There are three necessary prerequisites for effective self$-$regulation in any market: $1)$ there must be an association, $2)$ it must be motivated to regulate its members' behavior, $3)$ it must maintain sufficient powers of control for this purpose. In respect to stock exchanges, the first condition is undoubtedly satisfied, exchanges being, by definition, associations of member$-$brokers. As to the third condition, stock exchanges, through their decision$-$making bodies, have wide powers to discipline members and to make rules protecting investors. Whether the second condition would be satisfied in the absence of existing government regulation is$,$ however, debatable.

In principle, stock exchanges have ample motivation to regulate their members. A failure to curb abuses by member$-$brokers would deter investors, reducing the volume of trading on an exchange, hence lowering all members' profits. However, brokers are a diverse group of rivals and, as such, will regulate themselves effectively only within a system of checks and balances that fairly harmonizes their conflicting interests. Given sufficient diversity in its makeup and sufficient emphasis on consensual decision$-$making, the governing body of a stock exchange could provide an adequate check on dishonest practice by powerful individual members of the exchange, or groups of members. There is$,$ however, no evidence to confirm that such a pluralistic model accurately describes stock exchange governance in the real world.

The passage suggests that self$-$regulation would fail if which of the following were to occur in a stock exchange?

The volume of trading by investors decreased dramatically in a short period of time.

A particular small group of members within the governing body came to dominate that governing body.

Some member$-$brokers outside the governing body banded together to defend their common interests.

Investors' perceptions of the fairness of the market were based primarily on whether or not they had made a profit in that market.

Members were allowed to question the wisdom of decisions made by their governing body.

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