parison with the requirements of the Commission's rules. Moreover, there is no provision under State regulation for timely disclosure of events of major importance to investors, such as major acquisitions of assets, significant litigation, or the issuance of substantial amounts of stock. In contrast, the Commission's form 8-K, the filing of which would be required by H.R. 6789, must be filed soon after the occurrence of any of these material events. Furthermore, State regulation has nothing comparable to the Commission's proxy ruleswhich place financial and business information in the hands of the shareholders, nor does it provide any substitute for the various safeguards against insider trading.

The Special Study's examination of the reporting practices of insurance companies confirms that State regulation has not in the past produced the flow of necessary basic information that will result from H.R. 6789. In the category of companies in the study survey that would be covered by H.R. 6789, 12 percent failed to furnish any financial information to shareholders and 50 percent did not supply an income statement. Proxy soliciting practices were even more inadequate. Eight percent of the companies responding did not transmit any proxy material to shareholders. When shareholders were furnished these materials, the information provided was almost always greatly inadequate by standards applicable to listed companies. The serious weaknesses in this area were noted in a 1960 report by a subcommittee within the National Federation of Financial Analysts Societies:

"It is our conclusion that annual reports (to stockholders) of the life insurance industry are the poorest of any major industry in the United States." There may well have been improvements since that date; the findings of the report seem to indicate they are modest ones.

Insurance companies should be the first to appreciate a primary aim of H.R. 6789-to provide investors with adequate information. They continuously invest other people's money and rely on the adequacy and reliability of the disclosures about the companies in which they invest. Those who invest in insurance companies should be entitled to no less reliable information. The importance of publishing and disseminating financial information about a company, of course, rests firmly on the desirability of informed investor judgment. However, the absence of this information is also conducive to fraudulent practices and overreaching-which have occurred in recent years with an undesirable frequency in insurance company promotions. The assets and liabilities of insurance companies are usually of an intangible nature and, despite the vigilance of the State insurance commissioners, opportunities do exist for manipulation of these assets and liabilities by insiders in a manner detrimental to the interests of investors.

The insurance business has grown rapidly in the last decade. During the 10year period from 1951-61, the number of life insurance companies in the United States has more than doubled, from 659 to 1,457, with a high concentration of this growth in the South and Southwest. Many of the new insurance companies which emerged during this period were inevitably promotional to some degree and their operations presented problems of investor protection. In its 23d annual report (1957), the Commission, describing its most pressing enforcement problems, included this statement:

"Recent economic conditions have been relatively favorable for the sale of promotional stocks of new ventures, particularly in fields in which the securities of established enterprises have shown marked gains. For example, many new insurance and financial ventures have been promoted, particularly in the southcentral, southwestern, and southeastern parts of the country, and their securities have been distributed either through registration or regulation A, or more commonly in reliance upon the intrastate exemption. Many of these issues and the sales techniques employed in their distribution appear to involve abuses and possible violations of the antifraud and other provisions of the Securities Act or the Securities Exchange Act, which require extensive investigation. The large number of these promotions and the rapidity with which they have increased has placed a most serious burden on the Commission's field enforcement personnel charged with the conduct of such investigations."

Similar statements were made in the 22d and 24th annual reports of the Commission and these problems have not disappeared.

Special questions have been raised with regard to the financial reporting problems of life insurance companies. I should therefore like to describe the Commission's procedures and requirements respecting these companies-an area in

which the Commission has already had broad experience, as evidenced by the approximately 100 life insurance companies now filing annual and periodic reports.

At the outset a few basic points should be noted. First, the enactment of H.R. 6789 will not introduce new accounting regulations or alter the accounting practices of life insurance companies. There will be no need for a separate set of books or the establishment of new procedures. Second, life insurance companies can satisfy the financial reporting requirements of the Exchange Act essentially by filing the reports prepared annually for State authorities. Indeed, these reports must conform to the requirements of the State insurance commissions. Third, the reports filed with the Commission need not be certified by independent public accountants. These points reflect present Commission policies. The Commission has made very clear in a letter to Senator Robertson during the hearings on S. 1642 that it expects to continue to follow these policies in the future and the Senate committee report stated it expects the Commission to do so. I should briefly like to expand on these points, which are embodied in proposed article 7A to our regulation S-X. This proposed article specifically governs the financial statements of life insurance companies and basically embodies Commission practices. Comments have been received on the proposal and, as revised, it will be presented to the Commission for adoption after further conferences with interested parties.

