finra

Remarks by Mary L. Schapiro

Chairman and CEO, NASD

As Prepared for Delivery to

The First Annual Capital Markets Summit: Securing America's Competitiveness

U.S. Chamber of Commerce

Washington, DC

March 14, 2007

It's a real pleasure to be here to discuss the competitiveness of the U.S. capital markets. You've heard from many distinguished voices today—Chairman Cox, Chairman Frank and Chairman Dodd among them. Their leadership will be essential as we tackle this many-faceted issue of critical importance to the U.S. economy.

The financial services industry is fundamental to the success of our economy, our national security and the well-being of our citizens. It has the means and the intellect to solve a wide range of social and economic problems—and the potential to create secure financial futures for all Americans. And that is why today's conference, and others like it, that are exploring these issues, are critically important.

I've been a regulator for more than 25 years—and I have seen tremendous evolution of the markets and the industry in that time. But there is little to compare to the kind of dramatic changes we are now seeing—changes that will require some innovative approaches to regulation, if we are to continue to fulfill our responsibilities to protect investors and maintain market integrity. The changes have been well catalogued by the press, commentators and in the Commission's report and most are well known to everyone in this room: among them, the technological advances that have dramatically changed how the securities business is conducted. New participants, notably hedge funds, have become an important force in the marketplace. Exchanges—once operated like the public utilities of yore—are themselves publicly traded. Markets are merging internationally. Investors are seeking direct access to foreign stocks. Our population is aging and utterly unprepared financially for the future. And a dizzying array of new and complex products is being introduced to investors—many of which defy traditional jurisdictional boundaries of the regulators.

These forces demand that regulation and regulators, including private-sector regulators like NASD, modernize to protect investors and keep the markets fair. We are engaged in an extraordinary balancing act—to preserve integrity and honesty and fairness in financial dealings, yet allow for innovation, competition, and choice—while all the while minimizing burden and expense.

I truly believe that we owe much of the past success of the U.S. markets to an emphasis on regulation. Investors—both domestically and internationally—have flocked to our markets because they believed they were fair and well regulated. Over the long run, investor confidence in the integrity of our markets has been a source of strength and liquidity that has distinguished the U.S. markets from all others. The regulatory ramp-up of the last several years has been a necessary and direct response to some very bad conduct. Is it fair to revisit whether we got the balance right during this period? Absolutely. But let us also remember from whence we came.

I could spend all afternoon talking about this balancing act, and how I believe the modern regulator should function—but I will spare you and discuss just three initiatives that I think are especially important and where NASD has an important role to play.

The first is a rationalization of the regulatory structure. Regulatory resources are scarce, and like a company's capital, they have to be deployed thoughtfully. When self-regulatory agencies have overlapping jurisdiction and engage in duplicative activities, we have not deployed our assets well. This was one of the motivations for the planned regulatory consolidation that NASD and the New York Stock Exchange announced late last year.

This plan will combine the member regulation operations of NASD and NYSE Regulation into a single, new self-regulatory organization (SRO) that will be the sole private-sector regulator for all 5,100 securities brokers and dealers doing business with the public in the United States. The new SRO, with nearly 3,000 staff, will bring together all of NASD and NYSE Regulation's member firm examination and related enforcement functions, as well as arbitration and risk assessment. Not only does this plan produce the largest private-sector regulator in the financial world, it also simplifies a critical component of the U.S. financial regulatory structure. It ensures that under the strong oversight of the SEC, self-regulation will continue to play a vital role in the U.S. capital markets. Self-regulation at NASD—and soon at the new SRO—brings industry talent and expertise directly to bear in tackling the issues faced by investors and firms.

The consolidation plan sets forth a more sensible and less complex regulatory regime that will make private-sector regulation more efficient and effective. It will reduce regulatory costs for all firms—some quite dramatically—while providing more effective protection for the tens of millions of people who invest for their future in the U.S. capital markets. This is the first modernization of the self-regulatory regime in decades, and it sets up a unique structure that I believe will serve our industry and investors well for years to come.

