finra

Richard G. Ketchum
Chairman & Chief Executive Officer

Women in Housing and Finance Luncheon

 

Washington, DC

May 13, 2010

As prepared for delivery.

 

Thank you for that introduction, and thank you for the invitation to be with you today. The events of the last few years underscore the importance of a group such as this one. As this audience knows, both housing and finance can be used as tools to achieve financial security and to unlock economic opportunity. But we've seen how the two can be toxic when mixed together irresponsibly. One of the challenges ahead, for everyone operating in and around housing markets and financial markets, is to master the lessons of what went wrong and work to ensure that the same mistakes are not repeated.

 

Indeed, the financial crisis provided a potent reminder of the need for FINRA, and all other regulators, to re-examine how we can more effectively protect investors. That re-examination is well underway, and we have already taken a number of actions to close gaps in regulation, enhance market transparency and tackle fraud. The theme underpinning this work, and all of our work, is to promote investor protection and overall market integrity. I'll describe some of what we're doing in these areas, and then I'd be happy to try to answer any questions.

 

FINRA's Response to the Financial Crisis

 

In thinking about the many different dimensions of the financial crisis, the instances of fraud, both large and small, stand out. As I just stated, regulators were forced to take a step back and reassess how we could do a better job at both detecting—and preventing—fraud. At FINRA, we have focused intently on strengthening how we go about looking for fraud at firms, and how we process tips and allegations of fraud when they come our way. We have also worked hard to arm our examiners with new training and education on fraud detection.

 

Last year, we created an Office of the Whistleblower, which encourages individuals with first-hand knowledge of, or material information about, potentially illegal or unethical activity to come forward and share it with regulators. We also created an Office of Fraud Detection and Market Intelligence, which provides a heightened review of allegations of serious frauds, a centralized point of contact internally and externally on fraud issues, and consolidates recognized expertise in expedited fraud detection and investigation. And while both of these offices are relatively new, we feel they have already helped to find and, hopefully, prevent fraud.

 

As I mentioned, we have also enhanced our examination programs, procedures and training in a variety of ways intended to help us better detect conduct that could be indicative of fraud. A few examples of what we've done include:

  • Gathering more information—prior to each exam—regarding a firm's ownership and affiliate relationships.
  • Identifying indications of problematic behavior concerning the opening of investment advisory accounts at a broker-dealer.
  • Examining the relationship between broker-dealers and/or their affiliates with feeder funds, or master funds that utilize feeder funds.
  • Identifying potentially fraudulent activity by examining for material misstatements in financial reporting, unusual money movement, and apparent red flags involving a firm's auditor and off balance sheet items.

To ensure that serious matters get escalated quickly, FINRA has focused on bringing enforcement actions quickly and efficiently. Quicker action means more investors escape harm. Of course, no one can ensure that there won't be another Madoff or Stanford. But we are doing everything we can to ensure that we have a more laser-like focus on fraud detection, and this includes working with states and with other regulators to pursue and prosecute allegations of fraud.

 

To give you a few recent examples of our work to combat fraud, in March we announced that we had permanently barred a broker with ING Financial Partners from the securities industry for defrauding nearly 40 clients of at least $8 million. She did this through a scheme that involved converting client funds for her personal use while sending falsified account statements to her customers.

 

And just two weeks ago, we announced the permanent expulsion from the industry of the chief compliance officer and head trader of a New York-based firm for engaging in a fraudulent trading scheme. This individual chose to enrich himself—to the tune of more than $1.3 million—at his clients' expense and to conceal the fraud with falsified records. That he was both the head trader and chief compliance officer for the firm made this misconduct especially offensive.

 

Let me turn now to FINRA's role as a regulator of trading on equity markets. Last Thursday's extreme market volatility underscored the need for regulators, and others operating in and around financial markets, to quietly step back and recognize that with the huge changes in the market, there is a serious need to look at market structure.

 

The sometimes dizzying speed of change in the equity trading market—a market that puts a premium on innovation and competition—has made it imperative that regulators act now to close the gaps that could, effectively, encourage illicit activity in the shadows.

 

The lag between market innovation and regulation is particularly pronounced in the increasingly fragmented area of equity trading. There, we have seen a rapid evolution of how and where trading occurs, and how quickly—and transparently—it is executed. High-frequency trading, dark pools and direct access are now commonplace, challenging regulators to adapt to make sure that market participants play by the rules.

 

A generation ago, fewer than 10 exchanges handled all U.S. equity trades. Today, orders are routed to some 50 competing platforms. This complex environment creates opportunities for traders seeking unfair advantage to manipulate markets. How? By exploiting inconsistencies or gaps created when the responsibility of regulatory oversight is divided. Regulatory gaps and splintered oversight make it possible for trading abuses—such as market manipulation, marking the close and front-running customer orders—to be carried out secretly across multiple markets, with a reduced chance of detection.

