Self-regulation: let’s think about a person. ?Can he regulate his own life on his own? ?Of course he can. ?But will he?

The same is true of markets. SROs can be?effective if the culture is good, and people are willing to take actions against friends. ?But an SRO can also develop a culture that has a blind eye toward offenses, until the media embarrasses them. ?The same can be true of regulators, though. ?They can be “in bed” with the industry if the wrong culture exists in the regulatory body.

2) The trouble with financial companies and products is that they make promises, whether sharp or?vague, about the future. ?That leads some people to commit money today to those products, which may be bad or good. ?When done across a whole economy, that can lead to booms and busts. ?That is a great reason to regulate the promises made by financial firms.

3) But how do you regulate? ?Do you have a sharp separation between the regulators and the regulated, which can make regulation adversarial, or do you introduce a third party, the SRO? ?The SRO is a kind of middleman, who executes the will of the regulator, but takes into account the special conditions in each market, and talks with the regulator about where they might be wrong in what they would ordinarily do.

4) SROs have specialized knowledge, drawing from the firms they regulate. ?Well, regulators could have the also, if they hired the best, and paid them what they could earn in the private sector. ?My but the regulated would be baffled if they faced the “stone wall” of their equals in dealing with regulators.

But our government is chintzy where it should be bold. ?Aside from idealistic investors like me, (and I have applied to various government positions without the decency of a reply) it is difficult to attract top talent without paying top dollar. ?And as such, they have not gotten top talent. ?Academics are not top talent. ?They don’t really know how the markets work. ?They know how their models of the markets work.

Ideally, you need investors who understand the academic research, like me. ?If you have regulators with that strength of knowledge, you could regulate well.

5) Many of the speakers today talked about mining big data to get results. ?I will tell you that the only way to get those results is to hire talented programmers, then train them in the markets. ?Waste time teaching them; they’re bright, they will learn. ?Then after the initial training, propose the first project. ?You will create a cadre of clever programmers that can sniff out problems. ?Pamper them, and you will have a fantastic corps for sniffing out financial irregularities.

The guy from the National Futures Association emphasized the idea that mandatory membership in the association as a requirement to do business was paramount for an SRO and I can see that. ?The SRO then has the “death penalty” hanging over the heads of those they regulate. ?That said, consider this: the CFA Institute may dream of the day when all involved in investing *must* hold a?CFA Charter.

I have no doubt that this would be a good thing. ?Ethics codes are good for the industry, and to kick out bad apples would be a good thing.

6) When there are more than two?parties in any economic arrangement, regulation gets tough. ?It becomes difficult to separate the various interests, and come up with the right division of duties toward the ultimate consumer.

7) On Rules-based vs Principles-based regulation, in the American context, I lean toward rules-based. ?Rules-based has the advantage of comparability. ?Let the analysts make their adjustments, and let the companies provide the data to do so. ?But provide a consistent set of rules that all need to comply with first.

8 ) Finally, on derivatives. ?Regulate them as insurance, and let the states deal with it. ?Require insurable interest such that only bona fide hedgers can initiate trades. ?Speculators should not be allowed to trade with each other; that is gambling. ?If we did this, the derivatives market would shrink dramatically, and no one would be hurt.

That is what I would do, and Wall Street would fight it, tooth and nail.

US System of Self-Regulation through SROs: Strengths and Areas for Reform?

Questions

• What are the most substantial/significant contributions of the current SRO system in the United States?
• What areas present the greatest need for reform?
• How can the private versus ?state actor? functions of non-exchange SROs be reconciled?

David Blass
Chief Counsel, Division of Trading and Markets
US Securities and Exchange Commission

Trading markets division oversees oversees rules, rule changes, etc. ?Promulgate rules, exposes to the public. ?Dodd-Frank gives strict deadlines now, which if exceeded leads to proceedings, which now means further time to evaluate, decide, and additional public exposure.

Lynnette Kelly
Executive Director
Municipal Securities Rulemaking Board (MSRB)

Created in 1975 to deal with egregious conduct. ?Regulates the muni market. ?Writes rules and others enforce. ?SEC regulates on anti-fraud. ?Protect muni issuers since Dodd-Frank. ?Provides data to other regulators.

Daniel J. Roth
President and CEO
National Futures Association

SRO deals with Futures & Swaps — interacts with the CFTC. ?NFA is to CFTC as FINRA is to the SEC regarding crafting of regulations.

