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Thursday, October 16, 2003
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance and
Government Sponsored Enterprises
Committee on Financial Services,
Washington, D.C.
    The Subcommittee met, pursuant to call, at 10:05 a.m., in Room 2128, Rayburn House Office Building, Hon. Richard Baker [Chairman of the Subcommittee] presiding.
    Present: Representatives Baker, Ose, Shays, Bachus, Castle, Royce, Oxley (ex officio), Kelly, Ney, Ryun, Biggert, Capito, Hart, Kennedy, Tiberi, Harris, Leach, Kanjorski, Sherman, Meeks, Moore, Gonzalez, Frank (ex officio), Hinojosa, Lucas of Kentucky, Crowley, Israel, McCarthy, Baca, Miller of North Carolina, and Maloney.
    Chairman BAKER. [Presiding.] I would like to call this meeting of the Capital Market Subcommittee to order.
    This morning, the Subcommittee meets to begin a review of the nation's capital marketplace structure and it is the first in what, I think, will be a series to examine the many complex challenges facing today's marketplace. From ensuring proper regulation for the protection of investors to facilitating enhanced competition, we must maximize opportunities and preclude misinformation and potential losses.
    We must also think forward, beyond merely the next quarter of business performance, but what our capital markets should really look like within the decade to remain competitive and the dominant force in the international marketplace.
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    The focus of today's hearing will be on the corporate governance question relating to the New York Stock Exchange and the appropriate role of the proposed reforms. Is the SRO model one, as some suggest, too troubled to succeed?
    I am sure each of our witnesses today will provide valuable insight into this question, and I am anxious to learn of their perspectives. It is my judgment, however, that the lessons of the Sarbanes-Oxley Reform should not be overlooked.
    The committee looked at the issue of audit team independence, and for the first time statutorily required the audit team to report to the Audit Committee to establish, not Chinese, but firm concrete high walls between CEO/CFO conduct and the audit function to ensure that the financial statement is an accurate reflection of corporate value for the shareholder's assessment.
    This model, I think, establishes a valuable point: that those charged with regulatory or compliance functions within the Exchange should not directly report to the CEO of the for-profit enterprise. How this can be achieved is left to those within the market to best determine, but I think assurances of the separation are essential.
    Of recent note, the NYSE has been criticized for failing to recognize conflicts of interest and potential abuses in IPO allocation practices. Criticism has been levied at the Exchange for not enacting all essential corporate governance reforms. This criticism has increased in volume following the announcements of Mr. Grasso's compensation.
    Mr. John Reed, who will testify later this morning, has been installed as the interim Chairman and would quickly note, in contrast to his predecessor, Mr. Reed has agreed to a single dollar of compensation for his tenure, which began earlier this month. And that he has begun implementing changes that will enhance the regulatory efficiency of the Exchange.
    This committee will certainly look forward to Mr. Reed's leadership and do all that is necessary to facilitate that those stakeholders in the New York Stock Exchange understand appropriate governance and, more importantly, that those who extend their valuable dollars by investing in America's capital markets can be assured that it is not only a transparent functioning marketplace, but it is one that engages in fair and ethical practice that should instill confidence in the performance of our capital markets.
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    To restate, our capital markets function in the most efficient and helpful manner of any in the world, and no other market, other than the New York Stock Exchange, can be cited for its dynamic contributions over the history of economic growth of our country.
    But change is on the horizon. And, not only should we concern ourselves with ethical and appropriate conduct, but we must assess the impact of technological changes in the broader marketplace and facilitate that trades occur in the most appropriate fashion at the best price for those who invest.
    The investing landscape has changed. Now, over 50 percent of our households in America, through the workplace or through direct investment, are participants directly in our capital markets function. And, accordingly, the Congress has appropriately enhanced its sensitivity to these issues because it literally affects every congressional district and, potentially, the economic fabric of this country.
    For these reasons, the committee has turned its attention to this important matter and we look forward to the insights of those who will appear here today.
    Mr. Kanjorski?
    Mr. KANJORSKI. Thank you, Mr. Chairman.
    We meet today to review, generally, the structure of our nation's capital markets and examine specifically corporate governance issues of the New York Stock Exchange.
    In recent years, a variety of securities industry participants have questioned one or more aspects of the regulatory structure of our capital markets. Recent events at the New York Stock Exchange have also brought to light some of the potential conflicts that exist in a self-regulatory model. I, therefore, congratulate you for convening this well-timed hearing.
    Debate on market structure focuses on such important issues as competition, the definition of an exchange, access to market data, information transparency and technological advances. Each of these issues have evolved considerably in recent years. As a result, we have come to a crossroads facing a number of decisions that could fundamentally alter the structure of our capital markets for many years to come.
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    As my colleagues well know, I have made investor protection one of my top priorities for my work on this Committee. I, consequently, share your concerns, Mr. Chairman, that our committee must conduct vigorous oversight to examine whether the regulatory system for the securities industry is working as intended and to determine how we could make it stronger.
    In addition, I continue, by and large, to favor industry resolving its own problems through the use of self-regulation. Since the enactment of our Federal Securities Laws, U.S. Stock Exchanges have served both the marketplaces for securities trading and as regulators of their member companies. For the last 70 years, this system has worked remarkably well and balanced in protecting the integrity of our markets.
    In order for self-regulation to endure, however, the system must maintain the confidence of investors. We developed the self-regulatory model under the stewardship of William O. Douglas, who, before he became a Supreme Court justice, determined that it was impractical, unwise and unworkable for the Federal government to try to regulate our decentralized securities markets directly.
    In order for self-regulation to work, he also determined that the Securities and Exchange Commission needed to keep a shotgun, so to speak, behind the door loaded, well-oiled, cleaned, ready for use but with the hope it would never have to be used.
    Despite my strong support for self-regulation, recent events at the New York Stock Exchange have revealed some of the conflicts that exist in self-regulatory models and the need for effective Federal oversight.
    I, consequently, look forward to hearing from the interim head of the New York Stock Exchange about his recommendations for eliminating and abating these conflicts within his organization. In particular, I want to learn his thoughts as to how we should best separate the Exchange's regulatory and commercial functions.
    Additionally, I look forward to hearing from our distinguished witnesses on the second panel, which includes representatives from some of the regional exchanges, noted securities industry experts, and other market participants.
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    Their observations will help us to understand how the New York Stock Exchange might restructure its internal governance system. They will also help us to understand more about how important market structure subjects.
    As we begin this series of hearings on market structure issues in the 108th Congress, I must caution my colleagues on both sides of the aisle to move carefully and diligently in these matters.
    In testimony before the Senate yesterday, SEC Chairman Donaldson indicated that the Commission would be focusing with increased intensity on the structure of our equities markets in the upcoming months. It is my hope that the Commission will move expeditiously in these deliberations.
    It is also my hope that our securities market participants and their Federal regulator will resolve these issues without unnecessary congressional interference.
    In closing, I want to assure each of our witnesses that I approach the market structure debate with an open mind. Their comments about these matters will help me to discern how we can maintain the efficiency, effectiveness and competitiveness of our nation's capital markets in the future.
    I also look forward to continue to work closely with you, Mr. Chairman, and with others as we address these multi-faceted, complicated and important matters so that we can conduct effective oversight over our capital markets and ensure that we maintain an appropriate and sufficiently strong supervisory system for them.
    [The prepared statement of Hon. Paul E. Kanjorski can be found on page 79 in the appendix.]
    Chairman BAKER. I thank the gentleman for his statement and look forward to working with him as well.
    Chairman Oxley?
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    Mr. OXLEY. Thank you, Mr. Chairman, and thank you for holding this timely hearing and your leadership on investor protection issues.
    The New York Stock Exchange is an important symbol of capitalism here and throughout the world. It has a rich and storied history and has served investors well for over 200 years.
    The past year, though, has been a difficult one for the Exchange. Highly publicized controversies have tarnished the image of the New York Stock Exchange and have led many to call for changes to the corporate governance of the Exchange, its role as a self-regulator, and also to its defining characteristic: the auction market system.
    And these calls for reform have heightened the urgency of a thorough review and modernization of the regulatory and operational structure of our capital markets. As electronic trading and the growth in investor participation in the securities markets have transformed those markets, problems have arisen that were never envisioned when many of the significant rules affecting market structure were put into place.
    Indeed, the notion of a securities market as its own regulator is now in question. Several years ago, in response to a scandal on the over-the-counter market, the governance of the NASDAQ market was reformed considerably leading to a separation of its regulator from the market. Today, some are calling for a similar change to regulation of all exchanges.
    The corporate governance of exchanges is now receiving the kind of close scrutiny that corporate America underwent leading up to, and since the passage of, Sarbanes-Oxley. It is vitally important to investor confidence that the management of the Exchanges that are at the heart of our capital markets be held to the highest possible standards of integrity and transparency.
    Increasingly, institutional investors are calling for reforms of the New York Stock Exchange specialist system. Some view the specialist as an unnecessary middleman who impedes the efficiency of the marketplace. Even if the New York Stock Exchange is correct about its ability to achieve price improvement, large investors say they place a higher value on speed of execution and anonymity.
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    If we wanted to build a stock market from scratch, would it be run by humans or computers? Why does the New York Stock Exchange control 80 percent of the trading volume of its listed companies when NASDAQ controls only about 20 percent of the volume of its member companies? Have current rules and regulations contributed to these results? How does the current structure benefit or harm investors?
    These are important questions, and, fortunately, we will hear from an esteemed group of witnesses this morning that can provide answers. And, the first one, of course, Mr. John Reed, who has come out of a well-deserved retirement to accept this challenging position and is off to an impressive start.
    We are pleased to have you here, Mr. Reed, and we look forward to your testimony, and I please yield back.
    [The prepared statement of Hon. Michael G. Oxley can be found on page 72 in the appendix.]
    Chairman BAKER. I thank the Chairman.
    Ranking Member Frank?
    Mr. FRANK. Thank you, Mr. Chairman.
    I appreciate Mr. Reed's being here, and I appreciate even more Mr. Reed's being where he is in New York because it would seem, to the naked eye, to be a degree of aggravation which he did not need. And I am very appreciative of his stepping up here.
    It is a very great service to have someone who is literally disinterested, not bored, but in the literal sense of disinterested, someone who has no axe to grind, no interest other than trying to improve a very important institution.
    Now, I will not be making any great number of substantive comments here because I will confess that the governance of the New York Stock Exchange is not one of the subjects which has, heretofore, fascinated me. It was not within the jurisdiction of this Committee for most of my service on the committee, and we tend to be in a situation where, if things have not reached a crisis stage, we often aren't able to get there.
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    I now understand that we have some serious questions to be resolved. The question of a conflict between regulation and promotion, the question of—we are all for self-regulatory organizations—but the question is whether we have, in this instance, allowed self-regulation to be carried too far. And I appreciate Mr. Reed's willingness to address this.
    I understand that the compensation issue, of course, called our attention to it, but that, as I look at it, does not seem to be at the core of what we need to do here. We need to talk about what is the appropriate governance for a very important part of the American economic system.
    So, I think this hearing is an entirely appropriate one. I look forward to learning from it. I won't be able to stay for the whole hearing, but when we have a Congress that meets a day and a half a week, it tends to clutter up your day with other things to do. I regret that, but I have no control over it yet.
    But I will be taking the testimony with me, and I appreciate the chance for Mr. Reed to come and share with us his thinking.
    And I can say, finally, I am also struck by the way in which Mr. Reed has approached these issues, Mr. Chairman, namely, that he is prepared to listen, that he has outlined what the questions are, and I have hopes that we will come out of this with a very useful set of decisions.
    Thank you.
    Chairman BAKER. Thank the gentleman.
    Mr. Bachus, you had an opening statement?
    Mr. BACHUS. Thank you, Mr. Chairman.
    Mr. Chairman, and Chairman Reed, I have read your testimony today, and I appreciate your testimony.
    I do want to say that I think the issue that we are not discussing today, which is far more important, is the way that stocks are traded on the New York Stock Exchange. The fact that specialists are member firms which have an exclusive right to trade in each of the New York Stock Exchange listed stocks, and if a broker wants to trade in that stock he has to go to that specialist, and that specialist alone has the right to execute that sale or buy that stock.
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    And what, to me, is amazing about what I see as a monopoly is that the specialists make the bulk of their money by buying and selling stock for their own account. And, to me, that seems like a monopoly situation in which the specialist, who has monopoly, has an inherent right to make a lot of money at others' expenses.
    And I would hope that, as we go forward, we discuss this, the fact that this appears to be a monopoly at the expense of the public and that these specialists, the bulk of their money is buying and selling stock for their own account.
    So, I appreciate your attendance here.
    Chairman BAKER. Does the gentleman yield back?
    Mr. BACHUS. Yes.
    Chairman BAKER. The gentleman yields back his time.
    Mr. Israel, did you have an opening statement?
    Mr. ISRAEL. Thank you, Mr. Chairman. I will just be very brief.
    Mr. Reed, I represent a district in New York that is about 40 miles away from the Stock Exchange. And I want to welcome you and thank you for the important undertaking that you are engaged in and look forward to continuing to work with you for the betterment of the Stock Exchange, for investors and for all of our financial institutions.
    And I yield back, Mr. Chairman.
    Chairman BAKER. Thank the gentleman.
    Mr. Royce, did you have a statement?
    Mr. ROYCE. I do, Mr. Chairman.
    I want to thank you for holding this hearing on recent developments of the New York Stock Exchange. I also want to thank Mr. Reed, and I think you are to be commended for your current role at a particularly difficult time for the New York Stock Exchange.
    And I have had the opportunity to review your prepared remarks today and I was very pleased to see that you are addressing a number of corporate governance issues, Mr. Reed, that are before the Exchange. I think the New York Stock Exchange Board is too large; it needs reform. I think the Exchange also needs to alter the make-up of those that serve on the board.
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    It seems odd to me that regulatees are represented on the board and have a say in the compensation of the regulator. It would be as if bank CEOs decided the compensation of the comptroller of the currency.
    I believe the New York Stock Exchange's largest constituencies should be represented on the board. As a holder of some $6.7 trillion of assets, the mutual fund industry should have at least one board seat, it would seem to me.
    And the New York Stock Exchange should consider separating the dual roles of its CEO. There are clearly times when the role of regulator conflicts with the role of business leader.
    Finally, it is my view that the Exchange should not limit itself to examining corporate governance issues. I have felt, for some time, that the New York Stock Exchange needs to do a better job of explaining the benefits of the specialist system to the marketplace. I was very troubled to learn of this morning's news that five separate firms had engaged in improper trading activity.
    Mr. Chairman, I want to thank you, again, for your leadership on this issue and thank you for this timely hearing. And I look forward to the other testimony of the other panelists that are here today.
    I yield back.
    [The prepared statement of Hon. Edward R. Royce can be found on page 82 in the appendix.]
    Chairman BAKER. I thank the gentleman for his statement.
    If there are no other members desiring to give an opening statement, at this time I would like to welcome Mr. John Reed, Interim Chairman and Chief Executive Officer of the New York Stock Exchange.
    Mr. Reed, as you can tell from the members' expectations, your reputation precedes you in a very advantageous way. I think we are all very excited to have you here to receive your comments, and we look forward to working with you, sir.
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    Please proceed at your leisure. We will make your official statement part of the record.
    Mr. REED. Chairman Baker, thank you very much.
    If I could also say, Ranking Member Kanjorski and Chairman Oxley and Ranking Member Frank, I greatly appreciate the comments and the welcome that you have extended. And to all of the members of the Subcommittee, I am delighted to be here.
    I appreciate that you invited me, and I hope that I can, at least, share with you what it is that we are doing.
    I did, in fact, submit a written statement, and I appreciate that it will become part of the record, but what I will do is just summarize, very quickly, what it is that I am trying to do, where we stand. And I will touch on some of the issues that have been raised.
    The New York Stock Exchange, as everybody has said, is an extremely important institution, not only in terms of its function and role within the capital markets, but, indeed, I think it is a symbol of much that is important to this country in terms of its market system in general. And it is a symbol, not only within the United States, but, I believe, globally.
    And, so when I was asked if I would step in during a period of difficulty, I did so because I do recognize the importance of the Stock Exchange, and I felt that it was extremely important that we restore the credibility that the investing public, the American public and, in fact, the world at large, wants to have in this institution.
    And my job, in fact, is to try to see if we can restore that credibility as quickly as possible. My job is pretty clear: I have three things to do.
    The first is I must understand what happened recently at the board that caused it to arrive at its current situation. I do this, not because I have any interest in pointing fingers or anything else, but because, obviously, you must understand what happened if you are going to try to correct for the failures that we clearly suffered.
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    The second thing I have to do is draft a proposal for a new governance structure, processes at the board level. And, indeed, architecture at the board and managerial level that not only prevents a reoccurrence of the kind of problems that we have had but, more importantly, would be appropriate to serve the interests of the Stock Exchange and the investing public in the years ahead, because as many members of this Committee have said, clearly we are at a period of change and a period of transition.
    And it is extremely important that the board and the senior management structure of the Stock Exchange be appropriate to deal with the many issues that are coming down the pike. And, so, when I am looking at this architecture, I am doing so, not only from the point of view of trying to correct for whatever mistakes we did make, but, indeed, to try to make sure that the Stock Exchange has in place the kind of corporate governance and structure that can serve it going forward.
    The third thing I have to do is find a permanent leader for the Stock Exchange. As much as I may be able to help in the short term, having interim leadership is not in the interests of the Exchange nor the markets. You need a permanent leader who is there and can be expected to be there for a period of time.
    Whether we should end up with a Chairman separate from the CEO or a single person, I think, depends very much on the structure that we embrace. We first must have a structure then fill the slots, and the success of the structure depends, on the people. I think either structure could work. There are clearly benefits for having a separation.
    There are advantages sometimes to having it together, but I think that we should allow for either and when the new governance structure is in place, we will then be in a position to deal with that issue. I am hopeful that we will be able to go to the members of the Exchange with a proposal for a new structure by the end of this month; that means in the next 10 days, approximately.
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    As you know, the bylaws of the constitution of the Exchange require that the members vote for any changes to that structure. Of course, the Securities and Exchange Commission must approve such changes as well. The SEC takes the position, I think correctly, that any change to the constitution is a change of rules which they also have to approve.
    And so, there is a process here that involves first making recommendations, then getting a vote from the membership and approval from the Securities and Exchange Commission. I am hopeful, as I said before, that by the end of this month I will have that proposal in the public domain for discussion with the members.
    I would be hopeful because the bylaws require that we give the members between 10 and 50 days to make any change; I am planning on approximately two weeks. I am hopeful that we could have a vote by the membership that would take place by the middle of the month of November, and that would allow us to have a new structure in place, a new board in place that would then permit us to go on with my final task, which would be the selection of a permanent Chairman and CEO or Chairman/CEO.
    So this is my timetable. I have had nothing but cooperation from everybody surrounding the Exchange and, in the Exchange, we all feel that this task is extremely important. There is no question that our historic governance structure did not serve us well, and clearly the flaws that Mr. Frank made reference to happened to take the form of compensation, but there were fundamental flaws in the structure as it existed.
    It is not my task to make decisions about the long-term architecture of markets. This deserves, frankly, the attention of a permanent management and a new board. It is, intellectually, extremely interesting. It is not something that I would shy away from working on, but it is not the task of an interim Chairman to make important decisions with regard to architecture. But, indeed, I think we need a permanent management to get into this.
    And, frankly, as this Committee and others in the Congress, I am sure will ensure, whatever is done has to be done within a broader public debate that focuses, not on the role of the Exchange and the role and advantages and disadvantages of a given intermediary, but on what is good for the investing public, and, frankly, what is good for the issuers: those companies that come to these markets to raise the capital to strengthen their own business, and so forth.
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    I am sure that the public debate will focus on how these markets can best serve those who issue securities and those who might wish to buy securities. And the role of exchanges and the role of intermediaries are important but, I think, the well-being of the economy rests with the investors and with the issuers, and the mechanisms in between should serve their interests.
