[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
OVERSIGHT OF THE SEC'S DIVISION
OF TRADING AND MARKETS
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
__________
JUNE 26, 2014
__________
Printed for the use of the Committee on Financial Services
Serial No. 113-88
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HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
GARY G. MILLER, California, Vice MAXINE WATERS, California, Ranking
Chairman Member
SPENCER BACHUS, Alabama, Chairman CAROLYN B. MALONEY, New York
Emeritus NYDIA M. VELAAZQUEZ, New York
PETER T. KING, New York BRAD SHERMAN, California
EDWARD R. ROYCE, California GREGORY W. MEEKS, New York
FRANK D. LUCAS, Oklahoma MICHAEL E. CAPUANO, Massachusetts
SHELLEY MOORE CAPITO, West Virginia RUBEEN HINOJOSA, Texas
SCOTT GARRETT, New Jersey WM. LACY CLAY, Missouri
RANDY NEUGEBAUER, Texas CAROLYN McCARTHY, New York
PATRICK T. McHENRY, North Carolina STEPHEN F. LYNCH, Massachusetts
JOHN CAMPBELL, California DAVID SCOTT, Georgia
MICHELE BACHMANN, Minnesota AL GREEN, Texas
KEVIN McCARTHY, California EMANUEL CLEAVER, Missouri
STEVAN PEARCE, New Mexico GWEN MOORE, Wisconsin
BILL POSEY, Florida KEITH ELLISON, Minnesota
MICHAEL G. FITZPATRICK, ED PERLMUTTER, Colorado
Pennsylvania JAMES A. HIMES, Connecticut
LYNN A. WESTMORELAND, Georgia GARY C. PETERS, Michigan
BLAINE LUETKEMEYER, Missouri JOHN C. CARNEY, Jr., Delaware
BILL HUIZENGA, Michigan TERRI A. SEWELL, Alabama
SEAN P. DUFFY, Wisconsin BILL FOSTER, Illinois
ROBERT HURT, Virginia DANIEL T. KILDEE, Michigan
STEVE STIVERS, Ohio PATRICK MURPHY, Florida
STEPHEN LEE FINCHER, Tennessee JOHN K. DELANEY, Maryland
MARLIN A. STUTZMAN, Indiana KYRSTEN SINEMA, Arizona
MICK MULVANEY, South Carolina JOYCE BEATTY, Ohio
RANDY HULTGREN, Illinois DENNY HECK, Washington
DENNIS A. ROSS, Florida STEVEN HORSFORD, Nevada
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
KEITH J. ROTHFUS, Pennsylvania
LUKE MESSER, Indiana
Shannon McGahn, Staff Director
James H. Clinger, Chief Counsel
Subcommittee on Capital Markets and Government Sponsored Enterprises
SCOTT GARRETT, New Jersey, Chairman
ROBERT HURT, Virginia, Vice CAROLYN B. MALONEY, New York,
Chairman Ranking Member
SPENCER BACHUS, Alabama BRAD SHERMAN, California
PETER T. KING, New York RUBEEN HINOJOSA, Texas
EDWARD R. ROYCE, California STEPHEN F. LYNCH, Massachusetts
FRANK D. LUCAS, Oklahoma GWEN MOORE, Wisconsin
RANDY NEUGEBAUER, Texas ED PERLMUTTER, Colorado
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California JAMES A. HIMES, Connecticut
LYNN A. WESTMORELAND, Georgia GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan KEITH ELLISON, Minnesota
STEVE STIVERS, Ohio BILL FOSTER, Illinois
STEPHEN LEE FINCHER, Tennessee JOHN C. CARNEY, Jr., Delaware
MICK MULVANEY, South Carolina TERRI A. SEWELL, Alabama
RANDY HULTGREN, Illinois DANIEL T. KILDEE, Michigan
DENNIS A. ROSS, Florida PATRICK MURPHY, Florida
ANN WAGNER, Missouri
LUKE MESSER, Indiana
C O N T E N T S
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Page
Hearing held on:
June 26, 2014................................................ 1
Appendix:
June 26, 2014................................................ 35
WITNESSES
Thursday, June 26, 2014
Luparello, Hon. Stephen, Director, Division of Trading and
Markets, U.S. Securities and Exchange Commission............... 8
APPENDIX
Prepared statements:
Luparello, Hon. Stephen...................................... 36
Additional Material Submitted for the Record
Luparello, Hon. Stephen:
Written responses to questions for the record submitted by
Representative Messer...................................... 47
Written responses to questions for the record submitted by
Representative Fincher..................................... 50
Written responses to questions for the record submitted by
Representative Stivers..................................... 56
OVERSIGHT OF THE SEC'S DIVISION
OF TRADING AND MARKETS
----------
Thursday, June 26, 2014
U.S. House of Representatives,
Subcommittee on Capital Markets and
Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 9:19 a.m., in
room 2128, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Hurt, Neugebauer,
Huizenga, Mulvaney, Ross, Wagner, Messer; Maloney, Lynch,
Perlmutter, Scott, Himes, Foster, Carney, and Sewell.
Ex officio present: Representative Waters.
Chairman Garrett. Good morning.
Today's hearing of the Capital Markets and Government
Sponsored Enterprises Subcommittee is hereby called to order.
Today's hearing is entitled, ``Oversight of the SEC's Division
of Trading and Markets.'' And I welcome the panel. After
looking yesterday where it was an elongated two-panel hearing,
I welcome our one witness, Mr. Luparello, to the Capital
Markets Subcommittee hearing today, and I look forward to your
testimony.
We will begin with opening statements. And I recognize
myself for 6 minutes.
Today's hearing will focus on the activities of the
Division of Trading and Markets of the Securities and Exchange
Commission.
Director Luparello, welcome, and thank you for your
testimony that you provided in writing and the testimony that
you are going to present today.
The Division of Trading and Markets at the SEC, as you
know, has a broad swath of responsibility and authority over
activities that represent some of the core functions of the
U.S. capital markets.
Specifically, the Division sits at the epicenter, if you
will, of our Nation's equity, fixed-income, and derivatives
marketplaces.
The SEC is reforming or considering reforms of all three of
those markets. These changes will dramatically change the way
that investors invest, issuers raise capital, and businesses
hedge their risk.
First, let's look at the equity markets. Let me thank you
again for participating in the roundtable that we held, I guess
a little over a year ago up in New York City.
The roundtable, as you know, served as a substantive
starting point for Members and other attendees to learn about
the evolution of the rules governing equity markets today.
I think it was a very informative discussion we had there
and provided a solid foundation from which to better comprehend
the current challenges faced by the various market participants
as well as the potential impact rule changes could have.
And to that end, by the way, Chair White gave a speech
recently where she outlined a number of prospective changes to
various market practices in an attempt to address some of the
issues most frequently highlighted as concerns.
And so, when she did that, I applauded her, and I continue
to applaud her for her continued focus on our Nation's equity
markets.
But I caution that moving too quickly or in an ad hoc
manner without thinking through all of the possible
consequences could, as I say, do more harm than good.
It is so critical, then, that besides just addressing
specific narrow issues being faced by market participants, that
the Commission conduct a fundamental review and challenge many
of the central assumptions regarding the rationale of its
overall regulatory regime.
Let me provide perhaps two specifics areas where I would
like to see more attention from the Commission.
First, the world is vastly different, we all agree, from
1975, when Congress amended the Exchange Act in response to one
dominant equities exchange at the time.
We live in a world of demutualized exchanges where all
market centers are for-profit, providing similar functions, yet
they are competing under very different regulatory umbrellas.
The SEC should take the time, therefore, to thoroughly
analyze the situation and eventually make changes that put
these varying market participants on, as I always say, a more
level playing field.
Second, Reg NMS, as the order protection rule, is a very
heavy-handed rule dictating explicitly how venues and orders
are supposed to interact with each other in the marketplace.
Now, this has been highlighted by a number of the
commentators, including some of our previous panelists here, as
one of the significant factors underlining market practices
and, also, behavior.
So I look forward to discussing these issues, as well as
Chair White's recent proposals, during the questioning period
that we will have after the testimony.
Next, in regard to fixed income, many argue that this is
often a part of the marketplace that is overlooked compared to
the equity markets.
Our corporate and municipal bond markets have literally
trillions of dollars of outstanding issuances, and they provide
investment opportunities for millions of investors, but these
markets are very different than our equity markets.
Chair White gave a speech on Friday outlining some
proposals seeking additional practices and price transparency
for investors in these less liquid markets than the equity
markets.
So I believe increasing transparency and competition for
the benefit of the investors is appropriate, and I'm interested
to see more specifics on how these new proposals that she is
talking about will actually work.
All that said, I do worry that the Commission's reform
potentially robs from Peter to pay Paul, as they say.
Specifically, how do we help investors in the corporate bond
market if we improve pricing transparency, on the one hand, but
if we reduce liquidity through the Volcker Rule, on the other
hand?
Requiring additional transparency for markets that the
Commission made less liquid and where investors have to pay
wider spreads is not a net win for the investors at the end of
the day.
A greater investor protection in this market would be to
ensure greater liquidity and better ways for investors to get
in and out of the positions. That is what liquidity is about.
The SEC then needs to closely examine on an ongoing basis
the impact of the Volcker Rule on the liquidity in the
corporate bond market and keep policymakers well-informed of
this important information.
Finally, regarding derivatives, the Commission took a very
important step yesterday in finalizing rules that specify how
market participants that have affiliates overseas will be
impacted under the SEC's Title VII regime.
So I applaud the rigorous and thoughtful process that the
Commission undertook when finalizing those rules, and I am also
hopeful that the new leadership over at the CFTC, some of which
we just swore in the other day, will allow this process to go
forward and to follow suit and formalize their guidance which
they have had in the past under a rule now so that the force of
law will not be in question.
Finally, another issue that has continued to be one of much
debate is the proper regulatory approach for broker-dealers.
