Report Mildly Critical of NASD, Calls for Changes : Securities: Nasdaq governing board votes to adopt many Rudman Committee recommendations.

A committee appointed to examine alleged deficiencies in the Nasdaq Stock Market only mildly criticized the market and its parent body, even as it called for a radical restructuring of the organization and greatly stepped up enforcement of rules.

The report of the Rudman Committee, released Tuesday, as expected called for putting a majority of public members on the board of the National Assn. of Securities Dealers, Nasdaq’s parent. The 26-member board is currently dominated by representatives from big brokerage firms.

It also called for creating two semi-autonomous subsidiaries, one to operate the Nasdaq Stock Market and another to enforce rules and carry out disciplinary proceedings. Half the board members of the two new units would also be drawn from the public. However, the committee rejected a call by several critics to completely divorce Nasdaq from its parent organization. It called such a move undesirable, in part because it might deprive Nasdaq of “industry expertise.”

The NASD’s board of governors on Monday voted to adopt general principles it spelled out, including turning over its seats to a majority of public members. NASD Chief Executive Joseph Hardiman said the board will meet again in November to act on the specific recommendations. He indicated that it will probably adopt most of them, but left open the possibility that some will be changed or rejected.

In a Washington news conference, Hardiman lauded the report and called it “a historic review of the NASD’s governance.”

The seven-member committee, led by former Sen. Warren Rudman, was appointed by the NASD’s board last November, under strong prodding from the Securities and Exchange Commission. It followed a series in The Times, the launching of federal investigations and criticism by a wide range of investors’ groups that violations of trading rules on Nasdaq were rampant, and that the NASD was biased against public investors in favor of the big brokerage firms that dominated its board.

However, the report, for the most part, contained only mild criticism of the NASD’s record, and said the data the committee reviewed does not “support the proposition that the NASD systematically shuts its eyes to certain trading violations.”

And although it calls for a major overhaul of Nasdaq’s disciplinary system to make it fairer, it concluded that the current system “works well, albeit not perfectly, and is not deliberately biased.”

Instead, the committee said the major changes are needed to help the NASD adapt to the recent explosive growth of trading on Nasdaq, where average daily volume now exceeds that of the New York Stock Exchange. The NASD “has failed to keep pace with the significant growth and continuing evolution of the Nasdaq market,” the report said.

Two federal agencies--the SEC and the Justice Department’s antitrust division--are investigating Nasdaq and its dealers, and are expected to take action, probably by year’s end. By issuing the Rudman report and adopting changes before the investigations are finished, the NASD runs the risk of being forced to take different or stronger steps later by the federal agencies.

However, Hardiman dismissed suggestions that the NASD should wait, and contended that the subjects of the federal investigations are far narrower than those raised in the Rudman report. He predicted that “this report will long outlast the SEC and Department of Justice investigations.”

The SEC on Tuesday issued what appeared to be a tepid reaction to the report. The statement said greater public representation on Nasdaq’s board is “among the issues of principal concern” to the SEC.

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The Rudman Committee was not allowed to address a major issue being investigated by the Justice Department: allegations, strongly denied by the NASD, that dealers colluded to increase their profit margins on buying and selling Nasdaq stocks.

Although billed as an independent committee, a number of Rudman Committee members have close ties to the NASD and dealer firms, Nasdaq critics have said. Two of the committee’s members are associated with law firms that represent large Nasdaq dealers in private lawsuits and the federal investigations, including Rudman and A.A. Sommer Jr., who also is currently vice chairman of the NASD’s board. Another committee member, Stephen L. Hammerman, is vice chairman of Merrill Lynch & Co., a major Nasdaq dealer firm. Rudman and Sommer have denied that their law firm affiliations created any conflict of interest.

By putting a majority of public members on the NASD’s board, the move would take the NASD one step further than stock exchanges such as the NYSE and American Stock Exchange, whose boards have 50% public membership. Currently, only five members of the NASD’s 26-member board are public representatives. The overhaul would give NASD a new nine-member board.

The proposal to create two semi-autonomous bodies under the NASD stems from criticism that the NASD had conflicting missions of promoting and operating the Nasdaq market at the same time it was supposed to regulate it and its dealers. Under the plan, one subsidiary would be the Nasdaq market. The other would be a newly created entity, to be called NASD Regulation, which would have responsibility for enforcing rules, inspecting the books of brokerage and dealer firms, and carrying out disciplinary investigations.

However, not all disciplinary roles would be taken away from the Nasdaq market, leaving open some questions about how independent regulation of the market would evolve.

Alleged lax enforcement of these trading rules, including ones that ban late reporting of trades and failing to honor quoted prices, led to complaints against Nasdaq.

Rudman also said the NASD needs to “significantly increase resources dedicated to enforcement and discipline.” Some of the sharpest criticism in the report dealt with the NASD’s oversight of regional enforcement actions, which it called “moribund.”

It also called for greatly increased inspections of brokerage firms offices and records for rule violations.