finra

Remarks by Mary L. Schapiro
Chief Executive Officer, FINRA

Distinguished Speaker Series
Georgetown University McDonough School of Business
Washington, DC
September 26, 2007


Thank you, John for that kind introduction. It's an honor to speak at this great university – and the McDonough School in particular.

Georgetown University is an incredibly valuable resource – to its students and the entire business and financial community.

As some of you know, FINRA values deeply the contributions of the academic community and works closely with it to better understand the complexities of today's financial environment as it relates both to the securities industry and investors.

With that said, I'd like to begin by making a brief announcement. It's with great pleasure that I am able to announce tonight that we have lured one of Georgetown's best to FINRA.

Professor and Deputy Dean Reena Aggarwal will be coming on board as an Academic Fellow at FINRA. Reena's work will be multi-faceted, and will include consulting with and advising our staff on emerging regulatory issues.

We're very pleased she'll be joining us – her expertise will be welcomed. And she'll be joining another Georgetown faculty member, Andres Vinelli, who serves as FINRA's Chief Economist.

Professional Background and FINRA Overview

Now, some of you may be familiar with what I do, but others might be scratching their heads. I get that a lot when I tell people that I'm a regulator.


I'm a CEO and people understand what that means – they know I'm the head of something.

Well, that something is FINRA – the Financial Industry Regulatory Authority.

Don't worry – I won't hold it against you if you're not familiar with the name. Until about eight weeks ago, we were known as NASD.

This summer, NASD and the New York Stock Exchange merged their regulatory operations and formed FINRA.

FINRA is a self-regulatory organization which is funded by the securities industry.

It's an extraordinary approach to regulation, which, under the oversight of the SEC, invokes industry expertise to create and enforce the first level of investor protection.

In 2006, self-regulation provided a layer of informed and effective regulation valued at over three-quarters of a billion dollars – wholly funded by industry, NOT taxpayers.

In a nutshell, as the single, largest, non-governmental regulator of our nation's securities industry FINRA works to keep America's capital markets fair.

FINRA licenses and regulates all 5,100 brokerage firms and nearly 700,000 brokers that sell stocks, mutual funds, bonds and other securities to the public.

We write the rules that govern their behavior – particularly their interactions with investors, but also rules for investment banking, trading and financial and operational integrity. We examine firms for compliance with our rules, and those of the SEC, and discipline firms and brokers who violate investors' trust.

FINRA levies fines, suspends or expels individuals and firms from the industry, and can compel them to pay restitution to investors who have been harmed by rogue brokers. As we oversee the securities industry, we are, in turn, closely overseen by the Securities and Exchange Commission, which relies on us to supplement their regulatory and enforcement efforts.

We also regulate, be contract, the Nasdaq Stock Market, the American Stock Exchange, the I.S.E. and the Chicago Climate Exchange. We operate major industry utilities like TRACE, which collects and disseminates all corporate bond transaction data.

And, we also devote significant resources toward investor education programs.

Through public forums; targeted messaging to military families, seniors and aging baby boomers; and the funding of research, we aim to give investors a better understanding of the marketplace and introduce them to sound investment principles.

As you can see, FINRA has broad responsibilities reaching into a whole host of disciplines – legal, finance, education – to name just a few.

So, forgive me, but I would remiss if I came to a prestigious university like Georgetown without giving a recruiting pitch to the students in the audience. FINRA is a great place to work and offers many different career paths.

But a disclaimer is in order. Unlike some fields Georgetown students may be thinking about entering, regulatory policy isn't the most glamorous profession. Regulators usually aren't the most popular, the most famous or the most written about.

So why would anyone want to be a regulator? I can only tell you what motivated me. Let me try to explain with a quick story.

We hear a lot about bubbles in the market. Tech bubbles, housing bubbles. Well, back in the 70's there was a silver bubble.

At the time, gold couldn't be held by private citizens. So the Hunt Brothers of Texas – Nelson and William – decided to start buying silver in large quantities purportedly as a hedge against inflation.

With the help of a few investors they succeeded in cornering half of the world's silver supply. Over time, the price of silver skyrocketed, which of course is the intention when someone corners a market, causing the supply of a commodity to be severely constrained.

While many of us think of silver in terms of jewelry, candelabra and tea services – millions of which were melted down to produce bars and ingots – silver, is an essential component in many industrial processes and the squeeze impacted businesses ranging from auto manufacturing to photographic processing.

