Remarks at the ICI General Membership Meeting

Mary L. Schapiro

Chairman and CEO, NASD

Washington, DC
May 11, 2007

Good morning and thank you, Paul, for that kind introduction. I am very honored to have been invited to kickoff this morning's program.

Mutual funds are a true success story - for you, for investors and for the market. They've become an American institution.

Today, there are tens of millions of individuals who rely on you, and the integrity of the marketplace, to make their dreams a reality. They take stock of their financial goals and they come to you to help them realize their dreams and build their future.

Perhaps more than any other industry, that focus on the future is what defines financial services. Individual investors and institutions alike are always looking beyond the horizon to get a glimpse of the future and all its possibilities.

I believe the future of financial services holds much hope and unlimited possibilities for investors, the industry and even the regulators. But it also holds many challenges. And all of us in this room must be willing to meet those challenges head-on if we are to navigate today's dynamic marketplace, both here at home and abroad.

I'll talk about those challenges in a moment and how NASD is tackling them, but first let me share an interesting fact.

On this very date nine years ago, an event took place that symbolizes an historic step in the development of the global economy.

Nine years ago today, on May 11th, 1998, the very first Euro coin was struck at France's official mint. It was the prelude to the creation of what was at the time the world's second largest economy after the United States.

The formation of the European Union - essentially a continent-wide merger - was a monumental change to the old economic order - it was also a harbinger of what was to come.

Today, globalization, international mergers, lightning-fast technology and a dizzying array of new products are leaving the landscape of the markets forever altered.

Today's market is defined by one thing: constant change - and nothing can be taken for granted - not a product's popularity or a market's dominant position.

No doubt you've read the warnings that America risks losing its position as the world's financial capital. These reports have raised important issues concerning the future competitiveness of U.S. markets and have spurred much discussion - as well they should. Some agree with the findings, others aren't so sure.

But whether you believe regulation is a strength of our system or a handicap, whether you believe that private litigation is an important check on the excesses of corporate America or a boon only to the lawyers, or whether you believe that SOX 404 was an appropriate, measured response to corporate misdeeds or is a deleterious overreaction to a handful of scandals, the debate is raging and will continue for some time.

But one thing we can all agree on, and which is abundantly clear, is that the changes we are witnessing in today's capital markets are unprecedented and far-reaching.

If mutual funds and U.S. markets are to continue to be an "enduring value for investors" - to borrow a phrase from this conference - it's going to require all of us to adapt to today's market realities.

More than anything, it's going to demand change - including changes at NASD - in the way we interact with investors and those we regulate and an imperative to introduce a more modern approach to regulation.

I'd like to start by discussing some of the important changes taking place at NASD that will usher in our time as a modern regulator.

Very soon, we will make history by consolidating NASD with the member regulation operations of the New York Stock Exchange. The concept of regulatory consolidation has been around for a long time; it was a simple idea, but then again, most of the good ones are.

Former President Ronald Reagan had a pretty simple idea when he told Gorbachev to "Tear down this wall." Since then, capitalism and economic modernization have sprouted in countries from Eastern Europe to China.

Another individual, Bill Gates, had a simple idea too - making computers relevant to our daily lives. He accomplished that and, in doing so, transformed the way we all live, work, play…and invest.

Today, our capital markets are confronting the very forces unleashed by these two simple ideas: the spread of political and economic freedoms across the globe and the explosion of technology.

We at NASD realized that if we expected to keep up with the changes taking place around us, we needed to bring our work into the 21st Century. That meant streamlining regulation - making it more efficient, more effective and more responsive.

Our consolidation plan creates a single, new self-regulatory organization that will be the sole private-sector regulator for all securities brokers and dealers in the United States, doing business with the public. 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.

When the new organization is in place and fully-integrated, there will be one regulator where there once was two. There will be a single set of rules adapted to firms of different sizes and business models. There will be one set of examiners and one enforcement staff. Beginning this year, firms that have had the pleasure of hosting examination teams from both NASD and NYSE will receive one team and have one exam with one set of findings.

Duplicative regulation and overlapping jurisdiction will become a thing of the past. Inconsistent approaches and rule interpretations, and matters falling through the cracks between two separate regulators, will be historical footnotes. As well they should be. The time is long past for us to introduce as much efficiency as possible into regulation and this transaction represents the first major restructuring of the self-regulatory model, rooted in the laws of the 1930's, in many decades.

