Subcommittee on Securities

Hearing on Competition and Transparency in
the Financial Marketplace of the Future

Prepared Testimony Mr. Antonio Cecin
Senior Managing Director & Head of Equity Trading
US Bancorp Piper Jaffray

10:00 a.m., Wednesday, April 26, 2000

Good morning, Chairman Grams and Members of the Subcommittee. My name is Antonio Cecin, and I am pleased to testify on behalf of U.S. Bancorp Piper Jaffray. I am the firmís head of equity trading. U.S. Bancorp is the 11th largest bank holding company in the U.S., and U.S. Bancorp Piper Jaffray is also the 11th largest brokerage firm, with over 100 offices in 18 states.

In a speech earlier this month before the Economic Club of Washington, SEC Chairman Arthur Levitt observed: "Our markets today are experiencing change at a pace and on a scale weíve never seen before." In the face of rapidly evolving technologies, he went on to declare, "Ensuring the primacy of Americaís capital markets presents nothing less than a national economic challenge. We meet that challenge by earning the confidence of investors with scrupulous fairness and enduring efficiency. There is one clear path to markets that remain efficient over time, and that is vigorous competition. In this vein, I view the Commissionís role as maintaining and upholding a framework that fosters vibrant competition."

Chairman Levitt is absolutely correctótechnological developments are transforming the structure of the U.S. and global capital markets. But the Chairman understates the Commissionís role. The SEC has not merely responded to these changes. It has been a major catalyst of some of the most significant structural developments in the securities markets in recent years. Indeed, in many ways it has defined the marketís current competitive framework. In the process, the SEC has brought many constructive changes to the markets. However, further refinements to that framework are needed if we are to meet the Chairmanís objectives of scrupulous fairness and enduring efficiency.

Letís first look at the changes that have been brought to the market. Less than five years ago, a new category of participants was introduced, electronic communications networks (or ECNs). They were the result of SEC rulemaking. And even before the ink had dried on those rules, the SEC proposed yet another entity, alternative trading systems (or ATSs).

ECNs and ATSs have characteristics of both exchanges and broker-dealers, and under the SEC rules creating them enjoy certain advantages over both. As a result of these uneven rules, they have grown rapidly in numbers and in market share. By taking volume away from the traditional exchange and Nasdaq markets, as well as the traditional brokerage firms operating on those markets, they have also contributed to increasing fragmentation of trading activity and liquidity in the market. It is interesting that, only after adopting the rules creating ECNs and ATSs has the SEC now issued a release seeking comment on what the future structure of the securities markets should be.

Market makers are asked to put their capital at risk in order to promote a fair and orderly market. They are required to make regular and continuous markets in the stocks in which they are registered. In the past, they received certain benefits, in terms of market access, execution priority, trading costs and the like, in return for assuming those obligations. In the past several years, those advantages have largely been whittled away. The average investor enjoys market access on a par with the typical market maker. Public investor orders have trading priority. The typical on-line investor has lower trading costs than the typical market maker. And, unlike market makers, ECNs and the market participants who trade through them donít have any responsibility to the market.

They also enjoy significant advantages not available to market makers. They are not required to be in the market continuously; their trading can be completely opportunistic. They can charge for access to the quotes they publish, and almost all of them do, generally Ĺ to 1Ĺ cents per share. If you donít pay, they can and do refuse to trade with you. Market makers are prohibited from charging for access to their quotes, which must be made available to all participants. Persons entering orders through ECNs and ATSs do so anonymously. A market makerís identity appears next to its published quotes. (Market makers can enter orders through ECNs to achieve anonymity, and we frequently do so. But we must then pay the ECN for this privilege bestowed on ECNs by SEC rule.)

The securities markets are brutally competitive, but the competitors are also rational. Thus, these uneven rules have led to predictable consequences. Increased transparency, improved market access, enhanced order priority and lower costs have all promoted individual investor interest in the market. This is a very positive development. But these and other changes have also made it far riskier for market makers to put up their own capital to facilitate trading. Consequently, they are doing it less. As a result, we have the irony of rapidly increasing trading volume but greatly reduced liquidity, especially for institutions and other large traders. Market momentum, especially in the technology or "" sector, is fueled by seemingly endless waves of small orders, mainly from individual investors. Market makers are understandably reluctant to expose their own capital to retard these market swings. Weíd better get used to this increased volatilityóitís merely the marketís rational reaction to the uneven rules of the game.

So what should the structure of the markets look like? For starters, we should not make the mistake of going "back to the future." Many of the changes have been very beneficial. The SECís order handling rules, giving improved exposure and priority to customer limit orders, are a good example. Increased access to quotes and trading systems have brought millions of new investors to the markets. The competition to traditional exchanges and to Nasdaq brought by the ECNs and ATSs is welcome. These have been terrific developments, even if sometimes unnerving.

But the SEC can and should act immediately to level the playing field. If it doesnít, the Congress should step in to do so. It is inherently unfair for some market participants to be forced to offer free access, while others get to charge. It is unfair for some market participants to be forced to identify themselves, while others can trade anonymously. It is unfair for some participants to be required to maintain continuous two-sided markets, while others do not.

We concur with Chairman Levitt that an important Commission role is to maintain and uphold a framework that fosters vibrant competition. In our view, that means the Commission should foster linkages between markets, but must avoid an approach that forces all markets to conform to a specific model or into a unitary structure. The Commission may want to encourage development of a centralized limit order facility or CLOB, but it must not mandate use of such a facility or accord orders placed in it universal price and time priority. To do so would stifle further innovation and preclude competition on the basis of execution guarantees, reduced costs, speed of execution or other kinds of services.

Finally, I would like to touch on one other structural issueóthe establishment of a single SRO. As I understand it, most popular has been the idea of establishing one self-regulatory organization that would be independent of any marketplace. It would be responsible for matters such as financial responsibility and sales practices. Each marketplace would continue to be responsible for regulating trading activity in its own market. We support this proposal. We believe it can reduce duplication and costs for the SROs and broker-dealers alike. But it also has limitations. It will do little to address potential conflicts of interest. In our experience, SROs generally have not used their financial and sales practice rules or oversight capabilities in an anti-competitive manner. By contrast, rules that govern marketplace conduct have this potential. For example, rules that establish priority of limit orders, set out order exposure standards or impose order routing requirements, to name just a few, could all be used by a marketplace to gain a competitive advantage. Indeed, any rules by a marketplace that would seek to impose obligations on a participant with respect to orders not directed to that marketplace should be viewed with suspicion. Should a single SRO model be adopted, that will not reduce the need for the SEC to continue to be vigilant to rules and practices that impose potential burdens on competition.

In closing, I would like to thank the members of the Subcommittee for holding these hearings on competition and transparency in the financial marketplace. We appreciate the interest of the members in tackling these enormously difficult, challenging and important issues.

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