[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
DECIMALS 2000--WILL THE EXCHANGES CONVERT?
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
FINANCE AND HAZARDOUS MATERIALS
of the
COMMITTEE ON COMMERCE
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
SECOND SESSION
__________
JUNE 13, 2000
__________
Serial No. 106-107
__________
Printed for the use of the Committee on Commerce
U.S. GOVERNMENT PRINTING OFFICE
65-803CC WASHINGTON : 2000
COMMITTEE ON COMMERCE
TOM BLILEY, Virginia, Chairman
W.J. ``BILLY'' TAUZIN, Louisiana JOHN D. DINGELL, Michigan
MICHAEL G. OXLEY, Ohio HENRY A. WAXMAN, California
MICHAEL BILIRAKIS, Florida EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas RALPH M. HALL, Texas
FRED UPTON, Michigan RICK BOUCHER, Virginia
CLIFF STEARNS, Florida EDOLPHUS TOWNS, New York
PAUL E. GILLMOR, Ohio FRANK PALLONE, Jr., New Jersey
Vice Chairman SHERROD BROWN, Ohio
JAMES C. GREENWOOD, Pennsylvania BART GORDON, Tennessee
CHRISTOPHER COX, California PETER DEUTSCH, Florida
NATHAN DEAL, Georgia BOBBY L. RUSH, Illinois
STEVE LARGENT, Oklahoma ANNA G. ESHOO, California
RICHARD BURR, North Carolina RON KLINK, Pennsylvania
BRIAN P. BILBRAY, California BART STUPAK, Michigan
ED WHITFIELD, Kentucky ELIOT L. ENGEL, New York
GREG GANSKE, Iowa TOM SAWYER, Ohio
CHARLIE NORWOOD, Georgia ALBERT R. WYNN, Maryland
TOM A. COBURN, Oklahoma GENE GREEN, Texas
RICK LAZIO, New York KAREN McCARTHY, Missouri
BARBARA CUBIN, Wyoming TED STRICKLAND, Ohio
JAMES E. ROGAN, California DIANA DeGETTE, Colorado
JOHN SHIMKUS, Illinois THOMAS M. BARRETT, Wisconsin
HEATHER WILSON, New Mexico BILL LUTHER, Minnesota
JOHN B. SHADEGG, Arizona LOIS CAPPS, California
CHARLES W. ``CHIP'' PICKERING,
Mississippi
VITO FOSSELLA, New York
ROY BLUNT, Missouri
ED BRYANT, Tennessee
ROBERT L. EHRLICH, Jr., Maryland
James E. Derderian, Chief of Staff
James D. Barnette, General Counsel
Reid P.F. Stuntz, Minority Staff Director and Chief Counsel
------
Subcommittee on Finance and Hazardous Materials
MICHAEL G. OXLEY, Ohio, Chairman
W.J. ``BILLY'' TAUZIN, Louisiana EDOLPHUS TOWNS, New York
Vice Chairman PETER DEUTSCH, Florida
PAUL E. GILLMOR, Ohio BART STUPAK, Michigan
JAMES C. GREENWOOD, Pennsylvania ELIOT L. ENGEL, New York
CHRISTOPHER COX, California DIANA DeGETTE, Colorado
STEVE LARGENT, Oklahoma THOMAS M. BARRETT, Wisconsin
BRIAN P. BILBRAY, California BILL LUTHER, Minnesota
GREG GANSKE, Iowa LOIS CAPPS, California
RICK LAZIO, New York EDWARD J. MARKEY, Massachusetts
JOHN SHIMKUS, Illinois RALPH M. HALL, Texas
HEATHER WILSON, New Mexico FRANK PALLONE, Jr., New Jersey
JOHN B. SHADEGG, Arizona BOBBY L. RUSH, Illinois
VITO FOSSELLA, New York JOHN D. DINGELL, Michigan,
ROY BLUNT, Missouri (Ex Officio)
ROBERT L. EHRLICH, Jr., Maryland
TOM BLILEY, Virginia,
(Ex Officio)
C O N T E N T S
__________
Page
Testimony of:
Grasso, Richard A., Chairman and CEO, New York Stock
Exchange, Inc.............................................. 11
Levitt, Hon. Arthur, Chairman, Securities and Exchange
Commission................................................. 6
Zarb, Frank G., Chairman and CEO, National Association of
Securities Dealers, Inc.................................... 16
Material submitted for the record by:
Grasso, Richard A., Chairman and CEO, New York Stock
Exchange, Inc., letter dated July 17, 2000, enclosing
response for the record.................................... 27
Levitt, Hon. Arthur, Chairman, Securities and Exchange
Commission, letter dated July 25, 2000, enclosing response
for the record............................................. 39
Zarb, Frank G., Chairman and CEO, National Association of
Securities Dealers, Inc., letter dated July 14, 2000,
enclosing response for the record.......................... 34
(iii)
DECIMALS 2000--WILL THE EXCHANGES CONVERT?
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TUESDAY, JUNE 13, 2000
House of Representatives,
Committee on Commerce,
Subcommittee on Finance and Hazardous Materials,
Washington, DC.
The subcommittee met, pursuant to notice, at 2:35 p.m., in
room 2123, Rayburn House Office Building, Hon. Michael G. Oxley
(chairman) presiding.
Members present: Representatives Oxley, Shimkus, Wilson,
Fossella, Towns, Engel, and Luther.
Staff present: David Cavicke, majority counsel; Linda Rich,
majority counsel; Robert Simison, legislative clerk; Shannon
Vildostigvi; professional staff; Brian McCullough, professional
staff; and Consuela Washington, minority counsel.
Mr. Oxley. The subcommittee will come to order. The Chair
would recognize himself for an opening statement.
Three years ago I introduced a bill, along with Ed Markey
and Tom Bliley, the Common Sense Stock Pricing Act to convert
the U.S. securities markets to decimals. Some folks thought I
was behaving like a Democrat telling industry what to do. I
supported decimals for three reasons: One, competition in
spreads; two, ease of understanding; and three, international
competitiveness. Three years later, we have a date when our
securities markets will make the switch from trading in
fractions to trading in decimals. Given the deadlines that have
come and gone along the way, I am reminded of the words of the
great philosopher, Ringo Starr, ``you know it don't come
easy.''
We have a firm commitment from the SEC, the exchanges, and
the industry for conversion to decimals beginning this
September. The patience Congress has shown should not be
mistaken for anything other than our steadfast desire to
protect investors through competition.
Decimals is a classic case of a concentrated benefit to
some with a cost spread widely and invisibly. Chairman Bliley,
Congressman Markey and I took the lead to protect the public
when others failed.
Conversion to decimals is a win for our markets. Investors
will be able to pay a fair and accurate price for securities.
No longer will they be forced to quote and trade in the SEC-
mandated increments of a 16th, or before that, an 8th. They
will quote and trade securities in prices set by competitive
forces. When competition establishes trade increments, whether
it be a spread of a nickel, a penny, or less, a fair price will
be paid. The SEC should not meddle with the competitive
process. Competition alone should set the quoting and trade
increments.
The study on minimum increments requested by the SEC should
not become an excuse for collusion. Competitive spreads in
decimals will save investors money, as much as $3 million a
day, according to the GAO. Although that may not seem like a
lot of money to Wall Street, it is to the American investor.
Over the years, the SEC has stood by while fractions have
transferred investor money to Wall Street. Today we take a step
closer to allowing the market to put that money back in their
pockets, and as a result of the leadership of Chairman Levitt,
we are getting there.
I am pleased that Island ECN will begin trading in decimals
on July 3. I want to salute them for their leadership in the
market. They were able to recognize the need and visualize the
benefits of decimal conversion. For doing so they will get a
jump on the rest of the competition. I also would be
disappointed to see SEC rules or industry plans that inhibit
the ability of any competitor to compete on price.
The challenge is for the rest of the market to stick to the
conversion schedule to which they have agreed. The SEC needs to
monitor the market participants to ensure that all parties are
ready to convert to decimals by the new implementation
deadline. The GAO will continue its work auditing both the SEC
and industry to see that this is completed. Soon investors will
receive the benefits of H.R. 1053, the Common Sense Stock
Pricing Act of 1997 by trading in a decimalized market, a
victory we all can be proud of. Decimals in 2000, the time has
come.
At the dawn of the 21st century, our markets will no longer
trade in the increment of the 18th century. I want to
specifically thank our panelists today for their leadership and
hard work on this issue, Chairman Levitt, for your continued
guidance and leadership, Chairman Grasso and Chairman Zarb, for
your active participation in this. This is a team effort where
we have come, and I can't thank you enough. With that, let me
turn to my good friend, the ranking member from New York, Mr.
Towns, for an opening statement.
[The prepared statement of Hon. Michael G. Oxley follows:]
Prepared Statement of Hon. Mike Oxley, Chairman, Subcommittee on
Finance and Hazardous Materials
Three years ago I introduced a bill, the Common Cents Stock Pricing
Act, to convert the U.S. securities markets to decimals. Some folks
thought I was behaving like a Democrat--telling industry what to do. I
supported decimals for three reasons: (1) competition in spreads; (2)
ease of understanding; and (3) international competitiveness.
Three years later we have a date when our securities markets will
make the switch from trading in fractions to trading in decimals. Given
the deadlines that have come and gone along the way, I am reminded of
the words of the philosopher Ringo Starr--``you know it don't come
easy.''
We have a firm commitment from the SEC, the exchanges, and the
industry for conversion to decimals beginning this September. The
patience Congress has shown should not be mistaken for anything other
than our steadfast desire to protect investors though competition.
Decimals is a classic case of a concentrated benefit to some with the
cost spread widely and invisibly. Chairman Bliley, Congressman Markey,
and I took the lead to protect the public when others failed.
Conversion to decimals is a win for our markets. Investors will be
able to pay a fair and accurate price for securities. No longer will
they be forced to quote and trade in the SEC mandated increments of a
\1/16\th. They will quote and trade securities in prices set by
competitive forces. When competition establishes trade increments,
whether it be a spread of a nickel, a penny, or less, a fair price will
be paid. The SEC should not meddle with the competitive process.
Competition alone should set the quoting and trade increments. The
study on minimum increments requested by the SEC should not become an
excuse for collusion.
Competitive spreads decimals will bring will save investors money--
as much as $3 million a day--according to the GAO. Although that may
not seem like a lot of money to Wall Street, it is to the American
investor. Over the years the SEC has stood by while fractions have
transferred investor money to Wall Street. Today, we take a step closer
to allowing the market to put that money back in their pockets.
