received by the writer or by all writers with the same endorser do not exceed $500,000 (all puts or all calls on the same underlying security and having a last possible expiration date in the same calendar month are considered to be related); (3) that the writer of the option is not the issuer of the underlying security, an affiliate of the issuer, or an underwriter with respect to the security; and (4) that the endorser of the option is a broker-dealer who is registered with the Commission.

On the same day, the Commission also published for public comment proposed Exchange Act Rule 9b-2.2 That rule, among other things, would require that prior to the execution of a customer's initial option transaction, a broker or dealer would be required to furnish the customer a disclosure statement which clearly explained the obligations and risks attendant upon writing or purchasing an option. In addition to this requirement, the proposed rule specifies standards of suitability for customers dealing in puts and calls; requires endorsers of options to report their option transactions and outstanding endorsements on a weekly and monthly basis; and requires that endorsers maintain net capital of not less than $50,000.

The Commission is currently considering revisions in proposed Rules 238 and 9b-2 based upon the many comments it has received on the rules as originally proposed.

Legislative Initiatives

(1) H.R. 5050

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Regulation is concerned. On March 1, 1973, a bill entitled the Securities Exchange Act Amendments of 1973, designated H.R. 5050, was introduced in the House and referred to the Committee on Interstate and Foreign Commerce.

Title II of H.R. 5050 is designed, among other things, to conform Section 6 of the Exchange Act to Section 15A of that Act so that national securities exchanges and national securities associations, as well as their members, would be subject to substantially identical regulation. In this connection, Title II would expand the oversight authority of the Commission to include exchange rule-making and disciplinary actions. It would also phase-out fixed commission rates on national securities exchanges, prohibit persons from provid. ing both management and brokerage services for the same institutional account, direct the Commission to take the neces sary steps to establish a central market system, prohibit exchanges from preventing their members from executing transactions for customers in other markets, and require the Commission to adopt rules designed to ensure best execution.

Title III of H.R. 5050 would amend Exchange Act provisions relating to the reg. ulation of brokers, dealers and exchange members. The revisions, among other things, would modify financial responsibility requirements; the broker-dealer application, registration and examination process; and certain of the reporting requirements. They would clarify the Commission's authority to require a composite transaction tape and a composite quotation system, and grant the Commission expanded authority over the accounting procedures of broker-dealers and exchange members.

Title IV of H.R. 5050 provides for the development of an integrated national system for the prompt and accurate processing and settlement of securities transactions and includes provisions relating to the regulation and registration of clearing agencies, securities depositories and transfer agents. It also directs the Commission to eliminate the use of the stock certificate as a means of settlement by

December 31, 1976, and clarifies the Commission's authority to deal with miss. ing or stolen securities.

Provisions of Title IV would designate the Commission as the sole regulator of clearing agencies, depositories and transfer agents, regardless of whether certain of these entities were incorporated and authorized to operate as banking organizations. The Commission would be authorized to set standards for such entities, administer registration requirements, conduct inspections and ensure compliance with the standards it had set.

By way of contrast, the Senate version of Title IV (S. 2058) would provide for dual regulation of securities depositories, clearing agencies and transfer agents." The Commission would have general oversight responsibility with respect to those entities and would coordinate its activities, to the maximum possible extent, with the Federal bank regulatory authorities, i.e., the Federal Reserve Board, the Comptroller of the Currency and the Federal Deposit Insurance Corporation. With regard to depositories, transfer agents and clearing agents incorporated as banks, however, the Federal bank authorities would have the primary responsibility to conduct inspections and enforce the bill's provisions.

(2) S. 470

On June 18, 1973, S. 470 was passed by the Senate and sent to the House of Representatives for consideration. This bill would grant the Commission authority to regulate or prevent trading by members on national securities exchanges, either on or off the exchange floor, for the member's own account or the account of any affiliated person, and make it unlawful for a member to trade in contravention of rules the Commission might adopt. The bill would also make it unlawful after a prescribed period, for a member of a national securities exchange to effect any transaction on such exchange for or with its own account or that of any affiliated person or managed institutional account.

Such prohibition would not become effective prior to the last date on which any national securities exchange maintains or enforces any rule fixing rates of commission, or prior to April 30, 1976, whichever is later. Moreover, the prohibition would not be absolute until the expiration of two years from the date that fixed commission rates are totally eliminated, or April 30, 1976, whichever is later.

