WealthManagement Magazine

SROs to SEC: "We Like Our Cartel"

The NASD and the NYSE have warned the SEC about the dangers of allowing upstart SROs to regulate alternative trading systems.In comment letters to the agency's wide-ranging concept release on exchange regulation, both SROs recommend against the SEC's idea of allowing private trading systems to use potential new, specialized surveillance entities to oversee their activity.In the May release, the SEC

The NASD and the NYSE have warned the SEC about the dangers of allowing upstart SROs to regulate alternative trading systems.

In comment letters to the agency's wide-ranging concept release on exchange regulation, both SROs recommend against the SEC's idea of allowing private trading systems to use potential new, specialized surveillance entities to oversee their activity.

In the May release, the SEC asked for comment about the feasibility of regulating alternative trading systems under existing broker/dealer regulation, or alternatively, under a new scheme whereby all systems would be classified as exchanges and regulated by a tiered system of oversight, depending on their level of activity and purpose.

Newly classified "exchanges" could then be regulated by an "SRO not under the control of an entity that also operates a competing market," the SEC release states. Such a new SRO could be established by a group of member firms "solely" for the purpose of regulating a new trading system, the SEC theorized.

The SEC noted that existing alternative trading systems "have repeatedly questioned whether particular SRO actions were driven by competitive, rather than regulatory motives."

But the NASD and the NYSE blasted the idea of competing SROs.

Such a system "may fragment the existing cohesive regulation of the equity markets and dramatically increase the costs to the market," the NASD, Nasdaq and the NASDR said in a joint letter dated Oct. 10. "The NASD has developed an effective and unified surveillance program" where all Nasdaq trades are "subjected to a sophisticated computer-based analysis to identify violations [and are being] further enhanced by the development of OATS." OATS is the NASD's pending electronic order-audit trail system.

The NASD's letter noted that the NASDR has spent "considerable efforts" in developing OATs, and that the system could be "seriously compromised" by a tiered exchange approach if all orders were not captured in the OATs system.

If private, for-profit surveillance firms were allowed to compete with the principal SROs, the result would be "a regulatory race to the bottom, gaps in regulatory coverage, and increased costs" from reduced economies of scale, the letter stated. In addition, allowing new, less-regulated exchanges would "subject regulated markets to an unfair competitive disadvantage."

Meanwhile, the NYSE claimed, "Years of experience with intermarket surveillance and oversight of common members demonstrates that surveillance is best conducted by a limited number of SROs with well-trained staffs." Regulating alternative trading systems as exchanges "would result in multiple new SROs, each with a stand-alone surveillance system. ... We do not believe it is realistic to expect small, single-purpose SROs to conduct surveillance at a level comparable to currently registered SROs." The SEC "should not underestimate the problems that will arise with multiple [trading system] SROs," the NYSE warned, reminding the agency of problems at "some of the smaller [existing] SROs. ... "

Conflicts of interest between SRO-run exchanges and competing systems are "more theoretical than real," the Big Board added. "SROs generally separate their regulatory functions from their trading operations." The NASD also claimed, "The clear organizational separation of market operation and regulation within an SRO, as recently implemented by the NASD ... is well-designed to address the conflict of interest concerns."

When asked which parts of the comment letter were penned by Nasdaq, the NASDR or the NASD parent, NASDR spokesperson Michael Robinson would say only that "The NASD is one company."

The NYSE would not comment on whether its regulatory or market side prepared its comment letter.

(The SEC's concept release and some comments can be viewed at www.sec.gov. Click on "Current SEC Rulemaking," then "SEC Concept and Interpretive Releases.")

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