[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
COMPETITION AND CONSOLIDATION IN
FINANCIAL MARKETS
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
INTELLECTUAL PROPERTY,
COMPETITION, AND THE INTERNET
OF THE
COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
__________
APRIL 1, 2011
__________
Serial No. 112-24
__________
Printed for the use of the Committee on the Judiciary
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COMMITTEE ON THE JUDICIARY
LAMAR SMITH, Texas, Chairman
F. JAMES SENSENBRENNER, Jr., JOHN CONYERS, Jr., Michigan
Wisconsin HOWARD L. BERMAN, California
HOWARD COBLE, North Carolina JERROLD NADLER, New York
ELTON GALLEGLY, California ROBERT C. ``BOBBY'' SCOTT,
BOB GOODLATTE, Virginia Virginia
DANIEL E. LUNGREN, California MELVIN L. WATT, North Carolina
STEVE CHABOT, Ohio ZOE LOFGREN, California
DARRELL E. ISSA, California SHEILA JACKSON LEE, Texas
MIKE PENCE, Indiana MAXINE WATERS, California
J. RANDY FORBES, Virginia STEVE COHEN, Tennessee
STEVE KING, Iowa HENRY C. ``HANK'' JOHNSON, Jr.,
TRENT FRANKS, Arizona Georgia
LOUIE GOHMERT, Texas PEDRO PIERLUISI, Puerto Rico
JIM JORDAN, Ohio MIKE QUIGLEY, Illinois
TED POE, Texas JUDY CHU, California
JASON CHAFFETZ, Utah TED DEUTCH, Florida
TOM REED, New York LINDA T. SANCHEZ, California
TIM GRIFFIN, Arkansas DEBBIE WASSERMAN SCHULTZ, Florida
TOM MARINO, Pennsylvania
TREY GOWDY, South Carolina
DENNIS ROSS, Florida
SANDY ADAMS, Florida
BEN QUAYLE, Arizona
Sean McLaughlin, Majority Chief of Staff and General Counsel
Perry Apelbaum, Minority Staff Director and Chief Counsel
------
Subcommittee on Intellectual Property, Competition, and the Internet
BOB GOODLATTE, Virginia, Chairman
BEN QUAYLE, Arizona, Vice-Chairman
F. JAMES SENSENBRENNER, Jr., MELVIN L. WATT, North Carolina
Wisconsin JOHN CONYERS, Jr., Michigan
HOWARD COBLE, North Carolina HOWARD L. BERMAN, California
STEVE CHABOT, Ohio JUDY CHU, California
DARRELL E. ISSA, California TED DEUTCH, Florida
MIKE PENCE, Indiana LINDA T. SANCHEZ, California
JIM JORDAN, Ohio DEBBIE WASSERMAN SCHULTZ, Florida
TED POE, Texas JERROLD NADLER, New York
JASON CHAFFETZ, Utah ZOE LOFGREN, California
TOM REED, New York SHEILA JACKSON LEE, Texas
TIM GRIFFIN, Arkansas MAXINE WATERS, California
TOM MARINO, Pennsylvania
SANDY ADAMS, Florida
Blaine Merritt, Chief Counsel
Stephanie Moore, Minority Counsel
C O N T E N T S
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APRIL 1, 2011
Page
OPENING STATEMENTS
The Honorable Bob Goodlatte, a Representative in Congress from
the State of Virginia, and Chairman, Subcommittee on
Intellectual Property, Competition, and the Internet........... 1
The Honorable Melvin L. Watt, a Representative in Congress from
the State of North Carolina, and Ranking Member, Subcommittee
on Intellectual Property, Competition, and the Internet........ 2
The Honorable John Conyers, Jr., a Representative in Congress
from the State of Michigan, Ranking Member, Committee on the
Judiciary, and Member, Subcommittee on Intellectual Property,
Competition, and the Internet.................................. 3
WITNESSES
Lawrence E. Harris, Fred V. Keenan Chair in Finance, Professor of
Finance and Business Economics, Marshall School of Business,
University of Southern California
Oral Testimony................................................. 5
Prepared Statement............................................. 7
Mercer E. Bullard, Associate Professor of Law, The University of
Mississippi School of Law
Oral Testimony................................................. 15
LETTERS, STATEMENTS, ETC., SUBMITTED FOR THE HEARING
Material submitted by the Honorable Sheila Jackson Lee, a
Representative in Congress from the State of Texas, and Member,
Subcommittee on Intellectual Property, Competition, and the
Internet....................................................... 29
Material submitted by the Honorable Sheila Jackson Lee, a
Representative in Congress from the State of Texas, and Member,
Subcommittee on Intellectual Property, Competition, and the
Internet....................................................... 36
COMPETITION AND CONSOLIDATION IN FINANCIAL MARKETS
----------
FRIDAY, APRIL 1, 2011
House of Representatives,
Subcommittee on Intellectual Property,
Competition, and the Internet,
Committee on the Judiciary,
Washington, DC.
The Subcommittee met, pursuant to call, at 11:05 a.m., in
room 2141, Rayburn Office Building, the Honorable Bob Goodlatte
(Chairman of the Subcommittee) presiding.
Present: Representatives Goodlatte, Sensenbrenner, Chabot,
Marino, Quayle, Watt, Conyers, Jackson Lee, and Waters.
Staff present: (Majority) Holt Lackey, Counsel; Olivia Lee,
Clerk; and Stephanie Moore, Minority Counsel.
Mr. Goodlatte. Good morning. The Subcommittee will come to
order. And I will recognize myself for an opening statement.
The complexion of this hearing has changed considerably in
the last few hours. When we went to bed last night, the primary
focus of the hearing was the proposed merger between the New
York Stock Exchange Euronext, parent company of the New York
Stock Exchange, and Deutsche Borse, a leading German-based
securities and derivatives exchange company. Overnight, NASDAQ,
OMX, and the IntercontinentalExchange announced a joint
proposal to purchase NYSE Euronext. This Committee remains very
interested in evaluating the competing bids by Deutsche Borse
and NASDAQ, and their effects on competition and consumers.
At this point, a proper evaluation of the competing bids
demands a hearing at which the executives from the New York
Stock Exchange, NASDAQ, and Deutsche Borse have an equal
opportunity to debate the merits of the issue.
This morning's hearing was scheduled to include a witness
from NYSE, but not from NASDAQ or Deutsche Borse. In consulting
with representatives for all three companies this morning, it
became clear that there was no possibility of having executives
from all three testify today. In any case, testimony today
would likely have been premature.
At this point, it would not be appropriate to take
testimony only from the New York Stock Exchange without giving
the other companies an equal forum. For this reason, the
Committee decided to cancel the appearance by the NYSE at this
morning's hearing, and we will hold a hearing soon at which we
will take testimony from the interested companies and perhaps
other witnesses.
This morning's witness panel also included two expert
witnesses, Professor Larry Harris of the University of Southern
California, and Professor Mercer Bullard of the University of
Mississippi. These distinguished professors have traveled
across the country to assist the Committee in its evaluation of
competition in financial markets. They are both ready and able
to testify. This Committee and the public will benefit by the
insight that they can shed on these important issues. We will,
therefore, proceed today with what will now be part one of a
two-part hearing on Competition and Consolidation in Financial
Markets.
Today's hearing will take testimony from our two expert
witnesses. A hearing in the near future will take testimony
from executives of the three interested companies.
It would be premature for anyone to draw definitive
judgments about the newly-announced NASDAQ proposal or the
relative merits of the two proposals, but it is appropriate to
begin considering these profound issues without delay. The New
York Stock Exchange sits near the center of the American
economy; events on Wall Street ripple through our economy with
profound effects for every American. The stock market crash of
1929 contributed to the Great Depression, the most harrowing
and prolonged period of unemployment and economic instability
in our Nation's history. The crash of 2008 helped precipitate
our current economic downturn, and unemployment remains around
9 percent.
When he became CEO of the New York Stock Exchange in 2007,
Duncan Niederauer said, ``As NYSE Group reshapes its business
model, it reshapes global finance.'' I agree. The shape of the
future of global finance is at stake. Congress and the
Department of Justice must evaluate these proposed deals with
the utmost diligence and fairness. The future of American
business and jobs are inextricably tied to the future of the
New York Stock Exchange.
It is now my pleasure to recognize the Ranking Member of
the Committee, the gentleman from North Carolina, Mr. Watt?
Mr. Watt. Thank you, Mr. Chairman.
I have scrapped my opening statement and will make a few
observations off the cuff, which is always dangerous, but I
think necessary under the circumstances.
First of all, I want to applaud the Chair's decision not to
press to have the New York Stock Exchange represented here
today. I am not sure that I am exactly in accord with where the
Chair is leading us on the next stage of this because I have
some reservations about whether it is this Committee's or the
government's role to start to assess competing merger proposals
or takeover proposals before there is a final agreement between
parties, at which point our role obviously is to evaluate the
antitrust or potential antitrust consequences of whatever
agreement has been reached by the parties, not some theoretical
possible agreement that might be reached by the parties. In
other words, I am not sure I think it is appropriate for us to
be putting our finger on the balance and tipping the scale
either toward the NASDAQ merger or the other merger that was
already out there. But that is a subject of another day, and I
obviously do not want to have a public debate with my Chair
about that today.
