[18056]
October 7, 2004
TO: BOARD OF GOVERNORS No. 64-04
CEOS
CLOSED-END INVESTMENT COMPANY MEMBERS No. 67-04
PRIMARY CONTACTS - MEMBER COMPLEX No. 92-04
SEC RULES MEMBERS No. 149-04
SMALL FUNDS MEMBERS No. 110-04
UNIT INVESTMENT TRUST MEMBERS No. 39-04
RE: ICI 2004 EQUITY MARKETS CONFERENCE SPEECHES
On September 23, Institute General Counsel Elizabeth Krentzman, the Securities and
Exchange Commission’s Division of Market Regulation Director Annette L. Nazareth, Nasdaq’s
President and Chief Executive Officer Robert Greifeld, and the New York Stock Exchange’s
Chief Executive Officer John A. Thain spoke at the Institute’s 2004 Equity Markets Conference.*
Their remarks are summarized below.
Remarks by Ms. Krentzman
Ms. Krentzman, who provided the conference’s opening remarks, noted that the mutual
fund industry had reached the first anniversary of the mutual fund scandal and that to sustain
the confidence of investors, the industry “must dedicate itself to fulfilling its obligations as
fiduciaries.” Ms. Krentzman observed that “[a] vigorous and successful compliance program is
an essential part of this proposition.”
Turning to the topic of market regulation, Ms. Krentzman remarked that “a well-
regulated, fair, and efficient securities market” is “vitally important” to the Institute and its
members. She noted that the Institute continues to take an “active role” in the development of
regulatory initiatives that would change the way the securities markets are structured. For
instance, she noted the Institute’s ongoing examination of the effect on mutual funds of the
* A copy of Ms. Krentzman’s opening remarks are available on the Institute’s website at:
http://www.ici.org/statements/remarks/04_emc_krentzman_spch.html#TopOfPage. Ms. Nazareth’s, Mr.
Greifeld’s, and Mr. Thain’s remarks may be found at: http://www.sec.gov/news/speech/spch092304aln.htm,
http://www.nasdaq.com/newsroom/presentations/documents/ICI_speech_Sept2304.pdf, and
http://www.nyse.com/p1021232175378.html?displayPage=http%3A%2F%2Fgoogle.nyse.com%2Fsearch%3Fsite%3
Dnyse%26output%3Dxml_no_dtd%26client%3Dnyse%26proxystylesheet%3Dnyse%26filter%3D0%26restrict%3D%26
getfields%3Ddescription&q=speeches, respectively.
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SEC’s proposed Regulation National Market System (NMS). She also noted the Institute’s
continued promotion of more efficient trading of listed securities on the NYSE, such as the
decision of the new leadership at the Exchange to take the first step towards bringing
automation to the Exchange through their recent hybrid market proposal.
Ms. Krentzman expressed support for Regulation NMS and urged the SEC to focus its
efforts on the “core principals of a national market system – efficiency, competition, price
transparency, and the direct interaction of investor orders.” In closing, Ms. Krentzman
observed that the current debate over market structure affords the SEC the opportunity to
undertake long overdue reforms that would improve the quality of our markets and move us
closer to a “true national market system.”
Remarks by Ms. Nazareth
In her keynote address, Ms. Nazareth noted that the SEC is in the “thick of a rulemaking
process” that could result in some of the most important changes to the U.S. equity market
structure since 1975. Recognizing there have been “dramatic” changes to the markets over the
past several years, Ms. Nazareth remarked that the SEC has determined that the following areas
are “ripe” for review: the ITS trade-through rule, intermarket access requirements, subpenny
quoting, and the allocation of revenues produced by the consolidated data networks.
Before beginning her discussion of the views raised by commenters to Regulation NMS,
Ms. Nazareth reflected upon the comment process generally. In an effort to demonstrate the
challenges the SEC staff faces in assessing opposing views expressed in the comment process,
Ms. Nazareth provided examples of initiatives that have generated significant consternation
over the years, such as the firm quote rule, elimination of fixed commissions, and the Order
Handling Rules. She noted that in Regulation NMS, the SEC seeks to balance the comments
consistent with its guiding principles “to enhance best execution; improve market efficiency;
enhance price discovery; provide competition; encourage display of limit orders; and above all,
do no harm.”
Ms. Nazareth remarked that Regulation NMS comments were perhaps most disparate
with respect to the trade-through rule. She noted that overall the vast majority of commenters
supported the principle of price protection, although they expressed different opinions on the
best way to achieve that goal. For instance, institutional commenters were nearly unanimous in
their strong support for a trade-through rule without an opt-out exception. Other commenters
supported a trade-through rule, but specifically conditioned their support on inclusion of an
opt-out exception. Still other commenters, such as electronic markets and electronic traders, did
not believe that any trade-through rule was necessary.
Ms. Nazareth stated that there was wide support for the concept of allowing
“automated” or “fast” markets to trade through non-automated or “slow” markets. Ms.
Nazareth observed that the intent of the NYSE’s proposed enhancements to its Direct+
automatic execution system (hybrid market proposal), is to position itself to satisfy a trade-
through rule that incorporates the automated vs. manual quote approach, rather than the
automated vs. manual market approach.
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Ms. Nazareth stated her belief that whatever final Regulation NMS rules the SEC may
adopt, “they will signal the [SEC’s] continued belief in a core set of principles, ” such as the
protection of limit orders and the fulfillment of the agency duty of best execution. She indicated
that it is her hope that the SEC will consider Regulation NMS before year-end. In closing, Ms.
Nazareth remarked that it is “an historic moment in market regulation” and the SEC has an
“opportunity to make some pivotal changes that could guide our equity markets into the new
century.”
