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of the New York Stock Exchange, the American Stock Exchange, the principal regional exchanges, the National Association of Securities Dealers, Inc. (“NASD"), and certain quasi-regulatory agencies, notes the absence of self-regulatory organizations in certain areas, and assesses the role of the Commission in relation to all of them.
The market break of May 1962 was thought to merit separate examination as a major market phenomenon, and also afforded an opportunity to study certain aspects of the securities markets, already studied under more normal conditions, in the circumstances of a precipitous decline. The results of this study are set forth in Chapter XIII, the final chapter of the Report.
The Commission's judgment on the state of the securities markets and their regulation was summarized in its transmittal letter accompanying the first segment of the Report: “At the outset we emphasize that, although many specific recommendations for improvements in rules and practices are made in the Report of the Special Study, the report demonstrates that neither the fundamental structure of the securities markets nor of the regulatory pattern of the securities acts requires dramatic reconstruction. ... At the same time the Report makes very clear that important problems do exist, grave abuses do occur, and additional controls and improvements are much needed.”
The Report points up many shortcomings in investor protection, of various kinds and degrees, and makes 175 specific recommendations for their correction. In transmitting the Report to Congress, the Commission stated that "we do not embrace every recommendation as our own, but we do accept them as a sound point of departure for proposals to the Congress, for rule-making by the Commission and by the self-regulatory agencies, and for discussions with the industry." The Commission's letters of April 19, and July 23, 1963, to Chairman Oren Harris of the House Interstate and Foreign Commerce Committee and Chairman A. Willis Robertson of the Senate Banking and Currency Committee, and its transmittal letter to Congress of August 8, 1963, stated the Commission's response to each of the Study's recommendations.
As stated, the Study Report is a basic informational document. Among other things, it describes for the first time, in an organized and complete fashion, the operation of the current over-the-counter market, and the impact of the New York Stock Exchange minimum commission rate schedule on the securities markets. In addition, the Report provides an over-all review of the operation of self-regulation.
Secondly, the Study and its Report have been and will be a springboard for both industry and regulatory action. The Study's impact
has already been felt in many ways. Even while still in progress, it stimulated an extensive self-examination by various segments of the securities industry, most notably the self-regulatory agencies. As a result, these agencies have made a number of improvements in rules and practices, which may be in whole or part attributed to the Study. Thus, the American Stock Exchange followed up its reorganization, as reported in last year's annual report, by a number of beneficial changes. It substituted a staff system for the self-perpetuating standing committees of Exchange members, substantially augmented its staff and adopted higher listing and delisting standards. The Exchange also took disciplinary action against various members and allied members whose activities had been discussed in the January 1962 staff report on the Exchange. In sum, the Exchange has now instituted a responsible regulatory system as a basis for meeting its obligations under the Securities Exchange Act. The New York Stock Exchange has also made a substantial number of significant improvements. Qualification standards applicable to various classes of members and member-firm employees were raised. The rules covering market letters were strengthened and the procedures for review of these letters by the Exchange were improved. The Exchange staff was increased to strengthen the capacity for self-regulation. The NASD also increased its staff and expanded its surveillance activities. It is now undertaking a complete review of its by-laws, rules, and organizational structure, which is expected to result in more effective organization and operation.
The second result of the Special Study Report has been the Commission's legislative program, submitted to Congress in June 1963.2 Following hearings before a subcommittee of the Senate Banking and Currency Committee on a bill embodying the Commission's proposals, during which the broad purposes of the legislative program were strongly endorsed by all segments of the securities industry, the bill was passed by the Senate on July 30, 1963. As of December 1963, hearings had been held by a subcommittee of the Committee on Interstate and Foreign Commerce of the House of Representatives on the two bills introduced in the House of Representatives.
2 The Commission's proposals were submitted to the Committee on Banking and Currency of the Senate and the Committee on Interstate and Foreign Commerce of the House of Representatives. On June 4, 1963, three identical bills embodying the Commission's proposals were introduced in the Congress. S. 1642 was introduced (by request) in the Senate by Senator A. Willis Robertson, Chairman of the Senate Committee on Banking and Currency; H.R. 6789 was introduced in the House of Representatives by Representative Oren Harris, Chairman of the Committee on Interstate and Foreign Commerce, House of Representatives, and H.R. 6793 was introduced by Representative Harley 0. 'Staggers, Chairman of the Subcommittee on Commerce and Finance of the Committee on Interstate and Foreign Commerce, House of Representatives.