Recently, one of the Commissioners gave a speech
essentially saying that the SEC is now a systemic risk
regulator, and that statement caught us by surprise.
It is my understanding that Congress created the SEC as a
markets regulator with three-part function of: protecting the
investors; maintaining fair, orderly, and efficient markets;
and facilitating capital formation.
I served on the Dodd-Frank Act conference committee, and
nowhere in that do I recall the mission of the SEC actually
changing to a systemic risk regulator.
So I am very concerned that the Division of Trading and
Markets actually might be losing one of its primary
responsibilities, which is oversight of broker-dealers.
It appears that the Federal Reserve--without any proper
authority whatsoever from Congress, what they are trying to
spread is a regulatory and bailout net over even the broader
marketplace and over the broker-dealer community as well.
So we must stop enlarging the government's safety net and,
instead, remove moral hazard and reinstate market discipline.
The Division of Trading and Markets has many important
tasks at hand. Other issues that I have not gone into in
detail, but are nonetheless important, are: regulating clearing
agencies and transfer agents; overseeing FINRA and other SROs;
determining whether or not to change the duty of care for
broker-dealers; and conducting oversight of the out-of-control
and anti-investor Security Investor Protection Corporation.
So, Director, thank you for taking on this very difficult
assignment and also for being here today. This subcommittee
wants to make sure we work closely with you in the future and
also with Chair White and the rest of the Commission as well as
you carry out your important duties.
With that, I now recognize the ranking member of the
subcommittee, the gentlelady from New York, Mrs. Maloney, for 5
minutes.
Mrs. Maloney. Thank you, Chairman Garrett, for holding this
very important and timely hearing.
And welcome, Mr. Luparello.
Mr. Luparello also participated in your meeting on trading
and markets that you held in New York earlier, which was
tremendously informative and a fine experience for all of us
who were fortunate enough to attend.
The SEC has a critical role in our economy because it is
responsible for overseeing and regulating the Nation's capital
markets.
Without vibrant capital markets, companies would have a
difficult time raising money to expand their businesses and
create jobs, and our economy would be stalled.
The SEC's mission is to simultaneously protect investors,
encourage capital formation by businesses that are seeking to
grow, and maintain fair, orderly, and efficient markets.
Balancing these overlapping objectives is a difficult job,
but I believe the SEC has performed admirably under Chair
White, who, incidentally, is from the great City of New York.
And I look forward to hearing your testimony as well.
There is, however, one common theme that runs through each
of the SEC's three missions. In order to accomplish any of the
SEC's three missions, investors have to feel confident in the
fairness and integrity of our capital markets.
If they are not confident that they will get a fair shake,
they will not put their money at risk in our capital markets
and they will not invest in U.S. companies.
I have always said that markets run more on confidence than
on capital, and I believe that is particularly important right
now.
Over the past decade, the incredible advances in
technology, along with major overhauls of the regulatory
framework for trading stocks, has fundamentally changed our
equity market structure.
Some market participants have seen some huge benefits from
these changes, particularly retail investors. They have seen
their trading costs fall to some of the lowest levels on
record.
And other market participants have not fared as well. The
lower trading costs for retail investors has come at the
expense of certain brokers and intermediaries. This is all to
be expected.
Any fundamental overhaul of our market structures has
winners and losers, but these changes in our market structure
have at the very least caused many market participants to take
a step back and question whether they are still getting a fair
shake.
That is why I think confidence is so important right now.
If there are problems, we need to fix them, because investors'
confidence can disappear in the blink of an eye.
I was pleased to hear Chair White say in our April hearing
in response, really, to the chairman's question that the U.S.
stock market is not, in fact, rigged, as some have claimed.
And I will say that almost all of the market participants
that I speak to have expressed tremendous appreciation for the
SEC's careful, data-driven approach to market structure issues.
I was also pleased to see that just last night, the SEC
announced a pilot program that will test whether wider tick
sizes will increase capital formation for smaller companies.
This committee passed unanimously a bill last November that
required the SEC to conduct such a pilot program, and that
passed the House overwhelmingly.
So I am pleased to see that the SEC has shown a willingness
to work with this committee on these important and other very
complex market structure issues.
I look forward to working with our witness, Mr. Luparello,
who recently took over as the Director of the SEC's Division of
Trading and Markets.
Even though he has only been on the job for a few short
months, his Division has already announced several major
initiatives, and I look forward to hearing from him today.
Thank you very much. And I yield back the balance of my
time.
Chairman Garrett. The gentlelady yields back. Thank you
very much.
We now turn to the vice chairman of the subcommittee, Mr.
Hurt, for 2 minutes.
Mr. Hurt. Thank you, Mr. Chairman. And thank you for
holding today's hearing to conduct oversight over the SEC's
Division of Trading and Markets.
While the SEC's Division of Trading and Markets has a
number of consequential initiatives on its agenda, including
the review of our equity market structure, I am particularly
interested in hearing about issues related to the self-
regulatory organizations.
I am encouraged by SEC Chair White's recent comments that
the Commission's review of equity market structure will include
an examination of the nature of our self-regulatory model.
However, some, including SEC Commissioner Gallagher,
suggested that over time SROs have changed dramatically from
self-regulatory to quasi-governmental and now operate more like
an additional branch of government.
Congress delegated specific responsibilities to these
entities, and they should not be immune from our scrutiny. It
is important for this subcommittee to look closely at the
current structure of the SROs, their role in our financial
regulatory system, whether their operations are sufficiently
transparent and accountable, and finally, if changes are
necessary to ensure that they meet the standards and
responsibilities imposed by Congress.
I am pleased to see several of the SROs implementing more
robust processes for economic analysis in their rulemaking.
It is incumbent upon the SEC and Congress to ensure that
these cost-benefit standards are rigorously applied. Congress
and the SEC should also promote similar policies for the
remaining SROs, instead of a reliance on ad hoc measures.
I look forward to working with my colleagues on this
subcommittee to critically examine the SROs in our framework of
self-regulation in financial markets today.
I want to thank Mr. Luparello for appearing before our
subcommittee. I look forward to your testimony.
And thank you, Mr. Chairman. I yield back the balance of my
time.
Chairman Garrett. I thank the gentleman. And the gentleman
yields back.
We will go to Mr. Lynch now for 2 minutes.
Mr. Lynch. Thank you, Mr. Chairman.
And thank you, Ranking Member Maloney.
And welcome, Director Luparello.
Mr. Luparello, you are at the helm of the Securities and
Exchange Commission's Division of Trading and Markets at a time
of great importance.
Currently, our capital markets face many challenges,
including, most importantly, I think, high-frequency trading, a
subset of algorithmic trading, and you have mentioned that
extensively in your written remarks.
The rise of algorithmic trading, whereby computer
algorithms make trading decisions, creates both new
opportunities and challenges for U.S. investors and regulators.
As highlighted in Michael Lewis' book, ``Flash Boys,''
advancements in the speed of information are allowing high-
frequency traders to front-run trades and exploit market
fragmentation for profit without providing socially useful
intermediation between investment capital and the companies who
can put that capital to use.
Now, I am not sure if using the term ``rigged'' is proper,
that our markets are rigged, but I do know that there are two
firms: Virtu Financial, which traded heavily in the market for
5 years without a losing day, which is incredible; and
Tradebot, which traded for over 4 years without a losing day in
the market.
So maybe ``rigged'' isn't the proper term, but let's just
say the current structure of the market favors high-frequency
traders over average investors. And maybe that is why we are
seeing a lot of investors walk away from the market, because
they believe it is rigged.
I, along with many of my colleagues in Congress, am
particularly concerned about abuses in the markets caused by
this practice.
Both the Senate Banking Committee and the Senate Permanent
Subcommittee on Investigations recently held hearings to
examine disruptions in the market caused by high-frequency
trading. And I think this committee could do the same.
In a recent speech, SEC Chair Mary Jo White addressed the
public's growing concern about high-frequency trading and
proposed recommendations for new rules.
I would like to hear your thoughts today about how that
might be accomplished.
Thank you for the time, Mr. Chairman, and your indulgence.
I yield back.
Chairman Garrett. The gentleman yields back.
Mr. Foster is recognized for 3 minutes.
Mr. Foster. Thank you, Chairman Garrett. I appreciate your
holding this hearing.
Mr. Luparello, I appreciate your appearing before this
committee to discuss the complex and important issues around
market structure.
I believe it is easy to make the case that technology has
largely benefited retail investors who have seen spreads
between bid and ask prices narrow to historically low levels.
Ironically, one of the main challenges in market structure
is protecting the interests of large institutional investors
who are sophisticated participants and are normally thought of
as being fully capable of taking care of themselves.
One analogy that I like to use when thinking about high-
frequency trading and dark pools is the example of Disney
World. Forty years ago, Disney Corporation bought up large
blocks of swampland in central Florida using anonymous shell
corporations and paying the current market price. Was that
fair?
If Disney had attempted this in a State where the prices
and beneficial owners behind real estate transactions were
immediately made public, then land speculators would have
jumped in, buying up parcels of land nearby with the intent of
selling them back to Disney at a profit. Would that have been
fair?
The point I am trying to illustrate is that while dark
pools sound bad to the public because of the implication of
opacity, forcing every transaction into the open would create
winners and losers.
I agree with Chair White that our equities markets are not
rigged. But it is clear that, with 11 exchanges and 40
alternative trading systems, the market is overly fractured and
there is a lack of transparency in many respects.
This competition helps keep trading fees low for investors,
but it also incentivizes routing two exchanges that pay the
most for their orders.
It is also clear that many of the current market
regulations were developed in a world before the equity markets
were dominated by computer algorithms.
And, yet, it is absolutely clear that not enough
information is provided to market participants to know about
how their trades are routed and executed.
Additional measures should be taken to ensure that
alternative trading systems disclose harmonized digestible
information about how they operate and whether or not they are
really offering price improvements from the lit market.
