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Regulatory Complicity in Nasdaq's Troubles

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Nasdaq had another bad day last week. On Thursday, bringing back unpleasant memories of the troubled Facebook initial public offering, the exchange halted trading in its stocks for about three hours while it sorted through technical problems. Traders' impatience on Thursday is likely to be matched only by the impatience of regulators at the Securities and Exchange Commission, who understandably don't like such events on their watch and want to be seen to be doing something in response. Indeed, SEC chairwoman Mary Jo White wasted no time in issuing a statement promising "to enhance the safeguards necessary for strong market systems," including convening an industry summit and moving forward with Regulation Systems Compliance and Integrity--a rulemaking proposal related to exchanges' information technology systems.

The SEC ought to take care in how it approaches such problems in the securities markets. Past regulatory efforts have been expensive endeavors that have introduced new problems into the system. The hotly debated 2005 regulatory initiative, Regulation NMS, for example, mandated a costly remaking of the equities markets, which the Commission "firmly believe[d]" would "protect investors, promote fair competition, and enhance market efficiency." The industry spent lots of hours and dollars to come into compliance with Reg NMS. According to a recent assessment by Larry Tabb, the rule also imposed other costs:

Reg. NMS started a progression of technology changes that has exacerbated execution complexity, crippled the NYSE floor, prioritized speed over liquidity, and virtually put a bullet in the head of smaller, less-technology-adroit brokers and floor traders. It also fragmented the markets, drove ever-increasing messaging rates, created order-type complexity, and arguably enabled high-frequency traders to take advantage of the very investors Reg. NMS was intended to protect, while actually making the markets less transparent for regulators.

The SEC likewise acknowledged, in proposing Regulation Systems Compliance and Integrity earlier this year, that "[r]egulatory developments, such as Regulation NMS . . . have impacted the structure of the markets by, among other things, mandating and providing incentives that encourage automation and speed." These changes, along with other market developments, "have also increased the complexity of the markets and the challenges for market participants seeking to manage their information technology programs and to ensure compliance with Commission rules."

Exchanges' resource expenditures are driven by the regulatory environment in which they operate. Holman Jenkins explained it well in his weekend column in the Wall Street Journal, "NYSE, Nasdaq and their fellow exchanges are stuck living in the SEC's world. They will go on throwing technology at metastasizing complexity." The SEC's world could get even more complicated if the SEC presses carelessly forward with Regulation Systems Compliance and Integrity. In a rare show of unity, seventeen exchanges and the Financial Industry Regulatory Authority (which regulates broker-dealers) filed a joint comment letter on the rule proposal. The letter warned, among other things, that the rule "might not keep pace with a constantly evolving technological landscape" and could introduce new risks by allowing the SEC staff direct access to exchanges' computer networks.

Nasdaq does not need the SEC to tell it to shore up its information technology systems. Fear of more reputational harm is already conveying that message. The SEC, which has had its own information technology struggles in the very office that oversees exchanges' information technology programs, should take care not to upend improvement efforts by micromanaging them through carelessly conceived regulatory mandates.

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Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.