finra

Remarks by Elisse B. Walter

Senior Executive Vice President

Mutual Funds and Investment Management Conference

Palm Desert, California

March 27, 2007

 

Many thanks to the ICI and the Federal Bar Association for giving me the opportunity to join you here today. Unlike many of you, I'm a relative newcomer to mutual fund regulation. I've spent most of my career in public service—first at the SEC, then the CFTC and now at NASD—dealing with almost every aspect of the federal securities laws. Mutual fund regulation was the exception that defined my regulatory career for a very long time, despite Barry Barbash's prediction that I would end up working in the field. That has finally come to pass and, for several years now, I have found myself drawn into the mutual fund arena. I tell my rather expert staff—including Angela Goelzer, who is here with me today—that my diverse background in other aspects of federal securities law and regulation brings a fresh perspective to mutual fund issues. For some reason, they always roll their eyes when I say this.

One of the most important benefits of this conference is that it gives us a chance to step back and consider the big picture. The American financial services industry is, by and large, a phenomenal success story and our regulatory system is the envy of the world.

However, if we fail to appreciate fundamental changes in our industry and in our society as a whole—be they economic, demographic, technological, what have you—we can't adapt. And if we don't adapt, we are doomed to mediocrity or worse. Ultimately, it's the American investor who will pay the stiffest price for myopia on our part. Rather than stand by and let events overtake us, we need to be proactive in protecting and serving investors. This morning I'd like to talk with you about that need, along the way touching on many of the themes that Buddy Donohue and Paul Stevens spoke of yesterday.

One key aspect of serving investors is, of course, our regulatory framework. Today, we—regulators and the securities industry—are in the midst of making a major stride toward a better regulatory system. With the consolidation of NASD and NYSE member regulation, we will streamline the oversight of securities firms in the United States and change the way regulation is conducted. Most importantly, we will do this without in any way compromising investor protection. To the contrary, this consolidation will result in a more effective regulatory system that will better protect investors in our markets.

It would have been easy to stick with the old, fragmented system—after all, the status quo has worked very well over the years. But the industry and its regulators chose to take the right course of action, not the safe course of inaction. I'd like to thank the ICI for its support in helping us to move this plan forward.

The consolidation 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 members, will bring together all of NASD and NYSE Regulation's examination and 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 system 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 the potential for matters falling through the cracks between two separate regulators, will be historical footnotes.

The new SRO will be responsible for all member regulation, arbitration, mediation, risk assessment and all other current NASD responsibilities, including market regulation by contract for NASDAQ, the American Stock Exchange, the International Securities Exchange and the Chicago Climate Exchange. It will oversee all member compliance examinations, rule writing, training, licensing and registration, and industry utilities like the Alternative Display Facility, the OTC Bulletin Board, and Trade Reporting Facilities. In addition, the new organization will continue NASD's deep commitment to work with the industry to support their compliance efforts, provide extensive educational opportunities for those in the industry and continue with a strong and growing investor education program, which I'll discuss a bit more in a few minutes.

The governance structure for the new organization is well suited to the task. Ten members of the board will be from the industry, and representation of firms of differing sizes, elected by their peers, is guaranteed. The diversity of our industry will always be reflected on the board, and industry representatives, including a representative from the fund industry, will have a seat at the table when important decisions are being made. At the same time, eleven board members will come from outside the industry, assuring an appropriate balance.

A second way that we must be proactive in serving investors is by appreciating and responding to their changing needs. For example, one of the most important issues facing the nation today is retirement savings. That was one focal point of the general session yesterday. Let me point to some statistics, statistics that show how little Americans save:

  • Since the second quarter of 2005, the US personal savings rate has been in negative territory. According to the Bureau of Economic Analysis, the savings rate stood at minus 1.2 percent during January 2007. These are our lowest savings rates since 1932 and 1933, when the U.S. was struggling to emerge from the Great Depression.


  • At the same time, consumer debt is rising. According to Federal Reserve data, the ratio of household debt payments — meaning mortgages and consumer debt — to disposable income has increased steadily since 1980 and stood at just over 14.5 percent at the end of 2006. When you add in additional financial obligations, such as car loans, property taxes, and insurance, the ratio jumps to 18.2 percent for those who own their homes and more than 25.5 percent for those who rent. That's a lot of debt.


