Although the reshaping of self-regulation was largely being done pragmatically in response to specific circumstances and events, both the SEC and the SROs had nevertheless given it a great deal of thought. The collapse of the "dot-com bubble" in 2000, the corporate and accounting scandals leading to the Sarbanes-Oxley Act in 2002, and the specialist scandals at the NYSE in 2003 all informed their considerations. But the most influential factor was the fragmentation of the market created by increasing competition.
In the early 2000s there were nine national securities exchanges and the NASD. There were also a growing number of ECNs. Since few market participants limited themselves to a single exchange or ECN, duplicate exams, inconsistent rules, conflicting interpretations and disparate penalties abounded. Neither industry nor government regulators were able to assemble a unified picture of national market activity. Dishonest participants could easily disguise illegal trades by dispersing them across the fragmented market.110
These concerns spurred much self reflection. In 2000 the Securities Industry Association studied the fragmentation problem in a white paper. In 2002 the General Accounting Office issued its own study and directed the SEC to work with the industry to resolve rule inconsistencies. In March 2005, the SEC weighed in with a Concept Release on SROs, evaluating a variety of good governance and transparency rules, most of them drawn from the NASD experience.
But the bulk of the Concept Release was given over to an evaluation of the structural alternatives to the old exchange SRO model. Chief among these were: 1) an SRO with independent regulatory and market subsidiaries; 2) a hybrid "single member" SRO that served a number of unaffiliated exchanges; and 3) competing hybrids. Less likely alternatives considered were an "Universal Industry Self Regulator" that would register the exchanges instead of the SEC; a "Universal Non-Industry Self Regulator," a quasi-government agency similar to the Public Company Accounting Oversight Board created by the Sarbanes-Oxley Act; and the replacement of SROs altogether with expanded SEC regulation.111
The SRO Concept Release distilled a long and complex debate about structure but did little else. When it came to market mechanisms, however, the SEC led more firmly. "Trade-through" rules, put in place when electronic trading was new, required all orders to be routed to exchange floors long enough to give floor traders a chance to meet the market. By the 2000s, however, it was clear that this provision also enabled traders to ignore quotations during a market downturn, thus depriving customers of the best price.
In 2005 the SEC adopted the Regulation National Market System (Reg NMS), which required all exchanges to implement systems capable of unmediated electronic trading and barred trade-through. Reg NMS, which went into effect in 2006, promised to cut consumer costs and increase market fragmentation. Together, the SRO Concept Release and Reg NMS effectively forced the issue. The SEC ensured that the financial markets of the future would be fast and competitive, and then left it to the industry to choose, among clearly defined options, the best way to regulate them.112
(110.) Securities Industry Association, Reinventing Self-Regulation: White Paper for the SIA's Ad Hoc Committee on Regulatory Implications of Demutualization, January 5, 2000, updated October 14, 2003, http://www.sifma.org/regulatory/reinventingselfreg.html, 2-6.
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