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matters, so that responsibility for activities affecting the public interest will be lodged in a single individual.
5. PERSONS PROVIDING INVESTMENT ADVICE
Qualification standards for persons, other than salesmen as such, who are responsible for disseminating investment advice, whether through broker-dealers or through registered investment advisory or investment counsel firms, are nonexistent beyond the negative standard of the disqualifying statutory bars. Neither the Federal Government nor any self-regulatory body exercises any controls over the competence of these persons for the performance of their advisory work. This lack of controls results in an anomalous situation.
An individual in a broker-dealer's research department, charged with the responsibility of selecting the securities for his firm to recommend to its customers, is required to meet no qualification standards. The salesman, on the other hand, whose role may be limited to transmitting such research recommendations to the customers, must pass examinations which test, among various subjects, his ability to analyze securities. Furthermore, the proprietors of registered investment advisers who confine their activities to the giving of investment advice need not pass any examination at all, except in a few States, even though they may be responsible for advising individual clients or subscribers to their publications to engage in particular securities transactions.
While there is no need to impose qualification standards on every person employed by a registered broker-dealer or investment adviser to perform services as a researcher or analyst or statistician, minimal standards of competence or experience should be applied to each person who is responsible for actually transmitting unsupervised investment recommendations to the public, whether directly or through registered representatives. The self-regulatory organizations should assume the responsibility for determining and imposing such standards for persons employed by broker-dealer firms subject to their jurisdiction. Membership in an effective self-regulatory agency should be required for all investment advisers now or hereafter registered with the Commission, and the agency should assume responsibility for determining and imposing minimum standards for principals and appropriate categories of employees of registered investment adviser firms. Information concerning the names and histories of the persons covered by such qualification requirements should be included in the material which brokerdealers and investment advisers supply to the Commission as part of their applications for registration.
The Special Study concludes and recommends:
1. Under a regulatory scheme relying heavily on self-regulation, it is anomalous that some broker-dealers or investment advisers should remain outside of any official self-regulatory group so that their activities are subject only to direct regulation by the Commission. Membership in an appropriate self-regulatory group (exchange or national securities association or affiliate thereof) should therefore be a prerequisite to registration as a brokerdealer or investment adviser. If it should not prove feasible to establish a program of compulsory membership in a self-regulatory body for all broker-dealers and investment advisers subject to Commission jurisdiction, the added cost of governmental supervision should be passed on and directly borne by those in the industry who are not members of such a body, through fees or other assessments.
2. At present the only requirement for Federal registration as a broker-dealer or investment adviser is that the firm and its principals have not previously misbehaved in specified ways, and there is a separate list of statutory disqualifications for NASD membership. These statutory disqualifications should be combined and made applicable to all broker-dealer and investment adviser firms and certain categories of individuals in the securities business, such as principals, supervisors, and salesmen. There should be added to the combined list conviction within 10 years of crimes (a) involving theft, fraud, embezzlement, defalcation, or criminal breach of fiduciary duty, or (b) arising out of the conduct of the business of a broker or dealer or investment adviser.
3. The Commission's present registration forms for brokerdealers and registered investment advisers fail to supply essential information for determining initial qualifications and for continuous regulatory needs. Every broker-dealer firm should be required to furnish initially, and keep current through annual or other periodic reports, information concerning (a) major activities engaged in or to be engaged in; (b) exchange and NASD memberships; (c) number and location of branch offices; (d) clearing firms, correspondent firms, and wire connections; (e) size and composition of sales staff; (f) size and composition of any research department; (g) the individual in responsible charge of regulatory and self-regulatory matters within the firm, the supervisor of each major department of function (underwriting, retailing, research, trading, back office, etc.); the manager or supervisor of each branch office, and each individual authorized to handle discretionary accounts; and (h) the prior experience of any such individual, supervisor, or manager. Every registered investment adviser should be required to supply and keep current information concerning (a) major activities to be engaged in; (b) research techniques used and/or other bases of recommendations; (c) size and composition of any research department; (d) the individual in responsible charge of any such research department, and/or in responsible charge of the firm's investment recommendations; and (e) the prior experience of any such individual.
4. The individual rather than the firm is the appropriate "unit" for many regulatory purposes, in the interest of fairness as well as efficiency. The present statutory registration scheme does not reach individuals at all, and the self-regulatory concept of "registered representatives” of particular firms does so only partially and indirectly. Without limiting the responsibility of firms for the personnel they employ or the right of firms to select their own employees, there should be established a system of licensing and registering individual salesmen, supervisors, and other speci. fied categories of personnel. Each such individual should be required to file a single basic registration form containing necessary data as to his present and prior employment, disciplinary matters, and eligibility under statutory disqualifications, together with a certificate as to his good character and, for applicants without adequate prior experience, as to his successful completion of any required examination. Copies of the basic registration form would be made available to affected regulatory and selfregulatory agencies. Subsequent changes in employment and disciplinary actions should be required to be reported and recorded in the individual file. Duly licensed persons would be, for regulatory purposes, eligible for employment by any firm.
5. Under such a system of licensing and registering individuals, disciplinary actions could, in appropriate cases, relate to individuals without necessarily involving current or future employers, as is now the case. The present system, under which the Commission may proceed only against a broker-dealer firm, often operates inefficiently or unfairly in that the Commission must move against an employee's firm or not at all. The Commission's powers in this respect should therefore be made more flexible even apart from the recommendation in paragraph 4, so that it will have the power to bring administrative proceedings directly against individuals involved in violations of the securities laws.
