confidence if you try and create a state of fear. and set up strawman in terms of the boogiemen out there trying to game the system. the best way to ensure confidence, the best way to ensure best price, is through maximum competition, and transparency of the marketplace. i'm hoping that's certainly what this hearing reveals, and again i just want to thank all the witnesses. i'm looking forward to the testimony. >> thank you, senator johnson. we'll now call our first panel of witnesses for this morning's hearing. professor robert battalio, professor of finance at the mendoza college of business at the university of notre dame. in notre dame, indiana, and bradley katsuyama, president and ceo of the iex group in new york. i appreciate both of you being with us this morning. woo look forward to your testimony. all witnesses who testify before this subcommittee are required to be sworn. at this time i would both of you to please stand and raise your right hand. do you swear that the testimony you're about to give before this subcommittee will be the truth, the whole truth, and nothing but

the truth, so help you got? we will be using a timing system today. please be aware that 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. all of your written testimony will be printed in the record in its entirety and we would ask that you try to limit your oral testimony to five minutes. professor battalio, we will have you go first. thank you again for your work. >> good morning, chairman levin and ranking member mccain. thank you for inviting me to testify today. it's an honor to have the opportunity to present my views on conflicts of interest. in u.s. equity markets to the senate permanent subcommittee on investigations. my expertise is the relationship between order flow inducements offered by dealers and exchanges and the quality of trade execution. before discussing my current research with shane coreland and robert jennings i'd like to provide a bit of context. orders used by retailers can be broadly classified into two categories.

investors who want to trade quickly at the best available price use marketable orders. these orders demand or take liquidity from the market. investors who are willing to buy or sell stock but not at the prices that are currently prevailing on the marketplace use nonmarketable or standing orders to express their trading interests. nonmarketable orders do not immediately execute when they arrive on the market. exchanges use electronic books to keep track of their orders and they typically use price time priority to determine which nonmarketable order trades when the marketable order arrives. the nonmarketable orders resting on the electronic books make or supply liquidity for other market participants. several exchanges use make or liquidity rebates to attract nonmarketable orders. a make rebate is paid to an investor or her broker when their nonmarketable order trades to fund the make rebates, the same exchanges charge marketable orders a take free when they trade with nonmarketable orders.

as a result of competition, exchanges offering high make rebates also tend to charge high take fees and those offering low make rebates tend to charge low take fees. the incentives created by the maker taker fee structure suggests marketable orders will tend to be first routed to venues that have low take fees. and thus low make rebates. as a result, nonmarketable orders on high fee high rebate venues are likely to trade last at a given price. and thus can miss out on profitable trading opportunities. all odds equal this suggests that the likelihood that nonmarketable orders trade is lowest on the exchanges with the high make rebates. nasd notice to members 01-22 states that brokers must take into account differences in the likelihood of execution when determining where to route nonmarketable orders and that brokest must not allow inducements to interfere with the duty of best execution. the conflict of interest associated with make take fee

schedules arises from the fact that most brokers don't pass fees and rebates directly through to their customers but instead charge fixed commission rates that reflect fees, rebates, and other costs of doing business. thus while investors can prefer -- thus while investors prefer that the order be routed to the venue offering the highest possibility of trade, a broker may route the order to the venue offering the highest liquidity rebate. it may seem that economics and competition should align the incentives of a broker and its customers. however, this alignment of incentives is hampered by an important agency problem. brokers that maximize rebates may be able to charge lower commissions. if the investor chooses brokers based primarily on commissions, perhaps because they lack the sophistication, and/or the necessary information to fully evaluate execution quality, it may be profit maximizing for brokers to focus on liquidity rebates rather than the likelihood of execution when

deciding where to route their nonmarketable orders. unfortunately investors whose orders don't execute don't receive the benefit of the low commission. in our paper we examine two issues. we begin by exploring whether make rebaits influence the routing of retail brokers. we present evidence from s.e.c. mandated rule 606 filings at four popular retail brokers, route nonmarketable orders in a manner that's consistent with the goal of maximizing make rebates. our rule 606 data from the fourth quarter 2012 but sun subsequent rule 606 filings suggest these brokers have not significantly altered their routing of nonmarketable orders. after establishing that rebates appear to impact order routing decisions of some brokers, we next analyzed the relationship between make rebates and several measures of execution quality, including the likelihood that, and the conditions in which nonmarketable orders trade. our analysis makes use of a proprietary data set of nonmarketable orders that

represent about 1.5% of average daily volume. as hypothesized we find that nonmarketable orders routed to venues with low make rebates are more likely to trade, trade faster, and suffer less adverse selection than nonmarketable orders routed to venues with high make rebates. our results suggest that when decided where to route nonmarketable orders, situations frequently arise in which brokers must decide whether to maximize the likelihood of an execution, or to maximize make rebates. thanks for the opportunity to discuss my research with shane and bob today. >> thank you very much. professor battle yo. mr. katsuyama. >> good morning, chairman levin. ranking member mccain, senators, staff, ladies and gentlemen. thank you for the opportunity to participate in this hearing and share our thoughts on issues affecting u.s. equity markets. my name is brad katsuyama and i'm the president and ceo of iex group. since october of 2013 iex has been operating as an alternative trading system for u.s. equities. we intend to -- iex was founded on the premise of institutionalizing fairness in the market through the use of technology and offering a balanced, simplified and transparent market model.

we believe strongly in a market's respondibility to ensure just and ecquitable principles of trade as required by section 6 of the securities and exchange act of 1934. with that in mind, iex deliberately sought to build a platform that would eliminate conflicts of interest in your market. specifically iex is owned by mutual funds, hedge funds, family offices and individuals but only has registered broker dealers as trading participants. iex does not pay rebates or provide any other payment or flow and we have a limited umber of order types. iex has instituted a time buffer that applies to all of our trading participants to neutralize deficiencies we discovered. we use direct data feeds from all u.s. exchanges rather than the slow sip to price trades in our market and a ex was the first ats to publicly publish our ats in an effort to promote trance irensy. it's important to recognize that iex was created in the framework

serving as evidence that the spirit of the rules governing our current market do allow for innovative free market solutions to emerge. we believe the u.s. equity markets have improved dramatically over the past 20 years as participants can trade less expensively and faster than they did in the past. we believe this was mainly due to the inevitable improvements that technology has delivered across many industries. with financial markets being no exception. despite those benefits, it's become apparent to our team and our supporters that the u.s. equity markets are also far from perfect. and these imperfections that we have discovered over the last several years are the reason we started iex and the reason i'm sitting here today. we believe that the number of independent equity trading destinations across exchanges, dark pools and other internalizes each having their own unique technology, products rule sets and pricing schedules creates a tremendous amount of complexity. this combined with the lack of clear language disclosure has created structural inefficiencies which allow unfair advantages and disadvantages to various market participants. this complexity has also put the

health and stability of the overall market at risk. contributing to the market's ability to serve its core function, capital formation. the the conflicts of interest we would like to highlight. first due to the complex fee and trading structure brokers have perverse incentives when deciding where and how to route customer trades. many high quality studies including the one from professor battalio have demonstrated the direct relationship between a broker attempting to harvest rebates and worst execution quality for their customers. based on our team's prior experience we can confirm these findings. second to avoid high fees, many of the largest brokers created their own private dark pools to internalize order flow. in the process, isolating client orders away from the broader market. although many of these broker pools are interconnected at times, brokers are unwilling to route orders to other broker pools to avoid improving the performance of a competitor. even though it may be in the best interest of their client to

do so. third, trading venues, including exchanges in dark pools naturally seek to maximize profits by increasing trading volumes. and as a result, there are many predatory, high volume trading strategies that are left unattended as certain markets prioritize market share over protecting the interests of client orders. and fourth, markets that offer colocation and different speeds of market data and connectivity have a direct profit in these services versus the structural inefficiency created when those same products enable a participant to trade faster than the market itself. to the detriment of any participant who relies on the market to fairly price trades. although many of these issues are deeply embedded in our market structure, iex believes that the best policies to address these conflicts are those that promote transparency and disclosure. the s.e.c.'s website and ats reporting rule are recent positive steps and we would encourage further pursuit of transparency, specifically these three points. first, standardization of data

collection and reporting, second, disclosure of both routing and trading information in a standardized form between brokers and clients. and third, full disclosure of rules, products and services from all market centers. the most important implication of transparency is that it brings accountability to all participants in our market. heightened forced transparency will give participants the information they need to ask critical questions and to make better decisions. this will allow the market to self-regulate. respectfully ask that if congress or the commission looks to further modify the structure of the equity markets, careful consideration is given to deciding which issues are better solved through regulation, and which issues are better addressed through free market solutions. in closing iex would like to echo s.e.c. chair white's recent statement that quote the secondary markets exist for investors and public companies. and their interests must be paramount. as the financial services work

through this period of change none of us should forget why the market exists in the first place. thank you. >> thank you very much mr. katsuyama. let's try a first round of eight minutes if that's all right. we will have many rounds as we need it. and that's true with both panels. we have four votes that are going to begin at 11:00. i will stay here at least through the first two votes and miss those votes as currently planned, and others can come and make the votes, should they wish. professor batallio, let's talk about the nonmarketable orders. these are the ones that don't have an immediate match in the add or make liquidity. under the maker taker pricing, most exchanges are willing to pay brokers for sending them nonmarketable orders. so far -- >> yes, sir, very good. >> some retail brokers send virtually all nonmarketable orders to exchanges that pay a rebate is that correct. >> that also appears to be true. >> see if we can get that --

