Remarks at the NASD Fall Securities Conference

Robert R. Glauber

Chairman and CEO

San Francisco, California
November 18, 2005

Thank you, Elisse, and good morning.  This is a lovely time of year to be in San Francisco - not that there's ever a bad time to be here - so I hope you've made time for some enjoyment in and around this wonderful city.

The original schedule for the conference had me speaking yesterday morning and Mary Schapiro speaking now.  But then she and I were asked to testify in separate Congressional hearings yesterday in Washington, so our schedules got scrambled.  The result is that I'm on now, and after I'm through, I'll introduce one of our two keynote speakers, Harvey Goldschmid.

Mary testified in the Senate Banking Committee on abusive sales tactics that some firms have inflicted on members of the armed services and their families, and some affirmative steps we've taken to put a stop to them.

What I was asked to talk about at the House Capital Markets Subcommittee, was the SEC's November 2004 concept release on the present and future state of the SRO system.  This is a timely and worthy topic, as I'm sure you'll agree.  Congressman Richard Baker, the subcommittee's chairman, is to be commended for convening the discussion, and we're grateful to him for inviting NASD to take part.

You can find Mary's testimony and mine on our Web site if you're interested.

This month marks the five-year anniversary of my taking the helm of NASD.  And, in retrospect, I don't think I could have taken control of this organization at a more surreal time in our industry.  Or a more challenging time.

On November 1, 2000, when I became CEO, the high-tech bubble had just burst; NASDAQ had lost almost half of its value, plunging from just over 5,000 - its record high - in March of that year to under 3,000 in November; Enron was starting to come unraveled; and the most hotly contested presidential election in American history was a day away.

We were, at that time, less than a year away from a horrendous terrorist attack on New York and Washington.  We were less than two years away from the discovery that hedge funds and institutional investors were manipulating the net asset values of mutual funds through market-timing and late trading, a state of affairs that would come to be known as "the mutual fund scandal."  And a whole sordid procession of bubble-era market misdeeds and treachery was beginning to come to light.

That's a lot of water under the bridge.  But fortunately, the bridge is still standing and we have come along way in demonstrating our resolute commitment to fair markets and to the integrity of a financial system that remains the envy of the world.  Are we finished?  Absolutely not, but - without being in the least bit self-satisfied -- it strikes me as a reasonable time to look back and take stock in what NASD has accomplished during this most eventful half-decade.

All of you will parse what I say here and some will respond with opposing points of view.  We welcome that.  We are regulators first and foremost, but we can't regulate in a vacuum.  We listen carefully and dispassionately to what others have to say.

During this post-bubble period, NASD has developed a reputation for being a hard-nosed, aggressive regulator.  I confess that with my free markets bias, this has at times been something I have had to come to grips with.  That said, it's all too clear that our markets won't stay free if we don't police ourselves to root out those who would flout the rules that are in place to protect the integrity of the system and investors who supply the capital for the system.  Although some have charged that we've been over-zealous - a charge I reject - NASD's reputation for regulatory ardor is entirely accurate.

For what it's worth, there is nothing new or unique about this.  Throughout the history of the securities business, whenever a market bubble has inflated, abuses have ensued.  And when the bubble collapses, as it always does, there follows a period of intense scrutiny and the pendulum swings back toward increased regulation and new legislation.

Along with high-voltage regulation and enforcement, public skepticism of regulators is a characteristic of all post-bubble periods.  This is particularly true of private-sector regulators, which are subject to fox-in-charge-of-the-hen-house accusations.

Anything less than an aggressive response by NASD to the problems of the last five years would have had the effect of not only further damaging what was left of investor confidence, but also putting in peril the self-regulatory system.  As we saw with the accounting industry, if Washington feels there is a void in the way an industry regulates itself, a new government-managed structure will be put in place.

The efficacy of private-sector regulation - or self-regulation, if you will - has been questioned for other reasons, too.