  • Our negative savings rate and increasing consumer debt comes at a time when Baby Boomers are in their peak earnings years and presumably should be socking money away because they are about to start retiring.


  • But we know they're not. Studies show that half of all American households have no money at all in a qualified retirement plan, and two-thirds are not saving enough to get them safely through their retirement years.


  • Perhaps most frightening of all, half of all workers who are closest to retiring—people between the ages of 55 and 59—have $15,000 or less in a 401(k) plan or IRA.

These statistics are very sobering, particularly when you consider the demographic changes that are shaping the nation's future. Let's consider three. First, the aging of America. In 2003, there were almost 36 million people aged 65 and over in the United States, accounting for over 12 percent of the population. By 2030, at least one out of every five Americans—or 20 percent of the population—will be over 65.

Second, we have the coming of the "echo boomers," those young investors born between 1977 and 1994. How will their investment needs differ from the generations that preceded them, and what compliance challenges will you face as you serve this younger generation? As the mother of two young men who fit squarely in that category, I worry about this. Our generation, by and large, has accumulated far more wealth than our parents dreamed of. The generation following us may naively expect to repeat this phenomenon, and I fear that they may be victims of their own high expectations.

Third, we have a new wave of unseasoned investors, particularly our growing immigrant population and older women. These new investors will present many opportunities, but they also will require financial education and attention.

The financial services industry has an important role in helping Americans do a better job at managing their money. It must help to ensure that they set realistic financial goals, learn the principles of sound investing, and understand the products that are offered to them. One study estimates that at least $41 trillion will shift from one generation to the next over the coming 50 years. Those who have saved and invested, who have accumulated far more wealth than their parents, must do something with it. Those who have not saved enough, those who are not on the path towards financial security, must be encouraged. In either case, the aging population needs sound financial advice to protect their wealth and secure their retirement.

At NASD, we are doing our part. To cite just one example, we amended our advertising rules to permit brokers to offer their customers investment analysis tools. These interactive computer-based tools permit investors and their financial advisers to estimate the probability that an investor will meet her financial goals, given her current savings rate and choice of investments. These tools also can recommend a different savings rate and a different investment allocation to increase the probability that an investor will meet his goals. In doing this, we have allowed more Americans access to the types of information that demonstrate the power of saving and investing.

And, each year at NASD, we increase our focus on investor education. We offer various tools on our Web site that can help investors manage their money with confidence—from BrokerCheck to our Mutual Fund Expense Analyzer, from our Professional Designations database to our Required Minimum Distribution calculator, and from our "Smart Investing" learning centers to our Investor Alerts. We encourage all funds and firms to make our resources available to their customers and clients, and we do our best to get the word out through investor forums across the nation.

Because we view investor education as such an important part of our mission, we established the NASD Investor Education Foundation in 2003, currently funded with $82 million, making it the largest foundation in the U.S. dedicated to investor education. Our Foundation funds grants to universities and non-profits for research and programs that help mainstream investors understand the complexities of investing and the markets.

The Foundation also funds research that helps us understand investor behavior. For example, a study prepared for WISE Senior Services by The Consumer Fraud Research Group examined why older investors are victimized by financial fraud, and sheds light on the persuasion tactics used and the types of investors most likely to be harmed. Grant recipients at Iowa State and Ohio State have been researching how gender influences investment behavior—and ways these factors impact investment decision-making processes among men and women.

As I mentioned earlier, Americans do a woeful job of saving for retirement. Part of the problem is a lack of employee access to employer-sponsored retirement accounts. According to the Retirement Security Project—also known as RSP—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. A recent report published by the Commission on the Regulation of U.S. Capital Markets in the 21st Century found that 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 RSP to harness the power of inertia to promote, rather than hinder, retirement saving. Numerous 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. We have already published a brochure that highlights key automatic features and identifies the benefits of these features to both employers and employees.

I urge each of you here today to step back and consider how you might help investors better understand their savings and retirement needs—and better understand what they must do to meet their needs. I know that Paul and the rest of the ICI leadership are doing just that.

The third topic that I will mention this morning is globalization—more specifically, the pressures that globalization places upon our regulatory system in an era in which the preeminence of the US capital markets is not a matter of divine right.