I should first reemphasize that the financial reports filed by life insurance companies under the Exchange Act are not required to be recorded, certified, or audited by independent public accountants. Company officials may, in effect, file with us the financial statements which they file with the State insurance commissioners, together with certain additional explanatory notes. There is apparently an erroneous impression in the life insurance industry that an independent audit would be required under the bill. The facts are that the financial work of the company's own employees exclusively will be accepted under H.R. 6789. This has been the practice of the Commission for 30 years and, as I have stated, we are committed to continue it.

Moreover, article 7A does not prescribe any method of reporting which is inconsistent with the methods of reporting required in the annual statement blank adopted by the National Association of Insurance Commissioners. Indeed, the proposed article does not require the reporting of any financial information to the Commission which cannot be obtained from data contained in some form in the uniform NAIC annual statement or which is not otherwise readily available. The only difference between the reporting that will be required by the proposed Commission article and that currently required by the States is that the former will include substantially less detailed information pertaining to insurance matters than that included in the NAIC statement. The only other change is that the proposed article would require certain brief explanatory notes, including a historical analysis of surplus, for the benefit of investors not conversant with insurance accounting practices and terminology. I have gone into these points in more detail in letters to Chairman Harris and to certain of the State insurance commissioners, and I would like to offer those letters for the record.

We stress that, as in the case of over-the-counter companies generally, insurance companies will not encounter difficulties or incur significant expenses in satisfying the provisions of H.R. 6789. Indeed, an important expense for most companies will be an audit by an independent certified public accounting firm— which is not required for insurance company reports under Commission praetice. Moreover, as we have pointed out, insurance companies must already file detailed financial reports in each State exercising jurisdiction over them and presumably have adequate staffs to cope with the reporting requirements of State regulation. Their compliance with H.R. 6789 should prove to be a matter of relatively small additional cost and burden. To further coordinate our efforts with the insurance commissioners, we have suggested to them that it would be possible, if the National Association of Insurance Commissioners so desired, to modify the convention blank by adding an additional page of notes after the principal financial statements containing the explanatory material which we need. Should this be done, a life insurance company could simply file with us a copy of its filing with the State insurance commissioners as full compliance with the financial portion of its report.

It should also be kept in mind that the great majority of life insurance companies subject to the bill will be very substantial in size and that the companies meeting the minimum requirements are not small enterprises in any real

sense of the word. In the study's analysis of insurance companies meeting t statutory tests, over 50 percent had over $10 million in assets; at the lower e of the scale, only 18 percent had between $1 and $2 million in assets. Finall in this connection, I note that, of the estimated 400 insurance companies th would be covered by the bill, 126 are already required to file periodic repor with the Commission under section 15 (d) of the Exchange Act. For these co panies, the chief additional expense will be in complying with the proxy requir ments of the bill.

In summary, the importance of insurance companies to the public as a mediu of investment is undeniable. Yet the information available about many of the companies is totally inadequate. It seems clear that only H.R. 6789 will provid that minimum amount of data necessary for informed investing. Because the applicability of the reporting requirements to almost 150 insurance companie investors in some of these companies are already receiving partial protection Complete protection for investors in all insurance companies meeting the stat tory standards is necessary and desirable.

In opposing the provisions of the bill, representatives of insurance companie have pointed to the possibility of action in the areas covered by the bill by th National Association of Insurance Commissioners, which then presumably woul be implemented by the 50 States. Undoubtedly any developments with respec to proxy or insider trading regulation would require action by the 50 Stat legislatures. Thus, there would be no guarantee of immediate response, o assurance of uniform standards. The findings of the study demonstrate tha action is needed now. Because of the widespread investor interest in insuranc companies-not limited to State lines-that action should be on the Federal leve and in the context of a statute which applies to all companies, whatever their business, and establishes nationwide, uniform minimum standards. The neces sity for such standards in the securities markets, of course, was a basic reason for enactment of the Federal securities laws. Moreover, it is clear that H.R 6789 would not infringe upon action by the States; for example, the various States could impose more restrictive rules on insider trading than those con tained in the bill. All of the Federal securities acts specifically allow action by the States in the areas covered, limited only by a requirement that such State action not be inconsistent with the Federal statutes and rules. H.R. 6789 follows this same pattern.

