be in the form of an administrative hearing and procedure and thus would be a way of highlighting failure to comply. Another section provides the Commission with control over proxies of over-the-counter companies here covered as we have with respect to proxies of companies which presently are listed. There is further a provision for summary suspension of over-the-counter trading in a security. We could summarily suspend trading for fraudulent or manipulative practices that deprive the security of a fair and orderly market. We do occasionally suspend trading in a listed security. We permit trading to resume when information has been made available to the public. Finally, we recommend repeal of section 12(f) (3) of the exchange act which authorizes unlisted trading privileges on an exchange where a company is subject to disclosure requirements. We believe that the bill should have a neutral effect on the choice of trading markets as between the exchanges and the over-the-counter market. Mr. Lowe. Do you feel that most companies would decide to become listed or to remain as they are? Mr. CARY. There are differences of views about that among the industry, I am told, and we do not have any belief that all the companies will immediately want to list. There are various factors to consider here. I think Mr. Loomis, however, can speak much more fully and perhaps with greater experience than I on this point. Mr. LOOMIS. Well, we do not know, of course, but I think that a good many of them will probably find that they prefer the overthe-counter market. On the other hand, a fair number of them may decide to list. One thing this bill will do is eliminate the artificial influence of presence or absence of disclosure requirements in those decisions, and therefore the company can decide, as it should decide, on the basis of where it thinks the best market for its securities would be. Mr. MANUEL COHEN. Mr. Lowe, I just want to add that a great many of these companies will not be able to meet the listing requirements of the exchange. Mr. CARY. I think, Mr. Chairman, this completes my discussion of the first major area covered by S. 1642, and as you suggested we therefore after lunch can move into the second area, which will deal primarily upon the qualifications of persons entering the business. Senator WILLIAMS. To go back to unlisted trading, there is a grandfather clause which provides that those who now have this privilege are not affected, is that right? Mr. CARY. Yes, sir. Senator WILLIAMS. Does that represent a substantial part of the trading on an exchange? Mr. LOOMIS. Unlisted trading in a company not listed anywhere is rather insignificant. There are a certain amount of them important to the American Stock Exchange, a little on the Pacific Coast Stock Exchange, and that is all. On the other hand, a great many of the smaller exchanges make secondary markets in securities which are listed on the New York Stock Exchange, and that is very important to the smaller exchanges. (Additional information was supplied as follows:) Stocks admitted to unlisted trading privileges on stock exchanges as the result of grandfather clause in section 12(f) of 1934 act: 190, of which 162 are on American Stock Exchange. Stock issues listed on American Stock Exchange December 31, 1962: 1,001. Senator WILLIAMS. This has been a most enlightening presentation-clear, concise, comprehensive, and most responsive when it came to the questions. We certainly commend you, Mr. Chairman, your colleagues, and staff members, for a very productive morning. We will return at 2 o'clock. (Whereupon, at 12:15 p.m., the subcommittee recessed, to reconvene at 2 p.m., this date.) AFTERNOON SESSION, 2:10 P.M. Senator WILLIAMS. The subcommittee will reconvene. Mr. Cary, would you present part II? Mr. CARY. Before I start in with part II, Mr. Chairman, I wondered if it would be all right with you that I include in the record two things which I think might be of interest to the committee, and perhaps which will not be presented via any person testifying. One is a resolution of the Midwest Securities Administrators Conference the "blue sky" State administrators. The resolution approves the extension of the disclosure requirements, which we discussed this morning. Senator WILLIAMS. Would you want that to appear at this point in the record? Mr. CARY. I would like to have that appear in the record before we get to part II. (The document referred to is as follows:) RESOLUTION PROPOSED TO AND ADOPTED BY THE MIDWEST SECURITIES The Midwest Securities Administrators Conference met in Phoenix, Ariz., on February 22, 1963, at the Sahara Motel. The following members of the conference were present: Robert G. Cronson of Illinois, chairman, presiding. Joe Sotelo, director of Arizona. Thomas Gray, director of Illinois. John Sobieski, commissioner of California. Hugh F. Owens, commissioner of Oklahoma. E. Walter Behrens, commissioner of South Dakota. W. W. Cameron, chairman of Saskatchewan. The following members of the conference were absent: State of Indiana. State of North Dakota. Commissioner John Sobieski of the State of California moved that the following resolution be adopted. The motion was seconded by Commissioner Bill King of the State of Texas. The resolution was voted upon and unanimously adopted: "Whereas in February 1963 the Midwest Securities Commissioners Association by resolution endorsed the principles of the Fulbright bill which would generally require large unlisted corporations to comply with the