As Paul mentioned yesterday, earlier this month, an independent, a bipartisan commission established by the US Chamber of Commerce issued its report on the Regulation of the US Capital Markets in the 21st century. The Report observes that the US markets are under increasing competitive strain, with a steadily decreasing share of global capital markets activity. Other recent studies, such as the Interim Report of the Committee on Capital Markets Formation and a report commissioned by Senator Charles Schumer and New York City Mayor Michael Bloomberg also address these concerns.

Certainly, we cannot and will not let globalization become a rationale for a weakening of investor protection and market integrity in the United States. But by the same token, we don't want our regulatory system to push capital formation from our shores.

The role of the regulator in this era of globalization must become a finely-tuned balancing act. I continue to believe that a strong regulatory system promotes investor confidence and strengthens markets. On the other hand, more regulation for its own sake does not make for better markets. NASD believes strongly that an SRO should not impose a burden on industry that does not advance effective 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.

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. But we will not cling to outmoded practices when shifting environments demand change.

One way in which NASD is trying to strike the right balance is by assessing the impact of our rules on investors, firms and other market participants. Right now, NASD devotes considerable resources to evaluating the likely burdens and benefits of proposed new rules, and we have undertaken initiatives to modernize our rule book and identify obsolete rules. NASD is not required by law to perform a cost-benefit analysis related to rulemaking, but I can assure you that we are not cavalier about regulatory costs.

We want to go further and respond to concerns that the benefits of some NASD rules do not justify the burdens they impose. 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 that the way they should, and that the burden they impose is warranted given their beneficial effects.

Finally, I'd like to touch for a moment on a regulatory issue near and dear to my heart, another issue discussed yesterday—disclosure. We need to consider the entire universe of investment product disclosure, including mutual fund disclosure, to determine whether investors are getting the information they need when they need it, and in a way they can understand. I think that we owe investors a far more streamlined and effective disclosure regime. Fortunately, the SEC is leading the way with its comprehensive review of mutual fund disclosure and its XBRL initiative.

NASD enthusiastically supports the SEC's point-of-sale disclosure proposal. Investors deserve a clear, simple and brief explanation of what they're getting into before they buy.

As most of you know, NASD convened a Task Force of industry experts to consider point of sale disclosure. I'd like to thank the ICI for their support of that project and the Task Force views. The Task Force recommendations build upon the Commission's point of sale proposal. But, there are two major differences:

First, the Task Force believes that point of sale disclosure should give an investor a snapshot of the fund, including investment risks and strategies, as well as the information about fees, expenses and conflicts proposed by the Commission.

Second, the Task Force believes that this information should be available to investors through the Internet if they prefer that disclosure mechanism. Internet access will make it easy for investors to compare different funds and for investors to drill down to more detailed information through hyperlinks to other documents. In that way, investors will be able to choose as much or as little detail as they desire. Perhaps most important, internet access gets this information - the right information - to investors at the right time - before they buy.

Of course, while the Task Force focused on mutual funds, we need to consider the rest of the picture as well—focusing on the other products and services that are offered to investors every day. And, we should also focus on investors who may not receive adequate information today. Employee plan sponsors are not required to deliver a prospectus or any meaningful disclosure about the mutual funds in a 401k or similar employee plan. Yet millions of investors buy mutual funds through these plans.

Some plan administrators and fund groups deliver the fund prospectus voluntarily. Others have developed their own fund summaries that are included in retirement plan packets. ERISA imposes some disclosure requirements. But, there should be a requirement that all employees receive the information they need about the funds that they can purchase through their employee plans.

Years ago, the SEC granted the fund industry the ability to use the fund profile in the employee plan market. Regulators should go farther, and mandate whatever short-form disclosure document the SEC approves—hopefully, something very much like the Profile Plus recommended by our Task Force.

We also have to keep in mind those investors who purchase other vehicles, such as ETFs, commodity pools and insurance products. I appreciate the fact that mutual funds are the most popular investment product. But they are not the only one. If the SEC proceeds with a mandated, short-form disclosure document for mutual funds, it should consider extending a similar requirement to other investment products.

With that, I'll conclude. I hope that I have given you some sense of the big picture issues that concern me and my colleagues at NASD. Let me again thank the ICI and the FBA for inviting me to be with you. It's been a pleasure and an honor.