In my political education, I also benefited a great deal from the guidance of Ed Knight, Nasdaq’s general counsel, formerly at the U.S. Treasury Department, where he had served under Bob Rubin and Lloyd Bentsen. His thoughtful advice and deep well of wisdom regarding both law and politics were invaluable. I relied on his expertise, his knowledge of financial regulations, and his personal relationships with key players both in Washington and on Wall Street throughout my time at Nasdaq. For businesspeople, Washington can feel like a world apart. Like anyone thrown into a foreign culture, you need friends who understand the language and know how things get done.
I made many friends in Washington, but had my share of policy disagreements as well. My relationship with Bill Donaldson, head of the SEC from 2003 to 2005, was a case in point. Donaldson’s impressive résumé was a testament to success, power, and privilege in both the public and private sector. He was steeped in the old world of equity trading, and a veteran of the floor exchange model. In fact, he’d once been CEO of NYSE, which troubled me, to say the least.
My initial meeting with him, soon after I started at Nasdaq, was a sign of things to come. Ed Knight walked me over to the SEC offices one summer day. We invited Baldy Baldwin, Chairman of the Nasdaq Board, to join us, hoping he and Donaldson would connect given their shared history as U.S. Marines.
“I was just talking to my colleagues about how great the New York Stock Exchange is,” Donaldson declared, as we began the meeting.
NYSE? Even if he thought that privately, why say it at that moment? Surely he knew we were advocates of a completely different model. We were ready to talk to him about the ways NYSE’s trading practices and outdated regulations were holding back progress and competition in the equities market. Was he being deliberately provocative? Was he absentmindedly reliving his own past glories as CEO of NYSE? Or did he simply mistake whom he was talking to? To this day, I don’t know. But it was a worrisome sign, and indicative of his loyalty to old-style trading.
Some of the initial challenges in my relationship with the SEC had to do with understanding its role. Formed after the 1929 market crash, the SEC had the explicit purpose to help bring more order to stock trading and to protect investors. To that end, it was primarily concerned with rules and regulations and how the various players on Wall Street were following them. It goes without saying that this is an important function. But the narrow focus of the SEC was brought home to me when Businessweek published its 2003 cover article questioning whether or not Nasdaq could survive—a concern that many on Wall Street shared at the time. It accurately mentioned that we were losing money every single day. Yet no one from the SEC called or even seemed to notice. They cared about the minutiae of a rule filing but didn’t seem too concerned that we might be going out of business.
Later, I challenged Donaldson about this. Wasn’t that important information? Nasdaq, after all, is a fairly critical piece of the Wall Street machinery. If a big bank were going through the same issues, you can be sure the Federal Reserve would care about its viability! Of course, the stability of our nation’s banking system is part of the explicit mission of the Federal Reserve. That’s why we hear phrases like “too big to fail,” “stress tests,” “systemically important institutions,” and so on. Officially, the SEC has a three-part mission—to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. Notice that health and viability are not on that list, though obviously they should be related concerns. The mandate of the SEC revolves around policing markets. As Ed Knight explained it to me at the time, “The SEC is more like the Justice Department and less like the Treasury Department. The SEC has rooms full of lawyers, not economists.”
This may seem like an obscure point, but it had huge implications in the financial crisis of 2008. Much of the trouble started with unseen risk-taking on the balance sheets of the investment banks, which were regulated by the SEC, not the Federal Reserve.* But like punitive parents who care only about their child’s behavior, not their health, the regulators missed the cancer on the balance sheets at Bear Stearns and Lehman Brothers.
In contrast, stability was job number one over at the Federal Reserve, and it’s telling that the commercial banks weren’t the primary source of the troubles. Obviously, there were many causes of the financial crisis. But in retrospect, my 2003 conversation with Donaldson about Nasdaq’s precarious financial position and his lack of concern for our financial well-being was an ominous foreshadowing of the troubles that would start with the investment banks and eventually threaten the world economy.
Lobbying Is Education
It’s worth stating that I’ve never had a strong political ideology about regulations in financial markets. I’m a firm believer in capitalism, but not without clear boundaries. All markets benefit from smart, transparent, and consistent rules, and these need to be updated as markets evolve. To borrow Oxley’s favorite analogy, think about sports, where competent officials enforcing clear rulebooks are essential to enacting healthy competition on an even playing field. Likewise, good regulation allows capitalism and markets to thrive. Bad rules easily degrade the game, causing the public to lose faith in the fairness of our markets.
Where possible, I prefer market forces to work their magic without regulatory intrusion. But good regulation is an essential feature of modern markets, and certainly of the equities markets. I also believe that genuine competition is good for consumers—no less so in financial markets than in other parts of the economy.