    I do think that we should all take pride that the capital markets in the United States stand alone in terms of their competence and their efficiency and their effectiveness. So while there is reason to anticipate change going forward—and I certainly would welcome this change—there is no reason to look backwards and feel anything but pride, because I think the capital markets in their aggregate have served the country and the investors, as well as the issuers, extremely well.
    I will make a few comments with regard to some of the items that have been mentioned. They are, obviously, comments of somebody who is new to this business. But, with regard to regulation, I have had, in fact, in my business career, a fair amount of exposure to regulation, and I think I do have some understanding of it.
    There is no reason to doubt that the current structure of self-regulation that exists can be made to work. We, in the New York Stock Exchange, are good regulators. We are not perfect regulators, there are things that will need to be corrected and it is a continual improvement kind of thing, but we are quite good at it.
    And there is no reason to believe that there needs to be a change to correct that. It is true that the governance structure is probably unacceptable as a supervisory structure for a regulatory function, and it is my intention, in the proposals that we will be making public in the next couple weeks, that we would correct that.
    In other words, I intend to propose a governance structure that would clearly get rid of the conflicts that exist and, I think, were pointed out by one of the Members of having people who are regulated also sitting on the board that oversees the regulatory function itself. I would hope to have a board that is, essentially, independent and can pursue its activities without any conflicts whatsoever.
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    But I do not think there is any reason to believe that you need change the regulatory structure because of its ability to operate. I think it can operate well in its current configuration, and the need is to correct the supervisory, or the governance structure that sits on top of it, and my proposal is intended to, in fact, do that.
    There may be other reasons to look at regulation, but it shouldn't be because it cannot be made to be effective. I think it can.
    All indications are that the auction market serves investors well. It, too, can be improved. I am sure it will be improved, and the desire of large fund managers for more automation can, undoubtedly, be accommodated. I think it is important that we distinguish between accessing pools of liquidity and providing pools of liquidity.
    Automation will improve access, it won't improve the providing of liquidity to the markets. The auction system is intended to provide liquidity to the markets and that is an important function, but trade-offs can shift. Somebody said in their prepared comments that there are people who would trade price for speed. Those trade-offs can shift as people's interests shift.
    But the role of the auction market, every time it has been studied, has always been seen to have positive benefits for both investors and issuers. That doesn't mean that there is any reason to stop any further changes; I think changes should be looked at from the point of view of what is good for the overall functioning of the markets. And the New York Stock Exchange has, historically, embraced change, and there is no reason to believe that we will not do so going forward.
    The role of the Exchange in promulgating standards for corporate governance of listed companies is important. Obviously, we are not in any position to promulgate standards if our own behavior doesn't pass those standards themselves.
    So, obviously, one of my objectives in my proposals will be to make sure that our corporate governance is at least as good as anything that one might expect to be demanded of listed companies.
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    But the role of the Exchange in promulgating standards, while being in contact with the leadership of listed companies to make sure that those standards result in the improvement of governance but not in bureaucracies, I think is extremely important, and it is a role that the Exchange welcomes. And, I think, it will help the Exchange in its overall functioning.
    I believe very strongly that the strength of this company is in its private sector. I think the recent weaknesses that we have seen, not only in the New York Stock Exchange, but within the business community, point to the need for better boards and better governance. Obviously, the Congress has come to this opinion as well, because you have passed legislation that emphasizes that.
    But I would simply say that the Exchange welcomes its role in that and I think that it is important that we improve the functioning of boards and corporate governance, not only in the New York Stock Exchange, but throughout our private sector economy.
    So, I thank you, Mr. Chairman, for the opportunity to testify, and I welcome the opportunity to answer any questions that anybody might have.
    [The prepared statement of John Reed can be found on page 192 in the appendix.]
    Chairman BAKER. Thank you very much, Mr. Reed, for your appearance and your testimony.
    I, for one, am not yet ready to say the SRO model is fatally flawed and we need to go to the NASD, NASDAQ or some other model that has successfully operated. But I do believe the responsibility in this interim period is a very significant responsibility to demonstrate that the regulatory and/or compliance functions be clearly separate and above question as to their relationship to the CEO of the for-profit entity.
    To that end, I think the Sarbanes-Oxley legislation is very instructive in that the importance of that audit function be maintained as in independent, beyond reach, activity from the corporate leadership side.
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    In looking at what post-Gramm-Leach-Bliley, post-Sarbanes-Oxley and what the Exchange has done—and I will note, again, prior to your arrival in facilitating certain ethical changes in conduct, for example, investment banking analyst relationships—it is clear to me that the Exchange has demanded of its listed companies conduct which, at the same time, is not applicable to itself. I find that troubling.
    Not that all those rules are applicable or appropriate for the Exchange's operations but, in spirit and context, if we don't move away from the SRO model, we must establish a very clear high bar over which the Exchange must pass in order to, I think, obtain investor confidence that is so essential for all of us.
    And, sort of the last piece of this—because under our business we get five minutes and then you can talk for as long as you like—I am very impressed by your aggressive outline of the schedule.
    And it would also lead me to the observation that in that same time period, during which you are pursuing such extraordinary changes, how do we feel comfortable that a selection process for your successor can concurrently be engaged? And how would you suggest that that selection process be obtained?
    Mr. REED. Mr. Chairman, if I could respond to a few of these, I share this feeling that there is no way that the New York Stock Exchange could ask that listed companies have standards of governance which we ourselves don't meet.
    I fully expect that we will embrace a set of standards that go perhaps even beyond that which we are expecting of listed companies. And I share your sense of wonder that it took a problem of this sort to cause us to get there. Clearly that had to be done.
    I think it is imperative to us that we have governance of our regulatory functions that is visibly good, solid, without conflict and without problem with regard to our role as an exchange and as a regulator of both participants in the Exchange and the activity of the exchange itself.
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    I would point out that governance and regulatory structures like this abound. Most banks have internal controls for both audit and risk taking, and the national banking examiners and the Federal banking examiners from the Federal Reserve System, sit on top of that and make sure that those systems do, in fact, work and work adequately.
    And it is true that the SEC does sit on top of our own self-regulatory function and I must say, they do so quite effectively. And so, while we are self-regulated, we are self-regulated within a construct that does have checks and balances which, I think, are needed, and I do think they serve the investor public. But to your point, I will be proposing a governance structure for the Exchange that speaks directly to that issue and I believe would satisfy your concerns and those of the general public.
    The final issue is, of course, important. We had a board meeting two days after I took this job, or three, and we are not scheduled to have another board meeting until December. And so, just to expedite things, I asked that the existing search group that had been put in place by the board would be reactivated so we could begin to look at potential candidates to fill my job on a permanent basis.
    I don't, frankly, believe we want to get into it very seriously until we have revised the corporate governance because it is a little hard to figure out what kind of person you want if you don't know what the structure of the institution is going to be. But I didn't also want to wait until December to start, which would have been my next opportunity to have a meeting.
    What I am actually planning to do, I am hopeful, I can't guarantee this because it is difficult to do, but I am hopeful that when I go to the members for a vote to change corporate governance, I will also go to them with a slate of potential board members, which will be an essentially new board for the Exchange.
    Assuming that I am able to do that, the problem, of course, as you might appreciate, is that it is not easy to get people to be willing to stand in a public election of quite that sort. But I am hopeful that I will, in fact, be able to have a proposed board of directors slate for the members to vote on at the same time that they vote for the various changes.
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    I would then propose to go to that board, which will be a newly-constituted board and a board that has had the expression of support from the membership, and use them as the body to make the decision about my replacement. Because I think they would, by virtue of the election and by virtue of the new governance proposals, be seen by everybody to be a legitimate body to make that selection, as opposed to the situation we have today, where I have to rely on the old board.
    And so that was my answer to your final question, Mr. Chairman.
    Chairman BAKER. Thank you, sir.
    Just by way of clarification, it is my understanding that Mr. Grasso's compensation issue, which started all of this, he forewent in excess of $40 million, but he is legally entitled to and will receive, as far as I understand, $140 million package, which was the subject of controversy, or is that not the case?
    And secondly, in your new construct for the committee that would do the selection process for the follow-on CEO, would they also have similar authorities with regard to compensation? And would that disclosure be made public?
    Mr. REED. Yes. The answer with regard to your second question is, ''Yes.'' With regard to Mr. Grasso's compensation, as I said, the first thing I am doing is to try to find out what happened. The facts are: Mr. Grasso did receive a check and cashed it for $139.5 million prior to my election. The first question I asked was, ''Has the money, in fact, been paid out?'' The answer is yes.
    He has, under the contract that I guess was approved at the board meeting, other claims on the Exchange. I have taken the position that I don't want to deal with those until I feel comfortable that I know how all this transpired, because I have to feel that I am on solid ground as to what transpired and what is the nature of his claims to us.
    And I just felt that it wasn't prudent for me to speak to Mr. Grasso, whom I have never met, nor ever spoken with, until such a time that I was on, sort of, solid ground. I would expect to be there by early November. Subsequent to that time, when I have a firmer understanding of what happened and the basis on which decisions were made, I then would expect to call Mr. Grasso. Hopefully he will be able to sit down and resolve any continuing claims or any problems that I might have with regard to what he has already received.
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    Chairman BAKER. Thank you, gentleman. I am way over my time.
    Mr. Kanjorski?
    Mr. KANJORSKI. Thank you, Mr. Chairman.
    Mr. Reed, it is interesting that we come at a time when a conflict of interest internally on payment should have been made, but it seems that you may have some ability to look out over so many areas of our society that tests the same question: conflict of interest, greed, misstatement, lack of transparency, lack of accountability.
    And when I listened to your testimony I just thought of so many of the institutions across the board, whether it is the church, whether it is political institutions, whether it is the New York Stock Exchange, or some companies: Enron, WorldCom, we go on and on.
    It seems to me that it has always been our proposition that we presume an honest, participating society and whatever institutions they are in. Do you see any reason why we should start questioning that basic presumption? And that we have to develop processes and methodologies that anticipate that where opportunity of conflicts could be taken advantage of, they will be?
    And as a result, are we required now to go to some cellophane society to see what the product is before we buy it?
    Mr. REED. If I could say, I think that the great majority of practitioners in all of these institutions, be it the church, be it private sector, be it government, are honest, hard-working people that we have every reason to believe will do the right thing, serve the right interest and so forth.
    I do think we have all learned over the years that transparency is valuable. We embodied it in the Constitution of the United States in the form of free press and so forth, and I think most of us have felt that having a society in which you have a free press has been an appropriate thing.
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    And I think transparency with regard to corporate governance and how decisions are made and who is making them and whether or not there is the potential for conflict; these transparencies which have been enacted, I think, are appropriate. And checks and balances work.
    I think it is true that what we have seen recently was written about by the Greeks thousands of years ago; power does corrupt, greed is alive and well. But I repeat, I think our system works extremely well and the people who are not in the headlines, the companies that have had no problems far outnumber the ones that are in the headlines and that have had problems.
    But I think that it is appropriate that we have checks and balances; we have a board of directors that sits on top of the operating management of companies, with clear responsibilities. And I think transparency with regard to compensation, transparency with regard to accounting standards and performance, and so forth, is an appropriate safeguard.
    So, while I am fundamentally an optimist and fundamentally believe that most people in this world are pretty good and work pretty hard and do pretty well, I do support the idea that we need checks and balances and that transparency is useful.
    Had we, in the Stock Exchange, for example, had the same transparency with regard to compensation, I think some of the issues with regard to Mr. Grasso's pay would have come up years earlier when the first large compensation decisions were made, which, at that time, were not disclosed and therefore were not subject to any kind of conversation or reaction.
    Mr. KANJORSKI. I think I will just consume my time, Mr. Chairman. I yield back.
    Chairman BAKER. Thank the gentleman.
    Chairman Oxley?
    Mr. OXLEY. Thank you, Mr. Chairman.
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    And again, Mr. Reed, it is comforting to know that you are at the helm and I know that, based on your testimony and your answer to the questions, that you are setting up a governing structure, changing the board, doing some of the architectural things that are absolutely necessary and it is good to know that you are working yourself out of a job. And based on your compensation, I can understand why you would want to do that.
    But it is also true that, I think, the members of the committee would agree that you understand what your position is as an interim leader at the big board and are making the changes necessary. But the long-term market structure implications, obviously, will be after your departure, which, I think, is entirely understandable and laudatory in my estimation.
    It gives you a certain amount of leeway and autonomy to deal with some of those difficult issues that we struggle with, frankly, when we passed the legislation dealing with corporate governance, and your response has been extraordinary.
    Let me first begin on the SRO question, and I know that you have expressed a strong support for the idea of having an SRO. It has been my belief all along that without an SRO the SEC really is in a position where they are almost certainly overwhelmed in the real world trying to deal with regulatory matters.
    And for a long time, the concept of a self-regulatory organization working hand in glove with the SEC has been a pretty effective model, in my estimation. Do you agree with that?
    Mr. REED. Yes, Mr. Chairman, I definitely do. And I think that the facts would suggest that that is true. In other words, we are not here discussing a regulatory failure.
    Mr. OXLEY. Exactly. And I would think, when we have Chairman Donaldson here, I think next week, or soon anyway, I would ask him the same question. I think, perhaps, we would get the same answer, particularly given the fact that he once sat where you do. And that does make a difference, I think, in where we are headed.
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    Obviously you can make some changes and nothing is perfect, but at the end of the day, without an effective SRO, it really does burden the SEC rather dramatically and diffuses their ability to deal with the real big issues.
    On the auction system and specialists—this goes back to when I chaired a Subcommittee that had jurisdiction over securities and exchanges—and we had always, I think, most of the members of the committee, at that time, and we were told and learned that the special system and the auction system was to provide liquidity; that specialists were there to make a market.
    And to some extent, well it was before the advent of the ECNs, the changes in technology, the demands for more speed. To what extent has the creation and the birth of these ECNs, and even with the ability of the New York Stock Exchange to make—I think one of the great untold stories is the fact that the New York Stock Exchange, during this time—made significant improvements on their electronic capabilities?
    And the last time I was at the Exchange I was, frankly, amazed at how successful that the Exchange had been in adapting to the new world. Does it appear to you that the Exchange needs to continue to move in that direction? And what is the future of the auction market as you see it?
    Mr. REED. Well, Mr. Chairman, my impression is: number one, that the auction market has served us well. Every time we take a look and study it, it turns out that the process of searching for an appropriate price is greatly facilitated by the fact that you do have a specialist who is part of that system. And to the question that was asked before about the role of the specialists, it is true that specialists intervene in transactions, but there are distinct rules as to how they can intervene so as to ensure that they are not just snipping little profits. And indeed, the report in this morning's newspaper about some disciplinary and disgorgement actions that are underway, are because specialists did misbehave and broke the rules and they will be forced to disgorge those profits.
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    But the system works well. Every time we look at it, the benefit of having an auction system seems to rest on solid ground. But as you say, Mr. Chairman, I have been shocked myself. I, obviously now, have spent some time on the floor, and having been away for a while, the degree to which there is automation on the floor is amazing.
    Clearly the New York Stock Exchange is making use of the latest computer technology, a tremendous number of transactions never have to get to a specialist. If you have two people wanting to buy and sell a commodity at the same price, the computer can do that rather well.
    The problem is when the prices at which somebody wants to buy and sell are not the same, and then the question is, ''How do you move them toward a common price?'' And that is where the auction system is thought by those who look at it to provide better results.
    I think the challenge here—and by the way, the investors have changed in their desires, there was a time when price was everything. Some of the large mutual funds, and others, put a premium on time as opposed to price, and so maybe there is reason to look at this again.
    But, I think—to answer your question—the position of the Stock Exchange is that we should continually want to modernize. If there ever were to come a time when the specialist system didn't serve us well, we would have to acknowledge that. At this point, we don't believe we are there. And we think examination would support our position, but I am sure an examination will take place.
    The one thing that I would urge us to all do, is focus on the investor. I don't think we are trying to move profits from one intermediary to another. We are trying to ensure the investor's interests are served. Are the issuer's interests served? Can you go list on a market, get people to buy your stock reasonably? If you want to buy stock, can you go to the market and find things in a reasonable way to buy?
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    Everything I have seen, says, number one, the current system works pretty well. It has been substantially automated and it is not the position of the New York Stock Exchange that we are just trying to defend history and we are unwilling to make modifications and changes; quite to the contrary.
    And I must say, Mr. Chairman, in my own thinking, with regard to the kind of board and management that I would hope we will be able to put in place over this next five-or six-week period, I am looking for the kind of board that would be knowledgeable and be willing to accept change and the kind of management that would be willing to engage deeply with the investing community, including the State treasurers and the large mutual funds and all of what we refer to as the ''buy side'' of the market, as well as the traditional broker dealers and the ''sell side.''
    So when I am looking at the kind of governance structure, the kind of board and the kind of management that we want to have, I am looking at it from the point of view of people who are going to have to intermediate these different desires that exist and have to deal with them. I am not looking for the kind of board, or the kind of governance structure, that could simply ''tough it out'' as the saying goes.
    I don't think that would serve the American public and I don't think that it would serve the members of the Exchange. And so, my view is we have done a very good job to date.
    We have certainly embraced automation; There is always room for improvement and clearly, this is the time when there are many people asking for change and we have to accept that and deal with it. But we should deal with it from the point of view of what serves the American public, as opposed to what serves a special interest.
    Mr. OXLEY. If I could just use the Chairman's prerogative for one more question, Mr. Chairman, I would appreciate your indulgence.
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    There is a lot of skepticism out there, as you well know, about the specialist system, ''market makers are profit makers.'' I was stunned by the specialist firms' free tax margins are between 35-60 percent compared to 9.7 percent for the rest of the comparable industry.
    Even during the bear market, I am told, that none of these firms even lost money in a bear market, which if you are making a market and the market is going south, I guess that is pretty good. But I am not quite sure that that wasn't because of their particular position. I guess that skepticism will continue to be out there; it is obviously being fed now by advertising by some of the ECNs as a result.
    Can the specialist systems survive given all of that skepticism out there? It was a statement that your predecessor made a few years ago with the advent of the ECNs when he said he didn't want to preside over the New York Stock Exchange becoming the largest museum in Lower Manhattan.
    And it struck me because we had visited several of the bourses in Europe and not one of the, not one, had an auction exchange. As a matter of fact, we had a meeting on the floor of the Swedish Stock Exchange in Stockholm, where there was nobody there except the participants in this meeting.
    So, there is, I think, a lot of skepticism out there fed by, what appears to be, some rather interesting facts regarding the auction/specialist system.
    Mr. REED. Mr. Chairman, we, the New York Stock Exchange, and others who make use of an auction system have the responsibility for making the case as to why this serves the public interest and the investors. And we accept the challenge.
    There is, as you correctly say, a lot of skepticism. It is up to us, to answer that skepticism and I believe that we will be able to do it.
    There is nothing that I have seen on the Exchange during the very, very short time that I have been there that suggests to me that the specialists are unusually profitable. I would guess that they are profitable; from what I hear, they struggle hard to be profitable.
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    As you probably well know, many of the specialist firms, if not the majority, are owned by broker dealers themselves, in part because private individuals simply didn't have the capital and the capacity to perform this kind of function and they exited and sold their businesses because they were under such pressure and such need to invest capital in order to perform the function.
    And so it may be that, at one time or another, specialists have reported high margins. I don't get the impression from talking to these people—and I have asked about profitability—that they are particularly profitable, nor particularly confident about the continuing profitability.
    And I think the price of the one specialist firm that is publicly quoted probably reflects some investor skepticism as to the long-term attractiveness of this. So, I am not worried that money is being creamed away from the American people, if you will, by the specialist system, but it certainly is worthy of discussion.
    I think you want to look at all of the intermediaries. I would say that from the point in time that somebody decides to make some investments to provide for their retirement until they feel comfortable that they have done so, there are lots of intermediaries in that chain, each of which tends to be relatively profitable.
