Adoption of Rule 15c2-4

There have been instances where, as a result of financial reverses or for other reasons, underwriters and other broker-dealers participating in distributions have failed to remit amounts collected to the issuer, or to return payments made by customers to them where such return was required unless the distribution was completed within a specified period of time. Rule 15c2-4 was adopted to deal with this type of situation. The rule makes it a "fraudulent, deceptive, or manipulative act or practice" for any broker or dealer participating in any distribution other than a firm-commitment underwriting, to accept any part of the sale price of any security being distributed unless (1) it is promptly transmitted to the persons entitled thereto, or (2) if the distribution is being made on an "all-or-none” basis, or on any other contingent basis, the money is put into a trust or agency account, or delivered to an escrow bank, until the event or contingency has occurred, and it is then promptly transmitted or returned to the persons entitled thereto.16

Adoption of Rule 15c2-5

Shortly after the close of the fiscal year, the Commission adopted Rule 15c2-5 to prevent fraudulent practices by brokers or dealers in connection with the offer or sale of securities under a program which contemplates that the securities sold to the customer will be used as collateral for a loan, whose proceeds will be used to pay the premium on a life insurance policy sold to the customer at or about the same time (an activity which in various forms has come to be known as "equity funding," "secured funding," or "life funding”)." The Commission had previously expressed the view that such a plan generally involves the offer and sale of an additional security, i.e., an investment contract, which is required to be registered under the Securities Act of 1933.18 Some dealers were offering this type of program without adequate consideration of whether it was suitable for particular customers, and they failed to furnish customers with adequate information concerning the nature and extent of the obligations and risks involved and the commissions and other remuneration which the dealer and his associates would receive in connection with the transactions.

The rule makes it unlawful for any broker or dealer to offer, sell or attempt to induce the purchase of any security by any person if the broker or dealer, in connection therewith, offers to extend any credit to or to arrange any loan for such person, or participates in

14 Securities Exchange Act Release No. 6737 (February 21, 1962). "Securities Exchange Act Release No. 6851 (July 17, 1962).

1 Securities Act Release No. 4491 (May 22, 1962).

arranging any such loan or credit, unless, before any part of the transaction is entered into, the broker or dealer delivers to him a written statement setting forth certain material information concerning the arrangement being offered. In addition, the broker or dealer is required to obtain from each customer information concerning the latter's financial situation and needs, to reasonably determine that the entire transaction, including the loan arrangement, is suitable for the customer, and to deliver to him a written statement setting forth the basis upon which this determination was made. If, in connection with the transaction, it is contemplated that the prospect will cancel existing life insurance, the written statement delivered to the prospect before the transaction is entered into will have to disclose the disad vantages, if any, which the prospect will incur because of this Among other things, this may require disclosure that the premium on the new life insurance is higher than the premium on the old insurance; that the purchaser may be incurring additional expense because he is paying the "acquisition costs" twice; that it may take a specified additional period of time for the dividends or the cash value of the new policy to equal those under the old policy; and that the prospect may lose the benefits of the "incontestability provision" because the period during which the insurer may contest the policy for specified reasons may have expired under the old policy and the prospect may be required to "wait through" this period again under the new policy.

Amendment of Rule 15c3-1

Rule 15c3-1, which provides that no broker or dealer shall permit his aggregate indebtedness to exceed 2,000% of his net capital. exempts from its requirements the members of specified exchanges whose "rules and settled practices" were deemed by the Commission to impose requirements more comprehensive than the requirements of the rule. However, a condition precedent to the continuation of any such exemption is that the exchange conduct such inspections and maintain such other procedures as are necessary to be reasonably sure that members are complying with its capital requirements. The Salt Lake Stock Exchange requested termination of the exemption for its members because it was burdensome for it to conduct the inspec tions and other procedures necessary to a continuation of the exemp tion. Accordingly, the Commission amended Rule 15c3-1 to delete the exemption previously available to members of that exchange.19

Amendment of Rules 17a-3 and 17a-4

Rule 17a-3 specifies the books and records which must be maintained by certain members of national securities exchanges and other broker

19 Securities Exchange Act Release No. 6691 (Dec. 21, 1961).

dealers, and Rule 17a-4 requires the preservation of such books and records for specified periods.

The amendment of Rule 17a-3 requires each exchange member, broker or dealer subject to the rule to maintain a questionnaire or application for employment executed by each "associated person," as defined in the rule. This questionnaire or application must contain certain specified information and be approved in writing by an authorized representative of the member, broker or dealer. Under the amendment of Rule 17a-4, this information is required to be maintained until at least 3 years after such associated person terminates his employment and any other connection with the member, broker or dealer.20

There were two principal reasons for the adoption of the amendments. First, good business practice makes it appropriate for members, brokers and dealers to maintain fairly detailed data concerning the experience and past record of partners, officers, salesmen, traders, and other employees handling funds, securities or transactions for the firm. Secondly, the availability of such information in the firm's records will be of value to the Commission in its broker-dealer inspections and enforcement activities.

