There are three necessary prerequisites for effective self-regulation

Question

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.    1 
 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.

2 
 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
 
 3 
 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.

Sajjad1994 · Answer

Explanation

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

Explanation

A)  is mentioned in the passage as a potential consequence of a failure to curb abuses by member-brokers. A decrease in trading volume would deter investors and lower profits for all members, supporting the motivation for self-regulation. Therefore, this option is not a reason for self-regulation to fail.

B)   aligns with the passage's emphasis on diversity and checks and balances within the governing body. If a small group dominates, it could disrupt the balance and potentially lead to a failure of self-regulation. This is a plausible reason for self-regulation to fail.

C)  The passage suggests that brokers will regulate themselves effectively within a system of checks and balances. If member-brokers outside the governing body band together to defend their common interests, it does not necessarily imply a failure of self-regulation.

D)  is not directly discussed in the passage as a factor influencing self-regulation. It relates more to investor perceptions rather than the internal dynamics of self-regulation within the stock exchange.

E)  aligns with the concept of consensual decision-making and checks and balances mentioned in the passage. Allowing members to question decisions may contribute to a system that harmonizes conflicting interests, supporting effective self-regulation.

Answer: B

akashgu0611 · Answer

For Q2, why not option C correct. I understand that D is correct, but why not C also as that is also mentioned in text.

Priyanshi06 · Answer

Hey,
It is mentioned in the passage that "A failure to curb abuses by member-brokers would deter investors, reducing the volume of trading on an exchange, hence lowering all  members'  profits." On the other hand, option C talks about investors' profit. In the passage, it is nowhere mentioned that investors' profit will be low if there is a failure to check abuses by member-brokers.

I hope this makes sense.

AvinashSh · Answer

C is a consequence of what D does. So its a secondary/indirect effect of the action. When we focus on finding the function/ role/ effect of a given action or event > we can focus on the first immediate effect. 
So here as well : The investors get discourage from investing > which causes X, hence lowering Y

Azakura16 · Answer

The first paragraph discusses the three necessary prerequisites for effective self-regulation in any market. It then cedes that stock exchanges meet the first (they’re an association of member-brokers) and the third (they have wide powers to discipline members and make rules). 
The second paragraph discusses the second necessary prerequisite. While it’s theoretically true that stock exchanges are motivated to regulate members’ behavior, even in the absence of government regulation, in practice, the author is dubious. They claim that the brokers are a diverse group of rivals, and will only effectively regulate themselves in a system of checks and balances that accounts for their conflicting interests. If the governing body of the exchange were diverse enough and focused adequately on consensual decision-making, they could provide such a check on sketchy practices and members. The author then concludes that there is no evidence this ideal governing situation is being met in real world exchanges.

Q1: The passage suggests that self-regulation would fail if which of the following were to occur in a stock exchange?
A. Not addressed.
B. This could cause failure, as it would not meet the diversity requirement of the ideal governing body.
C. This should be controlled for by the three prerequisites, so it’s not a concern.
D. Out of scope of the passage.
E. The passage certainly does not suggest that the governing body should be above question.
Best answer is B.

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?
P2, S2: A failure to curb abuses by member-brokers would deter investors, reducing the volume of trading on an exchange, hence lowering all members' profits.
Best answer is D.

Q3. It can be inferred from the passage that the author believes which of the following about stock exchanges?
A. This is basically paraphrasing the final sentence of P1. 
B. This is a bit of an overstatement of the author’s opinion.
C. This is an overstatement as well. The author suspects that governing bodies might be inadequate, but their inadequacy hasn’t been  demonstrated . 
D. This isn’t supported. The author calls for governing body oversight of the exchange, not oversight of the governing body by the investors. 
E. The author directly disagrees with this assertion in P1, S3
Best answer is A.

GMATtest5566 · Answer

My understanding is that C says "The profits of most investors ..."

Referring back to the passage, the result is that all members' profits are lowered. C is saying something slightly different from what the passage is saying. Therefore I chose D in the end.

Basically a game of spot the difference

akashgu0611

For Q2, why not option C correct. I understand that D is correct, but why not C also as that is also mentioned in text.

anchitahuja · Answer

I believe "most investors" will be a subset of "all members" . So not sure why C is incorrect in this case. Can someone explain ?  GMATNinja   karishma

GMATNinja · Answer

As mentioned by a few others earlier in the thread, "members" and "investors" are not the same in this case. The passage specifically tells us that exchanges are “associations of  member-brokers “ (the brokers are the members).

And that makes sense. For example, you don't have to be a  member  of the New York Stock Exchange to be an  investor  in the New York Stock Exchange (anyone can invest). So it's possible that (C) is not true even if all members' profits are lowered.

(D) is a better choice.

VerbalBot · Answer

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There are three necessary prerequisites for effective self-regulation

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