The Need for Robust SEC Oversight of SROs
Commissioner Luis A. Aguilar
U.S. Securities and Exchange Commission*
May 8, 2013
The staff of the U.S. Securities and Exchange Commission (“Commission” or “SEC”) is planning to hold an SRO Outreach Conference (the “Conference”) this month.1 In anticipation of the Conference, I would like to address the challenges faced by self-regulatory organizations (“SROs”) as a result of the significant changes that the securities markets have undergone in the last decade, and the need for robust Commission oversight of SRO activities to enhance investor protection, maintain fair, orderly, and efficient markets, and facilitate capital formation.
The roles of SROs have a long tradition in our securities markets. As a practitioner in the securities industry for over 30 years, I’ve interacted with SROs as a member of the private sector as well as a Commissioner. I fully appreciate their role in the regulation of our marketplace by setting standards, conducting examinations, and enforcing rules among their members.2
Challenges of Self-Regulation
Self-regulation of market intermediaries through a system of SROs is one of the core elements of our existing regulatory framework. SROs are primarily responsible for establishing the standards under which their members conduct business and for monitoring the ways their members conduct business. SROs are also required to enforce compliance by their members with the federal securities laws, and discipline their members for violations of such laws and the SRO’s own rules.
During the last few years, SROs have faced increased competition in the markets where they operate. For example, SROs face competitive challenges from electronic communications networks and foreign trading markets that have slowly chipped away at the SROs’ market share. There also have been tremendous advances in trading systems that rely almost exclusively on fully-automated technology to process trades.3
In addition to these competitive challenges, there continues to be inherent conflicts of interests between the SROs’ regulatory functions and its members, market operations, issuers, and shareholders.4 To stay in business, SROs have to attract order flows, and this may lead to SROs being less inclined to enforce rules vigorously against financially supportive members, issuers, and shareholders. In the past, there have been instances where SROs have favored one member or customer over another; for example, by sharing market data with paying subscribers before releasing such data to the public.5
The advent of these new competitive challenges and continued conflicts of interests require, among other things, a closer working relationship between SROs and the SEC, and for the Commission to re-evaluate how it can best provide appropriate oversight over SROs.
SEC Oversight of SROs Is Necessary and Indispensable
Because of the inherent conflict of interests involved in self-regulation, robust SEC oversight over SROs is indispensable. As a result, Congress has vested in the Commission the power to supervise SROs as a matter of public interest.6 And to accomplish this, Congress has provided the Commission with several tools to oversee SROs. For example, exchanges, clearing agencies, and national securities associations must register with the Commission,7 and SROs must file their rule changes with the Commission.8 In addition, the Commission has the authority to inspect and examine SROs.
I recognize that many SROs work diligently to meet their obligations. Unfortunately, however, that isn’t always the case and, in such cases, the SEC is required to act. Over the years, there have been a growing number of enforcement actions by the Commission against SROs, who failed to meet their legal and regulatory obligations under the law. For instance:
In 1999, the Commission found that the New York Stock Exchange (“NYSE”) failed to detect and halt unlawful proprietary trading by certain independent floor brokers.9
In 2000, the Commission sued all four of the options exchanges – the American Stock Exchange, the Chicago Board Options Exchange, the Pacific Exchange, and the Philadelphia Stock Exchange – for inadequate surveillance of their markets for potential violations, for failure to conduct thorough investigations, and for failure to enforce rules applicable to members on their floors.10
In 2005, the Commission brought a second action against NYSE for failure to detect, investigate, and discipline widespread unlawful proprietary trading by specialists on the floor of the exchange.11 That year, the Commission also brought an action against the National Stock Exchange for failure to enforce compliance by its dealer firms with the market order exposure rule and the customer priority rule.12
In 2006, the Commission sued the Philadelphia Stock Exchange for failure to enforce rules relating to options and equities trading, as well as order handling rules.13
In 2007, the Commission sued the American Stock Exchange again for failure to enforce order handling rules and comply with recordkeeping obligations because of critical deficiencies in its surveillance, investigative, and enforcement programs.14 That year, the Commission also charged the Boston Stock Exchange for, among other things, failure to enforce rules to prevent specialists from trading in a way that benefited themselves at the expense of their customers.15
In 2011, the Commission sanctioned the Direct Edge exchanges for violating the federal securities laws because of weaknesses in their systems, processes, and controls that resulted in a systems outage and millions of dollars in trading losses.16
- Finally, in September 2012, the Commission charged NYSE for the third time for compliance failures that gave some of its customers an improper advantage on trading information.17 The Commission found that the NYSE sent data to some customers through two of its proprietary feeds before sending data to the consolidated feeds.18 The $5 million penalty imposed against NYSE marked the first time the Commission has ever imposed a financial penalty against an exchange.19
Obviously, these events undercut investor confidence.20 There is no doubt that the success or failure of the securities industry depends on its reputation, public perception, and its ability to earn investors’ confidence. Investor participation in the capital markets depends on the markets being fair and transparent. An orderly and efficient market requires that all of us maintain a watchful eye on market activities.
