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April 21, 2005

The SEC Raises Stakes in Self-Regulation

By Gregory Bresiger

The future of SROs may soon become as heated as the debate over Reg NMS. Dozens of comment letters are now pouring into the Securities and Exchange Commission from trading executives and average investors over the regulators' SRO proposed rule change and concept release.

The SEC proposals have raised at least two dicey issues: Should self-regulation be trashed, with a single neutral regulator taking over from the various SROs? And, with exchanges demutualizing, who should be allowed on an SRO's board of directors?

Investigate Abuses

"I fully support any SEC rules or actions that might remove authority of the exchanges to police themselves and to place that responsibility with an independent oversight authority with full power to investigate abuses and impose appropriate penalties," writes Henry Gwiazda, Ph.D., an academic who once worked for the U.S. National Archives and Records Administration.

The SEC, in a concept release, is raising the issue of the single neutral regulator that would take over from SROs. That is opposed by many trading officials who have filed letters. For example, the NYSE writes that, "A radical rearchitecture of the current system is the wrong way to resolve concerns. Governance and coordination initiatives that have already occurred, plus enhacements to the current model, make more sense."

But the SEC is also considering a more moderate reform: keeping SROs, but imposing stiff new disclosure and membership requirements. "The Commission believes that requiring SRO boards to have a majority of independent directors...should help address the conflicts of interest that otherwise might arise when persons with a nexus to the SRO are involved in key decisions," according to the SEC's proposed Fair Administration Rules (FAR) release.

But several trading organizations, in comment letters, say that these proposed SRO rules requirements would hinder their ability to seek out the best people. Indeed, Archipelago, in a consortium letter sent with Nasdaq and four other exchanges, writes, "We believe that all marketplaces, subject to the Commission's oversight, should have greater flexibility to develop their own approaches to independence, based upon a definition that focuses on materiality of a director's relationship to the market, and board composition than the FAR would permit."

Kevin O'Hara, Archipelago's general counsel told Traders Magazine: "We are huge proponents of independence. The overwhelming majority of our board is independent, but the SEC's narrow definition of independence would make it difficult for SRO boards." The proposed SRO changes, the letter said, would depart from the premises of the self-regulatory provisions of the 1934 Securities Act.

Outside Directors

The NASD, in its filing, called for a revision of the proposed independent director rules. It argues that it should not "preclude the participation of individuals who may have relevant experience and expertise, and yet may have recently served as outside directors of member firms." It also promised to move quickly in correcting its apparent conflict - the continued ownership of Nasdaq.

Rosenblatt Securities, an agency-only firm and NYSE floor broker, in a comment letter, argued that, despite several scandals, self-regulation at times has been very effective in detecting violations.