finra

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

NASD Spring Securities Conference

Chicago, IL
May 25, 2005 

     

Good afternoon and welcome to you all.  In these days of intense regulatory activity, it is testament to your commitment to compliance that you are here with us this week.  So, thank you.

 

I have spoken many times about the scandals of recent years that hurt many investors and damaged the industry's reputation.  But, today, rather than focusing on the problems of the past, I want to talk about some of the opportunities—and the risks—that we face in the future.   

 

I'm not suggesting that we forget the mistakes of the past or that all problems have been resolved.  And, I am sure we have not yet learned all of the lessons that recent history can teach us.  This conference is one of many ways to advance our understanding of what happened—and what we can do to ensure that such scandals never again occur.  But, I do think that it is equally critical for us to look forward so that we can work together to meet the challenges ahead.

 

As the Social Security debate has demonstrated, one of the most important issues facing the nation is retirement savings.  We are all familiar with the statistics that show how little Americans save:

  • During the first quarter of 2005, personal savings as a percentage of disposable personal income was only .6% —the lowest level since the Great Depression.  This compares with Germany's 11 percent rate and Japan's five percent savings rate.  

  • More than 50% of all workers do not participate in any kind of employer pension or retirement plan. 

  • The average balance an individual has in his or her 401(k) plan is about $69,000, and even this small amount is often tied up in company stock.

  • One in five workers does not contribute enough to qualify for the full employer matching contribution.  

These statistics tell a very depressing story.

 

But, we can't adequately address the country's retirement savings and investing needs unless we understand the demographic changes that are shaping the nation's future.

 

Today I would like to focus on three demographic changes.  First, the aging of America.  In 2003, there were almost 36 million people aged 65 and over in the United States, accounting for over 12 percent of the population.   By 2030, at least one out of every five Americans will be over 65. 

 

Second, the coming of the "echo boomers," those young investors born between 1977 and 1994.  How will their investment needs differ from the generations that preceded them, and what compliance challenges will you face as you serve this younger generation?

 

Finally, I'd like to talk about other unseasoned investors, particularly our growing immigrant population and older women.  These new investors will present many opportunities, but they also will require financial education and attention.

Our industry has a special role to play in helping Americans prepare for retirement.  We can help to ensure that they set realistic financial goals, learn the principles of sound investing, and understand the products that are offered to them.  The coming years will provide tremendous opportunities for the industry if we help Americans reach their financial goals.

 

NASD will help lead the way.  Last year, NASD's Investor Education Foundation awarded 11 grants, totaling more than $1 million, which are directed to investor education.  Many more will follow, as the Foundation will fund the development of a broad array of investor education programs and studies in the coming years.   NASD also will continue to issue Investor Alerts, which inform the public about specific investment issues and provide tools for investors, such as expense calculators and learning centers.

 

We recently amended our advertising rules to permit brokers to offer their customers investment analysis tools.  These interactive computer-based tools permit investors and their financial advisers to estimate the probability that an investor will meet his or her financial goals, given their current savings rate and choice of investments.  These tools also can recommend a different savings rate and a different investment allocation to increase the probability that an investor will meet his or her goals.   In doing this, we have given more Americans access to the types of information that demonstrate the power of saving and investing.

 

But I think we can do even more.  Of course, we will continue to protect the public from misleading sales material and advertising.  But some advertisements do not tout particular securities.  Rather, they encourage the public to save or invest for retirement.  This is an important message and I applaud the firms that have taken this approach.  We are working with SEC staff to see whether boilerplate disclosure can be simplified or even eliminated from these types of messages.

 

I am pleased to note that the brokerage industry also has taken steps to encourage Americans to invest for their retirement.  Indeed, just as it is your responsibility to your customers to do so, it also is in your business interest to do so.  The industry has created new products and services for its customers and, you have done so at a time of increased competition from investment advisers, financial planners, and insurance agents—all of whom are subject to different, and in many ways, lower standards than the sales practice rules that we impose upon the brokerage industry. 

 

Much of that effort has been directed toward the baby boomers, who are just beginning to retire.  This aging population is unlike any of its predecessors.  It is better educated than previous generations and its average income is higher.  Baby boomers will live longer, healthier lives.  Many will have multiple careers and families.  They will remain active into their 80s and beyond, and they will travel and consume more goods than their predecessors.

 

This new generation of retirees will present many opportunities for the industry.  One study estimates that at least $41 trillion will shift from one generation to the next over the coming 50 years.   Those who have saved and invested, who have accumulated far more wealth than their parents, must do something with it.  Those who have not saved enough, those who are not on the path towards financial security, must be encouraged.  In either case, the aging population needs sound financial advice to protect their wealth and secure their retirement.