In Washington, I embraced my role as an advocate for Nasdaq’s particular perspective when it came to regulatory oversight. This usually meant I was promoting the ongoing transformation of equities markets into customer-focused, technology-driven, for-profit businesses, functioning in a competitive ecosystem. The insider networks of traders, dealers, and manual market makers—however appropriate for another time and place—were becoming less relevant in the modern world. We were for “lit” markets, and by that I mean exchanges in which everyone can see the buyers and sellers operating in the market. As Louis Brandeis once said, “Sunlight is said to be the best of disinfectants.” I believed that these characteristics were the way of the future and would eventually prevail. Progress was coming, fueled by new technologies, and I didn’t want to be on the wrong side of history. I had no interest in protecting what I considered to be old and outdated ways of trading securities. We were working hard to compete, innovate, survive, change with the times, serve our customers, and make decent profits. I thought others should have to do so as well.
Representing Nasdaq also meant representing more than our particular organization and its needs. In the public mind, we were associated with innovation, entrepreneurship, and economic vitality, and people in Washington wanted to meet with me to take the pulse of the market. “What are CEOs telling you?” “Where is innovation really happening?” they would ask me. “How is the VC world doing?” “What is your sense of the economy right now?” “How are financial markets operating?” Questions like these were constant. As Ed explained it to me, “When we come to Washington we represent not just Nasdaq itself, but also the state of the tech economy and the several thousand companies listed on Nasdaq. We embody their aspirations, challenges, and also their collective impact on American business.”
Of course, those several thousand companies had their own questions. When I visited CEOs, they would ask me, “What’s happening in Washington?” “What are the politicians thinking?” “What regulations are coming?”
All of this meant many trips to Washington, lobbying Congressmen and Congresswomen, and testifying before the Financial Committees in the House and Senate. As in most fields, personal relationships matter in politics, and so I spent time with the politicians and government officials, got to know them as individuals, and put in the effort to develop trust and rapport.
In many respects, it was a fascinating journey. I was introduced to a new world and met people who were quite foreign to
my background and life experience—individuals like Richard Shelby, the powerful head of the Senate Banking Committee, a larger-than-life southern power broker right out of central casting. During my tenure, I developed relationships with many public servants on both sides of the aisle—people like Massachusetts Senator Barney Frank, Connecticut Senator Christopher Dodd, Treasury Secretary Hank Paulson, New York Senator Chuck Schumer, the aforementioned Mike Oxley, and many others. In general, my experience was that the politicians I engaged with were hardworking and dedicated public servants. Nevertheless, there were many elected officials who surprised me with their inability, or unwillingness, to grasp the basic dynamics of the equities market. For all those whom I came to deeply admire, there were others—on both sides of the aisle—whose inattention, ineffectiveness, and outright incompetence disturbed me.
Indeed, my colleagues and I spent a great deal of time lobbying political leaders and teaching them about the nature of financial markets—how they function, how they serve investors, how they have evolved over the years, and how they could change for the better. Lobbyists have a bad name right now, and perhaps deservedly so. I don’t hesitate to acknowledge that the quest for political influence leads people down some questionable paths. But effective lobbying, in my experience, has an important educational role to play. Not many Congressmen or Congresswomen have experience in the markets before taking office. In fact, if I were in Congress, I would bring people in to talk to me all day long, even if I didn’t need to fund-raise a dime, just so I could learn from the people on the ground.
Yes, we had a particular point of view, and our competitors had different ones, no doubt, and that is as it should be. But these conversations were not just a partisan effort at winning the argument. In fact, when I sat down with an elected official, I tried to represent both sides of the argument, and to frame them in the context of the larger issues at play. At its best, lobbying is what gets all these important perspectives on the table, so legislators and regulators can actually make informed decisions.
It’s easy to get frustrated or even cynical about what goes down on Capitol Hill. But for a business leader, such an attitude is neither smart nor strategic. Don’t feel like you’re above politics—none of us are. Learn to work with it and do your part to create a fairer world in which to do business. Even if your industry has not yet been subject to regulatory oversight, you never know exactly when that will change.
Leveling the Playing Field
Much of what we aimed to do with our initial regulatory push at Nasdaq was to change the rules of the market so that we could actually compete with NYSE on a level playing field.
In those days, we were fighting a battle on two fronts. The armada of new ECNs was only one side of the challenge facing Nasdaq; the other was our ongoing competition with the older exchange down the street. We competed with them for listings, and we also were intent on gaining market share in trading NYSE stocks. In 2003, NYSE controlled around 80 percent of trading in stocks listed on their exchange. However, this wasn’t a sign that they were competing well in the new world of electronic trading. Quite the opposite—they were avoiding competing altogether, with the help of sympathetic regulations.
The regulatory structure at the time favored NYSE’s manual style of trading, in which specialists controlled most of the order flow of any given stock and negotiated prices by trading with others at the exchange. If you wanted to trade NYSE stock electronically, outside the context of the exchange floor, it was hard to give the customer a truly up-to-date price. The floor brokers and specialists controlled most of the liquidity, and it took them about thirty seconds to execute a trade. Whereas if you wanted to trade a Nasdaq stock like Apple, all you would need to do is pull up your terminal and look across at various ECNs for the best offers. Then you could execute that trade in a millisecond.
