Any rep or branch office manager who has been disciplined by the NASD can attest to the organization's zealous dedication to enforcement.
However, a recent SEC report shows that the NASD is far less enthusiastic about policing itself — despite the fact that such self-regulation is part of its charter.
To wit: In 1996, the NASD created a regulatory subsidiary, NASD Regulation (NASDR) and a market subsidiary, Nasdaq. For the years 2002 through 2003, Nasdaq paid NASDR over $138 million dollars to serve as its primary regulator. Judging from the conclusions in the SEC's report, this was money poorly spent.
The SEC Section 21(a) Report of Investigation, issued Feb. 9, outlined some NASD failings in blunt language:
Nasdaq failed to communicate the observations of Nasdaq staff members relating to the trading described above [wash trades and matched orders in 2002 designed to generate trading activity for the sole purpose of obtaining rebates from Nasdaq] to NASDR, which is the primary regulator of Nasdaq's market center, and NASDR's automated surveillance programs did not independently detect the suspicious conduct. In addition, Nasdaq did not inform NASDR that MarketXT was delinquent to Nasdaq in the payment of trading fees, a fact that likely would have resulted in a targeted examination of MarketXT's net capital compliance, and NASDR did not resolve MarketXT's net capital deficiencies.
Serious as all this might sound, the SEC report findings will not result in any immediate action towards the NASD. According to the SEC, a 21(a) Report is intended only to “publish information concerning… (federal securities laws) violations” but “does not constitute an adjudication of any fact or issue…” Moreover, the NASD and Nasdaq merely “consented to the issuance of this Report without admitting or denying any of the statements or conclusions herein.”
Put another way, Nasdaq apparently failed to tell its primary regulator of improper trading, and the NASDR apparently didn't catch the wrongful conduct. Also, Nasdaq apparently didn't tell its regulator that a member wasn't paying required trading fees, and the NASDR apparently failed to catch a net capital problem. The SEC isn't really saying that any of this actually happened, and it hasn't really ruled it happened. To muddy the waters even more, the NASD and Nasdaq won't admit it happened, but they won't really deny it either.
When you read the 21(a) Report, you'll find some amazing omissions. Not a single NASD or Nasdaq employee is mentioned by name; no one is censured, no one is fined and no one is suspended. Was this SEC investigation a colossal waste of time? Not according to the SEC, which says it learned a number of dramatic lessons:
The facts learned in this investigation point to the need for reiteration of a fundamental premise of self-regulation: an SRO must vigorously enforce its regulatory responsibilities and must take particular care when market and regulatory functions are delegated to separate entities.
Wow! The SEC learned that self-regulators must carefully and vigorously enforce their regulatory responsibilities. Very useful. New memos surely are circulating like crazy at the SEC, NASD, NASDR and Nasdaq, reminding those organizations' employees of their regulatory responsibilities.
There are two things that are troubling about all this. First, this is déj vu all over again with regard to the NASD's lack of oversight on Nasdaq. In 1996, the SEC issued another 21(a) Report that noted “deficiencies in the NASD's oversight of the Nasdaq market and its failure to enforce compliance with the NASD's rules and the requirements of the federal securities laws.” In that report, regulators knew some things they apparently forgot in the intervening nine years. Specifically:
The Exchange Act requires the NASD to enforce its rules and the federal securities laws vigorously and in an evenhanded and impartial manner. Moreover, the NASD has an affirmative obligation to be vigilant in surveilling, evaluating, and effectively addressing potential violations of the federal securities laws and its rules, as well as conduct that could adversely affect the competitiveness or integrity of the Nasdaq market.
In the wake of this report, the SEC actually issued charges against the NASD, which the SRO settled with a censure. NASD also agreed to a number of undertakings designed to prevent future lapses. Guess those undertakings had a limited shelf life, as it seems everyone there all but dispensed with all that vigorous enforcement stuff. Did integrity take a back seat to ensuring that Nasdaq's trades didn't dip too seriously in the face of growing competition from ECNs and other exchanges? Hmmmm.
The second troubling thing about the mere wrist slap for the NASD is that it makes it clear that the NASD is being held to a different set of supervisory standards than the rank-and-file brokerage workers it oversees. For instance, the SEC in its report does not name a single human being at the NASD. Compare this to when the SEC or NASD comes after the little guys on Wall Street: The offending parties' names are placed front and center.
More important, the little guys are punished severely when they fail to live up to their supervisory obligations. Consider the recent NASD disciplinary case of Cantwell Paul Sandifur, Jr., #C3B040028, January 2005. Registered representatives under Sandifur's direction and control engaged in fraudulent and deceptive sales practices. Sandifur and the firm's compliance officer spent the majority of their time working as officers and/or directors of affiliated companies, and the compliance officer delegated his responsibilities to others who were unqualified, inexperienced and unable to perform the delegated tasks due to insufficient staffing.
Sandifur knew, or should have known, that the compliance officer and the supervisor of all the registered representatives were not effectively discharging their responsibilities. As president of the firm, Sandifur was responsible for establishing an effective supervisory system, but the firm's supervisory system was not reasonably designed to achieve compliance in the areas of misconduct cited. Without admitting or denying the facts, Sandifur settled the charges through an Acceptance, Waiver and Consent and was barred. He also agreed to testify if the NASD files disciplinary proceedings against the firm's current or former agents relating to the misconduct referenced in this AWC.
This brings the matter into high relief. When common reps or their supervisors engage in misconduct, the regulatory industry comes down on them like a ton of bricks. They get named in a press release. They lose their jobs and good reputations. But when a regulator fails, it's entirely different. No one is faulted, no one is named, no one is sanctioned — even if they were told not to make the same mistake again, even if they promised not to make the same mistake again.
It's not hard to see how we arrived at the current state of regulation on Wall Street.
Writer's BIO: Bill Singer is a practicing regulatory lawyer and the publisher of RRBDLAW.com