Remarks at the Spring Securities Conference
Chairman and CEO
Good morning. As we near the end of the conference, I want to say that I hope each of you has gotten something worthwhile out of it, and has had a chance to get out of the hotel and enjoy this lovely city.
We encourage you to let us know what you liked and didn't like about the conference, and to give us your thoughts on how we can make future ones better. If you're thinking of suggesting that we hold the next one in San Francisco, we're one step ahead of you. That's where it will be, in November.
As you know, we sponsor these conferences twice a year. Their purpose is to help you better understand your compliance responsibilities, in part by making our senior staff available to you for discussion and debate. We're regulators first and foremost, but we don't regulate in a vacuum. We listen. So, please don't be shy about speaking up.
Over the last few years, most of the public utterances you've heard from us have emphasized regulation, enforcement, righting wrongs and punishing those who break the rules. If you're hoping I'm going to announce some new way of doing things, I'm afraid I'm going to disappoint you.
Writing rules and enforcing them are central parts of what we do and we're going to keep doing them with no reduction in intensity. But I think by now you've gotten the message - at least I hope you have - and we've reached a point where talking about other matters needn't always take a back seat to a discussion of regulation and enforcement.
Yesterday, Mary Schapiro talked to you about the changing demographics of American investors and how they stand to affect your business models and compliance responsibilities in the years ahead.
Today, I'm going to look ahead, too. With the NYSE and Nasdaq both having made bold, competitive moves to position themselves for the market environment of the 21st Century - at least as they see it - and with the SEC looking broadly at the roughly 70-year-old system of self-regulation, it appears that the oversight of firms and markets may be in for some fundamental realignment. How should regulation evolve in light of events such as Nasdaq's acquisition of Inet? The NYSE's merger with Archipelago and its plan to recast itself as a publicly-traded, for-profit company?
But first, a look back.
The regulatory system we rely upon today has been around in pretty much its present form since the 1930s, when Congress established self-regulation as a means of avoiding pure government regulation of the industry. Congress reasoned that putting regulation entirely in the government's hands would have occasioned a large increase in the expenditure of public funds, the opening and staffing of SEC branch offices nationwide and rigid regulation of business conduct by government officials who would operate at some distance from the industry they oversaw.
Self-regulation, on the other hand, assured that first, taxpayers wouldn't have to finance oversight of the markets and second, the industry would be supervised by people who were closer to and more familiar with the complexities of broker-dealer operations.
Now zoom ahead to 1996, when the SEC took administrative action against NASD, which then fully owned, operated and regulated Nasdaq. At issue was pricing collusion among Nasdaq market makers and NASD's tepid response. The commission was particularly concerned about what it saw as a rather flimsy partition between NASD's regulatory staff and Nasdaq's market operations.
We took the commission's concerns seriously - so seriously, in fact, that we decided to chart an entirely new course for the organization. I want to tell you briefly what we did and how we did it, not because I want to toot NASD's horn, but because the way we resolved the conflict of regulating a market that we also owned may inform the thinking of those who are wondering what the future of regulation ought to be.
Our strategy started with a thorough examination of our regulatory and governance structure by an independent commission. That examination resulted in a number of recommendations, the most salient being that NASD put some distance between itself and Nasdaq by reconstituting Nasdaq as a separate operating subsidiary.
That was the right idea for the time, when NASD and Nasdaq were both private, not-for-profit companies. But in 1999, NASD decided to spin-off Nasdaq as a for-profit, publicly held company, and we decided there should be more separation of the regulatory operations. So we began the process of totally untying NASD from Nasdaq by placing it under its own separate management and separate board. NASD would continue to directly regulate member firms and would continue to regulate the Nasdaq market under contract. That clear blueprint is essentially how we operate today.
There is one important piece of the full-separation structure that still needs to be put in place. The SEC still must officially designate Nasdaq as a full-fledged exchange. I am encouraged by Chairman Donaldson's statement last week that Nasdaq Exchange Registration will be coming very soon.
At about the same time, and for the same reasons, we decided to sell the American Stock Exchange, which we had bought in 1998. Last year, we reached an agreement with Amex's seat-holders to transfer the exchange back to them and we consummated that deal on December 31. We continue to regulate that exchange under contract, as well.
Another reform we undertook was to alter the composition of our Board of Governors so that more than half its members would be independent of the securities industry. We wanted to avoid even the appearance of being controlled by the industry we regulate.
