Testimony Before the Permanent Subcommittee on Investigations Hearing on Micro-Cap Stock Fraud

Barry R. Goldsmith

Executive Vice President

U.S. Senate
September 22, 1997


The NASD would like to thank the Subcommittee for this opportunity to testify on micro-cap fraud in the U.S. markets, the nature of the problem and our efforts to address it. America’s securities markets are essential to the capital formation process and economic well being of our nation. It is our job to work together with the SEC, the states, and others to protect investors and the markets from fraud and abuse of any kind.

Your invitation letter asked for, among other things, our views on the nature of the problem, including recidivist individuals and firms, the role of the states in the licensing process, and any potential need for enhanced responsibilities for clearing firms in this area.

I readily acknowledge that there are some dishonest individuals and firms in the securities business today. However, let me also say that the overwhelming majority of individuals in the securities industry are honest, ethical professionals who treat their obligation to comply with the law seriously and put the individual investor’s interest first. The problem firms represent a tiny portion of the more than 5,500 securities firms in this country and are for the most part firms that concentrate their activities in the securities of thinly capitalized, micro-cap companies. While these smaller companies may provide significant growth potential for investors, sales of securities of these companies are also susceptible to abusive practices such as misrepresentations, manipulation, false price predictions, and phony guarantees against loss.

As securities regulators we must adopt a "zero-tolerance" approach to fraud. We must continue to look at ways of improving our enforcement and surveillance, as well as the rules we adopt to protect investors. We must also look at new ways of "investor outreach," so that the individual investor is armed with the information he or she needs to resist the scamsters and make responsible investment decisions. I will speak about these matters today.


Let me briefly outline the role of the NASD in the regulation of our securities markets. Established under authority granted by the 1938 Maloney Act Amendments to the Securities Exchange Act of 1934, the NASD is the largest self-regulatory organization for the securities industry in the world. Every broker dealer in the U.S. that conducts a securities business with the public is required by law to be a member of the NASD. The NASD’s membership comprises more than 5,500 securities firms that operate in excess of 62,000 branch offices and employ more than half a million registered securities professionals.

The NASD is the parent company of NASD Regulation, Inc. (NASDR), and The Nasdaq Stock Market, Inc. These wholly owned subsidiaries operate under delegated authority from the parent, which retains overall responsibility for ensuring that the organization’s statutory and self-regulatory functions and obligations are fulfilled. The NASD is governed by a twelve-member Board of Governors, a majority of whom are non-securities industry affiliated. The NASDR subsidiary is governed by a 24 member Board of Directors, balanced between securities industry and non-industry. Board members are drawn from leaders of industry, academia, and the public. Among many other responsibilities, the boards, through a series of standing and select committees, monitor trends in the industry and promulgate rules, guidelines, and policies to protect investors and ensure market integrity.

NASD Regulation

NASD Regulation is responsible for the registration, education, testing, and examination of member firms and their employees. In addition, we oversee and regulate our members’ market-making activities and trading practices in securities, including those that are listed on The Nasdaq Stock Market and those that are not listed on any exchange. Although activities involving these securities may be reflected in different quotation media, NASDR is ultimately responsible for regulating the trading activity of its members whether it occurs in The Nasdaq Stock Market, the over-the-counter market, or any other area over which the NASD has jurisdiction.

The 1,600 member staff of NASDR is devoted exclusively to carrying out the NASD’s regulatory and enforcement responsibilities. NASDR carries out its mandate from its Washington headquarters and 13 district offices located in major cities throughout the country. Through close cooperation with federal and state authorities and other self-regulators, overlap and duplication is minimized, freeing governmental resources to focus on other areas of securities regulation.

NASDR rulemaking is a widely participatory process with broad input from industry members, trade associations, other regulators, and the public. By the requirements of the Securities Exchange Act of 1934, NASDR rules do not become final until they are filed with and approved by the SEC. The SEC staff carefully reviews each rule filing and publishes NASDR rules for comment in the Federal Register.

