessarily pin it down as to where -- what causes that 22 confidence to increase. But clearly it has. Our volume 23 is -- you know, our volume is up over the period. 24 So, clients are engaged, and we think that that 25 -- a large measure is they feel like the market is fairer 0028 1 for them and particularly fair in the sense that there's 2 always been a worry about how technical and how fast our 3 markets are. And we have players who, you know, measure 4 in microseconds their activity. But our clients still 5 would like to know that, if they post a limit order and 6 it's at the top of book, it can be protected. That's an 7 important element. 8 So, in a sense then, you know, to borrow a 9 Washington phrase, we were opposed to it before we were 10 for it. And we are now fully supportive of Rule 611 and 11 how it operates to protect retail customer orders. 12 And then, in looking at what the committee has 13 recommended or is in the process of deciding whether to 14 recommend, first, the pilot, to me, isn't really -- it's 15 a repeal. It's a repeal of the rule and then let's see 16 what happens. And to me that's different than other 17 pilots that we've engaged in. We're engaged in right now 18 with the tick size pilot. And certainly, as you do that, 19 you then -- you'd be comparing results versus different 20 time -- you know, and you could have different market 21 environments. And so, it wouldn't necessarily, to me, 22 give you the opportunity to really judge apples to 23 apples. 24 I know that there are friction points with 25 respect to the rule, whether it's the cost of going out 0029 1 and hitting the top of book if you want to put up a 2 larger trade; that there is concern about information 3 leakage and market impact of large trades. Those are 4 legitimate issues and really need to be thought about how 5 we solve them. 6 Now, I would say, Schwab, we're not in favor of 7 a broad exemption for block trades if we're going back to 8 the old definition of a block trade, which is 10,000 9 shares or $200,000. The -- you know, in many stocks our 10 clients trade those all day. Yeah, it's 300 shares or so 11 of Amazon or Google. It's not really what you might 12 consider a block trade. So -- so, we have to really work 13 on that definition. But I think for us the 14 answer really is, if you take steps that threaten 15 investor confidence, you really have -- you don't know 16 the consequences. In a time when we want to encourage 17 investors to be in the marketplace, to get the gains that 18 can occur there -- and particularly in this -- you know, 19 the whole retirement debate -- I would be very concerned 20 if I was undermining that confidence. So, thank you. 21 MS. SEIDEL: Thank you, Jeff. 22 Charles? 23 MR. JONES: Thank you. Thank you. And thanks 24 for the opportunity to participate today. 25 In my opening remarks, I really want to make 0030 1 two points, one about sort of the basic economics that 2 are at play here and one about some of the data that 3 might help us make a decision. I totally agree with Joe 4 that this is not economically resolvable before we go 5 into it. But I think there is some data out there that 6 could help us come to a conclusion about how we might 7 want to proceed. 8 Commissioner Stein and Joe both mentioned sort 9 of agency problems and incentives. That's clearly one of 10 the market failures that a trade-through rule is designed 11 to address. I think there is one other one that is often 12 forgotten in all of this, and that's the notion of 13 monopoly. So, it's easy to forget, but before we had Reg 14 NMS, the NYSE had about 80 percent market share in 15 trading NYSE-listed stocks. And the trade-through rule 16 can really encourage competition by lowering the barriers 17 to entry by competing venues. 18 Without a trade-through rule, market 19 participants can ignore new entrants, particularly if 20 those market participants have something to lose because 21 they're earning economic rents via the incumbent. 22 So, some people have complained about 23 fragmentation in equity trading, and I don't know how 24 many venues is too many venues, but I know that, at least 25 based on our history, one venue with most of the market 0031 1 share was too few venues, right? And so, doing something 2 to open up competition seems like something useful. 3 And so, that brings me to the data that I think 4 can be brought to bear. And I brought a slide. I know 5 this is a panel discussion here and it's not common to 6 bring these kinds of slides. But I just thought I would 7 show one graph for you to sort of make this point. And I 8 apologize to the commissioners who can't see this very -- 9 oh, you have it in paper. Excellent. 10 This is actually taken from work done by 11 Chester Spatt and co-authors. It basically shows what's 12 happened to effective bid-ask spreads over time in both 13 NASDAQ-listed and NYSE-listed stocks. And what you see 14 here is that NASDAQ-listed stocks, in terms of effective 15 bid-ask spreads -- and I know there are other measures 16 out there that you can use to measure liquidity. But 17 NASDAQ-listed stocks don't show a big effect from Reg 18 NMS. They're basically post-Reg NMS and post-crisis, 19 about where they were pre-crisis. 20 Where the big improvements in liquidity come 21 are in the NYSE-listed stocks. And what that tells me is 22 that the biggest thing that NMS did was to encourage 23 competition, to break the NYSE monopoly and to basically 24 increase competition between venues and to increase 25 competition between liquidity providers on specific 0032 1 venues. 2 So, I think whatever we end up doing with Rule 3 611, I think we would do well to keep in mind that that 4 competition is really important and that, whatever we do, 5 we should be keeping the barriers to entry really low so 6 that liquidity providers can effectively compete with 7 each other and venues and various business models for 8 trading can effectively compete with each other. 9 And so, that brings me to my final point, which 10 is that a lot of this discussion is fairly inward- 11 looking. We tend to think about the U.S. as being 12 special and about our markets as being unusual in that we 13 should only look to our own practices and our own data on 14 this. 15 But I would assert that actually equity markets 16 in other countries have a lot that they can teach us. 17 Some have made analogous changes, and their systems are 18 not so different that we shouldn't be looking at their 19 results. 20 For example, Canada introduced an order 21 protection rule in 2011. I haven't seen a study of that. 22 I wonder whether that's because it didn't have much of 23 an effect and no academic can get a study published that 24 doesn't find an effect. That's just a conjecture. But I 25 think studying that change would be instructive. 0033 1 Canada also introduced a trade-at rule in 2012. 2 The researchers who have looked at that have found that, 3 if anything, trade-at worsened the Canadian market 4 quality overall, a result which maybe we should have 5 taken into account before we put it into our tick size 6 pilot. Canada has also introduced volume thresholds, 7 which Joe mentioned earlier. And so, those effects could 8 be instructive as well. In contrast, Australia 9 operates via best execution requirements. They don't 10 have a formal trade-at or trade-through rule. They do 11 have, however, different requirements for retail versus 12 institutional orders. And so, perhaps those different 13 requirements would be useful in the context of best 14 execution here. 15 In sum, I think, you know, these other markets 16 are close enough to ours that they are worth close study. 17 And because, you know, it's very hard to get beyond some 18 of these philosophical differences, I think it would be 19 useful to look at some of that data in thinking about how 20 we should proceed. 21 So I hope that kind of framework helps people 22 to think about the issues and the data, and I look 23 forward to the ensuing discussion. 24 MS. SEIDEL: Thank you, Charles. 25 Adam? 0034 1 MR. NUNES: Thank you. And thank you for the 2 opportunity to speak today to the commissioners, staff, 3 and the committee members. 4 First, I think it's important to note that we 5 are addressing this problem from a position of strength. 6 The markets are very efficient and very effective, serve 7 investors and listed companies well. But as always, we 8 should always strive to improve them, you know, and make 9 sure that they are modernized and meet the future needs 10 of the market and market participants. 11 So, I wanted to start by thinking back to the 12 early 2000s when we were initially going through the 13 trade-through rule and the debate at that time and look 14 at a -- across a few different issues that were there. 15 So, competition was clearly won. You know, as 16 Charles mentioned, the New York Stock Exchange had about 17 80 percent market share in their listed stocks. That 18 market was extremely slow, and everyone complained about 19 how slow it was. It's important to note, however, that 20 the general reason for that was because of a trade- 21 through. So, at the time, the New York Stock Exchange 22 market had the ITS trade-through rule, and it allowed 23 them to effectively slow other market participants. 24 Many at the time viewed the, you know, solution 25 to that problem as just getting rid of the trade-through 0035 1 rule and not adding a new one that would open them to 2 competition. 3 The NASDAQ market, on the other hand, was 4 heavily competitive and had a lot of new participants, so 5 there was a great deal of innovation there that you 6 didn't see in the NYSE market. 7 One of the issues was more uniform access to 8 quotations. So, at the time, a lot of the market was -- 9 you know, in the NASDAQ side was through ECNs that didn't 10 have the same requirements for access to their quotes. 11 And that was an issue even outside of the idea of there 12 being a trade-through rule that was just a market failure 13 where, you know, certain participants would have better 14 or worse access to quotes than others. I think that on 15 those two fronts Reg NMS, you know, was a very big step 16 forward. We've obviously seen the change in the NYSE- 17 listed market, and I think it shows through on the 18 execution quality that Charles showed. And certainly 19 access to protected quotations is very uniform. 20 One of the other goals was more uniform 21 regulation of different types of market centers. That 22 seems to have happened largely through ECNs becoming 23 exchanges. But we have seen that start to come through. 24 Access fees was a big issue at the time. We 25 had outlier exchanges charging nine-tenths of a penny. 0036 1 And you know, as Joe mentioned, even the three-tenths of 2 a penny per share, along with a rebate, led to a great 3 deal of locked markets. 4 I would suggest that we still have those locked 5 markets today; we just hide them. So, you know, that is 6 part of the exchange complexity, is it can't happen. 7 Those orders are locking the market. They're just hidden 8 and displayed at a compliant price. 9 One of the other issues was non-uniform tick 10 sizes. You know, that's been addressed separately 11 through the tick size pilot. I think that, as we move 12 forward and move to intelligent tick sizes, that isn't 13 only in the direction of making them bigger for stocks 14 that, you know, reasonably deserve a nickel tick; looking 15 at the stocks that are basically always a penny and 16 suggesting that perhaps some of those stocks should not 17 be. And there's a pretty good framework that they use in 18 Europe to find the appropriate stocks and put them in 19 while not just moving wholesale to that end. 20 And then, the last one that -- well, sorry -- 21 the second to last one, best execution, I think that's 22 been covered. The 605, 606 at the time, 11Ac1-5 and 1-6 23 reports, I think were approved in 2000 and came out in 24 2001. So, we're here in 2017, and I think it's good. 25 And frankly, any action on 610 and 611, you know, 0037 1 lock/cross and trade-through, that, to me, is a 2 prerequisite to get that done before that so that we have 3 strengthened best ex before we move on. 4 The last one Joe touched on was the market data 5 revenue sharing formulas. We had people splitting all 6 their trades up into hundred-share lots to maximize their 7 revenue share. And now, we look at today with, you know, 8 quote-sharing where, you know, you see a massive 9 disparity between exchanges' quote share and their market 10 share. So, I do think that that's something that should 11 be addressed. 12 So, I thought it was important to go back and 13 cover some of those issues because, if we were to repeal 14 lock/cross and trade-through, we would expose some of 15 those issues that it did address. I think some of them 16 are covered and we're not going to take a step back on, 17 but access fees were an issue prior. They'll continue to 18 be an issue after. 19 And I think it's important to also note that 20 the discussion now on access fees is about access to 21 protected quotations. If that concept goes away, I think 22 the scope of that discussion is going to be much broader 23 and, you know, basically be a discussion about access to 24 market centers. 25 Similarly, the discussion around impartial 0038 1 access to market centers and kind of what is subject to 2 that and what isn't is going to be a broadened discussion 3 in my view. So, I guess from my perspective, as I 4 look toward, you know, what's going to make the market 5 better in the next 10 years, 20 years because these rules 6 are going to stay around for a long time, I think that 7 the best approach is to address some of those underlying 8 issues now, so address the issues associated with 9 impartial access; strengthen best execution requirements; 10 fair competition among market centers. And if we do 11 that, I believe we will see greater competition as well 12 as greater innovation, you know, going forward. Thank 13 you. 14 MS. SEIDEL: Thank you, Adam. Paul. 15 MR. RUSSO: Sure. Thank you for the 16 opportunity to share my views today. 17 I, like many of the people around here was 18 involved in the original debate around Reg NMS. I 19 remember many of the conversations with the Commission 20 going back in time. And I'd argue there's been many, 21 many conversations post this amongst industry members. I 22 see Kevin nodding and Joe -- I mean, many of us have been 23 in these debates. 24 The central problem when we get into these 25 debates is whether it's camps form between different 0039 1 investor types that are being represented or ultimately 2 we talk about a particular issue but we all feel there's 3 more -- the issues are interrelated. You just can't 4 untangle one from the other. So, trying to just one 5 thing without doing another thing, you can never get to 6 any commonality without looking at it a little more 7 holistically. 8 So, I think with that as a framework, you know, 9 thinking through and being involved in some of the 10 conversations that Joe and Kevin have led, you know, it 11 just resonates that this is what constantly comes up in 12 these dialogues. And I imagine people at the Commission 13 have experienced that themselves. 14 I think it's also fair to say there's been an 15 enormous amount of change since 2005. You know, we were 16 in a truly manual world. People have talked about the 17 differences between ECNs and NASDAQ versus New York at 18 the time. We're in a wholly different world now. We 19 don't have the remnants of a lot of these manual things. 20 Actually, I'd argue it would be inconceivable to roll 21 back to the world we were in before. So, the problem we 22 were solving back then strikes me can't be the same 23 problem today because the world has moved on. 24 And I also think of it in our personal lives. 25 Without, you know, these, I don't know what we'd do, but 0040 1 20 years ago we didn't have all these, so somehow it 2 worked. But the world has moved on. 3 So, when I look at the issues, I think it's 4 fair to say the market is more efficient than it was 5 then. I think it's fair to say all users, retail users, 6 institutional users, issuers, everybody has been 7 benefitted. 8 However, I do think the result of what happened 9 is we got to a more fragmented world. I think that's 10 subjective. And I think you can say speed has been a 11 defining characteristic of most of the things that center 12 around changes in the market structure over the last 13 number of years. And arguably, that's the way people are 14 competing. 15 Our concern as an organization is centered in 16 some ways a little bit outside of the direct conversation 17 here. I'd phrase it as safety and soundness. The number 18 one thing that we worry about as a result of the market 19 structure we've entered into, which was not designed 20 necessarily as one holistic system -- it just is has 21 evolved toward this -- is that safety and soundness 22 wasn't maybe as strong of an objective that it could be 23 today. 24 And the question becomes how does changing some 25 of these rules affect the safety and soundness of that 0041 1 overall structure. And I think what -- you know, we 2 would phrase the term "increasing operational risk," I 3 think that's just a byproduct of we've come from. 4 So, things which reduce that, I think, are very 5 important because ultimately investor confidence is 6 really important. And investor confidence is important, 7 I would argue, to every participant at this table because 8 it fundamentally is what we need to look to defend. 9 So, we would be focused on issues which would 10 reduce some of this complex state, reduce some of this 11 fragmentation. So, those type of things would certainly 12 be welcomed. 13 Measures, which also at the same time reduce 14 perceived or actual, you could argue -- but I'd say 15 perceived -- conflict of interests that exist in the 16 marketplace. So, when -- when I think about the 17 production rule and access fees in combination, I think 18 they've led to potential conflict of interest. So, 19 investing clients that I may represent normally, large 20 institutions, one of their concerns is that conflict of 21 interest. It's just inherent. The access fees is one of 22 the things that drived it. Joe talked about it in his 23 comments. I think addressing that's important. 24 Order protection itself has probably enabled 25 more fragmentation. That plus access fees, helps to 0042 1 create a business model where it's just easy to keep 2 listing new things without necessarily the benefits 3 bestowed to the overall market as utility but yet, I 4 would argue, a operational risk tax on the system, which 5 is not free. So, that tax not being free, again, is just 6 an important, I think, point we need to put into the 7 dialogue. 8 However, you know, by no means, I think, do you 9 want to reduce innovation or creativity. I think, at its 10 essence, you know, this is something that's very 11 important. But I know when the SEC originally debated 12 this, that balance between competition and, you know, the 13 centralization of orders and that tradeoff was inherent 14 in the original dialogues that we were all entering into 15 at the time. 16 So, I guess, while we don't have one position 17 because it's very hard to coalesce all these different 18 constituents into one, I would say an objective should be 19 a greater focus on managing and reducing this operational 20 risk; reducing the conflict of interest. I think 611 and 21 the access fees are integral to that conversation, and 22 doing work on both of those would be very helpful. I 23 think that will promote more innovation. 24 I think it's also fair to say, coming from a 25 broker-dealer perspective, the trade-through protection 0043 1 rule and best execution are not the same thing. They're 2 uniquely different. And actually, when I think about 3 what truly drives us in the way we route and do things, 4 we never talk about the protection. We always talk about 5 best execution. We don't think you can avoid depth of 6 book if you choose to. We think you have to consider all 7 of those things even though it's not explicitly in the 8 regulation. 