finra

Remarks by Mary L. Schapiro
Vice Chairman, NASD President, Regulatory Policy and Oversight

SIA Compliance & Legal Division Conference
JW Marriott Resort, Palm Desert, CA
April 4, 2005  
 

 

Good morning and thank you for inviting me once again to visit with you during the annual conference.  Given the last few talks I have delivered from this podium, it is heartening that you continue to invite me to speak.  I know you will find it as remarkable as I do that some folks have found my recent addresses at SIA Compliance and Legal to be depressing or even frightening.

 

Okay, I think we have gotten the message that you have gotten the message.  So, now, take a deep breath and relax because our conversation this morning will hopefully be more forward-looking and positive.  And nary the words "Enron," "Gruttadaria," "research analysts," or "IPO allocations" shall escape these lips—well they just did but I will refrain from uttering that mantra for the remainder of my time this morning.

 

I want to share with you today my views on the role and importance of self-regulation.  At this time when the SEC is considering the role and construct of self-regulatory organizations, I think it important that the industry recognize its stake in self-regulation and not regard it as a burden to be endured, but rather as an opportunity to be reaped.  Will we disagree on policy or on the reach and extent of rules?  Yes, that is both inevitable and healthy.  But, that doesn't mean we have to be consigned to a working relationship of hostility or suspicion.  We can disagree and yet our efforts can be constructive. 

 

Am I describing aspirations for the future?  I don't think so.  I think this has been the experience of our relationship to date, but it has been forgotten or recast because of recent events.

 

I recognize there is a sense of exhaustion and frayed nerves from the pace of regulation.  We understand because we struggle to keep up as well.  But in this time when the SEC is proposing changes to SRO governance and structure, in this time when it is easy to utter the pithy phrase "where is the S in SRO," it is very important that you understand us, what we do, how we do it and the constant role that you play in our deliberative policy processes.

 

First, a word about you, I mean "you" as in this audience.  The financial services industry suffers from no shortage of intellectual firepower.  The complexity resident in understanding certain products, financial forecasting, responding to customers' needs or the pricing of a derivative, only begin to hint at the breadth of subject matter to be mastered and conundrums to be solved.  Most people in this industry specialize in certain segments of it.  But it is this audience who must master the business person's area of endeavor across myriad business lines, then apply the correct laws and regulations and make the judgment calls.

 

Many of you become counselors to your in-house clients on matters well beyond the technicalities of applicable regulations.  And you and I share the secret as to just how difficult this role is because all of us understand, that in this business there are often more questions than there are answers.

 

When I come to these meetings, I understand that I am addressing among the best and the brightest in the financial services industry.  And the truth is that you need to be.  Long gone are the days when the industry could populate the compliance officer position with the employee who drew the shortest straw.  The notion of this group in any way as "support staff" or somehow "back office" is dangerously antiquated.  We understand your importance and role.

 

Whatever criticism we took for our CEO certification rule, I trust no one disagrees with its animating purpose-that compliance professionals occupy a critical role within the broker-dealer and should be recognized as such.  And we know first-hand just how talented you are.  We rely on many in this room to teach us the in-the-weeds details of what we must regulate.  It has always been our experience that you took up that task with zeal and generosity.  You did that even in times when our policy and rulemaking initiatives had you at wits end and when you vehemently disagreed with us.  And there is no shame in a regulator recognizing that and saying thank you.  As I said earlier, a cooperative relationship between the regulator and the industry is not an aspiration, it is a reality and I think it has always been the case.

 

I didn't become a regulator to just be a cop.  Being a police officer is a wonderful profession, but I don't really see that as my primary role.  I am drawn to regulation by the desire to shape policy and implement regulatory structure that will serve to protect the interests of investors and the integrity of the capital markets.  I have said before that, there is no more important resource to this country than our capital markets.  In my view this is true not because money and finance must be valued for their own sake over all other things.  It is true because it is the financial strength of this country and its citizenry that keeps it strong in all of our shared national endeavors.

 

What drives me, indeed what drives virtually all of NASD, is to develop regulatory policy that will protect markets, allow them to flourish, and make sure that investors' interests do not become inappropriately subservient to commercial interests.  We seek to make sure that the financial services industry stands on sound and solid stanchions that are not undermined by any lack of trust, integrity or ethical conduct that cause it to fall from its own weight.

