NASD: 2004 in Review
Sarah Bohn (202) 728-8988
Washington, DC – NASD will finish another extremely productive year in 2004 protecting investors and instilling investor confidence through comprehensive enforcement actions, rule writing and investor education activities. Highlights for 2004 include filing 1,360 enforcement actions, barring or suspending 830 individuals from the securities industry and collecting more than $102 million in disciplinary fines.
In the area of rule writing, NASD moved forward with a number of important investor-focused proposals that touch on nearly every aspect of the securities industry, including variable annuity suitability and other recommendation requirements; requirements for securities firms to establish emergency preparedness plans; and new rules to ensure that firms effectively monitor the activities of their employees, especially those who manage office locations and also conduct their own securities business. NASD also put in place a required annual certification by chief executive officers of securities firms that the firm has processes to establish, maintain, review, test and modify written compliance policies and written supervisory procedures.
NASD dramatically increased transparency in the corporate debt market during 2004 through its dissemination of transaction information on corporate bonds reported through its Trade Reporting and Compliance Engine (TRACE) and will bring full transparency to the corporate bond market in early 2005. By enabling investors to obtain previously inaccessible information on bond sale prices, TRACE enables investors to confirm that they are paying a fair market price for bonds.
In October 2004, NASD began Phase III of TRACE dissemination, increasing the number of bonds eligible for dissemination to approximately 22,000,more than 98 percent of the investment grade market and 81 percent of the high yield market. Overall average daily volume in the corporate debt market declined to $18.5 billion in 2004 from $19.5 billion in 2003 and $17.8 billion in 2002.
NASD Dispute Resolution closed 2004 with 8,100 claims filed in arbitration and 1,200 claims filed in mediation. The forum also closed 9,000 cases, an all time record. NASD Dispute Resolution has adopted procedures on a national basis to expedite arbitration cases in which a complainant is elderly and/or infirm. The procedures were tested in a pilot program in NASD-DR's Southeast Region that began in July 2003. Also, in 2004, Dispute Resolution opened seven new United States hearing locations in Wilmington, DE; Wichita, KS, Birmingham, AL; Columbia, SC; Des Moines, IA; Providence, RI; and Hartford, CT., as well as a location in London for U.S. investors living abroad. By end of first quarter 2005, NASD will offer a hearing location in every state.
NASD established the NASD Investor Education Foundation, funded with an initial grant of $10 million. The Foundation conducted its first round of grant making and will announce the grants early next year. NASD also issued a variety of Investor Alerts on issues ranging from using home equity to buy securities to online identity theft scams and mutual fund issues including share classes, NAV transfers and breakpoints.
NASD continued its work on the significant issues confronting the mutual fund industry. It facilitated the implementation of the operational, disclosure and education recommendation of the 2003 Breakpoint Task Force. During 2004, NASD also led an industry task force on holding mutual funds through omnibus accounts, which informed the SEC’s rulemaking, and began work with a third task mutual fund force, which issued a report making recommendations on soft dollars and disclosure of mutual fund portfolio transactions costs.
Mutual Fund Sales and Trading Practices
NASD enforcement continued its focus on mutual fund sales and trading issues bringing more than 120 disciplinary actions in this area against securities firms in 2004. Violations in these cases concerned market timing and late trading as well as mutual fund sales and compensation practices. The 120 mutual fund-related actions bring to more than 300 the number of cases NASD has taken in the investment company area since 2000.
Most recently, NASD, together with the SEC, settled a major mutual fund sales practice case against First Command, a Texas-based firm that specialized in selling expensive systematic investment plans to military personnel. First Command paid $12 million following NASD’s findings that the plans were sold in a misleading fashion; the fines will be used for restitution to affected investors with the balance used for investor education for the U.S. military and their families.
Following NASD’s initiative in 2003 in which NASD directed firms to make refunds to customers who were entitled to a breakpoint discount that they did not receive in connection with a mutual fund purchase, NASD and the SEC settled charges against 15 firms with the most substantial breakpoint failures; those firms were ordered to pay over $21.5 million in penalties. In addition, NASD sanctioned AXA Advisors for failing to waive mutual fund sales charges for eligible customers of funds offering special waiver programs.
In the area of mutual fund late trading and market timing, NASD brought a number of precedent-setting actions. For example, NASD was the first regulator to charge a mutual fund distributor, State Street Research Investment Services, with failing to have adequate systems to prevent the impermissible market timing of their funds. NASD was also the first regulator to charge a firm with failing to prevent market timing in variable annuity sub-accounts. With regard to late trading of mutual funds, NASD fined five firms for failing to have supervisory procedures to prevent such activities. NASD will continue to focus on these areas in the coming year.
NASD settled excessive mark-up charges with Goldman Sachs, Deutsche Bank, Citibank and Miller Tabak, for $5 million each. The four firms each agreed to sanctions of $2 million for excessive markups, $1.5 million for deficient books and records and $1.5 million for inadequate Supervision. They also agreed to pay restitution from the $2 million allocated for the excessive markups.
