to adviser to salesman to investor. The techniques of the publicist are often designed to produce exactly this result; they include the placement of articles favorable to the client in the columns of the financial press, the use of "contacts" and personal influence with persons with brokerage firms and investment advisory services, and the entertainment of financial writers and security analysts. The financial press too often permits propaganda to pass as news. Financial analysts too often depend upon public relations material rather than official disclosures or independent research as the basis for the investment advice which they give the public. Not only may these practices and others described in this report seriously mislead stockholders and potential investors; they also tend to corrupt the media of communication upon which the investing public must rely for its information.

The publicity material reviewed by the Special Study had a broad range of accuracy-from straightforward reporting to material that appeared to be deliberately misleading. Most of the inaccurate publicity, however, appeared to have some basis in fact but erred in being overoptimistic. One issuer, over a period of several months, repeatedly announced plans to expand its business-plans which never came to fruition, if indeed they were ever seriously contemplated. Other companies announced earnings projections which were without basis and were not fulfilled, descriptions of new products which were still in the experimental stage, and announcements of mergers or acquisitions which were only vague possibilities. Related to the premature disclosure of corporate "news" were the problems of withholding information that should have been published and the generation or encouragement of optimistic rumors, thus giving "insiders" an unfair advantage over members of the public.

Controls over corporate publicity are relatively limited. Publicity distributed in connection with a registered offering of securities is subject to the restrictions on offers and sales of the Securities Act. Material disseminated in proxy contests is controlled by regulations under the Exchange Act. In other situations than these, the only Federal restraints on corporate publicity are the antifraud and antimanipulative provisions of the securities laws. These provisions-particularly rule 10b-5 under the Exchange Act-have proved to be of some value against the dissemination of false and misleading publicity. The policy of the exchanges and the NASD in favor of prompt disclosure by issuers of corporate news that may affect security prices is a strong weapon against fraud, but these self-regulatory bodies have thus far done little to improve the accuracy of corporate publicity or to control unethical practices in this field.

Undoubtedly, the most effective restraint on irresponsible publicity is the regular reporting and wide dissemination of reliable data-see part B of this chapter-but the worst abuses would still call for more direct measures. To some extent, the abuses can be corrected or controlled by direct prohibitions and penalties. Just as the Exchange Act now provides both civil liability (sec. 18(a)) as well as criminal sanctions (sec. 32(a)) in respect of falsity of officially filed informa

The English Prevention of Fraud (Investments) Act, 1958, attempts just such a solution. Sec. 13 imposes a penalty for faudulently inducing persons to invest money, in terms broad enough to reach the fraudulent or irresponsible conduct of issuers and their publicity agents, of the type herein discussed.

tion, a statute designed to prevent misuse of channels of publicity should provide for both civil and criminal sanctions. Such a statute would eliminate the uncertainties and problems surrounding the existing antifraud and antimanipulative provisions of the securities acts and the rules thereunder, and its provisions relating to civil liability could simplify problems of proof under the existing law.

Moreover, payment of publicists in clients' securities (including options) would seem to be an appropriate and important area for disclosure on a regulated basis. The Commission's forms and regulations for annual and current reports, or for proxy statements, should require such disclosure.

Nevertheless, there are limits to what can and should be accomplished by direct regulation in this area. The volume of corporate publicity, the paramount aim of full and prompt disclosure, the difficulty of making judgments concerning specific items of publicity, and the proximity of this field to the constitutionally protected right of freedom of expression-all combine to make legal control a relatively clumsy instrument. It remains for the self-regulatory groups, official and unofficial, the business and financial communities, and the press itself to exercise their powers and responsibilities. The privilege of having securities listed on an exchange or publicly quoted under NASD sponsorship should carry corresponding responsibilities, and the exchanges and even the NASD are in a position to impose needed restraints on issuers as well as their own members. An organization such as the Public Relations Society of America can be of value not only in regulating its members but also by raising professional standards through educational and informational activities. Not least, the news media and press and public relations associations could be far more effective than they have been in imposing standards designed to separate corporate propaganda from news, and to control conflicts of interest on the part of writers of financial news.

