Remarks by Mary L. Schapiro
Chairman and CEO, NASD
(As Prepared for Delivery)
NASAA Annual Conference
September 18, 2006
Thank you, Fred [Joseph, Colorado Securities Commissioner], for a very generous introduction and thanks to NASAA for offering me the privilege of being here today.
I haven't spoken to NASAA since the spring of 2001, which almost seems like a by-gone era, given all that's transpired in the securities world since then. The last time an NASD Chairman spoke at a NASAA Annual Conference was on September 10, 2001. And, of course, the day after that really was the end of an era. I want to say what a pleasure it's been to work with Patty Struck this past year. And I look forward eagerly to working with my friend, Joe Borg. I had the pleasure of spending some time with Joe recently in Montgomery, where he and I appeared together on an Alabama Public Radio program.
Joe has a tough act to follow in taking over for Patty, but he has the advantage of having done this before. I understand that Joe will be only the second person to serve as NASAA President twice. The first, of course, was Lew Brothers of Virginia in 1992 and '93, and if he hadn't been lured into the private sector, he might have tempted to go for a third term. Joe, I trust you'll be strong enough – and tired enough – to avoid that temptation.
I think most of you know Chip Jones, who has served as our State Liaison since 2001. Chip will be leaving that position to head our new Office of Member Relations, so we'll soon be hiring someone to take over for him as State Liaison, a duty he has performed with great skill. I understand Chip's golf game has improved substantially over these past five years and I'm going to assume that's purely coincidental.
NASAA and NASD have done a lot of good work together over the last few years – work that both you and we can be proud of. And what better example than the Waddell & Reed variable annuity switching case? That led to $7 million in fines paid to NASD and state regulators last year, and $11 million in restitution to be paid to Waddell & Reed's victims all around the country. I hope and expect our collective action on that case will lead others to think carefully about their clients' best interests when persuading them to switch annuity contracts.
The Waddell & Reed case was one impetus that led us to propose the annuities roundtable we held in Washington last May. We partnered with Glenn Wilson and Scott Borchert of Minnesota to plan that event and they, Patty and Joe very capably represented their states and your organization on the panel. I'm confident that the work that's being done to follow up on the roundtable will supply us with some good ideas on how to most effectively manage the regulation of fixed, variable and equity-indexed annuities.
As a result of the roundtable, we've formed a working group of regulators, including Karen Tyler of North Dakota, to work on the issues that came to light at the roundtable. The working group will consider the issues of disclosure, suitability, supervision and marketing of fixed, variable and equity-indexed annuities. Regardless of which regulator has jurisdiction over these products, investors deserve as level a playing field as possible. When product lines blur and regulators' reach is limited, we have an important responsibility to ensure that we work closely together to ensure the highest quality of investor protection. As you know, NASD, the SEC and securities regulators from six states have also been cooperating on a nationwide investigation of so-called "free lunch seminars" for senior citizens. We're concerned with whether brokers – who sometimes hold themselves out as specialists in seniors financial issues and planning – are complying with applicable rules and federal and state laws when they conduct sales seminars, and whether their firms are adequately supervising these events. We know that some brokers have lured retirees to seminars with the promise of a free meal and unbiased financial management advice, then sold them products that are likely unsuitable for their needs.
Yet, even with all our good work together, there are areas of disagreement between NASD and NASAA and, frankly, that's understandable.
Three areas come to mind as requiring continued discussion. BrokerCheck disclosure, expungement and arbitration. NASD is committed to helping investors both get the information they need to make good decisions, and assure that we offer them a fair forum to resolve their disputes. Let me spend a moment on each of these issues.
On BrokerCheck, there is a debate over whether certain historic customer complaint data, including un-adjudicated matters, should count against a broker when determining whether he or she is eligible for expanded disclosure in BrokerCheck. While NASD and NASAA disagree on whether the formula for making that determination should be applied retroactively or should only include events that occur after the proposed new rule takes effect, we both have the same goal – giving investors the information they need to make wise decisions when choosing a broker.
Regarding expungement, NASD continues to work diligently with NASAA and states to assess the effect of Rule 2130 governing expungement of information from CRD arising from disputes with customers. This is a rule that both NASAA and NASD worked for years to agree on before we submitted it to the SEC, and clearly we both want to be confident that it's working properly.
And on arbitration, NASD is committed to a providing forum that is fair to investors and that allows them to resolve issues without delay. And I think our track record of making improvements to our arbitration forum during the last few years demonstrates our commitment to an investor-friendly medium.
For instance, in 2003 we proposed significant changes to our Code of Arbitration Procedure, including simplifying its language and reorganizing it in a more logical, user-friendly way. The Code rewrite project now awaits SEC approval. Last year, in fulfilling a commitment that we made to NASAA, NASD completed its arbitration and mediation hearing location expansion project, and now has 68 locations – at least one in each state, one in Puerto Rico and one in London. This has given investors easier access to arbitration and mediation services.
