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THURSDAY, JULY 26, 2001,
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises,
Committee on Financial Services,
Washington, DC.

    The subcommittee met, pursuant to call, at 2 p.m., in room 2128, Rayburn House Office Building, Hon. Richard H. Baker, [chairman of the subcommittee], presiding.

    Present: Chairman Baker; Representatives Shays, Oxley, Biggert, Miller, Kanjorski, Ackerman, Bentsen, Sandlin, Sherman, Inslee, Moore, Crowley, and Israel.

    Chairman BAKER. I would like to call this hearing of the Capital Markets Subcommittee to order. I am informed that Mr. Kanjorski is on his way and will be here momentarily for his own opening statement.

    Today, the Congress faces the challenge of reviewing the national market system to determine how securities laws may be amended not only to reflect today's technology, but also be flexible enough to adapt to the changing market condition.

    This is our second hearing on market data, the stock price information that is basically the lifeblood of our capital markets. In a sense, we are beginning to weigh in on very difficult questions, but one with very important implications. What is the metaphysical status of market data? Where does it reside? Who owns it? How can the system be improved so that all investors have equal access?
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    The 1975 amendments to the 1934 Act reflect the need for a system that would provide consolidated quotes so investors could easily match lowest offers with highest bids. While the plans established as a result of the amendments have provided a valuable function, they do not operate, in my view, in a truly competitive environment. Moreover, recent technological advances and explosion of the internet usage were not and could not have been contemplated in 1975.

    In March we focused on how market data is collected, consolidated and distributed. We examined whether the fees collected by the exchanges from users, investors, are being used solely to fund the Government-mandated consolidating functions, or whether fees were subsidizing other activities.

    Today, we will discuss whether there should be additional legislation to explicitly establish a proprietary right over the market database or to give special protection to the operators of the databases through new private causes of action.

    The plans claim they already have a property right in the data because they build and maintain the system and add value to the information. Others, including the electronic communications networks and online trading systems, argue that the quotes from their customers are what give the databases their value. These same market participants claim that opening the market data system to a competitive environment would allow them to provide investors with better quality and depth of information and perhaps even at lower cost.

    In a time when we are considering the entire national market system, we are faced with the question of whether Congress should act to give further legal protections to the exchanges over market data. Today, we will examine whether there is a need for such legislation and whether or not the cost and dissemination of market data to investors and other participants is adequately served. More importantly, we will ask whether legislation on this issue is appropriate when there is such a broad array of concerns with the underlying national market system itself.
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    I would note, beyond the prepared statement, that in reading all of the testimony last evening, there is a clear bifurcation in opinion. From one perspective it is our data, and we not only want to preserve and protect it, but we want an additional right of civil action against those who use it inappropriately. From the other perspective it is not yours, it belongs to me, and you should give it to me for very little cost and perhaps create an environment in which the generation of that data itself is put in jeopardy.

    So this is no easy question to resolve. Clearly there is a need for modification. The question is the appropriateness of those modifications and whether we bring about any disruptive consequences of suggesting those alterations.

    With that, Mr. Bentsen, do you have an opening statement?

    Mr. Israel, do you have an opening statement?

    Mr. Israel.

    Mr. ISRAEL. Thank you, Mr. Chairman. I am pleased to be here, and thank you for convening this hearing, and I would like to welcome the witnesses.

    Mr. Chairman, as you know, the securities markets have been producing market data for two centuries. In my home State of New York, the New York Stock Exchange provides an essential liquidity source for the collection of information of millions of orders every day and creates valuable, reliable and accurate market data that is relied upon by investors worldwide. The markets invest billions of dollars in state-of-the-art technology to ensure that the public receives real-time data on demand, and no one has to worry that that data is not truthful or that its integrity has been compromised.
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    Now, some would suggest that the New York Stock Exchange and the other security markets do nothing more than collect orders and charge others to receive the data. I strongly disagree. I visited with the New York Stock Exchange, I have seen their technology, and I am convinced that the New York Stock Exchange provides an efficient forum for price discovery that produces accurate and valuable market information that is unparalleled worldwide.

    It does concern me that as we move to a greater reliance on the internet, enterprising hackers could make unauthorized uses of market data and hurt investor confidence in market information. So we have to ensure that any legislation that this subcommittee chooses to consider protects the authorized use of data and provides a uniform Federal standard. Efforts that would deter those who would pirate market data and attempt to damage the integrity of the greatest capital markets in the world would be a welcome tool.

    I thank you, Mr. Chairman, for holding this hearing. I look forward to the testimony of our witnesses, and I yield back.

    Chairman BAKER. Thank you, Mr. Israel.

    Mr. Kanjorski.

    Mr. KANJORSKI. Thank you, Mr. Chairman. And thank you for the opportunity to comment on market data issues, and particularly the implication to investors and for market transparency of granting ownership rights over stock quotes, before we hear our witnesses today.
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    We last discussed this issue of market data at a hearing in March. At that time, I noted that the securities industry presently faces few issues as important or as complex as those surrounding the ownership and distribution of market data. In short, the wide distribution of market data remains a fundamental component of our Nation's securities markets.

    A regulatory framework that promotes the transparency of market data, especially the real-time, public dissemination of trade and quote information, helps to make certain that all market participants have access to prices across our national market system. This access, in turn, helps to provide an efficient price discovery and the best execution of customers' orders.

    In our current system for distributing market data, millions of investors worldwide have easy access to market data. The world, however, has changed substantially since Congress enacted a law governing market data in 1975, and we are therefore reexamining these issues to determine whether we need to refine our approach on such matters. For example, the Securities and Exchange Commission (SEC) has recently begun to examine these difficult issues and other related and complicated questions through its Advisory Committee on Market Data.

    As you may also recall, at the end of our last hearing, Mr. Chairman, you and I wrote to the SEC inquiring about the activities of its Advisory Committee on Market Data issues. In her response, SEC Acting Chairman Unger noted that she expects the Advisory Committee to issue its report no later than September 15. She also expects this report to be quite helpful, not only to the Commission, but to others interested in reviewing market data issues. Although it is appropriate for us to begin to educate the Members of our subcommittee about this complex issue, I would hope that our subcommittee would wait to pursue any further action on market data issues until we hear and fully digest the recommendations of the Advisory Committee.
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    In closing, Mr. Chairman, I want each of our witnesses to know that I continue to approach the issue of market data with an open mind. The comments of our panelists about securities database issues and market data ownership rights will therefore help me to discern how we can maintain the efficiency, effectiveness and competitiveness of our Nation's capital markets in the future.

    I yield back.

    Chairman BAKER. Thank you, Mr. Kanjorski.

    Mr. Shays, would you have an opening comment?

    Mr. SHAYS. Thank you, Mr. Chairman.

    For disclosure, since Nasdaq is in my district, I disclose that it is in Trumbull, Connecticut, but I intend to have an open mind, but be very slanted toward Nasdaq.

    Chairman BAKER. As your historic conduct has indicated. Thank you, Mr. Shays.

    Any other Member have an opening statement? If not, at this time I would like to proceed to introduce our first witness, pleased to have you here, the Senior Vice President and General Counsel of Charles Schwab, Mr. Hardy Callcott. Welcome.

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    Mr. CALLCOTT. Good afternoon.

    Chairman BAKER. And I am sorry for interrupting already. Everyone's full testimony will be made part of the official record. Please feel free to summarize as appropriate, Mr. Callcott, and you will need to pull those mikes pretty close. They are not as sensitive as you might think.


    Mr. CALLCOTT. Thank you. Thank you, Chairman Baker, Ranking Member Kanjorski and Members of the subcommittee. My name is Hardy Callcott, and, as you say, I am senior vice president and general counsel of Charles Schwab and Company. Schwab offers a full range of financial services to our more than 7.7 million active customer accounts, helping our customers manage more than $850 billion in assets. Thank you for inviting me to testify this afternoon.

    As many of you are aware, Schwab has at been at the forefront of the debate on market data for several years. In 1999, our rulemaking petition to the SEC was a catalyst that helped bring this issue to the forefront. We have participated in the SEC's Advisory Committee on Market Data, which the SEC formed last year after its 1999 concept release on market data, which was, in turn, a response to our rulemaking petition.

    We asked the SEC to review the market data system for one major reason. Our clients and millions of individual investors that make the U.S. capital markets the most vibrant in the world want and deserve a system that uses cutting-edge technology to provide the robust, innovative market data essential to success in today's volatile markets.
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    Over the past 2 years, we have come to recognize that market data reform for the 21st century is absolutely essential for our markets, and that reform must be based on three basic principles: deregulation, competition and equal access. Today, individual investors are disadvantaged in several ways by the current Government-granted monopoly in market data.

    First, the high cost of market data prevents brokerages like Schwab from offering its customers the best possible product. It is technologically feasible for Schwab to provide real-time streaming quotes to all of our online customers so that, just like institutional investors, they can watch the markets as they move. But providing all currently-available streaming data to our customers who have electronic access would cost in the neighborhood of $157 million a year, some nine times what we currently pay for market data. As a result, we can't afford to offer streaming quotes to most of our client base. With rapidly changing quotes in today's market, static market data places individual investors at a disadvantage compared to other market participants.

    Second, the introduction of decimal pricing in our markets is making the monopoly quotes irrelevant for all investors. Decimals have lowered the bid-ask spread for stock, saving billions of dollars for investors. The decimals have also decreased the depth of quotations, the amount of stock available for purchase that the inside bid or ask, by some 60 to 80 percent. As a result, the basic market data provided by the markets, the inside bid and ask, no longer provides investors with enough information to make informed trading decisions.

    No market currently provides a retail depth-of-book quote product. Nasdaq does provide a Level 2 quote product for an additional fee, which provides the best quote offered by each market-maker in a given security, but even Level 2 is not a true depth-of-book product, and the Consolidated Tape Association, (CTA), which processes quotes for exchange-traded stocks, has no product even equivalent to Nasdaq Level 2. As is always true when the Government grants a monopoly, product innovation and technological development is stifled.
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    Further, because of the increasing cost and decreasing relevance of the monopoly quotes, internet portals such as Yahoo now provide real-time quotes from ECNs in preference to the quotes produced by the markets. Brokerages like Schwab are legally precluded from providing these alternative quotes to clients without also having to display the market data provided by the self regulatory organizations.

    With that context, let me briefly address two important issues today. First is our view of what not to do, and that relates to the database protection legislation that has been proposed in the last three Congresses. The second is our suggestion of what Congress can do to make a market data system that best addresses the needs of all investors.

    For the past several years, the SROs have advocated database protection legislation that would grant them a property right over market data. But market information is a set of facts: bid prices, ask prices, limit order prices, last sale prices. No one can own facts. The Supreme Court's unanimous 1991 decision in Feist Publications v. Rural Telephone Service Company held that facts, in that case telephone numbers, cannot be owned, and we see no reason why this set of facts should be any different. In the several years that the markets have sought a property right in market data, they have not been able to point to any real-world abuses which would justify such a lucrative windfall.

    Moreover, it is investors and brokerages who create these facts, not the securities markets. Brokerages are required by law to provide these facts to the SROs without any compensation. Brokerages are then required by law to buy this information back from these Government-created monopolies and provide it to our clients.
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    Schwab is not advocating that brokerages be given property rights in market data, but if we are legally required to provide the information free of charge and then are legally required to purchase it back from the markets, in our view it would be grossly inequitable to grant those markets property rights in that information in preference to us. Moreover, such a property right would be counter to Congress' laudable goal of ensuring ready public availability of the information.

    Let me now turn to the principles Schwab believes should form the core of a reform plan. The solution is not to require more regulation of what should be displayed and how. Rather, it is to deregulate market data systems so that multiple vendors can compete to provide the most innovative and cost-effective market data products. To promote competition, legislation should require the SROs to make available the same raw data that brokerages and clients are required to report to them. The SROs would then be required to offer all of that data on the same terms to everyone; not just inside quotes, but also depth-of-book information. This would enable brokerages and market data vendors to disseminate real-time market data independently in ways that best respond to investor needs.

    Second, all aspects of the market data system must have greater transparency.

    Third, under our proposal, regulatory oversight would be limited to ensuring fair and nondiscriminatory access requirements are enforced so that no one is penalized because of how they use or distribute market data.

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    Finally, database protection legislation should not give the securities markets a property right over market data in preference to brokerages who create the information.

    Thank you very much for the opportunity to testify this afternoon, and I look forward to answering your questions.

    Chairman BAKER. Thank you very much, Mr. Callcott.

