Third, the reports filed with the Commission need not be certified. by independent public accountants. That is a notion which appears to be generally held, but it simply is not true. 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 7-A 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 7-A of regulation S-X 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 this letter for the record. Mr. STAGGERS. They may be included in the record. SECURITIES AND EXCHANGE COMMISSION, Hon. OREN HARRIS, House of Representatives, Washington, D.C. DEAR MR. HARRIS: This is in reply to your letter of August 14, 1963, requesting our comments on a letter you received expressing opposition to S. 1642 insofar as it would include "small life insurance companies." You describe this letter as representative of many being received by you and other Members of the Congress. As you know, S. 1642 has passed the Senate and is now pending before the House. ! along with its House counterparts, H.R. 6789 and H.R. 6793. For convenience İ in this letter, I shall designate the pending legislation by reference to H.R. 6789. | I H.R. 6789 would apply the reporting requirements, proxy rules, and insider trading provisions of the Securities Exchange Act of 1934-presently applicable ¦ to listed companies-to any over-the-counter company having more than $1 million of assets and a class of equity securities held of record by 750 or more persons. After 2 years, or a longer period if the Commission determined, the stockholder requirement would drop to 500. H.R. 6789 applies to stock companies, not mutual insurance companies, because the latter do not have stockholders as such; and--even more important-there are no shares being traded. Thus, in answer to the letter, the bill does not "discriminate" in favor of mutual companies; the same need for investor protection does not exist for them. The report of the Special Study of Securities Markets found that stock insurance companies, on the other hand, constitute an important part of the over-thecounter market and urged that investors in them need the same protections as investors in other over-the-counter companies. The Commission strongly agrees with this recommendation, and stock insurance companies are covered by H.R. 6789. However, the bill does not blanket in small companies. As already stated, no company having less than 750 shareholders (or 500 after 2 years) is involved. We estimate that only about 400 insurance companies meet the standards of H.R. 6789, of which approximately a third are already subject to our reporting rules. The information available on these 400 companies indicates that they have over 1,300,000 shareholders and the market value of their outstanding shares is over $20 billion. It is thus clear that insurance companies represent substantial centers of investor interest in the over-the-counter market. II The letter states the opinion that insurance companies are now quite adequately regulated by State insurance authorities. From the beginning, Congress has been of the view that investors in insurance companies need all of the protections afforded to those in all other businesses by the Federal securities laws. When an insurance company goes to the public for funds, it must comply with the Seenrities Act of 1933 and provide complete information. Moreover, approximately 150 insurance companies, including about 100 life insurance companies, are now subject to the reporting requirements of the Exchange Act as a result of having made a registered offering of securities. The market value of the shares of 126 of these insurance companies (as to which information is presently available) is over $5 billion; their number of stockholders is estimated at approximately 700,000. Existing State regulation of insurance companies, designed primarily to safeguard policyholders, is not an adequate substitute for the investor protections provided by H.R. 6789. The functions of H.R. 6789 are to make available reliable financial and business data as a base for the exercise of informed investment judgment and to prevent abuses by insiders in securities trading. The aim of insurance regulation, on the other hand, is to safeguard policyholders' claims against a company. Accordingly, the stress is laid upon the adequacy of reserves and upon investment in conformity with specified standards. In other words. a company may be sound enough to meet its obligations, but its stock may or may not be a worthwhile investment for the public. No one, not even a sophisticated financial analyst, can arrive at a judgment as to a stock's merits unless there is adequate information available. Disclosure, therefore, is necessary to protect at least 1,300,000 owners already having more than $20 billion invested in the insurance companies covered by the bill. 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 insurance companies studied in the special study report that would be cov ered by H.R. 6789, 14 percent failed to furnish any financial information to stockholders and 50 percent failed to supply an income statement. Proxy soliciting practices were even more inadequate. The serious weaknesses in disclosure practices were noted in a 1960 report by a group of financial analysts: "It is our couclusion that annual reports [to stockholders] of the life insurance industry are the poorest of any major industry in the United States," 12th Annual Report, National Federation of Financial Analysts Societies, page 12 (1960). Of course, the general protections against abuses by insiders in securities transactions have no general counterpart in State insurance regulation. 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. III The various disclosure requirements of H.R. 6789 also have a beneficial effect in protecting against overreaching-of importance in the insurance company industry where there has been extensive promotional activity. The insurance company business has expanded immensely in the last decade: from 1951 to 1961 life insurance firms in the United States have more than doubled, from 659 to 1.457, with a high concentration of this growth in the South and Southwest. Many of these companies which emerged during this period were inevitably promotional to some degree and their activities posed problems of investor protection. In its 23d annual report (1957) this 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 south-central, 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. In this connection, I enclose a copy of a memorandum submitted during the hearings on S. 1642 which details certain fraud cases involving over-the-counter insurance companies. IV The letter has also raised questions concerning the costs of compliance with the reporting and registration provisions of the pending legislation. As we have already stated, H.R. 6789 is applicable only to those companies with 500 shareholders of record and $1 million in gross assets. In the study's analysis of insurance companies meeting the statutory tests, over 50 percent had over $10 million in assets; at the lower end of the scale, only 18 percent had between 81 and $2 million in assets. Thus, it would appear that the great majority of the 