PART I CURRENT PROBLEMS BEFORE THE COMMISSION The foreword to this report has described the nature of the laws administered by this Commission, the abuses in the securities markets which led to their enactment and some of the problems encountered in administering these laws during the past quarter century. During the 1959 fiscal year these laws were put to their severest test for during that year the nation witnessed the highest level of activity in the securities markets since the organization of the Commission in 1934. This increase in market activity created complex enforcement problems, required the adoption of new regulatory measures and techniques and imposed heavy administrative burdens upon the staff of the Commission. The effects of surging securities markets upon the activities of the Commission are described in detail later in this report. This section briefly sets forth some of the more important problems created by these conditions and the impact of these problems upon the work of the Commission. The following salient statistics reveal the remarkable increase in activity in the securities markets and the tremendous growth of public interest and participation in those markets: The total amount of new securities for which registration statements were filed with the Commission in fiscal 1959 totaled $16.6 billion, only $300 million less than the record amount filed in fiscal 1958. During fiscal 1959 the Commission processed 1,119 registration statements, the largest number of registration statements ever to be processed in a single year in the history of the Commission. The number of broker-dealers registered with the Commission rose to 4,907, an increase of almost 1,000 registrants since 1951, and the number of representatives registered with the National Association of Securities Dealers, Inc., on June 30, 1959 was 77,917, the largest number in its 20-year history. The aggregate market value of all stocks on all stock exchanges, which never exceeded $100 billion between 1933 and 1945, reached $337.6 billion on June 30, 1959, almost three times the market value of all stocks on exchanges during the first decade of the Commission's history. The reported volume of trading on the New York Stock Exchange increased from a daily average of 2 million shares in February 1958, to a peak of 4,100,000 shares in October and November 1958, the highest daily average for any month since June 1933. The number of holders of shares of publicly owned corporations, according to estimates by the New York Stock Exchange, increased from 6,490,000 in 1952 to 12,500,000 in 1959, the largest number of public shareholders in the nation's history. The number of registered investment companies increased from 367 in 1952 to 512 in 1959, and the total assets of investment companies increased from $6.8 billion in 1952 to $20 billion in 1959. A number of factors appear to be responsible for this increase in activity and interest in the securities markets. Among these are the attractiveness of these markets for financing new corporate enterprises and the expansion of old ones, the emphasis upon capital gains in selling equity securities, the fear of inflation, the growing participation in the market of the large institutional investor and an unfortunate tendency among some persons to use the stock market as a medium for gambling. However, the principal concern of the Commission is not with the cause of this activity but with insuring that the securities markets, however active, are fair, orderly and honest, that prices in these markets express the free interplay of supply and demand and that decisions by investors to buy or sell are made in the light of full disclosure of all material facts. The discharge of these statutory responsibilities by the Commission is complicated in present securities markets by the participation of a large number of inexperienced investors and by broker-dealers and promoters unfamiliar with, or contemptuous of, the ethical and legal obligations owed to investors. Fraud in the Sale of Securities Active and rising markets have raised the expectations of a substantial segment of the public that it is possible for the unsophisticated investor to reap large and quick profits. In this atmosphere opportunities for fraud and manipulation multiply. Investors become less concerned with the facts about the issuer and the investment characteristics of its securities than with the allure of a possible "killing" described to them by an unknown salesman over the telephone. They become more susceptible to baseless tips and rumors, thus facilitating a variety of deceptive and manipulative practices. This atmosphere has attracted into the business of selling securities not only the confidence man, the petty swindler and the corporate plunger, but also an outright criminal element. These persons have seized upon the technique of selling securities to unsuspecting customers through the use of boiler rooms. The term "boiler room" refers to a firm engaged in the sale of securities primarily over the long distance telephone, to persons with whom the firm has had no previous contact and by high pressure methods ordinarily accompanied by gross misrepresentation and other fraudulent devices. Boiler rooms may operate not only from the large financial cen ters but also in other locations around the country. There has been a noticeable increase, for example, in migratory operators moving from state to state. In some promotions several boiler rooms may be used to sell the spurious issue in widely scattered areas around the country, each boiler room being assigned to saturate its particular region. Not infrequently the long distance telephone salesmen for the boiler room establish themselves in hotel rooms, apartments and alleged business offices. In many cases, the security sold by a boiler room is unknown and worthless. To create the appearance of an active over-the-counter market for the security, the promoter will place with numerous brokers and dealers, orders for the purchase and sale of small amounts of the security at prices set by him, or arrange to have others do this, with the result that such brokers and dealers will publish quotations for the security at the prices specified in the orders. The salesmen for the boiler room are now able to refer in their sales "pitch" to a market price for the security which the unsuspecting investor can independently verify. When the distribution of the promoter's holdings is completed, however, the orders are withdrawn and the "market" disappears. In his telephone sales pitch, the boiler room salesman usually promises rapid increases in the market price of the security and no risk of loss in its purchase; he may make numerous misrepresentations concerning the issuer and its future prospects; he may urge purchases notwithstanding statements on the part of the customer that he cannot afford to do so; and he may advise the customer, of whose financial situation