NASD Consultative Committees:
Old Wine in Old Bottles

by Bill Singer, Esq.,bsinger@rrbdlaw.com
February 12, 2003

It's for your benefit, that's why we didn't ask you first.

Sometimes, you just wonder what someone was thinking . . . or not thinking.  On February 10, 2003, the NASD posted Notice to Members 03-10: NASD Establishes Consultative Committees, wherein  “greater industry input into [the NASD's] investigatory process” is supposedly touted through the establishment of a pilot program of Consultative Committees.  You just got to love that alliterative name, but not much else about the idea. It’s also a bit absurd that the NASD simply creates these committees to enable “greater industry input,” but never substantively put the idea before its membership for a vote before promulgating the program.  Typical. The we-know-best paternalism is still flourishing in Washington, DC.

The high-sounding motive behind this pilot program is to “provide staff with a resource for obtaining the benefits of industry expertise during the course of an investigation . . . without compromising the staff’s autonomy in performing its regulatory obligations”  The NTM notes that during investigations, “NASD staff may encounter situations where industry expertise would be a useful resource. Such situations may arise, for example, as the result of new or complex securities products, technological developments, or industry practices . . .”  The Committee will supposedly serve in a strictly “advisory” capacity and will have “no role in determining whether a regulatory proceeding will be initiated [and] staff will be advised that there are no circumstances inwhich it may ask Consultative Committee members whether NASD should initiate a proceeding . . .”

As you may have guessed, I don’t like the proposal. In August 1996, perhaps the nadir of NASD’s reputation, the SRO was sanctioned for serious marketplace misconduct by the SEC. In a scathing Report Pursuant to Section 21(a) of the Securities Exchange Act of 1934 Regarding the NASD and the NASDAQ Market (August 1996),the SEC criticized the NASD for many shortcomings, among the more noteworthy were allowing its investigative/enforcement process to become politicized in favor of major national members, and permitting its staff to selectively enforce various rules and regulations. 

Consider the following pertinent quotes from the 21(a) Report:

The NASD, like any regulator, must be cognizant of the natural tendency of a regulated industry to influence its regulator to protect the industry's proprietary interests. As an SRO, the NASD must guard against the efforts of any one segment of its membership, such as its market maker members, to assert undue influence over its regulatory functions and processes . . . Other less organized constituencies, such as retail and institutional investors and other broker-dealers, did not have comparable representation on those boards and committees. (Page 40-41)

The NASD has undertaken to provide for the autonomy and independence of its staff with respect to disciplinary and regulatory matters where the commercial interests of the NASD's members, or any particular segment of its members, could be inappropriately inserted. Staff autonomy and independence are vital to the future effectiveness of the NASD if it is to comply with its statutory mandate.  The NASD staff must have an environment in which they can bring to bear the objectivity, professionalism, and concern for investor protection that an SRO must always display. (page 52 –53)

The NASD Dissidents’ Grassroots Movement (NDGM)http://rrbdlaw.com/NDGM/NDGMhttp://www.rrbdlaw.com/index2.html  has set forth a thoughtful agenda to reform NASD and to promote the more active involvement of the membership.  In contradistinction to the Consultative Committees, NDGM has called for the creation of a full-time Office of the Industry’s Advocate. That office would function as an unabashed spokesperson for industry interests and would be free to --- and in fact charged with --- representing Wall Street’s parochial interests during all phases of the NASD’s activities.  We envision the quintessential in-house Devil’s Advocate.  

The distinction between the proposed Office of the Industry’s Advocate and the Consultative Committees is that the latter envisions some formal process by which the regulatory staff would consult with industry members, who, if not by design certainly by deed, will likely become a quasi-Grand Jury that will ultimately give an imprimatur to a prosecution.  Further, these so-called consultants will wield significant power, regardless of what NASD would have us believe.  Already cast in the role of mini Wizards of Oz --- all knowing and powerful experts --- it is unlikely that the staff would either disregard the advice provided during a consultation, nor is it likely that situations will not frequently arise in which issues involving competitive advantages in the marketplace will not be raised.  And all of these consultations will apparently occur behind closed doors, confidentially, and without disclosure.  This happened once before. It’s documented in the 21(a) Report.  Yet, still, the NASD doesn't bother to insist upon safeguards in this Consultative Committee scheme wherebyless organized constituencies have comparable representation on this  committee.

As NDGM specifically raised in its agenda, NASD has yet to satisfactorily address the overdue reform of its elective office process.  Until that occurs, the District Committees are likely to fail to fully reflect the diversity of the NASD’s membership --- small firms as well as large. Imagine a few years ago if the staff had sought a consultation with a committee dominated by national market makers concerning an ECN issue.  Imagine if the staff sought a consultation about reasonable research practices from a committee dominated by national retail firms.  Imagine the staff has an issue about something your small BD is doing, and unbeknownst to you, your arch-competitor (who’s on the Consultative Committee) puts the kibosh on whatever you’re undertaking.  The NASD will likely claim it has installed safeguards against just such a problem. We all know better. There are no such protections.  

It should strike a somewhat unsettling note with industry members that NASD would need to set up a formal consulting body based upon an implied inability of its staff to stay current with the pace of technology and product development. I thought the way it worked was that registered persons weren’t supposed to sell product they didn’t understand and weren’t supposed to engage in activities for which they hadn’t based the requisite exam.  Doesn’t it seem sensible to impose at least the same thresholds upon those who regulate us? NDGM has urged the NASD to make more of an effort to hire staff with industry background --- rather than those exclusively from the ranks of academe or regulation.  

Similarly, I’m unclear as to what presently prevents NASD staff from picking up a phone and calling anyone in the industry to learn how something works. Is there something preventing an energetic examiner from telephoning anyone and asking for an explanation? Are the libraries and Internet off limits?  Couldn’t an enterprising investigator simply walk in to the District Director’s office and ask for a referral to someone in the industry with knowledge of a problem?  Within the entire bureaucracy of NASD are there no qualified individuals to answer such questions? Under NDGM’s proposal, the staff would be welcome to contact the Office of the Industry’s Advocate and that office’s employees would do the grunt work. 

Finally, and most importantly, the whole Consultative Committee smacks of some Star Chamber. I just don’t like the idea of the NASD swearing industry members to secrecy and protecting them from being forced to testify concerning those discussions.  Nothing good can come from such closed-door dalliances.  Human nature, being what it is, members of these committees will be in a position to stab competitors in the back and no one will ever know who plunged the knife. It reminds me of something used by a totalitarian state to spy on its citizens --- it just doesn’t seem to strike the right tone for a self-regulatory, collegial process. 

Ultimately, this is old wine in an old bottle. It’s also a bad idea repackaged as only NASD can do it.  Lipstick on a pig --- as the controversial ad says.