finra

Remarks by Mary L. Schapiro
Chairman and CEO, NASD

SIFMA Launch Meeting 2006
Boca Raton Resort & Club, Boca Raton, FL
November 9, 2006

 

Thank you Marc [Lackritz], and thank you all for inviting me to speak at your inaugural conference under the new acronym of SIFMA. The occasion has all the more meaning for me because this is my inaugural year as Chief Executive Officer of NASD.

I want to chat with you today about current and future regulatory trends and, hopefully, keep the discussion out of the weeds.

Before I do that, I have to confess to you that I have heard some industry jokes about your new acronym. Naturally, I have forbidden these jokes from either being repeated or originated at NASD. This is not a problem for us because, as you all know, regulators are genetically disinclined from humor in all its forms. I will simply respond to the ribbing regarding the new acronym by repeating the question from Romeo and Juliet "what's in a name?" But I don't want to be rhetorical here so let me answer that question as it applies to this organization. To me, SIFMA is the combination of two trade associations that have been our ardent and persistent critics, contributors and even teachers. And I mention all of those functions in the most positive way.

You have been our professional critic in the best sense that is aspired to by a trade association. You have never failed to join the issues with us and you should know that we respect and appreciate that effort and have great admiration for the people who contribute to the work of this association. The consultation process we undertake in rule making is not just something required by law; it is much more than that. We need this dialogue to keep our thinking informed, honest and honed. Even where we do not agree in wholesale fashion, there is oftentimes your influence in the shading of a rule's meaning. We expect that your contribution to this process will continue to be an essential component of NASD's success.

You have always stood ready to partner with us on initiatives at our asking. At NASD, we do regulation for a living. We are mindful that those who work with us in the industry on our various task forces, be it mutual fund breakpoints or ACATS, have day jobs and, in all cases, day jobs that are already incredibly demanding without the added burden of assisting our efforts. And yet, it has been our experience that the industry never forgoes our invitation to participate and never participates half-heartedly.

Lastly, you have always been our teachers. Whether we need to learn more about structured debt, or how you vet new products, or delta hedging a cash position with derivatives, we can count on you to teach us what a regulator cannot learn within the confines of its own building. This is a form of collegiality between the regulator and the regulated at its highest form of expression; it is the essence of self-regulation. It is the reason that Congress created this type of private sector regulation and it is imperative for our markets, investors and this industry that there be a regulator on watch that has access to, and makes use of, the informed knowledge of market professionals.

So it is with the understanding of all your contributions that I say it is an honor to be invited to visit with you today and express congratulations on your newly combined association. We are counting on you to continue the mission of being our ardent and persistent critic, partner and teacher.

I began today with a Shakespearian quote and now let me turn to one of a much more dubious origin. "May you live in interesting times." It is generally presumed to be a Chinese proverb and it is really meant as a curse rather than a blessing. I say it is of dubious origin because scholars cannot actually trace it back to any Chinese writings, but irrespective of its origins, we certainly live in interesting times and I mean that in the sense of unceasing change rather than any negative premonition when it comes to the financial services industry.

We have lived through the longest bull market period in recent memory, the major market correction of 2000 and beyond, the seemingly sideways markets that ensued, the regulatory reaction to the excesses of conduct in that bull market, and now, we seem to be in the post regulatory response period. If all this seems less than linear in its description, well, that's because it is.

Some of the voices that urged us to take tough action in the wake of the research analyst scandals now bring to our attention the alternative of prudential regulation. Indeed we are in a period not of deregulation, but perhaps one where there is time to improve and shore up the processes and systems that effectuate and implement the many new rules of the past several years. This process is less conscious in its outcome than organic. It would have been unnecessary, unwise and really impossible to keep our rule pipeline at the pace it was 30 months ago.

It is my hope that we are in a period where we can stand back a bit, review, and fine tune some of our judgments on prior rulemaking. To be honest we have always been engaged in that process in one form or another in our building. Most recently, I directed that NASD initiate a small firm rules task force to take a look at our rulebook through their lens to see whether there are existing rules that are ripe for change, while not diminishing investor protection.

We remain utterly committed to our regulatory mission but we should be also committed to doing no unnecessary harm or restriction to innovation in the industry and markets. But, while we will remain vigilant in revisiting the utility and necessity of existing regulation, I must sound a cautionary note. Our industry is not unique in its tendency to be episodic—which serves to undermine the view of the past in informing the future.

If the industry experiences future pernicious conduct of the nature that provoked the greater regulatory scrutiny of the recent past, then the odds of future invasive regulation are greatly enhanced. Even today, in a somewhat more benign environment, there are press reports of competing voices for both more enforcement and more prudential regulation.

By way of example, as to what we worry about as a looming problem, let me reference the aging of the baby boom generation. An event that creates both great potential for the industry, the promise of great benefit for investors and the potential for great abuse. Scandals in this area of financial services are certain to set off a reaction not just by NASD and the SEC, but also by federal and state elected officials.