 

In thinking through how to present our view of self-regulation, I thought it might make sense to run through our own top-8 myths on the subject.  Before I begin I want to say that I do not mean to present NASD as either perfect or defensive in the face of criticism.  We accept that we reside in a permanent state of imperfection that must be met with permanent vigilance to get better at what we do every day.  With that noted, here we go:

 

Myth number 1NASD examiners are required to come back with something wrong on every examination we conduct.  Only a small percentage of the 2500 routine exams we conduct each year result in any type of disciplinary action.  We don't employ quotas as an enforcement tool.   We are an organization whose culture is to be driven by the facts we confront.  Trust me, conducting an exam and finding a member in compliance is not a bad day for us.  I will note on a matter related to examinations, that we do hear from firms that sometimes they get a view expressed from an examiner that they think is clearly wrong.  I always ask the same question:  "Who did you call next?"  Examiners have supervisors and matters should be followed up the chain from there if necessary.

 

We employ great people throughout our organization, but we recognize that errors will be made and there is no institutional desire to back our people in aid of the wrong answer.  When necessary, go up the line—we are in the best answer business not the saving face business.

 

Myth number 2Wells submissions in enforcement cases are a waste of time.  [Actually, this one is true….  I am only kidding!].  Look, it is my hope and expectation that we think long and hard about the cases we bring, because in this area we should never be nonchalant.  If many cases fell by the wayside because of the Wells process that would indicate a failure on our part in doing our homework early and completely.  But that doesn't mean we are married to a result before the submission of the Wells.

 

Our reaction to finding a fact, circumstance or construction of law that we hadn't considered earlier is not to sweep it under the table.  We have dropped big cases and small cases against firms of all sizes in the Wells process.  For us that doesn't spell failure in a specific case, it means the check on the system has worked.

 

Myth number 3The regulatory sweep process is out of control.  I think I can say that currently-and this has been true for some time now—we have a better handle on sweeps.  No NASD office or department has carte blanche to initiate a sweep.  We employ a centralized approval process to review sweeps before they commence to make sure they are necessary, focused, consistent with our regulatory obligations and do not overlap with something else that we have in play elsewhere at NASD, and to limit, when possible, overlap with the activity of other regulators.

 

And, as a result of a meeting just last week with a number of firms, you will see in all new sweep letters, a contact name and phone number of someone to call at NASD if you have already received a similar request from another regulator. We will then contact the other regulator and work it out so that no firm is subject to the same sweep from two regulators.   While sweeps are an extremely valuable tool for us—and a permanent component of our regulatory toolset, we will endeavor to increase the efficiency and reduce the burdens of sweeps going forward as best we can.

 

Myth number 4Self-reporting to NASD on regulatory violations gets you nothing.  I sense the answer that "confession and humility are their own rewards" will have only a certain limited appeal with this audience.  Fair enough.  But, self-reporting brings both tangible and intangible benefits to investors and firms.  It is true, however, that self-reporting is not a get-out-of-jail free card.  Nonetheless, the firm that self-reports inevitably gains a measure of credibility in dealing with us both in its efforts to work through the pending problem and in the relationship generally.  Moreover, it is the case that self-reporting firms face lower settlement sanctions than they would otherwise and we will cite that fact prominently in the release that we publish on the matter.

 

Myth number 5NASD is in the gotcha business and preventive compliance is not our concern.  Just, plain, flat out, not true.  We are not willing to be your compliance department, but that's not the same thing as being disinterested in preventive compliance.  We have done templates and workshops on anti-money laundering and business continuity plans.  On our website you will find a training template for personnel on mutual fund breakpoints, a breakpoint checklist and worksheet to help members and reps gather the information necessary to deliver breakpoint discounts on sales of Class A shares of mutual funds, a searchable OFAC list to apprise yourself of blocked countries and nationals with whom you cannot conduct business, a training webcast on mutual fund share classes and e-learning courses on variable annuities.
 
Recently, we held a phone-in conference on how the new supervisory controls rule works to which over 1,000 firms dialed in.  This week, we will release a paper detailing the Best Practices in new product approval and deployment.  Finally, our own conferences are designed with the purpose of educating those who seek to practice preventive compliance.  This list is certainly not exhaustive and we will keep expanding our efforts in this area.

 

Myth number 6We favor certain business models over others.  This is one of my favorites because the nature of the complaints we get on this proves, I think, that we are not guilty.  The independent contractor firms are sure we prefer the traditional national or regional wire-house model.  Small firms think that we only care about big firms and big firms are sure that we enforce the rules only against them and allow small firms to do whatever they please.

