“We have the technology to combat fraud in the securities industry. However, we cannot protect investors as long as a gang of stockbrokerages posing as a regulatory organization, the National Association of Securities Dealers, is allowed to control public access to the industry’s disciplinary records.”
Federal Court Allows NASD To Withhold Brokerage Disciplinary Records
On October 30, 2002, U. S. District Judge Susan C. Bucklew ruled in the case of Edward A.H. Siedle and The Siedle Directory of Securities Dealers, Inc. vs. National Association of Securities Dealers, Inc., that the National Association of Securities Dealers could limit public access to and use of information regarding the criminal and disciplinary histories of the nation’s stockbrokerages. That’s right— the court ruled the brokerage industry is allowed to determine how much of its dirty linen the public is allowed to see. Talk about limiting the right of investors to educate themselves prior to making an investment decision!
This was a must-win case for the NASD. In order to defend its disclosure practices the NASD hired the law firm of Brobeck, Phleger & Harrison. You may have seen their ads on CNBC: “Brobeck…. When your business is on the line.” The NASD’s business was on the line this time. If this so-called self-regulator were to lose control over the disciplinary records of its members, it would no longer be able to limit public awareness of the prevalence of wrongdoing within the brokerage industry. If you think stockbrokers are poorly regarded by the American public today, imagine what their reputation would be if all information regarding their wrongdoings were publicly available. Under current law, investors only get to see information the NASD members have agreed to allow their self-regulator to show and only after a lengthy deliberation process during which the concerns of the brokerage firm members regarding specific disclosure initiatives are fully weighed.
What kind of information are we talking about? Criminal charges and convictions, regulatory actions brought by the SEC, NASD and the states; civil judicial actions, such as arbitrations; and financial actions, such as bankruptcies, unsatisfied judgments or liens. This is information that is critical to investors seeking to determine whom they can trust with their savings.
Pitt’s SEC Declines To Intervene
Today SEC oversight of the brokerage industry is more distant than ever. Our letter to Chairman Harvey Pitt of the SEC, asking the SEC to intervene on behalf of investors in this important disclosure matter was unsuccessful. Catherine McGuire, Chief Counsel in the Division of Market Regulation of the SEC responded indicating that the NASD was free to limit public access to the disciplinary information regarding its membership and impose use restrictions. While enhancing investor access to information regarding the risks of doing business with brokerages could only be helpful to investors, the SEC was not interested in stepping on the toes of the NASD.
The Silence Of The Lambs: State Securities Regulators
As perverse as it may seem, the brokerage industry is not only allowed the privilege of self-regulation, self-adjudication through NASD mandatory arbitration and self insurance through SIPC, it has also been permitted to maintain and control the only database that exists of its members’ misdeeds. Law enforcement and state securities regulators may input information into the Central Registration Depository (CRD) database, yet ultimately the NASD and the NASD alone determines who may withdraw information, how much they may withdraw and for what purpose. While every state has its own “sunshine” or “freedom of information” statute, since the NASD is not a government agency, the federal Freedom of Information Act does not apply.
Nine months after we asked Matthew J. Nestor, First Deputy Secretary of the Commonwealth of Massachusetts for the disciplinary information the NASD would not provide, he indicated that while his office routinely provides such information to investors from the CRD (which is jointly administered by the NASD and the states), he would not provide it to us because of the NASD’s objections. In other words, the identity of the party requesting the information could be considered in determining whether the Commonwealth would honor a disclosure request. If the NASD doesn’t like you, it can withhold information from you. Again, the fact that publication of The Directory could only benefit Massachusetts investors did not spur his office into action. The wrath of the NASD was of greater concern than investor protection. We are awaiting a response to our similar request from the State of Florida.
The North American Securities Administrators Association, whose membership includes the securities administrators of the fifty states, also declined to support our publication of the industry’s disciplinary records. State securities regulators have been under pressure from the NASD to leave the regulation of securities dealers to it. The NASD believes “quasi-federal self-regulation” somehow serves investors better than each state having a regulator concerned for its citizenry coupled with a true regulator, such as the SEC, on the federal level. Elliot Spitzer aside, the NASD has been remarkably successful in persuading most state regulators to leave regulation of the brokerage industry to it.
