Hearing of the Senate Committee on Banking, Housing and Urban Affairs - Regulation National Market System and Development in Market Structure, Part 1

Federal News Service

HEADLINE: HEARING OF THE SENATE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS SUBJECT: REGULATION NATIONAL MARKET SYSTEM AND DEVELOPMENT IN MARKET STRUCTURE, PART I

CHAIRED BY: SENATOR RICHARD SHELBY (R-AL)

WITNESSES PANEL I: WILLIAM H. DONALDSON, CHAIRMAN, SECURITIES AND EXCHANGE COMMISSION;

PANEL II:

ROBERT GREIFELD, PRESIDENT AND CEO, NASDAQ STOCK MARKET, INC.; DAVID HARRIS, SENIOR VICE PRESIDENT, STRATEGIC PLANNING, AMERICAN STOCK EXCHANGE;

EDWARD NICOLL, CEO AND DIRECTOR, INSTINET GROUP, INC.;

GERALD PUTNAM, CEO, ARCHIPELAGO, LLC;

JOHN THAIN, CEO, NEW YORK STOCK EXCHANGE

LOCATION: 538 DIRKSEN SENATE OFFICE BUILDING, WASHINGTON, D.C.

TIME: 10:00 A.M.

BODY:
SEN. CHARLES E. SCHUMER (D-NY): Well, thank you, Mr. Chairman. I want to thank you for holding this very timely hearing and I want to add my voice to that of Senator Sarbanes here, and I imagine yours too, Mr. Chairman, although I didn't get to hear your opening remarks.

The process which the SEC is using deserves a lot of commendation. It is open and I think it is very, very aware, if you will, if a process can be aware, that these are very, very difficult issues and that if you make the wrong turn, you could do something terribly, terribly damaging that you might not recoup. And so I thank you for the care with which you're going through. I know there's been a lot of pushing, change quick, change quick.

I worry about that. I worry, you know, because-again, our market system, you put it very well. You said, it's far from broken. It needs change. Technology always introduces change. But technology is not the end all and be all, because if we were to have the most technologically efficient market, the quickest market, and yet it wasn't as transparent, it wasn't as deep, it wasn't-it became fragmented in six different places and it was opaque, my guess is the number one thing that has made American markets the envy of the world and why trillions of dollars come here, that people know it's open and on the level, would be gone.

So I think we have to be careful and I don't think we should be sort of involved in this sort of technology mania. We have to adopt to technology, no question. If we don't, we'll lose. But at the same time, we have to be mindful that there are lots of other benefits here that are part of the market.

I'd just like to mention a few, since because of the, whatever it was, broken water main, I didn't get a chance to make a few points. And then I'll ask a question or two with the chairman's indulgence.

SEN. SHELBY: Go ahead.

SEN. SCHUMER: First, best price is still-if you had to pick one thing, speed or best price, you'd want best price. And let's take a look at the small investor. My father is a small investor in stocks. He's been doing this for years and years and years. When I was a little kid I remember all those little booklets, you know, things I'd never heard of, Buckby Mirrors (?) coming to the house. And, you know, he would pour over them. The amount of time he put in --

SEN. SARBANES: I thought you read them all.

SEN. SCHUMER: No. The amount of time he put in --

SEN. SHELBY: I guess that you're trying --

SEN. SCHUMER: What?

SEN. SHELBY: Are you trying to think of the term prospectus?

SEN. SCHUMER: Prospectus. That's it. It wasn't prospectus, no. They were the annual reports. That's what they were. But in any case, the amount of time he put in compared to the amount of money he made, made it not a very good investment, I think. But he wants best price. The small investor-I asked him the other day. He's 81, knock wood, he's still doing this. Still spends time, to my mother's chagrin, at the desk, looking at all these reports and stuff and figuring out things. He doesn't care if it takes three seconds, 10 seconds or two minutes. He wants best price. And I don't think we should abandon the small investor.

I understand that the big boys may want it another way. But as you so well put in the answer to Senator Sarbanes' question, for both mini stocks and even for larger stocks, you have to be mindful of both. So that's one point that I would make. And then there's a more fundamental point-by the way, the AARP surveyed in their investors and they found that two-thirds said that price, not balancing price with speed, was their number one priority when trading. And that's whether they're trading IBM or some tiny little stock.

Second, I greatly worry about fragmentation of the market and the concomitant opacity. We could make a change here. We could not-no one can fully predict what will happen. And instead of one deep liquid market, you get six little markets. That could really lead, first, to a failure to get best price. But, second, if each market is not so deep and so liquid-I understand capitalism. I know there are people in the audience who say, give me my chance. But we have a greater good here. And the greater good is one deep liquid market. And we could end up losing that to some other country.

