SECURITIES EXCHANGE ACT AMENDMENTS OF 1973

TUESDAY, JUNE 5, 1973

HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON COMMERCE AND FINANCE,

COMMITTEE ON INTERSTATE AND FOREIGN COMMERCE,

Washington, D.C. The subcommittee met at 10 a.m., pursuant to notice, in room 2322, Rayburn House Office Building, Hon. John E. Moss, chairman; Hon. W. S. (Bill) Stuckey presiding.

Mr. STUCKEY. The Interstate and Foreign Commerce Committee's Subcommittee on Commerce and Finance will come to order.

This morning we are holding hearings on title I of H.R. 5050, which deals with the administrative and selection procedure of the SEC. Before hearing our two witnesses this morning, I would first like to read a short statement by Chairman Moss.

We regret the chairman was unable to be with us in the opening session of H.R. 5050. I do think it would be appropriate this morning to start off with his statement.

STATEMENT OF HON. JOHN E. MOSS, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF CALIFORNIA, AS READ BY MR. STUCKEY

"Chairman Moss. I regret that a prior commitment has made it impossible for me to chair the opening day's hearings on H.R. 5050. I would like, however, to have the record reflect my reasoning in determining to go forward with hearings at this time.

"In the course of the last Congress after a most careful and comprehensive study of the securities industry-the subcommittee unanimously concluded that the regulatory mechanisms at work in our securities markets and the industry itself, must be substantially reformed and restructured if our capital markets are to remain strong and responsive to ever-changing economic needs. The bill, H.R. 5050, on which this subcommittee commences hearings today, represents the legislative embodiment of our recommendations for reform.

"Many in the industry and some in Government have argued against moving forward at this time. They are deeply concerned, as am I, with the worsening financial condition of the broker-dealer community and the serious effect which a sustained deterioration of profitability may have on the continued viability of large and important segments of the industry.

"In my opinion, however, reform of the securities markets cannot await better times. The difficulties which confront this industry today have grown up under and have, in part, resulted from the existing (1)

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system. We cannot continue to stand by and attempt patchwork repairs and shoring up of mechanisms which so many have agreed are in need of substantial revision.

"It is becoming increasingly clear that financial planners and professional participants in our markets are finding it impossible to function in an environment so fraught with anticipation and uncertainty. The great issues which face the industry require resolution now and that task may be put off no longer.

"I understand that there are sharp, widely varying views among those in the industry as to what changes are required. These divergent views, I know, are advanced in good faith and are the product of very careful study and analysis. Complex issues can be expected to spark sharp differences of opinion and great controversy.

"We will, of course, give all parties the fullest opportunity to present their views, and we will listen carefully. As I have said on other occasions, we are not irrevocably wedded to the provisions of H.R. 5050. Today, as legislative hearings commence, I would like to reaffirm my confidence in the legislative process to provide a reasoned and equitable resolution of these issues.'

Mr. STUCKEY. Before hearing our first witness this morning, I would like to make a statement, and make some general comments on the legislation which we have before us, and some specific comments on title I.

There are strong indications that historians and economists may look back at this session of Congress as the turning point in the evolution of this country's capital market system. The deterioration of our equity markets has not only persisted, but it has also become pronounced.

Trading volume has declined for each month of this year. Institutional trading practices account for much of the stock market's volatility. Institutions account for 70 percent of NYSE total volume. The individual investor is practically obsolete.

These trends, coupled with increased trading activity in the separate markets, are jeopardizing the auction nature of our equity markets. Not only is the brokerage industry growing more concentrated, it also continues to suffer from net losses this year. NYSE member firms reported net losses of $75 million for the first quarter of 1973. Mutual funds have been experiencing net redemptions for 15 consecutive months.

Public confidence in the securities industry has reached its lowest point in the post-war period. A Lou Harris poll of individual investors published this March found that only 16 percent of those polled have confidence in broker executives.

