one of the most useful means available to the Commission for the protection of investors. Among other things, the staff members conducting the inspection determine a broker-dealer's financial condition, review his pricing practices, evaluate the safeguards employed in handling customers' funds and securities, and determine whether adequate and accurate disclosures are made to customers. The Commission's inspectors also determine whether brokers and dealers are maintaining books and records as required by the Exchange Act and the Commission's rules thereunder and are conforming to the margin and other requirements of Regulation T of the Board of Governors of the Federal Reserve System. Inspectors also look for excessive trading or switching in customers' accounts. They frequently find evidence of the sale of unregistered securities or of fraudulent practices such as use of improper sales literature or sales techniques. When an inspection reveals that a broker-dealer is in violation of applicable statutory provisions or rules, the action taken depends on the type of violation and its effect on the public. The Commission does not take formal action as a result of every infraction discovered. However, if the violation appears to be wilful and the public interest is best served by formal action against the broker-dealer, the Commission promptly institutes appropriate proceedings. The table below shows the types of infractions uncovered by the inspection program during the fiscal year: Unreasonable prices in securities purchases and sales-- 58 82 Section 15A of the Exchange Act provides for registration with the Commission of national securities associations and establishes standards and requirements for such associations. The National Association. of Securities Dealers, Inc. (NASD) is the only association registered under the Act. The Act contemplates that such associations will serve as a medium for self-regulation by over-the-counter brokers and dealers. Their rules must be designed to protect investors and the public interest, to promote just and equitable principles of trade, and to meet other statutory requirements. They are to operate under the general supervision of the Commission, which is authorized to review disciplinary actions taken by them and to consider all changes in their rules. Review of the NASD rules, generally speaking, is carried out in the same manner and for similar purposes as the review of exchange rules described above.11 In adopting legislation permitting the formation and registration of national securities associations, Congress provided an incentive to membership by permitting such associations to adopt rules which preclude a member from dealing with a non-member 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 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 statutory disqualification, or the failure to meet standards of qualification established in NASD rules, may thus constitute a severe economic sanction. At the close of the fiscal year the NASD had 3,707 members, reflecting a net decrease of 158 members during the year. This decrease was the net result of 229 admissions to and 387 terminations of membership. At the end of the year NASD member firms had 5,025 branch offices, reflecting a net increase of 197 offices during the year. This increase was the net result of the opening of 768 new offices and the closing of 571 offices. During the year the registered representative population, which generally includes all partners, officers, traders, salesmen and other persons employed by or affiliated with member firms in capacities which involve their doing business directly with the public, increased by 6,798 to stand at 83,641 as of June 30, 1966. This increase was the net result of 13,424 initial registrations, 11,418 reregistrations and 18,044 terminations of registrations during the year. NASD Disciplinary Actions The Commission receives from the NASD copies of its decisions in all disciplinary actions against members and registered representatives. In general, such actions are based on allegations that the respondents violated specified provisions of the NASD's Rules of Fair Practice. Where violations are found the NASD may impose one or more sanctions upon a member, including expulsion, suspension, fine, or censure. If the violator is an individual, his registration as a representative may be suspended or revoked, he may be suspended or barred from being associated with all members, and he may be fined and/or censured. Under Section 15A (b) (4) of the Exchange Act and the NASD's bylaws, no broker-dealer may be admitted to or continued in NASD membership without Commission approval if he has been suspended or expelled from membership in the NASD or a national securities exchange; he is barred or suspended from association with a broker or dealer or with all members of the NASD or an exchange; his registration as a broker-dealer has been denied, suspended, or revoked; he has been found to be a cause of certain sanctions imposed upon a member by the Commission, the NASD or an exchange; or he has associated with him any person subject to one of the above disqualifications. During the past fiscal year the Association reported to the Commission its final disposition of disciplinary complaint actions against 197 member firms and 167 individuals associated with them. With respect to 52 members, complaints were dismissed as a result of findings that the allegations of violations had not been sustained.12 In the remaining cases, violations were found and penalties were imposed on 145 members and 115 registered representatives or other individuals. The maximum penalty of expulsion from membership was imposed against 14 members, and 6 members were suspended from membership for periods ranging from 15 days to 3 months. In many of these cases, substantial fines were also imposed. In another 104 cases, members were fined amounts ranging from $50 to $7,500. In 21 cases, the only sanction imposed was censure, although censure was usually a secondary penalty where a more severe penalty was also imposed. Various penalties were also imposed on registered representatives found in violation of NASD rules. The registrations of 50 representatives were revoked, and 23 representatives had their registration suspended for periods ranging from 30 days to 18 months.13 Fines in various amounts were also imposed against many revoked or suspended representatives. In addition, 42 other representatives were censured and/or fined amounts ranging from $100 to $10,000. Complaints against 52 representatives were dismissed on findings that no violations had been established. 