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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks at the NASD
Spring Conference

by Richard R. Lindsey

Director, Division of Market Regulation
U.S. Securities & Exchange Commission

May 21, 1998

Good afternoon. It is a real pleasure to be here today to share a few brief thoughts with you. As usual, before I start, I am required to point out that the comments I am about to give represent my opinion – they may or may not represent the views of the Commission or my colleagues on the staff. 1

The past several years have been very exciting and dynamic times for the securities industry. We have seen unprecedented changes in how our markets function. Today, I would like to try to put these changes into perspective. Let's look back just 30 years ago. Most of us are too young to remember, but in the late 1960s many major NYSE member firms went out of business due to the so-called "back office" crisis caused by a high sustained volume of approximately 12 million shares per day. Today, our markets routinely handle 1 billion shares per day and, as last October showed, our markets can handle more than 2 billion share days. Back in the 70s, fails were a major problem. Today, with fast and efficient clearing corporations and depositories, settlement occurs in three days and we are looking toward T+1 in the very near future. In the 80s, the U.S. securities business was confined primarily to our borders. Today, we truly are part of a global marketplace.

This growth and change did not just happen – it was the result of hard work on the part of the SEC, the SROs, and the industry they represent. This cooperative effort has produced the finest capital markets in the world. You've all heard it before – the finest capital markets in the world – the deepest, most liquid, most efficient capital raising and economic allocation system in the world. We hear it – say it – so many times that it almost sounds trite. But stop and think for just a minute – look around the world – the disruption in the Asian markets – the struggles of Easdaq in Europe – and the lack of depth, transparency, and ability to raise capital almost everywhere else. Our markets are nothing short of remarkable. I am convinced that this success has been the result of our shared focus – to ensure fair and orderly markets and to protect investors. Those are the cornerstones of America's success.

I want to thank the NASD for helping make today's markets possible. As the last two years demonstrate, you continue to be one step ahead – ensuring that you remain one of the world's most innovative and strongest markets. But even the strongest markets stumble and several years ago the NASD did stumble. As a result, the Commission took action that resulted in the 21(a) Report. I am convinced that this action was necessary because the NASD had lost its focus and had allowed business interests to dominate the best interests of the public. Today – I am convinced that the NASD's management has once again reestablished its priorities. I would like to commend Frank Zarb, Rich Ketchum, and Mary Schapiro for the excellent job they have done. Under their leadership, the NASD has worked long and hard to correct deficiencies and, in many ways, has taken the lead in defining how an SRO should operate.

The NASD and the industry also stepped up to the plate to improve the Nasdaq market by helping to ensure the smooth implementation of the order handling rules. This was a fundamental mind shift for the market and, as a result of these efforts, spreads are shrinking, volatility is declining, and the number of market makers per stock is increasing. These trends benefit investors and build public confidence in our markets – a confidence the industry cannot afford to lose.

The issue of public confidence in the integrity of the markets is one that cannot be overemphasized. I thank all of you who have helped in the uphill battle to prevent microcap fraud. As I am sure you are aware, the SEC and the NASD have proposed rules aimed at addressing this issue. We have proposed changes to Rule 15c2-11, and Rule 504 talked about the responsibilities of clearing firms. The NASD has proposed raising listing standards, moving non-reporting firms off the bulletin board, and requiring the taping of firms with a high concentration of disciplined brokers. I know that these are all somewhat controversial, but criticism is not what's needed – action and workable solutions are. You are the front line – you know the early warning signs – you probably have the best solutions. I ask each of you to assist in this effort because together we must find a way to stop fraudulent practices at their inception. To do otherwise would severely weaken our markets and undermine public confidence – confidence that, once lost, would not be easily regained.

I would like now to turn to some of the "hot" topics on the NASD's agenda in the coming months.

Perhaps the most dramatic change contemplated is the announcement that the NASD and the Amex are committed to merge. While there are still details that need to be worked out, it is clear that such a merger would fundamentally change the landscape of U.S. equity markets. There are still obstacles to overcome before the merger becomes reality, but I look forward to the opportunity to consider the possibilities it creates.

Another development is the NASD proposal to create an Integrated Order Delivery and Execution System – "IODES" – also referred to as Next Nasdaq. We have already received over 2,000 comments on this proposal. Depending on who you ask, Next Nasdaq either is the greatest thing since sliced bread or the end of modern civilization as we know it. At the very least, Next Nasdaq seems to be an innovative approach that the NASD hopes will ensure Nasdaq's position as a key player in a radically changing marketplace.

A couple of related issues are worth noting. The Commission is currently considering the NASD's proposal to adopt more meaningful standards for Primary Nasdaq Market Makers. Those firms that meet the new, stronger standards would have enhanced incentives for providing quality market making services. I think we need to reward those firms that make a positive contribution to the market and meaningful PMM standards may be a good way to do that.

The NASD has also announced that it has reached an agreement in principle to somehow try to incorporate Optimark into the Nasdaq system. As yet, the specifics of this proposal are not known, but I will say that this arrangement could have significant implications for the market.

