Stock Exchanges and the Implications of Demutualization

The WSJ reported that the SEC was clamping down on the efforts by stock exchanges to "bolster profits by pumping out products that increasingly have catered to high-speed traders."  As the article noted:

  • Since the flash crash of May 2010, SEC Chairman Mary Schapiro has been personally involved in driving inquiries about whether exchanges are improperly favoring customers whose rivers of buy and sell orders drive exchange profits, according to a person familiar with her thinking.
  • The agency is investigating whether exchanges have provided such clients order-routing privileges that give them an edge over ordinary investors.

The article comes on the heels of the decision by the SEC to fine the NYSE $5 million for violations of Rule 603 (a)(1) of Regulation NMS.

The article suggests that the stock exchanges are motivated by profit maximization in the introduction of new products.  They should be.  Both have converted to for-profit companies with the accompanying obligation to profit maximize.  At the same time, however, they are self regulatory organizations with legal and regulatory responsibilities.  As the SEC described:

National securities exchanges, such as NYSE, are critical elements of the national market system.   Because of this central role, an exchange is required to satisfy among the most significant regulatory responsibilities of any market participant.  These regulatory responsibilities implicate both an exchange’s own operations and its role as a self-regulatory organization that acts as a co-regulator with the Commission and other authorities.

While the exchanges strive to profit maximize while protecting the regulatory function (the NYSE for example has created a separate nonprofit subsidiary with an independent board to perform regulatory functions), one has to wonder whether, in the end, the NYSE (and Nasdaq) would benefit from sheering off any remaining regulatory responsibilities.  That would not prevent the SEC from adopting rules (such as Rule 603) and bringing actions against companies that violated the rules.  But it would give the exchanges greater freedom to act as the "for profit" companies that they have become.  

J Robert Brown Jr.