Remarks at the SIA Annual Conference

Robert R. Glauber

Chairman and CEO

Boca Raton, Fla.
November 4, 2004

Thank you, Dick [Thornburgh], for a very kind introduction.  I am grateful to the SIA for giving me the opportunity to speak and to bring you up to date on developments at NASD.

I spoke to a group of senior industry leaders a few weeks ago in New York and during the Q&A someone asked me why NASD has been behaving so much like a regulator lately. Why aren’t we concentrating on our real job, he asked, which is to be an advocate for the securities industry, to lobby for it and represent its interests in the administration and the halls of Congress?

I told him the answer was simple: we’ve been acting like regulators because we are regulators.  That is our job.  It is what Congress intended when it created NASD in the 1930s and it’s what we’ve been doing ever since.

I suspect the questioner didn’t really think NASD was supposed to be a trade association, and I pointed out to him that the SIA does a superb job of representing the interests of registered reps.  I think what he was really trying to ask was: why have we been regulating so forcefully, so aggressively, in recent times?

That would have been a perfectly reasonable question, and I know it’s one that a lot of people in the industry have been asking.  And the answer I would have given is this: we have turned up the heat because the climate has demanded it.  The wrongdoing that has come to light since the market bubble burst in 2000 has been serious and widespread.  And investors have been harmed – not just in terms of their net worth, but also in terms of their confidence in the markets and their level of trust in our industry.

And they express their concerns about this to us.  I travel around the country fairly often to meet with investors in a town hall format.  And what a lot of them tell me is that they think the deck is stacked against them. 

Not just the mutual fund scandals, but also the corporate governance debacles at Enron and WorldCom, the Martha Stewart saga and all the other financial abuses that have made for sensational headlines over the past few years have led investors to think that the securities industry exists more for the benefit of those who work in it than for those invest in it.

NASD’s mission is to protect investors.  So this unfortunate state of affairs has left us with no choice but to ramp up our regulatory and enforcement efforts. 

It may give you some small comfort to know that there is nothing new or unique about this.  Throughout the history of the securities business, whenever a market bubble has inflated, abuses have followed.  And when the bubble collapses, as they always do, there follows a period of intense scrutiny and the pendulum swings back toward increased regulation.

You can trace this at least as far back as the South Sea Bubble of the early 18th Century, which led to the first stock market crash, in England, in 1720.

I won’t bore you with the details of that debacle, except to say that far-reaching regulatory reforms ensued – the formation of new corporations was banned for 100 years, short sales, futures and options trading were formally outlawed for 165 years.  The South Sea Bubble remained in the consciousness of Westerners on both sides of the Atlantic for decades.

In the aftermath of the high-tech bubble of 2000, we and the SEC have undertaken reforms in the areas of mutual fund sales, disclosure and governance; variable annuity sales practices; corporate bond transparency; and most recently, hedge fund practices. 

Just last week, the SEC voted to require hedge fund advisers to register with the commission, and NASD fined Citigroup Global Markets a quarter of a million dollars for disseminating inappropriate hedge fund sales literature.  As hedge funds float farther downstream toward retail investors, I expect our regulatory scrutiny of how they are promoted, marketed and sold will only increase.

As for how long this intensified regulatory climate persists, the ball is in the industry’s court.  And the solution is not simply technical; it is cultural.  Industry professionals need not only to comply with our rules and the federal securities laws – they need to develop and adhere to a culture of compliance.  I’m talking about a culture in which staying on the right side of the rules is at the top of the industry’s priority list.  Not the bottom, not the middle.  The top.  And a culture that places a high premium on transparency, full disclosure, and fair dealing.    Investors are better off if they are never short-changed in the first place, rather than waiting for regulators to get restitution to them.  And obviously, fair-dealing is in the interests of your firms as well.

We can do our part to encourage this, and we have.  In September, the SEC approved a rule we had proposed to require each firm to designate a chief compliance officer and to require that officer to meet periodically with senior management to review and, where necessary, improve the firm’s supervisory systems. 

And finally the rule requires the CEO to certify each year to us that the firm has a process that assures there will be policies and procedures in place to enforce compliance with our rules and the SEC’s.

