try were not limited to rule changes and new requirements. The Commission has also established the Office of Chief Examiner to intensify its inspection of broker-dealers and its oversight over self-regulatory agencies. In March, 1972, the Commission submitted to Congress the draft of a proposed bill to give to the Commission additional authority over the entire paperwork processing mechanism in securities transactions. Two other bills were subsequently introduced, both in the House and Senate. All contemplate that the Commission will set standards for performance, operational compatibility, access to facilities and standards for safety of cash and securities. The thrust of this legislation is to provide coordination and direction for a nation wide system for clearance, settlement and ownership transfer in securities transactions. In addition, to speed the development of new systems for securities processing, the Commission in the 1972 fiscal year created a special operations group composed of former securities industry operations personnel to work closely with the industry on stock depositories, clearing and settlement systems and elimination of the stock certificate.

Restructuring of the Markets

In addition to knowing that the broker he is dealing with is financially sound and operating under close regulatory supervision, the investor should be able to exercise investment judgments in markets that are liquid, free from manipulation, fair to large and small investors and geared to make the best price available to investors in all parts of the country at all times. These factors, plus an emphasis on making available to investors the most professional service possible, are the continuing thrust of the Commission's efforts in the restructuring of the securities markets.

Both the nature of the securities markets and the economics of the securities business have undergone rapid and radical change with increasing institutionalization of the market. Today, while individuals still own most of the stock, institutions do most of the trading. In recent years, the massive flow of large block trades from institutions has required new market mechanisms outside the specialist and the auction market for their absorption. Increased institutional emphasis in brokerage services has led to new research, positioning and execution functions unknown until recently. A commission rate structure often not reflective of the economic realities of the business and pressure from institutions to cut or reallocate commissions has led to a maze of practices which themselves affected the pattern of securities trading. The overall results, on the one hand, have been the creation of substantial new market mechanisms for handling of today's volume and a greater professionalism in brokerage services, particularly in research. On the other hand, these changes had brought a fragmentation of markets, an absence of information on many trades, a directing of transactions to some markets on the basis of commission practices rather than best price, and a growing gap in the quality of investment research services available to individuals as compared with institutions.

The concern of the Commission is that in the future structure of the securities markets competition be made to work for the investor. Our intent is that markets become more publicly oriented, more liquid and that full information on transactions, quotations and the performance of issuers put the individual and the institution on an equal footing in getting information needed for investment decisions and in obtaining the best available price.

Accordingly, in October, 1971, the

Commission began two months of hearings to get the views of all concerned with the structure of the markets and the economics of the securities industry: investors and investor groups, stock exchanges, other self-regulatory agencies, institutions, brokerage firms and securities industry groups. Out of these hearings, we developed our Policy Statement on the Future Structure of the Securities Markets, published in February, 1972.

At the heart of the Commission's market structure policy is a central mar. ket system for listed securities. The development of competing markets to handle the increasing number and complexity of securities transactions should be directed so that these markets are part of an all-inclusive system with full disclosure of activity, comparable regulation and standards, and direct competition between market-makers based on performance. The central market would not be one market, but in fact a communications system tying together all competing markets so that investors can see where the best price is available. In this way, trades will flow to the best market, whether it be in New York, California, Chicago and whether it be on the floor of an exchange or in the office of a market-maker. Only in this way can competition be put to work for the investor. Only through centralization of information can the separate capabilities of our markets be combined to strengthen the overall ability of the nation to mobilize and allocate capital.

To implement the development of the central market system and other policy recommendations, the Commission

sought to utilize the practical expertise of those most directly involved. Advisory committees comprised of experienced members of the industry and other qualified experts were named to provide the Commission with a full range of options and suggestions. One committee, the Advisory Committee on Market Dis

closure, has recommended the structure and governance of a reporting system to include last sale and volume information from all markets in a composite presentation, with trades identified by market. This Committee now is at work on recommendations for a system that will provide the heart of the central market: a quotations network that would capture and display current quotations from all competing market makers so brokers can direct investor orders to the best market. Another committee, the Advisory Committee on a Central Market System, is developing recommendations on regulation and operating standards for competing markets in the system, as well as the proper means for providing economic access among such markets. The third group, the Advisory Committee on Block Trading has submitted recommendations relating to the impact of large blocks on securities markets and methods of handling them, which are now under study by the Commission's staff. The staff is also conducting its own analysis of how the central market system should be designed, implemented and regulated.

