Table 14. A 38-year summary classifying all defendants in criminal cases developed by the Commission-1934 to June 30, 1971 Table 15. Summary of criminal cases developed by the Commission which were pending at June 30, 1971 Table 16. Reorganization proceedings under Chapter X of the Bankruptcy Act in which the Commission participated during fiscal year 1971 230 230 231 XVII PART I IMPORTANT RECENT DEVELOPMENTS INVESTOR PROTECTION; MARKET STRUCTURE Major efforts were launched in 1971 to provide additional investor protection and to review on a comprehensive basis the structure and functioning of our securities markets. Among other things, the Commission adopted or proposed new rules designed to strengthen the financial and operational responsibility of brokerage firms, and it commenced broad-based public hearings to examine the structure and functioning of the markets. The re-examination which is in progress was occasioned in large part by the substantial operational and financial problems that the securities industry experienced during the period from 1968 through 1970. Large, unanticipated increases in trading volume occurred in the exchange and over-the-counter markets during the middle 1960's. Existing systems for processing securities transactions proved inadequate at individual brokerage firms and at the industry-wide level. Many firms were unable to maintain recordkeeping control and lost physical control over stock certificates. In the resulting confusion, a significant number of securities were either lost or stolen. Errors and delays in executing and settling trades were widespread, and customers frequently found it difficult to obtain delivery of securities they had paid for. Although a decrease in trading volume in 1969 eased the operational problems somewhat, it brought with it lower income for the industry. A financial squeeze ensued, and the industry's overall capital base shrank under the impact of operating losses and a significant drop in market value of trading and investment accounts. As a result, a number of firms, including some of the industry's largest, were forced into liquidation, and many others were merged out of existence. Hundreds of thousands of customers were saved from major loss by having their accounts transferred to stronger firms or through the injection of stock exchange trust fund monies. In all, the industry expended about $130 million in its rescue efforts. In order to restore public confidence in the safety of the markets, Congress passed the Securities Investor Protection Act of 1970.1 This legislation, the most important in the securities field in 30 years, established the Securities Investor Protection Corporation to provide insurance for customer accounts. Customers are now insured up to $50,000 per account (of which no more than $20,000 can be in cash). To minimize the exposure of the SIPC fund, which is backed by a billion dollars in taxpayers' monies, Congress ordered the Commission to study and report on the unsafe and unsound practices of brokerage firms, and on the need for additional legislation to correct such practices. Some of the operational problem areas scheduled to be examined in the Commission's study of brokerage practices were: physical facilities for effecting and processing securities transactions; automation and record-keeping systems; order entry and execution systems; trade comparisons and settlements; transfer and custody of securities; relationships of banks to brokers; internal controls maintained at brokerage firms; customer accounts; and needed expansion programs. In the financial area the major problem areas to be covered are: permanence and adequacy of the industry's capitalization; reliance upon customers' funds and securities; lack of internal controls over financial condition; faulty handling of customer accounts; and stock record differ ences. The experiences of recent years, the various Congressional hearings of 1970 and 1971, and the SIPC Study all point up the need for additional investor protection measures. Of those already implemented or under consideration, the most significant are those dealing with the establishment of reserves against customer free credit balances and the segregation of customers' securities. Authority to pass rules in these areas was explicitly granted to the Commission by the Securities Investor Protection Act. Following consideration of various proposals, the Commission on November 8, 1971 issued proposed new Rules 15c3-3 and 15c3-4 and proposed amended Rules 8c-1 and 15c2-1 under the Securities Exchange Act of 1934.2 Proposed Rule 15c3-3 requires the complete separation of customer funds from firm funds and provides for reserves designed to protect customer funds held by 1 See 36th Annual Report, pp. 3-5, for a discussion of the history and major provisions of this legislation. broker-dealers. Proposed Rule 15c3-4, concerned with customer protection in the area of custody and use of customers' securities, requires that the broker-dealer promptly obtain physical possession or control of customer securities and contains provisions for reserves against securities of customers which should be but are not in the physical possession or control of a broker-dealer. Supplementing proposed Rule 15c3-4 are proposed amendments to Rules 8c-1 and 15c2-1 (the hypothecation rules) which would, as regards securities carried for the accounts of customers which are loaned or borrowed by a broker-dealer, provide the same protections as are currently provided for by rules of the selfregulatory organizations with regard to the lending of securities as well as by the hypothecation rules with regard to rehypothecated securities. In addition to acting to protect customers' funds and securities on deposit with brokers, the Commission has taken steps to improve procedures for detecting and monitoring financial and operational problems at firms. On September 15, 1971, Rule 17a-11 under the Securities Exchange Act went into effect. It requires the giving of immediate notice by a broker-dealer who is in violation of a net capital rule or whose books and records are not being maintained in a current manner. Where a firm's financial condition is deteriorating, although it is not in violation of a net capital rule, it must file detailed financial and operational information on a monthly basis. Reports under the rule are to be sent both to the Commission and to all self-regulatory organizations of which the troubled firm is a member, so as to permit early consideration of problems and assistance to the firm on a coordinated basis. Another rule recently promulgated by the Commission under the Securities Exchange Act, Rule 17a-13,4 requires firms to count their "box" at least once each calendar quarter. During the 1968-1970 period when some firms lost control of their back offices, sizeable differences sprang up between records reflecting stock ownership and the inventory of securities actually on hand (or at identifiable outside locations, such as transfer agents). Some firms had substantial amounts of securities on hand whose ownership they could not identify and were missing large amounts of other securities which their records reflected as being owned by customers. Because these differences were in many cases not discovered, researched and resolved promptly, customers whose 3 Securities Exchange Act Release No. 9268 (July 30, 1971). |