I do think it is important to have what we are about to
have today, and that is an academic discussion about this
question of concentration, the implications that it has,
whether there are potential antitrust implications from the
growing concentration in this area, as we have expressed
concerns about concentration in other areas. And so, for that
purpose I certainly welcome these two outstanding academicians
to have an academic discussion because I think they are well
equipped to guide us in that discussion. And what we learn from
academic discussions educate us and allow us to make better
decisions as we go forward, regardless of which direction we go
forward in.
So I welcome the witnesses. I thank them for the sacrifices
they have made to be here. It would have been a shame to have
you travel all this way and then not have your perspective on
the concentration issues and the potential consequences of
mergers. But I hope that we will not put you in the awkward
position of trying to evaluate either one of these proposed
mergers without enough detail about the real body of what the
merger would look like or consist of.
So, I welcome you and thank you for being here.
And with that, Mr. Chairman, I yield back the balance of my
time.
Mr. Goodlatte. I thank the gentleman for his very pertinent
comments, and we certainly will take them into full
consideration as we plan for that subsequent hearing.
The Chair would ask the Ranking Member of the full
Committee if he has any opening statement that he would like to
make.
Mr. Conyers. Yes, sir.
Mr. Goodlatte. The Chair recognizes the gentleman from
Michigan for 5 minutes?
Mr. Conyers. Thank you very much. I am delighted to be here
and to have this hearing. We welcome our witnesses.
But for the life of me, I do not see what has changed,
outside of the fact that there is now a new bidder in this
ballgame. What about next week when a fourth company comes in?
We want to cancel another meeting? I do not think so.
I want to just indicate we are in a wave of mergers that
have only been slowed down by the fact that the American
economy is in the worst circumstance since 1929. And so, for us
to be concerned about every time a bunch of Wall Street actors
decide that this is a ripe opportunity for them to take over
something, or make yet another acquisition, that we have got to
wait to see what happens then, to me is no reason for us to
stop the examination of mergers and acquisitions that go on in
this country.
And while I am at it, we should take another good look at
the title, ``Competition and Consolidation in Financial
Markets.'' Guess what? Competition and consolidation are
antithetical. You do not get the same results from both of
them. And for us, it is important to me that our distinguished
witnesses separate this out. What happens when consolidation
keeps going on at the greatest wave of mergers that have
occurred since the turn of the 20th century? And here we are
again in the midst of another.
And so, I just want you to know that the adjournment
proposal is totally unacceptable to me. It would do the same
thing that any other merger would do in this financial area, a
reduced consumer choice. It will cost us jobs and create a
massive transnational regulatory issue in terms of how we can
regulate such a global combined entity.
But the latest offer is worse. Now we are talking about
General Motors and Chrysler coming together as if that is going
to help the automobile industry and job creation in Detroit and
the United States. This is totally unacceptable. Oh, is there
more being offered and put on the table, Chairman Emeritus?
Yes, there is more being put on the table, but that does not
make it any better. This would be another takeover within the
United States.
And so, I would like to revise and extend my remarks and
wait for the comments of our two witnesses. And I thank them
for their appearance.
Mr. Goodlatte. I thank the gentleman, and we have a
diversity of views about the appropriate way to proceed here.
And we will proceed by hearing from Professor Harris and
Professor Bullard, but first we have a series of votes on the
floor, and we will resume as soon as those votes have
concluded.
The Committee stands in recess.
[Whereupon, at 11:18 a.m., the Subcommittee recessed, to
reconvene at 1 p.m., the same day.]
Mr. Goodlatte. Before I introduce our witnesses, we would
ask you both to stand and be sworn in.
[Witnesses sworn.]
Mr. Goodlatte. Thank you, and be seated.
You have little lights in front of you there which will
turn on in just a minute, and they indicate the 5 minutes. We
ask that you summarize your testimony in 5 minutes. When it
gets to 1 minute remaining, a yellow light will come on, and
then when the red light comes on, your 5 minutes are up. Your
entire statement will be made a part of the record whether you
verbally get it out here or not, so do not worry about that.
And give us the best points.
And we will start with Professor Harris, who is a scholar
who literally wrote the book on trading and exchanges. His 2003
book titled, Trading and Exchanges: Market Microstructure for
Practitioners, is widely regarded as a must read for entrance
into the securities industry.
From 2002 to 2004, Professor Harris served as the Chief
Economist at the Securities and Exchange Commission. As Chief
Economist, Harris was the primary advisor to the Commission on
all economic issues. He contributed extensively to the
development of regulations, implementing Sarbanes-Oxley, the
resolution of the mutual fund timing crisis, the specification
of regulation NMS, which stands for National Market System, the
promotion of bond price transparency, and numerous legal cases.
Professor Harris currently holds the Fred V. Keenan Chair
in Finance at the University of Southern California, Marshall
School of Business, where his research, teaching, and
consulting focus on regulatory and practitioner issues in
trading and in investment management.
Professor Harris, welcome.
TESTIMONY OF LAWRENCE E. HARRIS, FRED V. KEENAN CHAIR IN
FINANCE, PROFESSOR OF FINANCE AND BUSINESS ECONOMICS, MARSHALL
SCHOOL OF BUSINESS, UNIVERSITY OF SOUTHERN CALIFORNIA
Mr. Harris. Thank you very much, Mr. Chairman.
Voice. Press that button there. There we go.
Mr. Harris. Now does it work?
Mr. Goodlatte. Yes.
Mr. Harris. Very good.
Thank you, Mr. Chairman, Mr. Watt, and Members. Thank you
for inviting me.
A number of competition issues are coming before the
country at this point in the area of market microstructure,
which is the structure of how we organize our trading in the
United States. I would like to highlight what the competitive
issues are and then comment very briefly on the two proposed
transactions that we have before us.
First of all, within markets, we have a very strange
situation that we do not see in other industries. We are all
generally in favor of competition, but there actually are two
competitions that take place in the marketplace for stocks or
for bonds, options or futures, or even currencies. And the two
competitions are these:
The first competition is the competition among traders to
find the best price. The buyers are looking for sellers, and
the sellers are looking for buyers. The buyers, of course, want
the lowest prices, and the sellers want the highest prices.
The second competition is the competition among exchanges
and other entities that behave like exchanges--dealers,
brokers--to provide the forum for the first competition. So,
the second competition is the New York Stock Exchange competing
against NASDAQ, or the Chicago Mercantile Exchange competing
against life in Europe.
Now, it turns out that it is very difficult to be in favor
of both of these competitions and still be consistent. To make
it as easy as possible for a buyer to find a seller, we could
just require that everybody come to a single exchange by
putting them all in a single place and time, and it is very
cheap for them to find each other. But in doing so, we
eliminate the competition among exchanges. And the competition
among exchanges is something we respect because it promotes low
cost trading, innovation, and because, frankly, we are, as
regulators, we would not be certain what the proper market
structure is by letting the market or the marketplace discover
for itself what is the best structure, whether trading should
be--rewards should be given to people who arrive first or to
large traders or to the traders who expose those orders. These
are all issues that have to be decided by exchanges.
Exchanges compete with each other to provide a set of
trading rules that will be attractive to the traders, who
themselves are competing among themselves to get the best
price. So, there is this tension between the two types of
trading, and when we talk about competition, we always have to
be aware of that tension.
Consolidation is good for the traders as long as the
consolidation is through a market that they like. But
consolidation is not good for the competition among
marketplaces because it effectively creates monopolies.
So, those are things to keep in mind as we start thinking
about transactions.
Now, I would like to take a quick survey of the types of
competition that we see among the exchanges as we consider the
mergers that have been proposed by these three players, NYSE,
Deutsche Borse, and NASDAQ.
The first competition we have to think about is the
competition to provide exchange services, a place where people
trade. In the United States, we see these competitions in
equities, futures, and options. And in the equities market, the
market is extraordinarily complex--competitive. We have an
awful lot of competition in that area. The mergers that we are
seeing here are not going to affect it. Even a NASDAQ merger
with the NYSE will not make much difference.
In the futures markets, that is not an issue that is
engaged here in the United States. There are some issues in
Europe, but we will let the Europeans deal with it. I can
comment about that later if you would like.
In the options markets, we have presently nine options
exchanges. Although those options exchanges are often--several
of them are held by single entities. If the New York Stock
Exchange were to merge with Deutsche Borse, one of the major
entities, the International Stock Exchange--Securities
Exchange, I forget--ISE--would then come under a common control
and we would see more concentration.
That said, it is very easy to start options exchanges in
the United States. BATS just started an exchange, and the
market share is growing rather quickly, so I am not
particularly worried about any of these mergers with respect to
options.
Where I do have concerns is with respect to listings. A
merger between NYSE and Deutsche Borse will not have much
effect on the listing market in the United States, but a merger
between NASDAQ and NYSE would concentrate virtually all the
listings into a single market, and that would be quite
problematic.
[The prepared statement of Mr. Harris follows:]
__________
Mr. Goodlatte. Thank you, Professor Harris.
