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District of Columbia Securities Act. This letter proposes certain amendments to H.R. 4200 that relate to the manner in which salesmen of “variable annuity” insurance contracts are excluded from the coverage of the bill.
If you wish to have any additional information regarding these proposed amendments I will be happy to furnish it. Sincerely,
G. DUANE VIETH.
ARNOLD, FORTAS & PORTER,
Washington, D.C., June 20, 1963. Hon. THOMAS G. ABERNETHY, Chairman, Subcommittee No. 2, House Committee on the District of Columbia,
House of Representatives, Washington, D.C. DEAR MR. CHAIRMAN: I am writing you on behalf of our client, Investors Diversified Services, Inc., of Minneapolis, Minn., with regard to H.R. 4200, the District of Columbia Securities Act, presently pending before your subcommittee. Investors Diversified Services, Inc., is engaged, among other things, in acting as principal underwriter in the sale of shares of five mutual funds: Investors Mutual, Inc., Investors Stock Fund, Inc., Investors Selective Fund, Inc., Investors Variable Payment Fund, Inc., and Investors Inter-Continental Fund, Ltd.
H.R. 4200, in its present text, would exclude from the definition of "security," insurance contracts issued under section 35–541 of the District of Columbia Code-the so-called variable annuity policies. The purpose of this exclusion is, as we understand it, to avoid subjecting insurance agents and brokers who sell variable annuity contracts to dual regulation by local authorities, inasmuch as the sale of variable annuities is, under existing law, subject to regulation by the District of Columbia Superintendent of Insurance.
We are concerned that the technique employed in H.R. 4200 for excluding such agents and brokers from dual regulation will set a bad precedent. That technique is to exclude variable annuities from the definition of "security.” The basic definition of “security” found in H.R. 4200 is taken from the Uniform Securities Act. The exclusion for variable annuities, however, is not part of the definition in the Uniform Act. Should the Congress of the United States define “security" to exclude variable annuities it might serve as a precedent for similar definitions by State legislatures, even though such States might not exercise a degree of control over the sale of variable annuities commensurate with that exercised by the District of Columbia Superintendent of Insurance. In addition, we feel that such a pronouncement by Congress might tend to undercut the holding of the Supreme Court in the VALIC case (SEC v. Variable Annuity Life Insurance Co., 359 U.S. 65 (1959)), that variable annuities may be regulated as securities.
In view of this possibility, we would like to suggest an alternative technique that would substantially accomplish the purpose of H.R. 4200, while avoiding the problems we have raised. We propose that the present exclusion for variable annuities be deleted from section 2(m) of H.R. 4200, and that section 4 be amended to exclude from the licensing requirements of H.R. 4200 those broker-dealers or agents who sell no securities other than variable annuities and who are properly licensed under the District of Columbia Life Insurance Act. The specific language of these proposed amendments is attached herewith.
The effect of these amendments would be to retain variable annuities within the definition of "security," while avoiding the burden of dual licensing. The language we propose would, coincidentally, leave sellers of variable annuities subject to the fraud provisions of section 3 of H.R. 4200. Although this is beyond the scope of our interest in the bill, we can see no reason to exclude variable anunities from section 3 in view of the absence of a fully comparable provision in existing law.
We understand that the majority of a three-man committee made up of David C. Acheson, U.S. Attorney for the District of Columbia, Irving Bryan, of the Corporation Counsel's Office, and Bernard J. Nees, of the Investment Bankers Association, has concluded that variable annuities should not be exempt in any way from the provisions of H.R. 4200. While we would support this position, we respectfully urge that if this majority committee position is rejected, consideration be given to the alternative we have suggested.
We are taking the liberty of sending copies of this letter and our draft proposals to the chairman and ranking minority member of the House District Committee, to the members of Subcommittee No. 2, and to Messrs, Acheson, Bryan, and Nees. Respectfully,
G. DUANE VIETU.
SUGGESTED AMENDMENTS TO H.R. 4200
1. Page 10, line 8, delete the comma and the balance of the sentence following the word "period” and insert a period in place thereof.
2. Page 12, line 6, add new subsection 4(d):
"(d) The requirements of subsections (a) and (b) of this section shall not be applicable to any broker-dealer or agent properly licensed under section 26 or section 29 of chapter II of the Life Insurance Act (D.C. Code, secs. 35-425, 35–428) who effects no transactions in securities, or effects or attempts to effect no purchases or sales of securities, other than contracts issued by an insurance company pursuant to section 41 of chapter III of the Life Insurance Act, as added by Public Law 86–520 (D.C. Code, sec. 35–541).”
(Whereupon, at 12:32 p.m., the committee adjourned, subject to the call of the Chair.)
