Remarks at the Securities Industry Association Market Structure Conference
Chairman and CEO
Thank you all for being here. I'm pleased to join you this morning.
This is a difficult time in our industry. We're seeing more choices for investors -- yet quite possibly less investor confidence -- than at any time in recent memory.
Is this combination entirely a coincidence?
Or is there some possible connection between a marketplace with so many products and trading platforms that it's grown confusing and fragmented -- and an investor psychology that has grown skeptical about corporate issuers, executives, and boards; accountants, research analysts and securities regulators alike?
That's certainly a provocative and timely topic for a market structure conference. And particularly for the industry's largest self-regulator.
So let's get to it.
Now, I would be the first to acknowledge that the present erosion in investor confidence has much more to do with the ills symbolized by Enron than issues of market structure per se. Those ills included accounting that was unaccountable, corporate governance that didn't govern, and research analysts who were far from analytical in ferreting out the truth.
I would also point out that surveys have shown consistently that investor confidence plainly ebbs and flows with the performance of the markets. Bluntly put, with more than $4 trillion lost in the markets over the last two years, it's little surprise that today's investor is in a shaky, "show me" mood. This despite an economy that is on the mend and a market infrastructure -- strengthened since the 1987 crash -- which responded to the 9/11 aftermath with noteworthy resiliency.
The question is, what do we learn from this state of affairs? Do we chalk it up as purely the result and hangover of undue euphoria during the speculative market bubble of the 90s? Or do we abjectly accept every accusation about the industry as a den of thieves with no honor among them and no self-regulation worthy of the name?
I say the truth lies at neither of these extremes. I believe we all learned lessons whose value in the long run is related to their painfulness in the short. That definitely includes all of us regulators.
Investors have surely been reminded that fundamentals matter; that not even a "new economy" can completely rewrite all the old rules; and that there is no substitute for doing one's own investment homework -- no matter what the loud and breathless clamor of the day.
The industry has been reminded that what is good for investors is what's good for the markets; that a boom time is no time to bend the rules; and that revelations of real or perceived conflicts of interest -- even years after the fact -- will result in lost reputation and lost business as surely as shareholder litigation follows shareholder losses.
And finally, we regulators have learned that it is precisely when the markets are roaring, volumes are soaring, bonuses are fat and investors are happy that all of us need to muster the greatest amounts of both vigilance and vision.
Vigilance, to ensure that every possible member firm and representative complies as a matter of course with the rules and the law. And that the few who don't, experience enforcement with teeth.
And vision -- ah, it's vision that's really the hard part ... especially since I'm not talking about 20/20 hindsight. For it's vision and foresight that's required for SROs, the SEC, the states, and the front-line compliance officers at the firms to look around the corner and see what the next big problem trend is going to be that needs our collective attention.
For NASD, I know, the market bubble of the late 90s made for a very busy time.
To give you just a flavor of what I'm talking about, consider just a few of the significant regulatory initiatives NASD was working on then that ultimately came to fruition in a single year -- 2001.
We issued cutting-edge guidance regarding online suitability that today forms the framework for industry operations and policy.
We brought a series of strong enforcement actions and wrote and implemented extensive new rules to govern day-trading activities -- including such matters as disclosure, suitability and margin.
During this same time, we were pursuing a series of leading-edge cases in the IPO allocation area. One major result was our joint $100 million sanction, with the SEC, against Credit Suisse First Boston.
Also during this period, we began investigations into related conduct -- that of research analysts recommending stocks, many of which themselves were the subject of initial public offerings.
As a result, NASD last year proposed rules to broaden the disclosure obligations of analysts publicly recommending stocks.
And this year, the SEC approved our tough and comprehensive new rules to both increase the disclosures and decrease the conflicts of interest associated with research analyst recommendations. These rules were greeted with bipartisan praise when first announced in February 2002.
What a difference a few months makes.
Seriously, we believe the new rules will go a long way toward winning back investor confidence -- once a given in our industry -- that analyst research reports contain useful information, not mere salesmanship.
As our enforcement record demonstrates, NASD will not hesitate to enforce these new rules vigorously -- with a full range of disciplinary options ranging from stiff monetary sanctions to expulsions from the industry. Meanwhile, we will continue our vigilant pursuit of market integrity by promptly completing our ongoing investigations in this area and undertaking any additional rulemaking we find necessary.