Our second witness is Mercer Bullard, an Associate
Professor of Law at the University of Mississippi. Professor
Bullard focuses his scholarship and teaching on securities,
banking, corporations, corporate finance, and law and
economics. He is also the founder and president of Fund
Democracy, an advocacy group for mutual fund shareholders, and
a senior advisor with the wealth management firm Plan Corp,
Incorporated.
He currently serves as the Securities and Exchange
Commission's Investment Advisory Committee member and the
Public Policy Council of the Certified Financial Planner Board
of Standards.
Before entering academia, Professor Bullard served as
Assistant Chief Counsel at the Securities and Exchange
Commission and practiced securities law at WilmerHale here in
Washington, D.C.
Professor Bullard, welcome.
TESTIMONY OF MERCER E. BULLARD, ASSOCIATE PROFESSOR OF LAW, THE
UNIVERSITY OF MISSISSIPPI SCHOOL OF LAW
Mr. Bullard. Thank you, Mr. Chairman.
Chairman Goodlatte, Ranking Member Watt, Ranking Member
Conyers, Members of the Committee, thank you for the
opportunity to appear here today.
Professor Harris, I think, has covered in his testimony and
in his statement today some of the more specific antitrust
issues. What I would like to talk about is something I refer to
as the regulatory market, and although my discussion might seem
a little bit securities law laden to you, I believe the
regulatory market is really an integral part of any evaluation
of the competitive effects of any kind of merger in this
business. That is because financial exchanges are not simply
markets for trading of financial instruments that are also
regulatory markets. Exchanges establish listing rules that are
in effect a form of regulation themselves. In the United
States, for example, the rules of national securities exchanges
are approved and reviewed by the SEC, so exchanges do not have
complete freedom to choose their rules. But the rules reflect
the exchanges' general view of their position in this kind of
regulatory market, and it is, to some extent, a private or
privately-ordered regulatory market, the lines of which are
drawn based somewhat on competitive forces, and not necessarily
on state or Federal law.
Exchanges are also subject to Federal rules. They have no
authority over those rules. If they want to operate a
securities or other financial market in the U.S., they must
follow Federal law.
Now this monopoly of Federal law has been possible because
these financial markets have been manifested in tangible ways.
They have trading floors. They have buildings for those trading
floors. They used to trade actual stock certificates so they
are even selling something that was arguably tangible itself.
They had back offices where piles of trading slips accumulated
over time. And essentially, there was something to regulate,
and it was not easy for exchanges to go somewhere else.
Well, exchanges could lobby for changes in these Federal
rules. They could not change them, and they could not really go
anywhere else. Perhaps more importantly, issuers are subject to
the Federal rules if they want to take advantage of these
exchanges' services. For example, public companies are subject
to the Federal proxy rules and Federal tender offer rules that
effectively cannot be escaped if the company wants to raise
capital in U.S. markets.
This monopoly has created a kind of regulatory equilibrium.
Exchanges and issuers often lobby legislators and regulators in
order to ease the burdens of regulation. Legislators and
regulators sometimes create new rules and new burdens.
For better or for worse, the evolution of modern exchanges,
principally as a result of technology, is threatening that
equilibrium. The operation of modern exchanges has shed the
tangible context that enabled the Federal monopoly over rules
governing the raising of capital. U.S. issuers can now raise
capital overseas in foreign markets, while bypassing U.S.
securities regulation.
Now, only a small number of U.S. companies have gone public
overseas, but that number is sure to rise, and the New York
Stock Exchange/Deutsche Borse merger or, what I think are
inevitably going to be more transnational mergers, is likely to
accelerate that process of even U.S.-based companies doing IPOs
and seeking capital overseas.
Now, is this kind of regulatory arbitrage a positive
development? Well, that depends on your faith in free markets.
Rest free markets, if left alone, will arrive in an equilibrium
that results in the most efficient allocation of capital. If
they do not, however, there will be no supranational overseer
to set them straight. If they create systemic risk that
threatens U.S. interests, it will be up to the host nation to
take action.
The structure of corporate law provides an illustration of
this dynamic. Some commentators consider the ability of
corporations to choose the state laws under which they operate
to create a kind of regulatory market. But it truly is not
free. There is only a free market to the extents that Congress
allows such a free market. Federal law can trump law, and often
does.
Now, in the case of free international regulatory markets,
there is no such parental oversight. No entity currently has
the authority to step in and impose rules. This might not be a
significant risk for the regulatory arbitrage that is going on
between countries with highly-developed business regulatory
regimes. However, Congress needs to think about this risk as
the globalization of financial exchanges expands to less
developed countries.
A parallel concern is the expansion of the self-regulatory
state. Self-regulatory organizations may seek transnational
regulatory authority to resolve the issue of parental
supervision and oversight. They may have the flexibility and
the resources to be quite successful; however, Congress should
consider the implications that further derogation of
administrative authority could have for broader national
interests.
Transnational SRO is no longer a national SRO. The Supreme
Court recently expressed concern that the constitutionality of
SROs are already two steps removed from the authority of
elected government officials. The transnational SRO structure
will hardly mitigate that concern.
Congress should also consider ways to address the risk
created by transnational exchanges and transnational regulatory
arbitrage. The multiplication of exchanges will increase the
likelihood that U.S. retail investors will purchase securities
in foreign markets without the protection of fundamental
investor and shareholder rights that apply in the United
States. This may militate for reforms to our regulation to the
point of sale; and that is, at the broker-dealer or at the
advisor point of sale, contact with the customer. And this is
an illustration of how in some cases freeing up the regulatory
marketplace in one area, for example, exchanges, can sometimes
be balanced by adjustments in other areas, such as with respect
to the duties of brokers, dealers, and other salespersons and
advisors.
In conclusion, we could also look inward at our own private
markets as potential outlets for a more flexible regulatory
market. The current private offering rules, like the regulation
of exchanges, have been overwhelmed by technological advances.
Facebook's failed private offering in the United States
illustrates the incompatibility of modern communications and
the Securities Act's restriction on offers.
Congress should consider reforming restrictions on offers
so that private markets can provide a more feasible escape
valve for issuers that seek capital and more regulatory
freedom.
So, the New York Stock Exchange/Deutsche Borse merger will
take us another step down the road to free regulatory markets
for financial exchanges. I strongly encourage Congress to look
carefully down this road and think hard about where it is
taking us.
Thank you again for the opportunity to appear before you
today, and I will do the best I can to answer any questions you
might have.
----------
Mr. Goodlatte. Thank you both. Those are both very
instructive statements.
Professor Harris focused on the issue of competition
amongst the companies that may want to list their securities on
exchanges and the consumers, and how they might be affected by
these mergers, and expressed concern that maybe two domestic
mergers might reduce that more than the international. And you
addressed an issue that I was going to ask you about, and you
pretty much addressed it, in terms of the concern that I have
had in the--how do we handle, in our responsibility of putting
forth laws that are then translated into regulations, and not
keep people from taking these transactions outside the United
States to the lowest common denominator?
So, I am going to ask you to flip. I want you to comment on
Professor Harris' observations about the competition from the
standpoint of the consumer and from the companies being listed
on these exchanges. And I will come back to Professor Harris
and ask him to comment on your observations.
So, Professor Bullard, I will let you start with that.
Mr. Bullard. I would be happy to. It is quite a challenge
and a little bit intimidating.
But what I hear when I listen to a kind of antitrust
analysis is, what is the demand side of the market, because
that what is I have generally focused on, and that is what is
the type of investor? What is the most efficient regulatory
regime for that investor? And what I would like to see is an
analysis that thinks about what is the appropriate role for
individual retail investors, and how will these exchange
mergers affect them? And what is the overarching U.S. policy as
to how it wants to regulate those investors? That is really a
separate question from the exchange mergers as such, but it is
one that really stands behind them because I think Congress
needs to decide where it wants to be with respect to retail
investors going forward.
There are some proposals that have talked about some of the
issues I discussed, and that is how you deal with this kind of
transnational, super national law. The source of that law is
intended to deal with investors as individuals who should be
able to go out and choose whatever regulatory regime they want.
Without those fundamental investor protections, they can opt
for the anti-fraud rules of Germany, if they wish, as opposed
to the SEC, and then buy German stocks on U.S. exchanges. Then
I think Congress needs to decide it wants to go that way, and
then the answer to the antitrust question would clearly be
affected by that because some of these regulatory decisions
will drive, to some extent, the antitrust issues.
If, on the other hand, Congress is committed to the
structures that we have for the last 80 years, which is where
we essentially draw a line--we decide what is at least a close
approximation of a kind of investor with respect to which we
want to have different rules, and it is clearly a paternalistic
regime, but it is one that nonetheless has created the most
liquid, deepest, most successful capital markets in the world,
then that really goes right to your concern. In that case, the
model that we would follow to deal with these issues and these
antitrust concerns would be very different.
And we need to think about issues, such as how do we really
want retail investors to be accessing the marketplace? If we
are going to oversee the way they do so, there are serious
questions about what role individual retail investors have
buying stocks directly in the first place, not to mention
buying stocks on overseas exchange perhaps where you have got
fundamentally different investor and shareholder protections.