U.S. DEPARTMENT OF JUSTICE,
OFFICE OF THE U.S. ATTORNEY,
Washington, D.C., June 21, 1963. Hon. THOMAS G. ABERNETHY, Chairman, Subcommittee No.2, Committee on the District of Columbia, House of
Representatives, Washington, D.C. DEAR MR. CHAIRMAN: This is to report on the conferences that Mr. Irving Bryan and I have had with representatives of the Investment Bankers Association relative to H.R. 4200, the District of Columbia securities bill. At the hearings of May 2, you asked Mr. Bryan to talk with Mr. Bernard J. Nees and me and that we explore possible accommodations between the provisions of the bill as introduced and the proposed amendments contained in the Investment Bankers Association memorandum of May 2, which is now part of the record of the subcommittee hearing.
We have had several long conferences with Mr. Nees and Mr. Gordon Calvert, joined by Mr. Sharon Risk of Johnston, Lemon & Co. The upshot of our meetings was agreement or compromise on all but one point of the IBA proposals.
I will refer to the itemized proposals, by number, as set out in the IBA memorandum of May 2. I will first itemize the proposals on which we have reached agreement, then discuss the one on which we have not reached agreement.
ITEMS OF AGREEMENT IBA item No. (2)
Mr. Bryan and I do not oppose the IBA proposal that the licenses provided for in section 4 of the bill be changed to run for 1 year instead of 2. The purpose of the 2-year license was to minimize the administrative burden on the Commission and the cost of processing applications. Nevertheless, we do not believe that 1-year licenses will involve much more administrative work. Accordingly, we concur in the IBA proposal. To carry out this purpose, the following amendment should also be made: Page 12, line 5, strike “two years" and insert in lieu thereof “one year". IBA item No. (3)
Mr. Bryan and I concur in the IBA proposals listed in their memorandum as items (3) (a), (b), and (c), to amend section 5(a) of the bill. IBA item No. (4)
This proposal of the IBA has been compromised along the following line:
(a) ĪBA recedes from its proposal of a $500 ceiling on aggregate filing fees for a broker-dealer and its agents. (6) The schedule of filing fees for the first year will be:
$125.00 Each partner--
12.50 Each agent--
12. 50 (C) For each succeeding year the fee for each agent is reduced to $5. The fees for broker-dealer and each partner will remain the same as for the first year.
The following is a suggested amended subsection 5(b) reflecting these points of agreement:
“(b) An applicant for an initial or renewal license shall pay a filing fee. The filing fee for an initial or a renewal license shall, except for agents, be fixed by the Commission but shall not exceed $125 for a broker-dealer, plus an amount not exceeding $12.50 for each partner, officer, and director, and each person occupying a similar status or performing similar functions, who transacts busi
ness in the District. The filing fee for an initial license for an agent shall be $12.50. The filing fee for each renewal license for an agent shall be $5."
(The refund provision has been stricken from this language to minimize the burden of irresponsible applications.) IBA item No. (5)
Mr. Bryan and I concur in the IBA proposal, and in their suggested statutory language, which would (a) make the minimum capital requirement one of net capital, (b) raise the amount from $15,000 to $25,000, and (c) provide for a $5,000 net capital minimum for broker-dealers which are limited to investment company transactions.
These changes would increase the protection to the public arising from the minimum net capital requirement and would alleviate any hardship upon dealers who are limited to mutual funds, who do not incur independent financial obligations to the public. IBA item No. (6)
We have reached a compromise with Mr. Nees and his associates on the question of a bonding ceiling in IBA item (6 This compromise would simply strike the figure $50,000 in line 25, page 14, of H.R. 4200, and substitute the figure $25,000.
Maryland and Virginia have a bonding ceiling of $10,000 and $25,000, respectively (Virginia omits a bond requirement for agents). Among the other States that require bonding (19 States do not), more have a ceiling of $10,000 or $15,000 than of $25,000. The ceiling of no State exceeds $25,000 except New Jersey (only after conviction of certain crimes), Arkansas ($50,000 ceiling, but no bonding requirement for dealer registered with the SEC), and New Mexico ($100,000 ceiling, but no bonding requirement for dealer registered with SEC). Accordingly, the $25,000 compromise ceiling on bonding under the District of Columbia statute would be in harmony with the normal requirement in the States.
Mr. Bryan and I concur in proposals (a) and (b) (on p. 4 of the IBA memorandum), to provide that (a) a single bond shall cover a broker-dealer and its licensed agents and (b) that the bonding company should be required to be licensed to do business in the District of Columbia. As a consequence of these agreements, we concur in the proposed amendment (i) and amendment (ii) down to the semicolon, exclusive of the proviso.
The IBA recedes from its proposal contained in the proviso of amendment (ii) on page 4 of the May 2 memorandum. IBA item No. (7)
Mr. Bryan and I concur in this proposal. In conjunction with this amendment, a minor amendment should be made on page 12, line 8, of the bill by eliminating the phrase “or renewal." IBA item No. (8)
Mr. Bryan and I concur in these proposed amendments. IBA item No. (9)
Mr. Bryan and I concur in this proposed amendment, which would follow the language of the Uniform Securities Act. IBA item No. (10)
The IBA recedes from its objection to the power of suspension prior to hearing.