NASDR has examination responsibilities for all of its 5,500 members. In addition to special cause investigations that address customer complaints and terminations of brokers for regulatory reasons, NASDR has established a comprehensive routine cycle examination program. This program is carried out through a regulatory plan that focuses each District's examination efforts on the firms, individuals, issues and practices that present the greatest regulatory challenges and concerns. Annual on-site inspections are conducted of high priority areas. In addition, NASDR has established an examination frequency cycle for all of its members, which is based upon the type of business conducted by the member, the scope of that business, the extent of customer exposure, method of operation, past regulatory history, and other factors. During 1996, almost 2,400 main office routine examinations were completed and over 5,200 customer complaints and 3,892 terminations for cause were investigated.

Another key factor in NASDR's overall regulatory program involves developing and administering qualifications testing for securities professionals. All sales and supervisory persons associated with NASD member firms must demonstrate a requisite understanding of the products offered by their firms, as well as regulatory requirements for the functions they are to perform for their employer-members. Individuals acting in a management capacity must pass the appropriate principal's examination, while sales personnel must demonstrate specific understanding of the products they intend to sell and the regulations that govern those products. In 1996, NASDR administered its 29 different qualifications tests to 267,000 individuals.

The Nasdaq Stock Market

The Nasdaq Stock Market, Inc., develops, operates, and regulates a variety of marketplace systems and services. The Nasdaq Stock Market is the largest electronic, screen-based stock market in the world, capable of handling trading volume in excess of one billion shares a day. Today, more than one-half of all equity shares traded in the United States each day are traded on Nasdaq. Companies trading either on Nasdaq’s SmallCap Market or the Nasdaq National Market -- the two respective tiers of The Nasdaq Stock Market -- are required to make extensive financial disclosure and meet well-established listing standards. As I will discuss, these standards are being strengthened, particularly in the Nasdaq SmallCap market.

The Over-The-Counter Market

While not part of The Nasdaq Stock market, the NASD has regulatory responsibilities for what is known as the OTC or over-the-counter market. The over-the-counter market is a vast amalgam of publicly traded companies that list neither on Nasdaq nor on any exchange. Contrary to a popular misconception, often perpetuated by unscrupulous operators, the over-the-counter market is not Nasdaq. The two are separate and distinct. It is in the thinly traded, micro-cap securities that characterize the over-the-counter-market where we find great potential for fraudulent activity.

There are several reasons for this. First, thinly traded stocks typically have a small market capitalization. Accordingly, they are more easily subject to manipulative practices by unscrupulous brokers, issuers, and promoters. Second, a significant number of OTC companies report absolutely no information to the SEC, making their financial situation a virtual blank slate to investors. While some of these companies make financial information available, what reaches investors is not required to be subject to accounting auditing standards. Third, there is no minimum price that an OTC company must maintain to trade. Stocks in the OTC market can and do trade for mere pennies, and indeed the OTC is where you find the so-called "penny" stocks.

A part of the over-the-counter market is what is known as The OTC Bulletin Board. While it is a system operated by Nasdaq, the Bulletin Board is markedly different and separate and distinct from The Nasdaq Stock Market. It is an electronic quotation service for subscribing members. While the system displays real-time quotes, last sale prices, and volume information in domestic securities, there is no formal legal relationship between the OTC issuers whose shares are quoted there and Nasdaq. The companies need not meet any listing standards to have their stock included in the Bulletin Board. There are no periodic reporting requirements for continued inclusion in the service; only limited phone, contact, and address information is available in the OTC Bulletin Board company listings. This system provides a centralized and automated alternative to the Pink Sheets, which historically have been published on paper once each day, but which are now available electronically via market data vendors.

A misperception that is frequently fostered by scam artists is that trading on the OTC Bulletin Board is akin to trading in a highly regulated market such as Nasdaq. They will often refer to an OTC stock as listing on "Nasdaq’s OTC Bulletin Board" or on "the Nasdaq OTC" or some other deliberately confusing variation that improperly links the two. As I will describe, we are considering several approaches to more effective regulation of the OTC markets as a whole and the OTC Bulletin Board in particular.