As we await final word from the SEC, my expectation is that by this summer, the New SRO - with a new name - will be up and running.

It's my hope that consolidation will also encourage more cooperation among regulators of all financial products. This cooperation will be critical to fixing what I consider the soft-underbelly of regulation today: jurisdictional boundaries that focus on the product rather than the investor.

In my opinion, the regulatory regime simply must become more investor-centered. Regulators really need to stand in the shoes of the investor and look at issues beyond our narrow jurisdiction.

A charitable way to describe financial product regulation today would be to say it's "stove-piped." There are also less charitable ways to describe it, but it's much too early in the morning for that.

In the past, products being offered to investors were far less complex than they are today. Stocks looked like stocks, bonds like bonds, and insurance products like insurance. And there were clear lines governing the regulation of each product.

In a simpler world, that approach was appropriate. But the world is growing more complex, not less, and regulators need to appreciate this.

Right now, the burden is placed squarely on the shoulders of the investor. Within an individual's financial plan, there will be a number of different products regulated by as many different regulators.

We have the SEC, CFTC, NASD, MSRB, 50 state insurance regulators, multiple banking authorities - all looking at specific products within their own jurisdiction, but rarely working in concert. For the investor, that's a recipe for confusion.

I really can't say it enough - the focus shouldn't only be on the product, the focus should be on the investor. You might remember the old debates about "functional regulation" - the predominant view was that we must have different agencies regulating different products and markets because those products and markets served different functions. For example, the CFTC regulated risk shifting markets and the SEC regulated investment markets and hence we needed two agencies.

I would suggest that functional regulation today is something quite different and must be viewed from the perspective of the investor for whom each product may be serving multiple purposes: insurance and investment, as in variable annuities; risk shifting and investment as in hedge funds or credit default swaps.

Today's markets offer so many different kinds of investment products and vehicles that I would be surprised if even the most sophisticated investor could distinguish which products are regulated by whom.

And with those different regulators come different investor rights. Why should the protections that investors receive vary from product to product? The answer is: they shouldn't - there is no excuse for offering investors second-class protection.

Nobel Laureate and British philosopher Bertrand Russell once said, "The only thing that will redeem mankind is cooperation."

Now, I'm assuming the term "mankind" includes regulators, but I'm not sure how familiar Bertrand Russell was with modern securities regulation.

So I'm going take a little poetic license here. In my opinion, the only thing that will redeem "regulators" is more cooperation. It will take more cooperation among regulators to better protect all investors.

An excellent example of this is the joint statement issued earlier this week by NASD and state insurance regulators from North Dakota, Iowa and Minnesota. Together, we are supporting a new rule requiring insurance companies and agencies to recommend only suitable annuity products to their customers.

I believe it represents an important step toward future cooperation among regulators.

As we evolve as modern regulators we must also ensure investors have choices - in the types of firms they seek to do business with and the array of products and services those firms offer. Regulators must be more sophisticated in understanding and accommodating different distribution mechanisms and business models without compromising investor protection.

Part of that means losing the blinders of "one size fits all" rulemaking. In some areas that argues for a more principles-based approach to regulation; in others it may argue for tiered regulation based on firm size or business model; and in others, a clearer distinction in the rule set between retail and institutional investors.

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? NASD is engaged in a rule review process, as we work through the consolidation of our rulebook with the NYSE, that is endeavoring to ask and answer those very questions.

If mutual funds and U.S. markets are to continue to have enduring value, we also need to put more relevant information into the hands of investors in a more timely fashion because information and transparency breed confidence.

Investor confidence in well-regulated U.S. markets has always been our source of strength. It has distinguished our markets from others for years. The mutual fund industry understands this particularly well.

With the explosion of technology and information, it is my hope that in the near future the uneducated investor will be headed the way of the dinosaur.

As modern regulators we can't simply respond to investor complaints - or problems that have already come to light - we need to engage investors.

As the stewards of the largest Investor Education Foundation in the United States, we have a special obligation and opportunity to reach out to the public with the education and tools necessary to make them successful investors.

This week, we gathered together at Dartmouth College, the leaders of US foundations, not-for-profits and government agencies with responsibilities for investor education. Our goal was to understand the landscape of investor engagement, learn the tools of effective social marketing and establish strategic partnerships that will allow all of us to leverage our resources most effectively.