Remarks by Mr. Greifeld
Mr. Greifeld observed that the goal at Nasdaq is to “facilitate” the broker-dealer
function and to ensure that Nasdaq’s activities never compete with this function. He noted that
Nasdaq’s goal is to “practice the highest standards of public company governance, to provide
effective utility services, to the industry, and bring to the market the innovations that result
from the spirit of competitive capitalism.” With respect to competitive dynamics in the market
data industry, Mr. Greifeld noted that Nasdaq is advocating a “dramatic” reduction in the fees
that investors pay for market data and that as a matter of public policy “let us charge a basic
rate for basic data that is reflective of the current cost of providing such data.”
Mr. Greifeld remarked on Nasdaq’s recent changes to its opening and closing processes.
“The lack of an opening and closing process has always been an area where the Nasdaq market
could be improved.” He stated Nasdaq saw a “great opportunity to improve the Nasdaq
market and leapfrog the opening and closing processes” by studying the role specialists play on
manual floor based markets and how the electronics are utilized in the electronic European
markets. He noted that Nasdaq is “thrilled” with the performance of its closing cross and
eagerly awaits the launch of its opening cross on October 25th.
Turning to Regulation NMS, Mr. Greifeld remarked that Nasdaq spent many hours of
management time formulating its position, but recently realized they had made a
“fundamental” mistake in their consideration of Regulation NMS. He noted that although its
“cerebral” discussions were a success, Nasdaq failed to realize that Regulation NMS is “as much
about practicality as it is about philosophy.” Commenting on a situation that the SEC has
identified as a “false positive,” Mr. Greifeld questioned the practicality of a trade-through rule.
“If the quote update rate on a particular stock is faster than the response time on an order to
trade that stock, [then] the ability of the broker/dealer to avoid a trade though is a matter of
luck.” He noted that it is “impossible to build a fair system of regulation where the violators are
forced by the rule to always violate the rule.” To limit the incidents of false positives, Mr.
Greifeld observed, the SEC may be forced to specify certain parameters regarding how long a
quote must be standing and low long a quote is in the market before that quote is considered
traded through. Such parameters, he noted, may result in a trade-through rule not being
applied to 90% of the trading activity in a given stock. “What would be the benefit of this huge
expenditure when the [trade -through] rule itself would not even apply to a large percentage of
trading activity.” Mr. Greifeld remarked that “[w]e are witnessing the direct intersection of
regulatory initiatives with technology realities of the marketplace.”
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Remarks by Mr. Thain
Mr. Thain began by noting the changes the NYSE has undergone this past year in the
areas of independence, separation of duties, and transparency. With respect to independence
changes, Mr. Thain noted that the NYSE established a smaller and more independent Board of
Directors to replace the old Board, which he viewed as “too big” at 27 members.
In the area of separation of duties, Mr. Thain remarked that the Exchange separated the
chairman and chief executive officer positions as a way of creating “one further check on the
CEO at the board level.” He observed that about a third of U.S. companies have a similar
structure. Mr. Thain also remarked that the NYSE separated the regulatory function from the
business operations of the Exchange. He explained that he runs the business of the NYSE and
Rick Ketchum runs the regulatory function and reports directly to a subcommittee of the board.
The third way that the NYSE separated responsibilities, Mr. Thain noted, was between the
Board of Directors and the Board of Executives. Mr. Thain explained that the new Board of
Executives consists of representatives from the NYSE’s constituent populations, such as listed
companies, member firms, lessor firms, various buy side representatives, and individual
shareholder representatives.
With respect to transparency, Mr. Thain observed that the Exchange now provides
“public-company type disclosure, “ in its annual report, such as “real financials” with “real
footnotes” and the compensation of the top five officers.
Mr. Thain next discussed the NYSE’s hybrid market proposal. He noted that the NYSE
has much lower volatility in the trading of its listed company stocks compared to electronic
markets and lower transaction costs in the trading of its company stocks. Mr. Thain
acknowledged, however, that the NYSE is not fast. “It takes longer, on average, to trade on the
stock exchange than it does on an electronic market.” He indicated that the Exchange’s
customer base, particularly the buy side, has not liked the fact that the Exchange cannot trade
electronically, instantaneously and anonymously. In an effort to be more customer-sensitive,
Mr. Thain remarked that the NYSE has recently filed three rule changes with the SEC, including
the hybrid market proposal. In response to suggestions that the NYSE become more like an
ECN, he noted that the NYSE does not want to be an ECN. “There are things that are better on
the [NYSE]; our opens and closes are better[,] how we deal with order imbalances, how we deal
with unusual events.” Mr. Thain emphasized that any changes made to the Exchange should
keep what is good about the Exchange but still give customers a choice, such as the ability to
execute against the best bid and the best offer electronically, instantaneously and anonymously.
He noted that the NYSE’s goal is to be electronically accessible “virtually” all of the time. “[I]t’s
not going to be electronically accessible all the time because that’s bad for the marketplace.” He
explained, for example, that the Exchange wants to continue handling big order imbalances
manually, on the floor, with the specialists.
Mr. Thain next observed that the Intermarket Trading System does not work. As
support for this, he explained that the Exchange recently conducted a two-week experiment in
three stocks that yielded no executions when the stocks were routed through ITS to other
marketplaces. “If we want the inter-market structure to really work, we have to fix ITS because
it doesn’t work today.” In closing, Mr. Thain remarked that with respect to Regulation NMS,
the proposed opt-out exception is “bad public policy.” “[E]ven if the SEC allowed it, you all
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shouldn’t do it because if you opt-out, if you internalize trades, if you don’t expose your
customers’ orders to the marketplace, if you don’t get your customers the best price, this is
going to be the future mutual fund scandal or investment banking broker scandal, this is going
to be the problem in the future.”
Jane G. Heinrichs
Assistant Counsel