Speech by SEC Chairman:
Open Meeting Regarding SRO Governance Rule Proposal
William H. Donaldson
U.S. Securities and Exchange Commission
November 9, 2004
Good morning. Today, the Commission will consider two items from the Division of Market Regulation that relate to the system of self-regulation in our nation's securities markets. First, the Division recommends that we propose new rules designed to strengthen the governance of SROs that operate securities markets, increase the transparency of their operations, address their evolving ownership structures, and enhance our ability to oversee them. Second, the Division recommends that we issue a concept release that discusses more broadly the role of self-regulation in today's market environment and seeks public comment on several alternatives to the current self-regulatory structure.
Our securities markets have historically operated under a system of self-regulation. In 1934, when Congress gave the Commission authority over securities exchanges, it recognized the important role they had already assumed in overseeing their members' activities, imposing rules of conduct, and punishing wrongdoing. The fundamentals of self-regulation have changed little since that time. Oversight of our securities markets and market participants remains grounded in the principle that regulation works best when it occurs close to the regulated activity.
SROs perform a crucial role in our nation's economy. They provide issuers with an entry point to our capital markets. They sponsor venues where investors' buy and sell orders can interact and, by doing so, they facilitate liquidity. By gathering liquidity they enable the price-discovery process, which, in turn, fosters capital formation. Most importantly, however, they are the front-line regulators of securities firms and markets, and are thus critical to assuring the integrity of our securities marketplace.
In light of the importance of the self-regulatory system to the nation's economic well-being and to the protection of investors, recent events and longer-term trends point toward the need for the Commission to consider whether changes are needed to improve the system.
SROs enforce their members' compliance with the federal securities laws and their own rules. We have, unfortunately, seen recent examples of the harm that can occur when an SRO fails to execute this responsibility energetically. While the root causes of these problems are complex and varied, a common theme in many cases is the lack of a vigorous regulatory function within the SRO.
This lack may be abetted by internal governance structures that do not adequately insulate an SRO's regulatory function from its market operations. Certainly, recent history has shown that SROs are not immune from governance missteps. After a period of intense focus on public-company governance, we would be remiss if we did not seek to apply the lessons learned to the governance of SROs.
We have also seen the U.S. securities markets evolve dramatically during the last few years. Just a short while ago, all SROs were non-profit, member-owned entities, and the major markets dominated trading in their listed securities. Electronic trading systems now compete actively with traditional exchange markets and have captured significant volume. In 1998 the Commission signaled for the first time that SROs could operate as for-profit, shareholder-owned entities. Following this guidance and in response to competitive pressures, several SROs have demutualized and become shareholder-owned enterprises. Similar trends have occurred in securities markets around the world.
These developments have aggravated the inherent tensions in our system of self-regulation. As SROs face the pressure of competition for market share, their regulatory function can become vulnerable to influence from members and management. Moreover, demutualized exchanges are facing new challenges as they attempt to balance their members' interests with their fiduciary duties to shareholders, and at the same time fulfill their obligations to the public under the Exchange Act.
For these reasons, I believe that the proposed rulemaking is particularly timely. I do, however, wish to make clear that I appreciate the enormous competitive challenges that market centers face today. The rulemaking proposed today recognizes the important and often difficult role that SROs play in running our securities markets, but focuses on assuring that SROs effectively carry out their most important role: that of fulfilling their regulatory obligations under the Exchange Act.
Finally, while I believe that this rulemaking proposal would greatly enhance the governance, transparency and oversight of SROs, I also believe that broader questions remain as to whether the self-regulatory system, as currently structured, remains the best and most efficient model for overseeing markets and market participants. There are, for example, legitimate questions about duplicative and overlapping oversight of market participants by multiple SROs. I have therefore asked the staff to prepare a concept release that examines the continuing efficacy of our existing model, and discusses possible alternatives to that model. I am greatly interested in the views and insights of investors, marketplace participants, academics, other members of the public, and SROs themselves on the questions raised in the concept release. In particular, I welcome your ideas on novel approaches to organizing our system of marketplace and broker-dealer regulation.
I hope that this rulemaking proposal and concept release will lead to a robust and thoughtful discussion of useful improvements to the regulation of our national markets.
I would like to thank the staff of the Division of Market Regulation for their work on these proposals, and in particular Annette Nazareth, Bob Colby, Elizabeth King, David Shillman, Nancy Sanow, Heather Seidel and Christopher Stone.
Annette, please present the details of your proposals.