WELCOME
David A. Walker
Director, Capital Markets Research Center

It is an honor for the Capital Markets Research Center to have Mary Schapiro, the President of NASD Regulation, Inc., as our guest and keynote speaker for the Sixth Annual Conference on Alternative Structures for Securities Markets.  Mary is one of America’s most important financial regulators because she has undertaken the task to resolve broker - dealer market conflicts and to enhance the nation’s confidence in the electronic markets.

NASD Regulation regulates 5,500 member broker firms and 670,000 individual registered representatives.  It also has oversight responsibilities for the Nasdaq Stock market.

Ms. Schapiro’s impeccable reputation immediately gave credibility to the new regulator when NASD Regulation was established.  She has an extensive public service career.  Mary was appointed to important financial regulatory positions by three different American presidents - Presidents Reagan, Bush, and Clinton.  And they surely exhibited very different economic philosophies.

Mary assumed her current position in February 1996.  Previously, she was Chairman of the Commodity Futures Trading Corporation; she was a Commissioner of the US Securities and Exchange Commission; and she served as an active member of both the Technical Committee and Developing Markets Committee of IOSCO.  Before her appointment to the SEC, Mary Schapiro was general counsel and senior vice president of the Futures Industry of America.
Mary Schapiro is a alumna of Franklin and Marshall College, where she now serves on the Board of Trustees.  She is also a law graduate of the George Washington University.

On a personal note, a number of years ago, I was a visiting scholar with the US Small Business Administration, where my boss was Chas Caldwell.  I had heard from staff colleagues that Chas was married to a brilliant attorney.  Only last year did I learn that Mary is that brilliant attorney.  Mary lives up to all of the good things I heard about her from people at the Small Business Administration.

It is my pleasure to introduce you to the Honorable Mary Schapiro, President of NASD Regulation, Inc.

Introduction and Overview

I am honored to address the delegates to the Sixth Annual Alternative Structures for Securities Markets international forum.  This conference brings together interesting and talented senior financial leaders to discuss issues of enormous concern to all of us involved in capital markets.

The concept of this conference, to share the experience of stock market executives and regulators from around the world, is more important than ever as markets heasd inmto a future that less than ever resembles the past.  Given the hyper speed of change today, none of us has the luxury of making many mistakes.

I do appreciate that regulation is just one of the issues that you must deal with to make your markets a success.  Strong, effective regulation may not be sufficient for creating a strong market, but it is absolutely necessary.

I am extremely fortunate to have a career -- quite by accident -- that has brought me into contact with the most powerful agents of economic change in modern history.  Those agents are capital markets -- free markets that attract and harness capital from individual and institutional investors -- that channel resources into everything from infrastructure development to the latest dot com idea.

Growth and Regulatory Needs

The growth and expansion of competitive markets is a powerful trend.  In 1985, barely 50 countries had stock markets. Today, that number has tripled.  Not only can you trade in virtually any country on a domestic market,  but if the vision of Nasdaq International is realized, soon you may be able to raise capital and trade on a single technology platform in multiple markets around the world.

Just as the number of countries with stock markets has tripled in the last 15 years, worldwide market capitalization has also tripled in the same time.  While we think of this growth as astonishing -- and it certainly is -- consider that only 30 percent of the world’s population is part of the global financial system.  The remaining 70 percent of the people who are yet to become part of that system,  present enormous opportunities for world markets. The possibilities for raising and allocating investment dollars efficiently around the world are now greater than ever imagined.

We have seen enormous changes over the past decade in our U.S. markets.  From my perspective as a regulator who, among other things, writes the rules that govern the relationships between brokers and clients and the processes of trading and allocating securities, the growth of our investor class is the most   transforming development.  Fifty percent of Americans directly or indirectly own stock, and for the first time in history they have more invested in the equity markets than in real estate.

The burgeoning popularity of investing in the U.S. has been driven by many factors -- the proliferation of mutual funds, the growth of tax deferred retirement plans, increased access to economic education,  and, most importantly, technology, which has driven down the costs of transacting and accessing high quality corporate information.

The Internet is the latest development along these lines.   It provides both information and trading opportunities. Without question, the emergence of the Internet is affecting the global economy profoundly.  Buyers and sellers of investment products now interact through the click of a mouse, crossing geographic barriers with ease.  In the financial services industry, this means that market information and  -- as we have learned from some recent hoaxes, notably Emulex --  misinformation are quickly and efficiently disseminated around the globe.

