71256 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

1 15 U.S.C. 78o15(b)(8).

2Analysis in this release focuses primarily on one 

registered national securities association SRO, the 

National Association of Securities Dealers 

(‘‘NASD’’) (including its subsidiary, the Nasdaq 

Stock Market (‘‘Nasdaq’’)), and those registered 

national securities exchange SROs that operate 

equity or options markets, the American Stock 

Exchange (‘‘Amex’’), the Boston Stock Exchange 

(‘‘BSE’’), the Chicago Board Options Exchange 

(‘‘CBOE’’), the Chicago Stock Exchange (‘‘CHX’’), 

the International Securities Exchange (‘‘ISE’’), the 

National Stock Exchange (‘‘NSX’’) the New York 

Stock Exchange (‘‘NYSE’’), the Pacific Exchange 

(‘‘PCX’’), and the Philadelphia Stock Exchange 

(‘‘Phlx’’). Unless otherwise specifically noted, 

discussion in this release does not necessarily relate 

to other registered SROs, including the National 

Futures Association (‘‘NFA’’), the Municipal 

Securities Rulemaking Board (‘‘MSRB’’), the 

registered clearing agencies, and notice registered 

national securities exchanges.

3 15 U.S.C. 78a et seq.

4Pub. L. 75–719, 52 Stat. 1070 (1938) (codified 

as amended at 15 U.S.C. 78o, authorizing the U.S. 

Securities and Exchange Commission to register 

national securities associations).

5Pub. L. 29, 89 Stat. 97 (1975).

6See generally S. Rep. No. 1455, 73d Cong., 2d 

Sess. (1934); H.R. Doc. No. 1383, 73d Cong., 2d 

Sess. (1934); S. Rep. No. 1455, 73d Cong., 2d Sess. 

(1934).

7 Id.

8 Id.

9 Id.

10See e.g., 1961–1963 Special Study of Securities 

Markets. Securities and Exchange Commission, 

Report of Special Study of Securities Markets, 

(‘‘Special Study’’), H.R. Doc. No. 95, 88th Cong., 1st 

Sess. (1963) and Market 2000: An Examination of 

Current Equity Market Developments, Division of 

Market Regulation, U.S. Securities and Exchange 

Commission (January 1994) (‘‘Market 2000 

Report’’).

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Part 240

[Release No. 34–50700; File No. S7–40–04] 

RIN 3235–AJ36

Concept Release Concerning SelfRegulation

AGENCY: Securities and Exchange 

Commission.

ACTION: Concept release; request for 

comment. 

SUMMARY: The Securities and Exchange 

Commission (‘‘Commission’’ or ‘‘SEC’’) 

is publishing this concept release and 

seeking public comment on a range of 

issues related to the self-regulatory 

system of the securities industry. This 

release discusses the foundations of the 

self-regulatory system and new 

considerations that the Commission and 

the industry are facing. In addition, this 

release describes certain enhancements 

that could be made to the current 

system that could improve its operation 

and also discusses a variety of other 

potential approaches to securities 

industry regulation.

DATES: Comments should be submitted 

on or before March 8, 2005.

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/

rules/concept.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number S7–40–04 on the subject line; 

or 

• Use the Federal eRulemaking Portal 

(http://www.regulations.gov). Follow the 

instructions for submitting comments. 

Paper Comments 

• Send paper comments in triplicate 

to Jonathan G. Katz, Secretary, 

Securities and Exchange Commission, 

450 Fifth Street, NW., Washington, DC 

20549–0609. 

All submissions should refer to File 

Number S7–40–04. This file number 

should be included on the subject line 

if e-mail is used. To help us process and 

review your comments more efficiently, 

please use only one method. The 

Commission will post all comments on 

the Commission’s Internet Web site 

(http://www.sec.gov/rules/

concept.shtml). Comments are also 

available for public inspection and 

copying in the Commission’s Public 

Reference Room, 450 Fifth Street, NW., 

Washington, DC 20549. All comments 

received will be posted without change; 

we do not edit personal identifying 

information from submissions. You 

should submit only information that 

you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT:

Christopher B. Stone, Senior Special 

Counsel to the Director, at (202) 942–

7938 who is in the Division of Market 

Regulation, Securities and Exchange 

Commission, 450 Fifth Street NW., 

Washington DC 20549–1001.

SUPPLEMENTARY INFORMATION:

Table of Contents 

I. Introduction 

II. Foundations of Self-Regulation 

III. New Considerations 

IV. Current SRO System Attributes 

A. Inherent Conflicts With Members, 

Market Operations, Issuers, and 

Shareholders 

1. Inherent Conflicts with Members 

2. Inherent Conflicts with Market 

Operations 

3. Inherent Conflicts with Issuers 

4. Inherent Conflicts with Shareholders 

B. Inefficiencies of Multiple SROs 

C. Intermarket Surveillance 

D. Funding 

1. Overview 

2. SRO Funding Sources 

a. Regulatory Fees 

b. Transaction Fees 

c. Listing Fees 

d. Market Data Fees 

e. Miscellaneous Fees 

V. Alternative Regulatory Approaches 

A. Proposed Enhancements to the Current 

SRO System 

1. SRO Governance and Transparency 

Rulemaking 

2. Intermarket Surveillance Enhancements 

B. Independent Regulatory and Market 

Corporate Subsidiaries 

C. Hybrid Model 

D. Competing Hybrid Model

E. Universal Industry Self-Regulator 

F. Universal Non-Industry Regulator 

G. SEC Regulation 

H. Other Models 

VI. Solicitation of Additional Comments

I. Introduction 

Self-regulation is a key component of 

U.S. securities industry regulation. All 

broker-dealers are required to be 

members of a self-regulatory 

organization (‘‘SRO’’), which sets 

standards, conducts examinations, and 

enforces rules regarding its members.1

Most, but not all, SROs also operate and 

regulate markets or clearing services.2

Inherent in self-regulation is the conflict 

of interest that exists when an 

organization both serves the commercial 

interests of and regulates its members or 

users.

The Securities Exchange Act of 1934 

(‘‘Exchange Act’’),3 the Maloney Act of 

1938 (‘‘Maloney Act’’),4 and the 

Exchange Act Amendments of 1975 

(‘‘1975 Amendments’’),5 reflect 

Congress’ determination to rely on selfregulation as a fundamental component 

of U.S. market and broker-dealer 

regulation, despite this inherent conflict 

of interest. Congress favored selfregulation for a variety of reasons. A key 

reason was that the cost of effectively 

regulating the inner-workings of the 

securities industry at the federal level 

was viewed as cost prohibitive and 

inefficient.6 In addition, the complexity 

of securities trading practices made it 

desirable for SRO regulatory staff to be 

intimately involved with SRO 

rulemaking and enforcement.7

Moreover, the SROs could set standards 

that exceeded those imposed by the 

Commission, such as just and equitable 

principles of trade and detailed 

proscriptive business conduct 

standards.8 In short, Congress 

determined that the securities industry 

self-regulatory system would provide a 

workable balance between federal and 

industry regulation.9

Since the self-regulatory system was 

incorporated into the federal securities 

laws, the Commission has reexamined it 

periodically.10 While steps have been 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71257

11See e.g., Id.; infra notes 30–31.

12See generally infra Section IV.

13 Id.

14 Id.

15 Id.

16 Id.

17Robert Sobel, The Big Board, A History of the 

New York Stock Market 14–27 (The Free Press 

1965). The agreement generally bound its signors to 

give preference to each other when buying and 

selling. Id.

18 Id. at 30–31.

19 Id. at 38–40.

20 Joel Seligman, The Transformation of Wall 

Street: A History of the Securities and Exchange 

Commission and Modern Corporate Finance at 1–

38 (Aspen Pub. N.Y. 3rd ed. 2003).

21Exchange Act Section 6, 15 U.S.C. 78f.

22Seligman at 183–85.

23The IBC, however, proved to be imperfect, 

because only seventeen hundred of the nation’s six 

thousand securities dealers ultimately joined. While 

the Commission realized that this voluntary 

organization was not effectively regulating the OTC 

market, it also determined that direct Commission 

regulation of the OTC market was not practicable. 

See Seligman at 183–85. While not speaking for the 

whole Commission, one early Commissioner 

compared the prospect of regulating the OTC 

market to building a structure out of sand because 

‘‘there is no cohesive force to hold it together, no 

organization with which [the Commission] could 

build, as authoritatively representing a substantial 

element in the over-the-counter business.’’ Id.

24 Id.

25Exchange Act Section 15A, 15 U.S.C. 78o–3.

26NFA is a national securities association 

registered for the limited purpose of regulating the 

activities of members who are registered as brokers 

or dealers in security futures products under 

Section 15(b)(11) of the Exchange Act, 15 U.S.C. 

78o(b)(11).

27See supra notes 6–9.

28 Id.

29Market 2000 Report at VI–6.

30S. Rep. No. 1455, 75th Cong., 3d Sess. I.B.4. 

(1938); H.R. Rep. No. 2307, 75th Cong., 3d Sess. 

I.B.4. (1938) (duplicate text quoted in both reports).

taken over time to redress perceived 

shortcomings, the SRO structure has 

been repeatedly reaffirmed both by 

Congress and the Commission.11 In 

recent years, changes in the markets and 

in the ownership structure of SROs have 

generated questions about the fairness 

and efficiency of the current SRO 

structure.12 The increased dispersion of 

order flow across multiple markets has 

produced questions of comparable 

regulation by SROs and the 

effectiveness of cross-market 

supervision.13 The increased 

competition among markets for listings 

and trading volume has applied 

pressure on SRO regulatory efforts and 

sources of funding.14 Moreover, the 

advent of for-profit, shareholder-owned 

SROs has introduced potential new 

conflicts of interest and issues of 

regulatory incentives.15 In addition, 

recent failings or perceived failings with 

respect to SROs fulfilling their selfregulatory obligations have sparked 

public debate as to the efficacy of the 

SRO system in general.16

For these reasons, the Commission is 

publishing this release to discuss and 

solicit comments on the role and 

operation of SROs in today’s markets. 

This release examines a number of 

issues concerning securities industry 

self-regulation, including: (1) The 

inherent conflicts of interest between an 

SRO’s regulatory obligations and the 

interests of its members, its market 

operations, its listed issuers, and, in the 

case of a demutualized SRO, its 

shareholders; (2) the costs and 

inefficiencies of the multiple SRO 

model; (3) the challenges of surveillance 

across markets by multiple SROs; and 

(4) the manner in which SROs generate 

revenue and how SROs fund regulatory 

operations. Finally, this release 

examines and seeks comment on certain 

enhancements to the current system and 

a number of regulatory approaches or 

legislative initiatives that could be 

considered by the Commission to 

address concerns with the current SRO 

model. 

II. Foundations of Self-Regulation 

Securities industry self-regulation has 

a long tradition in the U.S. securities 

markets. In its earliest years, the nascent 

U.S. securities industry was subject 

loosely to state laws and, in 1792, the 

New York broker community negotiated 

the historic Buttonwood Agreement to 

form the first organized stock market in 

New York.17 As the NYSE and other 

stock exchanges developed, trading 

conventions became formalized as 

exchange rules. In 1817, the NYSE’s 

Constitution was adopted and the NYSE 

subsequently adopted a range of rules 

governing its members and listed 

companies, including member financial 

responsibility rules and listed company 

registration and financial reporting 

rules.18 In 1820, a detailed set of NYSE 

By-Laws was adopted.19

Federal regulation of exchanges, and 

their formal recognition as selfregulatory organizations, followed a 

number of significant events, including 

the stock market crash of 1929 and the 

evidence of NYSE investigatory failures 

related to market manipulation 

highlighted at the 1934 Pecora 

Hearings.20 In Section 6 of the Exchange 

Act, Congress recognized the regulatory 

role of exchanges, and required all 

existing securities exchanges, including 

the NYSE, to register with the 

Commission and to function as selfregulatory organizations.21

The stock market crash of 1929 also 

severely damaged the public reputation 

of over-the-counter (‘‘OTC’’) securities 

dealers. In 1933, in an effort to improve 

their collective image, OTC dealers 

formed the Investment Bankers Code 

Committee (‘‘IBCC’’), which 

promulgated industry best practices.22

In 1936, the IBCC was succeeded, by the 

Investment Bankers Conference (‘‘IBC’’), 

a prominent group of investment banks 

formed to act as a national, voluntary 

industry organization.23

After experience with the IBCC and 

the IBC, the Commission and leaders of 

the investment banking community 

generally agreed that an industry 

association needed official legal status 

in order to effectively carry out the task 

of self-regulating the OTC market.24

Ultimately, in 1938, the Maloney Act 

amended the Exchange Act by adding a 

new Section 15A and establishing the 

concept of registered national securities 

association SROs.25 To date, the NASD 

and the NFA 26 are the only registered 

national securities associations.

In enacting these provisions, Congress 

concluded that self-regulation of both 

the exchange markets and the OTC 

market was a mutually beneficial 

balance between government and 

securities industry interests.27 Through 

establishment of self-regulation, the 

securities industry was supervised by an 

organization familiar with the nuances 

of securities industry operations. In 

addition, industry participants preferred 

the less invasive regulation by their 

peers to direct government regulation 

and the government benefited by being 

able to leverage its resources through its 

oversight of self-regulatory 

organizations.28 Moreover, the SROs 

had the ability to set proscriptive 

standards relating to just and equitable 

principles of trade and detailed business 

conduct standards.29 In enacting the 

Maloney Act in 1938, Congress stated 

that an approach to securities regulation 

relying solely on government regulation 

‘‘would involve a pronounced 

expansion of the organization of the 

Securities and Exchange Commission; 

the multiplication of branch offices; a 

large increase in the expenditure of 

public funds; an increase in the problem 

of avoiding the evils of bureaucracy; and 

a minute, detailed, and rigid regulation 

of business conduct by law.’’ 30

The legislative history of the 1975 

Amendments noted that, rather than 

adopt this purely governmental 

approach, Congress determined that it 

was ‘‘distinctly preferable’’ to rely on 

‘‘cooperative regulation, in which the 

task will be largely performed by 

representative organizations of 

investment bankers, dealers, and 

brokers, with the Government exercising 

appropriate supervision in the public 

interest, and exercising supplementary 

71258 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

31S. Rep. No. 94–75, 94th Cong., 1st Sess. 7, II 

(1975). 32 Id. 33See e.g., supra note 10. In addition, the 

Commission speaks implicitly and explicitly to selfregulatory concepts in virtually every SRO rule that 

is noticed for public comment and approved 

through the Commission Rule 19b–4 rule filing 

process. SEC Rule 19b–4, 17 CFR 240.19b–4. 34Specialist domination of the Amex resulted in 

a series of scandals in the late 1950s involving 

market manipulations. In 1961, the Commission 

launched an investigation into the trading practices 

of two Amex specialists in particular. This 

investigation was ultimately broadened into the 

Special Study. See Seligman at 281–86.

35See generally Seligman at 299–348.

36 Id.

37 Id. Congress recognized that self-regulators may 

not always be as diligent as desired, and, indeed, 

may use self-regulation as a device to avoid 

regulation altogether. Nonetheless, Congress also 

was of the view that members of the securities 

industry could bring down to bear on the problems 

of regulation a degree of expertise and, in many 

circumstances, expedition not expected of a 

necessarily more remote governmental agency. 

Special Study at 693–697.

38See Market 2000 Report at III–1.

39 Id. at III–3.

40 Id. at III–5–7.

41 Id. at III–10. See also infra Section IV.

42See In the Matter of National Association of 

Securities Dealers, Inc.; SEC Release No. 34–37538, 

August 8, 1996; Administrative Proceeding File No. 

3–9056 (‘‘21(a) Administrative Order’’). See also

Report and Appendix to Report Pursuant to Section 

21(a) of the Securities Exchange Act of 1934 

Regarding the NASD and The Nasdaq Stock Market 

(August 8, 1996) and Securities Exchange Act 

Release No. 37538 (August 8, 1996) (‘‘21(a) 

Report’’). The undertakings were included in the 

SEC Order (‘‘21(a) Report Undertakings’’).

43See 21(a) Administrative Order Section III; 

21(a) Report at 40–47.

44See 21(a) Administrative Order Section III; 

21(a) Report at 52–54.

45See e.g., supra note 10.

46The figure is based on Nasdaq/UTP Plan market 

data (as of September 2004).

47The figure is based on Network B, CTS Activity 

market data (as of September 2004).

48The figure is based on Network A, CTS Activity 

market data (as of September 2004). See also e.g.,

Ivy Schmerken, Will the NYSE’s Specialist Probe 

Open the Listed Market to ECNs?, Wall Street + 

Technology, July 1, 2003, at 18; Robert Sales, The 

Big Picture—ECN Evolution, Wall Street + 

Technology, February 1, 2003, at 6.

49See Securities Exchange Act Release Nos. 

50173 (August 10, 2004), 69 FR 50407 (August 16, 

2004) (notice of proposed rule change proposing 

improvements to NYSE’s existing automatic 

execution facility, NYSE Direct+); and 49921 

(June 25, 2004), 69 FR 40690 (July 6, 2004) 

(approval of proposed rule change by Amex to 

enhance its Auto-Ex technology for exchange-traded 

funds and Nasdaq stocks traded on the exchange).

50 In August 1999, 32% of equity options were 

traded on more than one exchange. By September 

2000, that number had risen to 45%. Over the same 

period, the percentage of aggregate option volume 

traded on only one exchange fell from 60% to 15%. 

See Exchange Act Release No. 43085 (July 28, 

powers of direct regulation.’’ 31

Similarly, in 1975, Congress stated that 

a principal reason for retaining a selfregulatory regime was the ‘‘sheer 

ineffectiveness of attempting to assure 

[regulation] directly through the 

government on a wide scale,’’ and that, 

although the SROs had not always 

performed their role up to expectations, 

self-regulation generally was considered 

to have worked well and ‘‘should be 

preserved and strengthened.’’ 32

The Commission has periodically 

examined the self-regulatory system and 

the extent to which SROs have 

successfully fulfilled their statutory 

obligations.33 Such analysis has 

sometimes resulted in SROs making 

changes to their structures or regulatory 

programs. For example, after problems 

surfaced regarding the floor operations 

of Amex specialists, the Commission 

sponsored the sweeping 1961–1963 

Special Study.34 The Special Study 

concluded that SROs have a natural 

tendency to protect member firms and 

that SRO regulatory operations appear 

to falter without the ‘‘pointed stimuli’’

of vigilant Commission oversight.35

Among other conclusions, the Special 

Study found a need for a reduction in 

the amount of control that exchange 

floor members exercised over exchange 

regulatory operations and governance.36

Moreover, the study called for a general 

strengthening of SRO governance.37

Another example of past analysis was 

the Commission’s Division of Market 

Regulation review of the structure and 

costs of the SRO system in the Market 

2000 Report, which was published by 

the Commission in 1994. The Market 

2000 Report noted the impact that 

increasing intermarket competition and 

duplicative SRO rules were having on 

the self-regulatory system.38 In addition, 

the report discussed the extent to which 

costs to support the SRO system were 

being fairly allocated across the 

markets.39 The report also examined the 

desirability of reallocating the 

regulatory and market functions of SROs 

and the possibility of the Commission 

assuming a greater role with respect to 

the functions carried out by the SROs.40

While the opinion advanced in the 

Market 2000 Report was that such 

changes were unlikely to improve the 

existing SRO system, it did not foreclose 

the possibility of reconsidering this 

position in the future in light of changed 

circumstances.41

Another example of past Commission 

analysis on this issue was in 1996 when 

the Commission instituted 

administrative proceedings against the 

NASD with respect to OTC market 

maker pricing collusion.42 At the same 

time, the Commission issued the 21(a) 

Report regarding the NASD and Nasdaq. 

In the 21(a) Report, issued pursuant to 

Section 21(a) of the Exchange Act, the 

Commission discussed at length a range 

of issues concerning the efficacy of the 

self-regulatory system and the potential 

problems associated with inherent SRO 

conflicts.43 Of particular concern, in this 

case, was the lack of independence of 

the NASD regulatory staff from Nasdaq’s 

market operations.44

In sum, while Congress and the 

Commission have criticized and 

modified the SRO system in the past, it 

has not been radically revised or 

dismantled since its establishment. 

Rather, it is generally considered that 

the SRO system has functioned 

effectively and has served government, 

industry, and investors well.45

Notwithstanding this positive record, 

because of new considerations in our 

markets, the Commission believes it is 

an appropriate time to reexamine and 

solicit public comment on the efficacy 

of the system overall.

III. New Considerations 

In recent years, the U.S. markets have 

experienced increasingly vigorous 

competition. The effect of this 

development is that markets operated by 

SROs have faced increased competition 

from foreign trading markets and from 

electronic communications networks 

(‘‘ECNs’’) that have shifted significant 

amounts of market share away from the 

primary markets, especially with respect 

to Nasdaq securities. For example, the 

NYSE and Amex historically dominated 

trading in their listed securities, and 

market makers dominated trading in 

Nasdaq stocks. Today, however, in the 

Nasdaq market, automated market 

centers (such as Nasdaq’s order 

collector, aggregator, and execution 

system, SuperMontage, the Archipelago 

exchange (‘‘ArcaEx’’), and the INET 

ECN) have captured more than 50% of 

share volume.46 For Amex-listed stocks 

(for which approximately 39% of share 

volume now is represented by two 

extremely active exchange-traded funds 

(‘‘ETFs’’)—the QQQ and SPDR), Amex 

now handles approximately 21% of the 

volume, with the remaining balance 

split among Arca-Ex, INET, and 

others.47 The NYSE has managed to 

retain approximately 80% of the volume 

in its listed stocks, but other market 

centers are raising the level of 

competition and reducing the NYSE’s 

share of trading.48 Moreover, the NYSE 

and Amex have sought to add 

automated facilities that are integrated 

with and complement their traditional 

exchange floors.49 In the listed options 

markets, the proliferation of multiple 

trading of options and the entry of two 

new electronic exchanges has raised the 

tempo of competition among these 

markets and redistributed their market 

share.50

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71259

2000), 65 FR 47918 (August 4, 2000) (proposing to 

extend Exchange Act Rule 11Ac1–1 to options). 

According to the Options Clearing Corporation, by 

September 2003, 98.3% of equity options classes 

traded on more than one exchange. As of December 

2003, the market shares held by options exchanges 

were 31.3% by the CBOE, 27.0% by the ISE, 19.8% 

by the Amex, 12.4% by the Phlx, and 9.5% by the 

PCX. Options Clearing Corporation, 2003 Annual 

Report 1 (2004). By June of 2004, the ISE’s market 

share was 33.6%, the CBOE’s was 26.0%, the 

Amex’s was 18.6%, the Phlx’s was 11.6%, the 

PCX’s was 8.4% , and the BSE Boston Options 

Exchange (‘‘BOX’’) facility’s was 1.8%. Will 

Acworth, Electronic Trading Sweeps Options 

Industry, Futures Industry Magazine, September/

October 2004 (citing Futures Industry Association 

statistics).

51See generally infra Section IV.

52 Id.

53 Id.

54 Id.

55 Id.

56 Id.

57 Id.

58 Id.

59 Id.

60 Id.

61See In the Matter of Chicago Stock Exchange,

Securities Exchange Act Release No. 48566 

(September 30, 2003). See also In the Matter of Bear 

Wagner Specialists LLC, Securities Exchange Act 

Release No. 49498 (March 30, 2004); In the Matter 

of Fleet Specialist, Inc., Securities Exchange Act 

Release No. 49499 (March 30, 2004); In the Matter 

of LaBranche & Co. LLC, Securities Exchange Act 

Release No. 49500 (March 30, 2004); In the Matter 

of Spear, Leeds & Kellogg Specialists LLC, Securities 

Exchange Act Release No. 49501 (March 30, 2004); 

In the Matter of Van der Moolen Specialists USA, 

LLC, Securities Exchange Act Release No. 49502 

(March 30, 2004). See In the Matter of SIG 

Specialists, Inc., Securities Exchange Act Release 

No. 50076 (July 26, 2004) and In the Matter of 

Performance Specialist Group LLC, Securities 

Exchange Act Release No. 50075 (July 26, 2004). 

See also Securities Exchange Act Release No. 48946 

(December 17, 2003), 68 FR 74678 (December 24, 

2003) (approving NYSE proposal to restructure 

NYSE corporate governance structure).

62See Exchange Act Release No. 49325 (February 

26, 2004), 69 FR 11126 (March 9, 2004) (noticing 

proposed rulemaking for comment); Exchange Act 

Release No. 49749 (May 20, 2003), 69 FR 30142 

(May 26, 2004) (extending comment period and 

seeking additional comments).

63See infra Section IV.

