PART X ADMINISTRATION OF THE INVESTMENT ADVISERS ACT OF 1940 The Investment Advisers Act of 1940 requires the registration of persons engaged for compensation in the business of advising others with respect to securities. Certain advisers are exempt from the requirement of registration, including those who advise only investment companies or insurance companies and those who, within the last 12 months, had fewer than 15 clients and who do not hold themselves out generally to the public as investment advisers. Furthermore, the registration requirements do not apply to an adviser whose investment advice is given only to persons resident in the state in which he maintains his principal place of business, as long as the advice does not concern securities listed on a national securities exchange or admitted to unlisted trading privileges on such an exchange. As discussed in the last Annual Report1 Section 206 of the Act, which prohibits certain unlawful practices by investment advisers, was amended in September 1960 by the addition of subsection (4). That subsection prohibits any investment adviser from engaging in fraudulent, deceptive or manipulative acts or practices and gives the Commission authority, by rules and regulations, to define and to prescribe means reasonably designed to prevent such acts and practices. In accordance with this provision the Commission during the fiscal year adopted Rule 206(4)-1, effective January 1, 1962,2 which defines certain advertisements by investment advisers as fraudulent, deceptive or manipulative. It also adopted Rule 206 (4)-2, effective April 2, 1962,3 which requires an investment adviser who has custody of funds or securities of any client to segregate them, maintain them in the manner provided in the rule, and to comply with other conditions specified in the rule. Investment advisers who also effect transactions as brokers and dealers must disclose any interest they may have in transactions effected for clients if acting as an investment adviser with regard to such transactions. The Act prohibits any investment adviser not 127th Annual Report, p. 159. * Investment Advisers Act Release No. 121. 'Investment Advisers Act Release No. 123. exempt from registration from basing his compensation upon a share of the capital gains or appreciation of his client's funds. The Act also makes it unlawful for any such investment adviser to enter into, extend or renew any investment advisory contract or to perform such contract if the contract provides for compensation to the investment adviser on the basis of a share of capital gains or capital appreciation of the funds or any portion of the funds of the client or fails to provide that no assignment of such contract shall be made by the investment adviser without the consent of the other party to the contract. Prior to the 1960 amendments, the Act did not require investment advisers to keep and preserve books and records, nor was the Commission empowered to inspect books and records kept by investment advisers. Section 204 of the Act, as amended, now requires every investment adviser who is not exempt from registration to make, keep and preserve such books and records as may be prescribed by the Commission and empowers the Commission to inspect such books and records. In accordance with this provision, the Commission adopted Rule 204-2, effective July 1, 1961, specifying the books and records to be maintained by investment advisers. Inspection procedures have been revised to obtain information concerning compliance with the new rules. These rules are more fully discussed in Part III of this report. Investment advisers who violate any of the provisions of the Act are subject to appropriate administrative, civil or criminal remedies. With respect to administrative remedies, the Act provides, in Section 203 (d), that the Commission shall deny, revoke, or suspend for not more than 12 months, the registration of an investment adviser if it finds that such action is in the public interest and that the investment adviser or any partner, officer, director or controlling or controlled person of the investment adviser is subject to a specified disqualification. These disqualifications include willful misstatements in an application or report filed with the Commission, the existence of a conviction or injunction based on or related to specified types of misconduct, willful violation of any provision of the Securities Act, Securities Exchange Act or Investment Advisers Act or any rule or regulation thereunder, or aiding and abetting any other person's violation of such provisions, rules or regulations. At the close of the fiscal year, 1836 investment advisers were registered with the Commission. The following tabulation contains statistics with respect to registrations and applications for registration during fiscal year 1962: Investment Advisers Act Release No. 114. Investment Adviser Registrations-1962 Fiscal Year Effective registrations at close of preceding fiscal year__. 1,855 24 Total_____ Registrations cancelled or withdrawn during year_. Applications withdrawn during year_-_ Registrations effective at end of year___ Applications pending at end of year.. Total___. ADMINISTRATIVE PROCEEDINGS 315 2, 194 338 0 4 1,836 16 2, 194 During fiscal 1962, the Commission instituted revocation proceedings against six registered investment advisers and in another instance instituted proceedings to determine whether an application for registration should be denied. These proceedings, and four revocation proceedings previously instituted, were pending at the close of the year. The proceedings instituted during the year included the following: Carroll Tillman and John Francis Ryan, Jr. each doing business as The Tillman Survey-The Commission instituted proceedings to determine whether the registrants had engaged in fraudulent and deceptive acts including the distribution of advertising material which was "lurid and flamboyant" contrary to Rule 206(4)-1 under the Act and whether the public interest required that their registrations as investment advisers be revoked. The Commission's staff charged that Tillman, aided and abetted by Ryan, published and distributed