    Before I recognize our next witness, we have been joined by the Chairman of the full committee, Congressman Oxley. I would like to recognize him at this time if he has an opening statement.

    Mr. OXLEY. Thank you, Mr. Chairman, and I will submit my full opening statement for the record, but simply to welcome our witnesses on a series of hearings on market data. And as the last hearing pointed out, clearly there is a crying need for reform and modernization through the structure governing market data dissemination, but obviously a lot of different views on how we should do that. Ultimately our subcommittee will be working on making certain that whatever ultimately the outcome is, it is based on transparency and giving the average investor and the market players adequate information that they can use and at a reasonable cost.

    And so I want to commend you, Mr. Chairman, for what you have been able to accomplish in setting up an excellent panel that will focus in on all sides of this very difficult issue, but one that we simply have to address, and obviously the sooner, the better.

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    And with that, let me yield back, and I look forward to the rest of the testimony.

    Chairman BAKER. Thank you, Mr. Chairman, and as always I certainly appreciate your interest in these issues and participation in the subcommittee's work.

    Our next witness is the General Counsel for The Island ECN, Mr. Cameron Smith. Welcome, Mr. Smith.


    Mr. SMITH. Good afternoon, Mr. Chairman, Members of the subcommittee. I commend the Chairman and the Members of the subcommittee for holding these hearings concerning the integral part of our securities markets, market data.

    Island has played a leading role in providing investors with unprecedented access to market information through the Island Book Viewer, a free real-time view of all open buy and sell orders on Island. It is available to all investors on our website. For this reason Island greatly appreciates the opportunity to share its views on market data.

    In brief, it would be a mistake to grant exclusive proprietary ownership rights in market data before reviewing the outdated policies that create regulatory monopolies for the producers of market data. Therefore, we should embrace those reforms that promote competition and innovation.
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    I am Cameron Smith. I am the general counsel of Island ECN. Island is an automated trading system for equities securities. We function as a pure auction market directly matching buy and sell orders. Island is a network of approximately 700 broker-dealers represent ing a diverse array of market participants.

    On an average day, Island will trade over 320 million shares, approximately 16 percent of Nasdaq's transaction volume. Through June of this year, Island has traded over 44 billion shares worth almost $1.5 trillion.

    Since Island introduced the Book Viewer in 1998, hundreds of thousands of investors have visited the Island website to get the latest market information. In light of the popularity of the Island Book Viewer, the New York Stock Exchange has recently announced OpenBook, and Nasdaq plans to introduce the Super-Montage. Both initiatives are designed to provide investors and market participants with a broader and deeper level of market data.

    It was the very success of Island's Book Viewer and its competitive effect on the market that drove the subsequent market reforms. Consequently, we risk undermining the very process of competition and innovation if each market were granted an exclusive proprietary right in its market data.

    Let's briefly review the extensive regulations currently governing market data. By regulation, all broker-dealers are required to become members of self-regulatory organizations such as the National Association of Securities Dealers or the New York Stock Exchange. By regulation self-regulatory organization members are required to report transactions exclusively to the applicable SRO. By regulation this information is required to be consolidated. And by regulation, any party disseminating market data must only disseminate consolidated market data from every SRO.
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    As you can see, there are no competitive free market forces at work with respect to market data. The price is determined by SROs, subject to SEC approval. The SEC, therefore, is entrusted with a difficult task of regulating market data fees.

    One of the key regulatory requirements underpinning the current regulatory monopoly enjoyed by SROs is what is known as the vendor display rule. The decision as to whether to abrogate the vendor display rule is the key decision in creating a truly competitive market for data. In its simplest terms, the vendor display rule requires every vendor market participant to disseminate only consolidated quotation information. Thus, the issues related to market data rates that Charles Schwab, among others, has long raised all emanate from the existence of the vendor display rule. Ultimately the decision concerning whether to continue the vendor display rule should only be made after careful consideration of the cost and benefits.

    Let me briefly identify three of the clear costs to the rule. First, the current regulatory structure confers monopoly power on the SROs that could only be checked by Government regulation.

    Second, a vendor display rule subsidizes smaller markets, thus distorting competition between markets.

    And third, the vendor display rule harms innovation by either directly prohibiting new data services or making such new data services cost-prohibitive to provide to investors.

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    In conclusion, Mr. Chairman, given the comprehensive regulatory structure already governing market data, it is not an appropriate time to create additional proprietary rights in market data. Instead, we must first reexamine the current regulatory structure, particularly the vendor display rule.

    I look forward to working with you and your colleagues in introducing competition and innovation to market data and thereby strengthening our Nation's equity markets. Thank you.

    Chairman BAKER. Thank you, Mr. Smith.

    Our next witness is no stranger to the subcommittee, President of the Securities Industry Association, Mr. Marc Lackritz. Welcome, Mr. Lackritz.


    Mr. LACKRITZ. Thank you, Mr. Chairman. It is a pleasure to be here, Chairman Oxley, Chairman Baker, Mr. Kanjorski and distinguished Members of the subcommittee. The Securities Industry Association, (SIA), appreciates the opportunity to testify today on the implication of granting ownership rights in stock market information.

    SIA member-firms, regulators, legislators and other market participants have been reconsidering the current system of providing securities market data now for several years. We have examined the appropriate avenues to collect and consolidate the information, the fees charged for this information, and the role of revenue derived from those fees. The issue is complex, and the impact on market structure will be quite significant.
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    As the database industry in the United States continues to grow, efforts are now underway to grant new protections to those who collect and compile information, including securities information processors. We believe that legislation that would create new property rights in stock market information would seriously undermine the current effort to reform the process of consolidating and disseminating stock market information. Moreover, it would be contrary to the goals that Congress set forth in the Securities Act amendments of 1975. We believe that adequate protections currently exist to address information theft, and to legislate in this area would disrupt the regulatory and contractual regimes that make real-time market information so widely available today.

    Securities markets are synonymous with information. Market information, that is the quotes at which people are willing to buy and sell stock and the price of the last sale of the stock, is truly the lifeblood of the market. The widespread availability of this information, also known as transparency, ensures that buyers of securities do not pay more than the lowest price at which someone is willing to sell, or sellers do not sell for less than the highest price at which someone is willing to buy.

    Transparency of market information has also given individual investors unparalleled access to much of the same information that previously was available only to market professionals. Unrestricted easy access to this information is what has made the U.S. capital markets the envy of the world. Our markets are deep, liquid and fair. Transparency is one of the reasons.

    The advent of the information age has raised concerns about database piracy and the need to protect those who compile information in online databases. Copyright law will generally prevent the wholesale copying of an entire database as long as there is at least a minimal amount of original expression, but it does not protect the extraction and reuse of individual facts.
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    Securities market information, that is, the best bid and offer and last sale reports, is no more than a collection of facts derived from various market participants. Database publishers, including securities information processors, also rely on contracts, common law and technological measures to prevent the misappropriation and misuse of data that the publishers compile.

    Such measures have always been sufficient, at least until recent actions in Europe created the possibility of powerful new rights for database publishers. We must be careful not to let international initiatives trigger the dismantling of a system that has grown up over the last 30 years in the U.S. securities industry. Any legislation that would create an intellectual property right in securities market data would have huge implications on the system for collecting and disseminating market information that Congress so carefully devised in the 1975 Act amendments.

    In addition, conferring new property rights could impede the flow of real-time market information, because as single-source monopolies, the markets could charge excessive fees and restrict the downstream use of that information. Because they are SROs subject to SEC oversight, this may not seem problematic at this point in time, but these markets may soon be operating as for-profit enterprises that will be obligated to shareholders to maximize their earnings.

    Under SEC rules broker-dealers are required to submit last sale and best bid and offer information to the markets securities information processors. Vendors in turn receive and distribute market information from the processor pursuant to various contract and licensing arrangements. Although it is important to protect the markets' joint investment in data technology and infrastructure against persons who would take market information without paying for it, we do not believe that markets are without protection under the current structure.
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    Our industry strongly supports broad dissemination of stock market information. Granting new property rights in market information through database protection legislation, no matter how well-intentioned, will vest control of market information into the hands of single-source monopolies in the securities industry, and that would be the antithesis of broad access to market information that Congress intended in enacting the 1975 Act amendments.

    With new proprietary rights in the information, the only constraints on pricing would be the statutory standard that requires fees to be fair, reasonable and not discriminatory. What is considered fair and reasonable by an exchange might be very different than what is considered fair and reasonable by a market participant that conducts business off of the exchange. If costs should prove to be excessive, the result is likely to be less information available to investors. Legislation that would restrict such downstream use of market information would cripple this industry and impede, rather than enhance, investors' access to information.

    Bids, offers and last sale prices are nothing more than facts generated by investors. Alone they have no value, but when they are consolidated into a single stream of information, they tell investors what the market for a particular security is at a given point in time. The value of this information is unquestioned. It generates hundreds of millions of dollars each year.

    Today, a combination of regulation, copyright, contract and common law ensures that information is widely accessible to all investors, and that compilers of information are adequately compensated for their efforts. New property rights will unnecessarily upset this careful balance.
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    Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Lackritz.

    Our next witness is the Executive Vice President and General Counsel for the New York Stock Exchange (NYSE), Mr. Richard Bernard. Welcome, Mr. Bernard.


    Mr. BERNARD. Thank you, Chairman Baker and Mr. Kanjorski and Members of the subcommittee. I am glad to be here on behalf of our Chairman Dick Grasso and have the opportunity to testify about protecting market data, and it is with particular pleasure I note that this is our 134th year of electronically disseminating market data, the ticker having been invented and used since 1867. It is the 26th year since your predecessors gave jurisdiction over these matters to the SEC, and as a personal note, it is 22 years since I wrote my first memo on proprietary rights in market data. So this is a special opportunity for me.

    To the extent I have time, I will touch on three themes briefly. First, contrary to what some of my colleagues have suggested, we don't merely collect data, we create it.

    Second, the law, as Marc has indicated, already recognizes proprietary rights, not only the common law such as State misappropriation law, but also the 1934 Act itself.
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    And thirdly, lest we forget, those same members of Mr. Lackritz's group are also members of the New York Stock Exchange, and they, through our board of directors, are the ones who decide how much market data fees ought to be and what percentage of our costs ought to be covered by market data fees. And so the very structure of the New York Stock Exchange is where the subcommittee should be looking to satisfy itself that what is being done with market data fees is fair and reasonable and fairly allocates our costs.

    We exist to provide market data. We provide a mechanism to discover prices, and to echo a point that Congressman Israel made in his opening remarks, the orders that come from investors and the proprietary trading interests of broker-dealers, these are the inputs to our process, but the output is the trade and the last sale price, and that is what happens at the New York Stock Exchange. That is why I characterize what we do as creating data and not simply collecting data.

    Second, in this regard I want to point out that current law, as I mentioned, protects the stock exchange, as Marc has mentioned. You can look to copyright law. You can look to the State common law on misappropriation. You can look to contract law, and you look to Section 11A itself, which very explicitly recognizes that the exchanges have the rights, or, I should say, confirms, since we have been doing it for some 100 years before Congress got around to speaking on the topic, but confirms a right that had been recognized by the Supreme Court of the exchanges to use market data as a way of fairly allocating their costs among their members.

    Mr. Chairman, you will recall from last March's hearing that many people tried to take the matters that Mr. Kanjorski mentioned of the Seligman Committee and keep trying to boil it down to a matter of who owns the data. We think that this debate is somewhat misplaced, and it is not just because the Supreme Court settled these matters a century ago, but it is because the real issue is if you are going to change the system, you have to think about how you do it in a way that is revenue-neutral to the stock exchange and the other markets and doesn't create winners and losers among the broker-dealers and others who bear the market data fees. And for all the rhetoric that has accompanied this topic, both here, in previous hearings, and the hearings that your predecessor subcommittees, and before the Seligman Committee and at the SEC, no one has come forward with a better answer to the questions that the exchanges face as we try to fairly allocate our costs for creating this market data in the first place.
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    Let me close by simply reminding the subcommittee that we support legislation that will Federalize and codify the existing common law around misappropriation, although we are not a prime mover for it and were not part of the original discussions in the 104th Congress. But we think it will be a useful thing, in particular in reference to the Feist case, but more importantly, if a Federal law made clear the rights beyond what the statute does today, of the exchange to use market data as we do, then it would be simply confirming the process of our constituents, our listed companies, our broker-dealers and those who represent the public in using market data fees as one of the tools which they have to equally allocate the costs of creating this extraordinary database.

    Thank you very much.

