finra

Remarks by Robert Glauber

Chairman and CEO

SIA Market Structure Conference
New York

May 20, 2005


Good afternoon.  We at NASD are often invited to speak at SIA events and we're always happy to accept.  While we don't always agree on everything, our two organizations enjoy a cordial and constructive relationship and investors are quite well-served by that.

 

With the myriad changes afoot in the make-up of the capital markets - both in terms of regulation and realignment - participants in this year's Market Structure Conference certainly have had a lot to talk about.

 

Obviously, we don't know exactly what the markets will look like five or 10 years from now.  But, with the recent competitive moves by the NYSE and Nasdaq to extend and strengthen their electronic trading capabilities, among other evolutionary changes, I think it's safe to say that the markets of the not-too-distant future will have a different complexion than they have now.  The only question is how different.

 

At the same time, the SEC has undertaken a broad and comprehensive examination of the system of self-regulation that Congress established in the 1930s as a layer of private-sector regulation between the markets and the government.  Here, too, there has been a great deal of speculation, in this case about the future of the SRO model. The notion of an organization regulating a market that it also operates as a for-profit enterprise is a question of much debate at the moment.

 

I'm not here to predict what will come to pass, or to editorialize about what should.  I simply want to offer some food for thought to those involved in this discussion and those observing and thinking about it.  Specifically, I want to explain how we at NASD resolved a dilemma similar to the one now facing the New York Stock Exchange - that is, how to reconcile the simultaneous operation and regulation of markets.  In so doing, I hope I can add some historical perspective to the on-going debate about how markets ought to be structured and regulated in the 21st Century.

 

As I'm sure you know, NASD created Nasdaq in 1971 as an electronic market that NASD would own, operate and regulate.  This arrangement worked well enough until the mid-90s, when the tech boom was in full swing.  Those of you who were working in the industry then will remember that NASD's regulation of Nasdaq and of its member firms went off the tracks.

 

These problems  resulted in investigations by the SEC and the Justice Department.  They also resulted in NASD's deciding that a comprehensive, rigorous and independent examination of its governance and oversight structure was very much in order.  This examination resulted in a series of recommendations, the most salient being that NASD should put some distance between itself and Nasdaq by reconstituting the latter as a separate operating subsidiary, still owned by NASD but having as much autonomy as securities law would allow.  

 

This was the right idea for the time, when NASD and Nasdaq were both private, not-for-profit companies.  But in 1999, NASD made the decision to spin-off Nasdaq as a for-profit, publicly held company, and we concluded we needed more separation of the regulatory operations.  So  we began the process of separating from Nasdaq altogether and putting it under its own separate management and separate board, with NASD continuing to directly regulate member firms and  continuing to regulate the Nasdaq market under contract.  That was the very clear blueprint we decided upon and that is essentially how we operate today.

 

There is an important piece of the puzzle still missing for full and final separation, though, and that is the SEC's official designation of Nasdaq as a full-fledged stock exchange.  We have been working closely with the SEC to make this happen, and I'm optimistic we can come to a resolution in the near future.

 

At about the same time, and for the same reasons, we decided it would be prudent also to sell the American Stock Exchange, which we had bought in 1998.  We reached agreement with Amex's seat-holders to sell the exchange back to them and that deal was consummated on December 31, 2004.

 

The issue of Dick Grasso's compensation, along with other governance issues at the NYSE, touched off a debate about the concerns raised by the exchange chairman having dual roles, or as Grasso himself put it, wearing two hats - the hat of an operator and the hat of a regulator.  The are lots of ways of putting the two hats on two separate heads.  One is the NYSE's proposal on how to deal with regulation after the NYSE-Archipelago merger - put it into a separate, not-for-profit company overseen by the NYSE Board.  An alternative is the completely decoupled structure that we created in separating from Nasdaq.  There are no doubt other ideas, and it's not for me to say what's best.  But I will say that our means of resolving this sort of conflict has worked well for us.

 

It has worked well for us because it has allowed us to focus all our time, attention and resources on our core mission of regulating the 5,200 firms and 660,000 registered reps that make up the brokerage industry.

 

When I say "regulating," I'm sure the first thing that springs to mind for most of you is writing and enforcing rules.  That is the very heart of our mission and it will remain so.  But as markets and industries evolve, so must we.  We can't simply be cops.  We also have a responsibility to provide the industry and the people we oversee with the tools and educational resources they need to clearly understand the rules and to comply with them.  This is a responsibility we take very seriously.

 

It is better for industry and investors alike that industry professionals know the rules and obey them than for us to have to arrive on the scene after a violation has occurred.  Because in the latter event, investors may have sustained injuries that can't be completely mended, and the industry's reputation may have suffered a stain that can't be completely erased.

 

Just in the past year, we have substantially broadened the range of training and educational services we offer to the brokerage community in the hope of helping professionals get it right the first time and avoid run-ins with us. 

 

I'll give you a few examples:

 

We inaugurated a series of Fixed Income Conferences, where industry professionals can learn about the latest developments in bond pricing, disclosure and regulation.

 

We developed plans to initiate a series of Nuts and Bolts Compliance Conferences, where  compliance and legal professionals, officers of new firms, attorneys who advise broker-dealers on legal and compliance issues and other professionals can learn about a variety of practices, from dealing with customer complaints to working through the examination and disciplinary processes.  This series will debut June 20 here in New York.

