formation is at least as great as, if not greater than, that in the exchange markets.

The over-the-counter market has become a great institution in channeling the flow of investor capital and has undergone a spectacular growth in the last decade. A brief summary of that development will perhaps clearly demonstrate the importance of this market.

C. GROWTH IN THE OVER-THE-COUNTER MARKET

The recognized need for adequate protection in the over-the-counter market has been greatly accentuated by its expansion and increasing importance, as vividly documented by findings of the special study. The average number of stocks quoted in the daily "sheets" of the National Quotation Bureau, circulated among dealers in the over-thecounter market, increased from 5,000 in 1946 to 8,200 as of January 15, 1963.

Moreover, during a 10-month period in 1961 and 1962, quotations were entered in over 14,000 different domestic stocks traded exclusively in the over-the-counter market.

In addition, over-the-counter sales of corporate stocks, excluding sales of mutual fund shares and syndicated distributions, increased almost 700 percent in 12 years-from an estimated $4.9 billion in 1949 to $38.9 billion in 1961.

The importance of the over-the-counter market is further reflected in the fact that, considering only public sales, the volume of over-thecounter stock transactions in 1961 amounted to approximately 75 percent of exchange transactions in terms of shares and 35 percent in terms of dollars.

Companies with stocks traded exclusively in the over-the-counter market constitute an important sector of our economy. A special study sample of over 1,600 of these companies showed that 31 percent had assets of over $10 million, 47 percent had assets of over $5 million, and 77 percent had assets or $1 million or more. Approximately onehalf had 500 or more record shareholders and 16 percent had 2,000 or

more.

Thus, it is clear this is not a modest market, nor are these modest companies with which we are dealing. A substantial public interest needs to be served.

D. THE NEED FOR DISCLOSURE IN THE OVER-THE-COUNTER MARKET

The lack of basic investor protection in the over-the-counter market has made informed investment judgment difficult, has introduced an artificial factor in the allocation of securities between the exchange and over-the-counter markets, and has created grave difficulties for brokers and dealers who try to fulfill their responsibilities to provide sound investment advice to the public. It has further deprived investors of important bulwarks against fraud.

The entire report of the special study so far submitted to the Congress is a documented analysis of the necessity for disclosure. The report demonstrates that irresponsible selling tactics, reckless investment advice, extravagant financial public relations and erratic markets for new issues of securities thrive best where lack of information is most marked.

One deplorable manifestation of these ill effects is reflected in the fact that the overwhelming preponderance of securities fraud cases in past years have involved over-the-counter securities. Vigorous enforcement efforts by the Commission cannot be a full substitute for preventative measures which would be far less costly to the taxpayer and to the victimized investor.

Eloquent testimony of investor needs is provided by investors themselves. The most significant number of public complaints received by the Commission concern requests for information about over-thecounter companies with respect to which the public has little or no adequate information.

Senator WILLIAMS. Mr. Chairman, I wonder if your studies indicate, perhaps generally, the extent to which the securities fraud cases involve companies with more than 500 shareholders? Can you give us a sample of fraud cases involving over-the-counter companies?

Mr. CARY. I will have to ask Mr. Cohen and Mr. Loomis if they have any figures on that. We do find that well over 90 percent of the fraud cases involve over-the-counter securities.

Now, whether or not we have it broken down to the point of whether they are cases in which there are more or less than 500 shareholders I cannot say. I will check with Mr. Cohen and Mr. Loomis.

Mr. MILTON COHEN. I do not think we have it at hand. I think we have data from which that might be determined, sir, and we might be able to supply it. But I do not have it here.

Senator WILLIAMS. I think it might be helpful to us in connection with this matter.

Mr. CARY. We will supply it for the record. (The material submitted begins on p. 288.)

Mr. CARY. The public should not be asked to buy and sell in darkness, nor can professionals in the securities markets advise them properly in the absence of reliable information. An analyst attempting to assess the investment worth of a company which does not file reports may be unable to find adequate or reliable data in the financial manuals and often is relegated to the choice of utilizing that information which management chooses to make public or expending considerable effort and expense in making his own investigation.

