Skip to main content

tv   Key Capitol Hill Hearings  CSPAN  June 17, 2014 8:00pm-10:01pm EDT

8:00 pm
others. this may be a factor that over half according to the gallup survey earlier this year owned the stock or the mutual funds which are down for more than two thirds of americans who go stock or mutual funds in 2002. the lack of the faith has allowed us to grow and will undermine a very important public purpose of the stock markets to efficiently raise capital so that businesses may grow to create new jobs and added to america's prosperity. in the previous hearings and investigations, this subcommittee has shown that our financial markets have become plagued by conflicts of interest. we have uncovered investment banks willing to create securities based on the junk assets, help them with their clients independent against the same securities making it to the
8:01 pm
expense of their clients. we have assigned artificially high ratings of securities in order to keep the business. now with that history in mind, those that argue that the conflicts that we will explore in this hearing are manageable are acceptable have a mighty high burden of proof which seems to the average investor to be a simple stock market traders usually a complicated series of transactions involving multiple parties, complex technology and the ever-increasing number of border types and payment arrangements. there are retail brokers like the ones found in the main street offices across the country and on tv advertisements. there are wholesale brokers who buy orders from the retail brokers come and there are dozens of trading venues where the shares are bought and sold.
8:02 pm
..
8:03 pm
>> the party making the decision should be influenced by the best interest of the investor. that is what ethics demand and what the law requires. but there is another factor in play. at both decisions points, the current structure gives brokers an incentive to place their interest ahead of their clients and here is how. the first conflict, which is illustrated in that chart, occurs when retail brokers receive payments from wholesale brokers for their orders. this money known as payment for order flow can add up to untold millions and almost every retail broker keeps these payments rather than passing them on the clients. the reasons wholesale brokers are willing to pay for order flow are complex. the one big one is that who
8:04 pm
wholesale brokers fill from their own inventory and profit from the trade. a practice known as internalizing. a second problem arises when a broker uses a public trading venue and then choses which venue it will send orders to for execution. under what is known as the maker-taker plan there is an ince incentive to chose the broker venue on their interest rather than the client. here is a simplified explanation of maker-taker. when a broker makes an offer on an ex change to buy or sell a stock at a certain price the broker is a maker. and most pay the broker a rebate
8:05 pm
when that offer to buy or sell is accepted. a broker who accepts a maker's offer to buy or sell is called taker. and will generally pay a fee to the trading venue. the important thing to remember is that brokers, my maximizing rebates and by avoiding taker fees, can add millions of dollars to the bottom line, giving them a powerful incentive to send the order to the trading venue that is in their best interest even if it is not in there client's best interest. it is significant that earlier this year, speculation that regilators were considering restrictions on payment for order flow, shares of broker forms were lowered.
8:06 pm
obviously there is a lot of money at stake in preserving these conflicts of interest. their legal obligation is to provide clients with what is known as best execution. whether they are meeting that obligation is a subjective judgment. the outcome of this subjective judgment effects the way tens of millions are executed. some who profit from revenue say seeking the revenue doesn't interfere with seeking the best execution. but a witness today from the
8:07 pm
notre dame university has done research that shows when given a choice four leader retail brokers send their retail orders it to the markets every the biggest rebate at every opportunity. the research suggests that exchanges offering the highest rebates don't offer the best execution for clients. these brokers argue they can pocket these rebates while still meeting their obligation to provide clients with best execution. so while they make a subjective judgment as to which trading venue provides best execution on tens of millions of trades a year that subjective judgment happens to result in the biggest payment to brokers.
8:08 pm
marked participants are worried about the conflicts of interest embedded in the current market structure. in addition to that, today's 1st panel will include the president and ceo of iex and a prominent wall street advocate for market reform. our second panel will include four witnesses. they are thomas farly of the new york stock exchange, whose corporate owners have described conflicts as having a quote corrosive impact close quote on stock markets. the next person on the second panel is joseph radderman of that's global market that operate exchanges that compete with the new york stock exchange
8:09 pm
and has a different view. the third witness on the second panel is joseph brennan. a vanguard group, a major mutual fund company that expresses concern and the 4th is steven cork of td america trade. a retail broker that derives revenue from payment to wholesale and rebates that they receive from exchanges. the duty of lawmakers and financial reglator is to look for the public. they can damage retirement and pension holdings and other investments on which americans rely. and even americans without a single share of stock or mutual
8:10 pm
fund account have something at stake because they exist to foster job and growth and conflicts of in the jeopardize that function. americans don't shy from innovation or technology. indeed we embrace them. but americans are understandably suspicious when technology can be turned against them and their family's interest. they are rightly concerned when technology is used to undermine basic principles as as trust and duty to a client. our goal is to advance the free market by providing those values. i want to thank senator mccain and his staff for their
8:11 pm
corruption in this matter and all matter. senator mccain. >> thank you very much. i think this is an important hearing and i appreciate the hard work you and your staff have done on it. i want to thank the witness for being here today. when michael lewis's bock flash boys came out people were questioning if the stock market was rigged with people who had access to advanced trading and is high frequency trading adding cost for others? stock markets face another crash like in 2010 when the dow jones temporary lost $1 trillion in
8:12 pm
market value in 20 minutes. these concerns about high frequency trading fueled suspicions at wall street may have become the altimate insider's game when the average investor can't participate. consumers see firms that can make trades is a second and wonder if the stock exchanges is still a place where their interest matter. hopefully this hearing sheds light on the high frequency trading practices and help restore our financial system confidence. there were many researches and academics that locked at this. they are complex but we can address it solutions. one of the most high frequency trading practices depends on the
8:13 pm
unintended consequences of the reg national system. that regulation mandated that investment firms must buy or sell stocks at the best price variable. high frequency trading firms take advantage of the rule by putting out offers to buy or sell small amounts of stock at attra attractive prices. when a large investor accepts a high frequency trading offer because it is the best price variable, the high frequency trader can predict the large investor has to go to another exchange to purchase the rest of his order. the high frequency trader can rush ahead and buy up the shares and sell them to the larger
8:14 pm
investor at a high price. changing this so investment firms are not required to take the high frequencies trader debt is the first step to clean up the practice. another is cola-location. this involves firms renting space in the same rooms that run the market computers so they can receive information from the exchange computers as fast as possible. the investors that don't buy the direct connection receive data using out of date technology called the security information processor that compiles market data slowly. there is no reason why public data feeds like the security information processor can't be
8:15 pm
improved so they are as fast as private data fees. updating the technology and the security's information processor is another helpful measure that can be adopted to shore up consumer confidence in the market. in addition to high frequency trading, flash boys described how shock exchanges to pay rebates as senator levin pointed out to stock brokers to entice them on the exchanges. those rebates called make or taker payments create an apparent conflict of interest for the stock brokers who must chose between sending their client's orders to exchanges offering a he rebate or exchanges that will fill the orders as quickly as possible. many argue they spur more activity and reduce cost for
8:16 pm
consumers, some experts say the benefits are minimum and investors are harmed by the conflict of interest. the subcommittee found there is a lack of publically available data regarding make or taker payments leading to difficulties in determining the payments have an adverse affect on the market. a logical first step would be to have more transparency in the payments and allow researchers to study in greater details. i hope this will help educate the public about high frequency trading and broker conflict interest. and i hope action will be take taken to restore confidence which has been eroded. thank you, mr. chairman. >> senator johnson.
