finra

Remarks by Robert R. Glauber

Chairman and CEO

NASD Fall Securities Conference Speech
Rancho Mirage, California

October 15, 2004

 

Good morning. As we're nearing the end of the conference, I suspect your thoughts are starting to drift away from variable annuities and mutual funds and toward golf and Mediterranean mud wraps. So, I really do appreciate your being here this morning.

 

I have three specific topics I want to talk to you about today. The first is NASD's Mutual Fund Task Force, whose formation I announced at our Spring Securities Conference last May in Baltimore. The Task Force is not quite finished with its deliberations, but I think I can tell you about some of its expected recommendations without getting into trouble.

 

The second topic is our Corporate Debt Market Panel, which has finished its work and has made some recommendations about how to disseminate more and better information about corporate bond pricing. It turns out that corporate bonds aren't just for institutional investors anymore.

 

And the third subject is our role in regulating 529 college-savings plans - a role that I think needs some adjustment.

 

Before I get to those, though, I want to give you a brief rundown on the current state of NASD. We're a somewhat different organization from the NASD of a few years ago, and I want to bring you up-to-date on some changes we've made.

 

A few years ago, we began the process of reconfiguring ourselves as a pure private-sector regulator, unencumbered by the responsibilities - and the inherent conflicts - of owning and operating markets. That process entails, in large part, our spinning off Nasdaq and Amex. We have reached agreements to separate from both of them - by setting up Nasdaq as a separate registered exchange and selling our remaining ownership interest to the public and by transferring Amex to its seat-holders. We're waiting for the SEC to sign off on both those deals and hope those approvals will come soon.

 

We'll continue to regulate them both under contract, but we won't own them. This alignment allows us to focus all our time and resources on our regulatory mission of protecting investors and upholding market integrity.

 

The decision to structurally separate NASD from these two markets and recast it solely as a regulator has also allowed us to move ahead and become the regulator of other exchanges - ones that we also regulate under contract. These are the International Securities Exchange, the International Financial Futures and Options Exchange, or LIFFE, and the Chicago Climate Exchange.

 

Our realignment has also entailed a change in the composition of our Board of Governors, which has gone from being dominated by securities industry representatives to having a majority of members who are not affiliated with the industry. It goes without saying that the industry needs to be well-represented on the board of an industry regulator.

 

But, given that our mission is, first and foremost, to protect investors, it is critical that the public's interests are well-represented, too.

 

Now let me talk briefly about how we've acted as a regulator. I doubt anyone in this room has failed to notice that NASD has been more forceful and aggressive in carrying out its regulatory mission. Events have very much shaped our behavior.

 

The industry's conduct abuses of the late '90s - such as IPO misallocations, corrupted analyst research reports, mutual fund market timing and late trading, as well as the Enron and WorldCom corporate governance debacles - most of which came to light after the bubble burst in 2000, created an environment that naturally engenders more and tougher regulation.

 

This is nothing new. Throughout history, whenever a market bubble has inflated, abuses have followed. And when the bubble collapses, as they always do, there follows a period of intense scrutiny and the pendulum swings back toward increased regulation.

 

This go-round is no different. We have substantially ramped up our enforcement and rule-making efforts over mutual funds, variable annuities, new product sales, the so-called retailization of hedge funds and other areas where mainstream investors are the target audience.

 

I know that, for the securities industry, increased regulation means more burden, costs and intrusion. While we must meet our mandate as an effective regulator, we must do our regulatory job without needless intrusion or burden. We should strive to make our rules clear and coherent, so the industry fully understands our expectations. Then we should enforce them rigorously and consistently. And we should and do regularly review our existing rules with the intent of simplifying them and, where appropriate, eliminating those that are out-of-date.

 

It doesn't end there. We are also committed to helping brokers and firms choose the right path by giving them the tools and resources they need to understand and comply with our rules and avoid run-ins with us.