When the new organization is in place and fully integrated, there will be a single set of rules adapted to firms of all sizes and business models. There will be one set of examiners and one enforcement staff. Duplicative regulation and overlapping jurisdiction will become a thing of the past. Inconsistent approaches and rule interpretations, and matters falling through the cracks between two separate regulators, will be historical footnotes.

I think it is important to note that this approach to modernization of regulation was widely embraced by regulators, as well as the industry. All understood that change was necessary. The industry in particular, with its overwhelmingly positive vote on the By-Law changes needed to effect consolidation, gave the green light to replace an outdated regulatory structure with one that better serves investors and the markets—and they deserve a great deal of credit.

Those By-Laws are now at the SEC to be published for public comment and, we hope, approval. Our goal is to have all the necessary approvals and a final agreement with the NYSE Group completed in the second quarter. And, we have already begun the hard work of integrating these two great regulatory organizations into one.

My expectation is that by this summer, this new SRO—with a new name—will be up and running.

Aside from the consolidation with NYSE, the second area that NASD is focused on is modernizing how we conduct examinations of securities firms. Regular examinations—you might think of them as audits—are the bread-and-butter of what we do to ensure compliance by the industry with the rules of the NASD, the SEC and the MSRB. We conduct more than 2,300 examinations each year, and they serve as our main regulatory interaction with firms and our first line of investor protection. But for the last six decades, these exams have been dictated more by the calendar than by risk.

Under our current exam program, every firm undergoes a compliance examination at least once every four years, but for some, it's as often as every year. The timing of these exams is determined by a firm's basic risk profile.

Technology now allows a better, more effective way for us to perform exams. We are currently in the middle of a technological overhaul of our examination process that is designed to make sure that NASD's program keeps up with the constantly evolving marketplace. Using the latest and best surveillance technology, we will be able to better use our resources and focus on firm risk management, effectiveness of controls and specific product areas and firms that present a real risk to investors. There is simply no other way for regulators to go forward other than with a truly risk-based approach, given the enormity of our task.

Under the new exam program, more sophisticated risk modeling will drive how often we examine a firm—and help us determine the scope and depth of that exam, as well. We'll be able to replace the highly manual, on-site compliance reviews that we currently perform, with automated reviews. The technology we plan to implement will give examiners extensive data and analytics that will allow them to better use their expertise to identify problematic areas upfront and see trends in firm conduct as they are developing. In conjunction with the focused work we are doing on emerging regulatory issues, we expect to be better equipped to address problems in a more timely and consistent manner: clarity and certainty for firms, quicker identification of improper business practices and remediation for investors.

For firms doing business the right way—this will mean a less intrusive, more flexible and more efficient exam program that results in less distraction for them and less expense to us. Most importantly, investors will be better served because NASD will identify areas of risk sooner and take actions to rectify problems faster.

We are also striving to improve how we assess the impact of our rules on investors, firms and other market participants. Right now, NASD devotes considerable resources to evaluating the likely costs and benefits of new rules, and we have undertaken an initiative to modernize our rule book and identify obsolete rules. NASD is not required by law to perform this kind of analysis related to rulemaking, but I can assure you that we are not cavalier about these costs.

We are committed to a rule regime that creates well-functioning and fair markets, which builds investor confidence. Still, we want to respond to concerns that the benefits of some NASD rules do not justify their costs. So, we have created a pilot program to analyze the impact of recently enacted rules. Our goal is to re-visit certain rules that have been on the books for a couple of years to ensure that they are working the way they should be, and that the burden they impose is warranted given their beneficial effects.

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. The process we have developed will occur after the fact, so it can be performed with harder data that would eliminate much of the guesswork, and produce more reliable conclusions.

Not all rules lend themselves to this type of review; for example, our broad ethical principle pertaining to the obligation to conduct business in accordance with high standards of commercial honor and just and equitable principles of trade—or any rules with a broad public mandate, for that matter. These rules are foundations of our regulatory scheme, yet their benefits cannot be readily quantified, so they don't easily lend themselves to this analysis.

But we see this initiative as consonant with the need for efficient regulation. It ensures that the law of unintended consequences, which often bedevils regulators, will not have a chance to take hold. And, just as importantly, it will allow us to discover if recently enacted rules are actually protecting investors the way they were designed to do.

