be duplicated, strength may be indicated. But, to the extent that the contributing factors may not be lasting, weakness may be indicated. So a wide profit margin constitutes a warning signal; the investor must determine to what extent the margin is likely to continue. A narrow profit margin may likewise be indicative of strength or weakness. If the narrow profit margin represents the choice of the management to do a large volume of business at prices but little above the cost of production and if this method has resulted in a large scale, integrated, efficient business, the very narrowness of the margin may be an effective barrier to competition. On the other hand, a narrow profit margin may be indicative of a variety of causes, such as strong or even destructive competition, managerial inefficiency, increasing prices of raw materials relative to selling price. It follows, therefore, that, unless the size of the profit margin is known to the investor, a vital element of the information necessary for informed judgment and for this minimum protection is lacking. Moreover, in either case the extent of fluctuations in sales and cost of sales is itself an important factor in appraising the degree of fluctuations in the profit margin.

"In the third place, knowledge of sales is vital also if the quality of various balance sheet items is to be tested. The comparison of sales to receivables, inventories, fixed assets, and net worth is ordinarily one of the first steps taken in attempting to appraise the results of operations, and to predict their future

course.

"Unless, in short, an adequate profit and loss statement, including gross sales and cost of sales, is made available, a sound appraisal of the management is likely to be impossible. Institutional investors and investment experts, it is true, may on occasion be able to obtain the necessary information through their own analyses or investigations, even though it is not contained in the published records. It is possible in this case, for example, that a skilled analyst, possessing expert and detailed knowledge respecting the tobacco industry, could on the basis of the disclosures contained in the nonconfidential portion of the registrant's financial statements calculate approximately its gross sales and cost of sales in dollars. Similarly, controlling stockholders may have access to such information. But the average investor will not have this information and will not be able to obtain it. As a result, he may well be helpless in making an adequate estimate of the efficiency with which the management of the company has conducted the business during the period covered by the particular profit and loss statement, in judging the future trends of the business, or, in sum, in making a sound decision whether to 'hold, buy, or sell' a security.

"It should not be implied, of course, in our emphasis of the importance to the investor of the need of an adequate profit and loss statement, that it will automatically give him a perfect and detailed picture of the operating results that the management is achieving with the enterprise. If, however, the profit and loss statement is adequate, the investor can form some judgment as to the future. And as financial reporting becomes increasingly clear and adequate, the more comprehensive will be the analysis which the investor can make of his investment, and the more intelligent will be his investment decisions." 16

Problems continued to arise during the year as to the use of what has been termed a quasi or accounting reorganization. Despite treatment of this problem in several opinions of the Commission and accounting series releases, as related in the Sixth Annual Report." it became apparent that it would be desirable to integrate and amplify

16 Footnote citations omitted.

Page 173.

the several statements on this question. Accordingly, an opinion of the Chief Accountant was issued as Accounting Series Release No. 25,18 indicating the conditions under which a quasi-reorganization may be said to have been effected:

"It has been the Commission's view for some time that a quasi-reorganization may not be considered to have been effected unless at least all of the following conditions exist:

"(1) Earned surplus as of the date selected is exhausted;

"(2) Upon consummation of the quasi-reorganization no deficit exists in any surplus account;

"(3) The entire procedure is made known to all persons entitled to vote on matters of general corporate policy and the appropriate consents to the particular transactions are obtained in advance in accordance with the applicable law and charter provisions;

66

(4) The procedure accomplishes with respect to the accounts substantially what might be accomplished in a reorganization by legal proceedings-namely, the restatement of assets in terms of present conditions as well as appropriate modifications of capital and capital surplus, in order to obviate so far as possible the necessity of future reorganizations of like

nature.

"It is implicit in such a procedure that reductions in the carrying value of assets at the effective date may not be made beyond a point which gives appropriate recognition to conditions which appear to have resulted in relatively permanent reductions in asset values; as for example, complete or partial obsolescence, lessened utility value, reduction in investment value due to changed economic conditions, or, in the case of current assets, declines in indicated realization value. It also implicit in a procedure of this kind that it is not to be employed recurrently but only under circumstances which would justify an actual reorganization or formation of a new corporation, particularly if the sole or principal purpose of the quasi-reorganization is the elimination of a deficit in earned surplus resulting from operating losses.'"

During the past year four amendments and two clarifying interpretations of Regulation S-X were published. One of these adapted the requirements of this regulation for use by companies in filing registration statements and annual reports under the Investment Company Act of 1940. It is intended that instructions as to the form and content of financial statements of such companies will be reconsidered with a view to further changes that may be deemed necessary or desirable as a result of experience gained from the original filings under

that Act.

Miscellaneous Research.

Among other accounting research work performed during the year was the beginning of an extensive survey and study of annual reports to stockholders as compared with annual reports filed by industrial and commercial companies with this Commission under the Securities Exchange Act of 1934. The objective of this study will be to deter

18 Published May 29, 1941.

424232-42-14

mine, if possible, the extent to which the Commission's rules and decisions on accounting matters have influenced reports to stockholders which, with the exception of companies registered under the Investment Company Act of 1940, are not ordinarily subject to the jurisdiction of the Commission, and whether the financial statements accompanying such reports are in form, content, and disclosure reasonably consistent with and comparable to statements filed with this Commission. The study, however, has not progressed sufficiently to warrant a substantive report of its results.

