Indiana Securities Commissioner
President, North American Securities Administrators Association
September 28, 1999
NASAA Annual Conference
Thank you for that very kind and gracious introduction. I also want to express my appreciation to Peter Hildreth, our outgoing president. It’s been quite a year for NASAA: the press coverage we’ve received, the progress we’ve made on Capitol Hill, the changes in our Corporate Office, and the work we’ve done to adjust to our new bylaws. Peter’s guided us well and deserves much of the credit for the success that NASAA has enjoyed this past year. I know it hasn’t been easy. He’s worked hard. But he doesn’t look much worse for it, maybe a little grayer. He still has his hair. That’s one thing I don’t have to worry about losing in this job, my hair. But, seriously, Peter deserves our thanks and a big hand for a job well done.
Next I want to say how grateful I am for the opportunity to represent you as NASAA’s President, and through NASAA to represent the interests of tens of millions of investors all across North America. We hear a lot of talk today about global markets—and our markets today are global. But securities are still sold locally—to you, me, our friends, neighbors, parents, Americans, Canadians and Mexicans, who live in cities, towns, and rural areas. These are the people whose interests we represent and seek to protect as state and provincial securities regulators.
These are exciting times to be securities regulators, and I’m excited about the job you’ve entrusted me to do. Today I want to focus on three key issues that confront us as regulators:
First, the regulatory implications now that we’ve become a nation—I should say a continent—of investors.
Second, how technology is changing our jobs and challenging some long established tenets of regulation.
Third, and finally, I want to talk about federalism and how we may be able to put an end to the pre-emption issue once and for all.
First, what does it mean for us that the United States and Canada are now nations of investors? As we heard in the opening panel on Sunday afternoon, in just a generation we’ve gone from a nation of savers to a nation of investors. Just consider: In 1980, only 1 in 10 American households owned stock. Today, half of all households are invested in the stock market, either directly or through mutual funds, 401(k)’s, or other retirement plans. Assets invested in mutual funds have grown from a little over $1 trillion in 1990 to over $6 trillion today. Individuals in the U.S. now have more assets invested in mutual funds than in federally insured bank accounts. According to Newsweek columnist Allan Sloan, the U.S. stock market is now worth about $13 trillion. That averages out to about $40,000 for each man, woman, and child in the United States.
At the same time, of course, technology has made it easier to invest and easier to get information about investing. Online brokerages are the fastest-growing segment of the industry; some 5 million investors have online accounts. Also, there has been a proliferation of Internet sites and cable TV programming—not to mention countless articles, magazines, books, and newsletters—all dealing with personal finance. There are even stock tickers at major league baseball parks. People used to stand around the water cooler and talk about last night’s game. Now they talk about investments, hot stocks, and their portfolios.
All this means one thing: our jobs as state and provincial securities regulators have never been more important. We’re the local cops on the securities beat. Nobody polices the retail point of sale the way we do.
We’ve never had more or investors to protect. And millions more are in the wings. If Social Security is privatized in the U.S., with some form of investment in the stock market, stock ownership will be virtually universal. And yet our resources, budgets, and manpower are already strained. Beyond brokerage firms and registered persons, we need to prepare to address the growth in the investment adviser area, which we are doing with a new competency exam and, later, a CRD-type database.
On top of this, we’re combating the explosion in unregistered securities fraud…viaticals, promissory notes, prime bank schemes, foreign exchange scams, internet fraud…the list goes on and on.
Investor education, of course, is an essential part of the long-term answer. Despite the record number of people investing, financial literacy remains dangerously low. Now more than ever, investors of all ages need to know more about financial markets, the difference between trading and investing, and the importance of a long-term investment strategy. From senior citizens who need to preserve and protect their life savings to students learning the basic life skills they’ll need in the next century, investors need to be equipped with the tools to make sound financial decisions. In the end, a well-educated investor is the best protection against financial predators.
Financial literacy is so important I believe we need to elevate it within NASAA. We’ve got a Broker-Dealer Section, an Enforcement Section, an Investment Adviser Section, and a Corporate Finance Section. I propose that we consider adding an Investor Education Section, to demonstrate our commitment to protecting investors by educating them. Only by educating investors can we effectively serve the millions of constituents in our nation of shareholders.