We also want to do everything in our power to help the brokers and firms we regulate understand and comply with our rules.  To that end, we offer an array of compliance-based educational and training resources for registered reps.  They range from webcasts you can watch while sitting at your desk to seminars and conferences at sites all around the country.

For example, about a year ago we started a series of industry compliance conferences, and we plan to hold one per region per year.  In September, we had a Small Firm Best Practices Conference in Chicago.  That event gave small firm compliance officers a chance to meet with one another and share experiences and ideas about how to help their front-office staff comply with our rules and the federal securities laws.

We’ll soon have a conference on ethical conduct, which will use interactive sessions and a series of real-world case studies to explore various ethical issues that industry professionals might be expected to face.  For example, what should a supervisor do when he or she encounters questionable or unethical conduct that may not reach the level of a securities law or rule violation?  The time and place of this event are still in flux.  Check our website for those and other details.

There are more of these conferences to come, and we’ll spread them out around the country to make it easier for people from different regions to attend.

Another way we can try to make self-compliance easier is to be mindful of the burdens that our increased regulation and enforcement activities inflict on the industry.  While we must meet our mandate as an effective regulator, we should seek to do our regulatory job without needless intrusion or burden.  We should seek to set clear and appropriate rules and then enforce them rigorously and consistently. 

And we should, as we have over the last several years, regularly review our existing rules with the intent of simplifying them and, where appropriate, eliminating those that are out-of-date.

But again, the burden of rebuilding the investing public’s confidence and trust in the markets rests primarily on those who operate and work in those markets.  And I believe the most important value they can adopt is transparency.  Brokers are salespeople, but they are also intermediaries.

And as such, they have a responsibility to provide their clients with information about their securities transactions – particularly information the clients might not easily get from other sources.

If you look at the abuses that have recently been uncovered in the insurance industry, you’ll see that an absence of transparency – a calculated absence, it seems – is behind a lot of them.

Brokers apparently received contingent commissions for picking one insurer over another and made at best minimal disclosure to the customers they represented.  Faced with the embarrassment of inadequate disclosure, the major brokers quickly suspended the practice of receiving these contingent commissions once regulators and prosecutors focused the public’s attention.

As Yogi Berra might say, it’s like déjà vu all over again.  It is exactly those types of under-the-table arrangements that have pervaded the mutual fund industry and darkened its reputation.  We have come down hard on a number of firms for engaging in directed brokerage, sponsoring sales contests and other violations, and I dare say we’re not finished.

If a broker or a firm receives financial incentives – 12b-1 fees, revenue sharing payments – to push one investment product over another, then customers have an absolute right to know about it and know the details. 

With that in mind, we have asked the SEC to approve a rule that would require brokers who sell mutual funds to individual investors to provide those investors with a one-page document explaining in plain English what the customer pays to own the fund and what the broker earns for selling it.

I spoke at the SIA’s Mutual Fund Reform Update Conference in New York a couple of weeks ago, and those of you who were there heard me express my belief in the supreme importance of full and unfettered disclosure.  I said then, and I’ll say again, that one of the most basic principles of our free market system is that all participants should have access to information about prices and costs that will influence their decisions.  When this information is hidden or distorted, investors are not able to make the best-informed decisions about where to invest their money.

With this information in hand, investors are in a better position to evaluate the recommendations of those who create and sell these investment products, and to act accordingly.

An area where this argument is especially pertinent is Section 529 college-savings plans.  These are very popular products and rightly so.  They allow parents to put away more than $200,000 with no tax on earnings and to use that money for qualified education expenses, again untaxed.  But parents who want to pick one of the roughly eighty 529 plans available to save for their children’s college education will find the process of comparing them frustrating indeed. 

529s are like snowflakes; no two of them are the same.  Moreover, there is no uniform disclosure regime for them, so one state’s disclosure materials may have about as much in common with another’s as Mozart has in common with Bob Dylan.  If there’s an exception to this, it’s that the state issuers of 529s generally do a better job of promoting the benefits of investing than disclosing the risks.

I don’t mean to be unduly critical of the state governments.  When Minnesota’s plan managers were drafting their disclosure materials, there was no reason why they should have been aware of what their counterparts in Arkansas or Utah were doing.