I am pleased that Island ECN will begin trading in decimals on July
3rd. I want to salute them for their leadership in the market. They
were able to recognize the need and visualize the benefits of decimal
conversion, and for doing so will get a jump on the rest of the
competition. I also would be disappointed to see SEC rules, or industry
plans, that inhibit the ability of any competitor to compete on price.
Now the challenge is for the rest of the market to stick to the
conversion schedule to which they have agreed. The SEC needs to monitor
the market participants to ensure all parties are ready to convert to
decimals by the new implementation deadline. The GAO will continue its
work auditing both the SEC and industry to see that this gets done.
Soon investors will receive the benefits of H.R. 1053, the Common
Sense Stock Pricing Act of 1997 by trading in a decimalized market--a
victory we can all be proud of.
Decimals in 2000--the time has come. At the dawn of the 21st
century our markets will no longer trade in the increment of the 18th
century.
I yield back.
Mr. Towns. Thank you very much, Mr. Chairman. I want to
thank you for holding this hearing. I also want to thank you
for behaving like a Democrat and for your long-standing
commitment to decimal trading in the U.S. equity markets.
U.S. securities markets are very, very important to the
economy of New York City. Therefore, I am committed to making
sure that these markets are competitive internationally.
Decimal trading is an important part of keeping the U.S. equity
market internationally competitive, because all of the world's
other equity markets already trade in decimals. I am especially
pleased with my good friend, one of the witnesses here today,
Dick Grasso, the chairman of the New York Stock Exchange. Dick
is a visionary, and it is good to see you here. He has
successfully positioned the New York Stock Exchange to compete
in the 21st century, and we congratulate you for that.
Decimal trading has benefits for investors, too. Trading in
pennies or nickels will certainly make it easier for retail
investors to track price movements in their stocks. Trading in
pennies will also result in narrower spreads in many stocks
providing significant savings to investors.
The impact of decimal trading will reach far beyond this.
In fact, I don't believe that anyone yet fully understands how
far-reaching these changes will be. Decimal trading will affect
message traffic and is likely to have an impact on quote debt
and incentives to engage in payments for order flow.
The challenges in starting decimal trading are great and we
will not underestimate that. For this reason, I think it is
very prudent to begin decimal trading with a pilot program
before fully implementing decimal trading in all stocks. Again,
Mr. Chairman, I thank you for calling this hearing and I look
forward to the testimony coming from the various witnesses, and
on that note, I will yield back.
Mr. Oxley. I thank the gentleman for his contribution. I
now recognize the gentleman from Staten Island, Mr. Fossella.
Mr. Fossella. Thank you, Mr. Chairman. And welcome to the
panel, distinguished as they may be. Let me commend you as
well, and Chairman Bliley, my good colleague, Ed Towns for
pursuing this as well as Ed Markey, who is not here.
As I said earlier today, this is a common sense measure
that I think is long overdue, and one of the things that was
stated earlier, I think it was Mr. Zarb had talked about one of
the wonders of the last several years has been the growth and
participation by ordinary Americans who, decades ago, probably
would not have participated in the enhancement of wealth in
this country, and it is a great thing.
I think 1 day every family should own a share of corporate
America and will be better off for it. But this is a measure
that I think goes beyond those who just failed math who may not
understand fractions. It is something whose time has come. Over
the last couple of years, while the industry, mind you, there
were folks who were in the trenches trying to make this
conversion happen, they deserve a lot of credit too for doing
so in an appropriate way and to the degree that we were able to
work and interface with the industry.
I always found them to be honest and people of integrity as
those you see before us, Chairman Levitt, and especially Dick
Grasso as well on the New York Stock Exchange. Not only is it
important in the envy of the world in terms of the capital
markets that we should be very proud of, and these gentlemen
and all of whom they represent, but it is also important to the
people I represent. New York City, as Ed Towns said, is really
so closely related to the financial service industry and the
markets, and we should never lose that, but also because people
that live in Ed Towns' district and people that live in my
district work every day for the New York Stock Exchange and for
Nasdaq. So for that, I am grateful. Let's get on with the
hearing.
[Additional statements submitted for the record follow:]
Prepared Statement of Hon. Tom Bliley, Chairman, Committee on Commerce
Mr. Chairman, three years ago I joined you and Ed Markey to move
our stock markets to decimals. Decimals are important for two reasons.
The first is that investors will save money--a lot of it--by ending SEC
mandated minimum spreads. According to the GAO investors will save $2
billion per year. The second reason is that decimals are easier to
understand. Nobody knows how much \13/16\ths is, but everybody knows
how much eighty-one cents is.
After we marked up the Common Cents Stock Pricing Act of 1997, our
witnesses before us today committed to get it done. We have waited
patiently for three years, and through a number of excuses, for
conversion to take place. Today, I understand our witnesses will commit
to begin conversion in September and complete it by April 9 of next
year.
This is not one minute too soon. Each day you wait, investors lose
$3 million to Wall Street. I expect you will keep your commitment and
make this change happen. When we began this process, we were opposed by
much of Wall Street and the SEC. Now, the continuation of trading in
fractions is widely considered an embarrassment. The SEC and the
industry need to make this their number one priority.
I would like to applaud those market participants who are ready to
make the conversion to decimals sooner. The Island, ECN has announced
that it will begin offering decimal trading on July 3. Island should be
commended for their efforts to bring greater transparency to the market
and American investors. Competition is the best protector of investors.
We should be sure that no barriers are placed in the way of those who
want to offer better prices to the public.
I also repeat my insistence that there be no mandated minimum
increments for quoting or trading. Those practices are illegal under
the antitrust laws. Competition', not collusion, should set prices. I
trust that the study of minimum increments called for by the SEC will
not be a vehicle for continued obstruction of market forces.
Mr. Chairman, I would like to congratulate you on your hard work to
bring decimals to our markets. Your tireless advance of this issue is
letting American investors see the light at the end of the tunnel. Soon
they will also be seeing a more competitive market where the market
decides the price of stocks and not the government. We in Congress led,
and the public is the better for it.
I yield back.
______
Prepared Statement of Hon. Eliot L. Engel, a Representative in Congress
from the State of New York
Mr. Chairman, I first want to thank you and the distinguished
members of this Subcommittee for having this hearing today. I am
equally pleased that Chairmen Levitt, Grasso, and Zarb taking time to
appear before this Subcommittee to discuss the issue of decimalization.
As you know, Mr. Chairman converting to decimal trading has been
one of my concerns since 1997. All market participants, whether
individual investors or professionals, would be affected in some way by
a conversion to decimal pricing.
While at times progress toward decimal trading has not been as fast
as it could be, I also want to be sure that Exchanges and market
participants have taken measures to prudently implement a transition.
I understand that NYSE is prepared to move forward with
decimalization and applaud its efforts bringing NYSE and the U.S.
financial market in line with our International counterparts. However,
like a symphony orchestra, unless all market participants do their
parts the financial market may experience unintended consequences. I am
aware that NASD may not be fully prepared to move toward decimalization
and look forward to asking questions related to this topic.
Once again, I thank the Chairman and Subcommittee for holding a
hearing on this important matter.
______
Prepared Statement of Hon. John D. Dingell, a Representative in
Congress from the State of Michigan
Mr. Chairman, I commend you for holding this hearing and I welcome
the panel of distinguished witnesses.
I believe that an orderly transition to decimal pricing in the
United States securities markets will benefit the markets and
investors. It will make stock prices more understandable to the average
investor. It also will narrow the quotation spreads in many stocks,
thus providing significant savings to investors. While there is not a
big difference between a nickel and the current \1/16\th (6.25 cents),
there is if the variation drops to a penny. A penny spread may not
prove economical for market makers, in which case bid and ask prices
will widen, and the market, and not the securities industry, will
decide how narrow or wide spreads will be.
The Securities and Exchange Commission (SEC) issued an order on
June 8 calling for a phased-in decimal conversion schedule and full
systems testing. The order directs the exchanges and Nasdaq to submit a
plan that would phase in decimal pricing for listed stocks and certain
options starting no later than September 5, 2000, and phase in decimal
pricing for Nasdaq securities beginning no later than March 12, 2001.
All securities must be priced in decimals no later than April 9, 2001.
I believe that this plan is reasonable and responsible, and I will
support it.
I do want to raise one concern that I hope will be addressed during
the implementation of the SEC's order. The conversion to decimal
pricing for listed securities allows for up to three months of testing,
while the testing for Nasdaq securities appears to be only three weeks.
Given the proposed NASD timetable, which I understand to be two weeks
of self-testing from February 26, 2001 to March 12, 2001, I am not
satisfied that the industry will have sufficient time to test systems
in conjunction with the Nasdaq's new computer system and be ready for
full conversion by March 31, 2001. I urge the SEC, Nasdaq, and the
industry to work together to resolve this shortcoming within the
parameters of the SEC order.
Mr. Oxley. I thank the gentleman. We now turn to our
distinguished panel and the aforementioned individual. Let me
begin with Chairman Levitt, chairman of the Securities And
Exchange Commission, the longest serving chairman of the
Securities And Exchange Commission in our Nation's history.
Again, we thank you for your leadership and vision on this
issue, Arthur.
STATEMENTS OF HON. ARTHUR LEVITT, CHAIRMAN, SECURITIES AND
EXCHANGE COMMISSION; RICHARD A. GRASSO, CHAIRMAN AND CEO, NEW
YORK STOCK EXCHANGE, INC.; AND FRANK G. ZARB, CHAIRMAN AND CEO,
NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.
Mr. Levitt. Chairman Oxley and members of the subcommittee,
I appreciate the opportunity to address you concerning the
transition to decimal pricing in both our securities and
options markets. Your leadership, along with Chairman Bliley,
Congressman Markey and other Members of Congress, has paved the
way for our Nation's securities markets to begin making this
truly watershed change this year. The significance of the
transformation to decimals is likely to be enormous. Many
seasoned market veterans disagree in their predictions of
exactly what decimal pricing will mean for our markets. Most
agree, however, that, in the end, investors will clearly
benefit, particularly small investors using market orders. As
prices are quoted in smaller and smaller increments, it will be
easier and cheaper for dealers and investors to improve the bid
or offer on a given security; but the imperative to embrace
decimal pricing goes beyond the quality of our domestic
markets.
As securities markets become more global with many stocks
traded in multiple jurisdictions, U.S. markets must adopt the
international convention of decimal pricing to remain
competitive. I firmly believe the time is now to make this
important move to decimals. The changeover, however, must
proceed in a prudent manner. Vigilance on all of our parts and
a sharp focus on the maintenance of orderly markets have never
been more important.