8:17 pm
>> thank you, mr. chairman. i also want to thank you for holding the hearing. senator levin and mccain mention the word complex. there is no doubt what is happening with trading is highly complex. i think the primary solution is in increase competition and transparency and we understand what is happening but because it is complex it is difficult to fully understand. i happen hoping this hearing will lay out the retality of the situation and as an individual investor who bought stocks for decades the competition increased in the market place. i used to have to pay $100 for stocks and now i pay $20. so i hope it goes over what is
8:18 pm
happening and the bottom line is restoring confidence and i don't think we will get that through a state of fear and the boogie man out there trying to gain the system. the best way to ensure confidence and best price is maximum competition and transparency in the market place and i am hoping that is what this hearing reveals. thank you for the witnesses as i am looking forward to your testimony. >> thank you, senator johnson. we will call the first panel of witnesses for this morning's hearing. the professor from notre dame is here and president and ceo of the iex group in new york. i appreciate you being with us.
8:19 pm
and all people to testify are required to be sworn. i would ask you to please stand and raise your right hand. do you swear the testimony you are about to give before this subcommittee will be the truth, the whole truth, and nothing but the truth so help you god? we will be using a timing system. one minute before the red light comes on you will see the light change from green to yellow giving you an opportunity to conclude your remarks and all of your written testimony will be printed in the record and we will ask you limit your oral testimony to five minutes. professor we will have you go first. thank you for coming again. >> good morning, chairman levin
8:20 pm
and ranking member mccain, thank you for letting me testify. it is an honor to present to the senate committee on investigation. i am an ex pertin the dealers and quality of transfusion. i would like to provide a bit of context. orders used by retail investors can be put into two categories. investors who want to trade quickly at the best available price use marketable orders and they demand or take liquidity. non-markable orders don't execute immediately on the market. exchanges use electronic books to keep track of them and they use price-time priority to
8:21 pm
determine which market order trades who they arrive. they rest on the electronic books make or supply liquidity. it is paid to the investor or broker with the non-marketable trade and the same exchange a take fee when trading. exchange offers high take fees and those offering low rebates tend to take low fees. the incentives suggest that marketable orderers are routed to venues with low take fees and low rebates. non-marketable orders are likely to trade last at a given price and can miss out on profitable opportunities.
8:22 pm
this suggest that the likelihood that non-marketable order trade is lowest on the exchanges with the high rebates. 0-1-22 states that brokers must take into account the differences of execution when determining when the route marketable orders and brokers must not allow duty to interfere. most brokers don't pass the fees through to the customer but reflect fees and rebates and other cost of doing business. thus while invisitors prefer it is the highest trade but they may go to the venue with the highest liquidity rate. this alignment of incentives is hampered by an important agency problem. brokers that maximize rebates
8:23 pm
maybe able to charge lower commissions. if they chose them on commissions because they lack sophistication to examine quality it maybe profiting to focus on rebates rather than executi execution. unfortunately, investors whose orders don't execute don't receive the benefit of the low commission. we examined two issues in my paper. whether it influenced the routing of behavior and four poplar retail brokers route non-marketable orderers in a manner that is consistent with making rebates. from the 4th quarter of 2012, but subfiles so the shame. we next analyzed the relationship between make
8:24 pm
rebates and several measures of execution quality including the likelihood and the condition in which non market orders trade. the orders represent about 1.5 percent of daily volume and a public database that has have traits and quotes. they are more likely to trade and trade faster and suffer less ever selection than non marketable orders. when decided where to route non-market orderers and situation arise. thanks for the opportunities to discuss my research. >> thank you very much. >> good morning, chairman levin and ranking member mccain and staff and ladies and gentlemen,
8:25 pm
thank you for the opportunities to participate in the hearing and share thoughts on what affects the equity market. we have been opterates as an alternati alternati alternative situation. i use technology and offer a balance simplified transparent model. we believe in the market's responsibility to ensure just principles of trade from the exchange act of 1934. i sought to build a platform that would eliminate the issues with the market. it is owned by fund, hedge funds, family offices and individuals but only has registered broker details as participants. as a result we have a limited number of order times.
8:26 pm
we instituted a time buffer to neutralize certainly struck structural issues we are discovered. iex was the first to publish our reports publically. it is important to recognize we were created within the framework showing evidence that the spirit of the laws do allow for free markets to emerge. we believe the markets have improved and participants trade less expensively and faster than the past. we believe this is due to the improvements that technology delivered and markets being no exception. despite the benefits it is apparent that the u.s. markets are far from perfect and these
8:27 pm
imperfections are the reason why started iex and we believe the number of tradeling destinations each have their own unique technology, products, rule sets and pricing schedules creates complexty and this combined with the lack of clear structure created structure inefficiencies and this has put the health and stability of the overall market at risk without contributing to serve capital formation. due to the complex trading venues, brokers have preverse decisions on where and how to run the rebates. boston basto avoid fees, many o
8:28 pm
the largest brokers created dark pools and isolated clients from the broader market. many of the pools are interconnected as times they are unwilling to route orders to avoid improving the performance of a com peter. third, they maximize profit by increasing trading volumes and many strategy is left unattended as they cover market share over the client orders. and markets that offer different speeds have a direct conflict in the profits garnered from selling the stories versus the same product that enable a participants to trade factor than the market itself. although many of the issues are
8:29 pm
deeply embedded in the market structure, we believe the best policy to address them is those that promote transparency and disclosure. it is recent positive steps. and we will encourage these points. ch standardization of data reporting, and second routeing in a standardizeed form between brokers and clients, and third full disclosure of markets and rule from the market center. the most important implication of transparency will give them the information they need to ask questions and make better decisions. we respectfully ask that careful consideration is given to deciding which issues are better through regulation and free
8:30 pm
market solutions. the second markets exist for investorers companies and as we work through change none of us should forget why the market exist in the first place. >> let's try a first round of question. we will do many rounds as we need and that is true with both panel. we have four votes beginning at 11:00. i will stay here at lease least through the first two and others can came -- come -- make the votes. let's talk about the non-marketable orders. the ones that don't have an immediate match and add or make
8:31 pm
liquidity. they are made non-market ordes d yest. >> that is appears to be true. >> see if we can get that noise to stop. your paper looked at where retail brokers routed non-marketable customer orders and stated that american-trade and e-trade and fidelity and scott trade route orders in a way that suggest that maybe focused on liquidity rebates. how often did those retail brokers route non-marketable
8:32 pm
orders to the exchange offering the highest rebates? >> those four brokers, well 3-4 either route things -- the fcc reports are not good enough to tell the difference between the marketable and non-marketable limit orders. but based on the assumption that is solid, 3-4 either route limit orders to people that pay for order flow and those are probably in marketable orders. or the high fee venue. nowhere else. >> and the high fee venue are the exchanges. >> it is one venue offering the make rebate. >> and they go to the whole sale? >> yes, with the marketable stuff. >> and they are paid for that? >> yes, sir. >> and they go to the high rebate exchange for the non-marketable one? >> yes, sir. >> now your paper assessed
8:33 pm
whether the decision by retail brokers to route non-marketable customer orders to exchanges that pay the highest rebate was consistent with the brokers obligation to obtain best execution of their customer's orders and this is now quoting from your paper. quote, the results of our analysis suggest throuting all non-market officers to exchanges that offer the highest liquidity is non consistent with quality. is that quote correct? >> yes, sir. >> the decision, your paper says, to use a single venue that offers the highest liquidity rebate isn't consistent with the objection of obtaining best
8:34 pm
execution. >> it results in deminished fill rates. >> that is the reason but i quoted you? >> exactly. >> that the eaves -- is that evidence that harms the consumer? >> we think it could be better. >> has that been evidence that harms consumers? >> yes, sir. >> highest rebate and best execution don't go together. >> yes, sir, in certain circumstances they don't go together. not always. >> would that be in the most circumstances where these orders are routed to an ex change? >> the lines to trade with the biggest is where it matters the
8:35 pm
most. >> that is true what i just said? >> yes. now, i expect that some of the retail brokers that are named in professor's paper would claim the fact they directed all of the non-marketable orders to the exchange that plays them the most isn't consistent with providing the best execution to customers. what is your view of that? >> from a practitioner standpoint, i worked with a large broker. the exchange that pays the highest rebate has the longest queue because people posting liquidity want the rebate so more people line up. the second thing to consider,
8:36 pm
getting in the longest line lowers the probability of getting filled because there are more in front of you. the second thing is the inducement on the seller, let's say. where is the seller going when looking for seller stock? they are likely to go to the place that either pays them a fee or definitely to attempt to avoid those who pay or charge the highest fees. getting in the longest line posting in the highest rebate venue makes you the least likely venue to get filled out because of the seller on the other side of the order isn't incentvised to go there. we have run a series of test using capital and they confirmed the finding that the professor outlined in the paper.