6. Apart from statutory disqualifications and requirements for filing of basic data by firms and individuals, standards for entry into the securities business should encompass (a) competence, in the sense of knowledge and experience; (b) character and integrity; and (c) financial capacity and responsibility—the first two applying essentially to individuals and the third essentially to firms. In all three areas there have been significant accomplishments but there are serious gaps and deficiencies that need to be remedied promptly, as set forth in the following paragraphs.
7. The basic regulatory control in respect of competence is the examination. Present examinations and examination programs can and should be considerably improved, refined, and coordinated. The standard examination should cover a core of basic subjects for salesmen, supervisors, and principals, with appropriate supplemental questions for supervisors and principals, and with such further supplementation as any particular agency may desire for its own purposes. For certain recognized specialties, special supplementary questions should be provided; individuals whose activity (and license to act) is to be limited to any such specialty may be permitted to qualify through appropriately limited examinations. To achieve maximum results with minimum burdens, a National Board of Securities Examiners should be established by and for the various regulatory and self-regulatory agencies, to administer existing programs, and foster improved programs. Through the same or a similar agency, the various existing training programs should be coordinated, extended, and improved.
8. Quite apart from knowledge as tested through examination procedures, appropriate experience in the securities business should be a requirement for individuals in certain crucial roles. The individuals for whom there should be an experience requirement include at least one principal in each registered firm and, if other than such principal, the individual designated as being in
charge of regulatory and self-regulatory matters, the supervisor of selling activities, the supervisor or manager of each branch office, and the supervisor of research activities. Appropriate periods and types of prior experience are left for future definition.
9. The matter of part-time salesmen has been the subject of considerable difference of opinion among members of the financial community and regulatory agencies. There appears to be no reason to exclude part-time salesmen as such, but they should be subject to exactly the same qualification requirements as fulltime salesmen.
10. Of all the types of qualifications needed for the securities business, perhaps the most important, but also the most difficult to assure by formal regulation, is that of character and integrity. As rapidly as possible a system involving local "character and fitness" committees, as in the legal profession, should be established. More immediately, the responsibility for maintaining a proper level of character and integrity of all personnel must reside in the individual firm, but with effective enforcement of this responsibility by the self-regulatory agencies. In addition, regulatory and ethical standards should receive greater emphasis in training and examination programs of the self-regulatory agencies. If the latter are to fulfill the role for which they are thought to be uniquely suited, they must also, of course, exert leadership in defining and elevating ethical standards for their members, above and beyond legal requirements.
11. A minimum net capital requirement is of high importance as one of the several different approaches to assuring a broker-dealer community of principals and firms reasonably qualified in terms of responsibility and commitment. The requirement need not and should not be a uniform one for all firms but should be appropriately scaled to reflect the type and size of business engaged in. Subject to exceptions and refinements to be worked out in the future (such as special provision for small proprietorships engaged only in sale of open-end investment company shares), and subject to an appropriate "grandfather" clause or adjustment period, every broker-dealer should be required to have at the commencement of business, and maintain at all times thereafter, net capital of at least $5,000, plus, say, $2,500 for each branch office and, say, $500 for each salesman employed at any time.
12. Since the underwriting of public offerings involves special obligations and responsibilities, any firm engaging or proposing to engage in underwriting securities offered to the public pursuant to the Federal securities laws, whether on a "firm commitment" or "best efforts" or any other basis, should be required to have and maintain minimum net capital of $50,000 plus, say, 2 percent of the aggregate amount of underwriting commitments or undertakings in the most recent 12-month period (but not less than the amount required under par. 11).
BROKER-DEALERS, INVESTMENT ADVISERS, AND THEIR
CUSTOMERS-ACTIVITIES AND RESPONSIBILITIES
[Part A (Introduction) discusses generally the nature of the obligations of broker-dealers and investment advisers to the public and also considers the concept of "profession" as applied to the securities business. ]
PART B. SELLING PRACTICES
The predominant concern of the securities industry is the sale of securities, and in pursuit of this activity members of the industry make use of many of the standard techniques of merchandising. Some seg. ments of the industry appear to be earnestly promoting high standards of selling while others seem only to be earnestly promoting sales. In its review of selling practices the study has given principal attention to abuses and improper practices, but no quantitative measurement of the extent of these practices is intended to be reflected. On the other hand it has noted areas in which firms and segments of the industry have instituted techniques to raise standards and to assure fair dealings, in its highest sense.
Public investors are attracted to securities markets through the extensive use of sales promotion activities, which include advertising in almost all media of communication as well as market letters, research reports, lectures, and even investor contests. In style and emphasis these range from the "institutional” approach to the highly Hamboyant, and the former is not necessarily the exclusive domain of the more conservative firms. Whatever style is used, one of two themes predominates: the trust and confidence which the customer should place in the firm because of its superior research facilities and experience, or the potential profits to be reaped by investors from the purchase of its merchandise. When characterized by restraint and the proper regard for the facts, the use of each theme is legitimate, but There are many pitfalls for the unwary in advertisements making spurious claims of research expertise and responsible analysis on the one hand, and unbridled appeals to gambling instincts on the other.
The one indispensable factor in selling securities is, of course, the individual salesman, who has direct contact with the customer. Most salesmen perform the dual function of prospecting for new customers and servicing existing ones. Aggressive prospecting is encouraged throughout the securities industry, although more extreme forms, such as the "cold turkey” telephone call to unknown persons, are generally frowned upon. In all dealings with public customers, whether or not the customer relies on the salesman in making his investment decision, broker-dealers and salesmen are obliged to conform their activities to the fair-dealing standards of the industry. These standards include a recognition of the customer's financial resources, obligations,