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Nasdaq to take on greater policing role on its stock exchange

Commuters pass by the NASDAQ Marketsite in New York, May 21, 2012. REUTERS/Brendan McDermid
Commuters pass by the NASDAQ Marketsite in New York, May 21, 2012. REUTERS/Brendan McDermid

By John McCrank

NEW YORK (Reuters) - Nasdaq OMX Group Inc plans to assume a greater role in the policing of its U.S. stock exchange, according to a regulatory filing, in a move that follows calls by Wall Street for an end to the self-regulatory status of exchanges.

As self-regulatory organizations (SROs), exchanges are responsible for monitoring and enforcing their members' compliance with securities laws and exchange rules.

Nasdaq has outsourced most if its equity market regulatory duties to the Financial Industry Regulatory Authority (FINRA) since it received approval from the U.S. Securities and Exchange Commission (SEC) to operate as a securities exchange in 2006.

The Securities Industry and Financial Markets Association (SIFMA), which represents Wall Street, had been pushing for FINRA, or some other independent agency, to take over full supervision of exchanges to prevent conflicts of interest.

New York-based Nasdaq said in a SEC filing, dated August 12, it plans to take over the surveillance of trading on its exchange. The exchange is also responsible for member examinations and investigation and prosecution of suspicious activity, but will continue to outsource those duties to FINRA.

Nasdaq said it would also continue to use FINRA for cross-market surveillance, which incorporates data from exchanges run by Big Board operator NYSE Euronext.

The transition of the duties could be as soon as 45 days after the filing.

Nasdaq has been in discussions with FINRA over the past nine months on the transition plan. The filing comes less than two weeks after SIFMA, the largest U.S. securities trade group, asked the SEC to end the self-regulatory status of stock exchanges.

As for-profit businesses, exchanges compete with broker-dealers for the same order flow, with around 40 percent of equities trades taking place on non-exchange venues, SIFMA said in a letter to the SEC. It said this self-regulatory structure at exchanges creates conflicts of interest and should be replaced by some form of outside supervision.

NYSE and Direct Edge also currently outsource many of their regulatory duties to FINRA, while BATS Global Markets does its own surveillance and then makes referrals to the Chicago Board Options Exchange for further investigation.

SIFMA argued that since exchanges already outsource most of their regulatory duties, not much would change if the exchanges lost their SRO status. It added that the line between where regulatory functions at exchanges end and commercial activities begin has never been clearly drawn.

Nasdaq said in the filing it believes that its expertise in its own market structure coupled with its continued monitoring of these activities in real-time would enable it to better detect improper activity on its market.

The exchange operator plans to use staff already in place, including analysts, lawyers, programmers and market structure experts, to perform the new regulatory functions.

Nasdaq Regulation will review surveillance alerts and refer potential violations to FINRA.

The SEC "has made clear on many occasions" that ultimately, exchanges are responsible for their regulatory duties, Nasdaq said in the filing.

Nasdaq and FINRA declined to comment on the filing on Tuesday.

(This story is corrected in paragraph 5 to say Nasdaq will continue to outsource member examinations and investigation and prosecution of suspicious activity to FINRA)

(Reporting by John McCrank; editing by Andrew Hay)

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