“Recent Initiatives Related to Supervisory Practices”

*    The views expressed herein are those of Commissioner Hunt
     and do not necessarily represent those of the Commission,
     other Commissioners or the staff.

     Good morning.  I appreciate the opportunity to speak at this
fine conference.  I can tell from your agenda that some of the
most important issues facing the brokerage industry and the
Commission will be addressed.  While I’ll try not to dwell on the
issues covered by your workshops, there probably will be some
overlap since I’ll focus on several recent initiatives related to the
supervision of brokerage firm employees.  

     Let me begin with the standard disclaimer that the views I
express today are my own, and not necessarily those of the
Commission, other Commissioners, or the Commission’s staff.  I
also should note that I know the NSCP is committed to strong and
effective supervision of securities firm employees, and I applaud
the NSCP for its leadership in this area.

     Joint Sweep.  Early in 1996, staff from the Commission, the
states, and the SROs undertook a “Joint Regulatory Sales Practice
Sweep.”  Their objective was to review sales practices of select
registered reps, and the hiring and supervisory practices of firms
employing those sales reps.  The Sweep identified 300-plus reps
with significant disciplinary and customer complaint histories, and
the firms targeted had employed two or more of those sales reps.

     A “Sweep Report,” issued in March 1996, concluded that at
least as to the firms examined, supervisory and compliance
systems needed to be improved.  The Sweep Report made several
non-mandatory recommendations -- they were not mandatory
since, as I noted, the report was issued by the staff of these
regulators.  Nevertheless, the recommendations were good ones,
such as enhanced background checks, tying compensation for
supervisors to how well they supervise brokers, and tougher
supervision of those brokers with disciplinary or complaint
histories.  

     The Sweep Report found, for example, that some firms
would hire sales reps with suspect histories and, then, not take
greater efforts to supervise those reps.  That is an unacceptable
practice in my view.  I appreciate that the Securities Industry
Association generally endorsed the report’s regulatory findings,
even if there still is disagreement as to how the report’s
recommendations should be implemented.   

     Commission Enforcement.  Next, I want to highlight a
change in my agency’s enforcement policy:  that is, our decision to
increase the severity of disciplinary sanctions in so-called “failure
to supervise” cases.  The Commission now disfavors settlement
offers in failure to supervise cases that do not include “time out”
from the securities industry for at least some period of time.  In
the past, the Commission routinely accepted settlement offers
which required an individual charged with failure to supervise to
limit his or her supervisory functions, and just those functions.  

     There were several reasons why I thought that time outs
from just supervisory functions were insufficient.  First, I
considered several cases where, by the time an offer was made,
the supervisor was, in fact, no longer a supervisor.  In many of
those cases, the former supervisor was now a sales rep or a non-
supervisory officer.  It made little sense to me to accept an offer
only limiting supervisory activities when no such supervisory
activities were being performed.  

     Next, for small firms, our old policy was problematic even
when the individual was a supervisor at the time a settlement
offer was made.  This is because it is hard to see how, as a
practical matter, a supervisor at a small firm could be walled off
from all supervisory responsibilities.  Next, and perhaps most
importantly, I decided that more “complete” bars were in the
public interest and better protected investors.  

     Our change in policy should make firms heighten their focus
on sales and supervisory practices.  It also seems to be having
positive consequences that I hadn’t anticipated:  for example, I’ve
been told that some firms, concerned their supervisors now may
be suspended outright, are more closely examining prospective
sales rep hires.  I also have heard that some firms have formed a
special committee to make hiring decisions as to reps who have
been disciplined or who have customer complaints.  
     
     On a related note, let me point out that, in a recent 3-1 vote,
the Commission decided that it had the authority under the
relevant statute to bar brokerage firm employees and supervisors
from the industry as a whole, rather than just from the brokerage
industry.  The name of the case I refer to is Meyer Blinder.  I
dissented from this decision because I do not believe that our
authority can be so broadly construed.  So please consider my
earlier remarks -- about why more “complete” bars are necessary
-- as pertaining to why I believe that more complete bars from the
brokerage industry, and not the industry as a whole, are needed.  