>> now, your paper -- your paper looked at where retail brokers routed nonmarketable customer orders and stated that ameritrade, e-trade, fidelity and scottrade route orders in a way that suggest that may be focused on liquidity rebates. how often did those retail brokers route nonmarketable orders to the exchange offering the highest rebate? >> those four brokers -- well, three of the four brokers either route things called -- so the s.e.c. reports are not good enough to distinguish between marketable and nonmarketable limit orders. okay. but based on an assumption that's pretty solid, three of the four either route market -- either route limit orders to people that pay for it or flow and those are probably marketable orders. or to the high fee venue. nowhere else. >> and the high fee venue are

the exchanges? >> it's one venue offering the high make rebate. >> when it comes to order flow they go to the wholesale brokers generally, is that correct? >> with the marketable stuff they go to the wholesalers. >> and they're paid for that? >> yes, sir. >> and they always go to the high rebate exchange -- >> the one high fee -- >> for the nonmarketable one. >> yes, sir. >> yes, sir. >> now your paper assessed whether the decision by retail brokers to route nonmarketable customer orders to exchanges that pay the highest rebate was consistent with the broker's obligation to obtain best execution of their customers' orders. and this is now quoting from your paper. quote, the results of our analysis suggest that's routing all nonmarketable orders to a single exchange that offers the highest liquidity rebates is inconsistent with maximizing

nonmarketable order execution quality. is that quote correct? >> yes, sir. >> all right. now, the decision, your paper says, to use a single venue that offers the highest liquidity rebates does not appear to be consistent with the objective of obtaining best execution, closed quote. am i quoting you correctly. >> yes, it results in a diminished fill rates. >> that's the reason why, but nonetheless, i quoted you accurately? >> exactly. >> is that evidence of a conflict that harms consumers. >> we certainly think that the routing could be done better, yes. >> well, to put it in terms that i understand.

is that evidence of a conflict that would harm consumers. >> yes, sir. >> and your data then shows and your conclusion shows that highest rebate and best execution do not go together. >> yes, sir. in certain circumstances they don't go together. not always, but certain circumstances. >> would that be in most circumstances where these orders are routed to an exchange. >> so in the most actively traded stocks where the lines to trade are the biggest of the that's where it matters the most. >> and that would be true what i just said? >> yes. >> now, mr. katsuyama, i expect that some of the retail brokers

that are named in professor batallio's paper who claim that the fact that they directed all of their nonmarketable orders that pays them the most is not inconsistent with providing the best execution for their customers. what's your view of that. your mike please. >> so from a practitioner's standpoint. prior to iex i worked and ran trading at a large broker dealer. you know, i think there's two ways to look at it. first is that the exchange that pays the highest rebate will have the longest queue because people that are posting liquidity, let's just say, on the bid, they want the rebate. so more people will line up, because of that inducement. the second thing to consider, so getting in the longest line will lower your probability of getting filled because there are

more people in front of you in line. the second thing to consider is the inducement on let's say in this instance the seller. where is the seller most likely to go when selling stock to sell stock on the bid? the seller is most likely to go to the place with -- that either pays them a fee, or definitely to attempt to those who pay -- or who charge the highest fees. so getting in the longest line, posting in the highest rebate venue, exposes you to larger competition reducing the probability of fill and it also makes you the least likely venue to get filled at because the seller on the other side of the order is not incentivized to go there first. so it works both ways. we've run a series of tests on this using our own capital back when i was at rbc and they confirmed the findings that the professor battalio outlined in his paper. >> and can you repeat that finding in your words? >> sure. that routing specifically with the goal of maximizing your rebate lowers the probability of getting filled and it leads to adverse execution quality -- worse execution quality. for the client's order who you're representing or even your own order, if the bank's routing on its own behalf. >> does that create a conflict

of interest? >> yes. >> let me just go back to professor batallio for one moment. is best execution a subjective determination, at least in part? >> at least in part. we would argue more so subjective for market orders because a lot of determinates go to figuring out whether you have a good trade price or not. with standing orders or these nonmarketable limits it seems like getting filled is paramount. we came across a nasdaq notice

to members 01-22, after we submitted this draft to a journal and will incorporate, and we will certainly use that to buttress what best execution means for nonmarketable limits. fill rate is paramount. >> but is there also subjective factors in that determination for both? >> you're pushing the balance of what i -- >> all right. you can't answer. >> can't answer. >> mr. katsuyama? >> sir, can you repeat the question? >> is there subjective factors in determining which market to go to for the ones for the orders which are -- non -- let me get the ride word here. nonmarketable? >> sure. at times there are for example if there are -- if you're establishing a new price meaning that you will be the only person on the bid, bidding on an exchange that pays a high rebate since you're the only person on the bid, it is justifiable. it makes sense. if you're joining a queue that is very thick that has multiple

exchanges represented and you choose to get at the end of the longest line, i would say that would be a conflict. >> would that be a subjective factor -- are there subjective factors in that determination? >> yes. it's based on what is currently on the bid which would primarily be determined by the stock. so there are factors where a broker looking to get a rebate isn't necessarily in conflict with their duty to their client. so it's conditional, based on the -- conditions of the stock -- this is a complicated answer. based on what's happening in the stock, there are different decision points and there are times when you could be getting the highest rebate but also serving your client's interest. >> and there are times when it's not true? >> yes. >> senator mccain? senator johnson. >> thank you, mr. chairman. professor battalio, i'm hearing terms adverse execution quality. conflict of interest. dark pools. it all sounds pretty sinister. what i want to do is go to an example of a trade so we can really kind of put this all into perspective.

let's talk about 100 shares at $20 just a retail consumer, placing that with a broker. if you're using one of the online brokers it's costing you $10. so you're basically buying $2,000 worth of stock. you're paying $10 to buy $2,000 worth of stock. 20 years ago i know i'd be paying $200, $300 commission, correct? >> yep. >> now we're paying $10. so if this is going into one of these dark pools, or if this is going into one of these maker taker arrangements, how much additional money could it cost the consumer, if -- if there's a conflict of interest? if it's routed to a situation where there's a higher maker taker fee? >> so imagine, you have two orders to buy. one here, one here. this one is the high fee venue. this is the low fee venue. only one trades so they want to buy at ten. one's going to trade and then the price is going to rise to 20. which one trades. the one on the low fee venue. >> first of all, how many times in the stock market do you try

and buy a stock for $10 and it goes up to $20? >> okay, make it go to $11. >> again, realistically, when i put in a trade i say i want to buy a stock, i made a decision this company is worth $20 a share. and i put in an order for 100 shares. i'm going to get that executed 20 bucks, aren't i? >> so at -- goldman sachs and others have done studies kind of with better data than we have. so data is a big problem to do these types of analyses. to really get at what you ask we need to have data that we don't have. so -- so goldman sachs, the claim would be that you lose three basis points, five basis points, over the course of a day by making an inferior order routing -- >> i'm talking about a retail investor like myself. i buy 100 shares of stock at 20 bucks i'm going to pay $2,000. you buy the stock. okay. i'm going to get that stock at 20 bucks, aren't i? >> no. >> if i put in an order. if i put an order, did i say i want to buy that stock at $20. i get it at $20.

>> no. you won't trade. one person -- >> so what do i -- well -- >> you're going to cancel -- >> if the order is on the books. >> you're going to cancel and chase the market up. that's the point. does this happen always? no. >> listen, i can't remember a trade that i haven't put in where i say i want to buy 100 shares at $20 where i don't get it at 20 bucks. because i put in a stop/loss. i'm only going to buy it at 20 bucks. >> you're trading volatile stocks that don't have long queues. that's my answer to you. the data -- >> that's what most people do. so anyway, look again i'm trying to get -- forget the price movement. let's talk about just the dollar value this maker taker fee. on a $2,000 trade how much is that maker taker fee? on 100 shares of stock, at $20 a share how much is that maker taker fee? >> 30 cents per 100.

>> 30 cents per 100 what dollars or shares? >> shares. >> so if there's a maker taker fee that's just outrageous at what 50? >> the maximum is 30 cents per 100 that they can charge. the taker fee. >> so we're talking about on a $2,000 trade, this conflict of interest, a broker's going to, you know, push a trade into a maker taker arrangement where he gets 30 cents? versus -- i mean what's the high range of this? 30 to 50? 30 to -- what is the range of pricing on this maker taker arrangement per 100 shares? >> negative 14 cents. maybe to 32 cents per 100. these are all per 100. >> so you've got a maximum range of 40 cents. so if i'm doing a $2,000 trade, you're concerned about a conflict of interest where i might have to pay an additional 40 cents on a $2,000 trade. is that what this is about, really? >> no, it's about the fact that you didn't get to friday. so your assumption that you trade is wrong. >> but i always have been able to trade. >> maybe you have. >> how many times have people not get to trade? >> the difference for certain types of stocks at certain circumstances, the difference at flow rate is 25%. stanford bernstein puts out reports since 2010, highlighting the stocks in which this type of routing has a huge impact on whether or not you trade at a price. >> now how much -- how much of that is institutional investor

and the high frequency trader versus, you know, the standard retail guy that, again, i'm looking at -- i'm a very long-term investor. and i'm looking at a stock and i go, really, i think this thing is worth 20 bucks and i'm willing to, you know, i'll buy it at 20 dollars but if not, no harm, no foul. so, there are definitely different investors, right? so when you're talking about 25 cent trades not being executed is that in all the institutional or very high volume or is that really individuals like myself to say you know, i want to buy 100 shares of stock i'll pay any price or i'll put a stop order and say i'm only going to buy it at 20 bucks. >> so is schwab a retail broker? because they don't make this decision. is an interactive broker re -- >> i'll surely ask in the next panel those folks, how many trades into retail brokers like schwab, like td ameritrade don't get executed? do you have any idea? >> we've asked for the data and they've never responded to give us the data. we can't answer. >> so where did you get your data from? >> from a major i-bank. >> and again what's the data on? >> orders, they get routed to two different venues. they show up at the marketplace

at exactly the same time and we watch what happens. and then we use data from the entire marketplace. all trades and quotes. >> i did see td ameritrade revealed how much they're making on this maker and taker this order flow fee something like $200 million. sounds like an awful lot of money. but isn't it true that the market trades almost 27 trillion dollars per year? >> sure. >> so what's 200 million in relation to 27 trillion in percentage. >> what we're here to speak to is the poor investor, not like you, that wanted to buy at ten and didn't get to because the market moved away and the broker choose to route, make sure, so the broker routed -- >> again i'm trying to figure out how often that is. okay i'm sorry.