    But in any event, I think the specialist system is subject to question. I think it is up to us to defend it. I believe the facts I have read, some of the studies that were made; I have looked at times of dislocation.
    I have also looked, with regard to Europe, at some of the exchanges that did give up the auction system and moved to computers, and one of the things that strikes you is that the number of listed companies on those exchanges has dropped, which suggests that at least, from a listed company point of view, they didn't find that to be the best place to attract the type of investors they wanted.
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    And it seems to me that the volume of transactions that take place in some of these highly automated exchanges reflects the fact that they aren't great pools of liquidity. And it is important for us not to fracture the pools of liquidity around the system. I think it is important to point out to the American public that we in the New York Stock Exchange, and others, have an obligation to take the best price.
    So, if there is a price on the New York Stock Exchange, that at the moment, that second, that it is going to be taken, there is a better price available through an ECN, the obligation is to take the best price so that the person engaged in the transaction is not disadvantaged by us, vis-a-vis some other particular pool of liquidity.
    But if you look at some of the European Stock Exchanges that have gone into automation, while they function well and it is true that you could have a cocktail party on the floor without worrying about the number of people, it is not clear that it has served the listing companies, i.e., you have seen listings fall on those exchanges, nor does it appear that they have attracted great pools of liquidity.
    So, I think, as this Committee, and others, examine this there will undoubtedly be witnesses a bit more confident than I am who will be able to put these issues in full context.
    My whole career has been a career of trying to bring technology into the banking business, so I am not somebody who is up here trying to push back appropriate technology. I just think that we want to bring it into a system that serves the investors and the listers in an appropriate way.
    Mr. OXLEY. Thank you, Mr. Chairman.
    Mr. Chairman, let me just say that the turnout for members of this Subcommittee is quite extraordinary. It indicates how interested the members are on this critical issue, and again, thank you for your leadership.
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    Chairman BAKER. Thank you, Mr. Chairman.
    Ranking Member Frank?
    Mr. FRANK. Mr. Chairman, we have been taking a lot of time so far and I worry about all of the members not getting a chance to question, so I am going to waive. Would you go on to the next Democrat?
    Chairman BAKER. Mr. Chairman?
    Thank you.
    Mr. SHERMAN. I want to thank the Ranking Member.
    Mr. Reed you have made headlines by saying you would accept only $1 in compensation. Can you assure the committee—and I know it is not legally binding—that you will not accept any additional compensation, fixed or contingent, current or deferred?
    Mr. REED. I can indeed. I would like to state, just for the record—since you seem concerned—I have no contract. When I was called and asked if I would take this job and the representative of the Exchange talked to me about compensation, I said, ''Why don't we simply agree on $1?'' I have no contract, it is not in writing, I am not sure that I could make good that claim that I have on the Exchange, if it came to that.
    My understanding is it is $1 to get the job done, not $1 per year, so if I can get it done in three months I would like to take the dollar, not only a quarter.
    Mr. SHERMAN. I understand your point. I understand your point.
    Mr. REED. But I would like——
    Mr. SHERMAN. Yes. But the reason I have to bring this up is that you serve under a board of directors that, in dealing with your predecessor, was either grossly negligent or is suffering from a strange new disease that I would identify as kleptophilia: a strange love and affection for those who would want to rip off institutions.
    How you have a board—and I will point out—that includes very prominent Democrats, as well as prominent Republicans, who would embrace the contractual relationship with your predecessor is just amazing. And it is this kleptophilia that seems to afflict a number of boards of directors around the country.
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    But it is particularly bad when you have, in effect, a public utility, a quasi-monopoly, a regulated industry, and even more so when that board's representative's here in Washington came to our committee and said, ''You have got to serve the American people by reducing the transactions cost on selling stock on the New York Stock Exchange. Cut that SEC tax.''
    So we cut the tax, reduced the Treasury; we thought that was going to inure to the benefit of investors. We didn't know the money was going to Grasso.
    The board of directors you work for has made some very strange decisions. It is also often argued that our exchanges are somehow the best in the world—God it feels good to say that—I have no reason to think that it is anything other than a reflection of the incredible hard work of American working families that have built this incredible economy.
    Yes, we have to assume that WorldCom and Enron are the exceptions, but we have no assurance that they are as limited exceptions as we thought. I am going to be working, hopefully with others would join me, in putting together legislation designed to regulate the compensation of those who work for the Exchanges and design to set standards for those who serve on the boards of directors, so that we don't have kleptophiliacs continuing to serve on these boards.
    I don't know how people missed what was going on, or whether they just thought, ''$180 million''; sounds good to them. But one way or another, this system has got to be checked and you may be gone—and if your wishes are complied with in just a few months—and this strange, new disease could rear its head again.
    Can you tell me, is there any reason why your successor should—well we couldn't find a person to do a good job for $5 million in current dollars?
    Mr. REED. I would certainly expect that you could find a person who would do the job for that, or less.
    Mr. SHERMAN. So, we would not be preventing the Exchange from finding a competent replacement in allowing you to go off into the sunset, as you so wishly desire, if we limited your successor's total compensation to $5 million?
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    Mr. REED. Well, I wouldn't want to be thought to agree that you should legislate this, because, by and large, I would prefer that you have transparency and accountability and allow that work to——
    Mr. SHERMAN. We had transparency, accountability, and——
    Mr. REED. Well, we certainly did not in this case, Congressman, but to the point of what I believe will be necessary to have appropriate leadership of the Exchange, I don't think that we want people to take the job because of what it pays.
    And there are many jobs, such as the President of the New York Fed, which is certainly a job of immense responsibility and with operating responsibility and markets and so forth, and you don't have any lack of people willing to take that job. And none of them: Mr. Volcker, Mr. Corrigan, Bill McDonough, none of these people were paid exceptional amounts.
    I believe that we can find appropriate leadership for the Exchange at a quite reasonable price. But I would not encourage you to legislate it.
    Mr. SHERMAN. Well, the system we had last year didn't work very well.
    And I yield back.
    Chairman BAKER. I thank the gentleman.
    Mr. Bachus?
    Mr. BACHUS. Thank you, Mr. Chairman.
    Chairman Reed—is it on?
    Chairman Reed—is it working now?
    Chairman BAKER. No.
    Mr. BACHUS. Sorry. I hope my time starts right now, right?
    Chairman Reed, as a self-regulatory body, of course, you have rules, and then when people violate the rules they are fined or other actions taken against them. The GAO recently did a study and they found that the NASD levied $211 million worth of fines between 1997 and 2002 in about 4,700 cases.
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    The New York Stock Exchange during that same period of time, as opposed to 4,700 cases, brought 256 cases, and as opposed to $211 million in fines there were only $19 million in fines. While I recognize that the NASD has more entities under its regulatory jurisdiction, this wide disparity does seem to, at least, send the wrong message, and that message is about how rigorous the NYSE's enforcement is.
    Does it trouble you that you have such a wide discrepancy between at least the fines levied?
    Mr. REED. Congressman, it doesn't, to be honest. I, obviously, don't know what the circumstance at the NASD is or was. I would like to have no actions and no fines, in other words, I would love to run an exchange where people knew what the rules were and followed them.
    And I don't think the level of fines or the number of actions is necessarily a measure of the regulatory function, it might be a measure of the quality of the market.
    Mr. BACHUS. Well, it would either show that people are not violating the rules or the rules aren't being enforced. I think it would——
    Mr. REED. It could be either, obviously. In other words, you could have a situation where the rules were being violated and we weren't paying attention. But I wouldn't take that one indicator as a negative. I have——
    Mr. BACHUS. You wouldn't take it as a negative or, at all as a negative, or at least——
    Mr. REED. Frankly, it would make me look at what is going on in the NASD, if you wanted an honest answer, not necessarily the politically correct answer. Because it seems to me——
    Mr. BACHUS. Do you believe that by the high level of fines there, that that is——
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    Mr. REED. You would worry about it, because—when I was running Citi, which was a pretty big company strewn around the world, and we had a very disciplined audit process and regulatory process and so forth—when we started seeing a lot of audit comments and problems that typically to us was an indication that we had bad management and sloppy activities, not that we had a particularly diligent audit group.
    Mr. BACHUS. I would think that when actions are being brought and fines are being levied, it is certainly an indication that enforcement is going forward.
    Mr. REED. That certainly is true.
    Mr. BACHUS. And the absence of that would, to me——
    Mr. REED. You could at least ask the question.
    Mr. BACHUS. It could either indicate that nothing bad was going on or the rules weren't being enforced.
    Mr. REED. That is certainly true.
    Mr. BACHUS. All right.
    You referred to this, and others have, as an auction system or an auction market. But I think when the public thinks about an auction, they think about an auctioneer who does it by himself for his own profit, so that is a distinction, is it not?
    Mr. REED. Certainly it is.
    Mr. BACHUS. Does it bother you that the specialists, who really have a monopoly in a certain listed stock, that the bulk of their money is made buying and selling stock for their own account? Is that troubling?
    Mr. REED. It is disturbing. If you look over the last five years there has been a shift from Commission to trading income on the part of the specialist. This reflects, frankly, that the Commissions have been squeezed to almost nothing. Whether that is good for the functioning of the market, you could debate.
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    Mr. BACHUS. To me, at a time when the market is falling and people are losing money, and as you mentioned earlier, they have to hang back or they have to step in, so if anything, it ought to be harder for them to make a profit, than——
    Mr. REED. And I think it is. In other words, from what I could gather talking to only one with public data—we obviously have other data—I don't think there is anybody who believes that the specialists have been doing particularly well over the last year or so.
    Mr. BACHUS. Let me just, and I will say this.
    Mr. Glassman is going to testify, I read his testimony, and he actually says, as opposed to not being particularly well over this period of time, that their pre-tax—and I think the Chairman mentioned this, it is on page six of his testimony—their pre-tax margins are between 35 and 60 percent, compared to a little less than 10 percent for the industry.
    So it would appear as if, if Mr. Glassman and, I think a Mr. Becker—he quotes him—if their figures are right, it has been a very profitable enterprise in a time of falling market. And you would think a period of time, if they were ever going to lose money, they would lose money over that period of time.
    But I would ask——
    Mr. REED. I would suggest you ask them directly and they will be in a better position than I am to answer. My overall impression is it is not a great business, certainly not a business I would invest in.
    Mr. BACHUS. Not that profitable?
    Mr. REED. First of all, you have to commit capital, so I don't know if this margin you are making reference to is the return on revenue or a return on capital. I would be astounded if it were a return on capital.
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    And it is hard work. It is hard work and it is a difficult business. And I don't believe that you have seen the consolidation of specialists that we have all witnessed and the buying of specialists by institutions——
    Mr. BACHUS. Let me——
    Mr. REED.—because it is a great business.
    Mr. BACHUS. Let me say this. I will end with this.
    Actually, I think four specialists account for 80 percent of activity on the floor, so you had a consolidation. And all of those either sit on the board or the company that owns them sits on the board. Is that a possible area to be addressed, whether those two specialists or the two representatives of those companies that own them sit on the board?
    Mr. REED. Absolutely.
    Mr. BACHUS. Thank you.
    Chairman BAKER. I thank the gentleman, his time has expired.
    Mr. Gonzalez?
    Mr. GONZALEZ. Thank you very much, Mr. Chairman, and good morning, Mr. Reed and thank you for your testimony.
    I want to clarify something at the outset and then go into the questions. And I think in response to Chairman Oxley's inquiry you indicated, ''We are not discussing a regulatory failure.'' Is that correct?
    Mr. REED. That is correct.
    Mr. GONZALEZ. Okay. All right.
    And I want to kind of put the world on notice that Congress doesn't require a regulatory failure in order to revamp, modify and alternate any regulatory scheme. And the legislation we have pending now in GSEs would be a real good example of that. And I don't think anyone has ever said that regulatory scheme that was in place, in any way, failed to detect anything that would affect safety and soundness, which is really the cornerstone of what the regulatory apparatus is supposed to protect.
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    Nevertheless, we will move forward with that. So, anyone that comes before this Committee or Congress needs to be placed on notice that it doesn't have to be broken in order for us to try to fix it. Now do I agree with that? Not necessarily.
    And there are those that will say, ''You don't have to be sick to feel better.'' And in Texas—I will end this with another little Texas axiom—and it all depends whose ox is being gored at any given time in this Congress.
    What is curious about what you have stated, and I do wish you well, because I like the concept of self-regulation. The strength of self-regulation is its weakness, and I think your written testimony points that out, and somehow you are trying to find this balance.
    You still want individuals in a self-regulatory scheme that have the familiarity and the knowledge of the Stock Exchange and what goes on, but maybe not have as great a stake in what is going on, directly. How do you accomplish that when you keep talking about this independence?
    You are talking about independence in the context of a SRO. So I guess what I am trying to get at is how do you keep all the strength and the familiarity and the knowledge and all that, and still somehow insulate those individuals from some self-interest and conflict of interests?
    Mr. REED. If I could, first of all, I fully accept and do understand that you may well have very good reason to change regulation with no visible failure. So I cede to you the point.
    My hope here is that we will create a board that is independent. In other words, a board that is not made up of people who are regulated or who have interests in the industry. But I want to, at the same time, create an industry group that can get deeply engaged in the substance of what we are concerned about here, with regard to regulation and with regard to the evolutionary pathway, if you will, of these markets.
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    In order to keep the regulatory function clean you clearly need professionalism at the level of the people who do the regulation itself, just as within a firm you need an audit department that is professional as auditors, even though they may rest within the structure of the firm.
    And you need to make sure that, with regard to compensation, with regard to budgets, with regard to manpower, and things of this sort, that the regulatory process is quite free of any constraints that might stem from the operational side of the business.
    In most private sector companies, the audit department tends to report to the Chairman of the audit committee and not to the CEO of the company, even though they work within the company. And usually budgets for audit functions, and so forth, are approved by the audit committee and not within the overall budget process for the rest of the company.
    And so, I think, you could set up mechanisms that give you some reason to be comfortable that self-regulatory activities can live in a particularly good environment without any kind of conflict. And frankly, you don't want a board that is engaged in compensation decisions and other things that is made up of people who are regulated because there is no question but that there is a chilling effect on their willingness to operate as fiduciaries if they also are in a position where they are being regulated.
    And so I think we need to come up with a governance structure that cleans up some of these things. On the other hand, at the working level, you want a regulatory function that is tightly coupled with the activities.
    And when you get into situations, for example, such as the one reported in today's newspaper where we are going to pursue some of the specialists firms for possible misbehavior, those conversations will have to be where the people know exactly how the specialist system works and what the rules are. Because, obviously, in order to decide whether something improper has happened or not happened, you have to be a hands on practitioner.
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    And you will see that in the existing structure of the Exchange, which I am told has worked well, the court of last appeal, if you will, of a member who is being fined by the Exchange is a committee of the board with a majority of outside directors, but with two representatives from the Stock Exchange floor itself, who bring to that deliberation some understanding. Obviously, not people representing the particular firm being disciplined.
    But you do need the coming together with expertise and independence at that level. And by the way, the overview of the SEC is extremely important. The fact that the SEC gets engaged in these disciplinary matters, the matters that were reported this morning in the press, the SEC was deeply engaged. We happened to find the first problems and we obviously shared that with the SEC.
    But they came back to us with subsequent demands for further information, that frankly, broadened the investigation and made it a better one, I think.
    And so, this interaction between an SRO, as we are calling it, and the overall regulatory function is a delicate one. It does, I think, work pretty well. And what I am trying to do is to clean up the board and its supervision of the regulatory function so there is no conflict there.
    But I am also going to try to clean up the board with regard to its other functions, including compensation, so that we don't have people who are being regulated by the Exchange making decisions, with regard to the compensation of the management of the Exchange. I don't believe that people are incapable of dealing with those conflicts, but I think most people would say it has a chilling effect.
    If you are being investigated by the regulatory side of the Exchange, and you happen to sit on the compensation committee of the board, it is probably quite likely that you are going to be a quiet participant in those discussions, because anything you say is going to be taken out of context. They are either going to think you are trying to affect the regulatory process or you are trying to behave improperly on the other side.
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    So my proposal, with regard to corporate governance, is designed to eliminate those potential problems on both sides; to provide an appropriate governance structure, budget and manpower structure for the regulatory function that is independent of other considerations. And also make sure that those on the board who have fiduciary responsibilities and include the compensation and selection of management, and so forth, aren't people who also are subject to the regulation.
    Mr. GONZALEZ. Thank you very much and good luck.
    Mr. REED. Thank you.
    Chairman BAKER. Ms. Hart?
    Ms. HART. Thank you, Mr. Chairman.
    I also wanted to welcome you, Mr. Reed. And ask my colleagues to have confidence in you because of your pedigree, as a fellow Washington and Jefferson alum. And also, knowing of your reputation in your prior business, I am pleased that you have decided to take this on, as well.
    One of the things that you discuss in your testimony was that you believe that the board must be independent, and I think all of us in this room agree with that. And having read the last several weeks' worth of articles, numerous newspapers about the whole situation and the resignations that followed and all those interesting drama, I would agree.
    Does that also mean that you believe the Chairman's position and the CEO position should be separate?
    Mr. REED. Not necessarily. In other words, I certainly believe that there are places where a Chairman and a CEO being the same person can work. I suffer, of course, I was Chairman and CEO for 16 years, and we didn't have that separation, and so I am sure I have biases resulting from that.
    I think the jobs are quite different. In other words, I think as Chairman your responsibility is to make sure that the board functions effectively; that it is sort of like the Chairman of the Subcommittee, his responsibility is to make sure that the right subjects are talked about with the right kind of witnesses in the right kind of environment allowing the right discussion, and so forth.
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    A Chairman of a board has to make sure that the board thinks about the right things, has the right information when they do, the meetings are arranged so that, in fact, you could have substantive discussions, et cetera, et cetera, et cetera. The CEO is responsible for running the company.
    You can do the two as one person. There are some distinct advantages in having two people, because, obviously, you have two human beings sharing a responsibility and it gives you twice the manpower, if nothing else, or womanpower. And in the case of the Stock Exchange, you could argue that our public responsibilities as a leader of the community almost require a Chairman who has a public role and maybe being hands on running the place everyday makes that somewhat harder.
    So, I am quite open as to which is the better configuration. Frankly, I am just getting engaged in the process of looking at who might be potential candidates to take my job. Clearly you have more people to look at if you separate it. You have a broader potential arena if you separate it.
    There are, however, at least two people I have thought of that I would be quite happy to see in a joint role. So, I could be persuaded either way.
    Ms. HART. What, when you say, you have already found several people that you believe may fit the role, what kind of qualities and background are you looking for someone who may be able to take on those roles, or separate roles?
    Mr. REED. Well, I could read you the job description if you would like.
    You need somebody who is capable of acting as a spokesman for the industry and who can be fully engaged with the industry and bring all these disparate views about regulation, about the role of computers and automated exchanges and so forth to fruitful discussions. You need somebody who is credible in that, capable and can play a public, as well as a private role in that.
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    Obviously, whoever is there has to have the capability to run the board, which, if one could criticize Mr. Grasso, you would have to say he didn't run the board very effectively. And——
    Ms. HART. Or, if you are a banker, he did.
    Mr. REED. Clearly the board did not function well.
    Ms. HART. Not enough.
    Mr. REED. He may have been the best CEO the Exchange ever had, I have no opinion, but I think there is enough evidence on the table that the board didn't do its job very well. And so running the board is an important capability. I wouldn't want a person on the job who hadn't had some experience at running boards and doing so properly, and so forth. Integrity is everything.
    When you get down to operational characteristics, you need somebody who can be an engaged leader of the diverse communities who are in the Stock Exchange. You go down to that Stock Exchange floor and it is a bunch of very small businesses that all come together and interact; you have broker dealers, you have independent brokers, you have specialists.
