SEC Commissioner Gallagher's Speech: "Time for a Fresh Look at Equity Market Structure and Self-Regulation" (Important Speech) (With Lofchie Comment and Related Memo)

In a speech at SIFMA's 15th Annual Market Structure Conference, Commissioner Gallagher suggests that the basic premises on which the self-regulatory framework was developed (in the context of private, mutualized exchanges) no longer hold. He goes on to state that the SEC needs to reconsider the role of exchanges as SROs, and questions whether FINRA has become a "deputy SEC."

And if it is the case that FINRA has developed into a deputy SEC, Gallagher asks the following: Should FINRA's regulatory responsibility be expanded beyond the broker-dealer industry, "such as regulating investment advisors," or is mission creep "affecting FINRA’s ability to perform its core duties"?

Lofchie Comment: From the standpoint of regulatory philosophy, Commissioner Gallagher is asking an important question: Should the task of government be delegated to a non-governmental organization? For those who are interested in some general background on this topic, I am attaching a link to a memo which I wrote some years ago that I think will be useful. For some general discussion of the role of SROs, one may also look at Chapter 1 of the Broker-Dealer Guide. There are a lot of others who have also written much more extensively about the role of self-regulatory organizations, notably former SEC Commissioner (now Professor) Roberta Karmel. (You can find a number of articles by her on the topic if you do an Internet search for her name and self-regulation.) I note that one philosophical question that Commissioner Gallagher does not address is the extent to which, if FINRA is a "deputy SEC," parties accused of misconduct by FINRA should have the same protections that they would have in a governmental action. These philosophical questions aside, I have always understood that one of the principal justifications for self-regulation is that it keeps the expense of running the government off the balance sheet of the government. Given the monumental expansion of government regulation by Dodd-Frank, I wonder how practical at this moment the prospect of a discussion of the future of self-regulation could be. As the Commissioner notes, questions have lately been raised as to whether a self-regulatory organization (most likely FINRA) would take responsibility for investment advisers, the regulation of which is going to stretch the SEC still further.Interestingly, and somewhat coincidentally I assume, in yesterday's news we had a story about the President of NASAA criticizing the concept of an investment adviser SRO as being a form of unwarranted federal preemption. One additional comment that I will make (not just because I am always looking to criticize Dodd-Frank, but there is that): Section 733 of Dodd-Frank, which is now Section 5H of the CEA (regulating to-be-formed Swap Execution Facilities), seems to suggest that SEFs will somehow spring into being as fully formed entities (think of Athena springing full-born from the head of Zeus) with the ability to fully regulate the conduct of their members. See paragraph (f)(2) of 5H. This is, of course, absurd (the part about the SEFs, not the part about Athena). The only way that a new SEF would be "able" to perform this obligation is to outsource it, just as most securities SROs have outsourced regulation to FINRA. The CEA requirement is just indicative of the fact that legislation and regulation grow up by copying models that are already long outmoded.

View speech in full here (links externally to SEC website).