Cornell Law Review


According to statute, securities exchanges play an essential role in ensuring compliance with applicable laws and industry standards. Long imagined as unique in their institutional capacity to bring traders together, collect information and exclude problem participants from the marketplace, exchanges have offered an efficient source of private discipline for public regulators. The classic conception of the exchange, however, no longer holds true in today's markets. Rather than concentrate activity within a handful of exchanges, equity markets are fragmented across a network of thirteen exchanges and around forty lightly regulated, off-exchange alternative venues (colloquially, "dark pools"). This Article shows that the goal of exchange oversight is rendered unachievable in fragmented markets. First, exchanges no longer constitute the central forums for convening traders, who now enjoy enormous choice regarding where and how to trade. Fragmentation also increases the costs of performing oversight and reduces its effectiveness. Exchanges must work harder to collect information across multiple exchanges and dark pools. Tough enforcement can result in lost business. And the power to exclude traders from the exchange is weak where traders can move fluidly to other venues. Secondly, exchanges have incentives to underinvest in oversight. They reap private gains by winning business, but share the risks of losses with competitor exchanges and dark pools. This Article proposes a structural solution to motivate stronger surveillance, outlining a new liability regime for exchanges and dark pools. Liability aligns the incentives of trading venues toward delivering oversight. In so doing, it helps recapture the benefits of consolidation, while maintaining competition in market structure.