Self Regulation:
The US Experience
Ethiopis Tafara
US Securities & Exchange
Commission
History of Self-Regulation
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Securities Exchange Act of 1934
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NYSE largest of about 30 exchanges in 1934
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SEC created in aftermath of 1929 stock market crash
Over 80% of US securities trading in dollar volume
Congress let stock exchanges continue to
regulate own activity
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SEC to watch over exchanges
NASD: Expanded Self-Regulation
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1938: Congress created the concept of national
securities association
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Regulated the market for “over the counter” stocks not
traded on any exchange
National Securities Dealers Association (NASD) is the
only major registered securities association today
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All broker-dealers conducting business with the public are
members of the NASD
Partially owns and operates NASDAQ stock market
When broker-dealers are members of both NASD and other
exchange(s), one SRO is designated examining authority
Registered US Exchanges
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Currently 9 registered US exchanges
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New York Stock Exchange (NYSE)
American Stock Exchange
Philadelphia Stock Exchange
Boston Stock Exchange
Chicago Stock Exchange
Chicago Board Options Exchange
Cincinnati Stock Exchange
International Securities Exchange
Pacific Stock Exchange
Standards for Self-Regulation
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Exchange Act requires SROs to meet a
number of standards, including:
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Ability to comply with securities laws and enforce its
members´ compliance
SRO rules must give all members fair representation in
selection of its directors and administration of its affairs
Must have rules designed to prevent fraud and promote “just
and equitable principles of trade”
Must have fair procedure for bringing disciplinary actions
against its members and associated persons
Rules must not impose unnecessary burden on competition
SEC´s Role
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SEC covers every aspect of self-regulation:
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SRO must file proposed rule changes with SEC
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Rules do not take effect until SEC approval
SEC examines SROs
Members can appeal SRO disciplinary actions to SEC
SEC can directly enforce SRO rules if SRO unable or
unwilling to do so
SEC can bring enforcement action against SROs
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Rare, but threat of such action gives SEC leverage
SEC has brought significant enforcement action against both the NASD
and NYSE within past 5 years
Advantages of Self-Regulation
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Technical Expertise
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Flexibility
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SRO may have greater ability to adapt to new developments
Greater Acceptance of Rules
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Market professionals may better understand technical aspects of
exchange regulation
SRO members elect their directors and participate in rulemaking;
may cause greater willingness to comply with rules
Cost Savings to Federal Government
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More than 5,000 registered broker-dealers of varying complexity
Nearly 600,000 registered securities professionals
Disadvantages of Self-Regulation
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Conflicts of Interest
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Antitrust Implications
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Securities exchanges are both business ventures and
regulatory bodies; may not enforce rules if detrimental to
business
Members of an SRO are collectively regulating their own
behavior; danger of collusive behavior that hurts customers
Due Process Concerns
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Members regulated by individuals exercising a form of
governmental power, yet may not have all procedural rights
that would apply if the government were the disciplinary
body
SEC Concept Release
Recent SEC concept release (34-50700)
addresses concerns regarding role and
operation of SROs, including:
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1.
2.
3.
4.
Conflicts of interest between SROs´ regulatory
obligations and interests of members, market
operations, listed issuers, and, in the case of a
demutualized SRO, shareholders
Costs and inefficiencies of the multiple SRO model
Challenges of surveillance across markets
Manner in which SROs generate revenue and how
SROs fund regulatory operations
Conflicts of Interest
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With Members
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Trend: Declining number of member firms increasingly
important to their regulator SROs´ business interests
Creates inappropriate business pressure on regulatory staff
With Market Operations
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Trend: Increasing competition among markets creating
pressure to attract order flow
Creates pressure for permissive market activity or overregulation of competitors
Conflicts of Interest, cont´d.
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With Issuers
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Trend: SROs simultaneously responsible for monitoring
issuers and delisting securities while competing to attract
and retain listings
With Shareholders
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Trend: SRO demutualization creates additional
conflict regarding profit motive of a shareholderowned SRO
May commit insufficient funds to regulatory
operations or use disciplinary function as revenue
generator with respect to member firms that operate
competing trading systems
Costs and Inefficiencies
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Existence of multiple SROs can result in
duplicative and conflicting rules, rule
interpretations, and inspection regimes
The system can also result in redundant SRO
regulatory staff and infrastructure across SROs
May be aggravated by trend toward greater
market fragmentation of order flow among
SROs
Intermarket Surveillance & Funding
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Intermarket Surveillance
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Trading in multiple active markets facilitates veiling
illegal activity by dispersing trades across markets
Funding
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Self-funding structure leverages limited SEC resources
SEC supervision of SRO regulatory funding adequacy is
challenging, given temptation for SROs to fund
business operations at regulation´s expense
Hard to know whether an SRO is insufficiently funding
its regulatory function or simply administering an
efficient regulatory program
Alternative Approaches
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Enhance current SRO system
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Strengthen governance, enhance disclosure and
reporting requirements
Enhance SEC´s and SROs’ ability to regulate
intermarket trading activity
Mandated SRO internal restructuring
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Increase SRO regulatory independence, e.g., by
requiring all SROs create independent subsidiaries
for regulatory and market operations
Alternative Approaches, cont´d.
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Hybrid model
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Designation of a market neutral single SRO (“Single
Member SRO”) to regulate all SRO members with
respect to membership rules
Each SRO that operates a market (“Market SRO”)
would be solely responsible for its own market
operations and market regulation
Competing hybrid model
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Multiple competing member SROs (“Competing
Member SROs”), required to register with the SEC
and authorized to provide member regulatory
services
Alternative Approaches, cont´d.
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Universal industry self-regulator
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Universal non-industry regulator
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One industry SRO responsible for all market and
member rules for all members and all markets
One non-industry entity designated as responsible
for all markets and member regulation for all
members and all markets
SEC regulation
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Termination of the SRO system in favor of direct SEC
regulation