8:37 pm
>> can you repeat that finding in your words? >> that routing, specifically with the goal oh lowering the rebate lowers the probability of getting filled and leads to worse execution for the client's order or your own order if the bank is routing on their own behalf. >> does that create a conflict of interest? >> yes. >> is best execution a subjective determination at least in part? >> we would argue more subjective for market orders. with standing orders or
8:38 pm
non-marketable limits it seem like getting filled is paramount. and we noticedit. >> are there subjective factors in both? >> i cannot answer that. >> can you repeat the question? >> is there subjective factors to determine which market to go to for the ones for the orders which are non-marketable? >> sure. at times there are. for example, if you are establishing a new price meaning that you will be the only person on the bid, bidding on an ex
8:39 pm
change that pays the high rebate since you are the only person on the bid makes sense. if you are joining a queue that is thick and has multiple exchanges represented and you chose to get at the end of the longest line that would be a conflict. >> are there subjective factors? >> yes, it is based on what is on the bid which is primarily what is on the stocks. a broker looking to get a rebate isn't in conflict with their duty to their client necessarily. so it is conditional based on the conditions of the stock when you -- this is a complicated answer -- based on what is happening in the stock there are different points and there are
8:40 pm
times you could be getting the highest rebate but not in the client's interest. >> senator johnson. >> professor, i am hearing adverse execution quality, conflict of interest, and it sounds sinister. i want to go to an example of the trade. let's talk about hundred shares at $25 -- $20 -- and you are buying $2, 000 in stocks and you are paying $10 in commission. i used to be paying like $300. so if this is a make or take plan, how much additional money could it cost the consumer if there is a conflict of interest? if is routed to a situation with a higher make or taker fee.
8:41 pm
>> you have two orders imagine. this is the high fee, this is the low, only one trade. one is going to trade and the price is rising to $20. which one trades? the low fee. >> how many times in the strong market do you buy for $10 and it goes up to $20. realistically when i say i want to buy the stock and i made the decision this company is worth $20 a share. >> goldman sach's and others have done studies, but to get at what you ask, we need to have data we don't have. so goldman sach's the claim
8:42 pm
would be you lose 4-5 points >> i buy them for $,000 for the stock, i get it at $20, right? >> no, it won't trade. >> what -- well -- >> you will cancel and chase the market out. that is the point. >> listen i cannot remember a trade where i said i want to buy a hundred shares of $20 and don't get it at $20. >> you are trading volitle stocks without long queues. >> that is what most people do. i am trying to get -- forget the price move -- let's talk about the dollar value of the maker or taker fee. on a $2, 000 trade how much is
8:43 pm
that fee? >> 30 cents per hundred. >> per dollars or shares? >> shares. >> so if the make or take fee is outrageous at -- >> the maximum is 30 cents per hundred shares. >> so on a $2,000 trade the conflict of interest -- the broker pushes it into a make or take where they get 30 cents? what is the high range of this? 30-50? what is the range of pricing on this make or take range per hundred shares. >> negative 14 cents to 32 cents per hundred. >> so you have a maximum range of 40 cents. so if i am doing a $,000 trade you are concerned about a conflict of interest where i
8:44 pm
might pay 40 cents on the trade. >> your assumption you trade is wrong. >> i have been able to trade. >> maybe you have. >> how many times don't people get to? >> the rate is 25%. reports since 2010 have been highlighting the stock in which this has a huge impact on trading out of cost. >> how much is the standard retail guy, i am a long term investor and i am looking at the stock and i go i think this is worth $20 and i will buy the $20 but if not, no harm or foul. when you talk about 25 cent traits -- is that like individuals myself. i will pay any price and only
8:45 pm
use $20. >> schab doesn't do this. >> how many, and let me ask you, how many trades in the retail brokers like td america trade don't get executed? >> we asked for their data and they don't respond. >> where did you get it from? >> from a major i bank. >> what is the data? >> two different venues and ship from the same time and we watch what happens and then use data from the entire market place. all trades and quotes. >> i see td america trade said they were making $200 million which sounds like a lot but isn't it true the market trades almost $27 trillion per year.
8:46 pm
so what is $200 million. >> we are hear to speak to is the poor investor, not like you, that wanted to buy at $10 and didn't get to because the market moved away -- >> i am trying to figure out how often that is -- finish the answer, i am sorry. >> with better data i could answer that. it could be as big as 25% difference in getting the trade done. >> watt i am concerned about is just, creating this sinister atmosphere of words like dark pool and conflict of interest and what we are talking about literally, i think, is 30-40 cents on a $2,000 trade. i have looked add at my coast of the trade going from hundreds
8:47 pm
down to ten dollars and no we fight over 10.30 or 10.40. we are talking about government intervention versus letting the free market system drive competition and that is what happened over my life temperature -- life time it is more affordable and transparent. >> i am not arguing with that. >> you want to give a more response that really this hearing doesn't matter -- either you or -- either one of you. >> to respond to that, i think the fact that it is 30 cents for
8:48 pm
a hundred share and it is a $2, 000 trade is the point. you can view this as trival nature of why they are doing this. the conflicts are real and even though the harm is diffuse. there are retail investors invested in large pension funds and mutual funds who are affected by this. so i think trying to say sense it is a small amount it can be used against the conflict and it is principle based argument. the other part on cost. cost have come down. technology has delivered that cost reduction. there is a harvard story showing
8:49 pm
that extra low broker services and trade is falling down to $8 and that report was written in 2000. so when you look at the cost of technology since the year 2000 it is down further. competitive forces should be setting prices. but we have a prisoners dilemma. the one that moves away from the exchange rebate, if people still go after the rebate, they will use market share. so i think when you look at payments, it is something to say there is a known conflict in the market and let's address it. the size of the conflict relative to the amount traded isn't a reason to ignore the issue. >> and with that increasing technology, hasn't that
8:50 pm
facilitated to a significant increase in volume of trade as well? >> i think the fact that advances in technology rehabilitation harnessed by certain participants and there is nothing wrong with that. the challenge the market is faced with, and i think the biggest confusion out there, is the person that pay for the severs has an unfair advantage versus the person trading over a retail account. >> i think that is the key to this problem. there are certain players that make this an unlevel playing field whether it is 30 cents or whatever. >> sure. in order for the person at home to get disadvantage by the person that has spent all of money on high-speed technology. in order for them to be
8:51 pm
disadvantage they have to trade and that trade has to happen on a market. the market's responsibility in your view is knowing that different parties have different access to technology but when the trade happens the condition which the trade happens is fair. meaning we have no bias what happens when this trades. and the problem is technology has evolved and you know, the exchange or the dark pool or market itself should have advances in their own technology to ensure we are investing in technology that maintains the fairness. and people got in the business of selling technology as the markets evolved and people are enabling participants instead of maintaining their neutrality and as that happened the condition for fair trading changed. what is happening in the market
8:52 pm
itself creates a significant situation we believe is unfair. >> well, sir, many commonitators including the editors of the wall street journal noted that they are enabled a number of high frequency trading practices. do you think reg-mns should be reformed? if so, what do you recommend? >> i think it makes sense. you have multiple markets and want to attempt to tie them together. if you eliminate the conflicts and that brokers have invested in technology and get around the liquidty. we had the problem in 2007-2009 and solved the problem.
