NASD Solves Crisis of Confidence on Wall Street:
Dramatic Proposals Call for Scrutiny of Bad Guys!

The National Association of Securities Dealers, Inc. ("NASD"), a self-regulatory organization ("SRO") charged with monitoring Wall Street, recently issued a press release announcing that "NASD Proposes Heightened Supervision for Brokers with a History of Customer Complaints, Investigations or Regulatory Actions." Essentially, the NASD seeks to require 

  Securities firms to adopt heightened supervision plans for registered brokers who, within the last five years, have had

• three or more customer complaints and arbitrations, 
• three or more regulatory actions or investigations, or 
• two or more terminations or internal firm reviews involving wrongdoing.

  Supervisors to approve the plan in writing and acknowledge responsibility for the execution of the plan. http://www.nasdr.com/news/pr2003/release_03_037.html (August 28, 2003). 

Okay, so call me a cynic. But isn't it amazing how these critical studies and rule proposals always seem to get announced on some quiet news day before a holiday . . . like the Thursday before Labor Day, for example. Apparently, the driving force behind the NASD's proposal is a study of the 663,000 brokers registered with SRO that disclosed the following data for the last five years (I've noted the percentages in parentheses): 

2,751 (.41 %) have three or more customer complaints and arbitrations,
216 (.03 %) have been subject to three or more investigations or regulatory actions, and 
1,198 (.18 %) have been subject to two or more terminations or internal reviews based on allegations of wrongdoing. 

The statistics speak for themselves --- a range of potential miscreants who account of between three-hundredths of one percent to four-tenths of one percent of all stockbrokers registered with NASD. Consequently, the overwhelming majority of registered persons have not garnered the attention of claimants' attorneys or industry regulators. Good news, but, notwithstanding, the raw numbers still indicate that as many as 2,751 individuals have had at least three customer complaints/arbitrations within the past five years. 

Okay, so what does one of Wall Street's cops make of the data? Well, NASD Chairman/CEO Robert Glauber says that 

Investors face higher risk dealing with a broker who has a long regulatory record. Securities firms must respond to that risk with enhanced controls. Putting heightened supervision plans in writing and holding supervisors accountable will ensure that these plans are a part of the compliance and management process that is critical to investor protection. 

Let's carefully analyze the above three sentences by Mr. Glauber.

 Investors face higher risk dealing with a broker who has a long regulatory record.

Great sound bite, but I wonder if it doesn't cause more harm than good. Here's my point. The public faces a high risk when dealing with a broker with a long regulatory record. Would be foolish not to admit the obvious. However, on what basis does Mr. Glauber extrapolate that a "high" risk becomes a "high-er" one? Higher than what? The following supposed upright citizens of Wall Street paid a collective $1.4 billion settlement for conflicts of interest: Bear Stearns, CSFB, Goldman, J.P. Morgan, Lehman, Merrill Lynch, Morgan Stanley, Piper Jaffray, SSB, and UBS. If a public investor dealt with any individual from those ten NASD member firms during the past five years, how much less risk did you incur than if you had merely invested with some stockbroker (from any other broker-dealer) with at least two terminations during the same period? Would Jack Grubman or Henry Blodgett have satisfied any of the NASD's five-year warning criteria --- I don't think so. And what about all those high-flying NASDAQ stocks (that's right, the NASDAQ that the NASD itself used to own) --- was it less risky to invest in some of those $100 plus stocks that are now trading for pennies and whose CEOs face criminal charges? 

The danger of the Glauber quote is that it perpetuates a now discredited myth that it's only the stereotypical boiler-room with its fast-talking kids and its Rolex-wearing, custom-suited, Porsche-driving owners who defraud the public. It also fails to address one of Wall Street's dirty, little secrets: For years the regulatory community has meted out two forms of justice --- one for the smaller firms and one for the larger firms. The big broker-dealers rarely found themselves subjected to the same intense investigations as their smaller competitors. And when it came time to handing out punishment, well, you go read the headlines; historically, they often got slaps on the wrist. 

No, Mr. Glauber, it wasn't your cited recidivists who besmirched Wall Street's reputation this last round. Fact is, it was the best and the brightest, the biggest and the richest. Fact is, it was the star performers and favored sons of Wall Street --- or at least that's the type of billing you regulators gave them for years. 

Securities firms must respond to that risk with enhanced controls.

Now there is an exercise is profundity. What the hell is self regulation about anyway? We need a 2003 press release to remind broker-dealers that they need to respond to warning signs of misconduct? Is this the sorry state to which industry regulation has finally fallen --- we issue SRO press releases restating the obvious? And if we really, really need to remind broker-dealers of this basic obligation of self-regulation, then we need to overhaul the entire system of Wall Street's regulation.  Frankly, my mother stopped telling me years ago to look both ways before I crossed the street.

Putting heightened supervision plans in writing and holding supervisors accountable will ensure that these plans are a part of the compliance and management process that is critical to investor protection.

Folks, Wall Street already requires that every broker-dealer prepare and maintain extensive written supervisory procedures --- or WSPs as we industry pros call them. Further, haven't we all finally learned that more written documents, written procedures, written rules, and written regulations never solve any serious problems? In my opinion, the NASD Press Release and the Chairman's remarks underscore the real problem with Wall Street --- ineffective regulation. Regulation that lacks vision. Regulation that seems to be conducted in the press on quiet news days. Regulation by autopsy--- after the crimes are committed. And now, regulation by the obvious. Gee, what a profound proposal coming out of the NASD: Let's carefully supervise those individuals with problems and make sure that we have written procedures to accomplish the same. 

Wake up and don't be mislead. You need to be suspicious and wary of any individual and any firm that's trying to get your hard earned money to invest on Wall Street. The Harvard-educated stockbroker with an unblemished record who works at one of the household-name broker-dealers could defraud you of every penny in your account. There is no security to be found in an unblemished record or with a popular broker-dealer that runs expensive television ads. You shouldn't let your vigilance relax because the company whose stock you own was just featured in the newspapers. 

The NASD asks you to buy into some fantasy that if the brokerage firms would only watch the bad guys more carefully, then you could sleep better at night. In the final analysis, I fear that Mr. Glauber and his colleagues simply fail to understand the lessons of these past few years. A fish stinks from the head down. It wasn't that the brokerage industry failed to implement better supervisory policies. It wasn't that supervisors weren't trying to do their jobs. It wasn't that every stockbroker has stepped out of an audition line from central casting and is looking to rip off the public. No, it's actually more basic. The regulators failed. They coddled the major, national firms and sent the wrong message to those organizations and to the public investor. And the regulators are back at it again.