Testimony from June 16, 1999

Prepared Testimony from Alfred R. Berkeley, III, NASDAQ

I am Alfred R. Berkeley, III, President of The Nasdaq Stock Market, Inc. The Nasdaq Stock Market and our parent, the National Association of Securities Dealers, Inc. (NASD), would like to thank the Joint Committee for this opportunity to testify on the role technology plays in our economy, specifically in the securities market.

NASD First, 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 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 5,600 securities firms that operate in excess of 7 1,000 branch offices and employ more than 589,000 registered securities professionals. The NASD is the parent company of The Nasdaq Stock Market, Inc., the American Stock Exchange, Inc., and NASD Regulation, Inc. (NASDRsm). These wholly-owned subsidiaries operate under delegated authority from the parent, which retains overall responsibility for ensuring that the organization's statutory and self-regulatory functions and obligations are fulfilled. The NASD is governed by a 27-member Board of Governors, a majority of whom are non-securities industry affiliated. Board members are drawn from leaders of industry, academia, and the public. Among many other responsibilities, the Board, through a series of standing and select committees, monitors trends in theindustry and promulgates rules, guidelines, and policies to protect investors and ensure market integrity.

The Nasdaq Stock Market In keeping with the NASD's mission of facilitating capital formation for the
ultimate benefit of investors, The Nasdaq Stock Market develops and operates a variety of market
systems and services. The Nasdaq Stock Market is the largest electronic, screen-based market in the
world, capable of handling trading levels of at least one-and-a-half billion shares a day. Founded in 1971,
Nasdaq today accounts for more than one-half of all equity shares traded in the nation and, since January
of this year, is also the largest stock market in the world in terms of share volume and dollar volume
traded. It lists the securities of 5,068 domestic and foreign companies, more than all other U.S. stock
markets combined. American Stock Exchange The American Stock Exchange is the nation's second
largest floor- based securities exchange, listing 770 companies, 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. Amex has been the nation's foremost innovator in structured derivative
securities and index share securities. The latter are registered investment companies that permit an indexed
equity investment, as do index mutual funds, but afford investors the opportunity to purchase or sell on
the Exchange at any time during the trading day. NASD Regulation 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. NASDR
carries out its mandate from its Washington headquarters and 14 district offices located in major cities
throughout the country. Through close cooperation with federal and state authorities and other self-
regulators, overlap and duplication is minimized, freeing governmental resources to focus on other areas
of securities regulation. NASDR has examination responsibilities for all of the NASD's 5,600 members. In
addition to special cause investigations that address customer complaints and termination s of brokers for
regulatory reasons, NASDR conducts a comprehensive routine cycle examination program. Nasdaq Fuels
Economic Growth Nasdaq has driven the country's growth by providing capital to finance entrepreneurs'
ideas. We have raised about $160 billion for entrepreneurs since the beginning of the decade, averaging
roughly 520 initial public offerings (IPO's) each year for the last five years. If one looks at our share of
these businesses, or IPOs, across industries, one will find that Nasdaq has a large number of technology
and software-related companies, and a substantial number of telecommunications companies. We have a
definite affinity for high-tech companies and a large percentage of the companies that go public in the
United States have been founded on the backs of the semi-conductor revolution, the telecommunications
revolution, or the biotech revolution. Nasdaq has provided financing for almost all of these companies,
and today most of them are Nasdaq companies of biotechnology companies. Nasdaq continues to be the
premier market for Silicon Valley and the technology industry-with 94 percent market share of software
companies; 88.8 percent of computer manufacturers; 86.8 percent of communications equipment makers;
81.9 percent of electronic components; and 87 percent These companies have created and given us
products and services that have raised our standard of living. Our companies' growth has driven Nasdaq's
growth. We reinvest what we earn in lowering the costs to trade, principally by investing in the technology
that our own companies have created. In short, Nasdaq gives entrepreneurs in all industries a place to
raise the capital they need. It is a freely competitive market-and repeatedly one of these start up
companies grows up to be an MCI WorldCom, an Intel, or a Microsoft. The Stock Market of Tomorrow
It has often been said that the future will be what you make it. At Nasdaq, we plan to create the stock
market of tomorrow by aggressively employing technology, understanding investor needs, and serving as
an agent of change. We believe that tomorrow's market will be huge. Growth will continue regardless of
the market's ups and downs. At Nasdaq, we utilize technology to accommodate, manage, and even propel
that growth. Virtually every aspect of tomorrow's stock market-its size, efficiency, safety, and
sophistication-will be shaped by technology. The impact of the Internet, however, will stand alone in its
far-reaching influence over markets and the securities industry. Impact of the Internet The Internet's