Only 27 percent have confidence in the overall leadership of the securities industry. The number who express a "great deal of confidence" in their own brokerage firm came to no more than 32 percent. There was a time not long ago when the individual wanted to own a share in America. Now the pessimism resulting from inflation, Watergate, and an impending economic slowdown has been added to this lack of confidence in the securities industry. When these considerations were added to the increased trading activity of institutions, the individual made an investment decision to go short on America.

The full implications of these trends are still not apparent, although we do have reason to believe that they may condition a market very

different from the one which has been the traditional basis of our capital formation system.

It is likely that these trends may significantly restrict the breadth and depth of our equity markets. They will most certainly affect investment decisionmaking and the execution of these decisions.

These trends may even go so far as to affect corporate decisionmaking and accountability, particularly if the financial institutions come to own a sufficient number of outstanding shares in these corpo

rations.

While some brokerage houses could adapt to these changes, the traditionally strong, independent, and viable network of broker-dealers may be eroded. In the future, we may see brokerage firms competing with financial institutions for the public's investment dollar. A major part of this competition will be the variety of investment services. that a firm offers its customers. However, the brokerage industry will be entering this new marketplace with a serious disadvantage, as was evidenced by the Lou Harris poll. While broker executives had a lowly 16 percent confidence level, commercial bankers have been able to hold on to an astoundingly high 59 percent confidence level.

People seem to be pleased with the growth of retail services of banking. However, in the securities marketplace no such growth of customer confidence in services has been evidenced. For example, Harris found that no more than 20 percent of those now owning stocks feel they have an adequate plan for investment. Almost one in four-24 percent-says he feels his mutual fund was "overpromised" when he bought it. Almost one in five-19 percent-feels he was overpromised by his broker when he purchased his last security. Sixty percent of all stockholders say that owning securities is a "luxury," not a necessity. Finally, a majority of shareholders-53 percent-feel that brokerage firms with which they did business were "more interested in the sale rather than in their customers' best interests."

This indication of the individual's dissatisfaction with the securities industry has been growing now for some time. It is my concern and the concern of this subcommittee that the individual investor may already be lost. If the public is to continue to supply our economy with capital through the security markets in the coming decades, then the market must be designed to serve the public interest.

Without the individual's direct investment, corporations, especially small and medium-sized corporations, as well as new companies, may be faced with a serious shortage of investment capital. As more investors withhold capital from the security markets, some corporations may be targets for take-overs; others may not have the option to expand; and many entrepreneurs will have little incentive to undertake new business risks.

Ultimately, the disappearance of the individual from our equity markets may go so far as to affect the growth and prosperity of our

economy.

I was pleased to read in a May 14 article in the Christian Science Monitor that a recently formed organization, the Committee of Publicly Owned Companies, is also concerned about the impact of the individual's exit from the stock market. Many of the committee's 400 medium and smaller sized member companies believe they would be the chief beneficiaries of the individual's return to active trading.

In its white paper, the committee lists the effect of institutionalization on its members' stocks:

1. We cannot obtain new public financing for our needs, or can get it only at sacrifice prices.

2. Expansion plans must be deferred.

3. We are targets for takeovers by foreign as well as domestic capital.

4. Our shareholders are disaffected.

5. Our ability to provide additional goods and services needed by the Nation is threatened.

6. Our capability to provide more jobs for employees is diminished. A representative of the Committee of Publicly Owned Companies will address this subcommittee during our hearings. I think it is imperative that we hear from the companies that are so dependent on the individual investor.

As the individual exits, our capital market may become increasingly similar to those in many continental European countries. The institutionally dominated European markets have never outperformed the American equity markets. It would not only be ironic that the American market, always esteemed for its breadth and depth, transformed itself into the European model, but it would also be unfortunate. Our capital market system has provided American business with a competitive advantage that has never been equalled.

