NASD Discusses Investor Protection Agenda
ASD's Mary Schapiro recently spoke to brokerage firm compliance and legal department employees at the Securities Industry Association's annual conference. Mary Schapiro is NASD's Vice Chairman and President of Regulatory Policy and Oversight. So her remarks (which can be found at
www.nasd.com/media/speeches/schapiro_2004_02.asp)
signal the direction of the NASD in its efforts to protect investors.
According to Ms. Schapiro, the NASD plans to continue to aggressively enforce securities rules and enforce what she called the "bedrock ethical rule", which is that brokerage firms must observe high standards of commercial honor and equitable principles of trade. That means "doing the right thing", she explained, even if there is no specific rule addressing a particular situation.
Likewise, the NASD plans to continue to bring enforcement actions up the chain of command and hold increasingly senior members of management responsible for brokerage firm transgressions. For example, she cited the NASD's charges against Morgan Stanley's national head of retail sales for failure to supervise regional and branch offices that held illegal sales contests involving mutual funds.
Specific areas of concern will continue to include brokers who recommend that investors use a mortgage to purchase investments. Ms. Schapiro minced no words: "I will go out on a limb here and say that 99% of the time, a recommendation that an investor mortgage his or her home in order to speculate in the securities market IS UNSUITABLE and subject to potential enforcement action." The NASD already has brought enforcement actions against stockbrokers for recommending the mortgaged investment strategy. The grave concern exists, according to the NASD, because mortgages are worse than margin loans (because mortgages can be much larger loans), mortgages risk more than life savings (mortgages risk one's home), and mortgages require investment returns sufficient to pay the mortgage interest.
Another specific area of concern is mutual fund sales, disclosure and compensation. Ms. Schapiro noted that the focus of the NASD has been, and will continue to be, on ensuring that brokers sell investors the appropriate share classes (A shares instead of B shares, for example), as well as ensuring that brokers give investors the proper volume discounts ("breakpoints) off of the A share front end sales charges (loads). Likewise, the NASD plans to continue disciplining brokerage firms for accepting compensation (in the form of "directed brokerage commissions") to pay for sales promotions (known as shelf space).
Another major concern of the NASD is how variable annuities are marketed to investors. Ms. Schapiro discussed three "important" cases that the NASD recently brought related to the sale of those products. The NASD filed one of those actions against Prudential, which was ordered to pay customers $9.5 million and a $2 million fine for inappropriate variable annuity sales and exchanges. Another NASD action was filed against Waddell & Reed and two of its senior executives, charging them with recommending 6,700 variable annuity exchanges to its customers without determining whether they were suitable. Ms. Schapiro also noted that the NASD will increase its scrutiny, and it is considering whether to require firms to adopt special supervisory and risk disclosure procedures.
Investors should welcome these protections. In commenting upon the "litany of scandals of the past three years, Ms. Schapiro stated that a "tipping point has occurred and this industry will, for the foreseeable future, face increased obligations and heightened scrutiny of regulators." Hallelujah!
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James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.
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