Richard R. Lindsey, 42, has been director of the Securities and Exchange Commission's division of market regulation since November 1995. He is responsible for the SEC's oversight of the securities markets, including broker-dealer firms, securities professionals, self-regulatory organizations, the exchanges, and securities trading.
Before joining the division, he was the SEC's chief economist and earlier a finance professor at Yale University's School of Management.
In an interview this week with staff reporter Lynn Stevens Hume, Lindsey discussed the concept release the commission issued on May 23, which is designed to rethink regulation of the financial markets in light of technology advancements.
Below are excerpts from that interview.
Q: Could you talk about the idea behind the concept release?
A: This concept release is about the future moving more and more toward electronic-based exchanges, less and less toward exchanges that look like a stock exchange of 1934. And given that that's happening, what should be the appropriate way to regulate these things? What's the appropriate degree of regulation associated with these different types of marketplaces?
Q: You're looking at over-the-counter trading that would include municipal bonds as well as other types of debt?
A: I think you have to be much more specific than that. What we talk about are exchanges, or we talk about entities that may serve the function of an exchange. There's nothing any place that says exchanges are limited to stocks. I mean, you can exchange-trade an awful lot of things. So the question is, when you have an exchange, how should it be regulated?
Q: How might this affect the municipal market? Or does it have any effect?
A: Well, I can't say clearly whether it does or does not. What I would say is it should not have an effect on dealer-to-dealer types of trading, or dealer-to-customer trading, or in-house systems because none of those things would necessarily constitute an exchange.
If, on the other hand, you constructed something that brought a lot of buyers and sellers together, you had standardized rules for the interaction of those buyers and sellers, and those buyers and sellers could access each other and hit each other in that type of marketplace, then that starts to look like an exchange.
But again, this is a concept release. And we're asking, what's the right way to do this? We don't want to forestall innovation, we don't want to forestall market developments here at all. At the same time, there may be situations where these things represent a level of activity or something that's probably not appropriately regulated as a broker-dealer, and may be more appropriately regulated as an exchange.
But then what should be the right degree of regulation? How much do you want to do? My personal opinion is you don't want to construct the same type of exchange regulation for electronic systems or for these newer and innovative systems that the New York Stock Exchange is currently subjected to. But, at the same time, there may be concerns that you have to pay some attention to, for instance, what the implications are for the marketplace as a whole.
Q: So it seems you're saying that right now you really don't see anything in the municipal market that approaches the level where it would be defined as some sort of exchange?
A: In the concept release we specifically say that interdealer-broker systems for the municipal and the government markets may be excluded.
Q: Unless the interdealer market became more automated?
A: If the interdealer-broker market became automated enough, then it clearly could fall within the purview. And I don't know if there are any small systems out there that could potentially be classified as a exchange under the scheme that's been laid out in the concept release.
But remember, there are three tiers of regulation associated with that. One tier being what we all recognize as an exchange today. The second tier being electronic exchanges with a significantly different regulatory overlay. Examples of that may be - and the lines have not been drawn here - on the stock side, for instance ... Island or Bloomberg or Instinet. And the third level is what we're calling exempt exchanges. These are things that would be called an exchange. They would be registered as an exchange, in our minds, with a very simple process. Right now, I think people estimate that it would take two years to become registered as an exchange. We would imagine something like two weeks, basically about as easy as becoming registered as a broker-dealer. And then with very minimal regulatory overlay, the idea that you'd have to keep an audit trail, for instance.
Q: What else?
A: The other basic things are ... reporting to some type of a self- regulatory organization, and also having some type of control system in place to prevent the employees of such an entity from abusing the users of the system, whether that may be front-running or insider trading or whatever ... And we ask, are there more that we haven't thought of?
But we would expect that most things that would look like an exchange may fall into that category, depending on what kind of role they play in the market. If they play a significant role in the market, then they may kick up into the next level.
But again the release is not, and I stress not, meant to catch broker- dealers' internal systems or their dealings with their customers ...
Q: Or their dealings with each other?