The second key issue facing us is technology. Not only has technology changed Wall Street, it’s changed the way Main Street investors access the financial markets and buy financial products and services. For us as regulators, technology presents an opportunity as well as a challenge.
One example is the new CRD system. This is a major technology project that will make our jobs both easier and more challenging. As all of you know, the CRD system badly needed an overhaul. The new Windows-based Web CRD is state-of-the-art and will make it easier for us to devote our limited resources to the firms and brokers that most need our attention. The upgrade has not been without glitches, but these are to be expected, given the size and scope of the project. The NASD, as well as the NASAA CRD Committee, deserve a lot of credit for seeing this project through.
For years we’ve been urging investors to check the CRD before they do business with a broker or a firm. Unfortunately, our advice has reached only a relative handful of investors. We need to do a better job of informing investors about this important tool, and I’ve got an idea for how we can do it. I propose that brokerage firms partner with us proactively to educate investors about the new CRD system by providing their new customers, when they open an account, with a description of the CRD system and how it works, along with their broker’s CRD number. This would be a voluntary program. Participating firms would be saying, in essence, “The vast majority of professionals in the industry are good people, and we want to make sure that you’re doing business with one of them.”
Technology, of course, also includes the Internet. All of us know that securities fraud on the Internet is a big problem. State regulators have responded in several ways. For example, we joined last fall with regulators at the national level in the first ever Investment Opportunity Surf Day. Several state securities agencies have also launched ongoing Internet surveillance programs aimed at combating investment fraud on the Internet. We shared our ideas about investment scams on the Internet with the U.S. Senate when we testified this past spring. But the problem of Internet fraud is growing, and we need to address the broader issue of the proper role of state securities regulators in policing cyberspace. Does it make sense to have 50 states individually surfing the `Net looking for schemes that could potentially harm investors in their states? How can we work closer together and partner with our fellow regulators at the national level? It’s important that we develop a strategy to address this issue as soon as possible.
In addition, all of us as regulators need to do a better job of using technology to reach out and interact with investors and our other constituents. As an example, I urge all of you to look at the home page of the Pennsylvania Securities Commission. The PSC, I believe, could provide a model for all of us to follow.
Technology raises another question that the regulators and the securities industry need to explore. It’s the question of whether changes in technology will result in more, fewer, or the same number of registered professionals. Given the implications of the Internet, are we, as a nation “over-brokered”? What do these technological changes mean for the future of the securities industry? These issues deserve study. Therefore, I propose that we raise these questions at NASAA’s Spring Conference in Washington and that the NASAA corporate office invite industry, regulators, and consumer groups to sit down and look ahead, across that digital bridge to the next century.
Another big challenge posed by technology has to do with suitability. The suitability rule requires brokers to recommend only those investments that are appropriate for a client, taking into account factors such as the client’s age, income and risk tolerance. Suitability may have meant one thing in 1969, when nearly all investors were getting stock recommendations from their brokers. Thirty years later, however, millions of investors never meet, let alone receive recommendations from, their brokers. They’re managing their money themselves, with a
computer, a modem and, maybe a little help from a talking head on television.
Given this new reality, do we need to change, modify, rethink, or update the suitability rule in the age of the Internet and do-it-yourself online investing? The issue of suitability is raised by the new NASD rule on day trading now before the SEC. But, in theory, it could also apply to online brokerage firms. Indeed, some have suggested that day trading firms as we know
them may eventually be subsumed by online firms that will offer virtually the same market access, speed and information. Clearly, it’s our job as regulators to protect people from other people: brokers who churn accounts or put seniors on Social Security into unsuitable stocks such as high-risk microcaps or Internet high-fliers. But what is our role in protecting people from themselves? What if a senior on Social Security goes on line and starts trading microcap
stocks or chasing Internet IPOs? Should online firms periodically review trading of their customers in light of the information they have on file about those customers…their age, their assets, their financial goals? Surely the technology exists to do this. But should firms or regulators be concerned about what investors do for themselves online?
