A self-regulatory organization (SRO) is an entity which has the power to create and enforce industry regulations that govern the SRO's members. For the securities markets, the Securities Exchange Act gives SROs this limited power to act as quasi-regulatory bodies subject to oversight by the U.S. Securities and Exchange Commission (SEC). Under that oversight, SROs have a special power to create rules for their members that become legally enforceable requirements under the U.S. federal securities laws. But with great power comes great responsibility.
Examples of SROs in the U.S. securities markets include FINRA, the New York Stock Exchange, and NASDAQ. The DTCC registered clearing agency subsidiaries, DTC, NSCC and FICC, are also SROs and the rules for each of these SROs can be found in the respective clearing agency rulebook. Our SROs can propose and implement rules for many reasons: risk management, compliance with a new SEC requirement, or the introduction of a new service are common examples. And, while it’s not a competition, as a general matter our SROs don’t even generate the most rule filings for SEC review in a given year. That honor consistently rests with the stock exchanges.
When NSCC wanted to introduce to the marketplace the Securities Financing Transactions (SFT) Clearing Service, NSCC had to propose and get the SEC to approve a rule to support that service.
Putting Pen to Paper
At DTCC, the rulemaking process starts with discussions among internal cross-functional teams. We put the idea on paper and work it into the form of a proposed rule, which can either be a modification to an existing rule or an entirely new section of the rulebook. Once drafted, we run that documentation through our internal governance processes with functions like the business teams, risk, and legal shepherding the paperwork along the way.
We often socialize the proposed rule with external stakeholders and those affected by it, who know the underlying issues best. These stakeholders can include our clearing agency participants, their clients, the broader financial industry, and even SEC regulators. The idea is to make sure we are spotting any particular issues early and designing the rule in the intended manner. But, as discussed below, that is no guaranty of smooth sailing once the formal regulatory rule process begins!
Once we have internal and external input, as well as formal internal approval, we move ahead with filing the proposed rule with the SEC. We need the SEC to review and approve the rule before we can bring it into reality. This can be rather stressful from a commercial perspective, particularly when we are using a rule to bring to market new products like the SFT Clearing Service.
Crossing T’s and Dotting I’s
The official filing journey begins with the SEC’s Division of Trading and Markets (TM). This step is not required, but we hold pre-filing discussions with the TM team as a best practice. There are two good reasons to do this: we want to ensure that our proposed rule doesn’t immediately raise any glaring inconsistencies with existing laws and ensure all rule filing paperwork is in good order. The latter is a critical step; if seemingly minor areas like page numbers or punctuation in the draft rule text are wrong, then the TM staff will reject the paperwork and send it back to you to fix. At that point the filing has to go back to the end of the review line, further delaying the process.
After acceptance, the SEC publishes the proposed rule in the Federal Register and posts a copy on its website. We also publish a copy of the rule proposal on our website, which we are legally required to do. This way, everyone can see exactly what we plan on doing as an SRO.
The majority of the time a rule filing goes through a full comment process before the SRO can receive an answer from the SEC. Our SFT Clearing Service rule went through this process. For some initiatives, such as changing the title of a business or a clearing agency fee, SROs are able to make those changes effective immediately with no comment period or proactive SEC action.
One caveat is that the SEC reserves the right during the first 60 days following publication to suspend and review these types of filings if they have a good reason for it. Good reason usually means a savvy commenter (particularly one who is sensitive to fees) sees the filing in the FR and submits a comment letter that raises a meaningful issue the SEC decides it wants to consider. If that happens, the filing is suspended, the SRO has to stop the change, and you have a notice and comment period before the SEC makes a final decision.
Waiting Through the Comment Period
Once the proposed rule is submitted and accepted, it is published in the Federal Register and goes out for comment. The comment period has fixed timelines. Once the rule is published, anyone in the general public can comment and the SEC has a legal obligation to review and consider all comments before making a final decision. If they receive a comment that raises concerns about what we want to do, then the TM staff will often turn to us to see if we want to address the concerns raised. We can choose to ignore the comment or reply. Our options for replying include submitting our own letter into the comment file to reply or even file an amendment to our original filing that tries to respond to commenters.
Under the law, it can take up to 240 calendar days before the SEC must approve or disapprove an SRO rule proposal. The odds of hitting the outer limit of this timeline go up if there is a lot of debate and comments. In extreme scenarios, an SRO and the SEC might run out of time and the SRO might re-file the proposed rule change to reset the clock. This can be a frustrating process for all the parties involved.
Overall, it can sometimes be a tough balancing act for a business like us that is also an SRO to manage the regulatory uncertainty inherent in the SRO rule approval process. This is why we put our proposed rule changes through such a stringent internal vetting process and try to engage with key stakeholders and regulators to resolve issues ahead of time. While nothing is guaranteed once the formal regulatory review process starts, we have found putting in this extra attention and effort is often worth it in the end.
Reaching the End of the Road
All that said, the consummation of the SEC review process can be somewhat anti-climactic. On the happy day of approval, all that will usually happen is a discrete phone call from the TM staff informing us of the decision to approve, which was ultimately the case with the SFT Clearing Service. Shortly thereafter, sharp-eyed observers will see that the SEC has posted an approval order for the rule change on its website. And with that, the public has been made aware of a new SRO power under the U.S. securities laws. The rest of the process is on us – alerting clients and the broader markets to when the change will come on-line and turning the switch when we’re ready to go.