Chairman Gramm, and other distinguished Members of the Committee, I appreciate your interest in the Section 31(a) fee issue and welcome the opportunity to offer my views on behalf of the Chicago Stock Exchange. The excessive Section 31(a) fees, monies that end up in the general revenues rather than the intended purpose of funding the SEC, are simply a hidden tax on the American people who are working hard to build a secure financial future for themselves and their families. You are to be commended for your efforts on this very important issue.
The Chicago Stock Exchange ("CHX") opened for trading in 1882 and today has become the second-largest stock exchange in the United States. In 2000, over 26 billion shares traded and approximately 65 million trades executed – transactions representing a total value of over $1.2 trillion. We are known as an innovative, low-cost, and high quality equity marketplace that is a leader in technology. Our automated trading systems provide a significant boost in productivity, capacity and reliability while reducing our operating costs. Our investment in technology has served us well, resulting in an average annual growth rate of more than of 70% over the past 5 years. Today, we are able to process over 10,000 trades per minute. The CHX also uniquely benefits the investor by providing the largest auction market for NASDAQ stocks. These and other aspects of our exchange, such as extended trading hours, automated price improvement, and the ability to trade more than 4,400 issues - more than any other U.S. exchange – distinguishes the CHX.
While we are justifiably proud of our growth, we continue to be an organization mostly comprised of small businesses that fiercely compete with much larger rivals. Excessive Section 31(a) fees are not just an unfair burden on investors, they are also an impediment to small trading firms growing their businesses, providing quality jobs to people in our community, and providing serious competition that benefits all investors.
The Case For Reducing Section 31(a) Fees
Before I lay out the arguments for reducing fees, let me reassure you that the Chicago Stock Exchange supports a fully funded SEC. Investor protection is of the utmost importance – investors have to have confidence in the integrity of our markets. At the same time, these excessive collections must be brought into line with the true budget needs of the SEC.
Section 31(a) Fee Collections Far Exceed Expectations and SEC Budget Needs
When the NSMIA fee structure was established in 1996, no one could have anticipated the explosion in transaction volume that has occurred and the huge increase in fees that are being collected as a result. As SEC Chairman Arthur Levitt noted in 1998,
[t]he projections made in 1996 when NSMIA was enacted did not anticipate the strength of the bull market we are enjoying today. Collections are currently up across the board – not only for Nasdaq trades. Collections will continue to increase if market activity continues to grow.
They did. The fiscal year 2000 revenue generated by Section 31(a) transaction fees alone (not including other fees, such as registration fees) was $1.1 billion, which far exceeded the SEC’s appropriated budget of $377 million. In fiscal year 2001, Section 31 (a) fees are again expected to exceed $ 1 billion because the sharply increasing volume of transactions is expected to continue. For many reasons that include growing investor activity in the United States and around the world, we believe that even if market values decline, transaction volume is likely to continue to grow.
This unexpected growth in securities market transaction since 1996, which at our exchange has averaged more than 70% growth per year, provides sufficient reason for Congress to revisit the fee structure established in NSMIA to bring it more in line with the purposes Congress articulated. If left unchecked, the Section 31 (a) fee is expected to continue to swell, imposing a back-door tax on capital and limiting the U.S. securities industry’s ability to create better products for investors at lower costs and aggressively compete in the global market.
The Section 31(a) Fee Structure Harms Competition in the Industry
Excessive Section 31(a) fees also reduce competition within the industry. The CHX is a regional exchange that trades securities that are listed and also traded on the primary markets (the New York Stock Exchange, American Stock Exchange, and NASDAQ). CHX competes for these trades almost entirely based upon speed, quality, and cost of execution. To be successful, it must better the primary markets in these areas.
The CHX strategy is to gain a cost advantage over its competitors through greater reliance on technology and enhance productivity. The CHX has invested heavily in creating systems and processes that can efficiently execute large numbers of transactions. Our productivity has increased more than 50% in each of the past five years. These investments are fixed costs. As volume increases, these fixed costs are being spread over a greater number of trades, which, in turn, allows the CHX to reduce transaction fees for all users of its markets. The strategy has proven to be successful to the point where there are now many products that have no associated exchange fee.