These steps were important components of our operating plan - a plan to which we still adhere. NASD today is focused entirely on its core mission of regulating the broker-dealer industry - 5,200 firms and 660,000 registered representatives - without fear or favor.
When Dick Grasso's compensation package and abrupt departure from the NYSE made for some rather creative headlines in the press, there began a public debate about the future of exchange self-regulation - a debate informed by the words of Dick Grasso himself, who said before leaving: "I wear two hats. I run the New York Stock Exchange and I regulate the New York Stock Exchange ."
Dual roles for the Exchange CEO - exchange operator and exchange regulator - invite concerns about conflicts of interest. There are lots of ways of putting the two hats on two separate heads. One is the NYSE's proposal on how to deal with regulation after the NYSE-Archipelago merger - put it into a separate, not-for-profit company overseen by the NYSE Board. An alternative is the completely decoupled structure we created in separating from Nasdaq.
There are no doubt other ideas, and it's not for me to say what's best. But I will say that our means of resolving this sort of conflict has worked for us.
Regulation of all markets must be firm, fair and consistent. And regulation must be fully funded, insulated from the pressures on a for-profit company to meet quarterly earnings projections. But, in my view, regulators have a responsibility not simply to regulate, but to do much more.
Your local fire department would rather give you advice on how to avoid starting a fire than to have to come racing to your house to put one out. By the same token, NASD would much rather give you the education and training you need to understand clearly what is permissible under our rules and what isn't than to have to take action against you for stepping across the line. Just as a burned-down house is hard to rebuild, investor trust is hard to restore. And a damaged reputation for our industry is hard to repair.
As I said at the outset, NASD has been hard at the business of enforcement for some years now - and for good reason. But at the same time, we've been working doggedly to give the people and firms we regulate an abundance of tools and information to help them stay on the right side of our rules.
So let me tell you about some new resources that we offer, and some we're planning, to help you stay on the path of compliance and proper behavior.
One that just debuted this week is our E-Learning Exchange, a Web-based educational utility designed to make quality, affordable on-line compliance training easily available to brokers, compliance staff, and other employees. This is a resource that users can access at their convenience, at their desks. The program will comprise a series of 25- to 30-minute interactive, on-line courses covering a variety of compliance-related topics - variable annuity sales practices, anti-money laundering and others.
The subject matter for these courses is being developed cooperatively by NASD and firms that have particular expertise in the topics at hand. The beauty of this approach is that it blends NASD's expertise on rules and rule-making with the industry's knowledge on the practical application of those rules. This is what private-sector regulation is all about.
The industry we regulate is overwhelmingly dominated by small firms - 83 percent of them have 50 or fewer employees. And unlike the Merrill Lynches and the Morgan Stanleys, they don't have armies of lawyers and compliance experts to parse every new rule that comes down the pike and explain to front-office staff how to avoid breaking it. So, we work doubly hard to make sure small firm personnel have all the tools they need to understand and comply with those rules.
I hope those of you who work in smaller firms saw an e-mail sent this month by Bill Alsover, Chairman of Centennial Securities in Grand Rapids, Michigan. Bill is a member of our Board of Governors and also chairs NASD's Small Firm Advisory Board. He is keenly aware of the challenges that smaller firms face. The e-mail drew your attention to a Notice to Members we posted in mid-April, explaining our new Rule 3012, which, among other things, requires member firms to test and certify their supervisory policies and procedures.
I hope and expect that Bill's e-mail brought the Notice to Members to the attention of a lot of people who may not have focused on it. Bill tells me he plans to send these to you on a regular basis, as events warrant.
Bill also presides over our occasional Small Firms Best Practices Conferences. These are one-day events where small firm compliance officers can learn about how best to supervise employees and stay in compliance. The best thing about these events is that they are designed to help participants learn from each other, as well as from us. The next one is scheduled for September 23 here in Chicago. You can find out more about it on our Web site.
A similar conference series that debuts next month in New York is our Nuts and Bolts Compliance Conference. At this event, compliance and legal professionals, officers of new firms, attorneys who advise broker-dealers on legal and compliance issues and other professionals can learn about a variety of practices, from dealing with customer complaints to working through the examination and disciplinary processes.
Getting the right information to the right people at the right time is not easy - particularly given that brokers, traders and others have little time to devote to keeping up. A service we offer with that in mind is a series of webcasts on particular products, sales practices and ethical standards where we perceive a need for better understanding of our rules. These are short, concise and to-the-point, and you can watch them whenever is convenient for you.
The first one went on-line in January and explained briefly the ins and outs of mutual fund share class distinctions and breakpoint discount rules. About 10,000 people have seen it, and some firms have incorporated it into their internal training programs.