Today, NASD has a number of active investigations underway in the research analyst area.
Moreover, in light of our strong ongoing commitment to enforcement, the NASD Board has approved a significant infusion of additional resources for our enforcement efforts. With the addition of as many as 60 new investigators and attorneys, NASD will create several rapid response teams to commence investigations into emerging areas of concern and conclude enforcement actions in a matter of months. In addition, we will increase our ability to conduct examination sweeps in critical areas such as conflicts of interest, anti-money laundering, internal controls and risk management.
I'm not going to describe every detail of the analyst rules worked out by the NASD and NYSE, acting under the leadership of Congress and the vision of SEC Chairman Pitt. You all know the basics. Our rules use a combination of disclosure and outright prohibitions. Our approach was that it's better to have more information, not less -- and to let better-informed investors decide what they want to do with this information.
As an industry, we all have to acknowledge that the kinds of e-mails and compensation practices we've seen reported are simply unacceptable. They don't meet the high standards our industry should be held to. Period. The firm most prominently in the headlines has said as much.
So I was pleased when the SEC launched its formal investigation in this area, acting in concert with the New York Stock Exchange and NASD. Because Chairman Pitt, the self-regulatory organizations and New York Attorney General Spitzer all share the same concerns. We all want to enhance market integrity, investor protection and public confidence.
That's why I believe it's fully appropriate for the SEC to be exercising leadership. We have to remember that a big reason for the success of the U.S. securities industry over the last six decades is the unified leadership and level playing field provided by our federalized system of securities laws and regulation. For that has historically been a great global advantage of U.S. capital markets.
This brings me to the most central issue for a self-regulator at a conference on market structure -- namely, regulatory arbitrage, which is what can happen when regulators treat similar activities differently.
Regulatory arbitrage has the potential in today's securities industry to become a very real and damaging phenomenon. In its broadest sense it is as benign as companies incorporating in the great state of Delaware because of its favorable corporation laws. In a much more malignant sense, regulatory arbitrage is what permits things such as offshore tax havens.
This is all fine philosophical musing, you may be thinking, but why bother me with it in this conference?
Because at this moment there is greater competition among market structures and trading platforms than ever before. It is not news that Nasdaq faces increasing competition, not just internally from ECNs, but externally from established exchanges making strategic plays for Nasdaq's market share. Order flow competition between the options markets gets more intense with each passing month. In the very near future, ECNs and others will press the NYSE for market share, and the new single stock futures may battle not just each other but the options and equities markets as well.
Competition, as such, is a good thing. Fragmentation is not. It is even more clearly a negative thing when it encourages or leads to regulatory arbitrage.
As markets compete, they must do so based on factors such as depth, liquidity, efficiency -- not the level of regulation. Lowering costs by being smarter and faster is great; lowering costs by taking a pass on fundamental regulatory requirements is not.
So we have a situation where the lack of consistency is a consequence of both market competition and technology. In the current climate of shaky investor confidence, is this really the time to be permitting this kind of regulatory inconsistency in the marketplace?
I don't think so. Information available for regulatory purposes in one market should be available in other markets, regardless of trading platforms. A good example is OATS, the Order Audit Trail System -- which provides useful regulatory information in some markets, but as yet is not present in others.
The SEC, of course, is neither unaware nor unconcerned about these problems. In a paper prepared for the most recent SEC Historical Society Conference, Annette Nazareth, Director of the SEC's Division of Market Regulation, wrote with her co-author:
"Transparency of orders, quotes and trades, as well as clarity of trading rules, may provide investors with significant assurance that their orders are dealt with fairly. Markets may also seek to demonstrate a record of effective self-regulation of trading through their facilities, or seek heightened third-party or government regulation to provide investors with an additional degree of assurance."
With our completed sale of Nasdaq, and the coming departure of Amex, NASD's interest in all of this is purely regulatory. Our interest, in lockstep with the SEC, is in coherent, consistent investor protection and a level regulatory playing field.
We don't think the degree of protection an investor gets should depend on the fortuity of what trading platform happens to be used to execute the order. Nor should investors have to worry or even wonder about this. U.S.-quality trading and execution should be U.S.-quality. Period.
