Securities Exchanges: Regulation and Reform Proposals (Section 501 of S. 2155, Section 496 of H.R. 10, and H.R. 4546)
March 30, 2018
Securities Exchanges: Regulation and Reform Proposals
(Section 501 of S. 2155, Section 496 of H.R. 10, and H.R. 4546)
Introduction
exemption from additional state-based registration,
Overseen by the Securities and Exchange Commission
described in more detail below, to securities listed on
(SEC), the federal securities laws are broadly aimed at (1)
investor protection; (2) maintaining fair, orderly, and
the three “national securities exchanges,” the New York
efficient markets; and (3) facilitating capital formation.
Stock Exchange, the American Stock Exchange, and the
They do so by providing clear rules for honest dealing
National Market System of the Nasdaq Stock Market
among securities market participants, including antifraud
(the Nasdaq Exchange); and
provisions, and a disclosure regime that requires the various
entities involved in securities markets to disclose
exchanges or their segments or tiers with listing
information deemed necessary for informed
standards that are “substantially similar” to those of the
decisionmaking.
aforementioned three “national securities exchanges”
(including Tiers 1 and 2 of the Bats BZX Exchange and
The Securities Act of 1933 (the Securities Act; P.L. 73-22),
the Nasdaq Capital Market).
the initial federal securities law, has two fundamental
objectives: (1) requiring that investors have access to
State Securities Registration
financial and other salient data regarding securities that are
Securities listed on the three national securities exchanges
offered for public sale; and (2) prohibiting fraud in the sale
and the “substantially similar” exchanges are called covered
of those securities. To help accomplish these, the Securities
securities and are exempt from the state-based securities
Act generally requires issuers that offer securities for public
registration protocol known as blue sky laws. The basic
sale to provide key financial and nonfinancial information
reasoning is that investors who acquire securities listed on
on the securities and themselves to the SEC through
the three national exchanges or exchanges with
registering the securities with the agency.
“substantially similar” listing standards may find the blue
sky regulatory regimen to be not only somewhat
Registration entails SEC disclosures that become publicly
duplicative, but potentially onerous in other ways as well
available, including disclosures about how much of the
(as in the case of merit review, described below).
company is up for sale and what portion of it will remain in
the hands of the existing owners. Also required is
Reportedly a response to perceived securities offering and
information on the financial history of the firm; information
sale fraud, state-based securities registration existed
on the planned use of the proceeds from the sale of the
decades before the initial adoption of the major federal
securities; an explanation of the firm’s current business
securities laws in the 1930s and 1940s. They were aimed at
model; the nature of the competition that it faces; and
protecting investors from fraudulent securities sales
significant information on the prospective securities issue,
practices and related activities. The laws can vary,
including the method used to formulate its offering price.
depending on the particular state. In most states, companies
issuing securities must register their securities offerings in
The second federal securities law to be enacted was the
advance of their sale in that state. Like the SEC, states
Securities Exchange Act of 1934 (Exchange Act; P.L. 73-
generally require corporate securities issuers to provide
291). Among its provisions, the Exchange Act authorized
various disclosures about themselves and the securities that
the creation of the SEC and requires a host of securities
they are issuing. A subset of states also conduct a “merit
market participants, including securities exchanges, to also
review” wherein securities cannot be sold in a given state if
register with the agency.
it has determined that they are prohibitively risky for many
retail investors.
Section 18 of the Securities Act of 1933
Companies seeking to issue their stock on a specific stock
Corporate issuers interested in having their securities listed
exchange must satisfy its listing requirements, both initially
and traded on an exchange that is not deemed to be
and continually. Such minimum thresholds vary depending
substantially similar to the three aforementioned national
on the exchange and commonly include variables such as a
exchanges would likely face the prospect that the securities
company’s market capitalization, annual income, measures
would not be deemed to be covered securities and would
of its financial strength, and the number of shareholders.
thus be subject to state-based registration and its associated
regulatory costs. Those additional costs could deter an
The National Securities Market Improvement Act of 1996
issuer from deciding to list and trade securities on a
(NSMIA; P.L. 104-290) amended the Securities Act by
securities exchange.
adding Section 18. That section gives a registration
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Securities Exchanges: Regulation and Reform Proposals (Section 501 of S. 2155, Section 496 of H.R. 10, and H.R. 4546)
Legislative Proposals
a so-called venture exchange, a trading platform often
Section 496 of H.R. 10 (the Financial CHOICE Act, which
envisioned as a centralized secondary market equity trading
passed the House); Section 501 of S. 2155 (the Economic
venue for smaller capitalized (small cap) firms. The current
Growth, Regulatory Relief, and Consumer Protection Act,
legislation would provide regulatory relief that could
passed by the Senate); and H.R. 4546 (marked up by the
arguably help to foster such an exchange. Some, however,
House Financial Services Committee) are similar bills and
have questioned whether the absence of such an exchange
are collectively referred to in this In Focus as the current
simply stems from market forces, not regulatory challenges
legislation.
and costs.
