Friday, November 1, 2024

Taking the Right Medicine

Like the common cold, compliance problems are easy to contract but difficult to get rid of. Perhaps the following checklists for broker dealers and the NASD may be just the right medicine.

Broker-Dealer Checklist

1.) Plan ahead. A strong offense is always the best defense.

2.) Learn the rules, and get a grip on best execution. Familiarize yourself with trading rules and National Association of Securities Dealers interpretations.

3.) Beef up your compliance practice. Hire a full-time compliance officer or supplement your existing staff with the services of an independent compliance consultant. Perform mock examinations. Prepare checklists for daily and periodic supervisory reviews of trading activity.

4.) Update your Written Supervisory Procedures Manual, remembering to answer these four questions for each trading issue: who, what, when and how.

5.) Approach each NASD Regulation examination, review or inquiry as an opportunity to correct what you're doing wrong, or not doing but should be doing. By correcting known deficiencies, intentional or not, you will reduce the number of sanctionable events and eliminate unnecessary disruptions to your business.

6.) Relate more closely with the NASD Regulation staff. Create a dialogue and see where they are coming from. When dealing with staff members who have limited trading experience, add some flesh and blood to the cold facts and statistics they are compiling from transaction reports and trade documentation.

Finally, respond immediately to NASD Regulation findings. It is in your best interest to correct any problems and thereby minimize the impact of trailing fines or sanctions.

7.) Respond to customer limit orders within 30 seconds, and don't forget about your Manning obligations on customer limit orders that are routed to other broker dealers.

8.) Develop compliance awareness. Your traders should establish informal trader networks to learn what's hot and how others are handling the rules.

9.) Inform other firms about who at your firm is responsible for handling and resolving trade disputes. This may reduce the likelihood of backing-away charges.

10.) Understand the value of the Continuing Education Program and the Annual Compliance Program. Develop comprehensive written plans that result in programs tailored for your traders. Go through the compliance history of your firm, identify soft spots and ask your traders about their unanswered compliance questions. Keep a file of all training materials, including handouts. Most importantly, conduct training programs more than once a year.

NASD Checklist

1.) Provide more timely guidance to market makers. Why has the NASD never released its sample Written Supervisory Procedures Manual, which was substantially completed by the summer of 1996? In the same vein, why did it take the NASD nine months to release its first interpretation of traders' best-execution obligations (Notice to Member 97-57)?

2.) Control the pace of self-regulatory surveillance over trading desks. In 1997, many market makers were receiving weekly correspondence from NASD Market Regulation on concurrent examinations, reviews and inquiries. Some of these inquiries involved single trades dating back to early 1996.

3.) Dispel the perception that the record fines and sanctions against market makers were intended solely to finance the association's operating budget. If perception is reality, the NASD might follow the lead of the Internal Revenue Service, which recently issued a detailed confession that its management had become overly obsessed with boosting tax-collection efficiency in recent years at the expense of treating taxpayers properly.

4.) Limit your "zero-tolerance" standards to the discovery of trading violations and deficiencies; apply market conditions, traders' intentions and patterns of deficient trading practices before deciding on disciplinary sanctions. Fines and sanctions for isolated or unintentional rule violations simply do not match their crimes.

5.) Drop the double standard. When Nasdaq and ACT, Nasdaq's Automated Confirmation Transaction trade-reporting system, went down on Oct. 27, 1997, volume overload was an acceptable excuse. Why then should market makers, who are human, be held to a higher standard for occasionally reporting trades late or handling customer limit orders in a less than timely fashion, particularly when operating under similar circumstances?

6.) Help level off the playing field between market makers and institutions in the Nasdaq market. While these participants compete in the same market, institutions have the advantage of operating without self-regulatory oversight and are able to use SelectNet to broadcast anonymous orders. It is unlikely that the Securities Exchange Commission would agree to major changes, but clearly some form of compromise is needed.

7.) Work with Nasdaq traders to correct onerous fees imposed on transactions. It has been estimated that since January 1997, Section 31(a) fees have generated more than $150 million, all of which has been earmarked to fund the SEC's budget. Nice work if you can get it.

8.) Visit broker dealers more often, and reduce the scope of routine and other examinations. This will lead to more interaction with members and help provide better accomodation for traders' schedules.

Getting an Early Start

On Monday morning, Beverly York was tired. She had spent the weekend trying to keep up with her spirited two-year-old granddaughter. While most of Seattle slept early that March Monday, she awoke in the dark at 4 a.m. and then walked her two dogs before the 20-mile drive to work.