Finally, the Commission is reviewing the NASD's request to expand the "Actual Size" proposal to all Nasdaq stocks on a permanent basis. Actual Size reduces the minimum quotation size requirement for all Nasdaq securities to 100 shares. As Nasdaq moves toward a more order-driven market, it may make sense to remove some of the constraints that have historically applied to the dealer market. The data on Actual Size seems to indicate that the Actual Size pilot has worked as intended and has not negatively impacted the market for Nasdaq stocks.

We are still reviewing the comments on Next Nasdaq, PMM, and Actual Size, and hope to move forward on these proposals as quickly as possible.

In addition to the NASD proposals in the hopper, we have a few of our own that you may want to pay attention to.

As you know, technology has revolutionized our markets. One of the effects of the technological revolution has been the tremendous growth of screen-based alternative trading systems. The lower cost of technology has enabled completely automated systems to play a more important role in securities markets and even to compete directly with Nasdaq and the exchanges. As technology has advanced, these systems, which were historically regulated as broker-dealers, have begun to perform functions once limited to established markets like Nasdaq.

Alternative trading systems now account for more than 20% of the trading in Nasdaq securities and new systems are sprouting up almost daily. These systems are an important part of the market and likely will become more important over time. Our goal is to better integrate these systems into our national market system and to help ensure that the benefits of the systems are available to all investors.

To accomplish these goals, we recently proposed rules to allow each alternative trading system to make a business decision to operate either as an exchange or as a broker-dealer. The choice that the system makes would impact its regulatory responsibilities.

At the same time, we proposed two additional proposals that are intended to give the NASD and registered exchanges greater freedom and flexibility. As an SRO, the NASD must file all of its proposed rule changes with the Commission for approval. As you know, in a fast-moving marketplace, innovation does not wait for the regulator. Chances are that, if the NASD has an innovative proposal today, others will be ready to run with it tomorrow. If we hold up the NASD's proposal, then we are hampering its ability to compete with others, including alternative trading systems and foreign markets which do not have the same regulatory responsibilities. This is not good for business or for our overall regulatory efforts.

Our goal is to enable the NASD and registered exchanges to bring new products to market more quickly. Under this proposal, if an SRO has trading rules, surveillance procedures, and listing standards that apply to a broad class of products that includes a particular new derivative securities product, the SRO could trade that new derivative securities product without prior approval from the Commission. Instead, an SRO would only have to submit a one-page summary form after the product begins trading. We estimate that about 90% of new product filings would no longer be subject to prior Commission approval under this proposal.

A second proposal would permit an SRO to operate a trading system that had limited trading volume for up to two years without prior Commission approval. An SRO would only file a notice with the Commission prior to commencing operation of the pilot trading system, followed by quarterly trading reports and reports on any operational changes in the pilot system. All of this information would remain confidential until the SRO requests permanent approval of the system.

I believe that these proposals should provide the NASD and other SROs with greater flexibility and should help them stay competitive.

Recently, I was at a conference where I heard a story that I would like to pass on to you. It seems that...........

[ Y2K Joke ]

In reality, none of us can afford to ignore Year 2000. We all know that we are at a critical juncture on Y2K readiness. I would like to point out a few specific issues that require immediate attention.

In March of this year, we proposed a rule that would require large broker-dealers to file reports with the SEC regarding their Y2K compliance. The comment period for this proposal has expired and we plan to adopt a final rule shortly. Once that rule is adopted, broker-dealers will be required to file their first reports within 45 days.

But beyond that reporting requirement, we are also relying on the NASD to monitor all of its members' Y2K efforts.

...which brings me to the mandatory survey the NASD conducted earlier this year. You can imagine my concern when I learned in mid-April that over one-third of the NASD's membership had not responded to this survey. I understand that, once we asked the NASD to provide us with the names of those who had not responded, the response rate went up to 90%. We all need to be doing more on Y2K readiness and sooner rather than later.

Our next big Y2K milestone is industry-wide testing. Beta testing is scheduled to begin in July and the SROs are ready to conduct point-to-point testing with individual members right now. Everyone must take full advantage of these testing opportunities.

I cannot overemphasize the fact that there will be no time extension for Y2K – January 1, 2000 is just around the corner. All market participants must play a proactive role in ensuring that they are ready individually and as a group.

Finally, let me say a word about decimalization. As you probably know, the SEC and the markets are committed to moving toward decimal pricing as soon as we have secured our Y2K readiness. It would be easy to sit back and wait until January 1, 2000 before we start making the necessary system changes to move toward decimals. It would be easy – but it would not be smart. Decimals are coming and, the sooner we realize that and begin to prepare, the better we will all be. We are committed to completing decimal testing by mid-year 2000. I encourage you to do all that you can to help us meet this goal.

In closing, let me say that the last few years have brought about dramatic and, I believe, positive and necessary changes to the NASD. The NASD has moved forward in some very fundamental ways, both as a regulator and as a marketplace. Your continuing efforts, I believe, will preserve your place as a dynamic, positive force in the securities markets. I congratulate you on a job well done and look forward to continuing to work with you in the months and years ahead.

1 The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publications or statements by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or the author's colleagues on the staff of the Commission.