SEC Chairman Endorses Single SRO

Brokerage firms have lobbied for a new self-regulatory organization (SRO) model for years, saying the current system of two cops on the beat is redundant and, therefore, too time consuming and expensive. Now that SEC Chairman Christopher Cox has made creating a single SRO for the brokerage industry a top priority, why are some suddenly wondering if it's a good thing after all? Under the plan, NYSE

Brokerage firms have lobbied for a new self-regulatory organization (SRO) model for years, saying the current system of two cops on the beat is redundant and, therefore, too time consuming and expensive. Now that SEC Chairman Christopher Cox has made creating a single SRO for the brokerage industry a top priority, why are some suddenly wondering if it's a good thing after all?

Under the plan, NYSE Regulation and NASD Regulation would merge — perhaps before the end of December. Few dispute that it's time for a change. “Unless we act now to remove unnecessary duplication and conflicts of interest in our regulatory structure, we will actually impair the ability of America's capital markets to remain the world's strongest,” Cox told attendees at the Securities Industry and Financial Markets Association (SIFMA) launch in Boca Raton, Fla., last month.

Cox also said investors are currently bearing the brunt of “needless costs and inefficiency of multiple SROs that result from multiple rulebooks, duplicative inspection regimes and redundant staff.” In a study published earlier this year, SIFMA cited duplication as a contributing factor in the near doubling of compliance costs, from $13.1 billion in 2002 to $25.5 billion in 2005. If the SROs are combined — one group of regulators, one set of rules — firms would be able to better allocate their resources.

NYSE Chief Executive John Thain said during a speech to SIFMA attendees that a deal could happen “before the end of the year.”

Not So Fast

But not everybody is excited about a possible merger, especially small broker/dealers. There are 5,100 b/d members of the NASD, and only 180 of them are also members of the NYSE. But under the proposed merger, the rulebooks would be rewritten (or harmonized, as the NASD puts it), and everybody would have to follow the new book, small b/d executives say, essentially changing up the rules for the benefit of 180 firms. Small b/ds say they would be disenfranchised under such a merger.

As evidence that something really is fishy, small b/ds ask, “What's the hurry?” Usually, regulators put rule changes out for public comment for months. Why the rush to overhaul the SRO system in weeks? “Cox would be lucky to get this proposal out by the end of the year,” says Mark Perlow, a securities attorney at Kirkpatrick & Lockhart in San Francisco. A better timetable, he says, is some time in 2008.

One reason for the frenzied pace is that the combined NYSE and NASD regulatory units would no longer be affiliated as closely with the individual stock markets, which are now both publicly traded. Of course, the combined NYSE/NASD regulatory body would still be an SRO, with monetary support being paid by the member firms. “The system needed fixing,” says former SEC Chairman Arthur Levitt. “There was redundancy in cost that needed to be squeezed out. Would I prefer to see a totally independent entity of some sort? Probably. But this is better than what it was. This is a step in the right direction.”

Some lawmakers in Washington view the current SRO model as a threat to investor protection. And, despite NYSE spinning off a separate regulatory arm in March 2006, members of Congress say there are still too many conflicts. “While there have been changes in the exchange's governance structure, questions remain as to whether robust and vigorous self-regulation will be subordinated to profit-making activities,” said Senator Richard Shelby (R-Ala.), chairman of the Senate Banking Committee, at a hearing last March.

No Representation

Small NASD member firms are concerned that the deal will strip them of representation, tipping the scale in favor of the largest firms. “This is a smoke screen,” says John Busacca, president of North American Clearing, a small independent firm in Longwood, Fla., and a founding member of The Financial Industry Association, a group representing small, independent b/ds that seeks sweeping industry reforms. “They're going to try and do away with the by-laws that allow for one firm, one vote.”

The one-firm, one-vote rule affords member firms the opportunity to elect the candidates of their choice to the NASD's 17-member board of directors. And that's something that the FIA has been exercising in the recent NASD district elections, where FIA-backed candidates have won 19 out of a possible 37 seats as of press time. The NASD dubbed those FIA-backed candidates “dissident.” That gives you some idea about the diverging interests among small and big firms. Busacca says that NASD has made no attempt to ask its members for comment on the NASD/NYSE Regulation merger and has not pledged that it will retain the one-firm, one-vote policy granted under the securities laws.

For her part, NASD Chairman and CEO Mary Schapiro has promised that the new SRO will accommodate all members. “This new entity will be committed to being more efficient and effective for all 5,100 firms in the securities industry, not just those that are dually regulated,” she said during a speech last month at the NASD Fall securities conference in Los Angeles. “You have a commitment from me that firms of all sizes will be represented on the Board of Governors.”

Despite Schapiro's assurance of equal representation, it seems that would only mean more seats on the board and not a guarantee of one firm, one vote. For the smaller firms, the prospect of dealing with unequal representation is more threatening than coping with overlapping regulation. If their concerns are not addressed, Busacca says, he'd be willing to take it up with Congress.

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