Tuesday, August 19, 2008

SEC Approves BATS Exchange Conditioned on FINRA Performing Regulatory Duties

The SEC has approved the registration of a new national securities exchange, BATS Exchange, conditioned on the further approval of the exchange’s contract with FINRA to perform examination, enforcement, and disciplinary functions. FINRA will also provide dispute resolution services, including the operation of the exchange’s arbitration program. In addition, FINRA will provide the exchange with access to FINRA’s WebCRD system. Release No. 34-58375.

The SEC believes that FINRA has the expertise and experience needed to perform these functions on behalf of the new exchange. The Exchange Act requires SROs to examine their members and associated persons and enforce compliance with the federal securities laws and their own rules. But the Act also permits an exchange to allocate regulatory duties. The exchange has indicated that it will submit an agreement with FINRA for SEC approval.

The SEC emphasized that the exchange bears the ultimate responsibility for self-regulatory conduct and primary liability for self-regulatory failures, not the SRO retained to perform regulatory functions on the exchange’s behalf. In performing these regulatory functions, however, FINRA may nonetheless bear liability for causing or aiding and abetting the failure of BATS Exchange to perform its regulatory functions. For example, if failings by FINRA have the effect of leaving the exchange in violation of any aspect of its self-regulatory obligations, BATS Exchange would bear direct liability for the violation, while FINRA may bear liability for causing or aiding and abetting the violation.

Thus, although FINRA will not act on its own behalf under its SRO responsibilities in carrying out these regulatory services for BATS Exchange, FINRA may have secondary liability if, for example, the SEC finds that the contracted functions are being performed so inadequately as to cause a violation of the federal securities laws by BATS Exchange.

Under the pact, FINRA will examine and investigate common members of BATS Exchange and FINRA for compliance with federal securities laws and regulations; and exchange rules that have been certified by BATS Exchange as identical or substantially similar to FINRA rules. FINRA will also enforce compliance by common members with federal securities laws and regulations; and exchange rules certified as identical or substantially similar to FINRA rules.

In performing many of the initial disciplinary processes on behalf of BATS Exchange, FINRA will investigate potential securities laws violations, issue complaints, and conduct hearings pursuant to exchange rules. FINRA will also assist exchange staff on registration issues on an as-needed basis, investigate potential violations of BATS Exchange’s rules or federal securities laws related to activity on the exchange, conduct examinations related to market conduct on the exchange by members, assist the exchange with disciplinary proceedings, and conduct hearings.