Archives: SROs

One SEC commissioner is pushing for a comprehensive review of the structure and regulatory regime of United States financial markets, including SROs.

The SEC is serious about looking comprehensively at market structure issues, and must be willing to review its existing rules to see their impact on market structure.  One item is the regulatory framework concerning the status of SROs, given the proliferation of dark pools and alternative trading venues.

In short, the SEC will examine market structure to see if changes are necessary.

The United States Securities and Exchange Commission Division of Trading and Markets granted class no-action relief from securities-exchange and broker-dealer registration requirements for foreign options markets and their members that engage in certain “familiarization activities.”  See LIFFE A&M, SEC No-Action Letter, avail. 7/1/13, http://www.sec.gov/divisions/marketreg/mr-noaction/2013/liffe-am-070113.pdf.

The Staff noted it has granted similar relief on “numerous occasions” to other non-U.S. exchanges.  The position in those letters is well-settled, and itbelieves that extending class relief—rather than continuing to issue individual no-action responses—is appropriate.  Specifically, the Staff would not recommend enforcement action against certain exchanges and affiliated individuals, who do not register as a national securities exchange or as a broker-dealer, if they engage in activities intended to familiarize certain registered broker-dealers and large U.S. financial institutions with certain equity and index options traded.  Granting the relief requested on a class basis, the Staff said the class no-action response differs from past no-action letters in one material respect in that it does not require the preparation and distribution of an options disclosure document providing an overview of the foreign market and products.  However, the class relief will require that the foreign options market maintain, in English, and on its website, at a minimum, current information concerning its trading rules, clearance and settlement procedures, hours of operation, and holidays, and ability to respond to requests.

In short, this relief was expected, and intended to streamline the process.

New competitive challenges and continued conflicts of interest require a better relationship between securities SROs and the SEC.  Over the past several years, SROs have faced increased competition in the markets where they operate.

SROs face competitive challenges from electronic communications networks and foreign trading markets that have slowly chipped away at the SROs’ market share.  The current period has seen advances in fully automated technology, and there continues to be inherent conflicts of interest between the SROs’ regulatory function and their business operations.  To stay in business, SRO’s have to attract order flow, and this may lead to SROs being less inclined to enforce rules vigorously against financially supportive members, issuers, and shareholders. The SEC has taken enforcement action against SROs that fail to meet their legal and regulatory obligations.

Accordingly, the SEC expects to continue its strong oversight of SROs.

This past week, the House Financial Services Committee conducted hearings regarding the oversight of registered investment advisers, as well as the SEC’s recommendation of a uniform fiduciary duty standard for investment advisers and broker-dealers.  The SEC, however, did not receive many accolades at the hearings.  Instead, the SEC received significant criticism for its failure to uncover the Madoff and Sandford Ponzi schemes, despite a budget that has increased significantly in the past few years.

In some of the more compelling testimony, SEC Chairman Schapiro acknowledged that the SEC can only examine 9% of the nearly 12,000 registered advisers on a yearly basis.  Schapiro conceded that such scant oversight is unacceptable considering the fact that investment advisers manage nearly $43 trillion in assets.  This failure has resulted in the outcry for greater oversight so that the world can avoid another Madoff.

This call has resulted in the debate over who will oversee investment advisers going forward.  The SEC has asked for more funding to conduct this task.  This request has been met with, at best, tepid support.  If the SEC could not detect Madoff and Sandford despite its billion plus annual budget, the critics suggest pouring more money on a failed venture is not the way to go.

Others have called for the formation of a new self-regulatory organization separate and apart from the SEC.  Issues with the creation of such an entity focus on funding and structure, among others.  The Financial Industry Regulatory Authority (“FINRA”) has called for Congress to vest it with oversight similar to the oversight it has for broker-dealers.  Opponents of such a proposition point out that investment advisers are subject to a fiduciary duty standard of care, where broker-dealers are only subject to a suitability standard.  As such, the critics claims that FINRA lacks the institutional capital to handle this oversight.  Moreover, the critics claim that giving FINRA this authority will drag it away from its mission of broker-dealer oversight.

 The question remains, will anything come about from these hearings or will there be more debate with nothing to show for it.  Although I foresee additional meandering debate, I believe that investment advisers will have a new regulator, at least in principle, by the end of the year.  From what I have seen of these debates, the logical approach will be a middle ground; FINRA will be asked to create a separate division for investment adviser oversight.  This way, FINRA can have one arm completely focused on broker-dealers and, at the same time, have another arm completely focused on investment advisers.  Both arms will report to the SEC.  Although structure and funding would have to be resolved, this middle approach seems the most likely to be sold to Congress.  Whatever the ultimate approach, it is beyond dispute that investment advisers will be subject to oversight unlike that they have experienced in the past and they better be prepared for it.