 

One of those resources that you may be familiar with is the NASD Report Center, a secure website where firms can get current data and reports to help them with their compliance activities and nip problems in the bud, before they get out of hand.

 

We have broadened all our education and training programs for industry professionals. We have, for example, launched a series of compliance conferences for small firms. In the last month, we've held a Small Firm Best Practices Conference in Chicago and a Fixed Income Conference in New York. Supervision and compliance issues were high on the agenda of both those events. And there are more like them to come.

 

We hold seminars for brokers and advisers on a regular basis in several locations around the country. And our 14 District Offices conduct a regular series of smaller preventive compliance conferences for brokers and dealers. You can find information about these offerings on our website or by calling your local District Office.

 

And we have on the drawing board several additional tools aimed specifically at making compliance easier.

I should add that in all these efforts, we are well served by the wise counsel of experts throughout the securities industry, including some of you here.

 

I think I've digressed enough, so let me get back to the topics at hand.

 

By the end of this month, we expect to release the first report of our 20-member Mutual Fund Task Force, which convened last Spring to look for ways to bring greater transparency to mutual fund costs and distribution arrangements. This first of two reports deals with fund portfolio transaction costs, including soft dollars and disclosure issues.

 

Since it's not out yet, I can't talk about it in detail - and I'm not sure you'd want me to anyway. But I think I can safely tell you that the Task Force will strongly recommend that the "safe harbor" provision of the Exchange Act be preserved for third-party research as well as that provided directly by the executing broker-dealer.

 

That means the freedom of investment advisers to pay more than the lowest available commission rates for research should be maintained. It also means that there should be no disincentive to use research that comes from an independent source and, thus, the best research regardless of the source.

 

I think it's also safe to tell you that the Task Force will recommend that the SEC clarify and more narrowly tailor the safe harbor provision. Primarily, it will say that safe harbor protection should apply only to the intellectual content of research, as opposed to the means by which that content is provided. This should restrict the safe harbor to services for the benefit of clients, not their advisers.

 

These strike me as reasonable steps forward. Third-party research is a valuable asset for investment advisers and should not be discriminated against compared with research provided directly by executing broker-dealers. And when soft dollars are used, they should pay for research ideas, not physical equipment.

 

Whatever else the Task Force recommends, those are the salient points, and I don't think you will find them objectionable. As I said, this report is the first of two.

 

The second, which is some months away, will focus on distribution arrangements, including 12b-1 fees and revenue sharing.

The Task Force consists predominantly of industry representatives with expertise in broker-dealer and mutual fund issues. If you want to find out who they are - there are 20 of them - you can easily do so by looking on our website.

 

While the Task Force was deliberating about mutual funds, another group of experts was scrutinizing the corporate debt market with a similar goal in mind - recommending ways of making that market more transparent and comprehensible to mainstream investors.

 

I'm happy to say that this group, which we call the Corporate Debt Market Panel, has finished its work and released its findings on September 30, so there are no impediments to my talking about what they've recommended.

 

And what they've recommended is simple and straight-forward: a concerted effort should be made to educate and inform individual investors about corporate bonds - an effort that includes giving those investors clear and concise information before they buy bonds and again at the time of purchase; an effort that includes increased alerts concerning trading costs on post-trade confirmations; and an effort that includes wider distribution of bond trade information through various channels, including the media.

 

The need for this level of outreach couldn't be clearer. Today, retail investors are responsible for about two-thirds of corporate bond transactions. Yet those investors, by and large, know very little about the corporate bond market. An investor survey we sponsored last year showed, for example, that 60 percent of people who characterize themselves as at least occasional investors do not understand the most basic principle of bond behavior - that bond prices fall as interest rates rise. Almost 30 percent don't understand exactly what a bond investment is - a loan to the issuer.

 

Another survey this year showed that about 35 percent of investors who had invested directly in corporate bonds thought they paid the dealer nothing for making the trade.