9 So, for us best execution is more of a driver 10 than trade-through protection anyway. So, any broker- 11 dealer representing clients, I think, should be subject 12 to it. And if anybody is acting as routing for others, I 13 think they should be subject to all the same constraints 14 around best execution. So, I'm not sure trade-through 15 and best execution are the same thing, but they 16 frequently get talked about as if they are. 17 And the, lastly, as was mentioned as well, 18 there is a whole other series of things in that ecosystem 19 which are important to the safety and soundness. 20 Arguably, the way exchanges work with clearing is quite 21 important. Notably, it's a different -- there isn't the 22 same level of risk in -- a stock exchange has to, let's 23 say, a futures exchange, which has, you know, in the 24 waterfall level of risk right away. That aids to doing 25 things around safety and soundness. 0044 1 And lastly, market data. You know, in this 2 very fast world that we live in, market data, to me, is 3 like, you know, the fuel of this system. Bad data, bad 4 outcomes. So, having really good data -- all these 5 things kind of come together to the extent you want this 6 ecosystem to work together. Thank you. 7 MS. SEIDEL: Thank you, Paul. 8 Tom? 9 MR. WITTMAN: Thank you. 10 Commissioners, committee members, and members 11 of the staff, thanks for having me back to day, as I was 12 here last year. So, I'd like to touch on a few points, 13 and I'll try not to go through and read my statement. 14 For clarity, we've submitted a statement last night, 15 discussed in detail in it, and I'll reflect on a couple 16 points. 17 I'd say one thing that's probably unique about 18 NASDAQ that could be different than what we've heard here 19 so far today, we are very focused on the institutions 20 that we represent for listed companies, and we are 21 focused on displayed liquidity. So, that's probably a 22 tenant that we, you know, derive some of my statements 23 here as we -- as I go through a few points. 24 We do really believe in data-driven analysis on 25 the pilots that are put in place and how we measure the 0045 1 effectiveness of this. And as we sit around and talk 2 about, you know, what should we do different, we've had a 3 little bit of a difficult time saying what is -- what is 4 actually broken. 5 We do talk about interdependencies. I know 6 it's -- you know, I don't want to throw the word around 7 too much. But interdependencies both from a technology 8 infrastructure and also with the rules, as Paul and Adam 9 have talked about. 10 If you look at one of the basis, we do believe 11 that 605 and 606 do need to be modernized. And it's 12 probably a key tenet in what should be done no matter 13 what we do with 610 and 611 going forward. 14 On the interconnectivity of these markets and 15 these rules, when it comes to order protection, we do 16 believe in -- one of my previous experiences, as Charles 17 noted, being part of the Philadelphia Stock Exchange, we 18 tried to compete. We traded Tape A securities, and those 19 Tape A securities were traded through all day long by the 20 NYSE. So, you know, we welcome the order protection rule 21 and the ability to have displayed markets and make sure 22 those are protected. 23 Now, today what we look at -- a lot of markets 24 are price-timed, and those price-timed markets bids and 25 offers are protected. You can see some evolution. And 0046 1 what we're trying to do are things like ELO or retail 2 priority. There's retail priority in the options 3 markets. And I think that still is an important concept 4 to have in these markets going forward. NASDAQ believes 5 in the order protection rule although we'll talk a little 6 bit about what complicates that in the form of access 7 fees specifically. 8 You know, one size does not fit all. We've 9 said it a few times. But if you take a look at, you 10 know, the companies that trade and the regime around 11 access fees, they're distortionary at times. And I think 12 that, you know, we could probably create a program where 13 access fees for certain securities aren't all the same. 14 So, another way to look at it is looking at the 15 rebates, not the fee to remove liquidity. And those 16 rebates could be in place in a way to support the listed 17 companies on the exchanges. There are -- there are 18 products that don't need a 30 mil rebate. Effectively, 19 they trade in between, you know, a penny-wide market. 20 So, I would say have intelligent tick size and 21 intelligent rebates. And we don't have to have one 22 rebate and one access fee for all securities. 23 I think one thing that we've learned through 24 the tick pilot is that everyone's been able to adapt to 25 having three classifications or different groups of 0047 1 stocks to trade differently. So, maybe we can utilize 2 that concept going forward to test some of the things 3 that the subcommittee has come up with if we can refine 4 some of that output. 5 Second, the pilot should study the impact of 6 the access fees and liquidity rebates going forward. The 7 study might be particularly useful in assessing the 8 impacts of fees and rebates in locked markets and 9 behavior of locked markets. Adam talked a little bit 10 about locked markets. A locked market and a very liquid 11 low-price security with a 30 rebate is not truly a locked 12 market or a trade-at market. 13 Pilots should harmonize fees in the sense it's 14 permitted in both on-exchange and off-exchange to 15 maintain a healthy balance of displayed and non-displayed 16 liquidity trading. Limiting fees and rebates in one 17 segment of the market could result in a higher percent of 18 investors' orders executing on venues that are not 19 required, providing fair and equal access. 20 The current one-size-fits-all approach is 21 suboptimal. The interplay between access fees, liquidity 22 rebates, minimum tick increments, locked and crossed 23 market rules are all different. Stocks trade 24 differently. In particular, it's decremental for low- 25 price/low-liquidity stocks. NASDAQ believes, to be well- 0048 1 designed, the pilot must gauge the impact on order 2 protection, the access fee, and liquidity rebates both on 3 and off-exchange and groups of stocks with different 4 trading characteristics as has been designed in the tick 5 pilot. 6 And with that, I'll close and thanks for 7 allowing us to be here. 8 MS. SEIDEL: Thank you, Tom. I will now open 9 it up to the committee members for questions and 10 discussion. 11 Kevin? 12 MR. CRONIN: So, thanks everybody for your 13 comments, certainly appreciate it and your time today. 14 Jeff, I wanted to ask you a question just with 15 respect to the protection for retail investors. Is it 16 your sense that, if you were to do more work in defining 17 best execution requirements and -- I think it was as it 18 extended beyond broker-dealer to any exchanges that route 19 orders -- do you think that that helps bridge the gap and 20 some of the concerns that retail investors would have 21 around removing the protection? 22 MR. BROWN: You know, I've read in your summary 23 an enhanced best execution guidance. And it kind of -- 24 it confuses me because, to me, best execution is an 25 obligation that the broker who has the client order or 0049 1 passes it to an executing broker to act, they have the 2 duty to best ex that order. 3 And I don't understand how -- so, for example, 4 if there is a trade-through, does the party who executes 5 the trade on behalf -- we'll say an institutional client 6 that trades through the top of book -- owe a duty to 7 those orders that are at the top of book? No. The duty 8 goes to the client that he is executing his order for. 9 And certainly, if you could make the argument that the 10 hundred shares that might be posted would be -- would so 11 influence the value of the trade that was being, you 12 know, put up through the best bid and offer, then you 13 might have an argument that he did fail to get best 14 execution. 15 But you would -- most likely, a large block 16 would argue, "No, I don't want the market impact; I don't 17 want the information leakage. And therefore, I'm doing 18 my job to give my client best ex. I don't owe a duty to 19 the top of book. Those are someone else's orders." 20 And I don't -- so, I don't quite understand 21 where the best ex argument comes into this for -- it 22 could be that you might consider, well, if I'm, like, at 23 Schwab, I would have to watch where orders are being 24 executed and maybe post on exchanges that have more 25 executions in those securities. That's possible, and you 0050 1 would certainly want to do that anyway. We would -- you 2 know, I don't know if that requires an enhancement to a 3 best execution because I would think you would be doing 4 that anyway. If I knew I could get a better fill at 5 another place, I would want to be using that in my 6 calculation of order-routing anyway. 7 So, to answer your question, Kevin, I'm just 8 not sure what the guidance would be that would be helpful 9 to a retail investor. 10 MR. CRONIN: Well, I think it starts with not 11 defining it just around price, right, because I think a 12 lot of us around the table would define best execution as 13 a number of other variables other than price. Price is 14 an important consideration, but as you described, 15 certainly from an institutional perspective, protecting 16 the information, the amount of liquidity that we're able 17 to find at particular price points, factor very 18 prominently in determining the best outcome for our 19 clients in measuring that. 20 MR. BROWN: And I don't disagree with that at 21 all. But I also think, for our clients, when we look at 22 it, price is probably going to be the most important 23 because it's a small -- you know, it's a retail-sized 24 order, and it would be influenced by price probably more 25 than other factors. 0051 1 MR. CRONIN: Right. 2 MS. SEIDEL: Jamil? 3 MR. NAZARALI: Thanks, Heather. 4 We've spent a lot of time talking to our 5 clients about Reg NMS, probably more time about Reg NMS 6 than any other topic. And one thing that we've heard 7 loud and clear from our broker-dealer clients is, getting 8 rid of 611 would be bad for retail investors. Not only 9 would it remove a fundamental protection that they 10 receive the best price for their orders, but it would 11 impact investor confidence. 12 And as we go around listening to, you know, the 13 pros and cons of doing this, one thing that really 14 strikes me is that no one has really articulated a 15 compelling reason for why we should do that. And it 16 strikes me that, before undertaking this very fundamental 17 change to our equity markets, which work very, very well, 18 we really should have a compelling reason for why we 19 should do that. 20 MR. BROWNE: Good morning. Just to echo, I 21 think, a comment from Charles Jones, I think, if we 22 studied the Canadian system, I think we'll find some 23 empirical data that it's a failed market in how they 24 treat their orders. A lot of orders actually come to the 25 United States for execution and goes back into Canada. 0052 1 So, when you're approaching some of the elements that are 2 found in the Canadian system, I think there's elements 3 there that we should explore. 4 And in talking to, you know, our clients, the 5 retail experience, it's phenomenal. And I'm not sure 6 what we're really trying to address here. Is it the cost 7 to the system, or is to enhance the experience to the 8 retail investor. Everyone that I talk to on the retail 9 side says their experience is fantastic in the current -- 10 in the current day. 11 And maybe looking at some of the complexities 12 around locking markets and clearing, just reduce the 13 incentives around locked markets. Don't pay the person 14 that blocked the market. Don't charge a fee to the 15 person clearing the market. And you got to be very clear 16 about some of the arbitrage games that goes on in the 17 background even today with the complexity of the 18 marketplace. 19 And I think the real problem that should be 20 addressed is the number of exchanges that are not that 21 meaningful and are kept -- that are kept alive without a 22 meaningful reason why the still exist today. 23 So, perhaps look at the number of venues that 24 are here that have less than one percent or even less 25 than five percent of the ADV that occurs in the 0053 1 marketplace, you know. Just wipe them away from 2 existence. 3 (Laughter.) 4 MR. BROWNE: You know, increase the cost 5 burdens for them to stay alive. And I think that's 6 really what I'm hearing from our clients around the 7 complexity of the marketplace, is the number of venues 8 that cause stress to the system. 9 MR. KETCHUM: Actually I had a question for 10 Adam that sort of follows on the discussions and Jamil's 11 points, knowing that at this point you're sitting with 12 order-by-order best execution, so I'm not quite sure how 13 we'd do much more for you, at least. 14 But Adam, you talked about strengthening best 15 execution and strengthening impartial access. How much 16 of that relates to either type of institutional 17 executions that Kevin was talking about or to access fee 18 issues from the standpoint of complexity of best 19 execution? Or are you thinking of different things 20 beyond those? 21 MR. NUNES: So, I guess I'm thinking more along 22 the lines of some of the best execution items. Like, I 23 just kind of mentioned the order-by-order, which I think 24 did that, right? So FINRA's guidance on that certainly 25 strengthened the burden on firms executing orders. The 0054 1 disclosure side, I think, could be improved dramatically. 2 3 And I guess it's worth addressing Jamil's 4 point. From my perspective -- I have a nine-year-old 5 daughter. And in 15 years when she's a junior market 6 structure analyst and asks me about the trade-through 7 rule, first I'll be sad that she didn't listen to me all 8 these years. But after that, it just kind of strikes me 9 as, if we spend the next 15 or 20 years operating in the 10 rigid NMS framework -- and we talk about innovation. The 11 one real innovative thing that people point to required a 12 substantial change or interpretation of the term 13 "immediate". So, that framework has already had to 14 change to allow innovation that isn't all that 15 innovative. 16 So, from my perspective, I think if we look 17 forward -- we're all here because we're firms that have 18 navigated the current environment. So, I kind of feel 19 like there's a lot of complacency in the room because we 20 live with it; we've been living with it; we know how to 21 do it. 22 If we want to look forward to what's going to 23 serve investors in 10 years or 20 years, I think that 24 having everything operating under this framework is the 25 wrong way to go. We're going to continue to see more of 0055 1 the same. But more of the same isn't terrible. 2 And then, I think the other thing that is kind 3 of worth -- and Rick, you touched on this -- is there is 4 a -- you know, kind of a trade-off when you look at 5 things that are potentially the best for retail versus 6 the things that are best for institutions. And you know, 7 for institutions, the ability to get a trade done a penny 8 through the best price or two pennies through the best 9 price may be optimal and may be best ex for the retail 10 order that was sitting on the book that got traded 11 through or the principal order that was on the book that 12 got traded through. You know, that's suboptimal. 13 So, I think we need to focus on an environment 14 where competitive forces are going to work. You know, if 15 that retail order is accessible, somebody's going to want 16 to trade with it. It's at a price that, you know, is 17 kind of no longer necessarily -- it's probably at an 18 attractive price at that point. 19 So, I think market forces can take care of a 20 lot of those issues, but I think kind of addressing the 21 fact that those are going to be trade-offs that we have 22 to deal with. So, there's no just right answer. We just 23 have to think about the trade-offs and try to make the 24 best answer. 25 MR. MECANE: I'll probably just maybe -- this 0056 1 is probably at Jeff, but I'll just share maybe two of the 2 things that I think we struggled with because they're not 3 easily answerable, but I'm curious if you have any 4 perspective on them. 5 One is that everything you said makes sense, 6 and clearly overall market volumes have gone up over the 7 last decade. But one data point that we struggled with 8 is why hasn't displayed liquidity increased as a 9 percentage of the market in a Reg NMS world. Like, from 10 a logical standpoint, you would think you put this rule 11 in place that said you protect a displayed quote. But 12 all the data that we've seen doesn't clearly show that 13 there's been an increase in limit orders as you outlined 14 as a result of that. And that's, to me, an interesting 15 question but one that we couldn't really resolve. 16 And so, that's at least one thing that led us, 17 at least, to saying maybe this rule isn't really that 18 effective. Clearly, there's an optical safeguard from 19 having this rule in place that people rely on. But 20 that's at least one thing we struggled with. 21 The other is that, on the best ex point -- and 22 clearly there's degrees of this. But one thought that we 23 had was that, to the extent you have an order protection 24 rule and you're displaying on one venue -- an extreme 25 example just to make the point -- if all executions are 0057 1 happening on another venue while you displayed on Venue 2 A, clearly that's not best execution, meaning you would 3 want to move your orders to the venue where you would get 4 executed even if it would be at the same price that your 5 limit order is looking to trade at. 6 No 611 could exacerbate that to a certain 7 extent because, in that case, it's not just executions 8 happening on another venue; it could be executions 9 happening at a better 10 -- or a worse price on a different venue. Again, not a 11 perfect argument, but we at least thought that, in the 12 framework of changing best execution, taking out the 13 trade-through rule, to some extent makes what really 14 exists today perhaps a little more visual or heightened 15 but doesn't necessarily change the same best execution 16 framework that people have to operate under today. So, 17 those are just two things we struggled with. I'm curious 18 if you had any reaction. 19 MR. BROWN: Sure. On limit orders, you know, 20 as I said in opening remarks, we didn't think limit 21 orders were going to change much anyway, you know, 22 because limit orders are -- there's an optionality to it 23 that you are putting yourself out there. And you just 24 have to understand the trade people who trade don't like 25 to give that away. 0058 1 And secondly, in an era where speed just kept 2 increasing, that putting -- posting an order, you're at 3 the vagaries of whether you're going to get hit or not. 4 And so, I think the -- our clients view it as, okay, 5 speed's so -- the trades are so instantaneous, I'll just 6 go grab them. And it just seems to be the way a retail 7 investor -- at least the investor at Schwab -- are 8 looking at things. 9 On the best ex piece about -- see, my concern 10 is, yes, if you saw that you were -- particularly in a 11 no-611 world where you could be traded through; another 12 market was garnering the majority of volume, you'd be 13 inclined to -- you know, you should move your order where 14 you believe it would be executed. 15 However, you might also be chasing a queue, and 16 you could be in the environment where I'm going to go to 17 this other market and suddenly they start trading where I 18 was. And how are you going to know, and how -- so you 19 really have a very difficult decision to make if you are 20 constantly saying -- trying to measure where am I going 21 to increase the likelihood because this is all -- you 22 would be having to just be prescient and say, "Okay. I 23 know the next trade's going to occur where I haven't 24 been, so I'm going to move there." 