There are three necessary prerequisites for effective self-regulation

­There are three necessary prerequisites for effective self-regulation in any market: 1) there must be an association, 2) it must be motivated to regulate its members' behavior, 3) it must maintain sufficient powers of control for this purpose. In respect to stock exchanges, the first condition is undoubtedly satisfied, exchanges being, by definition, associations of member-brokers. As to the third condition, stock exchanges, through their decision-making bodies, have wide powers to discipline members and to make rules protecting investors. Whether the second condition would be satisfied in the absence of existing government regulation is, however, debatable.

In principle, stock exchanges have ample motivation to regulate their members. A failure to curb abuses by member-brokers would deter investors, reducing the volume of trading on an exchange, hence lowering all members' profits. However, brokers are a diverse group of rivals and, as such, will regulate themselves effectively only within a system of checks and balances that fairly harmonizes their conflicting interests. Given sufficient diversity in its makeup and sufficient emphasis on consensual decision-making, the governing body of a stock exchange could provide an adequate check on dishonest practice by powerful individual members of the exchange, or groups of members. There is, however, no evidence to confirm that such a pluralistic model accurately describes stock exchange governance in the real­ world.

Q1: The passage suggests that self-regulation would fail if which of the following were to occur in a stock exchange?

A) The volume of trading by investors decreased dramatically in a short period of time.
B) A particular small group of members within the governing body came to dominate that governing body.
C) Some member-brokers outside the governing body banded together to defend their common interests.
D) Investors' perceptions of the fairness of the market were based primarily on whether or not they had made a profit in that market.
E) Members were allowed to question the wisdom of decisions made by their governing.


Q2. According to the passage, which of the following will occur if, in the absence of government regulation, a stock exchange fails to curb abuses by its members?

A) Pressure will mount for government regulation of the market.
B) Certain groups of investors will become too influential.
C) The profits of most investors in the market will decrease.
D) Investors will be discouraged from investing in the market.
E) Conflicts among association members will increase
 

Q3. It can be inferred from the passage that the author believes which of the following about stock exchanges?

A) It is unclear that stock exchange governing bodies would fairly and effectively regulate exchange members' behavior in the absence of government regulation.
B) At present, dishonest practice by stockbrokers is too often overlooked by those responsible for regulating stock exchanges.
C) Current stock exchange governing bodies have been demonstrated to be inadequate for effective self-regulation.
D) The fairness of stock exchanges depends on close monitoring by investors of decisions made by stock exchange governing bodies.
E) Stock exchanges currently lack sufficient power to discipline members who behave dishonestly.­­­