 

Let say me something only slightly tongue-in-cheek, how can we be favoring somebody when everyone is convinced that we prefer the other business model?  I will state it simply:  we are agnostic as to business model but we believe that business model is not an excuse for the ability to be in compliance.  We maintain standing committees for small firms and independent contractor firms not because we cater to any one particular business model but because we do not want to hinder competition in the enactment of rules and policies where it is not appropriate and necessary.

 

Myth number 7Once a rule proposal is published in a Notice to Members for comment, it is as good as done.  I hear that often and it mystifies me because it begs an obvious question.  If that were true then why publish the Notice to Members, effectively doubling the time for the notice and comment process?  We issue Notices to Members because we want the comments and we want to improve imperfections.  Most particularly, we are always anxious to receive comments that help us to understand the operational implications of our proposals.

And, we have certainly issued Notices to Members and subsequently did not follow up with rulemaking because we either thought the Notice by itself had a sufficient salutary effect or the contemplated rulemaking wasn't right as a matter of substance or timing.

 

And finally, Myth number 8There is no "S" in SRO.  I have to admit it is a catchy, jingly sort of myth.  And it is the most important myth that my comments today will address.  And it must be addressed, because that myth says you have no investment in self-regulation.  As I noted in the beginning of my talk this morning, last year I stood before you and delivered what some felt was a harsh speech about new realities on the regulatory front.  There is no question but that the last several years have seen a heavy stream of rulemaking and enforcement.  And, I know that in the wake of the Commission's recent SRO Concept release that some have questioned whether a system of direct supervision by the SEC would not be superior.  I would urge you not to let recent events obscure the truth of the industry's role in self-regulation or the invaluable role of self-regulation to this industry.

 

The "S" in self-regulation was never meant to connote industry control of its own regulation because, bluntly, I must tell you that that form of self-regulation would already be history in the wake of recent events as it would have no sustaining credibility.  The "S" in self-regulation is the role of industry in informing regulation and, in my view, that is the essential functional element needed if self-regulation is to have any meaning.

 

Virtually every rule that we file with the SEC goes through a rigorous process of consultation with the industry.  It may be presented to district committees, the Small Firm Advisory Board, the Membership Committee, the Uniform Practice Code Committee or a subject matter expert committee such as Corporate Finance or Market Regulation; each of these committees are populated by persons associated with members.  This consultation process is neither passive nor devoid of impact.

 

Our recently issued Notice to Members 05-21 on additional disclosures in debt market transactions was heavily revised due to comments by the Fixed Income Committee and the Small Firm Advisory Board after the proposal made two passes through each committee.  Notice to Members 04-83 dealing with conflicts of interests in connection with the issuance of fairness opinions in change of control transactions was fundamentally changed in its approach based on comments from the Corporate Finance Committee.

 

Even the much-maligned final CEO certification rule bears little resemblance to the proposal that the NASD board approved for initial publication in a Notice to Members.  The list goes on and on because our rulemaking process is replete with examples of informed industry impact without industry control.

 

But, I believe that self-regulation is uniquely positioned to strike the appropriate balance because of its tradition of putting investors and markets first and yet allowing the informed views of those regulated to help shape regulation.

 

I also believe that self-regulation elevates the financial services industry from being merely a business to being a profession.  A profession stands apart from other commercial endeavors by virtue of the presence of widely accepted and applied ethical principles.  NASD rule 2110 is an ethical rule, it compels observance of high standards of commercial honor and just and equitable principles of trade.  Would you want to be associated with an enterprise that aspires to less?  You do not find those words in the federal securities laws.  But they are present in the SRO rules and they confer upon this business the status of profession with all attendant responsibilities that being a profession entails.

 

Doesn't all of the marketing and advertising in this industry boil down to the same simple thought—that the firm is here to know and serve the best interests of its clients? And, isn't that exactly what is meant by the words "high standards of commercial honor and just and equitable principles of trade?"  Can you expect to make a promise of trust and not comport yourself in accordance with those responsibilities?  Can this industry thrive, can you expect the confidence of investors and can endurance of our capital markets be counted on in the absence of ethical guideposts that are enforced by an SRO and informed by the industry?

 

I close with those questions, confident that I know your answer.  Thank you again for the invitation to speak.