8:53 pm
so free market solutions can emerge to address the issues. i think undoing it, runs the risk of again, further unintended conscious consequences. it is something that warrants review. it depends on what regulation comes out of redefining what it does and that is something i cannot com comment on. >> any suggestions? >> do it with a pilot study and study it carefully. >> have you got other solutions? >> with regard to high frequency trading that is not something i studies. >> michael lewis in 60 minutes interview regarding his book "flash boys"ed that the stock market is rigged. is that an accurate description?
8:54 pm
>> so, you know, we have discovered that investors have systemmatically disadvantaged in the way the market is set-up. rigged is a word that can describe that. it is loaded but it describes, again, the investment process isn't broken. i am an investor in this market. rigged gave the critics and people part of the problem a reason to talk about something else other than what we were talking about which was the much more precise way to put it or question which is the disadvanta disadvantages and how they are created. it was a distraction. the interesting part was the people taking most offense to the word were on wall street.
8:55 pm
we have a tendency to talk to ourselves on wall street and the response is anything but the name we hurt investor confidence in the things we brought to light and everyoning is opposite of that in terms of the general public and their reaction to what we said and did. >> on the issue of colication how do you address something like that? someone rents a place or computer? they are free to do that. that is america. how do you address that issue since it seems to be one of the facilitating aspects of this whole system? >> i think, you know, i don't think you can regulate it. if you say you cannot share space next to the engine
8:56 pm
cottages will by estate across the street and throw cables over the fence. it is every markets choice to decide how they would like to set-up the market. at iex we introduced the opposite and put 350 seconds of lateancy between us and customers. we coiled 38 miles of cable and did that for everyone. >> i understand what you did but what is the remedy to this? >> we keep harping on transparency and disclosure and i think that you know, there are differences. >> it should be disclosed if they are locating like this? >> it should be and things like anonymous listing of participants on venues. meaning does one represent 35%
8:57 pm
of the trading volume. if they do, do they represent 50% on every other market. that would indicate something. and i think the message rates across certain participants so much higher than others. i think that we lack as professor said we lack the data. what we learned was from experience and from talking in the industry. but we lack the data and we learned a lot in attempts to provide clearer understanding of what is happening in the market. we can learn so much more. the thing about this is that just discussing and understanding what the advantage is of being 5-10 microseconds from a matching engine is you get information quickly and you can react quickly to getting information. as we push the boundary out to
8:58 pm
350 seconds we had traders and it is small. three. there are dozens of firms that connect. they have taken away something they found valuable. it is every markets choice to do something. it is hard practice to regulate. but with transparency and disclosure they can they can decisions on if they want trade with services. >> senator mccain made refere e references but the best execution can't be waved? >> absolutely. i think it might need further refinement. you know, it is a pretty subjective, i guess it is subjective term and i think it is used liberally. one thing that we definitely
8:59 pm
think -- >> that is a legal obligation, is that correct? >> it is. >> you cannot disclose in best execution of this firm? that would not fly, correct? >> that would not fly. >> do you agree with that? >> yes, sir. >> going back to the best execution -- did i interrupt you? ...
9:00 pm
if it is eliminated i know that the pilot has already been proposed. >> i think that it should have -- which eliminates make or take in certain stocks i think it should be given the chance to prove that eliminating that make or take more harm the quality of the market. so yes i definitely think that steps should be taken. it should be analyzed. >> at least that is taken. >> definitely. >> professor? >> i am an academic. my view would be not to eliminate because you might push things underground and it would be even less able to kind of see what people are doing.
9:01 pm
so, our view would be the book you should do perhaps his push the disclosure back so that it's easier to tell so you don't have to do the studies that we did it to map out how is your broker doing or regarding the orders. we took a first step with this and 2000-2001. >> would you support the test case? >> if you insist on doing -- >> other people are interesting and i have to agree. >> the pilot is better than going all in. >> some of argue it is beneficial and it has rated the lovers bread coming up i think that you indicated that was technology that did not long before. >> i think that the technology both contributed to the spread. >> okay. now, in terms of the -- do they
9:02 pm
make a similar distinction of some high frequency trading may be predatory? >> not all is predatory. some practices are, yes. >> do you make the distinction that some high frequency may be predatory? and that's what hurt regulatoryy investors while others may benefit and hasn't led to the creation of more exchanges and trading markets and more complex order types? >> yes. >> is the proliferation of the trading venues creating opportunities for the predatory high-frequency traders to take advantage of the investments? >> at times, yes. >> and what are those opportunities, what kind of opportunities? >> i think given the structure a quick example of this is that there is 10,000 shares on the
9:03 pm
offer to sell intel at $21 a share. the trading firm could be offering the stock against multiple markets. one of the markets might be a what's called a make or take venue that actually charges someone to the post-liquidity and will pay the rebate to the other side of the trade that comes to access that liquidity. it causes them to row for the orders and move the liquidity in a very predictable systematic way starting at the highest rebate for taking the liquidity and working its way down to those that are charging the highest fee. this predictable routing leads to the lower field rates and ultimately works the execution for data being a combination of
9:04 pm
vast technology, the combination of inducement and of the broker calling for those inducements. so that is -- that would be the series of events. >> you have been quoted as saying that people lost confidence and that they are fair that they are working in their best interest. charging the standard fee regardless of whether the order adds or removes liquidity increases the investor confidence that they are getting a fair deal. >> i think that it is a step, you know, i charge a flat fee regarding us whether you are making or taking the price competition is something that is hard to regulate so some people want to charge a lesser or higher fee and justify through the service. i think that i it is acceptablet eliminating the conflict most of the general public don't know this exists. they are talking through these issues and admitting to the fact they exist and then addressing to the conflict that's kind of
9:05 pm
the way to restore that confidence. so i think that he is addressing this issue will help restore confidence or it is a step in the right direction. >> eliminating would help restore confidence? >> without a question. they said that the data that you use to assess whether the retail brokers were getting the best execution doesn't accurately reflect the typical flow and the results cannot be generalized. how do you respond to that. >> and a couple of the ways the critics seem to ignore the fact where we use all trades "-end-quotes in the equity market over the same time horizon to demonstrate the results that we find with our limited data generalized in the
9:06 pm
marketplace. >> second as we have been pushing it around we wrote the major exchange and operates in two different fee structures and they showed us the retail orders resting on their exchange for a couple of weeks get the same results we get. it'd generates a loss so we are quite comfortable. >> would you be willing to run your analysis frorentyour analyl brokerages identified in your paper if they were willing to give you? >> we spent two years asking for the data to test this because people -- and it's very, very hard. they were starting to do this
9:07 pm
with these institutions and unfortunately they are pushing back and threatening so, the executing venues have threatened that if they share the data with us they will stop doing business with the clients. >> so it's hard to get the data to do the analysis. we were very lucky to find the data. the argument that is at the 30 cents out of order is a tiny miniscule amount. you've given a strong answer in response to that in the ways of the orders that are not filled. it's also you've given it a strong answer to that as well. they have added up to hundreds of million dollars for a blank of the payment revenue of the brokers that do this practice to the ones that don't and you will see the market difference. >> yes, i think it's -- i think
9:08 pm
the revenue source -- >> while, some brokers. we can't paint them all in the same brush. they end up paying a high fee and that is subsidizing the payments due to other players. so some are hurt worse than some benefit. it's depending on who brokered it. >> i have time here so i do want to go back and explore exactly what is happening and what type of harm could be happening. when you're talking about 25% of the trade that you simply are not executing it is more the volatility of that and what is being missed. i will buy the stock. tell me how that works.