Virtually every investor in the world is being empowered through access to market and trading information.  Already, technology allows investors to develop asset allocation models, stress test a hypothetical portfolio, build customized mutual funds, develop investment strategies for educational and retirement needs, and track performance on a real-time basis.  It is technology that allows you to trade in a dozen different venues on a myriad of trading systems.  You can trade commission-free, and do so before the primary markets are open and after they close.

The possibilities are limited only by the imagination.  These new developments offer terrific promise and, as is often the case, serious pitfalls.  That is why regulation is critical.

Securities Regulation

Since time immemorial, regulation has been a response to either the chaos of rapid change or market-induced disruptions, such as when the promise of a new product, technology, or approach creates risks for some or all of the citizenry.

Although regulation sometimes may be heavy-handed or occasionally even misdirected, it is vitally important to the success of any capital market.  Regulation is essential to maintaining both the breadth of an investor base and the quality of information about the companies that are traded in financial markets.  Without effective regulation, there simply will not be the investor confidence needed to attract capital to fuel markets and economies.  No investor willingly commits money to a market they see as unfair or dishonest.

The relentless innovations of technology and globalization, the advent of electronic communications networks, and the introduction of publicly owned exchanges are already changing the way that the regulators do their jobs and the tools we use to do them.  However, the fundamental principles that drive regulation will not change.

These fundamental principles include the basic, essential standards of fair play -- the prohibitions against insider trading and market manipulation, and the duty of brokers to deal fairly with clients, to seek the best price, to disclose the potential risks as well as the rewards, and to compete vigorously, yet fairly.  These basic standards, as well as the nondiscriminatory application of public, explicit laws, the sanctity of contracts, and the rights and processes that protect the quality of markets are the bedrock foundation of our markets’ success.

Regulation is not, as some would espouse, an enemy of free capital markets.  Market credibility and investor confidence are essential ingredients to efficient markets.

The Neuer Markt provides an excellent example of the successful  application  of regulatory principles and the rapid development of investor confidence.  The Neuer Markt is the German Stock Market for small, high-growth companies.  It has developed from two companies to 302 in three years, with a market value of $172 billion and hundreds of thousands of investors.  While initial public offerings have historically been rare in Germany, companies have raised more than $18 billion on the Neuer Markt.  What does the Neuer Markt say is the reason for its phenomenal success? And how does it market itself? The answer to both questions is tougher regulation and more stringent rules than the other German markets.  These are what the Wall Street Journal says are the lessons from the Neuer Markt:  ATough regulation can be the ally, rather than the enemy, of business.  And protecting investors from abuse can be a key to a stock market’s success.

 Self-Regulation

In the U.S., the concept of self-regulation -- and its many, distinct benefits to investor protection-- is as important as ever to the fundamental goal of maintaining confidence in our markets, and I believe that other markets could benefit from self-regulation as well.  Self-regulation, that is -- regulation by those who participate in the securities industry and which is informed by their practical judgment developed through experience, helps give our markets the credibility they need to earn investor confidence.  Self-regulation, by its design, nurtures and enforces the very highest ethical and business standards.

In contrast, even though the idea that countries need a capital market to have economic growth is widely accepted, as underscored by the tripling in number of stock markets around the world, only a handful of markets are proving highly successful in contributing the desired financial rocket-fuel for rapid, real economic growth.  Why is it, when the technology and the rules related to operating a stock market can be copied or e-mailed anywhere on the globe, that it has proved so difficult for many countries to establish not only stock markets, but other financial markets as well?

Regulation Across Borders

There are many contributors to the difficulty that many nations have had in building robust capital markets.  The case of an historic British bank can help us understand an important part of the difficulty.  Barings Plc, you will recall, was a 233-year-old bank that financed the Napoleonic wars and the Louisiana Purchase and included Queen Elizabeth as a client.  In 1995, the bank continued to make history when it collapsed spectacularly and threatened the international financial system because one of its derivatives’ traders incurred losses of $1.3 billion on the Singapore International Monetary Exchange, the SIMEX.  When you heard the news about Barings, you may have thought that SIMEX must have had no existing regulations for such a fraud to go undetected for three years.  That is not true; SIMEX has rules and regulations that are a virtual copy of the highly successful Chicago Mercantile Exchange.  Obviously, something more than the Aright A rulebook must exist to provide safe, strong markets.  Processes and resources are also needed to ensure compliance with rules and proper business practices.