Mr. Goodlatte. Thank you.
Professor Harris, you make a very valid point in creating
this tension, or observing this tension, that exists between
the two levels of competition that we are inviting with these
exchanges, that it is perhaps easier to regulate the fewer the
exchanges there are because there are fewer opportunities for
people to go elsewhere. We would bring everybody together, and
you have more competition at that lower level.
On the other hand, I would like you to address what
Professor Bullard talked about in terms of the fact that it is
not easier to regulate if they all escape to Europe or some
other exchange that can be formed elsewhere, that it
constitutes a race to the lowest common denominator.
Mr. Harris. Professor Bullard raises some very interesting
issues that trouble all of us. I want to distinguish between
the problems that we presently encounter and those problems
that we have not yet encountered and may never encounter.
First of all, with respect to the transactions that we have
seen already and that are proposed in the last few weeks, these
are transactions that involve the ownership of regulated
exchanges. The owners are not the ones that are primarily
regulated; it is the exchanges themselves. So, the New York
Stock Exchange, whether it is owned by New York Stock Exchange
Euronext or whether it is owned by some consortium involving
Deutsche Borse or NASDAQ, will continue to be regulated by the
SEC. And all trading at the New York Stock Exchange will be
under the same arrangement. So, the notion that we have these
transnational combinations raising regulatory problems is, at
this point, premature.
Now, one of the potential benefits of having these
transnational combinations is that in some distant future, it
might be possible with changes in the regulatory environment to
allow German investors and U.S. investors to trade these same
securities in the same trading system so that a buyer could
easily find a seller regardless of whether they are in Germany
or in America. And that would be very advantageous both for the
American traders and for the German traders, making the market
much more liquid.
But to get to that point, we would have to have a
regulatory agreement between the regulators of those two
exchanges to allow the merger of their order books and of their
trading systems, at which point, of course, there would be some
sort of negotiation, and we would have a strong arm in that
negotiation because we could always say it should not happen.
Now, that said, the attraction of that is that you would
now have a market that would operate maybe for 12 or 14 hours
and would be liquid during that entire period. And the
implication of that might be that, or the extension of that
would be that they would bring in somebody in the Far East, and
they have a 24-hour market.
But running against that is the fact that we already have
24-hour markets in many instruments, particularly the futures
contracts, and we have markets that are moving toward 24 hours
in the individual securities equities and whatnot. Those
markets operate out of a single exchange, and, of course, we
would like those exchanges to be U.S. domiciled, and often they
are, but maybe they are not.
Presently in the United States, if you want to trade in a
European exchange, you go through an American broker. The
broker has a responsibility to you that is governed by
regulations that are domiciled here in the United States. And
so your relationship to the broker is governed by U.S.
regulations, and that broker then takes you to the foreign
market either through that broker subsidiary in the foreign
market or through a correspondent relationship where the broker
is responsible ultimately for your relationship to that market,
subject to our laws. And so, we really have not lost that much
control at this point over Americans who would be trading
either in the United States or elsewhere.
So, those are things that are current and potentially
future.
I want to address two, or at least one other quick point.
People often speak about the loss of the IPOs in the United
States, that this represents some sort of problem. And, in
fact, the press releases that we saw this morning from NASDAQ
referred to IPOs going abroad. So, the fact that IPOs are going
abroad should be of concern to all of us, but we should also be
mature about what it is happening. It could be happening for
two reasons.
It could be happening because somehow we have failed and we
have imposed significant costs on firms here in the United
States, and we are driving them away. But the other reason, and
a very likely reason, in my opinion, is that the other markets
have simply become more mature. There is more liquidity in
those markets, there is more financial sophistication, and they
have simply become better competitors.
There was a time when an Israeli firm or a European firm in
a smaller place would do its IPO in the United States simply
because it had to because there were no good markets in Europe.
As the Europeans have become more financially sophisticated and
wealthier, and this is true also in Asia, they are doing more
IPOs. And so, the fact that we do fewer IPOs is disappointing
to us, but not necessarily a reflection of our regulations. It
may be a reflection of the increasing sophistication and power
from competitors that we see elsewhere.
Now, that is disappointing to us because we would like to
have all of the business, but we also recognize that these
people are our partners. We are all better off when everybody
is wealthy. I would like to have more of that wealth here, but
I am not going to cry too much about it.
Mr. Goodlatte. Thank you. My time has expired. I anticipate
we may do a second round, but we will now go to the Ranking
Member, the gentleman from North Carolina, Mr. Watt?
Mr. Watt. Thank you, Mr. Chairman.
Professor Harris, Professor Bullard, thank you for being
here, and thank you for being patient while we were over
booting. It has been a kind of a choppy experience for us this
morning.
I perhaps have a little bias here because I serve not only
on the Judiciary Committee, but on the Financial Services
Committee. And it seems to me that most of what you all have
talked about here, both the things that Professor Harris and
the things that Professor Bullard addressed, we have been
trying to deal with appropriately in the Financial Services
Committee. The regulatory framework that Professor Harris just
outlined very cogently is one that we have been working on
aggressively in Financial Services to bulk up the Securities
and Exchange Commission, bulk up the protections for individual
investors, unsophisticated investors who might be investing
either domestically or in foreign markets.
The issues that Professor Bullard talked about, we have
been aggressively working on because we have been trying to
harmonize the standards that are applicable worldwide in this
global market in which we are operating.
What is surprising is that neither one of you has addressed
what I was expecting us to address this morning in this
Committee, which is the antitrust aspects of this. And it seems
to me that I would have expected some discussion of what is
driving us toward this greater concentration of ownerships,
which, from my perspective, is cost and the drive for cost
savings, and the drive for greater profits, or to minimize
losses, whichever way you want to look at that--flip sides of
the same coin.
And the mix of things that are going on on these exchanges
now, as I understand it, we would be hard pressed to make a
case that either of these mergers--well, I have not looked at
NASDAQ quite as closely, but certainly the first one has
substantial antitrust implications for stock ownership, stock
transfers, because the New York Stock Exchange apparently has
gone from trading 70 percent or 69 percent of trading to down
to like 24 percent now. And most of the trading is taking place
on smaller platforms electronically outside any kind of
exchange.
What at least one writer has suggesting is that this is
being driven by the concentration of trading derivatives, which
contributed, according to that writer, 40 percent of the
profits of the New York Stock Exchange. And if you put the
derivatives that the New York Stock Exchange is controlling and
derivatives that the German Exchange is controlling together,
then you have got potentially an antitrust concern.
So, I guess my question is, let us talk about what this
Committee has jurisdiction over, which is the antitrust aspects
of this. Do either one of you see any particular antitrust
concerns about either the prospect that the New York Stock
Exchange will either merge with German Exchange or the NASDAQ
domestic exchange? Do you see any adverse consequences from the
control or administration of derivatives from either one of
these kind of mergers taking place? That is what I want to hear
because, I mean, at the end of the day, our jurisdiction in
this Committee--I mean, I might invite you back to talk about
all the things you all talked about in the Financial Services
Committee, although I cannot invite you for that. I cannot
invite you over here. I am not in control. We are not in the
majority any more.
So, but it seems to me that most of what you have talked
about are subjects that we are dealing with in the other
Committee. I want to hear your perspective, if I can get it, on
the antitrust aspects of this. Are there any antitrust
implications, and are they driven more by the monopoly that we
are creating about transfer of stocks, or is it being driven
more by the monopoly or movement toward a monopoly that we may
be creating in the control of trading of derivatives? That is a
long question. I am sorry.
Mr. Goodlatte. I will give you both a chance to answer.
Mr. Harris. May I answer first?
Mr. Watt. Sure.
Mr. Harris. There are two places where I see antitrust
problems. One is in front of us and the other one is not in
front of us.
The one that is in front of us is with respect to listings.
If the NASDAQ is able to purchase the New York Stock Exchange,
we will have one entity that will be responsible for the vast
majority--virtually all listings in the United States.
Now coincidentally--I presume it is coincidental, but I do
not know--the BATS Exchange just announced on Tuesday that they
wanted to enter the listing business. The listing business is
an extremely difficult business to penetrate because a listing
is a brand; it is association with a brand. And the New York
Stock Exchange and NASDAQ both have strong brands that took a
long time to develop. BATS does not presently have a brand.
They might in the future, but I suspect that if a listing is
valuable to a company, that the BATS brand will have a
challenge getting started up. So, to put all the listings into
a single entity seems somewhat problematic to me. So, that is
the area where there is----
Mr. Watt. Even if those listings are going to be allowed to
be traded by different platforms? Is it the listing that is
troubling you, or is it the trading that is troubling you?
Mr. Harris. No. It is the listing itself.
Mr. Watt. Okay.
Mr. Harris. The trading is subject to all the different
platforms, and we have no problem there. There is very, very
competitive markets in the equities space. But the listings are
associated with control over governance, control over capital
structure, and control over disclosure. And one might argue
that it is best to put that under one entity so that the SEC
can control all of it in a single place. But if we do believe
that exchanges should be allowed to appeal to different
clienteles among their issuers, then we basically preclude a
significant competition by allowing this type of merger.
