Mr. KEITH. I know it is in the report. I just wanted to be certain that you knew the instance.

Mr. CARY. Yes, sir.

Mr. KEITH. What do your recommendations do to correct that kind of a situation?

Mr. CARY. Well, sir, the steps we are taking certainly should provide some solutions to those problems. First of all, I would think the steps we are making in connection with selling practices would be helpful. Another vital point is better supervisory controls over branches in these large firms.

One of the things that we are doing in following up on the study is to try to force the level of supervision of these large firms to a higher point than it has been in the past. I think that will definitely be a factor. The facts of the matter are in that case, if I am not mistaken, that the particular brokerage firm there involved reimbursed all persons who had been damaged in connection with it. It was the result of activities by two or three branch offices all located in a very narrow area in California.

Mr. KEITH. As I read it here, it is much broader in scope than that, because they talk about 10 new New York Stock Exchange member firms who were involved, some 80 different retail brokerage firms selling 600,000 shares of stock.

The point I am trying to get to is that here are some highly regarded member firms of the stock exchange where presumably the personnel has not much changed in those organizations today from what it was at the time this took place. Under the philosophy that you are recommending for the policing of the securities business as a whole, it is to enlarge the membership and the scope of activity of organizations like the New York Exchange, further removing yourself from this particular area of policing. It would seem to me, pursuing the line of Mr. Glenn, that there is something to be said for the point of view of these independent operators who want to have the policing by the SEC, particularly with reference to mutual funds. It might be that the public interest would be better protected by more direct supervision by the SEC than by further extending the self-regulating power and responsibility.

Mr. CARY. Congressman Keith, if I could start to answer that and then ask two people from the Commission to answer, I would appreciate it. First of all, let me say that there were some remedies in that particular case. I believe the partner of that firm who was involved is no longer active in that firm.

Second, disciplinary actions are either underway or have been undertaken, and we are participating in that as well as one of the regulatory agencies. I will have to leave that to Mr. Saul to give us further details.

I think you can be sure, further, that although we are vesting some further responsibilities, as you indicate, in the exchanges and in the NASD, we also feel that as we do so, our oversight has to be deeper than it has been in the past.

Finally, I want to assure you that we will not cede jurisdiction with respect to major fraud cases, for example, and disciplinary actions of that type, to those agencies exclusively.

We feel that when a violation of the Federal laws is involved, we ought to step in. Indeed, we do in cases of that kind.

I think those are some of the points that may be in response to your question, but I think I may not have fully covered it. I would like to ask Mr. Saul or Mr. Loomis to speak further to it.

Mr. SAUL. Congressman Keith, I just have one further point to add to what the Chairman said, and that is on the Aquafilter situa tion, it was described in the report primarily as an example of a breakdown, a partial breakdown, in controls over branch offices. One of the things that has concerned the Commission, and which was a subject of study of the Special Study Group, was this supervision of branch office personnel.

What you witnessed in the Aquafilter case was this problem of supervision of branch offices. It was primarily that the Aquafilter situation was placed in the report as an example of that problem of supervision.

We recommended in the special study, and this was recommendation No. 1 of part B of chapter III, dealing with selling practices. that the supervision by broker-dealers of the selling activities of their personnel, particularly in branch offices, should be generally strengthened by the adoption of appropriate procedures, and se

on.

Mr. KEITH. I think that is self-evident. One of the first principles of any command or procedure would be to do just exactly what you recommended. Of course, what we learn is by example. What did you people do in the way of exercising your responsibility? How many people did you prefer charges against in connection with this?

Mr. SAUL. There has been a significant action taken, Congressman Keith, since the Special Study Report. The New York Stock Exchange has put into effect new procedures for the inspection and supervision of personnel.

Mr. KEITH. I think Mr. Cary led me to believe that you took action yourself. What did you do?

Mr. SAUL. In the Aquafilter case, no action has been taken. As I mentioned, I think it was primarily a problem of supervision, so far, at least; on the facts that we had available, it did not appear to be the basis for disciplinary action to be recommended to the Commission.

Mr. KEITH. In other words, there was no real misrepresentation of the situation to the buying public that needed the attention of the SEC?

Mr. SAUL. No, I think, Congressman Keith, it goes beyond that. I think it is primarily a problem of supervision. As we saw it, it didn't seem to involve a question of Commission disciplinary action. It seemed to me that the problem involved a much larger problem and that is the problem of supervision of branch offices. I think that the New York Stock Exchange has been taking significant steps in that direction.

It would seem to me that that is the area, the more significant area, where action should be taken.

Mr. KEITH. I would say that they would be encouraged to take this action if they found some direction on the part of the SEC if there were as many as 600,000 shares of stock sold to more than 2,000 investors who suffered substantial losses.

Mr. CARY. May I ask Mr. Loomis to supplement this with his knowledge with respect to this particular case?

Mr. LOOMIS. I would like to add a few things to what Mr. Saul said. This was an example of the type of thing that went on during this "hot issue" period, and in addition to the supervision problem that Mr. Saul described, there was the problem of salesmen giving advice upon the basis of insufficient information, and lots of rumors being circulated around and planted by various people which were uncritically picked up by securities salesmen and repeated.