The Special Study concludes and recommends:

1. The stock exchanges in respect of listed securities and the NASD in respect of securities enjoying the privilege of NASDsponsored newspaper quotations should establish high standards for the dissemination of corporate publicity to which the respective issuers would be expected to conform. These might appropriately take the form of statements of policy and should cover both positive and negative aspects; i.e., types of disclosure and publicity that are required or expected and types that are discouraged or excluded in specified circumstances.

2. Consideration should be given to the enactment of a statute providing criminal sanctions and civil liability for intentional or reckless dissemination by issuers or their agents, of false and misleading statements, including forecasts unwarranted by existing circumstances, which may reasonably be expected to affect investment decisions, loans, or other transactions involving the issuer's securities.

3. The Commission's rules with respect to registration statements, offering circulars, proxy statements, and reports should be revised to require disclosure of material facts concerning compensation paid or payable to any public relations counselor or firm in the form of any equity security of the issuer, including options, warrants, or rights to subscribe to any such security.

CHAPTER X

SECURITY CREDIT

The area of security credit is unique among the subjects discussed in this report in that, although the governing provisions of law are contained in the Exchange Act, administrative jurisdiction to implement these provisions is divided between the Board of Governors of the Federal Reserve System and the Commission, with substantive matters largely in the jurisdiction of the former and responsibility for enforcement in the latter. Traditionally, the Board of Governors' concern with security credit has been related to monetary control and the total economy, whereas the Commission's concern is with security credit and its regulation as factors in the securities markets themselves. Because of the latter special concern and because the study has revealed several substantial security credit problems, it is believed appropriate to state conclusions and recommendations, notwithstanding that the recommendations relate essentially to matters in the jurisdiction of the Board of Governors. The recommendations set. forth below are expressed with full regard for, and without intending to impinge in any way upon, the Board of Governors' authority to regulate security credit in relation to monetary control and the total economy, including raising and lowering margin requirements and classifying securities and loans for that purpose.

Security credit controls have been described by the Chairman of the Federal Reserve Board as one of the instruments for effectuating the credit and monetary policies of the Board. The Federal Reserve Board has exercised its broad authority by promulgation of Regulations T and U governing, respectively, broker-dealers and domestic banks. Other types of lenders are not directly covered by the regulations. Credit controls on broker-dealers limit the amount which may be lent on listed securities, and the Securities Exchange Act prohibits them altogether from lending on unlisted securities, where the purpose is to purchase or carry securities. Controls on banks. limit them in the amount that may be lent on stocks to purchase or carry listed stocks, but otherwise do not limit them in lending for the purpose of purchasing or carrying other listed securities or unlisted securities. Both domestic banks and brokers are permitted to make loans secured by unlisted securities or by no collateral at all so long as the borrower's purpose is other than purchasing or carrying securities. Lenders other than domestic banks and brokers are generally free of security credit controls except in relation to borrowing from domestic banks.

The unique nature of readily marketable, publicly traded securities and the extraordinary facility of the market mechanisms that have been developed to trade them, which together make possible rapid and wide price fluctuation, cause both an initial margin and a margin

maintenance requirement to be an inherent feature of almost all security credit transactions. Public initial margin controls are considered useful in the governmental effort to regulate national credit and monetary conditions, and from the more restricted point of view of securities regulation they are indispensible in guarding against uncontrolled price declines that can result when the initial requirement is so low in relation to the maintenance requirement as to cause numerous margin calls in the event of any significant price decline. The evidence provided by the sharp market break in the spring of 1962 tends to demonstrate that, by reason of the preceding relatively high initial requirements, those loans that were regulated withstood the break well and those free of controls were much more vulnerable. As a general principle, therefore, the power should exist to extend initial margin controls to all security credit transactions to which their extension is feasible and not precluded by countervailing considerations.