 

Until regulators have a complete view of the equity markets, it will be difficult to effectively monitor for—and enforce rules against—this kind of abusive trading activity. And that makes it essential to create a consolidated audit trail that provides comprehensive surveillance across platforms and investment products.

 

Last week's announcement that FINRA is assuming market regulation for NYSE Euronext's U.S. platforms is a major step toward establishing such a unified approach to market oversight. Under the plan, FINRA—which already regulates the NASDAQ Stock Market and a number of other exchanges and platforms—will have regulatory oversight of trading on the New York Stock Exchange and other NYSE Euronext U.S. equities and options market centers. Once approved, a single organization will be responsible for aggregating and regulating approximately 80 percent of trades in equities made at U.S. market centers. The benefits for market integrity and investor protection are profound. But perhaps more importantly, empowering a single set of eyes to oversee the majority of transactions will facilitate the necessary progress toward a truly holistic approach to regulation that addresses the realities of today's marketplace.

 

Expansion of Transparency Initiatives

 

Let's now turn from equities to fixed income—where FINRA is taking a number of important steps to bring greater transparency. At the height of the financial crisis, the proliferation of highly-opaque financial instruments had the effect of destabilizing the markets when investors could not easily obtain reliable pricing information. And the lack of transparency also made it extremely difficult for regulators to monitor market activity.

 

The SEC took an important step in support of market transparency this past September when it approved an expansion of FINRA's Trade Reporting and Compliance Engine—known as TRACE—to include debt issued by federal government agencies, government corporations and government-sponsored enterprises, as well as primary market transactions in new issues. This expansion, which took effect March 1, helps investors, and especially retail investors, better monitor their executions by putting immediate and accurate sales and pricing information in their hands. It marks a 50 percent increase in the number of debt securities subject to our reporting requirements and enhances our ability to detect fraud, manipulation, unfair pricing and other misconduct.

 

FINRA has also proposed expanding TRACE to cover asset-backed securities. The reporting of ABS transactions would provide FINRA with trade prices, volume and other information, thus enhancing our ability to supervise the market.

 

These developments, when combined with the move for FINRA to assume market regulation for NYSE Euronext's U.S. platforms, represent significant progress in advancing transparency and providing us with a deeper understanding of market dynamics.

 

Reform of Financial Regulation

 

One of the lessons of the last few years is that investors are vulnerable when there are gaps in our regulatory system. I talked earlier about the regulatory gaps in market surveillance. Now, let me touch on some of the financial reform issues that all of us, from the Congress and the Administration on down, are grappling with. That is how to allow for innovation and growth that meets investor needs, while eliminating regulatory gaps and avoiding inefficient regulatory overlaps.

 

The immediate task is to reform the regulatory architecture to address the vulnerabilities in the financial system and help restore investor confidence. Part of the long-term objective must be to create an architecture in which regulations can evolve to adapt to the changed circumstances in the financial sector. Because of the catastrophic nature of the recent financial crisis, almost every assumption, conviction and article of faith about financial regulation, no matter how firmly entrenched, is now up for grabs.

 

FINRA believes one of the most important reforms that's needed is to eliminate, or at least substantially reduce, the unequal consumer protections across product lines. We believe that anyone selling securities or providing advice, whether an investment advisor or broker-dealer, should be making recommendations that are in the best interest of the customer.

 

At this moment it remains unclear whether Congress will adopt a fiduciary standard for broker-dealers, or whether it will require that the SEC study the issue. We support a fiduciary standard for broker-dealers that provide personalized advice. But even if Congress does not immediately impose such a standard, FINRA and the industry cannot stand back as if we have learned nothing from recent history.

 

To that end, FINRA has been focused on improving point-of-sale procedures, to ensure that customers receive more plain English disclosure about products from broker-dealers, and disclosure about brokerage services—including the conflicts of interest that a broker-dealer faces when it offers these services. In short, we are focused on ensuring that brokers put the interests of their customers first.

 

In 2005, FINRA developed a model document, called the "Profile Plus," which would require disclosure of the features of a particular mutual fund and the conflicts of interest in the way that the broker is paid. We designed the Profile Plus in a manner that permits each customer, through the use of hyperlinks to other documents, to obtain the level of information that the customer prefers. In our tests of Profile Plus with investors, we confirmed that they would strongly prefer the flexibility of receiving this type of plain English disclosure online.

 

FINRA's Work to Educate Investors

 

Our work on Profile Plus is just one example of how we're working to better address the needs of investors. At FINRA, we have long believed that education is the best form of investor protection. And over the last decade, we have worked hard to develop a number of robust investor education outreach programs.

 

I will walk you through more details on FINRA's programs in just a few minutes, but first, I'd like to brief you on a ground-breaking financial capability survey we conducted last year. The results of this survey alone should serve to give you insight into why we feel there is such an urgent need for financial education in this country—and why we still have so much work to do.

 

Last December, the FINRA Investor Education Foundation, along with the Department of Treasury, released the findings of the National Financial Capability Survey. Never before has a study of this kind been conducted in the United States. It took more than 22 months, and involved more than 28,000 respondents.

