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Chairman Donaldson Testifies on Regulation NMS SEC

Chairman William Donaldson told the Senate Banking Committee that the recent merger announcements by the New York Stock Exchange and Nasdaq confirm the importance of newly adopted Regulation NMS. "That these two transactions came just a few weeks after its passage is not entirely a coincidence," he said. "Of course, the mergers are being driven primarily by economic reasons, but the regulatory certainty of Regulation NMS helped," added the chairman.

Several senators expressed concern about how self-regulation would work with public ownership of the stock markets. Mr. Donaldson acknowledged that there has been a breakdown of self-regulation, including well-publicized corporate governance issues at the NYSE. He said that SEC recognizes that public ownership creates a new level of possible conflicts of interest, and he assured the panel that the Commission was addressing the issue. Sen. Paul Sarbanes advised the SEC to be mindful of even the appearance of conflicts in order to protect investor confidence in the markets.

Committee chairman Richard Shelby noted that many people are troubled by the 3-to-2 Commission vote on Regulation NMS and asked whether Mr. Donaldson felt the SEC should have greater consensus on such an important rule. Mr. Donaldson said that of the 3,000 Commission votes during his chairmanship, only two percent have not been unanimous. The chairman emphasized that commissioners should be focused on the protection of investors and should leave political concerns at the door when making decisions.

Sen. Mike Crapo suggested that there is an impression of a lack of consensus right now at the SEC because there have been 3-to-2 votes on three major issues recently, regulation of hedge funds, independent chairs for mutual funds and Regulation NMS. There is a trade-off between reaching a consensus and making a decision, Mr. Donaldson said. He explained that the three recent issues were so important that he voted in the interest of making a decision rather than delaying or watering down what needed to be done.

The process at the SEC is open and fair, he said, with each issue debated publicly on the record. Recently the process has deteriorated, in his opinion, because after the Commission reaches a decision, commissioners opposed to the measures have published dissents. "These issues could have been brought out in the open debate, but as it is now they are published with no chance for comment," he said. The chairman concluded that "this is the wrong direction for the Commission to go."

Sen. Wayne Allard expressed concern that Regulation NMS might create barriers for smaller markets. Mr. Donaldson said he thinks NMS is pro-competitive for large and small markets. "Small markets have an unbeatable weapon," he said, as "they just have to offer the best price." Sen. Allard also asked whether Mr. Donaldson thought that the NYSE's hybrid market proposal undermines Regulation NMS. Mr. Donaldson said that the hybrid approach serves those that want speed and price protection, and those who like what a capital specialist has to offer. He said that floor traders ensure that human judgment is involved, and that the hybrid approach preserves this valuable part of the system.

Several senators inquired about the status of the Nasdaq exchange application, which has been pending at the SEC for four years. He said that a fundamental principle of markets is that you must have time and price priority built into the system. Nasdaq has refused to do that until recently, he noted. Now that they have, Mr. Donaldson expects the application to be approved shortly.