     Form U-5.  Moving on, let’s talk a bit about Form U-5.
SRO rules call for a firm to file a Form U-5 when an associated
person leaves the firm, and to disclose why that person left.  A
firm making a hiring decision must review the person’s Form U-5.
Arbitration claims have been brought against supervisors and
firms based on allegedly defamatory statements contained in these
forms.  In a few cases, punitive damages were awarded where the
panel concluded that the firm either intentionally or recklessly
made misstatements on the Form.  Understandably, firms and
supervisors are concerned, and they contend that the ability to sue
makes them less candid on these forms.  

     The policy issue is clear:  firms have a duty to file complete
and candid responses on Form U-5, but how they discharge that
duty may be affected as liability concerns overshadow the Form’s
purposes.  In theory, of course, a firm’s duty to prepare an
accurate Form does not expose it to liability since there is no
liability for telling the truth.  In practice, however, the more
negative the statements on Form U-5, the more likely there is to
be a lawsuit.  Given this, absent some kind of protection from
liability, firms have an incentive to be less than frank.   

     The importance of candor on the Form can’t be understated.
It is a critical warning mechanism, alerting prospective (hiring)
firms.  Accurate reports help rid the industry of problem sales
reps, or at least ensure that firms have adequate notice of the
potential risks and accompanying supervisory responsibilities if
they hire those with suspect histories.  

     It is said, however, that some firms supply “clean” Forms U-
5 to avoid possible defamation exposure.  There also are charges
that the Form is misused to punish sales reps with whom a firm
has an unrelated employment dispute.  A false report on Form U-
5 to punish a sales rep is potentially as serious an abuse as
withholding information about a problem rep.  All of these
problems compromise the usefulness of the reports on Form U-5.

     There seems to be a consensus among regulators, firms,
courts and arbitrators that firms should receive some protection
for U-5 disclosures, but the consensus ends there.  Two
approaches have been discussed.  The first is absolute immunity:
complete immunity for statements without consideration of motive
or bad faith.  The second is qualified immunity: generally defined
as immunity for statements made in good faith.  Courts that have
addressed the issue have, as a preliminary matter, found that
firms enjoy some form of immunity, but those courts have
disagreed on whether it is absolute or qualified.

     Let me offer just a few basic observations on the qualified-
or-absolute-immunity debate.

     A few years ago, Commission staff recommended that the
Commission find ways to implement a uniform policy of qualified
immunity.  In the Sweep Report I referred to earlier, Commission
staff again suggested that qualified immunity was the preferable
approach.

     The U-5 debate has heated up recently, and an SRO
proposal may be before the Commission shortly.  While I am open
to other ideas and have not yet formed an opinion on any rule
proposal, I currently favor a qualified immunity approach.  I
agree with an observation in the Seventh Circuit’s Baravati
decision that, absent safeguards, such as civil liability, the risks of
abuse are too great and the consequences too onerous for
brokerage firms to be granted absolute immunity.  We should be
wary of policies that insulate intentional retaliatory conduct from
review.  Further, toleration of such conduct could frustrate
legitimate law enforcement objectives.  Indeed, in Baravati, the
associated person claimed that the defamatory statements made on
his U-5 were in retaliation for reporting improper conduct at the
firm.  

     I also have concerns about the potential lack of uniformity
on the immunity issue across state jurisdictions.  Currently, the
issue of immunity for statements made on Form U-5s is a state
law question either of statutory or common law.  This has resulted
in different standards of liability in different jurisdictions.
Because candid and accurate disclosure on Form U-5 is important
to our self-regulatory system of broker-dealer oversight and
supervision, I would prefer a uniform standard.  

     Finally on this issue, we must not lose sight of the ultimate
regulatory objective:  firms must provide candid disclosure on U-
5’s regardless of how the immunity debate plays out.  Firms have
been held liable for subsequent acts committed by a sales rep at
another firm when the former firm conceals the rep’s problem
history.  Further, a knowing failure to identify problem sales reps
also may lead to disciplinary action.  I urge SROs to take strong
disciplinary action against any firm that is deficient in discharging
its U-5 obligations, especially where the deficiencies enable a rep
to defraud customers at another firm.  

     SRO Initiatives.  Two other SRO initiatives deserve mention.

     First, the NASD’s “taping” proposal, has raised a good bit of
controversy.  It would require a firm whose work force is made
up of a specified percentage of persons that have been associated
with a so-called “disciplined firm,” or each firm that is itself a
“disciplined firm,” to tape telephone conversations of all of its
associated persons with existing and potential customers.  