    And each of those communities, and many of the members of the Exchange, rent their seats from owners who are retired. They have a very different point of view on things than some of the owners, who are retired. And so whoever comes in has to be an engaged and effective leader of all those various communities.
    And the most difficult problem we are going to be facing going forward is what I call this ''evolutionary pathway.'' Today, the New York Stock Exchange, I believe, functions exceedingly well. We have 80-plus percent of the volume, we have the best of the companies listed on the Exchange. The real challenge for the new leadership is, ''Will that be true seven years from now?''
    And if so, it has got to be because we continue to occupy that position where people want to list on our exchange and where people want to come to the Exchange to transact business. And if anything we do over the next seven years loses either of those constituencies: those who would list and those would bring business to us, then the Exchange is going to get fragmented.
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    And so the principal requirement of the new leadership, including the board, is how you manage yourself through that evolutionary pathway.
    Chairman BAKER. Gentlelady's time has expired.
    Ms. HART. Unfortunately. Thank you.
    Chairman BAKER. Thank you, Ms. Hart.
    Mr. Hinojosa?
    Mr. HINOJOSA. Thank you, Mr. Chairman.
    In light of recent developments in the capital markets, particularly the reported New York Stock Exchange actions against the five largest specialist firms, I appreciate hearing the testimony of Interim Chairman Reed and learning what initial changes you believe must be made to corporate governance at the New York Stock Exchange.
    I further understand that the Senate Banking Securities Subcommittee held another hearing on market structure yesterday, at which SEC Chairman William Donaldson testified. It is clear to me that Chairman Donaldson expressed certain concerns about the current corporate governance at the various exchanges.
    And after the hearing, he reportedly stated that SEC approval for the New York listing standards proposed by the New York Stock Exchange and NASDAQ is imminent. Having said that, do you believe that there are directors who would be willing to accept directorships on the New York Stock Exchange after you have finished with your remodeling of such corporate governance?
    Mr. REED. Congressman, that is a very good question. I believe so, obviously, because I couldn't put in place a proposal that would fail simply by being unable to get a board together. But there is no question that sitting on a public board nowadays is an undertaking of greater gravity, if you will, and accountability than maybe it was 20, 25 years ago.
    And there is no question that there are any number of people who would be very good directors, but who when approached, simply are unwilling to accept those extra responsibilities. I am hoping that the same thing that causes me to be here with you this morning will cause directors to serve on the Exchange; that is, an appreciation of the importance and the role of the Exchange.
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    And it is a semi-public both honor and responsibility. This is not the same as sitting on the board of a purely for-profit quoted company. We have a greater public role and public responsibility and I am hoping that we will find very good directors who respond to the public responsibility associated with being on the board and are willing to serve, in part because it is a challenging technical, intellectual business activity, but more because they sense the importance of this particular entity and the imperative that it have appropriate governance.
    Mr. HINOJOSA. Knowing that you will be stepping down after you get this job done, would you personally accept such a directorship?
    Mr. REED. That is an interesting question, Congressman. From a personal point of view, I would rather not, because I am happily retired and you never quite appreciate retirement as much as when you give it up.
    But on the one hand, and there is a second concern, I wouldn't want to bring in a new Chairman who, in any way, found it difficult to have the prior Chairman, sitting there on the board. Obviously, the new Chairman should not, in any way, worry that somebody before him was sitting on the board.
    On the other hand, I will be honest, when I have talked to some people about the possibility of joining the board, they inevitably ask me, ''Hey John, are you going to be willing to stay on the board?'' And it is hard for me to say, ''I am not, but you should.'' And so I get a little bit of a problem there, and I don't have a strong point of view.
    My personal preference would be to not stay on. But if it seemed to me that in order to help getting the board to gel and so forth, that my continuing presence for a short period of time—a year, two years, whatever, would be useful, I certainly think that I have some obligation to take that seriously.
    Mr. HINOJOSA. Well, I think you would make a great director, and I will respect whatever decision you make.
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    But let me ask you for some clarification. In today's New York Times' article entitled ''Big Board Plans Fines for Specialists,'' dated October 16th, it States that, ''The New York Stock Exchange has decided to fine its five largest floor-trading firms about $150 million for trading in ways that deprived investors of the best price they could have received.''
    Has that amount already been set, or is it plus or minus that $150 million? And the second part to that question, is it a $150 million per-trading firm?
    Chairman BAKER. And that will have to be the gentleman's last question as his time expired. But please respond, sir.
    Mr. REED. The answer is that—first of all, I don't know where that number came from because the press release that the Exchange issued did not have any numbers in it—what happened is very simple.
    We detected, some time ago—I say we, I was not there—but the Exchange detected that there seemed to be some strange behavior in the price of a stock and they investigated and they discovered that there had been some inappropriate behavior on the part of the specialist. They expanded the investigation and said, ''Hey, if one specialist did this, maybe other specialists have done this.''
    And it is amazing—you might not be aware of this—but they actually could cut down to every five seconds, so that they could look in five second slices at all the information that was displayed on all of the screens that are available to the specialist and then they could see what the specialist did every five seconds.
    And therefore, if you know what the specialist should have done, given the information that was available to him, and compare it to what they did do, you can decide whether or not they behaved properly or not. Needless to say, you could fill a fairly large room with the data accounting for transactions.
    We went back and looked over a three-year period across all the specialists. At the end of that analysis, it was decided, not by me but by the people in our enforcement division, that indeed, there had been, amongst these firms, improper behavior. That doesn't mean all transactions, all specialists, but within each of these firms, there had been improper behavior, i.e., they didn't do what the facts, circumstances would have dictated they do.
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    You can calculate the difference between the price that was agreed to and the price that should have been agreed to and, therefore, you could sum it up and come up with a number, and the number you have is in the ballpark.
    Each of the firms will be called up, and we will be talking to them both about disgorging the profits back to the people whose transactions were involved as well as paying a fine. In other words, it is not sufficient simply to disgorge, but also these firms—our proposal is going to be—that these firms will be fined.
    There is an appeals process within the Exchange where the firms can contest, they could argue with the data, they could suggest that our calculations are incorrect, et cetera, et cetera.
    And so, what you are seeing here is simply the first notification that we have given to these firms of our intention to pursue it. And my guess is what you are seeing here will be pretty close to what, in fact, will actually happen. But there is a process and it is subject to disagreement and that process has to be allowed to take place.
    Chairman BAKER. That gentleman's time has expired.
    Mr. HINOJOSA. Thank you, Mr. Chairman. I look forward to learning more about it and working with you and our Ranking Member.
    Chairman BAKER. I thank the gentleman.
    Ms. Kelly?
    Mrs. KELLY. Thank you, Mr. Chairman.
    Welcome, Mr. Reed. We are glad to have you here.
    Yesterday, Chairman Donaldson testified, and he was talking about the market system being fair and efficient and so forth. And he raised an issue that I would like you to address, if possible.
    He was talking about some questions regarding the fragmentation of the markets and whether or not that is reducing the effectiveness of the regulatory process. I wonder if you would give us some of your thoughts on that issue.
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    Mr. REED. Well, I think it is a very important issue. It is not in anybody's interest to see these markets fragment. The reason being, of course, if you don't have all of the potential buyers and sellers in contact with each other, the danger of getting a bad price goes up, for obvious reasons.
    This is the reason why in buying and selling houses, brokers tend to list with all the brokers in a community so that you are sure that all of the people who might be interested in buying your house, not just the ones who happen to deal with the broker that you selected to sell it, get a chance to come and look at the home and maybe buy it.
    And, so, it is in everybody's interest that the liquidities be pulled together, now they can be pulled together by rules that require, as I mentioned before, that you be aware of prices and alternative locations and, if they are better from the customer's point of view, you must take advantage of them.
    From a regulatory point of view, the fragmentation is even worse because you have more things to regulate, but you also have to regulate the interaction among them. And, so not only do you have to regulate each individual exchange, but you must make sure that the interactions among them are as they should be so as to produce the best possible result.
    And, so from a regulatory point of view, the fragmentation is also a problem and it makes it more difficult to be assured that the total marketplace is working the way you want it to. And, as you well know, some of these markets exist only in software. I mean, it isn't that there is something there you could watch.
    All of a sudden the regulatory function becomes one actually of looking at the software and seeing whether that software would respond to potential different scenarios in ways that you would deem to be appropriate.
    And, so, you are beginning to have to regulate the underlying logic under each exchange. I think Mr. Donaldson, who has the ultimate responsibility, is quite correct to point out that this fragmentation is a danger not only to the well functioning of the markets, but it is also a danger to the regulatory process itself.
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    And the likelihood of having an aberrant something off in a corner someplace, that you maybe didn't fully understand that could lead to some problems for you, becomes quite important. So, I am happy that I am not the regulator who would have to overview all of this.
    Mrs. KELLY. Since we are talking about regulation, in your testimony you say, ''Self-regulation is one of the two legs of a larger regulatory regime that includes government regulations by the SEC and Congress.''
    I am curious as to where you see State legislators and State security regulators fitting into the framework since you didn't talk about them. I think we would all agree that it is better to have a lot of cops on the beat, but it would be good to, anything we can do, to ensure against fraud. But do you see any benefit to having States participating in setting securities regulation?
    Do you think this could create fragmentation?
    Mr. REED. Yes, I would prefer that the regulation—this is a personal preference—be at least tightly coupled together, if not that we simply have national regulation. But you would have to honestly say that the States have played a role in bringing some discipline to some recent misbehaviors.
    It is certainly true that there have been States attorneys general who have felt that there have been inappropriate behaviors and have made a constructive contribution to reform. So, I do believe that the diversity of State vs. Federal interests are there.
    I would hate to have States begin to enact legislation that started to conflict with the legislation that this body might enact because then you really do put the working entities in a situation where you can conceivably have conflicting regulation and it makes it almost impossible to operate.
    But certainly the activism on the part of some of the State Attorneys general, I think, has to be seen as positive. I would like to hope that the framework, whether it be the State or the Federal government, be approximately the same.
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    Mrs. KELLY. But you are not worried that this would add to fragmentation and impact the market structure?
    Mr. REED. It clearly would.
    If you started getting significant differences in regulation it would, in fact, fragment the market. And that should be avoided to the extent that it can be.
    My own sense is the Federal government stepped in in the 1930s after our problems with the big crash and created an over-arching framework for the capital markets that looks pretty good across time.
    If you look at it, it seems to me, that as compared to other regulatory regimes, the securities acts and the creation of the SEC have served the American public rather well. I would hate to see lots of independent States creating their own regulation even though, as I say, their attorneys general probably helped this process a little bit, if we look at recent history.
    Mrs. KELLY. Thank you.
    Chairman BAKER. I thank the gentlelady.
    Mr. Tiberi?
    Mr. TIBERI. Thank you, Mr. Chairman. Thank you, Mr. Reed, for coming here today.
    I am concerned—you touched on this throughout the hearing today but let me get more specific—I am concerned about the apparent conflict at the Exchange between the one hat you wear as a regulator, the other hat you wear as a marketplace competitor.
    The former Chairman once said he viewed his job as one-third regulator, two-thirds businessman. The NASD solved that conflict by separating its marketplace competition function from its regulatory function.
    Two questions. One: do you believe, specifically, there is a conflict? And two: would you support what the NASD did at the Exchange by separating those two functions clearly?
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    Mr. REED. I don't believe there is a conflict. I said this in a press conference once, ''I believe that regulation in the New York Stock Exchange is analogous to quality control in Toyota.'' People come to the New York Stock Exchange because they believe it is a well-regulated market.
    I have personally—when I was in my prior incarnation—listed the stock of Citi at other exchanges and the New York Stock Exchange and delisted from most of these other exchanges. And I have sat over the years on any number of investment committees, and I would tell you that in a couple of instances, I have insisted that we simply make no investments in certain markets because I didn't have confidence in the functioning of those markets.
    And, if you don't have confidence in how they function, you are really at risk if you buy and sell in them.
    And, so, this question of the quality of the market—I think one reason that the United States attracts something in the area of $200 billion to $300 billion a year of excess investment, by excess I mean more than our current account might suggest that we would have—is because if you were to be given a large sum of money and you were to live any place in the world and you say, ''Gee, where do I want to invest?'' You would inevitably come here.
    And you would come here, in part, because the underlying companies are attractive investments, but you would also come here, in part, because you could invest in the American capital markets knowing that they are honest, that they are straight, that they are well-regulated and that you will be fairly treated.
    So my view is, were I to be the permanent leader of the Stock Exchange, I would want to keep regulation only because I think the better regulated that we are, and the better our reputation is for being toughly regulated, the more people who would want to list on us and the more people who would want to do business with us.
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    So I view the promise that you make to your customers that you are going to do things properly, which can only be enforced through supervision and regulation, is part of the business and shouldn't be separated as if it were on the side.
    And I don't think there is a conflict because anybody who would want to run the business poorly—I mean, it is good for a week, it is good for a month—but you will lose business over time.
    The particular path that NASDAQ took, I don't have an informed view. It may have served their interests quite well given where they were and what they were trying to do. I am going to hope to propose, to you and to the American public, a governance structure that permits the regulation to work side by side with the Exchange in a positive way and that would appear to everybody to be an appropriate governance structure. And that is my objective.
    Mr. TIBERI. Second question, briefly. The exchange, in the past—talking about corporate governance—has resisted representation on its board from the mutual fund industry. There are 95 million mutual fund investors out there—I am one of them—what do you propose doing to allow mutual fund industry?
    Mr. REED. Absolutely. I am going to come up with a complicated structure—but within the structure we are going to have representation from the big, state pension fund leadership, the big, private pension fund leadership, the large——
    Mr. TIBERI. The board representatives?
    Mr. REED. We are going to try to get senior representatives from each of these constituencies to sit with us on a board that will have the broker dealer community, the floor community, and so forth; the professionals who surround this industry. I think that we all believe we need the buy side, which are these people, as well as the sellers.
    Mr. TIBERI. Thank you. Thank you, Mr. Chairman.
    Chairman BAKER. We have a vote pending and at least one, perhaps two more votes. I am going to recognize Ms. Biggert. I would then go to Mr. Castle, and then to Mr. Shays, if time permits.
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    Ms. Biggert?
    Mrs. BIGGERT. Mr. Chairman, I would thank Mr. Reed for coming, but I think that he has answered, several times, all the questions that I had. So I would just yield back.
    Chairman BAKER. I thank the gentle lady.
    Mr. Castle?
    Mr. CASTLE. Thank you, Mr. Chairman. I will also be brief. Let me just, first of all, thank you and Mr. Kanjorski. I think these hearings are necessary.
    I will say, Mr. Reed, I just become increasingly concerned with all the corporate scandals that we have had with the mutual fund issues and they seem to always be holier than thou, if you will, and some of the securities exchange issues which have arisen in a variety of ways.
    And, in addition, we are trying to deal with some of the housing entities here, and some questions have been raised about some of their practices.
    It just seems, to me, when we get into large monetary circumstances people try to develop ways to, obviously, take advantage of whatever they can, not necessarily always in a criminal way, but in the sense of perhaps deprivation to the smaller owners of this. So, all those things concern me.
    And I am delighted you are here, I am delighted you are there. If these notes are correct and you are being paid $1 for the rest of your tenure there, then maybe you should get a pay increase like some of the others we have had there in the past.
    I guess I do have one very brief question and, that is—and you may have already answered this, I wasn't here—but I think the New York Stock Exchange is probably going to get away from the specialists and go to electronic at some point. I don't know when; that is what I gleaned from everything.
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    If that happened, can you opine as whether it would be easier or more difficult to regulate or is that just not something that is in your purview at this point?
    Mr. REED. It will be more difficult to regulate if you get there. Electronic systems of whatever sort, are more difficult to deal with than human systems. There is no question, just ask Microsoft how many bugs are in some of their releases and how long it takes to get the bugs out. Even Intel has occasionally had to recall a chip because it turned out that there was a flaw in the architecture.
    When we get into highly-automated systems, the regulation becomes much, much more difficult because, basically, you have to regulate the code, and that is inherently difficult.
    Mr. CASTLE. Thank you. I yield back, Mr. Chairman. Thank you.
    Chairman BAKER. I thank you, Mr. Castle.
    Mr. Shays?
    Mr. SHAYS. Thank you, Mr. Chairman. Just to thank you for holding these hearings; to apologize to Mr. Reed for my not being here, I was in the district.
    And look forward to the next panel, and just, also, to thank him for, not just being here, but for the good work; the very important work that he needs to do.
    Thank you.
    Chairman BAKER. I thank the gentleman.
    Mr. Reed, we certainly appreciate your patience and courtesies extended today. Your remarks and responses to questions have been most helpful. We look forward to working with you and the Administration of the Exchange to assure all investors that our markets are transparent and functioning fairly for all those who are involved.
    And we appreciate your contributions.
    To the participants in our second panel, it is unclear whether we have two or three votes. We are well into the first vote. We will just stand in recess for 20 minutes. Thank you.
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    Mr. REED. Chairman Baker, thank you for your courtesy.
    Chairman BAKER. Oh, thank you, sir.
    Mrs. BIGGERT. [Presiding.] The committee will come to order.
    We are happy to have our second panel. Sorry for the delay with the votes.
    I would like to introduce the second panel and, as you know, give you five minutes, and then we will have questions. And I am sure there will be more members back by then.
    First on our panel is Mr. Robert Greifeld, President and Chief Executive Officer of NASDAQ Stock Exchange; second, Mr. Mark Lackritz, President, Securities Industry Association; third, Mr. James Glassman, Resident Fellow, American Enterprise Institute; and then Mr. Gerald D. Putnam, Chairman and Chief Executive Officer, Archipelago Holdings.
    Mr. Meyer ''Sandy'' Frucher—the names are very difficult here, for me, anyway—Chairman and Chief Executive Officer, Philadelphia Stock Exchange; Mr. David Colker, President and Chief Executive Officer of the Cincinnati Stock Exchange.
    And a special welcome to Mr. Colker, who is a resident of Chicago, even though the name of the Stock Exchange at the current moment is Cincinnati, it does exist in Chicago, Illinois. Professor John C. Coffee, Jr., Columbia University School of Law.
    You can correct my pronunciation when you give your testimony. And so we will start with Mr. Greifeld.
    Mr. GREIFELD. Thank you, Madam Chairman, and all the members of the Subcommittee.
    I appreciate the invitation to testify before you today. As you may know, I became CEO and President of NASDAQ Stock Market some five months ago. I consider NASDAQ to be a unique asset of the U.S. economy and the growth of this economy. Our success is driven by how well we serve the individual investor.
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    My premise today is that the individual investor is best served by free choice, competition and fundamental fairness. Of course, every aspect of this country's capital markets is affected by the decision of the public policymakers. In this regard, we are fortunate to be served by an institution, like the SEC, with its expertise and tradition of excellence.
    I have learned that the SEC can say, ''Yes,'' and can say, ''No.'' And for a manager, such as myself, in a fiercely competitive market, when they don't say anything, this means ''no'' as well. So, as we examine the issue of capital market structure, I urge you to encourage the SEC to continue to be deliberative and cautious, but also expeditious.
    With respect to the debate about securities market structure, the Securities and Exchange Commission is faced with critical decisions at a unique time in our economic history. Now is the time to face these decisions.
    At the top of the list, I would put three issues. One: reform of the trade-through rule; two: the need to separate the securities regulator from the market center, and in this position, we are not advocating the abolition of the SRO function, but we are advocating that the SRO function needs to be separated from the market center. And third: the need to ensure uniform regulation of the marketplace by addressing the emergence of trading in sub-pennies.
    NASDAQ is the listing market for over 3,500 companies. Corporations list their shares because of the good name of NASDAQ, our listing standards and our government practices. The corporation's decision to list on the NASDAQ stock market does not mandate trading on the NASDAQ stock market.
    Currently, 55 percent of the trading of stocks on NASDAQ, occurs within our system. NASDAQ competes for every listing, every quote, every execution, and every trade report, and we feel other markets should do so as well.