9:09 pm
>> they say i want to buy a share of stock is 20, 100 shares at 20. they were routing orders with traded last at the price. that's true a large part of the time. that is the trading experience so some of the stocks are less volatile in the trading day and not all of the people looking to trade it to the trade. some don't because it trades a little bit and moves up. some have a lot of time to just be watching this in real time hundred% of the time most investors like myself you look
9:10 pm
at it about once a year and put the trade. so that is always going to be the case. if you were what invest 100% of the time if you are putting the right type of order you could make sure that you were going to have him executed a trade, couldn't you as the investor makes sure that you get the stock purchased no matter what? >> knocked out of all of the interest in a given price because of the way that they were out. they are putting you at the back of the line of the price over time. and so if the line does not fully exhaust, you go wanted. >> and is this -- this happens in certain stocks all the time. i'm trying to get my mind around the magnitude of the problem because we are using all of the student figures and i agree with the senators this is about restoring confidence in the
9:11 pm
market and i am concerned by throwing out those types of terms and. it's to stick to any retail investor that his advice scene. it's been in the investment banking community in my lifetime but it just seems that we are moving in the right direction and greater constitution and lower prices far easier trading today than it was 20 years ago where you just kind of call the broker and you didn't know what was pulling off and now you've got a computer and you can plug it in. how come i didn't get that --] is almost instantaneous. online brokers are in order and it comes back. >> for the mark order, yes. i'm not going to sit here and argue that we have made games. that isn't what the paper is about. and we are not crying fire in the theater. we are pointing out certain
9:12 pm
circumstances and we are arriving only to be venue that is a disadvantage to investors, so those that get made like we employ the sophisticated technology and processes to seek the best execution for the client orders how can that be if you are always writing to the venue plaques that is what got us interested as academics in this problem. >> and again, you might not be shouting fire but i think the way that this is reported in the press -- i think it really is. do you disagree with that? >> some people out there are yelling fire. >> so again that's what i appreciate about the hearing is about laying off the reality situation to put this all in perspective and again, i want to get back to the overall dollar value of these vague or take arrangements to the total trade. and i kind of want to -- if at all possible if you have some of the historical perspective in terms of how much trading
9:13 pm
commissions there were 20 years ago versus what we are talking about today. >> i will give you one and then i will give it to brad. if you eliminate all of the inducements, the research predicts that one broker would have a 16% burning share decli decline. that's real time now and i would have to say i don't know the answer to the question. >> there is no question that the price per trade has come down with technology. i read this and the last time i will read it again the harvard business review report that is titled how to win a price war talks about electronic brokers changing the terrain of the financial services with their extraordinarily low price services and the prevailing price. here we are in the technical team they sent me this, but the
9:14 pm
price of a gigabyte of storage was $10 today it is 10 cents. so, when we talk about the low fees, the low commissions coming yesterday countdown but they stop going down. and i think that's -- it could probably come down further. the notion of the payment goes away the price will go up, i think that would be hard to justify. and again as you said, become head of the forces will force that out of the market if you double the price per share were the price for the new entrance will come into the market and so i think that it is one where it comes down but it isn't executed for what's happening right now. >> are there other competitors in the marketplace that would conduct the trade the way that you want to see them conduct it, and you've seen those of the companies thaare thecompanies tr with in terms of what is being provided to the service because one thing i value in the online is that i've got research, i've got -- there is just an awful lot within those online platforms that are very helpful
9:15 pm
to the investor. do those competitive systems have similar types of things come is that a part of the recent -- again, it doesn't bother me that people make money they need to provide different money for different products and services. >> i am not as familiar with each individual platform i do know the interactive brokers were out in a way that would be consistent with how i would route them. they are connected in a trade with us. they have been pretty vocal about that. i look at institutional brokers and the professor noted my experience at even working with the people at goldman sachs, they've spent a tremendous amount of time in understanding this conflict where you can route for the rebate and not harm your client and where you row for the rebate and you do harit you doharm the client ande where because it can't talk if
9:16 pm
they offer $21 the rebate someone would pay me to route bears at 10,000 shares and i have 200 shares to buy i can route it there and get the rebate and no one is harmed. if i have 100,000 i cannot have the 100,000 in the venue that is going to pay me because they are only showing 10,000 because i will ruin my experience in the rest of the venue but there are times you can get the rebate and fulfill your obligation into there are times that you can't. and it is up to every broker to understand where that inflection point is and can be very transparent in terms of how they run. >> so, i guess that's my point is if those companies are already present in the marketplace in the way that you are suggesting the conflict of interest so that an individual investors they are biding $2,000 worth of stock doesn't have to worry about being charged 40 cents versus 30 cents. those platforms exist.
9:17 pm
the free market competitive system has already provided that investment model in that level of transparency and kind of getting back to a part of your opening statement you said this is a question that we need government regulation and the force of transparency into the constitution or th the free-mart competitive system based on your answer come you're saying the free-market competitive system is already reacted to it and that civility exists. you are concerned about not being able to have the trade executed were paying another 10 cents on the $2,000 trade there are people out there and they just need to do a little more advertising so that americans understand it or maybe this hearing well hoping that more investors will take a look at finding i guess companies like yours great >> i totally agree with you. i think first of -- for stuff coming you have to let -- make people aware that the conflict does exist and you have to educate them on what the conflict means to them. now they can make a better informed decision as to before
9:18 pm
when they didn't even know that it existed in the first place i think that the disclosure and transparency will let people make better decisions independent marketplace works out. it's one with increased disclosure and transparency everybody knows exactly how the game works and things still happen if you can kind of look back and say i guess that's the inducement wasn't enough or more rented the fact that they made this decision, but right now a lot of it is opaque and the professor noted that it is really, really hard to get the beta and the data that you get is not standardized. it's hard to synchronize across multiple places because the data comes back advising the client data where they've gotten from different brokers or even from the brokers from different venues and it is coming back and all sorts of forms. so i think that the standardization and the force of the disclosure, people will just ultimately make better decisions that is the most proactive way to advance this discussion. >> thinks mr. tremendous. >> professor, the reason that this is an agency problem was first pushed -- and i will
9:19 pm
describe it as the two former chief economist, the justice -- larry was around eight or so was the guy on the board of directors put forth the theory that the test on the paper and they claim that the retail investors, 80 of you, are able to shop on commission. so, the broker that offers the lowest commission will get the retail trade. the brokers that maximize the rebate are able to offer the lowest commissions in fact anecdotal evidence suggests that even in our sample. what they had a higher commission and these other brokers and so the four brokers attract the retail investor by offering low commission and the retail investor trust th trustse broker because the best execution obligations and doesn't have the tools. you can look at the paper and decide how hard it is to figure out what we did. they don't have the tools to understand in this instance we were to the right of venue to maximize the likelihood of the
9:20 pm
execution. that's the agency problem. you can shop on commission, you cannot evaluate the execution quality. and so, they are doing things that make optimize execution quality and they have the lowest commission and they are going to attract a swath of customers that way. and if you talk to people on the board of the interactive brokers, they would complain about this. i'm certainly competition is forcing the commission's lover, but the people that do the practice of the routing of all of the nonmarket to the venue and selling the marketable to the wholesalers, they get more revenue that could be used to push back the commissions, right-click said this is the case where maybe the market cannot fix things unless you can educate to evaluate this decision affirming the nonmarket orders where it's tough. >> so you are saying that maybe it cannot be solved in this case. >> i'm all about free market. >> in this case it may not work.
9:21 pm
>> that's what we are seeing. >> do you agree with that? the >> i think the hardest part is that we launched the new venue before they published the data and before they had the reporting rule we had no idea how we compare to other markets. so other markets would make the claims that could or could not be substantiated. so how do you compete in a market that is completely opaque and it is self generated repor reports. we fully had the chance to solve this problem from the industry standpoint because the data was not available to make good decisions or better decisions. >> i think that the investor can make a decision on where the broker is going to get the best execution. >> that is a good question. i would say probably not.