So as you embark on a comprehensive review of our equity
market structure, including issues like order times and
consolidated data feeds, I urge you to use a data-driven
approach to bring about more transparency. Market forces and
transparencies are often the best disinfectant.
Thank you. I yield back.
Chairman Garrett. Thank you.
And the gentleman yields back.
We will now turn to our witness. Mr. Stephen Luparello is
the Director of the Division of Trading and Markets at the U.S.
Securities and Exchange Commission. Mr. Luparello, we can now
turn to you, finally, and hear your testimony.
There are two things I always say: one is to make sure you
bring the microphone close enough to you because we can't hear
otherwise; and, of course, your entire written testimony will
be made a part of the record.
You are now recognized for 5 minutes, Mr. Luparello, and
thank you for being with us.
STATEMENT OF THE HONORABLE STEPHEN LUPARELLO, DIRECTOR,
DIVISION OF TRADING AND MARKETS, U.S. SECURITIES AND EXCHANGE
COMMISSION
Mr. Luparello. Chairman Garrett, Ranking Member Maloney,
and members of the subcommittee, thank you for inviting me to
testify on behalf of the U.S. Securities and Exchange
Commission regarding the Division of Trading and Markets'
activities and responsibilities.
The mission of the Division is to support the Commission's
mandate by fostering investor protection and establishing and
maintaining standards for fair, orderly, and efficient markets.
To this end, the Division is responsible for the rules that
apply to many of the major participants in the U.S. securities
markets. We also oversee the rulemaking activities of the
exchanges, clearing agencies, and FINRA in their capacity as
self-regulatory organizations; monitor risks at large broker-
dealers and clearing agencies; and assist the Commission with
major international regulatory coordination efforts.
Under the Dodd-Frank and JOBS Acts, the Division has
primary responsibility for more than 30 separate mandatory
rulemaking initiatives and studies under the two statutes, as
well as the ongoing oversight and the implementation they
require.
These new responsibilities include the creation of a
regulatory structure for securities-based swaps, the regulation
and monitoring of clearing agencies designated as systemically
important, the prohibition of proprietary trading by insured
depository institutions and their affiliates as part of the
Volcker Rule, and the development of rules for intermediaries
engaged in crowdfunding.
Although the Division's day-to-day and long-term focus
cover a wider set of initiatives and mandates, I want to
highlight a few of the key areas of responsibility and
summarize our current efforts in each.
First, the Division is playing a lead role in the
comprehensive review of equity market structure recently
described by Chair White to ensure that the U.S. equities
markets remain the strongest in the world.
This initiative includes a review of the evolution of
market practices over the last decade and the role of
Commission rules, including Regulation NMS, in that evolution
and the need for any adjustments to that structure.
Chair White has directed the Division to take a number of
specific actions related to high-frequency trading, market
transparency, and order handling, and has recommended that the
Commission create a Market Structure Advisory Committee to
review specific initiatives and rule proposals.
Beyond this, the Division is working with FINRA and the
exchanges to advance several initiatives, including efforts to
minimize consolidated data latency and enhanced transparency
and the extent to which such latency exists, clarify how
exchanges themselves use data feeds for regulatory and routing
purposes, and review order types offered by the exchanges to
clarify their operation.
Another important part of the review is developing
recommendations to improve the market for smaller issuers, as a
core guiding principle of our review is the recognition that,
when considering market structure, one size certainly does not
fit all.
To this end, the Commission is continuing its evaluation of
decimalization rules, including its consideration of a tick-
size pilot that would widen the quoting and trading increment
for certain smaller company securities and exploring other
competitive market structure alternatives for smaller cap
issuers.
In addition, last year, at Chair White's request, each of
the exchanges, FINRA, and the clearing agencies prepared action
plans to strengthen critical market infrastructure.
These entities currently are working to implement these
plans, including through several important measures that should
be completed in the very near future.
Additionally, in March 2013, the Commission proposed Reg
SCI to improve the Commission's oversight of market
infrastructure.
As proposed, the rule would require exchanges, clearing
agencies, and other critical market participants to have in
place policies and procedures reasonably designed to help
ensure that their systems are robust, secure, and compliant.
Beyond the many important market initiatives, the Division
is working to fulfill the Dodd-Frank Act Title VII mandate to
establish a new regulatory regime for security-based swaps,
which historically have traded over-the-counter.
These rules are intended to achieve a number of goals,
including facilitating the centralized clearing of swaps with
the intent of reducing counterparty risk, increasing
transparency for regulators and market participants, and
addressing capital and margin requirements for security-based
swap dealers and major security-based swap participants.
To date, the Commission has proposed all of the rules
required by Title VII, adopted a number of final rules and
interpretations, and provided a road map for the further
implementation of its Title VII rulemaking, and has taken other
actions to provide legal certainty to market participants
during the implementation process.
Just yesterday, the Commission adopted rules regarding the
application of Title VII to cross-border activity. Division
staff continues to work to develop recommendations for final
rules required by Title VII and has been actively engaged in
discussions with domestic and foreign regulators regarding the
direction and coordination of international derivatives
regulation.
The Division is also continuing its efforts to establish
rules pursuant to Title VIII of the Dodd-Frank Act, which
requires the Commission to increase regulation of financial
market utilities and financial institutions engaged in payment
clearing and settlement activities that are designated as
systemically important.
Finally, the Division and other SEC staff are considering
how to recommend the Commission use its authority under the
Dodd-Frank Act to adopt rules establishing a uniform fiduciary
standard for conduct for broker-dealers and investment advisors
when providing personalized investment advice about securities
to retail customers.
To more fully inform the Commission's decision on this
issue, Chair White has directed the Division to work with its
colleagues in DERA and the Division of Investment Management to
evaluate potential options in light of the information
available for the Commission's consideration.
Thank you again for inviting me to discuss the Division's
activities and responsibilities, and I look forward to
answering your questions.
[The prepared statement of Mr. Luparello can be found on
page 36 of the appendix.]
Chairman Garrett. Thank you very much. We appreciate your
testimony.
I now recognize myself for 5 minutes for questions.
I am going to begin with the same question that I asked
Chair White: Director, are the markets rigged?
Mr. Luparello. That is an easy question to start with.
No. The markets are not rigged. There are clearly things
about the markets that require further attention and perhaps
some regulatory response or enhanced transparency, and the
Commission and the Division are focused on that. But
fundamentally, the markets are fair for investors.
Chairman Garrett. So when the issue of investor confidence
is raised, should investors have confidence in the markets?
Mr. Luparello. I think it is fair to worry about investor
confidence, even if you think the markets are not rigged.
The extent to which there is a perception that it is rigged
is maybe--it is not as important as whether the markets are
actually rigged, but it is obviously a very important thing for
the Commission.
So one of the things we have to do in our policymaking is
do things that reassure participants in the market that the
markets are fundamentally fair to them.
Chairman Garrett. Okay. This may be a segue; I don't know.
Chair White, just recently, in her speech the other day,
touched on some of the proposals that you--one of the proposals
was the creation of a market advisory committee. And I presume
such an advisory committee is supposed to serve as a resource,
if you will, of information from stakeholders and the like.
And I assume that the purpose of it is to provide that
information as you go forward--you and the entire SEC goes
forward with the other recommendations that she and you are
considering. Is that correct?
Mr. Luparello. That is correct.
Chairman Garrett. And she didn't really elaborate. She just
spoke one or two sentences in her speech.
So is this advisory committee being put together by her or
is this being put together by the entire Commission? How does
that work? Maybe you could flesh it out, if you will, a little
bit.
Mr. Luparello. I will flesh it out to the extent I can.
Chairman Garrett. Okay.
Mr. Luparello. The committee will be a committee that will
be consistent with the obligations of the Federal Advisory
Committee Act.
Chairman Garrett. Okay.
Mr. Luparello. At this point, the staff is presenting a
recommendation to the entire Commission, which will include the
mandate, the charter, and the proposed participants.
Chairman Garrett. Okay.
Mr. Luparello. And, to that point, the entire Commission
will have an opportunity to vote on the--
Chairman Garrett. So, where do the people come from? Who
makes the recommendations to serve on this? Is that from Chair
White or is it from the whole Commission?
Mr. Luparello. The recommendations in the first instance
will be made by staff--
Chairman Garrett. By staff.
Mr. Luparello. --on Trading and Markets and others. But,
obviously, the Commission will have input into that.
Chairman Garrett. The Commission.
Mr. Luparello. Yes.
Chairman Garrett. Okay.
A whole slew of issues are being run through here today.
Other people have raised, and we have talked about in this
committee previously, Reg 611, also known as the trade-through
rule, as an area some people say needs extensive, thorough
review, and other people push away and say not.
One of the people who says that it does need further review
is Andy Kessler, in a recent Wall Street Journal piece--I
remember reading that the other day--and across the Chamber,
Senator John McCain. In his opening statement at the Permanent
Subcommittee on Investigation hearing on market structure, he
also said it does.
What is your take on this? Is this an area that is going to
be one of the primary focuses of the SEC for review?
Mr. Luparello. The Chair, in her speech, laid out what I
think you can basically categorize as short-term initiatives
and longer-term initiatives.
Chairman Garrett. Okay.
Mr. Luparello. Clearly, the study of Reg NMS, broadly, but
specifically the issue of the trade-through rule is one that is
very much on our agenda.
Unlike the shorter-term issues, I think the staff tends to
think that there is more study and more discussion that needs
to go on. There are obviously some benefits that have come with
Reg 611 in terms of competition.
Obviously, there is also a substantial amount of
fragmentation that has come with it. That is a very difficult
issue to balance.
Chairman Garrett. Yes.
Mr. Luparello. It is very much on our agenda, but at this
point I don't think we have reached a conclusion.
Chairman Garrett. Okay. So one other question. I have 50
seconds here to go.
There is an issue about dealing with best execution and
whether you are enforcing and modernizing that whole system.
Right?