It is in this context that NASD's market operations -- ADF and TRACE -- should be understood. And here let me hasten to say at the outset that these are not NASD market operations in the old sense of our owning Nasdaq or Amex.
The first of these is ADF -- the Alternative Display Facility we are building to satisfy the mandate to provide a neutral facility for our members to report quotes and trades. We have made great progress on ADF -- filing the rules and managing the process towards SEC approval, while building the technology that will support the system by mid-2002.
ADF remains on track for its mid-year launch. We're ready and looking forward to it. We don't expect the launch to be a big bang all at once. Rather, given all the uncertainties of the moment, we expect "rolling admissions," as it were, with participants coming on board when they are ready throughout the summer.
TRACE, our bond trade reporting system, is also on track for a July launch. I want to thank the entire bond trading community for all its hard work in helping us prepare for a successful launch.
TRACE is a system about which we frankly have a more proprietary feeling of warmth. This is not just an external mandate -- it really is a system we feel is core to our mission and strategy of protecting investors and fostering market integrity.
NASD is deeply committed to transparency in the bond market. This is far too important a sector to have people operating largely in the dark. Our aim is to provide quality information to the market about fixed income activity.
We believe the approach we've arrived at with the bond trading community maximizes transparency, while optimizing liquidity. We think it will help this sector realize its potential for growth -- as more individual investors and institutions gain the information and understanding they need to participate more fully in the fixed income market.
So we're very excited about our July launch. Because we think in the long term, the increased transparency that TRACE creates will have a positive effect on both market integrity and investor confidence. And as TRACE gets up and running in the months to come, we look ahead to working with the fixed income community to assess the best way forward.
Speaking of the best way forward, I'd like to take this occasion to publicly announce some things about NASD's plans for its own future -- including some key organizational changes we have made.
With Nasdaq spun off and Amex soon to go its own way, NASD several months ago undertook a far-ranging strategic review to chart its course independent of those two markets.
Late last month, we presented the resulting strategic plan to our Board -- which approved it enthusiastically.
The Board has also approved -- with the full knowledge and support of the SEC -- a new divisional structure for NASD. Our unified new structure reflects the fact that since we all now work for investor protection and market integrity, it no longer makes sense for NASD to wall off our regulatory operations in a separate subsidiary.
This new divisional structure has just taken effect. We'll seek approval from our membership later this summer of the bylaw changes needed officially to consolidate our NASD Regulation and NASD Dispute Resolution subsidiaries.
Mary Schapiro is now NASD's President of Regulatory Policy and Oversight, with primary responsibility for all rule making; member regulation and examinations; corporate financing and investment companies regulation; market surveillance; and enforcement. Mary's division will be taking on our efforts to expand NASD's regulation of U.S. markets other than Nasdaq.
Doug Shulman is President of Regulatory Services and Operations, with primary responsibility for ADF and TRACE; technology; the Central Registration Depository; and member services, including education and training. Doug's division will take the lead in offering our services to markets, exchanges and regulators abroad. He'll also continue to lead NASD's corporate development efforts. Doug, why don't you stand, so those who don't yet know you can see who you are.
Linda Fienberg is President of Dispute Resolution. She'll continue to guide the growth -- in quality as well as caseload -- of the largest and leading dispute resolution forum in the securities industry.
At the request of the Board, I have agreed to extend my commitment to NASD to five years -- so that I can take full responsibility for this strategic plan and its full implementation.
I'm also pleased to announce that NASD's Board has elected Mary Schapiro as Vice Chairman -- and deservedly so. Based on her tenure at the SEC, the CFTC, and for the last six years here, she is one of the most respected regulators in the securities industry.
Finally, in support of these changes, NASD has unveiled a new logo and word mark. Our tagline is direct and right for the times: "Investor protection. Market integrity."
This is not a frivolous effort. Our industry's main self-regulator needs a recognizable public identity. We need to let the world know what we do -- and the importance and value of what we do -- to protect investors and keep the markets fair.
In closing, some might think this is a tough time for NASD to do its job -- much less to embark on an ambitious new strategic plan. But the truth is, the present erosion of investor confidence makes it clear the markets have never needed tough, fair private-sector regulation more than they do today.
So we look to the future with confidence in our mission. For NASD's return to its roots could not be more timely. And we have prepared ourselves well for both the challenges and opportunities to come.
Thank you very much.