9:22 pm
but the part is the people that spend the time to look at it, some people in the media are very sophisticated. they understand the heart of the issue and i think that as they report on things that are happening into the retail investors have to look at it and make decisions it does create the right comment on that someone who doesn't understand that people are looking out for their best interest and they can make decisions that way. >> how do they make a judgment on the best execution? objective judgment how is that your average just looking at the fees and the commission? that's lower. pretty attractive. here's what the professors say. if that's not right, professor? how does the average investor do what you think needs to be done to meet some kind of an assessment on the best execution how does he do that? >> writinwriting code again, yoe to put in the requisite amount of time to understand to make the judgment. most people won't. so, again i think that the more that this discussed they get the
9:23 pm
right amount of credit. >> transparency is the answer should the government force transparency? >> there are cases that would help. >> the government would actually have to force transparency. >> i think outlining the types of metrics that needed to be reported in a calculated and presented would definitely be helpful. >> the government has done this once and it isn't a big step woulstep forthey would have to f clean things up. but the market hasn't done that yet. it would take the government forcing.com is that correct? there has been no attempt by the markets to try to solve this issue and this standardizes across themselves to say listening to you to make things easier to understand. we haven't seen evidence that is happening. >> and therefore? >> the government would be very helpful in getting the industry to coordinate to a level to make these issues easier to identify. >> the options market tried to do it on a voluntary basis in 2010 and the numbers that they
9:24 pm
put out for garbage mostly, so yes. >> just a quick comment the way that i evaluate as i put in order for $20 i got it for $20. this is so incredibly complex and there are so many a satiric terms of art you have to bring it back. i'm bringing it back to the simplicity of what happened in a marketplace with individual retail investors and if i put an order for 100 shares and i get it and i'm only paying $10 i'm reasonably satisfied. now there may be some very strange every now and again circumstances where i don't get that share, but i kind of say i didn't get it but maybe there is some harm. but i am highly concerned about the government interference in the marketplace. if there is a very minimal amount of transparency legislation in terms of this is the data that we want everybody to report, again, minimal not a huge regulation that harms the
9:25 pm
market that's something i would be willing to support but i do want to take a look at what is going to do this in perspective and what is the harm that is being caused and let's make sure that we do not do more harm in trying to solve the problem but right now this is a solution but we are looking for. >> i definitely would say that focusing on the disclosure will create the least amount of harm and implementation rather than diving into things such as the location and the actual mechanics of the market. so if we are going to move that forward -- >> i agree 100%. >> mr. johnson -- >> did you want to have disclosure? you want to have transparency so you would agree that it may take the government action to get that transparency? >> and push it back onto the brokers. >> and this is a minor issue that we shouldn't be focused on in a minor scheme of things. >> the recent academics and reporters are around the
9:26 pm
retailers cannot understand it and bring into ligh it to lightn things get cleaned up. >> is this a serious issue? >> we think it is but we also think it is an easy one to fix. >> is this a significant issue? >> i think it is significant and effective as a principle-based issue that you can try to minimize it by trying to, you know, relates how much people are holding for years. but this is a principle-based issue and it comes down to the foundation of why the markets exist into people's trust in those markets. trust is about the same without me paying attention it's happening in my best interest. and when you find out that they are not, that is what undermines it in your opening statement, you know, discussing the fact that we have had one of the -- we have had a tremendous rally from 2009 and yet the amount of the households owning the equities has not solved the trend. so, you know i would argue that a series of events over the last
9:27 pm
number of years have led to a decrease in the investor confidence and lead us to quit our jobs and i think that from the investor confidence standpoint my hope is that march 31 becomes a low point. we have a tremendous amount of calls and e-mails and letters about people who are actually looking to get back into the market. so i do think it is one where if there are people that i feel like we did the wrong thing by speaking about it, we haven't heard from them in the general public. we have gotten a lot of anger from wall street, not all. but again, people embedded in the status quo don't want to see the change happening and i think those that do want to change have been very supportive of us. >> thank you both. appreciate you coming.
9:28 pm
>> i think the votes are starting. we will now call the second panel of witnesses. the president of the new york stock exchange group of new york. joseph, chief executive officer of the global markets and the i hope i'm pronouncing that correctly, the principles and the head of the global group at the vanguard group in pennsylvania and the senior vice president at td ameritrade in omaha nebraska. we appreciate all of you being here today. under the rules as i think that you heard all of the witnesses are required to be sworn in, so we would ask you to please stand and raise your right hand. >> the testimony that you are about to give kobe the whole
9:29 pm
truth and nothing but the truth, so help you god? thank you and we will use the timing system before the light comes on you will see the light changed from green to yellow giving you an opportunity to include your remarks and your written testimony will be printed in the record in its empire tp is limited to more than five minutes. we are going to have you go first. thank you for being with us. >> mr. chairman, senator johnson, we appreciate your interest in the regulatory structure of the capital markets. my name is tom farley and i'm the president of the new york stock exchange trade i've been in the business of running exchange as most of my career including its president and ceo of the vice futures u.s. formerly the new york board of trade. as market operators can't come to the view that the market is highly fragmented again it
9:30 pm
overly complex. the regulations and structures in place today incentivize the participants to make it more complex and more opaque. numerous surveys and recent history have shown that the structure does not contribute to investor confidence were high systems reliability. as the dominant rule setting in the boundaries of equity market structure, regulation set out to accomplish several objectives. the first is to increase competition among the markets and among the borders. while the rule did an excellent job of increasing competition among the markets, we believe the competition in the order has been severely damaged, particularly in the recent years due to the record level of the off exchange trading and increased levels of the order fragmentation. in fact, just last week the exchange trading reached a record high of 45% across all of the regulation securities. this means that despite someone taking a risk to establish a
9:31 pm
national best offer on a displayed market fully regulated exchange or the brokers decided to execute the trade away from that display of the employee regulated market. the people that establish a national best offer wit within execution. we find this troubling and damaging to the price discovery it's to the benefit of long-term investors and public companies. long-term investors benefited in many ways from the implementation of regulation. however, the data shows that some of the benefits such as lower cost might be reversing. in addition, we consistently hear from the large institutions of the investors that there are too many conflicts in the current market structure and that they would like to see the conflicts eliminated or at least reduced. perhaps most importantly, you we hear from the listed companies and on shipping orders that the
9:32 pm
beauty of the market is not designed for them, but rather for the trading community and as a result they have lost confidence in the market. newly listed companies are the lifeblood of the economy and the markets. the goal is simple. reduce the level of complexity and fragmentation of the u.s. stock market to publish the goal there are several unilateral steps that we are committing to take and that we would welcome the industry colleagues to also adopt. to start we are self imposing a six-month moratorium on any new and novel order types of further segment the market. in addition, we've already announced the elimination of more than a dozen existing order types. we defeat these are first steps towards reducing complexities and towards a more sufficient market structure. at the industry level, we are seeking support for the elimination of the make or take price indexing and the use of
9:33 pm
the rebates. broad adoption of the policy would reduce the pricing scheme and further reduce complexities through fewer order types and venues. in conjunction and the elimination of the make or take we be lead by regulation should require that evidence be given to the displayed quotes on fully regulated exchanges. there is a risk involved on such a venue. and we be lead strongly the person taking the risk should be reworded within execution at a price. unfortunately, in today's environment, those displayed quotes are used to inform the trading on the dark markets are not contributing to the price discovery process. the original investors that posted these quotes are all too often left with no trade at all. several including canada and australia fairly recently have adopted the rules that established this type of privacy of public quotes. in the cases of canada and australia the regulators have established that this policy has simplified and even improve
9:34 pm
their market. last come as you heard on the first panel this morning, there are questions as to whether or not some market participants are able to build an advantage by using high-speed data feeds and co- location services. while it should be noted both of the services are regulated and made available to all investors equally weedy leav leave that if something results in a loss of investor confidence we should find a way to change it. we are willing to put all of our options on the table as it pertains to the delivery of the market data however we highlighted this cannot be done in a vacuum and any changes must be applied to all exchange all e carpool venues. thank you for your time and i look forward to answering any questions that you may have. i'm the chief executive officer of the market and one of the founding employees. i want to thank the chair and into the ranking member and senator johnson for inviting me to participate in today's
9:35 pm
proceedings. i was encouraged in this and that's recently expressed by the chair who said that the markets are, quote, not broken, let alone raid. i agree with her. the automation of markets has resulted in significant enhancements in the market quality for the long-term investors. importantly, however, i also recognize the markets are not perfect and that efforts to improve them should never let up or cease. the current market structure is the product of the 1975 active in once to the exchange act and subsequent rulemaking by the fcc to the market system. the fcc working in significant part to the exchanges and others has traded a system that allows market competition while at the same time and just as vital to price competition. today the markets are widely considered to be the most liquid transparent, efficient and competitive in the world. the cost for the long-term investors and u.s. equities are among the lowest globally and are declining.