S. 470 would also amend the Investment Company and Investment Adviser Acts: (1) to provide that under specified conditions, it would not be unlawful or a breach of fiduciary duty for an investment adviser to pay a higher commission to a broker for effecting a transaction than that charged by other brokers for effecting similar transactions; and (2) to establish standards with respect to the sale of an interest in an investment adviser. The latter section is designed to remedy certain problems raised by a recent court decision, which held that the general principle in equity that a fiduciary cannot sell his office for personal gain is impliedly incorporated into Section 15(a) of the Investment Company Act requiring shareholder approval of any new investment advisory contract. For a more detailed discussion, see Part 5.

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Tax Shelters

During the fiscal year, the NASD and the Commission's staff gave extensive consideration to the regulatory problems associated with the public offering of taxshelter programs. Shortly after the close of the year, the Commission announced that it was requesting public comments on proposed NASD Rules of Fair Practice which would establish a system of regulation for the distribution of such programs. The proposed rules, among other things, would prohibit NASD members from participating in the distribution of tax-sheltered programs which did not meet prescribed standards of fairness and reasonableness. These standards relate to the underwriting and other terms and conditions of the public distribution, including all elements of compensation to be paid to sponsors or broker-dealers, and

to the operation, structure and manage. ment of such programs. Suitability standards for investment in such programs, and requirements concerning the content and filing with the NASD of advertising and supplemental sales literature would also be established.

The Commission has requested public comment on the NASD's proposals not only to aid in its consideration of the specifics of the NASD's proposed plan, but also to provide it with a broadened base upon which to develop its own policies in the area of tax shelter programs. DISCLOSURE-RELATED MATTERS "Hot" Issues

In February 1972, the Commission began public, fact-finding investigatory proceedings on "hot issues" securities markets (i.e., markets in which new is. sues have experienced substantial price rises in their after-markets) to determine the adequacy of existing disclosure and regulatory protection for investors.

On July 26, 1972, following completion of the first phase of the hearings, the Commission requested the registered national securities exchanges and the NASD to consider the establishment of appropriate standards to alleviate some of the problems found to exist in such markets-particularly with respect to the adequacy of investigations by underwrit ers and the suitability for customers of the securities being distributed. As a result of this request, the NASD established a committee to review the Commission's comments and to make appropriate recommendations designed to strengthen regulatory and disclosure control over the sale of new issues of securities to public investors. On March 14, 1973, the NASD's Board of Governors requested membership and public comments on the committee's recommendations that: (1) special customer suitability rules be adopted with respect to first time offerings of companies in a promotional stage; (2) a rule be adopted to require that written procedures be established and followed by underwriters

in conducting due diligence investiga. tions; (3) a new category of qualification and registration for broker-dealer personnel be established ("underwriter principals"); and (4) the NASD's regulations stress a member's obligation to make a bona fide public offering in all new issues. At the end of the fiscal year, the numerous comments received concerning these recommendations were reviewed and considered by the NASD.

On June 1, 1973, the Commission published a number of releases dealing with the first phase of the "hot issues" hearings.30

The amendments to the registration and reporting forms adopted in these releases require more meaningful disclosure relating to all registrants, including information concerning the status of new product development and general competitive conditions, the position of the issuer in the industry in which it operates, and, in the case of certain registrants offering securities to the public for the first time, a description of their plan of operation.

The amendments added a new guide, 59, to the Guides for Preparation and Filing of Registration Statements under the Securities Act requiring that all prospectuses on Forms S-1 and S-2 include, immediately following the cover page, a summary highlighting the salient features of the offering with appropriate cross references to the prospectus.

Guide 5, "Preparation of Prospectuses," as amended, notes that stock phrases or "boiler plate" relating to subjects such as the company's chances of success or competition often do not provide meaningful disclosure and, therefore, should usually be accompanied by a brief explanation of the basis for the statement and the effect such conditions may have on the registrant's business. In addition, it now requires disclosure in preliminary prospectuses actually circulated of the estimated maximum offering price and number of shares or other units to be offered, or, with respect to debt se. curities, the estimated principal amount to be offered for first time public offer.

ings. In addition, disclosure is now required of factors that were considered in establishing the offering price, and an estimate, with appropriate caveats, of the value placed on outstanding securities of the registrant as a result of the estimated offering price. Such bare bones statements as "the initial public offering price has been arbitrarily determined by the company" or "such price has been established by negotiations between the underwriter and the registrant" are no longer sufficient.

Guide 16 was amended to deal speIcifically with the due diligence inquiry required of underwriters of new or speculative issues.

The second phase of the "hot issues" proceedings which began in September 1972 and focused on distribution and aftermarket trading is continuing. In November 1972, the Commission announced that three new issues of securities which were distributed during calendar year 1972 had been selected for analysis during public hearings scheduled to be held beginning December 11, 1972 in New York. The selection of the three issues was based solely on the fact that they experienced a price increase of approximately 100 percent or more from the initial offering price.

