NASD: 2005 in Review
Washington, DC — This last year saw NASD intensify its regulatory focus on sales of mutual funds, variable annuities and 529 College Savings Plans by bringing significant enforcement actions, advocating enhanced point-of-sale transparency and creating tools for investors aimed at better understanding these products. In total for 2005, NASD set records for the number of new enforcement actions brought and the amount of fines collected.
NASD dramatically increased transparency in the corporate debt market with full implementation of NASD's TRACE (Trade Reporting and Compliance Engine). In February of this year, TRACE began disseminating publicly, in real-time, price data for 99 percent of corporate bond trades, and in September NASD submitted a rule proposal to the Securities and Exchange Commission (SEC) to allow real-time public dissemination of the remaining one percent of trades. On average, information is available daily on TRACE on 22,000 transactions representing approximately $18 billion in par value.
As part of its ongoing efforts to demystify the corporate, municipal and government bond markets for retail investors, NASD introduced a comprehensive, on-line learning center called Smart Bond Investing. NASD also introduced two major tools for mutual fund investing - a new and improved Mutual Fund Expense Analyzer that delivers fee and expense information to investors for virtually all of the more than 18,000 mutual funds and 160 Exchange Traded Funds (ETFs). Among other things, the analyzer will compare the expenses of up to three ETFs, mutual funds or share classes of the same mutual fund simultaneously. The new analyzers automatically populate fee and expense data, saving investors from the task of searching through the prospectus and sales materials and manually inputting the information. NASD's new Mutual Fund Breakpoint Search Tool offers users a groundbreaking way to research eligibility for breakpoint discounts. Investors and brokers can look up breakpoint schedules and linkage rules for mutual funds with front-end sales charges, most commonly A shares.
NASD continued to bolster its investor education initiatives by issuing a variety of Investor Alerts on topics ranging from identifying bogus stock tips on cell phones to protecting online brokerage accounts from identity thieves. The NASD Investor Education Foundation completed three grant cycles and awarded more than $3.7 million to organizations for educational programs and research projects targeting the underserved segments of the population.
NASD Dispute Resolution saw close to 6,000 new arbitration claims and 1,250 mediation claims filed in 2005. And, 9,150 arbitration cases and 1,700 mediation cases were closed during the year. NASD completed its arbitration and mediation hearing location expansion project in 2005 - and now has 68 hearing locations, at least one in each state, Puerto Rico and London. Also in 2005, NASD filed a rule proposal with the SEC to further tighten the definition of who may serve as a public arbitrator in its Dispute Resolution forum, and is close to finalizing its new Code of Arbitration Procedure, a plain-English document that will enhance investor accessibility to the forum.
NASD pushed for improvements in point of sale disclosure to mutual fund investors by proposing Internet disclosure of a new "Profile Plus" - a two-page document providing basic information about a mutual fund, including its investment objectives, risks, performance, fees and expenses and information about potential conflicts of interest. NASD also recommended that every broker-dealer be required to post a Profile Plus for each mutual fund it sells on its website, with hyperlinks to the fund's prospectus. Profile Plus is the chief recommendation of NASD's Mutual Fund Task Force in its second and final report to the SEC, Mutual Fund Distribution.
Also in 2005, NASD submitted a number of rule proposals to the SEC - including one that would impose more formal procedures for issuing fairness opinions and require broker-dealers to disclose potential conflicts of interest in the fairness opinions they write. NASD has also been working with the Municipal Securities Rulemaking Board (MSRB) to harmonize the rules for sales of 529 Plans (which are municipal securities) and mutual funds.
Mutual Fund Sales and Trading Practices
NASD intensified its focus on mutual fund sales and trading issues, bringing more than 120 disciplinary actions involving deceptive market timing, late trading, unsuitable sales of Class B and Class C mutual fund shares and impermissible revenue sharing. This year's actions bring to more than 400 the number of cases NASD has taken in the mutual fund area since 2000.