There are basic lessons about regulation that we still need to learn and implement more rapidly.  For example, in September the IMF issued a report on the over-the-counter derivatives markets.  Just as Barings had been a venerable and stable institution that no one could have expected to go awry, it was equally inconceivable two years ago when the hedge fund Long Term Capital Management, created and run by Nobel Laureates, nearly collapsed and threatened to take a sizable portion of the world’s financial markets with it.  The IMF report found that while some progress has been made, much more action is still needed on transparency, risk management, disclosure, monitoring, and supervision of over-the-counter activities.  These are very basic concepts and huge sums of money are involved, but not all of the basic changes that should be made have been implemented.

What can we learn from the Barings and Long Term Capital Management experiences and a dozen other failures in world markets?  It is clear that our markets need effective regulation, both narrowly considered, as the sort of specific work that the NASD and the SEC do, but also more broadly, as regulation that provides for orderly bankruptcy processes, meaningful corporate governance, and reliable enforcement of contracts.

The rush to build the trappings of a successful market is not the same as having the necessary institutions.  Credit, clearance and settlement, independent inspections, financial monitoring, insurance, and dispute resolution all have to work in order for complex, national financial structures to succeed.  It is important to add to this mix the will, the authority, and political accountability of regulators to take action against those who would threaten the honesty and credibility of the marketplace. These are issues that for many nations will require years to solve, but they must be resolved if the markets are to provide the large horsepower capital formation engines that we all want.

Turning Regulatory Principles into Action

Practically speaking, how do regulators turn principles of market integrity and investor protection into action in a world in which technology and globalization drive change at an astonishing pace?  After all, regulators have always been largely reactive.  Now, at Internet speed, what possible hope can there be that we will not be rendered completely irrelevant or obsolete?  Of course, this challenge must be faced in a way that both protects investors and allows regulators to be sufficiently flexible so that markets can grow and innovate.

We at NASD Regulation have found that there are four ways to turn market integrity principles into action.  First of all, regulators, like business in general,  must embrace change and harness the same technologies to do our jobs.  Despite the blessing of a large technology budget, we are barely keeping our heads above the rising tide.  It is only by automating as many processes as possible that we will be successful.  We must approach our task in a smart way, which to me means that we must operate a risk-based regulatory system that constantly assesses risks and is the focus of our resources.

We cannot pursue every problem; we cannot thoroughly audit every broker; and we cannot sit at every trading desk waiting to see if a customer is disadvantaged.  What we must do is to marshal all of our regulatory intelligence and use technology to collect and sort information to identify those firms and products that present a genuine risk to the investing public and the trading environment. We must exploit technology to find trading patterns and practices that threaten the integrity of The Nasdaq Stock Market.  With 4.5 million quotes and 2 million trades a day on Nasdaq, the only way to understand what is truly happening to customers’ orders, to the pricing mechanism, and to market quality is initially from the 10,000 foot view and then to identify the specifics when a pattern of potential abuse is detected.  When we find such a pattern of abuse and we can prove our case, we have to be unflinching in our willingness to enforce the law.

We must also arm investors with educational and other tools to help them to protect themselves.  If you want to see how we at NASD Regulation use the Internet to do this, please access the website: www.nasdr.com.

Second, in an era in which exchanges operate more like for-profit, public companies than traditional utilities, regulation must be independent of market operations.  A self-regulator will never be perceived as evenhanded when it regulates both its own market and that of competitors. That is one of the major reasons that NASD Regulation is in the process of separating from The Nasdaq Stock Market as Nasdaq becomes a profit-making exchange.

Third, regulators must think both globally and creatively.  Many of the rules that govern specific conduct and activities in our markets were written for a very different time.  To have credibility and to remain relevant the rules must be constantly tested and measured against the new environment.

Fourth, regulators should use industry as a partner in regulation.  I truly believe that the regulation that works best is all of the above -- technologically enabled, risk-based, independent, and global in approach -- and generated through a partnership between industry and regulatory authorities. We call it self-regulation and it is the heart and soul of our regulatory system, but it can take many forms and operate on many different levels.  We must preserve the unique strength of our self-regulatory system that links the talents of the best and the brightest in the business with professional regulators to generate regulation that targets real problems and addresses them in ways that work in the real world.

Looking to the Future

None of the challenges we face will be easy to address, but all of them can be resolved in a way that permits the markets to innovate and prosper, while properly protecting investors.  The challenges can be most easily and reasonably achieved through the cooperative efforts of the regulators, financial services industry, and investors, operating in an environment of trust.