June 27, 2017

House Financial Services Subcommittee on Capital Markets, Securities, and Investment: Equity Market Structure Part I – A Review of the Evolution of Today’s Equity Market Structure and How We Got Here

Key Topics & Takeaways

  • Securities Information Processors: Rep. Huizenga (R-Mich.) posed the question if broker-dealers should have direct voting on NMS Plan Operating Committees and was interested in discussing the concerns associated with the Securities Information Processors (SIPs) vs. the exchanges proprietary market data feeds.
  • Regulation NMS: Rep. Thomas MacArthur (R-N.J.) stated that it is an interesting time to revisit Regulation NMS and noted its goals of efficiency, fairness, availability of information, access and optimal execution. MacArthur posed the question as to how to deal with conflicts of interests with Self-Regulatory Organization (SROs) and how NMS Plan governance could be alleviated.
  • MiFID II: Rep. Randy Hultgren (R-Ill.) stated that it is important that as MiFID II progresses in Europe, the regulators in the United States should be engaged in the policy implications and take appropriate steps to ensure that the United States capital markets remain competitive.



  • Matt Lyons, Senior Vice President and Global Trading Manager, The Capital Group
  • Joseph Saluzzi, Partner, Themis Trading LLC
  • Ari Rubenstein, Chief Executive Officer, Global Trading Systems
  • Jeff Brown, Senior Vice President, Legislative and Regulatory Affairs, Charles Schwab
  • Thomas Farley, President, New York Stock Exchange
  • Brad Katsuyama, Chief Executive Officer, The Investors Exchange
  • Chris Concannon, President and Chief Operating Officer, Chicago Board of Options Exchange
  • John Comerford, Head of Global Trading Research, Instinet
  • Tom Wittman, Executive Vice President and Global Head of Equities, NASDAQ


Opening Statements

In his overview, Subcommittee Chairman Bill Huizenga (R-Mich.) gave a historical overview of the equity markets. Huizenga stated that the modern markets trace their history to four regulations and rules: (1) Order Handling Rules, (2) Regulation ATS, (3) Decimalization, and (4) Regulation NMS. Huizenga noted that with the technological advances, investors have benefited substantially, but the markets are not perfect.


Ranking Member Carolyn Maloney (D-N.Y.) thanked everyone in attendance and stated that the United States has the deepest and most efficient markets in the world. Noting that, Maloney stated that it is important to look at how to improve them, in particular if they are safe, innovative, and fair to all investors. Maloney noted that “undoubtedly the markets are better today,” but they are not perfect and improvements can be made. For instance, she noted that “there is a fine line between too many trading venues and too few.” Maloney also noted that Regulation NMS promoted price competition and drove down costs, but also prioritized speed over all else. Lastly, she stated that any changes made to the market should be ground in data and that she is pleased to see the Tick Size Pilot running and hope that it yielded solid data.


Subcommittee Vice Chairman Randy Hultgren (R-Ill.) stated that Congress has a responsibly to ensure “we are all on the same page” and that he does not believe the market is “rigged.” Hultgren stated that he was concerned that significant events have shaken investor confidence, such as the volatility events of August 24th, 2015. He also noted that it is important that as MiFID II progresses in Europe, the regulators in the United States should be engaged in the policy implications and take appropriate steps to ensure that the United States Capital Markets remain competitive.


Panel 1 Opening Statements

Matt Lyons, Senior Vice President and Global Trading Manager, The Capital Group

In his testimony, Lyons stated that the 1975 amendments to the Securities and Exchange Act were overdue for inspection and believed the Securities and Exchange Commission (“Commission”) should lead the review. In particular, Lyons stated that the Commission should prioritize reforms to minimize conflicts of interest and increase transparency. Additionally, he highlighted that the Commission should: (1) evaluate the maker-taker pricing model and conduct an access fee pilot, (2) improve NMS Plan governance by giving market participants a meaningful voice, and (3) approve its proposed rules that enhance ATS transparency and institutional order routing disclosures.