Moderated by: Cheryl L. Evans, CFA Institute

Exchange SROs: Meeting the Needs of Investors and the Financial Marketplace

Questions:

• How do exchange SROs contribute to the effective functioning of the securities markets?
• How has the role of exchanges changed since they were first designated as SROs, and have these changes affected their ability to function effectively in that role?
• Do recent breakdowns in exchange oversight functions indicate a need for an overhaul of structure/functions or point to ?fatal flaws? in the current system?
• Are conflicts in the current system of demutualized exchanges resolvable or inherent in the system?
• What needs to be done to reinforce the integrity of the system and increase investor protections?
• How does increased competition from broker/dealer internalization networks and foreign trading markets affect exchanges under the constraints of the current self-regulatory system?

Panel

Roberta Karmel
Centennial Professor of Law, Brooklyn Law School
Former Commissioner of the US Securities and Exchange Commission

The change from fixed commissions was significant. ?NASD traders had preferential rates trading with one another. ?Existing SROs continued on. ?Expulsion was a threat. ?Exchange listing standards were a significant protection.

Many markets, and profit seeking exchanges have changed matters. ?Sarbox and Dodd-Frank have affected matters ?with listing requirements. ?JOBS act has opened up listing standards, and perhaps not in a good way. ?SEC was happy to see the monopoly of the NYSE broken, but there have been unanticipated secondary effects. ?We need to ask what kind of regulation we need now in the present environment.

Richard G. Ketchum
Chairman and CEO,?Financial Industry Regulatory Authority

Mentions MS was the first Chair of FINRA. ?Merger of NASD and NYSE Reg. ?FINRA has an enhanced majority of public governors. ?No way for industry to capture FINRA. ?Oversees all bond and equity trading. ?Exchange SROs can delegate to FINRA, but they must oversee what FINRA does for them.

Mary Schapiro
Vice Chairman of the Advisory Board, Promontory Financial Group
Former Chairman of the US Securities and Exchange Commission
Former CEO of the Financial Industry Regulatory Authority (FINRA)
Former Chairman of the Commodity Futures Trading Commission

SROs are cost-effective and flexible, with deep expertise. ?Examine participants, Surveill markets, etc. ?New tech, markets, exchanges as profit-seeking entities are new challenges. ?Conflicts of interest have grown along with HFT.

Moderated by: Andrew N. Vollmer, University of Virginia School of Law

Q: Does the current system work well? What areas do we need to change?

MS: It’s working well. ?Vigilence is needed. ?Well-functioning SROs are an aid to regulators. ?Easier for an SRO to address an issue with stakeholders.

RK: Wants the SEC to have a bigger budget, merge the CFTC into the SEC. ?SROs are necessary now because the system won’t work without them. ?Fragmentation of?trading makes self-regulation less effective.

ANV asks RGK to reply.

RGK says FINRA aids regulators. ?FINRA brings knowledge, focus and access. ?Government regulators are more confrontational, FINRA can get more done. ?Exchanges are the only ones enforcing listing?standards.

MS concurs that listing standards are needed.

Q: Have we lost some of the benefits of SROs with the delegation of authority to FINRA?

RGK: has worked with SROs his whole life. ?Comments how things were often worse in the past, not all things are worse today.

MS:?Concurs with RGK.

RK: There has been loss, much of it through the destruction of exchange-based trading. ?2008 meltdown — few firms did anything to stop the crisis. ?Everyone acted in their own interest.

Q: Aside from listing standards, what other?things should the exchange SROs do?

MS: Exchanges will always be responsible for aspects of investor protection.

RK: Exchanges will always have an interest in the integrity of their markets.

RGK: Comments that exchanges should watch over the quality of products traded [DM: think of leveraged and inverse ETFs, ETNs, penny stocks, promoted stocks, etc.]

Q: What about efficiency at the SRO level?

MS: Competition and efficiency don’t always work well together. ?SEC and CFTC should be merged.

RK:?SEC and CFTC should be merged. ?Need more than one regulator, though. ?Did not work in the UK. ?FSOC a disaster, a non-solution.

RGK: We interact with everyone. ?No opinion on whether the?SEC and CFTC should be merged.

I’m at the?Self-Regulation in the Financial Markets: Exchange Issues, Market Structure, and Investor Protections Conference hosted by the CFA Institute and the DC Society. ?I will be making occasional posts on this today, in the form of summary notes.

Jim Allen, CFA
Head, Capital Markets Policy ? Americas

CFA Institute ? already self-regulated.? Aids in flexibility of regulation.? De facto standards of investment performance measurement ? GIPS [Global Investment Performance Standards].

