1. Self Regulation: The US Experience Ethiopis Tafara US Securities & Exchange Commission

2. History of Self-Regulation Securities Exchange Act of 1934 SEC created in aftermath of 1929 stock market crash NYSE largest of about 30 exchanges in 1934 Over 80% of US securities trading in dollar volume Congress let stock exchanges continue to regulate own activity SEC to watch over exchanges

3. NASD: Expanded Self-Regulation 1938: Congress created the concept of national securities association Regulated the market for “over the counter” stocks not traded on any exchange National Securities Dealers Association (NASD) is the only major registered securities association today All broker-dealers conducting business with the public are members of the NASD Partially owns and operates NASDAQ stock market When broker-dealers are members of both NASD and other exchange(s), one SRO is designated examining authority

4. Registered US Exchanges Currently 9 registered US exchanges New York Stock Exchange (NYSE) American Stock Exchange Philadelphia Stock Exchange Boston Stock Exchange Chicago Stock Exchange Chicago Board Options Exchange Cincinnati Stock Exchange International Securities Exchange Pacific Stock Exchange

5. Standards for Self-Regulation Exchange Act requires SROs to meet a number of standards, including: Ability to comply with securities laws and enforce its members´ compliance SRO rules must give all members fair representation in selection of its directors and administration of its affairs Must have rules designed to prevent fraud and promote “just and equitable principles of trade” Must have fair procedure for bringing disciplinary actions against its members and associated persons Rules must not impose unnecessary burden on competition

6. SEC´s Role SEC covers every aspect of self-regulation: SRO must file proposed rule changes with SEC Rules do not take effect until SEC approval SEC examines SROs Members can appeal SRO disciplinary actions to SEC SEC can directly enforce SRO rules if SRO unable or unwilling to do so SEC can bring enforcement action against SROs Rare, but threat of such action gives SEC leverage SEC has brought significant enforcement action against both the NASD and NYSE within past 5 years

7. Advantages of Self-Regulation Technical Expertise Market professionals may better understand technical aspects of exchange regulation Flexibility SRO may have greater ability to adapt to new developments Greater Acceptance of Rules SRO members elect their directors and participate in rulemaking; may cause greater willingness to comply with rules Cost Savings to Federal Government More than 5,000 registered broker-dealers of varying complexity Nearly 600,000 registered securities professionals

8. Disadvantages of Self-Regulation Conflicts of Interest Securities exchanges are both business ventures and regulatory bodies; may not enforce rules if detrimental to business Antitrust Implications Members of an SRO are collectively regulating their own behavior; danger of collusive behavior that hurts customers Due Process Concerns Members regulated by individuals exercising a form of governmental power, yet may not have all procedural rights that would apply if the government were the disciplinary body

9. SEC Concept Release Recent SEC concept release (34-50700) addresses concerns regarding role and operation of SROs, including: 1. Conflicts of interest between SROs´ regulatory obligations and interests of members, market operations, listed issuers, and, in the case of a demutualized SRO, shareholders 2. Costs and inefficiencies of the multiple SRO model 3. Challenges of surveillance across markets 4. Manner in which SROs generate revenue and how SROs fund regulatory operations

10. Conflicts of Interest With Members Trend: Declining number of member firms increasingly important to their regulator SROs´ business interests Creates inappropriate business pressure on regulatory staff With Market Operations Trend: Increasing competition among markets creating pressure to attract order flow Creates pressure for permissive market activity or over- regulation of competitors

11. Conflicts of Interest, cont´d. With Issuers Trend: SROs simultaneously responsible for monitoring issuers and delisting securities while competing to attract and retain listings With Shareholders Trend: SRO demutualization creates additional conflict regarding profit motive of a shareholder- owned SRO May commit insufficient funds to regulatory operations or use disciplinary function as revenue generator with respect to member firms that operate competing trading systems

12. Costs and Inefficiencies Existence of multiple SROs can result in duplicative and conflicting rules, rule interpretations, and inspection regimes The system can also result in redundant SRO regulatory staff and infrastructure across SROs May be aggravated by trend toward greater market fragmentation of order flow among SROs

13. Intermarket Surveillance & Funding Intermarket Surveillance Trading in multiple active markets facilitates veiling illegal activity by dispersing trades across markets Funding Self-funding structure leverages limited SEC resources SEC supervision of SRO regulatory funding adequacy is challenging, given temptation for SROs to fund business operations at regulation´s expense Hard to know whether an SRO is insufficiently funding its regulatory function or simply administering an efficient regulatory program

14. Alternative Approaches Enhance current SRO system Strengthen governance, enhance disclosure and reporting requirements Enhance SEC´s and SROs’ ability to regulate intermarket trading activity Mandated SRO internal restructuring Increase SRO regulatory independence, e.g., by requiring all SROs create independent subsidiaries for regulatory and market operations

15. Alternative Approaches, cont´d. Hybrid model Designation of a market neutral single SRO (“Single Member SRO”) to regulate all SRO members with respect to membership rules Each SRO that operates a market (“Market SRO”) would be solely responsible for its own market operations and market regulation Competing hybrid model Multiple competing member SROs (“Competing Member SROs”), required to register with the SEC and authorized to provide member regulatory services

16. Alternative Approaches, cont´d. Universal industry self-regulator One industry SRO responsible for all market and member rules for all members and all markets Universal non-industry regulator One non-industry entity designated as responsible for all markets and member regulation for all members and all markets SEC regulation Termination of the SRO system in favor of direct SEC regulation