12 The majority of the cases where allegations against members were dismissed involved misuse of customers' and/or firm securities or funds by a representative under such circumstances that the member could not have known of or prevented the impropriety. The Securities Acts Amendments of 1964 authorized registered securities associations to take disciplinary action directly against individuals associated with members. The NASD has amended its rules to provide for such action. In the fiscal year there were eight cases in which the sole respondents were individuals associated with members. 13 As has been noted, a person found a cause of the expulsion or suspension of a member is disqualified from association with a member. The cause finding is therefore often used where an individual found to have violated Association rules should have been but was not registered as a registered representative. The numbers used in the text combine unregistered individuals found to have been a cause of the expulsion or suspension of a member with registered representatives whose registrations were revoked or suspended, since this is the practical consequence of a cause finding. Commission Review of NASD Disciplinary Action Section 15A (g) of the Act, as amended, provides that disciplinary actions by the NASD are subject to review by the Commission on its own motion or on the timely application of any aggrieved person. This Section also provides that upon application for or institution of review by the Commission the effectiveness of any penalty imposed by the NASD is automatically stayed pending Commission review, unless the Commission otherwise orders after notice and opportunity for hearing. Section 15A (h) of the Act defines the scope of the Commission's review. If the Commission finds that the disciplined party committed the acts found by the NASD and thereby violated the rules specified in the determination, and that such conduct was inconsistent with just and equitable principles of trade, the Commission must sustain the NASD's action unless it finds that the penalties imposed are excessive or oppressive, in which case it must cancel or reduce them. At the start of the fiscal year, 19 NASD disciplinary decisions were pending before the Commission on review. During the year 13 additional cases were brought up for review. Seventeen cases were disposed of by the Commission. In 14 of these cases, the Commission sustained the disciplinary action taken by the NASD,14 in one it set aside the Association action,15 and in the remaining two cases the Commission reduced the penalties imposed by the Association.16 Fifteen cases were pending as of the end of the year. In the course of the year there were two important decisions concerning the obligation of members to exercise adequate supervision over employees. The Commission sustained the NASD's action expelling L. B. Securities Corporation from membership in the Association and revoking the registration as a registered representative of R. B. Marx, its president and sole stockholder." The action of the NASD was in large part based upon the activities of C. Mackie Brown, Jr., a salesman, who was found to have violated the Association's fraud rule by causing the firm to send confirmations for the purchase of stock of L. F. Popell & Co., Inc. ("Popell") to two customers who had never ordered the stock. 14 Securities Exchange Act Release Nos. 7652 (July 22, 1965); 7676 (August 10, 1965); 7696 (September 3, 1965); 7718 (October 5, 1965); 7729 (October 22, 1965); 7762 (December 7, 1965); 7806 (January 28, 1966); 7809 (January 31, 1966); 7823 (February 15, 1966); 7834 (March 7, 1966); 7856 (April 8, 1966); 7875 (April 29, 1966); 7880 (May 3, 1966); and 7907 (June 29, 1966). 15 Securities Exchange Act Release No. 7660 (July 28, 1965). 16 Securities Exchange Act Release Nos. 7682 (August 24, 1965) and 7864 (April 18, 1966). 17 Securities Exchange Act Release No. 7806 (January 28, 1966). According to the Commission's opinion, at a time when L. B. Securities was making a market in Popell stock, Marx had telephone conversations with Brown who was then employed by another member and, being impressed by his selling abilities, offered him a position. Marx had never met Brown and knew nothing about his character and background. Marx's pre-employment investigation consisted of a telephone conversation with Brown's former employer who told Marx that he had had some "problems" with Brown, but that if he "could be controlled he would be a heck of a salesman." The nature of the problems was not identified and Marx did not inquire about them. While Marx claimed that he had received a favorable recommendation concerning Brown from other firms who were trading Popell stock, the Commission noted that Brown had never been employed by any of these firms and that it appeared that the recommendations were related to his selling abilities. The Commission found that during the 2 weeks Brown was employed by L. B. Securities he sold large quantities of Popell stock to his prior customers and that he was given a free hand and no attempt was made to supervise him. The Commission rejected applicants' excuse that they were unable to supervise Brown because Marx was the firm's sole supervisor and the market for Popell stock during Brown's association with the firm was hectic and disorderly. It stated that it was incumbent upon applicants to provide supervisory controls adequate to the business being conducted and added that this duty was "heightened by the fact that they were permitting a newly hired salesman with a doubtful recommendation to engage in selling activities, directed to customers who were not known to the applicants, in a highly speculative security that was declining in price." The Commission also sustained NASD findings that applicants violated the Commission's net capital and books and records requirements and that the firm had permitted Brown to effect securities transactions before he became registered with the NASD as a representative of the firm. In another case involving failure to supervise, the Commission sustained the NASD's action expelling A. J. Gabriel & Co., Inc. from membership in the Association and revoking the registration of Aaron J. Gabriel, its president and sole stockholder.18 It was undisputed that in a 20-month period the member confirmed as agent and charged customers commissions in 73 transactions in which the member actually had acted as principal; failed to disclose in 28 transactions that it was acting in a dual agency capacity; and failed to liquidate promptly 116 purchases by customers as to which payment was not made within 7 business days as required by Regulation T of 18 Securities Exchange Act Release No. 7696 (September 3, 1965). |