In their remarks before the 2014 SRO Outreach Conference, SEC Chair Mary Jo White and Commissioner Daniel M. Gallagher spoke about reevaluating the role and function of SROs.
Chair White highlighted the key concerns for SROs and equity markets, including the risk of instability and disruption. She explained that there should be “zero tolerance for systems issues that undermine the reliability of our markets and erode investor confidence.” Chair White recommended that SROs develop a collaborative approach across landscapes to help reduce the number of disruptions. She also briefly touched on the importance of the SRO rule-filing process and participation in the National Examination Program.
Commissioner Gallagher advocated reexamining the status and structure of SROs, explaining that they are “fundamentally different from what Congress conceived of as self-regulation decades ago,” and that the circumstances under which they were put in place no longer exist.
The fact that the majority of equities exchanges outsource their SRO obligations and market surveillance to FINRA, Commissioner Gallagher said, calls into question the meaning of the SRO concept. He explained that, while there are benefits that arise from the consolidation of oversight into a single entity, regulators must still question whether this is the optimal solution, especially where the possibility of subjecting investment advisers to self-regulation is being considered. He recommended that regulators compare and contrast the two industries to better examine the strengths and weaknesses of self-regulation.
Lofchie Comment: As to technology failures and self-regulatory organizations, the stated policy objective of “zero tolerance” should be reexamined. In complex systems, things go wrong. A regulatory system that accepts the existence of imperfection is better able to develop mechanisms to catch smaller errors and to share information about how to make improvements. A regulatory system that punishes every mistake results either in the concealment of errors or in driving anyone that makes a mistake out of business, leaving an industry with so few players that it is too dangerous to drive out the rest.
Now that virtually all of the exchange SROs have delegated the relevant regulatory tasks to FINRA, it is awfully hard to see why the system should be maintained in its current form. Let’s just acknowledge that, outside of certain self-surveillance obligations, the exchanges are not, and should not be, regulatory organizations.