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NASD DEMUTUALIZATION AND REGULATORY REFORM

by Bill Singer, Esq.

From time to time I believe it important to discuss controversial industry issues that are the subject of heated debate.  In publishing such editorial pieces I use a special edition of the Securities Industry Commentator™ entitled Dispatches from the Frontline™.  The following article addresses the proposed NASD demutualization and my position on the historic undertaking.
Bill Singer

I believe that Wall Street is at a critical crossroads, with historic changes pending in areas of demutualization, decimalization, regulatory consolidation and reform, and rapidly accelerating technological advances. Further, I believe that the fragmentation among the key market participants has been caused by inexcusable and inappropriate power politics played within the halls of the NASD and the SEC, such that smaller BDs, individual registered personnel, and advocates for industry reform have effectively been frozen out of the process. This alienation paved the way for the historic upset victory of two dissident candidates in the 1999 NASD Board of Governors election. The NASD created Frankenstein's monster and has no one else to blame for the poor state of relations with the majority of its members.

But having flexed its muscle, having experimented with and gauged the strength of its new found power, the question is what will the independent/regional BD membership do next?  Unfortunately, it seems that the previously disenfranchised now stand poised to throw the proverbial monkey's wrench. Although it would be a satisfying revenge to derail the proposed demutualization, it would not be the right move at the right time. What is called for now is leadership, not vendetta. 

I believe that a consolidated self-regulatory organization (or a significantly reformed NASDR) is in the best interests of the securities industry.  I believe that smaller firms have a legitimate right to fear  the creation of  a monolithic SRO, especially one that will be imposed upon them, without a fair opportunity to establish the formative rules, regulations and By-Laws. Nonetheless, the writing is on the wall . . . or on Wall Street . . .  and to deny the inevitable is to ultimately become marginalized in the ensuing debate. The best strategy for smaller BDs is to demand that the resulting unified or reformed SRO be operated in a manner reflecting their interests and the Board and Committees not be ruled, directly or indirectly, from a few powerful Wall Street firms.

Accordingly, efforts to further consolidate and reduce both economic and cost inefficiencies within the industry are both compelling and proper.  Once again, the historically disenfranchised industry participants are correct in fearing such decisions have been and will be made without their involvement. Nonetheless, I believe it is more sensible to accept the proposition and attempt to negotiate the groundwork, then to merely seek to scrap the entire project. Yes, a lot of smaller BDs can get together, oppose the proposal, make a big commotion, and likely trash the initiative. Very shortly after fireworks make a loud noise and light up the sky they are gone. Ear candy. Eye candy. This is not the best approach for smaller BDs.

In recent weeks several of my broker-dealer clients have asked me whether or not I support the present NASD demutualization proposal. In all candor, I am not unreservedly enthusiastic about the proposal because I think it could be more favorable to the broker-dealer community and it lacks a firm commitment to regulatory reform and the reduction of oppressive recordkeeping requirements. Nonetheless, I have concluded that although it wasn't the best deal that could have been drafted, it is the best deal that all the industry factions can agree to.

Compromise requires concessions.  The NASD's independent/regional BD membership has every right to complain that other marketplace participants are getting too large a share of the proposed stock distribution, or that the shares are priced too high, or whatever. But the more the pendulum shifts in one direction the more the inequities will emerge from the other. Ultimately the overwhelmingly important issues confronting BDs and registered personnel today are not the price of the shares in the proposed offering, nor the number of shares available . . . the pressing concern must be the wholesale reform of oppressive regulation and the need to ensure that the NASD's members are regulated by individuals sensitive to the daily pressures of Wall Street and professionally responsive to the legitimate complaints of the industry.

Without question the present structure of the NASD fails on too many fronts to address the needs of members. The SRO is understaffed in areas deemed key by members. The retention of staff through higher salaries and more progressive management seems a failed priority. The rank and file have been over populated with candidates whose sole industry experience has been working for a regulator.  The efficiencies of capitalism have lost out to the redundancy of bloated bureaucracies.  This prosecutor mentality results in an organization that all too frequently resorts to an adversarial posture when confronting member criticism and there seem few avenues of internal appeal available to firms and individuals. But that criticism can be applied to many regulatory organizations in many industries. It is an age-old problem; not one unique to the NASD.

Despite all the shortcomings and reservation, I remain convinced that it is time to throw the baby out with the bathwater. I seek and my clients desperately desire fundamental change . . . even at a high price. By cutting NASDAQ free from the NASD I believe that we will have a once-in-a-lifetime opportunity to recreate the NASD more in keeping with the industry's image. To lose this opportunity would be a shame. Furthermore, I believe that senior NASD management is fully aware of the potential for victory by future dissident slates of candidates and the ability of diverse industry groups to coalesce in opposition to unpopular regulation. Under such a looming shadow I sense that the NASD is finally prepared to set a wider table and implement wide reaching reforms . . . grudgingly or otherwise.

Consequently, in light of the balancing of the equities of the arguments pro and con, I have concluded that my clients should support the present NASD demutualization proposal and am so advising. However, I am also urging those same clients to actively seek to have the NASD agree to the following three-point regulatory reform package.

  1. Bill of Rights

The formal codification of the rights of members/associated persons involved in NASD examinations and investigations. These rights would be in a written notice accompanying all requests for testimony and production, and would minimally provide that

  • individuals and firms are entitled to legal counsel and that such right may not be unreasonably compromised by the Staff,
  • reasonable requests for adjournments and extensions will be accepted,
  • reasonable limits will be imposed upon the frequency of and the duration of on-the-record interviews,
  • all requests for testimony provide sufficient information to reasonably notify witnesses of the scope of the investigation and to sufficiently permit adequate preparation, and
  • detail the process by which firms and individuals could challenge arbitrary Staff actions.
  1. NASDR Website Button

The inclusion on the NASDR's website of a permanent button requesting comments or complaints from members concerning difficulties with the regulatory process or Staff. The button should permit anonymous communication, if desired. Additionally, NASDR should maintain statistics as to specific areas of complaint and prepare a report explaining the responsive solutions implemented.

  1. Office of the Members' Advocate

The creation of an Office of the Members' Advocate (OMA), which would function as an in-house champion for members' issues. Modeled after the successful Office of the Ombudsman, the OMA would focus less on specific complaints (which would continue to be processed by the Ombudsman) and more on agendas and issues. OMA would always seek to streamline burdensome recordkeeping proposals, represent the members' perspective when new rules are proposed, and serve as a watchdog against unfair or unreasonable practices.

In recent months I have discussed these proposals with the press and have raised these issues with senior management at the NASD, and am hopeful that with the coming membership vote on demutualization that the SRO may finally move to implement some of the proposals. I have been encouraged by the positive reception my suggestions have received and have given such favorable response great weight in urging my clients to support the present demutualization proposal.





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