finra

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

NASAA Spring Conference

Washington, D.C.
April 29, 1996

 

It's a pleasure and an honor to be here to address the NASAA Spring Conference. Spring is a time of new beginnings and with the recent incorporation of a new self-regulatory organization NASD Regulation we begin a new era of securities regulation in the United States. Spring is also a time of renewal, and the creation of NASDR is the perfect opportunity to renew and enhance long-standing relationships between self-regulators and state regulators.

 

The regulatory cooperation the securities industry has historically enjoyed while not very public has been highly productive. It has resulted in the most efficient, most emulated, best regulated and I believe most confidence-inspiring system of capital markets in the world. This is a direct result not of bi-partisanship but tri-partisanship regulation involving the states, the SEC and the SROs.

 

The way to build on the success of our capital markets is to improve and strengthen this regulatory partnership. I'm here this afternoon to talk about some ways in which NASAA and NASD Regulation can do just that.

 

Let's start with the first component of any successful partnership: getting to know your partner. You should know that NASD Regulation's highest priority is effective regulation and strong enforcement with the goal of protecting the investor. Improved investor protection is, in fact, one of the fundamental reasons NASD Regulation came into existence as a corporate entity separate and distinct from Nasdaq.

 

As you know, the NASD is in the midst of unprecedented change. But let's go back a few months. To determine the best course of change, the NASD appointed a Special Committee, headed by Warren Rudman in November of 1994.

The Committee found that the NASD's regulatory responsibilities were expanding. It noted that Nasdaq, which didn't even exist when the NASD was created, continued to grow by leaps and bounds. When the Committee had looked at every aspect of the NASD's responsibilities, it came to two major conclusions: 

  • One...that the present corporate structure simply wasn't suited to allowing the NASD to succeed as both the primary regulator of the U.S. broker-dealer profession and the regulator, operator, and owner of The Nasdaq Stock Market.

  • And two...that changes needed to be made to the disciplinary and enforcement process, which was becoming, in the Committee's estimation, "more contentious, complex, and consequential than the existing system was designed to accommodate."

With respect to corporate structure, the Rudman Committee did not recommend a formal "divorce" between the NASD and Nasdaq. What it did recommend, though, was that considerably more daylight be put between the membership association and the market.

 

The NASD Board and its members have since acted on this recommendation by approving a new corporate structure. It consists of a parent organization NASD, Inc. which oversees two separate and independent subsidiaries: first, NASD Regulation, Inc., which is responsible for regulating the broker-dealer profession and for surveillance and enforcement of Nasdaq trading rules and, second, The Nasdaq Stock Market, Inc. which is responsible for operating the Nasdaq market and other trading systems.

 

What you have, then, are two separate subsidiaries each with its own agenda, its own priorities, and its own independent staff, budget, and policymaking Board.

 

Let's talk about policymaking for a minute. Policies set day-to-day agendas. They set future directions. When the policy-making structure changes, the policies themselves change and the policy-making structure at the NASD has recently undergone a major overhaul.

 

Board composition has been re-structured to include 50 percent non-industry participants in each subsidiary Board and a majority of non-industry Board members for the NASD parent, which makes it the first SRO to establish such a standard. The restructuring was accomplished when members of the new Boards for the NASD parent, NASD Regulation and Nasdaq were selected. You might call it "investor protection by equal representation."

 

Assembling an extremely knowledgeable, very hands-on, NASD Regulation Board was my first and highest priority when I took the job a few months ago, and I am very pleased with the results of the selection process. I'm looking forward to working with the Board which includes two former state securities administrators and three former SEC commissioners. The industry and non-industry members together bring a diversity of experience and insight to the table which will serve the organization and the market extremely well. Most importantly, each Board member is one hundred percent committed to upholding the integrity of the marketplace by heightening the quality of regulatory protection we provide.

 

Marketplace integrity always begins with a reasonable regulatory scheme plus active enforcement. Consistent with my record as a federal regulator, I am 100% committed to those concepts, and I am presently working to add significant resources and improve efficiencies to the examination and disciplinary processes.

 

At the same time, it's essential that we harness technology to maximize our effectiveness. Here we can take the lead from the Nasdaq market, which is constantly upgrading technology to improve market efficiency in the face of increasing volume. We have to do the same thing, because the volume of regulatory business we're being asked to handle continues to grow.

