s just under three hours. >> today u.s. capital markets which traditionally have been the envy of the world are fractured, vulnerable to system failures and trading abuses, and are operating with oversight blindspots. the very markets that we rely on to jump start our economy and invest in america's future are susceptible to market

dysfunctions that jeopardize investor confidence. i want to begin by thanking chairman jack reed, his ranking member senator bunning, and our colleagues on their subcommittee, the securities, insurance, and investment subcommittee, who have already held hearings on these issues. we thank them for welcoming our subcommittee to join with them to shine a light on problems that threaten u.s. market stability and integrity. seven years ago the new york stock a chick predicted york stock exchange accounted for 80% of trade in its listed stocks. today, less than 25% of the nyse-listed stocks are traded there. what happened?

there's a chart that we will put up. , exhibit 1, and it shows us u.s. stock market has fractured. stock trading now takes place not on one or two but on 13 stock exchanges, as well as multiple off-exchange trading venues, including 3 electronic communication networks, 36 "dark pools," and over 200 registered "of broker-dealer internalizers." they may need more explanation. electronic communication networks are computerized networks that enable their participants to post public quotes to buy or sell stocks without going through a formal exchange. dark pools, by contrast, are electronic networks that are close to the public and allow pool members to buy and sell

stock without fully disclosing to each other either their identities or the details of their prospective trades. a broker-dealer internalizer is a system set up by regulated broker-dealer to execute trades with or among its own clients without sending those trades outside of the firm. these off-exchange venues are increasing their trading volumes. most use high speed electronic trading, and they escape much of the regulation that applies to formal exchanges. the new trading venues did not appear out of thin air. they are largely the result of regulation nms which should the sec issued in 2005. some call it the resulting world news -- they call it a model of competition. others call it a free-for-all that defies oversight and is ripe for system failures and trading abuses. both descriptions have some truth. trading competition has led to

lower trading costs and trade -- and faster trading, but it is open the door to new problems. one of those problems involves system fell years, of which the may 6 flash crash is the most famous recent example. on that day, out of the blue, the futures market suddenly collapsed and dragged the dow jones industrial average down nearly 700 points, wiping out billions of dollars of value in a few minutes for no apparent reason. both the futures and stock markets recovered in less than 20 minutes, but left investors and traders in shock. after five months of study, a joint report has concluded that the crash was essentially triggered by one large sell order placed in a volatile futures market using an algorithm that set off a cascade of out-of-control computerized trading in futures and equities and options.

that one futures order placed at the wrong time in the wrong way set off a chain reaction that damaged confidence in u.s. financial markets. in some ways, the may 6 crash was a high-speed version of the 1987 market crash, where a sudden decline in the futures market led to a corresponding collapse in the broad stock market, which led in turn to crashes in individual stocks. and it is not the only type of system the your affecting our potential markets. so-called "mini flash crashes," in which one stock suddenly plummets in value for no apparent reason have become commonplace. on june jet 10th, 2010, shares in diebold, a large ohio corporation, suddenly dropped from $28 to $18 per share. the stock recovered but the company was trying to understand and explain what happened.

even after the sec initiated a pilot circuit breaker program after the may 6 crash, at least 15 other companies have had similar experiences, including nucor, intel, and cisco. of former senior nasdaq executive told the subcommittee that the nasdaq exchange has experienced single-stock flash crashes 5 times per week. the nyse-listed and finra have told us these crashes are commonplace and attribute them to various glitches in computerized trading programs. single-stock crashes might seem to be a minor problem. what happens if the security that crashes is a basket of stocks or commodities? on november 29, 2010, 3 of the top 5 equities traded by volume were actually baskets of stocks. if a basket of stocks or

commodities crashes in value, what happens to the underlying financial instruments? uncontrolled electronic trading and cascading price declines in multiple trading venues, including in futures, options, and equities markets, could be the result -- in other words, another may 6. many investors are not waiting around to find out if our regulators have fixed the problem. according to the investment company institute, each month since may, more investors have fled our markets, pulling billions of dollars of u.s. investments. system failures are not the only problem raised by our fractured markets. another problem is their increased vulnerability to trading abuses. traders today buy and sell stock on and off exchange, simultaneously trading in multiple venues. traders have told my subcommittee that orders in some stock venues are being used to

affect prices in other stock venues. futures trade on cftc-regulated markets are being used to affect prices on sec-regulated options and stock markets. some traders are using high speed trading programs to execute their strategies, sometimes submitting and then cancelling thousands of phony orders to affect prices. to get a sense of the trading activity day goes on today, take a look at this stack of papers. this stack, nearly 5 inches high, contains the actual message traffic generated in the futures, options, and equity markets with respect to one major u.s. stock over the

.ourse of one second t one stock in one second produced over 29,000 orders, order modifications, order executions, and cancellations in all three markets. this stack shows in black and white how traders are now analyzing trades in all three markets at once, evidencing how the futures, options, and equity markets are interconnected. imagine the same stack multiplied countless times, filling this entire hearing room, and the interconnectedness of the markets as well as the potential for system failures and trading abuses becoming alarmingly clear. one well known trader, karl denninger, recently made this public comment about u.s. trading activity.

folks, this crap is totally at hand. and it is no a daily game that is being played by the machines. they are the only things that can react with this sort of speed, and they are guaranteed to screw you, the rest -- the average investor or trader. go ahead, he said, keep thinking you can invest. now wall fractured markets -- let me start over. walt fractured markets and high speed trading are causing new problems and forms of manipulation, they are leaving our regulators far behind. traders are equipped today with the latest, fastest technology. our regulators are riding the equivalent of mopeds going 20 miles per hour chasing traders whose cars are going 100 m.p.h.. our regulators are confronting at les four challenges. and before i go through them, i want to join chairman reed in

congratulating and thanking our witnesses today. you lead your agencies in important you reforms in you are doing it with great professionalism and talent. we are amending the efforts that you are making. here are some of the challenges that our regulators are facing. each trading venue today has its own infrastructure, rules, and surveillance practices. besides the expense and inefficiency of all, no regulatory agency has a complete collection of trade data from all the venues, much less a single integrated data flow allowing regulators to see how orders and trades in one venue may affect prices in another. second, even if regulators had an integrated data flow, the current data systems fail to identify key information, including the names of the executing broker and customer making the trades. that means that regulators can i

use the electronic records to trace trading by one person or set up alerts to flag trades. instead, before any trading analysis can start, regulators have to figure out the broker and customer behind each trade. patterns of manipulation are hidden. the third problem is that the sec has no minimum standards for automated market surveillance by self-regulatory organizations -- sro's, and the quality of those efforts is apparently all over the map. recent sec examinations of certain exchanges have found some ineffective surveillance systems that were unable to detect basic manipulations or used such restrictive criteria that they failed to flag suspect activity, exchanges that failed to review some surveillance alerts, and exchanges with only rudimentary or under-budgeted investigative, examination, and

enforcement programs. the fourth problem is that the sec and cftc have not set up procedures to coordinate their screening of market data to see if trades in one agencies markets are affecting the prices in the other's markets. given the strong relationship between the futures, options, and equities markets, joint measures to detect inter market trading abuses are essential. the impact of the regulatory and technological barriers is demonstrated that it took the s -- the cftc and sec five months of intense work to figure out what happened over a few minutes on may 6. and i believe that chairman reed made the same reference. in addition, over the past five years, there have been few meaningful single day price manipulation cases. one recent case involves a small trading firm, trillium trading, which apparently used phony

trading orders to bid up the price of several stocks. in that case, finra found that over a three month period in 2006 and 2007, trillium submitted phony orders in over 46,000 manipulations, netting gains of about $575,000. apparently the victims of the price manipulation got annoyed enough to research the mandate to bullet -- the manipulative trading and hand over the data to finra. even then it took finra four years to reconstruct the order books, prove who was behind the trades, and resolve the matter. trillium and its executives recently settled the case by agreeing to pay over -- to pay fines and disgorgements. traders and regulators have told us that trillium is not the only company that has engaged in or is engaging in price

manipulation in u.s. financial markets. in fact, one of the more chilling examples involves suspect trading involving traders located in leave china. if our overseas traders trying to manipulate u.s. stocks? our regulators are currently unequipped to find out. the may 6 flash crash and the trillion case provide powerful warnings that we need to strengthen u.s. oversight of our financial markets to restore investor confidence. much needs to be done. recent action by the sec to prohibit phony quotes, impose single issue circuit breakers, and set up a consolidated audit trail are important vances'. there is a long, long way to go, particularly with respect to coordinating market protections and surveillance across market venues, and across the futures, options, and equity markets. there also needs to be a greater sense of urgency. the sec's proposed consolidated audit trail is expected to take years to put into place and will

not cover all the relevant products and markets. requiring executing broker and customer execution -- information, an essential component, is in limbo pending completion of the consolidated audit which a consolidated audit trail. integrating trading data and market surveillance of the futures, options, and equities markets by the cftc and sec is not even on the drawing board. i hope this hearing will help inject greater urgency into strengthening u.s. oversight of our fractured, high speed markets to restore investor confidence. again, i want to thank you, chairman reed, for holding these hearings and for the kind of leadership that you have shown in digging into these kind of issues over the years. >> thank you very much, chairman. let me introduce our witnesses.

