January 3, 1963 (later extended to April 3), the results of its study and investigation together with its recommendations, including such recommendations for legislation as it deems advisable (H.J. Res. 436, Public Law 87-196).

Today the Securities and Exchange Commission has made a report to the Congress, which the Speaker has referred to this committee for consideration. We have scheduled this meeting, accordingly, for the subcommittee to hear the Commission present what have been the results of this study and investigation, and what may be its recommendations including recommendations for additional legislation.

The subcommittee fully appreciates the magnitude of the task which was before the Commission this past year and a half. We took occasion to stress in our report on the resolution creating this study that while the language of the resolution is short and specific, the scope of the resolution is very broad inasmuch as the subject matter covered by the rules or just as significant, not covered by the rules of the securities exchanges and associations is extremely wide in breadth. We shall be very interested, accordingly, in seeing just how the Commission has interpreted this broad mandate, and just what it is recommending.

It is our purpose here this afternoon merely to hear from the Commission on those portions of its full study which it is submitting today, and get some indication of what is yet to come. In view of the fact that the report filed today has not been available to any of the committee before this time, we obviously are not in position at this juncture to enter into any discussion or examination of it.

Mr. Cary, it is a pleasure to welcome you here; and I assume that you are rather happy to have reached this milepost toward the conclusion of your special study. I see you have your colleagues with you, whom you may wish to introduce; and I know you also will wish to introduce Mr. Milton Cohen who has been in charge of this study. STATEMENT OF WILLIAM L. CARY, CHAIRMAN, SECURITIES AND EXCHANGE COMMISSION; ACCOMPANIED BY MILTON H. COHEN, DIRECTOR, SPECIAL STUDY OF SECURITIES MARKETS, SECURITIES AND EXCHANGE COMMISSION

Mr. CARY. Mr. Chairman, I welcome the opportunity to be here and I would like to introduce my colleagues and also the members of the Special Study who have done so much in producing this volume. I would like to introduce Commissioners Woodside, Frear, Cohen, and Whitney.

Then on the other side of this first row, I would like to introduce the persons who are the chief staff directors of the Special Study. I will leave the Director himself to the last, but we have here the Associate Director, Mr. Ralph Saul: Chief Counsel, Richard Paul: Chief Economist, Sidney Robbins; and Assistant Director, Herbert Schick. I have beside me the Director of the Special Study, Milton H. Cohen.

Mr. Chairman, I have the honor to transmit the first segment of this report of the Special Study of the Securities Markets. It is submitted pursuant to section 19 (d) of the Securities and Exchange Act, which was originally House Joint Resolution 438, initiated by this very committee.

At the outset, we emphasize that although many specific recommendations for improvements in rules and practices are made in the report of the Special Study, the report demonstrates that neither the fundamental structure of the securities markets nor of the regulatory pattern of the Securities Act requires dramatic reconstruction.

The report should not impair public confidence in the securities markets but should strengthen it as suggestions for raising standards are put into effect.

Serious shortcomings are apparent, and the report, of course, has concentrated on their examination and analysis. Yet it is not a picture of pervasive fraudulent activity, and in this respect contrasts markedly with the hearings and findings of the early thirties preceding the enactment of the Federal securities laws. The study confirms the strength of those laws, and the heightened sense of obligation of the financial community.

At the same time, the report makes very clear that important problems do exist, grave abuses do occur, and additional controls and improvements are much needed. The tremendous growth in the securities markets over the past 25 years, and most particularly the increased public participation, imposed strains on the regulatory system and revealed structural weaknesses. Some of these problems resulted from inadequacies in established enforcement machinery, both Government and industry. Others reflect patterns of conduct now tolerated but which upon exposure and analysis appear incompatible with the public interest. Testimony to this effect has been given by many responsible members of the financial community in their comments and most vividly in their adoption of higher standards of conduct without compulsion of law. It is these voluntary higher standards which regulation should reflect and make generally applicable. Now, the functions of this report and of any changes proposed are to strengthen the mechanisms facilitating the free flow of capital into the markets and to raise the standards of investor protection, thus preserving and enhancing the level of investor confidence.