One of NASD’s major trading cases in 2004 was the joint settlement between Knight Securities, LP, the SEC and NASD. NASD determined that Knight’s former lead institutional sales trader had the firm acquire a stock position after receiving an institutional customer’s order, and then waited until the price of the stock moved before executing trades to fill the customer’s order, creating greater profits for Knight at the expense of his customer. Knight paid a $12.5 million fine to NASD, a $12.5 million civil penalty to the SEC, and $54 million in disgorgement and interest to customers.
NASD continued its commitment to investigating abuses relating to the marketing and sale of variable annuities. In 2004, NASD barred and fined individuals and firms in over 65 cases. In addition, NASD charged Waddell & Reed with failing to have supervisory systems in place to prevent unsuitable recommendations to replace variable annuities; NASD’s charges against Waddell & Reed arose from that firm’s replacement of thousands of its customers’ variable annuities.
NASD increased its disciplinary focus on the arbitration process. For example, NASD settled three cases this year against firms that had failed to comply with their discovery obligations in arbitration cases brought by their customers, with record-setting fines for such actions that totaled $750,000. Separately, NASD settled a case against Sigma Financial for improperly suing their clients in state court as part of a campaign of harassment initiated after the customers won their arbitration case against the firm. Sigma was ordered to pay the original arbitration award, $135,000 in fines and more than $100,000 to the elderly couple for the attorneys’ fees they had to pay to defend themselves in the state court actions.
Innovative Sanctions/Temporary Cease and Desist Action
In settling enforcement actions this year, NASD sought and obtained special disciplinary sanctions tailored to the nature of the violations. For example, in a market timing case brought against National Securities, the firm, in addition to paying $600,000 in fines and restitution, was barred from opening new mutual fund accounts for a period of 30 days. In 30 cases brought against firms for failing to timely file regulatory reports regarding their brokers, three of the firms with a history of regulatory problems in this area – Morgan Stanley, Merrill Lynch, and Wachovia Securities -- were temporarily suspended from registering new brokers. And finally, Christine Gochuico, a research analyst who assisted former Salomon Smith Barney analyst Jack Grubman, was barred from appearing on research reports for a period of 18 months.
In 2003, the SEC granted NASD the authority to seek Temporary Cease and Desist Orders (TCDO) in cases involving certain serious, on-going violations such as fraud. This year, NASD used its TCDO authority against LH Ross & Co., of Boca Raton, Florida. An NASD panel ordered the firm to cease and desist from engaging in fraudulent activities in connection with a self-offering of the firm’s own securities.
In addition to enforcing the federal securities laws and NASD rules, NASD is also charged with enforcing the rules of the Municipal Securities Rulemaking Board. This year, NASD brought several important cases in this area, including a series of seventeen cases against firms for failing to make appropriate efforts to get fair prices for their clients seeking to sell municipal bonds; the firms were fined and ordered to pay restitution of more than $700,000. NASD fined Morgan Stanley $100,000 for failing to disclose to municipal bond purchasers that their bonds were “callable” which would affect the yield of the bonds. NASD also continued to enforce the important “pay-to-play” provisions in MSRB Rule G-37.
NASD is the leading private-sector provider of financial regulatory services, dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology-based services. NASD touches virtually every aspect of the securities business - from registering and educating all industry participants, to examining securities firms, enforcing both NASD rules and the federal securities laws, and administering the largest dispute resolution forum for investors and member firms. For more information, please visit our Web Site at www.nasd.com.
2004 Year End Statistics*
|New Disciplinary Actions Filed||1,360||1,410||1,271||1,257|
|Formal Actions Resolved||1,293||1,324||1,129||1,205|
|Firms Expelled From Membership||23||30||25||11|
|Individuals Barred From The Industry||450||494||440||466|
|Firms Suspended From Membership||4||7||5||6|
|Disciplinary Fines Collected (millions)||$102||$33.30||$68.20||$13.20|
|Customer Complaints Received||4,745||4,843||4,495||5,155|
|Customer Complaints Resolved||5,101||5,686||4,611||5,123|
|Firm Examinations Initiated||2,351||2,645||2,662||2,623|
|Firm Examinations Completed||2,327||2,787||2,480||2,414|
|Terminations For Cause Initiated||12,404||6,510||4,438||4,027|
|Terminations For Cause Resolved||13,139||7,539||4,448||3,683|
|Examinations For Cause Initiated||10,545||3,384||2,100||1,841|
|Examinations For Cause Resolved||13,760||3,453||1,950||1,988|
|Advertisements and Sales Communications Reviewed||87,500||85,737||87,855||86,932|
|Arbitration Claims Filed||8,100||8,945||7,704||6,915|
|Arbitration Cases Closed||8,900||7,278||5,957||5,582|
|Mediation Claims Filed||1,200||1,200||936||880|
|Mediation Cases Closed||2,000||1,889||1,360||1,262|
|BrokerCheck Searches and Reports||3,720,390||2,956,974||2,329,307||1,802,109|
* The data provided is preliminary. Final numbers may vary slightly.