he knows nothing, to sell valuable securities in order to purchase the spurious boiler room security being offered. The Commission has found that resort to the civil injunction and administrative proceeding, no matter how vigorously employed, is not completely effective in halting the operation of boiler rooms. Promoters easily find another worthless issue and either establish or use an existing boiler room as a vehicle for a new fraudulent promotion. The Commission believes that only criminal prosecution will effectively stop those who show such a contemptuous disregard for the law. The Commission has, therefore, placed increased emphasis in its work upon the prosecution of such offenders. In fiscal 1959 the Commission referred to the Department of Justice 45 cases for criminal prosecution, one of the highest number of referrals in the Commission's history, and referrals are continuing at approximately the same rate in fiscal 1960. A large portion of the Commission's staff is now engaged in investigating, developing, and assisting in the prosecution of criminal actions. Such activity requires careful and painstaking work usually over a period of many months. Investors must be identified and inter 529523 59 viewed. Books and records of brokers, dealers and others must be examined and analyzed. The information thus obtained then has to be developed in a form permitting its introduction into evidence in legal proceedings. Emphasis upon developing criminal cases means that the Commission with its limited resources has had to utilize staff personnel who would otherwise devote their full attention to other urgent enforcement and regulatory problems. The Commission believes, however, that its policy of pressing for criminal prosecution of violators of the Federal securities laws is the most effective deterrent to fraud in the sale of securities and must be vigorously pursued. In addition to its enforcement program against boiler rooms, the Commission has sought through a broad publicity campaign to alert investors to the risks involved in the purchase of securities from unknown high-pressure salesmen. Posters warning investors of boiler room operators have been widely distributed, spot radio and television announcements carrying similar warnings have been prepared to be broadcast in cooperation with The Advertising Council, and brochures listing protective measures that an investor should take before making a purchase have been prepared for wide public distribution. Manipulation in the Securities Markets In April 1959 the Commission issued a statement warning investors to exercise extreme caution and self-restraint when considering the purchase of securities upon the basis of tips and rumors.1 Price fluctuations were occurring in certain securities on the exchanges and in the over-the-counter markets without apparent economic reason. Also there appeared to be a considerable amount of speculation on the part of public investors. These conditions facilitated the manipulation of securities prices and boded eventual losses to investors. Officials of the leading exchanges also joined in warning investors, and brokerage houses urged their customers to exercise caution in purchasing unknown securities. In volatile markets where prices are susceptible to swift and wide changes on the basis of rumors, manipulation is facilitated and the task of enforcement becomes increasingly difficult. The Commission has therefore had to place greater emphasis upon the detection and prevention of manipulation and a substantial number of investigations are now in progress. Some of these investigations have resulted in indictments and it is anticipated that certain other cases now under investigation will also lead to criminal prosecution. Exemptions From Registration and Prefiling Publicity One of the areas of evasion of the registration and prospectus requirements of the Securities Act of 1933 is the claiming of exemp 1 Securities Exchange Act Release No. 5927 (Apr. 7, 1959). tions which, in fact, are not available. The attempt to use these exemptions to evade registration requirements usually occurs where the issue, or the sales procedure to be employed, would not stand the light of the full disclosure requirements of registration. In order to narrow this area of evasion, the Commission has consistently sought through its participation in litigation involving claimed exemptions, through its own decisions and through its rule-making power, to define and clarify the proper limits of certain of these exemptions. One of the significant developments in this area has been the recent amendment by the Commission of Rule 133. Under Rule 133, which embodies an interpretation of long standing, the issue of securities in connection with certain types of corporate mergers, consolidations, reclassifications of securities and acquisitions of corporate assets is not deemed to constitute a "sale" of securities to stockholders of corporate parties to the transactions. This rule has the effect of exempting these transactions from the registration requirements, but not from the anti-fraud provisions, of the Securities Act. The rule provides no exemption for subsequent distribution of such securities. Because of the substantial number of transactions ostensibly effected in reliance upon the rule but which involved violation of the registration requirements, the Commission amended Rule 133 to restate the purpose and effect of that rule and to clarify its application and limitations. In addition, the Commission adopted a new registration form to provide an expeditious registration procedure for securities issued in a transaction within Rule 133 where such registration is required and where the issuer has solicited proxies under the Commission's proxy rule with respect to such transaction." In three significant cases the courts have further delineated the boundaries of exemptions from the registration requirements of the Securities Act. A frequently used device for evasion has been the abuse of the intrastate exemption under section 3(a) (11) of the act. The issuer may attempt to use a resident of the state as a nominee for non-resident beneficial owners or the alleged sales to residents may be merely a step in a planned interstate distribution. In S.E.C. v. Hillsborough Investment Corporation, et al.3 the Court upheld the limitation on the scope of that exemption, long viewed as applicable by the Commission, that a single sale to a non-resident, directly or indirectly, destroys the intrastate exemption for the entire issue, including the securities sold only to residents. Various devices have been used in an attempt to avoid registration on the claim that a distribution is within the "private offering" exemption under section 4(1) of the act. The Commission and the courts have consistently rejected a numerical test as a conclusive basis * Securities Act Release No. 4115 (July 6, 1959). D. New Hampshire No. 1965 (Dec. 11, 1958). |