or supervisor. The Commission has consistently held that brokerage firms and their principals have a duty to supervise and on numerous occasions has stressed the necessity for adequate supervision as an essential key to maintaining proper standards.

The report of the Special Study documented the damage that can result to investors from its absence, particularly in the case of a large firm with branch offices scattered throughout the country. The proposed amendment will make this important supervisory responsibility explicit on the face of the statute and set express guidelines for its fulfillment. This codification becomes more important in view of the proposed authority for the Commission to proceed directly against individuals.

D. COMMISSION DISCIPLINARY CONTROLS OVER BROKERS AND DEALERS

The Report of the Special Study pointed out the rigidity and artificiality of the present statutory scheme for disciplining violators, in neither providing for direct action against individual wrongdoers, nor expressly authorizing useful intermediate sanctions against a firm short of revoking registration. Section 6(b) of the bill would add needed flexibility to the Commission's disciplinary powers to overcome these limitations.

At the present time, if an individual connected with a securities. firm violates the law without the approval or the knowledge of his employer, the Commission can take disciplinary action only by a proceeding against the entire firm. This approach, possibly involving many persons wholly innocent of the violations in question, is awkward and may be unfair. For this reason, individuals may sometimes not be properly disciplined.

Accordingly, section 6(b) (3) would permit the Commission to act directly against offending individuals, where that course is appropriate, in lieu of proceeding against the entire firm. The power of the NASD so to act would also be clarified. Of course, this section would not in any way reduce the responsibility of a firm to supervise its employees, an obligation expressly recognized, as already discussed, in the bill.

Section 6(b) would also provide needed flexibility by authorizing the Commission to impose sanctions intermediate to putting a firm out of busness. Short of such revocation, the Commission could temporarily suspend or censure. At present, the Commission has only three alternatives: It may revoke registration and expel a firm from any exchange or association of which it is a member; it may, at the other extreme, impose no sanction at all; the only intermediate sanction is a suspension of membership in the NASD or an exchange if the firm happens to be a member.

The effectiveness of a suspension from an exchange or the NASD as a meaningful sanction varies considerably in accordance with a firm's business and its reliance for profits upon professional price concessions from members of an exchange or securities association.

Another aspect of present law which dilutes the effectiveness of Commission regulation is the exemption from registration for brokers and dealers doing an exclusively intrastate business but who use the mails or instrumentalities of interstate commerce to effect purchases

and sales. This narrow exemption from registration would be eliminated by section 6(a) of the bill.

To qualify for the exemption, a broker must deal not only with customers who are exclusively within a State, but he must deal exclusively in securities originating in the State. Information obtained in the course of investigations indicates that intrastate brokers and dealers quite frequently overstep these restrictions and thus involve themselves in inadvertent or willful-violations of Federal laws. There are several reasons why the Commission believes this exemption should be eliminated.

First, the Congress has imposed upon the Commission statutory responsibility for the conduct of these intrastate brokers and dealers in various important respects, including the enforcement of the antifraud provisions and the financial responsibility requirements of the Exchange Act. However, the Commission lacks adequate means to discharge these responsibilities, since it does not learn of the existence of these brokers except as a result of a complaint and, furthermore, it has no authority to require them to keep books and records.

This leads to the anomalous result, for example, that intrastate firms are subject to the capital requirements prescribed under the statute, but are not required to keep any records as to how much capital they have. As a result of these handicaps, the Commission must devote an amount of time and effort to fraud investigations involving intrastate broker-dealers that is out of proportion to their number and importance.

In that connection, I just happened to have brought to my attentior an article in the Wall Street Journal of June 14, 1963, which I would like to ask have go into the record. It deals with Indiana alone and it says, "Indiana Fears Scandal in Intrastate Stocks," and "SEC Seeks Reforms." It says:

"Frankly, I'm holding my breath until I get out of office, for fear there will be a major scandal in the Indiana securities markets.”

The speaker is the tall distinguished looking Charles O. Hendricks, who, as Indiana secretary of State, will remain responsible for the State's securities department until his term ends on November 30, 1964.

He points out here that:

Although stocks and dealers are subject to policing by the State, many reputable brokers contend that the regulatory system in Indiana, like some it other States, is woefully inadequate. Moreover, these critics point out that most dealers specializing in intrastate stocks don't belong to the NASD, and thus escape disciplines imposed by this watchdog of over-the-counter trading.

They give examples of situations that have occurred in that particu lar State. I think this is symptomatic of some of the problems that we have under our general antifraud provisions with respect even to intrastate brokers and dealers at the present time when we don't have the means and facilities to deal with them at the present time.

