finra

Remarks by Robert Glauber

Chairman and CEO 

Securities Industry Association Annual Meeting

Boca Raton, Florida

November 11, 2005

 

Good morning.  Many thanks to SIA for again inviting me to address your Annual Meeting.  It's important for me to meet face-to-face and often with the people under NASD's supervision.  So this gathering is a particularly important one for us.

 

I see SIA has put together a line-up of major league all-stars for this year's conference - Chris Cox, Bob Greifeld, John Thain and your own Marc Lackritz.  These are truly the leading lights of our industry and SIA is to be commended for putting them all in front of you.

 

During the last few years, you've heard a lot of talk from NASD about how we've had to turn up the voltage on our regulatory and enforcement operations in response to all the misbehavior that came to light after the bubble deflated in 2000.  Congress has passed new laws and the SEC has written new rules.

 

If you've studied the history of the securities markets, you know there are ample precedents for this, as I have pointed out on previous occasions.  After the 1920s bubble collapsed in the U.S., Congress wrote a whole set of new securities laws in the '30s.  And after the South Sea Bubble collapsed in London in 1720, Parliament sent all the king's ministers to jail for taking bribes and getting pre-IPO stock. 

 

Parliament also outlawed the formation of new corporations, short sales of stock, and futures and options trading.  So recent events are nothing new.  The abuses that go on in a bubble have always provoked strong government response after the bubble bursts.

 

As I said, we've talked a lot about how we've turned up the heat in the aftermath of the tech bubble, both to protect investors and to be seen as protecting investors, so as to help them regain their confidence.  But we haven't talked so much about the costs of regulating 660,000 registered reps and 5,200 firms.  And here I'm not just talking about the costs to NASD, but also the costs and burdens that increased regulation and enforcement impose on the industry.

 

Operating in such an environment is a lot tougher for a small firm with 50 registered reps than it is for, say, Goldman Sachs.  Small firms comprise a large majority of the firms we regulate.  More and more regulations and higher and higher costs can put those firms in danger of failing, and that's a fate we don't want to impose on anyone.  When firms go out of business, it is not only they and their employees that suffer, although that's bad enough.  Investors are not well-served either if the brokerage industry is effectively shrunken, and they are left with fewer choices.

 

At the same time, though, our costs of doing business do nothing but rise.  In terms of inevitability, that's right up there with death and taxes.

 

New regulatory mandates and their associated costs continue to grow as new products and new players enter the markets.  Our compensation costs continue to grow, too, because we are committed to finding, hiring and retaining the smartest, most capable, most dedicated people in our industry.  The annual growth in these and other costs far outstrips the very modest annual growth in our revenue.

 

Since you are the people who foot the bill for virtually everything we do, you have a right to know how we try to control our costs and infuse efficiency into everything we do, so as to avoid loading you down with unnecessary financial and regulatory hardship.

 

I want to approach this from two perspectives.  First, I'll discuss some of the initiatives we have taken to make it easier, less costly and less burdensome to comply with our rules.  These include new training and technology tools, as well as steps we have taken to run our own shop more efficiently.  Then I'll talk about some ideas to cut costs and overhead by eliminating regulatory redundancy.

 

During the last five years, we have followed many of the regulations we've imposed with initiatives aimed at helping the people and firms we oversee avoid committing the transgressions that led us to impose the regulations.

 

Take mutual fund breakpoints, for example.

 

In 2002, we discovered that failures by registered reps to credit eligible clients with discounts for high-volume purchases of Class A mutual fund shares were common and pervasive.  Investors had been deprived of hundreds of millions of dollars in savings.

 

Our first and most important duty was to stop the bleeding.  So we took disciplinary actions against firms whose failures to award these discounts amounted to extreme negligence, and we required firms to reimburse customers who had not gotten discounts that were owed to them.

 

I suppose we could have stopped there, issued a warning that we wouldn't tolerate such failures in the future, and left it at that.  But we didn't do that.

 

After seeing that most of these failures were not deliberate, but more the result of confusion and misunderstanding, we set out to help brokers and firms get it right on their own.

 

Last week, with the cooperation of The Depository Trust and Clearing Corporation, we launched a user-friendly, on-line database that brokers can use to figure out whether their front-end load mutual fund customers are eligible for volume discounts.  As I'm sure many of you have discovered, making that determination is not so easy.  Does the investor have money in more than one mutual fund of the same fund family?  Does he have holdings at more than one brokerage firm?  Does he plan to invest more at some point?  Do members of his family have mutual fund shares that can be counted toward a discount?

 

The database, which you can get to on the NASD website, makes the process of sorting all this out a lot easier.  And we'll continue to work with DTCC to ensure the data stays accurate and up-to-date.  Let me emphasize that we provide this to you at our expense.  This is precisely the kind of industry utility for which we should foot the bill.

 

We're working now on another mutual fund-related utility that will complement the breakpoint on-line database.  Enlightened by the recommendations of a task force of mutual fund and brokerage firm leaders we convened, we have been working with the SEC to develop new mutual fund point-of-sale disclosure documents that would be delivered on the Internet, among other, more traditional means. 
The documents, probably two pages for each fund, would show in a standardized format returns, risks, costs, and potential sales practice conflicts.

