PREAMBLE

The Council of Securities Regulators of the Americas ("COSRA") strongly believes that securities markets, as well as futures and commodity options ("futures") markets, are important national assets essential to economic growth and prosperity. Because of the central role these markets play in the efficient allocation of the region's capital resources, the integrity of these markets is a matter of public interest. Investors will seek out markets they perceive as fair, honest, and orderly. Therefore, regulators^/ should strive to make the region's securities and futures markets fair, honest, and orderly through the regulation of sales practices, prohibitions against fraudulent and manipulative conduct, the promotion of ethical business conduct, establishment of high standards for market intermediaries, and vigorous enforcement of governing laws, regulations, and rules. Countries that do not have prohibitions against fraudulent, manipulative, and improper conduct risk becoming havens for illegal activities. Market abuses result in less efficient markets, higher transactional and systemic costs, losses to investors, and most important, the absence from those markets of individuals and institutional investors who consider market integrity to be an essential market characteristic.

COSRA members agree that an effective market oversight program promotes investor confidence and provides the foundation for fair, honest, and orderly markets. In this regard, COSRA members agree that effective oversight requires the following three components:

• a mechanism for guiding the development and enhancement of fair, honest, and orderly markets, and for imposing responsibility and accountability on market operators and market intermediaries;^/

• a mechanism for monitoring compliance with laws governing securities and futures transactions and applicable regulatory and self-regulatory organization rules; and

• an effective system for enforcing laws, regulations, and self-regulatory organization rules governing the operation of these markets.

These components should be emphasized in the development and enhancement of the region's market oversight systems. COSRA members strongly believe that countries currently without government oversight of markets should consider the creation of a government authority to protect the public interest. As markets advance economically and become more complex, the government authority may find it necessary to impose greater levels of responsibility on market operators and market intermediaries. Self-regulation, subject to appropriate government oversight, can provide an effective means for overseeing the activities of market intermediaries and market operators. In a system of self-regulation, industry practitioners -- such as market intermediaries and market operators -- develop, implement, and enforce rules that govern their activities. Self-regulation conserves government resources and encourages the development of beneficial and workable rules in the industry. It offers greater flexibility in resolving complex problems than direct government intervention. In countries where no self-regulatory organizations exist, consideration should be given to the establishment of such organizations. Government oversight of self-regulatory organizations, however, is critical to guard against the potential conflicts between industry self-interest and the public interest.

Countries have taken various approaches when developing a market oversight system, ranging from an oversight system operated solely by associations comprised of industry participants to one operated and maintained solely by the government. After considering the various approaches, COSRA members share the view that the following principles provide an effective balance between public and industry interests, and incorporate the essential components described above. These principles can be combined with previous COSRA principles on transparency and audit trails to provide the foundation for an effective regulatory framework.

I. AUTHORIZATION, RESPONSIBILITY, AND ACCOUNTABILITY

1. Market operators and market intermediaries should be required to receive authorization from the government authority before they may lawfully engage in the securities or futures business. The government authority should impose appropriate conditions before granting such authorization, such as an obligation to comply with applicable laws, regulations, and rules, and demonstration of the absence of past misconduct.

By requiring authorization for a market operator or market intermediary to conduct its business, the government authority can control entry into the securities and futures businesses and can impose conditions on those seeking to engage in those businesses. Part of this authorization process should include mechanisms to obtain assurances that market intermediaries and market operators have proper operational and other qualifications. For example, the government authority may wish to impose capital requirements on market intermediaries, or it may wish to require market operators to adopt standards of conduct for those seeking to use the markets to trade. Other conditions for authorization may include: licensing requirements for individuals, including educational requirements; preparation and preservation of certain records, such as customer account information or audit trails; and limitations of the types of business in which the authorized entity may engage.

Therefore, through the authorization process, the government authority retains an important enforcement tool: the ability to prohibit or place restrictions upon the operations of a market operator or market intermediary. Moreover, the risk that the government authority may revoke its authorization provides a powerful incentive for market operators and market intermediaries to comply with applicable laws. The authorization process also can act as a screening device to keep repeat offenders from engaging in the securities or futures business.

2. The goal of an effective market oversight system is fair, honest, and orderly markets. To achieve this goal, a regulatory system requires a mechanism for imposing responsibility and accountability on market operators and market intermediaries.