During the fiscal year the Commission developed two rule proposals as a first step toward a regulatory framework for the central market system. One Rule, 17a-14, requires registered exchanges and the National Association of Securities Dealers to make quotations of listed securities traded by their members available on a continuing basis; the second, 17a-15, requires these agencies to make last sale and volume information available on a current, real-time basis. The next step in this process will be the promulgation of short sale and other rules necessary to make the transaction and quotation disclosure systems not misleading. Once these communications systems are operational, the course toward the development of a truly national central market system will have been set.

The central market system is not an end in itself. It is a crucial part, but only a part, of what should be a totally professional investment service to the public. The system would inform the broker of all markets being made in a security and enable him to achieve the best possible price for his customer. But the best execution in the world is worth little if the investment decision is based on service that is unprofessional and ill-informed. The second critical recommendation of the Commission's policy statement sought to improve the quality of service to all investors by directly addressing the problems of commission rates, investment research and suitability, reciprocal practices in sale of investment company shares, and institutional membership. Together these issues present a complex, interrelated, often jumbled picture that can be clarified only by policies that bring all practices into the open and subject them to the test of public interest.

In the case of brokerage commissions, a drastic overhaul of the rate system clearly is called for and is taking place. In April, 1971, negotiated rates were introduced into the fixed-rate system for the first time, covering portions of orders over $500,000. In this fiscal year, the negotiated rate sector was expanded to portions of orders over $300,000. Over the full range of the commission schedule, the Commission reviewed and allowed implementation of a new rate schedule by the New York Stock Exchange which eliminated a temporary surcharge on smaller trades while at the same time it provided rate relief for the industry on these transactions. Because the rate structure bears so closely on the availability of investment services, the policy of the Commission is to weigh the pace of expansion of competitive rates against its economic impact on firms.

The Commission's policy statement described research as an integral and

vital part of any truly professional investment process. In an elaboration of that statement last May, the Commission said that investment managers need not necessarily seek the lowest price for brokerage services in discharging their fiduciary obligations, providing that the quality of research and other brokerage services available at a higher cost can justify that cost difference. Our concern for the quality of service available to investors extends also to creation of new services by broker-dealers and others that will provide individualized investment advisory services, probably computerized, to direct investors with relatively small amounts of money to invest. The Commission after the close of the fiscal year appointed an industry advisory committee to review its rules with a view to encouraging the development of such services and recommending standards for them.

In another area, the Commission has been concerned about reciprocal practices whereby mutual funds reward broker-dealers for the sale of fund shares by directing commission business through them. Aside from the conflict of interest this creates for the broker in recommending fund shares, and the investment manager in seeking best execution, there are very substantial problems of non-disclosure to buyers of the compensation paid to sell to them and of improper cost to fundholders who in effect may pay for the distribution of shares to others through commission dollars. The Commission in its policy statement recommended that these practices be terminated. The NASD at mid-year published for comment [or proposed] a rule barring the directing of brokerage by mutual funds on the basis of the sale of fund shares.

Finally, the question of who should be members of exchanges is closely tied to any consideration of quality of service to the investor. The view of the Commission expressed in its policy

statement was that as the central market system develops it should have at its heart a core of professional brokers and market makers serving investors. The primary purpose of these professionals would be to execute orders for investors. This means that membership on exchanges would depend not on the nature of the brokerage organization but whether it contributes to the purpose of the market by serving investors other than itself. After requesting the advice and recommendations of exchanges, the Commission issued for comment a proposed rule which would allow exchange membership for broker-dealers if at least 80 percent of the value of their exchange securities transactions represents orders from non-affiliated customers.

As a further part of its efforts to implement a policy of maintaining the fundamentally public character of the securities markets, the Commission during the fiscal year sent to Congress a bill that would empower it to further regulate trading by existing exchange members for their own or for affiliated accounts. In essence, it would require that all members, when trading for their own accounts, be required to yield priority, parity and precedence to public customers. This must not be confused with our belief that all exchange members must do a predominantly public business when transacting business on an exchange; we are merely saying that exchange members, when they do trade for their own or for affiliated accounts, even as market makers, must fully recognize their responsibility to the general public and be prepared to yield to public orders.

