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Ribstein [Illinois]: The SEC and the SROs
Ribstein [Illinois]: The SEC and the SROs

Larry Ribstein, University of Illinois College of Law:

"The SEC announced yesterday rulemaking initiatives aimed at so-called "self-regulatory organizations" such as stock exchanges. These include specific proposals to change the rules on ownership, governance, reporting and transparency by these organizations. The governance proposal would, consistent with many other SEC moves, require more independent directors. The ownership proposal would limit ownership of exchanges by broker-dealer members.

The most interesting part of the release was a so-called "concept release" that calls for comments on pursuing an "alternative" to the SRO regulatory model.

The SEC apparently fails to see the irony in its release: in proposing detailed and sweeping changes in how exchanges are run, it demonstrates how little "self" there is in "self-regulation."

True self-regulation would involve permitting firms to opt out of federal regulation. They could, in effect, bond their behavior through a variety of competing certification regimes, including listing on true self-regulating securities exchanges. See, e.g., Paul Mahoney, The Exchange as Regulator, 83 Virginia Law Review 1453 (1997).

Would this be a "race to the bottom"? Not necessarily. Firms could reduce their cost of capital by accepting enough regulation to comfort investors, while having an opportunity to avoid excessive regulation. Exchanges would have an incentive to compete for regulatory business because more listings means more listing fees for their owners. Also, more investor trust means more market liquidity, which helps the exchanges' broker-dealer members (whose ownership the SEC is considering capping).

True, this regime poses some risks of conflicts. Perhaps these risks are increased by broker-dealer membership, and by combining regulatory and trading arms under a single umbrella. But if these risks are apparent to the SEC, they are also apparent to sophisticated securities markets, and therefore can be expected to show up in the prices of firms that trade on the exchanges. These firms, in turn, have every incentive to reduce their cost of capital.

But this is obviously not the direction in which the SEC is moving. We shouldn't be surprised — this is just a continuation of the federalization of corporate governance that was accelerated with Sarbanes-Oxley (some of my thoughts on that Act are here).

There is something to be said for the honesty of getting rid of the sham of "self-regulation" and owning up to the fact that we're really talking about SEC regulation. Particularly since the SEC uses this sham to expand its role beyond regulation of disclosure to regulation of the internal governance of firms under "SRO" listing rules.

It's too much to hope that this system is going to change drastically (see my exchange with Professor Bainbridge on this). In the meantime, we can hope that reason will prevail before this "concept" becomes law." [November 10, 2004; Ideoblog has more]

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