finra

Remarks by Doug Shulman 

Vice Chairman

NASD Fall Securities Conference

San Francisco, California

November 17, 2005

 

Good morning.  I'm going to talk for a few minutes about the rapid evolution of the securities world over the last few years, what NASD is doing to keep up with this fast-moving train, and what we're doing to help investors and industry professionals keep up as well.  After that, I will turn the floor over to Linda Thomsen, Director of Enforcement at the SEC.

 

In my opinion, there are two powerful forces that have recently changed the expectations of investors.  The first is the abuses in the industry that came to light after the bubble burst and the second is the advent and continued evolution of the Internet. 

 

Five years ago, the tech bubble burst and the effect on the industry and the markets was profound.  Portfolios were shattered, savings were lost, and a wealth of fraud and malfeasance that went on during the boom years came to view as investors crawled out from under the rubble.

 

NASD and other regulators responded as we always respond after a bubble bursts - forcefully, as investors would expect us to respond.  There has been, as you well know, a great deal of enforcement activity.  In 2003 and 2004, NASD set records for cases brought, registered reps suspended or barred and disciplinary fines levied.  I'm sure Linda Thomsen will talk more about enforcement issues in a few minutes.

 

Another upshot of the malfeasance coming to light is that investors today are more likely to scrutinize their investment professionals and demand more and clearer information about investment products.  They want to know how professionals are being paid and what conflicts they may have, and they want to know the details about the products they are buying.

 

As all this has been going on, another potent force has been growing more powerful by the day and changing the way we invest, indeed the way we live.  And that is the Internet.  Today, information that used to take hours, days, weeks or even months to acquire is now accessible in seconds.  That, in turn, has dramatically changed the expectations of investors about the variety, volume and timeliness of the market information they can receive.

 

Let me just take the example of airline travel to make the point.  In 1990, if you wanted to travel from one city to another, you either called a travel agent or called an airline directly.  After several calls, and maybe a half-hour of effort, you had a couple of options for flights, but usually no basis for comparison with other airlines, and you basically had to trust that either the airline you called was competitive or that your travel agent had given you a good deal.  Today, within 30 seconds, you can access on any number of web sites all of the available flights in and out of a city, sort them by price, check nearby airports, and make your reservation.  If you call a travel agent or airline, you are equipped with many more facts than you had fifteen years ago.  And if you book your reservation online, with another click of a button you can get a rental car and hotel, saving another half-hour of work.  You get the point.  Expectations about the variety, accuracy and timeliness of information have changed.

 

How you as industry professionals respond to these changed expectations is up to you.  The most innovative firms seem to be responding aggressively and spending a lot of money trying to ensure that their customers are fully informed.

 

We regulators have also been putting an emphasis on ensuring that the disclosure regime in the industry keeps up to pace with the realities of today.  So, making information available to investors and making markets more transparent - to investors and to all industry professionals - has recently become a major focus of the regulatory community, and I think you'll find that it will remain so over the next few years.

 

Let me quote the Chairman of the SEC, Chris Cox.  In a recent speech he said: "Technology is fueling a radical change in the way that business and individuals receive, process and interact with data."  He goes on to say that "when EDGAR was born, the way most people searched the news was to manually go through huge stacks of newspapers and magazines.  Today, almost anyone … can not only search the entire planet for news that is seconds old, but also have the news robotically sorted for them."  This issue is clearly a focus of the regulatory community.

 

One challenge within this challenge is to know how to provide information to the investing public in a way that they can most easily digest it, rather than just dumping it into their laps and letting them sort through it.  This is really the trick.  As we move from the often incomprehensible world of prospectuses, to something more rational and streamlined, we have to get the balance right.  In a world where attention spans have shrunk, and the news is delivered in 3-sentence sound-bites, we need to determine the right balance of quick, simple information and complete information.  It is not an easy task, but it is one that I believe is essential that we get right.

 

NASD has put a particular effort, through its market transparency and investor education programs, into ensuring that investors have the information they need to make good investment decisions.

 

In the area of market information, TRACE, our Trade Reporting and Compliance Engine, makes information on corporate bond market activity quickly and easily available.  A few years ago, mainstream investors were mostly sanguine about the fact that basic information about bond trades and prices was not easily obtained.  Today, Any person can log onto TRACE by way of NASD's website, type in the name of a corporation and get instant, up-to-the-minute information on all that corporation's outstanding bonds - their yields, when they last traded and for how much, their ratings and more.  Today, after three years of incremental growth, every single bond on the corporate market is TRACE-accessible.  That's about 29,000 issues.  And now that we have made basic trade information available, we are working hard to make bond information accessible and understandable to mainstream investors.  We have launched a website called Smart Bond Investing, have begun publishing corporate bond aggregate statistics in major newspapers like the New York Times and Wall Street Journal, and we recently launched two corporate bond indices in cooperation with Bloomberg to give investors a simple tool to track that market. 

 

Another area where we've worked hard to make information about a product accessible is the area of mutual funds.  The conflicts of interest and sales practice issues that we've been trying to stop - to say nothing of the market-timing and late-trading issues that other regulators have addressed - made it painfully clear to us that more disclosure and more transparency was needed in this market.

