Rudman Committee Releases Summary Of Conclusions And Recommendations

Below are the summary conclusions and recommendations that the Rudman Committee released on Tuesday, September 19, 1995.

Overall Conclusions

Based on its Review, the Select Committee concludes that the NASD^® has discharged its self-regulatory responsibilities, not of course with perfection or without difficulty, but professionally and reasonably. The NASD's role as the primary regulator of the broker/dealer profession and the non-exchange securities markets, combined with its stewardship of the vast Nasdaq^® market, is both difficult and unique. No other SRO is faced with such complex and challenging obligations.

The Committee's Review does not support the claims of those who assert that the NASD is controlled by and for the benefit of Nasdaq market makers. Nor does it support those who assert that the NASD cloaks in regulatory garb actions that are in fact designed solely to advance the commercial interests of certain segments of the NASD's membership.

The Select Committee does find, however, that the NASD's governance structure has failed to keep pace with the significant growth and continuing evolution of the Nasdaq market, and the concomitant expansion of the NASD's regulatory responsibilities. In some cases, the existing governance structure has led to ineffective rulemaking for the Nasdaq market. In others, it has required the NASD to mediate economic clashes among its members arising from their divergent interests in the Nasdaq market—a daunting role which the NASD, as a membership association and regulator of the entire broker/dealer profession, did not seek and was never designed to play. The current structure has also placed the NASD, as the owner of Nasdaq's trading systems, in the unenviable position of regulating the competing systems owned by NASD members.

The NASD's existing governance structure thus blurs the distinction between regulating the broker/dealer profession and overseeing the Nasdaq stock market. Both missions are thereby disserved.

The NASD's existing structure would also benefit from increasing public representation on the NASD's governing bodies. Not only would a full measure of public representation befit the NASD's current stature and importance, it should also bolster confidence in the NASD's policies. It would not be inconsistent with self-regulation, because NASD members would still be fairly represented in the Association's affairs and have ample opportunity to bring their expertise and viewpoint to bear.

Regarding NASD enforcement, the Committee believes that the core of the NASD's disciplinary process is sound. No doubt, mistakes have been made, and some judgments certainly can be questioned in retrospect, but the overall process is designed to be effective and fair. At the same time, however, NASD disciplinary proceedings have become more contentious, complex, and consequential than the existing system was designed to accommodate. New measures are required to address these developments.

This will entail certain changes significant in the conduct of most NASD disciplinary proceedings. It will also entail greater national oversight within the NASD itself, greater public participation, more frequent, formal coordination of enforcement efforts with the SEC, the states and the major securities exchanges, and prompt deployment of increased financial and human resources. The Committee believes that these measures can be implemented without compromising the principle of peer review.

Finally, the Committee believes that the critical internal review function (including regular district audits) has not been given the mandate, resources, or prominence necessary for effective oversight within the NASD itself. Significant improvement is required.

Principles Of Effective Governance

Based on its Review, the Committee believes that, to be fully effective, the NASD's governance structure should conform to the following principles:

• The NASD and the Nasdaq market should not be divorced, but regulation of the broker/dealer profession should otherwise be separated from and performed independently of regulation of the Nasdaq and other OTC markets.
  
  
• To this end, the governing Board charged with regulating the NASD's member firms should be separate and independent from the governing Board responsible for overseeing the Nasdaq market. So, too, should their respective professional staffs. Those two governing Boards and staffs, however, should remain associated within a single SRO structure. This will maintain the strength of the existing NASD organization in linking commercial and technical expertise to regulation so that each informs and enhances the other.
  
  
• In all events, enforcement should be independent of responsibility for the Nasdaq and other OTC markets and should be the paramount task of the Board charged with regulating the broker/dealer profession.
  
  
• The separate governing Boards responsible for regulating the broker/dealer profession and for regulating the Nasdaq market should each have 50 percent public membership. The parent (or equivalent) Board should have a majority of public members. Other governing bodies with substantial policymaking or oversight authority also should have strong public representation, as appropriate to their specific tasks.
  
  
• The public members of the Boards and other governing bodies, though not affiliated with NASD member firms, should have sufficient knowledge, experience, and interest in the securities industry or markets to play a meaningful role in governance, and should represent a wide spectrum of skills and interests.
  
  
• Apart from public representation, the composition of the separate governing Boards should be tailored to reflect the interests of their respective constituencies.
  
  
• In addition, the composition of the Board responsible for regulating the broker/dealer profession should provide for balanced representation of the NASD's diverse membership, including small and large firms and firms involved in different business specialties.
  
  
• The Nominating Committees for the principal governing bodies should be composed equally of NASD members and public representatives, and the selection process should provide an opportunity for all interested and qualified constituencies to participate.
  
  
• The NASD's professional staff should take an active management role, and should ensure that all governing bodies are equipped to reach decisions in a fully informed and timely fashion and that the views of all relevant constituencies are taken into account.
  
  
• NASD discipline and enforcement should be, in fact and appearance, fair, effective, and professional.
  
  
• The NASD should have a strong, independent and well-equipped Office of Internal Review, with provision for regular district audits and an Ombudsman.
  
  
• The NASD should at all times devote the financial and human resources necessary to meet its paramount regulatory obligations.

Specific Recommendations

Guided by the foregoing, and based on the Review, the Select Committee makes the following specific recommendations:

Corporate Restructuring

Discipline And Enforcement

District Committees

Office Of Internal Review

Coordination With Other Regulators

On at least a semi-annual basis, high-level NASD and NASDR officials should engage in formal consultations to coordinate national enforcement policy with the other principal securities industry regulators, i.e., the SEC, state regulators, and the New York and American Stock Exchanges.

Membership Voting

The Select Committee finds no reason to change the NASD's decision, approved by the SEC in 1994, to eliminate the requirement of membership voting on proposed rule changes except in those unusual cases in which the NASD Board or NASDR Board determines otherwise.

Professional Staff

The NASD, NASDR, and Nasdaq professional staffs should take an active role in management and in identifying and pursuing issues and recommending proposed solutions, policies, and rules.

Individual Investors

The Committee notes that, in accordance with the principles of effective governance endorsed by this Committee, the NASD is creating an Office dedicated to representing the interests of individual investors and making certain that those interests are taken into account in policy and rulemaking.

Allocation Of Financial Resources

The NASD should allocate the necessary financial resources and personnel to achieve the foregoing goals as soon as practicable. In particular, the NASD should significantly increase the resources it currently allocates to enforcement and discipline and to internal audit and review.

Exhibit D

Current and Proposed Makeup of NASD and Subsidiary Boards

Exhibit E

Recommended Role and Composition of NASD and Subsidiary Boards