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The Securities and Exchange Commission warned the nation’s stock markets Tuesday that they may lose the right to regulate themselves without major improvements in governance. Voting unanimously, the five SEC commissioners agreed to publish a so-called concept release, soliciting comment on whether the government should retain the self-regulation model or replace it with a new system, such as direct federal oversight. “Broader questions remain as to whether the self-regulatory system, as currently structured, remains the best and most efficient model for overseeing markets and market participants,” SEC chairman William Donaldson said. Controversy over stock markets policing themselves has flared in recent months. The New York Stock Exchange has been beset by allegations of widespread trading violations by its members and by the highly controversial $187 million pay package of former Big Board Chairman Richard Grasso. The public has 90 days to comment on the SEC plan. The agency is seeking suggestions on how to ensure that “self-regulatory organizations,” as such entities are called, best serve investors, but it will accept more general comments. Industry officials vowed to cooperate with the SEC, although they expressed support for the current regulatory system. “We look forward to … understanding the concerns behind the concept release on self-regulation,” NYSE spokesman Scott Peterson said. “We believe that the most effective regulation occurs when the regulator is as close as possible to the regulated activity, thereby gaining detailed knowledge in overseeing market operations appropriate to that exchange.” The alternatives mentioned by the SEC include taking the regulatory function away from the exchanges and giving it to a single regulator similar to the Public Company Accounting Oversight Board. “There is a case for some form of consolidated regulation, which might make our markets and our regulatory structure, in particular, more efficient and more effective,” said SEC Commissioner Harvey Goldschmid. Despite the concept release, the SRO system is not expected to be overhauled anytime soon. The agency would need to issue a new proposal for public comment before it could alter the self-regulatory process. Legislation also may be required. Of more immediate concern to the stock exchanges is the SEC’s proposal Tuesday to standardize governance rules, foster greater transparency and force them to provide the agency with more information about their operations. This initiative could take effect in the first quarter. “After a period of intense focus on public company governance, we would be remiss if we did not seek to apply the lessons learned to the governance of self-regulatory organizations,” Donaldson said. SROs are “not immune from governance missteps.” Ten exchanges, including the NYSE and the Nasdaq Stock Market Inc. would be required to file quarterly reports with regulators and maintain a majority of independent directors. The proposal also mandates that the exchanges separate their regulatory and market functions and set up nominating, compensation, regulatory oversight and audit committees made up entirely of independent directors. Already in place at some exchanges, the proposal would require them to file confidential reports with SEC inspectors about trends or potential problems the exchanges identified. Additionally, the proposal would limit any member from owning more than 20 percent of an exchange. Other requirements would include disclosing the salaries of the top five officers of the SRO. This action stems from last year’s brouhaha over Grasso’s pay package. Members of the NYSE’s compensation board who approved that package were all appointed by Grasso, raising charges of conflicts of interest. “We have, unfortunately, seen recent examples of the harm that can occur when an SRO fails to execute this responsibility energetically,” Donaldson said. While all five SEC commissioners praised the proposal, some raised questions. Commissioner Paul Atkins worried that the cost to exchanges of complying with the rules “may be too great,” while Roel Campos asked why the staff did not propose separating the roles of chairman and chief executive officer. The SEC’s proposal received a warm reception from the Securities Industry Association, a Washington-based industry trade group. “The SEC’s initiative continues the process that the SEC undertook last year in approving significant changes to the New York Stock Exchange’s governance,” said Ira Hammerman, SIA senior vice president and general counsel. “These rules were a constructive transitional step, and we look forward to reviewing how the SEC proposes to enhance them.” Interested parties have 45 days to comment before the agency votes on finalizing the rules. Copyright �2004 TDD, LLC. All rights reserved.

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