>> let me finish the answer. >> with better data i could answer that. in our data set it can be as big as 25% difference in getting the trade done. >> okay. i'll just finish by saying, you know, what i'm concerned about is again just creating this sinister atmosphere, words like dark pool, and conflict of interest, and what we're talking about, literally, i think, is 30 or 40 cents on a $2,000 trade. or maybe a $3,000 trade. we're really talking about minuscule amounts. and again, what i'm looking at is over time of investing, i've looked at my cost of a trade going from hundreds of dollars, down to 10 bucks and now we're arguing over it should be $10.30 or $10.40. i don't know. i'm just trying to put it into perspective and trying to figure out where the problem is here that i guess we're talking about potentially government regulation intervention which i think might have very harmful unintended consequences versus letting the free market competitive system drive

transparency, drive competition, and that's what's happened certainly over my lifetime of investing over 20 years. it's gotten from my standpoint more transparent and a whole lot cheaper. >> i'm not arguing with that. >> okay. well good. thank you, i'll be back. >> thank you, senator mccain. >> you want to give a more elaborate response to -- that really this hearing doesn't matter, either you or mr. battalio, or you mr. katsuyama? >> so i guess just to kind of respond to that, i mean, i think, you know, the fact that it's 30 cents for 100 shares, and it's a $2,000 trade, i think that's exactly the point. we're talking about conflicts where, you know, there's evidence that there -- brokers are routing to get this 30 cents, and they're representing the $2,000 order. it can go on both sides. can you view it as trivial. but you can view the trivial nature of why is the broker doing that in the first place if they're representing a $2,000 trade? so it is one where, you know, the conflicts are real and i think that even though the harm is diffuse, you know, there are -- there are detail -- there are more retail investors invested in large pension funds

and mutual funds. and you know, who also are affected by this practice. so i think that, you know, just trying to say that, you know, since it's a small amount, it could be used against the fact that the conflict exists, and it could be, you know, i think that it's a principle-based argument. the other part on cost, costs have come down. of course they have. technology has delivered that cost reduction. you know, there's a harvard business review study titled how to win a price war. and talked about electronic brokers are charging competitive terrain of financial services with their extraordinarily low brokerage services, the prevailing price for discount trade has fallen from $30 to $15 to $8 in the past few years. that report was written in 2000. so when you look at the costs of technology since the year 2000, it's fallen even further. so i think that it's -- it is one where you know competitive forces agree with the fact that competitive forces should be setting prices. the problem is that the

inducement is so great, we do have a prisoner's dilemma. where every exchange pays an exchange rebate the one that moves away from the exchange rebate, if people are still incentivized to go after that rebate they will lose market share. so i do think, you know, when you look at payments, it is something to say, there's a known conflict in the market and let's just address it. the size of the conflict relative to the notional amount traded, it's not a reason just to ignore the issue. >> and with that increase in technology, hasn't that facilitated to a significant increase in volume of trades, as well? >> so you know, i think the fact that tech -- advances in technology have been harnessed by certain participants, i think that's part of free market competitive forces and there's absolutely nothing wrong with that. i think the challenge the challenge that the market was

faced with, i think one of the biggest confusions out there is that the person that buys co-location and pays for these servers has an unfair advantage versus the person sitting at home trading over, you know, a retail account. there will always be a symmetry -- >> actually i think that's the key to this problem. is that there are certain players that have made this a non-level playing field. whether it's 30 cents or whatever. >> sure, so when those two, in order for the person at home to get disadvantaged by the person that has spent all of the money on high speed technology, in order for them to be disadvantaged they have to trade. and that trade has to happen on a market, you know the market's responsibility at least in our view is that, you know, that knowing that different parties will have different access to technology, and different levels of resources, different levels of information. but when the trade happens, that the condition with which this

trade happens is done -- is fair. meaning that we have no bias one way or another what happens when this trades. and the problem is technology has evolved, you know, the exchange, or the dark pool, the market itself, should have advanced their own technology to ensure that we're investing in technology and building solutions with technology that maintains this fairness. and the problem is is that as the markets have evolved people got in the business of selling technology. people got in the business of actually enabling participants, rather than creating and maintaining their neutrality. and i think that as that happened, you know, the conditions for fair trading changed. you know, when your participants understand the market, what's happening in the market faster than the market itself, that creates a pretty significant situation that we believe is unfair. >> well, sir, many commentators including the editors of the

emergency have noted that reg nms has enabled or exacerbated a number of predatory high frequency trading practices. do you think that reg nms should be reformed, and if so, what would you recommend? >> sure. you know, so i think reg nms, the spirit of reg nms as was indicated makes sense. you have multiple competitive markets and you want to try to attempt to tie them all to the. i think if you eliminate some of the conflicts in how orders are routed that brokers have invested heavily in tech nothing that can get around this issue of liquidity disappearing. i mean we went at rbc we had this problem in 2007 to 2009. then we solved the problem. so i think that free market solutions can emerge to address the issues with regular nms. i think undoing reg nms runs the risk of again further unintended consequences. how exactly do you address it? i think that it is -- it's something that definitely warrants review. it just depends on what

regulation comes out of redefining what reg nms does. and that's something that obviously i can't comment on. >> you have any suggestions, mr. battalio? >> if you do anything to reg nms do it with a pilot study and study it very carefully. >> have you got other solutions to this issue? >> with regard to high frequency trading, that's not something i've extensively studied, no. >> mr. katsuyama michael lewis in his 60 minutes interview regarding his excellent book "flash boys" said that the stock market is rigged. is that an accurate description? >> so we've discovered that investors are systematically disadvantaged in the way the markets have been set up. i think rigged is a word that can be used to describe that. i think it is loaded. i think it describes -- the investment process is not broken. i'm still an investor in this market. you know, rig, what it did is it kind of gave our critics and people who are part of the problem a reason to talk about

something else. other than what we were actually talking about which were these, you know, a much more precise way to put it or a much more precise question which is the systematic disadvantages and how they are created. so you know, it of a distraction which was unfortunate. and i guess the interesting part is that the people who took most offense to that word were people on wall street. we have a tendency to talk to ourselves on wall street, and i think that, you know, the response we've seen from the general public is anything but -- you know, i guess the claim that we hurt investor confidence in the things that we've brought to light, you know, everything that we've seen i think would be exactly the opposite of that in terms of the general public and their reaction to kind of what we've said and what we've done. >> on this issue of co-location, how do you -- how do you address something like that?

somebody rents a place or computer. they are free to do that. that's america. what do you -- how do you address that issue since co-location seems to be one of the facilitating aspects of this whole system. >> sure. yeah, i think, you know, you can -- i don't think you can regulate co-location. if you say to an exchange you can't sell space next to your matching engine, cottage industries will pop up and buy real estate across the street and throw cables over the fence. so i think it's every market's choice to decide how they would like to set their market up. at iex what we've done is we've introduced almost the opposite of colocation, where we've put 350 microseconds of latency in between us, and all of our customers. which essentially means that we've coiled 38 miles of cable in a data center and we do that for all of our participants. 9 opposite of getting close is pushing everyone an equal distance away. >> i understand what you've

done. but what's the remedy to this? >> i think the remedy is, you know, we keep harkining on transparency and disclosure. and i think that, you know, there are distinctive -- >> it should be disclosed if they're co-locating? >> it should be disclosed. but also things like you know, anonymous listings of participants on venues. meaning, does one participant represent 35% of our trading volume? or 50% of your trading volume on any dark pool or exchange? and if they do, do they represent 50% of the volume on every other market? because you know, if they're an outsized portion of your own order flow that would indicate something. so i think that or the message rates across certain participants so much higher than others. i think that we lack, you know, as professor battalio said, we

lack the data. what we learned we learned from experience. we learned from talking in the industry. but, we lack the data and i think, again the s.e.c.'s midas february scythe, the ats report we learned a lot and basically two attempts to provide clearer understanding of what's happening in the market we could learn so much more. you know the thing about co-location is that, you know, just discussing and understanding what the advantage is of being five or ten microseconds away from a matching engine, you get information quickly. and you can react quickly to getting information. as we push that boundary farther out to 350 microseconds what we found is that we did have certain high frequency traders that did show up to iex. but the number of those high frequency traders was small. right now, three. you know, there are dozens and dozens of firms who have decided not to connect. i can't speculate as to why that is. but clearly we've taken away

something that they found valuable. so it is one where it's every market's choice to do something. it becomes a very hard practice to regulate. but i think with the increased transparency and disclosure, people can make better decisions on whether they want to trade in venues that do offer such services. >> thank you. thank you mr. chairman. >> thank you very much, senator mccain. you made reference to disclosure on things like co-location. but when it comes to the best execution obligation i gather that cannot be waived. is that that's correct? >> absolutely, best execution, i think it might need some further refinement. you know, it is a pretty subjective -- i guess it's a pretty subjective term. i think it's used fairly liberally. you know, one thing that we definitely think -- >> that is a legal obligation, is that correct? >> it is. it is. >> so that's nothing that -- you can't disclose -- we don't engage in best execution in this firm. that does not fly, is that correct? >> that would not fly, no. >> you agree with that professor?

>> yes, sir. >> okay. >> going back to best execution as to who determined -- did i interrupt you? >> no. >> who determines best execution for a broker? is it the broker himself? >> the broker, my understanding, is supposed to based on what i read monthly have meetings and just evaluate where they're routing, can it be done better, you know, where should we alter things around the edges. >> but it's the broker? >> yes. >> who determines best execution? >> yes. >> okay. >> i believe mr. katsuyama that you indicated that the maker taker system creates a conflict of interest, and i think testimony of both of you is that this was a significant matter. let me just ask you, mr. katsuyama, should the maker taker system be eliminated? >> i think that steps should be taken to address what happens to the market if it is eliminated. i know that pilot study has been proposed. >> say that again? >> the pilot study that's been proposed, i think that it should have -- >> which eliminates it?