The other place where I have significant concern is not in
front of us, but it is worth discussing. You spoke about the
derivatives and the profitability in the derivatives. The
profitability in derivatives has to do with the clearing houses
and the fact that the clearing houses are vertically integrated
with the exchanges that feed contracts to them. It is a simply
a felony in the United States for us to trade a futures
contract off an exchange, whereas you and I, if we wanted to
right now, could trade IBM among us. We might have difficulty
settling it, but that would just be a practical problem; it
would not be a felony.
The exchanges and their clearing houses effectively have
extraordinary market power in their successful contracts. And
that is a fact already, and the aggregation of various
contracts under a single holding company does not change that
fact. So, if the New York Stock Exchange Euronext merges with
Deutsche Borse, then we will see a lot more futures contracts
aggregated under a single umbrella, but each one of those
presently operates, by and large, with an awful lot of market
power. It would make it very difficult for any competitor to
open up a similar contract and try to trade against them.
So, the market power is already there. The notion that
these exchanges are buying or merging to acquire that market
power seems wrong to me. It is already there, and they are
undoubtedly paying for it. So that cannot be the source of
value from these transactions. The source of value is that they
hope to substantially reduce their expenditures on information
technologies.
Exchange platforms are essentially the same whether you are
trading equities, futures, options. They are all about the
same. They are electronic databases, in effect, and they have
pretty much become a commodity. But to maintain two when they
are both identical is very expensive, so if you combine the two
into one entity, you have a great cost savings.
Mr. Watt. Let me quickly get Mr. Bullard's reaction,
because my time has long since expired.
Mr. Bullard. I think I agree with the point about the
brands. The way I would see it is that listing requirements are
essentially the set of rules that are imposed in order to list
with that exchange. You can go trade on another exchange, but
where it is listed is what determines what the rules are. And
those are very much kind of corporate governance type rules in
many cases. And to see the merger of those two sets of rules
into one set of rules is not consistent, in my mind, with the
kind of useful free market in regulatory approaches that we
would like to see because that has the kind of super national
oversight to make sure things do not get out of hand. And that
is essentially today the SEC and the CFTC.
As to the international issue, you know, even though, as
Professor Harris has pointed out, some of these have not come
to pass yet, although, of course, NYSE itself exists because of
the merger with a transnational set of exchanges. I think we
need to look forward to what I think is a real serious
antitrust problem, and that is that you will have the primary
regulator of competition among exchanges missing from the
picture to the extent you have the kinds of transactions
Professor Harris described going on where a U.S. retail
investor is buying securities traded under a German listing.
Now, I do not have particular concerns with respect to German
listings and German corporate requirements; in fact, they are a
lot more stringent and a lot more burdensome than Sarbanes-
Oxley if you actually look at them. But I do have a concern as
we go down the road that we will see other jurisdictions where
we will not be comfortable, and we will need to have some kind
of umbrella oversight mechanism in place, or we will not have a
regulator as to the competitive aspects of these exchanges.
And the inverse of our system where you have orders trading
through different exchanges, and you have, as he pointed out, a
lot of competition, is the more European approach where they do
not push so hard for that, and where you have exchanges able to
act opportunistically by having essentially sold trading
privileges. And, you know, that is the kind of development that
I ask who is going to be overseeing that when we have these
transnational types of transactions.
Mr. Watt. Thank you, Mr. Chairman. I yield back.
Mr. Goodlatte. I thank the gentleman.
The gentleman from Michigan, Mr. Conyers, is recognized for
5 minutes?
Mr. Conyers. Thank you.
Professor Bullard, what is your law student organization
like doing in this related activities at this time?
Mr. Bullard. Well, as we were discussing before the
hearing, there is another related SRO issue, and that is
whether FINRA's authority would be extended to allow them to
regulate investment advisors. And there are a number of
investment advisors in the United States who would like to be
regulated by a separate entity, and students at University of
Mississippi, and not just the University of Mississippi. We
have students in Ohio, Alabama, California, New York, Kentucky,
Florida, and California--we have not heard from Michigan yet--
that are all working on this project to develop a structure
whereby if Congress authorizes the creation of an SRO for
advisors, there would then be one ready to apply with the SEC
to provide that for investment advisors.
And it is not directly relevant here, but it is
structurally relevant in that the principle purpose that these
students see this serving is to establish a different brand, a
different set of regulatory requirements, where the SOROYA, as
we are calling it, could compete with FINRA and offer different
options.
The idea that exchanges might coalesce and thereby
eliminate that kind of regulatory marketplace in a way is
nearer in the SRO world, and there are lots of different SRO
type organizations. In the United States, you have, for
example, the Municipals Securities Rulemaking Board, which
interestingly has essentially rulemaking promulgation
authority, but then leaves examinations and enforcement to
others. You have FINRA, on the other hand, which really
captures the whole mix and does just about everything,
including arbitration or private disputes.
So there are a lot of different models and there are lot of
different models on an international scale. One model for some
kind of super national authority might be IOSCO, which is the
existing long-standing international group for securities
regulators. Another would be something structured perhaps along
the lines of the World Trade Organization. So, there are a lot
of different models in which what we are seeing is the
development of NGOs, the administrative state coming in and
serving roles that are problematic under a constitutional
authority, but are particularly problematic in deciding how are
U.S. interests being protected abroad as we move into more
formal transnational relationships in a lot of different areas.
Mr. Conyers. Professor Harris, have there been any kind of
student law school combinations of activities going on at the
University of Southern California?
Mr. Harris. None in this area.
Mr. Conyers. In any area.
Mr. Harris. I believe so. I know that we have students in
the two schools working together on issues involving, I
believe, venture capital and also, I believe, involving
distressed workout situations.
Mr. Conyers. Professor Bullard, has the antitrust division
been dormant here for several Administrations?
Mr. Bullard. I am sorry? Has the antitrust----
Mr. Conyers. Division of the Department of Justice----
Voice. He said dormant.
Mr. Conyers. Dormant.
Mr. Bullard. Dormant? I cannot really speak to that. It is
not an area that I follow closely enough. But in the world of
exchanges, especially as a securities lawyer, I generally view
antitrust activities as being a securities regulation issue.
And I would say that the SEC has been dormant on a number of
fronts increasingly in the time preceding Mary Schapiro's
tenure. And I think that in the respect of regulating
investment banks, for example, and other aspects of SEC
oversight, you have seen some of those problems bearing fruit
today.
Mr. Conyers. Professor Harris, do you think there are
things we could do to improve DoJ and SEC in terms of oversight
and enforcement?
Mr. Harris. Certainly having two agencies who can
reasonably believe that they have jurisdiction over similar
issues is potentially problematic. The SEC, of course, has more
expertise with respect to the financial markets. DoJ, when it
is paying attention, potentially has more expertise over
antitrust issues. And we would, of course, like to see the two
of them cooperate.
I will note that the SEC, in my opinion, has actually been
pretty pro-competitive in the last decade. In particular,
regulation NMS is the reason why we see so much competition now
among the equities markets because we basically allowed those
equity markets to become electronic and compete. And electronic
competition has just vastly opened the marketplace for low-cost
competitors who are providing really great service.
But to your question of how they get along, they have
different perspectives. I have a particular fear here in the
options markets. The options markets now have a common clearing
corporation called OCC, the Options Clearing Corp., which
operates as an industry utility, and it serves the nine
different exchanges that trade options. Those nine different
exchanges are in a vicious competition with each other for
order flow, and it is only because they are all served by the
same clearing corp., the implication of which is that you can
buy a contract at one exchange and sell the same contract in
another exchange, which is a tremendous benefit to consumers.
Now if we see substantial consolidation in the option space
under the control of, say, two or three different entities that
own these nine exchanges, and if that consolidation leads to
substantial power over this OCC--and I frankly do not know the
governance structure there--if that were to result, then the
options markets will start looking a lot more like the futures
markets. Futures markets produce an incredible amount of
revenue for the clearing houses and the exchanges that own them
in this vertical structure, a structure that, of course, the
Department of Justice might more readily recognize than perhaps
the CFTC.
So, I would think that this would be an unattractive
outcome if, as a result of mergers like this, the independence
of the Options Clearing Corp. were in some way challenged.
Mr. Conyers. Thank you, Chairman.
Mr. Goodlatte. I thank the gentleman.
The gentlewoman from Texas, Ms. Jackson Lee, is recognized
for 5 minutes?
Ms. Jackson Lee. Mr. Chairman, let me thank you very much.
I had engaged the Chairman of the full Committee and the
Ranking Member of this full Committee on the importance of
having a hearing on this proposed purchase really by Deutsch
Bank initially with German shareholders, to hold such a hearing
as quickly as possible. And I thank the Chairman of the
Subcommittee and the Ranking Member of this Committee.
And let me express amazement and dismay because it looks as
if we are tool-less. And I must place on the record, Mr.
Chairman, my concern that the chief operating officer, Mr.
Leibowitz, is not here. And I am disappointed that a short trip
from New York City prevented him from being here. I can just
well assume that the next trip from Germany might be even more
challenging.