reporting and proxy standards applicable to companies whose securities are listed on stock exchanges; and "Whereas further study and experience have demonstrated that the protection of investors, the development of proper securities markets, and the proper conduct of corporate affairs all require that corporations whose shares are publicly held, supply adequate information to their shareholders, and when soliciting proxies for annual meetings and that such objectives cannot be achieved without authority being granted to expert administrative agencies to see to it that such beneficial requirements are complied with; and "Whereas the Securities and Exchange Commission has studied this problem and is expected to make a recommendation for legislation to accomplish the objectives of the Fulbright bill; and "Whereas on February 11, 1963, assembly bill 1184 was introduced in the California Legislature which, if enacted, would accomplish said objectives on the State level, exempting, however, those companies complying with similar Federal laws; and "Where it is our judgment, based on experience that this area is so important that complementary State and Federal legislation appears urgently necessary and desirable: Now, therefore, be it "Resolved, That the Midwest Securities Commissioners Association hereby endorses the principles of California Assembly bill 1184 and urges its adoption by the California Legislature and the adoption of similar legislation by the legislatures of the other States; and be it further "Resolved, That the Midwest Securities Commissioners Association heartily endorses the action of the Securities and Exchange Commission in studying this particular area, which study is said to be nearing completion, and urges that legislation be adopted by the Congress which will achieve the objectives of the Fulbright bill to the end that on both the State and Federal level there will be adequate legislation, backed by proper expert administrative authority to insure that corporations which have sold their shares to the public properly report to their shareholders as to the management of the corporate affairs including financial statements independently audited, and that when the corporate managements solicit renewal of their powers that they likewise be required to give reasonable reports to the shareholders as to their stewardship to the end that the shareholders be granted adequate information in connection with the voting of their shares; be it further "Resolved, That a copy of this resolution be forwarded to the Securities and Exchange Commission and to the securities commissioners of each of the 19 member States of the Midwest Securities Commissioners Association." On motion duly made and seconded, the meeting adjourned. ROBERT G. CRONSON, Chairman. Mr. CARY. Secondly, I have here an editorial from the Journal of Accountancy of May 1963, page 35, headed "Extension of Securities Regulation," which I also would like to make a part of the record. I do not want to commit the American Institute of Certified Public Accountants, but it demonstrates in general their attitude toward this question. Senator WILLIAMS. We will include that in the record, without objection. (The document referred to is as follows:) EDITORIAL-EXTENSION OF SECURITIES REGULATION To accountants, whether in public practice or in industry, the most interesting recommendation in the voluminous report of the special study of securities markets is that present controls over securities sold on regulated stock exchanges should be extended to those sold over the counter. The basic approach of chapter IX of the report, "Obligations of Owners of Publicly Held Securities," is outlined in the first paragraph of the summary of section B: "Disclosure is the cornerstone of Federal securities regulation; it is the great safeguard that governs the conduct of corporate managements in many of their activities; it is the best bulwark against reckless corporate publicity and irressponsible recommendation and sale of securities. In light of such considerations, it seems wholly indefensible, in terms of logic and of public policy, that most investors in over-the-counter securities should be afforded drastically less protection than is provided for investors in exchange-listed securities through sections 13, 14, and 16 of the Exchange Act. It is also highly anomalous that market allocations (in the sense of selections between exchange markets and over-the-counter markets) should be importantly affected by a sort of Gresham's law whereby many issuers may avoid the protective measures applicable to all listed securities by simply electing to have their securities traded over the counter. Issues traded in over-the-counter markets are far too numerous and important-partly as a result of this Gresham's law-to permit the present anomalous distinction to continue." Almost the same wording is used in the first section of the introduction to the whole chapter: "The keystone of the entire structure of Federal securities legislation is disclosure." This is, of course, an approach heartily endorsed by the accounting profession. Professional accountants well know that Government investigation and evaluation of all corporations issuing securities to the public would be impossible without destruction of basic elements of the free enterprise system. Most of them will probably agree, on the other hand, that if adequate financial disclosure by listed companies is desirable for protection of the public, similar