9:36 pm
these have been noted by investors and experts alike. in april of 2010, vanguard confirmed estimates of the declining cost over the previous ten to 15 years ranging from the reduction of 35% to more than 60%. the savings that flow directly to the investors in the form of a higher returns. in the respected economists they found that between 2001 and 2013 that spread by investors have decreased by more than 70% of the enlisted stocks. in april of 2014, the black rock noted that since 1998 cut the institutional trading costs declined among the lowest in the world. earlier this month, they reported between 2009 and 2013 the implementation shortfall costs decreased from 45 basis points to 40 basis points and dropped from 63 basis points in 2003. further, the market is able to hinder the volume and the traffic considered astronomical in a short time ago.
9:37 pm
the market structure stresses from the 2009 financial crisis indicates the systemic risk that had been reduced as a result. efforts to address the risk since the crash of 2010 are producing further beneficial results. for example, the number of the executions are occurring on the markets and it's in the five-year average. it's in the plan is measured by the so-called declaration that is dropped by more than 80% since the first year after the regulation. we must nonetheless remain squarely focused on improving the market quality and stability in the coherent and responsible way. we are also aware that the investor confidence is important not only to helping americans realize the investment and retirement goals come u about tt plays directly into the overall health of the country's
9:38 pm
economist debate economy into something 20 investors are competent enough to put their hard-earned capital to work in the stock market the entrepreneurs and corporations can grow and thrive as well. as such we are fully supportive of the plan for the comprehensive market structure review and we look forward to participating in the process. among other things i see the following areas is offering a potential benefit benefit withot disrupting existing market quality gains. first institutional investors can benefit from the transparency related to the brokers that they brought orders too. including the publication of the form which some have already done. consistent and thorough reporting standards create the greatest level of investor confidence so additional regulatory direction may be required here. second i support reviewing the current rules designed to provide execution qualities interrupting transparencies. for example, rule 606 could be amended to require disclosure of
9:39 pm
the routing of the institutional orders as well as separate disclosures regarding the marketable versus the nonmarketable orders. third, to strengthen the confidence of the public and the market today that i continue to support the initiatives to make the certain consolidated tapes also know as fast as possible. this is a position that they have advocated since becoming an exchange in 2008. finally, i support the elimination of the ban on the walk markets that we believe is a primary driver of the complexity in the international market system. thank you for the opportunity to appear before you today and i would be happy to answer your questions. >> thank you very much. >> thank you chairman and ranking member mccain and members of the committee for inviting me to purchase a pda. at the vanguard i'm responsible for overseeing the management of the equity index bejeweled funds.
9:40 pm
we serve more than 20 million investors who entrust us with $2.6 trillion of the retirement and education savings. the core mission is simple, to take a stand for the investors, to treat them fairly, and to give them the best chance of the investment success. before getting into the specific comments on the potential improvements in the equity market structure, i would like to make two fundamental points. first the markets are not rigged to really have a high degree of confidence in the market is a safe place for investors to place their assets. second all investors benefited from improvements to the equity market structure. through the regulatory initiatives over the past two decades, most notably the regulation nms, the markets have evolved to a competitive marketplace that is connected to the highly advanced technologi technologies. over time, the structure has led to the low returns action cost for all market participants. individual investors to exit the managers like vanguard has
9:41 pm
benefited from the market structure improvements that have been made over the past 20 years. additional improvements can be made and we are very pleased to discuss those issues and the committee today. we also commend the chair for initiating comprehensive review of ways to further strengthen the markets. we look forward to working with the commission in this regard. i will now briefly discuss the topic that has garnered considerable public attention recently. the high frequency trading. while the term high frequency trading has become short end for disruptive trading, there's a significant amount of legitimate activity such as market-making which also falls into this broad umbrella. today's market structure contains many venues in which the trades can be executed. professional traders are beyond the venues together. our efforts should be focused on banning high frequency trading. rather we suggest the market structure holistically to ensure
9:42 pm
that it's providing the incentive to the activity that we would like to see. to accomplish this goal, we support efforts by the regulators to comprehensively reevaluate. as the time has passed into the markets have changed, most would agree that it is time to reassess whether the regulations continue to further the goals of the national market system. we would suggest most important goal of the market system is to create a structure that encourages market participants to publicly display their limit orders. such a structure promotes the price discovery of the transaction costs for all investors. investors. in that light, they support regulatory efforts to revisit the current make or take pricing model of the exchanges. fundamentally, it is important to understand the models did not develop from our intent. they are the exchanges responses to the proliferation of market sensors in a way for the
9:43 pm
exchanges to contract it could attract liquidity. however they have become unnecessarily complex and the decision to submit the orders to the public markets should not be driven by the desire to capture the rebate. an evaluation of the make or take model must be connected to an analyst of other ways to encourage publicly displayed orders. specifically, we support the pilot of the trade out rule under nms. today market center can execute an order at the best displayed price without actually contributing to public price the discovery process. generally speaking, those that publicly display their interests first should be first for any execution at the price across the markets. the well-designed pilot of the trade rule under could help strike the appropriate balance between promoting public competition of orders while still encouraging competition among a variety of market centers. regulators and industry participants have been working
9:44 pm
diligently over the past few years to take steps to continuously improve the manner in which the markets operate. the equity markets are extremely complex. and it is vitally important to examine all of the potential consequences of any changes to the structure. we leave that the fcc and fnra have ways to improve the markets and we commend them for their work that they have already performed. i thank you for allowing me to participate in discussion and i welcome your questions. >> thank you very much. >> morning, chairman levin, ranking member mccain and members of the subcommittee. my name is steve and i'm the senior vice president with ameritrade. i appreciate the opportunity to be before you today. i thought i would spend a brief moment on td ameritrade so you would have a better understanding of what we do. we are a financial service companies serving primarily retail investors.
9:45 pm
we have over 6 million client accounts with 600 billion in assets including custodial services for 4500 individual representative registered investment advisors and their clients. we are based in omaha mother ask and we are one of the first firms to offer discount commissions to retail investors. since the founding in 1975 1975 county has also pioneered innovations such as touchstone trading, internet trading and most recently mobile trading. we have been on a quest to level the playing field for almost 40 years. as a result of that th of the ce entrusted uthat the clientshavet virtually and in the assets since 2007. we interact with the client and we do third-party surveys to better understand the markets based on this and other data we do the leave the current equity
9:46 pm
market structure has never been better for those retail investors. in fact the number of the accounts that are trading is up 31% on the year-over-year basis. the clients tell us they wanted their entire orders filled quickly and inexpensively at the price quoted or better. in each of those areas, we have seen significant improvements in the last decade as detailed in the written testimony. when it comes to the order routing the broker firms have two options. they can in turn allies and trade against that or they can route that back to the market centers and destinations. based on our open architecture of the unbiased and the unconflicted business model, we belief that it is in the best interest of our clients to send their orders to the mix of market centers including exchanges, wholesale market makers. while these market destinations serve a variety of purposes, we think they are all vital in
9:47 pm
driving the competition that ultimately benefits investors. the subcommittee has asked for their views on conflicts of interest on the broker is obligated to obtain the client orders but also received payments and rebates based on where the flow is directed. we strongly believe the compliance of the best execution obligations improper disclosures brokers can effectively manage any conflict that may arise from the payments. furthermore, we strongly believe that we effectively manage any such conflict. brokers are required to seek the most favorable terms reasonably available under the circumstances for the client orders and in our firm we consider the opportunity to have a better price than currently quoted at the speed of execution and likelihood among other factors when making that assessment. we also give our clients and other choice. the orders can be routed using our proprietary order logic with a can choose from the list of the direct destinations.