Mary Schapiro
Vice Chairman of the Advisory Board, Promontory Financial Group
Former Chairman of the US Securities and Exchange Commission
Former CEO of the Financial Industry Regulatory Authority (FINRA)
Former Chairman of the Commodity Futures Trading Commission

Keynote talk

Has spent much of her life heading self-regulatory organizations [SROs].? She thinks SROs lever the effectiveness of government in regulating finance.? Congress does not appropriate the proper amount of money to regulate finance on its own.? Employee levels in the government regulators have not grown.

Regulating RIAs ? only 9% examined in 2013 managing $55 Trillion of assets.? SROs are not a second choice solution.? There is more expertise, tech knowledge, etc.

The Future of Self-Regulatory Organizations

Cited this article: Top 10 Characteristics of Effective Self-Regulatory Organizations

DM note: There are about 60 people here in this room adequate to hold about 150.

First Panel

Global Overview: Role of Self-Regulation in Increasingly Interconnected and Complex Markets

Topics

• What are the benefits of an effective self-regulatory system in the securities markets?
• What challenges does the self-regulatory system face in light of the complexity of financial products and trading mechanisms (algorithmic trading, dark pools, etc.), and what resources are needed in response?
• How does the use of ?front-line? regulators in certain market sectors contribute to more effective regulation?
• What is the future for self-regulation? How do the experiences differ between emerging markets and those that are more established?

Chris Brummer
Professor of Law — Georgetown University Law Center
No intro talk.
Amarilis Sardenberg
Chair of the Board?– BM&FBOVESPA Market Supervision

Government Bond ? Central Bank

OTC Bond, Securities, and Derivatives ? all under one regulator.? Each has its own SRO.? Her securities SRO audits brokers and custodians.? All trades tracked by beneficial owner; makes tracking manipulation easier.
Susan Wolburgh Jenah
President and CEO –Investment Industry Regulatory Organization of Canada [IROC]

Heads a national SRO in Canada.? Provinces have financial regulatory authority.? This is somewhat similar to insurance regulation in the US.? SROs have greater authority in Canada.? Audited regularly, and the results are made public.? Thinks they hold to the Top 10 Characteristics of Effective Self-Regulatory Organizations pretty well.

Moderated by: Jim Allen, CFA, CFA Institute

Q: Challenges of SROs?

CB: 2 ? points: 1) Globalization ? financial trade can go on anywhere ? affects regulation.? Coordination is helpful, the US cannot dictate international rules.? Soft principles have dominated over negotiating hard principles.

2) Disintermediation of financial services firms eliminates gatekeeping functions of financial firms.? Bitcoin, Crowdfunding, Dark pools, etc.? (DM: I would have said derivatives or money market funds?)

SWJ: Changes have been huge ? explosion of exchanges in Canada and the US. ?High frequency trading [HFT] is highly controversial ? and it is a data-intensive task to investigate what is right or wrong.

AS: Coordination of policy is important.? A little surprised at arbitrage trades.

Q: What to do about attacks from hackers?

SWJ: Big issue, the investment banks are big targets.? Smaller firms lag on resources.? We try to educate on the issue, create best practices, policies, etc.? Their SRO hires hackers to test their systems.

AS: Similar answer to SWJ, adds that the exchanges have their own efforts.

CB: Capture the right data, analyze it.

Q: Regulatory arbitrage, how to reduce?

CB: Cites: The Danger of Divergence: Transatlantic Financial Reform & the G20 Agenda

Different regulators move at different speeds, and face local challenges.? Different cultures affect implementation.

SWJ: Businesses move faster than regulators.? Are provincial securities regulators able to adapt more rapidly than a national regulator? [DM: If they cooperate, I think it can work.]

AS: There are so many trades going across borders that it is very difficult to police.? Post-trade settlement is tough ? harmonizing settlement standards has a long way to go.

Q: How do you avoid industry capture?

SWJ: IROC does not advocate, it only regulates.? Purity of purpose is important.? Board is 7 independent, 7 industry and the Chair.? Nominating Committee composed of the independent directors plus Chair.? Everything public and transparent.

AS: Her exchange SRO is established by statute, and has clear authority and goals as a result.? Board of 11, 8 must be independent.

Q: Not many SROs in banking, as finance goes more global, how will SROs fare?

CB: Harmonization of data collection would help.? Difficult to harmonize all regulation under one roof.? Federal Reserve doing some of this. [DM: not really]? Long history of SROs in finance and other areas, like accounting.? Independent majority on SRO boards need with an independent source of revenues.

SWJ: There is an academic paper to be written here.? [DM: Panic of 1907, Great Depression help explain it.]

AS: Not many exchange based SROs: US, Canada, Brazil, Columbia…