U.S. securities group seeks end of self regulation in exchanges
NEW YORK, Aug 1 (Reuters) - The largest U.S. securities trade group asked regulators on Thursday to end the self-regulatory status of stock exchanges, saying the structure creates conflicts of interest and should be replaced by some form of outside supervision.
U.S. exchange operators have already outsourced most of their equity market regulatory duties to the Financial Industry Regulatory Authority (FINRA).
This kind of arrangement could be formalized to end self regulation by stock exchanges which gives them an unfair advantage over other trading platforms, the Securities Industry and Financial Markets Association (SIFMA) said in a letter to the U.S. Securities and Exchange Commission (SEC).
Securities exchanges and non-exchange trading venues operated by broker-dealers perform largely identical functions in many respects.
As for-profit businesses, exchanges compete with broker-dealers for the same order flow, with around 40 percent of equities trades taking place on non-exchange venues.
In their regulatory function, exchanges are responsible for setting rules that govern their members' activities, and for enforcing those rules, as well as compliance with the federal securities laws, and discipline their members for violations of those rules and laws.
"A result of this structure is that one group of businesses is empowered to oversee and regulate the business and activities of its competitors. Conflicts of interest in this model abound and only worsen as they are left unresolved," SIFMA said in the letter.
Exchanges began as member-owned trading platforms, but have transformed over the years into for-profit businesses. At the same time, regulatory changes put in place by the SEC, along with advances in technology and the automation of the markets, have blurred the distinctions between exchanges and trading platforms owned by broker-dealers, SIFMA said.
As self-regulatory organizations (SROs), exchanges are immune from private liability for damages they cause, while broker-dealers performing similar services are subject to private liability, SIFMA said. The line between where regulatory functions at exchanges end and commercial activities begin has never been clearly drawn, it added.
Regulatory immunity at exchanges came under scrutiny last year, when market making firms said they lost up to a combined $500 million as a result of technical errors by Nasdaq OMX Group's main exchange during Facebook's market debut.
The exchange was fined $10 million by the SEC, and made voluntary payments totaling $62 million to trading firms. Some market participants said the exchange should have been fully liable.
In its letter, SIFMA called the current self-regulatory structure "outdated and in great need of rethought and reform."
Exchange operators NYSE Euronext, Nasdaq, and Direct Edge, currently outsource many of their regulatory duties to the Financial Industry Regulatory Authority. FINRA will have oversight of more than 90 percent of U.S. equity markets by this fall. BATS Global Markets does its own surveillance and then makes referrals to the Chicago Board Options Exchange for further investigation.
Since exchanges have largely separated the regulatory function from their market function, the distinction between the activities performed by an exchange compared to an alternative trading system lacks functional difference, SIFMA said.
"This conflict can be resolved by simply eliminating the obligation for exchanges to act as SROs. It is easy to envision what an exchange would look like without its SRO status, because it is how most exchanges look today in all practical effect," SIFMA said.
(Reporting by John McCrank; editing by Andrew Hay)