64See e.g., Exchange Act Sections 6(b) and 

15A(b), 15 U.S.C. 78f(b) and 78o–3(b).

65LaBranche & Co. Inc., 2002 Annual Report 6 

(2002).

66LaBranche & Co. Inc., 2002 Annual Report 14 

(2003).

67Peter Chapman, Windy City Loses Another 

Specialist, Traders Magazine, July 1, 2004.

This heightened competition has 

benefited trading markets by spurring 

innovation in trading systems and 

responsiveness to customers.51 It has 

also driven down costs, including fees 

charged by the trading markets.52 At the 

same time, this competition places 

greater strains on the self-regulatory 

system.53 Some industry observers have 

posited that trading previously covered 

by one market’s rules may move to 

another market in search of lower 

regulatory standards.54 Others have 

argued that trading across markets may 

be subject to inconsistent rules across 

several markets.55 Some have voiced 

concerns about falling market share 

inducing SROs to reduce the rigor of 

their member and market supervision 

programs.56 Also, concerns have been 

raised about SROs favoring key 

participants in their markets to 

encourage those key participants to 

remain active in their markets or to 

attract other users.57 Shifts in market 

share can undermine revenues 

supporting an SRO’s regulatory 

functions, without reducing the SRO’s 

responsibility for supervision of its 

members trading across markets.58

Shifts in trading to multiple markets 

also increase concerns about potential 

gaps in the surveillance of intermarket 

trading.59

Other considerations also may alter 

the delicate balance of the SRO system. 

The conversion of some SROs to 

publicly traded, for profit status may 

increase the actual or perceived 

conflicts inherent in the SRO model.60

Likewise, numerous recent SRO failings 

related to governance, member oversight 

and trading supervision raise significant 

concerns about the efficacy of the selfregulatory model.61 Finally, in response 

to the recently proposed Regulation 

NMS (‘‘Reg NMS’’),62 commenters 

raised serious questions about the level 

of market data fees, which are an 

important component of SRO revenues 

and the funding of self-regulation.63 The 

Commission believes that it is an 

appropriate time to issue a concept 

release to examine and solicit public 

comment on the extent to which recent 

developments in our markets warrant 

changes to the current system.

IV. Current SRO System Attributes 

This discussion focuses on the 

following distinctive attributes of the 

existing SRO system and explores how 

recent market changes have impacted 

them: (1) The inherent conflicts of 

interest between SRO regulatory 

operations and members, market 

operations, issuers, and shareholders; 

(2) the costs and inefficiencies of 

multiple SROs, arising from multiple 

SRO rulebooks, inspection regimes, and 

staff; (3) the challenges of surveillance 

of cross market trading by multiple 

SROs; and (4) the funding SROs have 

available for regulatory operations and 

the manner in which SROs allocate 

revenue to regulatory operations. 

A. Inherent Conflicts With Members, 

Market Operations, Issuers, and 

Shareholders 

Among the most controversial 

features of the existing SRO system is 

the inherent conflict that exists within 

every SRO between its regulatory 

functions and its members, market 

operations, listed issuers, and 

shareholders. The following discussion 

considers these conflicts. 

1. Inherent Conflicts With Members 

The SROs are responsible for 

promulgating and enforcing rules that 

govern all aspects of their members’

securities business, including their 

financial condition, operational 

capabilities, sales practices, and the 

qualifications of their personnel.64 In 

fulfilling these functions, the SROs 

conduct examinations on the premises 

of their members, monitor financial and 

other operational reports, investigate 

potential violations of rules, and bring 

disciplinary proceedings when 

appropriate. In addition, SROs must 

surveil trading on any markets they 

operate to detect rule violations and 

other improper practices, such as 

insider trading and market 

manipulation. Unchecked conflicts in 

the dual role of regulating and serving 

can result in poorly targeted SRO 

rulemaking, less extensive SRO 

rulemaking, and under zealous 

enforcement of SRO rules against 

members. It is also important to note 

that, even where an SRO structure may 

appear sound, successful self-regulation 

relies on sufficiently vigorous rule 

enforcement against members on the 

part of the SRO. If regulatory staff is 

disinclined to regulate members, selfregulation will fail. Thus, to be effective, 

an SRO must be structured in such a 

way that regulatory staff is 

unencumbered by inappropriate 

business pressure.

Pressures that inhibit effective 

regulation and discourage vigorous 

enforcement against members can arise 

for a variety of reasons, including 

member domination of SRO funding, 

member control of SRO governance, and 

member influence over regulatory and 

enforcement staff. In addition, the 

economic importance of certain SRO 

members may create particularly acute 

conflicts, especially in light of the 

consolidation of some of the largest 

securities firms. For example, the 

number of NYSE specialist firms, which 

are central to the NYSE’s auction 

trading model, has dropped from 27 in 

1999 to 7 in 2002.65 One NYSE 

specialist firm in 2003 accounted for 

over 28% of total NYSE trading 

volume.66 The number of specialist 

firms at the CHX has dropped from 15 

in 2002 to 8 in 2004.67 Approximately 

47% and 29% of the NSX’s total 

71260 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

68NSX, 2003 Annual Report Exhibit I–12 (2004).

69 Id.

70 Id.

71Eric Noll, Shifting Models of Option Market 

Participants, Futures Industry Magazine, 

September/October 2004.

72See Exchange Act Release No. 44983 (October 

25, 2001), 66 FR 55225, 55229–30 (November 1, 

2001) (approving SR–PCX–00–25) (‘‘ArcaEx 

Approval Order’’). ArcaEx is operated by 

Archipelago Exchange LLC. At the time of this 

approval, PCX’s ownership interest in Arca LLC 

consisted solely of a 10% interest in Archipelago 

Holdings LLC, the parent company of Arca LLC. See

66 FR at 55225.

73 Id.

74 Id.

75See Section 6(b)(5) of the Act, 15 U.S.C. 

78f(b)(5).

76See ArcaEx Approval Order at 55233.

77The term ‘‘facility’’ when used with respect to 

an exchange includes its premises, tangible or 

intangible property whether on the premises or not, 

any right to use of such premises or property or any 

service thereof for the purpose of effecting or 

reporting a transaction on the exchange (including, 

among other things, any system of communication 

to or from the exchange, by ticket or otherwise 

maintained by or with the consent of the exchange), 

and any right of the exchange to the use of any 

property or service. (Emphasis added.) Exchange 

Act Section 3(a)(2), 15 U.S.C. 78c(a)(2). 78See ArcaEx Approval Order at 55233–55234. 79See 21(a) Report at 41. 80See 21(a) Report at 40–44. 81See supra note 42. See also infra Section V.B. 82See generally Exchange Act Release Nos. 48764 

(November 7, 2003), 68 FR 64380 (November 13, 

2003), and 48946 (December 17, 2003), 68 FR 74678 

(December 24, 2003) (‘‘NYSE Governance Changes 

Approval’’). 83 Id.

84 Id.

transaction charges were derived from 

one member for the years 2003 and 

2002, respectively.68 In addition, this 

single NSX member was responsible for 

generating 93% and 10% of Tape B 

market data revenues for the years 2003 

and 2002, respectively.69 This single 

NSX member was also responsible for 

generating 100% of NSX’s Tape C 

market data revenues in both 2003 and 

2002.70 In the options market, there are 

just over 40 specialists and market 

makers on the nation’s options 

exchanges, whereas just three years ago 

there were over 70.71

Thus, the current situation appears to 

be one in which a declining number of 

member firms are increasingly 

important to the business interests of 

their regulator SROs. The anecdotal 

evidence cited above could indicate that 

SROs have become more dependent on 

large members for their funding, 

potentially enabling those members to 

wield significant influence with respect 

to their regulator SROs. This creates the 

potential for failures by SROs to enforce 

rules against these members, especially 

when compared to enforcement against 

other smaller or less economically 

influential members, and SRO failures 

to develop rules that would disrupt the 

business practices of important 

members. 

The PCX’s proposal in 2001 to enter 

into an arrangement in which ArcaEx 

would become the PCX’s equity trading 

facility presented a particularly 

complicated situation in which an SRO 

would be affiliated with a member. 72 In 

the ArcaEx Approval Order, the 

Commission examined a variety of 

issues related to self-regulation, 

including the regulatory responsibilities 

of the PCX under the new structure and 

the potential for inherent conflicts to be 

exacerbated when an SRO is affiliated 

with a member. In addition, the 

Commission imposed certain 

requirements with respect to PCX and 

ArcaEx that were designed to ensure 

that the various functions of the 

affiliated broker-dealer were properly 

regulated.73

In the ArcaEx Approval Order, the 

Commission discussed the PCX’s 

proposal that Wave Securities LLC 

(‘‘Wave’’), a wholly owned subsidiary of 

ArcaEx, would be a registered brokerdealer and a member of both the PCX 

and the NASD. Wave would have two 

primary functions with respect to 

ArcaEx. Specifically, Wave would act as 

an introducing broker for customers that 

were not PCX members and would 

provide sponsored access to ArcaEx. 

Wave would also provide an optional 

routing service for ArcaEx, and, as 

necessary, would route orders to other 

market centers from ArcaEx.74

Under Section 6(b)(5) of the Exchange 

Act, the rules of a national securities 

exchange must not be designed to 

permit unfair discrimination between 

customers, issuers, brokers, or dealers.75

The Commission noted in the ArcaEx 

Approval Order that the potential for 

unfair discrimination may be 

heightened if a national securities 

exchange or its affiliate owns or 

operates a broker-dealer. This is 

because, the Commission stated, the 

financial interests of the exchange may 

conflict with its responsibilities as an 

SRO regarding the affiliated brokerdealer. Moreover, the Commission 

described the conflict of interest that 

may arise if a national securities 

exchange (or an affiliate) provides 

advantages to its broker-dealer that are 

not available to other members, or 

provides a feature to all members that 

was designed to give its broker-dealer a 

special advantage. These advantages, 

such as greater access to information, 

improved speed of execution, or 

enhanced operational capabilities in 

dealing with the exchange, might 

constitute unfair discrimination under 

the Exchange Act, the Commission 

concluded. Thus, the Commission 

required that the PCX not serve as the 

self-regulatory organization primarily 

responsible for examining the Wave 

broker dealer.76

The Commission ultimately 

determined that, although Wave’s 

routing services would be optional, 

Wave’s order-routing function occupied 

a special position with respect to 

ArcaEx. In the Commission’s view, 

Wave was uniquely linked to and 

endorsed by ArcaEx to provide its 

outbound routing functionality. 

Therefore, the Commission concluded 

that the PCX application of the Wave 

order-routing function fell within the 

definition of a facility under Section 

3(a)(2) of the Exchange Act 77 and, as 

such, would be subject to the 

Commission’s continuing oversight. In 

particular, under the Exchange Act, the 

PCX would be required to file rule 

changes and fees relating to the Wave 

order-routing function, and Wave would 

be subject to exchange nondiscrimination requirements. Thus, the 

Commission imposed these 

requirements to address the potential 

misuse of advantages that might arise 

from an SRO member carrying out an 

order-routing function on behalf of an 

SRO.78

In the past, members also have 

historically controlled the boards and 

the key committees of SROs. For 

example, in the 21(a) Report concerning 

the NASD, the Commission discussed 

the extent to which large members had 

made up a majority or substantial 

proportion of the NASD’s Board of 

Governors.79 Moreover, the Commission 

discussed the extensive influence 

wielded by market maker members over 

the SRO’s disciplinary process due to 

their strong representation on the 

NASD’s District Business Conduct 

Committees (‘‘DBCCs’’), which served a 

‘‘grand jury’’ function with respect to 

the initiation of disciplinary 

proceedings.80 Ultimately, the 

Commission’s settlement with the 

NASD resulted in significant corporate 

structure changes designed to prevent 

these conflicts from occurring in the 

future.81

Recently, the NYSE changed its 

governance structure to reduce conflicts 

of interest with respect to members.82

Specifically, the NYSE created a wholly 

independent board and regulatory staff 

that report to an independent board 

committee.83 In addition, amendments 

to the NYSE’s charter mandated 

increased transparency of the NYSE’s 

operations and corporate governance.84

The governance changes included the

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71261

85 Id. at 74679.

86 Id.

87 Id. at 74681.

88 Id. at 74682.

89 Id. at 74681.

90 Id. at 74680–74681.

91 Id. at 74679–74680.

92 Id.

93 Id. at 74679.

94 Id. at 74687.

95See infra Section IV.A.4.

96See e.g., Securities Exchange Act Release Nos. 

45803 (April 23, 2003), 67 FR 21306 (April 30, 

2003) (order approving the restructuring of the ISE 

from a limited liability company to a corporation); 

49718 (May 17, 2004), 69 FR 29611 (May 24, 2004) 

(order approving the demutualization of the PCX); 

and 49098 (January 16, 2004), 69 FR 3974 (January 

27, 2004) (order approving the demutualization of 

the Phlx).

97 Id.

98See Securities Exchange Act Release Nos. 

49451 (March 19, 2004), 69 FR 16305 (March 29, 

2004) (PCX stating that by ‘‘restructuring its 

business as a stock corporation with business 

control and management vested in a Board of 

Directors, the entity will have greater flexibility to 

develop and execute strategies designed to improve 

its competitive position than it has under the 

current membership-cooperative structure’’ and that 

it anticipates that ‘‘by restructuring as a stock 

corporation, PCX management will be better able to 

respond quickly to competitive pressures and to 

make changes to its operations as market conditions 

warrant, without diminishing the integrity of its 

regulatory programs.’’) and 49098, supra note (Phlx 

stating that it proposed to effect a demutualization 

for a number of reasons, including to ‘‘expand its 

sources of capital and revenue; to facilitate its 

ability to enter into relationships with strategic for 

financial partners who may be crucial for the 

Exchange’s future development, capital formation 

and viability; to facilitate the introduction for new 

products and thus potentially increase transaction 

volume and Exchange revenues; and to better 

position itself to react to new opportunities and 

challenges’’).

99See Exchange Act Release No. 34–50699, 

(November 18, 2004).

100For a more detailed description of the SRO 

Governance and Transparency Proposal see 

infraSection V.A.1.

101See e.g., Exchange Act Sections 6(b) and 

15A(b), 15 U.S.C. 78f(b) and 78o–3(b).

establishment of a fully independent 

board of directors composed of 6 to 12 

fully independent directors, the NYSE 

Chief Executive Officer (‘‘CEO’’), and 

the NYSE Chairman.85 The concept of 

‘‘independence’’ under the NYSE rules 

was redefined with respect to directors 

to exclude essentially all persons with 

any relationship or association to the 

exchange, an exchange member, or an 

exchange listed issuer.86 A fully 

independent board committee, the 

Regulatory Oversight & Regulatory 

Budget Committee, was established and 

tasked with overseeing the NYSE’s 

regulatory plans, programs, budget and 

staffing proposals on an annual basis.87

In an effort to ensure that the NYSE’s 

regulatory function was sufficiently 

independent, a new Chief Regulatory 

Officer position was created that reports 

directly to the Regulatory Oversight & 

Regulatory Budget Committee 88 An 

additional fully independent committee, 

the Human Resources & Compensation 

Committee, was created to set staff 

compensation.89 Other fully 

independent committees included the 

Audit Committee and the Nominating & 

Governance Committee, which was 

designed to ensure that governance 

procedures are appropriate and to 

administer the board’s annual selfreview process.90

Because the new definition of 

independent director excluded most 

users of the NYSE’s services, an 

advisory Board of Executives was also 

created to ensure that NYSE 

constituents continued to have a 

meaningful voice in the affairs of the 

exchange.91 This advisory group was to 

be composed of 22 individuals 

representing key NYSE constituencies 

and tasked primarily with advising the 

board on operational issues.92 The 

Board of Directors is required to meet on 

at least a quarterly basis both with and 

without the Board of Executives 

present.93 In approving these 

amendments, the Commission noted the 

importance of independence of 

regulatory staff from business 

pressures.94

As discussed further below,95 another 

recent concern is the extent to which 

the profit motive of a demutualized SRO 

could detract from proper selfregulation. In that regard, the 

Commission recently approved SRO 

rule changes that permitted several 

SROs to convert to for-profit entities.96

To avoid the potential for member 

shareholders to wield an in appropriate 

amount of influence over the regulatory 

function of the SROs, limits were 

imposed on the percentage that could be 

controlled by any one member.97 SROs 

have put forth various reasons for 

demutualizing, but a common theme is 

an increased ability to more quickly 

respond to competitive pressures.98

In a companion release, the 

Commission is proposing SRO 

governance and transparency measures 

(the ‘‘SRO Governance and 

Transparency Proposal’’) to address a 

range of concerns, including member 

ownership controls for demutualized 

exchanges.99 If adopted, the SRO 

Governance and Transparency Proposal, 

which will be discussed in greater detail 

below,100 would impose a variety of 

restrictions on shareholder owned 

SROs, including effectively restricting 

revenue from regulatory operations 

being used to pay dividends to 

shareholders.

The Commission seeks public 

comment on the following specific 

questions related to conflicts in member 

regulation: 

Question 1: To what extent are the 

conflicts caused by member funding of 

SRO operations a concern? Has 

consolidation within the securities 

industry, and the dependence of SROs 

on a relatively small number of firms for 

the bulk of their funding, or other 

developments exacerbated this conflict? 

If other developments have done so, 

identify them. Is it possible to minimize 

these conflicts through SRO governance 

initiatives that are designed to ensure 

greater independence of the board and 

key committees from the regulated 

members? 

Question 2: To what extent are 

member governance conflicts a concern? 

Have the governance changes recently 

made by the NYSE and other SROs to 

enhance their independence been 

effective in reducing these conflicts? 

Are there other governance changes that 

could be made by the SROs that would 

further reduce these conflicts? 

Question 3: Can potential conflicts 

between the regulatory function and 

SRO members be effectively managed 

through the recent enhancements made 

to SRO governance and the changes 

proposed by the SRO Governance and 

Transparency Proposal? Are there other 

measures the Commission should 

consider? 

2. Inherent Conflicts with Market 

Operations 

In addition to conflicts with members, 

an SRO’s regulatory obligations may 

conflict with the interests of its own or 

its affiliate’s market operations. The 

SROs that operate markets (currently, all 

except the MSRB, the NFA, and the 

clearing agencies) are responsible for 

promulgating rules that govern trading 

in their markets; establishing the 

necessary systems and procedures to 

monitor such trading; identifying 

instances of suspicious trading, such as 

potential insider trading and market 

manipulation; and enforcing the 

Exchange Act, the rules thereunder, and 

their own rules.101 If an SRO identifies 

potential misconduct involving persons 

or entities within its jurisdiction, the 

SRO is responsible for conducting a 

further investigation and bringing a 

disciplinary action when appropriate. 

For potential misconduct outside its 

jurisdiction, an SRO is responsible for 

making referrals to the Commission or 

other appropriate agencies and assisting 

these agencies in their investigations.

As competition among markets grows, 

the markets that SROs operate will 

continue to come under increased 

pressure to attract order flow. This

71262 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

102See Citadel Investment Group LLC Web site 

(https://www.citadelgroup.com/).

103Charles Forelle, Fidelity Opposes NYSE 

Proposal Over Limits on ‘‘Sweeps’’ of Trades, The 

Wall Street Journal, August 17, 2004, at C3.

104Traders Magazine, The Windy City’s Auto-Ex 

Democracy (March 1, 2004).

105 Isabelle Clary, Markets Editor, Securities 

Industry News, Brut Buy May Boost Nasdaq, 

(September 6, 2004).

106 Isabelle Clary, Markets Editor, Securities 

Industry News, Nasdaq Strikes Back with Brut Deal

(May 31, 2004). The Brut ECN has subsequently 

shifted the reporting of all of its Tape C trading 

activity to Nasdaq. See Nasdaq Head Trader Alert 

#2004–115, Nasdaq Completes Acquisition of Brut 

LLC (September 7, 2004).

107See 21(a) Report at 40–44.

108 Id.

109 Id.

110 Id.

111For example, complaints related to market 

makers failing to abide by the firm quote rule were 

effectively discouraged both by an ineffective 

procedure for enforcing the rule and by the absence 

of adequate sanctions for demonstrated misconduct. 

The Commission found that the small number of 

NASD formal disciplinary actions for market related 

rule violations brought against joint NYSE/NASD 

member firms, which would encompass the larger 

firms in the securities industry, was cause for 

serious concern over the NASD’s enforcement 

priorities. See 21(a) Report at 40–44.

112Securities and Exchange Commission Concept 

Release, Regulation of Exchanges, S7–16–97, 

Exchange Act Release No. 38672 (May 23, 1997), 62 

FR 30485 (June 4, 1997) (‘‘ATS Concept Release’’). 

The Commission acknowledged that conflicts could 

become particularly acute when an ATS member is 

regulated by an SRO that operates a competing 

market. Id. at 30486–30487.

113See Exchange Act Release No. 43863 (January 

19, 2001), 66 FR 8020 (January 26, 2001); Exchange 

Act Release No. 42166 (November 22, 1999), 64 FR 

68125 (December 6, 1999); Exchange Act Release 

No. 42573 (March 23, 2000), 65 FR 16981 (March 

30, 2000); Exchange Act Release No. 43133 (August 

10, 2000), 65 FR 49842 (August 15, 2000); and 

Exchange Act Release No. 43514 (November 3, 

2000), 65 FR 69084 (November 15, 2000). The 

Commission received 104 comments regarding 

Nasdaq’s order collector, aggregator, and execution 

facility (‘‘SuperMontage’’) proposal.

114 17 CFR 240.11Ac1–1.

115 66 FR 8020, 8052–8055.

116 Id.

117 Id.

118 Id.

business pressure can create a strong 

conflict between the SRO regulatory and 

market operations functions. Because 

increasing inter-market competition has 

provided members (and those that 

represent their orders through members) 

with increasing flexibility as to where to 

direct order flow, SRO staff may be less 

inclined to enforce vigorously SRO rules 

that would cause large liquidity 

providers to redirect order flow. 

For example, one hedge fund 

typically may account for between 1% 

and 2% of total daily dollar volume 

traded on the NYSE.102 One mutual 

fund complex may account for as much 

as 5% of the NYSE’s daily trading 

volume.103 Approximately half of the 80 

million exchange-listed shares executed 

per day on the CHX is directed to eight 

specialist firms.104 Moreover, as of July 

2004, the NSX’s market share grew to 

26.2 percent of the Nasdaq market with 

the majority of that trading activity 

being generated by one member, the 

INET ECN.105 As of May 2004, the Brut 

ECN’s matched shares reported to the 

BSE represented 8.7% of overall Nasdaq 

trading volume.106

While regulatory staff is responsible 

for carrying out self-regulatory 

obligations, they are also a component 

of a competitive business organization. 

As intermarket competition increases, 

regulatory staff may come under 

pressure to permit market activity that 

attracts order flow to their market. 

Market operations staff may also be less 

likely to cooperate and communicate 

with regulatory staff if they think such 

cooperation or communication will 

hinder their effort to attract order flow. 

In addition, SROs face conflicts in 

regulating members that are influential 

in the their markets. For example, in the 

21(a) Report concerning the NASD, the 

Commission found that Nasdaq market 

makers had exerted substantial 

influence over the affairs of the NASD 

through their dominant role in its 

governance, the administration of the 

NASD’s disciplinary process, and the 

operation of Nasdaq.107 Other less 

favored constituencies, such as retail 

and institutional investors and other 

broker-dealers, particularly those day 

trading firms that heavily used Nasdaq’s 

Small Order Execution System (‘‘SOES 

Firms’’), did not have comparable 

representation on the key NASD boards 

and committees.108

The Commission found that market 

maker influence led to a concerted effort 

by the NASD staff to bring disciplinary 

actions against SOES firms.109 Indeed, 

the 21(a) Report concluded that the 

NASD made a high priority of 

enforcement related to violations of its 

SOES rules by subjecting firms to 

special ‘‘sweep’’ examinations, and 

devoting substantial resources to 

monitoring, examining, and bringing 

disciplinary actions for potential 

violations of the day trading rules.110 In 

contrast, the Commission found that the 

NASD was far less aggressive with 

respect to its enforcement of rule 

violations by market makers.111

Another concern is the potential for 

SRO regulatory staff, in the course of 

developing rules and examining 

members, to become overly dependent 

on members for their understanding of 

market practices and to lose their 

independent perspective concerning 

these practices. A potential loss of 

objectivity could accompany the greater 

knowledge and expertise that result 

from having SRO regulatory staff 

interwoven with SRO market 

operations. 