NASD Regulation's Enforcement Record

As these hearings demonstrate, we as regulators must redouble our efforts in the micro-cap area. NASD Regulation has already begun to do so. In 1996, we significantly increased the number of staff dedicated to regulation and enforcement by adding more than 150 new positions. By the year 2000, NASDR plans to spend more than $100 million to enhance its systems for market surveillance and increase examination, surveillance, enforcement, and internal audit staff.

We are already beginning to see the fruits of our investment. In 1996, disciplinary actions brought by the NASD reached 1,200, an increase of 12 percent over the prior year. Last year 394 individuals were barred and 204 were suspended. Disciplinary fines collected increased by almost two-thirds and the number of firms expelled from the NASD increased by approximately 20 percent. In addition to disciplinary fines, orders of restitution to investors reached $21.8 million in 1996.

Enforcement Cases

In our focus on the microcap market, we have brought many significant cases in recent years, including:

Stratton Oakmont — In December of last year, NASD Regulation expelled Stratton Oakmont from the securities industry. Following our own disciplinary proceeding and prior actions by the SEC and at least 19 different states, NASD Regulation expelled the firm and barred its president and its head trader from the securities industry. The head trader has appealed the case to the SEC. This case imposed restitution and fines in excess of $1 million. Another complaint was filed last year against Stratton Oakmont and others alleging that the firm made approximately $28 million in illegal profits during the first day of aftermarket trading of five small stock offerings. Other enforcement actions against those directly responsible for the firm’s actions are contemplated.

Hibbard Brown — Innocent investors are too often the victims of exploitation by aggressive sales tactics. This happened with a shell company called Site-Based Media. Working with the New Jersey Bureau of Securities, the NASD reviewed over 6,000 trades and uncovered fraudulent tactics by the firm of Hibbard Brown that generated $8.7 million in illicit profits in just eight days.

Hibbard and its sole owner Richard Brown were subsequently expelled by the NASD and ordered to pay $8.7 million back to retail customers. Additionally, the firm’s head trader and Brown were barred and fined. We continue to prosecute former Hibbard employees for their conduct with the firm. The investigation brought to light hundreds of examples of improper sales tactics, ranging from guarantees against loss, to unauthorized trading, to high pressure, intimidating, fully scripted sales pitches. Indeed, sales reps at Hibbard, in addition to being required to read from scripts, were encouraged to call customers continually, even if the customer refused to do business. To date, 13 branch office managers and registered representatives have been barred for their abusive sales practice activities.

A.R. Baron — In May, the Manhattan District Attorney announced the indictment of A.R. Baron & Co., Inc. and the arrest of 13 individuals for cheating thousands of investors out of more than $75 million. The individuals and the firm, which is now defunct, were charged with participating in a pattern of criminal activity. Included in that pattern were lying to investors to induce them to buy certain low-priced securities; manipulating the markets in certain micro-cap stocks to benefit themselves and their favored customers; making unauthorized trades in the millions of dollars; refusing to honor its customers’ directives to sell securities in their accounts; outright thefts from investors; and forging documents to prevent detection of their crimes. Four NASD Regulation examiners from our Chicago office worked closely with the Manhattan DA throughout this important investigation.

NASD Regulation has brought its own cases against A.R. Baron, its principals and reps. In one of those actions, the firm paid more than $1.5 million in restitution to customers and fines for charging fraudulently excessive markups in more than 200 separate transactions. Other cases against Baron’s brokers are still pending.

D.H. Blair — In August, D.H. Blair & Co. Inc., was fined $2 million for overcharging its customers and for engaging in fraudulent pricing activity. Blair will repay almost $2.4 million to investors who were overcharged as the result of fraudulent and excessive mark-ups in 16 securities. D.H. Blair’s chief executive officer and head trader were also fined a combined $525,000. More than 3,100 retail customers from 43 states will receive restitution payments.

