Oral Statement Before the Senate Committee on Governmental Affairs Hearing On Analyst Independence
Mr. Chairman, Senator Thompson, Members of the Committee, thank you for this opportunity to testify.
First, let me briefly describe the NASD – because who we are bears directly on both the substance of what I'll be saying and on the usefulness of what we've been doing to strengthen analyst independence.
The National Association of Securities Dealers is the world's largest self-regulatory organization, or SRO. Under federal law, every one of the roughly 5,500 brokerage firms and almost 700,000 registered representatives in the U.S. securities industry comes under our jurisdiction – which also includes every securities analyst employed by a member firm.
Our mission and our mandate from Congress is clear: to bring integrity to the markets and confidence to investors. Employing industry expertise and resources, we license industry participants, write rules to govern the conduct of brokerage firms, educate our members on legal and ethical standards, examine them for compliance with NASD and federal rules, investigate infractions and discipline those who fail to comply. We are staffed by 1600 professional regulators and governed by a Board of Governors – at least half of whom are unaffiliated with the securities industry.
All this has given NASD a special responsibility to do something about the lack of transparency and increasing conflicts of interest that have eroded public confidence in securities analyst recommendations. And Mr. Chairman, it has given us the means to do something about it, as well. For the NASD is equipped to provide a layer of real private sector regulation between the industry and the SEC.
In July of last year – well before the Enron collapse – NASD issued a proposed new rule to significantly expand analysts' disclosure obligations.
And three weeks ago – culminating a process several months in the making – I joined several of your congressional colleagues and SEC Chairman Pitt in announcing far-ranging proposed new rules to govern the overall responsibilities of research analysts when they recommend securities.
These tough, comprehensive rules represent a big step forward in investor protection. They will provide disclosure of much more information about analysts' potential conflicts of interest – as when analysts or their brokerage firms own stock in the company being recommended, or the brokerage firm receives investment banking revenue from the company.
And they will prohibit certain kinds of behavior as simply being too riddled with such conflicts – such as analysts receiving pre-IPO stock, or trading against their recommendations, or promising favorable research to get underwriting business.
The bottom line is not only enhanced investor protection, but enhanced analyst independence.
Now, will our new analyst rules themselves prevent future Enrons? I will not sit before you and make that claim. For Enron was a multifaceted disaster – involving corporate governance that didn't govern, and accounting that was unaccountable, as well as analysts who were far from analytical in ferreting out the truth.
But I will say this. Under our new rules, the perverse incentives that may have caused analysts not to WANT to know or acknowledge the truth about Enron – because, say, their investment banks had lucrative client relationships with the company – those kinds of incentives will be reduced, in part because sunlight is the great disinfectant. And if there's any remaining reason to wonder whether an analyst has a conflict, he will have to fess up and disclose why to the investing public.
Let me make one final point, which I believe is critical. These new rules are a matter of private sector self-regulation. And not self-regulation in name, but self-regulation in fact.
The proposed rules were hammered out by the industry's foremost SROs, acting under the strong oversight of Congress and the clear vision of SEC Chairman Pitt. They will strengthen the industry's own business practices and ethical standards – but as enforceable regulatory rules, not trade association "best practices."
The new rules' impact is already being felt as some firms hasten to adopt the tougher standards. They will be enforced by the NASD with a full range of disciplinary options – which this year alone have included multimillion dollar fines and expulsions from the industry. And as detailed in my written statement, NASD has not hesitated to use its existing enforcement authority against analysts whose conduct has undermined market integrity.
Simply put, Mr. Chairman, these proposed rules will have teeth because self-regulation in the securities industry has teeth. That's what Congress wisely intended more than 60 years ago and it's what we continue to deliver with these rules today.