>> which eliminates maker taker in certain stocks. i think it should be given the chance to prove that eliminating maker taker won't harm the quality of the markets. so yes definitely think that that step should be taken. it should be analyzed and then we should, you know -- >> so at least that step. >> definitely. >> professor. >> i'm not a risk taker, i'm an academic. my view would be maybe not. push to eliminate maker taker because you might push things underground into soft auto world where id would be even less able to kind of see what people are doing. >> okay. >> so our view would be with shane core win and jennings perhaps what you should do is curb disclosure back onto the broker so it's easier to tell so you don't have to do the studies we just did, to map how is your broker doing regarding routing your orders. the s.e.c. took a first step with this in 2000, 2001, we think that you could do a better job of that now. >> would you support that best

case that mr. katsuyama talked about? >> if you insist on doing away with maker -- >> not me. >> a pilot -- >> a lot of other people are insisting on it. and i happen to agree with that. >> a pilot is better than going all-in. >> some have argued that the maker taker system is beneficial and that it has led to lower spreads, and i think you indicated, did you not, mr. katsuyama, that that was technology that did that long before -- >> yeah, i think decimalization and technology both contributed to the lowering of spreads. >> all right. >> now in terms of -- does iex make a similar distinction that some high frequency trading may be predatory? >> so i think not all high frequency trading is predatory. but some practices are, yes. >> so do you make a distinction that some high frequency trading

may be predatory? >> yes. >> and that that would hurt regular investors while others may benefit? >> yes. >> and as the maker taker system led to the creation of more exchanges in trading markets, and more complex order types, mr. katsuyama? >> yes. >> is the proliferation of trading venues and order types created opportunities for predatory, high frequent traders to take advantage of investors? >> at times, yes. >> and what are those opportunities? what kinds of opportunities? >> sure. so, you know, i think given the structure, a quick example is if -- if there's 10,000 shares on offer to sell intel, at $21 a share. you know, high frequency trading firm could be offering stock across multiple markets. one of those markets where they're offering stock might be

a -- what's called a taker maker venue that actually charges someone to post liquidity. and will pay a rebate to the other side of the trade who comes to access that liquidity. so this inducement what it does, if a broker is going to follow that inducement it causes them to route orders and remove liquidity from, in intel in a very predictable and systematic way. starting at the highest rebate for taking liquidity and working its way down to the venue -- charging the highest fee. this predictable pattern of routing leads to lower fill rates, and ultimately worse execution for the client being represented. so, you know, it's a combination of vast technology, a combination of inducements, and a combination of the broker following those inducements. that would be a series of events. >> you're been quoted as saying that people have lost confidence that the markets are working and are fair and that they're working in their best interest.

would charging a standard fee, regardless of whether the order adds or removes liquidity, increase investors' confidence that they're getting a fair deal? >> i think it's a step, you know, at iex we charge a flat fee regardless of whether you're making or taking. you know, price competition is something that is hard to regulate so if some people you know, want to charge a lesser or higher fee and justify it through their service i think that's acceptable. but i think eliminating a conflict, you know, most of the general public don't even know this conflict exists. you know, i think that as we talk through it, as we try to regain the trust of the general public, talking through these issues, and admitting to the fact that they exist, and then addressing, you know, these conflicts, i think that that's kind of the way to restore that confidence. so i think that, yeah, addressing this issue will help

restore confidence. or at least it's a step in the right direction. >> and eliminating the conflict would help restore confidence? >> without question. >> professor? >> yes, sir. >> critics of your paper, professor, said that the data that you used to assess whether retail brokers were getting best execution, does not accurately reflect typical retail order flow and that your results can't be generalized to judge the best execution performance of retail brokers. how do you respond to that? >> in a couple ways. those critics seem to ignore the back third of our paper where we use all trades and all quotes in the u.s. equity market over the same time horizon to demonstrate the results that we find with our limited data, generalized to the marketplace. second, as we've been pushing the paper around, we've seen lots and lots -- we were with a major exchange that operates two different fee structures and they showed us that for the retail orders resting on their exchange for a couple weeks, they get the same results we get. you know, sanford bernstein we

came across a report, same results we get. so you can argue that our most detailed data analysis comes from specialized data. but the results generalize with a lot of different data sets. so we're quite comfortable. >> now, would you be willing to run your analysis using data from the retail brokerages identified in your paper, if they were willing to give you the data? >> of course. anybody. we -- the hard part for an academic, we spent two years asking for data to test this. because people, and it's just very, very hard. so yes, that's a standing offer that we made. it's become -- we thought we were going to be able to work with a guy who is starting to do this with institutions, and unfortunately the cell side's pushing back and threatening, so, the executing venues have threatened that if this guy shares data with us, they will stop doing business with their buy side clients. it is very hard to get data to do the analysis that we did. we were very lucky to find these data. >> the argument that 30 cents on an order is tiny, minuscule amount.

you've given a very strong answer, response to that, by the way, in terms of the orders that aren't filled. is it also -- and also, mr. katsuyama, you give a pretty strong answer to that, as well. these 30 cents also add up to hundreds of millions of dollars for a broker, do they not? >> yes, delay do. compare the payment revenue of the brokers that do this practice to the ones that don't. and you'll see a marked difference at the aggregate. >> mr. katsuyama? >> yeah, i think it's, you know -- >> a big revenue source for the broker, is it not? >> yes. well, some brokers. i think we can't paint them all in the same brush. some brokers end up paying the high take fee and that high take fee is subsidizing payments to other players. so it's -- some are hurt worse, and some benefit. depending on who the broker is. >> thank you. senator johnson. >> i've got a little more time

here. so i do want to go back and really explore the -- exactly what's happening, exactly what type of harm could be happening. when you are talking about 25% of trades that aren't executed, the volatility of that, what is being missed. aren't those trades basically because people put in stop orders and say i'll buy stock at this price? just tell me how that doesn't work. >> so you have people that maybe place an order before they go to work and say, gee, i want to buy a share of stock at 20. 100 shares of stock at 20. and it is just a standing order. not a stop or anything like that. just a standing order. what we identify in our papers that some brokers are routing that order so they trade last at a price. and so if throughout the day the market goes through your limit price, you trade. doesn't matter where you were routed. that's true a large part of the

time, right? and that would be what i would argue, that's your trading experience. but some stocks are much less volatile throughout the trading day and not all of the people looking to trade at a price get to trade. some don't. and they miss out. why? because the price trades a little bit and moves up. the ones that don't trade, missed out. >> so if -- part of the problem is some investors have a lot of time to just be watching this in realtime, 100% of the time. most investors like myself, you look at it once a year and you put a trade. that's always going to be the case. if you were watching this 100% of the time, if you were putting in the right type of order you can make sure you were going to have an executed trade just about, can't you? can't you make sure you get that stock purchased no matter what? >> not if all the interest at a given price doesn't trade, no. because of the way they route. they are putting you at the back of the line at a price all the

time. and so if the line doesn't fully exhaust, you go wanting. is this -- this happens -- is this all stocks all the time? no. but measurable time, 10%, 20% of the time, certain stocks, yes. >> again, i'm trying to get my head around the magnitude of this problem. >> okay. >> it is true -- we're using all these sinister figures. and i agree with the senators. this is about restoring confidence in the market. and i am concerned by throwing out, you know, those types of terms and making it seem like everybody is in this business and is just really trying to stick it to the individual retail investor, i am -- that's not my experience. that's not what i've seen. yeah, i'm -- >> and i would hope -- >> i've been pleased with the transparency of the investment banking committee in my lifetime.

it just seems we're moving in a better direction. greater competition, lower prices. very easier trading today than 20 years ago where you just kind of call your broker and you didn't know what was going off. now you have the computer you can plug it in. how come i didn't get that? right now it's almost instantaneous? >> for a market order, yes. >> boom, it comes right back. >> for a mark order, yes. and i'm not going to sit here and argue that we haven't made great gains over the past 20 years. that's not what our paper is about. we're not crying fire in a theater. we're -- have you read our paper carefully, i think we're very caveated. we're pointing out certain circumstances. we're routing only to the high fee venue is going to -- we employ sophisticated order routing technology and processes to seek best execution for client orders. how can that be if you are routing always to the high fee venue? that's what got us interested as academics in this problem. >> you may not be shouting fire, but i think the way that it's reported in the press, i think it really is. do you disagree with that?