The firm charged excessive markups in 16 Nasdaq SmallCap securities whose Initial Public Offerings (IPOs) were underwritten by D.H. Blair Investment Banking Corp. NASD Regulation found mark-ups greater than 10 percent (a level considered fraudulent) in 14 of the 16 securities that D.H. Blair Investment Banking Corporation had underwritten. D.H. Blair placed virtually all of the offerings with its own customers and controlled the after-market trading in all 16 securities, in some cases for up to four and a half months after the IPO effective date.

As part of the settlement, D.H. Blair is also required to hire an independent consultant to review and monitor the firm’s trading, sales, supervision, and other compliance-related policies and practices for two years. This consultant will also recommend necessary improvements, which the firm must implement.

Test Cheaters — Finally, every investor has the right to expect that his or her broker is honest and understands the securities markets and its regulations. This is the cornerstone of investor protection. To fulfill this responsibility, NASD Regulation last month announced that it had barred, censured, and fined 20 more registered representatives suspected of paying an impostor to take a qualification exam on their behalf. More than $1.8 million in fines and forfeited commissions were assessed against these brokers. This brings to 41 the number of suspected "test cheaters" we have thrown out of the industry. NASD Regulation has also worked closely with the Manhattan District Attorney’s office in the indictments of 52 impostors and others implicated in this matter.

Strengthening Investor Protection

A strong regulatory response is needed to the problems in the micro-cap market. We have already made this area a prime focus of our regulatory program, but we need to expand our efforts even further. The NASD is actively studying this market, particularly the OTC Bulletin Board, to determine what rule changes and enforcement initiatives are needed to address the problems we see. Investors need to have access to more accurate and current information about the companies whose shares trade there. Too often the only information investors have is the misinformation and hype posted on a stock promoter’s Web page or the pie-in-the-sky promises made by a brash cold-calling broker.

We must take a hard look at whether there should be higher threshold standards for including a stock in the Bulletin Board. We will look closely at whether a company that is unwilling or unable to provide full and timely disclosure of information to the public or to regulators should be given quotation visibility on this electronic medium. Such a proposal could limit quotation on the OTC Bulletin Board to companies filing periodic reports with the SEC or banking or insurance regulators.

We must also work with the SEC to strengthen the tools we have to keep the shares of bogus companies from being traded in the over-the-counter market in the first place. This can be accomplished by toughening and clarifying the rules we have to prevent broker-dealers from initiating or continuing to quote an OTC security when they do not have current reliable financial and other information about the issuer. In particular, we are considering whether to prohibit broker dealers from recommending a transaction in an OTC security unless they have first reviewed the issuer’s current financial statements and reasonably believe that they are accurate.

In addition, we need to explore rule changes that would place tougher new requirements — beyond the existing suitability requirements — on brokers to confirm with their customers, based on objective criteria, that purchases of these types of securities are suitable investments. We are also looking at ways that brokers can be required to disclose to their customer’s specific information about these types of investments and their differences from those traded on The Nasdaq Stock Market. We will determine if there is a need for increased regulation on the operation of the OTC Bulletin Board, such as the authority for the NASD to halt trading under certain circumstances, including when a foreign regulator issues a quote halt in the stock for regulatory purposes.

Finally, we must be more proactive in educating investors on the specific and unique characteristics of the OTC equities markets. The NASD has already begun a program to educate investors about the specific characteristics of the OTC Bulletin Board, the Pink Sheets, and other quotation media. The program will emphasize the distinct differences between those markets and The Nasdaq Stock Market. In addition, the program will describe to investors the risks associated with the OTC equities marketplace, including that certain issuers in this marketplace are not subject to listing or maintenance standards.

Repeat Offenders

One of the best ways to protect the public from securities fraud is to help ensure that those who have previously broken securities laws are not allowed to do it again. Securities regulators monitor the activities of past offenders to assure that they do not repeat their transgressions and cause more harm to investors. This is accomplished by better regulator and investor access to information on past violations, punishing repeat violators more heavily, and more closely monitoring firms that hire past violators. Coupled with these efforts the NASD has a rigorous process in place that makes it difficult for expelled members or barred brokers to re-enter the industry. Where barred brokers reappear as promoters and officers of companies that are suspected of wrongdoing and are beyond our jurisdiction, we will refer those cases to the SEC and other enforcement agencies.