    Competition has always been good for NASDAQ. Our open architecture has facilitated competition. We have nearly 300 market makers who are willing to commit capital and we have numerous ECNs matching buyers and sellers, all helping with the execution process. Our market structure promotes efficiency and market quality stats mandated by the SEC bear this out.
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    Attached to my written testimony is an analysis of how stocks trade on the electronic NASDAQ market vs. the floor-based New York Stock Exchange. As an example, the trading of the S&P 500 stocks, NASDAQ has a spread that is 38 percent better than what you see on the floor-based market. Our order execution time is 3.3 times faster and our trading costs are 37 percent lower. At NASDAQ, the speed of execution is faster than ever and the spreads are tighter.
    Many argue that a floor-based monopoly can produce short-term benefits. But history and economics show that monopoly power is corrupting and is bad for citizens, markets and investors. Competition forces market participants to focus on how to best serve the customer and the investor.
    Rapid technological strides, as well as decimal pricing, has helped to promote the spread of electronic markets and should lead to a reappraisal of market structure. Electronic trading has revolutionized trading on NASDAQ, but the listed arena is frozen in time. When electronic orders try to move in the listed environment, they are held up for an eternity of seconds because of the trade-through rule. Trading in New York Stock Exchange stocks is slowed to the pace of the slowest market.
    The example I use to illustrate this point is a story I have. It happened two Saturdays ago. My son had a football game. And after the football game, we went to our local fast-food place. And we sat down to have, as us good Americans do, a burger and a Coke. My son was about to sip on his Coke, and I said, ''You cannot have that.''
    And he said, ''Dad, why not? I am thirsty. I just played a game.''
    I said, ''That Coke is 99 cents in this fast-food place. But if you go across the six-lane highway, there's a place advertised at 98 cents.''
    And he said, ''But I want the Coke now.''
    And I said, ''Well, in this market that we have today, you do not have the right to drink that Coke.''
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    The amazing thing is if he decided to cross that six-lane highway, when he got there, there is no obligation for that Coke to be available at 98 cents. In fact, it could be 99 cents. It could be a dollar. It could be $1.01.
    We need to have choice for investors. My son wanted to drink that Coca-Cola then and there. He was willing to pay 99 cents. He did not want the possibility of going across the six-lane highway.
    And when I talk to individual investors, which I do on a regular basis—I see it as a key part of my job—I ask them what do they value most in an execution. And they describe a situation where they are on an online Web site and they click on that button to buy or sell a stock. They care about two things.
    One is speed. When they click on it, the sooner they get that execution message back, the happier they are. And two is certainty of price. They see 99 cents advertised, 98 cents. If they get it back at 98 cents in two seconds, they are happy.
    This trade-through rule is a 20-year-old provision of a plan approved by the SEC. Clearly, now is the time for reform of the trade-through.
    Much is being written these days about corporate governance within the Exchange itself. America's exchanges rely on the trust of investors. At the moment, NASDAQ is in the process of separating from its regulator, the NASD, based on the belief that separation is the only structure that works for all markets.
    As CEO and President of the NASDAQ, I cannot imagine explaining to Congress that my regulator hat was on one day and off the next. This is why we contract with the NASD to provide our market with unsurpassed regulation. NASD regulations are on the case 24 hours a day, seven days a week. It is untenable to combine a market center with a regulator in one corporate parent. It would be as if the FDA had an ownership interest in Merck.
    And as we were waiting for this meeting to restart, I came up with another analogy. It is this. If I was going to sit here and testify, be done with my testimony, take my hat off, walk up there, sit down and put my other hat on, it just does not work.
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    And what is important, again, in the eyes of the individual investor, you can come up with tortured descriptions of why it is tenable. But they don't buy it. We are in a post-Enron era where we have to be very concerned about our credibility.
    I sit here and I say, ''Really, I do like the position the Exchange takes and that they want to keep the things together.'' I think that is great for our business, my listing business. The listing companies, the corporate CEOs that I talk to understand that you have to be separated from a regulator. So in a real sense, I would have a competitive advantage if the New York Stock Exchange chose to keep the regulator combined with the market center.
    What really would have to carry the day is the individual investor. You cannot have these investors walk away from this market because they believe the game is rigged. And I do tie back to John Reed's comment. And he came up with a couple of words that I think are very interesting.
    He said, ''You can become comfortable with having a regulator and the market center together.'' He said, ''I am going to come up with a complicated structure.'' Clearly, there are ways to engineer it, but in that engineering process, you will lose the interest and the faith of the individual investor.
    NASDAQ does not simply list public companies. It is itself part of the environment of public companies. No NASDAQ CEO has ever sat on the board of a listed company. NASDAQ is subject to Sarbanes-Oxley and it adheres to the same listing requirements that we impose upon our listed companies. This list includes standards such as Sarbanes-Oxley 404 and Regulation FD.
    NASDAQ will not complete the task of separating from the——
    Mrs. BIGGERT. If you could come up——
    Mr. GREIFELD. I sure will. Okay.
    Just a last point that we want to make is with respect to subpennies. We have a market today that really disadvantages retail investors. Professional investors trade in subpennies. Retailer investors that I talk to; every survey shows that they are not aware of this. I think it is harmful and would erode investor confidence. And we need to make sure that the investors believe Main Street and Wall Street play by the same rules.
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    If the SEC does not act quickly, we will be forced to accept no action as a policy decision endorsing subpennies.
    I do thank you for your time.
    [The prepared statement of Robert Greifeld can be found on page 128 in the appendix.]
    Mrs. BIGGERT. Thank you very much.
    Mr. Lackritz?
    Mr. LACKRITZ. Thank you, Madam Chair.
    My name is Marc Lackritz, and I am the President of the Securities Industry Association. I appreciate the opportunity to testify on this very important topic of the structure of the U.S. capital markets, because our nation's securities markets have long been the most transparent, liquid and dynamic in the world.
    This is a really important issue because the functioning of our secondary markets allows us to raise capital in the primary markets that finances economic growth and is the engine of entrepreneurs and jobs and success.
    In the past 10 years, the securities industry has raised over $21 trillion of equity and debt to finance economic growth. So in a lot of ways, we are at the center of the engine of growth. And these secondary markets are critical to ensuring that that function continues.
    The success of these markets depends on one word, trust. Investors and market participants must always have confidence that the markets operate fairly and with complete integrity. And they must also trust that the regulators will make fair and well-informed decisions about how to regulate these complex markets and that they will enforce the rules evenhandedly.
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    The dot.com meltdown, the economic recession, terrorist attacks, and accounting and corporate scandals have combined to form a perfect storm that has greatly shaken the public's trust in our industry.
    But Congress and the regulators have taken decisive steps through enactment and implementation of the Sarbanes-Oxley Act and, more importantly, through tough enforcement actions to address corporate wrongdoings, bad faith behavior and outright criminal conduct.
    Our industry has worked closely with Congress and the regulators on these legislative and regulatory initiatives, and we have undertaken efforts on our own to help restore the public's faith in our markets and our industry.
    And new revelations at the New York Stock Exchange have raised concerns about the dual role of the Exchange as both marketplace and regulator of its own activities and those of its members. We believe that action should be taken to address these concerns, and we suggest that one near-term step should be to separate clearly the New York Stock Exchange's member regulatory function from its function as a marketplace.
    For example, it might be appropriate to remove regulatory activities from the marketplace reporting lines and put them in a separate unit within the New York Stock Exchange. There are other models, too, that we have outlined in a white paper that we submitted to the committee along with my testimony. In the longer term, it is appropriate to address the broader issue of the structure of self-regulation, and we believe that this debate should be shaped by the following four considerations.
    First and foremost, investor protection: Regulation should put investors' interests first and foremost. Effective, consistent and transparent regulation is essential to keeping investors' trust, the most essential element in the success of our markets. Secondly, competition: Regulation should promote competition, rather than favoring or protecting one market over another.
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    Three, uniform national standards: The regulatory system should ensure the primacy of the SEC as a strong, national regulator. The system also should include appropriate roles for, and coordination with, the self-regulatory organizations, the States, and broker-dealer firms, to achieve uniform national standards. And, fourth, expert regulation: Our system should be structured in such a way as to ensure that the regulatory staff overseeing day-to-day activities possesses the requisite expertise necessary to perform their duties.
    We believe the current model of self-regulation has worked quite well for our nation, and that this model should be preserved and strengthened. Self-regulation contemplates self-policing by professionals who have the requisite working knowledge and expertise about the intricacies involved in the marketplace and the technical aspects of regulation.
    The system of self-regulation is supplemented, of course, by government oversight. This tiered regulatory structure provides the checks and the balances that protect investors much better than might otherwise be achievable. Moreover, it can be more effective and less costly than regulation by government alone.
    Before the recent controversy at the New York Stock Exchange, other events raised questions about the needs to alter the current regulatory system. We have long advocated making timely improvements to self-regulation when appropriate, and we strongly support the elimination of unnecessary inconsistencies among Federal regulators and self-regulators. Duplicative and inconsistent regulation diminishes investor protection and contributes to the cost of regulation.
    Investor protection should not be subject to the happenstance or whim of whether a broker-dealer is a member of one SRO as opposed to another. Redundant regulation also hurts investors. They ultimately pay for costs of compliance through higher fees or costs. We owe it to investors to give them absolutely the best protection we can at the lowest cost.
    We believe there are opportunities to improve the current self-regulatory structure, and we stand ready to contribute to that effort. In that vein, as I mentioned, we are attaching our White Paper that we prepared three years ago, evaluating the advantages and disadvantages of six different approaches to self-regulation.
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    Our securities markets remain the envy of the world. The United States continues to offer investors and companies the most liquid, innovative, and fair capital markets available with unparalleled levels of investor protection.
    And it is this structure that really allows us to raise the capital that fuels the economic growth of the broad economy. But we hope that an improved regulatory structure can preserve these goals that we all share, effective, efficient regulation that maintains the trust of investors and all market participants.
    We are confident that by working together we can seize this opportunity to enhance corporate governance and transparency within the SROs and further improve the securities industry's regulatory system.
    Thank you very much.
    [The prepared statement of Marc E. Lackritz can be found on page 135 in the appendix.]
    Mrs. BIGGERT. Thank you very much, Mr. Lackritz.
    Mr. Glassman?
    Mr. GLASSMAN. Thank you, Madam Chair, members of the Subcommittee. My name is James K. Glassman. I am a fellow at the American Enterprise Institute, host of the Web site Tech Central Station and a syndicated financial columnist.
    One of my main concerns is the nexus between finance and public policy, especially as it affects small investors.
    Madam Chair, may I first ask for permission to enter into the record the study of economist Brian Becker that was referred to earlier by Congressman Bachus. This shows the high level of profitability of specialists. This study was the subject of a conference just last week at the American Enterprise Institute.
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    Mrs. BIGGERT. Without objection.
    [The following information can be found on page 203 in the appendix.]
    Mr. GLASSMAN. Thank you.
    The recent resignation of the CEO of the New York Stock Exchange in the wake of controversies over specialist activity, board composition and compensation has provided a once-in-a-lifetime opportunity to reform a management structure built on a massive conflict of interest. So far, this opportunity has been squandered.
    This hearing coming at a crucial time must help reverse a course that will inevitably lead to more scandals like those involving specialists that we just learned of this morning and a further erosion of confidence among your constituents.
    The remedy is to put an end to an unconscionable conflict through two steps: first, separating the regulatory and business functions of the Exchange and, second, making the NYSE a public company owned by thousands of outside shareholders just like the nearly 3,000 companies that the Exchange itself lists.
    The regulatory function of the New York Stock Exchange and of every other exchange and market should be separated by contract and by structure from its commercial market function. As the best insurance against conflict, the NYSE and the NASDAQ should become public companies with the majority of their shares owned by outside shareholders who would choose directors.
    A system of electing board members, whether there are 27 or 17 based on the constituencies that they represent, is doomed to failure. All directors must be rowing in the same direction toward the same goal.
    Unfortunately, top officials of the New York Stock Exchange and the Securities and Exchange Commission have not supported separation. It happened again today in Mr. Reed's testimony. This is a shame, and it is inexplicable, especially today with the news that at long last five large NYSE specialist firms will face disciplinary action for trading violations that, according to reports, could cost investors $100 million.
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    And let me be clear: Such violations are inevitable given the current structure of the Exchange. Five specialist firms have been named. Four of them sit on the board of the NYSE.
    The structure is behind not merely specialist trading violations but the very existence of the anachronistic floor trading system of the NYSE, the only exchange in the world—the only major exchange—that uses an auction system with specialists.
    The alternative is to separate the regulated from the regulator and to take the Exchange public. And the Exchange would not be a completely passive party. It would choose its regulator, either private or public, and be responsible for that choice.
    The model exists today: the National Association of Securities Dealers. The NASD, a private entity with a staff of 2,000, already regulates the NASDAQ stock market and 5,330 securities firms. The NASD used to own NASDAQ outright and the structure was self-regulatory. The separation was part of an effort by the SEC to remedy serious trading proprieties of the NASDAQ that emerged in 1996.
    It has worked well, but it is still unfinished. And to achieve complete separation, the SEC should move quickly to grant exchange status to NASDAQ. A similar complete separation should be effected for the NYSE. And both exchanges would then be free to launch initial public offerings.
    Finally, the decline in scandals at the NYSE should not have been surprising. As Sarah Teslik, executive director of the Council of Institutional Investors put it, ''The nicest thing you can say about the NYSE and their performance is that they are set up in such a way that you can't expect them to do a good job. And they have not disappointed us.''
    The Congress, the SEC and the Exchanges and markets themselves have the opportunity to end the conflict that brought about the current scandals by establishing a new regulatory regime when built on choice, competition, strict compliance and investor protection. Time is short.
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    Thank you.
    [The prepared statement of James Glassman can be found on page 120 in the appendix.]
    Mrs. BIGGERT. Thank you very much.
    Mr. Putnam?
    Mr. PUTNAM. Thank you, Madam Chair, members of the Subcommittee. I am honored to have the chance to testify here today on behalf of Archipelago today, which I refer to as ArcaEx. Just one moment of branding opportunity here—we used to be a very large ECN—today, we are a U.S. national securities exchange.
    We have heard a lot today about the virtues of an auction marketplace. We, in fact, operate an auction marketplace. The difference between ours and the New York Stock Exchange is that our auction marketplace involves no specialists and it is entirely electronic.
    Today, we operate the largest electronic exchange in the world based on dollar volume and the second largest exchange in the United States behind the New York Stock Exchange. I guess, in the spirit of the season, one of my favorite quotes, it is deja vu all over again. We have been here before.''
    Why is the New York Stock Exchange in need of reform? Why does the New York Stock Exchange not innovate? And the simple answer is that the New York Stock Exchange does not have to compete.
    Back in 1995, we were in a similar situation. NASDAQ was coming out of a massive scandal: price fixing, collusion by market makers.
    One of the solutions, a new rule came from the SEC that lowered the barriers to entry and created a competitive environment, which actually is the reason why I started my firm, Archipelago.
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    The results are in. Seven years later—I think it was seven years later—we have a marketplace where NASDAQ, the trading of a NASDAQ stock like Microsoft went from horrific to where it as good or better than the trading of GE, the largest stock on the New York Stock Exchange.
    I was asked for my opinion or my views, my expert views, on what we should do to fix the New York Stock Exchange; some of these things are actually in my best interest to stay broken. As a competitor, we like to differentiate ourselves from the New York Stock Exchange.
    But one of the key areas, I think, in terms of creating more competition for New York, is that a large part of the problem is based on New York as a monopoly and New York as the regulator.
    We read in the Wall Street Journal today about the specialists' scandal. How can a situation like this exist? This is not a recent event. This has been going on since that blasted goat came into Wrigley Field and cursed our team in 1945. It is not new.
    How can that happen? And how can we have a CEO of a monopoly earn $185 million? When Mr. Bachus pointed this out to earlier, there are conflicts on that board and the thing that comes to my mind, are things like, ''Why rock the boat?'' I won't rock the boat if you don't rock the boat. One hand washes the other.
    There are conflicts there. The business head is in charge of regulation. Those on the floor that do the things that are pointed out in the Wall Street Journal, sit on the board of the company and the compensation committee that rewards that individual.
    As far as Archipelago is concerned or ArcaEx is concerned, we don't like the bullying that takes place. When the regulator shows up at our member's office and says, ''We noticed you have been trading on ArcaEx. We understand that the floor of the New York Stock Exchange represents best execution. We are not sure about ArcaEx. So we think we are going to need to have, 12 of our police officers in your company for the foreseeable future just to make sure you are getting best X.'' It is a competitive weapon. It is used.
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    I think if you compare the New York's model to the ArcaEx model, we actually have this situation of having to be a regulator and a marketplace, although our model is very similar, is actually similar to the NASDAQ and NASD model.
    I head up the business unit. The people that work for me run the business of operating an exchange. Phil DeFeo heads up the regulator. The people who are in the business of regulating report to him, there is no cross reporting. I have no say over their compensation. I have no say over their duties.
    And for those of you—and we heard earlier today about how it is hard to regulate electronic marketplaces—for any of you that believe that, just one word, the movie ''The Matrix.'' It is not a documentary, it is science fiction. It is not hard. The machines aren't taking over and thinking for themselves. Humans do.
    A very important point to us, and this is something that has been raised at the Commission. I have raised it down there many times. And we have a window of opportunity to fix something here.
    How do you get New York to compete? It is through ITS reform. ITS is governed in a way where if any one of the competitors of the New York Stock Exchange so much as eyeballed that moat around 11 Wall Street, they show up for the meeting with a blackball.
    There is a current example. Three very unlikely competitors: NASDAQ with its market-makers; ArcaEx with its electronic model; and the Chicago Stock Exchange, joined together to bring a proposal to the ITS Committee; a major reform. The thing that you heard from Bob Greifeld earlier, this reform will allow us to compete.
    We showed up with a very, very negotiated proposal. The New York Stock Exchange showed up with a black walnut in their front pocket. That proposal for change; reform was put on the table. The New York Stock Exchange used its single veto and vetoed it.
    Fortunately today, we actually have a program that was put in place by the SEC, a pilot program about a year ago in three securities: these three securities, one of which is QQQ. It is the largest, most liquid stock in the world. We have a de minimus trade-through experiment going on there. You can trade through the better price by up to three cents when a customer chooses speed over absolute dollar best price.
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    Well, the results are in. We are the largest marketplace, ArcaEx is, for trading QQQs. New York has one-third the market share that we do in that security. Put them in a competitive environment with their system, and they don't do so well.
    I am going to ask the question: Why don't we do as well in GE, the most liquid, largest stock that trades on the New York Stock Exchange? It is because of the competitive barriers. Those competitive barriers need to be removed.
    Thank you.
    [The prepared statement of Gerald D. Putnam can be found on page 182 in the appendix.]
    Mrs. BIGGERT. Thank you very much.
    Mr. Frucher?
    Mr. FRUCHER. Thank you very much. I would like to thank the committee for having me here today.
    My name is Sandy Frucher. I am Chairman and Chief Executive Officer of the Philadelphia Stock Exchange. On behalf of the Philadelphia, I appreciate the opportunity to speak at this hearing. And I would like to express our views on market structure.
    This is a complicated subject, but I think it is very simple in a lot of ways. It is all about competition.
    Let me begin by saying a word about the Philadelphia and the role of the regional Stock Exchanges. The Philadelphia is the oldest securities exchange in the United States. We trade over 2,000 stocks listed on the New York and American Stock Exchanges, over 1,000 equity options, and industry sector and currency options.
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    Collectively, the Philadelphia, the Chicago, the Pacific, the Boston and the Cincinnati Stock Exchange form an essential pillar of our national market system. While we differ in many respects, we all make markets in stocks listed by the New York and, thereby, provide needed competition for the Big Board.
    The regional Stock Exchange survived because competition forces us to innovate. For example, the Philadelphia employs an electronic system of remote competing specialists. On our exchange, many stocks have three or four specialists competing to offer the best price rather than a single specialist as on the New York.