Also, SROs may have a tendency to 

abuse their SRO status by overregulating members that operate markets 

that compete with the SRO’s own 

market for order flow.112 Indeed, among 

other reasons, these concerns led the 

Commission to require the NASD to 

establish the Alternative Display 

Facility (‘‘ADF’’).113 Exchange Act rule 

11Ac1–1 114 requires that SRO members 

communicate their best bids and offers 

to an SRO and in the late 1990s brokerdealer choice as to where to post quotes 

in Nasdaq securities was effectively 

limited to Nasdaq.115 Thus, certain 

users of Nasdaq were concerned that 

they would be put at a distinct 

competitive disadvantage if they were 

compelled to provide their best bids and 

offers to the exclusive securities 

information processor (‘‘SIP’’) for 

Nasdaq securities through the new 

SuperMontage system.116 These users 

argued that, not only would their quotes 

be subject to a competing market’s 

trading rules, but that the situation 

would be rife for abuse because of 

Nasdaq functioning both as a regulator 

and competitor of the ECNs.117 Thus, 

before permitting the launch of Nasdaq’s 

SuperMontage, the Commission 

required that the NASD provide an 

alternative, the ADF, to Nasdaq’s 

SuperMontage on which to quote 

Nasdaq securities.118

The Commission specifically seeks 

public comment on the following 

questions related to conflicts with 

market operations: 

Question 4: To what extent do 

conflicts exist between SRO regulatory 

and market operations functions? Has 

increased intermarket competition 

exacerbated this potential conflict? Are 

markets today attempting to use ‘‘lax 

regulation’’ as a means to attract 

business? Are they attempting to use 

‘‘aggressive regulation’’ as a weapon 

against competitors? Is it unrealistic to 

expect a ‘‘cost center,’’ such as 

regulation, to resist pressure from a 

function that generates business revenue 

in a modern business enterprise? 

Question 5: To what extent has 

internal SRO separation of these 

functions addressed these concerns? 

Has the restructuring of the NASD, and 

the recent governance changes of the 

NYSE and other SROs to enhance their 

independence, been effective in better 

insulating the regulatory function from 

the market function? 

Question 6: Can potential conflicts 

between the regulatory function and

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71263

119Pub. L. 107–204, 116 Stat. 745 (2002).

120See generally Exchange Act Release No. 47654 

(April 9, 2003), 68 FR 18788 (April 16, 2003).

121 Id. at 18790.

122 Id.

123 Id.

124 Id.

125Andrei Postelnicu, Listing Chief Sets Sights 

Abroad, Financial Times, August 23, 2004, at 25.

126Andrei Postelnicu, ArcaEx launches listings 

drive, Financial Times, September 16, 2004, at 22.

127Nasdaq CEO: Competitive Practices Could 

Have Helped NYSE, Dow Jones News Service, 

August 25, 2004.

128 Yuka Hayashi, Foreign Firms Consider Listing 

Shares in Tokyo, Wall Street Journal, October 18, 

2004, at C16.

129 It is also possible for demutualization of SROs 

to cause complicated transactional issues to arise. 

For instance, complications could surface if a 

demutualized SRO bid to purchase a listed 

company. Another problematic situation could be 

one in which a demutualized SRO competes with 

Continued

SRO market operations be effectively 

managed through the recent 

enhancements made to SRO governance 

and the changes proposed by the SRO 

Governance and Transparency 

Proposal? Are there other measures the 

Commission should consider? 

3. Inherent Conflicts With Issuers 

Another potential SRO conflict is 

with listed issuers. The SROs 

promulgate and administer listing 

standards that govern the securities that 

may be traded in their markets. For 

corporate securities, these rules include 

minimum financial qualifications and 

reporting requirements for their issuers. 

Obtaining a listing on a prominent SRO 

market provides corporate issuers with 

enhanced visibility and prestige in the 

eyes of investors, as well as the 

appearance of a well-operated and wellregulated trading market for their 

securities. An active market for 

secondary trading in a corporation’s 

securities benefits not only its 

shareholders, but also the corporation 

itself through enhanced capital-raising 

capacities. 

SRO listing standards also have a 

major role in corporate governance, 

particularly since the passage of the 

Sarbanes-Oxley Act.119 Specifically, 

under recently adopted rules, SROs are 

prohibited from listing any security of 

an issuer that is not in compliance with 

certain standards.120 Each member of 

the audit committee of the issuer must 

be independent according to specified 

criteria.121 In addition, the audit 

committee of each issuer must be 

directly responsible for the 

appointment, compensation, retention 

and oversight of the work of any 

registered public accounting firm 

engaged for the purpose of preparing or 

issuing an audit report or performing 

other audit, review or attest services for 

the issuer, and each such registered 

public accounting firm must report 

directly to the audit committee.122

Moreover, each audit committee must 

establish procedures for the receipt, 

retention and treatment of complaints 

regarding accounting, internal 

accounting controls or auditing matters, 

including procedures for the 

confidential, anonymous submission by 

employees of the issuer of concerns 

regarding questionable accounting or 

auditing matters.123 Each audit 

committee must also have the authority 

to engage independent counsel and 

other advisors, as it determines 

necessary, to carry out its duties and 

each issuer must provide appropriate 

funding for the audit committee.124

The SROs are responsible for 

monitoring issuers and delisting the 

securities of those that fail to meet SRO 

minimum requirements, but also 

compete vigorously to attract and retain 

listings, as illustrated recently by the 

high profile competition to list the 

Google Initial Public Offering.125 This 

competition has been heightened by 

new listing venues. For instance, the 

equity trading facility of the PCX, 

ArcaEx, has been actively courting 

issuers to list 126 and in the Spring of 

2004, Nasdaq launched a high profile 

dual listing program for NYSE stocks.127

Moreover, there are indications that 

international stock exchanges are 

becoming more competitive with 

respect to attracting foreign companies 

to list on their markets (rather than on 

U.S. markets).128

As issuers are offered new alternatives 

as to markets on which to list their 

securities, SROs face increasing 

competitive pressure to gain and retain 

listings. As with SRO competition for 

members and order flow, competition 

for issuers may cause an SRO to fail to 

discharge its self-regulatory 

responsibilities properly. This can take 

the form of admitting to trading issuers 

that fail to satisfy initial listing 

standards; delaying the delisting of 

issuers that no longer satisfy 

maintenance standards; failing to 

enforce listing standards (including the 

new issuer corporate governance 

standards); and reducing (or even 

eliminating) listing fees. This 

competition also can reveal itself in an 

unwillingness to restrict issuer activities 

or impose requirements that may be 

more stringent than similar rules of 

competitor SROs. 

Another issue with respect to listings 

relates to conflicts associated with 

listings of members’ proprietary 

products such as Exchange Traded 

Funds (‘‘ETFs’’). In some instances, the 

creator of a proprietary product may be 

an SRO member that becomes the 

specialist or primary market maker of 

the product. In the equity markets, the 

issuer typically has authority with 

respect to where the stock is to be listed. 

With respect to such proprietary 

products, the product creator (and 

potentially the product’s sole specialist 

or primary market maker) may have 

significant authority as to where the 

product is listed. When an SRO member 

is a combined member/issuer of a 

popular product and that member 

wields authority with respect to 

transferring the listing of the product to 

another SRO, the SRO may be 

disinclined to regulate that member 

vigorously. 

The Commission specifically seeks 

public comment on the following 

questions related to conflicts with 

issuers: 

Question 7: To what extent have 

conflicts arisen between SRO regulatory 

and issuer listing functions? Has the 

recent increase in competition among 

SRO markets for listings created 

incentives to admit issuers that fail to 

satisfy initial listing standards or delay 

the delisting of issuers that no longer 

satisfy maintenance standards? To the 

extent increased competition for listings 

has caused SROs to waive or lower 

listing fees, has this negatively impacted 

regulatory funding and further inhibited 

enforcement of listing standards?

Question 8: Has the sponsorship of 

popular proprietary products by 

member firms compounded the inherent 

conflicts discussed above with both 

members and issuers? Specifically, are 

SROs disinclined to regulate vigorously 

either the trading activity of popular 

proprietary products or the activity of 

members firms that are the sponsors of 

such products? 

4. Inherent Conflicts With Shareholders 

Another significant conflict of interest 

for SRO responsibilities is with SRO 

shareholders. SRO demutualization 

raises the concern that the profit motive 

of a shareholder-owned SRO could 

detract from proper self-regulation. For 

instance, shareholder owned SROs may 

commit insufficient funds to regulatory 

operations or use their disciplinary 

function as a revenue generator with 

respect to member firms that operate 

competing trading systems or whose 

trading activity is otherwise perceived 

as undesirable. Moreover, as with the 

inherent conflicts discussed above, this 

conflict can be exacerbated by increased 

intermarket competition.129

71264 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

a listed company for the purchase of a third entity. 

Conflicts would clearly present themselves in these 

situations. 130For instance, several exchanges that have 

converted to shareholder-owned structures have 

limited the ability of any person, including their 

members, to directly or indirectly own and vote 

more than a certain percentage of the interest in the 

exchange. See e.g., Securities Exchange Act Release 

Nos. 49718 and 49098. Exchanges also have similar 

limits on concentration of ownership of facilities 

that are separate corporate entities from the 

exchange. See e.g., Securities Exchange Act Release 

Nos. 50170 and 49067. The Commission approved 

these limitations on a case-by-case basis pursuant 

to the rule filing process of Section 19(b) of the 

Exchange Act and Rule 19b–4 thereunder. 15 U.S.C. 

78s(b) and 17 CFR 240.19b–4. 131 15 U.S.C. 78q and 17 CFR 240.17d–1.

132 17 CFR 240.17d–1.

133 Id.

134 17 CFR 240.17d–2.

135 Id.

136See generally Exchange Act Release No. 49197 

(February 5, 2004), 69 FR 7046 (February 12, 2004).

137Under the plan, the SRO participant 

responsible for conducting options-related sales 

practice examinations of a firm, and investigating 

options-related customer complaints and 

terminations for cause of associated persons of that 

firm, is known as the firm’s Designated Options 

Examining Authority (‘‘DOEA’’). Pursuant to the 

plan, any other SRO of which the firm is a member 

is relieved of these responsibilities during the 

period the firm is assigned to a DOEA. The options 

17d–2 Plan is administered by a committee, the 

Options Self-Regulatory Council, which is 

composed of one representative from each SRO 

signatory to the plan. Under the Options 17d–2 

plan, common options rules across the different 

options SROs have been designated and are 

enforced by the DOEA. The DOEAs for common 

members are assigned based on a variety of factors, 

including the most equitable allocation of the 

regulatory burden of carrying out the duties of the 

DOEA. In addition, all DOEA assignments are made 

by a majority vote of all SRO participants of the 

plan. Common rules covered by the plan include 

those related to the opening of options accounts, the 

supervision of options trading, and customer 

suitability for trading options. See e.g., Exchange 

Act Release No. 49197 (February 5, 2004), 69 FR 

7046 (February 12, 2004).

138See supra Section II.

139U.S. General Accounting Office Report to 

Congressional Committees, ‘‘Securities Markets 

Competition and Multiple Regulators Heighten 

Concern about Self-Regulation’’ (May 2004) (‘‘GAO 

Report’’).

140 GAO Report at 30.

141See e.g., notice and comment process for the 

adoption of a uniform NASD and NYSE ‘‘branch 

office’’ definition. Exchange Act Release Nos. 48897 

(December 9, 2003), 68 FR 70059 (December 16, 

2003); 46888 (November 22, 2002), 67 FR 72257 

(December 4, 2002).

142Concept Release: Request for Comment on 

Nasdaq Petition Relating to the Regulation of 

Nasdaq-Listed Securities, Exchange Act Release No. 

47849 (May 14, 2003), 68 FR 27722 (May 20, 2003) 

(‘‘Intermarket Trading Concept Release’’).

143 Intermarket Trading Concept Release at 27724.

144 Id.

A variety of ownership controls for 

demutualized SROs can potentially 

prevent some of these conflicts.130

Indeed, as previously noted, this 

concept release is being published in 

conjunction with the SRO Governance 

and Transparency Proposal, which 

would, if adopted, impose a variety of 

restrictions, including an effective 

restriction on revenue from regulatory 

operations being used to pay dividends 

to shareholders.

The Commission specifically seeks 

public comment on the following 

questions related to conflicts with 

shareholders: 

Question 9: What are the conflicts 

between a demutualized SRO’s 

regulatory responsibilities and the 

profit-making orientation of its 

shareholders? To what extent do they 

heighten the inherent SRO conflicts 

with members, market operations, and 

listed issuers discussed above? 

Question 10: Can potential conflicts 

between the regulatory function and 

SRO shareholders be effectively 

managed through the recent 

enhancements to SRO governance and 

the changes proposed by the SRO 

Governance and Transparency 

Proposal? Or are there other measures 

the Commission should take to help 

ensure that the effectiveness of the 

regulatory function is not diminished? 

B. Inefficiencies of Multiple SROs 

Securities industry self-regulation 

carries with it an inherent inefficiency 

in that it can cause duplicative and 

potentially conflicting regulation. 

Specifically, the existence of multiple 

SROs can result in duplicative and 

conflicting SRO rules, rule 

interpretations, and inspection regimes. 

The system can also result in redundant 

SRO regulatory staff and infrastructure 

across SROs. 

Congress and the Commission have 

put in place methods for reducing a 

certain amount of regulatory 

duplication. Pursuant to Exchange Act 

Section 17(d) and Rule 17d–1,131 when 

a member belongs to more than one 

SRO, the SEC shall designate the 

responsibility to one SRO for examining 

the member for compliance with 

applicable financial responsibility 

rules.132 The undesignated SRO is 

relieved of responsibility for examining 

the member for compliance with 

financial responsibility rules.133 In 

addition, Rule 17d–2 under the 

Exchange Act permits SROs to establish 

Commission approved joint plans for 

allocating regulatory responsibilities 

with respect to common members.134

An SRO participating in such a 

regulatory plan approved by the 

Commission is relieved of regulatory 

responsibilities with respect to a brokerdealer member, if those regulatory 

responsibilities have been allocated to 

another SRO under the regulatory 

plan.135

The options SROs, for example, have 

utilized a 17d–2 agreement to reduce 

regulatory redundancies.136 The options 

markets’ 17d–2 Plan reduces regulatory 

duplication for a large number of firms 

currently members of two or more of the 

SRO participants by equitably allocating 

regulatory responsibility for a set of 

options sales practice rules that are 

substantially identical for each of the 

SRO participants.137

While the potential for the SRO 

system to cause regulatory redundancies 

is not a novel issue for the 

Commission,138 it appears that the 

inefficiencies caused by the SRO system 

are being aggravated by greater market 

fragmentation of order flow among 

SROs. Thus, a recent U.S. General 

Accounting Office (‘‘GAO’’) analysis is 

worth discussing. In May of 2002, the 

GAO issued a report, which specifically 

focused on the implications of market 

fragmentation with respect to securities 

industry regulatory redundancies.139 It 

ultimately discussed a broad range of 

issues related to the relationship 

between self-regulation and intermarket 

competition for order flow. The GAO 

Report recommended that the 

Commission work with the SROs and 

broker-dealers to implement a formal 

process for systematically identifying 

and addressing material regulatory 

inefficiencies caused by differences in 

rules and rule interpretations among 

SROs and by multiple examinations of 

broker-dealers.140 In the wake of the 

GAO Report, the Commission supported 

the formation of a joint NASD and 

NYSE task force with the mission of 

examining their conflicting rules and 

determining how those conflicts could 

be resolved. The Commission has been 

working with the SROs in this respect 

and facilitating SRO rule amendments 

when appropriate.141

More recently, in light of issues raised 

in a petition for rulemaking filed by 

Nasdaq, the Commission published a 

concept release covering the regulation 

of intermarket trading of Nasdaq 

securities.142 The Intermarket Trading 

Concept Release discussed Nasdaq’s 

concern about the potential 

development of ‘‘regulatory arbitrage’’

when SRO rules are inconsistent across 

markets.143 Specifically, according to 

Nasdaq, this type of arbitrage could 

result in the attraction of order flow and 

members to certain SROs over others 

because of the prospect of lax 

regulation.144 The Intermarket Trading 

Concept Release sought public comment 

on the importance of uniformity with 

respect to a variety of rules related to 

intermarket trading of Nasdaq-listed 

securities, including rules related to 

market manipulation, illegal short 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71265

145 Id.

146 Id.

147Exchange Act Sections 12(f)(2) and (3), 15 

U.S.C. 78l(f)(2) and (3). Intermarket Trading 

Concept Release at 27725.

148See Intermarket Trading Concept Release at 

27724–27725.

149See letter from John S. Markle, Associate 

General Counsel, Ameritrade Holding Company, to 

Jonathan G. Katz, Secretary, Commission, pp. 2–3 

(July 10, 2003) (‘‘Ameritrade Letter’’); letter from 

William O’Brien, Chief Operating Officer, Brut, 

LLC, to Jonathan G. Katz, Secretary, the 

Commission, p. 2 (June 19, 2003) (‘‘Brut Letter’’); 

letter from Jeffrey T. Brown, Cincinnati Stock 

Exchange, to Jonathan G. Katz, Secretary, 

Commission, pp. 5–6 (June 19, 2003) (‘‘CSE 

Letter’’); letter from Michael J. Simon, Senior Vice 

President and Secretary, ISE, to Jonathan G. Katz, 

Secretary, Commission, p. 2 (June 19, 2003) (‘‘ISE 

Letter’’); letter from Brian F. Colby, Chairman, 

Intermarket Surveillance Group, to Jonathan G. 

Katz, Secretary, Commission, pp. 1–2 (June 18, 

2003) (‘‘ISG Letter’’); letter from Darla C. Stuckey, 

Corporate Secretary, NYSE, to Jonathan G. Katz, 

Secretary, Commission, pp. 4–5 (June 19, 2003) 

(‘‘NYSE letter’’); letter from Meyer S. Frucher, Phlx, 

to Jonathan G. Katz, Secretary, Commission, pp. 2–

6 (June 17, 2003) (‘‘Phlx Letter’’).

150See Ameritrade Letter pp. 2–3; letter from Kim 

Bang, Bloomberg Tradebook LLC, to Jonathan G. 

Katz, Secretary, Commission, p. 2 (June 20, 2003) 

(Bloomberg letter); Brut letter pp. 3–4, letter from 

Richard Ketchum, General Counsel, Global 

Corporate & Investment Bank, Citigroup Global 

Capital Markets, to Jonathan G. Katz, Secretary, 

Commission, pp. 7–9 (July 8, 2003) (‘‘Citigroup 

letter’’); letter from Edward J. Joyce, President and 

Chief Operating Officer, Chicago Board Options 

Exchange, Incorporated, to Jonathan G. Katz, 

Secretary, Commission, p. 2 (June 30, 2003) (‘‘CBOE 

letter’’); letter from Eric Schwartz, Managing 

Director, Goldman Sachs & Co., and Duncan 

Niederauer, Co-Chief Executive Officer, Spear, 

Leeds & Kellogg, L.P., to Jonathan G. Katz, Secretary 

, Commission, p. 2 (July 25, 2003) (‘‘GS/SLK 

letter’’); letter from Craig S. Tyle, General Counsel, 

Investment Company Institute , to Jonathan G. Katz, 

Secretary, Commission, p. 1 (June 19, 2003) (‘‘ICI 

letter’’); letter from Barbara Z. Sweeney, Senior Vice 

President and Corporate Secretary, NASD, to 

Jonathan G. Katz, Secretary, Commission, p. 12 

(June 20, 2003) (‘‘NASD letter’’); letter from Donald 

D. Kittell, Executive Vice President, Securities 

Industry Association, to Jonathan G. Katz, 

Secretary, Commission, pp. 3–5 (June 27, 2003) 

(‘‘SIA letter’’); and Mary McDermott Holland, Mark 

Madoff, and John C. Giesea, Securities Traders 

Association, to Jonathan G. Katz, Secretary, 

Commission, p. 3 (June 19, 2003) (‘‘STA letter’’).

151See letter from W. Hardy Callcott, SVP & 

General Counsel, Charles Schwab & Co., Inc., to 

Jonathan G. Katz, Secretary, Commission (July 7, 

2003) (‘‘Schwab letter’’).

152 Intermarket Trading Concept Release at 

27724.

153 Intermarket Trading Concept Release at 

27724. OATS is part of an integrated audit trail 

system, developed by NASD. It provides a source 

of timed, sequenced order events, which, when 

combined with existing quotation and trading 

information, assists in the surveillance of the 

Nasdaq market. See OATS Subscriber Manual 

2004.3, 1–1 (October 4, 2004). The general objective 

of OATS is to recreate daily market activity by 

capturing and maintaining order data reported by 

member firms. OATS Subscriber Manual at 2–1.

154 Intermarket Trading Concept Release at 

27723.

155 Id.

156 15 U.S.C. 78k–1 or 78q(d).

157See ISG letter at 1.

158 In its comment letter, ISG states that it has 

also established an affiliate category of membership 

to all futures exchanges and non-U.S. organizations 

to join. Moroever, ISG notes that certain ISG 

affiliate members (One Chicago LLC, Nasdaq LIFFE 

Markets LLC, CME Inc. and Island Futures 

Exchange LLC) by virtue of their status as ‘‘notice 

registered National Securities Exchanges’’ and as 

signatories to the Addendum for Securities Futures 

products, have already submitted themselves to 

elements of the ISG Agreement, as amended in 

1994. As such, ISG maintains they have accepted 

ISG as the appropriate forum for resolving intermarket issues. See ISG Letter p. 1–2.

159 Id.

selling, insider trading, fraud, front 

running, marking the open or close, 

non-compliance with the limit order 

display rule, and non-compliance with 

the firm quote rule.145 The Intermarket 

Trading Concept Release solicited 

comment on whether uniform rules are 

necessary to prevent regulatory 

arbitrage.146 It also noted Nasdaq’s 

contention that the disparities in rules 

between SROs pose a serious threat to 

investor protection and discussed 

Nasdaq’s request that the Commission 

exercise its authority under Sections 

12(f)(2) and (3) of the Act 147 to prohibit 

the launch or continuation of Nasdaq 

trading by any market that failed to 

adopt adequate regulatory protections, 

including rules related to inter-market 

trading issues.148

The Commission received a variety of 

comments in response to the 

Intermarket Trading Concept Release. 

Commenters, including certain SROs 

and ECNs that compete with Nasdaq for 

order flow, argued that there is, in fact, 

no unequal regulation across markets 

and that trading that falls within each 

SRO’s purview is effectively 

regulated.149 Some commenters voiced a 

qualified endorsement of uniform rules 

in certain areas, but were careful to note 

that uniform rules should in no way 

restrict each SRO’s ability to craft rules 

that reinforce its own unique intramarket structures or competitive 

business models.150 At least one 

commenter even supported the creation 

of a single independent regulator that 

would be responsible for regulating all 

broker-dealers in all markets.151

Thus, while the Intermarket Trading 

Concept Release drew out thoughtful 

public commentary on discrete issues 

related to the SRO system’s regulatory 

inefficiencies and redundancies, this 

concept release seeks public 

commentary on these issues in the 

broader context of the efficacy of the 

SRO system overall. Specifically, the 

Commission specifically seeks public 

comment on the following questions: 

Question 11: Is the lack of intermarket 

rules across markets trading the same 

type of securities causing regulatory 

arbitrage and, if so, what is the impact 

of this on the SRO system? Should this 

issue be addressed through changes at 

the SRO system level, rather than at the 

individual SRO level? 

Question 12: How significant are the 

inefficiencies resulting from multiple 

SROs overseeing the activities of the 

same members? In what areas do these 

issues primarily arise? 

C. Intermarket Surveillance 

Another area in which the SRO 

system has recently come under 

increasing strain because of market 

fragmentation is with respect to SRO 

and Commission supervision of 

intermarket trading. When order flow 

was largely concentrated in the primary 

markets, traders had limited ability to 

cloak illicit activity by spreading trades 

across markets. When trading takes 

place in multiple active markets, 

however, it is possible for traders to veil 

illegal trading activity by dispersing 

trades across markets.