our first witnesses the honorable mary schapiro, chairman of the securities exchange commission. before that, she was the ceo of a financial industry regulatory country, the largest non- governmental regulator. as chairman of the commodities futures trading commission, from 1994-1996. our second witness is gary gensler, who served at the department of treasury as the undersecretary of domestic finance from 1999-2000, and the assistance, and prior to joining the department of the treasury, chairman gensler worked 18 years at that goldman sachs company. before you begin your testimony, i will turn it over to chairman levin to administer

the oath on investigations. would you please stand? >> thank you very much, chairman reed. according to the rules are subcommittee, each with its bid to be sworn. do you solemnly swear that the testimony you would get before the subcommittees will be the truth, the whole truth, and nothing but the truth, so help you god? they can. >> chairman shapiro, began. >> thank you for the opportunity to testify concerning the u.s. equity market structure. when we discuss market structure, we talk about everything from the organization of a market to the number and types of venues that trade a financial product, and the rules by which those markets operate. although these issues can be complex and the rules are kane, a stable, fair, and efficient structure is the backbone of the equity markets and importance

engine of our economy. keeping that backbone strong response to the problems. most of the volume in stocks are seen manually. neyra -- nearly all orders now are operated on an automated system. as you mentioned just five years ago, the new york stock exchange executed about 80% of the volume. today it executes about a quarter of that volume. the remainder split among 13 public exchanges, more than 30 dark pools, and more than 200 in retirement -- and fertilizers. -- internalizers. they don't make their data generally available to the public. we know we must keep pace with changing landscape of our security markets. that is why we initiated up for review of the equity market structure. as part of the review, we've received public of -- hundreds

of public comments. many raising concerns. we of heard how this fosters competition. we've heard about the benefits of highly interconnected markets and had been cautioned about regulatory changes and unintended consequences. on the other hand, we've also heard the concerned about the quality of price discovery and whether the current market structure offers a level playing field on which all investors can participate meaningfully and fairly. as we consider regulatory response is, the commission will evaluate these issues but a particular focus is on obtaining data and analysis. we'll ask whether the changes we consider will aid capital formation and investor protection, enhance competition and price discovery, and improve inspection and surveillance and enforcement. in this context, we will have

the role of professionals, and whether they compete in ways that ultimately benefit investors, and our company seeking to raise capital. as in the, our market structure review is not a theoretical exercise. it for family impacts investors in these companies. the may 6 crash highlighted the ability to reconstruct the events of a million -- of the data across multiple shares and many markets. today each exchange heads its own unique and incomplete data collection systems. it complicates efforts to reconstruct activity that can involve millions of records across dozens of exchanges. in response, the commission has proposed reporting requirements and a consolidated audit trail. this would for the first time allow regulators to track trade data across multiple markets simultaneously. it would also be able to rapidly

reconstruct trading and quickly in dallas -- analyze unusual activity. we have taken a series of measures to reduce the chances of such an event occurring. for instance, we approve the circuit breaker program that limited by the volatility in individual stocks. ibm proved order transparency to the process of breaking clearly erroneous trades. we adopted new rules to a rigid to require risk controls in place before providing customers with access to the market, or rule that effectively bans naked assets. we've improved rules including eliminated stet quotes which represented a significant portion of the trades that broke on may 6. we are lining our examination and enforcement efforts with current realities of market fragmentation and high frequency trading. we're looking at fundamental structure changes in the way we

approach examinations of organizations, including a focus on how sro's frequently abused algorithmic trading strategy. we are investigating whether various market participants have sought to unlawfully exploited the fragmentation of the product, the volume of securities, or contribute to market volatility at the expense of investors. additionally, we created a specialized market to in -- on to investigate how this program areas. we cannot turn the clock back to the days of trading crowds on exchange floors but we must continue to carefully analyze market structure issues to ensure our roles to keep pace with the trading realities and identify way to improve our markets, provide additional transparency, and increase investor protection. as we move ahead, we look forward to looking closely with the congress.

>> chairman gensler. >> good afternoon, chairman reed, chairman levin, members of the subcommittee. i thank you for inviting us here today and pleased to be testifying here. i think this is the seventh time testifying together. and our third time since may 6. the cftc-regulated markets have rapidly transitioned, an electronic trading represents 88% of our markets. as a father of three daughters, i've learned much about the new world of twitter and social networking and certainly testing. just this week -- just as we cannot turn that clock, we cannot turn back the clock which now we have a automated execution in of -- in high frequency trading. the may 6 the event highlighted across market linkages that you

spoke about, but when prices and volatility in the securities market, the futures market, and other derivative markets, and it was all enabled by technology. price discovery, which may first occur in any one of these markets, futures or security, they can move rapidly over into correlated products and other markets. small disparities in prices arise, even in milliseconds, market participants try to profit in what markets call arbitrage. the sec surveillance program works to promote market surveillance and to protect against fraud and manipulation and other abuses. we're working closely on a policy level, specifically tried to coordinate with rulemaking implement a taste -- implementation. we also look for surveillance and data sharing. after macy's, one example, our staff promptly shared with the sec position data and transaction data with regard to

that day's events. and the exchanges and self- regulatory organizations, is a board to conduct front-line market surveillance and coordinate closely not just on may 6 but on other days as well, and have regular interactions. in terms of data, the cftc proceeds futures data on a daily basis. its most important for us to get the very next morning. we do not regularly get the order book because we do not have the resources to get that. may 6, we ask for it. there were 14 million orders. i just calculated that, 476 times more than that stack right there. for that one day and one contract and one month. and that was why it took all while to analyze that data. but we did get it and share it with that -- with the sec. we have what we would call a

pre-trade risk management functionality. these safeguards protect against extreme movements, maximum order side, protection against orders, and market clauses that timeout. a little time out in the market. exchanges are required have these, and executing brokers have to have some pre trade risk parameters for uses of the clearing houses. last week, the commission actually put out a proposal that mandates that markets have pre- trade with safeguards like this, but asked the public for their views. the events of may 6 and the act present new challenges. our new authority tests give us at the of party to work with regard to disrupt -- disruptive

trading practices. whether it is three specific things, and we're asking the public to work on other acts and we put out an advance notice of rulemaking. the second thing that i want to mention is resources. the current funding is less than what we would need to really do their surveillance, not only from the events of may 6, but the new pact. we have 680 full-time staff currently. we estimate that we will need about 400 more staff. and in dollar terms, our current funding is $169 million. the president's request for 2011 is $261 million. we anticipate we will have 400 new applicants the wall of arrive on our doorstep next summer. either swap dealers are swap execution facilities. we have no intention of robles signing these applications.

we're going that awfully look at these and we will need the resources to do that. >> thank you both during much. chairman gensler, i want to thank you but i think you have raised a troubling they had2000 ban 2008 d

declining bubudget. there is dysfunction in the marketplace. your workforce is still below the 2005 level. there was the dodd/frank legislation. to what extent our staff levels ability to have clearl a high-tech trading?

>> thank you. the richest of reaching our 2005 levels. we have been enormously fortunate to be able to attract a minutes -- immensely talented staff. there are people from hedge funds and trading desks to help as had the ability to do the job we have always been charged

with. it is essential that we bring that kind of cells thaskill sete agency. rohm & hoss in order to make use of adaptive we would receive, even understanding the exchanges, we need people with management, quantitative analysis and capability to see something on the order. it is to respect of our oversight marketplace.