We have issued an order directing the exchanges and Nasdaq
to submit a plan that would phase in decimal pricing for listed
stocks and certain options starting no later than this coming
September, and for Nasdaq securities no later than March 12,
2001. At least some securities must begin quoting in pennies in
September, and all securities must be priced in decimals no
later than April 9, 2001. But we have afforded markets the
flexibility to set a more aggressive phase-in schedule provided
that they can satisfy themselves that there will be minimal
disruptions to the markets. I expect that this plan will move
our markets appropriately and prudently toward decimal pricing,
the goal all of us share, a goal that was moved constructively
and aggressively by this committee and by a number of members
of your staffs. I realize that many of you have been frustrated
with the pace of the market's conversion to decimals. I share
these frustrations. Earlier this year I was surprised to learn
of the NASD's inability to meet the July 3 conversion deadline.
I do appreciate, however, that unprecedented volume spikes
and unexpected test results contributed to that delay. The
experience reaffirms my judgment that technology must remain
second to none among the priorities of each of our markets, and
that close Commission oversight is critical. Since March, we
have received numerous briefings by the NASD's technology
group, and we have scheduled weekly conference calls between
the NASD, the Commission, and private technology consultants
selected by us. I believe that the Nasdaq is taking the
formidable challenges it faces extremely seriously, and I am
completely optimistic that they will meet this schedule on
time.
I look forward to the cooperation and collective effort of
all market participants as we move closer to bringing decimal
pricing to our markets. It is a profound and a positive step
both for America's investors and for America's competitive edge
in the coming global marketplace.
Thank you.
[The prepared statement of Hon. Arthur Levitt follows:]
Prepared Statement of Hon. Arthur Levitt, Chairman, Securities and
Exchange Commission
Chairman Oxley and Members of the Subcommittee: I would like to
thank Chairman Oxley and the members of the Subcommittee for the
opportunity to testify on behalf of the U.S. Securities and Exchange
Commission concerning the implementation of decimal pricing. Your
leadership has paved the way for our nation's securities markets to
begin making this truly revolutionary change this year.
i. executive summary
The convention of quoting stock prices in fractions dates back more
than two hundred years. Currently, the United States securities markets
are the only major markets not to price stocks in decimals. As the
securities markets become more global, with many stocks traded in
multiple jurisdictions, the U.S. securities markets need to adopt the
international convention of decimal pricing to remain competitive. And
the overall benefits of decimal pricing are likely to be significant.
Investors may benefit from lower transaction costs due to narrower
spreads.1 Moreover, the markets will be easier to understand
for the average investor, who is used to dealing in dollars and cents
for every-day transactions. It is time for the U.S. securities markets
to make this change.
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\1\ The Canadian exchanges implemented decimal pricing on April 15,
1996. This change reduced the minimum tick size on the primary Canadian
exchange, the Toronto Stock Exchange (``TSE''), from 12.5 cents to 5
cents for stocks trading above $5. For stocks trading between $3 and
$5, the minimum tick size was reduced from 5 cents to 1 cent. The
minimum tick size for stocks trading under $3 was unchanged. According
to a 1997 study, spreads for stocks listed solely on the TSE narrowed
by 20.18%. This study also indicated that investors save 139 million
Canadian dollars per year as a result of the narrowing of the spread
(or 102 million U.S. dollars). Because the value of shares traded
annually in the U.S. is approximately 30 times that on the Canadian
markets, the potential cost savings for U.S. investors that trade at
the spread using market orders could be significant. See Jeffery M.
Bacidore, The Impact of Decimalization on Market Quality: An Empirical
Investigation of the Toronto Stock Exchange, 6 Journal of Financial
Intermediation 92, 100-115 (1997).
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The Commission recognizes the efforts of Chairman Oxley, Chairman
Bliley, Congressman Markey, and other members of Congress in
spearheading the conversion to decimal pricing. We want to assure you
that the Commission is also committed to implementing decimal pricing
as soon as possible. That is why the Commission issued an order
directing the exchanges and Nasdaq to submit a plan that would phase in
decimal pricing for listed stocks and certain options starting no later
than September 5, 2000, and phase in decimal pricing for Nasdaq
securities beginning no later than March 12, 2001.2 Under
the order, all securities must be priced in decimals no later than
April 9, 2001--shortly after the end of the quarter.
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\2\ See Securities Exchange Act Release No. 42914 (June 8, 2000).
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I realize that many of you are frustrated with the pace of the U.S.
markets' conversion to decimals. I share some of these frustrations.
The Commission has been working with the securities industry to
implement decimal pricing since 1997. Like Congress, we believe the
time is right for the securities industry to convert to decimal
pricing.
Nevertheless, it is critical that this conversion take place in a
safe and orderly manner. The Commission has serious concerns about a
full-scale conversion to decimal pricing in listed securities without
an orderly phase-in. In particular, based on our discussions with the
industry, we are concerned that making an immediate leap to decimal
pricing could jeopardize systems capacity and capabilities. Without
adequate time for planning and systems testing, an immediate full-scale
conversion has the potential to create widespread operational problems,
which in turn could adversely affect investors.
Of course, some of the planning and testing has already been
completed. Most of these prior efforts, however, assumed that Nasdaq
stocks would be converted to decimals at the same time as listed
stocks. Any different plan to trade listed stocks in decimals, Nasdaq
stocks in fractions, and some options in both, raises issues that must
be addressed. For these reasons, we believe that the prudent approach
is to phase-in decimals starting in September 2000 to ensure that the
markets continue to operate in a fair and orderly manner, and that
investors are fully apprised of the changes ahead. Nevertheless, we
have left the markets and the securities industry the flexibility to
set a more aggressive phase-in schedule, provided that they can satisfy
themselves that there will be mimimal disruptions to the markets.
I will now briefly discuss the chronology of events leading up to
this point, including the recent Commission order.
ii. background
Throughout the mid and late 1990s, the Commission engaged the
securities industry and the public in a discussion regarding the need
for decimal pricing in the U.S. securities markets. On March 13, 1997,
this debate moved to the legislative arena when Congressman Oxley
introduced a bill in the U.S. House of Representatives that would have
directed the Commission to adopt a rule requiring quotations in dollars
and cents for transactions in equity securities. Subsequently, the New
York Stock Exchange announced that it would implement decimal pricing
by January 2000. Other markets soon followed suit. In light of this
activity, the bill was not taken to full markup in the House Commerce
Committee.
On May 8, 1998, the General Accounting Office (``GAO'') determined
that ``[e]nsuring that securities industry systems are ready for the
Year 2000 is too important to the continued functioning of the industry
to risk failure by attempting to implement decimal trading before the
Year 2000 effort is completed.'' 3 I concurred in this
assessment, but I also noted the importance of setting a date certain
by which the markets must move to decimal pricing. At that time, I
believed that the industry should strive to implement decimal pricing
by June 30, 2000.
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\3\ Testimony of Thomas J. McCool, Director, Financial Institutions
and Markets Issues, GAO, before the Subcommittee on Finance and
Hazardous Materials, Committee on Commerce, U.S. House of
Representatives on May 8, 1998. The GAO also recommended that the
Commission, in directing the securities industry's move to decimal
pricing, assess: (1) the potential impact of decimal trading on the
industry's processing and communication capacity; and (2) the impact on
market regulations and exchange rules.
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On August 25, 1998, Commission staff requested that the exchanges
and the National Association of Securities Dealers, Inc. (``NASD'')
provide information regarding the status of rule and systems changes
that would need to be adopted to implement decimal pricing. Their
responses indicated that a range of rules and systems would require
modification to accommodate decimal pricing. Because of the impact of
decimal pricing on the securities industry as a whole, virtually all
the market participants, and the Commission, believed that a
coordinated approach to implementation was necessary. To expedite the
conversion to decimal pricing and to alleviate the industry's antitrust
concerns, 4 on January 28, 2000, the Commission ordered the
exchanges and NASD to begin implementing decimals on July 3, 2000, and
to complete implementation for all equities and options within six
months after the July 3rd date.5
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\4\ As joint discussions regarding the implementation of decimal
pricing became more detailed, the exchanges and NASD began voicing
concerns regarding antitrust liability. See, e.g., letter from Colleen
P. Mahoney to Harvey J. Goldschmid, General Counsel, Commission, dated
October 14, 1999.
\5\ See Securities Exchange Act Release 42360 (Jan. 28, 2000), 65
FR 5004 (Feb. 2, 2000) (``Decimals Order'').
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The January 28th order also required the markets to submit, by
March 13, 2000, a joint plan detailing specifically how decimal pricing
would be implemented. To mitigate the potential strain on the computer
capacity of the industry and to minimize the potential for systems
errors, the order permitted the markets to phase-in decimals over
several months and permitted trading to begin in nickel increments for
equities and greater increments for options.
Prior to issuing the January 28th order, the Commission staff
surveyed the exchanges and NASD regarding their preparation for decimal
pricing. I understand that Nasdaq officials informed the staff that
Nasdaq would be ready for a decimal pilot by July 3rd. In late
February, Nasdaq reaffirmed its readiness in its formal response to the
survey, but indicated that it was continuing testing to confirm its
readiness. As I understand it, the testing revealed unexpected capacity
problems stemming, in part, from unprecedented volume surges. On March
6, 2000, the NASD announced that it would not have sufficient capacity
to meet the target dates for implementation.
The NASD also expressed concerns regarding overall industry
readiness and requested that the Commission work with the industry and
the markets to determine an appropriate time frame that would not
impose unnecessary risks on investors. Moreover, the NASD said that it
was not able to determine when it would be ready to implement decimal
pricing. As a result, on March 10, 2000, the Commission issued an order
delaying the March deadlines for approximately one month.6
In addition to the March 10th order, I sent a letter to each of the
markets requesting their opinions regarding issues central to the
implementation of decimal pricing. These issues included:
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\6\ See Securities Exchange Act Release No. 42516 (March 10, 2000),
65 FR 14637 (March 17, 2000).
whether or not it would be feasible or advisable to implement
decimal pricing in exchange-listed securities while Nasdaq
securities continued to trade in fractions;
whether or not it would be feasible to trade the same
securities in decimals on an exchange and in fractions on
Nasdaq; and
what the impact of trading the same securities in fractions
and decimals would be on the options markets.7
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\7\ After receiving responses from the markets regarding these
questions, the Commission, on April 13, 2000, issued an order
suspending the current deadlines for the implementation of decimal
pricing. See Securities Exchange Act Release 42685 (April 13, 2000), 65
FR 21046 (April 19, 2000) (``April Order'').