A: If you're talking about their dealings with each other over the telephone, no. But if you're talking about certain types of electronic systems, if they're constructed the right way, they could fall into that category.
Q: So basically the idea here is that technology is changing, and the system that's in place has been in place since 1934?
A: Yes, with some updates in 1975. Basically what we're saying is, the world is changing. There was a regulatory scheme that was constructed in 1934. Is it going to be the right regulatory scheme for the next century? (Laughs) I mean, I don't expect any regulatory scheme to be right for the next century because I have no clue as to what's going to be there 20 years from now, maybe not even 10 or five. But given that technology is changing so rapidly, we should ask some fundamental questions. Are we regulating the markets in the right way? Are we looking at the right things? What should we be concerned about? And that's what this concept release is about.
Q: Because today alternative trading systems are regulated as broker- dealers?
A: That's right.
Q: So one approach in this concept release would be to continue to regulate them as broker-dealers but making self-regulatory organizations ...
A: Somewhat more responsible for the trading activity that goes on.
Q: And the other approach is to integrate them into the national market system, such as exchanges?
A: That has much less meaning in the municipal area, of course, because there isn't really a national market system. ... But to recognize them as stand-alone entities. And the reason we can do this now is because of the legislation last year that gave us exemptive authority. Before, we only had two boxes. You could call something a broker-dealer or you could call something an exchange. And when you called them one of those two things, that implied something about the regulations that had to be applied to them.
Q: The National Securities Markets Improvement Act of 1996?
A: Yes, under NSMIA we now have the ability to take and break those boxes and that's really what that second alternative is. We can now look at exchange regulation and we can say, okay, what doesn't really make sense, both for existing exchanges and for these systems if they were to be regulated as exchanges.
For instance, there have been no for-profit exchanges. I don't see any reason that you can't have a for-profit exchange. It's not specifically prohibited in the Securities Exchange Act of 1934, but the way certain things in the act are constructed in terms of representation, in terms of control. ... It's prevented for-profit entities from running exchanges. Well, we can now use the exemptive authority to remove some of those restrictions.
There are a lot of things that were constructed in '34 that maybe we don't really need to regulate some of these newer things. In my mind, if you contrast an electronic system where, by virtue of the fact that it's electronic, there's a precise - an extremely precise - audit trail, maybe the regulatory concerns that might exist in systems that have a significantly less precise audit trail, may not be the same.
Therefore, you may be able to use a slightly different, or potentially a significantly different, regulatory approach with systems like that. It's much harder for somebody to play certain types of games anyway in an electronic marketplace.
Q: The idea here is to make sure there's investor protection with these alternative trading systems?
A: That's right. Another example that comes to mind is that the Securities Exchange Act of 1934 essentially prevented direct institutional access to exchanges. Well, clearly there's not necessarily a reason to prevent that. What we do is explore the possibility that exchanges could be opened up to allow direct institutional access, such as to an institutional investor, rather than going through a broker-dealer.
Q: What is the next step after you get comments on Sept. 2?
A: We'll take a look at the comments we've got. A concept release is really that, it's a concept release. We've tossed out some pretty big ideas here that we're looking for comment on.
Q: What do you say to those worried the SEC may try to regulate debt under some equities-oriented regulatory framework?
A: In some cases I think the debt markets do differ from the equities markets and I don't think that they're regulated exactly the same, nor would you want them to be regulated exactly the same.
... I think the market is much better at regulating the market than any entity sitting in Washington, D.C. The way that you have markets regulated, you try to provide for two basic things. You try to provide for access to those markets and you try to provide for transparency. And if you have access and transparency in the markets, then the market does a great job of regulating itself.
Q: After you look at the comments, what's the next step?
A: That's when the commission will decide whether or not it does a proposing release ... and at that time it would propose a certain set of rules and let people comment on those proposed rules. ... I can't speak to how long it would take. There are concept releases that the commission has put out and has never taken action on. There are concept releases that the commission moves fairly quickly on. It's always hard to say where it would be.