Before closing, I want to discuss one last area that I believe is critical if NASD—and its next generation SRO—are to function as an effective regulator in the modern marketplace. This is an area that I was so pleased to see is highlighted in the Commission's report: the need to educate investors and to move toward a presumptive enrollment and automatic escalation standard for employer-sponsored savings programs. We believe deeply that it is our obligation to inform and teach investors to be intelligently engaged in the capital markets. A savings account is no longer enough to secure a financial future and a long retirement. NASD can and should be a source of unbiased, honest and accessible investor education.

Never has it been more important for investors to be well informed when making investment decisions—yet, they are anything but. As I mentioned earlier, a dizzying array of products are being invented and marketed to investors. The complexity of many new products—with elements of insurance, options, interest rate, commodity or real estate exposure, to name just a few twists—makes understanding their risks through different economic cycles a challenge, and deciding how they fit into a diversified portfolio even more daunting.

Many investors feel they are simply not capable of understanding, so they toss the dice and buy an expensive, complex product they don't understand, or they give up in defeat and don't invest at all. And, frankly, we also need to educate investors about the techniques used by the less-than-scrupulous to part them from their money, and how they can protect themselves.

There are many consequences to this paucity of financial knowledge among American consumers and investors. The most pervasive consequence is that Americans, by and large, do a poor job of saving for retirement. And with the Baby Boom generation about to slam like a tidal wave into our country's system of caring for retirees, I think this is also the most worrisome consequence. Not only are there huge numbers of us in this retirement wave, but the wave is unlike anything we've seen before. Over the next 20 years, 75 million Americans will turn 60. That's 10,000 new 60-year-olds every day.

Perhaps the most frightening statistic is that half of workers nearing retirement—people between the ages of 55 and 59—have $15,000 or less in a 401(k) type of plan or IRA. Other studies have shown that nearly half of American households have no savings at all, and two-thirds are not saving enough to get them safely through their retirement years.

As the Commission's report rightly identifies, part of the problem is a lack of employee access to employer-sponsored retirement accounts. Nearly half of all American workers lack such access. However, even those who do have access to an employer-sponsored retirement plan don't take full advantage of their plan. According to the Commission, only about 75 percent of employees who are eligible to participate in 401(k) plans actually do so. Of those who do participate, many fail to save the amount needed to take full advantage of employer matching contributions.

Why? Inertia appears to be the primary reason.

NASD is working with AARP and The Retirement Security Project—also known as RSP—to harness the power of inertia to promote, rather than hinder, retirement saving. A number of academic studies have found that a 401(k) with automatic features increases participation, contribution rates and asset accumulation. Automatic enrollment—which requires workers to opt out instead of opting in—raises participation rates to nearly 90 percent. NASD, AARP and RSP will jointly fund a research and public outreach plan to encourage medium-size employers to adopt automatic 401(k) features, in whole or in part. We have already published a brochure that highlights key automatic 401(k) features and identifies the benefits of these features to both employers and employees.

Because NASD views investor education as such an important part of its mission, we established the NASD Investor Education Foundation, currently funded with $82 million, making it the largest foundation in the U.S. dedicated to investor education. Our foundation issues grants to universities and non-profits for research and programs that help mainstream investors understand the complexities of investing and the markets. And, in consonance with the recommendations in the Commission's report, it is particularly concerned with population segments that are underserved, such as minorities, members of the armed forces and older Americans.

The end result of our efforts hopefully will be smarter investors, who can play a larger role in protecting themselves and in building solid, secure financial futures for themselves and their families. Obviously, NASD will always be vigilant in doing our mandated job. But if investors do more to protect themselves, more problems can be avoided.

As you've heard today, the financial services landscape is changing rapidly—and sometimes unpredictably—because of the forces that are transforming the structure, and the reach, of our markets. The future of our economy, our security and our pre-eminence in the global marketplace demands that regulators not only keep pace, but whenever possible, anticipate change and get out in front of it. The millions upon millions of investors who participate in our markets and fuel capital formation deserve—and should demand—no less.

We at NASD are committed to meeting those demands. And once our consolidation with New York Stock Exchange Regulation is consummated, our new successor SRO will be in an even stronger position to meet the challenges the lie ahead.

Thank you.