Joseph Saluzzi, Partner, Themis Trading LLC

In his testimony, Saluzzi stated that the markets have become more complex and that Regulation ATS is the source of the issue. Saluzzi further noted that he did not believe the Commission would have wanted fragmentation as it exists today. Saluzzi also expressed his concerns with exchanges, in particular that they are no longer non-profit businesses, their usage of maker-taking pricing, and proprietary data feeds. He noted that “common sense” reforms were necessary, including eliminating Payment for Order Flow (“PFOF”) and reducing the amount of exclusive information provided via the proprietary data feeds.


Ari Rubenstein, Chief Executive Officer, Global Trading Systems

In his testimony, Rubenstein highlighted that the markets have improved due to technology and smart regulation. However, Rubenstein noted that there is a concern with technological vulnerabilities to the markets and highlighted that the Market Access Rule, Regulation SCI, and the Consolidated Audit Trail (“CAT”) have been positive improvements. Rubenstein indicated that any discussion related to changing market structure should be done with the needs of public companies in mind. Lastly, Rubenstein stressed the importance of improving the Securities Information Processors (“SIPs”) market data feeds.


Jeff Brown, Senior Vice President, Legislative and Regulatory Affairs, Charles Schwab

In his testimony, Brown stated that he was appearing on behalf of the Securities Industry and Financial Markets Association (“SIFMA”). Brown noted that today’s market is fully electronic with a vibrant ecosystem. Brown highlighted three major regulatory developments: (1) Regulation ATS, (2) Decimalization, and (3) Regulation NMS. Brown noted Regulation NMS Rule 611 which prevents displayed investor orders from being traded through. Brown stated that retail investors have benefited from these developments. Brown also stated that once exchanges became for-profit business, their incentives changed. Brown highlighted two recommendations: (1) that the self-regulatory model and NMS Plan governance needs to be rethought, and (2) consolidated market-data requires an overhaul.


Question & Answer

Benefits and State of the Current Market Structure

Huizenga briefly discussed the 1975 amendments to the Securities and Exchange Act and posed questions to both Brown and Lyons as to what is currently working well in market structure and if there is any consensus on any issues. Brown stated that since Regulation NMS, retail investors get a far better price improvement than exists if the orders were to flow to exchange. Brown also noted the low costs of trading overall and improved execution quality. Lyons stated that technology has empowered the buyside and has given them more control over their orders. Lyons stated where it falls short is maker-taker pricing and broker-dealer routing technology.


Huizenga posed the question to Rubenstein as to what Congress should be looking at. Rubenstein noted that the data show the markets are the most efficient in the world, yet, transparency and disclosure needs to be improved.


Rep. Ann Wagner (R-Mo.) highlighted the panelists comments regarding how the equity markets are the most efficient and posed the question as to how institutional and retail investors have benefited from the improvements to market structure. Lyons stated that Regulation NMS “removed frictions from the market” and that buyside traders now have more control. Brown noted that retail investors now have instantaneous access to the markets.


In response to Wagner’s question if the increase in execution speeds are attributable to Regulation NMS, Brown stated that it is not fully attributable, as technology has contributed and that retail investors have it the best they have ever had.


Rep. David Scott (D-Ga.) noted that the U.S. markets are the greatest and that everyone wants a fairer and more transparent market place. Scott posed the question as to what can Congress do ensure the strongest economic system on the planet. Lyons recommended decreasing conflicts of interest and better broker disclosures. Saluzzi stated that trust and confidence is important.


Scott then raised his concern with volume decreasing on the NYSE and Saluzzi responded by stating the cause was fragmentation.


Rep. Bruce Poliquin (R-Maine) discussed that retail investors get the best price at the lowest cost possible and that this is important in order to ensure they have the largest “nest egg” possible. Poliquin posed the question to Lyons as to what the challenges institutional investors are facing in today’s market structure and for Lyons to walk him through an institutional trade. Lyons stated that his firm does fundamental analysis and that when he has a large order, he breaks it up and is concerned with information leakage. Lyons raised his concerns with the lack of orders in lit markets and the impact on price formation.