"These early hours still bother me," York sighed. "I've tried for 30 years, and I'm still not used to getting up so early." But with heavy volume York can't afford to be sleepy-eyed.

York is the head equity trader at Safeco Asset Management Company in Seattle, a subsidiary of Safeco Corporation. Her three-person desk arrives by 6 a.m. each day, ready for the stock market openings a half hour later.

Since the year began, her desk York, a second trader and an assistant has clocked orders with 89 broker dealers. The desk averages 50 trades each day, and may log up to 90 trades during busy sessions. "This desk has gradually gotten busier, and the firm has grown rapidly because people are still investing in mutual funds," she said.

York takes advantage of many technological tools. Her desk uses Instinet for small orders, AutEx for trade reporting and indications of interest and a Bloomberg terminal for information and quotes.

York is also interested in the heavily-marketed OptiMark trading system. "I'm waiting to see what it's all about. I'm optimistically cautious about OptiMark," York said.

"A lot of new systems stir interest in the beginning, but they're really like new offerings," she added. "They all start out with a lot of excitement, but only a few stick around."

York trades for six portfolio managers handling the ten Safeco Asset Management mutual funds. Two recently topped $1 billion in assets each. The equity desk also trades for the firm's managed accounts.

Safeco Corporation is one of the largest diversified financial corporations in the U.S., with 1997 assets exceeding $29 billion. Based in Seattle, the company's 7,500 employees work in a variety of product areas, including property and casualty insurance, life and health insurance, surety, real-estate investment, commercial credit and asset management.

Safeco Asset Management, established in 1967, is the investment adviser for Safeco's mutual funds, and manages investment portfolios for Safeco Life Insurance Company's variable annuity products and pension accounts for other businesses. Safeco Asset Management has $28 billion in assets under management, $5 billion in equities.

York was hired at Safeco in 1968, after she moved to Seattle with her husband they have since divorced and young son from rustic Oroville. In Oroville, her quiet Washington hometown, she had a much different job working at an apple orchard, packing apples for shipping.

At Safeco, work at first was quite ordinary compared to packing apples. "When I arrived in Seattle, Safeco was just a job," York said. "It certainly wasn't like apple packing."

At Safeco, York first worked in the investment department, learning the business and working wherever she was needed. "I was lucky. I had a lot of fun as I learned the business," York said. "It really got my interest once I started."

In 1985, she was asked to rechannel her enthusiasm and succeed the retiring equity trader. "It was a lot quieter then," York said. "I was able to learn trading while I worked."

Now 13 years later, she is still challenged by her work. She enjoys the different trading needs of each mutual fund, working to find the best place for each trade.

"You talk to such interesting people each day portfolio managers, broker dealers, other traders," York said. "You find different types of people in each fund area you trade in."

When her trading day ends at 1 p.m., she makes the short drive to her home in the Woodenville area outside Seattle, well-before the rush of late-day traffic. She plays with her dogs, works in her yard and takes long walks around nearby Green Lake before the sun sets in the Pacific Northwest.

York plans to retire in 2008, after 40 years of service at Safeco Asset Management. When she started fresh from the packing shed in Oroville, she laughed at the thought of a career in finance. "In 1968, when they told me about retirement plans for 2008, I rolled on the floor," she said. "Now, retiring here is going to be my choice. It makes sense."

When she retires, she'll have more time to enjoy the outdoors with her dogs and her granddaughter. And being a little older too, their youthful energy won't seem so boundless.

Merger Rumor

With smaller profit margins hurting the payment-for-order-flow business, some industry experts are waiting for the first big merger among major Nasdaq wholesalers. Already, rumors are swirling on Wall Street that Nasdaq powerhouse Mayer & Schweitzer and Jersey-City based competitor Herzog, Heine, Geduld may merge.

According to sources close to Herzog's trading desk, Mayer is negotiating a purchase of Herzog. The sources said that the acquisition was not imminent, but expected a deal to be completed by year's end.

E.E. "Buzzy" Geduld, president of Herzog, said there was no truth to the rumor. A Mayer spokesman had not returned calls at press time.

A combined Mayer and Herzog would be a formidable giant. Mayer and Herzog were ranked first and second, respectively, in the AutEx year-end rankings of Nasdaq and over-the-counter volume for 1997. Mayer, a New York-based Charles Schwab Corporation affiliate, had an advertised trading volume of 12.4 million shares, according to the AutEx 1997 rankings. Herzog had a 1997 advertised volume of 11.08 million shares.