And also tied to that is the issue of disclosure
requirements on that. So there is an issue there as far--as you
do that, whether that has a conflict of interest as far as the
broker is concerned.
So, in 26 seconds: first, address that; and second, if you
are going to be addressing those couple of issues there and
that point, the other issue is: Are you getting into the weeds
too much on these specific issues before you do a more holistic
analysis of the overall market structure before getting down
into trying to fix those pieces of it?
Mr. Luparello. You touched on it perfectly, which is that
so many of these issues are fundamentally interrelated.
Chairman Garrett. Right.
Mr. Luparello. And to try to look at them in a stovepipe
means you are probably going to have as many unintended
consequences as intended consequences.
Chairman Garrett. Exactly.
Mr. Luparello. There is a very important sort of
overarching analysis of how much best execution drives a
variety of things, whether it is the need for the trade-through
rule or further disclosure on payment for order flow or things
like maker-taker pricing. All of those issues, I think we will
look at together.
Again, I think it is important for confidence and, because
of a variety of smaller fixes, that we move quickly on the
shorter-term initiatives.
But we will, on the longer-term initiatives, look at all
these things together and not attempt to sort of pick them
apart in ways that are artificial.
Chairman Garrett. Good luck. I appreciate that.
The gentlelady from New York is now recognized for 5
minutes.
Mrs. Maloney. Thank you very much.
The chairman started with his first question to Chair
White. I am going to begin with mine.
I asked, ``Are the markets rigged?'' And Chair White said,
``Absolutely not.'' And I said, ``Some of my constituents think
they are.''
So, that goes to the confidence issue. And they think they
are because of books that have been written alleging it,
statements by people alleging it, and basically, that some
people have access to information before other people and that
gives them an unfair advantage.
I truly do believe that confidence is an important part of
markets, and if people don't have confidence that it's fair and
that they have a fair shot, the same shot that anyone else has,
it will hurt our markets.
So I am wondering, what could we do to address this concern
that some people have? I am sure your office is getting the--my
office is getting it. You have to be getting these allegations.
Mr. Luparello. We do. And we obviously take them very
seriously. And we are borderline inundated on it. But that is
our job.
I think the answer to that is going to be different for
different segments of the marketplace. Clearly, at the retail
end, there is a lot that is good and works well for the market.
By all available metrics, retail investors are doing better
now than they have ever done in the past. That is mostly
driven, obviously, by technology.
But there are certain things that lead to confidence
concerns. One of those is stories around the different access
to information.
We are working with the exchanges and the SIPs to make sure
that everything is being done to deal with the issue of SIP
data latency, for example.
And we are doing things around order types--
Mrs. Maloney. Dealing with--pardon me--what? Entry?
Mr. Luparello. I'm sorry. Data latency.
Mrs. Maloney. Data latency. I see.
Mr. Luparello. So doing a variety of things that reinforce
fundamental fairness of the market is going to be our first
step.
Institutions have different issues and concerns around
whether the market works well for them, and part of that is
around some level of transparency of what happens in dark
pools.
And we are going to pursue an initiative that deals with
greater transparency of routing of institutional orders. That
exists on the retail side.
It is also worth looking at this time whether that rule,
which has been in place for 10 or 12 years, could use some
modernization.
But there are a variety of things we can do to bring
transparency to the market and attempt to communicate well to
retail investors about the fundamental fairness in the market.
Mrs. Maloney. In Chair White's speech earlier this month,
she said she was directing the staff to develop an ``anti-
disruptive trading rule.''
And the purpose of this rule, according to her statement
that day, is to limit the use of ``aggressive destabilizing
trading strategies in vulnerable market conditions.''
Can you walk us through what you would consider to be an
``aggressive short-term trading strategy?''
Mr. Luparello. I can at a high level. The specifics of that
rule are still a topic of conversation and in development.
But, as is generally thought, there are three types of
strategies that together form what people think of as high-
frequency trading, and there is a lot of gray area around those
margins. So, I don't like to get too invested in it.
Mrs. Maloney. What is an aggressive short-term trading
strategy that she is talking about?
Mr. Luparello. One of the strategies is when a trader,
based on a signal, aggressively takes liquidity on the same
side of the market at multiple times and it is--as compared to
a market-making strategy, where you are more passive and
providing liquidity on both sides. This is a strategy that sees
weakness on either the bid side or the offer side and takes
liquidity in sequence.
What the Chair was talking about was developing a rule
where, whether or not that's illegal now--and I think, in most
cases, we would all agree that it is not illegal--whether there
are times when the market is vulnerable and subject to
volatility that you restrict a subset of traders from executing
strategies like that during short periods of time.
That writ large is what the anti-disruptive trading rule
would look like.
Mrs. Maloney. How would you distinguish between an
aggressive trading strategy and the more legitimate trading
strategies that major institutional investors and retailers
follow? Do you differentiate based on the type of investor or
based on the market conditions? How do you differentiate?
Mr. Luparello. Those are very important details.
In our early thinking, I think it is based on a strategy in
a very short period of time that is liquidity taking on one
side of the market when the market itself is somewhat fragile,
all those terms still to be defined.
Mrs. Maloney. My time has expired.
Chairman Garrett. Thank you. Good question.
The vice chairman of the subcommittee, the gentleman from
Virginia, Mr. Hurt, is recognized for 5 minutes.
Mr. Hurt. Thank you, Mr. Chairman.
And, again, I thank Mr. Luparello for appearing today.
As we undertake a review of the equity market structure in
this country, I wanted to talk a little bit about the self-
regulatory organizations generally. Obviously, they play an
important role, a rulemaking role.
I am a member of the Virginia State Bar and, as an
attorney, as a member of a State regulatory organization
charged with the creation of rules as well as the enforcement
of those rules, I certainly understand the virtues of SROs
generally.
But I want to talk to you about your view on the evolution
of SROs. Are they making good rules? Are they going through
rigorous analysis to reach those rules? And what about
transparency and accountability?
Clearly, those are issues that I think promote the--
certainly the response--promote the things that the SEC should
be worried about: transparency; capital formation; and investor
protection. And so, they play a critical role there.
Can you talk a little bit about that evolution and where
they are now and where you could see room for improvement?
Mr. Luparello. Absolutely. And when talking about SROs,
clearly there are--the exchanges are also self-regulatory
organizations.
It is a very important issue, one that we are looking at
more long-term. Your question is, I think, more specifically
pointed at the broader rulemaking SROs, specifically FINRA and
the Municipal Securities Rulemaking Board (MSRB).
I think all of those points are extraordinarily important
both in terms of the ability to have input into the rulemaking
process as well as ensuring a level of confidence about that
rulemaking process.
Both FINRA and the MSRB, on significant rulemakings over
the past few years, have added layers of opportunities for
comment.
So, as a general matter, when they are doing rules, first
they subject them to their own internal notice and comment
process.
And then, after that, if there are major tweaks, they
sometimes repeat that process and then eventually come to the
Commission, where it goes through a separate notice-and-comment
process.
So we are comfortable with that level. One of the things is
there is no specific obligation on the SROs to have that
internal notice-and-comment process.
I think they tend to think it improves the quality of their
product and so are committed to it. But that is one of the
things that I think we would like to stay vigilant on and make
sure they stay committed to that.
They have also--and this is a fairly recent development--
embraced more careful, more specific cost-benefit analysis in
their rulemaking. I think that is something that, backsliding,
I think we would think would be a very bad idea.
I think, having spent a decent amount of time at FINRA, I
always feel the need a little bit to defend the quality of the
rulemaking process.
And that early round of communications through notice and
comment, as well as going through the committee process, often
had a very, very strong cost-benefit component.
And so, I would like to think that most of the rulemaking,
even without an explicit cost-benefit obligation, had gone
through some fairly careful cost-benefit analysis. That said,
making that routinized and making that obligatory is, I think,
a fundamentally good idea.
When we at the Commission get rule filings from MSRB and
FINRA, the two most important things were, obviously, we want
to make sure it is good public policy, but we also want to make
sure it is consistent with their statutory obligations and it
does pass cost-benefit muster.
Mr. Hurt. Talk a little about the role of the SEC.
Do you think the SEC conducts robust oversight over these
agencies? And is there room for improvement there?
Mr. Luparello. The oversight of the SROs is the
responsibility of our Office of Compliance Inspections and
Examinations (OCIE).
So I am a little bit more comfortable talking about being
the overseen as opposed to the overseer. But there are
substantial resources that are committed to overseeing the
SROs.
One of the things that came out of the Dodd-Frank Act was
an obligation on the Commission to have a more routine
oversight structure with the securities associations, of which
FINRA is the only one I know that exists and is robust.
And, look, especially FINRA has a very broad mandate, a
very complicated program, and increasing the touch points and
paying attention to it is something that you have to do
basically all the time because there are just so many different
moving parts.
But I know both the Commission, again through the OCIE
Staff, as well as the folks at FINRA, are very committed to
that ongoing relationship.
Mr. Hurt. I see my time is about to expire, so I will yield
back the balance of it.
Thank you, sir.
Chairman Garrett. The gentleman yields back 7 seconds.
And I now recognize the gentlelady from California.
Ms. Waters. Thank you very much, Mr. Chairman, and Ranking
Member Maloney. I appreciate the opportunity to join with you
today on the issues that you have identified dealing with the
SEC.
I have an issue that is very important to me that I have
been trying to advance. I have a bill, H.R. 1627, the
Investment Adviser Examination Improvement Act, which would
authorize the SEC to levy user fees to cover the costs of an
increase in the frequency of examinations of investment
advisers.
The Investment Advisory Committee of the Commission has
endorsed this legislation, which is one of the recommendations
that SEC staff originally provided in the study required in
Section 914 of Dodd-Frank.
From your perspective, do user fees represent a scaleable
and workable way for the Commission to improve investor
protection?
Mr. Luparello. I think, at a high level, the Chair and the
Commission, as well as the staff, remain very concerned about
the coverage of investment advisors from an examination
standpoint, especially as compared to broker-dealers, and those
statistics are well-known.