 

Every regulator, including NASDR, needs to make the most of its staff and monetary resources. This means leveraging those resources with other regulators, including NASAA. It also means making a concerted and continuous effort to coordinate examinations, and to avoid regulatory duplication. Regulators as much as securities firms benefit from coordinated exam planning. All of us have far too much on our plates to waste resources layering on redundant examinations. We are committed to improving this process and hope you will work with us to achieve broad coverage, yet efficiency in examinations, and give full effect to the MOU we all signed in November.

 

Next, we are making substantive changes to our disciplinary process that will make that process both more efficient and fair to all participants.

 

The biggest change to the disciplinary process is the addition of professional hearing officers. Hearing officers will be employees of NASD Regulation and will be voting members of a disciplinary hearing panel. The Rudman Committee recommended that we establish a formal Office of Professional Hearing Officers within NASD Regulation, and we're well on our way to full implementation of that recommendation.

 

Turning the recommendation into a reality has meant making significant changes to our Code of Procedure, which we're in the process of doing. The changes clarify the role and responsibilities for Hearing Officers: 

  • They will be given the ability to exercise key responsibilities in administering the pre- hearing and motion process.

  • They will also oversee the discovery process, ensuring that all relevant documents available through expanded discovery rules have been timely produced.

  • Hearing Officers will also guard against "ex parte" or other improper communication during all phases of the hearing process.

There's one more recommendation from the Committee that I want to mention because it affects NASAA directly. The Committee recommended the creation of a formal national liaison function at the NASD to coordinate regulatory and enforcement policy with the SEC, other federal regulators, the states and our SRO partners.

 

The NASD has had an informal liaison function through which joint initiatives are planned and implemented, and the process has worked fairly well but it can be improved. We intend to follow the Committee's recommendation to formalize our communication and coordination. There will be more to report on this in the coming weeks, but we're not going to wait for the formal creation of this function to begin better communication with you and other regulatory groups.

 

As we continue to lay a foundation for improved self-regulation, we have an obligation to prove that we can be effective regulators without limiting the creativity or the competitiveness of our members. In virtually all instances, creativity and competition generally provide greater services and benefits to investors. In this regard, we must avoid the tendency to view regulation in zero sum terms: whatever is good for the public must be bad for the industry. That's simply not the case.

The industry, like the markets themselves, runs on investor trust and confidence. Where we can extend a helping hand to our members in the form of compliance tools, improved communication and disclosure, better service instead of just holding up a stop sign or taking an enforcement action we should do so.

 

And we're working on it. An internal staff re-organization is underway that will help us better balance member service with member regulation, especially in the areas of arbitration and CRD since each of these areas of service has a strong regulatory component. But the bottom line has to be whether or not our actions enforcement proceedings, market surveillance, preventive regulation, services, or other activities result in the ultimate protection of investors.

 

Having professed to you my singular commitment to effective, proactive regulation, there are three areas that I would like to ask for your ongoing assistance.

 

The first is in generating greater interest among state and local district attorneys in cases the NASDR feels warrant criminal prosecution.

 

I think we're all in agreement that monetary and other sanctions are no substitute for criminal prosecution. The courts can be the most effective vehicle for dealing with fraud and other egregious violations of customer trust. The threat of jail time for misappropriation of customer funds needs to be real. The simple reality is that the threat of criminal conviction fosters compliance.

 

For our part, we have informed our District Offices that state securities administrators are to be informed of referrals to administrative, civil, and criminal authorities. A formal, internal policy regarding referrals has been prepared and recently circulated to designated enforcement policy committee representatives. The policy was developed in partnership with your designated representatives and is just one example of how I envision our organizations working toward a common goal. We will also more actively solicit your help in interesting the local criminal authorities in pursuing cases including theft, misappropriation and conversion.

 

Second, I would ask for your continued cooperation in joint enforcement efforts, such as the recent Piper Jaffray case and the broader joint regulatory sales practice sweep that NASAA, the NASD, the NYSE and the SEC conducted.

 

Formalizing the liaison process will help these joint efforts. The reality is that a one regulator often can't get its arms around a nationwide problem. But it's just these kinds of problems that impact not scores but potentially hundreds, even thousands, of investors. They're exactly the kinds of cases that NASD Regulation and our regulatory partners must pursue.

 

A precedent for successful joint efforts has been established with the Piper Jaffray case an extremely complex and labor intensive investigation involving mortgage-backed derivatives. Something on the order of 25 joint depositions were taken, not to mention the tens of thousands of pages of documentation that were reviewed. It took staff and resources from both the NASD and NASAA to deliver the monetary sanction totaling almost $2 million and more importantly, the $67 million restitution fund for investors.