NASD fined six major firms - Citigroup Global Markets, American Express Financial Advisors (now known as Ameriprise Financial Services), Chase Investment Services, Merrill Lynch, Wells Fargo and Linsco/Private Ledger a total of more than $40 million for unsuitable B share and C share sales. NASD ordered the firms to offer customer remediation on more than 400,000 mutual fund transactions made by more than 79,000 households, at a cost potentially greater than the amount of the fines.
In the area of directed brokerage and impermissible revenue sharing, NASD settled 27 cases against retail firms for providing preferential treatment to select mutual funds in exchange for brokerage business, in violation of NASD's Anti-Reciprocal Rule. In the largest settled case, Ameriprise Financial Services was fined $12.3 million. In total, the 26 firms paid nearly $55 million in fines.
NASD brought 11 cases against firms for facilitating deceptive market timing in mutual funds or variable annuity sub-accounts, and for failing to have procedures in place to prevent late trading of mutual funds. Two of the largest cases involved a $1.5 million fine against ING Fund Distributors and a $1.2 million fine against Janney Montgomery Scott. ING Fund distributors was ordered to pay $1.4 million in restitution to the affected mutual funds, while Janney Montgomery Scott paid nearly $1 million in restitution.
NASD's continued focus on the sale of variable annuities and variable life products resulted in the filing of 88 cases in 2005. NASD settled a major enforcement action against Waddell & Reed, in which the firm agreed to pay a $5 million fine and $11 million in restitution to injured customers for engaging in a campaign to exchange the variable annuity contracts of thousands of customers without regard to the suitability of those switches.
Corporate Bonds and Trade Reporting
NASD continued its vigorous enforcement of rules prohibiting excessive markups and markdowns in bond transactions. S.G. Americas, RBC Capital Markets and RBC Dain Rauscher paid a total of $6.75 million in fines for excessive markups, inadequate supervision and faulty books and records. A fourth firm, Debt Traders, was expelled from the securities industry for similar violations. The four firms were also ordered to pay a total of $1.12 million in restitution to customers.
A number of 2005's cases concerned the failure of firms to promptly and accurately report corporate bond transactions to NASD and/or municipal bond transactions to the Municipal Securities Rulemaking Board (MSRB). NASD settled charges against 20 firms for late and/or inaccurate reporting of tens of thousand of municipal securities transactions to the MSRB, imposing fines totaling $1.65 million. Municipal and corporate bond trade reporting failures led to a record-breaking settlement with State Street Global Markets, which paid a $1.4 million fine. Edward D. Jones was fined $300,000 for failing to disclose municipal bond yields on more than 86,000 municipal customer sales confirmations. And NASD charged Oppenheimer & Co. (formerly known as Fahnestock & Co.) with failing to report municipal bond transactions, reporting others that were never effected and reporting thousands of other trades late and inaccurately - and with attempting to thwart NASD's investigation of that misconduct.
Abuses in PIPE transactions were a new area of focus for NASD investigators in 2005. A PIPE (Private Investment in a Public Equity) is a private offering in which accredited investors agree to purchase restricted, unregistered securities of public companies. Hilary L. Shane, a hedge fund manager formerly registered with First New York Securities, was permanently barred and paid more than $1.45 million to settle NASD and SEC charges of fraud and insider trading arising from her purchase and sale of shares in a PIPE transaction. John F. Mangan, Jr., a former broker and hedge fund manager formerly registered with Friedman, Billings Ramsey & Co., was permanently barred and paid a $125,000 fine to settle NASD charges that he deceptively obtained shares in the same PIPE offering, improperly sold the sales short and secretly shared in the profits from the those sales. Additional investigations are continuing.
NASD filed a complaint against Kenneth Pasternak, former CEO of Knight Securities and John Leighton, former head of the firm's Institutional Sales Desk, charging them with supervisory violations in connection with fraudulent sales to institutional customers in 1999 and 2000. Knight's former lead institutional sales trader, Joseph Leighton, agreed to a permanent bar and paid $4 million to settle NASD and SEC charges related to those fraudulent trades. In late 2004, NASD and the SEC sanctioned Knight Securities $79 million in connection with the same misconduct.