    Chairman BAKER. Thank you, Mr. Bernard.

    Our final witness is the President of the Nasdaq stock market, welcome to you, Mr. Richard Ketchum.


    Mr. KETCHUM. Thank you. Mr. Chairman, Members of the subcommittee, I am Richard Ketchum, President of the Nasdaq stock market. I want to first commend you on holding this hearing on extremely timely issues, and I welcome very much the opportunity to continue our dialogue with this subcommittee on market data issues.
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    Under the thoughtful leadership of Congress and the SEC, the U.S. capital markets are the envy of the world. In particular it is under this leadership that markets like Nasdaq have been able to provide American investors with wide access to the highest quality, most current and lowest-cost market data of any major nation.

    Initially, I would like to address the questions you raised in your letter of invitation. Within that context, though, I don't want there to be any misunderstanding. I strongly agree with what Mr. Lackritz said that in effect and in large part the environment today works well with respect to the regulation of market information data. As I indicated, that data is widely available; available not only to market participants, but public investors as well at costs substantially lower than available in the rest of the world. In addition, our rights to that data and other markets' rights to that data are properly protected, and we are quite comfortable with those protections that exist today.

    And finally, and somewhat contrary to what may have been at least implicitly suggested before, entities that are not markets are not restricted from making available their order information, as long as they do so consistent with SEC rules and requirements that look to both encouraging competition among markets and look to ensuring that investors have knowledge of what the best prices in the markets are.

    Within that context and within the recognition that indeed the environment today does work well as the internet expansion continues and other communication modes develop, some additional legislation to protect databases may be necessary. We believe that a database of market data, like any other valuable database, would benefit from greater protection mechanisms. The value of that market data is in its integrity. When unauthorized parties can misappropriate it and perhaps change it, that integrity is jeopardized to the detriment of investors here and worldwide, and for that reason we would be pleased to continue to work with the subcommittee as we have in the past in your efforts to evaluate possible legislative action.
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    In this regard I would like to highlight several reasons why Nasdaq, as with any exchange or self-regulatory organization, has a right, first, to protect its market data and, second, to be able to establish prices for its market data consistent with basic free market principles.

    First, Nasdaq's market data is created within our marketplace and is shaped by our regulatory framework and internal quality controls. It is in this way that Nasdaq adds layer on layer of value to our market data. In particular Nasdaq has created a market structure designed to promote liquidity and transparency. Our market is supported by quality market participants, such as on the panel today, that are subject to stringent marketplace rules. We have also developed and maintained sophisticated automated market surveillance tools to monitor trading and issuer activity.

    The investments made by Nasdaq in our market, regulatory and technological infrastructure facilitate universal access to quality market data that investors can trust.

    Second, under the contracts we have established with our market data subscribers, investors enjoy broad access to our quality market data at fair and reasonable prices. In 1975, Congress made certain that our national market system must be premised on investors having access to consolidated market data. Nasdaq has long recognized the importance of market data to investors' decisionmaking process and has sought to disseminate our market data to the broadest population of industry professionals and investors.

    In fact, Nasdaq's market data today is distributed to over 550,000 industry professionals and millions of investors, and investors have enjoyed a 75 percent decrease in our market data fees over the past 2 years. In fact, a full month of Nasdaq market data costs only $1, less than a single ATM transaction.
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    Third, our Nation's markets operate in a highly competitive environment which acts as a natural regulator of market data fees. Exchanges and other self-regulatory organizations vigorously compete for issuers' listings, market participants and trading volume, which culminates in the ultimate value of particular markets' quote and trade data.

    Fourth, in this competitive environment Nasdaq understands the need to protect the flow of its market data to contracted parties. However, the risk of unauthorized use of our market data by others is an issue that requires some attention. If markets like Nasdaq are to continue to seek innovative ways to ensure unparalleled market integrity through greater market transparency of high-quality data to investors, our ability to limit the flow of this valuable market data to parties who have contracted for its use must be apparent and expansive relative to existing rights.

    In summary, it is important to ensure that the core policy goals established by Congress in 1975, including broad public access to consolidated market data, the maintenance of stable and orderly markets, and the ability to promote competition, are preserved and encouraged to the greatest extent possible. Our legislative and regulatory framework, such as exists today, that encourages competition and innovation among markets will result in a continued development of quality market data that investors can trust.

    Nasdaq stands ready to assist the subcommittee as it continues to consider this very important issue, and I thank you again for allowing me to participate in this hearing.

    Chairman BAKER. Thank you, Mr. Ketchum.
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    I do very much appreciate all the witnesses' participation here today, and your openness to discussion of this topic, which is a very difficult one.

    Mr. Bernard, in your written statement, you make reference on page 7 to the importance of market data, and actually make the comment that it is important to preserve the revenue stream for the market that is generated by the fees associated with the sale of that data. And, Mr. Ketchum, I think I recall reading something where Nasdaq's revenue stream, approximately a quarter to a third of that comes from market data fees. Is that still a broad statement of accuracy?

    Mr. KETCHUM. It is broadly accurate, though each year is a little different, broadly accurate that somewhat less than a quarter of our revenue comes from that.

    Chairman BAKER. All I wanted to establish is the significance of this to both markets as an element of your stability so I understand the sensitivity of this discussion.

    Second, the basis on which you feel the current revenue stream is appropriate is still difficult. You will recall from the hearing in March, I raised the issue, how do we know about appropriateness if we can't allocate the costs associated with the function? The response to this is that the breadth and depth of the data we collect and the assimilation and the value added are all very difficult to segregate. Therefore, we may not have the ability to generate a fixed dollar cost per transaction, for example.
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    In looking at the provisions of Section 11A, which you made reference to, Mr. Bernard, it does allocate the responsibility to the SEC to make a determination as to whether the charges are fair and reasonable, and I have asked staff basically to look at the elements that are reviewed, and I got back fair and reasonable. It doesn't seem to be real clear.

    On the other hand, both have taken some credit in recent years for significant fee reductions that, depending on which type of investor we are examining, reductions could be from significant to very significant. It again is a troublesome point, and that is, if we are able to reduce fees and acknowledge that that fee reduction has come about through efficiencies, how does one measure the appropriate level of fees if you can't tell me what the cost basis for the fee is to begin with other than perhaps pressures from the consumer side of the equation are saying this is too much? Which then, I think, gets to Mr. Kanjorski's issue of what is it you do to the data that is the value-added aspect of the process?

    And I am going on a bit, because we have got a vote, and I am going to give you a chance to respond at length during the vote, but, for example, Mr. Kanjorski and I enter into a transaction, the broker-dealer executes, the trade is done, it is a $20-per-share activity, you record it. I assume your response would be, yes, that is correct, and we just report the $30 trade, but we do it across market breadth so we have the depth and assure quality of that information. So therein is the value; not one transaction, but perhaps thousands. And you would claim that the value added is the quantity and quality, verification of that activity is what is representing the value of that transaction.

    In looking at the report language of the 1975 Act, which I had here somewhere, it went on to say that we must be sure that the central processor is not under control or domination of any particular market center. Any exclusive processor is, in effect, a public utility, and thus, it must function in a manner which is absolutely neutral with respect to all market centers, all market-makers and all private firms.
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    The point here is that the function, as I am understanding it, it is a collection of data, a distribution of data, with an obligation to do so for the national economic good as a public utility, and the argument that the fees are not related to the cost associated with this transaction is the difficult point for me. I am at a loss as to how we establish the fairness of the transactional cost associated with your process, because you are, in effect, aggregating a utility as a utility, a publicly reported value of a transaction.

    Lastly, with regard to the competitive action aspect, and I am restating Mr. Smith's testimony on these points, by regulation every broker dealer who wants to trade has to be a member of some SRO, let's just say Nasdaq. If I am a Nasdaq member, I have got to report exclusively to you on my activities. Then you are required to consolidate and make that available to investors, and that anybody we catch disseminating this inappropriately is subject to some SEC enforcement action. That is a different model of free market competition. I will admit that the problem is that we don't have a counterparty ability for someone else to do this, because by Government regulation, the responsibility is created and the authority to govern solely granted to the particular SRO.

    So in a broad context we have a fee system established without an understanding of the cost basis which has been reduced over the last few years that is required by a law to preserve the economic function of our investment community.

    Help me out here. Give me a picture that makes me understand why significant modifications—and let me answer Mr. Kanjorski's opening statement, I have no intent to do anything anytime soon. We are certainly going to wait on the Seligman Committee before I would recommend any action. And this is not with the idea that tomorrow morning we are going to wake up with a new national market system, but I certainly have concerns in light of the explanations given about how these functions are conducted.
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    Mr. Bernard, why don't you take a swipe at it.

    Mr. BERNARD. I think I tracked about five questions within your comments, and let me try to answer them in turn.

    First, just as a point of reference, about 17 percent of our revenue is from market data, and as you will remember from Mr. Lackritz's testimony, that has been consistent for about 70 years. That is as far back as we can trace it.

    When you get to the question of fair and reasonable, it is important to remember that Section 11A is not the only provision in the 1934 Act. If you go to Section 6, under which we are registered as an exchange, and under which Rick will shortly be registered, you will see that we are obliged to have constituent boards, with fair representation of everybody, not just the broker-dealers, but also the listed companies and the public. And so if you look at the scheme as a whole, the SEC is just a fail-safe mechanism. The real defense to ''fairness and reasonableness'' lies in having the very people who pay the fees decide what the fees shall be. The SEC is a fail-safe. The focus should be on the board of directors, and you will see in recent SEC actions over the last 10 years that the SEC has intervened with the Nasdaq and with the Philadelphia Stock Exchange to make sure that those boards of directors really do do a good job of representing all the constituencies.

    Second, to characterize us as being in the business of collecting data is not accurate. We don't have any conventional vendors on the panel today, but such companies, like ILX or Bloomberg, those people are in the business of collecting data. We are in the business of generating data. Two people don't just show up and do a trade and tell us. Rather, we provide a facility for price discovery, investors send orders through systems to the New York Stock Exchange or call them into brokers on our floor, we provide a facility for that. We provide a facility for arraying those interests. We provide a facility for figuring out which of those interests by itself are aggregated with others as the best quotes, and we provide a facility for actually making that execution take place. So we are far more than a mere data collection operation.
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    And in that lies the answer to your third question regarding whether we are just charging for the quality and quantity. First of all, we are not charging for anything. What we are doing is allocating our costs, as our members and our listed companies and investors direct us to, into various ''buckets,'' i.e., listing fees, transaction fees, market data fees and other fees. They have chosen in their wisdom to put about 17 percent of our costs into market data fees.

    No one is trying to decide that listed company fees are collected to only pay for services provided to listed companies. What we are talking about is one big machine, one big factory, the NYSE, to use an earlier analogy, and how do you finance that thing, and what are the vehicles for financing it.

    To your fourth question regarding the 1975 language, not to prejudge the work of the Seligman Committee, but I should tell you that consistent with the NYSE's position for more than a year-and-a-half now, the Seligman Committee does seem poised to recommend the New York Stock Exchange and the Nasdaq and the other exchanges withdraw from the Consolidated Tape Association and the other consortia. That language that you are talking about was very specifically related to anticipating that these consortia would be created, and they were. Now they are about to be dissolved, and so this issue of exclusive authority to process evaporates if the Seligman Committee makes the recommendations and the SEC supports them as they go forward.

    And I think I will yield to Mr. Ketchum, if I might, on the last question having to do with competition in membership.

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    Mr. KETCHUM. Thank you, Mr. Chairman, and I would agree with everything that Mr. Bernard has said. I will just add two additional points and certainly get to your point with respect to the membership question.

    My first point is to reiterate what he has said, the level of SEC oversight with respect to reasonable fees. The Commission does look at and does recognize that both the membership participation and investor participation in the board has a governing effect on fees as well as it looks very closely itself to ensure that we are reacting to an expansion in the numbers of investors and numbers of participants taking the fee and the growth in those fees. So it is not an accident. It is not an accident from the standpoint of competition from the desire of our marketplace to increase the dissemination of public information, because increasing the dissemination of public information increases the volume in our market, increases the desires of investors to trade. The Commission looks very, very closely at those issues.

    The last piece I will just mention as you go is that while it is true a broker-dealer must be a member of an exchange and must be a member of the NASD, they are not required to be a Nasdaq market-maker or required to be a dealer or participant in any particular market. They can choose to bring their orders or participate as a dealer in any market that they choose, and with that have the ability and indeed in many cases have the ability to share in transaction fees as those markets compete with each other.