Because of the crucial disparity between the exchanges and the overthe-counter market, that market undoubtedly fails to receive the measure of confidence which it might otherwise enjoy. Thus, the public may draw a fairly sharp line in its investments, as it appears to have done after the market break of a year ago. It is well known that the over-the-counter market has not shown the same resiliency since that sharp decline as the exchange markets, both in terms of price and of volume.

Experience under the Federal securities laws has proved that providing basic investor protection encourages a healthy development of the securities markets. If the present double standard is eliminated, investor confidence in the over-the-counter market will be increased, the ability of companies to raise necessary capital will be enhanced, and securities will gravitate to the market best suited to them.

The need of the over-the-counter market for the benefits offered by this legislation is clear. In its report on S. 1168, 85th Congress, a bill similar in purpose to S. 1642, the Senate Committee on Banking and

Currency recognized the inadequacies of the present protection afforded investors in the over-the-counter market.

I will not quote from that Senate committee report but I would like it part of the record.

(The quotation referred to follows:)

The principle of equal treatment by the law of listed and unlisted large corporations in requiring them to furnish financial information to investors has received thorough consideration for nearly a quarter of a century. Many of the arguments against S. 1168 are the same as those advanced against the original Securities Exchange Act of 1934. It is significant that many of the groups opposing the original laws have now become its stanch supporters because of its protection to investors and its furthering of the public interest. The committee believes that the same recognition of the public interest will follow the enactment of S. 1168.

Senator WILLIAMS. As a matter of fact, Mr. Chairman, S. 1642 does not represent a revolutionary departure from the principles upon which our securities laws are based. Has not the principle of full disclosure for larger companies in the over-the-counter market been expounded since 1949 when Senator Frear first graphically described the need in this area?

Mr. CARY. That is correct, sir. As you have indicated, this is by no means new. It is a point of view which the Commission has entertained over a period of years, but it has become in our opinion increasingly important as the years go by.

I think the facts as I have indicated in this statement thus farindicating this enormous expansion, almost an explosion in the growth in the over-the-counter market in terms of the number of securities traded, the size of those companies, the number of shareholders who participate-all of these factors have made more important a view which we entertained many years ago and which has been previously before this Congress.

The need has not diminished, nor is it theoretical. The over-thecounter market has grown tremendously, as I have just said, in securities traded and in number of investors. Only the protections have stood still.

E. EXAMINATION OF REPORTING BY OVER-THE-COUNTER COMPANIES

The disclosure habits of over-the-counter companies confirm the justifications in logic and policy for a statutory base of responsibility. On three previous occasions, in 1946, 1950 and 1956, Commission surveys have shown that the financial reporting and proxy solicitation practices of these companies were seriously deficient. An even more exhaustive examinations made by the special study corroborated these findings.

The study analyzed the reporting practices of 556 industrial-I should say nonbank or insurance companies; this would include, therefore, service companies and the like-companies which were selected on a random basis. Deficiencies ranged from a failure to distribute any reports to shareholders on the part of a significant number of companies to important defects in the disclosures of numerous others.

The results of the special study's examination of proxy solicitation practices of these same companies were even more striking. Many

did not even solicit proxies. Of those that did, a clear majority omitted such vital information as the names or experience of nominees for directors or the remuneration of the management.

The findings of the special study do indicate that disclosure patterns tend to improve with increased shareholder ownership. This improvement would, of course, be reflected in those companies with $1 million of assets and 500 shareholders that will be covered by S. 1642.

Nevertheless, in companies of that category included in the special study survey, significant inadequacies were found in reporting customs. Thirteen percent did not distribute any financial information to shareholders in 1961. Of that that did, in 12 percent of the cases, it was not certified by an independent public accountant.

The proxy solicitation practices of these companies showed even greater need of improvement. Seventeen percent did not furnish any material to stockholders during 1961; 62 percent of the companies which solicited proxies involving election of directors did not disclose the name of nominees; and 92 percent made no disclosure of the remuneration of management. Significant deficiencies were found in many other respects.