That isn't the type of thing necessarily that you discipline a person for until you have raised the standards. There is one other important aspect, also: This was an over-the-counter company, and although it had a large number of stockholders, as pointed out, it was not reporting and there wasn't reliable information available about it, with the result that the vacuum was filled with all types of miscellaneous misinformation, the sources of which none of us were able to check. So in addition to the things which Mr. Saul has suggested, certainly the study recommendations with regard to the quality of investment advice, the requirement that people check the sources of their information, and the material proposed by this bill, to require over-the-counter companies to report so that there would be some reliable information available, would contribute to the solution of this problem.

The broker-dealer firm that was principally involved in selling this stock to the public, when it learned of the fact that its salesmen had gone off the deep end, so to speak, reimbursed the investors for their losses. This was another reason why we didn't think it necessary to act agains that firm. Under present law, we couldn't act against the salesmen individually.

The bill you have before you would remedy that defect so that if the case occurred again, we could proceed against the individual salesman without having to proceed against the whole firm when it had done all it could to make good and try and clean up the situation.

Mr. CARY. I might want to ask Mr. Loomis to clarify one thing I have said, Congressman Keith. I indicated that I thought action was taken with respect to the partner in charge of the branch office there by one agency or another, and I may be incorrect. I would like to ask him to clarify that point for the record.

Mr. LOOMIS. I believe that is incorrect. I think that the chairman may have had in his mind the other cause celebre which is described in the study where that did happen.

Mr. KEITH. My point, Mr. Chairman, is simply to try and develop the sensitivity on the part of the Congress of the need to keep the SEC's responsibility very clear in such an instance as this sort, and to show that we are not going to solve things just by going along with the Senate version which makes mandatory membership in the National Association of Securities Dealers or some association of mutual fund dealers.

There may be certain value to having the SEC maintain a closer responsibility for supervision than would be the end result if we further strengthened the NASD or created a mutual fund organization for that purpose.

I notice it is 5 o'clock, Mr. Chairman. I appreciate very much your letting me ask these questions.

Mr. CARY. I just want to repeat my assurance that we will not be ceding jurisdiction. This is using the NASD as a medium to raise standards, as a vehicle to raise standards, which we think would supplement activities in which we are already engaged.

Mr. STAGGERS. Mr. Chairman, all of us want to thank you for your presentation today. You are certainly patient and have great help in explaining the matters before us. To me, the job is increasingly difficult. We have many things to go into in this hearing. If you will agree to return again at 10 o'clock tomorrow, we will resume. (Whereupon, at 5 p.m. the subcommittee recessed, to reconvene at 10a.m., Wednesday, November 20, 1963).

INVESTOR PROTECTION

WEDNESDAY, NOVEMBER 20, 1963

HOUSE OF REPRESENTATIVES,
SUBCOMMITTEE ON COMMERCE AND

FINANCE OF THE COMMITTEE ON

INTERSTATE AND FOREIGN COMMERCE,

Washington, D.C.

The subcommittee met at 10 a.m., pursuant to recess, in room 1334, Longworth Building, Hon. Harley O. Staggers (chairman of the subcommittee) presiding.

Mr. STAGGERS. The subcommittee will come to order, please.

As we recessed last night, Mr. Cary was answering questions of the committee. At this time we will commence with Mr. Curtin. Mr. Curtin?

STATEMENT OF WILLIAM L. CARY, CHAIRMAN, SECURITIES AND EXCHANGE COMMISSION; ACCOMPANIED BY BYRON D. WOODSIDE, COMMISSIONER; MANUEL F. COHEN, COMMISSIONER; JACK M. WHITNEY II, COMMISSIONER; PHILIP S. LOOMIS, JR., GENERAL COUNSEL; EDMUND H. WORTHY, DIRECTOR, DIVISION OF CORPORATION FINANCE; ALLAN F. CONWILL, DIRECTOR, DIVISION OF CORPORATE REGULATION; RALPH S. SAUL, DIRECTOR, DIVISION OF TRADING AND MARKETS; WALTER WERNER, DIRECTOR, OFFICE OF PROGRAM PLANNING; ANDREW BARR, CHIEF ACCOUNTANT; ARTHUR FLEISCHER, JR., EXECUTIVE ASSISTANT TO THE CHAIRMAN; AND MORGAN SHIPMAN, SPECIAL COUNSEL. OFFICE OF PROGRAM PLANNING, SECURITIES AND EXCHANGE COMMISSION-Resumed

Mr. CURTIN. Thank you, Mr. Chairman.

Chairman Cary, I want to first congratulate you on a very fine presentation yesterday. You had an extremely lucid statement which you presented very well.

Mr. CARY. Thank you, sir.

Mr. CURTIN. There are, however, one or two features of this proposed legislation on which I have some questions, one of which is this compulsory membership in NASD.

As I understand section 6(a), it provides compulsory membership by broker-dealers in NASD or any similar private, self-regulatory industry group, which might be registered with the SEC; is that

correct?

Mr. CARY. That is correct, sir.