Small Firms Move to Block NYSE/NASD SRO Merger

Not everybody is cheering the formation of a single self-regulatory organization. An insurgency of small brokerage firms is urging their peers to strike down yesterday's announced merger between the regulatory arms of NYSE and NASD. The Financial Industry Association, an upstart advocacy group of an estimated 1,000 small independent broker/dealers that seeks sweeping industry reforms, sent a letter to all NASD member firms asking them to vote “no” on the merger citing disingenuous motives and a lack of time to consider its terms.

Not everybody is cheering the formation of a single self-regulatory organization. An insurgency of small brokerage firms is urging their peers to strike down yesterday's announced merger between the regulatory arms of NYSE and NASD. The Financial Industry Association, an upstart advocacy group of an estimated 1,000 small independent broker/dealers that seeks sweeping industry reforms, sent a letter to all NASD member firms asking them to vote “no” on the merger citing disingenuous motives and a lack of time to consider its terms.

The letter comes just hours after NASD and NYSE Group announced the signing of a letter of intent to combine their member regulatory operations into a single self-regulatory organization to oversee all securities broker/dealers doing business with the U.S. investing public. In a note to NASD member firm executives opposing the merger, FIA Director Richard Goble wrote:

“After an extremely successful NASD District and NAC election by all members it now appears the NASD and “insider” firms are attempting to prevent this from ever occurring again. Like a thief in the night and after 67 years of existence, the NASD and “insider” firms are attempting to buy your rights, with your own rightful money, and take away your right to vote for the entire NASD Board of Governors. This payoff for your vote is your money and FIA demands that your money be sent to you immediately. The NYSE regulation proposed merger does not need to include the forfeiture of any of your current voting rights…vote “no” or “against” on any NASD ballot seeking your approval of the proposed removal of your voting rights; disguised as a merger.”

NASD, which typically gives firms year-end rebates on fines and other compliance-related fees, is offering each firm a one-time payment of $35,000 “in recognition of anticipated cost savings” from the merger but only after the transaction has been completed. The FIA argues that this is an attempt by NASD officials to bribe small firms into voting for the merger. The FIA further alleges that the rush to merge the two entities is a knee jerk response to the FIA’s success contesting NASD elections this year. An NASD official could not be reached for comment on the contents of the letter at press time.

Under the current securities laws, each member firm has one vote in the SRO electoral process. The one-firm, one-vote rule enabled small firms to elect the candidates of their choice to the NASD’s 17-member board of directors. And that’s something that the FIA has been exercising in the recent NASD district elections, where 21 FIA-backed candidates have won out of a possible 33 seats. In February, it successfully contested the nominations for the NASD National Board of Governors, winning two seats on the board.

The NASD dubbed those FIA-backed candidates as “dissidents” and issued so-called “assertions of fact” to dissuade voters from electing them. That gives you some idea about the diverging interests among small and big firms. FIA argues that NASD has made no attempt to ask its members for comment on the NASD/NYSE Regulation merger and has moved forward without input from members.

NASD has been scrambling to push through a merger of the two SROs before the end of the year, citing duplicative regulation, excessive compliance costs, sometimes conflicting rules between NYSE Regulation and NASD, and inherent conflicts of interest brought on by the Big Board’s decision to go public and operate on a for-profit basis. Experts agree that this is a step in the right direction.

But FIA argues that standard operating procedure for rule changes is to put a proposal out for comment and consider feedback in order to ensure there are no unintended consequences. “Why the bum rush for such an important transformation of our industry,” Goble asks in the letter.

While FIA members are outraged by the way it has unfolded, the merits of the NYSE Regulation/NASD merger have been clearly articulated. It would mean lower costs and a streamlined regulatory process for brokerage firms. Brokerages have long complained that the current system of two cops on the beat is redundant and, therefore, too time consuming and expensive. And a single SRO will go a long way toward alleviating those burdens.

“This plan establishes a more sensible and less complex regulatory regime that makes private sector regulation more efficient and effective,” NASD Chairman and Chief Executive Mary Schapiro said in a statement. Schapiro will serve as CEO of the new SRO. “We will reduce the regulatory costs for all our member firms, while providing protection for the tens of millions of people who invest for their future in the U.S. capital markets.” NYSE Regulation’s CEO Richard Ketchum will serve as the non-executive chairman of the combined organization’s Board of Governors during a three-year transition period while staying at the helm of NYSE Regulation. “It is an idea whose time has come,” he said in a prepared statement.

The new watchdog is expected to launch operations in the second quarter of 2007 and will consist of the current 2,400 NASD personnel and roughly 470 of NYSE Regulation's staff who oversee member regulation, arbitration, and related enforcement activities. The new SRO will be responsible for all member examination, enforcement, arbitration and mediation functions as well as other NASD responsibilities. A name for the new SRO has yet to be decided. The merger will require amendments to the NASD bylaws, which are subject to an NASD member vote. Formal documentation must then be finalized and submitted to the Securities and Exchange Commission for approval

Still, small firms fear they will be marginalized in the process. There are 5,100 b/d members of the NASD, and only 180 of them are also members of the NYSE. But under the merger, small b/d executives say, NASD is essentially changing up the rules for the benefit of 180 firms.

Instead of sticking to one-firm, one vote representation, NASD is aiming to change the electoral process to give more power to the larger firms that are dually registered. Here’s what the NASD proposed: The interim Board of Governors will have 23 members. Eleven governors will be appointed from outside the securities industry while another 10 governors will be industry insiders. Seven of these governors will be elected to the interim board and three will be appointed.

Small firms – those with 150 or fewer registered persons – will elect three seats on the board. Medium-sized firms – 151 to 499 registered persons – will elect one board representative and large firms – 500 or more registered persons – will elect three representatives on the interim board. An NYSE floor member, a representative of independent dealers/insurance affiliated broker-dealers and a representative of investment companies will round out industry representation on the board. Additionally, only small firms will vote for candidates running for board seats reserved for small firms. Similarly, only large firms will vote for candidates running for large firm seats, and only medium-sized firms will vote for the medium firm seat.

FIA members see this as the death knell for the democratic process that has governed the brokerage business for nearly seven decades. But they don’t plan on relinquishing their rights without a fight. “We’re going to do an all-out blitz to get members to vote no,” says John Busacca, president of North American Clearing and one of the founders of the FIA. He supports the idea of a single SRO but not at the cost of losing representation. “We’re not dead-set against this merger but we want one firm, one vote.”

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