 

But our cooperation needs to extend well beyond the investigative and enforcement phases. This is eminently clear after you study, say, the findings of the joint sales practice sweep which resulted in enforcement referrals for one-fifth of the 179 firms that were part of the sweep and letters of caution or deficiency letters to one-fourth of the firms.

 

The enforcement referrals and cautions are a sign of just how much work we as regulators have to do to raise the overall level of protection to investors and require firms to substantially raise supervisory standards.

 

The sweep also made clear that whatever is being done to remind our members of their supervisory obligations we have to do more. We are working very hard in following up on the sales practice sweep with some specific recommendations that we believe will help to address the supervisory problems identified.

 

We are focusing on innovative ways to deal with the problem of rogue brokers, heightened supervision of these brokers, and inadequate supervision of all brokers by firms.

 

At the same time, we have to be responsive to each and every customer complaint we receive. A new rule now requires members to report to the NASD the occurrence not only of customer complaints but a variety of regulatory and internal actions. In addition, the rule requires our members to submit to us quarterly statistical summaries of all customer complaints.

Not only will we follow up on all and I mean ALL complaints, but we will analyze this ever growing database for patterns and trends that will help identify problem firms and individual brokers more quickly and more completely.

 

I would also like to make it easier for investors to log their complaints with us. NASD Regulation will soon be launching a site on the World Wide Web. This should ultimately provide an excellent means for investors to contact the NASD directly if they have a complaint. In other words, we want to use the web site not just to give out information, but to receive it, as well.

This brings me to the third area where we can work cooperatively. It's in the area of disclosure of information about our members to the public.

 

The last year or so has seen the NASD's public disclosure program moving in close step with where NASAA and more to the point, where investors want it to be.

 

The NASD Board has in fact agreed in concept to release full public disclosure of CRD information. The concept will be fully implemented in 1997, when all state jurisdictions and SROs should be completely operational in the new CRD.

In the interim, the NASD and NASAA are working out our deletion protocols to clean up our database to make it ready for prime time, if you will.

 

We are also taking steps to implement disclosure of matters that under current policy are not disclosed by us. This includes all pending arbitrations and arbitrations settled in amounts of $10,000 or more. It also includes customer complaints settled in amounts of $10,000 or more. In addition, we will begin disclosing pending customer complaints of $5,000 or more. We expect to implement all of these changes no later than year end.

 

I've been quite public about my own view that it is vital to give the public convenient access to the records of brokers.

The key word here is convenient. If we can make this information available on-line and the logical place is the NASD Regulation web site we should, and that's the direction we'll be taking things.

 

Once you say you're going to release all this information, it suddenly makes the brokerage community extremely concerned about the content of this information. Those concerns are legitimate. Both the NASD and NASAA have been wrestling with what qualifies as a de minimis event and when do you wipe a broker's slate clean.

 

For its part, the NASD has established that any customer complaint of $5,000 or more must be reported to the CRD thus establishing a de minimis threshold. And in its January meeting, the NASD Board voted in favor of a two-year deletion provision that would apply to customer complaints that go nowhere or are settled for an amount less than $10,000.

 

NASAA's Board voted its approval of an identical provision, and the NASD heartily endorses the action. When you clean off the jaywalking violations and dormant complaints, you shed more light on the information that can really help the public make effective choices with respect to researching a broker's credentials.

 

It's very important that the public hears the states and the NASD speaking in one voice on the public disclosure issue. It is equally important that we're in agreement with respect to data input and maintenance. At the moment, I think we're harmonizing pretty well.

 

Those are three major areas where it makes sense to develop a stable and lasting partnership.

 

Effective partnerships take work and I'm here to tell you that NASD Regulation is committed to doing whatever it takes to make our partnership succeed. I'm talking about working with you on issues where you need our help whenever and wherever they arise. I expect nothing less from you, as well.

 

I'm also talking about keeping you informed about on-going changes and permutations within NASD Regulation. We are a work in progress. If I have been light on details about the organization's regulatory agenda, it is because that agenda is just being shaped. The prioritization process is going on as we speak.

 

Now that a Board has been selected, the organization can concentrate on policy making and how best to do our business. There are significant changes on the horizon. We want to keep you informed about our actions and our thought processes. I personally welcome any and all input you might have that will help us more completely fulfill our regulatory obligations to the public.

 

Thank you.