Actual Merger

Minneapolis-based Dean Rauscher, a full-service regional brokerage and investment bank, is acquiring Twin City rival Wessels, Arnold & Henderson in a deal valued at $150 million. The nominal purchase, which is expected to close March 31, includes $120 million in cash and $30 million in five-year subordinated debentures. The price tag is more than 13 times Wessel's estimated 1998 earnings.

Rob Gales, head of equity trading at Wessels, cited a strong combination in research expertise as reason for the agreement. "Dain has a proven background in financial-services and energy research," Gales said. "Wessels has a strong research staff in technology, healthcare and consumer-product [sectors]."

He added that Wessels agreed to the merger to have access to Dain's network of 1,200 retail brokers. "I also think with our office in Palo Alto, Dain can make a push to expand in California," Gales said.

William A. Johnstone, Dain's vice chairman, and Wessel's Chief Executive Kenneth J. Wessels will lead the transition team.

Circuit Breakers

stock market price abstract

It would take a plunge of at least 20 percent, or roughly 800 points in the Dow Jones Industrial Average at current levels, to halt trading under new circuit-breaker rules adopted by the New York Stock Exchange. The rules are expected to be approved by the Securities and Exchange Commission. The current rules triggered the circuit breakers that shut down trading on Oct. 27 when the Dow sank 7.2 percent, or 554 points. Under the new proposal, that would not have happened because circuit breakers would be triggered at higher levels, based on the Dow, updated every three months. The triggers would first take effect on a ten-percent decline, closing the market for an hour before 2 p.m.; for 30 minutes by 2:30 p.m. Trading would resume in either case by 3 p.m. If a ten-percent decline occurred after 3 p.m., trading would not be halted.

The circuit breakers would next take effect when the Dow dropped 20 percent, closing trading for two hours before 1 p.m.; one hour before 2 p.m. The market would reopen by 3 p.m. If a 20-percent drop hit after 2 p.m., the market would close for the day. The market would also close for the day if the Dow dropped 30 percent.

Red Wrapper

On Tuesday, Feb. 10, the media-relations people at the New York Stock Exchange issued a press release that said Cleveland-based American Greetings will "wrap the New York Stock Exchange building with a giant, red ribbon to hail its transfer from Nasdaq."

Sure enough, on Feb. 11, the card and gift company wrapped the red flag around the hulking exchange and distributed 4,000 announcement cards, 1,500 pocket calendars and 500 boxes of chocolates throughout the morning at the corner of Broad Street and Wall Street. The press release was headlined, "American Greetings Wraps the NYSE as a Gift Celebration of Transfer from Nasdaq." Ouch.

A little triumphalist perhaps? "We wanted to make an interesting headline," responded a spokeswoman for the exchange. "The media does that kind of thing all the time." American Greetings is the fifth company to transfer to the Big Board from Nasdaq this year, coming on the heels of record transfers in 1997.

NASD May Give Traders Next Nasdaq’ Income: Ketchum: Limit-Order Book Should Be Designed to Benefi

The National Association of Securities Dealers may have a tough time convincing traders that its proposed integrated order-delivery and execution platform suits them. But one of the NASD's top officials, Rick Ketchum, is trying very hard.

"We're going to look at a means to pass on the execution-fee income of the book to the market makers themselves," said Ketchum, referring to the voluntary limit-order book and order-delivery system that would replace SOES and SelectNet. "We think the book should be designed in a way that's a benefit to the market makers."

Nasdaq Blueprint

In an interview at the NASD's Washington headquarters, and in follow-up telephone conversations, Ketchum laid out Nasdaq's blueprint for the proposed trading platform, originally dubbed Next Nasdaq, and boldly dismissed suggestions that the NASD is seeking competition with market makers. Aside from the commissions market makers could charge for executions via the limit-order book, Ketchum repeated that there could be profit-sharing arrangements in store.

"We don't want to design this in a way that it is competing against our members," said Ketchum, chief operating officer at the NASD. "[As the facilities processor] we want to pass through the execution-fee income to market makers who are stepping up and providing liquidity in the market." Ketchum did not elaborate, except to say the NASD is "tossing around" several ideas.

The proposed Nasdaq system's greatness, Ketchum continued, is that "investors can control their orders, and at the same time, market makers can have a central and unique place that encourages liquidity in the market. We'll never do anything to jeopardize that. We don't think the book does."

OptiMark

The original interview took on dramatic new life as soon as the NASD announced an agreement in principle between Nasdaq and OptiMark Technologies. The plan aims to integrate OptiMark with Nasdaq's trading platform and planned limit-order book.