    But frankly, that should be their choice. Their market structure should be their own. And how they compete in the marketplace, the marketplace should ultimately determine their fate, not a regulator.
    The legal and regulatory environment in which the regional exchanges operate must foster the broadest possible competition. Congress has already endorsed this view. In 1975, Congress told the SEC to promote, ''Fair competition among brokers and dealers, among exchange markets and between exchange markets and markets other than exchange markets.''
    Congress understood that greater competition produces greater benefits for investors and more dynamic and fair markets. To maximize competition, exchanges and dealer markets must be free to compete in terms of all the services they offer investors. Markets obviously compete on price, generally the best bid and offer available on each market. We also compete on the basis of fees we charge, on speed of execution, the depth of our liquidity, the convenience of our technology, our trading rules and so on.
    The Philadelphia believes that exchanges must also be free to compete on factors such as degree of order interaction and possibility for price improvement. So long as the SEC allows all exchanges the chance to explore different modes of trading, this competition between marketplaces will translate directly into benefits for investors.
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    Let me turn to the self-regulation functions for a second. The Philadelphia believes that self-regulation by individual exchanges has worked very, very well. Each exchange is most knowledgeable about its own trading system and trading rules, its own members and the dynamics of trading in its marketplace. As the local authority, each exchange is therefore better situated to assess conditions, enforce its rules and prevent violations than is a distant regulator.
    Monopoly in regulation is as bad as monopoly in trading. The fact is is that self-regulation is not sole regulation. There is a tiered system of regulation. And it is very, very important, I believe, to keep the ethic of regulation, of integrity in the marketplace. To separate it would be a grave mistake.
    The cornerstone of our financial system is the obligation of every player to self-regulate. And that should not be lost during this period of time.
    While the PHLX does not support a single self-regulator, we do support regular evaluation by Congress and the SEC on how well the Exchanges are doing their job. Recent events at the New York Stock Exchange may create a perception that exchange regulatory functions are subject to inappropriate influence.
    Rather than abandoning self-regulation, the Philadelphia believes the SEC and the New York Stock Exchange should look at overall governance issues. That is the key; that is the problem. And Mr. Reed seems to be doing that.
    Since 1997 in the Philadelphia, non-industry members have consisted of a majority, they have been a majority of our board. They have played a very influential role based on their enhanced participation in our governing committee. We believe that this structural change has been a very, very important part of the integrity and the enhancement of our regulatory program.
    Exchange members also have an important role to play in exchange governance, particularly because they bring to bear critical knowledge of industry trends, operations, and practices. We don't want to dumb up the boards. We just want to make sure that there isn't a conflict of interest.
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    Therefore, they have, and should have, a significant role on exchange board and committees. But there is an appropriate balance that must be struck between public members' representation and how oversight is conducted in key functions such as regulation, audit, compensation, and nomination of future directors.
    This is the best way to safeguard independence of the regulatory function through the governance. You have to have a majority public, and they have to be in the key areas to ensure that you don't have a conflict.
    I will conclude by touching on two risks important to independent regulation.
    First, we understand that the SEC is considering proposals that would affect the structure of market data revenues and the distribution among market participants. Exchanges are required to collect and disseminate market data from their members and incur costs in doing so. Revenue from the sale of that data is an important source of funding, particularly for regional exchanges.
    Reducing the market data revenue available to regional exchanges would limit our ability to fund our operations, including regulatory functions, and to provide competition to the New York and to the NASDAQ.
    A second concern is the creation or sponsorship by exchanges of programs for payment for order flow. Exchange-sponsored payment for order flow programs, in my view, are a conflict. We believe that these programs may create conflicts in the exercise of exchanges' self-regulatory obligations, and we have submitted a petition to the SEC and we have asked them to ban the practice.
    A more complete statement of my views on these important matters is contained in my written testimony.
    I want to thank the Chairman and the members of the committee for affording me the opportunity to share my views and those of the Philadelphia Stock Exchange.
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    [The prepared statement of Meyer Frucher can be found on page 103 in the appendix.]
    Mrs. BIGGERT. Thank you very much, Mr. Frucher.
    Mr. Colker?
    Mr. COLKER. Madam Chair and other members of the Subcommittee, I would like to thank you for the chance to share my thoughts on the important issues of the day.
    I would also like to thank Mrs. Biggert for her kind recognition of our presence and important place in the Chicago financial community. Thank you.
    Last year, Cincinnati became one of the largest Stock Exchanges in the country. We recently set a trading record of 415 million shares and 900,000 trades. We currently trade 20 percent of all the business in NASDAQ-listed issues.
    We have achieved this growth by being a leader in technology, market structure, innovation, cost reduction, and effective regulation.
    For example, we were the first exchange to eliminate our physical trading floor and go totally electronic. We were also the first exchange to provide automatic executions in the Intermarket Trading System, as well as the first to develop a complete electronic audit trail for trading activity.
    In addition, we were the first exchange to implement a competing specialist system and to combine that system with a professional time modification called preferencing to facilitate electronic internalization of order flow.
    Finally, Cincinnati was the first exchange to share all of its excess transaction fee and market data revenue with its members. By combining the operating leverage that comes from being all-electronic with the adoption of a utility cost model, we have established ourselves as the low-cost provider of exchange services.
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    All these innovations have come in the face of enormous resistance to change by the incumbents. For too long we have had to live with policies that protect monopolies rather than promote competition. For too long policymakers have accepted the false belief that if only all order flow could be directed to one physical location, then customer order interaction would be maximized and the public investor would get the best price.
    Lip service was paid to the idea of competition between exchanges, but if any of the non-primary exchanges came up with too good an idea and started capturing order flow, this accomplishment was viewed as a problem and labeled with the pejorative word ''fragmentation.''
    Recent events, however, have called these beliefs and policies into question. More importantly, recent troubles in New York are symptomatic of deeper problems and highlight the need for the SEC to seriously address the outstanding market structure issues.
    We hope that the current problems in New York will translate into constructive market structure modification so that the public investor can benefit from the interplay of true competition.
    While Cincinnati certainly doesn't have all the answers, there are two issues, however, that we believe deserve immediate attention. First, we would like to address the unfairness that allows NASDAQ to monopolize the decentralized market model, a model that does not require price-time priority.
    Exchanges have been trying for over two years to get SEC permission to compete with NASDAQ by adopting NASDAQ's model when the Exchanges trade NASDAQ issues. This request is just plain fairness and common sense; particularly in light of the fact that the empirical evidence shows that a decentralized trading model like NASDAQ's actually provides better execution quality than New York's auction market.
    In a world where NASDAQ is handling 12 percent of all the trading in New York-listed issues, there is no longer any legitimate distinction between exchanges and the securities association, and therefore it is no longer appropriate to prevent Cincinnati from trading NASDAQ stocks in the NASDAQ style simply because it is an exchange.
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    If the SEC is unwilling to permit an exchange to make price-time priority voluntary because of perceived investor harm, then the Commission should act to equally protect investors who trade on NASDAQ by requiring NASDAQ to impose price-time priority.
    Second, the Intermarket Trading System needs to be changed, as my compatriots have also said. Three developments are driving this need for reform.
    First, the world is much more electronic than when ITS was first created. Second, the minimum trading variation has been reduced to a penny. And, third, the national best bid and offer is no longer a reliable indicator of the best available price.
    All of this has created tensions and frictions as automated markets are struggling to interact with manual markets. No other market structure change would do as much to force New York to have to compete than the modification or elimination of the ITS trade-through and locked market rules.
    The definition of best execution has evolved beyond just price and now really is defined as a variable set of expectations that include price, cost, speed, and certainty of execution. Best execution can no longer suffer the inherent delays in ITS.
    If the SEC were to remove the constraints of the ITS trade-through and locked crossed-market rules, and require ITS participants to provide automatic executions, then the broker-dealer community would have the tools it needs to provide investors with best execution and the securities industry would begin to realize the full potential of a national market system.
    In closing, let me just stress to you just how profoundly the capital markets have changed. Because of electronic markets it is an entirely different world than even a few years ago. Our regulatory overseers have to adapt to this change.
    It is imperative that the rules establishing the structure of our markets change soon so that the full value of competitive choice can be unlocked. Anything short of that will only protect the incumbent exchanges and hurt the public investor.
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    Thank you.
    [The prepared statement of David Colker can be found on page 92 in the appendix.]
    Mrs. BIGGERT. Thank you very much, Mr. Colker.
    Professor Coffee?
    Mr. COFFEE. Good morning, Madam Chair.
    As your final speaker, I will try to be brief and keep my message very simple; focused on the corporate governance issues.
    When you pierce through the lurid tabloid-style details about Mr. Grasso's extravagant compensation, and when you get just beneath the surface, you hit the real public policy issue, that this embarrassment, this scandal, revealed a deep-seated conflict of interest.
    Put simply, Mr. Grasso's 1995 and 1999 contracts were negotiated with a compensation committee of the New York Stock Exchange Board, all of whose members were Chief Executive Officers of broker-dealers.
    In effect, the securities industry had a structure, under which, it held a carrot and a stick by which it could reward or punish, not just Mr. Grasso, but all the senior officers of the New York Stock Exchange, including those who had primary responsibility for regulatory and enforcement matters.
    That compromises, at least in the eyes of the public, the independence of the New York Stock Exchange as a regulator. Mr. Donaldson testified yesterday that he considered it to be, ''An inherent conflict to combine regulatory and market functions.''
    Okay, I think there is no need to further argue the point that there is a deep conflict of interest. What do we do about it? I think there are two potential models that the SEC would see. And I am going to suggest that the more conservative of the two is perfectly adequate. But we have to go all the way with that more conservative model.
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    That is, there is already a proven and workable remedy, which lies in what was done in 1996 when the NASD was reorganized. Following a scandal, at that time, the NASD was also in the public eye as an organization that had become dysfunctional.
    And it solved the problem based on a committee led by Senator Warren Rudman, which recommended separating the two functions and placing all of the regulatory activities of the NASD in a new, wholly-owned subsidiary called NASD Regulation, which was in principle, to have an all independent board of directors having no contact with the securities industry.
    Okay. That was done 1996, 1997. Once, and not so long ago, well within my professional memory, the NASD was seen by most as a tame and largely toothless tiger, not a very powerful enforcer.
    Today, the world has changed. The NASD, or NASD Regulation is perceived by all as proactive and a very effective enforcer. What is the message? The message, I believe, is that independence makes a difference. Independence can improve the quality and the quantity of enforcement.
    Now, please note that if we were to follow the NASD model, we would place all of the regulatory activities of the New York Stock Exchange in a wholly-owned subsidiary—call it New York Stock Exchange Regulation, Inc.—which would have independent directors having no contact with the industry. What would be the costs of doing that?
    Let me suggest that there is no wrenching organizational change that follows from this simple step. No one even would have to change their office, no lines of authority or reporting would be changed, no one becomes more distant. I am not suggesting having the New York Stock Exchange regulated by some super regulator located in Washington.
    I am suggesting the same people doing it today, who continue to do their job, but they would have an independent board of directors to insulate them. And insulation is what you need, particularly when an organization faces increased competitive pressure.
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    In the past, the New York Stock Exchange did not face competitive pressure. As you are hearing, it is going to face more pressure for the future. When you look at what really happened in the NASD embarrassment in 1996, most commentators have said, as I summarize in my materials, that essentially a very zealous management of the NASD subordinated their regulatory responsibilities to their desire to maximize their marketing of their institution: the NASDAQ market.
    That same thing could happen in the future to the New York Stock Exchange even if all compensation problems are resolved. Even though we have a perfectly clean system for determining the compensation of the New York Stock Exchange's officials, there is still the desire in the competitive world not to embarrass your organization. And that could lead to having regulators pull their punch.
    Therefore, what you want is an insulated regulatory arm with its own board of directors. And the key role to that board of directors would really be to determine each year what is an adequate regulatory budget, because that is the invisible issue that no one else has yet mentioned.
    You have got to have an independent board to say, ''Here's what we need to function effectively.'' And that adds transparency to the process. That group could handle those issues.
    My time has run out so let me not address anything more on this issue. Let me just add one final sentence. You have heard a lot of talk about other reforms that might be pursued. Let me say from some experience in this deal that there are very inconsistent goals in securities market regulation.
    The public wants the lowest possible spread, the highest possible liquidity, the quickest possible execution, and oh, yes, a buyer and seller of last resort always there. Those things don't all go together. There are trade-offs. There are inevitable trade-offs.
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    You have to move incrementally. There is no magic bullet. And I would suggest to you that many of these problems require SEC study.
    The one simple problem is minimized conflicts of interest. And if all we do is come back in a few months and have a better board for the New York Stock Exchange, we haven't protected and insulated the regulatory function.
    That requires a truly independent board of directors so that enforcers know they will not be subject to invisible reprisals.
    Thank you.
    [The prepared statement of John C. Coffee, Jr. can be found on page 83 in the appendix.]
    Mrs. BIGGERT. Thank you very much, and now we will turn to questions. And each of us will have five minutes, so I will yield myself five minutes for questions.
    Mr. Glassman, in your testimony, you criticized the SRO framework. And self-regulation has been viewed as having certain advantages over direct government regulation.
    Number one: that industry participants bring expertise and intimate knowledge of the complexity of the industry. And, two: self-regulation supplements the resources of the government, thus reducing the need for large government bureaucracies.
    What do you say about these purported benefits? And do they justify the existence and continuing of the current system?
    Mr. GLASSMAN. Yes. Madam Chair, I agree that there are benefits to, let us call it private regulation rather than government regulation, and that is, in fact, why I advocate private regulation.
    But that regulation should be separate from the commercial activities of the institution that is being regulated.
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    So in my model what I would suggest would be something very similar to what is going on right now with the NASD's regulation of NASDAQ. NASD is a private company that has been contracted, that NASDAQ has contracted with, to provide its regulation.
    There might be other private companies that could compete.
    In fact, there could be public regulators who could also compete, and compete for the regulatory contract and would be paid by the institution being regulated. But I do not advocate this as an extra function for, for example, the SEC.
    Mrs. BIGGERT. Okay, thank you.
    Professor Coffee, when you talk about the independent directors—and I know Mr. Reed talked about the independent directors as excluding individuals from the trading floor and other broker-dealer industry, as well as the current CEOs of the listed companies, and he kept talking about how you need a professional board—so, who would serve on such an independent board that is not tied into the industry?
    Mr. COFFEE. I think you could look at NASD Regulation. They also set up an independent board. There are people from the buy side. There are retired CEOs. There are people who once upon a time, five years ago, were chairmen. There are New York Fed bank Presidents. There are Nobel Prize economists in economics.
    All of these people understand something about trading markets. They are not people who are very distant from it. And I think they would be interested in such a role.
    I think there is going to be a lot of people who would be very interested in working with the New York Stock Exchange, either at the board of the entire exchange, or in a board specially focused on regulation.
    On the regulatory board, you could have people who had formerly been the head of enforcement of the SEC. All those people know about enforcement and know what makes it work.
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    Mrs. BIGGERT. As long as there is no conflict of interest, then.
    Mr. COFFEE. I think anyone who is going to be head of enforcement of an agency knows that there is body language by which the Chief Executive can signal to him he doesn't want this pursued, ''This is embarrassing, this is messing up our IPO we had planned for next year, or this is giving us a bad image, you are doing too much.''
    If you instead are insulated by a board of independent directors who know their function is to make you an effective regulator, I believe your behavior will be different and I think the change in behavior at NASDR is some evidence of that.
    Mrs. BIGGERT. Thank you.
    Mr. Putnam, I share the concern about the goat's curse of the Cubs. ''Wait till next year!''
    You talked about the 1990s investigation of the NASDAQ stock market that led to the separation of the regulatory to the NASD.
    And then there is an ongoing investigation of the specialists for the New York Stock Exchange, and that has been in the paper this morning. Did that announcement color your speech as far as—the action against the five specialists—has that colored your view any more or was that expected?
    Mr. PUTNAM. It was expected. And as a participant in the industry for 22 years, what goes on with the specialists on the floor of the New York Stock Exchange, since the first day I learned about New York Stock Exchange trading, it has been going on. So it is not recent.
    Mrs. BIGGERT. And how would you recommend that the New York Stock Exchange restructure its market trade function to prevent the middlemen in the trading of securities from benefiting at the public expense?
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    Mr. PUTNAM. Again, I think that what I was trying to say is that when you have the head of the business wear the same hat as the head of the regulator, these inherent conflicts are going to exist. And we have seen this, ''Right?''
    So a very large paycheck goes out to the CEO of a monopoly who is also looking the other way when those people, who are the participants on the floor, are making a bundle of money by violating these rules and standards.
    So you need to separate, at a minimum. I am not saying New York needs to spin off that regulator into a separate company that has no relationship to it, but, at a minimum, you can't have the same head of each organization.
    In our PCX relationship, PCX is independent of us. They have a committee called the ROC, the Regulatory Oversight Committee. It is made up of independent directors. No relationship whatsoever to me. That is the ultimate jurisdiction.
    On the regulatory side of that business, it governs ArcaEx, the Exchange. It is clean. There are no conflicts.
    Mrs. BIGGERT. Thank you.
    Mr. Kanjorski is recognized for five minutes.
    Mr. KANJORSKI. Well, thank you very much, Madam Chairman.
    One of the issues in the debate about the market structure that concerns internalization of customer orders—I know that some of the panelists have views on this issue—if internalization of orders increased, how will this affect the investors? And I would actually like an opinion of all seven of you, if I can.
    But we can start off with the Philadelphia Exchange and then go to NASDAQ——
    Mr. FRUCHER. I am sorry. Could you repeat the question just a bit? I have lost——
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    Mr. KANJORSKI. The issue of internalization.
    Mr. FRUCHER. Oh, internalization.
    Mr. KANJORSKI. Yes.
    Mr. FRUCHER. I am glad you raised that issue. The SEC has taken a position on two issues. And three Chairman, actually that I have known, have all wagged their fingers at us and said both internalization and the question of payment for order flow is a terrible, terrible thing. And yet they proceed to move the ball forward in both those areas as they promised continuously to come out with a position paper to clarify their position.
    Internalization itself is not necessarily bad; it is the degree of internalization. If you have extensive internalization, you have an inherent, or the potential for an inherent, conflict of interest. If you have a regulator—such as an exchange engaged in a taxing process where we take money from one player, give it to another player to buy order flow to the Exchange—it is inherently a conflict of interest.
    That and issues like the ITS system really require leadership from the SEC. We need to know their position on these issues, and then you need to devise policies, or at least get comment from the public, including the affected public on where it stands.
    So, I think that internalization and payment for order flow by exchanges are two issues that the SEC really must come forward before they allow a new exchange like the BOX, which is an internalization model, to proceed and before payment for order flow further erodes the integrity of the marketplace.
    Mr. GREIFELD. Internalization really is another word for competition. NASDAQ has been about competition since its inception in 1972. And the market makers in the NASDAQ market structure provide execution solutions to investors. And they need to improve upon what is available through the NBBO.
    And what we have today is a very clear measuring stick and it is called the Dash 5 stats. And that is what the SEC mandated when they collected the data. And the Dash 5 stats clearly show that NASDAQ's competitive model yields a better outcome for investors.
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    In my testimony, I have made reference to the S&P 500, where our spreads are tighter; our speed of execution is quicker. That does not happen by accident. That happens because we have competition; we have competition between ECNs, we have competition between market makers who are trying to offer a better execution solution.
    And that is in stark contrast to the competing model, where there is one specialist who is monopolous. NASDAQ has multiple market participants and it yields a better outcome, and you can track that through the Dash 5 stats.
    Mr. COLKER. Mr. Kanjorski, if I may also, respond to that question?
    Mr. KANJORSKI. Yes.
    Mr. COLKER. Thank you.
