[107th Congress House Hearings]

<PRE><DOC>
[107th Congress House Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:77119.wais]

ELECTRONIC COMMUNICATION NETWORKS IN THE WAKE OF SEPTEMBER 11
=======================================================================

HEARING

before the

SUBCOMMITTEE ON
COMMERCE, TRADE, AND CONSUMER PROTECTION

of the

COMMITTEE ON ENERGY AND COMMERCE
HOUSE OF REPRESENTATIVES

ONE HUNDRED SEVENTH CONGRESS

FIRST SESSION
__________

DECEMBER 19, 2001
__________

Serial No. 107-79
__________

Printed for the use of the Committee on Energy and Commerce

Available via the World Wide Web: http://www.access.gpo.gov/congress/
house
__________

U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 2002
_____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512-1800
Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001

COMMITTEE ON ENERGY AND COMMERCE

W.J. ``BILLY'' TAUZIN, Louisiana, Chairman

MICHAEL BILIRAKIS, Florida JOHN D. DINGELL, Michigan
JOE BARTON, Texas HENRY A. WAXMAN, California
FRED UPTON, Michigan EDWARD J. MARKEY, Massachusetts
CLIFF STEARNS, Florida RALPH M. HALL, Texas
PAUL E. GILLMOR, Ohio RICK BOUCHER, Virginia
JAMES C. GREENWOOD, Pennsylvania EDOLPHUS TOWNS, New York
CHRISTOPHER COX, California FRANK PALLONE, Jr., New Jersey
NATHAN DEAL, Georgia SHERROD BROWN, Ohio
STEVE LARGENT, Oklahoma BART GORDON, Tennessee
RICHARD BURR, North Carolina PETER DEUTSCH, Florida
ED WHITFIELD, Kentucky BOBBY L. RUSH, Illinois
GREG GANSKE, Iowa ANNA G. ESHOO, California
CHARLIE NORWOOD, Georgia BART STUPAK, Michigan
BARBARA CUBIN, Wyoming ELIOT L. ENGEL, New York
JOHN SHIMKUS, Illinois TOM SAWYER, Ohio
HEATHER WILSON, New Mexico ALBERT R. WYNN, Maryland
JOHN B. SHADEGG, Arizona GENE GREEN, Texas
CHARLES ``CHIP'' PICKERING, Mississippi KAREN McCARTHY, Missouri
VITO FOSSELLA, New York TED STRICKLAND, Ohio
ROY BLUNT, Missouri DIANA DeGETTE, Colorado
TOM DAVIS, Virginia THOMAS M. BARRETT, Wisconsin
ED BRYANT, Tennessee BILL LUTHER, Minnesota
ROBERT L. EHRLICH, Jr., Maryland LOIS CAPPS, California
STEVE BUYER, Indiana MICHAEL F. DOYLE, Pennsylvania
GEORGE RADANOVICH, California CHRISTOPHER JOHN, Louisiana
CHARLES F. BASS, New Hampshire JANE HARMAN, California
JOSEPH R. PITTS, Pennsylvania
MARY BONO, California
GREG WALDEN, Oregon
LEE TERRY, Nebraska

David V. Marventano, Staff Director
James D. Barnette, General Counsel
Reid P.F. Stuntz, Minority Staff Director and Chief Counsel
______

Subcommittee on Commerce, Trade, and Consumer Protection

CLIFF STEARNS, Florida, Chairman

NATHAN DEAL, Georgia EDOLPHUS TOWNS, New York
Vice Chairman DIANA DeGETTE, Colorado
ED WHITFIELD, Kentucky LOIS CAPPS, California
BARBARA CUBIN, Wyoming MICHAEL F. DOYLE, Pennsylvania
JOHN SHIMKUS, Illinois CHRISTOPHER JOHN, Louisiana
JOHN B. SHADEGG, Arizona JANE HARMAN, California
ED BRYANT, Tennessee HENRY A. WAXMAN, California
STEVE BUYER, Indiana EDWARD J. MARKEY, Massachusetts
GEORGE RADANOVICH, California BART GORDON, Tennessee
CHARLES F. BASS, New Hampshire PETER DEUTSCH, Florida
JOSEPH R. PITTS, Pennsylvania BOBBY L. RUSH, Illinois
GREG WALDEN, Oregon ANNA G. ESHOO, California
LEE TERRY, Nebraska JOHN D. DINGELL, Michigan,
W.J. ``BILLY'' TAUZIN, Louisiana (Ex Officio)
(Ex Officio)

(ii)

C O N T E N T S

__________
Page

Testimony of:
Andresen, Matthew, President & Chief Executive Officer, The
Island ECN................................................. 12
Bang, Kim, President, Bloomberg Tradebook.................... 22
Jamiatis, Keith R., Senior Vice President, NYFIX Millenium... 40
Kinney, Catherine R., Group Executive Vice President, New
York Stock Exchange, Inc................................... 17
O'Hara, Kevin J.P., General Counsel, Archipelago, LLC........ 28
Randich, Steven J., Executive Vice President of Operations &
Technology, Chief Information Officer, The Nasdaq Stock
Market, Inc................................................ 35
Steinmetz, Joel, Senior Vice President, Instinet............. 7

(iii)

ELECTRONIC COMMUNICATION NETWORKS IN THE WAKE OF SEPTEMBER 11

----------

WEDNESDAY, DECEMBER 19, 2001

House of Representatives,
Committee on Energy and Commerce,
Subcommittee on Commerce, Trade, and
Consumer Protection,
Washington, DC.
The subcommittee met, pursuant to notice, at 10:23 a.m., in
room 2322, Rayburn House Office Building, Hon. Cliff Stearns
(chairman) presiding.
Members present: Representatives Stearns, Deal, Shimkus,
Shadegg, Bryant, Pitts, Bass, Towns, Harman, and Markey.
Staff present: David Cavicke, majority counsel; Ramsen
Betfarhad, majority counsel and policy coordinator; Shannon
Vildostegui, majority counsel; Brian McCullough, majority
counsel; Will Carty, legislative clerk; Jon Tripp, assistant
press secretary; and Consuela Washington, minority counsel.
Mr. Stearns. Good morning. I would like to welcome
everybody to our hearing today and apologize for its lateness.
We had the President come over to speak to the Republican
Conference, and we were delayed and that is why we are starting
a little late.
I appreciate the indulgence of the ranking member, Mr.
Towns of New York, and we look forward to our witnesses.
The topic we will discuss today is a very important one. It
has become more obvious since the attacks of September 11 that
the decentralization in this country is good--or some would
call it ``sprawl'' of the United States--is a huge asset in
this war that has found its way to our shores. A widely
dispersed population ensures viability in the unfortunate event
of terror in a particular locale.
Mirroring the advantages of our population distribution,
the Internet also uses an assortment of distinct connections to
ensure performance even when certain locations are troubled.
The Internet has a packet switch design that allows data to run
on different paths until it is reassembled at its destination.
Its strategic design should come as no surprise, given it was
invented by the Department of Defense.
On September 11, the Internet stayed operational even with
an unprecedented surge in demand. It quickly became the
preferred method of communication when cellular and telephone
networks became temporarily overloaded. Many Americans turned
to e-mail and instant messages to communicate with loved ones
and business associates.
The Web also became an important media for information-
gathering. Like the television networks, news sites updated
information rapidly at a time when up-to-the-minute information
was extremely vital to the world.
Like the entities that provided continuity of business and
personal communications on September 11, others were arguably
capable of, but prevented from, performing such a mission.
ECNs, as the name implies, are communication networks that
facilitate commerce. At a basic level, a company like eBay is
an ECN because it facilitates the meeting of buyers and sellers
without the intervention of a middleman. More specialized ECNs,
like our panel today will talk about, specialize in
facilitating markets in stock by causing buyers and sellers to
meet electronically using private electronic networks.
ECNs are electronic networks that do not have physical
trading locations. Therefore, they are somewhat less
susceptible to disruption of service stemming from events in a
particular location. However, a catastrophic incident of the
magnitude of September 11 can still affect the communication
infrastructure that the ECNs depend on.
The technology of the ECNs is a development that reflects
the changing nature of all commerce, both domestic and, of
course, global. An ECN is not unlike the Internet in that it
provides a platform that allows perfect strangers to enter from
anywhere and meet in an anonymous environment. In this
particular case, they meet in order to trade stock. Although
they are quite different from the traditional exchanges, the
ECNs can provide a unique alternative to the markets. However,
securities regulations prevent these entities from operating
when the traditional exchanges are closed.
Following the attacks of September 11, the markets were
closed for 4 business days and no rules--excuse me--no trades
were conducted. I understand the decision was based in part on
both security concerns and the loss of power for market
participants and their ability to connect to these markets.
Additionally, even though it appears some of these ECNs had the
ability to operate in a situation such as the market shutdown,
the markets remained closed. It would have been impractical to
trade when the consolidated tape was closed for 4 days.
My colleagues--on a related note, the committee has had
correspondence last year with the SEC on an issue that affects
ECNs, the rules governing the Consolidated Tape Association, or
CTA. The CTA, as I understand it, is a group that splits the
fees from market data generated by stock trades. This data is
very valuable to ordinary people who wish to buy or sell
stocks. To change the rules of CTA or to admit new members
requires the unanimous consent of all the current members.
Because of our dealings with the Senate, we know that this
unanimous consent is difficult to achieve. That is why we are
here today.
I would like our witnesses to address what changes they
think could be made to the CTA to make it a more modern and
efficient organization. So I look forward to learning more
about these issues and considering the suggestions from our
witnesses on shaping a stronger market that can utilize the
advantages of today's technology.
And, with that, the opening statement from our
distinguished ranking member, Mr. Towns of New York.
[The prepared statement of Hon. Cliff Stearns follows:]
Prepared Statement of Hon. Clifford Stearns, Chairman, Subcommittee on
Commerce, Trade, and Consumer Protection
I would like to thank our panel of witnesses for being here today.
The topic we will discuss is an important one. It has become more
obvious since the attacks that the decentralized nature, or as some
call ``sprawl'' of the United States is a huge asset in this war that
has found its way to our shores. A widely dispersed population ensures
viability in the unfortunate event of terror in a particular locale.
Mirroring the advantages of our population distribution, the Internet
also uses an assortment of distinct connections to ensure performance
even when certain locations are troubled. The Internet has a packet
switch design that allows data to run on different paths until it is
reassembled at its destination. Its strategic design should come as no
surprise given it was invented by the Department of Defense.
On September 11th, the Internet stayed operational even with an
unprecedented surge in demand. It quickly became the preferred method
of communication when cellular and telephone networks became
temporarily overloaded. Many Americans turned to email and instant
messages to communicate with loved ones and business associates.
The Web also became an important medium for information gathering.
Like the television networks, news sites updated information rapidly at
a time when up to the minute information was vital to the world.
Like the entities that provided continuity of business and personal
communications on the 11th, others were arguably capable of, but
prevented from, performing such a mission. Electronic Communications
Networks, or ECNs, are entities that provide an electronic platform for
trading securities. As their name implies, ECNs are electronic networks
that do not have physical trading locations. Therefore, they are
somewhat less susceptible to disruption of service stemming from events
in a particular location. However, a catastrophe the magnitude of
September 11 can still affect the communication infrastructure that the
ECNs depend on.
The technology of the ECNs is a development that reflects the
changing nature of all commerce--both domestic and global. An ECN is
not unlike the Internet in that it provides a platform that allows
perfect strangers to enter from anywhere and meet in an anonymous
environment. In this particular case, they meet in order to trade
stock. Although they are quite different from the traditional
exchanges, ECNs can provide a unique alternative to the markets.
However, securities regulations prevent these entities from operating
when the traditional exchanges are closed. Following the attacks of
September 11th, the markets were closed for four business days and no
trades were conducted. I understand the decision was based in part on
both security concerns and the loss of power for market participants
and their ability to connect to markets. Additionally, even though it
appears some of the ECNs had the ability to operate in a situation such
as the market shutdown, the markets remained closed. It would have been
impracticable to trade when the consolidated tape was closed for four
days.
On a related note, I would like our witnesses to address another
issue with the consolidated tape. It is my understanding that the
Consolidated Tape Association requires unanimity for rule changes to
the operations of the system. I find this troubling as one participant
can hold up advances in the system. I would be grateful if the
witnesses would address solutions to this problem.
I look forward to learning more about these issues and considering
our witnesses' suggestions on shaping a stronger market that can
utilize the advantages of today's technology.

Mr. Towns. Thank you very much, Mr. Chairman, and also
thank you for holding this hearing.
The Nasdaq stock market and the New York Stock Exchange
should be commended for the heroic efforts that their staffs
performed to allow for the opening of their markets within 6
days after the attacks. The unified action taken by them,
together with the American Stock Exchange and the SEC and New
York State and city officials, should serve as a model for
future public-private undertakings.
It is truly a shame that it takes events like September 11
to bring the best out of us. I am hopeful that this new spirit
can be a permanent part of our financial landscape.
While this hearing is focused on ECNs, it would be a
mistake to overlook or minimize the value of the primary
markets and all they contribute to capital formation and
economic improvement in this country. They are truly natural
resources and enjoy the envy of the rest of the world.
Moreover, this committee has jurisdiction over the computer
systems and telecommunications infrastructure that forms the
backbone of ECNs and exchanges, indeed, the entirety of the
securities industry.
I firmly believe that you all provide important services to
investors. I deeply regret the losses that you sustained, be
they personal or physical, in the September 11 attacks. I look
forward to hearing from you about lessons that we can learn and
what steps we should be taking, going forward, to improve our
response to such disasters. I am especially interested in your
suggestions regarding systems security and continuity planning.
Mr. Chairman, on that note, I yield back.
Mr. Stearns. I thank my colleague.
The gentleman from New Hampshire, Mr. Bass.
Mr. Bass. Thank you very much, Mr. Chairman. I thank you
for holding this fascinating hearing. I really didn't
understand this issue until a week or so ago, and I think it is
yet another example of how modern technology is moving forward
to dramatically expand opportunities for commerce in this
country. And as you mentioned in your opening statement, what
platforms like eBay and others do for the auction business, so
electronic communications networks may do for all sorts of
other commerce-related issues, especially securities trade and
so forth.
As you also mentioned in your opening statement, there are,
however, issues that may need to be addressed in order to
protect consumers and to make sure that commerce that does
occur through this medium is done in an orderly and reliable
and secure manner.
So I welcome the witnesses that we have here today. This is
going to be a learning experience for me, and I appreciate your
holding this hearing. I yield back.
Mr. Stearns. I thank the gentleman.
Mr. Bass. Can I submit a statement for the record?
Mr. Stearns. By unanimous consent, so ordered.
[The prepared statement of Hon. Charles F. Bass follows:]
Prepared Statement of Hon. Charles Bass, a Representative in Congress
from the State of New Hampshire
Mr. Chairman, thank you for holding this hearing. As others have
pointed out, September 11 gave our system of electronic communications
quite a test.
Most of us were part of that test as we rushed to our landline and
mobile phones, our pagers, our PDAs, and our email accounts. Although
phone service from our offices was intermittently down or overloaded,
and the mobile networks were incapable of handling the volume, Internet
based systems performed well due to their packet switching technology.
I don't know what the proper role is for Congress to play in
ensuring continuity of service during a crisis. Certainly, several
items stand out as needing review. For example, why weren't emergency
broadcasting systems used to better effect? Why were those of us in
this area unable to have the numerous false rumors disproven for so
long? And why weren't we able to more effectively ask the public to use
the communications network sparingly, thus keeping it free for
emergency use? I hope that this hearing will, in part, begin to answer
these and other questions.
On September 24, I visited southern Manhattan with several members
of this committee. We saw for ourselves the extent of the horror and
damage to the area. While there, we toured the site of the World Trade
Center and the nearby Verizon building at 140 West Street. Like so many
other nearby facilities, it was impossible to imagine that the building
would be able to perform any serviceable action whatsoever.
Nevertheless, Verizon and many other service providers undertook
absolutely monumental efforts to get the system running as quickly and
confidently as possible. Each of these communications workers deserves
our thanks--and they certainly have mine.
I look forward to hearing from these witnesses, and I yield back to
the Chairman.

Mr. Stearns. The gentleman from Tennessee, Mr. Bryant.
Mr. Bryant. Thank you, Mr. Chairman. I think Mr. Pitts
actually arrived before I did, but I will be brief.
I want to welcome this panel. And like Mr. Bass, I think he
has probably already learned enough about this, but there is
more I need to learn. But I think neither of us knew very much
before we started. I welcome you.
And I thank you for holding this hearing and I would yield
back the balance of my time.
Mr. Stearns. Mr. Pitts?
Mr. Pitts. I have no opening statement.
Mr. Stearns. Mr. Shimkus.
Mr. Shimkus. Just a brief follow-up. I know Chairman Upton
in the telecom subcommittee visited Ground Zero about 4 days
after. One of the reasons why was to observe the enormous
amount of work that went--and I don't think the public really
understands what was accomplished to get the financial markets
back on line. It is a tremendous, tremendous success story; but
as much as a success story, it is also a warning on how do we
have the infrastructure to make sure that we can respond and
continue to operate in a manner that provides confidence.
I think that was one of the--of all the tremendous things
that occurred in the visit and seeing everything, the fact that
the economic stability of the country was maintained with such
a devastating blow to a large portion of the financial sector,
and the communication aspects and the ability to get up and
running and really without--I don't think the vast majority of
the public understands and saw no difference after the delay
and when the markets reopened. It is an incredible statement.
But we do have to look at how we can make sure, how we are
able to do that in the future and what type of systems need to
be in place.
Mr. Chairman, I thank you for the hearing. I think it is
going to be educational, eye-opening; and hopefully, even for
the constituents across the country, they will understand the
incredible amount of work that went on to help provide economic
stability for this country in a tremendous time of crisis.
And with that, I yield back the balance of my time.
Mr. Stearns. I thank the gentleman.
With no further opening statements, we will move to our
panel, which again, I want to welcome all of you. We have Mr.
Joe Steinmetz, senior vice president of--yes, Mr. Towns?
Mr. Towns. I would like unanimous consent that other
members who are not here also have an opportunity to put their
statements in the record.
Mr. Stearns. So ordered.
[Additional statements submitted for the record follow:]
Prepared Statement of Hon. John Shadegg, a Representative in Congress
from the State of Arizona
Thank you Mr. Chairman for holding this important hearing today.
Let me first express my deepest sympathy to those in the financial
services sector who lost employees in the terrible attack on the World
Trade Center towers. Words cannot describe the tragedy and loss.
I also want to applaud the tremendous effort of all who were
involved in putting the telecommunications infrastructure back in place
in order to get trading back up in such a short time after the 9/11
tragedy.
Mr. Chairman, today, half of all Americans own stocks, up from 36
percent in the early 1990s. At the same time, however, I would guess
that a very small fraction of that percentage understand Electronic
Communications Networks and how they may change the future of
investing.
So, it is with anticipation Mr. Chairman, that I look forward to
learning more today about the telecommunications infrastructure that
supports ECNs and the regulatory structure that may or may not need to
be changed to keep pace with technological innovation.
I yield back.
______

Prepared Statement of Hon. W.J. ``Billy'' Tauzin, Chairman, Committee
on Energy and Commerce
Chairman Stearns, thank you for holding this hearing this morning,
a hearing that will help us understand how we might improve a vital
aspect of electronic commerce.
As the name of this Committee implies, commerce is the cornerstone
of our jurisdiction. Since the September 11 tragedies, we have been
spending quite a bit of time determining how various industries
essential to commerce fared in the wake of the attacks. We have spent
time examining how these industries are prepared to deal with future
shocks to the system. As the familiar old cliche perfectly states:
``Failing to prepare is preparing to fail.''
There is ample evidence that, in the aftermath of the attacks, most
industries' inability to operate as normal was only temporary. However,
temporary interruptions still had severe results. We learned last month
of losses suffered by the travel and tourism industry from the drop-off
in air travel. Unfortunately, it has been a hard road back for that
industry.
The securities markets, too, were among the most severely affected
by the attacks. The policy decision was made to close the markets for
several days. While circumstances were extraordinary, it is
disconcerting that the markets in this day and age were shut down as
long as they were.
As our economy continues to evolve into an electronic marketplace,
the fundamental principle of commerce that we must protect is the
ability to exchange information as efficiently and reliably as
possible. Continuity of operations is part of this equation.
Fortunately, with the technology and communication advancements of
the past decade, electronic communications networks--ECNs--have filled
that vital role and emerged as viable conduits to the securities
markets. Many have made a niche in continuing trading in the hours
after markets are traditionally closed. By meeting the demands of
investors in creative and efficient ways, ECNs have sparked competition
and innovation that has improved our marketplace and benefited
consumers and the businesses that rely on access to capital.
The purpose of the hearing today is to identify any barriers that
may prevent the technology at our witnesses' disposal from being used
more broadly to benefit of investors. As the world leader of free
markets, the United States must make sure that regulation serves to
make technology an asset to strong markets--not stand as an impediment.
I thank the participants for coming today to share their views with
the Committee and look forward to continuing to work with you as we
discuss these matters of public policy.

Mr. Stearns. [continuing] Instinet of New York City.
We have Mr. Matthew Andresen, President and CEO of The
Island ECN. We have Ms. Catherine Kinney, Group Executive Vice
President of the New York Stock Exchange.
And I understand you are going to be the President.
Congratulations.
Mr. Kim Bang, President of Bloomberg Tradebook, New York
City; Mr. Kevin O'Hara, General Counsel, Archipelago, LLC; Mr.
Steven Randich, Executive Vice President of Operations and
Technology, Chief Information Officer of the Nasdaq; and last,
Mr. Keith Jamaitis, Senior Vice President, Chief Operating
Officer of NYFIX.
So, with that, we are very pleased to have your opening
statement. And we will start with you, Mr. Steinmetz.