>> i think there are some people out there yelling fire. but i would hope we would not be characterized -- >> that's what i appreciate. about this hearing. it's trying to lay out the reality of the situation. put this all in perspective. i want to get back to the overall dollar value of these make and take arrangements in that type of thing in relationship to total trades. >> all right. so i can give you -- >> i kind of want, if at all possible you have some sort of historical perspective in terms of how much trading commissions there were 20 years ago versus what we're talking about today. >> i'll give you one stat and then give it to brad. if you eliminated all the rebates and inducements, bernstein research predicts that one broker would have a 16% earning per share decline. that's realtime now and i'll have to say i don't know the answer to your question and give it to brad. >> there's no question that price per trade has come down

with technology. i think that again, i kind of read this last time. i'll read it again. a harvard business report "how to win a price war" talks about electronic brokers are changing the competitive terrain with their extraordinarily low priced brokerage services. the prevailing price for discount trades has fallen from $30 to $15 to $8 in the past few years. and that report was written in the year 2000. here we are in 2014. and just my tech team sent me this. the historic price worth a gigabyte of storage in 2000 was $10. today it's 10 cents. when we talk about lower fees, you know, lower commissions, yeah, they've come down. but they stopped going down. and i think that, you know, it can probably come down further. the notion if the payment goes away the price will go up, i think that would be hard to justify. competitive forces will force that out of the market. if you double your price per

share or price to trade, then new entrants will come into the market. i think it is one where they've come down but that's not an excuse for what's happening now. >> are there competitors in the marketplace that conduct trades the way you want to see the trades conducted, and compare those to some of the online models that companies that we're really familiar with in terms of what they provide in their service. one thing i value on online, i've got research. there's just an awful lot within those online platforms that are very helpful to an investor. >> sure. >> do those competitive systems have similar types of things? is that part of the reason, again, i'm a business guy. doesn't bother me that people make money. they need to make money to provide different products and services. >> i'm not as familiar with each individual retail platform what they offer. i know interactive brokers, route in a way consistent with how i'd route.

they are connected to ix. they trade with us. so i think that there are examples. and they've been pretty vocal about that. i look at institutional brokers. as professor battalio noted. my experience at rbc or bernstein or working with the people at goldman sachs. people have spent a tremendous amount of time in understanding this conflict. where you can route for a rebate and not harm your client and where you route for a rebate and you do harm your client. it is one where because it can toggle, for example, if there's 100,000 shares on offer in intel at $21 and they rebate someone who will pay me to route theirs offering 10,000 shares and i have 200 shares to buy, i can route it there, buy the 200 and get the rebate and no one is harmed. if i have 100,000 shares to buy, i can route it to one venue because they are only showing 10,000 because i'll ruin my experience in the rest of the venues. there are times you can get a

rebate and fulfill your obligation and times you can't. it's up to every broker to understand where that inflection point is and to be very transparent in terms of how they route. >> so i guess my point is, if those companies are already present in the marketplace, the trade the way you are suggesting without a conflict of interest, so that an individual investor, if they are buying $2,000 worth of stock, doesn't have to worry about being charged, you know, 40 cents versus 30 cents. those platforms exist. those -- the marketplace, a free market competitive system have already provided that investing model with that low transparency and kind of getting back to part of your opening statement. this is a question of whether we need government regulation to force a transparency, the competition or free market competitive system is doing it. based on your answer you are saying the free market competitive system is already reacting to it and that possibility exists. if you are concerned about not being able to have your trade executed or paying another ten

cents on a $2,000 trade, there are people out there and they just need to, i guess, do a little more advertising so americans continued or maybe this hearing will help out and more investors will take a look at finding companies like yours. >> so, yeah. totally agree. i think first off, you -- you have to let -- make people aware the conflict does exist. you vo have to educate them on who that conflict means to them. now they can make a better informed decision as to before when they didn't know the conflict existed. disclosure and transparency and help people make better decisions. the market sorts it out. it is one where with increased digs low sure, increased transparency, everyone knows exactly how the game works and things still happen. you can look back and say, i guess the inducement, you know, was enough or warranted the fact they made this decision. right now, a lot of it is opaque.

as the professor noted, it's really, really hard to get data. and the data you get is not standardized. it's very hard to synchronize data across multiple places because the data comes back and it's just -- i've seen client data where they got them from different brokers or brokers from different venues. it's coming back in all sorts of forms. that standardization in transparency forced disclosure. people will ultimately make better decisions. that's the most proactive way to advance this discussion. >> thank you. thanks, mr. chairman. >> yeah, professor, you have a comment? >> so the reason this is an agency problem was first pushed -- >> you say agency? >> i'll describe. two former chief economists, chester spat and larry harris. larry was around. so was chester. then a guy on the board of direct edge, jim angel, put -- it's their theory we test in our paper. they claim the retail investors, maybe not you, are able to shop on commission. so the broker that offers the lowest commission will get the retail trade. okay. the brokers that maximize rebates are able to offer the

lowest commissions. anecdotal evidence suggests interactive brokers in our sample period had a higher commission than these other four brokers. so these four brokers attract the retail investor by offering low commission and the retail investor trusts the broker because the best execution obligations and doesn't have the tools and decide how hard it is to figure out what we did. they don't have the tools to understand, gee, in this instance did my broker route to the right venue, the likelihood like 011 says? that's the agency problem. you can shop on commission. you can't evaluate the execution quality. and so they are doing things that may compromise execution quality. they have the lowest commission and they're going to attract a swath of customers that way. if you talk to people on the board of interactive brokers, they'll complain about this. certainly competition is forcing commissions lower, but people

who do the practice of routing all the nonmarketable to the high fee venue and selling the marketable to the wholesalers, they get more revenue that can be used to push back through commissions, right? and so it's hard -- this would be a case where maybe the market can't fix things unless you can educate the investor to evaluate this decision of routing nonmarketable orders which is tough. >> so you are saying that maybe it can't be solved in this case? >> i'm all about free markets. trust me. >> of course. in this case it hasn't so far worked. that's what you're saying. >> that's what we're thinking. >> you disagree with that, mr. katsuyama? >> you know, i think it's, you know, the hardest part, we launched iex. we're a new venue. before the s.e.c. published the midas data and before fnra had their ats reporting rule, we had no idea how we compared to other markets. other markets would make claims that could or could not be substantiated.

as you're competing, how do you compete in a market that's completely opaque and primarily dictated by word of mouth or self-generated reports? i think that, you know we -- i don't think we've fully had a chance to solve this problem from an industry standpoint because the data was just not available for people to make good decisions or better decisions. >> do you think the average investor can make a decision on where a person -- where a broker will get best execution? >> that's a good question. i'd say probably not. but the key part is that the people that do spend the time to look at it, some people in the media are very sophisticated. they understand the heart of this issue, and i think as they report on things that are happening, as the retail investors who do look at it start to make decisions it does create the right amount of momentum that someone who doesn't understands that people are looking out for their best interests. and they can make decisions that way. >> how do they make a judgment on best execution? subjective judgment.

how is it your average investor just looking at the fees, the commission. hey, that's lower. pretty attractive. here's what the professor is saying. is that not right, professor? so how does that average investor do what you think needs to be done? make some kind of assessment on best execution. how does he do that? >> sure. i think, again, you have to put in the requisite amount of time to understand it, to make that judgment. most people won't. so again, i think that the more this is discussed and reported on, hopefully the venues doing the right thing get the right amount of credit. >> if transparency is the answer, can the government force transparency? >> i believe there are cases where that would definitely help. >> the government would have to force transparency? >> i think outlining the types of metrics that need to be reported and the way they need to be calculated and presented would definitely be helpful, yes. >> the government has done this once. and it's not a big step what they'd have to do to clean things up. >> the market hasn't done that yet. it would take the government forcing it?

is that correct? >> so there's been no attempt by the market to try to solve this issue, and just standardize across themselves. and to say let's make this easier for people to understand. we have not seen evidence that that is happening. >> indeed -- >> and, therefore? >> therefore, i think the government would be very helpful in getting the industry to coordinate to a level to make these issues easier to identify. >> it would be helpful if the government required that? >> yes. >> the options market tried to do it on a voluntary basis in 2010 and the numbers they put out were garbage mostly. so, yes. >> just a quick comment. again, as an individual investor, the way i evaluate best execution is i put an order for 20 bucks, i got it for 20 bucks. this is so incredibly complex and there's so many esoteric terms of art here. i'm trying to bring it back to just simplicity of what's happening in the marketplace with individual retail investors. and if i put in an order for 100

shares of 20 bucks and i get it and i'm only paying ten bucks i'm reasonably satisfied. there may be some very strange every now and again circumstances where i don't get that share, but, i mean, i kind of shrug and go, okay, i didn't get it. maybe there's some harm. but i'm trying to -- i'm highly concerned about government interference in the marketplace. if there's a very minimal amount of transparency, legislation in terms of this is the data that we want everybody to report, again, minimal. not some huge overall regulation that harms the market. that's something i'd be willing to support. i really want to take a look at, what is the -- put this in perspective, what is the real harm being caused? and let's make sure we don't do more harm in trying to solve a problem, but right now this is really a solution looking for a problem in many respects. >> i definitely would say that focusing on disclosure will create the least amount of harm and implementation risk rather than diving into things such as the location and the actual mechanics of the market.

so if we are going to move forward, i think that's -- >> i agree 100%. >> and with what mr. johnson said. >> you want to have disclosure. you want transparency, but you agree it may take government action to get that transparency? >> yes. and push it back on to the brokers. >> this is just a minor issue that we shouldn't be concerned about and the overall scheme of things, is that correct? >> my view is the reason academics are around and reporters are around is if retail investors can't understand it, we study it, bring to life and things get cleaned up. >> is this a serious issue? >> we think it is. but we also think it's an easy one to fix. >> thank you. >> is this a significant issue? >> it's significant that it's a principle-based issue. you can try to minimize it by trying to relate how much it's pennies, et cetera, people are holding for years.

this is a principle-based issue and comes down to the foundation of why the markets exist. and people's trust in those markets. trust is really about saying, without me paying attention that the right things are happening in my best interest. when you find out they're not, that's what undermines it. your opening statement, discussing the fact that we've had one of -- we've had a tremendous rally from 2009, yet the amount of households owning equities has not followed that trend. i would argue that a series of events over the last number of years have led to a decrease in investor confidence and to quit our jobs and start iex. i think from an investor confidence standpoint, my hope is march 31st becomes a low point we've gotten tremendous amount, thousands of letters and e-mails about people looking to get back into the market. so i do think it's one where if there are people that feel like we did the wrong thing by

speaking about it, we have not heard from them from the general public. we've gotten a lot of anger from wall street. not all. but again, people embedded in the status quo don't want to see change happen. those who do want to change have been very supportive of us. >> thank you. thank you both. appreciate your coming. >> thanks a lot. >> let's see what time is it now. i think the votes are starting. we'll now call our second panel of witnesses. thomas farley, the president of the new york stock exchange group in new york. joseph ratterman, chief executive officer of bats global markets. and the next, kansas, i hope i'm pronouncing that correctly, joseph brennan, a principal and head of global equity index group at the vanguard group in

malvern, pennsylvania, and steven quirk, senior vice president of the trader group at tt ameritrade in omaha, nebraska. we appreciate all of you being here today. and under our rules as i think you heard, all of our witnesses are required to be sworn so we'd ask you to please stand and raise your right hands. do you swear the testimony you are about to give to the subcommittee will be the truth, the whole truth and nothing but the truth so help you god? thank you. and we'll use, again, the timing system. a minute before the red light comes on. you'll see the lights change from green to yellow giving you an opportunity to conclude your remarks. your written testimony will be printed in the record in its entirety. please try to limit your oral testimony to no more than five minutes. mr. farley, we're going to have to go first followed by mr. ratterman, then mr. brennan and then mr. quirk. >> thank you. >> kindly thank you all for being with us.

