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Securities and Exchange Commission Chairman William Donaldson told lawmakers on Thursday that the agency’s new market rules will encourage competition among large and small stock exchanges, despite concerns that an impending exchange consolidation could hurt or deter new entrants. “I predict that entrepreneurial entities that are out there now, and new ones that will be out there soon, will be very prevalent in the years to come,” Donaldson told the Senate Banking Committee on the second day of a two-day hearing on proposed mergers of the nation’s two biggest stock markets with smaller, electronic exchanges. In April New York Stock Exchange Inc. announced plans to take over Archipelago Holdings Inc., while Nasdaq Stock Market Inc. said it would acquire Instinet Group Inc. Some said the deals could produce a duopoly that would stifle smaller stock exchanges. On Wednesday, Meyer “Sandy” Frucher, chairman and chief executive of Philadelphia Stock Exchange Inc., told the committee that the mergers threaten the remaining exchanges, most of them smaller, regional markets like his own. But Donaldson contended that the SEC’s recently approved market rules, called Reg NMS, for National Market System, will allow even the smallest stock exchanges to compete. Under Reg NMS, the best price for a security must be displayed electronically, no matter where it comes from. A key component of the regulation is the “trade-through” rule, which takes effect in April 2006, under which an investor is entitled to the best price for a trade no matter which market executes the order. “Small markets have an unbeatable weapon: If they offer the best price, investors will come to them,” Donaldson said. “You must honor the best price trade-through rule.” He said Reg NMS will not only encourage newer, smaller stock exchanges to prosper and develop new technologies but that it will also bolster vigorous competition between the two large stock exchanges. “Reg NMS is pro-competitive for large markets and small markets,” Donaldson said. “NYSE will have to battle to maintain its market share, given the expanded opportunities for fully electronic markets to compete in NYSE stocks after the implementation of Reg NMS.” Indeed, Donaldson said, the SEC’s adoption of Reg NMS may have helped spur Nasdaq and the NYSE to consider mergers. “While the adoption of Regulation NMS did not cause the corporate consolidations to occur, it may have helped create the conditions under which the forces of competition and innovation — rather than uncertainty — can drive decision making,” he said. Banking Committee members generally expressed positive opinions regarding the proposed mergers and the new market regulations. “I think the SEC is fulfilling its obligation here,” said Sen. Christopher Dodd, D-Conn. While not specifically expressing concerns about Reg NMS, some lawmakers expressed concern that five SEC commissioners have split over some key initiatives. Senate Commerce Committee Chairman Richard Shelby, R-Ala., noted that the commission did vote 3-2 when adopting Reg NMS last month. Republican Chairman Donaldson sided with the agency’s two Democratic commissioners in the vote, while Republican commissioners Cynthia Glassman and Paul Atkins voted against the regulation. “Some people are troubled by the 3-2 vote,” Shelby said. Donaldson responded by noting that 98 percent of SEC votes are unanimous. Sen. Michael Crapo, R-Idaho, conceded that SEC commissioners vote together on most measures, but he expressed concern that regarding three major agency proposals that have been reviewed recently by the Senate Commerce Committee, Donaldson has not been able to form a consensus with his commissioners. Crapo pointed out that Donaldson was not able to get all of the commissioners to support rules governing hedge fund regulation, independent mutual fund chairmen and the controversial Reg NMS. The agency is also expected shortly to approve a long-delayed application by Nasdaq to win stock exchange status. It is currently a stock market or trading venue. The Nasdaq proposal has been languishing at the SEC since 2000. Donaldson said Nasdaq has recently agreed to resolve a stumbling block on price-time priority for orders to buy and sell stocks. He said Nasdaq is expected to provide the agency with a revised proposal by early summer. “Now we can move forward,” Donaldson said. Becoming an exchange will allow Nasdaq to separate itself from the NASD — formerly the National Association of Securities Dealers — which still controls it. Exchange status will allow Nasdaq to operate more efficiently and quickly. Currently, whatever Nasdaq wants to do requires the approval of two boards, Nasdaq’s and the NASD’s. Copyright �2005 TDD, LLC. All rights reserved.

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