 

The brokerage industry has responded in many creative ways.  I would like to mention just a few examples. 

 

Many firms have fundamentally changed their compensation structure.  These firms offer fee-based brokerage in addition to the traditional commission structure.  Fee-based brokerage is not suitable for every customer.  However, it can help those customers who engage in significant trading activity, by aligning the firm's interests with their own.

 

Moreover, the financial services industry has introduced new products to help Americans who are approaching retirement.  For example, new types of immediate annuities permit a customer to convert his accumulated wealth into guaranteed income streams.  Life cycle mutual funds, which offer portfolios that change according to an investors' age and risk tolerance, can help baby boomers who will soon retire with a long life expectancy.

 

These are just a few examples of how the industry has responded to the needs of aging baby boomers.  I expect firms will continue to innovate and develop many new products and services that are unfamiliar to us today.

 

At the same time, the industry's effort to meet the needs of the aging population presents risks to you and your customers, and the need to ensure that  compliance procedures address these risks.

 

The first risk is to assume that baby boomers have a level of financial acumen that eliminates the need for proper suitability analysis.  True, as a group, this generation is better educated than those that preceded it.  This is the first generation that became broadly comfortable with mutual funds, with stock and bond investing, even with hedge funds and non-conventional products.  But, suitability is not a "group" analysis.  Whether an investment is suitable for a particular investor—and whether the investor understands the risks and potential rewards of the product—will depend upon his or her particular circumstances.   Unfortunately, many baby boomers are trying to play catch up with their retirement savings.  We must help them understand that chasing high returns through risky investment strategies is not the path to a secure retirement.

 

Many of the suitability concerns are the same as have been faced with previous generations of elderly.  But, as a matter of fact, the suitability analysis may be even more complex than it has been historically.  A baby boomer will need to maintain retirement income for a longer period of time, and may even require continued accumulation of wealth during retirement.  But he also may have the same concerns about illiquidity and market volatility as any other elderly person. 

 

We cannot allow the greater wealth and financial sophistication of the aging population to lull us into a sense of complacency.  Suitability challenges must be addressed one customer at a time.

 

A second risk comes from the very product innovation that has generally served your customers so well.  A new, innovative product will not be suitable for every investor.  When a firm offers a product for the first time, the firm may be tempted to market certain features without presenting a full and balanced description of the product, and brokers may be less familiar with the product.  The firm must ensure adequate training and guide the brokers' disclosure and suitability analysis.  We recently issued a Notice to Members that suggests a variety of compliance measures concerning the sale of new products. I strongly urge you to look at the guiding principles that are outlined there.

 

A third risk is a failure to analyze the status of these new products under the federal securities laws.  Suppose your broker wishes to sell a new financial product that combines investment with an insurance component or an estate-planning feature.  Is it a security, or is it something else? This question will become important because the firm must supervise the sale of securities by its brokers.

 

Let's consider one example: equity-indexed annuities.  Equity-indexed annuities are financial products that guarantee a stated interest rate and protect against loss of principal.  They also earn additional interest based, in part, upon the performance of a securities market index.  Consequently, they may be useful for baby boomers who need to continue their wealth accumulation, while protecting the wealth that they have already built.

 

Some equity-indexed annuities are not registered as securities and firms allow their reps to sell these products as if they were traditional insurance products.  However, the legal distinction between a security and insurance is not always clear, and it is very difficult to determine whether a particular equity-indexed annuity is a security or a form of insurance.

 

These firms are taking a risk.  What if the equity-indexed annuity is, in fact, a security?  Then the firm has a "selling away" problem that it has not adequately policed.  Moreover, equity-indexed annuities are very complicated products that do not provide the liquidity that some older investors may need.  Consequently, they present disclosure and suitability issues that the firm has failed to address.  I urge you to consider whether your reps should be selling any unregistered equity-indexed annuity without being fully supervised by your firm.

 

Equity-indexed annuities are only one example of a financial product that a firm might erroneously treat as a non-security.  Other examples include tenants-in-common exchanges, and viatical and life settlements.   NASD considers all of these products to be securities, subject to firm supervision.

 

In summary, our aging population presents many opportunities for the brokerage industry.  You are responding to the needs of this generation by creating new services and products that can help many customers.  Nevertheless, your response to this demographic phenomenon requires careful supervision, particularly with respect to new products.

 

A second demographic phenomenon concerns the so-called "echo boomers," the generation of Americans born between 1977 and 1994.  While there are 75 million baby boomers, there are also 72 million echo boomers.   These young investors started entering the labor force about five years ago.   They are beginning to accumulate wealth and plan for their family's future.  How will you serve them?  What special challenges will they present?