So, I would like to raise these questions with you, and as
I do that, I am interested in the antitrust issues, but I am
just going to put the information on the record so that both
professors can speak from your level of expertise. If it
happens to be antitrust, so be it.
But we have a very good memorandum that is prepared for us.
And when you look to the issue of the Hart-Scott-Rodino review
processes--7A Clayton--let me say that initially Teddy
Roosevelt got it right to break up these large monopolies, to
increase competitiveness, and for the 20th century it worked.
And I understand that we may have to assess, but just listen to
what the Justice Department has to do when there is this
merger. The parties must notify the Federal Government, send
them a note, or maybe you send them an e-mail, or you Twitter
to them, while you are continuing to negotiate and get ready to
sign the deal. Then the parties must then wait for a specified
period of time, simply 30 days. That is the average. That can
go in the flick of a hand--30 days to look at a complex merger
such as the one before us or NASDAQ.
Then after--let's see. The parties then wait a period of
time, determine through a clearance process established by the
Congress. The two agencies that have to be involved decides
whether to clear the merger, after which it may be consummated.
So, it could be 30 days plus one, and then maybe if they are a
little challenged, they can issue a second level of
information. They cannot stop it. They cannot enjoin it. And
only after all of that and they feel that there's comfort, they
can go into the courthouse that has already narrowed the
interpretation of the Clayton Act.
Literally America's hands are tied, and I have been asking,
and I think it is important, for all the case law to go back
and look at Section 7, to give us something to talk about with
all these mergers, whether it is securities, whether it is
automobile industry, whether it is TV, whatever it happens to
be. It is because of the lack of teeth that we have in this
particular legislation that is on antitrust.
But let me go to you, Professor Bullard, and just ask a
question, and I think you were saying about the race to the
bottom for the financial markets premised on these mergers. Is
there some truth to that kind of analysis, and expand on your
issue of the potential lack of oversight of the securities and
exchange market, I think is truly one that I would be concerned
about.
Mr. Harris, with this economy percolating and the global
economy making some efforts, we saw job creation today
increase, I believe. We see the efforts that were made,
funding, stimulus dollars, American Reinvestment and Recovery
Act, which is really putting this market in a direction where
it is making a profit. But years past, as you well know, we
moved the market from a little club of bankers and others, and
shareholders are there, and it is the argument that the leaders
of the stock exchange will say, which is, we need to make
money. And these mergers help make money for the general
public, the shareholders.
So, my question to Professor Bullard, speak to me about a
race to the bottom. And what should we be looking at when we
assess whether this is a right approach and whether it is anti-
competitive, worry about whether we have a Clayton Act. And,
two, Professor Harris, how does this skew the markets for the
common man when we are talking about these kinds of mergers?
Professor Bullard first, please.
Mr. Bullard. I should probably warn you I have a bit of a
different view of the common popular theory of the race to the
bottom, which is usually used to describe state corporate law,
and the theory that companies will go to the state with the
worst regulation.
I think that the idea of a race only makes sense when there
is no higher authority that can ultimately place a check on
that kind of race. And that is precisely what the Federal
Government does. That is precisely what it has done repeatedly
over the last 10 years. And to give you a concrete example, one
of the provisions of Sarbanes-Oxley prohibits loans to
executives by companies. That is precisely the kind of thing
that no state law prohibited. The Federal Government stepped in
because of the WorldCom scandal and decided to make that a
minimum floor below which states could not drop.
Ms. Jackson Lee. Right.
Mr. Bullard. So in that sense, if you have that strong
centralized Federal regulator, I am not concerned personally
with the race to the bottom because structurally to me it just
does not----
Ms. Jackson Lee. But if your entity moves off shore----
Mr. Bullard. I was going to add, in the national context,
if the SEC continues to have both a doubling of its burdens and
a having of its budget, you are no longer going to have that
oversight in the U.S.. And then the race to the bottom will be
a serious issue because securities regulation does supplement
and, in many cases, supplant state law. If you do not have an
agency, such as the SEC, that can carry out its enforcement
responsibilities, then you really do have a race to the bottom.
And I think that is what would happen.
Ms. Jackson Lee. And mergers do not help the situation.
Mr. Bullard. And in addition to that, it is a given
structurally that if you go abroad, you are going to have a
race to the bottom because, again, you have no formal mechanism
that can impose requirements in order to constrain the
competition that will exist if you do not have that oversight.
Ms. Jackson Lee. Professor Harris. Thank you.
Mr. Harris. These mergers will reduce the cost to the
companies who are providing their services because they reduce
duplicative processes.
To the extent that they can reduce the costs if the firms
remain in competition with other firms, those benefits will be
passed through to the public, and that will be for the best,
both for Americans and for others who use these markets,
whether they are here or abroad.
Now, with respect to regulation, I think it is important to
recognize that the need for regulation has changed
substantially with electronic trading. So, we regulate in
several different areas. We regulate trading practices. We
regulate brokers and their relations with their clients. And we
regulate issuers and their capital structure and their
governance.
With respect to trading practices in electronic systems,
there is hardly any need to regulate anymore because those
computers simply do not break the rules. We still need to
regulate the brokers, but the brokers are locally domiciled,
and we have control over that, which brings us back to the
listing issue.
So, we regulate listings or listings agencies, which are
the NYSE and NASDAQ, regulate the issuers through their listing
standards, with some input from the SEC. And, of course, these
issues are all states' rights issues by and large. Those are
places where we may have some concern with these transactions.
Ms. Jackson Lee. Mr. Chairman, if I could ask unanimous
consent to put into the record From Shame to Antitrust: New
York Stock Exchange and NASDAQ/ICE Merger, and----
Mr. Goodlatte. Let me interrupt the gentle lady. Her time
has expired. We are going to do a second round, and we will
return to you in a----
Ms. Jackson Lee. I am just asking to enter into the
record----
Mr. Goodlatte. Without objection.
[The information referred to follows:]
__________
Ms. Jackson Lee. And I would just make an inquiry to you,
and I know we are doing a second round, but it is just an
inquiry. I do appreciate being informed that the COO is not
here because of the potential NASDAQ/ICE merger. Since I happen
to question that potential merger and am opposed to it, I am
still disappointed that he is not here. But I would just make
the inquiry, Mr. Chairman, will he be able to come back sooner
rather than later? Will this Committee reconvene for the
opportunity for us to hear him?
Mr. Goodlatte. Well, I thank you for raising that point
because we, at the outset of the hearing, made clear that his
presence here was not, in my opinion, to be characterized as
ducking the hearing. The Committee made the determination that
because Mr. Leibowitz was confronted last night with a sudden
development involving another major competing bid for the
acquisition of the NYSE Euronext, that it would be
inappropriate to call him to testify today. It was the
Committee's decision to do so. I also announced that we would
hold another hearing on the issue. The exact timing of that
will depend upon a number of variables, including the
Committee's schedule. But it is our hope that we will be able
to accomplish that, and I will work with the Chairman of the
full Committee to accomplish that.
Ms. Jackson Lee. Thank you, Mr. Chairman. It is a very
important issue. Thank you.
Mr. Goodlatte. I recognize myself for some additional
questions, and then I will recognize other Members who may wish
to ask some questions as well. I have several, so I would ask
you to keep your answers as brief as possible, although I know
some of these are not easy to answer briefly.
First of all, I would ask both of you, why is it that the
New York Stock Exchange, which is the world's largest exchange
by trading volume, has a relatively small market
capitalization? Do either of you know the answer to that?
Mr. Harris. I believe I----
Mr. Goodlatte. Professor Harris?
Mr. Harris. The New York Stock Exchange market share has
dropped very substantially as it competes with other electronic
entities that have provided high quality service. Has been very
attractive to brokers and to traders. So where the New York
Stock Exchange used to have a market share in excess of 90
percent at one time, it has now dropped into the 20's. And with
that and all that competition, they have had to reduce fees
very substantially, and as a consequence, the market
capitalization is much lower.
Mr. Goodlatte. It is lower because the profitability of the
entity is much lower.
Mr. Harris. The electronic trading has substantially
reduced the costs of providing service in this area, and as a
consequence, the business is less profitable.
Mr. Goodlatte. In your testimony, you reflect that
technology and regulations have made securities markets far
more competitive in the past 15 years. And according to some
estimates, this competition has shrunk the New York Stock
Exchange share of the securities market from over 70 percent to
under 30 percent since 1996. How has this competition affected
ordinary investors, and how has it affected small and
developing companies that are seeking capital? How has it
affected established listing companies? Has it been a plus or a
minus for each of those three areas? And I will start with you,
and then go to Professor Bullard.
Mr. Harris. I recently did a study on the quality of
markets over the last 20 years. Market quality has increased
very substantially. Those spreads have gotten smaller for large
companies and small companies. The aggregate sizes on the bids
and the offers have increased over time. Just about every
measure of market quality has improved. The public is being
served by much better markets now than they used to be. And it
is, I think, pretty easy to understand that the entities that
are now providing service to the public are largely computers
and not people. And it is not that we do not like the people,
but the computers just work a whole lot cheaper. They are more
reliable. They are certainly more trustworthy in the sense that
they never break the rules. And they are, of course, governed
by people who are trying to use them to make profits. But they
are only able to make profits within the narrow confines of
electronic exchanges where the rules are well defined and
completely enforced.
