NASD to emphasize regulation ‘principles’

NEW YORK — NASD will put increasing emphasis on “principles based” regulation rather than “one size fits all” rulemaking, even as it concedes that such a move could confuse many in the brokerage industry. “We must be more sophisticated in understanding and accommodating different business models without compromising investor protection,” Mary Schapiro, NASD’s chairman and chief executive, said during a speech at an industry meeting of compliance and legal executives in Phoenix last Monday. “Part of that means losing the blinders of one-size-fits-all rulemaking,” she said, according to a transcript of her speech posted on the website of Washington-based NASD. “In some areas, that argues for a more principles-based approach to regulation; in others, it may argue for tiered regulation based on firm size and business model; and in others, a clearer distinction in the rule set between retail and institutional investors.” Global competition Pointing to global competition, Ms. Schapiro stressed that for regulation to be effective, it needs to evolve “at the same pace as today’s capital markets.” Principles-based regulation clearly has its proponents. “Principles-based, versus rules-based is much more pertinent, because you’re emphasizing the spirit of the law rather than multiple interpretations of the law,” said Tony Cherbak, chief operating officer of Resources Global Professionals, a professional services firm in Costa Mesa, Calif. Others point to the inherent tug between the two methods. There always is a “tension” or “balance” between rules and principles, Nell Minow, chairman of The Corporate Library LLC, a Portland, Maine-based group that addresses corporate-governance issues, said in an e-mail message. Rules are “nice and specific but not flexible enough for certainty in a range of situations,” and principles are “nice and flexible but not clear enough to provide safe harbors,” she said. “I think it is a distinction without a difference, and all the systems are converging on a combination of rules and principles that is similar to what we have in the law: common law and legislation,” Ms. Minow said. Ms. Schapiro’s comments echoed those made earlier last month by Treasury Secretary Henry Paulson, who said that lawmakers should do more “cost-benefit analysis” of new regulation on companies and think about a “principles-based” regulatory system. He pointed to the accounting industry’s need for reform at a meeting March 13, which included Warren E. Buffett, chairman and chief executive of Berkshire Hathaway Inc. of Omaha, Neb.; Charles R. Schwab, founder and chief executive of The Charles Schwab Corp. in San Francisco; and New York Stock Exchange chief executive John A. Thain. Record profits Ms. Schapiro’s call for more principles-based regulation comes at a time of record profits for some firms in the brokerage industry. It also comes at a time when NASD is heavily fining some of its 5,038 broker-dealers and hearing more complaints from investors. In 2005, the last year information was available, NASD fines of broker-dealers hit $148.5 million, an in-crease of 29.8% over the number a year earlier (InvestmentNews, June 12). Last year, NASD received 5,671 complaints from investors, an increase of 10.4% over 2005. However, the number of disciplinary actions that NASD filed against broker-dealers dropped 13.9% last year, with NASD filing 1,204 such actions. In her speech, Ms. Schapiro stressed that NASD is “no stranger to principle-based regulation,” citing NASD’s “just and equitable principles of trade and suitability.” But, she said, “we continue to look to where we can do better.” NASD is looking to the United Kingdom’s Financial Services Authority, which is akin to the Securities and Exchange Commission, as an example. “The FSA, which has been held up by many as the paradigm of the modern regulator, relies upon 11 principles for financial services regulation,” Ms. Schapiro said. “One of the principles is simply called ‘Treating Customers Fairly,’ and it states, ‘a firm must pay due regard to the interests of its customers and treat them fairly.’” The FSA, Ms. Schapiro noted, also had 8,000 pages of rules to go along with its 11 principles. “In other words, their combination is a system of rules and principles, as is ours. But we place more emphasis on rules and they on principles,” Ms. Schapiro said. “While I believe that we can move in their direction, I think a challenge for everyone in this room will be to operate with less certainty and clarity, which, of course, is inherent to the principles-based approach,” she said. “Business entertainment” is one area where principles-based regulation already is at work, Ms. Schapiro said. Some welcome that approach, while it makes others “decidedly uncomfortable,” she said. “So with the benefits of principles-based regulation also come the challenges,” Ms. Schapiro said.