    First of all, internalization is a widespread practice on all exchanges. As Bob mentioned, the NASDAQ is really entirely an internalized market and also just on Cincinnati and the other exchanges. The empirical evidence, as Bob said, shows that, in fact, maybe it appears counterintuitive to people that are not in the business, but the empirical evidence shows that, in fact, internalized markets provide better executions than in the auction market.
    And the reason is it gives the brokers better control over the execution quality for their own customers. It is like Wal-Mart wanting to keep control of their customers vs. sending it down to Target. And the reality is that all this activity is transparent. The SEC is requiring the Exchanges to disclose this information.
    And so the customers see the quality of service they get. And you can bet that if they are not getting the service they need, they are going to go to a competitor. So, internalization is really a necessary tool in the community to keep control over execution quality and efficiency of execution.
    Mr. KANJORSKI. Yes?
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    Mr. LACKRITZ. Mr. Kanjorski, I think that internalization is an inevitable result of deregulation of Commissions and encouraging competition. Since the regulatory structure that we favor should encourage competition, internalization and payment for order flow obviously are outcomes of that.
    But that doesn't mean that the transactions are removed from other kinds of considerations in the regulations, such as best execution. The broker-dealer still has the obligation of getting best execution for the customers under any circumstance.
    And so there is a check and a balance to protect against any kind of abuse or excess that result from it. But the existence of internalization really is a natural outgrowth of competition and, therefore, it is not a bad thing, although it sounds like it initially.
    Mr. PUTNAM. I would agree that internalization is certainly an outgrowth of competition. It is one way that an investor can get a stock executed. But it is important, and there is some missing information here. Is a lot of that one-five data that we are talking about, so that measuring how a marketplace does; a big component of that is executions that occur in our system where internalization is not allowed.
    In our system, price competition is rewarded. If you are the first one in line at the best price, you are guaranteed to get the next trade at that price. In that way, investors compete aggressively to make tight spreads, to be the next one in line.
    There is a serious question today about whether exchanges should be allowed to play both roles. And I would say it is a serious mistake to change the definition of an exchange that takes the value of that price competition away by allowing an internalizer to merely match, to step in front of the next investor that is in line.
    You will dilute the value of price discovery if you allow it. It is on the table today with NASDAQ's exchange application. It absolutely should be prohibited.
    Mr. FRUCHER. Mr. Chairman, I just want to say, you know, every Chairman of the SEC in the last six years has raised questions about the question of internalization. What is internalization? It is one firm taking both sides of the market and that looks inherently like a conflict.
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    I think it is very, very important—it doesn't necessarily mean it is—it looks like it is a conflict. And I think that we really need guidance here from the regulator as to what their position is on these issues.
    You can't just keep shaking your finger at it, saying it is a vile practice, and then not give us any direction or any insight on your thoughts.
    I really think that we are all waiting for this SEC position paper on this issue so that we can have a reasonable debate. People with different business models obviously have different points of view, as you do on things like the ITS system.
    But I think it is important for the regulator to step forward and give us its views so that this debate can begin.
    Mr. COFFEE. For the future—I am giving you a slightly dissenting view here from the rest—for the future, the problem with internalization, which certainly is the product of deregulation, and it is not a sinister practice—it is predatory in design, but its problem is that it is a form of market fragmentation.
    When the broker-dealer internalizes the order and trades at what the distant market price was, we are losing order flow that went into the former process of price discovery.
    Today, NASDAQ trades less than 20 percent of NASDAQ-listed stocks. Maybe 30 or 35 percent are internalized, the rest go through ECNs which match limit orders in Cincinnati. Against that backdrop, if that trend continues, and if NASDAQ were to fall to trading something around 10-12 percent, we don't have the same deep, liquid market determining price discovery.
    We have got 70 percent or more of the market being determined, with reference to a relatively thin market, because internalization effectively is drawing stock outside of the normal processes of price discovery. And I think the historic goal of the SEC is to make sure there is a deep, centralized, liquid market, and they have a reason to be nervous about excessive fragmentation.
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    If the orders fragment away from the central market, over the long run I think there are some dangers to small investors.
    Mr. PUTNAM. My branding speech, though: Cincinnati exchange, ARCA exchange, ECNs, NASDAQ.
    Mr. COLKER. I have one quick thing. What people may not realize today is that the market really is centralized electronically. There is no give-up of interaction in market information today simply because of internalization.
    Anybody who is internalizing or trading in any other fashion has complete information today on their PC of the market information of every other exchange and ability to route. So, there really is a centralization. And fragmentation really is just a pejorative word for competition.
    Mr. KANJORSKI. I have never seen Jim without an opinion. Did you want to throw yours into——
    Mr. GLASSMAN. Actually, thank you, Congressman.
    I actually don't have a very strong opinion on this. I am generally in favor of internalization, but I think you have heard from people who are more expert than I am.
    You probably never thought you would hear me say this.
    Mr. KANJORSKI. Very good.
    Mr. GLASSMAN. Thank you.
    Mr. KANJORSKI. Thank you, Madam Chair.
    Chairman BAKER. [Presiding.] Thank the gentleman.
    Mr. Shays?
    Mr. SHAYS. Thank you, Mr. Chairman.
    Mr. Chairman, I am grateful that all of these gentlemen are here. I was kind of enjoying the fact that there were few of us here so we could ask lots of questions. I was feeling very honored that so many would speak to so few.
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    As I see Mr. Glassman and Mr. Coffee, I view you more as disinterested parties, in the sense that you are not speaking for the businesses that you are involved in.
    Mr. Glassman, when I heard you speak, I said, ''Yes, I agree with everything. It was pretty definitive and so on.'' If you were listening to Mr. Coffee, he started to qualify—educate me a little bit more about all of these other things I should consider—he went beyond your area of discussion.
    Where would you disagree with him?
    Mr. GLASSMAN. Well, I think that Mr. Coffee was saying that he feels that as long as you separate the regulatory function from what is called the business function, within the same institution, but with different boards of directors, that you can do the job.
    I don't want to misstate anything that he said. I would say, go all the way. I don't see why that is necessary.
    What I would say would be essentially something similar to the, as yet, incomplete NASD NASDAQ separation where you have a business that contracts with a regulator—in this case NASDAQ contracting with NASD, or the NYSE contracting with NASD or anyone else that it chooses—and has a complete arm's length relationship, is a contractor, really.
    And I think that would provide much more of a separation than what Professor Coffee just said. I don't have a huge disagreement with what he said, but I think at any rate that is the direction that it ought to go in.
    Let me just repeat what I said in my testimony. I think this is a massive conflict of interest. And it is hard for me to even understand why there are——
    Mr. SHAYS. I am kind of with you on that. So you reached me.
    Mr. GLASSMAN. Okay.
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    Mr. SHAYS. I would probably make sure that my conflicts of interests are stated, given that NASDAQ is in the district that I represent. First, they are first among equals with this group, but obviously I have a conflict here.
    What I would love to have—and I gather that the other exchanges have variations on what we are talking about, some don't go, ''All the way,'' as you say, Mr. Glassman—but I would love to have someone speak to the issue of why the New York Stock Exchange has—in fact, I am almost feeling sorry for this organization and I never thought I would, given what everybody has said about it today—but given it has 84 percent of the trading that it has listed—and I believe NASDAQ has how much of the trading?
    Mr. GREIFELD. Fifty-five percent.
    Mr. SHAYS. Not 20?
    Mr. GREIFELD. Well, we have 20 percent in our time price priority product called Super Montage. And then in addition to that, you have the market makers internalization, which represents another 30-something percent of the market.
    So the percent of trades that happen in NASDAQ is around 55 percent. And I think it is important to note in tying back to Professor Coffee's point, before NASDAQ had execution systems, the way the Professor was defining it, our market share was zero.
    So you have to understand that NASDAQ has never been about doing executions in and of itself. It is about providing competition in a given market structure where market makers can provide execution solutions.
    Mr. SHAYS. So you have benefited by the competition, but there are others who want to compete with you. And are you in any way, can anyone accuse NASDAQ of opposing others from competing with what it is doing?
    Mr. GREIFELD. No. I mean, post-1997, as I think a lot of panelists have said NASDAQ truly was an open, competitive environment. What you saw is when decimalization came about—and it was a good act of Congress that brought that on—you had a demand for an agency solution in our marketplace. And that demand was met quite effectively by the ECNs.
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    The market makers are geared around principle transactions. And when decimals made the spread so tight, they didn't want to act on a principle basis; the ECN stepped in NASDAQ marketplace and really helped drive the great outcome we see for investors today.
    Mr. SHAYS. Let me quickly ask, ''Can someone give me a keen defense of why we have to have specialists?''
    Mr. FRUCHER. Yes. Specialists provide depth of liquidity to the market. I think everyone has a right, or should have a right, Congressman, to create and to execute their market structure. I think competition is a good thing.
    The New York specialist is not the only specialist. We have multiple specialists in the same stock in Philadelphia, which I think is an advantage. It may work for us; it may not work for New York. A single specialist did not work for us.
    I think market structure should be left to the individual market and the market will determine who the winners and the losers are. What you need to ensure is the integrity of the marketplace, an integrated national market system so that you can, in fact, have best executions for the customer.
    So it is a question of integrity and competition. Those should be the two cornerstones. Regulation shouldn't determine New York market structure any more than it should the NASDAQ market structure, but frequently regulation does. And with all due respect to Mr. Greifeld's statement, before he got to NASDAQ, NASDAQ spent a whole lot of time trying to protect its own monopoly, if you will.
    And Mr. Greifeld was on the other side——
    Mr. SHAYS. You don't believe in being born again?
    Mr. FRUCHER. What?
    Mr. SHAYS. You don't believe in being born again?
    Mr. GREIFELD. I am the same guy I was before.
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    I am the same guy I was, but I came to NASDAQ recognizing we are in an open, competitive environment and if we didn't have that, I probably would not have come to NASDAQ. And that is my background, that is what I like to do. And that is truly the——
    Mr. SHAYS. I am going to let him get the last word, only because I am the constituent.
    Mr. FRUCHER. You know, all politics is local.
    Mr. SHAYS. All politics is personal. Thank you.
    Chairman BAKER. Enough of that. Thank you.
    Mr. Meeks?
    Mr. MEEKS. Thank you, Mr. Chairman. I thought he was good.
    Coming from New York or being from New York and finding basically the capital markets in particular are important to New York's economy, but it is also important for the cause of this nation.
    In fact, I think that one of the reasons why the World Trade Center was targeted by terrorists is because they really want to attack our economy and our financial institutions. And all of you, including the New York Stock Exchange, are very important to our great economy.
    And so, having you here at once and seeing you basically competing in that competition between you, I think that is a good thing. It is a good thing for me because competition is good, and I just wish that all of you and I hope that all of you prosper and become very prosperous and make a whole lot of money over the next coming years, because it is good for America, it is good for the American people.
    I just have one—just trying to understand—one quick question that I will throw out to the group. And that is that some argue that there is a trade-off between attempting to receive price improvement and obtaining fast, certain execution speed.
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    My question is, ''How often does a 10-to 30-second delay in execution cause a change in the original best price?''
    Mr. GREIFELD. If I can respond to that.
    Decimals, again, really represented a sea change in our environment. Before Congress mandated decimals, you had spreads that approached 25 cents, 12.5 cents. And you could argue, I think successfully then, that there was true value in running an auction on a floor, where you could save an investor a nickel or a dime, you could say that was worth the time differential.
    But post-decimals, we see that stocks trade for the one-cent spread or a two-cent spread. I was with the CFO of Microsoft a week or so ago and I was reviewing his trading characteristics, and he actually trades with a net effective spread today less than a penny.
    The investors in Microsoft do not want to wait. Once you have got the price discovery happening in the quote, where the spread is a penny, investors demand speed, first and foremost.
    That was very public this week with Fidelity in the press, but it is also very much the concern of the retail investors. I talk to them on a regular basis and they care about speed. When they click on that buyer sale order, they want to see that execution come back.
    So in the world that we live in today, where you have tight spreads as a result of decimals, speed is paramount.
    Mr. PUTNAM. If I could add something. The 10-to 30-second price improvement period without competition, it causes this: the specialist probe. It is during those 10 to 30 seconds that all the shenanigans in the name of price improvement take place.
    Now, you get a choice. If you have real competition without barriers, you don't like the food in that restaurant, you don't go there. But in our world, there is no choice to use us. There is no choice to use NASDAQ. There is no choice to use another venue for trading listed stocks because of the ITS plan rules.
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    It forces us, as competitors, to always go to the New York Stock Exchange because of this definition of what best price is. You have got to expand the definition of best price. So, like Bob's example, his son can choose to drink the Coke for 99 cents instead of running across the expressway and drinking the Coke for 98 cents.
    I mean, this is absolutely the key ingredient to changing the New York Stock Exchange. It will not change on its own. The NYSE will stay in the condition it is today if it is not actually forced to change the way that it operates as a result of competition.
    Mr. MEEKS. Mr. Coffee?
    Mr. COFFEE. As I mentioned earlier, this is a field that has inherent trade-offs, and all good things don't go together.
    Investors want the best price and they want maximum liquidity, and they want the fastest possible execution. They can't both be maximized at the same time. And different investors want different things.
    I understand that Fidelity wants speed, and that is why Fidelity did criticize the specialist system. They are responding to the impact of decimalization. Decimalization reduced the spread to such a narrow level that specialists no longer provide the same level of liquidity and they force investors to break up large trades into smaller blocks; that takes longer to execute.
    How much that costs you, depends on who you are. If you are a big trader, like Fidelity, the inability to trade large blocks like you could in the past is a severe injury.
    If you are a small investor trading 500 shares as your typical order or less, you like the fact that the spreads are now down to 2.5 or 3 cents. So I think different investors want different things. And I think a complete thorough-going reform that eliminated the trade-through rules wouldn't work to the best interest of the smaller investor.
    There are all kinds of compromises here, and I am not arguing against compromises that might permit some kind of opt-in systems for some investors who are willing to sacrifice.
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    But I think you want to keep the central market with a strong trade-through rule that tries to enforce best execution. I agree we could have some different definitions about what best execution was.
    Mr. MEEKS. Mr. Chairman?
    Chairman BAKER. Congressman Meeks?
    Mr. MEEKS. This is a very complicated subject and everybody has a vested interest in the outcome of that subject. Even on my own floor, in Philadelphia, I would say if you went to three different people who function on the Exchange, they all have different business models and they all would have a different point of view.
    This is precisely the area, or the kind of area, that requires us to get some leadership.
    I think the SEC needs to put its proposals on the table, not to dictate an outcome, but to start the dialogue and the debate, to elicit comments, to come to you and to present their views and get your views and to get our views as part of a public debate.
    Because the rules are one aspect of it, and the structure of the ITS is the second, as Mr. Greifeld and others here have indicated.
    Right now, you have a system—I think Harry pointed out—right now you have a system where you have 100 percent; you require a unanimous vote of the committee in order to change the ITS rules. Sometimes I think that is terrific. I am the small guy on the block and so it is good not to have the big guys be able to force change down our throat. And so, we have a veto.
    But on the other hand, that veto is used, sometimes, to perpetuate a monopolistic position.
    So the structure of ITS has to be looked at, as well as the rules. And one of the problems now is that the regulator is very reluctant to step in even though it has the authority to be an arbitrator or a judge as to what is appropriate behavior or what is appropriate rules, et cetera.
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    I think that needs to be clarified as well. I think there needs to be reform. I think there needs to be reform, not just of the rules, but of the process. And I think there also needs to be an arbitration process, if you will, by the overall regulator, the SEC, to ensure that there is fairness and equity.
    Chairman BAKER. Thank you, Mr. Meeks.
    Mr. Bachus?
    Mr. BACHUS. Thank you.
    This first question will be for Mr. Putnam in Archipelago.
    Mr. Putnam, reading your testimony—and tell me if I am wrong—I get the sense that what you are saying is that the recent corporate governing issues at the New York Stock Exchange were not really the problem, they were the symptom of the problem. And that the symptom of the real problem was lack of competition in trading of listed securities. Is that——
    Mr. PUTNAM. That is exactly the point. When you are in an environment—and, again, we have seen this, we have seen this before, we saw this with NASDAQ and the NASD as a monopoly—when the monopoly and the regulator are the same, the conflicts exist, one hand washes another, one side doesn't want to rock the boat to disrupt the other. And that is exactly the point.
    Mr. BACHUS. So if competition existed, then they would be incented to have appropriate corporate governance rules?
    Mr. PUTNAM. You want to watch the New York Stock Exchange change? Let that market share go from 80 percent to 60 percent. And that thing is going to change overnight.
    I mean, my worst nightmare is that they change so fast that I can't make an impact myself, so that we actually have a differentiation to where people will choose us.
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    But today the problem is that you don't have the right to choose us. So if you want to fix it, you have got to scare them. And they are only going to be scared if they think that they are going to lose some of that market share.
    Mr. BACHUS. Okay. Let me ask you this: In your judgment, what are the greatest structural obstacles to competition in trading of listed securities?
    Mr. PUTNAM. I think the two that I pointed out: one is when the chief of regulation and the chief of the business in this monopoly organization is the same person, members are afraid to speak up.
    And we heard earlier today, we are going to go to the members and ask them what they think. Well, if you disagree with the New York Stock Exchange, they send the cops over to your office and start tearing your books and records apart. That is what happens. So they can't be the same person.
    The second thing, again, is this ITS reform; we are not allowed under the current rules to differentiate ourselves, except in three securities where there is a pilot program going on. In those three securities, ArcaEx outweighs the New York Stock Exchange in market share: QQQ, SPY, and DIA, the most liquid stocks in the world by three times.
    They do one-third of the volume that we do every day in those stocks. There, they are forced to compete. And guess what happens, investors aren't getting cheated. We have better markets.
    The reason why we have attracted that volume is because we offer this choice of immediacy at the best price. We cannot do that in the, what is it, 2,000 other stocks that trade on the NYSE.
    Mr. BACHUS. Okay. Thank you.
    Mr. Frucher, let me ask this question to you and the Philadelphia Stock Exchange.
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    And this is somewhat related to the specialists, but how does the Philadelphia Stock Exchange differ from the NYSE? What aspects of the Philadelphia Stock Exchange corporate governance and also the business model should Mr. Reed be looking at as he considers changes at the NYSE?
    Mr. FRUCHER. Well, I would say that there were two fundamental differences. The first one, we went through our own corporate governance issues seven years ago. The SEC basically came down and told us to change, and we did.
    And what we did was we totally restructured our board so it is 100 percent, there is a clear majority public directors. And when I mean public directors, I mean people like one of Professor Coffee's colleagues. You know, we have professors. We have deans of law schools and Presidents of colleges so that the corporate governance distinguishes it.
    We believe we can conduct self-regulatory practices because the audit committee, which is three public directors, has a direct reporting responsibility that goes to them by our regulatory function. Compensation is done by public directors. Nominations done by public directors so that the governance, I believe, is the key.
    Self-regulation is critical. You must have a culture of regulation and compliance. You understand. You want to have a local cop and not the FBI do your local law enforcement.
    You have a tiered system. It's not a sole regulatory responsibility. You have the SEC there. And the other distinction here is that they have a broader function and responsibility New York and at the NASD. They regulate the industry, and that's a different function than the self-regulatory function of the marketplace and that seems to be getting lost in this dialogue.
    So we have to look at these separate issues. The other thing that we do differently in Philadelphia is that we have a multiple specialist system. So it's not just one specialist. Gerry Putnam has no specialists.
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    I think the marketplace should determine it. And New York will decide, as Mr. Reed said, whether or not the sole specialist system will prevail or survive.
    I think what we are all saying is you need to have integrity. You have to have the appearance of integrity. You have to have open markets and access. Competition is the key, integrity and competition.
    Mr. BACHUS. And your specialist there is competition.
    Mr. FRUCHER. Yes. You have competing specialists within our marketplace.
    Mr. BACHUS. Third question is for NASDAQ, Mr. Greifeld. Have there been any differences following the separation of NASDAQ from its regulator, NASD?