Mr. STAGGERS. Without objection, the statement will be included in the record.

(The document referred to follows:)

[From the Wall Street Journal, June 14, 1963]

INDIANA FEARS SCANDAL IN INTRASTATE STOCKS; SEC SEEKS REFORMS GLIB DEALERS DECEIVE INVESTORS; REPUTABLE BROKERS COMPLAIN REGULATION BY STATE IS WEAK

(By Kenneth G. Slocum, staff reporter of the Wall Street Journal)

INDIANAPOLIS.—"Frankly, I'm holding my breath until I get out of office, for fear there will be a major scandal in the Indiana securities market."

The speaker is tall, distinguished-looking Charles O. Hendricks, who as Indiana secretary of State will remain responsible for the State's securities department until his term ends on November 30, 1964. His statement reflects growing concern over a securities problem, the significance of which reaches well beyond the banks of the Wabash.

The problem involves alleged fraudulent transactions in intrastate securities. These are over-the-counter stocks issued and distributed solely within a State; as such, these securities, and broker-dealers who handle them exclusively, now are exempt from registration with the Federal Securities and Exchange Commission.

Although such stocks and dealers are subject to policing by the State, many reputable brokers contend that the regulatory system in Indiana, like some in other States, is woefully inadequate. Moreover, these critics point out that most dealers specializing in intrastate stocks don't belong to the National Association of Securities Dealers (NASD), and thus escape disciplines imposed by this watchdog of over-the-counter trading.

Proposed reforms

To help remedy such situations, the SEC last week submitted to Congress, among other proposed reforms, a recommendation that would in effect eliminate the exemption from registration for most intrastate dealers. The SEC also proposed that all such dealers be required to belong to the NASD, or some other selfregulatory agency. Meanwhile, SEC agents have been active in Indiana, investigating, claims of some companies to intrastate exemptions for their stocks. Intrastate stocks, for the most part, are issued by companies just getting into business. Major securities houses usually won't underwrite a company's stock issue until it has a record of several years of earnings. So small brokers often handle the issue on a "best efforts" basis, that is, the company gets its money as the stock is sold, instead of in one lump sum as underwriters traditionally handle it.

Major Indiana broker-dealers have no quarrel with the principle of these highrisk, intrastate stock issues or those ethical brokers who specialize in them. The country was built on such speculative investments," one observes. But they say most intrastate stocks are so thinly traded it's often difficult or impossible to determine the going price. This enables some unscrupulous dealers to buy stocks cheaply and sell them at high prices to unsuspecting customers.

A manager of a big Indianapolis securities house says, "As true as I sit here, this sort of thing happens at least once a week: A downstate banker called me to say a client was about to make a sizable investment in an Indianapolis company at $4 a share. But when I ran it down it was bid at 25 cents." Few persons investing in the speculative issues bother to check with bankers or other brokers, he said. "Cases of deceit"

"We hear of pitiful cases of securities deceit almost every day," says Noble Biddinger, president of City Securities Corp., Indianapolis, and a member of a committee of Indianapolis brokers formed recently to combat the situation. "While all of us consider venture capital necessary, we don't think widows, orphans, and thrifty old ladies should be fast talked into putting their savings into them under the guise they are safe investments." He notes that any reflec tion on the securities industry affects all dealers.

28-738-64-pt. 1-8

Lehman Sadler, an Indianapolis attorney who was a State securities commissioner in 1959-60, cites the recent case of a widow who had been left a $22,000 investment in a mutual fund and almost no other income. A roving securities salesman persuaded her to take her money out of the mutual fund and put it in the intrastate stock of a small insurance company. His major pitch was personal assurance that the stock, bought at $1.50 a share (about 25 cents above the going price) would climb to $2 in 6 months. Instead it dived to near $1.

The salesman, confronted with the complaint about his deceptive sales pitch and the fact he had no State securities license, paid back the widow's loss, Mr. Sadler says. Few victims are so lucky, he notes.

Such issues and dealers are not major problems in States, such as California and Illinois, that have strong securities departments and regulations that often are tighter than the SEC's. But both Mr. Sadler, a Democrat, and Secretary of State Hendricks, a Republican, agree that the Indiana Securities Department's shortage of funds and experienced personnel leaves the door open to irregularities. The present Indiana securities commissioner is Martin K. Edwards, 25, a parttime law student, who draws an annual salary of $7,200. He has two investigators, paid $375 a month, who have little pertinent experience. All jobs are controlled by political patronage and usually last 2 years at the most.

"I'm the first to admit my job demands a veteran, top flight attorney," says Mr. Edwards. "We're doing the best we can with what we have."