>> chairman levin, senator johnson, we appreciate your interest in regulatory structure of the u.s. capital markets. my name is tom farley and i'm the president of the new york stock exchange. i have been in the business of running exchanges for most of my career, including as president and c.o.o. vice futures u.s., formerly the new york board of trade. as market operators, we have come to the view that the u.s. equities market is highly fragmented, making it overly complex and opaque. the regulations and structures in place today incentivize participants to make it more complex and more opaque. numerous surveys have shown that this structure does not contribute to investor confidence or high systems reliability. as the dominant rule setting the boundaries of equity market structure, regulation set out to accomplish several objectives. the first was to increase competition among markets and among orders. while the rule did an excellent

job increasing competition among markets, we believe competition of orders has been severely damaged. particularly in recent years due to the record level of off exchange trading and increased levels of order fragmentation. in fact, just last week, off exchange trading reached a record high of 40.5% across all regulation nms securities. this means despite someone taking a risk to establish the national best bid or offer on a displayed market fully regulated exchange, brokers decided to execute the trade away from the displayed or fully regulated market. 40% of the time, rather than rewarding the people who establish the nbbo, national best bidder offer with an execution. we find this troubling. and damaging to price discovery. the second objective of regulation nms was to design a structure to the benefit of long-term investors and public companies. long-term investors have

benefited in many ways from the implementation of regulation nms. however, data now shows that some of these benefits such as lower costs might be reversing. in addition, we consistently hear from large institutional investors that there are too many conflicts in the current market structure and that they would like to see those conflicts eliminated or at least reduced. perhaps most importantly, we hear from listed companies and entrepreneurs that they believe 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 via the ipo process are the lifeblood of our economy and our markets. the new york stock exchange will take a leadership role in bringing about beneficial change. our goal is simple. reduce the level of complexity and fragmentation of the u.s. stock market. to accomplish this goal, there are several unilateral steps that we are committing to take and that we would welcome our industry colleagues to also adopt. to start, we are self-imposing a

six-month moratorium on any new or novel order types that further segment the market. in addition, we have already announced the elimination of more than a dozen existing order types. we believe these are first steps toward reducing complexity and toward a more efficient market structure. and we will look for other steps we can take along these lines. at an industry level, we are seeking support for the elimination of maker-take pricing and the use of rebates. broad adoption of this policy would reduce the conflicts inherent in such pricing schema and further reduce complexity. through fewer order types and fewer venues. in conjunction with the elimination of maker-taker rebates we believe regulation should require the deference be given to displayed quotes on fully regulated exchanges. there's risk involved in displaying a quote on such a venue. we believe the person taking that risk should be rewarded with an execution at that price. unfortunately, in today's environment, those display

quotes are used to inform trading on dark markets which are not contributing to the price discovery process. the original investors who posted these public quotes are all too often left with no trade at all. several countries, including canada and australia fairly recently have adopted rules that establish this type of privacy of public quotes. in the cases of canada and australia, the regulators have established this policy has simplified and even improved their markets. lastly, 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 over others by using high-speed data feeds and co-location services. it should be noted both of these services are regulated and made available to all investors equally, we believe in something results in a loss of investor confidence, we should find a way to change it. nyse is willing to put all options on the table as it pertains to the delivery of market data. however, we highlight this cannot be done in a vacuum and

any changes must be applied to all exchange and dark pool venues. thank you for your time. i look forward to answering any questions you may have. >> thank you very much, mr. farley. mr. ratterman? >> good morning. my name is joe ratterson, chief executive officer of bats global markets and one of the founding employees. i want to thank chairman levin, ranking member mccain and senator johnson for inviting me to participate in today's proceedings. i was encouraged with the sentiments recently expressed who said our markets were, quote, not broken, yet alone rigged. i agree with her. the automation of the u.s. equity markets resulted in significant enhancements in market quality for long-term investors. however, i also recognize our markets are not perfect and that efforts to improve them should never let up and never cease. our current market structure is product of congress' 1975 act amendments to the exchange act

and subsequent rule making by the s.e.c. to implement a national market system. the s.e.c. working in significant part through the exchanges and other sros created a system that allows market competition while at the same time and just as vital, fostering price competition. today our equity markets are widely considered to be the most liquid, transparent, efficient and competitive in the world. cost for long-term investors and u.s. equities are among the lowest globally and declining. these gains have been noted by investors and experts alike. in april 2010, vanguard confirmed estimates of declining trading costs over the previous 10 to 15 years ranging from a reduction of 35% to more than 60%. savings which flowed directly to investors in the form of higher returns. three respected economists recently found that between 2001 and 2013, the spread paid by investors decreased more than 70%.

from nyse listed stocks. in april 2014, blackrock noted that since 1998, institutional trading costs declined and are among the lowest in the world. earlier this month, itg reported between 2009 and 2013, implementation shortfall costs decreased from roughly 45 basis points to 40 basis points. further, our market is able to handle volume and message traffic considered astronomical only a short time ago. the efficient operation of our market structure throughout the stress of the 2007 to 2009 financial crisis indicates the systemic risks that have been reduced as a result. efforts to introduce infrastructure risk since the flash crash of 2010 are producing beneficial results. for example, the number of erroneous executions occurring on our markets is on pace this year to be nearly 85% lower than the previous 5-year average. results that stem from this success of the recently enacted

up limit, plan. in addition, exchange system issues as measured by self-help declarations have dropped by more than 80% since the first years after regulation nms. we must nonetheless remain squarely focused on improving market quality and stability in a coherent and responsible way. we're also keenly aware investor confidence is important not only to help american realize their investment and retirement goals but plays directly into the overall health of our country's economy. simply put, when investors are confident enough to put their hard earned capital to work in our stock market, entrepreneurs and corporations can grow and thrive as well. as such, we are fully supportive of the s.e.c.'s plan for a comprehensive market structure review and we look forward to actively participating in that process. among other things, i see the following four areas as offering potential benefits without disrupting existing market quality gains. first, institutional investors can benefit from implemental

transparency related to the hss their brokers route orders to. including the publication of form ats which some have already done. consistent and thorough reporting standards will create the greatest level investor confidence so additional regulatory direction may be required here. second, i support reviewing current s.e.c. rules designed to provide execution quality and routing transparency. for example, rule 606 could be amended to require disclosure about the routing of institutional orders as well as separate disclosures regarding the routing of marketable versus nonmarketable orders. third, to strengthen the confidence of the investing public in market data, i continue to support initiatives to make the consolidated tapes as fast as possible. this is a position that bats has advocated since 2008. i support the elimination of the ban on locked markets which we believe is a primary driver of excessive complexity in our

national market system. thank you for the opportunity to appear before you today. and i'd be happy to answer your questions. >> thank you very much. mr. ratterman. mr. brennan? >> thank you chairman levin, ranking member mccain and members of the committee. my name is joe brennan. at vanguard, i'm responsible for overseeing the management of our equity index mutual funds. vanguard serves more than 20 million investors who entrust us with $2.6 trillion of their retirement and education savings. vanguard's core mission is simple. to take a stand for all investors, to treat them fairly, and to give them the best chance for investment success. before getting into specific comments on potential improvements to our current equity market structure, i'd like to make two fundamental points. first, the markets are not rigged. we have a high degree of confidence in the markets as a safe place for investors to place their assets.

second, all investors have benefited from improvements to our equity market structure. through regulatory initiatives over the past two decades, most notably regulation nms, our equity markets have evolved to a competitive marketplace that is connected through highly advanced technology. over time, this structure has led to lower transaction costs for all market participants. individual investors who access the equity markets through asset managers like vanguard have 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 with the committee today. we also commend s.e.c. chair white for initiating a 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 a topic that has garnered considerable public attention recently. high frequency trading. while the term high frequency

trading has become shorthand for disruptive trading, there's a significant amount of legitimate activity such as market making which also falls under this broad umbrella. today's market structure contains many venues in which trades can be executed. our effort should not be focused on banning high frequency trading, yet we suggest examining our market structure holistically to provide incentives for the types of activity we'd like to see. to accomplish this goal, vanguard supports efforts by regulators to comprehensively re-evaluate reg nms. as time has passed and the markets have changed, most would agree it's time to reassess whether this regulation continues to further the goals of our national market system. we would suggest the most important goal of a national market system is to create a structure that encourages market participants to publicly display limit orders.

such a structure promotes price discovery and lowers transaction costs for all investors. in that light, vanguard supports regulatory efforts to revisit the current maker-taker pricing. fundamentally, it's important to understand these models did not develop from nebraska fair intent. they are the exchange's response to the proliferation of market centers enabled by reg nms and a way for them to continue to attract liquidity. however, the models have become unnecessarily complex. and the decision to submit orders to the public markets should not be driven by the desire to capture a rebate or hold a fee. any re-evaluation of the make or taker model must be connected to an analysis of other ways to encourage publicly displayed orders. specifically, we support a pilot of a trade-out rule under reg nms. today a market center can execute an order at the best publicly displayed price without actually contributing to the

public price discovery process. generally speaking, those that publicly display their interest first should be first in line for any execution at that price across the markets. a well-designed pilot of a trade app rule under reg nms 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 diligently over the past few years to take steps to improve the manner in which our markets operate. the equity markets are extremely complex. and it is vitally important to examine all of the potential consequences any of changes to our structure. we believe the s.e.c. and fnra are well equipped to evaluate ways to improve our markets and we commend them for the work they've already performed. i thank you for allowing me to participate in this discussion and i welcome your questions. >> thank you very much, mr. brennan. mr. quirk?

