A Primer on Regulation Of U.S. Stock Markets

The furor over Dick Grasso's $187.5 million pay package for running the New York Stock Exchange has increased the level scrutiny on how companies are run and how much executives are paid. Following his resignation as chairman and CEO of an organization that, in part, regulates business on Wall Street, fresh attention is being given to governance standards. Securities and Exchange Commission Chairman William Donaldson is calling for the 10 major stock exchanges to spell out the compensation of their executives and who sets it.

Since the spate of corporate-accounting scandals, transparency has been the watchword of regulators seeking to make public companies accountable to their shareholders. Now, the heat is on those who maintain Wall Street's standards. See a primer on who regulates what in the securities industry.


Securities and Exchange Commission

The Securities and Exchange Commission is a broad regulatory body comprised of several divisions to ensure fair, efficient markets. The SEC oversees stock exchanges, broker-dealers, investment advisors, mutual funds and public-utility-holding companies.

The agency enforces federal securities laws, and while Congress makes and passes the laws, the SEC is heavily involved in writing the laws, particularly the more technical aspects, says Alan Bromberg, professor of securities law at Dedman School of Law at SMU. In theory, Congress only holds hearings to determine if new legislation is needed, but has held some investigative hearings, such as the analyst conflict-of-interest cases last year.

The SEC, by law, requires that public companies disclose financial information to the public. It does conduct some investigations, but generally leaves that up to exchange regulators, who may then hold a panel hearing on the matter. Appeals of panel decisions involving a penalty or sanction may escalate to the SEC, but this is rare.

The SEC's powers have increased with recent changes in legislation, where the agency, without congressional approval, can suspend a broker and even put them out of business, or bar executives from serving on boards or as CEOs of major companies.

Since its creation in 1934 to help restore investor confidence in capital markets by providing more structure and government oversight, the SEC's reach has broadened to include regulation of the New York Stock Exchange, the American Stock Exchange and the National Association of Securities Dealers, which operates the Nasdaq Stock Market.

The SEC is comprised of five commissioners, all of whom are appointed by the president of the U.S., with the advice and consent of the Senate. No more than three of the five may belong to the same political party.

The New York Stock Exchange

The NYSE was given a self-regulatory mandate by appointment of the SEC, to ensure that its member firms comply with federal securities laws, as well as the exchange's own. The exchange's regulators are responsible for monitoring member firms, launching investigations when there is suspected misconduct -- be it in customer-sales practices or on the trading floor -- and penalizing members when they commit violations.

Penalties range from informal actions, such as sending an education or admonition letter to bringing formal charges. Appeals of these decisions are taken to the NYSE board of directors and then to the SEC, and may escalate as far as the U.S. Court of Appeals and even to the Supreme Court. The exchange also has the right to expel, suspend or fine any firm under investigation or that refuses to comply with an investigation.

Since the resignation of Dick Grasso, the NYSE's chairman and CEO, the exchange's self-regulatory model has been under intense scrutiny. The SEC plans to consider whether to split off the regulatory function of the NYSE and other stock exchanges as part of a larger review. SEC officials are concerned that acting as both a regulator and a marketplace may create conflicts and that investors might be better protected if regulation were handled by an independent entity. Two possibilities are allowing the exchanges to continue monitoring market practices but outsourcing regulation of member firms; and creating an independent regulator to take over all the regulatory duties -- a miniature SEC, of sorts.

Some SEC officials are interested in a third option: stripping the NYSE and other exchanges of all self-regulation authority and letting the SEC oversee the markets. But that scenario isn't likely since it would require a significant boost in the agency's budget and work force.

For the NYSE, the questions come amid accusations that it is too light-handed with its member firms, more inclined to push members to hire consultants or recruit independent directors, than to levy hefty fines. Some say this is fueled by member firms sitting on the board which is charged with the task of regulating them, as was the case with Ken Langone, a founder of Home Depot.

National Association of Securities Dealers

The National Association of Securities Dealers is the parent company of the Nasdaq Stock Market. It is in the process of splitting its marketplace from its regulatory arm.

Its regulatory function operates in a similar way as the NYSE's -- its job is to make sure its members comply with federal securities laws as well as the exchange's own laws. It conducts investigations into member firms, holds hearings and issues penalties.

However, it differs in two huge ways: 1) it has moved to split the regulatory and market functions, as opposed to the NYSE's self-regulatory system, and 2) it is known for being much harsher than the NYSE in terms of issuing penalties.

"The NASD takes its enforcement role much more seriously," said New York attorney Bill Singer, who defends clients before both the NASD and the NYSE. "If you had a choice, you'd rather be sanctioned by the NYSE."

--Compiled by Cindy Perman

Sources: SEC, WSJ reporting, Online Journal research

Updated October 20, 2003 4:05 p.m.