The issue of suitability in the age of on-line investing is a Main Street concern potentially affecting the interests of millions of small investors. We will need to address it sooner or later. I’m therefore proposing that NASAA sponsor a “Suitability Summit” in Washington in November, where regulators, industry, consumer groups, policy makers and the media can meet in an informal roundtable to brainstorm about what suitability or “appropriateness” should mean in the age of on-line investing. I’m not suggesting there are any easy answers. Some may contend that we don’t need to do anything with the suitability rule. Others may argue that it needs tweaking or even an overhaul. In any event, because of the rapid growth in the number
of Americans investing online, I think the issue deserves to be put on the table now and that all parties have an opportunity to share their views.
A year ago, in a speech before a group of business writers and editors, Mary Schapiro, President of NASD Regulation, asked whether the Internet would make securities regulators irrelevant. She concluded that we’ve never been more important to protecting investors. I couldn’t agree more with her conclusion–with this caveat: We have to stay on top of technology, we have to be responsive to change and innovation, and, finally, we have to exercise common sense.
The last item I want to address this afternoon is the role of state securities regulation in an increasingly global economy.Some critics of state securities regulation argue that we are increasingly irrelevant and actually may pose a roadblock to global financial commerce. This view is dangerously misguided. While it’s true that our marketplace is global, investment products are sold locally. A salesman, offering an investment opportunity to an elderly widow in Knightstown, Indiana, is not engaged in global finance. It’s a retail sale in a small community in America’s heartland. To protect that widow’s interests, there needs to be an effective local cop on the beat. This, of course, leads to the licensing issue, which like the Arnold Schwarzenegger character in “The Terminator,” just seems to keep coming back. There are those who argue that state licensing authority over stockbrokers needs to be pre-empted or curtailed. In our nation of shareholders, this is a bad idea, a risky idea. Not only would this harm investors, it would violate long-cherished notions of American federalism.
Protecting people against fraud and punishing people who commit fraud are fundamental roles of state and local government. Protecting consumers within our jurisdictions is something Republicans, Democrats and even Libertarians could agree is a valid role for state and local government. While there is a role for Washington to play in all of this, state securities regulators are the ones best situated to provide grass-roots protection for millions of small investors in communities and neighborhoods across this vast country.
The preemption debate therefore needs to be framed in the larger context of federalism. When evaluating any proposal we must ask ourselves what’s the proper role for the states and what’s the proper role for the federal government? We must also never lose sight of the fact that our securities markets are the envy of the world in no small part because of our
complimentary system of regulation– state, industry and federal.
I happen to believe that regulation and law enforcement are more effective the closer they are to the problems. Unfortunately, there’s a notion, all too prevalent in some quarters, that the solutions to all problems and the wisdom to meet all new challenges have to come from inside the Beltway. This is simply not true! Just look at the success of welfare reform and community policing.
That’s why we need to continue to work with the National Governors’ Association and other groups to support the federalism bill in Congress. It’s common sense legislation. I also call on NASAA members to do more to educate policy makers and elected officials, both at home and in Washington, D.C., about what we are doing to protect our nation of investors.
It’s important to let your Congressional delegation in Washington know about the good work you’re doing and why it’s important to their constituents. You don’t necessarily need to make a special trip to Washington to do this. You can do it by something as simple as adding them to your press release list. And then make sure you stop by when you’re in town for the spring conference; or visit them when they’re back home during Congressional recess.
Only when key policy makers and elected officials understand the critical role we play as the local cops on the securities beat will the preemption issue be put to rest once and for all.
To conclude, these are exciting times for us as securities regulators and members of the securities industry. There are lots of issues, including the ones discussed today: technology, democratization of investing and the important role played by state securities regulators. A lot is changing and changing fast. There are lots of opportunities. And there’s a lot of pressure to get it right. We don’t have a lot of time to waste. Unfortunately, today there are more questions than answers. But that’s a part of the process of how we address issues and move forward. Thank you for listening. I look forward to working with all of you as NASAA’s President.
September 28, 1999