25 If that becomes a standard by which you would 0059 1 measure best ex, it's a very difficult standard to be 2 held to. How am I going to know exactly where a trade is 3 going to occur in the future? So, I would be reluctant 4 to say that's a good idea. 5 But I understand the problem of trying to 6 maximize limit order execution. And I do believe -- and 7 we've heard a lot of talk about access fees. And to me, 8 that is still a big problem, and we ought to deal with 9 access fees and rebates, that it does -- someone used the 10 word "distortionary". I believe that's correct. 11 And so, it's -- so, if that changes, you may 12 see an inclination to go into -- you know, limit orders 13 might become more popular because they aren't going to be 14 subject to having to pay a fee to execute against them. 15 MS. SEIDEL: Joe? 16 MR. RATTERMAN: At the risk of saying things 17 that have already been said, I'd like to just relay some 18 of the thoughts that came out of the meeting that we held 19 yesterday. Jamil and I sponsor a retail advisory group 20 of which Jeff is a part of, and he was on that call as 21 well. And Reggie said some of the same things, but I 22 just want to make sure their voices are heard. 23 Certainly, the rest of the retail group that 24 was on that call in addition to Jeff thought that the 25 markets are really, really good today for their 0060 1 investors. There is not a -- they don't see the problem 2 that we're trying to fix with a repeal of the trade- 3 through. So, that was loud and clear. 4 They felt that taking away the rule would 5 actually degrade retail investor confidence. That was a 6 direct quote. They weren't really excited about the idea 7 of exemptions. Although I agree with Jeff that, if we're 8 going to have exemptions, we should reexamine what a 9 block is so that, you know, it's not every day that 10 you're having hundreds and thousands of block exemptions 11 if they really are true blocks in today's environment. 12 And also repeating some of the things that have 13 been said today, they felt that, if we're going to talk 14 about the trade-through, that it has to be in the -- you 15 know, holistically, a balanced view of all things market 16 structure or at least all things Reg NMS that you can't 17 talk about in isolation. 18 And then, finally, a pretty important thought 19 for them was that, if something were to come out of 20 subcommittee and then into the broader committee, that 21 even then they would like to see the SEC maybe take that 22 and formulate maybe a redo of the 2010 concept release, 23 put it out for broader comment to not have something that 24 comes out of this group handled only within this group. 25 And then, finally -- and so I agree with all 0061 1 those points. I'm relaying those on behalf of that 2 group, and I also agree with all those points. 3 Then, finally, maybe a point or two from myself 4 is that, there is an argument that the market's more 5 complex. And certainly, when you went from, you know, 6 2004 to 2008, in that time frame, through the compliance 7 efforts, it was complex putting these rules. But they're 8 in the system today. They're in the plumbing. And from 9 an exchange's perspective, I really don't feel like it's 10 complex to keep the compliance and keep the plumbing in 11 place. Once it's there, things seem to be working. It's 12 not certainly on the top list of things that, you know, 13 challenge us as an exchange to keep our systems running 14 smoothly and efficiently. 15 MS. SEIDEL: Adam? 16 MR. NUNES: Thank you. Just a -- I guess a 17 minor point. You know, there's a lot of discussion about 18 access fees and the access fee pilot. One thing to keep 19 in mind is that, if we are, like, looking to do something 20 on the lock/cross rule; we do the pilot before that, 21 we're basically going to negate a lot of the results 22 because we're not going to learn anything about access 23 fee's effect on locked and crossed markets. 24 So, if we run the pilot when they're against 25 the rules, no one is going to do it. So, it's possible 0062 1 that the result of the access fee pilot is that rebates 2 are great and they really help market quality. And if we 3 then next move forward and eliminate the lock/cross rule, 4 we'll likely learn rebates lead to a lot of locked and 5 crossed markets. 6 So, I think that that's something just -- Joe 7 alluded to it in the setup -- that is important to think 8 about if we are looking to move forward on that. 9 MS. KIMMEL: Just a question for Joe and Jamil. 10 When you talked to the Retail Advisory Group, did they 11 have thoughts particularly on the lock/cross and whether 12 or not they raised the same issues? I think OPR is -- 13 you're taking a protection away, and I get that. Just 14 curious if that extended to lock/cross market. 15 MR. RATTERMAN: I'll probably let Jeff answer 16 for that. We didn't really talk about that specifically 17 in the call yesterday, so I don't have a recent kind of 18 view on their thoughts in general in that. The only 19 place that this kind of extended was to the discussion 20 about trade-at. And so, removing order protection, if 21 that led to a trade-at regime, then that was -- that 22 certainly wasn't something they appreciated. 23 MR. BROWN: I guess I'd just add that there are 24 concerns about access fees and locked and crossed 25 markets. And as we heard, you know, it's because a 0063 1 locked market's really not locked. There's a spread of 2 the rebate fee. 3 And in my view -- and I guess -- this goes back 4 to when I -- you know, as a trader. If I'm bidding the 5 same price as a seller, we ought to trade. And the idea 6 that we now want a locked market's because neither of us 7 wants to pay a fee and we both want a rebate, that's a 8 distorted market. And when two parties are at the same 9 price, they ought to execute a trade. 10 And so, that's just a -- you know, if you fix 11 the access fee issue, you'll probably fixed locked and 12 crossed markets. 13 MS. SEIDEL: Met, did you want to -- 14 MR. KINAK: Yeah. So, there's a lot of issues 15 going on there. And I think Kevin said this best. I 16 think when we sit at the table and we start to discuss 17 610 and access fees, there's a lot of people that have an 18 interest one way or another, and they're impacted one way 19 or another. And when you look at 611, it bifurcates even 20 further. So, you have the retail community, and you hear 21 comments on how retail is affected. And removing the 22 order protection rule would be, you know, a detriment to 23 them. 24 The institutional community probably has a 25 different view, so I want to opine on that. First of 0064 1 all, we are retail. I want to make sure I address that 2 every single time we're here. We are pooled retail 3 unlike mom and pop. And by the way, I love to hear that 4 mom and pop are spending $200,000 per trade. That's a 5 great robust for our economy, so that's fantastic. 6 But when you look at kind of what we are trying 7 to do from an institutional perspective, everything is 8 done -- and I think Rick kind of pointed to this -- on an 9 order-by-order basis. So, everything has now been shrunk 10 down to the child order, as we refer to it. 11 That's great when you have a couple of hundred 12 shares to trade. It's not so great for us as we're 13 trying to trade hundreds of thousands or millions of 14 shares at times. The market really doesn't give us much 15 choice. We're basically handcuffed. 16 So, as much as Commissioner Stein said that it 17 set a floor, I think it set a safety net. And that 18 safety net has also been an inhibitor to innovation and 19 kind of creativity. So, unfortunately, exchanges have 20 kind of just fallen back into this price-time priority 21 sequencing, and we have to go 60 percent of the time -- 22 that's the market share that they have collectively -- 23 and function in those parameters. 24 Brokers, unfortunately, have also been 25 inhibited to say, "Well, on an order-by-order basis, 0065 1 which is what I'm measured according to FINRA, I have to 2 make sure that I provide you the best price every single 3 time I go to the market." I'm not worried about looking 4 at the parent order and seeing that you might have 5 100,000 shares on top of what you have. I'm not really 6 concerned about what that looks like from depth of book. 7 I'm really just trying to make sure I don't violate 8 NBBO. 9 That's not necessarily best execution from an 10 institutional perspective. I get how retail is 11 benefitting from that. But if I touch on retail a little 12 bit, it's really interesting to me that you guys are 13 centrally focused on 611. And I'm sure, when you have 14 your retail conferences, that 611 is something that is 15 really kind of pumped up and talked to them about how it 16 raises confidence. 17 It's funny because 612 doesn't get mentioned. 18 And if you read 612, it actually says that orders 19 shouldn't be jumped -- displayed orders should not be 20 jumped in front of for de minimis price improvements, 21 which is basically the concept of what retail does in the 22 wholesaling market. But that's never addressed or kind 23 of highlighted. 24 It's also not addressed to them that the 4.95 25 commission or whatever the commission rate is now is 0066 1 really not optimal and should be more of a transparent 2 disclosed product to say, look, really it's $10, and I'm 3 benefitting from other benefits that I gain by posting to 4 the place with the largest rebate, not necessarily the 5 venue that gives me the certainty of fill but the venue 6 that gives me the largest kickback. 7 So, I think when you address those other issues 8 around best execution when it comes to retail, I think we 9 can have a much cleaner market. 10 So, Jeff, I appreciate your comments around 11 it's hard to jump from venue to venue. You can pretty 12 much optimize that now the way we have it by going and 13 paying to get that execution every single time for a 14 limit order if you wanted to. 15 But from what I understand, retail firms don't 16 generally like to do that because it costs a little more. 17 But let's be open and transparent with the retail 18 community and tell them that. "Hey, it costs me money to 19 execute your orders, so your commission rate is actually 20 going to be $9.00 and not 4.95." 21 And by the way, I love the pricing wars you 22 guys go through. It's kind of funny to me that, when we 23 sit down with those firms, they say, pricing wars don't 24 really actually add to any volume driving -- you know, 25 kind of driving volume back and forth between the 0067 1 different brokers. But you guys still engage in it 2 constantly, which is kind of -- a little bit comical. 3 But anyway, the point being, as I circle back, 4 from an institutional community, we are handcuffed by 5 rules that are basically, you know allowing a 6 monopolistic nature for the exchanges. Like, for 7 example, I'm a fan of Tom's. But if I felt I wasn't 8 getting a good execution at some of the exchanges that he 9 oversees, I can't actually turn them off. I have no 10 choice. I have no selectivity in where I get to go 11 because I have to take out the best bidder offer. So, it 12 kind of handcuffs me from that standpoint. 13 And I'd love to push firms like Goldman to say, 14 "Hey, look, we've come up with some great innovations on 15 how we execute orders at the parent level, at a level 16 that makes more sense for an institution and not just be 17 worried about each order that we place in the market." 18 MR. WITTMAN: Can you pick on Adam a little 19 bit? 20 (Laughter.) 21 MR. KINAK: I -- if you want me to, I can go 22 down the list, but Charles I don't have anything for. 23 MS. SEIDEL: So -- Gary? 24 MR. STONE: So, there's a lot of different 25 issues here, right, that are being bandied about. And I 0068 1 think what's happening is -- and I think this happened in 2 our subcommittee that we realized that we probably do 3 need a holistic review to really work these out. And I'd 4 like to be in support of that -- is one thing that comes 5 out of this meeting again. This si the second time we're 6 talking about 611. 7 Section 11(a) says that the marketplace is 8 supposed to work for all investors. That's one of the 9 tenets that the SEC is supposed to do, is it looks over 10 market structure and was reinforced in '75. I think what 11 you're hearing today is the long-term investors, which 12 NMS was put in for, the institutions are having issues 13 with lack of innovation to be able to take care of their 14 unique trading needs. I would argue that the tick pilot 15 was put in place for a similar reason, because it's not 16 working for the small and mid-cap stocks either. And so, 17 we need to work through these issues and find out what is 18 the optimal structure. 19 We asked the question, "What's broken?" I'd 20 like to ask the question as to what are we actually 21 protecting. And the reason why I ask that question is 22 because, when we heard from some of the other retail 23 brokers, Jeff, they said that, when they put their limit 24 orders in; it's in the depth, they get traded around 25 regularly. 0069 1 So, it's an imperfect rule, and it creates this 2 aura of confidence, but when you get down to it, the 3 person who gets traded through in the depth, because it's 4 not protected, it's not really working for them either. 5 And so, the question really is -- is that where does that 6 protection or where does the strength come from. 7 I think that the work that we did on the 8 proposed rule for the order-handling disclosure that 9 Commissioner Stein alluded to, we can't do anything with 10 these rules until after that's put in place. I would 11 argue that we need to actually solidify what best 12 execution is and what the responsibilities of that are 13 more formally than we ever have. And then we can 14 actually look at what the responsibilities are and 15 whether or not the order protection rule is actually a 16 porous net or whether or not it's something which is 17 really backstopping anything or just creating a -- an 18 illusion of confidence that those two other things would 19 do. 20 I just want to reiterate one thing that Adam 21 said, and it's kind of lost. The biggest innovation in 22 the marketplace that's happened in the last 12 years only 23 occurred because we had to reinterpret what "immediate" 24 meant. There has really been nothing about the customer 25 experience, about changing what the customer experience 0070 1 will be that's happened since in the past 12 years. And 2 I think that is an indication of the stifling nature of 3 what 611 actually has done to the marketplace. And I 4 think, if we look at where we could be, we maybe end up 5 at a better place that has a lot more confidence in it 6 than where we are right now. 7 MR. CRONIN: Welcome to my world. 8 So, you are now saying what we had hoped to 9 allow people to see, which is there are some very good 10 and considered opinions on the topic, but they are very, 11 very different in their orientation and certainly where 12 they end up in this conversation. 13 So, our process is designed to really 14 understand all the issues from all the different 15 perspectives. We have tried to be more inclusive this 16 time. We've invited more folks from the buy side. We've 17 invited more brokers. We have participation from 18 individuals from the listing side of the equation and 19 certainly have extended invitations to all the exchanges 20 because we want to get this right. And we're not going 21 to put forth anything that we think is incongruent with 22 the principal of doing something that will be beneficial 23 to the overall industry. But at this point, this is, as 24 you can probably see and sense, somewhat elusive. 25 I do think that, again, if we were to try to 0071 1 diagnose some of the issues that the access fee and the 2 proposal that we've put forth in particular is a really 3 important one to start to get to at least some of the 4 fabric of what's wrong, at least from an institutional 5 perspective. And I think Met put a number of the issues 6 out there very, very well. 7 But the 611 issue is a much more complicated 8 issue. That said, we will endeavor to try to figure out 9 what is a reasonable approach here but do appreciate 10 there are a number of different opinions on this which 11 are very, very far apart. MR. NAZARALI: 12 Actually, I have a question for you guys. And that is, 13 in 2010, we started this undertaking of this holistic 14 review, which I think a lot of us here are suggesting 15 might be a better approach to visiting these issues. But 16 it kind of didn't happen. What are your thoughts about 17 doing that and why didn't it happen other than the flash 18 crash? 19 COMMISSISSONER PIWOWAR: Two words. Dodd- 20 Frank. 21 (Mic malfunction.) 22 COMMISSIONER PIWOWAR: You know, I've been 23 saying that for years. Dodd-Frank took all the capacity 24 out of the staff to do important things, right? So, we 25 had the flash crash, and then six and a half years, 77 0072 1 months of Dodd-Frank. And so, I've been calling for -- 2 we need to have Audit Committee comprehensive review. I 3 think we have an opportunity with, you know, likely new 4 chairman coming in fairly quickly. And I'd love to do 5 that. 6 MR. NAZARALI: I mean, it sounds like from what 7 everyone here is saying, that may be something that's 8 due. So -- 9 MR. STONE: So, Chester, I'm putting you on the 10 spot. Sorry. And I'm going to put Charles on the spot, 11 too, since you two are the -- really the academics 12 because Maureen is not here. 13 We talked a lot about a data-driven discussion. 14 What data do you think that the Commission has or you 15 would like to see the Commission to collate or try and 16 get that we don't have right now? You don't have to 17 answer it now, but I think it would be really interesting 18 that, if we have a ton of academics, to unleash them on 19 some of these things about what were the benefits; where 20 are we now in trying to answer this. I think it would 21 get us very away from the innuendo, the supposition, and 22 the emotion and actually really look at what the cost 23 benefit really was that we entered into and where we 24 ended up. 25 MR. SPATT: Well, I think that's a very good 0073 1 question. Without attempting to speak for Charles or 2 Maureen, you know, certainly this is an issue I think 3 that we should reflect on. I thought that Charles raised 4 some important points in his presentation today about the 5 other -- about what can we learn from the other 6 countries' experience. Frankly, I think sometimes in the 7 United States we don't look enough at what we can learn 8 from Canada, from what we can learn from Australia, what 9 we can learn from some of the European markets. So, I do 10 think that's very important. 11 You know, I also think that we can potentially 12 learn a lot by trying to think about analogies with other 13 kinds of markets. I mean, one of the things that's 14 really striking -- I'm talking now about not equity 15 trading per se. But one of the things that's striking 16 about this particular market, we have a particular 17 regulatory structure that circumscribes exactly how one 18 is supposed to execute an order and who you're supposed 19 to -- to some extent, who you're supposed to purchase 20 from and that you're supposed to go after the next price 21 on the next little piece of shares. 22 And is this something that we follow in other 23 industries in our economy? What would those other 24 industries look like if we did that? And we might be 25 able to learn from looking at situations where we don't 0074 1 do that. But it does seem to me reflecting on the data 2 is very, very important. 3 I did think that Charles' use of the graph, I 4 thought, made a very important point, which is that there 5 was one really big impact, I think, a first-order impact 6 of Reg NMS, the monopolization by the NYSE specialists, 7 which had been part of our marketplace for many decades. 