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. Under Rule 206 (4)-2, which became effective in April 1962, an investment adviser who has custody of funds or securities of any client is required to segregate them, maintain them in the manner provided in the rule, and to comply with other conditions specified in the rule. Moreover, every investment adviser who is not exempt from registration is required, since the 1960 amendments, to make, keep and preserve such books and records as may be prescribed by the Commission and the Commission is empowered to inspect such books and records. The books and records to be maintained by investment advisers are specified in Rule 204–2, which became effective in July 1961. Inspection procedures have been revised to obtain information concerning compliance with the new rules. During the fiscal year 1963, 219 inspections were completed and 131 violations of the new rules were disclosed. It is anticipated that the number of inspections will increase annually until the investment advisers registered with the Commission are subject to a regular cycle of inspections. 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, 1,564 investment advisers were registered with the Commission. The following tabulation contains statistics with respect to registrations and applications for registra tion during fiscal year 1963: Investment Adviser Registrations—1963 Fiscal Year Effective registrations at close of preceding fiscal year............ Total.... Registrations cancelled or withdrawn during year.. Registrations denied or revoked during year. Applications withdrawn during year......... Registrations effective at end of year.... Total... 2, 137 An extensive program pursued during the year resulted in the withdrawal or cancellation of the registrations of several hundred investment advisers who failed to file supplements to their registration as required by the Act. ADMINISTRATIVE PROCEEDINGS At the beginning of the fiscal year, 10 revocation proceedings and 1 denial proceeding were pending. With respect to these, the Commission during the year revoked 5 registrations;2 in the denial proceedings, it held that denial of the application for investment adviser registration was not required in the public interest and permitted the application to become effective, subject to certain conditions designed to ensure that the applicant would confine his activities exclusively to those of an investment adviser. During fiscal 1963, the Commission instituted revocation proceedings against 7 registered investment advisers. These proceedings, and the remaining 5 revocation proceedings previously instituted, were pending at the close of the year. Owen K. Taylor, Inc., Edward Blatt, Walter Rosenbush, Financial Forecaster, Inc., Investment Advisers Act Release No. 129 (July 9, 1962); Seymour J. Schlesinger, Investment Advisers Act Release No. 130 (October 4, 1962). • William H. Biesel, Investment Advisers Act Release No. 145 (May 21, 1963). 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 is important that its view regarding the interpretation of the statutes be furnished to the court. At the beginning of the fiscal year 1963 there were pending in the courts 105 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 121 additional proceedings were instituted and 105 cases were disposed of, leaving 121 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 10 proceedings in the district courts under Section 11(e) of the Public Utility Holding Company Act, and in 14 miscellaneous actions. The Commission also participated in 46 civil appeals in the United States courts of appeals. Of these, 19 came before the courts on petition for review of an administrative order, 15 arose out of corporate reorganizations in which the Commission had taken an active part, 2 were appeals in actions brought by or against the Commission, 3 were appeals from orders entered pursuant to Section 11(e) of the Public Utility Holding Company Act, and 6 were appeals in cases in which the Commission appeared as amicus curiae. The Commission also participated in 9 petitions for or memoranda in opposition to 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. Since publication of the last Annual Report, the United States Supreme Court has rendered two significant decisions in the field of securities regulation, one relating to the permissible scope of regulation by a stock exchange of its members, the other to the interpretation of anti-fraud provisions of the Investment Advisers Act of 1940. In Silver v. New York Stock Exchange, the Supreme Court, reversing the court of appeals, held that the stock exchange violated Section 1 of the Sherman Act in ordering several of its member firms to remove telephone wire connections previously in operation between their offices and those of a nonmember-a broker-dealer trading in over-the-counter securities-without giving the nonmember notice, assigning him any reason for the action or affording him an opportunity to be heard. The court found that such action by the exchange would constitute a per se anti-trust violation had it occurred in a context free from other Federal regulation, but agreed with the court of appeals that the exchange's rules governing its members' relationships with nonmembers are within its duty of self-regulation under the Securities Exchange Act, even where the particular nonmember deals only in "unlisted" securities. The court held, however, that particular applications of these rules by the exchange are outside the purview of the anti-trust laws only when justified by its self-regulatory duty and that the Exchange Act affords no justification for anti-competitive collective action taken without according fair procedures. In Securities and Exchange Commission v. Capital Gains Research Bureau, Inc.,2 decided subsequent to the end of the fiscal year, the Supreme Court held that it was fraudulent and deceptive within the meaning of Sections 206 (1) and (2) of the Investment Advisers Act of 1940 for a registered investment adviser to fail to disclose to his clients a practice-known in the trade as "scalping" of purchasing shares of a security for his own account shortly before recommending that security for long-term investment and then immediately selling the shares at a profit upon the rise in the market price following the recommendation. The court pointed out the conflict of interests present in such a situation by noting that "[a]n adviser who, like respondents, secretly trades on the market effect of his own recom 1 373 U.S. 341 (1963). Earlier stages of the litigation in this case are discussed in the 28th Annual Report, pp. 126-127. 232 U.S.L. Week 4029 (1963). Earlier stages of the litigation in this case are discussed in the 28th Annual Report, p. 129, and the 27th Annual Report, p. 163. mendation, may be motivated-consciously or unconsciously-to recommend a given security not because of its potential for long-run price increase (which would profit the client), but because of its potential for short-run price increase in response to anticipated activity from the recommendation (which would profit the adviser)." The court rejected the interpretations of the lower courts to the effect that the Act requires the Commission to establish intent to injure and actual injury to the adviser's clients in order to obtain a preliminary injunction requiring disclosure of such practices. It pointed out that "Congress intended the Investment Advisers Act of 1940 to be construed like other securities legislation 'enacted for the purpose of avoiding frauds,' not technically and restrictively, but rather flexibly to effectuate its remedial purposes." [Footnote omitted.] Among the numerous actions instituted in the Federal district courts by the Commission, seeking injunctions against continuing or threatened violations of the Securities Act or Securities Exchange Act, and related types of proceedings, the following were of particular interest or significance: In Securities and Exchange Commission v. Chamberlain Associates, et al., the Commission sought to enjoin an issuing corporation and a person retained as public relations counsel for the issuer 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 Section 17 (a) of that Act. The public relations counsel had prepared a "Report to Stockholders" which was a verbatim copy of a letter by the company's president. The letter contained false and misleading statements concerning the issuer. The public relations counsel displayed the report and other material to various broker-dealers, encouraged them to establish markets at prices he suggested and on one occasion placed a purchase order for 200 shares. In this manner, the broker-dealers were induced to buy and sell some 3,000 shares, most of which emanated from a Canadian source and as to which no registration statement had been filed and no exemption appeared to be available. The district court concluded that the Commission was entitled to a permanent injunction. It held that the activities of the public relations counsel amounted to a solicitation of offers to buy and thus constituted offers to sell, as defined in Section 2(3) of the Securities Act, and that he was an underwriter as defined in Section 2(11) of that Act. The court concluded that his activities were therefore in violation of Section 5 of that Act. It further held that the counsel also S.D. N.Y., No. 61 Civ. 2150, CCH Fed. Sec. L. Rep. 91,228. |