NASD also filed several rule proposals with the SEC to further tighten the definition of who may serve as a public arbitrator in our Dispute Resolution forum, and the Dispute resolution staff is working with a task force of investor and firm representatives and arbitrators to develop additional changes to further tighten the definition of public arbitrator.
I bring up these areas of disagreement simply to assure you that we are not deaf to your arguments; we consider them carefully and we intend to work with you in good faith to find solutions that we all can live with.
What I really want to talk about today is something I find deeply worrisome. And that is the issue of fraud and other financial crime perpetrated against elderly Americans. This is, without a doubt, one of the most critical issues we as regulators are going to face during the next 10 years. And a major focus of my tenure as NASD's Chairman and CEO will be providing seniors and baby boomers with financial education and weapons against fraud, as well as catching and punishing those who prey on them.
Last week, NASD fined Securities America Inc. of Omaha $2.5 million for failing to adequately supervise a broker who had persuaded some older Exxon-Mobil employees to retire early, cash out their company-sponsored 401(k) and pension plans and reinvest the proceeds in accounts managed by Securities America. The broker then put these customers into variable annuities, ETFs and Class B and C mutual fund shares and told them, erroneously, that their monthly income from these investments would match what they'd been earning in salary. Thus, he assured them that in retirement, they could safely withdraw an amount equivalent to their salary every month. In addition to the $2.5 million fine, we ordered Securities America to pay $13.8 million in restitution to 32 customers.
We followed up on the enforcement case by issuing an Investor Alert that warns working people to be wary of suggestions or promises that they can live in financial comfort if they retire early, cash in their company pension plan and reinvest their retirement savings. Among the advice: Investors need to be especially skeptical when they are told that they can make as much in retirement as they did while working – such promises usually hinge on projections of unrealistically high returns and unsustainably large yearly withdrawals. They must be wary of pitches that invoke exceptions to Internal Revenue Code 72(t) as a "little known loophole" that allows you to retire early. There is a lot more to successful early retirement than avoiding a 10% tax penalty.
All the victims in Securities America case were upwards of 50 years old. Today, American households run by someone in this age group control more than 75 percent of the nation's privately-held wealth, according to the Federal Reserve. That amounts to some $16 trillion.1
People 60 and older account for about 15 percent of the U.S. population, but they comprise an alarmingly higher proportion of financial fraud victims. A survey of state regulators done for NASAA found that 45 percent of financial fraud complaints filed with those regulators are filed by senior citizens. In Florida, according to Don Saxon's office, it's 75 percent.
And these numbers are by no means static. Every day in the United States, 10,000 people turn 60. That's about 3.7 million new 60-year-olds every year. When these Baby-Boomers start swelling the ranks of the 65-and-over population in five years, the term "target-rich environment" is going to take on a whole new meaning.
Today, people 65 and over hold about 29 percent of the nation's net worth. By 2040, they are projected to hold 42 percent of it.2
Aside from the obvious fact that they have money, why are senior citizens disproportionately the victims of financial fraud? And what characteristics can be ascribed to seniors who fall for the machinations of con artists, as opposed to those who don't?
The answers to the first question – why? – are not so surprising. Research by AARP and others has shown that seniors tend to be more trusting and less skeptical than younger people. They have trouble spotting fraud. They find it difficult to end telemarketing calls. They tend to be reluctant to ask for advice about financial matters.
The answers to the second question – what are the distinctions between victims and non-victims? – are actually quite surprising.
The NASD Investor Education Foundation is particularly interested in these sorts of questions, so it awarded a grant to Wise Senior Services, which worked with the AARP Foundation on a comprehensive study of financial fraud perpetrated against the elderly.
The researchers released their findings in May of this year and some of them really took us by surprise. For example, one would think that investment fraud victims would be less financially literate than non-victims. It turns out that exactly the opposite is true. Also, fraud victims are likely to be better educated and better off financially than non-victims. This, too, seems counter-intuitive.
Less surprising, but no less disturbing, is that seniors who are victimized by financial con artists tend not to complain to authorities. In some cases, the con artist has used a psychological ruse to create the illusion of a friendship between himself and his victim, so the victim is reluctant to turn him in. In many cases, the victims don't file complaints because they're embarrassed about having been taken.
They really shouldn't be, because some of these con artists are highly skilled predators with a large bag of tricks. In fact, the NASD Foundation study found that investment con artists use a wider variety of nefarious tactics than do their counterparts in other areas.
Perhaps the study's most disturbing finding, though, is that investment scammers seem particularly adept at psychologically manipulating their intended victims.
Among the most common subterfuges are: leading targets to believe they'll win a valuable prize if they take the bait; suggesting that if they don't act right away the opportunity to invest will be lost; claiming a connection to some famous person or institution as a way of impressing the target and gaining his or her trust; creating a false sense of friendship between the perpetrator and the victim. If you are familiar with the Stockholm syndrome you will understand the psychological ploy of a fraudster who seeks to have his victim sympathize with him. Financial con artists often try to put their elderly victims in this state of mind.
These and other tactics cause what the researchers called a "psychological haze," in which victims' ability to spot and reject fraud is diminished.