I urge you to stress test your products and strategies offered to seniors, to train your supervisors and sales force in the appropriate use of these strategies and products, and make sure that you have the appropriate internal oversight in place. If the retirement investment needs of these investors are undermined by unduly risky products and ill-informed decisions, then regulatory reaction will be as swift and wide-sweeping as experienced in the past.

Moving beyond our industry we have been doing a lot of thinking about the need for the harmonization of regulation in the financial services arena. In our own back yard we have met with the industry and the New York Stock Exchange to harmonize the rulebooks of both self-regulatory organizations and we will begin to propose harmonizing rule amendments, on a rolling basis, beginning with our next Board meeting in December.

But we are thinking more broadly than that. We believe that financial service products should have a harmonized approach irrespective of whether the product is insurance, securities, banking, or investment advisory. I am not necessarily talking about more regulation. But there should not be a kind of regulatory arbitrage that provides an incentive for the sale of one product over another. A customer should be sold an insurance product rather than a security because the salesperson makes the reasoned judgment that the insurance product meets the best interests of the client as opposed to the fact that such a sale may not be regulated by NASD, and subject to our myriad sales practice rules.

That's not only bad business for customers, it's risky business for firms; the fact that a customer was sold a product or service that doesn't come within our jurisdiction will not insulate from the lawsuit that is based on the customer being sold the wrong product. Therefore I argue that these regulatory arbitrage incentives among competing financial service products do not meet anyone's interests. It will take a long process of partnering with other regulators to harmonize the investor protections available for related products, but if we don't undertake it then who will?

Last spring, to start down this road, we held an Annuities Roundtable in which state securities and insurance regulators and industry professionals participated. We are now working with our fellow regulators to extend the protections of suitability to insurance products, such as equity linked and fixed annuities. Investors deserve no less.

A little earlier, I mentioned that there are voices urging a more prudential approach to regulation. What does prudential regulation mean? In a nutshell it is an emphasis on helping regulated entities in their efforts to ensure regulatory compliance rather than relying on enforcement towards the same end. On this front, you'll have to excuse me if I brag a little about NASD.

We do quite a bit outside the realm of enforcement to help firms come into compliance and we have been doing this for at least 5 years now.

When the Anti-Money Laundering laws came into effect for the industry, we developed templates to map out for firms how to come into compliance with these rules. We developed similar templates for Business Continuity Planning. And we developed a mutual fund expense analyzer and breakpoints search tool to help firms make better informed decisions in their mutual fund sales. Today, on our website you will find e-learning courses and free webcasts in two dozen subject areas, with more being added all the time. All of our e-learning courses and webcasts can be used for training personnel, making sure that a firm knows what is needed to be in compliance, and helping firms in meeting their continuing education requirements.

I'm not sure that any regulator has the breadth of these offerings in the vein of prudential regulatory efforts, yet we will remain steadfastly unsatisfied with our efforts no matter to what extent they expand; after all, that is the only way we can remain committed to raising our game in this area. And, of course, all of this augments conferences and face to face training that cover all of the most pressing regulatory issues-ranging from Operations to Fixed Income to Advertising compliance and other myriad topics.

Just to prove that Steve Jobs has nothing on us, we have even entered the Podcast space and you can download to your iPod a variety of subjects in which we deal with commonly asked questions across a broad array of subject matter.

If I was going to flesh out with you this morning all of the details of our prudential efforts in education, information and assistance it might fill the balance of my remarks and there are some other areas I would like to touch upon. But let me just add two further thoughts on this. First, we are trying to square the circle in our efforts to help firms comply by developing a series of "What to Expect Webcasts" that are designed to enlighten members on what they can expect in their interactions with NASD.

The first two deal with what to expect in advertising review and member regulation routine examinations and we will follow these up with other webcasts, perhaps most notably in the area of what to expect in dealing with our enforcement department. We are committed to not only teaching the subject matter of regulation, but also what to expect in your interactions with us.

 

Finally, let me observe that the prudential versus enforcement based method of regulation is not an either/or proposition. There needs to be a balance between both forms of regulation and within enforcement itself there needs to be a balance of purpose.

We recently amended our sanction guidelines to reemphasize that, because enforcement sanctions are intended to be remedial and not punitive, the size and resources of a firm matter when assessing the appropriate size of a sanction or whether any monetary sanction at all is appropriate. In cases not involving fraud or which are not otherwise egregious, the sanction should not be of such size that its impact is more than is necessary to achieve remediation.

These revisions may be correctly read with smaller firms in mind, but the concept of enforcement as a means to remediation remains true irrespective of the size of the firm and, at NASD, we recognize that we must balance our enforcement efforts to achieve that outcome.

Let me turn to recent developments in markets, not their performance because as a regulator that is not my métier, but, rather, to the pending globalization of their structure. On one level, I suppose we can say that the combination of market centers domestically and the potential combination of international market centers simply follows the consolidation of broker-dealers we have seen in our lifetime. However, on further reflection, something more profound in the capital markets may be occurring to which we should be attuned.