NASD Disclosure System Omits 95% Of Disciplinary Data
How good is the NASD’s public disclosure system? As we documented in the first edition of The Siedle Directory of Securities Dealers, not surprisingly, the NASD has not done a very good job of keeping the publicly available database of its members misdeeds current and comprehensive.
“Data regarding millions of nationwide brokerage firm customer complaints are not disclosed to the public, despite the fact that state securities regulators, the SEC and National Association of Securities Dealers, each keep such records. Only information regarding arbitration cases filed with the NASD is disclosed to the public. Arbitration cases filed elsewhere, an additional 10-15% are not disclosed-- although information regarding these cases is available. Cases ending short of a final decision by arbitrators are not disclosed. Cases decided by arbitrators that are subsequently “expunged” from firm records as a condition of settling claims are not disclosed. Arbitrations between brokerages and their employees and between firms are not disclosed. Only 15% of all NASD arbitration cases filed are disclosed —less than two arbitrations per firm over a 15-year period. Only one-half to a third of regulatory actions are disclosed to the public. Only two criminal actions and no bankruptcies are disclosed for the entire industry. Data regarding firms that become insolvent, are expelled or otherwise cease business operations is removed from public disclosure within two years.”
We should note that the NASD has never disputed the above findings rather, their complaint is with our publishing of the full disciplinary records for the public to see.
Danger To The Nation’s Pensions
As outrageous as it may seem that a federal judge would permit a gang of brokerages to restrict the general public from learning about their misdeeds, the implications for fiduciaries charged with prudently managing the assets of the nation’s pensions, mutual funds and other separately managed accounts, are serious. We believe that the NASD’s obsession to maintain control of data regarding its member’s disciplinary histories has blinded it to the harm its disclosure policies inflict upon the nation’s pensions and other fiduciaries.
Fiduciaries are required to conduct an adequate due diligence of the firms they utilize in trading securities. A single pension fund or money manager may utilize dozens of brokerage firms. As we stated in the brochure for The Siedle Directory of Securities Dealers,
“For the general public, a review of brokerage firms prior to investing and on an ongoing basis, makes sound financial sense. For fiduciaries involved in brokerage decision-making, such as money managers, pensions, endowments and foundations, regular review of the brokerages they entrust with assets is mandatory.”
The NASD’s Public Disclosure System permits fiduciaries to request disciplinary information regarding only one brokerage firm at a time. Any excessive or repetitive requests for information may be denied by the NASD. Information regarding the largest brokerages is sent regular mail arriving weeks later, if at all. (Many investors, and virtually all members of the press, never receive the information requested.) Thus, every pension that utilizes dozens of brokers has to call or e-mail dozens of separate requests to the NASD and await (hopefully) receipt of the information. No comparative analysis is possible since pensions are never permitted by the NASD to view the entire universe of brokerages and establish industry norms. For example, it is impossible for fiduciaries to establish whether multiple net capital violations by a brokerage are unusual and a cause for concern or not because they are never allowed to see the entire universe of firms or those with net capital violations.
As a result of the severe restrictions applicable to the NASD’s Public Disclosure System, most pensions and other fiduciaries do not utilize the NASD’s System and do not perform adequate due diligence reviews of the brokerages they employ.
In our marketing of The Siedle Directory we were astonished by the number of fiduciaries that had no awareness of how to perform a review of a brokerage. Many felt there was no need to conduct such a review. Some pensions left reviewing brokerages to their external investment managers. Money managers were largely unaware of or unconcerned about firm disciplinary records. “Why should I care how many times Goldman Sachs has been sued in arbitration or whether Merrill Lynch has violated some state’s securities laws,” traders would say. We recognized that marketing The Directory involved educating fiduciaries regarding the reasons for reviewing brokerages, the sources of information available, loopholes in the various public disclosure systems and how to interpret the results of a due diligence search.