 

Within a week, we'll unveil our new E-Learning Exchange, a series of 25- to 30-minute interactive courses on a variety of compliance-related topics - variable annuity sales practices, anti-money laundering and others.  Course-takers from entry-level employees to more senior staff will be presented with hypothetical on-the-job scenarios and given choices on how to address them.  And they can take these courses on-line in the comfort and privacy of their own desks.

 

Also new this year is a series of webcasts we offer on specific compliance-related topics, tailored to investment products where we perceive a need for better understanding of our rules.  The first installment went on-line in January and explained briefly the ins and outs of mutual fund share class distinctions and breakpoint discount rules.  About 10,000 people have seen it, and some firms have incorporated it into their internal training programs.

 

The second in the series is newly available on-line.  It addresses variable annuity sales practices, with a particular emphasis on switches.  We've seen problems in this area and have disciplined some firms for inappropriately switching clients from one variable annuity to another, exposing them to unwarranted commissions and surrender charges without improving their financial well-being at all.

 

Broker compliance with mutual fund "breakpoint" rules, which afford investors fee discounts on large mutual fund investments, has been a past problem.  We are working to provide brokers with Web-based tools to access this mutual fund breakpoint information to ensure that investors get the fee discounts to which they are entitled.

 

And finally, I would draw your attention to the NASD Report Center and strongly encourage you to use it.  While not new, the Report Center gives firms access to compliance data and reports on market operations, mutual fund breakpoint discounts, and bond transaction reporting - all on  a secure NASD Web site.  Here, your firm can get a fix on not just its own performance, but how it stacks up against the industry as a whole.

 

Rapid evolution in the structure of markets also increases the pressure on investors to keep up.  And for them, keeping up can be daunting and intimidating, because they generally don't dwell in the investment world day in and day out, as we do.  Therefore, NASD has made a substantial commitment to investor education.

 

We are particularly proud of our Investor Education Foundation, which we established early last year and has   funding of $16 million derived entirely from disciplinary fines we've imposed. The foundation funds educational programs for mainstream investors, and research into new and creative means of improving their financial literacy. At present, the foundation board is particularly interested in projects that target younger investors, women and senior citizens, and investor education of military personnel and their families.

 

The foundation is but one of many educational resources we have created for the benefit of investors.  We also publish Investor Alerts, which are plain-English discussions of various issues that are particularly timely.

 

Recent ones have addressed Section 529 College Savings Plans, variable annuities and on-line identity theft, or "phishing."  These alerts tend to get a fair amount of press coverage.

 

We have also posted on our Web site two audiovisual tutorials, one on 401(k)s and one on 529s.  And, we offer on-line expense analyzers for investors interested in mutual funds and ETFs.

 

All these services are free and we intend to add more of them as time goes on.  But simply making them available isn't very helpful if investors don't know about them.  So, NASD Vice Chairman Mary Schapiro and I regularly travel around the country and hold town meetings with investors, to let them know what NASD has to offer them, and to listen to their questions and concerns.

 

Even the most well-informed investor is at a serious loss when markets are not transparent and investors don't have easy access to transaction prices and information.  Imagine a blackjack game where the dealer plays both his cards face-down.  However markets are structured in the future, they can no longer be opaque.

 

Market transparency itself provides important protection to investors.  It is harder to cheat investors when transactions are open and understood.  So, in addition to educating and meeting with investors, NASD has embarked on a campaign of opening drapes and turning on lights.  Through rule proposals and operating facilities, we are working vigorously to make markets as transparent as possible.

 

Perhaps the best illustration of this is TRACE, our Trade Reporting and Compliance Engine.  Three years ago, basic information about the corporate debt market, such as how much particular bonds were trading for, was all but impossible for retail investors to find - this despite the fact that retail investors now account for about two-thirds of the trading volume in that market.

 

Seeing no reason why this should be the case, we launched TRACE in 2002 and issued a requirement that trade and price information about certain corporate bond trades must be made available for public dissemination via TRACE.  Three years later, we are at a point where trades in all but the most illiquid corporate bonds must be reported within 30 minutes of execution.  

 

TRACE is easy to find - it's on our Web site and the Bond Market Association's Web site - and easy to use.  If an investor wants to know what, say, General Electric bonds are trading for, how they're rated, how much interest they're paying and when they last traded, all he has to do is log on to TRACE and type the words "General Electric."  It's that simple.

 

We're applying this principle of transparency in different markets and in different ways.  But the goal is always the same - to light the way for investors.  Once they pick up the phone and call a broker or adviser, they're on their own.  But we want to be sure that they have access to all the information they want or need before they make the call.

 

In conclusion, whatever shape the market landscape takes in the coming years, there is no question that industry professionals should have all the requisite tools and information to operate within the rules, and that investors should have all the requisite tools and information to invest with knowledge and confidence.

 

Educating and training professionals, educating and informing investors, bringing markets into the light of day.  In addition to writing rules and enforcing them, NASD is and will remain committed to providing these resources to the firms we regulate, and to the investors we serve.

 

Thanks again to the SIA for inviting me to be with you and thank you very much for listening.  Now I'll be happy to answer any questions.