The study's review of financial reporting habits would indicateto the extent permitted by such an examination-that some companies presently furnish adequate information. A company making such voluntary disclosures should have no objection to continue doing so under a congressionally endorsed policy. Most importantly, investors in over-the-counter securities are entitled to be assured of the adequacy of the information revealed. This can be achieved only by the imposition of legal obligations which would shape the development of appropriate accounting and other disclosure practices.

In the absence of statutory requirements, it cannot be expected that in times of corporate stress-when the need for full and accurate information is most acute-managements will necessarily disclose, on a voluntary basis, matters which may tend to reflect adversely on their activities or on their companies.

F. OVER-THE-COUNTER COMPANIES COVERED BY S. 1642

The necessity for disclosure has long been recognized. The extent of coverage of any disclosure requirements, however, has been a more difficult issue from the point of view of both the issue, the size and type of company to be covered. The special study made a particular effort to develop appropriate tests and also especially examined the disclosure practices of banks and insurance companies, examples of regulated industries which have raised special questions in the past.

S. 1642 would extend sections 12, 13, 14, and 16 of the Exchange Act initially to those companies having $1 million in assets and 750 stockholders of record. After a 2-year period, or such later date as the Commission may determine, the shareholder test would be reduced to 500. It is estimated that under the 750-shareholder standard, approximately 3,100 companies would be covered of which about 400 would be banks, subject to the appropriate Federal banking regulatory agency. About 1,500 of the remaining 2,700 are already required to file reports with the Commission under section 15(d) of the Exchange Act.

Senator JAVITS. Mr. Chairman, I have got to take a phone call but I want to talk with you about the banks and insurance companies when you get to some convenient stopping point.

Mr. CARY. Senator Javits, we have a separate section on that.

Senator JAVITS. Fine. I will wait.

Mr. CARY. We would be going to that shortly.

Senator JAVITS. I will wait.

Mr. CARY. Under the 500-shareholder standard, the estimated figures are 3,900 companies covered, 600 banks, and 1,700 companies already reporting.

Senator WILLIAMS. Mr. Chairman, at this point I wonder if Mr. Lowe might address an inquiry to you?

Mr. Lowe (subcommittee counsel). Mr. Cary, of the approximately 3,000 to 4,000 companies that would be covered, is it your opinion that only a very small fraction would be banks and insurance companies? Mr. CARY. That is correct. As I understand it, when you get down to the 500-shareholder level, we estimate about 600 banks will be covered. Moreover, an estimate based upon Moody's Bank and Finance Manual indicates about 560 banks meeting the 500-shareholder test. We estimate the number would be reduced somewhere to the neighborhood of 400 banks if the standard were at the 750 level, where it will be for the first 2 years.

And in respect to the insurance companies, if it is at the 500 level, it would be about 400 insurance companies. It would be somewhat less than that if it were at the 750-shareholder level.

Mr. LowE. And, therefore, much of the controversy in the press about banks and insurance companies misses the point, does it not, in that the bill would extend coverage to numerous large companies in the over-the-counter market, only a small percentage of which would be banks and insurance companies? Is that correct?

Mr. CARY. That is correct. If you take the 3,900 figure, with 600 of them banks, it would be around 15 percent. At the 750 level the 400 banks in total would be just a little over 10 percent of the 3,100 companies.

Mr. Lowe. Mr. Cary, would you explain for the record what a section 15 (d) company is?

Mr. CARY. Yes, sir. At the present time we do have, in addition to those companies whose stocks are listed on the exchange, a requirement that companies file periodic and annual reports with respect to their stocks if they have publicly issued securities and the total amount of securities offered and outstanding in the hands of the public is $2 million. So that at the present time, if there is a fairly large issue of securities outstanding and the company has gone to the public before, the reporting requirements are presently applicable. That is only the reporting requirements, not the proxy rules and not the insider-trading provisions.

Senator JAVITS. Mr. Chairman, may I be heard on the bank disclosure question you have mentioned?

Senator WILLIAMS. Yes.

Senator JAVITS. Mr. Cary, how many bank stocks are covered by this discussion?

Mr. CARY. At the outset, Senator Javits, when we have a 750shareholder level, it will be roughly 400 banks. At the 500 level