Regulatory Agency for Brokers Prepares to Leave the Stone Age
To protect stock market investors from swindlers, regulators need basic information: Which brokers are drawing the most, and worst, complaints from investors around the country?
Even in this age of powerful computers, there’s been no quick way to find such facts. The national database of stockbrokers’ work histories and disciplinary records is so antiquated that it can’t produce reports zeroing in on the most troublesome brokers and firms.
But that is about to change. The National Assn. of Securities Dealers--the industry organization that manages the stockbroker database for its own regulators and for government regulators around the country--is introducing a modernized system next month.
For the NASD, which has quasi-governmental authority to help police much of the investment business, the launch of its new system is a landmark event. Long ridiculed for its ineptitude as a cop on the securities industry beat, the NASD is spending big money on technology as part of its effort to shape up its regulatory operations.
Along with the new database, the group’s arsenal of modern regulatory technology includes an artificial intelligence system designed to detect stock-trading irregularities such as price-fixing by dealers. Known as the Advanced Detection System, it reviews the nearly 3 million price quotes and transactions in the over-the-counter markets every day.
The NASD has also developed such tools as NetWatcher, a search engine that monitors targeted investment Web sites, message groups and chat rooms to make sure scam artists are not using them to manipulate stocks.
NASD officials say the new technology is crucial for tracking booming stock market trading and for coping with the inevitable limits on regulators’ staff sizes.
“The answer is not always to add more bodies, but to get more from the critical mass we have in place,” said Frank G. Zarb, the NASD’s chairman and chief executive.
The technology budget for the organization’s NASD Regulation unit has climbed from $30 million to $44.7 million in the last three years. What’s more, the NASD parent organization in June cut a 10-year deal valued at up to $2 billion with Electronic Data Systems Corp. to help maintain computer systems and develop software, mainly for regulatory purposes.
Today, the NASD “is unique in the world. There’s not another regulatory entity that spends anywhere near the kind of dollars we do on technology,” said Mary L. Schapiro, president of the NASD Regulation unit.
Even so, some skeptics still question whether the organization is hiring enough staff to fully exploit the new technology and to keep improving the NASD’s regulatory performance.
The new technology, moreover, doesn’t always work as intended. For instance, the artificial intelligence system for detecting trading irregularities came up short in several tests by an independent consultant last year.
Zarb acknowledges, too, that the NASD’s technology doesn’t so much put it on the cutting edge of technology as it simply helps the organization catch up to the bristling technologies of the firms it regulates.
Zarb, former chief executive of Wall Street firm Smith Barney, said that when he took the helm of the NASD in 1997, the “member firms’ technology was far more advanced than the regulators’.”
Probably nothing reflects the NASD’s commitment to improved regulatory technology more than the development of the new stockbroker database.
“It’s like moving from the Stone Age. The old system was developed in 1984, and in computer years that’s eons,” said Maurice Cox, the California official who supervises the state’s broker approval program. “Provided that it works well, it’s going to be a great system.”
The database logs everything from brokers’ bankruptcy filings--a broke broker, the theory goes, might be tempted to raid customers’ accounts or “churn” them for extra commissions--to professional sanctions by NASD, state or federal authorities.
Back in 1992, a redesign of the old database--called the Central Registration Depository, or CRD--was launched. But less than a year after Schapiro arrived at NASD Regulation in February 1996--and after millions already had been spent on the almost-completed CRD redesign--she halted the work.
Schapiro had concluded that the project had a fundamental flaw that already rendered it out of date: It wasn’t designed to operate on the Internet’s World Wide Web.
As a practical matter, that meant that too few regulators would be able to use the system.
On top of that, there was no way to provide direct public access to CRD disciplinary information, a goal now supported by NASD officials.
Schapiro’s decision to scrap the original plan and instead start developing a Web-based system, now dubbed Web CRD, delayed completion of the project by a couple of years and added millions in expenses, bringing the overall cost to an estimated $50 million.
But her decision has been validated by the enormous growth in use of the Web by businesses, government and consumers.
One of the principal benefits of the new system will be its vastly improved ability to automatically alert state securities commissioners when brokers licensed in their states get new blemishes on their records. That’s important because state officials often are far more aggressive than the NASD itself in barring brokers with disciplinary problems.
Even so, state officials until now typically have reviewed brokers’ CRD records only when they apply for new licenses. That normally occurs when a broker switches firms or applies to do business in the state for the first time.
As a result, brokers who stay in their current jobs, even if they are the target of numerous investor complaints and arbitration claims, commonly escape the notice of state authorities for years.
That has long meant that there was “no way for me to know whether someone I licensed last week, who had a totally clean record then, had multiple new disciplinary events the day after I licensed him or her. There’s no effective notification and no monitoring system,” said Maine Securities Administrator Christine A. Bruenn, who heads a committee of state officials working with the NASD on the CRD project.
But the new Web CRD system, Bruenn said, will enable her staff to monitor important developments in a shady broker’s career.
In broker-rich California, the improved filtering and alert capabilities may be even more critical.
Cox, a supervising examiner with the Securities Regulation Division of the California Corporations Department, said that during May alone, nearly 5,997 brokers from across the country submitted applications to do business in California. Nearly 5,300 of them received automatic approvals because they had no disciplinary actions on their records.
The other 700 candidates had problems ranging from minor to serious marks on their records.
With Web CRD, Cox said, his staff will be able to instantly distinguish those candidates with the most worrisome disciplinary problems, rather than spending time evaluating everyone with any kind of blemish.
Eventually, investors interested in scrutinizing their current or prospective brokers are expected to gain direct access to certain disciplinary records via a public Web site hosted by the NASD.
That plan, however, is on hold until Congress passes legislation giving the NASD the same protection against defamation lawsuits for material it posts on the proposed Web site that it already has for other written correspondence.
In the meantime, CRD disciplinary information can be requested via phone or e-mail from the NASD or state authorities, whose policies commonly allow them to release more details.
Coming Tuesday: Although the NASD has made some improvements in its arbitration system, critics say it is still too hard for investors to collect from brokers who have cheated them.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Cost of Regulation
The National Assn. of Securities Dealers’ efforts to improve its policing of the securities industry have relied increasingly on new technology. Since 1996, when the association set up its NASD Regulation Inc. unit to handle regulatory matters, spending on technology has climbed.
NASD spending on technology
In millions
1996*: $30
1997: $41.9
1998: $41.7
1999**: $44.7
*Estimate
**Budgeted amount
Source: NASD Regulation
