These are activities in relation to the credit absent which the credit would not be supplied by the factor. If the broker acts for the customer or the factor in these matters, he has involved himself in the financial arrangements which are entirely unrelated to his function of executing his customer's orders and following the customer's instructions as to delivery of securities and payment. If the credit provided the customer exceeds the amount which the broker could himself extend, we think the broker has violated Regulation T."

The Commission rejected the contention that the prohibitions of Regulation T did not apply to a salesman who arranged for the extension of credit through a factor for his own account or that of a member of his family. The Commission said that a salesman who effects transactions in his own account occupies a dual role of customer and representative of the broker-dealer and the credit restrictions of Regulation T apply to his activities in the latter capacity. "It is immaterial," the Commission stated, "that the salesman himself is the instrument through whom the broker-dealer arranges for the extension of credit."

While the Commission recognized that registrant had sought to discourage and to forbid factoring, the Commission concluded that registrant had not been diligent and alert enough in its supervision procedures under all the circumstances. The Commission emphasized the need for adequate supervision of branch offices in large organizations.

Suspension of Registration

Section 15 (b) of the Securities Exchange Act authorizes the Commission to suspend a broker-dealer's registration pending final determination as to whether registration should be revoked. In order to suspend registration, the Commission must find, after notice and opportunity for a hearing, that suspension is necessary or appropriate in the public interest or for the protection of investors. The registrations of four broker-dealers were suspended during the past fiscal year after hearings at which the evidence revealed that they were engaging in serious misconduct.14 To prevent further harm to investors the Commission determined that it was in the public interest to suspend those registrations pending determination of the question of revocation. The entry of a suspension order is not determinative of the ultimate questions of willful violations or revocation itself.

14 Lloyd, Miller and Company, Securities Exchange Act Release No. 6883 (August 15, 1962); Joe Bert Sissom, doing business as Sissom Investment Securities, Securities Exchange Act Release No. 6892 (August 27, 1962); Nance-Keith Corporation (September 10, 1962); Norman Joseph Adams, doing business as Adams & Company, Securities Exchange Act Release No. 7072 (April 30, 1963).

Net Capital Rule

The basic purpose of Rule 15c3-1, promulgated by the Commission under Section 15 (c) (3) of the Exchange Act, is to safeguard funds and securities of customers dealing with registered broker-dealers. This rule, commonly known as the net capital rule, limits the amount of indebtedness which may be incurred by a broker-dealer in relation to its capital. It provides that the "aggregate indebtedness" of a broker-dealer may not exceed 20 times the amount of its "net capital" as computed under the rule.

If it appears from an examination of the reports filed by a registered broker-dealer with the Commission, or through inspection of its books and records, that the ratio is exceeded, the Commission normally notifies the broker-dealer of the deficiency and affords an opportunity for compliance. Unless the capital situation is promptly remedied, injunctive action may be taken by the Commission and in addition proceedings may be instituted to revoke the broker-dealer's registration. During the past fiscal year, violations of the net capital rule were charged in 33 injunctive actions and in 25 revocation proceedings instituted against broker-dealers.

Registered broker-dealers who participate in "firm commitment" underwritings must have sufficient capital to permit the participation provided by the underwriting contract without impairing the capitaldebt ratio prescribed by the rule. For the protection of issuers and customers of the broker-dealer, the Commission's staff carefully analyzes the latest available information on the capital position of the participants to determine whether they will be in compliance with the rule upon assumption of the new obligations involved in the underwritings. Acceleration of the effective date of registration statements filed under the Securities Act will be denied where underwriting commitments may engender violations of the net capital rule by any participating underwriter. A participant found to be inadequately capitalized to take down his commitment is notified and given an opportunity to adjust his financial position to meet the requirements of the rule without reducing his commitments. If he is unable to meet such requirements, he must decrease his "firm commitment" until compliance with the rule is reached. If necessary he may have to withdraw from the underwriting or participate on a "best efforts" basis only.

As a result of recommendations of the Special Study of Securities Markets, the Commission presently has under consideration a proposed rule which would establish minimum net capital requirements for broker-dealers.

Financial Statements

Rule 17a-5 under Section 17(a) of the Exchange Act requires registered broker-dealers to file annual reports of financial condition with the Commission. Such reports must be certified by a certified public accountant or public accountant who is in fact independent, with certain specified limited exemptions applicable to situations where certification does not appear necessary for customer protection. Under certain circumstances member firms of national securities exchanges are exempt from the necessity of certification and an exemption is available for a broker-dealer who, since his previous report, has limited his securities business to soliciting subscriptions as an agent for issuers, has transmitted funds and securities promptly, and has not otherwise held funds or securities for or owed monies or securities to customers. Also exempt is a broker or dealer who, from the date of his last report, has confined his business to buying and selling evidences of indebtedness secured by liens on real estate and has carried no margin accounts, credit balances or securities for any customers.

