Self-regulation by the Mexican stock exchange: a promising path toward developing Mexico's securities market?

• Author: Cardenas, Eugenio J.

1. INTRODUCTION II. BACKGROUND AND EXISTING LITERATURE A. Brief Note on Self-Regulation in Modem Securities Markets B. Securities Enforcement for Capital Market Development: An Ongoing Debate III. SELF-REGULATION IN THE MEXICAN SECURITIES MARKET A. An Overview of Self-Regulation in Mexico's Formal Legal System B. A Self-Regulatory Framework for the Mexican Stock Exchange IV. RESEARCH QUESTIONS AND DESIGN A. Addressing the Questions B. Methodology 1. Analysis of Trading Suspension Decisions a. Wrongdoing Regulated and Sanctioned b. Company Characteristics c. Compliance Following Suspension 2. Semi-Structured Interviews V. FINDINGS AND DISCUSSION A. What is the Nature and Aim of the Self-Regulation? B. What Issuers are Being Targeted? C. How do Firms Respond to the Sanctions? VI. CONCLUDING REMARKS I. INTRODUCTION

   This study ventures into a global phenomenon of modem securities markets: self-regulation by stock exchanges. The purpose is to better understand the benefits (or lack thereof) of self-regulation by the Mexican Stock Exchange (MSE), as an alternative channel (to public enforcement by regulators and private rights of action) that may potentially contribute to better achieving the investor protection required by the Mexican securities market to further develop and compete in today's global marketplace.

   The research involves an empirical analysis of 128 decisions issued by MSE during a recent five-year period, involving 89 cases of trading suspension sanctions against issuing companies. Seeking to shed light on the extent to which self-regulation works in the Mexican securities market, the study examines: i) the nature and aim of the self-regulation, on account of the type of wrongdoing regulated and sanctioned; ii) the characteristics of issuing companies being targeted; and iii) the way these companies reacted to MSE's trading suspension sanctions, in terms of how they complied and corrected their wrongdoing. Reaction to the findings through a series of semi-structured interviews with officers and directors of the Mexican Stock Exchange, the National Banking and Securities Commission (CNBV), (1) and the Secretary of Finance and Public Credit (SHCP), (2) among others, further illustrate the development, role, and challenges of self-regulation in Mexico's securities market.

   The research finds that self-regulation by the Mexican Stock Exchange is largely preventive and procedural in nature, aimed primarily at inducing timely and complete filing of periodic information. Focus is, seemingly, not substantive in terms of detecting and punishing serious misconduct like securities fraud, insider trading, and self-dealing. Moreover, the firms targeted and commonly sanctioned are usually smaller and less profitable, with low trading volumes and share prices.

   Nonetheless, compliance rates by issuers, after being suspended, are fairly high, and firms tend to comply very quickly, often resuming trade within hours. Even if the trading suspensions do not seem to have an impact on the price of stock, issuers apparently care significantly about being suspended. Among other factors, there appears to be a reputational component involved. Sanctions are made public and reach the media instantly, and firms reportedly care about potential economic impact regarding access to finance, future ventures, and fines by the regulator.

   The study also points to challenges faced by the current self-regulatory regime, including certain wrongdoing not being detected, the absence of stronger sanctions like fines, the need for more revision and auditing, and the need to overcome the conflicts of interest derived from the Mexican Stock Exchange becoming a publicly-held company, policing the same market that it manages and in which it trades.

   Aiming at contributing to legal scholarship, this paper involves an initial effort to collect and assess data on enforcement activity for Latin America, a region with widespread support for market development but with a hostile corporate environment, often characterized by concentrated ownership structures, strong controlling owners, and tunneling, that could benefit from a better understanding of securities enforcement. Moreover, the research adds new dimensions to the existing literature by both focusing on an emerging region, and addressing self- regulation by stock exchanges as an additional enforcement channel with the potential to contribute to financial development.