But finally the bubble burst as they always do.

Speculators lost their money and the Hunts declared bankruptcy. And finally, in 1988 the Hunt brothers were convicted of conspiring to manipulate the market.

As someone just starting a career, that story fascinated me.

It was hard for me to believe that a couple of people thought they were rich and powerful enough to get away with manipulating markets affecting millions of investors.

Thus began my career as a regulator – at the tiny, largely unknown federal agency responsible for regulating the silver and other commodity markets.

I started as a staff attorney at the Commodity Futures Trading Commission in 1980 and 14 years later returned to become its chairman, after being appointed by President Clinton.

Along the way, I served as an SEC Commissioner – appointed first by President Ronald Reagan and then the first President Bush.

This makes me an unusual creature in Washington—someone appointed by both Ronald Reagan and Bill Clinton. You don't hear that a lot, do you?

I like to think my background highlights my independence – and to the students here I would just say that's a trait that will serve you well no matter what field you work in.

In 1996 I moved over to head-up NASD's regulatory operations, at a time when the NASD and its subsidiary, NASDAQ, were under investigation by the Department of Justice and the SEC for failing to fulfill their regulatory responsibilities and for allowing market makers to engage in a trading convention of only quoting stock prices in even-eighths, effectively profiting from artificially wide spreads. I came to NASD to revitalize the regulatory operations. I became Chairman and CEO just last year and was named FINRA CEO in July.
It's turned out to be an exceedingly gratifying career choice – and I guess I have the Hunt brothers to thank for it.

I've been a regulator during good markets and bad, during recessions and economic booms. But throughout my career there has been one constant – I've seen the financial services sector become increasingly complex and global.

International borders are disappearing, every day new financial products are being developed and sold to investors and more Americans are relying on the capital markets than ever before to secure their financial futures.

In fact, last year was a record year on Wall Street. Total revenues rose 35 percent over 2005 to $436 billion.

In this environment, regulators face many challenges. Tonight, I'd like to focus on three of them.

The Challenge of Cross-Border Regulation

The first relates to the increasingly global nature of finance today. In the last 10 years we have witnessed an unprecedented internationalization of the financial markets.

The global scale of financial operations is evidenced by the size and scope of some of the larger financial institutions and the growing consolidation of financial entities, especially those once viewed primarily as national institutions, such as stock exchanges.

The largest global bank – Citigroup – is the fourth largest company in the world – and it's just one of four banks that make up the top ten largest companies in the world.

The transatlantic merger of NYSE and Euronext highlights the emergence of institutions that now operate across multiple international jurisdictions.

There's no doubt the markets are moving forward, They're innovating and expanding – creating a new infrastructure by taking advantage of today's technological and communications advancements.

The only element of the new financial architecture still lagging behind the trend towards greater globalization is regulation, which has tended to remain inherently national, hemmed in by borders.

In most countries, regulation continues to be more or less the exclusive responsibility of agencies created by sovereign governments.

In an environment where finance is global and regulation is national, market regulators are really playing a game of catch-up with ever more powerful market forces.

Regulators' failure to cooperate effectively will almost surely lead to very serious problems. I saw this very close up a number of years ago when Barings Bank collapsed.

Barings was a British bank operating around the world. It happened to employ a renegade trader – Nick Leeson – in its Singapore branch office, who evaded internal supervisors as well as national regulators as he made a series of reckless derivatives trades on the Singapore International Monetary Exchange, or SIMEX.

Those trades eventually led to the fall of Barings, an institution that had been in existence since 1762 – and, by the way, believed that it had a God-given right to remain in business forever.

It also shook markets around the world – notably Japan, Chicago and London where Barings held large positions.

As bad as it was, the Barings collapse turned out to be pivotal moment in the development of a more international approach to regulation.

When the dust settled, regulators from 16 countries issued the "Windsor Declaration" which called for greater disclosure of information related to an institution's derivatives exposure, promoted the sharing of information between exchanges and encouraged the development of cooperative structures to make it possible for regulators to intervene during a future crisis.

Cooperation among international regulators can be effective to a point, but it is only the beginning. Right now, regulatory cooperation consists of general agreements of principle and memoranda of understanding between national regulators.