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In response, the exchanges indicated that their individual systems
are capable of converting to decimal pricing by July 3, 2000, though
many of them expressed concerns about the readiness of the securities
industry as a whole. The NASD asserted that Nasdaq has sufficient
capacity to implement decimal pricing for market makers trading
exchange-listed securities (i.e., the third market) by September 4,
2000, with full implementation of decimal pricing by March 31, 2001.
Two electronic communications networks stated that they are prepared
for decimals, and that trading exchange-listed securities in decimals
should not be delayed because of Nasdaq's inability to meet the July
3rd target date.
The vast majority of the markets and securities firms, however,
believed that it would be difficult and confusing to implement
widespread trading of exchange-listed securities in decimals while
trading of Nasdaq securities remains in fractions. Many responses
indicated that bifurcating the implementation of decimal pricing for
different markets on other than a pilot basis raised serious concerns.
For example, some responses indicated that trading of Nasdaq stocks in
fractions and exchange-listed securities in decimals over an extended
period of time could prove costly to markets, broker-dealers, and
vendors. In addition, the Financial Industry Forum (``FIF'') pointed
out that systems would have to be adapted to perform price format
checking for each and every security traded in a different format.
Without this format checking, and considering the investor confusion
caused by mixed pricing, the FIF believed that error rates and
corresponding order rejection rates could sharply increase. Moreover,
the Securities Industry Association's (``SIA'') Testing and
Implementation Subcommittee warned that piecemeal testing of systems
would be inefficient. The SIA's experts found that any testing that was
conducted at a point in time that was distant from the implementation
date would not provide an accurate determination of readiness.
iii. decimals phase-in plan
In view of these comments, on April 13, 2000, the Commission stayed
the deadlines in the original Decimals Order and solicited public
comment on two alternative proposals for decimal
implementation.8 In the first alternative, the Commission
requested comment on the advisability of pricing all exchange-listed
securities in decimals (in nickel or penny increments) by September 4,
2000 (``Dual Pricing''). In the second alternative, the Commission
requested comment on the advisability of phasing in decimal pricing in
certain exchange-listed securities on a pilot basis (``Decimals
Pilot'').
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\8\ Id.
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The Commission received 36 comment letters on these decimal
implementation alternatives. Some commenters urged the Commission to
delay decimalization until all markets are prepared for decimals.
Others supported full decimalization for both exchange-listed and
Nasdaq securities either immediately or no later than the July 3, 2000
start-up date proposed in the Commission's Decimals Order. The largest
number of commenters, consisting of broker-dealers, exchanges, clearing
organizations, the NASD, and the SIA, believed that some form of
phased-in dual pricing starting on or about September 5 would be both
feasible and advisable.
The commenters who preferred a phased-in approach varied on the
optimal method for achieving this approach. Most of these commenters
advocated an extended pilot of only a small number of listed securities
(along the lines of the Decimals Pilot alternative proposed for comment
in the April Order), with most listed securities moving to decimals at
the same time as Nasdaq securities. For example, the SIA believed that
a pilot was more feasible than Dual Pricing because Dual Pricing would
create major difficulties for the securities industry in creating and
maintaining separate processes, systems, and programs to trade large
number of securities in decimals while many others trade in fractions.
The SIA also believed that a pilot would simplify educational efforts
designed to inform the investing public of the way in which specific
securities would be priced. Other commenters, however, thought it
possible to phase-in decimal pricing in all exchange-listed securities
more quickly. The New York Stock Exchange, for example, favored
commencing decimal pricing in a limited number of NYSE-listed
securities, advancing to a full pilot of perhaps 50 NYSE-listed
securities during an initial phase-in period of one month or less. The
New York Stock Exchange indicated that an expansion to all of its
listed securities could prudently occur after approximately 60 days of
trading in all pilot stocks. All of the commenters stressed the need
for careful planning and systems testing to avoid potential market
disruptions and to minimize investor confusion.
The Commission carefully considered the comments, particularly the
request of Congressmen Oxley, Bliley, and Markey to implement decimal
pricing in all exchange-listed securities by September 4, 2000. In view
of the concerns raised by commenters and our own discussions with
industry participants, the Commission came to the conclusion that an
immediate full-scale introduction of decimalization in listed stocks,
without adequate planning and systems testing, had the potential to
create widespread operational problems in the markets and the
securities industry, which in turn could adversely affect investors.
The Commission therefore ordered the exchanges and Nasdaq to submit
a plan that would phase in decimal pricing for listed stocks and
certain options starting no later than September 5, 2000, and phase in
decimal pricing for Nasdaq securities beginning no later than March 12,
2001.9 Under the order, all securities must be priced in
decimals no later than April 9, 2001--shortly after the end of the
quarter.
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\9\ See supra note 2.
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A phase-in period should give the industry time to finalize
testing, to adjust their systems to correct errors as they phase in
particular stocks in decimals, to educate investors, and to monitor
changes in trading behavior. In particular, trading in decimals,
especially in penny increments, may affect the use and display of
customer limit orders, the liquidity of certain stocks, and the ability
to sell short. A phase-in period, even a short one, will allow the
Commission and the markets to monitor the impact of decimalization on
trading behavior and to determine if trading rules need to be adjusted.
The Commission did not mandate widespread Dual Pricing ahead of
Nasdaq's projected decimal date because of the potentially serious
systems and capacity problems raised by market participants. In view of
the New York Stock Exchange's position and other comments on a more
rapid move to full Dual Pricing, the Commission did not want to
foreclose the possibility that the problems could be addressed and
broader decimal trading begin in listed stocks before April 9.
Therefore, the Commission's order gives industry participants the
flexibility to begin broader Dual Pricing between September of this
year and April of next year. If operational issues can be addressed and
investor confusion can be minimized through educational efforts within
a shorter time frame--such as the one suggested by the NYSE--the order
allows the industry to move to full decimalization well before April 9,
2001.
As for quoting increments, there was little agreement among the
commenters regarding a minimum increment during the phase-in period--
suggestions ranged from a dime to a penny. Accordingly, in its order,
the Commission allowed the exchanges and NASD to fix the minimum
quoting increment during the phase-in period, provided that the minimum
increment is no greater than five cents and no less than one cent for
any equity security, and that at least some equity securities are
quoted in one-cent minimum increments. We fully expect that the pilot
in listed stocks under consideration will trade in penny increments.
Finally, the Commission directed the exchanges and NASD to submit
(either individually or jointly) a study to the Commission on June 9,
2001, that evaluates the impact of decimals on trading patterns and
capacity and that makes a recommendation regarding a minimum increment,
if any. Further, the order directed the exchanges and NASD to submit
rule change proposals to the Commission thirty days after submitting
the study that would establish their individual choice of minimum
increments by which equities or options are quoted on their respective
markets
iv. nasdaq capacity
Before I conclude, I would like to briefly address Nasdaq's
technology and planning. As I indicated above, the unprecedented growth
in volume and quote traffic is presenting the Nasdaq market with
formidable challenges, and I am committed to ensuring that Nasdaq faces
them squarely. Last August and September, my staff reviewed Nasdaq's
computer operations and identified to Nasdaq staff concerns about
Nasdaq's capacity planning. In January of this year, the staff issued a
report to Nasdaq identifying systems capacity as a key concern and
recommending that Nasdaq obtain an independent assessment of its
infrastructure capacity and its capacity planning process.
In response to Nasdaq's announcement that it would not be decimal
ready by July 3rd, we prompted Nasdaq to accelerate its process for
hiring an independent consultant to evaluate Nasdaq systems capacity
and capacity planning. That review is nearing completion. Since that
time, we also have closely monitored Nasdaq's progress with decimal
implementation, including weekly conference calls with Nasdaq's Chief
Information Officer. Last week, I personally met with Nasdaq
management, including its Chief Information Officer, to discuss its
readiness for decimals and broader capacity issues. We believe that
Nasdaq is taking seriously the challenges presented by the conversion
to decimals, as well as other capacity issues. Our goal is to see to it
that Nasdaq remains on schedule for decimalization in Spring of next
year.
v. conclusion
In conclusion, because of your leadership, decimalization will
become a reality this year, and investors will soon reap the benefits
of trading in decimal increments. The Commission remains committed to
implementing decimal pricing in a safe and orderly manner, with minimal
disruptions to the markets. We appreciate your leadership on this issue
and hope to work closely with you in the months ahead.
Mr. Oxley. Thank you, Mr. Chairman. Our next witness is the
Chairman and CEO of the New York Stock Exchange, Dick Grasso.
Mr. Grasso, welcome.
STATEMENT OF RICHARD A. GRASSO
Mr. Grasso. Thank you, Mr. Chairman. Good afternoon. Mr.
Chairman, Mr. Towns, members of the subcommittee, I am pleased
to be here today to discuss the New York Stock Exchange's
conversion to a decimal pricing table. The legislation approved
by this subcommittee in early 1997 was the single most
important catalyst to the decimal conversion process. Chairman
Bliley, Chairman Oxley, Representative Markey, and all members
of the subcommittee are to be commended and congratulated. I am
particularly grateful for the support of the delegation members
from New York, Mr. Towns, Mr. Fossella, Mr. Engel, who have
supported and indeed encouraged the New York Stock Exchange to
take this bold conversion move.
I am pleased, Mr. Chairman, to be able to answer the
question posed by the title of today's hearing by saying simply
yes, the NYSE will convert. Consistent with the timetables set
by the SEC order, the NYSE will begin the conversion to decimal
pricing in September. We expect to introduce a pilot for some
50 securities which will trade both on the New York Stock
Exchange and in the Nasdaq third market quoted and traded on a
penny-denominated basis. The NYSE was the first market to
approve conversion to decimal pricing when our board, with the
encouragement of this committee, considered it at its meeting
in June 1997.
The NYSE sees conversion to decimals as a win-win-win
proposition. That is, it will benefit investors, the companies
they invest in, and all those in the industry who serve our
consumers. Decimals will ultimately make prices more easily
understood by individuals particularly. Spreads and highly
liquid stocks should tighten appreciably. This should provide
significant cost savings for investors, particularly given the
minimum price variation being reduced to one cent. By bringing
the United States into conformity with international practices,
decimalization should improve the competitiveness of U.S.
markets on a truly global scale. Decimal trading will
ultimately increase the number of possible trading increments
within a single dollar from the current level of 16 to 100.
It is in the interest of all market participants to ensure
that the markets can handle the increased message traffic which
decimalization will produce.
Today, the NYSE has significant capability to handle 1,000
messages per second. Stated in volume terms, some 5-plus
billion shares in a single trading session. By the end of this
year, that capacity will double to 2,000 messages per second
producing a capability of some 10 billion shares of capacity in
a single trading session.
