Rethinking the National Market System.

AuthorPeirce, Hester
  1. INTRODUCTION II. THE MUDDY 1975 CONGRESSIONAL VISION: A NATIONAL MARKET SYSTEM A. The Genesis of the '75 Amendments B. Discerning the Purpose of the '75 Amendments III. THE SEC'S APPROACH TO FACILITATING A NATIONAL MARKET SYSTEM A. Early Implementation of the National Market System Mandate B. Assessing the SEC's Early Steps Toward a National Market System C. Regulation NMS--An Enthusiastic Embrace of the National Market System Mandate IV. THE ABILITY OF THE MARKETS TO CONSTRUCT A NATIONAL MARKET SYSTEM ORGANICALLY V. WHY RECONSIDERING THE NATIONAL MARKET SYSTEM IDEA MATTERS NOW VI. CONCLUSION I. INTRODUCTION

    In 2005, the Securities and Exchange Commission (SEC) adopted Regulation National Market System (Regulation NMS), a set of rules that instigated major changes in the structure of US equity markets. (1) Regulation NMS was controversial before it was adopted and has remained so a decade after its implementation. That regulation was the offspring of a much older statutory directive to the SEC to build a national market system. The Securities Acts Amendments of 1975 ('75 Amendments), among other things, attempted to integrate, coordinate, and modernize the equity markets.

    The '75 Amendments--an ambiguous mandate to the SEC to remove barriers to competition in the equity markets, yet also to manage that competition for the public good--were a fitting product of their time. In many areas, the 1970s were a decade of deregulation born of a realization that heavily regulated industries, such as airlines and trucking, were not serving customers as well as they would if they were less regulated. In other areas, such as President Nixon's price controls and the environment, the 1970s saw experimentation with more centralized and comprehensive regulation. one contemporary author, looking back at the period from 1960 to 1979, explained: "all of us--scholars, legislators, the general public--are at this moment confronting the peculiar spectacle of two powerful trends that seem to be directly at odds with each other. one is toward greater government regulation, the other toward less." (2) The national market system embodied this same tension--a recognition of the importance of the value of competition, but a belief that the government needed to manage competition to make sure that the market worked in the public interest as efficiently as possible.

    This Article looks back at the adoption of the '75 Amendments and argues that it is time to reconsider the necessity of the law's national market system mandate. Part II introduces the national market system mandate in the context of the time in which it became law. Part III discusses the SEC's role in acting on the national market system mandate. Part IV discusses why a national market system could develop better organically than as the product of a statutory mandate. Part V posits that now is a good time to reconsider the SEC's national market system mandate, and Part VI concludes.

  2. THE MUDDY 1975 CONGRESSIONAL VISION: A NATIONAL MARKET SYSTEM

    Described both as "deregulatory" (3) and as "the most fundamental restructuring of the securities industry since the adoption of the Securities Exchange Act of 1934," (4) the '75 Amendments were designed, among other things, "to facilitate the establishment of a national market system for securities." (5) This mandate grew out of a period of great interest in the securities markets during which people were asking questions such as whether the stock market could support the broader economy as it grew rapidly, how computerized the markets should be, and how investor confidence in the functioning of the markets could be strengthened. (6) Congress and the SEC investigated these and other issues in a series of inquiries. (7) According to Congress, the '75 Amendments were "the culmination of' Congress' "most searching reexamination of the competitive, statutory, and economic issues facing the securities markets, the securities industry, and, of course, public investors, since the 1930's." (8)

    1. The Genesis of the '75 Amendments

      SEC and congressional interest in the securities markets was driven by the changes--some of them disorderly--occurring in those markets. Many of these changes were the product of a dramatic increase in institutional participation in markets--the institutional share of the market grew from 34% of the NYSE's volume in 1961 to 70% in 1974. (9) Increased trading volumes contributed to the paperwork crisis of the late 1960s and early 1970s, which shook the industry, led to special Wednesday closures of the NYSE, and caused many firms to fail. (10) Regional exchanges began to challenge the competitive dominance of the New York Stock Exchange (NYSE), (11) which led to fragmentation of the markets. (12) In 1975, the SEC ended fixed commissions--an almost sacred hallmark of the brokerage business. The growing availability of new technology made possible changes in the market's structure. (13)