STATEMENTS OF JOEL STEINMETZ, SENIOR VICE PRESIDENT, INSTINET;
MATTHEW ANDRESEN, PRESIDENT AND CHIEF EXECUTIVE OFFICER, THE
ISLAND ECN; CATHERINE R. KINNEY, GROUP EXECUTIVE VICE
PRESIDENT, NEW YORK STOCK EXCHANGE, INC.; KIM BANG, PRESIDENT,
BLOOMBERG TRADEBOOK; KEVIN J.P. O'HARA, GENERAL COUNSEL,
ARCHIPELAGO, LLC; STEVEN J. RANDICH, EXECUTIVE VICE PRESIDENT
OF OPERATIONS AND TECHNOLOGY, CHIEF INFORMATION OFFICER, THE
NASDAQ STOCK MARKET, INC.; AND KEITH R. JAMAITIS, SENIOR VICE
PRESIDENT, NYFIX MILLENIUM

Mr. Steinmetz. Thank you.
Mr. Chairman and members of the subcommittee, thank you for
the opportunity to appear before you this morning to discuss
the impact of the events of September 11 upon electronic
communications networks. My name is Joel Steinmetz and I am
Senior Vice President, responsible for equities at Instinet
Corporation.
Instinet is the world's largest and oldest electronic
agency securities broker and has been providing investors with
electronic trading solutions for more than 30 years. Instinet's
clients--mutual funds, pension funds, insurance companies,
corporations and market professionals--represent more than 90
percent of U.S. Managed institutional stock funds. Instinet is
a member of 20 exchanges in North America Europe and Asia, and
our clients use our services to trade on more than 40 markets
around the world. Last year, Instinet's customers used its
systems to execute almost 88 million transactions globally of
which almost 83 million transactions were in U.S. Equity
securities.
As an important part of its services to its clients,
Instinet acts as an electronic communications network, or ECN.
ECNs are electronic marketplaces that allow institutional,
retail and professional participants to trade securities
directly with one another, as well as with other securities
firms. ECNs are operated by companies that are registered with
the Securities and Exchange Commission as broker-dealers and
that are members of the National Association of Securities
Dealers.
ECNs provide electronic agency brokerage services, meaning
that they match customer orders as agents, not principals. In
other words, an order is executed if a matching order is
immediately available from another customer of the ECN. If no
matching order is available, the order is displayed in the
electronic order book and becomes eligible for execution by
orders entered by other subscribers. ECNs typically are
compensated by small commissions paid equally by the seller and
buyer in each transaction, generally on a per-share basis.
Another consequence of being an agency broker is that,
unlike Nasdaq market-makers or exchange specialists, ECNs do
not trade for their own accounts. In recent years, the SEC has
established special additional regulatory requirements
applicable to ECNs as well as to other alternative trading
systems.
ECNs function both through the operation of proprietary
internal networks that connect their customers to the ECNs own
systems and through external networks that connect them to
other ECNs and other market participants. The proprietary
systems are used to display the available order book, offers of
sales or purchases at stated prices and volumes, as well as to
provide connectivity to other systems that execute the trades
once they match. ECNs may also offer other products and
services through their networks, including research and
analysis.
ECNs provide important services to issuers and investors in
the financial marketplace. First, ECNs allow their customers to
trade with one another directly. Second, ECNs do not trade
their own accounts. They are completely neutral with regard to
their clients trading strategies. Together these factors allow
ECNs to create efficiencies that can significantly improve
their client's trading prices and reduce overall transaction
costs.
In addition, ECNs do not require the identity of the
ultimate buyer or seller to be disclosed to the other market
participant at any point in the trading process. This anonymity
can reduce the potential market impact of large transactions
and transactions by certain investors whose trading activity,
if known, may be more likely to influence other market
activity.
Another benefit that ECNs provide is direct access to
markets for all of their customers, which can increase the
speed at which trades are executed and can level the playing
field among market participants.
In short, ECNs have been leaders of innovation in bringing
technological advances and using those advances for the benefit
of consumers. Among the advances we are now developing, as I
will discuss shortly, is increased use of distributed systems,
which allows for more robust trading systems and could help in
the future to absorb shocks.
Turning to the events of September 11, I would first like
to take the opportunity on behalf of Instinet to extend my
deepest sympathy to all who suffered and continue to suffer in
the wake of that unspeakable tragedy. I would also like to
express any admiration and thanks to the countless people whose
courage, strength and determination have helped our country get
through this difficult time.
Instinet, too, was directly affected by the events of
September 11. Tragically, we lost two Instinet colleagues who
were attending a conference in the World Trade Center at the
time of the attacks. Everyone in the Instinet community has
felt this loss deeply.
Fortunately, our other employees who worked at the World
Trade Center were able to escape. Instinet had important
facilities located in the World Trade Center that were
destroyed by the attacks, thus Instinet's operations were
disrupted but not solely due to the loss of our own facilities.
Specifically, 1 of our 3 principal data centers, through which
many of our customer communications were routed, were destroyed
in the collapse. As a result, we lost connectivity with those
customers whose sole access to our system was through the data
center in the World Trade Center. Our clearing operations were
also housed in the World Trade Center and were also destroyed.
In addition, however, we were affected by the destruction
of Verizon's West Street central office across from the Towers.
In addition to the direct impact of the loss of Verizon's
service to us, the Verizon outage also caused us to be
disconnected from some of our customers on Verizon's network
who otherwise connected, or could connect, to one of our two
other principal data centers. These losses in combination
resulted in our losing connectivity to about one-third of our
customer base immediately after the attacks.
Fortunately, however, due to the hard work of Verizon,
government regulators and, above all, our employees, we were
able to restore connectivity with most of our customers in
remarkably short time. We did this through a variety of means.
For example, in the days after the attacks, we worked to
circumvent the damaged units and by utilizing alternative
lines. Customers that previously connected to the World Trade
Center data center were rerouted to or through our centers in
New Jersey and Boston, and we made use of ISDN lines in some
instances. Also, we accelerated a pilot project we already had
in place to provide access through the Internet, which provided
an alternative and quite effective means to restore connections
for some customers where it would have taken longer to restore
standard methods of communication.
By using these alternative communication routes, we were
able to restore connectivity to approximately 90 percent of our
customers by the end of the week.
It is important to note, however, that our ability to
conduct trading itself was not disrupted. Our customers in
Europe and Asia, for example, were able to resume trading the
day after the attacks; and customers in the United States that
had not lost connectivity to us were able to view price
information on the system that day as well. The principal
constraint on trading in the United States was the need for
settlement services and for the interconnection with other
market segments, in addition to restoration of connectivity to
all of our customers.
In the weeks that followed, we began to focus not only on
rebuilding our damaged infrastructure, but also on improving on
it going forward. For instance, we sought to identify and
eliminate potential single points of failure that could, in the
event they were impaired, result in a loss of connectivity or
other functionality. Our efforts in this regard have proceeded
rapidly and are already about 70 percent of the way there.
In addition, we are creating a more resilient and robust
network, one which we expect will be less subject to disruption
in the event of future catastrophic events. We are achieving
this by, among other things, increasing the number of available
connections with our customers.
The events of September 11 and their impact upon our
business have taught us a number of important lessons. Even
before September 11, we placed a high premium on redundant
systems to permit continuous service at all times. The
unprecedented damage caused on September 11 underscored the
necessity of backup systems, redundant systems and contingency
planning.
Mr. Stearns. We will need you to sum up, if you could.
Mr. Steinmetz. Such systems and backup plans must be
thorough and reliable and capable of being implemented on short
notice. In general, less centralized systems like the Internet
are better able to absorb and respond to disruption and
devastating events than are more centralized ones. The less
centralized systems thereby minimize interruption to the many
affected parties.
Indeed, the attacks did not impair Internet communications
at all. Had Instinet's system of Internet access already been
fully operational, there likely would have been significantly
less disruption to our customer connectivity. Moreover, a
network-style market structure provides a better framework to
encourage competition and innovation through the use of
emerging technologies.
This has been Congress' goal since the 1975 amendments to
the Securities Exchange Act of 1934; and it is one Instinet
strongly promotes. Thank you.
[The prepared statement of Joel Steinmetz follows:]
Prepared Statement of Joel Steinmetz, Senior Vice President, Equities,
Instinet Corporation
i. instinet and ecns
Mr. Chairman and members of the Subcommittee, thank you for the
opportunity to appear before you this morning to discuss the impact of
the events of September 11 upon electronic communications networks. My
name is Joel Steinmetz and I am Senior Vice President for Equities at
Instinet Corporation.
Instinet is the world's largest and oldest electronic agency
securities broker, and has been providing investors with electronic
trading solutions for more than 30 years. Instinet's clients--mutual
funds, pension funds, insurance companies, corporations, and market
professionals--represent more than 90% of U.S.-managed institutional
stock funds. Instinet is a member of 20 exchanges in North America,
Europe, and Asia and our clients use our services to trade in more than
40 markets around the world. Last year, Instinet's customers used its
systems to execute almost 87.6 million transactions globally, of which
82.4 million transactions were in U.S. equity securities.
As an important part of its services to clients, Instinet acts as
an electronic communications network, or ``ECN.'' ECNs are electronic
marketplaces that allow institutional, retail and professional market
participants to trade securities directly with one another, as well as
with other securities firms. ECNs are operated by companies that are
registered with the Securities and Exchange Commission as ``broker-
dealers'' and that are members of the National Association of
Securities Dealers. ECNs provide electronic agency brokerage services,
meaning that they match customer orders as agents, not principals. In
other words, an order is executed if a matching order is immediately
available from another customer on the ECN. If no matching order is
available, the order is displayed in the electronic order ``book'' and
becomes eligible for execution by orders entered by other subscribers.
ECNs typically are compensated by commissions paid by the seller and
buyer in each transaction, generally on a per share basis. Another
consequence of being an agency broker is that, unlike Nasdaq market
makers or exchange specialists, ECNs do not trade for their own
accounts. In recent years, the SEC has established special additional
regulatory requirements applicable to ECNs, as well as to other
``alternative trading systems.'' 1
---------------------------------------------------------------------------
\1\ These include in particular the Order Handling Rules and
Regulation ATS.
---------------------------------------------------------------------------
ECNs function both through the operation of proprietary internal
networks that connect their customers to the ECN's own systems and
through external networks that connect them to other ECNs and other
market participants. The proprietary systems are used to display the
available order ``book''--offers of sales or purchases at stated prices
and volumes that have not yet been matched--as well as to provide
connectivity to other systems that execute the trades once they
match.2 Instinet also offers other products and services
through its network, including research, analytics, and ``smart
routing'' of customers' orders to other execution venues.
---------------------------------------------------------------------------
\2\ Pursuant to the SEC's Order Handling Rules, ECNs display their
customers' best-priced buy and sell orders to Nasdaq and provide access
to those orders through Nasdaq to NASD members who are not ECN
subscribers. Non-subscribers accessing ECN orders may be charged a fee,
but it is capped at 1.5 cents per share.
---------------------------------------------------------------------------
ECNs provide important services to issuers and investors in the
financial marketplace. First, ECNs allow their customers to trade with
one another directly. Second, ECNs do not trade for their own
accounts--they are completely neutral with regard to their clients'
trading strategies. Together these factors allow ECNs to create
efficiencies that can significantly improve their clients' trading
prices and reduce overall transaction costs. In addition, ECNs do not
require the identity of the ultimate buyer or seller to be disclosed to
the other market participants at any point in the trading process. This
anonymity can reduce the potential market impact of large transactions
and transactions by certain investors whose trading activity, if known,
may be more likely to influence other market activity. Another benefit
that ECNs provide is direct access to markets for all of their
customers, which can increase the speed at which trades are executed
and can level the playing field among market participants.
In short, ECNs have been leaders of innovation in bringing
technological advances to securities trading and using those advances
for the benefit of consumers. Among the advances we are now developing,
as I will discuss shortly, is increased use of decentralized systems,
which allows for more robust trading systems and could help in the
future to absorb shocks.
ii. the impact of the events of september 11 upon instinet
Turning to the events of September 11, I would first like to take
the opportunity, on behalf of Instinet, to extend my deepest sympathy
to all who suffered, and continue to suffer, in the wake of that
unspeakable tragedy. I would also like to express my admiration and
thanks to the countless people whose courage, strength, and
determination have helped our country get through this difficult time.
Instinet, too, was directly affected by the events of September 11.
Tragically, we lost two Instinet colleagues who were attending a
conference in the World Trade Center at the time of the attacks.
Everyone in the Instinet community has felt this loss deeply.
Fortunately, our other employees who worked at the World Trade Center
were able to escape.
Instinet had important facilities located in the World Trade Center
that were destroyed by the attacks. Thus, Instinet's operations were
disrupted, but not solely due to the loss of our own facilities.
Specifically, one of our three principal data centers, through which
many of our customer communications were routed, was destroyed in the
collapse. As a result, we lost connectivity with those customers whose
sole access to our system was through the data center in the World
Trade Center. Our clearing operations were also housed in the World
Trade Center and were also destroyed. In addition, however, we were
affected by the destruction of Verizon's West Street central office
across from the towers. In addition to the direct impact of the loss of
Verizon's service to us, the Verizon outage also caused us to be
disconnected from some of our customers on Verizon's network who
otherwise connected, or could connect, to one of our two other
principal data centers. These losses in combination resulted in our
losing connectivity to about one-third of our customer base immediately
after the attacks.
Fortunately, however, due to the hard work of Verizon, government
regulators, and, above all, our employees, we were able to restore
connectivity with most of our customers in a remarkably short time. We
did this through a variety of means. For example, in the days after the
attacks, we worked to circumvent the damaged units and to utilize
alternative lines. Customers that previously connected to the World
Trade Center data center were re-routed to or through our centers in
New Jersey and Boston, and we made use of ISDN lines in some instances.
Also, we accelerated a pilot project we already had in place to provide
access through the Internet. This provided an alternative and quite
effective means to restore connections for some customers where it
would have taken longer to restore our standard methods for connection.
By using these alternative communication routes, we were able to
restore connectivity to approximately 90% of our high-volume customers
by the end of September 13. Within a day of the equity markets
reopening on September 17, we had restored connectivity to 75% of all
our customers and were at the 95% level two days later. It is important
to note, however, that our ability to conduct trading itself was not
disrupted. Our customers in Europe and Asia, for example, were able to
resume trading in non-U.S. securities the day after the attacks, and
customers in the United States that had not lost connectivity to us
were able to view price information on the system that day as well. The
principal constraint on trading in the United States was the need for
settlement services and for interconnection with other market segments,
in addition to restoration of connectivity to all our customers.
In the weeks that followed, we began to focus not only on
rebuilding our damaged infrastructure, but also on improving it going
forward. For instance, we sought to identify and eliminate potential
single points of failure that could, in the event they were impaired,
result in a loss of connectivity or other functionality. Our efforts in
this regard have proceeded rapidly and are already about 70% of the way
there in implementing these improvements. In addition, we are creating
a more resilient and robust network, one which we expect will be less
subject to disruption in the event of future catastrophic events. We
are achieving this by, among other things, increasing the number of
``backup'' or ``redundant'' connections with each of our customers.
iii. lessons learned in the wake of september 11
The events of September 11 and their impact upon our business have
taught us a number of important lessons. Even before September 11, we
placed a high premium on redundant systems to permit continuous service
at all times. The unprecedented damage caused on September 11
underscored the necessity of backup systems, redundant systems, and
contingency planning. Such systems and backup plans must be thorough,
reliable, and capable of being implemented upon short notice.
The disruption caused by the attacks also demonstrated the value of
``network'' or decentralized systems, such as the Internet, relative to
older, more centralized ``mainframe''-type communications and trading
systems. Indeed, the attacks did not impair Internet communications at
all. Similarly, more decentralized financial markets like the currency
markets and bond markets suffered disruption equal to or greater than
the stock markets, but were able to resume trading more quickly. In
general, less centralized systems like the Internet are better able to
absorb and respond to disruption and devastating events than are more
centralized ones. The less centralized systems thereby minimize
interruption to the many affected parties. Moreover, a network-style
structure provides a better framework to encourage competition and
innovation through the use of emerging technologies.
Instinet believes that ``network''-style communications systems
hold continuing promise for the equities markets as well. Moving from
the current system, with its mandatory linkages and centralized
information monopoly, to a network-style structure would produce
benefits for investors. Competition, spurred by advances in information
technology, has substantially improved the transparency of the
securities markets over the last several decades. Investors have a
variety of options for the display and execution of their orders.
Competition has also led market participants to develop voluntary
linkages among themselves. These facilitate execution of investors'
orders in other market centers while preserving the freedom of
individual systems to innovate. A decentralized, ``open architecture''
structure would provide the greatest scope for competition and
innovation to operate, benefiting investors through lower costs, better
services, and more efficient trading. These have been Congress's goals
since the 1975 amendments to the Securities Exchange Act of 1934, and
they are goals Instinet strongly promotes.
Thank you.

Mr. Stearns. Thank you.
Mr. Andresen.

STATEMENT OF MATTHEW ANDRESEN

Mr. Andresen. Thank you, Chairman Stearns, Ranking Member
Towns and the members of the subcommittee.
I would like first to commend the chairman and the members
of the subcommittee for holding these hearings concerning the
tragic events of September 11 and specifically the role of
electronic communications networks in our securities markets.
I am Matthew Andresen. I am the Chief Executive Officer of
Island ECN. Island is an electronic marketplace that enables
market participants to display and match orders for stocks and
other securities. Island's proprietary technology allows it to
offer this low-cost, rapid and reliable order display and
matching service to a network of approximately 700 broker-
dealers representing a diverse array of market participants.
On an average day, Island will trade over 460 million
shares and over 1 in every 5 trades on Nasdaq. Through November
of this year, Island has traded over 82 billion shares worth
$2.5 trillion. Indeed, recent analyst reports indicate that
Island is now the largest ECN in the world today.
Mr. Chairman, unquestionably the events of September 11
have had a profound impact on our whole Nation, not just on the
securities markets. Those in the New York financial community,
however, have felt an additional obligation to prove to the
world the strength and the resilience of America's financial
markets.
I am proud that despite the initial shock of the attacks
and even the fear of further attacks, Island has rebounded
quickly. From the employees who were on the roof that morning
cleaning out air conditioning ducts while burning soot
blackened the whole of Wall Street to a team of technical staff
that literally worked around the clock to reestablish
connectivity to our subscribers whose lines ran through Ground
Zero, the Island staff rose to the challenge ensuring our
market was ready to trade when the markets reopened.
Now, however, we have an opportunity to look back and
consider not only what went well but also what could have been
done differently or better. Through such critical analysis, the
industry can become stronger and send a clear signal of the
commitment we have all made to building the world's most robust
equity markets. My testimony has some specific recommendations
based on our experience.
While contingency planning can always improve our response
to unforeseen events, perhaps the best plan that we can
undertake is to foster competition between markets and enjoy
the beneficial effects that produces. You know, if you fill up
your tank at Texaco in the morning and the Texaco station goes
belly up, you can always fill up at AMOCO across the street or
Exxon down the block.
So, too, if Island has a system problem, all of our
customers take about a second to start shunting all their
orders to other people at this table. That is a very painful
process for me, but is great for the customer; and just like
the mythical hydra, a many-headed market structure where people
have multiple connections to multiple competing marketplaces is
the best way to insert continuity for the investor.
If we can all agree that strong competition between markets
will ultimately provide us with the most efficient market
model, the question becomes, what changes, if any, are
necessary to ensure varied and vibrant competition between
markets?
In Island's view, we should eliminate any barriers that
inhibit fair competition between electronic and traditional
markets. Currently, there are two main market structure changes
that must be immediately pursued to ensure such fair
competition. First, ECNs must be permitted to freely
disseminate their market data to investors without sacrificing
those very qualities that make ECNs such compelling
alternatives in traditional marketplaces. Second, ECNs must
have alternatives to Nasdaq in which to operate.
On the first point, Island's quotation data cannot be
included in the consolidated tape mentioned earlier by the
chairman and disseminated by market data vendors, because only
markets that participate in the so-called intermarket trading
system, or ITS, are permitted to have their quotation data
disseminated in the consolidated tape. Unfortunately, Island
cannot participate in the intermarket trading system because
having such participation would undermine the very advantages
of speed and certainty of execution upon which Island has built
its business. I think this would put at risk the whole segment
of trading and price discovery that have been created since
Island began trading New York Stock Exchange, Nasdaq and AMEX-
listed stocks.
I think the best way to conceptualize this ITS issue is to
answer the following question: Would you take a $50 guaranteed
seat to the World Series; or would you risk that for the off
chance that you could get a $49 ticket, but not be sure that
you could make other arrangements if you didn't get the ticket,
or that you might even get the ticket the day after the game
was played and end up not even going to the game. Speaking for
myself, I will always take the guaranteed ticket and a chance
to actually go to the game.
Island has had tremendous success in the last year trading
selected listed stocks. In fact, in the largest AMEX- or New
York Stock Exchange-listed security, the QQQ or Nasdaq 100
tracking stock, Island has now taken over 30 percent of the
shares traded in the stock and has actually become the largest
single marketplace. In fact, on these points, Nasdaq's Wick
Simmons made these points in a December 4 letter to SEC
Chairman Harvey Pitt.
I quote, ``Because ITS orders require a minimum life of 60
seconds, it would greatly frustrate those investors and market
professionals who wish to immediately lock in an execution. We
are concerned that such a result would drive liquidity from
U.S. Markets, producing a net loss for our Nation's economy and
for its investors.'' And I will submit that letter for the
official record.
The second point that I would like to make is that Nasdaq
is the only market today that is not required to maintain
strict time price priority through a so-called central limit
order book on the exchange. The absence of a central limit
order book makes Nasdaq the only place the ECNs can operate
autonomously and efficiently.
To that end, the Cincinnati Stock Exchange recently filed a
rulemaking its central book and priority rules voluntary. In
effect, Cincinnati filed a rule requesting to operate in the
exact manner as Nasdaq, a market that competes with them in the
same securities for the same customers. Island believes that
quick approval of the Cincinnati Stock Exchange's filing will
promote competition between markets strengthening our
securities markets.
In conclusion, Mr. Chairman, I appreciate the
subcommittee's interest in the Island's perspective on the
events of September 11 and their implications for the markets;
and I hope that the members of the subcommittee agree that in
the wake of these events, we should redouble our efforts to
create the strongest, most efficient market structure possible.
I hope we can work together in the future on implementing both
of Island's recommendations for fostering competition and
thereby strengthen our equity markets.
[The prepared statement of Matthew Andresen follows:]
Prepared Statement of Matthew Andresen, Chief Executive Officer, The
Island ECN
Chairman Stearns and Members of the Subcommittee: I commend the
Chairman and the Members of the Sub-committee for holding these
hearings concerning the tragic events of September 11th and the role of
Electronic Communications Networks in our securities markets.
I am Matthew Andresen, Chief Executive Officer of The Island ECN
(``Island''). Island is an electronic marketplace that enables market
professionals to display and match limit orders for stocks and other
securities. Island's proprietary technology allows it to offer this low
cost, rapid and reliable order display and matching service to a
network of approximately 700 broker-dealers representing a diverse
array of market participants. On an average day, Island will trade over
460 million shares--approximately one in every 5 trades on Nasdaq.
Through November, Island has traded over 81.9 billion shares worth
almost $2.5 trillion during 2001. Indeed, recent analyst reports
indicate that Island is now the largest ECN in the world today.
Mr. Chairman, unquestionably, the events of September 11 had a
profound impact on our Nation, not just our securities markets. Those
of us in the New York financial community have felt an additional
obligation to prove to the world the strength and resilience of
America's stock markets. As members of New York City's downtown
financial community, every Island employee joins with me in expressing
our sadness for the events of that day and the loss of lives of
innocent people, some of who were close to me. I am certain nobody will
ever forget that day and how it changed our lives.
I am proud that despite the initial shock and even the fear of
further attacks, Island rebounded quickly. From the employees who were
on the roof cleaning out air conditioning ducts while burning soot
blackened the whole of Wall Street to the team of technical staff that
literally worked around the clock to reestablish connectivity to our
subscribers, the Island staff rose to the challenge, ensuring our
market was ready to trade when the markets reopened. The efforts at
Island were replicated throughout the industry. Thanks to all the hard
work, the contingency planning, the leadership of the Securities and
Exchange Commission, and the sheer determination of the entire
industry, the markets re-opened without incident on September 17.
Now more than three months later, we have an opportunity to look
back and consider not only what went well, but what could have been
done differently or better. Through such critical analysis, the
industry can become stronger and send a clear signal of the commitment
we have all made to building the world's most robust equity markets.
I believe that the industry was generally as prepared as possible
for the events of September 11. Though we have already discussed our
recommendations with the Securities and Exchange Commission, I would
like to take a moment to touch on a few observations based on Island's
experience:

1) Back-up connectivity--I think the entire industry learned the
importance of maintaining connectivity not only to primary data
centers but also back-up sites. Prior to September 11, some
companies did not test or even maintain connectivity to
Island's back-up facility. In the subsequent months, nearly all
of our subscribers secured redundant connections to Island.
2) Contingency planning--The entire industry realized the importance of
maintaining contingency plans. I am proud of how Island was
able to re-establish its entire operation in our New Jersey
back-up site within a day.
3) Inter-market Coordination--The SEC did an excellent job in keeping
market participants informed. The SEC, however, may want to re-
consider the composition of some of the emergency working
groups. For example, although Island is approximately the same
size as all the regional markets combined, Island was not asked
to directly participate in many post September 11 meetings.
Perhaps the SEC should consider basing future working groups on
relative market size rather than on regulatory designation.
While contingency planning can always improve our response to
unforeseen events, perhaps the best planning we can undertake is to
foster competition between markets and the beneficial effects it
produces. Though some commentators, such as the Wall Street Journal,
wrote articles suggesting that centralized physical markets are out-
dated, Island does not believe that to be the case. While electronic
markets may be less vulnerable to physical attacks, the extent to which
centralized physical markets continue to attract orders demonstrates
their continued necessity. Accordingly, Island would not support any
initiative that would essentially dictate the structure of
marketplaces. Instead, the future of the markets should be determined
through competition. If all can agree that strong competition between
markets will ultimately provide us with the most efficient market
model, the question becomes ``what changes, if any, are necessary to
ensure fair yet vibrant competition between markets.''
In Island's view, we should eliminate any barriers that inhibit
fair competition between electronic and traditional markets. Currently,
there are two main market structure changes that must be immediately
pursued to ensure such fair competition. First, ECNs must be permitted
to freely disseminate their market data to investors without
sacrificing the very qualities that make ECNs compelling alternatives
to traditional markets. Second, since all markets are competing in the
same securities for the same customers, all markets must be permitted
to operate under the same ground rules in the same manner. Let me more
fully explain each one of these recommendations.
With respect to the first recommendation, many Sub-committee
members are aware of the fact that while ECNs account for more than 50%
of the transactions in Nasdaq listed securities, ECNs only account for
approximately 5% of the transactions in listed securities. What
accounts for this difference?
With respect to Nasdaq listed securities, ECN market data is
permitted to be included in the quotation data disseminated to
investors through the multitude of market data vendors. For example, if
Island has the highest bid price in Cisco, which it often does, any
investor or broker looking at information on Bloomberg, Reuters, Yahoo!
or any other vendor service will see the high bid on Island. This
transparency increases the likelihood that the order represented on
Island will be executed and serves the best interests of investors.
In contrast, if Island has the highest bid or lowest offer price in
the American Stock Exchange listed Nasdaq 100 tracking stock (known as
``QQQ''), which Island has approximately 50% of the trading day,
investors monitoring the same major vendor service will NOT see
Island's best price. In fact, despite the fact that Island is regularly
the largest market in the world for the QQQ, regularly matching more
than 30% of the QQQ total shares traded on a given day, Island's market
data is not included in the Consolidated Quote disseminated by vendor
services. Island's exclusion from the Consolidated Quote prevents
investors from receiving the best possible price.
Ironically, the National Market System, that was created to ensure
that investors have access to all relevant market data, now prevents
Island's market data in QQQ, and all other exchange listed securities,
from being disseminated to investors. Further, the National Market
System that was created to promote competition between markets now
serves to inhibit competition from all-electronic markets.
Island's quotation data cannot be included in the Consolidated
Quotation disseminated by market data vendors because only markets that
participate in the Intermarket Trading System are permitted to have
their quotation data disseminated in the official Consolidated Quote.
Unfortunately, Island cannot participate in the Intermarket Trading
System because such participation would undermine Island's advantages
of speed and certainty of execution, destroying a whole segment of
trading that has been created since Island began trading QQQ and
preventing electronic markets from competing effectively in any
exchange listed securities. The fact that Island has achieved this
success with the severe handicap of not having its quotation data
disseminated by market data vendors in the Consolidated Quote reflects
the strong demand for a competitive alternative to traditional markets.
When it was created more than 20 years ago, the Intermarket Trading
System was designed to ensure that investors received the best price
irrespective of what market received the investor's order. The
Intermarket Trading System, however, never contemplated that all-
electronic agency markets would someday exist where users would demand
responses within milliseconds of placing an order. Specifically, an
Island subscriber utilizing the latest technology to implement a
trading strategy that depends on millisecond responses should not be
forced to send an order to a market that can respond up to 60 seconds
later. Further, many market participants have reasonably concluded that
the opportunity cost associated with waiting 60 seconds for the mere
possibility of an execution exceeds the value of receiving an execution
at a better price. If forced to always send the order to the best-
advertised price, this new liquidity would vanish or go overseas,
harming the competitive position of our Nation's markets. Nasdaq CEO
Wick Simmons made these same points in a December 4 letter to SEC
Chairman Harvey Pitt. ``Because ITS orders require a minimum life of 60
seconds it would greatly frustrate those investors and market
professionals who wish to immediately lock in an execution. We are
concerned that such a result would drive liquidity from U.S. markets,
producing a loss for the nation's economy and its investors.''
A way to conceptualize the issue raised by the Intermarket Trading
System is through the following question: ``Would you take a guaranteed
ticket to the World Series for $50 or take a chance on getting a ticket
for $49 but not find out until it was too late to make other
arrangements?'' Speaking for myself, I would take the guaranteed
ticket. Similarly, market participants should not be precluded by the
rules governing the Intermarket Trading System from making the same
choice when trading securities. Indeed, market participants trading
Nasdaq listed securities are not required to always try to interact
with the best-advertised price and Island is unaware of any widespread
investor harm. Why, then, do we continue with a structure that we know
prevents competition from electronic markets in exchange listed
securities?
Island's second recommendation for promoting competition involves
ensuring that all markets are able to compete on a level playing field.
Currently, the Nasdaq market controls almost 100 percent of all
transactions in securities listed on Nasdaq. Nasdaq is also the second
largest market for exchange-listed securities. A key component of
Nasdaq's monopoly in Nasdaq securities and success in listed securities
is its unique regulatory structure that provides a regulatory advantage
over other markets.
Specifically, Nasdaq is the only market that is not required to
maintain strict price time priority through a central limit order book.
The absence of a central limit order book makes Nasdaq the only place
that ECNs can operate autonomously and efficiently. Nasdaq's monopoly
on this type of market structure, however, restricts competition
between markets. For example, no market can effectively compete with
Nasdaq for hosting ECN trading unless they are permitted to change
their rules regarding a central book and operate to match the rules of
Nasdaq. To that end, the Cincinnati Stock Exchange recently filed a
rule making its central book and priority rules voluntary. In effect,
Cincinnati filed a rule requesting to operate in the same manner as
Nasdaq, a market that competes with them in the same securities for the
same customers.
Island believes that quick approval of the Cincinnati Stock
Exchange's filing will promote competition between markets,
strengthening our securities markets. Certainly, no market can continue
to be permitted to use a regulatory inequity to maintain a monopoly
over certain segments of market participants. I would hope that in the
name of fostering fair competition that members of this Sub-committee
would support Cincinnati's filing and urge expeditious review by the
SEC.
conclusion
In conclusion, Mr. Chairman, I appreciate the Subcommittee's
interest in the Island's perspective on the events of September 11 and
their implications for the market. I hope members of the Sub-committee
agree that in the wake of these events we should redouble our efforts
to create the strongest, most efficient market structure possible. This
is done by ensuring fair and vibrant competition between markets,
particularly competition between traditional markets and newer all-
electronic markets such as ECNs. I hope that we can work together in
the future on implementing both of Island's recommendations for
fostering competition, thereby strengthening our nation's equity
markets.

Mr. Stearns. We thank the gentleman.
Ms. Kinney.

STATEMENT OF CATHERINE R. KINNEY

Ms. Kinney. Good morning, Chairman Stearns, Congressman
Towns and members of the subcommittee. My name is Catherine
Kinney, and I am the Group Executive Vice President at the New
York Stock Exchange. I, and our Chairman Richard Grasso, as
well would like to thank you all for the opportunity to testify
this morning on the industry's recovery following the attacks
of September 11 and also the lessons that we have learned for
electronic communications networks.
I wanted to cover a couple of specific areas this morning:
First, as I said, thank you so much for having us here this
morning and certainly to express the Exchange's sympathies for
all who were involved in the attacks following September 11 and
on September 11.
I also wanted to talk a little bit this morning about re-
creating the environment, because I think some of the members
of your committee started to do that this morning.
The devastation in downtown New York was enormous. The
facilities of many of our broker-dealers, the major firms who
supply order flow to the Exchange and who connect with many of
the customers, representing both individuals and individuals
themselves, were completely destroyed or rendered
uninhabitable; and many of those firms had to relocate to New
Jersey or other locations that had already been preestablished
by those firms.
I think you all know and certainly have jurisdiction over
telecommunications, so I know that you are very aware of
Verizon's circumstances as well as Con Edison's circumstances.
These were unprecedented for them. I think in our written
testimony you will see we outlined that. But Verizon's central
switching station was very heavily damaged, and actually they
had no access to that building until September 14.
Con Edison lost 5 of its 7 feeder cables, also
unprecedented. And those of you who have visited downtown
Manhattan recently know that they had to run those cables
through the streets and then cover them with wood and now we
have nice bumps that you have to crawl over getting from street
to street. But these are high voltage cables that obviously
made our life easier and certainly gave us the opportunity to
reopen our markets successfully on the morning of September 17.
But with the devastation and the infrastructure such as it
was and the heroic effort of so many to reestablish the
markets, I think it is very important to focus on what really
happened following September 11.
Certainly the New York Stock Exchange's facilities were
unaffected. I think there have been numerous reports and
articles written that we didn't have power, we didn't have lots
of things. The New York Stock Exchange facilities were
unaffected, as well as two data sites unaffected. So if it were
simply a matter of the New York Stock Exchange showing up to
trade, that would not have been a problem for the Exchange. But
the problem really was, as you will hear today and have already
heard, our modern market model depends on connectivity; and
that is not just connectivity to the market centers, but it is
the connectivity to the customers and the member firms.
We described, and have described, our situation as a hub-
and-spoke model, the Exchange being the hub and the spokes
being the firms and their customers. As I said, if it were the
matter of the hub only, I think most of the people here could
have assembled something to trade. But it really was about a
much larger population in the financial services
infrastructure, which included the member firms.
Those member firms supply order flow to us, and the order
flow is the lifeblood. It is the interaction of the buyers and
the sellers each day which make the markets in our respective
environments. But all of that order flow and getting that order
flow to these respective models depends on connectivity.
Without that, we are simply a hub with no spokes. The
interruption of these connections meant that the buyers and
sellers couldn't meet, whether it was on the New York Stock
Exchange or any of these decentralized models or in cyberspace.
And really the debate, in our view, should not be about
these central hubs, but rather about the issue of connectivity,
about what we need to do with respect to restoring that
connectivity and ensuring that in the future all of the
connectivity and the alternatives and contingencies are well
planned for.
I think that the two issues and two questions that faced
all of us, and certainly those that participated in the variety
of meetings that occurred following September 11 as we debated
when to restart the markets, the two very important questions
were the provision of liquidity and could we produce a fair and
orderly pricing mechanism and pricing model that investors
could rely on. And in doing that and in providing that
liquidity, the two questions we asked, is it possible to engage
in reliable price discovery if a significant source of order
flow is cutoff, and is it fair to open those markets if a
significant amount, or number of the buyers and sellers cannot
reach the marketplace? So it is with those two questions that
we began to look at restarting the markets following September
11.
As you know, meetings were conducted for 2 days by the SEC,
or among the SEC, the Treasury, the Fed, the New York Stock
Exchange, NASDAQ and all major market participants as well as
the utilities. Clearly, the marketplaces and the member firms
had issues in terms of this connectivity, but I can certainly
say that in telecommunications, both Verizon and Con Ed played
a major issue in terms of our ability to restart those markets,
since they were not fully operational until at least Friday.
I think then, at the Thursday meeting following September
11, all of the participants were very concerned about a false
start. I think it was said here this morning that everybody was
very concerned about having orderly, reliable pricing and a
market that would not start and fail again. I think that would
have been something that both the American people and the
financial services markets could not have withstood.
There was--we felt an opportunity both on Friday and over
the weekend to continue to test the connectivity which was
being restored. If you can imagine the number of firms
relocating, having to repath, even as was described for
Instinet here, repathing all of their connectivity to their
customers as well as to the markets, all of that had to be
retested and restarted. And the time that it took gave us that
opportunity, the weekend was used to test the connectivity.
I think the results on Monday, September 17, spoke for
themselves about the successful decisions that were made, that
the work that went on for the days that followed September 11
was really the right work, and the focus was very apparent in
the success of September 17. We had a single record volume day
of 2.3 billion shares. We had a record week, trading 10 billion
shares. I don't think any of us who were at our respective
sites on Wednesday, Thursday or Friday would have concluded or
would have even thought we could have had that kind of volume.
Mr. Stearns. Ms. Kinney, I will just have you sum up.
Ms. Kinney. I think if we focus on lessons learned, every
business is located somewhere. All of the trading platforms
that will speak this morning are reliant on some physical
plants but, as well, a very significant portion of us are
reliant on our data processing equipment. We will have to
continue to make significant investments to ensure that we have
both the connectivity and reliable sites within a 24-hour basis
in order to continue to trade. Thank you.
[The prepared statement of Catherine R. Kinney follows:]
Prepared Statement of Catherine R. Kinney, Group Executive Vice
President, New York Stock Exchange, Inc.
Good morning Chairman Stearns, Congressman Towns, and members of
the Subcommittee. My name is Catherine Kinney, and I am a Group
Executive Vice President of the New York Stock Exchange (``NYSE''). I
would like to thank the Committee for the opportunity to testify this
morning on behalf of the NYSE, and our Chairman, Richard A. Grasso, on
the industry's recovery from the attacks of September 11, and on the
lessons from our experience for electronic communications networks
(``ECN's'').
Mr. Chairman as you know, the September 11th attacks devastated
downtown New York City. Everyone in our industry lost a family member,
a friend or a cherished coworker, and our thoughts and prayers remain
with them.
The destruction of the World Trade Center complex resulted in
tremendous collateral damage to the infrastructure of the entire area.
Adjacent office buildings were rendered uninhabitable. Electricity,
water and telephone service to much of the area was destroyed or
disrupted. Verizon's central switching station was heavily damaged, and
rendered inaccessible until the following Friday evening.
That the national securities markets were able to operate again
just four business days later--at record volumes and without any
systemic problems--is a tribute to an extraordinary partnership among
the securities industry, the federal and local authorities, and the New
York utilities. When the markets reopened, it was on an inclusive
basis; every customer who wanted trade could access the market. The
market did experience a 10% decline, but this adjustment was consistent
with the European markets in the aftermath of the attacks. But the
trading was fair and orderly, even in the face of record volume. During
that first week of resumed trading, as the NYSE set new records for one
day volume (over 2.3 billion shares on Monday September 17th) and first
hour volume (660 million shares on Friday, September 21st), our market
operated in a fair and orderly manner.
Mr. Chairman, order flow creates price discovery, and in the modern
marketplace, order flow is dependent on connectivity. I will discuss
these two factors in some detail, and then close with a brief mention
description of the lessons we learned from the attacks.
``connectivity'', order flow and the financial markets
Thankfully, NYSE people, facilities (including its our two remote
data-processing sites), heavy infrastructure, networks, and trading
systems and--thanks to diverse routing--most of our voice lines, were
unaffected. So we had no need to move to an alternative site. Indeed,
if we could operate our business solely by convening 3000 people on our
trading floor, trading could have resumed immediately.
But today's markets, whether national exchanges, decentralized
dealer markets, ECN's, or other alternative trading systems, depend on
``connectivity'', i.e., continuous access to the telecommunication
systems that simultaneously link all market participants and provide
the conduit for orders to interact and create markets. We live in an
electronic age that permits participants from around the world to
access, enhance, and benefit from, the unrivaled liquidity and order
competition that takes place on the floor of the New York Stock
Exchange.
Mr. Chairman, telecommunications connectivity, whether it be data
or voice communication, is the lifeblood of our industry.
The NYSE, and our member firms which introduce the orders of some
85 million U.S. investors and millions of international investors, are
linked through a complex, global communications and data delivery
network. Through It is this electronic network, they place more than
90% of the orders that the NYSE executes, representing over 50% of our
volume. The NYSE owns and operates fully redundant networks with no
dependence on a third-party carrier, and is thus better positioned than
others.
The hub (e.g. NYSE) and spokes (broker-dealers) of our securities
markets represent a classic example of the ``network effect'' where
connectivity is critical. Markets of all types deploy data networks to
connect the broker-dealers transmitting orders to the markets. The
broker-dealers, in turn, are dependent on networks for communications
to their customers.
It is as simple as this: it takes the interaction of buyers and
sellers to make markets. If, as on September 11th, something interrupts
the connections of the broker-dealers to their customers and to the
markets' networks, as occurred on September 11, the orders of buyers
and sellers cannot meet--on the NYSE, on the trading floors of Nasdaq
market-makers, or in cyberspace.
Although the market centers, (except for the American Stock
Exchange) were intact, we soon knew that the industry had suffered a
massive loss of connectivity. We and our government and industry
partners understood that this loss of connectivity posed two questions
that we had to answer in deciding when to reopen the markets.
First, from the perspective of the U.S. capital markets, and
indeed, of the world, we asked, ``Is it possible to engage in reliable
price discovery if significant sources of order flow are cut off?''
Second, from the perspective of those buyers and sellers who, on
Wednesday, September 12, could not reach their brokers and the markets,
we asked, ``Is it fair to open the markets when a significant number of
buyers and sellers are cut off?''
As you know, we answered both questions, ``No.''
restarting the markets
The events of September 11th devastated the infrastructure of
downtown Manhattan. Many firms had to relocate. Those whose physical
plants were unaffected were deprived of the comprehensive network of
communications, and the flow of information, that permits informed
decisions, the placing of trades and the creation of deep pools of
liquidity.
Nevertheless, four business days later, the equity markets were
fully operational at record volumes and fair prices. Allow me to
present a brief chronology of the events that made this possible.
During the six days following the attack, the NYSE, the other
markets and our member firms, along with the city, state, and federal
officials, Con Edison, Verizon and our central technology provider, the
Securities Industry Automation Corporation (SIAC), worked continuously
to restore and test the telecommunications infrastructure that ensures
the connectivity of market participants. The task of recreating and
rerouting downtown New York's telecommunications infrastructure, and
ensuring that industry participants and end-users could access our data
systems, was daunting. Many firms were forced to relocate.
Communications routing systems had to be redirected or changed
completely. Our staff assisted in this massive rerouting effort,
testing every newly fashioned linkage. Virtually every aspect of that
interconnected network--markets to firms and firms to customers, from
the introduction of a trade to comparison and settlement--was verified.
Against the backdrop of the enormous task of relocating, rewiring
and rerouting, on Wednesday, September 12, representatives of the SEC,
Treasury and the Federal Reserve System, as well as of the three
principal equities markets, met with the senior management of the major
financial institutions. It was clear to all participants at that
Wednesday's meeting that the physical devastation in downtown New York
City precluded opening the next day.
It is hard to describe the extent of the damage to downtown New
York's infrastructure. Verizon's switching station had been flooded,
and was to remain completely inaccessible until Friday night. Five of
Con Edison's seven feeder cables that run the downtown power grid were
destroyed. Con Edison was forced to recreate this grid above ground,
and run 135,000 volt cables down the street. Even those firms that had
not suffered physical damage had no long-distance service, so they
could not reach their customers.
At this Wednesday meeting, we agreed to reconvene in 24 hours to
review the situation with a clearer understanding of when connectivity
could be reestablished with the broker-dealer community and with
customers. The decision to resume trading on Monday was made during a
Thursday, September 13th, meeting of essentially the same group. We all
knew that opening the equities markets without assuring connectivity
could result in illiquid markets if buyers, sellers and their brokers
could not access the market centers. We concluded that the resulting
lack of liquidity would produce unprecedented volatility and suspect
prices, leading to a crisis in investor confidence. We further
determined that a premature or false start would do greater damage than
delaying the opening of our markets until the next business day.
So we determined it was prudent to resume trading on Monday,
September 17th. This gave the utilities a chance to restore services to
broker-dealers and the 85 million American investors they serve. It
permitted our member firms to complete their reconnection of data and
voice communications to their customers and to us, and for us to test
to ensure they had succeeded in reconnecting. The best evidence of our
success in this impressive collective effort was the seamless
resumption of trading on Monday, September 17--the most active day in
our history. The NYSE handled a record 2.3 billion shares, twice our
average volume. Our market was liquid. Every system worked. Every buyer
and every seller had a way to reach our auction. No one was left out.
Indeed, thanks to the ubiquity of our fiber optics network, we even
managed to establish the American Stock Exchange's equities market on
our floor.
lessons learned
What lessons have we taken from meeting this extraordinary
challenge? What are we doing to be even better prepared in the future?
Planning for contingencies that would have seemed farfetched a year
ago now seems prudent. As an initial response, we have made the
investments necessary to make ready on shorter notice a fully equipped
alternative-trading floor. This alternative facility could be
operational within 24 hours if any future attack rendered our trading
floor unusable.
Our constituent board of directors--CEO's of member firms, issuers
and institutional investors, as well as leaders drawn from the public
sector--has met twice since September 11. Each meeting has included a
discussion of the nature of the threats that September 11, made so
apparent and of how we should respond. My colleagues and I are engaged
in a contingency planning process that looks beyond our current
alternative floor, and takes into account the opportunity presented by
our planned new trading facility across Broad Street, as well as by
other possible sites.
Mr. Chairman, let me close by saying that, ``Every business is
located somewhere.'' Every market center, be it a floor-based exchange,
a decentralized dealer market or an ECN, relies on physical locations
for personnel and data processing equipment.
Again, I want to thank you, Mr. Chairman, for the opportunity to
appear before you today.

