Securities and Exchange Commission Historical Society

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

Born Regulated

Splitting the Baby

"To the extent that the NASD's two broad missions, as membership association and as overseer of the Nasdaq market, have become confused—in reality or appearance—both are disserved... Fundamental change is required."

- September 19, 1995 Executive Summary of the Report of the NASD Select Committee on Structure and Governance (Rudman Committee) to the NASD Board of Governors

The reluctance of market makers to trade in odd eighths was not a violation of any particular NASD rule. It was more a systemic flaw hidden in plain sight.

The SEC and the U.S. Department of Justice launched investigations that focused on structure and governance, as well as anti-competitive practices. The NASD commissioned a comprehensive study, headed by former Senator Warren Rudman, which sharply criticized the committee system and recommended complete separation of the NASD's market and self-regulatory functions. The SEC and the NASD agreed to resolve the investigation with the SEC's issuance of a Section 21(a) Report. The report reflects the NASD's undertakings to separate its market activities from its self-regulatory function, and to provide for greater non-industry representation on its board and policy committees.

 In January 1996 the NASD reorganized as a parent holding company, with NASD Regulation and Nasdaq as subsidiaries. At its helm was industry veteran Frank Zarb, handpicked by SEC Chairman Arthur Levitt. Zarb began implementing thoroughgoing governance reforms, including the seating of boards required to have a majority of non-industry members.67

Nasdaq implemented a set of "order handling rules" promulgated by the SEC. Since Nasdaq was primarily a quote-driven rather than an order-driven market, participants could not know where, inside the spread, the limit orders were. Professionals with access to Level III did know. Similarly, with the exception of small orders, Nasdaq still did not match buying and selling brokers automatically, although a proprietary system called Instinet, widely used by the largest brokers, did. Phased in beginning in January 1997, the order handling rules required the same level of transparency—real-time knowledge of the size and price of orders and automated matching of buyers and sellers—for all market participants. This sudden diffusion of price information mounted a threat to Nasdaq, as electronic communications networks offering direct matching and execution of orders rushed into the market and drained away volume.68

And so, as the NASD transformed its governance, it was also compelled to revolutionize its market. To compete in the new world, Nasdaq would need flexibility and capital. There seemed to be only one sure way to get both, while giving members some incentive to vote for a change that would do away with their old business.

In 1999, Zarb announced that the NASD would spin Nasdaq off as a private company and focus solely on the business of self-regulation. In January 2000, more than 80 percent of the members, soon to be holders of valuable Nasdaq shares, approved. More than sixty years after its inception, the NASD, a curious blend of the conservative and cutting edge, was reborn, left to define for a second time what it meant to be the largest self-regulatory organization in the securities industry.69

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Related Museum Resources


September 19, 1995
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November 11, 1995
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November 8, 1996
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Oral Histories

05 February 2010

Barry Goldsmith

29 October 2009

Joseph Hardiman

25 August 2008

Richard Ketchum - Part II

02 November 2005

Mary Schapiro

Video: 4.33

From 1988 to 1993, Mary Schapiro served as SEC Commissioner. In 1993, President Bill Clinton appointed Schapiro Acting Chairman of the SEC, then appointed her Chairman of the Commodity Futures Trading Commission in 1994. In 1996 she joined the National Association of Securities Dealers (NASD) (now the Financial Industry Regulatory Authority) as the president of NASD Regulation. In 2006 she became NASD's Chairman and CEO. In January 2009 she became the SEC's 29th SEC Chairman. After leaving the SEC, Schapiro joined Promontory Financial Group in 2013 as Advisory Board Vice Chairman. She was one of the founding Trustees of the SEC Historical Society.

01 March 2011

Frank Zarb

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