By the end of next year, NYSE Group will bring most of its market surveillance, investigation, and enforcement functions back in-house when an existing contract with the Financial Industry Regulation Authority expires. NYSE Regulation, a non-profit subsidiary of the New York Stock Exchange, will perform these duties for its three equities exchanges and two options exchanges.
NYSE Regulation currently oversees FINRA’s performance of various regulatory duties on behalf of the New York Stock Exchange, NYSE Arca and NYSE MKT, including administering surveillance, enforcement, and disciplinary programs to ensure member firms’ compliance with exchange rules and federal securities laws, as well as monitoring and enforcing compliance by listed companies with listing standards.
FINRA, whose contract with NYSE Group expires on New Year’s Eve 2015, will retain cross-market surveillance and investigation functions and will continue to conduct the registration, testing, and examinations of broker-dealer members of NYSE Group’s exchanges. NYSE Regulation has selected Cinnober, a supplier of financial technology to trading and clearing venues, as a technology partner for the development and implementation of the enhanced surveillance system.
The decision by NYSE Group, similar to changes put in place by rival Nasdaq OMX Group last year, comes amid growing scrutiny of the role for-profit exchanges play as self-regulatory organizations and the potential for conflicts of interest. Last August, the Securities Industry and Financial Markets Association – which represents securities firms, banks and asset managers – wrote to the Securities and Exchange Commission and members of Congress asking them to reexamine whether exchanges like the New York Stock Exchange and Nasdaq should continue to exercise rulemaking and enforcement authority over their members, typically insulated from legal liabilities as they do so.
“Exchanges face an irreconcilable conflict of interest in the performance of their SRO responsibilities,” Theodore Lazo, SIFMA's managing director and associate general counsel wrote. “On the one hand, they are bound by a fiduciary duty to maximize profits for their corporate shareholders. On the other hand, they are required to be fair and impartial regulators of the broker-dealers with which they compete… Conflicts of interest in this model abound and only worsen as they are left unresolved.”
The letter also questioned the competitive benefits gained from exchanges' status as SROs, including limitations on legal liability. Courts have held that an exchange “steps into the shoes” of the SEC with respect to the regulatory functions delegated to it and is therefore entitled to immunity from private liability with respect to those activities.
NYSE Group’s plan could be seen as an effort to address the concern raised by both SIFMA and SEC Commissioner Daniel Gallagher that outsourcing the majority of regulatory functions to FINRA eliminates the need for exchanges to enjoy their status as SROs. “We need to ask whether allowing exchanges to outsource the bulk of their regulatory responsibilities to FINRA through regulatory services agreements risks implicitly transforming the meaning of SRO to ‘selectively regulatory organizations,'” Gallagher said in a speech last year.