The Intermarket Trading Concept 

Release specifically sought public 

comment on this topic. 152 The release 

focused public attention on Nasdaq’s 

contention that its extensive audit trail 

data was of limited use for cross-market 

surveillance, because it cannot capture 

relevant data for executions that take 

place on other markets trading Nasdaq 

securities, and other markets do not 

have comparable systems that can 

interact with NASD’s Order Audit Trail 

System (‘‘OATS’’), which captures 

regulatory data concerning the 

important stages in the life of a trade. 153

The Intermarket Trading Concept 

Release also focused comment on the 

role of the Intermarket Surveillance 

Group (‘‘ISG’’), which is an industry 

organization created in 1983 to 

coordinate intermarket surveillance 

among the self-regulatory organizations 

by cooperatively sharing regulatory 

information pursuant to a written 

agreement between the parties. 154 The 

goal of the ISG’s information sharing is 

to coordinate regulatory efforts to 

address potential intermarket trading 

abuses and manipulations. 155 Although 

the ISG Agreement was not established 

under Section 11A or 17(d) of the 

Securities Exchange Act of 1934, 156 ISG 

asserts that the Commission has 

required new markets to become ISG 

members as a condition of registration, 

thus recognizing its importance. 157

ISG’s full members are the Amex, BSE, 

CBOE, CHX, NSX, ISE, NASD, NYSE, 

PCX, and the Phlx (collectively ‘‘Full 

Members’’). 158 Each of the Full 

Members is an SRO for which the 

Commission has direct oversight. 159 As 

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160 Id.

161For instance, ISG audit trail information is 

clearing level data, rather than executing firm level 

data. According to Nasdaq, the ISG data time fields 

are not generated by clocks subject to uniform 

synchronization protocols, as is the case with OATS 

data. Moreover, Nasdaq states that ISG data is 

transmitted two days after the trade takes place and 

in a format that cannot be readily integrated into the 

NASD’s automated surveillance systems. Nasdaq 

argued that the two day delay significantly hinders 

NASD’s ability to investigate unlawful trading 

activity on a real-time basis and can prevent NASD 

from obtaining non-stale regulatory information in 

an ongoing investigation. Inter-Market Trading 

Concept Release at 27723.

162 Id.

163See infra notes 164–176.

164CSE letter at 3–7 and ISG letter at 2.

165Ameritrade letter at 3; CSE letter at 17–18; ISE 

letter at 3–4; GS/SLK letter at 3–4; Phlx letter at 6–

7; SIA letter at 4; STA letter at 3.

166Ameritrade letter at 2; Brut letter at 6; CBOE 

letter at 2; CSE letter at 10–13; ISE letter at 3–4; ISG 

letter at 2; NYSE letter at 3–5; Phlx letter at 6–7; 

and SIA letter at 7.

167 ISG letter at 2.

168 Id.

169 Id.

170 ISG letter at 2–3.

171 ISG letter at 2–3.

172See generally NYSE letter.

173NYSE letter at 4–5.

174NYSE letter at 4–5.

175NASD letter at 9.

176NASD letter at 8.

177See Exchange Act Release No. 43268 

(September 11, 2000), File No. 3–10282, (‘‘Options 

Settlement’’).

178See Id. at Section IV.B.e.

179 Id.

180 Id.

a result, the regulatory procedures that 

these SROs have developed, 

individually and jointly, including 

those developed for insider trading and 

certain types of market manipulation, 

are subject to Commission jurisdiction 

and are regularly examined for 

sufficiency. 160

In its petition, Nasdaq asserted that, 

for a variety of reasons, the data, 

received through ISG regarding other 

markets, is insufficient to enable Nasdaq 

to properly surveil intermarket trading 

activity. 161 Nasdaq also posited that 

consolidated regulation of Nasdaq 

trading across all markets for 

intermarket surveillance purposes 

would be fundamentally more effective 

because of the flaws of ISG data and 

because the ISG is composed of some 

members that do not necessarily trade 

Nasdaq securities (including certain 

non-Full Members that are not regulated 

as SROs by the Commission). 162

In response to the Intermarket Trading 

Concept Release, the Commission 

received a variety of comments on 

intermarket surveillance and order audit 

trail issues. 163 Some commenters 

argued that existing audit trail systems 

were well designed, even though they 

did not interact with Nasdaq’s. 164 In 

addition, many commenters were 

concerned that complying with multiple 

SROs’ different order audit trail systems 

would be burdensome and expensive to 

implement and administer. 165 Other 

commenters argued that Nasdaq had 

understated the effectiveness of ISG and 

that the organization should be allowed 

to continue in its role as the facilitator 

of regulatory data sharing among 

markets. 166

In its comment letter, the ISG 

described its consolidated audit trail 

system, which supplements individual 

markets’ surveillance systems by 

facilitating the analysis and review of 

information concerning potential 

trading violations. 167 By allowing the 

SROs to share their regulatory 

information, ISG asserts, the SROs are 

able to view trading activity in the 

context of all markets’ clearing level 

quote and trade data. 168 The ISG argued 

that its Equity Audit Trail system 

provides a consolidated view across all 

markets of quotes and trades, including 

clearing information. 169 Moreover, ISG 

stated that its systems serve their 

purpose well and that no other market 

had raised the issues that Nasdaq raised 

in its petition. 170 Specifically, the ISG 

claimed that neither the time delays in 

receiving information through ISG nor 

the lack of a uniform synchronization 

protocol had proven to be 

problematic. 171

In the NYSE’s comment letter, it 

generally supported the traditional role 

of the ISG. 172 Moreover, the NYSE 

described its own order audit trail, the 

Order Tracking System (‘‘OTS’’), and 

how its rules are comparable to those of 

the NASD’s OATS. 173 The NYSE raised 

the possibility of the Commission 

requiring that each individual market 

establish an order audit trail system 

similar to the NYSE’s and the NASD’s 

and mandating that the data from these 

separate order audit trails be integrated 

into the ISG’s consolidated order audit 

trail. 174

In its comment letter in response to 

the Intermarket Trading Concept 

Release, the NASD echoed many of the 

concerns raised by Nasdaq in its 

petition. Specifically, the NASD argued 

that the current model of coordinated 

regulation results in regulatory gaps and 

that potential misconduct can occur 

across markets undetected by 

regulators. 175 It also argued that the less 

detailed regulatory information 

collected by the ISG lacks certain 

critical pieces of information to 

effectively assist SROs in regulating 

intermarket trading activity. 176

With respect to the options markets, 

in September of 2000, the Commission 

accepted settlement agreements from 

the Amex, CBOE, Phlx, and PCX in 

connection with administrative 

proceedings, alleging, among other 

things, that these options exchanges had 

inadequately discharged their 

obligations as SROs by failing to enforce 

compliance with certain rules, 

including order handling rules, 

reporting rules, and rules prohibiting 

anticompetitive conduct. 177 As a result, 

in settling the Commission’s 

enforcement action, the options 

exchanges undertook a variety of steps 

to prevent future self-regulatory lapses, 

including the design and 

implementation of a consolidated 

options audit trail system 

(‘‘COATS’’). 178 COATS would enable 

the options exchanges to reconstruct 

markets promptly, effectively surveil 

them and enforce order handling, firm 

quote, trade reporting and other 

rules. 179 The full extent to which 

COATS effectively enhances 

intermarket options surveillance is not 

known as of yet because the system is 

in the final stage of its implementation. 

COATS, however, suggests the potential 

for a consolidated audit trail for the 

equity markets.

While the full implementation of 

robust intermarket order audit trails 

would be a significant step forward, an 

order audit trail is simply a tool that can 

be used by regulators to better surveil 

for illicit trading activity. In the 2000 

Options Settlement, the options 

exchanges undertook to design and 

implement, concurrent with the design 

and implementation of COATS, 

effective surveillance systems to use the 

newly available COATS data to enforce 

the federal securities laws and SRO 

rules. 180 Thus, even when COATS is 

fully implemented and even if a similar 

intermarket audit trail were developed 

for the equity markets, the SRO 

regulatory function would still play a 

critical role in the regulation of 

intermarket trading.

The Commission specifically seeks 

public comment on the following 

questions related to intermarket 

surveillance and regulation: 

Question 13: To what extent does our 

market model of multiple competing 

SROs create gaps in intermarket trading 

surveillance? What types of illicit 

trading activity in particular can be 

hidden from regulators by dispersing 

trading across multiple markets? 

Question 14: How effectively does the 

ISG serve as a facilitator of regulatory 

data sharing and surveillance 

coordination among SROs? Is the ISG’s 

order audit trail effective as a regulatory 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71267

181The SECO program was implemented because 

neither the Exchange Act nor the Maloney Act 

compelled broker-dealers to become SRO members. 

In 1964, the Commission was in favor of 

compulsory membership in the NASD. Congress, 

however, opted for Commission regulation of 

broker-dealers who were not members of an 

association. Congress intended the SECO 

regulations to mirror the substantive and most of 

the procedural requirements of the NASD so that 

SECO firms would not enjoy a competitive 

advantage over NASD members or escape the 

regulation of ethical standards. Consequently, the 

Commission was tasked with designing rules to 

promote just and equitable principles of trade; to 

regulate the training and competency of securities 

industry professionals; to adopt regulations 

regarding broker-dealers and associated persons 

qualifications and training; and to adopt standards 

to cooperate with associations on qualification 

exams and exam fees. See Market 2000 Report VI–

6.

182See Pub L. 98–38; Exchange Act Release No. 

20409 (November 22, 1983), 48 FR 53688(November 

29, 1983).

183 Id. See also Exchange Act Section 15, 15 

U.S.C. 78o.

184H.R. Rep. No. 98–106 (1983).

185H.R. Rep. No. 98–106, at 7 (1983).

186 Id.

187 Id. at 6.

188See Market 2000 Report at VI–6.

189As noted above, two ongoing Commission 

rulemakings have a bearing on SRO funding. First, 

proposed Reg NMS contains a provision that would 

reallocate market data revenues to encourage price 

formation. The Commission is also proposing the 

SRO Governance and Transparency Proposal, a 

rulemaking that would greatly increase SRO 

transparency with respect to funding (including 

regulatory funding) and funding allocations.

190See generally Exchange Act Sections 6 and 

15A, 15 U.S.C. 78f and 78o–3.

191Exchange Act Section 6(b)(4), 15 U.S.C. 

78f(b)(4).

192See Exchange Act Section 15A(b)(5), 15 U.S.C. 

78o-3(b)(5).

193See Exchange Act Section 15A(b)(2) and 

6(b)(1) 15 U.S.C. 78o-3(b)(2) and 78f(b)(1).

tool? How feasible would it be to require 

all markets to adopt order audit trails 

similar to those of the NYSE and the 

NASD and ultimately to integrate all 

markets’ order audit trails into the ISG’s 

consolidated order audit trail? 

Question 15: How similar are the 

order audit trail systems of the NYSE 

and the NASD? Could they be merged 

into one consolidated system and what 

would be the benefits of such a 

consolidated system? Should NASD’s 

OATS or NYSE’s OTS requirements be 

extended to all equity markets to 

enhance the ability of SROs to surveill 

intermarket activity? If so, could all 

markets’ individual order audit trails be 

successfully integrated into the ISG’s 

consolidated order audit trail or another 

consolidated system? How useful a 

regulatory tool would the ISG’s 

consolidated order audit trail system be 

if all markets were required to adopt 

their own order audit trail systems and 

their data was required to be integrated 

into the ISG’s?

Question 16: To what extent is there 

a need for an order audit trail to provide 

crossover surveillance between the 

equities and options markets? To what 

extent would such crossover 

surveillance detect specific types of 

illicit trading activity? 

D. Funding 

Another feature of the SRO system to 

be discussed relates to the funding of 

SRO regulatory operations. One of the 

key historical benefits of the SRO 

system is its self-funding structure, 

which leverages the limited resources of 

the Commission. Experience appears to 

indicate that the Commission, in its 

current form, does not have the 

resources to effectively carry out on its 

own the full panoply of duties for which 

the SROs are currently responsible. In 

1983, after 18 years of experience with 

directly regulating over-the-counter 

broker-dealer activity through the SEC 

Only (‘‘SECO’’) program,181 the regime 

was repealed.182 Congress amended the 

Exchange Act provisions covering direct 

regulation of broker dealers by the SEC 

and imposed compulsory SRO 

membership.183

At the time of the repeal of the SECO 

program, the House Committee on 

Energy and Commerce reported to the 

Committee of the Whole House that the 

SECO program was unnecessarily costly 

and diverted the SEC’s limited resources 

away from areas of major concern, 

merely to duplicate the functions of the 

NASD.184 The House Committee stated 

‘‘that any attempt to put SECO 

regulation on a par with that provided 

by the NASD would require significant 

expenditures by the Commission for 

additional staff and administrative 

costs.’’ 185 The committee also noted 

that SROs were better able to maintain 

ethical standards for the industry and to 

perform certain detailed oversight 

functions.186 The House also cited the 

limitations of enforcement and 

compliance remedies available to the 

Commission in comparison to the 

remedies available to the NASD.187

In the Market 2000 Report, the 

Commission’s staff provided its 

retrospective impression of the SECO 

program’s performance. The staff noted 

its belief that the SECO experience 

illustrated ‘‘that the resources necessary 

for the Commission to assume SRO 

regulatory functions directly and 

effectively are not realistically 

attainable.’’ 188 The SECO experience 

demonstrated the important role that 

SROs play in maximizing the 

Commission’s limited resources. It also 

illustrated that regulation must be 

properly funded and have sufficient 

resources to be effective. In that regard, 

the most finely-balanced SRO structure 

will not ensure that SRO statutory 

obligations are met, if regulatory 

operations are insufficiently funded. 

Thus, SRO funding arrangements are 

critical to the SRO system.189

1. Overview 

While Congress was fairly 

prescriptive in its initial enactment of 

the Exchange Act and in subsequent 

amendments as to the standing 

responsibilities of SROs, it has not 

provided explicit guidance as to the 

proper levels or methods of funding for 

self-regulatory operations.190 Section 6 

of the Exchange Act, which addresses 

the registration of national securities 

exchanges, requires that ‘‘the rules of 

the exchange provide for the equitable 

allocation of reasonable dues, fees, and 

other charges among its members and 

issuers and other persons using its 

facilities.’’ 191 Section 15A contains a 

similar provision in connection with the 

registration of national securities 

associations.192 These provisions also 

require that an SRO be ‘‘so organized 

and [have] the capacity to be able to 

carry out the purposes’’ of the Exchange 

Act and ‘‘to comply, and * * * to 

enforce compliance by its members, and 

persons associated with its members, 

with the provisions’ of the Exchange 

Act.193 Accordingly, while Congress 

provided only general guidance with 

respect to SRO funding, a reasonable 

reading of the Exchange Act indicates 

that it intended that regulatory funding 

be sufficient to permit SROs to fulfill 

their statutory responsibilities under the 

Exchange Act, and contemplated that 

such funding would be achieved 

through equitable assessments on the 

members, issuers, and other users of an 

SRO’s facilities.

The Commission to date has not 

issued detailed rules specifying proper 

funding levels of SRO regulatory 

programs, or how costs should be 

allocated among the various SRO 

constituencies. Rather, the Commission 

has examined the SROs to determine 

whether they are complying with their 

statutory responsibilities. This approach 

was developed in response to the 

diverse characteristics and roles of the 

various SROs and the markets they 

operate. The mechanics of SRO funding, 

including the amount of revenue that is 

spent on regulation and how that 

amount is allocated among various 

regulatory operations, is related to the 

type of market that an SRO is operating. 

Prior to the SRO Governance and 

Transparency Proposal, the Commission 

had not proposed requiring a single 

71268 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

194See generally Exchange Act Section 11A, 15 

U.S.C. 78k–1.

195See generally Policy Statement: Automated 

Systems of Self-Regulatory Organizations, Exchange 

Act Release No. 27445 (November 16, 1989), 54 FR 

48703 (November 24, 1989); Policy Statement: 

Automated Systems of Self-Regulatory 

Organizations (II), Exchange Act Release No. 29185 

(May 9, 1991), 56 FR 22490 (May 15, 1991).

196See Concept Release, Regulation of Market 

information Fees and Revenues (‘‘Market Data 

Concept Release’’), Exchange Act Release No. 42208 

(File No. S7–28–99) (December 9, 1999), 64 FR 

70613, 70615 (December 17, 1999).

197 Data compiled from SRO 2003 Annual 

Reports.

198Even if the Commission were to determine 

that an SRO was insufficiently funding regulation, 

it would then have the difficult task of deciding 

whether to take extreme action (such as 

deregistration of an SRO) or more measured action 

(such as the NASD’s 21(a) Undertaking requiring 

that it commit $100 million on self-regulatory 

enhancements). See e.g., 21(a) Report requiring that 

the NASD expend $100 million over a five year 

period, to enhance its systems for market 

surveillance, including the development and 

implementation of an enhanced audit trail, and to 

increase its staffing in the areas of examination, 

surveillance, enforcement, and internal audit; see 

also NYSE settlement in connection with Exchange 

Act section 11(a), 15 U.S.C. 78k(a), violations 

requiring establishment of OTS, Exchange Act 

Release No. 41574 (June 29, 1999), Administrative 

Proceeding File No. 3–9925; see also Options 

Settlement requiring establishment of COATS.

199See Exchange Act Rule 6a–2, 17 CFR 240.6a–

2, and 15Aj–1, 17 CFR 240.15Aj–1.

regulatory structure for all SROs, and 

the financial structure of each 

individual SRO is a result of a variety 

of factors, including the SRO’s 

particular history and competitive 

position. Thus, each SRO and its 

financial structure is, to a certain extent, 

unique. While this uniqueness can 

result in different levels of SRO funding 

across markets, it also is a reflection of 

one of the primary underpinnings of the 

National Market System. Specifically, 

by fostering an environment in which 

diverse markets with diverse business 

models compete within a unified 

National Market System, investors and 

market participants benefit.194

The ‘‘appropriate’’ amount of funding 

to be spent by SROs on regulatory 

operations is governed by a variety of 

factors, including the SRO’s business 

model, trading systems, regulatory 

responsibilities, and types of members. 

For instance, electronic marketplaces 

may be able to supervise trading 

occurring in their markets at lower cost 

than floor-based markets because their 

trading systems may capture 

comparatively more information 

associated with any given trade. 

Likewise, the characteristics of an SRO’s 

membership base may affect the 

appropriate level of regulatory funding 

and how the funding is allocated.

Potential varying levels of regulatory 

funding notwithstanding, all SROs must 

meet their statutory obligations. The 

Exchange Act itself, as well as the 

Commission’s rules and automation 

review policies thereunder, impose on 

the SROs important regulatory and 

operational responsibilities, including 

most of the day-to-day responsibilities 

for market and broker-dealer 

oversight.195 Satisfying these selfregulatory responsibilities requires a 

substantial expenditure of expertise and 

funds. The SROs’ combined total 

operating expenses in 1998 were $1.68 

billion 196 and total combined SRO 

operating expenses in 2003 were $2.4 

billion.197 As stated above, a significant 

benefit of self-regulation in the 

securities industry is that this 

significant cost is largely self-funded.

The Commission’s supervision of the 

adequacy of SRO regulatory funding 

presents considerable challenges. Given 

the inherent tension between an SRO’s 

role as a business and as a regulator, 

there undoubtedly is a temptation for an 

SRO to fund the business side of its 

operations at the expense of regulation. 

For example, if the ‘‘appropriate’’

amount of regulatory spending would 

seriously impair the financial stability 

of an SRO, that SRO would likely 

reduce regulatory spending rather than 

jeopardize its financial viability. When 

the Commission examines the 

underlying reasons for regulatory 

failings, it is often clear that an SRO has 

not allocated sufficient resources to its 

regulatory function. Without such 

failings, however, it can be difficult for 

the Commission to determine whether 

an SRO is insufficiently funding its 

regulatory function or simply 

administering an efficient regulatory 

program.198

If the Commission’s SRO Governance 

and Transparency Proposal is adopted, 

however, it could illuminate more 

clearly SRO practices with respect to 

regulatory spending levels and 

allocations. Specifically, the detailed 

accounting of SRO revenues and 

expenses proposed could enable the 

Commission to more accurately and 

efficiently compare these items. Under 

the current reporting regime, SROs 

update their Form 1 annually, including 

an updated financial statement, but 

their financial information is not 

necessarily submitted in a comparable 

format.199 Thus, the Commission could 

use this new information to assist in its 

effort to detect when an SRO is 

becoming an industry outlier in terms of 

relative regulatory spending levels. If 

the Commission made such a 

determination, it has the ability to 

pursue a range of regulatory responses, 

including designating that SRO for 

heightened Commission oversight or 

stronger action, such as SRO 

deregistration.

Although not proposed in the SRO 

Governance and Transparency Proposal, 

the Commission could also consider 

developing formal or informal 

regulatory spending guidelines for 

SROs. Establishing uniform guidelines 

for SROs generally would be a very 

complex task, however, given the 

diversity of their marketplaces and 

memberships and the evolving nature of 

regulatory oversight. While the SRO 

Governance and Transparency Proposal 

would likely result in a heightened 

Commission ability to detect low 

regulatory spending levels, it is 

important to note that gauging the 

effectiveness of an SRO’s self-regulation 

cannot necessarily be accurately judged 

by considering capital expenditures in 

isolation. 

The Commission specifically seeks 

public comment on the following 

questions related to SRO funding 

generally: 

Question 17: Should the Commission 

prescribe specific regulatory funding 

and allocation levels for SROs and, if so, 

how? Also, how would these levels be 

determined? 

Question 18: Could enhanced 

transparency of SRO funding be used 

effectively to promote adequate SRO 

regulatory funding levels or would other 

steps be more effective in that regard? 

What measures could be used to 

promote adequate SRO regulatory 

funding levels? 

2. SRO Funding Sources 

To provide commenters a basis for 

considering SRO funding, this section 

discusses the five primary sources of 

SRO funding: (a) Regulatory fees; (b) 

transaction fees; (c) listing fees; (d) 

market data fees; and (e) other 

miscellaneous fees. While each source 

of SRO revenue is important, this 

discussion will provide an extensive 

discussion of market data and 

specifically the level of fees charged for 

market data.

a. Regulatory Fees 

SROs charge members fees for joining 

and maintaining membership. In 

addition, SROs charge regulatory fees to 

members that typically take the form of 

per member or per transaction fees and 

are generally allocated to funding selfregulatory operations. SROs also 

contract with other SROs to provide 

regulatory services. In 1998, regulatory 

fees accounted for approximately 19% 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71269

200Market Data Concept Release at 70625.

201 Data compiled from SRO 2003 Annual 

Reports. Note that the NYSE 1998 Consolidated 

Statement of Revenue did not account for ‘‘Data 

Processing Fee’’ revenue. Due to an intervening 

change in accounting procedures, the NYSE 2003 

Consolidated Statement of Revenue includes this 

item. To provide a more accurate comparison 

between the 1998 and 2003 percentages, ‘‘Data Fee 

Processing’’ revenue was not included in total SRO 

revenue for the purpose of calculating the 

percentage of total SRO revenue represented by 

regulatory fee revenue. Based on SRO 2003 Annual 

Report Consolidated Statements of Income certain 

items were allocated to regulatory fees with respect 

to the NYSE (‘‘Regulatory Fees’’ and ‘‘Annual 

Membership Fees’’), the BSE (‘‘Members’’ Dues and 

Fees’’), the Phlx (‘‘Regulatory Fees’’), the NASD 

(including Amex and Nasdaq consolidated 

statements of income) (‘‘Regulatory Fees,’’

‘‘Registration Fees,’’ ‘‘Qualification Fees,’’

‘‘Corporate Financing Fees,’’ and ‘‘Fines’’), the PCX 

(‘‘Regulatory and Registration Fees,’’ ‘‘Archipelago 

Revenue: Regulatory Oversight,’’ and ‘‘Member and 

Participant Dues’’), the CHX (‘‘Member Services and 

Fees’’ and ‘‘Member Dues’’), the CBOE (‘‘Regulatory 

Fees’’ and ‘‘Other Member Fees’’), and the NSX 

(‘‘Regulatory Fees’’).

202See Exchange Act Release Nos. 46817 

(November 12, 2002), 67 FR 69784 (November 19, 

2002) (‘‘TAF Proposing Release’’); 47946 (May 30, 

2003), 68 FR 34021 (June 6, 2003) (‘‘TAF Approval 

Order’’). See also Exchange Act Release Nos. 49114 

(January 22, 2004), 69 FR 4194 (January 28, 2004) 

(proposing to amend the TAF and extend it to Trade 

Reporting and Compliance Engine (‘‘TRACE’’)-

eligible and municipal securities); 50485 (October 

1, 2004), 69 FR 60445 (October 8, 2004)(approving 

proposal to amend the TAF and extend it to 

TRACE-eligible and municipal securities).

203 In its filing, the NASD noted its belief that 

assessing the regulatory fees only for Nasdaq 

transactions was no longer appropriate for three 

reasons. First, on a corporate entity level, Nasdaq 

was separating itself from the NASD and attempting 

to register as a national securities exchange. 

Second, the NASD believed that the historic 

regulatory fee structure was out of step with recent 

changes in the markets, such as the drastic growth 

in trading volumes, reductions in average trade size, 

decimalization, and trading no longer remaining 

exclusive to the listing market. Finally, the 

regulatory fee was only assessed against Nasdaqlisted and other transactions that are reported 

through Nasdaq’s trade reporting system, although 

these fees were used to support member regulatory 

activities across all markets. See TAF Proposing 

Release at 69785. 

