Securities and Exchange Commission Historical Society

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

A Quiet Revolution

The Big Picture

"One of the challenges we face...is the reality that the technologies used for market oversight and surveillance have not kept pace with the technology and trading patterns of the rapidly evolving and expanding securities markets."

- May 20, 2010 Examining the Causes and Lessons of the May 6th Market Plunge — Statement of SEC Chairman Mary Schapiro before the Subcommittee on Securities, Insurance and Investments of the U.S. Senate Committee on Banking, Housing and Urban Affairs

The creation in FINRA of a super regulator was part of a broader attempt to understand, and therefore effectively regulate, the whole of the ever more fragmented securities market.

In 2005 the NYSE had handled 79.1 percent of its own listed shares. Just four years later, that percentage had plunged to 25.1 percent. By 2010, "high frequency traders" accounted for an estimated 50 percent of the market. These developments heightened existing concerns about market surveillance.

Although the creation of FINRA had ended duplicative member firm regulation, most exchanges—NYSE included—were still singly focused on their own trading floors, where dishonest traders could work the margins of several. In the new environment, it began to appear that whatever benefits exchange self regulators possessed in proximity to their trading floors were offset by their inability to see the big picture. This became something less of a problem when, in 2008, FINRA contracted with ten securities and options exchanges in the United States to take over market surveillance.118

Then came financial crisis. Equities markets nose-dived, big institutions folded or merged, and questions of investor protection became paramount.   In the wake of the market collapse, FINRA worked with other regulators and the SEC to examine firms and investigate malfeasance. In December 2008, FINRA, along with the public, shifted its attention from the market to member regulation when Bernard Madoff was charged with operating the largest Ponzi scheme in history.119

In the aftermath of the Madoff scandal, FINRA, with SEC encouragement, took several decisive steps. In March 2009 it created the Office of the Whistleblower to encourage reluctant informants to come forward. That fall, FINRA implemented a number of internal practice reforms, including centralized receipt of information, more attention to change at brokerage firms, and more attention to third-party information on firms. Contending that Madoff's chicanery was concealed in his investment advisory business, FINRA began urging the SEC in 2010 to grant it authority over investment advisors as well.120

The "flash crash" of May 6, 2010, when financial markets lost 7 percent of their value in fifteen minutes and nearly as quickly gained most of it back, confirmed that for all the dynamism and cost competitiveness of the new financial markets, there were hazards as well. Months later, the cause of the crash was unknown. All that was certain was that continued market fragmentation could only make things worse. At the SEC's instruction, FINRA began working on a consolidated audit trail intended to help regulators follow transactions across multiple markets. In June 2010 FINRA took over market surveillance for NYSE Euronext, making it responsible for some 80 percent of the U.S. equities market. At three years of age, FINRA possessed an unprecedented authority over securities markets and had harnessed the institutional experience of more than two hundred years of self regulation.121

How well this reconstitution of the basic self-regulatory structure of the securities industry will succeed is unknown. Will FINRA indeed be less likely to bow to market mandates than other SROs whose regulatory responsibilities have gradually been circumscribed?  Can independent regulators from an unaffiliated organization command the same intimate knowledge of a market as its own members?  Such questions will be answered in due time. What is clear now is that the creation of FINRA, like the creation of the public/private partnership in the aftermath of the Exchange Act of 1934, was less the working out of a coherent SRO plan than a further attempt at the "institution of experience," an effort to build on practical knowledge and adapt the regulation of the securities industry in America to ever-changing markets and always-shifting public expectations.

<<Previous Next >>


Footnotes:

(118.) May 18, 2010 Preliminary Findings Regarding The Market Events of May 6 2010 – Report of the Staffs of the CFTC and SEC to the Joint Advisory Committee on Emerging Regulatory Issues; FINRA Annual Report, 2008.

(119.) August 31, 2009 SEC Office of Investigations: Investigation of Failure of SEC to Uncover Bernard Madoff's Ponzi Scheme

(120.) FINRA Annual Report, 2008; On Wall Street, June 2009; Washington Post, October 3, 2009; Wall Street Journal, November 18, 2009; Barron's, March 8, 2010.

(121.) Wall Street Journal, May 5, 2010; FINRA Annual Report, 2009.


Related Museum Resources

Papers

August 31, 2009
image pdf (Government Records)
May 18, 2010
image pdf (Government Records)
May 20, 2010
image pdf (Government Records)

Programs

29 September 2010

Bingham Presents 2010: Harmonization of the Regulation of Investment Advisers and Broker Dealers

Moderator: Erik Sirri

Presenter(s): W. Hardy Callcott, Michael Sharp, David Tittsworth

03 June 2010

Self-Regulation in the Securities Industry (Eleventh Annual Meeting)

Moderator: Donna Nagy

Presenter(s): James Brigagliano, James Duffy, Richard Ketchum, Joanne Moffic-Silver

Permission for Use

The virtual museum and archive is copyrighted by the SEC Historical Society. The Society reserves the right to restrict access to or use of the museum by any user at any time.

Users are prohibited from sharing or downloading any material for publication or commercial purposes without written permission from the Executive Director. Requests for permission must be submitted by email and specify the material requested and for what purpose.

Material used with the Society's permission should be credited to: www.sechistorical.org.