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The Father of the Bride

The party’s over and the NASD is stuck with a hangover and the tab. Will it seek more broker fines to fill the gap?

Having thrown the lavish wedding, the bride's father was required to pay the bill. The same could also be said for the NASD. The tab for the explosive Nasdaq growth of the late '90s has now come due. But as with many a shareholder of Enron who anticipated selling stock to pay for the mortgage, the tuition and the wedding, the NASD may not be as flush as it hoped. So, don't be surprised if you're asked to pay for the band or the champagne.

Fact is that as the NASD separates from Nasdaq, it must develop more cost-effective policies and find ways to support its bureaucracy. It has just a few sources of revenue: transaction fees (from Nasdaq National Market Issues and its Small-Cap Stock Issues), membership fees and regulatory fees. And with business down, way down, the cash just isn't coming in like it did. Plus, Nasdaq faces new competition.

“Given the dynamic changes taking place in our industry, the existing pricing structure is becoming outdated,” the NASD stated in Special Notice to Members 02-09. “Moreover, NASD needs to modernize the structure of the regulatory fee to take into account Nasdaq's separation from NASD and registration as a national securities exchange.”

Okay, so the Nasdaq gravy train is pulling out of the station and the NASD must still function as a regulator or risk losing its reason for being. But can the NASD really be independent if it receives funding from the Nasdaq market it is regulating? Will the regulator pursue any agenda that would negatively affect trading volume? Isn't it inevitable that those NASD member firms generating greater numbers of transactions and paying larger fees will have more influence? Doesn't that again put us on that slippery slope where the big boys are treated with kid gloves and everyone else (including the lowly individual registered rep) is fair game?

Additionally, the notice to members is not so much an effort by the NASD to justify its existing Nasdaq revenue stream as it is an effort to prepare members for additional (if not increased) fees — and, no doubt, increased fines. However, this is not the economy in which to raise transaction fees. Similarly, smaller firms are in no position to pay increased membership fees.

Consequently, I'm left with the uncomfortable feeling that regulatory fines may be viewed as a convenient way to cover costs. Of course, the secret with such an agenda is that one frequently notices an increase in the number of enforcement actions in addition to the subtle increase in monetary fines.

During such blitzes, the practice is to ticket for a whole host of minor violations — hoping for the quick payment to settle the nuisance. Such a practice is all too reminiscent of a speed trap behind some billboard on a quiet rural highway. It certainly beats raising taxes on the locals or tightening the belt and firing your former campaign contributors from a plum town job. Obviously, we should be concerned when a critical source of a regulator's income is the amount of fines it collects from its members.

Regulators should not be in the “business” of collecting fines. Wall Street would certainly be taking the moral high ground if it allocated all collected regulatory fines to a fund for the benefit of defrauded public customers. It still strikes me as unseemly that the NASD or the SEC collect millions of dollars in fines but public customers' awards frequently go unsatisfied. Ultimately, by relying upon the collection of fines to cover some expenses, the self-regulatory organizations put themselves in the position of competing with defrauded investors for whatever funds may be left at a disreputable firm.

What's the solution? I'd combine all the SROs into one national body. In addition to reasonable membership fees, let this new regulator collect a modest fee on the sale of every stock and from every public offering. Since no one regulator would be relying solely upon revenue from its “own” market that would reduce economic conflicts. I'd also require that all collected fines be deposited into a fund for the benefit of defrauded investors.

Writer's BIO:
Bill Singer practices securities industry law and is a partner at the New York law firm of Duane Morris LLP.

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