But MOUs aren't legally binding and don't always take precedence over domestic laws. It's also very difficult for regulators in one country to have access to all of the information they need to investigate a firm doing business on multiple continents.

We regulators really need to move towards regulatory convergence – meaning having rules in multiple jurisdictions that are virtually the same, if not identical.

Global businesses have figured out how to operate using the same rules and procedures anywhere in the world – but regulators haven't.

I believe by moving in that direction we can significantly lessen regulatory arbitrage and eliminate the safe havens for those who would violate the law.

Right now, the problem is that the quality and scope of national securities regulations varies greatly. Some countries have comprehensive securities laws and in others we see much more fragmentation.

But it's about more than having the same rules on the books of all the regulators. Our success at tackling growing internationalization is highly-dependent upon all regulators having the necessary resources – legal, human, technological and financial.

There are no easy answers but it's an area that is crying out for reform.

To be honest, though, the international arena isn't the only area where fragmentation is a problem. It's also an issue domestically.

Need for Harmonized Investor Protection

Another equally important challenge emerges when we look at regulation through the eyes of an investor in this country.

Here in the United States we have what I call a spaghetti bowl of regulators.

We have the SEC, CFTC, FINRA, NFA, myriad banking regulators and 50 state insurance and 50 state securities regulators, and the list goes on.

And there are so many different kinds of investment products in today's market that I would be surprised if even the most sophisticated investor could distinguish which products are regulated by whom. Frankly, they shouldn't have to.

Whether an investor is buying insurance, securities or banking products or whether they're working with an investment adviser, a broker or an insurance agent, the protections afforded to them should be the same – but they most decidedly are not.

My view is that retail investors should get the same basic regulatory safeguards and protections no matter which investment product they choose.

Financial product regulation must have a harmonized approach irrespective of whether the product is insurance, securities, banking, or investment advisory, or which regulator has jurisdiction over it.

I am not talking about more regulation—or additional jurisdiction for FINRA. The point is that for the sake of investors, regulators need to work together to regulate products that look and act in similar ways.

The U.K has the Financial Services Authority. It's a good example of a unified regulatory body that is responsible for regulating virtually the entire financial sector, from securities and banking to insurance and mortgages.

Here in the U.S. our jurisdiction as regulators is defined by the products we regulate – or, absurdly, the way investors pay for the product—even though many products are virtually interchangeable from the perspective of the investor.

While rationalization of the regulatory structure may not happen overnight, at a minimum, we regulators must lock arms and work together for a harmonized system of investor protection under a set of unifying standards.

It's my view that there are four basic areas requiring harmonization in the sale of financial instruments: suitability, disclosure, advertising and qualifications/training of salespeople.

Until we can achieve a more harmonized approach domestically, our ability to work with foreign regulators will be severely hampered.

It's my hope that FINRA will contribute to this goal. We're committed to working with all regulators to establish as level a playing field as possible for all investment products.

At the end of the day, investors need to have confidence that they've been sold a product that meets their needs.

Without investor confidence, the markets will wither. If investors feel they're going to be taken advantage of they'll just stay away.

Seniors

The final challenge that I want to mention has garnered a lot of attention lately, as well it should.

One of the most formidable tests facing regulators for the foreseeable future is America's growing number of senior citizens. Over the next twenty years, 75 million Americans will turn 60. That's 10,000 new 60 year-olds every day.

These seniors have a lifetime's worth of savings and they need to invest it somewhere. In most cases they're simply looking for financial stability in their golden years.

The problem is that there are a few unscrupulous brokers who target seniors and their money only to enrich themselves.

Of the 55 percent of seniors who said in a recent survey that they lost money on an investment, 19 percent—almost one in five—attribute that loss to being misled or defrauded.

Those are disturbing numbers. And regulators are concerned that not only are current seniors at risk, but as the population grows older, that these scams will only grow more sophisticated.

To combat this activity, FINRA is taking action on multiple fronts.

One of our most critical tools when confronting fraud against seniors is our enforcement division.

Right now, FINRA, is conducting focused examination sweeps in several areas related to seniors. I'd like to mention two of them tonight.

The first sweep is aimed at the use of inflated or meaningless professional titles by investment advisers seeking to fool seniors into thinking they're experts in retirement planning.

They use impressive sounding titles like "retirement expert" or "senior financial planner." The use of these so-called "professional" designations has become an increasingly common device used to entice investors to make an investment.