In the opinion of the Commission it is most important that insurance companies be included under H.R. 6789. The Senate has approved this judgment in its passage of S. 1642 and the Commission strongly urges the House of Representatives to do the same.

I. THE INSIDER TRADING PROVISIONS

We have thus far focused on the extreme importance of extending basic disclosure principles to the over-the-counter market. Prior proposals to equalize protections between markets have included as a necessary ingredient safeguards against insider trading abuses provided by section 16 of the Exchange Act. This necessity still prevails; accordingly, H.R. 6789 would make section 16 apply to those over-the-counter companies to be covered by the reporting and proxy requirements.

The Commission's experience in administering the securities laws has demonstrated the need for this portection in the over-the-counter market. The analysis of the Report of the Special Study supports this experience. The absence of adequate disclosure by over-the-counter companies, the difficulties of preventing insider trading misconduct through traditional enforcement procedures, the lack of data concerning the volume and prices of transactions, and the important extent to which insiders control over-the-counter companies-these factors create conditions conducive to insider speculation and manipulation on the basis of information not available to the public. Expanded interest in over-the-counter securities, together with greater volatility in the market for many of these securities in the postwar period, has added to the potential for abuse. The extension of section 16 should have as sound an effect as it has had in the exchange markets.

These provisions, of course, do not prevent an insider from investing in his company's stock. He may buy or sell as much as and whenever he pleases. However, because of his fiduciary relationship to the issuer, he must report his securities transactions, disgorge not-swing profits, and not sell his company's stock short.

Section 8(b) of the bill exempts from the profit recovery provisions of section 16(b) and the short-selling prohibitions of section 16(c) transactions by a dealer which are part of his ordinary trading activities in a company's securities and incident to his establishment or maintenance of a primary or secondary overthe-counter market for those securities. This provision is designed to take care of the so-called sponsorship problem.

As a result of a prior connection with a company, most usually as underwriter, it is claimed that a dealer necessarily undertakes to make a market in its securities-in other words, act as a "sponsor." In addition, because of his broad financial experience, he is sometimes sought as a member of the board of directors. If section 16(b) were applied to market-making transactions by broker-dealer directors, they would be compelled to cease their market-making activities or resign their directorships. This "director-market-maker" issue has been a subject of concern in prior legislative proposals. The Report of the Special Study found that this combination involved a little less than 10 percent of all registered broker-dealers and an estimated 13 percent of those over-thecounter securities which evoked some trading interest during a 10-month period examined by the study.

The Report of the Special Study recommended the general application of section 16 in this area, with exemptive power in the Commission. H.R. 6789 takes a somewhat different approach and would permit the continuation of the joint function of market-maker and director under certain conditions. Under this section, the Commission would have rulemaking power to prescribe the terms under which securities would be deemed held in an investment account and under which transactions would be considered made in the ordinary course of business incident to the establishment or maintenance of a primary or secondary market. The Commission would also have power to define each of these terms. The proposed section would avoid the necessity of considering applications for exemption on an ad hoc basis, as recommended by the Special Study Report.

Insofar as broker-dealer insiders are concerned, the Commission has special powers to curb the misuse of inside information. Analysis of the reports which would be furnished pursuant to subsection 16(a) and the periodic inspections of dealers by the Commission's staff will serve as a deterrent. Moreover, overreaching by the actual abuse of inside information would violate the antifraud provisions of the securities acts and would be the basis for administrative action against a firm.

J. OTHER PROVISIONS OF THE REGISTRATION REQUIREMENTS FOR
OVER-THE-COUNTER COMPANIES

Securities issued by foreign companies and certificates of deposits issued against such securities initially would be exempt from the proposed registration requirements for over-the-counter securities. The commission could terminate the exemption for a class or classes of such securities only upon a finding that they enjoy a substantial public market in the United States and that continued exemption is not in the public interest or consistent with the protection of investors. These procedures would afford interested companies, brokers, dealers, and investors adequate opportunity to bring to the Commission's attention all relevant considerations.

