finra

Remarks by Mary L. Schapiro
President, NASD Regulation, Inc.

NASD Regulation Spring Securities Conference

Grand Hyatt Hotel, Washington, DC
April 23, 2002

 

Thank you, Elisse—and thank you all for coming. Especially after the tragedy that led us to cancel our Fall Securities Conference, I feel like our gathering today is a real testament to you and your firms’ commitment not only to be back in the game, but to play by the rules.

 

In fact, I sometimes wish the investing public could be a fly on the wall at one of these conferences.

 

Admittedly, the 99 percent who aren’t lawyers or compliance officers might quickly be bored.

 

But more than that, I think that these days they’d all be reassured—and on reflection, maybe even a bit inspired, as I am.

 

Because no one forces you to spend your time and your firms’ money to be here. You come here voluntarily, to make our partnership in self-regulation work—and thus to help keep our markets the fairest and most successful in the world. I can’t tell you how wonderful I think that is.

 

So in a very real way here, I believe we’re carrying on the work of all the friends and colleagues we missed seeing in the fall—after that terrible day in September—and whom we will never forget.

 

Often when I speak at our spring and Fall Conferences, I spend the bulk of my time like those two movie critics up in the balcony—previewing coming attractions. And believe me, with all the transformations in our industry, our program this year is so chock-full, I hope you’ll have trouble deciding which panels to attend.

 

But for these same reasons, there are a couple of larger subjects I’d like to cover with you in a bit more depth this time. And if that means I can preview fewer panels, well, you’ve got the written program and we trust you know how to flip a coin.

Two things, above all, are driving the regulatory agenda these days.

 

The first has been adapting to what I’ve called "the new normal" in our industry, post-9/11. That entails a whole range of things, from enhancing our cooperation and contacts with one another, to doing more to terror-proof the places and ways in which we work.

 

Many of these changes are coming over time. One will be upon us literally tomorrow—the deadline for most elements of the anti-money laundering compliance programs required by the USA PATRIOT Act.

 

Your firms’ anti-money laundering programs should be comprehensive and customized.

 

By comprehensive, I mean that Congress has required a full soup-to-nuts compliance program—with everything from developing internal policies and procedures; to designating a compliance officer; to setting up a training program and establishing a testing function.

 

By customized, I mean that NASD has been faithful to congressional intent and written a general, non-prescriptive rule that allows your firms to determine what you need to do to meet the rule’s requirements. All this is spelled out in a detailed Notice to Members we put out the week before last. We’ve also posted a new anti-money laundering section on our Web Site.

 

By the way, we’ve already seen strong demand for our educational offerings on anti-money laundering, with more than 900 members taking part in our telephonic workshop this past Friday.

 

The second specific near-term adaptation you face as a result of 9/11 is in our proposed rule requiring business continuity plans and emergency contact information.

 

Obviously no one—no sane person, anyway—could have known the exact nature or magnitude of the assault on our nation, our markets and our industry that day. And there may be some in our industry who view the resulting requirements as burdensome or excessive.

 

But in fact, now that the unthinkable has happened—and revealed gaps in readiness that we all can rectify—it would be the height of folly not to do so simply because 9/11 was a tragedy the likes of which we pray will never happen again.

 

Because, in truth, we’re talking about far more than terrorism. Infrastructures fail; floods and storms strike; hackers hack; power grids go down. And even small-town brokerages get mail from big-city Post Offices whose vulnerabilities have become all too clear.

 

So having a sound business continuity plan in place is not optional. After 9/11, NASD performed a major, statistically reliable survey and found that while most of our members had such plans in place, many others did not.

 

Based on our findings, we’ve proposed a new rule, now out for comment, which would require firms to make basic disaster recovery plans. The plans should cover such things as database backups; mission-critical systems; FINOP assessments; communications with key constituencies; and third-party impacts. Here again, our rule is general—to give you flexibility to tailor a plan that meets the specific of your firm.

 

All this may seem like a lot of trouble to cover eventualities we all hope are remote. But remember that these plans are like the airbags in your car. When you need them, you really need them. And designing in only an 80 percent likelihood that they’ll work is about 20 percent too low.

 

The second part of this planning effort is for firms to establish and maintain the best possible emergency contact information with the NASD. One of the lessons of September 11 was the need for emergency contact information to be 100 percent reliable as well. Incomplete information at that time hampered our efforts to help the industry recover quickly.

 

The additional information required will include key staff; a designated contact person; location of books and records; clearance and settlement information; key banking relationships; and alternative communications plans for investors. To make this information easy to keep current, we will collect it through the Member Firm Contact Questionnaire on our Web Site.

To some this might seem ministerial—but our interdependent industry must build the best possible emergency networks if we are to maintain investor access and confidence. This is not only a matter of disaster-proofing, but of improved cooperation, market resiliency, and investor trust as well.

 

The second big category of changes I want to talk about also stems from a man-made disaster—but this one was born in the USA. I mean, of course, Enron—and all that has come in the wake of that debacle.

 

The changes in the financial sector and in our broader economy that have begun to take shape as a result of Enron are still too big and too many to predict in detail. But some outlines have already begun to emerge.

 

There will be fundamental changes in accounting industry oversight. Based on the NASD’s long experience as a private sector regulator, our model is one that is being closely studied.

 

We will see reform of the corporate disclosure system in the direction of "real time" disclosure and shorter reporting periods for insider transactions, as well as new accounting principles for such things as special purpose entities and perhaps stock options.

 

We will likely see enhanced authority for the SEC’s enforcement program in dealing with wrongdoing and negligence by corporate officers and directors.

 

We will see reform proposals for corporate audit committees, as well as pension reform and perhaps even re-regulation of the energy derivatives market.