    Chairman BAKER. If I may, Mr. Ketchum, we will return to this. We won't cut off any discussion. I am told we have about 3 or 4 minutes left on the vote under consideration. There is a subsequent 5-minute vote. Depending on the outcomes, could be a third. So at best expectation the most we will be gone is about 15 minutes, and we will recess momentarily. Thank you.
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    Chairman BAKER. Mr. Ketchum, I curtailed your remarks at the end of the last question if you wanted to respond for us.

    Mr. KETCHUM. Mr. Chairman, I think you gave me the opportunity to finish my response, and I guess the only thing I would add from what I said, just on the particular point you raised is to emphasize again the choice that brokers have between other markets, the fact that those markets do compete very aggressively to have them choose, and the one point I did not indicate; that the SEC has spent a great deal of time looking at the policy issues involved of brokers that wish to operate free from the marketplace, including the right way for them to do that is to register as an exchange. And in fact Island, represented at this table, has begun the process of doing exactly that.

    Chairman BAKER. I read through a Nasdaq subscription agreement, and I am not a subscriber, just for the sake of saying I had done it.

    Mr. KETCHUM. I admire you for merely taking up the——

    Chairman BAKER. You can tell I am not well. Section 7 of that agreement has an interesting provision, and I wanted you to explain it to me, because I understand this is the agreement that would be used for a retail agreement, is that not only do you make records available—and that is understandable—upon reasonable notice, but ''subscribers shall make its premise available for review of said records and for physical inspection of vendor services.'' Does this mean in a technical sense that if I sign the agreement and my computer at home is the location for distribution of the data, do you have the right to examine that physical location?
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    Mr. KETCHUM. No. That provision is basically aimed at professional participants in the marketplace. It does not apply to a nonprofessional agreement and to an individual investor from that standpoint, as I understand it, Mr. Chairman.

    Chairman BAKER. Oh, sure. Well, have your folks look at it, because I went back and read it a couple of times to make sure that I didn't want to bring it up inappropriately, but I didn't find any qualifying conditions around it, and if it is something you want to get back to me on later, that is fine.

    Mr. KETCHUM. Mr. Chairman, it has just been added to the fact that it can be read as client and nonprofessionals, and I think it is a good point. In fact, we are in the process of looking at it and making sure that if—we have never invaded the premise of an individual investor with respect to——

    Chairman BAKER. The market consequences of that headline would not be favorable, but, you know, examine it, get back to me, and it is something that I found—it is a basis for saying we need to be looking at the whole subject matter.

    We have been joined by Chairman Oxley, Mr. Kanjorski has just returned. And Mr. Kanjorski has waived his right at the moment. Mr. Chairman, if you would like to proceed.

    Mr. OXLEY. Thank you, Mr. Chairman, and I appreciate the gentleman from Pennsylvania's courtesy. Let me ask Mr. Callcott. You mentioned the Seligman Advisory Committee during your testimony. If the Seligman Committee were to recommend a competing consolidator model, what would be your position? Does that really provide the kind of competition we are looking for, or do we need to look at other avenues?
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    Mr. CALLCOTT. I think a lot of the participants in the Seligman Committee have been advocating a competing consolidator model, including us. It depends what that model consists of. For a competing consolidator model to work, as Mr. Smith indicated, in our view, you have to eliminate the display rule, because otherwise the requirement under the display rule is that you display the quotes from every market. And so even if you have competing consolidators, every market has the right to charge monopoly rents. But we think a competing consolidator model, as we have outlined in our testimony, where every market has to sell information on the same terms to every customer does create the possibility of actual price competition. That would bring down the prices for market data, and, in our view, improve the quality and innovation in market data products.

    Mr. OXLEY. Mr. Smith, do you agree with that?

    Mr. SMITH. Certainly I do. I want to make clear that we certainly would not be opposed to a market owning its market data, but in order to get to that ultimate goal, we do need to reexamine the current regulatory structure. And as Mr. Callcott said, the vendor display rule. And I was struck by something Mr. Bernard said earlier about how the board sets the prices for the market data. The board meets and they, in consultation with their members and other constituencies, decide the price for the market data. That struck me as not a very market-oriented approach to deciding a price. To me, a price is determined by a free market, where a buyer meets a seller, instead of having it be set. If we could all determine prices like that, that gives—to the extent that, for instance, Nasdaq has capacity issues or something, I suppose we could have this subcommittee to meet and decide the closing prices for the stocks each day, because that would be certainly much more convenient than having the market forces decide the closing prices.
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    Mr. OXLEY. Mr. Smith, while you are on, let me ask you, Mr. Ketchum observed in his testimony that competition in the marketplace acts as a natural regulator of market data fees. Do you agree with that perception?

    Mr. SMITH. Yes. It is certainly their duty to ensure that all fees are fair and reasonable. Clearly, it is a very difficult position for the commission, but it is a role that they do play.

    Mr. OXLEY. And Mr. Callcott, what do you think about that?

    Mr. CALLCOTT. Well, there is active competition right now between the markets for listing. There is no question about that for listed companies, but as we set forth in our testimony, right now each of the major markets, the exchanges, Nasdaq and options, has a monopoly in the market data area. And so there is not effective competition in the market data area, and all the competition in the world on the listing side is not going to create competition on the market data side.

    If I could expand on that, I very much agree with what Chairman Baker said earlier, that as the exchanges are going to for-profit status, this idea of cross-subsidization, that you have a monopoly in one area that cross-subsidizes other areas, becomes even more problematic. I mean, their boards are going to have a fiduciary duty to their shareholders—and we are a shareholder in Nasdaq—to maximize their profits, and that is just an inherent conflict for us with the idea of having low priced, widely available market data as the 1975 Act amendments contemplate.
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    Mr. OXLEY. I will start with Mr. Bernard and respond to Mr. Callcott's last statement.

    Mr. BERNARD. Well, first, for the record, the New York Stock Exchange has no plans to demutualize. So its members will continue to run the exchange in order to minimize their costs while getting the best services possible, deciding how much of those costs ought to be recovered by market data fees. The structure is like a condominium or the New York City cooperative building in which I live, or a golf club. So, at least in the context of a mutualized institution like the New York Stock Exchange, I don't understand that issue.

    Mr. OXLEY. Mr. Ketchum.

    Mr. KETCHUM. Thank you, Chairman Oxley.

    I think the point we meant in our testimony with respect to competition, why we do think it is quite effective, as Hardy correctly indicated, there is aggressive competition between markets, both for listings and also for market share. Beyond that, there are efforts by markets in as many ways as possible to increase the amount of trading that occurs on their marketplaces, and overall in the United States. Market competition—that is a natural competitive regulator with respect to price and market information.

    It is our desire and always a balance to both be able to gain sufficient return with respect to market information to support, not cross-subsidize, but to support the things that make that market information valuable. The running of the technology, the maintenance of the network that allows market makers and ECNs to collect information and to compete and the regulatory surveillance that ensures fair and orderly markets and the accuracy of that information.
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    But within that balance on the other side is the need to have the prices sufficiently low enough that as Mr. Lackritz said before, that in the United States, we have the widest most broadest dissemination of market information in the world, and that is equally critical to our mission if we are going to succeed as a market.

    Mr. OXLEY. If I could have one more question, Mr. Chairman. And as the Chairman pointed out, you have had a lowering of costs, and that has been rather significant in some areas. What drove that cost lower, and if there is no competition—or not adequate competition, then why would those costs be lower?

    Mr. KETCHUM. Well, I guess part of the answer to that is that there is adequate competition, in our view. Those costs were driven lower, and indeed the initial decisions, both with respect to Nasdaq and its securities and with regard to listed securities where we participate in a joint plan, resulted basically from the initial decision to have separate pricing for when data was disseminated to individual investors or nonprofessionals in the marketplace. That was because of our desire to expand the availability of that information, a continuing desire to expand that information, continuing belief that the lower the price, the more focus on that information, particularly with the revolution as a result of the internet and online investing that would lead us and allow us to benefit in two ways: One, if a price is low enough, more investors will take it; second, if more investors take it, more investors see that information. They will be more interested in trading and have a higher degree of trust and confidence in the marketplace, which will encourage their trading as well, and that is how we gain our primary means of being able to operate and profit as a marketplace.

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    Mr. OXLEY. Well, that turned out to be a softball for you, Mr. Ketchum. Let me just finish with asking Mr. Callcott and Mr. Smith essentially the same question. If, indeed, those prices have gone down, wouldn't that indicate that competition is truly working in the market data area?

    Mr. CALLCOTT. I think the prices have come down per individual. The market's revenues for market data have been growing at double digit rates because of the increase of individuals who are coming online and are paying prices for quotes that they never paid before. I would say that the market's prices have come down precisely because in the last 2 to 3 years, the SEC and the Congress has been paying attention to this issue and putting pressure on the markets, and as a result of that, monopolies respond to their regulators, not to market price.

    But the fact is, their revenues have been growing at 18 to 20 percent annual rates for the last half-dozen years.

    Mr. OXLEY. But, there haven't been any changes in the regulations, nor have there been any changes in the statute.

    Mr. CALLCOTT. Right. The change has been that once the SEC started putting out concept releases and Congress started holding hearings, the markets all of a sudden had a very substantial incentive to keep their prices fair and reasonable.

    Mr. OXLEY. So ergo, if we keep having hearings, the price will continue to drop; is that correct?
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    Mr. CALLCOTT. This is a very useful function that Congress serves, Mr. Chairman.

    Mr. OXLEY. Well, Mr. Chairman, I had no idea we had that kind of power.

    Chairman BAKER. And I am so appreciative of this. You have finally learned I am worth something, Mr. Chairman.

    Mr. OXLEY. Let me let Mr. Smith take a crack at it, and then I will yield back.

    Mr. SMITH. Thank you, Mr. Chairman. At the risk of sounding repetitive, I think I would return to my earlier comments. While it is certainly good that market data prices have declined, there is still the fundamental fact that the price charged by the consortium of SROs is still not determined by a competitive market. It is determined by a group of individuals who, after canvassing market participants, decide on what they think an appropriate price is.

    Mr. OXLEY. That describes a cartel, doesn't it?

    Mr. SMITH. I agree, yes.

    Mr. OXLEY. I yield back.
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    Chairman BAKER. Thank you, Mr. Chairman.

    Mr. Kanjorski.

    Mr. KANJORSKI. I just want to make the observation, Mr. Chairman, that if you look at the panel, we have two of the investor groups, and then we have two of the exchanges, and in the middle we have the association. It probably is interesting and what is reflective of the issue. I want to address it, first, to the investor groups. I listened to your testimony, Mr. Callcott, and isn't this just a fight over how much and who pays?

    Mr. CALLCOTT. It is a fight about money.

    Mr. KANJORSKI. Do you have any feeling about being a little guilty of talking about the freest market in the world and charging the exchanges with being monopolistic utilities?

    Mr. CALLCOTT. We would like to provide the best possible information to our customers. There is very good market data information out there, streaming market data that professional investors, institutional investors use. Most investors, because of the current cost structure, do not have access to that data. We would like to provide it to them. We can't afford it at the current rates, and most individual investors can't afford to pay for it themselves at the current rates. We think we could make that available under a competitive structure.

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    Mr. KANJORSKI. OK. On the other hand, you have to concede, don't you, that this is a utility and a monopoly? I mean, this portion of it? There is nobody else that can announce to go out there and create this information. You are really granted this right through the SEC and through the Federal legislation. I am not criticizing what you have done, and I cannot go into business tomorrow and compete against you.

    Mr. BERNARD. If you break up the consortium, which we have been a strong advocate of, what you are talking about is ten or more stock exchanges competing with each other for order flow. Now, it is certainly true that the New York Stock Exchange has consistently enjoyed market share of about 85 percent, but that hasn't been because of an absence of competition. It is because——

    Mr. KANJORSKI. But you are not representing the same companies on the same exchanges. They are different.

    Mr. BERNARD. Oh, yes, we are. Nasdaq has what they call the ''intermarket'' that trades in New York Stock Exchange-listed stocks; Philadelphia, Chicago, Pacific trade NYSE stocks. Island, for that matter is trading New York Stock Exchange stocks.

    Mr. KANJORSKI. So when they do greater volume, they are just better than the New York Stock Exchange?

