Demythologizing the Stock Exchange: Reconciling Self-Regulation and the National Market System

Abstract

The Securities Exchange Act of 1934 (the "Exchange Act") advances two principles for the regulation of securities trading. The principle of self-regulation requires stock exchanges and other self-regulatory organizations to use their dominant market power to regulate marketplace activity, issuers of publicly traded securities, and broker-dealers who intermediate securities transactions. The national market system mandate requires the Commission to promote competition in securities trading and listing by eliminating barriers to competition and improving the transparency and accessibility of primary stock exchanges.

I argue that the Exchange Act's imposition of self-regulatory duties on exchanges and its simultaneous mandate to erode their monopoly power are inherently contradictory, and that this contradiction is partly responsible for the significant difficulties the Commission has encountered in advancing its market structure agenda. For example, even as competitors to exchanges unrelentingly demand the elimination of regulatory privileges enjoyed by exchanges, corporate governance and exchange floor scandals renew concerns about the adequacy of exchanges' efforts to discharge their self-regulatory responsibilities.

I propose a different framework for regulating securities markets, which fosters competition while preserving the unique benefits of self-regulation. Though dismissed by some as a "myth," self-regulation has endured because it allows the Commission to maintain a special relationship with markets that have the power to dictate norms for public companies, broker-dealers, and other market participants. I believe these benefits may be preserved by reallocating some self-regulatory authority from individual exchanges to a more representative group of market participants - effectively "demythologizing" the stock exchanges.