advertising material which contained untrue statements and was false and misleading. The alleged misrepresentations in the advertisements involved comparisons between the securities recommended by Tillman and other securities without adequately disclosing the material differences between the securities, and representations that a list of 10 stocks which Tillman offered was selected in accordance with 7 tests prescribed by him and that these tests could "dig up" securities which eventually could be enormously profitable. The staff charged that the advertising material created false and misleading impressions by referring to 25%, 50% and 100% increases in market values, by falsely representing that certain subscription offers were available only to a selected group and by guaranteeing that a refund would be made to subscribers unless a group of 10 stocks rose 175 points before September 7, 1962, while omitting to disclose Tillman's complex and misleading method of determining the dates and figures used in ascertaining the availability of such guarantee." • Investment Advisers Act Release No. 128 (June 20, 1962). PART XI OTHER ACTIVITIES OF THE COMMISSION CIVIL LITIGATION The several statutes administered by the Commission authorize the Commission to seek injunctions against continuing or threatened violations of such statutes. Such violations may involve a wide range of illegal practices, including the purchase or sale of securities by fraud, and the sale of securities without compliance with the registration requirements of the Securities Act. The Commission also participates in various other types of proceedings, including appearances as amicus curiae in litigation between private parties where it deems important that its views regarding the interpretation of the statutes be furnished to the court. At the beginning of the fiscal year 1962 there were pending in the courts 96 injunctive and related enforcement proceedings instituted by the Commission to prevent fraudulent and other illegal practices in the sale or purchase of securities. During the year 89 additional proceedings were instituted and 80 cases were disposed of, leaving 105 such proceedings pending at the end of the year. In addition the Commission participated in a number of corporate reorganization cases under Chapter X of the Bankruptcy Act, in 9 proceedings in the District Courts under Section 11(e) of the Public Utility Holding Company Act, and in 9 miscellaneous actions. The Commission also participated in 50 civil appeals in the United States Courts of Appeals. Of these, 14 came before the courts on petition for review of an administrative order, 9 arose out of corporate reorganizations in which the Commission had taken an active part, 11 were appeals in actions brought by or against the Commission, 2 were appeals from orders entered pursuant to Section 11(e) of the Public Utility Holding Company Act, and 10 were appeals in cases in which the Commission appeared as amicus curiae. The Commission also participated in 6 appeals or petitions for certiorari before the United States Supreme Court resulting from these or similar actions. Complete lists of all cases in which the Commission appeared before a Federal or state court during the fiscal year, either as a party or as amicus curiae, and the status of such cases at the close of the year are contained in the appendix tables. This section describes a few of the more noteworthy cases, not including, however, any cases arising under the Public Utility Holding Company Act or Chapter X of the Bankruptcy Act; cases arising under those statutes are discussed in the sections of this report dealing with such statutes. In S.E.C. v. Herbert Rapp, et al.,1 the Commission sought a permanent injunction against Rapp, a registered broker-dealer, and certain of his salesmen for violating Section 17(a) of the Securities Act, by making false and misleading statements in the offer and sale of the stock of an aircraft manufacturing company. The District Court, after trial, dismissed the complaint for failure of proof, finding, among other things, that expressions of opinion by salesmen that the stock would soon increase significantly in value did not constitute a material misrepresentation. The Court made no reference to the distribution of misleading sales literature, and it further apparently exonerated Rapp because he had made no oral representations. It also denied the Commission's motion at the end of the trial, pursuant to Rule 15 (b) of the Federal Rules of Civil Procedure, to conform the pleadings to the proof. The Court of Appeals for the Second Circuit reversed the District Court, ordering that a permanent injunction issue as to Rapp and remanding as to the salesman involved in the appeal. The Appellate Court held that where the defendants failed to object to the trial of issues not raised by the pleadings, the District Court was required to grant the Commission's motion to conform the pleadings. It further held that since the salesmen had no knowledge of the securities business and their statements were in accord with the sales literature which Rapp instructed them to follow, the District Court erred in stating that the latter was not responsible for the misrepresentations made by them. Furthermore, it held that Rapp was responsible for misrepresentations in a brochure mailed to prospective investors, and that he also violated Section 17(a) by leading customers to believe he was acting as agent in the sale of the stock, when in fact he was acting as principal. The action as to the salesman was remanded for further proceedings since the findings of fact were insufficient to determine whether his predictions of future value were opinions without basis in fact. In S.E.C. v. Custer Channel Wing Corporation, et al. the Commission sought to enjoin an issuing corporation, its president and a trustee from offering and selling securities without registration in violation of Section 5 of the Securities Act, and from engaging in practices operating as a fraud upon purchasers in violation of Sec 1 S.D.N.Y. No. 132-344. 2 CCH Sec. L. Rep. 191048. 29 U.S.C.A. Rule 15(b). 304 F. 2d 786 (1962). D. Md. No. 13,500 Civil. |