   This note develops as follows. Section II explores the existing literature. It presents debates on the extent to which self-regulation works in securities markets, and on the optimal levels and modes of securities enforcement required to achieve financial market development. Section III discusses the self-regulatory legal framework of Mexico's securities markets, with focus on stock exchanges and on the disciplinary measures that the Mexican Stock Exchange may impose on issuing companies. Section IV addresses the research questions and design. Section V presents results and evaluates the findings, and Section VI concludes.

2. BACKGROUND AND EXISTING LITERATURE

   1. Brief Note on Self-Regulation in Modern Securities Markets

      Self-regulation in securities markets has been around for some time. The New York Stock Exchange (NYSE) was a self-regulatory organization (SRO) that exerted market discipline well before the enactment of the U.S. federal securities laws. (3) But, as a result of globalization, which brought increased activity, technology, and competition to financial markets--and, in turn, demutualized publicly held stock exchanges (traditionally non-profit mutual or member organizations)--self-regulation has gained relevance in securities markets across the globe. (4) It has been considered a means to acquire enhanced disclosure and corporate governance standards, with the purpose of attracting investors and achieving market competitiveness, being increasingly adopted by formal legal systems to strengthen financial markets. (5) This global trend reached Latin America during the past decade, with self-regulation being considered key in promoting a "legal culture" (6) of corporate governance necessary to develop the region's financial systems. (7)

      "On the face of it, self-regulation can be defined simply as an institutional arrangement whereby an organization regulates the standards of behavior of its members." (8) It occurs when, absent government oversight, individuals or institutions of a branch of the private sector voluntarily decide that it is in their best interest to establish a private normative order to govern and supervise their activities and affairs. (9) However, "regimes governing company affairs, equity markets, and financial services which have self-regulatory characteristics are not examples of self-regulation in its purest form." (10) As set forth by Alan C. Page: "Self-regulation is a matter of degree" (11) and "government has been heavily involved not only in the formation of self-regulatory regimes but also in their monitoring and adjustment." (12)

      Rob Baggott classifies varying degrees of self-regulation in terms of (1) formality, (2) legal status, and (3) outside intervention. (13) As opposed to a private organization supervising its own members, a self-regulatory framework with a higher level of formality would, for instance, entail a specialized and independent surveillance body empowered with rule-making and enforcement powers to oversee the organization and its members. This is often the case with SROs in securities markets, which have independent surveillance divisions or non-profit associations.

      With regard to legal status, a self-regulatory regime would be governed, in essence, by mere voluntary agreements. However, these agreements are often backed by statutory law, and it is not uncommon for governments to reserve powers for overseeing and enforcing self-regulatory regimes. (14) An example of this would be a securities regulator's oversight of stock exchanges and associations of broker-dealers, setting general legal guidelines for them to follow. Moreover, it is increasingly common for self-regulation to be recognized and adopted by formal legal systems as supplementary to statutory law, a recent instance being the case of Mexico, further detailed in Section IV.

      Finally, in terms of outside intervention, self-regulatory regimes may involve the participation of third parties. Current examples comprise private enterprises to which stock exchanges outsource market supervision to overcome conflicts of interest resulting from becoming for-profit and publicly-held companies trading in the same markets that they manage and police. The Financial Industry Regulatory Authority, Inc. (F1NRA) is a private company that has taken on this role for U.S. financial markets since 2007.

      Hence, in the context of securities markets, self-regulatory organizations would usually entail stock-exchanges and organizations of broker-dealers with authority (often provided by law) to create and enforce rules of conduct (ethical and legal standards) to govern the financial services industry and its members. (15)

      But how ideal is self-regulation in achieving market supervision? Arguments for and against enforcement by self-regulatory organizations have been set forth and different conclusions have been reached. Assessing different empirical accounts within the British financial sector, Brian Cheffins concludes that self-regulation is not ideal to supervise market behavior, as it does not offer clear-cut advantages over enforcement by government regulators. (16) Self-regulation may be more flexible and offer more expertise and lower costs than government supervision, as has been the British tradition in many sectors. (17) However, it may also lack the strength, legitimacy, and coercion of public enforcement, as would, for instance, be offered by the Securities and Exchange Commission in the United States. (18)

      Could a healthy...