SROs must have strong compliance cultures and adequate and dedicated compliance resources to provide the first line of defense; however, when SROs fall short, the SEC needs to stand ready to take action. The SEC’s oversight of SROs is an important component to instill public confidence in the securities industry.
I support the spirit behind the SRO Outreach Conference. It is a pro-active step in the SEC’s oversight of SROs for the SEC to meet regularly with SROs to share collective views on matters affecting SROs and the markets. In particular, it is my expectation that the Conference will address those areas where SROs and the SEC can improve collaboration, cooperation, and oversight. In the end, the protection of investors and the effectiveness of our capital markets are best served when the SEC and SROs have a strong working relationship.
I commend the staffs of the SEC and the SROs for coming together, and I look forward to their hard work in protecting investors and maintaining fair, orderly, and efficient markets.
* The views expressed in this statement are those of Commissioner Luis A. Aguilar and do not necessarily reflect the views of the SEC, other SEC Commissioners, or members of the staff.
1 See “Fourth Report on the Implementation of SEC Organizational Reform Recommendations, As Required by Section 967 of the Dodd-Frank Wall Street Reform and Consumer Protection Act,” p. 28 (Apr. 30, 2013), http://www.sec.gov/news/studies/2013/sec-organizational-reform-recommendations-043013.pdf.
2 Under the Securities Exchange Act of 1934 (“Exchange Act”), a variety of SROs, including national securities exchanges and the Financial Industry Regulatory Authority (“FINRA”), exercise extensive oversight over securities broker-dealers, stock exchange members and listed companies, and other market intermediaries. Stock exchanges were the original SROs that governed the trading of securities and regulated their members well before the creation of the Securities and Exchange Commission and the current statutory framework formalizing their SRO status. The New York Stock Exchange is the largest SRO among the registered national securities exchanges. For an updated list of SROs, please visit the SEC’s website, http://www.sec.gov/rules/sro.shtml (last visited Mar. 4, 2013).
3 Securities and Exchange Commission Release No. 34-61358, File No. S7-02-10 (Jan. 14, 2010).
4 See Concept Release Concerning Self-Regulation, Exchange Act Release No. 34-50700, 69 Fed. Reg. 71,256 (Dec. 8, 2004) at 71, 259-64.
5 See, e.g., In the Matter of New York Stock Exchange LLC, and NYSE Euronext, Admin. Proc. File No. 3-15023, Exchange Act Release No. 67857 (Sept. 14, 2012) (The NYSE earned revenue from selling market data through its proprietary data feeds, and shared market data with its subscribers through these proprietary feeds sooner than releasing the market data to the public through the consolidated feeds.); In the Matter of Boston Stock Exchange, Inc. and James B. Crofwell, Admin. Proc. File No. 3-12744, Exchange Act Release No. 56352 (Sept. 5, 2007) (“The [Boston Stock Exchange] placed its business interests in developing the [Competing Specialist Initiative] ahead of its responsibilities as a self-regulatory organization with a statutory duty to regulate its members.”); In the Matter of Certain Activities of Options Exchanges, Admin. Proc. File No. 3-10282, Exchange Act Release No. 43268 (Sept. 11, 2000) (“In some instances, floor officials overlooked indications of rule violations by, or addressed them selectively against, some members, but not others.”); In the Matter of National Association of Securities Dealers, Inc., Admin. Proc. File No. 3-9056, Exchange Act Release No. 37538 (Aug. 8, 1996) (NASD, among other things, “processed the applications for membership of certain firms in a manner inconsistent with its rules.”).