In that environment where people can instantly move from
one market to another looking for liquidity, it is very easy to
find the other side, even when the markets are broken up and
fragmented. And that indeed is what is happening. So, I believe
that at least with respect to exchange services, the public and
the small investors and small issuers have never been better
served.
Mr. Goodlatte. Thank you. Professor Bullard? Turn the
microphone on.
Mr. Bullard. I would echo that in that that is directly
felt by retail investors, for example, through mutual funds who
are now trading at small fractions of the cost of trading that
existed 20 or 25 years ago. And the same indirect benefits
accrue to issuers on those markets, including small issuers.
Mr. Goodlatte. Sal Amuk, AMUK, an institutional broker at
Themis Trading, has questioned the for-profit exchange model
and argued that exchanges should be utilities that look after
their customers and the markets rather than for-profit
businesses that ``act like bonus-seeking bankers.'' What are
the advantages of the for-profit exchange model? Professor
Harris?
Mr. Harris. The for-profit exchange model, when the for-
profit exchange is in competition with many other exchanges,
tends to innovate a lot faster than does the mutual model, and
it tends to lower costs much more aggressively.
The mutual model has its advantages in that you don't have
a conflict of interest between the interest of the shareholders
and the interest of the customers. In the mutual model, if the
directors of the exchange are looking out for the interests of
the customers, then, of course, the customer comes first,
although quite frequently in the mutual model, the directors
are looking out for the members, in which case you have a
conflict between the members and their customers.
Mr. Goodlatte. And are there examples of the mutual
exchange model? Are there any operating entities?
Mr. Harris. Over the last 10 years, almost all exchanges
that used to be mutual model exchanges have converted to public
equity exchanges.
Mr. Goodlatte. For-profit exchanges.
Mr. Harris. For-profit, yes.
Mr. Goodlatte. All right.
Mr. Harris. Undoubtedly, there are some left somewhere, but
I frankly do not know which ones they would be.
Mr. Goodlatte. Professor Bullard, do you have any comment
on that?
Mr. Bullard. The essential difference between a mutual
model and a for-profit model is that one is answerable to the
members--traders--who use the services on the exchange, and the
other being shareholders. Shareholders have no loyalty other
than to their company as a profit-making concern. So, there are
necessarily going to be far fewer responsibilities of
shareholders as such to other types of relationships that
members have in the mutual context. Members of the New York
Stock Exchange, for example, are directly regulated by the SEC,
and that puts a significant crimp in their ability to act
solely not only in the interest of making profits for the New
York Stock Exchange, it also puts a serious crimp in their
ability to run contrary to what might be U.S. policy in the
securities markets. On the other hand, when you have got public
shareholders who can be anyone around the world essentially, so
I think there may be some limits on share ownership with
exchanges. They are looking for one thing, and that is profits.
And as much as you may hear those talking about mergers, hoping
that they will be in the best interests of the United States,
you know, I consider that nothing more than diplomacy. They are
out there doing one thing, and that is trying to maximize value
for their shareholders. And if it means going abroad, that is
where they will go. If it means staying in the U.S., they will
stay.
Mr. Goodlatte. Thank you. Two more questions I will direct
each of you. Do you believe that the Deutsche Borse merger will
enhance or reduce New York City's role as a global financial
center?
Mr. Harris. I do not think it will have any difference at
all. The trading of securities now is not a major issue within
financial markets. The financial markets, the intelligence, the
where the money is made, the where the difficulties are, have
to do with raising capital. They have to do with structuring
transactions. They have to do with recognizing where value
lies.
The actual trading in the securities and electronic markets
is a commodity business, could take place anywhere. There is
not a lot of money to be made in it. And, frankly, that is the
reason why we are seeing these mergers is because they are
trying to reduce those costs.
Mr. Goodlatte. Thank you. Professor Bullard?
Mr. Bullard. I just do not know the answer to that
question.
Mr. Goodlatte. Okay, very good.
Mr. Bullard. We do not say that very often.
Mr. Goodlatte. We certainly understand. There are questions
like that out there.
And the last question I have is, some, such as Grant
Thornton Senior Advisor David Weild, argue that the
technological and regulatory changes that have increased
competition for exchanges have helped to drive spreads and fees
so low that exchanges focus on generating trading volume with
large-cap companies rather than helping small- and mid-cap
companies access capital. Do you agree with his analysis?
Professor Harris?
Mr. Harris. No, I do not.
Mr. Goodlatte. Can you explain?
Mr. Harris. I just do not see any evidence of it. The
exchanges are actively looking for listings, both for large
firms and small firms. There might be some basis in the
argument on the sense that in the past, the exchanges tried to
encourage dealers to subsidize the trading in the smaller firms
by charging wider spreads, but standing present in the event
that somebody needed to trade. It is harder to do that in an
electronic environment, but that subsidy was, in some sense, a
false subsidy. It was damaging traders or hurting traders when
trading was normal, and it was helping only the dealers'
friends when the liquidity was really necessary. It represented
a regulatory problem that, frankly, I think has gone away, and
I welcome that we do not face it anymore.
Mr. Goodlatte. Thank you. Professor Bullard?
Mr. Bullard. You know, I do not have an opinion on that
issue.
Mr. Goodlatte. Thank you.
Gentleman from North Carolina, Mr. Watt?
Mr. Watt. Mr. Chairman, I think I will pass on this round.
Mr. Goodlatte. The gentlewoman from California, Ms. Waters.
Are you ready to ask questions?
Ms. Waters. Thank you very much, Mr. Chairman. Sorry I
could not be here during the entire hearing.
And I suppose I am wondering, as many others are, about
this NASDAQ/New York Stock Exchange merger. What are the
implications of this merger? Are there some anti-competitive
aspects of this that we should be concerned about? I suppose
that is on everybody's minds, so I would appreciate any
thoughts on that.
Mr. Goodlatte. I thank the--go ahead.
Mr. Bullard. I could repeat Professor Harris' comments, and
he could repeat mine. Earlier we had a discussion about some
potential impacts, and we talked about how there does not seem
to be much market benefit to merging the two primary brands in
U.S. markets. And that with respect to trading, where you have
a system where trades can really find their best execution, to
a great extent, under current SEC rules, that is an area where
there is probably less of a concern, although I also noted at
the time that, you know, it concerns me as to whether you will
have on an ongoing basis the kind of oversight of that kind of
enforced competition if the SEC continues to see restrictions
on its ability to provide that degree of oversight.
Mr. Harris. I will introduce a new observation without
commenting much on it.
The NASDAQ used to have market share approaching 80 percent
in its securities. It was eroded by competition from Island and
InstaNet and other ECMs. NASDAQ bought those entities in an
attempt to acquire their technology and restored their market
share only to see the market share drop to new entities, like
Direct Edge and BATS. And now once again, NASDAQ's market share
is on the order of 20 or 30 percent, I believe. Maybe it is 40
percent, I am not sure.
So, now they propose to buy the New York Stock Exchange,
hopefully with a different outcome. And I do not want to
comment on it; it has other dimensions, including the fact that
now they will control listings if the transaction works--the
control listings for both markets, and essentially be the
exclusive listing agent, except perhaps for a new entrant in
BATS that was just announced on Tuesday.
But I do wonder whether the continual combination is just a
denial of what is ultimately true, which is that this is a
commodity business in which people with computers can buy
software off the shelf, open up an exchange that provides
excellent service to everybody. How can you compete well
against that model? And the answer is it is very difficult, but
that is great for the consumer because they are getting pretty
good service.
There are market fragmentation concerns by having so many
competitors where, you know, there is a buyer in one market and
a seller in another market. How do they ever find each other?
But the answer is, there are electronic mechanisms that connect
them. Many of those mechanisms are operated by the so-called
high frequency traders who are in the business of basically
connecting a buyer in one market to a seller in another market.
And they do earn some profit from it, but in the end the
consumer is better off because it is so cheap to trade.
In a world where we had perfect, perfect foresight, we
might construct a single exchange that in some way would
hopefully serve everybody's interests perfectly, which is
impossible because people have different interests. And then it
would be really easy for the buyer to find the seller. But
there we would have a problem with, what about the tension
between well-informed traders and large institutions? Large
institutions often represent pensioners. They are often not
particularly well informed, and they do not like to lose to
well-informed traders. So, they patronize dark pools, these so-
called hidden order systems, where they actually obtain much
better executions because they do not display their orders. If
they display the orders, there are a variety of strategies that
allow other people to become parasites off of these
institutions and ultimately hurt pensioners.
So, we have a diversity of market structures that appeal to
the diverse needs of different types of traders, and to force
them all into a single structure would seem pretty unwise to
me.
Ms. Waters. Well, I certainly thank you for that answer.
You have certainly provided me with more information than I can
digest or comprehend at this time. Thank you very much.
Mr. Goodlatte. I thank the gentlewoman.
The gentlewoman from Texas, Ms. Jackson Lee, is recognized
for 5 minutes?
Ms. Jackson Lee. Thank you very much, Mr. Chairman.