    Mr. BERNARD. Well, they haven't done greater value. We continue to do 85 percent. The rest of them together do 15 percent. So I guess that means we are doing better.
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    Mr. KANJORSKI. This is going to call for the wisdom of Solomon, I think, and I don't know any of my colleagues up here that possess that type of wisdom. The one thing that really does disturb me is the fact that when you are privatizing, this does seem to go to that conflict. It was indicated that there are just two fiduciary responsibilities that have to be there, the charge that you are under to charge reasonable and fair rates, and to disseminate this information; on the other hand, to earn as much for the investors as possible. Why can't we take market data and treat it like a monopolistic utility and just set it over there and with the SEC as the regulator, to take the complaints of the new internet market and other things that weren't here in 1975, and treat the data in that regard. This will ensure a fair return on an investment, that you continue to have the excellence for which that material goes out, but that no one feels disadvantaged as to price, nor do they want to come in with another competition.

    I have to mention that just the other day, as you know, we have had deregulation recently in telephones and utility companies, and I can address just the telephone problem that was interesting. My wife called me up, and she said, you know, we have a telephone, but we are only listed in one book. And there are four books that are disbursed, but we would take advertisements or whatever we have to do to get the other three books, which costs me four times what it is going to cost today.

    I don't know that we can get in there every year with new technology and new methodology, trying to figure out who is advantaged or who is disadvantaged, but if we look at this market data accumulation and disbursing and we did it and said this is a utility. It is monopolistic, because the SEC has given it to you. You are entitled to a fair return on your investment, as a utility would be, and then the SEC will be your regulator when there are complaints and changes in the marketplace that this information should be available. Because quite frankly, if you think about it, nothing stops you from charging $1,000 a hit, and that would take away all day traders.
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    I am not sorry if it probably took them away, but, you know, that is one nice way to get rid of day traders, just hit them so hard, that they cannot participate. That wouldn't be the fair thing to do if we really have a free and open competitive market. And on the other hand, we can't anticipate where Schwab or other firms are going and what is the change in evolution of technology that is going to occur over the next 2 or 3 years. By the time we get done drafting a bill, it will probably be obsolete and not relative to the situation.

    But if we did recognize that the 17 percent of your revenues that come out of data processing get carved out of whatever you are going to do in privatizing and put that into a utility-type, agreed-to monopoly and give you a decent return on your capital and evaluate that fairly, and then have a very broad board or representation of users to help set rates, and even they won't be able to finalize it, and have the final determiner the Federal Communications Commission, wouldn't that be fair to both sides?

    Mr. KETCHUM. Congressman, if I could, let me try to address each of the points that I think you have made. I guess the first point is that indeed there is somebody who stands between us and imposing a $1,000 charge with respect to this information, and that somebody is the SEC that has the ability and responsibility to both ensure that the fees are fair and reasonable and the authority to look at all relevant issues, including our costs involved with the information.

    The second thing is I do have to respectfully disagree. I don't believe in any way this is a monopoly, or certainly as Rich Bernard indicated, it does not raise any consortium issues if indeed the position, both Nasdaq and the New York Stock Exchange, is taken, that we should eliminate the plans and each market should have the ability to offer its data separately and separately price it. Third, not only are there 10 exchanges operating today, but there is also the ability for trading systems, such as Island, to become an exchange and to compete directly with respect to——
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    Mr. KANJORSKI. Do you think by defining that as a property right and maintaining your own data collected that you would do a favor to the free market system that we have, and the transparency and access that we have in this market? Isn't it to the advantage of the members of the Exchange that they have the absolute access to the most investors possible, that it is accurate, reliable? I mean, that is the precondition to good trading. It wouldn't seem to me so that you could get some return on, quote, this property right interest, which I still have some difficulty with. It would seem to me that you would be shooting off your toe to spite your foot.

    Mr. KETCHUM. Well, again, I think it very much is an advantage to the members of the Exchange or from the standpoint of Nasdaq, of Nasdaq, for there to be wide dissemination of this information. It is just as much to the advantage of Nasdaq to occur, because it does attract activity and increase confidence in the market. That is the very reason why the prices have been reduced as much as they have and why there is a different price for access to the information of the individual investors. And indeed, I wonder if you had utility rate regulation, whether there would be anything such as a separate charge for individual investors.

    Mr. KANJORSKI. Maybe there wouldn't be.

    Mr. KETCHUM. And I think that necessarily wouldn't be in the interest of our——

    Mr. KANJORSKI. Why?

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    Mr. KETCHUM. Because I think you would not necessarily have seen the innovation of providing lower cost information.

    Mr. KANJORSKI. Well, if you were making a decent return on your investment as a utility, you mean you are only driven to make more, and that is the only reason that you change?

    Mr. KETCHUM. The primary reason we are driven to provide the information is, because it increases investor confidence and increases investors.

    Mr. KANJORSKI. That's right. So giving this information out, if you could effectively do it for nothing or almost nothing, and increase the activity of the market and increase the activity of capitals in general in the United States, that is to your benefit. You are going to drive brokerage fees and other fees and transactions that are going to make more than enough money for you.

    Mr. KETCHUM. And that is usually what competition is quite effective in driving forward, if indeed it is to our benefit, and I would agree it is, and it is exactly that reason why we have continued to reduce the price and to distinguish the price for individual investors over market professionals.

    Mr. KANJORSKI. Well, how about if we allocate part of this excess money that the SEC is collecting to you fellows, some portion of it, so we do not have to charge the other fellows anything, or an extremely low rate. Is that a fair way to do it?

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    Mr. KETCHUM. Well, those other fellows are the same ones being charged that other fee, and we think it is a great step that Congress has taken to try to reduce transaction fees, which is an important step to ensuring the continued competitiveness of the U.S. markets.

    Mr. KANJORSKI. I am sort of disappointed that we have to have—I mean, I know our activity and attention to this probably plays to make all parties work better together, but it just seems to me you are almost disproving the effectiveness of the private market to work these things out. This shouldn't be before the Congress, and if it has gotten to that point, you know, we certainly should not cut favoritism on either side. But then, you know, don't argue if we start regulating things. Do we want to empower the SEC as a great super-regulator to constantly be hearing who is being charged what? It seems so infinitesimal, in terms of the whole capital market of the United States, that you all have to come together and do what is right and what is reasonable.

    And that would get a return on investment that is reasonable. I would say make it a utility rate or both. It doesn't matter to me. But not exceptional. I mean, you know, it is possible that, as a result of technology or change or activity, you could end up like these banks with the ATM fees. I mean, you know, I keep telling my friends in the banking business, and incidentally the credit union business, that they keep making more money on ATM fees than anything else, they are apt to get themselves regulated, because I am one of the guys that will do it.

    I mean, I find that incomprehensible that a college kid has to pay a buck-and-a-half or $3 bucks to get $20 or $30 out of an ATM machine. And they say that is not the cost of the transaction, but they can get it. Do we want to get into that regulation? You are almost forcing us to get into the exchange regulation. I don't see that as very profitable for the Government to start thinking in your business and regulating your business any more than we absolutely have to.
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    So I would hope you take away—I am hoping—and I look at Art Folcum in the middle there. It is your job to come up here or tell these fellows to work this out. And this is something that should be able to be negotiated in the private market without Government involvement. If it requires Government involvement, all five of you are going to come up here and be yelling at us, oh, you are moving into the private market and you are doing things, but you are not giving us a heck of a lot of choice.

    Yes, Mr. Bernard.

    Mr. BERNARD. If I might respond, first of all, neither the New York Stock Exchange or the Nasdaq is a proponent of creating database legislation. That is coming from the outside. Second, the very negotiation that you want to have happen happens every other month at the board table at the New York Stock Exchange. You may be hearing from some people who don't like the outcome of that consensus, but that consensus, for at least 70 years by our count, has said that market data fees is a good way to cover about 17 percent of the New York Stock Exchange's expenses.

    I don't think Congress should intervene and tell Merrill Lynch and Goldman Sachs and Salomon Smith Barney and IBM and Leon Panetta, representing the individual investors—and by the way, I don't know why you call two broker dealers more of a representative of individual investors than the New York Stock Exchange or Nasdaq. I have got three people on my board who are specifically charged with representing the interests of individual investors, not to mention ten broker dealers. So I don't understand that dichotomy.

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    But to finish my thought, that board decides that 17 percent is a good number. All the continued recognition of our proprietary rights does is permit that negotiated outcome to be activated.

    Chairman BAKER. Thank you, Mr. Kanjorski.

    Mr. Shays.

    Mr. SHAYS. I have questions, but Mrs. Biggert needs to leave, so I will defer to her.

    Chairman BAKER. Certainly.

    Mrs. Biggert.

    Mrs. BIGGERT. Thank you, Mr. Chairman. And I thank the gentleman from Connecticut for yielding.

    Mr. Bernard, you just mentioned that you are a proponent of the legislation. Why do you need this legislation to protect your databases?

    Mr. BERNARD. I am sorry if I said I was a proponent. I misspoke. What I said was that we did not initiate this legislation. However, if there is going to be database legislation, then discriminating against markets' data as opposed to baseball scores is not something that we think ought to happen.
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    Mrs. BIGGERT. Well, I guess I was changing the question a little bit. I assumed that you thought that you needed legislation and I just wondered if you could cite any examples of someone who has disseminated your stock quotes, those obtained from you without your permission?

    Mr. BERNARD. Well, it does happen when we don't know about it, but when we catch it, let me just quickly explain. First of all, the common law of misappropriation, which is all you are proposing to do in the database legislation simply tries to federalize and codify an existing common law that has been out there for centuries, and is one of the protections that we enjoy today.

    The second, of course, is contracts. The contract that the Chairman was reading, although I believe it applies to professional subscribers, it is those network of contracts that helps us make sure that no one is pirating the data. And just to finish the point, remember what is the relevance of preventing pirating? We are allocating the cost of running the Exchange among various users as those users have chosen. If someone is pirating the data, they are cheating. They are not paying their fair share. And that is why it is important that we be permitted to do this, but we are not proponents of legislation.

    Mrs. BIGGERT. So you have been able to use the current copyright protection laws, as well as the contract laws?

    Mr. BERNARD. Not the copyright laws, although the copyright laws may protect us. It is a fine question for the litigators, but clearly the State law, the common law of misappropriation, as well as contract law, have been the two pillars upon which we have been able to minimize any pirating.
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    Mrs. BIGGERT. OK. What has been the practical effect, then, of the 1991 Supreme Court, their first decision?

    Mr. BERNARD. Well, we have seen no impact in our world, and I point out the case was about putting together a telephone directory. As I have already mentioned, we don't simply collect data. We actually create the data. So we are in a different place from someone who puts together a telephone book anyway. So it has had no impact.

    Mrs. BIGGERT. I guess I was looking for what would be creating the data?

    Mr. BERNARD. Well, as I have mentioned—let me go a little slower on it. If Island and Schwab and Salomon Smith Barney and Merrill Lynch and the rest of them all send orders to us—and take General Electric, the world's largest company—to the New York Stock Exchange, our job is to have systems that collect those orders, safe-store them, validate them, route them to the place where the stock is traded, have them interact with each other, and with the brokers on the floor who are representing institutional investors and with the specialists who are market making and have them all come together, and when the buyer meets seller, to perform an execution.

    When we do that execution, we have systems that disseminate that data out to the world. That is the market data side of it. It also reports the trade back to Salomon and Merrill Lynch and the rest of the firms and sends it into the Securities Industry Automated Corporation. So it is no different than producing anything else. We are in the business of producing trades under the allowed sale prices.
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    Mrs. BIGGERT. OK. Thank you. That is all I have. Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mrs. Biggert.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman.

    Is the position of Schwab and Island that—if I read this right, Mr. Callcott, is that you believe that the exchanges should provide the raw market data to anybody at no price or the same price, or what do you mean exactly?

    Mr. CALLCOTT. Our concept is the Most-Favored-Nations concept. So if they provide it to anybody, everybody else gets the benefit of that best price that they offer to anyone, and then our expectation is that private sector enterprises like Reuters, Bloomberg, Bridge, and so on, will compete to aggregate that data in ways that is both cost-effective and innovative in terms of the quality of the information.

    Mr. BENTSEN. And so, under the current structure, as allowed under the 1975 Act, the raw data is just provided by the exchanges to their own processors, and then resold to the market. And the processors are effectively subsidiaries of the exchanges?

    Mr. CALLCOTT. That's correct.
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    Mr. BENTSEN. And then members of the exchanges are able to subscribe to the refined data, but rather, you would almost—you would want to—I mean, I don't know that they charge for the raw data. So maybe it is a bookkeeping exercise. I am not sure how it works out with the exchanges. I guess I have two concerns. One is do current SEC regulations, govern how the raw data is refined? I don't want to say ''manipulated,'' but that may not be the appropriate term. I think it is, but it has unfair connotations. But are there any regulations governing how the raw data is refined and then made public? Because there are regulations in how it is utilized by the brokerages after it is made public, the crosses and things like that.