8 That basically ended immediately, and that had a huge 9 impact, not only as measured by the quantity of trading 10 that they did, but as measured by the pricing. And using 11 the NASDAQ as actually a benchmark, I thought provides an 12 interesting perspective. But I think one does want to 13 revisit these issues. 14 But on the data point, you know, I think that's 15 something that I think we should reflect on a bit. But 16 we also should try to use the information from other 17 markets and countries. 18 MR. JONES: Yeah. I guess what I would add to 19 that is that it's going to be very difficult to know what 20 happens here until you do it, right? And so, that -- you 21 can't -- I don't think this is something where it's 22 useful to think about a simulation or some of the other 23 tools that we actually sometimes use. I don't know that 24 high frequency data or MIDAS data tells us anything 25 particular about what would happen if we made some of 0075 1 these rule changes, which is why I think Chester and I 2 are advocating that we look at some closely related 3 though obviously not exactly parallel events that have 4 happened elsewhere. 5 I guess the one other thing that I think we -- 6 is worth going back to look at is actually what happened 7 right when we put in the order protection rule. There is 8 a paper out there that actually looks at this and comes 9 to the conclusion that I think we've always sort of 10 wondered about, which is the -- right after we put in NMS 11 there was not a big improvement in market quality, not 12 immediate. 13 And I think we should go back and look at that 14 and ask ourselves why wasn't there an immediate increase 15 in market -- you know, improvement in market quality. 16 Was it something about -- was there an adjustment period 17 that was required? Were people sort of holding back 18 until they sort of saw how the new markets were going to 19 work? I think that might be instructive to us. 20 MR. NUNES: Yeah. I just wanted to highlight 21 one of the things that Tom said that I feel like has not 22 gotten enough discussion. He discussed displayed 23 liquidity and public markets. And one of the aims of Reg 24 NMS was to encourage limit orders. And what we have seen 25 is the market share of exchanges has gone down and, you 0076 1 know, for the most part has continued to go down. 2 And I think it's important. I don't know 3 exactly where it fits into this because we did something 4 to encourage it and it seems to have discouraged it. But 5 I think it's important to think about the role of the 6 public exchanges and displayed price discovery in the 7 market as we think about this because, to the extent that 8 we -- you know, the price discovery function 9 deteriorates, that's going to affect investors in a 10 negative way. 11 MR. RUSSO: Yeah. Just as you said that, 12 something dawned on me. And actually, as I listened to 13 all this, I was -- couldn't help but thinking, just like 14 all the other times I've engaged in this conversation, it 15 feels like we're ending like all those other ones did. 16 It's really hard. It's really complicated. 17 If I were to kind of rank order, if you could 18 do just one thing and only one thing, what would you do, 19 I think I would attack access fees. It's been mentioned 20 by almost everybody as the biggest distortion in the 21 marketplace. Frankly, it was said. And if you hear 22 people who were at the table when it was being said, you 23 know, it just happened to be something that was out 24 there. But I don't know anything over a decade-plus in 25 the financial -- which hasn't narrowed. So, it just 0077 1 strikes me, if you could do one thing and only one thing, 2 you'd start there. 3 The next piece, I think, that would come out of 4 that, to your point, is part of the reason volume trades 5 off exchange is because, if you make me go and pay a fee 6 to do something that I don't have to pay a fee for, why 7 would I do that? So, I think actually that alone will 8 encourage more volume back in. So, I think you pick up a 9 couple benefits. You know, again, I'll reiterate 10 I think the safety and soundness concept and really 11 thinking about the overall -- the way the ecosystem 12 operates, you know, is really very important because at 13 the end what issuers care about most is that they can 14 come to a market and investors have confidence. What, 15 you know, everybody needs for their different business 16 models is for that to be vibrant between investors and 17 issuers. So, I think that's something we have to keep at 18 the forefront all the time. 19 MR. NUNES: So, I will preface this with I was 20 on the subcommittee and am a proponent of the access fee 21 pilot. The one tool exchanges have to encourage 22 displayed liquidity is the rebate. I guess I shouldn't 23 say, "the one tool," but a very important tool they have 24 is the rebate, and that helps them to try to balance the 25 supply of liquidity and the demand for liquidity. I 0078 1 think that we will learn a lot from the pilot. 2 But that is my main concern in the pilot, is 3 that, you know, if you're a rational actor -- and you 4 know, my firm is a rational actor -- it will affect our 5 desire to provide liquidity unless spreads kind of 6 compensate for it, right? 7 We think of things in a net between the 8 price -- you know, the explicit price and the rebate. 9 If the spread's wide enough to compensate for 10 the loss in rebate, we'll be fine. That will mean 11 spreads widened. That'll mean other investors are kind 12 of using a benchmark that's wider but may be more 13 reflective of true value, which is fine. 14 MR. WITTMAN: So, 3700 companies have greater 15 than 50 percent trades that take place off-exchange, to 16 Adam's and to Paul's point a bit. You know, we are very 17 focused on driving liquidity. And we also agree with the 18 access fees. But it's got to be very prescriptive. We 19 have to take a look at making sure that we have rebates 20 for these less liquid companies that are on the exchange 21 to make sure that there are varied liquid or at least 22 more liquid bids and offer -- bid/offer spreads. So, 23 we're very focused on that. 24 MR. MECANE: Just to address Adam's point, I'll 25 just refresh the point about not driving more off- 0079 1 exchange was part of why we went with the two-cent cap 2 instead of a no-rebate bucket. There were a few other 3 reasons, but one of the reasons was because we didn't 4 want to completely take away the ability for venues to 5 attract limit orders to compete with off-exchange -- so 6 just as a refresher. 7 MS. SEIDEL: Anyone else? Okay. Thank you. 8 This has been a great discussion, and I would like to 9 thank the panelists for their contributions. 10 As a next step, I think we'll leave it up to 11 Kevin and the subcommittee to decide when and how to 12 update their proposal to reflect this morning's 13 discussion and convert it into a formal recommendation 14 from the full committee to the Commission. Once a new 15 draft is provided to the committee, it will be publicly 16 posted on the website, and the interested parties will be 17 welcome to submit comments. And we would then plan to 18 have a full committee take a vote on the final 19 recommendation to the Commission at the next full 20 committee meeting. 21 With that, I think we are at our lunch break. 22 And so, I think the plan is to meet back here at 12:30. 23 Thank you. 24 (Whereupon, at 11:21 a.m., a luncheon recess 25 was taken.) 0080 1 A F T E R N O O N S E S S I O N 2 MS. SEIDEL: All right. Welcome back 3 everybody. Thank you. 4 And before we start, I just want to note we 5 have -- we're having, I think, some technical 6 difficulties, so our wonderful panelists will be sharing 7 that microphone. Thank you. And I believe that Chester 8 and Gary also have to ask to share that microphone. So, 9 we apologize. 10 This afternoon's session will follow the same 11 format as this morning's with an overview of the 12 subcommittee's recommendation, then the panelists' 13 statements and a full committee discussion. 14 And so, with that, Rick, as Chair of the 15 Trading Venues Regulation Subcommittee, I'll turn it over 16 to you. 17 MR. KETCHUM: Thank you very much. And I'm 18 honored that my microphone works. 19 So, we've killed a couple hours this afternoon 20 on the small issues of order protection, best execution, 21 investor confidence. I'm glad to say we're going to 22 spend the afternoon on things that really matter, market 23 surveillance and exchange liability. But there are some 24 of us who love it, so. 25 I thought I would first shift the order from 0081 1 the document a little bit to first reflect what the panel 2 had been initially invited to discuss, and I think it may 3 make more sense. 4 I'm going to talk first about some of the 5 issues involved with respect to cross-market regulation 6 from the surveillance and examination side and 7 particularly from the standpoint of the impact with the 8 SEC's leadership of the sometime-in-the-near-future 9 implementation of the consolidated audit trail. 10 I should start with the committee's recognition 11 that we think today, within the context of the 12 information that's available, that the regulatory 13 structure and operations of both FINRA and the exchanges 14 doing surveillance and examinations has bene quite good 15 and that the coordination has been excellent across 16 stocks and options and, on a good day, even across the 17 regulatory barriers with respect to futures. 18 But I think the committee was particularly 19 concerned -- and I should note that this is an issue that 20 only recently I have become involved in the committee 21 after I retired from any operational responsibility at 22 FINRA. 23 But the committee was particularly concerned 24 that the consolidated audit trail is a profound moment 25 from the standpoint of affecting market surveillance and 0082 1 affecting regulatory oversight generally of the markets 2 and in a very positive way from the standpoint of 3 creating dramatically more granular information that will 4 allow the surveillance function itself to be evaluating 5 and identifying with far less false positives, serious 6 and significant predatory and manipulative activity in 7 far quicker time frames and far more accurately. 8 But I think we felt, within the context of the 9 preliminary recommendations, that it made a good deal of 10 sense for the Commission and the SROs, and the industry 11 to spend some time thinking about the actual operation of 12 regulatory oversight and particularly market surveillance 13 in this new world. 14 Stated most simply, today there -- with respect 15 to the extent that there is consolidated information, 16 particularly in the equity side, it is an -- effectively 17 a proprietary database of FINRA, the exchange is doing -- 18 make choices from the standpoint of their exchange rules 19 only and do an excellent job when they do choose to do 20 oversight from that standpoint. 21 But the CAT environment is dramatically 22 different. The Commission and each SRO will have access 23 to a full and complete database and with that providing 24 both all the dramatic improvements that I mentioned and 25 also the question of a risk of duplication and 0083 1 differential interpretations that at least we think need 2 to be thought through carefully. 3 And our preliminary recommendation and focus 4 was an effort to try to balance -- and with this, I 5 reflect back very clearly some points well made by our -- 6 the chairman with respect to concern to encourage 7 innovation and creativity from the standpoint of persons 8 involved in surveillance but at the same time to try to 9 avoid the duplication of differential interpretations in 10 a variety of ways and unnecessary burden to the industry 11 from the standpoint of how that surveillance is incurred. 12 So, with that, we -- the preliminary 13 recommendation suggested that it would be good to look at 14 a differentiation form the standpoint of what would be -- 15 what would be wide open as to which entities would 16 conduct it versus what would be preferable to be focused 17 on a single market surveillance operation, emphasizing 18 the committee had no view as to what entity existing or 19 not presently existing would do that but what would be 20 appropriate. 21 And we think that, from the standpoint of 22 detection, if you will, from the standpoint of the design 23 of the surveillances as well as from the standpoint of 24 looking at issues particularly related to the integrity 25 of individual exchange markets, it was terribly critical 0084 1 to provide great flexibility, competition, if you will, 2 among regulators, and encouragement of creativity. 3 So, from the standpoint of designing those 4 surveillances, using the expertise of the variety of 5 different markets that they provide, we would suggest 6 that nothing change from the standpoint of the 7 flexibility and that the primary question should be the 8 competence of the entity that operated. 9 But when you move past detection, particularly 10 in this new world with granular information and CAT where 11 essentially you no longer have to go out and find out who 12 the customer is or who the actual party is driving the 13 information. When you move past detection to the point 14 of making inquiries to the firms and beginning 15 investigations or the analysis of that inquiries, we do 16 believe that it makes a great deal of sense to look to 17 centralize that just as exist today with respect to 18 insider trading with full and active participation across 19 all of the SROs that have a statutory responsibility to 20 ensure the quality of the full regulatory oversight. 21 But to -- once you've provided that creativity 22 with respect to the initial step of detection and 23 designing these surveillances, to have a single entity 24 conducting and operating a single threat outside of, 25 obviously, the separate analysis that the Commission may 0085 1 be choosing to do on any particular matter -- a single 2 threat from the standpoint of interacting with the 3 industry and also from the standpoint of developing and 4 bringing enforcement actions. 5 So, that is essentially the context of why we 6 believe that this is at least worth thinking about, and 7 we wanted to encourage discussion from this standpoint. 8 The second issue that the committee had 9 previously been looking at and continued to pursue in the 10 recent months -- and I should note that the first issue, 11 we benefitted from a dialogue across a number of the 12 self-regulatory organizations in recent weeks, regret 13 that, unfortunately, two of the major self-regulatory 14 organizations chose not to participate in that. I'm 15 delighted that both of those SROs are participating in at 16 least one or the other of the panels today. 17 The second are that we did want to take a look at -- 18 I'll recall a little bit from the comments made by Paul 19 Russo this morning from the standpoint of focusing on 20 operational and systemic exposure. And that relates to 21 the general issue of SRO responsibility with respect to 22 their operations where errors may have occurred that 23 result in harm either to investors or to the 24 intermediaries representing those investors. 25 And there has been, for a long time, in 0086 1 securities oversight, a dual track with respect to that 2 exchange liability question. There has been a broad- 3 based albeit somewhat changing interpretation from the 4 standpoint of where SRO immunity may stand in a recent 5 SEC amicus brief that probably discussed that in more 6 detail than has occurred in a substantial time before 7 that. 8 And the committee, while it has many different 9 views with respect to immunity, has no consistent view 10 from the standpoint of that, so I'm not here to discuss 11 any recommendation with respect to SRO immunity. 12 But the separate track that has always existed 13 to provide some assurance of the ability to address those 14 type of errors, issues, whether it be errors in judgment 15 or technology problems, has been rule-based from the 16 standpoint of liability limits that have been built into 17 each of the exchanges that have operated. 18 And we essentially have three recommendations 19 or preliminary areas that we believe deserve focus from 20 the standpoint of that. The first, we note that there 21 is, with respect to many exchanges, a consistent approach 22 with respect to dollar limits, but it's not consistent 23 across all exchanges, particularly not consistent 24 necessarily with respect to every new exchange. And we 25 do think that the commission should look and identify 0087 1 what the appropriate cost of admission to compete is from 2 the standpoint of this and ensure that there's a 3 consistency across any exchanges with respect to initial 4 threshold minimum level. 5 Secondly, recognizing these threshold levels 6 can be relatively small with respect to the alleged 7 damages that may occur. We believe that a second 8 approach that exists with respect to the New York Stock 9 Exchange rule at the present time, which is a steady 10 allocation to reserve fund of unpaid amounts that have 11 been accreted with regard to these levels also makes a 12 good deal of sense because, given the exposure that may 13 exist and the resulting exposure from the standpoint of 14 trying to settle something like this where they may have 15 been significant alleged damages, it makes sense to try 16 to build over time somewhat larger funds to fall back on. 17 And third, the committee took note of the fact 18 that there are certain instances which have historically 19 been the areas where the largest overall exposures have 20 occurred with respect to either technology or judgment 21 areas. And those have tended to relate to the opening, 22 the close, and particularly bringing on IPOs from the 23 standpoint of new listings. 24 The third piece of the preliminary 25 recommendation was that we think that should reflect as a 0088 1 beginning of an analysis led by the Commission of a 2 recognition that listing exchanges that both historically 3 are the dominant player from the standpoint of IPO and 4 also have tended, in the evolution of the market, to 5 dominate through an opening and closing auction, the 6 trading during those times, that listing markets -- 7 recognizing there might be variableness depending on the 8 size of those listing markets -- but that listing markets 9 should take on additional responsibility and have higher 10 levels. 11 The committee did not make recommendations on 12 specific amounts because we think that should be more 13 data-driven than we had the opportunity to do and that we 14 recommend that the Commission, working with the SROs and 15 the industry, engage in a dialogue to look closely at a 16 fair analysis with respect to the claims that have been 17 settled, that the amounts that have been alleged from a 18 harm standpoint and the like -- to try to reach what 19 makes most sense with respect to those potentially higher 20 levels. 21 So, those -- those are our two preliminary 22 recommendations. We recommend that they are very much, 23 just as in the morning, things in play. They aren't 24 final views by the committee as a whole or by committee 25 members, but we do believe there are two areas that 0089 1 deserve additional conversation, and I'm very much 2 looking forward to the insights of the panel. Thank you. 3 MS. SEIDEL: Thank you, Rick. 4 Again, let me quickly introduce our panel. 5 This afternoon we have, going from left to right, Anthony 6 Albanese, the chief regulatory officer at the New York 7 Stock Exchange; Lev Bagramian, a senior securities policy 8 advisor at Better Markets. Next to Lev is Tom Gira, 9 Executive Vice President of Market Regulation and 10 Transparency Services at FINRA. Next to him is John 11 Kerin, President and CEO of the Chicago Stock Exchange. 12 And finally, we have Brett Redfearn, the global head of 13 Equity Market Structure Strategy at JP Morgan Securities. 14 Anthony, would you like to begin? 