Given these prospects for our capital market, the time has come for us, as makers of public policy, to decide if this is the kind of marketplace we desire. Do we want a market providing broad public ownership, or a market dominated by institutions? Do we envision a market based on the auction mechanism, or one in which liquidity for investors is, at best, minimal?

These are some of the fundamental questions to which we must address ourselves now, or be resigned to the outcome of the trends that are now working themselves out. Congress is mandated to act in the face of the probable outcome of these trends, and it has the responsibility to take action.

In 1970, Congress established the Securities Investor Protection Corporation against the backdrop of the most prolonged and severe crisis in the securities industry since the 1930's. Congress involved the U.S. Treasury in the health of the securities industry to the tune of $1 billion, in the event customer losses from the bankrupt broker-dealer firms exceed SIPC's liquidation funds.

In addition to our commitment of Treasury funds to insure investors' accounts, our obligation encompasses the entire economy. The consequences of a failing securities industry will ricochet throughout every sector of the economy.

At this time, we have already gone part way toward meeting this obligation. After the 1970 congressional commitment to the securities industry, this subcommittee decided that it was necessary to conduct a thorough study of the industry. The subcommittee heard testimony from 87 witnesses during 26 days of hearings. The transcripts of the testimony and additional material are contained in 9 volumes-over 4.600 pages.

The bill before us, H.R. 5050, is based on the recommendations set forth in the final report published in August 1972. H.R. 5050 was co

sponsored by every member of our subcommittee with the understanding that all provisions would be open for amendment.

We have quite a task before us: To report out a bill that meets our obligations as well as provides for the kind of capital marketplace we envision. The size of this task must not deter us from acting quickly and judiciously. Some contend that Congress has already waited too long. The extent of the impact of this delay, I think, is open to question. Governmental inaction coupled with industry inertia have had, at the very least, a negative impact on the securities industry. Proposals for change have been under study by the Congress and the SEC at least since 1960.

To have been under continuous study for over a decade with no resulting legislative decisions as to the fundamental ground rules by which the industry would operate has been detrimental to the morale of the industry. It is only fair that these ground rules be established in order that the industry might return to conducting its business. It is time to end this uncertainty as to what the Government may tell the industry to do. If for no other reason, we must act expeditiously and prudently in order that the securities industry can better perform its pivotal function in our capital formation system.

This morning we are moving closer to the point of action by beginning hearings on H.R. 5050. The hearings are divided into three phases. Phase I deals with title I, concerning the selection and administration of the SEC. Phase I hearings will be held today, tomorrow, and Thursday. Phase II, dealing with titles II, III, and V will begin on the 12th of June and will continue on the 13th, 14th, and 15th. On these days the committee will hear representatives of the exchanges, the SEC, the trade association of the securities industry, and the National Association of Securities Dealers. We anticipate an additional 2 to 3 weeks of hearings on these three titles. Upon completion of phase II, hearings then will be scheduled for title IV, which deals with securities processing.

Title I of H.R. 5050 deals with the selection and administration of the Securities and Exchange Commission. It would amend the Securities Exchange Act of 1934 in order to :

1. Provide that any Commissioner may be removed by the President. for neglect of duty or malfeasance in office, but for no other causes. 2. Provide a procedure for the appointment of a Commission chair

man.

3. Provide that the Commission shall submit any budget request to the Congress concurrently with transmittal to OMB.

4. Provide that when the Commission transmits any legislative recommendations, testimony, or comment on legislation to the Executive, it shall concurrently transmit a copy to the Congress.

Title I also adds a new subsection concerning the obligation of the Commission to supply requested documents to the Congress.

Before beginning deliberation on these provisions, we must agree if there is a need for enactment of title I. It is my contention that there is a need to make the SEC as independent as possible. My contention rests on two considerations: First, Congress must provide for the SEC's independence in order to insure compliance with the intent of the legislation that established the regulatory agency. Every administration since the creation of the SEC has subjected the agency