>> i do think our agency will be asked to take on the market. it is nearly 20 times the size and if our economy. we currently oversee them about $40 trillion. we have more in this coming year. this is to deal with data.

into what's going on. how are you doing that? informal and formal way is? how are you coordinating and i presume chairman gensler, you have something kabul to the consolidated order trail that you are trying to roll out, so let me begin with chairman schapiro. talk about the collaboration as you go forward. you might want to talk about the timetables. >> assure. the collaboration with has --

may 6 is a demonstration of the to work together, understand each other stable and interconnections between the marketplace. it would be argued that over time it would include all related financial products so that we shouldn't lose municipal securities, government securities and futures that are the equities or equity products so that we have a truly comprehensive view of the trading of instruments in a economics otherwise it will be a very effective system. to initial estimates of the sec staff when we proposed the consolidated audit trail, were quite extraordinary in terms of the dollar cost and timeframe. about $4 billion all income and as long as three to four years

to implement. we would as at the sr does develop a plan for the consolidated audit trail. the sec would set up the criteria. would have to be real-time reporting and what all the data elements are. there are many in order to have the information that we need. but as result of the comment process and army with a number of technology firms we believe we can dramatically reduce costs and a timetable to implement patient because a large portion of those costs, well over half, were thought to be necessary to allow broker-dealers to build a reporting system to get the information into the repository. we don't think that that is likely to be necessary and that there are, in fact, technologies that already exist that can be utilized in this space. so we are hopeful that when we come to approving a final rule the cost and implementation period will be down significantly, which to my mind would mean we can more quickly

bring all the more related products that we think are necessary for this to be a consolidated audit trail. >> and in that regard, chairman gensler, you both essentially regulate economic equivalents of each other, in some cases. and you i present a complementary sort of vision about how you can build something like to consult audit trail, can you comment? >> we are fortunate we have a less fragmented market that i think and swaps -- swaps, by the morning at may 7, but every morning we have a full transaction file from the day before in the futures world already in our system and our analysts are able to analyze it. actually on the evening of may 6 we already knew of at a single large crater, the 75,000-dollar contract, and we told the sec that evening and some of the other regulators that eating. an entity to execute broker the morning of the seventh.

so we are fortunate in that way. our challenge is we don't currently have what's called account ownership and control information. we put out a rule for some and we very much need to do that. we have the data but we don't always have the ownership. the second challenges we don't have the resources to analyze the order book every day. we only did that for may 6, but it's 40 million orders on one contractor imagine on the whole market. and a third challenge is with the swaps market coming in how we aggregate the data across the swaps of the futures market, and, of course, aggregate. i do believe that we have work to do to institutionalize our cooperative nature. it's been a great working relationship but we will be there. our staff will change and i think we do have work to institutionalize some of that. >> you are collectively working on it, institutionalization both in terms of technology systems and communication systems,

that's ongoing? >> yes. in the midst of a lot of rule-making. >> i recognize the chairman. >> chairman schapiro, since we're talking about your consolidated audit trail and the good news you brought us, give us an estimate as to how much, will be less than half the cost and have the time? is that to optimistic statements almost serving as what i did you will be wrong but i will tell you that we think between 50 and 80% of the current cost estimate is associated with the route the requirement for the broker-dealers to build the reporting system. and to the extent to our existing technology that would facilitate that, should make a very significant change in the cost level. >> would that that be up to have, could be as much as half of? >> i would hope so. i honestly don't know. i also think it's important to

point out that while it's a very large number, $4 million, these are markets that trade $220 billion worth of securities every day. so it's a big number but there'i a lot at stake in getting this -- to right.su. >> that's why we are pressing it. is there also, do you think it could be done perhaps less than half the previously estimated time of? >> again, i don't know and i don't want to be misleading in anyway because i truly don't know. it would very much be michael. i think perhaps for me were the most important things i do try to get accomplished at the sec. >> thank you. in your opening statement you both acknowledged the market prices in each venue were nearly synonymously simultaneously effecting each other in the futures of stock prices and markets also affect each other. in my judgment, since these markets are so connected it would seem to me that there's nothing preventing somebody from

using one market to make it to another market. let's take a look at exhibit number two, the chart. i don't know if you can see it or not. turn that around if you would so they can see the that unless it is in front of them. let's assume that joe traitor was entering orders and never attended have executed in one market. so that it wouldn't prices tove his p benefit in another related market the. moving e after taking advantage of the market he costly than cancelse his original orders allow the markets to return toca normal. that seems to me to be a fariation of what trillium traders did at this time using to market. my question to you is, might that type of trading strategy, might that type of trading strategy be a manipulation?

i am not asking you whether it is. my that kind of strategy t i jut outlined the manipulative? >> i think it is entirelyir possible telhat it could be. >> because our statutory framework relate to impact it would depend on the parties intend, but it could be if the intent was there to manipulate a market. >> no, -- now, i think you testified already that since people trade in multiple markets and that our regulars need to be able to compare the trading data from more than one market to see if trading in multiple markets

is being improperly used. can your agencies coordinate your automated surveillance t er efforts to spot this type ofcros cross market price manipulation? or anything else that might be appropriate? is that a possibility? >> i would say i think it is a possibility with consolidated audit trail, we have to agencies with different jurisdictions. we would have to ultimately agreed to require that thewe wi exchanges inha the market becaue of an under two separate a just jurisdictions agreed contribute data to the samee consolidatedr same audit trail. but i don't know of any why come it is a well-to-do and there's the technical capacity to do why we wouldn't do it, frankly. >> mr. gensler? >> we already do it, i was a is more on an ad hoc basis or an even driven basis. and an enforcement basis.

we've had very good collaboration. i thinllk to do it, it might tae some rule changes on both sides of the exchanges and self regulatory on a regular basis from the two jurisdictions being sharing information. and that would be worthwhile to consider. >> okay. if you would consider that, it would be helpful. chairman schapiro, is theirly current -- geico have an an automated surveillance to detect cross market manipulations? do you have that in place now? >> no, we have, we have some tools in place that allow us, upon request, we request the exchanges to provide us with information so we can see burd. activity >> you hope it will obtain that?

>> when do think that is possible? >> it was proposed earlier this year. if they offerldid not know more traders.

use. >> the old system, gathers data. it covers a significant portion of the marketplace. so we could look at whether to spend resources and time trying to make it a little bit better and a little more robust and broader. or we could take those resources in time and create a genuine consolidated audit trail system that is very scalable and very capable of capturing all of the economic substitutes for equities. so i think what we set in the consolidated audit trail proposal is we expect the

exchanges and tranforty come to us for a plan for how they're going to implement consolidated audit trail's, that gives us all ey the data that we need asl th regulators and that we expect them to use as market surveyors and leave the choice of the technology to them. >> to try to summarize what your previous point was and at this point, basically at the moment at least you're relying on someone identifying a problem for you first come and then you can look across markets, at the> moment. >> i think that's generally too. either someone identifying a problem our on staff sees market activity and may be concerned about a big spike in volume, for example, ahead of a corporate announcement that they would utilize a tool to investigate whether the people who traded ahead of the corporate announcement might have that access to material nonpublic information and violated the federal securities law. so it's a combination. >> let me just raise a question before i have to run off in a few minutes.

we were talking about trading abuses here and i want to just,g i want to talk about a trading and abuse, looks like a trading it used to me. at least it involves credit default swaps. now, they were not subject, though swaps, to regulation before dodd-frank came along. and that includes credit default swaps to bet against mortgage-backed securities and those of the beds that made a major contribution to the made m financial crisis. con we have dodd-frank which requires your agencies to monitor those types of swaps foa a variety of abuses. i want to give you a description of something that my subcommittee uncovered during our investigation of the financial crisis. i think you have been, your staff has seen some of these documents. we are able to get you i think yesterday that we uncoveredwe during our investigation of the financial crisis.

i want to get your thoughts as to either of your agencies could monitor swaps electronically to detect a type of market to squeeze. that's what we are talking about.pare from late 2006 to early spring of '07 major financial investors have begun betting against subprime related details by purchasing credit default swaps, cds's. soon the price rose, no one in no amarket was willing to offer pry more cds protection against a fall in the back of the subprime related cbos. goldman sachs wanted to continue to buy cds is but none were available at a reasonable price, so change the situation. golden, the abs desk, decided it would offer cds protection at a lower and lower price in order to drive down the market price. and induced current cvs holders to sell off their holdings.