"What we need are two competent and permanent auditors who can make surprise audits in the field and discern suspicious entries in routine financial reports," says Mr. Hendricks. Indiana legislators failed to approve a recent request to double the securities department's annual budget of $57,000. Currently almost any person can become a securities salesman in Indiana for a $5 fee and a routine credit check, a situation Mr. Edwards is seeking to correct with a proposed entrance examination.

Purporting to fill the policing gap is a new group, the Indiana Broker-Dealer Association, comprised of 28 broker-dealers who specialize in buying and selling intrastate stocks. "We'll kick them out and order members not to buy from them," says the group's president, Walter E. Holt, explaining how it would discipline errant members.

But a considerable segment of the financial community looks askance at the organization. While the NASD is taking no formal position on the group, it has ordered its public relations counsel, Conway & Associates, Chicago, to direct its Hoosier members in resisting the new organization.

Says Frank L. Reissner, former chairman of the NASD Board of Governors and president of the Indianapolis Bond & Share Corp. :"By claiming that they can do the same policing job for intrastate brokers as NASD does nationally, this organization can delude the public into thinking the situation is under control."

SEC activity in Indiana has resulted in injunctions preventing some companies from distributing more stock until they file a full registration with the SEC. These injunctions have been granted on the ground that the companies violated some aspect of the intrastate exemption requirements. Some companies, for example, distributed their stock outside the State.

Mr. CARY. Secondly, these intrastate firms are wholly outside the scope of the pattern of self-regulation, which is otherwise such a significant part of the statutory scheme. Unless the present exemption is deleted from the statute, the enactment of H.R. 6789 will result in the establishment of minimum standards of qualification for all broker-dealers except those in the intrastate category.

Thirdly, when an intrastate broker-dealer restricts himself to the permissible area contemplated by the exemption, he is strictly limited in the securities which he may recommend and sell to his customers. For example, he may not be able to deal in any securities listed on the New York Stock Exchange. It is unfortunate that any brokerdealer is so limited since the very securities that he cannot recommend might be those most suitable for his customers.

Finally, if the Commission suspends broker-dealer registration for a limited period, a firm should not be able to minimize the impact

of this suspension by conducting an exclusively intrastate business during the period specified.

The only feasible way to manage these problems is to require registration of those intrastate broker-dealers who use the instrumentalities of interstate commerce in their business. Registration will allow the Commission to discharge the obligations already imposed upon it by the Congress.

At the same time, it should be made perfectly clear that the repeal of this exemption in no way interferes with the States' regulation of broker-dealers. Section 28(a) of the Exchange Act explicitly reserves State jurisdiction in these areas and this philosophy should and would apply to the intrastate broker-dealers as it does to interstate brokerdealers.

Section 6(b) would dispense with proof of the use of the mails or interstate facilities in the case of Exchange Act violations by federally registered brokers or dealers. I want to emphasize that the primary purpose of this change is not to expand our jurisdiction over registered broker-dealers, which is already comprehensive, but rather to relieve our enforcement staff from the essentially useless task of collecting envelopes or other evidences of the use of the mails or interstate facilities in connection with particular transactions. The amendment will thus enable us to use our resources more productively and eliminate unnecessary expense to the taxpayers.

The use of the mails or facilities of interstate commerce has been viewed by the Congress as a basis for requiring registration by brokerdealers with the Federal Government. Once registration has been effected, there is no constitutional necessity or little good reason why the Commission's power to discipline broker-dealers for violations of the securities laws should depend upon the fact that Federal instrumentalities were utilized in the particular unlawful transactions. There are numerous precedents for this position in the securities acts, including sections 7, 8, and 16(b) of the Exchange Act. It should here be emphasized that dispensing with technical proof of jurisdiction in connection with particular transactions does not affect reliance on the interstate commerce clause as the basis for Federal registration of broker-dealers. Registration would be required only if a broker-dealer makes use of interstate facilities.

Section 6(b) will not place the Commission much further into the regulation of intrastate transactions of registered broker-dealers than it already is. Various general regulations of the conduct of the business, such as the bookkeeping rules, the margin rules, and, as a practical matter, the capital rules apply whether particular transactions are interstate or intrastate, and whether or not the mails or interstate instrumentalities are used in them.

Members of exchanges are subject to certain provisions merely because of their status, as such. Any transaction on an exchange is subject to Commission jurisdiction, even if all of the parties reside in the same State, since a national securities exchange is itself a facility of interstate commerce. More significantly, any use of the mails invokes our jurisdiction, even if the addressee lives across the street. Broker-dealers use the mails in most of their transactions, local or otherwise, if only to send out confirmations, and the great bulk of their