15 MR. ALBANESE: Sure. I think I have a working 16 microphone. Is it working? Okay. Good. 17 Good afternoon, Acting Chairman Piwowar, 18 Commissioner Stein, SEC staff, and committee members. I 19 would like to thank the Commission and this committee for 20 the opportunity to participate in today's Equity Market 21 Structure Advisory Committee Meeting. 22 My name is Anthony Albanese, and I am the chief 23 regulatory officer of the New York Stock Exchange. Prior 24 to going to the New York Stock Exchange, I served as a 25 regulator running the New York State Department of 0090 1 Financial Services. As many of you know, the department 2 regulates the financial services industry in New York. 3 I appreciate the opportunity to share our views 4 on the Trading Venues Subcommittee's recent 5 recommendations regarding regulatory consolidation 6 following implementation of the consolidated audit trail. 7 As I am the CRO, I won't be participating in the 8 discussion today on SRO liability limits. 9 I would like to begin today by sharing our 10 thoughts on NYSE market regulation generally and 11 providing an update on the changes at NYSE over the past 12 year after taking back our market-specific surveillance 13 investigation and enforcement work from FINRA. 14 Then, in the context of the subcommittee's 15 recommendations, I will provide our thoughts on what 16 cross-market regulation should look like in a post-CAT 17 implementation environment. 18 As I will discuss, we believe that the proposal 19 to create a cross-market regulatory monopoly in the post- 20 CAT world would suppress efficiency and innovation and 21 not serve the markets or investors. 22 I will start with a brief overview of 23 regulation at the New York Stock Exchange. NYSE 24 regulation enforces compliance with exchange rules and 25 securities laws for each of the four NYSE securities 0091 1 exchanges. NYSE regulation is independent from the 2 business at NYSE both in structure and function. 3 In my role as chief regulatory officer, I 4 report to an independent committee of the NYSE board 5 known as the Regulatory Oversight Committee, referred to 6 as the ROC. The chair of the ROC is a well-regarded 7 former regulator, Fred Hatfield, former commissioner of 8 the CFTC. 9 The ROC oversees our regulatory 10 responsibilities, and the ROC had adopted a policy to 11 provide for the independence of the CRO. And as CRO, I 12 am required to ensure that non-regulatory exchange 13 personnel do not influence any investigation enforcement 14 or other regulatory action. 15 NYSE regulation is comprised of approximately 16 100 professionals, including lawyers who have served at 17 the SEC and other with regulatory analyst skill sets. 18 NYSE regulation prioritizes collaboration, cooperation, 19 and communication within our team. 20 Our surveillance analysts and investigators, 21 who have extensive industry knowledge, work closely with 22 our enforcement lawyers as matters are detected, 23 investigated, and when appropriate, disciplined through 24 formal action. 25 Our expertise as a market operator provides us 0092 1 with a deep understanding of market practices and allows 2 us to keep abreast of new issues and developments 3 impacting market participants. 4 I'm now going to turn to our recent in-sourcing 5 of regulation at NYSE. Approximately 15 months ago, NYSE 6 brought back our market surveillance, investigation, and 7 enforcement functions from FINRA where they had been 8 handled for five years pursuant to a regulatory services 9 agreement. FINRA continues to conduct under an RSA and 10 under our oversight cross-market surveillance, 11 investigations, and enforcement activity that occurs 12 across multiple exchanges. 13 The decision to in-source our regulatory 14 function was largely driven by our belief that a well- 15 regulated market is one of the core responsibilities of 16 an operating exchange. More importantly, we believed 17 that we could conduct this regulatory work in-house more 18 effectively and efficiently than any third party, given 19 our in-depth knowledge of both our markets and our 20 members. 21 Based on our experience over the past year and 22 as our statistics bear our, our belief was correct. We 23 are completing the investigation and enforcement of 24 single-market cases far more quickly than before, in some 25 cases months faster, in some cases, years faster. 0093 1 In creating our regulatory program, we spent 2 millions of dollars developing a state-of-the-art real- 3 time surveillance system which did not exist at FINRA. 4 This real-time system allows us to quickly identify and 5 review potential problems. We believe this is a 6 significant improvement over surveillances being run on a 7 quarterly basis. 8 The real-time nature of our surveillances 9 allows us to work with members to correct issues soon 10 after they occur rather than addressing them months or 11 years after the fact. Not only is this a huge benefit in 12 regulating the markets, but it is also more efficient for 13 members who can address questions about potential 14 violations involving current conduct, which is still 15 fresh in people's memories. 16 We've received great feedback from members on 17 our new program. As an example, when we first started 18 our program, one compliance officer expressed disbelief 19 when one of our enforcement attorneys was contacting that 20 firm about recent activity and potential issues. And the 21 compliance officer at that firm said she was shocked 22 because she was used to working in a T plus 437 world. 23 Another example of the efficiencies we have 24 gained relates to NYSE Regulations successfully working 25 through the backlog of cases that existed at FINRA at the 0094 1 end of 2015. As we brought back our market regulation 2 program, FINRA alerted us to several hundred single- 3 market cases that had accumulated over time but had not 4 yet been completed. More than half of the cases were 5 more than a year old, and approximately a quarter of them 6 were over two years old. 7 We decided to handle the cases in-house instead 8 of having FINRA complete them on our behalf. In just six 9 months from having those cases transferred back to the 10 New York Stock Exchange, we were able to complete all of 11 the investigations, a fraction of that time that FINRA 12 had estimated it would take to complete. The percentage 13 of those investigations that resulted in disciplinary 14 actions is consistent with our program today. 15 In sum, in the year since we have moved our 16 regulatory function in-house, the quality of our program 17 has improved significantly. We are surveilling market 18 activity in real-time, completing investigations and 19 disciplinary actions far more efficiently, and 20 communicating more timely and effectively with our 21 regulated members. 22 I will now turn to the subcommittee's 23 recommendation before us. The subcommittee recommends 24 that cross-market investigations and enforcement be 25 centralized in a post-CAT world. We respectfully 0095 1 disagree with that recommendation, and we believe that it 2 is premature, especially since SROs have not yet had the 3 opportunity to operate under the CAT. 4 With the establishment of the CAT, each SRO 5 will have access to cross-market data. This new 6 landscape, in turn, would permit any SRO to conduct 7 cross-market investigations. We view this as a positive 8 development, not something to be quashed by a preemptive 9 sanctioning of a single entity as the cross-market 10 regulator. 11 The subcommittee's recommendation seeks to 12 provide a regulatory monopoly to a single SRO for cross- 13 market investigation and enforcement but does not give a 14 compelling rationale based on the evidence as to why such 15 action is a necessary solution to a problem in the 16 market. 17 While the subcommittee has raised concerns 18 about regulatory duplication, there is no reason that 19 this could not be addressed through appropriate 20 coordination as we are accustomed to doing with our 21 fellow exchanges. 22 Moreover, various regulators such as the SEC, 23 FINRA, the Department of Justice, state attorney 24 generals, the New York State Department of Financial 25 Services, routinely conduct and coordinate parallel 0096 1 investigations in a way that is efficient, effective, and 2 sends a strong regulatory message. It's all about 3 appropriate coordination. 4 Having regulation conducted by only a single 5 SRO across multiple exchanges requires a cookie cutter 6 one-size-fits-all approach. By contrast, encouraging 7 multiple exchanges to look at these issues allows for a 8 variety of different approaches developed by the market 9 experts themselves and incentivizes exchanges to adopt 10 better practices. 11 Currently, even using single market data, 12 exchanges detect and refer cross-market misconduct that 13 would not necessarily be picked up by existing cross- 14 market surveillances. And we at the New York Stock 15 Exchange have been innovative over the past year in 16 adopting new investigative and enforcement approaches in 17 addressing manipulative activity. 18 In a complex world where sophisticated traders 19 are quickly developing new and evolving trading 20 strategies, having multiple experts looking at this 21 activity from a variety of different angles is far better 22 than limiting any investigation to a single entity. 23 Providing a single SRO a monopoly over cross- 24 market investigation and enforcement, especially without 25 accountability to and oversight by the exchanges, would 0097 1 significantly reduce incentives for efficiency, 2 creativity, self-improvement and innovation. And it 3 would take away responsibility for regulating trading 4 from the exchanges who have the greatest interest in 5 promoting the quality of their markets. 6 The successful in-sourcing of regulation at 7 NYSE demonstrates that individual exchanges are uniquely 8 qualified to regulate their markets through surveillance, 9 investigation, and enforcement. Since taking over 10 market-specific regulation, the quality of our regulatory 11 program has improved in every meaningful way. In- 12 sourcing has yielded a number of significant benefits, 13 including a reduction in the aging of matters; the 14 prosecution of stronger cases; and the development of a 15 new real-time approach to disruptive activity. 16 This experience counsels against requiring 17 today, even before we have had any experience with the 18 CAT, that all cross-market regulation be performed by a 19 single entity removed from the markets, the exchanges, 20 and their members. 21 The NYSE and its fellow exchanges are well- 22 positioned to work together to make sure that America's 23 securities markets remain the strongest and the fairest 24 in the world. Thank you. 25 MS. SEIDEL: Thank you, Anthony. 0098 1 Lev? 2 MR. BAGRAMIAN: Thank you, Heather. Good 3 afternoon everyone. I will get this mic to work. 4 We are grateful for the opportunity to offer 5 our views to the Equity Market Structure Advisory 6 Committee, to Commissioners Piwowar and Stein, both of 7 whom I've had the pleasure of working with in our days at 8 the Senate Banking Committee, and to the staff of the SEC 9 about the Trading Venues Regulations Subcommittee 10 recommendations that Rick presented earlier. 11 If I may, I would like to briefly introduce my 12 organization, offer some observations on the state of the 13 exchange SROs, and then address some of the specifics of 14 the preliminary recommendation. 15 Better Markets is an independent non-profit 16 organization that fights for the economic security, 17 opportunity, and prosperity of the American people by 18 ensuring that finance serves society and is not a threat 19 to it. We accomplish this goal by advocating for 20 financial reform. We have submitted over 200 detailed 21 comment letters to all of the major financial regulators, 22 many of them to the SEC. We also conduct research, 23 engage in litigation when necessary, and advocate for 24 reform through all forms of media. 25 At the same time, Better Markets is a strong 0099 1 believer in markets and market discipline and believes 2 that the private sector is key to ensuring that the 3 American economy works for everyone. That, however, 4 requires clear rules of the road that are enforced with 5 no favors to large and politically savvy firms. 6 Ultimately, we want the SEC to succeed in its mission of 7 protecting investors, ensuring the integrity of the 8 market, and facilitating capital formation. 9 Exchange SROs are tasked with writing and 10 enforcing rules that govern all aspects of their members' 11 securities business, including their financial condition, 12 operational capabilities, sales practices, and the 13 qualification of their personnel. In addition, exchange 14 SROs are supposed to surveil the market to detect rule 15 violations and objectionable practices such as insider 16 trading and market manipulation. 17 The Commission, aiming to augment its 18 regulatory capabilities, enlists the help of the 19 exchanges because of their proximity to the market and on 20 the theory that using the wisdom of seasoned 21 practitioners would be beneficial for both the industry 22 and the investors the Commission is statutorily required 23 to protect. 24 This interdependency between government and 25 quasi-governmental entities in pursuit of investor 0100 1 protection can work, but it presents extraordinary and 2 inherent risks. It therefore requires the Commission's 3 robust oversight. Or as the 1961-63 SEC special study 4 which thoroughly examined the securities markets and 5 self-regulatory model put it, the exchange SROs will need 6 "the pointed stimuli of the SEC" to be effective 7 frontline regulators of the market. 8 Unfortunately, today's profit-seeking exchanges 9 have morphed into entities that are unrecognizable from 10 the first organized exchange established under a tree on 11 Wall Street in 1792. Today's large exchanges are 12 conflicted to the core. On the one hand, they have 13 committed to the Commission and the investing public that 14 they will be the frontline regulators overseeing members 15 who abuse the privileges of their membership and 16 manipulate the markets. 17 On the other hand, they sell data, offer 18 preferential access to markets, and existentially depend 19 on some of the most egregious manipulators of the 20 markets. How are they supposed to bite the hand that 21 feeds them? Aren't we asking too much of them? 22 The Commission itself has recognized this 23 serious conflict. In a 2004 concept release, the 24 Commission warned that "unchecked conflicts in the dual 25 role of regulating and serving the markets can result in 0101 1 poorly targeted SRO rulemaking, less extensive SRO 2 rulemaking, and under-zealous enforcement of SRO rules 3 against members". 4 I would add that all these conflicts are 5 intensified when an exchange SRO is over-dependent on a 6 few large members. 7 As competition among profit-seeking exchanges 8 grows, they increase business pressure of attracting 9 listings, and overflow is only making this worse. 10 The Commission depends on this advisory 11 committee to help it rid the markets of abusive practices 12 and help restore and maintain the investor confidence 13 that is essential ingredient of strong capital markets. 14 Unfortunately, today's 15 recommendations and really this advisory committee's body 16 of work has yet to begin addressing these serious 17 conflicts and the problems our equity markets face. The 18 recommendations are a good start, but they do not provide 19 anywhere near complete solutions to our market structure 20 challenges. 21 I will now address some of the specifics. On 22 SRO immunity, a topical and important issue today is 23 whether exchange SROs are immune to lawsuits by members 24 or investors when they design and sell certain 25 potentially harmful products or services. It is 0102 1 disappointing that the subcommittee did not come to an 2 agreement on exchange SRO immunity. 3 It is clear to us and others that exchange SROs 4 cannot have their cake and eat it too. They either 5 should not be in the business of selling data and 6 preferential access to some members who use this access 7 to manipulate markets or be ready to face fraud and 8 liability claims by other members or investors who feel 9 they are wronged by such abusive practices. 10 On consistent limits and reserve fund. Another 11 of the recommendations would set consistent liability 12 limits and create a reserve fund. We think both 13 recommendations are worthy of serious consideration by 14 the Commission. The reserve fund should be funded by the 15 industry at levels set by the Commission, which, in turn, 16 should be informed by real world episodes of market 17 disruptions caused by the exchanges. 18 Finally, on regulatory centralization, the 19 recommendation would centralize certain regulatory 20 programs under one non-exchange SRO. As I discussed 21 earlier, today's exchange SROs are more conflicted than 22 ever before in their dual role of creating wealth for 23 their own shareholders and regulating the members who 24 help generate this wealth. We therefore view the 25 subcommittee's recommendations, perhaps wishfully, 0103 1 through this lens. Any initiative that begins to 2 mitigate this inherent conflict of interest is worth of 3 serious consideration by the Commission. 4 Centralizing certain market surveillance may provide 5 some benefits. When the consolidated audit trail becomes 6 operational, it is conceivable that exchange SROs will 7 use it to surveil cross-market activities. This 8 surveillance can cause multiple exchange SROs to make 9 inquiries to firms who engage in potentially violative 10 practices. These multiple inquiries can be costly to 11 members. But much more importantly, it can slow the 12 enforcement process down, which will hurt investors. 13 Consolidating cross-market surveillance into one non- 14 exchange regulator will likely speed up enforcement 15 proceedings and reduce harm to investors. 16 Additionally, by putting the responsibility of 17 cross-market surveillance on the shoulders of a non- 18 conflicted SRO, the Commission may end up encouraging 19 more proactive and vigorous surveillance of the markets. 20 21 If the Commission does decide to consolidate 22 cross-market surveillance into one non-exchange SRO, it 23 must also enhance its own oversight of that SRO. The 24 pointed stimuli of the Commission will be especially 25 critical as more of the surveillance eggs will be in one 0104 1 basket, so to speak. 2 In conclusion, Americans who depend on 3 functioning in safe capital markets are harmed because of 4 the conflicts of interest that exist in exchange SRO 5 model. The Commission has both the staff expertise and 6 the regulatory toolkit to address these conflicts. The 7 recommendations offered today are a small step in the 8 right direction and ought to be given their due 9 consideration. But reliance on the self-regulatory model 10 to fix our market structure problems can only go so far. 11 Commission must forge ahead with additional regulatory 12 measures to make markets more fair, transparent, and free 13 from abusive practices. 14 Thank you for your attention. 15 MS. SEIDEL: Thank you. 16 Tom? 17 MR. GIRA: Good morning. I'm sorry. Good 18 afternoon. My name is Tom Gira. I'm responsible for 19 FINRA's Market Regulation and Transparency Services 20 Department. I'd like to thank the commissioners, the 21 committee members, and the SEC staff for inviting me to 22 participate in this discussion today. 23 I'd like to hear FINRA's thoughts regarding 24 regulatory centralization, given FINRA's experience 25 providing regulatory services to U.S. equity and options 0105 1 exchanges in comment on the preliminary recommendations 2 of the Trading Venues Regulations Subcommittee concerning 3 regulatory centralization. 