    Do you believe this should be the model for the rest of the U.S. market community? And if so, why?
    Mr. GREIFELD. There certainly has been dramatic differences. If you go back five or six years ago, the standard reputation, or standard conventional wisdom, was the NASD was essentially a toothless tiger.
    And if we fast forward to today and we look at the stats with respect to the amount of fines they collect and the fact that they are functioning as the tough cop on the beat, we see that good things have happened. So there has been dramatic change in really a few years when you look at it from an historical context.
    So it has worked, it has worked well. We think it truly is the only way to go forward. I believe that you can set up separate boards and you can convince yourself and you can convince professionals that this is the right way to go. And we heard that from Professor Coffee.
    But in my direct discussions with retail investors, they don't buy it. Why create that inherent conflict? Why have any NYSER? Separate it out. If you are going to have a separate board, you are 80 percent of the way there. Get it 100 percent, and you will eliminate that issue in investors. And I think we all: New York, NASDAQ, everybody here will benefit from that.
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    Mr. BACHUS. Have you actually been adversely affected by having the New York Stock Exchange marketplace and the regulator under the same roof?
    Mr. GREIFELD. Yes. I tie back to the comment. I flew back to New York last night and I had dinner with one of the large bulge-bracket firms, and I said, ''We want you to post two-sided bids and offers upstairs for listed stocks.''
    And this was a senior person there. And in spite of everything that has transpired in the last month or two, he said, ''You have to understand, New York is our largest regulator.''
    And for them to now actively post markets to effectively compete with the specialists, they are reluctant to do it. So, when you have that separation, and when that potential retribution threat goes away, that is when you will introduce real competition into this phase.
    Mr. BACHUS. Okay. Final question, then a series of questions.
    Why do you feel the modification or repeal of the trade-through rule would be a desirable change? And is that a NASDAQ position or have you heard from other market participants who share your view?
    Mr. GREIFELD. Well, it is certainly a NASDAQ position. And I believe this is one of the positions in the industry that you truly have broad consensus. Everybody that I know and have talked to is for reform or repeal of trade-through.
    It really is a rule that in today's day and age is protectionism. And it is protecting New York's volume; it is protecting them from competition. It is allowing the specialist to be the only person making markets in the stock.
    So to the extent that we can have reform, you will see true competition in the trading of listed stocks and you will have a better outcome for investors as a result.
    Mr. BACHUS. Final question and this follows up on that: the trade-through rule. Is it your position that all listed stocks should be traded in any approved venue or whether or not it is the primary listing venue?
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    Mr. GREIFELD. Well, we at NASDAQ are the primary listing venue for 3,500 stocks. And as I said, 45 percent of the volume doesn't trade in our market.
    And I think that is good for investors. And it has resulted in helping competition and forces us to continue to improve. And we think that should be the outcome with respect to New York.
    They will become a more effective competitor and yield a better outcome for investors if they are forced to compete.
    Mr. BACHUS. Okay. All listed stocks traded in any approved venue?
    Mr. GREIFELD. Yes.
    Mr. BACHUS. Thank you. Thank you very much.
    Chairman BAKER. Thank you, Mr. Bachus.
    Chairman Leach?
    Mr. LEACH. Thank you, Mr. Chairman. And I appreciate your allowing a non-Subcommittee member to come.
    I have just been trying to seek perspective. And it strikes me all markets depend on confidence and we have had that confidence shattered. And I am struck by, despite the vigorous discussion here, the silence of much of corporate America.
    And one has a sense that silence relates to a concern that frankness might have a downside to their individual companies. But all of us were a bit surprised by one person's compensation and in the world in which a lot of people get a lot of big compensation, that doesn't seem overly startling.
    But the strong impression was that it was an insider's compensation based on full implicit understanding that the insider was protecting an insider's game. And that is the issue on the table. And then when you have an issue of confidence, the question is, ''How do you rectify it?''
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    And obviously there can be a role for government. Several of you have suggested the SEC's preeminence in this regard. But in addition, when you comment on competition, in a free market economy, competition is often antidote. And so to stress competition I think is startlingly important.
    And that is one of the reasons why one is taken very strongly by some of your testimony, Mr. Greifeld.
    Now having said that, there are definitions. And I got in a little bit late here, but I keep reading in newspaper article after newspaper article, ''What is the problem?'' Ninety-three percent of the trades are done on the best price basis.
    And I am saying to myself, ''What is the definition of best price? Is there a criteria out there that everyone accepts that statement?'' So I want to go to you, Mr. Greifeld.
    There is an assertion that 93 percent of the trades are at the best price for the consumer at the New York Stock Exchange. Is that a true statement?
    Mr. GREIFELD. To answer the second part of your question first, I think that is an impossible question to answer in that there is not competition to yield a better price. So I think when they say 93 percent, they are defining it within the strict confines of an essentially noncompetitive market.
    And what we are here today to say is, ''Let us introduce competition into that marketplace and let us yield a better outcome.''
    It is very interesting to note that with certain listed stocks, they trade very actively on the NASDAQ stock market, in spite, of the current rule environment. And they trade that way because certain investors just cannot tolerate the special system any longer.
    So, we are saying, ''Let us have competition and we will yield the outcome for investors that we need.''
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    With respect to your first question on governance, I think certainly that is at the heart of a lot of different issues. And clearly, we believe the NASDAQ model is the right model. But what you have to realize, and you folks do better than I, there is so much effort going on with corporate governance. And I think exchanges should follow along in their draft.
    We, as a publicly traded company, follow Sarbanes-Oxley, we are struggling with Sarbanes-Oxley 404, like the rest of the world, we are subject to F.D. and I have to have people stop me from saying things on a regular basis, and I will become well-trained on that soon enough.
    And we also have an independent board of directors that has a tough comp committee. And certain executive officers cannot be approved by the comp committee. It has to go to the full board.
    So I think governance will solve a lot of problems. We have the governance structure in place for all of corporate America. And I don't see why that just doesn't apply to exchanges en masse.
    Let us go with that.
    Mr. LEACH. Let me return to a topic that you have discussed several times, and this is just an issue of buying on account, I have heard this all my adult life and how this is very helpful to the system when it comes from the New York Stock Exchange's perspective.
    And I can visualize situations where it is. I can't visualize what might have been the case 30 years ago on a thinly traded stock being the same thing today when you have options of electronics in many environments.
    And therefore, when you look at the trends, which is, that the trends are that the makers of markets are increasing their percentage of buying on account rather than decreasing at a time when the need seems to be less. Does that strike you as inherently a conflict of interest or not? Is this one of the great moral issues of American economics or is it one of the very practical circumstances on the world's largest trading floor?
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    Mr. GREIFELD. Well, it is certainly counterintuitive because I agree completely with the thought. As the stocks become more and more liquid and trade more and more actively, there is less and less reason for dealer intervention. So if you look at the New York Stock Exchange and their actively traded stocks have increased dealer intervention, I think it is a symptom of something that is not right.
    What we like about the NASDAQ model, with the growth of ECNs in our market, you see the ability for buyers and sellers to get together electronically at a very low cost. And we have 300 market makers. And that is really the same thing as a specialist in that they will commit capital, but you are getting that to the right balance of where they should be in the market.
    So market makers going back in the NASDAQ market was 100 percent of the volume 10 years ago. Today, they are about a third. And we think that is approaching the proper balance, based upon the trading characteristics of our stocks.
    Mr. LEACH. And so, when you emphasize the word ''speed,'' you are really talking about the trained dealer intervention?
    Mr. GREIFELD. I didn't catch the last part.
    Mr. LEACH. When you were talking about the speed, you are really talking about the issue of dealer intervention?
    Mr. GREIFELD. That is part of it. The second part of it is they are trying essentially to run an auction where the auction has little value. And in that period of time where they are running the auction, that is when the dealer can intervene and sometimes, as we see in the paper today, not for the benefit of the investors but, obviously, for his benefit.
    Mr. LEACH. Well, I would only like to stress that the history of regulation, to the degree there is a history of regulation and economics, is to protect the small guy and that means Main Street rather than what we figuratively refer to as Wall Street.
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    One has a sense that New York has been a bit slow. And most of us know people that we respect a great deal in these markets. I think there is nothing more insensitive to say than to say someone's livelihood might be reduced. But that is what is partly at stake.
    But I think that the great state for the system is to have confidence in it. And confidence is the overwhelming issue and there is no other issue that is more important. And confidence depends upon an assumption of minimalist conflicts of interest and total integrity.
    And that raises a lot of issues that I think the SEC is empowered to handle, Congress could address, although I, frankly, think you are more likely to get a better result from the SEC than you are in your Congress.
    But I would just say as a citizen representing a group of very small investors. The one thing you don't want in the American system is a question of confidence. And many of us inherently are very proud of the New York Stock Exchange, but I think this is a time for some change.
    Anyway, thank you very much, Mr. Chairman.
    Chairman BAKER. I thank the gentleman.
    We have come to the end, but, unfortunately, I haven't had my turn. So, I just want to—in listening to the discussion, it has been very informative, very helpful, to some extent troubling—Mr. Frucher, I think it was your example when you talked about the individual buying the 98-cent Coke and walking across the street.
    You were the Coca-Cola man?
    Mr. GREIFELD. Yes. That was my son.
    Chairman BAKER. Okay.
    But Mr. Frucher, maybe along a similar thing was talking about standardization in national market regulation, and that is not an Eliot Spitzer question. It means an ability to trade under similar rules wherever the venue might exist.
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    If we are to achieve a national regulatory structure where you can go buy the cola at $.98 or $.99, depending on whether you want it with ice or without, doesn't that lend itself to a single national regulator in order to enable that activity to be uniformly governed and to give everybody free access to whatever market they want to go to?
    As I understand, most of you have expressed concerns about the consequences of the trade-through rule and limiting access of customers to products that are listed at the New York Stock Exchange.
    But somebody be un-delicate. Are we saying we need to do more than just worry about corporate governance at the New York Stock Exchange; that we need to rebuild the blocks?
    Mr. COLKER. Mr. Chairman, I would be happy to address that briefly.
    I think we really have a unified regulatory scheme, and that is the SEC which oversees all of the Exchanges. And on a routine basis, inspects the Exchanges to make sure that they can enforce their rules on best execution.
    Chairman BAKER. But at this point, if I wanted to buy ABC stock, I can't go anywhere I want to if it is listed on the New York Stock Exchange. There are constraints on where I can exercise that trade.
    Mr. FRUCHER. Well, there are limitations. The fact of the matter is they have 82 percent. That means 18 percent is, in fact, traded somewhere else. What, in fact, is happening is that New York has rules that have effectively protected it.
    What we are saying is you have to reduce some of those rules. But the issue of regulation——
    Chairman BAKER. Well, I think that is exactly my point. I am suggesting that we may need to be more aggressive. We may need to review everybody's rules.
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    If we are going through the painful exercise of shrinking the New York Stock Exchange Board in attempting to provide the appearance and reality of self-regulation, with an interim Chairman in a window, in which every person who is a stakeholder has questions about what is going on out there, the difficulty presents an opportunity.
    And we ought not be looking at necessarily just the New York exchange alone, but the rules that govern the function of our capital market system to enable us to transition to whatever we all ultimately know it is going to look like five years from now anyway.
    The Congress should not be an interference lobby to make it more costly to ultimately get to the reform goal. And to great extent, the Congress drags its feet; the SEC has not yet acted. We are in the midst of a confidence crisis with investors. Why don't we fix this thing?
    And I am looking for the plan. I mean, I recognize everybody has a particular view of the current system from their own stakeholder position, as I think you did indicate.
    Mr. FRUCHER. Yes.
    Chairman BAKER. And each of us has a reason to want to protect or promote that perspective. How do we get to the broader view where we are not taking Archipelago or the Philadelphia Exchange or somebody else's perspective as a committee exercising its responsibility in public policy and help formulate the construction of an open, transparent capital market, where you can go buy what you want where you want to go?
    Mr. FRUCHER. Mr. Chairman, I think that you have hit a lot of points right on the head. And I want to make that nexus, that connection; because I think it is an important one.
    A lot of the problems associated with competition was a function of a regulator effectively protecting noncompetitive situations, so that a single regulator—let us just say the SEC—has allowed the ITS rule and the trade-through rule to exist.
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    That is not a question of self-regulation. That is a question of central regulation that has, in fact, created barriers to competition.
    It was only under the pressure from people like yourselves and yourself included, that the SEC only seven years ago changed the rules to have Rule ATS that allowed open competitive markets that brought in electronics.
    You are right. Everybody is going to be a lot more electronic, certainly floor-based exchanges are either going to be hybrids or they are going to be electronic.
    The issue is you want to have different kinds of structures with different kinds of rules and different kinds of technology. You want to have 1,000 flowers bloom and give the investing public the opportunity to invest in a number of different ways.
    What has to be uniform is the integrity of the marketplace and the access to the marketplace. But the rules shouldn't be similar. And the notion of regulation really does start at home. A bank has to be responsible for its tellers. A market has to be responsible for its players. But that doesn't mean that they are the only regulatory player.
    They can't be. We are not a sole regulator, we are a self-regulator. On top of that there should be different regulators. The issue of self-regulation of the marketplace seems to be confused with self-regulation of the industry.
    We currently have two regulators—actually three—that regulate the industry: the broker-dealers, outside of the trading community. You have NASDR, you have New York and you have the SEC.
    That isn't, you know, a self-regulation issue. It is a designation that New York is the listing market and the NASDAQ, now through NASDR, becomes the regulator of the industry.
    These are very interesting, very complicated questions. You want to have multiplicity. You want to have different kinds of systems and approaches. But what you need to have is independence in that regulatory process.
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    You have to have independent directors ensure the integrity of that market, whether it is local or whether or not it is central. And that is the key. So a lot of it does come back to governance. But you have helped create the most robust, most liquid marketplace in the world by enhancing competition.
    And that means different rules, different technologies and 1,000 flowers blooming.
    Chairman BAKER. Thank you, sir.
    Mr. Lackritz?
    Mr. LACKRITZ. Thank you, Mr. Chairman. I would echo what Sandy has just said, but also address the issue about how to design, you know, the architecture of this entire system.
    We talk about investors' interests first, which is the most important principle for the self-regulation and for the regulatory structure. We are talking about different kinds of investors. We have retail investors, individuals on the one hand, and we have institutions on the other.
    They have different preferences for the way they want to trade. For some of them, time is of the essence. Certainty is of the essence. Anonymity is much more important than anything else. And for some, price is the most important.
    That says to me, and I think it is reflected in the structure, that the key is regulation that promotes competition, promotes transparency, and ensures integrity. And if you could keep those principles in the forefront, and at the same time, you get the expertise of people close to the market regulating it, that allows the system to evolve in a way that takes advantage of technological innovation, provides the best service to investors, and assures that investors are going to get the best execution.
    Chairman BAKER. Let me give you a bank analogy. And these are old numbers, but it still makes the point. At one juncture a study indicated that if you were to do a transaction at the teller window, it would cost the bank $1.30. If you were going to do the same transaction through the ATM, it would be 67 cents. And if you had access to do it online, it dropped to 4 cents.
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    Now, I as an individual, on many occasions when I call the bank, I want to talk to a teller. I don't want to have a nice recording telling me what their business hours are.
    So I make a choice whether I want to go get cash for dinner at the ATM or whether I really want to go in and talk to a person, but that gives me the flexibility. I am not arbitrarily steered toward any particular point of service; I make the choice as the consumer of the product.
    Secondly, as a consumer of product, I want to understand the cost I cannot apparently see today, where somebody on the other end of the phone line, even if I am talking to them, may be engaged in activities that are not disclosed to me that don't offer me the clinical best price to which Mr. Leach referred, that the best price may be determined by the regulatory constraints. It is the best price because we don't let anybody else look.
    That is not the best price, not in the common investor's mind. And I guess that is what I am driving to. I don't think it necessarily is prejudicial to any one participant's stake in future markets necessarily as to survival. There may be readjustments in the percentages.
    But I think people will pick, when the institutional investor wants large block trades instantaneously, he goes that route. When it is someone investing for their retirement, and it is a $1,000, they want to know who it is getting, where it is going, what am I going get and the full service treatment. That is great.
    I am not confident that the rules we now have enable me to be able to make an informed choice as to what I am getting until after I get that lovely statement at the end of the year which requires my CPA and three of my neighbors to tell me what I lost.
    So, we are looking for a simple way through this mess, which apparently is very convoluted. And without delaying what has been a much longer hearing than anyone probably expected, I want to ask each of you from your various professional perspective, we are not looking to jump to any quick remedy because we understand the value that the system currently makes to our overall economic vitality.
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    But we have got to start talking about blueprints. Recognizing that each of you will have varying reasons for your particular perspective, the committee really needs to have, whether it is trade-through rule concerns, whether it is a grand scheme, whether it is regulatory, whether you defend the current system and think is how we make it work better; really reach out to this panel of experts and say, ''Let the committee hear from you further detail about your views as to what directions the committee should consider.''
    There will be others to follow this panel in the weeks to come. It will not be something the committee will casually engage in. There are considerable concerns, we think, as a matter of public policy, need to be reconciled. And we want to work with those who understand the markets to ensure we develop the best product.
    Unless, anyone has further comment—yes, sir?
    Mr. GREIFELD. Just as a follow up, we published a white paper yesterday, which we will be happy to give you copies of, with respect to our positions as NASDAQ, on a variety of these mortgage structure issues that are facing us all.
    Chairman BAKER. Terrific.
    Yes, sir?
    Mr. GLASSMAN. Could I just make one comment that sort of ties together the last two discussions.
    Your mention of choice, which I think it really is perhaps the most important thing. Right now, because of the trade-through rules, people don't have choice. And I think that is one of the reasons that the New York Stock Exchange has been able to maintain the system that it has now.
    But if it were pushed, it were buffeted by competitive winds there is no way that the current self-regulatory system could exist, I don't think. Because, for competitive reasons, it would have to be modified to serve the interests of the actual customers; but right now it is insulated.
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    So, the first thing that ought to be done, certainly, is to end the SRO. But really, the reason that it exists at all is because of the trade-through rules and I think that needs to be addressed.
    Chairman BAKER. Yes, sir.
    Mr. FRUCHER. Mr. Chairman, if I hear you correctly—and I hope I did—I want to congratulate you on what I hear you saying.
    You are saying that you are going to start and this Committee is going to help engage this community, and the broader community, in a dialogue on a lot of these market structure issues.
    Some of these things have really been dormant for the last couple of years. I mean, the NASDAQ application, whether it goes up or down, shouldn't be sitting here for three years. And my, as a smaller exchange, my rules sit behind his rules, my rules to allow us to compete with him is dormant because we were waiting three years for a resolution on his application.
    So whether or not, through your structure, you are going to engage this debate and have the regulator come forth with its proposals or whether or not you end up with statute that, in fact, directs it, I congratulate you and I want to pledge the support of the Philadelphia Stock Exchange and myself to this endeavor as best we can.
    Chairman BAKER. Well, I don't know that we will be helpful in the process, but I think we will engage in the process.
    Mr. FRUCHER. You know, transparency always helps, in any forum.
    Chairman BAKER. I would only point to my experience with investment banks, analysts, mutual funds, GSEs; be careful what you ask for. But I will say that this is a process, and we don't intend to jump off a cliff and, ill-advisedly, take the wrong step.
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    But I have got to tell you, over the last several years, becoming more conversant with the way in which the capital markets have functioned, it looks like a novel written by Stephen King to a great extent. Every time I turn the page, I get a new surprise, and it isn't always good.
    And I think what we want to do is to take the surprise out, get it to where somebody, a member of Congress, can understand it. And get it to that level. And then I think we have got something transparent and understandable that our constituents can engage themselves in as well.
    If there are no further comments, I do appreciate your participation and your helpful comments. And we look forward to hearing from you again soon.
    The meeting is adjourned.
    [Whereupon, at 2:28 p.m., the Subcommittee was adjourned.]