We continue to be supportive of any solution that allows
for a greater coverage of investment investors that is,
frankly, consistent with the statute.
Ms. Waters. Section 911 of the Dodd-Frank Act provides that
each time the Investor Advisory Committee submits a finding or
recommendation to the Commission, the SEC shall promptly issue
a public statement assessing the finding or recommendation of
the committee and disclosing the action, if any, it intends to
take with respect to the recommendation.
Does the Commission plan on responding to this
recommendation from the Investor Advisory Commission?
Mr. Luparello. Congresswoman, I am afraid that is an area
of the Commission's responsibility, specifically the Division
of Investment Management, that is outside my scope, and I can't
speak to it. I'm sorry. I can find out the answer, though.
Ms. Waters. All right. Let me just wrap this up, Mr.
Chairman, by saying that the examinations are done for the
investor advisors once every 12 years.
That is all they can expect to have to respond to in terms
of an examination, which means only 8 percent of the exams are
being done.
And so, this is a very important issue, and I am hopeful
that everything possible can be done to continue to advance it.
And if user fees probably are the only way that we can get
the resources to do the examinations, of course, I am hoping
that everyone will support the idea of user fees.
Mr. Luparello. I couldn't agree more with your observation.
Ms. Waters. Thank you. I yield back the balance of my time.
Chairman Garrett. Thank you.
The gentleman from Texas is recognized for 5 minutes.
Mr. Neugebauer. Thank you, Mr. Chairman. And thank you for
having this important hearing.
Mr. Luparello, in a recent speech Commissioner Gallagher
had an interesting observation. He stated that when people ask
him how the SEC should respond to Michael Lewis' ``Flash
Boys,'' which focuses, as you know, on striking, tells about
the high-frequency trading in equities, his response is, we
still need to respond to Lewis' 1989 classic, ``Liar's Poker,''
which is a vivid description of the bond market structure
issues that are still present today.
I agree with him. That scenario is one we haven't really
looked at in the past.
And when I look at the allocation of resources at the SEC,
you have hundreds of staffers in your division that are devoted
to oversight of the equity and options market.
And I believe there are six employees in the Office of
Municipal Securities and, amazingly, no staffers focused on the
corporate bond market.
Given that debt financing is nearly $15 trillion of the
market, why has the SEC allocated such a small amount of its
resources to those markets?
Mr. Luparello. Overall, I entirely share your concern and
support Commissioner Gallagher's observation. Let me just
correct you every so slightly.
While Trading and Markets does not have a subsection that
is solely focused on the fixed-income market, specifically, the
corporate fixed-income market, there are a number of people for
whom that is their responsibility.
But overall, I couldn't agree more. Obviously, we have a
lot of work to do on equity market structure. We also have a
lot of work to do creating a market structure for over-the-
counter derivatives.
But fixed-income, especially given how investing appetites
are going to change going forward, is only going to become more
and more of a retail market and more and more worthy of our
interest and investigation.
The Chair did give a speech within the past few days where
she outlined at least some preliminary thoughts on how to
address market structure in the fixed-income space. That work
is going to come out of my division, and it is something we
take very seriously.
Mr. Neugebauer. I think I have heard people say that there
is probably less efficiency in the bond markets than in the
equity markets.
Would you agree with that statement?
Mr. Luparello. Yes, 100 percent.
Mr. Neugebauer. Yes.
So somebody is paying for inefficiency?
Mr. Luparello. Part of that inefficiency comes with the
fact that it is just fundamentally a less liquid market. But
there is certainly some transparency that we would like to
explore bringing to that market.
Mr. Neugebauer. Turning to the Volcker Rule, in, I think,
October of 2011 and January of 2012, the agencies received
nearly 18,000 comments voicing opinions on a rule and, at the
prodding of the White House and the Treasury Department, the
rule was completed at the end of last year.
Now, a lot of us felt like the initial rule that was put
out was pretty vague, which prompted a lot of questions about
it.
And then, when the rule came back out, a lot of us were
hoping that it would be re-proposed and be opened back up for
comment, but that was not the case.
And so, I think the industry felt like they were left with
a lot of unanswered questions, and there continues to be, as
I'm am sure you are aware, a growing number of concerns about
the enforcement and how the rule is going to be interpreted.
So tell me kind of, what the game plan is here. You have
the Volcker Rule working group. But how are people going to
have the opportunity to respond to those in a timely manner?
And have you worked out who makes the final decision where you
have a multi-agency Commission here looking over that process?
Mr. Luparello. Obviously, coordination is important. And
the working group, which has representatives from the five
regulatory agencies, meets constantly and is committed to
consistency.
One would hope that commitment to consistency doesn't come
with a cost of being slow in terms of getting guidance out, and
my observation in my short time there is that has not been the
case.
So, as I said, the agencies are committed to doing these
things completely consistently.
We have started putting out responses to frequently asked
questions. Three additional ones went up within the past couple
of weeks. I think there are six now. Our view obviously is that
is a living document that we will continue to try to populate
to the greatest extent possible.
Also, in our examination programs we are reaching out and
having those conversations to try to get additional questions
from entities that will be covered by the Volcker Rule so we
can give them as much guidance as we possibly can. The
extension of the conformance date also gives us a little bit
more of a window to get that done.
Mr. Neugebauer. So are these interpretations--are they
being made public so that everybody gets a look at them?
Mr. Luparello. Absolutely.
Mr. Neugebauer. And what about the minutes of the working
group and how they are making those decisions and how they are
coming to those conclusions? Any transparency there?
Mr. Luparello. Complete transparency on the FAQs that are
on our Web site and the Web sites of the other four agencies. I
am afraid I don't know the answer to your question.
Chairman Garrett. The gentleman's time has expired.
We will give a little leeway to the gentleman from
Massachusetts, Mr. Lynch.
Mr. Lynch. Thank you, Mr. Chairman.
Mr. Luparello, I want to go back to the speech that Chair
Mary Jo White gave back at Sandler O'Neill on June 5, 2014.
She mentioned that the SEC is assessing the extent to which
specific elements of the high-frequency trading environment may
be working against investors rather than for them. This was
about a month ago.
Have we made any progress on that?
Mr. Luparello. The Enforcement Division obviously has a
number of--
Mr. Lynch. Could you pull that microphone closer? My
hearing is not good.
Mr. Luparello. Neither is mine. So I apologize. And I could
hear you perfectly. I apologize for the microphone being too
far away.
Obviously, if the Commission's staff in the Enforcement
Division believes that there are market participants who are
violating existing rules, that is subject to very careful
investigation and enforcement. There have been a small number
of cases, but I think, to be perfectly frank, the vast majority
of high-frequency trading activity exists inside what is
currently considered legal trading.
The Chair brought forward a number of initiatives, all of
which are in development, including the one we had spoken about
just briefly on the anti-disruptive trading rule being one that
is very much directed at the conduct you are looking at.
That is something that is a very high priority for the
Division to come up with a recommendation to the Commission in
the very near future, but we have not presented that to the
Commission yet.
Mr. Lynch. All right. Thank you.
Let me ask you--she also raised the issue of eliminating
the exception right now from FINRA registration for dealers
that trade in off-exchange venues.
Are we making any progress on that?
Mr. Luparello. That is actually--that is half of two
pieces, the other of which is to clarify that certain market
participants that trade at a certain level need to register as
broker-dealers.
Then, having clarified that obligation to register as
broker-dealers, if they participate in the over-the-counter
markets, which clearly most high-frequency traders do because
that is where dark pool volume gets reported, they would need
to register as FINRA members.
Those proposals are in development. Again, I think we are
hoping to get them to the Commission soon.
Mr. Lynch. She also talked about the volume of trading
being done in dark pools versus on lit exchanges and mentioned
that there might be some way to put a little bit more light on
some of these dark pools.
Are there any concrete steps in that direction?
Mr. Luparello. Specifically, those proposals would call for
enhanced transparency in terms of the business operations of
ATSs.
It is not so much changing the mix of lit quotes versus
dark quotes, but basically the business operations, how they
execute orders, how their fees work--
Mr. Lynch. A lot of dark pools are not ATSs, though.
Mr. Luparello. No. They are ATSs.
Mr. Lynch. Are you doing anything in that regard?
Mr. Luparello. Yes.
I'm sorry. They are ATSs.
So it would basically be looking back at our ATS rulemaking
of 10 or 12 years ago and modernizing it, enhancing the level
of disclosure about the business operations of ATSs, including,
importantly, the mix of participants in the ATSs and then
making that information publicly available.
Again, I feel like I am repeating myself, but that one is
also in development.
Mr. Lynch. No. I understand.
And it sort of leads to--the last question I have is, in
her speech the Chair actually brought up a couple of
enforcement cases where broker conflicts--because of the maker-
taker fee structure, where some brokers were getting enhanced
fees if they sent their trades in a certain direction.
There was a conflict there with the general duty to place
the best trade for an investor. She had a couple of fraud
enforcement actions that she mentioned.
What are we doing in that area to try to manage those
conflicts for the brokers?
Mr. Luparello. Maker-taker is a very important issue. It is
a very complex issue, one that we have been studying for a
while, and will continue to study.
I will say, however, that if a broker is routing his
customer orders based only on the desire to obtain rebates or
avoid fees without making sure that he is meeting his
overarching obligation of best execution, I think that would
clearly violate our existing rule set.
Mr. Lynch. Thank you.
I have exhausted my time. I yield back.
Chairman Garrett. Thank you.
The gentleman's time has expired.
Mr. Ross is recognized for 5 minutes.
Mr. Ross. Thank you, Mr. Chairman.
Mr. Luparello, in reviewing your opening statement, you
talk about providing technical assistance to the Department of
Labor with regard to their definition of ``fiduciary'' and
specifically as to the practical application of making sure
investors have proper guidance with regard to ERISA.
I have some grave concerns over that.