Mr. Stearns. I thank you.
Just to remind the panel of witnesses, generally the
opening statements are about 5 minutes. We are allowing you to
go over 5 minutes, but certainly want to keep it below 10
minutes. So we would appreciate it as close to 5--that would be
very helpful.
Mr. Bang.

STATEMENT OF KIM BANG

Mr. Bang. Mr. Chairman and members of the subcommittee, my
name is Kim Bang.
Mr. Stearns. Mr. Bang, just move that a little closer to
your mouth.
Mr. Bang. I am President of Bloomberg Tradebook. I am
pleased to testify on behalf of Bloomberg Tradebook regarding
ECNs in the wake of September 11.
Bloomberg Tradebook is an electronic agency broker. We
count among our clients many of the Nation's largest
institutional investors, who themselves represents millions of
individual investors. Bloomberg Tradebook specializes in
providing innovative tools that enable our clients to step
unobtrusively into the electronic crowd of the national market
system to find liquidity for themselves and, in the process
thereby, also providing liquidity for others. Our clients have
rewarded our creativity and our service by entrusting us with
their business, allowing us to regularly execute 200 million
shares a day.
The reason ECNs now account for more than 46 percent of the
reported share volume on Nasdaq is simple. ECNs are a market
solution to investor demand. By providing a combination of
neutrality, transparency, fairness and innovation, investors
are now empowered with the direct access to liquidity in the
national market system.
By definition, we are agency brokers. We take no position
for our own accounts, and thus, we are neutral in the
marketplace. We exist to service our customers' execution needs
who want to buy and sell shares.
Over the past year, we estimate that we have saved our
clients in excess of $1 billion dollars in transactional costs
alone. Like market-makers, we maintain an electronic book of
our customers' bids and offers. But unlike market-makers, we
publish our entire book of quoted prices electronically for our
customers to see. Indeed, unlike some of the ECN competitors,
we employ an open architectural platform designed to route our
customer orders to the best available price even when that
means the price does not exist in the Bloomberg Tradebook
system.
Without a government-sponsored monopoly to rely on, the
market commands that ECNs compete and innovate. For example, at
our inception in 1996, Bloomberg Tradebook instituted the
concept of a reserve. A reserve is a process that controls the
release of an order into the marketplace, enabling clients to
trade large orders more efficiently. Like all innovations, the
reserve gave us a leg up initially on our competitors, but only
for a brief period of time. It has since become an industry
standard, and today nobody would introduce a system without it.
Any edge that we gain is a momentary one, and we are forced to
continue to innovate, and we have done so continuously over the
past 5 years.
When the Senate Banking Committee held a hearing in the
last Congress, exploring the role of ECNs, Frank Zarb, then
chairman of the National Association of Security Dealers,
stated that, ``I guess I sum up the answer as to why we have
ECNs as the fact that the national stock exchanges, and I am
not only talking about ours, but the exchanges around the world
haven't been keeping pace with the needs of the market.''
Mr. Chairman, it is worth pondering why the stock exchanges
didn't keep pace with investor demands, as Mr. Zarb stated. We
would submit that a government-sponsored monopoly ultimately
cannot provide those innovative ideas and customer solutions of
the best ECNs precisely because they are government-sponsored
monopolies.
At present, most SROs are nonprofit organizations. The
Nasdaq, however--the NASD, however, has largely completed its
privatization of Nasdaq, and it may well be that other
privatizations are going to follow. For-profit exchanges will
have powerful incentives to leverage their existing government-
sponsored advantages to gain an unfair advantage in current
competitive markets. They will have incentive to keep pace with
market innovators not by moving forward themselves, but by
slowing down other market participants that tend to centralize
order flow.
As to the specific tragedy of September 11, the financial
service industry was Ground Zero of the attack on America. All
of us in this industry have suffered enormous losses. At
Bloomberg, the steps we have taken include the immediate
allocation of substantial sums of money to provide free office
space and support for our clients, including phones, computers,
Bloomberg terminals and other necessities needed, in fact, more
than 1,200 displaced financial workers since the tragedy.
Many of them have lost friends and colleagues, and we at
Bloomberg, ourselves, have lost three people. Yet our clients
and everyone involved inspire us with their commitments to get
back to work and their display of the extraordinary strength in
the human spirit.
As a technological matter, Bloomberg could have traded on
the afternoon of September 11. That statement does not,
however, imply any criticism of the collective and difficult
decision to close the markets during this unprecedented crisis.
As to the long-term public policy lessons to be gleaned from
this tragedy, I have observed there has been a debate over the
past few years over whether public policy should favor a more
decentralized market structure or whether public policy should
encourage a more centralized market structure as often
advocated by the exchanges. I believe, if there is anything
approximating a level playing field, market forces will drive
toward decentralization. Clearly, September 11 underscored the
wisdom of moving in that direction.
In conclusion, billions of transaction costs have been
saved by ECNs in the Nasdaq marketplace. Investors in the New
York Stock Exchange's listed market should be permitted an
opportunity to enjoy the same benefits. As the exchanges that
have traditionally functioned as public utilities become for-
profit entities, investors will suffer if the exchanges succeed
in leveraging their existing government-sponsored monopolies
into currently competitive arenas. We should opt instead for a
continuation of tremendous progress that has been made over the
past 5 years in the Nasdaq marketplace. We should attempt to
allow similar competition and innovation to flourish in the
listed market, thus preserving America's status as the world's
premier capital market.
Thank you.
[The prepared statement of Kim Bang follows:]
Prepared Statement of Kim Bang, President, Bloomberg Tradebook LLC
Introduction. Mr. Chairman and Members of the Subcommittee. My name
is Kim Bang, and I am pleased to testify on behalf of Bloomberg
Tradebook regarding ECNs in the wake of September 11th.
Bloomberg Tradebook is owned by Bloomberg L.P. and is located in
New York City. Bloomberg L.P. provides multimedia, analytical and news
services to more than 150,000 terminals used by 350,000 financial
professionals in 100 countries worldwide. Bloomberg tracks more than
135,000 equity securities in 85 countries, more than 50,000 companies
trading on 82 exchanges and more than 406,000 corporate bonds.
Bloomberg News is syndicated in over 350 newspapers, and on 550 radio
and television stations worldwide. Bloomberg publishes seven magazines,
as well as books on financial subjects for the investment professional
and non-professional reader.
Bloomberg Tradebook is an electronic agency broker serving
institutions and other broker-dealers. We count among our clients many
of the nation's largest institutional investors. Bloomberg Tradebook
specializes in providing innovative tools that allow our clients to
step unobtrusively into the electronic ``crowd'' of the new national
market system to find liquidity for themselves and, in the process,
provide it for others. Our clients have rewarded our creativity and our
service by trusting us with their business, allowing us to regularly
match in excess of 200 million shares a day.
What are ECNs? Before analyzing the effects of September 11th on
ECNs, we must first explore what ECNs are and how they came into
existence. There has been an enormous growth in ECNs over the past five
years. That growth has been made possible by the issuance in 1996 of
the SEC's Order Handling Rules. These rules--aimed primarily at
exchange specialists and Over-the-Counter market makers--were designed
to promote market transparency.
A few years ago, the SEC took a number of steps to reform the
markets--starting with directing the reorganization of the governance
structure of the NASD. On a limited number of critical committees, the
NASD was directed to provide for significantly greater involvement by
representatives of the public and NASD constituencies other than market
makers. I am privileged to serve on one of the key committees cited in
the order--the Quality of Markets Committee. The express purpose of the
SEC in directing these changes was to alter the perspectives of the
NASD and infuse the NASD with a greater sense of objectivity and
impartiality.
It is often remarked that sunlight is the best disinfectant, and,
indeed, the increased transparency promoted by the SEC's Order Handling
Rules and the subsequent integration of ECNs into the national
quotation montage narrowed Nasdaq spreads by nearly 30% in a year.
While the complete list of reforms ordered by the SEC to promote
transparency is long and varied, all of these changes, including the
promulgation of the Order Handling Rules, were animated by the same
underlying principle--namely that the sunlight produces the most honest
and efficient markets.
ECNs--A Market Solution to a Market Problem. A regulatory regime
that encourages transparency was a necessary, but not sufficient,
precondition to the growth of ECNs. The reason ECNs account now for
more than 46% of the reported share volume of Nasdaq is simple--ECNs
are a market solution to a market problem.
ECNs are distinguished by four characteristics--neutrality,
transparency, fairness and innovation.
Neutrality? By definition we are agency brokers and take no
position for our own accounts. Thus we are neutral in the marketplace
and exist only to serve our customers' need to buy or sell shares.
Transparency? Like market makers, we maintain an electronic book of
our customers' bids and offers. But unlike market makers we publish our
entire book of quoted prices electronically for all our customers to
see. Indeed, unlike some of our ECN competitors, we take advantage of
this transparency to route our customers to the best available price,
even if it is outside of Bloomberg Tradebook.
Fairness? ECNs are required by SEC rules to respond immediately--
and I mean immediately--to orders in the order they are received,
whether they come from our best customers or from our competitors.
That's probably the highest standard of fairness in the industry.
Innovation? Without a government-sponsored monopoly to rely on, the
market demands that ECNs innovate. For example, at its inception in
1996, Bloomberg Tradebook introduced the concept of ``Reserve'' to the
U.S. equity markets. ``Reserve'' is a process that controls the release
of orders into the market, enabling clients to trade large orders more
efficiently. Like all innovations, the ``Reserve'' gave us a leg up on
our competitors for a brief period of time. It has since become the
industry standard. Today no one would introduce a system without it.
Any edge we gain is a momentary one--and we are forced to continue to
innovate. We have done so continuously in the past five years.
Along with neutrality, transparency, fairness and innovation, add
lots of enthusiasm and creativity from people passionately devoted to
serving their customers and you have a picture of who we are and why we
exist.
When the Senate Banking Committee held a hearing in the last
Congress exploring the role of ECNs, Frank Zarb, then-Chairman of the
National Association of Securities Dealers, stated that ``. . . I guess
I sum up the answer as to why we have ECNs as the fact that the
national stock exchanges, and I'm not only talking about ours, but the
exchanges around the world haven't been keeping pace with the needs of
the market.''
Mr. Zarb is an accomplished leader in business and public service.
Investors are fortunate to have had the benefit of his leadership, but
I respectfully submit that the reason ECNs exist is not only because of
what national stock exchanges failed to do, but also because of what we
innovating broker-dealers have done, in the heat of competition. Mr.
Chairman, it's worth pondering why the stock exchanges didn't keep
pace, as Mr. Zarb stated. We would submit that a government-sponsored
monopoly ultimately cannot provide the innovative ideas and customer
service of the best ECNs precisely because they are a government-
sponsored monopoly. To spur future innovation, I'd rather place my
faith in the NASD's members--the marketplace of competing broker-
dealers.
The Current Challenge. At present, most SROs are non-profit
organizations. The NASD, however, has largely completed its
privatization of Nasdaq and it may well be that other privatizations
will follow. Under the cover of a non-transparent bureaucracy, non-
profit SROs have exploited the opportunity to subsidize their other
costs (e.g. costs of market operation, market regulation, market
surveillance, member regulation) through market information fees. For
all SROs, the incentive will be strong to exploit this government-
sponsored monopoly over market data by charging excessive rates for
market data and using those monopoly rents to subsidize their
competitive businesses. Indeed, shareholders of these now for-profit
entities will effectively demand that market data charges remain
excessive.
Along with its market data monopoly, Nasdaq will also have a
powerful incentive to leverage its trade execution monopoly to the
detriment of consumers, investors and the markets. Currently, there is
no real alternative to Nasdaq's monopoly with respect to the execution
of market-maker quotations/orders in securities traded via Nasdaq.
Through a series of developments, starting with the inauguration of the
Small Order Execution System (``SOES'') in the 1980's and progressing
through the development of SuperSOES and SuperMontage, Nasdaq has
evolved from a decentralized, quotation and telephone-based system into
a screen-based, electronic communications network embodying an
electronic limit order book.
In theory, NASD members can bypass SuperSOES through private wire
connections between a market maker and a customer or dealer. In
reality, however, that means of avoiding SuperSOES is not on an equal
competitive footing with the use of SuperSOES. Orders transmitted
through SuperSOES impose obligations on the market maker to execute
against its published quotation. Those obligations are not replicated
by private wire connections.
Only Nasdaq has the monopolistic power to execute transactions
against market makers quotations. Individual market participants do not
have the market power to replicate that obligation through private
contractual arrangements or other private ordering.
The same issue is raised by the recent approval by the Nasdaq Board
of a pricing proposal that will charge excessive connectivity fees for
routing trades outside of Nasdaq. This proposal was approved by the
Nasdaq Board despite having been rejected by the Quality of Markets
Committee by a 14 to 6 vote. If the best price for a stock exists
outside of Nasdaq, consumers should be able to avail themselves of that
price without the obstacle of a connectivity fee that bears no
relationship to actual costs incurred in consummating the transaction.
The NASD currently is putting together a proposal for a new
Alternative Display Facility (``ADF''). The ADF is intended to provide
a competitive alternative to the Nasdaq SuperMontage/SuperSOES
facility. It remains to be seen, however, how effective an alternative
the ADF will be and whether it will be adequately funded. As it is,
Nasdaq has taken unto itself the enterprise value of its market system,
which the NASD developed over 30 years. Nasdaq embodies both a
quotation facility and an execution/clearance facility, which the ADF
is not intended to provide. It may be that the ADF will nevertheless be
a preferred venue, but that will eventuate only if it is allowed to
compete on an equal footing with Nasdaq. Exclusionary and anti-
competitive elements in the SuperMontage/SuperSOES combination should
be revised to provide that equal footing.
Currently, there is no ``glue'' in the proposed ADF. In the absence
of mandated intermarket connections between Nasdaq and the ADF, the ADF
may become a ghost town.
For-profit exchanges will have powerful incentives to leverage
their existing government-sponsored monopolies to gain an unfair
advantage in currently competitive markets. They'll have incentives to
``keep pace'' with market innovators not by moving forward themselves,
but by slowing down all market participants and centralizing order
flow.
If that occurs, consumers, investors and the markets themselves
will be denied the benefits of competition. Everyone loses if
exchanges--comfortable as government-sponsored monopolies--fail to
innovate, leaving American markets vulnerable to offshore competitions.
ECNs--Consumers and Investors Benefit. So who has benefited from
the existence of ECNs? For one, small retail customers who, for the
first time, have gained direct unfettered access to the liquidity of
institutional order flow represented directly in the market.
Institutional investors who, for the first time, are able to find
liquidity for their orders by interacting directly with small order
flow. All investors who have seen the speed and fairness of their
executions improve, as ECNs have raised the standard for all broker-
dealers. Even traders not participating in ECNs benefit from our depth,
liquidity and immediacy each time they hit an ECN bid or take an ECN
offer.
Who Hasn't Benefited from ECNs? Useful linkages have yet to be
developed for the New York Stock Exchange listed market. As a result,
investors in that market have yet to reap the full benefits of the
competition provided by ECNs. While the SEC has allowed ECNs access to
the Intermarket Trading System (ITS) through Nasdaq, this is not
sufficient. ITS remains crippled both by its technological
ineffectiveness and an unworkable governance structure that makes any
movement nearly impossible. As stated above, the same issue will arise
if there is not an effective linkage between Nasdaq and the proposed
ADF, without which a viable third market in Nasdaq securities likely
will be impossible.
Government-sponsored market centers like the Nasdaq Stock Market
and the New York Stock Exchange can either make ECN transparency
available to the entire national market system or reduce transparency
by seeking to block ECN display linkages. Clearly the NYSE has
historically had no interest in encouraging linkages that would make
ECNs players in the listed market.
ECNs in the Wake of September 11th. The financial services industry
was ground zero of the attack on America. All of us in this industry
have suffered enormous loss. At Bloomberg, we have been privileged to
provide free office space and support--phones, computers, Bloomberg
terminals, and whatever else is needed--to more than 1,200 displaced
financial workers since the tragedy. Many of them have lost friends and
colleagues--as we at Bloomberg did. Yet they inspire us with their
commitment to getting back to work and their display of the
extraordinary strength of the human spirit. They convince us that,
although the terrorists have inflicted profound losses, they have not
diminished our resolve. That resolution, that spirit of cooperation and
sacrifice has animated the incredible ongoing efforts by so many in
both the public and private sectors to resurrect our securities
markets.
It is very difficult to think of September 11th in terms of its
policy ramifications. It is clear, however, that all industries must go
through the painful process of analyzing whether there are applicable
lessons to be gleaned from this tragedy. We believe there are.
While I've described how the Order Handling Rules and the market's
demand for these services made the growth of ECNs in the Nasdaq market
possible, the third critical component is, of course, the advent of
modern telecommunications and computing technology. This technology has
facilitated a volume and speed of trading that would have been
unimaginable not so long ago.
Technology makes possible a market structure that wouldn't have
previously been possible. That has spawned a debate over the past few
years over whether public policy should favor a more decentralized
market structure, or whether public policy should encourage
centralization as advocated often by the exchanges.
This argument has manifested itself in a number of different ways.
A few years ago, proponents of centralization urged support for a time
priority Central Limit Order Book (CLOB) to deal with the alleged
``problem'' of market fragmentation. The notion behind the CLOB was
that, by centralizing orders in one place, a single ``black box'',
maximum order interaction and perhaps better prices might be achieved.
While the CLOB was ultimately rejected, the previously described
interaction of SuperSOES and SuperMontage within Nasdaq represent the
same effort to centralize. The recent Nasdaq pricing proposal, which
would clearly discourage execution of trades outside of Nasdaq--even if
the best price for a stock were being offered outside of Nasdaq--is
simply the latest manifestation of this urge towards centralization. As
exchanges contemplate for-profit futures, this urge to centralize order
flow and execution will grow more pronounced. This emphasizes the need
for a functional, fully competitive ADF as a means to mitigate the
anti-competitive effects of Nasdaq's market scheme. It may well be that
additional remedial measures will be needed. The continued vigilance of
the Congress and the SEC will be essential as these developments
unfold.
As the growth of ECNs illustrates, modern technology allows the
advantages of maximum order interaction without the downside of
centralization. State-of-the-art telecommunications systems like the
Internet don't rely on a single monopoly channel--rather they rely on
networked webs of multiple competing and redundant linkages. Why should
the securities markets work differently?
In addition, centralized systems are resistant to change. The
innovations that ECNs have brought to the market would not have
occurred under more centralized systems.
A centralized system also provides the significant downside of a
central point of failure. Those of us who deal regularly with Nasdaq's
SelectNet system know only too well how cumbersome and inefficient a
centralized system can be. Like SelectNet, the ITS system is conceded
even by the sympathetic to be technologically outmoded, with a
bureaucracy that thwarts change. Why make those failed systems the
model?
Bloomberg Tradebook, as well as others in our industry, has
expressed concerns for years about the problem of a single point of
failure posed by a centralized system. The tragedy of September 11th
underscores that concern.
Conclusion. I thank the Committee for the opportunity to describe
the regulatory structure, investor demand and the technological
advances that have made possible the enormous growth of ECNs in the
Nasdaq market. The neutrality, transparency, fairness and innovation we
collectively bring to the Nasdaq market have dramatically increased
efficiency on Wall Street, redounding to the benefit of Main Street and
the economy. Investors in the New York Stock Exchange listed market
should be permitted an opportunity to enjoy the same benefits.
Historically not-for-profit exchanges are contemplating a for-
profit future. As market players that have traditionally functioned as
public utilities become for-profit entities, their goals, incentives
and agendas radically change as well. Consumers and investors will
suffer if exchanges succeed in leveraging their existing government-
sponsored monopolies into currently competitive arenas. These efforts
will increase centralization in a manner that is not only unnecessary
given modern technology, but also economically ill advised and
potentially perilous.

Mr. Stearns. Thank you, Mr. Bang.
Mr. O'Hara.