 

And of course, we are seeing closer attention to our own industry—including unprecedented scrutiny of the work done, disclosures made and conflicts faced by research analysts.

 

It’s worth taking a moment to trace what brought us to this point. Not so long ago, securities analysts provided their research primarily to institutional investors—and it primarily covered traditional, bricks and mortar industrial companies.

 

In the 1980s, however, high tech and other enterprises with little earnings history or reputation started to transform our economy. In evaluating these emerging companies, investment bankers relied more than ever on analysts.

 

Analysts became more involved in investment banking, and then in marketing "road shows." They were celebrities on financial television and other media. And during the exuberant bull market of the late 90s, some could even send a stock’s price higher simply with the "booster shot" of a positive rating—almost without regard to the actual condition or prospects of the issuer.

 

At the height of the exuberance, if a well-known analyst reported a stock was a good buy, it often became a good buy—at least in the short term. Some retail investors even concluded that if their favorite analyst said a stock was a strong buy, that was all they needed to know. Not surprisingly, such investors were among those hit hardest when the bubble began to burst in 2000.

 

NASD had started earlier, in the late 1990s, to see if our rules should be changed to require greater disclosure when analysts issue recommendations. As a result of that process, in July of last year we issued a rule proposal to mandate new disclosures by analysts recommending securities in research reports or public appearances. It struck a chord with the investing public and retail brokers, resulting in more comments – overwhelmingly positive – than any other rule proposal in the NASD’s history.

 

Then came the Enron collapse. Securities analysts came to be seen as one key part of the problem—having maintained strong buy ratings even as the share price tumbled. And given the lucrative relationships Enron had with many of the analysts’ firms, Congress and the press have not been inclined to accept Enron’s financial deceptions as much of an excuse for our industry.

 

Now, I applaud the SIA’s best practices and encourage the industry to follow them. But it should be clear from Congress, SEC Chairman Pitt, and New York Attorney General Spitzer, among others, that merely voluntary standards will not be enough.

 

We’re plainly operating in a post-Enron environment. But let me make one thing equally plain about the comprehensive new rules NASD developed jointly with the NYSE and filed with the SEC on February 8. Our proposed new rule is the culmination of a process that began well before Enron. And although it was not a response to Enron, it can go a long way to restore the investor confidence in research analysts that has been undermined by Enron and subsequent events.

 

Our proposal requires additional disclosures about analyst rating systems, track records, and potential conflicts of interest.

And it imposes outright prohibitions for certain behavior that is simply too rife with such conflicts—such as analysts receiving pre-IPO stock, or trading against their recommendations, or promising favorable research to win banking business.

To increase analyst independence, our rule removes analysts from the control of a firm’s investment banking department—and strictly limits bankers’ review of analysts’ reports.

 

To deal with analysts trading stock that they cover, our rule uses blackout periods and other measures—rather than imposing an outright ban on analysts putting their money where their mouth is.

 

To increase investor understanding of how different firms grade on a curve, each firm will disclose the percentage of ratings it gives in each category—along with how many of its best ratings go to its investment banking clients.

 

And to give investors an idea of analysts’ track records, research reports will contain a chart showing stock price changes over time and what the firms’ ratings were during that period.

 

I know that some in our industry feel that this proposal is too tough. And we fully expect the comments on it to raise some complex and difficult issues. But I have to tell you, in all my conversations in Washington and investor forums around the country, there is strikingly little sympathy for the burdens these new rules will place on our industry.

 

So we must seize this opportunity to make real self-regulation work. That’s precisely what we’re talking about here—new rules hammered out by the industry’s foremost SROs, acting under the strong oversight of Congress and the clear vision of SEC Chairman Pitt. And if we fail now to restore public confidence in our industry, we needn’t look far to see what is happening to a related profession that enjoyed self-regulation in name—but failed to exercise it in fact.

 

You can find out much more about our new analyst proposal in tomorrow morning’s workshop on Underwriting and Related Issues. It will also cover several other vital Corporate Financing issues, including a change to mandatory electronic filing.

Let me quickly highlight just a few other parts of this Conference.

 

The Market Regulation workshop will cover such topics of interest as the Alternative Display Facility, mixed capacity trading, OATS, SuperMontage and Nasdaq Exchange Registration.

 

If you want insight into our INSITE system, attend our workshop on the Examination Process. There you’ll hear about how we’ll use INSITE to guide our examinations by compliance risk, not only the calendar—and find out what we’re learning in our pilot tests of the system.

 

I heartily recommend our two open forums—one with our District Directors and one with our Enforcement Staff. Both are great chances for you to ask questions and learn about the latest developments before they affect you.

 

Speaking of great chances, when I wrap up in just a minute, Elisse Walter will immediately chair our next panel, the Open Forum with senior regulatory staff. This is a superb opportunity for you to see what’s on the horizon and to probe the thinking of many of the wisest program heads in NASD Regulation.

 

These are not shy people. They always find something to talk about. So you may as well have them respond to your questions and concerns. And the way to do that is to fill in your blue cards now with your questions, and have them ready to pass forward right at the start of the Open Forum.

 

Your question cards are one tiny example of a much larger point on which I want to end.

 

I referred at the start to our "partnership" in self-regulation. And that is precisely how I see it

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This grand experiment has worked for more than 60 years because it makes use of industry insights and resources not easily available to government regulators.

 

And NASD works best when we are in the closest communication with our industry—not imposing edicts from on high, but seeking out your ideas, paying attention to your comments, being mindful of your burdens.

 

We won’t always make you happy. But we will always hear you out and try to address your concerns in good faith.

That kind of two-way street is what makes self-regulation work. It fosters the investor confidence that makes our markets successful. And it’s what this conference is all about.

 

So we’re glad you’re here. We’ve got a lot to share with you. And let’s get right to it.

 

Thank you very much.