With an effective market oversight system, no market operator or market intermediary should be permitted to engage in unfair, dishonest, or disorderly practices. In such a system, market operators and market intermediaries should be obligated to establish policies and procedures designed to prevent fraudulent or manipulative trading in the market and should assess periodically whether such policies and procedures are functioning as intended. Failure to implement such policies and procedures should result in sanctions from any relevant self-regulatory organization authorized by a government authority and/or by the government authority.

3. The government authority should consider creating a regulatory system where market operators or market intermediaries exercise direct oversight responsibility over their respective areas of competence, subject to appropriate government supervision, and to the extent appropriate to the size and complexity of the markets.

As markets expand, government authorities should consider allowing market operators or market intermediaries to exercise oversight responsibility, i.e., a system of self-regulation under the oversight of the government authority. In this manner, government authorities can more efficiently use limited resources and create a network of shared responsibility throughout the industry.

There are a number of advantages to shared responsibility between market intermediaries, market operators, and the government authority. First, when market intermediaries participate in promoting markets through self-regulation, they are more likely to comply with the rules that are imposed. Second, market intermediaries offer considerable depth and expertise regarding market operations and practices, and may be able to respond more quickly and flexibly than the government authority to changing market conditions. Third, market intermediaries and market operators should be highly motivated to develop cost-effective, workable regulations. Fourth, market intermediaries and market operators can establish high standards of business practice and ethics that surpass legal standards. With industry cooperation and assistance, the government authority can achieve its goals of protecting investors from fraud and manipulation, and maintaining fair, honest, and orderly markets. This structure also may have the benefit of encouraging innovation.

The concept of self-regulation, however, does not imply that the government authority can or should abdicate responsibility for oversight of the operation of the self- regulatory system. Indeed, all those involved in the self- regulatory system should ensure that conflicts of interest between self-regulatory organizations, their members and the public, as well as other potentially anti-competitive behavior, be avoided and, where they arise, be affirmatively redressed.

A system of shared oversight responsibility can be pictured as a pyramid. The bottom tier is comprised of market intermediaries, which are members of the self-regulatory organization and must meet established standards to join the organization. The second tier consists of self-regulatory organizations, which include exchanges and other market operators. At the top of the pyramid, oversight authority converges in the government authority, which is responsible for the entire oversight system.

In such a system, the first level of oversight is conducted by the market intermediaries. These entities are responsible for training and educating their employees about applicable laws, regulations, and self-regulatory organization rules, and for supervising their activities. At the next level, self-regulatory organizations should be given the legal obligation to oversee daily trading activity, and oversee and enforce standards of conduct and financial integrity, including capital if appropriate by market intermediaries. In enforcing standards of conduct by market intermediaries, self-regulatory organizations may find it useful to establish a membership structure. This allows the self-regulatory organization to protect the integrity of the organization by adopting standards that regulate member conduct, while at the same time permitting fair and open access to the organization. The self-regulatory organizations also should be legally obligated to cooperate with and assist the government authority in investigating and enforcing applicable laws and regulations. The government authority has ultimate responsibility for the fair and effective operation of this oversight system.

Consequently, if the market operator is granted oversight responsibility and authority, the market operator should be responsible for the oversight and regulation of the conduct of market intermediaries within its jurisdiction. The market intermediary, in turn, should be required to comply with the rules and mechanisms a market operator imposes to address fraud or manipulation.

The market intermediary should be held accountable for the actions of its individual employees. For example, if the market intermediary or its management fails to adequately supervise an employee who engages in an illegal or improper activity, both the market intermediary and its management may be held responsible for this failure. Imposing these responsibilities creates an incentive for market operators and market intermediaries to provide adequate training and supervision of their work force. The widespread distribution of responsibility for market integrity among market intermediaries and market operators increases the opportunities to detect and deter fraudulent and illegal conduct.

4. As part of the establishment of a mechanism for guiding the development and enhancement of fair, honest, and orderly markets, the government authority should require a self-regulatory organization to meet appropriate conditions before allowing the organization to exercise its authority. Moreover, once the self-regulatory organization is operating, the government authority should assure itself that the exercise of this power results in fair and consistent enforcement of applicable securities and futures laws, regulations, and appropriate self-regulatory organization rules.