STATEMENT OF KEVIN J.P. O'HARA

Mr. O'Hara. Good morning, Chairman Stearns, Congressman
Towns and other distinguished members of the subcommittee. On
behalf of Archipelago, I am pleased and honored to be with you
this morning and thank the subcommittee for holding this
hearing.
Archipelago was co-founded by Jerry Putnam, our Chairman
and CEO, and software developers MarrGwen and Stuart Townsend
in late 1996. From January 20, 1997, the day Archipelago
executed its first order as 1 of the 4 original ``qualified''
ECNs, its operating business has grown to average over 200
million shares per day, or roughly 10 percent of Nasdaq's
overall volume, and 25 million shares per day of NYSE- and
AMEX-listed volume.
In October of this year Archipelago was approved by the
Securities and Exchange Commission to become the first fully
open electronic national stock exchange. Through its business
arrangement with the Pacific Stock Exchange, the Archipelago
Exchange will launch early next year with its ``best
execution'' business model at its core. The Archipelago
Exchange, like its younger brother the Archipelago ECN, will
route orders to superior prices if they exist outside the
Archipelago system.
Further, only 3 weeks ago Archipelago and REDIBook, the two
fastest growing ECNs, announced their intention to combine
businesses. This merger of equals brings together two deep
pools of liquidity into one fully integrated and innovative
trading platform. The combined owners of Archipelago and
REDIBook represent diverse investors from all walks of life,
including institutional and retail brokers as well as
professional trading houses and established Wall Street firms.
September 11 has compelled our Nation to fundamentally
rethink risk--the risk of future attacks, the risk of providing
global leadership and even the risk of an open society. In
terms of our capital markets, the extreme concentration in
lower Manhattan appears now to pose unsustainable geographic
and economic risk. Indeed, the Wall Street Journal and the
Washington Post both editorialize that the week-long trading
hiatus from September 11 to September 17 was far too long,
given our 21st century resources and wherewithal.
How do we manage the glaring risk exposed by September 11,
and what does the future portend for our capital markets? An
educated guess envisions a network of multiple competitive
market centers linked by robust linkages which compete for
business on the basis of price, product and service. A system
of linked competitors is identical to the Internet model
designed to provide redundancy and avert a single point of
failure. It was precisely this decentralized model that proved
unconditionally successful as a means of communication on
September 11.
This notion is not new to the financial markets. In 1975,
Congress laid out the road map for a national market system of
informationally linked competing exchanges. The question,
therefore, is not whether linkages exist or if electronic
facilities such as ECNs and regional exchanges located outside
lower Manhattan could have shouldered the burden of trading on
September 12, 13 or 14. If called upon, we believe we could
have answered the bell. Rather, the query is whether our
industry is prepared to move to embrace a less centralized
model and thereby eliminate the risk of shutting our markets
down in the face of the unthinkable.
In our quest to manage risk of the unthinkable, perhaps we
can draw lessons from the thinkable. An overused criticism of
alternative markets such as ECNs disputes that their
efficiencies are only available when times are good and the
market is going up but are nowhere to be found when markets are
stressed or, in industry parlance, are ``cratering.'' The
argument continues that only the anointed specialists or
market-makers would be there to ``catch the falling knife'' by
buying in the face of extreme selling.
However, empirical evidence to date erodes the ``falling
knife'' critique. This is evidenced by data reflected in the
display chart off to your right there, Enron trading from
November 28, 2001, which plots the price action of Enron, the
beleaguered energy giant, on November 28, 2001.
On that day, Standard & Poors announced a downgrade of
Enron's debt to junk status, which sent the stock into another
leg down in its free-fall. Minutes before the announcement, the
New York Stock Exchange halted trading at 10:58 a.m. Due to a,
quote, order imbalance. In other words, there were more sellers
of Enron than buyers, and the ``knife'' was too sharp for the
specialist to catch. Note that unlike a regulatory halt, which
is marketwide, a halt for an order imbalance or operational
failure does not impact the ability of other markets to trade.
While the New York Stock Exchange specialist responsible
for trading Enron shut down his post over the next half hour,
ECNs and other alternative venues traded over 10 million shares
of Enron as the stock went from $2.60 to $1.10. At 11:27 a.m.,
the New York Stock Exchange specialist resumed trading in Enron
at prices discovered by these alternative markets.
The upshot: No single entity, be it exchange, specialist or
market-maker, can go it alone to catch a falling knife.
Efficient price discovery is the product of the entire
marketplace, including ECNs and alternative exchanges.
Finally, before I conclude, I would be remiss in not
commending Congress, the SEC, and public advocates for
supporting the conversion of our equity markets to decimal
pricing. In particular, the Commerce Committee was a critical
catalyst for this positive change that, to date, has narrowed
effective spreads in the most liquid stocks on Nasdaq and the
New York Stock Exchange by an average of 50 percent and 15
percent respectively. This fundamental change has directly led
to enormous reductions in trading costs and, importantly, puts
tens of millions of dollars back in the pockets of investors.
Thank you for your steadfast perseverance.
[The prepared statement of Kevin J.P. O'Hara follows:]
Prepared Statement of Kevin J.P. O'Hara, General Counsel, Archipelago
Holdings, L.L.C.
i. introduction
Good morning Chairman Stearns, Congressman Towns and other
distinguished members of the Subcommittee. On behalf of Archipelago
Holdings, L.L.C. (``Archipelago''), I am pleased and honored to be with
you this morning, and commend the Subcommittee for holding this hearing
in the wake of the September 11 attacks.
Archipelago was co-founded by Jerry Putnam, our Chairman and CEO,
in late 1996, and software developers MarrGwen and Stuart Townsend.
From January 20, 1997, the day Archipelago executed its first order as
one of the four original ``qualified'' Electronic Communication
Networks (``ECN''), its current operating business has grown to average
over 200 million shares per day, or roughly 10% of Nasdaq's overall
volume, and 25 million shares per day of NYSE- and Amex-listed volume.
Today, Archipelago is the only ECN to reflect a quote in the National
Market System for listed securities, such as AOL and IBM.
In October of this year, after working side-by-side with the
dedicated staff of the Securities and Exchange Commission (``SEC'' or
``Commission''), Archipelago was approved by the Commission to become
the first fully open electronic national stock exchange. Through its
business arrangement with the Pacific Stock Exchange, who will serve as
its regulator, the Archipelago Exchange will launch early next year
with its ``best execution'' business model at its core. The Archipelago
Exchange--like its younger brother the Archipelago ECN--will route
orders to superior prices if they exist outside of the Archipelago
system. The Archipelago Exchange will be fully integrated into the
National Market System and will compete toe-to-toe with the NYSE,
Nasdaq, and Amex.
Further, only three weeks ago, Archipelago and REDIBook, the two
fastest growing ECNs, announced their intention to combine businesses.
This merger of equals brings together two deep pools of liquidity into
one fully integrated and innovative trading platform. The combined
owners of Archipelago and REDIBook represent diverse investors from all
walks of life, including institutional and retail brokers as well as
professional trading houses and established Wall Street firms. They
include American Century Funds, Charles Schwab, Goldman Sachs, Credit
Suisse First Boston, E*Trade, Fidelity Investments, BNP Cooper Neff,
J.P. Morgan Chase, Lehman Brothers, Merrill Lynch, Fleet Securities,
Pershing, Spear Leeds & Kellogg, TD Waterhouse and CNBC. Archipelago
and REDIBook look forward to closing their transaction and are excited
to getting down to work in delivering value to investors and competing
effectively against traditional exchanges and marketplaces.
ii. the unthinkable: september 11, 2001
In preparing for this hearing, I had the opportunity to peruse the
statements of many distinguished administration officials, regulators,
and industry representatives who have testified before congressional
committees. I will not attempt to match their perspective or ability to
articulate the unthinkable events and repercussions of September 11,
but will only highlight the recent words of SEC Chairman Harvey Pitt:
``The events surrounding this meeting are both a cause for grieving and
a cause for giving thanks.'' At Archipelago, we were blessed by good
fortune unlike some of friends and neighbors in the industry. While
shaken, none of our employees or their families were killed or injured
in the attacks. Although headquartered in Chicago, Archipelago
maintains its second largest office, complete with a backup data
center, just a stone's throw from the NYSE. After assuring the safety
of our New York employees, we began the process of restoring power to
our New York office with round-the-clock help by the NYPD, the NYFD,
ConEd, the Army Corps of Engineers, and FEMA. Like other marketplaces,
the SEC asked us whether we would be ready to go in the immediate days
following September 11. And, we responded, ``we are,'' though we
deferred to the SEC, Congress and the Administration as to when we
should begin trading again. On Monday, September 17, I am happy to
report that Archipelago joined other securities markets in a fully
successful reopening. I might add that we, like the rest of the
financial industry, owe a particular debt of gratitude to, among
others, Mayor Guliani, SEC Chairman Harvey Pitt, Congressman Fossella,
Senator Schumer, Congressman Towns and the staff of the Nasdaq and NYSE
for successfully reopening our markets on that Monday.
Yet, despite the Herculean efforts and heroic actions, September 11
has compelled our nation to fundamentally rethink ``risk'': the risk of
future attacks, the risk of providing global leadership and, even, the
risk of an open society. Once assessed, the rational response is how
best to manage these risks. In terms of our capital markets, the
extreme concentration in Lower Manhattan appears now to pose
unsustainable geographic and economic risk. Indeed, The Wall Street
Journal and Washington Post both editorialized that the weeklong hiatus
was far too long for our markets to be closed, given our 21st century
resources and wherewithal.
iii. the risk management challenge: a competitive response
In the face of adversity, our nation is nothing if not resourceful
and flexible and innovative. We quickly learn from our mistakes, and
our robust financial system is no exception.
Archipelago has spent the last two years evolving from an ECN to a
fully electronic national securities exchange. Others, such as many of
my colleagues on the panel today, have blazed the same or similar
trails. Though not yet complete, the aggregate effect of our
innovations has been the metamorphosis from a floor-based, utility
stock-trading model to an electronic, for-profit one.
How do we manage the glaring risks exposed by September 11, and
what does the future portend for our capital markets? An educated guess
envisions a network of multiple competitive market centers, linked by
robust linkages, which compete for business on the basis of price,
product, and service. A feature of ``service'' is certainly
accessibility: some markets will offer a floor-based solution, with the
advantages of ``high touch'' order handling, while others will offer
screen-based and anonymous access, perhaps as a means to mitigate
geographic risk. A system of linked competitors is identical to the
Internet model, originally designed to provide redundancy and avert a
single point of failure. It was precisely this decentralized model that
proved unconditionally successful as a means of communication on
September 11.
This notion is not new to financial markets. In 1975, for instance,
Congress laid out the roadmap for a National Market System of
informationally-linked competing exchanges, including the now-outdated
Intermarket Trading System completed in 1980. The question, therefore,
is not whether linkages exist, or if electronic facilities such as ECNs
and regional exchanges located outside Lower Manhattan could have
shouldered the burden of trading on September 12 or 13. If called upon,
we believe we could have answered the bell. Rather, the proper query is
whether our industry is prepared to move to embrace a less centralized
model, and thereby eliminate the risk of shutting our markets down in
the face of the unthinkable.
iv. one of the ``thinkable'': enron on november 28
In our quest to manage risk of the unthinkable, perhaps we can draw
lessons from the thinkable. An overused criticism of alternative
markets (e.g., ECNs, ATSs) disputes that their efficiencies are only
available when times are good and the market is going up, but are no
where to be found when markets are stressed or, in industry parlance,
``cratering.'' The argument continues that only the anointed specialist
or market makers would be there to ``catch the falling knife'' by
buying in the face of extreme selling. This criticism speaks to the
core hesitancy that some have with safeguarding our financial markets
to those of us without 209-year operating histories. It goes something
like this: ``Newcomers can't be trusted in stressful times.''
However, empirical evidence to date clearly erodes the ``falling
knife'' critique. And, with the growth of alternative markets and
continued technological progress, the ``falling knife'' critique loses
credibility with each passing day. This is evidenced by the data
reflected in Exhibit A (a copy of which is attached hereto), which
plots the price action of Enron, the beleaguered energy giant, on
November 28, 2001.
On that day, Standard & Poor's announced a downgrade of Enron's
debt to junk status, which sent the stock into another leg down in its
freefall. Minutes before the announcement, the NYSE halted trading at
10:58 a.m. (EST) due to an ``order imbalance''--in other words, there
were more sellers of Enron than buyers, and the ``knife'' was too sharp
for the specialist to catch. Note that unlike a regulatory halt, which
is market-wide, a halt for an ``order imbalance'' or operational
failure doe not impact the ability of other markets to trade.
Which is exactly what happened . . .
While the NYSE specialist responsible for trading Enron shut down
his post over the next half-hour, ECNs and other alternative venues
traded over 10 million shares of Enron (NYSE Symbol: ENE), as the stock
went from $2.60 to $1.10. At 11:27 a.m., the NYSE specialist resumed
trading in Enron at prices discovered by these alternative markets.
The upshot: no single entity--be it exchange, specialist, or market
maker--can go it alone when asked to ``catch a falling knife.''
Efficient price discovery is the product of the entire marketplace.
Provided that competing venues are informationally linked and
accessible, efficient price discovery will occur at all available and
open trading venues, including ECNs and alternative
exchanges.1
---------------------------------------------------------------------------
\1\ A similar example of the ``Enron'' phenomenon, as evidenced in
Exhibit B, occurred at the NYSE on December 12, 2001, in the stock of
Calpine Corporation.
---------------------------------------------------------------------------
v. pennies from heaven
Finally, before concluding, I would be remiss in not commending
Congress, the SEC, and public advocates for supporting the conversion
of our equity markets to decimal pricing. In particular, the Commerce
Committee was one of the critical catalysts for this positive change
that, to date, has narrowed effective spreads in the most liquid stocks
on Nasdaq and the NYSE by an average of 50% and 15%, respectively. This
fundamental change has directly lead to enormous reductions in trading
costs and put tens of millions of dollars back in the pockets of
investors. Thank you for your steadfast perseverance.
vi. conclusion
The dark events of September 11 continue to loom large in the
collective consciousness of the world, our nation, and our financial
industry. Since that day, many have called into question the wisdom of
a Ptolemaic unitary model, in which our financial universe revolves
around a single building at the corner of Wall and Broad Streets. The
task before us is to manage risks, so that a single act of terrorism,
however severe, does not endanger our system of financial markets.
Alternative markets continue to evolve toward a goal of equal
standing with their more storied and traditional brethren. As Congress
found in its analysis of decimalization, and as traders in Enron found
in the tempest's eye of the largest corporate failure in U.S. history,
it is time to set aside parochial biases. The risk of single points of
failure is much too great.
I wish to thank the Subcommittee for permitting Archipelago to
testify on these important matters. I would be pleased to answer your
questions at the appropriate time.
[GRAPHIC] [TIFF OMITTED] T7119.001

[GRAPHIC] [TIFF OMITTED] T7119.002

Mr. Stearns. Thank you, Mr. O'Hara.
Mr. Randich.

STATEMENT OF STEVEN J. RANDICH

Mr. Randich. Thank you, Mr. Chairman, members of the
subcommittee for inviting me to testify today. I welcome the
opportunity to discuss Nasdaq's response to the horrendous acts
of September 11 and the role of ECNs in our market.
I am Steve Randich, and I am responsible for the operations
and technology of the Nasdaq stock market.
The tragic events of September 11 compelled us immediately
to begin a process of evaluating the extent of any damage to
Nasdaq and our market participants and determining the
necessary steps to reopen the market. In doing so, we were
guided by several principals. First, we would do nothing that
impeded the rescue effort. Second, we would closely coordinate
all of our activities with the SEC. Third, we would open our
market only when major market participants were fully prepared
and preferably simultaneously with the other markets. Finally,
we would be as open and transparent in reaching out to
assisting our members and issuing companies in a crisis as we
were in everyday operations.
Because our primary backup technology centers are outside
of Manhattan, our primary concern related to our ability to
connect with the firms that are active in our marketplace and
bring liquidity and order flow. It is critical to understand
that disasters such as these are not averted by hardening any
single point of failure. Rather, they are avoided by having
resilience built into the network through backup connections
and backup vendors. This is the key lesson from this tragedy.
In our view, the decision process to reopen the markets was
a textbook example of effective cooperation among the
government markets and private industry. Telecommunication,
power and employee access problems created enormous
complications and risks in reopening the market. In addition,
there was total unanimous agreement among all participants that
the equity markets should open as quickly as possible but only
when we could ensure that they could operate efficiently with
proper liquidity available, without additional constraints and
with universal access for investors. We also believed that,
given the uncertainties, it was important for investor
confidence that all equity markets and their market
participants begin trading simultaneously.
To achieve the successful reopening of the markets, the
Nasdaq, the government and financial services industry all
worked in concert.
I believe SEC Chairman Harvey Pitt said it best during his
testimony before the Senate Banking Committee on September 20.
``We can be justifiably proud of our market participants and
the way they performed. Everyone pulled together to overcome
this disaster to successfully reopen the U.S. Equities and
options markets. Americans demonstrated continued confidence in
our markets. With the momentum built from this experience, we
will move forward to make our markets even stronger, more
transparent and more vibrant.''
It might be helpful to review Nasdaq's current market
structure as the subcommittee looks at the role of ECNs. As the
worlds' largest electronic stock market, Nasdaq is not limited
to one central trading location. Rather, trading is executed
through Nasdaq's sophisticated computer and telecommunication
network, which transmits real-time quote and trade data to more
than 2 million users in 83 countries. Last month, InfoWorld
named Nasdaq 36th among the top 100 companies for information
technology achievements and 5th among financial services
companies.
Today, Nasdaq lists the securities of nearly 4,200 of the
world's leading companies. Nasdaq's ``open architecture''
market structure places virtually no limit on the number of
market participants that can provide liquidity on Nasdaq and
places no geographical restrictions on those market
participants. Indeed, Nasdaq, unlike its physical floor-based
competitors, made the decision to include ECNs within its
quotation and transaction systems.
At the core of Nasdaq's market structure are a group of
financial firms called market-makers. More than 340 of these
market-maker firms actively trade on Nasdaq, acting as
liquidity providers for Nasdaq-listed securities. Also known as
dealers, market-makers are unique in that they commit their own
capital to Nasdaq-listed securities. Each market-maker is
required at all times to maintain a bid and an offer at each of
the securities in which they are registered as a market-maker.
ECNs are electronic systems that widely disseminate to
third parties orders entered into the system by market-makers
and permit those orders to be executed.
Mr. Stearns. Let me have you sum up, if you could.
Mr. Randich. It is important to recognize ECNs, with one
exception, have chosen to be brokers and, therefore, are not
required to provide broad-based regulatory oversight and self-
regulatory organizations.
In response to September 11, our primary focus was to
ensure that our market participants were able to access our
market. We believe we have the responsibility to keep up with
the changing needs of the investing public to ensure that
investors can buy and sell stocks quickly, efficiently and
affordably, all in a fair, well-regulated market.
Mr. Chairman, we welcome this subcommittee's interest in
this important topic; and I look forward to any questions that
you and the other members may have.
[The prepared statement of Steven J. Randich follows:]
Prepared Statement of Steven J. Randich, Executive Vice President of
Operations & Technology and Chief Information Officer, The Nasdaq Stock
Market
Thank you Mr. Chairman and Members of the Subcommittee for inviting
me to testify before you today. On behalf of the more than 1,200
employees of the Nasdaq Stock Market', I welcome the
opportunity to discuss Nasdaq's response to the horrendous acts of
September 11, 2001, and the role of our various market participants,
particularly electronic communications networks (ECNs).
i. nasdaq response to events of 9/11
The tragic events of 9/11 compelled us to immediately begin a
process of evaluating the extent of any damage to Nasdaq and our market
participants and determining the necessary steps to reopen the market.
In doing so, we were guided by several principles: First, we would do
nothing that impeded the rescue effort. Second, we would closely
coordinate all our activities with the SEC. Third, we would open our
market only when major market participants were fully prepared and,
preferably, simultaneously with other markets. Finally, we would be as
open and transparent in reaching out to and assisting our members and
issuers in crisis as we are in our every day operations. A number of
our participants were unable to access the network due to telephone
failures. Our system could have been open on the 11th and on every day
between the 11th and 17th, however we believed then, and continue to
believe now, that investor protection and market integrity
considerations dictated that the markets be closed. This was
particularly true because of the terrible impact of the events of 9/11
on the trading facilities in lower Manhattan, including the New York
Stock Exchange, the American Stock Exchange, and many Nasdaq market
participants.
As to Nasdaq's technology, at no time during this disaster were
Nasdaq's systems inoperative. At the time of the attacks, trading was
suspended but Nasdaq's systems and network continued to operate.
Because our primary and backup technology centers are outside
Manhattan, our primary concern related to our ability to connect with
the firms that are active in our marketplace and bring liquidity and
order flow. In fact, Nasdaq continued to operate systems later than
normal on Tuesday to allow firms manual access for reconciliation and
mutual fund pricing and related activities. Nasdaq's systems operated
virtually continuously throughout the rest of the week to allow firms
to test connectivity.
Nasdaq's geographically decentralized network has several levels of
redundancies, which are specifically designed to withstand these types
of catastrophic events. Virtually all firms are connected to Nasdaq
through a set of several Nasdaq servers on their sites and in their
backup centers. Each of the servers in the Nasdaq network is connected
to two distinct Nasdaq network centers using diverse telecommunications
providers.
There are more than twenty Nasdaq network centers located
throughout the United States--including four in the NY metropolitan
area. Each of these centers is connected to both our Primary and Backup
data centers. Additionally, while MCI WorldCom provides the overall
management of our network, each of our critical connections is backed
up by another telecommunications vendor so as to offer resiliency
against a systemic provider failure.
While this may be a lengthy description, it is critical to
understand that disasters such as these are not averted by hardening
any single point of failure, rather they are avoided by having
resilience built into the network through backup connections and backup
vendors. This is a key lesson from this tragedy.1 Therefore,
one early priority was to reach out to the 344 market makers, and the 8
electronic communications networks (ECNs), that are part of the Nasdaq
market. We spoke to each of these firms. We asked: Can you connect with
our network? Can your employees get to their trading workstations? What
problems do you foresee?
---------------------------------------------------------------------------
\1\ See, e.g., ``Key Lessons learned in attack on New York,''
Financial Times, December 5, 2001, ``Another aspect of business
continuity planning is examining how much of the organisation can be
physically distributed. For example, although the headquarters of
Nasdaq, the electronic stock exchange, were damaged in the September 11
attack, its distributed organisation helped it tremendously. Its two
main data centers were in Connecticut and Maryland, many miles away.
And its trading partners were on a network with a high degree of
redundancy and only a relatively small number were unable to trade
immediately after the attack. More importantly, its key people were
also distributed.''
---------------------------------------------------------------------------
While many of our firms were not physically impacted by the
disaster, many others, both market makers and ECNs, faced great
challenges, in terms of personnel, technology and connectivity. Nasdaq
staff worked around the clock to provide whatever support we could.
This included providing alternative trading facilities, provisioning
backup facilities with new equipment, testing backup and new network
connections, providing assistance in acquiring emergency resources and
gaining access to critical facilities in lower Manhattan.
We also reached out to the 4,190 companies that list their shares
on Nasdaq. To enhance prospective liquidity, we recommended they look
at buy back programs, as authorized by the SEC on an emergency basis,
and get board approval if necessary.
We reached out to the SEC and other government agencies, as they
reached out to us. And, we cooperated closely with each of the equity
and options exchanges. The unprecedented cooperation between all market
centers and with local and national governmental authorities was
continuous and excellent.
I want to reiterate our appreciation of the Federal, state and
local governments for their willingness to use their vast resources and
regulatory powers to assist the markets in this time of crisis. The SEC
and the City of New York were particularly instrumental in helping us
open the markets as quickly and as smoothly as we did.
In our view, the decision process to reopen the markets was a
textbook example of effective cooperation among the government, markets
and private industry. Telecommunication, power and employee access
problems created enormous complications and risks in reopening the
market. In addition, there was total unanimity among all participants
that the equity markets should open as quickly as possible, but only
when we could ensure that they could operate efficiently with proper
liquidity available, without additional constraints, and with universal
access for investors. We also believed that, given the uncertainties,
it was important for investor confidence that all equity markets--and
their market participants--begin trading simultaneously.
After two all hands meetings, and with the strong leadership of
Chairman Pitt and the full support of the SEC, Department of Treasury
and Federal Reserve Board, the decision was made that trading should
resume no later than Monday, September 17th. This decision was based on
three primary factors. First, through the efforts of Verizon, MCI
Worldcom and the affected financial firms and markets, there was a
geometric improvement of telecommunications connectivity each day
following 9/11. Second, the critical importance of the continuing
rescue operation at the World Trade Center site made provisions for
widespread physical access to financial firms and the New York Stock
Exchange floor and an earlier start-up inappropriate. Third, there was
complete consensus that the markets should not resume without
widespread system connectivity testing that could most effectively
occur over the weekend. The successful resumption of trading on Monday
would be an important signal to our citizens and the world. It was
accomplished by the extraordinary efforts of thousands of financial
market and brokerage firm employees who collectively are owed an
enormous debt of gratitude.
The SEC reassured the markets, indicated appropriate relaxation of
regulatory constraints, and focused the markets on critical systems.
The SEC's speedy action to ease the rules governing corporate stock
repurchases was especially helpful and responsive to the needs of
Nasdaq-listed companies with which we were working.
Nasdaq employees provided technological support to over 800 Nasdaq
and non-Nasdaq participants including market makers, order entry firms,
ECNs, other markets, and even some foreign markets seeking to re-
establish their local connectivity. Many firms had to activate disaster
recovery sites, which presented special technological needs.
To achieve the successful reopening of the markets, Nasdaq, the
government and the financial services industry all worked in concert.
The strength of the U.S. financial markets today reflects the
cumulative efforts of far-sighted leadership many years ago. Of course,
Congress laid the foundation with the passage and careful oversight of
the U.S. securities laws.
The U.S. financial industry has demonstrated its resilience and
resolve to maintain the most liquid and stable markets in the face of
terrible challenges, and clearly Nasdaq's trading network has
demonstrated its unique value as a part of this infrastructure.
I believe SEC Chairman Harvey Pitt said it best during his
testimony before the Senate Banking Committee on September 20, 2001:
``We can be justifiably proud of our market participants and the way
they have performed. Everyone pulled together to overcome this disaster
and successfully reopen the U.S. equities and options markets.
Americans demonstrated continued confidence in our markets. With the
momentum built from this experience, we will move forward to make our
markets even stronger, more transparent and more vibrant.''
ii. nasdaq market structure
A. Overview
It might be helpful to review Nasdaq's current market structure as
the Subcommittee looks at the role of ECNs. As the world's largest
electronic stock market, Nasdaq is not limited to one central trading
location. Rather, trading is executed through Nasdaq's sophisticated
computer and telecommunications network, which transmits real-time
quote and trade data to more than 2 million users in 83 countries. Last
month, InfoWorld named Nasdaq as 36th among the top 100 companies for
information technology achievements, and 5th among financial services
companies.
Today, Nasdaq lists the securities of nearly 4,200 of the world's
leading companies, representing the entire spectrum of the U.S.
economy--from information technology and telecommunications to
agriculture, manufacturing and finance. Nasdaq's ``open architecture''
market structure places virtually no limit on the number of market
participants that can provide liquidity on Nasdaq and places virtually
no geographical restrictions on those market participants. Indeed,
Nasdaq, unlike its physical floor-based competitors, made the decision
to include ECNs within its quotation and transaction systems.
B. Nasdaq's Market Participants
At the core of Nasdaq's market structure are a group of financial
firms called ``market makers.'' More than 340 market making firms
actively trade on Nasdaq, acting as liquidity providers for Nasdaq-
listed securities. Also known as ``dealers,'' market makers are unique
in that they commit their own capital to Nasdaq-listed securities. Each
market maker is required at all times to maintain a bid and an offer in
each of the securities in which it is registered as a market maker. By
being willing to buy and sell stock--using their own funds--market
makers add liquidity to Nasdaq's market, ensure that there are always
buyers and sellers for Nasdaq-listed securities, and enable invertors'
trades to be filled quickly and efficiently. Market makers adhere to
strict trading regulations and are required to:

<bullet> Disclose their buy and sell interest by displaying continuous
two-sided quotes in all stocks in which they choose to make a
market.
<bullet> Display customer orders in their quotes in Nasdaq or in the
quotes of ECNs, in compliance with SEC Order Handling Rules.
<bullet> Honor their quoted prices and report trading in a timely
manner. Failure to do so can lead to disciplinary action.
In addition to market makers, the Nasdaq network also connects
alternative trading systems into the market, such as ECNs. ECNs are
electronic systems that widely disseminate to third parties orders
entered into the system by market makers and permit those orders to be
executed against. Preliminarily, it is important to recognize that
ECNs, with one exception, have chosen to be brokers and, therefore, are
not required to provide broad based regulatory oversight as are self-
regulatory organizations.
The largest ECNs are: (1) Instinet, which is majority owned by the
British firm Reuters, and (2) Island. Other ECNs include Bloomberg's
Tradebook, Archipelago (which recently merged with the Pacific Stock
Exchange), and Redibook (which recently agreed to merge with
Archipelago). With the exception of Archipelago, which will operate in
part as an affiliate of a regulated exchange, the ECNs are regulated
just like other broker-dealers.
These ECNs provide electronic facilities that investors can use to
trade directly with each other. Additionally, they provide investors
with an anonymous way to enter orders into the marketplace. ECNs
operate as order-matching mechanisms and do not maintain inventories of
their own or risk their own capital. ECNs are not required to maintain
continuous two-sided quotations in the securities that they trade.
Nasdaq recognizes the unique role that ECNs play as part of an
integrated Nasdaq Stock Market. In 1997, the SEC required ECNs to allow
access to their systems by non-subscribers. As a result, ECNs are
integrated into the National Market System and investors have benefited
through enhanced liquidity.
iii. conclusion
In response to 9/11, our primary focus was to ensure that our major
market participants were able to access our market; each of them has an
important role to play. At Nasdaq, we believe that we have a
responsibility to keep up with the changing needs of the investing
public to ensure that investors can buy and sell stocks quickly,
efficiently, and affordably, all in a fair, well-regulated market.
As we move forward, all of Nasdaq's efforts to improve its market
structure, including SuperSOES (small order execution system) and
SuperMontage, will impact the quality and depth of information that we
can provide to investors. Today, investors in Nasdaq securities can
only see the aggregate trading interest at the best prices to buy and
sell. When implemented next year, SuperMontage will display the total
amount of trading interest in Nasdaq at the best bid price and at the
best offer price, as well as two trading increments away from those
prices. This expanded display will increase transparency by allowing
customers and other market participants to see greater depth of market.
As a result, investors will have more information on which to make
better-informed trading decisions.
Nasdaq's open architecture market structure fosters innovation in
the creation of new products and services, new market participants--
such as ECNs--and new business models for the ultimate benefit of
investors.
Mr. Chairman, we welcome the Subcommittee's interest in these
important issues, and I look forward to any questions you and the other
Members may have.

Mr. Stearns. I thank the gentleman.
Mr. Jamaitis, we welcome your opening statement. Roughly
about 5 minutes.

STATEMENT OF KEITH R. JAMAITIS

Mr. Jamaitis. Good morning, Chairman Stearns, members of
the subcommittee. I am Keith Jamaitis, Chief Operating Officer
of NYFIX. I appreciate the opportunity to testify on behalf of
NYFIX Millennium regarding the important role that electronic
communication networks, ECNs, and alternative trading systems,
ATSs, played in the wake of September 11.
It is our view that the SEC's vision of fostering
competition among execution centers such as ECNs, ATSs and
exchanges contributed directly to the swift recovery of our
markets after the September 11 attacks. We are pleased to offer
the following remarks which will touch upon NYFIX's activities
and role in helping the equity markets reopen following the
tragic events of September 11.
NYFIX Millennium is a registered NASD broker-dealer that
operates an ATS. The NYFIX Millennium ATS is an electronic
execution venue focusing specifically on exchange-listed
securities. The company was founded in order to provide a
superior execution platform by leveraging the technological
infrastructure and order routing volume of the NYFIX network.
Our mission is to provide high-quality executions in the
listing trading arena through anonymous and efficient matching
of pass-through and conditional order flow.
The NYFIX financial technology infrastructure delivers
approximately 500 to 600 million shares of listed trading
volume to the New York Stock exchange each day. This order flow
represents a substantial portion of the block trading volume
delivered to the New York Stock Exchange electronically and
executed in the crowd.
NYFIX Millennium was a victim of the September 11 attacks
along with the rest of the financial services community and the
rest of the world. Our sympathies are with our professional
peers and all the people and families affected by these events.
During and after the World Trade Center attacks, the NYFIX
service bureau staff kept focused on helping our customers and
industry recover from these disastrous events. NYFIX is
uniquely positioned with offices in Stamford, Connecticut, as
well as New York City. The corporate headquarters and the help
desk are located in Connecticut. The help desk, while normally
servicing trading systems and issues with our customers,
quickly became an industry information hub in the wake of
attacks.
NYFIX maintains many critical communication links that
cross-connect the electronic trading systems that service our
equity markets. These connections are very comprehensive and
allow trade data to flow from buy-site institutions to sell-
site institutions to execution destinations such as the New
York Stock Exchange, third party market destinations, and ECNs
and ATSs.
NYFIX Millennium's connectivity with the financial services
industry allowed us to share information among the financial
institutions. Most importantly it gave our operations staff a
clear assessment of the technological impact of the World Trade
Center disaster. NYFIX immediately undertook an inventory of
all internal systems that were affected. The data centers have
dual locations in Carlstadt and North Bergen, New Jersey, so
the effect to core systems was minimal. The major problem was
telecommunication outages. The NYFIX network lost over 60
percent of its telecommunications data services into New York
City. Immediately after the disaster, our data network into New
York Stock Exchange was reduced by approximately 80 percent.
System recovery operations began immediately from the
Stamford, Connecticut, office. Our telecommunications carriers
were notified, and specialized task teams were deployed to
resolve system issues. Once in-house issues were under control,
the help desk and account management staff attempted to contact
each of our over 100 broker-dealers in our network.
The primary problem remained telecommunications data
circuits. As a true business partner, we began to address the
secondary issues of relocating customers who have been
displaced from the World Trade Center and other downtown
locations. The specific steps taken included shipping multiple
systems to newly established customer disaster recovery sites,
assembling over 100 additional systems into inventory,
deploying our application engineer staff to alternate sites to
work on network configurations and new trading system
installations, reconnecting several customer systems via the
Internet, providing Internet access through the NYFIX
Millennium network out to our customers, making our office
space in New York available for temporarily displaced customer
users, reengineering some trades clearing processes that our
customers use on the New York Stock Exchange.
It is important to note that our service bureau is a
significant investment. It is a dual data center model with
multiple redundant telecommunications circuits that allow for
maximum reliability and flexibility. Our commitment to
providing the highest level of data services made the systems
recovery effort possible. It is difficult to measure the value
of the substantial investment in multiple backup systems and
facilities. The best technology is good only to the extent that
it is available.
We understand our role in the industry and the
responsibility associated with it. We understand our
responsibility to our over 1,700 users on institutional trading
desks. We understand our responsibility to the over 180 broker-
dealer clients on the floor of the New York Stock Exchange. We
fulfill these responsibilities on a daily basis.
We will continue to invest in reenforcing our technology
platform to deliver the best service possible to the investing
public. NYFIX Millennium's disaster relief procedures and
systems performed well under the extremely adverse conditions
of September 11. We are consulting with the financial services
industry on adopting and implementing similar best practices,
including dual mirrored data centers on dual power grids
located at different geographic locations; adopting formal
procedures to require regular system recovery testing; and
adopting NYFIX disaster recovery policies and procedures to be
applied to our clients' proprietary systems.
The events of September 11 demonstrated the value and
strength of our technology. Our NYFIX network remained online
during the terrorist attacks and were 100 percent prepared for
markets reopening. In fact, we experienced our greatest share
volume on September 17, routing approximately 1.2 billion
shares to the floor of the New York Stock Exchange through our
systems.
In conclusion, upon the approval and coordination of the
regulatory community, our equity markets were prepared to open
on September 17. We are proud to have been a significant
contributor to their successful opening and operations on that
day. Our efforts have continued through to the present to
improve and refine our disaster recovery capabilities. We are
particularly pleased with our service to the investing public
and our clients as coordinated through the New York Stock
Exchange, its member firms, and other industry leaders
participating on this panel today. Thank you.
[The prepared statement of Keith R. Jamaitis follows:]
Prepared Statement of Keith R. Jamaitis, Senior Vice President, Chief
Operating Officer, NYFIX, Inc.
Chairman Stearns, members of the Subcommittee: I appreciate the
opportunity to testify on behalf of NYFIX Millennium, Inc. (``NYFIX
Millennium'') regarding the important role that electronic
communication networks (``ECNs'') and alternative trading systems
(``ATSs''), played in the wake of September 11.
It is our view that the SEC's vision of fostering competition among
execution centers such as ECNs, ATSs and exchanges contributed directly
to the swift recovery of our markets after the September 11 attacks. We
are pleased to offer the following remarks, which will touch upon
NYFIX's activities and its role in helping the equity markets reopen
following the tragic events of September 11.
i. about nyfix millennium
NYFIX Millennium is a registered NASD broker-dealer that operates
an ATS. The NYFIX Millennium ATS is an electronic execution venue
focusing specifically on exchange-listed securities. The Company was
founded in order to provide a superior execution platform by leveraging
the technological infrastructure and order routing volume of the NYFIX
Network. Our mission is to provide high quality executions in the
listed trading arena through anonymous and efficient matching of pass-
through and conditional order flow.
The NYFIX financial technology infrastructure delivers
approximately 500-600 million shares of listed trading volume to the
New York Stock Exchange each day. This order flow represents a
substantial portion of the block trading volume delivered to New York
Stock Exchange electronically, and executed in the crowd.
ii. september 11
NYFIX Millennium was a victim of the September 11 attacks along
with the rest of the financial services community, and the rest of the
world. Our sympathies are with our professional peers and all the
people and families affected by these events.
During and after the World Trade Center attacks the NYFIX service
bureau staff kept focused on helping our customers and the industry
recover from these disastrous events.
NYFIX is uniquely positioned with offices in Stamford, Connecticut
as well as New York City. The corporate headquarters and the Help Desk
are located in Connecticut. The Help Desk, while normally servicing
trading and systems issues for our customers, quickly became an
industry information hub in the wake of the attacks.
NYFIX maintains many critical communications links that cross-
connect the electronic trading systems that service our equities
markets. These connections are very comprehensive and allow trade data
to flow from buy-side institutions to sell-side institutions to
execution destinations such as the New York Stock Exchange, third
market destinations, ECNs and ATSs.
NYFIX Millennium's connectivity with the financial services
industry allowed us to share information among the financial
institutions. Most importantly, it gave our operations staff a clear
assessment of the technological impact of the World Trade Center
disaster.
NYFIX immediately undertook an inventory of all internal systems
that were affected. The data centers have dual locations in Carlstadt
and North Bergen, New Jersey, so the effect to core systems was
minimal. The major problem was telecommunication outages. The NYFIX
network lost over 60% of its telecommunication data services into New
York City. Immediately after the disaster, our data network into the
New York Stock Exchange was reduced by approximately 80%.
System recovery operations began immediately from the Stamford,
Connecticut office. All telecommunications carriers were notified and
specialized task teams were deployed to resolve systems issues. Once
in-house issues were under control, the Help Desk and account
management staff attempted to contact each of the over 100 broker-
dealers in our network.
The primary problem remained telecommunication data circuits. As a
true business partner, we began to address the secondary issues of
relocating customers who were displaced from the World Trade Center and
other downtown locations. Specific steps taken included:

<bullet> Shipping multiple systems to newly established customer
disaster recovery sites for immediate use;
<bullet> Assembling over 100 additional trading systems into inventory;
<bullet> Deploying application engineers to alternate customer sites to
work on network configuration and new trading systems
installations;
<bullet> Reconnecting several customer trading systems via the
Internet;
<bullet> Providing Internet access through the Millennium network to
our customers;
<bullet> Making office space available in both of our New York office
locations to temporarily house displaced users; and
<bullet> Reengineering several trades clearing processes associated
with our New York Stock Exchange customers.
It is important to note that our service bureau is a significant
investment. It is a dual data center model with multiple redundant
telecommunications circuits that allow for maximum reliability and
flexibility. Our commitment to providing the highest level of data
services made the systems recovery effort possible. It is difficult to
measure the value of the substantial investment in multiple backup
systems and facilities. The best technology is good only to the extent
that it is available and reliable. We understand our role in the
industry and the responsibility associated with it. We understand our
responsibility to our 1700 users on institutional trading desks. We
understand our responsibility to the over 180 broker-dealer clients on
the floor of the New York Stock Exchange. We fulfill these
responsibilities on a daily basis.
We will continue to invest in reinforcing our technology platform
to deliver the best service possible to the investing public.
NYFIX Millennium's disaster relief procedures and systems performed
well under extremely adverse conditions. We are consulting with the
financial services industry on adopting and implementing similar best
practices, including:

<bullet> Dual mirrored data centers with dual power grids, located at
different geographic sites;
<bullet> Maintaining multi-carrier WAN infrastructure of data circuits;
<bullet> Adopting formal procedures requiring regular systems recovery
testing; and
<bullet> Adopting NYFIX disaster relief policies and procedures to be
applied to our clients' proprietary systems.
The events of September 11 demonstrated the value and strength of
our technology. Our NYFIX network remained online during the terrorist
attacks and were 100% prepared for the market's reopening. In fact, we
experienced our greatest share volume on September 17, routing
approximately 1.2 billion shares to the floor of the New York Stock
Exchange through our systems.
iii. conclusion
Upon the approval and coordination of the regulatory community, our
equity markets were prepared to open on September 17. We are proud to
have been a significant contributor to their successful opening and
operation on that day. Our efforts have continued through the present,
to improve and refine our disaster relief capabilities. We are
particularly pleased with our service to the investing public and our
clients as we coordinated with the New York Stock Exchange, its member
firms and the other industry leaders participating on this panel in
ensuring that our equity markets got back to business.