    And the second is—are you arguing that there is no value in that?

    Mr. CALLCOTT. The answer to the first question is the plans are subject to SEC regulation and any amendment to the plans has to be approved by the SEC, and no, we are not arguing that there is no value in the Exchange's function. What we are arguing is that there can be alternative sources. If the NYSE or Nasdaq or the Pacific Exchange decides to charge too much to all-comers, we could put together a quote today from Schwab, Waterhouse, Island, Datek, Knight, which we think would have equal or greater value to the quote products currently being offered by the Exchange or Nasdaq. If there is that level of competition in the markets, we think that will keep the prices down and improve the quality of the overall information.

    Mr. BENTSEN. Is there a risk that, you know, Schwab is a pretty good-sized company. Is there a risk that if you were to open up the primary market for this data, if you will, that the bigger, well-capitalized players would have access to it, but the smaller brokerages wouldn't necessarily have the ability to go in and create the systems to refine the data and make it available. Could there potentially be a disadvantage to the smaller brokerages?
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    Mr. CALLCOTT. Under a competitive system, our view is that, sure, they probably wouldn't do it themselves, but they would have multiple different vendors, such as Bloomberg, Bridge, Reuters, plus bigger brokerage firms from which they could buy the data. There would certainly be competition. Of course, those little brokerage firms are overseen by the NYSE or the NASDR, and so if they were providing something that was so far out of the mainstream that it was problematic from an investor protection standpoint, there would be that level of regulation.

    Mr. BENTSEN. But the other point is that the smaller brokerages are—if I understand the essence of the exchanges, already two parts to it. One are the members who make the Exchange, and the other are the stocks that trade through the Exchange. Wouldn't this be unraveling the exchanges effectively and unraveling the national market system as we have it today? And maybe we want to do that. I don't know, but I suspect there is a structure in place. And it may be a cartel. But we established these exchanges so you had some regulated exchanges to ensure that the most accurate market data was available to the consumer and that somehow has to be paid for.

    Mr. CALLCOTT. Well, that is a good question. Right now we have, as Mr. Bernard and Mr. Ketchum have indicated, a great deal of competition on the listing side. Different Nasdaq market makers compete with each other. The New York competes with Island and with Nasdaq third market makers and with the regional exchanges. So on that side, the natural market system is built on competition. In 1975, it wasn't feasible to build competition on the market data side. Computer systems just hadn't sufficiently evolved. Today, 26 years later, we think that evolution has occurred and that it is worth exploring the possibility of competition.
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    Mr. BENTSEN. I guess, then, with the Chairman's indulgence here, could you make an argument that the members of the NASD and the members of the NYSE and the other exchanges, for that matter, pay their dues and created these systems and created these exchanges and made the initial capital investment and created these markets and created the asset? And even if it is a regulated asset and they have monopoly power, you now have Island. You have got other market makers out there. You have, you know, these electronic networks that can trade stocks. You have after-hour networks, things such as that. Why should somebody who can set up their own operation receive a preferential benefit to information that these others set up earlier?

    Mr. CALLCOTT. Well, we are legally required by the 1975 Act amendments and the rules to buy the information from the existing consolidators. That is the display rule. We have to show it to customers, and I should tell you, Chairman Baker, we have tried for 3 years to convince Nasdaq to drop that very clause that you read, because we get hundreds of complaints a year from customers saying, well, why does Nasdaq want to come into my house to examine my computer? And the Nasdaq subscriber agreement, you have to check in six different places. Furthermore, because it is a monopoly, they don't have to negotiate with us on those terms and conditions. So, again, our view is if you can create a competitive system, you won't have those sort of hallmarks of monopoly behavior.

    Mr. BENTSEN. Can I ask another question?

    To Nasdaq and NYSE, it seems to me the problem here is that with the change in the structure of the market, particularly the retail market, where people like Schwab and others—they have more individual trading on their own, and I think this is where Mr. Lackritz is coming from, whereas the SIA membership consists of brokers and dealers with their rates and all sitting up on the phone calling and making trades. Now you have more online brokerage through traditional brokerage houses. Would it not be appropriate—and maybe this is what the Commission is looking at—to revisit the pricing structure?
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    I mean, on the one hand, it is not fair to say that, well, online brokerage should get a better deal, a group deal when traditional brokerage houses have to carry the freight, because they are the ones that have 10,000 brokers or 12,000 brokers or whatever. On the other hand, the marketplace has changed, and maybe there ought to be some weighted form of pricing for the service. To me, somewhere in between there seems to make more sense than disrupting the national market system, which I think is not necessarily a bad thing. I think, as you have said in your testimony, it has served us quite well. I mean, what would your comment be on that?

    Mr. BERNARD. First of all, we have done exactly the weighting you are talking about. The New York Stock Exchange's revenue for market data—74 percent of it comes from charges on traditional market participants; that is, broker dealers who are operating with registered representatives interfacing with customers and individual traders and institutional investors who are taking the data as professionals. Only 17 percent in 2000 came from the sort of consumer end. These are the $1.00 a month that we charge to nonprofessionals or the so-called ''per quote'' or ''pay as you go'' at a penny per quote that is capped.

    So we have done exactly that and it is exactly as you say. If you start from the premise that you are going to collect 17 percent or cover 17 percent of your costs from market data, you want to hit each of the market data users in a fair way, and we have struggled with that. And the reason that the prices have not come down for the professional, except in real terms, but the nominal amounts have been stable for a very, very long time. But the rates for non-professionals have dropped and dropped and dropped, and that is because the explosion of the internet has greatly increased that end of the spectrum, and so we have responded by reducing those charges.
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    Chairman BAKER. Thank you, Mr. Bentsen.

    Mr. Shays.

    Mr. SHAYS. Thank you, Mr. Chairman. I love being on this subcommittee, but I am not ready for prime time yet. So I ask these questions with some trepidation. From my simple mind, I have this basic sense that if innovation should be rewarded that cost should be covered. I see Nasdaq and I see the New York Stock Exchange as providing the service. I came here thinking that Nasdaq and the New York Stock Exchange and others were asking for something to happen that doesn't exist right now. In the hearing, I am realizing that the court case basically established a challenge. We want to see a change. Am I wrong?

    Mr. Callcott, am I wrong? I mean, you are basically asking for the change; correct?

    Mr. CALLCOTT. We are not asking for database protection legislation.

    Mr. SHAYS. That is not what I asked. What I asked, though, is you don't like the present system. You want the present system changed. Basically, the court has established that they have a right to own this data and that they can charge a fee for it. Isn't that accurate? I am not saying in the end I won't agree with you, even though if there is a tie, I am going with my constituent.

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    Mr. CALLCOTT. And we have tens of thousands of constituents in your district, Mr. Shays.

    Mr. SHAYS. That is a problem.

    Mr. CALLCOTT. Anyway, the court case said that facts are not something that anybody can own. So we are in complete agreement with the Feist case. The legislation that we think is necessary is to reform the 1975 Act amendments and introduce competition into this one area of market data where Congress established a set of monopolies.

    Mr. SHAYS. So you are saying the Feist case basically left this question unanswered?

    Mr. CALLCOTT. No. We think the Feist case resolved the ownership question in our favor. Facts are facts. You can't own facts.

    Mr. SHAYS. Would the New York Exchange agree that that is what the case determined?

    Mr. BERNARD. I don't believe that was a fair reading of the Feist case. It was relating to telephone pages. That is what we do.

    Mr. CALLCOTT. It is related to data; can you own data, can you own facts?

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    Chairman BAKER. And if I can further complicate your picture, Mr. Shays, as I understand it.

    Mr. SHAYS. The way you talk, you need to talk more slowly with me.

    Chairman BAKER. That is a rare comment on a southerner. Thank you. Let me say it this way. I believe the gentleman represented correctly that the court determined that facts are not intellectual property which belong to an individual, but that intellectual value or some asset must be added to the fact that creates a property right which the exchanges would say is their role. They are taking the facts, the dollars from the sale, and doing things to it that create value to that asset, to which the other team is saying, no, you are not. We want the raw data. It is a fact. Give us the raw data, and then we can compete with you in the marketplace. So that complicates your problem, I think.

    Mr. KETCHUM. One thing, Congressman, I think you are absolutely correct on your characterization. Both, I think, Nasdaq and the New York Stock Exchange are perfectly comfortable with our interpretation of the law at the present time and our ability to enforce our rights from adding the value that the Chairman has articulately stated. So we don't believe there is a need for Congress to be involved in that determination.

    Mr. SHAYS. Let me just ask, why is the remedy here and not in the courts? I am just curious, from your standpoint.

    Mr. CALLCOTT. The basic concern we have is with the regulatory system set up in the 1975 Act amendments for market data. And so that can be changed either perhaps by the SEC, but more probably by Congress.
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    Mr. SHAYS. So the bottom line is your reading of the 1993 case—is it 1993 or 1991?

    Mr. LACKRITZ. 1991.

    Mr. SHAYS. The 1991 case. Your reading of the 1991 case suggests that the 1975 law is somewhat in conflict with that case?

    Mr. CALLCOTT. No. Again, the issues are about who owns the market data. We are satisfied with the status quo on that issue, as are I think the exchanges and Nasdaq. The problem that we see is with the regulatory issue, which has caused the price of this data to be so high. That is a separate issue, in our view, from the ownership issue as resulted from the Feist case.

    Mr. SHAYS. Just a basic question. Is Nasdaq and your exchange and other exchanges getting complaints from general consumers, or is this basically being generated by companies like Schwab and others that are saying, you know, they want Congress to deal with it?

    Mr. KETCHUM. I can speak for Nasdaq, Congressman. No, this is not an area where we receive complaints from investors or consumers. To my knowledge, if we have had any, it has been very few, and I am not aware of any.

    Mr. SHAYS. What practical difference does it make as to who owns the market data? I open that up to any of you.
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    Mr. BERNARD. May I just make a point regarding Rick's point? The reason consumers aren't complaining——

    Mr. SHAYS. I want the mike a little closer.

    Mr. BERNARD. I am sorry. The reason the consumers aren't complaining is they never see these charges. These charges are imposed on broker dealers, not on individual investors. So if an individual investor is even aware of them, it is because the broker dealer has made a decision to pass through this particular cost in a more explicit way and all the other costs they face in doing business.

    Mr. SHAYS. See, that wouldn't bother me if they made that cost clear to their consumers, to their clients. And you do that? You let clients know that that is part of the cost?

    Mr. CALLCOTT. We do.

    Mr. SHAYS. Is the cost so small that it is almost insignificant to point out?

    Mr. CALLCOTT. Well, to provide the Nasdaq level 2 data to our customers, costs $10 per customer per month. We are able to pass that on to some customers, but very few. We make that data available for free to a very small number of our very best customers. We would like to make that best quality data that institutional investors get available to all of our customers. Technologically, it is perfectly possible to do that, and it wouldn't impose any additional marginal cost on the exchanges at all. We can't do it because of the current cost structure.
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    Mr. SHAYS. What practical difference does it make as to who owns the data? What is the practical effect of that?

    Mr. CALLCOTT. Our view is that this data is pervasively regulated in the public interest by legislation, and that is the way that it is and should be and should stay. So that basically no one owns it. It is facts.

    Mr. LACKRITZ. If I could just address that for a second. The whole issue of property rights and the reason that we don't think there needs to be legislation providing property rights to market data is, because owners of property can control its use after it is gone. And so, for example, if there is a database of historical data, if there is a property right to that data, then it would be illegal to take that historical data and use it for other purposes or put it into new products or services. So, property rights would provide an impediment to users from getting access to large bodies of data, in essence.

    Mr. BERNARD. I am sorry. I don't understand the conversation. We have had property rights recognized by the Supreme Court for more than 100 years. This discussion is not about adding proprietary rights. If anything were going to happen in the area of database legislation in regard to market data, what you would be talking about is federalizing common law. That is an accurate statement of the law as it exists.

    As to why it matters, it is as I said before. If the broker dealers and the listed companies and the representatives of the individual investors on our board feel that market data fees is a good way of allocating our costs among themselves in an equitable matter, then you need the legal tools to make that stick. It was the question about pirating data that I addressed to your colleague before. That is why the proprietary rights——
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    Mr. SHAYS. OK. And maybe one of the three, not with the Exchange, could just explain to me. How do you view their board as being representative of your interests or not being representative of your interests?

