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The SEC Asks For Comment On
Whether Technology Should Change
The Way It Regulates Markets

The U.S. Securities and Exchange Commission (SEC), the federal government agency that oversees the securities markets, seeks your comment on how it should regulate securities markets in light of changes in technology. On May 23, 1997, the SEC published a “concept release,” that presented the issues now confronting the SEC on how to best regulate new electronic trading systems, traditional stock exchanges, and foreign market activities in the United States. The concept release does not propose to change any of the SEC's regulations. Instead, the SEC is asking the public for comments on a broad range of questions to help it decide whether to change SEC regulations and, if so, how.

The following document summarizes the concept release. If you would like to submit your comments on these issues, you should obtain a complete copy of the concept release from the SEC. Your comments are due on October 3, 1997.


The SEC's concept release asks the public for its views on ways to update the Commission's regulatory framework for securities markets. Over the past two decades, technology has revolutionized the way in which our securities markets operate. With the advent of computers, securities transactions that were once slow, costly, and dependent on intensive human labor have become instantaneous and inexpensive. Technology has changed the way securities quotations and other market information is displayed, and the way orders are executed, cleared, and settled. Technology is now a part of everyday life for those involved in our securities markets — professional traders use computers in every aspect of their jobs, and some individual investors use them to monitor the markets and to place orders from their homes and offices.

Technology has also made it easier to cross national boundaries. Through electronic linkages, some mutual funds, pension funds, and other institutional investors in the United States now have the ability to trade directly on foreign markets.

These changes have benefitted investors by lowering costs and providing more ways to trade securities. At the same time, however, technological changes pose challenges for the regulatory framework for securities markets. The concept release focuses on two principal issues:

  1. Fundamental changes in the domestic securities markets, especially the rapid growth of electronic trading systems that present alternatives to traditional stock markets; and

  2. The development of automated systems that enable U.S. investors to trade directly on foreign markets from the United States.

Domestic Securities Markets

What Is a Stock Market?

Stock markets provide a place for buyers and sellers of securities to trade, and include exchanges, the Nasdaq Stock Market, and privately-owned, electronic trading systems. Some exchanges, such as the New York Stock Exchange (NYSE), have trading floors where securities firms meet to buy and sell securities for themselves and for their customers. On other markets, such as the Nasdaq Stock Market, dealers post quotations for securities on computer screens and then buy and sell those securities using a computer network and the telephone. Over the past two decades, stock markets are becoming partially or fully automated. For example, fully-automated, privately-operated, electronic trading systems now handle one and a half times the trading volume of the American Stock Exchange and all of the regional exchanges combined. In addition, traditional stock markets with trading floors now use computers to route and execute orders.

How Does the SEC Oversee the U.S. Stock Markets?

Although exchanges, Nasdaq, and privately-owned, electronic trading systems serve the same function — as a place where investors can buy and sell securities — historically, the SEC regulates them differently.

SEC Oversight of Exchanges and
the Nasdaq Stock Market

Currently, there are eight exchanges registered with the SEC, including the NYSE, the American Stock Exchange, the Chicago Board Options Exchange, and five regional exchanges. The Nasdaq Stock Market is registered with the SEC as a securities association. In overseeing these exchanges and Nasdaq, the SEC works:

  • To ensure that investors have fair access to investment opportunities on these stock markets and that these stock markets treat diverse investors fairly;

  • To make sure that these stock markets are linked, so that brokers can get the best prices for their customers;

  • To prevent fraud and manipulation on these stock markets; and

  • To reduce the risk that investors' orders will not be filled due to the failure of any one computer system.

SEC Oversight of Electronic Trading Systems

Today more than 20 privately-owned, electronic trading systems provide mostly institutional investors a place to trade securities. Until recently, electronic trading systems had insignificant trading volume. Although these electronic trading systems provide many of the same services as the registered exchanges and Nasdaq, in order to foster their innovation and growth, the SEC has regulated these systems in the same way as traditional brokers. Regulation as a traditional broker may not be appropriate because, for example, it subjects electronic trading systems to capital requirements that may not be appropriate for their activities.

What is the Purpose of the Concept Release?

In recent years, some electronic trading systems have become viable substitutes for registered exchanges and Nasdaq. This raises concerns that the current regulation of electronic trading systems as brokers may not be appropriate. The SEC is especially concerned that it does not have the tools to make sure that important information about prices and trading interest on these systems is available to all investors. In addition, the SEC's ability to prevent these private electronic trading systems from being used for fraudulent or manipulative activities is more limited compared to the SEC's ability to oversee the exchanges and Nasdaq.

The increasing significance of electronic trading systems has prompted the SEC to rethink the way it treats these systems. In addition, a recent amendment by Congress to the securities laws was designed to help the SEC address concerns about these private electronic trading systems. For these reasons, the SEC believes that it is now a good time to begin a dialogue about how to improve the regulation of these new and growing electronic trading systems. The release attempts to lay a foundation for this dialogue by outlining the current problems in the regulatory structure and presenting possible solutions.