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. Companies with 500 750 shareholders and $1 million in assets are affected by a substantial investor interest. Any burdens of compliance with H.R. 6789 are minimal when compared to the benefits of adequate disclosure provided by the bill in these cases. In this connection, weight should be given to the statement of Mr. Edwin D. Etherington, president of the American Stock Exchange, on S. 1642 before the Securities Subcommittee of the Senate Committee on Banking and Currency, as follows: "(w)e conclude that the total cost of annual compliance with all of the requirements now applicable to listed companies apparently would be in the area of $1,500 to $3,000 for the smaller industrial companies covered by this bill except in most unusual circumstances." Furthermore, Mr. James E. Day, president of the Midwest Stock Exchange, estimated that the costs to smaller and medium size over-the-counter companies to meet the requirements of H.R. 6789 should not be more than $1,500 to $2,000 except in the most unusual cases: "and for many of the firms who were now using legal counsel for tax purposes and receiving regular CPA audits, as low as $50 more than they were now paying." As in the case of over-the-counter companies generally, there is no indication that insurance companies will encounter difficulties in satisfying the provisions of H.R. 6789. Indeed, an important expense for most companies, included in the estimates above, will be an audit by an independent certified public account- 1 ing firm which is not required for life insurance reports under Commission practice. Moreover, insurance companies must already file detailed financia reports in each State exercising jurisdiction over them and presumably have adquate staffs to cope with the reporting requirements of State regulation. Their compliance with H.R. 6789 should prove to be a matter of relatively smal additional cost and burden. This fact is understood by the practice of the Com mission to accept, in lieu of the financial reports required under sections 12 and 13 of the Exchange Act, excerpts from the State financial reports, supplemented by brief explanatory notes. V The letter further questions whether the Commission is equipped to handle the reporting problems of life insurance companies. I should like to describe briefly the Commission's procedures and requirements with respect to financial reporting by life insurance companies-an area in which the Commission has already had broad experience, as evidenced by the approximately 100 life insurance com panies now filing annual and periodic reports. Because of the numerous life insurance companies subject to the Securities Acts, the Commission has recently proposed the adoption of article 7-A to our ' regulation S-X specifically governing their financial statements. Comments have been received on this proposal and, as revised, it will be presented to the Commission for adoption after further conferences with the industry. It should be emphasized that article 7-A 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 Com missioners. Indeed, the proposed article does not require the reporting of any financial information to the Commission which cannot be obtained out of the uniform NAIC annual statement or which is not otherwise readily available. The basic 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 information than that included in the NAIC state ment. The only other change is that the proposed article would require certai: brief explanatory notes, including a historical analysis of surplus, for the bene fit of investors not conversant with insurance accounting practices and term nology. In short, the information required by the Commission will be condensed and rearranged for the use of investors to achieve a simplification of thei financial presentation-and will permit the omission of a substantial amount. of detail prescribed by the State insurance commissioners. Thus, the enactment of H.R. 6789 will not alter the accounting practices of life insurance companies. There will be no need for a separate set of books These points should be absolutely crystal clear and I attempted to settle them in a letter to Senator Robertson during the hearings on S. 1642. In that letter I stated as follows: : "I should also add that the Commission has accepted, and would continue to accept, in lieu of the financial reports required under sections 12 and 13 of th Securities Exchange Act, copies of the annual statement prepared for submission to State authorities, or parts thereof, supplemented by brief explanatory* notes as referred to above. It should also be noted that under present require ments financial statements required to be filed by life insurance companies under the Securities Exchange Act need not be certified." In the preceding paragraphs I have devoted attention to the Commission's financial reporting requirements with respect to life insurance companies. have emphasized that these requirements can be basically satisfied from the I information filed with State authorities. It should further be brought out tha H.R. 6789 would provide nonfinancial information not now generally availab under State insurance regulation. For example, a State report typically contains: only limited data concerning material transactions of insiders in compariso with the requirements of the Commission's rules. Moreover, there is no pre vision under State regulation for timely disclosure of events of major importance to investors such as mergers, acquisitions, and 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 rules and required reporting of securities transactions by insiders. We have already noted the seriously deficient quality of the proxy statements and annual reports which life insurance companies presently distribute. 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 will strongly urge the House of Representatives to do the same. We hope that this letter adequately answers the questions raised. If you feel that we can be of any further assistance in this matter, please do not hesitate to call upon us. Sincerely yours, WILLIAM L. CARY, Chairman. Mr. CARY. 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 practice. 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 mater 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 the statutory tests, over 50 percent had over $10 million in assets; at the lower end of the scale, only 18 percent had between $1 and $2 million in assets. Finally, in this connection, I note that, of the estimated 400 insurance companies that would be covered by the bill, 126 are already required to file periodic reports with the Commission under section 15(d) of the Exchange Act. For these companies, the chief additional expense will be in complying with the proxy requirements of the bill. In summary, the importance of insurance companies to the public as a medium of investment is undeniable. Yet the information available about many of these companies is totally inadequate. It seems clear that only I.R. 6789 will provide that minimum amount of data necessary for informed investing. Because of the applicability of the |