In 2000, Nasdaq demutualized and became a for-profit exchange.  A few years later, in 2006, the NYSE followed a similar path and also became a for profit exchange.  While technically still classified as SRO’s (self regulatory organizations), exchanges no longer perform many of their traditional regulatory roles.  That role was taken over by FINRA in 2007 (the NASD and the member regulation, enforcement and arbitration functions of the New York Stock Exchange were consolidated into FINRA).

However, for some reason, exchanges are still afforded legal protections under their SRO status.  And according to a Bloomberg article , these SRO protections are likely to save Nasdaq a lot of money with the Facebook fiasco.

 “Rules that are specific to the unique regulatory roles played by exchanges may well insulate Nasdaq from facing the consequences of significant damages”, according to Neal Wolkoff.

So that’s why Greifeld was relaxing in business class thirty minutes after the Facebook opening.  Nasdaq knew it had limited liability.

The article further states:

“Curbs on SRO liability were developed to keep the member-firm owners of an exchange from having to pay another broker for losses caused by technical breakdowns”, according to George T. Simon, a partner at Foley & Lardner LLP and former associate director in the SEC’s division of market regulation.   “Today, since none of the exchanges are member-owned, one could argue that the premise behind the limited liability is no longer relevant”, Simon said. “On the other hand, these rules are still in effect and courts, except in cases of real abuse, have honored them.””

Let’s think about the exchange model.  Exchanges compete ferociously with one another so that they can produce bottom line profits for their investors.  To produce these profits, they offer services to their best clients such as colocation, the sale of enhanced private data feeds and the introduction of conflicted order types.  All the while, they know they have limited liability when it comes to lawsuits if they screw up.

For-profit exchanges essentially have a free put option.  If the exchanges want to be for-profit, then its time this free put option is removed.  Maybe then they will start acting in a more responsible way.