While the CHX has been able to reduce its transaction fees as volume has increased, Section 31(a) fees have remained constant. The result has been that an increasingly larger percentage of our customer’s cost of doing business at the CHX is beyond our ability to control. Cost is, in large part, what gives the CHX a competitive advantage and that advantage grows as our volume grows. A government tax rate that remains fixed regardless of volume or SEC needs limits our ability to compete and provides a disincentive to pursuing further volume-related efficiencies.
Mr. Chairman, let me cite a specific example of just how these excessive fees can impact a small business trading on our Exchange. Rock Island Specialists, a specialist firm on our floor, has 70 employees. It competes successfully with firms many times its size because of the quality of its service and importantly, its ability to control its costs. Like all successful small businesses, Rock Island would like to grow its business and create new employment opportunities, but growth requires capital.
This year Rock Island will pay the U. S. government approximately $4 million in federal income taxes. It will pay the U.S. government an additional $1.75 million in Section 31(a) fees; a 44% federal surtax on its business. I believe that we are all better served by allowing small businesses to use the excess fees to build their businesses and create greater competition in the marketplace. Investors will benefit from the competition and new jobs will be created.
Section 31(a) Fees Harm Our Ability to Compete Internationally
European exchanges are consolidating their operations. It is our view that, in the near future, only a few large exchanges are likely to dominate the European market. These exchanges will pose a competitive threat to U.S. exchanges should they add U.S. securities to the multi-national mix of securities traded in their markets. The ability to route orders over vast distances to foreign markets and to receive prompt reports of executions is becoming less difficult with each advancement in communications technology. National boundaries are losing their relevance in the securities markets.
Foreign exchanges will be in direct competition with U.S. regional exchanges for trades in securities listed on the U.S.. primary securities markets. The foreign exchanges are likely to find, as U.S. regional exchanges have found, that to be successful they will have to compete on quality and cost executions. But these foreign competitors will not be subject to Section 31(a) fees and therefore have a cost advantage over U.S. regional exchanges. This advantage could prove critical to the CHX and other U.S. regional exchanges that compete with the primary markets, and with each other, based largely on their ability to provide lower cost transactions.
This potential competitive threat can be seen in the financial futures markets which, since their inception in the 1970’s, have been international markets. Traders from around the world direct orders to U.S. futures exchanges to trade foreign currency; Eurodollars, U.S. Treasury Bonds and other financial futures contracts. Similarly, traders from around the world direct their orders for German Bund financial futures to a German futures exchange. As recently as two years ago, those traders directed their orders for Bund futures contracts to a futures exchange in England. In this example, the business left England and went to Germany because the futures exchange in Germany could provided the same product in a more cost efficient means.
The lessons learned form events in the international derivatives markets also can apply to securities markets. We can expect that investors will shift from a market in one country to a market in another to trade the same product at a lower cost, just as has happened in the derivatives markets. Anything that imposes a higher costs on U.S. exchanges, such as excessive Section 31(a) fees, risks harming our international competitiveness.
The Current Section 31(a) Fees Structure Deserves Congressional Attention
As noted above, the current Section 31(a) fee structure was carefully crafted by Congress in 1996 to meet important public policy goals. Again, the CHX supports a fee structure that provides stable, long-term funding mechanism for the SEC to ensure that its essential regulatory and oversight functions are continued. Today, the Commission’s funding is no longer in question. Given the explosive growth in securities transactions and the likelihood of continued expansion, the issue has become whether the current Section 31(a) fee formula is appropriate in 2001 and beyond. From the perspective of the CHX, excessive fees harm our ability to compete at home and abroad to provide the highest quality service at the lowest industry costs for our members and all investors.
The Competitive Market Supervision Act of 2001 will restore the Section 31(a) fee structure to its intended purpose: fully funding the SEC. We support this effort to eliminate what has become an unfair tax on investors and an unfair burden on participants in the U.S. equity markets.
We appreciate the Committee’s interest in this issue and the opportunity to present the views of the CHX. We remain committed to focusing our efforts on lowering trading costs while enhancing U.S. leadership in this most critical of industries.
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