Chairman Grams, Senator Dodd, and Members of the Subcommittee, thank you for the opportunity to appear this morning. I appreciate the time and effort that you and your committee colleagues have dedicated to the complex issue of market structure. The ongoing debate that you have initiated is extremely important and will help strengthen the competitive position of our nation’s equities markets.
Today, my testimony will focus on the New York Stock Exchange’s recently adopted Market Structure Report. A copy of this report is appended to my testimony and incorporated by reference.
This report is a product of a Special Committee of the NYSE’s Board of Directors, composed entirely of public directors. The Committee’s charter was to lay a blueprint for the NYSE’s future market structure designed from the vantage point of investors and public companies. The Committee’s recommendations were embraced by the Exchange’s Board at its last meeting. The principles will allow the NYSE to evolve into a platform for customer choice - - - one that we’ve labeled "Network NYSE." The NYSE must provide a market structure that offers investors the best execution of their orders, one which is flexible enough to accommodate multiple investor execution objectives — including best price, the opportunity for price improvement and low costs as well as speed and certainty of execution. The report recognizes the different characteristics of our listed companies and the differing needs of investors – both small and large.
Network NYSE will be a process of constant innovation and reinvention.
This platform of choice will be implemented over the course of the next year as the NYSE unveils two order execution systems -- Institutional Xpresstm and NYSE Direct – Plus. These systems will expand available order-execution choices. Automatic execution of smaller trades will be available. A related initiative that will soon be online is Virtual NYSE, a real-time virtual representation of the Exchange floor. For the first time, investors will have access to each specialist’s book of limit orders. The choice of execution will include an internalization model though we continue to believe that internalization should only be allowable on a price-improved basis.
The Special Committee has also proposed that the Intermarket Trading System (commonly referred to as "ITS") be phased-out and replaced by industry initiatives to ensure connectivty of markets and investor access to best available price.
The Intermarket Trading System was developed to facilitate intermarket trading in equities over 25 years ago. ITS was developed to link markets at a time when the state of technology was such that those linkages needed to be created through regulatory oversight.
There are those who believe that ITS has outlived its utility. We agree. The advent of 21st Century technology and the fiduciary obligation of brokers to achieve best execution warrant a different approach today from the solutions of quarter century ago.
The philosophy of competing markets embodied in the 1975 Securities Acts Amendments and the National Market System have served investors well. We believe, however, that developments in communications technology have eliminated the need for a government-mandated intermarket order-routing system such as ITS.
Today, the electronic systems developed by broker-dealers themselves make equities trading a global operation. When there are insufficient linkages, market participants will create their own superior linkages. This is a point that both Charles Schwab and several ECNs have made in past hearings before the Subcommittee. We believe that the free market process, the pursuit of competitive advantage and the need to ensure customers of the best possible price should shape the market structure of this century.
If any market (the NYSE included) or market participant fails to provide such pricing, its business will fade away and become a distant memory.
To the extent that policy makers believe that ITS continues to be needed, membership should require self-regulatory status as approved by the SEC.
Broker-dealers should link to ITS only through SROs participating in the ITS plan. This is essential to maintaining the integrity of intermarketplace connectivity.
Last week, Fed Chairman Greenspan suggested that the term "CLOB" is an imprecise term. By extension, I would suggest that we must avoid a debate over semantics. We should maintain as our primary goal the achievement of marketplace connectivity - - with competing arenas for order flow and guaranteeing best system-wide pricing as our standard.
No market or broker-dealer can ever support inferior executions. It is essential that price, connectivity and transparency dictate where a customer’s order is executed. Equally important is that we not perpetuate a structure designed in pursuit of a goal of the last century. In other words, if a so-called "market" linked into the intermarket arena ends up executing a majority, or even a substantial minority, of its orders over ITS, it is probable that those entering orders on that alternate system are doing so primarily to free-ride the liquidity of competing markets.
As SEC Chairman Levitt recently observed, the investments in systems that the NYSE and other ITS participants make should not be subject to such "free-riding." Chairman Levitt makes an essential, and sometimes overlooked, point. An NYSE membership is valuable because of the benefit it confers – namely, access to the world’s most liquid marketplace.
The governance structure of ITS should only be expanded to include markets as chartered by the SEC. Those entities that opt to retain non-self-regulatory status must be interlinked as members of the NASD or the NYSE. The current governance structure gives veto power to any member of ITS over any change in the system. While our preference is to scrap this quarter-century-old process if this is retained, it should continue to foster competition and intermarket innovation. SRO’s should be encouraged to compete with one another and other market participants. To ensure free and fair competition, SROs must retain control over their own business models. Converting ITS’s governance structure to include non-marketplace participants would hold markets hostage to those who would stifle competition to their competitive advantage.
Chairman Grams, the NYSE has been and will continue to be a technology leader. Our competitive position depends on it. The NYSE is committed to the plan of action that I have outlined for you. Implementation of cutting-edge technology is part of the plan. Also key is permitting technology to provide market-based answers to problems that once demanded government solutions.
In the final analysis, America’s capital markets have been and continue to be the envy of the world. As the centerpiece of our markets, the NYSE is dedicated to ensuring that leadership role in the 21st Century. I look forward to working with the Committee towards achieving that goal.
Mr. Chairman, I ask that my complete statement be entered in the record, and of course, would gladly answer whatever questions you or the members may have.
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