 

These are alarming statistics. With the baby-boom generation approaching retirement age, the ranks of individual investors with a stake in the bond market will only grow. Consequently, it is incumbent on all of us to see that retail investors can enter this market with the same level of confidence, knowledge and access to information they have when they participate in the equity markets.

 

When I say "all of us," I mean to include the regulators. And here, NASD is leading the way. At the first of this month, our Trade Reporting and Compliance Engine, or TRACE, began providing price and other data on most corporate bond transactions within 30 minutes of execution. That's about 17,000 bonds, from investment grade to high-yield, and the number grows all the time. That represents substantial progress since TRACE's inception in July 2002, when it disseminated trade data on only about 550 bonds - investment-grade only - and took as long as 75 minutes to do so.

 

We'll further refine TRACE early next year by increasing reporting to cover virtually the entire corporate bond universe - some 23,000 bonds - and narrowing the reporting window to 15 minutes.

 

We have referred the Corporate Debt Market Panel's report to the appropriate staff and committees within NASD and we will keep you posted on developments.

 

I want to leave you with some thoughts about 529 college savings plans. I know Mary Schapiro spoke to you in some length about these yesterday morning, but there's an additional point I'd like to make. And I'll make it briefly, because I want to leave plenty of time for your questions.

 

I'm sure you've all heard the expression: if it walks like a duck and quacks like a duck, then it's probably a duck. Well, I think few would dispute the premise that 529s walk and quack very much like mutual funds. When an investor buys a 529, he or she is, in fact, buying into a mutual fund to which has been added a complex series of tax benefits.

 

Yet, the authority for making rules governing 529 sales practices belongs to the Municipal Securities Rulemaking Board - the MSRB -- while the authority for making rules governing mutual fund sales practices belongs to NASD.

 

That leads to situations such as this: we have asked the SEC to approve a requirement that brokers provide mutual fund investors with a one-page document briefly summarizing in plain English the basic facts investors need to know - what they pay - front-end load, 12b-1 fee, fund expenses and management fee - and what the broker receives - commission payments both up-front and over time, revenue sharing payments, and so forth.

 

I know the wisdom of this is not universally accepted and I can even hear some of you groaning right now, but that's a debate for another time.

 

The problem I'm concerned about is that if the SEC approves this proposal, the rule will apply to all mutual funds - except those that are packaged as 529s. This simply doesn't make sense.

 

We think mutual fund disclosure practices like this, whatever the final form, should apply to all mutual funds - those covered by our rules and those covered by the MSRB's. We have worked long and hard with the industry and the SEC to develop effective sales practice rules for mutual funds. It makes no sense to reinvent the wheel for 529-plan mutual funds.

 

There is a simple way to achieve harmonized sales practice rules for all mutual funds. Indeed, we have already started cooperatively down that path with the MSRB. Recently, we have supported the MSRB's efforts to align their advertising and non-cash compensation rules governing 529 plans with SEC and NASD rules governing mutual funds. The next step would be for the MSRB to adopt as their own rules the remaining SEC and NASD rules governing the sale of mutual funds. That's it. Doing so would complete the process of harmonizing sales practices for 529 plans with all other mutual funds.

 

Let me say in closing that the three products I chose to talk about this morning - mutual funds, 529 plans and corporate bonds - are particularly important vehicles for retail investors and therefore of particular interest to NASD. Protecting investors - particularly individual investors - is our raison d'etre.

 

But as I hope I've made clear, we also place a high premium on protecting you, the professionals, by doing everything in our power to help you understand and comply with the rules. We're always open to your comments and suggestions about how we can do this better, so please don't be shy about offering them.

 

I think I've rattled on for long enough. So, let me again thank you all for coming. We hope you feel this conference has been worth your while, and that you're able to find time for a little golf or tennis or well-earned self-indulgence while you're here in this desert playground. NASD does not regulate expense accounts, so that's entirely between you and your employers. Now, if there are any questions, I'd be happy to try to answer them.