Forecasts of Economic Performance

On November 1, 1972, the Commission announced a public rulemaking proceeding relating to the use, both in filings with the Commission and otherwise, of estimates, forecasts or projections of economic performance by issuers whose securities are publicly traded. Hearings were ordered by the Commission for the purpose of gathering information relevant to a reassessment of Commission policies relating to disclosure of projected sales and earnings. The Division of Cor. poration Finance conducted public hear. ings from November 20 to December 12, 1972, and received testimony from 53 witnesses, including representatives or publicly-held corporations, the securities industry, the academic community, the self-regulatory organizations, and the ac

counting and legal professions. In addition, letters from over 200 persons were received and made part of the public record.

On February 2, 1973, the Commission indicated that it plans to take the first steps toward integrating projections into the disclosure system. In summary, the Commission determined that:

1. Disclosure of projections in Commission filings should not be required except under the circumstances set forth in paragraphs 7 and 8 below.

2. Issuers which are reporting companies and meet certain standards relating to their earnings histories and budgeting experience should be permitted to include projections in filings made with the Commission pursuant to the Securities Act and the Exchange Act.

3. Projections disclosed in Commission filings should meet certain standards. For example, the underlying assumptions should be set forth, the projection should be of sales and earnings and expressed as a reasonably definite figure, and the projections should be for a reasonable period of time.

4. Any issuer which files projection information should be required to update the filed projection on a regular basis and whenever the issuer materially changes its projection.

5. Any issuer which has previously filed projection information should be allowed to stop filing such information if it discloses its decision and the reasons therefor.

6. No statement of verification or certification of the projections by any third party should be permitted in any filing with the Commission at this time.

7. Any issuer which discloses projections outside of filings with the Commission, whether through financial media, financial analysts or otherwise, should be required to file such projections with the Commission on a special projection form.

8. Any issuer subject to the reporting requirements of the Exchange Act which discloses a projection, whether in a Commission filing or not, should be required to include in its annual report on Form

10-K for the fiscal year during which the projection was made a statement of the projection, the circumstances under which it was disclosed, and a comparison of the projection with actual results.

9. The Commission should adopt rules under the securities laws to define the circumstances under which a projection would not be considered a misleading statement of a material fact.

10. The Commission should issue a release setting forth certain standards for the preparation and dissemination of projections by the management of public companies, financial analysts, and other members of the financial community. The release should highlight the Commission's reservations as to whether anyone who makes a projection with respect to an issuer having a limited history of operations can meet the standards necessary to avoid liability. In addition, the adverse consequences of selective disclosure of material information such as projections should be phasized.

em

The staff of the Division of Corporation Finance is currently preparing specific releases and the rule and form changes necessary to implement the foregoing conclusions. The rule and form changes will be published for comment prior to adoption.

Rule 144

In April 1972, Rule 144, "Persons Deemed Not to be Engaged in a Distribution and Therefore Not Underwriters," became effective. It provides a method of resale for securities acquired in private placements and for securities held by affiliates. During the first months of the rule's operation, the Division of Corporation Finance received a number of requests for interpretations of the rule. In September 1972, the Division consolidated some of the more important interpretations in question and answer form and, with Commission approval, published them. Among the significant interpretations were those dealing with securities acquired by an underwriter in

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connection with a public offering, the solicitation of customers' orders, and the use of a moving average of trading volume for calculating the amount of securities that might be sold under the rule.

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In addition, the Commission proposed for comment an amendment to the rule which would permit brokers to continue their quotations in an interdealer quotation service while selling securities pursuant to the rule, subject to certain conditions. Under the proposal, quotations could be continued provided they were incident to the maintenance of a bona fide interdealer market. To insure that a broker was a bona fide market maker, the proposal would require him to have published quotations on at least 15 out of the last 20 trading days, and 4 out of the last 5, prior to receipt of the order. To insure that the predominant percentage of a market maker's transactions on a given day in the particular security were unrelated to Rule 144 transactions, the proposal suggested a limitation on the number of shares to be sold pursuant to Rule 144 based on a percentage of the dealer's average daily trading volume in that security over a prior period of time.

The Commission received numerous comments on this proposed amendment and its staff is currently reviewing them.

On June 14, 1973, the Commission reminded persons selling securities pursuant to Rule 144 of their obligation to file a duly completed Form 144.38 It pointed out that Form 144 must be filed at the time an order to sell is placed, not after the sale. Other common mistakes in using the form were also noted, and sellers were reminded that strict compliance with the rule is necessary.

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