Inspired by the problems at the New York Stock Exchange and, just as importantly, the NYSE's and NASDAQ's announced intentions to become for-profit, publicly traded companies, the SEC started a review of some alternatives to the current self-regulation system through a concept release a year ago this month.  They range from making some moderate adjustments to the status quo to creating something similar to what I mentioned earlier that was done for the accounting industry, the PCAOB.

Yesterday, I told Congress that NASD opposes dismantling the self-regulatory system.  While I urged specific improvements that I believe would best serve investors and firms, I believe the self-regulatory system we have relied upon since the 1930s remains valid and worthy of preserving, if not precisely as envisioned 70 years ago.

- Private-sector regulation ensures that real expertise informs decision-making in an extremely complicated industry.

- Private-sector regulators are sheltered from the shifting winds of politics and needn't worry about appropriations and continuity of funding.

- Private-sector regulation is more resource-rich than government regulation; its personnel are better compensated, it has more advanced technology, and it is less encumbered by bureaucracy.

NASD has been - and has been seen to be - a vigorous and uncompromising, yet fair and smart regulator.  We've written a lot of new rules, particularly in the area of point-of-sale disclosure, and we've substantially increased our enforcement firepower.

We've been out in front on several issues:

  • In 2002, we discovered that non-provision of breakpoint discounts was pervasive among broker-dealers selling front-end load mutual funds.  We disciplined those firms and individuals whose failures amounted to extreme negligence, and ordered restitution to investors who had been deprived of their discounts.  But we didn't stop there.  We ordered all the firms we oversee to examine their records to see if they had missed any breakpoint opportunities and to make amends where necessary.  And, in conjunction with the DTCC, we launched an online database that registered reps can use to determine customers' eligibility for breakpoint discounts.  NASD is committed to working with the DTCC to ensure the data are accurate and up-to-date.  We are providing this service to brokers and investors at our expense.  This is precisely the kind of industry utility for which we should foot the bill.
  • Also in 2002, we brought the first case having to do with the misallocation of hot IPO shares against CSFB.  The firm paid a $100 million fine to NASD and the SEC.
  • We have come down hard on variable-annuity sales abuses and proposed new rules to protect investors from being taken advantage of when they buy those products.
  • And we have drawn attention to the vast disparities in the ways that state governments disclose basic information about 529 college savings plans.  We have called on them to harmonize disclosure so that investors can judge one plan against another without the frustration of having to compare apples to oranges.  And the states have responded splendidly; nearly all of them have either adopted a set of disclosure principles drafted by the MSRB and the College Savings Plan Network, or are close to doing so.

I'm not sure how credible we would have been in any of these cases if we hadn't also gotten our own house in order.

Ten years ago, NASD was the sole owner of NASDAQ and the sole regulator of NASDAQ.  After a series of events that illustrated the inadvisability of that relationship - most notably NASDAQ's decision to become a publicly traded, for-profit company - we decided in 2000 to separate entirely from NASDAQ and to continue regulating it under contract.

Today, our ownership of NASDAQ is down to under 20 percent and we hope to reduce it to zero next year.  NASD and NASDAQ now operate as separate entities, each with its own board and management structure. And the separation will become complete after the SEC grants exchange status to NASDAQ.  We hope that will happen by the end of this year.

And last year, we sold the American Stock Exchange, which we bought in 1998, to its seat-holders.

In 2000, long before the SEC proposed this for all SROs, we realigned our Board of Governors so that a majority of its members would be from outside the securities industry.  We took the additional step two years ago of prohibiting industry Board members from serving on the Compensation Committee.

Another challenge we need to address is that of the costs and regulatory burdens that we all face in this industry as a result of the problems of the post-bubble period.  NASD's costs have risen steadily and unavoidably every year.   Our revenue, barring any increase in assessments on the industry, rises at a much slower rate.

We realize that our rising costs, some of which we have to pass on to firms, not to mention the increasing regulatory burdens on firms, are of real concern to the industry and, by extension, to investors.