when the selloff was large enough, the price got loaded up the golden plan to move in and purchase a cds is for itself it artificially low prices. now, that schwarz we strategy was described in a number of exhibits including exit three a. which was shared with you and effective self-evaluation which was done by one of the goldman traders on the abs desk who participated in that activity, and i will include injury record at this time. they self-evaluation report by -- on page 15 of that exhibit, three a. at the bottom of the first paragraph, this is what h wrote. we remained as negative as ever on the fundamentals of subprime the market was trading very short. and susceptible to a squeeze. he began to encourage hishis. squeeze with plans of getting very short again, and after the

short squeeze cause capitulation of decent short. this strategy seemed doable and brilliant. once the negative fundamental news kept coming in at a tremendous rate we stopped waiting for the short capitulate, and instead just reinitiated shorts ourselves immediately, closed quote. in an interview with is a trader who wrote the self-evaluation denied that the abs desk ever intended to squeeze the market. he claimed he wrongly worded his own evaluation report. that his account is consistent i with other goldman documents are in may '07 for example, michael swinton the manager of the abstw desk oversaw the traders efforts wrote e-mails in which he encouraged the attempt to squeeze the market and will include these e-mails three b. and three c. in the record at this time. and the first e-mail dated may 25, i think these exhibits are in front of you. we should be offering a single name protection down on the

offer side to the street on tier one stuff that cause maximum pain. we should start killing the single short in the street. let's pick some high quality stuff that guys are hoping is wider today and offer protection type. this will have people totally demoralized. women interviewed him he also denied there was an effort by goldman to squeeze the short market. he said the purpose behind goldman's effort was to restore balance to the market had gone too far to one side. but he could not explain why he used the terms he did cause he s maximum pain and his love people totally demoralized to describe an effort to restore balance to re the market. teher e-mails suggest that the n attempted short squeeze by goldman negatively impacted itse own clients. for several weeks as gold and try to drive down the prices of cds protection it required some

of its clients to make collateral payments to goldman on cds protection that they had bought at a higher price. and some e-mails clients asked to goldman how they could owe more clout to goldman when the client ensured the mortgage market which was declining in value. in the end short-sellers did not offer to sell their short at a lower price. instead most would even shorter in goldman abandoned its effort to squeeze the marketer even after goldman abandoned efforts, some investors were harmed by the lower prices. this is my question. chairman gensler goes to george, with a short squeeze in the commodities markets, with this type of attempted short squeeze intin the mortgage-backed securities market trouble you? number one. as either as a conflict of interest, or as manipulation on the part of goldman. mr. gensler. >> are you sure you did want to chrmanhree to go?

[laughter] >> no, more seriousness. the not familiar enough with the facts and this is the first time i've seen the documents of course now.e in the futures markets manipulation relates to intent and to distort a price. there's a four factor test about price manipulation to the dodd-frank bill actually for chili i think broadness that and whether proposedk rule out onat. broad-based manipulation and also congress has given us additional authorities for disrupted trading practices, all that we will be publishing goes on, get public comment on that will be helpful. in the current statutory framework on what's called price manipulation, you need to haven an intent to in essence distort a price and the price has to have been distorted, and those would be sort of the factors that would have to be applied to the situation or other

situations spirit and an chairman schapiro, let me ask a question. whether the sec has the capacito to monitor abs market for thisef type of activity, is the capacity there to monitor? >> it's not there now. >> would be helpful for you to have it? >> i think so. i think we will have better capacity generally with respect to the asset-backed security's market going forward. they several proposals we did last spring, but also authorities under dodd-frank. but it would be obviously helpful. troublingly what you read to us. >> thank you both -- thank you both very, very much. i've got to go and vote. >> well, we again apologize for the tagteam actions caused by the votes, but one point i wantt to raise, and it goes to sort of

i think a conceptual issue. isse the presumption i think for most people, or has not the most this year trader in the world, the people who own a few stocks is about the value of stocks, the liquidity associate with the stocks is directly a function of the economic value. f the same thing with debt instrument. ther same thing, there's a real economic value here.re is aeal n one ofom the issues that we have to do with is with the proliferation of these proli algorithmic high-frequency of ts trading's, some of these takrithms don't take into account the fundamentals of instrument, that the economice value, the dividends or the status of the misspelled issue, they are subleasing enough ofy these are sold and we start selling. and that if we start selling of another algorithm kicks in. to the extent we get further

away from the economic values here, does that not only cause concern but is that, you know, is that something that is good for the economy? i know it may be a naïve question, -- >> i don't think it's a naïve question that i think a sort off the funundamental question we ae really grappling with. what is the role of traders versus investors come and what kind of trading really provide liquidity to the marketplace that enables investors to get in and out of positions and successfully. when we meet with public companies and i always ask this question of them and asked this question of retail broker dealers, how are the markers -- markets working for you? what your customers, retail broker dealers are looking for in the marketplace. and there is a lot concerned about whether the price discovery mechanism is efficient, or whether the development of two-tiered markets that hendry effective

price discovery. lether the playing field is level so that long-term investors are going to be buyers and sellers of securities, have an equal opportunity to get the best price in the marketplace a. traders do, what issues likee speed and co-location and access goe theietary data feed so skews the ability of others to effectively participate in the marketplace at and i don't know the answers to all of those questions but they are questions on the minds of the public and undermines then public companies who really, for whom these capital markets are their lifeblood. this is their capacity and capability is in these marketsng to expand and grow and createng. jobs.e i think this is exactly thes kinds of questions were trying e to explore through our concept release when we ask about what's the quality of the marketplace and what's the quality of our market structure and what are the best metrics to measure that. tha in additiont? to look into detailed questions about the role of algorithms and

high-frequency traders as well as dark pools of liquidity. >> before he turned to chairman gensler, one of our rules is to amplify these questions so that in the broader context and in we public debate, and also to see these we can drive effective answers. they might change over time, so i appreciate how i know whatre you're doing, but your efforts, and please ask is how we can be helpful, to find real answers that are questions that as you both want out, not only by investor on the street but large rporatioional investors, large corporations, et cetera are really the nature of thee functioning market versus a m highly lucrative trading venue. and they are too, they can be two different things.

>> i think he made an excellent point. in a comment process, and at the roundtable we also held back in june to look at market structurs issues, one commentor supplied a survey that they had done of a f number of investors across the range, not just investors but also trading firms and others, even large institutional houghtors in that survey, only about half of them said they felt the market structure was fundamentally working for institutional investors interest at this point.es. >> chairman gensler, yourhat comments and your perspective. >> i think that markets have toi have the cdeonfidence of the public, not just the investing public but as chair schapiro said, the capital formation and the markets. we oversee those are what is a farmer a major in a corporate or a cutting-edge and arrested i think that markets for decades have included hedgers come investors and speculators and it even included the energies are

trader. in the old days it was somebody in the pits of the chicago futures exchange, or on the floor of the newark stock exchange. today it's in the modern twitter high-frequency world. somebody with a computer he was maybe co-located and so forth. i think the core that we have to make sure is that these markets, that everybody has sort of an equal access to these markets, eqat they are very transparent that's at the core of the new dodd-frank bill. somebody does that information advantages and that we do itgain effectively police them against fraud and manipulation. whichever level -- chairman levin laid out, but we have to police against the manipulations and have the tools to do that. >> let me give you, i think i've asked this question in differenf words, but distinctly so much ot this is of course market activity and you alluded to it,

chairman gensler tom abbott chairman schapiro, your comments, is that arbitrage is something that is attractive because if you can catch to markets in a mismatch, that's a profitable exchange. again, anything that you want to add with respect to the steps is you're taking to ensure that course market activities, someone who is trading at future to affect the price of an equity so that they can either short oe yo go long on equity, what are youe doing? and chairman schapiro, what areh you doing or what do you both think you are doing? most t of what we are doing is within the jurofisdiction that e are income and so there's cros market arbitrageurs within the futures market. the options on futures, and then west recently a swaps market. so we're going to try to make sure that we really do have thee data set within these markets

and can aggregate anticipated across those markets because it can even be in one futures contract between the months that is a spread tribute i do think we need to do more to institutionalize across the markets as well, but it's within the jurisdiction and across our jurisdiction. >> i would really agree with that. we have sr problem is with so many markets and we have so mano venues where trades are executed, that just getting to a point where you consolidated data about the equity markets would be an enormous step forward. it would be my hope that we would ultimately have consolidated audit trail and capability to surveilled across related instruments. rse, your current release in january 2010, chairman schapiro, he said quote regulation is not kept pace with the rapid evolution of the security markets, closed quote. i would assume you would both agree with that?both agree >> i certainly agree with that. >> but there's another i think perhaps naïve but found

question, is a better, there's a window to catch up. and if you can't catch up, are somethinggoing passionate is this something that will get beyond our capacity to regulate, frankly? and i think it goes back to the issues with talked about during the resources in terms of personnel, technology systems, et cetera. but, you know, this is not youri father's market or your grandfather's market where it moves at something close to the pace, i would hesitate to use as congress as a model, but the pace is much slower than what's happening p now.wer now. and i must say that one of my fears -- years is that this is a critical moment to comment on the get up to speed and so that we are regulating on a near real-time basis or effect a basis, but if we miss this moment the gap will widen so significantly that regulation

will be simply -- it won't be effective it will be there but it will be affected and the is, theart of this proliferation of markets where you don't even have a perspective into it. comment on those two major the points and and i will conclude. >> i think there are two things i think that are critical. one is the need for regulatorssh to be up to speed for the the purposes of placing the market. to understand activity that is happening with his abusive practices going on in our enforcement program is looking into about 12 different kinds of trading strategies that we think have the potential to be problematic. so we have had the capacity to do all that with the audit traie and with the human and technical resources at the sros as well as the sec. i think we also have to look at whether there are regulatory changes that are necessary in our marketplace in order toreate create a stronger a infrastructure. we talked about the things we've