 

Our goal in conducting the study was to begin to get a basic understanding of the financial capabilities of adults in the United States. Over the last several decades, the financial landscape in this country has changed dramatically. The responsibility of saving for retirement has shifted from the employer to the employee. The cost of housing and college education has risen dramatically. And on top of that, financial products have only gotten more complex—making saving and investing increasingly complicated for American families.

 

This study gave us a wealth of important—and in some cases, unsettling—data that we can use to help Americans better manage their finances and plan for their futures.

 

Many of the people we surveyed said they were having difficulty making ends meet. Of the people we talked to, nearly 49 percent said they had difficulties just covering their monthly expenses. Twelve percent said that their household expenses over the past year were greater than their income. And 36 percent said that their household expenses were about equal to their income.

 

That kind of financial strain makes it difficult for people to plan ahead—even at the most basic level. Our findings also showed that fewer than half of the Americans we polled had a rainy day fund—or enough savings to cover expenses for three months in case of sickness, job loss or other emergency. And the majority of Americans appear not to have done any retirement planning. Given the significant shift from defined benefit to defined contribution plans as the primary means of retirement savings in this country today, we may be looking at an emerging national crisis.

 

We also found that many Americans don't have bank accounts at all. Twelve percent of the individuals we surveyed reported not having either a checking or savings account. People in this group—sometimes referred to as "the unbanked"—have even greater difficulty managing their money. They are also more likely to engage in expensive borrowing methods—such as payday loans, tax refund advances or pawn shops.

 

Finally, the complexity of many of today's financial products has created a knowledge gap for many Americans as they try to understand and choose among so many different and complicated ways to save and invest. And while many American adults may believe they are adept at dealing with these kinds of day-to-day financial matters, their actual behavior tells a different story. Far too many tend to engage in financial behaviors that generate excessive expenses and fees. And all too few are able to calculate basic interest and other math-oriented tasks. In addition, few people seem to compare the terms of financial products or shop around before making financial decisions.

 

The study underscores how many Americans are disadvantaged by their lack of financial capability. And that speaks to the need for FINRA and other entities focused on investor education to redouble our efforts to ensure that people have access to the information and resources they need to make sound financial decisions.

 

As I mentioned earlier, FINRA is already highly focused on investor education, and we have a number of strong programs in place. One of our top priorities is to ensure that investors have access to free, unbiased educational information. We offer a wide array of online resources and interactive tools—such as FINRA's BrokerCheck system and mutual fund expense analyzer—to help investors better understand our markets and compare investment products and professionals. 

 

FINRA is also focused on protecting investors and equipping them to fight fraud. As part of our investor education efforts, we issue Investor Alerts to give investors the information they need to protect their money and avoid being victimized by fraudulent activity.

 

In 2003, we created the FINRA Investor Education Foundation, and in the intervening years it has funded more than $40 million in research, grants and other education programs. It is the largest foundation in the United States devoted to financial literacy, and it supports innovative research and educational projects aimed at segments of the investing public that could benefit from additional resources.

 

The Foundation's focus on investor education complements FINRA's work to combat investment fraud, particularly given the recent surge in fraudulent activity that preys on vulnerable groups. In 2008, the Foundation launched a research-based, social change campaign designed to reduce the incidence of investment fraud among investors age 55 and over. This campaign, which was designed in collaboration with the AARP, state regulators and noted fraud and persuasion experts, uses in-person workshops, events and online resources—including an hour-long documentary, "Tricks of the Trade: Outsmarting Investment Fraud," which will run on PBS later this year—to teach the tactics commonly used by fraudsters and the simple steps every investor can take to reduce their risk of being defrauded.

 

The Foundation also works with the Pentagon's Financial Readiness Campaign to support the Military Financial Education Project. The project, which uses fine money levied against firms for misleading sales practices targeting military personnel, helps military families manage their money with confidence by delivering free, unbiased tools and training to service members, their spouses and military financial educators.

 

We have also expanded our reach at the grassroots level. Our grant programs in partnership with the American Library Association are helping local libraries provide free, unbiased financial education resources to library users across America. And together with United Way, we are helping community-based organizations provide effective and unbiased financial education to low- and middle-income Americans.

 

Conclusion

 

So this is a very busy period at FINRA, and last week's dramatic market swings only affirmed the need for all market participants—and particularly regulators—to have a more complete picture of what's happening in the markets. Some of the measures being debated in Congress have the potential to help promote market transparency, and create conditions that would contribute to market stability.

 

But we should not get lulled into a false sense of security about regulation. New regulations can only achieve so much, and recent market history shows, quite conclusively, that the effect of regulatory crackdowns on one segment of the market is for capital to simply be reallocated to another segment of the market.

 

So there is critically important work ahead. I am confident the individuals leading, and participating in, Women in Housing & Finance, will remain a positive force in the markets. My colleagues and I hope to have an opportunity to work with you in support of the reforms that will promote both the vitality and integrity of America's markets. Thank you.