First of all, it gives rise to a new cause of action. As a
lawyer, that is great. As a litigator, it is even better. But I
think that it directly and adversely impacts the investors.
Because I think, once you put that standard in there and
you have an exodus of broker-dealers from the market, you still
have a demand for that advice, and I think you create a more
volatile investment market because of it.
And my concerns are: What technical assistance are you
providing? And do you feel that there should be a fiduciary
definition with regard to investments with ERISA for broker-
dealers?
Mr. Luparello. The Chair has asked the staff of Trading and
Markets, as well as the staff of Investment Management, to come
up with some proposals on that very issue, the standard of
care, whether you can continue to have separate standards of
care for different distribution venues or whether you need a
single standard of care and whether that single standard of
care is--
Mr. Ross. And I think that is appropriate.
I think there also should be a cost-benefit analysis
because I think you are going to see, again, an exodus in the
market of the broker-dealers. And, I think there are standards
of care. There are standards of care just by way of common law.
There is misfeasance, malfeasance, and negligence. And
there are errors and omissions policies out there that cover
that for some of these professional broker-dealers.
So I am just very concerned that moving in this direction
is going to do more harm to the investment market of those who
want to engage in it than it will do as a benefit.
Mr. Luparello. I completely agree.
And in developing our recommendations, cost clearly is an
issue. We also worry about investor choice.
As for the guidance, the technical assistance we are giving
the Department of Labor, that is mostly in terms of providing
them our understanding of how the market operates. Obviously,
their decision-making process is one over which we don't have
any control.
Mr. Ross. Thank you.
Turning to the Volcker Rule again, the Volcker Rule will
take place about the same time as the Basel III capital
requirements are going to be imposed--what may very well be--
when they may very well be imposed.
My concern--and I want to know if it is a concern of
yours--is whether there is going to be an impact on interest
rates for corporate borrowers because of Basel III and the
Volcker Rule.
Mr. Luparello. Obviously, we are concerned about and
carefully look at liquidity in the marketplace. Even if we
didn't, the Chair has asked us to provide information on a
quarterly basis, I believe, of--
Mr. Ross. Because that could impact our markets pretty
significantly. It might be--
Mr. Luparello. Absolutely. We have--
Mr. Ross. --a little bit more regulation than we might need
there.
With regard to the Volcker Rule and the exemption for
municipal and State debt as well as sovereign debt, because
these types of investments, these types of debt, if you will,
may fluctuate in the market, do you think that there is more
advantage to the larger banks to take riskier investments
because they will be protected as being exempted from the
Volcker Rule?
Mr. Luparello. I will be honest with you, Congressman. It
is not an area that I have spent enough time studying to
provide an insightful point of view.
Mr. Ross. But I guess Congress exempted certain debt of
State and municipal debt, but then the regulatory environment
added sovereign debt.
And that has me concerned because I think that those are
gambles that--I don't know how many people want to invest in
the City of Detroit right now, but that is an exempted debt
under the Volcker Rule.
Let's see. Lastly, the United States remains the only
developed country to implement a restriction on proprietary
trading.
Will U.S. corporations face higher borrowing costs and be
placed at a competitive disadvantage with regard to their
foreign counterparts?
Mr. Luparello. Clearly, that is something we plan on
studying and plan on continuing to communicate about with this
subcommittee.
Mr. Ross. I appreciate your insight on that.
And I will yield back the balance of my time.
Chairman Garrett. Thank you.
The gentleman yields back the remainder of his time.
Mr. Perlmutter is recognized for 5 minutes.
Mr. Perlmutter. I thank the kinder and gentler chairman for
my 5 minutes.
Mr. Luparello, thank you for being here today. I just have
kind of a series of questions about different kinds of rules
that are out there.
In the lead-up to the crash of 2008, there were a couple of
rules that were not in place that I think ultimately were then
put back into place, and I would like to know what their status
is.
What is the status of naked short sales and the uptick
rule? Do those exist or exist in some form or another?
Mr. Luparello. I will look for my staff folks over my
shoulder to tap me on the shoulder if I am wrong.
But I understand that the--to the best of my recollection,
the short sale rule exists, but it exists only during certain
times of market stress. So, the short-sale tick-test rule
exists only in narrow instances.
Mr. Perlmutter. In sort of times of--
Mr. Luparello. Right.
Mr. Perlmutter. --where the market is diving, in effect?
Mr. Luparello. When the market is already directionally
going--when it is already directionally going down.
Mr. Perlmutter. Okay. Thanks.
Talk to me about--and explain to the committee, if you
would, because--this exchange-traded funds and leveraged
exchange-traded funds and how those might have an effect on the
overall market if things were to go sour.
Mr. Luparello. I think we talk about market structure for
equities and we talk about market structure for fixed income
and derivatives.
But exchange-traded funds is an enormously important part
of the market. It is something that my staff spends a lot of
time on, as well as the Division of Investment Management,
studying whether there are aspects of that from a market
structure standpoint that we need to look at.
There is also obviously--
Mr. Perlmutter. So what is an exchange-traded fund?
Mr. Luparello. It is any number of products that either
represent a basket of securities or some other reference asset
that you can trade intraday. It is basically like a mutual fund
except that there is pricing during the day.
There is not always perfect transparency around the
components of it. And so, the arbitrage between the components
and the ETF are very, very important.
Mr. Perlmutter. So in the SEC's sort of overview of these
funds and the trading of these funds, what are you seeing
today?
Because I have seen kind of an increase in articles about
potential problems, one part of the market saying, ``No. There
is no problem here,'' others saying, ``Well, we had better
watch this.''
Mr. Luparello. I think, from a market structure standpoint,
it is certainly worthy of further attention.
I think we are also always worried about whether some of
these products are complex and being sold to investors who
don't actually understand the complexity and that they create
separate sales practice issues.
That is another part of it to which we need to pay very
close attention.
Mr. Perlmutter. Can you tell us what the--a couple of years
ago, Mr. McHenry sponsored a bill on crowdfunding for small
purchasers, small investors.
And there are fears about--part of your job, obviously, is
being a policeman, making sure that people aren't taken
advantage of, there isn't fraud in the marketplace.
So, you have been tasked with some rulemaking on
crowdfunding. What is the status of that?
Mr. Luparello. The proposed rules were published in October
of last year, I believe, and we received a number of very
thoughtful comments. The staff is working on it.
There are issuer obligations that are embedded in the
rulemaking that are the responsibility of the Division of
Corporation Finance.
The intermediary obligations, whether that is broker-dealer
obligations or funding portal obligations, are our
responsibility.
We are working through it to the best of our ability and
hope to get a recommendation to the Commission very soon.
Mr. Perlmutter. All right. Thank you, Mr. Chairman. I yield
back.
Chairman Garrett. Thank you.
Mrs. Wagner is recognized for 5 minutes.
Mrs. Wagner. Thank you, Mr. Chairman.
And I thank Director Luparello for being here.
I want to continue the discussion on the fiduciary standard
of conduct and, in your own words, consider whether and, if
so--I underscore ``if so''--you will adopt rules establishing a
uniform standard.
To me, the most critical issue raised by the potential
fiduciary rulemaking is whether the new rules will, in fact,
hurt low- and moderate- and middle-income individuals' access
and affordable financial advice.
And I appreciated your statement to Congressman Ross about
the concerns of cost and choice in that investor market.
Dodd-Frank required the SEC, I know, to study whether to
subject broker-dealers to a fiduciary standard. However, the
SEC's 2011 study ``failed to identify whether retail investors
are systemically being harmed or disadvantaged under one
regulatory regime as compared to the other.'' This was, of
course, according to Commissioners Paredes and Casey.
Without investor harm, Director Luparello, is there any
basis to conclude that a uniform standard would, in fact,
enhance investor protection?
Mr. Luparello. I think clearly, one needs to identify a
benefit to stand up against the cost. The Commission before my
time, but in the recent past, put out a request for further
information around a variety of these issues. It is something
that we continue to study very carefully.
But I think it is a fair question that you need to identify
a real benefit before you start to analyze the costs and
benefits of these things.
Obviously, there are certain aspects of the fiduciary
standard which provide enhanced investor protection. But again,
cost and choice are things that have to be balanced against
that.
Mrs. Wagner. And I appreciate that.
Following up on that 2011 study, Chair White, I know, told
the committee in 2013 that she would do that request for
information to better inform the rulemaking. What were the
results of that request for information?
Mr. Luparello. I think, to a certain extent, the level of
information that flowed in was less than the staff thought it
was going to be.
And so, one of the questions we have is: If we are going to
come up with recommendations, will there be a need for a new
round of information-gathering?
Mrs. Wagner. And that was my understanding, that there
really was not much feedback there. And I continue to be
concerned about, again, this being a solution in search of a
problem.
Has any of the information helped inform your thoughts on
how--thoughts on this potential rulemaking? And how that would
be played out?
Mr. Luparello. Clearly, all input we get is important
input. But it is all part of a multifaceted analysis that
includes multiple divisions of the Commission.
So, again, any input we can get is going to be helpful
input. What the final recommendation is and how much that input
is going to drive that is still something that is being--
Mrs. Wagner. I know that the SEC found in 2008 that
investors were somewhat confused about whether they were
dealing with broker-dealers or investment advisers. However,
they did not identify any specific harm.
Is the only solution to impose a fiduciary standard of care
on broker-dealers or could any issues be fixed by, let's say,
amending existing FINRA rules?
Mr. Luparello. One of the questions is whether there are
enhancements to existing rules for broker-dealers and--as well
as recognition of some of the existing rules on broker-dealers
that deal specifically with conflicts. That is always an option
that I think has to be considered.
Mrs. Wagner. Good.
One source of confusion for investors might be the variety
of titles that brokers and investment advisors use.
Would a simple way to fix the problem be to clarify which
titles they can use, sir?
Mr. Luparello. I don't know if that would entirely solve
investor confusion.