One of the primary methods of defense against recidivism is to ensure that violators are widely known to those who must license them or who might do business with them. Through the NASD’s Central Registration Depository (CRD), all federal and state securities and futures regulators are quickly made aware of an individual’s violations. This extensive database, which is presently being revamped, incorporates an individual’s disciplinary history as part of his or her permanent record.

This same system also forms the base of the NASD’s toll free Hotline, which permits investors — without charge — to check out an individual or firm’s regulatory history, including prior violations, before doing business with them.

The NASD’s Sanction Guidelines, which are used by its disciplinary committees and hearing officers to decide on appropriate punishment for securities violations, also come down hard on recidivism. These Guidelines reflect the NASD’s belief that a primary objective of its disciplinary process is to deter future violations by imposing progressively escalating sanctions on repeat offenders.

If an individual defies a bar against working in the securities industry, the NASD will then sanction the firm and its responsible principals for employing the violator. The NASD has brought several cases in recent years against firms who have employed barred or disqualified individuals, as well as against individuals who have misrepresented their disciplinary history on their official NASD records. However, since the NASD is a membership organization, it can only sanction its members and their associated persons. Thus, if a barred individual engages in securities fraud outside of a member firm as, for example, a promoter, the NASD must refer the matter to the SEC, state regulators and, in the most egregious cases, criminal law enforcement agencies.

Individuals and firms that are barred from the securities industry are allowed back only through a formal, rigorous process designed to minimize recidivism. Those who have committed specified crimes or have been barred or enjoined by the SEC or barred by a self regulatory organization are disqualified by statute from association with a broker. Reentry into the securities industry after a statutory disqualification is a relatively rare event. For example, in 1996, the NASD barred 394 individuals. During that same year, the NASD received no applications for re-entry from individuals that it had previously barred.

A person is subject to a statutory disqualification if he or she has committed any of the offenses listed under Sections 3(a)(39) and 15(b)(4) of the 1934 Securities Exchange Act or Paragraph II, Section 4 of the NASD’s By-Laws. The offenses include any felony conviction within the past ten years and misdemeanor convictions involving securities, theft, false statements, bribery, forgery, and similar crimes. Injunctions obtained by the SEC, Commodity Futures Trading Commission, or state regulators against violations of securities and futures laws and bars imposed by the SEC, CFTC or futures and securities self-regulatory organizations also constitute statutory disqualifications.

Statutorily disqualified individuals can seek re-entry into the securities industry through NASD eligibility proceedings. NASDR Member Regulation may also bring a proceeding to disqualify from NASD membership a firm that is employing a statutorily disqualified person. In either case, a hearing is held before a hearing panel of the NASDR’s Statutory Disqualification Committee. In the case of an eligibility proceeding, the statutorily disqualified individual and his or her proposed supervisors are required to attend. The hearing panel obtains information about the firm, the supervisors, the proposed supervision, and the individual’s proposed activities to decide on the individual’s proposed or continued employment in the securities industry.

In both eligibility and disqualifications proceedings, the hearing panel will make a recommendation to NASDR’s Statutory Disqualification Committee, where it will be reviewed by the NASD’s National Business Conduct Committee, the NASDR and NASD Boards and the SEC.

The individual must show that the employment should be permitted in spite of past misconduct, considering the gravity of the disqualifying misconduct, the time since it occurred, the criminal sentence or injunctive restrictions imposed, and the potential for future regulatory problems. The individual’s firm must show that it understands the need for — and has the capability to provide — adequate supervision over a person with a statutory disqualification.

On August 7, 1997, the SEC approved important changes in the procedures that the NASD employs to review statutory disqualification applications or to disqualify firms that employ statutorily disqualified individuals. NASDR’s staff is now authorized to participate in application and disqualification hearings as a party. This means that NASDR staff will be able to initiate disqualification proceedings and advocate a position that it believes the NASDR Statutory Disqualification Committee should take in eligibility hearings.