4 By way of background, FINRA started providing 5 regulatory services to exchanges when the International 6 Securities Exchange became the first electronic options 7 market back in May of 2000. Since then, we commenced 8 providing regulatory services to the NASDAQ family of 9 markets -- which ironically now owns ISE -- the New York 10 family of markets, and the recently growing CBOE family 11 of markets as well as IEX, MIAX, and BOX. 12 At the present time, we provide regulatory 13 services for 19 SROs that operate in 25 markets. Ten of 14 those are equity markets, and 15 of those are options 15 markets. At one time, we did regulate hot air. We 16 regulated CO2 credits that were trading on the Chicago 17 Climate Exchange, but we don't do that anymore. 18 By combining data from FINRA's order audit 19 trail system, client exchanges, and the over-the-counter 20 market, FINRA launched a cross-market surveillance 21 program in August of 2012 that makes today's highly 22 fragmented market seem like one integrated market for 23 surveillance purposes. 24 On average, we process 50 billion market events 25 a day, and we presently cover 99 percent of the listed 0106 1 equity market and 65 percent of the listed options market 2 in our cross-market programs. 3 This is important because market participants 4 engaging in improper conduct increasingly try to spread 5 their activity across multiple markets in an attempt to 6 avoid detection. 7 We run surveillance patterns across this data 8 that look for 180 different threat scenarios. And 75 9 percent of the alerts we generate involve activity 10 occurring on more than one exchange. Sixty percent of 11 the alerts we generate involve trading activity flowing 12 through more than one broker. 13 Many of these alerts would not have been 14 generated but for FINRA's cross-market surveillance 15 program. And some of the abusive algorithms that we're 16 looking for would only work if the participants spread 17 their activity across markets. 18 Another significant component of FINRA's cross- 19 market surveillance program is the regulatory 20 intelligence that we receive from our client exchanges. 21 Anthony was exactly right. They are -- a lot of our 22 clients are producing and monitoring their own markets, 23 and they give us information that helps enrich our 24 program. 25 Since 2015, FINRA has received over 1,100 0107 1 referrals from its client exchanges, resulting from the 2 exchanging surveillance and monitoring of their own 3 markets, tips, and complaints. 4 Our cross-market surveillance program has been 5 highly successful in my opinion. Since 2015, FINRA has 6 made over 800 referrals to the SEC concerning abuse of 7 trading algorithms on behalf of FINRA and its exchange 8 clients. These referrals, as well as referrals from 9 prior years, have resulted in numerous SEC actions. I 10 would point to the complaint that came out as one example 11 of that. 12 In addition, FINRA and our client exchanges 13 bring actions based on our cross-market program and 14 supervisory controls related to cross-market activity 15 when we do have jurisdiction. 16 FINRA believes the regulatory ecosystem that 17 the cross-market regulation of our program created by 18 FINRA and our client exchange can serve as a strong 19 foundation for surveillance in a post-CAT world. 20 Again, I think we -- I think the word 21 "monopoly" has been used a couple times. I would view 22 this more as a partnership than a monopoly. It's the 23 banding together of exchanges together with FINRA. 24 At the same time, it's very appropriate and 25 timely that the subcommittee and EMSAC are considering 0108 1 centralized regulation because with CAT necessary 2 surveillance data will become ubiquitous, and as a 3 result, there is greater chance for regulatory 4 duplication, regulatory gaps, and inefficiency. 5 As Rick mentioned in his opening remarks, the 6 subcommittee -- I don't know that they took opinion 7 whether there should be multiple surveillance providers 8 or there should be one surveillance provider to do the 9 detection phase of regulation. You know, I think from my 10 perspective, I would say that there -- I'm sorry. I 11 flipped my order. I'll get to that point in a little 12 bit. 13 I do have two comments on the subcommittee's 14 preliminary recommendations. First, I completely agree 15 with the subcommittee's recommendation that the SEC 16 should make clear what their regulatory expectations are 17 with respect to cross-market regulation in a post-CAT 18 world. I would ask the Commission to go even further and 19 articulate expected standards with respect to cross- 20 product regulation. And by that I mean trading that 21 spans multiple asset classes, for example, options and 22 equities or related ETFs. 23 Just as we have seen market participants spread 24 their activity across multiple markets for the same 25 instrument to avoid detection, it is highly probable that 0109 1 they will do and, for a fact, maybe are engaging using 2 synthetic instruments or cross-markets and related 3 products, particularly where there might be some 4 leverage. 5 FINRA presently has a few surveillance patterns 6 that look for cross-product abuses. And in 2004 -- I'm 7 sorry -- 2014 we brought a case on behalf of our options 8 exchange clients against a firm and an individual who was 9 manipulating the equity market to get favorable positions 10 in the options market. 11 But the significantly enhanced options audit 12 trail data that will be available in the CAT will enable 13 FINRA and the exchanges to take cross-product 14 surveillance to a new level that will better protect 15 investors. 16 And as I said -- the other point I wanted to 17 make on the recommendation with respect to the detection 18 level, whether that should be sort of multiple or single, 19 in my view, you know, I think the recommendation strikes 20 a reasonable balance between the need to avoid regulatory 21 duplication and promote regulatory innovation. But at 22 the end of the day I think that regulatory consolidation 23 is superior to regulatory coordination. 24 Among other reasons, having multiple 25 surveillance providers could impede efficiency in the 0110 1 feedback loop of investigative findings in forming 2 improvements and surveillance patterns. It could result 3 in unnecessary duplicative efforts, particularly when the 4 surveillance patterns are comparable. Multiple 5 surveillance systems could increase the cost to the 6 industry. It could also foster an unhealthy race by 7 surveillance providers to submit as many alerts as 8 possible to show their value versus other providers. And 9 that's extreme. It could create a flood of noise into a 10 central body that would have to sift through that. 11 And the investigative teams could be put in the 12 position of pushing edge cases to be perceived as neutral 13 to all surveillance providers. As a result, FINRA 14 submits that it would be more desirable to have the 15 exchanges and FINRA operate one cross-market surveillance 16 platform that reflects ongoing collaboration and 17 partnership between the SROs, as is the case today. 18 In closing, while there can be different points 19 of views about the efficacy of a single provider model 20 for cross-market and cross-product surveillance versus a 21 multiple provider model, I believe it is important for 22 the Commission and the SROs to keep the following guiding 23 principles in mind as we seek to leverage the much- 24 improved audit trail data that will be available through 25 the CAT: to conduct comprehensive and uniform 0111 1 surveillance across all markets; maintain a community 2 policing environment where the knowledge and experience 3 of each SRO is leveraged and the SROs collaborate 4 routinely about surveillance patterns, problematic firms, 5 cases, and other matters; promote innovations and 6 surveillance methodologies and techniques; minimize 7 duplication and other unnecessary burdens on firms; 8 provide consistent outcome for firms based on the 9 totality of the activity across all markets; ensure there 10 are sufficient resources devoted to cross-market 11 regulation. 12 Our markets are the envy of the world, and they 13 deserve high-quality oversight -- promote effective SEC 14 oversight by minimizing the fragmentation of functions; 15 and promote operational efficiency across market 16 regulation programs by, among other things, shifting to 17 multilateral agreements across the SROs instead of 18 current bilateral agreements; and lastly, promote cost 19 mutualization. Thank you. 20 MS. SEIDEL: Thank you, Tom. 21 John? 22 MR. KERIN: Good afternoon. My name is John 23 Kerin. I'm the CEO of the Chicago Stock Exchange. I 24 want to start by thanking the commissioners, the SEC 25 staff, and the committee for allowing me to participate 0112 1 today. 2 I think it's important that all of you hear the 3 prospective of a smaller exchange, a smaller exchange 4 operator. 5 We have sent a letter in. It might be up on 6 the SEC website. I am not going to read it to you; I'll 7 just speak to the salient points in that letter. 8 The -- regarding the harmonizing of liability 9 limits, for the record, we do not support anything that 10 might potentially erode SRO immunity. And regarding the 11 liability limits, whether they be a high limit or a low 12 limit that's set, it's problematic for us, and we believe 13 that's a business decision best left to the SROs. 14 When you think about the size check in a 15 liability situation that JP Morgan might be satisfied 16 with, that the New York Stock Exchange might be able to 17 write, that would be problematic for us. It's 18 problematic for an organization our size to accept some 19 minimum liability threshold -- and don't support that. 20 We view that as anti-competitive, and it creates 21 artificial barriers to entry. 22 Regarding CAT and regulatory centralization, 23 we, as consistent with findings, believe that the SROs 24 best -- are best suited to regulate their own markets. 25 But we've spent a lot of time on CAT getting to 0113 1 this point. We're like, on the threshold of being able 2 to make very significant advancements because all of our 3 data -- all of ours being in the United States national 4 market system is in one place and one format, normalized 5 with common access or methods so that anybody can see and 6 access that, which affords me the opportunity to be able 7 to give the New York Stock Exchange a call or FINRA a 8 call and ask them, "Will you do this for me? If you're 9 writing these cross-market algorithms, will you do it for 10 me?" And I can ask them to train their systems on my 11 data and come back with performance metrics, you know, 12 precision and recall limits so that we -- I can 13 objectively look to see how FINRA's data did or New 14 York's or BATS if they want to go down that path and 15 choose best of breed. 16 Over time, compute power, the cost has 17 continued to decline, and all of these markets have, you 18 know, plenty of overnight capacity, unutilized capacity. 19 So, the overall cost, their cost, is going to trend 20 down. So, I'm going to be able to realize not just best 21 of breed in terms of the quality of the work but cost. 22 And I know the findings go beyond that. The 23 point that I've been asked to speak to goes, well, what 24 happens when there is something that requires further 25 investigation? Well, the SROs have a history of being 0114 1 able to work together and cooperating. And I don't 2 believe that that's going to change with CAT. I think 3 we're attempting to address a problem that doesn't exist. 4 5 I do hear broker-dealers being concerned about 6 being approached from multiple SROs to address the same 7 issue, but with cooperation, I think that will be swiftly 8 resolved. 9 And then, additionally, I would like to -- if I 10 need to go to the outside for additional regulatory 11 services, not just have one stop and have to go to FINRA. 12 But I should be able to go to the -- to go to the New 13 York Stock Exchange. I should be able to go to some 14 other SRO performing those services. Competition is 15 good, and I think we all benefit from it. 16 So, in summary, I do not support the 17 recommendation to consolidate cross-market regulatory 18 activity in one single entity. I am looking for options 19 in competition. Thank you. 20 MS. SEIDEL: Thank you, John. 21 Brett? 22 MR. REDFEARN: Good afternoon. Good afternoon, 23 Acting Chair Piwowar, Commissioner Stein, SEC staff and 24 members of the committee. Thank you very much for the 25 opportunity to share our thoughts today regarding the 0115 1 reforms to the current regulatory environment for U.S. 2 equity markets. 3 I'm Brett Redfearn. I'm the global head of 4 Market Structure Strategy for JP Morgan Securities. And 5 I'd just like to start by saying that we very much 6 appreciate the work of the subcommittee. We think that 7 it was very thoughtful and brings us a lot closer to 8 where we need to go, so thank you for that. 9 Just to start, after years of focusing 10 personally on market structure, I've come to appreciate 11 some basic realities that I think we're dealing with 12 here. The rules that we've put in place have created 13 some remarkable benefits, many significant challenges, 14 and some very strong entrenched interests. Arguments on 15 all sides of these issues are going to be made in the 16 name of investor confidence, price formation, market 17 quality, what have you. And nonetheless, it's going to 18 be up to you to navigate through all these things and 19 address the outdated and anticompetitive pricing 20 structures and regulatory constructs to truly achieve the 21 objectives that we're trying to achieve. So, I certainly 22 appreciate that challenge. 23 If you don't mind, I'd like to make a couple 24 quick comments on the issues this morning on Reg NMS. I 25 will be brief. 0116 1 First of all, we believe that Reg NMS is indeed 2 overdue for reform and that the order protection rule 3 should be reevaluated and possibly repealed. At a 4 minimum, we think the OPR should be updated to include an 5 exception for blocks as well as volume thresholds to 6 receive protected quote status. I am not convinced that 7 we need another pilot. 8 On the access fee cap proposal, while the 9 proposed pilot may have the benefit of generating 10 insights and data that could be used to help empirically 11 evaluate fee caps, we believe the pilot has three 12 important limitations. 13 One, it would not provide data for over 85 14 percent of the securities that are listed, including 15 about 50 percent of the volume. Two, it would not test 16 the benefits that could result from an elimination of 17 rebates. And three, upon completion, it would ensure 18 that the SEC, as opposed to the marketplace, would be in 19 the position of setting caps and determining transaction 20 pricing for the market price. 21 If we proceed with the pilot as designed, I 22 think we'll miss some important opportunities. We'd like 23 to see some changes along these lines, especially the 24 contemplation of the elimination of rebates. 25 We think that, if rebates were eliminated 0117 1 within the right construct, that market competition could 2 effectively cap fees in our markets, and regulators would 3 not have to be involved in setting prices and fee caps. 4 Moving on to the discussion of our self- 5 regulatory model, again, we're generally supportive of 6 the recommendations that have been made. I just want to 7 start by saying we have a fundamental tension in our 8 system of self-regulation that needs to be addressed. 9 As has been said and as you all know, the major 10 stock exchange groups have evolved into for-profit 11 publicly traded entities. This corporate structure for 12 stock exchanges is not what was envisioned when the 13 Exchange Act was passed and when the Exchange Act 14 amendments were passed in 1975. The evolution in 15 corporate structure has not been accompanied by a 16 similarly dramatic evolution in regulatory structure. 17 And as a result, we think we're overdue for revisions and 18 modifications to our system of self-regulation. 19 So, first, let me address the issue of 20 regulatory immunity and limits on liability. These are 21 very important issues to address because, if immunity and 22 limitations on liability were more fairly applied, then 23 brokers would no longer be in the unenviable position of 24 having to take on an inordinate amount of financial risk 25 that can result from exchange technology issues, 0118 1 including liabilities that could arise from exchange 2 commercial decisions. 3 On regulatory immunity, the SEC has, we 4 believe, an accurate and appropriate perspective on this 5 issue. I will quote from the 2016 SEC amicus brief that 6 was filed relating to the Providence case. "The 7 Commission believes that absolute immunity is properly 8 afforded to the exchanges when they are engaged in their 9 traditional self-regulatory functions, when the exchanges 10 are acting as regulators of their members. But immunity 11 does not properly extend to functions performed by an 12 exchange itself in the operation of its own market or to 13 the sales of products and services arising out of those 14 functions." 15 We agree with this brief, and we hope that it 16 serves as a road map for how regulatory immunity is 17 treated going forward. 18 Related on the issue of limitations of 19 liability, we need to ask what is the basis for limiting 20 liability for profit-maximizing business that compete 21 with member firms and other service providers. It's not 22 obvious to us that any such limits continue to be 23 warranted or necessary. We'd like to see a clear 24 justification for these limits in the current exchange 25 landscape and clarification and delineation of when and 0119 1 where such limits are warranted similar to that which we 2 have seen in the Providence amicus brief. 3 So, let's think about this. What is the basis 4 for liability, and how does it apply in today's world? 5 Is it connected to a concern about whether a market 6 failure of an exchange would result in a larger systemic 7 risk to the broader market? 8 So, let's think about it. There was a time 9 when there was a significant dependency on the primary 10 market. We can remember when 80 percent or more was 11 listed in one particular market, right? Our markets 12 today are highly resilient, and there's a lot of 13 competition. And we've seen this during times when any 14 given market has gone down. The markets keep 15 functioning. 16 Any possible systemic issues would likely be 17 limited to certain services provided by primary markets 18 like auctions or perhaps listing services. And I would 19 say it would be very difficult to make a case for any 20 systemic risk associated with a failure of one of the 21 smaller non-listing venues. So, it seems clear that 22 limitations on liability are less necessary than in times 23 past, if indeed necessary at all. 24 So, let's assume that limitations on liability 25 need to exist. How do we draw a line between exchange 0120 1 products and services that might be afforded certain 2 limits and those that might not? A possible framework 3 for this would be to distinguish between essential market 4 functions of an exchange and nonessential functions. 5 So, essential functions might include products 6 and services provided by the exchanges that are necessary 7 and fundamental to the trading of securities and used by 8 all brokers out of necessity. An example would, again, 9 be opening and closing auctions. 10 Nonessential functions would include the other 11 products, possibly including premium products and 12 services not used by or affordable to all of the 13 customers in the marketplace. This could include 14 sophisticated routing services that compete with broker- 15 dealer smart routers and go well beyond their Reg NMS 16 obligations. 17 Lastly, we believe there should be provisions 18 that eliminate or widen any limits in cases where it can 19 be demonstrated that business decisions were made by an 20 SRO in a manner that demonstrated a disregard for the 21 integrity of the market or that knowingly transferred 22 economic risk onto broker-dealers. 23 Once we've adequately delineated products and 24 services that warrant rational limitations on liability, 25 we need to start thinking about what would be the way of 0121 1 appropriately setting those limits. 