Taking Stock: Insuring Securities Broker/Dealers

Taking Stock:Taking Stock:

InsuringInsuring

Securities Broker/DealersSecurities Broker/Dealers

in the New Millenniumin the New Millennium

Percentage of American Households Percentage of American Households with Stock Market Investmentswith Stock Market Investments

C. Conda & D. Clifton, National Review, 10/18/06

53%

17%

1981 2006

Percentage of American Investors Who Percentage of American Investors Who Purchase Mutual Funds through Purchase Mutual Funds through

Financial ProfessionalsFinancial Professionals

USA Today, 3/23/05

65%

59%

1995 2003

Percentage of Mutual Funds Percentage of Mutual Funds Purchased Directly from Fund Purchased Directly from Fund

CompanyCompany

USA Today, 3/23/05

21%

13%

1995 2003

INCREASING IMPORTANCEINCREASING IMPORTANCEOF FINANCIAL OF FINANCIAL

PROFESSIONALSPROFESSIONALS

71% of stock investors rely on 71% of stock investors rely on professional advice in choosing their professional advice in choosing their

investmentsinvestments

Comparison of Market Performance to Comparison of Market Performance to # of Cases Filed# of Cases Filed

Dow Jones, S&P 500 and NASDAQ (10/91 – 10/06)

NASD Arbitrations Filed by Year

0

2,000

4,000

6,000

8,000

10,000

Year

Ca

se

s f

ile

d

NASD Statistics per website

Controversies Involved Controversies Involved in Arbitration Casesin Arbitration Cases


0

1000

2000

3000

4000

5000

6000

2002 2003 2004 2005 Sep-06

Year

Ty

pe

of

Co

ntr

ov

ers

y Margin Calls

Churning

Unauthorized Trading

Failure to Supervise

Negligence

Omission of Facts

Breach of Contract

Breach of Fiduciary Duty

Unsuitability

Misrepresentation

Online Trading

Security Types Involved Security Types Involved in Arbitration Casesin Arbitration Cases

*Certificates of Deposit were first tracked in January 2001.


0

500

1000

1500

2000

2500

3000

3500

4000

4500

2002 2003 2004 2005 Sep-06

Year

Typ

e o

f S

ecu

rity

Corporate Bonds

Certificates of Deposit*

Mutual Funds

Options

Common Stock

Limited Partnerships

Annuities

How Arbitration Cases CloseHow Arbitration Cases Close


0%

10%

20%

30%

40%

50%

60%

2002 2003 2004 2005 Sep-06

Cases Decided by Arbitration

Pe

rce

nta

ge

of

Ca

se

s

After Hearing

After Review ofDocuments

Direct Settlement byParties

Settled Via Mediation

Withdrawn

All Others*

*All Other reasons for closed includes cases closed by: Stipulated Award, Bankruptcy of critical party; Uncured Deficient Claim; Forum Denied; Stayed by Court Action, etc. Note cases counted as closed in this report do not include those cases that closed and were then reopened.

Percentage of Customer Awards Percentage of Customer Awards in Arbitrations by Yearin Arbitrations by Year


0

10

20

30

40

50

60

2000 2001 2002 2003 2004 2005

Year

Pe

rce

nta

ge

of

Ca

se

s

Note: Percentage of customer claimant award cases has been recalculated to reflect only instances in which investors as claimants recovered monetary damages or non-monetary relief.

SECURITIESSECURITIES EXCHANGE EXCHANGE COMMISSIONCOMMISSION

Primary Overseer/Regulator of U.S. Primary Overseer/Regulator of U.S. Securities MarketsSecurities Markets

Oversees Self-Regulatory Organizations Oversees Self-Regulatory Organizations (NASD, Stock Exchanges, etc.)(NASD, Stock Exchanges, etc.)

Authority includes Enforcement Actions Authority includes Enforcement Actions against b/d’s and individuals for violations against b/d’s and individuals for violations of securities lawsof securities laws

NASDNASD

World’s largest private-sector regulator of World’s largest private-sector regulator of financial servicesfinancial services

Registers securities firmsRegisters securities firms

Writes rulesWrites rules

Examines for complianceExamines for compliance

Brings enforcement actionsBrings enforcement actions

NASD Notices to MembersNASD Notices to Members

Provide notice of recently approved rules Provide notice of recently approved rules & rule amendments& rule amendments

Solicit comment on proposed Solicit comment on proposed rules/amendmentsrules/amendments

Legal interpretation & compliance Legal interpretation & compliance guidelinesguidelines

Central Registration Depository Central Registration Depository (CRD)(CRD)

Central licensing and registration system Central licensing and registration system for U.S. securities industryfor U.S. securities industry

Contains records of more than Contains records of more than 6,8006,800 b/d’s b/d’s and and 660,000660,000 registered individuals registered individuals

Registration, Testing & Registration, Testing & QualificationsQualifications

2 levels of qualification/registration2 levels of qualification/registration

Registered representativesRegistered representatives

PrincipalsPrincipals

Series 6Series 6

Investment Company/Variable Contracts RepresentativeInvestment Company/Variable Contracts Representative

Authorized to sell only investment company products (e.g., Authorized to sell only investment company products (e.g., mutual funds and money-market funds) and variable mutual funds and money-market funds) and variable annuities annuities

Series 7Series 7

General Securities RepresentativeGeneral Securities Representative

Entitled to sell all types of securities products, with the Entitled to sell all types of securities products, with the exception of commodities futures (which require a Series 3 exception of commodities futures (which require a Series 3 license).license).

