finra

Remarks by Doug Shulman

Vice Chairman 

Welcome Remarks

16th Annual NASD Spring Securities Conference

May 23, 2007

 

Thank you, Elisse, for that kind introduction. I'd like to welcome you all to Chicago and thank you for joining us to kick-off NASD's 16th Annual Spring Conference.

Conferences like this provide an ideal setting for regulators and market participants to engage in a productive dialogue concerning the exciting issues in this fast-changing market.

Over the next two days, you'll have the opportunity to talk directly to NASD staff about any issue that's on your mind. We look forward to answering any specific questions you may have.

But this morning, I'd like to take a wide-angle view of the industry and discuss some of the extraordinary changes taking place in the capital markets, as well as the challenges ahead.

Given the nature of my remarks today, it's somewhat fitting that we are in Chicago, a city that has seen great change over the years.

In 1900, this city was the meatpacking capital of the world. The industry was a staple of the local economy. But by the 1970s most of the city's meatpacking houses had left Chicago. Why? Changes in transportation, refrigeration and modern technologies had transformed the industry.

Now, I realize we aren't in the meat business. But there's a lesson to be learned here. No matter what line of work, every industry experiences periods of upheaval that fundamentally change the way business is conducted.

Today, globalization, international mergers, faster technology and an aging population are transforming the financial services industry. Our challenge will be to anticipate that change and, when possible, get out in front of it.

As I look ahead, there is no doubt in my mind that the challenges we face will test firms of all business models and sizes, as well as regulators.

So today, I want to focus on what NASD is doing to prepare for these challenges and the evolving markets of the future, as well as what NASD is doing to help your firms prepare for tomorrow's market realities.

Regulatory Consolidation

The most visible step we are taking to keep pace with the changing marketplace is the NASD/NYSE regulatory consolidation.

This plan will combine NASD and NYSE Member Regulation into a single, new self-regulatory organization (SRO) responsible for all 5,100 securities brokers and dealers doing business with the public in the United States.

The consolidation plan will enable us to establish a more sensible and less complex regulatory regime that will be more efficient and effective. 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.

We will also look toward fashioning the new rulebook in a more targeted way taking into account firm size and business model. We believe that this tiered approach to regulation should yield a rulebook better rationalized between intent and impact and, therefore, more efficient regulation.

As far as governance, the new SRO's Board will balance strong, independent public governors with robust industry representation. Ten of the 23 governors will be industry representatives. Of these industry seats, three are allocated to large firms, one to medium-sized firms, and three to small firms. In addition, there are three industry seats set aside for particular business models, one of which is allocated to an independent dealer/insurance-affiliated firm, one to a NYSE floor broker and one to an investment company-affiliated firm. The goal is to balance industry expertise with independent voices, with the entire Board working together to ensure that investors are protected.

As you know, there have been three recent reports questioning whether the U.S. capital markets can keep their current competitive edge with the current regulatory regime. Many people from Europe and Asia look at our regulatory scheme in the United States, which includes the SEC, CFTC, States and multiple SROs, and are often confused. Through our merger with NYSE Member Regulation, we are doing our part to streamline the regulatory structure of the U.S. markets.

Now that the By-Law amendments have been approved, they have been sent to the SEC for approval. Our hope is to have all the necessary approvals and a final agreement with the NYSE Group completed in June.

It is important to understand that once consolidation takes effect, there will be no immediate, dramatic changes for firms as far as rulebooks, exam cycles or forms and technology interfaces.

Upon closing, rulebooks will remain the same for firms. Dual firms will be subject to both rule sets until our rulebook is merged, and NASD-regulated firms will continue to be subject only to the NASD ruleset.

Exam cycles will remain the same, except dual firms will have coordinated exams. Forms and technology interfaces will stay the same as we merge systems and rulebooks. And most of 2007 will be spent integrating staffs, systems and rulebooks. Firms can expect to see more significant changes in 2008.

In other words, there should be no surprises for you.

Trends and Issues

One of our jobs as a regulator is to understand the trends facing the industry, and to stay ahead of those trends.

Let me speak for a few minutes about what we see as the most significant issues facing investors and the brokerage industry today.

First, there is the technology revolution. Simply put, technology has changed our everyday lives and has empowered investors like never before.

Today, essentially all of our computers are connected to one another through the Internet. At the click of a mouse, investors in Australia can receive real-time information about U.S. markets and even place an order from the beach in Perth.