New NASD Rules to Combat Fraud in the Micro-Cap Market

NASD Regulation combats fraud in the micro-cap market not only with enforcement actions directed at specific firms and registered reps, but through aggressive new rules as well. These rules apply to all of our members and all of their associated persons. While you requested in your invitation letter that we specifically address the issue of the responsibilities of clearing firms, we also need to report to you on other initiatives, including those involving cold calling, taping requirements, the Internet, and listing requirements.

Clearing Firms

A focus of these hearings has been the responsibility of clearing firms, and your invitation letter specifically requested our views on enhancing the role of clearing firms in the regulation of thinly capitalized introducing firms. This idea is one on which we have been already acting. We are working hand in hand with both the SEC and the New York Stock Exchange to explore imposing, through across-the-board rulemaking, new reporting responsibilities on firms that act as clearing brokers for other firms. These proposals would require clearing firms to provide information that will allow self-regulators to better monitor the activities of the firms on whose behalf they clear trades -- so called "introducing firms." Under proposals that that are being considered by our Board, clearing firms will be required to report to the NASD or other Designated Examining Authority certain written complaints that they receive on activities of the introducing firm, and forward all complaints received to the introducing firm. The clearing firm will also be required to make available to its introducing firms reports and analyses of the introducing firm’s own activities.

Taping Rule

When we succeed in putting a recidivist firm out of business, our job is not over. Sometimes the principals in those firms turn around and form new firms under a different name, other times the brokers go in clusters to existing broker-dealers. When a large number of these brokers become employed at another broker-dealer, this raises the risk that their new firm will have significant sales staff who may not have yet forgotten their old bad habits. In addition to our statutory disqualification program I described earlier, the NASD Board last month attacked this problem in a new way by approving and sending to the SEC for its approval a rule that would require brokerage firms to tape all customer sales calls for two years if a certain percentage of the firm’s brokers worked for firms that have been expelled for telemarketing fraud or sales practice abuse.


We have seen too many instances where investors become the unwitting victims of "cold calls" and high pressure sales tactics. These tactics are used by certain brokers to convince an investor to purchase stock over the telephone from a broker they do not know and, in all likelihood, would never want to know. NASD Regulation has responded to abuses of this type by adopting "telemarketing rules." In 1995, we adopted a "cold call" rule that requires NASD member firms to keep "do not call" lists of persons who do not wish to receive telephone solicitations from the securities firm or its brokers. More recently we have strengthened the regulation of this area by prohibiting firms and their brokers from telephoning a noncustomer’s residence to sell securities during certain times, unless they have the prior consent of the person. In addition, in making these calls, member firms and brokers must immediately give their names, the name of their firms, their telephone number or address, and state that the purpose of the call is to sell securities or related products.

Electronic Media and The Internet

The use of electronic media -- including the Internet and e-mail -- to disseminate securities related information has grown enormously. This is an area of concern to NASDR. This year we will implement an automated system that will greatly increase the range, speed, and early warning capabilities of our Internet surveillance. In addition to enhancing our technology, we have filed proposed rule changes with the SEC that require member firms to establish written procedures for the review of electronic correspondence.

Nasdaq Listing Requirements

In August, the SEC approved new listing standards for Nasdaq listed companies. These standards will raise financial listing requirements significantly, eliminate issuers with a bid price below $1.00, and also extend corporate governance standards to all Nasdaq listed companies. These listing standards, which do not apply to companies whose shares trade on the OTC Bulletin Board or the Pink Sheets, will continue to improve the quality of smaller issuers on The Nasdaq Stock Market.

Earlier this year, The Nasdaq Stock Market significantly increased its listing qualifications staff and created and staffed a new Listing Investigations Unit – a group of accountants, investigators and lawyers who will proactively investigate the financial reports, business plans and other filings of companies suspected of potentially fraudulent behavior. Investigations conducted by the Department will focus on issuers that otherwise comply with Nasdaq’s listing standards, but may have issued false financial statements or otherwise engaged in fraudulent conduct to become or remain listed on the Nasdaq.