The current legislation would expand the current
Relatedly, there are some small cap firms that are traded on
exemptions from blue sky securities registration by
the Nasdaq Exchange and on the various marketplaces of
amending Section 18 of the Securities Act so that a
the OTC markets (OTC markets, or over-the-counter
securities issuer’s receipt of covered blue sky exempt status
markets, are where stocks are traded via dispersed dealers,
would no longer be dependent on it being one of the
in contrast to exchanges, which generally provide for
aforementioned three major securities exchanges or being
centralized trading). Still, there is a widely held view that
deemed by the SEC to be “substantially similar.” The
there is a problematic deficiency of secondary (resell)
listing exchange would merely have to be a national
market trading opportunities for small cap firm securities.
securities exchange, defined as a securities exchange that
Proponents of the current legislation could arguably find
has registered with the SEC under the Securities Exchange
additional support for the bills as mechanisms that could
Act of 1934 (P.L. 73-291). The category includes
help address such perceived inadequacies.
exchanges that specialize in the stocks of companies with a
national focus (for example, the NYSE) and the stocks of
The North American Securities Administrators Association
companies with a regional focus (such as the Miami
(NASAA) is an association of state and Canadian provincial
International Securities Exchange).
securities regulators. The group, whose policy focus tends
to include investor protection concerns, has criticized both
Several arguments have been made in support of the
H.R. 5421 in the 114th Congress and some of the current
legislation.
legislation.
One case for the broad-based elimination of all existing
Exchanges establish their own standards for listing and
state securities registration has been made by a number of
continuing to trade securities. And the NASAA has noted
observers, including the Heritage Foundation, a free-
that the current regulatory regime allows for a range of
market-oriented think tank. In 2017, the foundation argued
SEC-registered exchanges with their diverse qualitative
that absent the blue sky laws, states would still be able to
range of listing standards. The association, however,
use their critical securities antifraud authority. It also
stressed that unless a trading venue conforms to the
argued that registration under the blue sky laws stymies
“substantially similar” listing standards of the three
“efficient capital formation,” while offering “no economic
aforementioned national exchanges, it is then subject to
or societal benefits, such as protection of investors from
state securities regulatory review.
fraud.”
By eliminating the “substantially similar” reference to a
While arguing in support of H.R. 5421 in the 114th
national exchange in Section 18, NASAA argued that the
Congress, a bill that was similar to the current legislation,
legislation would undermine the potentially important
the 2016 report accompanying the House Financial Services
qualitative listing distinctions between alternative securities
Committee’s markup of the bill (H.Rept. 114-684) observed
trading venues and the major national exchanges. As such,
that Section 18 problematically required the SEC to
the group has raised concerns that investors could
compare unconventional “innovative” securities listing
potentially be disadvantaged due to the blurring of those
standards that depart from the standards for the three
distinctions under the legislation. It has argued that
aforementioned national exchanges “that may have been in
securities traded on alternative exchanges with less rigorous
effect” when the section was adopted back in 1996. As a
listing standards would be exempt from state securities
consequence, the report argued that Section 18 “place[s] the
regulation, as are securities listed on the three national
SEC in a … position to limit innovation and competition to
exchanges with their generally more rigorous standards.
certain exchanges”—a situation that it indicated would be
remedied by H.R. 5421.
Relatedly, NASAA also warned that the legislation could
help spur the creation of exchanges with lowered listing
A frequently discussed example of this kind of innovation
standards or regulatory requirements. The concern is that
is the concept of a venture exchange. As evidenced by other
such a scenario could help to foster fraud that would
legislation in the 115th Congress (for example, Subtitle L of
victimize investors.
the Financial CHOICE Act); comments from SEC officials
and securities market stakeholders; and some congressional
Gary Shorter, Specialist in Financial Economics
hearings, there is growing interest in using regulatory relief
from the regulations in federal securities laws to help foster
IF10862
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Securities Exchanges: Regulation and Reform Proposals (Section 501 of S. 2155, Section 496 of H.R. 10, and H.R. 4546)
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