 

NASD believes Internet delivery would be a big step forward, allowing investors and brokers easy access to these disclosure documents, simplified comparison of one fund with another, and a platform on which to build analytical tools.  If the SEC approves Internet delivery, NASD is prepared to put its money where its mouth is.  We would work with all the industry players to establish and maintain a utility, accessible on-line, for all the required documents for all mutual funds.  This will benefit investors and will significantly reduce the costs and overhead of mutual fund sales for brokers.

 

We have also added to our repertoire a host of on-line tools that you can use at your leisure and at no cost.  These include our E-Learning Exchange; a series of short webcasts on particularly timely compliance-related issues; and the NASD Report Center, which provides firms with a series of confidential report cards on their compliance with various NASD rules.

 

And, we are hard at work to make our internal operations more efficient by using training and technology to raise the productivity of our people.  We have opened Examiner University, which provides a one-year course of classroom and on-the-job training for all our incoming examiners.  The goal is to make sure our exam program keeps up with a constantly evolving marketplace.

 

This is especially important given the array of new products that regularly show up on the markets - actively-traded ETFs, for example, or funds of hedge funds that target less well-heeled and less sophisticated investors.

 

Examiner University's goal is to turn out examiners who know as much about a firm and its products at the start of an exam as their forebears knew at the end of one.  This enables them to get in and out faster, less obtrusively, with less expense to us and less distraction to you.  And we will have more certainty that the exam we do in Boston will look like the one we do in Boca Raton.

 

At the same time, we're subjecting the exam program itself to a technological injection.

 

What will emerge from it is a system enabling us to identify potential problems by analyzing data and documents that firms submit to us electronically, and to formulate responses tailored for each firm.  A benefit of this is that decisions on whether to initiate exams will be based more on evidence of risk than on the calendar.  And that means a less intrusive, more flexible and more efficient exam program.

 

These and other efficiency steps we have already taken have paid off in the past, and we expect them to pay off in the future.

 

Over the last five years, we have beaten our budget by more than $250 million and have given more than half that amount - $140 million - back to the industry in the form of rebates against the regulatory assessments we levy.

 

It has been that length of time - five years - since I was named CEO of NASD.  And I think you'll agree that we are a measurably changed organization from what we were on November 1, 2000.  The new technologies I've just described, and others like them, are prime examples of what we do now that we couldn't or didn't do then.

 

But perhaps the most profound move we've made is to un-tether ourselves from Nasdaq and set it off on its own independent course under its own management and board.

 

The separation will be complete after the SEC grants Nasdaq exchange status, which we hope will happen by the end of this year.

 

This allowed us to realign ourselves as purely a private sector regulator of the broker-dealer industry and, by contract, of exchanges, with a board of governors most of whose members do not work in the securities industry.

 

The separation from Nasdaq became necessary when Nasdaq became a for-profit, publicly-traded company.  In our view, the inherent conflicts in simultaneously running a market for profit and regulating it were and are unmanageable.

 

Today, the New York Stock Exchange finds itself in a similar position as it merges with Archipelago and moves toward going public.  Should it continue operating as a regulator after it begins operating as a for-profit company? 

 

This question - indeed, the very concept of self-regulation - has been the subject of a great deal of healthy and needed debate in our industry.

 

Next week, for example, the House Financial Services Subcommittee on Capital Markets, under the leadership of Congressman Richard Baker of Louisiana, will convene a very timely and welcome public hearing on this issue, and Chairman Baker has been kind enough to invite NASD to testify.

 

Specifically, the hearing will focus on the SEC's concept release of last November, in which it floated some alternatives to the present SRO system.

 

They range from making some adjustments on the margins to scrapping the whole system and replacing it with a so-called universal non-industry regulator along the lines of the PCAOB that would oversee everything - brokers, firms, markets and exchanges.

 

I intend to tell the subcommittee that NASD is certainly opposed to the latter.  The current SRO model of private-sector regulation has conflicts, but I think it's preferable to a PCAOB-type structure.  Having said that, there is one fairly substantive change to the present SRO structure that we intend to propose.

 

If you work for one of the 180 firms that are regulated by both the NYSE and NASD, you know that your firm pays assessments to both organizations.

 

Making matters worse, your firm is subject to dual rulebooks, dual examinations, dual investigations, dual sweeps, dual enforcement actions.

 

Now, you could get out of this situation by relinquishing your membership in the NYSE, as Charles Schwab and Wells Fargo have recently done.  Membership in NASD is not optional.  But we need a more forward-looking solution that that.

 

And one that makes sense is a partnership between the NYSE and NASD to jointly handle the regulation - rule-writing, examination, enforcement - of the 180 firms that are members of both organizations.

 

This structure is very much in line with the hybrid SRO proposal that the SIA put forward a few years ago and has recently again endorsed.

 

This arrangement poses clear and tangible benefits to firms that now have to devote time, money and manpower to complying with rules imposed by two regulators, and have to pay fees and assessments to both.  The arrangement we hope to achieve would end that.