Obviously, we can't meet our growing regulatory responsibilities by simply throwing more people at them.  That would only increase our costs even more.  Instead, we need to focus on making our personnel and our technology even more productive.  This means training people so they can do their jobs better.  It means being smart in what we do, how we do it and how we plan for it.  And, it means managing our finances effectively and responsibly and doing all we can to avoid increasing the financial burden we place on the firms we regulate.  The huge majority of those firms are small ones - 150 registered reps or fewer - and they cannot easily absorb new financial demands.  They have to pass them on to their clients or even go out business.  That is a fate we would be loath to impose on anyone.

One example of how NASD is working hard to make NASD's internal operations more efficient by using training and technology to raise the productivity of our people is the recently opened Examiner University.  Examiner U provides a one-year course of classroom and on-the-job training for all our incoming NASD examiners.  The goal is to make sure our exam program keeps up with a constantly evolving marketplace.

This is especially important given the array of new products that regularly show up on the markets - actively-traded ETFs, for example, or funds of hedge funds that target less well-heeled and less sophisticated investors.

Examiner University's goal is to turn out examiners who know as much about a firm and its products at the start of an exam as their forebears knew at the end of one.  This enables them to get in and out faster, less obtrusively, with less expense to us and less distraction to you.  And we will have more certainty that the exam we do in Seattle will look like the one we do in San Francisco.

At the same time, we're subjecting the exam program itself to a technological overhaul.  What will emerge from it is a system enabling us to identify potential problems by analyzing data and documents that firms submit to us electronically, and to formulate responses tailored for each firm.  A benefit of this is that decisions on whether to initiate exams will be based more on evidence of risk than on the calendar.  And that means a less intrusive, more flexible and more efficient exam program.

These and other efficiency steps we have already taken have paid off in the past, and we expect them to pay off in the future.

Over the last five years, we have beaten our budget by more than $250 million and have given more than half that amount - $140 million - back to the industry in the form of rebates against the regulatory assessments we levy.

The sum total of all this is that we operate today not as an SRO in the traditional sense, but as a private-sector regulator of securities firms and, under contract, exchanges.  We are, as we like to say, informed, but not controlled, by the people and firms we regulate.

It seems pretty clear that both NASD and the securities industry are better off for our having redefined and simplified our mission.  There is still another step I think we should take, though, and if you were at the SIA Annual Meeting last week or read about it in the press, you probably know that John Thain, head of the NYSE, and I both separately discussed the idea of a regulatory partnership or joint venture.

The idea that has surfaced is to consolidate the regulation of the 180 firms who are members of both NASD and the NYSE.  The benefits of this arrangement are obvious: those 180 firms currently pay regulatory fees and assessments to both SROs.  But under a partnership, there would be only one rulebook, one regulatory fee, one examination staff and one enforcement staff to contend with.  We estimate the industry would collectively save more than $100 million a year in fees and compliance costs.  That's nothing to sneeze at.

This idea is very much in line with the so-called hybrid SRO proposal that SIA put forth a few years ago.

As with most everything we do that affects the people and firms we oversee, their reaction to this idea is valuable to us.  It informs our thinking and decision-making.  So please don't be shy about contacting us with your thoughts on this idea.

In fact, you should never be reticent about calling us, for whatever reason.  To that end, we're about to unveil a new system to provide you with quick and direct answers to your compliance-related questions.  Getting good answers - even if they're not the ones you hope to get - shouldn't be hard.  We've always tried to adhere to that principle, but now we're going to make the process even easier.

Early next year, we will designate an NASD liaison person for each firm we regulate.  That person will be an employee of your local NASD District Office and will be your principal point of contact for any questions you have for us.  The executive representative for each firm will get a letter and an email with the name and contact information of the person we have designated as that firm's liaison.

Since no one can be available all the time, we're also putting in place a nationwide, second-tier support group consisting of people who can either answer your basic questions or put you in touch with someone who can.

