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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.

Section 206 of the Act, as amended in September 1960, prohibits an 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 1962 fiscal year, adopted Rule 206(4)-1, effective January 1, 1962, which defines certain advertisements by investment advisers as fraudulent, deceptive or manipulative. During the 1963 fiscal year an informal program was instituted to secure compliance with Rule 206(4)-1 by those investment advisers whose advertising continued to be objectionable. The cooperation of the investment advisers who were contacted has resulted in a marked reduction in the publication and distribution of advertising material violative of Rule 206 (4)-1.

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 exempt from registration from basing his compensation upon a share

1 In S.E.O. v. Capital Gains Research Bureau, Inc., an important action under the antifraud provisions of the Act as in effect prior to its amendment, the Supreme Court in December 1963 reversed lower court decisions denying the Commission's motion for a preliminary injunction. See pp. 112-113, infra.

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 registration during fiscal year 1963:

Investment Adviser Registrations1968 Fiscal Year Effective registrations at close of preceding fiscal year. Applications pending at close of preceding fiscal year. Applications filed during fiscal year.--

1, 836

16 285

Total...

2, 137

Registrations cancelled or withdrawn during year..
Registrations denied or revoked during year..
Applications withdrawn during year...
Registrations effective at end of year..-
Applications pending at end of year.---

539

5

3 1, 564

26

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 Rosendush, Financial Forecaster, Inc., Investment Advisers Act Release No. 129 (July 9, 1962); Seymour J. Schlesinger, Invest. ment Advisers Act Release No. 130 (October 4, 1962).

William H. Biesel, Investment Advisers Act Release No. 145 (May 21, 1963).

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., 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

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1 373 U.S. 341 (1963). Earlier stages of the litigation in this case are discussed in the 28th Annual Report, pp. 126-127.

2 32 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.

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