The NYSE takes its commitment to decimalization seriously,
and we have built and will continue to buildupon our technology
infrastructure. This is a conclusion which we share by the GAO
in its report to this committee this past spring.
Later this year, the Exchange will begin the implementation
of what we call network NYSE, a platform for customer choice.
The new products that we will offer under the umbrella NYSE
network include NYSE direct plus, institutional express, and a
virtual 3-D trading floor, all of which will support decimal
pricing tables as they are brought on-line.
Testing between the exchange and the member firm community
began in mid January of this year, industry wide testing in
listed securities in April, and we are almost 90 percent
complete. The Exchange is taking steps to make sure our member
firms are prepared for decimal trading. At its meeting earlier
this month, the Exchange's board of directors approved a rule
which mandates each member organization must participate in
industry testing. This rule will be filed with the commission.
We have also sent out a decimalization preparedness survey to
our member organizations and expect to complete our evaluation
by the mid- to late part of July.
The New York Stock Exchange has committed, Mr. Chairman,
significant resources and personnel at the highest levels to
implement the wishes of this committee consistent with the
timetable embraced by Chairman Levitt and the Securities And
Exchange Commission. We remain committed to working with the
Congress, the Commission, and the industry, to ensure that
decimalization conversion is done on an expedited timetable
without any risk to consumers.
I thank you again, Mr. Chairman, for the opportunity to
testify today. I ask permission to submit my written statement
for the record and would be pleased to answer any questions
after my colleague has testified. Thank you.
[The prepared statement of Richard A. Grasso follows:]
Prepared Statement of Richard A. Grasso, Chairman and Chief Executive
Officer, New York Stock Exchange
Mr. Chairman, Mr. Towns, and Members of the Subcommittee: I am
pleased to be here today to discuss the New York Stock Exchange's
progress in converting to decimal pricing. I know that decimalization
of U.S. securities markets has been a high priority for this
Subcommittee for several years. The legislation considered and approved
by the Subcommittee in early 1997 was the single most important
catalyst for the U.S. securities markets to commit to decimal
conversion.
For this reason, I am pleased to be able to answer the question
posed by today's hearing with an unequivocal ``YES.'' Consistent with
the timetable to be set by the SEC order, the NYSE will begin the
conversion to decimal pricing in September, with conversion fully
completed by next spring. The Exchange has committed significant
resources to ensure successful implementation of decimal pricing this
year.
Moving to decimal trading has been a major focus at the New York
Stock Exchange for the last three years. We first began these efforts
as early as 1995 with discussions of trading foreign shares in local
currencies.
Our Board approved conversion to decimal pricing on June 5, 1997.
We were the first U.S. securities market to take that step. As we
stated at that time, decimals will ultimately make prices more easily
understood by individual investors. Spreads in highly liquid stocks
should tighten appreciably. By bringing the United States into
conformity with international practices, decimalization should improve
the competitiveness of the U.S. markets on a global basis.
To begin the move toward decimalization, the Exchange created a
committee of senior operations executives to assist in the preparation
and implementation of industry efforts. This Operations Advisory
Committee began meeting in September 1997. Subcommittees dedicated to
specific subjects began meeting in November of that year. At the
suggestion of the SEC, the Exchange convened a small working group of
equity and options markets, which met in February 1998 to propose a
plan for the securities industry's conversion to decimal trading. The
input from the Operations Advisory Committee served as the basis for
discussion among the markets at that meeting. The proposed plan was
endorsed by the Securities Industry Association, which also agreed to
act as the industry focal point for implementation.
At the NYSE, a Decimalization Project Team was formalized in early
1999. In order to optimize the efficiency of the conversion process,
the Team worked in concert with the Year 2000 Project Planning Team.
Participants in the Decimalization Project Team included representation
from the following NYSE offices: Systems Planning, Trading Services,
Market Operations, Market Surveillance, Market Data Vendor Relations,
Listing Systems, Research Systems, Communications Systems and Media,
Capacity Planning, Contingency Planning and Securities Industry
Automation Corporation (SIAC).
Decimal conversion impacts every NYSE system, from trading systems
to surveillance and financial systems. Imagine that all of the
information travelling to and from the New York Stock Exchange is
contained in one large pipeline. Currently that pipeline receives and
transmits information, such as orders, quotations, last-sale data and
administrative messages from the Exchange to and from, among others,
broker-dealers, broadcasters, and financial information vendors. The
conversion to decimals implicates: the capacity of that pipeline; the
ability of switches within the pipeline to recognize where the data
should go; and the interface between the NYSE pipeline and other
systems outside of the NYSE.
Decimal trading will ultimately increase the number of possible
trading increments within a dollar from 16 to 100. Largely due to this,
we believe that decimal conversion is going to increase the volume of
information in the pipeline. It is in the interests of all market
participants to ensure that this information pipeline can handle the
increased volume. Today, the NYSE's ``pipeline'' has sufficient
capacity to handle 1000 messages per second, or, stated otherwise, 5
billion shares per day. By the end of this year, the pipeline will
handle 2000 messages per second or 10 billion shares per day.
Typically an order sent to our Trading Floor electronically,
through the NYSE's SuperDot system, is executed and confirmed to the
originating broker in less than 20 seconds. (When NYSE Direct+ is
introduced later this year, this turnaround time will be nine seconds
for customers choosing this service.) The processing of an order
involves a number of different steps and implicates several systems.
The order is recognized, validated, routed to the trading post, appears
on the display book, is exposed to the auction, may receive price
improvement, and is executed and returned to the originating broker.
The NYSE cannot tolerate system slowdown due to increased message
traffic. All of the NYSE's new products, including NYSE Direct+,
Institutional Xpress, and the virtual 3D Trading Floor, will support
decimal pricing as they are brought online later this year.
Additionally, the Broker Booth Support System (BBSS) must be able
to transmit and receive decimal orders. (The BBSS provides electronic
support to the NYSE floor broker; it receives orders from member firms,
transmits orders to the trading post, researches stock trends and
market data, and provides access to other broker support services.) All
components of the trading post, including the specialist display book,
the overhead display and the auxiliary display monitor, which provides
market data and financial news to the Trading Floor, must support a
decimal environment, i.e., must be able to recognize and display
decimals. The NYSE's regulatory surveillance systems must be able to
recognize decimal trading in order to properly alert surveillance
personnel to trading irregularities.
The NYSE employs a highly dependable network of systems. During the
last 12 years, the NYSE has experienced a total of two hours of system
downtime during the trading day. The conversion to decimals is another
challenge to ensure that the NYSE's systems operate as efficiently as
possible. Currently all NYSE systems--including our switching and order
processing systems, market data systems, surveillance systems, listed
company and financial systems, common shared services systems, after-
hours and comparison systems--are decimal-ready, and we will be ready
to implement consistent with the timetable established by the SEC
order.
The NYSE is committed to providing its clientele with the fastest,
most accurate service possible. Most of the NYSE's decimal conversion
costs were incurred simultaneously with our Year 2000 system
conversion. This simultaneous systemic conversion upgrade cost
approximately $30 million.
With the advent of decimal trading, the Exchange is well-positioned
to handle the increased traffic across all of our systems. This, of
course, is not enough. If investors are to obtain the benefits of
decimalization, market participants, from the regional stock exchanges,
to the broker-dealer community, to financial information providers, to
clearing organizations, should have the capacity and the ability to
transmit and accept data priced in decimals. With this in mind, an
industry-wide effort to coordinate the decimalization process was put
in place.
In July 1998, a Decimalization Steering Committee was formed, led
by SIA and composed of representatives of the equity and options
markets and member firms. The Committee engaged SRI Consulting to
conduct a study designed to develop capacity planning assumptions for
the industry's order execution, market data, and clearing systems. The
SRI study, released in early May 1999, forecast increases in quote
messages per second for stocks of approximately 50%, using a minimum
price variation of a nickel, and well over 200% using a minimum price
variation of a penny.
At an industry-wide Decimalization Conference in September 1999, a
proposed implementation schedule was announced by the Decimalization
Steering Committee. It included three phases:
Phase One, to be conducted from July 3-August 4, 2000, with a
limited number of securities trading in increments of a nickel.
This phase was scheduled to last five weeks and would involve
30-40 securities selected by the markets and the Committee.
Phase Two, to be conducted from August 7-September 29, 2000,
when all securities would begin trading in nickel increments.
This phase was scheduled to last eight weeks.
Phase Three, to begin October 2, 2000, when all securities
would trade in increments determined by market forces.
On January 28 of this year, the SEC issued a release on decimal
pricing, directing the exchanges and NASD to submit a decimalization
implementation plan. This action provided the industry with guidelines
for conversion and cleared the way for the industry-wide cooperation
necessary for the successful conversion to decimal pricing. The SEC
specified that the plan should provide that decimal pricing of at least
some equities and options on those equities should begin no later than
July 3, 2000, and that decimal pricing of all equities and options
should be completed within six months of that date. The SEC also stated
that the plan may fix a minimum increment no greater than five cents
during the phase-in period.
The NYSE moved early to convert our systems to decimal-readiness. A
major test conducted in mid-December 1999 found that 99% of our trading
systems were ready to operate in decimals. The remaining work was
completed and the Exchange was 100% decimal-ready by April 30, 2000. On
June 3, we conducted a full-blown decimal production test on the
Trading Floor, which revealed no problems, and we have now completed
all internal testing.
Testing between the Exchange and some member firms began in mid-
January of this year. Industry-wide testing began in April. In order to
maintain momentum, industry-wide testing in listed securities has
continued and is now 85% complete.
On April 13, the SEC issued an order staying the deadlines for
decimal implementation and requesting comment on a revised schedule for
implementation of decimal pricing. The SEC solicited public comment on
two alternative proposals:
(1) beginning trading in all exchange-listed securities in decimals, in
nickel or penny increments, by September 4, 2000; or
(2) phasing in decimal pricing in certain exchange-listed securities on
a pilot basis, to begin by September 4, 2000. Trading would be
in penny increments. The pilot would expand to all listed
stocks on March 31, 2001. Selected Nasdaq stocks would be added
if feasible, and the SEC would expect all Nasdaq stocks to be
trading in decimals by March 31.
In response to the SEC's latest request for comment on a timetable
for implementing decimal pricing, the Exchange has stated that we are
prepared to begin decimal pricing this year whenever the Commission
deems it appropriate.
