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Jared Dillian
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May 31, 2002

Competition, Regulators Don't Mix? GAO Questions SROs, Demutualization, Market Structure

By Gregory Bresiger

So many regulators, so little time. That's what some securities industry players, many of whom are regulated by multiple agencies, complain about these days.

A report by the General Accounting Office said that industry participants are "facing a high degree of unnecessary duplication, inconsistency and inefficiencies associated with the current multiple self-regulatory organization (SRO) structure."

The report also notes that, as some SROs consider de-mutualization, this would give markets a greater ability to compete, but it also might give them unfair advantages [see sidebar].

"Heightened competitive pressures have generated concern that an SRO might abuse its regulatory authority - for example, by imposing rules or disciplinary actions that are unfair to the competitors it regulates. Market participants' views differed on whether demutualization will heighten the potential for such abuses," according to the GAO report.

Recommendations include a call for the SEC to work with SROs and broker dealer officials to find a way to correct the "material regulatory inefficiencies caused by differences in rules or rule interpretations among SROs and by the multiple examinations of broker dealers." The report calls for using a neutral party to obtain comments and complaints about the work of SROs.

SRO Status

Richard Roberts, a former SEC Commissioner, said there is a movement toward the consolidation of examining authority. "The NYSE and the NASD seem to be taking over and I'm sure some would like to see just one examining authority," Roberts said.

Roberts, who served on the commission between 1990 and 1995, said that the concept of self-regulation still is a sensible one. However, he added that the greatest need for a reformed securities regulatory model is on the state level.

GAO, the investigative arm of Congress, noted that it is too soon to determine if, for example, Nasdaq will be given a competitive advantage as it demutalizes. Nevertheless, GAO said that, "Concerns about conflicts of interest persist despite measures by the SEC and the SROs that are intended to address them."

Nasdaq, in a comment letter, generally agreed with the conclusions of the report, but warned that the SEC had overlooked "a serious challenge to the integrity of the self-regulatory system - that is, the alignment of regional stock exchanges with ECNs for trading Nasdaq stocks."

In a letter from Nasdaq President Richard Ketchum to the GAO, Nasdaq once again focused its criticism of what it sees as lax oversight of the regional exchanges such as the Cincinnati Stock Exchange (CSE).

"Based on public financial information that the CSE provides to the SEC, it is evident that the CSE's total expenditures are less than 1/10 of those that Nasdaq spends on regulation alone in a given year. Presumably not all of the CSE's budget goes to fund its regulatory program. The CSE itself has claimed that its regulatory function is as robust as and in some instances more robust than that of the Nasdaq Stock Market and yet the financial realities make the accuracy of those statements highly suspect," according to Nasdaq's comment letter.

An official of the CSE, who agreed that the regional exchange spends less on regulation than Nasdaq but would not disclose actual figures, stood by the exchange's contention that its regulation is effective.

"We have an excellent order audit trail system. In fact Nasdaq came to us for help in working on their system," Jeff Brown, general counsel for the CSE, told Traders Magazine. "It is not necessary to spend a lot of money to do a good job on regulation," he added. Brown said that Nasdaq's complaints were motivated by "a fear of competition."