 

An issue you've heard us talk about a lot over the last couple of years is breakpoints.  As you know, we discovered in 2002 that many high-volume investors in front-end load mutual funds were not getting the volume discounts that were owed to them.  While some of these failures on the part of brokers were inexcusably negligent, and merited enforcement action, most of them were the result of confusion, operational breakdowns and lack of easy access to basic information. 

 

So, after taking disciplinary action where needed and ordering firms to make every effort to reimburse investors who had been deprived of their discounts, we set out to take the confusion out of this process.

 

A couple of weeks ago, we launched a user-friendly, on-line tool that brokers can use to figure out whether their front-end load mutual fund customers are eligible for volume discounts.  We developed this in conjunction with the DTCC and you can find it on our website. For the first time it makes accessible to the public all of the rules regarding breakpoints for each fund family.  We provide this to the industry at our expense, and we will bear the cost and responsibility for ensuring that the data-base is up-to-date and accurate. 

 

We've also committed to facilitate the operational implementation of point-of-sale disclosure of mutual fund information, if the SEC approves a point-of-sale rule.  The proposal that NASD put forward is to have internet pre-sale disclosure of information pertinent to a fund - costs, risks, performance, investment style, potential conflicts of interest.  If this rule passes, as with breakpoints, the mutual fund and broker/dealer industries will need to work together to ensure that operationally such disclosure can be achieved.  As I said, NASD has committed to provide financial and other resources to ensure that this important goal is achieved.

 

I should point out that in the area of mutual funds all our activities in this area have been based on the recommendations of two task forces we put together - one to help us sort through the breakpoints issue, the other to consider ways to make mutual fund costs and distribution arrangement more transparent to investors.  Both taskforces were comprised of leaders of the broker-dealer and mutual fund communities.

 

I hope you've discerned from what I've said so far and what we've said before, that whenever we saddle you with new rules and requirements, we also do everything we can to make compliance with them as simple as possible.

 

You may also have noticed that a lot of these new rules and requirements have to do with improving disclosure - particularly point-of-sale disclosure.  In this era of instantaneous access to obscure or arcane information, there simply is no reason why an investor should still have to slog through a 30-page prospectus that - let's face it - is often incomprehensible to investors.

 

There are several other areas where we have focused on disclosure of better information:

 

Variable and equity-indexed annuities are among the most complicated products out there.  Add to that the fact that they are marketed disproportionately to elderly people and you have a recipe for serious problems.

 

And we've already seen some of those.  NASD has brought dozens of variable annuity enforcement cases in the last couple of years for a variety of violations - inadequate disclosure, inadequate supervisory systems, improper switches and others.

 

We are moving forward with a proposed rule that would substantially improve point-of-sale disclosure for these products.  The rule, if approved by the SEC, will also require a thorough suitability analysis before any annuity sales recommendation is made, and approval of that recommendation by a principal of the selling broker's firm.

 

We've done something similar in the area of corporate bonds.  We currently have a proposal that recommends clearer information on confirmation of bond trades and gives guidelines to firms about what information is important to be disclosed to investors before a bond is sold to them.  These recommendations stem from a task force comprised of broker/dealers, institutional buy-side firms, investor advocates, and others. 

 

We are also upgrading the service we offer investors to look up the background of brokers.  BrokerCheck, a web-based utility that lets investors look into any registered person's background, including disciplinary history, customer complaints filed and so on, will have a major facelift in early 2006.  Again, the goal is quick, easy information available to investors. 

 

And, finally, we have significantly increased our efforts in the area of investor education.  Between the NASD Investor Education Foundation and our own internal investor education programs, we've funded programs ranging from 401(k) investing, to 529 plans, to annuities.  We also publish Investor Alerts, which briefly inform investors about new products that may be complicated and in need of a plain-English explanation, and about frauds and scams that are prevalent in the market at the moment.  The last alert we put out dealt with stock frauds that have reared their ugly heads in the aftermath of Hurricane Katrina.

 

We also have on our website about a dozen calculators that investors can use, for example, to analyze mutual fund and ETF fees and expenses, or to figure out how much they'll need to save per year in order to pay for their children's college education.

 

I've touched on a lot of different topics this morning, but they all share a common theme: we've entered a new era in which increased disclosure, increased transparency, more and better information are not luxuries; they are necessities.  The abuses of the bubble years have led investors to be more skeptical of financial professionals and the Internet has changed expectations of all consumers.  These two forces have fundamentally changed the demands of your customers, and firms that respond to this new demand will thrive.  And as I've said, we as regulators are going to work with the industry to ensure that we make information available, accessible and digestible by the investing public. 

 

I now want to turn the podium over to Linda Thomsen. 

 

Linda Thomsen is the Director of the SEC's Division of Enforcement. She joined the Commission's staff in 1995 as Assistant Chief Litigation Counsel. In 1997 she was named an Assistant Director in the Division of Enforcement. She was named an Associate Director in 2000, Deputy Director in 2002, and was named Director of the Division of Enforcement in May 2005. Before joining the staff of the Commission, Ms. Thomsen was in private law practice in Washington, DC and New York and also served as an Assistant United States Attorney for the District of Maryland. She received her A.B. from Smith College and her law degree from Harvard University.

 

It is now my distinct pleasure to introduce Linda C. Thomsen.