This article describes the rise and fall of exchange trading floors on exchanges in both the stock and derivatives markets. The colorful “open outcry” trading in the “pits” of the Chicago futures exchanges and the bell ringing tradition opening trading on the floor of the New York Stock Exchange (“NYSE”) have long dominated the public perception of how those markets operate. Those scenes are now fast becoming history as the exchanges implement radical changes to their trading practices as the result of competition from electronic communications networks (“ECNs”). That competition has already forced the NYSE and the Chicago futures exchanges to demutalize, consolidate and reduce the role of their trading floors, while expanding their own electronic execution facilities.

The amazing growth of the ECNs and their displacement of the traditional exchanges has raised regulatory concerns. The Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”) have been struggling with this market transformation for nearly a decade. The CFTC initially tried to prevent virtually all non-exchange trading of derivatives. It then reversed itself and deregulated ECNs that provide execution services only to institutional investors. However, as the result of a number of problems in the energy markets, the CFTC is reversing course once again and is now seeking to regulate those institutional markets in much the same way that it regulates exchanges that service retail investors.

The SEC faces a larger issue. Its burdensome regulations are driving capital away from public markets such as the NYSE and Nasdaq and into ECNs, which are more lightly regulated. Many public companies are also opting out of the public markets by going private; institutional trading markets in unregistered securities are growing; and foreign issuers are rethinking the value of listing in regulated U.S. markets. The ECNs are also encouraging U.S. investors to invest abroad. As a result, the SEC and the CFTC are experiencing the effects of regulatory arbitrages as issuers and market participants flee the excessive regulation imposed in domestic markets.

This article describes the growth of the securities and commodity exchanges in the United States. It will show how their traditional trading floors became the center of market activity well into the last century, a dominance that was aided in no small measure by the monopoly positions allowed them by their regulators. The article traces the growth of electronic competition that undermined those monopolies through electronic matching of trades by algorithms and describes the responses of the exchanges to those electronic networks. The article then describes the regulatory challenges that these electronic markets are facing in an increasingly global economy and the responses of the CFTC and SEC to these developments.