Rep. Ted Budd (R-N.C.) highlighted that the general theme of the discussion is that the markets are efficient and well-capitalized and asked how to ensure we preserve the things that have led us to this position. Lyons responded with removing frictions and allowing buyers and sellers to interact and limit unnecessary intermediation. Brown stated that the United States has the highest percentage of retail investors in the market and that we do not want to take steps that disincentives their participation in the markets.


NMS Plan Governance

Huizenga raised the question to Browns and Lyons regarding NMS Plan governance and what are the benefits of brokers and asset managers being on it. Brown replied that by adding industry participants, the Plans would benefit from their expertise early in the process and be pointed in a direction that is better for the markets. Lyons agreed with Brown and stated that adding non-SRO members and their views will bring added benefit and that a “seat at the table would be meaningful.”


Rep. French Hill (R-Ark.) noted that exchanges are now for-profit and posed the question regarding the benefits of asset managers and broker-dealers serving in the governance model. Lyons stated representation of institutional investors is additive to the process and that with only SROs, there are conflicts of interest, for example the SIPs.


Rep. Thomas MacArthur (R-N.J) stated that it is an interesting time to revisit Regulation NMS and noted goals of efficiency, fairness, availability of information, access and optimal execution. MacArthur posed the question to Brown regarding SROs and conflicts of interest, and how conflicts can be alleviated. Brown responded that exchanges operate as SROs, a government granted status and that they regulate the very participants they compete against. Brown stated that this is an issue that Congress should evaluate. Brown highlighted FINRA should be the sole SRO and the exchanges free to be commercial enterprises. Saluzzi noted that with being an SRO, the exchanges also have regulatory immunity, which protects them against business failures and errors. Lyons stated that SROs and exchanges play an important function and that the SEC needs to take a leading role and advocate additional participants in NMS Plans.


Market Data

In response to a question from Wagner regarding market data, Brown stated that the current system is “antiquated,” in that the SIPs are slower than what is available from exchange. Brown also noted how expensive the exchanges’ proprietary data feeds are and that this industry is the only business “where you have to give your raw materials to a company and buy it back.”


Rep. Bill Foster (D-Ill.) noted to Brown regarding SIP technology improvements and if there was any reason to not upgrade. Brown in response stated that the exchanges will claim that improvements have been made, but that this is only in response to technology failures. Brown further stated that the exchanges and Operating Committees are never going to make them so good that they compete with their proprietary product. Brown noted that the SIPs should include depth of book and that latency could be narrowed.


Hill posed the question to Brown regarding market data and modernization. Brown stated that modernization of market data would mean providing more information via the SIPs to investors and being maintained at higher levels. Brown noted that with the way the system is currently structured, market participants are locked into it and that innovation has occurred outside of the current market structure.


Rep. Tom Emmer (R-Minn.) stated that Congress needs to know what policies will drive better results and raised the question regarding SIP market data feeds. Rubenstein stated that the SIP has improved dramatically but more work needs to be done.


Access Fees

Maloney discussed access fees and the incentive for broker-dealers to route order to the exchange with the highest rebate. Maloney posed the question to Saluzzi if the SEC should move forward with the Equity Market Structure Advisory Committee (“EMSAC”) access fee recommendation and if so, who should design it or should it be delegated to the “committee of exchanges.” Saluzzi responded by stating that brokers are taking advantage of rebates and that exchanges should only charge fees on both sides of a transaction. Saluzzi also stated that with market makers paying for order flow, it corrupted order routing. Lyons stated that investors need more information and transparency and that the SEC should adopt its proposed rules related to institutional order handling and transparency.


Payment for Order Flow

Foster posed the question if “mom and pop” traders get a “better deal” due to payment for order flow (“PFOF”). Brown responded in the affirmative, in that mom and pop orders are valuable in that there is less risk associated with their orders. Brown noted that his firm receives on average a ¼ price improvement and that his firm discloses this information and performs best execution. Brown believed that further disclosure is a good idea. Saluzzi noted that in addition to retail, it is important to look at how institutional investors are performing in the market. Lyons stated that his firm looks at implicit costs and they have not decreased as much as they would like. Lyons attributed the improvement in pricing and executions to decimalization and technology.