Raising capital from the general public is a marked feature of the American economic system. In this country there are now approximately 17 million shareholders. As the study attests, this phenomenon has been advanced and protected by the Securities Acts, a proven legislative achievement. Yet no regulation can be static in a dynamic Society. Unanticipated changes in the markets and the broader public participation should be accompanied by corresponding investor protection.

The importance of the capital markets to our national economic progress does not permit anything less than the most fair and efficient operations. Government and industry regulation, and the efforts of the financial community, must continue to be directed against practices which undermine the integrity of the securities markets and which can only be harmful to the economic growth of this country and to the investors who furnish the funds for that growth.

Now, while the report focuses upon shortcomings in the industry and in the self-regulatory authorities, in certain respects it is an express or implied criticism of the Commission as an institution. The Commission has not fully exercised its powers, nor coped effectively with all of the problems confronting it. But our job, like industry's,

is not to rationalize inactivity but to initiate improvements, and the report of the Special Study will be a force in that direction.

The complete report of the Special Study of Securities Markets will be the most comprehensive of its kind in 25 years. It has been done by separate groups in the Commission designated the Special Study of Securities Markets under, as I have said before, the direction and supervision of Milton H. Cohen.

The Special Study was given freedom to analyze and point out problems as they appeared to it. In this respect the judgments, analyses, and recommendations in the report are those of the Special Study and not of the Commission. However, the Commission has worked very closely with the study throughout, and has gone over every section of the report. We believe that the report is a thoroughly responsible document. We do not embrace every recommendation as our own, but we do accept them as a sound point of departure.

Now we are transmitting in this small bundle chapters I through IV and chapter IX. The remainder of the report, while nearing completion is not available at this time essentially because of the scope of the undertaking. The chapters submitted in many respects disclose problems calling for vigorous and prompt responses by the Commission and the industry.

The Commission will very shortly recommend to the Congress certain legislative proposals, which I will outline now, where the present statutory scheme appears inadequate. An important part of these reflects our continuing belief in self-regulation as an ingredient in protection of the investor. Certain deficiencies can be treated through rulemaking by either the Commission or self-regulatory agencies. Still others can be resolved only by a more uniform and voluntary adoption of improved procedures by members of the industry.

The report begins where regulation must begin, at the point of entry into the business. It is self-evident that the standards of conduct of the securities industry are vitally dependent on the integrity and competency of its personnel. Obviously no system can be devised which eliminates all potential wrongdoers. But the report of the Special Study concludes that minimal controls furnished by existing regulation are inadequate. Ease of entry is apparent under both Federal law and the rules of the National Association of Securities Dealers, the self-regulatory agency for the over-the-counter market. With the exception of the major exchanges, significant standards of character, competence and minimum capital have not been generally imposed nor has attention been sufficiently directed to the unique problems of supervisors such as branch managers and research analysts. Furthermore, certain sectors of the industry, including most importantly certain distributors of mutual funds and real estate securities and also investments advisers, are not subject to the discipline of self-regulation.

We shall, therefore, recommend to the Congress legislative proposals roughly as follows:

One, authorizing standards of character, competence and financial responsibility as conditions for entry into the business to be established and administered by the National Association of Securities Dealers, notably the NASD, which will complement similar regulation by the exchanges of their members.

Second, requiring all firms and individuals to be subject to the authority of one of the self-regulatory agencies.

Third, granting the Commission direct disciplinary controls over individuals and perfecting NASD controls in this area.

Fourth, providing the Commission with intermediate sanctions over firms and individuals.

Moving on to the second area, selling practices: The heightened public participation in the securities market severely tested the adequacy of controls particularly in the area of selling practices and investment advice. The examples of sales techniques cited by the study show a striking spectrum; from the illegal operations of boiler room to the disciplined patterns of the responsible, reflecting elaborate supervisory procedures and voluntary codes of conduct. Even in the latter which represent high standards of achievement, serious lapses have occurred. Yet it is their best standards which, if universally followed, would result in increased investor protection. Certain excesses also appear to have developed in the investment advisory materials of both broker dealers and investment advisers as evidenced by fanciful recommendations based on little more than mere rumor. Here again, uniform application of the best industry practices would seem to be in order. In this area legislation is not presently recommended. Powers exist in the self-regulatory institutions and the Commission to advance selling and investment advisory practices.

