From 1996 until the beginning of this year, Barry R. Goldsmith served as NASD's top enforcement official. During his tenure as executive vice president for enforcement, NASD more than doubled the size of its enforcement staff and dramatically increased the number of enforcement actions undertaken by its offices around the country.
Prior to joining NASD, Goldsmith served as chief litigation counsel at the Securities and Exchange Commission. He is now a partner in the Washington, D.C., office of Gibson, Dunn & Crutcher, and a member of the firm's Securities Litigation Practice Group and Business Crimes and Investigations Practice Group. We caught up with Goldsmith this spring in his Washington office, just as NASD was considering revisions to its gifts and entertainment rules.
Financial & Insurance Meetings: What led NASD to issue its regulations for noncash-compensation (covering activities like sales contests and educational meetings) in the first place?
Goldsmith: The competition for shelf space for certain products has resulted in a proliferation of mutual funds and variable annuities. Many of these regulations are based on ensuring that brokers have the correct incentives in place when they make recommendations to investors about these products.
FIM: What is NASD trying to do with its rules and regulations concerning gifts and entertainment?
Goldsmith: The existing rule has been quite clear on gifts: There is a prohibition on gifts amounting to more than $100 value per year. The rule on entertainment, that it's “neither so frequent nor so extensive as to raise any question of propriety,” has given companies trouble on the edges when it comes to determining what that means. The proposed revisions now under consideration should provide each company with more flexibility and more certainty about what's prohibited. [Under the proposal, member firms would be required to have a written policy for entertainment, one that identifies which forms of entertainment are appropriate and which aren't.] One thing you always hear from the industry is, “We just want to know where the lines are drawn, and we'll comply.”
FIM: What are the factors that can set off an NASD investigation?
Goldsmith: It could be a number of things. For example, the gifts and gratuities rules investigations that started two years ago came out of a routine examination being conducted by NASD's Lost Angeles office. Or, investigations could stem from a customer complaint. Some of the largest cases have started from anonymous tips. And we do read the newspapers, so if there appears to be a problem in a certain area, NASD and other regulators investigate. If there are a number of problematic sales contests, for example, examiners will probably look further to see how broad the problem is.
FIM: Roughly how many investigations does NASD carry out during the course of a year?
Goldsmith: When I was there, NASD averaged 1,400 formal cases a year. But there are many more examinations and investigations that never result in formal charges. It's the dog that doesn't bark. I'm sure the numbers are in the many thousands when you factor in those that are dropped because there is no wrongdoing nor problems found. And there are many cases that are resolved informally through a letter of caution that essentially says: “We've found some problems that don't require a formal enforcement action, and here's what they are. If it happens again there will be consequences.” It's a way of dealing with a lot of first-time problems where investors are not harmed. Many cases are closed without formal action — it's the job of good regulators to recognize when there's no cause, and when it's appropriate to proceed.
FIM: How disruptive is it for a company that's being investigated?
Goldsmith: Generally, cases will take several months to go through an examination process. It's in everybody's interests to narrow the scope and not ask for extraneous information or take the testimony of too many people. Yet it can be burdensome and it's quite easy to turn a company upside down, so it takes some effort on both sides to get to the essentials. And it's usually the job of the lawyers on the other [corporate] side to minimize the burden on their clients.
FIM: What should companies be doing to ensure they are in compliance with NASD regulations?
Goldsmith: The first line of compliance is in-house. If you look at the Morgan Stanley case [Morgan Stanley was fined $2 million in 2003 for conducting prohibited sales contests.], they held sales contests at the national, regional, and branch levels for three years, all of which violated NASD rules. They didn't have the appropriate in-house staff and resources necessary to keep track of compliance in the sales contest area.
Companies should comply with the rules in the first instance — you don't even want to get to the informal investigatory stage. Make sure there is an in-house compliance department, properly staffed, of sufficient caliber to monitor compliance. And if there is a problem, you need to detect it quickly, and aggressively deal with it internally — or if it's of sufficient magnitude, immediately notify the regulators. The worst thing you can do is avoid dealing with the problem.
FIM: How are sanctions determined?
Goldsmith: NASD publishes its sanctions guidelines. There are principles that apply to all cases, such as the specifics of the violations, or whether the firm has self-reported the problem. Other factors that determine the extent of sanctions are whether there is a comparable precedent and how much harm has been done to investors. While I was at NASD we looked at the kinds of sanctions that could have a greater deterrent effect than dollars, such as prohibiting a firm from engaging in certain actions [NASD recently banned Merrill Lynch from holding sales contests for its Financial Advisory Center personnel for three years, for example]. These kinds of ancillary enforcement actions are becoming more common.
FIM: Can firms be investigated by more than one regulatory agency at a time?
Goldsmith: Every broker-dealer company must be a member of NASD. There are approximately 5,500 of these broker-dealers in the United States, and people who work for those entities must be registered with NASD as well. Every member of the New York Stock Exchange is also regulated by NASD, so there is overlap. And the Securities and Exchange Commission's jurisdiction is total. State agencies have jurisdiction as well. In a relatively small number of cases, if there is a regulatory interest on the part of all the regulators in an investigation, every regulatory body may be involved. In a case like that the sanction [in terms of monetary fines or penalties] may be divided. There can be a degree of overlap and double-teaming — one of the big issues around a possible consolidation of NASD and the NYSE [currently being discussed] is to avoid that kind of duplication.
FIM: What kind of an educational role does NASD play?
Goldsmith: It's a major part of its operations. NASD offers compliance conferences, webcasts, and courses. It provides investor advisories. Look around on the NASD Web site [www.nasd.com] and you'll find that NASD is offering more compliance tools than ever before. In many ways these provide the first line of defense for NASD-member companies when it comes to compliance.
FIM: Do enforcement actions have an educational role as well?
Goldsmith: One of the purposes of enforcement is to publicize the fact that there have been shortcomings by a company in a certain area. Obviously you hope that companies get the message. NASD often chooses cases strategically, in areas it believes it will have an impact beyond the immediate case. Certainly that has happened with sales contests. An example like Morgan Stanley, with so many violations and such a big fine, definitely gets people to pay attention.