I can say that years ago, I was involved in a project where
there were a variety of titles that were being used, especially
around advice to senior citizens, that were, basically,
fundamentally baseless.
And so FINRA has in the past attempted, as well as other
regulators, to crack down on the misleading use of titles.
Whether you get to specificity around the words that can be
used and that solves investor confusion is certainly worthy of
additional consideration--
Mrs. Wagner. In my limited time, Chair White recently said
the rulemaking was a high priority and she wanted to make a
decision this year. So, she asked the staff for options.
What other options have the staff suggested to the
Commission?
Mr. Luparello. The development of those options is still in
process, but I think you have touched on what the variety of
choices could be.
Mrs. Wagner. And will you be able to report back to us some
of those options at some point in time, sir?
Mr. Luparello. I believe I need to report to my Chair,
first. But, yes, absolutely.
Mrs. Wagner. Wonderful. Thank you. I appreciate it.
I yield back, Mr. Chairman.
Chairman Garrett. The gentlelady yields back.
Mr. Scott is now recognized.
Mr. Scott. Thank you very much, Mr. Chairman.
Mr. Luparello, when Securities and Exchange Commission
Chair White appeared before our committee, I expressed some
concerns about what is referred to as the lack of order
competition and I asked her what her plans are to deal with
market structure.
And I want to make a note that I am somewhat encouraged by
the recent announcements of the items that you intend to take
action on before the end of the year. However, it appears that
much of this is low-hanging fruit and does not directly address
my concerns that I addressed to her about order competition.
So let me ask you: What is your plan to address some of the
bigger market structure issues such as the increased level of
dark trading that even the SEC has recognized as having a
negative impact on price discovery?
Mr. Luparello. I think your characterization of the Chair's
plan is fair and, frankly, what she would articulate as well,
that there are a variety of initiatives that the staff is ready
to move on quickly and that there are others that deserve,
frankly, a little bit more study, a little bit more
interaction--
Mr. Scott. What would be some of those you want to move on
quickly?
Mr. Luparello. The ones we would want to move on quickly
are an anti-disruptive trading rule, the registration of all
high-frequency traders as broker-dealers, the requirement that
those that trade over the counter become FINRA members,
enhanced disclosures on the business operations of ATSs and
enhanced disclosures on the routing of institutional orders.
The issue you touch on is an extraordinarily important
one--right?--that there is an extraordinary amount of
fragmentation in the marketplace these days, some of which
leads to positive competition and lower costs, but some of it
clearly can lead to degraded opportunities for lit quoting and
for order interaction.
That is a very important balance and one that we desire to
get--
Mr. Scott. But are you all assessing point by point the
negative impacts on price discovery?
Mr. Luparello. Absolutely. So as we study NMS--and, again,
I don't want to refer to it as a long-term study--what--our
next plan is to put out a series of White Papers, work very
closely with a variety of participants, including our Market
Structure Advisory Committee, once it is stood up and
operational, to look at these issues.
I tend to like to think of that one in the context of the
trade-through rule, that a lot of these things come with the
fragmentation of those venues.
And so we will look at--we are very much going to look at
that. That is one of our most important longer-term issues.
Mr. Scott. Okay. Let me share very quickly, this is a
rather startling observation. But today, only 63 percent of
trades are conducted in what is referred to as lit markets,
where we can see them. Now, that means 37 percent are in dark
pools. It means that investors are not seeing the true depth of
the liquidity behind the stocks.
So while high-frequency traders will, what you refer to,
ping the market by sending out a bid to see if there is a
response from the dark pools, this is not possible for all
investors.
How does this affect an investor's ability to even price a
stock? And is this a significant advantage for some
participants over others?
Mr. Luparello. It is certainly worthy of study. And I
completely agree with the importance of those statistics.
That said, it is probably worth noting that, of that 37
percent, a significant portion are actually retail investors
getting good-quality executions very quickly done. That doesn't
at all touch on the issue of whether we have quote degradation
that we need to worry about.
But one of the things we need to do as we study is to make
sure that some of the better features of the markets, including
how retail investors experience both high-quality and rapid
executions, doesn't get degraded or, frankly, if it does get
degraded, it is a decision we are making with our eyes wide
open.
So, yes, it is, I think, just sort of troubling on its face
that such a large percentage of activity happens off of lit
markets and there are more headwinds than there are
encouragements to quote in lit markets. But, to a certain
extent, that has come to the benefit of certain retail
investor-type trades.
It is a very complex issue, one that we plan on studying
very carefully.
Mr. Scott. Thank you very much.
The lack of order competition is a very, very serious
issue.
Mr. Luparello. I could not agree more.
Mr. Scott. Thank you, Mr. Chairman. I yield back.
Chairman Garrett. Thank you. The gentleman yields back.
The remaining gentleman on our side, Mr. Mulvaney, is now
recognized.
Mr. Mulvaney. Thank you, Mr. Chairman.
Mr. Luparello, let's talk a little bit about litigation and
liability, which I used to know something about in a previous
life.
One of the things that Dodd-Frank did--I think it was
Section 921(a)--is give the SEC the ability, but not the
obligation, to limit the use of arbitration in securities
litigation.
I used to do a little of that. I have been on the
plaintiffs' side of that, and I have been on the defendants'
side of that. And while it was certainly different than going
through the court system--the ordinary court system, I have to
tell you that I liked parts of it. It was a lot quicker. It was
a lot easier. And for both sides, it was usually a lot cheaper.
I recognize the fact, again, that it was different than
going through ordinary litigation. There were certain tools
that were not available to me, for example, as a plaintiffs'
lawyer, that would be in the courts. But, conversely, it was a
trade-off there of having it be easier, quicker, to do.
So, I guess, now that you have this ability to limit--or to
possibly limit the use of arbitration, I have to ask you:
What's wrong with arbitration? What is the SEC's stance on
arbitration within financial securities litigation?
Mr. Luparello. I can't help but sort of flash back a little
bit to my extended tenure at FINRA, where we ran the dispute
resolution forum and worked very hard to make sure that it
worked as efficiently as possible, but felt a certain need to
defend the arbitration program as a viable alternative.
Obviously, the statute provides the Commission the
authority, but not the obligation, to act. As a general matter,
in its oversight capacity, the Commission spends a substantial
amount of time with FINRA making sure that forum is run as
carefully and fairly and transparently as it possibly can be.
Obviously, there have been a lot of enhancements made to
that forum, I think very much to the benefit, over the past few
years.
The Commission hasn't particularly--hasn't taken a position
on Section 921 at this point, to the best of my knowledge. And
while I am relatively new and have had a variety of
conversations with the Chair, that is one that I still haven't
had.
Mr. Mulvaney. And just to clarify one thing--because I
understand a little bit of the history of how it ended up in
Dodd-Frank--is it the opinion of the SEC that arbitration
contributed to the financial crisis?
Mr. Luparello. Not to my knowledge.
Mr. Mulvaney. Okay. Thank you very much.
Let's talk about a different, but somewhat related, topic,
which is the liability of exchanges.
My understanding is that exchanges, when they perform their
regulatory functions, have certain immunities from liability;
when they perform their commercial functions, they don't.
I think this has become relevant in the last couple of
weeks and months as NASDAQ has sought to assert its immunity
vis-a-vis the Facebook IPO and that what we might be seeing, is
an attempt by certain exchanges to sort of blur the lines, to
make that which is commercial appear regulatory in order to
avail oneself of immunity from liability.
Has the SEC looked at this issue? I don't think you have
expressed any opinions on it yet. Do you expect to do so in the
near future?
Mr. Luparello. SRO immunity is a creature of case law and,
like any good litigator, one tries to expand that protection
based on the facts.
The SRO status of exchanges--and you described the issue
perfectly--is the difference between the commercial and the
regulatory, and it is certainly on our agenda to do.
I think, when we think about the SRO status of exchanges,
we are thinking about two different issues, one of which is the
competitive playing field between exchanges and other venues
that do things that look an awful lot like exchanges.
But part of it is analyzing the SRO obligations and
protections that go with being an SRO that the exchanges
currently enjoy.
So that is an issue we are going to continue to look at.
Specifically on the Facebook litigation, to my knowledge, I
don't know that we have been asked to opine and I don't know
that we--
Mr. Mulvaney. I am not asking you to opine--I used that
only as an example.
So I guess my last question is this: Can we expect the SEC
to provide some guidance in the near future and say, ``This is
regulatory and this is commercial?''
Mr. Luparello. Perhaps in the context of studying the SRO
issue more broadly, which is one of our longer-term
initiatives, that will be something that we opine on.
At this point, I think giving specific guidance is probably
not in the near--is not going to happen in the near future.
Mr. Mulvaney. Thank you, Mr. Luparello.
I yield back.
Chairman Garrett. Thank you. The gentleman yields back.
Mr. Foster is recognized for 5 minutes.
Mr. Foster. Thank you, Mr. Chairman.
One example of the current system for not incentivizing
maybe the best behavior is the proliferation of order types
that are designed to capture rebates from the exchanges. Reg
NMS put in place a uniform, one-size-fits-all, 30-mils fee cap
for all stocks.
And this rebate model has arguably increased liquidity for
active named stocks, but some would say that it actually made
those stocks more costly for institutional investors. It also
has perhaps pushed transactions to off-exchange venues as
investors try to avoid these fees.
My question is: Is the Commission contemplating--or should
it contemplate a pilot program to reduce the market fee access
cap, perhaps alongside the tick-size pilot, particularly for
very liquid stocks? And specifically, what would you think of
tiered access fees based on the liquidity?
Mr. Luparello. I think those are all--first of all, I
completely agree with the observations.
Maker-taker in certain areas of the market is definitely
tied inextricably to the growth of complex order types. In the
short term, we have asked the exchanges to go back and do an
inventory of their order types, make sure they understand how
all their order types work and how those order types--whether
or not those order types are consistent with how they were
described to us in the first instance.