Cooperation with Professional Organizations.

The development of uniform standards and practice in major accounting questions continues to be a common objective of the Commission and the accounting profession. Outstanding among efforts of professional associations toward this goal was the publication by the executive committee of the American Accounting Association, in June 1941, of a revised "Statement of Accounting Principles Underlying Corporate Financial Statements." Originally published in 1936. the statement gave rise to a very large volume of critical comment and discussion. The present revision should further stimulate progress toward its announced objective, the expression of a unified and coordinated body of accounting theory to the end that financial statements may be both intelligible and, as far as possible, comparable with statements of other periods and other corporations. Efforts of the authorized committees of the American Institute of Accountants toward improved accounting procedure resulted in the publication of seven official bulletins setting forth recommended procedure with respect to such auditing and accounting problems as the weight to be given a client's representations as to inventories and liabilities; the treatment of certain contingent liabilities; the accountant's certificate; accounting terminology; and combined income and surplus state

ments.

In connection with the promulgation of accounting series opinions and accounting rules, the practice of the Commission was continued of securing the comments and suggestions of cooperating committees of the various professional societies interested in accounting and of other interested persons. Many of the suggestions received in this manner are reflected in the substance of the rule or opinion as finally issued.

Not less important than the official and semiofficial publications are the papers presented at regular and annual meetings of the various societies and at accounting clinics and conferences frequently sponsored by leading universities and accounting societies. In addition to the educational value of such public discussions, the published papers form a valuable addition to accounting literature on a wide variety of

important issues and may be taken as a continuing indication of professional efforts to improve and clarify accounting and auditing procedures. Various members of the Commission and its staff have participated, from time to time, in such meetings.

INTERPRETATIVE AND ADVISORY SERVICE

From its inception, the Commission has realized that the technical nature of the statutes administered requires the maintenance of an interpretative and advisory service to provide attorneys and the general public with prompt advice concerning problems arising under those statutes. The large volume of requests for interpretations received annually by the Washington office and regional offices of the Commission was augmented this year by the many new problems arising under the Investment Company Act of 1940 and the Investment Advisers Act of 1940, which are administered by the Commission. These requests embrace an extremely wide area extending from complaints attending the failure of corporations to declare dividends— a situation over which the Commission has no jurisdiction-to inquiries by foreign governments desirous of selling, for war purposes, securities held locally by their nationals. Generally, however, inquiries relate to problems confronting modest business enterprises interested in capital expansion. In every case, the Commission attempts to aid the person making the inquiry to understand and comply with the law.

The jurisdiction of the Commission does not extend to private disputes of a civil nature arising under the Securities laws. Consequently, the Commission cannot advise litigants concerning the prosecution or defense in such cases.

COMPLAINTS AND INVESTIGATIONS

One of the important functions of the Commission is, of course, the enforcement of the several statutes which it administers. The Commission annually receives and replies to thousands of complaints from the public with respect to alleged violations. Information indicating statutory violations also reaches the Commission from other sources, such as the constant surveillance of market activities, the examination of registration statements, and the facts furnished by cooperating State and Federal agencies.

Every complaint lodged with the Commission receives careful consideration. Frequently, the complainant seeks the Commission's aid to recover money invested in securities or to rectify strictly internal conditions of a corporation, matters over which the Commission has no jurisdiction. While the Commission cannot assist investors directly in recovering money obtained from them in violation of law, it can, and does, give them helpful information contained in its public

records, investment manuals, and other public sources to which the investor may not have ready access.

Where the violation of a statute is indicated, preliminary inquiries are made to substantiate statements made by the complainant. If. after this preliminary inquiry, it appears to the Commission that one of the statutes has been violated, an investigation is initiated in an effort to determine the facts. Much of this investigative work is conducted through the Commission's nine regional offices and the Washington Field Office. These offices are strategically located in principal financial centers throughout the country. Such investigations may lead to civil, criminal, or administrative proceedings; on the other hand, they may prove negative. Sometimes a violation of statutes administered by other branches of the Federal government, or by State authorities, is indicated. It is the Commission's policy to cooperate fully with such bodies and to furnish them with information in which they are interested.

At the beginning of the past fiscal year, the enforcement section had pending 696 investigations and legal cases under the Securities Act of 1933, Securities Exchange Act of 1934, Public Utility Holding Company Act of 1935, Investment Company Act of 1940 and Investment Advisers Act of 1940. During the year, 484 additional investigations were initiated. Out of this total of 1,180 cases, 548 were disposed of during the past year, leaving 632 cases pending as of June 30, 1941. The following table indicates the number of such cases pending and disposed of during the past fiscal year:

Investigations and legal cases developed therefrom under the Securities Act of 1933, the Securities Exchange Act of 1934, Section 12 (h) of the Public Utility Holding Company Act of 1935, the Investment Company Act of 1940, and the Investment Advisers Act of 1940, for the fiscal year ended June 30, 1941

• Investigations carried on primarily through correspondence. Investigations assigned to field investigators.

• Includes 180 informal and 142 formal docketed investigations. Includes 55 informal and 112 formal docketed investigations.

The Commission has long recognized the advantages to be realized from cooperation between Federal and State agencies and certain private organizations interested in the prevention of fraud in the sale