Rep. Trey Hollingsworth (R-Ind.) posed the question to Brown why execution quality has improved with internalization rather than routing to an exchange. Brown stated firms compete for retail orders, as there is less risk with them. Brown noted that if PFOF were removed, professional traders sit at the bid and offer at an exchange, and in effect it would be a wealth transfer. Brown also noted that the delta between exchanges and internalizers is growing, since exchanges are limited in their ability to compete on price.


Conflicts of Interest

Emmer noted Lyons’ testimony and his discussion on conflicts of interest. In response, Lyons highlighted order routing as a conflict of interest and the need for increased broker-dealer disclosures. Brown noted PFOF as a potential conflict of interest and that his company looks at it very closely and takes steps to mitigate it. Brown noted that his firm monitors execution quality and that PFOF is reinvested back into the business to improve trading tools and lower commissions.


ATS Disclosure

Hultgren noted Lyons’ testimony regarding ATS disclosure and asked Lyons whether ATS disclosures should be voluntary and whether he has a choice in terms of which ATS he chooses to do business with. Lyons stated that there are benefits of ATSs and that a standardized response would provide the means to engage in meaningful discussion regarding how they operate. Additionally, Lyons stated that the SEC’s proposed Institutional Order Handling rule would provide investors with order routing information in a “digestible format.”



Hultgren highlighted Rubenstein’s testimony regard cybersecurity, notably his recommendation for a better system for sharing information between stakeholders, and asked what role the SEC and Congress should play. Rubenstein responded that firms are hesitant to share information and that they should be mandated to get together and discuss the issues.


Equity Market Structure Advisory Committee

Hultgren posed to Brown his thoughts on the SEC’s EMSAC. Brown stated that the EMSAC is a good tool to confront challenges. Yet, Brown indicated that he is disappointed in the make-up of the EMSAC, noting that it does not include a retail firm or primary listing exchanges.


Intermediation in the Markets

Rep. Stephen Lynch (D-Mass.) referenced Saluzzi’s book and highlighted that a properly functioning market includes a pricing mechanism that establishes a “proper equilibrium.” Lynch further noted that maker-taker, colocation, and payment for order flow is an encumbrance on a properly functioning market and highlighted his legislation regarding the current maker-taker model. Saluzzi stated “we need to match buyers and sellers” and that there is “too much intermediation.” Saluzzi further noted that there are “too many order types” and highlighted the SEC’s fine against an exchange for not disclosing order types.


Exchange Traded Funds

Hill highlighted that public policy has encouraged individual investors to invest in exchange-traded funds (ETFs) and that he is concerned with potential risks. Rubenstein agreed that there has been adoption with ETFS and is concerned that investors may not be prepared for ETF volatility in the future.



Rep. Warren Davidson (R-Ohio) posed the question regarding challenges to liquidity in smaller companies. Saluzzi raised his concern with the one-size-fits-all market. Rubenstein stated that if you remove rebates, you will impact liquidity for small and midcap companies. Rubenstein also stated that it is important for auctions to stay at the primary listing exchange.


Consolidated Audit Trail

Davidson asked if the exchanges are selling market data, isn this information already available in the Consolidated Audit Trail (CAT). Brown stated that this is what is troubling with not having broker-dealers on the NMS Plans, as this data could be used for business purposes.


Panel 2: Opening Statements

Thomas Farley, President, New York Stock Exchange

In his testimony, Farley highlighted that NYSE recently celebrated its 225th birthday and that displayed liquidity is the lifeblood of the market. Farley stated that from a listed company perspective, Initial Public Offerings (“IPOs”) have declined dramatically, that the market is only working for large cap companies, and that proxy adviser firms are a concern. Farley also highlighted concerns with Sarbanes Oxley and Dodd-Frank and their contribution to decreasing IPOs. Lastly, Farley noted that listed companies would prefer that the focus be on simplicity and transparency.