Because we are always careful to implement new systems after full
testing, we suggest that the first phase of implementation be a pilot
program in which decimal trading in pennies would begin in a limited
number of NYSE-listed securities. This initial program would ultimately
include about 50 NYSE-listed securities, with a range of trading
volumes and other trading characteristics, during an initial phase-in
period of one month or less. Such a measured approach would provide the
opportunity to assess the impact of decimal trading on an inter-
systemic basis. Of particular concern is the expected increase in
message traffic associated with decimal pricing. We believe that
expansion of the pilot program to all NYSE-listed securities could
occur after approximately 60 days of trading, subject to evaluation of
the pilot program results.
The Exchange is taking steps to enhance the preparedness of our
member firms for decimal trading. At its meeting earlier this month,
our Board approved a rule mandating that each member organization
participate in industry testing. This rule is being filed with the SEC.
We have also developed, and are conducting this month, a
decimalization preparedness survey. The survey, which was sent out on
June 9, asks whether member organizations:
are currently ready to handle decimal pricing;
have tested their systems;
have implemented the requisite capacity for penny increments;
have assessed third party vendors' preparedness; and
have addressed the pending changes with both retail and
institutional customers.
We expect to complete evaluation of the responses by the end of
July.
The New York Stock Exchange has committed significant resources and
personnel at the highest levels to implement decimal pricing. We
continue to believe that decimal pricing will enhance our global
position. More importantly, decimalization will make stock prices more
easily understood by individual investors, and will result in narrower
quotation spreads in many stocks. This will provide significant savings
to investors, particularly if the minimum price variation is reduced to
a penny. We remain committed to working with the SEC, Congress, and the
securities industry to achieve decimalization of U.S. securities
markets as soon as practicable.
Thank you again for the opportunity to testify today. I would be
pleased to answer any questions you may have.
Mr. Oxley. The Chair would ask unanimous consent that all
written statements will be made part of the record including
the members' opening statements as well.
We now recognize the Chairman and CEO of Nasdaq, our good
friend, Frank Zarb.
STATEMENT OF FRANK G. ZARB
Mr. Zarb. Thank you, Mr. Chairman, members of the
committee. Thank you for this hearing and thank you for your
leadership.
I am with the opening comments of Chairman Levitt and the
following comments by Chairman Grasso. I think they have
covered a good part of where we stand, and we certainly
associate ourselves with both the spirit and the substance of
what has been outlined here this afternoon. So I am going to
make my opening statement very, very brief so we can get to
your questions.
I did want to say, however, the significance of what we are
doing is more meaningful than simply a rearrangement of market
structure. It does follow the way the world is turning with
respect to Mr. and Mrs. average middle class, participating in
the wealth of the securities markets. The world will have
within 5 years about 500 million Internet users. That is 500
million Internet users worldwide. A good many of them are going
to be able to trade on-line as we see now, even in places like
Japan, where 50 brokerages are offering on-line trading.
All of this means that average people, especially here in
the United States, are going to want to have an opportunity to
share in the wealth of the securities markets. This step toward
decimalization moves the country in that direction in a
meaningful way. In my opinion, this is the most significant and
meaningful aspect of what we are about to do here. It clearly
will have advantages in terms of spreads and economics to the
investor, but more meaningfully than that, it has both a
society and a cultural dimension that we should not overlook.
With respect to commitment, the NASD and Nasdaq are
committed to decimals. We will follow the same general outline
that has been articulated here earlier. We will be prepared in
September to move in unison with my good friend Dick Grasso,
and the New York Stock Exchange in order to open a test and we
will do it in pennies. By the March date articulated by the
chairman, we will be ready to start to move into Nasdaq
securities and have it completed on schedule.
There are obviously questions that have been raised with
respect to capacity. We have moved to ensure those capacity
issues are resolved. I would just remind you that in the first
6 months of last year, we averaged about 900 million shares a
day on the Nasdaq stock market. This year to date so far we
have averaged 1.7 billion shares per day on the Nasdaq stock
market. That is an example of the changes in capacity that we
have had to provide for. Having said all of that and given
those numbers, we are prepared to move on schedule, and we will
hopefully be moving in a parallel way that is a quality-of-
market dimension and not one which is a competitive aspect.
This is not a structure that should be used as a competitive
tool where you run the risk of confusion and worst to
investors.
There is a question that still needs to be addressed
hopefully during the pilot stage, the impact on options. I have
read a lot of studies and they don't always all agree with each
other. I am sure you have seen some of the statement studies as
to the volume aspect of options trading in decimals. We are
going to have to look at those numbers very carefully during
the pilot period and make sure we make the appropriate
judgments going forward.
Mr. Chairman, members of the committee, we are, at Nasdaq,
completely supportive of this goal and we will be there on time
with a performance that has been outlined to the benefit of the
marketplace.
[The prepared statement of Frank G. Zarb follows:]
Prepared Statement of Frank G. Zarb, Chairman and Chief Executive
Officer, National Association of Securities Dealers, Inc.
I am Frank Zarb, Chairman and CEO of the National Association of
Securities Dealers, Inc. I thank Chairman Oxley and this Committee for
this opportunity to testify on the NASD's preparedness for
decimalization and our schedule of implementation for conversion to
decimal pricing.
By way of summary, the NASD remains a strong proponent of
decimalization. We are prepared to implement decimal pricing, as the
SEC finds to be in the public interest in maintaining fair and orderly
markets and to protect investors. We are thus prepared to implement
decimal pricing for listed securities on September 4 of this year on a
pilot or full basis, in nickels or pennies. We are also prepared to
implement decimal pricing in Nasdaq securities by March 31, 2001, on
either a pilot or full basis, in nickels or pennies. Because conversion
to decimals requires the efforts of all market participants to be
successful, we will continue to work with the SEC, Securities Industry
Association, and our membership to ensure that decimalization occurs in
a timely and non-disruptive manner.
the nasd
Let me briefly outline the role of the NASD in the regulation and
operation of our securities markets. Established under authority
granted by the 1938 Maloney Act Amendments to the Securities Exchange
Act of 1934, the NASD is the largest self-regulatory organization (SRO)
for the securities industry in the world. Virtually every broker-dealer
in the U.S. that conducts a securities business with the public is
required by law to be a member of the NASD. The NASD's membership
comprises 5,500 securities firms that operate in excess of 80,000
branch offices and employ more than 638,000 registered securities
professionals.
The NASD is the parent company of The Nasdaq Stock Market, Inc.,
the American Stock Exchange, and NASD Regulation, Inc. (NASDR). These
wholly owned subsidiaries operate under the authority of the parent,
which retains overall responsibility for ensuring that the
organization's statutory and self-regulatory functions and obligations
are fulfilled.
NASD Regulation is responsible for the registration, education,
testing, and examination of member firms and their employees. In
addition, it oversees and regulates our members' market-making
activities and trading practices in securities, including those that
are listed on The Nasdaq Stock Market and those that are not listed on
any exchange.
The American Stock Exchange is the nation's second largest floor-
based securities exchange, and is the only U.S. securities exchange
that is both a primary market for listed equity securities as well as a
market for equity options, index options, and equity derivatives.
The Nasdaq Stock Market is the largest electronic, screen-based
securities market in the world. Founded in 1971 as the world's first
all electronic stock exchange, it is the original on-line market, and
the pioneer in e-commerce. Nasdaq today accounts for more than one-half
of all equity shares traded in the nation and, since January of last
year, is also the largest stock market in the world in terms of dollar
value of shares traded. Nasdaq lists the securities of 4,854 domestic
and foreign companies, more than all other U.S. stock markets combined.
There are over 70 million investors in Nasdaq companies.
Nasdaq ended 1999 with its fifth consecutive year of record gains.
That year produced 136 trading days where volume exceeded one billion
shares traded on Nasdaq. Annual share volume reached 265.6 billion, up
from 201.5 billion in 1998--a 32 percent increase for the year. The
market value of the more than 4,800 companies listed on Nasdaq ended
the year at $5.2 trillion, up over 100 percent from year-end 1998. It
is not hard to see, with such explosive growth, how estimates of 1999
and 2000 market volume made several years ago were too low.
nasdaq decimalization
The NASD welcomes this opportunity to describe our preparedness and
implementation schedule for decimals, and applauds Chairman Oxley and
the Subcommittee on the leadership they have shown in ensuring that our
markets decimalize as soon as possible. This constant attention
contributes to the speed with which the markets and the industry are
converting to decimal trading.
Like the Subcommittee and the SEC, the NASD remains committed to
implementing decimal pricing as expeditiously as possible. However, we
too are concerned that decimals be implemented in a way that does not
negatively impact order routing, trading, and settlement systems of the
markets and the securities industry, and that does not result in
investor confusion.
The NASD's commitment to decimals was early and strong. As you are
aware, the NASD was the first US market to support decimal pricing,
beginning with our testimony before this Subcommittee on April 16,
1997. The NASD Board on August 7, 1997 voted to begin operating Nasdaq
systems using decimals. In a May 7, 1998 letter to Congressmen Bliley,
Oxley, and Markey we underscored our commitment to decimal pricing, but
cautioned that the implementation date should be set for September 2000
to allow time to deal with the Year 2000 problem.
We would also point out that Nasdaq is the first and only US market
whose systems support trading of decimals today. While we do not yet
provide decimal quotation services, Nasdaq's trade reporting systems
support decimals and allow participants to trade and report trades for
comparison and clearing in decimals now.
Our position on converting our markets to decimals has not changed.
We remain a strong proponent of the shift to decimals because they will
make the markets even more accessible to investors and can potentially
reduce transaction costs. We want to reemphasize to the Subcommittee
that we will commit whatever capital and personal resources are
necessary to implement decimalization on a timely basis.
As you are aware, in 1999 and early 2000 Nasdaq experienced a
doubling of share volume, accompanied by an even greater increase in
quote and trade message traffic. As a result, Nasdaq encountered
problems with previous decimalization schedules because of systems
capacity problems stemming from the unprecedented, explosive growth of
Nasdaq trading since the last quarter of last year. We have addressed
those problems and are confident that we will fully comply with the
revised schedules.
Nasdaq will not be an impediment to decimalization of the exchange-
listed market, on either a full or pilot basis in September 2000. From
a technical standpoint, it appears possible for exchange-listed
securities to be traded in decimals while Nasdaq trades in fractions.
This transition will not pose the system problems that full Nasdaq
implementation of decimals would entail, because the exchange listed
securities are a small fraction of Nasdaq volume and exchange volume is
growing much slower than Nasdaq. For example, NASD exchange listed
trade volumes in the Consolidated Quotation System are only 6% of
Nasdaq's 2.2 million trades per day. Moreover, listed market average
daily trade volume, although roughly equal to Nasdaq at the end of
1998, is now substantially lower than Nasdaq volume, as shown in the
following chart.