9:48 pm
finally we work with multiple destinations rather than internalize the client flow we belief that all workers in the market are more transparent and better aligned with the need of our clients and we select these market centers based on the due diligence where the execution quality is the top priority. after and only after the market satisfies the standards for the best execution due we consider the transaction costs or the revenue opportunities. this process complies with the rules enacted after thoroughly reviewing this issue on numerous occasions. the payment of thei payments ofs received are transparently disclosed as an average per share in the quarterly 606 reports and they are also on the account statements and confirmations that are required. finally, we've provided a subcommittee with a list of recommendations that we belief could enhance the nation's current market structure without compromising many of the benefits to retail investors
9:49 pm
have realized in the past years. just as we constantly seek to improve our clients experience of her industry should do the same but let's not lose sight or compromise the improvements that have been made. we appreciate the opportunity to be part of the conversation. >> thank you mr. quirk. the head of the intercontinental exchange which owns the new york stock exchange which you represent here today said the make or take system this aligns the interests of the brokers and their customers and it hurts everyone in the market. we should get rid of it, he said. do you agree with him? >> leslie also say, senator the u.s. capital markets are indeed the best in the world, but for 225 years the new york stock exchange has stood for in
9:50 pm
proving markets and not just accepting the flawed status quo. to answer your question directly, there are two areas where we are the most concerned about the markets today. one is the appearance of conflicts early because we think that undermines confidence in the markets. and the second is undue cost and complexities in the markets that we have heard a lot about today. make or take gets to the heart of both of those issues and concerns that we have and it's for those reasons that we've advocated eliminating make or take in its entirety in the markets in the country. >> very significant testimony in the exchange which has been here as long as you have been here makes that point.
9:51 pm
and as you said in her testimony, we are seeking support for the make or take pricing and the use of the rebates and the and venues at te broad adoption of the policy was reduced this inherent in such pricing scheme. explain that now to the subcommittee. i happen to agree with you that the conflicts are inherent with tell us in your words why the adoption of elimination excuse me, the make or take pricing would reduce the conflicts that are inherent in such pricing. if i may provide a little bit of context, i came from a company called the intercontinental exchange and we agree they acquire the new york stock exchange and that is giving in 2002 and so we can do this with a perspective of other markets like the futures markets which are deep and liquid and people
9:52 pm
generally will acknowledge that those markets functioned properly and there is no such thing as make or take or pricing, for example. so it was something that we very quickly wanted to understand more about end of the first thing that we noticed is that the make or the take scheme resulted in many more order types in the markets and you have another markets such as, for example the future market and many of those are simply an existence to help the market participants captured the make or take spread so we realizes that introduces a great deal of complexity. with the complex issues that you described in particular, it has been frustrating to us that in the period of the rising stock prices we have not seen my participation in the equities market from the investors in fact, the data shows that the participation in terms of the percentage of the presentation odissipation ofthe u.s. citizen6 year low. and we think that they reason
9:53 pm
for the upcoming important reason for this confidence in the markets. markets rely on the confidence. we can't say that enough. and irrespective of whether or not there is an actual conflict or a conflict that's resulting in some sort of a bad behavior, the appearance of the conflict matters. and it's for that reason that we look at the make or take pricing coming and we say there may be an appearance of conflict if a broker dealer's interests are not aligned with their customers and that is something that can potentially rise with the make or take pricing. >> your testimony goes beyond -- the appearance is important because the confidence issue and also because underneath of the appearance, there may be more than an appearance. your testimony actually is even more clear than that because he's a pretty elimination of the make or take pricing and the use of the rebates and the broad adoption of the policy would reduce the conflict inherent.
9:54 pm
explain that. any reasonable business person doesn't like to be in the position of having their interests not aligned with their customers. when you have the make or take pricing there could be examples. there are examples as the professor described this morning where a broker dealer has an incentive to post the price on a high make rebate then you even if the execution quality on that particular venue is not as high as another venue. that arises specifically because of poor it certainly is exacerbated because of the make or take pricing. >> and that is why there is a conflict inherent in a pricing scheme click >> that's right.
9:55 pm
>> now, mr. ratterman, i will give you a chance before we ask you to comment or react to that, you said earlier this year i believe that the business offers incentives for customers to be in their ecosystem all the time. who are the customers that you are referring to, are they brokers click >> yes or customers are all brokers. now let me ask you could give yoco give youthe opportunity too mr. farley's testimony. >> in the firm we don't be leave that therbeliefthat there shouln the make or take. we are certainly open my answer stems from the potential benefits and the spread of reduction that make or take may
9:56 pm
have produced over the last ten or 15 years. not for any commercial purpose about the way that we were in the exchanges in the business of the matching of the buyers and sellers in the fair and orderly markets when we have a trade we are going to -- we are going to deserve the revenue for the trade as it happens. how he do that come it is today a significant amount of flexibility and i believe that flexibility has allowed for innovation and pricing and market and incrementally the rebates are offered in many cases to the market makers to take the risk and offers in the market has yielded the tight spread over time. i also don't believe that eliminating the make or take would eliminate a conflict. i am talking about the example earlier of the evaluation of the trade examining where he would get a rebate for 30 seconds or pay for 15 cents.
9:57 pm
he's looking at a spread of 45 cents in relationship to that likelihood or the knock likelihood of an execution where he does get paid and when he doesn't trade or his order doesn't fill there is no commission to the broker. by eliminating make or take you would only compress the range of the conflict but it would still exist as long as there is a differential pricing in between exchanges. so i think the only way to potentially limit the conflict then is to mandate of the exchange pricing at a fixed level for all exchanges all the time so the conflict will remain unless there is a significant intervention and i believe that disclosure that we talked about earlier today in the hearin ands the right answer to provide the information so that not only the brokers for the customers can evaluate whether the conflicts have actually been managed well and in favor of the client or not. but i do not see any path by which the conflict can be
9:58 pm
achieved. >> mr. farley, do you want to comment on that click >> we reduced the conflict that is inherent that you talked about and can't reduce the appearance bike removing the make or take of the pricing. areas of the agreement with mr. ratterman i would have otherwise expected he said that may reduce the conflict but it wouldn't eliminate it so we are both agreeing directionally that it would have an impact on conflict or the appearance of conflict in the market. but i also want to highlight it and the reasons whin the reasonn focused on this are twofold.
9:59 pm
one is around the conflict issue into the second is about the complexity and the markets of additional order types and venues and it is worth noting that i have three equities changing and we have a competitor that also has four and a lot of the venues exist really principally because of the make or take pricing and those venues are creating different pricing schemes as the make or take pricing for the customers. ..
10:00 pm
but the market is really not the price because there are rebates and other discounts applied, so we do not have a view of the actual price, which i think is to a certain degree false advertising. you agreed that the thieves are distorting market price? >> tom, i agree with what jeff said. he is my boss, after all. >> he is not listening. [laughter] >> do you believe that fees are distorting market prices? >> if i can, if i could address the comment "that was made, it is a matter of fact that posted prices on exchanges and posted prices that go out through our

44 Views

info Stream Only

Uploaded by TV Archive on