Nonetheless, these disparities are most unhelpful and we have made clear our belief that the states should move toward standardized disclosure.  And there is at least some agreement in Congress.  During a Senate subcommittee hearing on 529s, the out-going subcommittee Chairman, Peter Fitzgerald of Illinois, said, “At a minimum, Congress ought to simplify and improve fee disclosures so that families can more easily compare Section 529 plans on an apples to apples basis.”

We have also made clear our belief that the current regulatory structure for 529 plans needs some adjustment. 

A 529, as you know, is simply a mutual fund to which has been added a layer of state and federal tax benefits. 

Yet, the authority for making rules governing 529 sales practices belongs to the Municipal Securities Rulemaking Board – the MSRB – while the authority for making rules governing mutual fund sales practices belongs to NASD.

You’ve all heard the phrase, “if it walks like a duck and quacks like a duck, then it’s probably a duck.”  Well, 529 plans walk and quack very much like mutual funds.  So why should the rules governing two virtually identical products be different?  We think they shouldn’t, and here’s an example of why: I mentioned a few minutes ago our proposal for a one-page document explaining to investors all the costs they will incur when they buy mutual funds.  If the SEC approves this proposal, the requirement will apply to all mutual funds – except those that are packaged as 529s.  This simply doesn’t make sense.

We think mutual fund disclosure practices like this, whatever the final form, should apply to all mutual funds and 529 plans – those covered by our rules and those covered by the MSRB’s. 

We have worked long and hard with the industry and the SEC to develop effective sales practice rules for mutual funds.  It makes no sense to reinvent the wheel for 529-plan mutual funds.

There is a simple way to achieve harmonized sales practice rules for all mutual funds.  Indeed, we have already started cooperatively down that path with the MSRB.

Recently, we have supported the MSRB’s efforts to align their advertising and non-cash compensation rules governing 529 plans with SEC and NASD rules governing mutual funds.  The next step would be for the MSRB to adopt as its own rules the remaining SEC and NASD rules governing the sale of mutual funds.  That’s it.  Doing so would complete the process of harmonizing sales practices for 529 plans with all other mutual funds.

There is one other subject I want to touch on before I stand down, and it is unrelated to anything I’ve said so far. 

As I’m sure you know, NASD has since the early 1970s been both a market regulator and a market owner. 

NASD created Nasdaq and ran it from its inception in 1971 until 2000.  Over the years, it became increasingly clear to us that regulating a market that you own was not an easy proposition to defend.  So in 1999, we reached an agreement to spin off Nasdaq as its own separate exchange and that agreement awaits final approval from the SEC. 

Pending that final approval, Nasdaq operates with separate management and a separate board, and NASD regulates Nasdaq as if under a contract.

NASD also bought the American Stock Exchange in 1998 and, for the same reasons, decided to detach ourselves from it as well.  We reached an agreement earlier this year to transfer Amex to its seat-holders.  That deal, too, awaits SEC approval.  After the divestitures, we will continue to regulate both Nasdaq and the Amex under explicit contract.

The decision to spin off Nasdaq brought into stark relief the conflict between running an exchange and regulating it.  NASD dealt with that conflict by the surgical solution of putting the two roles into two wholly separate entities. 

NASD became an institution with only one job – that of a regulator, both of its members and, under contract, of the Nasdaq exchange.  Three years later the conflict between running a market and regulating it became even clearer when the problems of the NYSE hit the front pages of newspapers across the nation. 

Dick Grasso stated the conflict with great clarity when he said: "I wear two hats.  I run the business of the NYSE and I regulate the NYSE."

Today, the CEOs of NASD and Nasdaq wear separate hats.  NASD wears the hat of a private-sector regulator of financial services, free of conflict.  This alignment allows us to focus all our time and resources on the mission of protecting investors and upholding market integrity.  And both we and the investors are, I think, much better off for it.

I hope I’ve given you a sense of where things stand in the regulatory sphere and what you might expect from us in the near future.  We often describe ourselves as a regulator informed, but not directed, by the industry we regulate.  Those are not just words; we truly value your thoughts and suggestions on how we can do our job better. 

And now I’ll put my money where my mouth is and invite your questions and comments.  Thank you very much for listening.