done already with respect to purdavely simple things like a single stop circuit breakers limiting stub quotes, printing they get access to the market. but we also have a menu of ideas and at this point they are just ideas for other steps that weid. might be able to take at the sec that would strengthen that backbone of the market structure, including requiring broker-dealers out procedures and prevent algorithms from behaving constructively in the marketplace, something was off obviously on may 6. whether they should be be obligations by market makers eager to support the markets or at least not to trade in ways that detracts from the quality of the marketplace. looking again at the quality of exchange data feeds and whether the public data feed is sufficiently robust in comparison to the one they fell -- sofa a lot more money in a ie proprietary context. we need to assess the fee

structures within the exchanges, ce make or take fees. so i think we're talking a very actively about migrating to single stock circuit breakers to limit up model which was wmicked the futures markets its think there are lots of things for us to do that will be incrementally important, but important to try to solidify this market structure in addition to trying to do a better job with surveillance and getting across all markets, the activity that we have seen. >> i was going to say that maybe the glass as half-full, i'm an optimist and we have certainimit tools. we leverage off of the exchanges. will we leverage off of the self-regulatory organizations, and also the big market participants, the dealers mostly come in what we call commission. we leverage by certain tools. we publish rules have we fully update and. they are never quite up to date but we update them on irregular

we and we use enforcement actions as well. sometimes they are signaling tom sis.ets went there is a particular bad factor or manipulation and so forth. i think these free trade wisdom safeguards are absolutely theical. it's why the week last week published a rule that the exchanges himself to affect in any voluntary way and the h futures markets are very fortunate to have very robust free trade risk management. that now that we require someone desperately risk management, so tthink we have to always markrage off the market participants in the suffering of toward organizations whose rules enforcement mechanisms. and as i say, safeguards but the last thing we use is transparent to pick i'm a big believer in tt transparency helps economic after the but it also helps in a sense of the regulators, because, frankly, you get more people bring information to you, too. >> thank you very much for your testimony and for your great effort, both the securities and

exchange commission and theery h cftc.urdah thank you very much. and i'm sure we will meet again. thank you.et again. >> thank you. >> the second panel can come forward. [inaudible conversations] [inaudible conversations] [inaudible conversations]

[inaudible conversations] >> let me introduce now the second panel, and then i'm awaiting senator levin to am return. the second vote has been called. he will return and then i will depart. meantime, i can introduce the panel. he is not here. i will also swear the panel and and and we can get testimony ous first witness is doctor james

angel. associate professor of finance at georgetown university, mcdonough school ofge business. he specialized in the structure focesvelation of financial markets around the world. his current research focuses on short selling and regulation. doctor into currently serves on the board of directors on to dire direct edge stock exchange. our next witness is thomas that if he. thomas he is chairman and ceo of the interactive brokers group, aokee global market making firm with nearly $5 billion in equity capital. it's trading subsidiary is a registered broker-dealer that provide high speed technologyte. driven trade to individual clients come hedge funds and institutional investors and others. and a subsidiary was among the first electronic marketing firms on all major u.s. futures and security markets. our third witness is manoj narang, the ceo of tradeworkx.

during the 1990 feel the bride of technology research and h trading positions at several major wall street firms gain experience in a multitude of trrketswa llincluding equities,s foreign exchange features and fixed income. in 1999 he left wall street to find tradeworkx with the democratizing the role of -- our fourth witness is mr. kevin cronin, global net and invesco ltd. he is responsible for invesco's trading desk in atlanta, hong kong, tokyo and toronto. he joined invesco in 1997 s.esco ahead of equity trading for invesco, and later became director of equity trading. .. the equity market and buys series.

does the largest with the united states public. now pursuant to rule 6, would the gentleman please add fan racial right hand? they you swear the testimony will give before this subcommittee will be the truth, the whole truth and nothing but the truth so help you judge? dr. angel, your testimony. >> of like to thank you for the invitation. to study the financial markets operating around the world. i am also the guy who warned the

fcc in writing, find time in the year before the flash crash that markets are vulnerable to these events and i would like to say the flash craft who could happen again and here's why. it is a complex network. it consists not only of equity exchanges and options exchanges, the world of broker-dealers, merchant, to vendors clippers will media entities, investors. it's a rich system. most of the time this market network works pretty well except when it doesn't. by most measurable dimensions of market quality, our market works better, faster and cheaper than it did 20 years ago. however, like any finite system, like any human system our market

has finite capacity. it can only handle so much trading activity before it chokes. from time to time our market is overwhelmed. our market is overwhelmed by massive trading in activity because the market is choked. look in the history of the financial markets, you will see going back in time this has happened over and over again. in 1906 the new york times had a headline that blared -- let me get the words right -- stocks break and then recover. 1929, 1962, 1987. we see waves of activity that overwhelmed the market mechanism. what we need is safeguards for this market network that are integrated across the entire market network. what we need is for somebody to

call a time out when the market is going crazy and we don't really have that right now. some people grumble about market fragmentation. i worry less about fragmentation of the market than fragmentation of regulation. we have hundreds of financial regulators that the federal and state levels. they don't always place with each other. a lot of stuff has fallen through the cracks as we saw in the meltdown of 2008 and there's a lot of duplication. most of these regulators have a pretty narrow mandate. it ends here in washington with the fcc, and the cftc in another fortress a couple miles away. both of them are hundreds of miles from the financial markets they try to regulate. that lack of physical proximity makes it really hard to actually

regulate the markets because it makes it much harder to figure out what is going on. we saw how long it took regulators to the route what was going on in the flesh crash as a direct result of the fragmentation of regulation and having regulators hundred of miles from the markets they're trying to regulate. so our regulators need better market intelligence and better funding as well. we spent approximately $18 billion on the fcc since its founding in 1934. that is less than half of what investors loss from bernie madoff alone. we have been foolish in the way we fund our regulators. what can we do about this? i understand there are political forces that make it hard to consolidate agencies but one thing we can do to deal with fragmentation of regulation by

putting all the financial regulatory in one building. instead of miles apart which makes any interaction difficult, stick them in the same building. let's stick this building in the heart of the financial district in new york. that will make it easier for regulators to find out what is going on and easier for them to attract the kind of people with market experience they need to understand what is going on in the markets. finally as we pay attention to market structure we need to think about how the markets are working for all companies, large and small. we need to pay attention to the fact that the number of public u.s. companies has fallen by almost 50% in the last 15 years. the number of public companies is shrinking steadily and if we ran out of public companies we ran out of jobs. 1997 before the dot.com public

got out of hand we had more public companies listed on the exchange. the end of 2009 approximately 4400. half of the missing 4,000 companies work dot.coms this should be there or companies that emerged that means 2,000 public companies. each of the responsible for a thousand jobs. two million jobs lost to our public markets. that would make a big dent in the unemployment rate of fifteen million. there are a lot of reasons for that and i think you should hold further hearings on the reasons why we are losing public capital markets. thank you. >> your records made by your statement was made by the record. if you want to summarize feel free to do that and i will thank

you. >> thank you for inviting me. i am chairman of interactive brokers group, haymarketmaking firm headquartered in connecticut. $21 billion of assets, we are very focused on the u.s. market. it is my worst nightmare. imagine high-frequency trading firm with a few computers, some programmers and $32 billion in capital. these operations exist all over the world with access where an undercapitalized u.s. broker allows the orders sent to the exchange using the broker membership id. these are never seen by the broker. one day, 3:45 p.m. vhf be starts

sending waves of orders. more sellers jump in. market closes down very fast. the next morning, 35 investors and holders will under margins run for -- sell in to cascading circuit breakers. brokers sale like dominoes but there's a huge profit covering these prices and before the regulators know who did it. in the alternate scenario the market realiseds -- no news is seen causing the drop and the market moves up $0.35. vhf see short sales are big losers.

so brokers go bust. possibly starting a chain reaction. under either scenario, investors will be caused by the huge down move work up move and markets will suffer further. this is not far-fetched. we have nothing in place to prevent this from happening. it could happen on any day. it could be a manipulator thinking profit where disgruntled employee, hedge funds or hfc or brokerage firm. it could be a terrorist act, where a simple computer -- what can be done? i have four recommendations to read you briefly that i will explain in detail in my written testimony. these recommendations apply to security futures markets because these markets are inextricably

linked and it is difficult for surveillance of the two markets to be coordinated. coordination between those two. first, excess. rather than in july of next year, the sec's new rules banning sponsored access should apply right away by emergency order of the commission. seven months is too long to continue risk. we screen or hat down over a million people every day to prevent a plane crash yet we do not screen electronic orders to prevent a market crash. the ability to send orders to the exchange with brokers of the members of the pleading house. brokers have no stake to be sending orders to exchanges any

more than hfc should. second, surveillance tools. regulators real times survey especially the identity of the person behind each case. the sec should approve its proposal but shorten vote two year implementation deadline. until then the commissioner should order the brokers to record the identity of the person associated with each trade starting now. the cftc should approve similar rules. third, improving liquidity of the exchange. we must improve liquidity by banning or restricting exchange trading of exchanges of securities. it is bizarre that on the dodd frank, must trade on exchanges.