2 Today's exchange liability limits are dated, 3 inconsistent, and in our view, egregiously low relative 4 to recent experience. All the major exchanges -- at the 5 major exchanges they generally range from half a million 6 dollars to $3 million on a given month. These limits 7 could be exceeded with a single instance with a single 8 counterparty. And even more so still, in the event of a 9 market-wide event, they're not even close to what could 10 conceivably be at issue. 11 We support the subcommittee's recommendation 12 that the appropriate level should be informed based on an 13 exchange level of listing activity; the cost to the firm 14 of outages and other disruptive events; the stuff that's 15 in the recommendation, right, including amounts that have 16 been paid out. It would be good to have more information 17 and transparency about what is sort of the gap between 18 claims and what is the gap between what has been paid as 19 well as possibly input from insurance providers. Hard to 20 think of what that methodology should be, but that seemed 21 like a very thoughtful start. 22 Keep in mind that raising liability limits 23 could increase risk and cost for exchanges. However, we 24 would believe that the current construct of immunity and 25 limitations on liability has eliminated appropriate 0122 1 accountability and resiliency. This artificial 2 elimination of cost and risk has been a factor 3 contributing to the proliferation of exchanges and market 4 fragmentation. 5 We also agree with the subcommittee's 6 recommendations that SROs should maintain reserve funds. 7 We think this is a very good idea to satisfy liability 8 claims, and this would help ensure that liabilities could 9 be met and would reduce concerns about potential business 10 failures. 11 Lastly, on the issue of regulatory 12 centralization, we wholeheartedly agree with the 13 recommendation that certain cross-market regulations 14 should be centralized. Individual exchanges should not 15 be conducting duplicative and overlapping surveillance 16 beyond their own market. This should be done by one 17 central regulator. And I think Tom made a lot of good 18 points on that front. 19 Exchanges should continue to discipline the 20 trading activity on their own markets under their own 21 rules. And given their -- I think that the 22 recommendation said, "their unique expertise in 23 regulating their own markets." 24 But the walls of an exchange and its data 25 center should define the scope of an exchange's self- 0123 1 regulatory functions. Why is this important? Broker- 2 dealers have indeed been subject to regulatory 3 duplication and at times contradiction where different 4 exchanges have differing interpretations on the same or 5 similar rules. This construct is inefficient both for 6 broker-dealers and for the regulators. 7 We agree that, as the regulatory evolves with 8 the implementation of the CAT, that this centralization 9 will be even more critical. It will be a situation where 10 more exchanges have more access to more cross asset 11 trading data, and they could conceivably get this data -- 12 each one of them come around and start investigating 13 similar things when one could effectively do that job. 14 So, our regulatory model does need to evolve with the 15 regulatory infrastructure 16 Indeed, we have the concern about the 17 possibility of the creation of a regulatory monopoly. 18 This centralized construct would therefore require a high 19 degree of transparency, industry engagement and 20 accountability. I like the -- Tom's words about 21 collaboration and partnership and accountability and 22 oversight -- those are all very important things in this 23 construct -- so that we don't end up in a model that 24 increases inefficiencies or unintended behavior or 25 outcomes. 0124 1 That's it for now. We're going to be 2 submitting some written comments that are even more 3 extensive, and we look forward to discussing. 4 MS. SEIDEL: Thank you, Brett. 5 So, now I'll open it up to the committee for 6 questions and discussion. 7 Jamil? 8 MR. NAZARALI: Yeah. I'd like to -- well, I'd 9 like to start by just saying we support the 10 subcommittee's recommendations and then also to address a 11 point that John made, that, you know, having a central 12 regulator is -- is an idea that solves a problem that 13 doesn't exist. 14 There is a problem that exists, and that 15 problem is that you have multiple regulators that are 16 doing the same function, which for the industry creates 17 duplication and inefficiency and an enormous burden. 18 And it may have made sense in the old world 19 where there are basically two SROs, each which have the 20 trading about 80 percent of the issues that were listed 21 there, but it doesn't make sense in today's world where 22 you have multiple SROs. And as an industry, it's really 23 creating a big burden of compliance. And so, it's a real 24 problem. It does need to be addressed, and we're 25 wholeheartedly supportive of the recommendation. 0125 1 MR. KETCHUM: I won't belabor things too much, 2 because I had that conversation before. And I would 3 underline that I wholly admire some of the efforts that 4 have been made from the standpoint of exchanges bringing 5 their expertise and identifying a range of problematic 6 activity. 7 I would not just for clarification vis-a-vis 8 Chicago's comment that the one comment you made with 9 respect to a specialized order type and your ability to 10 oversee that actually is consistent with the 11 recommendation because it is an exchange-only rule 12 environment. 13 I would note to Anthony that I admire his 14 program, and what he describes is quite impressive. Of 15 course, some of the concerns you raised -- this was 16 clarified afterwards -- aren't relevant here because 17 anything recommended by the committee does anticipate 18 exchange oversight and -- as exists today with respect to 19 insider trading or as exists from a collective basis. 20 And we would expect to do it. 21 I may be somewhat unique here that I actually 22 lived in an environment where there wasn't a single audit 23 trail but where two major markets were -- had similar 24 rules. It was called the New York Stock Exchange and the 25 NASD -- and often engaged and identified activity with 0126 1 respect to those similar rules and worked through 2 investigations. 3 I do agree that cooperation works. It doesn't 4 work far from perfectly. You create a large 5 organization, and that organization wants to receive 6 credit and the ability to continue through. And there is 7 inevitable duplication that runs through that. 8 That's very different than coordinating with 9 the SEC because the SEC is the quarterback and gets to 10 call who's going to handle the recommendation, who's 11 going to drive it, so completely different than that -- 12 that type of environment. 13 To Jamil's point, we've moved to an environment 14 that's way different. We've got 15 or so different 15 venues, and there is no such thing as a high-frequency 16 trading manipulation. It does not occur essentially in 17 every one of those venues; it's split across. And the 18 coordination challenges across those venues, in being 19 able to conduct separate investigations of related 20 behavior, I just respectfully say is -- not to say it 21 can't be done and that certainly any SRO that was 22 involved with it would do their level best to coordinate 23 and work closely together, it's extremely difficult. 24 And the likelihood of either differential 25 position point of views, problems from coordination, 0127 1 timing issues, and the like, and the impact that may have 2 with respect to either the effective investigation or the 3 burden on the industry, I just respectfully say I think 4 it's a greater problem than may have been reflected. But 5 I'll just leave it at that. 6 MS. SEIDEL: Joe? 7 MR. MECANE: Yeah. I'll maybe expand on that a 8 little bit, and I'll make two points, and I'll mainly 9 direct them maybe to John and Anthony just for you guys 10 to react to in terms of what I think we at least 11 struggled with or discussed that kind of led to the 12 recommendation. 13 So, I think we intentionally used the two words 14 "efficiency" and "effectiveness" even though they're kind 15 of generic terms. But I think we have specifics behind 16 them. And on the efficiency piece, I'll echo a little of 17 what Jamil said in that coordination clearly is the -- is 18 a good answer and makes sense. But what I think we 19 worried about is, absent an actual framework for that, as 20 Rick said, it doesn't happen naturally. 21 So, part one of the question is how would you 22 guys see that coordination evolving naturally in a way 23 that was efficient in terms of, you know, ensuring that 24 we didn't end up in the situation Brett outlined with a 25 lot of duplicative investigations going on. 0128 1 I think the effectiveness point is maybe a 2 little more important. And specifically, what I think we 3 struggled with is, absent a framework where someone is 4 actually responsible, how does cross-market and cross- 5 product surveillance actually happen in an effective 6 manner. Meaning, in a world with CAT where everyone has 7 access to all of the data and can go down the path of 8 cross-market or cross-product surveillance, as Tom 9 articulated, but no one is actually responsible for it. 10 You end up in a non-effective world where no 11 one's really responsible for it; everyone is doing it to 12 some extent. And then, on top of it, it's not done in a 13 well-coordinated manner. And I think part of what we 14 struggled with was, without a specific construct around 15 that, do you end up with an effective regulatory solution 16 for the industry. 17 MR. GIRA: I know you directed it to them. Can 18 I 19 -- I mean, I think one thought to consider is, you know, 20 you can either have an exchange make a decision to go by 21 itself, or you could make a decision to go with others. 22 And I think from a -- we could be indifferent to that. 23 I think we're -- to get to your point, Joe, I 24 think it comes to the standards. If you go it on your 25 own, what are the standards you have to meet so that you 0129 1 have comparability between those programs? Because if 2 you don't have that comparability, there could be gaps; 3 there could be a race to the bottom; you could have some 4 entities sort of underwriting other entities that might 5 have inefficient or not as a good a program. 6 And again, I would say in terms of the -- how 7 you actually might be able to coordinate, I would just 8 point out that, in our environment today, we do not 9 introduce a surveillance pattern. We do not modify our 10 surveillance pattern without getting the approval of all 11 of our clients. 12 So, it really comes down to the quality of the 13 surveillance patterns, I think, that we should be most 14 concerned about. And whether you can do that in a 15 desegregated way, that's great. But at the end of the 16 day I think we just want to make sure that there are good 17 patterns canvassing the data and finding violations. 18 There's different ways to get there. I would 19 just submit bringing all of the best minds together into 20 one platform would have a higher probability. 21 Anthony? 22 MR. KERIN: We have a history of sharing 23 information and making referrals to other markets, and 24 when that's done, working collaboratively towards a 25 resolution. I don't expect that to change at all that, 0130 1 you know -- as I said, we have been working together. 2 You should also know I'm somewhat disadvantaged 3 because I'm not the CRO. And the cases that we do refer, 4 I'm not privy to. But I do know we do quite a bit of 5 that, and it works. And it hasn't been problematic. And 6 firms are not shy about calling me up and complaining, 7 whether it's a regulatory matter or not, if they feel 8 that our actions are duplicative of that of another 9 market or problematic. 10 In terms of going forward, I understand the 11 concern about a duplicative effort and consuming a lot of 12 time. But I think we should let this play out. We 13 should see if there are indeed problems. And if there 14 are, let's fix them. But I don't have much of an 15 appetite to fix that now until we know what the problem 16 really is. 17 MR. ALBANESE: Yeah. I just wanted to also 18 quickly address one thing that Rick had said. Rick had 19 said that, if I understood, that our oversight would be 20 the same as with respect to insider trading. 21 Did I understand that? 22 MR. KETCHUM: Oh, the -- no. Insider trading 23 is actually done through a 17d-2 agreement, so it would 24 be somewhat different. 25 MR. ALBANESE: Right. It would be different. 0131 1 That's what I wanted to clarify. 2 MR. KETCHUM: It would be analogous to -- I 3 mean, either that works through -- and obviously there's 4 a variety of discussions over the possibility of -- the 5 vision of the committee was that it would be 6 multilateral, not exchange to whatever the provider was, 7 that it would be multilateral from that standpoint and 8 thus analogous to the type of oversight you have with 9 respect to insider trading, if anything greater, because 10 in insider trading there is a 17d-2 give-up of 11 responsibility. And here there would not be. 12 MR. ALBANESE: Right. That's what I wanted to 13 clarify -- 14 MR. KETCHUM: Yeah. 15 MR. ALBANESE: -- because currently we have 16 much greater oversight under the RSA than we do under 17 17d-2. 18 MR. KETCHUM: And it was not proposed that we 19 would move away -- 20 MR. ALBANESE: Rights. 21 MR. KETCHUM: Move towards the multilateral RSA 22 to increase the effectiveness of that coordination across 23 exchanges but not proposed one way or another which type 24 of approach it would be. 25 MR. ALBANESE: Okay. 0132 1 And then, to respond to the other question, 2 look, we believe that coordination is possible and it 3 works. And I think that what we're saying is it's 4 premature to make this determination without seeing how 5 the CAT works. And we do work closely with the other 6 exchanges. As John had said, he may -- the exchanges 7 might get together and choose one exchange to do cross- 8 market work, or they might want to choose a third party. 9 For the Commission to sanction one -- to choose 10 one entity and sanction that entity to do cross-market 11 surveillance, it is creating a monopoly. You do -- you 12 lose the benefits of competition. And I don't think you 13 can ignore the substance. I don't think you can put 14 aside that the entity may be less efficient and less 15 aggressive and not as strong a regulator. 16 I think we have to look at the facts on the 17 table. I think we have to look at the history. I don't 18 think we can ignore all of that. I think it's important, 19 and I think that, if you have more than one regulator, 20 it's going to force those regulators to be more 21 effective, to be more efficient. And if you don't, then 22 you won't have that effect. 23 MR. RATTERMAN: (Mic malfunction.) That's all 24 right. I'll just talk loud. 25 If we can coordinate once there's a detection 0133 1 problem, then we should reduce that load. I firmly 2 believe that, if we allow the industry to have one and 3 only one party looking for -- behavior. 4 So, I personally strongly believe multiple 5 parties looking shouldn't provide an extra cost to you as 6 a member. We should get together and coordinate as soon 7 as possible when it looks like we're all going to be 8 hitting you. But to have multiple parties looking is the 9 only way that we can guarantee that we keep each other 10 sharp and that we find -- fact that BATS has brought many 11 things to FINRA. You know, other exchanges have brought 12 -- it has to be multiple people looking for this 13 behavior. It can't be done in one party. 14 But we shouldn't put that load on you. Once 15 we're looking past the point of inquiry, it should very 16 quickly be consolidated. And I think that the 17 subcommittee's proposal strikes a good balance in that 18 regard. 19 MR. ALBANESE: And again, just to reiterate, I 20 think that this is all new. We haven't seen the CAT. As 21 you said, there can be a determination as to a point of, 22 once your problem is detected, how to resolve it, how to 23 coordinate. And I think that's -- we feel strongly 24 that's something that can be worked through and 25 coordinated in a way to minimize the burden on firms. 0134 1 MR. REDFEARN: I have just a question, I think, 2 for Rick maybe, because in the document, it makes a 3 differentiation between the fact that individual 4 exchanges would still be looking at activity that could 5 be an issue that's a cross-market activity; identify it; 6 initiate something with respect to a single regulator. 7 But what the difference is, is material 8 insomuch it wouldn't be five different regulators 9 potentially coming forth and doing an investigation and 10 doing all of the follow-up. 11 So, can you just clarify -- 12 MR. KETCHUM: Sure. 13 MR. REDFEARN: -- because it seems like -- some 14 of what's being said seems like they wouldn't even be 15 watching. 16 MR. KETCHUM: I think actually that -- thank 17 you for the question. I think Joe said it quite 18 well, that the recommendation does -- while there may be 19 a variety of efficiencies in coordinating a range of 20 cross-market surveillance to ensure the excellence of 21 that basic surveillance, even in today's environment -- 22 Anthony mentioned New York's real-time piece. I think 23 the leader from the standpoint of real-time surveillance 24 was BATS from the standpoint of identifying a range of 25 manipulative activity and did a terrific job from that 0135 1 standpoint that basically drove its initial rule filing 2 from a market integrity standpoint. And no one would 3 want to change that. 4 I say, it may make sense for a wide variety of 5 surveillances to be consolidated into a single provider, 6 but every market should be concerned about its integrity 7 and with that should be able to use its expertise to 8 ensure that the best possible detection devices are going 9 on. 10 So, none of the -- the recommendation simply 11 does not propose to restrict in any way the ability of 12 markets to do that. It is focused, as Joe properly said, 13 at the point that this starts to impinge from a judgment 14 standpoint of where the investigation's going; how it -- 15 how those questioning is going to go from an exchange 16 standpoint -- from a firm standpoint, etcetera. 17 And there we believe that, properly oversighted 18 by the SEC and by all the SROs that have a statutory 19 responsibility, that it is vastly preferable for that to 20 be done by a single set of analytics and a single 21 interface with respect to the industry folks that are 22 being investigated. 23 MR. GIRA: I would just add -- and you know, I 24 think it takes a village to do this. And when I 25 mentioned the over-a-thousand referrals that we've gotten 0136 1 over just the last two years, it's because of things like 2 alerts that were generated looking at an exchange's 3 specific activity. So, that definitely is part of the 4 equation. 5 Now, I also -- you know, I get it in the sense 6 that, because you -- it can't be compulsory though. I 7 mean, it's got to be something where the exchanges, 8 FINRA, etcetera, want to do this, want to bring this 9 together. I think there are concerns or that if it isn't 10 -- if you don't have the ability to sort of do it 11 yourself, you know, could bad behavior develop. I'm not 12 saying that that's been the case, but I think if it is 13 compulsory, I think that changes the game a little bit. 14 MS. SEIDEL: Anyone else? 15 MS. KIMMEL: One other piece of the 16 recommendation was the centralization of oversight for 17 CAT itself, for compliance with the CAT NMS plan. Can 18 you all comment on your thoughts with respect to that 19 recommendation? 20 MR. GIRA: I thought it was consistent with the 21 broader crossed market. I will say that CAT, as OATS has 22 been for us, is hyper technical. And I do think, in that 23 area it probably makes maybe even more sense to have a 24 centralized group of real subject matter experts. 