The Commission received a total of 23 comment 

letters on the proposal, all of which objected to the 

proposal, either for substantive or procedural 

reasons. Commenters of the TAF proposal argued 

that the NASD should not charge members for 

services related to transactions on other markets, 

where the NASD does not provide the relevant 

service. In addition, commenters argued that the 

TAF proposal was anti-competitive in that it 

indirectly subsidized Nasdaq by effectively 

reducing the cost of regulatory services the NASD 

provides to Nasdaq. They also posited that the TAF 

could establish a dangerous precedent under which 

fees could be charged by SROs for trading activity 

that had little or no nexus to that SRO’s market. See 

TAF Approval Order at 34022–34023. 

In response, the NASD clarified that the TAF was 

to be used only to fund its member regulatory 

activities in a variety of areas such as sales 

practices, examinations, financial and operational 

reviews, new member applications, and 

enforcement wherever such member activity occurs. 

In addition, the NASD argued that it regulates the 

activities of its members in all securities, not simply 

Nasdaq securities. The specific revenues from the 

TAF, the NASD stated, would not fund regulatory 

activities of the Nasdaq stock Market and, thus, not 

create an inappropriate regulatory subsidy. Finally, 

with regard to comments that no clear nexus existed 

between the TAF and the corresponding NASD 

regulatory responsibilities, the NASD maintained 

that its mandate is broad, and that its regulatory 

obligations ‘‘exist separate and apart from any 

market-specific rules and obligations.’’ See TAF 

Approval Order at 34023.

204TAF Approval Order at 34023–34024.

205 Id.

206 Id.

207The Commission also stated its belief that the 

TAF approval was not a harbinger for the 

imposition of fees on transactions executed on 

markets for which an SRO either has little or no 

nexus to regulatory tasks performed by the SRO or 

for which the SRO has no business interest. Most 

SROs, the Commission concluded, do not have the 

broad aegis of the NASD regarding members’

customer business, and so will not have a 

regulatory nexus to support a transaction fee 

applicable to other markets. See TAF Approval 

Order at 34023–34024.

208Market Data Concept Release at 70625.

209 Data compiled from SRO 2003 Annual 

Reports. Note that the NYSE 1998 Consolidated 

Statement of Revenue did not account for ‘‘Data 

Processing Fee’’ revenue. Due to an intervening 

change in accounting procedures, the NYSE 2003 

Consolidated Statement of Revenue includes this 

item. To provide a more accurate comparison 

between the 1998 and 2003 percentages, ‘‘Data Fee 

Processing’’ revenue was not included in total SRO 

revenue for the purpose of calculating the 

percentage of total SRO revenue represented by 

transaction fee revenue. Based on SRO 2003 Annual 

Report Consolidated Statements of Income certain 

items were allocated to transaction fees with respect 

to the NYSE (‘‘Transaction Fees’’), the BSE 

(‘‘Transaction Fees’’), the Phlx (‘‘Transaction 

Fees’’), the NASD (including Amex and Nasdaq 

consolidated statements of income) (‘‘Transaction 

Fees’’), the PCX (‘‘Transaction Fees and Data 

Service Charges’’), the CHX (‘‘Transaction Fees’’), 

the CBOE (‘‘Transaction Fees’’), and the NSX 

(‘‘Transaction Fees’’).

210See generally Concept Release: Competitive 

Developments in the Options Markets. Exchange 

Act Release No. 49175 (February 3, 2004), 69 FR 

6124, 6125 (February 9, 2004) (‘‘Options Concept 

Release’’).

of SRO revenue,200 while, in 2003, 

approximately 23% of SRO revenue was 

derived from such fees.201

A recent development with respect to 

SRO regulatory fees was the NASD’s 

establishment of a Trading Activity Fee 

(‘‘TAF’’), to supplement the regulatory 

fees it historically charged its 

members.202 The TAF assessed a 

transaction-based fee that was not 

linked to trading activity reported 

through Nasdaq systems.203 In 

approving the TAF, the Commission 

found that it was reasonably designed to 

recover the NASD’s costs related to 

regulation and oversight of its 

members.204 A principal factor in the 

Commission’s approval was its explicit 

recognition of the NASD’s broad 

responsibilities with respect to its 

members’ activities, irrespective of 

where securities transactions take 

place.205 Specifically, the Commission 

noted that, as a national securities 

association, the NASD has the 

responsibility to oversee its members’

finances and conduct toward their 

customers, except in limited 

circumstances where this responsibility 

is allocated to another SRO.206 The 

Commission further stated that the 

NASD’s responsibility exists even if the 

conduct involves a transaction executed 

on a market not directly regulated by the 

NASD because it has direct 

responsibility to oversee the firm’s 

dealing with the public in effecting the 

transactions and may also have 

responsibility to oversee the impact of 

the trading on the firm’s financial 

condition.207

The Commission specifically seeks 

public comment on the following 

question related to SRO regulatory fees: 

Question 19: Under current SRO cost 

structures, SRO funding for regulatory 

operations is not derived strictly from 

revenue associated with regulatory fees 

and operations. Instead, SROs cross 

subsidize the cost of regulatory 

operations with revenue that is not 

strictly derived from regulatory fees and 

operations. Should the Commission 

require that SRO funding for regulatory 

operations be derived only from 

regulatory fees, rather than allowing the 

cost of regulatory operations to be 

subsidized by other revenue sources? If 

regulatory funding should be limited 

strictly to revenue generated by 

regulatory fees, how should the 

Commission address a situation in 

which an SRO does not generate 

sufficient regulatory revenue to fully 

fund regulatory operations?

b. Transaction Fees 

Another important source of revenue 

for SROs that operate markets is derived 

from fees that are associated with 

members’ or others’ use of the SRO’s 

systems, such as order routing systems, 

trade execution systems, and electronic 

connectivity services. These fees are 

paid by any user of an SRO’s market 

facilities for services, including 

executing, reporting, and clearing 

transactions. In 1998, transaction fees 

accounted for approximately 30% of 

SRO revenue,208 while, in 2003, 

approximately 27% of SRO revenue was 

associated with transaction fees.209

The intense intermarket competition 

for order flow has put substantial 

pressure on these fees. For example, 

greater competition among options 

markets has caused transaction fees to 

all but disappear in the options 

markets.210 The equity markets have 

also come under intense competitive 

pressure to lower transaction fees. As 

discussed in the Reg NMS proposal, 

transaction fees have decreased steadily 

71270 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

211See supra note 62.

212Most ECNs and Nasdaq pay a per-share rebate 

for limit orders that become executed against 

incoming orders. This rebate rewards market 

participants for submitting ‘‘resting’’ limit orders 

that give depth to the trading book. The ECNs and 

Nasdaq also impose a per-share access fee on the 

incoming marketable orders that execute against the 

resting limit orders and thereby ‘‘remove liquidity’’

from the book. In this way, the ECNs and Nasdaq 

use access fee rebates as payment to attract liquidity 

to their limit order books. Because non-subscribers 

cannot place limit orders on an ECN’s book and 

therefore cannot receive the rebates, the fees that 

they pay act as a subsidy to the subscribers that 

place standing limit orders on the ECN’s book. See

Reg NMS at 11157.

213Market Data Concept Release at 70625.

214 Data compiled from SRO 2003 Annual 

Reports. Note that the NYSE 1998 Consolidated 

Statement of Revenue did not account for ‘‘Data 

Processing Fee’’ revenue. Due to an intervening 

change in accounting procedures, the NYSE 2003 

Consolidated Statement of Revenue includes this 

item. To provide a more accurate comparison 

between the 1998 and 2003 percentages, ‘‘Data Fee 

Processing’’ revenue was not included in total SRO 

revenue for the purpose of calculating the 

percentage of total SRO revenue represented by 

listing fee revenue. Based on SRO 2003 Annual 

Report Consolidated Statements of Income certain 

items were allocated to listing fees with respect to 

the NYSE (‘‘Listing Fees’’), the BSE (‘‘Listing Fees’’), 

the NASD (including Amex and Nasdaq 

consolidated statements of income) (‘‘Issuer 

Services’’), and the CHX (‘‘Listing Fees’’).

215The recent increase in intermarket 

competition for equity listings has raised issues 

related to listing fees and SRO funding. In early 

2004, for example, the Nasdaq Stock Market 

launched a dual listing program to attract NYSElisted issuers and offered a one year waiver of all 

entry fees and annual fees for NYSE-listed 

companies that became dually listed. Craig Karmin, 

Nasdaq Recruits Six NYSE Firms to Dual Listings,

Wall Street Journal, January 13, 2004, at C1.

216See Commission, 2003 Annual Report, 140 

(2004).

217As noted above, while the level of fees charged 

by the SROs for market data was not directly 

addressed in Reg NMS, broad industry interest in 

the issue was apparent from the comments received 

by the Commission in response to Reg NMS. Thus, 

while each source of SRO revenue is important, this 

discussion examines market data extensively and 

specifically examines the level of fees charged for 

market data. Various commenters in response to 

Reg NMS stated that market data revenues are an 

important source of funding for SROs and should 

therefore not be capped or reduced. See letter from 

William J. Brodsky, Chairman and Chief Executive 

Officer, The Chicago Board Options Exchange, Inc., 

to Jonathan G. Katz, Secretary, Commission, p. 9 

(July 1, 2004) (‘‘Reg NMS CBOE letter’’); letter from 

David A. Herron, Chief Executive Officer, Chicago 

Stock Exchange, to Jonathan G. Katz, Secretary, 

Commission, pp.18–19 (June 30, 2004); and letter 

from David Humphreville, President, The Specialist 

Association, to Jonathan G. Katz, Secretary, 

Commission, p. 17 (June 30, 2004). One Reg NMS 

commenter believed that, in absence of market 

discipline, the Commission and SROs must ensure 

that the collection and allocation of revenues to 

different regulatory functions maximize investor 

protections at a reasonable cost. See letter from 

Huw Jenkins on behalf of UBS Securities LLC, 

Managing Director, Head of Equities for the 

Americas, to Jonathan G. Katz, Secretary, 

Commission, p. 10 (June 30, 2004) (‘‘Reg NMS UBS 

letter’’). An SRO commenter stated that it is 

consistent with the purpose and intent of Section 

11A of the Exchange Act for a significant portion 

of the market data revenue to be used by SROs for 

operations and regulation because such costs are 

directly related to the quality of the market data 

disseminated. See Reg NMS CBOE letter, p. 9.

218Market Data Concept Release at 70625.

219 Data compiled from SRO 2003 Annual 

Reports. Note that the NYSE 1998 Consolidated 

Statement of Revenue did not account for ‘‘Data 

Processing Fee’’ revenue. Due to an intervening 

change in accounting procedures, the NYSE 2003 

Consolidated Statement of Revenue includes this 

item. To provide a more accurate comparison 

between the 1998 and 2003 percentages, ‘‘Data Fee 

Processing’’ revenue was not included in total SRO 

revenue for the purpose of calculating the 

percentage of total SRO revenue represented by 

market data fee revenue. Based on SRO 2003 

Annual Report Consolidated Statements of Income 

certain items were allocated to market data fees 

with respect to the NYSE (‘‘Market Data Fees’’), the 

BSE (‘‘Communications, Net Note B’’), the Phlx 

(‘‘Security Price Data and Floor Charges’’), the 

NASD (including Amex and Nasdaq consolidated 

statements of income) (‘‘Market Data Fees’’), the 

PCX (‘‘Peripheral Equipment and Market Data 

Fees’’), the CHX (‘‘Market Data Fees’’), the CBOE 

(‘‘OPRA Income’’), and the NSX (‘‘Market Data 

Fees’’).

220 Data compiled from NYSE and NASD 2003 

Annual Reports.

221See NSX, 2003 Annual Report Exhibit I–12 

(2004).

222See Market Data Concept Release Appendix.

223See Reg NMS at 11179.

in recent years.211 In addition, most 

ECNs and Nasdaq are paying a per-share 

rebate for limit orders that become 

executed against incoming orders, 

thereby further reducing net transaction 

fees.212 Thus, not only are SRO 

transaction fees being driven lower, but 

competition is compelling certain SROs 

to rebate a significant percentage of 

transaction fees collected to market 

participants.

The Commission specifically seeks 

public comment on the following 

questions related to SRO transaction 

fees: 

Question 20: SRO transaction fees 

have been driven sharply lower in 

recent years by competition. In light of 

that, why has the overall percentage of 

SRO revenue associated with 

transaction fees not dropped as 

dramatically since 1998 (approximately 

27% in 2003 compared to 

approximately 30% in 1998)? 

Question 21: How has the trend of 

decreasing transaction fees impacted the 

SROs’ ability to fulfill their statutory 

obligations? 

c. Listing Fees 

Another important source of revenue 

for some SROs is listing fees, which are 

paid by issuers that list their securities 

on an SRO’s market. Initial listing fees 

are paid at the time of listing and are 

typically related to the amount of shares 

being offered. Listing maintenance fees 

are paid annually and are generally 

related to the issuers’ total shares 

outstanding in the listed security. In 

1998, listing fees accounted for 

approximately 23% of SRO revenue,213

while, in 2003, these fees represented 

approximately 20% of SRO revenue.214

These revenues have been highly 

concentrated in the primary listing 

markets, with secondary markets 

charging little or no listing fee.215 This 

concentration is exemplified by the fact 

that of the $9,182 billion worth of stocks 

listed on exchanges in 2002, $9,119 

billion was listed on the New York 

Stock Exchange.216

The Commission specifically seeks 

public comment on the following 

question related to SRO listing fees: 

Question 22: To what extent has 

increased inter-market competition 

impacted SRO listing fee revenue? To 

what extent has this impacted the SROs’

ability to fulfill their regulatory 

obligations? 

d. Market Data Fees 

Market data revenue has traditionally 

been a very important component of 

SRO funding.217 In 1998, market data 

revenue represented approximately 21% 

of SROs’ total revenues,218 while, in 

2003, approximately 18% of SRO 

revenue flowed from market data.219

Market data revenues represented 16% 

of NYSE revenues and 24% of Nasdaq 

revenues in 2003.220 For one SRO, 

market data fees accounted for more 

than 80% of its total 2003 revenue.221

In contrast to the importance of 

market data revenue to overall SRO 

funding, it is worth noting that it 

represents a relatively small portion of 

the securities industry’s total expenses. 

For example, in 1998, the total SRO 

market data revenue of $410.6 million 

represented a very small portion of the 

securities industry’s total expenses for 

the year—less than 1/4th of one 

percent.222 In spite of revenue derived 

from market data playing an important 

role in SRO funding, some SROs rebate 

substantial market data revenues to the 

market participants that contribute to 

creating the market data.223

The U.S. equity markets are not alone 

in their reliance on market data 

revenues as a source of funding. All of 

the other major world equity markets 

currently derive large amounts of 

revenues from selling market 

information, despite having 

significantly less trading volume and 

less market capitalization than the 

NYSE and Nasdaq. To illustrate, the 

following table sets forth the respective 

market information revenues, dollar 

value of trading, and market 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71271

224Table data is derived from the 2003 annual 

reports of the various markets and from statistics 

compiled by the World Federation of Exchanges.

225See Exchange Act Sections 6(b), 11A(c), and 

15A(b), 15 U.S.C. 78f(b), 78k–1(c), and 78o–3. Two 

provisions of the Exchange Act directly address 

market data fees. Section 11A(c)(1)(C) grants 

rulemaking authority to the Commission to assure 

that all securities information processors may 

obtain market information from an exclusive 

processor of that information (i.e., the processors for 

the three Networks) on terms that are fair and 

reasonable. Section 11A(c)(1)(D) also grants 

rulemaking authority to the Commission to assure 

that all persons may obtain market information on 

terms that are not unreasonably discriminatory. The 

Commission applies these standards in reviewing 

fee filings submitted by exclusive processors for the 

three consolidated networks that disseminate 

market data in NMS stocks. The three Networks are 

(1) Network A, which disseminates data in stocks 

listed on the NYSE; (2) Network B, which 

disseminates data in stocks listed on Amex and the 

regional exchanges; and (3) Network C, which 

disseminates data in stocks listed on Nasdaq. The 

Commission also applies these standards in 

reviewing market data filings submitted by 

individual SROs. 226See Market Data Concept Release at 70628. 227Reg NMS at p.11176. 228 In the past, SROs have attempted to distribute 

market data in ways that could potentially harm 

competitors. For example, in proposing a new 

‘‘depth of book’’ market data product, Liquidity 

Quote, the NYSE asserted that it would incorporate 

a downstream data consolidation restriction clause 

into its agreements with market data vendors for the 

product that would prohibit its being integrated 

with any other market data product. A variety of 

anti-competition arguments were raised in 

connection with this proposal and, ultimately, the 

Commission approved the proposal, but made the 

approval expressly contingent upon the NYSE not 

applying the downstream restrictions that were in 

its vendor agreements at the time of the approval. 

See generally Exchange Act Release Nos. 47091 

(December 23, 2002), 68 FR 133 (January 1, 2003); 

47614 (April 2, 2003), 68 FR 17140 (April 8, 2003).

229When Congress mandated the creation of a 

national market system, it stated that 

‘‘communication systems, particularly those 

designed to provide automated dissemination of 

last sale and quotation information with respect to 

securities, will form the heart of the national market 

system.’’ H.R. Rep. No. 94–229, 94th Cong., 1st 

Sess. 93 (1975). While Congress did not specifically 

mandate the creation of a consolidated market data 

processor system, the Commission has recently 

emphasized the benefits of consolidated market 

data, particularly for retail investors. See Reg NMS 

at 11177.

230See Exchange Act Section 11A(c)(1)(C). 15 

U.S.C. 78k–1(c)(1)(C).

231Several Reg NMS commenters believed that 

the existing notice and comment process for 

effecting market data fee changes does not facilitate 

informed and meaningful public and industry 

participation and comment. See letter from Gary 

Cohn, Managing Director, Goldman, Sachs & Co., to 

Jonathan G. Katz, Secretary, Commission, p. 12 

(July 19, 2004) (‘‘Reg NMS Goldman letter’’); letter 

from Carrie E. Dwyer, Charles Schwab & Co., Inc., 

to Jonathan G. Katz, Secretary, Commission, p. 9 

(June 30, 2004) (‘‘Reg NMS Schwab letter’’); letter 

from Marc Lackritz, President, Securities Industry 

Association, to Jonathan G. Katz, Secretary, 

Commission, pp. 24 and 26 (June 30, 2004) (‘‘Reg 

NMS SIA letter’’); and letter from Mary McDermottHolland, Chairman, John C. Giesea, President/CEO, 

Continued

capitalization for the largest world 

equity markets in 2003: 224

Data revenues

(millions) 

Trading volume

(trillions) 

Market

capitalization

(trillions) 

London ....................................................................................................................... $180 $3.6 $2.5 

NYSE ......................................................................................................................... 172 9.7 11.3 

Nasdaq ....................................................................................................................... 147 7.1 2.8 

Deutsche Bourse ....................................................................................................... 146 1.3 1.1 

Euronext ..................................................................................................................... 109 1.9 2.1 

Tokyo ......................................................................................................................... 60 2.1 3.0 

Understanding market data pricing 

and the role that market data plays with 

respect to SRO funding is an important 

part of this discussion. Congress 

recognized that SROs would charge for 

market data when it gave the 

Commission authority in the 1975 

Amendments to determine the extent to 

which SRO fees charged for market data 

are ‘‘fair and reasonable,’’ are ‘‘not 

unreasonably discriminatory,’’ and 

achieve ‘‘equitable allocation’’ of 

reasonable fees among persons who use 

an SRO’s facilities.225 Market 

information revenues serve an 

important and unique role in that they 

provide a broad source of SRO funding. 

The fees are paid by all users of market 

information, including, for example 

options and futures markets participants 

that otherwise would not contribute 

(through transactions services fees or 

listing fees) to the funding of the 

particular markets on whose 

information they rely. 226

In addition to being important to 

SROs, market data is also critical to

market participants and investors. 

Market data is essential to investors and 

other market participants not physically 

present in a trading market, enabling 

them to make informed decisions when 

to buy and sell. It provides the basis for 

investment and portfolio decisions. And 

it creates confidence in the fairness and 

reliability of the markets. The current 

market data systems for equities and 

options collect quotes and trades from 

many different market centers and 

disseminate them to the public in a 

single stream of information for each 

security. This market information has 

been an essential element in the success 

of the U.S. securities markets. In 

addition to providing transparency of 

buying and selling interest, consolidated 

data is the principal tool for addressing 

fragmentation of trading among many 

different market centers, and for 

facilitating the best execution of 

investor orders by their brokers.227

Market data fees can have a major 

impact on the effectiveness of the 

market data system. The level of these 

fees and their structure determines the 

extent that market data is available to 

different types of market participants 

and investors. And market data can 

have anticompetitive effects if it is sold 

on discriminatory terms or in an unfair 

fashion.228

Market data fees also support the 

timeliness, accuracy, and reliability of 

the market data being disseminated. 

Market data, whether consolidated or 

not, that is untimely or untrustworthy 

could harm investors and reduce 

confidence in the fairness of the U.S. 

securities markets. One of the 

Commission’s most important market 

structure responsibilities is to assure the 

integrity of market data.229 Today, 

market data from all equity and options 

markets is highly reliable and widely 

used. In order to promote the wide 

public availability of this information, 

market data fees must be fair and 

reasonable.230 Consistent with this is 

the notion that such fees should at least 

generate sufficient revenue to provide 

adequate funding for the dissemination 

of market data.

Currently, the Commission typically 

reviews market data fees in the context 

of proposed fee changes filed by the 

three networks that disseminate market 

data in NMS stocks. These fee filings are 

published for notice and comment 

before Commission action.231 After 

71272 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

The Security Traders Association, to Jonathan G. 

Katz, Secretary, Commission, p. 15 (June 30, 2004) 

(‘‘Reg NMS STANY letter’’). A few of these 

commenters also believed that these procedures, 

which provide that market data fee changes are 

effective upon filing, gives excessive power to selfinterested parties. See Reg NMS Schwab letter, p. 

9; Reg NMS SIA letter, p. 26; and Reg NMS STANY 

letter, p. 15. The SIA also stated that ‘‘[t]he fact that 

the Commission may abrogate the proposal and 

require refiling does not equate to a substantive 

review or challenge to the fees charged, and has not 

proved such in the past.’’ See Reg NMS SIA letter, 

p. 26. The SIA and STANY also suggested that this 

is responsible, in part, for excessive market data 

fees. See Reg NMS SIA letter, pp. 3 and 26–27; 

STANY letter, p. 15. Schwab recommended 

amending Commission rules and the joint-SRO 

plans to eliminate the ‘‘effective upon filing’’

process for market data fee changes, including 

changes that would impact the treatment of market 

data users and market data distribution policies. 

See Reg NMS Schwab letter, p. 9. Schwab also 

recommended that the Commission require the 

joint-SRO plans to file material policy changes as 

rule changes that require public notice and 

comment prior to adoption. See Reg NMS Schwab 

letter, p. 9. Although fees charged by SROs to 

members generally are effective on filing, market 

data fees charged to the public are published for 

notice and comment before approval. See Exchange 

Act Rule 19b-4, 17 CFR 240.19b-4.

232See Exchange Act Section 11A, 15 U.S.C. 78k–

1; Exchange Act Rule 11Aa3–2, 17 CFR 240.11Aa3–

2.

233The Internet had greatly expanded the 

opportunity for retail investors to obtain access to 

real-time market data through on-line accounts with 

their broker-dealers, and investor demand for this 

data had grown exponentially. For example, the 

Market Data Concept Release noted that the 

revenues derived from fees applicable to retail 

investors had grown from $3.7 million in 1994 to 

$38.9 million in 1998, and represented 

approximately 9% of total market data revenues. 

Market Data Concept Release at 70614 and 70631.

234See generally Id. at Section IV.

235The Appendix, for example, included 16 

tables setting forth all of the different subscriber 

fees of the Networks, the revenues, expenses, and 

distributions of the Networks, and the revenues and 

expenses of each of the individual SROs that are 

participants in the Networks. In addition, the 

Market Data Concept Release included information 

to help the public assess whether the level of 

market data fees remained fair and reasonable. For 

example, the release noted that even prior to 

creation of the national market system and the 

Networks, market data revenues were an important 

source of SRO funding—market data revenues 

represented 14.7% of the NYSE’s total revenues in 

1975, compared to 15.3% in 1998. Market Data 

Concept Release at 70621. As noted above, market 

data revenues represented 16.0% of NYSE revenues 

in 2003. In addition, although the total amount of 

market data revenues had grown substantially in 

recent years, the increase was proportional to the 

increase in other SRO revenues. In 1994, market 

information revenues amounted to $246.1 million 

and represented 20% of SRO funding. In 1998, such 

revenues amounted to $410.6 million and 

represented 21% of SRO funding. The Commission 

noted that ‘‘the growth in market information 

revenues has simply kept pace with the growth of 

other SRO revenues during the prolonged 

expansion in trading volume of the last five years. 