    Mr. CALLCOTT. Not particularly representative of the retail interests. Our view is their board tends to be dominated by their institutional and floor membership.

    Mr. SHAYS. So is this a battle between the institutions and the general consumer?

    Mr. SMITH. I think I have a unique view on this. I keep coming back to the same point. Island is troubled, because——

    Mr. SHAYS. A little louder, please.

    Mr. SMITH. Island is troubled, because the whole price-setting mechanism is determined by a board rather than the free market, and a board can never completely represent all interests it needs to represent. We are certainly not represented on those boards.

    Mr. SHAYS. Let me just conclude. If the 17 percent disappears, how do you cover your costs?

    Mr. BERNARD. Well, first of all, that 17 percent—the answer is that the members who could decide tomorrow to make that 17 percent disappear, would have to look to other sorts of ways of allocating the costs among themselves, the members of the listed companies. Presumably that would mean we would raise listing fees, raise transaction fees, or we would institute other charges.
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    Mr. KETCHUM. Congressman, if I could, I just would like to clarify, because I don't want you to leave an impression that certainly the board of the Nasdaq stock market doesn't reflect firms that are actively involved in serving individual investors. Among the members of the board of the Nasdaq stock market is Dave Pottruck, the CEO of Schwab. Another member is a CEO of Knight Securities, which from a market making standpoint, has its basic business providing executions and service to, again, individual investors.

    Mr. SHAYS. Well, that is weird, frankly.

    Mr. CALLCOTT. And he is correct that we feel better represented on the Nasdaq board than we do on the New York board.

    Mr. SHAYS. Oh, that is a good answer.

    Mr. BERNARD. I think I would point out that just as every citizen of the United States is not sitting in Congress, so, too, not every broker dealer or every listed company can sit on the New York board. But we have ten positions that are allocated to so-called public directors, included listed company representatives, institution investors and individual investors. Ten director positions are allocated to broker dealers, four from the Exchange floor, the other six from ''upstairs'' firms. At least one of which includes DLJ Direct, which is a major online broker.

    Mr. SHAYS. Let me just ask another question of the three. Are you basically saying that you are paying for a service in which you are overpaying for the cost of the service you are getting and that you are, in a sense, by the fee, paying for other parts that the Exchange should cover by other expenses? Do you understand the basic question? Do you feel that basically you are paying more than your fair share of the cost?
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    Mr. CALLCOTT. We do, and moreover, the current cost structure prevents us from providing the best quality information to all of our customers. If we were to purchase that, it would increase our costs approximately ninefold over what we are currently paying for market data.

    Chairman BAKER. Mr. Shays, if I can, I am going to go to one other Member, and we will come back for another round.

    Mr. SHAYS. I didn't know another Member was here. I apologize.

    Chairman BAKER. Mr. Inslee, did you have a question?

    Mr. INSLEE. I will pass.

    Chairman BAKER. Do you want to start a second round?

    Mr. SHAYS. Yes. Let us do that.

    Chairman BAKER. Let me try at a summary here and get a reaction. On the one hand, the exchanges will not acknowledge the view that you are in the role of a public utility, which would perform a public service at a cost plus a percentage rate of return, which would require supervision by an outside Government party, SEC, to determine whether or not the charges for the public good are fair and reasonable. It is my view the SEC has not exercised that authority, to my knowledge, has never acted unfavorably toward a rate structure, if they have reviewed them. And second, that there is no understandable methodology by which an outside party today can look at the Exchange's operations and come to a conclusion as to the promptness of the rate schedule in relation to the cost of providing that service. So if you are a public utility, which I know—I am not saying that you are acknowledging this. It is just part A. If you are a public utility, it would appear we need to have additional authority or have the authority now granted be exercised to understand the now apparent mystical methodology which does not lead one to conclude as to the reasonable charge associated with data production.
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    On the other hand, if we assume that we are corporations funded by investors who are making a profit, which I still have to believe is OK in America, and that you are providing a service, you should not, however, then be in a privileged position, granted by statute, regulation or other provisor, that enables you to engage in a service or activity which others are not offered the opportunity to provide. I don't know how you describe the circumstance differently, but take a shot at it, because if we are A and we are a public utility, I have a problem. If we are not and we are a private corporation, then the benefits of business conduct that are afforded those enterprises should be removed, or at least, similarly, granted to others, to enable them to compete in a similar regulatory environment. Are either observations close or are both wrong?

    Mr. BERNARD. I think ultimately we are somewhere in between what you just described, but let me make one point. The only—this display rule—we need to talk about this, because it is the only SEC regulation that is creating what is being called a monopoly here, and you should know that that rule was invented to prevent the New York Stock Exchange from being the only source of data. We are trying to promote competition by forcing vendors—in those days they had different names, but just like ILX today—from only displaying New York data.

    When that issue was before the Seligman Committee, we had a real conflict on that issue, because on the one hand, we agree with Schwab and Island and others that if you want to get the most power out of dissolving these consortia, you should get rid of the display rule and let the strongest competitive forces apply. The reason that New York was among the majority that voted against getting rid of the display rule was for the very reason why the SEC continues to feel that that display rule is important, because no one is worried about broker dealers or institutional investors getting any data they want. They have got enough clout. The issue is the individual investor, and the fear that if you drop a display rule, then, perhaps we will be back to where they only see the New York data and they only see the 15 percent of the——
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    Chairman BAKER. Let me interject on that point. This is not 1901. It is 2001, and the ability of an investor to get access to information via the internet, for example, or telephone or any other mechanism, is extraordinarily different from the environment in which many of these rules were constructed. And I think the person who is investing $200 who makes $30,000 a year is going to be just as interested in knowing where his money is going as a fellow investing $200,000 who makes $3 million a year.

    I think the investing environment is different, and you know, I don't want to pass anybody up for blame here, but you know the media, to a great extent, contributed to a lot of this enthusiastic activity until the last few months, I would say. So people have a different mindset. We have a different set of market conditions which are being constrained by rules written many years ago, although I am not agreeing with the ECN approach to resolve this.

    I don't think we ought to blow up the national market system, but it sure appears on its face if you can't explain to me what the charges relate to, other than a board meeting, you know, some mechanism, maybe not the Congress, maybe not the SEC, maybe somebody ought to have to be able to make that assessment and your problem goes away.

    I think the question that is being asked here from a market practitioner's view, are the fees that are being charged for the service being rendered appropriate in light of the services that are available, and if they aren't, perhaps adjustments are required.

    I think the most onerous suggestion would be to rewrite all the rules and have 50 people claiming to be able to process this data knowing full well the enormous investments you make preclude most people from doing it at the level of competency which you provide.
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    So I have regard for your ability and what you do, but we need to have more disclosures to understand it in order to take a position that stands in defense of the practice. Do you understand our dilemma?

    Mr. KETCHUM. Mr. Chairman, if I could say one thing on that, and you are right there, it is 2001. There is enormous access in the internet. It is for exactly that reason that we applaud, and think it is a great idea that a variety of brokers like Island and other ECNs do provide information available on the internet that provide one picture of what is going on in the marketplace.

    I think our experience has been, and I think any study would find, most investors don't avail themselves of that information. Some sophisticated investors will, and that is good and it should be there and available. Most investors look at the consolidated information. They look at it because it is the simplest and easiest way to gain a picture of the marketplace, and as Rich indicated before, there was a requirement of consolidating information. Vendors simply did not make that information available and brokers given the choice of providing to their customers all information in all markets, speaking as a primary market in the securities we list as a competing market to the New York Stock Exchange and sectors we don't, vendors and brokers didn't make that information available in the third market of the other competing exchanges.

    Chairman BAKER. But today, we have the delayed tape disclosures, which prior to that determination, it was viewed as being a highly controversial decision to let this information go out, even on a 15-minute tape delay for fear there might be some inappropriate market response. My view of that is that the 15-minute tape delay for free is an exact comment about its value. If you don't know what is going on at the moment, you are trading in the dark. So I take no comfort in the fact that we shouldn't disclose real-time information to any investor who chooses, and let them, through their own judgment, make whatever decision they may make. That is my problem. I think we are giving people information that is worthless.
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    Mr. BERNARD. No one disagrees with that. The SEC's concern is that that is not what would happen. They would never see, if the past is prologue, the prices from Boston or Philadelphia or Pacific. That is the SEC's concern, and you can take it for what it is worth, but it is a thoughtful discussion. Although that rule was passed, I think when this guy was running the division, we looked very carefully at that.

    Chairman BAKER. But the next logical step is to assume that because we are giving people information that is of no value that we are providing a public service. How do we argue, if the real value is in real-time data and the trouble with these gentlemen is that if they provided real-time data to all customers within their base, they make the allegation they would have to pay $157 million annually in order to get that level of access, level two disclosure is that correct?

    Mr. CALLCOTT. Yes.

    Chairman BAKER. And our judgment is that may be appropriate, but how do we know that if we can't get disclosure of the cost associated with the management of the data?

    Mr. BERNARD. Well, I did tell you we were hybrid and I owe you an answer to those questions.

    First, remember, we are like the guy who produces a cow, when you produce both the leather and the steak. I can't tell you, and you keep asking me and my colleague to tell you how much do I spend on producing market data and how much do I spend on producing trade executions.
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    Chairman BAKER. Your illustration is perfect. If I find out the guy who is selling me the leather is doing it in the same room where he is making the steak, I ain't buying. They have got to be separately allocable activities to which a reasonable business—I will tell you, I have dealt with some—the Government sponsored enterprises are extraordinarily complex organization, and they can almost break it down to the microsecond expenditure of what they do and where they do it, even given their level of sophistication. Now, I can't do it and I may not understand it, frankly, even if you give it to me. But the point is there has got to be some way to come to a defensible position in understanding the broad subject matter, and maybe there will be art form judgments made as to allocation of cost. As for capital costs, I know they are traditionally costs such as real estate—you are going to allocate those to different areas of your activity, but what do you call that?

    I mean, is that an investment cost? Is it an advertising cost? I understand the problem, but I think there is a remedy to it.

    Mr. BERNARD. Mr. Chairman, if I am feeding grain to the cow, I don't know whether it goes to the leather or to the steak. My problem is that I produce last sale prices and quotes at the same time I produce trades. What I can tell you is that I only allocate to market data 17 percent of my costs. So I am very comfortable in telling you that whatever I am doing, I am not allocating too much cost to market data.

    Chairman BAKER. But when the board sits down and makes that judgment from the broad array of participation you have, what information do they look at that helps them decide 17 percent?
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    Mr. BERNARD. I have already testified, they don't care about that question.

    Chairman BAKER. But I do.

    Mr. BERNARD. That is a question that's being posed by others. The board is saying I have $700 million or $800 million of expense to cover next year to run the stock exchange that produces, among other things, market data. What is a fair way to hit listed companies, broker dealers and institutional investors in doing that, what is the fair way? And over the years, they have come up with a variety of ways of doing it. That is how the board looks at the question, and I don't know that Congress, when it imposes taxes, tries to understand, does any kind of a cost allocation, either. Congress says I have got this budget, we make decisions about expenses, Congress makes decisions about expenses. Once you have done that, you have got to cover those expenses, and then the question is not cost allocation, you know, how much goes to the military, so we will have a military charge. It is fair allocation of those costs, in your case, through taxes and through us, the different types of charges.

    Chairman BAKER. That engenders a longer conversation, which I won't abuse my fellow colleagues with.

    Mr. Bentsen.

    Mr. BENTSEN. I think that is all, with due respect, somewhat simplistic observation of the budget process up here. Mr. Shays would agree with that. We have sat on the Budget Committee for a while and I think, Mr. Chairman, that after hearing this, that you should rename this subcommittee when you brought up the GSEs, this ought to be the subcommittee on hybrids.
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    But I think what Mr. Bernard is saying, to use the cattle analogy, is that the butcher and the tanner are the same person, and because you are getting the information on pricing at the same time that you are executing the trades, and so it is hard to tell whether he spends more time with his right hand or his left hand.

    But again, I mean the fundamental issue here, it seems to me, and I may be wrong about this, is that Mr. Callcott feels that in on-line trading and very broad discount brokerage, that under the current fee structure, you are paying too much for the information that you are getting, and that you ought to just get—that this information, these facts of trades are basically public domain, and you ought to have access to them and you manipulate them how you want and you make whatever investment you want.