As a condition to authorization, the government authority might consider requiring the self-regulatory organization to:

• promote the public interest;

• have the capacity to carry out the purposes of governing laws, regulations, and self-regulatory organization rules, and to enforce compliance by its members and persons associated with its members with those laws, regulations, and rules;

• treat all members of the self-regulatory organization or applicants for membership in a fair and consistent manner;

• develop rules that are designed to prevent fraudulent and manipulative practices, to promote just and equitable principles of trade, to provide supervision and maintenance of fair, honest, and orderly markets, and to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in, financial instruments, including the transfer of ownership of financial instruments;

• Submit to the government authority its rules for review and/or approval as the government authority deems appropriate, and ensure that the rules of the self-regulatory organization are consistent with the public policy directives established by the government authority;

• cooperate with the government authority and other self-regulatory organizations to investigate and enforce applicable laws and regulations;

• enforce its own rules and impose appropriate sanctions for non-compliance;

• assure a fair representation of members in selection of its directors and administration of its affairs;

• avoid rules that impose any unnecessary burden on competition;

• avoid acting out of self-interest; and

• avoid using the oversight role to allow any market participant unfairly to gain advantage in the market.

5. The government authority and/or self-regulatory organization should develop enforceable standards including standards of business conduct for market intermediaries, based on high standards of commercial honor, and just and equitable principles of trade, and standards of financial integrity.

Standards for market intermediaries, adopted by the government authority, market intermediaries and/or the industry, provide the underpinnings for an effective market oversight system and a basis for evaluating market practices.

The International Organization of Securities Commissions ("IOSCO") has established seven principles of business conduct, which are illustrative of the concepts such standards might contain. These principles essentially reflect sound business practices, which foster market integrity and investor confidence.

• In conducting its business activities, market intermediaries should act honestly and fairly in the best interests of their customers and the integrity of the market;

• In conducting its business activities, market intermediaries should act with due skill, care, and diligence in the best interests of their customers and the integrity of the market;

• Market intermediaries should have and employ the resources and procedures which are needed for proper performance of their business activities;

• Market intermediaries should seek from their customers information about their financial situation, investment experience, and investment objectives relevant to the services to be provided;

• Market intermediaries should make adequate disclosure of relevant material information in their dealings with their customers;

• Market intermediaries should try to avoid conflicts of interest, and when they cannot be avoided, should ensure that their customers are fairly treated; and

• Market intermediaries should comply with all regulatory requirements applicable to the conduct of business activities so as to promote the best interests of customers and the integrity of the market.

6. Where a government authority allows market operators or market intermediaries to exercise oversight authority in a system of self-regulation, the government authority should retain direct authority over all market operators and market intermediaries, to be exercised at its discretion.

If the government authority allows a self-regulatory organization to exercise oversight responsibilities, it should remain the primary market overseer. It is important to do so should there appear to be a breakdown in the self-regulatory system. In addition, the government authority should retain the power to direct, when necessary, self-regulatory organizations toward more effective oversight and fairer operations. The government authority should:

• provide the public policy directives that guide markets and market intermediaries in the development of a strong oversight program;

• review periodically the quality of the self-regulatory organization's performance;

• assure itself that oversight authority is in fact used to perform regulatory duties and not to provide an unfair advantage to segments of the market;

• establish a mechanism for reviewing and/or approving the rules of self-regulatory organizations and, in accordance with applicable procedures, for abrogating rules that are not consistent with the government authority's policies;

• prohibit the activities of self-regulatory organizations when their activities fail to promote the public interest or reflect biases against certain market participants;

• facilitate the development of a consistent approach to market issues when numerous self-regulatory organizations operate within the government authority's jurisdiction;

• act as an independent decisionmaker when two or more market participants have conflicting interests, the resolution of which is within the jurisdiction of the government authority;

• require swift and full cooperation by self-regulatory organizations and market intermediaries to facilitate effective enforcement of applicable laws, regulations, and self-regulatory organization rules;

• assure fair processes to members of self-regulatory organizations; and

• enforce compliance by market operators, market intermediaries, and their employees with applicable laws and regulations.

In view of the authority of a self-regulatory organization to sanction and take other action against its members and deny applications for membership, the government authority should provide a mechanism for market intermediaries to appeal decisions of self-regulatory organizations to the government authority.

II. MONITORING FOR COMPLIANCE

7. An effective market oversight system must have a mechanism for monitoring compliance with laws, regulations, and self-regulatory organization rules.

Monitoring compliance with relevant laws, regulations, and self-regulatory organization rules essentially involves three major elements: (1) monitoring the day-to-day trading activity in the markets; (2) monitoring the conduct of market intermediaries; and (3) collecting and analyzing information gathered from these activities.