Disclosure

American securities markets are the strongest in the world in large measure because the investor in the American market is the best informed investor in the world. Important steps were taken

or started in fiscal 1972 to strengthen this system of disclosure. These changes were based on three concepts: (1) that investor protection and confidence could be improved by converting much of the "boiler plate" and other meaningless language of the new offering prospectus and other documents into meaningful disclosure about the issuer; (2) that greater certainty and clarity was needed in rules governing securities transactions, particularly those involving the securities offering and resale process; and (3) that financial reporting should be made more comparable, more comprehensive, and more meaningful.

Significant new disclosure concepts grew out of hearings held in 1972 by the Commission on new issues. These so-called "hot issue" hearings dealt with the role of the issuer, underwriter and market-makers in the handling of these first-time securities, many of a highly speculative nature. Commission proposals issued last July outlined potential requirements for companies bringing their securities to the public for the first time to discuss business plans, budget projections, plans for use of proceeds, and analysis of expected markets. Equally important, these proposals spoke to the problem of meaningless prospectus language oriented more to considerations of liability than disclosure by requiring specific and direct description of this information and other factors, as well as better organization and presentation of information to highlight and clarify the elements of risk and potential gain.

Commission emphasis on making disclosure more available, significant and meaningful also extended to the volume of information filed by companies whose securities already are publicly held. This involved computerization to speed availability of reports on company insider transactions; introduction of a requirement that companies specifically report

changes in auditors, with more detailed disclosure when the change results from a conflict of views; examination of a potential requirement that companies note items for stockholders that are reported in their annual reports to the Commission but not in their reports to shareholders; and the launching of a major information dissemination program aimed at getting more SEC data to the public through information vendors, public libraries, broker-dealers, news media and Commission publications.

To create greater clarity and certainty in securities transactions, the Commission implemented rules covering sale of restricted stock. Rule 144 is only the first of a series of rules governing troublesome aspects of securities offering and resale. Work was completed in fiscal 1972 which led to drastic revisions of disclosure and resale rules involved in mergers and acquisitions of companies. Work also began on examination of potentially more objective rules in the private placement area. Our objective in these changes is to remove artificial barriers which have been troublesome to issuers in these areas and at the same time create greater disclosure for investors.

The third phase of our disclosure activity involved financial reporting. The Commission is considering acceleration of requirements for supplemental disclosure on the meaning of different accounting policies, the effect of changes in these policies, the nature and significance of accounting choices and the basis for and changes in assumptions and estimates which could be critical to the financial results a company reports.

The independence of auditors and their continuing responsibility was of special concern. As mentioned, we now require notice of auditor changes and special notification if this resulted from difference of views. We issued Accounting Series Release 123 recommending

that corporations establish audit committees composed of outside directors to create a direct channel of communication between auditors and the Board to give greater objectivity to financial statements. In the fall of 1972, we issued another release proposing that auditors report in timely fashion on the fairness of material unusual changes or credits reported to the Commission on Form 8-K, our interim material information report form. At the same time, the Commission proposed amending disclosure forms to require more comprehensive and timely disclosure on writedowns, writeoffs and extraordinary charges. The thrust of this proposal was to discourage arbitrary timing and limited explanations on these often highly significant charges.

The Commission also looked into special problems of financial reporting encountered by companies engaged in defense and other long-term contracts, and cited the need for companies to specifically assess for investors the problems and developments in contracts and programs of a long-term nature. This statement was an outgrowth of a staff study on the severe problems encountered by Lockheed Aircraft Corporation in the C5A contract.

The sale of real estate interests to public investors, a business that has emerged in recent years perhaps as the largest user of public equity funds, was also the subject of Commission disclosure activity. A special advisory committee of professionals was named during the fiscal year to make recommendations for disclosure standards in this complex and growing area. This group completed its work in the fall of 1972 in a report with a principal recommendation calling for uniformity of regulation on real estate offerings among states, self-regulatory agencies and the Commission.