>> morning, chairman levin. ranking member mccain and members of the subcommittee. my name is steve quirk. i am senior vice president with td ameritrade. appreciate the opportunity to appear before you today. thought i'd spend a brief moment on td ameritrade and the clients that we serve so you have a better understanding of what we do. we are a financial services company serving primarily retail investors. we have over 6 million client accounts with $600 billion in assets, including custodial services for 4,500 individual representative registered investment advisers and their clients. we're based in omaha, nebraska, and we were one of the first firms to offer discounted commissions to retail investors. since our founding in 1975, we have also pioneered innovations such as touch-tone trading, internet trading and mobile trading. we have been on a quest to level

the playing field between wall street and main street investors for almost 40 years. as a result of that, our clients have entrusted us with approximately a quarter trillion in net new assets since 2007. excuse me. we interact with these clients daily and do third-party surveys to better understand their market sentiment. based on this and other data, we do believe the current u.s. equity market structure has never been better for those retail investors. in fact, the number of our firm's accounts that are trading is up 31% on a year over year basis. our retail clients tell us they want their entire order filled quickly and inexpensively at the price quoted or better. in each of those areas, we've seen significant improvement in the last decade as detailed in the written testimony. when it comes to order routing, brokerage firms have two options. they can internalize and trade

against that. or they can route that to the market centers and destinations. based on our open architecture and unbiased and uncomplicated business model, we believe it's in the best interest of our clients to send their orders to a mix of market centers, including exchanges, wholesale market makers and ecms. while these market destinations serve a variety of purposes, we think they are all vital in driving the competition which ultimately benefits investors. the subcommittee asked for our views on conflicts of interest for brokers obligated to obtain best execution for client orders but also receive payments or rebates based on where that flow is directed. we strongly believe the compliance with best execution obligations and proper disclosure, brokers can effectively manage any conflict that may arise from payments. furthermore, we strongly believe we effectively manage any such conflict. brokers are required to seek the

most favorable terms reasonably available under the circumstances for client orders. at our firm we consider the opportunity to obtain a better price than currently quoted, the speed of execution, likelihood of execution amongst other factors when making that assessment. we also give our clients a choice. their orders can be routed using our proprietary order routing logic or choose from a list of direct routing destinations. finally, we work with multiple market destinations. rather than internalize our client flow we believe routing all orders to the market is more transparent and better aligned with the need of our clients. we select these market centers based on rigorous due diligence where execution quality is the top priority. after and only after a market satisfied our standards for best execution, do we consider transaction costs or revenue opportunities. this process complies with s.e.c. rules enacted after thoroughly reviewing this issue

on numerous occasions. the payments or rebates brokers receive are transparently disclosed as an average per share in our quarterly 606 reports. they are also on our account statements and our confirmations which are all required by s.e.c. rules. finally, we have provided the subcommittee with a list of recommendations that we believe could enhance our nation's current market structure without compromising many of the benefits real tail investors have realized in the past years. just as we constantly seek to improve our client experience, our industry should do the same. but let's not lose sight or compromise many of the improvements that have been made. we appreciate the opportunity to be part of the conversation. thank you. >> thank you very much, mr. quirk. let me start first with you, mr. farley. jeff sprecker, the head of the intercontinental exchange which owns the new york stock exchange, which you represent here today, has said that the

maker-taker system misaligns the interests of brokers and their customers. it hurts everyone in the market. we should get rid of it, he said. do you agree with him? >> yes. jeff also says, and let me start by saying, senator, that the u.s. capital markets are indeed the best in the world. but for 225 years, the new york stock exchange has advocated on behalf of customers and stood for improving markets, and not just accepting a flawed status quo. to answer your question directly, there's really two areas where we're most concerned about the markets today. one is the appearance of conflicts. primarily because we think that undermines confidence in the markets. and the second is undue cost and complexity in the markets that we've heard a lot about today. maker-taker gets to the heart of both of those issues and

concerns that we have and it's for those reasons we've advocated eliminating make or taker in its entirety in the equity markets in this country. >> well, i -- very, very significant testimony with an exchange which has been here as long as you have been here makes that point. and you have said in your testimony that we're seeking support for the elimination of maker-taker pricing and the use of rebates. and then you said broad adoption of this policy would reduce the conflicts inherent in such pricing schema. explain that now to the subcommittee. i happen to agree those conflicts are inherent. tell us in your words why

adoption, elimination of the maker-taker pricing would reduce conflicts that are inherent in such pricing? >> sure. and if i may, if i can just provide a little context. i came from a company called intercontinental exchange. in thanksgiving of 2002. so we came to this with a perspective of other markets like the futures markets which are deep and liquid and, you know, people generally will acknowledge that those markets function properly and there's no such thing in those markets as maker-taker pricing, for example. was something we very quickly wanted to understand more about. the first thing we noticed was that the maker-taker schema results in many more order types in the equities markets than you have in other markets, such as, for example the futures markets. many of those order types are in existence to help them capture

the maker-tamer spread. we realized, this pricing schema introduces a great deal of complexity. with respect to the conflicts issue that you describe in particular, it's been frustrating to us that in a period of rising stock prices we've not seen more participation in the equities markets from investors. in fact, data shows that the participation in terms of percentage, participation of u.s. citizens is at a 16-year low. and we think a reason for that, an important reason for that is just confidence in the markets. markets rely on confidence. we can't say that enough. and irrespective of whether or not there's an actual conflict or a conflict that's resulting in some sort of bad behavior, the appearance of conflict matters. and it's for that reason that we look at maker-taker pricing and we say, there may be an appearance of conflict there if a broker/dealer's interests are not aligned with their customers. and that is something that can potentially arise with maker taker pricing. >> your testimony goes beyond --

the appearance is important because of the confidence issue and underneath there may be more than an appearance. but your testimony is actually even clearer than that. as you say that you support elimination of maker-taker pricing and the use of rebates in the broad adoption of that policy would reduce the conflicts inherent. you use the word inherent. explain that. >> so, any reasonable busine businessperson opportunity like to be in a position of having their interest not align with their customers. when you have maker-taker pricing there could be examples as professor -- there are examples as professor battalio described this morning, where a broker/dealer has an incentive to postal price. on a high make rebate venue even if the execution quality on that particular venn withdrew is not

as high as another venue. that arises specifically because of -- or it's exacerbated because of maker-taker pricing. >> and that's why there's a conflict inherent in that pricing schema? >> that's right. >> now, mr. ratterman. i'll give you a chance now to -- first of all, before we ask you to comment or react to that, you said earlier this year, i believe, that business offers -- businesses offer incentives for customers to be in their ecosystem all the time. who are the customers you were referring to? are they brokers? pardon?

>> yes, our customers are all brokers. >> all right. now let me ask you to give you an opportunity to respond to mr. farley's testimony. >> sure. so from my perspective in our firm, we don't believe -- we don't believe that there should be a ban on maker-taker. certainly open if there's a pilot to looking at the data, but my answer stems from my concern for the potential benefits and spread reduction that maker-taker may have produced over the last 10 or 15 years. not for any commercial purpose about the way we run our exchange. our exchange is in the business of matching buyers and sellers, fair and orderly markets when we have a trade. if we're going to deserve revenue for that trade as it happens, how we do that there is today a significant amount of flexibility. i believe that flexibility has allowed for innovation in pricing and markets, and that the incrementally the rebates that are offered in many cases

to market makers to take the risk to put bids and offers in the market has yielded tighter spreads over time. i also don't believe that eliminating maker-taker would eliminate a conflict. we're talking about, as senator johnson walked through an example earlier, a broker's evaluation of a trade examining where he would get a rebate for 30 cents or maybe pay, you know, 15 cents. he's looking at a spread of 45 cents in relation to the likelihood or not likelihood of getting an execution where he actually does get paid and when he doesn't trade or his order doesn't fill there is no commission to the broker. so by eliminating maker-taker, you would only compress the range of the conflict, but the conflict would still exist as long as there's differential pricing between exchanges. so i think the only way to potentially eliminate the conflict then is to mandate exchange pricing at a fixed level for all exchanges all the

time. so the conflict will remain unless there's significant intervention, and i believe disclosure as we've talked about earlier today in the hearing is the right answer to provide the information so that not only brokers but their customers can evaluate whether these conflicts have actually been managed well in favor of the client or not. but i don't see any path by which the elimination of the conflict can be achieved. >> the -- mr. farley, want to comment on that? >> sure. >> we reduce the conflict that's inherent that you talked about and can we reduce the appearance by removing the maker-taker pricing? have you changed your mind after hearing mr. ratterman? >> i actually found more areas of agreement with mr. ratterman than maybe i would have otherwise expected from the way his answer started.

