"PROFESSIONAL STANDARDS: THE NEXT COMPETITIVE FRONTIER" REMARKS BY CHAIRMAN ARTHUR LEVITT UNITED STATES SECURITIES AND EXCHANGE COMMISSION NEW YORK STOCK EXCHANGE ETHICS CONFERENCE NEW YORK, NEW YORK FEBRUARY 9, 1995 We've had some outstanding discussions this morning -- and that's all the more admirable because of the difficult subject. To speak frankly about ethics is to risk sounding sanctimonious. A predecessor of mine had a clever way of getting around that: Joseph Kennedy, Sr., the first Chairman of the SEC, used to say that, had the Commission existed just ten years earlier, he might never have become a millionaire. He was kidding, of course. The truth is, no one has a monopoly on morality. As long as we remember that, then we can reason together about standards of excellence, as we have today. I thought I might close the day's discussion with a few words about why we believe it's critical to raise professional standards, where our various initiatives stand now, and the vital role you play in that process. The Commission's renewed emphasis on ethics is the result of two factors that converged during the 1990s. First, the financial profile of our nation is changing. In 1993, we crossed an important threshold: for the first time in history, investment company assets surpassed commercial bank deposits. The decline in interest rates from 1991 to 1993 helped transform us from a nation of savers to a nation of investors. One out of three American families now holds an investment in mutual funds or the stock market. While this huge influx of new investors is surely a healthy development for our markets, a lot of those people are just not as informed as they should be. That's the first problem. The second problem is the abysmally low level of confidence in the industry. People have come into the marketplace for many reasons -- low interest rates, an expanding economy, the demise of defined benefit pension plans -- but faith in registered representatives doesn't seem to be one of them. Public opinion surveys consistently show that of all professionals, lawyers, lobbyists, and brokers are among the least trusted. We in this room know that there are valid reasons why some Americans don't trust brokers. Now I'll grant that the extent of the problem has certainly been exaggerated. But we all recognize that, even though bad brokers are a minority, they inflict disproportionate damage on the reputation of the entire profession. We also know that the front line of defense against them is not the SEC, but rather YOU, the compliance officers and general counsels of the firms. The SEC is not the KGB of capitalism; we can't pre-screen and approve brokers -- only firms can do that. And in our day- to-day policing of the industry, we've found that some firms are much better at maintaining high standards than others. This shows that the tone set at the top can make a real difference. That's a crucial insight: Brokers don't set company standards; FIRMS do. And you are the guardians of those standards. This is not the type of task that wins popularity contests. Team spirit is a wonderful thing. But it can lead people to subordinate personal judgements to those of the group. That's where compliance officers play an absolutely critical role. In many cases, it falls to YOU to serve as the company conscience. We at the Commission know what it's like to be vilified for trying to maintain a fair and orderly market. But we're not affiliated with any firm -- you are, and it's a lot harder to stand apart from the team when you're a member of it. But stand apart you must. How else is a firm to know when a judgement is wrong, or a standard too low, unless someone with a clear sense of right and wrong has the courage to question it? Thirty years ago, it was common to curry favor with New York City policemen by offering them "gifts." One officer couldn't accept the system; his efforts succeeded in raising law enforcement standards in New York and throughout the nation. Not every question is that clear-cut. You are in a position to define standards for your companies. The SEC is working to create an atmosphere that empowers you -- we're trying to encourage a sales culture that makes the right choices. The path to that better culture starts with management and supervision, and leads directly through your office. The Commission has stressed its belief that many cases of investor fraud, if not most, really constitute TWO failures -- that of the broker, and that of his supervisor. In every case where we find bad practices, we now ask: "Where was the supervisor? How did he let this happen?" And we expect firms to do the same when THEY find evidence of wrongdoing. It's up to managers to create a culture in which dishonesty is not tolerated; in which mistakes, once made, are quickly 'fessed up; in which the long view prevails over short- sightedness, and the high road is taken over the low. I've spent a lifetime in and around the industry. I've been a broker, a manager, and I've run a large firm. We all know that there's a fine line between good sales practices and poor sales practices. The problem is that too many people SKIRT that line - - and frankly, some managers and firms create a sales culture that pushes brokers right up to it. We want to exert an equal or greater force that will push brokers and managers away from that line. We want professional standards set far to the north of questionable behavior. And we've been working hard to achieve that. Last year, the SEC staff recommended increased sanctions in sales practice matters; the Commission is now turning down settlement offers it might have accepted a year ago, and SRO fines have increased. We're working to improve the CRD, for both investors and the industry. We're encouraging firms to scrutinize a broker's background BEFORE they hire. We've called for better broker-dealer compliance systems for identifying problem brokers. Some firms have already developed sophisticated computer systems that flag possible instances of churning, or suitability infractions. We'll continue to encourage this kind of effort. We've restored meaning to the term "unqualified bar," and we have notified the SROs that any broker applying to the SEC for re-entry into the industry after an unqualified bar can expect the administrative equivalent of climbing Mt. Everest. There's one key issue on which we haven't yet made significant headway -- that of offering qualified immunity to firms on form U-5. Hardly a day goes by without a reminder of the importance of this issue --like the article in the Wall Street Journal last week which observed that "Brokers can move from firm to firm with impunity." The president of a firm went on to say, "The problem is, on Wall Street, the brokerage firm that has an employee terminated [is] scared to death to give the real reason." It's a complex issue. But I assure you today that we intend to address it -- whether it requires an SRO or SEC rule, or an act of Congress, we will continue to seek an environment in which firms are not penalized for honesty on Form U-5. For until firms are comfortable