yet exchange of speculators trading over-the-counter. exchanges of products are traded on the otc, marketmakers leave liquidity on the exchanges allowing crashes like may 6th. we must bring trading and securities back to the exchange. and circuit breakers. the circuit breakers are in affect only from 9:45 a.m. to 3:35 p.m. but should be an aspect of all signs of the market. the circuit breakers should begin fixed-price intervals instead of being moving targets so that everyone can calculate what prices are allowed. this would eliminate many crashes that seem to occur almost every week and that you

were referring to to some time ago. there should also be a market live circuit breaker that would not allow transactions to take place outside the limits for the day but continued trading inside those limits. finally the circuit breaker level must be coordinated up along the stock manipulated to the real free-market so as not to oppose alignments that could result in temporary insolvency. thank you. >> thank you. my name minoshan rang is that we

provide high-performance trading structure. providing clients with their technology we operate proprietary trading practice that utilizes the same strategies. how proprietary trading business consists of highly complex and data intensive algorithms based on coordination between securities that have multiple market including stock-options and futures. i would like to express my gratitude for the opportunity to share my perspective that insights in today's hearing and recognize smaller firms are often not accorded such a privilege. my remarks are on the topic of investor confidence. it is self-evident that they need markets to function smoothly and the confidence investors was shaken and may 6th. it is confident that transformed the flash crash from the most recent chapter of the ongoing credit crisis into the referendum on market structure it has become.

ever since may 6th investors have been plagued by the nagging suspicion that the regulatory agencies are powerless to understand the inner workings of a market or meaningfully assess the practices of its most active participants. for the past week to use the public has been treated to debate about market structure issues. the they subject to widespread manipulation? what impact our rebates elevated cancellation have on liquidity? why is speed important to strategies that provide liquidity? how did the equity options and futures markets interact with each other? the public should not be forced to accept anecdotal or speculative answers to such questions when definitive answers can be found by analyzing data. tradeworx can calculate answers to these questions and while we share insights with the sec what is needed to boost market confidence is for the chief regulator to have regulators on some. the key issue related to

investor confidence is the market has become too complicated for ordinary investors to understand the. that is one of the things that need to speculation and unsubstantiated hypothesis. stock market supports the most complex and fragmented structure known to mankind. the cornerstone of system regulation was ten years in the making and stands 520 pages. for perspective consider in competitive games like chess extraordinary complexity arises from a handful of rules. it's in should surprise no one that undertaking of this magnitude might backfire and that such unnecessary complexity might fuel the perception that the system is rigged against them. at its core, the objective is to keep prices synchronize. in most markets this is accomplished by arbitrage which tends to be incredibly efficient in this role. consider the relationship

between stock s p y and the s&p futures contracts both of which tracks the s&p 500 index. because they are different securities and trade on different markets their prices are not protected but if you sample their prices at intervals you will find they have made 99.9% correlation to each other. i have a diagram that correlation in the exhibit. you can see how stable this relationship is despite the existence of any regulation to cause that correlation. but apparently 99% correlation was not good enough to dissuade policymaker from the daunting task of crafting rules. the price for complex rules to solve the imaginary problems is rather high. rather than minimizing fragmentation which was the stated goal, it was exacerbated

by guaranteeing new exchanges will have borders. rather than limiting the role of arbitrage, they diverted from productive uses to the regulation itself to top of the rule managed to ignite a massive technology arms race by making the speed of information transition a more critical issue that was before. not a hat and i put a formal rulemaking exists i feel we are doomed to repeat past mistakes. once again proposals of nonexistent problems, is easy to conjure up imagess like speed limits and order cancellations but it is trivially easy to demonstrate how they would backfire and harm certain investors. lawyers with minimal trading expertise advise such rules they should recognize world-class engineers are the profit motive will be there to exploit them. history makes it clear who tends to win battles of which. many market professionals with strong opinions on how to fix market structure but to win back

the confidence of investors the sec should engage in rulemaking supported by empirical evidence and analysis rather than speculation. furthermore adding ambitious or superfluous regulations to a system which is already hopelessly complex is guaranteed to backfire by inviting unintended consequences. such rulemaking will not return investor confidence in our markets. i hope to have the opportunity to elaborate on these topics that today's hearing and i ask my remarks be included in the record. >> they will be. thank you very much, nanoj narang. mr. cronin? >> thank you. ranking members and members of the subcommittee for the opportunity to speak here today. i am pleased to participate examinee efficiency, stability and integrity of the u.s. capital market. invesco is a leading management

firm with operations in 20 countries and assets under management of $620 billion. i will keep my comments brief but ask for a more detailed statement. an efficient and the fashion capital process is essential to growth and vitality of the u.s. economy. the most important aspect of the process is that it attracts long-term investors capital. it is important to the primary and secondary capital markets to facilitate capital process transparent, effective and fair. to that end is essential that sensible consistent rules and regulations replace to govern the markets and regulators have tools necessary to assure stability and integrity of those markets. long-term investor confidence is the key to robust securities markets. investors retail and institutional more than a few years ago. competition in the market which was virtually absent five years

ago has spurred innovation and enhanced investor access. trading costs have been reduced. investors have more choice on how they execute their orders. that said, the past several years long-term investor confidence has been challenged by a serious financial crisis, including most recently the flash crash of may 6th. in order to cover long-term investor confidence regulators must ensure securities markets are highly competitive and efficient as well as transparent and above all else ferret. the gains made in the last years, today's market structures far from perfect. the event of may 6th brought to the forefront several inefficiencies, and into dependencies of equity options, futures and futures markets. most significantly this underscored the absence of a mechanism to scandal volatility

at the stock level. the synchronization of rules which cover exchanges, outside impact trading algorithms can have in the price of securities in times of the arrests and not surprisingly the fact that the market making mechanism provides virtually no liquidity to investors at times of market stress. ruling all instability and volatility from equity markets is not impossible or appropriate. establishing mechanisms to address those prices in the markets, volatility related to the efficient market structure will be critical in promoting investor confidence. these issues have been addressed by regulators. the potential for another may 6th will not be removed from these actions alone. the sec, and s r os must be coordinated, diligent and measured to create sensible regulations designed to minimize inefficiency in the market

structure and advanced surveillance capabilities for serious behavior. there are a piece 13 exchanges. competition between exchanges is first resulting in innovations to seek and provide liquidity. this is a welcome development from our perspective provided the rules and regulations which govern various exchanges are consistent and not congruent with fairness and equal access for investors. the potentials concern we have about competition is it is ignited in electronic commerce raise where speed appears to be the singular objective. invesco believes speed is an important variable to consider execution of trade we believe price is the most important variable. find stock at the right price for a price discovery process is what long-term investing is all about. there is a point where speed and robust price discovery diverge. concept that must be understood by exchanges as a race to trade

in increments of billionths of a second. also 40 different trading venues including dark pools and two hundred dealers to interlock customer orders. the exchanges and then use resulted in a very complicated web of conflict and practices by broker-dealers and executions. we believe investors need improved information about the execution practices to make better informed decisions. 56% of trading activity in u.s. equity markets is attributed to high frequency traders. given the recent ascendants there is not a lot known about their practice and very regulatory little oversight. invesco believes there are many beneficial high-frequency trading strategies which provide valuable liquidity to the market. on the other hand we are concerned some strategies could be considered manipulative activity.

some of these strategies like so-called border anticipation or momentum strategies provide no real liquidity to the market utility in any way to pray on institutional orders creating and unnecessary tax on investors. there was a recent case about improper activity, we are concerned that regulators monitor various behaviors by these participants is not where it needs to be. additionally, regulators must address increasing number of order cancellations on the securities market. as many as 90% of high-frequency traders are subsequently canceled. order cancellations to make a market is one thing but orders sent to the market with no intention of being traded is quite another before their canceled. these tax markets with technological infrastructure and under the right circumstances could overwhelm the capacity to process orders causing massive system failures and trading

disruption. efficient trading markets provide many investors, it is noteworthy that in the interest of long-term investors and short-term trading professionals divergency sec has repeatedly emphasized its duty to hold long-term investors. we need to ensure there are no practices with high-frequency trading, or any participant in the marketplace which contravene the interest of long-term investors. thank you for the opportunity to speak today and i look forward to answering your questions. >> thank you very much. >> thank you for the opportunity to testify today. i served as vice chairman of the financial industry regulatory authority. we are the primary independent regulator for security brokerage firms doing business in the united states. in addition to work overseeing firms and brokers, market regulation under contract for market centered in the united states.