For the sake of completeness of the record, the subcommittee should know the considerations that underlie the summary suspension provision of H.R. 4200, section 10(c).
1. The power of inter suspension, prior to hearing, is essential in many cases for the protection of the public while the administrative proceeding is underway. Of course the suspension power involves a risk of serious injury to the business of a broker-dealer, but the consideration of protection of the public is at least as important as the property interests of the broker-dealer. Where there is strong evidence of illegal activity by a broker-dealer, such as would persuade the Commission that it should inititate a proceeding to permanently revoke the license, and particularly where the violation is of a provision designed to protect investors from injury, it would be unconscionable to permit the brokerdealer to continue those operations while the administrative proceeding is pending. Particularly is this true where the broker-dealer could protract the proceeding and delay final determination by dilatory tactics, or threatens to frustrate
a court injunction by a demonstrated disposition to commit new violations other than those specifically enjoined. Both the Federal SEC and the Securities Administrator for the State of Maryland feel strongly that the power to suspend prior to hearing is absolutely essential to put effective teeth into securities regulation on a local level and to insure compliance. The Maryland statute contains a provision (sec. 18(c)) identical to that in H.R. 4200. The drafters of the Uniform Securities Act (sec. 204 (c)) believed that this power was necessary, as did the Commissioners on Uniform State Laws, who approved the act.
2. The argument has been made that court injunctive proceedings provided for by section 12 of the bill would give the Commission sufficient power to stop illegal practices pending final determination of Commission proceedings. But there will be many cases in which this is not true. Under familiar equity principles, injunctions run to particular violations alleged, not against all illegal conduct in whatever form, and not against the broker-dealer doing business at all. Thus, if the Commission had evidence that a broker-dealer was making fraudulent representations in selling stock in X company to the public, an allegation of those facts would be made under section 12 of the bill in the U.S. district court, setting forth those violations of the act and asking for a temporary restraining order. If the Commission obtained the temporary restraining order from the court, the order would normally forbid the acts alleged or conceivably would be broad enough to restrain any sales to the public of stock X. However, the broker-dealer would be entirely free under the court order to commence fraudulent representations and sales with respect to stock Y, and new injunctive proceedings would have to be initiated against those practices. The suspension power in H.R. 4200 would prevent the broker-dealer from being able to leapfrog the Commission in the equity courts by this means. It is for this reason that the Commissioners on Uniform State Laws and the Securities and Exchange Commission and the Maryland administrator all have thought that the power of suspension before hearing is essential, and it is for this reason that courts have thought that the need for public protection outweighs the property interest of the broker-dealer.
I am the first to agree that the summary suspension power should be exercised sparingly and only after mature judgment, but this is not an adequate reason to eliminate this essential power altogether. Perhaps language in the committee report pointing to the need for self-restraint and sparing use of the suspension power would not be out of place, but I feel strongly that a change in section 10(c) of the bill would be most unwise.
3. There is no doubt of the constitutionality of section 10(c) of H.R. 4200. In determining the constitutionality of comparable provisions, the type of inquiry the courts have made is to weigh the need for summary suspension against the damage to the broker-dealer and determine whether the need for public protection outweighs the private interest involved. This is precisely the inquiry that, for example, the Supreme Court of Wisconsin made 30 years ago, in a leading securities case, sustaining the constitutionality of a summary suspension order of the Public Service Commission of Wisconsin. Halsey, Stuart & Co. v. Public Service Commission of Wisconsin, 248 N.W. 458 (1933). In that case the court disposed of the argument that summary suspension prior to hearing gave arbitrary power to the commission :
"It is said that there is no provision for a hearing. It is true that there is none prior to suspension. We do not regard this as fatal to the validity of the law. Having in mind that this is an exercise of the police power, and that it is valid insofar as it is reasonably necessary and appropriate to the promotion of the public welfare, it seems to us that the act must be sustained. The court may take notice of the fact that much harm may come to the citizens of the State, and that they may be the victims of much fraud and imposition unless they are speedily protected from improper practices in the sale of securities. Having in mind modern sales methods and the speed at which the business of today is done, promptness of action on the part of the commission may be the measure of its effectiveness. While the suspension may seriously damage the business of a particular broker, this consideration is not fatal to the validity of the act, provided it is reasonably necessary to protect the public. The rights of the public to exercise the police power in its own protection are superior to those of any individual broker to sell under his license or certificate.
"Further than this, there is a provision for hearing upon the suspension order. The statute provides that the certificate holder thus suspended may, within 30 days, serve upon the commission a demand for a public hearing, which must