The government should strip U.S. stock exchanges of the legalstatus that protects them from most lawsuits, a trade group forbrokers said.

In a letter to the Securities and Exchange Commission (SEC), theSecurities Industry and Financial Markets Association (SIFMA) saidthe self-regulatory model of organizations such as the New YorkStock Exchange and Nasdaq Stock Market is outdated. Though the SECfined Nasdaq for mishandling Facebook Inc.'s initial publicoffering last year, the legal protections may shield the marketoperator from liabilities.

The Sifma letter is the latest salvo in the fight betweenbrokers and exchanges, who in recent years have become competitorsfor stock transaction volume. The proliferation of trading venuessuch as dark pools at broker-dealers and the decline of the publicexchanges' market share has created tensions on Wall Street.

Exchanges' status as self-regulatory organizations, or SROs,means “one group of businesses is empowered to oversee and regulatethe business and activities of its competitors,” Theodore R. Lazo,associate general counsel at Sifma, wrote in the letter to the SEC.“Conflicts of interest in this model abound and only worsen as theyare left unresolved.”

1929 Crash

The self-regulatory structure for U.S. exchanges dates to theaftermath of the 1929 stock market crash. Under that model,exchanges write and enforce rules of conduct for their members,including how they interact with customers.

In the last decade, the two biggest U.S. bourse operators—NYSEEuronext and Nasdaq OMX Group Inc.—became shareholder-ownedcompanies. At the same time, the brokerages they oversawincreasingly executed trades on venues they own.

Being an SRO brings both costs and benefits to exchanges. Theyare under more regulatory scrutiny than the broker-dealer venues,which are known as alternative trading systems (ATSs). Joe Mecane,head of U.S. equities at NYSE Euronext, said in a December Senatehearing that ATSs “are able to employ different practices thanexchanges with far less oversight and disclosure.”

Richard Adamonis, NYSE spokesman, said the proposal is motivatedby the firms' commercial interests.

“We have long been supportive of a comprehensive review of thebalance of benefits and obligations among exchanges andnon-exchange trading venues, which we do not believe is accuratelyrepresented in the Sifma letter,” Adamonis said in an e-mail. “Wealso continue to be discouraged by the efforts by heavilyconflicted brokers to reduce the influence of exchanges andinterests of investors, further decrease transparency and pricediscovery in the equities marketplace, and generate additionalprofits for the broker community.”

Robert Madden, a spokesman for Nasdaq, and Randy Williams ofBats Global Markets Inc., another U.S. exchange owner, declined tocomment on the letter. James Gorman, spokesman for bourse ownerDirect Edge Inc., couldn't be reached for comment.

The request from Sifma follows an escalation in the fightbetween U.S. exchanges and dark pools, the venues run bybroker-dealers that don't publicly post bids and offers. The chiefexecutive officers of NYSE Euronext, Nasdaq OMX, and Bats met withSEC officials on April 9 to discuss the migration of trading fromtheir venues to dark pools. The meetings in Washington followedrequests by the exchanges that regulators consider measures tointroduce curbs on the venues.

Nasdaq Fine

In the letter, posted on Sifma'swebsite today, the trade group for securities firms argued thatthe exchanges' SRO status works in their favor, in particular inlimiting their liabilities. Nasdaq agreed to pay $10 million in Mayto settle SEC charges that its mishandling of Facebook's IPO was aviolation of securities laws.

“Exchanges have claimed a right to immunity even in connectionwith damages flowing from activities that appear to be commercialin nature,” Lazo wrote. “With exchanges seeking to engage in morebroker-dealer-like activities, the risk grows that exchanges willclaim that more of these commercial ventures are entitled toimmunity based on some incidental regulatory aspect. Abroker-dealer cannot fairly compete with a party that offers thesame services but does not face the same risk of liability.”

The letter is part of a broad review of market structure, saidLazo in an interview, and Sifma isn't suggesting one side is rightor wrong.

“It's about regulating who does what in a more rational manner,”he said in a phone interview. “You might see more exchanges—maybemake everyone exchanges with a more appropriate market structurearound them, and then have one or more entities, such as theFinancial Industry Regulatory Authority, fully dedicated to beingthe SRO.”

While the SEC can't change the exchanges' special status, it cansupport changing the rules, which could influence Congress, Lazowrote in the letter. A change in the SEC's position may alsoprovide guidance for courts, he added.

“Because courts have based exchanges' immunity on their SROstatus, the commission's support for an eventual legislative end tothis status would undermine the basis for the doctrine,” Lazo wrotein the letter. He added that the SEC could also force exchanges toadopt rules that would strip immunity from their commercialofferings.

Sifma also argued that exchanges have too much authority indesigning and implementing changes to market structure.

“Viewing exchanges as independent regulators that will designand implement the Commission's market structure initiatives withoutconsidering their own competitive interests is no longerrealistic,” Lazo said in the letter. “As for-profit businesses,exchanges should no longer be entrusted with such important publicfunctions and expected to act as if they are disinterested partiesacting in the public interest.”

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