US Equities Average Daily Trade Volume
[GRAPHIC] [TIFF OMITTED] T5803.044
We are prepared to implement either of the alternatives suggested
in the SEC's recent release seeking comment on revised decimal
implementation schedules. We are thus prepared to implement either full
dual pricing or a pilot of dual pricing, in listed stocks in nickels or
pennies, by September 4, 2000, as the SEC finds to be in the public
interest in maintaining fair and orderly markets and to protect
investors. We will also be ready to initiate decimal pricing in Nasdaq
securities on March 31, 2001, in nickels or pennies, on a pilot or full
market basis. In this connection, we note that Nasdaq has never had and
does not support a government mandated minimum trade price variation
for equities.
options decimalization
The largest challenge of decimalization relates to options trading.
Because each option trades both puts and calls in multiple series, a
single quotation change in its underlying equity can trigger a large
amount of quote activity for that option. The demands currently placed
on the systems that disseminate options quote and trade data are
already substantial due to highly volatile equity markets and a rapidly
changing competitive landscape. In addition, a recent industry study
projected that the transition to decimal pricing will increase the
demands placed on these systems to levels well beyond their anticipated
capacities. The exchanges continue to work with each other and the SEC
on a solution to this complicated and challenging problem.
conclusion
We applaud the work that the SEC, the Securities Industry
Association's Decimalization Steering Committee, and the Decimal
Exchange Committee are doing to ensure that the industry will be
prepared for decimals as soon as possible. We recommend that you
consult with them on their plans and schedules, which are a major
component of the decimalization process, to gain a more complete view
of how all market participants will convert to decimal pricing. Because
conversion to decimals requires the efforts of all market participants
to be successful, we will continue to work with the SEC, the industry,
and our membership to ensure that decimalization occurs in a timely and
non-disruptive manner.
Thank you for the opportunity to testify on this important issue.
We look forward to working with the Subcommittee, the SEC, and all
market participants to implement decimals as soon and as safely as
possible. I will be happy to answer any questions that you may have.
Mr. Oxley. Thank you, Mr. Zarb. Thanks to all of you. Let
me begin the round of questioning with a general question. It
seems
the first issue that comes up when we are talking about this
conversion, which will begin in September, is what factors will
be considered in the number of stocks in the pilot program
initially, and what will be the minimum increment? In other
words, the order, as I understand it, Chairman Levitt, does not
specify these issues. Could you give us some kind of an idea,
and I would like to ask the other two CEOs exactly what they
have in mind. Under your orders, I understand you can have as
few as one stock or as many as several thousands. Where are we
in terms of that number?
Mr. Levitt. We don't require nickel increments, and we
allow the markets to determine, subject to Commission approval,
the scope and the pace of the phase-in. We do set a minimum
increment of a penny during the phase-in period, which lasts
until April 9, 2001. After that period of time, market forces
will prevail and any increment can be implemented at that
point, subject to Commission approval.
Mr. Oxley. Now, when you testified in 1997, that seemed to
be the implication in that regard. Is it also true you will
have a market study that will track that in terms of trying to
come up with a minimum increment or not coming up with a
minimum increment?
Mr. Levitt. In 1997, the question was pennies, nickels, or
dimes? Today, the question really is whether the system is
capable of handling hundredths, and we are going to watch very
closely what happens during this pilot period, but, certainly,
our inclination in terms of formulating this program is to
allow market forces to determine the scope of the program, the
number of securities that are phased in, and eventually after
April 2001, the level of what the increment will be. Obviously,
if during this pilot period we see systemic risks, we are going
to work very closely with the exchanges and with the committee
to address that, but we will work very, very closely and watch
it closely.
Mr. Oxley. Mr. Chairman, would you envision or would you
indicate to the committee that perhaps as much as a minimum of
50 stocks would be a rather valid and effective number of
stocks in the initial pilot program of listed stocks?
Mr. Levitt. I think that 50 would certainly be a minimum
expectation, and Chairman Grasso has indicated already that
that is his intention, to select 50 stocks to be part of the
pilot.
Mr. Oxley. Is that the magic number, Mr. Grasso, or is that
just an example?
Mr. Grasso. It is, Mr. Chairman. What we seek to do in the
pilot is create a representative sample of the most active, the
least active, the mid caps, and more importantly, from a
capacity standpoint, to recognize that there can be securities
that don't necessarily appear in the most actively traded
tables each day that have an enormous velocity of consumer
activity built into them. So what we are going to do, Mr.
Chairman, is build a sample of 50 securities that really cover
the landscape NYSE.
It would be our intent to both quote and trade those
securities with penny increments, and this is going to be very
important that I underscore that, Mr. Chairman, because we are
going to coordinate a pilot with the NASD's third market, the
Nasdaq intermarket. We would have to be on the same pricing
platform, and we would have to both quote and trade in the same
minimum variations. I think the simplest approach is to do that
in pennies from day one. There are some, Mr. Chairman, who
would say quote in nickels and trade in pennies. I think that
would be a terrible mistake for consumers because four price
points would be missed for the public to see. I believe, as
Chairman Levitt has said and Chairman Zarb agrees, that there
is enormous benefit to consumers in conversion to decimal
pricing.
I think that ultimately the marketplace will decide the
minimum price variation, but we should engineer to permit the
penny to be the platform of both quotation and, if you will,
minimum price variation. It would be our goal, Mr. Chairman, to
open up on 5 September with just a few number of stocks. By the
mid part of September, we would have our 50 pilot in place. We
would run that pilot for 2 months in partnership with the NASD,
and then in close coordination with the Commission, evaluate
the results, and following, I would have to believe, Mr.
Chairman, the first of the year we would be in a position to
expand it to all listed securities.
Mr. Oxley. Mr. Zarb, I would like to have you comment on
the two issues that were addressed by the gentleman on your
left, and also ask you specifically if Nasdaq will quote in
pennies. Will you also execute in pennies?
Mr. Zarb. We will on the intermarket during the September
period for listed securities and, yes, the answer to your
question is yes. The pilot should really be a learning process
and a measuring process, so we should make sure that we work
closely with the New York Stock Exchange and with the
Commission to make sure the basket of securities are the right
ones selected, and that the measurements, every step of the
way, are the right measurements so we can learn.
As we learn, that will speed up the process of the entire
rollout. So we certainly support the notion of 50 in the
September period.
Mr. Oxley. This will be my last question. It occurred to me
that, and I would be interested in all of our answers, the
Island ECN has already announced that they will be quoting and
trading in decimals on July 3. What effect, if any, would you
see that having in terms of the pilot program and in terms of
long-term conversion to decimals? Not only from a competitive
standpoint for you two gentleman, but also for Mr. Levitt, how
is that going to affect the overall markets? I know it is a
little bit of a crystal ball, but I am curious as to what
reaction you might have with that.
Mr. Levitt?
Mr. Levitt. I think the ECN's use of lower than pennies
represents a very small portion of the market, and I am not
concerned with that. As I suggested, I think the pilot period
will give us an opportunity to phase in the use of decimals
without running any kind of systemic risk and making sure we
are protecting investors. I think once we pass the phase-in
period in April of next year, obviously, the ECNs and any other
competitors at that point will be out there; and if the markets
say that we should go to hundredths or thousandths or whatever,
that is where the markets will take us; but I am not motivated
to do otherwise, to run the risk of a systemic disruption by
virtue of the fact that one relatively small part of our
overall market will be trading at less than pennies.
Mr. Oxley. Mr. Grasso?
Mr. Grasso. Historically, Mr. Chairman, the ECN's business
has primarily been confined to Nasdaq securities, so I am not
certain that there is going to be profound impact. I commend
Island for initiating their pilot on the 3rd of July. In
reality, I think it will not be until we see unlisted
securities in a decimal format that we can make any conclusions
as to the effectiveness of splitting the penny. You will
recall, Mr. Chairman, when we were discussing the legislation
back 3 years ago, that we shared with this committee, the fact
that our engineering has the capacity to handle fractions of
1/4,096, if anything can create a massive
strain upon the investor eyesight community of this world, it
would be to split the penny into 4,096 increments.
To Chairman Levitt's observation, I believe competition
will drive the pricing table. We are prepared to split the
penny if that is what the consumer wants. We are prepared to
split the fraction. We have got the ability to do that today. I
think in the final analysis, though, the market is going to be
the judge, and certainly, at least historically, ECNs have not
had significant market shares in listed securities, although I
would encourage the Island and those who will pilot in decimals
beginning in July to consider not only the traditional bridge
through the system of the NASD, but through the opportunity to
become electronic access members at the New York Stock Exchange
for a very modest fee.
Mr. Zarb. I thought advertising wasn't allowed, Mr.
Chairman.
Mr. Oxley. Mr. Zarb, you can do some advertising of your
own if you would like.
Mr. Zarb. Whatever Island wants to do, Island moves its
trading through the Nasdaq system as do the other ECNs.
Whatever they do, we can handle. We will just convert it as it
moves to the Nasdaq system until we are on a full decimalized
platform. I think it is good to have pieces of the industry
leading in various areas. I am a little concerned with too many
moving in different directions at different denominations. In
order to think in terms of a competitive leg up, I don't think
that is correct at all, and I would hope that the markets will
move, generally speaking, with us in September, and then by the
early part of next year.
Mr. Oxley. Thank you. My time has long expired. Let me now
recognize my good friend from New York, Mr. Towns.
Mr. Towns. Thank you very much, Mr. Chairman.
Let me begin with you, Mr. Levitt, Chairman Levitt. Given
the Nasdaq proposed timetable, which I understand to be 2 weeks
of self-testing from February 26, 2001, to March 12, 2001, are
you satisfied that the industry will have sufficient time to
test the system in conjunction with the Nasdaq's new computer
system and all the other things, and be ready for full
conversion by March 31, 2001?
Mr. Levitt. I am. I believe that, the way this phase-in has
been devised, the markets themselves will determine the level
of acceptance of trading in decimals and the level of phase-in.
I think by the time we reach 2001, I am satisfied, on the basis
of our analysis of Nasdaq's capabilities, on the basis of our
weekly discussions with the technical people at Nasdaq, on the
basis of the assurances that Nasdaq executives have given to us
and to the markets, and on the basis of the kinds of
competitive pressures which will develop during this period to
prove the excellence of the system, that Nasdaq will be well
equipped to meet the timetable they have committed to.
Mr. Towns. Why would 3 months be allowed for industry
testing on the conversion for listed securities and less than 2
weeks for testing for Nasdaq securities?
Mr. Levitt. I am not sure that I understand that question.
Nasdaq will have the ability to test their systems all during
the rest of this year. They just are unable to have their
systems on-line in sufficient time period to be able to begin
the phase-in of Nasdaq securities in September.