     The NASD contends that the proposal responds to concerns
expressed in the Sweep Report regarding the need for heightened
supervision of sales reps with troubled regulatory and compliance
records.  While associated persons who would be affected by the
proposal may not have been disciplined themselves, the NASD’s
rationale for its proposal is that such persons may not have been
adequately trained and supervised at the disciplined firm.

     The proposal wasn’t warmly received by the brokerage
industry.  Complaints seem to focus on the proposal’s “Big
Brother” nature and its expense, its taint of all sales reps from a
disciplined firm (even reps not involved in any violations), and the
overall effectiveness of taping as a supervisory mechanism.

     I have not had a chance to fully consider the NASD’s
proposal or the issues it raises.  Moreover, since the proposal may
be before the Commission in the near future, I will offer only two
brief observations.  First, the NASD’s proposal shows the level of
concern the NASD has with the supervision of suspect, or
potentially suspect, reps.  I share that concern.  Second, I would
urge critics of the NASD’s proposal not just to condemn it, but to
offer reasonable alternatives or modifications.

     Next, the New York Stock Exchange has filed with the
Commission proposed rule changes dealing with e-mail and other
correspondence.  While I understand that the NASD filed a
similar proposal, my remarks generally refer to the NYSE’s
proposal, because I am a little more familiar with it.

     NYSE Rule 342 would allow firms to establish “reasonable
procedures” for the review of sales rep correspondence, thereby
affording firms and supervisors with greater flexibility than they
have today.  What constitutes “reasonable procedures” does not
seem to be clearly defined, but I understand that the term
includes, among other things, the actual review of some
percentage of sales rep correspondence.  

     NYSE Rule 472 then would be amended to require prior
approval only for sales literature, market letters, advertisements,
or other similar communications generally made available or
distributed to customers or the public.  As you know, the current
standard calls for prior approval of any communication generally
distributed or made available to customers or the public.
     
     I have not seen the latest version of the NYSE’s proposal.  I
have not discussed it with Commission staff.  But because the
proposal physically is “at” the Commission, I’ll just be able to
offer a few thoughts.
     
     When I first heard of the NYSE’s proposal, my chief
concern was how the proposed changes would apply to incoming
correspondence from investors, and whether such correspondence
must continue to be reviewed by supervisors.  Incoming
correspondence, of course, raises special concerns, for it may give
an early warning of a potential problem with a sales rep’s conduct
or state an actual complaint.  

     I understand that the NYSE modified its proposal so as to
maintain its current rule requiring review of all incoming written
communications, and that seems to be a good approach.  But I
also understand that incoming “e-mail” would be treated
differently by the NYSE than all other “written communications,”
so that incoming e-mail would not be automatically reviewed.
Instead, incoming e-mail would be subject to the new, and much
more flexible, “reasonable procedures” standard.

     The Commission must carefully consider whether this
approach is adequate.  Having said that, I believe that the NYSE
already has a rule -- Rule 351(d) -- which requires that firms
report to the NYSE certain information regarding all customer
complaints, whether they are received by a firm via e-mail or in
written form.  If the NYSE’s proposal is adopted, I’d expect the
NYSE to vigorously enforce its Rule 351(d), especially with
respect to customer complaints received via e-mail.

     I also have questions about whether and how the NYSE
proposal would apply to e-mail recommendations made by sales
reps to customers.  I can’t answer those questions until I see the
proposal.  In general, however, I believe that review of outgoing
correspondence is an important part of a firm’s supervisory
responsibilities.  Nevertheless, what kind of review is necessary is
not an easy question since, for example, the benefits of automatic
review of all recommendations must be weighed against the
obvious costs and other attendant obstacles of that approach.

     Finally on this matter, and to make the proposals most
effective, the NYSE probably should provide sufficient guidance
to firms as to what procedures are acceptable.  I am concerned
about this because, while affording additional flexibility to firms
in this area may be quite appropriate, affording the absolute
maximum flexibility may not.  In other words, not offering any
real guidance except through an occasional enforcement action
may not be the right way to go.  Moreover, assuming that the
proposal is adopted, the issue of what constitutes reasonable
procedures probably should be revisited from time to time by the
NYSE, the firms, and the Commission and its staff.  

     Conclusion.  Thank you for allowing me to share my views.
I look forward to exploring many of these issues further with the
industry in the months ahead.