6 See S. Rep. No. 94-75, 94th Cong., 1st Sess. 7, II (1975).
7 See Section 19 of the Exchange Act.
8 See Section 19(b)(4) of the Exchange Act.
9 See In the Matter of New York Stock Exchange, Inc. Admin. Proc. File No. 3-9925, Exchange Act Release No. 41574 (June 29, 1999).
10 See In the Matter of Certain Activities of Options Exchanges, Admin. Proc. File No. 3-10282, Exchange Act Release No. 43268 (Sept. 11, 2000).
11 See In the Matter of The New York Stock Exchange, Admin. Proc. File No. 3-11892, Exchange Act Release No. 51524 (Apr. 12, 2005).
12 See In the Matter of National Stock Exchange and David Colker, Admin. Proc. File No. 3-11931, Exchange Act Release No. 51714 (May 19, 2005).
13 See In the Matter of Philadelphia Stock Exchange, Admin. Proc. File No. 3-12315, Exchange Act Release No. 53919 (June 1, 2006).
14 See In the Matter of American Stock Exchange LLC, Admin. Proc. File No. 3-12594, Exchange Act Release No. 55507 (Mar. 22, 2007).
15 See In the Matter of Boston Stock Exchange, Inc. and James B. Crofwell, Admin. Proc. File No. 3-12744, Exchange Act Release No. 56352 (Sept. 5, 2007).
16 See In the Matter of EDGX Exchange, Inc., EDGA Exchange, Inc., and Direct Edge ECN, LLC, Admin. Proc. File No. 3-14586, Exchange Act Release No. 65556 (Oct. 13, 2011).
17 See In the Matter of New York Stock Exchange LLC, and NYSE Euronext, Admin. Proc. File No. 3-15023, Exchange Act Release No. 67857 (Sept. 14, 2012).
20 See also In the Matter of Financial Industry Regulatory Authority, Inc., Admin. Proc. File No. 3-14605, Exchange Act Release No. 65643 (Oct. 27, 2011) (Commission proceeding arising out of FINRA’s production of altered documents in response to a document request by Commission staff; this was the third instance during an eight year period where a FINRA/NASD employee provided altered or misleading documents to the Commission); Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 Regarding the Nasdaq Stock Market, Inc. as Overseen by its Parent, The National Association of Securities Dealers, Inc., Exchange Act Release No. 51163 (Feb. 9, 2005) (“The facts learned in this investigation point to the need for reiteration of a fundamental premise of self-regulation: an SRO must vigorously enforce its regulatory responsibilities, and must take particular care when market and regulatory functions are delegated to separate entities.”); In the Matter of The Chicago Stock Exchange, Admin. Proc. File No. 3-11282, Exchange Act Release No. 48566 (Sept. 30, 2003) (The Commission charged the Chicago Stock Exchange for failure to enforce its rules affecting trading by specialists.); In the Matter of Stock Clearing Corporation of Philadelphia and Philadelphia Depository Trust Company, Admin. Proc. File No. 3-9360, Exchange Act Release No. 38918 (Aug. 11, 1997) (The Commission charged the respondents “for failure to comply with their respective rules and procedures, failure to file necessary proposed rule changes with the Commission and, in the case of SCCP, violations of Regulation T.”); In the Matter of National Association of Securities Dealers, Inc., Admin. Proc. File No. 3-9056, Exchange Act Release No. 37538 (Aug. 8, 1996) (The Commission disciplined FINRA’s predecessor, the NASD, for, among other things, failure to comply with its own rules, or enforce its rules and the federal securities laws against market makers.).