ascendance has made information about investing and investments significantly more accessible to
individuals than ever before. On our own Nasdaq-Amex Web site (www.nasdaq- amex.com), for
example, investors can find everything from analysts' stock recommendations to company news releases,
earnings reports, historical charts, and mutual fund reviews. Information that was once the privilege of
securities professionals is now making its way to the World Wide Web-some of it for a price, but most of
it free. Investors seem to like our Web site; we average more than 20 million hits per day. Nasdaq-
Amex.com is one of the five most popular financial Web site in the world. According to some predictions,
overall Internet use worldwide will grow by 60 percent on English-language sites by next year, and will
double in non-English sites, to a total of more than 160 million users worldwide. This surge of information
has helped unveil securities investing to the general public, attracting new investors to the market. It is no
secret that online trading is the fastest-growing form of trading. Today, about 15 percent of retail stock
trades are made by online investors, and the number of online brokerage accounts will soon top 10
million. The number of online investors in the U.S. is likely to more than quadruple by 1-002, to almost
23) million investors. Full-service brokers may well feel threatened by this online boom and will need to
adapt to maintain their share of business. Virtually all of the large, traditional brokerage firms now offer
online trading to their customers. We will begin to see full service brokers adapt their roles, placing more
emphasis on being financial advisors. Meanwhile, new firms, created specifically to be online brokers, are
springing up. As the Internet continues to grow, Nasdaq must facilitate and regulate trading in this new
computerized environment. Our "sister" organization and regulatory unit, NASD Regulation, is in the
midst of spending more than $1 00 million to enhance its systems for market surveillance and to increase
examination, surveillance, enforcement, and internal audit capabilities. Much of that spending has been on
technology to protect investors through initiatives such as an order audit trail system and a customized
"web crawler" that will be able to look through information on the Internet, flagging suspicious catch
phrases for questionable practices that regulators might be interested in looking at more closely. New
Investors Mean Growth Meanwhile, there are a growing number of first-time investors entering the
market. As I stated before, we believe that many are lured by the ease of online investing and even more
by a new level of comfort attained through the broad base of information about investments and investing
available on the Internet. According to a 1997 study conducted for Nasdaq, the overall number of
investors doubled in the previous seven years to 43 percent of all American adults-it has surely grown
since then- and the country's investor base has diversified drastically, to "look more like America." A
majority of investors are under the age of 50, almost half are women, half are not college graduates, and
10 percent describe themselves as "homemakers." The trend in personal finance is moving away from
saving, toward investing, and baby boomers are leading the way. Not long ago, "ordinary" Americans
deposited their money in traditional institutions like banks. They perceived investing, particularly in the
stock market, as risky ventures undertaken by wealthy individuals and large corporations. That perception
has faded and today this money is moving into our markets. As these middle-aged baby
boomers-generally those born between 1946 and 1964-move toward and into retirement, the age by
which they will have accumulated maximum savings, they will become clearly the dominant group of
investors. With their investment capital, controlling considerable wealth, they will have a major impact on
the market for years to come. The growth in trading volume will continue with the succeeding
generations-which we call "Generation V and "Generation Y." More technologically savvy and skeptical
about Social Security as a retirement safety net, Generation X-ers and Y-ers are also more likely than
their parents to begin trading actively and investing early. They will have a significant impact on the
market over the next 20 years. Trading volume has been increasing, and this will likely continue. Three
years ago at Nasdaq we were averaging 650 million shares a day; today it is up to about one billion. It is
not hard to predict continued growth in trading volume-the real challenge is in dealing with it. Technology
has enabled this growth and we will utilize technology to meet the challenges of continued growth through
increased system capacity and further automation. The challenge of matching capacity with the market's
growth will continue well into the next century. To date, our highest volume day was just over 1.4 billion
shares, in April of this year. We are adding capacity that will give us the ability to handle four billion, and
then eight billion, shares a day. We are going to need that capacity to be prepared for the growth that we
see as the market becomes increasingly open and accessible to more people-not just in the United States,
but around the world. Globalization and Worldwide Access Global demand for investment capital has
continued to grow. Purchases of U.S. securities from outside the United States nearly quadrupled from $4
trillion in 1990 to $15 trillion in 1998. In the same way, American purchases of foreign securities have
nearly quintupled during the same period, from less than $1 trillion in 1990 to almost $5 trillion in 1998.
