Charles Schwab & Co., Inc.
July 7, 2003
Via Electronic Mail
Jonathan G. Katz
Re: SEC Concept Release on Nasdaq Petition Concerning the Regulation of Nasdaq-Listed Securities (Release No. 34-47849; File No. S7-11-03)
Dear Mr. Katz:
The Charles Schwab Corporation ("Schwab") appreciates the opportunity to comment on the competitive and regulatory issues raised in the Nasdaq petition referenced above. Schwab serves its broker-dealer clients through its direct and indirect subsidiaries Charles Schwab & Co., Inc., Schwab Capital Markets L.P., CyberTrader, Inc. and U.S. Trust Securities. Schwab joins in and supports the letter submitted by the Securities Industry Association ("SIA"). All markets that trade a security should have sufficient and comparable audit trails. All markets that trade a security should have consistent surveillance and examination functions. Short sale rules should be consistent in the different markets that trade a security (in our view preferably by deregulating most current short sale restrictions). Market participants should not be able to engage in regulatory arbitrage across the different markets for a single security.
In our view, all of the considerations discussed in the SIA letter point to a single, inexorable conclusion: the need for a single self-regulator for broker-dealers in all markets. Schwab has long advocated the creation or designation of a single, independent regulator for the securities markets, including the options markets. We believe that such an entity would provide a much more consistent approach to regulation, surveillance and examinations across all markets and securities than exists today and the resulting benefits would be great.1
Today, broker-dealer firms such as Schwab and its broker-dealer affiliates are regulated by multiple self-regulatory organizations ("SROs") based on the markets in which the firms operate. Despite the appointment of a Designated Examining Authority ("DEA") with responsibility for coordinating oversight, every market in which the firm operates has regulatory, surveillance and examination requirements that differ to some degree. As a result, customers have different levels of protection, depending on which SRO their broker-dealer is a member, and in which market a particular order is executed. There is no policy justification for different levels of customer protection depending on the happenstance of who regulates a particular broker-dealer or where a particular order is executed. For those firms that are focused on one type of securities, it is possible to select the market with the least constraining regulatory requirements, which while less costly to the firm in terms of regulatory costs, may in fact cost customers in quality of execution. The differences between SROs create significant regulatory redundancies and costs to a firm that accesses multiple markets, and those costs are ultimately passed on to the firm's customers. A single, independent market regulator would not only reduce redundancies and costs to member firms and their customers, it would also eliminate the regulatory gaps that exist across the multiple SROs today.
Another troubling aspect of the current SRO structure is the potential for conflicts of interest that arise when SROs regulate their competitors. For example, some SROs regulate ECNs with which they compete for order flow. It is fundamentally unsound to have an SRO regulate a brokerage firm with which it competes for business. Other SROs regulate broker-dealers that are members of multiple markets. A conflict can arise where the SRO takes a position toward one broker-dealer that is inconsistent with that taken for firms that are more solidly entrenched in that SRO's market. A single, independent market regulator would not only eliminate these potential conflicts of interest, but would also eliminate any potential motive an SRO may have to treat differently its highest revenue-generating members.
While there are many possible ways to create a single, independent market regulator, we believe that the National Association of Securities Dealers ("NASD") is best positioned to take on that role with the least additional costs. More than any other market, it has separated its regulatory function from its competitive market function, and the complete divestiture of Nasdaq is well on track. The NASD has served as the primary regulator of broker-dealers since its inception, improving its technology and personnel infrastructure to meet the changes in the industry. It has regulated both OTC and listed equities in the third market, along with OTC options; thus it has the foundation from which to regulate all securities. While less directly involved in the regulation of exchange-traded equities and options, building out its infrastructure to cover these areas would be a much lower cost than building a regulator from scratch or opening a competitive bidding process. Either of these options would be very costly to the industry, and, again, ultimately the cost would be passed on to investors.
Schwab believes that for the U.S. securities markets to continue to provide the best possible protections to investors while retaining the competitiveness that has led to greater efficiencies for all market participants, the markets must be regulated in an independent and consistent manner. We appreciate the opportunity to share our views. If you have any questions concerning these comments, or would like to discuss our views further, please contact me at 415-636-3199.