And the end result is particularly tragic. You know, if you're 35 or 40 and a con artist takes you to the cleaners, you still have time to start over. But, if you're 65 or 70, you're largely out of time – and out of luck.
As valuable and illuminating as the NASD Foundation study is, we still need to know more. So, the Foundation has commissioned a follow-up survey of senior citizens that will supply us with a more detailed analysis of their investment behavior. For example, where do seniors get investment information? Have they been invited to investment seminars and, if so, what products were pitched to them? Do they rely on newspapers, magazines, TV and radio? If so, which publications and programs? Whom do they trust and why?
Armed with that information, which we will have within the next few weeks, we can fashion an anti-fraud campaign that reaches them through those same avenues. We will try to turn some of the tactics for defrauding the elderly into tactics for educating and arming them to protect themselves. For example, we already know from the NASD Foundation study that seniors are more likely than younger people to open and read junk mail. So, maybe mass mail would be an effective way of reaching them with anti-fraud and financial literacy materials.
Those are the kinds of questions we hope to be able to answer with the results of the follow-up survey, and we'll share those results with you and other regulators as soon as we get them.
As I mentioned, investment seminars present another set of problems. In the Securities America case I mentioned, the broker who bilked the Exxon-Mobil employees made his initial contact with them by inviting them to investment seminars. Some of these events are perfectly legitimate, but we're finding that many are not.
NASD, the SEC and securities regulators in Florida, California, Arizona, Texas, North Carolina, South Carolina and Alabama have a sweep underway to determine the extent to which sales seminars comply with our rules and state and federal laws, and whether firms are adequately monitoring and supervising reps who offer these seminars.
Since the sweep is still going on, I won't talk about it in detail, but I can tell you about a few things we've learned.
Our Advertising Regulation Department has reviewed seminar sales material and scripts and has found a substantial number of potentially misleading or exaggerated claims. We have seen a number of instances where there has been no supervision of the sales process and we have seen instances where little attention has been paid to the duty to recommend only suitable investments.
What have we learned from all this? One of the most important lessons is that offering educational resources on financial literacy and investing basics isn't enough. People generally don't fall for investment scams because they're ill-informed about finance. Quite the contrary, as our senior fraud study showed conclusively. People more often fall for investment scams because they're susceptible to the persuasion tactics of con artists.
Our efforts to educate seniors and others about finance and investing has to start taking these tactics into account. And that's going to be a challenge, to say the least. The basics of financial management – price-earnings ratios, yield curves, the difference between an exchange-traded fund and a mutual fund and so on – tend to be pretty basic and straightforward, and therefore not so difficult to teach. But how do we go about educating seniors and others on how to spot and avoid the so-called social persuasion tactics that con artists use to separate them from their money?
This is going to be a major focus of the NASD Investor Education Foundation, which is starting to formulate a comprehensive plan to tackle these issues. I expect that we'll end up with something similar to the ongoing military education campaign that the Foundation unveiled last year.
That campaign, funded from an enforcement settlement with First Command Financial Planning, includes a wide range of education and training resources to help all military personnel – from enlisted to flag officer – better understand the basics of investing and the capital markets.
The program has many components, including a specialized website, saveandinvest.org. . It serves as a trustworthy source of unbiased information on saving and investing, including, interactive tools and games, partner resources and more. We have also trained about 200 military spouses, done 22 military investor forums in locations as diverse as Pearl Harbor, Kings Bay Submarine base in Georgia and on the aircraft carrier Ronald Reagan during its maiden deployment in the Persian Gulf.
But, as we begin to fashion a similar program for seniors, we know that setting up a website like saveandinvest.org will be of limited value. AARP reports that less than 25 percent of Americans over 65 go on-line, and those who do, use the Internet mostly for e-mail and shopping.
I mentioned earlier that some brokers who put on investment seminars claim to hold some official designation as senior specialists. NASD has a professional designation database on its website. If a financial professional claims to be a Certified Financial Gerontologist, or a Certified Wealth Preservation Planner, or one of dozens of other designations that one could have, a potential investor can look up that designation and find out exactly what it means and what qualifications – if any – one needs to earn it.
But, since seniors don't use the Internet very much, we have to find other ways to get this type of information to them. One idea we are working on is to use public libraries as contact points. If you go into a library on a weekday, you'll find a lot of seniors there, many of them reading books, magazines and other materials about finance and investing. If we could empower librarians to steer them toward more credible and unbiased sources of information than they might pick up on their own, I think that would be a very helpful step.
At NASD, we have a great thirst for new and unconventional ideas like this one. So, as we move forward, I hope that all of us in the regulatory community can put our heads together and find new and innovative ways to protect our large and rapidly growing elderly population from financial harm. This is one of the most significant issues that we're going to face in the foreseeable future. And it's our responsibility.
So, in addition to answering your questions, I'd love to hear any thoughts you may have about how we can get hold of this problem.
Thank you all very much for listening.
1 Federal Reserve Board 2004 Survey of Consumer Finances
2 "The Impact of Population Aging on Financial Markets," James M. Poturba, MIT, 2004