Going on now to the question of distributions of new issues. The mechanism, practices, and rules for distributions in the securities markets are examined in the report with particular emphasis on the socalled "hot issue" phenomenon that accompanied the active and rising markets of the late 1950's and the early 1960's and involved primarily companies going to the public for the first time. I know by the way this was one matter which concerned this committee when House Joint Resolution 438 came before it.

A record flow of these new issues was another critical trial for both the regulatory pattern and industry practices. The findings of the report do not invalidate this pattern or those practices. At the same time particular weaknesses have developed, and their elimination should strengthen the distribution mechanism without impairing access to the capital markets. Most of these can be remedied by rules of the Commission and the NASD with one important exception. At present a prospectus containing business and financial information about a company must be delivered to the purchasers of the company's stock during a period of 40 days after a registered public offering of that stock. The findings of the report and the Special Study demonstrate that particularly in the case of new issues dramatic price movements may result from uninformed investor action and that minimum exposure of financial and public information is crucial to securing knowledgeable evaluation of these securities. The Commission will, therefore, recommend to the Congress, that in the case of new issues the 40-day period be extended to 90 days or such shorter period as the Commission may prescribe by rule or order.

Now, I should like to move on to the area of broader disclosure provisions. Much of the material submitted here evidences the fundamental importance of adequate disclosure by issuers as a most vital means of investor protection. The report points out the broad range

of problems and abuses in the securities market, including improper selling practices, misleading public relations, irresponsible investment advice, and erratic aftermarkets for new issues which can be greatly mitigated by the more complete availability and dissemination of financial information. The report further demonstrates, as have prior studies, that the longstanding contrast in the disclosure protections afforded investors owning securities listed on national exchanges, and investors owning securities traded in the over-the-counter market is not warranted. Issuers of over-the-counter securities, unlike their listed counterparts are under no obligation to comply with the Commission's proxy rules or, except in certain cases, to furnish annual and periodic financial reports. Another void in investor protection in the over-the-counter market relates to insider trading. An insider of a listed company must report his transactions in the company's stock. His short swing trading profits in the stock are recoverable by the company and he is prohibited from selling the stock short. The policies expressed in these sections should also be applicable in the over-the-counter market.

Accordingly, the Commission will recommend extension of those sections of the Securities Exchange Act which provide for the filing of annual and periodic reports, compliance with the proxy rules, and protections against insider trading to certain companies whose secuities are traded in the over-the-counter market. A phased program of coverage would gradually include all those companies with 300 or more shareholders. In the case of bank stocks which appear to account for 20 percent of the issues of the over-the-counter market, if Congress so desires, disclosure requirements could be administered by the appropriate Federal bank regulatory authorities in order to integrate these controls with the existing pattern of bank regulation.

Finally, an analysis of the over-the-counter market will be submitted in our complete report; it is not available, may I say, in this material that is coming to you today. At this time, however, we wish to inform the Congress that we shall propose a legislative recommendation essentially directed to the wholesale quotations system in that market. At present the National Quotation Bureau dominates the business of over-the-counter wholesale quotations.

The bureau, a private corporation, I sometimes refer to it as a oneman public utility, is not regulated by any agency, Federal, State or self-regulatory. Despite the efforts of the bureau, which is operated with a consciencious regard for the responsibility which its function and dominant responsibility entails, this vital segment of the over-thecounter market has had inadequate controls. Numerous abuses involving quotations have been perpetrated by broker-dealers. Moreover, developments in electronic data processing have foreshadowed the emergence of new and perhaps revolutionary quotation systems. view of the vital significance which these systems can have to the functioning of the over-the-counter market, they should not be allowed to emerge without due regard to the welfare of the market and to the public interest.

Accordingly, the Commission will recommend to the Congress that operators of quotations systems, like the National Quotation Bureau, be required to register with the Commission and adopt and enforce rules of fair practice in the use of their systems just as is presently the case with the self-regulatory agencies.