i think he -- if i'm putting words in your mouth, joe, correct me. but he said look, that may reduce the conflict, but it wouldn't eliminate it. and so we're 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 that again, the reasons why we've been focused on this are twofold. one is around this conflicts issue and the second is around complexity in the markets. additional order types and venues and it's worth noting that i, the new york stock exchange, i have three equities trading venues. mr. ratterman has four. we have a competitor who has four. a lot of those venues exist, really, principally because of maker-taker pricing and those venues are creating different pricing schemas using maker-taker pricing for our customers. and then finally, and i'll conclude briefly, i agree with mr. ratterman about another

point he made which is that we have to be careful about the elimination of maker-taker to make sure there aren't wider spreads on fully regulated exchanges, which is why it's very important to us that such a move would be tightly coupled with giving what we call primacy on the public quote on lit exchanges to the participant who made those quotes. that's something that doesn't exist today. and people are able to trade in dark markets at the same price as is posted on an exchange. >> and reducing the conflict would be valuable even if you can't eliminate it? >> yes. >> mr. sprecker in january said the following, your boss. quote, the price that we see is a bid offered price and the market is really not the price because there are rebates and other thdiscounts that are applied. so we don't have a view of the actual price which i think is to a certain degree false advertising when you have a public ticker. do you agree that maker-taker

fees are distorting market prices? >> i agree with -- i agree with what jeff said. he's my boss, after all. >> if he weren't your boss -- he's not listening. do you believe maker-taker fees are distorting market prices? >> well, if i can, if i can just address the comment that jeff made. i think it's a matter of fact that posted prices on exchanges and also those posted prices that go out through our own raw data feeds or public feeds do not include the fees associated with them. so that is accurate that they don't include all in prices. so to the extent somebody is viewing that data and assuming that it does include the various make rebates and take fees from their perspective it would be distorted. if somebody understands it's not included, they are just receiving a different data set. >> did anything that you heard mr. ratterman say change your view that the maker-taker schema, as you put it, creates

an inherent conflict? >> no. >> mr. sprecker also said the following, mr. farley, that maker-taker, quote, creates false liquidity. do you agree with that? >> i suppose i have a slightly different perspective on it. >> give us your perspective. >> so again, i come from a career mostly spent in the futures markets. and the type of liquidity and market making we most value comes from participants who will show up and buy from sellers and sell from buyers and actually engage in risk transference where they will hold a position for a period in time. fairly new to the equities markets now a year and a half in. what i see is there's a whole swath of market making that is essentially stitching back the 50-plus venues you mentioned

earlier this morning. and there's many examples of participants who are buying and selling at the exact same price at the exact same time on different venues in part to capture maker-taker rebates. that's a different form of liquidity. i would choose different words than jeff did. false liquidity. but it's not as valuable as the type of liquidity that we've always valued at building markets. >> it's a different kind of liquidity that is not as valuable as the kind of liquidity that's created where there's a real shifting of risk. >> and it's a blanket of cost on the industry stitching back together those 50 venues. >> i think we've all heard about a recent survey of market equity participants that suggested that

the majority of those surveyed thought the equity markets were not fair for all participants. is there a lack of confidence, would you agree, mr. farley, and would the conflicts of interest fuel that lack of confidence? >> i look at statistics such as the one that i believe you cited, senator, that two-thirds of americans had equities in their account. not too long ago. and maybe a decade ago. and now it's half that participation in the equities markets is at a 16-year low. i look at that empirical data. i also look at the anecdotal data. and i'm sure you, like i, have conversations about the equity markets with your friends and family. i grew up down the road here in pg county. when i go back home, people ask me, what's going on in the equities markets? tell me about these high frequency traders.

and there is a sense, you know -- it's unfortunate, but there is a sense that, boy, we don't have as much confidence in the markets as we once had. which is why we as the new york stock exchange, from the moment i.c.e. agreed to acquire the new york stock exchange has been standing for what can we do to increase confidence? what can we do to simplify the markets? because as simple as you can make the -- to inspire confidence, you want to make the market as simple as you possibly can and as transparent as you possibly can. >> and free of conflicts of interest as you possibly can? >> yes. >> mr. brennan, your main business is investment management, and you offer mutual funds and other investment opportunities for your customers. do you believe that maker-taker pricing creates a conflict of interest between a broker's duty to seek best execution and the

money a broker can make by pursuing rebaits? >> yes. we think the maker-taker pricing model creates an appearance of a conflict of interest and adds additional complexity to the market. we're in favor, as we've stated, of looking at maker-taker as part of a comprehensive review of reg nms in our market structure. >> do you think it should be eliminated? >> i think we should test any changes with a pilot. i'm not sure elimination is the answer. i think pilots and data-driven analysis are the best way to really make decisions on changes in market structure. >> and the pilot would be in an area to remove maker-taker in a particular pilot area? >> sure. i think -- >> what area would you suggest maker-taker be eliminated on a pilot basis? how would you describe the pilot or how would you define the pilot area? >> i think experts at the s.e.c. should work with industry

participants to define the pilot. i think all market participants should be involved in the definition of the pilot. >> and the reason that you want to move in that direction is because you believe and your company believes there's an appearance of a conflict? >> yeah, maker-taker does create an appearance of a conflict. i think we're all in agreement. >> now, mr. brennan, some of the conflicts that we discussed today are the result of payments that are a penny a share or a few cents a share. why does it matter? why does it matter to you that a

conflict or an appearance of a conflict be removed if it's a few pennies a transaction? >> well, we generally stand for what's in the best interest of our clients. and we're for transparency and a fair market. and conflicts -- eliminating conflicts and reducing conflicts of interest in our market is something that would benefit our clients. >> does it also create a problem for you to check on execution? >> it doesn't -- it does not create a problem for us. >> do you spend time looking at the execution of brokers? >> yes. >> maker-taker were eliminated, would that result in less time being spent by you and your company in reviewing the execution of brokers? >> our approach to our counterparties is probably four or fivefold. first -- >> you say counterparties tsh -- >> brokers. to the use of brokers. we have a lot of choice in how

we can transact with. we really scour the marketplace looking for the best place to execute our transactions. we have highly skilled traders. who manage our portfolios. on behalf of our clients. >> we have a choice to eliminate a broker if they're not living up to our needs. along with that skill and expertise, we also have a trust to verify a mode of operation where post-trade analytics are performed to see that our brokers are actually living up to our requirements. >> and i think your company told our staff that monitoring brokers to try to ensure best execution is a significant effort and that they would rather not have to do so in an inflicted environment, is that true? >> we think it would be a significant effort. to be honest, we do a lot of trading a day, $2 billion.

we ensure every execution is top-notch. >> even though the amount of money per transaction may be 30 cents or whatever it is? is it still true? do you worry about that being added to a transaction. >> the 30 mill cap? >> yeah, yeah. >> yeah. that's a cap on a pricing model. what actually happens with our transactions isn't necessary lid 30 mills. we have a lot of control over our trades. we don't just hand them over to a broker. >> if it was less of a conflict of environment, would you have less need to review? >> i think we would still review.

>> would you rather the trading in anon--conflicted environment? >> sure. >> now, as a retail broker, does vanguard accept payments from wholesale brokers. so called payments for autosale. >> vanguard has -- >> do you know whether or not vanguard accepts payments from wholesale brokers. >> vanguard in its retail brokerage does not accept payments for equity and flow. >> do you know why? >> we'd have to talk to that area of our company. i'm quite sprat from our retail broker.

>> here's what the persons in that area told our staff. tell me whether or not you disagree with this. they told us they could make money by selling their retail order flow, but they believe accepting payments would create a conflict, so they do not do so. >> can you lets us know for the record if that, in fact, is the case?

>> i understand that your company, td ameritrade sends orders which would incur a fee to a wholesale broker dealer. is that correct? >> that's correct. >> and that the broker dealer pafs ameritrade for those orders. is that correct? >> that's correct. >> you said non-marketable orders. the ones that are eligible for

rebates to exchanges; is that correct? >> that's correct. >> is it true that they receive payment for order flow or from an exchange as a rebate on nearly every trade completed? >> i wouldn't say on every -- >> i said fearly every trade. >> nearly every trade. yes. >> so on nearly every trade, td ameritrade receives two payments. one is from the customer, one is from the venue where the payment is executed. who decides whether an exchange or a wholesaler has provided best execution?

is it tdameritrade itself? >> we would have committees that would make that decision. we have a best-estimation committee. >> all right. can different brokers come to a conclusion about which brokers offer the best execution? >> the answer is yes. but i think what's going to drive the decision is the client. what i mean by that is if a retail client puts in a market order, they're telling us they want a quick, timely execution at or bettered, at the kurncurr price or better, in its entirety. they're telling you they want that order to be visible. they've picked a price to determine whether they're interested in purchasing that

stock and they want it to be visible. >> but, basically t question is still the same. can different brokers reach a different conclusion about which venue offers the best execution. >> yes, but i think the determinant factor would be what their client is looking for. so we're going have different needs. >> but the answer to the question is different brokers with the same clients can reach different conclusions. >> yes. >> would you all agree with that? >> are you shaking your head yes? >> yes. >> all right.

now, mr. quirk, back in 2009, chris neggie said the following. he said with maker taker, there is a higher cost to retail investors. now, that's not your position today; is that correct? >> no, and i don't know what that's in reference to. >> all right. but that's not your position today? >> no. >> and that was in forbes magazine, september 10th, 2009. and he was the head of managing director and he said the following september 21st, 2009 edition. we felt it would become

deleterious were allowed to proliferate. that was in 2009. is that your position? >> no, it's not. >> do you know what dhanged? >> i don't know what his position was. so i actually wasn't impb volved with the ordering of it. >> were you there? >> i was there, but nots in this capacity. >> do some trading venues, mr. quirk, offer higher rebates than others? >> yes. >> is the size of the rebate offered by an exchange, a factor in determining whether you route non-marketable customer orders. >> the way that our committees approach this, they start with the best execution and they would go through a list of variables that we should

consider as hurdles. and in etch to git to the point where it has to be shared. >> and you're talking about the rebate? >> correct, sir! so my question is, when you get to that point, after you say you looked at the oh factors, my question is is the size of the rebathe offered by an exchange? a knack xx in determining where you route those nonmarktble customer orders. >> yes, stl be the last factor. all things being equal, that would be a factor. >> and so the greater the rebate, that would be where you would go? >> yes. >> how many trades does ameritrade route to exchanges in a typical quarter?