Mr. Stearns. I thank the panel very much. Let me first of
all say congratulations on how quick that you did get back to
operation. And it shows the ingenuity and the entrepreneurship
for all of you to get back so quickly. Mr. Shimkus and I, as he
mentioned, were able to go up to Ground Zero shortly after
September 11, and we are so impressed with Verizon, how quickly
not only they got the cell phones back, but the land lease
lines, considering the flooding and all the damage there.
The first thing I wanted to speak to is the ECNs. Lots of
them are located in New York City, and, I mean, is there a
reason why you would have to be located in New York City
considering that?
Mr. Towns. I will answer that, Mr. Chairman.
Mr. Stearns. Mr. Towns is a little sensitive about that.
Mr. Andresen. Certainly in any business there is an
advantage to geographic proximity to your customers from a
relationship standpoint and everything else, but there is
certainly no direct need from a technological standpoint to
have our one and only business in New York. Island has a data
center at 50 Broad Street right down from our distinguished
colleagues at the New York Stock Exchange. We also have a site
out in Secaucus, New Jersey.
Mr. Stearns. It looks like your--some of them are located
at Times Square and also Broad Street. Mr. Jamaitis has
mentioned that he has something out in Stamford, Connecticut.
Mr. Jamaitis. Our headquarters and operations are based out
of Stamford, Connecticut.
Mr. Stearns. So that if we had another calamitous event in
New York City down near the World Trade Center, the question
is, is there enough redundancy that the ECNs would be affected
or not?
Mr. Jamaitis. The policy of our network and our systems, we
have our core data centers located in two locations in New
Jersey, both Carlstadt and North Bergen; then that tertiary
fail over capability on Wall Street, and we can also fail over
back to our Stamford offices. So we feel being geographically
remote and diverse has been a great advantage, especially
weathering, you know, the disasters we saw.
Mr. Stearns. Mr. Andresen, you mentioned that--I think you
said you do 460 million shares a day.
Mr. Andresen. That is correct.
Mr. Stearns. How many employees do you have?
Mr. Andresen. We have 138 employees.
Mr. Stearns. Okay. Am I free to ask what your revenue is a
year? Not the revenue of the trade--you don't have to give
this, but if you feel comfortable.
Mr. Andresen. We are a private company, so our investors
will come find me after the meeting if I disclose too much.
Mr. Stearns. Mr. Steinmetz, you said in your testimony that
the bond markets and currency markets suffered greater
devastation on September 11 than the stock market, and I don't
think most people realize that fact, but were able to resume
trading more quickly. Can you perhaps give us more detail on
those markets and why they were able to resume trading quicker,
more quickly?
Mr. Steinmetz. The bond markets and the currency markets
have very different market structure particularly as it relates
to the networking versus the standard mainframe communications,
if you will. There are approximately 49, I believe, trading
platforms and fixed income that people trade on. There are
numerous amounts of instruments, a lot more instruments than
equity instruments, and they trade all over through different
networks. So, therefore, even though we had such terrible
devastation to some of the bigger companies that trade in those
markets, they were able to get up and running on alternative
systems.
Mr. Stearns. Okay. Mr. Bang, you had mentioned that--you
used the word ``government-sponsored monopoly,'' and you talked
about decentralizing versus centralizing. Yet as I understand,
the New York Stock Exchange has allowed ECNs to access the
intermarket trading system through NASDAQ. Why is this access
insufficient for ECNs, and why would this not show that, you
know, there is this accessibility?
Mr. Bang. Mr. Chairman, the access into NASDAQ's
intermarket trading is a partial solution. It would give us the
ability to display our quotes in the consolidated quotes system
for listed securities. However, we would also be subject to the
ITS rules that Matt Andresen pointed out and described as
somewhat incumbent or problematic for extending the services
out to our clients with the features that they are accustomed
to, which is one of immediacy, which is one of the ability to
access liquidity where liquidity is to be had. And the problem
of being subject to trade through rules and such, where you
have to go outside and access liquidity over the ITS systems
against other market centers, that can take up to a minute to
respond to those outbound orders.
Mr. Stearns. Mr. O'Hara shows this graph of Enron trading
and showing how ECNs stepped up to the plate. And then actually
when the markets came on board, they used as a reference plane
the actual trading values of Enron to establish a base from
which to work. So, would the market take care of itself? Are
you saying to us, Mr. Bang, that you expect to let the market
eventually decentralize this, or are you looking toward some
kind of outside influence, either policy from the government or
policy de facto, but never regulated by the SEC or somebody, to
provide what you have indicated is a monopoly--to open it up to
more competition, which in the end would mean if we had a
calamitous September 11 again, there would be more redundancy?
Mr. Bang. Yes, I believe that is an accurate statement. You
know, just as the rule 390 was done away with, it gave--opened
up a certain element of competition for printing the New York
Stock Exchange list of securities off other exchanges, and that
was a good development, likewise I would say if ECNs have the
ability to represent their investors' and clients' interest in
the national, quote montage, that additional transparency would
create, you know, liquidity to the national market system and
would provide alternative venues to trade away from, which Ms.
Kinney talked about, a central hub.
Currently we have, you know, very high centralization for
the New York Stock Exchange list of securities on the exchange,
that central hub. I think it would behoove the industry to have
more than one hub or alternative hubs with subsequent spokes
into them. And ECN certainly is a venue that is well suited to
fulfill that.
Mr. Stearns. I think my time has expired.
The gentleman from New York.
Mr. Towns. Thank you, Mr. Chairman.
Ms. Kinney, would you please respond to the points that Mr.
Bang made about access to the New York Stock Exchange system?
Ms. Kinney. Well, I think he pointed out that he has access
to our systems through the NASDAQ intermarket system, but he
also pointed out that the ECNs are unwilling to conform to one
of the principles of ITS, which is price protection for
customers' orders, and as such, they have been precluded from
participating.
We think that price protection is one of the foundations
and hallmarks of the national market system, that a customer is
entitled to the best price wherever it exists, and if an order
arrives in a certain venue, any one of these, including our
own, and there is a better price elsewhere, the customer should
be protected at that price.
Mr. O'Hara. If I may just clarify the record, Archipelago
does today--is the only ECN to access the New York Stock
Exchange through our friends here at NASDAQ through ITSKs. We
have a different customer base than others, but they have told
us that they want access through ITSKs, and we access New York
through ITSK as well as their proprietary DOT line as well. So
the fact is that our customers are happy with it, and we give
them that service.
Mr. Andresen. I just wanted to thank you, Congressman
Towns. From Island's perspective our customers are, as Mr.
O'Hara pointed out, a different group of customers who have a
different value proposition that they value.
On point--in addition to your point, Mr. Chairman, there is
a difference between what people see on ECNs and what people
see in the national quote. If it is--we are trading in a NASDAQ
stock, say Intel, and Island has the best price, if someone
goes to NASDAQ and says, hey, NASDAQ, where is the best price
in Intel, they will see Island's quotes. However, if the best
price is queried for QQQ or for IBM, ECNs right now are not
permitted to show their quotes in the national quotes.
Now, Island distributes all of its market data for free
over the Internet to make sure investors still have access to
this information, but there is a difference between what is
actually happening and what has received the stamp of the
national market system.
Island does have issues with the intermarket trading
system. Specifically our view is that our marketplace and
liquidity we have built are significantly new traders doing new
trades, and they rely on the speed and reliability and cost
that Island gives. I think a great analogy to ITS is I used to
be--Mr. Towns, you will be pleased to know that I did move back
to New York from New Jersey. I couldn't stay away. But I used
to drive through the Holland Tunnel every morning. Every
morning I get up there, at first I had to go to the full-
service lane because I didn't have EZ Pass, so I had to get my
4 bucks out and have to pay. It took forever. So I got an EZ
Pass, and I was able to shoot right through. EZ Pass was worth
a lot to me because I was able to get to work like a half an
hour earlier.
What ITS does is basically says, well, Island, if you would
like to open up an EZ Pass booth here and transact
electronically, that is great, but you can't allow anyone to go
through your gate until the guy on the other end of the line,
the full-service lines, breaks his $100 bill. You have sort of
allowed competition in allowing us to transact electronically,
but you slowed Island down to being no faster than the slowest
other toll lane. And I think as Wick Simmons pointed out in his
letter to Harvey Pitt, these trades will not move back
somewhere else if Island has to slow down. They will simply
disappear or move offshore.
Mr. Bang. If I may add, since the advent of
decimalization----
Mr. Towns. Go ahead. I want to come back to Ms. Kinney.
Then I will go to you.
Ms. Kinney. I think that Matt makes a point about his
customer base. I think that Matt's and Island's sole value
proposition is speed, and the markets that are linked have a
responsibility to provide price protection to their customers.
The fact that the value proposition is exclusively speed, his
customers enter that market knowing what the value proposition
is, pursue it, and receive it. And it is not conceivable to me
to understand how in--and he cites in his own testimony about
the QQQ, they have a significant market share there. The value
proposition has obviously worked in that model. And we continue
to compete with them in that product, but we are offering the
best price at the lowest spread with price protection.
So, again, it is going to be customers choosing among the
markets, but there have to be fundamental and underlying value
propositions for each of us, and customers are choosing those
very freely today in the market, whether it is in Enron or in
the QQQ.
So I think the markets are very accessible at the moment.
Information is available, and customers are taking advantage of
the models they were pursuing.
Mr. Towns. I thought I would get a little extra time being
I am from New York. Thank you, Mr. Chairman.
Mr. Bang. It is exactly that choice that we are advocates
of. And we believe that it would behoove industry to provide
that choice, the true choice for investors, and the way to do
that is to give--I would say, one way to give it is to provide
ECNs direct access into national quotes. The trade-through
issues are much less of an issue today as we are in a
decimalized environment than it was prior to decimalization. We
were describing different increments. A penny here and penny
there is a small price to give up for the certainty of
accessing a certain pool of liquidity or a given price,and we
believe that investors should have that choice and be able to
make that decision.
Mr. O'Hara. And just to confirm, I think, what you are
hearing here is a marketplace right here, is that different
customer bases want different services, and that through
competition companies should be allowed to provide it. And I
think from a congressional standpoint or from a regulator
standpoint at the SEC is as long as policies are established
that allow competition to grow within a certain structure, that
you are exactly hearing the marketplace here: Different
customers want different things. Some want ITS access, some
don't.
I think if we allow things to evolve as they currently are,
we will find the solutions that I think we are looking for at
this hearing today.
Mr. Towns. Thank you, Mr. Chairman.
Mr. Stearns. Sure.
I would say we probably have a second round here. Mr.
Shimkus.
Mr. Shimkus. Thank you, Mr. Chairman.
I want to kind of go back and focus on the two hats that I
wear with respect to my telecommunications hat and, of course,
as the consumer protection issue. I was able to during the last
trip get some pictures. I know you all can't see them, but you
all will recognize some of them. This is 140 West and building
7, about three stories high of rubble up against there. I will
share these with my colleagues. This is 140 West, rubble almost
four stories high. These are the windows that got impaled--you
can see that is probably a 20-foot by 20-foot hole in 140
West--by the beams that shot across.
This is the one I really want--there is a couple that I
really want to--I didn't have all of them, but this is one of
the switching rooms in 140 West. If you can look closely, here
they are, the cabinets one of the switching rooms. Now, this is
of the basement of 140 West, all these cables. And with the
chairman, we walked down there, and it was--they are still
trying to dry it out with fans down there. You can see the
multitude of cables, such that what they had to do was they
brought the cables outside the building seven stories high into
a window. That is the effort that was made. Here are some good
workers hand-twining the little phone lines, millions.
My question is--the question that I am posing is--goes back
to a debate that we have here in Washington on the telecom
side, which is regional Bell operating companies versus
competitive local exchanges. Fun, huh? This whole facility, 140
West, is operated by a regional Bell operating company, an RBOC
as we call it in the vernacular, versus a CLEC which has the
ability to be there. The difference is this 20-some-odd-story
building with all that infrastructure versus a CLEC being one
or two of these cabinets.
In the event of another major catastrophe, who do you think
is better able to respond in a timely manner, an RBOC with
vested interest in infrastructure or the competitive local
exchange? And how do we look beyond there to make sure that we
have the capacity to meet major infrastructure needs? And I
will just throw it open to those who want to dare walk into
this mire.
Mr. O'Hara. Well, I certainly don't pretend to be an expert
on RBOCs and the CLECs, although I have obviously read some
things about it. I think what you can take from our industry to
that is as long as there is open, free competition, you know,
and a level playing field, I think you will find, you know,
through literally thousands of years of history now that you
will get to the place that you want to be, and that is the most
efficient, you know, price, best service, that type of thing.
You know, in our industry that is where our Archipelago
and, I know, some of my colleagues come from. As long as there
is a fair regulatory and level playing field, let's have it,
and in the end consumers and investors will win. I would
assume, given the hundreds of thousands of years of history of
competition since the history of capitalism, as to your
specific question, that is where you would end up if you had
that type of a level playing field.
Mr. Steinmetz. I think what your question really
underscores is an interesting connectional bridge between some
of the market structure issues that were discussed here today
as well as the technological issues that we know existed. And
if we step back and sort of bridge those two and combine them,
we actually will be able to determine that the best way to do
it is to have a broader networking communications area as
opposed to one centralized area.
Now, whether those things include exchange floors or
whether they include ECNs, it is possible to include all of
them in a general market structure. But if we can, going
forward, not necessarily rely on either one of those solutions,
but rather rely on a joint solution of multiple players that
can interconnect better, then we would have the backup systems
and redundancy and contingency plans necessary to exist in any
other catastrophe that might come our way.
Mr. Randich. I think the lesson learned in those
photographs is you can't put all your eggs in one basket. We as
enterprises need to take the opportunity to ensure that we have
diversity, diverse connections to our customers, and the only
way we can do that is if we have a number of valid choices, and
those choices range between the local access carriers, the
long-haul carriers, as well as the RBOCs. NASDAQ uses all three
of those types of carriers to provide that diversity
nationwide.
Mr. Shimkus. Do you think it also makes a statement--and I
have no real agenda here, but I am just trying to debate for
your industry--you need to have secure lines of communication,
and in essence our eggs are in one basket. If there is
diversification, doesn't it argue that CLECs ought to be a
little more infrastructure-independent instead of reliant?
Mr. O'Hara. I think you have us puzzled there.
Mr. Shimkus. Infrastructure-independent means one cabinet
versus a 20-story building.
Mr. O'Hara. I would underscore what Mr. Randich said, that
you can't have all your eggs in one basket as long as you have
a level playing field so they can compete, and not knowing what
the CLECs--you know, what their long regulatory structure looks
like, as long as they have the ability to raise capital, if
they have a good idea and build that infrastructure, and there
are no impediments, I think it will take care of itself.
Mr. Bang. I would like to add to that we learned that our
dependency on the West Street telecommunication hub for all of
us was clearly too large, and for our customers. And I think
that each one of us have, you know, taken measures to decrease
that dependency, and so have our customers. But we probably
didn't realize quite how large our dependency was in that
particular area, and that is something that we have to be
cognizant of.
Mr. Stearns. The gentleman's time has expired.
Mr. Shimkus. If I could say this is one of the first times
that I have been able to throw out acronyms that may have
befuddled the panel, so this is a big victory for me.
Just to close, I want to welcome Mr. O'Hara, who is from
Chicago, Illinois, a great State, and also appreciate your work
in the Eastern bloc countries, Lithuania, and trying to work on
their entry into NATO. I know you spent time on that effort.
Mr. Stearns. Mr. Deal, gentleman from Georgia.
Mr. Deal. Thank you, Mr. Chairman.
During the discussion of this, the ECNs and the Internet
have been compared, and as you may know, this committee is
constantly wrestling with the issue of data integrity and
security issues as it relates to the Internet. And I would like
to ask the ECNs if there is a concern or an issue with regard
to data integrity within your systems, and if so, what are you
doing to allay those concerns?
Mr. Andresen. At Island we have the advantage in our
business model and the business model of most of the people up
here, unlike the Internet which is eventually giving access to
everybody, we are giving access to a select number of
professional brokerage firms. Island has about 700 different
brokerage firms connected to us. The way they connect to us is
either through a frame relay from MCI or AT&T or through a
direct point-to-point line. Because of this, because it is a
small universe of actual users, although an immense amount of
data, it is much easier to control our problems than it would
be for, you know, eBay or Amazon to control theirs. So that is
an innate advantage to our business model.
Our biggest concern on data integrity is something that Mr.
Steinmetz from Instinet brought up earlier, and that is the
importance of anonymity. The most important thing that we can
do for the integrity of our marketplace is information about
who bought what where is not available in an asymmetric
fashion, so Island gives out all of its market data for free
over the Internet in real time; every piece of information,
that is, except who it is.
I remember when I was trading, and any time Goldman Sachs
made a low offer on my stock, I got a terrible feeling in the
pit of my stomach. If I saw a low offer on Instinet, I was--I
wondered whether it was Goldman, but I could never know. That
is better for Goldman, that is better for me, and that is
better if it happens to be my mom trading the stocks as well.
Mr. Deal. Anyone else?
Mr. Steinmetz. We have dealt with the security issues on
several levels. The first is a simple encryption level on the
base level making sure that it is secure, as well as
certifications on the terminal-by-terminal level to assure
that, again, there is further security depending upon what
customer connects where. So certain customers would like
certain levels of security, and they can settle with the
encryption on the base level. Others require something a little
further and therefore get the certification on the higher
level.
In either case, though, the Internet technology has not
caused a slowdown in the connectivity, which is crucial. As has
been mentioned on this panel already, speed of customers
interacting with the market is essential toward better
execution.
With that in mind, as long as we can assure the security,
and the Internet allows that, and still provide the speed, then
we shouldn't have much of the problems in the security area
using the Internet.
Mr. Deal. Mr. O'Hara, you may be from Chicago, but thanks
to Margaret Mitchell, that is a good Georgia name as well.
I would like to ask you, you say that the linkages between
the electronic facilities could have allowed trading to occur
after September 11 at an earlier timeframe. You posed the
question as to whether the industry is prepared to move to a
decentralized model. I would like to ask you if you would
elaborate on what is preventing the industry from moving to a
decentralized model, and what are the disadvantages of moving
to a decentralized model, if any?
Mr. O'Hara. I know our friends at the New York Stock
Exchange would differ with us as to the latter part of your
question, but as to the former, I think we certainly have over
the last 10 years, especially the last 5 years, moved rather
quickly toward decentralization in large part. We have a lot of
work to do yet and a lot of wood to cut, but in large part,
because of some of the people here and others that aren't here,
NASDAQ, through the order handling rules, the SEC opening up
NASDAQ to ECNs, that in large part--creating many networks
within NASDAQ, that has allowed us to decentralize in part.
Also, just technology is at a place today where--for
instance, where Island or REDIBook and Bloomberg--for instance,
we have proprietary lines that we put in between each other,
not government-mandated, the SEC hasn't told us to do that, but
we have on our own said our customers want this, so we have
done that. In the current environment, given the regulatory
environment allowing this to happen, and second, given that
technology is where it is today--this couldn't have happened
most likely 15, 20 years ago, especially predevolution of
AT&T--because technology is where it is today, it has allowed
decentralization to occur.
Now, you ask the question on the down side there are some
who argue, and I am not sure if Ms. Kinney is going to argue
this point, but that all orders should be brought to one
location. So, in other words, the deepest pool of liquidity is
where people will get best price or price improvement or that
type of thing. The SEC floated that idea with a central limit
order back with NASDAQ, and I think everyone from alpha to
omega said that is not a good idea, that you don't want to
bring all your orders to one place in part because of what we
learned from September 11.
What we can do and what actually exists in part today is to
have a network of virtual--a virtual world where everyone is
talking to each other, we are talking to Island, we are talking
to the New York Stock Exchange, and customers can access prices
at different places as we compete against each other, although
we are all connected to each other.
So the upshot is we are working toward it. I think we are
partially there, but we have some wood to cut toward getting
there.
Mr. Deal. I assume you are saying since you are virtually
unregulated by the government, you don't need our help in
moving that direction.
Mr. O'Hara. We are certainly--I see my friends at the SEC
over there--we are very much regulated by the government, and
we should be, quite frankly. But the fact is, and I think is a
real credit to the SEC, that over the last 5 years they have
allowed a lot of competition, they have taken some chances,
rational chances, and I think in the end people are seeing
results and cheaper, more efficient services for customers and
investors.
Mr. Stearns. The gentleman's time has expired.
Mr. Deal. Could I ask unanimous consent for Ms. Kinney to
respond to the question?
Mr. Stearns. Sure.
Ms. Kinney. The market models today and the New York Stock
Exchange has a lot of competition. We certainly open every
morning and have every regional exchange, NASDAQ, all the ECNs
competing with us very aggressively, as you can hear from all
of these testimonies. ECNs represent only 3 percent of the
trading volume on the New York Stock Exchange, and you contrast
that to the kind of activity that you see in the NASDAQ model
where ECNs may be as much as 30 to 40 percent of the activity
in Microsoft, for example.
So the marketplace and the structures exist for the
competition to occur. I would like to think that the New York
Stock Exchange innovates very aggressively to compete. We have
been successful there. We do believe that some centralization
of the orders flow does provide the best prices.
That said, we have to constantly be alert to those that are
appearing today so that we are providing the kinds of services
that customers want. At the end of the day, if they don't want
what we are providing, they are going to send the order to Matt
Andresen or to Mr. O'Hara or to anybody here and get an
execution from them.
So the New York Stock Exchange will compete. I think I am
happy to report that so far, so good. But we are very alert.
These are competitors we have a lot of respect for.
Mr. Deal. Thank you, Mr. Chairman.
Mr. Stearns. The gentleman from Arizona.
Mr. Shadegg. Thank you, Mr. Chairman. I commend you for
holding this hearing. I appreciate the unanimous consent to
file my opening statement since I was a little late.
Mr. Stearns. So ordered.
Mr. Shadegg. Many of you have focused on the benefits of an
Internet packet switched network system over a traditional
circuit switch system. I guess I would like to kind of go the
next step and ask you if you would comment on or elucidate us
on what kind of challenges you think we need to think about to
such a system given the possible threat of a cyberterrorist
attack as opposed to a physical attack like the one we
experienced on September 11.
Ms. Kinney. I don't know that we would be supporting
necessarily an Internet kind of connectivity. I think that Matt
made the point, which we would agree completely with, and that
is we are fortunate in that we can invite into the marketplace
our members, those that have qualified and have certain
requirements for capital, knowing their customers, and a
variety of other regulatory requirements that at least make
them on some level known to us.
The New York Stock Exchange operates a private network
among its members and therefore is protected in many ways from
the security issues Mr. Deal questioned. And, in fact,
following September 11, a number of the member firms have asked
the Exchange, the Securities Industry Automation Corporation
and, I think, others on this panel to be part of that
discussion, to have for our industry a very private network
that could be insulated in some way from some of the things
that we experienced on September 11.
I think many of our customers, many member firms, were