 

Some might argue that these young investors will feel more confident about their own investment ability.  They are skilled Internet users and may be perfectly capable of researching stocks, bonds and mutual funds.  They are more familiar with defined contribution than defined benefit plans.  Therefore, they might shun the services of a broker-dealer or financial planner.

 

I doubt it.  These investors will find that the markets can be volatile and the best choice of investment is often unclear.  And they will need a broad array of services to help them meet their financial goals.

 

I believe that the brokerage industry can meet the needs of these young investors.  Many of the same tools that the industry has recently developed primarily for the baby boomers will also serve the echo boomers.

 

But, what are the particular challenges that the echo boomers present?  We have heard that this generation of new investors does not believe that it can count on Social Security.  If they are correct, then their own financial decisions are even more important.  It will be incumbent upon the industry to encourage these investors to increase their savings and diligently build their wealth.

 

These young investors also may not have experienced the dramatic movements of the stock market, such as the bull market of the 1980s and 1990s and the collapse of the Internet bubble.   It is possible that these investors will embrace the latest investment fad or chase the performance of the hottest mutual fund.  We must teach the lessons of the past, and guide these investors along a prudent, fiscally responsible course.  They do not need to "swing for the fences."  Better for them to understand the virtues of long-term investing and aim for a steady, acceptable return on their investment.

 

The third demographic change that I would like to discuss concerns the unseasoned investors, particularly the growing immigrant population and women.

 

Our nation is becoming more racially and culturally diverse.  Much of this growing diversity comes from new immigration.  Following the patterns of past immigration, the children of today's immigrants will experience an increase in wealth over that of their parents.  A recent study compared the incomes of first and second generation Hispanics and found that, while 11% of first generation Hispanics have income of more than $50,000 per year, this figure rises to 27% for second generation Hispanics.

 

As their incomes rise and their wealth accumulates, the immigrant population and their children can be expected to devote a higher percentage of their resources to investment.  They will share the concerns of their fellow Americans in seeking financial security and planning for their families' futures, from housing to college to retirement.  These investors present opportunities for the brokerage industry.  But, many of them will be inexperienced with the American markets, and firms will have to devote significant time and resources to their financial education.

 

Some broker-dealers already have become very active in immigrant communities.  One recent article described how a large firm created a unit to reach out to the immigrant and minority population.  In 2001, this unit began its work with a $500,000 budget.  Within four years, the unit had brought in 3,000 new accounts and $6 billion in assets to the firm.

 

NASD also is reaching out to our immigrant communities.  The NASD Investor Education Foundation recently provided a grant to Metropolitan New York to create a national education project for financial decision-making.  The material will be in English and Spanish, and will be designed to appeal to people who may not be seeking investment advice.

 

The Foundation also provided a grant to the First Nations Development Institute, to provide investment education to Native American populations.

 

Women, and particularly older women constitute another group of underserved investors.  Women have different investing needs than men for several reasons:

  • Department of Labor studies show that women earn an average of 24% less than men doing the same jobs.

  • The Labor Department also reports that women spend an average of seven years out of the workforce—taking time out to raise children and care for aging family members. These circumstances may lead to the situation where many older women in particular, find that their retirement plans are under-funded.

  • According to the Census Bureau, women, on average, live seven years longer than men and at some point in their lifetimes, 90% will be the sole financial decisionmakers, whether they never marry, get divorced or are widowed.

It is tragically stunning to me, that a third of all women over 85 without a husband are classified as poor, even though only one-sixth were poor when they entered retirement.  Because of this significant risk, women particularly need the financial education and skills necessary to prepare for their own retirement.  The brokerage industry can help, through education and guidance.

 

Here again, the industry is stepping up its efforts. A quick tour of firm web sites shows that many are beginning to dedicate pages to the unique needs of women investors.

 

The NASD Investor Education Foundation has commissioned several investor education programs for women investors.  One program, in conjunction with the Boston College Center for Retirement Research, will develop an interactive educational program, with an emphasis on retirement planning.  It will be primarily directed to 45 to 60 year old women.  Another grant to Iowa State University will study gender differences in investment.

 

Working with the industry and consumer groups, I hope that we can close the gender gap in investing.

 

Conclusion

 

A great financier of the 20th century, Bernard Baruch, once said the following:  "Millions saw the apple fall, but Newton was the one who asked why."

 

Many can see the ways in which the American population is changing.  Baby boomers are aging while the work force is open to the younger generation, immigrants and women.  Many firms can see the opportunities that lie ahead.

 

The successful firms will ask why.  Why have these new investors sought their services, and what can be done to help them achieve their goals?  A firm's success will largely depend upon the quality of its service.  Success will also come to those who deal honestly with their customers, put integrity above profit, and adhere to the highest ethical standards.

 

Thank you for your attention.