Since the National Association of Securities Dealers, Inc., and various national securities exchanges require all personnel engaged in managing, supervising or handling securities transactions for their members to be registered with or approved by the Association or the exchange, and also require the execution of applications for registration or for approval by such persons which contain information similar to the information required under Rule 17a-3, as amended, the amendment provides that the retention of copies of such applications made to the Association or to the specified exchanges shall constitute compliance with Rule 17a-3 so far as those persons are concerned.

Amendment of Rule 15ag-1

Rule 15ag-1 sets out the procedures to be followed in connection with Commission review of disciplinary action, or of denial of membership, by a national securities association, on the application of a person aggrieved by such action or denial. Amendments to the rule adopted during the fiscal year are designed to facilitate and expedite the handling of review proceedings.

21

The amendments make it mandatory for the applicant to file a brief or statement in support of his application, specifying the basis of the appeal and the relief sought, within a specified period, and

"Securities Exchange Act Release No. 6646 (October 6, 1961). "Securities Exchange Act Release No. 6606 (July 26, 1961).

672175-63- -3

authorize summary dismissal of an application where a timely brief is not filed. The filing of an answering brief by the association or of a reply by the applicant to an answering brief is optional. The amendments also provide that oral argument will be heard only with special Commission permission. The former provision which specified that oral argument would take place in all cases except where waived by the parties resulted in uncertainty and undue delay where an applicant failed to appear or where it was not possible to obtain a waiver.

THE TRUST INDENTURE ACT OF 1939

Amendment of Form T-3

Form T-3 is used for applications for the qualification of indentures in cases where the indenture securities are not required to be registered under the Securities Act of 1933. An amendment to this form, adopted during the fiscal year, requires that there be filed as an exhibit to such applications a cross reference sheet showing the location in the indenture of the provisions which the Trust Indenture Act requires to be included in all qualified indentures.22 The purpose of the amendment is to facilitate the examination of indentures to determine whether they meet the requirements of the Act.

THE INVESTMENT COMPANY ACT OF 1940

Amendments to Rules 31a-1 and 31a-2; Adoption of Rule 31a-3

During the fiscal year, the Commission issued a notice of proposal to amend its existing Rules 31a-1 and 31a-2 under the Investment Company Act, and to adopt a new Rule 31a-3 under the Act.23 The existing rules relate to records required to be maintained and preserved by registered investment companies, certain majority-owned subsidiaries thereof, and other persons having transactions with registered investment companies. As a result of the experience gained by the Commission in its administration and enforcement of the Act, including the experience derived from staff inspections of registered investment companies and certain affiliated persons, it appeared to the Commission that the public interest and the interest of investors required that Rules 31a-1 and 31a-2 should be amended to prescribe with greater specificity and detail the records of securities transactions required to be kept, and to prescribe the keeping of certain memoranda and documents not previously required. It also appeared that a new Rule 31a-3 should be adopted setting forth cer tain requirements in circumstances where the records called for in Rules 31a-1 and 31a-2 are prepared or maintained by others on behalf of the person required to maintain them.

"Trust Indenture Act Release No. 170 (May 7. 1962).

23 Investment Company Act Release No. 3368 (November 28, 1961).

Subsequent to the end of the fiscal year, the Commission adopted the amendments and the new rule.24

Adoption of Exemptive Rules Applicable to Licensed Small Business Investment Companies

In the fiscal year, the Commission adopted rules and a related form applicable to small business investment companies licensed by the Small Business Administration, to provide exemptions from certain requirements of Sections 17(a), 17(d), and 18(c) of the Investment Company Act.25 Rule 17a-6 exempts from the prohibitions of Sections 17(a) (1) and 17(a)(3) of the Act, subject to certain conditions, loans and other securities transactions which would be prohibited by those Sections solely because an SBIC owns, holds, or controls with power to vote the voting securities of a small business concern. At the same time the Commission adopted, pursuant to Section 17(d) of the Act, an amendment to Rule 17d-1 which exempts from that rule's requirements certain transactions where banks and an affiliated SBIC make investments in the same small business concern, and a new Rule 17d-2 which prescribes a related reporting Form N-17D-1. The Commission has adopted a new Rule 18c-1 which exempts a small business investment company from the requirements of Section 18(c) so as to permit it to issue more than one class of senior security representing indebtedness so long as all such indebtedness is privately held and the company does not have outstanding any publicly held indebtedness.

THE INVESTMENT ADVISERS ACT OF 1940

Adoption of Rules 206(4)-1 and 206(4)−2

Section 206 (4) of the Investment Advisers Act, which was enacted in September 1960, prohibits an investment adviser from engaging in any act, practice, or course of business which is fraudulent, deceptive, or manipulative, and gives the Commission the power by rules and regulations to define and prescribe means reasonably designed to prevent such acts, practices, and courses of business.

The Commission during the fiscal year adopted Rule 206(4)–1, effective January 1, 1962, defining certain advertisements by investment advisers to be fraudulent, deceptive, or manipulative within the meaning of Section 206 (4) of the Act.26 The rule is intended to implement the statutory mandate by foreclosing the use of advertisements which have a tendency to mislead or deceive clients or prospective clients.

24 Investment Company Act Release No. 3578 (November 28, 1962). 25 Investment Company Act Release No. 3361 (November 17, 1961). Investment Advisers Act Release No. 121 (Nov. 2, 1961).