Brad Katsuyama, Chief Executive Officer, The Investors Exchange

In his testimony, Katsuyama posed the question if markets serve investors and the capital markets, or are they serving themselves. Katsuyama stated that technology drove improvements in the market and raised his concern with exchanges selling data feeds and their conflicts of interest as SROs. Katsuyama further highlighted his concerns with rising market data prices and that there is no basis for these cost increases. Katsuyama also noted his concerns with the lack of broker representation on NMS Plans and the conflicts associated with rebates and broker-dealer order routing.


Chris Concannon, President and Chief Operating Officer, Chicago Board of Options Exchange

In his testimony, Concannon highlighted that with the regulatory developments since the 1975 amendments to the Securities and Exchange Act, retail investors have a great market experience. Concannon stated, however, that the Order Protection Rule provides new or smaller exchanges with a commercial advantage and that it is expensive for market participants to connect to them. Concannon further noted the fragmentation in and of itself is not a concern, but complexity is a concern to institutional investors. Concannon provided that a flaw in Regulation NMS is its one-size-fits-all approach and that he encourages a comprehensive review of the regulation. Lastly, Concannon recommended a minimum volume threshold for protected quotations.


John Comerford, Head of Global Trading Research, Instinet

In his testimony, Comerford stated that decimalization was responsible for tighter spreads, rather than Regulation NMS. Comerford further noted that tick size can be too small and too large and that the tick size spread is the primary incentive for liquidity providers to provide liquidity. Comerford raised his concerns with the one-size-fits-all approach and that tick sizes and access fees are completely related.


Tom Wittman, Executive Vice President and Global Head of Equities, NASDAQ

In his testimony, Wittman stated that the U.S. markets are the strongest and fairest in the world and that only data driven analysis should underpin changes. Wittman highlighted that without SROs, the SEC would have to grow. Wittman further stated that the trading experience for small and midcap securities needs to be improved. Wittman raised his concerns with fragmentation, particularly its impact of price formation. Lastly, Wittman recognized the need for an appropriate rebate structure.


Question & Answer

NMS Plan Governance

Huizenga posed the question if broker-dealers should have direct voting on NMS Plan Operating Committees and to discuss concerns related to SIP vs. proprietary market data. Wittman stated that industry participants sit on advisory committees and they already have a voice in the conversation and that there is more transparency today. Wittman provided that with respect to the SIPs, they have reduced the latency. Concannon stated that the SIP plans have improved over the past several years and have increased transparency. Concannon stated that they are willing to consider adding broker-dealers to the Operating Committee. Concannon stated that there is heated competition for proprietary market data products. Farley provided that there is room for improvement and strengthening the NMS Plans. Farley stated that the SEC has become more reliant on NMS Plans because it is faster and that in turn engenders ill will with market participant.


Maloney stated that the EMSAC recommended an access fee pilot and posed the question if the SEC or the “committee of exchanges” should be responsible for it. Farley stated that they feel “strongly” that the SEC should do it. Farley noted that primary listing companies are not on the EMSAC and for the pilot, they “didn’t get it right” and need to look at it more. Wittman stated that the conversation needs to focus more on rebates and not access fee caps and that the market needs intelligent rebates and tick sizes.


Hill posed the question if asset managers and broker-dealers should be integrated into the SIP plans. Farley stated that their interaction has increased over time. Katsuyama stated that advisory committee members would disagree with that characterization.


Market Data

Maloney asked Katsuyama about his comment on why the cost to buy market data bears no resemblance to its underlying costs. Katsuyama stated that market data is like “radio,” in that the costs are upfront to build it and additional connections are de minimis. Katsuyama stated there is no market data competition.


Rep. Brad Sherman (D-Calif.) posed the question to Katsuyama why IEX does not charge for market data. Katsuyama in response stated they build the cost of data into their trading fee. Katsuyama noted that regulations are designed to mitigate conflict of interest rather than address them head-on.