For most, if not all of us in this room, the prospect 10 years ago that the US capital markets would not be the dominant in the world for capital formation might have seemed a remote or even unthinkable proposition. While I am not suggesting that such a proposition is necessarily of more certain currency now, I would observe that maintaining competitive dominance is not a matter of divine right.

In his recent book entitled "The War of the World"—and I am not confusing this with the H.G. Wells novel of nearly the same name—the eminent historian Niall Ferguson, a professor of history at Harvard with concurrent academic appointments at Oxford and Stanford reviews the 20th century and makes certain observations that I think have application as we ponder globalization in financial services.

The 20th century for all of its medical, educational, technological and resource innovations was the century that saw the most volatility and carnage in mankind's existence. Ferguson notes that no fewer than 12 empires terminated in the prior century, which is remarkable because in preceding times empires could last 300 to 600 years. What we can discern from this observation is that the rate of change in political and economic domination is geometrically increasing.

Let's link Ferguson's more global world history observations with a recent article co-authored in the October 30th Wall Street Journal in which Glen Hubbard and John Thornton, respectively the Dean of the Columbia Business School and the Chairman of the Brookings Institute, note that in the year 2000, 90% of all funds raised by foreign companies were raised in the United States while in year 2005, 90% of the same funds were raised outside the United States.

We indeed live in interesting times. From my perspective, globalization argues for regulation informed by the desire not to unnecessarily push capital formation from our shores. We cannot and do not intend to use impending greater globalization as a foil not to do what is required to ensure the protection of investors and the integrity and transparency of markets. But, I believe that the role of the regulator in this era will become a balancing act that needs to be evermore fine tuned.

On the one hand, there are economic studies that support the premise that regulation that promotes protection, confidence, integrity and transparency in markets allows those markets to prosper. But that does not necessarily mean that more regulation for its own sake makes for better markets.

The Exchange Act precludes us as an SRO from imposing an undue burden on competition not necessary to advance rational regulation. This is not just good law or good common sense, rather it is imperative to the health of markets, and therefore in the interests of investors, that we do not regulate to a point of unnecessary competitive disadvantage in this country.

 

In practice this means, that we are looking at our activities and rulemaking to ensure that we do not provide unnecessary incentives for our members that are multi-national financial service conglomerates, to move their activities outside the United States. Let me reemphasize how carefully we must balance these interests because I am not suggesting that we will engage in a race to the bottom of the least regulation.

As an example of our thinking about regulation in an international context, we are presently engaged in dialogue with the industry and the NYSE about the scope of our jurisdictional reach to their activities beyond this country. Our definition of "associated person," which tracks the definition in the federal securities laws, is very broad and is the foundation in many instances for our assertion of jurisdiction. The elasticity of this definition was constructed at a time that could not have contemplated the impending trans-national markets.

For the very reasons I have just articulated, the answer for NASD is not to cling to old definitions where they should be modified in shifting environments.

Interesting times indeed, but not necessarily the harbinger of the curse implicit in the supposed Chinese aphorism. As the historian Ferguson said in a recent interview, many a historian has prematurely called an end to the position of US influence in the world. I am not betting against the US capital markets and I want NASD's efforts, wherever possible, to bolster the interests of all investors in US markets.

Let me close my remarks today, while I am on the subject of regulatory balancing, with our thinking on a possible initiative that we have conceived separate and apart from issues of globalization; namely, the need to initiate a rule assessment program. Earlier, I spoke about a small firm rules task force, but what I am thinking about at this time is a more permanent systematic assessment of rules and their impact, benefit and costs. NASD is not required to do a cost/benefit analysis in its rulemaking under the law, but I can assure you that this does not mean that we are cavalier about costs in our rulemaking—although I know that some of you have your doubts.

Most cost/benefit analyses are done before the fact, what we lawyers call ex ante. But these before the fact analyses suffer from the defect that assumptions must be made about the rule's operation and its costs—in a sense guesswork is implicit in the process. What we are thinking about is a process that would occur on an ex post basis, that is, after the fact, and presumably be performed with harder data that would eliminate the need for some of the projections and assumptions that lead to more uncertain conclusions.

Not all rules lend themselves to this type of review; for example our broad ethical rule pertaining to the just and equitable principles of trade, would not lend itself to this analysis. Whereas a rule we are contemplating that would require members to file with us private placements for the purpose of raising operating capital for their firms would arguably be a perfect candidate for such review.

This initiative is consonant with the need for efficient regulation that addresses a problem without unnecessary burden on members, competition, innovation and capital formation that I was mentioning in the context of globalization. I believe it has relevance whether or not these trans-national market mergers come to fruition.

The rate of change is increasing, the challenge to being an effective and efficient regulator is keeping pace with that rate of change, but I take comfort in knowing that this audience will challenge us and think along with us.

Thank you again for inviting me to address you and I wish for your new combination as this trade association that it is greater than the sum of its parts.