MWA Financial Services, Inc.
December 18, 2002
Jonathan G. Katz
Dear Mr. Katz,
MWA Financial Services, Inc. (MWAFS) is a fully disclosed retail broker-dealer licensed to conduct business in 47 domestic jurisdictions, with over 250 Registered Representatives offering securities services through 70 Offices of Supervisory Jurisdiction. As President of MWAFS, I appreciate the opportunity to submit comments on the issues raised in the above proposed rule change by the National Association of Securities Dealers, Inc. (NASD).
Effective supervision is a cornerstone of investor confidence and efficient markets. Efforts to improve supervision should be commended. The issues raised above are of such import that they deserve member consideration. To this end, I respectfully request that time be allotted to the comment period so that all member firms may diligently review the proposal and evaluate the potential impact on their business. Bypassing traditional channels designed to afford member comment and input ignores the benefits of self-regulation. The many small firms and firms that operate on an independent contractor basis were not included in the usual process of NASD notification of a proposed rule and the call for comment. It would be unfair to these firms, such as ours, to implement this rule without adequate opportunities for us to learn about it, thoroughly review it, and comment on it. This full, thorough analysis by all NASD member firms will afford the Commission a broader understanding from which to create a fair and meaningful final rule.
We have the following specific concerns regarding the substance of the proposal:
Separating supervision and audit functions reduces their effectiveness and results in a waste of compliance resources.
MWAFS Registered Representatives engaged in sales functions do so from their own non-OSJ Branch and unregistered satellite offices. Each branch and satellite office is assigned to an Office of Supervisory Jurisdiction ("OSJ") for supervision in our hierarchical system. The OSJ Manager is also responsible for an annual inspection of each office under his/her supervision. The OSJ, in turn, is supervised and inspected by a salaried employee of the firm or, rarely, an external consultant. MWAFS is particularly concerned over the requirement that the office audit function be independent of the supervisory function.
We believe that our OSJ Managers, who are most familiar with the Representatives and their activities, are best qualified to perform the periodic inspection. The increased understanding gained from the inspections enhances the effectiveness of the OSJ Managers' supervision. Moreover, OSJ Managers' supervision activities provide additional information regarding the types of activities that require additional attention during the inspection. When OSJ Managers audit the Branch and satellite offices, it serves to reinforce the OSJ Managers' accountability for their Representatives' actions. Delegating the audit task to persons unrelated to daily operations, such as the Compliance Department, may decrease OSJ Managers' sense of responsibility for the activities conducted at the offices under their supervision. Dividing the inspection and supervision of these offices diminishes the efficacy of our firms' supervisory structure.
Currently, our OSJ Managers understand that in the event of wrongdoing by a Representative, the OSJ Manager will be held accountable by the firm and its regulators unless he/she is able to demonstrate effective supervision over the Representative. The NASD's proposal may lead some OSJ Managers to feel that their supervision is less important, as they begin to rely on the firm's Compliance Department to detect problems during the periodic office inspections. In essence, the overall level and quality of supervision over the Representatives may decline.
The proposed rule requires significant changes to our operations and creates undue financial burdens.
For firms such as ours that do not own or operate the offices at which sales activities occur, this proposal will lead to a substantial reallocation of resources. At a time when the financial and personnel resources of all NASD Members are increasingly limited, such a reallocation will be highly detrimental. If the firm is faced with sending its compliance employees to audit hundreds of additional locations on a regular basis, the frequency and the quality of the audits may decline. As a matter of financial necessity, the audit cycle will be forced to extend inspections for a multi-year duration between inspections. The proposed rule will substantially increase costs for a significant percentage of member firms without providing meaningful improvement in investor protection.
The proposed rule, as written, would have a negative impact on MWAFS' ability to supervise the sales activities of its registered representatives. Therefore, we strongly believe that by barring the firm from making appropriate use of its OSJ Managers, the proposal will result not only in decreased supervision of our Representatives, but in a waste of the resources allocated to supervisory and compliance functions.
Effective enforcement of existing rules will promote investor protection more effectively than additional rules and regulations.
Current regulations are reasonable and sufficient to prevent unlawful conduct when effectively implemented and enforced. No set of rules can specifically protect against every circumstance, and it is unreasonable to expect that they will. The costs of implementing the changed rule would be great, but the benefit to investors and NASD membership is limited, if any. In light of the relatively small number of serious cases among the membership, it is apparent that the majority of firms strive to conduct business in a manner compliant with industry rules and regulations. NASD has bolstered its abilities to gather information from each member to determine the effectiveness of the supervisory system at the firm. NASD can then allocate resources to the review and correction of any problems, rather than establishing rules that burden the entire membership based on the actions of the very few firms and individuals creating the issues the rule attempts to address.
The proposal lacks definition of key operative terms.
Key words in various provisions of the proposed rules lack sufficient clarity. Specifically, the heart of the proposed Rule 3012 and the revisions to Rule 3010(c) bring up "independence." There is no clear definition or explanation of "independent" as used in either rule. As "independent:" is the cornerstone of the proposal, a failure to define the term invites inconsistent application within member firms and among various NASD District Offices responsible for its enforcement. Guidance illuminating the intentioned encompassment of "essential facts" remains lacking as well. Without specific definition of inclusions, the proposed amendments will not result in enhanced supervision of sales practices.
The proposed rules are unduly burdensome.
Existing regulatory schemes require firms to adopt policies and procedures reasonably designed to prevent and detect violations. Geography, structures and functions unique to small firms and those that operate on an independent contractor basis have developed functioning systems to meet these requirements. Requiring independence in the supervisory system would result in the prohibition of these numerous systems.
Further, the proposal severely reduces the number of principals eligible to conduct branch exams. Members would have the choice to either hire additional staff or stretch limited auditing resources over a large sample of branches. Stretching resources may decrease the duration and quality of audits and increase the period of time between inspections. MWAFS and many other firms have actively sought to make supervision more hands on and as close to the point of sale as possible. To this end, MWAFS has invested substantial resources in training and firm element continuing education materials that instruct managers on supervision. This established model has proven effective and cost efficient, but would be destroyed by the proposed rule changes.
The proposed requirement regarding supervisory controls is flawed.
At our firm, similar to many of our peers, the Chief Compliance Officer ("CCO") is responsible for the design, implementation and oversight of the firm's system of supervisory controls. Restricting the CCO from performing and/or overseeing such a
review would compromise the quality and thoroughness of each review.
We are confident that the current regulatory environment already provides the necessary tools and resources for firms to properly oversee their representatives. We strongly believe that the proposed changes will actually have a negative impact on the effectiveness of our overall supervision as well as place a significant financial burden on NASD members.
Again, we thank the Commission for the opportunity to comment on these important issues.