Mr. Towns. The industry, I am sorry. I misled you, I think.
Mr. Levitt. The firms actually will have been trading in
decimals for at least 6 months before the Nasdaq phase-in.
Mr. Towns. Thank you.
Mr. Zarb, by what date will the Nasdaq be prepared to have
the industry begin testing on your new computer system?
Mr. Zarb. We will be testing almost right away. We are
running tests now. We will be running, in answer to your former
question, we will be testing with the industry months and
months before the actual startup next year so that there will
be live testing with the industry going on throughout this
period, and we will be ready to follow the listed security
pilot and to be up and running on our system in September, by
September 5, along with the New York Stock Exchange, and then
by the early part of next year in March on Nasdaq securities.
Mr. Towns. Thank you. Let me say this, Mr. Chairman. We
don't get a hearing like this too often where we get an
agreement across the board. I want you to know that this is a
historic hearing that you put together here. I want you to know
that I am delighted to be part of it. Thank you. I yield back.
Mr. Oxley. Thank you for your help in this matter as well.
I know the gentleman from New York, the other gentleman from
New York, and the other gentleman from New York have unique
constituencies with regard to the securities markets, the
financial markets in New York, and we have always respected
that and appreciated their input.
The gentleman from Illinois, Mr. Shimkus.
Mr. Shimkus. Thank you, Mr. Chairman. It is great to be
here and also applaud the work that you have all done, Mr.
Levitt and the Exchanges and Chairman Oxley. I know this is
something that has been near and dear to his heart and the
ranking member for a long time, and I see the benefits of
simplification from my constituents to have a better
understanding of perhaps what many folks feel is a very
complicated issue. I am very excited about it, and I think it
is a win-win for everybody.
Projections of the increase in transactions, have you run
any analysis of how the simplification might sell to the
consumers and the possibility of increased traffic and use? And
could you give us a positive, or based upon your analysis which
all businesses do, what do you project the benefits to be of
moving to a decimal system?
Mr. Grasso. If I might, Congressman, it is certainly from
an investor's standpoint make pricing far easier understood.
From a volume standpoint, I have seen estimates that range from
a 50 percent increment to over a 300 percent increment in the
core equity business, and that, I think, is in large part based
on a simulation of experience from the conversion from 8ths to
16ths, which occurred some 3 years ago. I think it is important
to recognize that the reason we are going to coordinate a
phase-in is that a lot of the analytical work done is purely
that, theoretical analytical work.
I think as both Chairman Levitt and Chairman Zarb pointed
out, it is not just a matter for the equity markets to be
concerned about. The equity markets are woven into the
derivative markets and the vendors of financial information who
must push the data into the consumer world. It is fair to say
that the traffic on systems is going to increase geometrically
to the level of usage today, just simple mathematics.
In the core equity product, you are moving from 16 price
changes to 100 price changes per dollar. When you multiply that
or, if you will, magnify it in almost a fast breeder effect
into the options and futures markets, it causes all of us to
want to actually have hands-on experience as we will from
September 5 through the balance of this year in evaluating, not
just the impact from an equity market standpoint, but from an
options market, a futures market, a vendor community, and all
of those interrelated systems in the comparison clearance and
settlement process, which is why we believe with the leadership
of this committee, and certainly the leadership of the
Commission, that we are approaching it with the proper amount
of speed and the proper amount of care to make certain
consumers benefit, and there is no unforeseen harm out there in
this conversion activity.
Mr. Shimkus. If I may follow up, Mr. Grasso, with the pilot
program and this transition, how have you gone about deciding
which stocks to initially include?
Mr. Grasso. What we will attempt to do, we are in the
process of segmenting our list right now. If you were to look
at our business today, of the 3,100 issuers whom we are
privileged to trade, the first 500 produce almost 80 percent of
our daily activity, daily activity being an average daily
volume of just slightly in excess of a billion shares. My
colleague to my right likes to probably point out that his good
friend, Dick Grasso, runs the second most active exchange in
the world.
Mr. Zarb. I don't usually say ``good friend,'' though.
Mr. Grasso. Close friend, except during market hours. If
you were to look at our daily activity, 80 percent is
concentrated in the first 500 issues. We would select a
sampling from the most active, from the least active from the
high priced, from the low priced and then a bit more esoteric
to the credibility of the experiment, we will look at those
securities that aren't necessarily the most actively traded
from a volume standpoint but are the most, if you will,
populated by large numbers of small orders.
So we have a truly representative sampling of the
experience we can expect when we flip the switch and thus can
have an absolute total confidence that we are not going to flip
the switch and disappoint investors.
Mr. Zarb. Let me just add to the answer to your first
question briefly. There are two forces working here, one is
truly the democratization of the marketplace. We have enormous
additions of retail transactions on our system this year over
last year, a very substantial measurable number of individual
people that are entering the securities markets. It is not only
true here; it is true worldwide. That is going to happen with
or without decimals. Decimals then come along, make it easier
for that to happen, make it a more friendly market. That will
have an increasing propelling effect on the expansion of
volumes.
Mr. Levitt. I might also add to that, amidst the euphoria
about this action which all of us share, this testing period is
absolutely essential. We have talked thus far about the
possibility of systemic risk, and I believe that the plans that
have been formulated obviate the likelihood of that. But we
don't know yet what kinds of rule changes will have to be
implemented to account for a very different world that we are
about to enter. We don't really know what impact decimalization
is going to have upon liquidity. These are very, very important
considerations, and I think the coming months will be critical
in terms of making judgments and decisions and reactions to all
three of these elements.
Mr. Shimkus. Thank you very much, Mr. Chairman. I yield
back.
Mr. Oxley. The gentleman yields back. Before I recognize
the other gentleman from New York, the chairman hit on a very
important point. There is so much we can learn beginning
September 5 through the rest of this year and into the next
quarter next year, that frankly I hadn't considered. Until you
mentioned that in terms of volume, in terms of the capacity,
all of the different issues that are there, which obviously
makes your decision very critical in terms of setting up this
pilot program to the point where it can really reflect what we
can expect from the full blown conversion to decimals in the
next year. So that is something worthy of thinking about. Maybe
even at some point, worthy of another hearing so we can sort
that out and have the major players here, as you are today,
telling us where we are, and perhaps what we might need to do,
or what the SEC might need to do to facilitate that change.
This committee, as you know, is dominated by New Yorkers,
and I now recognize another gentleman from New York, Mr. Engel.
Mr. Engel. Thank you, Mr. Chairman. You should consider
yourself blessed that there are so many New Yorkers here. You
know Ohio is just a little bit away.
Mr. Oxley. We are growing, though.
Mr. Engel. Let me welcome all three gentlemen. As Mr. Towns
said, it is very rare that everyone agrees. It is almost
difficult to ask questions. I remember back in 1997 when we
were talking about decimalization, and one of the questions I
asked during one of the hearings was well, why should
government impose decimalization, why don't we just let the
market kind of naturally change, and I decided I sounded too
much like a Republican, and I decided to pull the question.
Let me ask Mr. Zarb first. I read in your testimony, you
talk about options trading in your submitted testimony, and you
say because each option trades both puts and calls in multiple
series, a single quotation change in its underlying equity can
trigger a large amount of quote activity for that option. And
then you add, a recent industry study projected that the
transition to decimal pricing will increase the demands placed
on these systems to levels well beyond their anticipated
capacities. And you say the exchanges continue to work with
each other and the SEC on a solution to this complicated and
challenging problem. I wonder if you can elaborate.
Mr. Zarb. Obviously, the options market is different from
the underlying securities market in that you do have--
especially in a volatile period, you have both puts and calls
being written against the same security at different levels of
pricing. So both the quote traffic and the execution traffic is
a geometric dimension of what it is for the underlying
securities and what it is today. We are going to get our first
good look at that in the September pilot, and as we begin the
process of testing with our own members.
To the extent that that volume is what has been predicted,
frankly I have got to be convinced that the projections that
have been raised are correct. I have seen a good many of them.
They have come from all over the lot. Some of them are scare
stories. I know that the SEC is working with the major options
markets and are going to be watching this very, very carefully.
Mr. Engel. When you say the Exchanges are working with each
other and the SEC on a solution, how----
Mr. Zarb. To be able to determine what the volume increases
are going to be, and what capacity is going to be required to
accommodate it. This is not a question of ``if,'' it is a
question of ``when,'' and making sure that there are no hiccups
along the way. We just don't know enough of how the options
market is going to react here. The projections are that they
are going to have a substantial increase in volume. They will,
and it has to be managed.
Mr. Levitt. They are increasing their capacity, but they
may have to reduce their quotation volume to handle the
increases caused by decimals.
Mr. Engel. Mr. Zarb, I am told--please correct me if I am
wrong--that the NASD's new computers won't be on-line until end
of February in 2001, and that you won't test your own system
until March 12. Isn't that a problem?
Mr. Zarb. If that were correct, it would really be a
problem because we already committed to go live, the capacity
is being added all the time and the necessary programming is
being built, and we are fairly confident of that. We will be
testing with the industry with our members and our market
makers months before we go live in March.
Mr. Engel. With regard to the third market, are you also
going to quote your prices in pennies and execute orders in
pennies?
Mr. Zarb. We dutifully follow our senior exchange on the
listed side of the House, and whatever they do, we do, yes,
sir.
Mr. Engel. Mr. Grasso, that leads me right to you.
Mr. Grasso. Does that put me back in the category of good
friend?
Mr. Zarb. My good friend, Mr. Grasso.
Mr. Engel. He is my good friend too. That is what counts.
I guess that is all the questions I have. I just wanted to
ask Mr. Grasso, first of all, I wanted to compliment him
because the decimal trading, those of us in New York have
really been focusing on this issue a great deal, and at the
beginning there seemed to be some resistance in some corners,
and I think the New York Stock Exchange has really took the
resistance and really grabbed the bull by the horns and decided
not only to go with the flow, but really to implement it and
really be a leader in it. I think it is something that we need
to take notice and mention, because I think it really was due
to your leadership. As you mentioned, this committee had been
prodding for a long time, and it was really good to work
together to do that. I want to thank all of you.
Mr. Oxley. Thank you. And I understand the gentlelady from
New Mexico has no questions; is that correct?
Thank you for being here. There is a very historic hearing
and one that I think all of us will look back on with a great
deal of pride and satisfaction of where we have come and where
we are going, and we couldn't have done it literally without
all three of your gentlemen's leadership and friendship. We
thank you so much, and the subcommittee stands adjourned.
[Whereupon, at 3:30 p.m., the subcommittee was adjourned.]
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