We have given them a deadline of November to come back with
that study, which, given the complexity in the growth and order
types, is a challenge.
Maker-taker and the issue of potential broker conflicts
married, of course, to the fact that does, I think, pretty
clearly drive a substantial amount of volume from on exchange
to off exchange is something that we are going to consider.
I don't know at the end of the day that we will decide to
go with a pilot, but I think certainly a pilot is one of the
options. And, again, I think the way you articulated it that--
and sort of consistent with our notion of one size not fitting
all, clearly maker-taker has a different impact at the more
liquid end of the market than it does at the less liquid end of
the market.
So, I can't say we have reached any conclusions yet. There
is a lot of work to do there. But I think the issues that you
have articulated are ones that are both very much at top of the
book for us, but also somewhat consistent with how we are
thinking about it.
Mr. Foster. Are there alternatives you are considering in
addition to pilot programs? You could obviously just adopt
something market-wide, but it seems like it mitigates the risk
if it starts with a pilot program.
Mr. Luparello. It is certainly too early to tell in terms
of our thinking. And so I will just cite what others have
cited, which I think are worthy of further analysis.
Obviously, a maker-taker pilot with trade at the most
liquid end of the market.
The other thing is looking at perhaps quoting in subpennies
versus quoting in pennies, which would have a natural
compression aspect on maker-taker, as well as just considering
the consequences of banning it outright.
I think these are all things that we are going to think
about over the next few months.
Mr. Foster. Are you thinking of changes to the attribution
rules?
Basically, it is my understanding that when a trade is made
public, the venue is not made public in most or maybe all
instances, whereas other countries, in fact, do it differently,
where the venue is also made public.
This may allow third parties or the participants themselves
a better view of whether you are actually getting the best
deals on which venues.
Mr. Luparello. I think that is especially true with dark
pools. There still is a fair amount of opacity whether an over-
the-counter trade was a dark pool trade versus just an
internalized trade of a broker-dealer.
FINRA has made some steps going forward on that to enhance
transparency. So you now have a requirement that transactions
that are reported by a broker-dealer that sponsors an ATS
clarifies whether it is a broker-dealer or whether it is the
ATS. That is an important first step.
They are also publishing transaction volume information. It
is an important next step.
But one of the interesting things about the over-the-
counter market is there is sort of an assumption that the 30-
something percent that makes up the over-the-counter market is
entirely dark pools. The reality is, it is only about a third
in dark pools.
And so, we are going to have conversations with FINRA to
continue to try to develop greater transparency in that space,
just how much of the over-the-counter activity is happening
inside of ATSs versus happening broker-broker versus happening
internalized.
And I think one of the next steps off of that is looking at
whether attribution of location, hitting the tape as opposed to
just hitting the regulatory tape, is something worth pursuing.
Mr. Foster. Okay. And, quickly--I guess I have about 15
seconds--do retail investors today have relatively simple tools
to get some idea of whether their trades are being executed
well or not? They can see their fees actually, but what about
the other part of it?
Mr. Luparello. The information is made available to them
through existing Rules 605 and 606, which are Commission rules.
Just how usable they are for retail investors is a very good
question.
Obviously, they also get disclosures through their
confirms. I suspect most investors, if they are trading with
their broker, have ready access to what is the inside market at
the time and they can evaluate how well they are doing with the
inside market. That clearly doesn't tell the entirety of the
story, but it does tell some of the story.
We would also hope that broker-dealers in their
responsibility to their customers both look out for their
customers, but, also, communicate well the quality of those
executions. Their ability on a trade-by-trade basis to say,
``Is this broker versus this broker going to give me a better
deal?'' is a very complex analysis.
Mr. Foster. Thank you.
I yield back.
Chairman Garrett. Thank you.
And now, for the last word.
Mr. Carney. That must be me, Mr. Chairman.
Chairman Garrett. The gentleman is recognized.
Mr. Carney. Thank you very much, Mr. Chairman. And thank
you for having this hearing today. It is very interesting, if
not a little bit complex and esoteric, for sure.
I just have a few questions on some of the issues that I
have been thinking about and working on over the past couple of
years. Mr. Luparello, I appreciate you coming in today and
having this conversation with us.
You had some conversation a little bit about the tick-size
pilot. I have been working with my colleague on the other side
of the aisle, Mr. Duffy, for over a year on that, and we
actually passed a bill out of this committee and on to the
Floor as well. So, I was happy to see that the SEC is moving
forward on that program.
What do you expect to or hope to achieve out of the pilot
and the framework that you have come up with?
Mr. Luparello. I, too, am happy that it is out the door.
Obviously, there are a couple of procedural--
Mr. Carney. By the way, I thought it was very well done.
Not that I am an expert at all, but we were really just--our
effort was to try to encourage the SEC to do something, and we
were pleased with what you did.
Mr. Luparello. I appreciate that.
And in the short term, the issues we want to study most
carefully. So there will be a substantial amount of data that
the SROs need to push to us to help in our analysis.
But, fundamentally, what we want to see is whether there is
more depth at the quotes based on the wider tick size, whether
there is greater market-maker participation and, therefore,
greater market-maker support.
Obviously, at the same time, we want to see whether the
wider tick size causes--certainly, in some cases, it may
actually raise investor costs, especially retail investor
costs, a little bit. That is an issue we need to pay careful
attention to and evaluate.
I will say, while this is an important step forward and
something that gives us a real vision into whether there are
solutions for a segment of the market that work really well, I
would like to think this is not the only thing we plan to do in
the lower capitalization area.
Mr. Carney. So talk about some of those other things that
you think you would like to do. I think some of them were part
of what you were just discussing.
But what are some of those things?
Mr. Luparello. A little bit.
But one of our longer--as I have talked about the Chair's
speech and the Chair's vision on market structure, there are
the shorter-term steps, which are our concrete actions to take,
and there are longer-term things to think about.
And in that longer term is just specifically the market
structure for lower-cap, lower-volume stocks. And I think--one
of the ideas that has been thrown around, one that has garnered
a lot of conversation, is things like venture exchanges.
And I think we are very open to the idea of competitive
solutions. That is based--and we will continue to work with a
variety of market participants.
Mr. Carney. Sounds good. I am glad to hear that. I know my
colleague on the other side of the aisle, Mr. Duffy, would be
as well.
Moving on to cross-border swaps, another kind of esoteric
area, but an area on which I have worked with the Chair of this
committee to try to get harmonization, we have taken a lot of
heat from our approach. You came out with a rule just
yesterday, I think.
Could you talk about that? And in particular, your piece of
the market is small, security-based swaps, I guess. What kind
of coordination went into it with the CFTC?
Mr. Luparello. Careful coordination with both the CFTC and
the other regulators. The vast majority of what we did
yesterday is very consistent with the CFTC approach.
There are clearly a couple of areas where we come up with a
slightly different answer. Some of that is driven by our
understanding of the workability of our markets. Some of it is
driven by slight differences in the statute and potentially
different authority questions.
But literally all we did yesterday was clarify, given that
the swaps market is fundamentally a cross-border market, some
very substantial percentage of trades are between a U.S. person
and a non-U.S. person--clarifying what transactions gave--would
give rise to registration--
Mr. Carney. Would you agree that the objective is to get
harmonization of regulations across market venues around the
world?
Mr. Luparello. Absolutely. And so, part of this is it is
not just coordinating with the domestic regulators, but
coordinating with the international regulators.
Mr. Carney. What do you think is the biggest challenge
there? What do we need to be concerned about?
There was some reporting about--and I know the ranking
member has expressed some concern about non-guaranteed entities
or something.
Could you comment on that briefly?
Mr. Luparello. Yes. One of the big issues that we dealt
with yesterday was the question of when you have a non-U.S.
person that--you know, a subsidiary of a U.S. bank that is
located in London, for example, and they do a transaction with
another non-U.S. person. If that transaction is guaranteed by
the U.S. bank. If there is an explicit recourse guarantee.
It is really--the economic reality of that transaction is
that the German hedge fund is actually doing business with the
New York bank. So requiring that transaction to be counted for
jurisdictional purposes made sense to us.
When those guarantees become softer, there are some
questions about whether we can reach what is essentially a
transaction between one non-U.S. entity and another non-U.S.
entity.
And so part of this is--those are very difficult nuanced
questions that do have the color of what our authority is over
transactions that involve two non-U.S. persons, one of the
difficult issues we try to navigate.
Mr. Carney. My time is up. I would encourage you to keep
working on that. It is, we believe, a very important issue. I
work with the Chair on it and also encourage your cooperation
and work with Department of Labor on fiduciary as well.
Mr. Luparello. I appreciate it.
Mr. Carney. Thank you.
Chairman Garrett. I thank the gentleman.
And I thank the Director.
Before I let you go, Vice Chairman Hurt and I wrote a
letter to Chair White several weeks back with regard to venture
exchanges and the work that is being done there.
Do you know when we will be receiving a response? Or do you
want to just comment on that topic in general?
Mr. Luparello. I will find out when the response is coming.
And, as I said, I think we are open to a variety of
potential solutions and look to flexibility at different
segments of the market.
Conversations I have had with market participants and
experts before I started at the Commission around venture
exchanges create many sort of, I think, interesting
opportunities.
Chairman Garrett. Opportunities. Yes.
Mr. Luparello. As is always the case, there are
occasionally authority questions that go along with that, which
need to be navigated. But we continue to think that this is an
idea worthy of further conversation.
Chairman Garrett. Great. I appreciate your answer.
That brings the hearing to a close.
The Chair notes that some Members may have additional
questions for this witness, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to this witness and to place his responses in the record. Also,
without objection, Members will have 5 legislative days to
submit extraneous materials to the Chair for inclusion in the
record.
And with that, the hearing is adjourned. And thank you
again.
Mr. Luparello. Thank you, Mr. Chairman.
[Whereupon, at 10:52 a.m., the hearing was adjourned.]
A P P E N D I X
June 26, 2014
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