Investors now demand quicker access to more information that is easier to understand.

That's why NASD recently advocated revamping the disclosure regime for mutual funds. We've recommended to the SEC that they adopt a two-page, Internet-based disclosure form for mutual funds, which states in plain English the objectives, risks, benefits and costs of the fund.

In this information-rich world we live in, receiving a prospectus in the mail three days after purchasing a fund doesn't really benefit investors. We think that the demand for information, together with new technology, will drive a new kind of disclosure regime in the future.

This rapid technological change also creates challenges for firms.

As we emerge from a period of active rulemaking that followed the excesses of the dot-com era, firms have spent a great deal of money on systems and data to enhance supervisory and compliance processes.

On balance, better technology should translate into enhanced investor protection.

I encourage firms to continue to invest in providing their compliance professionals with better access to information, be it through better data on the products that they sell, better exception reports showing anomalous activities or better management reports to allow executives to monitor activities at the firm.

For our part, we've expanded the data that we provide free of charge to firms through the NASD Report Center. You can now get monthly reports showing your firm's performance against trade reporting obligations, or timeliness with reporting disclosures to CRD, to name two examples.

On the whole, investment in compliance technology is a positive trend that we hope will continue. As with any investment in technology, though, we must remain vigilant to ensure that the systems are performing as expected.

As firms move from using staff resources to technology resources for compliance, they must be careful not to lull themselves into thinking that the systems are without flaws, and supplement them with the right level of staff oversight.

The second trend that is transforming our industry is the coming tidal wave of baby boomer retirees. Over the next 20 years, 75 million Americans will turn 60. That's 10,000 new 60-year-olds every day. And with uncertainty surrounding the federal government's safety net, namely Social Security, and the erosion of company pension plans, the stakes are higher than ever before.

As our population grows older and baby-boomers close in on retirement, more and more American households are looking for your help to provide them with a safe and secure financial future.

The difference between a senior who is well prepared for the challenges of retirement and one who is not becomes a stark reality in the golden years. It's the difference between living a life of dignity, with the means to live comfortably, and living one's last years in worry and debt.

The third, and related, major trend we are watching is customers' desire for holistic financial solutions from their financial professional, not just a securities purchase or sale.

This trend shows more and more investors relying on structured or packaged products, such as mutual funds and variable annuities, rather than traditional stocks and bonds. A robust and competitive market for a new generation of packaged products could be quite helpful to investors struggling to make sense out of complexity.

In any competitive business, with the attendant time-to-market pressures, we need to balance the innovation that these products will bring with an equal emphasis on training those who sell these products, and on providing clear and approachable information to investors.

We remain willing and interested in a dialogue with distributors and product manufacturers to do whatever we can to ensure that products are sold appropriately, and with full disclosure of the risks, costs and benefits of each product.

The Modern Regulator

These are just some of the changes taking place in the market today. But these changes don't only impact firms; they obviously impact regulators as well, and NASD recognizes the need to keep pace.

As our Chairman and CEO Mary Schapiro has pointed out, to be a successful regulator today, we must be more things to more people. In other words, we need to evolve with the times. In a recent speech, she outlined several characteristics a modern regulator must embrace to be effective. Let me walk you through them today.

First, the modern regulator must ensure that investors have choices in the types of firms they seek to do business with and the array of products and services those firms offer. We must be more sophisticated in understanding different business models, and the particular challenges of different sized firms, without compromising investor protection.

That means "one size fits all" rulemaking isn't always the best approach. It means considering a principles-based approach to regulation, or tiered regulation based on firm size.

A first step has been our move to change sanction guidelines to require consideration of a firm's size and revenues when imposing monetary sanctions.

Another example is the work emerging from the Small Firm Rules Impact Task Force, created last September to examine how existing NASD rules impact smaller firms. In April, the NASD Board adopted two proposals recommended by the Task Force.

The first proposal would eliminate the requirement that firms verify designated contact persons on a quarterly basis for the NASD Contact System. Under the new amendment, member firms will be required to verify contact information on an annual basis only.

The second proposal would create an exception to NASD Rule 2210 (Communications with the Public), which requires all sales materials to be reviewed by a registered principal of an NASD member firm.

When adopted, principal review will no longer be necessary if a broker-dealer is using a distributor's sales material already on file with NASD.

The proposed amendment approved by the Board will eliminate dual review by registered principals, saving retail firms numerous hours spent reviewing sales materials previously approved by a registered principal at the product distributor.