In principle, U.S. investors in foreign securities ought to be afforded the same protections as are provided for investors in domestic securities. As a practical matter, however, enforcement of the pertinent provisions of H.R. 6789 against foreign companies outside the jurisdiction of the United States would present serious difficulties. Many of these companies have no assets or operations in the United States, have never sought funds in the American capital markets, and have never listed a security on an exchange. Even in the case of listed securities, where companies voluntarily assume certain obligations, the Commission has found it necessary to provide an exemption from the proxy and insider trading provisions for foreign issuers other than North American and Cuban companies.

The Commission believes that H.R. 6789 affords the most effective and prac tical solution to the foreign security problem. It takes account of the difficulties of enforcement against foreign companies, provides the possibility of greater protection to existing trading markets in foreign securities, and permits the Commission to deal flexibly with the application of the disclosure requirements in the context of particular issuers or classes of issuers.

28-738-64-pt. 1——-9

Under section 3(d) of the bill, the Commission would have broad powers exempt companies, persons, and securities from the reporting, proxy, and i sider trading provisions. Exercise of these powers-together with a broad a thority to classify-will permit a responsible accommodation of the requirement of the public interest with the varied circumstances of over-the-counter securitie and their issuers. For example, if there were any company with no busines activity or very limited trading interest, it could be exempted from all bu minimal reporting requirements.

K. OTHER AMENDMENTS PROPOSED BY H.B. 6789

In addition to extending the disclosure protections of the Exchange Act various provisions of H.R. 6789 are intended to make the basic disclosure philos ophy of the securities acts more effective. A most important one of these, se tion 11 of the bill, would amend section 4(1) of the Securities Act of 1933 t extend the present 40-day requirement for delivery of a prospectus by a deale to 90 days for new issues a registered offering by a company which has no previously sold its securities pursuant to an effective registration statemen under the Securities Act.

As indicated by the Report of the Special Study of Securities Markets, during the years 1959 to 1961, the flotation of new issues reached the highest level in history. "Hot issues," usually stocks of companies in certain "glamour" indus tries, were eagerly sought in the expectation that their price would quickly rise to a substantial premium. Sometimes this expectation was fulfilled; but in many cases the market price of a "hot issue" later fell to a fraction of its original offering price.

The Report of the Special Study pointed out that substantial redistributions of "hot issues" often occurred through trading after the original offering was purportedly completed. These redistributions were frequently marked by intensive sales efforts by dealers to solicit purchases at high premiums over the initial offering prices. The Report of the Special Study concluded that:

"* * * persons who bought in the aftermarket often were less sophisticated and more susceptible to the allure of publicity and rumor about 'hot isues.' These persons, who frequently purchased at premium prices, probably needed the benefits of the information contained in the prospectus more than the original distributees. Yet in many cases they never saw a prospectus or offering circular."

The Commission believes that a period of 90 days is a more realistic appraisal of the time during which the actual distribution process continues in the case of many new issues. This requirement is, of course, substantially shorter than the 1-year period, which prior to 1954 was required by section 4(1) for delivery of prospectuses for all issues.

This proposed amendment of section 4(1) will not be a cure-all for the "hot issue" problem. It will, however, assist in the establishment of more orderly and informed trading in the aftermarket. Under this amendment, the Commission also could, where appropriate, shorten either the 40- or 90-day period in the case of companies for which a reservoir of public information exists. This will permit greater flexibility in the administration of the disclosure requirements of the Securities Act of 1933.

Other sections of H.R. 6789 amending the Exchange Act would also reinforce the fundamental disclosure principles. Under section 5(c) a company subject to the proxy rules which did not solicit proxies would be required to furnish shareholders with information equivalent to that contained in a proxy statement prior to the annual or other meeting of shareholders. At the present time avoidance of the disclosures required by the proxy rules is made possible by the simple device of not soliciting proxies. Thus, mantockholde in be deprived of material information. The New York Stock ire issuers of securities listed on that exchange to solicit p American Stock Exchange has embarked on a program It. ever, similar requirements as to listed or unli all other exchanges or by any other authori would be accentuated by the extension of companies where nonsolicitation could occur ment's relatively larger holding holders in over-the-counter assured of informed voting