The proposed legislation, in its broadest terms, has two major purposes. The first is to improve investor protection in the over-thecounter market, primarily by extending to investors in over-thecounter securities the fundamental protections which under existing legislation are generally afforded only to investors in securities listed on an exchange. Briefly, these protections are as follows: A company listing its securities on an exchange must file a registration statement containing material information regarding its business and must keep such information current by periodic reports; securityholders whose votes are solicited must be furnished with a proxy statement, which must contain adequate and accurate information; and corporate "insiders" must report their securities transactions and are liable to the company for short-swing trading profits. The proposed legislation would extend these protections to investors in over-thecounter companies having more than 750 shareholders (500 shareholders at a subsequent date) and more than $1 million in assets. The second purpose of the proposed legislation is to strengthen qualification standards for entrance into the securities business and controls over those already in that business, again with emphasis on the overthe-counter market. The principal proposed changes in this area would include the following: All over-the-counter broker or dealer firms would be required to be members of a registered securities association, in order to bring them within the self-regulatory scheme. Registered securities associations would be required to adopt rules, subject to Commission approval, establishing standards of training, experience and competence for members and their employees and to establish capital requirements for members. In addition, the rigidity of the present statutory scheme for disciplining violators, which does not provide for direct Commission action against individual wrongdoers connected with a broker or dealer, or expressly authorize the Commission to impose useful intermediate sanctions against a registered firm short of revoking its registration, would be removed by permitting action against the individual in lieu of proceeding against the entire firm, and by authorizing the imposition of intermediate sanctions such as temporary suspension or censure. The authority of a national securities association to act directly against offending individuals would also be clarified.
A major part of the Study's recommendations can be implemented under existing legislation, through the rule-making powers of the Commission or the self-regulatory agencies. At the present time, the Commission and the industry are actively engaged in considering the Study's recommendations and analyzing the problems discussed by the Study Report. Because of the vast number of recommendations, the
Commission has thought it necessary to select out certain priority items which will be given first attention. To this end, the recommendations have been divided into two main groups. The first, those of particular concern to specific self-regulatory agencies, have been taken up with the affected exchange or the NASD and agreement has been reached on the subjects to be given first attention. Thus, in the exchange area, priority designation has been given to the proposals relating to odd-lot dealers, floor traders, specialists and automation. Further, the Commission and the NASD are giving first priority in the over-the-counter market to the quotation systems, the “markup” policy, execution of retail transactions and the strengthening of the organization and structure of the NASD itself.
The other major group of recommendations are those of concern to the securities industry as a whole, transcending the particular interest of any one self-regulatory agency. These have already been discussed with the members of the Industry Advisory Committee. The Committee is designating appropriate subcommittees to consider such vital matters as selling practices, the establishment of minimum capital requirements, and rules relating to the conduct of those who distribute securities.
The priority groups include those matters which in the Commission's opinion warrant immediate attention. As a practical matter, not all 175 specific recommendations can be implemented immediately and simultaneously. But those recommendations not receiving first priority are being neither discarded nor neglected. A considerable amount of work has already been done on a number of them; it is expected that in a reasonable period of time they will all receive full attention and action by the Commission and its staff.
The Commission has taken steps to reorganize its personnel for the implementation of the Study's recommendations. Thus, a new Office of Program Planning was created, with the initial task of assisting and advising the Commission with respect to the implementation program. The Division of Trading and Exchanges was renamed the Division of Trading and Markets and was reorganized. Many of the Special Study's personnel have been assigned to these units, as well as to other staff offices, and they are playing an important role in the implementation program.
The Special Study recommended that the Commission more fully exercise its powers of oversight and supervision over the self-regulatory agencies. Accordingly, a new office within the Division of Trading and Markets, the Office of Regulation, has been created and assigned the general responsibility of overseeing the operations of the self-regulatory agencies. At the same time, the Commission has
strengthened and instituted important oversight programs, including an increased schedule of examinations of the exchanges and of the NASD and in general securing more information about their operations.
As has been noted, the securities industry and the various selfregulatory agencies have already taken many important and significant steps which should have the effect of raising investor protection. The Commission itself has issued a proposed rule, based on the Study's recommendations, which would require financial statements in annual reports transmitted to stockholders not to be materially misleading in light of the reports filed with the Commission, and, as of December 1963, consideration was being given to other possible proposed rules. Furthermore, out of the very intensive and active scrutiny and examination of rules and practices stimulated by the Special Study Report and now being conducted by the Commission, the self-regulatory agencies and the securities industry itself, it can be anticipated that many additional important changes in rules and practices can be adopted, which will contribute to the improvement of investor protection. Enforcement Activity
As described in more detail in other parts of this report, the Commission continued to pursue a vigorous enforcement program during the fiscal year in an effort to combat fraudulent and other illegal practices in securities transactions. The Commission, as in the past, took action on all available fronts—civil, criminal and administrative. Thus, 121 injunction or related court enforcement proceedings were instituted by the Commission during the year, a larger number than in any previous year. Six hundred and twenty-two investigations of securities transactions involving possible violations of the anti-fraud or other provisions of the securities acts were instituted. Forty-nine cases were referred to the Department of Justice for criminal prosecution. A striking example of the complexity which criminal cases in this field may assume, and the extent of the investigative work which must necessarily precede the actual prosecution of such cases, is presented by United States v. Garfield, in which, after the longest trial in the history of Federal criminal prosecutions (some 11 months), the defendants were convicted in February 1963 of manipulating the market price of the common stock of United Dye and Chemical Corporation and fraudulently distributing unregistered shares of such stock through “boiler-rooms.” At the conclusion of the trial, the judge commented that "there never was a case that was proved to the hilt the way this case was proved.” He commended two members of the Commission's staff for their investigative efforts, stating that "it