The purpose for which security credit is extended may be particularly significant to the broad effort to regulate general credit and monetary conditions, but inadequately margined nonpurpose loans may be as vulnerable to margin calls as purpose loans and the disruptive effect of such calls is as undesirable in the one case as the other. Evidence now available, moreover, indicates that the aggregate amount of stock-collateralized, nonpurpose credit extended by banks, the principal source of such credit, is relatively and absolutely very great, and unless adequately margined presents a threat to market stability. Without prejudice to the retention of separate or additional margin requirements for purpose loans, it appears to the Special Study that authority should exist and consideration should be given to extending some type of initial margin requirement to all or some categories of nonpurpose loans collateralized by actively traded stocks, as the Federal Reserve Board may find appropriate.

Again with particular reference to the securities markets, the present pattern of credit regulation is marked by other disparities that may be explained historically but do not appear to be justifiable at present. These arise principally in the distinctions drawn between exchange-listed and over-the-counter securities and in the further distinctions drawn between lending by broker-dealers and lending by banks. Since over-the-counter securities and their markets are far more heterogeneous than listed securities and their markets, it would not be appropriate to equate all of the former to all of the latter, but for that segment of over-the-counter securities reasonably resembling listed securities in pertinent respects it would appear appropriate and equitable to remove or at least minimize some of the present distinctions. The most pertinent considerations in defining that segment are the availability of reliable information so that risks may be appraised, the availability of reliable quotations so that values may be assigned to pledged securities, and the availability of market depth so that collateral will not be unduly frozen in the hands of lenders. Implementation of recommendations in chapters VII and IX would have the result of assuring a fund of reliable information for "OTClisted" securities through required disclosures by issuers; establishing more dependable and informative interdealer and publicly disseminated quotations; identifying primary market makers of each overthe-counter security as a measure of depth of dealer interest; and

presumably (through selection of securities to be included in newspaper and other publicly disseminated quotations) singling out those securities having widest public interest and activity. It would therefore also be appropriate to permit broker-dealers to extend credit on some over-the-counter securities to purchase or carry listed or unlisted securities as and to the extent provided by regulations of the Board of Governors. Assuming implementation of the above recommendations, extension of credit by broker-dealers might be permitted on "OTC-listed" stocks and convertible bonds included in any officially recognized public quotation system, subject to such exclusions or limitations as the Board of Governors may provide as to particular categories of such securities. The margin limit for such securities or particular categories of them might be fixed in relation to, but need not necessarily be the same as, the limit prevailing at any time for listed securities.

Stocks that are actively traded in over-the-counter markets as well as some convertible bonds that are actively traded in such markets or listed on an exchange may be subject to price fluctuations to as great a degree as are listed stocks. The categories of securities referred to in the preceding sentence probably coincide generally, but not necessarily exactly, with the categories referred to in the preceding paragraph as eligible for extension of credit by broker-dealers. Minimum initial margins should be required on these securities (as they may be more precisely defined in the regulation) when used as collateral for bank loans. It is not contemplated that such a requirement would restrict banks from lending at their discretion on inactively traded over-the-counter stocks, convertible bonds or nonequity securities.

The absence of any controls on lenders other than broker-dealers and domestic banks "unregulated lenders") affords a significant loophole in the regulatory scheme and may have had the effect of reducing the effectiveness of credit regulations in those areas in which they have been imposed and also facilitating the activities of persons bent on securities law violations. Controls should be extended, to the extent feasible, to all persons regularly engaged in the business of lending on securities and adequate information-gathering about their activities should be instituted.

The Special Study concludes and recommends:

The Board of Governors of the Federal Reserve System has primary responsibility for the regulation of security credit in relation to monetary control and the entire economy. The Commission's concern, more limited in nature, is with security credit and its regulation as factors in the securities markets themselves. While recognizing the primary and broader responsibility and authority of the Board in this area and without intending to impinge upon that responsibility and authority in any way, the Special Study nevertheless believes it appropriate to express the following conclusions and recommendations relevant to the Commission's more limited area of concern:

1. Data assembled by the Special Study, with cooperation from the Federal Reserve System, are believed by the Special Study to confirm the general principle that the Board of Governors should have authority to extend some kind and degree of margin control on all loans collateralized by securities whose forced liquidation in a declining market would have a significant market-disruptive