As somebody from New York, financial center of the world, I hope we don't roll the dice in that regard, even though I know people are pushing. I've read all the stuff and heard all that from all these people who are pushing. Fragmentation is my greatest worry. And, again, that means moving with care. Moving with care. Competition is good and there's a tension between competition and depth and liquidity. Be careful.

Finally, again, I want to get to opacity. Senator Sarbanes mentioned that a specialist can take advantage. Sure. But you put it well, is it the system or the individual specialist? A broker-dealer can also take advantage. And we're not hearing because we've had charges against broker-dealers here and there that we should get rid of that system. In fact, I would say in an open auction system, rather than a closed system, where things can be reported under the screen and much later, you have a greater chance for those scoundrels, if you want to call them that, to take advantage of the system.

And so I think, again, your approach has been great. I worry about opt-out. I think opt-out could undo all the things you're talking about here, all the things I'm talking about. I know that some of the big boys want to opt out. I wonder if it's really speed they're after, Mr. Chairman. I think they want opacity. I think they want to hide their trades. Some of that's legitimate. I understand if you're trading a huge amount you want to maximize what you can trade it at and not tip your hand, but with opacity comes the problem that more illicit things can happen, and comes the fact that people may be taken advantage of and not either get best price or quickest trade.

So, again, these are balances here. And the simple notion that I know that a few of the commissioners have, just let a thousand flowers bloom, let everybody just do what they want, well, in the 1890s that argument made sense. And we've had 100 years of history, maybe 200 and something since the Buttonwood Tree. I don't know when the Buttonwood Tree was. And we've learned that the balance is important. The balance between technology and regulation, the balance between opacity and openness, the balance between all of these things. So I just hope that you'll be careful, because I think the opt-out rule, I think it's a little bit of a disguise here to undo a lot of the other things that you are trying to do. Fast market, slow market, that makes eminent sense to me, and I think you ought to have that. But you opt out and you have large players opt out and you can end up with the fragmented market system that we have, and even worse, the opaque-an opaque system where there's no ability to police, or there's policing after the action, et cetera. So I think you're right on trade-through in this Regulation NMS. And it's fine to have it for NASDAQ too, but not opt-out. I'd be really careful before going to opt-out.

Well, maybe I'll let you comment on what I had to say since it was a little longer, but I feel this issue quite passionately.

MR. DONALDSON: Well, there are several words that you've used that are, in my view, right on. The word "balance," the word "protecting individual investors." We have a unique situation in this country, as you all know, which is that we have more participation by individual investors than any other market in the world. And it's interesting to me how many institutional clients have told us in their filings how important it is to maintain the diversity of individual investors in the marketplace, there's no other market in the world that has that the way we have it, no other industrialized society.

So I think protecting the small investor, making sure-I think it's hard for small investors to feel like they're not up against it if a big institutional investor sweeps through the marketplace and bypasses the individual. I think we've got to protect against that.

Having said that, the commission's role here is, as I see it, to try and modify this marketplace so we get a combination that addresses some of the issues that you're saying but also addresses some of the issues that come from large institutional investors of all sorts who claim that their ability to get to the best bid or offer is inhibited. By the time they get there they can't get their trade done because the bid is no longer there, all sources of legitimate, in my view, complaints and I think that the kind of bifurcated structure that maybe we're heading toward where you have-you've eliminated a lot of that by the electronic capability of some of our auction markets, but at the same time by signaling that some of those electronic bids are not-they are not-they do not qualify to be classified as electronic-you can designate this on the tape-and therefore they go into the slow market mode for whatever reason. And then in the slow markets you are able to get some of the benefits of the auction process.

And I just want to assure you in terms of your comments that we are not wedded to any particular market structure. We're wedded to benefits that different market structures have and ways of doing business and the different demands of institutional investors versus individual investors. So we're --

SEN. SCHUMER: Do you worry about fragmentation?

MR. DONALDSON: We're worried about fragmentation and we worry about opt-out too. I mean, the concept of out-out-again, I go back to sort of asking the question that we're asking ourselves, which is if this electronic instantaneous capability can be developed by the so-called soft markets, then what do you have to opt out for?

SEN. SCHUMER: Exactly.

MR. DONALDSON: It's totally competitive with electronic markets.

SEN. SCHUMER: Thank you, Mr. Chairman.