Henry Paulson and the Self Regulatory Organizations

Henry Paulson, the Secretary of the Treasury, has built much of his tenure around the them of excessive regulation.  His preference is for the market to solve matters.  Yet the current crisis has demonstrated the failings of the market and put pressure on him to devise a regulatory correction.  He is having a hard time philosophically coming to terms with this new approach. 

One example concerns his treatment of self regulatory organizations. While Paulson usually refers to SROs generically, he seems most concern with the stock exchanges (NYSE-Euronext and Nasdaq).  His proposals calls for the streamlining of SEC approval of SRO rule changes, with some becoming effective upon filing.  As the summary notes:

• The SEC should issue a rule to update and streamline the self-regulatory organization (“SRO”) rulemaking process to recognize the market and product innovations of the past two decades. The SEC should consider streamlining and expediting the SRO rule approval process, including a firm time limit for the SEC to publish SRO rule filings and more clearly defining and expanding the type of rules deemed effective upon filing, including trading rules and administrative rules. The SEC should also consider streamlining the approval for any securities products common to the marketplace as the agency did in a 1998 rulemaking vis-à-vis certain derivatives securities products. An updated, streamlined, and expedited approval process will allow U.S. securities firms to remain competitive with the over-the-counter markets and international institutions and increase product innovation and investor choice.

There is no question that the exchanges, both of which are for profit companies, face competitive pressures.  There is also no doubt that they would like the right to act more quickly in the face of changed competitive circumstances. 

But if the exchanges want to act like profit making entities, they should receive the responsibilities that come with it.  For all of the difficulty or delay associated with regulatory approval, the exchanges receiveimmunity from lawsuits for anything done pursuant to their regulatory mission. 

The exchanges have reduced their regulatory role, particularly in the aftermath of the NYSE merging its broker-dealer oversight role into the NASD (now FINRA).  Perhaps the future for the exchanges ought to be that they exist the regulatory function entirely.  They would benefit competitively by reducing regulatory oversight but would likewise be subject to the market disciplining process, including law suits for wrongful behavior.