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June 21, 2000
Time ripe for market-based stock exchange regulation, study says
Securities and Exchange Commission Chairman Arthur Levitt recently called for stepped-up action to join all securities exchanges, such as the NYSE and NASDAQ, in a "National Market System." But a new Cato study finds that if all exchanges were required to be part of an umbrella linking system, "that system could easily become an anti-competitive combination of otherwise independent competitors."
All exchanges should not be forced to combine into one national exchange, with a giant regulatory body to match, Dale A. Oesterle, author of the study and professor at the University of Colorado School of Law, says. Indeed, the proliferation of electronic trading systems and the recent proposal by the NYSE to become a publicly traded company point toward less regulation.
The present regulatory regime imposed on securities markets by the government is unique. The Securities and Exchange Act requires exchanges to operate self-regulatory organizations (SROs) that police themselves under the supervision of the SEC. That leads member-controlled exchanges to use SROs to create cartels and stifle competition, Oesterle says. Rather than eliminate SROs and the perverse effects that accompany them, the SEC opts for more regulation. "It is the SEC, not the exchanges, that creates the conditions that allow cartels and monopolies in trading markets to arise and flourish," he says.
By contrast, new electronic communications networks (ECNs), such as Instinet and Island, match buyers and sellers of securities automatically and have no traditional exchange membership to discipline. They therefore do not succumb to cartel problems. Nevertheless, the SEC insists that ECNs declare themselves either exchanges that are required to operate an SRO or broker-dealers that are policed by the SRO of the National Association of Securities Dealers Inc.
"The drastic reduction in manpower at the point of trade in an ECN," writes Oesterle, "suggests that there need be only laws that require an ECN to operate free from fraud."
The study concludes that a more market-based system of regulation is optimal. The role of the SEC should be limited to enforcing disclosure, prosecuting fraud and ensuring that markets are open and competitive, Oesterle says. As competition from ECNs pressures exchanges such as the NASDAQ and the NYSE to become for-profit publicly traded companies, shareholder control will make SROs obsolete.
"Securities Markets Regulation: Time to Move to a Market-Based Approach"
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