An effective market surveillance program allows the regulator to discover patterns or market conditions indicative of infractions of securities and futures laws and regulations, or self-regulatory organization rules. The regulator should adapt its market surveillance techniques to the marketplace and optimize its human and technological resources. Many regulators rely on automated stock watch programs or audit trails (i.e., automated, time-sequenced records of trades) to detect deviations from normal price and volume movements. In 1993, COSRA adopted principles on audit trails, where members agreed that authorities should design audit trail systems to monitor market activities. Activities commonly detected through these surveillance methods include such forms of prohibited or improper conduct as insider trading (trading while in possession of material, nonpublic information) and frontrunning (transactions by an intermediary to take advantage of nonpublic information about other prospective transactions).

In addition, regulators should conduct examinations of market intermediaries, which center on compliance with financial responsibility and sales practices. One essential component of this form of oversight involves the requirement that market intermediaries make and maintain detailed records of their business operation, and provide those records to the regulator upon request. To monitor compliance with financial responsibility requirements, the regulator must have access to and periodically review the records and accounts of market intermediaries. In this way, it can assure itself that market intermediaries maintain good systems of internal control, operate with sufficient capital, and safeguard customer funds and securities, among other requirements. To monitor sales practices, the market intermediary's customer accounts are reviewed for instances of unauthorized trading, unsuitable transactions, excessive trading, and other abusive sales practices.

If the self-regulatory organization operates market surveillance and examination programs, the government authority must verify the integrity of the oversight system by inspecting the self-regulatory organization to determine whether it is effectively carrying out its duties. For example, if the self-regulatory organization conducts examinations of market intermediaries, the government authority should evaluate the results of particular examinations, perhaps by conducting its own examinations.

III. ENFORCEMENT

8. An effective market oversight system requires a strong enforcement program. An enforcement program safeguards the integrity of the marketplace by deterring market participants from violating laws, regulations, and self-regulatory organization rules, by providing an effective mechanism for compliance, and by enhancing investor confidence in the integrity of the markets and market intermediaries.

If a government authority allows market operators and market intermediaries to exercise oversight authority, each entity must have a stake in promoting compliance with applicable laws, regulations, and self-regulatory organization rules. The government authority must have the authority to sanction self-regulatory organizations and market intermediaries for failing to perform their supervisory roles. By making market operators and market intermediaries fully accountable for market integrity, regulators can strengthen and preserve the markets.

An effective enforcement program requires the government authority to have adequate resources and a range of disciplinary tools at its disposal. Such a program should include trained investigators to investigate allegations of violations and pursue appropriate sanctions. These investigators should have broad powers to obtain information from anyone in the regulator's jurisdiction, subject to fairness requirements. The major areas of enforcement for the government authority or the self-regulatory organization include investigation and prosecution of fraudulent, manipulative, and other illegal forms of conduct.

Government regulators should be able to sanction self-regulatory organizations that fail to perform their regulatory responsibilities. Non-exclusive alternative sanctions that may be available to the government authority include the following:

(1) censure of the self-regulatory organization;

(2) monetary sanctions;

(3) remedial measures, including requirements for independent reviews or monitors;

(4) limitations on activity;

(5) require the self-regulatory organization to make special reports to the government authority; and

(6) suspension or revocation of authorization to act as a self-regulatory organization.

Government authorities and self-regulatory organizations also should have a wide array of remedies to address improper conduct by market intermediaries. To assure compliance with government and self-regulatory organization requirements, sanctions should be imposed on market intermediaries for non-compliance.

• Regulatory Sanctions: Non-exclusive alternatives that may be available to the government authority in order to achieve compliance include:

(1) censure of a market intermediary;

(2) monetary sanctions;

(3) disqualifications from serving in certain capacities in the markets;

(4) suspension, limitation on activity, cessation of trading, or revocation of registration;

(5) remedial measures, including requirements for independent reviews or monitors; and

(6) proscriptions against further non-compliance.

• Criminal Sanctions: In appropriate cases, criminal sanctions may be imposed by the appropriate authority for non-compliance, including monetary penalties and imprisonment.

• Sanctions Imposed by Self-Regulatory Organizations: The self-regulatory organization can employ a range of sanctions, in addition to those available to the government authority. For example, self-regulatory organizations should be able to suspend, expel, or fine members who violate relevant laws, regulations, and self-regulatory organization rules.

• Enforcement by Private Parties: Investors may be provided with rights of redress to seek compensation for damages suffered as a result of non-compliance with fundamental investor protection provisions.

As a supplement to the regulator's enforcement efforts, the government authority should encourage the implementation of programs for resolving customer/market intermediary disputes in a swift and efficient manner.