With the uncertainty of the US election behind us, it is time for regulators of financial markets to get serious about preventing market malfunctions, from out-of-control algorithms to initial public offerings marred by technology breakdowns.

To some wary investors, these incidents show that the markets are unstable, unreliable and tilted against them. Given the extraordinary complexity of today’s fast equities markets and the speed of technological change, there is no single solution. A logical place to start is a fresh approach to the regulation of US stock exchanges.

For the past two decades, the Securities and Exchange Commission (SEC) has overseen exchanges by inspecting them occasionally and urging them, voluntarily, to examine themselves, file annual reports, and notify the agency of planned technology changes and significant system outages. In the past year, the SEC has also charged two exchanges, Direct Edge and the New York Stock Exchange (NYSE), with unintentional rule violations, and may be investigating cases against others.

The SEC has highlighted these enforcement actions as proof that it is getting tough on exchanges. In fact, the actions reveal regulatory failures. If Direct Edge had weak internal controls that caused a significant glitch in November 2010, as the SEC alleged, why did the commission grant it a licence to operate as an exchange just four months earlier?

If the NYSE allegedly failed to comply with an SEC market-data rule beginning in 2008, wouldn’t it have been better for commission examiners to detect the problem and direct the exchange to fix it immediately, rather than for SEC enforcement lawyers to bring a case four years later?

Instead of signalling a need for more enforcement actions, which by definition look backward, recent market failures show that the SEC needs to do much more to prevent problems before they occur.

The agency should take a cue from another federal regulator that places the highest priority on prevention: the Nuclear Regulatory Commission (NRC). This agency has achieved impressive results through a regulatory regime that includes continuous inspection of all 104 operating US nuclear plants.

Adapting this framework to the SEC’s regulation of stock exchanges would be feasible and much more effective than its hindsight-oriented approach. Here’s why:

Resources would be used more efficiently. Continuous oversight may require more resources than selective examinations, but not much. SEC technical expertise would also improve.

Exchanges would have better incentives. In a less enforcement-focused regulatory climate, exchanges would be more open to sharing new ideas with and reporting problems to SEC staff. And if the commission could shut them down immediately for serious failings, exchanges would protect against such a disaster.

Investors would be better protected. Selective enforcement action can leave the public unprotected and place some exchanges at an unfair competitive disadvantage, if others have similar problems unaddressed by the SEC.

Granted, nuclear accidents are potentially far more catastrophic than even the most serious stock-exchange malfunctions. But the NRC’s regulatory philosophy is just what the SEC needs to prevent the next stock market meltdown. – Bloomberg

David Kornblau, a partner in the New York office of Covington & Burling, was the chief litigation counsel for the SEC’s enforcement division.