disclosure should be required of all companies in which there are substantial numbers of public investors. Giving practical recognition to the administrative problems involved in the extension of controls, the report recommends that they should be extended first only to companies with 750 or more stockholders. Eventually, companies with 300 or more stockholders would be brought under regulation. It is especially noteworthy that the recommendations reject the traditional argument that banks and insurance companies should be exempt from disclosure requirements because they are subject to other regulatory authorities. While SEC Chairman William Cary's comment on the study contained the welcome statement that it revealed no widespread abuses, the lack of adequate disclosure by many companies whose stocks are traded in over-the-counter markets calls attention to a situation in which abuses are a continuing possibility. It would be premature to give a blind endorsement to the proposals before specific legislation is offered to carry them out. It is not too early to hope, however, that for once the barn door may be locked before the horse is gone. Mr. CARY. If I may move on, then, into part II of our discussion, the second major area with which S. 1642 deals is qualification standards and controls over those in the securities business. The vast growth in the securities markets has been accompanied by a rapid increase of brokers and dealers and their employees. For example, the membership of the National Association of Securities Dealers (NASD), the self-regulatory agency for the over-the-counter market, has more than doubled since 1945; over the same period its registered representatives have increased from about 25,000 to 95,000 and branch offices of members from 790 to 4,713. This expansion-accompanied by a comparable growth in securities traded and in the number of investors has strained the regulatory pattern of the securities acts and emphasized the dramatic need for stronger and more refined controls. Accordingly, the Commission recommends the enactment of a series of proposals, contained in sections 2, 6, and 7 of the bill designed to raise the standards for entry into the securities business; to enlarge the scope of self-regulation; to refine Commission disci plinary controls over brokers, dealers, and their employees; and to clarify and improve existing provisions dealing with related matters. The controls provided would have their primary impact upon those who deal in over-the-counter securities and would complement the protections recommended with respect to companies whose securities are traded in that market. A. SUMMARY OF PRESENT LAW AND PROPOSED AMENDMENTS Before I describe the proposed amendments, a short outline of present law may be helpful. Control over over-the-counter brokers and dealers begins with the requirement that they register with the Commission. Section 15 of the Exchange Act provides for revocation or denial of registration if a firm, or any person associated with it, (1) has been convicted of a crime involving securities transactions or the securities business; (2) is enjoined from engaging in any act or practice in connection with securities transactions; or (3) has willfully violated the Securities Act or the Exchange Act. Section 15A of the Exchange Act authorizes registration with the Commission of national securities associations. These organizations of over-the-counter brokers and dealers were intended to provide a medium for self-regulation for the over-the-counter market comparable to the securities exchanges in the listed market. Section 15A contains rather detailed provisions concerning the rules, organization, and disciplinary proceedings of such associations and gives the Commission a certain amount of regulatory power over them. At present, only one association, the NASD, has registered and the great majority of brokers and dealers are members. Against this background of existing law, the principal proposed changes are as follows: 1. All over-the-counter broker or dealer firms would be required to be members of a registered securities association. 2. Registered securities associations would be required to adopt rules establishing standards of training, experience, and competence for members and their employees and to establish capital requirements for members. The Commission's powers to change the rules of an association would be expanded to include these rules. 3. In a disciplinary action, the Commission could proceed directly against an employee of a broker or dealer in lieu of proceeding against the entire firm, and the authority of a national securities association to do the same would be clarified. The Commission could also impose sanctions short of revoking registration, such as a temporary suspension or censure. 4. Certain other changes are proposed, including a slight broadening of the category of crimes, injunctions, acts, and omissions that afford a basis for disciplinary proceedings by the Commission. In the case of brokers and dealers registered with the Commission, the necessity for proving that the mails or instrumentalities of interstate or foreign commerce were used in a particular proscribed transaction would be eliminated. Also, the exemption from registration for brokers or dealers whose business is "exclusively intrastate," but who use the mails or any instrumentality of interstate or foreign commerce would be repealed. Finally, certain other limited changes in existing law would be made. |