The Self-Regulation of Enforcement: Evidence from Investor-Broker Disputes at NASD

This paper investigates whether allocating more control rights to industry groups in customer-firm enforcement proceedings (i.e., the self-regulation of enforcement) leads to greater industry bias and expertise in enforcement. The approach used in this paper focuses on a particular way that bias and expertise can arise in enforcement: through the selection of adjudicators to enforcement panels. Using novel data on customer-firm enforcement run by a specific self-regulatory organization (the National Association of Securities Dealers (NASD)), I document that pro-industry arbitrators are selected to arbitration panels more often than pro-investor ones (selection on bias) and that experts are selected more frequently to cases (selection on expertise). To assess whether the NASD is responsible for these patterns, I examine the impact of a change in regulation that moved much of the control rights over arbitrator selection from the NASD to investors and brokers jointly. Following this change, the allocation of expertise to cases declined dramatically while selection on bias increased. These findings suggest that the NASD is not responsible for selection on bias but that it increases selection on expertise. Thus, I do not find support of industry favoritism at the NASD and find evidence that it adds expertise to enforcement. Moreover, these results suggest that alternative control structures commonly used in enforcement have important drawbacks (e.g., jury selection mechanisms). The extent to which these findings are robust and generalizable is discussed in this paper as well.