mistaken when they thought if they bought from two carriers a
service, that would be protecting them, one as a primary, one
as a backup. They sadly learned that some of those were running
through the exact same channels or cable.
So I think that the question here is not to invite more
opportunity and less security, but how do we provide that
access at a very low cost with the assurances and with the
redundancy that we all rely on in our industry.
Mr. Andresen. I think the one positive thing we looked at
in lower Manhattan Island is that our conversations with our
subscribers about the importance of backup connectivity are
much different today than they were in August. And Island has
two data centers. They are two hot data centers, so they both
link with the primary data center, but it only works for all of
our customers, just like Cathy was saying in the New York Stock
Exchange's case, if people are actually able to be physically
connected. All of our subscribers were connected in New York,
and about half were connected to our New Jersey data centers.
Now all of the people are connected.
I think the one very good thing, as I said, that has come
out of this is that all the brokerage firms, all of the
institutions are now painfully aware of what a point of failure
truly is; that you need redundant geography, redundant
connectivity in terms of carriers, and redundant lines, and you
better have redundant hardware as well. It has to be tested, it
has to be stressed.
Mr. O'Hara. If I may add, the SEC has changes through its
automated review process audit. It has very high standards in
ECNs as well. They are contemplated in part--they are ARP'd
today, as they say. The SEC, I know, is discussing whether to
have full ARP compliance by ECNs as well. What ARP does is make
you think about that exact issue, and you have to meet that
standard. So from a regulatory standpoint it is covered, and
exchanges and ECNs to an extent, and probably the fullest
extent of exchanges will have to meet ARP audit standards of
the SEC.
Mr. Shadegg. Anybody else?
Mr. Andresen, you said that we should eliminate any
barriers that inhibit fair competition between electronic and
traditional markets. Can you expand on that a little bit and
elaborate?
Mr. Andresen. Yes sir. Right now, as Ms. Kinney pointed
out, ECNs are very--have been very successful in trading a lot
of--conducting a lot of business in stocks. We have not been
successful doing it in New York. I think that most of that
credit has to go to the New York Stock Exchange. They are the
preeminent price discovery marketplace in the world.
However, in some ways Island feels that we are still
competing with one hand tied behind our back. That is, when
someone looks to see who has the best price in IBM, the
investor who goes on to their Schwab account or goes onto Yahoo
Finance to get their stock quotes doesn't see Island's price
included, and that is, in my mind, one of the barriers to
competition is that some marketplaces prices are treated as
more legitimate than others, when, in fact, the legitimacy
comes down to which one is faster, more reliable, more
accountable, cheaper and has a greater certainty of execution.
So as I have said earlier, Island actually takes all of our
information and gives it out over the Internet for free.
Unfortunately, while most professionals see that, and maybe a
lot of investors do, when you go and ask where the best price
is, you don't see it.
I think it is analogous to a shopping mall. If you go to
the shopping mall, you walk in, and you are like me, you like
to get out of there fast. You go right to the map at the front.
It tells you the men's shoes, B-6, and you go there and you get
something to eat and you are out of there. The national market
system provides such a map. It tells you where the best price
is. Unfortunately, right now Island is treated like, you know,
a Burlington Coat Factory across the highway. We hope that
people, after they are done shopping, go over there and check
us out on their way home. That quasi legitimacy that being in
that shopping mall affords, and not having that is a
significant competitive disadvantage for us.
Mr. Stearns. The gentleman's time has expired.
The gentleman from Massachusetts Mr. Markey.
Mr. Markey. Thank you, Mr. Chairman very much. And thank
you for holding this very, very important hearing.
In a November 14th speech, Peter Vinella, the CEO of PVA
International, a Wall Street consulting firm, identified a
number of vulnerabilities in the U.S. financial system to a
terrorist attack. I would like to walk the panel through three
that he highlighted and get your reaction.
Mr. Vinella said, quote, the financial--the U.S. financial
system is vulnerable to a number of types of deliberate
terrorist attacks. Here are three of the most obvious. No. 1,
terrorists could destroy the major telephone switching stations
in Midtown and downtown New York. Most of the financial system
interacts over a network of dedicated point-to-point phone
lines leased by individual firms. Nearly all electronic
communications, even dedicated lease lines, use public phone
company services and infrastructure. The destruction of a
single Verizon switching station near the Trade Center
disrupted electronic communications in Manhattan for weeks.
Two, terrorists could place erroneous activity into the
financial system. Most electronic trading systems are designed
to prevent access by people unauthorized to trade, but nothing
prevents a terrorist with the appropriate authorization from
sowing enormous confusion in the financial markets. The New
York Stock Exchange direct order turnaround trading system, the
DOT system, is particularly vulnerable. The New York Stock
Exchange members commonly allow their large institutional
clients to direct their orders directly to the floor by way of
the DOT system. From the New York Stock Exchange point of view,
any traffic coming from the member firm is authorized activity.
Although member firms are responsible for all activity on the
line, they do not monitor their clients' DOT lines and assume
that all the traffic on the line is authorized by their
clients. A single terrorist working at an institutional client
with access to the DOT line could send a high volume of
convincingly realistic orders that would trigger a major sell-
off. All he would need to do is simply access a trading
terminal and a simple password or two.
And three, terrorists could destroy both the primary and
disaster recovery sites of major financial institutions. The
disaster recovery location of most firms is public knowledge.
It wouldn't be difficult to place a truck bomb in New York and
in a site in New Jersey.
So I would like to ask our witnesses to deal with this
question and begin with you, Ms. Kinney, if we could.
Ms. Kinney. Since we all can hope to be in business for a
long time to come, we will have to address all of these issues.
Let me just start with the issue of the telecommunication and
switching system. As I said earlier, the Exchange has developed
private networks to access and to have a communication with its
member firms. So we continue to look at that as a model and
perhaps extend that model further, and also to continue to use
other sources of connectivity other than simply lease lines or
lines--dedicated lines, perhaps even using both virtual private
networks as well as the Internet.
So I think to the point, Mr. Markey, that was made here
earlier, we all understand the importance of connectivity. We
all understand the importance of redundancy, and we all have
been--have brought all of that back and fresh and looking at it
again to make sure that we can ensure and give confidence to
investors that we are going to be there and able to trade, so
that all of that that we have done that has worked well we will
continue, and that which we found to be an area that could be
improved subsequent to September 11 and even to these points is
being addressed.
With respect to the activity or unauthorized activity, I
would say two things. One is the member firms, when they
introduce orders to the New York Stock Exchange, they do have
all of those orders coming through their infrastructure today.
They are responsible for that order flow. Many of them do
actually monitor that. And the Exchange will be putting in some
services over time so that the firms can monitor the order flow
and the commitment of capital or guarantees that the member
firms have extended to those institutions more aggressively. We
think that because of this connection, this private connection,
between the firms and the Exchange, and the knowledge that the
firms have to maintain with who are their customers, and the
fact that these orders are going through their infrastructure
before they get to our infrastructure, that together from a
regulatory perspective we at least will be alert to who our
customers are.
That said, I think all of the points that have been raised
here certainly are under way and are being addressed by all of
us to ensure that we don't have circumstances where
unauthorized people are accessing our systems.
And I would say, last but not least, primary and backup
services particularly for data sites are being evaluated by all
of us. I think you probably are aware and have visited both of
our data sites, many of you have. They are about a mile and a
half apart as the crow flies. So all of those things are under
discussion right now as to whether the Exchange moves to a
third or move one of its data sites to a more desirable
geographic location.
So that said, all of these things I think very much came
out of our experience on September 11. Many of them have been
addressed, and many will continue.
Mr. Markey. Can I ask you this question, because it is
raised by Verizon, which has been making the case that it is
really better to have one big monopoly there rather than having
competitors there as alternative networks that could be used.
What happened to you on that day and subsequent days? Was it
helpful to have alternative networks that could be used in
addition to Verizon, or would it have been better if just one
company, the monopoly as Verizon was saying, is there?
Ms. Kinney. It didn't matter what might have happened or
what might have been better. I think all of us had the
experience of relying on Verizon. So we face the challenge of
having to work with them to get our customers reestablished in
either their new locations or the current locations that were
affected.
Mr. Markey. But it does matter prospectively. Are you
better having one network, or would you prefer to have
redundant networks there so that you didn't have to be
dependent just on one company, but there would be alternative
ways to get business done?
Ms. Kinney. It seems to me that Verizon has central offices
located around the New York City area. I think this is more a
question of making sure that everybody has redundancies within,
you know, the New York City locations that are not as
vulnerable perhaps as what was experienced.
I think, Mr. Markey, also one of the things I said earlier
that we all learned was that even if I thought I had Verizon as
a primary and MCI as a backup, lots of cables have not been
pulled in New York City for a very long time. So we all find
ourselves, like it or not, with an issue that has to be
addressed. We are reliant on their services.
Mr. Markey. I know you are today, but we are also the
telecommunications committee, so from my perspective I have
always believed that if you had many competitors each
providing, you know, service, that if one went down because
their location was hit, then could you move the system,
basically the economic system of the country, over to others if
the New York Stock Exchange is vital in terms of the entire
competent functioning. So philosophically would you prefer to
have multiple networks or just one in terms of the
vulnerability?
Ms. Kinney. I don't think we have one network. I think you
have heard everybody talk about the fact that there are a
variety of points, a variety of execution models. We all have--
--
Mr. Markey. So you prefer to have multiple networks.
Ms. Kinney. We have multiple data sites today. We have two
active data sites that support the New York Stock Exchange. I
think that where we feel strongly about centralization, leaving
the telecommunications side aside for a moment, is that
bringing lots of buyers and sellers together in a single point
provides benefits for the price discovery model, provides,
certainly for us, benefits in terms of information flow. It
certainly provides benefits to us in terms of regulation. So we
feel very strongly about that.
Back to your other point, I think we will all be searching
for ways to insulate ourselves from whatever vulnerabilities or
difficulties we experienced on September 11, and we will be
looking for providers who do that. Verizon will have to comport
with that along with all the other providers of service that
exist.
Mr. O'Hara. Congressman Markey, can I answer your question?
Yes.
Mr. Markey. Yes, you want redundancy. That is all I am
looking for.
Let's go down. Yes or no, do you want redundancy; yes or
not?
Ms. Kinney. Yes, of course. We have to.
Mr. Markey. First man, could you say yes or no?
Mr. Steinmetz. Yes.
Mr. Andresen. Yes.
Ms. Kinney. Yes.
Mr. O'Hara. Yes.
Mr. Bang. Yes.
Mr. Randich. Yes.
Mr. Jamaitis. Absolutely, yes.
Mr. Stearns. The gentleman's time has expired. We are going
to do a second round, so he is welcome to ask his questions----
Mr. Markey. It is a yes or no for this question, so it
would take no more than 10 seconds, then I could finish up. Do
you believe that the institutions that use the DOT currently
have appropriate internal controls to address the problems of a
terrorist using the DOT to trigger a sell-off?
Mr. Steinmetz. That actually depends what system they are
using. It is not a simple yes or no answer.
Mr. Markey. Maybe yes? More yes or no?
Mr. Steinmetz. I could give a maybe on that.
Mr. Andresen. I will give a Washington answer. I don't have
an idea about their system.
Mr. Markey. Good.
Ms. Kinney. It doesn't--terrorists are not----
Mr. Stearns. Could you talk into the mike?
Ms. Kinney. The terrorist issue is not the issue. Today
every single day everybody shows up and enters orders into the
systems and think that the controls are there. Certainly
September 11 heightened all of our----
Mr. Markey. So you think the controls are there. So you
don't believe that institutions are vulnerable to this kind of
attack?
Ms. Kinney. I think that institutions will need to be more
alert, but----
Mr. Markey. You don't think they are vulnerable.
Ms. Kinney. We face these issues every single day.
Mr. Bang. We employ risk management systems, so for the
most part we are protected against this.
Mr. Markey. You are protected.
Mr. O'Hara. Yes.
Then I would confirm the same thing with us. Again, I will
point back before you came in Congressman, we talked about the
ARP review that is an audit done by the SEC. This is picked up
by it; that if they need to tweak that, maybe that is a place
to start.
Mr. Markey. Are more safeguards needed?
Mr. O'Hara. I defer to the SEC. They do come in and audit
these types of things.
Mr. Markey. The SEC did not believe there was a problem
with program trading in the summer of 1987. They all testified
here, every one of the exchanges in the SEC, we have safeguards
in place. So this is going to be the hearing, by the way, if
anything happens in the future, you are all saying, no problem.
So just so you know, they all said no problem, which got them
in a lot of problems 3 months later. No problems, they all
said. So you are on record now for this issue the way they were
for program trading.
Mr. Randich.
Mr. Randich. NASDAQ uses real-time surveillance systems for
this purpose and others, but we need to be continuously
cautious.
Mr. Markey. Mr. Jamaitis.
Mr. Jamaitis. Any safeguards would be very system-
dependent, so it is not a simple yes or no. As technology
improved our ability to detect these type of things----
Mr. Markey. Does every institution have the internal
controls necessary to make sure there can't be an attack? Do
you agree that they do or don't?
Mr. Jamaitis. I agree there is probably room for
improvement.
Mr. Markey. Do you know institutions that do not have
controls that are sufficient to protect against it?
Mr. Jamaitis. No.
Mr. Markey. That is all good news to us that terrorists
cannot really get through the system.
Mr. Stearns. We will have a second round. We would like to
have your questions. Let me open up. I will just take a short
amount of time.
Ms. Kinney had mentioned that the ECNs are only about 3
percent of the New York Stock Exchange. And let me ask Mr.
Randich, what percent is ECN of NASDAQ?
Mr. Randich. Thirty-five to 40 percent.
Mr. Stearns. So they are 40 percent. Now, why is it 40
percent with the NASDAQ, but only 3 percent of the New York
Stock Exchange?
Mr. Randich. I can speak for NASDAQ as NASDAQ has a very
open democrat architecture. We allow free access to many
participants, and the ECNs have thrived in that environment.
Mr. Stearns. So most of the ECNs were started in the late
1990's, 1996. So in that short amount of time, they have gotten
40 percent of the business of NASDAQ, but they are only stuck
at 3 percent at the New York Stock Exchange. So, Mr. O'Hara,
what is your comment why?
Mr. O'Hara. I think if you refer back to our testimony and
others at a data hearing, it is fairly--there is a primary
answer, and then there are some side answers. But the primary
answer is that there are legal and regulatory hurdles, some
large, some have come down a little bit, for ECNs to compete in
listed----
Mr. Stearns. With the New York Stock Exchange, but they are
not with NASDAQ.
Mr. O'Hara. That is correct.
Mr. Stearns. So all these regulatory hurdles are difficult
for you to do business on the New York Stock Exchange.
Mr. O'Hara. We have found it that way. Now we are
graduating to Exchange status ourselves and would certainly
like to change the clubby atmosphere that we call a fraternity
house. There are certain blackballs, who is allowed in and who
gets paddled for doing bad things.
Mr. Stearns. So you are saying that the New York Stock
Exchange is a fraternity with blackballs?
Mr. O'Hara. No. I am saying that the national market
assists the committees, the ITS committee and CTA, and we have
had our battles there. If one--I believe there is eight or nine
people on that. If one of them doesn't like the way you look
that day, they pull out blackball, just the fraternity house,
and you are done.
Mr. Stearns. Would you put into our record a letter
outlining what you think the regulatory hurdles are?
Mr. O'Hara. I certainly would. Thank you.
Mr. Stearns. Ms. Kinney, obviously, you would like to
respond to that?
Ms. Kinney. I don't know about fraternities, but----
Mr. Stearns. I think being a fraternity might not be the
right word.
Ms. Kinney. I think the New York Stock Exchange provides a
platform for competition. I keep referring to the chart to the
left that was brought by the same gentleman who said that the
barriers are high. I would say that all of these market models
are free to compete with the New York Stock Exchange every day.
Mr. Stearns. Last year, the Subcommittee Chairman of
Finance and Hazardous Materials wrote to the SEC on an issue
that seemed to affect the ECNs. I mentioned that in my opening
statement. What I would like to do is have someone explain to
me what the Consolidated Tape Association, or CTA, is. And just
maybe the New York Stock Exchange could start; and, Mr.
Steinmetz, you could talk in terms of if you are having access
to the information that is generated by the stock trades and
have the counterpoint to Ms. Kinney--is that possible--that you
could explain what the Consolidated Tape Association, or the
CTA, is?
Ms. Kinney. I will do my best.
Coming out of the 1975 act's amendment, the first priority
was to provide information to the marketplace transparency
about the markets and the bids and offers and trades that were
taking place in those variety of marketplaces or market
centers. So the Consolidated Tape Association was formed as the
first block.
Mr. Stearns. What year was that?
Ms. Kinney. That was in the 1970's. Following--1979, just
following the 1975 act's amendments. It was the first piece,
the intermarket trading system coming just after that.
But, again, it was to provide the marketplaces with an
opportunity to centralize their information to provide a
summarized best bid and offer and to provide the transaction
information that was occurring in the various market centers.
You know, the CTA has operated since that time. Hearings
have been held--in fact, Mr. Seligman, at the direction of the
SEC, held quite a number of--I won't say they were called
hearings but meetings about how to make information, what about
transparency, what about the Consolidated Tape Association, how
to make that information--and those recommendations certainly
have been put into the marketplace over the last several
months.
Mr. Stearns. Mr. Steinmetz, do you think there should be
changes to the CTA? And, if so, what should they be?
Mr. Steinmetz. Well, yes, there probably should be some
changes to the CTA. I think the idea is that market data has
similar issues to the ability to execute trades, and that is
the ability to do it in different places or--as far as
executing trades and as far as delivering the data, it should
be able to be delivered dependent upon the network that
actually has the data. So, for instance, if Instinet has
certain data order flow quotes and orders that could be
displayed, there should be some participation from the
participant who actually has that data and order flow to be
able to get something out of it.
It, like the standard systems in general, should again go
down the whole idea of the network effect rather than the
single point so that there can be access to it and reward from
it from multiple participants and not just one central
location.
Mr. Stearns. Mr. Andresen, do you have any comments on
what, if any, regulatory change should be made to the CTA?
Mr. Andresen. Yes, sir. One thing I want to point out, it
is important to draw distinction between the New York Stock
Exchange and the trading of the New York Stock Exchange listed
stocks. The New York Stock Exchange in itself is not keeping us
down on Broad Street.
What is going on is the New York Stock Exchange lists these
securities. They trade primarily on the New York. New York, as
was outlined here today, does the majority of the trading of
the stock. However, trading is facilitated in other places like
Island and Archipelago and Instinet.
So to continue with my analogy about a shopping mall, it
would just be like having--the New York Stock Exchange is just
like Macy's, the enormous store at the end of the shopping
mall, and there are lots of little stores around it. The
consolidated tape is that shopping mall, takes the prices from
the different market places and right now primarily from the
New York Stock Exchange.
The issue with the consolidated tape in our mind at Island
is that, for us to gain admission into the consolidated tape
and now have our prices in the shopping mall, we then must also
be a part of the intermarket trading system. You know, this, as
I have outlined earlier, would be akin to if someone came in to
buy some orange juice in our store in the shopping mall and
someone had a better advertised price in another part of the
shopping mall, it would be my obligation to grab them and put
them in one of the carts and wheel them down to the other store
and say I can't sell this to you, you have to go somewhere
else.
Nowhere else in our economy--if I go into 7-Eleven to buy a
quart of milk, I do it at 2 in the morning, I don't want 7-
Eleven to send me off to Sam's Club in the boonies which isn't
open for 8 hours, which I have to pay $50 to get in and where
the milk is in five gallon jugs.
So different customers are going to want different
services. I think we have--there is unanimity----
Mr. Stearns. So the interim market trading system is what
really should be addressed, rather than the Consolidated Tape
Association, in your opinion.
Mr. Andresen. That is correct.
Mr. Stearns. And in that area is where we need the reform.
Mr. Andresen. That is correct.
Mr. Stearns. Does anyone disagree or agree with that?
Mr. O'Hara. I think a couple things, a couple historical
markers here. In 1975 Congress, from a law standpoint, called
on the SEC to build these structures. I think it was well
intended and worked well until the days when we are now
competing. These are competitors to primary markets.
The SEC--and I think this is a good education for all--they
held a yearlong committee headed by Dean Joel Seligman and
discussed this issue where all the market centers, including
probably everyone at this table, submitted white papers on this
very issue.
I think--from our standpoint, I think the New York Stock
Exchange actually agreed with this, that the whole idea of
consolidating reflecting sale of market data should be
deregulated. And today it is heavily regulated. It is--there is
a quasi-monopolistic pricing, if you will.
If there is something to be looked at here it is the
deregulation of this conglomeration of national market
committees, i.e., ITS, CTA, and especially, you know, how they
govern, again going back to this one black ball governance
system where, if someone doesn't like you that day, you are
done.
Mr. Stearns. I think my time is up. And now the
distinguished ranking member from New York, who will have his
questions.
Mr. Towns. Thank you very much, Mr. Chairman.
I think earlier--I think it might have been you, Mr. Bang,
that mentioned, in terms of the public policy discussion in
terms of decentralization versus centralization, I noticed that
you sort of came down on the side of decentralization. However,
I would think that the trend would be the centralization with a
back-up system, wouldn't it, in terms of efficiency?
Mr. Bang. No. I would argue that decentralization is a
better redundancy and provides for more competition and
innovation in the long term because the centralization implies
one counter party--one central point of failure and one service
provider, whereas a decentralized marketplace implies multiple
liquidity hubs operated by competing market centers offering
the end investor an alternative destination for trading the
same securities. So I would say decentralization is the
preferable way to go.
Mr. Towns. Ms. Kinney, can I ask you to respond to that as
well?
Let me just say, first of all, before I say that,
congratulations on your being the future president of the
Exchange. It is a great milestone and can only happen in New
York. And also to give you an opportunity to speak a word on
behalf of the sororities.
Ms. Kinney. I think that one of the things that you are
seeing in the marketplace today is a lot of consolidation among
the various participants. I think Mr. O'Hara talked about the
consolidation of Archipelago and REDIBook, and I think all of
us are clearly looking at how to provide efficiency, a very
cost-effective access to our respective models but to do that
in a way that ensures that there is both redundancy as well as
certainty to the customers who choose us. So I think we have to
have--to Mr. Markey's question--redundancy and decentralization
of our data sites and a variety of other things.
That said, I think you are correct in the sense that we
feel that the more centralization for order flow and a variety
of other things the better investors and customers are served.
Mr. Bang. Decentralization of order flow is essentially
achieved today through a virtual network, and the key is to get
these liquidity centers representing their clients' interests
in quote montage. If you have that transparency and it is
disseminated and the connectivity is provided, then essentially
you have a virtual centralization of liquidity, which is better
than a physical centralization of that liquidity.
Mr. Towns. Thank very much, Mr. Chairman.
On that note, I yield back; and I wanted to congratulate
you on having this hearing. I think it is important that we are
able to get this kind of information. And I wanted to let you
know the SEC is in the room.
Mr. Stearns. I thank my distinguished colleague.
Let me conclude the hearing by again complimenting the
exchanges for getting back into business so quickly and the
ECNs for their rapid deployment during this September 11
crisis. As a result of this hearing, there is a lot of perhaps
policy issues that the committee should look at.
I thank you for your participation and hope all of you have
a happy holiday.
[Whereupon, at 12:30 p.m., the subcommittee was adjourned.]

<greek-d>
<greek-d>