enough to be candid, the "Wild West" image of Wall Street will continue to plague us all. The things I've mentioned so far -- stronger sanctions, more examinations, better compliance systems, qualified immunity on U- 5 -- are all in the best regulatory and enforcement tradition. So, too, is our second joint sweep of the industry with the SROs and state regulators, which has already begun. But there's a limit to what rules can do. We'll regulate where warranted -- but many of the areas we need to address are grey, not black and white, and don't lend themselves easily to rulemaking. That's where you can make a huge difference. We'd like to see a sales culture that considers our rules merely a starting point -- a culture in which we enforce the MINIMUM standard of behavior, while you enforce the HIGHEST -- a culture in which BEST practice becomes COMMON practice. Take the question of compensation. We all know that product-specific sales contests, up-front money, extra compensation for proprietary products, and similar practices can sometimes foster conflicts of interest between brokers and clients. There's lots of room for improvement there. An industry-led Compensation Practices Committee has spent the better part of the last year identifying best practices, and they will report their findings in the next few weeks. Since it's not the place of the SEC to decide how people ought to be paid, that report will be directed more to YOU than to me. I ask you to circulate the Committee Report on Best Practices widely and read it thoroughly; compare their findings with your firm's practices; and be the gadfly, the catalyst, the agent of change within your firms. Recently, Prudential decided to join the trend and eliminate extra compensation for the sale of proprietary products. I hope all of you will take this opportunity to review your own firms' compensation systems, with an eye toward keeping the investor's interests first -- ahead of the broker's, and ahead of the firm's. Education offers another avenue of approach to higher professional standards. As many of you know, yesterday the SEC reached a milestone in broker education. After much work, and much cooperation between the industry and its regulators, we have now approved a rule that for the first time will require continuing education for brokers. I've long believed that in a field as dynamic as securities, investors are best served by a brokerage force that is continually educated about products, ethics, and regulations. An astonishing 83 percent of registered representatives have been in the business for LESS THAN 10 YEARS -- they haven't even been through a bear market yet. If we can reach them with education this early in their tenure, we have a chance to make this a better industry for many years to come. The new program requires brokers to go to the NASD's proctor centers on the 2nd, 5th, and 10th anniversaries of their registration and sit for three and a half hours of training. The curriculum has two parts: the Regulatory Element, featuring state-of-the-art, computer-based instruction about compliance, regulatory, and ethical issues as well as sales practices; and the Firm Element, which will include firm-specific products and practices. All registered representatives who deal with the public will participate -- or have their license deemed inactive. I applaud the Council on Continuing Education for taking an important first step toward raising educational standards in the industry. But I also stress that at this stage, the real impact of their work depends less on the Council than on YOU. It's within your power to make the Firm Element either meaningful or meaningless. I've talked a lot about the responsibilities of firms -- but none of that absolves investors of THEIR responsibility. For every speech that I've made to brokers about their obligations to investors, I've made two to investors about holding up THEIR end of the bargain by becoming better informed. I'm telling people it takes a lot of work to be an investor; a lot of research; and a lot of time. I've known people to spend more time comparison shopping for paper towels than for investments -- there's absolutely no excuse for that. It's been said that the SEC can prevent someone from making a fool of you -- but NO ONE can prevent you from making a fool of YOURSELF. There's a lot of truth in that. That's why the Commission has undertaken an investor education campaign. We've held town hall meetings across the nation; we've published and distributed brochures; we've appeared on television and radio; we've developed a toll-free information line; we're even on the Internet. We want people to understand the market -- to know what questions to ask, and to ASK them. We also believe that educated investors will join us in demanding higher professional standards from the industry. This is a new approach for the SEC, which has usually promoted change in our markets from the top down, by passing rules. It's our feeling that regulation can be a blunt instrument, with unintended consequences. Wall Street is a free market, and we prefer to use market forces. By taking our case right to the people most affected -- individual investors -- we feel we will be able to influence market behavior "from the bottom up," so to speak. I hope I've shed some light on our efforts to raise professional standards. We know you support that goal, and we want to make it easier for you to work toward achieving it. I have a sense of how difficult your position can be -- your often lone voice; the sometimes conflicting loyalties. But we've got to make it clear that no one stands to gain more from high standards than the firms themselves. The past year has seen a sharp decline in profitability, almost across the board. It's a time for special vigilance -- a time when the unbridled culture of sell-sell-sell, and a compensation structure that worships gross commissions, can push brokers across the line. Competition is intense. In such an environment, firms with high standards and steadfast integrity have a competitive edge -- and indeed many have already recognized professional standards as a legitimate frontier for competition. I've tried to foster this by publicly recognizing firms with good practices, and I welcome you to share the practices you're proudest of -- I'd like to help you call attention to them. There will, of course, be instances when your firms do NOT recognize their self-interest in higher standards. In those cases, I ask you to remember your other constituency -- one that extends far beyond the confines of your company. Every time you stand up for what's right, even if you think you may be alone, millions of investors stand with you. What's more, the SEC stands with you. Some of our greatest hopes for the industry lie in your hands. The actions you take, and the standards you set, have an impact far beyond any individual company. The millions of Americans who invest in the market are counting on you and me to maintain high standards. That's a tremendous show of faith. We must KEEP that faith -- in the years ahead as in years past. # # #