25 It's hard -- not that it's impossible, but it's 0137 1 hard to replicate that minutiae knowledge to do the 2 surveillance that you would need for CAT compliance, I 3 think. 4 MR. BAGRAMIAN: Thank you for that question. 5 Yeah. In our comment letter, to the Commission 6 on CAT, we discussed that issue, and we lamented the fact 7 that some of the SROs that the Commission had just 8 brought enforcement cases against also had access to the 9 same CAT. So, we felt -- exchange SROs, we felt that 10 users should be limited and it should be up to the SEC to 11 decide which who should have access to it. 12 So, we support that recommendation and we -- as 13 Tom said, I think it requires sort of full-time 14 specialized expertise. 15 And I remember reading the original CAT 16 proposal, not only had limited number of accounts, but 17 also sort of it was up to the CAT NMS to give access to 18 the SEC. And we felt that was inappropriate. We thought 19 it should be the other way around, that the SEC should 20 control who has access to the CAT. 21 MS. KIMMEL: Anyone else? Any of the 22 exchanges? 23 I mean, this is a particular area where you can 24 see a centralized SRO deciding issues with respect to 25 data quality is a much superior scenario than having 0138 1 multiple SROs trying to police compliance with respect to 2 the CAT NMS plan. 3 And I know you had objections to that cross- 4 market surveillance, Anthony. I'm not sure if you have 5 those same objections with respect to the CAT NMS plan 6 itself. 7 MR. ALBANESE: I mean, as far as you're saying 8 access to the CAT data? 9 MS. KIMMEL: No. So, data quality associated 10 with CAT. You know, there'll be fines potentially. 11 MR. ALBANESE: Right. 12 MS. KIMMEL: You know, maybe there won't be. 13 MR. ALBANESE: Presumably. 14 MS. KIMMEL: But that whole process is -- well, 15 now because FINRA runs OATS, it's all FINRA. I think 16 there's a concern in the industry that, because it is now 17 an NMS plan, that you could potentially have multiple 18 SROs fining you for CAT data quality issues. And that 19 seems like a situation which we could all agree would not 20 be optimal. 21 MR. ALBANESE: Yeah. I mean, again, I think 22 there we think coordination is the key. I mean, I think 23 we think that there should be coordination among the 24 exchanges and FINRA, but we should be a part of that 25 process. 0139 1 MR. REDFEARN: I don't think it would be a 2 surprise that we would be very supportive of that. I 3 mean, when we think about a scenario where they find data 4 quality issues and put that information out to 12 5 different regulators and each one of them feels that in 6 some way they're -- we're going to hear from them, that 7 just seems like a completely inefficient and bad way to 8 go. So, centralization here is imperative. 9 And the CAT, assuming it's as efficient as 10 we're all hoping, right, that efficiency will bring 11 potentially more duplication. So, the regulatory model 12 here has to evolve with what's happening here with the 13 infrastructure. 14 MR. GIRA: You know, I guess, having done OATS 15 compliance in some way for 20 years, be great to have 16 somebody else do it. But I -- again, I think it really 17 is very hyper technical, and I do think we have to give a 18 lot of thought to how that would work. 19 MS. SEIDEL: Thank you. Any other comments? 20 Questions? No. 21 Okay. Well, thank you. This has been another 22 very good discussion, and I want to again thank the 23 panelists for their contributions. 24 As a next step, I would suggest an approach 25 similar to the first subcommittee to leave it to your 0140 1 discretion to update the proposal to reflect this 2 afternoon's discussion and, at an appropriate time, 3 convert it into a formal committee recommendation to the 4 Commission, which we would then plan on these 5 recommendations being considered at the next full 6 committee meeting. 7 I think now it is time for a 15-minute break. 8 So, it's 2:00, so maybe come back at 2:20, and then we 9 can get to the next items on the agenda, the status 10 reports from the other two subcommittees. 11 (A brief recess was taken.) 12 MS. SEIDEL: All right. Welcome back, 13 everyone. The last order of business for today is an 14 update from the Market Quality Subcommittee and the 15 Customer Issues Subcommittee. I'd like to ask each of 16 the subcommittee chairs to provide a brief report on the 17 issues that they are focusing on. 18 So, if we could start with the Market Quality 19 Subcommittee, Eric, I'll turn it over to you. 20 MR. NOLL: Thank you, Heather. Thank you, the 21 Commissioners who are probably taking a well-advised 22 afternoon break from this and staff for the opportunity 23 to continue to serve on EMSAC and to do the work of the 24 Market Quality Subcommittee. 25 A couple of updates on things and then some of 0141 1 the things that we're working on. So, the updated things 2 are, following our recommendation to adopt a no-halt 3 limit up/limit down regime, the exchanges have 4 established a working group to start to consider the 5 implications of that and how it would change the existing 6 limit up/limit down and the work on them to see if it's 7 feasible and useful to move in that direction. 8 That work has slowed down a little bit over the 9 last couple of weeks, I think, due to the implementation 10 of Amendment 12 and some of the other things on the limit 11 up/limit down plan that they wanted to get into place. 12 But they remain committed to working on this. They have 13 invited our subcommittee to participate to the extent 14 that we can. And I have been participating in those 15 meetings, so we expect that that will continue and we'll 16 continue to take that up. 17 The three areas that we are going to be looking 18 at and working on and that we've already started some 19 work on already, one is reviewing a little bit about the 20 tick size pilot and what that means for small cap 21 liquidity. And our initial review finds that, while -- 22 we found bids and offers in the tick size pilots across 23 all the buckets, really, have, in fact, increased, 24 they've gone up in size, which is logical given the tick 25 increments that are there. 0142 1 Some of the other potential hoped for and/or 2 expected consequences around the tick side pilot have yet 3 to appear. So, we haven't seen a meaningful uptick in 4 volume. We have not seen a meaningful uptick in trade 5 size. We have seen an increase in costs, trading costs, 6 and an increase in intraday volatility in those names, 7 which, again, I think is consistent with the wider tick. 8 And there has been no sign of any of the other 9 things that were proposed around the tick size pilot 10 appearing yet like increased research coverage or an IPO 11 pipeline. 12 It is possible that we're still too early in 13 the pilot to really have seen those effects. I took note 14 of Charles's earlier comment talking about Reg NMS, that 15 it took some period of time until the effects of Reg NMS 16 started to appear in the marketplace. And there may be 17 some sort of adaptive time frame her as people's algos 18 and behaviors change around the market. But we have yet 19 to see it yet, and there has been no visible signs that 20 there's more participation in these buckets. 21 We're going to continue to review this. We may 22 come back with a more substantive recommendation to the 23 EMSAC around this. But I think in the interim we would 24 encourage the commission to perhaps do an interim review 25 of where we are with it and maybe publish some of those 0143 1 findings and some initial thoughts around that, because 2 at least as market participants, our view is that we 3 haven't seen anything that would warrant sort of the 4 continued growth in this area or a continued use of the 5 tick size pilot. 6 I will, though, thank NASDAQ. NASDAQ, I think, 7 has taken some steps in this direction. They've come up 8 with a new plan to try to incent more liquidity in these 9 names, so we can see how that plays out. And I believe 10 that plan just came into effect today. 11 So, along the lines of small cap liquidity, we 12 heard loud and clear, particularly Commissioner Stein's 13 comments at the last EMSAC as well as some of the other 14 commissioners around taking another look at small cap 15 liquidity and what could be done there. 16 And so, the areas that we're looking at are the 17 notion of should there be an exclusivity around small cap 18 listings that is either outside of Reg NMS -- and they're 19 very -- there are various variations around that, so, an 20 exclusive listing that allows off-exchange trading; an 21 exclusive listing that doesn't allow off-exchange trading 22 but only on-exchange trading; an exclusive listing that 23 expires upon the achievement of certain metrics in terms 24 of liquidity or price discovery; or an exclusivity that 25 expires on time. You know, after six months it no longer 0144 1 is an exclusive listing. 2 But with the idea being that, if we want to 3 focus trading interest around some of these cap names to 4 have them bring liquidity into the marketplace, that is a 5 mechanism that could potentially work. 6 We haven't -- as you might suspect, there are 7 wide divergences of opinion about this one. We have not 8 selected or made a recommendation here, but it is an area 9 that we will continue to look at with the idea being that 10 we might bring forward some recommendation in this area 11 for the next EMSAC meeting. 12 And then, the last thing that we're going to be 13 spending some time with, which has always been on our 14 mandate and we haven't addressed yet but -- is about 15 closing auctions. 16 We had some earlier comments in previous EMSAC 17 meetings about the closing auction being a single point 18 of failure in the marketplace and something that we had 19 some concerns with. 20 Recently, as I think most market participants 21 know, Arca was unable to run its closing auctions for its 22 listed securities, primarily ETFs for many of its listed 23 securities. 24 And while there seemed to be little or no 25 impact to market participants or a negative impact to 0145 1 market participants on that day, to a certain extent, 2 that might have been luck because it was a low-volume day 3 and a low-volatility day, and the prices weren't moving 4 around much. 5 So, we're going to take a look at, you know, 6 what are some of the safeguards we can put in around that 7 and what are some of the recommendations we can do to not 8 expose the marketplace to again -- to try to eliminate 9 those single point of failure activities. And that's 10 what we'll be working on. 11 MS. SEIDEL: Thank you. 12 Are there any questions for Eric or the Market 13 Quality Subcommittee? 14 Reggie? 15 MR. BROWNE: I think looking at characteristics 16 of equities and designing a market structures around 17 these characteristics is beneficial, particularly around 18 thinly trade equities or small mid-cap companies. You 19 know, maybe a return to somewhat like of a AMEX system -- 20 the American Stock Exchange had an emerging market 21 program for newly listed companies that's probably 22 beneficial. 23 We haven't had the opportunity -- I'm a member 24 of the subcommittee -- to bring forth views from listed 25 companies, treasurers or CFOs or CEOs around the trading 0146 1 of their securities. However, ETF community would 2 benefit, I believe, from a marketplace where newly listed 3 ETFs had a ecosystem benefiting the characteristics of a 4 new ETF and how it's born, particularly the -- initial 5 float or shares outstanding is probably held by one 6 member or a few members. And it would benefit from a 7 ecosystem where consolidated and liquidity is probably 8 beneficial. 9 However, I would be against any divisions of 10 trade-at or essential limit order book. I think it would 11 being provisions such as -- like described in Canada 12 where it would have a negative outcome without empirical 13 data -- that it will be helpful. 14 So, some study around that and getting views 15 from participants, particularly from the ETF community, I 16 think, is beneficial in light of designing a system such 17 as what we said. 18 MS. SEIDEL: Thank you. 19 Any other questions? 20 Thank you. And we look forward to the 21 subcommittee's further work in the areas that you just 22 outlined. 23 And I think now we'll turn to the Customer 24 Issues Subcommittee. 25 And Manisha, would you like to give an update? 0147 1 MS. KIMMEL: Sure. 2 So, the Customer Issues Subcommittee recently, 3 last Thursday, held a buy side roundtable where we 4 invited representatives from Wellington Management, the 5 Capital Group, Marshall -- and Franklin Templeton to 6 discuss several different topics, the first being ATS 7 disclosure. 8 So, we discussed Form ATSN, the proposed form 9 and got feedback from the group that really the majority 10 of the group felt, given the high number of trades 11 that -- of theirs that are done on ATSs, that this level of 12 disclosure was necessary and the additional transparency 13 was worth the burden imposed. 14 There were some concerns raised by other 15 participants that there's potential that the compliance 16 burden itself will stifle innovation. However, you know, 17 the majority felt it was worth it. 18 The other issue we talked about with respect to 19 ATS transparency was whether or not there would be 20 benefit to having ATS inputs on the tape in addition to 21 just the D modifier. 22 And you know, this has been an issue that was 23 discussed probably about six years ago and, you know, 24 largely rejected by the industry. But given the fact 25 that you have 0148 1 -- we're in a situation now where -- of increased ATS 2 volume and decreased ATS average trade size, it might 3 warrant looking at this again. 4 You know, the concerns that were raised six 5 years ago included reverse engineering and front-running 6 issues. And so, those would still have to be addressed. 7 The next major topic we talked about was the 8 impact of MiFID II changes to research payments as it 9 relates to the U.S. soft dollar regime. 10 So, the group unanimously felt that this is an 11 issue that needed to be addressed. And really, they 12 talked about two main topics. First is ensuring that the 13 safe harbor established under Section 28(e) would allow 14 firms to pay for research out of separate research 15 payment accounts that are defined as part of MiFID since 16 those accounts are going to be funded out of clients' 17 custodian accounts and ensuring that that would continue 18 to be acceptable under Section 28(e). 19 The next issue that was raised under -- with 20 respect to MiFID II and the same soft dollar questions 21 was the extent to which U.S. broker-dealers that would be 22 accepting hard payment for research would be considered 23 investment advisors under 202(a), 11(c) and in violation 24 of the special compensation clause. 25 So, the buy-side participants were concerned 0149 1 that failure to provide such relief would limit U.S. 2 broker-dealer counterparties and also prevent U.S. 3 broker-dealers from trading with them on a principal 4 basis. 5 In addition, we -- we asked our buy-side 6 visitors what other issues they're most concerned with. 7 And the majority of the buy-side participants felt that 8 addressing exchange rebates was the most important U.S. 9 equity market structure issue that they believe needs to 10 be addressed. 11 And we did talk about the access fee pilot, and 12 the concern was raised that, you know, lack of a no- 13 bucket fee and the exclusion of inverted markets was an 14 issue. And recognizing that Reg NMS doesn't have 15 anything to do with rebates or doesn't specifically call 16 out rebates, I think the point was made that if you're 17 doing new rulemaking, that maybe rebates could explicitly 18 be addressed. It was also suggested that this should be 19 an SEC rulemaking and not an NMS plan. 20 The sort of alternate perspective given in the 21 group was that until -- unless exchange fees are uniform, 22 you will always have conflicts of interest. And there's 23 -- the variability, in itself, is an issue. 24 Also discussed was the extent to which cost 25 could be included on fixed messages so that, you know, in 0150 1 addition, as you think about this sort of a transparency 2 regime, this would be the most transparent understanding 3 of cost. Of course, for that to happen, there would have 4 to be changes to cost structures. 5 Another topic raised by this group was exchange 6 market data fees and port fees and the impact of those 7 costs on competition in the broker-dealer market. It was 8 talked about with respect to new entrants to the market 9 as well as potentially forcing industry consolidation. 10 And topics discussed there included the role of rebates 11 and the relationship between the rebates and market data 12 as well as the economics involved with exchanges having 13 exclusive rights to their market data. 14 Finally, we talked about the tick size pilot, 15 and the discussion centered around whether or not there 16 would be -- or it was wise to have a one-year checkpoint 17 -- so, one year would be October of this year -- and for 18 the SEC to establish criteria for success and then do the 19 analysis to see if, in fact, the tick size pilot was 20 meeting that criteria. 21 So, the next steps for the Customer Issues 22 Subcommittee are to review the input received from the 23 buy-side roundtable and move forward from there. 24 MS. SEIDEL: Thank you. Are there any 25 questions for Manisha or the subcommittee? 0151 1 Kevin? 2 MR. CRONIN: It's not really a question, more 3 of a statement. So, I would just echo the concern around 4 the incongruence of 28(e) and MiFID II. There isn't a 5 lot of time to get the answer, so I certainly hope that 6 the regulators collectively can take a look at this and 7 help us all understand the way forward. 8 MS. SEIDEL: Any other questions or comments? 9 All right. Thank you. And we look forward to 10 the further steps from that subcommittee as well. 11 So, are there any other issues or topics at 12 this point that the committee would like to discuss? 13 Gary? 14 MR. STONE: Manisha, when you guys were talking 15 about MiFID, did you talk at all about the trading 16 obligation and the effect it could have on the U.S. 17 markets? 18 MS. KIMMEL: The focus of this group was really 19 around research, so that might be something else to 20 explore. 21 MS. SEIDEL: Okay. Anything else? 22 All right. Well, thank you again. This has 23 been a very useful discussion on these varied, important 24 market structures issues. And to sum up, I think where 25 we are, both the Regulation NMS and Trading Venues 0152 1 Regulations Subcommittees will continue to refine their 2 recommendations based upon the conversations with the 3 goal of having a final committee vote at the next 4 meeting. 5 And the Market Quality and Customer Issues 6 Subcommittees will continue to discuss and finalize their 7 preliminary recommendations for the next full committee 8 meeting. 9 And for our part, the Commission staff has been 10 assessing the first set of committee recommendations, 11 particularly the parameter for some type of access fee 12 pilot. And we will continue to work on developing 13 recommendations for consideration by the Commission. 14 And so, with that, I will entertain a motion to 15 adjourn. 16 COMMITTEE MEMBER: So moved. 17 COMMITTEE MEMBER: Second. 18 MS. SEIDEL: Second. 19 All in favor? 20 (Chorus of ayes.) 21 MS. SEIDEL: All right. Thank you for all your 22 hard work on these issues, and we are adjourned. 23 (Whereupon, at 2:40 p.m., the proceedings were 24 concluded.) 25 * * * * * 0153 1 PROOFREADER'S CERTIFICATE 2 3 In the Matter of: EQUITY MARKET STRUCTURE ADVISORY 4 COMMITTEE 5 File Number: OS-0405 6 Date: Wednesday, April 5, 2017 7 Location: Washington, D.C. 8 9 This is to certify that I, Christine Boyce, 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, 13 and that this is the original, complete, true and 14 accurate transcript, which has been compared with the 15 reporting or recording accomplished at the hearing. 16 17 18 _________________________ _______________________ 19 (Proofreader's Name) (Date) 20 21 22 23 24 25