This trend in globalization will call for a worldwide electronic network of inter-linked securities markets
offering investors maximum access and the opportunity to invest in companies anywhere in the world. In
the next decade we will see more "cross- listings"-companies being listed on American markets as well as
on their own countries' markets. Nasdaq- Amex has an arrangement with the Stock Exchange of Hong
Kong to promote cross listings. It is likely to be just the first of many suchcross- listing initiatives
Extended trading hours will complement market globalization- likely in the form of a separate evening
session from 5:30 p.m. to about 9:00 or I 0:00 p.m. While we are excited about the access this will
provide investors in widespread time zones, we plan to move forward responsibly in a coordinated
industry-wide effort that will ensure this added trading time is also safe, fair, and efficient for all involved.
If this venture proves successful, round-the-clock trading may not be far away. Nasdaq, which has been a
computer-based, "floorless" market from its inception, is well suited to operate in tomorrow's globally
linked, around-the-clock market environment. Open access to markets will not be limited to investors. We
believe that issuers- the public companies that list their stocks on markets like Nasdaq-should have an
unfettered choice among the markets, driven only by free and fair competition for their listings and
supported by technology. Last year, the NASD was encouraged by the New York Stock Exchange's first
moves to eliminate its Rule 500, which tightly constrains companies wishing to change markets. We
believe the future lies in an open market, even among markets, and that anti- competitive practices will be
torn down by the people who want change. Investors will benefit from free and fair competition among
markets. Investing in Our Future As millions of new investors enter the market, volume grows, and access
to trading opens up around the world and around the clock, it will be more critical than ever for markets
to reinvest in themselves. Right now, we are working with a variety of partners to create s-sterns capable
of meeting the expectations of investors well into the next century. Along with the need for greater
capacity comes the need for more sophisticated capabilities in trade execution. This summer, Nasdaq will
integrate an electronic equity trading process into its system that will offer investors a "third dimension" to
their trading criteria. Instead of being able to enter orders at only one price and size, investors will be able
to indicate, across a range of prices and sizes, their preferences with respect to a particular trade. The
supercomputer-powered OptiMark system, which uses patented algorithms, matches buying and selling
desires in a manner that maximizes the mutual satisfaction. OptiMark Technologies will also give investors
the ability to trade stocks anonymously. This is one example of how technology will continue to enable
more sophisticated stock trading. With the boom in electronic markets, we are often asked the fate of
traditional floor-based markets like the American Stock Exchange. The NASD acquired the Amex last
year in our first step toward creating a "Market of Markets , which brings together two systems under one
corporate roof to offer better choices and opportunities to all market participants. One aspect of last year's
merger was to leverage the strength of Nasdaq's technology throughout the enterprise. For example, in
September, the newest version of the Amex's electronic order book will be put in place, making orders
more transparent and giving order makers even more visibility into the market. Everything about the
Amex options market is already fully electronic, but now we are expanding that technology into member
firms' offices, where they will be able to access the market more efficiently. The floor still has its place in
the trading world, but because of technology enhancements, the exchange is moving in a direction where
4 6upstairs brokers," the representatives who take orders from the public, have better direct access to the
trading floor. Conclusion The NASD thanks the Joint Committee for this opportunity to testify, and for its
interest in the role technology plays in our economy. America's equity markets are the envy of the world.
Nasdaq is now the largest equity market in the world. Even with this success, we must change with the
technological change around us. We welcome change as we welcome investors and entrepreneurs . We
are willing to change everything except our belief in the simple, elegant power of competition.