The SROs are no more, but also no less, dependent 

on market information revenues today than they 

were in 1994.’’ Market Data Concept Release at 

70615. Moreover, the percentage growth in market 

data revenues from 1994 to 1998 was 67%, but had 

not kept pace with the percentage growth in the 

securities industry’s total revenues during this 

major expansion of trading, which was 139%. Id.

at 70626.

236The Commission noted that one of the most 

important functions of the Commission is to assist 

retail investors in accessing the information they 

need to protect and further their own interests. 

Moreover, the Commission stated that 

communications technology had progressed so that 

broad access to real-time market information should 

be an affordable option for most retail investors. 

This information, the Commission believed, could 

greatly expand the ability of retail investors to trade 

securities. The Commission stated its intention that 

to assure that market information fees applicable to 

retail investors do not restrict their access to market 

information and that such fees must be nondiscriminatory when compared with the fees 

charged to professional users of market information. 

Market Data Concept Release at 70614.

237See Network C / NASD–2003–132, Securities 

Exchange Act Release No. 48386 (August 21, 2003), 

68 FR 51618 (August 27, 2003) (extending pilot 

program for reduced non-professional NQDS user 

fee); Network C / NASD–2002–117, Securities 

Exchange Act Release No. 46446 (August 30, 2002), 

67 FR 57260 (September 9, 2002) (extending pilot 

program for reduced non-professional NQDS user 

fee); Network C / NASD–2001–56, Securities 

Exchange Act Release No. 44788 (September 13, 

2001), 66 FR 48303 (September 19, 2001) (extending 

pilot program allowing for reduced nonprofessional NQDS user fee); Network C / NASD–

2001–32, Securities Exchange Act Release No. 

44363 (May 29, 2001), 66 FR 30254 (June 5, 2001) 

(permanently approving reduced Level 1 Service 

fees for non-professional users on a monthly and 

per query basis); Network B / CTA–01–01, 

Securities Exchange Act Release No. 44047 (March 

7, 2001), 66 FR 15151 (March 15, 2001) (reducing 

the initial ticker charge at each customer location 

from $21.50 to $13.50 and thereby creating a 

uniform charge for each location); Network C / 

NASD–00–47, Securities Exchange Act Release No. 

43190 (August 22, 2000), 65 FR 52460 (August 29, 

2000) (establishing pilot program for reduced nonprofessional NQDS user fee); Network C / NASD–

00–19, Securities Exchange Act Release No. 42715 

(April 24, 2000), 65 FR 25411 (May 1, 2000) 

these filings are published, the 

Commission determines whether the 

fees are fair and reasonable, not 

unreasonably discriminatory, and 

otherwise consistent with the 

requirements of the Exchange Act.232

Although most market data fee filings 

currently involve Network fees, the 

same standard applies and the same 

questions arise with regard to the 

market data fees of an individual SRO.

In reviewing a market data fee filing, 

the Commission has relied to a great 

extent on the ability of the Networks to 

negotiate fees that are acceptable to SRO 

members, information vendors, 

investors, and other interested parties. 

The negotiation process is buttressed by 

the public notice and comment 

procedures that accompany the 

Commission’s consideration of 

proposed rule changes. 

As equities and options markets have 

evolved in recent years, strains began to 

develop in the arrangements for market 

data, particularly with respect to setting 

fees. In evaluating the issues raised, an 

extensive public record has been 

developed on the subject of market data 

fees in the last five years. In 1999, the 

Commission initiated a full-scale review 

of market data fees and revenues in the 

Market Data Concept Release. The 

review was prompted, in part, by the 

Commission’s concern that retail 

investors might be paying too much for 

market data.233 The Market Data 

Concept Release included the role of 

revenues derived from such fees in 

funding the operation and regulation of 

markets.234 The Market Data Concept 

Release presented for public review a 

great deal of factual information on 

market data fees and revenues.235 In the 

course of that effort, the Commission 

emphasized that market data must be 

affordable for retail investors.236 At 

about the same time, the Networks filed 

proposed rule changes that reduced 

retail investor fees generally by 75% to 

80%. The following table sets forth 

retail investor fees for NYSE and Nasdaq 

stocks in 2003 and in 1998:

NYSE Nasdaq 

2003 1998 2003 1998 

Per Query ............................................................................................................. 1⁄4¢ to 3⁄4¢ ............. 1¢ 1⁄2¢ 1¢ 

Monthly ................................................................................................................. $0.50 to $1.00 ....... $5.25 $1.00 $4.00 

The per-query fees are charged each 

time that a retail investor requests quote 

and trade information in a particular 

stock. The monthly fees represent limits 

on the total amount that a retail investor 

can be charged for market data in any 

month. Thus, for example, all retail 

investors currently have access to an 

unlimited quantity of the millions of 

best quotes and trades in Network A 

stocks during each trading day for no 

more than $1 per month, compared to 

the $5.25 that was charged before the 

Commission’s review of market data 

fees.237

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71273

(extending pilot program for reduced Level 1 

Service fees for non-professional users on a 

monthly and per query basis and further reducing 

the Level 1 Service monthly fee for nonprofessionals); Network B / CTA/CQ–99–02, 

Securities Exchange Act Release No. 42138 

(November 15, 1999), 64 FR 63350 (November 19, 

1999) (reducing the Network B non-professional 

subscriber flat service rate, permanently approving 

and reducing tiered pay-for-use rates for nonprofessional subscribers, and allowing nonprofessional subscribers to pay the lower of the payfor-use or flat rates); Network A / CTA/CQ–99–01, 

Securities Exchange Act Release No. 41977 (October 

5, 1999), 64 FR 55503 (October 13, 1999) (reducing, 

inter alia, the Network A non-professional 

subscriber flat service rate, permanently approving 

and reducing tiered pay-for-use rates for nonprofessional subscribers, and allowing nonprofessional subscribers to pay the lower of the payfor-use or flat rates); Network C / NASD–99–25, 

Securities Exchange Act Release No. 41499 (June 9, 

1999), 64 FR 32910 (June 18, 1999) (establishing 

pilot program for reduced Level 1 fees for nonprofessional users on a monthly and per query 

basis); Network C / NASD–99–17, Securities 

Exchange Act Release No. 38608 (May 12, 1997), 62 

FR 27095 (May 16, 1997) (increasing monthly 

subscriber fee for Level 1 Service); Network B / 

Securities Exchange Act Release No. 29879 (October 

29, 1991), 56 FR 56430 (November 4, 1991) 

(increasing Network B professional and nonprofessional subscriber fees); and Network A / 

Securities Exchange Act Release No. 29863 (October 

25, 1991), 56 FR 56429 (November 4, 1991) 

(increasing Network A professional and nonprofessional subscriber fees).

238Market Data Concept Release at 70629–70632.

239 Id. at 70619.

240 Id.

241 Id.

242 Id.

243 Id.

244See generally Securities Exchange Act Release 

No. 20874 (April 17, 1984), 49 FR 17640 (April 24, 

1984) (‘‘Instinet Order’’).

245 Id.

246 Id.

247 Id. The Market Data Concept Release then 

related the long process that ensued to arrive at a 

cost-based fee: 

The practical difficulties of implementing this 

strict, cost-of-service approach are demonstrated by 

the subsequent history of the fee involved in the 

Instinet Order (later named the ‘‘NQDS’’ fee). In 

August 1985, the NASD proposed a revised fee of 

$79 per month. The Commission did not approve 

this proposal, but instead instituted proceedings to 

determine whether it should be disapproved, based 

primarily on the question whether the fee included 

some costs that were inconsistent with the Instinet 

Order. In September 1986, the NASD proposed 

another NQDS fee of $50.75 per month. This 

proposal was supported by an extensive and 

complex ratemaking analysis. It included a 

comprehensive allocation of costs to pools 

consisting of six resources and eleven services. The 

major categories of costs were summarized as (1) 

operational costs, which were allocated to the six 

resource pools based on identifiable personnel, 

equipment, and physical facilities dedicated to 

those operations, (2) systems and product/service 

development costs, which were allocated to the six 

resource cost pools based on the historical or 

anticipated level of effort to be devoted to the 

respective resources, (3) overhead and general and 

administrative costs, which were allocated directly 

to resource and service cost pools to the extent that 

a causal relationship existed between those 

resources or services and the incurrence of the 

affected costs, and (4) residual overhead and 

general and administrative costs, which were 

allocated to resource and service cost pools based 

on the total cost input base. 

The Commission had not acted on this proposal 

when the NASD, in July 1990, proposed yet another 

NQDS fee of $50 per month. This fee, however, 

included last sale information in addition to 

quotation information. The Commission approved 

the fee in October 1990. Notably, the Commission 

did not undertake any cost-based explanation of the 

$50 fee, nor did it express any opinion on the 

extensive cost-of-service analysis that had been 

included in the NASD’s September 1986 proposal. 

Instead, it noted that, ‘‘in reviewing the fairness and 

reasonableness of the proposal, the Commission 

finds it significant that the proposed fee of $50 is 

the result of negotiations among the concerned 

parties after protracted proceedings.’’ The $50 fee 

approved for NQDS information in 1990 has 

remained unchanged up to the present. 

Market Data Concept Release at 70623 (footnotes 

omitted).

248 Id. at 70627.

249 Id. 70615.

250As the Commission described in the Market 

Data Concept Release, under the flexible, cost-based 

approach, the information that the SROs provide to 

the Networks would not be considered cost-free. 

Before quotations and transaction reports can be 

consolidated and made available to the public, an 

organized market must provide a mechanism for 

facilitating the buying and selling of securities in a 

fair and orderly manner. In addition, the SROs must 

establish, monitor, and enforce trading rules, as 

well as otherwise regulate their markets to prevent 

fraudulent and manipulative acts or practices. The 

SROs incur substantial costs in performing these 

functions, and they contribute substantially to the 

value of the information. Id. at 70627.

251 In contrast to costs incurred to operate and 

regulate markets, the flexible, cost-based approach 

set forth in the Market Data Concept Release 

excluded those SRO costs that did not directly 

contribute to the quality of market data. These 

included the costs of member regulation (e.g., sales 

practice and net capital requirements) and those 

Continued

In reviewing the basis for evaluating 

market data fees, the Market Data 

Concept Release laid out in detail a 

‘‘flexible cost-based approach’’ to 

market data fees.238 The Commission 

noted that terms such as ‘‘fair’’ and 

‘‘reasonable’’ generally need standards 

to guide their application in practice, 

and that one such standard often used 

to evaluate fees is the amount of costs 

incurred to provide a service.239 The 

Commission stated that an inflexible 

cost-based standard, although 

unavoidable in some contexts, can 

entail severe practical difficulties.240

Instead, Congress, consistent with its 

approach to the National Market System 

in general, granted the Commission 

some flexibility in evaluating the 

fairness and reasonableness of market 

information fees.241 Specifically, 

Congress articulated general findings 

and objectives for the National Market 

System in section 11A and directed the 

Commission to act accordingly in 

overseeing its development.242 Congress 

thereby allowed the Commission to 

adopt a more flexible approach than 

ratemaking.243

To illustrate the practical difficulties 

of a strict, cost-of-service ratemaking 

approach, the Market Data Concept 

Release described one prior instance in 

which the Commission had sought to 

implement such an approach in 1984.244

In that instance, Instinet had brought a 

proceeding before the Commission 

asserting that the NASD’s fee for full 

quotation information from all Nasdaq 

market participants was an unwarranted 

denial of access to the information.245

The Commission found in favor of 

Instinet, primarily because the NASD 

had failed to submit an adequate costbased justification for the fee.246 The 

Instinet Order emphasized, however, 

that the scope of its decision was 

limited to the particular competitive 

context presented in the proceedings 

and did not apply to all market data 

fees.247

While recognizing the practical 

difficulties of a detailed cost-of-service 

approach, the Commission nevertheless 

concluded in the Market Data Concept 

Release that ‘‘the total amount of market 

information revenues should remain 

reasonably related to the cost of market 

information.’’ 248 In this regard, one of 

the issues on which comment 

particularly was requested was whether 

the Commission should adopt ‘‘a 

conceptual approach to evaluating the 

fairness and reasonableness of fees that, 

among other things, could establish a 

link between the cost of market 

information and the total amount of 

market information revenues.’’ 249

Critical to this concept was the 

determination of what SRO costs should 

be included in the cost of market data.

The Market Data Concept Release’s 

flexible, cost-based approach was 

intended to arrive at an approach to 

market data fees that could be 

implemented in a reasonably efficient 

manner, as opposed to a full-fledged 

ratemaking approach. The first step in 

fashioning the approach was to identify 

the categories of SRO costs incurred to 

generate and disseminate market data. 

All direct market data costs, such as 

market data recordation, 

communication, consolidation, and 

dissemination, would be included. The 

flexible cost-based approach would also 

have included in market data costs some 

portion of ‘‘common costs’’—those costs 

that support multiple SRO functions, in 

addition to market data, and therefore 

must be allocated among these 

services.250 These common costs 

comprised the costs of operating the 

market that produced the market data 

and the costs of regulating that market 

so that the data was not inaccurate and 

not derived from fraudulent or abusive 

conduct. 251 The Market Data Concept 

71274 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

costs directly associated with other SRO services. 

Advertising and marketing expenditures were 

specifically excluded from market data costs.

252Market Data Concept Release at 70627.

253For example, in times of significant price 

volatility and spikes in trading volume, it is 

critically important that the markets remain fair and 

orderly and that investors continue to have access 

to a timely stream of market information.

254Market Data Concept Release at 70628–70629.

255Market Data Concept Release at 70628.

256Market Data Concept Release at 70630–70632.

257See generally Report of the Advisory 

Committee on Market Information: A Blueprint for 

Responsible Change (September 14, 2001), Section 

V (available at http://www.sec.gov) (‘‘Advisory 

Committee Report’’). The Advisory Committee 

Report includes a comprehensive description of the 

arrangements for disseminating market data to the 

public, including the terms, fees, and revenues of 

the Plans.

258See Advisory Committee Report.

259 In the view of a majority of the Advisory 

Committee, ‘‘the ‘public utility’ cost-based 

ratemaking approach is generally disfavored today. 

It is resource-intensive, involves arbitrary 

judgments on appropriate costs, and creates 

distortive economic incentives. Accordingly, the 

Advisory Committee recommends that the 

Commission not adopt a cost-based approach for 

determining whether market information fees are 

consistent with the Exchange Act * * * 

Furthermore, the Advisory Committee does not 

recommend any specific changes to the standard 

under which the Commission reviews market data 

fees and revenues, or to the manner in which it 

conducts this review.’’ Advisory Committee Report 

at Section VII.D.3.

260Advisory Committee Report at Section V.

261Many commenters, mostly securities firms and 

associations, believed that the Commission failed to 

address the main underlying problem, which they 

believe to be the root of the economic and 

regulatory distortions that the Commission is trying 

to address—whether the current fees for market 

data are excessive in relation to the actual cost of 

collecting and disseminating market data. See letter 

from Daniel M. Clifton, Executive Director, 

American Shareholders Association, to Jonathan G. 

Katz, Secretary, Commission, ASA Letter, p. 2 (June 

10, 2004) (‘‘Reg NMS ASA letter’’); letter from Kim 

Bang, President and Chief Executive Officer, 

Bloomberg Tradebook, LLC, to Jonathan G. Katz, 

Secretary, Commission, pp. 2 and 8–9 (June 30, 

2004) (‘‘Reg NMS Bloomberg letter’’); letter from C. 

Thomas Richardson, Citigroup Global Markets, Inc., 

to Jonathan G. Katz, Secretary, Commission, pp. 4 

and 15 (July 20, 2004) (‘‘Reg NMS Citigroup letter’’); 

Reg NMS Goldman Sachs Letter, pp. 2 and 10; letter 

from Samuel F. Lek, Chief Executive Officer, Lek 

Securities Corporation, to Jonathan G. Katz, 

Secretary, Commission, (no page numbers) (May 24, 

2004) (‘‘Reg NMS Lek letter’’); letter from Thomas 

N. McManus, Managing Director and Counsel, 

Morgan Stanley, to Jonathan G. Katz, Secretary, 

Commission, pp. 3 and 21 (August 19, 2004) (‘‘Reg 

NMS Morgan Stanley letter’’); letter from David 

Colker, Chief Executive Officer and President, NSX, 

to Jonathan G. Katz, Secretary, Commission, pp. 6–

7 (June 29, 2004) (‘‘Reg NMS NSX letter’’); Reg NMS 

Schwab letter, p. 2; Reg NMS SIA letter, pp. 3 and 

22; and Reg NMS STANY letter, p. 14. 

A range of commenters believed that the current 

level of market data fees warranted review. See

letter from Ellen L. S. Koplow, Executive Vice 

President and General Counsel, Ameritrade, Inc., to 

Jonathan G. Katz, Secretary, Commission, Letter, 

pp. 3 and 10 (June 30, 2004) (‘‘Reg NMS Ameritrade 

letter’’); letter from James J. Angel, Ph.D., CFA, 

Associate Professor of Finance, McDonough School 

of Business, to Jonathan G. Katz, Secretary, 

Commission, Letter I, p. 5 (June 30, 2004)(‘‘Reg 

NMS Angel letter’’); Reg NMS ASA Letter, p. 2; Reg 

NMS Bloomberg Letter, pp. 2 and 8–9; letter from 

William O’Brien, Chief Operating Officer, Brut, 

LLC, to Jonathan G. Katz, Secretary, Commission, 

pp. 21–23 (July 29, 2004) (‘‘Reg NMS Brut letter’’); 

Reg NMS Citigroup Letter, p. 15; letter from W. Leo 

McBlain, Chairman, Financial Information Forum, 

and Thomas J. Jordan, Executive Director, Financial 

Information Forum, to Jonathan G. Katz, Secretary, 

Commission, p. 3 (July 9, 2004)(‘‘Reg NMS FIF 

letter’’); letter from Richard M. Whiting, Executive 

Director and General Counsel, Financial Services 

Roundtable, to Jonathan G. Katz, Secretary, 

Commission, pp. 6–7 (June 30, 2004) (‘‘Reg NMS 

FSR letter’’); Reg NMS Goldman Sachs letter, pp. 2 

and 10; letter from Ari Burstein, Associate Counsel, 

Investment Company Institute, to Jonathan G. Katz, 

Secretary, Commission, pp. 21–22 (June 30, 2004) 

(‘‘Reg NMS ICI letter’’); Reg NMS Lek letter (no page 

numbers); Reg NMS Morgan Stanley letter, pp. 3 

and 21–22; Reg NMS Nasdaq letter, pp. 4 and 24–

26; Reg NMS NSX letter, pp. 6–7; Reg NMS Schwab 

letter, p. 2; Reg NMS SIA letter, pp. 3 and 22; Reg 

NMS STANY letter, p. 14; and Reg NMS UBS letter, 

p. 10.

262Many commenters believed that market data 

revenues should not be used to fund regulatory 

costs of the SROs. See Reg NMS Citigroup letter, pp. 

15–16; Reg NMS FIF letter, p. 3; Reg NMS Goldman 

Sachs letter, p. 11; Reg NMS Schwab letter, p. 3; 

and Reg NMS SIA letter, pp. 3 and 23.

263Some Reg NMS commenters believed that 

market data fees are not transparent enough to 

allow a proper assessment of the appropriateness of 

fees charged because SROs’ operating costs and use 

of revenues are not revealed. See Reg NMS 

Ameritrade Letter, pp. 10–11; letter from W. Hardy 

Callcott, to Jonathan G. Katz, Secretary, 

Commission, pp. 2–3 (May 6, 2004) (‘‘Callcott 

letter’’); Reg NMS Goldman Sachs letter, p. 11; Reg 

NMS Schwab letter, p. 7; Reg NMS SIA letter, pp. 

22–23 and 25; and Reg NMS STANY letter, pp. 14–

15.

Release noted that there is little value to 

market information that is tainted by 

fraud, deception, or manipulation.252

Moreover, the goal of producing high 

quality market data cannot be achieved 

by a poorly operated market that is 

prone to systems outages and delays.253

The Market Data Concept Release 

recognized that not all common costs 

should be funded by market data, and 

that any resulting allocation decision 

would be conceptually difficult.254

While the Market Data Concept 

Release’s approach to evaluating the 

fees of the Networks would require 

aggregating the allocated costs of the 

contributing SROs, the Market Data 

Concept Release specifically stated that 

a distribution of the revenues need not 

follow the costs of each SRO, but could 

be based on the quality of the data 

contributed by the SRO and its 

contribution to the market data 

stream.255 The Market Data Concept 

Release also questioned whether the 

rebate of market data revenues 

demonstrated that the existing fees were 

too high.256

In reflecting on the Market Data 

Concept Release and the industry’s 

reaction to it, the Commission gained an 

understanding of the serious divisions 

in the securities industry over how best 

to regulate market data. Specifically, 

there was a sharp division on the 

fairness and reasonableness of the 

existing fee levels of market data. In 

addition, there was a split of opinion as 

to whether market information fees 

should provide funding for other SRO 

functions such as market regulation or 

should be more closely related to the 

direct cost of producing the data. Also 

significant in the comments to the 

Market Data Concept Release were 

proposals that more competition be 

introduced to the compilation and 

dissemination of market data.257

To help resolve these divisions, the 

Commission established its Advisory 

Committee on Market Information in the 

summer of 2000. In its 2001 report, 

however, the Advisory Committee 

specifically rejected the flexible costbased approach.258 The Advisory 

Committee report noted the consensus 

view that it was essentially a 

‘‘ratemaking’’ approach that was unwise 

and, ultimately, unworkable.259 The 

Advisory Committee recommended 

retaining price transparency and 

consolidated market information as core 

elements of the U.S. securities markets, 

while adopting a ‘‘competing 

consolidators’’ model of data 

dissemination.260 Under this model, 

vendors and market data users would 

themselves consolidate the data from 

the various markets, with each SRO 

separately providing and setting fees for 

its own data, rather than consolidating 

this data through the Networks.

In commenting on proposed 

Regulation NMS, a number of SROs said 

the current market data Networks and 

their fees were reasonable, while several 

larger markets and their adherents 

advocated the competing consolidator 

model. Many other commenters said 

that the fees they pay to obtain basic 

market data—NBBO and trades—are 

excessive, and are not reasonably 

related to the cost of producing such 

data.261 As in earlier debates, some 

commenters said that market data fees 

should be limited to covering solely the 

costs incurred to disseminate 

consolidated market data, not the costs 

incurred by the individual SROs to 

produce the data and provide it to the 

Networks.262 Other commenters said 

that a prerequisite for evaluating the 

appropriateness of funding SRO 

operations and regulatory costs from 

market data revenues was a transparent 

accounting of the revenues received for 

market data and the expenses incurred 

in operating and regulating the SRO’s 

market.263

As noted above, to provide greater 

transparency of SRO revenues and 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71275

264See supra note 99.

265For example, the NASD operates both the 

Central Registration Depository (‘‘CRD’’) System for 

registered representative registration and the 

Investment Advisor Registration Depository 

(‘‘IARD’’) system. In addition, certain SROs earn 

fees from the administration of the consolidated 

data networks.

266For example, Nasdaq receives licensing fees 

from regional exchanges that report trades in 

Nasdaq–100 Index Tracking Stock. Nasdaq, 2003 

Annual Report 43 (2004).

267Market Data Concept Release at 70625.

268 Data compiled from SRO 2003 Annual 

Reports. Note that the NYSE 1998 Consolidated 

Statement of Revenue did not account for ‘‘Data 

Processing Fee’’ revenue. Due to an intervening 

change in accounting procedures, the NYSE 2003 

Consolidated Statement of Revenue includes this 

item. To provide a more accurate comparison 

between the 1998 and 2003 percentages, ‘‘Data Fee 

Processing’’ revenue was not included in total SRO 

revenue for the purpose of calculating the 

percentage of total SRO revenue represented by 

miscellaneous fee revenue. Based on SRO 2003 

Annual Report Consolidated Statements of Income 

certain items were allocated to miscellaneous fees 

with respect to the NYSE (‘‘Facility and 

Equipment’’ and ‘‘Investment Income’’), the BSE 

(‘‘Interest’’ and ‘‘Other’’), the Phlx (‘‘Clearing and 

settlement,’’ ‘‘Dividend and Interest,’’ and ‘‘Other’’), 

the NASD (including Amex and Nasdaq 

consolidated statements of income) (‘‘Dispute 

Resolution Fees’’ and ‘‘Other Revenue’’), the PCX 

(‘‘Archipelago Revenue: Original Consideration 

Amortization,’’ ‘‘Communications,’’ and ‘‘Other’’), 

the CHX (‘‘Interest’’ and ‘‘Other’’), and the CBOE 

(‘‘Interest’’ and ‘‘Other’’).