Instinet and INET ATS paid a $1.475 million fine to settle NASD charges of publishing inaccurate reports on order execution quality, backing away from posted quotes, failure to report orders, improper "last sale" or trade reporting and supervision violations. INET's and Instinet's flawed reports compromised the ability of investors and other market participants to accurately assess execution quality and compare venues for execution.
While fee-based brokerage accounts have become increasingly popular over the past several years, NASD brought two cases in which firms failed to institute appropriate supervisory procedures for fee-based business, to the detriment of their customers. NASD fined Morgan Stanley DW, Inc. $1.5 million and ordered the firm to pay more than $4.6 million in restitution to 3,500 customers for failing to adequately supervise its fee-based brokerage business. In addition, NASD censured and fined Raymond James & Associates and Raymond James Financial Services $750,000 for violations relating to the firms' fee-based brokerage business and ordered to pay restitution totaling $138,000. The firms also violated NASD rules by recommending and opening fee-based brokerage accounts for customers without first determining whether these accounts were appropriate and by allowing fee-based accounts to remain open without determining whether they continued to be appropriate for customers.
Research Analyst Rules
Enforcement of NASD's research analyst rules remained a high priority in 2005. Over the last 18 months, NASD has brought more than 30 cases in this area. Among 2005's notable cases were: a six-month suspension and $130,000 fine against Jesup & Lamont Securities Corporation research analyst Gary Davis for trading contrary to the recommendations in his research reports and other violations; formal charges against the firm and its chief compliance officer, Robert Strong, for failing to detect and prevent the illegal trading activity by Davis and for other violations relating to research reports published by the firm; a $75,000 fine against Fulcrum Global Partners research analyst Walter Piecyk for circulating a false rumor about RF Micro Devices, Inc. while selling short 3,000 shares of that company and earning a profit of $7,815; and, a $100,000 fine against SunTrust Capital Markets and a $150,000 fine against Green Street Advisors for failing to qualify and register their research analysts under new NASD rules.
529 College Savings Plans
Another area of focus in 2005 was sales of 529 College Savings Plans. In the first action of its kind, NASD fined Ameriprise Financial Services (formerly American Express Financial Advisors) $500,000, and ordered it to pay approximately $750,000 to compensate more than 500 disadvantaged customer accounts - for failing to adequately supervise the firm's sales of 529 Plans. As a result of those failures, Ameriprise had no procedures in place to ensure that sales recommendations took into account available state tax benefits for in-state 529 Plans. NASD's investigations into 529 Plan sales are continuing.
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 registered firms. For more information, please visit our website at www.nasd.com.
2005 Year End Statistics*
|New Disciplinary Actions Filed||1,412||1,396||1,410||1,271|
|Formal Actions Resolved||1,296||1,336||1,324||1,129|
|Firms Expelled From Membership||14||22||30||25|
|Individuals Barred From The Industry||381||454||494||440|
|Firms Suspended From Membership||3||4||7||5|
|Disciplinary Fines Collected (millions)||$125.4||$103.9||$33.3||$68.2|
|Customer Complaints Received||4,800||4,687||4,843||4,495|
|Customer Complaints Resolved||4,500||4,730||5,686||4,611|
|Firm Examinations Initiated||2,284||2,351||2,645||2,662|
|Firm Examinations Completed||1,925||2,174||2,787||2,480|
|Terminations For Cause Initiated||8,600||12,081||6,510||4,438|
|Terminations For Cause Resolved||8,500||12,421||7,359||4,448|
|Examinations For Cause Initiated||6,600||10,658||3,384||2,100|
|Examinations For Cause Resolved||6,500||10,258||3,453||1,950|
|Advertisements and Sales
|Arbitration Claims Filed||6,000||8,201||8,945||7,704|
|Arbitration Cases Closed||9,150||9,209||7,278||5,957|
|Mediation Claims Filed||1,250||1,217||1,200||936|
|Mediation Cases Closed||1,700||2,063||1,889||1,360|
|BrokerCheck Searches and Reports||4,086,451||3,815,961||2,956,974||2,329,307|
The data provided is preliminary. Final numbers may vary slightly.