      The concept of a national market system did not originate with Congress. In its 1971 Institutional Investor Study, the SEC deemed the time to be right for a "strong central market system:"

      our objective is to see a strong central market system created to which all investors have access, in which, all qualified broker-dealers and existing market institutions may participate in accordance with their respective capabilities, and which is controlled not only by appropriate regulation but also by the forces of competition. (14) The Martin Report, an NYSE-commissioned study, called for a "[central market system] ... to provide a single, national auction market for each security qualified for listing." (15) In 1972, the SEC issued a statement that embraced a central market system based, not on a centralized auction mechanism, but on composite quotation and transaction data. (16) In 1973, then SEC chairman Bradford Cook pledged "to make the central market system an operational reality within two years." (17) His version of the central market system would ensure that the "public investor ... has an equal crack at the best available price, no matter where it is being made." (18) Cook's pledge was made at the same time the SEC issued a policy statement that embraced a central market system. (19) Professor Oesterle described that statement as a "dramatic proposal" to "control[] order routing and execution for all the country's markets." (20)

      The SEC's embrace of the national market system marked a departure from the SEC's prior approach to regulating the equity markets. As Al Sommer, an SEC commissioner at the time, explained, the SEC shifted from taking "the industry as economics shaped it" to an "activist role"--undertaking "an effort ... to order the emerging forces in a rational manner." (21)

      The '75 Amendments offered the SEC the statutory authority to pursue its new vision. The amendments became law on June 4, 1975. Of particular interest here is Section 11A of the Exchange Act, which begins by acknowledging that the "securities markets are an important national asset which must be preserved and strengthened." (22) Other congressional findings that formed the basis for the national market system were:

      (1) "New data processing and communications techniques create the opportunity for more efficient and effective market operations."

      (2) It is both appropriate and in the public interest "to assure" "economically efficient" transactions, "fair competition" among market participants and trading centers, availability of transaction and quotation data to market participants, "the practicability of brokers executing investors' orders in the best market," and an opportunity for dealer-free execution of orders.

      (3) Market linkages "through communication and data processing facilities" are beneficial. (23)

      Based on these findings, Congress directed the SEC, "having due regard for the public interest, the protection of investors, and the maintenance of fair and orderly markets, to use its authority ... to facilitate the establishment of a national market system for securities." (24) Congress directed the SEC to bind the markets together through "communications systems, particularly those designed to provide automated dissemination of last sale and quotation information with respect to securities." (25) Accordingly, Congress gave the SEC "pervasive rulemaking power to regulate ... all organizations engaged in the business of collecting, processing, or publishing information relating to quotations for and transactions in securities." (23) Congress gave the SEC the option of setting up a governing body for the national market system, the nature and powers of which were unclear. (27)

    2. Discerning the Purpose of the '75 Amendments

      Contemporaneous observers and those looking back over time have wondered exactly what the national market system was intended to be and how active a role in shaping it the SEC was intended to take. In the words of one commentator, "[t]he legislators hoped to improve an essential economic mechanism that they admired and respected without supplanting the existing market structure." (28) Some observers read the mandate as a directive to forcefully meld trading venues together into one national computer platform for executing trades. (29) Others saw the statute as a mandate for industry-driven, incremental steps to improve communication among market participants and interaction between markets. (30) Still others read the statutory mandate as an intentionally broad invitation for the SEC to exercise its regulatory discretion. (31) One longtime SEC staffer explained that the "NMS approach to market structure" seeks to preserve "the benefits of competition among markets," while "minimizing] any adverse effects of 'fragmentation.'" (32)

      Congress chose the Senate's phrase--"facilitating" the national market system--rather than the more interventionist-sounding "establishment" role envisioned for the SEC in the House's version...

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