269E.g., the Amex’s affiliation with the NASD and 

Arca’s affiliation with the PCX.

expenses, the Commission is proposing 

in the SRO Governance and 

Transparency Proposal to require SROs 

to file with the Commission public 

reports detailing their sources of 

revenues and their uses of these 

revenues, specifically including their 

costs of regulation.264 These reports 

could provide observers greater ability 

to evaluate the role of market data 

revenues in financing an SRO, and to 

compare these revenues to the expenses 

of operating and regulating their market. 

This information also could empower 

users to respond to market data fee 

changes on a more informed basis.

Thus, given the concerns raised in 

response to proposed Reg NMS 

regarding market data fees and because 

these issues are related to 

considerations of overall SRO funding 

and regulatory operations, the 

Commission is seeking comment on a 

number of issues. 

Question 23: Should market data 

revenue be used to cross subsidize SRO 

regulatory operations?

Question 24: Are current market data 

fees significantly limiting access of 

market participants, investors, or other 

users to data? Why are certain market 

data fees more problematic than others, 

such as those associated with SRO data 

products that are not part of the 

consolidated quote stream? If so, which 

fees and why? 

Question 25: Should the Commission 

reconsider the flexible, cost-based 

approach? 

Question 26: Should the Commission 

consider a narrow cost-based approach 

that takes into account only limited 

costs, such as consolidation costs? 

Question 27: On a conceptual basis, 

what should be included in the cost of 

generating market data? 

Question 28: Are there other, better 

cost-based approaches? What are their 

potential benefits and drawbacks? 

Question 29: Should the Commission 

require a more detailed explanation of 

how SROs spend the revenue generated 

from market data fees? Would the 

requirements proposed in the SRO 

Governance and Transparency Proposal 

that SROs detail their sources and uses 

of revenues add sufficient transparency 

in this area, or should more detailed 

reporting be mandated? 

Question 30: If the Commission were 

to implement a revised approach to 

market data fees that substantially 

reduced this element of SRO funding, 

would SROs be able to raise the level of 

other revenue sources to remain 

adequately funded to comply with their 

statutory obligations? 

Question 31: What SRO fees or other 

charges presently are under priced? 

What SRO fees or charges are over 

priced? On balance, are SROs over 

funded or under funded? What would 

be the impact on smaller SRO members 

of funding regulatory costs exclusively 

through regulatory fees? 

Question 32: If market data fees were 

substantially reduced and SROs were 

unable to replace these revenues from 

other sources, would SROs be able to 

adequately fund their regulatory 

operations? If an SRO’s funding were to 

become insufficient because of such a 

decline in revenue, should that SRO 

lose its status as a registered SRO? 

Question 33: If market data fees were 

substantially reduced, would this 

exacerbate the conflicts inherent in the 

SRO system—in particular, the 

incentive to fund business functions at 

the expense of regulation? 

Question 34: To what extent would 

the enhancements proposed in the SRO 

Governance and Transparency Proposal 

mitigate these concerns about inherent 

conflicts? Are there other measures that 

could mitigate these conflicts? 

Question 35: Should the Commission 

require that all SRO fees and charges be 

closely related to the cost of the SRO 

providing the service in question? What 

would be the benefits and risks of doing 

so? 

e. Miscellaneous Fees 

In addition to regulatory fees, 

transaction fees, listing fees, and market 

data fees, SROs receive revenue from a 

variety of miscellaneous sources as well. 

For instance, SROs charge fees for 

administering joint industry plans and 

market systems.265 SROs also derive 

funding from product licensing,266

investment gains, and fines. In 1998, 

these types of miscellaneous SRO fees 

accounted for 8% of SRO revenue,267

while, in 2003, 12% of SRO revenue 

was associated with these miscellaneous 

fees.268 This relatively significant 

increase (a 50% increase compared with 

the 1998 percentage for miscellaneous 

fees) may have been caused by an 

increase in certain SRO sources of 

revenue, such as derivative product 

licensing fees, and by the intervening 

establishment of SRO relationships with 

other markets.269

The Commission specifically seeks 

public comment on the following 

question related to SRO miscellaneous 

fees: 

Question 36: In light of the recent 

growth in SRO revenue that is derived 

from miscellaneous fees, how important 

are these fees to SRO funding generally 

and will this growth trend continue? If 

so, how does this revenue pose conflicts 

with respect to the SRO regulatory 

function? How should these conflicts be 

addressed? How does it relate, if at all, 

to the SROs’ fulfilling their statutory 

obligations? 

V. Alternative Regulatory Approaches 

In order to focus consideration of the 

strengths and weaknesses of the SRO 

system, the following section discusses 

a variety of enhancements and 

alternative approaches, which would 

require either Commission or 

Congressional action to achieve. 

Specifically, this section will examine: 

(1) Proposed enhancements to the 

current SRO system; (2) implementing 

an independent regulatory and market 

corporate subsidiary model; (3) 

implementing a hybrid model; (4) 

implementing a competing hybrid 

model; (5) implementing a universal 

industry self-regulator model; (6) 

implementing a universal non-industry 

regulator model; and (7) establishing 

direct Commission regulation of the 

securities industry. The discussion of 

each alternative examines how 

effectively it would manage the current 

SRO system’s inherent limitations. 

It is important to note that this 

discussion does not attempt to provide 

an exhaustive list of every potential 

option and alternative approach that 

71276 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

270See supra note 99.

271 Id.

272 Id.

273 Id.

274See Exchange Act Release Nos. 48946 

(December 17, 2003), 68 FR 74678; 48764 

(November 7, 2003), 68 FR 64380 (November 13, 

2003) (regarding NYSE governance and regulatory 

function amendments).

could be considered. The purpose of 

this section is to provide a discussion of 

what appear to be some of the more 

promising alternatives. Public comment 

sought, however, is not limited to the 

options and alternative approaches 

described herein. In addition, while this 

section attempts to detail the strengths 

and weaknesses of the various options 

and alternative approaches, it should be 

noted that such a discussion is 

inherently speculative. The full range of 

strengths and weaknesses of any given 

option or alternative approach would 

likely not be known until that approach 

were fully implemented.

A. Proposed Enhancements to the 

Current SRO System 

The current SRO system has provided 

essential regulation of markets and 

members for over seven decades. 

Nonetheless, this system has inherent 

limitations that should be considered. 

This section discusses possible 

enhancements to the status quo that 

could be implemented to address these 

SRO limitations. 

1. SRO Governance and Transparency 

Rulemaking 

The Commission today is proposing 

an SRO Governance and Transparency 

Proposal.270 If adopted, the proposed 

rulemaking would strengthen SRO 

governance, enhance SRO disclosure 

and reporting requirements, and address 

various issues that have arisen with 

respect to shareholder-owned SROs.271

The proposed governance standards 

would require SROs that are national 

securities exchanges and registered 

securities associations to have a 

majority independent board and fully 

independent Nominations, Governance, 

Audit, Compensation, and Regulatory 

Oversight Committees (or their 

equivalent).272 SROs also would be 

required to effectively separate their 

regulatory function from their market 

operations and other commercial 

interests.273

With respect to the regulatory 

function, each SRO would be required 

to establish standards to assure the 

independence of its regulatory program. 

At a minimum, the regulatory function 

of an SRO would be required to be 

overseen by a Chief Regulatory Officer 

who reports to, and is evaluated by, an 

independent Regulatory Oversight 

Committee. Moreover, SROs would be 

required to provide the Commission 

with specified information concerning 

their regulatory programs on a regular 

basis. As part of this proposal, each SRO 

would be required to prepare for the 

Commission annual and quarterly 

regulatory reports that would give 

details regarding key aspects of the 

SRO’s regulatory program. As part of the 

annual report, each SRO also would be 

required to disclose employment 

arrangements with its Chief Regulatory 

Officer and other key regulatory 

personnel. The filing of this regulatory 

program information is intended to 

bolster the Commission’s SRO 

inspections program and thus would be 

kept confidential to the extent permitted 

by law. 

In addition to filing quarterly and 

annual reports about their regulatory 

programs, each SRO would be required 

to disclose publicly information about 

its regulatory program and provide 

greater disclosure regarding revenues 

and expenses and staffing of its 

regulatory program. Finally, the SRO 

Governance and Transparency Proposal 

proposes ownership and voting 

concentration limits on members that 

are broker-dealers to mitigate the 

conflict of interest that would arise if a 

broker-dealer were to control a 

significant interest in its regulator or if 

a member could exercise too much 

control over the operations of the SRO. 

If the proposed SRO Governance and 

Transparency Proposal is adopted, a 

number of benefits could be gained. 

Regulatory conflicts with members, 

market operations, issuers, and 

shareholders could be reduced. The 

strict reporting lines of the Chief 

Regulatory Officer reporting to an 

independent board committee could 

reduce the SRO regulation conflicts. In 

addition, the wholly independent 

Regulatory Oversight Committee’s sole 

responsibility for budgeting decisions 

with respect to regulatory operations 

could help insulate the budgeting 

process from business pressures. 

While the Governance and 

Transparency Proposal could help 

manage a variety of the traditional SRO 

limitations, it would not eliminate 

them. For instance, conflicts could 

persist in spite of the majority 

independent board because of the 

influence of representatives of large 

members serving on the board, 

particularly if intermarket competition 

pressures continue to increase. In 

addition, the fact that the independent 

directors would necessarily rely on the 

expertise of the industry directors to 

some degree could undermine some of 

the structural protections put in place. 

Moreover, the independent directors’

own imperceptible institutional biases 

could compromise some of the 

structural protections. 

Concerns regarding unequal 

regulation and unequal regulatory 

funding across markets would persist 

under the SRO Governance and 

Transparency Proposal. This would be 

true even if each SRO’s Regulatory 

Oversight Committee were to make 

regulatory budgeting decisions 

irrespective of business or other 

pressures. These committees would not 

all necessarily allocate regulatory 

funding in the same fashion in the 

different SROs; thus, regulatory 

inequalities could still exist. The 

concerns regarding conflicting SRO 

rules, conflicting SRO rule 

interpretations, conflicting SRO 

inspection regimes, and redundant 

regulatory staff and infrastructure across 

markets would remain under this 

proposal. Finally, the proposal also does 

not address potential intermarket 

trading surveillance issues. 

The Commission specifically seeks 

public comment on the following 

questions related to the SRO 

Governance and Transparency Proposal: 

Question 37: To what extent would 

the changes proposed in the SRO 

Governance and Transparency Proposal 

effectively manage inherent SRO 

limitations related to conflicts, funding, 

redundancies, and intermarket 

surveillance? 

Question 38: To what extent would 

the changes proposed in the SRO 

Governance and Transparency Proposal 

continue to provide the benefits of the 

current SRO system (e.g., largely selffunded system with market specific 

expertise of SRO regulatory staff 

enhancing rule promulgation and 

enforcement)? 

Question 39: If adopted, would the 

SRO Governance and Transparency 

Proposal enable the Commission, 

investors, and market participants to 

perceive when a particular SRO was 

insufficiently funding its regulatory 

function? If so, could this lead the SROs 

to develop and follow voluntary 

guidelines or standards with respect to 

regulatory spending levels? 

Question 40: Would the changes 

proposed in the SRO Governance and 

Transparency Proposal more effectively 

manage inherent SRO limitations 

compared to the NYSE’s recent 

corporate and regulatory function 

restructuring? 274

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71277

275See 21(a) Administrative Order and 21(a) 

Report.

276See 21(a) Report at 50–55.

2. Intermarket Surveillance 

Enhancements 

Another incremental improvement to 

the current system could be the 

enhancement of the Commission’s and 

the SROs’ ability to regulate intermarket 

trading activity. As discussed at length 

above, several equity markets have 

developed individual order audit trails, 

the options markets have developed 

COATS to assist in the surveillance of 

order flow in the options markets, and 

the ISG has developed a clearing level 

order audit trail. Full implementation of 

a more robust intermarket order audit 

trail for both the options and equity 

markets could enhance the surveillance 

of intermarket order flow. It would not 

by itself, however, manage any of the 

other inherent SRO limitations, 

including conflicts, regulatory 

redundancies, and funding problems. In 

addition, even with a consolidated order 

audit trail, the Commission would have 

to be vigilant in determining whether 

the SROs used it to enhance 

surveillance and regulation of 

intermarket trading. 

The Commission specifically seeks 

public comment on the following 

questions related to intermarket 

surveillance enhancements: 

Question 41: To what extent would 

the establishment of a more robust 

intermarket surveillance regime more 

effectively manage inherent SRO 

limitations related to conflicts, funding, 

redundancies, and intermarket 

surveillance? 

Question 42: To what extent would 

enhancing intermarket surveillance 

continue to provide the benefits of the 

current SRO system (e.g., largely selffunded system with market specific 

expertise of SRO regulatory staff 

enhancing rule promulgation and 

enforcement)? 

Question 43: To what extent is 

COATS serving as an effective tool for 

enhancing intermarket surveillance? 

Question 44: To what extent should 

COATS be used as a template for the 

establishment of a consolidated order 

audit trail for the equity markets? 

Question 45: To what extent are SROs 

effectively using intermarket order audit 

trail data to enhance surveillance?

Question 46: What are examples of 

illicit intermarket trading activity that 

can be engaged in undetected by 

regulators? 

B. Independent Regulatory and Market 

Corporate Subsidiaries 

Another approach would be to 

increase SRO regulatory independence 

through mandated SRO internal 

restructuring. One option would be to 

require that all SROs create independent 

subsidiaries for regulatory and market 

operations. This model could resemble 

the NASD corporate structure that was 

devised in the wake of the joint 

Department of Justice and SEC 

investigation into OTC market maker 

pricing collusion that resulted in a 

Commission enforcement action.275

Among the most important NASD 

Undertaking resulting from the 

settlement was a corporate restructuring 

of the NASD and the establishment of 

an independent regulatory corporate 

subsidiary, NASD Regulation, Inc. 

(‘‘NASDR’’).276

Under this model, regulatory staff of 

each SRO would be placed within an 

independent regulatory subsidiary, 

which would report directly to the 

corporate parent’s board. Substantially 

all regulatory operations would be 

housed in the regulatory subsidiary, 

including examination, rulemaking, and 

enforcement responsibilities. All market 

operations responsibilities would be 

placed within an independent market 

subsidiary. 

This model would provide a more 

clear organizational separation than 

most SROs currently exhibit. It would 

help strengthen an independent attitude 

in the regulatory subsidiary, which 

could address conflicts with members, 

market operations, issuers, and 

shareholders. This approach might 

establish even more clearly defined 

divisions between the regulator and the 

market functions than the proposed 

SRO Governance and Transparency 

Proposal. While the SRO Governance 

and Transparency Proposal relies on 

corporate reporting lines to insulate the 

regulator function, this model would 

house the regulator and market in 

distinct corporate subsidiaries that 

would be governed by separate boards. 

As with making incremental changes 

to the current system, however, this 

model would not alleviate all SRO 

limitations. A primary purpose of the 

regulatory subsidiary would be 

supervising the competitive market 

subsidiary. Thus, the independent 

regulatory subsidiary would still be a 

component of a larger competitive 

enterprise and subject to business 

pressure on some level. With respect to 

regulatory funding, the influence of 

major members, issuers, and 

shareholders, and increased intermarket 

competitive pressure could still have a 

detrimental impact on the regulatory 

budgeting process. Even though an 

independent board committee would be 

responsible for budgeting decisions, 

there would still be reliance on major 

members and the market operation for 

funding. As with the approaches already 

described, the self-funding of regulatory 

operations by each SRO would cause a 

continued degree of unequal funding 

and unequal regulation across markets. 

Moreover, conflicting SRO rules, 

conflicting SRO rule interpretations, 

conflicting SRO inspection regimes, 

redundant SRO regulatory staff and 

redundant regulatory infrastructures 

across markets would remain. This 

approach also could reduce market 

specific knowledge on the part of 

regulatory staff by removing it on a 

corporate level from market operations. 

In addition, the intermarket trading 

surveillance issues in the system would 

persist. 

The Commission specifically seeks 

public comment on the following 

questions related to the separate market 

and regulatory subsidiary SRO structure 

model: 

Question 47: To what extent would 

the implementation of the separate 

market and regulatory subsidiary SRO 

structure model effectively manage 

inherent SRO limitations related to 

conflicts, funding, redundancies, and 

intermarket surveillance? 

Question 48: To what extent would 

the separate market and regulatory 

subsidiary SRO structure model 

continue to provide the benefits of the 

current SRO system (e.g., largely selffunded system with market specific 

expertise of SRO regulatory staff 

enhancing rule promulgation and 

enforcement)? 

Question 49: To what extent is the 

separate market and regulatory 

subsidiary SRO structure model 

effective in managing inherent SRO 

limitations specifically with respect to 

the NASD? 

C. Hybrid Model 

Another option, which would require 

significant system restructuring, would 

be the Commission’s designation of a 

market neutral single self-regulatory 

organization (‘‘Single Member SRO’’) to 

regulate all SRO members with respect 

to membership rules, including rules 

governing members’ financial condition, 

margin practice, handling of customer 

accounts, registered representative 

registration, branch office supervision, 

and sale practices. The Single Member 

SRO would be solely responsible for 

promulgating membership rules, 

inspecting members for compliance 

with ‘‘member’’ rules, and taking 

enforcement action against those 

members that fail to comply. Each SRO 

that operates a market (‘‘Market SRO’’) 

71278 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

would be solely responsible for its own 

market operations and market 

regulation.

This approach would have a variety of 

sub-options with respect to the Market 

SROs’ role in surveillance of the market 

and enforcement of ‘‘market’’ rules. For 

instance, the Market SROs could 

maintain all of the functions that SROs 

currently carry out with respect to their 

market operations, including 

promulgating market rules, conducting 

market surveillance, and taking 

enforcement action with respect to 

violations of market rules. Alternatively, 

the Market SROs could be responsible 

for promulgating rules and conducting 

surveillance, but enforcement actions 

could be referred to the Single Member 

SRO. Another option would limit the 

Market SROs’ responsibility to market 

rule promulgation and the Single 

Member SRO would be responsible for 

all other market surveillance and 

enforcement functions. 

As with the approaches already 

discussed, this Hybrid model could 

improve upon the current system in a 

variety of respects. For instance, 

because the Single Member SRO would 

not be affiliated with a particular 

market, inherent conflicts that exist 

between the regulatory function and 

market operation of an SRO would be 

reduced. It would also eliminate 

duplicative regulation with respect to 

membership rules. This approach could 

result in beneficial synergies by the 

centralization of membership 

regulation, while maintaining the value 

of having market regulatory staff 

embedded within the Market SROs. The 

Single Member SRO would also 

potentially serve as a more effective 

liaison with the SEC, Congress, and 

international entities on behalf of the 

industry because it would be a single, 

market neutral voice. Depending on the 

extent to which the Single Member SRO 

was delegated responsibility under this 

approach for intermarket surveillance, 

cross-market surveillance could be 

simplified and enhanced. 

As with other models, this approach 

has limitations. For example, this 

approach could reduce self-regulatory 

knowledge of business practices by 

removing the Single Member SRO from 

market operations. In addition, this 

model would raise a ‘‘boundary issue’’

between member and market rules, in 

that every SRO rule would have to be 

characterized as either a ‘‘member’’ or 

‘‘market’’ rule. Some rules, such as 

those related to member capital 

requirements, would likely be 

categorized as member rules, because 

they are unrelated to direct trading 

activity and deal with requirements 

imposed on members in support of 

trading operations. In contrast, certain 

rules, such as those related to the 

priority of orders on a market’s trading 

floor or system, would clearly be 

characterized as trading rules. A variety 

of other rules, however, such as those 

related to front running or margin 

requirements, could be categorized as 

either ‘‘market’’ or ‘‘member’’ rules 

because they embody elements of both 

types of rules. 

While this Single Member SRO 

approach could reduce certain conflicts, 

it would not resolve the conflicts arising 

from member funding, and control, and 

from reliance on industry members for 

business experience. Also, conflicts 

would persist unabated in the Market 

SROs. As noted above, sub-issues with 

respect to the duties of the Market SROs 

would have to be determined and the 

extent of this conflict would depend on 

the extent of the Market SRO’s 

regulatory responsibility. For instance, 

the Market SRO’s role in market rule 

promulgation, market surveillance, and 

market rule enforcement would have to 

be determined. 

The concerns about unequal funding 

and unequal regulation of members 

would be substantially reduced. 

Specifically, unequal funding and 

unequal regulation with respect to 

member regulation would be eliminated 

because only one Single Member SRO 

would exist. However, other funding 

issues could arise. Either the Single 

Member SRO would be required to 

depend solely on regulatory fees for 

funding or the Market SROs would have 

to contribute to the Single Member SRO 

from listing, market data, and market 

operation revenues. Determining the 

absolute and relative amounts of these 

contributions would raise difficult 

issues. Specifically, an allocation 

formula would have to be devised for 

determining the relative amount that 

each Market SRO owed annually for 

funding the Single Member SRO. The 

formula could be weighted based on a 

host of complex and potentially 

subjective factors, including trading 

volume, average member size, number 

of members, type of security traded on 

the market, and type of business (e.g., 

agency or proprietary) engaged in by the 

SROs’ members. The concern about 

unequal funding and unequal regulation 

would also persist with respect to the 

Market SROs. Although, inconsistent 

member rules, staff, and infrastructure 

would be eliminated, inconsistent 

market rules, staff, and infrastructure 

would remain. 

The Commission specifically seeks 

public comment on the following 

questions related to the Hybrid SRO 

structure model: 

Question 50: To what extent would 

the implementation of the Hybrid model 

more effectively manage inherent SRO 

limitations related to conflicts, funding, 

redundancies, and intermarket 

surveillance? 

Question 51: To what extent would 

the Hybrid model continue to provide 

the benefits of the current SRO system 

(e.g., largely self-funded system with 

market specific expertise of SRO 

regulatory staff enhancing rule 

promulgation and enforcement)? 

Question 52: How would the Single 

Member SRO be funded under the 

Hybrid approach?

Question 53: To what extent would 

the boundary issue with respect to 

‘‘member’’ and ‘‘market’’ rules be a 

concern in implementing the Hybrid 

approach? Which types of rules would 

be subject to the ‘‘boundary’’ problem 

(i.e., which types of rules could be 

categorized either as ‘‘market’’ or 

‘‘member’’ rules)? How should these 

‘‘boundary’’ issue rules be categorized 

and why? 

Question 54: In establishing itself, 

should the Single Member SRO draw 

personnel, facilities, or other assets from 

the existing SROs? If so, would the 

Market SROs from which personnel, 

facilities, or assets were drawn be able 

to replace those resources? Would there 

be any conflicts of interest with respect 

to Single Member SRO personnel 

allegiance to their former Market SROs? 

Question 55: To what extent should 

the Market SROs or the Single Member 

SRO under the Hybrid approach be 

responsible for market rule 

promulgation, market surveillance, and 

enforcement of market rules? 

D. Competing Hybrid Model 

Another approach involving a 

significant departure from the current 

system would be a derivative of the 

Hybrid approach. Under this approach, 

Market SROs would exist as in the pure 

Hybrid approach and market regulation 

would be conducted separately from 

member regulation. Rather than one 

Single Member SRO, however, this 

approach would permit the existence of 

multiple competing member SROs 

(‘‘Competing Member SROs’’), which 

would be required to be registered with 

the Commission and, thereby, 

authorized to provide member 

regulatory services. Under this 

approach, each Market SRO member 

would also have to be a member of one 

of the Competing Member SROs. A 

Competing Member SRO would charge 

its members a regulatory fee. Because of 

the potential disparity in bargaining 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71279

277 15 U.S.C. 78k–1.

power between the Competing Member 

SROs and individual brokerage firms, 

this regulatory fee would likely need to 

be subject to appropriate oversight, 

including Commission approval. The 

Competing Member SROs would be 

responsible for promulgating the range 

of member rules described in the Hybrid 

discussion, inspecting members for 

compliance with member rules, and 

taking enforcement action against those 

members that fail to comply. Under this 

approach, as with the pure Hybrid 

approach, Market SROs would retain 

their market regulatory responsibilities. 