Ketchum acknowledged, however, that plans for the limit-order book and the OptiMark plan are not foregone conclusions. "[OptiMark] is not a done deal," he said. "It is an agreement in principle."

Nevertheless, Kethum believed that a large group of NASD members supported the limit-order book, another large group opposed the book, and a third was sitting on the sidelines.

"Our main effort is going to be to get out there and answer their questions," Ketchum said. "We're continuing to look at a variety of questions with respect to our book, and we'll use the notice and comment period as a means to try to respond to legitimate concerns."

A prominent critic of the NASD's plan, Bernard L. Madoff, who chairs the Securities Industry Association's Trading Committee, contends that the current NASD proposal would create a system that competes with market makers.

Under an alternative plan proposed by the SIA Trading Committee, limit orders would come into Nasdaq and then be rerouted to market makers on a rotating basis. Nasdaq's limit-order book would serve as a fail-safe system, and display any limit orders market makers were unwilling to display. Market makers would receive a fee for putting the limit orders in their quotes.

Ketchum said the NASD is continuing talks with the SIA's Trading Committee, and will present the SIA's trading-platform proposal to Nasdaq's Quality of Markets Committee. That may just be a pro-forma move. "It is our judgment that the limit-order book provides the level of benefits to investors that justifies our moving forward," Ketchum said.

Conciliatory

Ketchum struck a conciliatory tone, singling Madoff for praise. Madoff has been "the most effective competitor to the New York Stock Exchange…in the history of listed trading," he said.

"Madoff and his firm are perfect examples of how market makers can provide value-added over a limit-order book, and why they will continue to flourish in this environment," Ketchum added.

The NASD does not envision significant costs for firms if the proposed Nasdaq trading platform is approved by the Securities and Exchange Commission. Current workstations would be used. The limit-order book would be called up as a separate page like any other electronic communications network when it appears on the screen.

"[Market makers] would be able to call it on a separate page, but they'll have to call it to get the whole book," Ketchum said. "That's a key difference in the limit-order book. It would disseminate all the limit orders, not just the top of the book. The order-routing and execution system again should be seamless, and dramatically reduce their exposure and difficulty in handling orders."

The NASD is hoping for final SEC approval by June, and to implement the proposed trading system, perhaps with OptiMark on board, by year's end.

Year 2000: SEC Is Playing Hardball

The Securities and Exchange Commission is putting pressure on mutual funds and investment advisers, as well as public companies, to state clearly how they are tackling the Year 2000 computer problem.

At issue are mounting concerns that computers, not adequately programmed, will interpret the standard two-digit year code 00 as Jan. 1, 1900, instead of Jan. 1, 2000, a flaw that could ultimately hurt investors.

The agency did not mince words in a Jan. 12 staff bulletin, stating its case for Year 2000 disclosure. With that bold move, it may now be pointless for Sen. Robert Bennett (R-Utah) to press ahead with legislation he introduced earlier, requiring extensive disclosure of companies' Year 2000 compliance plans

Nevertheless, Bennett, who nicknamed his legislation Crash, quickly seized upon the SEC's bulletin and praised "[SEC] Chairman Arthur Levitt for his leadership and courage in taking this initiative. The information I will receive from reviewing the results of this new bulletin will be very valuable in determining how to proceed with my own legislation."

The SEC bulletin states that for any company that "has not made an assessment of its Year 2000 issues, or has not determined whether it has material Year 2000 issues, the staff believes that disclosure of this known uncertainty is required.

"The determination as to whether a company's Year 2000 issues should be disclosed should be based on whether the Year 2000 issues are material to a company's business, operations or financial condition, without regard to related countervailing circumstances (such as Year 2000 remediation programs or contingency plans)."

The Year 2000 problem is likely to preoccupy Washington as the new millennium draws near. For investors, the impact of massive Year 2000 computer glitches are almost too frightening to contemplate.

"Just suppose a company runs up against a sudden outlay, perhaps a big balloon expenditure in 2000," explained a government official familiar with the problem. "Instead of earning 4 cents per share, for example, the investor could wind up with a 6 cents per share loss. Investors are relying on companies to know what they are doing."

Bennett, chairman of the Senate Financial Services and Technology Subcommittee, held a series of hearings on the subject last year, and in November introduced the Computer Remediation and Shareholder Protection Act.

"The Year 2000 problem lies at the heart of our economy," said Bennett. Investors, he added, deserve to know companies are responding to the Year 2000 challenge.