through this work, responsible for regulating 80% of u.s. equity trading. these are overseen by the sec which approves all rules with oversight authority over operations. over the last several years, how aware it occurs has evolved rapidly as well as the executions with equity trading. high-frequency trading and access are commonplace and contributed to the fragmented markets that exist today. fragmentation and increased competition resulted in a narrow quotations read that high level of activity but can also result in vast electronic removal of liquidity when markets are stressed. the events of that day identified several areas where regulators take steps to increase the impact of extreme market volatility and provide increased predictability in restoring order following such events. these discussions with the leadership and direction of the sec to establish and implement

important changes in my written statement. the destruction of may 6th focused attention on high-frequency trading, already scrutinizing trading activity to attempt to use these technologies to implement manipulative strategies. we find a new york brokerage firm, suspended and fined several individuals that the firm for the use of high-frequency trading strategy. numerous layers and non bonafide moving orders to generate interest in specific stocks by creating a false appearance of pressure. this strategy induced other market participants to execute against trillion women orders. traders obtained advantageous prices that otherwise would not have been available. pursuing instances of this and other illegal trading strategies in markets we regulate due to the limitations of current audit sales the risk of missing instances of manipulation, blocked sales and short selling

and other improper gaming strategies is unacceptably large. with the drop in and along with increased competition and connectivity among exchanges, it is clear market quality can no longer be insured by a single exchange. the sec recognized this evolution of markets created an environment where consolidated rail is essential to ensuring proper surveillance of investor confidence. see this as a critical step to enhance regulators' ability to conduct surveillance, trading activity across multiple markets. it is plausible that certain market participants knowing the extent of current regulatory fragmentation consciously spread trading activity across several markets in an effort to exploit this fragmentation and avoid detection. based on our experience developing and operating the order, key aspects necessary to ensure an effective

comprehensive and official trail uniform data, reliable data and timely access to that data. the most effective way to achieve the goals of consolidated a arbitraged is to extend existing systems such as those and consolidate exchange data with discreet new data like large trader information into a central -- building off existing systems with reduced time required for implementation of a fully consolidated on a trailer and information to the surveillance systems. significant changes in the financial market in recent years necessitated adaptation by regulators across a wide spectrum of issues. technological policy development made this practice of regulating the markets more complex. the sec has identified one of the most pressing challenges for regulators. we are all hampered by lack of a comprehensive sufficiently granular and robust audit trail across the equities market.

ready to work with congress and the commission and as our owns to bring about an enhanced audit trail that will facilitate more effective surveillance for the protection of investors. thank you for the opportunity to share our views and happy to answer any questions. >> thank you for your testimony. and i want to recognize senator coats who has joined us and recognize -- i have a question for all the panel. let's focus on the market participants. mr. peterffy and nanoj narang, you feel regulators don't have all the information they need at this time. from your perspective, what market intelligence should they have? and you have listened to chairman shapiro and chairman against the about what to do in

the audit trail. your comments on whether that is adequate to pursue mr. peterffy? >> i agree they do not have all the tools they need. i do not think we should wait for the two or four years to get consolidated. as of tomorrow, all the brokers to keep an audit trail of their own order and most of all to record the name associated with beneficial interest associated with each order. if anything happens in the the market, we go around and ask who did this trade, please send it to me tomorrow. it doesn't cost anything to do that. it can be done today.

>> nanoj narang, your comments? turn on your microphone. >> in terms of what data the regulatory bodies could benefit from, absolutely i support the acquisition of data that helps regulators engage in forensic analysis of various types such as the audit trail or large trader reporting. that is somebody who would be affected. that said, i think there has been lesser-known items that could be rather useful as well. many people pointed to the analogy that one of you said earlier that regulators are akin to a moped on a highway

dominated by 100 miles an hour race cars. the way i would rephrase that in terms of data requirements is regulators very much need to be able to see the markets in the same way that its most active participants see it. they need not just direct data from an exchange rather than the consolidated view than they see now with standard information processes. those are consolidated feet. the regulators need to see direct data from the exchanges but they need better than that. they need to synchronize that day in the same way a high frequency trader would. that means they can't just rely on time stamps that the exchanges put on their data to synchronize them. they need to collect it over high-speed telecommunications networks and time stamp it. furthermore, both ms. shapiro

and mr. regan's lawyer noted they don't need to efficiently build order books from that quotation data. that is something that is prerequisite if you are going to have the capability to have modern trips. technologies are out there. they allow you to very efficiently construct order books from quotation data. the data itself is just the starting point. one of the thing that makes me nervous is the sec barely has the ability as far as i can understand to analyze the data it already has. adding 100 to 1,000 times more information will not help matters if their analytical capabilities are not amended at the same time. the main thing analytical capabilities are missing as was rightfully alluded to earlier is

the ability to analyze security based on their correlation. the tremendous amount i would say the majority of the volume that occurs in today's markets is premised on the fact that securities within the same market and across markets have semi stable correlations to each other so when price discovery happens in one instrument it must propagate to other instruments that are correlated. regulators currently have no clue how that works and no tools to analyze those effects. those effects are structural issues and i think the regulators need to have analytical tools with those capabilities. >> your comments and i will recognize the chairman. >> i would quickly add that having the information from a regulatory standpoint is helpful. i tend to agree that being able to analyze the data is fundamental. the other point that is important is the regulators have to be able to coordinate the

information. having the data, having the ability to analyze in the absence of cooling the pieces together isn't going to get us where we need to be. this will be an effective deterrent to the extent that it is in place. but i don't agree we have the kind of time it sounds like it is going to take. it is something that needs to happen. >> there will be a second round. let me recognized chairman 11. >> thank you, senator read. mr peterffy, you describe your worst nightmare. and every member of the panel heard that description of your mind there. i am wondering if the other members first of all believe as you do that the nightmare is plausible. >> it definitely could happen. our market is very complex and there are all kinds of things

that can go wrong and murphy's law will strike. there will come a time when on heavy trading volume, weather because of some malevolent action, some b 9 action or programming error, something is going to go haywire. this is the nation of complex electronic systems. sometimes computers crashed, computerized stock network will as well and we need good safeguards in place to protect us next time it happens. >> this wasn't so much a crash based on a glitch. this was an intentional effort on the part of somebody who had $50 million and a few computers and a couple programmers and in any event you would agree that that nightmare scenario is possible. . the believe it is possible? >> i will explain why think it

is implausible. there's no doubt that a large trader could impact the market but the attribution of that nightmare scenario to a high frequency trader that controls $50 million in capital is utterly preposterous on its face. you can do the math. you can estimate as we have done that for instance, the trade by waddell and read on may 6th, in $41 billion trade likely at a price impact our round 2.7%. at the same time you have 300% of impact. it is entirely impossible. a firm like that would exhaust its capital base before the market would even notice the movement. >> do you believe a scenario

like that is possible? >> plausible yes. 300 shares took from $52 to $100,000. >> i falls somewhere between my fellow panelists. i think it is implausible but not impossible. i think there are structures in place around risk controls in terms of firms that provide access to the marketplace. is not a comforting thing to rely on risk control. those steps the sec has taken in the adoption of rules around controlling access will go along way toward making that scenario even more implausible and nearly impossible. >> mr. peterffy. you want to comment on nanoj narang's comment? >> you do not need to have any capital to send ordinance. you send in the order, the orders are not even seen. you only need the money the next

day, when the broker gets these end says where is of the money? in this scenario, there is a lot of money there because the trader holds the london. even if there isn't money it is discover this shouldn't have happened. that is why naked access is a problem. these should be screened. >> let me go through your remedies. i am over my time. this may take a few minutes. i am happy to come back. to the remedies. whether it is plausible, implausible, possible, or at least that much, there are a number of remedies that mr.

peterffy suggested. one of them is the ability to submit orders to exchanges should be restricted to brokers that are clearly members. that is one of the suggestion that you make. i wonder if anybody wants to comment on that and also on the other suggestion it relates to this, brokers who were not members of the clearing house are allowed to send orders directly to an exchange with the arrangement of a clearing member broker. auld these 5,000 brokers are not members of the clearing house to send orders directly and you would prohibit that. there are two suggestions now. prof. angel, what do you think of those ideas? >> there are a lot of subtleties involved with the proposal to ban anyone but clearing members from putting orders directly

into the exchange. given the economy, there has been quite a consolidation of business. that would limit direct access to the very largest wall street firms. do we really want to encourage that kind of consolidation in the industry? that is one thing to think about. also, i can see a clearing member actually providing they get access. i support the sec's proposals to get rid of naked access where brokers providing a direct pipe without screening the order's first. that is the most important thing here. we have to have the right risk controls in place so that the people who are responsible for the trade know what they are sending into the markets. >> even if they do it through a clearing broker. not be in a clearing broker themselves. >> you need to risk controls in place.