Payment for Order Flow and Rebates

Hill stated that he appreciates IEX innovation and posed the question to Farley if broker-dealers paid for order flow, are they ignoring their best execution responsibilities. Farley responded that broker-dealers are conscientious actors and he does not want to “demonize” them. Farley stated the broker-dealers acknowledge there is an inherent conflict of interest with rebates.


In response to Hultgren’s question regarding rebates, Concannon stated that rebates go to dealers who are trying to support smaller companies. Concannon noted however that the size of the rebate should likely be modified as the company becomes more liquid. Concannon also noted that rebates are highly regulated and broker-dealers are still subject to best execution and it would insult them to insinuate that they are not following their obligations. Concannon noted that there are always conflicts of interest, and the better question is how do you deal with conflicts. Concannon further stated that broker-dealers have full committees that focus solely on best execution. Lastly, Concannon stated that IEX is a dark pool that has wrapped itself as an exchange.



Emmer raised the question to Wittman regarding liquidity in the top 100 names and how intelligent tick sizes compare to the tick pilot today. Wittman responded that the top 100 names are very liquid and for those companies you do not need a large rebate. For small and midcap securities, Wittman recommended focusing on rebates, tick size and off-exchange trading. With respect to the intelligent tick sizes, Wittman highlighted his concerns with the one-size-fits-all market. Concannon agreed that the one-size-fits-all approach does not work and recommended that Regulation NMS be modified to focus on liquidity and market cap.


IEX Speed Bump

Lynch posed the question if IEX “Speed Bump” has accomplished its goal. Katsuyama replied in the affirmative and that the speed bump is designed to ensure that the exchange can price trades fairly and accurately.


Lynch then questioned why IEX was against NYSE’s speed bump. Katsuyama stated they did not object to their speed bump, just request clarification as to why they were only offering one speed bump on exchange.



Hollingsworth asked if the costs outweigh the benefits in terms of fragmentation. Wittman responded by stating that fragmentation spurns the ability to startup a new trading venue.


In response to Hollingworth’s question that execution quality is worse on an exchange, Farley stated that an exchange’s hands are tied to a certain extent and that they can only trade at a penny or mid-point, whereas an ATS can customize its price points.


High-Frequency Trading

Hollingsworth asked if high-frequency trading provided benefits. Farley responded in the affirmative, with Katsuyama stating some are providing value and those who remove liquidity are the ones that are of concern.


Decline of NYSE

Scott asked why NYSE is in decline, to which Farley stated that the NYSE still leads the world in IPOs and NYSE is not in decline.



Scott raised his concerns with cyber terrorism. Farley stated he shares his concerns and encouraged public and private partnership. Concannon stated that while all firms compete aggressively, they partner and share information with respect to cybersecurity.


Consolidated Audit Trail

Davidson stated that the CAT does not include futures trades and it seems like the exchange’s market data they sell is part of the CAT. Concannon stated that there is some confusion with the CAT and that it is the next step in the evolution of market surveillance. Farley stated that he is very concerned with personal identifiable information (“PII”) in the CAT.



Sherman stated that it is important to get more companies listed and available to the general public. Sherman stated that the trend is for companies to stay private longer and posed the question as to what are the benefits of public markets and what do we need to do to get a greater percentage to the market. Wittman stated that private equity has played a role in this, as well as frivolous law suits when a company is looking to go public and the burdensome 10Q. Wittman suggested making changes to make it easier to go public. Sherman agreed with Wittman that determining the appropriate requirements is important.


Poliquin stated that it is good when companies go public and grow, and asked why so few companies choose to go public. Farley stated that there are a number of reasons, including class action lawsuits, proxy advisors, Sarbanes Oxley, and shareholder reporting regime.



Poliquin stated that short-selling felt “icky and un-American,” but that the data demonstrates that it does provide a good service.


Regulatory Review

Budd asked if Congress should take another look at the market’s regulatory framework, in which Wittman responded in the affirmative.


Definition of Exchange Facility.

Rep. Barry Loudermilk (R-Ga.) asked if the NYSE has affiliates not involved in market pricing but are being deemed facilities of the exchange. Farley stated this is occurring and Loudermilk responded that they have legislation affecting this


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