Right the First Time: Regulation, Quality, and Preventive Compliance in the Securities Industry

Wednesday, January 1st, 1997 at 12:00 am by John H. Walsh
John H. Walsh, Right the First Time: Regulation, Quality, and Preventive Compliance in the Securities Industry, 1997 Colum. Bus. L. Rev. 165

In March of 1985, Aulana L. Peters, then a Commissioner of the United States Securities and Exchange Commission (“SEC” or “Commission”), gave a speech at Brooklyn Law School entitled Investor Protection: The First Line of Defense. In her presentation, Commissioner Peters described the structure for enforcing the securities laws as a pyramid. At the top is the “federal watchdog,” the SEC. In the middle are the self-regulatory organizations for broker-dealers, an association, and several exchanges that are federally registered and regulated by the SEC. Finally, “at the largest, and perhaps most important level,” are the securities firms themselves. It is here that “customer protection begins.” Commissioner Peters continued that the lowest level of the pyramid was increasingly important to the SEC as the agency’s resources lagged behind growth in the securities markets. With its limited resources, the Commission could not “pursue every case involving violations of the law by single registered representatives.” Therefore, it had to rely to a greater degree on brokerage firms “to police their own ranks.” Commissioner Peters delivered her speech more than a dozen years ago, but her simile of the pyramid still rings true. Its elegant simplicity certainly has much to do with its continued descriptive value. The SEC is a small agency responsible for regulating a huge and growing market, and self-regulatory organizations and compliance officials in private firms provide the bulk of enforcement. However, when we turn from description to analysis, the simile yields less desirable results. To the extent that Commissioner Peters suggested that private compliance systems are primarily extensions of the SEC’s enforcement program, she significantly understated their value. It is the thesis of this article that private compliance systems are more than outposts of regulation left behind by a retreating federal agency. Rather, they add a distinctive, indeed unique, value to the regulatory system. They institutionalize compliance within a firm’s normal operations, because, in a manner that would be impossible for a government agency promulgating standards of general application, they work within the particular circumstances of each firm to identify and preemptively remedy the causes of potential violations. In other words, they are the best available means for getting compliance right the first time.

Author Information

Chief Counsel in the Office of Compliance Inspections and Examinations at the Securities and Exchange Commission