In addition, Nasdaq is completing development of an automated risk scoring system. This system, which uses advanced visualization tools, identifies companies with compliance profiles that suggest the need for heightened scrutiny.

Investor Education

As you can see, investor protection initiatives through new rule proposals have been one of our highest priorities. We have coupled these efforts with an enhanced investor education and outreach program through our Office of Individual Investor Services. This Office was launched by the NASD in August of 1996 and given a mandate to help focus the attention of the organization and industry on the individual investor. NASD Regulation believes that one of the most effective ways to protect individual investors is to provide them with information they need to make educated and sound investment decisions. Through this Office, the individual investor has a strong advocate within our organization.

The foundation of this program is the NASD Regulation Web site (www.nasdr.com). This site provides investors a basic primer on how the regulatory process works, how investors can avoid problems before they occur, and steps they can take should they run into difficulty. The site contains an overview of NASD Regulation’s activities, information on investing wisely, timely messages on current regulatory developments, and descriptions of the arbitration and mediation process. It also allows investors the on-line ability to request disciplinary histories of brokers, file complaints, and comment on proposed rules.

Noting the importance of this information to investors, we have recently expanded the information available to investors about the disciplinary history of a member firm or an associated person. Earlier this year, new rules went into effect by which we will publicize disciplinary complaints at the time they are filed and non-final "trial level" decisions in cases involving designated investor protection rules and statutory provisions.

Our Web site is complemented by the NASD’s Individual Investor Services site (investor.nasd.com), which offers training on investment basics, guidance on working with a broker, market research, and a calendar of investor events. In addition, the NASD publishes an investor newsletter, makes presentations, and provides information at investor forums. And, continuing to focus our efforts on the use of electronic media, NASDR initiated an Internet Education program. The key element of this program is a brochure distributed free to investors through the NASD and its member firms either on-line or by mail. This brochure provides guidelines for using securities information on the Internet safely.

Another way in which the NASD is trying to educate investors so that they can protect themselves are two pieces of literature that we have created titled "There are Rules to Protect You When Stockbrokers Call" And "What To Do If A Broker Calls To Pitch An IPO (Initial Public Offering)." These short pieces are designed to be distributed widely to consumers as envelope stuffers or short items in newsletters, to inform them of the requirements placed on brokers making sales calls in general or calls for an IPO in particular. We are now working with utilities in the New York area to include the pieces in their monthly statements.

State Licencing Authority

Your invitation letter requested our views on whether state authority to license broker dealers and their registered representatives is critical to protecting small investors. Your question is timely because the SEC is now studying this important question under a Congressional mandate from last year’s National Securities Markets Improvement Act.

Broker dealers and their registered representatives are licensed by more than one regulator. Federal law requires that all firms doing interstate securities business must register with the SEC and the NASD. Representatives working for those firms must register with the NASD and the stock exchanges, who license them after they complete written exams and background checks.

In addition, states require licensing of firms and representatives that do business in their state. Thus, for example, if a registered representative working in the New York office of a New York firm does a certain amount of business with a resident of Indiana, that representative and firm must be licensed in Indiana. Although most self-regulatory organization and state registration is carried out through the Central Registration Depository system that the NASD operates, not all states apply the same standards to the firms and representatives that they review for licensing.

The SEC’s study of this complex issue is due shortly under the National Securities Markets Improvement Act. We believe that the Commission would be best equipped to provide the Subcommittee with assistance on the question that it poses, and would refer you to their upcoming report.


In closing, I wish to emphasize that the NASD is committed to providing a fair, well-regulated environment for the trading of all securities, even the most thinly-traded stocks. We must do this while at the same time providing legitimate small, entrepreneurial companies access to capital. Significant enhancements to investor protection have been made in the micro-cap market; however, as these hearings and our own experience demonstrate, we must all do much more. And more will be forthcoming from the NASD.

Thank you.