Under this approach, members of 

Competing Member SROs would have 

the right to periodically switch 

Competing Member SROs. A limit on 

the frequency with which members 

could switch between Competing 

Member SROs would likely need to be 

imposed for a variety of reasons. For 

instance, members could conceivably 

avoid being effectively regulated by 

switching between Competing Member 

SROs whenever regulatory action 

loomed. Further, Competing Member 

SROs may not vigorously regulate 

important members that are able to 

switch to another Competing Member 

SRO, if the members believe they can 

receive more lenient regulation from a 

different Competing Member SRO. In 

addition, longer Competing Member 

SRO experience with a particular 

member would likely result in increased 

institutional knowledge and potentially 

more effective regulation. 

As with the pure Hybrid model, this 

approach would have a variety of subissues to be resolved with respect to the 

Market SROs’ role in promulgating 

market rules, conducting surveillance of 

the market, and enforcement of market 

rules. For instance, the Market SROs 

could maintain all of the functions that 

SROs currently carry out with respect to 

their market operations. Alternatively, 

the Market SROs could be responsible 

for promulgating market rules and 

conducting market surveillance, but 

enforcement actions could be referred to 

the Competing Member SRO of the 

offending Market SRO member. Another 

option would be the Market SROs being 

responsible solely for market rule 

promulgation and the Competing 

Member SROs being responsible for all 

other market surveillance and 

enforcement functions. This approach 

would also require considering whether 

Competing Member SROs should be 

required to have uniform membership 

rules to ensure uniformity of rules 

governing the membership of each 

market and to limit the potential for 

regulatory arbitrage. In addition, 

difficult issues would have to be 

addressed with respect to the criteria for 

a Commission determination as to 

whether a Competing Member SRO was 

‘‘authorized’’ to provide member 

regulation. 

This model carries with it a variety of 

benefits. For example, as with the pure 

Hybrid model, if uniform membership 

rules were required, this approach could 

significantly reduce conflicts and 

inconsistent application and 

enforcement with respect to 

membership rules. In addition, it would 

concentrate membership regulatory 

expertise in a small number of entities, 

while continuing to foster market 

specific expertise in the regulatory staff 

embedded in Market SROs. As with the 

Hybrid model, the Competing Member 

SROs could be more effective liaisons 

with the SEC, Congress, and 

international entities on behalf of the 

industry. 

This approach would be a 

compromise between the Single 

Member SRO approach and the current 

system of numerous redundant SRO 

member regulators. Moreover, this 

approach would not require the 

potential elimination of one of the 

existing primary member regulators in 

favor of another. Depending on the 

extent to which the Competing Member 

SROs are delegated responsibility for 

inter-market surveillance (and if 

ultimately a limited number of these 

Competing Member SROs are 

registered), cross-market surveillance 

could be simplified and enhanced. 

Finally, this model might succeed in 

centralizing member regulation to a 

much greater extent than under the 

current system, but at the same time 

foster competitive discipline by 

allowing Competing Member SROs to 

compete with each other. 

As with the approaches already 

discussed, this model has significant 

drawbacks. For instance, and as 

discussed above, it would require the 

same difficult ‘‘boundary issue’’

determinations between ‘‘market’’ and 

‘‘member’’ rules to be made as would be 

made under the Hybrid approach. As 

with the pure Hybrid approach, this 

model could reduce self-regulatory 

experience by separating self-regulatory 

member staff from market operations. 

Moreover, conflicts with members, 

market operations, issuers, and 

shareholders would remain unabated in 

the Market SROs. 

Competition could result in an effort 

by the Competing Member SROs to 

reduce their fees to attract and keep 

members and the Commission would 

ultimately continue to be responsible for 

determining whether funding remained 

adequate. This model could reduce 

conflicting member rules, but would 

only eliminate these conflicting rules if 

the Competing Member SROs adopted a 

uniform set of member rules. In 

addition, conflicting market rules across 

Market SROs would still exist. Ideally, 

under this approach, competitive forces 

would discipline the Competing 

Member SROs and discourage them 

from becoming unresponsive. 

As noted above, a significant issue 

with the Competing Member SRO model 

would be the ability of an SRO to 

discipline members if the members 

could then choose another regulator. 

This could be addressed by limitations 

on the ability of members to make 

changes or a charge for switching from 

one regulator to another, but such 

barriers might tend to diminish the 

benefits of competition. 

Finally, if the NASD should be one of 

the Competing Member SROs, its 

specific role in overseeing the OTC 

market and its operation of the ADF, in 

particular, would also require further 

analysis under this model. While the 

NASD, as a registered national securities 

association under Exchange Act Section 

15A,277 is responsible for overseeing 

OTC broker-dealer activity, many of its 

rules related to member use of the ADF 

could be characterized as market rules 

(e.g., NASD Rule 4300A regarding direct 

and indirect electronic access to best 

bids and offers posted in the ADF).

The Commission specifically seeks 

public comment on the following 

questions related to the Competing 

Hybrid SRO structure model: 

Question 56: To what extent would 

the implementation of the Competing 

Hybrid SRO structure model effectively 

manage inherent SRO limitations 

related to conflicts, funding, 

redundancies, and intermarket 

surveillance? 

Question 57: To what extent would 

the Competing Hybrid SRO structure 

model continue to provide the benefits 

of the current SRO system (e.g., largely 

self-funded system with market specific 

expertise of SRO regulatory staff 

enhancing rule promulgation and 

enforcement)? 

Question 58: What should the criteria 

be upon which Competing Member 

SROs would be registered under the 

Competing Hybrid approach? 

Question 59: What would be the ideal 

number of Competing Member SROs 

under the Competing Hybrid approach?

Question 60: What limitations, if any, 

should be placed on members’ ability to 

change Competing Member SROs? 

71280 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

278See Exchange Act Sections 6 and 15A, 15 

U.S.C. 78f and 78k–1. It is conceivable that this 

approach could be achieved by the SROs engaging 

in an omnibus market and member regulatory 

agreement pursuant to Exchange Act Rule 17d–2, 17 

CFR 240,17d–2. However, this approach would 

require significant restructuring of the existing 

SROs.

279Pub. L. 107–204, 116 Stat. 745 (2002).

280Prior to the establishment of the PCAOB, the 

American Institute of Certified Public Accountants 

(‘‘AICPA’’) established and interpreted Generally 

Accepted Auditing Standards (‘‘GAAS’’). The 

AICPA is a private, professional organization 

composed of certified public accountants (‘‘CPAs’’). 

The Public Oversight Board (‘‘POB’’), created by the 

Question 61: Should the Competing 

Member SROs be required to adopt a 

uniform set of member rules? 

E. Universal Industry Self-Regulator 

Another model, which would require 

significant restructuring, would be the 

establishment of a universal industry 

self-regulator (‘‘Universal Industry SelfRegulator’’). Under this model, one 

industry self-regulatory organization 

would be responsible for all market and 

member rules for all members and all 

markets. The current SROs’ selfregulatory authority would be 

transferred to the Universal Industry 

Self-Regulator, including member and 

market rulemaking, member and market 

surveillance, and member and market 

rule enforcement. This approach likely 

would require legislation or significant 

restructuring of the current SROs.278

Under this approach, all member firms 

would be registered directly with the 

Universal Industry Self-Regulator and 

all markets would be non-SROs 

registered with the Universal Industry 

Self-Regulator similar to how ATSs are 

currently registered with SROs. Under 

this approach, the markets’ selfregulatory authority would be 

eliminated.

This model could resolve weaknesses 

of prior alternatives in a variety of ways. 

For instance, and as discussed above, it 

would erase the ‘‘boundary’’ issues 

between market and member rules 

associated with the Hybrid and 

Competing Hybrid Models because one 

entity would be responsible for all 

‘‘market’’ and ‘‘member’’ rules. This 

model would establish a level playing 

field among competing markets in that 

they would all be subject to the same 

uniform standards of a single SRO. The 

Universal Industry Self-Regulator would 

benefit from a broader knowledge of 

regulated entities and markets because it 

would be responsible for all member 

and market regulation. Because one SRO 

would exist that would not be subject to 

inter-market competition, conflicts with 

market operations, issuers, and 

shareholders would be almost entirely 

eliminated as would regulatory 

redundancies. 

Moreover, this approach would 

address the arguments that unequal 

funding of regulatory operations and 

unequal allocation of costs for 

regulation across the markets cause 

market distortions. Specifically, the 

existence of one SRO would prevent 

unequal regulation in the sense that 

only one entity would be responsible for 

the regulation across all markets. 

Because one SRO would be in 

possession of all regulatory data (rather 

than it being held by disparate SROs), 

this model would also facilitate the 

development of a consolidated order 

audit trail for intermarket trading and 

better enable the regulation of 

intermarket trading. Because of the 

central role the Universal Industry SelfRegulator would play in the U.S. 

securities markets, demutualization of 

the entity would likely be prohibited. 

Thus, the primary concern of the profit 

motive of a shareholder owned market 

detracting from proper self-regulation 

could be eliminated under this 

approach as well. 

As with other models discussed, this 

approach has limitations. The Universal 

Industry Self-Regulator would be 

precluded from being a market specific 

regulator and as such would likely lack 

market specific expertise. In addition, 

member conflicts would still remain 

under this approach in that the 

Universal Industry Self-Regulator would 

still rely on members for funding. As 

discussed above, this conflict would be 

further complicated if the Universal 

Industry Self-Regulator became 

particularly dependent on certain large 

members for the disproportionately 

large amount of funding that they 

provide the SRO in regulatory fees. This 

universal approach would still require 

separate market rules to account for 

different market structures and types of 

securities traded. For instance, the 

market operation of an options exchange 

has markedly different trading rules 

than an equity exchange. There would 

also be the potential under this model 

for the functions of the Universal 

Industry Self-Regulator and the SEC to 

overlap with one another. Moreover, the 

potential for the Universal Industry SelfRegulator to become unresponsive to 

industry developments would greatly 

increase because of its size, scope, and 

lack of competition. Finally, 

implementing this model would 

effectively result in the elimination of 

the existing SROs’ role and, thus, could 

be met with significant resistance. 

The Commission specifically seeks 

public comment on the following 

questions related to the universal 

industry self-regulator SRO structure 

model: 

Question 62: To what extent would 

the implementation of the Universal 

Industry Self-Regulator model 

effectively manage inherent SRO 

limitations related to conflicts, funding, 

redundancies, and intermarket 

surveillance? 

Question 63: To what extent would 

the Universal Industry Self-Regulator 

model continue to provide the benefits 

of the current SRO system (e.g., largely 

self-funded system with market specific 

expertise of SRO regulatory staff 

enhancing rule promulgation and 

enforcement)?

Question 64: Would the NASD’s role 

as the regulator of the OTC market be 

completely occupied by the Universal 

Industry Self-Regulator or would there 

be a continuing need for the NASD’s 

existence? 

Question 65: To what extent would 

the Universal Industry Self-Regulator 

compete or conflict with the 

Commission? 

F. Universal Non-Industry Regulator 

Another approach, which would also 

require significant industry reshaping, 

would be the establishment of a 

universal non-industry regulator 

(‘‘Universal Non-Industry Regulator’’). 

Under this approach, one non-industry 

entity would be designated to be 

responsible for all markets and member 

regulation for all members and all 

markets. As with the Universal Industry 

Self-Regulator, this model would 

require all member firms to be registered 

with the Universal Non-Industry 

Regulator. All markets would be 

registered with the Universal NonIndustry Regulator similar to how ATSs 

are currently registered with SROs and 

would not have any self-regulatory 

authority. The Universal Non-Industry 

Regulator would be solely responsible 

for promulgating member and market 

rules, inspecting for compliance with 

member and market rules, and taking 

enforcement action with respect to 

member and market rules. 

While not exactly analogous, this 

model could resemble the regulatory 

regime recently adopted for audits of 

public companies. Specifically, the 

Public Company Accounting Oversight 

Board (‘‘PCAOB’’) was established, 

pursuant to the Sarbanes-Oxley Act,279

as an independent, non-profit 

corporation, to oversee the audits of 

public companies that are subject to the 

securities laws, and related matters, in 

light of significant failings in selfregulatory oversight of the accounting 

profession.280 If this approach were to 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71281

AICPA, administered peer reviews of CPAs to 

assess whether CPAs’ auditing practices were in 

conformity with GAAS. Jerry W. Markham, 

Accountants Make Miserable Policemen: Rethinking 

the Federal Securities Laws, 28 N.C.J. Int’l L. & 

Com. Reg. 725, 764–80 (2003). In addition, the 

Financial Accounting Standards Board (‘‘FASB’’) 

promulgated Generally Accepted Accounting 

Principles (‘‘GAAP’’). 

The PCAOB was given broad authority, including 

the power: (1) to register public accounting firms; 

(2) to set rules covering auditing, ethics, quality 

control and independence standards; (3) to inspect 

the auditing operations of registered public 

accounting firms; (4) to investigate and discipline 

registered public accounting firms and associated 

persons of such firms; and (5) to enforce 

compliance with the new legislation, the PCAOB’s 

own rules and certain securities laws. The 

standards for audits of public companies are now 

set by the PCAOB, not the accounting profession. 

While the AICPA still has a role in setting the 

standards for audits of non-public companies, the 

POB has been terminated. There has been no 

change in the setting of accounting standards, 

where the FASB, as the standards-setting body 

designated by the Commission, retains primary 

responsibility for the promulgation of GAAP, 

subject to the Commission’s oversight. Markham at 

790–92.

281Section 109 of the Sarbanes-Oxley Act.

282The Sarbanes-Oxley Act provides that the 

PCAOB be funded by accounting support fees 

assessed on issuers as defined therein. Each year 

the PCAOB develops an operating budget that must 

be approved by the Commission. The 2003 PCAOB 

budget, as approved by the Commission, was $68 

million. The accounting support fees are equal to 

the PCAOB’s total budgeted outlays for the fiscal 

year in which they are set, less the amount of fees 

received from public accounting firms to cover the 

cost of processing and reviewing registration 

applications. The accounting support fees are based 

on the average monthly U.S. equity market 

capitalization of publicly traded companies, 

investment companies, and other equity issuers. 

Issuers with average market capitalizations below 

$25 million and investment companies with net 

assets of less than $250 million are exempt from the 

fees. PCAOB, 2003 Annual Report 15 (2004). The 

2004 PCAOB accounting support fee, as approved 

by the Commission, was $101 million.

283Total combined SRO operating expenses in 

2003 were over $2.4 billion. See supra note 197.

be adopted in the securities industry, an 

independent, non-profit, nongovernmental body could be established 

to be the Universal Non-Industry 

Regulator. The board of the Universal 

Non-Industry Regulator would consist 

of full-time members appointed by the 

Commission, and would be tasked with 

overseeing all member and market rules 

for all members and all markets. The 

SEC would have ongoing oversight 

responsibility for supervising the 

universal regulator, including 

appointing and removing members, 

approving its budget, and approving its 

rules. The Universal Non-Industry 

Regulator approach would reduce 

substantially, if not eliminate, the 

industry’s self-regulatory role in that the 

universal regulator’s board would be 

entirely selected by the Commission and 

its staff would be entirely appointed by 

the board.

The sources of funding for this model 

would have to be established. The 

PCAOB is primarily funded through 

accounting support fees, as provided in 

the Sarbanes-Oxley Act, paid by 

issuers.281 The goal of this funding 

structure is to ensure that the PCAOB’s 

funding is independent of both the 

accounting profession and the federal 

government.282 A determination by 

Congress would have to be made as to 

whether shifting the significant cost of 

regulation of the securities industry to 

issuers would be appropriate or if some 

other funding structure would be more 

appropriate (such as a fee on trades or 

on markets and broker-dealer 

revenues).283

This model would have several 

advantages over other approaches. For 

instance, this approach would likely 

eliminate the member rule and market 

rule boundary concerns that exist under 

the Hybrid and Competing Hybrid 

approaches. Even more than the Hybrid 

and Competing Hybrid approaches, this 

model would result in broad interaction 

between the regulator, members, and 

markets. Conflicts with members, 

market operations, issuers, and 

shareholders would be substantially 

eliminated under this model because 

the entity would have no direct 

affiliation with any of those 

constituencies. Regulatory redundancies 

would also be effectively diminished 

because the Universal Non-Industry 

Regulator would be responsible for all 

‘‘member’’ and ‘‘market’’ rules for all 

members and markets. This would be 

particularly true if the NASD’s role were 

completely subsumed by the new 

Universal Non-Industry Regulator. As 

with the Hybrid and Competing Hybrid 

models, this approach would address 

the concern of unequal funding and 

unequal allocation of regulatory costs 

across markets. Moreover, cross market 

surveillance would likely be facilitated 

by this approach because the Universal 

Non-Industry Regulator would be 

responsible for all regulatory data from 

all markets. Because of the critical role 

the Universal Non-Industry Regulator 

would play in the U.S. securities 

markets, demutualization of the entity 

would likely be prohibited. Thus, the 

primary concern of the profit motive of 

a shareholder owned market detracting 

from proper self-regulation could be 

eliminated under this approach as well. 

This model also has serious 

drawbacks. For example, it could result 

in a lower degree of market specific 

expertise in the regulator. In addition, 

the degree of direct industry 

involvement with respect to rulemaking 

and enforcement would be significantly 

reduced, which could reduce the 

Universal Non-Industry Regulator’s 

ability to refine and target its regulation. 

Market rules would still differ to 

account for different market structures 

and types of securities traded. As with 

the Universal Industry Self-Regulator, 

there would be the potential under this 

model for the regulatory entity and the 

SEC to overlap or even compete with 

one another. In addition, there is also 

the risk that this model would become 

inefficient, inflexible, and unresponsive 

to evolutionary market practices. Also 

similar to the Universal Industry SelfRegulator, this model would likely 

require legislation and could be met 

with resistance from the existing SROs, 

whose SRO role would be largely 

eliminated. 

The Commission specifically seeks 

public comment on the following 

questions related to the Universal NonIndustry Regulator model:

Question 66: To what extent would 

the implementation of the Universal 

Non-Industry Regulator model 

effectively manage inherent SRO 

limitations related to conflicts, funding, 

redundancies, and intermarket 

surveillance? 

Question 67: To what extent would 

the Universal Non-Industry Regulator 

model continue to provide the benefits 

of the current SRO system (e.g., largely 

self-funded system with market specific 

expertise of SRO regulatory staff 

enhancing rule promulgation and 

enforcement)? 

Question 68: How would the 

Universal Non-Industry Regulator 

model be funded? 

Question 69: What would be the 

relationship between the Universal NonIndustry Regulator, the Commission, 

and the NASD under this model? 

G. SEC Regulation 

Another alternative that will be 

discussed in this section would be the 

termination of the SRO system in favor 

of direct Commission regulation of the 

industry. Under this approach, the 

Commission would be solely 

responsible for the market and member 

regulation of all members and all 

markets. All member firms and markets 

would be required to register directly 

with the Commission under this model. 

Markets would be non-SROs registered 

with the Commission similar to how 

ATSs are currently registered with 

SROs. The markets’ registered status, 

however, would carry with it no selfregulatory authority. The Commission 

would be responsible for the 

promulgation of detailed member and 

market rules, the surveillance of 

members and markets, and the 

enforcement of member and market 

71282 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

284Although the Commission currently deposits 

the variety of fees that it collects in the U.S. 

Treasury, where its deposits are treated as offsetting 

collections and not general funds of the Treasury, 

it cannot deposit its fees in a depository institution, 

and its monies are annually appropriated and 

apportioned. U.S. General Accounting Office Report 

to Congressional Committees, ‘‘SEC Operations ‘‘

Implications of Alternative Funding Structures,’’ 1 

(July 2002). 285For instance, the Financial Services Authority 

(‘‘FSA’’) was created in the United Kingdom in 

1997 and is an ‘‘independent non-governmental 

body which exercises statutory powers.’’ Through 

the creation of the FSA, the duties of nine 

regulatory entities were consolidated and the use of 

the British equivalent of U.S. SROs was abandoned. 

The FSA was given extensive financial regulation 

responsibility, assuming the same roles played in 

the U.S. by the SEC, the Commodity Futures 

Trading Commission, federal and state banking 

regulators, state insurance and state securities 

commissions, as well as the SROs. Among other 

initiatives, the FSA has assigned one office to 

develop policy on prudential issues across all 

financial sectors, so as to develop a common 

approach to risk and capital requirements. The 

agency also announced that it was streamlining the 

existing financial services rules and has been 

focusing its regulatory attention on high-risk firms. 

See Jerry W. Markham, A Comparative Analysis of 

Consolidated and Functional Regulation: Super 

Regulator: A Comparative Analysis of Securities 

and Derivatives Regulation in the United States, 

United Kingdom, and Japan, 28 Brooklyn J. Int’l L. 

319, 374–82 (2003).

286See supra note 181.

rules. With respect to funding, this 

model would require dramatic change 

in that the public would be directly 

responsible for substantially all of the 

costs of regulating the industry, albeit 

perhaps, through a range of fees 

imposed on the industry for the 

Commission’s increased services. The 

Commission, however, is not selffunded under its enabling statute and, 

thus, Congress would need to 

appropriate funds for this approach.284

Benefits could be gained from this 

approach. For instance, because only 

one centralized regulator would exist, 

SEC direct regulation would eliminate 

substantially all of the conflicts that 

exist between SRO regulation and 

members, market operations, issuers, 

and shareholders. As with the Hybrid, 

Competing Hybrid, Universal Industry 

Self-Regulator, and Universal NonIndustry Regulator approaches, direct 

SEC regulation would provide the 

Commission with a broader 

understanding of the members and 

markets. Conflicting member rules, 

interpretations, and inspection regimes, 

and regulatory redundancies would be 

eliminated under this model because 

the Commission would be able to adopt 

uniform member rules. The Commission 

would need to adopt numerous detailed 

operations and conduct rules for 

members to replace existing SRO rules 

related to business practices and just 

and equitable principles of trade. Cross 

market surveillance would likely be 

facilitated by this approach because the 

relevant regulatory data would be 

collected and examined by the 

Commission, rather than by disparate 

SROs. In addition, this model could 

potentially align the U.S. regulatory 

scheme more closely with those of a 

variety of other countries.285

An SEC-only approach would also 

have numerous problems. The SEC 

would be responsible for detailed 

regulation and interpretation of complex 

areas previously the province of SROs, 

without the aid of direct industry 

involvement and with a significant 

lessening of industry input in 

rulemaking. Market specific rules, under 

this model, would still conflict because 

of the markets’ different market 

structures and types of securities traded. 

Direct Commission regulation would be 

governed by the limitations and rules 

addressing federal rulemaking and 

would be undertaken in a political 

environment and the cost of carrying 

out all of the duties of the SROs would 

be extensive. It is important to note that 

the Commission has attempted to 

undertake direct SRO level regulatory 

duties in the past. As discussed above, 

the Commission ultimately requested 

that Congress terminate the SECO 

program because the Commission could 

not effectively carry out the detailed 

responsibilities required.286

The Commission specifically seeks 

public comment on the following 

questions related to the direct SEC 

regulation model: 

Question 70: To what extent would 

the implementation of the direct SEC 

regulation model effectively manage 

inherent SRO limitations related to 

conflicts, funding, redundancies, and 

intermarket surveillance? 

Question 71: To what extent would 

direct SEC regulation continue to 

provide the benefits of the current SRO 

system (e.g., largely self-funded system 

with market specific expertise of SRO 

regulatory staff enhancing rule 

promulgation and enforcement)? 

Question 72: Could current SRO staff 

be effectively drawn upon by the 

Commission under the direct SEC 

regulation model, or would this staff be 

inappropriately influenced by their 

prior affiliations with specific SROs? 

H. Other Models 

Alternative models of regulation exist 

that were not specifically explored in 

this release. Such approaches may be 

variations of the above alternatives or 

completely different models. The 

Commission specifically seeks public 

comment on the following question: 

Question 73: Are there any other 

approaches to regulation of the 

securities industry that are worthy of 

consideration whether discussed herein 

or not? Should the current model 

remain unaltered? 

VI. Solicitation of Additional 

Comments 

In addition to the areas for comment 

identified above, we are interested in 

any other issues that commenters may 

wish to address relating to the current 

structure of the SRO system, potential 

enhancements that could be made to the 

current system, or potential models that 

could be implemented that would 

restructure the SRO system. Please be as 

specific as possible in your discussion 

and analysis of any additional issues. 

Where possible, please provide 

empirical data or observations to 

support or illustrate your comments.

By the Commission.

Dated: November 18, 2004. 

Margaret H. McFarland, 

Deputy Secretary.

[FR Doc. 04–26154 Filed 12–7–04; 8:45 am] 

BILLING CODE 8010–01–P