 

Firms would be regulated according to one rulebook instead of two.  They would pay one regulation fee instead of two and, we estimate, would collectively save about $50 million per year.  They would have only one examination and enforcement staff to contend with and that would lower their compliance costs, also by more than $50 million a year, by our estimate.

 

In summary, to best serve investors, any structure would have to solve the conflict inherent in both regulating and managing a for-profit exchange.  It would also have to eliminate the redundancy of having two regulatory groups performing the same functions.

 

This is one way we can bring about measurable reductions in costs and regulatory burdens.  Another way is to provide you with compliance tools and training so that you can understand our rules and stay on the right side of them.  But the ball is not always in your court.  Investors have their responsibilities, too, so we provide them with a wealth of education and information about the markets in which they trade and the products in which they invest.

 

Smarter investors are better investors and safer investors.  They can play a larger role in protecting themselves.  Obviously, NASD will always be vigilant in doing our mandated job.  But the more investors do for themselves, the less costly and burdensome need be our regulatory regime.

 

To be fair, though, part of the confusion investors now confront comes from the way we - the government and the SROs - regulate different products.  Too often, products that look the same to investors are subject to entirely different regulatory regimes.  Investors have the right to expect similar protection when they buy similar products.  But they often don't get it.

 

Take the sale of 529 plans.  NASD regulates sales of mutual funds based on rules that we wrote.  NASD also regulates sales of 529s, but under rules that the MSRB wrote.

 

Mutual funds and 529s are about as dissimilar as oranges and tangerines, but Congress designated 529s as municipal securities, so the rules governing their sales are different.

 

They shouldn't be.  As I said, investors have a right to expect that products that look the same are covered by the same regulatory regime.  So, we've been working with the MSRB on harmonizing the sales rules for 529s and mutual funds, and together we have made progress toward that goal.  Kit Taylor, the MSRB's executive director, and his staff have been very cooperative and congenial about this, and we are very grateful to them.  What we have been able to achieve is a model of cooperation between two organizations in the service of investors.

 

Then there are annuities, which present a more complicated problem than 529s.

 

There are variable annuities, which are subject to NASD regulation, fixed annuities, which are subject to state insurance commissioners' regulation, and equity-indexed annuities which are subject to utterly ambiguous regulation because it isn't entirely clear to anyone whether they're insurance products or securities.  Yet all these products look pretty much the same to investors.

 

EIAs are particularly complex.  They are often marketed as risk-free, which they most certainly are not.  And they are marketed disproportionately to elderly people, often without suitability analyses having been made.  And sales commissions are as high as 10 percent.  Small wonder they have been a fast selling product.

 

We've proposed a set of rules to put a stop to this sort of irresponsible behavior in sales of variable annuities - including a tailored suitability analysis and approval of any annuity sale by a principal of the selling broker's firm.  But we can't touch all equity-indexed annuities sales, because they aren't registered as securities and are often sold by non-broker-dealers.

 

I think what we need to do here is invite the state insurance regulators to work with us on harmonizing and clarifying the rules for fixed and equity-indexed annuities sales.  We've had some preliminary discussions with some of them toward that end, but we have a long way to go.

 

A similar issue is the differing levels of regulation we apply to mutual funds, ETFs and separately-managed accounts.

 

I fully confess that we've made it harder to sell mutual funds.  Given all the chicanery that we and other regulators have discovered in the last few years, we've had no choice but to do so, in order to protect investors.

 

An entirely predictable result of this increased regulation is that some registered reps may shy away from mutual funds in favor of similar products that are less heavily regulated and thus easier to sell - such as ETFs and separately-managed accounts.  This is not how it should be.  What's best for the investor, not regulatory overhead, should determine what a broker recommends.

 

You may think the solution is to ease up on mutual fund regulation.  I think it's the opposite.

 

What I think we need to do - and will do - is to raise the regulatory protections for these other products so that investors who are looking at them enjoy the same degree of protection as investors who are looking at mutual funds.  Recommendations to investors should be based on what's best for them, not what's easiest to sell or generates the highest commissions.

 

In closing, let me say that I hope one message has emerged from all I've talked about today; it is that we at NASD well understand the costs and burdens that regulation imposes on the industry we oversee.

 

The line between overbearing and laissez-faire regulation is a thin one. 

 

Writing clear and appropriate rules and enforcing them without fear or favor is, has always been and will always be the heart and soul of our mission.  That will never change.  But at the same time, we can and do make every reasonable effort to operate as efficiently and as cost-effectively as possible.

 

We can also continue drawing attention to redundant or duplicative rules and regulatory regimes and encourage other regulators to work with us to eliminate them.

 

And we can help the people and firms we oversee to stay on the path of compliance - and help their customers feel knowledgeable and confident when they invest, so that they, too, can stay out of trouble.

 

That is NASD today - an independent, multi-faceted regulator that is informed, but not controlled, by the industry it regulates.  Part of being informed is listening to your questions and comments.  So, I will again thank SIA for inviting me, thank all of you for being here - particularly given that I am the last speaker on the program - and invite your questions.