The unfortunate truth is that seniors can be susceptible to these tactics. Our research shows that some seniors are more likely to listen to pitches from people with such designations.

The sad reality is that some designations can be obtained simply by paying membership dues to an organization with an impressive sounding name.

Too many times these designations mean absolutely nothing. And all too often, seniors put their trust in these individuals and are led down a path of financial ruin.

FINRA has reminded firms that under our rules, using any title or designation that conveys an expertise in senior investments or retirement planning where no such expertise exists will open firms up to enforcement action.

The second sweep targets deceptive early retirement seminars. These seminars focus on a special IRS regulation which permits workers to make an early withdrawal from a retirement account without the usual tax penalty.

The programs pressure individuals who are still working to move their retirement assets to a specific firm or representative, often promising unrealistic returns on an investment through the use of misleading projections.

In the past year, FINRA has fined two firms $5.5 million and ordered them firm to pay $26 million in restitution related to early retirement investment schemes aimed at Exxon and Bell South employees.

While enforcement is a valuable tool, as a regulator, FINRA's ultimate goal is to prevent instances where older investors are mistreated by financial professionals.

And I believe our strongest weapon in fighting fraud is research and education. In this area, FINRA has marshaled significant resources.

Last year, we funded a survey which profiled investment fraud victims.

The research revealed that fraud victims typically tended to be married men with above-average financial literacy, a college education, above-average incomes, and a personality that was optimistic and self-reliant. That profile ran counter to previous profiles, and has since been verified by two subsequent surveys.

Armed with this data, we're testing messages that will help investors counter scams by giving them the knowledge to ask the right questions and control the conversation.

Seniors need to be well-armed in dealing with the fraudsters, regardless of the product or service that's being pitched. The messages and material we develop will be unveiled as part of a national educational campaign.

Our latest educational efforts also include the launch of a new program aimed at informing human resource professionals and unions about the risks of fraudulent early retirement seminars.

Both of these groups are in a position to influence employee attendance and receptivity to these seminars and strategies—and to get the word out about the potential risks they hold to retirement security.

You have been very kind to listen, so let me close with this:

I don't know how many of you saw it, but there was an article in the New York Times about two weeks ago that mentioned a now-defunct brokerage firm that was based on Long Island, New York.

The firm was named Stratton Oakmont. I don't expect it to ring a bell – but for securities regulators the name causes nightmares.

There are probably only two ways you would know about this firm.

One, if you read the New York Times story. The other is if you happened to be one of its victims.

In the '90s, Stratton Oakmont robbed countless investors of more than $100 million – selling them artificially-inflated penny stocks through fraudulent sales practices. The firm's charge to its brokers was, "No one hangs up the phone until the customer buys or dies."

They gave the industry a huge black eye and ruined the lives of the investors they swindled.

Well, as the New York Times explained, the former head of Stratton Oakmont – now out of prison – has written a book and Hollywood is going to make a movie about the firm's exploits. It's going to be directed by Martin Scorcese and star Leonardo DiCaprio.

As the top enforcer at NASD at the time, I led NASD's case against Stratton Oakmont.

Ultimately, we succeeded in expelling the firm from the industry and, as I said, Stratton's CEO went to prison.

And now he's the one with a new book and a movie coming out. That should tell you a little about the life of a regulator.

Of course, I'm only joking. Then again, maybe some of the students will read this book and the story will have the same impact the Hunt Brothers had on me.

I can only tell you that this field is one of the most rewarding and fulfilling careers I can think of. I truly hope some of the students in the audience give it the consideration it deserves.

While 99 percent of any industry is made up of honest, hard-working professionals, the Hunt Brothers and the Stratton Oakmonts of the world will always be with us. And so will be the need for smart, motivated, professional regulators.

As I pointed out tonight, the securities industry is being transformed by technological and global market forces that define our age. The markets are adapting and innovating and regulators need to do the same.

The challenge will be not only to adapt to these changes, but when possible, to anticipate change.

For regulators, whether the issue is the internationalization of the markets, domestic regulatory harmonization or a coming demographic tidal wave, we all need to be prepared and thinking ahead about how to confront these challenges.

And that's where schools like Georgetown and the McDonough School of Business become more valuable than ever before.

Thank you so much for inviting me – it's been an honor to speak to you tonight.