Watering Down Self Regulation?

May 2, 2005

Better late than never just shouldn't be the regulatory gold standard for Wall Street. Sadly,it is.

On April 29, 2005, the NASD proudly blew its own horn when it issued a press release proclaiming:



Waddell & Reed, Inc. Agrees to Pay $5 Million Fine, up to $11 Million in Restitution to Settle NASD Charges Relating to Variable Annuity Switching: Former Waddell & Reed President, Sales Manager Suspended, Each Fined $150,000; Firm to Pay Additional $2 Million Fine to Coalition of State Securities Regulators



Essentially, in the Waddell case, thousands of customers were persuaded to switch their variable annuities from United Investors Life Insurance Co. (UILIC) to Nationwide. What was the compelling reason for these switches? Well, the NASD release says that the



switching campaign was initiated after Waddell failed to obtain an agreement from UILIC to receive a share of annual mortality and expense (M&E) fees collected by UILIC from Waddell's customers. Waddell approached Nationwide,which agreed to a fee sharing arrangement. . .


[R]obert Hechler, then the firm's president, and other senior managers encouraged the sales force to engage aggressively in switching customers and made statements to them that - as one broker noted - were intended to "prod and scare" the sales force into making switches. During this campaign, some advisors expressed concern that these switches were not in the best interests of their clients.



Prod and Scare? Shock and Awe! Gee --- when did all this misconduct begin? The NASD says in January 2001. And how long did all this misconduct persist? The NASD says through August 2002. And did any regulator learn about this during that 20 month period? Did any regulator knock down the firm's doors to protect the public's interest during those 20 months? Apparently not --- the thousands of switches apparently went on without nary a notice by any of Wall Street's cops. Fact is, NASD states it didn't even issue a complaint until January 2004 --- and then settlement negotiations seem to have gone on for an additional 16 months.

Remember the old Westerns? The bad guys ride into town. Guns blazing. But the Sheriff doesn't hear them and no one tells him. They blow up the bank's vault. No one hears anything and the Sheriff doesn't leave his office. They ride out of town with all the loot. About two years later, a few townsfolk mosey on down to the Sheriff's office. They tell him about the robbery. The Sherriff quickly arms himself and puts together a posse. The posse goes to the saloon for several rounds of drink and a few cappuccinos (and some espressos --- a few folks order decaf). They then groom their horses and hold a meeting as to which direction to give chase. First, they attend some law enforcement seminars in Las Vegas, Orlando, and other resort locales. About a year later, they find the bad guys. A protracted negotiation ensues in which the Sheriff insists that the bad guys give back all, some, or none of the loot. Regardless, the Sheriff returns to town with much fanfare and issues a press release claiming he caught the bank robbers.

Funny,though, that's not exactly how I remember the old Westerns. Used to be simple. The bad guys wore the black hats. The good guys wore the white hats. The guys in black hats didn't make campaign contributions to the guys in white hats.

Please, please read an article I wrote on August 16, 2002 --- just around the time all the Waddell switching was in full bloom. You can find that article at

http://www.rrbdlaw.com/2002/Q3/hollomon.htm

In that column, I discussed my belief that until such time as registered persons are made to feel part of the self-regulatory system (and are treated as professionals), the system is doomed to failure. I pointed to two particular problem areas. One, there are nearly three-quarters of a million registered persons, but they get no vote on any self-regulatory organization (SRO) rule proposal that involves their profession. Two, that these men and women are treated as the property of their employers and that undermines the entire regulatory effort. I suggested that registered persons be able to file their registrations directly with the SROs --- rather than being forced to do so through their employer. As I noted, this latter practice leaves registered persons highly exposed to their employer's wrongful demands. Far too often, NASD member firms engage in misconduct that is made possible because management intimidates their salesforce with the loss of their registration.

Three years ago, Tom Holloman, an NASD Regulation, Inc. spokesperson, responded to my proposals as follows:



Mr. Singer's agenda is clearly out of step with the times, pandering to those who would seek less, not more oversight and accountability. For example, Mr. Singer's proposal that registered representatives vote on all regulatory changes governing their behavior would almost certainly block or delay any effort to enact meaningful reforms. We will resist proposals that would water down industry oversight.



As I responded then, I never said RRs should vote on "all" proposals --- only those that were reasonably related to the discharge of their professional responsibilities. Further, to this date I don't understand why it's okay to give the
employer/management a vote (after all, Waddell & Reed was and still is voting on all NASD rule proposals) but not to employee/labor. Hat's off to Mr. Holloman and his NASD colleagues. I see you have used the past three years well. Clearly, you have made sure that industry oversight remains fully undiluted.

However, you might want to re-read that part of the Waddell press release where you say that the improper annuity switches were accomplished because management was able to "prod and scare," its salesforce. Maybe you should ask how you scare a salesforce? Also, while you continue bashing the integrity of the hundreds of thousands of decent registered persons, re-read that part of your press release where you note that "advisors expressed concern that these switches were not in the best interests of their clients." Also, how come no one seems to trust you guys enough to call you with a timely tip? Oh, that's right, you all are too busy resisting proposals that would water down your aggressive industry oversight.