    And that, I would understand, if it was just this sort of open marketplace, that anybody could show up in the morning and trade and there was no regulation, but the market system doesn't work that way, does it? I mean, it is an organized exchange with listed companies. There are fees allocated to it. There are investments that are made and somehow that cost has to be recouped. And you get the benefit of this stable exchange. Isn't there some value to that?

    Mr. CALLCOTT. Sure there is, but what I should say is that at the New York, they compete for listed companies, they compete for trade executions. There is a monopoly for market data, and when they are allocating their costs among those three, it is very easy for them to say, well, let's put some more on the market data side, because we know we are going to get that. You know we don't want to raise the cost on listed companies, we don't want to raise the cost on transactions, because we might lose those to other markets. It is the cross-subsidization problem when you have a monopoly that is the basic core of what we see as the problem here.
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    Mr. BENTSEN. Would then the analogy be that—Congress went through this a few years ago, and we are still going through it in the telecommunications industry, and we said that the regional Bell companies had to open up their monopoly markets for local phone service, and, in return, they would be allowed to get into the local long distance market. I mean, would the corollary be here that the exchanges could go beyond just being an even exchange and get into the brokerage side and the sell side, buy and sell side of the business?

    Mr. CALLCOTT. Well, I think that is a very appropriate analogy. If they provide the raw market data to everyone on the same basis, they can set up a separate subsidiary to aggregate that market data and sell it at whatever the market price would bear for their aggregation services as long as everybody is getting the same raw feed on the same terms.

    Mr. BENTSEN. But the Bell companies are doing that. In theory they are going to sell their local phone service at the same time they are allowing others to come in and sell local phone service, but they are going to also include the long distance companies, but then they are going to get into the business of selling long distance as well within the local region. So what would preclude Nasdaq or NYSE to set up their own discount brokerage operation? Would that be fair trade?

    Mr. CALLCOTT. Well, the concern is, of course we are members of them and we are regulated by them. If they were to get into the brokerage business, I think they would have to move that regulatory responsibility they have into a separate organization that was independent from their market. Indeed, the SIA has done a white paper suggesting precisely that, and Schwab supports that idea.
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    Mr. BENTSEN. I guess that is my point. They are a separate entity that has sort of a regulatory function, and they are ideally an honest broker where trades are executed and market data is made available and it is highly regulated. So wouldn't we be better in this instance in having this regulated structure where if there's a pricing issue and a cross-subsidy issue, that the regulator ought to be doing this so that we maintain the national market system as fair and open structure? If there is a problem, if there has been market disintermediation and shift to more discount brokerage and an uneven pricing structure, shouldn't that be the purview of the regulator and, say, your pricing structure is messed up?

    Mr. CALLCOTT. That is certainly a possible result of the system we have now. We have identified what we think are some problems with that system in terms of pricing and innovation, both of which are skewed by having that kind of monopoly, but I certainly do agree that as the markets move more toward a for-profit competitive structure on their market side, there is a real problem with them keeping the traditional regulatory responsibilities that they have had since the 1975 Act amendments, and indeed, since the 1934 Act was first passed in the Roosevelt Administration.

    Mr. BENTSEN. Well, I would agree with that aspect and that is why I wonder if we are not, I mean, I guess the feeling is nobody comes up here and offers anything for free. Any agreement would probably mean give us something in return and giving something in return might upset what is otherwise a pretty efficient model and which could, where you might otherwise find a remedy to your concern.

    Mr. CALLCOTT. And my only suggestion would be that it is already happening. I mean, Nasdaq is going to for-profit status. We are a shareholder in Nasdaq. New York announced that they were and then they withdrew that.
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    Mr. BENTSEN. But they are not, to my knowledge, and you are much more knowledgeable on this than I am, but to my knowledge, they are not trying to become a broker dealer or anything along those lines, are they? They are just trying to create a for-profit model of their exchange, which will still be a regulated entity.

    Mr. CALLCOTT. Well, in the Pacific Exchange context, you know, Archipelago, which is now basically a broker dealer, is basically becoming an exchange. Island has also filed to become an exchange. So I think the distinction between brokerages and exchanges is, in fact, currently breaking down.

    Mr. BENTSEN. This is my last point, but the difference would seem to me that the 1975 Act doesn't necessarily recognize Island or any other as this sort of standard bearer exchange, nor does the marketplace at this point in time. Now maybe the marketplace will ultimately, but I don't think the 1975 Act does, where there are sanctioned exchanges and there are market created exchanges, which sophisticated investors, at least, do know the difference of, but it is a topic that is obviously going to take some time to figure out.

    Thank you, Mr. Chairman.

    Chairman BAKER. Thank you Mr. Bentsen.

    Mr. Shays.

    Mr. SHAYS. Mr. Chairman, you know, when a southerner speaks like a southerner, I have no problem, but when he speaks as a southerner like a auctioneer, I do have a problem, and I just want to say, Mr. Bentsen, I always enjoy being in this subcommittee. I learn so much from the questions you ask, as well as from the Chairman, and I appreciate it a lot.
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    I tell people being a legislator is like going to school, a large university. The only scary thing is I ultimately have to vote on these things.

    My sense, as I have been listening to the questions and the responses, is that the bottom line is that Schwab, which is a member of the New York Stock Exchange and a voting member and, in fact, has a CEO on the board, does have impact. And then I say, well, it is only $10 per client, but you have got a lot of clients, so that $10 adds up. So the bottom line is you just want to pay less and I understand that.

    And what I am also hearing is that it is really take it or leave it. I mean you, in a sense, have a vote on the board and the scary thing could be they could double it and you still have to pay the fee. Is that accurate?

     Mr. CALLCOTT. Yes. Obviously we could complain to the SEC, which we have done on occasion.

    Mr. SHAYS. And the SEC could respond and that is where you have to go, but it is a little scary, because ultimately the market forces at work is an arbitrary price, and you are part of that system.

    From the standpoint of listening to the exchanges, I am struck by the fact that this has been the way it has been, and it is a source of income, and it is a threat, obviously, to your operation, and you would have to do some shifting if you had to charge less.

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    So it strikes me that some of this is somewhat of a political battle. It is also one where the SEC and you all are going to basically charge about as much as you can charge without getting Congress mad and the SEC mad that they ultimately step in. You shook your head, Mr. Bernard. I am happy to hear your response.

    Mr. BERNARD. Yes. I just want to remind you, at least for 70 years, we have charged essentially the same amount as a percentage, 17 percent.

    Mr. SHAYS. That is not comforting to me honestly, because the world is different.

    Mr. BERNARD. But the point is, it is the users charging themselves. As Rick testified earlier, there is a lot of reasons why we don't want to charge too much for market data, because it is the magnet that brings in the orders in the first place.

    Mr. SHAYS. Monopolists have a monopolistic price and they can charge that price and in a sense, you do have a monopoly here.

    Mr. BERNARD. I am not agreeing with that entirely since I have a lot of competitors. The answer is that situation has been true for 70 years and we haven't done it. There must be something else going on here, and that something else is the decision by the users, the payers of these fees, that that is all they want to pay through market data fees, and they want to get the rest of it done through listings.

    If I may make one other point, we should understand what we are talking about here. If the nonpro and the pro quote fees are 17 percent of the market data fees and the market data fees are 17 percent of the overall NYSE revenue, then we are talking about something like less than four percent of the NYSE revenue and we are talking about something like $30 million a year from all broker dealers. I am not sure this Congress should be spending so much on this topic.
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    Mr. SHAYS. Fair enough.

    Mr. Ketchum, you are not a mutual anymore, so how do your customers in a sense get to impact and determine the price they pay?

    Mr. KETCHUM. It is a good question, Congressman, and I should clarify at this point, because while we look forward to the day that the SEC approves exchange registration, that day has not occurred yet. The NASD, which is a mutual, still has majority voting rights with respect to their position in ownership of Nasdaq, but beyond that, we remain a creature of statute, today, as an affiliate of the NASD, in the future as an exchange, as Rich indicated earlier under Section 6. That statute requires us to have a board that reflects our constituents. It will require us to have a board that reflects both participants in the market as well as investors in the marketplace, as well as our issuers listing on our marketplace.

    So those requirements don't disappear and indeed we, as the New York Stock Exchange, are now required to have a board that has a majority not affiliated with a broker dealer. So it has to be people that are either issuers or direct investor representatives.

    Mr. SHAYS. The analogy, and I will end on this, but the analogy is that of the telephone company, the breakup of AT&T. It can no longer own the Baby Bells and the Baby Bells have to open up their markets and so on. I mean, if that were the analogy, then I would want to jump in big time, because I think that was important to do, the break up, but I don't see why that analogy fits. Can someone tell me how, so I don't see it fitting. Why do some of you seem to think that fits.
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    Mr. KETCHUM. Well, I have to personally say I don't see how it fits as well. I guess one interesting thing to note is that with respect to the entities that profit most with respect to market information, it is starting off with no markets, it is the information vendors that retail that information out. And probably indirectly the broker dealers use that information to encourage transactions through their customers.

    The second piece is about the only piece of analogy vis-a-vis AT&T that I can see fitting is the SEC has made a decision to make it much easier for electronic trading systems such as Island to become exchanges and to choose if they would rather be an exchange, become in the business of collecting data and disseminating it, among other things, and providing executions in that way rather than being in the business of a broker. So that Congress, always in its wisdom, has never placed a quota on the number of exchanges that may exist in the United States, and now the SEC has made it much easier for different for-profit models to become exchanges.

    Mr. SHAYS. Anybody else want to respond?

    Mr. SMITH. If I can comment on that. To the extent that Island can become an exchange, while that certainly will help in competition for transaction services, I don't know that it will have any effect on the price of market data. If Island were to become an exchange, we then become part of the consortium that sets the prices that everyone pays, including Schwab, when they go to purchase consolidated quotation data.

    At the end of the day, I think it is important for this subcommittee to really think about the vendor display rule, because everything we talk about it, and it is not a very sexy rule, but it actually is a very important rule, because it distorts the market and creates everything we are talking about today, because it forces every market participant to purchase this one set of information. And what you need to ask yourself is, certainly the consolidated data is very important, it is critical to investors and I certainly believe they should have it, but the real question is should that be the only data investors get, and we, certainly at Island, believe that investors should get as much information as possible, and by limiting them only to consolidated information, what you are actually doing is limiting the amount of information they can get.
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    Mr. SHAYS. Thank you. Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Shays. I always enjoy your participation. I just want to make an attempt at sort of a wrap-up here.

    Obviously, we need from all sides more information. It would not be my intention to take any significant action on any front until we certainly have receipt of the Seligman Committee recommendations, but I think it important or fair to say that this is a concern I believe is appropriate for our subcommittee to understand and examine. The nature of the participation in the markets has been dramatically democratized because of technology, and therein is the Congress's responsibility to ensure that market participation is based on the best information possible, fairly distributed without prejudice to anyone.

    To that end, it has been stated that the SROs are creatures of statute, which is exactly my point of beginning, that because you are privileged by creation of statute, there comes with that specific duties and obligations one must discharge. One element of that responsibility is a fair and reasonable pricing of distribution of data.

    Unfortunately, I don't feel that we can determine today, based on what I now know, that the charge is fair and reasonable, although it is apparent that from a historic perspective, it hasn't vacillated dramatically, at least in the New York Exchange's examples, but it doesn't necessarily relate to the provision of the information as a condition of your statutory authority.

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    I think the point that Schwab makes that it does not pass on level 2 information to all customers as an economic decision is unfortunate. When someone gets delayed tape information, and makes investment decisions on that information alone, I have great discomfort in feeling that that is the way large numbers of unsophisticated investors are making their decisions.

    At the same time when that occurs, I think there is a larger economic concern that is warranted by this and that is, that level of investment activity based on untimely information does, in fact, lead to additional market volatility. That is not good public policy.

    For these reasons, I feel it is important for us to engage the new chair of the SEC, assuming confirmation finally occurs this week, to assist us in better understanding this issue. I invite the participants here today and others who may have interest to forward additional information for us to review through our summer recess. I can't wait to get on the beach with an explanation of how Section 11A and other provisions of the Act affect our judgment on this matter, but I am just anxious to get there.

    But we will return this fall, hopefully, better informed with the assistance of the Chairman of the SEC and any other appropriate agency, to help us understand the functions of the exchanges in relation to this important public policy matter.

    Beyond that, I wish to thank you for your patience and endurance. No one would have dreamed that a hearing on market data would have held us here until 4:45. I am sure you can't believe it either. Thank you for your courtesy. Hearing adjourned.

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    [Whereupon, the hearing was adjourned.]