By William J. Casey, Chairman Securities and Exchange Commission

CHANGE IN THE SECURITIES
MARKETS

As the June 30, 1971 fiscal year came to an end, there were many problems clamoring for attention in the structure and operation both of the securities markets and of the institutions on which these markets depend.

In assigning priorities to these problems, the Commission focused its atten

tion first on the economic soundness of the firms making up the securities industry, their financial responsibility and the safety of investors' cash and securities left in their custody. During the previous years, the failure of substantial firms had brought about Congressional enactment of the Securities Investor Protection Act potentially committing a billion dollars of public funds to guaranteeing the safety of cash and securities left with brokerage firms by public customers. There was a widespread recognition that brokerage firms needed

more adequate, more liquid and more permanent capital, that their procedures and accountability had to be tightened up and that there had to be closer surveillance over their financial and operational soundness. At the same time, there was a clear need to reshape the structure of the markets themselves to modernize the way securities were both traded and transferred. Thus, going into the fiscal year, the Commission sought to strengthen the industry and its accountability to, and financial protection for, its customers while developing a policy and a framework for modernizing the structure of the markets. To lay the basis for the latter, it scheduled hearings at which investors, members of the industry and all those interested were asked to present their views on the future structure of the securities markets. At the same time, there was strong emphasis on developing greater clarity and certainty in the rules governing the sale of securities and on making financial information on more companies available to the public as well as improving the quality and sensitivity of financial reporting and disclosure. These three concerns financial responsibility of the industry, the structure of the markets and better disclosure to investors-were the foci of major actions taken by the Commission during the 1972 fiscal year.

Additionally, through staff studies, advisory committees or public hearings, the Commission undertook a thorough review of its policy, rules and practices in these areas:

(1) unsound and unsafe practices in the securities industry,

(2) the future structure of the

markets,

(3) enforcement policy and procedures,

(4) disclosure and marketing practices with respect to hot or new issues,

(5) rules governing the resale of restricted stock, stock issued in acquisitions, private offerings and intra-state offerings, real estate securities,

(6)

(7)

use of earnings forecasts in disclosure documents,

(8) use, coordination and simplification of reports and other requirements imposed on issuers, broker-dealers and investment companies by the Commission and the selfregulatory agencies, (9) oil and gas offerings in the course of developing an improved Regulation B and formulation of an Oil and Gas Investment Act pursuant to Congressional request, and (10) advertising, sales compensation, pricing and related problems in the economics and marketing of mutual funds.

Financial Responsibility and
Accountability

Investor confidence is the cornerstone of public participation in the securities markets. Much was lost in the broker-dealer failures of 1969 and 1970. The lessons of that financial crisis in the securities industry, the creation and operation of the Securities Investor Protection Corporation and new emphasis on early detection and prevention of potential firm failures have led to major new rules to assure financial responsibility and accountability in the securities industry and justify renewed investor confidence.

A major undertaking during the 1972 fiscal year was the working out of basic provisions for a comprehensive rule governing the day-to-day control and protection of customer cash and securities left with brokerage firms. Congress in passing the SIPC legislation in late 1970 gave the Commission specific

powers to develop rules to prevent misuse, improper segregation and loss of control over customer assets.

It was important that this be effected without disrupting the flow of certificates to consummate transactions, and without placing an unnecessary strain on the banking and brokerage system by requiring billions of dollars to lie fallow.

This was substantially accomplished in a rule proposal circulated in May. The new Rule (15c3-3) controls use of customer funds by requiring broker-dealers to set up reserve bank accounts to cover all customer assets not being used in specified, limited, non-risk areas of customer service. The size of the reserve account for each firm is calculated continually through a formula applied to all broker-dealers carrying public accounts. For customer securities left with the firm, broker-dealers have to show actual possession or control of such securities in such locations as banks or certificate depositories. Specific time limits are set for establishing and verifying control or possession of these securities and penalties are imposed for exceeding them.

The many provisions of this rule accomplish the major intent of Congress by isolating customer assets from the risk of the broker-dealer's business in such areas as underwriting or firm trading for its own account. They also prohibit unwarranted expansion of a firm's business which had been accomplished by some broker-dealers through use of customer funds, a major factor in the collapse of many broker-dealers in recent years. The rule penalizes faulty record-keeping by increasing the amount of reserve that must be set aside against customer assets. Finally, these provisions are fully consistent with efforts by the Commission, the industry, and others to bring about a total systems approach to the processing of securities transactions and the changing

of ownership through improved clearance and settlement operations, computerized depositories and eventual elimination of the stock certificate. The rule, with minor modifications and amendments, went into effect around the turn of the 1972 calendar year.

The protection given investors through this rule should be looked at as only part of a total program covering a series of interrelated and comprehensive new requirements. In July, 1971, the Commission required immediate reporting by broker-dealers of any violations of rules governing net capital or any non-current status of books or records. At the same time, any broker-dealer whose aggregate debt was more than 12 times its net capital was required to report in full its operational and financial condition within 15 days after the end of the month in which this ratio occurred. In November, 1971, the Commission passed a rule mandating quarterly box counts by broker-dealers of all securities and certification of securities not in the broker's possession. To increase reporting of financial condition of firms to their customers, the Commission last June passed an amendment to Rule 17a-5 requiring distribution of balance sheets on a quarterly basis to all customers. And to provide for effective screening and regulation of new firms entering the securities business, the Commission in the same month passed amendments to Rules 15c3-1 and 15b1-2, increasing minimum required net capital for new firms entering the securities business and requiring detailed presentations on the firm's facilities, personnel and financing.

These amendments, like many others, were an outgrowth of the Commission's 1971 Study of Unsafe and Unsound Practices detailing the causes of the 1969-70 financial crisis in the securities industry.

Steps to insure financial soundness and operational efficiency in the indus