What Solutions Are Being Considered by the SEC?

The concept release discusses two ways to address the SEC's concerns about electronic trading systems.

First Alternative: Creating Three Tiers
of Exchange Regulation

The SEC could treat private electronic trading systems as exchanges. If the SEC does this, it could create a tiered framework of exchange regulation. Under this framework, the SEC may improve investors' access to the best prices and protect against fraud and manipulation.

  • The First Tier. Relatively small electronic trading systems would form the first tier. This new category could foster innovation by allowing new trading systems to develop. In most cases, these systems would actually be subject to fewer requirements than they are subject today under broker-dealer regulation. For example, as first tier exchanges, electronic trading systems would not be subject to broker-dealer capital requirements or to oversight by the National Association of Securities Dealers, Inc. or the NYSE, which operate competing markets. As these systems grow, they would move from this first tier to a second tier.

  • The Second Tier. Electronic trading systems with significant volume would form the second tier of exchanges. These systems could be regulated like existing stock exchanges, but without requirements that may be incompatible with how these systems currently operate. For example, currently the securities laws only permit the eight registered exchanges to have broker-dealers as members of their markets. Because this requirement would be a problem for electronic trading system whose participants are comprised almost exclusively of institutions, the SEC is considering whether second tier exchanges should be allowed to have institutional participants.

  • The Third Tier. Traditional stock markets, such as the NYSE, that are currently registered with the SEC would form the third tier of exchanges. For these exchanges, the concept release explores ways in which the SEC could reduce unnecessary regulatory requirements that make it difficult for them to innovate and remain competitive in a changing business environment. For example, the concept release solicits comment on ways to further reduce requirements that exchanges seek SEC approval of all changes to their rules, and how automation might be used to lower the costs and improve the effectiveness of exchanges' surveillance and enforcement responsibilities.

Second Alternative: Enhanced Regulation as Brokers

Rather than treating private electronic trading systems as exchanges, another way to improve the SEC's oversight of these trading systems could be to continue to regulate them as brokers and adopt specific rules to correct current weaknesses in how they are regulated. For example, the SEC could:

  • adopt rules to link private electronic trading systems to the existing stock exchanges so that investors have access to better prices on these systems;

  • adopt rules to make sure that these trading systems have enough computer capacity and have procedures to reduce the risk that their computer systems will fail; and

  • require the registered exchanges and Nasdaq to assume greater responsibility for supervising electronic trading systems.

Investors' Access to Foreign Markets

How Do U.S. Investors Trade Foreign Securities?

In the past, U.S. investors who wanted to buy and sell foreign securities would contact their U.S. broker. In most cases, the U.S. broker would provide its customers with current information about the prices of foreign securities and then send any customer order to a foreign broker. That foreign broker would fill the order from its inventory or buy or sell the foreign securities on a foreign market. Alternatively, a U.S. investor could contact the foreign broker directly.

Technology has made it easier for U.S. investors to trade stocks in foreign markets. Computers allow mutual funds, pension funds, and other institutional investors in the United States to now trade directly in foreign markets -- bypassing the broker. Many U.S. institutions are able to view stock quotes from foreign markets, and electronically send orders to those markets. In the future, small investors may be able to trade in foreign markets from their personal computers.

How Does the Concept Release
Address These Issues?

The concept release looks at the impact of technology on U.S. investors' ability to trade directly on foreign markets and tries to address the realities of the global marketplace. When trading in the U.S. markets investors receive protections that may not be available when they trade in foreign markets. For example, investors may not receive the same high-quality disclosure about the companies in which they are investing. The concept release asks for comment on how to allow electronic global trading, and whether to provide U.S. investors with the essential protections they may have come to expect.

What Solution is the SEC Considering?

Although the concept release discusses various approaches, it highlights one in particular — a limited regulatory framework that would focus on the point of entry into the United States.

In today's world, any number of sources, including a broker, an Internet service provider, or the foreign market itself, may provide U.S. investors with linkages to a foreign market. Supervising the entity that provides a U.S. investor with access to a foreign market could give U.S. investors essential protections, regardless of who provides this access.

For example, the release asks for comments on whether the SEC should require these entities to comply with certain recordkeeping, reporting, and disclosure requirements.

Your Views

Because this is a concept release, the SEC has not decided on the best ways to proceed. The SEC is interested in your views. If you would like a copy of the complete, 230-page SEC concept release that describes these proposed changes, you can download it from our World Wide Web site or

write to: Office of Investor Education and Assistance
450 Fifth Street, N.W.
Washington, D.C. 20549
Attention: Aldis Lapins

Ask for Release No. 34-38672

Please address your comments to: Jonathan Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549,

and mark your response with the following file number:

S7-16-97 Comments may be submitted via electronic mail as well. Send electronic mail-format letters of comment to the mailbox For the "subject" of your electronic mail message, use the "S7" file number given above. Note this e-mail address has been created to provide the public with the opportunity to comment on proposed Commission rules. It is not designed to be a general question and answer service.

All reponses are due by October 3, 1997.

Modified: 09/04/1997