II

e submitted deal with diverse subjects, including e structures and practices of the self-regulatory edit regulation, mutual fund selling practices, and the market break of May 1962. As in the case of report, the Special Study was given freedom to ut problems as they appeared to it; in this respect yses, and recommendations in the report are those y and not the Commission. We strongly endorse ss of these chapters as a basis for discussion with lemaking, and for legislative proposals. Without omment, we may not speak definitively on those substantive changes in our rules or the rules of agencies. In any case, we believe the responsible s for discussions with the securities industry before ade.

g up the chapters in order, we shall first focus on analyzes the role of the self-regulatory instituon to the Commission.

A

of the Securities Exchange Act, the authorizing ecial Study, the Congress emphasized an examinaof the rules of the self-regulatory agencies. The mment on this theme. Chapter II evaluates the and of the principal exchanges relating to qualifiIII those governing selling practices and invest

ment advice. Chapters VI and VII examine the rules and procedures of the self-regulatory agencies with respect to trading practices in the exchanges and over-the-counter market. Chapter XII, transmitted today, analyzes the organization and self-regulatory operation_of those agencies, with primary emphasis on the New York Stock Exchange and the National Association of Securities Dealers, Inc., and their relationship to the Commission and each other.

We agree with the report that "the basic statutory design of substantial reliance on industry self-regulation appears to have stood the test of time and to have worked effectively in most areas." This conclusion obviously does not minimize in any way the need promptly to remedy the disclosed inadequacies, a need more critical as increased reliance is placed on the self-regulatory agencies-which this report and the Commission contemplate.

1

The New York Stock Exchange occupies an unrivalled position as a self-regulatory institution because of its importance as a market and because of the dominant position of its membership in the securities business. We believe it important to point out, first, that the study quite properly devoted particular attention to problem areas and, secondly, that, although there are defects in the functioning of the Exchange market which should be corrected, the Exchange has worked diligently, and on the whole successfully, to maintain a fair and honest market. The report points out the strong performance of the Exchange in many areas, including qualifications and net capital. Its disclosure and related requirements, some antedating the enactment of the Federal securities laws, represent a major contribution to investor protection and, in some respects, have gone beyond anything the Commission could do. In certain areas, judged by the Exchange's own standards of accomplishment, performance has been less satisfactory. For example, controls over branch office operations and investment advisory and selling practices require strengthening; the Exchange itself has recognized this in its initiation of new programs. The report discloses a failure of regulation over odd-lot dealers and raises serious questions about floor trading. The Special Study's examination of the Exchange's specialist system reveals no widespread abuses or patterns of illegality. On the other hand, there are subtle and complex problems discussed in the report which call for examination and review by the Exchange and the Commission with a view to strengthening the system and raising the quality of operation of some segments to that of the most effective and most efficient.

Moreover, disciplinary action does not appear to have been as forceful as circumstances have warranted. With regard to the organization of the Exchange, the report points to a need for a reallocation of voting power among members and allied members in order to give firms dealing with the public more responsibility in the government of the Exchange.

The importance of the New York Stock Exchange as a self-regulatory institution and as a market makes it imperative that it bring its entire level of performance up to its demonstrated capabilities. The recommendations in chapter XII-B of the report and elsewhere are designed, as the report states, "to point toward an even stronger

future role" for the Exchange. With limited reservations in two instances which are footnoted below, we agree with these recommendations.1

2

Early in 1962 the Division of Trading and Exchanges of the Commission, in conjunction with the Special Study of Securities Markets, issued a report concerning the American Stock Exchange. This report pointed out serious problems in regard to the operations of that exchange and practices occurring on its floor. The American Stock Exchange, together with selected representatives from the securities industry, and in consultation with the Commission, has since engaged in a substantial reorganization of its management, constitution, and operations. As the report concluded in subchapter XII-C: "In contrast to the prior breakdown of self-regulation described in the staff report, the accomplishment of this reform appears to be an excellent demonstration of the effectiveness of self-regulation under responsible exchange leadership and active Commission oversight." It is apparent that the American Stock Exchange has now instituted a responsible regulatory system as a basis for meeting its obligations under the Exchange Act, including problems it shares with the NYSE.

The Special Study made a more limited examination of the regional exchanges, with primary emphasis on the Midwest and Pacific Coast stock exchanges the major regional exchanges. We agree with the recommendations with respect to these exchanges in subchapters XIID, XII-E, and XII-F of the report.

3

The primary responsibility of the National Association of Securities Dealers, Inc., is to regulate the conduct of its members in the over-thecounter market. Because the over-the-counter market is scattered throughout the country, includes all varieties of securities, and is open to all persons, the NASD's job is a difficult one. Its role will become more important, since many recommendations in the report call for increased activity on the part of the NASD in both policymaking and enforcement.

