Overseeing Private Rulemaking: Evidence from SEC Review of SRO Rules

Securities markets rely heavily on private rulemaking by self-regulatory organizations (SROs) such as FINRA and the stock exchanges, supervised by the Securities and Exchange Commission. The SRO-centric model is marred by problems with democratic accountability and inherent conflicts of interest, where insiders might prioritize private benefits over public needs. For these and related reasons, the SRO model is in a moment of transition— with increasing judicial scrutiny of SROs’ roles and powers within separation-of-powers and administrative-law frameworks. Scholars, meanwhile, know little about how the SROs and SEC jointly produce rules for capital markets. Previous securities regulation scholarship has focused on specific aspects of SRO rulemaking, such as the stock exchanges’ corporate governance rules, largely without addressing systemic issues in the production and SEC oversight of SRO rules. Yet SRO rulemaking practices have important consequences for the regulation of securities markets, including the role of procedural reform on regulatory effectiveness and public participation. This article’s approach uses a comprehensive new dataset drawn from every issue of the Federal Register from 2000 to 2023, providing a unique macro perspective that reveals significant inefficiencies and oversight challenges in the current system. By employing a political economy lens, this study focuses on procedural inadequacies while aligning them with policy concerns about accountability, oversight, and democratic control over regulation. This article argues that the SRO rulemaking system is not functioning well, producing a firehose of securities law that is at once a massive drain on agency resources, as well as an impediment to robust public participation in the rules governing capital markets. After the Dodd-Frank Act, most rule change proposals go effective immediately upon filing unless the SEC takes action to halt effectiveness and need not require preapproval. The dominance of this mode of SRO rulemaking, I suggest, alters both the incentives as well as opportunities the SEC has to engage in robust oversight. I also find evidence that the SEC’s oversight responds to a judicial-review shock. I assess the Dodd-Frank reforms under a framework that recognizes the tradeoff between the costs of deciding and the costs of making wrong decisions, and connect this tradeoff to deeper debates about the role of SROs in our constitutional structure. This project contributes to our understanding of the political economy of capital markets regulation, as well as our understanding of federal oversight of SRO rulemaking.