TYPES OF LICENSESTYPES OF LICENSES

Series 24Series 24

General Securities PrincipalGeneral Securities Principal

This would entitle the holder to supervise trades involving This would entitle the holder to supervise trades involving corporate securities, direct participation programs (DPP’s) corporate securities, direct participation programs (DPP’s) and investment company/variable contracts.and investment company/variable contracts.

Series 63Series 63

Uniform Securities AgentUniform Securities Agent

Qualifies candidates to sell securities and give investment Qualifies candidates to sell securities and give investment advice in those states that require Series 63 registrationadvice in those states that require Series 63 registration

TYPES OF LICENSESTYPES OF LICENSES(cont.)(cont.)

OTHER CERTIFICATIONSOTHER CERTIFICATIONS//DESIGNATIONSDESIGNATIONS

RIA (Registered Investment Advisor)RIA (Registered Investment Advisor)

CFP (Certified Financial Planner)CFP (Certified Financial Planner)

CLU (Certified Life Underwriter)CLU (Certified Life Underwriter)

BROKER FEES:BROKER FEES:FIXEDFIXED V. COMMISSIONV. COMMISSION

Fee-Based v. Commission per TradeFee-Based v. Commission per Trade

Conflicts in each?Conflicts in each?

THE “MERRILL RULE:”THE “MERRILL RULE:”Tempest in a Teapot?Tempest in a Teapot?

SEC Rule passed in April 2005SEC Rule passed in April 2005

Allows b/d’s to offer fee-based accounts Allows b/d’s to offer fee-based accounts without registering as Investment Advisors without registering as Investment Advisors as long as advice is “incidental” to as long as advice is “incidental” to Brokerage ServicesBrokerage Services

Broker Prohibited ConductBroker Prohibited Conduct

Recommending unsuitable investments Recommending unsuitable investments

Unauthorized tradingUnauthorized trading

““Churning” (Excessive trading to increase Churning” (Excessive trading to increase commissions)commissions)

““Switching”/Break Point Sales Switching”/Break Point Sales

Broker Prohibited ConductBroker Prohibited Conduct(cont.)(cont.)

Misrepresenting or failing to disclose material Misrepresenting or failing to disclose material factsfacts

Conflict of interestConflict of interest

Guaranteeing there will be no monetary loss, Guaranteeing there will be no monetary loss, making price predictions or agreeing to share making price predictions or agreeing to share in lossesin losses


Purchasing/selling security while Purchasing/selling security while possessing material, non-public possessing material, non-public informationinformation

“ “Selling away”Selling away”

Using manipulative, deceptive or Using manipulative, deceptive or fraudulent device affecting transactionfraudulent device affecting transaction


Conducting private securities Conducting private securities transactions/sharing accountstransactions/sharing accounts

““Front running”Front running”

Failing to use reasonable diligence to ensure Failing to use reasonable diligence to ensure order is executed at best possible priceorder is executed at best possible price

FAILURE TO SUPERVISEFAILURE TO SUPERVISE

Principal can be liable for actions of broker Principal can be liable for actions of broker who engages in prohibited conduct if who engages in prohibited conduct if principal “failed to properly supervise” the principal “failed to properly supervise” the brokerbroker

NASD ARBITRATIONNASD ARBITRATION

All industry disputes (member v. member, All industry disputes (member v. member, member v. registered rep., etc.) are member v. registered rep., etc.) are subject to mandatory arbitration (except subject to mandatory arbitration (except employment discrimination claimsemployment discrimination claims

Customer disputes subject to mandatory Customer disputes subject to mandatory arbitration arbitration only ifonly if there is a signed, there is a signed, enforceable arb. agreementenforceable arb. agreement

NASD ArbitrationNASD Arbitration(cont.)(cont.)

NASD Code of Arbitration Procedure sets NASD Code of Arbitration Procedure sets rules/proceduresrules/procedures

Up to Up to 6 years6 years to file Claim to file Claim

Initiated by filing Statement of ClaimInitiated by filing Statement of Claim

NASD ArbitrationNASD Arbitration(cont.)(cont.)

1 or 3 Arbitrators (depending on amt in 1 or 3 Arbitrators (depending on amt in controversy)controversy)

Minimal Discovery (no depos, etc.)Minimal Discovery (no depos, etc.)

FINAL AWARD IS NOT APPEALABLE FINAL AWARD IS NOT APPEALABLE (absent evidence of fraud, etc.)(absent evidence of fraud, etc.)

Looking Ahead:Looking Ahead:Evaluating B/D Risk in the New Evaluating B/D Risk in the New

CenturyCentury

““DOW 12,000”: Another Bust Coming?DOW 12,000”: Another Bust Coming?

““Alternative Investments:” The Next Tech Alternative Investments:” The Next Tech Market?Market?

Increased Regulation = Decreased Risk? Increased Regulation = Decreased Risk?

Taking Stock: Insuring Securities Broker/Dealers

Economy & Finance

Transcript of Taking Stock: Insuring Securities Broker/Dealers