Bennett's bill would mandate the SEC to amend its disclosure regulations and require companies to disclose a wealth of information about Year 2000 compliance. Specifically, they would have to provide a detailed description of their progress in Year 2000 remediation; a statement of likely litigation costs and liability outlays associated with the defense of possible lawsuits; disclosure of insurance coverage for computer failures and related lawsuits filed by investors; and a breakdown of contingency plans for computer failure.

This is the second time in recent months that an influential Republican senator has attempted, in effect, to legislate a top-level agency's rule-making authority. Sen. Lauch Faircloth (R-N.C.) blunted the Federal Accounting Standard Board's proposed rules on derivatives, prompting a top SEC official to privately complain that Faircloth should have stayed clear of that controversy.

The SEC official believes Bennett's Year 2000 legislation was out of step with reality. "You usually don't have new rules for every topical problem. The revised bulletin simply tries to make clearer what is already on the books," the official said.

Meanwhile, the Security Industry Association's board of directors supports a proposal to declare Friday, Dec. 31, 1999, a trading holiday in order to complete as much year-end processing as possible before 2000 begins.

Mixed Reviews for Labor Soft-Dollar Report

A ten-member panel, created last year by a U.S. Department of Labor advisory body to review the soft-dollar business, has received mixed reviews.

The panel, set up under the auspices of the 1997 ERISA Advisory Council on Employee Welfare and Pension Benefit Plans, recommended that Labor and the Securities and Exchange Commission make some statutory and regulatory changes.

ERISA, or the Employee Retirement Income Security Act, enacted in 1974, sets minimum standards for private-sector pension plans.

Fees

Specifically, Labor was urged to require plan sponsors to report all fees above $5,000 paid for with directed brokerage. Plan sponsors would also be required to certify that they are complying with the existing requirements of ERISA Technical Release 86-1 in directed-brokerage programs.

Labor was asked to recommend to the SEC that the Section 28(e) definition of research be changed, and that it prepare a list of which brokerage and research services are acceptable purchases with soft dollars. Investment managers would be required to provide clients with full disclosure of all trades for each client involving soft dollars, and the benefits investment managers receive from those rebates. They would also be required to detail their policies involving soft dollars.

In addition, disclosure of external research provided to investment managers would be required.

Howard Schwartz, chairman and chief executive of New York-based Lynch, Jones & Ryan, an institutional brokerage firm, said he was "very pleased that the soft-dollar and commission-recapture business which [Labor] has said fosters brokerage-industry competition and ultimately benefits individual pension-plan investors is moving toward self regulation."

The report is "very much in line" with the Securities Industry Association's new best-practices guidelines for soft dollars and other commission arrangements, added Schwartz, who is chairman of the SIA's Soft-Dollar Committee. Schwartz testified before the Labor panel, representing the SIA.

But another industry official, requesting anonymity, was not impressed with the soft-dollar report. "It is unworkable and not well thought out. I don't believe the SEC engages in substantive-type regulation. How do you determine whether Bloomberg is an acceptable research product and fails the test?," asked the official. "People were expecting the production of a credible report, but it is too vague, too general."

Main Concern

The panel's main concern was whether plan fiduciaries have sufficient guidance to properly administer their pension plans in compliance with ERISA's fiduciary requirements. The panel was given a mandate to study the need for regulatory changes or additional disclosure to pension-plan sponsors and fiduciaries on soft-dollar and directed-brokerage practices.

One soft-dollar expert thinks the panel's recommendation could have a far-reaching impact. "If they [the recommendations] are carried out, they will have some significant impact on business," said Lee Pickard, a Washington-based attorney and counsel to The Alliance in Support of Independent Research. A paper written by Pickard, "The Provisions of Investment Services by Broker-Dealers: A Guide to Soft-Dollar Practices," was submitted to the panel for review.

New Soft-Dollar Standards Proposed

The Association for Investment Management and Research (AIMR), a Charlottesville, Va.-based non-profit trade group, has released a proposed set of soft-dollar standards for its buy-side members.

The standards, developed by a blue-ribbon task force of industry leaders convened by the trade group, are open to public comment until Feb. 28.

Understanding

These standards include the creation of a common understanding of soft-dollar issues by providing definitions of major terms; and requirements that the content of research purchased with client brokerage directly assist an investment manager in his decision-making processing, and not in the management of the firm.

Also included in the standards are a clarification of an investment manager's responsibility to justify the use of client knowledge to pay for a portion of mixed-use products.

Disclose

The standards require AIMR members to disclose certain information with regard to soft dollar practices; uniform record keeping; and clarification of an investment manager's real and fiduciary responsibilities to his client, including the client-directed brokerage area.

These responsibilities cover the client-directed brokerage area.

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