The second in the webcast series is newly on-line. It addresses variable annuity sales practices, with a particular emphasis on switches. We've seen problems in this area and have had to discipline some firms for inappropriately switching clients from one variable annuity to another, exposing them to unwarranted commissions and surrender charges without improving their financial well-being at all.
Finally, I want to draw your attention to the NASD Report Center and strongly encourage you to use it. While not new, the Report Center gives firms access to a range of NASD compliance data and reports, such as Municipal Bond Report Cards and TRACE Operations Reports, all on a single, secure Web site. Here, your firm can get a fix on its compliance performance, detect reporting problems early and identify areas for improvement. And it can benchmark its performance against other firms.
So, those are a few of the resources we offer to help you avoid running afoul of the rules. There are many more and I invite you to visit our Web site to find out about them.
Investors have responsibilities, too, and foremost among them is the responsibility to know as much as they can when they invest in securities.
Again, it's better for everyone if problems are prevented. So, we offer investors a large and growing menu of educational resources to help them approach the markets more knowledgeably and confidently.
These include Investor Alerts on issues that are particularly timely and pressing. In the past few months we've published alerts about the danger of putting too much of one's retirement nest egg in the stock of one's employer; on-line identity theft, known as "phishing" - with a ph instead of an f; Section 529 college-savings plans and other hot topics.
The newest one, unveiled on Tuesday, deals with bond investing and announces our new on-line tutorial for investors on that subject. This expands our Smart Investing series to three tutorials, the previous two dealing with 401(k)s and 529s.
These are but a few of the educational initiatives we've developed to help investors. These initiatives also include our Investor Education Foundation, a $16 million project that funds research on a variety of subjects pertinent to individual investors, such as figuring out the best way to disclose financial product information to them. What types of information best serve investors' purposes? How much detail do they want or need? What's the best way to get it to them?
An investor who takes advantage of every educational resource we offer, and then some, is hardly better off than an investor who takes advantage of none of them if the market in which he wants to trade is inscrutable. What is the value of understanding bond behavior if you have no access to information about the bond market?
Even the most well-informed investor is at a serious loss when markets are not transparent and investors don't have easy access to transaction prices and information. Imagine a blackjack game where the dealer plays both his cards face-down.
Market transparency itself provides important protection to investors. It is harder to cheat them when transactions are open and understandable. So, in addition to educating and meeting with investors, NASD is committed to lighting the road they travel, so they can see for themselves where they're headed.
I mentioned the bond market. In 2002, we started pulling back the curtains that obscured essential information about corporate bonds from the view of retail investors, and in July of this year, that process will be complete. Through our Trade Reporting and Compliance Engine, or TRACE, investors can now get trade and price information on all but the most illiquid corporate bonds, and can get it within 30 minutes of any trade. In July, trade reporting time for bond dealers will be reduced to 15 minutes.
Corporate bonds are the starting place for TRACE. We are looking at other fixed income instruments to include in the TRACE transparency process.
Beyond TRACE, there are ways we are bringing more transparency to the transactions investors make. We have for example, proposed a rule that says brokers who sell mutual funds must provide customers with a brief summary of all the costs they may incur in buying fund shares, and of potential conflicts of interest that may arise from the broker's relationship with the fund, such as any revenue-sharing agreements.
If a broker is better compensated for selling one fund than he is for selling others, we think the customer has a right to know about it. This summary would be provided at the time of sale and in addition to the prospectus and would also include information about a fund's investment strategy and performance.
We think the Internet should be the principal medium for disclosing this information to investors. Focus group research we've done shows that investors prefer instantaneous on-line disclosure to having more piles of paper arrive in the mail a day or two after the initial conversation with the broker or adviser.
We have also sent to the SEC a rule proposal on variable annuities sales. These are complicated products, not easy for brokers to understand, to say nothing of investors. And, as I mentioned, there have been problems with inappropriate switches, as well as unsuitable sales recommendations.
Educating and training our members, educating and informing investors, and working to increase market transparency and improve sales disclosure - these are important parts of our mission, quite apart from our responsibility for rule-writing and enforcement. We'll continue broadening this part of our province, while at the same time continuing to protect investors through vigorous enforcement of our rules.
I think I've fairly brought you up to date on new and planned initiatives that we've developed for your benefit, and that of your clients. I hope you will explore them and that you'll find them helpful.
And if I can better explain anything I've said here, I'd be happy to do so now in response to your questions.