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

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

Self-Regulation in the Financial Markets: Exchange Issues, Market Structure, and Investor Protections (Part 3) by David Merkel, CFA of AlephBlog

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


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  • 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

DM Note: attendance down to about 50 at this point.
Q to LK:  How does MSRB “protect issuers?”
LK: Qualified professionals are held to a higher standard.  [DM: note Poway School District…]
Q: What do you look for in an SRO?
DJR: Mandatory membership is needed, which makes expulsion end the business of the one thrown out.
LK: Collection of data is important.  Led the way on “pay to play” issues.  Argues that the muni market is the most transparent bond market after Treasuries.  [DM: I doubt that.]
DB: Authority, Deep Knowledge, Sanctions help make for a good SRO.
Q: How can SROs aid regulators with data issues?
DB: we are data hungry in order to classify market participants.  MIDAS — more timely analysis of market trading data.
LK: Aids in collecting analyzing data.  Analyzes trade data daily.  Responds to requests from law enforcement and regulators.  They have allocated a lot more time and money getting analyses together.
DJR: Drawing together all of the data is tough, but when you do it, you uncover anomalies.  Constantly developing new systems.  Have to have human intervention, computers aren’t enough.
Q to DB: How are you increasing your analyses of data at the SEC?
DB: lots of ways, one example is churning.
Q: Conflict challenges, how do you deal with them?
DJR: Create a system of checks and balances.  34 people on his board, public director are the largest bloc.  Diverse interest also sometimes checks matters.
LK: We are audited.  Staff is independent of the board.  Directors must be competent & ethical.
Q to LK: How do you provide interpretative guidance?
LK: they try to interact quietly with the regulators to resolve differences of opinion.
DB: FINRA is in the same place regarding the SEC.  FINRA has to enforce SEC securities rules.
Q: What the data sharing rules regarding agencies and SROs?
DJR: CFTC has full access to our data.  We notify other affiliated regulators/SROs.
LK: Formal rules w/FINRA, IRS, banking regulators, etc., law enforcement via subpoenas.
Q to LK: Additional financial information on new issues?
LK: No authority over financial issuers, more frequent disclosure would be better.  We make our systems easy for issuers to upload data.  FOIA requests can be made as well on issuers.  Munis are not high quality liquid securities.
Q: Thoughts on principles-based rules and regulations?
DB: perennial issue, we will never be fully one way or another.  Market participants request rules to guide them when principles are issued.
LK concurs.
DJR says that principles-based rules allow them to be tougher.  Market participants have a rule: they complain.  (laughter from audience)

Updated on

David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.
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