We realize that, for various reasons, it may not always make sense for you to call us with compliance questions.  So, we're also publishing a list of consultants, lawyers, technology professionals and others you can turn to when we are not the best source of the information you're looking for.  We can't endorse any of these sources or verify the information you get from them, but the network will be at least one more resource you can exploit if all else fails.

We are also beefing-up our Web site,, to serve as a one-stop center for firms looking for answers to questions and to quickly find information.

I know there may be a presumption that calling NASD to ask a compliance-related question is like putting your head in a beehive.  I want to tell you that this simply isn't true.  The belief that some have that calling us with questions is a sure route to an examination is not correct.  I cannot overemphasize that.  It is very much in your interest to put your questions and concerns to us, and we strongly encourage you not be reticent about doing so.  Indeed, thousands of firms call us with their compliance-related questions every year.  And they will tell you the result has not been a reign of examination terror visited upon them.

Having said that, I must also issue this caveat: If you call us to report a possible violation, the fact that you did the right thing by reporting it to us doesn't mean we won't investigate it further.  However, we routinely credit firms with finding problems before we do and reporting them to us, and we'll continue to do that.

Before I finish, I'd like to talk briefly about hedge funds, which have been on my mind - and in the news - quite a bit lately.

Today, to invest in a hedge fund, you need to meet financial thresholds that vary depending on the type of fund and whether or not it charges a performance fee, but they all require at least a million dollars of net worth, or annual income of 200,000 dollars for an individual and 300,000 for a married couple.  These thresholds were set as a proxy for a "sophisticated investor."  But they were set way back in 1982.  However well they worked then, they make much less sense in the face of the economic realities of 2005.

With the rapid economic growth and the huge run-up in residential real estate values of the last couple of decades, a lot more people are worth a million dollars or more today than 15 or 20 years ago.  So a lot of people who might not be considered sophisticated investors are now eligible to invest in hedge funds.

Moreover, hedge funds have become hugely popular among rich and institutional investors.  The SEC estimates they have about $870 billion under management, and other estimates run as high as $1 trillion. And we all have read about the recent problems at hedge funds like Bayou and Wood River.

NASD doesn't regulate the operations of hedge funds.  But we are responsible for overseeing their sale by brokers.  And we have been concerned for some time about the so-called retailization of these products.  And we've said before that the farther downstream they float, the more concerned we'll be.  So, I think it may be time for a rule raising the minimum net worth and income of investors to whom registered reps can recommend hedge fund shares and perhaps other risky products.  Wealth is not a good proxy for sophistication and suitability, but it can be a valuable tool.  I don't have any particular numbers in mind at this point, but I do think the current levels present too low a hurdle.

I plan to discuss this with our board and committees.  We'll keep you posted.

I've covered a lot of ground today.  As I said at the outset, we welcome your reactions to the proposed regulatory partnership with the NYSE, the notion of raising net worth and income thresholds for hedge fund investors or anything else I've discussed.  Time permitting, you'll have an opportunity for that at the end of this morning's session, when both our keynote speaker and I will invite your questions.

Now it is my great pleasure to introduce Harvey Goldschmid.

Harvey is again back at Columbia Law School, where he started teaching in 1970 and where he is now Dwight Professor of Law.  For the 3 years ending last summer, he was an SEC commissioner and one who had a profound influence on the Commission's agenda.  Previously, he played an active role on the senior staff of the SEC during the Arthur Levitt era, where he was a consultant in 1997 and '98, General Counsel in '98 and '99, and then a Special Senior Advisor to Chairman Levitt in 2000.

Over the years, Harvey has chaired a number of professional legal committees, been on the NYSE Legal Advisory Committee, authored a host of scholarly books and articles, and in the years before he became a SEC Commissioner, he was a special advisor to us at NASD.

Harvey is a renowned legal scholar, outstanding public servant and for me, personally, a very good friend.

Will you please join me in welcoming Harvey J. Goldschmid.