I indicated to you that I wanted to submit into the record
the article that I believe is CNN. But anyhow, just the
headline, From Shame to Anti-Trust. And then I have one from
Financial
Times.com, and they have a very good sentence here. ``The
move''--and this is about NASDAQ--``is a sign that a wave of
exchange consolidation triggered 5 months ago has become a
battle between the world's biggest entities for poll position
in an industry pressured by competition.'' What an irony that
we have now tried to demonize competition and find a way to
swallow up, to consume anyone or any entity that poses a
competitive edge, or allows there to be some tension in the
industry, tension in the media industry, good tension in the
airline industry. And so, besides the board of directors and
the shareholders, the CEO apparently gets brownie points for
coming and saying, here is our next opportunity for making
money. You are not making a product. You are not creating more
jobs. But the way to make more money is let us, you know, just
consume--put a little salt on it, a little pepper--the
competitor.
[The information referred to follows:]
__________
Ms. Jackson Lee. I do not get it, I really do not. And so,
my question, since we are in the midst of job surging and job
creating, it is just a simple question. Will these mergers--and
I know these are the financial markets--lead to further job
creation for Americans? Do they have any impact on reversing
job growth trends that we are experiencing--good news that we
are experiencing? Americans need jobs, and obviously this is
financial markets and very technical. Most Americans do not
understand.
But let me add to that that if there was a merger, does
that mean that the special, talented guys and ladies that I
have come to know and being on the floor of the New York Stock
Exchange, and paper falling all over everywhere--they have
gotten a little bit more sophisticated. Do they get slashed in
the hand? Do you cut them? Professor Harris, you talked about
technology, but when you go to the stock exchange, there are
still a bunch of folk running around--quite a number of jobs
and also jobs that provide a good income.
And let me add this point to my inquiry. Is there any
precedent--and obviously I am answering my own question, but I
want to hear from you--for these types of mergers? And what
have you seen, and what results have you seen with respect to
these types of mergers? And I do not know whether you would
assume that the bank mergers equal that, but I sort of separate
out the bank mergers from the exchange. But if you can deal
with this question of job creation. Can we go back and say this
is really a good initiative for job creation? Are we going to
see the cutting of personnel at the New York Stock Exchange?
And what impact have you seen on mergers similar to this kind
of financial merger?
Professor Harris and then Professor Bullard. Thank you.
Mr. Harris. First, let us put things into perspective. The
exchange services industry is really a very small industry.
There is not a lot of employment here, and, of course,
employment has been dropping as computers are doing the work
more effectively.
Before the New York Stock Exchange used to be a much, much
busier place than it presently is, and it has gotten much less
busy because they are using computers increasingly. And it will
get less busy in the future undoubtedly.
The vast majority of the people who trade on the floor of
the exchange are honest people and always have been. But there
are unfortunately a good number of them who were not honest. We
had scandals with the specialists. We had scandals with
brokers. We had people who were violating rules because we
could not see that they were violating the rules. That does not
happen with computers anymore, and that is a good thing.
So, to be concerned about their jobs, absolutely. There are
people about whom we should be concerned. But at the same time,
we do not want people to be plowing our fields behind oxen
because that is the way they always did it. There have been
changes that allow us to be far more productive, and we feed
far more people now because we use powered machines to plow our
fields. In the same way, we are able to do far more in the
exchange services arena using computers.
Now, with respect to job creation in general, there is
basically within the Western world a single market for capital.
Capital moves quite easily among countries, and while we would
like to have the managers of that capital to be working in the
United States, the sources of capital are all over the place.
And they will serve up capital to people who have good ideas
regardless of how the financial system is organized.
So, we need to do things to make it possible for those
transactions that take place here to support jobs in this
country. But the big story, will capital go to the best ideas,
that is going to happen no matter what. And getting capital to
the best ideas is the way we get the most jobs in the United
States.
Within the exchange services industry, we would like to see
a very strong industry that is reliable, safe, that does
provide sensible employment where it is possible. And for that
we just need to have well-educated people who can manage money
and who know how to connect the buyers and sellers, the savers
to the investors.
Ms. Jackson Lee. Professor Bullard?
Mr. Bullard. I think I would largely echo virtually all of
that. I think just more bluntly, in the short term, there is no
question there will be job lost, and there will be jobs lost in
New York. Whatever merger happens, the CEOs will ensure that
the promise of savings happens, and it will be in the form of
some job losses. In theory, what happens to those people is
then they find jobs with the new competitors of this new
entity, and they continue to thrive and----
Ms. Jackson Lee. Maybe.
Mr. Bullard [continuing]. Engage in competition, in theory.
As to job creation going forward, I think that is a
function of whether the United States is producing the bodies
that are going to be paid these higher incomes for providing
this high-end, very sophisticated service, which is setting up
the kinds of exchanges that do the best job for the markets.
And all you have to look at is just the training and testing
scores that you see in the United States to make judgments
about where we are in that competition. I think some of the
news is good and some of the news is bad, but I think that is
really where you are going to find the answers.
Whether in the long term, the bottom line is whether those
exchanges are going to be paying U.S. people or are they going
to be paying other people.
Mr. Goodlatte. The time of the gentlewoman has expired.
Ms. Jackson Lee. I thank the gentleman.
Mr. Goodlatte. The gentleman from Ohio, Mr. Chabot, is
recognized for 5 minutes?
Mr. Chabot. Thank you, Mr. Chairman. I will not take up the
5 minutes. It was just a point that I wanted to make, or at
least ask a question related to the questioning and the answers
that we just heard.
Professor, you had mentioned that there were fewer people
working on the floor of the Stock Exchange nowadays, and that
we have computers that have replaced some of those folks. And
obviously, if you are one of those folks, that is very
unfortunate.
But what has it done relative to the, say, the per cost
transaction to the consumer, the person that is either buying
or selling stocks? What has been the trend over time, even
though we have fewer people there?
Mr. Harris. The trend has been extremely obvious and in one
direction. The cost of trading to individuals and institutions
has dropped very significantly. We see this both in bid out
spreads that have dropped from--it used to be a quarter, 25
cents; it is now typically one penny or two pennies.
We also see it in the form of much lower commissions. Now,
this is in the brokerage industry, not in the exchange services
industry. But it is an allied industry subject to the same
technological innovations. Brokerage commissions have dropped
very substantially, both for institutions and for individuals,
where individuals now can trade essentially as much as they
want for about $10. It used to cost them $150 or more.
Institutions used to pay 5, 7, 10 cents a share; now they are
typically paying 1 and a half to 3 cents, and they can pay and
get excellent quality service for less than a penny.
Mr. Chabot. And so, the consumer, small investors--and
would it be accurate to say that nowadays, other than after the
meltdown, in which case I am guessing that a lot of small
consumers either got out or were scared out of the market or
whatever. But the trends other than that, more and more people
are investing, I would say, on their own and in larger
percentages of the population than in the past? Would that be
accurate?
Mr. Harris. That certainly has been the trend since World
War II, and I believe it continues.
Mr. Chabot. And so, the consumer--if the consumer is the
person who buys and sells stock, especially the small consumer,
they would be making more money in each transaction because
they are paying out less costs, or at least the expenses are
lower to them. Is that correct?
Mr. Harris. Yes. Any time the expenses are lower, the
trading activity is more profitable or, alternatively, less
costly.
What we hope by this is that if the consumer believes that
they can use the markets to move their money from the present
to the future so that they can retire, or move money from the
present to the future so that their children can go to a
university, if they can do that more cheaply than they
otherwise could do it, then they will save their money in the
markets, and that will make money available to companies who
hopefully have good ideas and generate more employment.
Mr. Chabot. Thank you very much, Professor.
Professor Bullard, I do not know if you----
Mr. Bullard. When you were talking about there are more
direct investors, I think there has actually been declining
direct investment in equities as opposed to investment through
other collective investment vehicles. These savings----
Mr. Chabot. Do you mean mutual funds in particular? Do you
mean----
Mr. Bullard. Mutual funds, but there you have seen equally
drastic reduction in trading costs as well. So, investors are
benefitting in that context just as well.
Mr. Chabot. Okay, very good. Thank you very much. I yield
back, Mr. Chairman.
Mr. Goodlatte. I thank the gentleman.
I would like to thank both of our witnesses for their
testimony. They have made, I think, an important contribution
to our understanding of competition in this market. And as I
noted at the outset, because of the rapid developments that
have occurred within the last now 15 hours, we will revisit
this issue at the appropriate time with the appropriate
witnesses and taking heed of the concerns raised by the Ranking
Member, Mr. Watt, that the Subcommittee do so with the fairness
that one would expect of us.
So without objection, all Members will have 5 legislative
days to submit to the Chair additional written questions for
the witnesses, which we will forward and ask the witnesses to
respond as promptly as they can so that their answers may be
made a part of the record.
Without objection, all Members will have 5 legislative days
to submit any additional materials for inclusion in the record.
And with that, I, again, thank the witnesses and declare
the hearing adjourned.
Mr. Harris. Thank you.
Mr. Bullard. Thank you.
[Whereupon, at 2:22 p.m., the Subcommittee was adjourned.]