While these two actions will help reduce the regulatory burden for all members, they will most positively impact smaller firms.

Second, the modern regulator is proactive, not just reactive.

We must always be on the lookout for risk and developing problems. Waiting for a product or practice to blow up and then reacting is not effective investor protection. And it is no longer sufficient in this day and age.

Proactive regulation means exploring all of our options for addressing emerging issues once we identify them. There should be no automatic response, such as writing a rule, when we see an issue emerge in the industry. We must consider a range of options, including best practices, guidance, education and task forces to help us understand the problem and propose effective solutions.

One example is our work with the industry to examine the clarity and accessibility of account opening forms. It's no surprise to you that customers often find these forms dense and confusing. And the density of these disclosures may have diluted their impact.

But we're working on a fix—a voluntary online and paper template that firms could CHOOSE to use. It would present, in plain English and a clear format, the critical terms of the agreement. The forms will be customizable, so that a firm can tailor them to its business model, as well as its branding needs.

As this example shows, the modern regulator can be proactive, and that doesn't mean just writing new rules. But even where rules are the right answer, we have an obligation to follow through with appropriate steps to help member firms comply.

Which underscores my third point: A modern regulator needs to find ways to assist you in meeting your compliance and regulatory obligations.

Education is one of our central obligations as a regulator. Ten years ago, we offered a small handful of conferences to the industry.

Today, we've invested significant energy and resources into developing a wide range of programs to offer, from conferences, training courses and, more recently, a compliance boot camp, to a wide range of online programs such as e-learning, webcasts, podcasts and online workshops.

You will see much more from us in terms of member education, particularly when it comes to offering online programs that are easily accessible for firms of all sizes.

Aside from helping firms comply with our rules by offering educational programs, we also need to make sure that we periodically step back and examine the impact of those rules. What we need to be asking ourselves on a regular basis is: Are the rules doing what we intended them to do? Are they protecting investors? At what cost? And finally, is there a better, more efficient way to achieve the benefit? One of the first rules we are focusing on for comprehensive review is our OATS rules. Are they meeting their intended goal, and if not, how should we change them? We will continue to view other rules through this lens as we learn from the pilot.

The fourth attribute of the modern regulator is to understand the world in which we operate. It is clear that regulatory jurisdictional boundaries are blurring, both abroad and at home.

Whether it is through U.S. investors' appetite for exposure to foreign stocks, or exchange mergers such as the NYSE/Euronext merger, regulation of broker-dealers in the U.S. is no longer just a U.S. proposition.

This necessitates that regulators must learn to operate in a world less and less defined by geographic borders. This global transformation won't wait for regulators to figure it out, so we need to re-double our efforts to work with fellow regulators across the globe.

But international boundaries should not be our only concern. Jurisdictional boundaries are not serving investors well, either. As investors turn to financial professionals to help them manage their assets, they often do not know the difference between insurance and securities products, or fiduciary duties versus suitability obligations. They just want someone they can trust to help them put their money to work so they can meet their financial and life goals.

We believe 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.

We're not talking about more regulation or additional jurisdiction for NASD. The point is that as the market evolves, products and providers no longer fit into neat little boxes. Therefore, regulators need to work together to regulate products that look and act in similar ways.

The fifth and final attribute of the modern regulator is that rather than simply respond to investor complaints, or problems that have already come to light, we need to engage investors. Investor education is a component of this, as is delivery of information directly to the public through systems like TRACE and BrokerCheck that inform and ease an investor's interaction with the marketplace. NASD has significantly increased its investor education efforts over the past several years, and will continue to do so as the New SRO.

Conclusion

As I pointed out in the beginning of my speech, the history of Chicago teaches us that change is inevitable. But the difference between success and failure lies in how we respond to change.

While other cities may have faltered when a pillar of its economy, meatpacking in the case of Chicago, practically vanished, today Chicago thrives. It's a world financial center home to major financial institutions: the Chicago Board of Trade (CBOT), the Chicago Board Options Exchange (CBOE) and the Merc.

For the financial services industry, change is also inevitable.

I hope you have gotten the sense from me today, that as we emerge as the new, consolidated SRO, we plan to continually evolve our approach to achieve our mission of investor protection and market integrity.

We look upon these times of change as an opportunity to improve our capital markets and further solidify them as the most efficient, liquid and best regulated in the world.

Thank you for listening. I hope you enjoy the conference.