Purchasers of The Directory have included fiduciaries with over $1 trillion in assets, business and law school libraries, brokerages, and law firms. In addition, copies have been donated to public libraries throughout the State of Florida.
Reasons For Dropping Appeal Of NASD Victory
The very day of Judge Bucklew’s ruling supporting the NASD’s non-disclosure policy, the NASD issued a Notice to Members requesting comments on a proposal to improve its Public Disclosure Program. This Notice responded to many of the criticisms of the Disclosure Program contained in The Siedle Directory. (Note: the NASD purchased a copy of The Directory. Apparently someone read it.) We filed a Motion for Reconsideration with the court asking the judge to reconsider the issues in our case, in light of the fact that the NASD was now admitting its Disclosure Program had many faults which we had properly identified. Our Motion for Reconsideration was summarily denied.
After extensive deliberation, we have decided to drop our appeal of Judge Bucklew’s decision. Despite our certainty that the judge’s decision is wrong, as well as harmful to investors, we are not pursuing the case further for the following reasons:
First, it is clear that the NASD is intent upon opposing publication of disciplinary information regarding its membership, despite the fact that such publication is in the public interest. As we quoted in The Siedle Directory from the NASD’s website, “It (the NASD) has successfully resisted many proposals inimical to the best interests of the securities businesses at large as well as to its members.” Even if we were to win on appeal, the case might very well be remanded to the same judge and drag on for years.
Since the NASD’s mandate is the protection of its membership, it must continue the fight as long as possible to fulfill its obligation to its membership. There is no reason for the association to explore a reasonable settlement. With its deep pockets and political influence, nothing short of a public outcry can bring about a change in the status quo. As mentioned earlier, neither the SEC nor the state securities regulators were willing to file briefs supportive of our case. Thus, we believe that we must push for publication of The Directory through alternative means other than the legal system. We intend to bring this matter to the attention of certain elected representatives known for championing investor protection issues.
Second, given that 60% of NASD members have no disciplinary histories at all, we doubt whether the NASD is even pursuing the best interests of the majority of its membership in opposing publication of The Directory. Many brokerages, especially many smaller brokerages, compare favorably with the national wirehouses with respect to disciplinary matters. We believe the NASD is acting to protect the interests of a limited number of its largest and most powerful members, not the majority of its membership. As a member firm of the NASD, we intend to bring this matter to the attention of the entire membership.
(Ironically, we were approached by Regulatory DataCorp, International, LLC, the owners of which include many of the NASD’s largest members, for permission to include in their database information from The Siedle Directory. RDC was created to help financial institutions identify and manage risks associated with money laundering, terrorist financing, organized crime, fraud and corruption. Apparently these large, powerful NASD members were uncomfortable approaching the NASD for the information we possessed—even for purposes of combating terrorism.)
Third, we hope to be able to obtain the information we need to update The Directory from alternative sources. If we can find one state securities regulator who is committed to investor protection or aware of fiduciary issues, we should be able to obtain the information necessary to produce the next edition of The Directory. We have no doubt the NASD will continue to thwart publication of the industry’s disciplinary records, regardless of the harm inflicted upon investors. Hopefully another party with access to the data, who is not primarily concerned with shielding the brokerage industry from public scrutiny, will release the data to the public, including us.
Finally, we believe this is a matter as to which fiduciaries should make their voices heard. Following recent revelations regarding conflicts of interest surrounding Wall Street investment research, many public pension funds issued statements of policy regarding such conflicts and asked the brokerages they did business with to make certain representations. While these efforts were well intentioned, they will have virtually no effect on the way brokerages operate going forward. If pensions urge the NASD and SEC make publicly available all disciplinary information regarding brokerages, this could have enormous implications for individual investors and the nation’s retirement savings.
We urge you to write: Robert Glauber, Chairman and CEO, National Association of Securities Dealers, 1735 K St. NW, Washington, DC 20006 or call him at (301) 590-6500.
Until control of the disciplinary data regarding its membership is taken from the NASD, no investor can adequately assess the risks of doing business with brokerages.
Setting Standards For The Investment Management Industry
