The Institution of Experience: Self-Regulatory Organizations in the Securities Industry, 1792-2010

Dr. Kenneth Durr and Robert Colby, History Associates, Inc., Curator
Opened December 1, 2010

"In framing a regulatory measure, the practical problem of administration has always to be faced and when regulation gets beyond a certain point the sheer ineffectiveness of attempting to exercise it directly through government on a wide scale counter-balances the fact that possibly the exchanges might not be as diligent as we would wish them to be about regulating themselves."

- Assistant Secretary of Commerce John Dickinson, 1963 SEC Special Study of the Securities Markets, 501

Introduction

The self-regulatory organization (SRO) in the American securities industry is the product of more than two centuries of historical development. It is also the result of a compromise.

SROs grew first as member-owned stock exchanges and out of necessity developed private mechanisms of direction and control. Then, in 1934, for the "practical" reasons cited by Assistant Secretary of Commerce John Dickinson, landmark legislation entered these private entities into partnership with federal regulators. The SROs became responsible for policing their members and enforcing compliance, not only with their own rules, but also with the requirements imposed by an entirely new scheme of federal securities regulation.

The federal government, through the U.S. Securities and Exchange Commission (SEC), kept watch over the SROs and wielded a "big stick" on occasion. This public/private partnership has endured, developing over time in response to the changing priorities of industry and government.

In looking at three different SROs—the New York Stock Exchange; the National Association of Securities Dealers, along with the Nasdaq, its market mechanism, and the Financial Industry Regulatory Authority, its successor organization; and the Chicago Board Options Exchange—we can document their development within the broader context of shifting markets, varying membership, and economic and political change.

As a general concept, the idea of self-regulation is straightforward. As Webster"s primarily defines it, it is "regulation of or by oneself." During the early 20th century, a new meaning (and Webster's secondary definition) emerged: "control or supervision from within," particularly of a business entity. It is no accident that this definition of self-regulation appeared during the Progressive Era (1890s to 1920s). Reformers were intent on reining in newly-emerging big businesses and institutions, for self-regulation provided a less threatening alternative to direct outside control.

The securities industry followed the trend of the time. In 1930 the president of the embattled New York Stock Exchange (NYSE) called his institution "a triumphant example of the possibilities of self-regulation in modern business." To be sure, the NYSE had devised its own private regime of control and supervision in the preceding century. But, by the 1930s, events ensured that self-regulation in the securities industry would become increasingly regimented. Federal regulators would be ever more insistent on setting the rules for SROs. Indeed, by the beginning of the 21st century it was unclear to what extent the SROs really were "self" regulators and even less apparent how this idiosyncratic system had come about. This is the story.

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Photos

1979
(Courtesy of Chicago Board Options Exchange )

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