After his registration, a broker-dealer's first financial report must reflect his condition as of a date between the end of the 1st and 5th months after the effective date of the registration. All reports must be filed within 45 days after the date as of which the report speaks. Through these reports the Commission and the public may evaluate the financial position and responsibility of broker-dealers. The financial report is one means by which the staff of the Commission determines whether the registrant is in compliance with the net capital rule. Failure to file the required reports may result in the institution of revocation proceedings. However, it is the policy of the Commission first to advise the broker-dealer of his obligations under the rule and to give him an opportunity to file the report.

During the fiscal year 5,197 reports of financial condition were filed with the Commission compared to the 1962 total of 5,228.

As of February 14, 1963, the last date for broker-dealers to file their 1962 annual financial reports, if prepared as of December 31, 1962, a large number were delinquent in their filings. An effort has been made to obtain the termination of the registrations of those brokerdealers through revocation, withdrawal or cancellation. A continuing effort will be made to secure the filing of financial reports of all registered broker-dealers in compliance with the Commission's requirements.

Broker-Dealer Inspections

Section 17(a) of the Exchange Act provides for regular and periodic inspections of registered broker-dealers. During the fiscal year the

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number of such inspections totaled 1,534. The inspection device is a most useful instrument in protecting investors and detecting violations of the Federal securities laws. The inspection, among other things, determines a broker-dealer's financial condition, reviews his pricing practices, evaluates the safeguards employed in handling customers' funds and securities, and determines whether adequate and accurate disclosures are made to customers.

The Commission's inspectors also determine whether brokers and dealers are keeping books and records as required by the Exchange Act and the Commission's rules thereunder and conforming to the margin and other requirements of Regulation T of the Federal Reserve Board. Inspectors also look for excessive trading or switching in customers' accounts. Inspectors frequently find evidence of the sale of unregistered securities or of fraudulent practices such as use of improper sales literature or sales techniques.

When inspections reveal that a broker-dealer is violating the statutes or rules, consideration is given to the type of violation and the effect on the public. The Commission does not take formal action as a result of every infraction discovered. Inspections frequently reveal inadvertent violations which are discovered before becoming serious and before customers' funds or securities are in danger. When no harm has come to the investing public the registrant is informed of the violations and advised to correct the improper practices. If the violation appears to be willful and the public interest is best served by formal action against the broker-dealer, the Commission will institute appropriate proceedings.

The table below shows the types of infractions uncovered by the inspection program during the fiscal year:

Type

Financial difficulties..

Hypothecation rules__

Unreasonable prices in securities purchases and sales--

Regulation T of the Federal Reserve Board__.

"Secret profit”.

Confirmation and bookkeeping rules.

Other...

Total indicated violations..

Number of brokers

328

39

187

147

5

847

384

1, 937

The National Association of Securities Dealers, Inc., and the principal stock exchanges also conduct inspections of their members, and some states have inspection programs. Each inspecting agency conducts inspections in accordance with its own procedures and with particular reference to its own regulations and jurisdiction. Inspections by the Commission are primarily concerned with the detection

of violations of the Federal securities laws and the Commission's regulations. The inspection programs of the self-regulatory agencies and of the states afford added protection to the public. The Commission and certain other inspecting agencies coordinate their inspections to avoid duplication and to obtain the widest possible coverage of brokers and dealers. Agencies now participating in this coordination program include the New York Stock Exchange, the American Stock Exchange, the Boston Stock Exchange, the Midwest Stock Exchange, the Pacific Coast Stock Exchange, the Philadelphia-Baltimore-Washington Stock Exchange, the Pittsburgh Stock Exchange, and the National Association of Securities Dealers, Inc. It is hoped that even closer coordination may become possible in the future as recommended by the Special Study of Securities Markets. This program, however, does not preclude the Commission from inspecting any broker-dealer that has also been inspected by another agency, and such inspections are made whenever reason therefor exists.

SUPERVISION OF ACTIVITIES OF NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.

The Securities Exchange Act of 1934, in Section 15A (the "Maloney Act"), provides for the registration with the Commission of national securities associations and establishes standards for such associations. The rules of such associations must be designed to promote just and equitable principles of trade, to prevent fraudulent and manipulative acts and practices and to meet other statutory requirements. Such associations are essentially disciplinary in purpose and serve as a medium for the cooperative self-regulation of over-the-counter brokers and dealers. They operate under the general supervision of this Commission which is authorized to review disciplinary actions and decisions which affect the membership of members, or of applicants for membership, and to consider all changes in the rules of associations. The National Association of Securities Dealers, Inc. (NASD) is the only Association registered under the Act.

In adopting legislation permitting the formation and registration of such associations, Congress provided an incentive to membership by permitting such associations to adopt rules which preclude a member from dealing with a nonmember, except on the same terms and conditions as the member affords the investing public. The NASD has adopted such rules. Accordingly, membership is necessary to profitable participation in underwritings and over-the-counter trading since members may properly grant price concessions, discounts and similar allowances only to other members. Loss or denial of membership due to expulsion or suspension or other ineligibility due to a