The work of the NASD is in large measure performed by its members who volunteer their time and effort to the job of self-regulation. The NASD has established important standards of business conduct, including restrictions against unconscionable underwriting compensation and rules dealing with "free-riding." It has assisted in the general enforcement efforts against overreaching and abuses in the over-the-counter market. However, there are many key areas in need of improvement in the over-the-counter market, in terms of new standards, as well as strengthened enforcement programs. In this context,

1 As to the recommendations in item 2, we favor steps looking towards a more representative distribution of voting power among regular and allied members. We will explore further the need for altering the composition of the governing bodies of the Exchange. With respect to item 7, the obligation of the Exchange, of which it is not unmindful, to avoid exaggerations and misunderstandings in its advertisements is clear. Whether any further restrictions should be placed on the Exchange's public relations activities is not so clear. The Commission has encouraged the Exchange to undertake the supervision of the advertising of its member firms, including advertising of an institutional character, some of which is the work product of the Exchange's own staff. (The Commission is not now prepared to dispense with the advantages of the present system without further examination of the problem.

certain organizational characteristics, including the emphasis on member participation and the heavy demands on the Board of Governors, necessitate significant rethinking and redirection. More effective regulation requires a larger staff-a direction in which the NASD has been moving during the last few years with increased responsibility and a reallocation of work among member participants in the government of the NASD. The participants would then have more opportunity to consider general policy and the NASD could better carry its formidable workload.

We agree with all of the recommendations of the report in subchapter XII-G which are designed to strenthen the organization of the NASD and make its operations more effective.

4

The fundamental issue of the relationship between the Commission and the self-regulatory agencies requires special comment. The report states in chapter XII-I that "regulation in the area of securities should, in short, be a cooperative effort, with the Government fostering maximum self-regulatory responsibility, overseeing its exercise, and standing ready to regulate directly where and as circumstances may require." We subscribe to this statement of policy and generally agree with the specific recommendations in chapter XII-I. The obligations of the self-regulatory agencies should be increased, through both their adoption of rules in many areas and their assumption of new enforcement duties including certain duties now borne by the Commission.

The failure of the self-regulatory agencies to operate at maximum capacity and with full regard for the public interest in certain areas is in part attributable to the Commission's own failure to provide the necessary continuing guidance and oversight. We are certain that the present statutory pattern permits more effective and more pervasive self-regulation than has yet been achieved. Undoubtedly this will require a reorientation of our present procedures in the directions suggested by the report's recommendations. For example, under section 19 (b) of the Exchange Act, we have a duty to review exchange rules to determine whether they are consistent with the protection of investors. We should place more emphasis on newly adopted rules than is now the case. Thus, our present arrangements with regard to the exchanges' notification to us of rule changes prior to their adoption might be revamped along the lines of the procedures worked out with the New York Stock Exchange respecting changes in the minimum commission rate schedule. With respect to the NASD, our authority to alter or amend their rules is more limited than in the case of the exchanges. We have, however, direct powers over practices in the over-the-counter market, in many respects unexercised, which can be utilized. Until these have been fully exercised and found wanting, we shall not ask Congress for legislation. In any event, up to this time needed improvements have been secured after conferences and discussions with the NASD.

We shall examine with the exchanges the need for further procedural safeguards for those affected by exchange actions-a problem that has taken on new significance because of the recent Supreme Court case of Silver v. New York Stock Exchange. In addition, as

suggested by both subchapters XII-I and XII-J, we will confer with the self-regulatory agencies to determine methods by which enforcement and inspection responsibilities can be better allocated between the Commission and the self-regulatory agencies and among those agencies themselves.

One sector of the self-regulatory scheme will require joint analysis with the exchanges of the need for legislation. In the Silver case the Supreme Court held that the termination, at the order of the New York Stock Exchange, of wire service from its members to a nonmember, without any hearing afforded the nonmember, involved a violation of the antitrust laws.

We believe it essential that the Silver decision should in no way be construed to inhibit vigorous performance by the exchanges of their self-regulatory responsibilities. We are confident that the Supreme Court intended no such result: indeed the Court emphasized "the federally mandated duty of self-policing by exchanges." Steps can and must be taken to avoid any possible problems. These could include appropriate procedural changes by the exchanges and careful analysis of the need for some form of review of exchange actions by the Commission. If review procedures are thought necessary, legislation may be required.

Our firm conviction is that self-regulation, an essential ingredient in investor protection, must continue in a strong, forward movement. Accordingly, we have written to the New York Stock Exchange advising of our concern and shall undertake to resolve with it any problems presented by the Silver case.

B

In chapter X, the report has examined security credit regulation as a factor in the securities markets. This regulation, of course, has broader aims: it is an instrument for credit control in the economy. As such, it is the primary concern of the Board of Governors of the Federal Reserve System. Accordingly, as the Special Study has pointed out, recommendations in this area including legislative proposals relate essentially to matters within the jurisdiction of the Board of Governors. The Commission believes that all the recommendations of the study have merit, but, recognizing the paramount authority of the Board, will not initiate any action. We shall work closely with the Board towards the resolution of the problems raised. The staff of the Special Study received generous assistance and cooperation from the staff of the Board of Governors who reviewed chapter X from a technical point of view and who also prepared all of the appendixes. Of course, none of the Reserve personnel, nor the Board, is in any way responsible for the final views expressed in the chapter.

с

Chapter XI of the study deals with selected aspects of open-end investment companies, so-called "mutual funds," including selling practices, contractual plans, insider trading in portfolio securities and portfolio-brokerage reciprocal business patterns. It must be emphasized that this chapter should in no way be construed as a reflection upon the investment merits of mutual fund shares, upon the investment company as an important vehicle for investment, or upon any particular company. Furthermore, it should also be emphasized that