However, while NYSE might have been more effective at holding back the electronic trading future for the time being, inevitably it was going to catch up with them. After all, much of what the digital revolution was doing was cutting out the middleman. In 2003, NYSE trading specialists were still shouting on the floor like it was 1969, but sooner or later progress would do to floor trading what it did to rotary phones. However, there would need to be a regulatory change to allow it to happen. Progress, in this case, needed a nudge.
In 2004, an opportunity presented itself, in the form of a regulatory package designed to “modernize and strengthen” our securities markets. Known as Reg NMS (Regulation of the National Market System), it was a chance to improve the efficiency of stock markets, encourage their technological evolution, and change the rules of the game to our advantage—all at the same time. My role in the process was to help legislators and Commissioners understand some key aspects of how equities trading worked, and how the proposed rule changes could help it work better. Lobbying is education, and sometimes these important but technical matters took some explaining.
My three kids were playing soccer in those days, which inspired a helpful analogy. Let’s say I’m at one of their soccer games on a hot day, and after leaving the field, I look around for some refreshment. Just down the street, there is a store with a sign in the window—Soft Drinks, $1.79. Then I turn my head and see another sign, far in the distance, across a suburban six-lane highway, over a median, around a turn. I can just make out the advertisement—Soft Drinks, $1.69. All things being equal, I might choose the cheaper price. But it might take me twenty minutes to get to that other store. It’s late in the day; it’s getting dark. By the time I get there, the store might be closed. I’m thirsty now and so are the kids. The choice is simple.
In 2004, however, as I explained to lawmakers, when it came to financial markets, that choice was anything but simple. In fact, the regulatory structure at the time required that you take the “best price” on any given trade, wherever you might find it. The “trade through rule,” as it was known, stated that you could not trade through a posted quote, meaning ignore it for another, slightly more expensive quote listed somewhere else. This created a problem. If NYSE had the best price, you had to take it. That may sound like a good idea, but the NYSE trading floor was like a black hole where time slowed down. Trading speed was measured in tens of seconds, compared to milliseconds on Nasdaq’s marketplace (today, it’s microseconds). On the NYSE floor, they literally had runners who would carry paper quotes between trading desks. The image of middle-aged men shuffling across the floor captures the anachronistic reality of that trading system.
The Nasdaq ecosystem, meanwhile, was not constrained by human athleticism. If I saw Exxon quoted at 100 on Nasdaq, I could execute an order in a moment and be done with it instantly. At the same moment, I might see Exxon quoted at 99.98 on NYSE. That price difference might save me hundreds of dollars on a large order, but since that trade is happening through human specialists on the floor, I have to wait for the order to be processed. Nothing good happens in that time gap. By the time that order is finally ready to be executed, the shares may not even be available at the same price. It’s like dragging my kids across the highway only to find that the drinks have gotten more expensive or even sold out. Any quote is temporary. The market is always moving, and as the clock is ticking, I can quickly find myself losing money.
Customers wanted the option to choose certainty, even over price. Just like the thirsty parent coming out of the ball game, investors want to get the trade that is available immediately, not the cheaper one that comes with so many uncertainties. Simply put, the regulatory structure at the time didn’t provide a pathway to get from the floor-based past to the electronic future. We needed new regulations for a new world.
Finally, there was the questionable information advantage that NYSE specialists had over everyone else. The specialists had the ability to trade in a proprietary way. They weren’t simply objective auctioneers, dispassionately interested in matching bids and offers. They could place bids themselves. I’ve never been a trader, but give me unique kn
owledge of the whole order book in a certain stock and a thirty-second information advantage, and I could do pretty well!
In 2004, I testified before the Senate Banking Committee with a clear and unequivocal message. “The trade through rule is the primary obstacle to competition amongst our nation’s equity markets,” I explained, “and competition is the driving force in making the U.S. markets the strongest in the world, the best for investors large and small, and accountable to the public.” I also stressed that the markets had uncovered a fundamental truth: “Electronic trading is best for investors.”
The proposed regulation change was important to Nasdaq, but we weren’t waiting for it to save the day. After our purchase of INET and BRUT, Nasdaq had successfully begun to trade NYSE securities on our own system. Little by little we were having success, building up liquidity in our electronically traded order book. If a customer ordered a NYSE stock from us, sometimes we could fill that order from our own book immediately. If we weren’t able to do so, we would then send it down to the NYSE floor and get it filled that way. This was helped along by our purchase of BRUT, as the ECN was a broker-dealer and became a member of NYSE, licensed to trade on the floor.
Around that time, our BRUT executive was invited to a party over at NYSE and ended up chatting with the Chairman of the NYSE Board.
“Who are you with?” he asked our trader.
“BRUT,” he replied.
“That’s interesting. Perhaps we could have a party here at NYSE, sponsored by your company and featuring your champagne.”
At this point, a NYSE employee, overhearing the conversation, quickly pulled the Chairman aside and explained that BRUT was an ECN that was part of Nasdaq, and not associated with the bubbly wine we all enjoy!
Mistaken identities aside, Nasdaq was determined to compete in trading NYSE stocks. As our market share grew, our execution time improved, and our liquidity did as well. After all, customers wanted the option of trading electronically. Our hope was that Reg NMS would provide a massive push in that direction.
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