Each year since I've been at NASD, we have increased and deepened our focus on investor education. To cite just one example, we now offer multiple tools on our web site that can help investors manage their money with confidence in what is now a much more complex market. And, as you know, we have turned our attention to the mutual fund arena in this regard.

I believe - and you will not be surprised to hear me say this - that there is a real opportunity for better information and vastly improved disclosure at the point of sale.

Three years ago, NASD formed a task force to examine this area. And from the task force's discussions we developed Profile Plus, a concise two-page document explaining the funds' strategies, objectives, performance, costs and risks.

Profile Plus permits investors to customize disclosure to meet their needs and to obtain more detailed information if they want it through hyperlinks. But, first and foremost, it puts into investors' hands the most relevant information at the right time - before they purchase any product. It's my hope the SEC will move in the direction of our proposal.

This kind of investor-friendly disclosure is going to become even more important as new and more complex products come to market.

New products demonstrate clearly why it's more important than ever that we, as modern regulators, be proactive not just reactive.

We must always survey the landscape for risk and look around the corners for nascent 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.

To address the flood of new products, NASD has developed a sophisticated approach, designed to meet new investor needs.

We actively monitor the marketplace for new products and analyze their terms, conditions, risks and fees. New products are identified through reviews of marketing materials, examinations, the membership application process and discussions with experts of all kinds, including research analysts, academics, consumer advocates and industry insiders.

We focus on products that have exceptionally high fees or hard-to-understand risks, as well as investment fads, reincarnations of troublesome products from the past, and those that target vulnerable populations.

Once the new products have been identified, our chief economist performs a thorough analysis and works with NASD staff to formulate the proper regulatory response - perhaps a rule change or enforcement action, but more likely an investor alert or a Notice to Members with best practices related to the sale of the product.

New products are always a challenge, but we believe our coordinated approach will help us keep pace with the rapid product innovation we are witnessing today in the markets.

At the beginning of this speech I said I believed the future is full of possibility - for investors, for your industry and for regulators. That is true if we all have the wisdom and foresight to understand the world around us.

As I said, nine years ago today we saw the first Euro coin and with it a glimpse of the new economic landscape. With the creation of the EU, European borders were virtually wiped away, at least in economic terms. Today, international economic borders continue to fade away.

You can't pick up a newspaper today without reading about international exchange mergers and joint ventures. Whether it's NYSE/ Euronext, Deutsche Bourse/ISE, brokerage firms investing in foreign markets such as India, or Americans' hunger for direct access to foreign stocks - the necessity for regulators to operate in a world no longer defined by geographic borders or time zones is now an imperative.

This global transformation isn't waiting for regulators to figure it out—the business is moving forward—and if we are to fulfill our obligations to investors and market integrity, then we had better re-double our efforts to link arms with fellow regulators across the globe. And importantly, we need to learn from our colleagues in other countries.

We are just now wrapping up an internal study of the UK Financial Services Authority and how it approaches its mission and fulfills its responsibilities. Much has been made of the competitive benefits of their more principle based approach to regulation, in contrast to our US system with its heavy reliance on prescriptive rules of conduct.

Our review includes a look at how we and the FSA have each handled two areas of recent interest - soft dollars and research analyst/investment banking conflicts of interest - as well as a look at enforcement philosophy and examination practices.

I can't tell you that I know where this will lead, but our goal is to ensure that we have a system that truly protects investors and maintains market integrity while allowing firms to innovate, compete and grow. If this means that we should do some things differently, then we will.

We have been handed a unique chance through the consolidation, to write on - if not a clean slate - one that allows many opportunities to re-think and recalibrate our approaches.

If there's one thing I've learned in my 25 years as a regulator it's that the market is in a perpetual state of evolution. And if we expect to be successful, we must have the capacity to evolve with it, making regulation more effective, efficient and investor-centered.

As regulators, we at NASD will seize every opportunity we can to build stronger and healthier markets, defined by fairness and integrity. But your help will be crucial. And I look forward to working with you.

Both mutual funds and our markets will have enduring value only if there exists smart, sound and fair regulation able to respond to the transformations taking place in the global economy.

If you expect your products to remain popular, if we want U.S. markets to remain dominant and if we want investors to have the confidence to invest, it will be up to all of us to be open, alert and flexible to the changing world around us - now more than ever.

Thank you so much for listening - I hope you enjoy the rest of the conference.

I'd be happy to answer a few questions.