PART IV CONTROL OF IMPROPER PRACTICES One of the major areas of the Commission's work is its enforcement activities, which encompass the detection and investigation of possible violations of the Federal securities laws and the taking of appropriate action to curtail fraudulent and other unlawful activities. The Commission's enforcement program is designed to achieve a broad regulatory impact within the framework of its limited resources. In addition to direct action by the Commission, the various self-regulatory organizations have a responsibility (subject to Commission oversight) to uncover and take appropriate action with respect to improper practices by their respective members. Moreover, there is a significant degree of coordination between the enforcement activities of the Commission, the selfregulatory agencies, the various states, and certain foreign securities agencies. This part of the report deals with some of the more significant aspects of these enforcement activities conducted during the fiscal year and with developments in litigation arising out of prior enforcement actions. It also summarizes certain noteworthy cases involving private litigation under the Federal securities laws in which the Commission participated as amicus curiae. DETECTION OF IMPROPER PRACTICES PUBLIC COMPLAINTS AND INQUIRIES The Commission receives many communications from the public, consisting predominantly of complaints against members of the securities industry and requests for information about issuers. These complaints and inquiries are given careful attention in connection with the Commission's responsibility to enforce the Federal securities laws. Within the scope of its authority, the Commission endeavors to assist investors in obtaining the desired information or resolving their complaints. Where violations of 1 For enforcement matters related to disclosure requirements under the Securities Act or Securities Exchange Act, see Part II, at pp. 40-42 and 50-52, supra. Enforcement activities related to investment companies are discussed in Part V, at pp. 156-165, infra. the Federal securities laws are indicated, the matters are referred to the enforcement officials of the Commission for appropriate action. The Commission may also refer matters to the stock exchanges or the National Association of Securities Dealers, Inc. (NASD). Analysis of complaints and inquiries helps the Commission to recognize problems being experienced by a particular firm or by the industry in general. Indicated below are the approximate number of written and telephoned complaints and inquiries relating specifically to brokerdealers which the Commission received from the public during the last 4 fiscal years. Approximately 80 percent of the complaints against brokerdealers involve back-office problems, such as the failure of firms to deliver securities or funds promptly and the alleged improper handling of accounts. As a result of the inquiries the Commission makes of brokerage firms upon receipt of complaints, thousands of investor complaints have been resolved. The Commission's authority, however, does not extend to arbitrating private disputes or controversies between brokerage firms and investors or to assisting investors in the assertion of their private rights. The Commission generally does not reveal the existence, progress, or results of any investigation it may undertake as a result of a particular complaint unless and until these are made a matter of public record in proceedings brought before the Commission or in the courts. Other sources of information regarding possible securities law violations include stock exchanges, the NASD, brokerage firms, State and Canadian securities authorities, better business bureaus, and various law enforcement agencies. INSPECTIONS The program of surprise inspections of broker-dealers and investment advisers by the Commission's staff is another important device for the detection of unlawful practices. During fiscal 1971, the staff conducted 772 broker-dealer inspections (as compared with 707 the previous year) and 121 inspections of investment advisers (as compared to 96 during the previous year). The table below shows the types of infractions indicated by the 1 False, misleading, or otherwise prohibited advertising_- 11 6 5 Other 13 84 Failure to provide for nonassignability in investment advisory contract Total indicated violations *"Hedge clauses" used in literature distributed by investment advisers generally state in substance that the information furnished is obtained from sources believed to be reliable, but that no assurance can be given as to its accuracy. A clause of this nature may be improper where the recipient may be led to believe that he has waived any right of action against the investment adviser. MARKET SURVEILLANCE In order to enable the Commission to meet its responsibilities for the surveillance of the securities markets, the market surveillance staff has devised a number of procedures to identify possible manipulative activities. These include a program of staff surveillance over listed securities, which is coordinated with the stock watching operations of the New York, American and regional stock exchanges. The staff reviews the daily and periodic stock watch reports prepared by these exchanges and, on the basis of its analysis of the information developed by the exchanges and other sources, determines matters of interest, possible violations of applicable law, and the appropriate action to be taken. In addition, the market surveillance staff maintains a continuous ticker tape watch of transactions on the New York and American Stock Exchanges, and monitors the sales and quotation sheets of regional exchanges in order to detect any unusual or news ticker, leading newspapers and various financial publications and statistical services are also closely followed. If any of these sources reveals possible violations, the market surveillance staff conducts a preliminary inquiry into the matter. These inquiries, some of which are conducted with the cooperation of the exchange concerned, generally begin with the identification of the brokerage firms which were active in the security. The staff may communicate with principals or registered representatives of these firms, with customers, or with officials of the issuer involved to determine the reasons for the activity or price change in the securities in question and whether violations may have occurred. The Commission has also developed an over-the-counter surveillance program involving the use of automated equipment to provide more efficient and comprehensive surveillance of stock quotations distributed by the National Quotation Bureau and the NASD's automated NASDAQ service. That equipment is programmed to identify, among other things, unlisted securities whose price movement or dealer interest varies beyond specified limits in a pre-established time period. When a security is so identified, the automated system prints out current and historic market information concerning it. This data, combined with other available information, is collated and analyzed to select those securities whose activity indicates the need for further inquiry or referral to the Commission's enforcement staff. INVESTIGATIONS Each of the Acts administered by the Commission specifically authorizes it to conduct investigations to determine whether violations of the Federal securities laws have occurred. The nine regional offices of the Commission are chiefly responsible for the conduct of investigations. In addition, the Office of Enforcement of the Division of Trading and Markets at the Commission's headquarters office conducts investigations dealing with matters of particular interest or urgency, either independently or with the assistance of the regional offices. The Office of Enforcement exercises general supervision over and coordinates the investigative activities of the regional offices and recommends appropriate action to the Commission. Investigations are also conducted by the Divisions of Corporation Finance and Corporate Regulation in the areas under their respective jurisdictions. It is the Commission's general policy to conduct its investigations on a confidential basis. Such a policy is necessary to effective law enforcement and to protect persons against whom unfounded or unconfirmed charges might be made. The Commission investigates many complaints where no violation is ultimately found to have occurred. To conduct such investigations publicly would ordinarily result in hardship or embarrassment to many interested persons and might affect the market for the securities involved, resulting in injury to investors with no countervailing public benefits. Moreover, members of the public would tend to be reluctant to furnish information concerning violations if they thought their personal affairs would be made public. Accordingly, the Commission does not generally divulge the existence or findings of a nonpublic investigation unless they are made a matter of public record in proceedings brought before the Commission or in the courts. When it appears from a preliminary investigation that a serious violation of the Federal securities laws has occurred or is occurring, a full investigation is conducted. Under certain circumstances the Commission may issue a formal order of investigation which designates members of its staff as officers authorized to issue subpoenas, take testimony under oath, and require the production of documents. The following tables reflect in summarized form the Commission's investigative activities during fiscal year 1971: Investigations of Possible Violations of the Acts Administered by the Pending June 30, 1970 New Cases Total Closed Pending June 30, 1971 Commission Formal Orders of Investigation Issued by the Commission upon Division of Trading and Markets Division of Corporation Finance Division of Corporate Regulation 862 410 1,272 447 825 131 15 9 155 Total ENFORCEMENT OF INVESTIGATIVE SUBPOENAS In Vesco and International Controls Corp. v. S.E.C.,2 plaintiffs sought to enjoin the Commission from requiring compliance with investigative subpoenas. The Commission counterclaimed for enforcement of the subpoenas. The United States District Court for |