>> nanoj narang, your comment on that suggestion? >> i would like to comment on that suggestion and done mr. peterffy's refutation of my refutation. >> you know what the next -- refutation of your refutation of -- happily my time will be a before that happens. >> first of all, i fail to see the need for additional remedies. i think peterffy's scenario by its own admission was based on a situation where naked access or sponsored access are in place. we are already at the stage where a ban unsponsored access has been posted to the federal register and is due to go into effect. >> you make that effective immediately? >> i can't say -- >> an emergency argument that mr. peterffy suggests? >> i can't say i fully endorse the ban on sponsored access.

i can see some other rationale behind it but there are some little-known issues that are peripheral to that that are anti-competitive. that i think perhaps above the scope of this hearing. >> above the scope of this hearing -- [laughter] >> if you want to keep a few hours longer i am happy. as far as the, and about the capital not being there or risk checks not being applied, that is misleading because of that naked access means is risk checks are not done on a prepaid basis but are done on a post trade basis and there's not much latency between the time a trade occurs -- >> that was the next morning. >> it does not mean next morning. it means as soon as the trade happens your buying power is produced. brokerage firms monitor your day trading buying power. >> defect is there are many

little brokers that provide naked access. there is nobody policing activity. some of the-do hold screenings. many of them do not. >> i don't know of any who did not. that is a hypothetical statement. fact is post trade work checks are universal. and adequately prevent people from exceeding their buying power. >> we get hung up listening to this and scratching your heads and we're talking about they get access and losing sight of the goal of the structure. there have to be rules in place to prevent nefarious activity. if we think there's a chance

that shutting the door can contained that we should shut the door today. >> thank you. >> mr. peterffy's scenario was based on the assumption that they're not -- clearing firms trade that context would be -- i don't want to say every clearing firm is perfect managing today risk but their livelihood is staked on it. i will go back to the recent rulemaking which put real teeth into what that monitoring means but as a general matter, because it is open day after day. >> would you make that will effective? >> there's a fair amount that will go with that. the clearing for was mismanaging enter day risk to have that much dislocation in a period of time.

i worry the cost -- >> we have been dueling by the worthy and assessor, senator ted kaufman, one of the great -- if the right word would be. the persistent analysts of the issue of the impact on markets. thank you for joining us. >> made a major contribution. senator reid was right in the middle of that. just extraordinary contributor to of our efforts and we are right in that capability. >> thank you. i hope to be senator kaufman's -- subject matter interest in -- kaufman did a great deal of work to assure the stability of

transparency and fairness and liquidity of markets following the greatest dislocations' we have known. i report back to him that we had the opportunity, the reputation, and with that testimony. i want to focus, and the economy in my view with capital formation or protecting long term investment for the purpose of transparency and stability. my question to you is to what degree are you concerned markets are no longer serving this function and high-frequency trading is detracting from price discovery in a way that undermine the goals of the market? >> the overall function in the market is not the way it was five years ago. competition has been an enhanced with control of our orders has

clearly been enhanced and we see transaction costs. that has not been a universal experience. given the ubiquitous liquidity that is available now, we move down market cap that this market structures not serving smaller companies, and it can always be better, it could always be better. be high-frequency trading has entered the market, we are fairly agnostic to the point that it adds liquidity and doesn't cause undue dislocation on a a given day or week we are okay. we don't believe regulators have the appropriate tools to understand all the things that go on. we are pretty smart and understand a lot that goes on and i am sure there are areas we can't possibly understand today

what does concern me is there are nefarious activities and participants who are out there who today are taking advantage of investors'. that is wrong. if you bring nothing to the party in terms of liquidity work efficiency you shouldn't tax investors. there is no purpose. we have concerns about high frequency or any participant manipulating the market. >> two follow-up questions i will ask members of the panel and comment on both of these. some propose there is an ipo crisis that in part is a consequence or outcome of short-term strategies. what link do you see between the dynamics of market fragmentation and difficulties identified particularly in markets sectors that you don't participate in but others and what is the impact of that innovation of capital formation and the follow-on question should

high-frequency traders who act like market makers be subject to additional regulations that would help solve that specific problem if you would? >> i am very glad you are cognizant of the crisis because i think it has serious implications for long-term growth and stability of the economy. i do not think high-frequency trading is at the root of it. there are many other things ranging from the litigation environment and other market structure changes we can talk about in a few hours. the thing about high-frequency trading is there is good and that computerized trading. all investors these days are using computers basically to do what they used to do manual the and this is good for the market. a lot of high-frequency traders follow the old strategy of buying on the debt that fell on the rebound. one of the things that happened on may 6th is when this got

scrambled and people said we can't trust the data feed, those people stabilizing the market stepped aside and other traders kept going causing the market mechanism to fail. some high-frequency traders are really good. others help keep prices in line with each other. if coke gets out of line with pepsi they stepped in to make sure those prices state in the same correlated path. a lot of what they do is good. and won't say everything they do is good the weekend as they high-frequency trading is bad. there are strategies that may be harmful to the market but the bulk are doing things that help the market. i do think we need to pay attention to smaller capsize markets because we have collapsed transaction costs. we have a 1-size-fits-all market mentality at the sec and i am suggesting smaller companies needed different market mechanism and having a market

mechanism is not necessarily the best market mechanism. we need to pay a lot of attention to house small companies hit the market and how hospitable the market is to them because that is where future growth lies and that is where we have a serious crisis on our hands. >> i am overtime. if any members of the panel want to comment keep it on that one question. i would appreciate it. >> high-frequency traders are not by themselves. they provide liquidity and they are good and they are not so good. this would be very simple to regulate. a high-frequency trader provides frequency and an offer that doesn't take up any other offer, that is a useful activity that should be encouraged to do so. that could incentivize

marketmakers to -- when they are taking liquidity which is basically probably front running correlation to come back in line, they should be slowed. by tenths of a second. >> sorry. i would like to comment about your question earlier about capital formation process and more generally the social utility of high-frequency trading because many people have raised that issue. i would like to point out when an investor buys shares of a company in the open market the proceeds of that purchase go to the seller. they do not go to the company the stock is written on. no capital is raised for the firm in question when investor purchases shares of that

security. no capital formation happens in the secondary market. capital formation in the primary market. the role of the secondary market is exclusively to encourage investors to participate in the primary market by providing liquidity. when you are planning desirable attributes for secondary market i firmly believe there are few if any attributes that can trump liquidity. that is the overriding social purpose of the secondary market. so to the extent that you believe high-frequency trading is a fixture of the market in terms of liquidity provision, you would have to argue that it serves just as much if not more of social value than investing in company shares in secondary market. second of all on the notion of obligations, my major concern there is obligations really put us on a slippery slope towards the two tier market we had in

the 90s. i think our goal or your goal as policymakers is to keep the good teachers of the market that occurred, asset markets have evolved and address or ameliorate the bad ones. i don't think in terms of that future is we're talking mostly unbridled fragmentation. in terms of good features i don't think anyone disputes that markets have got more liquid and spreads have gotten tighter and transactions calm down and virtually no one -- the notion that that happened because the marketmaking function opened to competition. the two tiered system we dismantled. going back to that system would be counterproductive. furthermore, i can't think of any empirical evidence that marketmaker obligations matter in practice. take the example that on may 6th there is a quarter of our

industry known as the wholesale industry which executes the bulk of all retail orders. every firm in that industry shutdown during the flash crash and dumped shares on to the market. that is the one quarter of the industry that does have obligations. shows you how effective obligations are. in 1987 during the great crash in october, black monday marketmakers took a lot of heat in the press after that event for, quote, putting their hands down and refusing to take orders. even if you are obligated 99% of the time to provide liquidity if the 0.1% of the time you choose not to it is precisely at those moments when the market needs it most. obligations, there is no empirical evidence that such a thing will work. there is empirical evidence that people who request obligations will also request certain privilegeds that go along with

that. >> thank you. >> that is a question with a lot of dimensions. i will try to condense my thoughts to this. there is always confusion of volume and liquidity in the market. there is without doubt much more liquidity in the top 200 names than there has been historically. i am not sure 1 hundred million shares of trading in citigroup qualifies as liquidity in the marketplace. i don't think it qualifies at all. if we were to look at the market in terms of all the different components of the market there is clearly a part which has been servicing very well by the current structure. very much less clear in terms of transaction costs and we have done the analysis that the market structure currently is serving the other parts of the market very well. if there were value in marketmaking an historically marketmaking has bear