"When self regulation is in fact SHARED regulation—when industry practitioners work in concert with regulators and self regulators—it promotes a culture of integrity that pervades the entire securities industry. In such an environment, investor confidence flourishes."
In the mid-1990s, despite years of technological innovation in the industry, Nasdaq still carefully controlled information and trading, and the New York Stock Exchange still made sure that most transactions took place on the exchange floor.
By opening up information and breaking down barriers, the SEC's 1997 order handling rules changed all of that, allowing for-profit electronic communications networks (ECNs) like Brut, Island, and Archipelago to begin matching buyers and sellers in OTC stocks. After the SEC gave the ECNs formal sanction with its Regulation Automated Trading System (Reg ATS) in 1998, the old exchanges scrambled to catch up.
The New York Stock Exchange, under pressure from big brokerages, introduced—on a pilot basis only—NYSE Direct+ in 2000. Nasdaq, having lost a third of its trades to ECNs, rolled out SuperMontage, a much more ambitious integrated system, in 2001. Reg ATS had provided clarity for the ECNs but made things murky for the older institutions. Could the membership organizations become for-profits as well? The SEC seemed to suggest in Reg ATS, as long as their self-regulatory obligations were upheld, they could.99
Membership organizations once seemed well suited to operating exchanges, a fact confirmed when the 1934 Exchange Act enveloped them within a newly-constructed scheme of federal securities regulation. This was a practical decision, but the framers of the 1934 Act had reasons beyond expediency. They believed that member organizations were potentially better able to discipline market participants for unethical as well as illegal conduct.
But member organizations also moved slowly and could not mobilize the capital necessary to make big acquisitions or investments. There was an alternative: turn the member organization into a shareholder-owned entity. The "demutualization" of member-owned exchanges was soon well under way.100
(99.) Joel Seligman, "Cautious Evolution of Perennial Irresolution: Self-Regulation and Market Structure During the First 70 years of the Securities and Exchange Commission," http://www.fuqua.duke.edu/conference/dei/nyse/docs/Cautious_Evolution_Or_Perennial_Irresolution.pdf, 43; December 8, 1998 SEC Release: Regulation of Exchanges and Alternative Trading Systems
(100.) Andreas M. Fleckner, "Stock Exchanges at the Crossroads," Fordham Law Review 74 (2006).
